fROm chALLENgE cOmEs sTRENgTh
2 0 1 0 A N N U A L R E P O R T
L
E
T
T
E
R
T O
s h A R
E h O L d E
R
s
The banking industry, like the overall economy, continued to contend with significant
challenges in 2010. Unemployment remains stubbornly high, personal income growth is
virtually non-existent and the housing market is still weak – all key measures in which our
home state of Michigan fares considerably worse than the national average. As the year drew
to a close, however, it appeared that the United States might be slowly emerging from its
prolonged recession. Signs of a possible economic recovery became evident – including an
improved holiday shopping season, an expansion in employee recruitment, an upturn in
Michigan manufacturing activity and solid year-to-year gains in the stock market.
Our fortunes mirrored the fortunes of both the banking industry and the local economy,
as we too closed 2010 on a wave of encouraging trends. We reduced our level of
non-performing assets from their peak in early 2010, improved our net interest margin and
lowered overhead expenses in many areas. We were gratified to see the investment community
take notice – the share price of our company increased 167.0 percent during the year.
The issues that will ultimately determine the health of the economy and the banking
industry are beyond our control. But it is clear investors are pleased with the steps we
have taken to improve our fundamentals – and many believe we are well positioned to
benefit from a recovery.
mAkiNg PROgREss
A few key metrics help illustrate the progress that has encouraged investors:
We increased total revenue by 11.4 percent from 2009 to 2010. Net interest income was
up by 9.8 percent over the period, while noninterest income increased by 11.7 percent,
excluding non-recurring gains from the sale of securities and SBA-guaranteed commercial
loans. Our provision for loan and lease losses decreased by 46.0 percent and we decreased
controllable operating expenses by 11.6 percent.
In addition to the progress we made in strengthening these and other fundamentals,
we continued to broaden our customer focus in 2010. One of the lessons learned from this
Great Recession is the importance of diversity of risk, and we have worked hard to expand
our reach within the retail segments of our markets.
EmPOwERiNg
yOUNg PEOPLE
Junior Achievement helps
educate young people
about workforce readiness,
entrepreneurship and financial
literacy through experiential,
hands-on programs. Our
employees serve as classroom
volunteers for the michigan
great Lakes chapter,
teaching k-12 students how
to generate and manage
wealth, and how to apply
entrepreneurial thinking
to their lives.
2
We began operation in 1997 as a business-focused bank. We served personal banking
customers, to be sure, but our initial success was firmly grounded in our partnerships with
small- and mid-sized businesses. Yet market research we conducted several years ago
concluded that even non-customers were aware of our reputation for strong business
acumen, outstanding customer service and community-centered philanthropy. These
positive associations greatly enhanced our efforts to expand our retail market share.
We also enjoyed tremendous word of mouth from our existing account holders. From day
one, our unrelenting focus on exceptional service turned customers into evangelists for
our brand, quick to extol our virtues to family, friends and colleagues. Their very vocal
support has helped facilitate our ongoing transition to a banking model that places a broad
emphasis on both business and personal relationships.
The success of this transition is evident in the growth of the bank’s local deposits,
which have increased $294 million over the past 24 months. Local deposits represented
60.0 percent of total deposits at year-end 2010. At year-end 2008, local deposits were
just 29.4 percent of the total.
This growth was fueled in part by new and innovative products – including these
two breakthrough technologies introduced in 2010:
financeworks®. The next generation of online financial management, powered by
Quicken®, the top-selling brand of personal finance software, and specially configured to
interface with Mercantile Internet Banking. FinanceWorks® empowers users to manage all
of their accounts and bills – even from other financial institutions – in one place, with a
single login. Users can also create and track budgets, generate reports at tax time and much
more. FinanceWorks® is offered free to anyone with a Mercantile Bank account.
mercmobile® Personal Payments. Allows our customers to use their cell phones
to make payments anytime, anywhere, to anyone with an email address or cell phone
number. Customers are using it to split restaurant and bar tabs, pay babysitters and lawn
services, make garage sale and eBay® purchases, send money to kids at college and more.
bOOsTiNg
bAbiEs
march of dimes® strives to
improve the health of babies
by preventing birth defects,
premature birth and infant
mortality. we advanced this
mission in 2010 by sponsoring
the organization’s signature
chefs Auction® fundraisers in
both grand Rapids and
Lansing. A number of
employees participated in
the organization’s march for
babies® walk this year, raising
funds from co-workers and
customers, and walking with
the group named Top family
Team in grand Rapids.
3
ENhANciNg
sENiOR LivEs
senior Neighbors promotes
the health and well being of
older adults in kent county
through a variety of services,
from the provision of hot,
nutritious meals to assistance
with housing issues. since
1998, our employees have
staged an annual skeet-shoot
fundraiser for customers and
colleagues, with all proceeds –
$4,800 in 2010 – going directly
to this charity.
4
We were the first bank in the U.S. to offer this mobile payments platform, which is
powered by PayPal®, the world’s largest payments network. MercMobile® Personal
Payments is also a free service for Mercantile Bank account holders.
mAkiNg sTRATEgic mOvEs
Each of these new product offerings represents another step in our journey to broaden our
appeal beyond our initial customer base. They are strategically significant in a number of
other ways, as well.
We remain committed to our strategy of limiting brick-and-mortar investment, and these
technologies further increase access while reducing the need for customers to travel to one
of our branch offices to do their banking. They help solidify our position as a leader in
innovation, not only in the markets we serve, but also across the nation, as we received
national attention for our trailblazing alliances with Quicken® and PayPal®.
These new products also help position us as the bank of choice for the demographic most
dependent on Internet and cell phone technologies: Young adults, many of whom are seek-
ing to establish their first banking relationship. Engaging and satisfying customers at this
age and stage can create enduring loyalty for the Mercantile Bank brand.
An expanded focus on personal banking doesn’t mean we’ve abandoned our business base.
Far from it. Both FinanceWorks® and MercMobile® Personal Payments have commercial
applications, especially for small businesses. Many of our business customers are weathering
the recession just fine, and we continue to serve them with a mix of targeted products and
expert advice. We’re also working diligently to identify new opportunities and industries.
Strategically, we are focusing on increasing our lending to commercial and industrial businesses.
Our steadfast commitment to business banking was made clear in September 2010,
when the Grand Rapids Business Journal ranked us number one in Small Business
Administration (SBA) Loans. We are very proud of this honor, which was awarded based
on the 2009 dollar amount of West Michigan SBA loans, and we continue to make smart,
sound investments in businesses with solid long-term potential.
mAkiNg A diffERENcE
We also continue to make smart, sound investments in the people who reside in the
communities we serve. We are no longer constrained by a “business bank” label. Nor are
we a “personal bank.” We are a community bank, in the truest sense of the word: started
by local people, run by local people, dedicated to the advancement of local people –
whether they bank with us or not.
As an organization, we’ve always directed the bulk of our philanthropy to the underserved
and the young. We aim to provide not just a handout, but also a leg up, seeking to
empower each individual to reach his or her full potential and contribute to the health and
vitality of the larger community. This philosophy remained in force in 2010, as did the
volunteer spirit of our employees, whose hands-on involvement magnified our financial
contributions many times over.
Each of our employees spent an average of 55 hours helping out various causes and
charities in 2010. That was no surprise to us – we know how special our employees are –
and we’re excited to make their contributions public. You’ll see some of their work
highlighted throughout this Report.
We also want to publicly recognize the sterling service of one of our key employees,
Howard Haas. The first and only city president of our Lansing branch office, Howard
is a homegrown guy whose experience and esteemed reputation helped make our foray
into central Michigan an immediate success. He also proved a valuable leader in turbulent
times – even in the midst of a very difficult Lansing economy, he led his team to achieve
a significant increase in local deposits in 2010. Howard decided to retire at the end of
February 2011. We thank him for his service, and wish him the very best in the next
stage of his life.
Meanwhile, we look forward to continuous financial improvement. We believe we are
strategically positioned to thrive in an economic recovery, and we believe a recovery is
on the horizon. Barring catastrophic circumstances, 2011 should be a stronger year for
America, the banking industry and Mercantile Bank.
sUPPORTiNg
TRANsiTiONs
The center for women in
Transition assists women and
children dealing with the
results of domestic violence,
sexual assault and other
life-changing situations.
for the past five years, our
holland employees have
worked with the center to
“adopt” a family in need
during the holidays. in 2010,
employees collected enough
money to purchase everything
on the wish list of a 20-year-
old single mother with a
one-year-old son – and to
make their holidays brighter
with a range of personal gifts.
5
PREPARiNg
TOmORROw’s LEAdERs
grand valley state
University®, named one of
the best universities in the
midwest by The Princeton
Review, serves nearly 25,000
students on campuses in
This recession has been far deeper and longer than most anyone imagined. The past three
years have been very difficult for our customers, employees and shareholders. We greatly
appreciate your support. Working together, with the guidance of our dedicated Board of
Directors, we have been able to weather the storm, maintaining our well-capitalized status
throughout the crisis. We pledge the same tenacity as we move forward into a better
economic climate.
grand Rapids, holland
We wish all of you a year of success and prosperity.
and Allendale, michigan.
A number of our employees
teach classes for grand valley
state and serve on related
boards, and two of our
board members serve on
high-level advisory boards
at the University.
6
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
2010 board of directors: (L-R back row) cal murdock, Larry Larsen, susan Jones, Tim schad, dale visser
and Ed clark. (L-R front row) don williams, merle Prins, doyle hayes and dave cassard.
2010 Executive Officers: (L-R foreground) mike Price, bob kaminski and chuck christmas.
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, 2010
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 whether the registrant has submitted electronically and posted on its corporate Web site,
if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files). Yes 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 ___
Smaller reporting company X
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 $43.0 million.
As of February 1, 2011, there were issued and outstanding 8,597,993 shares of the registrant’s common stock.
Portions of the proxy statement for the 2011 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 (“our 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. In May
2009, we raised $21.0 million from the sale of preferred stock and a warrant for common stock to the United
States Treasury Department under the Capital Purchase Program. 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, which election became effective March
23, 2000. Effective June 1, 2009, we withdrew our election to be a financial holding company.
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 offices in the
cities of East Lansing and Ann Arbor, Michigan, during 2005, and in Novi, Michigan, during 2007. The Ann
Arbor and Novi offices were closed in mid-2009.
Our bank, through its seven offices, provides commercial banking services primarily to small- to
medium-sized businesses and retail banking services in and around the Grand Rapids, Holland and Lansing
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, and 3737 Coolidge Road, East Lansing, 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 each of our office locations, 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 each of our office locations. Our
bank does not have trust powers.
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.
Our Trust
In 2004, we formed our trust, a Delaware business trust. Our 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. Our 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 our 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 are 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.
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.
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.
The scope of existing regulation and supervision of various aspects of our business will be expanded
as a result of the adoption in July, 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(the “Dodd-Frank Act”). For additional information on this legislation and its potential impact, refer to the
Risk Factor entitled “The effect of financial services legislation and regulations remains uncertain” in Item 1A-
Risk Factors in this Annual Report.
Employees
As of December 31, 2010, we and our bank employed 219 full-time and 58 part-time persons.
Management believes that relations with employees are good.
4.
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 $38.4 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.
Provisions of recent legislation, including the Dodd-Frank Act, when fully implemented by
regulations to be adopted by Federal agencies, may have a significant impact on our lending policy, especially
in the areas of single-family residential real estate and other consumer lending. For additional information on
this legislation and its potential impact, refer to the Risk Factor entitled “The effect of financial services
legislation and regulations remains uncertain” in Item 1A- Risk Factors in this Annual Report.
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.
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 Bank 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 Bank Prime Rate.
5.
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 and to owners of non-owner occupied properties who have an established profitable
history and satisfactory tenant structure. In many cases, risk is further reduced by requiring personal
guarantees, limiting the amount of credit to any one borrower to an amount considerably less than our legal
lending limit and avoiding certain types of commercial real estate financings.
We have no material foreign loans, and only limited exposure to companies engaged in energy
producing and agricultural-related activities.
Single-Family Residential Real Estate Loans. Our mortgage company originates single-family
residential real estate loans in our market areas, 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, boats, 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.
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,
operating performance, financial condition, collateral, industry condition and management. All commercial
loans and leases are graded at inception and reviewed at various intervals. 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.
6.
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 Board of Directors and our Watch List Committee, the latter of 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, 2010, loans and leases placed in nonaccrual
status totaled $63.9 million, or 5.1% of total loans and leases. As of the same date, loans and leases past due
90 days or more and still accruing interest totaled $0.8 million, or 0.06% 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 Operations (“Management’s
Discussion and Analysis”) and Note 3 of the Notes to 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 an adequate level. Through the loan and lease
review and credit departments, we 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 Allowance Analysis, loan and lease loss migration analysis,
composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes
and portfolio, and general economic conditions.
The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan and lease
balances, which is combined with specific reserves to calculate an overall allowance dollar amount. For non-
impaired commercial loans and leases, which continue to comprise a vast majority of our total loans and
leases, reserve allocation factors are based upon loan ratings as determined by our standardized grade
paradigms and by loan purpose. We have divided our commercial loan and lease portfolio into five classes: 1)
commercial and industrial loans and leases; 2) vacant land, land development and residential construction
loans; 3) owner occupied real estate loans; 4) non-owner occupied real estate loans; and 5) multi-family and
residential rental property loans. The reserve allocation factors are primarily based on the historical trends of
net loan and lease charge-offs through a migration analysis whereby net loan and lease losses are tracked via
assigned grades over various time periods, with adjustments made for environmental factors reflecting the
current status of, or recent changes in, items such as: lending policies and procedures; economic conditions;
nature and volume of the loan and lease portfolio; experience, ability and depth of management and lending
staff; volume and severity of past due, nonaccrual and adversely classified loans and leases; effectiveness of
the loan and lease review program; value of underlying collateral; lending concentrations; and other external
factors, including competition and regulatory environment. Adjustments for specific lending relationships,
particularly impaired loans and leases, are made on a case-by-case basis. Non-impaired retail loan reserve
allocations are determined in a similar fashion as those for non-impaired commercial loans and leases, except
that retail loans are segmented by type of credit and not a grading system. We regularly review the Allowance
Analysis and make adjustments periodically based upon identifiable trends and experience.
A migration analysis is completed quarterly to assist us in determining appropriate reserve allocation
factors for non-impaired commercial loans and leases. Our migration analysis takes into account various time
periods, and while we generally place most weight on the eight-quarter time frame as that period is close to the
average duration of our loan and lease portfolio, consideration is given to the other time periods as part of our
assessment. Although the migration analysis provides an accurate historical accounting of our loan and lease
losses, it is not able to fully account for environmental factors that will also very likely impact the
collectability of our commercial loans and leases as of any quarter-end date. Therefore, we incorporate the
environmental factors as adjustments to the historical data.
7.
Environmental factors include both internal and external items. We believe the most significant
internal environmental factor is our credit culture and relative aggressiveness in assigning and revising
commercial loan and lease risk ratings. Although we have been consistent in our approach to commercial loan
and lease ratings, ongoing stressed economic conditions have resulted in an even higher sense of
aggressiveness with regards to the downgrading of lending relationships. In addition, we made revisions to
our grading paradigms in early 2009 that mathematically resulted in commercial loan and lease relationships
being more quickly downgraded when signs of stress are noted, such as slower sales activity for construction
and land development commercial real estate relationships and reduced operating performance/cash flow
coverage for commercial and industrial relationships. These changes, coupled with the stressed economic
environment, have resulted in significant downgrades and the need for substantial provisions to the allowance.
To more effectively manage our commercial loan and lease portfolio, we created two specific groups tasked
with managing our higher exposure lending relationships. One team manages the most distressed credit
relationships, while the other team manages larger weakened credit relationships.
The most significant external environmental factor is the assessment of the current economic
environment and the resulting implications on our commercial loan and lease portfolio. Currently, we believe
conditions remain especially stressed for non-owner occupied commercial real estate; however, recent data and
performance reflect a level of stability in the commercial and industrial class of our loan and lease portfolio.
The primary risk elements with respect to commercial loans and leases are the financial condition of
the borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of
requesting and reviewing periodic financial statements from commercial loan and lease customers and employ
a disciplined and formalized review of the existence of collateral and its value. The primary risk element with
respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments. We
have a reporting system that monitors past due loans and leases and have adopted policies to pursue creditor’s
rights in order to preserve our collateral position.
Reflecting the stressed economic conditions and resulting negative impact on our loan and lease
portfolio, we have substantially increased the allowance as a percent of the loan and lease portfolio over the
past couple of years. The allowance equaled $45.4 million, or 3.59% of total loans and leases outstanding, as
of December 31, 2010. As of December 31, 2009, the allowance balance was higher at $47.9 million, but a
lower 3.11% of total loans and leases. The allowance as a percent of total loans and leases was 1.46%, 1.43%
and 1.23% at year-end 2008, 2007, and 2006, respectively. Although we believe the allowance is adequate to
absorb 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.
Additional detail regarding the allowance is incorporated by reference to Management’s Discussion
and Analysis and Note 3 of the Notes to Consolidated Financial Statements included in this Annual Report.
Investments
Bank Holding Company Investments. The principal investments of our bank holding company are the
investments in the common stock of our bank and the common securities of 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. Our bank holding company has no plans at this time to make directly any of these equity
investments at the bank holding company level. Our Board of Directors may, however, alter the investment
policy at any time without shareholder approval.
8.
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 and Lansing
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 specified circumstances (that have been modified by the Dodd-Frank Act), securities firms
and insurance companies that elect to become financial holding companies under the Bank Holding Company
Act may acquire banks and other financial institutions. Federal banking law affects the competitive
environment in which we conduct our business. The financial services industry is also likely to become more
competitive as further technological advances enable more companies to provide financial services.
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 several 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 have 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.
Significant declines in the value of commercial real estate adversely impact us.
Many of our loans relate to commercial real estate. Stressed economic conditions have significantly
reduced the value of commercial real estate and have strained the financial condition of our commercial real
estate borrowers, especially in the land development and non-owner occupied CRE segments of our loan and
lease portfolio. Those difficulties have adversely affected us and could produce additional losses and other
adverse effects on our business.
Market volatility may adversely affect us.
The capital and credit markets have been experiencing volatility and disruption. In some cases, the
markets have produced downward pressure on stock prices and credit availability for certain issuers without
apparent regard to those issuers’ underlying financial strength. 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.
10.
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, have been 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, as well as provisions to the allowance for loan
and lease losses. Substantially all of our loans are to businesses and individuals in the cities and surrounding
areas of Grand Rapids, Holland and Lansing, Michigan, and the decline in the economy of these areas has
adversely affected us. Continued stress on our financial condition is likely until economic conditions improve
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.
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.
11.
The effect of the U.S. Government’s response to the financial crisis remains uncertain.
In response to the turmoil in the financial services sector and the severe recession in the broader
economy, the U.S. Government has taken legislative and other action intended to restore financial stability and
economic growth. On October 3, 2008, then President Bush signed into law the Emergency Economic
Stabilization Act of 2008 (the “EESA”). Among other things, the EESA established the Troubled Asset Relief
Program, or TARP. Under TARP, the United States Treasury Department (the “Treasury Department”) 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 Treasury
Department announced a program under EESA pursuant to which it would make senior preferred stock
investments in qualifying financial institutions (the “TARP Capital Purchase Program”). On February 17,
2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “ARRA”).
The ARRA contained, among other things, a further package of economic stimulus measures and amendments
to EESA’s restrictions on compensation of executives of financial institutions and others participating in the
TARP. In addition to legislation, the Federal Reserve Board eased short-term interest rates and implemented a
series of emergency programs to furnish liquidity to the financial markets and credit to various participants in
those markets. The FDIC created a program to guarantee, on specified conditions, certain indebtedness and
noninterest-bearing transaction accounts of participating insured depository institutions for limited periods.
The Treasury Department also implemented further measures to address the crisis in the financial services
sector. After permitting some of its emergency programs to lapse during the first half of the year, in
November, 2010, the Federal Reserve Board implemented a further program of quantitative easing involving
the purchase of an additional $600 billion of longer-term Treasury securities by the end of the second quarter
of 2011. In addition, on December 17, 2010, President Obama signed the Tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Tax Relief Act”) which is intended to
stimulate the economy. Among other things, the 2010 Tax Relief Act contained two-year extensions of the
Bush era tax cuts and of Alternative Minimum Tax relief, a two-percentage point reduction in employee-paid
payroll taxes and self-employment tax for 2011, new incentives for investment in machinery and equipment,
estate tax relief, and a significant number of tax breaks for individuals and businesses. There can be no
assurance as to the actual impact of the EESA, the ARRA, the 2010 Tax Relief Act, and their respective
implementing regulations, the programs of the government agencies, or any further legislation or regulations,
on the financial markets or the broader economy. A failure to stabilize the financial markets, and a
continuation or worsening of the 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 effect of financial services legislation and regulations remains uncertain.
In response to the financial crisis, on July 21, 2010, President Obama signed the Dodd-Frank Act, the
most comprehensive reform of the regulation of the financial services industry since the Great Depression of
the 1930’s. Among many other things, the Dodd-Frank Act provides for increased supervision of financial
institutions by regulatory agencies, more stringent capital requirements for financial institutions, major
changes to deposit insurance assessments by the FDIC, heightened regulation of hedging and derivatives
activities, a greater focus on consumer protection issues, in part through the formation of a new Consumer
Finance Protection Bureau having powers formerly split among different regulatory agencies, extensive
changes to the regulation of mortgage lending, imposition of limits on interchange transaction and network
fees for electronic debit transactions, repeal of the existing prohibition on payment of interest on demand
deposits, the effective winding up of additional expenditures of funds under the TARP, and the imposition of a
“sunset date” of December 31, 2012 on expenditures under the ARRA. Many of the Dodd-Frank Act
provisions have delayed effective dates that have not yet occurred, while others require implementing
regulations of Federal agencies that have not yet been adopted. There can be no assurance that the Dodd-
Frank Act and its implementing regulations will not limit our ability to pursue business opportunities, impose
additional costs on us, impact our revenues and/or the value of assets, or otherwise adversely affect our
business.
12.
The U.S. Government’s legislative and regulatory response to the financial crisis and our participation
in its programs may have adverse effects on us.
The programs established or to be established under the EESA, TARP, the ARRA, the Dodd-Frank
Act or other legislation or regulations may have adverse effects upon us. We may face increased regulation in
our industry. Compliance with such regulations may increase our costs and limit our ability to pursue business
opportunities. Also, our participation in specific programs may subject us to additional restrictions. For
example, we participated in the TARP Capital Purchase Program by selling preferred stock and a warrant for
common stock to the Treasury Department for $21.0 million in May of 2009. That participation limits our
ability, without the consent of the Treasury Department, to increase the cash dividend on, or to repurchase, our
common stock. It also subjects us to restrictions on the compensation we may pay to our executives. The
restrictions may adversely affect the trading price of our common stock or our ability to recruit and retain
executives.
Our credit losses could increase and our allowance may not be adequate to cover actual loan losses.
The risk of nonpayment of loans is inherent in all lending activities, and nonpayment, when it occurs,
may have a materially adverse effect on our earnings and overall financial condition as well as the value of our
common stock. Our focus on commercial lending may result in a larger concentration of loans to small
businesses. As a result, we may assume different or greater lending risks than other banks. We make various
assumptions and judgments about the collectability of our loan portfolio and provide an allowance for losses
based on several factors. If our assumptions are wrong, our allowance may not be sufficient to cover our
losses, which would have an adverse effect on our operating results. The actual amounts of future provisions
for loan and lease losses cannot be determined at this time and may exceed the amounts of past provisions.
Additions to our allowance decrease our net income.
We rely heavily on our management and other key personnel, and the loss of any of them may adversely
affect our operations.
We are and will continue to be dependent upon the services of our management team, including
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 key commercial loan officers. Several of our commercial
loan officers are responsible, or share responsibility, for generating and managing a significant portion of our
commercial loan 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.
13.
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
assets. 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.
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 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 specified circumstances (that have been modified by the
Dodd-Frank Act), securities firms and insurance companies that elect to become financial holding companies
under the Bank Holding Company Act may acquire banks and other financial institutions. Federal banking
law affects the competitive environment in which we conduct our business. The financial services industry is
also likely to become more competitive as further technological advances enable more companies to provide
financial services. These technological advances may diminish the importance of depository institutions and
other financial intermediaries in the transfer of funds between parties.
14.
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.
The impending repeal of Federal prohibitions on payment of interest on demand deposits could increase
our interest expense.
All federal law prohibitions on the ability of depository institutions to pay interest on demand deposit
accounts will be repealed as part of the Dodd-Frank Act, effective on July 21, 2011. As a result, depository
institutions could commence offering interest on demand deposits to compete for customers. We do not yet
know what interest rates we or other depository institutions may offer on demand deposit accounts. Our
interest expense could increase and our net interest margin could decrease if we were to begin offering interest
on demand deposits to attract additional customers or maintain current customers. Some customers, however,
may choose to use noninterest-bearing checking accounts because the Dodd-Frank Act provides that those
accounts are fully insured by the FDIC until December 31, 2012.
We may need to raise additional capital in the future, and such capital may not be available when
needed or at all.
We may need or want to raise additional capital in the future to provide us with sufficient capital
resources and liquidity to meet our commitments and business needs, particularly if our asset quality or
earnings were to deteriorate significantly. Our ability to raise additional capital will depend on, among other
things, conditions in the capital markets at that time, which are outside of our control, and our financial
performance. Economic conditions and any loss of confidence in financial institutions generally may increase
our cost of funding and limit access to certain customary sources of capital.
There can be no assurance that capital will be available on acceptable terms or at all. Any occurrence
that may limit our access to the capital markets, such as a decline in the confidence of equity or debt
purchasers, or counterparties participating in the capital markets, may adversely affect our capital costs and our
ability to raise capital and, potentially, our liquidity. Also, if we need to raise capital in the future, we may
have to do so when many other financial institutions are also seeking to raise capital and would have to
compete with those institutions for investors. An inability to raise additional capital on acceptable terms when
needed could have a materially adverse effect on our business, financial condition and results of operations.
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.
15.
Our Articles of Incorporation and By-laws and the laws of Michigan contain provisions that may
discourage or prevent a takeover of our company and reduce any takeover premium.
Our Articles of Incorporation and By-laws, and the corporate laws of the State of Michigan, include
provisions which are designed to provide our Board of Directors with time to consider whether a hostile
takeover offer is in our and our shareholders’ best interest. These provisions, however, could discourage
potential acquisition proposals and could delay or prevent a change in control. The provisions also could
diminish the opportunities for a holder of our common stock to participate in tender offers, including tender
offers at a price above the then-current market price for our common stock. These provisions could also
prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-
current market prices, and may limit the ability of our shareholders to approve transactions that they may deem
to be in their best interests.
The Michigan Business Corporation Act contains provisions intended to protect shareholders and
prohibit or discourage various types of hostile takeover activities. In addition to these provisions and the
provisions of our Articles of Incorporation and Bylaws, federal law requires the Federal Reserve Board’s
approval prior to acquiring “control” of a bank holding company. All of these provisions may delay or prevent
a change in control without action by our shareholders and could adversely affect the price of our common
stock.
There is a limited trading market for our common stock.
The price of our common stock has been, and will likely continue to be, subject to fluctuations based
on, among other things, economic and market conditions for bank holding companies and the stock market in
general, as well as changes in investor perceptions of our company. The issuance of new shares of our
common stock also may affect the market for our common stock.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “MBWM”. The
development and maintenance of an active public trading market depends upon the existence of willing buyers
and sellers, the presence of which is beyond our control. While we are a publicly-traded company, the volume
of trading activity in our stock is still relatively limited. Even if a more active market develops, there can be no
assurance that such a market will continue, or that our shareholders will be able to sell their shares at or above
the offering price.
At present we are not paying any dividends on our common stock. For more information on the
suspension of our cash dividend, see Item 5 of this Annual Report. Our ability to pay cash and stock dividends
is subject to limitations under various laws and regulations, to prudent and sound banking practices, and to
contractual provisions relating to our subordinated debentures and participation in the Capital Purchase
Program.
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.
16.
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 2010 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.
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.
17.
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 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.
Item 3. Legal Proceedings.
From time to time, we may be involved in various legal proceedings that are incidental to our
business. In the opinion of management, we are not a party to any legal proceedings that are material to our
financial condition, either individually or in the aggregate.
Item 4. Reserved
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 1, 2011, there were 366 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.
High Low Dividend
2010
First Quarter.............................................
Second Quarter ........................................
Third Quarter ...........................................
Fourth Quarter .........................................
2009
First Quarter.............................................
Second Quarter ........................................
Third Quarter ...........................................
Fourth Quarter .........................................
$ 4.06
$ 3.10
6.66
5.99
8.40
6.00
4.79
4.33
$ 0.01
0.00
0.00
0.00
3.95
3.99
3.87
$ 0.04
0.01
0.01
0.01
2.84
3.02
3.00
$ 6.48
$ 3.01
18.
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. Also, in connection with our
participation in the Treasury Department’s Capital Purchase Program, we agreed that we would not, without
the Treasury Department’s consent, increase our cash dividend rate on our common stock, or with certain
exceptions, repurchase any shares of our common stock. These restrictions relating to the Capital Purchase
Program remain in effect until the earlier of (i) May 15, 2012, or (ii) when all of the preferred stock that we
sold to the Treasury Department has been redeemed by us or transferred by the Treasury Department to third
parties.
On July 9, 2010, we announced via a Form 8-K filed with the Securities and Exchange Commission
that we were deferring regularly scheduled quarterly interest payments on our subordinated debentures
beginning with the quarterly interest payment scheduled to have been paid on July 18, 2010. The deferral of
interest payments on the subordinated debentures results in the deferral of distributions on our trust preferred
securities. We also announced that we were deferring regularly scheduled quarterly dividend payments on our
preferred stock beginning with the quarterly dividend payment scheduled to have been paid on August 15,
2010. We have not determined the duration of the deferral period.
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 bank’s ability to pay cash and stock dividends is
subject to limitations under various laws and regulations, to prudent and sound banking practices, and to
contractual provisions relating to our subordinated debentures and participation in the Capital Purchase
Program. During 2009, 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 the year. During the first quarter of 2009, our cash dividend was $0.04 per share,
but was lowered to $0.01 per share for the second, third and fourth quarters. Our cash dividend on our
common stock was also $0.01 per common share during the first quarter of 2010. In April 2010, we
suspended future payments of cash dividends on our common stock until economic conditions and our
financial condition improve. In addition, we are precluded from paying cash dividends on our common stock
and preferred stock because, under the terms of our subordinated debentures, we cannot pay cash dividends
during periods when we have deferred the payment of interest on our subordinated debentures, and, we are
now deferring such interest payments. Also, pursuant to our Articles of Incorporation, we are precluded from
paying dividends on our common stock while any dividends accrued on our preferred stock have not been
declared and paid. Because we have suspended the payment of cash dividends on our preferred stock, we are
precluded from paying cash dividends on our common stock.
Issuer Purchases of Equity Securities
We did not purchase any shares of our common stock during the fourth quarter of 2010.
Shareholder Return Performance Graph
Set forth below is a line graph comparing the yearly percentage change in the cumulative total
shareholder return on our common stock (based on the last reported sales price of the respective year) with the
cumulative total return of the Nasdaq Composite Index and the SNL Bank Nasdaq Index from December 31,
2005 through December 31, 2010. The following is based on an investment of $100 on December 31, 2005 in
our common stock, the Nasdaq Composite Index and the SNL Bank Nasdaq Index, with dividends reinvested
where applicable.
19.
Total Return Performance
150
125
100
75
50
25
0
Mercantile Bank Corporation
NASDAQ Composite
SNL Bank NASDAQ
l
e
u
a
V
x
e
d
n
I
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
Index
Mercantile Bank Corporation
NASDAQ Composite
SNL Bank NASDAQ
Period Ending
12/31/05
100.00
100.00
100.00
12/31/06
104.18
110.39
112.27
12/31/07
46.07
122.15
88.14
12/31/08
13.14
73.32
64.01
12/31/09
9.58
106.57
51.93
12/31/10
25.58
125.91
61.27
Item 6.
Selected Financial Data.
The Selected Financial Data on page F-3 in this Annual Report is incorporated here by reference.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s Discussion and Analysis included in this Annual Report is incorporated here by
reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information under the heading “Market Risk Analysis” included in this Annual Report is
incorporated here by reference.
Item 8.
Financial Statements and Supplementary Data.
The Consolidated Financial Statements, Notes to Consolidated Financial Statements and the Reports
of Independent Registered Public Accounting Firm included in this Annual Report are incorporated here by
reference.
20.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None
Item 9A. Controls and Procedures.
As of December 31, 2010, 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, 2010.
There have been no significant changes in our internal controls over financial reporting during the
quarter ended December 31, 2010, 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, 2010. 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, 2010. Refer to page F-37 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
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 28, 2011 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 David
M. Cassard, 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, Prins 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.
21.
Item 11. Executive Compensation.
The information presented under the captions “Executive Compensation,” “Corporate Governance –
Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the
Proxy Statement is incorporated here by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
The information presented under the caption “Stock Ownership of Certain Beneficial Owners and
Management” in the Proxy Statement is incorporated here by reference.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2010, 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)
262,042
$ 21.18
419,000 (2)
0
0
0
Plan Category
Equity compensation
plans approved by
security holders (1)
Equity compensation
plans not approved by
security holders
Total
262,042
$ 21.18
419,000
(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.
22.
Item 15. Exhibits and Financial Statement Schedules
PART IV
(a) (1) Financial Statements. The following financial statements and reports of the independent registered
public accounting firm of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:
Reports of Independent Registered Public Accounting Firm dated March 14, 2011 – BDO USA, LLP
Consolidated Balance Sheets --- December 31, 2010 and 2009
Consolidated Statements of Operations for each of the three years in the period ended December 31,
2010
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period
ended December 31, 2010
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
2010
Notes to Consolidated Financial Statements
The consolidated financial statements, the notes to the consolidated financial statements, and the
reports of our 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
10.4
Our Articles of Incorporation are incorporated by reference to exhibit 3.1 of our
Form 10-Q for the quarter ended June 30, 2009
Our Amended and Restated Bylaws dated as of January 16, 2003 are incorporated
by reference to exhibit 3.2 of our Registration Statement on Form S-3
(Commission File No. 333-103376) that became effective on February 21, 2003
Our 1997 Employee Stock Option Plan is incorporated by reference to exhibit
10.1 of our Registration Statement on Form SB-2 (Commission File No. 333-
33081) that became effective on October 23, 1997 *
Our 2000 Employee Stock Option Plan is incorporated by reference to exhibit
10.14 of our Form 10-K for the year ended December 31, 2000 *
Our 2004 Employee Stock Option Plan is incorporated by reference to exhibit
10.1 of our Form 10-Q for the quarter ended September 30, 2004 *
Form of Stock Option Agreement for options under the 2004 Employee Stock
Option Plan is incorporated by reference to exhibit 10.2 of our Form 10-Q for the
quarter ended September 30, 2004 *
23.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
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 is incorporated by reference to exhibit 10.9 of our
Form 10-K for the year ended December 31, 2008
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 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 *
24.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
10.27
10.28
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 *
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 *
25.
EXHIBIT NO.
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37
10.38
EXHIBIT DESCRIPTION
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 is incorporated by reference to exhibit 10.34 of our Form 10-K for the year
ended December 31, 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 is incorporated by reference to exhibit 10.33 of our Form
10-K for the year ended December 31, 2009 *
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 *
Amendment and Restatement of Stock Incentive Plan of 2006 dated November
18, 2008 is incorporated by reference to exhibit 10.39 of our Form 10-K for the
year ended December 31, 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 *
26.
EXHIBIT NO.
10.39
10.40
10.41
10.42
10.43
10.44
10.45
10.46
10.47
10.48
10.49
EXHIBIT DESCRIPTION
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 *
Mercantile Bank Corporation Employee Stock Purchase Plan of 2002 is
incorporated by reference to exhibit 10.47 of our Form 10-K for the year ended
December 31, 2008
First Amendment to Mercantile Bank Corporation Employee Stock Purchase Plan
of 2002 is incorporated by reference to exhibit 4(c) of our Registration Statement
on Form S-8 (Commission File No. 333-158280) that became effective on March
30, 2009
Second Amendment to Mercantile Bank Corporation Employee Stock Purchase
Plan of 2002 is incorporated by reference to exhibit 4(d) of our Registration
Statement on Form S-8 (Commission File No. 333-158280) that became effective
on March 30, 2009
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
Letter Agreement, dated as of May 15, 2009, between Mercantile Bank
Corporation and the United States Department of the Treasury, including the
Securities Purchase Agreement – Standard Terms and Schedules is incorporated
by reference to exhibit 10.1 of our Form 8-K filed May 15, 2009
Side Letter Agreement, dated as of May 15, 2009, between Mercantile Bank
Corporation and the United States Department of the Treasury regarding the
American Recovery and Reinvestment Act of 2009 is incorporated by reference to
exhibit 10.2 of our Form 8-K filed May 15, 2009
Amendment to Employment Agreements, dated May 15, 2009, by and among
Mercantile Bank Corporation, Mercantile Bank of Michigan, Michael H. Price,
Robert B. Kaminski, Jr. and Charles E. Christmas is incorporated by reference to
exhibit 10.3 of our Form 8-K filed May 15, 2009 *
Form of Waiver executed by each of Michael H. Price, Robert B. Kaminski, Jr.
and Charles E. Christmas is incorporated by reference to exhibit 10.4 of our Form
8-K filed May 15, 2009
Amendment to Commercial Lease between our bank and Jerry Helmer and
Ruthann Helmer dated August 14, 2007 for our Ann Arbor, Michigan office is
incorporated by reference to exhibit 10.5 of our Form 10-Q for the quarter ended
June 30, 2009
27.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.50
10.51
10.52
21
23
31
32.1
32.2
99.1
Termination of Lease Agreement between our bank and CD Partners LLC dated
May 21, 2009 for our Oakland County, Michigan office is incorporated by
reference to exhibit 10.6 of our Form 10-Q for the quarter ended June 30, 2009
Termination of Lease Agreement between our bank and Jerry Helmer and
Ruthann Helmer dated July 22, 2009 for our Ann Arbor, Michigan office is
incorporated by reference to exhibit 10.7 of our Form 10-Q for the quarter ended
June 30, 2009
Warrant to Purchase Common Stock of Mercantile Bank Corporation, dated May
15, 2009 is incorporated by reference to exhibit 4.2 of our Form 8-K filed May
15, 2009
Subsidiaries of the company is incorporated by reference to exhibit 21 of our
Form 10-K for the year ended December 31, 2008
Consent of BDO USA, LLP
Rule 13a-14(a) Certifications
Section 1350 Chief Executive Officer Certification
Section 1350 Chief Financial Officer Certification
Certification of our principal executive officer and principal financial officer
relating to our participation in the Capital Purchase Program of the Troubled
Asset Relief Program
* Management contract or compensatory plan
(c)
Financial Statements Not Included In Annual Report
Not applicable
28.
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2010 and 2009
F-1
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2010 and 2009
CONTENTS
SELECTED FINANCIAL DATA........................................................................................................................ F-3
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ........................................................................................................................... F-4
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ........................................... F-35
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING................................................................................................ F-37
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS ..................................................................................................... F-38
CONSOLIDATED STATEMENTS OF OPERATIONS ............................................................................. F-39
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY ............................. F-41
CONSOLIDATED STATEMENTS OF CASH FLOWS ............................................................................. F-44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ................................................................... F-46
F-2
SELECTED FINANCIAL DATA
2010
2009
2008
(Dollars in thousands except per share data)
2007
2006
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)
Preferred stock dividends and accretion
Net income (loss) attributable to common shares
Consolidated Balance Sheet Data:
Total assets
Cash and cash equivalents
Securities
Loans and leases
Allowance for loan and lease losses
Bank owned life insurance
Deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated debentures
Shareholders’ equity
Consolidated Financial Ratios:
$ 88,143 $ 104,909
53,576
51,333
59,000
7,558
46,488
(46,597)
5,490
(52,087)
802
$ (14,611) $ (52,889)
31,794
56,349
31,800
9,244
47,156
(13,363)
(47)
(13,316)
1,295
$ 121,072 $ 144,181 $ 137,260
75,673
88,624
74,863
61,587
55,557
46,209
5,775
11,070
21,200
5,261
5,870
7,282
32,262
38,356
42,126
28,811
12,001
(9,835)
8,964
3,035
(4,876)
19,847
8,966
(4,959)
0
0
0
$ (4,959) $ 8,966 $ 19,847
$1,632,421 $1,906,208 $2,208,010 $2,121,403 $2,067,268
51,380
64,198
29,430
25,804
242,787
235,175
202,419
211,736
1,856,915 1,799,880 1,745,478
1,262,630
21,411
25,814
27,108
45,368
30,858
39,118
42,462
46,743
21,735
257,384
1,539,818
47,878
45,024
1,273,832
116,979
65,000
32,990
125,936
1,401,627
99,755
205,000
32,990
140,104
1,599,575 1,591,181 1,646,903
85,472
97,465
94,413
95,000
180,000
270,000
32,990
32,990
32,990
171,915
178,155
174,372
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
(0.80%)
(10.62%)
7.56%
(2.51%)
(29.91%)
8.40%
(0.23%)
(2.87%)
8.01%
0.43%
5.10%
8.44%
1.01%
12.19%
8.31%
Nonperforming loans and leases to total loans and leases
Allowance for loan and lease losses to total loans and leases
5.50%
3.59%
5.52%
3.11%
2.66%
1.46%
1.66%
1.43%
0.49%
1.23%
Tier 1 leverage capital
Tier 1 leverage risk-based capital
Total risk-based capital
9.09%
11.17%
12.45%
8.64%
9.92%
11.18%
9.17%
9.68%
10.93%
9.97%
10.14%
11.39%
10.04%
10.37%
11.45%
Per Common Share Data:
Net income (loss):
Basic
Diluted
Book value at end of period
Dividends declared
Dividend payout ratio
$
(1.72) $
(1.72)
(6.23)
(6.23)
$
(0.59) $
(0.59)
1.06 $
1.05
2.36
2.33
12.20
0.01
NA
13.86
0.07
NA
20.29
0.31
NA
20.89
0.55
52.16%
21.43
0.48
20.34%
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, among others, 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 or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; impact of
technological advances; governmental and regulatory policy changes; 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 forward-looking
statement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s
Discussion and Analysis”) is based on Mercantile Bank Corporation’s consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses. 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, guidance from bank regulatory agencies, 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 our judgment, should be charged-off.
Loan and lease losses are charged against the allowance when we believe the uncollectability of a loan or lease is
likely. The balance of the allowance represents our 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. Uncollectable 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 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. The timing of obtaining outside appraisals varies, generally
depending on the nature and complexity of the property being evaluated, general breadth of activity within the
marketplace and the age of the most recent appraisal. For collateral dependent impaired loans and leases, in most
cases we obtain and use the “as is” value as indicated in the appraisal report, adjusting for any expected selling
costs. In certain circumstances, we may internally update outside appraisals based on recent information impacting
a particular or similar property, or due to identifiable trends (e.g., recent sales of similar properties) within our
markets. The expected future cash flows exclude potential cash flows from certain guarantors. To the extent these
guarantors are able to provide repayments, a recovery would be recorded upon receipt. 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: Current income tax liabilities or assets are established for the amount of taxes payable or
refundable for the current year. In the preparation of income tax returns, tax positions are taken based on
interpretation of federal and state income tax laws for which the outcome may be uncertain. We periodically review
and evaluate the status of our tax positions and make adjustments as necessary. 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 our net
deferred income tax asset is considered critical as it requires us to make estimates based on provisions of the enacted
tax laws. The assessment of the realizability of the net deferred income tax asset 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.
Accounting guidance requires us to assess whether a valuation allowance should be established against our deferred
tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making
such judgments, 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. Significant weight is given to
evidence that can be objectively verified. Despite improvements in key areas such as an expanded net interest
margin, increased regulatory capital levels, a continued shift to local funding sources and reduced controllable
overhead costs, the loan and lease loss provision expense and problem asset administration costs remain sizable.
The continuing recent losses resulting from the distressed operating environment have significantly restricted our
ability to rely on projections of future taxable income to support the recovery of our deferred tax assets.
Consequently, we determined it necessary to carry a valuation allowance against our entire net deferred tax asset as
of December 31, 2010 and 2009. We will continue to monitor our net deferred tax asset quarterly for changes
affecting its realizability.
F-5
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 and Lansing areas. Our bank utilizes deposits from customers located
outside of our primary market areas to assist in funding assets.
We formed a business trust, Mercantile Bank Capital Trust I (“our trust”), in 2004 to issue trust preferred securities.
We issued subordinated debentures to our trust in return for the proceeds raised from the issuance of the trust
preferred securities. In accordance with accounting guidelines, our trust is not consolidated, but instead we report
the subordinated debentures issued to our trust as a liability.
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 OVERVIEW
Our earnings performance has been negatively impacted by substantial provisions to the allowance and problem
asset administration costs. Ongoing state, regional and national economic struggles have negatively impacted some
of our borrowers’ cash flows and underlying collateral values, leading to increased nonperforming assets, higher
loan and lease charge-offs and increased overall credit risk within our loan portfolio when compared to historical
levels. We continue to work with our borrowers to develop constructive dialogue to strengthen our relationships
and enhance our ability to resolve complex issues; however, with the environment for the banking industry likely to
remain stressed until economic conditions improve, credit quality will continue to be our major concern. We will
remain vigilant in the identification and administration of problem assets, but provisions to the allowance and
problem asset administration costs will likely remain above historical levels, dampening future earnings
performance.
F-6
Our earnings performance also reflects positive steps we have taken to not only partially mitigate the impact of
deteriorating asset quality in the near term, but to benefit us on a longer-term basis as well. First, our net interest
margin has been expanding as we have replaced maturing high-rate deposits and borrowed funds with lower-cost
funds, while at the same time our commercial loan pricing initiatives significantly offset the negative impact of a
relatively high level of nonaccrual loans. Next, our regulatory risk-based capital ratios are increasing, as the 2009
sale of preferred stock under the Treasury’s Capital Purchase Program and the reduction of loans and leases
outstanding have more than offset the impact of our net losses. In addition, we are increasing our local deposit
balances, reflecting the successful implementation of various initiatives, campaigns and product enhancements. The
local deposit growth, combined with the reduction of loans and leases outstanding, are providing for a substantial
reduction of, and reliance on, wholesale funds. Lastly, we continue to see the positive effect of our branch
consolidation and other overhead cost reduction initiatives, as we continue to make strides to reduce controllable
noninterest expense.
FINANCIAL CONDITION
Reflecting strategies employed in regards to our financial condition and the continued weak and poor economic
environments within our markets, our balance sheet has shrunk during the past two years. Total assets declined
from $1.91 billion on December 31, 2009 to $1.63 billion on December 31, 2010, representing a decrease in total
assets of $273.8 million, or 14.4%. During 2009, we had shrunk our balance sheet by $301.8 million, or 13.7%.
The decline in total assets during 2010 was primarily comprised of a $277.2 million decrease in total loans and
leases, following a decline of $317.1 million during 2009. Our total deposits decreased $127.8 million and Federal
Home Loan Bank (“FHLB”) advances declined $140.0 million during 2010, compared to declines of $197.9 million
and $65.0 million, respectively, during 2009.
Earning Assets
Average earning assets equaled 94.8% of average total assets during 2010, a level very similar to the 95.1% during
2009. The loan and lease portfolio continued to comprise a majority of earning assets, followed by securities,
federal funds sold and interest-bearing deposits; however, during 2010, securities, federal funds sold and interest-
bearing deposits comprised a larger percentage of earning assets primarily reflecting our decision to operate with a
larger volume of on-balance sheet liquidity given market conditions. Average total loans and leases equaled 81.8%
of average total assets during 2010, a decline from 85.1% in 2009. Meanwhile, average securities, federal funds
sold and interest-bearing deposits equaled a combined 18.2% of average total assets during 2010, an increase from
14.9% during 2009.
Our loan and lease portfolio is primarily comprised of commercial loans and leases. Commercial loans and leases
declined by $266.7 million during 2010, and at December 31, 2010, totaled $1.18 billion, or 93.1% of the total loan
and lease portfolio. The decline in outstanding balances reflects the slowdown in business activity in our markets
and the impact of a concerted effort on our part to reduce exposure to certain non-owner occupied commercial real
estate (“CRE”) lending. Our commercial and industrial (“C&I”) loan portfolio declined $119.7 million during
2010, as usage of commercial lines of credit was reduced, in large part reflecting the slowdown in business activity
and a corresponding reduction in accounts receivable and inventory financings, along with only nominal equipment
financing requests. We would expect to see higher commercial line of credit usage, along with increased equipment
financing requests, when economic conditions improve. Commercial loans collateralized by non-owner occupied
CRE declined $95.2 million during 2010. Our systematic approach to reducing our exposure to certain non-owner
occupied CRE lending will be prolonged, given the nature of CRE lending and depressed economic conditions;
however, we believe that such a reduction is in our best interest when taking into account the increased inherent
credit risk and nominal deposit balances associated with targeted borrowing relationships. Also during 2010,
commercial loans collateralized by owner-occupied real estate declined $42.8 million and commercial loans related
to residential land development and construction decreased by $9.7 million.
F-7
The commercial loan and lease portfolio represents loans to businesses generally located within our market areas.
Approximately 77% 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 concentration of the loan and lease portfolio in commercial loans and leases is consistent with our
strategy of focusing a substantial amount of our efforts on commercial banking. Corporate and business lending is
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.
The following table summarizes our loans secured by real estate, excluding residential mortgage loans representing
permanent financing of owner occupied dwellings and home equity lines of credit:
12/31/10
9/30/10
6/30/10
3/31/10
12/31/09
Residential-Related:
Vacant Land
$
17,201,000 $
18,013,000 $
20,351,000 $
20,871,000 $
19,465,000
Land Development
28,147,000
29,735,000
29,627,000
Construction
5,621,000
5,854,000
6,627,000
50,969,000
53,602,000
56,605,000
32,199,000
7,872,000
60,942,000
34,027,000
7,199,000
60,691,000
Comm'l Non-Owner Occupied:
Vacant Land
Land Development
Construction
Commercial
Buildings
Comm'l Owner Occupied:
Construction
Commercial
Buildings
14,293,000
17,807,000
31,827,000
15,416,000
18,221,000
39,620,000
19,812,000
18,585,000
52,295,000
22,304,000
19,058,000
52,107,000
25,549,000
19,402,000
65,697,000
489,371,000
509,777,000
512,816,000
539,284,000
537,891,000
553,298,000
583,034,000
603,508,000
632,753,000
648,539,000
672,000
0
1,360,000
1,651,000
1,404,000
282,388,000
298,846,000
302,768,000
316,302,000
324,451,000
283,060,000
298,846,000
304,128,000
317,953,000
325,855,000
Total
$
887,327,000 $
935,482,000 $
964,241,000 $ 1,011,648,000 $ 1,035,085,000
Residential mortgage loans and consumer loans declined in aggregate $10.4 million during 2010, and at December
31, 2010, totaled $86.7 million, or 6.9% 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.
F-8
The following table presents total loans outstanding as of December 31, 2010, 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 floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.
Less Than
One Year
One Through
Five Years
More Than
Five Years
Total
Construction and land development
$
79,504,000
$
37,272,000
$
889,000
$
117,665,000
Real estate - residential properties
Real estate - multi-family properties
Real estate - commercial properties
Commercial and industrial
Leases
Consumer
Total
48,884,000
4,335,000
329,051,000
161,094,000
132,000
2,548,000
51,674,000
44,445,000
378,266,000
93,627,000
262,000
2,318,000
9,956,000
235,000
13,673,000
4,348,000
0
117,000
110,514,000
49,015,000
720,990,000
259,069,000
394,000
4,983,000
$
625,548,000
$
607,864,000
$
29,218,000
$ 1,262,630,000
Fixed rate loans and leases
$
377,525,000
$
594,289,000
$
29,218,000
$ 1,001,032,000
Floating rate loans and leases
248,024,000
13,574,000
0
261,598,000
Total
$
625,549,000
$
607,863,000
$
29,218,000
$ 1,262,630,000
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. Market value estimates of collateral on
impaired loans, as well as on foreclosed and repossessed assets, are reviewed periodically; however, we have a
process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions.
Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also
adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar
properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal
value estimates to address distressed market conditions.
The levels of net loan and lease charge-offs and nonperforming assets have been elevated since early 2007.
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 has stretched the cash flow of our local
developers and eroded the value of our underlying collateral, which caused elevated levels of nonperforming assets
and net loan and lease charge-offs. Since that time, we have witnessed and been impacted by poor economic
conditions in Michigan and throughout the country. The resulting decline in business revenue has negatively
impacted the cash flows of many of our borrowers, some to the point where loan payments have become past due or
may likely become delinquent in future periods. In addition, real estate and equipment prices are significantly
depressed, thereby exposing us to larger-than-typical losses in those instances where the sale of collateral is the
primary source of repayment. Also during this time, we have seen deterioration in guarantors’ financial capacities
to fund deficient cash flows and reduce or eliminate collateral deficiencies. It is likely that net loan and lease
charge-offs and nonperforming assets will remain elevated in comparison to our historical levels until economic
conditions improve.
F-9
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 about 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.
Throughout most of 2008, we experienced a sudden and rapid deterioration in a number of commercial loan
relationships which previously had been performing satisfactorily. Analyses 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.
As of December 31, 2008, nonperforming assets totaled $57.4 million, or 2.60% of total assets. 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. The increase in net loan and lease charge-
offs during 2008 over prior periods primarily reflected a higher level of nonperforming assets and significant
declines in property values.
As of December 31, 2009, nonperforming assets totaled $111.7 million, or 5.86% of total assets. Nonperforming
loans and leases totaled $85.1 million and foreclosed properties/repossessed assets equaled $26.6 million at year-
end 2009. As of December 31, 2009, nonperforming loans secured by, and foreclosed properties consisting of, non-
owner occupied CRE properties totaled $62.6 million. Nonperforming loans and foreclosed properties associated
with the development of residential-related real estate totaled $31.8 million, with another $7.5 million in
nonperforming loans secured by, and foreclosed properties consisting of, residential properties. Nonperforming
C&I loans and repossessed assets totaled $9.8 million. Net loan and lease charge-offs during 2009 totaled $38.2
million, or 2.24% of average total loans and leases. The increase in net loan and lease charge-offs during 2009 over
prior periods primarily reflected a higher level of nonperforming assets and depressed property values.
As of December 31, 2010, nonperforming assets totaled $86.1 million, or 5.28% of total assets. Nonperforming
loans and leases totaled $69.4 million and foreclosed properties/repossessed assets equaled $16.7 million at year-
end 2010. As of December 31, 2010, nonperforming loans secured by, and foreclosed properties consisting of, non-
owner occupied CRE properties totaled $51.4 million. Nonperforming loans and foreclosed properties associated
with the development of residential-related real estate totaled $16.9 million, with another $9.5 million in
nonperforming loans secured by, and foreclosed properties consisting of, residential properties. Nonperforming
C&I loans and repossessed assets totaled $8.4 million. Net loan and lease charge-offs during 2010 totaled $34.3
million, or 2.43% of average total loans and leases. The elevated level of net loan and lease charge-offs during
2010, like those during 2008 and 2009, were significantly higher than historical averages due to a higher level of
nonperforming loans and depressed property values.
During the latter part of 2008 and throughout 2009 and 2010, we saw a continuation of the stresses caused by the
poor economic conditions, especially in the non-owner occupied CRE markets. High vacancy rates or slow
absorption has resulted in inadequate cash flow generated from some real estate projects we have financed, and
have required guarantors to provide personal funds to make full contractual loan payments and pay other operating
costs. In some cases, the guarantors’ cash and other liquid reserves have become seriously diminished. In other
cases, sale of the collateral, either by the borrower or us, is our primary source of repayment.
F-10
We are, however, encouraged by the apparent credit quality stabilization within our loan and lease portfolio during
the past several quarters. After a period of significant and ongoing increases from 2007 through September 30,
2009, the level of nonperforming assets remained relatively unchanged through June 30, 2010 and then declined
during the third and fourth quarters of 2010. Of particular note are the reduced level of additions to the
nonperforming asset category and an increased level of nonaccrual loans returning to performing status. We also
saw an improved level of interest in, and sales of, foreclosed properties and assets securing nonaccrual loans during
the latter half of 2010.
The following table provides a breakdown of nonperforming assets by property type:
12/31/10
9/30/10
6/30/10
3/31/10
12/31/09
Residential Real Estate:
Land Development
$ 14,547,000 $
16,746,000 $
21,551,000 $
22,781,000 $
19,722,000
Construction
Owner Occupied / Rental
2,333,000
9,454,000
2,924,000
7,251,000
10,231,000
11,425,000
12,103,000
6,159,000
5,908,000
7,493,000
26,334,000
26,921,000
37,941,000
40,114,000
39,318,000
Commercial Real Estate:
Land Development
2,454,000
2,277,000
Construction
0
0
Owner Occupied
14,740,000
15,083,000
Non-Owner Occupied
34,209,000
41,725,000
51,403,000
59,085,000
2,050,000
571,000
16,216,000
46,706,000
65,543,000
3,031,000
1,238,000
17,311,000
46,552,000
68,132,000
2,971,000
1,268,000
19,918,000
38,417,000
62,574,000
Non-Real Estate:
Commercial Assets
8,221,000
6,386,000
7,049,000
9,303,000
9,758,000
Consumer Assets
161,000
5,000
0
8,000
8,000
8,382,000
6,391,000
7,049,000
9,311,000
9,766,000
Total
$ 86,119,000 $
92,397,000 $ 110,533,000 $ 117,557,000 $ 111,658,000
F-11
The following table provides a breakdown of net loan and lease charge-offs by collateral type:
4th Qtr
2010
3rd Qtr
2010
2nd Qtr
2010
1st Qtr
2010
Whole
Year
2010
Residential Real Estate:
Land Development
$
312,000 $
2,115,000 $
1,254,000 $
565,000 $
4,246,000
Construction
Owner Occupied / Rental
173,000
120,000
605,000
93,000
1,212,000
3,420,000
649,000
407,000
587,000
326,000
2,310,000
1,478,000
1,502,000
2,065,000
7,813,000
Commercial Real Estate:
Land Development
219,000
360,000
Construction
Owner Occupied
Non-Owner Occupied
0
976,000
2,642,000
3,837,000
0
2,159,000
6,805,000
9,324,000
674,000
660,000
726,000
2,551,000
4,611,000
617,000
1,870,000
0
1,091,000
1,945,000
660,000
4,952,000
13,943,000
3,653,000
21,425,000
Non-Real Estate:
Commercial Assets
Consumer Assets
819,000
47,000
866,000
1,517,000
1,670,000
1,012,000
5,018,000
1,000
(3,000)
9,000
54,000
1,518,000
1,667,000
1,021,000
5,072,000
Total
$
5,308,000 $ 14,262,000 $
8,588,000 $
6,152,000 $ 34,310,000
The following table summarizes nonperforming loans and leases, including troubled debt restructurings:
12/31/10
12/31/09
12/31/08
12/31/07
12/31/06
Past due 90 days or more and
accruing interest
$
766,000 $
243,000 $
1,358,000 $
977,000 $
819,000
Nonaccrual, including troubled
debt restructurings
63,915,000
81,818,000
47,945,000
28,832,000
7,752,000
Troubled debt restructurings,
accruing interest
4,763,000
2,989,000
0
0
0
Total
$
69,444,000 $
85,050,000 $
49,303,000 $
29,809,000 $
8,571,000
F-12
The following table summarizes changes in the allowance for loan and lease losses for the past five years:
2010
2009
2008
2007
2006
Loans and leases outstanding at year-end
$
1,262,630,000
$
1,539,818,000
$
1,856,915,000
$
1,799,880,000
$
1,745,478,000
Daily average balance of loans and leases
outstanding during the year
$
1,412,555,000
$
1,704,335,000
$
1,829,686,000
$
1,765,465,000
$
1,660,284,000
Balance of allowance at beginning of year
$
47,878,000
$
27,108,000
$
25,814,000
$
21,411,000
$
20,527,000
Loans and leases charged-off:
Commercial, financial and agricultural
(25,498,000)
(25,858,000)
(12,566,000)
Construction and land development
(9,273,000)
(9,606,000)
(4,835,000)
Leases
(41,000)
(120,000)
(174,000)
(4,232,000)
(1,353,000)
(18,000)
Residential real estate
(2,242,000)
(3,797,000)
(2,900,000)
(1,618,000)
Instalment loans to individuals
(74,000)
(240,000)
(119,000)
(53,000)
(5,208,000)
0
0
(50,000)
(131,000)
Total charge-offs
(37,128,000)
(39,621,000)
(20,594,000)
(7,274,000)
(5,389,000)
Recoveries of previously charged-off
loans and leases:
Commercial, financial and agricultural
1,599,000
1,141,000
597,000
Construction and land development
Leases
Residential real estate
Instalment loans to individuals
995,000
38,000
178,000
8,000
81,000
4,000
150,000
15,000
8,000
6,000
51,000
26,000
586,000
11,000
0
3,000
7,000
487,000
0
0
2,000
9,000
Total recoveries
2,818,000
1,391,000
688,000
607,000
498,000
Net loan and lease charge-offs
(34,310,000)
(38,230,000)
(19,906,000)
(6,667,000)
(4,891,000)
Provision for loan and lease losses
31,800,000
59,000,000
21,200,000
11,070,000
5,775,000
Balance of allowance at year-end
$
45,368,000 $
47,878,000
$
27,108,000 $
25,814,000 $
21,411,000
Ratio of net loan and lease charge-offs
during the year to average loans and leases
outstanding during the year
(2.43%)
(2.24%)
(1.09%)
(0.38%)
(0.29%)
Ratio of allowance to loans and leases
outstanding at year-end
3.59%
3.11%
1.46%
1.43%
1.23%
F-13
The following table illustrates the breakdown of the allowance balance by loan type (dollars in thousands) and of
the total loan and lease portfolio (in percentages):
12/31/2010
12/31/2009
12/31/2008
12/31/2007
12/31/2006
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Commercial,
financial and
agricultural
Construction and
land development
$ 32,624
81.5%
$ 37,590
80.0%
$20,170
77.9%
$18,947
77.4%
$15,706
74.7%
7,019
9.3
6,566
11.4
5,137
14.1
4,907
14.7
3,975
17.1
Leases
21
0.0
49
0.1
41
0.1
29
0.1
15
0.1
Residential real
estate
Instalment loans to
individuals
5,495
8.8
3,517
8.1
1,656
7.6
1,829
7.5
1,591
7.6
172
0.4
156
0.4
104
0.3
102
0.3
124
0.5
Unallocated
37
0.0
0
0.0
0
0.0
0
0.0
0
0.0
Total
$ 45,368
100.0%
$ 47,878
100.0%
$27,108
100.0%
$25,814
100.0%
$21,411
100.0%
In each accounting period, we adjust the allowance to the amount we believe is necessary to maintain the allowance
at an adequate level. Through the loan and lease review and credit departments, we 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 Allowance Analysis, loan and lease loss
migration analysis, composition of the loan and lease portfolio, third party analysis of the loan and lease
administration processes and portfolio, and general economic conditions.
The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan and lease balances,
which is combined with specific reserves to calculate an overall allowance dollar amount. For non-impaired
commercial loans and leases, which continue to comprise a vast majority of our total loans and leases, reserve
allocation factors are based upon loan ratings as determined by our standardized grade paradigms and by loan
purpose. We have divided our commercial loan and lease portfolio into five classes: 1) commercial and industrial
loans and leases; 2) vacant land, land development and residential construction loans; 3) owner occupied real estate
loans; 4) non-owner occupied real estate loans; and 5) multi-family and residential rental property loans. The
reserve allocation factors are primarily based on the historical trends of net loan and lease charge-offs through a
migration analysis whereby net loan and lease losses are tracked via assigned grades over various time periods, with
adjustments made for environmental factors reflecting the current status of, or recent changes in, items such as:
lending policies and procedures; economic conditions; nature and volume of the loan and lease portfolio;
experience, ability and depth of management and lending staff; volume and severity of past due, nonaccrual and
adversely classified loans and leases; effectiveness of the loan and lease review program; value of underlying
collateral; lending concentrations; and other external factors, including competition and regulatory environment.
Adjustments for specific lending relationships, particularly impaired loans and leases, are made on a case-by-case
basis. Non-impaired retail loan reserve allocations are determined in a similar fashion as those for non-impaired
commercial loans and leases, except that retail loans are segmented by type of credit and not a grading system. We
regularly review the Allowance Analysis and make adjustments periodically based upon identifiable trends and
experience.
F-14
A migration analysis is completed quarterly to assist us in determining appropriate reserve allocation factors for
non-impaired commercial loans and leases. Our migration takes into account various time periods, and while we
generally place most weight on the eight-quarter time frame as that period is close to the average duration of our
loan and lease portfolio, consideration is given to the other time periods as part of our assessment. Although the
migration analysis provides an accurate historical accounting of our loan and lease losses, it is not able to fully
account for environmental factors that will also very likely impact the collectability of our commercial loans and
leases as of any quarter-end date. Therefore, we incorporate the environmental factors as adjustments to the
historical data.
Environmental factors include both internal and external items. We believe the most significant internal
environmental factor is our credit culture and the relative aggressiveness in assigning and revising commercial loan
and lease risk ratings. Although we have been consistent in our approach to commercial loan and lease ratings,
ongoing stressed economic conditions have resulted in an even higher sense of aggressiveness with regards to the
downgrading of lending relationships. In addition, we made revisions to our grading paradigms in early 2009 that
mathematically resulted in commercial loan and lease relationships being more quickly downgraded when signs of
stress are noted, such as slower sales activity for construction and land development CRE relationships and reduced
operating performance/cash flow coverage for C&I relationships. These changes, coupled with the stressed
economic environment, have resulted in significant downgrades and the need for substantial provisions to the
allowance. To more effectively manage our commercial loan and lease portfolio, we created two specific groups
tasked with managing our higher exposure lending relationships. One team manages the most distressed credit
relationships, while the other team manages larger weakened credit relationships.
The most significant external environmental factor is the assessment of the current economic environment and the
resulting implications on our commercial loan and lease portfolio. Currently, we believe conditions remain
especially stressed for non-owner occupied CRE; however, recent data and performance reflect a level of stability in
the C&I class of our loan and lease portfolio.
The primary risk elements with respect to commercial loans and leases are the financial condition of the borrower,
the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing
periodic financial statements from commercial loan and lease customers and employ a disciplined and formalized
review of the existence of collateral and its value. The primary risk element with respect to each residential real
estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors
past due loans and leases and have adopted policies to pursue creditor’s rights in order to preserve our collateral
position.
Reflecting the stressed economic conditions and resulting negative impact on our loan and lease portfolio, we have
substantially increased the allowance as a percent of the loan and lease portfolio over the past couple of years. The
allowance equaled $45.4 million, or 3.59% of total loans and leases outstanding, as of December 31, 2010. As of
December 31, 2009, the allowance balance was higher at $47.9 million, but a lower 3.11% of total loans and leases.
The allowance as a percent of total loans and leases was 1.46%, 1.43% and 1.23% at year-end 2008, 2007, and
2006, respectively.
As of December 31, 2010, the allowance was comprised of $35.7 million in general reserves relating to non-
impaired loans and leases and $9.7 million in specific reserve allocations relating to impaired loans and leases. At
year-end 2010, impaired loans and leases with an aggregate carrying value of $27.7 million had been subject to
previous partial charge-offs aggregating $26.1 million. Those partial charge-offs were recorded as follows: $21.7
million in 2010, $3.4 million in 2009 and $1.0 million in 2008. As of December 31, 2010, specific reserves
allocated to impaired loans that had been subject to a previous partial charge-off totaled $1.0 million.
Although we believe the allowance is adequate to absorb 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.
F-15
Securities decreased $22.2 million during 2010, totaling $235.2 million as of December 31, 2010. During 2010, the
securities portfolio equaled 13.7% of average earning assets. The decline in the securities portfolio primarily
reflects the sale of certain tax-exempt municipal general obligation and revenue bonds with an aggregate book value
of $20.0 million, which were sold during the first quarter of 2010 after analyzing our current and forecasted federal
income tax position. Proceeds from matured and called U.S. Government agency bonds totaled $81.2 during 2010,
with another $17.9 million received from principal paydowns on mortgage-backed securities, $5.8 million from
matured and called tax-exempt municipal securities, $2.4 million from matured Michigan Strategic Fund bonds and
$1.3 million from redeemed FHLB stock. Purchases during 2010, consisting almost exclusively of U.S.
Government agency bonds, totaled $106.3 million. We maintain the securities portfolio at levels to provide for
required pledging purposes and secondary liquidity for our daily operations. In addition, the portfolio serves a
primary interest rate risk management function. At December 31, 2010, the portfolio was comprised of U.S.
Government agency issued bonds (51%), U.S. Government agency issued or guaranteed mortgage-backed securities
(20%), tax-exempt municipal general obligation and revenue bonds (14%), Michigan Strategic Fund bonds (8%),
FHLB stock (6%) and mutual funds (1%).
The following table reflects the composition of the securities portfolio, excluding FHLB stock:
12/31/10
Carrying
12/31/09
Carrying
12/31/08
Carrying
Value
Percent
Value
Percent
Value
Percent
U.S. Government agency
debt obligations
$
121,562,000
55.1%
$
95,544,000
39.6%
$
62,382,000
27.5%
Mortgage-backed
securities
Michigan Strategic
Fund bonds
Municipal general
obligations
46,941,000
21.2
64,982,000
26.9
77,026,000
33.9
18,175,000
8.2
20,550,000
8.5
22,105,000
9.7
28,042,000
12.7
49,892,000
20.6
54,066,000
23.8
Municipal revenue bonds
4,843,000
2.2
9,319,000
3.9
10,371,000
4.6
Mutual funds
1,267,000
0.6
1,416,000
0.5
1,156,000
0.5
Totals
$
220,830,000
100.0%
$
241,703,000
100.0%
$
227,106,000
100.0%
All of our securities are currently designated as available for sale. Historically, we had designated our tax-exempt
municipal general obligation and revenue bonds as held to maturity; however, we changed the designation to
available for sale immediately after the sale of certain of our tax-exempt general obligation and revenue bonds
during the first quarter of 2010. Securities designated as available for sale are stated at fair value. The fair value of
securities designated as available for sale at December 31, 2010 totaled $220.8 million, including a net unrealized
gain of $2.0 million.
FHLB stock totaled $14.3 million as of December 31, 2010, compared to $15.7 million at December 31, 2009. The
reduction reflects the FHLB’s unsolicited redemption of $1.4 million in late 2010. Our investment in FHLB stock is
necessary to engage in their advance and other financing programs. We received a quarterly cash dividend
throughout 2010 at an average rate of 1.88%, and believe a cash dividend will continue to be declared and paid in
future quarters.
F-16
Market values on our U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S.
Government agencies and tax-exempt general obligation and revenue municipal bonds 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
accounting guidelines. Reference is made to Note 15 of the Notes to Consolidated Financial Statements for
additional information.
The following table shows by class of maturities as of December 31, 2010, the amounts and weighted average yields
(on a fully taxable-equivalent basis) of investment securities:
Obligations of U.S. Government agencies:
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 funds
Totals
Carrying
Value
Average
Yield
$
0
3,321,000
19,828,000
98,413,000
121,562,000
0
2,495,000
1,420,000
28,970,000
32,885,000
46,941,000
18,175,000
1,267,000
NA
4.96%
3.80
4.29
4.23
NA
6.82
6.21
6.20
6.24
5.14
3.04
3.08
$ 220,830,000
4.62%
Federal funds sold, consisting of excess funds sold overnight to a correspondent bank, along with investments in
interest-bearing deposits at correspondent banks, are used to manage daily liquidity needs and interest rate
sensitivity. During 2010, the average balance of these funds equaled 4.5% of average earning assets, up from 3.0%
during 2009 and considerably higher than the historical average of less than 1%. Given stressed market and
economic conditions, we made the decision in early 2009 to operate with a higher than traditional balance of federal
funds sold and interest-bearing deposits. We expect to maintain the higher balance of federal funds sold and other
interest-bearing deposits, likely to average 2.5% to 3.5% of average earning assets, until market and economic
conditions return to more normalized levels.
F-17
Non-Earning Assets
Cash and due from bank balances totaled $6.7 million at December 31, 2010, compared to $18.9 million on
December 31, 2009. Cash and due from bank balances averaged $15.4 million during 2010. The relatively low
balance as of December 31, 2010 reflected the fact that many of our business customers were closed that particular
day (i.e., Friday of a holiday weekend) and therefore did not make their typical deposits, resulting in a lower than
typical outgoing cash letter. Net premises and equipment decreased from $29.7 million at December 31, 2009, to
$27.9 million on December 31, 2010, primarily reflecting depreciation expense. Purchases of premises and
equipment during 2010 were nominal.
On December 30, 2009, all FDIC-insured financial institutions were required to pre-pay estimated FDIC deposit
insurance assessments for the years 2010, 2011 and 2012. The prepaid amounts are used to offset regular quarterly
deposit insurance assessments. The amount we paid equaled $16.3 million, which is being expensed over the future
quarterly assessment periods. The balance at December 31, 2010 equaled $12.1 million. The Dodd-Frank Act
significantly revised the program of federal deposit insurance. Among other things, the Dodd-Frank Act redefined
the deposit insurance assessment base generally to equal average consolidated total assets minus average tangible
equity, raised the minimum designated reserve ratio (“DRR”) of the Deposit Insurance Fund (“DIF”) to 1.35%,
required the DRR to reach 1.35% by September 30, 2020 (rather than 1.15% by the end of 2016, as previously
required), directed the FDIC to offset the effect of that accelerated timetable on insured institutions with
consolidated assets of less than $10.0 billion, restricted any dividend from the DIF unless the DRR exceeds 1.50%,
and made any declaration of dividend discretionary with the FDIC. The FDIC has adopted regulations that, among
other things, set the minimum DRR at 2.00%, generally require use of a daily averaging method in calculating
average consolidated total assets, define “tangible equity” as Tier 1 capital calculated monthly, and specify new
risk-based assessment rates (effective April 1, 2011) that are subject to adjustment for institution-specific
circumstances (such as an increase for most institutions having a ratio of brokered deposits to domestic deposits in
excess of 10.00%) and for the level of the DRR, with rates gradually declining once the DRR reaches 2.00%.
Separate assessment rates are specified for large institutions (i.e., those with total assets more than $10.0 billion)
and for highly complex institutions. With respect to the prepaid insurance assessments paid December 30, 2009, the
FDIC in adopting the regulations declined to bring forward the time (the third quarter of 2013) at which any unused
prepaid amounts would be returned to an institution. The FDIC stated that it would monitor its cash resources to
determine whether to adopt a rule regarding earlier return of the unused prepaid amounts.
Foreclosed and repossessed assets totaled $16.7 million at December 31, 2010, compared to $26.6 million on
December 31, 2009 and $8.1 million on December 31, 2008. The increased balance at year-end 2009 reflects the
stressed economic environment, and in certain situations our decision to foreclose or repossess collateral. The State
of Michigan has a relatively protracted foreclosure process that generally takes six to twelve months before a deed is
obtained. While we experienced further transfers from loans and leases to foreclosed and repossessed assets during
2010 reflecting our collection efforts on impaired lending relationships, a lower volume of such transfers combined
with increased sales activity provided for a net $9.9 million reduction during 2010.
Source of Funds
Our major sources of funds are from deposits, repurchase agreements and FHLB advances. Total deposits declined
from $1.40 billion at December 31, 2009 to $1.27 billion on December 31, 2010, a decrease of $127.8 million. In
comparing total deposit balances as of December 31, 2010 to those at December 31, 2008, total deposits have
declined by $325.7 million. Local deposits increased $294.4 million during the two-year period ended December
31, 2010, including an $88.0 million increase during 2010. Meanwhile, out-of-area deposits decreased $620.1
million during the two-year period ended December 31, 2010, including a $215.8 million decline during 2010. As
of December 31, 2010, local deposits comprised 60.0% of total deposits, compared to 48.3% and 29.4% at
December 31, 2009 and December 31, 2008, respectively.
Repurchase agreements increased from $99.8 million at December 31, 2009 to $117.0 million on December 31,
2010, an increase of $17.2 million. Repurchase agreements increased $22.6 million during the two-year period
ended December 31, 2010. FHLB advances declined from $205.0 million at December 31, 2009 to $65.0 million
on December 31, 2010, a decline of $140.0 million. FHLB advances declined $205.0 million during the two-year
period ended December 31, 2010. At December 31, 2010, local deposits and repurchase agreements equaled 60.2%
of total funding liabilities, compared to 45.0% and 28.5% on December 31, 2009 and December 31, 2008,
respectively.
F-18
The significant reduction in wholesale funding reliance reflects the increase in local deposits and repurchase
agreements, combined with the decline in total loans and leases. The increase in local deposits reflects various
programs and initiatives we have implemented over the past two years, including: certificate of deposit campaign;
implementation of several deposit-gathering initiatives in our commercial lending function; introduction of new
deposit-related products and services; and the continuation of providing our customers with the latest in
technological advances that give improved information, convenience and timeliness.
Noninterest-bearing checking deposit accounts remain relatively stable, averaging between $110.0 million and
$120.0 million over the past several years, and $118.9 million during 2010. The relatively lower balance of $112.9
million as of December 31, 2010 reflected the fact that many of our business customers were closed that particular
day (i.e., Friday of a holiday weekend) and therefore did not make their typical deposits. Interest-bearing checking
accounts, in large part reflecting the strong success of our executive banking product, have increased $107.9 million
during the two-year period ended December 31, 2010, including a $71.9 million increase during 2010. Savings
deposits increased $21.6 million during 2010 after having declined by $11.3 million during 2009. The 2010
increase primarily reflects increased deposit balances from several local municipal customers, while the 2009
decline resulted primarily from deposit transfers to other deposit products, particularly the executive banking
product. Money market deposit accounts increased $118.6 million during 2010 after having increased $7.1 million
during 2009. The increases reflect the success of our enhanced marketing program and relatively aggressive rate
which resulted in many new individual, business and municipality deposits and increased balances from existing
money market deposit account holders.
Certificates of deposit purchased by customers located within our market areas declined $115.8 million during 2010
after having increased $164.1 million during 2009, thereby providing a net increase of $48.3 million during the two-
year period ended December 31, 2010. During 2009, we ran a high-rate one-year certificate of deposit campaign
that raised about $65.0 million, with most of the funds representing new deposit funds. As these certificates of
deposit matured during the first quarter of 2010, we were able to retain about 70% of the maturing funds, a majority
of which were transferred to our executive banking or money market deposit accounts. The remaining increases
during 2009 primarily reflect the success of our enhanced marketing program and relatively aggressive rate which
resulted in many new individual, business and municipality deposits. The decline during 2010 is primarily due to
maturing certificates of deposit being transferred to our executive banking and money market deposit accounts.
Certificates of deposit obtained from customers located outside of our market areas declined $620.1 million during
the two-year period ended December 31, 2010, including a $215.8 million decline during 2010. Out-of-area
deposits consist of certificates of deposit obtained from depositors located outside our market areas and 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. The significant decline in out-of-area deposits since year-end 2008 primarily reflects the influx of
cash resulting from the reduction in total loans and leases and from increased local deposits.
Repurchase agreements increased $22.6 million during the two-year period ended December 31, 2010, including a
$17.2 million increase during 2010. 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. All of our
repurchase agreements are accounted for as secured borrowings.
FHLB advances declined $205.0 million during the two-year period ended December 31, 2010, including a $140.0
million decline during 2010. The decline during the past two years, which includes the prepayment of $95.0 million
during the fourth quarter of 2010, primarily reflects the influx of cash resulting from the reduction in total loans and
leases and from increased local deposits. 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, 2010 totaled about $169.7 million, with availability of $104.7 million.
F-19
Shareholders’ equity declined $48.4 million during the two-year period ended December 31, 2010, including a
$14.2 million decline during 2010. The decline during the past two years was primarily due to the net loss
attributable to common shares of $67.5 million, of which $23.2 million was related to the recording of a valuation
allowance on our net deferred tax assets during 2009. Positively impacting shareholders’ equity was the sale of
preferred stock and a warrant for common stock to the United States Treasury Department for $21.0 million under
the Capital Purchase Program during 2009. Cash dividends on our common stock reduced shareholders’ equity by
$0.1 million and $0.6 million during 2010 and 2009, respectively.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
Summary
We recorded a net loss attributable to common shares of $14.6 million, or $1.72 per basic and diluted share, for
2010, compared to a net loss of $52.9 million, or $6.23 per basic and diluted share, for 2009. The establishment of
a valuation allowance against our net deferred tax asset in the fourth quarter of 2009 distorts 2010 after-tax
operating result comparisons with earlier reporting periods. On a pre-tax basis, our net loss for 2010 was $13.4
million compared to $46.6 million for 2009.
The 71.3% improvement in pre-tax earnings performance in 2010 compared to 2009 is primarily the result of a
substantially lower provision for loan and lease losses and higher net interest income. The reduced provision for
loan and lease losses reflects lower levels of loan rating downgrades, nonperforming loans, and net loan and lease
charge-offs, as well as the solidification of real estate market conditions and resulting valuations. An increase in
loan rating upgrades during 2010 compared to the nominal level of 2009 upgrades also contributed to the lower
provision expense. The increase in net interest income is the result of an improved net interest margin, which has
been positively impacted by a substantial reduction in our cost of funds.
The net loss recorded in 2010 primarily results from a substantial provision for loan and lease losses and costs
associated with the administration and resolution of problem assets, reflecting continuing difficulties in the loan
portfolio, most notably in the CRE and construction and development segments. Continued state, regional and
national economic struggles have significantly hampered certain commercial borrowers’ cash flows and negatively
impacted real estate values, resulting in elevated levels of nonperforming assets and net loan and lease charge-offs
when compared to pre-2007 reporting periods.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2010
and 2009:
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
2010
2009
(0.80%)
(10.62%)
7.56%
(2.51%)
(29.91%)
8.40%
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 $89.0 million and $31.8 million, respectively, during 2010, providing for net interest income of
$57.2 million. During 2009, interest income and interest expense equaled $106.2 million and $53.6 million,
respectively, providing for net interest income of $52.6 million. In comparing 2010 with 2009, interest income
decreased 16.2%, interest expense was down 40.7%, and net interest income increased 8.7%. 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-20
The $4.6 million increase in net interest income in 2010 compared to 2009 resulted from an improved net interest
margin, which more than offset a decreased level of average earning assets. Although our yield on earning assets
declined slightly in 2010 compared to 2009 primarily due to a shift in earning asset mix (lower level of average total
loans and leases and a higher level of low-yielding average federal funds sold) and a decreased yield on average
securities, our cost of funds declined at a far greater rate, resulting in the improved net interest margin. Average
total loans and leases equaled 81.8% of average earning assets during 2010, down from 85.1% during 2009, while
average federal funds sold represented 4.0% of average earning assets during 2010 compared to 2.7% during 2009.
The cost of funds primarily decreased as a result of higher-costing matured certificates of deposit and FHLB
advances being replaced by lower-costing funds or being allowed to runoff. The prepayment of $95.0 million in
higher-costing FHLB advances during the fourth quarter of 2010 also positively impacted the cost of funds.
Given the multitude of factors that impact the net interest margin, it is difficult to predict future net interest margins.
However, in light of the current interest rate environment, our net interest margin in 2011 should benefit from a
continued reduction in our cost of funds and the loan pricing initiatives instituted in 2008 and 2009. While we
expect further reductions in our cost of funds during 2011, the magnitude of the reductions will likely be at a much
lower level than during the past couple of years. While a continued reduction in our cost of funds will positively
impact our net interest margin, the impact of asset quality on the net interest margin is difficult to predict.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets,
liabilities and shareholders’ equity during 2010, 2009 and 2008. 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 $0.8 million in 2010, $1.3 million in 2009, and $1.2 million in 2008.
F-21
(Dollars in thousands)
Years ended December 31,
---------------------- 2 0 1 0 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 0 9 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 0 8 -----------------
Average
Rate
Average
Balance
Interest
Taxable securities $
Tax-exempt
securities
Total securities
176,084 $
7,846
4.46%
$
155,041 $
7,498
4.84%
$
148,347 $
7,888
5.32%
59,911
235,995
3,125
10,971
5.22
4.65
83,048
238,089
4,623
12,121
5.57
5.09
69,178
217,525
4,180
12,068
6.04
5.55
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
1,412,555
77,791
5.51
1,704,335
93,903
5.51
1,829,686
110,013
6.01
9,251
69,319
39
176
0.42
0.25
6,730
53,825
21
136
0.31
0.25
392
11,353
7
204
1.79
1.80
1,727,120
88,977
5.15
2,002,979
106,181
5.30
2,058,956
122,292
5.94
(48,963)
15,414
127,354
(34,155)
16,341
120,508
(30,184)
21,004
107,546
Total assets
$ 1,820,925
$ 2,105,673
$ 2,157,322
Interest-bearing
demand deposits
Savings deposits
Money market
accounts
Time deposits
Total interest-
bearing deposits
$
140,384 $
43,571
2,419
305
1.72%
0.70
$
60,155 $
48,182
867
521
1.44%
1.08
$
42,734 $
65,091
492
922
1.15%
1.42
86,283
979,584
1,225
19,580
1.42
2.00
25,759
1,279,188
361
39,520
1.40
3.09
13,948
1,332,071
192
58,206
1.38
4.37
1,249,822
23,529
1.88
1,413,284
41,269
2.92
1,453,844
59,812
4.11
107,802
Short-term
borrowings
Federal Home Loan
Bank advances
Other borrowings
Total interest-
bearing liabilities 1,558,514
153,575
47,315
1,410
1.31
98,513
1,845
1.87
97,313
2,021
2.08
5,509
1,346
3.59
2.84
239,699
50,278
8,808
1,654
3.67
3.29
258,939
46,579
10,554
2,476
4.08
5.32
31,794
2.04
1,801,774
53,576
2.97
1,856,675
74,863
4.03
Demand deposits
Other liabilities
Total liabilities
Average equity
Total liabilities
and equity
118,904
5,913
1,683,331
137,594
$ 1,820,925
112,821
14,258
1,928,853
176,820
$ 2,105,673
108,584
19,286
1,984,545
172,777
$ 2,157,322
Net interest
income
Rate spread
Net interest
margin
$
57,183
$
52,605
$
47,429
3.11%
3.31%
2.33%
2.63%
1.91%
2.30%
F-22
-------------------- 2010 over 2009 ---------------------
Volume
Total
Rate
-------------------- 2009 over 2008 --------------------
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
$
348,000
(1,498,000)
(16,112,000)
18,000
40,000
$
967,000
(1,222,000)
(16,069,000)
9,000
40,000
$
(619,000)
(276,000)
(43,000)
9,000
0
$
(390,000)
443,000
(16,110,000)
14,000
(68,000)
$
345,000
791,000
(7,253,000)
24,000
230,000
$
(735,000)
(348,000)
(8,857,000)
(10,000)
(298,000)
interest income
(17,204,000)
(16,275,000)
(929,000)
(16,111,000)
(5,863,000)
(10,248,000)
Increase (decrease) in interest expense
Interest-bearing demand deposits
Savings deposits
Money market accounts
Time deposits
Short-term borrowings
Federal Home Loan Bank
advances
Other borrowings
Net change in interest
expense
Net change in tax-equivalent
1,552,000
(216,000)
864,000
(19,940,000)
(435,000)
1,354,000
(46,000)
859,000
(7,953,000)
162,000
198,000
(170,000)
5,000
(11,987,000)
(597,000)
375,000
(401,000)
169,000
(18,686,000)
(176,000)
232,000
(210,000)
165,000
(2,230,000)
25,000
143,000
(191,000)
4,000
(16,456,000)
(201,000)
(3,299,000)
(308,000)
(3,094,000)
(93,000)
(205,000)
(215,000)
(1,746,000)
(822,000)
(751,000)
184,000
(995,000)
(1,006,000)
(21,782,000)
(8,811,000)
(12,971,000)
(21,287,000)
(2,585,000)
(18,702,000)
net interest income
$ 4,578,000
$ (7,464,000)
$ 12,042,000
$ 5,176,000
$ (3,278,000)
$ 8,454,000
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 $17.2 million during 2010 from that
earned in 2009, totaling $89.0 million in 2010 compared to $106.2 million in the previous year. The reduction in
interest income is attributable to a decreased level of average earning assets and, to a much lesser degree, a
declining yield on average earning assets, primarily resulting from a decreased yield on average securities, a
decreased percentage of average total loans and leases to total earning assets, and an increased percentage of low-
yielding federal funds sold to total earning assets.
During 2010, earning assets averaged $1.73 billion, or $275.9 million lower than average earning assets of $2.00
billion during 2009. A decrease in average total loans and leases totaling $291.8 million primarily resulted in the
lower level of average earning assets during 2010. Interest income generated from the loan and lease portfolio
decreased $16.1 million in 2010 compared to the level earned in 2009; the reduction in the loan and lease portfolio
during 2010 resulted in the $16.1 million decrease in interest income. The loan and lease portfolio yield was 5.51%
in both 2010 and 2009.
Interest income generated from the securities portfolio decreased $1.2 million in 2010 compared to the level earned
in 2009 due to a lower yield on average securities, which equaled 4.65% in 2010 compared to 5.09% in 2009, and
portfolio contraction. The lower yield on average securities in 2010 compared to 2009 primarily resulted from a
decreased yield on U.S. Government agency bonds, reflecting a decrease in market rates, and a shift in the securities
portfolio mix from higher-yielding municipal securities to lower-yielding U.S. Government agency bonds.
Reflective of the low market rate environment experienced during 2010, U.S. Government agency bonds totaling
$78.2 million were called during the year, with a vast majority of the proceeds reinvested in the same type of
securities at reduced rates. After analyzing our current and forecasted federal income tax position, we decided to
sell certain tax-exempt municipal bonds with an aggregate book value of $20.0 million in late March 2010. A vast
majority of the sales proceeds were used to purchase U.S. Government agency bonds during April and early May.
Average securities equaled $236.0 million during 2010 compared to $238.1 million during 2009. The lower yield
on average securities equated to a decrease in interest income of $0.9 million, while the reduced average portfolio
balance resulted in a $0.3 million decrease in interest income. Interest income earned on federal funds sold
increased slightly due to an increase in the average balance.
F-23
During 2010 and 2009, earning assets had an average yield (tax equivalent-adjusted basis) of 5.15% and 5.30%,
respectively. The slight decline in earning asset yield in 2010 compared to the prior year primarily resulted from a
shift in earning asset mix (lower level of average total loans and leases and a higher level of low-yielding average
federal funds sold) and a decreased yield on average securities. Average total loans and leases equaled $1.41
billion, or 81.8% of average earning assets, during 2010, compared to $1.70 billion, or 85.1% of average earning
assets, during 2009. Average federal funds sold were $69.3 million, or 4.0% of average earning assets during 2010,
compared to $53.8 million, or 2.7% of average earning assets, during 2009. During 2010 and 2009, the yield on
average earning assets was relatively stable due to the effectiveness of loan pricing initiatives instituted within the
commercial loan function in 2008 and 2009.
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 $21.8 million during 2010
from that expensed in 2009, totaling $31.8 million in 2010 compared to $53.6 million in the previous year. The
decline in interest expense is attributable to a decreased cost of funds and a decreased level of average interest-
bearing liabilities. The decreased cost of funds in 2010 compared to 2009 mainly resulted from fixed-rate
certificates of deposit and borrowings being renewed or replaced at lower interest rates, reflecting the decreasing
interest rate environment during the period of September 2007 through December 2008, or being allowed to runoff.
Interest-bearing liabilities averaged $1.56 billion during 2010, or $243.3 million lower than average interest-bearing
liabilities of $1.80 billion during 2009. This reduction resulted in decreased interest expense of $8.8 million. A
decline in interest expense of $13.0 million was recorded during 2010 due to a decreased cost of funds, which
resulted primarily from lower average rates paid on fixed rate certificates of deposit and borrowings. The cost of
average interest-bearing liabilities decreased from 2.97% in 2009 to 2.04% in 2010.
Average certificates of deposit declined $299.6 million during 2010, which equated to a decrease in interest expense
of $7.9 million. An additional $12.0 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 2010. Growth in other average interest-bearing deposit accounts, totaling $136.1
million, equated to an increase in interest expense of $2.2 million, while an increase in the average rate paid on
these deposit accounts resulted in a nominal increase in interest expense.
Average short-term borrowings, comprised of repurchase agreements and federal funds purchased, increased $9.3
million during 2010, resulting in increased interest expense of $0.2 million, while a decrease in the average rate paid
during 2010 resulted in a reduction in interest expense of $0.6 million. Average FHLB advances decreased $86.1
million, equating to a $3.1 million reduction in interest expense, while a decreased average rate paid on the
advances resulted in a $0.2 million reduction in interest expense. A reduction in average other borrowings, which is
comprised of subordinated debentures, structured repurchase agreements, and deferred director and officer
compensation programs, equating to a decrease in interest expense of $0.1 million during 2010, with a decreased
average rate reducing interest expense by $0.2 million.
Provision for Loan and Lease Losses
The provision for loan and lease losses totaled $31.8 million in 2010, compared to $59.0 million in 2009. The
significant provision expense incurred in both 2010 and 2009 is in response to the deterioration of the quality of our
loan portfolio. Continued state, regional, and national economic struggles have negatively impacted some of our
borrowers’ cash flows and underlying collateral values, leading to increased nonperforming assets, elevated net loan
and lease charge-offs, and increased overall credit risk within our loan and lease portfolio.
The decreased provision expense in 2010 compared to 2009 reflects lower levels of loan rating downgrades,
nonperforming loans, and net loan and lease charge-offs, as well as the solidification of real estate market
conditions and resulting valuations. Nonperforming loans and leases totaled $69.4 million, or 5.50% of total loans
and leases, as of December 31, 2010, compared to $85.1 million, or 5.52% of total loans and leases, as of December
31, 2009. Net loan and lease charge-offs during 2010 totaled $34.3 million, or 2.43% of average total loans and
leases. Net loan and lease charge-offs during 2009 totaled $38.2 million, or 2.24% of average total loans and leases.
F-24
Noninterest Income
Noninterest income totaled $9.2 million in 2010, an increase of $1.6 million, or 22.3%, from the $7.6 million earned
in 2009. Noninterest income during 2010 includes gains totaling $0.3 million from the sales of guaranteed portions
of certain Small Business Administration-guaranteed loans and $0.5 million from the sales of tax-exempt municipal
bonds. Excluding these gains, noninterest income during 2010 increased $0.9 million, or 11.7%, from the prior
year. Increased rental income from foreclosed properties and earnings on bank-owned life insurance, which more
than offset decreased service charges on accounts and mortgage banking income, mainly resulted in the higher level
of noninterest income during 2010 compared to 2009, after consideration of the above discussed gains on loan and
security sales. The decreased level of service charges on accounts during 2010 compared to the prior-year primarily
resulted from a lower level of overdraft service fees.
Noninterest Expense
Noninterest expense during 2010 totaled $47.2 million, an increase of $0.7 million, or 1.4%, from the $46.5 million
expensed in 2009. Overhead costs during 2010 include $1.0 million in nonrecurring fees related to the prepayment
of $95.0 million in FHLB advances, while overhead costs during 2009 include $1.3 million in charges for the
branch consolidations and a $0.9 million charge for the bank industry-wide FDIC special assessment. Excluding
these one-time charges, noninterest expense in 2010 totaled $46.1 million, or $1.9 million higher than in 2009. The
increase in overhead costs during 2010 compared to 2009 primarily resulted from higher costs associated with the
administration and resolution of nonperforming assets, including legal expenses, property tax payments, appraisal
fees, and write-downs on foreclosed properties, and increased normal FDIC insurance premiums.
Nonperforming asset administration and resolution costs totaled $10.9 million during 2010, an increase of $3.6
million from the $7.3 million in costs incurred during 2009. FDIC insurance premiums were $4.4 million during
2010, compared to $4.0 million, excluding the one-time special assessment in the prior-year. Given the enormous
stress on the DIF resulting from the significant number of insured institution failures in the last three years and the
major changes to the deposit insurance program made by the Dodd-Frank Act and implementing regulations of the
FDIC, it is difficult to predict the level of our future deposit insurance assessments.
Controllable operating expenses, including salaries and benefits, occupancy, and furniture and equipment costs,
declined $3.0 million, or 11.6%, during 2010 compared to 2009. Salary and benefit costs were down $2.0 million
in 2010 compared to 2009, primarily resulting from a reduction in full-time equivalent employees from 257 at year-
end 2009 to 242 at year-end 2010. Occupancy and furniture and equipment costs declined by $0.9 million in 2010
compared to 2009, primarily resulting from an aggregate reduction in rent and depreciation expenses. Beginning in
the fourth quarter of 2009, overhead cost savings of approximately $0.2 million per month were achieved as a result
of the consolidation of the mid- and eastern-Michigan regions of our banking activities that was completed in
August of 2009.
Federal Income Tax Expense
During 2010, we recorded a loss before federal income tax of $13.4 million and a federal income tax benefit of less
than $0.1 million, compared to a loss before federal income tax of $46.6 million and a federal income tax expense
of $5.5 million during 2009. The tax benefit of the 2010 loss was mostly offset by the expense to record a valuation
allowance against the net deferred tax asset it created; the nominal benefit resulted from adjustments between
continuing operations and other comprehensive income due to intraperiod tax allocation accounting rules. The tax
benefit of the 2009 loss was offset by a one-time non-cash charge of $23.2 million to establish a valuation
allowance against the entire balance of net deferred tax assets at year-end 2009.
Accounting guidance 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.
We reviewed our deferred tax assets and determined that a valuation allowance was necessary at year-end 2009 and
again at year-end 2010, in light of our recent operating losses. The utilization of our net deferred tax assets for
future tax deductions will be analyzed quarterly, and the valuation allowance will be adjusted in accordance with
accounting rules.
F-25
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008
Summary
We recorded a net loss attributable to common shares of $52.9 million, or $6.23 per basic and diluted share, for
2009, compared to a net loss of $5.0 million, or $0.59 per basic and diluted share, for 2008. The net loss
attributable to common shares for 2009 includes a one-time non-cash charge of $23.2 million to federal income tax
expense to establish a valuation allowance against our net deferred tax assets. In addition, 2009 operating results
also include $1.3 million in expenses associated with the consolidation of the mid- and eastern-Michigan regions of
our banking activities and a $0.9 million charge for the bank industry-wide FDIC special assessment.
The decline in earnings performance during 2009 from that of 2008 is primarily the result of a substantially higher
provision for loan and lease losses, which more than offset increased net interest income. The elevated provision
for loan and lease losses reflects continuing deterioration in the quality of the loan portfolio, most notably in the
CRE and C&I segments. The increase in net interest income is the result of an improved net interest margin, which
has been positively impacted by a substantial reduction in our cost of funds.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2009
and 2008:
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
2009
2008
(2.51%)
(29.91%)
8.40%
(0.23%)
(2.87%)
8.01%
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 $106.2 million and $53.6 million during 2009, respectively, providing for net interest income of
$52.6 million. During 2008, interest income and interest expense equaled $122.3 million and $74.9 million,
respectively, providing for net interest income of $47.4 million. In comparing 2009 with 2008, interest income
decreased 13.2%, interest expense was down 28.4%, and net interest income increased 10.9%. 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 $5.2 million increase in net interest income in 2009 compared to 2008 resulted from an improved net interest
margin, which more than offset a decreased level of average earning assets. Although our yield on earning assets
declined in 2009 compared to 2008 primarily due to an increased level of nonperforming assets and a declining
interest rate environment, our cost of funds declined at a far greater rate, resulting in the improved net interest
margin. The cost of funds primarily decreased as a result of higher-costing matured wholesale funds, consisting of
certificates of deposit and FHLB advances, being replaced by lower-costing funds.
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 $16.1 million during 2009 from that
earned in 2008, totaling $106.2 million in 2009 compared to $122.3 million in the previous year. The reduction in
interest income is attributable to a decreased level of average earning assets and a declining yield on earning assets,
primarily resulting from a decreased interest rate environment, an increased level of nonperforming assets, and an
increased percentage of low-yielding federal funds sold to total earning assets.
During 2009, earning assets averaged $2.00 billion, or $56.0 million lower than average earning assets of $2.06
billion during 2008. A reduction in average total loans and leases totaling $125.4 million resulted in the lower level
of average earning assets during 2009.
F-26
Interest income generated from the loan and lease portfolio decreased $16.1 million in 2009 compared to the level
earned in 2008; a decline in loan yield from 6.01% in 2008 to 5.51% in 2009 resulted in an $8.9 million decrease in
interest income while a reduction in the loan and lease portfolio during 2009 resulted in a $7.2 million decrease in
interest income. The decrease in the loan and lease portfolio yield is primarily due to a lower interest rate
environment and an increase in nonperforming loans.
Interest income generated from the securities portfolio increased slightly in 2009 compared to the level earned in
2008 as a result of growth in the portfolio. Average securities equaled $238.1 million during 2009 compared to
$217.5 million during 2008, an increase of $20.6 million. The growth equated to an increase in interest income of
$1.13 million, while the declined yield, which equaled 5.09% in 2009 compared to 5.55% in 2008, resulted in a
$1.08 million decrease in interest income. Interest income earned on federal funds sold decreased by $0.1 million
due to a decline in the average rate, which more than offset an increase in the average balance.
During 2009 and 2008, earning assets had an average yield (tax equivalent-adjusted basis) of 5.30% and 5.94%,
respectively. With approximately 60% of our total loans and leases tied to Prime or LIBOR rates, our earning asset
yield has been substantially impacted by the steep reduction in market interest rates since late third quarter of 2007.
Between mid-September 2007 and early-October 2008, the Federal Market Committee (“FOMC”) lowered the
targeted federal funds rate by a total of 375 basis points. The resulting similar decline in the Prime and LIBOR
rates, combined with an increased level of nonperforming assets, significantly lowered our yield on earning assets
and level of interest income. 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 kept the Mercantile Bank Prime
Rate unchanged at 4.50% in an effort to shield interest income from further erosion. Virtually all of our prime-
based commercial floating rate loans are tied to the Mercantile Bank Prime Rate. A higher level of nonperforming
assets has also negatively impacted the yield on earning assets in 2009 compared to 2008, increasing from 2.60% of
total assets at December 31, 2008, to 5.86% at December 31, 2009. A significant increase in average federal funds
sold during 2009 also had an adverse effect on earning asset yield. During 2009, the yield on average earning assets
was relatively stable, as the loan pricing initiatives instituted within the commercial loan function in 2008 and 2009
mitigated the negative impact of an increase in nonaccrual loans.
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 $21.3 million during 2009
from that expensed in 2008, totaling $53.6 million in 2009 compared to $74.9 million in the previous year. The
decline in interest expense is attributable to a decreased cost of funds and a decreased level of average interest-
bearing liabilities. The decreased cost of funds in 2009 compared to 2008 mainly resulted from fixed rate
certificates of deposit and borrowings being renewed or replaced at lower interest rates, reflecting the decreasing
interest rate environment during the period of September 2007 through December 2009.
Interest-bearing liabilities averaged $1.80 billion during 2009, or $54.9 million lower than average interest-bearing
liabilities of $1.86 billion during 2008. This reduction resulted in decreased interest expense of $2.6 million. A
decline in interest expense of $18.7 million was recorded during 2009 due to a decreased cost of funds, which
resulted primarily from lower average rates paid on fixed rate certificates of deposit and borrowings. The cost of
average interest-bearing liabilities decreased from 4.03% in 2008 to 2.97% in 2009.
Average certificates of deposit declined $52.9 million during 2009, which equated to a decrease in interest expense
of $2.2 million. An additional $16.5 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 2009. Growth in other average interest-bearing deposit accounts, totaling $12.3
million, equated to an increase in interest expense of $0.2 million, while a decrease in the average rate paid on these
deposit accounts resulted in a $0.1 million reduction in interest expense.
F-27
Average short-term borrowings, primarily comprised of repurchase agreements and federal funds purchased,
increased $1.2 million during 2009, resulting in increased interest expense of less than $0.1 million, while a
decrease in the average rate paid during 2009 resulted in a reduction in interest expense of $0.2 million. Average
FHLB advances decreased $19.2 million, equating to a $0.7 million reduction in interest expense, while a decreased
average rate paid on the advances resulted in a $1.0 million reduction in interest expense. Growth in average other
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 $0.2 million during 2009,
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 $59.0 million in 2009, compared to the $21.2 million expensed in
2008. The increase primarily reflects a higher volume of nonperforming loans and leases, increased net loan and
lease charge-offs, other downgrades within our commercial loan and lease portfolio, and increased reserve
allocation factors, necessitating a higher allowance balance. Nonperforming loans and leases totaled $85.1 million,
or 5.52% of total loans and leases, as of December 31, 2009, compared to $49.3 million, or 2.66% of total loans and
leases, as of December 31, 2008. Net loan and lease charge-offs during 2009 totaled $38.2 million, or 2.24% of
average total loans and leases. Net loan and lease charge-offs during 2008 totaled $19.9 million, or 1.09% of
average total loans and leases. The allowance as a percentage of total loans and leases outstanding as of December
31, 2009 was 3.11%, compared to 1.46% at year-end 2008.
Noninterest Income
Noninterest income totaled $7.6 million in 2009, an increase of $0.3 million, or 3.8%, from the $7.3 million earned
in 2008. Income from mortgage banking activities increased $0.5 million in 2009, reflecting a higher volume of
refinancing activity due to the lower interest rate environment, while rental income on foreclosed properties,
included in other income, increased $0.4 million.
Noninterest Expense
Noninterest expense during 2009 totaled $46.5 million, an increase of $4.4 million over the $42.1 million expensed
in 2008. Overhead costs during 2009 include a $1.3 million charge for the branch consolidation and a $0.9 million
charge for the bank industry-wide FDIC special assessment. The one-time charges related to the branch
consolidation were fully expensed during the second and third quarters of 2009; beginning in the fourth quarter of
2009, overhead cost savings of $0.2 million per month were achieved as a result of the branch consolidation.
Excluding these one-time charges, noninterest expense in 2009 totaled $44.3 million, or $2.1 million higher than in
2008.
Controllable operating expenses, including salaries and benefits (excluding a $0.5 million one-time charge for
severance payments included in the branch consolidation costs), occupancy, furniture and equipment costs, and
various other expenses declined $3.9 million in 2009 compared to 2008. Salary and benefit costs were down $2.2
million, exclusive of the $0.5 million one-time charge taken in the second quarter, in 2009 compared to 2008,
primarily resulting from a reduction in full-time equivalent employees from 303 at year-end 2008 to 257 at year-end
2009. 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 $7.3 million in 2009 compared to $3.3
million in 2008. Excluding the $0.9 million one-time special assessment, FDIC deposit insurance assessments
totaled $3.9 million in 2009, up $2.0 million from the previous year.
Federal Income Tax Expense
During 2009, we recorded a loss before federal income tax of $46.6 million and federal income tax expense of $5.5
million, compared to a loss before federal income tax of $9.8 million and a federal income tax benefit of $4.9
million during 2008. In spite of the loss before federal income tax recorded during 2009, a federal income tax
expense was recognized due to the establishment of a full valuation allowance against our net deferred tax assets.
F-28
Accounting guidance 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.
We reviewed our deferred tax assets and determined that a valuation allowance was necessary at year-end 2009 in
light of our recent operating losses. As a result of establishing the valuation allowance against the entire balance of
net deferred tax assets at year-end 2009, a one-time non-cash charge of $23.2 million to federal income tax expense
was recognized.
CAPITAL RESOURCES
Shareholders’ equity is a noninterest-bearing source of funds that can provide support for our asset growth.
Shareholders’ equity declined $48.4 million during the two-year period ended December 31, 2010, including a
$14.2 million decline during 2010. The decline during the past two years was primarily due to the net loss
attributable to common shares of $67.5 million, of which $23.2 million was related to the creation of a valuation
allowance on our net deferred tax assets in 2009. Positively impacting shareholders’ equity was the sale of
preferred stock and a warrant for common stock to the United States Treasury Department for $21.0 million under
the Capital Purchase Program during 2009. Cash dividends on our common stock reduced shareholders’ equity by
$0.1 million and $0.6 million during 2010 and 2009, respectively.
Despite the reduction in shareholders’ equity during the past two years, our and our bank’s regulatory risk-based
capital ratios increased, and our bank remains “well capitalized.” As of December 31, 2010, our bank’s total risk-
based capital ratio was 12.5%, compared to 11.1% and 10.8% at December 31, 2009 and December 31, 2008,
respectively. Our bank’s total regulatory capital, consisting of our shareholders’ equity plus a portion of the
allowance, declined an aggregate $50.9 million during 2010 and 2009, primarily reflecting a net loss of $57.8
million and a reduction of $8.3 million in eligible allowance due to a decline in total risk-weighted assets, which
was partially offset by a $19.0 million capital injection from Mercantile Bank Corporation from the proceeds of the
preferred stock and warrant sale. Despite the reduction in total regulatory capital, our bank’s total risk-based capital
ratio increased due to a decline of $688.5 million in total risk-weighted assets, primarily resulting from a reduction
in commercial loans. As of December 31, 2010, our bank’s total regulatory capital equaled $175.1 million, or $34.6
million in excess of the 10.0% minimum which is among the requirements to be categorized as “well capitalized.”
Our and our bank’s capital ratios as of December 31, 2010 and 2009 are disclosed in Note 18 of the Notes to
Consolidated Financial Statements.
On July 9, 2010, we announced via a Form 8-K filed with the Securities and Exchange Commission that we are
deferring regularly scheduled quarterly interest payments on our subordinated debentures beginning with the
quarterly interest payment scheduled to have been paid on July 18, 2010. The deferral of interest payments on the
subordinated debentures results in the deferral of distributions on our trust preferred securities. We also announced
that we were deferring regularly scheduled quarterly dividend payments on our preferred stock beginning with the
quarterly dividend payment scheduled to have been paid on August 15, 2010. We have not determined the duration
of the deferral period.
F-29
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 bank’s ability to pay cash and stock dividends is subject to limitations under
various laws and regulations, to prudent and sound banking practices, and to contractual provisions relating to our
subordinated debentures and participation in the Capital Purchase Program. During 2009, 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 the year. During the first quarter of
2009, our cash dividend was $0.04 per share, but was lowered to $0.01 per share for the second, third and fourth
quarters. Our cash dividend on our common stock was also $0.01 per common share during the first quarter of
2010. In April 2010, we suspended future payments of cash dividends on our common stock until economic
conditions and our financial condition improve. In addition, we are precluded from paying cash dividends on our
common stock and preferred stock because, under the terms of our subordinated debentures, we cannot pay cash
dividends during periods when we have deferred the payment of interest on our subordinated debentures, and, we
are now deferring such interest payments. Also, pursuant to our Articles of Incorporation, we are precluded from
paying dividends on our common stock while any dividends accrued on our preferred stock have not been declared
and paid. Because we have suspended the payment of cash dividends on our preferred stock, we are precluded from
paying cash dividends on our common stock.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed funds, capital or cash flow from the
repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve
requirements and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and
liquid assets such as securities available for sale, matured and called 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.
To assist in providing needed funds, we have regularly obtained monies from wholesale funding sources.
Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from
the FHLB, totaled $584.1 million, or 39.8% of combined deposits and borrowed funds, as of December 31, 2010,
compared to $944.9 million, or 54.8% of combined deposits and borrowed funds, as of December 31, 2009, and
$1.41 billion, or 71.5% of combined deposits and borrowed funds, as of December 31, 2008. The significant
decline in wholesale funds since year-end 2008 primarily reflects the influx of cash resulting from the reduction in
total loans and leases and from increased local deposits.
Although local deposits have generally increased as new business, municipal governmental unit and individual
deposit relationships are established and as existing customers increase the balances in their accounts, and we
witnessed significant local deposit growth during 2010 and 2009, 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 Mercantile Bank Prime Rate 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.
F-30
As part of our sweep program, collected funds from certain business noninterest-bearing checking accounts are
invested into over-night interest-bearing repurchase agreements. Such repurchase agreements are not deposit
accounts and are not afforded federal deposit insurance. Repurchase agreements increased $17.2 million during
2010, totaling $117.0 million as of December 31, 2010. Approximately 50% of the increase is associated with one
customer electing to switch their noninterest-bearing checking account to a repurchase agreement. Generally, we
see an increase in the repurchase agreement aggregate balance throughout the calendar year, and then a decline of
10% to 20% during the early part of the first quarter of each calendar year as customers use funds primarily for the
payment of taxes and bonuses. Information regarding our repurchase agreements as of December 31, 2010 and
during 2010 is as follows:
Outstanding balance at December 31, 2010
Weighted average interest rate at December 31, 2010
Maximum daily balance for twelve months ended December 31, 2010
Average daily balance for twelve months ended December 31, 2010
Weighted average interest rate for twelve months ended December 31, 2010
$
116,979,000
0.69%
$
$
133,280,000
107,781,000
1.31%
As a member of the FHLB, we have access to the FHLB advance borrowing programs. Advances totaled $65.0
million as of December 31, 2010, compared to $205.0 million and $270.0 million as of December 31, 2009 and
December 31, 2008, respectively. Based on available collateral as of December 31, 2010, we could borrow an
additional $104.7 million.
We also have 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 of credit. During 2010, our federal funds purchased position
averaged less than $0.1 million, compared to an average federal funds sold position of $69.3 million and another
$9.3 million invested in interest-bearing deposits at correspondent banks. During 2009, our federal funds purchased
position averaged only $0.1 million, compared to an average federal funds sold position of $53.8 million and
another $6.7 million invested in interest-bearing deposits at correspondent banks. Given the volatile market and
stressed economic conditions, we have been operating with a higher than normal balance of federal funds sold and
other short-term investments. It is expected that we will maintain the higher balance of liquid funds, likely to
average 2.5% to 3.5% of average earning assets, until market and economic 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.
We have 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, we could have borrowed up to $28.0
million for terms of 1 to 28 days at December 31, 2010. We did not utilize this line of credit during 2010 or 2009,
and do not plan to access this line of credit in future periods.
The following table reflects, as of December 31, 2010, significant fixed and determinable contractual obligations to
third parties by payment date, excluding accrued interest:
One Year
or Less
One to
Three to
Over
Three Years
Five Years
Five Years
Total
Deposits without a stated maturity
$ 481,953,000 $
0 $
0 $
0 $
481,953,000
Certificates of deposit
Short-term borrowings
Federal Home Loan Bank
advances
Subordinated debentures
Other borrowed money
495,914,000
250,469,000
45,496,000
116,979,000
0
0
10,000,000
50,000,000
5,000,000
0
0
0
0
10,000,000
0
0
0
0
32,990,000
1,804,000
791,879,000
116,979,000
65,000,000
32,990,000
11,804,000
F-31
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, 2010, we had a total of $207.5 million
in unfunded loan commitments and $19.3 million in unfunded standby letters of credit. Of the total unfunded loan
commitments, $197.7 million were commitments available as lines of credit to be drawn at any time as customers’
cash needs vary, and $9.8 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
levels, primarily reflecting relatively stressed economic conditions. We regularly 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:
12/31/10
12/31/09
12/31/08
Commercial unused lines of credit
$
158,945,000 $
205,018,000 $
323,785,000
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
26,870,000
24,916,000
30,658,000
7,768,000
4,052,000
9,840,000
8,565,000
4,526,000
7,701,000
19,343,000
36,512,000
9,413,000
4,881,000
10,959,000
51,439,000
Total
$
226,818,000 $
287,238,000 $
431,135,000
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 cause liquidity challenges. While we believe it is unlikely that a funding crisis of any significant
degree is likely to materialize, we have developed a comprehensive contingency funding plan that provides a
framework for meeting liquidity disruptions.
MARKET RISK ANALYSIS
Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. 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.
F-32
We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis,
measures the difference between the dollar amounts of interest-sensitive assets and liabilities that will be refinanced
or repriced during a given time period. A significant repricing gap could result in a negative impact to the net
interest margin during periods of changing market interest rates.
The following table depicts our GAP position as of December 31, 2010:
Within
Three
Months
Three to
Twelve
Months
One to
Five
Years
After
Five
Years
Total
Assets:
Commercial loans (1)
$
332,181,000 $
241,803,000 $
553,610,000 $
19,145,000 $ 1,146,739,000
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 deposits
Money market accounts
Time deposits under $100,000
Time deposits $100,000 & over
Short-term borrowings
Noninterest-bearing checking
Other liabilities
Total liabilities
Shareholders' equity
Total liabilities & shareholders'
13,000
42,176,000
2,280,000
33,787,000
47,924,000
9,600,000
0
0
119,000
262,000
6,708,000
51,674,000
268,000
2,318,000
0
9,956,000
117,000
394,000
110,514,000
4,983,000
0
0
0
0
0
49,318,000
152,070,000
235,175,000
0
0
0
0
0
0
0
0
47,924,000
9,600,000
(45,368,000)
122,460,000
467,961,000
248,898,000
657,182,000
181,288,000 $ 1,632,421,000
158,177,000
60,201,000
150,631,000
35,930,000
184,283,000
116,979,000
0
0
0
0
0
0
0
0
38,423,000
38,757,000
237,278,000
257,208,000
0
10,000,000
10,000,000
0
0
0
55,000,000
0
0
0
740,995,000
295,701,000
350,965,000
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
158,177,000
60,201,000
150,631,000
113,110,000
678,769,000
116,979,000
65,000,000
44,794,000
112,944,000
5,880,000
1,506,485,000
125,936,000
Federal Home Loan Bank advances
0
Other borrowed money
34,794,000
equity
740,995,000
295,701,000
350,965,000
0 $ 1,632,421,000
Net asset (liability) GAP
$
(273,034,000) $
(46,803,000) $
306,217,000 $
181,288,000
Cumulative GAP
$
(273,034,000) $
(319,837,000) $
(13,620,000) $
167,668,000
Percent of cumulative GAP to
total assets
(16.7%)
(19.6%)
(0.8%)
10.3%
(1) Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity
date and not repricing frequency.
(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2010.
F-33
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.
We conducted multiple simulations as of December 31, 2010, in which it was assumed that changes in market
interest rates occurred ranging from up 400 basis points to down 400 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, 2010. The resulting estimates are well within our policy parameters established to manage and
monitor interest rate risk.
Interest Rate Scenario
Interest rates down 400 basis points
Interest rates down 300 basis points
Interest rates down 200 basis points
Interest rates down 100 basis points
No change in interest rates
Interest rates up 100 basis points
Interest rates up 200 basis points
Interest rates up 300 basis points
Interest rates up 400 basis points
Dollar Change
Percent Change
In Net
In Net
Interest Income
Interest Income
$
585,000
1,125,000
1,645,000
2,105,000
2,590,000
905,000
645,000
1,555,000
1,190,000
1.1%
2.1
3.0
3.9
4.8
1.7
1.2
2.9
2.2
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, 2010, the Mercantile Bank 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 Bank 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 since year-end 2008, we have made the assumption that the Mercantile Bank Prime Rate will remain
unchanged until the Wall Street Journal Prime Rate equals the Mercantile Bank Prime Rate, at which time the two
indices will remain equal in the increasing interest rate scenarios. Also, brokered certificate of deposit rates have
substantially decreased since year-end 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-34
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, 2010 and 2009, and the related
consolidated statements of operations, changes in shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2010. 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, 2010 and 2009, and the results of its
operations and its cash flows for each of the three years in the period ended December 31, 2010, 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, 2010,
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 14, 2011 expressed an unqualified
opinion thereon.
/s/ BDO USA, LLP
BDO USA, LLP
Grand Rapids, Michigan
March 14, 2011
F-35
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, 2010,
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, 2010, 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, 2010 and 2009,
and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the
three years in the period ended December 31, 2010, and our report dated March 14, 2011 expressed an unqualified
opinion thereon.
/s/ BDO USA, LLP
BDO USA, LLP
Grand Rapids, Michigan
March 14, 2011
F-36
March 14, 2011
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective system of internal control over financial
reporting that is designed to produce reliable financial statements presented in conformity with generally accepted
accounting principles. There are inherent limitations in the effectiveness of any system of internal control.
Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to
financial statement preparation.
Management assessed the Company’s system of internal control over financial reporting that is designed to produce
reliable financial statements presented in conformity with generally accepted accounting principles as of December
31, 2010. 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, 2010, Mercantile Bank
Corporation maintained an effective system of internal control over financial reporting that is designed to produce
reliable financial statements presented in conformity with generally accepted accounting principles based on those
criteria.
The Company’s independent auditors have issued an audit report on the effectiveness of the Company’s internal
control over financial reporting.
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-37
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2010 and 2009
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 $60,271,000 at December 31, 2009)
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
Accrued interest receivable
Other real estate owned and repossessed assets
Other assets
2010
2009
$
6,674,000
9,600,000
47,924,000
64,198,000
$
18,896,000
1,471,000
1,368,000
21,735,000
220,830,000
182,492,000
0
14,345,000
59,211,000
15,681,000
1,262,630,000
(45,368,000)
1,217,262,000
1,539,818,000
(47,878,000)
1,491,940,000
27,873,000
46,743,000
5,942,000
16,675,000
18,553,000
29,684,000
45,024,000
7,088,000
26,608,000
26,745,000
Total assets
$1,632,421,000
$1,906,208,000
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
$ 112,944,000
1,160,888,000
1,273,832,000
$ 121,157,000
1,280,470,000
1,401,627,000
116,979,000
0
65,000,000
32,990,000
11,804,000
5,880,000
1,506,485,000
99,755,000
2,600,000
205,000,000
32,990,000
16,890,000
7,242,000
1,766,104,000
Preferred stock, no par value; 1,000,000 shares authorized;
21,000 shares outstanding
Common stock, no par value; 20,000,000 shares
authorized; 8,597,993 shares outstanding at December 31, 2010
and 8,592,514 shares outstanding at December 31, 2009
Common stock warrant
Retained earnings (deficit)
Accumulated other comprehensive income
Total shareholders’ equity
20,077,000
19,839,000
172,677,000
1,138,000
(68,781,000)
825,000
125,936,000
172,438,000
1,138,000
(54,170,000)
859,000
140,104,000
Total liabilities and shareholders’ equity
$1,632,421,000
$1,906,208,000
See accompanying notes to consolidated financial statements.
F-38
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2010, 2009 and 2008
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
Other borrowings
Total interest expense
2010
2009
2008
$ 77,791,000
7,846,000
2,291,000
176,000
39,000
88,143,000
$ 93,903,000
7,498,000
3,351,000
136,000
21,000
104,909,000
$ 110,013,000
7,888,000
2,960,000
204,000
7,000
121,072,000
23,529,000
1,410,000
5,509,000
1,346,000
31,794,000
41,269,000
1,845,000
8,808,000
1,654,000
53,576,000
59,812,000
2,021,000
10,554,000
2,476,000
74,863,000
Net interest income
56,349,000
51,333,000
46,209,000
Provision for loan and lease losses
31,800,000
59,000,000
21,200,000
Net interest income (deficiency) after provision
for loan and lease losses
24,549,000
(7,667,000)
25,009,000
Noninterest income
Service charges on accounts
Earnings on bank owned life insurance
Rental income from other real estate owned
Mortgage banking activities
Credit and debit card fees
Letter of credit fees
Net gain on sale of securities
Gain on sale of commercial loans
Other income
Total noninterest income
Noninterest expense
Salaries and benefits
Occupancy
Furniture and equipment rent, depreciation and maintenance
Nonperforming asset costs
FDIC insurance costs
Data processing
Branch consolidation costs
Advertising
FHLB advance prepayment fees
Other expense
Total noninterest expenses
1,797,000
1,718,000
1,488,000
1,092,000
727,000
460,000
476,000
324,000
1,162,000
9,244,000
18,297,000
2,838,000
1,481,000
10,858,000
4,370,000
2,598,000
0
906,000
1,021,000
4,787,000
47,156,000
2,023,000
1,444,000
438,000
1,202,000
670,000
541,000
0
0
1,240,000
7,558,000
20,331,000
3,377,000
1,871,000
7,294,000
4,852,000
2,526,000
1,308,000
650,000
0
4,279,000
46,488,000
1,994,000
1,727,000
27,000
662,000
745,000
687,000
0
0
1,440,000
7,282,000
22,493,000
3,826,000
1,980,000
3,266,000
1,890,000
2,394,000
0
559,000
0
5,718,000
42,126,000
Income (loss) before federal income tax expense (benefit)
(13,363,000)
(46,597,000)
(9,835,000)
Federal income tax expense (benefit)
(47,000)
5,490,000
(4,876,000)
Net income (loss)
(13,316,000)
(52,087,000)
(4,959,000)
Preferred stock dividends and accretion
1,295,000
802,000
0
Net income (loss) attributable to common shares
$ (14,611,000)
$ (52,889,000)
$
(4,959,000)
See accompanying notes to consolidated financial statements.
F-39
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
Years ended December 31, 2010, 2009 and 2008
Earnings (loss) per share:
Basic
Diluted
2010
2009
2008
$ (1.72)
$ (1.72)
$ (6.23)
$ (6.23)
$ (0.59)
$ (0.59)
See accompanying notes to consolidated financial statements.
F-40
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2010, 2009 and 2008
($ in thousands)
Preferred
Stock
Common
Stock
Common
Stock
Warrant
Retained
Earnings
(Deficit)
Accumulated
Other
Comprehensive
Income (Loss)
Total
Shareholders’
Equity
Balances, January 1, 2008
$
0
$ 172,938
$
0
$ 4,948
$
269
$ 178,155
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
Cash dividends
($0.31 per common share)
Comprehensive income (loss):
Net loss
Change in net unrealized gain (loss)
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
76
40
16
(16)
654
76
40
16
(16)
654
(1,355)
(1,270)
(2,625)
(4,959)
(4,959)
1,795
1,795
1,236
1,236
(1,928)
Balances, December 31, 2008
$
0
$ 172,353
$
0
$ (1,281)
$ 3,300
$ 174,372
See accompanying notes to consolidated financial statements.
F-41
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2010, 2009 and 2008
($ in thousands)
Preferred
Stock
Common
Stock
Common
Stock
Warrant
Retained
Earnings
(Deficit)
Accumulated
Other
Comprehensive
Income (Loss)
Total
Shareholders’
Equity
Balances, January 1, 2009
$
0
$ 172,353
$
0
$ (1,281)
$ 3,300
$ 174,372
Preferred stock issued, net
Accretion of preferred stock
Common stock warrant issued
Employee stock purchase plan
(14,694 shares)
Dividend reinvestment plan
(2,875 shares)
Stock-based compensation expense
Cash dividends
($0.07 per common share)
Preferred stock dividends
Comprehensive loss:
Net loss
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassifications
Reclassification of unrealized gain on
interest rate swaps, net of tax effect
Total comprehensive loss
19,696
143
(143)
1,138
57
11
611
(594)
(659)
19,696
0
1,138
57
11
611
(594)
(659)
(52,087)
(52,087)
(1,269)
(1,269)
(1,172)
(1,172)
(54,528)
Balances, December 31, 2009
$ 19,839
$ 172,438
$ 1,138
$(54,170)
$
859
$ 140,104
See accompanying notes to consolidated financial statements.
F-42
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2010, 2009 and 2008
($ in thousands)
Preferred
Stock
Common
Stock
Common
Stock
Warrant
Retained
Earnings
(Deficit)
Accumulated
Other
Comprehensive
Income (Loss)
Total
Shareholders’
Equity
Balances, January 1, 2010
$ 19,839
$ 172,438
$ 1,138
$(54,170)
$
859
$ 140,104
Accretion of preferred stock
238
(238)
Employee stock purchase plan
(9,129 shares)
Dividend reinvestment plan
(687 shares)
Stock-based compensation expense
Cash dividends
($0.01 per common share)
Preferred stock dividends
Comprehensive loss:
Net loss
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassifications and tax effect
Net unrealized gain on securities
transferred from held to maturity to
available for sale, net of tax effect
Reclassification of unrealized gain on
interest rate swaps, net of tax effect
Total comprehensive loss
47
2
275
(85)
(1,057)
0
47
2
275
(85)
(1,057)
(13,316)
(13,316)
(244)
(244)
274
274
(64)
(64)
(13,350)
$ 125,936
Balances, December 31, 2010
$ 20,077
$ 172,677
$ 1,138
$(68,781)
$
825
See accompanying notes to consolidated financial statements.
F-43
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2010, 2009 and 2008
Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income (loss)
to net cash from (for) operating activities:
2010
2009
2008
$
(13,316,000) $
(52,087,000) $
(4,959,000)
Depreciation and amortization
Provision for loan and lease losses
Deferred income tax expense (benefit)
Stock-based compensation expense
Proceeds from sales of mortgage loans held for sale
Origination of mortgage loans held for sale
Net gain on sale of mortgage loans held for sale
Net gain on sale of held to maturity securities
Gain on sale of commercial loans
Net (gain) loss on sale and write-down of premises and equipment
Net loss on sale and valuation write-downs of foreclosed assets
Recognition of unrealized gain on interest rate swaps
Earnings on bank owned life insurance
Net change in:
Accrued interest receivable
Other assets
Accrued interest and other liabilities
Net cash from (for) operating activities
2,440,000
31,800,000
(47,000)
275,000
66,795,000
(66,104,000)
(846,000)
(476,000)
(324,000)
(2,000)
4,432,000
(99,000)
(1,718,000)
1,146,000
7,540,000
(1,894,000)
29,602,000
2,577,000
59,000,000
9,973,000
611,000
80,782,000
(82,251,000)
(905,000)
0
0
227,000
3,551,000
(1,803,000)
(1,444,000)
1,425,000
(18,407,000)
(10,024,000)
(8,775,000)
2,773,000
21,200,000
(1,558,000)
654,000
44,095,000
(42,810,000)
(506,000)
0
0
(11,000)
1,768,000
(974,000)
(1,727,000)
1,444,000
913,000
(6,667,000)
13,635,000
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
Proceeds from sale of held to maturity securities
Proceeds from Federal Home Loan Bank stock redemption
Loan and lease originations and payments, net
Proceeds from sale of commercial loans
Purchases of premises and equipment, net
Proceeds from sale of foreclosed assets
Purchases of bank owned life insurance
Net cash from (for) investing activities
(106,329,000)
0
0
(73,059,000)
(1,025,000)
0
(96,292,000)
(978,000)
(5,948,000)
107,480,000
52,343,000
73,571,000
0
20,452,000
1,336,000
226,563,000
7,395,000
(118,000)
14,900,000
0
271,679,000
6,270,000
0
0
240,291,000
11,633,000
(44,000)
7,276,000
(1,118,000)
242,567,000
1,840,000
0
0
(86,489,000)
0
(673,000)
4,777,000
(1,617,000)
(111,809,000)
See accompanying notes to consolidated financial statements.
F-44
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 2010, 2009 and 2008
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
Maturities and prepayments of Federal Home Loan Bank advances
Increase in structured repurchase agreements
Maturities of structured repurchase agreements
Increase (decrease) in other borrowed money
Proceeds from issuance of preferred stock and common
stock warrant, net
Employee stock purchase plan
Dividend reinvestment plan
Payment of cash dividends on preferred stock
Payment of cash dividends to common shareholders
Net cash from (for) financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest
Federal income taxes
Noncash financing and investing activities:
Transfers from loans and leases to foreclosed assets
Preferred stock cash dividend accrued
2010
2009
2008
(331,638,000)
203,843,000
(240,269,000)
42,321,000
42,774,000
(34,380,000)
17,224,000
(2,600,000)
0
(140,000,000)
0
(5,000,000)
(86,000)
0
47,000
2,000
(525,000)
(85,000)
(258,818,000)
42,463,000
21,735,000
64,198,000
33,203,000
0
9,399,000
666,000
$
$
5,342,000
2,600,000
5,000,000
(70,000,000)
0
0
(2,638,000)
20,834,000
57,000
11,000
(525,000)
(594,000)
(237,861,000)
(4,069,000)
25,804,000
21,735,000
62,663,000
0
29,317,000
134,000
$
$
(3,052,000)
(13,800,000)
266,500,000
(176,500,000)
15,000,000
0
515,000
0
76,000
40,000
0
(2,625,000)
94,548,000
(3,626,000)
29,430,000
25,804,000
80,748,000
0
9,062,000
0
$
$
See accompanying notes to consolidated financial statements.
F-45
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
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 (“our trust”), in 2004 to issue trust preferred securities.
We issued subordinated debentures to our trust in return for the proceeds raised from the issuance of the trust
preferred securities. In accordance with accounting guidelines, our 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 and Lansing 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 the Mortgage Company, a
limited liability company, which is 99% owned by the Bank and 1% owned by Mercantile Insurance. Mortgage
loans originated and held by the 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.
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.
(Continued)
F-46
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 (as applicable). Other securities such as FHLB 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 in
earnings or other comprehensive income, as appropriate. For those debt securities whose fair value is less than their
amortized cost basis, we consider our intent to sell the security, whether it is more likely than not that we will be
required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the
security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the
federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of
reviews of the issuer’s financial condition.
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 $0.5 million at
December 31, 2010 and 2009.
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.
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 $2.7 million and $2.5 million as of December 31, 2010 and 2009,
respectively. Mortgage banking activities include fees on direct brokered mortgage loans and the net gain on sale of
mortgage loans originated for sale.
(Continued)
F-47
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Troubled Debt Restructurings: A loan or lease is accounted for as a troubled debt restructuring if we, for economic
or legal reasons related to the borrower’s financial condition, grant a significant concession to the borrower that we
would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in
partial or full satisfaction of the loan or lease, or a modification of terms such as a reduction of the stated interest
rate or balance of the loan or lease, a reduction of accrued interest, an extension of the maturity date at a stated
interest rate lower than the current market rate for a new loan with similar risk, or some combination of these
concessions. Troubled debt restructurings generally remain categorized as nonperforming loans and leases until a
six-month payment history has been maintained.
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 uncollectability 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 Bank and put presumptively beyond the reach of the transferor and its creditors, even in
bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective
control over the transferred assets through an agreement to repurchase them before their maturity or the ability to
unilaterally cause the holder to return specific assets. Our transfers of financial assets are limited to commercial
loan participations sold, which were insignificant for 2010, 2009 and 2008, the 2010 sale of the guaranteed portions
of certain Small Business Administration-guaranteed loans, the 2010 sale of tax-exempt municipal bonds and the
sale of residential mortgage loans in the secondary market; the extent of the latter three are 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.
(Continued)
F-48
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
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 noninterest expense, as are collection and operating costs after acquisition.
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: The Bank sells certain securities under agreements to repurchase. The agreements are
treated as collateralized financing transactions and the obligations to repurchase securities sold are reflected as a
liability in the Consolidated Balance Sheet. The dollar amount of the securities underlying the agreements remains
in the asset accounts.
Financial Instruments and Loan Commitments: Financial instruments include off-balance-sheet credit instruments,
such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The
face amount for these items represents the exposure to loss, before considering customer collateral or ability to
repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit,
that are considered financial guarantees are recorded at fair value.
Stock-Based Compensation: Compensation cost for equity-based awards is measured on the grant date based on the
fair value of the award at that date, and is recognized over the requisite service period, net of estimated forfeitures.
Fair value of stock option awards is estimated using a closed option valuation (Black-Scholes) model. Fair value of
restricted stock awards is based upon the quoted market price of the common stock on the date of grant.
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. A full
valuation allowance was recorded at December 31, 2010 and 2009 as described in Note 8.
Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market
information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair
value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated
future business or the values of assets and liabilities not considered financial instruments.
Earnings Per Share: Basic earnings per share is based on the weighted average number of common shares and
participating securities outstanding during the period. Diluted earnings per share include the dilutive effect of
additional potential common shares issuable under our stock-based compensation plans and our common stock
warrant, and are determined using the treasury stock method. Our unvested stock awards, which contain non-
forfeitable rights to dividends whether paid or unpaid (i.e., participating securities), are included in the number of
shares outstanding for both basic and diluted earnings per share calculations. In the event of a net loss, our unvested
stock awards are excluded from the calculations of both basic and diluted earnings per share.
(Continued)
F-49
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income (Loss): Comprehensive income (loss) consists of net income (loss) and other
comprehensive income (loss). Other comprehensive income includes unrealized gains and losses on securities
available for sale which are also recognized as separate components of equity. For 2010, 2009 and 2008, other
comprehensive income (loss) also includes the change in fair value of interest rate swaps, and the reclassification of
unrealized gain on the 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 had no derivatives outstanding during 2010
or 2009. 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.
Operating Segment: While we monitor the revenue streams of the various products and services offered, Mercantile
manages its business on the basis of one operating segment, banking.
Adoption of New Accounting Standards: In December 2009, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update (“ASU”) 2009-16, Accounting for Transfers of Financial Assets (formerly
Statement No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140). This
ASU amends the guidance on accounting for transfers of financial assets, including securitization transactions,
where entities have continued exposure to risks related to transferred financial assets. This ASU also expands the
disclosure requirements for such transactions. It is effective as of the beginning of the first annual reporting period
that begins after November 15, 2009. The adoption of this ASU on January 1, 2010 had no impact on our results of
operations or financial position.
(Continued)
F-50
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In January 2010, the FASB issued ASU 2010-06, Improving Disclosure about Fair Value Measurements. This
ASU requires new disclosures on the amount and reason for transfers in and out of Level 1 and Level 2 recurring
fair value measurements. The ASU also requires disclosure of activities (i.e., on a gross basis), including purchases,
sales, issuances, and settlements, in the reconciliation of Level 3 fair value recurring measurements. The ASU
clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation
techniques. The new disclosure regarding Level 1 and Level 2 fair value measurements and clarification of existing
disclosures are effective for periods beginning after December 15, 2009. The disclosures about the reconciliation of
information in Level 3 recurring fair value measurements are required for periods beginning after December 15,
2010. Upon adoption of the applicable portions of this ASU on January 1, 2010, we provided the required
disclosures as presented in Note 15. For those additional disclosures required for fiscal years beginning after
December 15, 2010, we anticipate first including those disclosures in our financial statements for the period ending
March 31, 2011.
In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and
the Allowance for Credit Losses. In order to provide greater transparency, this ASU requires significant new
disclosures on a disaggregated basis about the allowance for credit losses (e.g., allowance for loan and lease losses
for banks) and the credit quality of financing receivables (e.g., loans and leases for banks). Under the ASU, a
rollforward schedule of the allowance for loan and lease losses, with the ending allowance balance further
disaggregated on the basis of the impairment method, along with the related ending loan and lease balance and
significant purchases and sales of loans and leases during the period are to be disclosed by portfolio segment.
Additional disclosures are required by class of loan and lease, including credit quality, aging of past due loans and
leases, nonaccrual status and impairment information. Disclosure of the nature and extent of troubled debt
restructurings that occurred during the period and their effect on the allowance for loan and leases losses as well as
the effect on the allowance of troubled debt restructurings that occurred within the prior twelve months that
defaulted during the current reporting period will also be required. The disclosures are to be presented at the level
of disaggregation that management uses when assessing and monitoring the loan and lease portfolio’s risk and
performance. The majority of the disclosures required as of the end of a reporting period are effective for interim
and annual periods ending after December 15, 2010 and have been presented in Note 3. The disclosures about
activity that occurred prior to the issuance of the ASU are effective for reporting periods beginning after December
15, 2010. In January 2011, the FASB issued ASU 2011-01, Deferral of the Effective Date of Disclosures about
Troubled Debt Restructurings in Update No. 2010-20, which temporarily defers the effective date for disclosures
related to troubled debt restructurings, which is currently expected to be effective for periods ending after June 15,
2011.
(Continued)
F-51
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 2 – SECURITIES
The amortized cost and fair value of available for sale securities and the related gross unrealized gains and losses
recognized in accumulated other comprehensive income (loss) were as follows:
2010
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general obligation bonds
Municipal revenue bonds
Mutual funds
2009
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Mutual funds
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
$ 121,633,000
44,340,000
18,175,000
28,594,000
4,841,000
1,264,000
$ 1,704,000
2,601,000
0
227,000
46,000
3,000
$ (1,775,000)
0
0
(779,000)
(44,000)
0
$ 121,562,000
46,941,000
18,175,000
28,042,000
4,843,000
1,267,000
$ 218,847,000
$ 4,581,000
$ (2,598,000)
$ 220,830,000
$
96,438,000
62,171,000
20,550,000
1,425,000
$ 490,000
2,811,000
0
0
$ (1,384,000)
0
0
(9,000)
$
95,544,000
64,982,000
20,550,000
1,416,000
$ 180,584,000
$ 3,301,000
$ (1,393,000)
$ 182,492,000
The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows at
December 31, 2009 (none at December 31, 2010):
2009
Municipal general obligation bonds
Municipal revenue bonds
Carrying
Amount
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
$
49,892,000
9,319,000
$ 1,000,000
190,000
$ (111,000)
(19,000)
$
50,781,000
9,490,000
$
59,211,000
$ 1,190,000
$ (130,000)
$
60,271,000
(Continued)
F-52
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 2 – SECURITIES (Continued)
Securities with unrealized losses at year-end 2010 and 2009, aggregated by investment category and length of time
that individual securities have been in a continuous loss position, are as follows:
Description of Securities
2010
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Mutual funds
Municipal general
obligation bonds
Municipal revenue bonds
2009
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Mutual funds
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
$56,588,000 $(1,775,000) $
0
0
0
0
0
0
0 $
0
0
0
0
0
0
0
$56,588,000 $(1,775,000)
0
0
0
0
0
0
7,847,000
811,000
(299,000)
(25,000)
6,497,000
805,000
(480,000)
(19,000)
14,344,000 (779,000)
(44,000)
1,616,000
$65,246,000 $ (2,099,000) $ 7,302,000 $ (499,000) $ 72,548,000 $(2,598,000)
$50,190,000 $(1,322,000) $ 7,927,000 $ (62,000)
0
0
(9,000)
0
0
1,211,000
0
0
0
0
0
0
$58,117,000 $(1,384,000)
0
0
1,211,000
0
0
(9,000)
738,000
228,000
(5,000)
(12,000)
8,638,000
1,073,000
(106,000)
(7,000)
9,376,000 (111,000)
(19,000)
1,301,000
$51,156,000 $ (1,339,000) $18,849,000 $ (184,000) $ 70,005,000 $(1,523,000)
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, our intent to sell the security, whether it is more likely than not that we will be required
to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security.
In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal
government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews
of the issuer’s financial condition.
(Continued)
F-53
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 2 – SECURITIES (Continued)
There were 22 municipal general obligation bonds and three municipal revenue bonds in a continuous loss position
for 12 months or more at December 31, 2010. At December 31, 2010, 91 debt securities with a combined fair value
totaling $72.5 million have unrealized losses with aggregate depreciation of $2.6 million, or 1.2% from the
amortized cost basis of total securities. At December 31, 2010, 178 debt securities and a mutual fund with a
combined fair value totaling $119.2 million have unrealized gains with aggregate appreciation of $4.6 million, or
2.1% from the amortized cost basis of total securities. After we considered whether the securities were issued by
the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we
determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell the
securities, we believe it is more likely than not that we will not be required to sell the securities before recovery and
we do expect to recover the entire amortized cost of the securities, no declines are deemed to be other-than-
temporary.
The amortized cost and fair values of debt securities at year-end 2010, 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, 2010 are also shown in the following
table. The yields for municipal securities are shown at their tax equivalent yield.
Due in one year or less
Due from one to five years
Due from five to ten years
Due after ten years
Mortgage-backed securities
Michigan Strategic Fund bonds
Mutual funds
Weighted
Average
Yield
NA
5.80%
3.96
4.73
5.14
3.04
3.08
Amortized
Cost
Fair
Value
$
0
5,430,000
21,318,000
128,320,000
44,340,000
18,175,000
1,264,000
$
0
5,816,000
21,248,000
127,383,000
46,941,000
18,175,000
1,267,000
4.62%
$ 218,847,000
$ 220,830,000
After analyzing our current and forecasted federal income tax position, we sold certain tax-exempt municipal bonds
with an aggregate book value of $20.0 million in late March of 2010. Immediately subsequent to the sale, we
reclassified the remaining tax-exempt municipal bonds with an amortized cost of $39.2 million from held to
maturity to available for sale. The net unrealized gain at the date of transfer amounted to $0.4 million and was
reported in other comprehensive income net of tax effect. During 2009 and 2008, there were no securities sold.
At year-end 2010 and 2009, the amortized cost of securities issued by the State of Michigan and all its political
subdivisions totaled $33.4 million and $59.2 million, with an estimated fair value of $32.9 million and $60.3
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.
(Continued)
F-54
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 2 – SECURITIES (Continued)
The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to
secure repurchase agreements, other deposits, and letters of credit issued on behalf of our customers was $166.9
million and $158.1 million at December 31, 2010 and 2009, 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 FHLB stock are restricted and may only be resold, or redeemed by, the issuer.
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Year-end loans and leases disaggregated by class of loan and lease within the loan and lease portfolio segments
were as follows:
Commercial:
Commercial and industrial
Vacant land, land
development, and
residential construction
Real estate – owner occupied
Real estate – non-owner
occupied
Real estate – multi-family
and residential rental
Total commercial
Retail:
Home equity and other
1-4 family mortgages
Total retail
December 31, 2010
Balance
%
December 31, 2009
Balance
%
Percent
Increase
(Decrease)
$ 288,515,000
22.8%
$ 408,234,000
26.5%
(29.3)%
83,786,000
277,377,000
6.6
22.0
109,293,000
332,793,000
7.1
21.6
(23.3)
(16.7)
449,104,000
35.6
503,736,000
32.7
(10.8)
77,188,000
1,175,970,000
6.1
93.1
88,657,000
1,442,713,000
5.8
93.7
(12.9)
(18.5)
51,186,000
35,474,000
86,660,000
4.1
2.8
6.9
57,537,000
39,568,000
97,105,000
3.7
2.6
6.3
(11.0)
(10.3)
(10.8)
Total loans and leases
$1,262,630,000
100.0%
$1,539,818,000
100.0%
(18.0)%
Concentrations within the loan portfolio were as follows at year-end:
2010
2009
Balance
Percentage of
Loan Portfolio
Balance
Percentage of
Loan Portfolio
Commercial real estate loans to
lessors of non-residential
buildings
$ 391,056,000
31.0%
$ 467,017,000
30.3%
(Continued)
F-55
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Year-end nonperforming loans and leases were as follows:
Loans and leases past due 90 days or more still accruing interest
Nonaccrual loans and leases, including troubled debt restructurings
Troubled debt restructurings, accruing interest
$
766,000
63,915,000
4,763,000
$
243,000
81,818,000
2,989,000
Total nonperforming loans and leases
$ 69,444,000
$ 85,050,000
2010
2009
Nonaccrual loans and leases, including troubled debt restructurings, were as follows as of December 31, 2010:
Commercial:
Commercial and industrial
Vacant land, land development and residential construction
Real estate – owner occupied
Real estate – non-owner occupied
Real estate – multi-family and residential rental
Total commercial
Retail:
Home equity and other
1-4 family mortgages
Total retail
Total nonaccrual loans and leases
Recorded
Principal
Balance
$ 10,128,000
12,441,000
10,172,000
22,609,000
4,686,000
60,036,000
2,425,000
1,454,000
3,879,000
$ 63,915,000
(Continued)
F-56
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F
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Impaired loans and leases were as follows as of December 31, 2010:
Unpaid
Contractual
Principal
Balance
Recorded
Principal
Balance
Related
Allowance
With no related allowance recorded:
Commercial:
Commercial and industrial
Vacant land, land development and
residential construction
Real estate – owner occupied
Real estate – non-owner occupied
Real estate – multi-family and residential rental
Total commercial
$ 3,133,000
$ 2,135,000
13,255,000
9,327,000
23,380,000
1,657,000
50,752,000
10,071,000
4,920,000
15,775,000
1,052,000
33,953,000
Retail:
Home equity and other
1-4 family mortgages
Total retail
277,000
151,000
428,000
151,000
137,000
288,000
Total with no related allowance recorded
$ 51,180,000
$ 34,241,000
With an allowance recorded:
Commercial:
Commercial and industrial
Vacant land, land development and
residential construction
Real estate – owner occupied
Real estate – non-owner occupied
Real estate – multi-family and residential rental
Total commercial
$ 7,405,000
$ 6,922,000
$ 3,554,000
5,702,000
7,047,000
13,773,000
5,544,000
39,471,000
4,370,000
6,257,000
7,875,000
3,472,000
28,896,000
954,000
1,996,000
1,091,000
909,000
8,504,000
Retail:
Home equity and other
1-4 family mortgages
Total retail
1,799,000
1,141,000
2,940,000
1,910,000
909,000
2,819,000
1,007,000
191,000
1,198,000
Total with an allowance recorded
$ 42,411,000
$ 31,715,000
$ 9,702,000
Total impaired loans and leases:
Commercial
Retail
Total impaired loans and leases
90,223,000
3,368,000
$ 93,591,000
62,849,000
3,107,000
$ 65,956,000
8,504,000
1,198,000
$ 9,702,000
(Continued)
F-58
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Impaired loans and leases were as follows as of December 31, 2009:
Loans with no allocated allowance for loan and lease losses
Loans with allocated allowance for loan and lease losses
Total impaired loans and leases
Amount of the allowance for loan and lease losses allocated
Recorded
Principal
Balance
$ 25,500,000
39,855,000
$ 65,355,000
$
9,832,000
Impaired loans and leases for which no allocation of the allowance for loan and lease losses has been made
generally reflect situations whereby the loans and leases have been charged-down to estimated collateral value.
Interest income of $0.2 million, $0.1 million and less than $0.1 million was recognized on impaired loans during
2010, 2009 and 2008, respectively. Average impaired loans were $75.1 million, $65.0 million and $35.9 million
during 2010, 2009 and 2008, respectively. Lost interest income on nonaccrual loans totaled $2.1 million during
2010, 2009 and 2008. Nonperforming loans include both smaller balance homogenous loans that are collectively
evaluated for impairment and the above individually classified impaired loans.
(Continued)
F-59
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R
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
All commercial loans and leases are graded using the following number system:
Grade 1. Excellent credit rating that contain very little, if any, risk of loss.
Grade 2. Strong sources of repayment and have low repayment risk.
Grade 3. Good sources of repayment and have limited repayment risk.
Grade 4. Adequate sources of repayment and acceptable repayment risk; however, characteristics are present
that render the credit more vulnerable to a negative event.
Grade 5. Marginally acceptable sources of repayment and exhibit defined weaknesses and negative
characteristics.
Grade 6. Well defined weaknesses which may include negative current cash flow, high leverage, or operating
losses. Generally, if the credit does not stabilize or if further deterioration is observed in the near
term, the loan will likely be downgraded and placed on the Watch List (i.e., list of lending
relationships that receive increased scrutiny and review by the Board of Directors and senior
management).
Grade 7. Defined weaknesses or negative trends that merit close monitoring through Watch List status.
Grade 8.
Inadequately protected by current sound net worth, paying capacity of the obligor, or pledged
collateral, resulting in a distinct possibility of loss requiring close monitoring through Watch List
status.
Grade 9. Vital weaknesses exist where collection of principal is highly questionable.
Grade 10. Considered uncollectible and of such little value that their continuance as an asset is not warranted.
The primary risk elements with respect to commercial loans and leases are the financial condition of the borrower,
the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing
periodic financial statements from commercial loan and lease customers and employ a disciplined and formalized
review of the existence of collateral and its value. The primary risk element with respect to each residential real
estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors
past due loans and leases and have adopted policies to pursue creditor’s rights in order to preserve our collateral
position.
(Continued)
F-61
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
The allowance for loan and lease losses and recorded investments in loans and leases for the year-ended December
31, 2010 are as follows:
Commercial
Loans and Leases
Retail
Loans
Unallocated
Total
Allowance for loan and lease losses:
Beginning balance
$
46,603,000
$ 1,256,000
$
19,000
$
47,878,000
Provision for loan and
lease losses
Charge-offs
Recoveries
Ending balance
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Total loans and leases:
Ending balance
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
29,030,000
(35,968,000)
2,694,000
42,359,000
2,752,000
(1,160,000)
124,000
$ 2,972,000
$
$
18,000
0
0
37,000
31,800,000
(37,128,000)
2,818,000
45,368,000
$
$
8,504,000
$ 1,198,000
$
0
$
9,702,000
$
33,855,000
$ 1,774,000
$
37,000
$
35,666,000
$1,175,970,000
$ 86,660,000
$1,262,630,000
$
62,850,000
$ 3,106,000
$
65,956,000
$1,113,120,000
$ 83,554,000
$1,196,674,000
Activity in the allowance for loan and lease losses is as follows:
Beginning balance
Provision for loan and lease losses
Charge-offs
Recoveries
Ending balance
2009
2008
$
27,108,000
59,000,000
(39,621,000)
1,391,000
$
25,814,000
21,200,000
(20,594,000)
688,000
$
47,878,000
$
27,108,000
(Continued)
F-62
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment were as follows:
Land and improvements
Buildings
Furniture and equipment
Less: accumulated depreciation
2010
2009
$
8,531,000
24,528,000
12,478,000
45,537,000
17,664,000
$
8,531,000
24,515,000
12,532,000
45,578,000
15,894,000
Total premises and equipment
$
27,873,000
$
29,684,000
Depreciation expense totaled $1.9 million in 2010, $2.5 million in 2009, and $2.7 million in 2008.
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, 2010
Balance
%
December 31, 2009
Balance
%
Percent
Increase
(Decrease)
$ 112,944,000
8.9% $ 121,157,000
8.6%
(6.8)%
158,177,000
150,631,000
60,201,000
75,857,000
12.4
11.8
4.7
6.0
86,320,000
32,008,000
38,625,000
105,195,000
6.2
2.3
2.8
7.5
206,954,000
764,764,000
16.2
60.0
293,455,000
676,760,000
20.9
48.3
83.2
370.6
55.9
(27.9)
(29.5)
13.0
37,253,000
2.9
62,760,000
4.5
(40.6)
471,815,000
509,068,000
37.1
40.0
662,107,000
724,867,000
47.2
51.7
(28.7)
(29.8)
Total deposits
$1,273,832,000
100.0% $1,401,627,000
100.0%
(9.1)%
Out-of-area certificates of deposit consist of certificates obtained from depositors outside of the primary market
areas. As of December 31, 2010, out-of-area certificates of deposit totaling $486.9 million were obtained through
deposit brokers, with the remaining $22.2 million obtained directly from the depositors.
(Continued)
F-63
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 5 – DEPOSITS (Continued)
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
2010
2009
$ 495,914,000
179,867,000
70,602,000
27,842,000
17,654,000
$ 850,801,000
186,135,000
68,210,000
11,565,000
6,806,000
Total certificates of deposit
$ 791,879,000
$1,123,517,000
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
2010
2009
$ 184,283,000
108,963,000
128,315,000
257,208,000
$ 314,358,000
164,870,000
235,315,000
241,019,000
Total certificates of deposit
$ 678,769,000
$ 955,562,000
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
2010
2009
$ 116,979,000
0.69%
$ 99,755,000
1.41%
107,781,000
1.31%
98,409,000
1.87%
Maximum daily balance during the year
133,280,000
111,692,000
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 our Bank
and are held in safekeeping by a correspondent bank. Repurchase agreements are offered principally to certain
large deposit customers. Repurchase agreements are secured by securities with an aggregate market value equal to
the aggregate outstanding balance.
(Continued)
F-64
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at December 31, 2010 totaled $65.0 million and mature at varying dates from June 2011
through January 2014, with fixed rates of interest from 3.04% to 4.42% and averaging 3.73%. At December 31,
2009, outstanding balances totaled $205.0 million with maturities ranging from January 2010 through January 2014
and fixed rates of interest from 2.95% to 4.18% and averaging 3.50%.
Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date.
The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential
property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our
Bank, under a blanket lien arrangement. Our borrowing line of credit as of December 31, 2010 totaled $169.7
million, with availability of $104.7 million.
Maturities over the next five years are:
2011
2012
2013
2014
2015
$ 10,000,000
40,000,000
10,000,000
5,000,000
0
NOTE 8 - FEDERAL INCOME TAXES
The consolidated income tax expense (benefit) is as follows:
2010
2009
2008
Current expense (benefit)
Deferred benefit
Deferred expense - establishment of valuation allowance
Tax expense (benefit)
$
$
0
(47,000)
0
(47,000)
$
$
(4,483,000)
(13,276,000)
23,249,000
5,490,000
$
$
(3,318,000)
(1,558,000)
0
(4,876,000)
For 2010, the tax benefit reflected in continuing operations relates to adjustments between other comprehensive
income and continuing operations tax expense due to accounting rules related to intraperiod tax allocation.
A reconciliation of the differences between the federal income tax expense (benefit) recorded and the amount
computed by applying the federal statutory rate to income before income taxes is as follows:
Tax at statutory rate (35%)
Increase (decrease) from
Tax-exempt interest
Bank owned life insurance
Change in valuation allowance
Other
Tax expense (benefit)
2010
2009
2008
$
(4,677,000)
$ (16,309,000)
$
(3,442,000)
(706,000)
(601,000)
5,896,000
41,000
(47,000)
(866,000)
(505,000)
23,249,000
(79,000)
5,490,000
$
(818,000)
(605,000)
0
(11,000)
(4,876,000)
$
$
(Continued)
F-65
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 8 - FEDERAL INCOME TAXES (Continued)
Significant components of deferred tax assets and liabilities as of December 31, 2010 and 2009 are as follows:
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
Net operating loss carryforward
Tax credit carryforwards
Other
Deferred income tax liabilities
Depreciation
Unrealized gain on securities
Interest rate swaps
Other
Net deferred tax asset before valuation allowance
Valuation allowance
Total net deferred tax asset
2010
2009
$ 15,879,000
165,000
631,000
935,000
2,038,000
10,379,000
807,000
704,000
31,538,000
$ 16,757,000
160,000
661,000
480,000
1,436,000
4,941,000
668,000
726,000
25,829,000
639,000
694,000
0
565,000
1,898,000
29,640,000
(29,640,000)
0
$
770,000
648,000
33,000
634,000
2,085,000
23,744,000
(23,744,000)
0
$
At December 31, 2010, we had carryfowards of the following tax attributes: gross federal net operating loss of
$29.7 million that expires in years 2029 through 2030; general business tax credits of $0.5 million that expire in the
years 2027 through 2030; and $0.3 million of federal alternative minimum tax credits with an indefinite life.
Accounting guidance requires us to assess whether a valuation allowance should be established against our deferred
tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making
such judgments, 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. Significant weight is given to
evidence that can be objectively verified. Despite improvements in key areas such as an expanded net interest
margin, increased regulatory capital levels, a continued shift to local funding sources and reduced controllable
overhead costs, loan and lease loss provision expense and problem asset administration costs remain sizable. The
continuing recent losses resulting from the distressed operating environment have significantly restricted our ability
to rely on projections of future taxable income to support the recovery of our deferred tax assets. Consequently, we
determined it necessary to carry a valuation allowance against our entire net deferred tax asset as of December 31,
2010 and 2009. We will continue to monitor our net deferred tax assets quarterly for changes affecting its
realizability.
We had no unrecognized tax benefits at any time during 2010 or 2009 and do not anticipate any significant increase
in unrecognized tax benefits during 2011. 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 2010 or 2009. We file U.S. federal income tax returns which are subject to examination
for all years after 2006.
(Continued)
F-66
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
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 2006, 2007 and 2008, stock option and restricted stock grants were provided to certain employees through
the Stock Incentive Plan of 2006. No stock option or restricted stock grants were made during 2009 or 2010.
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 2006, 2007 and 2008 fully vest after two years and expire
after seven years. The restricted stock awards granted to certain employees during 2006, 2007 and 2008 fully vest
after four years. No payments were required from employees for the restricted stock awards. At year-end 2010,
there were approximately 419,000 shares authorized for future incentive awards.
As of December 31, 2010, there was only a nominal amount of unrecognized compensation cost related to unvested
stock options granted under our various stock-based compensation plans. As of December 31, 2010, there was
$0.2 million of total unrecognized compensation cost related to unvested restricted stock granted under our Stock
Incentive Plan of 2006, which is expected to be recognized over a weighted-average period of 1.0 year.
A summary of restricted stock activity is as follows:
2010
2009
2008
Weighted
Average
Fair Value
$ 14.98
NA
37.76
14.62
Shares
91,233
0
(12,941)
(4,337)
Weighted
Average
Fair Value
Shares
Weighted
Average
Fair Value
Shares
113,010
0
(3,290)
(18,487)
$ 14.85
NA
20.39
13.20
63,024
56,710
(128)
(6,596)
$ 23.69
6.21
30.37
24.72
73,955
$ 11.02
91,233
$ 14.98
113,010
$ 14.85
Nonvested at
beginning of year
Granted
Vested
Forfeited
Nonvested at
end of year
(Continued)
F-67
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
A summary of stock option activity is as follows:
2010
2009
2008
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
293,572
0
0
(31,530)
$ 20.43
NA
NA
14.23
322,791
0
0
(29,219)
$ 20.58
NA
NA
22.05
271,755
67,460
(2,000)
(14,424)
$ 24.34
6.21
8.22
25.85
262,042
$ 21.18
293,572
$ 20.43
322,791
$ 20.58
Outstanding at
beginning of year
Granted
Exercised
Forfeited or expired
Outstanding at
end of year
Options exercisable
at year-end
250,222
$ 21.86
228,252
$ 24.20
196,051
$ 25.44
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
2010
NA
NA
NA
NA
2009
2008
NA
NA
NA
NA
2.00%
5 Years
44%
1%
(Continued)
F-68
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
Options outstanding at year-end 2010 were as follows:
Outstanding
Exercisable
Range of
Exercise
Prices
$ 4.00 - $ 8.00
$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
56,760
26,402
67,160
6,360
21,065
61,308
16,629
6,358
4.9 Years
0.8 Years
3.1 Years
1.8 Years
2.8 Years
4.3 Years
2.9 Years
3.8 Years
$ 6.21
12.84
17.16
20.18
26.61
34.75
37.94
40.28
Weighted
Average
Exercise
Price
Number
45,500
26,402
66,600
6,360
21,065
61,308
16,629
6,358
$ 6.21
12.84
17.15
20.18
26.61
34.75
37.94
40.28
Outstanding at year end
262,042
3.5 Years
$ 21.18
250,222
$ 21.86
The weighted-average remaining contractual life of the 250,222 stock options exercisable as of December 31, 2010
was 3.4 years.
Information related to options outstanding at year-end 2010, 2009 and 2008 were as follows:
Minimum exercise price
Maximum exercise price
Average remaining option term
2010
2009
2008
$
6.21
40.28
3.5 Years
$
6.21
40.28
4.2 Years
$
6.21
40.28
5.3 Years
Information related to stock option grants and exercises during 2010, 2009 and 2008 follows:
2010
2009
2008
Aggregate intrinsic value of stock options exercised
Cash received from stock option exercises
Tax benefit realized from stock option exercises
Weighted average per share fair value of stock
options granted
$ NA
NA
NA
NA
$ NA
NA
NA
$ 13,000
0
0
NA
2.32
The aggregate intrinsic value of all stock options outstanding and exercisable at December 31, 2010 was $0.1
million.
Shares issued as a result of the exercise of stock option grants have been authorized and unissued shares.
(Continued)
F-69
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
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 2010 and 2009, the Bank had $11.9
million and $13.4 million in loan commitments to directors and executive officers, of which $10.9 million and $12.2
million were outstanding at year-end 2010 and 2009, respectively, as reflected in the following table. The line item
entitled “Adjustments” primarily relates to Board member retirements during 2010.
Beginning balance
New loans
Repayments
Adjustments
Ending balance
2010
2009
$ 12,174,000
79,000
(757,000)
(615,000)
$ 14,090,000
519,000
(2,435,000)
0
$ 10,881,000
$ 12,174,000
Related party deposits and repurchase agreements totaled $9.8 million and $10.5 million at year-end 2010 and 2009,
respectively.
NOTE 11 – COMMITMENTS AND OFF-BALANCE-SHEET RISK
Our Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the
financing needs of our customers. These financial instruments include commitments to extend credit and standby
letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Standby letters of credit are conditional commitments issued
by our Bank to guarantee the performance of a customer to a third party. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future
cash requirements.
These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in
the balance sheet. Our 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 was $0 at December 31, 2010 and December 31, 2009.
At year-end 2010 and 2009, 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-70
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
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
2010
2009
$ 158,945,000
$ 205,018,000
26,870,000
7,768,000
4,052,000
9,840,000
19,343,000
24,916,000
8,565,000
4,526,000
7,701,000
36,512,000
Total commitments
$ 226,818,000
$ 287,238,000
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 Mercantile Bank Prime Rate. For term debt secured by real estate, customers are generally
offered a floating rate tied to the Mercantile Bank Prime Rate and a fixed rate currently ranging from 5.00% to
7.00%. 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 Mercantile Bank Prime Rate and a fixed rate currently ranging from 5.00% to 7.50%. 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, 2010, the total notional amount of the
underlying interest rate swap agreements was $45.3 million, with a net fair value from our commercial loan
customers’ perspective of negative $4.3 million. Payments made in regards to the risk participation agreements
total $0.5 million; however, we believe the affected customer will reimburse us for such payments and therefore we
have accrued no valuation allowance for our receivable from this customer and have accrued no liability for
potential future payments. These risk participation agreements are considered financial guarantees in accordance
with applicable accounting guidance 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 $0.2 million at December 31,
2010 and 2009.
(Continued)
F-71
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 11 – COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
The following instruments are considered financial guarantees under current accounting guidance. These
instruments are carried at fair value.
2010
2009
Contract
Amount
Carrying
Value
Contract
Amount
Carrying
Value
Standby letters of credit
$
19,343,000
$ 168,000
$ 36,512,000
$ 220,000
We were required to have $0.7 million and $0.6 million of cash on hand or on deposit with the Federal Reserve
Bank of Chicago to meet regulatory reserve and clearing requirements at year-end 2010 and 2009, respectively.
NOTE 12 – BENEFIT PLANS
We have a 401(k) benefit plan that covers substantially all of our employees. The percent of our matching
contributions to the 401(k) benefit plan is determined annually by the Board of Directors. Effective April 1, 2009,
we suspended matching contributions to the 401(k) benefit plan. The 401(k) benefit plan allows employee
contributions up to 15% of their compensation, which can be matched at 100% of the first 5% of the compensation
contributed up to a maximum matching contribution of $12,250. Matching contributions, if made, are immediately
vested. Our 2010, 2009 and 2008 matching 401(k) contributions charged to expense were $0, $206,000 and
$781,000, respectively.
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 2010, 2009 and 2008
was $19,000, $24,000 and $89,000, 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 2010, 2009 and 2008 was $40,000,
$51,000 and $140,000, 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 consolidated closing bid price of our common
stock reported on The Nasdaq Stock Market. A total of 55,000 shares of common stock may be issued under the
Stock Purchase Plan; however, the number of shares has been adjusted, and may continue to be adjusted in the
future, to reflect stock dividends and other changes in our capitalization. The number of shares issued under the
Stock Purchase Plan totaled 9,129 and 14,694 in 2010 and 2009, respectively. As of December 31, 2010, there
were 12,166 shares available under the Stock Purchase Plan.
(Continued)
F-72
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
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.
Historically, a majority of our assets have been comprised of commercial loans on which the interest rates are
variable, while a majority of our liabilities have been comprised of fixed rate certificates of deposit and FHLB
advances. Due to this repricing mismatch, we have periodically entered into derivative financial instruments to
mitigate the exposure in cash flows resulting from changes in interest rates.
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 has been accreted into interest income on loans and leases based on the original term of the
interest rate swaps. As of December 31, 2010, we had fully accreted the $2.4 million into interest income, including
$0.1 million during 2010.
(Continued)
F-73
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as follows at year-end:
2010
2009
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
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
Accrued interest receivable
$ 64,198,000
220,830,000
0
14,345,000
1,217,262,000
46,743,000
5,942,000
$ 64,198,000
220,830,000
0
14,345,000
1,223,911,000
46,743,000
5,942,000
$ 21,735,000
182,492,000
59,211,000
15,681,000
1,491,940,000
45,024,000
7,088,000
$ 21,735,000
182,492,000
60,271,000
15,681,000
1,501,860,000
45,024,000
7,088,000
Financial liabilities
Deposits
Securities sold under agreements
to repurchase
Federal funds purchased
Federal Home Loan Bank advances
Subordinated debentures
Accrued interest payable
1,273,832,000
1,284,767,000
1,401,627,000
1,407,310,000
116,979,000
0
65,000,000
32,990,000
4,749,000
116,979,000
0
67,668,000
33,006,000
4,749,000
99,755,000
2,600,000
205,000,000
32,990,000
6,158,000
99,755,000
2,600,000
208,435,000
32,971,000
6,158,000
Carrying amount is the estimated fair value for cash and cash equivalents, FHLB stock, accrued interest receivable
and payable, bank owned life insurance, 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 FHLB 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 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. Since negotiated prices in illiquid markets depend 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.
(Continued)
F-74
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 15 – FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or
transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market,
the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market
used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is
a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing
activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced
transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii)
knowledgeable, (iii) able to transact and (iv) willing to transact.
We are required to use valuation techniques that are consistent with the market approach, the income approach
and/or the cost approach. The market approach uses prices and other relevant information generated by market
transactions involving identical or comparable assets and liabilities. The income approach uses valuation
techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted
basis. The cost approach is based on the amount that currently would be required to replace the service capacity of
an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques
refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be
observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability
developed based on market data obtained from independent sources, or unobservable, meaning those that reflect our
own estimates about the assumptions market participants would use in pricing the asset or liability based on the best
information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that
gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority
to unobservable inputs. The fair value hierarchy is as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to
access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active;
or other inputs that are observable or can be derived from or corroborated by observable market data by correlation
or other means.
Level 3: Significant unobservable inputs that reflect our own estimates about the assumptions that market
participants would use in pricing an asset or liability.
The following is a description of our valuation methodologies used to measure and disclose the fair values of our
financial assets and liabilities on a recurring or nonrecurring basis:
Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value
measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured
using independent pricing models. Level 2 securities include U.S. Government agency debt obligations and
mortgage-backed securities issued or guaranteed by U.S. Government agencies, municipal general obligation and
revenue bonds, Michigan Strategic Fund bonds and mutual funds. We have no Level 1 or 3 securities available for
sale.
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 Note 2, is based on
quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing
models.
(Continued)
F-75
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
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, 2010 and 2009, we
determined that the fair value of our mortgage loans held for sale was similar to the cost; therefore, we carried the
$2.7 million and $2.5 million, respectively, 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.
Foreclosed assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair
value less costs to sell upon transfer of the loans and leases to foreclosed and repossessed assets, establishing a new
cost basis. We subsequently adjust estimated fair value on foreclosed assets on a nonrecurring basis to reflect write-
downs based on revised fair value estimates.
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 at year-end 2010 and 2009.
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, 2010 are as
follows:
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
$
0
0
0
0
0
0
Total
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general obligation
bonds
Municipal revenue bonds
Mutual funds
Total securities available
$ 121,562,000
46,941,000
18,175,000
28,042,000
4,843,000
1,267,000
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
$ 121,562,000
46,941,000
18,175,000
$
28,042,000
4,843,000
1,267,000
0
0
0
0
0
0
0
for sale
$ 220,830,000
$
0
$ 220,830,000
$
There were no transfers in or out of Level 1, Level 2 or Level 3 during 2010.
(Continued)
F-76
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 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
$ 182,492,000
$ 182,492,000
$
$
0
0
$ 182,492,000
$ 182,492,000
$
$
0
0
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, 2010 are as
follows:
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
Total
Impaired loans (1)
Foreclosed assets (1)
Total
$ 39,056,000
16,675,000
$ 55,731,000
$
$
0
0
0
Significant
Other
Observable
Inputs
(Level 2)
$
$
0
0
0
Significant
Unobservable
Inputs
(Level 3)
$ 39,056,000
16,675,000
$ 55,731,000
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2009 are as
follows:
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
Total
Impaired loans (1)
Foreclosed assets (1)
Total
$ 41,456,000
26,608,000
$ 68,064,000
$
$
0
0
0
Significant
Other
Observable
Inputs
(Level 2)
$
$
0
0
0
Significant
Unobservable
Inputs
(Level 3)
$ 41,456,000
26,608,000
$ 68,064,000
(1) Represents carrying value and related write-downs for which adjustments are based on the estimated value
of the property or other assets.
(Continued)
F-77
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
Fair value estimates of collateral on impaired loans, as well as on foreclosed assets, are reviewed periodically. Our
credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also
adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of
similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and
internal value estimates to address current distressed market conditions.
NOTE 16 – EARNINGS (LOSS) PER SHARE
The factors used in the earnings (loss) per share computation follow:
Basic
Net income (loss) attributable to common shares
$ (14,611,000)
$(52,889,000)
$ (4,959,000)
2010
2009
2008
Weighted average common shares outstanding
8,507,572
8,489,679
8,470,721
Basic earnings (loss) per common share
$
(1.72)
$
(6.23)
$
(0.59)
Diluted
Net income (loss) attributable to common shares
$ (14,611,000)
$(52,889,000)
$ (4,959,000)
Weighted average common shares outstanding for
basic earnings (loss) per common share
8,507,572
8,489,679
8,470,721
Add: Dilutive effects of share-based awards
0
0
0
Average shares and dilutive potential
common shares
8,507,572
8,489,679
8,470,721
Diluted earnings (loss) per common share
$
(1.72)
$
(6.23)
$
(0.59)
Due to our net loss in 2010, approximately 74,000 unvested restricted shares were not included in determining both
basic and diluted earnings per share. In addition, stock options and a stock warrant for approximately 262,000 and
616,000 shares of common stock, respectively, were antidilutive and were not included in determining diluted
earnings per share.
Due to our net loss in 2009, approximately 91,000 unvested restricted shares were not included in determining both
basic and diluted earnings per share. In addition, stock options and a stock warrant for approximately 294,000 and
616,000 shares of common stock, respectively, were antidilutive and were not included in determining diluted
earnings per share.
Due to our net loss in 2008, approximately 113,000 unvested restricted shares were not included in determining
both basic and diluted earnings per share. In addition, stock options for approximately 323,000 shares of common
stock were antidilutive and were not included in determining diluted earnings per share.
Weighted average diluted common shares outstanding equals the weighted average basic common shares
outstanding during 2010, 2009 and 2008 due to the net losses recorded during those periods.
(Continued)
F-78
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 17 – SUBORDINATED DEBENTURES
Our trust, a business trust formed by Mercantile, was organized in 2004 for the purpose of issuing Series A and
Series B Preferred Securities. On September 16, 2004, our 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, our
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 our 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 our trust are the Series A and Series B Floating Rate Notes, and the only significant
liabilities of our 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.
NOTE 18 - REGULATORY MATTERS
We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy
guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are
not used to represent overall financial condition. If an institution is not well capitalized, regulatory approval is
required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if,
after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close
monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital
restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the
discretion of the federal regulator. At year-end 2010 and 2009, our Bank was in the well capitalized category under
the regulatory framework for prompt corrective action. There are no conditions or events since December 31, 2010
that we believe has changed our Bank’s categorization.
(Continued)
F-79
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 18 - REGULATORY MATTERS (Continued)
Our actual capital levels (dollars in thousands) and minimum required levels 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
$ 175,029
175,122
12.5%
12.5
$ 112,480
112,398
8.0%
8.0
$
NA
140,497
NA
10.0%
157,111
157,217
11.2
11.2
157,111
157,217
9.1
9.1
56,240
56,199
69,135
69,112
4.0
4.0
4.0
4.0
NA
84,299
NA
6.0
NA
86,389
NA
5.0
$ 193,157
191,146
11.2%
11.1
$ 138,169
138,051
8.0%
8.0
$
NA
172,563
NA
10.0%
171,244
169,251
171,244
169,251
9.9
9.8
8.6
8.6
69,085
69,026
79,325
79,119
4.0
4.0
4.0
4.0
NA
103,538
NA
6.0
NA
98,899
NA
5.0
2010
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
2009
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
Federal and state banking laws and regulations place certain restrictions on the amount of dividends our Bank can
transfer to Mercantile and on the capital levels that must be maintained. At year-end 2010, under the most
restrictive of these regulations (to remain well capitalized), our Bank could distribute approximately $33.4 million
to Mercantile as dividends without prior regulatory approval.
(Continued)
F-80
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 18 - REGULATORY MATTERS (Continued)
Our consolidated capital levels as of December 31, 2010 and December 31, 2009 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. Our ability to include the trust preferred securities in Tier 1 capital in
accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such
treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated
assets as of December 31, 2009 were less than $15.0 billion. At December 31, 2010 and December 31, 2009, all
$32.0 million of the trust preferred securities were included as Tier 1 capital of Mercantile.
NOTE 19 – U.S. TREASURY CAPITAL PURCHASE PROGRAM PARTICIPATION
On May 15, 2009, we completed the sale of preferred stock and a warrant for common stock to the United States
Treasury Department (“Treasury”) for $21.0 million under the Treasury’s Capital Purchase Program. The program
was designed to attract broad participation by healthy banking institutions to help stabilize the financial system and
increase lending for the benefit of the U.S. economy. Under the terms of the sale, the Treasury received 21,000
shares of fixed rate cumulative perpetual preferred stock with a liquidation value of $1,000 per share and a warrant
to purchase 616,438 shares of our common stock, no par value, in exchange for $21.0 million. The preferred stock
qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5.00% for the first five years, and 9.00%
thereafter. Subject to regulatory approval, we are generally permitted to redeem the preferred shares at par plus
unpaid dividends. The common stock warrant has a 10-year term and was immediately exercisable upon its
issuance, with an exercise price equal to $5.11 per share. The Treasury has agreed not to exercise voting power
with respect to any shares of common stock issued upon exercise of the warrant, while it holds the shares.
We allocated the $21.0 million in proceeds to the preferred stock and the common stock warrant based on their
relative fair values. To determine the fair value of the preferred stock, we used a discounted cash flow model that
assumed redemption of the preferred stock at the end of year 5. The discount rate utilized was 12.00% and the
estimated fair value was determined to be $15.5 million. The fair value of the common stock warrant was estimated
to be $0.9 million using the Black-Scholes option pricing model with the following assumptions: expected dividend
yield of 1.00%; risk-free interest rate of 1.99%; expected life of five years; expected volatility of 53.00%; and a
weighted average fair value of $3.92.
The aggregate fair value for both the preferred stock and the common stock warrant was determined to be $16.4
million, with 94.6% of this aggregate attributable to the preferred stock and 5.4% attributable to the common stock
warrants. Therefore, the $21.0 million issuance was allocated with $19.9 million being assigned to the preferred
stock and $1.1 million being assigned to the common stock warrant.
The sum of the $1.1 million difference between the $21.0 million face value of the preferred stock and the $19.9
million allocated to it upon issuance and $0.2 million of direct costs associated with the transaction, or $1.3 million,
was recorded as a discount on the preferred stock. The $1.3 million discount is being accreted, using the effective
interest method, as a reduction in net income available to common shareholders over the five-year period at
approximately $0.2 million to $0.3 million per year.
(Continued)
F-81
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 20 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components, other than net income (loss), and related taxes were as follows:
Unrealized holding gains (losses) on
available for sale securities
Unrealized holding gain on securities transferred
from held to maturity to available for sale
Change in net fair value of interest rate swaps
Reclassification adjustments for gains
later recognized in income
Tax effect of unrealized holding gains (losses)
on available for sale securities and
unrealized gain on interest rate swaps
Tax effect of unrealized holding gain on securities
transferred from held to maturity to available
for sale
Tax effect of reclassification adjustments for
gains later recognized in income
2010
2009
2008
$ (345,000)
$ (1,269,000)
$ 2,761,000
421,000
0
0
0
0
2,876,000
(99,000)
(23,000)
(1,803,000)
(3,072,000)
(974,000)
4,663,000
101,000
(147,000)
0
0
(1,973,000)
0
35,000
631,000
341,000
Other comprehensive income (loss)
$
(34,000)
$ (2,441,000)
$ 3,031,000
At December 31, 2010, accumulated other comprehensive income, net of tax effects (as applicable), consists of a
net unrealized gain on available for sale securities of $825,000.
At December 31, 2009, accumulated other comprehensive income, net of tax effects (as applicable), consists of a
net unrealized gain on available for sale securities of $795,000 and the remaining unrealized gain on interest rate
swaps of $64,000.
At December 31, 2008, accumulated other comprehensive income, net of tax effects, consists of a net unrealized
gain on available for sale securities totaling $2,064,000 and a fair value of interest rate swaps of $1,236,000.
(Continued)
F-82
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 21 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest
Income
Net Interest
Income
Net Income (Loss)
Attributable to
Common
Shares
Earnings (Loss) per Share
Diluted
Basic
$ 23,189,000
22,696,000
21,734,000
20,523,000
$14,306,000
14,421,000
13,935,000
13,687,000
$ (2,963,000)
(684,000)
(5,682,000)
(5,282,000)
$ (0.35)
(0.08)
(0.67)
(0.62)
$ 28,021,000
26,866,000
25,893,000
24,129,000
$11,805,000
12,450,000
13,567,000
13,511,000
$ (4,489,000)
(6,388,000)
(5,606,000)
(36,406,000)
$ (0.53)
(0.75)
(0.66)
(4.28)
$ 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
$ (0.35)
(0.08)
(0.67)
(0.62)
$ (0.53)
(0.75)
(0.66)
(4.28)
$ (0.44)
(0.31)
0.13
0.04
2010
First quarter
Second quarter
Third quarter
Fourth quarter
2009
First quarter
Second quarter
Third quarter
Fourth quarter
2008
First quarter
Second quarter
Third quarter
Fourth quarter
During the fourth quarter of 2009, we recorded a charge of $23.2 million to federal income tax expense to establish
a valuation allowance against our net deferred tax asset.
NOTE 22 – 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
2010
2009
$
1,233,000
158,043,000
1,013,000
$
1,928,000
170,111,000
1,455,000
$ 160,289,000
$ 173,494,000
$
1,363,000
32,990,000
125,936,000
$
400,000
32,990,000
140,104,000
Total liabilities and shareholders’ equity
$ 160,289,000
$ 173,494,000
(Continued)
F-83
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 22 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF INCOME
Income
Interest and dividends from subsidiaries
Total income
Expenses
Interest expense
Other operating expenses
Total expenses
2010
2009
2008
$ 1,104,000
1,104,000
$ 2,852,000
2,852,000
$ 4,739,000
4,739,000
848,000
1,551,000
2,399,000
1,048,000
2,514,000
3,562,000
1,914,000
2,431,000
4,345,000
Income (loss) before income tax expense (benefit) and
equity in undistributed net income (loss) of subsidiary
(1,295,000)
(710,000)
394,000
Federal income tax expense (benefit)
(47,000)
1,767,000
(1,417,000)
Equity in undistributed net income (loss) of subsidiary
(12,068,000)
(49,610,000)
(6,770,000)
Net income (loss)
(13,316,000)
(52,087,000)
(4,959,000)
Preferred stock dividends and accretion
1,295,000
802,000
0
Net income (loss) attributable to common shares
$ (14,611,000)
$ (52,889,000)
$ (4,959,000)
(Continued)
F-84
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
NOTE 22 – 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 (for) operating activities:
Equity in undistributed (income) loss of subsidiary
Stock-based compensation expense
Change in other assets
Change in other liabilities
Net cash from (for) operating activities
Cash flows from investing activities
Net capital investment into subsidiaries
Net cash for investing activities
Cash flows from financing activities
Proceeds from issuance of preferred stock and
common stock warrant, net
Employee stock purchase plan
Dividend reinvestment plan
Cash dividends on common stock
Cash dividends on preferred stock
Fractional shares paid
Net cash from (for) financing activities
2010
2009
2008
$ (13,316,000)
$ (52,087,000)
$ (4,959,000)
12,068,000
275,000
(124,000)
963,000
(134,000)
49,610,000
611,000
2,798,000
(194,000)
738,000
6,770,000
654,000
(1,023,000)
(661,000)
779,000
0
0
(19,000,000)
(19,000,000)
0
0
0
47,000
2,000
(85,000)
(525,000)
0
(561,000)
20,834,000
57,000
11,000
(594,000)
(525,000)
0
19,783,000
0
76,000
40,000
(2,625,000)
0
0
(2,509,000)
Net change in cash and cash equivalents
(695,000)
1,521,000
(1,730,000)
Cash and cash equivalents at beginning of period
1,928,000
407,000
2,137,000
Cash and cash equivalents at end of period
$ 1,233,000
$ 1,928,000
$
407,000
F-85
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 14, 2011.
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 14, 2011.
/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)
/s/ David M. Cassard
David M. Cassard, Director
/s/ Edward J. Clark
Edward J. Clark, Director
/s/ Doyle A. Hayes
Doyle A. Hayes, 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)
CORPORATE INFORMATION
2011 DIRECTORS AND
EXECUTIVE OFFICERS
David M. Cassard
Chairman, 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
Doyle A. Hayes
President, dhayesGroup
(consulting and manufacturing business);
Majority Member, Talent Trax, LLC
(staffing organization)
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
Retired 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
2011 STRATEGIC PLANNING TEAM
MERCANTILE BANK OF MICHIGAN
Mark A. Alcock
Senior Vice President, Retail Manager
Mark S. Augustyn
Senior Vice President, Commercial Loan Manager
SHAREHOLDER INFORMATION
Annual Meeting
The Corporation’s Annual Meeting of
Shareholders will be held on Thursday,
April 28, 2011, at Kent Country Club,
1600 College Ave. NE, Grand Rapids,
MI 49505 at 9:00 a.m. local time.
Sherri A. Calcut
Senior Vice President,
Mortgage & Consumer Loan Manager
Charles E. Christmas
Senior Vice President, Chief Financial Officer
Thomas L. Fitzgerald
Senior Vice President, Commercial Loan Manager
Thomas Q. Hoban
Senior Vice President
Commercial Loan Manager – Lansing
Sandy K. Jager
Senior Vice President, Internal Auditor
Amy W.M. Kam
Assistant Vice President, Senior Executive Assistant
Robert B. Kaminski, Jr.
President & Chief Operating Officer
Michael H. Price
Chairman & 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
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
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 USA, 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.
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.
bOLsTERiNg
hEALTh
fighTiNg
disEAsE
REsTORiNg
sTRENgThENiNg
digNiTy
ThE fUTURE
we are committed to
helping people build
a stronger future for
themselves. we
strive to deliver
results that reward
shareholders,
solutions that
empower customers,
and financial and
time contributions
that enhance the
quality of life in our
health intervention services
The American cancer society®
in the image is a faith-based
(his) provides medical and
conducts Relay for Life® to give
organization that links gently
dental services, counseling
people in communities across
used clothing, housewares,
and spiritual care to the
the globe a chance to celebrate
furniture and appliances with
communities.
medically uninsured of
the lives of people who have
families in need. Employees
west michigan. Twelve of our
battled cancer, remember
volunteer their time and
employees, one of whom is an
loved ones lost and fight
donate materials throughout
his board member, created
back against the disease.
the year, with special focus on
multiple fundraisers
we have participated in the
the s.h.O.E.s. (shoes help
throughout the year in
holland-Zeeland Relay for Life®
Our Elementary students)
support of wheel-a-thon,
the past five years. in 2010,
program, which distributed
an annual biking event.
20 employees walked
more than 8,500 pairs of
many employees participated
their way to raising
footwear in 2010.
in the 2010 wheel-a-thon,
approximately $5,000.
collectively raising $12,000.
3 1 0 L e o n a r d s t r e e t N w
g r a n d R a p i d s m i 4 9 5 0 4
8 8 8 . 3 4 5 . 6 2 9 6
w w w . m e r c b a n k . c o m
002cs10758
mercantile bank corporation is a registered trademark of mercantile bank corporation. mercmobile is a trademark of mercantile bank corporation. PayPal is a
registered trademark of PayPal, inc. Quicken and financeworks are registered trademarks of intuit inc. ebay is a registered trademark of ebay inc. march of dimes,
signature chefs Auction and march for babies are registered trademarks of march of dimes foundation. grand valley state University is a registered trademark of
grand valley state University. The American cancer society and Relay for Life are registered trademarks of American cancer society, inc.