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S H A R E H O L D E R S
“FOCUS” has been an integral factor in Mercantile Bank’s
success since we opened for business more than 14 years ago.
From the beginning, we promised customers that “Our Focus
Is On You” – and we delivered on that promise with products
and services specifically tailored to the unique needs of
individuals and businesses in West and Central Michigan.
The rewards of this focus were immediate and impressive,
as Mercantile quickly became one of the fastest growing
banks in Michigan history.
Our growth continued apace until 2008, when the
“Great Recession” ravaged America’s banking industry.
While our success up to that point had put us in a better
position to manage the crisis than many of our banking peers,
it was clear that decisive action was needed to maximize our
future potential.
FOCUS ON EMPOWERMENT
We conducted more than 70 hours of
financial literacy training for nearly
600 people through Grand Rapids
missions and ministries – and another
38 hours of “Teach a Child to Save”
classes at middle and elementary
schools throughout our service areas.
2
Mercantile Bank Corporation®’s Board of Directors and
Even after the recession officially ended in June 2009,
management team responded by developing a specific set
our customers and communities continued to struggle with
of initiatives designed to safeguard the Company and its
the aftershocks of the deepest economic slide since World
shareholders as much as possible from the potentially
War II. The banking industry remained in the midst of a
disastrous effects of an extended economic downturn. Our
recession-fueled restructuring process that had in many
focus never strayed from our mission to provide the very best
cases slashed shareholder value and in some cases led to the
customer experience possible. But we refocused our energies
dissolution of longstanding banking entities.
on improving our core fundamentals at the same time.
Our response to all this was to increase our efforts to
We zeroed in on strengthening our capital position and
improve our fundamentals. As we reinforced our reputation
improving our net interest margin while trimming overhead
for providing outstanding personal service to both business
costs, reducing our concentration of commercial real estate
and retail customers, we made steady and sometimes
loans, minimizing our reliance on wholesale funding, and
dramatic progress toward our strategic goals.
decreasing our level of nonperforming assets. We were also
determined to maintain our well-capitalized position
without issuing additional common equity.
We are pleased to report that the Company’s
2011 results affirm our vision and our execution of
that vision. We have emerged from the economic
downturn with excellent earnings momentum,
poised for success in the coming years.
FOCUS ON GIVING
One day each month, employees pay for the privilege
to wear jeans to the office. This “Giving Together”
promotion raised $5,511 for 12 different organizations,
including the Arthritis Foundation, Indian Trails Camp
and Latin Americans United for Progress.
3
Mercantile marked a true turning point in 2011, as we
As of December 31, 2011, our Bank’s total risk-based capital
returned to profitability with four consecutive quarters
ratio was 15.5%, up from 12.5% at year-end 2010, and its
of positive earnings. We substantially increased net profits,
level of total capital was approximately $67 million higher
significantly decreased nonperforming assets, strengthened
than the amount necessary to attain the regulatory benchmark
our net interest margin, enhanced our regulatory capital
of 10% for a well-capitalized bank. Our liquidity position
ratios, improved our liquidity position and dramatically
benefited from substantial local deposit growth – local deposit
reduced our reliance on wholesale funding – all while
and sweep accounts increased by $7 million in the 4th quarter
lowering our operating costs.
of 2011 and were up about $289 million from 2008, the
beginning of the Great Recession.
THE FIGURES BEHIND THE FACTS
The numbers tell the story: We realized net income of
NET INCOME
$36.1 million for the full year of 2011, compared to a net
loss of $14.6 million in 2010. Nonperforming assets declined
by 30% since year-end 2010, and our loan loss provision
expense was down by 78%. Our net interest margin was
3.60% in 2011, up about 9% from the margin of
3.31% in 2010.
$40,000
$30,000
$20,000
$10,000
$0
$(10,000)
$(20,000)
$(30,000)
$(40,000)
$(50,000)
$(60,000)
$36,142
$8,966
$(4,959)
$(14,611)
$(52,889)
2007
2008
2009
2010
2011
FOCUS ON ENTREPRENEURS
We decided to sweeten the pot for
5x5 Night, a monthly Grand Rapids
event in which five people pitch their
“world-changing” ideas for the chance
to win all or part of a $5,000 prize. We
created $5 tokens to be given to event
attendees, who in turn “invest” them
in their favorite ideas – whether or not
those favorites won the judges’ vote.
4
FOCUS ON LIFE
Virtually every single employee at
every office has been involved with
the American Cancer Society’s
Relay for Life. We raised $14,344
in 2011 – and more than $172,000
in personal contributions since
the Bank became a lead sponsor
seven years ago.
Wholesale funds represented 31% of total funds at year-end
While we recognize that there is still work to do, it is
2011, down from 40% at year-end 2010. Given that
indisputable that Mercantile Bank Corporation is stronger
wholesale funds comprised 72% of total funds at year-end
today than at any point in the last three years. We enter
2008, this is quite a remarkable achievement, driven by
2012 riding a wave of sustained profitability and we are
our success at growing local deposits and crafting a
poised to continue our success as a major competitor in
smaller balance sheet.
the markets we serve.
We are very pleased by these results, especially since the
It’s worth noting that our 2011 performance is not just
numbers became more positive with each passing quarter.
objectively impressive, it’s also excellent relative to our peers.
STOCK PRICE
$16
$15.50
$14
$12
$10
$8
$6
$4
$2
$0
$4.30
$3.08
This represents an opportunity for our Bank to capture
greater market share, as many customers prefer to work
with strong and vital community banks. We continue to
aggressively market our capabilities, leading with advertising
$9.75
$8.20
and social media campaigns for the retail market, and
traditional person-to-person contact for the business sector.
We are very optimistic about our ability to attract more
customers in both segments going forward.
12/31/07
12/31/08
12/31/09
12/31/10
12/31/11
FOCUS ON CONNECTION
We engaged our very active online community to give a “Social Shout Out!”
to their favorite charities. Camp Fire USA West Michigan received the most
shout outs on our Facebook page and we donated $500 to the organization.
5
AN EVOLUTION IN BANKING
primarily from word of mouth generated by business owners
Today, propelled by the renewed strength of our
who touted us to their families, friends and employees.
fundamentals, we are presenting a Mercantile Bank that is
more diversified than ever before. Certainly, we remain
Even before the recession took hold, we began taking
relentlessly committed to delivering the best customer service
steps to broaden our appeal beyond the business community.
in our markets, driven by a consultative relationship model
That effort took on increased urgency as local companies
that adds value to the banking experience. Our customers
reduced spending and investment, and we simultaneously
continue to see us as more than a place to safeguard their
tightened our lending practices. We rewrote our marketing
money – they regard us as a trusted financial advisor that
plan to devote more time and effort to retail customers,
can help them achieve greater success.
a strategy that has proven just as successful as our focus
While we continue to help our customers succeed, we have
on fundamentals.
adjusted our approach to building business. Mercantile Bank
Today, Mercantile Bank enjoys a higher profile with the
began operation in 1997 primarily as a business bank
citizens of West and Central Michigan. Increasingly, retail
dedicated to serving small to mid-size companies. We offered
customers realize that we offer all the products and services
a full complement of retail (personal) banking products,
of the area’s large out-of-state banks, with none of the
but we didn’t really market them. Our retail business grew
large-bank hassle. This is an enviable position for us and we
FOCUS ON HEALTH
In October, 25 employees
rode in the Wheel-a-thon for
Health and Hope to benefit
Health Intervention Services
(HIS), which serves those
without access to health
care or affordable health
insurance. Throughout
the year, employees raised
$18,000 for HIS.
6
FOCUS ON KIDS
In March, we collected 700 books for National Reading Month.
In August, we collected school supplies for Grand Rapids Public
Schools through the “Stuff the Bus” program organized by
Heart of West Michigan United Way’s Schools of Hope.
In November, we faced another area bank on the basketball
court to benefit Boys
& Girls Clubs of
Grand Rapids Youth
Commonwealth –
an event that raised
$20,000.
are taking advantage of it in every way we can, from making
volume of payment flows electronically. The response to all of
it easier for customers to switch their accounts to introducing
these technologies has been enthusiastic, as customers eagerly
technologies that ease the task of personal banking.
embrace ways to incorporate banking into today’s lifestyles.
In fact, we are building a reputation as the go-to bank for
Also in 2011, we introduced a new checking product,
cutting-edge technologies. We were among the first in the
Mercantile WOW Checking, which is free to customers
market to offer such innovations as mobile banking
who opt for electronic statements and actively utilize their
(MercMobile®), remote deposit capture (Merc@Home®
account. This, too, has been avidly accepted by customers.
Online Deposit) and personal payments via mobile devices
(MercMobile® Personal Payments powered by PayPal™).
While we will continue to aggressively enhance our retail
In 2011, we debuted MercMobile® Deposit, which enables
strategy, we are by no means abandoning our solid business
our customers to deposit checks into their accounts by
base. Indeed, now that we’ve made such progress in cleaning
taking photos of the checks on their Apple or Android
up nonperforming loans and improving our balance sheet, we
device. On the business front, we are the first bank on the
are intent on boosting our commercial loan production in a
planet to partner with Bill.com, Inc. to offer our customers a
careful and measured way. Businesses are growing again, and
solution that makes accounts receivable and payable processes
we are poised to help them capitalize on new opportunities.
more efficient, and improves cash flow by increasing the
FOCUS ON PERSONALIZATION
We introduced the Mercantile My Card™ Debit Card –
customers can get it imprinted with their favorite
photo just by uploading the
image to our website.
7
THE ART OF COMMUNITY SERVICE
radically open arts competition – winners are chosen by
Just as we continued to invest in marketing and technology
popular vote – ArtPrize is a popular Grand Rapids event.
during the economic downturn, we maintained our record
For the past three years, upwards of 300,000 people have
of strong corporate citizenship within our communities.
ventured downtown to view the works of more than
Our donations of time and money were vitally important for
1,500 artists for 19 days in autumn. It’s a tremendous
thousands of Michigan residents facing hard times of late.
economic boon for the city and an eye-opening, soul-stirring
We recalibrated our philanthropic mix over the past three
experience for visitors.
years to include even more social service organizations
devoted to helping families secure food and shelter.
In the past, Mercantile hosted exhibits at its Grand Rapids
The Bank donated in excess of $250,000 to charitable causes
office, which is on the edge of the downtown area. In 2011,
in 2011. Furthermore, although our employees were
we repurposed a vacant building in the center of the city
working harder and longer to keep the Company moving
into a showcase for seven artists who created works using
forward, they still lent a helping hand to those who needed
various technological media. We also partnered with
it: Mercantile employees averaged 53 hours of assistance to
the West Michigan affiliate of Susan G. Komen for
various charities and causes last year.
the Cure to create an interactive exhibit raising
awareness of breast cancer.
Some of those hours were spent creating a special Mercantile
Bank exhibit at ArtPrize. Billed as the world’s largest, most
FOCUS ON A CURE
We partnered with Susan G. Komen for the Cure-West Michigan
to raise breast cancer awareness at ArtPrize, West Michigan’s
unique art competition. Cancer survivors, and friends and
family of cancer survivors, contributed their initials to an
interactive exhibit at our pop-up art gallery in the heart of
downtown Grand Rapids.
8
Our exhibition was a huge success, measured both by the
We welcome in their stead four new members, formally
number of people that toured it and by the connection
appointed to the Board of Directors in October 2011:
visitors drew between Mercantile Bank and technology.
Robert Kaminski, Jr., Executive Vice President, Chief
So we reinforced our brand even as we gave back to the
Operating Officer and Secretary of Mercantile; Michael Faas,
community. That’s the definition of win-win.
President of Metro Health Corporation; John Donnelly,
We thank all the employees who invested many hours
Donnelly Corporation; and Kirk Agerson, Medical Doctor.
helping with this event and many other charitable activities
We have already benefitted from their unique insights
throughout the year.
and talents, and we look forward to working with them
retired Senior Vice President of Sales and Marketing for
long into the future.
TOWARD THE FUTURE
It’s a future we are anticipating with great enthusiasm as
We also want to thank two members of the Mercantile Bank
we enter our 15th year of operation. We remain focused on
Corporation Board of Directors who decided to retire
doing all we can to create maximum value for our customers,
this year. We owe a huge debt of gratitude to Dale Visser,
communities, employees and shareholders. We believe
an original Director, and Merle Prins, a Director since 2004.
we all will be rewarded as a result.
We wish both gentlemen the very best in the next stage
of their lives.
FOCUS ON FUN
We uploaded photos of visitors
taken at our ArtPrize gallery to an
innovative digital billboard along a
busy Grand Rapids freeway. Visitors
captured their own images using our
touch screen kiosks.
9
Thank you for your continued support. We wish all of you peace and prosperity in 2012.
Michael H. Price
Chairman
President
Chief Executive Officer
Robert B. Kaminski, Jr.
Executive Vice President
Chief Operating Officer
Secretary
Charles E. Christmas
Senior Vice President
Chief Financial Officer
Treasurer
2011 Board of Directors: (L-R ) Michael Faas, Edward Clark, Timothy Schad, Susan Jones, Kirk Agerson, Lawrence Larsen,
Robert Kaminski, Donald Williams, Michael Price, David Cassard, Calvin Murdock, John Donnelly and Doyle Hayes.
201l Executive Officers: (L-R) Robert Kaminski, Michael Price and Charles Christmas.
10
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________ to ____________________________
For the fiscal year ended December 31, 2011
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 X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]
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 $69.1 million.
As of February 1, 2012, there were issued and outstanding 8,605,007 shares of the registrant’s common stock.
Portions of the proxy statement for the 2012 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,
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.
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.
2.
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.
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.
3.
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 has expanded, and
continues to expand, as a result of the adoption in July, 2010 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the “Dodd-Frank Act”), and of implementing regulations that are being adopted by
federal regulators. 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, 2011, we employed 206 full-time and 55 part-time persons. Management
believes that relations with employees are good.
Lending Policy
As a routine part of our business, we make loans to businesses and individuals located within our
market areas. Our lending policy states that the function of the lending operation is twofold: to provide a
means for the investment of funds at a profitable rate of return with an acceptable degree of risk, and to meet
the credit needs of the creditworthy businesses and individuals who are our customers. We recognize that in
the normal business of lending, some losses on loans will be inevitable and should be considered a part of the
normal cost of doing business.
4.
Our lending policy anticipates that priorities in extending loans will be modified from time to time as
interest rates, market conditions and competitive factors change. The policy sets forth guidelines on a
nondiscriminatory basis for lending in accordance with applicable laws and regulations. The policy describes
various criteria for granting loans, including the ability to pay; the character of the customer; evidence of
financial responsibility; purpose of the loan; knowledge of collateral and its value; terms of repayment; source
of repayment; payment history; and economic conditions.
The lending policy further limits the amount of funds that may be loaned against specified types of
real estate collateral. For certain loans secured by real estate, the policy requires an appraisal of the property
offered as collateral by a state certified independent appraiser. The policy also provides general guidelines for
loan to value for other types of collateral, such as accounts receivable and machinery and equipment. In
addition, the policy provides general guidelines as to environmental analysis, loans to employees, executive
officers and directors, problem loan identification, maintenance of an allowance for loan losses, loan review
and grading, mortgage and consumer lending, and other matters relating to our lending practices.
The Board of Directors has delegated significant lending authority to officers of our bank. The Board
of Directors believes this empowerment, supported by our strong credit culture and the significant experience
of our commercial lending staff, enables us to be responsive to our customers. The loan policy specifies
lending authority for our lending officers with amounts based on the experience level and ability of each lender.
Loan officers’ authorities are generally $1.0 million or less, while loan managers are able to approve loans up
to $2.5 million. We have established higher limits for our bank’s Senior Lender, President, and Chairman of
the Board and Chief Executive Officer, ranging from $5.0 million up to $10.0 million. These lending
authorities, however, are typically 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 primarily in our
market areas. Our commercial lenders have extensive commercial lending experience, with most having at
least ten years’ experience. Loans are originated for general business purposes, including working capital,
accounts receivable financing, machinery and equipment acquisition, and commercial real estate financing,
including new construction and land development.
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 a floating interest rate tied to the Mercantile Bank Prime Rate, Wall
Street Journal Prime Rate or 30-day Libor rate. Loans 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 typically have an interest
rate that is fixed to maturity or is tied to the Mercantile Bank Prime Rate, Wall Street Journal Prime Rate or 30-
day Libor rate.
5.
We evaluate many aspects of a commercial loan transaction in order to minimize credit and interest
rate risk. Underwriting includes an assessment of the management, products, markets, cash flow, capital,
income and collateral. This analysis includes a review of the borrower’s historical and projected financial
results. Appraisals are generally required to be performed by certified independent appraisers where real estate
is the primary collateral, and in some cases, where equipment is the primary collateral. In certain situations, for
creditworthy customers, we may accept title reports instead of requiring lenders’ policies of title insurance.
Commercial real estate lending involves more risk than residential lending because loan balances are
typically greater and repayment is dependent upon the borrower’s business operations. We attempt to minimize
the risks associated with these transactions by generally limiting our commercial real estate lending to owner-
operated properties and to owners of non-owner occupied properties who have an established profitable history
and satisfactory tenant structure. In many cases, risk is further reduced by requiring personal guarantees,
limiting the amount of credit to any one borrower to an amount considerably less than our legal lending limit
and avoiding certain types of commercial real estate financings.
We have no material foreign loans, and only limited exposure to companies engaged in energy
producing and agricultural-related activities.
Single-Family Residential Real Estate Loans. 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 and are
generally sold to certain investors.
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 Portfolio Quality
We utilize a comprehensive grading system for our commercial loans as well as for our residential
mortgage and consumer loans. All commercial loans are graded on a ten grade rating system. The rating
system utilizes standardized grade paradigms that analyze several critical factors such as cash flow, operating
performance, financial condition, collateral, industry condition and management. All commercial loans are
graded at inception and reviewed 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 review program is primarily responsible for the administration of the grading
system and ensuring adherence to established lending policies and procedures. The loan review program is an
integral part of maintaining our strong asset quality culture. The loan review function works closely with senior
management, although it functionally reports to the Board of Directors. All commercial loan relationships
equal to or exceeding $1.5 million are formally reviewed every twelve months, with a random sampling
performed on credits under $1.5 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 review functions.
Loans 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, 2011, loans placed in nonaccrual status totaled $45.1
million, or 4.2% of total loans. We had no loans past due 90 days or more and still accruing interest at year-
end 2011.
Additional detail and information relative to the loan portfolio is incorporated by reference to
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s
Discussion and Analysis”) and Note 3 of the Notes to Consolidated Financial Statements in this Annual Report.
Allowance for Loan Losses
In each accounting period, we adjust the allowance for loan losses (“allowance”) to the amount we
believe is necessary to maintain the allowance at an adequate level. Through the loan review and credit
departments, we establish specific portions of the allowance based on specifically identifiable problem loans.
The evaluation of the allowance is further based on, but not limited to, consideration of the internally prepared
Allowance Analysis, loan loss migration analysis, composition of the loan portfolio, third party analysis of the
loan administration processes and portfolio, and general economic conditions.
The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan balances,
which is combined with specific reserves to calculate an overall allowance dollar amount. For non-impaired
commercial loans, which continue to comprise a vast majority of our total loans, 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 portfolio into five classes: 1) commercial and industrial loans; 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 charge-offs through a migration analysis whereby net loan
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 portfolio; experience, ability and depth of management and
lending staff; volume and severity of past due, nonaccrual and adversely classified loans; effectiveness of the
loan 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, 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, 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. 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 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 losses, it is not able to
fully account for environmental factors that will also very likely impact the collectability of our commercial
loans 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 risk ratings. Although we have been consistent in our approach to commercial loan 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 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 over the past several years. To more
effectively manage our commercial loan portfolio, we created a specific group tasked with managing our higher
exposure lending relationships.
The most significant external environmental factor is the assessment of the current economic
environment and the resulting implications on our commercial loan 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 portfolio.
The primary risk elements with respect to commercial loans are the financial condition of the
borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting
and reviewing periodic financial statements from commercial loan customers and employ a disciplined and
formalized review of the existence of collateral and its value. The primary risk element with respect to each
residential real estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting
system that monitors past due loans 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 portfolio, we
have substantially increased the allowance as a percent of the loan portfolio over the past several years. The
allowance equaled $36.5 million, or 3.4% of total loans outstanding, as of December 31, 2011, compared to
3.6%, 3.1%, 1.5% and 1.4% at year-end 2010, 2009, 2008 and 2007, 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.
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. During 2011, economic conditions in our markets, the United States and worldwide did generally
improve; however, there can be no assurance that this improvement will continue.
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 commercial real estate segments
of our loan 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, 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
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 declines in the economies of these areas have adversely
affected us. Continued stress on our financial condition is likely even as economic conditions begin to 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.
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. In October, 2008, then President Bush signed the Emergency Economic Stabilization Act of
2008 (the “EESA”). Among other things, the EESA established the Troubled Asset Relief Program (“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 “Capital Purchase Program”). In February, 2009, President Obama signed 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, as well as programs of quantitative
easing through direct purchases of certain Treasury securities. The FDIC and the Treasury Department also
implemented further measures to address the crisis in the financial services sector. Further legislation
providing tax relief and other economic stimulus was adopted by Congress in 2010 and 2011. There can be no
assurance as to the actual impact of these laws, 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.
11.
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, prohibitions on proprietary trading and sponsorship or
investment in hedge funds and private equity funds by insured depository institutions and their affiliates,
heightened regulation of hedging and derivatives activities, a greater focus on consumer protection issues, in
part through the formation of a new Consumer Financial 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 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’s provisions have delayed effective dates, some of which have not yet occurred. In addition,
other provisions require implementing regulations of various federal agencies, some of which have not yet been
adopted in final form. 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 or
the value of our assets, or otherwise adversely affect our business.
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 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 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.
12.
In addition, we continue to depend on our key commercial loan officers. Several of our commercial
loan officers are responsible, or share responsibility, for generating and managing a significant portion of our
commercial loan portfolio. Our success can be attributed in large part to the relationships these officers as well
as members of our management team have developed and are able to maintain with our customers as we
continue to implement our community banking philosophy. The loss of any of these commercial loan officers
could adversely affect our loan portfolio and performance, and our ability to generate new loans. Many of our
key employees have signed agreements with us agreeing not to compete with us in one or more of our markets
for specified time periods if they leave employment with us.
Some of the other financial institutions in our markets also require their key employees to sign
agreements that preclude or limit their ability to leave their employment and compete with them or solicit their
customers. These agreements make it more difficult for us to hire loan officers with experience in our markets
who can immediately solicit their former or new customers on our behalf.
Decline in the availability of out-of-area deposits could cause liquidity or interest rate margin concerns,
or limit our growth.
We have utilized, and expect to continue to utilize, out-of-area or wholesale deposits to support our
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.
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.
13.
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.
Minimum capital requirements may increase.
The provisions of the Dodd-Frank Act relating to capital to be maintained by financial institutions
approach convergence with the standards (generally known as Basel III) adopted in December, 2010 by the
Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking
Supervision. Among other things, those standards contain a narrower definition of elements qualifying for
inclusion as Tier 1 capital, and higher minimum risk-based capital levels, than those required under current
U.S. law and regulations. Responsible officials of the federal bank regulatory agencies have suggested that the
agencies may issue proposed regulations, possibly as early as 2012, that would impose increased minimum risk-
based capital requirements applicable to all insured depository institutions comparable to those required under
Basel III. There can be no assurance when or if such regulatory changes may be proposed or if proposed,
become effective.
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.
14.
We continually encounter technological change, and we may have fewer resources than our competitors
to continue to invest in technological improvements.
The banking industry is undergoing technological changes with frequent introductions of new
technology-driven products and services. In addition to better serving customers, the effective use of
technology increases efficiency and enables financial institutions to reduce costs. Our future success will
depend, in part, on our ability to address the needs of our customers by using technology to provide products
and services that will satisfy customer demands for convenience as well as create additional efficiencies in our
operations. Many of our competitors have substantially greater resources to invest in technological
improvements than we do. There can be no assurance that we will be able to effectively implement new
technology-driven products and services or be successful in marketing these products and services to our
customers.
Our Articles of Incorporation and By-laws and the laws of the State of Michigan contain provisions that
may discourage or prevent a takeover of our company and reduce any takeover premium.
Our Articles of Incorporation and By-laws, and the corporate laws of the State of Michigan, include
provisions which are designed to provide our Board of Directors with time to consider whether a hostile
takeover offer is in our and our shareholders’ best interest. These provisions, however, could discourage
potential acquisition proposals and could delay or prevent a change in control. The provisions also could
diminish the opportunities for a holder of our common stock to participate in tender offers, including tender
offers at a price above the then-current market price for our common stock. These provisions could also
prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-
current market prices, and may limit the ability of our shareholders to approve transactions that they may deem
to be in their best 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 By-laws, federal law requires the Federal Reserve Board’s
approval prior to acquiring “control” of a bank holding company. All of these provisions may delay or prevent
a change in control without action by our shareholders and could adversely affect the price of our common
stock.
There is a limited trading market for our common stock.
The price of our common stock has been, and will likely continue to be, subject to fluctuations based
on, among other things, economic and market conditions for bank holding companies and the stock market in
general, as well as changes in investor perceptions of our company. The issuance of new shares of our common
stock also may affect the market for our common stock.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “MBWM.” The
development and maintenance of an active public trading market depends upon the existence of willing buyers
and sellers, the presence of which is beyond our control. While we are a publicly-traded company, the volume
of trading activity in our stock is still relatively limited. Even if a more active market develops, there can be no
assurance that such a market will continue, or that our shareholders will be able to sell their shares at or above
the 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.
15.
Our business is subject to operational risks.
We, like most financial institutions, are exposed to many types of operational risks, including the risk
of fraud by employees or outsiders, unauthorized transactions by employees or operational errors. Operational
errors may include clerical or record keeping errors or those resulting from faulty or disabled computer or
telecommunications systems. Given our volume of transactions, certain errors may be repeated or compounded
before they are discovered and successfully corrected. Our necessary dependence upon automated systems to
record and process our transaction volume may further increase the risk that technical system flaws or
employee tampering or manipulation of those systems will result in losses that are difficult to detect.
We may also be subject to disruptions of our operating systems arising from events that are wholly or
partially beyond our control, including, for example, computer viruses or electrical or telecommunications
outages, which may give rise to losses in service to customers and to loss or liability to us. We are further
exposed to the risk that our external vendors may be unable to fulfill their contractual obligations to us, or will
be subject to the same risk of fraud or operational errors by their respective employees as are we, and to the risk
that our or our vendors’ business continuity and data security systems prove not to be adequate. We also face
the risk that the design of our controls and procedures proves 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 2011 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.
16.
During 2002, our bank designed and constructed a full service branch which opened in December of
2002 in the City of Kentwood, a southeast suburb of Grand Rapids. The land had been purchased by our bank
in 2001. The facility is one story and has approximately 10,000 square feet of usable space. The facility has
multiple drive-through lanes and ample parking space. The address of this facility is 4860 Broadmoor Avenue
SW, Kentwood, Michigan.
During 2003, our bank designed and constructed a full service branch in the northeast quadrant of the
City of Grand Rapids. The land had been purchased by our bank in 2002. The facility is one story and has
approximately 3,500 square feet of usable space. The facility has multiple drive-through lanes and ample
parking space. The address of this facility is 3156 Knapp Street NE, Grand Rapids, Michigan.
During 2003, our bank designed and started construction of a new two-story facility located in
Holland, Michigan. This facility, which was completed during the fourth quarter of 2004, serves as a full
service banking center for the Holland area, including commercial lending, retail lending and a full service
branch. The facility, which is owned by our bank, consists of approximately 30,000 square feet of usable space
and contains multiple drive-through lanes with ample parking. The address of this facility is 880 East 16th
Street, Holland, Michigan.
During 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. Mine Safety Disclosures.
Not applicable.
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, 2012, there were 342 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.
17.
High Low Dividend
2011
First Quarter .............................................
Second Quarter ........................................
9.85
Third Quarter ........................................... 10.09
9.99
Fourth Quarter .........................................
$ 10.26
$ 7.82
7.60
7.72
7.51
$ 0.00
0.00
0.00
0.00
2010
First Quarter .............................................
Second Quarter ........................................
Third Quarter ...........................................
Fourth Quarter .........................................
$ 4.06
$ 3.10
3.95
3.99
3.87
$ 0.01
0.00
0.00
0.00
6.66
5.99
8.40
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 resulted 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. On October 18, 2011, we announced via a Form 8-K filed with the Securities and Exchange Commission
that we were bringing all of the accrued and unpaid interest (approximately $1.28 million) current on the
subordinated debentures on that date, thereby providing for the distributions on our trust preferred securities to
also be brought current on that date. We also announced that on October 19, 2011, we intended to bring
current all accrued and unpaid dividends (approximately $1.36 million) on our preferred stock through October
18, 2011, which in fact we did consummate as planned. We had been accruing during the deferral period for
the unpaid interest under the subordinated debentures and undeclared dividends under the preferred stock. We
have made all scheduled payments on our subordinated debentures and preferred stock since, and we expect to
make the scheduled payments in future periods.
18.
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, from July 2010 through October 2011, we were precluded from paying cash dividends on
our common stock and preferred stock because, under the terms of our subordinated debentures, we could not
pay cash dividends during periods when we had deferred the payment of interest on our subordinated
debentures. Also, pursuant to our Articles of Incorporation, we were precluded from paying dividends on our
common stock while any dividends accrued on our preferred stock had not been declared and paid. As
discussed above, those restrictions were removed on October 18 and 19, 2011, when we terminated the deferral
of interest on our subordinated debentures and brought current the dividends on our preferred stock,
respectively.
Issuer Purchases of Equity Securities
We did not purchase any shares of our common stock during the fourth quarter of 2011.
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,
2006 through December 31, 2011. The following is based on an investment of $100 on December 31, 2006 in
our common stock, the Nasdaq Composite Index and the SNL Bank Nasdaq Index, with dividends reinvested
where applicable.
19.
Total Return Performance
125
100
75
50
25
e
u
l
a
V
x
e
d
n
I
0
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
12/31/11
Mercantile Bank Corporation
NASDAQ Composite
SNL Bank NASDAQ
Index
Mercantile Bank Corporation
NASDAQ Composite
SNL Bank NASDAQ
Period Ending
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
12/31/11
100.00
100.00
100.00
44.22
110.66
78.51
12.62
66.42
57.02
9.20
96.54
46.25
24.55
114.06
54.57
29.20
113.16
48.42
Item 6.
Selected Financial Data.
The Selected Financial Data 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, 2011, 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, 2011.
There have been no significant changes in our internal control over financial reporting during the
quarter ended December 31, 2011, 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, 2011. 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, 2011. Refer to page F-38 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 26, 2012 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.
21.
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, John F. Donnelly, Calvin D. Murdock, 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, Donnelly, Murdock, and Schad are independent, as independence for audit committee
members is defined in the Nasdaq listing standards and the rules of the Securities and Exchange Commission.
Item 11. Executive Compensation.
The information presented under the captions “Executive Compensation,” “Corporate Governance –
Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the
Proxy Statement is incorporated here by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
The information presented under the caption “Stock Ownership of Certain Beneficial Owners and
Management” in the Proxy Statement is incorporated here by reference.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2011, 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)
214,903
$ 22.40
429,000 (2)
0
0
0
Plan Category
Equity compensation
plans approved by
security holders (1)
Equity compensation
plans not approved by
security holders
Total
214,903
$ 22.40
429,000
(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.
22.
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.
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, 2012 – BDO USA, LLP
Consolidated Balance Sheets --- December 31, 2011 and 2010
Consolidated Statements of Operations for each of the three years in the period ended December 31,
2011
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period
ended December 31, 2011
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
2011
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
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 By-laws 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
23.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
Our 1997 Employee Stock Option Plan is incorporated by reference to exhibit
10.1 of our Registration Statement on Form SB-2 (Commission File No. 333-
33081) that became effective on October 23, 1997 *
Our 2000 Employee Stock Option Plan is incorporated by reference to exhibit
10.14 of our Form 10-K for the year ended December 31, 2000 *
Our 2004 Employee Stock Option Plan is incorporated by reference to exhibit
10.1 of our Form 10-Q for the quarter ended September 30, 2004 *
Form of Stock Option Agreement for options under the 2004 Employee Stock
Option Plan is incorporated by reference to exhibit 10.2 of our Form 10-Q for the
quarter ended September 30, 2004 *
Our Independent Director Stock Option Plan is incorporated by reference to
exhibit 10.26 of our Form 10-K for the year ended December 31, 2002 *
Form of Stock Option Agreement for options under the Independent Director
Stock Option Plan is incorporated by reference to exhibit 10.1 of our Form 8-K
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
24.
EXHIBIT NO.
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
EXHIBIT DESCRIPTION
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 *
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 *
25.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
Second Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Michael H. Price is incorporated by reference
to exhibit 10.29 of our Form 10-K for the year ended December 31, 2005 *
Third Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Robert B. Kaminski, Jr. is incorporated by
reference to exhibit 10.30 of our Form 10-K for the year ended December 31,
2005 *
Second Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Charles E. Christmas is incorporated by
reference to exhibit 10.31 of our Form 10-K for the year ended December 31,
2005 *
Form of Mercantile Bank of Michigan Amended and Restated Executive Deferred
Compensation Agreement dated November 18, 2006, that has been entered into
between our bank and each of Gerald R. Johnson, Jr., Michael H. Price, Robert B.
Kaminski, Jr., Charles E. Christmas, and certain other officers of our bank is
incorporated by reference to exhibit 10.34 of our Form 10-K for the year ended
December 31, 2007 *
Form of First Amendment to the Mercantile Bank of Michigan Executive Deferred
Compensation Agreement dated November 18, 2006, that has been entered into
between our bank and each of Gerald R. Johnson, Jr., Michael H. Price, Robert B.
Kaminski, Jr., Charles E. Christmas, and certain other officers of our bank, dated
October 25, 2007 is incorporated by reference to exhibit 10.35 of our Form 10-K
for the year ended December 31, 2007 *
Form of Second Amendment to the Mercantile Bank of Michigan Executive
Deferred Compensation Agreement date November 18, 2006, that has been
entered into between our bank and each of Michael H. Price, Robert B. Kaminski,
Charles E. Christmas, and certain other officers of our bank, dated October 23,
2008 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 *
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 *
26.
EXHIBIT NO.
10.36
10.37
10.38
10.39
10.40
10.41
10.42
10.43
10.44
10.45
10.46
EXHIBIT DESCRIPTION
Form of Notice of Grant of Incentive Stock Option and Stock Option Agreement
for incentive stock options granted in 2006 under our Stock Incentive Plan of 2006
is incorporated by reference to exhibit 10.1 of our Form 8-K filed November 22,
2006 *
Form of Notice of Grant of Incentive Stock Option and Stock Option Agreement
for incentive stock options granted after 2006 under our Stock Incentive Plan of
2006 is incorporated by reference to exhibit 10.41 of our Form 10-K for the year
ended December 31, 2007 *
Form of Restricted Stock Award Agreement Notification of Award and Terms and
Conditions of Award for restricted stock granted in 2006 under our Stock
Incentive Plan of 2006 is incorporated by reference to exhibit 10.2 of our Form 8-
K filed November 22, 2006 *
Form of Restricted Stock Award Agreement Notification of Award and Terms and
Conditions of Award for restricted stock granted after 2006 under our Stock
Incentive Plan of 2006 is incorporated by reference to exhibit 10.43 of our Form
10-K for the year ended December 31, 2007 *
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
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
27.
EXHIBIT NO.
10.47
21
23
31
32.1
32.2
99.1
101
EXHIBIT DESCRIPTION
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
The following information from Mercantile’s Annual Report on Form 10-K for the
year ended December 31, 2011, formatted in XBRL (eXtensible Business
Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated
Statements of Operations, (iii) the Consolidated Statements of Changes in
Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the
Notes to Consolidated Financial Statements **
* Management contract or compensatory plan.
** Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 are deemed not filed or
part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as
amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended,
and otherwise are not subject to liability under those sections.
(c)
Financial Statements Not Included In Annual Report
Not applicable
28.
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2011 and 2010
F-1
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2011 and 2010
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-36
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING ................................................................................................ F-38
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS ..................................................................................................... F-39
CONSOLIDATED STATEMENTS OF OPERATIONS .............................................................................. F-40
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY .............................. F-42
CONSOLIDATED STATEMENTS OF CASH FLOWS.............................................................................. F-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ................................................................... F-47
F-2
SELECTED FINANCIAL DATA
2011
2010
2009
(Dollars in thousands except per share data)
2008
2007
Consolidated Results of Operations:
Interest income
Interest expense
Net interest income
Provision for loan 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
Allowance for loan losses
Bank owned life insurance
Deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated debentures
Shareholders’ equity
Consolidated Financial Ratios:
$ 71,069 $ 88,143
31,794
56,349
31,800
9,244
47,156
(13,363)
(47)
(13,316)
1,295
$ 36,142 $ (14,611)
19,832
51,237
6,900
7,282
41,495
10,124
(27,361)
37,485
1,343
$ 104,909 $ 121,072 $ 144,181
88,624
74,863
53,576
55,557
46,209
51,333
11,070
21,200
59,000
5,870
7,282
7,558
38,356
42,126
46,488
12,001
(9,835)
(46,597)
3,035
(4,876)
5,490
8,966
(4,959)
(52,087)
0
0
802
$ (52,889) $ (4,959) $ 8,966
$1,433,229 $1,632,421 $1,906,208 $2,208,010 $2,121,403
29,430
76,372
25,804
21,735
257,384
184,953
211,736
242,787
1,539,818 1,856,915 1,799,880
1,072,422
25,814
27,108
47,878
36,532
39,118
42,462
45,024
48,520
64,198
235,175
1,262,630
45,368
46,743
1,112,075
72,569
45,000
32,990
164,999
1,273,832
116,979
65,000
32,990
125,936
1,401,627 1,599,575 1,591,181
97,465
94,413
99,755
180,000
270,000
205,000
32,990
32,990
32,990
178,155
174,372
140,104
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
2.36%
27.28%
8.66%
(0.80%)
(10.62%)
7.56%
(2.51%)
(29.91%)
8.40%
(0.23%)
(2.87%)
8.01%
Nonperforming loans to total loans
Allowance for loan losses to total loans
4.20%
3.41%
5.50%
3.59%
5.52%
3.11%
2.66%
1.46%
0.43%
5.10%
8.44%
1.66%
1.43%
Tier 1 leverage capital
Tier 1 leverage risk-based capital
Total risk-based capital
12.09%
14.19%
15.46%
9.09%
11.17%
12.45%
8.64%
9.92%
11.18%
9.17%
9.68%
10.93%
9.97%
10.14%
11.39%
Per Common Share Data:
Net income (loss):
Basic
Diluted
Book value at end of period
Dividends declared
Dividend payout ratio
$
4.20 $
4.07
(1.72)
(1.72)
$
(6.23) $
(6.23)
(0.59) $
(0.59)
1.06
1.05
16.73
0.00
NA
12.20
0.01
NA
13.86
0.07
NA
20.29
0.31
NA
20.89
0.55
52.16%
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 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 Losses: The allowance for loan losses (“allowance”) is maintained at a level we believe is
adequate to absorb probable incurred losses identified and inherent in the loan portfolio. Our evaluation of the
adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan
portfolio, information about specific borrower situations and estimated collateral values, guidance from bank
regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan
portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any
loan that, in our judgment, should be charged-off. Loan losses are charged against the allowance when we believe
the uncollectability of a loan is likely. The balance of the allowance represents our best estimate, but significant
downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an
increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result
in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant
impact on operating earnings.
F-4
The allowance is increased through a provision charged to operating expense. Uncollectable loans are charged-off
through the allowance. Recoveries of loans previously charged-off are added to the allowance. A loan is considered
impaired when it is probable that contractual principal and interest payments will not be collected either for the
amounts or by the dates as scheduled in the loan 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 basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported,
net, at the present value of estimated future cash flows using the loan’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, 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 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 that may impact future operating results. Significant weight is given to evidence
that can be objectively verified. During 2011, we returned to pre-tax profitability for four consecutive quarters.
Additionally, we experienced lower provision expense, continued declines in nonperforming assets and problem
asset administration costs, a higher net interest margin, a further strengthening of our regulatory capital ratios and
additional reductions in wholesale funding. This positive evidence allowed us to conclude that, as of December 31,
2011, it was more likely than not that we returned to sustainable profitability in amounts sufficient to allow for
realization of our deferred tax assets in future years. Consequently, we reversed the valuation allowance that we had
previously determined necessary to carry against our entire net deferred tax asset as of December 31, 2010 and 2009.
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
Over the past several years, 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
negatively impacted some of our borrowers’ cash flows and underlying collateral values, leading to increased
nonperforming assets, higher loan charge-offs and increased overall credit risk within our loan portfolio. We have
worked with our borrowers to develop constructive dialogue to strengthen our relationships and enhance our ability
to resolve complex issues. Although we experienced significant improvement in our asset quality during the latter
part of 2010 and throughout 2011, the environment for the banking industry will likely remain stressed until
economic conditions improve. Credit quality will continue to be our major concern, especially within our non-owner
occupied commercial real estate loan portfolio.
F-6
We recorded a net profit during 2011, after having recorded net losses during the previous three years. A
significantly lower provision expense primarily provided for the positive earnings performance; however, our
improved earnings performance also reflects the many positive steps we have taken over the past several years to not
only partially mitigate the impact of asset quality-related costs in the near term, but to benefit us on a longer-term
basis as well. First, our net interest margin has improved as we have lowered local non-CD deposit rates and have
replaced maturing high-rate deposits and borrowed funds with lower-costing funds, while at the same time our
commercial loan pricing initiatives have significantly offset the negative impact of a relatively high level of
nonaccrual loans. 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 outstanding, are providing for a substantial reduction of, and reliance on, wholesale funds. Next, our
regulatory risk-based capital ratios are increasing, reflecting the impact of the net income recorded during 2011, the
2009 sale of preferred stock under the Treasury’s Capital Purchase Program and the reduction of loans outstanding,
which have more than offset the impact of our net losses recorded in 2010 and 2009. Lastly, we continue to see the
positive effect of our overhead cost reduction initiatives, as we continue to make strides to reduce controllable
noninterest expense.
Our asset quality metrics are on an improving trend, and we are optimistic that the positive trend will continue. In
aggregate dollar amounts, nonperforming asset levels have declined almost 49% since the peak level at March 31,
2010, and at year-end 2011 were at the lowest level since December 31, 2008. Progress in the stabilization of
economic and real estate market conditions has provided for numerous loan rating upgrades and significantly lower
volumes of loan rating downgrades, providing for a substantially lower provision expense during 2011. We expect a
continuation of improved market conditions will provide for lower future period provision expense and problem
asset administration costs when compared to levels over the past several years.
FINANCIAL CONDITION
Reflecting strategies employed in regards to our financial condition and the continued weak economic environments
within our markets, we shrunk our balance sheet during the past three years. Total assets declined from $1.63 billion
on December 31, 2010 to $1.43 billion on December 31, 2011, representing a decrease in total assets of $199.2
million, or 12.2%. During 2010 and 2009, we had shrunk our balance sheet by $273.8 million and $301.8 million,
respectively. The decline in total assets during 2011 was primarily comprised of a $190.2 million decrease in total
loans, following a decline of $277.2 million and $317.1 million during 2010 and 2009, respectively. In addition, the
securities portfolio declined $50.2 million during 2011 and $22.2 million during 2010. Our total deposits declined
$161.8 million and our Federal Home Loan Bank (“FHLB”) advances decreased $20.0 million during 2011. During
2010 and 2009, our total deposits decreased $127.8 million and $197.9 million, respectively, while FHLB advances
declined $140.0 million and $65.0 million during the respective time periods.
Earning Assets
Average earning assets equaled 94.3% of average total assets during 2011, a level very similar to the 94.8% during
2010. The loan portfolio continued to comprise a majority of earning assets, followed by securities, federal funds
sold and interest-bearing deposits; however, during 2011, as in 2010, securities, federal funds sold and interest-
bearing deposits comprised a larger percentage of earning assets compared to prior periods, primarily reflecting our
decision to operate with a larger volume of on-balance sheet liquidity given market conditions. Average total loans
equaled 79.6% of average earning assets in 2011, compared to 81.8% in 2010 and 85.1% in 2009. Meanwhile,
average securities, federal funds sold and interest-bearing deposits equaled a combined 20.4% of average earning
assets in 2011, compared to 18.2% in 2010 and 14.9% in 2009.
F-7
Our loan portfolio is primarily comprised of commercial loans. Commercial loans declined by $179.1 million during
2011, and at December 31, 2011, totaled $996.9 million, or 93.0% of the total loan portfolio. The decline in
outstanding balances primarily reflects the impact of a concerted effort on our part to reduce exposure to certain non-
owner occupied commercial real estate (“CRE”) lending and the sluggishness in business activity in our markets that
results in fewer opportunities to make quality loans. During 2011, commercial loans collateralized by non-owner
occupied CRE declined $114.9 million. Our systematic approach to reducing our exposure to certain non-owner
occupied CRE lending has been prolonged, given the nature of CRE lending and depressed economic conditions;
however, we believe that such a reduction was in our best interest when taking into account the increased inherent
credit risk and nominal deposit balances associated with targeted borrowing relationships. Our commercial and
industrial (“C&I”) loan portfolio declined $22.0 million during 2011, in large part reflecting ongoing sluggish
business activity. We would expect to see higher commercial line of credit usage, along with increased equipment
financing requests, when economic conditions further improve. Also during 2011, commercial loans collateralized
by owner-occupied real estate declined $13.0 million, commercial loans related to residential land development and
construction decreased by $20.3 million and commercial loans related to multi-family and residential rental
properties declined by $8.9 million.
The commercial loan portfolio represents loans to businesses generally located within our market areas.
Approximately 73% of the commercial loan 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 portfolio in commercial loans 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 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:
12/31/11
9/30/11
6/30/11
3/31/11
12/31/10
Residential-Related:
Vacant Land
$
13,124,000 $
13,264,000 $
13,484,000 $
16,321,000 $
17,201,000
Land Development
17,007,000
17,441,000
18,134,000
27,171,000
28,147,000
Construction
4,923,000
4,647,000
4,706,000
4,906,000
5,621,000
35,054,000
35,352,000
36,324,000
48,398,000
50,969,000
Comm'l Non-Owner Occupied:
Vacant Land
Land Development
Construction
10,555,000
14,486,000
13,615,000
11,082,000
14,541,000
11,061,000
12,639,000
16,348,000
10,709,000
13,669,000
16,492,000
10,046,000
14,293,000
17,807,000
31,827,000
Commercial Buildings
376,805,000
397,279,000
429,708,000
484,629,000
489,371,000
415,461,000
433,963,000
469,404,000
524,836,000
553,298,000
Comm'l Owner Occupied:
Construction
4,213,000
2,986,000
1,517,000
1,404,000
672,000
Commercial Buildings
268,479,000
269,776,000
264,848,000
273,739,000
282,388,000
272,692,000
272,762,000
266,365,000
275,143,000
283,060,000
Total
$
723,207,000 $
742,077,000 $
772,093,000 $
848,377,000 $
887,327,000
F-8
Residential mortgage loans and consumer loans declined in aggregate $11.1 million during 2011, and at December
31, 2011, totaled $75.5 million, or 7.0% of the total loan portfolio. Although the 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.
The following table presents total loans outstanding as of December 31, 2011, 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, comprising a majority of our floating rate commercial loans, 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
$
47,124,000
$
31,553,000
$
2,008,000
$
80,685,000
Real estate - residential properties
Real estate - multi-family properties
Real estate - commercial properties
Commercial and industrial
Consumer
Total loans
Fixed rate loans
Floating rate loans
Total loans
44,392,000
26,870,000
212,871,000
173,825,000
2,078,000
39,638,000
18,719,000
372,692,000
72,312,000
1,902,000
10,167,000
226,000
12,180,000
3,752,000
113,000
94,197,000
45,815,000
597,743,000
249,889,000
4,093,000
$
507,160,000
$
536,816,000
$
28,446,000
$ 1,072,422,000
$
328,046,000
$
524,734,000
$
28,162,000
$
880,942,000
179,114,000
12,082,000
284,000
191,480,000
$
507,160,000
$
536,816,000
$
28,446,000
$ 1,072,422,000
Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review
and early identification of problem loans to provide effective loan portfolio administration. The credit policies and
procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and
procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these
could occur quickly because of changing economic conditions. Identified problem loans, which exhibit
characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring
in the future, are included on the internal “watch list.” Senior management 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 charge-offs and nonperforming assets have been elevated since early 2007. The substantial
and rapid country-wide collapse of the residential real estate market that started in 2007 had a significant negative
impact on the residential real estate development lending portion of our business. The resulting decline in real estate
prices and slowdown in sales stretched the cash flow of our local developers and eroded the value of our underlying
collateral, which caused elevated levels of nonperforming assets and net loan charge-offs. Since 2007, we have also
witnessed stressed economic conditions in Michigan and throughout the country. The resulting decline in business
revenue negatively impacted the cash flows of many of our borrowers, some to the point where loan payments
became past due. In addition, real estate prices have fallen significantly, 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 charge-offs and nonperforming assets will remain elevated in
comparison to our historical levels until economic conditions further improve.
F-9
Throughout 2008, we experienced a 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.
Throughout 2009, 2010 and 2011, 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.
We are, however, encouraged by the apparent credit quality stabilization within our loan portfolio during the latter
part of 2010 and throughout 2011. 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 last six months of 2010 and the first nine months of 2011. We did see an increase in nonperforming assets
during the fourth quarter of 2011; however, this was due primarily from one larger non-owner occupied CRE loan
being placed into nonaccrual status towards the end of 2011. Of particular note are the reduced level of additions to
the nonperforming asset category and an increased level of interest in, and sales of, foreclosed properties and assets
securing nonaccrual loans.
As of December 31, 2011, nonperforming assets totaled $60.3 million, or 4.2% of total assets, compared to $86.1
million (5.3% of total assets) and $111.7 million (5.9% of total assets) as of December 31, 2010 and 2009,
respectively. The reductions primarily reflect principal payments and charge-offs on nonaccruals loans, as well as
sales proceeds and valuation write-downs on foreclosed properties. The $25.8 million reduction during 2011 and the
$51.4 million reduction during the 24-month period ended December 31, 2011 equate to declines of 29.9% and
45.9%, respectively. Nonperforming loans and foreclosed properties associated with the development of residential-
related real estate totaled $6.9 million as of December 31, 2011, reflecting reductions of $10.0 million and $24.9
million during 2011 and the 24-month period ended December 31, 2011, respectively. As of December 31, 2011,
nonperforming loans secured by, and foreclosed properties consisting of, non-owner occupied CRE properties
totaled $30.1 million, reflecting reductions of $4.1 million and $8.3 million during the respective time periods. In
addition, nonperforming loans secured by, and foreclosed properties associated with, owner occupied CRE declined
$4.1 million during 2011 and $9.3 million during the 24-month period ended December 31, 2011, while
nonperforming commercial loans secured by non-real estate assets declined $5.2 million and $6.7 million during the
respective time periods.
F-10
The following table provides a breakdown of nonperforming assets by property type:
12/31/11
9/30/11
6/30/11
3/31/11
12/31/10
Residential Real Estate:
Land Development
$
5,479,000 $
8,139,000 $
8,531,000 $ 14,252,000 $ 14,547,000
Construction
Owner Occupied / Rental
1,397,000
7,138,000
1,418,000
7,737,000
2,089,000
8,996,000
2,268,000
8,893,000
2,333,000
9,454,000
14,014,000
17,294,000
19,616,000
25,413,000
26,334,000
Commercial Real Estate:
Land Development
2,111,000
1,885,000
2,223,000
2,422,000
2,454,000
Construction
409,000
0
0
0
0
Owner Occupied
10,642,000
11,287,000
10,749,000
13,389,000
14,740,000
Non-Owner Occupied
30,106,000
22,435,000
25,526,000
30,086,000
34,209,000
43,268,000
35,607,000
38,498,000
45,897,000
51,403,000
Non-Real Estate:
Commercial Assets
3,060,000
3,897,000
3,777,000
4,728,000
8,221,000
Consumer Assets
14,000
29,000
4,000
51,000
161,000
3,074,000
3,926,000
3,781,000
4,779,000
8,382,000
Total
$ 60,356,000 $ 56,827,000 $ 61,895,000 $ 76,089,000 $ 86,119,000
The following table provides a quarterly reconciliation of nonperforming assets during 2011:
Beginning balance
Additions
4th Qtr
2011
3rd Qtr
2011
2nd Qtr
2011
1st Qtr
2011
$
56,827,000 $
61,895,000 $
76,089,000 $
86,119,000
10,188,000
3,740,000
6,478,000
3,848,000
(766,000)
Returns to performing status
0
0
0
Principal payments
Sale proceeds
Loan charge-offs
Valuation write-downs
(2,115,000)
(5,058,000)
(12,067,000)
(5,555,000)
(3,038,000)
(2,670,000)
(2,547,000)
(2,085,000)
(890,000)
(616,000)
(476,000)
(604,000)
(5,393,000)
(4,800,000)
(665,000)
(672,000)
Total
$
60,356,000 $
56,827,000 $
61,895,000 $
76,089,000
Net loan charge-offs during 2011 totaled $15.7 million, or 1.4% of average total loans. This level represents a
significant decline from the $34.3 million (2.4% of average total loans) and $38.2 million (2.2% of average total
loans) charged-off during 2010 and 2009, respectively. While we are optimistic that we will see further declines in
net loan charge-offs in future periods, net loan charge-offs in at least the next few quarters are likely to remain
elevated from historical averages due to the higher volume of nonperforming loans and stressed economic
conditions.
F-11
The following table provides a breakdown of net loan charge-offs by collateral type:
4th Qtr
2011
3rd Qtr
2011
2nd Qtr
2011
1st Qtr
2011
Whole
Year
2011
Residential Real Estate:
Land Development
$
15,000 $
135,000 $
2,496,000 $
(2,000) $
2,644,000
Construction
Owner Occupied / Rental
(90,000)
1,176,000
1,101,000
(11,000)
(187,000)
(63,000)
(9,000)
1,819,000
4,306,000
0
1,208,000
1,206,000
(110,000)
4,016,000
6,550,000
Commercial Real Estate:
Land Development
(75,000)
47,000
(62,000)
(73,000)
(163,000)
Construction
Owner Occupied
Non-Owner Occupied
Non-Real Estate:
0
68,000
4,060,000
4,053,000
0
(18,000)
639,000
668,000
0
755,000
445,000
1,138,000
0
1,436,000
(40,000)
1,323,000
0
2,241,000
5,104,000
7,182,000
Commercial Assets
(435,000)
(162,000)
(336,000)
2,794,000
1,861,000
Consumer Assets
0
26,000
(9,000)
126,000
143,000
(435,000)
(136,000)
(345,000)
2,920,000
2,004,000
Total
$
4,719,000 $
469,000 $
5,099,000 $
5,449,000 $ 15,736,000
F-12
The following table summarizes changes in the allowance for loan losses for the past five years:
2011
2010
2009
2008
2007
Loans outstanding at year-end
$
1,072,422,000
$
1,262,630,000
$
1,539,818,000
$
1,856,915,000
$
1,799,880,000
Daily average balance of loans
outstanding during the year
$
1,148,671,000
$
1,412,555,000
$
1,704,335,000
$
1,829,686,000
$
1,765,465,000
Balance of allowance at beginning of year
$
45,368,000
$
47,878,000
$
27,108,000
$
25,814,000
$
21,411,000
Loans charged-off:
Commercial, financial and agricultural
(12,373,000)
(25,539,000)
(25,978,000)
(12,740,000)
Construction and land development
Residential real estate
Instalment loans to individuals
(2,919,000)
(4,422,000)
(183,000)
(9,273,000)
(2,242,000)
(74,000)
(9,606,000)
(3,797,000)
(240,000)
(4,835,000)
(2,900,000)
(119,000)
(4,250,000)
(1,353,000)
(1,618,000)
(53,000)
Total charge-offs
(19,897,000)
(37,128,000)
(39,621,000)
(20,594,000)
(7,274,000)
Recoveries of previously charged-off loans:
Commercial, financial and agricultural
3,186,000
1,637,000
1,145,000
Construction and land development
Residential real estate
Instalment loans to individuals
441,000
513,000
21,000
995,000
178,000
8,000
81,000
150,000
15,000
Total recoveries
4,161,000
2,818,000
1,391,000
603,000
8,000
51,000
26,000
688,000
586,000
11,000
3,000
7,000
607,000
Net loan charge-offs
(15,736,000)
(34,310,000)
(38,230,000)
(19,906,000)
(6,667,000)
Provision for loan losses
6,900,000
31,800,000
59,000,000
21,200,000
11,070,000
Balance of allowance at year-end
$
36,532,000 $
45,368,000 $
47,878,000 $
27,108,000 $
25,814,000
Ratio of net loan charge-offs during the year
to average loans outstanding during the year
(1.37%)
(2.43%)
(2.24%)
(1.09%)
(0.38%)
Ratio of allowance to loans outstanding
at year-end
3.41%
3.59%
3.11%
1.46%
1.43%
F-13
The following table illustrates the breakdown of the allowance balance by loan type (dollars in thousands) and of the
total loan portfolio (in percentages):
12/31/2011
12/31/2010
12/31/2009
12/31/2008
12/31/2007
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Commercial,
financial and
agricultural
Construction and
land development
Residential real
estate
Instalment loans to
individuals
$ 28,913
83.3%
$ 32,645
81.5%
$37,639
80.1%
$20,211
78.0%
$18,976
77.5%
3,484
7.5
7,019
9.3
6,566
11.4
5,137
14.1
4,907
14.7
3,895
8.8
5,495
8.8
3,517
8.1
1,656
7.6
1,829
7.5
158
0.4
172
0.4
156
0.4
104
0.3
102
0.3
Unallocated
82
0.0
37
0.0
0
0.0
0
0.0
0
0.0
Total
$ 36,532
100.0%
$ 45,368
100.0%
$47,878
100.0%
$27,108
100.0%
$25,814
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 review and credit departments, we establish specific portions of the
allowance based on specifically identifiable problem loans. The evaluation of the allowance is further based on, but
not limited to, consideration of the internally prepared Allowance Analysis, loan loss migration analysis,
composition of the loan portfolio, third party analysis of the loan administration processes and portfolio, and general
economic conditions.
The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan balances, which is
combined with specific reserves to calculate an overall allowance dollar amount. For non-impaired commercial
loans, which continue to comprise a vast majority of our total loans, 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 portfolio into five classes: 1) commercial and industrial loans; 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 charge-offs through a migration analysis whereby net loan 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 portfolio;
experience, ability and depth of management and lending staff; volume and severity of past due, nonaccrual and
adversely classified loans; effectiveness of the loan 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, 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, 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. 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 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 net loan losses, it is not able to fully account for environmental factors that
will also very likely impact the collectability of our commercial loans as of any quarter-end date. Therefore, we
incorporate the environmental factors as adjustments to the historical data.
F-14
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
risk ratings. Although we have been consistent in our approach to commercial loan 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 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 portfolio, we created a specific group tasked with managing our most
distressed lending relationships.
The most significant external environmental factor is the assessment of the current economic environment and the
resulting implications on our commercial loan portfolio. Currently, we believe conditions remain stressed for non-
owner occupied CRE; however, recent data and performance reflect a level of stability in the C&I class of our loan
portfolio.
The primary risk elements with respect to commercial loans are the financial condition of the borrower, the
sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing
periodic financial statements from commercial loan customers, and we have a disciplined and formalized review of
the existence of collateral and its value. The primary risk element with respect to each residential real estate loan
and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans
and have adopted policies to pursue creditor’s rights in order to preserve our collateral position.
Reflecting the stressed economic conditions and resulting negative impact on our loan portfolio, we have
substantially increased the allowance as a percent of the loan portfolio over the past several years. The allowance
equaled $36.5 million, or 3.4% of total loans outstanding, as of December 31, 2011, compared to 3.6%, 3.1%, 1.5%
and 1.4% at year-end 2010, 2009, 2008 and 2007, respectively. As of December 31, 2011, the allowance was
comprised of $17.5 million in general reserves relating to non-impaired loans and $19.0 million in specific
allocations relating to impaired loans. Of the latter amount, $11.2 million are specific reserves associated with credit
relationships that meet the definition of a troubled debt restructuring but are still on accrual status. Impaired loans
with an aggregate carrying value of $36.6 million as of December 31, 2011 had been subject to previous partial
charge-offs aggregating $27.1 million. Those partial charge-offs were recorded as follows: $11.9 million in 2011,
$10.8 million in 2010, $3.5 million in 2009 and $0.9 million in 2008. As of December 31, 2011, specific reserves
allocated to impaired loans that had been subject to a previous partial charge-off totaled $9.7 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.
Securities decreased $50.2 million during 2011, totaling $185.0 million as of December 31, 2011. The securities
portfolio equaled 14.3% of average earning assets during 2011. Proceeds from called U.S. Government agency
bonds during 2011 totaled $63.8 million, while $12.6 million was received from principal paydowns on mortgage-
backed securities, $2.9 million from called tax-exempt municipal securities, $1.5 million from matured Michigan
Strategic Fund bonds and $2.3 million from redeemed FHLB stock. Purchases during 2011, consisting almost
exclusively of U.S. Government agency bonds, totaled $28.8 million. At December 31, 2011, the portfolio was
comprised of U.S. Government agency issued bonds (48%), U.S. Government agency issued or guaranteed
mortgage-backed securities (19%), tax-exempt municipal general obligation and revenue bonds (17%), Michigan
Strategic Fund bonds (9%), FHLB stock (6%) and mutual funds (1%). 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.
F-15
The following table reflects the composition of the securities portfolio, excluding FHLB stock:
12/31/11
12/31/10
12/31/09
Carrying
Value
Percent
Carrying
Value
Percent
Carrying
Value
Percent
U.S. Government agency
debt obligations
$
88,596,000
51.2%
$
121,562,000
55.1%
$
95,544,000
39.6%
Mortgage-backed
securities
Michigan Strategic
Fund bonds
Municipal general
obligations
34,610,000
20.0
46,941,000
21.2
64,982,000
26.9
16,700,000
9.7
18,175,000
8.2
20,550,000
8.5
27,309,000
15.8
28,042,000
12.7
49,892,000
20.6
Municipal revenue bonds
4,423,000
2.5
4,843,000
2.2
9,319,000
3.9
Mutual funds
1,354,000
0.8
1,267,000
0.6
1,416,000
0.5
Totals
$
172,992,000
100.0%
$
220,830,000
100.0%
$
241,703,000
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, 2011 totaled $173.0 million, including a net unrealized
gain of $5.8 million.
FHLB stock totaled $12.0 million as of December 31, 2011, compared to $14.3 million at December 31, 2010. The
reduction reflects the FHLB’s unsolicited redemption of $2.3 million during 2011. Our investment in FHLB stock is
necessary to engage in their advance and other financing programs. We received a quarterly cash dividend
throughout 2011 at an average rate of 2.50%, and believe a cash dividend will continue to be declared and paid in
future quarters.
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.
F-16
The following table shows by class of maturities as of December 31, 2011, 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
7,327,000
22,806,000
58,463,000
88,596,000
177,000
2,418,000
5,794,000
23,343,000
31,732,000
34,610,000
16,700,000
1,354,000
NA
2.95%
2.79
4.24
3.76
7.79
6.69
6.07
6.26
6.27
5.15
2.87
3.68
$ 172,992,000
4.40%
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. The average balance of these funds equaled 6.1%, 4.5% and 3.0% of average earning assets during 2011,
2010, and 2009, respectively, considerably higher than the historical average of less than 1.0%. 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 interest-bearing deposits, likely to average 3.0% to 4.0% of average earning assets, until market and
economic conditions return to more normalized levels.
Non-Earning Assets
Cash and due from bank balances totaled $12.4 million at December 31, 2011, compared to $6.7 million on
December 31, 2010. Cash and due from bank balances averaged $15.1 million during 2011. The relatively low
balance as of December 31, 2010 reflected the fact that many of our business customers were closed that particular
day and therefore did not make their typical deposits, resulting in a lower than typical outgoing cash letter. Net
premises and equipment decreased from $27.9 million at December 31, 2010, to $26.8 million on December 31,
2011, primarily reflecting depreciation expense. Purchases of premises and equipment during 2011 were a net $0.6
million.
F-17
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, 2011 equaled $9.4 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 of 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 $15.3 million at December 31, 2011, compared to $16.7 million on
December 31, 2010 and $26.6 million on December 31, 2009. The $1.4 million decline during 2011 consisted of
$11.1 million in sales proceeds and $1.8 million in valuation writedowns and net losses on sales, which were
partially offset by $11.5 million in transfers from the loan portfolio. We expect foreclosed and repossessed assets to
remain at elevated levels as we move through the stressed economic environment and in certain situations elect to
foreclose or respossess collateral. The State of Michigan has a relatively protracted foreclosure process that
generally takes six to twelve months before deed is obtained. While we expect further transfers from loans to
foreclosed and repossessed assets in future periods reflecting our collection efforts on impaired lending relationships,
we are hopeful that the increased sales activity we witnessed during the latter part of 2010 and throughout 2011 will
continue and limit the overall increase in, and average balance of, this nonperforming asset category.
Source of Funds
Our major sources of funds are from deposits, securities sold under agreements to repurchase (“repurchase
agreements”) and FHLB advances. Total deposits declined from $1.27 billion at December 31, 2010 to $1.11 billion
on December 31, 2011, a decrease of $161.8 million. In comparing total deposit balances as of December 31, 2011
to those at December 31, 2008, total deposits have declined by $487.5 million. Local deposits increased $311.2
million during the three-year period ended December 31, 2011, while out-of-area deposits decreased $798.7 million
during the same time period. As of December 31, 2011, local deposits comprised 70.3% of total deposits, compared
to 60.0% and 29.4% at December 31, 2010 and December 31, 2008, respectively.
Repurchase agreements decreased from $117.0 million at December 31, 2010 to $72.6 million on December 31,
2011, a decrease of $44.4 million. A majority of the decline is comprised of transfers to noninterest-bearing
checking accounts reflecting a change in rates offered on the repurchase agreement product whereby for certain
lower-balance customers, maintaining their relationship with us in a noninterest-bearing checking account was less
expensive for them than keeping their funds in the repurchase agreement product when taking into account the rate
paid and fees assessed. 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 from $65.0 million at December 31, 2010 to $45.0 million on December 31, 2011, a
decline of $20.0 million. FHLB advances declined $225.0 million during the three-year period ended December 31,
2011. At December 31, 2011, local deposits and repurchase agreements equaled 69.5% of total funding liabilities,
compared to 60.2% and 28.5% on December 31, 2010 and December 31, 2008, respectively.
F-18
The significant reduction in wholesale funding reliance over the past three years is primarily a result of the increase
in local deposits and the decline in total loans. The increase in local deposits reflects various programs and
initiatives we have implemented over the past several 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 increased during 2011 after having been relatively stable over the
previous several years. Noninterest-bearing checking accounts averaged $137.0 million during 2011, compared to
an average balance of $110.0 million to $120.0 million over the past several years. During the fourth quarter of
2011, noninterest-bearing checking accounts averaged close to the year-end balance of $147.0 million. A majority
of the increase reflects the transfers from the repurchase agreement product during 2011 that are mentioned above.
Local interest-bearing checking accounts, in large part reflecting the strong success of our executive banking
product, increased $129.5 million during the three-year period ended December 31, 2011, including a $21.6 million
increase during 2011. Money market deposit accounts, which increased $120.5 million during the three-year period
ended December 31, 2011, were down $5.2 million during 2011 primarily due to one relatively large customer that
deposited funds in 2010 but withdrew its funds in early 2011. The net increase in both interest-bearing checking
accounts and money market deposit accounts over the past three years primarily reflects the success of our enhanced
marketing program and relatively aggressive rates, which resulted in many new individual, business and municipality
deposits and increased balances from existing deposit account holders. Savings deposits decreased $27.7 million
during 2011 after having increased $21.6 million during 2010 and declining $11.3 million during 2009. The
relatively large balance fluctuations in our savings deposits are typical, primarily reflecting periodic deposits and
withdrawals from several local municipal customers, as well as from certain municipal customers transferring funds
between savings accounts and certificates of deposit. In addition, some customers have transferred their savings
balances to other deposits products, particularly the executive banking product and money market deposit account.
Certificates of deposit purchased by customers located within our market areas declined $5.9 million during 2011,
after declining $115.8 million during 2010 and increasing $164.1 million during 2009, thereby providing a net
increase of $42.4 million during the three-year period ended December 31, 2011. 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 a
relatively large percentage of the maturing funds, a majority of which were transferred to our executive banking or
money market deposit accounts. The remaining increase during 2009 primarily reflects the success of our enhanced
marketing program and relatively aggressive rates, which resulted in many new individual, business and municipality
deposits. The declines during 2011 and 2010 are primarily due to maturing certificates of deposit being transferred
to our executive banking and money market deposit accounts.
Deposits obtained from customers located outside of our market areas declined $798.7 million during the three-year
period ended December 31, 2011, including a $178.5 million decline during 2011. Out-of-area deposits primarily
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.
In addition, in early 2011 we established an interest-bearing checking account relationship with an out-of-area
depositor engaged in managing retirement accounts. This custodial relationship totaled $26.1 million as of
December 31, 2011, and is expected to remain relatively stable for the foreseeable future. We expect this to be a
long-term relationship. 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 from increased local deposits.
FHLB advances declined $225.0 million during the three-year period ended December 31, 2011, including a $20.0
million decline during 2011. The decline during the past three years primarily reflects the influx of cash resulting
from the reduction in total loans 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, 2011 totaled $97.7 million, with availability of $50.9 million.
F-19
Shareholders’ equity decreased $9.4 million during the three-year period ended December 31, 2011. During 2011,
shareholders’ equity increased $39.1 million, primarily reflecting net income attributable to common shares of $36.1
million, of which $27.4 million was related to the reversal of our valuation allowance against our net deferred tax
asset. The net decline in shareholders’ equity during 2010 and 2009 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
against our net deferred tax asset 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, 2011 and 2010
Summary
We recorded net income attributable to common shares of $36.1 million, or $4.20 per basic share and $4.07 per
diluted share, for 2011, compared to a net loss attributable to common shares of $14.6 million, or $1.72 per basic
and diluted share, for 2010. The fourth quarter 2011 reversal of the valuation allowance established against our net
deferred tax asset in the fourth quarter of 2009 distorts 2011 and 2010 after-tax operating result comparisons. On a
pre-tax basis, our net income for 2011 was $10.1 million and net loss for 2010 was $13.4 million.
The improvement in pre-tax earnings performance in 2011 compared to 2010 is primarily the result of a substantially
lower provision expense. The decreased provision expense reflects lower volumes of loan rating downgrades and
nonperforming loans and a higher volume of loan rating upgrades, as well as progress in the stabilization of
economic and real estate market conditions and resulting collateral valuations. In addition, in many instances the
reserve allocation factors for non-impaired commercial loans were lowered as the higher loan charge-off periods of
2009 were replaced with the lower 2011 loan charge-off periods in the quarterly reserve migration calculations. An
increased net interest margin, which partially mitigated the negative impact of a lower level of average earning
assets, and a reduction in overhead expenses also contributed to the improved earnings performance in 2011
compared to 2010.
Our earnings performance continues to be hindered by elevated provisions to the allowance and costs associated with
the administration and resolution of problem assets, reflecting continuing difficulties in the loan portfolio, most
notably in the CRE segment. Ongoing state, regional and national economic struggles have significantly hampered
certain of our borrowers’ cash flows and negatively impacted real estate values, resulting in elevated levels of
nonperforming assets and net loan 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, 2011
and 2010:
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
2011
2010
2.36%
27.28%
8.66%
(0.80%)
(10.62%)
7.56%
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 $71.8 million and $19.8 million, respectively, during 2011, providing for net interest income of
$52.0 million. During 2010, interest income and interest expense equaled $89.0 million and $31.8 million,
respectively, providing for net interest income of $57.2 million. In comparing 2011 with 2010, interest income
decreased 19.3%, interest expense was down 37.6%, and net interest income decreased 9.2%. 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 $5.2 million decrease in net interest income in 2011 compared to 2010 resulted from a decreased level of
average earning assets, which more than offset an improved net interest margin. During 2011, the net interest margin
equaled 3.60%, up from 3.31% during 2010. Although our yield on earning assets declined slightly in 2011
compared to 2010 primarily due to a shift in earning asset mix (lower level of higher-yielding average total loans and
higher levels of lower-yielding securities and average federal funds sold) and a decreased yield on average loans, our
cost of funds declined at a far greater rate, resulting in the improved net interest margin. Average total loans equaled
79.6% of average earning assets during 2011, down from 81.8% during 2010, while average federal funds sold
represented 5.4% of average earning assets during 2011 compared to 4.0% during 2010. Average securities equaled
14.3% of average earning assets during 2011, up from 13.7% during 2010. The decline in loan yield primarily
resulted from a decreased yield on commercial loans, while the cost of funds primarily decreased as a result of
higher-costing matured certificates of deposit and borrowings being renewed at lower rates, replaced by lower-
costing funds, or allowed to runoff and the lowering of interest rates on non-certificate of deposit accounts and
repurchase agreements.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets,
liabilities and shareholders’ equity during 2011, 2010 and 2009. 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 $0.7 million in 2011, $0.8 million in 2010, and $1.3 million in 2009.
F-21
(Dollars in thousands)
Years ended December 31,
---------------------- 2 0 1 1 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 1 0 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 0 9 ----------------
Average
Rate
Average
Balance
Interest
Taxable securities $ 157,081 $
Tax-exempt
securities
Total securities
49,428
206,509
6,685
4.26%
$ 176,084 $
7,846
4.46%
$ 155,041 $
7,498
4.84%
2,508
9,193
5.07
4.45
59,911
235,995
3,125
10,971
5.22
4.65
83,048
238,089
4,623
12,121
5.57
5.09
Loans
Interest-bearing
deposit balances
Federal funds sold
Total earning
assets
Allowance for loan
losses
Cash and due
from banks
Other non-earning
assets
1,148,671
62,356
5.43
1,412,555
77,791
5.51
1,704,335
93,903
5.51
9,709
78,596
24
199
0.24
0.25
9,251
69,319
39
176
0.42
0.25
6,730
53,825
21
136
0.31
0.25
1,443,485
71,772
4.97
1,727,120
88,977
5.15
2,002,979
106,181
5.30
(41,517)
15,080
112,983
(48,963)
15,414
127,354
(34,155)
16,341
120,508
Total assets
$ 1,530,031
$ 1,820,925
$ 2,105,673
Interest-bearing
demand deposits $ 184,140 $
Savings deposits
Money market
accounts
Time deposits
Total interest-
bearing deposits
154,450
697,664
1,082,114
45,860
80,137
Short-term
borrowings
Federal Home Loan
Bank advances
Other borrowings
Total interest-
bearing liabilities 1,254,780
54,753
37,776
2,536
210
1.38%
0.46
$ 140,384 $
43,571
2,419
305
1.72%
0.70
$
60,155 $
48,182
867
521
1.44%
1.08
1,179
12,459
0.76
1.79
86,283
979,584
1,225
19,580
1.42
2.00
25,759
1,279,188
361
39,520
1.40
3.09
16,384
1.51
1,249,822
23,529
1.88
1,413,284
41,269
2.92
405
0.51
107,802
1,410
1.31
98,513
1,845
1.87
2,033
1,010
3.71
2.67
153,575
47,315
5,509
1,346
3.59
2.84
239,699
50,278
8,808
1,654
3.67
3.29
19,832
1.58
1,558,514
31,794
2.04
1,801,774
53,576
2.97
Demand deposits
Other liabilities
Total liabilities
Average equity
Total liabilities
and equity
136,980
5,808
1,397,568
132,463
$ 1,530,031
118,904
5,913
1,683,331
137,594
$ 1,820,925
112,821
14,258
1,928,853
176,820
$ 2,105,673
Net interest
income
Rate spread
Net interest
margin
$
51,940
$
57,183
$
52,605
3.39%
3.60%
3.11%
3.31%
2.33%
2.63%
F-22
-------------------- 2011 over 2010 --------------------
Volume
Total
Rate
-------------------- 2010 over 2009 --------------------
Volume
Total
Rate
Years ended December 31,
Increase (decrease) in interest income
Taxable securities
Tax exempt securities
Loans
Interest-bearing deposit balances
Federal funds sold
Net change in tax-equivalent
$ (1,161,000)
(617,000)
(15,435,000)
(15,000)
23,000
$
(821,000)
(533,000)
(14,340,000)
2,000
23,000
$
(340,000)
(84,000)
(1,095,000)
(17,000)
0
$
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
interest income
(17,205,000)
(15,669,000)
(1,536,000)
(17,204,000)
(16,275,000)
(929,000)
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
117,000
(95,000)
(46,000)
(7,121,000)
(1,005,000)
662,000
15,000
686,000
(5,197,000)
(296,000)
(545,000)
(110,000)
(732,000)
(1,924,000)
(709,000)
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)
(3,476,000)
(336,000)
(3,663,000)
(259,000)
187,000
(77,000)
(3,299,000)
(308,000)
(3,094,000)
(93,000)
(205,000)
(215,000)
(11,962,000)
(8,052,000)
(3,910,000)
(21,782,000)
(8,811,000)
(12,971,000)
net interest income
$ (5,243,000)
$ (7,617,000)
$ 2,374,000
$ 4,578,000
$ (7,464,000)
$ 12,042,000
Interest income is primarily generated from the loan portfolio, and to a significantly lesser degree, from securities,
federal funds sold, and interest-bearing deposit balances. Interest income decreased $17.2 million during 2011 from
that earned in 2010, totaling $71.8 million in 2011 compared to $89.0 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 extent, a declining
yield on average earning assets. During 2011, earning assets averaged $1.44 billion, or $283.6 million lower than
average earning assets of $1.73 billion during 2010. Average loans were down $263.9 million, average securities
decreased $29.5 million, average federal funds sold increased $9.3 million, and average interest-bearing deposit
balances increased $0.5 million.
Interest income generated from the loan portfolio decreased $15.4 million in 2011 compared to the level earned in
2010; the reduction in the loan portfolio during 2011 resulted in a $14.3 million decrease in interest income, while a
decline in loan yield from 5.51% in 2010 to 5.43% in 2011 resulted in a $1.1 million decrease in interest income.
The lower yield on average loans mainly resulted from a decreased yield on average commercial loans, which
equaled 5.46% in 2011 compared to 5.54% in 2010. The commercial loan yield was negatively impacted by the
lowering of rates on certain commercial loans throughout 2011 as a result of competitive pricing pressures and
borrowers warranting decreased loan rates due to improved financial performance. In addition, the commercial loan
yield in 2011 was negatively impacted by a $259,000 net decline in the present values of the purchased and sold
interest rate caps; excluding the impact of this net decline, the yield on average commercial loans was 5.48% and the
yield on average total loans was 5.45% in 2011.
F-23
Interest income generated from the securities portfolio decreased $1.8 million in 2011 compared to the level earned
in 2010 due to portfolio contraction and a lower yield on average securities, which equaled 4.45% in 2011 compared
to 4.65% in 2010. The reduced average portfolio balance resulted in a $1.4 million decrease in interest income,
while the lower yield on average securities equated to a decrease in interest income of $0.4 million. Average
securities equaled $206.5 million during 2011, down from $236.0 million during 2010 primarily due to decreases in
the average balances of mortgage-backed securities and municipal securities. The lower yield on average securities
in 2011 compared to 2010 mainly 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 and
mortgage-backed securities to lower-yielding U.S. Government agency bonds. The re-investment of proceeds
received from called U.S. Government agency bonds into bonds of the same type during the decreased market rate
environments experienced in the latter six months of 2010 and 2011, along with additional purchases of agency
bonds necessary to support increased collateral requirements during the last six months of 2010, negatively impacted
the yield on average securities in 2011. 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 of 2010. Principal payments received on mortgage-backed securities totaled $12.6 million in 2011.
Interest income earned on federal funds sold increased slightly in 2011 compared to 2010 due to an increased
average balance, while interest income earned on interest-bearing deposit balances decreased slightly as the negative
impact of a declined average rate more than offset the positive impact of an increased average balance.
During 2011 and 2010, earning assets had an average yield (tax equivalent-adjusted basis) of 4.97% and 5.15%,
respectively. The slight decline in earning asset yield in 2011 compared to 2010 resulted from a change in earning
asset mix, most notably a decrease in higher-yielding average loans and increases in lower-yielding average
securities and federal funds sold as a percentage of average earning assets, a decreased yield on average loans, and a
decreased yield on average securities. Average loans equaled 79.6% of average earning assets during 2011, while
average securities, federal funds sold, and interest-bearing deposit balances equaled 14.3%, 5.4%, and 0.7%,
respectively. During 2010, average loans, securities, federal funds sold, and interest-bearing deposit balances
represented 81.8%, 13.7%, 4.0%, and 0.5%, respectively, of average earning assets.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from FHLB advances,
repurchase agreements, subordinated debentures, and other borrowings. Interest expense decreased $12.0 million
during 2011 from that expensed in 2010, totaling $19.8 million in 2011 compared to $31.8 million in the previous
year. The decline in interest expense is attributable to a decreased level of average interest-bearing liabilities and a
decreased cost of funds. During 2011, interest-bearing liabilities averaged $1.25 billion, or $303.7 million lower
than average interest-bearing liabilities of $1.56 billion during the prior year. This reduction resulted in decreased
interest expense of $8.1 million. Average interest-bearing deposits were down $167.7 million, while average FHLB
advances decreased $98.8 million, average short-term borrowings decreased $27.7 million, and average other
borrowings decreased $9.5 million.
During 2011 and 2010, interest-bearing liabilities had a weighted average rate of 1.58% and 2.04%, respectively; a
decline in interest expense of $3.9 million was recorded during 2011 due to the decreased cost of funds. The lower
weighted average cost of interest-bearing liabilities in 2011 compared to 2010 is primarily due to the decline in
market interest rates that began late in the third quarter of 2007 and continued through December of 2008 and a
change in average interest-bearing liability mix, most notably decreases in higher-costing average certificates of
deposit and average FHLB advances and increases in certain lower-costing average non-certificate of deposit
accounts as a percentage of average interest-bearing liabilities. Market interest rates remained low during 2009,
2010, and 2011. Maturing fixed-rate certificates of deposit and borrowings were renewed at lower rates, replaced by
lower-costing funds, or allowed to runoff during the 24-month period ending December 31, 2011. In addition, the
lowering of interest rates on non-certificate of deposit accounts and repurchase agreements during this time frame
positively impacted the weighted average cost of interest-bearing liabilities in 2011 compared to 2010.
F-24
Average certificates of deposit declined $281.9 million during 2011, which equated to a decrease in interest expense
of $5.2 million. An additional $1.9 million reduction in interest expense resulted from a decrease in the average rate
paid as higher-rate certificates of deposit matured and were either renewed or replaced with lower-costing
certificates of deposit throughout 2011. Growth in other average interest-bearing deposit accounts, totaling $114.2
million, equated to an increase in interest expense of $1.4 million, while a decrease in the average rate paid on these
deposit accounts resulted in a $1.4 million decline in interest expense.
Average short-term borrowings, comprised primarily of repurchase agreements, declined $27.7 million during 2011,
resulting in decreased interest expense of $0.3 million, while a decrease in the average rate paid during 2011 resulted
in a reduction in interest expense of $0.7 million. Average FHLB advances decreased $98.8 million, equating to a
$3.7 million reduction in interest expense, while a higher average rate paid on the advances resulted in a $0.2 million
increase 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, equated to a
decrease in interest expense of $0.3 million during 2011, while a decrease in the average rate paid on these
borrowings reduced interest expense by $0.1 million.
Provision for Loan Losses
The provision for loan losses totaled $6.9 million in 2011, compared to $31.8 million in 2010. The reduced
provision expense reflects lower volumes of nonperforming loans and loan rating downgrades and a higher volume
of loan rating upgrades, as well as progress in the stabilization of economic and real estate market conditions and
resulting collateral valuations. In addition, in many instances the reserve allocation factors for non-impaired
commercial loans were lowered as the higher loan charge-off periods of 2009 were replaced with the lower 2011
loan charge-off periods in the quarterly reserve migration calculations. Nonperforming loans totaled $45.1 million,
or 4.20% of total loans, as of December 31, 2011, compared to $69.4 million, or 5.50% of total loans, as of
December 31, 2010. Net loan charge-offs totaled $15.7 million, or 1.37% of average total loans, during 2011
compared to $34.3 million, or 2.43% of average total loans, during 2010. Of the $19.9 million in gross loans
charged-off during 2011, $5.7 million, or 28.5%, represents the elimination of specific reserves that were established
through provision expense in earlier periods. The allowance, as a percentage of total loans outstanding, was 3.41%
as of December 31, 2011, compared to 3.59% as of December 31, 2010.
Noninterest Income
Noninterest income totaled $7.3 million in 2011, a decrease of $2.0 million, or 21.2%, from the $9.3 million earned
in 2010. Noninterest income during 2010 includes gains totaling $0.8 million from the sales of tax-exempt
municipal bonds and guaranteed portions of certain Small Business Administration-guaranteed loans. Excluding
these gains, noninterest income during 2011 decreased $1.2 million, or 13.8%, from the prior year. The decline in
noninterest income in 2011 compared to 2010, after consideration of the above discussed gains on security and loan
sales, was mainly due to lower rental income from fewer foreclosed properties and decreased mortgage banking
income, commercial letter of credit fees, and service charges on accounts.
Noninterest Expense
Noninterest expense during 2011 totaled $41.5 million, a decrease of $5.7 million, or 12.0%, from the $47.2 million
expensed in 2010. Overhead costs during 2011 include $0.2 million in nonrecurring fees related to the prepayment
of $10.0 million in FHLB advances, while overhead costs during 2010 include $1.0 million in such fees related to
the prepayment of $95.0 million in advances; excluding these prepayment fees, noninterest expense in 2011 and
2010 totaled $41.3 million and $46.2 million, respectively. The $4.9 million decline in noninterest expense in 2011
compared to 2010, excluding the impact of the prepayment fees, primarily resulted from lower 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 decreased FDIC insurance premiums.
Nonperforming asset administration and resolution costs totaled $8.3 million during 2011, a decrease of $2.6
million, or 23.7%, from the $10.9 million in costs incurred during 2010. As a result of the significant level of
nonperforming assets, these costs remain elevated; however, the costs are expected to decrease further in future
periods if the level of nonperforming assets continues to decline.
F-25
FDIC insurance premiums were $2.9 million during 2011, down $1.5 million from the $4.4 million in premiums
expensed during 2010; the lower premiums resulted from a decreased assessment rate. The implementation of the
FDIC’s revised risk-based assessment system on April 1, 2011, primarily resulted in the decreased assessment rate.
Given the large number of insured institution failures in recent years, the increase in per-depositor insurance
coverage, the temporary unlimited insurance of noninterest-bearing deposit accounts, and other changes in federal
deposit insurance made by the Dodd-Frank Act, 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 $0.7 million, or 3.3%, during 2011 compared to 2010. Salary and benefit costs, which declined $0.4
million in 2011 compared to 2010, were positively impacted by a reduction in full-time equivalent employees from
242 at December 31, 2010 to 232 at December 31, 2011. Occupancy and furniture and equipment costs declined by
$0.3 million in 2011 compared to 2010, primarily resulting from an aggregate reduction in depreciation expense.
Federal Income Tax Expense
During 2011, we recorded income before federal income tax of $10.1 million and a federal income tax benefit of
$27.4 million, compared to a loss before federal income tax of $13.4 million and a federal income tax benefit of less
than $0.1 million during 2010. Tax expense on 2011 income was entirely offset by a corresponding reduction to the
valuation allowance against deferred tax assets, and the $27.4 million benefit was the result of reversing the
remaining valuation allowance. 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 operations and other comprehensive income due to intraperiod tax allocation accounting rules.
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 the valuation allowance necessary at year-end 2010, due to
operating losses in 2010 and earlier years, was no longer necessary at year-end 2011 due to an expected return to
sustainable profitability. Consequently, we reversed the valuation allowance that we had previously determined
necessary to carry against our entire net deferred tax asset as of December 31, 2010 and 2009.
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 losses and higher net interest income. The reduced provision reflects lower
levels of loan rating downgrades, nonperforming loans, and net loan 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 expense 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 charge-offs when compared to pre-2007 reporting
periods.
F-26
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.
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 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 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.
Interest income is primarily generated from the loan portfolio, and to a lesser degree, from securities, federal funds
sold, and short-term investments. Interest income 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 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 totaling $291.8 million primarily resulted in the lower level of
average earning assets during 2010. Interest income generated from the loan portfolio decreased $16.1 million in
2010 compared to the level earned in 2009; the reduction in the loan portfolio during 2010 resulted in the $16.1
million decrease in interest income. The loan portfolio yield was 5.51% in both 2010 and 2009.
F-27
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.
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 a higher level of low-yielding average federal funds
sold) and a decreased yield on average securities. Average total loans 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, combined with a lower average rate, resulted in a decrease in interest expense of $0.3
million during 2010.
F-28
Provision for Loan Losses
The provision for loan 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
charge-offs, and increased overall credit risk within our loan portfolio.
The decreased provision expense in 2010 compared to 2009 reflects lower levels of loan rating downgrades,
nonperforming loans, and net loan charge-offs, as well as the solidification of real estate market conditions and
resulting valuations. Nonperforming loans totaled $69.4 million, or 5.50% of total loans, as of December 31, 2010,
compared to $85.1 million, or 5.52% of total loans, as of December 31, 2009. Net loan charge-offs during 2010
totaled $34.3 million, or 2.43% of average total loans. Net loan charge-offs during 2009 totaled $38.2 million, or
2.24% of average total loans.
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.
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
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.
F-29
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 then recent operating losses.
CAPITAL RESOURCES
Shareholders’ equity decreased $9.4 million during the three-year period ended December 31, 2011. During 2011,
shareholders’ equity increased $39.1 million, primarily reflecting net income attributable to common shares of $36.1
million, of which $27.4 million was related to the reversal of our valuation allowance against our net deferred tax
asset. The net decline in shareholders’ equity during 2010 and 2009 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
against 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.
Our and our bank’s regulatory risk-based capital ratios have increased throughout the past three years, and our bank
remains “well capitalized.” As of December 31, 2011, our bank’s total risk-based capital ratio was 15.5%, compared
to 12.5%, 11.1% and 10.8% at December 31, 2010, 2009 and 2008, respectively. Our bank’s total regulatory
capital, consisting of our shareholders’ equity plus a portion of the allowance but less a portion of our net deferred
tax asset, increased $13.3 million during 2011, primarily reflecting net income of $37.1 million, which more than
offset cash dividends to Mercantile Bank Corporation of $4.9 million and a reduction of $2.4 million in eligible
allowance due to a decline in risk-weighted assets. In addition, $16.5 million of our net deferred tax asset were not
eligible for inclusion in our regulatory capital as of December 31, 2011. Risk-weighted assets declined $189.9
million during 2011. As of December 31, 2011, our bank’s total regulatory capital equaled $188.4 million, or $66.9
million in excess of the amount necessary to attain the 10.0% minimum total risk-based capital ratio, which is among
the requirements to be categorized as “well capitalized.”
Our bank’s regulatory capital 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 during 2010 and 2009 due to a decline of $688.5 million in total risk-weighted
assets. 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, 2011 and 2010 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 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 resulted 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. On October 18, 2011, we announced
via a Form 8-K filed with the Securities and Exchange Commission that we were bringing all of the accrued and
unpaid interest (approximately $1.28 million) current on the subordinated debentures on that date, thereby providing
for the distributions on our trust preferred securities to also be brought current on that date. We also announced that
on October 19, 2011, we intended to bring current all accrued and unpaid dividends (approximately $1.36 million)
on our preferred stock through October 18, 2011, which in fact we did consummate as planned. We had been
accruing during the deferral period for the unpaid interest under the subordinated debentures and undeclared
dividends under the preferred stock. We have made all scheduled payments on our subordinated debentures and
preferred stock since, and we expect to make the scheduled payments in future periods.
F-30
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, from July 2010 through October 2011, we were precluded from paying
cash dividends on our common stock and preferred stock because, under the terms of our subordinated debentures,
we could not pay cash dividends during periods when we had deferred the payment of interest on our subordinated
debentures. Also, pursuant to our Articles of Incorporation, we were precluded from paying dividends on our
common stock while any dividends accrued on our preferred stock had not been declared and paid. As discussed
above, those restrictions were removed on October 18 and 19, 2011, when we terminated the deferral of interest on
our subordinated debentures and brought current the dividends on our preferred stock, respectively.
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, federal funds sold and interest-
bearing deposit balances. Asset and liability management is the process of managing the balance sheet to achieve a
mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.
To assist in providing needed funds, we have regularly obtained monies from wholesale funding sources. Wholesale
funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLB,
totaled $375.5 million, or 30.5% of combined deposits and borrowed funds as of December 31, 2011, compared to
$584.1 million, or 39.8% of combined deposits and borrowed funds, as of December 31, 2010, 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 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 the past three years, the relatively high reliance on wholesale funds
will likely remain, although at a much lower level than historical levels. 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 have a floating interest rate. 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-31
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 decreased $44.4 million during
2011, totaling $72.6 million as of December 31, 2011. A large portion of the decline represents transfers to
noninterest-bearing checking accounts, reflecting a reduction in rates offered on the repurchase agreement product
whereby for certain lower-balance customers, maintaining their relationship with us in a noninterest-bearing
checking account was less expensive for them than keeping their funds in the repurchase agreement product when
taking into account the rate paid and fees assessed. Information regarding our repurchase agreements as of
December 31, 2011 and during 2011 is as follows:
Outstanding balance at December 31, 2011
Weighted average interest rate at December 31, 2011
Maximum daily balance twelve months ended December 31, 2011
Average daily balance for twelve months ended December 31, 2011
Weighted average interest rate for twelve months ended December 31, 2011
$
72,569,000
0.31%
$
$
116,397,000
80,137,000
0.51%
As a member of the FHLB, we have access to the FHLB advance borrowing programs. Advances totaled $45.0
million as of December 31, 2011, compared to $65.0 million, $205.0 million, and $270.0 million as of December 31,
2010, 2009 and 2008, respectively. Based on available collateral as of December 31, 2011, we could borrow an
additional $50.9 million.
We also have the ability to borrow up to $38.0 million on a daily basis through correspondent banks using
established unsecured federal funds purchased lines of credit. We did not access these lines of credit during 2011; in
fact, we have not accessed the lines of credit since January of 2010. In contrast, federal funds sold averaged $78.6
million and $69.3 million during 2011 and 2010, respectively. In addition, interest-bearing deposit balances
averaged $9.7 million and $9.3 million during the respective time periods. Given the volatile market and stressed
economic conditions, we have been operating with a higher than normal balance of federal funds sold and interest-
bearing deposit balances. It is expected that we will maintain the higher balance of liquid funds, likely to average
3.0% to 4.0% 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 lines 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 $27.1 million for terms
of 1 to 28 days at December 31, 2011. We did not utilize this line of credit during the past three years, and do not
plan to access this line of credit in future periods.
The following table reflects, as of December 31, 2011, 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
$ 530,813,000 $
0 $
0 $
0 $
530,813,000
Certificates of deposit
Short-term borrowings
Federal Home Loan Bank
advances
Subordinated debentures
Other borrowed money
369,362,000
144,753,000
67,147,000
72,569,000
0
30,000,000
15,000,000
0
0
0
0
0
0
0
0
0
0
0
32,990,000
1,434,000
581,262,000
72,569,000
45,000,000
32,990,000
1,434,000
F-32
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, 2011, we had a total of $238.2 million
in unfunded loan commitments and $15.9 million in unfunded standby letters of credit. Of the total unfunded loan
commitments, $207.3 million were commitments available as lines of credit to be drawn at any time as customers’
cash needs vary, and $30.9 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; however, the $30.9 million level at December 31,
2011 is relatively high when compared to the levels over the past few years. 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:
12/31/11
12/31/10
12/31/09
Commercial unused lines of credit
$
171,683,000 $
158,945,000 $
205,018,000
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
24,663,000
26,870,000
24,916,000
7,565,000
3,367,000
30,929,000
15,923,000
7,768,000
4,052,000
9,840,000
8,565,000
4,526,000
7,701,000
19,343,000
36,512,000
Total
$
254,130,000 $
226,818,000 $
287,238,000
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-33
Residential real estate loans
Consumer loans
Securities (2)
Federal funds sold
Interest-bearing deposits
Allowance for loan losses
Other assets
Total assets
Liabilities:
Interest-bearing checking
Savings deposits
Money market accounts
Time deposits under $100,000
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, 2011:
Within
Three
Months
Three to
Twelve
Months
One to
Five
Years
After
Five
Years
Total
Assets:
Commercial loans (1)
$
255,638,000 $
205,052,000 $
495,276,000 $
18,166,000 $
974,132,000
33,142,000
1,962,000
30,015,000
54,329,000
9,641,000
0
0
116,000
205,000
0
0
0
0
11,250,000
39,638,000
10,167,000
1,902,000
113,000
94,197,000
4,093,000
41,472,000
113,261,000
184,953,000
0
0
0
0
0
0
0
0
54,329,000
9,641,000
(36,532,000)
148,416,000
384,727,000
216,623,000
578,288,000
141,707,000 $ 1,433,229,000
205,912,000
32,468,000
145,402,000
18,399,000
0
0
0
0
0
0
31,590,000
31,798,000
Time deposits $100,000 & over
163,617,000
155,756,000
180,102,000
Short-term borrowings
72,569,000
0
0
Federal Home Loan Bank advances
10,000,000
20,000,000
15,000,000
Other borrowed money
34,424,000
Noninterest-bearing checking
Other liabilities
Total liabilities
Shareholders' equity
Total liabilities & shareholders'
0
0
0
0
0
0
0
0
682,791,000
207,346,000
226,900,000
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
205,912,000
32,468,000
145,402,000
81,787,000
499,475,000
72,569,000
45,000,000
34,424,000
147,031,000
4,162,000
1,268,230,000
164,999,000
equity
682,791,000
207,346,000
226,900,000
0 $ 1,433,229,000
Net asset (liability) GAP
$
(298,064,000) $
9,277,000 $
351,388,000 $
141,707,000
Cumulative GAP
$
(298,064,000) $
(288,787,000) $
62,601,000 $
204,308,000
Percent of cumulative GAP to
total assets
(20.8%)
(20.1%)
4.4%
14.3%
(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, 2011.
F-34
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, 2011, 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, 2011. 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
$
(1,630,000)
(1,200,000)
(640,000)
40,000
1,120,000
700,000
450,000
590,000
40,000
(3.4%)
(2.5)
(1.3)
0.1
2.4
1.5
0.9
1.2
0.1
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, 2011, 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. The resulting estimates also
take into account the cap corridor that is addressed in Note 13, which provides for a net increase in net interest
income of $0.6 million, $1.0 million, $1.1 million and $1.2 million in the increasing interest rate environments of
100 basis points, 200 basis points, 300 basis points and 400 basis points, respectively.
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-35
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,
2011 and 2010, 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, 2011. 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, 2011 and 2010, and the results of its
operations and its cash flows for each of the three years in the period ended December 31, 2011, 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, 2011, 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, 2012 expressed an unqualified
opinion thereon.
/s/ BDO USA, LLP
BDO USA, LLP
Grand Rapids, Michigan
March 14, 2012
F-36
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, 2011,
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, 2011, 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, 2011 and 2010, 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, 2011, and our report dated March 14, 2012 expressed an unqualified
opinion thereon.
/s/ BDO USA, LLP
BDO USA, LLP
Grand Rapids, Michigan
March 14, 2012
F-37
March 14, 2012
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, 2011. 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, 2011, 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-38
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2011 and 2010
ASSETS
Cash and due from banks
Interest-bearing deposit balances
Federal funds sold
Total cash and cash equivalents
Securities available for sale
Federal Home Loan Bank stock
Loans
Allowance for loan losses
Loans, net
Premises and equipment, net
Bank owned life insurance
Accrued interest receivable
Other real estate owned and repossessed assets
Net deferred tax asset
Other assets
2011
2010
$
12,402,000
9,641,000
54,329,000
76,372,000
$
6,674,000
9,600,000
47,924,000
64,198,000
172,992,000
11,961,000
220,830,000
14,345,000
1,072,422,000
(36,532,000)
1,035,890,000
1,262,630,000
(45,368,000)
1,217,262,000
26,802,000
48,520,000
4,403,000
15,282,000
26,013,000
14,994,000
27,873,000
46,743,000
5,942,000
16,675,000
0
18,553,000
Total assets
$1,433,229,000
$1,632,421,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing
Interest-bearing
Total
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated debentures
Other borrowed money
Accrued interest and other liabilities
Total liabilities
Shareholders' equity
$ 147,031,000
965,044,000
1,112,075,000
$ 112,944,000
1,160,888,000
1,273,832,000
72,569,000
45,000,000
32,990,000
1,434,000
4,162,000
1,268,230,000
116,979,000
65,000,000
32,990,000
11,804,000
5,880,000
1,506,485,000
Preferred stock, no par value; 1,000,000 shares authorized;
21,000 shares outstanding
Common stock, no par value; 20,000,000 shares
authorized; 8,605,391 shares outstanding at December 31, 2011
and 8,597,993 shares outstanding at December 31, 2010
Common stock warrant
Retained earnings (deficit)
Accumulated other comprehensive income
Total shareholders’ equity
20,331,000
20,077,000
172,841,000
1,138,000
(32,639,000)
3,328,000
164,999,000
172,677,000
1,138,000
(68,781,000)
825,000
125,936,000
Total liabilities and shareholders’ equity
$1,433,229,000
$1,632,421,000
See accompanying notes to consolidated financial statements.
F-39
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2011, 2010 and 2009
Interest income
Loans, including fees
Securities, taxable
Securities, tax-exempt
Federal funds sold
Interest-bearing deposit balances
Total interest income
Interest expense
Deposits
Short-term borrowings
Federal Home Loan Bank advances
Other borrowings
Total interest expense
Net interest income
Provision for loan losses
2011
2010
2009
$ 62,356,000
6,685,000
1,805,000
199,000
24,000
71,069,000
$ 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
16,384,000
405,000
2,033,000
1,010,000
19,832,000
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
51,237,000
56,349,000
51,333,000
6,900,000
31,800,000
59,000,000
Net interest income (deficiency) after provision for loan losses
44,337,000
24,549,000
(7,667,000)
Noninterest income
Service charges on accounts
Earnings on bank owned life insurance
Mortgage banking activities
Rental income from other real estate owned
Credit and debit card fees
Payroll processing
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
Advertising
FHLB advance prepayment fees
Branch consolidation costs
Other expense
Total noninterest expenses
1,640,000
1,777,000
846,000
825,000
825,000
515,000
300,000
0
0
554,000
7,282,000
17,891,000
2,780,000
1,206,000
8,290,000
2,843,000
2,719,000
747,000
213,000
0
4,806,000
41,495,000
1,797,000
1,718,000
1,092,000
1,488,000
727,000
494,000
460,000
476,000
324,000
668,000
9,244,000
18,297,000
2,838,000
1,481,000
10,858,000
4,370,000
2,598,000
906,000
1,021,000
0
4,787,000
47,156,000
2,023,000
1,444,000
1,202,000
438,000
670,000
504,000
541,000
0
0
736,000
7,558,000
20,331,000
3,377,000
1,871,000
7,294,000
4,852,000
2,526,000
650,000
0
1,308,000
4,279,000
46,488,000
Income (loss) before federal income tax expense (benefit)
10,124,000
(13,363,000)
(46,597,000)
Federal income tax expense (benefit)
(27,361,000)
(47,000)
5,490,000
Net income (loss)
37,485,000
(13,316,000)
(52,087,000)
Preferred stock dividends and accretion
1,343,000
1,295,000
802,000
Net income (loss) attributable to common shares
$ 36,142,000
$ (14,611,000)
$ (52,889,000)
See accompanying notes to consolidated financial statements.
F-40
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
Years ended December 31, 2011, 2010 and 2009
Earnings (loss) per share:
Basic
Diluted
2011
2010
2009
$ 4.20
$ 4.07
$ (1.72)
$ (1.72)
$ (6.23)
$ (6.23)
See accompanying notes to consolidated financial statements.
F-41
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2011, 2010 and 2009
($ 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 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, 2011, 2010 and 2009
($ 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 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)
Balances, December 31, 2010
$ 20,077
$ 172,677
$ 1,138
$(68,781)
$
825
$ 125,936
See accompanying notes to consolidated financial statements.
F-43
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2011, 2010 and 2009
($ in thousands)
Preferred
Stock
Common
Stock
Common
Stock
Warrant
Retained
Earnings
(Deficit)
Accumulated
Other
Comprehensive
Income
Total
Shareholders’
Equity
Balances, January 1, 2011
$ 20,077
$ 172,677
$ 1,138
$(68,781)
$
825
$ 125,936
Accretion of preferred stock
254
(254)
Employee stock purchase plan
(4,726 shares)
Stock option exercises
(8,800 shares)
Dividend reinvestment plan
(644 shares)
Stock-based compensation expense
Preferred stock dividends
Comprehensive income:
Net income
Change in net unrealized gain on
securities available for sale, net
of reclassifications and tax effect
Total comprehensive income
42
55
6
61
42
55
6
61
(1,089)
(1,089)
37,485
37,485
2,503
2,503
39,988
Balances, December 31, 2011
$ 20,331
$ 172,841
$ 1,138
$(32,639)
$ 3,328
$ 164,999
See accompanying notes to consolidated financial statements.
F-44
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2011, 2010 and 2009
Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income (loss)
to net cash from (for) operating activities:
2011
2010
2009
$
37,485,000
$
(13,316,000) $
(52,087,000)
Depreciation and amortization
Provision for loan 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
2,200,000
6,900,000
(27,361,000)
61,000
50,925,000
(50,195,000)
(681,000)
0
0
0
1,826,000
0
(1,777,000)
1,539,000
2,771,000
(1,187,000)
22,506,000
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)
Cash flows from investing activities
Purchases of:
Securities available for sale
Securities held to maturity
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 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 investing activities
(28,835,000)
0
(106,329,000)
0
(73,059,000)
(1,025,000)
80,739,000
107,480,000
52,343,000
0
0
2,384,000
162,928,000
0
(556,000)
11,062,000
0
227,722,000
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
See accompanying notes to consolidated financial statements.
F-45
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 2011, 2010 and 2009
Cash flows from financing activities
Net decrease in time deposits
Net increase 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
Maturities of wholesale repurchase agreements
Decrease in other borrowed money
Proceeds from issuance of preferred stock and common
stock warrant, net
Proceeds from stock option exercises
Employee stock purchase plan
Dividend reinvestment plan
Payment of cash dividends on preferred stock
Payment of cash dividends to common shareholders
Net cash 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 to foreclosed assets
Preferred stock cash dividend accrued
2011
2010
2009
(210,617,000)
48,860,000
(331,638,000)
203,843,000
(240,269,000)
42,321,000
(44,410,000)
0
0
(20,000,000)
(10,000,000)
(370,000)
0
55,000
42,000
6,000
(1,620,000)
0
(238,054,000)
12,174,000
64,198,000
76,372,000
21,742,000
0
11,495,000
134,000
17,224,000
(2,600,000)
0
(140,000,000)
(5,000,000)
(86,000)
0
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
(2,638,000)
20,834,000
0
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
$
$
$
$
$
$
See accompanying notes to consolidated financial statements.
F-46
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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, and 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, residential mortgage loans, and instalment loans. Substantially all loans are
secured by specific items of collateral including business assets, real estate or consumer assets. Commercial loans
are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by commercial
or residential real estate. The Bank’s loan accounts and retail deposits are primarily with customers located in the
Grand Rapids, Holland and Lansing areas. As an alternative source of funds, the Bank has also issued certificates of
deposit to depositors outside of its primary market areas. Substantially all revenues are derived from banking
products and services and investment securities.
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 losses and the fair values of financial instruments are particularly
subject to change.
(Continued)
F-47
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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: Loans 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 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 $0.4 million and $0.5 million at December 31, 2011 and 2010,
respectively.
Interest income on commercial loans 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. In all
cases, loans 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 placed on nonaccrual is reversed against interest income. Interest
received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to
accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured.
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 $2.6 million and $2.7 million as of December 31, 2011 and 2010, 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-48
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Troubled Debt Restructurings: A loan is accounted for as a troubled debt restructuring if we, for economic or legal
reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not
otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full
satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the
loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate
lower than the current market rate for a new loan with similar risk, or some combination of these concessions.
Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings
are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from
nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured
terms will be collected.
In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition,
considered to be impaired loans. Impairment for these loans is measured on a loan-by-loan basis similar to other
impaired loans as described below under “Allowance for Loan Losses.” Certain loans modified as troubled debt
restructurings may have been previously measured for impairment under a general allowance methodology (i.e.,
pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the
difference between the results of these two measurement methodologies. Loans modified as troubled debt
restructurings that subsequently default are factored in to the determination of the allowance for loan losses in the
same manner as other defaulted loans.
Allowance for Loan Losses: The allowance for loan losses (“allowance”) is a valuation allowance for probable
incurred credit losses. Loan losses are charged against the allowance when we believe the uncollectability of a loan
is confirmed. Subsequent recoveries, if any, are credited to the allowance. We estimate the allowance balance
required using past loan loss experience, the nature and volume of the loan 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, but the entire allowance is available for any loan that, in our judgment,
should be charged-off.
A loan 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 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. We determine the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of delay, the reasons for 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 and construction loans by 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.
(Continued)
F-49
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets
has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been
isolated from 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 2011, 2010 and 2009, 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.
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.
(Continued)
F-50
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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. At
December 31, 2011, we reversed the full valuation allowance that was initially recorded at December 31, 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.
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 and 2009, 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.
Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for
changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for
hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our
derivatives have historically consisted of interest rate swap agreements that qualified for hedge accounting. In June
2011, as discussed in more detail in Note 13, we simultaneously purchased and sold an interest rate cap, a structure
commonly referred to as a “cap corridor”, which does not qualify for hedge accounting. 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, for accounting purposes, as a hedge of the variability of
cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive
income. They are later reclassified into earnings in the same periods during which the hedged transaction affects
earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not
apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or
expense.
(Continued)
F-51
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 hedge’s 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 January 2010, the Financial Accounting Standards Board (“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 January 1, 2010. Upon adoption of those portions of the ASU in our 2010 first quarter, we began
providing the required disclosures as currently presented in Note 15. The disclosures about the reconciliation of
information in Level 3 recurring fair value measurements were required for periods beginning January 1, 2011.
There was no effect on our fair value disclosures presented in Note 15 upon the adoption of the final portion of the
ASU in our 2011 first quarter, as we currently have no Level 3 recurring fair value measurements.
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 banks) and the credit
quality of financing receivables (e.g., loans for banks). Under the ASU, a rollforward schedule of the allowance,
with the ending allowance balance further disaggregated on the basis of the impairment method, along with the
related ending loan balance and significant purchases and sales of loans during the period are to be disclosed by
portfolio segment. Additional disclosures are required by class of loan, including credit quality, aging of past due
loans, 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 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 portfolio’s risk and performance. The majority of the
disclosures required as of the end of a reporting period were effective as of December 31, 2010. Upon adoption of
those portions of the ASU on December 31, 2010, we began providing the required end of period disclosures as
currently presented in Note 3. The disclosures about activity were effective January 1, 2011. Upon adoption of the
final portion of the ASU in our 2011 first quarter, we began providing the required activity disclosures, with the
exception of the new troubled debt restructuring related disclosures, as currently presented in Note 3. 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 deferred the effective date for disclosures related to
troubled debt restructurings. As discussed in the next paragraph, beginning with the 2011 third quarter, we began
providing the required troubled debt disclosures as presented in Note 3.
(Continued)
F-52
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In April 2011, the FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring is a
Troubled Debt Restructuring, to clarify when a loan modification or restructuring is considered a TDR. When
performing this evaluation under the ASU, a creditor must use judgment to determine whether (1) the debtor (i.e., the
borrower) is experiencing financial difficulty, and (2) the lender has granted a concession to the borrower. The ASU
amends current guidance to include indicators that a lender should consider in determining whether a borrower is
experiencing financial difficulties. It further clarifies that a borrower could be experiencing financial difficulty even
if it is not currently in default but default is probable in the foreseeable future. With respect to whether the lender
has granted a concession to the borrower, the ASU indicates (1) a borrower’s inability to access funds at a market
interest rate for debt with similar risk characteristics as the restructured debt indicates that the modification was
executed at a below-market rate and therefore may indicate a concession was granted, (2) a modification that
permanently or temporarily increases a loan’s contractual interest rate does not preclude it from being considered a
concession because the rate may still be below the market interest rate for new debt with similar risk characteristics,
and (3) a modification that results in a delay in payment that is insignificant is not considered to be a concession.
The ASU also clarifies that a creditor is precluded from using the borrower’s effective interest rate test when
performing this evaluation. For TDR identification and disclosure purposes, the guidance became effective for our
2011 third quarter and was applied retrospectively to modifications occurring on or after January 1, 2011 that
remained outstanding at September 30, 2011. The effect of the change in the method of calculating impairment was
reflected in our 2011 third quarter. As required by the ASU, we disclosed in our 2011 third quarter Form 10-Q the
total recorded investment and allowance for loan losses for newly identified TDRs, based on the new guidance, as of
September 30, 2011. Beginning in our 2011 third quarter Form 10-Q, we also disclosed the previously deferred
TDR activity related disclosures required by ASU 2010-20 in Note 3.
In April 2011, the FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements, to
improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor
to repurchase or redeem financial assets on substantially the agreed upon terms. This ASU eliminates consideration
of the transferor’s ability to fulfill its contractual rights and obligations from the criteria, as well as related
implementation guidance (i.e., that it possesses adequate collateral to fund substantially all the cost of purchasing
replacement financial assets), in determining effective control, even in the event of default by the transferee. Other
criteria applicable to the assessment of effective control are not changed by this new guidance. This ASU is
effective January 1, 2012. We do not expect the adoption of this new ASU to have a material effect on our results of
operations or financial position.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRS, to align the fair value measurement and disclosure requirements
in U.S. GAAP and International Financial Reporting Standards (“IFRSs”). Many of the amendments in this ASU
will not result in a change in requirements but simply clarify existing requirements. The amendments in this ASU
that do not change a principle or requirement for measuring fair value or disclosing information about fair value
measurements include the following: (1) the ASU permits an exception for measuring fair value when a reporting
entity manages its financial instruments on the basis of its net exposure, rather than gross exposure, to those risks; (2)
the ASU clarifies that the application of premiums and discounts in a fair value measurement is related to the unit of
account for the asset or liability being measured at fair value and specifically prohibits blockage discounts for Level
2 and 3 investments; and (3) the amendments expand fair value measurement disclosures. The more significant new
disclosures include: (1) for all Level 3 fair value measurements, quantitative information about significant
unobservable inputs used as well as a qualitative discussion about the sensitivity of recurring Level 3 fair value
measurements; (2) transfers between Level 1 and Level 2 fair value measurements on a gross basis, including the
reasons for those transfers; and (3) the categorization by level of the fair value hierarchy for items that are not
measured at fair value in the balance sheet but for which the fair value is required to be disclosed (e.g., held-to-
maturity securities and loans). The ASU is to be applied prospectively and is effective January 1, 2012. We do not
expect the adoption of this new ASU to have a material effect on our results of operations or financial position.
(Continued)
F-53
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, to improve the
comparability, consistency and transparency of financial reporting and to increase the prominence of items reported
in other comprehensive income. The ASU eliminates the option to present components of other comprehensive
income as part of the Statement of Changes in Shareholders’ Equity. Instead, all components of comprehensive
income must be presented either in a single continuous statement of comprehensive income or in two separate but
consecutive statements. In the single continuous statement approach, the statement should present the components of
net income and total net income, the components of other comprehensive income and total other comprehensive
income, and a total for comprehensive income. In the two-statement approach, the first statement should present the
components of net income and total net income followed consecutively by a second statement that should present the
components of other comprehensive income, a total for other comprehensive income and a total for comprehensive
income. Also known as “recycling,” companies will also be required to display reclassification adjustments and their
effect on net income and other comprehensive income in the statement(s) in which they appear. The ASU does not
change certain other current requirements including items that constitute net income and other comprehensive
income. The ASU is to be applied retrospectively and is effective January 1, 2012. We are currently evaluating the
two presentation approaches permitted by the ASU. In December 2011, the FASB issued ASU 2011-12, Deferral of
the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other
Comprehensive Income in Update No. 2011-05, which defers indefinitely the ASU 2011-05 requirement that entities
disclose on the face of the financial statements reclassification adjustments for items that are reclassified from other
comprehensive income to net income.
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:
2011
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general obligation bonds
Municipal revenue bonds
Mutual funds
2010
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general obligation bonds
Municipal revenue bonds
Mutual funds
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
$
$
86,783,000
31,851,000
16,700,000
26,212,000
4,300,000
1,312,000
$ 1,872,000
2,759,000
0
1,097,000
123,000
42,000
(59,000)
0
0
0
0
0
$
88,596,000
34,610,000
16,700,000
27,309,000
4,423,000
1,354,000
$ 167,158,000
$ 5,893,000
$
(59,000)
$ 172,992,000
$ 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
(Continued)
F-54
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 2 – SECURITIES (Continued)
Securities with unrealized losses at year-end 2011 and 2010, aggregated by investment category and length of time
that individual securities have been in a continuous loss position, are as follows:
Description of Securities
2011
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general
obligation bonds
Municipal revenue bonds
Mutual funds
2010
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general
obligation bonds
Municipal revenue bonds
Mutual funds
Less than 12 Months
Fair
Value
Unrealized
Loss
12 Months or More
Fair
Value
Unrealized
Loss
Total
Fair
Value
Unrealized
Loss
$ 9,765,000 $ (33,000) $ 9,526,000 $ (26,000) $ 19,291,000 $ (59,000)
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
$ 9,765,000 $
(33,000) $ 9,526,000 $
(26,000) $ 19,291,000 $ (59,000)
$56,588,000 $ (1,775,000) $
0 $
0
0
0
0
0
0
0
0
0
$ 56,588,000 $(1,775,000)
0
0
0
0
7,847,000
811,000
0
(299,000)
(25,000)
0
6,497,000
805,000
0
(480,000)
(19,000)
0
14,344,000 (779,000)
(44,000)
1,616,000
0
0
$65,246,000 $ (2,099,000) $7,302,000 $ (499,000) $ 72,548,000 $(2,598,000)
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.
Six U.S. Government agency debt obligations were in a continuous loss position for 12 months or more at December
31, 2011. At December 31, 2011, 12 debt securities with a combined fair value totaling $19.3 million have
unrealized losses with aggregate depreciation of $0.1 million, or 0.04% from the amortized cost basis of total
securities. At December 31, 2011, 223 debt securities and a mutual fund with a combined fair value totaling $123.0
million have unrealized gains with aggregate appreciation of $5.9 million, or 3.5% 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.
(Continued)
F-55
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 2 – SECURITIES (Continued)
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 2011, 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, 2011 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
7.78%
3.89
3.43
4.81
5.15
2.87
3.68
$
Amortized
Cost
175,000
9,416,000
28,293,000
79,411,000
31,851,000
16,700,000
1,312,000
Fair
Value
$
177,000
9,745,000
28,600,000
81,806,000
34,610,000
16,700,000
1,354,000
4.40%
$ 167,158,000
$ 172,992,000
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 2011 and 2009, there were no securities sold.
At year-end 2011 and 2010, the amortized cost of securities issued by the State of Michigan and all its political
subdivisions totaled $30.5 million and $33.4 million, with an estimated fair value of $31.7 million and $32.9 million,
respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies, did not
exceed 10% of shareholders’ equity.
The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to
secure repurchase agreements and letters of credit issued on behalf of our customers was $109.0 million and $166.9
million at December 31, 2011 and 2010, 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.
(Continued)
F-56
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES
Year-end loans disaggregated by class of loan within the loan 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, 2011
Balance
%
December 31, 2010
Balance
%
Percent
Increase
(Decrease)
$ 266,548,000
24.8%
$ 288,515,000
22.8%
(7.6)%
63,467,000
264,426,000
5.9
24.7
83,786,000
277,377,000
6.6
22.0
(24.3)
(4.7)
334,165,000
31.2
449,104,000
35.6
(25.6)
68,299,000
996,905,000
6.4
93.0
77,188,000
1,175,970,000
6.1
93.1
(11.5)
(15.2)
42,336,000
33,181,000
75,517,000
3.9
3.1
7.0
51,186,000
35,474,000
86,660,000
4.1
2.8
6.9
(17.3)
(6.5)
(12.9)
Total loans
$1,072,422,000
100.0%
$1,262,630,000
100.0%
(15.1)%
Concentrations within the loan portfolio were as follows at year-end:
2011
2010
Balance
Percentage of
Loan Portfolio
Balance
Percentage of
Loan Portfolio
Commercial real estate loans to
lessors of non-residential
buildings
$ 320,536,000
29.9%
$ 391,056,000
31.0%
(Continued)
F-57
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Year-end nonperforming loans were as follows:
Loans past due 90 days or more still accruing interest
Nonaccrual loans, including troubled debt restructurings
Troubled debt restructurings, accruing interest
2011
2010
$
0
45,074,000
0
$
766,000
63,915,000
4,763,000
Total nonperforming loans
$ 45,074,000
$ 69,444,000
As discussed in the “Troubled Debt Restructuring” section of Note 1, troubled debt restructurings can be in
either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans
whereas accruing troubled debt restructurings are generally excluded from nonperforming loans. At December
31, 2011, there were no accruing troubled debt restructurings included in nonperforming loans. At December
31, 2010, we categorized an accruing troubled debt restructured lending relationship as nonperforming due to
certain circumstances associated with this particular relationship. That credit relationship has been paid-off.
The recorded principal balance of nonaccrual loans, including troubled debt restructurings, was 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,
2011
December 31,
2010
$
5,916,000
3,448,000
6,635,000
24,169,000
2,532,000
42,700,000
$ 10,128,000
12,441,000
10,172,000
22,609,000
4,686,000
60,036,000
1,013,000
1,361,000
2,374,000
2,425,000
1,454,000
3,879,000
Total nonaccrual loans
$ 45,074,000
$ 63,915,000
(Continued)
F-58
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F
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired loans 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
1,979,000
1,141,000
3,120,000
1,910,000
909,000
2,819,000
1,007,000
191,000
1,198,000
Total with an allowance recorded
$ 42,591,000
$ 31,715,000
$ 9,702,000
Total impaired loans:
Commercial
Retail
Total impaired loans
90,223,000
3,548,000
$ 93,771,000
62,849,000
3,107,000
$ 65,956,000
8,504,000
1,198,000
$ 9,702,000
(Continued)
F-63
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations
whereby the loans have been charged-down to estimated collateral value. Interest income recognized on impaired
loans, consisting entirely of accruing troubled debt restructurings, totaled $0.2 million during 2011 and 2010, and
$0.1 million during 2009. Average impaired loans were $68.5 million and $75.1 million during 2011 and 2010,
respectively. Lost interest income on nonaccrual loans totaled $1.4 million during 2011 and $2.1 million during both
2010 and 2009.
(Continued)
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-
F
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
All commercial loans 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 uncollectable and of such little value that their continuance as an asset is not warranted.
The primary risk elements with respect to commercial loans are the financial condition of the borrower, the
sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing
periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the
existence of collateral and its value. The primary risk element with respect to each residential real estate loan and
consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and
have adopted policies to pursue creditor’s rights in order to preserve our collateral position.
(Continued)
F-67
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2011 are as
follows:
Allowance for loan losses:
Beginning balance
Provision for loan losses
Charge-offs
Recoveries
Ending balance
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Total loans:
Ending balance
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Commercial
Loans
Retail
Loans
Unallocated
Total
$
$
42,359,000
4,125,000
(16,978,000)
3,925,000
33,431,000
$ 2,972,000
2,730,000
(2,919,000)
236,000
$ 3,019,000
$
$
37,000
45,000
0
0
82,000
$
$
45,368,000
6,900,000
(19,897,000)
4,161,000
36,532,000
$
18,645,000
$
351,000
$
0
$
18,996,000
$
14,786,000
$ 2,668,000
$
82,000
$
17,536,000
$ 996,905,000
$ 75,517,000
$1,072,422,000
$
68,893,000
$ 2,085,000
$
70,978,000
$ 928,012,000
$ 73,432,000
$1,001,444,000
(Continued)
F-68
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2010 are as
follows:
Allowance for loan losses:
Beginning balance
Provision for loan losses
Charge-offs
Recoveries
Ending balance
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Total loans:
Ending balance
Ending balance: individually
evaluated for impairment
Ending balance: collectively
evaluated for impairment
Commercial
Loans
Retail
Loans
Unallocated
Total
$
$
46,603,000
29,030,000
(35,968,000)
2,694,000
42,359,000
$ 1,256,000
2,752,000
(1,160,000)
124,000
$ 2,972,000
$
$
19,000
18,000
0
0
37,000
$
$
47,878,000
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
$
62,849,000
$ 3,107,000
$
65,956,000
$1,113,121,000
$ 83,553,000
$1,196,674,000
Activity in the allowance for loan losses during 2009 was as follows:
Beginning balance
Provision for loan losses
Charge-offs
Recoveries
Ending balance
$
27,108,000
59,000,000
(39,621,000)
1,391,000
$
47,878,000
(Continued)
F-69
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Loans modified as troubled debt restructurings during 2011 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
Pre-
Post-
Modification Modification
Recorded
Principal
Balance
Recorded
Principal
Balance
$ 4,942,000
$ 4,936,000
5,543,000
6,727,000
8,921,000
5,542,000
6,220,000
8,918,000
Number of
Contracts
26
13
11
16
23
89
4,002,000
30,135,000
3,842,000
29,458,000
0
1
1
0
165,000
165,000
0
165,000
165,000
Total
90
$ 30,300,000
$ 29,623,000
The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30
days past due during the twelve months ended December 31, 2011 (amounts as of period end):
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
Number of
Contracts
5
2
1
5
10
23
0
0
0
Recorded
Principal
Balance
$ 1,347,000
297,000
69,000
1,506,000
490,000
3,709,000
0
0
0
23
$ 3,709,000
(Continued)
F-70
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
As a result of adopting the amendments in ASU 2011-02 effective September 30, 2011, we reassessed all loan
renewals and modifications that occurred on or after January 1, 2011 to determine whether they should now be
considered troubled debt restructurings. In general, our policy dictates that a renewal or modification of an 8- or 9-
rated loan meets the criteria of a troubled debt restructuring, although we review and consider all renewed and
modified loans as part of our troubled debt restructuring assessment procedures. Loan relationships rated 8 contain
significant financial weaknesses, resulting in a distinct possibility of loss, while relationships rated 9 reflect vital
financial weaknesses, resulting in a highly questionable ability on our part to collect principal; we believe borrowers
warranting such ratings would have difficulty obtaining financing from other market participants. Thus, due to the
lack of comparable market rates for loans with similar risk characteristics, we believe 8- or 9-rated loans that were
renewed or modified during 2011 were done so at below market rates. Loans that are identified as troubled debt
restructurings are considered impaired and are individually evaluated for impairment when assessing these credits in
our allowance for loan losses calculation. Certain of the loans, totaling $26.2 million as of December 31, 2011, that
were identified as troubled debt restructurings under the new guidance had been previously measured under a general
allowance methodology (i.e., pooling) for calculation of our allowance for loan losses. The allowance for loan losses
associated with these specific loans totaled $11.2 million as of December 31, 2011, or approximately $5.7 million
higher than would have been recorded using a general allowance methodology.
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment were as follows:
Land and improvements
Buildings
Furniture and equipment
Less: accumulated depreciation
2011
2010
$
8,531,000
24,528,000
12,977,000
46,036,000
19,234,000
$
8,531,000
24,528,000
12,478,000
45,537,000
17,664,000
Total premises and equipment
$
26,802,000
$
27,873,000
Depreciation expense totaled $1.6 million in 2011, $1.9 million in 2010, and $2.5 million in 2009.
(Continued)
F-71
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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 interest-
bearing checking
Out-of-area time,
under $100,000
Out-of-area time,
$100,000 and over
December 31, 2011
Balance
%
December 31, 2010
Balance
%
Percent
Increase
(Decrease)
$ 147,031,000
13.2% $ 112,944,000
8.9%
30.2%
179,770,000
145,402,000
32,468,000
63,330,000
213,548,000
781,549,000
26,142,000
18,457,000
285,927,000
330,526,000
16.2
13.1
2.9
5.7
19.2
70.3
2.3
1.7
25.7
29.7
158,177,000
150,631,000
60,201,000
75,857,000
12.4
11.8
4.7
6.0
206,954,000
764,764,000
16.2
60.0
13.7
(3.5)
(46.1)
(16.5)
3.2
2.2
0
NA
NA
37,253,000
2.9
(50.5)
471,815,000
509,068,000
37.1
40.0
(39.4)
(35.1)
Total deposits
$1,112,075,000
100.0% $1,273,832,000
100.0%
(12.7)%
Out-of-area certificates of deposit consist of certificates obtained from depositors outside of the primary market
areas. As of December 31, 2011, out-of-area certificates of deposit totaling $291.7 million were obtained through
deposit brokers, with the remaining $12.7 million obtained directly from the depositors.
The following table depicts the maturity distribution for certificates of deposit at year-end:
In one year or less
In one to two years
In two to three years
In three to four years
In four to five years
2011
2010
$ 369,362,000
107,463,000
37,290,000
44,034,000
23,113,000
$ 495,914,000
179,867,000
70,602,000
27,842,000
17,654,000
Total certificates of deposit
$ 581,262,000
$ 791,879,000
(Continued)
F-72
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 5 – DEPOSITS (Continued)
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
2011
2010
$ 163,617,000
77,164,000
78,592,000
180,102,000
$ 184,283,000
108,963,000
128,315,000
257,208,000
Total certificates of deposit
$ 499,475,000
$ 678,769,000
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
2011
2010
$ 72,569,000
0.31%
$ 116,979,000
0.69%
80,137,000
0.51%
107,781,000
1.31%
Maximum daily balance during the year
116,397,000
133,280,000
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 fair value equal to the
aggregate outstanding balance.
(Continued)
F-73
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at December 31, 2011 totaled $45.0 million and mature at varying dates from March 2012
through January 2014, with fixed rates of interest from 3.04% to 4.42% and averaging 3.57%. At December 31,
2010, outstanding balances totaled $65.0 million with maturities ranging from June 2011 through January 2014 and
fixed rates of interest from 3.04% to 4.42% and averaging 3.73%.
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, 2011 totaled $97.7
million, with availability of $50.9 million.
Maturities over the next five years are:
2012
2013
2014
2015
2016
$ 30,000,000
10,000,000
5,000,000
0
0
NOTE 8 - FEDERAL INCOME TAXES
The consolidated income tax expense (benefit) is as follows:
2011
2010
2009
Current expense (benefit)
Deferred benefit
Valuation allowance – change in estimate
Tax expense (benefit)
$
0
0
(27,361,000)
$ (27,361,000)
$
$
0
(47,000)
0
(47,000)
$
$
(4,483,000)
(13,276,000)
23,249,000
5,490,000
2009 reflects the establishment of a valuation allowance, and 2011 the reversal of the allowance, related to a change
in estimate about our ability to realize our net deferred tax assets in future years based on a change in circumstances.
For 2010, the tax benefit relates to adjustments between other comprehensive income and tax benefit from operations
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)
2011
2010
2009
$
3,543,000
$
(4,677,000)
$ (16,309,000)
(595,000)
(622,000)
(29,640,000)
(47,000)
$ (27,361,000)
(706,000)
(601,000)
5,896,000
41,000
(47,000)
(866,000)
(505,000)
23,249,000
(79,000)
5,490,000
$
$
(Continued)
F-74
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 8 - FEDERAL INCOME TAXES (Continued)
Significant components of deferred tax assets and liabilities as of December 31, 2011 and 2010 are as follows:
Deferred income tax assets
Allowance for loan 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
Other
Net deferred tax asset before valuation allowance
Valuation allowance
Total net deferred tax asset
2011
2010
$ 12,786,000
145,000
502,000
635,000
2,136,000
11,201,000
977,000
718,000
29,100,000
$ 15,879,000
165,000
631,000
935,000
2,038,000
10,379,000
807,000
704,000
31,538,000
549,000
2,042,000
496,000
3,087,000
26,013,000
0
$ 26,013,000
639,000
694,000
565,000
1,898,000
29,640,000
(29,640,000)
0
$
At December 31, 2011, we had carryforwards of the following tax attributes: gross federal net operating loss of
$32.0 million that expires in years 2029 through 2031; general business tax credits of $0.6 million that expire in the
years 2027 through 2031; 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 carried 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. During 2011, we returned to pre-tax profitability for four consecutive quarters. Additionally,
we experienced lower provision expense, continued declines in nonperforming assets and problem asset
administration costs, a higher net interest margin, further strengthening of our regulatory capital ratios, and
additional reductions in wholesale funding. Our analysis of the positive and negative evidence led us to conclude
that, as of December 31, 2011, it was more likely than not that we had returned to sustainable profitability in
amounts sufficient to allow for realization of our deferred tax assets in future years. Consequently, we reversed the
valuation allowance that we had previously determined necessary to carry against our entire net deferred tax asset as
of December 31, 2010 and 2009. $27.4 million of our December 31, 2010 valuation allowance was reversed due to
this change in judgment and the remaining $2.2 million was reduced due to the tax effects of our 2011 pre-tax
income.
We had no unrecognized tax benefits at any time during 2011 or 2010 and do not anticipate any significant increase
in unrecognized tax benefits during 2012. 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 2011 or 2010. Our U.S. federal income tax returns are no longer subject to examination for all years
before 2010.
(Continued)
F-75
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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, 2010 or 2011.
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 vested 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 2011,
there were approximately 429,000 shares authorized for future incentive awards.
There was no unrecognized compensation cost related to unvested stock options granted under our various stock-
based compensation plans, and less than $0.1 million of total unrecognized compensation cost related to unvested
restricted stock granted under our Stock Incentive Plan of 2006 as of December 31, 2011, the latter of which is
expected to be recognized over a weighted-average period of less than one year.
A summary of restricted stock activity is as follows:
2011
2010
2009
Weighted
Average
Fair Value
$ 11.02
NA
17.57
10.99
Shares
73,955
0
(28,533)
(6,772)
Weighted
Average
Fair Value
$ 14.98
NA
37.76
14.62
Weighted
Average
Fair Value
Shares
113,010
0
(3,290)
(18,487)
$ 14.85
NA
20.39
13.20
Shares
91,233
0
(12,941)
(4,337)
38,650
$
6.20
73,955
$ 11.02
91,233
$ 14.98
Nonvested at
beginning of year
Granted
Vested
Forfeited
Nonvested at
end of year
(Continued)
F-76
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
A summary of stock option activity is as follows:
2011
2010
2009
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
262,042
0
(8,800)
(38,339)
$ 21.18
NA
6.21
17.80
293,572
0
0
(31,530)
$ 20.43
NA
NA
14.23
322,791
0
0
(29,219)
$ 20.58
NA
NA
22.05
214,903
$ 22.40
262,042
$ 21.18
293,572
$ 20.43
Outstanding at
beginning of year
Granted
Exercised
Forfeited or expired
Outstanding at
end of year
Options exercisable
at year-end
212,643
$ 22.57
250,222
$ 21.86
228,252
$ 24.20
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. No stock option grants were made during 2009,
2010 or 2011.
Options outstanding at year-end 2011 were as follows:
Outstanding
Exercisable
Range of
Exercise
Prices
$ 6.21 - $ 8.00
$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
47,960
64,122
5,088
19,916
56,931
15,684
5,202
3.9 Years
2.1 Years
0.8 Years
1.8 Years
3.3 Years
1.9 Years
2.8 Years
$ 6.21
17.16
20.18
26.61
34.74
37.94
40.28
Weighted
Average
Exercise
Price
$ 6.21
17.16
20.18
26.61
34.74
37.94
40.28
Number
45,700
64,122
5,088
19,916
56,931
15,684
5,202
Outstanding at year end
214,903
2.8 Years
$ 22.40
212,643
$ 22.57
The weighted-average remaining contractual life of the 212,643 stock options exercisable as of December 31, 2011
was 2.8 years.
(Continued)
F-77
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
Information related to options outstanding at year-end 2011, 2010 and 2009 were as follows:
Minimum exercise price
Maximum exercise price
Average remaining option term
2011
2010
2009
$
6.21
40.28
2.8 Years
$
6.21
40.28
3.5 Years
$
6.21
40.28
4.2 Years
Information related to stock option grants and exercises during 2011, 2010 and 2009 follows:
2011
2010
2009
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
$ 26,000
55,000
0
$ NA
NA
NA
$
options granted
NA
NA
NA
NA
NA
NA
The aggregate intrinsic value of all stock options outstanding and exercisable at December 31, 2011 was $0.2
million.
Shares issued as a result of the exercise of stock option grants have been authorized and previously unissued shares.
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 2011 and 2010, the Bank had $2.0 million and
$10.9 million in loan commitments to directors and executive officers, of which $1.2 million and $10.9 million were
outstanding at year-end 2011 and 2010, respectively, as reflected in the following table. The line item entitled
“Adjustments” primarily relates to Board member retirements during 2011 and 2010.
Beginning balance
New loans
Repayments
Adjustments
Ending balance
2011
2010
$ 10,881,000
147,000
(195,000)
(9,591,000)
$ 12,174,000
79,000
(757,000)
(615,000)
$
1,242,000
$ 10,881,000
Related party deposits and repurchase agreements totaled $2.0 million and $9.8 million at year-end 2011 and 2010,
respectively.
(Continued)
F-78
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 11 – COMMITMENTS AND OFF-BALANCE-SHEET RISK
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the
financing needs of our customers. These financial instruments include commitments to extend credit and standby
letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Standby letters of credit are conditional commitments issued
by 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 generally recorded as a liability.
During 2011, we expensed $0.4 million through provision for loan losses in association with a particular standby
letter of credit. Due to the nature of the transaction and the insignificant amount, the $0.4 million was included as a
specific reserve within the allowance as of December 31, 2011. There was no reserve or liability balance as of
December 31, 2010.
At year-end 2011 and 2010, the rates on existing off-balance sheet instruments were substantially equivalent to
current market rates, considering the underlying credit standing of the counterparties.
Our maximum exposure to credit losses for loan commitments and standby letters of credit outstanding at year-end
was as follows:
Commercial unused lines of credit
Unused lines of credit secured by 1 – 4 family
residential properties
Credit card unused lines of credit
Other consumer unused lines of credit
Commitments to make loans
Standby letters of credit
2011
2010
$ 171,683,000
$ 158,945,000
24,663,000
7,565,000
3,367,000
30,929,000
15,923,000
26,870,000
7,768,000
4,052,000
9,840,000
19,343,000
Total commitments
$ 254,130,000
$ 226,818,000
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, the Wall Street Journal Prime Rate or the 30-Day Libor rate.
For term debt secured by real estate, customers are generally offered a floating rate tied to the Mercantile Bank
Prime Rate or Wall Street Journal Prime Rate, and a fixed rate currently ranging from 4.50% 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 or Wall Street Journal Prime Rate, and a fixed rate currently ranging from 4.00% to 7.50%. These
credit facilities generally mature and fully amortize within five years.
(Continued)
F-79
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 11 – COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
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, 2011, the total notional amount of the
underlying interest rate swap agreements was $40.6 million, with a net fair value from our commercial loan
customers’ perspective of negative $6.1 million. 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, 2011 and 2010.
The following instruments are considered financial guarantees under current accounting guidance. These
instruments are carried at fair value.
2011
2010
Contract
Amount
Carrying
Value
Contract
Amount
Carrying
Value
Standby letters of credit
$
15,923,000
$ 210,000
$ 19,343,000
$ 168,000
We were required to have $0.9 million and $0.7 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 2011 and 2010, 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 May 1, 2011 we
reinstituted our matching contribution to the 401(k) benefit plan at 2% after having suspended matching
contributions effective April 1, 2009. Effective January 1, 2012, we raised the matching contribution to 3%. 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 2011, 2010 and 2009 matching 401(k) contributions charged to
expense were $160,000, $0 and $206,000, 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 2011, 2010 and 2009
was $17,000, $19,000 and $24,000, 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 2011, 2010 and 2009 was $36,000, $40,000
and $51,000, respectively.
(Continued)
F-80
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 12 – BENEFIT PLANS (Continued)
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 4,726 and 9,129 in 2011 and 2010, respectively. As of December 31, 2011, there were 7,440 shares
available under the Stock Purchase Plan.
NOTE 13 – HEDGING ACTIVITIES
Our interest rate risk policy includes guidelines for measuring and monitoring interest rate risk. Within these
guidelines, parameters have been established for maximum fluctuations in net interest income. Possible fluctuations
are measured and monitored using net interest income simulation. Our policy provides for the use of certain
derivative instruments and hedging activities to aid in managing interest rate risk to within policy parameters.
A majority of our assets are comprised of commercial loans on which the interest rates are variable; however, the
interest rates on a significant portion of these loans will likely lag an increase in market interest rates under a rising
interest rate environment. As of December 31, 2011, the Mercantile Bank Prime Rate, the index on which a majority
of our commercial floating rate loans is based, was 4.50% 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. It is our intent to keep the Mercantile Bank Prime Rate unchanged until the Wall Street Journal
Prime Rate equals the Mercantile Bank Prime Rate, at which time the two indices will likely remain equal in future
periods. In addition, a majority of our floating rate loans, whether tied to the Mercantile Bank Prime Rate, Wall
Street Journal Prime Rate or Libor rates, have interest rate floors that are currently higher than the indexed rate
provides for. To help mitigate the negative impact to our net interest income in an increasing interest rate
environment resulting from our cost of funds likely increasing at a higher rate than the yield on our assets, we may
periodically enter into derivative financial instruments.
In June 2011, we simultaneously purchased and sold an interest rate cap with a correspondent bank, a structure
commonly referred to as a “cap corridor.” The cap corridor, which does not qualify for hedge accounting, consisted
of us purchasing a $100 million interest rate cap with a strike rate in close proximity to the then-current 30-day Libor
rate and selling a $100 million interest rate cap with a strike rate that is 125 basis points higher than the purchased
interest rate cap strike rate. On the settlement date, the present value of the purchased interest rate cap of $729,500
was recorded as an asset, while the present value of the sold interest rate cap of $213,500 was recorded as a liability.
At each month end, the recorded balances of the purchased and sold interest rate caps are adjusted to reflect the
current present values, with the offsetting entry being recorded to interest income on commercial loans. We
recorded a net decrease of $259,000 to interest income on commercial loans to reflect the net change in present
values during 2011. Payments made or received under the purchased and sold interest rate cap contracts, if any, are
also recorded to interest income on commercial loans. No such payments were made or received during 2011.
(Continued)
F-81
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as follows at year-end:
2011
2010
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
Financial assets
Cash and cash equivalents
Securities available for sale
Federal Home Loan Bank stock
Loans, net
Bank owned life insurance
Accrued interest receivable
Purchased interest rate cap
$ 76,372,000
172,992,000
11,961,000
1,035,890,000
48,520,000
4,403,000
312,000
$ 76,372,000
172,992,000
11,961,000
1,035,164,000
48,520,000
4,403,000
312,000
$ 64,198,000
220,830,000
14,345,000
1,217,262,000
46,743,000
5,942,000
0
$ 64,198,000
220,830,000
14,345,000
1,223,911,000
46,743,000
5,942,000
0
Financial liabilities
Deposits
Securities sold under agreements
to repurchase
Federal Home Loan Bank advances
Subordinated debentures
Accrued interest payable
Sold interest rate cap
1,112,075,000
1,117,803,000
1,273,832,000
1,284,767,000
72,569,000
45,000,000
32,990,000
2,839,000
55,000
72,569,000
46,019,000
33,096,000
2,839,000
55,000
116,979,000
65,000,000
32,990,000
4,749,000
0
116,979,000
67,668,000
33,006,000
4,749,000
0
Carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, accrued
interest receivable and payable, bank owned life insurance, demand deposits, securities sold under agreements to
repurchase, and variable rate loans and deposits that reprice frequently and fully. Security fair values are based on
market prices or dealer quotes, and if no such information is available, on the rate and term of the security and
information about the issuer. For fixed rate loans and deposits and for variable rate loans and deposits with
infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates
applied to the estimated life and credit risk. Fair value of subordinated debentures and Federal Home Loan Bank
advances is based on current rates for similar financing. Fair value of interest rate caps is determined primarily
utilizing market-consensus forecasted yield curves. 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-82
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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 based on market data
obtained from independent sources, or unobservable, meaning those that reflect our own estimates about the
assumptions market participants would use in pricing the asset or liability based on the best information available in
the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority
to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.
The fair value hierarchy is as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to
access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or
other inputs that are observable or can be derived from or corroborated by observable market data by correlation or
other means.
Level 3: Significant unobservable inputs that reflect our own estimates about the assumptions that market
participants would use in pricing an asset or liability.
The following is a description of our valuation methodologies used to measure and disclose the fair values of our
financial assets and liabilities on a recurring or nonrecurring basis:
Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value
measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured
using independent pricing models. Level 2 securities include U.S. Government agency debt obligations, mortgage-
backed securities issued or guaranteed by U.S. Government agencies, 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 is based on quoted prices, if
available. If quoted prices are not available, fair values are measured using independent pricing models. We had no
securities held to maturity outstanding as of December 31, 2011 or 2010.
(Continued)
F-83
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
Mortgage loans held for sale. Mortgage loans held for sale are carried at the lower of aggregate 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, 2011 and
2010, we determined that the fair value of our mortgage loans held for sale was similar to the cost; therefore, we
carried the $2.6 million and $2.7 million, respectively, of such loans at cost so they are not included in the
nonrecurring table below.
Loans. We do not record loans at fair value on a recurring basis. However, from time to time, we record
nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves
that are based on the observable market price or current estimated value of the collateral. These loans are reported in
the nonrecurring table below at initial recognition of 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 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 cap contracts, we measure fair value utilizing models that use primarily market
observable inputs, such as forecasted yield curves, and accordingly, are classified as Level 2.
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, 2011 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)
Available for sale securities
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Municipal general obligation
bonds
Municipal revenue bonds
Mutual funds
Derivatives
$ 88,596,000
34,610,000
16,700,000
$
27,309,000
4,423,000
1,354,000
0
0
0
0
0
0
$ 88,596,000
34,610,000
16,700,000
$
27,309,000
4,423,000
1,354,000
Interest rate cap contracts
Total
257,000
$ 173,249,000
$
0
257,000
$ 173,249,000
$
There were no transfers in or out of Level 1, Level 2 or Level 3 during 2011.
0
0
0
0
0
0
0
(Continued)
F-84
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
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.
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, 2011 are as
follows:
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
Total
Impaired loans (1)
Foreclosed assets (1)
Total
$ 44,915,000
15,282,000
$ 60,197,000
$
$
0
0
0
Significant
Other
Observable
Inputs
(Level 2)
$
$
0
0
0
Significant
Unobservable
Inputs
(Level 3)
$ 44,915,000
15,282,000
$ 60,197,000
(Continued)
F-85
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
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
(1) Represents carrying value and related write-downs for which adjustments are based on the estimated value of
the property or other assets.
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.
(Continued)
F-86
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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
$ 36,142,000
$(14,611,000)
$(52,889,000)
2011
2010
2009
Weighted average common shares outstanding
8,602,845
8,507,572
8,489,679
Basic earnings (loss) per common share
$
4.20
$
(1.72)
$
(6.23)
Diluted
Net income (loss) attributable to common shares
$ 36,142,000
$(14,611,000)
$(52,889,000)
Weighted average common shares outstanding for
basic earnings (loss) per common share
8,602,845
8,507,572
8,489,679
Add: Dilutive effects of share-based awards
275,335
0
0
Average shares and dilutive potential
common shares
8,878,180
8,507,572
8,489,679
Diluted earnings (loss) per common share
$
4.07
$
(1.72)
$
(6.23)
Stock options for approximately 167,000 shares of common stock were antidilutive and were not included in
determining dilutive earnings per share in 2011.
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.
Weighted average diluted common shares outstanding equals the weighted average basic common shares outstanding
during 2010 and 2009 due to the net losses recorded during those periods.
(Continued)
F-87
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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 other 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 2011 and 2010, 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, 2011
that we believe has changed our Bank’s categorization.
(Continued)
F-88
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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
$ 187,940
188,378
15.5%
15.5
$ 97,237
97,203
8.0%
8.0
$
NA
121,504
NA
10.0%
172,469
172,910
14.2
14.2
172,469
172,910
12.1
12.1
48,619
48,602
57,072
57,199
4.0
4.0
4.0
4.0
NA
72,902
NA
6.0
NA
71,499
NA
5.0
$ 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
2011
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
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
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 2011, under the most restrictive
of these regulations (to remain well capitalized), our Bank could distribute approximately $61.9 million to
Mercantile as dividends without prior regulatory approval.
(Continued)
F-89
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 18 - REGULATORY MATTERS (Continued)
Our consolidated capital levels as of December 31, 2011 and December 31, 2010 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, 2011 and December 31, 2010, 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-90
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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
Reclassification adjustments for gains
later recognized in income
Tax effect of unrealized holding gains (losses)
on available for sale securities
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
2011
2010
2009
$ 3,851,000
$
(345,000)
$ (1,269,000)
0
421,000
0
0
3,851,000
(99,000)
(23,000)
(1,803,000)
(3,072,000)
(1,348,000)
101,000
0
0
(147,000)
0
0
35,000
631,000
Other comprehensive income (loss)
$ 2,503,000
$
(34,000)
$ (2,441,000)
At December 31, 2011, accumulated other comprehensive income, net of tax effects (as applicable), consists of a net
unrealized gain on available for sale securities of $3.3 million.
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 $0.8 million.
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 $0.8 million and the remaining unrealized gain on interest rate
swaps of $0.1 million.
(Continued)
F-91
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
NOTE 21 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest
Income
Net Interest
Income
Net Income (Loss)
Attributable to
Common
Shares
Earnings (Loss) per Share
Diluted
Basic
$ 19,159,000
18,460,000
17,044,000
16,406,000
$ 13,449,000
13,158,000
12,295,000
12,335,000
$ 1,088,000
2,381,000
2,682,000
29,991,000
$ 0.13
0.28
0.31
3.49
$ 23,189,000
22,696,000
21,734,000
20,524,000
$ 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)
$ 0.12
0.27
0.30
3.37
$ (0.35)
(0.08)
(0.67)
(0.62)
$ (0.53)
(0.75)
(0.66)
(4.28)
2011
First quarter
Second quarter
Third quarter
Fourth quarter
2010
First quarter
Second quarter
Third quarter
Fourth quarter
2009
First quarter
Second quarter
Third quarter
Fourth quarter
During the fourth quarter of 2011, we fully reversed our previously established net deferred tax asset valuation
allowance resulting in a federal income tax benefit of $27.4 million. 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
2011
2010
$
542,000
192,703,000
5,151,000
$
1,233,000
158,043,000
1,013,000
$ 198,396,000
$ 160,289,000
$
407,000
32,990,000
164,999,000
$
1,363,000
32,990,000
125,936,000
Total liabilities and shareholders’ equity
$ 198,396,000
$ 160,289,000
(Continued)
F-92
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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
2011
2010
2009
$ 4,974,000
4,974,000
$ 1,104,000
1,104,000
$ 2,852,000
2,852,000
847,000
1,059,000
1,906,000
848,000
1,551,000
2,399,000
1,048,000
2,514,000
3,562,000
Income (loss) before income tax expense (benefit) and
equity in undistributed net income (loss) of subsidiary
3,068,000
(1,295,000)
(710,000)
Federal income tax expense (benefit)
(2,272,000)
(47,000)
1,767,000
Equity in undistributed net income (loss) of subsidiary
32,145,000
(12,068,000)
(49,610,000)
Net income (loss)
37,485,000
(13,316,000)
(52,087,000)
Preferred stock dividends and accretion
1,343,000
1,295,000
802,000
Net income (loss) attributable to common shares
$ 36,142,000
$ (14,611,000)
$ (52,889,000)
(Continued)
F-93
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2011 and 2010
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
Stock option exercises
Dividend reinvestment plan
Cash dividends on common stock
Cash dividends on preferred stock
Net cash from (for) financing activities
2011
2010
2009
$ 37,485,000
$ (13,316,000)
$ (52,087,000)
(32,145,000)
61,000
(3,619,000)
(956,000)
826,000
12,068,000
275,000
(124,000)
963,000
(134,000)
49,610,000
611,000
2,798,000
(194,000)
738,000
0
0
0
0
(19,000,000)
(19,000,000)
0
42,000
55,000
6,000
0
(1,620,000)
(1,517,000)
0
47,000
0
2,000
(85,000)
(525,000)
(561,000)
20,834,000
57,000
0
11,000
(594,000)
(525,000)
19,783,000
Net change in cash and cash equivalents
(691,000)
(695,000)
1,521,000
Cash and cash equivalents at beginning of period
1,233,000
1,928,000
407,000
Cash and cash equivalents at end of period
$
542,000
$ 1,233,000
$ 1,928,000
F-94
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, 2012.
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, 2012.
/s/ Kirk J. Agerson
Kirk J. Agerson, Director
/s/ David M. Cassard
David M. Cassard, Director
/s/ Edward J. Clark
Edward J. Clark, Director
/s/ John F. Donnelly
John F. Donnelly, Director
/s/ Michael D. Faas
Michael D. Faas, Director
/s/ Doyle A. Hayes
Doyle A. Hayes, Director
/s/ Susan K. Jones
Susan K. Jones, Director
/s/ Robert B. Kaminski, Jr.
Robert B. Kaminski, Jr., Director, Executive Vice
President, Chief Operating Officer and Secretary
/s/ Lawrence W. Larsen
Lawrence W. Larsen, Director
/s/ Calvin D. Murdock
Calvin D. Murdock, Director
/s/ Michael H. Price
Michael H. Price, Chairman of the Board,
President and Chief Executive Officer
(principal executive officer)
/s/ Timothy O. Schad
Timothy O. Schad, 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)
THIS PAGE LEFT INTENTIONALLY BLANK
CORPORATE INFORMATION
2012 DIRECTORS AND
EXECUTIVE OFFICERS
2012 STRATEGIC PLANNING TEAM
MERCANTILE BANK OF MICHIGAN
Kirk J. Agerson, MD
A.F. Associates Family Medicine, P.C.
Mark A. Alcock
Senior Vice President, Retail Manager
Mark S. Augustyn
Senior Vice President, Commercial Loan Manager
Sherri A. Calcut
Senior Vice President,
Mortgage & Consumer Loan Manager
Charles E. Christmas
Senior Vice President, Chief Financial Officer
Thomas Q. Hoban
Senior Vice President
City Executive – 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
& General Counsel
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
John F. Donnelly
Retired Global Automotive Supplier Executive
Michael D. Faas
President & Chief Executive Officer
MetroHealth
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
Timothy O. Schad
Chairman & Chief Executive Officer
Nucraft Furniture Company
SHAREHOLDER INFORMATION
Annual Meeting
The Corporation’s Annual Meeting of
Shareholders will be held on Thursday,
April 26, 2012, at Kent Country Club,
1600 College Ave. NE, Grand Rapids,
MI 49505 at 9:00 a.m. local time.
Administrative Headquarters
310 Leonard Street NW, 4th Floor
Grand Rapids, MI 49504
616-406-3000
888-345-6296
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 NW, Suite 800
Grand Rapids, MI 49503-2654
www.bdo.com
Investor Relations
Lambert, Edwards & Associates
47 Commerce
Grand Rapids, MI 49503
Common Stock Listing
Nasdaq Global Select Market
Symbol: MBWM
Stock Registrar and Transfer Agent
Computershare Investor Services
P.O. Box 43078
Providence, RI 02940-3078
Shareholder Inquiries 1-800-733-5001
www.computershare.com/investor
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.
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FOCUSING OUR GRIEF
Jason Kinzler, a 37-year-old Mercantile Bank
employee and avid athlete, died of a heart attack
while competing in the Fifth Third River Bank Run
25K on May 14, 2011. Jason’s Mercantile family
established a memorial fund to benefit his wife and
three young children, and planted a memorial
garden at our Leonard Street office, where he
worked. In August, a group of employees
participated in the American Heart Association’s
Grand Rapids Heart Walk in Jason’s honor.
FOCUS ON COMMUNITY
We encouraged volunteerism by awarding a quarterly
Community Investment Award to an employee who
exemplifies community spirit. The award includes a
$500 donation to the winner’s charity of choice.
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