MERCANTILE BANK CORP - Quarter Report: 2014 March (Form 10-Q)

mbwm20131231_10k.htm

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File No. 000-26719

MERCANTILE BANK CORPORATION

(Exact name of registrant as specified in its charter)

Michigan		38-3360865
(State or other jurisdiction of		(IRS Employer Identification No.)
incorporation or organization)

310 Leonard Street, NW, Grand Rapids, MI 49504

(Address of principal executive offices) (Zip Code)

(616) 406-3000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ___	Accelerated filer X
Non-accelerated filer ___	Smaller reporting company ___

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes

At April 30, 2014, there were 8,738,608 shares of common stock outstanding.

MERCANTILE BANK CORPORATION

INDEX

PART I.	Financial Information		Page No.

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets - March 31, 2014 (Unaudited) and December 31, 2013		1

	Condensed Consolidated Statements of Income - Three Months Ended March 31, 2014 (Unaudited) and March 31, 2013 (Unaudited)		2

	Condensed Consolidated Statements of Comprehensive Income -Three Months Ended March 31, 2014 (Unaudited) and March 31, 2013 (Unaudited)		3

	Condensed Consolidated Statements of Changes in Shareholders’ Equity - Three Months Ended March 31, 2014 (Unaudited) and March 31, 2013 (Unaudited)		4

	Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2014 (Unaudited) and March 31, 2013 (Unaudited)		6

	Notes to Condensed Consolidated Financial Statements (Unaudited)		7

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	43

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	67

	Item 4.	Controls and Procedures	70

PART II.	Other Information

	Item 1.	Legal Proceedings	71

	Item 1A.	Risk Factors	71

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	71

	Item 3.	Defaults Upon Senior Securities	71

	Item 4.	Mine Safety Disclosures	71

	Item 5.	Other Information	71

	Item 6.	Exhibits	72

	Signatures		73

MERCANTILE BANK CORPORATION

PART I --- FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

	March 31, 2014			December 31, 2013
	(Unaudited)			(Audited)
ASSETS
Cash and due from banks	$	25,823,000		$	17,149,000
Interest-bearing deposits		6,295,000			6,389,000
Federal funds sold		77,829,000			123,427,000
Total cash and cash equivalents		109,947,000			146,965,000

Securities available for sale		141,097,000			131,178,000
Federal Home Loan Bank stock		11,961,000			11,961,000

Loans		1,066,796,000			1,053,243,000
Allowance for loan losses		(20,954,000	)		(22,821,000	)
Loans, net		1,045,842,000			1,030,422,000

Premises and equipment, net		24,867,000			24,898,000
Bank owned life insurance		51,667,000			51,377,000
Accrued interest receivable		3,861,000			3,649,000
Other real estate owned and repossessed assets		2,350,000			2,851,000
Net deferred tax asset		15,768,000			17,754,000
Other assets		6,155,000			5,911,000

Total assets	$	1,413,515,000		$	1,426,966,000

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing	$	230,709,000		$	224,580,000
Interest-bearing		877,542,000			894,331,000
Total deposits		1,108,251,000			1,118,911,000

Securities sold under agreements to repurchase		63,165,000			69,305,000
Federal Home Loan Bank advances		45,000,000			45,000,000
Subordinated debentures		32,990,000			32,990,000
Accrued interest and other liabilities		6,420,000			7,435,000
Total liabilities		1,255,826,000			1,273,641,000

Shareholders' equity
Preferred stock, no par value; 1,000,000 shares authorized; none issued		0			0
Common stock, no par value; 20,000,000 shares authorized; 8,738,608 shares outstanding at March 31, 2014 and 8,739,108 shares outstanding at December 31, 2013		162,076,000			162,999,000
Retained earnings (deficit)		(521,000	)		(4,101,000	)
Accumulated other comprehensive income (loss)		(3,866,000	)		(5,573,000	)
Total shareholders’ equity		157,689,000			153,325,000

Total liabilities and shareholders’ equity	$	1,413,515,000		$	1,426,966,000

See accompanying notes to condensed consolidated financial statements.

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
Interest income
Loans, including fees	$	12,099,000		$	12,846,000
Securities, taxable		1,234,000			1,007,000
Securities, tax-exempt		183,000			295,000
Federal funds sold		68,000			54,000
Interest-bearing balances		4,000			7,000
Total interest income		13,588,000			14,209,000

Interest expense
Deposits		2,035,000			2,320,000
Short-term borrowings		22,000			20,000
Federal Home Loan Bank advances		150,000			118,000
Subordinated debentures and other borrowings		317,000			297,000
Total interest expense		2,524,000			2,755,000

Net interest income		11,064,000			11,454,000

Provision for loan losses		(1,900,000	)		(1,500,000	)

Net interest income after provision for loan losses		12,964,000			12,954,000

Noninterest income
Service charges on deposit and sweep accounts		365,000			374,000
Earnings on bank owned life insurance		290,000			338,000
Mortgage banking activities		63,000			252,000
Rental income from other real estate owned		56,000			199,000
Other income		732,000			664,000
Total noninterest income		1,506,000			1,827,000

Noninterest expense
Salaries and benefits		5,230,000			4,857,000
Occupancy		712,000			658,000
Furniture and equipment depreciation, rent and maintenance		247,000			256,000
FDIC insurance costs		177,000			245,000
Problem asset costs		(20,000	)		131,000
Merger-related costs		377,000			14,000
Other expense		2,484,000			2,423,000
Total noninterest expenses		9,207,000			8,584,000

Income before federal income tax expense		5,263,000			6,197,000

Federal income tax expense		1,683,000			1,797,000

Net income	$	3,580,000		$	4,400,000

Basic earnings per share	$	0.41		$	0.51
Diluted earnings per share	$	0.41		$	0.50
Cash dividends per share	$	0.12		$	0.10
Average basic shares outstanding		8,738,836			8,705,677
Average diluted shares outstanding		8,741,121			8,718,601

See accompanying notes to condensed consolidated financial statements.

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013

Net income	$	3,580,000		$	4,400,000

Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale		2,604,000			(1,002,000	)
Fair value of interest rate swap		14,000			114,000
		2,618,000			(888,000	)

Tax effect of unrealized holding gains (losses) on securities available for sale		(906,000	)		351,000
Tax effect of fair value of interest rate swap		(5,000	)		(40,000	)
		(911,000	)		311,000

Other comprehensive income (loss), net of tax effect		1,707,000			(577,000	)

Comprehensive income	$	5,287,000		$	3,823,000

See accompanying notes to condensed consolidated financial statements.

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

($ in thousands)	Preferred Stock		Common Stock			Retained Earnings (Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, January 1, 2014	$	0	$	162,999		$	(4,101	)	$	(5,573	)	$	153,325

Stock-based compensation expense				118									118

Cash dividends ($0.12 per common share)				(1,041	)								(1,041	)

Net income for the three months ended March 31, 2014							3,580						3,580

Change in net unrealized holding gain on securities available for sale, net of tax effect										1,698			1,698

Change in fair value of interest rate swap, net of tax effect										9			9

Balances, March 31, 2014	$	0	$	162,076		$	(521	)	$	(3,866	)	$	157,689

See accompanying notes to condensed consolidated financial statements.

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

($ in thousands)	Preferred Stock		Common Stock			Retained Earnings (Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, January 1, 2013	$	0	$	166,074		$	(21,134	)	$	1,650		$	146,590

Employee stock purchase plan (532 shares)				9									9

Dividend reinvestment plan (929 shares)				16									16

Stock-based compensation expense				118									118

Cash dividends ($0.10 per common share)				(864	)								(864	)

Net income for the three months ended March 31, 2013							4,400						4,400

Change in net unrealized holding gain on securities available for sale, net of tax effect										(651	)		(651	)

Change in fair value of interest rate swap, net of tax effect										74			74

Balances, March 31, 2013	$	0	$	165,353		$	(16,734	)	$	1,073		$	149,692

See accompanying notes to condensed consolidated financial statements.

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
Cash flows from operating activities
Net income	$	3,580,000		$	4,400,000
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		512,000			553,000
Provision for loan losses		(1,900,000	)		(1,500,000	)
Stock-based compensation expense		118,000			118,000
Proceeds from sales of mortgage loans held for sale		4,450,000			16,260,000
Origination of mortgage loans held for sale		(4,979,000	)		(15,393,000	)
Net gain from sales of mortgage loans held for sale		(52,000	)		(202,000	)
Net gain from sale and valuation write-down of foreclosed assets		(276,000	)		(528,000	)
Earnings on bank owned life insurance		(290,000	)		(338,000	)
Net change in:
Accrued interest receivable		(212,000	)		(25,000	)
Other assets		611,000			2,159,000
Accrued expenses and other liabilities		(1,060,000	)		(2,205,000	)
Net cash from operating activities		502,000			3,299,000

Cash flows from investing activities
Loan originations and payments, net		(12,939,000	)		14,779,000
Purchases of securities available for sale		(11,672,000	)		(14,984,000	)
Proceeds from maturities, calls and repayments of securities available for sale		4,407,000			12,314,000
Proceeds from sales of foreclosed assets		777,000			2,639,000
Purchases of premises and equipment		(311,000	)		(80,000	)
Net cash from (for) investing activities		(19,738,000	)		14,668,000

Cash flows from financing activities
Net decrease in time deposits		(14,142,000	)		(43,116,000	)
Net increase in all other deposits		3,482,000			702,000
Net increase (decrease) in securities sold under agreements to repurchase		(6,140,000	)		3,979,000
Net increase in other borrowed money		59,000			81,000
Employee stock purchase plan		0			9,000
Dividend reinvestment plan		0			16,000
Payment of cash dividends to common shareholders		(1,041,000	)		(864,000	)
Net cash for financing activities		(17,782,000	)		(39,193,000	)

Net change in cash and cash equivalents		(37,018,000	)		(21,226,000	)
Cash and cash equivalents at beginning of period		146,965,000			136,003,000
Cash and cash equivalents at end of period	$	109,947,000		$	114,777,000

Supplemental disclosures of cash flows information
Cash paid during the period for:
Interest	$	3,134,000		$	3,339,000
Federal income tax		0			0
Noncash financing and investing activities:
Transfers from loans to foreclosed assets		0			1,647,000

See accompanying notes to condensed consolidated financial statements.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation: The unaudited financial statements for the three months ended March 31, 2014 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance center”). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended March 31, 2014 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2013.

We formed a business trust, Mercantile Bank Capital Trust I (“the trust”), in 2004 to issue trust preferred securities. We issued subordinated debentures to the trust in return for the proceeds raised from the issuance of the trust preferred securities. The trust is not consolidated, but instead we report the subordinated debentures issued to the trust as a liability.

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 are determined using the treasury stock method. Our unvested restricted shares, which contain non-forfeitable rights to dividends whether paid or accrued (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 restricted shares are excluded from the calculation of both basic and diluted earnings per share.

Approximately 63,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2014. In addition, stock options for approximately 6,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2014. Stock options for approximately 55,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2014.

Approximately 65,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2013. In addition, stock options for approximately 21,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2013. Stock options for approximately 132,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2013.

(Continued)

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	SIGNIFICANT ACCOUNTING POLICIES (Continued)

Loans: Loans that we have 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.

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.

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 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 to be 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 either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.

(Continued)

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	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 above 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 into the determination of the allowance in the same manner as other defaulted loans.

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 generally consisted of interest rate swap agreements that qualified for hedge accounting. In February 2012, we entered into an interest rate swap agreement that qualifies for hedge accounting. The current outstanding interest rate swap is discussed in more detail in Note 9. 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 loans 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)

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	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 and liabilities 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 derivative as a hedge is no longer appropriate or intended.

Adoption of New Accounting Standards: In January of 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The ASU also requires additional related interim and annual disclosures. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2014. The implementation of ASU 2014-04 should not have a material impact on our financial position or results of operations.

(Continued)

10.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2.	SECURITIES

The amortized cost and fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) are as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
March 31, 2014
U.S. Government agency debt obligations	$	116,492,000	$	430,000	$	(7,628,000	)	$	109,294,000
Mortgage-backed securities		11,544,000		1,071,000		0			12,615,000
Municipal general obligation bonds		16,488,000		411,000		0			16,899,000
Municipal revenue bonds		877,000		42,000		0			919,000
Mutual funds		1,393,000		0		(23,000	)		1,370,000

	$	146,794,000	$	1,954,000	$	(7,651,000	)	$	141,097,000

December 31, 2013
U.S. Government agency debt obligations	$	108,279,000	$	263,000	$	(10,065,000	)	$	98,477,000
Mortgage-backed securities		12,456,000		1,102,000		0			13,558,000
Municipal general obligation bonds		16,488,000		388,000		(4,000	)		16,872,000
Municipal revenue bonds		878,000		38,000		0			916,000
Mutual funds		1,386,000		0		(31,000	)		1,355,000

	$	139,487,000	$	1,791,000	$	(10,100,000	)	$	131,178,000

(Continued)

11.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2.	SECURITIES (Continued)

Securities with unrealized losses at March 31, 2014 and December 31, 2013, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss

March 31, 2014
U.S. Government agency debt obligations	$	44,172,000	$	(2,532,000	)	$	42,828,000	$	(5,096,000	)	$	87,000,000	$	(7,628,000	)
Mortgage-backed securities		0		0			0		0			0		0
Municipal general obligation bonds		0		0			0		0			0		0
Municipal revenue bonds		0		0			0		0			0		0
Mutual funds		1,370,000		(23,000	)		0		0			1,370,000		(23,000	)

	$	45,542,000	$	(2,555,000	)	$	42,828,000	$	(5,096,000	)	$	88,370,000	$	(7,651,000	)


December 31, 2013
U.S. Government agency debt obligations	$	57,117,000	$	(5,798,000	)	$	29,679,000	$	(4,267,000	)	$	86,796,000	$	(10,065,000	)
Mortgage-backed securities		0		0			0		0			0		0
Municipal general obligation bonds		295,000		(4,000	)		0		0			295,000		(4,000	)
Municipal revenue bonds		0		0			0		0			0		0
Mutual funds		1,355,000		(31,000	)		0		0			1,355,000		(31,000	)

	$	58,767,000	$	(5,833,000	)	$	29,679,000	$	(4,267,000	)	$	88,446,000	$	(10,100,000	)

(Continued)

12.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2.	SECURITIES (Continued)

We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also 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.

At March 31, 2014, 63 debt securities and one mutual fund with fair values totaling $88.4 million have unrealized losses aggregating $7.7 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.

The amortized cost and fair value of debt securities at March 31, 2014, by maturity, are shown in the following table. The contractual maturity is utilized 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. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

	Weighted Average Yield			Amortized Cost		Fair Value

Due in 2014		5.44	%	$	1,770,000	$	1,801,000
Due in 2015 through 2019		6.31			1,018,000		1,040,000
Due in 2020 through 2024		3.44			44,432,000		43,437,000
Due in 2025 and beyond		3.63			86,637,000		80,834,000
Mortgage-backed securities		5.14			11,544,000		12,615,000
Mutual funds		2.11			1,393,000		1,370,000

		3.73	%	$	146,794,000	$	141,097,000

(Continued)

13.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2.	SECURITIES (Continued)

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $17.4 million and estimated market value of $17.8 million at March 31, 2014 and December 31, 2013. 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 was $105.2 million and $94.4 million at March 31, 2014 and December 31, 2013, respectively. In addition, substantially all of our municipal bonds have been pledged to the Discount Window of the Federal Reserve Bank of Chicago. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES

Our total loans at March 31, 2014 were $1.07 billion compared to $1.05 billion at December 31, 2013, an increase of $13.6 million, or 1.3%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at March 31, 2014 and December 31, 2013, and the percentage change in loans from the end of 2013 to the end of the first quarter of 2014, are as follows:

	March 31, 2014					December 31, 2013					Percent Increase
	Balance		%			Balance		%			(Decrease)
Commercial:
Commercial and industrial	$	289,009,000		27.1	%	$	286,373,000		27.2	%		0.9	%
Vacant land, land development, and residential construction		37,190,000		3.5			36,741,000		3.5			1.2
Real estate – owner occupied		264,299,000		24.8			261,877,000		24.9			0.9
Real estate – non-owner occupied		378,034,000		35.4			364,066,000		34.6			3.8
Real estate – multi-family and residential rental		35,686,000		3.3			37,639,000		3.5			(5.2	)
Total commercial		1,004,218,000		94.1			986,696,000		93.7			1.8

Retail:
Home equity and other		31,778,000		3.0			35,080,000		3.3			(9.4	)
1-4 family mortgages		30,800,000		2.9			31,467,000		3.0			(2.1	)
Total retail		62,578,000		5.9			66,547,000		6.3			(6.0	)

Total loans	$	1,066,796,000		100.0	%	$	1,053,243,000		100.0	%		1.3	%

(Continued)

14.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Nonperforming loans as of March 31, 2014 and December 31, 2013 were as follows:

	March 31, 2014		December 31, 2013

Loans past due 90 days or more still accruing interest	$	0	$	0
Nonaccrual loans		6,342,000		6,718,000

Total nonperforming loans	$	6,342,000	$	6,718,000

The recorded principal balance of nonaccrual loans was as follows:

	March 31, 2014		December 31, 2013

Commercial:
Commercial and industrial	$	919,000	$	1,501,000
Vacant land, land development, and residential construction		361,000		785,000
Real estate – owner occupied		684,000		389,000
Real estate – non-owner occupied		335,000		168,000
Real estate – multi-family and residential rental		492,000		208,000
Total commercial		2,791,000		3,051,000

Retail:
Home equity and other		762,000		788,000
1-4 family mortgages		2,789,000		2,879,000
Total retail		3,551,000		3,667,000

Total nonaccrual loans	$	6,342,000	$	6,718,000

(Continued)

15.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

An age analysis of past due loans is as follows as of March 31, 2014:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing

Commercial:
Commercial and industrial	$	0	$	0	$	121,000	$	121,000	$	288,888,000	$	289,009,000	$	0
Vacant land, land development, and residential construction		0		0		95,000		95,000		37,095,000		37,190,000		0
Real estate – owner occupied		0		0		0		0		264,299,000		264,299,000		0
Real estate – non-owner occupied		0		0		0		0		378,034,000		378,034,000		0
Real estate – multi-family and residential rental		0		0		0		0		35,686,000		35,686,000		0
Total commercial		0		0		216,000		216,000		1,004,002,000		1,004,218,000		0

Retail:
Home equity and other		0		0		0		0		31,778,000		31,778,000		0
1-4 family mortgages		0		0		391,000		391,000		30,409,000		30,800,000		0
Total retail		0		0		391,000		391,000		62,187,000		62,578,000		0

Total past due loans	$	0	$	0	$	607,000	$	607,000	$	1,066,189,000	$	1,066,796,000	$	0

(Continued)

16.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

An age analysis of past due loans is as follows as of December 31, 2013:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing

Commercial:
Commercial and industrial	$	0	$	0	$	309,000	$	309,000	$	286,064,000	$	286,373,000	$	0
Vacant land, land development, and residential construction		0		0		0		0		36,741,000		36,741,000		0
Real estate – owner occupied		65,000		0		50,000		115,000		261,762,000		261,877,000		0
Real estate – non-owner occupied		0		0		0		0		364,066,000		364,066,000		0
Real estate – multi-family and residential rental		0		0		64,000		64,000		37,575,000		37,639,000		0
Total commercial		65,000		0		423,000		488,000		986,208,000		986,696,000		0

Retail:
Home equity and other		14,000		0		0		14,000		35,066,000		35,080,000		0
1-4 family mortgages		21,000		44,000		375,000		440,000		31,027,000		31,467,000		0
Total retail		35,000		44,000		375,000		454,000		66,093,000		66,547,000		0

Total past due loans	$	100,000	$	44,000	$	798,000	$	942,000	$	1,052,301,000	$	1,053,243,000	$	0

(Continued)

17.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans as of March 31, 2014, and average impaired loans for the three months ended March 31, 2014, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Year-To-Date Average Recorded Principal Balance
With no related allowance recorded:
Commercial:
Commercial and industrial	$	1,693,000	$	205,000		$	358,000
Vacant land, land development and residential construction		459,000		343,000			353,000
Real estate – owner occupied		1,165,000		684,000			735,000
Real estate – non-owner occupied		1,831,000		1,761,000			1,247,000
Real estate – multi-family and residential rental		41,000		1,000			1,000
Total commercial		5,189,000		2,994,000			2,694,000

Retail:
Home equity and other		707,000		649,000			555,000
1-4 family mortgages		1,190,000		611,000			629,000
Total retail		1,897,000		1,260,000			1,184,000

Total with no related allowance recorded	$	7,086,000	$	4,254,000		$	3,878,000

(Continued)

18.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Year-To-Date Average Recorded Principal Balance
With an allowance recorded:
Commercial:
Commercial and industrial	$	1,006,000	$	953,000	$	451,000	$	1,197,000
Vacant land, land development and residential construction		4,213,000		3,908,000		728,000		4,023,000
Real estate – owner occupied		1,488,000		1,488,000		455,000		1,500,000
Real estate – non-owner occupied		19,470,000		19,451,000		7,370,000		20,262,000
Real estate – multi-family and residential rental		1,207,000		1,089,000		504,000		1,886,000
Total commercial		27,384,000		26,889,000		9,508,000		28,868,000

Retail:
Home equity and other		118,000		92,000		92,000		190,000
1-4 family mortgages		2,237,000		2,160,000		879,000		2,196,000
Total retail		2,355,000		2,252,000		971,000		2,386,000

Total with an allowance recorded	$	29,739,000	$	29,141,000	$	10,479,000	$	31,254,000

Total impaired loans:
Commercial	$	32,573,000	$	29,883,000	$	9,508,000	$	31,562,000
Retail		4,252,000		3,512,000		971,000		3,570,000
Total impaired loans	$	36,825,000	$	33,395,000	$	10,479,000	$	35,132,000

Interest income of $0.5 million was recognized on impaired loans during the first quarter of 2014.

(Continued)

19.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans were as follows as of December 31, 2013:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Year-To-Date Average Recorded Principal Balance
With no related allowance recorded:
Commercial:
Commercial and industrial	$	2,229,000	$	511,000		$	1,205,000
Vacant land, land development and residential construction		475,000		362,000			991,000
Real estate – owner occupied		1,270,000		785,000			1,084,000
Real estate – non-owner occupied		895,000		733,000			4,049,000
Real estate – multi-family and residential rental		41,000		1,000			390,000
Total commercial		4,910,000		2,392,000			7,719,000

Retail:
Home equity and other		507,000		461,000			471,000
1-4 family mortgages		1,272,000		647,000			727,000
Total retail		1,779,000		1,108,000			1,198,000

Total with no related allowance recorded	$	6,689,000	$	3,500,000		$	8,917,000

(Continued)

20.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Year-To-Date Average Recorded Principal Balance
With an allowance recorded:
Commercial:
Commercial and industrial	$	1,517,000	$	1,440,000	$	792,000	$	1,880,000
Vacant land, land development and residential construction		4,436,000		4,139,000		844,000		3,354,000
Real estate – owner occupied		1,513,000		1,513,000		528,000		2,550,000
Real estate – non-owner occupied		21,088,000		21,072,000		7,969,000		28,388,000
Real estate – multi-family and residential rental		3,219,000		2,684,000		1,127,000		2,915,000
Total commercial		31,773,000		30,848,000		11,260,000		39,087,000

Retail:
Home equity and other		320,000		289,000		96,000		329,000
1-4 family mortgages		2,274,000		2,231,000		1,030,000		1,628,000
Total retail		2,594,000		2,520,000		1,126,000		1,957,000

Total with an allowance recorded	$	34,367,000	$	33,368,000	$	12,386,000	$	41,044,000

Total impaired loans:
Commercial	$	36,683,000	$	33,240,000	$	11,260,000	$	46,806,000
Retail		4,373,000		3,628,000		1,126,000		3,155,000
Total impaired loans	$	41,056,000	$	36,868,000	$	12,386,000	$	49,961,000

(Continued)

21.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Credit Quality Indicators. We utilize a comprehensive grading system for our commercial 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 and, if appropriate, re-graded at various intervals thereafter. The risk assessment for retail loans is primarily based on the type of collateral and payment activity.

Loans by credit quality indicators were as follows as of March 31, 2014:

Commercial credit exposure – credit risk profiled by internal credit risk grades:

	Commercial and Industrial		Commercial Vacant Land, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	197,051,000	$	7,993,000	$	161,357,000	$	232,226,000	$	15,411,000
Grades 5 – 7		90,776,000		24,946,000		99,484,000		124,526,000		19,167,000
Grades 8 – 9		1,182,000		4,251,000		3,458,000		21,282,000		1,108,000
Total commercial	$	289,009,000	$	37,190,000	$	264,299,000	$	378,034,000	$	35,686,000

Retail credit exposure – credit risk profiled by collateral type:

Retail

Home Equity

and Other

Retail

1-4 Family

Mortgages

Total retail

31,778,000

30,800,000

(Continued)

22.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans by credit quality indicators were as follows as of December 31, 2013:

Commercial credit exposure – credit risk profiled by internal credit risk grades:

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - and Residential Multi-Family Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	208,151,000	$	6,973,000	$	156,230,000	$	219,325,000	$	15,465,000
Grades 5 – 7		76,237,000		25,535,000		103,066,000		122,717,000		19,469,000
Grades 8 – 9		1,985,000		4,233,000		2,581,000		22,024,000		2,705,000
Total commercial	$	286,373,000	$	36,741,000	$	261,877,000	$	364,066,000	$	37,639,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail		Retail
	Home Equity		1-4 Family
	and Other		Mortgages

Total retail	$	35,080,000	$	31,467,000

(Continued)

23.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

All commercial loans are graded using the following criteria:

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 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)

24.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity in the allowance for loan losses and the recorded investments in loans as of and during the three months ended March 31, 2014 are as follows:

	Commercial Loans			Retail Loans			Unallocated			Total

Allowance for loan losses:
Beginning balance	$	20,455,000		$	2,358,000		$	8,000		$	22,821,000
Provision for loan losses		(1,454,000	)		(434,000	)		(12,000	)		(1,900,000	)
Charge-offs		(586,000	)		(2,000	)		0			(588,000	)
Recoveries		586,000			35,000			0			621,000
Ending balance	$	19,001,000		$	1,957,000		$	(4,000	)	$	20,954,000

Ending balance: individually evaluated for impairment	$	9,508,000		$	971,000		$	0		$	10,479,000

Ending balance: collectively evaluated for impairment	$	9,493,000		$	986,000		$	(4,000	)	$	10,475,000

Total loans:
Ending balance	$	1,004,218,000		$	62,578,000					$	1,066,796,000

Ending balance: individually evaluated for impairment	$	29,883,000		$	3,512,000					$	33,395,000

Ending balance: collectively evaluated for impairment	$	974,335,000		$	59,066,000					$	1,033,401,000

(Continued)

25.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity in the allowance for loan losses and the recorded investments in loans as of and during the three months ended March 31, 2013 are as follows:

	Commercial Loans			Retail Loans			Unallocated			Total

Allowance for loan losses:
Beginning balance	$	26,043,000		$	2,645,000		$	(11,000	)	$	28,677,000
Provision for loan losses		(1,164,000	)		(363,000	)		27,000			(1,500,000	)
Charge-offs		(2,412,000	)		(3,000	)		0			(2,415,000	)
Recoveries		1,250,000			23,000			0			1,273,000
Ending balance	$	23,717,000		$	2,302,000		$	16,000		$	26,035,000

Ending balance: individually evaluated for impairment	$	14,616,000		$	277,000		$	0		$	14,893,000

Ending balance: collectively evaluated for impairment	$	9,101,000		$	2,025,000		$	16,000		$	11,142,000

Total loans:
Ending balance	$	948,964,000		$	73,992,000					$	1,022,956,000

Ending balance: individually evaluated for impairment	$	49,636,000		$	2,064,000					$	51,700,000

Ending balance: collectively evaluated for impairment	$	899,328,000		$	71,928,000					$	971,256,000

(Continued)

26.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans modified as troubled debt restructurings during the three months ended March 31, 2014 were as follows:

			Pre-		Post-
			Modification		Modification
			Recorded		Recorded
	Number of		Principal		Principal
	Contracts		Balance		Balance
Commercial:
Commercial and industrial		1	$	14,000	$	14,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		2		354,000		323,000
Real estate – multi-family and residential rental		0		0		0
Total commercial		3		368,000		337,000

Retail:
Home equity and other		0		0		0
1-4 family mortgages		0		0		0
Total retail		0		0		0

Total		3	$	368,000	$	337,000

Loans modified as troubled debt restructurings during the three months ended March 31, 2013 were as follows:

			Pre-		Post-
			Modification		Modification
			Recorded		Recorded
	Number of		Principal		Principal
	Contracts		Balance		Balance
Commercial:
Commercial and industrial		1	$	875,000	$	875,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		2		2,068,000		2,068,000
Real estate – multi-family and residential rental		0		0		0
Total commercial		3		2,943,000		2,943,000

Retail:
Home equity and other		0		0		0
1-4 family mortgages		0		0		0
Total retail		0		0		0

Total		3	$	2,943,000	$	2,943,000

(Continued)

27.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2014 (amounts as of period end):

			Recorded
	Number of		Principal
	Contracts		Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		0		0
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		0		0

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		0	$	0

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2013 (amounts as of period end):

			Recorded
	Number of		Principal
	Contracts		Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		1		44,000
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		1		44,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	44,000

(Continued)

28.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2014 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	1,656,000		$	4,501,000		$	1,816,000		$	22,311,000		$	2,620,000
Charge-Offs		0			0			(11,000	)		0			(420,000	)
Payments		(266,000	)		(3,149,000	)		(49,000	)		(1,001,000	)		(1,468,000	)
Transfers to ORE		0			0			0			0			0
Net Additions/Deletions		14,000			2,898,000			0			319,000			0
Ending Balance	$	1,404,000		$	4,250,000		$	1,756,000		$	21,629,000		$	732,000

	Retail		Retail
	Home Equity		1-4 Family
	and Other		Mortgages
Retail Loan Portfolio:
Beginning Balance	$	0	$	2,191,000
Charge-Offs		0		0
Payments		0		(69,000	)
Transfers to ORE		0		0
Net Additions/Deletions		0		0
Ending Balance	$	0	$	2,122,000

(Continued)

29.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2013 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Familyand Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	2,720,000		$	3,071,000		$	4,116,000		$	37,672,000		$	3,027,000
Charge-Offs		(35,000	)		(695,000	)		0			(711,000	)		(15,000	)
Payments		(514,000	)		(49,000	)		(61,000	)		(3,211,000	)		(54,000	)
Transfers to ORE		(74,000	)		0			(363,000	)		(803,000	)		0
Net Additions/Deletions		1,171,000			0			187,000			2,057,000			0
Ending Balance	$	3,268,000		$	2,327,000		$	3,879,000		$	35,004,000		$	2,958,000

	Retail		Retail
	Home Equity		1-4 Family
	and Other		Mortgages
Retail Loan Portfolio:
Beginning Balance	$	0	$	154,000
Charge-Offs		0		0
Payments		0		(2,000	)
Transfers to ORE		0		0
Net Additions/Deletions		0		0
Ending Balance	$	0	$	152,000

(Continued)

30.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The allowance related to loans categorized as troubled debt restructurings was as follows:

	March 31,		December 31,
	2014		2013

Commercial:
Commercial and industrial	$	95,000	$	187,000
Vacant land, land development, and residential construction		695,000		798,000
Real estate – owner occupied		455,000		528,000
Real estate – non-owner occupied		7,236,000		7,828,000
Real estate – multi-family and residential rental		304,000		1,010,000
Total commercial		8,785,000		10,351,000

Retail:
Home equity and other		0		0
1-4 family mortgages		32,000		0
Total retail		32,000		0

Total related allowance	$	8,817,000	$	10,351,000

In general, our policy dictates that a renewal or modification of an 8- or 9-rated commercial 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 renewed or modified 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.

(Continued)

31.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.	PREMISES AND EQUIPMENT, NET

Premises and equipment are comprised of the following:

	March 31,		December 31,
	2014		2013

Land and improvements	$	8,556,000	$	8,556,000
Buildings		24,742,000		24,733,000
Furniture and equipment		13,001,000		12,718,000
		46,299,000		46,007,000
Less: accumulated depreciation		21,432,000		21,109,000

Premises and equipment, net	$	24,867,000	$	24,898,000

Depreciation expense totaled $0.3 million during the first quarter of 2014 and 2013.

5.	DEPOSITS

Our total deposits at March 31, 2014 totaled $1.11 billion compared to $1.12 billion at December 31, 2013, a decrease of $10.7 million, or 1.0%. The components of our outstanding balances at March 31, 2014 and December 31, 2013, and percentage change in deposits from the end of 2013 to the end of the first quarter of 2014, are as follows:

	March 31, 2014					December 31, 2013					Percent Increase
	Balance		%			Balance		%			(Decrease)
Noninterest-bearing checking	$	230,709,000		20.8	%	$	224,580,000		20.1	%		2.7	%
Interest-bearing checking		189,971,000		17.1			197,388,000		17.6			(3.8	)
Money market		135,931,000		12.3			133,369,000		11.9			1.9
Savings		54,815,000		5.0			52,606,000		4.7			4.2
Time, under $100,000		42,261,000		3.8			43,251,000		3.9			(2.3	)
Time, $100,000 and over		263,998,000		23.8			254,600,000		22.8			3.7
		917,685,000		82.8			905,794,000		81.0			1.3
Out-of-area time, under $100,000		3,645,000		0.3			4,078,000		0.4			(10.6	)
Out-of-area time, $100,000 and over		186,921,000		16.9			209,039,000		18.6			(10.6	)
		190,566,000		17.2			213,117,000		19.0			(10.6	)

Total deposits	$	1,108,251,000		100.0	%	$	1,118,911,000		100.0	%		(1.0	)%

(Continued)

32.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

6.	SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase (“repurchase agreements”) are offered principally to certain large deposit customers. Information relating to our repurchase agreements follows:

	Three Months Ended March 31, 2014			Twelve Months Ended December 31, 2013

Outstanding balance at end of period	$	63,165,000		$	69,305,000
Average interest rate at end of period		0.13	%		0.12	%

Average daily balance during the period	$	76,412,000		$	65,939,000
Average interest rate during the period		0.12	%		0.12	%

Maximum daily balance during the period	$	91,303,000		$	78,960,000

Repurchase agreements generally have original maturities of less than one year. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank. Repurchase agreements are secured by securities with an aggregate market value equal to the aggregate outstanding balance.

7. FEDERAL HOME LOAN BANK ADVANCES

Federal Home Loan Bank advances totaled $45.0 million at March 31, 2014 and December 31, 2013, and mature at varying dates from March 2017 through September 2017, with fixed rates of interest from 1.22% to 1.51% and averaging 1.34%. 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 March 31, 2014 totaled about $179 million, with availability approximating $129 million.

Maturities of currently outstanding FHLB advances are as follows:

2014	$	0
2015		0
2016		0
2017		45,000,000
2018		0

(Continued)

33.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8.	COMMITMENTS AND OFF-BALANCE SHEET RISK

Our bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by our bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on our credit assessment of the borrower. If required, estimated loss exposure resulting from these instruments is expensed and is generally recorded as a liability. There was no reserve or liability balance for these instruments as of March 31, 2014 and December 31, 2013.

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at March 31, 2014 and December 31, 2013 follows:

	March 31,		December 31,
	2014		2013

Commercial unused lines of credit	$	263,387,000	$	257,937,000
Unused lines of credit secured by 1 – 4 family residential properties		22,994,000		23,429,000
Credit card unused lines of credit		8,929,000		9,013,000
Other consumer unused lines of credit		4,819,000		5,695,000
Commitments to make loans		200,374,000		58,799,000
Standby letters of credit		19,379,000		19,670,000
	$	519,882,000	$	374,543,000

(Continued)

34.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8.	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 March 31, 2014, the total notional amount of the underlying interest rate swap agreements was $17.8 million, with a net fair value from our commercial loan customers’ perspective of negative $2.5 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.

9.	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 the policy parameters. 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 February 2012, we entered into an interest rate swap agreement with a correspondent bank to hedge the floating rate on our subordinated debentures, which became effective in January 2013 and matures in January 2018. Our $32.0 million of subordinated debentures have a rate equal to the 90-Day Libor Rate plus a fixed spread of 218 basis points, and are subject to repricing quarterly. The interest rate swap agreement provides for us to pay our correspondent bank a fixed rate, while our correspondent bank will pay us the 90-Day Libor Rate on a $32.0 million notional amount. The quarterly re-set dates for the floating rate on the interest rate swap agreement are the same as the re-set dates for the floating rate on the subordinated debentures. The interest rate swap agreement does qualify for hedge accounting; therefore, monthly fluctuations in the present value of the interest rate swap agreement, net of tax effect, are recorded to other comprehensive income. As of March 31, 2014 and December 31, 2013, the present value of the interest rate swap agreement was recorded as a liability in the amount of $0.2 million and $0.3 million, respectively.

(Continued)

35.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10.	FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of March 31, 2014 and December 31, 2013 (dollars in thousands):

	Level in	March 31, 2014				December 31, 2013
	Fair Value	Carrying		Fair		Carrying		Fair
	Hierarchy	Values		Values		Values		Values

Financial assets:
Cash	Level 1	$	1,699	$	1,699	$	1,464	$	1,464
Cash equivalents	Level 2		108,248		108,248		145,501		145,501
Securities available for sale	(1)		141,097		141,097		131,178		131,178
FHLB stock	(2)		11,961		11,961		11,961		11,961
Loans, net	Level 3		1,045,842		1,045,151		1,030,422		1,027,300
Bank owned life insurance	Level 2		51,667		51,667		51,377		51,377
Accrued interest receivable	Level 2		3,861		3,861		3,649		3,649

Financial liabilities:
Deposits	Level 2		1,108,251		1,110,957		1,118,911		1,120,576
Repurchase agreements	Level 2		63,165		63,165		69,305		69,305
FHLB advances	Level 2		45,000		45,035		45,000		45,139
Subordinated debentures	Level 2		32,990		32,959		32,990		32,974
Accrued interest payable	Level 2		1,431		1,431		2,041		2,041
Interest rate swap	(1)		250		250		264		264

(1)

See Note 11 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities.

(2)

It is not practical to determine the fair value of FHLB stock due to transferability restrictions.

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, bank owned life insurance, noninterest checking 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 the interest rate swap is determined primarily utilizing market-consensus forecasted yield curves. Fair value of off-balance sheet items is estimated to be nominal.

(Continued)

36.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11.	FAIR VALUES

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 assumptions 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 assumptions about the assumptions that market participants would use in pricing an asset or liability.

(Continued)

37.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11.	FAIR VALUES (Continued)

The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities that are recorded at fair value on a recurring or nonrecurring basis:

Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies, municipal general obligation and revenue bonds and mutual funds. We have no Level 1 or 3 securities available for sale.

Derivatives. The interest rate swap is measured at fair value on a recurring basis. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves, and accordingly, the interest rate swap agreement is classified as Level 2.

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 March 31, 2014 and December 31, 2013, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $1.7 million and $1.1 million, respectively.

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 of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates.

(Continued)

38.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11.	FAIR VALUES (Continued)

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 are as follows:

				Quoted
				Prices in
				Active		Significant
				Markets for		Other			Significant
				Identical		Observable			Unobservable
				Assets		Inputs			Inputs
	Total			(Level 1)		(Level 2)			(Level 3)
Available for sale securities
U.S. Government agency debt obligations	$	109,294,000		$	0	$	109,294,000		$	0
Mortgage-backed securities		12,615,000			0		12,615,000			0
Municipal general obligation bonds		16,899,000			0		16,899,000			0
Municipal revenue bonds		919,000			0		919,000			0
Mutual funds		1,370,000			0		1,370,000			0
Interest rate swap		(250,000	)		0		(250,000	)		0
Total	$	140,847,000		$	0	$	140,847,000		$	0

There were no transfers in or out of Level 1, Level 2 or Level 3 during the first three months of 2014.

The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 are as follows:

				Quoted
				Prices in
				Active		Significant
				Markets for		Other			Significant
				Identical		Observable			Unobservable
				Assets		Inputs			Inputs
	Total			(Level 1)		(Level 2)			(Level 3)
Available for sale securities
U.S. Government agency debt obligations	$	98,477,000		$	0	$	98,477,000		$	0
Mortgage-backed securities		13,558,000			0		13,558,000			0
Municipal general obligation bonds		16,872,000			0		16,872,000			0
Municipal revenue bonds		916,000			0		916,000			0
Mutual funds		1,355,000			0		1,355,000			0
Interest rate swap		(264,000	)		0		(264,000	)		0
Total	$	130,914,000		$	0	$	130,914,000		$	0

There were no transfers in or out of Level 1, Level 2 or Level 3 during 2013.

(Continued)

39.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11.	FAIR VALUES (Continued)

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 March 31, 2014 are as follows:

			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)

Impaired loans ⁽¹⁾	$	21,152,000	$	0	$	0	$	21,152,000
Foreclosed assets ⁽¹⁾		2,350,000		0		0		2,350,000
Total	$	23,502,000	$	0	$	0	$	23,502,000

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2013 are as follows:

			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)

Impaired loans ⁽¹⁾	$	23,405,000	$	0	$	0	$	23,405,000
Foreclosed assets ⁽¹⁾		2,851,000		0		0		2,851,000
Total	$	26,256,000	$	0	$	0	$	26,256,000

⁽¹⁾Represents carrying value and related write-downs for which adjustments are based on the estimated value of the property or other assets.

12.	REGULATORY MATTERS

We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements.

(Continued)

40.

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

12.	REGULATORY MATTERS (Continued)

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 March 31, 2014 and December 31, 2013, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since March 31, 2014 that we believe have changed our bank’s categorization. Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:

											Minimum Required
											to be Well
						Minimum Required					Capitalized Under
						for Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
March 31, 2014
Total capital (to risk weighted assets)
Consolidated	$	198,667		16.2	%	$	98,218		8.0	%	$	NA	NA
Bank		196,418		16.0			98,168		8.0			122,710		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		183,251		14.9			49,109		4.0		NA		NA
Bank		181,010		14.8			49,084		4.0			73,626		6.0
Tier 1 capital (to average assets)
Consolidated		183,251		13.0			56,409		4.0		NA		NA
Bank		181,010		12.8			56,414		4.0			70,518		5.0

December 31, 2013
Total capital (to risk weighted assets)
Consolidated	$	193,925		15.9	%	$	97,498		8.0	%	$	NA	NA
Bank		190,493		15.7			97,329		8.0			121,662		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		178,598		14.7			48,749		4.0		NA		NA
Bank		175,192		14.4			48,665		4.0			72,997		6.0
Tier 1 capital (to average assets)
Consolidated		178,598		12.5			57,006		4.0		NA		NA
Bank		175,192		12.3			56,860		4.0			71,075		5.0

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

12.	REGULATORY MATTERS (Continued)

Our consolidated capital levels as of March 31, 2014 and December 31, 2013 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 our 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. As of March 31, 2014 and December 31, 2013, all $32.0 million of the trust preferred securities were included in our consolidated Tier 1 capital.

Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On January 16, 2014, our Board of Directors declared a cash dividend on our common stock in the amount of $0.12 per share that was paid on March 10, 2014 to shareholders of record as of February 10, 2014.

13.	BUSINESS COMBINATION

On August 14, 2013, Mercantile Bank Corporation (“Mercantile”) and Firstbank Corporation (“Firstbank”) entered into an Agreement and Plan of Merger (the “merger agreement”). Under the terms of the merger agreement, Firstbank will be merged with and into Mercantile, with Mercantile as the surviving corporation. Both Mercantile and Firstbank shareholders approved the merger effective December 12, 2013. Approval of the Board of Governors of the Federal Reserve System is required to complete the merger. Approval has not yet been obtained. Mercantile and Firstbank have each agreed to take actions in order to obtain regulatory clearance required to consummate the merger. On April 14, 2014, we filed an updated election to become a financial holding company with the Federal Reserve Bank of Chicago. We anticipate the election will become effective upon consummation of the planned merger with Firstbank.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and 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; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economies; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2013 or in this report. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.

Introduction

The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance company”), at March 31, 2014 and December 31, 2013 and the results of operations for the three months ended March 31, 2014 and March 31, 2013. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.

Critical Accounting Policies

Accounting principles generally accepted in the United States of America are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting policies, see Note 1 of the Notes to our Consolidated Financial Statements included on pages F-48 through F-53 in our Form 10-K for the fiscal year ended December 31, 2013 (Commission file number 000-26719). Our allowance for loan losses policy and accounting for income taxes are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements, and actual results may differ from those estimates. We have reviewed the application of these policies with the Audit Committee of our Board of Directors.

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MERCANTILE BANK CORPORATION

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 the allowance and operating results.

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 interest and principal 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 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 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 assets and liabilities 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 assets and liabilities 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 asset or liability 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 tax 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.

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MERCANTILE BANK CORPORATION

Accounting guidance requires that we assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors which may impact future operating results. Significant weight is given to evidence that can be objectively verified. 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 starting on December 31, 2009.

Merger Agreement

On August 14, 2013, Mercantile Bank Corporation (“Mercantile”) and Firstbank Corporation (“Firstbank”), a Michigan corporation, entered into an Agreement and Plan of Merger (the “merger agreement”). Under the terms of the merger agreement, Firstbank will be merged with and into Mercantile, with Mercantile as the surviving corporation. Both Mercantile and Firstbank shareholders approved the merger effective December 12, 2013.

Upon completion of the merger, Firstbank shareholders will receive one share of Mercantile common stock for each share of Firstbank common stock that they own. Each right of any kind to receive Firstbank common stock or benefits measured by the value of a number of shares of Firstbank common stock granted under the Firstbank stock plans will be converted into an award with respect to a number of shares of Mercantile common stock equal to the aggregate number of shares of Firstbank common stock subject to such award. Firstbank restricted stock and unvested stock options will become fully vested as of the effective time of the merger. The exchange ratio is fixed and will not be adjusted to reflect stock price changes prior to the effective time of the merger. Based on the closing price of Mercantile common stock on the Nasdaq Stock Market on August 14, 2013, the last trading day before public announcement of the merger agreement, the exchange ratio represented approximately $18.77 in value for each share of Firstbank common stock. Mercantile shareholders will continue to own their existing Mercantile shares.

Based on the estimated number of shares of Mercantile and Firstbank common stock that will be outstanding immediately prior to the effective time of the merger, we estimate that, upon the closing, former Mercantile shareholders will own approximately 52% of the combined company following the merger and former Firstbank shareholders will own approximately 48% of the combined company following the merger.

As part of the merger, Mercantile’s Board of Directors expects to declare and pay a special cash dividend of $2.00 per share to Mercantile shareholders prior to the effective time of the merger, subject to the satisfaction of the closing conditions set forth in the merger agreement.

Approval of the Board of Governors of the Federal Reserve System (“FRB”) is required to complete the merger. An application was filed with the FRB on September 17, 2013. Approval has not yet been obtained. Mercantile and Firstbank have each agreed to take actions in order to obtain regulatory clearance required to consummate the merger. On April 14, 2014, we filed an updated election to become a financial holding company with the Federal Reserve Bank of Chicago. We anticipate the election will become effective upon consummation of the planned merger with Firstbank.

45.

MERCANTILE BANK CORPORATION

The obligations of Mercantile and Firstbank to complete the merger are subject to the satisfaction of certain remaining conditions, which include, among others: (i) obtaining the consents, authorizations, approvals, or exemptions required under the Bank Holding Company Act, the FDI Act, and the Michigan Banking Code; (ii) the absence of any injunction, decree, order, statute, rule or regulation by a court or other governmental entity that makes unlawful or prohibits the consummation of the merger; and (iii) the authorization for the listing on Nasdaq of the shares of Mercantile common stock to be issued in connection with the merger and upon conversion of the Firstbank restricted stock and the shares of Mercantile common stock reserved for issuance pursuant to Mercantile stock options, subject to official notice of issuance.

Mercantile and Firstbank have each made customary representations, warranties and covenants in the merger agreement, including, among others, covenants to conduct their business in the ordinary course between the execution of the merger agreement and the completion of the merger, and covenants not to engage in certain kinds of transactions during that period.

The merger agreement generally precludes Mercantile and Firstbank from soliciting or engaging in discussions or negotiations with a third party with respect to an acquisition proposal. However, if Mercantile or Firstbank receives an unsolicited acquisition proposal from a third party and Mercantile’s or Firstbank’s Board of Directors, as applicable, among other things, determines in good faith (after consultation with its legal and financial advisors) that such unsolicited proposal is a superior proposal, then Mercantile or Firstbank, as applicable, may furnish non-public information to and enter into discussions with, and only with, that third party regarding such acquisition proposal.

Mercantile and Firstbank may mutually agree to terminate the merger agreement at any time, notwithstanding approval of the merger agreement by shareholders. Either company may also terminate the merger agreement if the merger is not consummated by June 30, 2014, subject to certain exceptions. In addition, either company may terminate the agreement to enter into a definitive agreement with respect to a superior proposal, subject to certain conditions and the payment of a termination fee.

Generally, all fees and expenses incurred in connection with the merger agreement and the transactions contemplated by the merger agreement will be paid by the party incurring those expenses. Subject to specific exceptions, Mercantile or Firstbank may be required to pay a termination fee of $7.9 million and/or expense reimbursement up to $2.0 million.

The merger will be accounted for using the acquisition method of accounting, with Mercantile treated as the acquirer for accounting purposes.

The merger agreement was filed as exhibit 2.1 to our Form 8-K filed August 15, 2013 to provide security holders with information regarding its terms. On February 20, 2014, Mercantile and Firstbank entered into a first amendment to the merger agreement, a copy of which was attached as exhibit 10.1 to our Form 8-K filed on February 21, 2014. The amendment extends the date on which the merger agreement becomes terminable from March 31, 2014 to June 30, 2014. Mercantile and Firstbank currently expect the effective time of the merger to occur before the extended termination date. However, the merger is subject to various regulatory clearances and the satisfaction or waiver of other conditions as described in the merger agreement, some of which are outside the control of Mercantile and Firstbank, and the merger could be completed at a later time through further extension(s) of the merger agreement or not at all.

46.

MERCANTILE BANK CORPORATION

The merger agreement and first amendment are not intended to provide any other factual information about Mercantile, Firstbank or their respective subsidiaries and affiliates. The merger agreement contains representations and warranties by each of the parties to the merger agreement. These representations and warranties were made solely for the benefit of the other party to the merger agreement and (i) are not intended to be treated as categorical statements of fact, but rather as a way of allocating risk to one of the parties if those statements prove to be inaccurate, (ii) may have been qualified in the merger agreement by confidential disclosure schedules that were delivered to the other party in connection with the signing of the merger agreement, which disclosure schedules may contain information that modifies, qualifies and creates exceptions to the representations, warranties and covenants set forth in the merger agreement, (iii) may be subject to standards of materiality applicable to the parties that differ from what might be viewed as material to investors, (iv) were made only as of the date of the merger agreement or such other date or dates as may be specified in the merger agreement or the amendment. Moreover, information concerning the subject matter of the representations, warranties and covenants may change after the date of the merger agreement, which subsequent information may or may not be fully reflected in public disclosures by Mercantile or Firstbank. Accordingly, the representations, warranties and covenants or any descriptions should not be relied upon as characterizations of the actual state of facts or condition of Mercantile or Firstbank.

Mercantile’s Board of Directors and Mercantile’s shareholders approved an amendment to the Mercantile articles of incorporation which increases the number of authorized shares of common stock from 20 million to 40 million. Although this proposal was approved by Mercantile shareholders, if the merger is not completed the amendment will not become effective.

Financial Overview

Our operating performance and financial condition continued to improve through the first quarter of 2014. In prior years, especially during the period of 2008 through 2010, our earnings performance was negatively impacted by substantial provisions to the allowance and problem asset administration costs. During that period, 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 worked with our borrowers to develop constructive dialogue to strengthen our relationships and enhance our ability to resolve complex issues. As a result of those efforts and improved economic conditions, we have experienced significant improvement in our asset quality since the early stages of 2011, resulting in substantially lower provisions to the allowance and problem asset administration costs. While we have increased our sales efforts to grow the commercial loan portfolio, we remain vigilant as to the administration and quality of our loan portfolio.

Our asset quality metrics remain on an improving trend, and we are optimistic that the positive trend will continue. In aggregate dollar amounts, nonperforming asset levels have declined over 92% since the peak level at March 31, 2010, and at March 31, 2014, were at the lowest level since year-end 2006. Progress in the stabilization of economic and real estate market conditions has resulted in numerous loan rating upgrades and significantly lower volumes of loan rating downgrades, which when combined with increasing recoveries of prior loan charge-offs and reversals of specific reserves, have provided for a substantially lower provision expense.

Financial Condition

Our total assets declined $13.5 million during the first three months of 2014, and totaled $1.41 billion as of March 31, 2014. Total loans increased $13.6 million and securities available for sale were up $9.9 million, while federal funds sold decreased $45.6 million and total deposits declined $10.7 million during the first quarter of 2014.

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MERCANTILE BANK CORPORATION

Our loan portfolio is primarily comprised of commercial loans. Commercial loans increased $17.5 million during the first three months of 2014, and at March 31, 2014 totaled $1.00 billion, or 94.1% of the loan portfolio. The $17.5 million net increase includes about $46 million in new commercial term loans to existing and new borrowers. Non-owner occupied commercial real estate (“CRE”) loans increased $14.0 million, commercial and industrial loans were up $2.6 million, owner occupied CRE loans increased $2.4 million and vacant land, land development and residential construction loans were up $0.5 million. Only the multi-family and residential rental segment of our commercial loan portfolio experienced a reduction during the quarter, declining $2.0 million.

Starting in early 2012, with a pruned commercial loan portfolio, an improved earnings performance and financial condition, and stabilized economic conditions, we significantly enhanced our commercial loan sales efforts. We are very pleased with the approximately $450 million in new commercial loan fundings since the beginning of 2012, and our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods. As of March 31, 2014, availability of existing construction and development loans totaled over $50 million, with most of those funds expected to be drawn over the next twelve months. In addition, we have made additional lending commitments totaling about $200 million, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial lenders also report over $200 million in additional opportunities they are currently discussing with potential new borrowers.

We continue to experience significant commercial loan principal paydowns and payoffs. A majority of these principal paydowns and payoffs received thus far have been welcomed, such as on stressed loan relationships; however, we have also experienced instances where well-performing relationships have been refinanced at other financial institutions and other situations where the borrower has sold the underlying asset, paying off the loan. In many of those cases where the loans were refinanced elsewhere, we believed the terms and conditions of the new lending arrangements were too aggressive, generally reflecting the very competitive banking environment in our markets. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship. In addition, we continue to receive accelerated principal paydowns from certain borrowers who have elevated deposit balances generally resulting from profitable operations and an apparent unwillingness to expand their businesses and/or replace equipment primarily due to economic- and tax-related uncertainties. Usage of existing commercial lines of credit has remained relatively steady.

The commercial loan portfolio represents loans to businesses generally located within our markets. Approximately 71% 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 noninterest-bearing checking accounts.

Residential mortgage loans and consumer loans decreased in aggregate $4.0 million during the first three months of 2014, and at March 31, 2014, totaled $62.6 million, or 5.9% of total loans. 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.

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The following table summarizes our loan portfolio:

	3/31/14		12/31/13		9/30/13		6/30/13		3/31/13

Commercial:
Commercial & Industrial	$	289,009,000	$	286,373,000	$	286,887,000	$	279,300,000	$	272,890,000
Land Development & Construction		37,190,000		36,741,000		40,741,000		42,170,000		45,174,000
Owner Occupied Commercial RE		264,299,000		261,877,000		258,656,000		253,172,000		253,089,000
Non-Owner Occupied Commercial RE		378,034,000		364,066,000		368,301,000		357,452,000		327,776,000
Multi-Family & Residential Rental		35,686,000		37,639,000		53,178,000		53,522,000		50,035,000
Total Commercial		1,004,218,000		986,696,000		1,007,763,000		985,616,000		948,964,000

Retail:
1-4 Family Mortgages		30,800,000		31,467,000		36,575,000		35,709,000		35,735,000
Home Equity & Other Consumer Loans		31,778,000		35,080,000		31,149,000		37,337,000		38,257,000
Total Retail		62,578,000		66,547,000		67,724,000		73,046,000		73,992,000

Total	$	1,066,796,000	$	1,053,243,000	$	1,075,487,000	$	1,058,662,000	$	1,022,956,000

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 an 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.

Our asset quality continued to improve during the first three months of 2014, and has now been on an improving trend for about four years. Nonperforming assets, comprised of nonaccrual loans and foreclosed properties, totaled $8.7 million as of March 31, 2014, compared to $9.6 million as of December 31, 2013. The volume of nonperforming assets has generally been on a declining trend since the peak of $117.6 million on March 31, 2010, and is currently at its lowest level since year-end 2006.

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The level of nonperforming assets had begun to increase during 2007, with ongoing and significant increases during 2008 and 2009. The increases primarily reflected the impact of poor economic conditions and the resulting negative impact on many of our commercial borrowers’ operating results and financial condition, but were also indicative of our aggressive posture and conservative loan administration practices in regards to measuring borrower financial strength and assigning loan grades on the entire commercial loan portfolio, and developing workout strategies for financially-troubled borrowers. Since 2009, the level of additions to the nonperforming asset category has declined significantly, while the level of interest in, and sales of, foreclosed properties and assets securing nonperforming loans has increased substantially. We believe that our loan administration strategies, combined with a stabilization of economic conditions, have provided for significant improvement in our asset quality and have given us optimism that the momentum will continue in future periods.

The substantial and rapid collapse of the residential real estate market that began 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. From the period of 2007 through most of 2011, we 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 had fallen significantly, thereby exposing us to larger-than-typical losses in those instances where the sale of collateral was the primary source of repayment. Also during that time, we saw deterioration in guarantors’ financial capacities to fund deficient cash flows and reduce or eliminate collateral deficiencies.

Throughout 2008, we experienced a rapid deterioration in a number of commercial loan relationships which previously had been performing satisfactorily. Analysis of certain commercial borrowers revealed a reduced capability 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 was 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 resulted in inadequate cash flow generated from some real estate projects we financed and 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 became seriously diminished. In other cases, sale of the collateral, either by the borrower or us, was our primary source of repayment.

As of March 31, 2014, nonperforming assets totaled $8.7 million, or 0.6% of total assets, compared to $9.6 million (0.7% of total assets) and $18.9 million (1.4% of total assets) as of December 31, 2013 and March 31, 2013, respectively. The reductions primarily reflect principal payments and charge-offs on nonaccrual loans, as well as sales proceeds on foreclosed properties.

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As of March 31, 2014, nonperforming loans and foreclosed properties consisting of non-owner occupied CRE totaled $1.9 million, reflecting reductions of $0.2 million and $6.8 million during the past three and twelve months, respectively. Nonperforming loans and foreclosed properties consisting of owner occupied CRE totaled $0.9 million as of March 31, 2014, reflecting reductions of $0.2 million and $1.8 million during the past three and twelve months, respectively. Nonperforming loans secured by, and foreclosed properties consisting of, owner occupied and rental residential properties totaled $4.2 million at March 31, 2014, reflecting a reduction of $0.2 million and an increase of $0.2 million during the past three and twelve months, respectively.

The following tables provide a breakdown of nonperforming assets by collateral type:

NONPERFORMING LOANS

	3/31/14		12/31/13		9/30/13		6/30/13		3/31/13
Residential Real Estate:
Land Development	$	38,000	$	40,000	$	43,000	$	317,000	$	471,000
Construction		0		0		0		0		316,000
Owner Occupied / Rental		4,026,000		4,219,000		2,859,000		3,201,000		3,298,000
		4,064,000		4,259,000		2,902,000		3,518,000		4,085,000

Commercial Real Estate:
Land Development		361,000		389,000		627,000		650,000		704,000
Construction		0		0		0		0		0
Owner Occupied		784,000		885,000		718,000		960,000		1,747,000
Non-Owner Occupied		335,000		169,000		3,251,000		4,642,000		4,988,000
		1,480,000		1,443,000		4,596,000		6,252,000		7,439,000

Non-Real Estate:
Commercial Assets		798,000		1,016,000		1,111,000		755,000		869,000
Consumer Assets		0		0		0		1,000		1,000
		798,000		1,016,000		1,111,000		756,000		870,000

Total	$	6,342,000	$	6,718,000	$	8,609,000	$	10,526,000	$	12,394,000

51.

MERCANTILE BANK CORPORATION

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

	3/31/14		12/31/13		9/30/13		6/30/13		3/31/13
Residential Real Estate:
Land Development	$	427,000	$	427,000	$	495,000	$	619,000	$	899,000
Construction		22,000		22,000		89,000		89,000		132,000
Owner Occupied / Rental		186,000		207,000		219,000		315,000		729,000
		635,000		656,000		803,000		1,023,000		1,760,000

Commercial Real Estate:
Land Development		92,000		92,000		6,000		31,000		51,000
Construction		0		0		0		0		0
Owner Occupied		75,000		164,000		501,000		606,000		961,000
Non-Owner Occupied		1,548,000		1,939,000		2,239,000		2,256,000		3,734,000
		1,715,000		2,195,000		2,746,000		2,893,000		4,746,000

Non-Real Estate:
Commercial Assets		0		0		0		0		0
Consumer Assets		0		0		0		0		0
		0		0		0		0		0

Total	$	2,350,000	$	2,851,000	$	3,549,000	$	3,916,000	$	6,506,000

The following tables provide a reconciliation of nonperforming assets:

NONPERFORMING LOANS RECONCILIATION

	1st Qtr			4th Qtr			3rd Qtr			2nd Qtr			1st Qtr
	2014			2013			2013			2013			2013

Beginning balance	$	6,718,000		$	8,609,000		$	10,526,000		$	12,395,000		$	18,970,000
Additions, net of transfers to ORE		174,000			1,734,000			502,000			438,000			(948,000	)
Returns to performing status		0			0			0			0			0
Principal payments		(449,000	)		(3,072,000	)		(2,363,000	)		(1,988,000	)		(3,511,000	)
Loan charge-offs		(101,000	)		(553,000	)		(56,000	)		(319,000	)		(2,116,000	)

Total	$	6,342,000		$	6,718,000		$	8,609,000		$	10,526,000		$	12,395,000

52.

MERCANTILE BANK CORPORATION

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

	1st Qtr			4th Qtr			3rd Qtr			2nd Qtr			1st Qtr
	2014			2013			2013			2013			2013

Beginning balance	$	2,851,000		$	3,549,000		$	3,916,000		$	6,505,000		$	6,969,000
Additions		0			134,000			350,000			57,000			1,640,000
Sale proceeds, net		(501,000	)		(797,000	)		(527,000	)		(2,374,000	)		(1,887,000	)
Valuation write-downs		0			(35,000	)		(190,000	)		(272,000	)		(217,000	)

Total	$	2,350,000		$	2,851,000		$	3,549,000		$	3,916,000		$	6,505,000

The level of loan charge-offs continues to decline, especially in comparison to the levels during 2010 and 2009. The improvement primarily reflects a decline in nonperforming loans, an overall improvement in the quality of the loan portfolio and recoveries of prior period charge-offs. During the first three months of 2014, we recorded a small net recovery as our recoveries of prior period charge-offs totaled just slightly more than our loan charge-offs. We recorded a net recovery of prior period charge-offs of $1.3 million in 2013, or a negative 0.1% of average total loans, compared to net loan charge-offs of 0.5%, 1.4%, 2.4% and 2.2% of average total loans during 2012, 2011, 2010 and 2009, respectively. Loan charge-offs totaled $0.6 million during the first three months of 2014, compared to $5.3 million, $12.7 million, $19.9 million, $37.1 million and $39.6 million during 2013, 2012, 2011, 2010 and 2009. Recoveries of previously charged-off loans totaled $0.6 million during the first three months of 2014, compared to $6.6 million, $7.9 million, $4.2 million, $2.8 million and $1.4 million in 2013, 2012, 2011, 2010 and 2009, respectively.

The following table provides a breakdown of net loan charge-offs (recoveries) by collateral type:

	1st Qtr			4th Qtr			3rd Qtr			2nd Qtr			1st Qtr
	2014			2013			2013			2013			2013
Residential Real Estate:
Land Development	$	(1,000	)	$	(78,000	)	$	(387,000	)	$	(119,000	)	$	690,000
Construction		0			0			0			0			0
Owner Occupied / Rental		(139,000	)		(144,000	)		(105,000	)		(301,000	)		479,000
		(140,000	)		(222,000	)		(492,000	)		(420,000	)		1,169,000

Commercial Real Estate:
Land Development		0			0			0			30,000			(210,000	)
Construction		0			0			0			0			0
Owner Occupied		37,000			47,000			(74,000	)		(6,000	)		54,000
Non-Owner Occupied		336,000			1,206,000			(1,215,000	)		79,000			61,000
		373,000			1,253,000			(1,289,000	)		103,000			(95,000	)

Non-Real Estate:
Commercial Assets		(267,000	)		(1,154,000	)		(172,000	)		(95,000	)		69,000
Consumer Assets		1,000			(4,000	)		5,000			1,000			(1,000	)
		(266,000	)		(1,158,000	)		(167,000	)		(94,000	)		68,000

Total	$	(33,000	)	$	(127,000	)	$	(1,948,000	)	$	(411,000	)	$	1,142,000

53.

MERCANTILE BANK CORPORATION

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 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, the result of 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 on the 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; loan concentrations; and other external factors such as 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 have historically placed most weight on the eight-quarter time frame, consideration was given to other time periods as part of our assessment. Given the stabilizing loan losses experienced in recent quarters in comparison to loan losses recorded in the more stressed economic conditions in earlier time periods, we decided to transition from the eight-quarter time frame to a longer twelve-quarter time frame during 2012. We believe the twelve-quarter period represents a more appropriate range of economic conditions, and that it provides for a more relevant basis in determining reserve allocation factors given current economic conditions and the general consensus of economic conditions in the near future.

54.

MERCANTILE BANK CORPORATION

Although the migration analysis provides a 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. 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, the stressed economic conditions of the past several years have resulted in an even higher sense of aggressiveness with regards to the downgrading of lending relationships. For example, 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, resulted in significant downgrades and the need for substantial provisions to the allowance during the three-year period ended December 31, 2010. To more effectively manage our commercial loan portfolio, we also 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, and in some cases improvement, in the other classes of our commercial 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 substantially increased the allowance as a percent of the loan portfolio beginning in 2009. However, with the improved quality of our loan portfolio, we have reduced the allowance in recent periods. The allowance equaled $21.0 million, or 2.0% of total loans outstanding, as of March 31, 2014, compared to 2.2%, 2.8%, 3.4%, 3.6%, 3.1%, 1.5% and 1.4% at year-end 2013, 2012, 2011, 2010, 2009, 2008 and 2007, respectively. A significant portion of the decline in the level of the allowance during the first three months of 2014 and all of 2013 and 2012 reflects the charge-off of specific reserves that were created in prior periods and the elimination and reduction of specific reserves due to successful collection efforts, while the remainder of the decline is primarily associated with commercial loan upgrades and reductions in many reserve allocation factors on non-impaired commercial loans resulting from the impact of lower net loan charge-offs in recent periods on our migration calculations. The allowance equaled 330.4% of nonperforming loans as of March 31, 2014, compared to 339.7%, 151.2%, 81.0%, 65.3%, 56.3%, 55.0% and 86.6% at year-end 2013, 2012, 2011, 2010, 2009, 2008 and 2007, respectively. This particular allowance measurement has increased significantly during the past several years, primarily reflecting total nonperforming loans declining at a faster rate than the balance of the allowance and certain accruing higher-balance commercial loan relationships that have been categorized as troubled debt restructurings resulting in higher specific reserve allocations.

55.

MERCANTILE BANK CORPORATION

As of March 31, 2014, the allowance was comprised of $10.5 million in general reserves relating to non-impaired loans, $1.7 million in specific reserve allocations relating to nonaccrual loans, and $8.8 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. Troubled debt restructurings totaled $31.9 million at March 31, 2014, consisting of $4.8 million that are on nonaccrual status and $27.1 million that are on accrual status. The latter, while considered and accounted for as impaired loans in accordance with accounting guidelines, is not included in our nonperforming loan totals. Impaired loans with an aggregate carrying value of $2.3 million as of March 31, 2014 had been subject to previous partial charge-offs aggregating $2.5 million. Those partial charge-offs were recorded as follows: less than $0.1 million during the first three months of 2014, $0.5 million in 2013, $1.1 million in 2012, $0.6 million in 2011 and $0.2 million in 2010. As of March 31, 2014, there were no specific reserves allocated to impaired loans that had been subject to a previous partial charge-off.

The following table provides a breakdown of our loans categorized as troubled debt restructurings:

	3/31/14		12/31/13		9/30/13		6/30/13		3/31/13

Performing	$	27,093,000	$	30,247,000	$	41,707,000	$	42,991,000	$	39,145,000
Nonperforming		4,800,000		4,645,000		5,782,000		7,523,000		8,444,000

Total	$	31,893,000	$	34,892,000	$	47,489,000	$	50,514,000	$	47,589,000

Although we believe the allowance is adequate to absorb loan losses as they arise, there can be no assurance that we will not sustain loan losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.

Securities increased $9.9 million during the first three months of 2014, totaling $153.1 million as of March 31, 2014. Purchases during the first three months of 2014, consisting almost exclusively of U.S. Government agency bonds, totaled $11.7 million. Proceeds from called U.S. Government agency bonds during the first three months of 2014 totaled $3.5 million, with another $0.9 million from principal paydowns on mortgage-backed securities. At March 31, 2014, the portfolio was comprised of U.S. Government agency bonds (71%), tax-exempt municipal bonds (12%), U.S. Government agency issued or guaranteed mortgage-backed securities (8%), FHLB stock (8%) and mutual funds (1%). All of our securities, exclusive of FHLB stock, are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at March 31, 2014 totaled $141.1 million, including a net unrealized loss of $5.7 million. The securities portfolio had a net unrealized gain of $2.6 million as of March 31, 2013. The $8.3 million decline during the past twelve months primarily results from higher medium- and longer-term market rates. We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations. In addition, the securities portfolio serves a primary interest rate risk management function.

FHLB stock totaled $12.0 million as of March 31, 2014, unchanged from December 31, 2013. Our investment in FHLB stock is necessary to engage in their advance and other financing programs. We have received regularly quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.

56.

MERCANTILE BANK CORPORATION

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. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.

Federal funds sold, consisting of excess funds sold overnight to a correspondent bank, along with investments in interest-bearing deposits at correspondent and other banks, are used to manage daily liquidity needs and interest rate sensitivity. During the first three months of 2014, the average balance of these funds equaled $114.6 million, or 8.7% of average earning assets, compared to the 7.1%, 6.7%, 6.1%, 4.5% and 3.0% maintained during all of 2013, 2012, 2011, 2010 and 2009, respectively, and considerably higher than our historical average of less than 1.0%. Given the 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. Reflecting our improved operating performance and financial condition, we expect to reduce the level of average federal funds sold and interest-bearing deposits in future periods, likely to an average of 3.0% to 4.0% of average earning assets; however, until market and economic conditions return to more normalized levels, the average balance of federal funds sold and interest-bearing deposits will likely remain well above our historical average of less than 1.0%.

Net premises and equipment at March 31, 2014 equaled $24.9 million, virtually unchanged since year-end 2013. Purchases of premises and equipment during the first three months of 2014 totaled $0.3 million, while depreciation expense also totaled $0.3 million. On December 30, 2009, all FDIC-insured financial institutions were required to prepay estimated FDIC deposit insurance assessments for the fourth quarter of 2009 and the years 2010, 2011 and 2012. The amount we paid equaled $16.3 million, which was expensed over the future quarterly assessment periods. Per regulations, any unused portion of the amount prepaid remaining after payment of amounts due on June 30, 2013 was to be returned to us by the FDIC; we received $8.1 million on June 28, 2013.

Foreclosed and repossessed assets totaled $2.4 million at March 31, 2014, compared to $2.9 million, $7.0 million, $15.3 million, $16.7 million and $26.6 million on December 31, 2013, 2012, 2011, 2010 and 2009, respectively. The $0.5 million decrease during the first three months of 2014 reflects sales proceeds, as we recorded no valuation write-downs or transfers from the loan portfolio during the first quarter. While we expect some transfers from loans to foreclosed and repossessed assets in future periods reflecting our collection efforts on impaired lending relationships, we are optimistic that the increased sales activity we witnessed during the past couple of years will continue and limit the overall increase in, and average balance of, this nonperforming asset category.

57.

MERCANTILE BANK CORPORATION

Total deposits declined $10.7 million during the first three months of 2014, totaling $1.11 billion at March 31, 2014. Local deposits increased $11.9 million, while out-of-area deposits decreased $22.6 million. As a percent of total deposits, local deposits equaled 82.8% on March 31, 2014, compared to 81.0%, 76.2%, 70.3%, 60.0%, 48.3% and 29.4% on December 31, 2013, 2012, 2011, 2010, 2009 and 2008, respectively. In comparing balances as of March 31, 2014 to those at December 31, 2008, total deposits have declined $491.3 million, consisting of a $447.3 million increase in local deposits and a $938.6 million decrease in out-of-area deposits. The decline in out-of-area deposits primarily results from the decline in total loans and the increase in local deposits. The increase in local deposits reflects various programs and initiatives we have implemented over the past several years, including: enhanced sales efforts to grow commercial loans, implementation of several deposit-gathering initiatives in our commercial lending function, introduction of new deposit-related products and services, certificate of deposit campaign, and the continuation of providing our customers with the latest in technological advances that give improved information, convenience and timeliness.

Noninterest-bearing checking accounts averaged $214.0 million during the first three months of 2014, compared to an average balance of $197.6 million during 2013, $164.1 million during 2012, $137.0 million during 2011, and $110 million to $120 million over the prior several years. The increase over the past couple of years in large part reflects deposit account openings as part of new commercial lending relationships. Increases in noninterest-bearing checking accounts during 2012 and 2011 also reflect transfers from our securities sold under agreements to repurchase (“repurchase agreements”) product, generally reflecting rate and pricing changes in the latter product.

Local interest-bearing checking accounts decreased $7.4 million during the first three months of 2014, but are up $139.7 million since year-end 2008. Money market deposit accounts increased $2.6 million during the first three months of 2014, and are up $111.0 million since year-end 2008. The net increase in both interest-bearing checking accounts and money market deposit accounts over the past several years reflects the success of our enhanced products and marketing programs, as well as relatively aggressive rates, which resulted in many new individual, business and municipality deposits and increased balances from existing deposit account holders and transfers from maturing certificates of deposit. The decline in interest-bearing checking accounts during the first three months of 2014 primarily reflects lower rates being offered on these deposit types and certain individuals using portions of their balances for things such as real estate and car purchases. Savings deposits increased $2.2 million during the first three months of 2014, and are up $4.9 million since year-end 2008. We typically experience relatively large balance fluctuations in our savings deposit products, primarily reflecting periodic deposits and withdrawals from several local municipal customers, as well as from certain municipal depositors transferring funds between savings accounts, certificates of deposit and repurchase agreements.

Certificates of deposit purchased by customers located within our market areas increased $8.4 million during the first three months of 2014, and have increased $71.7 million since year-end 2008. A majority of the increase during the first quarter of 2014 reflects the transfer of funds from noninterest-bearing checking accounts from one commercial loan/deposit relationship, while the remaining increase since year-end 2008 primarily reflects our enhanced marketing campaigns and savings accounts transfers from certain municipal customers. Deposits obtained from customers located outside of our market areas decreased $22.6 million during the first three months of 2014, and have declined $938.7 million since year-end 2008. As of March 31, 2014, out-of-area deposits totaled $190.6 million. 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 out-of-area deposits include individuals, businesses and municipalities located throughout the United States. The significant decline in out-of-area deposits since year-end 2008 primarily reflects the influx of cash resulting from the reduction in total loans and increase in local deposits.

58.

MERCANTILE BANK CORPORATION

Repurchase agreements decreased $6.1 million during the first three months of 2014, totaling $63.2 million as of March 31, 2014. However, reflecting an enhanced relationship with a certain customer, average repurchase agreements during the first quarter of 2014 were $76.4 million. This particular customer receives significant periodic deposits, and then generally distributes those funds over the following two-week period. As part of our sweep account program, collected funds from certain business noninterest-bearing checking accounts are invested into over-night interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance.

FHLB advances were unchanged during the first three months of 2014, and are down $225.0 million since year-end 2008. As of March 31, 2014, FHLB advances totaled $45.0 million. The decline in FHLB advances since year-end 2008 primarily reflects the influx of cash resulting from the reduction in total loans and increase in local deposits. The 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 as of March 31, 2014 totaled about $179 million, with availability approximating $129 million.

Liquidity

Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and 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 balances. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.

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 $235.6 million, or 19.4% of combined deposits and borrowed funds, as of March 31, 2014, compared to $258.1 million, or 20.9% of combined deposits and borrowed funds as of December 31, 2013, and $1.41 billion, or 71.5% of combined deposits and borrowed funds as of December 31, 2008. The significant decline since year-end 2008 primarily reflects the influx of cash resulting from the reduction in total loans and increased local deposits.

Although local deposits have generally increased as new business, municipality 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 several years, some reliance on wholesale funds will likely remain, although at a substantially lower degree than historical levels. As part of our current interest rate risk management strategy, a vast majority of our wholesale funds have a fixed interest rate and mature within five years, reflecting the fact that a majority of commercial loans have a floating interest rate or a fixed interest rate and balloon in five years from origination date. We have developed a comprehensive contingency funding plan which we believe mitigates any increased liquidity risk from our wholesale funding program.

59.

MERCANTILE BANK CORPORATION

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 our 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.

As part of our sweep account program, collected funds from certain business noninterest-bearing checking accounts are invested into over-night interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. Repurchase agreements decreased $6.1 million during the first three months of 2014, totaling $63.2 million as of March 31, 2014. However, reflecting an enhanced relationship with a certain customer, average repurchase agreements during the first quarter of 2014 were $76.4 million. This particular customer receives significant periodic deposits, and then generally distributes those funds over the following two-week period. Information regarding our repurchase agreements as of March 31, 2014 and during the first three months of 2014 is as follows:

Outstanding balance at March 31, 2014	$	63,165,000
Weighted average interest rate at March 31, 2014		0.13	%
Maximum daily balance three months ended March 31, 2014	$	91,303,000
Average daily balance for three months ended March 31, 2014	$	76,412,000
Weighted average interest rate for three months ended March 31, 2014		0.12	%

As a member of the FHLB, we have access to the FHLB advance borrowing programs. FHLB advances were unchanged during the first three months of 2014, and are down $225.0 million since year-end 2008. As of March 31, 2014, FHLB advances totaled $45.0 million. The decline in FHLB advances since year-end 2008 primarily reflects the influx of cash resulting from the reduction in total loans and increase in local deposits. Based on available collateral at March 31, 2014, we could borrow an additional $129.4 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 first three months of 2014; in fact, we have not accessed the lines of credit since January of 2010. In contrast, federal funds sold averaged $108.3 million during the first three months of 2014 and $83.5 million, $75.7 million, and $78.6 million during 2013, 2012 and 2011, respectively. Given the volatile market and stressed economic conditions, we have been operating with a higher than normal balance of federal funds sold over the past several years.

60.

MERCANTILE BANK CORPORATION

Reflecting our improved operating performance and financial condition, we expect to reduce the level of average federal funds sold in future periods, likely to an average of 3.0% to 4.0% of average earning assets; however, until market and economic conditions return to more normalized levels, the average balance of federal funds sold will likely remain well above our historical average of less than 1.0%.

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 $14.5 million as of March 31, 2014. We did not utilize this line of credit during the first three months of 2014 or at any time during the previous five fiscal years, and do not plan to access this line of credit in future periods.

The following table reflects, as of March 31, 2014, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

	One Year		One to		Three to		Over
	or Less		Three Years		Five Years		Five Years		Total

Deposits without a stated maturity	$	611,426,000	$	0	$	0	$	0	$	611,426,000
Certificates of deposit		204,624,000		179,164,000		113,037,000		0		496,825,000
Short-term borrowings		63,165,000		0		0		0		63,165,000
Federal Home Loan Bank advances		0		10,000,000		35,000,000		0		45,000,000
Subordinated debentures		0		0		0		32,990,000		32,990,000
Other borrowed money		0		0		0		1,678,000		1,678,000

In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of March 31, 2014, we had a total of $500.5 million in unfunded loan commitments and $19.4 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $300.1 million were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $200.4 million were for loan commitments generally expected to close and become funded within the next twelve months. The level of commitments to make loans over the past several years had declined significantly when compared to historical levels, primarily reflecting stressed economic conditions; however, the $200.4 million level at March 31, 2014 is substantially higher when compared to the levels over the past several years. The increase primarily reflects our expanded sales efforts and improved economic conditions. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.

We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, changes in economic or market conditions, a 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.

Capital Resources

Shareholders’ equity was $157.7 million at March 31, 2014, compared to $153.3 million at December 31, 2013. The $4.4 million increase during the first three months of 2014 was primarily due to net income of $3.6 million and a $1.7 million increase in the market value of our available for sale securities, the latter primarily reflecting the impact of lower medium- and longer-term market interest rates. Negatively impacting shareholder’s equity during the first quarter of 2014 were cash dividends on common shares totaling $1.0 million.

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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. The increase in shareholders’ equity during the first three months of 2014 provided for improved regulatory capital ratios, and our bank remains “well capitalized.” As of March 31, 2014, our bank’s total risk-based capital ratio was 16.0%, compared to 15.7% at December 31, 2013. Our bank’s total regulatory capital, consisting of Tier 1 capital plus a portion of the allowance, increased $5.9 million during the first three months of 2014, primarily reflecting net income of $4.1 million and a $3.3 million decrease in the amount of ineligible net deferred tax asset, which more than offset $1.6 million in cash dividends paid. Our bank’s total risk-based capital ratio was also impacted by a $10.5 million increase in total risk-weighted assets, primarily resulting from the growth in commercial loans. As of March 31, 2014, our bank’s total regulatory capital equaled $196.4 million, or approximately $74 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 March 31, 2014 and December 31, 2013 are disclosed in Note 12 of the Notes to Condensed Consolidated Financial Statements.

Results of Operations

We recorded net income of $3.6 million for the first quarter of 2014 ($0.41 per basic and diluted share), compared to net income of $4.4 million ($0.51 per basic share and $0.50 per diluted share) recorded during the first quarter 2013. The results for the first quarter of 2014 and the prior-year first quarter include costs associated with our pending merger with Firstbank Corporation. On an after-tax basis, we expensed $0.3 million during the first three months of 2014 and a negligible amount during the first three months of 2013. We expect to expense further merger-related costs during the next two quarters, although the exact amounts and timing are not currently known.

The decline in net income in the first quarter of 2014 compared to the prior-year first quarter resulted from higher overhead costs, decreased net interest income, and lower noninterest income. The increase in overhead costs primarily resulted from higher salary and benefit expenses and merger-related costs, while the decrease in net interest income in large part reflects a lower net interest margin. Salary and benefit expenses were higher due to the hiring of additional staff members over the past year and officer merit pay increases. The decline in the net interest margin primarily reflects a lower yield on commercial loans and a higher level of low-yielding federal funds sold. The decreased yield on commercial loans was primarily due to newly originated and renewed loans being generally extended at rates that were lower than the average rate on the existing portfolio, in large part reflecting the ongoing low interest rate environment and competitive marketplace. The lower level of noninterest income was mainly due to decreased residential mortgage banking fee income, rental income on foreclosed properties, and bank owned life insurance income.

The factors noted above that negatively impacted net income were partially offset by a larger negative provision expense. The continued improvement in the quality of our loan portfolio, recoveries of prior period loan charge-offs, and reversals of specific reserves, have produced a positive impact on our loan loss reserve calculations and allowed us to make negative provisions to the loan loss reserve during the first quarter of 2014 and the respective 2013 period.

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Costs associated with the administration and resolution of problem assets were slightly negative in the first quarter of 2014 and a nominal amount during the prior-year first quarter primarily due to gains on sales of other real estate, which are netted against these costs. Excluding the impact of these gains, problem asset costs still decreased in the first quarter of 2014 compared to the respective 2013 period as the level of problem assets continued to decline.

Interest income during the first quarter of 2014 was $13.6 million, a decrease of $0.6 million, or 4.4%, from the $14.2 million earned during the first quarter of 2013. The reduction in interest income was attributable to a declining yield on earning assets, which was partially offset by an increase in earning assets.

During the first quarter of 2014 and 2013, earning assets had a weighted average yield (tax equivalent-adjusted basis) of 4.20% and 4.55%, respectively. The decline in earning asset yield resulted from a decreased yield on average loans, and to a much lesser extent, a change in average earning asset mix involving an increase in low-yielding average federal funds sold as a percentage of average earning assets. A higher yield on average securities partially offset the reduction in earning asset yield resulting from the decreased yield on average loans and the change in earning asset mix.

The yield on average loans was 4.63% in the first quarter of 2014 compared to 5.05% in the respective 2013 period. The lower yield on average loans mainly resulted from a decreased yield on average commercial loans, which equaled 4.65% in the current-year first quarter compared to 5.07% in the prior-year first quarter. The commercial loan yield was negatively impacted by newly originated and renewed loans being generally extended at rates that were lower than the average rate on the existing portfolio, in large part reflecting the ongoing low interest rate environment and competitive marketplace. The commercial loan yield was also negatively impacted by the lowering of rates on certain commercial loans throughout 2013 and into 2014 as a result of borrowers warranting decreased loan rates due to improved financial performance and a reduction in commercial loan prepayment fees, which totaled less than $0.1 million in the first quarter of 2014 compared to $0.3 million in the prior-year first quarter. A declining level of nonaccrual loans helped to offset the negative impact of these factors on the commercial loan yield.

Average loans equaled 80.2% of average earning assets during the first quarter of 2014, while average securities, federal funds sold, and interest-bearing deposit balances equaled 11.1%, 8.2%, and 0.5%, respectively. During the first quarter of 2013, average loans, securities, federal funds sold, and interest-bearing deposit balances represented 80.7%, 11.7%, 6.8%, and 0.8%, respectively, of average earning assets.

The yield on average securities was 4.08% in the first quarter of 2014 compared to 3.84% in the respective 2013 period. The higher yield on average securities primarily resulted from an increased yield on U.S. Government agency bonds, primarily reflecting an increase in market interest rates, and an increased yield on other securities, mainly reflecting a higher yield on FHLB stock. The yield on U.S. Government agency bonds was 3.54% in the first quarter of 2014 compared to 3.25% in the first quarter of 2013, while the yield on other securities was 5.13% and 2.70% in the respective periods. Medium- and longer-term market interest rates increased significantly during mid and late 2013, in large part reflecting modified forecasts and commentary from the Federal Open Markets Committee and other major market participants relating to future economic conditions. Purchases of U.S. Government agency bonds with higher yields during mid and late 2013 using proceeds received from called bonds of the same type and principal paydowns on mortgage-backed securities positively impacted the yield on average securities. The bond purchases were necessary to meet pledging requirements and internal funds management policy guidelines. In addition to paying a regular quarterly dividend in the first quarter of 2014, the FHLB declared and paid a special dividend of 2.0%. A decline in the market value of the available for sale securities portfolio during 2013 also positively impacted the portfolio yield.

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The average net unrealized loss on available for sale securities equaled $7.0 million during the first quarter of 2014, while the average net unrealized gain on available for sale securities equaled $3.2 million during the first quarter of 2013. A shift in the securities portfolio mix from higher-yielding municipal, mortgage-backed and other securities to lower-yielding agency bonds negatively impacted the yield on securities. Average U.S. Government agency bonds, municipal securities, other securities, and mortgage-backed securities represented 69.9%, 12.1%, 9.1%, and 8.9%, respectively, of average total securities during the first quarter of 2014 compared to 53.4%, 16.4%, 16.4%, and 13.8%, respectively, during the first quarter of 2013.

During the first quarter of 2014, earning assets averaged $1.32 billion, an increase of $42.5 million, or 3.3%, from the $1.28 billion in average earning assets during the first quarter of 2013. Average loans were up $27.5 million, average federal funds sold increased $22.1 million, average interest-bearing deposit balances decreased $4.5 million, and average securities declined $2.6 million.

Interest expense during the first quarter of 2014 was $2.5 million, a decrease of $0.2 million, or 8.4%, from the $2.7 million expensed during the first quarter of 2013. The reduction in interest expense was attributable to a decline in the weighted average cost of interest-bearing liabilities and, to a much lesser extent, a decrease in the volume of average interest-bearing liabilities.

During the first quarter of 2014 and 2013, interest-bearing liabilities had a weighted average rate of 0.98% and 1.05%, respectively. The lower weighted average cost of interest-bearing liabilities was primarily due to decreases in the costs of various certificate of deposit account categories. Market interest rates began falling in the latter part of 2007 and have remained low since. Maturing fixed-rate certificates of deposit were renewed at lower rates, replaced by lower-costing funds, or allowed to runoff during 2013 and the first three months of 2014.

During the first quarter of 2014, interest-bearing liabilities averaged $1.05 billion, or $13.1 million lower than average interest-bearing liabilities of $1.06 billion during the prior-year first quarter. Average interest-bearing deposits were down $32.0 million, while average FHLB advances increased $10.0 million, short-term borrowings increased $8.7 million, and average other borrowings increased $0.2 million.

Net interest income during the first quarter of 2014 was $11.1 million, a decrease of $0.4 million, or 3.4%, from the $11.5 million earned during the first quarter of 2013. The decrease in net interest income was due to a lower net interest margin, which was partially offset by an increase in earning assets.

The net interest margin during the first quarter of 2014 was 3.42%, down from 3.68% during the first quarter of 2013. The lower net interest margin reflects a decreased yield on earning assets, which more than offset a reduction in the cost of funds. The decline in earning asset yield resulted from a decreased yield on average loans and a change in average earning asset mix involving an increase in low-yielding average federal funds sold as a percentage of average earning assets. Excess liquidity had a negative impact of approximately 15 basis points on the net interest margin during the first quarter of 2014. An increased yield on average securities partially offset the reduction in earning asset yield resulting from the decreased yield on average loans and the change in earning asset mix. The cost of funds was 0.78% in the first quarter of 2014, down from 0.87% in the first quarter of 2013 primarily due to decreases in the costs of various certificate of deposit account categories and certain non-certificate of deposit accounts and a change in funding mix, most notably a decrease in higher-costing average certificates of deposit and increases in certain lower-costing non-certificate of deposit accounts, noninterest-bearing deposit accounts, and repurchase agreements as a percentage of average total funding sources. Maturing fixed-rate certificates of deposit were renewed at lower rates, replaced by lower-costing funds, or allowed to runoff during 2013 and the first three months of 2014.

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In addition, the lowering of interest rates on certain non-certificate of deposit accounts in the latter part of the fourth quarter of 2013 positively impacted the cost of funds in the first quarter of 2014.

The following table sets forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the first quarter of 2014 and 2013. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. Tax-exempt securities interest income and yield have been computed on a tax equivalent basis using a marginal tax rate of 35%. Securities interest income was increased by $84,000 and $136,000 in the first quarter of 2014 and 2013, respectively, for this adjustment.

	Quarters ended March 31,
	2 0 1 4								2 0 1 3
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	1,059,595		$	12,099		4.63	%	$	1,032,066		$	12,846		5.05	%
Investment securities		147,164			1,501		4.08			149,721			1,438		3.84
Federal funds sold		108,332			68		0.25			86,285			54		0.25
Interest-bearing deposits		6,221			4		0.26			10,752			7		0.28
Total interest - earning assets		1,321,312			13,672		4.20			1,278,824			14,345		4.55

Allowance for loan losses		(22,558	)							(28,623	)
Other assets		121,758								138,699

Total assets	$	1,420,512							$	1,388,900


LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing deposits	$	890,698		$	2,035		0.93	%	$	922,653		$	2,320		1.02	%
Short-term borrowings		76,412			22		0.12			67,762			20		0.12
Federal Home Loan Bank advances		45,000			150		1.34			35,000			118		1.35
Other borrowings		34,631			317		3.66			34,469			297		3.45
Total interest-bearing liabilities		1,046,741			2,524		0.98			1,059,884			2,755		1.05

Noninterest-bearing deposits		214,037								176,343
Other liabilities		4,661								4,890
Shareholders’ equity		155,073								147,783

Total liabilities and shareholders’ equity	$	1,420,512							$	1,388,900

Net interest income				$	11,148							$	11,590

Net interest rate spread							3.22	%							3.50	%
Net interest spread on average assets							3.18	%							3.38	%
Net interest margin on earning assets							3.42	%							3.68	%

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A negative loan loss provision expense of $1.9 million was recorded during the first quarter of 2014, compared to a negative provision expense of $1.5 million during the first quarter of 2013. The negative provision expense reflects recoveries of previously charged-off loans, reversals of specific reserves, a reduced level of loan-rating downgrades, and ongoing loan-rating upgrades as the quality of the loan portfolio continued to improve. Continued progress in the stabilization of economic and real estate market conditions and resulting collateral valuations also positively impacted provision expense.

Recoveries of previously charged-off loans totaled $0.6 million during the first quarter of 2014, while loan charge-offs not specifically reserved for in prior periods amounted to $0.1 million, resulting in a net positive impact of $0.5 million on provision expense. Net loan recoveries of $33,000 were recorded during the first quarter of 2014, compared to net loan charge-offs of $1.1 million during the prior-year first quarter. Of the $0.6 million in gross loans charged-off during the first three months of 2014, $0.5 million, or 82.6%, represents the elimination of specific reserves that were established through provision expense in earlier periods. Nonperforming loans totaled $6.3 million, or 0.6% of total loans, as of March 31, 2014, compared to $12.4 million, or 1.2% of total loans, as of March 31, 2013. The allowance, as a percentage of total loans outstanding, was 2.0% as of March 31, 2014, compared to 2.2% as of December 31, 2013 and 2.6% as of March 31, 2013.

Noninterest income during the first quarter of 2014 was $1.5 million, a decrease of $0.3 million, or 17.6%, from the $1.8 million earned during the first quarter of 2013. The decrease in noninterest income was mainly due to lower residential mortgage banking fee income, rental income from foreclosed properties, and bank owned life insurance income. The level of refinance activity declined in 2013 and the first quarter of 2014 as many qualifying borrowers had already refinanced prior to 2013. Residential mortgage rates, which were relatively stable during the first few months of 2013, began increasing during the latter part of the second quarter and into the third quarter and remained at these higher levels during the rest of 2013 and the first three months of 2014. A reduction in the number of foreclosed properties, reflecting ongoing sales of these properties, resulted in the decreased rental income, while the decline in earnings on bank owned life insurance primarily resulted from reduced investment yields, as paydowns on mortgage-backed securities were reinvested into similar securities with lower rates.

Noninterest expense during the first quarter of 2014 was $9.2 million, an increase of $0.6 million, or 7.3%, from the $8.6 million expensed during the first quarter of 2013 primarily due to higher salary and benefit expenses and merger-related costs. Salary and benefit expenses totaled $5.2 million during the first quarter of 2014, an increase of $0.4 million, or 7.7%, from the $4.8 million expensed during the prior-year first quarter mainly due to the hiring of additional staff members over the past year and officer merit pay increases. As of March 31, 2014, full-time equivalent employees numbered 244, up from 231 as of March 31, 2013. Merger-related costs were $0.4 million in the first quarter of 2014 compared to a negligible amount in the first quarter of 2013.

Problem asset administration and resolution costs were slightly negative during the first quarter of 2014 and $0.1 million during the respective 2013 period. Gains on sales of other real estate owned, which are netted against problem asset costs, totaled $0.3 million in the first quarter of 2014 compared to $0.7 million during the first quarter of 2013. Excluding these gains, problem asset costs totaled $0.3 million in the first quarter of 2014 compared to $0.9 million in prior-year first quarter.

During the first quarter of 2014, we recorded income before federal income tax of $5.3 million and a federal income tax expense of $1.7 million. During the first quarter of 2013, we recorded income before federal income tax of $6.2 million and a federal income tax expense of $1.8 million. The decrease in federal income tax expense in the first quarter of 2014 resulted from the lower level of income before federal income tax, which was partially offset by an increase in our effective tax rate from 29.0% in the first quarter of 2013 to 32.0% in the first quarter of 2014.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates is assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates. We derive our income primarily from the excess of interest collected on our interest-earning assets over the interest paid on our interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness.

Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal control procedures are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk, we assess the existing and potential future effects of changes in interest rates on our financial condition, including capital adequacy, earnings, liquidity and asset quality.

We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to our net interest margin during periods of changing market interest rates.

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The following table depicts our GAP position as of March 31, 2014:

	Within			Three to			One to			After
	Three			Twelve			Five			Five
	Months			Months			Years			Years			Total
Assets:
Commercial loans (1)	$	194,301,000		$	132,037,000		$	628,027,000		$	41,046,000		$	995,411,000
Residential real estate loans		24,771,000			4,549,000			24,600,000			15,059,000			68,979,000
Consumer loans		1,427,000			58,000			683,000			238,000			2,406,000
Securities (2)		14,102,000			1,516,000			12,323,000			125,117,000			153,058,000
Federal funds sold		77,829,000			0			0			0			77,829,000
Interest-bearing deposits		5,545,000			0			750,000			0			6,295,000
Allowance for loan losses		0			0			0			0			(20,954,000	)
Other assets		0			0			0			0			130,491,000
Total assets		317,975,000			138,160,000			666,383,000			181,460,000		$	1,413,515,000

Liabilities:
Interest-bearing checking		189,971,000			0			0			0			189,971,000
Savings deposits		54,815,000			0			0			0			54,815,000
Money market accounts		135,931,000			0			0			0			135,931,000
Time deposits under $100,000		6,420,000			13,009,000			26,477,000			0			45,906,000
Time deposits $100,000 & over		47,882,000			137,313,000			265,724,000			0			450,919,000
Short-term borrowings		63,165,000			0			0			0			63,165,000
Federal Home Loan Bank advances		0			0			45,000,000			0			45,000,000
Other borrowed money		34,668,000			0			0			0			34,668,000
Noninterest-bearing checking		0			0			0			0			230,709,000
Other liabilities		0			0			0			0			4,742,000
Total liabilities		532,852,000			150,322,000			337,201,000			0			1,255,826,000
Shareholders' equity		0			0			0			0			157,689,000
Total liabilities & shareholders' equity		532,852,000			150,322,000			337,201,000			0		$	1,413,515,000

Net asset (liability) GAP	$	(214,877,000	)	$	(12,162,000	)	$	329,182,000		$	181,460,000

Cumulative GAP	$	(214,877,000	)	$	(227,039,000	)	$	102,143,000		$	283,603,000

Percent of cumulative GAP to total assets		(15.2%	)		(16.1%	)		7.2	%		20.1	%

⁽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 average life calculations based upon prepayment trends as of March 31, 2014.

The second interest rate risk measurement we use is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, 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.

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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 March 31, 2014, 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 March 31, 2014. The resulting estimates are well within our policy parameters established to manage and monitor interest rate risk.

	Dollar Change			Percent Change
	In Net			In Net
Interest Rate Scenario	Interest Income			Interest Income

Interest rates down 400 basis points	$	(3,420,000	)		(7.7%	)
Interest rates down 300 basis points		(2,920,000	)		(6.5	)
Interest rates down 200 basis points		(2,550,000	)		(5.7	)
Interest rates down 100 basis points		(2,030,000	)		(4.5	)
No change in interest rates		(590,000	)		(1.3	)
Interest rates up 100 basis points		450,000			1.0
Interest rates up 200 basis points		1,530,000			3.4
Interest rates up 300 basis points		2,600,000			5.8
Interest rates up 400 basis points		3,170,000			7.1

The resulting estimates have been significantly impacted by the current interest rate and economic environments, 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 sizable portion of our balance sheet.

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As of March 31, 2014, the Mercantile Bank Prime Rate was 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. One of our key interest rate goals has been to reduce the negative impact this repricing gap will likely have on our net interest income in an increasing interest rate environment. Starting in early 2011, we initiated a program to convert certain commercial loan relationships from the Mercantile Bank Prime Rate to the Wall Street Journal Prime Rate. As of March 31, 2014, approximately 82% of our floating rate commercial loans were tied to the Wall Street Journal Prime Rate, compared to less than 5% at year-end 2010. Although this program has a short-term negative impact on net interest income as the conversion generally involves an interest rate reduction on the affected commercial loans, it will have a positive impact on net interest income in a rising interest rate environment as the affected commercial loans will be subject to increased repricing sooner than otherwise.

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.

Item 4. Controls and Procedures

As of March 31, 2014, 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 March 31, 2014.

There have been no changes in our internal control over financial reporting during the quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we may be involved in various legal proceedings that are incidental to our business. In our opinion, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate.

Item 1A. Risk Factors.

There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K for the year ended December 31, 2013, and incorporated therein by reference.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

We made no unregistered sale of equity securities, nor did we purchase our equity securities, during the quarter ended March 31, 2014.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

Not applicable.

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Item 6. Exhibits

Exhibit No.	EXHIBIT DESCRIPTION

2.1	Agreement and Plan of Merger dated August 14, 2013, incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed August 15, 2013

2.2	First Amendment to Merger Agreement dated February 20, 2014, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed February 21, 2014

3.1	Our Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2009

3.2	Our Amended and Restated Bylaws dated as of January 16, 2003 are incorporated by reference to Exhibit 3.2 of our Registration Statement on Form S-3 (Commission File No. 333-103376) that became effective on February 21, 2003

10.1	2014 Mercantile Executive Officer Bonus Plan, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed February 24, 2014

31	Rule 13a-14(a) Certifications

32.1	Section 1350 Chief Executive Officer Certification

32.2	Section 1350 Chief Financial Officer Certification

101	The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to Condensed Consolidated Financial Statements

72.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on April 30, 2014.

	MERCANTILE BANK CORPORATION





	By:	/s/ Michael H. Price
	Michael H. Price
	Chairman of the Board, President and Chief Executive Officer
	(Principal Executive Officer)



	By:	/s/ Charles E. Christmas
	Charles E. Christmas
	Senior Vice President, Chief Financial Officer and Treasurer
	(Principal Financial and Accounting Officer)

73.

EXHIBIT INDEX

Exhibit No.	EXHIBIT DESCRIPTION

2.1	Agreement and Plan of Merger dated August 14, 2013, incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed August 15, 2013

2.2	First Amendment to Merger Agreement dated February 20, 2014, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed February 21, 2014

3.1	Our Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2009

3.2	Our Amended and Restated Bylaws dated as of January 16, 2003 are incorporated by reference to Exhibit 3.2 of our Registration Statement on Form S-3 (Commission File No. 333-103376) that became effective on February 21, 2003

10.1	2014 Mercantile Executive Officer Bonus Plan, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed February 24, 2014

31	Rule 13a-14(a) Certifications

32.1	Section 1350 Chief Executive Officer Certification

32.2	Section 1350 Chief Financial Officer Certification

101	The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to Condensed Consolidated Financial Statements