MERCANTILE BANK CORP - Quarter Report: 2021 March (Form 10-Q)
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021
☐ 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 incorporation or organization) | (IRS Employer Identification No.) |
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ☐ | Accelerated filer ☒ |
| Non-accelerated filer ☐ | Smaller reporting company ☐ |
| Emerging growth company ☐ |
Securities registered pursuant to Section 12(b) of the Exchange Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock | MBWM | The Nasdaq Stock Market LLC |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Yes ☐ No ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
At April 30, 2021, there were 16,158,431 shares of common stock outstanding.
INDEX
PART I --- FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(Unaudited)
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| ASSETS | ||||||||
| Cash and due from banks | $ | 55,489,000 | $ | 62,832,000 | ||||
| Interest-earning deposits | 596,855,000 | 563,174,000 | ||||||
| Total cash and cash equivalents | 652,344,000 | 626,006,000 | ||||||
| Securities available for sale | 434,257,000 | 387,347,000 | ||||||
| Federal Home Loan Bank stock | 18,002,000 | 18,002,000 | ||||||
| Loans | 3,364,370,000 | 3,193,470,000 | ||||||
| Allowance for loan losses | (38,695,000 | ) | (37,967,000 | ) | ||||
| Loans, net | 3,325,675,000 | 3,155,503,000 | ||||||
| Premises and equipment, net | 55,388,000 | 58,959,000 | ||||||
| Bank owned life insurance | 72,395,000 | 72,131,000 | ||||||
| Goodwill | 49,473,000 | 49,473,000 | ||||||
| Core deposit intangible, net | 2,118,000 | 2,436,000 | ||||||
| Mortgage loans held for sale | 40,297,000 | 22,888,000 | ||||||
| Assets held for sale | 13,159,000 | 0 | ||||||
| Other assets | 47,246,000 | 44,599,000 | ||||||
| Total assets | $ | 4,710,354,000 | $ | 4,437,344,000 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Deposits | ||||||||
| Noninterest-bearing | $ | 1,605,471,000 | $ | 1,433,403,000 | ||||
| Interest-bearing | 2,039,491,000 | 1,978,150,000 | ||||||
| Total deposits | 3,644,962,000 | 3,411,553,000 | ||||||
| Securities sold under agreements to repurchase | 141,310,000 | 118,365,000 | ||||||
| Federal Home Loan Bank advances | 394,000,000 | 394,000,000 | ||||||
| Subordinated debentures | 47,733,000 | 47,563,000 | ||||||
| Liabilities held for sale | 17,280,000 | 0 | ||||||
| Accrued interest and other liabilities | 23,826,000 | 24,309,000 | ||||||
| Total liabilities | 4,269,111,000 | 3,995,790,000 | ||||||
| Commitments and contingent liabilities (Note 8) | ||||||||
| Shareholders' equity | ||||||||
| Preferred stock, par value; shares authorized; issued | 0 | 0 | ||||||
| Common stock, par value; shares authorized; shares outstanding at March 31, 2021 and shares outstanding at December 31, 2020 | 299,358,000 | 302,029,000 | ||||||
| Retained earnings | 143,642,000 | 134,039,000 | ||||||
| Accumulated other comprehensive income (loss) | (1,757,000 | ) | 5,486,000 | |||||
| Total shareholders’ equity | 441,243,000 | 441,554,000 | ||||||
| Total liabilities and shareholders’ equity | $ | 4,710,354,000 | $ | 4,437,344,000 | ||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| Three Months | Three Months | |||||||
| Ended | Ended | |||||||
| March 31, | March 31, | |||||||
| 2021 | 2020 | |||||||
| Interest income | ||||||||
| Loans, including fees | $ | 32,985,000 | $ | 33,442,000 | ||||
| Securities, taxable | 1,035,000 | 3,441,000 | ||||||
| Securities, tax-exempt | 597,000 | 576,000 | ||||||
| Other interest-earning assets | 168,000 | 475,000 | ||||||
| Total interest income | 34,785,000 | 37,934,000 | ||||||
| Interest expense | ||||||||
| Deposits | 2,717,000 | 4,641,000 | ||||||
| Short-term borrowings | 36,000 | 40,000 | ||||||
| Federal Home Loan Bank advances | 2,027,000 | 2,212,000 | ||||||
| Subordinated debentures and other borrowings | 472,000 | 724,000 | ||||||
| Total interest expense | 5,252,000 | 7,617,000 | ||||||
| Net interest income | 29,533,000 | 30,317,000 | ||||||
| Provision for loan losses | 300,000 | 750,000 | ||||||
| Net interest income after provision for loan losses | 29,233,000 | 29,567,000 | ||||||
| Noninterest income | ||||||||
| Service charges on deposit and sweep accounts | 1,155,000 | 1,222,000 | ||||||
| Mortgage banking income | 8,800,000 | 2,627,000 | ||||||
| Credit and debit card income | 1,678,000 | 1,361,000 | ||||||
| Interest rate swap fees | 653,000 | 0 | ||||||
| Payroll processing | 557,000 | 577,000 | ||||||
| Earnings on bank owned life insurance | 277,000 | 336,000 | ||||||
| Other income | 343,000 | 427,000 | ||||||
| Total noninterest income | 13,463,000 | 6,550,000 | ||||||
| Noninterest expense | ||||||||
| Salaries and benefits | 15,086,000 | 13,528,000 | ||||||
| Occupancy | 2,014,000 | 2,059,000 | ||||||
| Furniture and equipment depreciation, rent and maintenance | 889,000 | 778,000 | ||||||
| Data processing costs | 2,617,000 | 2,483,000 | ||||||
| Other expense | 4,511,000 | 4,092,000 | ||||||
| Total noninterest expenses | 25,117,000 | 22,940,000 | ||||||
| Income before federal income tax expense | 17,579,000 | 13,177,000 | ||||||
| Federal income tax expense | 3,340,000 | 2,504,000 | ||||||
| Net income | $ | 14,239,000 | $ | 10,673,000 | ||||
| Basic earnings per share | $ | 0.87 | $ | 0.65 | ||||
| Diluted earnings per share | $ | 0.87 | $ | 0.65 | ||||
| Cash dividends per share | $ | 0.29 | $ | 0.28 | ||||
| Average basic shares outstanding | 16,283,044 | 16,350,281 | ||||||
| Average diluted shares outstanding | 16,283,490 | 16,351,559 | ||||||
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
| Three Months Ended March 31, 2021 | Three Months Ended March 31, 2020 | |||||||
| Net income | $ | 14,239,000 | $ | 10,673,000 | ||||
| Other comprehensive income (loss): | ||||||||
| Unrealized holding gains (losses) on securities available for sale | (9,168,000 | ) | 1,391,000 | |||||
| Tax effect of unrealized holding gains (losses) on securities available for sale | 1,925,000 | (293,000 | ) | |||||
| Other comprehensive income (loss), net of tax effect | (7,243,000 | ) | 1,098,000 | |||||
| Comprehensive income | $ | 6,996,000 | $ | 11,771,000 | ||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY
(Unaudited)
| ($ in thousands except per share amounts) | Preferred Stock | Common Stock | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Shareholders’ Equity | |||||||||||||||
| Balances, January 1, 2021 | $ | 0 | $ | 302,029 | $ | 134,039 | $ | 5,486 | $ | 441,554 | ||||||||||
| Employee stock purchase plan ( shares) | 11 | 11 | ||||||||||||||||||
| Dividend reinvestment plan ( shares) | 213 | 213 | ||||||||||||||||||
| Stock-based compensation expense | 643 | 643 | ||||||||||||||||||
| Share repurchase program ( shares) | (3,538 | ) | (3,538 | ) | ||||||||||||||||
| Cash dividends ( per common share) | (4,636 | ) | (4,636 | ) | ||||||||||||||||
| Net income for the three months ended March 31, 2021 | 14,239 | 14,239 | ||||||||||||||||||
| Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect | (7,243 | ) | (7,243 | ) | ||||||||||||||||
| Balances, March 31, 2021 | $ | 0 | $ | 299,358 | $ | 143,642 | $ | (1,757 | ) | $ | 441,243 | |||||||||
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY (Continued)
(Unaudited)
| ($ in thousands except per share amounts) | Preferred Stock | Common Stock | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Shareholders’ Equity | |||||||||||||||
| Balances, January 1, 2020 | $ | 0 | $ | 305,035 | $ | 107,831 | $ | 3,695 | $ | 416,561 | ||||||||||
| Employee stock purchase plan ( shares) | 14 | 14 | ||||||||||||||||||
| Dividend reinvestment plan ( shares) | 192 | 192 | ||||||||||||||||||
| Stock-based compensation expense | 625 | 625 | ||||||||||||||||||
| Share repurchase program ( shares) | (6,282 | ) | (6,282 | ) | ||||||||||||||||
| Cash dividends ( per common share) | (4,492 | ) | (4,492 | ) | ||||||||||||||||
| Net income for the three months ended March 31, 2020 | 10,673 | 10,673 | ||||||||||||||||||
| Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect | 1,098 | 1,098 | ||||||||||||||||||
| Balances, March 31, 2020 | $ | 0 | $ | 299,584 | $ | 114,012 | $ | 4,793 | $ | 418,389 | ||||||||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| Three Months | Three Months | |||||||
| Ended | Ended | |||||||
| March 31, 2021 | March 31, 2020 | |||||||
| Cash flows from operating activities | ||||||||
| Net income | $ | 14,239,000 | $ | 10,673,000 | ||||
| Adjustments to reconcile net income to net cash from operating activities | ||||||||
| Depreciation and amortization | 3,457,000 | 982,000 | ||||||
| Accretion of acquired loans | (34,000 | ) | (113,000 | ) | ||||
| Provision for loan losses | 300,000 | 750,000 | ||||||
| Stock-based compensation expense | 643,000 | 625,000 | ||||||
| Proceeds from sales of mortgage loans held for sale | 189,018,000 | 68,627,000 | ||||||
| Origination of mortgage loans held for sale | (197,245,000 | ) | (86,206,000 | ) | ||||
| Net gain from sales of mortgage loans held for sale | (9,182,000 | ) | (2,096,000 | ) | ||||
| Net gain from sales and valuation write-downs of foreclosed assets | (81,000 | ) | (49,000 | ) | ||||
| Net (gain) loss from sales and valuation write-downs of former bank premises | 250,000 | (27,000 | ) | |||||
| Net loss from sales and write-downs of fixed assets | 312,000 | 54,000 | ||||||
| Earnings on bank owned life insurance | (277,000 | ) | (336,000 | ) | ||||
| Net change in: | ||||||||
| Accrued interest receivable | (971,000 | ) | 220,000 | |||||
| Other assets | (1,367,000 | ) | 271,000 | |||||
| Accrued interest and other liabilities | (483,000 | ) | (3,153,000 | ) | ||||
| Net cash for operating activities | (1,421,000 | ) | (9,778,000 | ) | ||||
| Cash flows from investing activities | ||||||||
| Loan originations and payments, net | (180,147,000 | ) | (24,910,000 | ) | ||||
| Purchases of securities available for sale | (87,307,000 | ) | (99,002,000 | ) | ||||
| Proceeds from maturities, calls and repayments of securities available for sale | 30,974,000 | 124,510,000 | ||||||
| Proceeds from sales of foreclosed assets | 158,000 | 106,000 | ||||||
| Proceeds from sales of former bank premises | 0 | 162,000 | ||||||
| Net purchases of premises and equipment | (1,603,000 | ) | (3,159,000 | ) | ||||
| Net cash for investing activities | (237,925,000 | ) | (2,293,000 | ) | ||||
| Cash flows from financing activities | ||||||||
| Net decrease in time deposits | (51,961,000 | ) | (61,810,000 | ) | ||||
| Net increase in all other deposits | 302,650,000 | 16,842,000 | ||||||
| Net increase in securities sold under agreements to repurchase | 22,945,000 | 30,595,000 | ||||||
| Proceeds from Federal Home Loan Bank advances | 0 | 40,000,000 | ||||||
| Employee stock purchase plan | 11,000 | 14,000 | ||||||
| Dividend reinvestment plan | 213,000 | 192,000 | ||||||
| Repurchases of common stock | (3,538,000 | ) | (6,282,000 | ) | ||||
| Payment of cash dividends to common shareholders | (4,636,000 | ) | (4,492,000 | ) | ||||
| Net cash from financing activities | 265,684,000 | 15,059,000 | ||||||
| Net change in cash and cash equivalents | 26,338,000 | 2,988,000 | ||||||
| Cash and cash equivalents at beginning of period | 626,006,000 | 233,731,000 | ||||||
| Cash and cash equivalents at end of period | $ | 652,344,000 | $ | 236,719,000 | ||||
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
| Three Months |
Three Months |
|||||||
| Ended |
Ended |
|||||||
| March 31, 2021 |
March 31, 2020 |
|||||||
| Supplemental disclosures of cash flows information |
||||||||
| Cash paid during the period for: |
||||||||
| Interest |
$ | 5,509,000 | $ | 8,290,000 | ||||
| Federal income tax |
0 | 0 | ||||||
| Noncash financing and investing activities: |
||||||||
| Transfers from loans to foreclosed assets |
0 | 11,000 | ||||||
| Transfers from loans to assets held for sale |
9,709,000 | 0 | ||||||
| Transfers from bank premises to assets held for sale |
3,450,000 | 0 | ||||||
| Transfers from deposits to liabilities held for sale |
17,280,000 | 0 | ||||||
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The unaudited financial statements for the three months ended March 31, 2021 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 subsidiary 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 (“GAAP”) 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, 2021 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, 2020.
We have separate business trusts that were formed to issue trust preferred securities. Subordinated debentures were issued to the trusts in return for the proceeds raised from the issuance of the trust preferred securities. The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as a liability.
Coronavirus Pandemic: The U.S. economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). While the economic fallout has stabilized somewhat and the adult population in the United States is in the process of being vaccinated, there remains a significant amount of stress and uncertainty across national and global economies. This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances.
The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations. We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income. Additionally, the consequences of the unprecedented economic impact of the Coronavirus Pandemic may produce declining asset quality, reflected by a higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which may necessitate additional provisions for our allowance and reduced net income.
The following section summarizes the primary measures that directly impact us and our customers.
| ● | Paycheck Protection Program |
The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee paid by the Small Business Administration. The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology. The program ended on August 8, 2020. We originated approximately 2,200 loans aggregating $553 million. As of March 31, 2021, we recorded forgiveness transactions on approximately 1,600 loans aggregating $302 million. Net loan origination fees of $2.4 million were recorded during the first quarter of 2021.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in second draw PPP loans (“round 2 PPP loans”). The program is scheduled to end on May 31, 2021. Through March 31, 2021, we originated approximately 1,100 loans aggregating $203 million. Net loan origination fees of $0.4 million were recorded during the first quarter of 2021.
A PPP loan is assigned a risk weight of 0% under the risk-based capital rules of the federal banking agencies.
| ● | Individual Economic Impact Payments |
The Internal Revenue Service has made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks. In general, and subject to adjusted gross income limitations, qualifying individuals have received payments of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.
| ● | Troubled Debt Restructuring Relief |
From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. We elected to suspend GAAP principles and regulatory determinations as permitted. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022.
| ● | Current Expected Credit Loss Methodology Delay |
Financial institutions are not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022.
In early April 2020, in response to the early stages of the Coronavirus Pandemic and its pervasive impact across the economy and financial markets, we developed internal programs of loan payment deferments for commercial and retail borrowers. For commercial borrowers, we offered 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments. Under the latter program, borrowers were extended a 12-month single payment note at 0% interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments. The single payment notes receive a loan grade equal to the loan grade of each respective borrowing relationship. Certain of our commercial loan borrowers subsequently requested and received an additional 90-day (three payments) interest only amendment or 90-day (three payments) principal and interest payment deferment. Under the latter program, the amount equal to the three payments was added to the original deferment note which has nine months remaining to maturity; however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.
At the peak of activity in mid-2020, nearly 750 borrowers with loan balances aggregating $719 million were participating in the commercial loan deferment program. As of March 31, 2021, only borrowers with loan balances aggregating $1.8 million remained in the commercial loan deferment program. For retail borrowers, we offered 90-day (three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan. As of June 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $23.8 million. These payment deferral transactions largely applied to the borrowers’ April, May and June of 2020 loan payments. As of March 31, 2021, only borrowers with loan balances aggregating $0.8 million remained in the retail loan payment deferment program.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 262,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2021. In addition, stock options for approximately 3,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2021. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2021.
Approximately 256,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2020. In addition, stock options for approximately 4,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2020. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2020.
Securities: Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold prior to maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Federal Home Loan Bank stock is carried at cost.
Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Declines in the fair value of debt securities below their amortized cost that are other-than-temporary impairment (“OTTI”) are reflected in earnings or other comprehensive income, as appropriate. For those debt securities whose fair value is less than their amortized cost, we consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and whether we expect to recover the entire amortized cost of the security based on our assessment of the issuer’s financial condition. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies, and whether downgrades by bond rating agencies have occurred. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) OTTI related to other factors, such as liquidity conditions in the market or changes in market interest rates, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of March 31, 2021 and December 31, 2020, we determined that the fair value of our mortgage loans held for sale totaled $41.3 million and $24.0 million, respectively.
Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives, which is generally nominal in dollar amount, is included in the gain on sale of loans and recorded as part of mortgage banking income. Mortgage loans serviced for others totaled approximately $1.11 billion and $1.04 billion as of March 31, 2021 and December 31, 2020, respectively.
Mortgage Banking Activities: Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.
Servicing fee income is recorded for fees earned for servicing mortgage loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage loan servicing rights is netted against mortgage loan servicing income and recorded in mortgage banking activities in the income statement.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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 below under “Allowance for Loan Losses.” Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.
The federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” on March 22, 2020, which was subsequently revised on April 7, 2020. This guidance encourages financial institutions to work prudently with borrowers that are or may be unable to meet their contractual obligations because of the effects of the Coronavirus Pandemic. Pursuant to the guidance, the federal banking agencies concluded, in consultation with FASB staff, that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current prior to any relief are not troubled debt restructurings. This guidance complements Section 4013 of the CARES Act, which specified that Coronavirus-related modifications made on loans that were current as of December 31, 2019 and that occur between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency declared by President Trump on March 13, 2020 (the “National Emergency”) or December 31, 2020, as applicable, are not troubled debt restructurings. As part of the Consolidated Appropriations Act that was enacted in late 2020, this guidance was extended to January 1, 2022.
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. We estimate credit losses based on individual loans determined to be impaired and on all other loans grouped on similar risk characteristics. Our historical loss component is generally the most significant of the allowance components and is based on historical loss experience by credit risk grade for commercial loans and payment status for mortgage and consumer loans. Loans are pooled based on similar risk characteristics supported by observable data. The historical loss experience component of the allowance represents the results of migration analysis of historical net charge-offs for portfolios of loans, including groups of commercial loans within each credit risk grade. For measuring loss exposure in a pool of loans, the historical net charge-off or migration experience is utilized to estimate expected future losses to be realized from the pool of loans. These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative environmental factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, competition, increasing interest rates, external factors, Coronavirus Pandemic environment, and other considerations. 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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 1. | SIGNIFICANT ACCOUNTING POLICIES (Continued) |
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.
Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continue to experience an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments and financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted. Loans made under PPP are fully guaranteed by the Small Business Administration; therefore, such loans do not have an associated allowance.
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. We do not use derivatives for trading purposes.
Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.
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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 1. | SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Goodwill and Core Deposit Intangible: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We may elect to perform a qualitative assessment for the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value.
The core deposit intangible that arose from the Firstbank Corporation acquisition was initially measured at fair value and is being amortized into noninterest expense over a -year period using the sum-of-the-years-digits methodology.
Revenue from Contracts with Customers: We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Adoption of New Accounting Standards: In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended by ASU 2018-19) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (i) financial assets subject to credit losses and measured at amortized cost, and (ii) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans, and expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 1. | SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continue to experience an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments and financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly updated and there is no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.
Hastings Branch Sale: As previously disclosed in a Current Report on Form 8-K filed on October 26, 2020, we entered into a Purchase and Assumption Agreement (“Agreement”) on October 21, 2020 regarding the sale of our Hastings, Michigan branch office to Lake Trust Credit Union (“Lake Trust”). All regulatory approvals have been received, and the sale is expected to close on May 14, 2021. Under the terms of the Agreement, as amended on April 20, 2021, Lake Trust will: 1) purchase all loans at book balance; 2) purchase the branch facility at a price of $1.5 million; and 3) assume all deposit accounts at a premium price of 5.0% of the book balance. The loan and branch facility balances ($9.7 million and $1.2 million, respectively) are included in the Assets Held For Sale account, while the deposit balances ($17.3 million) are included in the Liabilities Held For Sale account on the Consolidated Balance Sheet as of March 31, 2021. On the consummation date, we expect to record a $0.9 million deposit premium and a $0.3 million gain on the sale of the branch facility
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. SECURITIES
The amortized cost and estimated fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
| March 31, 2021 | ||||||||||||||||
| U.S. Government agency debt obligations | $ | 274,038,000 | $ | 362,000 | $ | (7,572,000 | ) | $ | 266,828,000 | |||||||
| Mortgage-backed securities | 35,211,000 | 925,000 | (328,000 | ) | 35,808,000 | |||||||||||
| Municipal general obligation bonds | 111,294,000 | 4,517,000 | (274,000 | ) | 115,537,000 | |||||||||||
| Municipal revenue bonds | 15,438,000 | 303,000 | (157,000 | ) | 15,584,000 | |||||||||||
| Other investments | 500,000 | 0 | 0 | 500,000 | ||||||||||||
| $ | 436,481,000 | $ | 6,107,000 | $ | (8,331,000 | ) | $ | 434,257,000 | ||||||||
| December 31, 2020 | ||||||||||||||||
| U.S. Government agency debt obligations | $ | 242,522,000 | $ | 516,000 | $ | (897,000 | ) | $ | 242,141,000 | |||||||
| Mortgage-backed securities | 23,869,000 | 1,021,000 | 0 | 24,890,000 | ||||||||||||
| Municipal general obligation bonds | 101,991,000 | 5,833,000 | 0 | 107,824,000 | ||||||||||||
| Municipal revenue bonds | 11,521,000 | 473,000 | (2,000 | ) | 11,992,000 | |||||||||||
| Other investments | 500,000 | 0 | 0 | 500,000 | ||||||||||||
| $ | 380,403,000 | $ | 7,843,000 | $ | (899,000 | ) | $ | 387,347,000 | ||||||||
Securities with unrealized losses at March 31, 2021 and December 31, 2020, 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 | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Loss | Value | Loss | Value | Loss | |||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||
| U.S. Government agency debt obligations | $ | 234,832,000 | $ | 7,572,000 | $ | 0 | $ | 0 | $ | 234,832,000 | $ | 7,572,000 | ||||||||||||
| Mortgage-backed securities | 7,264,000 | 328,000 | 0 | 0 | 7,264,000 | 328,000 | ||||||||||||||||||
| Municipal general obligation bonds | 13,961,000 | 274,000 | 0 | 0 | 13,961,000 | 274,000 | ||||||||||||||||||
| Municipal revenue bonds | 6,796,000 | 157,000 | 0 | 0 | 6,796,000 | 157,000 | ||||||||||||||||||
| $ | 262,853,000 | $ | 8,331,000 | $ | 0 | $ | 0 | $ | 262,853,000 | $ | 8,331,000 | |||||||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. SECURITIES (Continued)
| Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | |||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||
| U.S. Government agency debt obligations | $ | 118,650,000 | $ | 897,000 | $ | 0 | $ | 0 | $ | 118,650,000 | $ | 897,000 | ||||||||||||
| Mortgage-backed securities | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||
| Municipal general obligation bonds | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||
| Municipal revenue bonds | 423,000 | 2,000 | 0 | 0 | 423,000 | 2,000 | ||||||||||||||||||
| $ | 119,073,000 | $ | 899,000 | $ | 0 | $ | 0 | $ | 119,073,000 | $ | 899,000 | |||||||||||||
We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. 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, 2021, 185 debt securities with estimated fair values totaling $263 million have unrealized losses aggregating $8.3 million. At December 31, 2020, 64 debt securities with estimated fair values totaling $119 million had unrealized losses aggregating $0.9 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 the 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, 2021, 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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. SECURITIES (Continued)
| Weighted | ||||||||||||
| Average | Amortized | Fair | ||||||||||
| Yield (%) | Cost | Value | ||||||||||
| Due in 2021 | 2.53 | $ | 5,414,000 | $ | 5,425,000 | |||||||
| Due in 2022 through 2026 | 1.16 | 142,876,000 | 143,569,000 | |||||||||
| Due in 2027 through 2031 | 1.63 | 197,842,000 | 195,378,000 | |||||||||
| Due in 2032 and beyond | 2.02 | 54,638,000 | 53,577,000 | |||||||||
| Mortgage-backed securities | 1.83 | 35,211,000 | 35,808,000 | |||||||||
| Other investments | 3.75 | 500,000 | 500,000 | |||||||||
| Total available for sale securities | 1.55 | $ | 436,481,000 | $ | 434,257,000 | |||||||
Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $123 million and $109 million at March 31, 2021 and December 31, 2020, respectively, with estimated market values of $128 million and $116 million, respectively. Securities issued by all other states and their political subdivisions had a combined amortized cost of $3.5 million and $4.1 million at March 31, 2021 and December 31, 2020, respectively, with estimated market values of $3.6 million and $4.2 million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, 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 $141 million and $118 million at March 31, 2021 and December 31, 2020, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans originated for investment are stated at their principal amount outstanding adjusted for partial charge-offs, the allowance, and net deferred loan fees and costs. Interest income on loans is accrued over the term of the loans primarily using the simple interest method based on the principal balance outstanding. Interest is not accrued on loans where collectability is uncertain. Accrued interest is presented separately in the consolidated balance sheet. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.
Our total loans at March 31, 2021 were $3.36 billion compared to $3.19 billion at December 31, 2020, an increase of $171 million, or 5.4%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at March 31, 2021 and December 31, 2020, and the percentage change in loans from the end of 2020 to the end of the first quarter of 2021, are as follows:
| Percent | ||||||||||||||||||||
| March 31, 2021 | December 31, 2020 | Increase | ||||||||||||||||||
| Balance | % | Balance | % | (Decrease) | ||||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial and industrial (1) | $ | 1,284,507,000 | 38.2 | % | $ | 1,145,423,000 | 35.9 | % | 12.1 | % | ||||||||||
| Vacant land, land development, and residential construction | 58,738,000 | 1.7 | 55,055,000 | 1.7 | 6.7 | |||||||||||||||
| Real estate – owner occupied | 544,342,000 | 16.2 | 529,953,000 | 16.6 | 2.7 | |||||||||||||||
| Real estate – non-owner occupied | 932,334,000 | 27.7 | 917,436,000 | 28.7 | 0.6 | |||||||||||||||
| Real estate – multi-family and residential rental | 147,294,000 | 4.4 | 146,095,000 | 4.6 | 0.8 | |||||||||||||||
| Total commercial | 2,967,215,000 | 88.2 | 2,793,962,000 | 87.5 | 6.2 | |||||||||||||||
| Retail: | ||||||||||||||||||||
| Home equity and other | 59,311,000 | 1.8 | 61,620,000 | 1.9 | (3.7 | ) | ||||||||||||||
| 1-4 family mortgages | 337,844,000 | 10.0 | 337,888,000 | 10.6 | (0.1 | ) | ||||||||||||||
| Total retail | 397,155,000 | 11.8 | 399,508,000 | 12.5 | (0.6 | ) | ||||||||||||||
| Total loans | $ | 3,364,370,000 | 100.0 | % | $ | 3,193,470,000 | 100.0 | % | 5.4 | % | ||||||||||
| (1) | Includes $455 million and $365 million in loans originated under the Paycheck Protection Program for March 31, 2021 and December 31, 2020, respectively. |
Nonperforming loans as of March 31, 2021 and December 31, 2020 were as follows:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Loans past due 90 days or more still accruing interest | $ | 0 | $ | 0 | ||||
| Nonaccrual loans | 2,793,000 | 3,384,000 | ||||||
| Total nonperforming loans | $ | 2,793,000 | $ | 3,384,000 | ||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The recorded principal balance of nonperforming loans was as follows:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | 169,000 | $ | 172,000 | ||||
| Vacant land, land development, and residential construction | 0 | 0 | ||||||
| Real estate – owner occupied | 283,000 | 619,000 | ||||||
| Real estate – non-owner occupied | 0 | 22,000 | ||||||
| Real estate – multi-family and residential rental | 0 | 0 | ||||||
| Total commercial | 452,000 | 813,000 | ||||||
| Retail: | ||||||||
| Home equity and other | 175,000 | 242,000 | ||||||
| 1-4 family mortgages | 2,166,000 | 2,329,000 | ||||||
| Total retail | 2,341,000 | 2,571,000 | ||||||
| Total nonperforming loans | $ | 2,793,000 | $ | 3,384,000 | ||||
An age analysis of past due loans is as follows as of March 31, 2021:
| 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 | $ | 593,000 | $ | 0 | $ | 169,000 | $ | 762,000 | $ | 1,283,745,000 | $ | 1,284,507,000 | $ | 0 | ||||||||||||||
| Vacant land, land development, and residential construction | 0 | 0 | 0 | 0 | 58,738,000 | 58,738,000 | 0 | |||||||||||||||||||||
| Real estate – owner occupied | 0 | 137,000 | 283,000 | 420,000 | 543,922,000 | 544,342,000 | 0 | |||||||||||||||||||||
| Real estate – non-owner occupied | 0 | 0 | 0 | 0 | 932,334,000 | 932,334,000 | 0 | |||||||||||||||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | 0 | 147,294,000 | 147,294,000 | 0 | |||||||||||||||||||||
| Total commercial | 593,000 | 137,000 | 452,000 | 1,182,000 | 2,966,033,000 | 2,967,215,000 | 0 | |||||||||||||||||||||
| Retail: | ||||||||||||||||||||||||||||
| Home equity and other | 112,000 | 0 | 45,000 | 157,000 | 59,154,000 | 59,311,000 | 0 | |||||||||||||||||||||
| 1-4 family mortgages | 565,000 | 1,000 | 213,000 | 779,000 | 337,065,000 | 337,844,000 | 0 | |||||||||||||||||||||
| Total retail | 677,000 | 1,000 | 258,000 | 936,000 | 396,219,000 | 397,155,000 | 0 | |||||||||||||||||||||
| Total past due loans | $ | 1,270,000 | $ | 138,000 | $ | 710,000 | $ | 2,118,000 | $ | 3,362,252,000 | $ | 3,364,370,000 | $ | 0 | ||||||||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2020:
| 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 | $ | 261,000 | $ | 172,000 | $ | 0 | $ | 433,000 | $ | 1,144,990,000 | $ | 1,145,423,000 | $ | 0 | ||||||||||||||
| Vacant land, land development, and residential construction | 0 | 0 | 0 | 0 | 55,055,000 | 55,055,000 | 0 | |||||||||||||||||||||
| Real estate – owner occupied | 0 | 197,000 | 421,000 | 618,000 | 529,335,000 | 529,953,000 | 0 | |||||||||||||||||||||
| Real estate – non-owner occupied | 0 | 0 | 23,000 | 23,000 | 917,413,000 | 917,436,000 | 0 | |||||||||||||||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | 0 | 146,095,000 | 146,095,000 | 0 | |||||||||||||||||||||
| Total commercial | 261,000 | 369,000 | 444,000 | 1,074,000 | 2,792,888,000 | 2,793,962,000 | 0 | |||||||||||||||||||||
| Retail: | ||||||||||||||||||||||||||||
| Home equity and other | 112,000 | 65,000 | 54,000 | 231,000 | 61,389,000 | 61,620,000 | 0 | |||||||||||||||||||||
| 1-4 family mortgages | 1,147,000 | 247,000 | 342,000 | 1,736,000 | 336,152,000 | 337,888,000 | 0 | |||||||||||||||||||||
| Total retail | 1,259,000 | 312,000 | 396,000 | 1,967,000 | 397,541,000 | 399,508,000 | 0 | |||||||||||||||||||||
| Total past due loans | $ | 1,520,000 | $ | 681,000 | $ | 840,000 | $ | 3,041,000 | $ | 3,190,429,000 | $ | 3,193,470,000 | $ | 0 | ||||||||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired loans as of March 31, 2021, and average impaired loans for the three months ended March 31, 2021, were as follows:
| First Quarter | ||||||||||||||||
| Unpaid | Average | |||||||||||||||
| Contractual | Recorded | Recorded | ||||||||||||||
| Principal | Principal | Related | Principal | |||||||||||||
| Balance | Balance | Allowance | Balance | |||||||||||||
| With no related allowance recorded: | ||||||||||||||||
| Commercial: | ||||||||||||||||
| Commercial and industrial | $ | 3,587,000 | $ | 3,584,000 | $ | 4,913,000 | ||||||||||
| Vacant land, land development and residential construction | 0 | 0 | 0 | |||||||||||||
| Real estate – owner occupied | 13,588,000 | 13,554,000 | 14,074,000 | |||||||||||||
| Real estate – non-owner occupied | 312,000 | 312,000 | 326,000 | |||||||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | |||||||||||||
| Total commercial | 17,487,000 | 17,450,000 | 19,313,000 | |||||||||||||
| Retail: | ||||||||||||||||
| Home equity and other | 1,019,000 | 940,000 | 963,000 | |||||||||||||
| 1-4 family mortgages | 4,390,000 | 2,525,000 | 2,550,000 | |||||||||||||
| Total retail | 5,409,000 | 3,465,000 | 3,513,000 | |||||||||||||
| Total with no related allowance recorded | $ | 22,896,000 | $ | 20,915,000 | $ | 22,826,000 | ||||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
| First Quarter | ||||||||||||||||
| Unpaid | Average | |||||||||||||||
| Contractual | Recorded | Recorded | ||||||||||||||
| Principal | Principal | Related | Principal | |||||||||||||
| Balance | Balance | Allowance | Balance | |||||||||||||
| With an allowance recorded: | ||||||||||||||||
| Commercial: | ||||||||||||||||
| Commercial and industrial | $ | 348,000 | $ | 348,000 | $ | 62,000 | $ | 345,000 | ||||||||
| Vacant land, land development and residential construction | 0 | 0 | 0 | 0 | ||||||||||||
| Real estate – owner occupied | 530,000 | 530,000 | 47,000 | 632,000 | ||||||||||||
| Real estate – non-owner occupied | 158,000 | 158,000 | 7,000 | 160,000 | ||||||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | 0 | ||||||||||||
| Total commercial | 1,036,000 | 1,036,000 | 116,000 | 1,137,000 | ||||||||||||
| Retail: | ||||||||||||||||
| Home equity and other | 270,000 | 252,000 | 230,000 | 267,000 | ||||||||||||
| 1-4 family mortgages | 633,000 | 634,000 | 141,000 | 665,000 | ||||||||||||
| Total retail | 903,000 | 886,000 | 371,000 | 932,000 | ||||||||||||
| Total with an allowance recorded | $ | 1,939,000 | $ | 1,922,000 | $ | 487,000 | $ | 2,069,000 | ||||||||
| Total impaired loans: | ||||||||||||||||
| Commercial | $ | 18,523,000 | $ | 18,486,000 | $ | 116,000 | $ | 20,450,000 | ||||||||
| Retail | 6,312,000 | 4,351,000 | 371,000 | 4,445,000 | ||||||||||||
| Total impaired loans | $ | 24,835,000 | $ | 22,837,000 | $ | 487,000 | $ | 24,895,000 | ||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired loans as of December 31, 2020, and average impaired loans for the three months ended March 31, 2020, were as follows:
| First Quarter | ||||||||||||||||
| Unpaid | Average | |||||||||||||||
| Contractual | Recorded | Recorded | ||||||||||||||
| Principal | Principal | Related | Principal | |||||||||||||
| Balance | Balance | Allowance | Balance | |||||||||||||
| With no related allowance recorded: | ||||||||||||||||
| Commercial: | ||||||||||||||||
| Commercial and industrial | $ | 6,242,000 | $ | 6,242,000 | $ | 9,148,000 | ||||||||||
| Vacant land, land development and residential construction | 0 | 0 | 142,000 | |||||||||||||
| Real estate – owner occupied | 14,782,000 | 14,593,000 | 2,762,000 | |||||||||||||
| Real estate – non-owner occupied | 341,000 | 341,000 | 89,000 | |||||||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 7,000 | |||||||||||||
| Total commercial | 21,365,000 | 21,176,000 | 12,148,000 | |||||||||||||
| Retail: | ||||||||||||||||
| Home equity and other | 1,072,000 | 987,000 | 1,241,000 | |||||||||||||
| 1-4 family mortgages | 4,455,000 | 2,575,000 | 2,325,000 | |||||||||||||
| Total retail | 5,527,000 | 3,562,000 | 3,566,000 | |||||||||||||
| Total with no related allowance recorded | $ | 26,892,000 | $ | 24,738,000 | $ | 15,714,000 | ||||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
| First Quarter | ||||||||||||||||
| Unpaid | Average | |||||||||||||||
| Contractual | Recorded | Recorded | ||||||||||||||
| Principal | Principal | Related | Principal | |||||||||||||
| Balance | Balance | Allowance | Balance | |||||||||||||
| With an allowance recorded: | ||||||||||||||||
| Commercial: | ||||||||||||||||
| Commercial and industrial | $ | 343,000 | $ | 343,000 | $ | 53,000 | $ | 1,315,000 | ||||||||
| Vacant land, land development and residential construction | 0 | 0 | 0 | 192,000 | ||||||||||||
| Real estate – owner occupied | 763,000 | 734,000 | 77,000 | 640,000 | ||||||||||||
| Real estate – non-owner occupied | 162,000 | 162,000 | 8,000 | 0 | ||||||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | 0 | ||||||||||||
| Total commercial | 1,268,000 | 1,239,000 | 138,000 | 2,147,000 | ||||||||||||
| Retail: | ||||||||||||||||
| Home equity and other | 300,000 | 283,000 | 241,000 | 440,000 | ||||||||||||
| 1-4 family mortgages | 698,000 | 698,000 | 172,000 | 485,000 | ||||||||||||
| Total retail | 998,000 | 981,000 | 413,000 | 925,000 | ||||||||||||
| Total with an allowance recorded | $ | 2,266,000 | $ | 2,220,000 | $ | 551,000 | $ | 3,072,000 | ||||||||
| Total impaired loans: | ||||||||||||||||
| Commercial | $ | 22,633,000 | $ | 22,415,000 | $ | 138,000 | $ | 14,295,000 | ||||||||
| Retail | 6,525,000 | 4,543,000 | 413,000 | 4,491,000 | ||||||||||||
| Total impaired loans | $ | 29,158,000 | $ | 26,958,000 | $ | 551,000 | $ | 18,786,000 | ||||||||
Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated fair value. Interest income recognized on accruing troubled debt restructurings totaled $0.4 million and $0.3 million during the first quarter of 2021 and 2020, respectively. No interest income was recognized on nonaccrual loans during either the first quarter of 2021 or 2020. Lost interest income on nonaccrual loans totaled less than $0.1 million during the first quarter of 2021 and 2020.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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.
Credit quality indicators were as follows as of March 31, 2021:
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 - Multi-Family and Residential Rental | ||||||||||||||||
| Internal credit risk grade groupings: | ||||||||||||||||||||
| Grades 1 – 4 (1) | $ | 944,884,000 | $ | 22,757,000 | $ | 310,071,000 | $ | 401,697,000 | $ | 91,487,000 | ||||||||||
| Grades 5 – 7 | 331,588,000 | 35,872,000 | 206,249,000 | 530,325,000 | 55,540,000 | |||||||||||||||
| Grades 8 – 9 | 8,035,000 | 109,000 | 28,022,000 | 312,000 | 267,000 | |||||||||||||||
| Total commercial | $ | 1,284,507,000 | $ | 58,738,000 | $ | 544,342,000 | $ | 932,334,000 | $ | 147,294,000 | ||||||||||
Retail credit exposure – credit risk profiled by collateral type:
| Retail | Retail | |||||||
| Home Equity | 1-4 Family | |||||||
| and Other | Mortgages | |||||||
| Performing | 59,136,000 | 335,678,000 | ||||||
| Nonperforming | 175,000 | 2,166,000 | ||||||
| Total retail | $ | 59,311,000 | $ | 337,844,000 | ||||
| (1) | Included in Commercial and Industrial Loans Grades 1 – 4 are $455 million of loans originated under the Paycheck Protection Program. |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Credit quality indicators were as follows as of December 31, 2020:
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 - Multi-Family and Residential Rental | ||||||||||||||||
| Internal credit risk grade groupings: | ||||||||||||||||||||
| Grades 1 – 4 (1) | $ | 828,706,000 | $ | 22,547,000 | $ | 315,134,000 | $ | 396,700,000 | $ | 91,711,000 | ||||||||||
| Grades 5 – 7 | 306,614,000 | 32,398,000 | 185,541,000 | 520,395,000 | 54,111,000 | |||||||||||||||
| Grades 8 – 9 | 10,103,000 | 110,000 | 29,278,000 | 341,000 | 273,000 | |||||||||||||||
| Total commercial | $ | 1,145,423,000 | $ | 55,055,000 | $ | 529,953,000 | $ | 917,436,000 | $ | 146,095,000 | ||||||||||
Retail credit exposure – credit risk profiled by collateral type:
| Retail | Retail | |||||||
| Home Equity | 1-4 Family | |||||||
| and Other | Mortgages | |||||||
| Performing | 61,378,000 | 335,559,000 | ||||||
| Nonperforming | 242,000 | 2,329,000 | ||||||
| Total retail | $ | 61,620,000 | $ | 337,888,000 | ||||
| (1) | Included in Commercial and Industrial Loans Grades 1 – 4 are $365 million of loans originated under the Paycheck Protection Program. |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
| All commercial loans are graded using the following criteria: |
| Grade 1. | “Exceptional” Loans with this rating contain very little, if any, risk. | |
|
| ||
| Grade 2. | “Outstanding” Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements. | |
|
| ||
| Grade 3. | “Very Good” Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are acceptable. | |
|
| ||
| Grade 4. | “Good” Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are modest. | |
|
| ||
| Grade 5. | “Acceptable” Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements. These are for loans for which repayment risks are satisfactory. | |
|
| ||
| Grade 6. | “Monitor” Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report. | |
|
| ||
| Grade 7. | “Special Mention” Loans with this rating have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date. | |
|
| ||
| Grade 8. | “Substandard” Loans with this rate are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any. A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility of loss if the deficiencies are not corrected. | |
|
| ||
| Grade 9. | “Doubtful” Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable. | |
|
| ||
| Grade 10. | “Loss” Loans with this rating are considered uncollectable, and of such little value that continuance as an active 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 creditors’ rights in order to preserve our collateral position. |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2021 are as follows:
| Commercial | Retail | |||||||||||||||
| Loans | Loans | Unallocated | Total | |||||||||||||
| Allowance for loan losses: | ||||||||||||||||
| Beginning balance | $ | 33,779,000 | $ | 4,129,000 | $ | 59,000 | $ | 37,967,000 | ||||||||
| Provision for loan losses | 583,000 | (414,000 | ) | 131,000 | 300,000 | |||||||||||
| Charge-offs | (15,000 | ) | (37,000 | ) | 0 | (52,000 | ) | |||||||||
| Recoveries | 364,000 | 116,000 | 0 | 480,000 | ||||||||||||
| Ending balance | $ | 34,711,000 | $ | 3,794,000 | $ | 190,000 | $ | 38,695,000 | ||||||||
| Ending balance: individually evaluated for impairment | $ | 116,000 | $ | 371,000 | $ | 0 | $ | 487,000 | ||||||||
| Ending balance: collectively evaluated for impairment | $ | 34,595,000 | $ | 3,423,000 | $ | 190,000 | $ | 38,208,000 | ||||||||
| Total loans: (*) | ||||||||||||||||
| Ending balance | $ | 2,512,644,000 | $ | 397,155,000 | $ | 2,909,799,000 | ||||||||||
| Ending balance: individually evaluated for impairment | $ | 18,486,000 | $ | 4,351,000 | $ | 22,837,000 | ||||||||||
| Ending balance: collectively evaluated for impairment | $ | 2,494,158,000 | $ | 392,804,000 | $ | 2,886,962,000 | ||||||||||
(*) Excludes $455 million in loans originated under the Paycheck Protection Program.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity in the allowance for loan losses for loans during the three months ended March 31, 2020 and the recorded investments in loans as of December 31, 2020 are as follows:
| Commercial | Retail | |||||||||||||||
| Loans | Loans | Unallocated | Total | |||||||||||||
| Allowance for loan losses: | ||||||||||||||||
| Beginning balance | $ | 21,070,000 | $ | 2,749,000 | $ | 70,000 | $ | 23,889,000 | ||||||||
| Provision for loan losses | 573,000 | 247,000 | (70,000 | ) | 750,000 | |||||||||||
| Charge-offs | (13,000 | ) | (27,000 | ) | 0 | (40,000 | ) | |||||||||
| Recoveries | 120,000 | 109,000 | 0 | 229,000 | ||||||||||||
| Ending balance | $ | 21,750,000 | $ | 3,078,000 | $ | 0 | $ | 24,828,000 | ||||||||
| Ending balance: individually evaluated for impairment | $ | 1,169,000 | $ | 443,000 | $ | 0 | $ | 1,612,000 | ||||||||
| Ending balance: collectively evaluated for impairment | $ | 20,581,000 | $ | 2,635,000 | $ | 0 | $ | 23,216,000 | ||||||||
| Total loans (*): | ||||||||||||||||
| Ending balance | $ | 2,428,703,000 | $ | 399,508,000 | $ | 2,828,211,000 | ||||||||||
| Ending balance: individually evaluated for impairment | $ | 22,415,000 | $ | 4,543,000 | $ | 26,958,000 | ||||||||||
| Ending balance: collectively evaluated for impairment | $ | 2,406,288,000 | $ | 394,965,000 | $ | 2,801,253,000 | ||||||||||
(*) Excludes $365 million in loans originated under the Paycheck Protection Program.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2021 were as follows:
| Pre- | Post- | |||||||||||
| Modification | Modification | |||||||||||
| Recorded | Recorded | |||||||||||
| Number of | Principal | Principal | ||||||||||
| Contracts | Balance | Balance | ||||||||||
| Commercial: | ||||||||||||
| Commercial and industrial | 1 | $ | 23,000 | $ | 22,000 | |||||||
| Vacant land, land development and residential construction | 0 | 0 | 0 | |||||||||
| Real estate – owner occupied | 0 | 0 | 0 | |||||||||
| Real estate – non-owner occupied | 0 | 0 | 0 | |||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | |||||||||
| Total commercial | 1 | 23,000 | 22,000 | |||||||||
| Retail: | ||||||||||||
| Home equity and other | 1 | 71,000 | 71,000 | |||||||||
| 1-4 family mortgages | 1 | 36,000 | 36,000 | |||||||||
| Total retail | 2 | 107,000 | 107,000 | |||||||||
| Total loans | 3 | $ | 130,000 | $ | 129,000 | |||||||
Loans modified as troubled debt restructurings during the three months ended March 31, 2020 were as follows:
| Pre- | Post- | |||||||||||
| Modification | Modification | |||||||||||
| Recorded | Recorded | |||||||||||
| Number of | Principal | Principal | ||||||||||
| Contracts | Balance | Balance | ||||||||||
| Commercial: | ||||||||||||
| Commercial and industrial | 6 | $ | 6,539,000 | $ | 6,536,000 | |||||||
| Vacant land, land development and residential construction | 0 | 0 | 0 | |||||||||
| Real estate – owner occupied | 8 | 3,661,000 | 4,259,000 | |||||||||
| Real estate – non-owner occupied | 0 | 0 | 0 | |||||||||
| Real estate – multi-family and residential rental | 0 | 0 | 0 | |||||||||
| Total commercial | 14 | 10,200,000 | 10,795,000 | |||||||||
| Retail: | ||||||||||||
| Home equity and other | 3 | 65,000 | 52,000 | |||||||||
| 1-4 family mortgages | 0 | 0 | 0 | |||||||||
| Total retail | 3 | 65,000 | 52,000 | |||||||||
| Total loans | 17 | $ | 10,265,000 | $ | 10,847,000 | |||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2021 (amounts as of period end):
| Recorded | ||||||||
| Number of | Principal | |||||||
| Contracts | Balance | |||||||
| Commercial: | ||||||||
| Commercial and industrial | 2 | $ | 593,000 | |||||
| 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 | 2 | 593,000 | ||||||
| Retail: | ||||||||
| Home equity and other | 0 | 0 | ||||||
| 1-4 family mortgages | 1 | 6,000 | ||||||
| Total retail | 1 | 6,000 | ||||||
| Total | 3 | $ | 599,000 | |||||
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, 2020 (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 | 97,000 | ||||||
| Real estate – non-owner occupied | 0 | 0 | ||||||
| Real estate – multi-family and residential rental | 0 | 0 | ||||||
| Total commercial | 1 | 97,000 | ||||||
| Retail: | ||||||||
| Home equity and other | 0 | 0 | ||||||
| 1-4 family mortgages | 0 | 0 | ||||||
| Total retail | 0 | 0 | ||||||
| Total | 1 | $ | 97,000 | |||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2021 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 | $ | 6,414,000 | $ | 0 | $ | 14,797,000 | $ | 480,000 | $ | 0 | ||||||||||
| Charge-Offs | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Payments | (2,676,000 | ) | 0 | (910,000 | ) | (9,000 | ) | 0 | ||||||||||||
| Transfers to ORE | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Net Additions/Deletions | 22,000 | 0 | 0 | 0 | 0 | |||||||||||||||
| Ending Balance | $ | 3,760,000 | $ | 0 | $ | 13,887,000 | $ | 471,000 | $ | 0 | ||||||||||
| Retail | Retail | |||||||
| Home Equity | 1-4 Family | |||||||
| and Other | Mortgages | |||||||
| Retail Loan Portfolio: | ||||||||
| Beginning Balance | $ | 1,146,000 | $ | 806,000 | ||||
| Charge-Offs | 0 | 0 | ||||||
| Payments | (118,000 | ) | (22,000 | ) | ||||
| Transfers to ORE | 0 | 0 | ||||||
| Net Additions/Deletions | 71,000 | 36,000 | ||||||
| Ending Balance | $ | 1,099,000 | $ | 820,000 | ||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2020 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 | $ | 8,587,000 | $ | 85,000 | $ | 1,145,000 | $ | 178,000 | $ | 7,000 | ||||||||||
| Charge-Offs | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Payments | (2,832,000 | ) | (3,000 | ) | (988,000 | ) | (4,000 | ) | (4,000 | ) | ||||||||||
| Transfers to ORE | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Net Additions/Deletions | 6,449,000 | 0 | 3,654,000 | 0 | 0 | |||||||||||||||
| Ending Balance | $ | 12,204,000 | $ | 82,000 | $ | 3,811,000 | $ | 174,000 | $ | 3,000 | ||||||||||
| Retail | Retail | |||||||
| Home Equity | 1-4 Family | |||||||
| and Other | Mortgages | |||||||
| Retail Loan Portfolio: | ||||||||
| Beginning Balance | $ | 1,415,000 | $ | 724,000 | ||||
| Charge-Offs | 0 | 0 | ||||||
| Payments | (29,000 | ) | (9,000 | ) | ||||
| Transfers to ORE | 0 | 0 | ||||||
| Net Additions/Deletions | 66,000 | 0 | ||||||
| Ending Balance | $ | 1,452,000 | $ | 715,000 | ||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, | |||||||
| 2021 | 2020 | |||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | 382,000 | $ | 53,000 | ||||
| Vacant land, land development, and residential construction | 0 | 0 | ||||||
| Real estate – owner occupied | 308,000 | 59,000 | ||||||
| Real estate – non-owner occupied | 0 | 8,000 | ||||||
| Real estate – multi-family and residential rental | 0 | 0 | ||||||
| Total commercial | 690,000 | 120,000 | ||||||
| Retail: | ||||||||
| Home equity and other | 258,000 | 202,000 | ||||||
| 1-4 family mortgages | 86,000 | 145,000 | ||||||
| Total retail | 344,000 | 347,000 | ||||||
| Total related allowance | $ | 1,034,000 | $ | 467,000 | ||||
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.
4. PREMISES AND EQUIPMENT, NET
Premises and equipment are comprised of the following:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Land and improvements | $ | 14,258,000 | $ | 16,533,000 | ||||
| Buildings | 52,717,000 | 56,114,000 | ||||||
| Furniture and equipment | 21,481,000 | 21,522,000 | ||||||
| 94,169,000 | ||||||||
| Less: accumulated depreciation | 33,068,000 | 35,210,000 | ||||||
| Premises and equipment, net | $ | 55,388,000 | $ | 58,959,000 | ||||
Depreciation expense totaled $1.4 million and $1.3 million during the first quarters of 2021 and 2020, respectively.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. DEPOSITS
Our total deposits at March 31, 2021 totaled $3.64 billion, an increase of $233 million, or 6.8%, from December 31, 2020. The components of our outstanding balances at March 31, 2021 and December 31, 2020, and percentage change in deposits from the end of 2020 to the end of the first quarter of 2021, are as follows:
| Percent | ||||||||||||||||||||
| March 31, 2021 | December 31, 2020 | Increase | ||||||||||||||||||
| Balance | % | Balance | % | (Decrease) | ||||||||||||||||
| Noninterest-bearing checking | $ | 1,605,471,000 | 44.0 | % | $ | 1,433,403,000 | 42.0 | % | 12.0 | % | ||||||||||
| Interest-bearing checking | 494,495,000 | 13.6 | 473,053,000 | 13.9 | 4.5 | |||||||||||||||
| Money market | 673,944,000 | 18.5 | 611,912,000 | 17.9 | 10.1 | |||||||||||||||
| Savings | 371,344,000 | 10.2 | 338,070,000 | 9.9 | 9.8 | |||||||||||||||
| Time, under $100,000 | 151,572,000 | 4.2 | 165,548,000 | 4.9 | (8.4 | ) | ||||||||||||||
| Time, $100,000 and over | 317,223,000 | 8.7 | 342,633,000 | 10.0 | (7.4 | ) | ||||||||||||||
| Total local deposits | 3,614,049,000 | 99.2 | 3,364,619,000 | 98.6 | 7.4 | |||||||||||||||
| Out-of-area time, $100,000 and over | 30,913,000 | 0.8 | 46,934,000 | 1.4 | (34.1 | ) | ||||||||||||||
| Total deposits | $ | 3,644,962,000 | 100.0 | % | $ | 3,411,553,000 | 100.0 | % | 6.8 | % | ||||||||||
Time deposits of more than $250,000 totaled $241 million and $272 million at March 31, 2021 and December 31, 2020, respectively.
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 | Twelve Months Ended | |||||||
| March 31, 2021 | December 31, 2020 | |||||||
| Outstanding balance at end of period | $ | 141,310,000 | $ | 118,365,000 | ||||
| Average interest rate at end of period | 0.11 | % | 0.12 | % | ||||
| Average daily balance during the period | $ | 132,845,000 | $ | 132,880,000 | ||||
| Average interest rate during the period | 0.11 | % | 0.12 | % | ||||
| Maximum daily balance during the period | $ | 169,102,000 | $ | 173,186,000 | ||||
Repurchase agreements generally have original maturities of less than 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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES
Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $394 million at March 31, 2021 and December 31, 2020, and were expected to mature at varying dates from November 2021 through June 2027, with fixed rates of interest from 0.55% to 3.18% and averaging 2.06% as of both dates.
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, 2021 totaled $737 million, with remaining availability based on collateral equaling $373 million.
Maturities of currently outstanding FHLBI advances are as follows:
| 2021 | $ | 20,000,000 | ||
| 2022 | 94,000,000 | |||
| 2023 | 80,000,000 | |||
| 2024 | 80,000,000 | |||
| 2025 | 50,000,000 | |||
| Thereafter | 70,000,000 |
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, 2021 and December 31, 2020.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)
A summary of the contractual amounts of our financial instruments with off-balance sheet risk at March 31, 2021 and December 31, 2020 is as follows:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Commercial unused lines of credit | $ | 1,052,778,000 | $ | 1,019,496,000 | ||||
| Unused lines of credit secured by 1 – 4 family residential properties | 59,986,000 | 59,396,000 | ||||||
| Credit card unused lines of credit | 76,556,000 | 72,495,000 | ||||||
| Other consumer unused lines of credit | 35,207,000 | 30,707,000 | ||||||
| Commitments to make loans | 176,548,000 | 227,558,000 | ||||||
| Standby letters of credit | 25,933,000 | 20,543,000 | ||||||
| $ | 1,427,008,000 | $ | 1,430,195,000 | |||||
9. DERIVATIVES AND HEDGING ACTIVITIES
We are exposed to certain risks arising from both business operations and economic conditions. We principally manage the exposure to a wide variety of operational risks through core business activities. Economic risks, including interest rate, liquidity and credit risk, are primarily administered via the amount, sources and duration of assets and liabilities. Derivative financial instruments may also be used to assist in managing economic risks.
Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers. We execute interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with a correspondent bank to offset the impact of the interest rate swaps with the commercial banking customers. The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent bank are recognized directly to earnings.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. DERIVATIVES AND HEDGING ACTIVITIES (Continued)
The estimated fair values of derivative instruments as of March 31, 2021 are reflected in the following table.
| Notional Amount | Balance Sheet Location | Fair Value | |||||||
| Derivative Assets | |||||||||
| Interest rate swaps | $ | 65,855,000 | Other Assets | $ | 787,000 | ||||
| Derivative Liabilities | |||||||||
| Interest rate swaps | 65,855,000 | Other Liabilities | 810,000 | ||||||
The effect of interest rate swaps that are not designated as hedging instruments resulted in a nominal level noninterest income during the first quarter of 2021.
The estimated fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $0.8 million as of March 31, 2021. Cash collateral totaling $0.7 million was provided to the counterparty correspondent bank as of March 31, 2021.
Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $65.9 million as of March 31, 2021. Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instrument that has been hedged.
The estimated fair values of derivative instruments as of December 31, 2020 are reflected in the following table.
| Notional Amount | Balance Sheet Location | Fair Value | |||||||
| Derivative Assets | |||||||||
| Interest rate swaps | $ | 33,731,000 | Other Assets | $ | 1,003,000 | ||||
| Derivative Liabilities | |||||||||
| Interest rate swaps | 33,731,000 | Other Liabilities | 1,027,000 | ||||||
The effect of interest rate swaps that are not designated as hedging instruments resulted in noninterest expense of less than $0.1 million during the year-ended December 31, 2020.
The estimated fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $1.0 million as of December 31, 2020. Cash collateral totaling $1.1 million was provided to the counterparty correspondent bank as of December 31, 2020.
Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $33.7 million as of December 31, 2020. Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instrument that has been hedged.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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, 2021 and December 31, 2020 (dollars in thousands):
| Level in | March 31, 2021 | December 31, 2020 | |||||||||||||||
| Fair Value | Carrying | Fair | Carrying | Fair | |||||||||||||
| Hierarchy | Values | Values | Values | Values | |||||||||||||
| Financial assets: | |||||||||||||||||
| Cash | Level 1 | $ | 16,853 | $ | 16,853 | $ | 16,953 | $ | 16,953 | ||||||||
| Cash equivalents | Level 2 | 635,491 | 635,491 | 609,053 | 609,053 | ||||||||||||
| Securities available for sale | (1) | 434,257 | 434,257 | 387,347 | 387,347 | ||||||||||||
| FHLBI stock | (2) | 18,002 | 18,002 | 18,002 | 18,002 | ||||||||||||
| Loans, net | Level 3 | 3,325,675 | 3,463,032 | 3,155,503 | 3,294,522 | ||||||||||||
| Mortgage loans held for sale | Level 2 | 40,297 | 41,318 | 22,888 | 24,029 | ||||||||||||
| Mortgage servicing rights | Level 2 | 9,029 | 11,036 | 8,189 | 10,006 | ||||||||||||
| Accrued interest receivable | Level 2 | 11,832 | 11,832 | 10,861 | 10,861 | ||||||||||||
| Financial liabilities: | |||||||||||||||||
| Deposits | Level 2 | 3,644,962 | 3,648,390 | 3,411,553 | 3,397,768 | ||||||||||||
| Repurchase agreements | Level 2 | 141,310 | 141,310 | 118,365 | 118,365 | ||||||||||||
| FHLBI advances | Level 2 | 394,000 | 409,589 | 394,000 | 410,881 | ||||||||||||
| Subordinated debentures | Level 2 | 47,733 | 47,733 | 47,563 | 47,574 | ||||||||||||
| Liabilities held for sale | Level 2 | 17,280 | 18,144 | 0 | 0 | ||||||||||||
| Accrued interest payable | Level 2 | 2,056 | 2,056 | 2,313 | 2,313 | ||||||||||||
| (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 FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount. |
Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. 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. Fair value for loans is based on an exit price model as required by ASU 2016-01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposit accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The fair values of subordinated debentures and FHLBI advances are based on current rates for similar financing. Liabilities held for sale reflects aggregate deposit balances that are included in the pending sale of our Hastings, Michigan branch; fair value reflects the 5.0% sales premium. The fair value of off-balance sheet items is estimated to be nominal.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO 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 conclusions about the assumptions that market participants would use in pricing an asset or liability.
The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities 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, and municipal general obligation and revenue bonds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment. There was no such impairment as of March 31, 2021 or December 31, 2020. We have no Level 1 securities available for sale.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11. FAIR VALUES (Continued)
Derivatives. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves.
Mortgage loans held for sale. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors, 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, 2021 and December 31, 2020, we determined the fair value of our mortgage loans held for sale to be $41.3 million and $24.0 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. The fair values of impaired loans are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.
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. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.
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, 2021 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 | $ | 266,828,000 | $ | 0 | $ | 266,828,000 | $ | 0 | ||||||||
| Mortgage-backed securities | 35,808,000 | 0 | 35,808,000 | 0 | ||||||||||||
| Municipal general obligation bonds | 115,537,000 | 0 | 114,771,000 | 766,000 | ||||||||||||
| Municipal revenue bonds | 15,584,000 | 0 | 15,584,000 | 0 | ||||||||||||
| Other investments | 500,000 | 0 | 500,000 | 0 | ||||||||||||
| Total | $ | 434,257,000 | $ | 0 | $ | 433,491,000 | $ | 766,000 | ||||||||
There were no transfers in or out of Level 1, Level 2 or Level 3 available for sale securities during the first three months of 2021.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11. FAIR VALUES (Continued)
The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2020 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 | $ | 242,141,000 | $ | 0 | $ | 242,141,000 | $ | 0 | ||||||||
| Mortgage-backed securities | 24,890,000 | 0 | 24,890,000 | 0 | ||||||||||||
| Municipal general obligation bonds | 107,824,000 | 0 | 107,058,000 | 766,000 | ||||||||||||
| Municipal revenue bonds | 11,992,000 | 0 | 11,992,000 | 0 | ||||||||||||
| Other investments | 500,000 | 0 | 500,000 | 0 | ||||||||||||
| Total | $ | 387,347,000 | $ | 0 | $ | 386,581,000 | $ | 766,000 | ||||||||
There were no transfers in or out of Level 1, Level 2 or Level 3 available for sale securities during 2020.
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, 2021 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 | $ | 2,425,000 | $ | 0 | $ | 0 | $ | 2,425,000 | ||||||||
| Foreclosed assets | 374,000 | 0 | 0 | 374,000 | ||||||||||||
| Total | $ | 2,799,000 | $ | 0 | $ | 0 | $ | 2,799,000 | ||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11. FAIR VALUES (Continued)
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2020 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 | $ | 2,880,000 | $ | 0 | $ | 0 | $ | 2,880,000 | ||||||||
| Foreclosed assets | 701,000 | 0 | 0 | 701,000 | ||||||||||||
| Total | $ | 3,581,000 | $ | 0 | $ | 0 | $ | 3,581,000 | ||||||||
The carrying values are based on the estimated value of the property or other assets. Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. For real estate dependent loans and foreclosed assets, we generally assign a 15% to 25% discount factor for commercial-related properties, and a 25% to 50% discount factor for residential-related properties. In a vast majority of cases, we assign a 10% discount factor for estimated selling costs.
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.
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, 2021 and December 31, 2020, 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, 2021 that we believe have changed our bank’s categorization.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12. REGULATORY MATTERS (Continued)
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, 2021 | ||||||||||||||||||||||||
| Total capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | $ | 476,462 | 13.5 | % | $ | 282,093 | 8.0 | % | NA | NA | ||||||||||||||
| Bank | 467,325 | 13.3 | 281,968 | 8.0 | 352,460 | 10.0 | % | |||||||||||||||||
| Tier 1 capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | 437,567 | 12.4 | 211,570 | 6.0 | NA | NA | ||||||||||||||||||
| Bank | 428,430 | 12.2 | 211,476 | 6.0 | 281,968 | 8.0 | ||||||||||||||||||
| Common equity tier 1 (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | 391,908 | 11.1 | 158,678 | 4.5 | NA | NA | ||||||||||||||||||
| Bank | 428,430 | 12.2 | 158,607 | 4.5 | 229,099 | 6.5 | ||||||||||||||||||
| Tier 1 capital (to average assets) | ||||||||||||||||||||||||
| Consolidated | 437,567 | 9.7 | 180,944 | 4.0 | NA | NA | ||||||||||||||||||
| Bank | 428,430 | 9.5 | 180,882 | 4.0 | 226,102 | 5.0 | ||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||
| Total capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | $ | 468,113 | 13.8 | % | $ | 271,325 | 8.0 | % | NA | NA | ||||||||||||||
| Bank | 457,203 | 13.5 | 271,196 | 8.0 | 338,995 | 10.0 | % | |||||||||||||||||
| Tier 1 capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | 430,146 | 12.7 | 203,494 | 6.0 | NA | NA | ||||||||||||||||||
| Bank | 419,236 | 12.4 | 203,397 | 6.0 | 271,196 | 8.0 | ||||||||||||||||||
| Common equity tier 1 (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | 384,658 | 11.3 | 152,621 | 4.5 | NA | NA | ||||||||||||||||||
| Bank | 419,236 | 12.4 | 152,548 | 4.5 | 220,347 | 6.5 | ||||||||||||||||||
| Tier 1 capital (to average assets) | ||||||||||||||||||||||||
| Consolidated | 430,146 | 9.8 | 176,053 | 4.0 | NA | NA | ||||||||||||||||||
| Bank | 419,236 | 9.5 | 175,999 | 4.0 | 219,999 | 5.0 | ||||||||||||||||||
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12. REGULATORY MATTERS (Continued)
Our consolidated capital levels as of March 31, 2021 and December 31, 2020 include $45.7 million and $45.5 million, respectively, of trust preferred securities. 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, 2021 and December 31, 2020, all $45.7 million and $45.5 million, respectively, of the trust preferred securities were included in our consolidated Tier 1 capital.
Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of March 31, 2021, our bank met all capital adequacy requirements under the BASEL III capital rules.
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 14, 2021, our Board of Directors declared a cash dividend on our common stock in the amount of $0.29 per share that was paid on March 17, 2021 to shareholders of record as of March 5, 2021. On April 15, 2021, our Board of Directors declared a cash dividend on our common stock in the amount of $0.29 per share that will be paid on June 16, 2021 to shareholders of record as of June 4, 2021.
In May 2019, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. During the first quarter of 2021, we repurchased a total of about 118,000 shares at a total price of $3.5 million, at an average price per share of $29.91. Availability under the repurchase plan totaled $6.3 million as of March 31, 2021. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.
MERCANTILE BANK CORPORATION
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,” “intends,” “is likely,” “plans,” “projects,” “indicates,” “strategy,” “future,” “likely,” “may,” “should,” “will,” 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, adverse changes in interest rates and interest rate relationships; significant declines in the value of commercial real estate; market volatility; 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 the method of determining Libor, or the replacement of Libor with an alternative reference rate; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; risks associated with cyber-attacks on our computer systems; governmental and regulatory policy changes; our participation in the Paycheck Protection Program administered by the Small Business Administration; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, the failure to meet client expectations and other facts; changes in the national and local economies, including the significant disruption to financial market and other economic activity caused by the outbreak and continuance of Covid-19; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2020 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 subsidiary Mercantile Insurance Center, Inc. (“our insurance company”), at March 31, 2021 and December 31, 2020 and the results of operations for the three months ended March 31, 2021 and March 31, 2020. 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
GAAP is complex and requires 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. This 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 in our Form 10-K for the fiscal year ended December 31, 2020 (Commission file number 000-26719). Our critical accounting policies 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.
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. Loans made under the Paycheck Protection Program are fully guaranteed by the Small Business Administration; therefore, such loans do not have an associated allowance.
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 on an individual loan basis. 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.
Financial institutions were not required to comply with the Current Expected Credit Loss (“CECL”) methodology requirements from the enactment date of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for an extension of the required CECL adoption date to January 1, 2022, which is the date we expect to adopt. An economic forecast is a key component of the CECL methodology. As we continue to experience an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments and financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.
MERCANTILE BANK CORPORATION
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.
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.
Securities and Other Financial Instruments: Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value. Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near term prospects of the issuer; and (3) the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Fair values for securities available for sale are obtained from outside sources and applied to individual securities within the portfolio. The difference between the amortized cost and the current fair value of securities is recorded as a valuation adjustment and reported in other comprehensive income.
Mortgage Servicing Rights: Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from servicing each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.
Goodwill: GAAP requires us to determine the fair value of all of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value. In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as goodwill.
Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur.
MERCANTILE BANK CORPORATION
Coronavirus Pandemic
The U.S. economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). While the economic fallout has stabilized somewhat and the adult population in the United States is in the process of being vaccinated, there remains a significant amount of stress and uncertainty across national and global economies. This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances.
The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations. We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income. Additionally, the consequences of the unprecedented economic impact of the Coronavirus Pandemic may produce declining asset quality, reflected by a higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which may necessitate additional provisions for our allowance and reduced net income.
The following section summarizes the primary measures that directly impact us and our customers.
| ● |
Paycheck Protection Program |
The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee paid by the Small Business Administration. The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology. The program ended on August 8, 2020. We originated approximately 2,200 loans aggregating $553 million. As of March 31, 2021, we recorded forgiveness transactions on approximately 1,600 loans aggregating $302 million.
The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in second draw PPP loans (“round 2 PPP loans”). The program is scheduled to end on May 31, 2021. Through March 31, 2021, we originated approximately 1,100 loans aggregating $203 million.
A PPP loan is assigned a risk weight of 0% under the risk-based capital rules of the federal banking agencies.
| ● |
Individual Economic Impact Payments |
The Internal Revenue Service has made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks. In general, and subject to adjusted gross income limitations, qualifying individuals have received payments of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.
| ● |
Troubled Debt Restructuring Relief |
From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. We elected to suspend GAAP principles and regulatory determinations as permitted. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022.
MERCANTILE BANK CORPORATION
| ● |
Current Expected Credit Loss Methodology Delay |
Financial institutions are not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022.
In early April 2020, in response to the early stages of the Coronavirus Pandemic and its pervasive impact across the economy and financial markets, we developed internal programs of loan payment deferments for commercial and retail borrowers. For commercial borrowers, we offered 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments. Under the latter program, borrowers were extended a 12-month single payment note at 0% interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments. The single payment notes receive a loan grade equal to the loan grade of each respective borrowing relationship. Certain of our commercial loan borrowers subsequently requested and received an additional 90-day (three payments) interest only amendment or 90-day (three payments) principal and interest payment deferment. Under the latter program, the amount equal to the three payments was added to the original deferment note which has nine months remaining to maturity; however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.
At the peak of activity in mid-2020, nearly 750 borrowers with loan balances aggregating $719 million were participating in the commercial loan deferment program. As of March 31, 2021, only two borrowers with loan balances aggregating $1.8 million remained in the commercial loan deferment program. For retail borrowers, we offered 90-day (three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan. As of June 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $23.8 million. These payment deferral transactions largely applied to the borrowers’ April, May and June of 2020 loan payments. As of March 31, 2021, only ten borrowers with loan balances aggregating $0.8 million remained in the retail loan payment deferment program.
First Quarter 2021 Financial Overview
We reported net income of $14.2 million, or $0.87 per diluted share, for the first quarter of 2021, compared with net income of $10.7 million, or $0.65 per diluted share, during the first quarter of 2020.
The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.08% of total loans as of March 31, 2021. Accruing loans past due 30 to 89 days remain very low. Gross loan charge-offs totaled $0.1 million during the first quarter of 2021, while recoveries of prior period loan charge-offs totaled $0.5 million, providing for net loan recoveries of $0.4 million, or 0.05% of average total loans on an annualized basis. We continue our collection efforts on charged-off loans and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. Provision expense during the first quarter of 2021 totaled $0.3 million, which combined with net loan recoveries provided for a $0.7 million increase in the balance of the loan loss reserve.
Commercial loans increased $173 million during the first three months of 2021, reflecting the combined net growth of core commercial loans and net activity under the PPP. Core commercial loans increased $83.7 million, or about 14% on an annualized basis, during the first three months of 2021. Commercial and industrial loans increased $49.5 million, non-owner occupied commercial real estate ("CRE") loans grew $14.9 million, owner occupied CRE loans were up $14.4 million, vacant land, land development and residential construction loans increased $3.7 million and multi-family and residential rental property loans grew $1.2 million. As a percent of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 54.7% as of March 31, 2021, compared to 53.9% at December 31, 2020. Origination of second round PPP loans during the first quarter totaled $203 million, while PPP loan forgiveness payments from the Small Business Administration of first round PPP loans totaled $113 million, providing for net increase in PPP loans of $89.6 million.
MERCANTILE BANK CORPORATION
Total deposits increased $233 million during the first three months of 2021, totaling $3.64 billion at March 31, 2021. Local deposits increased $249 million, while out-of-area deposits decreased $16.0 million. Noninterest-bearing deposits increased $172 million during the first three months of 2021, while interest-bearing checking accounts and money market deposit accounts increased $21.4 million and $62.0 million, respectively. The increases in these transactional deposit products largely reflect federal government stimulus, especially the PPP, as well as lower business investing and spending. Savings deposits were up $33.3 million during the first quarter of 2021, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending. Local time deposits declined $39.4 during the first three months of 2021, in large part reflecting the maturity of certain time deposits that were not renewed during the quarter as we did not aggressively seek to renew these time deposits which were opened as part of a special time deposit campaign that primarily ran during the latter half of the first quarter of 2019. The reduction of out-of-area deposits during the first three months of 2021 reflects maturities not replaced as the funds were no longer needed.
Interest-earning balances, primarily consisting of excess funds deposited at the Federal Reserve Bank of Chicago and a correspondent bank, are used to manage daily liquidity needs and interest rate sensitivity. During the first three months of 2021, the average balance of these funds equaled $592 million, or 13.7% of average earning assets, compared to $357 million, or 9.2% of average earning assets, during 2020, and a more typical $115 million, or 3.4% of average earning assets, during 2019. The elevated level during 2020 and into the first quarter of 2021, in large part reflecting increased local deposit balances, has had a significant negative impact on our net interest margin.
Net interest income totaled $29.5 million during the first quarter of 2021, compared to $30.3 million during the same time period in 2020. The decline reflects a lower net interest margin primarily resulting from the Federal Open Market Committee’s (“FOMC”) decision to lower the targeted federal funds rate by a total of 150 basis points at the onset of the Coronavirus Pandemic in early March of 2020 and substantial excess liquidity, which more than offset the positive impact of an increase in average earning assets.
Noninterest income totaled $13.5 million during the first quarter of 2021, up approximately 106% from the first quarter in 2020. The improved level mainly resulted from increased mortgage banking income stemming from a substantial upturn in refinance activity driven by a lower interest rate environment, an increase in home purchase activity and the ongoing success of strategic initiatives that have been implemented to gain market share. Fee income generated from an interest rate swap program that was initiated within our commercial lending function during the fourth quarter of 2020 also contributed to the increased level of noninterest income during the first three months of 2021.
Noninterest expense totaled $25.1 million during the first quarter of 2021, compared to $22.9 million during the same time period in 2020. The increased level of noninterest expense primarily reflects increased employee compensation costs, mainly depicting higher mortgage lender commissions and annual merit employee pay increases, higher employee health insurance costs and a bonus accrual. The higher level of mortgage lending commissions and associated incentives primarily reflects the significant increase in residential mortgage loan originations during the first quarter of 2021, which were up nearly 85% compared to the respective 2020 period. We did not accrue monies for the bonus programs during the first quarter of 2020 due to the onset of the Coronavirus Pandemic. Valuation write-downs of two former branch facilities totaled $0.5 million during the first three months of 2021.
Financial Condition
Our total assets increased $273 million during the first three months of 2021, and totaled $4.71 billion as of March 31, 2021. Total loans increased $171 million, securities available for sale grew $46.9 million and cash and cash equivalents increased $26.3 million. Total deposits increased $233 million and sweep accounts grew $22.9 million during the first three months of 2021.
MERCANTILE BANK CORPORATION
Commercial loans increased $173 million during the first three months of 2021, and at March 31, 2021 totaled $2.97 billion, or 88.2% of the loan portfolio. As of December 31, 2020, the commercial loan portfolio comprised 87.5% of total loans. The increase in commercial loans during the first quarter reflects combined net growth of core commercial loans of $83.7 million and net activity under PPP. Origination of second round PPP loans during the first quarter totaled $203 million, while PPP loan forgiveness payments from the Small Business Administration of first round PPP loans totaled $113 million, providing for a net increase in PPP loans of $89.6 million. Core commercial loans increased $83.7 million, or about 14% on an annualized basis, during the first three months of 2021. Commercial and industrial loans increased $49.5 million, non-owner occupied CRE loans grew $14.9 million, owner occupied CRE loans were up $14.4 million, vacant land, land development and residential construction loans increased $3.7 million and multi-family and residential rental property loans grew $1.2 million. As a percent of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 54.7% as of March 31, 2021, compared to 53.9% at December 31, 2020.
As of March 31, 2021, availability on existing construction and development loans totaled $135 million, with most of those funds expected to be drawn over the next 12 to 18 months. Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including approximately $177 million in new lending commitments, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial lenders also report ongoing additional opportunities they are currently discussing with existing and potentially new borrowers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. Usage of existing commercial lines of credit remained relatively steady during the first quarter of 2021, similar to levels during the last six months of 2020.
Residential mortgage loans decreased less than $0.1 million during the first quarter of 2021, totaling $338 million, or 10.0% of total loans, as of March 31, 2021. Activity within the residential mortgage function was very active, primarily reflecting ongoing significant refinance transactions spurred by low residential mortgage loan interest rates, ongoing strength in home purchase activity, and the continuing success of strategic initiatives that have been implemented over the past several years to gain market share and increase production. Residential mortgage loan originations totaled $245 million during the first three months of 2021, an almost 85% increase over the $133 million originated during the same time period in 2020. Refinance mortgage loans originated comprised about 67% of the total mortgage loans originated during the first quarter of 2021, compared to almost 65% during the first quarter of 2020. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $196 million during the first quarter of 2021, or almost 80% of the total residential mortgage loans originated. Residential mortgage loans originated not sold are generally comprised of adjustable rate residential mortgage loans. We remain pleased with the results of our strategic initiatives associated with the growth of our residential mortgage banking operation over the past few years, and remain optimistic that origination volumes will remain solid in future periods.
Other consumer-related loans declined $2.3 million during the first quarter of 2021, and at March 31, 2021 totaled $59.3 million, or 1.8% of total loans. Other consumer-related loans comprised 1.9% of total loans as of December 31, 2020. We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed origination volumes.
MERCANTILE BANK CORPORATION
The following table summarizes our loan portfolio over the past twelve months:
| 3/31/21 |
12/31/20 |
9/30/20 |
6/30/20 |
3/31/20 |
||||||||||||||||
| Commercial: |
||||||||||||||||||||
| Commercial & Industrial * |
$ | 1,284,507,000 | $ | 1,145,423,000 | $ | 1,321,419,000 | $ | 1,307,455,000 | $ | 873,679,000 | ||||||||||
| Land Development & Construction |
58,738,000 | 55,055,000 | 50,941,000 | 52,984,000 | 62,908,000 | |||||||||||||||
| Owner Occupied Commercial RE |
544,342,000 | 529,953,000 | 549,364,000 | 567,621,000 | 579,229,000 | |||||||||||||||
| Non-Owner Occupied Commercial RE |
932,334,000 | 917,436,000 | 878,897,000 | 841,145,000 | 823,366,000 | |||||||||||||||
| Multi-Family & Residential Rental |
147,294,000 | 146,095,000 | 137,740,000 | 132,047,000 | 133,148,000 | |||||||||||||||
| Total Commercial |
2,967,215,000 | 2,793,962,000 | 2,938,361,000 | 2,901,252,000 | 2,472,330,000 | |||||||||||||||
| Retail: |
||||||||||||||||||||
| 1-4 Family Mortgages |
337,844,000 | 337,888,000 | 348,460,000 | 367,061,000 | 356,338,000 | |||||||||||||||
| Home Equity & Other Consumer Loans |
59,311,000 | 61,620,000 | 63,723,000 | 64,743,000 | 72,875,000 | |||||||||||||||
| Total Retail |
397,155,000 | 399,508,000 | 412,183,000 | 431,804,000 | 429,213,000 | |||||||||||||||
| Total |
$ | 3,364,370,000 | $ | 3,193,470,000 | $ | 3,350,544,000 | $ | 3,333,056,000 | $ | 2,901,543,000 | ||||||||||
(*) Includes $455 million, $365 million, $555 million, and $549 million in loans originated under the Paycheck Protection Program for March 31, 2021, December 31, 2020, September 30, 2020, and June 30, 2020, respectively.
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. We also 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.
Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $3.2 million (0.1% of total assets) as of March 31, 2021, compared to $4.1 million (0.1% of total assets) as of December 31, 2020.
MERCANTILE BANK CORPORATION
The following tables provide a breakdown of nonperforming assets by collateral type:
NONPERFORMING LOANS
| 3/31/21 |
12/31/20 |
9/30/20 |
6/30/20 |
3/31/20 |
||||||||||||||||
| Residential Real Estate: |
||||||||||||||||||||
| Land Development |
$ | 34,000 | $ | 35,000 | $ | 36,000 | $ | 36,000 | $ | 37,000 | ||||||||||
| Construction |
0 | 0 | 198,000 | 198,000 | 283,000 | |||||||||||||||
| Owner Occupied / Rental |
2,294,000 | 2,519,000 | 2,399,000 | 2,552,000 | 2,651,000 | |||||||||||||||
| 2,328,000 | 2,554,000 | 2,633,000 | 2,786,000 | 2,971,000 | ||||||||||||||||
| Commercial Real Estate: |
||||||||||||||||||||
| Land Development |
0 | 0 | 0 | 0 | 43,000 | |||||||||||||||
| Construction |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied |
283,000 | 619,000 | 1,262,000 | 275,000 | 287,000 | |||||||||||||||
| Non-Owner Occupied |
0 | 22,000 | 23,000 | 25,000 | 0 | |||||||||||||||
| 283,000 | 641,000 | 1,285,000 | 300,000 | 330,000 | ||||||||||||||||
| Non-Real Estate: |
||||||||||||||||||||
| Commercial Assets |
169,000 | 172,000 | 198,000 | 98,000 | 156,000 | |||||||||||||||
| Consumer Assets |
13,000 | 17,000 | 25,000 | 28,000 | 12,000 | |||||||||||||||
| 182,000 | 189,000 | 223,000 | 126,000 | 168,000 | ||||||||||||||||
| Total |
$ | 2,793,000 | $ | 3,384,000 | $ | 4,141,000 | $ | 3,212,000 | $ | 3,469,000 | ||||||||||
OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS
| 3/31/21 |
12/31/20 |
9/30/20 |
6/30/20 |
3/31/20 |
||||||||||||||||
| Residential Real Estate: |
||||||||||||||||||||
| Land Development |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
| Construction |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied / Rental |
11,000 | 88,000 | 198,000 | 198,000 | 271,000 | |||||||||||||||
| 11,000 | 88,000 | 198,000 | 198,000 | 271,000 | ||||||||||||||||
| Commercial Real Estate: |
||||||||||||||||||||
| Land Development |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Construction |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied |
363,000 | 613,000 | 314,000 | 0 | 0 | |||||||||||||||
| Non-Owner Occupied |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| 363,000 | 613,000 | 314,000 | 0 | 0 | ||||||||||||||||
| Non-Real Estate: |
||||||||||||||||||||
| Commercial Assets |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Consumer Assets |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| 0 | 0 | 0 | 0 | 0 | ||||||||||||||||
| Total |
$ | 374,000 | $ | 701,000 | $ | 512,000 | $ | 198,000 | $ | 271,000 | ||||||||||
MERCANTILE BANK CORPORATION
The following tables provide a reconciliation of nonperforming assets:
| NONPERFORMING LOANS RECONCILIATION |
| 1st Qtr |
4th Qtr |
3rd Qtr |
2nd Qtr |
1st Qtr |
||||||||||||||||
| 2021 |
2020 |
2020 |
2020 |
2020 |
||||||||||||||||
| Beginning balance |
$ | 3,384,000 | $ | 4,141,000 | $ | 3,212,000 | $ | 3,469,000 | $ | 2,284,000 | ||||||||||
| Additions, net of transfers to ORE |
116,000 | 538,000 | 1,301,000 | 220,000 | 1,302,000 | |||||||||||||||
| Returns to performing status |
(115,000 | ) |
0 | (72,000 | ) |
(26,000 | ) |
(7,000 | ) |
|||||||||||
| Principal payments |
(559,000 | ) |
(1,064,000 | ) |
(249,000 | ) |
(278,000 | ) |
(110,000 | ) |
||||||||||
| Loan charge-offs |
(33,000 | ) |
(231,000 | ) |
(51,000 | ) |
(173,000 | ) |
0 | |||||||||||
| Total |
$ | 2,793,000 | $ | 3,384,000 | $ | 4,141,000 | $ | 3,212,000 | $ | 3,469,000 | ||||||||||
| OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION |
| 1st Qtr |
4th Qtr |
3rd Qtr |
2nd Qtr |
1st Qtr |
||||||||||||||||
| 2021 |
2020 |
2020 |
2020 |
2020 |
||||||||||||||||
| Beginning balance |
$ | 701,000 | $ | 512,000 | $ | 198,000 | $ | 271,000 | $ | 452,000 | ||||||||||
| Additions |
0 | 434,000 | 314,000 | 0 | 11,000 | |||||||||||||||
| Sale proceeds |
(77,000 | ) |
(245,000 | ) |
0 | (49,000 | ) |
(192,000 | ) |
|||||||||||
| Valuation write-downs |
(250,000 | ) |
0 | 0 | (24,000 | ) |
0 | |||||||||||||
| Total |
$ | 374,000 | $ | 701,000 | $ | 512,000 | $ | 198,000 | $ | 271,000 | ||||||||||
During the first quarter of 2021, loan charge-offs totaled $0.1 million while recoveries of prior period loan charge-offs equaled $0.5 million, providing for net loan recoveries of $0.4 million, or an annualized 0.05% of average total loans. We continue our collection efforts on charged-off loans and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. The allowance equaled $38.7 million, or 1.15% of total loans (1.33% of total loans excluding PPP loans), and 1,385% of nonperforming loans as of March 31, 2021.
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.
Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for an extension of the required CECL adoption date to January 1, 2022, which is the date we plan to adopt. An economic forecast is a key component of the CECL methodology. As we continue to experience an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments and financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.
MERCANTILE BANK CORPORATION
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, reserve allocation factors are based on the loan ratings as determined by our standardized grade paradigms and by loan purpose. Our commercial loan portfolio is segregated 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.
We established a Covid-19 reserve allocation factor to address the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio during the second quarter of 2020. The creation of this factor reflected our belief that the traditional nine environmental factors did not sufficiently capture and address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic, which include unprecedented federal government stimulus and interventions, statewide mandatory closures on nonessential businesses and periodic changes to such, and our ability to provide payment deferral programs to commercial and retail borrowers without the interjection of troubled debt restructuring accounting rules. We review a myriad of items assessing this new environmental factor, including virus infection rates, vaccine inoculation trends, economic outlooks, employment data, business closures, foreclosures, payment deferments and government-sponsored stimulus programs.
No changes were made to the environmental factor ratings during the first quarter of 2021.
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 needed adjustments 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, with most weight placed on the time frame from December 31, 2010 through March 31, 2021. We believe this time period represents an appropriate range of economic conditions, and that it provides for an appropriate basis in determining reserve allocation factors given current economic conditions and the general consensus of economic conditions in the near future. We are actively monitoring our loan portfolio and assessing reserve allocation factors in light of the Coronavirus Pandemic and its impact on the U.S. economic environment and our customers in particular.
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, with the most significant external environmental factor being the assessment of the current economic environment and the resulting implications on 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 creditors’ rights in order to preserve our collateral position.
MERCANTILE BANK CORPORATION
As of March 31, 2021, the allowance was comprised of $38.2 million in general reserves relating to non-impaired loans and $0.5 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. There were no specific reserve allocations relating to nonaccrual loans. Troubled debt restructurings totaled $20.0 million at March 31, 2021, consisting of $0.4 million that are on nonaccrual status and $19.6 million that are on accrual status. The latter, while considered and accounted for as impaired loans in accordance with accounting guidelines, are not included in our nonperforming loan totals. Impaired loans with an aggregate carrying value of $0.9 million as of March 31, 2021 had been subject to previous partial charge-offs aggregating $1.0 million. Those partial charge-offs were primarily recorded during the time period of 2010 through 2020, averaging approximately $0.1 million per year. As of March 31, 2021, 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:
| 3/31/21 |
12/31/20 |
9/30/20 |
6/30/20 |
3/31/20 |
||||||||||||||||
| Performing |
$ | 19,606,000 | $ | 23,133,000 | $ | 11,522,000 | $ | 16,018,000 | $ | 17,975,000 | ||||||||||
| Nonperforming |
431,000 | 510,000 | 1,113,000 | 521,000 | 466,000 | |||||||||||||||
| Total |
$ | 20,037,000 | $ | 23,643,000 | $ | 12,635,000 | $ | 16,539,000 | $ | 18,441,000 | ||||||||||
Although we believe the allowance is adequate to absorb loan losses in our originated loan portfolio as they arise, there can be no assurance, especially given the current uncertainties related to the Coronavirus Pandemic and its impact on the U.S. economic environment, 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 available for sale increased $46.9 million during the first three months of 2021, totaling $434 million as of March 31, 2021. Purchases of U.S. Government agency bonds totaled $58.9 million during the first quarter of 2021, in part reflecting the reinvestment of the proceeds from called U.S. Government agency bonds that totaled $27.4 million during the quarter. Purchases of U.S. Government agency guaranteed mortgage-backed securities totaled $14.4 million during the first three months of 2021, primarily reflecting investments in CRA-qualified securities and to a lesser degree the reinvestment of $3.0 million from principal paydowns on U.S. Government agency guaranteed mortgage-backed securities. Purchases of municipal bonds totaled $14.1 million during the first quarter of 2021; proceeds from matured municipal bonds totaled $0.6 million. At March 31, 2021, the portfolio was primarily comprised of U.S. Government agency bonds (62%), municipal bonds (30%) and U.S. Government agency guaranteed mortgage-backed securities (8%). All of our securities 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, 2021 totaled $434 million, including a net unrealized loss of $2.2 million. 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. We expect purchases during the remainder of 2021 to generally consist of U.S. Government agency bonds and municipal bonds, with the securities portfolio maintained at about 10% of total assets.
FHLBI stock totaled $18.0 million as of March 31, 2021, unchanged from the balance at December 31, 2020. Our investment in FHLBI stock is necessary to engage in their advance and other financing programs. We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.
Market values on our U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies and municipal bonds are generally determined on a monthly basis with the assistance of a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes and issuer spreads. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.
MERCANTILE BANK CORPORATION
Interest-earning balances, primarily consisting of excess funds deposited at the Federal Reserve Bank of Chicago and a correspondent bank, are used to manage daily liquidity needs and interest rate sensitivity. During the first three months of 2021, the average balance of these funds equaled $592 million, or 13.7% of average earning assets, compared to $357 million, or 9.2% of average earning assets, during 2020, and a more typical $115 million, or 3.4% of average earning assets, during 2019. The elevated level during 2020 and into the first quarter of 2021 reflects increased local deposit balances, primarily a product of federal government stimulus programs as well as lower business and individual investing and spending. We anticipate the level of interest-earning deposit balances to remain elevated throughout 2021 given the conditions associated with the Coronavirus Pandemic.
Net premises and equipment equaled $55.4 million at March 31, 2021, representing a decrease of $3.6 million during the first three months of 2021. The decline was primarily attributable to the transfer of $3.5 million associated with two branch locations from net premises and equipment to assets held for sale, combined with depreciation expense of $1.4 million. Leasehold improvements and equipment purchases during the first quarter of 2021 aggregated $1.3 million. Foreclosed and repossessed assets equaled $0.4 million as of March 31, 2021, down $0.3 million from year-end 2020.
Total deposits increased $233 million during the first three months of 2021, totaling $3.64 billion at March 31, 2021. Local deposits increased $249 million, while out-of-area deposits decreased $16.0 million during the first three months of 2021. As a percent of total deposits, out-of-area deposits equaled 0.8% as of March 31, 2021, compared to 1.4% as of December 31, 2020.
Noninterest-bearing deposits increased $172 million during the first three months of 2021, while interest-bearing checking accounts and money market deposit accounts increased $21.4 million and $62.0 million, respectively. The increases in these transactional deposit products largely reflect federal government stimulus, especially the PPP, as well as lower business investing and spending. Savings deposits were up $33.3 million during the first quarter of 2021, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending. Local time deposits declined $39.4 during the first three months of 2021, in large part reflecting the maturity of certain time deposits that were not renewed during the quarter as we did not aggressively seek to renew these time deposits which were opened as part of a special time deposit campaign that primarily ran during the latter half of the first quarter of 2019. The reduction of out-of-area deposits during the first three months of 2021 reflects maturities not replaced as the funds were no longer needed.
Sweep accounts increased $22.9 million during the first three months of 2021, totaling $141 million as of March 31, 2021. The aggregate balance of this funding type is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances maintained by many of the customers. The average balance of sweep accounts equaled $133 million during the first quarter of 2021, with a high balance of $169 million and a low balance of $113 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings.
FHLBI advances aggregated $394 million as of March 31, 2021, unchanged from the year-end 2020 balance. 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, 2021 totaled $737 million, with remaining availability based on collateral equaling $373 million.
Shareholders’ equity was $441 million at March 31, 2021, compared to $442 million at December 31, 2020. Shareholders’ equity was positively impacted by first quarter net income of $14.2 million, which was offset by the $4.6 million payment of a cash dividend, stock repurchases aggregating $3.5 million, and a $7.2 million after-tax decline in the market value of our available for sales securities portfolio. The latter reflects the impact of increasing interest rates during the first three months of 2021.
MERCANTILE BANK CORPORATION
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-earning deposits. 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 periodically obtain monies from wholesale funding sources. Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $425 million, or 10.1% of combined deposits and borrowed funds, as of March 31, 2021, compared to $441 million, or 11.2% of combined deposits and borrowed funds, as of December 31, 2020.
Sweep accounts increased $22.9 million during the first three months of 2021, totaling $141 million as of March 31, 2021. The aggregate balance of this funding type is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances maintained by many of the customers. The average balance of sweep accounts equaled $133 million during the first quarter of 2021, with a high balance of $169 million and a low balance of $113 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings. Information regarding our repurchase agreements as of March 31, 2021 and during the first three months of 2021 is as follows:
| Outstanding balance at March 31, 2021 |
$ | 141,310,000 | ||
| Weighted average interest rate at March 31, 2021 |
0.11 | % |
||
| Maximum daily balance three months ended March 31, 2021 |
$ | 169,102,000 | ||
| Average daily balance for three months ended March 31, 2021 |
$ | 132,845,000 | ||
| Weighted average interest rate for three months ended March 31, 2021 |
0.11 | % |
FHLBI advances aggregated $394 million as of March 31, 2021, unchanged from the year-end 2020 balance. 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, 2021 totaled $737 million, with remaining availability based on collateral equaling $373 million.
We also have the ability to borrow up to an aggregate $70.0 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 the first three months of 2021. In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago and a correspondent bank averaged an aggregate $587 million during the first three months of 2021. We also have a line of credit through the Discount Window of the Federal Reserve Bank of Chicago. Using certain municipal bonds as collateral, we could have borrowed up to $35.2 million as of March 31, 2021. We did not utilize this line of credit during the first three months of 2021 or at any time during the previous twelve fiscal years, and do not plan to access this line of credit in future periods.
MERCANTILE BANK CORPORATION
The following table reflects, as of March 31, 2021, 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 |
$ | 3,145,254,000 | $ | 0 | $ | 0 | $ | 0 | $ | 3,145,254,000 | ||||||||||
| Time deposits |
303,175,000 | 166,642,000 | 29,891,000 | 0 | 499,708,000 | |||||||||||||||
| Short-term borrowings |
141,310,000 | 0 | 0 | 0 | 141,310,000 | |||||||||||||||
| Federal Home Loan Bank advances |
40,000,000 | 174,000,000 | 120,000,000 | 60,000,000 | 394,000,000 | |||||||||||||||
| Subordinated debentures |
0 | 0 | 0 | 47,733,000 | 47,733,000 | |||||||||||||||
| Other borrowed money |
0 | 0 | 0 | 1,629,000 | 1,629,000 | |||||||||||||||
| Property leases |
634,000 | 1,272,000 | 373,000 | 1,182,000 | 3,461,000 | |||||||||||||||
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, 2021, we had a total of $1.40 billion in unfunded loan commitments and $25.9 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.22 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $177 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months. 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 $441 million at March 31, 2021, compared to $442 million at December 31, 2020. Shareholders’ equity was positively impacted by first quarter net income of $14.2 million, which was offset by the $4.6 million payment of a cash dividend, stock repurchases aggregating $3.5 million, and a $7.2 million after-tax decline in the market value of our available for sales securities portfolio. The latter reflects the impact of increasing interest rates during the first three months of 2021.
As part of a $20 million common stock repurchase program announced in May of 2019, we repurchased approximately 118,000 shares for $3.5 million, at a weighted average all-in cost per share of $29.91, during the first quarter of 2021. Since the beginning of the common stock repurchase program through March 31, 2021, we had repurchased approximately 469,000 shares for $13.7 million, at a weighted average all-in cost of $29.24. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made during in future periods under the authorized plan, which would also likely be funded from cash dividends paid to us from our bank.
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. Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of March 31, 2021, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.
MERCANTILE BANK CORPORATION
As of March 31, 2021, our bank’s total risk-based capital ratio was 13.3%, compared to 13.5% at December 31, 2020. Our bank’s total regulatory capital increased $10.1 million during the first three months of 2021, in large part reflecting the net impact of net income totaling $15.5 million and cash dividends paid to us aggregating $6.5 million. Our bank’s total risk-based capital ratio was also impacted by a $135 million increase in total risk-weighted assets, primarily resulting from net growth in commercial loans and the securities portfolio. As of March 31, 2021, our bank’s total regulatory capital equaled $467 million, or $115 million in excess of the 10.0% minimum that is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of March 31, 2021 and December 31, 2020 are disclosed in Note 12 of the Notes to Consolidated Financial Statements.
Results of Operations
We recorded net income of $14.2 million, or $0.87 per basic and diluted share, for the first quarter of 2021, compared to net income of $10.7 million, or $0.65 per basic and diluted share, for the first quarter of 2020. The improved level of net income primarily resulted from increased noninterest income, which more than offset decreased net interest income and higher noninterest expense. The increased noninterest income primarily reflected higher mortgage banking income. The decline in net interest income depicted a lower yield on earning assets, which more than offset growth in earning assets, while the higher level of noninterest expense mainly resulted from increased compensation costs.
Interest income during the first quarter of 2021 was $34.8 million, a decrease of $3.1 million, or 8.3%, from the $37.9 million earned during the first quarter of 2020. The decrease resulted from a lower yield on average earning assets, which more than offset the impact of growth in average earning assets. The yield on average earning assets was 3.26% during the first quarter of 2021, compared to 4.54% during the prior-year first quarter. The decreased yield primarily resulted from a lower yield on loans, which declined from 4.69% during the first quarter of 2020 to 4.03% during the current-year first quarter. The decrease in loan yield was mainly due to a lower yield on commercial loans, which equaled 4.07% in the first quarter of 2021 compared to 4.76% in the prior-year first quarter. The lower yield primarily reflected reduced interest rates on variable-rate commercial loans resulting from the FOMC significantly decreasing the targeted federal funds rate by a total of 150 basis points in March of 2020.
A change in earning asset mix and decreased yields on securities and interest-earning deposits also contributed to the lower yield on average earning assets in the current-year first quarter compared to the respective 2020 period. On average, lower-yielding interest-earning deposits represented 13.7% of earning assets during the first quarter of 2021, up from 4.6% during the first quarter of 2020, while higher-yielding loans represented 76.6% of earning assets during the current-year first quarter, down from 85.2% during the prior-year first quarter. A significant volume of excess on-balance sheet liquidity, which initially surfaced in the second quarter of 2020 as a result of the Covid-19 environment and persisted during the remainder of 2020 and the first three months of 2021, negatively impacted the yield on average earning assets by 44 basis points during the first quarter of 2021. The excess funds, consisting primarily of low-yielding deposits with the Federal Reserve Bank of Chicago, are mainly a product of federal government stimulus programs as well as lower business and consumer spending and investing. The yield on securities was 1.61% during the first three months of 2021, down from 4.73% during the respective 2020 period mainly due to decreased accelerated discount accretion on called U.S. Government agency bonds and lower yields on newly-purchased bonds, reflecting the declining interest rate environment. Accelerated discount accretion totaled less than $0.1 million during the first quarter of 2021, compared to $1.8 million during the prior-year first quarter. As part of our interest rate risk management program, U.S. Government agency bonds are periodically purchased at discounts during rising interest rate environments; if these bonds are called during decreasing interest rate environments, the remaining unaccreted discount amounts are immediately recognized as interest income. The yield on interest-earning deposits was 0.11% during the first quarter of 2021, down from 1.22% during the first quarter of 2020, primarily reflecting the decreased interest rate environment. Average earning assets equaled $4.33 billion during the current-year first quarter, up $970 million, or 28.9%, from the level of $3.36 billion during the respective 2020 period; average loans were up $457 million, average interest-earning deposits were up $438 million, and average securities were up $74.6 million.
MERCANTILE BANK CORPORATION
Interest expense during the first quarter of 2021 was $5.3 million, a decrease of $2.3 million, or 31.0%, from the $7.6 million expensed during the first quarter of 2020. The decrease in interest expense is attributable to a lower weighted average cost of interest-bearing liabilities, which equaled 0.82% in the current-year first quarter compared to 1.36% in the prior-year first quarter. The decrease in the weighted average cost of interest-bearing liabilities mainly reflected lower costs of deposit accounts and borrowed funds. The cost of interest-bearing non-time deposit accounts decreased from 0.46% during the first quarter of 2020 to 0.21% during the first quarter of 2021, primarily reflecting lower interest rates paid on money market accounts; the reduced interest rates mainly reflect the decreasing interest rate environment. The cost of time deposits declined from 2.21% during the first quarter of 2020 to 1.49% during the current-year first quarter due to lower interest rates paid on local time deposits, reflecting the decreasing interest rate environment, and a change in composition, primarily reflecting a decrease in higher-cost brokered funds. The cost of borrowed funds decreased from 2.31% during the first quarter of 2020 to 1.78% during the first quarter of 2021, mainly reflecting lower costs of FHLBI advances and subordinated debentures. The cost of FHLBI advances was 2.06% during the first quarter of 2021, down from 2.40% during the prior-year first quarter, primarily reflecting the declining interest rate environment and the impact of a blend and extend transaction that was executed in June 2020 with the FHLBI to extend the duration of our advance portfolio as part of our interest rate risk management program. The cost of subordinated debentures was 3.85% during the first quarter of 2021, down from 5.90% during the respective 2020 period due to decreases in the 90-Day Libor Rate. A change in funding mix, consisting of an increase in average lower-cost interest-bearing non-time deposits and a decrease in average higher-cost time deposits as a percentage of average total interest-bearing liabilities, also contributed to the lower weighted average cost of interest-bearing liabilities during the first quarter of 2021 compared to the prior-year first quarter. Average interest-bearing liabilities were $2.60 billion during the first quarter of 2021, up $362 million, or 16.1%, from the $2.24 billion average during the first quarter of 2020.
Net interest income during the first quarter of 2021 was $29.5 million, a decrease of $0.8 million, or 2.6%, from the $30.3 million earned during the respective 2020 period. The decline in net interest income resulted from a decreased net interest margin, which more than offset the positive impact of an increase in average earning assets. The net interest margin decreased from 3.63% in the first quarter of 2020 to 2.77% in the current-year first quarter due to a lower yield on average earning assets, which more than offset a reduction in the cost of funds. The decreased yield on average earning assets primarily reflected lower interest rates on variable-rate commercial loans stemming from the aforementioned FOMC rate cuts, while the decreased cost of funds mainly reflected lower rates paid on local deposit accounts and borrowed funds, along with the previously mentioned change in funding mix.
The decrease in the net interest margin from 3.00% in the fourth quarter of 2020 to 2.77% in the first quarter of 2021 reflected a lower yield on average earning assets, which more than offset a decline in the cost of funds. The yield on average earning assets was 3.26% during the first quarter of 2021, down from 3.55% during the fourth quarter of 2020, mainly due to a decreased yield on commercial loans, which equaled 4.07% and 4.41% in the respective periods. The decreased yield on commercial loans primarily reflected reduced PPP net loan fee accretion stemming from a lower level of forgiveness activity. Net PPP loan fee accretion totaled $2.8 million in the first quarter of 2021, compared to $5.4 million during the fourth quarter of 2020. The cost of funds declined from 0.55% during the fourth quarter of 2020 to 0.49% during the first quarter of 2021, mainly due to lower rates paid on renewed time deposits, reflecting the declining interest rate environment, and a change in funding mix, consisting of an increase in lower-costing non-time deposits as a percentage of total funding sources.
MERCANTILE BANK CORPORATION
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 quarters of 2021 and 2020. 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 for the first quarters of 2021 and 2020 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%. Securities interest income was increased by $60,000 in the first quarter of both 2021 and 2020 for this non-GAAP, but industry standard, adjustment. This adjustment equated to a one basis point increase in our net interest margin during both the first quarter of 2021 and the respective 2020 period.
| Quarters ended March 31, |
||||||||||||||||||||||||
| 2 0 2 1 |
2 0 2 0 |
|||||||||||||||||||||||
| Average |
Average |
Average |
Average |
|||||||||||||||||||||
| Balance |
Interest |
Rate |
Balance |
Interest |
Rate |
|||||||||||||||||||
| (dollars in thousands) |
||||||||||||||||||||||||
| ASSETS |
||||||||||||||||||||||||
| Loans |
$ | 3,318,281 | $ | 32,985 | 4.03 | % |
$ | 2,861,047 | $ | 33,442 | 4.69 | % |
||||||||||||
| Investment securities |
419,514 | 1,692 | 1.61 | 344,906 | 4,077 | 4.73 | ||||||||||||||||||
| Other interest-earning assets |
591,617 | 168 | 0.11 | 153,638 | 475 | 1.22 | ||||||||||||||||||
| Total interest - earning assets |
4,329,412 | 34,845 | 3.26 | 3,359,591 | 37,994 | 4.54 | ||||||||||||||||||
| Allowance for loan losses |
(38,467 | ) |
(23,710 | ) |
||||||||||||||||||||
| Other assets |
287,942 | 266,903 | ||||||||||||||||||||||
| Total assets |
$ | 4,578,887 | $ | 3,602,784 | ||||||||||||||||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||||||||||||||||||
| Interest-bearing deposits |
$ | 2,026,896 | $ | 2,717 | 0.54 | % |
$ | 1,724,030 | $ | 4,641 | 1.08 | % |
||||||||||||
| Short-term borrowings |
132,845 | 36 | 0.11 | 102,850 | 40 | 0.15 | ||||||||||||||||||
| Federal Home Loan Bank advances |
394,000 | 2,027 | 2.06 | 365,429 | 2,212 | 2.40 | ||||||||||||||||||
| Other borrowings |
49,801 | 472 | 3.79 | 49,682 | 724 | 5.77 | ||||||||||||||||||
| Total interest-bearing liabilities |
2,603,542 | 5,252 | 0.82 | 2,241,991 | 7,617 | 1.36 | ||||||||||||||||||
| Noninterest-bearing deposits |
1,510,334 | 923,827 | ||||||||||||||||||||||
| Other liabilities |
21,463 | 17,355 | ||||||||||||||||||||||
| Shareholders’ equity |
443,548 | 419,611 | ||||||||||||||||||||||
| Total liabilities and shareholders’ equity |
$ | 4,578,887 | $ | 3,602,784 | ||||||||||||||||||||
| Net interest income |
$ | 29,593 | $ | 30,377 | ||||||||||||||||||||
| Net interest rate spread |
2.44 | % |
3.18 | % |
||||||||||||||||||||
| Net interest spread on average assets |
2.62 | % |
3.38 | % |
||||||||||||||||||||
| Net interest margin on earning assets |
2.77 | % |
3.63 | % |
||||||||||||||||||||
MERCANTILE BANK CORPORATION
A loan loss provision expense of $0.3 million was recorded during the first quarter of 2021, compared to $0.8 million during the first quarter of 2020. The provision expense recorded during both periods primarily reflected net loan growth. The recording of net loan recoveries in both periods reduced the required provision amounts. During the first quarter of 2021, loan charge-offs totaled $0.1 million, while recoveries of prior period loan charge-offs equaled $0.5 million, providing for net loan recoveries of $0.4 million, or an annualized 0.05% of average total loans. During the first quarter of 2020, loan charge-offs totaled less than $0.1 million, while recoveries of prior period loan charge-offs equaled $0.2 million, providing for net loan recoveries of $0.2 million, or an annualized 0.03% of average total loans. The allowance for loans, as a percentage of total loans, was 1.2% as of March 31, 2021, and December 31, 2020, and 0.9% as of March 31, 2020. Excluding PPP loans, the allowance for loans represented 1.3% of total loans as of March 31, 2021, and December 31, 2020.
Noninterest income during the first quarter of 2021 was $13.5 million, an increase of $6.9 million, or approximately 106%, from the prior-year first quarter. The improved level of noninterest income primarily resulted from increased mortgage banking income, reflecting a significant increase in refinance activity driven by a decrease in residential mortgage loan interest rates, a higher level of purchase activity, the continuing success of strategic initiatives that were implemented to increase market share, including new lender hires and loan production office openings, an increase in the percentage of originated loans being sold, and a higher gain on sale margin influenced by market dynamics. Mortgage banking income totaled $8.8 million during the first quarter of 2021, representing an increase of $6.2 million, or nearly 235%, from the $2.6 million earned during the respective 2020 period. We originated $245 million in residential mortgage loans during the first three months of 2021, which was approximately 85% higher than originations during the first three months of 2020. Refinance transactions totaled $164 million during the first quarter of 2021, compared to $86.3 million during the respective 2020 period, representing an increase of $77.4 million, or approximately 90%. Purchase transactions totaled $81.5 million during the first three months of 2021, compared to $46.5 million during the first three months of 2020, representing an increase of $35.0 million, or approximately 75%. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $196 million, or approximately 80% of total mortgage loans originated, during the first quarter of 2021. During the prior-year first quarter, residential mortgage loans originated for sale totaled $95.3 million, or nearly 72% of total mortgage loans originated. Fee income generated from an interest rate swap program that was implemented during the fourth quarter of 2020 and growth in credit and debit card income also contributed to the increased level of noninterest income. The interest rate swap program provides certain commercial borrowers with a longer-term fixed-rate option and assists us in managing associated longer-term interest rate risk. Increased customer deposit account balances, in large part reflecting federal government stimulus programs and reduced business and consumer investing and spending and resulting in a higher level of account fees being waived, have continued to negatively impact service charges on accounts, which were down 5.5% in the first quarter of 2021 compared to the prior-year first quarter. Payroll processing fees declined 3.5% during the first three months of 2021 compared to the respective 2020 period, mainly reflecting decreased transaction volume stemming from the Coronavirus Pandemic-related increase in the unemployment rate.
Noninterest expense totaled $25.1 million during the first quarter of 2021, compared to $22.9 million during the first quarter of 2020. Overhead costs during the first three months of 2021 included write-downs of former branch facilities totaling $0.5 million. Excluding these transactions, noninterest expense increased $1.6 million, or 7.1%, during the first quarter of 2021 compared to the respective 2020 period. The higher level of expense primarily resulted from increased compensation costs, mainly depicting higher residential mortgage lender commissions and related incentives, annual employee merit pay increases, increased health insurance costs, and a bonus accrual. The higher level of commissions and associated incentives primarily reflected the significant increase in residential mortgage loan originations during the first quarter of 2021, which were up nearly 85% compared to the respective 2020 period. No bonus accrual was recorded during the first quarter of 2020 due to the Coronavirus Pandemic and associated weakened economic environment. An increase in Federal Deposit Insurance Corporation deposit insurance premiums from $0.2 million during the first quarter of 2020 to $0.4 million during current-year first quarter, mainly reflecting the impacts of a higher assessment rate and base, also contributed to the increased level of noninterest expense.
During the first quarter of 2021, we recorded income before federal income tax of $17.6 million and a federal income tax expense of $3.3 million. During the first quarter of 2020, we recorded income before federal income tax of $13.2 million and a federal income tax expense of $2.5 million. The increase in federal income tax expense during the first quarter of 2021 compared to the prior-year first quarter resulted from the higher level of income before federal income tax. Our effective tax rate was 19.0% during both the first three months of 2021 and the respective 2020 period.
MERCANTILE BANK CORPORATION
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.
MERCANTILE BANK CORPORATION
The following table depicts our GAP position as of March 31, 2021:
| Within |
Three to |
One to |
After |
|||||||||||||||||
| Three |
Twelve |
Five |
Five |
|||||||||||||||||
| Months |
Months |
Years |
Years |
Total |
||||||||||||||||
| Assets: |
||||||||||||||||||||
| Commercial loans (1) |
$ | 524,933,000 | $ | 224,561,000 | $ | 1,742,353,000 | $ | 484,106,000 | $ | 2,975,953,000 | ||||||||||
| Residential real estate loans |
6,415,000 | 18,080,000 | 144,419,000 | 204,053,000 | 372,967,000 | |||||||||||||||
| Consumer loans |
900,000 | 893,000 | 12,944,000 | 713,000 | 15,450,000 | |||||||||||||||
| Securities (2) |
23,051,000 | 2,806,000 | 127,280,000 | 299,122,000 | 452,259,000 | |||||||||||||||
| Other interest-earning assets |
594,105,000 | 1,000,000 | 1,750,000 | 0 | 596,855,000 | |||||||||||||||
| Allowance for loan losses |
0 | 0 | 0 | 0 | (38,695,000 | ) |
||||||||||||||
| Other assets |
0 | 0 | 0 | 0 | 335,565,000 | |||||||||||||||
| Total assets |
1,149,404,000 | 247,340,000 | 2,028,746,000 | 987,994,000 | $ | 4,710,354,000 | ||||||||||||||
| Liabilities: |
||||||||||||||||||||
| Interest-bearing checking |
494,495,000 | 0 | 0 | 0 | 494,495,000 | |||||||||||||||
| Savings deposits |
371,344,000 | 0 | 0 | 0 | 371,344,000 | |||||||||||||||
| Money market accounts |
673,944,000 | 0 | 0 | 0 | 673,944,000 | |||||||||||||||
| Time deposits under $100,000 |
25,959,000 | 54,664,000 | 70,949,000 | 0 | 151,572,000 | |||||||||||||||
| Time deposits $100,000 & over |
84,619,000 | 137,933,000 | 125,584,000 | 0 | 348,136,000 | |||||||||||||||
| Short-term borrowings |
141,310,000 | 0 | 0 | 0 | 141,310,000 | |||||||||||||||
| Federal Home Loan Bank advances |
0 | 40,000,000 | 294,000,000 | 60,000,000 | 394,000,000 | |||||||||||||||
| Other borrowed money |
49,362,000 | 0 | 0 | 0 | 49,362,000 | |||||||||||||||
| Noninterest-bearing checking |
0 | 0 | 0 | 0 | 1,605,471,000 | |||||||||||||||
| Other liabilities |
0 | 0 | 0 | 0 | 39,477,000 | |||||||||||||||
| Total liabilities |
1,841,033,000 | 232,597,000 | 490,533,000 | 60,000,000 | 4,269,111,000 | |||||||||||||||
| Shareholders' equity |
0 | 0 | 0 | 0 | 441,243,000 | |||||||||||||||
| Total liabilities & shareholders' equity |
1,841,033,000 | 232,597,000 | 490,533,000 | 60,000,000 | $ | 4,710,354,000 | ||||||||||||||
| Net asset (liability) GAP |
$ | (691,629,000 | ) |
$ | 14,743,000 | $ | 1,538,213,000 | $ | 927,994,000 | |||||||||||
| Cumulative GAP |
$ | (691,629,000 | ) |
$ | (676,886,000 | ) |
$ | 861,327,000 | $ | 1,789,321,000 | ||||||||||
| Percent of cumulative GAP to total assets |
(14.7 | %) | (14.4 | %) | 18.3 | % |
38.0 | % |
||||||||||||
| (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, 2021. |
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.
MERCANTILE BANK CORPORATION
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, 2021, in which it was assumed that changes in market interest rates occurred ranging from up 400 basis points to down 100 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $123 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of March 31, 2021. The resulting estimates are generally 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 100 basis points |
$ | (500,000 | ) |
(0.4 | %) |
|||
| Interest rates up 100 basis points |
6,100,000 | 4.9 | ||||||
| Interest rates up 200 basis points |
11,100,000 | 9.0 | ||||||
| Interest rates up 300 basis points |
16,000,000 | 13.0 | ||||||
| Interest rates up 400 basis points |
25,800,000 | 20.9 | ||||||
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, which comprise a sizable portion of our balance sheet.
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, 2021, 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, 2021.
There have been no changes in our internal control over financial reporting during the quarter ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
MERCANTILE BANK CORPORATION
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.
Changes in the method of determining Libor, or the replacement of Libor with an alternative reference rate, may adversely affect interest income or expense.
Many of the commercial loans we make bear interest at a floating rate based on Libor, the London inter-bank offered rate. We pay interest on certain subordinated notes related to our trust preferred securities at rates based on Libor.
On July 27, 2017, the United Kingdom Financial Conduct Authority (“FCA”), which oversees Libor, formally announced that it could not assure the continued existence of Libor in its current form beyond the end of 2021, and that an orderly transition process to one or more alternative benchmarks should begin. In June 2017, the Alternative Reference Rates Committee (“ARRC”), a steering committee comprised of large U.S. financial institutions organized by the Federal Reserve, announced that it had selected a modified version of the unpublished Broad Treasuries Financing Rate as the preferred alternative reference rate for U.S. dollar obligations. That rate, now referred to as the Secured Overnight Funding Rate (“SOFR”), is determined based upon actual transactions in certain portions of the bi-lateral and tri-party overnight repurchase agreement markets for certain U.S. Treasury obligations. The Federal Reserve Bank of New York (“FRBNY”) began publication of the SOFR in April 2018.
In May 2018, the Chicago Mercantile Exchange began trading SOFR futures contracts. The existence of a futures market may permit the development of a SOFR yield curve. In July 2018, the Federal National Mortgage Association (“FNMA”) issued bonds using SOFR (an overnight rate) as a pricing mechanism. This was possible because of an unusual bond structure, in which interest was payable quarterly, but the interest reset period was daily. By the end of 2020, each of FNMA and the Federal Home Loan Mortgage Corporation (“FHLMC”) had issued more than $125 billion in SOFR-indexed debt instruments in the capital markets.
In January 2019, the ICE Benchmark Administration, the current provider of Libor, proposed for comment to market participants a U.S. Dollar ICE Bank Yield Index. This index would be based on two types of U.S. dollar-denominated transaction data: primary market wholesale, unsecured funding transactions for large, internationally active banks; and secondary market transactions in wholesale, unsecured bonds issued by large, internationally active banks. These data would be used to construct a yield curve from which one-month, three-month and six-month settings could be obtained. Following comments from market participants, the ICE Benchmark Administration modified the methodology of calculation of its index (which it is continuing to test). In May 2020, it announced that the index may be made available as a credit-spread supplement to the SOFR. If the index was accepted by market participants, it might furnish commercial bank-based term rates more directly comparable to the existing structure of Libor than the government securities-based SOFR.
During 2019 and 2020, among other things, the ARRC published a white paper on ways in which market participants could use SOFR in cash markets, conducted surveys of market participants, engaged with cognizant U.S. government agencies and private sector groups regarding tax, securities, and derivatives issues presented by the transition from Libor, published sample transition provisions for a variety of types of loan and note agreements, and investigated methods by which a forward-looking term SOFR index could be established. To facilitate the development of a generally-recognized forward-looking SOFR index, on March 2, 2020 the FRBNY began publication of 30-, 90-, and 180-day SOFR Averages, as well as a SOFR Index, on each business day. The FRBNY has stated that it will consider the potential benefits of introducing calendar month-based rates and/or adding further tenors as additional reference rates.
MERCANTILE BANK CORPORATION
In July 2019, both FNMA and FHLMC announced their intention to develop new adjustable-rate mortgage loan products based on SOFR. In February 2020, FNMA and FHLMC each announced that they would: (i) require inclusion of ARRC-recommended transition language in all single-family adjustable rate mortgage (“ARM”) loans closed on or after June 1, 2020; (ii) require all Libor-based single-family and multi-family ARM loans to have loan application dates on or before September 30, 2020 in order to be eligible for acquisition; and (iii) cease acquisition of single-family and multi-family Libor ARM loans on or before December 31, 2020. During the fourth quarter of 2020, each of FNMA and FHLMC began acquiring SOFR ARM loans and ceased purchasing Libor-based products.
In November 2020, the ICE Benchmark Administration announced a consultation regarding the cessation of the publication of Libor. The consultation proposed a December 31, 2021 cessation for all tenors of various foreign currencies and for the one-week and two-month U.S. dollar Libor, and a June 30, 2023 cessation for the remaining overnight, one-month, three-month, six-month and twelve-month U.S. dollar Libor tenors. This represented an 18-month extension of Libor publication for the most frequently used tenors of U.S. dollar Libor from the cessation date originally proposed in 2017. The consultation period closed on January 25, 2021.
In coordinated announcements on November 30, 2020, the FCA and each of the U.S. federal banking agencies recognized the proposed extension of Libor publication for the identified tenors of U.S. dollar Libor. The federal banking agencies noted that this would allow most legacy U.S. dollar Libor contracts to mature before Libor experiences disruptions. At the same time, the agencies stated that entry into new contracts using Libor as a reference rate after December 31, 2021 by supervised banking organizations would create safety and soundness risks. Accordingly, the federal banking agencies encouraged supervised banking organizations to cease using Libor as a reference rate in their agreements as soon as possible, but in any event by December 31, 2021. They also stated that new contracts entered into before December 31, 2021 should either utilize a reference rate other than Libor or have robust fallback language that includes a clearly defined alternative reference rate after Libor’s discontinuation. Certain limited exceptions to that guidance were included by the federal banking agencies in the event the ICE Benchmark Administration does continue to publish Libor U.S. dollar tenors after December 31, 2021.
On January 25, 2021, the Interbank Offered Rates (“IBOR”) Fallbacks Protocol (“Protocol”) and IBOR Fallbacks Supplement (“Supplement”) of the International Swaps and Derivatives Association (“ISDA”) each took effect. Effectiveness of the Protocol means that existing swaps and other derivative contracts will incorporate the new ISDA fallbacks if both counterparties have accepted the Protocol. Effectiveness of the Supplement means that new derivatives contracts that incorporate standard ISDA definitions and reference a relevant IBOR will also incorporate the new fallbacks. These measures are intended to provide greater certainty with respect to derivatives contracts.
On March 5, 2021, the ICE Benchmark Administration announced that it would cease publication of Libor for all tenors of various foreign currencies and for the one-week and two-month U.S. dollar Libor on December 31, 2021, and for all remaining overnight, one-month, three-month, six-month and twelve-month U.S. dollar Libor tenors on June 30, 2023. The Ice Benchmark Administration’s announcement (i) in the view of ISDA, constituted an index cessation event that definitively determined the spread adjustments under the ISDA IBOR Protocol, and (ii) in the view of the ARRC, constituted a benchmark transition event for purposes of the ARRC-recommended robust fallback language for Libor contracts.
Also in March 2021, the Federal Reserve stated that its examiners will be scrutinizing the preparations that institutions it supervises are making to cease using Libor in their new loan contracts and other operations by December 31, 2021. Institutions found to have made inadequate preparations may face supervisory action.
The ARRC announced in March 2021 that it could not guarantee that it would be able, by December 31, 2021, to recommend an administrator that could produce a robust, forward-looking term secured overnight funding rate. In April 2021, the ARRC announced the principles it will apply to develop the conditions it believes are necessary to recommend a secured overnight funding term rate. The ARRC continues to encourage financial institutions not to wait for the recommendation of a secured overnight funding term rate in making Libor transition arrangements.
MERCANTILE BANK CORPORATION
In April 2021, the State of New York enacted legislation, suggested by the ARRC, to reduce legal uncertainty and adverse economic impacts of the transition on Libor contracts governed by New York law, which includes many derivative contracts. In respective testimony before Congressional committees, Chairman Jerome Powell of the Federal Reserve, Treasury Secretary Janet Yellen, and senior officials of all the federal bank regulatory agencies, have supported adoption of Libor transition legislation by Congress. There can be no assurance whether, or in what form, such legislation may be enacted by Congress.
It is unclear whether, or in what form, Libor will continue to exist after 2021. Any transition to an alternative benchmark will require careful consideration and implementation so as not to disrupt the stability of financial markets. If Libor ceases to exist, we may need to take a variety of actions, including negotiating certain of our agreements based on an alternative benchmark that may be established, if any. There is no guarantee that a transition from Libor to an alternative benchmark will not result in financial market disruptions, significant changes in benchmark rates, or adverse changes in the value of certain of our loans, and our income and expense.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
We made no unregistered sales of equity securities during the quarter ended March 31, 2021.
Issuer Purchases of Equity Securities
On May 7, 2019, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. The actual timing, number and value of shares repurchased under the program will be determined by management in its discretion and will depend on a number of factors, including the market price of our stock, general market and economic conditions, our capital position, financial performance and alternative uses of capital, and applicable legal requirements. The program may be discontinued at any time.
During the first quarter of 2021, we repurchased a total of 118,261 shares for $3.5 million, or a weighted average all-in cost per share of $29.91. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.
Repurchases made during the first quarter of 2021 are detailed in the table below.
| Period |
Total Number of Shares Purchased |
Average Price Paid Per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
Maximum Number of Shares or Approximate Dollar Value that May Yet Be Purchased Under the Plans or Programs |
||||||||||||
| January 1 – 31 |
13,740 | $ | 28.46 | 13,740 | $ | 9,827,000 | ||||||||||
| February 1 – 28 |
58,394 | 28.78 | 58,394 | 9,436,000 | ||||||||||||
| March 1 – 31 |
46,127 | 31.78 | 46,127 | 7,755,000 | ||||||||||||
| Total |
118,261 | $ | 29.91 | 118,261 | $ | 6,289,000 | ||||||||||
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Not applicable.
MERCANTILE BANK CORPORATION
| EXHIBIT NO. |
EXHIBIT DESCRIPTION |
| 3.1 |
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| 3.2 |
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| 31 |
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| 32.1 |
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| 32.2 |
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| 101 |
The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in Inline XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements |
| 104 |
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
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 May 7, 2021.
| MERCANTILE BANK CORPORATION |
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| By: |
/s/ Robert B. Kaminski, Jr. |
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| Robert B. Kaminski, Jr. |
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| President and Chief Executive Officer |
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| (Principal Executive Officer) |
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| By: |
/s/ Charles E. Christmas |
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| Charles E. Christmas |
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| Executive Vice President, Chief Financial Officer and Treasurer |
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| (Principal Financial and Accounting Officer) |
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