ITEM 1. BUSINESS
THE COMPANY
Mercantile Bank Corporation is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"). Unless the text clearly suggests otherwise, references to "us," "we," "our," or "the company" include Mercantile Bank Corporation and its wholly-owned subsidiaries. As a bank holding company, we are subject to regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). We were organized on July 15, 1997, under the laws of the State of Michigan, primarily for the purpose of holding all of the stock of Mercantile Bank of Michigan ("our bank"), and of such other subsidiaries as we may acquire or establish. Our bank commenced business on December 15, 1997.
Mercantile Bank Mortgage Company initiated business in October 2000 as a subsidiary of our bank, and was reorganized as Mercantile Bank Mortgage Company, LLC ("our mortgage company"), on January 1, 2004. On February 7, 2002, Mercantile BIDCO, Inc. ("our BIDCO"), a subsidiary of our bank, was granted a license by the Michigan Office of Financial and Insurance Services to operate as a Michigan Business and Industrial Development Company under the Michigan BIDCO Act of 1986. In 2005, we decided to terminate our BIDCO, and dissolved it in December of 2005. Mercantile Insurance Center, Inc. ("our insurance company"), a subsidiary of our bank, commenced operations during 2002 to offer insurance products. Mercantile Bank Real Estate Co., L.L.C., ("our real estate company"), a subsidiary of our bank, was organized on July 21, 2003, principally to develop, construct and own our new facility in downtown Grand Rapids which serves as our bank's new main office and Mercantile Bank Corporation's headquarters. Mercantile Bank Capital Trust I ("the Mercantile trust"), a business trust subsidiary, was formed in September 2004 to issue trust preferred securities.
To date we have raised capital from our initial public offering of common stock in October 1997, a public offering of common stock in July 1998, three private placements of common stock during 2001, a public offering of common stock in August 2001 and a public offering of common stock in September 2003. In addition, we raised capital through a public offering of $16.0 million of trust preferred securities in 1999, which was refinanced as part of a $32.0 million private placement of trust preferred securities in 2004. Our expenses have generally been paid using the proceeds of the capital sales and dividends from our bank. Our principal source of future operating funds is expected to be dividends from our bank.
We filed an election to become a financial holding company, pursuant to the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board regulations, which election became effective March 23, 2000.
OUR BANK
Our bank is a state banking company that operates under the laws of the State of Michigan, pursuant to a charter issued by the Michigan Office of Financial and Insurance Services. Our bank's deposits are insured to the maximum extent permitted by law by the Federal Deposit Insurance Corporation ("FDIC"). Our bank's primary service area is the Kent and Ottawa County areas of West Michigan, which includes the City of Grand Rapids, the second largest city in the State of Michigan. In addition, our bank opened new offices in the cities of East Lansing and Ann Arbor, Michigan, during 2005.
Our bank, through its eight offices, provides commercial and retail banking services primarily to small- to medium-sized businesses based in and around the Grand Rapids, Holland, Lansing and Ann Arbor metropolitan areas. These offices consist of a main office located at 310 Leonard Street NW, Grand Rapids, Michigan, a combination branch and retail loan center located at 4613 Alpine Avenue NW, Comstock Park, Michigan, a combination branch and operations center located at 5610 Byron Center Avenue SW, Wyoming, Michigan, and branches located at 4860 Broadmoor Avenue SE, Kentwood, Michigan, 3156 Knapp Street NE, Grand Rapids, Michigan, 880 East 16th Street, Holland, Michigan, 1651 West Lake Lansing Road, East Lansing, Michigan, and 325 Eisenhower Parkway, Ann Arbor, Michigan.
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Our bank makes secured and unsecured commercial, construction, mortgage and consumer loans, and accepts checking, savings and time deposits. Our bank owns six automated teller machines ("ATM"), located at our branch locations in Grand Rapids and Holland, that participate in the MAC, NYCE and PLUS regional network systems, as well as other ATM networks throughout the country. Our bank also enables customers to conduct certain loan and deposit transactions by telephone and personal computer. Courier service is provided to certain commercial customers, and safe deposit facilities are available at all branch locations. Our bank does not have trust powers. In December 2001, our bank entered into a joint brokerage services and marketing agreement with Raymond James Financial Services, Inc. to make available to its customers financial planning, retail brokerage, equity research, insurance and annuities, retirement planning, trust services and estate planning.
OUR MORTGAGE COMPANY
Our mortgage company's predecessor, Mercantile Bank Mortgage Company, commenced operations on October 24, 2000 when our bank contributed most of its residential mortgage loan portfolio and participation interests in certain commercial mortgage loans to Mercantile Bank Mortgage Company. On the same date, our bank also transferred its residential mortgage origination function to Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile Bank Mortgage Company was reorganized as Mercantile Bank Mortgage Company, LLC, a limited liability company, which is 99% owned by our bank and 1% owned by our insurance company. The reorganization had no impact on the company's financial position or results of operations. Mortgage loans originated and held by our mortgage company are serviced by our bank pursuant to a servicing agreement.
OUR BIDCO
Our BIDCO, a wholly-owned subsidiary of our bank, was granted a license by the Michigan Office of Financial and Insurance Services on February 7, 2002, to operate our BIDCO as a Michigan Business and Industrial Development Company. Our BIDCO, a non-depository Michigan financial institution, offered equipment lease financing, asset based loans, junior debt facilities and other financing where equity features may be part of the facility pricing. In 2005, we decided to terminate our BIDCO, and dissolved it in December of 2005. The assets of the BIDCO, primarily comprised of two commercial loan relationships, were transferred to our bank.
OUR INSURANCE COMPANY
Our insurance company acquired an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent.
OUR REAL ESTATE COMPANY
Our real estate company was organized on July 21, 2003, principally to develop, construct and own our facility in downtown Grand Rapids that serves as our bank's main office and Mercantile Bank Corporation's headquarters. This facility was placed into service during the second quarter of 2005. Our real estate company is 99% owned by our bank and 1% owned by our insurance company.
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THE MERCANTILE TRUST
In 2004 we formed the Mercantile trust, a Delaware business trust. Mercantile trust's business and affairs are conducted by its property trustee, a Delaware trust company, and three individual administrative trustees who are employees and officers of the company. Mercantile trust was established for the purpose of issuing and selling its Series A and Series B trust preferred securities and common securities, and used the proceeds from the sales of those securities to acquire Series A and Series B Floating Rate Notes issued by the company. Substantially all of the net proceeds received by the company from the Series A transaction were used to redeem the trust preferred securities that had been issued by MBWM Capital Trust I in September 1999. Substantially all of the net proceeds received by the company from the Series B transaction were contributed to our bank as capital. The Series A and Series B Floating Rate Notes are categorized on our consolidated financial statements as subordinated debentures. Additional information regarding Mercantile trust is incorporated by reference to "Note 15 - Subordinated Debentures" and "Note 16 - Regulatory Matters" of the Notes to Consolidated Financial Statements included in this Annual Report on pages and.
EFFECT OF GOVERNMENT MONETARY POLICIES
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government, its agencies, and the Federal Reserve Board. The Federal Reserve Board's monetary policies have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation, maintain employment, and mitigate economic recessions. The policies of the Federal Reserve Board have a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States government securities, and through its regulation of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. Our bank maintains reserves directly with the Federal Reserve Bank of Chicago to the extent required by law. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.
REGULATION AND SUPERVISION
As a bank holding company under the Bank Holding Company Act, we are required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require. We are also subject to examination by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding companies that have not qualified as financial holding companies to banking and the management of banking organizations, and to certain non-banking activities. These non-banking activities include those activities that the Federal Reserve Board found, by order or regulation as of the day prior to enactment of the Gramm-Leach-Bliley Act, to be so closely related to banking as to be a proper incident to banking. These non-banking activities include, among other things: operating a mortgage company, finance company, or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, nonoperating basis; and providing discount securities brokerage services for customers. With the exception of the activities of our mortgage company discussed above, neither we nor any of our subsidiaries engages in any of the non-banking activities listed above.
In March 2000, our election to become a financial holding company, as permitted by the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley Act, was accepted by the Federal Reserve Board. In order to continue as a financial holding company, we and our bank must satisfy statutory requirements regarding capitalization, management, and compliance with the Community Reinvestment Act. As a financial holding company, we are permitted to engage in a broader range of activities than are permitted to bank holding companies.
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Those expanded activities include any activity which the Federal Reserve Board (in certain instances in consultation with the Department of the Treasury) determines, by order or regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity and not to pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. Other than the insurance agency activities of our insurance company, neither we nor our subsidiaries presently engage in any of the expanded activities.
Our bank is subject to restrictions imposed by federal law and regulation. Among other things, these restrictions apply to any extension of credit to us or to our other subsidiaries, to investments in stock or other securities that we issue, to the taking of such stock or securities as collateral for loans to any borrower, and to acquisitions of assets or services from, and sales of certain types of assets to, us or our other subsidiaries. Federal law prevents us from borrowing from our bank unless the loans are secured in designated amounts with specified forms of collateral.
With respect to the acquisition of banking organizations, we are generally required to obtain the prior approval of the Federal Reserve Board before we can acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank or bank holding company, if, after the acquisition, we would own or control more than 5% of the voting shares of the bank or bank holding company. Acquisitions of banking organizations across state lines are subject to certain restrictions imposed by Federal and state laws and regulations.
EMPLOYEES
As of December 31, 2005, we and our bank employed 244 full-time and 60 part-time persons. Management believes that relations with employees are good.
LENDING POLICY
As a routine part of our business, we make loans and leases to businesses and individuals located within our market areas. Our lending policy states that the function of the lending operation is twofold: to provide a means for the investment of funds at a profitable rate of return with an acceptable degree of risk, and to meet the credit needs of the creditworthy businesses and individuals who are our customers. We recognize that in the normal business of lending, some losses on loans and leases will be inevitable and should be considered a part of the normal cost of doing business.
Our lending policy anticipates that priorities in extending loans and leases will be modified from time to time as interest rates, market conditions and competitive factors change. The policy sets forth guidelines on a nondiscriminatory basis for lending in accordance with applicable laws and regulations. The policy describes various criteria for granting loans and leases, including the ability to pay; the character of the customer; evidence of financial responsibility; purpose of the loan or lease; knowledge of collateral and its value; terms of repayment; source of repayment; payment history; and economic conditions.
The lending policy further limits the amount of funds that may be loaned or leased against specified types of real estate collateral. For certain loans secured by real estate, the policy requires an appraisal of the property offered as collateral by a state certified independent appraiser. The policy also provides general guidelines for loan to value and lease to value limits for other types of collateral, such as accounts receivable and machinery and equipment. In addition, the policy provides general guidelines as to environmental analysis, loans to employees, executive officers and directors, problem loan and lease identification, maintenance of an allowance for loan and lease losses, loan and lease review and grading, mortgage and consumer lending, and other matters relating to our lending practices.
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The Board of Directors has delegated significant lending authority to officers of our bank. The Board of Directors believes this empowerment, supported by our strong credit culture and the significant experience of our commercial lending staff, makes us responsive to our customers. The loan policy currently specifies lending authority for certain officers up to $2.5 million, and $7.5 million for our bank's Chairman of the Board and its President and Chief Executive Officer; however, the $7.5 million lending authority is generally used only in rare circumstances where timing is of the essence. Generally, loan requests exceeding $2.5 million require approval by the Officers Loan Committee, and loan requests exceeding $4.0 million, up to the legal lending limit of approximately $33.6 million, require approval by the Board of Directors. In most circumstances, we apply an in-house lending limit that is significantly less than our bank's legal lending limit.
LENDING ACTIVITY
Commercial Loans. Our commercial lending group originates commercial loans and leases primarily in our market areas. Our commercial lenders have extensive commercial lending experience, with most having at least ten years experience. Loans and leases are originated for general business purposes, including working capital, accounts receivable financing, machinery and equipment acquisition, and commercial real estate financing, including new construction and land development.
Working capital loans are often structured as a line of credit and are reviewed periodically in connection with the borrower's year-end financial reporting. These loans are generally secured by substantially all of the assets of the borrower, and have an interest rate tied to the national prime rate. Loans and leases for machinery and equipment purposes typically have a maturity of three to five years and are fully amortizing, while commercial real estate loans are usually written with a five-year maturity and amortize over a 15 year period. Commercial loans and leases typically have an interest rate that is fixed to maturity or is tied to the national prime rate.
We evaluate many aspects of a commercial loan or lease transaction in order to minimize credit and interest rate risk. Underwriting includes an assessment of the management, products, markets, cash flow, capital, income and collateral. This analysis includes a review of the borrower's historical and projected financial results. Appraisals are generally required by certified independent appraisers where real estate is the primary collateral, and in some cases, where equipment is the primary collateral. In certain situations, for creditworthy customers, we may accept title reports instead of requiring lenders' policies of title insurance.
Commercial real estate lending involves more risk than residential lending because loan balances are greater and repayment is dependent upon the borrower's business operations. We attempt to minimize the risks associated with these transactions by generally limiting our commercial real estate lending to owner-operated properties of well-known customers or new customers whose businesses have an established profitable history. In many cases, risk is further reduced by limiting the amount of credit to any one borrower to an amount considerably less than our legal lending limit and avoiding certain types of commercial real estate financings.
We have no material foreign loans, and no material loans to energy producing customers. We have only limited exposure to companies engaged in agricultural-related activities.
Single-Family Residential Real Estate Loans. Our mortgage company originates single-family residential real estate loans in our market area, usually according to secondary market underwriting standards. Loans not conforming to those standards are made in limited circumstances. Single-family residential real estate loans provide borrowers with a fixed or adjustable interest rate with terms up to 30 years.
Our bank has a home equity line of credit program. Home equity credit is generally secured by either a first or second mortgage on the borrower's primary residence. The program provides revolving credit at a rate tied to the national prime rate.
Consumer Loans. We originate consumer loans for a variety of personal financial needs, including new and used automobiles, boat loans, credit cards and overdraft protection for our checking account
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customers. Consumer loans generally have shorter terms and higher interest rates and usually involve more credit risk than single-family residential real estate loans because of the type and nature of the collateral.
Management believes our consumer loans are underwritten carefully, with a strong emphasis on the amount of the down payment, credit quality, employment stability and monthly income of the borrower. These loans are generally repaid on a monthly repayment schedule with the source of repayment tied to the borrower's periodic income. In addition, consumer lending collections are dependent on the borrower's continuing financial stability, and are thus likely to be adversely affected by job loss, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral.
Management believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans, and that consumer loans are important to our efforts to serve the credit needs of the communities and customers that we serve.
LOAN AND LEASE PORTFOLIO QUALITY
We utilize a comprehensive grading system for our commercial loans and leases as well as residential mortgage and consumer loans. Administered as part of the loan and lease review program, virtually all commercial loans and leases are graded on an eight grade rating system. The rating system utilizes a standardized grade paradigm that analyzes several critical factors such as cash flow, management and collateral coverage. Virtually all commercial loans and leases are graded at inception and later at various intervals. Residential mortgage and consumer loans are graded on a four grade rating system using a separate standardized grade paradigm that analyzes several critical factors such as debt-to-income and credit and employment histories. Residential mortgage and consumer loans are generally only graded once after the loans are made.
Our independent loan and lease review program is primarily responsible for the administration of the grading system and ensuring adherence to established lending policies and procedures. The loan and lease review program is an integral part of maintaining our strong asset quality culture. The loan and lease review function works closely with senior management, although it functionally reports to the Board of Directors. All commercial loan and lease relationships exceeding $1.0 million are formally reviewed every twelve to eighteen months. Credits between $0.5 million and $1.0 million are formally reviewed every two years, with a random sampling performed on credits under $0.5 million. Our watch list credits are reviewed monthly by our Watch List Committee, which is comprised of personnel from the administration, lending and loan and lease review functions.
Loans and leases are placed in a nonaccrual status when, in the opinion of management, uncertainty exists as to the ultimate collection of principal and interest. As of December 31, 2005, loans and leases placed in nonaccrual status totaled $3.6 million, or 0.23% of total loans and leases. As of the same date, loans and leases past due 90 days or more and still accruing interest totaled $0.4 million, or 0.03% of total loans and leases. As of December 31, 2005, there were no other significant loans and leases where known information about credit problems of borrowers warranted the placing of the loans or leases in a nonaccrual status. Management is not aware of any potential problem credits that could have a material adverse effect on our operating results, liquidity, or capital resources.
Additional detail and information relative to the loan and lease portfolio is incorporated by reference to Management's Discussion and Analysis of Financial Condition and Results of Operation ("Management's Discussion and Analysis") beginning on Page and Note 3 of the Notes to Consolidated Financial Statements on pages and included in this Annual Report.
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ALLOWANCE FOR LOAN AND LEASE LOSSES
In each accounting period, the allowance for loan and lease losses ("allowance") is adjusted by management to the amount management believes is necessary to maintain the allowance at adequate levels. Through its loan and lease review and credit departments, management attempts to allocate specific portions of the allowance based on specifically identifiable problem loans and leases. Management's evaluation of the allowance is further based on, but not limited to, consideration of internally prepared calculations based upon the experience of senior management and lending staff making similar loans and leases in the same community for almost 20 years, composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and portfolio and general economic conditions. In addition, our bank's status as a relatively new banking organization, the rapid loan growth since inception and commercial lending emphasis is taken into account. Management believes that the present allowance is adequate, based on the broad range of considerations listed above.
The primary risks associated with commercial loans and leases are the financial condition of the borrower, the sufficiency of collateral, and lack of timely payment. Management has a policy of requesting and reviewing periodic financial statements from its commercial loan and lease customers, and periodically reviews existence of collateral and its value. The primary risk element considered by management with respect to each consumer and residential real estate loan is lack of timely payment. Management has a reporting system that monitors past due loans and has adopted policies to pursue its creditor's rights in order to preserve our bank's collateral position.
Additional detail regarding the allowance is incorporated by reference to Management's Discussion and Analysis beginning on Page and Note 3 of the Notes to Consolidated Financial Statements of the Company on pages and included in this Annual Report.
Although management believes the allowance is adequate to absorb probable incurred losses as they arise, there can be no assurance that we will not sustain losses in any given period which could be substantial in relation to, or greater than, the size of the allowance.
INVESTMENTS
Bank Holding Company Investments. The principal investments of our bank holding company are the investments in the common stock of our bank and the common securities of Mercantile trust. Other funds of our bank holding company may be invested from time to time in various debt instruments.
As a bank holding company, we are also permitted to make portfolio investments in equity securities and to make equity investments in subsidiaries engaged in a variety of non-banking activities, which include real estate-related activities such as community development, real estate appraisals, arranging equity financing for commercial real estate, and owning and operating real estate used substantially by our bank or acquired for its future use. In addition, our bank holding company's qualification as a financial holding company enables us to make equity investments in companies engaged in a broader range of financial activities than we could do without that qualification. Such expanded activities include insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. Our bank holding company has no plans at this time to make directly any of these equity investments at the bank holding company level. Our Board of Directors may, however, alter the investment policy at any time without shareholder approval.
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In addition, so long as our bank holding company is qualified as a financial holding company, it would be permitted, as part of the business of underwriting or merchant banking activity and under certain circumstances and procedures, to invest in shares or other ownership interests in, or assets of, companies engaged in non-financial activities. In order to make those investments, our bank holding company would be required (i) to become, or to have an affiliate that is, a registered securities broker or dealer or a registered municipal securities dealer, or (ii) to control both an insurance company engaged in underwriting life, accident and health, or property and casualty insurance (other than credit insurance) or issuing annuities, and a registered investment adviser that furnishes investment advice to an insurance company. We do not currently have any securities, insurance, or investment advisory affiliates of the required types, nor does our bank holding company have any current plans to make any of the equity investments described in this paragraph.
Our Bank's Investments. Our bank may invest its funds in a wide variety of debt instruments and may participate in the federal funds market with other depository institutions. Subject to certain exceptions, our bank is prohibited from investing in equity securities. Among the equity investments permitted for our bank under various conditions and subject in some instances to amount limitations, are shares of a subsidiary insurance agency, mortgage company, real estate company, or Michigan business and industrial development company, such as our insurance company, our mortgage company, or our real estate company. Under another such exception, in certain circumstances and with prior notice to or approval of the FDIC, our bank could invest up to 10% of its total assets in the equity securities of a subsidiary corporation engaged in the acquisition and development of real property for sale, or the improvement of real property by construction or rehabilitation of residential or commercial units for sale or lease. Our bank has no present plans to make such an investment. Real estate acquired by our bank in satisfaction of or foreclosure upon loans may be held by our bank for specified periods. Our bank is also permitted to invest in such real estate as is necessary for the convenient transaction of its business. Our bank's Board of Directors may alter the bank's investment policy without shareholder approval at any time.
Additional detail and information relative to the securities portfolio is incorporated by reference to Management's Discussion and Analysis beginning on Page and Note 2 of the Notes to Consolidated Financial Statements on pages through included in this Annual Report.
COMPETITION
Our primary markets for loans and core deposits are the Grand Rapids, Holland, Lansing and Ann Arbor metropolitan areas. We face substantial competition in all phases of our operations from a variety of different competitors. We compete for deposits, loans and other financial services with numerous Michigan-based and out-of-state banks, savings banks, thrifts, credit unions and other financial institutions as well as from other entities that provide financial services. Some of the financial institutions and financial service organizations with which we compete are not subject to the same degree of regulation as we are. Many of our primary competitors have been in business for many years, have established customer bases, are larger, have substantially higher lending limits than we do, and offer larger branch networks and other services which we do not. Most of these same entities have greater capital resources than we do, which, among other things, may allow them to price their services at levels more favorable to the customer and to provide larger credit facilities than we do. Under the Gramm-Leach-Bliley Act, effective March 11, 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. The Gramm-Leach-Bliley Act may significantly change the competitive environment in which we conduct our business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services.
SELECTED STATISTICAL INFORMATION
Management's Discussion and Analysis beginning on Page in this Annual Report includes selected statistical information.
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RETURN ON EQUITY AND ASSETS
Return on Equity and Asset information is included in Management's Discussion and Analysis beginning on Page in this Annual Report.
AVAILABLE INFORMATION
We maintain an internet website at www.mercbank.com. We make available on or through our website, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practical after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We do not intend the address of our website to be an active link or to otherwise incorporate the contents of our website into this Annual Report.
ITEM 1A.
ITEM 1A. RISK FACTORS
The following risk factors could affect our business, financial condition or results of operations. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report because they could cause the actual results and conditions to differ materially from those projected in forward-looking statements. Before you buy our common stock, you should know that investing in our common stock involves risks, including the risks described below. The risks that are highlighted here are not the only ones we face. If the adverse matters referred to in any of the risks actually occur, our business, financial condition or operations could be adversely affected. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
ADVERSE CHANGES IN ECONOMIC CONDITIONS OR INTEREST RATES MAY NEGATIVELY AFFECT OUR EARNINGS, CAPITAL AND LIQUIDITY.
The results of operations for financial institutions, including our bank, may be materially and adversely affected by changes in prevailing local and national economic conditions, including declines in real estate market values and the related declines in value of our real estate collateral, rapid increases or decreases in interest rates and changes in the monetary and fiscal policies of the federal government. Our profitability is heavily influenced by the spread between the interest rates we earn on loans and investments and the interest rates we pay on deposits and other interest-bearing liabilities. Substantially all of our loans are to businesses and individuals in western, south central, or southeastern Michigan, and any decline in the economy of these areas could adversely affect us. Like most banking institutions, our net interest spread and margin will be affected by general economic conditions and other factors that influence market interest rates and our ability to respond to changes in these rates. At any given time, our assets and liabilities may be such that they will be affected differently by a given change in interest rates.
OUR CREDIT LOSSES COULD INCREASE AND OUR ALLOWANCE FOR LOAN AND LEASE LOSSES MAY NOT BE ADEQUATE TO COVER ACTUAL LOAN LOSSES.
The risk of nonpayment of loans is inherent in all lending activities, and nonpayment, when it occurs, may have a materially adverse effect on our earnings and overall financial condition as well as the value of our common stock. Our focus on commercial lending may result in a larger concentration of loans to small businesses. As a result, we may assume different or greater lending risks than other banks. We make various assumptions and judgments about the collectibility of our loan portfolio and provide an allowance for losses based on several factors. If our assumptions are wrong, our allowance for loan and lease losses may not be sufficient to cover our losses, which would have an adverse effect on our operating results. While we have not experienced unusual amounts of charge-offs or nonperforming loans, we cannot assure you that we will not experience an increase in delinquencies and losses as the loans and leases continue to mature. The actual amounts of future provisions for loan and lease losses cannot be determined at this time and may exceed the amounts of past provisions. Additions to our allowance for loan and lease losses decrease our net income.
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WE RELY HEAVILY ON OUR MANAGEMENT AND OTHER KEY PERSONNEL, AND THE LOSS OF ANY OF THEM MAY ADVERSELY AFFECT OUR OPERATIONS.
We are and will continue to be dependent upon the services of our management team, including Gerald R. Johnson, Jr., our Chairman and Chief Executive Officer, Michael H. Price, our President and Chief Operating Officer, and our other senior managers. The loss of either Mr. Johnson or Mr. Price, or any of our other senior managers, could have an adverse effect on our growth and performance. We have entered into employment contracts with Mr. Johnson and Mr. Price and two other senior managers. The contracts provide for a three year employment period that is extended for an additional year each year unless a notice is given indicating that the contract will not be extended.
In addition, we continue to depend on our city presidents and key commercial loan officers. Our city presidents and several of our commercial loan officers are responsible, or share responsibility, for generating and managing a significant portion of our commercial loan and lease portfolio. Our success can be attributed in large part to the relationships these officers as well as members of our management team have developed and are able to maintain with our customers as we continue to implement our community banking philosophy. The loss of any of these commercial loan officers could adversely affect our loan and lease portfolio and performance, and our ability to generate new loans and leases. Many of our key employees have signed agreements with us agreeing not to compete with us in one or more of our markets for specified time periods if they leave employment with us.
Some of the other financial institutions in our markets also require their key employees to sign agreements that preclude or limit their ability to leave their employment and compete with them or solicit their customers. These agreements make it more difficult for us to hire loan officers with experience in our markets who can immediately solicit their former or new customers on our behalf.
DECLINE IN THE AVAILABILITY OF OUT-OF-AREA DEPOSITS COULD CAUSE LIQUIDITY OR INTEREST RATE MARGIN CONCERNS, OR LIMIT OUR GROWTH.
We have utilized and expect to continue to utilize out-of-area or wholesale deposits to support our asset growth. These deposits are generally a lower cost source of funds when compared to the interest rates that we would have to offer in our local markets to generate a commensurate level of funds. In addition, the overhead costs associated with wholesale deposits are considerably less than the overhead costs we would incur to obtain and administer a similar level of local deposits. A decline in the availability of these wholesale deposits would require us to fund our growth with more costly funding sources, which could reduce our net interest margin, limit our growth, reduce our asset size, or increase our overhead costs.
FUTURE SALES OF OUR COMMON STOCK OR OTHER SECURITIES MAY DILUTE THE VALUE OF OUR COMMON STOCK.
In many situations, our Board of Directors has the authority, without any vote of our shareholders, to issue shares of our authorized but unissued stock, including shares authorized and unissued under our stock option plans. In the future, we may issue additional securities, through public or private offerings, in order to raise additional capital. Any such issuance would dilute the percentage of ownership interest of existing shareholders and may dilute the per share book value of the common stock. In addition, option holders may exercise their options at a time when we would otherwise be able to obtain additional equity capital on more favorable terms.
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OUR GROWTH AND EXPANSION MAY BE LIMITED BY MANY FACTORS.
Our primary growth strategy has been to grow internally by increasing our business in the western Michigan area, and more recently in the Lansing and Ann Arbor areas of Michigan. We are also considering other areas in which we may expand our business. This internal growth strategy depends in large part on generating an increasing level of loans and deposits at acceptable risk and interest rate levels without commensurate increases in non-interest expenses. There can be no assurance that we will be successful in continuing our growth strategy due to delays and other impediments resulting from regulatory oversight, limited availability of qualified personnel and favorable and cost effective branch sites, and management time, capital, and expenses required to develop new branch sites and markets. In addition, the success of our growth strategy will depend on maintaining sufficient regulatory capital levels and on adequate economic conditions in our market areas.
In addition, although we have no current plans to do so, we may acquire banks, related businesses or branches of other financial institutions that we believe provide a strategic fit with our business. To the extent that we grow through acquisitions, we cannot assure you that we will be able to adequately or profitably manage this growth. Acquiring other banks, businesses, or branches involves risks commonly associated with acquisitions, including exposure to unknown or contingent liabilities and asset quality issues, difficulty and expense of integrating the operations and personnel, potential disruption to our business including the diversion of management's time and attention, and the possible loss of key employees and customers.
OUR FUTURE SUCCESS IS DEPENDENT ON OUR ABILITY TO COMPETE EFFECTIVELY IN THE HIGHLY COMPETITIVE BANKING INDUSTRY.
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. We compete for deposits, loans and other financial services with numerous Michigan-based and out-of-state banks, thrifts, credit unions and other financial institutions as well as other entities that provide financial services, including securities firms and mutual funds. Some of the financial institutions and financial service organizations with which we compete are not subject to the same degree of regulation as we are. Most of our competitors have been in business for many years, have established customer bases, are larger, have substantially higher lending limits than we do and offer branch networks and other services which we do not, including trust and international banking services. Most of these entities have greater capital and other resources than we do, which, among other things, may allow them to price their services at levels more favorable to the customer and to provide larger credit facilities than we do. This competition may limit our growth or earnings. Under the Gramm-Leach-Bliley Act of 1999, effective March 11, 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. The Gramm-Leach-Bliley Act affects the competitive environment in which we conduct business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
WE ARE SUBJECT TO SIGNIFICANT GOVERNMENT REGULATION, AND ANY REGULATORY CHANGES MAY ADVERSELY AFFECT US.
The banking industry is heavily regulated under both federal and state law. These regulations are primarily intended to protect customers, not our creditors or shareholders. Existing state and federal banking laws subject us to substantial limitations with respect to the making of loans, the purchase of securities, the payment of dividends and many other aspects of our business. Some of these laws may benefit us, others may increase our costs of doing business, or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition. Federal economic and monetary policy may also affect our ability to attract deposits, make loans and achieve satisfactory interest spreads.
12.
WE CONTINUALLY ENCOUNTER TECHNOLOGICAL CHANGE, AND WE MAY HAVE FEWER RESOURCES THAN OUR COMPETITORS TO CONTINUE TO INVEST IN TECHNOLOGICAL IMPROVEMENTS.
The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
OUR ARTICLES OF INCORPORATION AND BY-LAWS AND THE LAWS OF MICHIGAN CONTAIN PROVISIONS THAT MAY DISCOURAGE OR PREVENT A TAKEOVER OF OUR COMPANY AND REDUCE ANY TAKEOVER PREMIUM.
Our Articles of Incorporation and By-laws, and the corporate laws of the State of Michigan, include provisions which are designed to provide our Board of Directors with time to consider whether a hostile takeover offer is in our and our shareholders' best interest. These provisions, however, could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of our common stock to participate in tender offers, including tender offers at a price above the then-current market price for our common stock. These provisions could also prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interests.
The Michigan Business Corporation Act contains provisions intended to protect shareholders and prohibit or discourage various types of hostile takeover activities. In addition to these provisions and the provisions of our Articles of Incorporation and Bylaws, federal law requires the Federal Reserve Board's approval prior to acquiring "control" of a bank holding company. All of these provisions may delay or prevent a change in control without action by our shareholders, and could adversely affect the price of our common stock.
THERE IS A LIMITED TRADING MARKET FOR OUR COMMON STOCK.
The price of our common stock has been, and will likely continue to be, subject to fluctuations based on, among other things, economic and market conditions for bank holding companies and the stock market in general, as well as changes in investor perceptions of our company. The issuance of new shares of our common stock also may affect the market for our common stock.
Our common stock is traded on the Nasdaq National Market under the symbol "MBWM". The development and maintenance of an active public trading market depends upon the existence of willing buyers and sellers, the presence of which is beyond our control. While we are a publicly-traded company, the volume of trading activity in our stock is still relatively limited. Even if a more active market develops, there can be no assurance that such a market will continue, or that our shareholders will be able to sell their shares at or above the offering price.
We have paid a 5% stock dividend on our common stock each year since 2001, and have paid a quarterly cash dividend each quarter beginning with the first quarter of 2003. While we expect to continue paying cash dividends, there is no assurance that we will continue to do so.
13.
OUR BUSINESS IS SUBJECT TO OPERATIONAL RISKS.
We, like most financial institutions, are exposed to many types of operational risks, including the risk of fraud by employees or outsiders, unauthorized transactions by employees or operational errors. Operational errors may include clerical or record keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Given our volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully corrected. Our necessary dependence upon automated systems to record and process our transaction volume may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.
We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, including, for example, computer viruses or electrical or telecommunications outages, which may give rise to losses in service to customers and to loss or liability to us. We are further exposed to the risk that our external vendors may be unable to fulfill their contractual obligations to us, or will be subject to the same risk of fraud or operational errors by their respective employees as are we, and to the risk that our or our vendors' business continuity and data security systems prove not to be sufficiently adequate. We also face the risk that the design of our controls and procedures prove inadequate or are circumvented, causing delays in detection or errors in information. Although we maintain a system of controls designed to keep operational risk at appropriate levels, there can be no assurance that we will not suffer losses from operational risks in the future that may be material in amount.
ITEM IB. UNRESOLVED STAFF COMMENTS
We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more before the end of our 2005 fiscal year and that remain unresolved.
ITEM 2.
ITEM 2. PROPERTIES
During 2005 our bank placed into service a new four-story facility located approximately two miles north from the center of downtown Grand Rapids. Design and construction of this facility had started during 2003. This new facility serves as the Company's headquarters and our bank's main office, and houses the administration function, our bank's commercial lending and review function, our bank's loan operations function, a full service branch, portions of our bank's retail lending and business development function and our bank's retail brokerage operation. A majority of functions housed at this facility were formerly operated out of a leased facility located at 216 North Division Avenue, Grand Rapids, Michigan, approximately two miles from the new facility. The new facility consists of approximately 55,000 square feet of usable space and contains multiple drive-through lanes with ample parking. The land and building are owned by our real estate company. The address of this facility is 310 Leonard Street NW, Grand Rapids, Michigan.
Our bank designed and constructed a full service branch and retail loan facility in Alpine Township, a northwest suburb of Grand Rapids, which opened in July of 1999. The facility is one story and has approximately 8,000 square feet of usable space. The land and building are owned by our bank. The facility has multiple drive-through lanes and ample parking space. The address of this facility is 4613 Alpine Avenue NW, Comstock Park, Michigan.
14.
During 2001 our bank designed and constructed two facilities on a 4-acre parcel of land located in the City of Wyoming, a southwest suburb of Grand Rapids. The land had been purchased by our bank in 2000. The larger of the two buildings is a full service branch and deposit operations facility which opened in September of 2001. The facility is two-stories and has approximately 25,000 square feet of usable space. The facility is owned by our bank and has multiple drive-through lanes and ample parking space. The address of this facility is 5610 Byron Center Avenue SW, Wyoming, Michigan. The other building is a single-story facility with approximately 11,000 square feet of usable space. Our bank's accounting, audit, loss prevention and wire transfer functions are housed in this building, which underwent a renovation in 2005 that almost doubled its size. This facility is also owned by our bank. The address of this facility is 5650 Byron Center Avenue SW, Wyoming, Michigan.
During 2002 our bank designed and constructed a full service branch in the City of Kentwood, a southeast suburb of Grand Rapids, which opened in December of 2002. The land had been purchased by our bank in 2001. The facility is one story and has approximately 10,000 square feet of usable space. The facility is owned by our bank, and has multiple drive-through lanes and ample parking space. The address of this facility is 4860 Broadmoor Avenue SW, Kentwood, Michigan.
During 2003 our bank designed and constructed a full service branch in the northeast quadrant of the City of Grand Rapids. The land had been purchased by our bank in 2002. The facility is one story and has approximately 3,500 square feet of usable space. The facility is owned by our bank, and has multiple drive-through lanes and ample parking space. The address of this facility is 3156 Knapp Street NE, Grand Rapids, Michigan.
During 2003 our bank designed and started construction of a new two-story facility located in Holland, Michigan. This facility, which was completed during the fourth quarter of 2004, serves as a full service banking center for the Holland area, including commercial lending, retail lending and a full service branch. The facility consists of approximately 30,000 square feet of usable space and contains multiple drive-through lanes with ample parking. The address of this facility is 880 East 16th Street, Holland, Michigan.
During 2005 our bank opened a branch facility in the City of East Lansing, Michigan. The facility is one story and has approximately 7,500 square feet of usable space. The facility is operated under a lease agreement between our bank and a third party. There is ample parking space, but no drive-through lanes. The address of this facility is 1651 West Lake Lansing Road, East Lansing, Michigan.
During 2005 our bank opened a branch facility in the City of Ann Arbor, Michigan. The facility is one story and has approximately 10,000 square feet of usable space. The facility is operated under a lease agreement between our bank and a third party. There is ample parking space, but no drive-through lanes. The address of this facility is 325 Eisenhower Parkway, Ann Arbor, Michigan.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that are incidental to our business. In the opinion of management, we are not a party to any legal proceedings that are material to our financial condition, either individually or in the aggregate.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
15.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the Nasdaq National Market under the symbol "MBWM". At February 10, 2006, there were 301 record holders of our common stock. In addition, we estimate that there were approximately 3,000 beneficial owners of our common stock who own their shares through brokers or banks.
The following table shows the high and low bid prices for our common stock as reported by the Nasdaq National Market for the periods indicated, and the quarterly cash dividends paid by us during those periods. The prices do not include retail mark-up, mark-down or commission, but have been adjusted for the 5% stock dividends paid on August 1, 2005 and May 3, 2004.
Holders of our common stock are entitled to receive dividends that the Board of Directors may declare from time to time. We may only pay dividends out of funds that are legally available for that purpose. We are a holding company and substantially all of our assets are held by our subsidiaries. Our ability to pay dividends to our shareholders depends primarily on our bank's ability to pay dividends to us. Dividend payments and extensions of credit to us from our bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings, imposed by law and regulatory agencies with authority over our bank. The ability of our bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. In addition, under the terms of our subordinated debentures, we would be precluded from paying dividends on our common stock if an event of default has occurred and is continuing under the subordinated debentures, or if we exercised our right to defer payments of interest on the subordinated debentures, until the deferral ended.
On January 10, 2006, we declared a $0.12 per share cash dividend on our common stock, payable on March 10, 2006, to record holders as of February 10, 2006. We currently expect to continue to pay a quarterly cash dividend, although there can be no assurance that we will continue to do so.
On October 10, 2005, we issued 2,000 shares of our common stock to one of our employees upon their exercise of employee stock options issued under our 1997 Employee Stock Option Plan. We received a weighted average exercise price of $9.207 per share aggregating $18,414. The exercise price for these shares was substantially paid by the employee delivering to us common stock of the company that he already owned having an aggregate value of $18,391, with the difference paid in cash. The shares issued under the 1997 Employee Stock Option Plan were issued in reliance on an exemption from registration under the Securities Act of 1933 based on Section 4(2) of that Act, and Regulation D issued under that Act.
16.
Issuer Purchases of Equity Securities
The shares shown in column (a) above as having been purchased were acquired from one of our employees when he used shares of common stock that he already owned to pay part of the exercise price when exercising stock options issued under one of our employee stock option plans.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data on page in this Annual Report is incorporated here by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Management's Discussion and Analysis on pages through in this Annual Report is incorporated here by reference.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the heading "Market Risk Analysis" on pages through in this Annual Report is incorporated here by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, Notes to Consolidated Financial Statements and the Reports of Independent Registered Public Accounting Firm on pages through in this Annual Report are incorporated here by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
17.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
As of December 31, 2005, an evaluation was performed under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of December 31, 2005. There have been no significant changes in our internal controls over financial reporting during the quarter ended December 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2005. Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Crowe Chizek and Company LLC, an independent registered public accounting firm, as stated in their report which is included in this Annual Report.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information presented under the captions "Information about Directors, Nominees and Executive Officers" and "Section 16(a) Beneficial Ownership Compliance" in the definitive Proxy Statement of Mercantile for its April 27, 2006 Annual Meeting of Shareholders (the "Proxy Statement"), a copy of which will be filed with the Securities and Exchange Commission before the meeting date, is incorporated here by reference.
We have a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The members of the Audit Committee consist of Betty S. Burton, David M. Cassard, C. John Gill, David M. Hecht, Calvin D. Murdock and Merle J. Prins. The Board of Directors has determined that Mr. Cassard, a member of the Audit Committee, is qualified as an audit committee financial expert, as that term is defined in the rules of the Securities and Exchange Commission. Mr. Cassard is independent, as independence for audit committee members is defined in the listing standards of the Nasdaq Stock Market and the rules of the Securities and Exchange Commission.
We have adopted a Code of Ethics that applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. The Code of Ethics is posted on our website (www.mercbank.com). We intend to post amendments to or waivers from our Code of Ethics, of the type referred to in Item 5.05 of Form 8-K, to the extent applicable to our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions, on our website.
18.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information presented under the captions "Director Compensation," "Compensation Committee Interlocks and Insider Participation," "Summary Compensation Table," "Option Grants in 2005," "Aggregated Stock Option Exercises in 2005 and Year End Option Values" and "Employment Agreements", in the Proxy Statement is incorporated here by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information presented under the caption "Stock Ownership of Certain Beneficial Owners and Management" in the Proxy Statement is incorporated here by reference.
The following table summarizes information, as of December 31, 2005, relating to compensation plans under which equity securities are authorized for issuance.
(1) These plans are Mercantile's 1997 Employee Stock Option Plan, 2000 Employee Stock Option Plan, 2004 Employee Stock Option Plan and Independent Director Stock Option Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information presented under the caption "Certain Transactions" in the Proxy Statement is incorporated here by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information presented under the caption "Fees to Independent Auditors for 2005 and 2004" in the Proxy Statement is incorporated here by reference.
19.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements. The following financial statements and reports of independent registered public accounting firm of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:
Reports of Independent Registered Public Accounting Firm dated February 23, 2006
Consolidated Balance Sheets --- December 31, 2005 and 2004
Consolidated Statements of Income for each of the three years in the period ended December 31, 2005
Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended December 31, 2005
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2005
Notes to Consolidated Financial Statements
The financial statements, the notes to financial statements, and the reports of independent registered public accounting firm listed above are incorporated by reference in Item 8 of this report.
(2) Financial Statement Schedules
Not applicable
(b) Exhibits:
20.
21.
22.
* Management contract or compensatory plan
(c) Financial Statements Not Included In Annual Report
Not applicable
23.
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
CONTENTS
SELECTED FINANCIAL DATA
NA - Not Applicable
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion and other portions of this Annual Report contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about our company. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "projects," and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.
Future Factors include changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in the national and local economies; and other risk factors described in Item 1A of this Annual Report. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Management's Discussion and Analysis of Financial Condition and Results of Operations is based on Mercantile Bank Corporation's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease losses, and actual results could differ from those estimates.
The allowance for loan and lease losses is maintained at a level we believe is adequate to absorb probable incurred losses identified and inherent in the loan and lease portfolio. Our evaluation of the adequacy of the allowance for loan and lease losses is an estimate based on reviews of individual loans, assessments of the impact of current and anticipated economic conditions on the portfolio, and historical loss experience. The allowance for loan and lease losses represents management's best estimate, but significant downturns in circumstances relating to loan and lease quality or economic conditions could result in a requirement for an increased allowance for loan and lease losses in the near future. Likewise, an upturn in loan and lease quality or improved economic conditions may result in a decline in the required allowance for loan and lease losses. In either instance, unanticipated changes could have a significant impact on operating earnings.
The allowance for loan and lease losses is increased through a provision charged to operating expense. Uncollectible loans and leases are charged-off through the allowance for loan and lease losses. Recoveries of loans and leases previously charged-off are added to the allowance for loan and lease losses. 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. Our policy for recognizing income on impaired loans is to accrue interest unless a loan is placed on nonaccrual status.
INTRODUCTION
This Management's Discussion and Analysis should be read in conjunction with the consolidated financial statements contained herein. This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiary, Mercantile Bank of Michigan ("our bank"), and of Mercantile Bank Mortgage Company, LLC ("our mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO"), Mercantile Bank Real Estate Co., L.L.C. ("our real estate company") and Mercantile Insurance Center, Inc. ("our insurance company"), which are subsidiaries of our bank. Unless the text clearly suggests otherwise, references to "us," "we," "our," or "the company" include Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.
We were incorporated on July 15, 1997 as a bank holding company to establish and own our bank. Our bank, after receiving all necessary regulatory approvals, began operations on December 15, 1997. Our bank has a strong commitment to community banking and offers a wide range of financial products and services, primarily to small- to medium-sized businesses, as well as individuals. Our bank's lending strategy focuses on commercial lending, and, to a lesser extent, residential mortgage and consumer lending. Our bank also offers a broad array of deposit products, including checking, savings, money market, and certificates of deposit, as well as security repurchase agreements. Our primary markets are the Grand Rapids, Holland, Lansing and Ann Arbor metropolitan areas. Our bank utilizes certificates of deposit from customers located outside of the primary market area to assist in funding the rapid asset growth our bank has experienced since inception.
Mercantile Bank Capital Trust I ("the Mercantile trust"), a business trust formed by the company, was incorporated in 2004 for the purpose of issuing Series A and Series B Preferred Securities. On September 16, 2004, the Mercantile trust sold the Series A Preferred Securities in a private sale for $16.0 million, and also sold $495,000 of Series A Common Securities to Mercantile Bank Corporation. The proceeds of the Series A Preferred Securities and the Series A Common Securities were used by the Mercantile trust to purchase $16,495,000 of Series A Floating Rate Notes that were issued by Mercantile Bank Corporation on September 16, 2004. Mercantile Bank Corporation used the proceeds of the Series A Floating Rate Notes to finance the redemption on September 17, 2004 of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. On December 10, 2004, the Mercantile trust sold the Series B Preferred Securities in a private sale for $16.0 million, and also sold $495,000 of Series B Common Securities to Mercantile Bank Corporation. The proceeds of the Series B Preferred Securities and the Series B Common Securities were used by the Mercantile trust to purchase $16,495,000 of Series B Floating Rate Notes that were issued by Mercantile Bank Corporation on December 10, 2004. Substantially all of the net proceeds of the Series B Floating Rate Notes were contributed to our bank as capital to provide support for asset growth, fund investments in loans and securities and for general corporate purposes.
The only significant assets of the Mercantile trust are the Series A and Series B Floating Rate Notes, and the only significant liabilities of the Mercantile trust are the Series A and Series B Preferred Securities. The Series A and Series B Floating Rate Notes are categorized on the company's consolidated balance sheet as subordinated debentures and the interest expense is recorded on the company's consolidated statement of income under interest expense on long-term borrowings.
Our mortgage company's predecessor, Mercantile Bank Mortgage Company, was formed to increase the profitability and efficiency of the company's mortgage loan operations. Mercantile Bank Mortgage Company initiated business on October 24, 2000 from our bank's contribution of most of its residential mortgage loan portfolio and participation interests in certain commercial mortgage loans. On the same date, our bank had also transferred its residential mortgage origination function to Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile Bank Mortgage Company was reorganized as Mercantile Bank Mortgage Company, LLC, a limited liability company. Mortgage loans originated and held by our mortgage company are serviced by our bank pursuant to a servicing agreement.
On February 7, 2002 our BIDCO was granted a license by the Michigan Office of Financial and Insurance Services to operate as a Michigan Business and Industrial Development Company. Our BIDCO, a non-depository Michigan financial institution, offered equipment lease financing, asset based loans, junior debt facilities and other financing where equity features may be part of the facility pricing. In 2005, we decided to terminate our BIDCO, and dissolved it in December of 2005. The assets of the BIDCO, primarily comprised of two commercial loan relationships, were transferred to our bank.
Our insurance company acquired, at nominal cost, an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent.
Our real estate company was organized on July 21, 2003, principally to develop, construct and own our new facility in downtown Grand Rapids which serves as our bank's new main office and Mercantile Bank Corporation's headquarters. Construction was completed during the second quarter of 2005.
FINANCIAL CONDITION
We continued to experience significant asset growth during 2005. Assets increased from $1,536.1 million on December 31, 2004 to $1,838.2 million on December 31, 2005. This represents an increase in total assets of $302.1 million, or 19.7%. The increase in total assets was primarily comprised of a $242.0 million increase in net loans and leases and a $28.6 million increase in securities. The increase in assets was primarily funded by a $260.2 million increase in deposits, a $15.9 million increase in repurchase agreements and a $13.5 million increase in shareholders' equity.
EARNING ASSETS
Average earning assets equaled 94.8% of average total assets during 2005, compared to 95.3% during 2004. Although we experienced significant asset growth during 2005, the asset composition remained relatively constant. The loan portfolio continued to comprise a majority of earning assets, followed by securities and federal funds sold.
Our loan and lease portfolio, which equaled 88.8% of average earning assets during 2005, is primarily comprised of commercial loans and leases. Constituting over 91% of loans and leases and growing by $238.8 million during 2005, the commercial loan and lease portfolio represents loans to businesses generally located within our market areas. Approximately 68% of the commercial loan and lease portfolio is primarily secured by real estate properties, with the remaining generally secured by other business assets such as accounts receivable, inventory, and equipment. The continued significant concentration of the loan and lease portfolio in commercial loans and leases and the rapid growth of this portion of our lending business are consistent with our strategy of focusing a substantial amount of our efforts on "wholesale" banking. Corporate and business lending continues to be an area of expertise for our senior management team, and our commercial lenders have extensive commercial lending experience, with most having at least ten years experience. Of each of the loan categories that we originate, commercial loans and leases are most efficiently originated and managed, thus limiting overhead costs by necessitating the attention of fewer full-time employees. Our commercial lending business generates the greatest amount of local deposits and is virtually our only source of significant demand deposits.
Residential mortgage and consumer lending, while equaling less than 9% of total loans and leases during 2005, also experienced strong growth; however, while we expect the residential mortgage loan and consumer loan portfolios to increase in future periods, given our wholesale banking strategy, the commercial sector of the lending efforts and resultant assets are expected to remain the dominant loan portfolio category.
The following tables present the maturity of total loans outstanding, as of December 31, 2005, according to scheduled repayments of principal on fixed rate loans and repricing frequency on variable rate loans. Floating rate loans that are currently at interest rate ceilings are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.
Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to provide effective loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur quickly because of changing economic conditions. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on the internal "Watch List." Senior management reviews this list regularly.
The quality of our loan portfolio remains strong, with past due loans and net loan charge-offs below banking industry averages during 2005. As of December 31, 2005, past due and nonaccrual loans and leases totaled $4.0 million, or 0.26% of total loans and leases. At December 31, 2004, past due and nonaccrual loans totaled $2.8 million, or 0.22% of total loans. Net loan and lease charge-offs during 2005 totaled $1.1 million, or 0.08% of average total loans and leases. During 2004 net loan and lease charge-offs totaled $1.2 million, or 0.10% of average total loans and leases. Over 98% of the loan portfolio consists of loans extended directly to companies or individuals doing business and residing within our market areas. The remaining portion is comprised of commercial loans participated with certain unaffiliated commercial banks outside of our market areas, which are underwritten using the same loan criteria as though our bank was the originating bank.
The following table summarizes nonperforming loans and troubled debt restructurings.
The following table summarizes changes in the allowance for loan and lease losses for the past five years.
In each accounting period the allowance for loan and lease losses ("allowance") is adjusted to the amount believed necessary to maintain the allowance at adequate levels. Through the loan review and credit departments, we attempt to allocate specific portions of the allowance based on specifically identifiable problem loans and leases. The evaluation of the allowance is further based on, although not limited to, consideration of the internally prepared Loan Loss Reserve Analysis ("Reserve Analysis"), composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and portfolio and general economic conditions. In addition, the rapid commercial loan and lease growth is taken into account.
The Reserve Analysis, used since the inception of our bank and completed monthly, applies reserve allocation factors to outstanding loan and lease balances to calculate an overall allowance dollar amount. For commercial loans and leases, which continue to comprise a vast majority of our total loans, reserve allocation factors are based upon the loan ratings as determined by our loan rating paradigm that is administered by our loan review function. For retail loans, reserve allocation factors are based upon the type of credit. Adjustments for specific loan relationships, including impaired loans, are made on a case-by-case basis. The reserve allocation factors are primarily based on the experience of senior management making similar loans for almost 20 years. The Reserve Analysis is reviewed regularly by senior management and the Board of Directors and is adjusted periodically based upon identifiable trends and experience.
The following table illustrates the breakdown of the allowance balance to loan type (dollars in thousands) and of the total loan and lease portfolio (in percentages).
The primary risk elements with respect to commercial loans and leases are the financial condition of the borrower, the sufficiency of collateral, and lack of timely payment. We have a policy of requesting and reviewing periodic financial statements from commercial loan and lease customers, and we periodically review the existence of collateral and its value. The primary risk element with respect to each instalment and residential real estate loan is lack of timely payment. We have a reporting system that monitors past due loans and have adopted policies to pursue creditor's rights in order to preserve our bank's position.
Although we believe that the allowance is adequate to sustain losses as they arise, there can be no assurance that our bank will not sustain losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.
The securities portfolio also experienced significant growth during 2005, increasing from $153.0 million on December 31, 2004 to $181.6 million at December 31, 2005. During 2005, the securities portfolio equaled 10.7% of average earning assets. We maintain the portfolio at levels to provide adequate pledging for the repurchase agreement program and secondary liquidity for our daily operations. In addition, the portfolio serves a primary interest rate risk management function. At December 31, 2005, the portfolio was comprised of high credit quality U.S. Government Agency issued bonds (35%), municipal general obligation and revenue bonds (33%), U.S. Government Agency issued and guaranteed mortgage-backed securities (27%), Federal Home Loan Bank stock (4%) and a mutual fund (1%).
The following table reflects the composition of the securities portfolio.
All securities, with the exception of tax-exempt municipal bonds, have been designated as "available for sale" as defined in Financial Accounting Standards Board Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Securities designated as available for sale are stated at fair value, with the unrealized gains and losses, net of income tax, reported as a separate component of shareholders' equity in accumulated other comprehensive income. The fair value of securities designated as available for sale at December 31, 2005 and 2004 was $113.0 million and $93.8 million, respectively. The net unrealized loss recorded at December 31, 2005 was $2.2 million, while the net unrealized gain recorded at December 31, 2004 was $0.2 million. All tax-exempt municipal bonds have been designated as "held to maturity" as defined in SFAS No. 115, and are stated at amortized cost. As of December 31, 2005 and 2004, held to maturity securities had an amortized cost of $60.8 million and $52.3 million and a fair value of $62.9 million and $54.6 million, respectively.
The following table shows by class of maturities as of December 31, 2005, the amounts and weighted average yields of investment securities (1):
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent basis.
Federal funds sold, consisting of excess funds sold overnight to correspondent banks, are used to manage daily liquidity needs and interest rate sensitivity. During 2005, the average balance of these funds equaled 0.5% of average earning assets. This level is well within our internal policy guidelines and is not expected to change significantly in the near future.
Cash and due from bank balances increased from $20.7 million at December 31, 2004, to $36.2 million on December 31, 2005, an increase of $15.5 million. The increase was primarily the result of larger amounts of deposits made by our deposit customers on the last business day of 2005 when compared to the last business day of 2004. Our commercial lending and wholesale funding focus results in relatively large day-to-day fluctuations of our cash and due from bank balances; however, relative to our asset size the average balances are generally stable. Cash and due from bank balances averaged $36.8 million, or 2.3% of average assets during 2005, compared to $31.6 million, or 2.4% of average assets, during 2004.
Net premises and equipment increased from $24.6 million at December 31, 2004, to $30.2 million on December 31, 2005, an increase of $5.6 million. The increase primarily reflects the construction costs associated with our new main office facility in downtown Grand Rapids. Construction was completed during the second quarter of 2005.
SOURCE OF FUNDS
Our major sources of funds are from deposits, repurchase agreements and Federal Home Loan Bank ("FHLB") advances. Total deposits increased from $1,159.2 million at December 31, 2004, to $1,419.4 million on December 31, 2005, an increase of $260.2 million, or 22.4%. Included within these numbers is the success we achieved in generating deposit growth from customers located within our market areas during 2005. Local deposits increased from $388.0 million at December 31, 2004, to $456.5 million on December 31, 2005, an increase of $68.5 million, or 17.7%. Despite this success in obtaining funds from local customers, the substantial asset growth has necessitated the continued acquisition of funds from depositors outside of our market areas and FHLB advances. Out-of-area deposits increased from $771.2 million at December 31, 2004, to $962.8 million on December 31, 2005, an increase of $191.6 million, or 24.8%. Repurchase agreements increased from $56.3 million at December 31, 2004, to $72.2 million on December 31, 2005, an increase of $15.9 million, or 28.2%. FHLB advances increased from $120.0 million at December 31, 2004, to $130.0 million on December 31, 2005, an increase of $10.0 million, or 8.3%. At December 31, 2005, local deposits and repurchase agreements equaled 32.6% of total funding liabilities, compared to 33.3% on December 31, 2004.
During 2005 we experienced strong growth in our noninterest-bearing checking deposit accounts. Comprised primarily of business loan customers, noninterest-bearing checking deposit accounts grew $19.1 million, or 18.8%, and equaled 7.2% of average total liabilities during 2005. Interest-bearing checking accounts increased $2.1 million, or 5.7%, and equaled 2.3% of average total liabilities during 2005. Money market deposit accounts decreased $0.2 million, or 1.7%, and equaled 0.6% of average total liabilities during 2005. Business loan customers also comprise the majority of interest-bearing checking and money market deposit accounts, although to a lesser extent than noninterest-bearing checking accounts. Pursuant to Federal law and regulations, incorporated businesses may not own interest-bearing checking accounts and transactions from money market accounts are limited. We anticipate continued overall growth of our check-writing deposit accounts as additional business loans are extended and through the efforts of our branch network and business development activities.
During 2005, savings account balances recorded a decrease of $23.1 million, or 17.9%, and equaled 7.3% of average total liabilities. The decline in savings account balances during 2005 is primarily due to customers opening certificates of deposit with funds from their savings accounts, as rates offered on certificates of deposit have risen at a faster pace than rates offered on savings accounts. Business loan customers also comprise the majority of savings account holders, although to a lesser extent than check-writing accounts. While we anticipate an increase in savings account balances as additional business loans are extended and through the efforts of our branch network and business development activities, the increase may be negatively impacted by potential continued fund transfers to certificate of deposit products.
Certificates of deposit purchased by customers located within our market areas increased significantly during 2005, growing from $108.7 million at December 31, 2004, to $179.3 million on December 31, 2005, an increase of $70.6 million, or 64.9%. These deposits accounted for 9.0% of average total liabilities during 2005. The growth was primarily attributable to individuals and municipalities, and includes new monies to our bank from existing and new customers as well as transfers from existing savings accounts. The increase in local municipality certificates of deposit has been facilitated by our qualifying for funds from new municipal customers and additional funds from existing customers through a combination of our asset growth and increased profitability as measured by the municipalities' investment policy guidelines, and is a trend that we expect to continue.
During 2005, certificates of deposit obtained from customers located outside of our market areas increased by $191.6 million, and represented 57.7% of average total liabilities. At December 31, 2005, out-of-area deposits totaled $962.8 million. Out-of-area deposits consist primarily of certificates of deposit placed by deposit brokers for a fee, but also include certificates of deposit obtained from the deposit owners directly. The owners of the out-of-area deposits include individuals, businesses and governmental units located throughout the country. Out-of-area deposits are utilized to support our asset growth, and are generally a lower cost source of funds when compared to the interest rates that would have to be offered in the local market to generate a sufficient level of funds. During most of 2005, rates paid on new out-of-area deposits were very similar to rates paid on new certificates of deposit issued to local customers. In addition, the overhead costs associated with the out-of-area deposits are considerably less than the overhead costs that would be incurred to administer a similar level of local deposits. Although local deposits have and are expected to increase as new business, governmental and consumer deposit relationships are established and as existing customers increase the balances in their deposit accounts, the relatively high reliance on out-of-area deposits will likely remain.
Repurchase agreements increased $15.9 million and equaled 3.9% of average total liabilities during 2005. As part of our sweep account program, collected funds from certain business noninterest-bearing checking accounts are invested in overnight interest-bearing repurchase agreements. Although not considered a deposit account and therefore not afforded federal deposit insurance, the repurchase agreements have characteristics very similar to that of an interest-bearing checking deposit account.
FHLB advances increased $10.0 million and equaled 8.4% of average total liabilities during 2005. FHLB advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit at December 31, 2005 totaled $205.8 million. We first started to use FHLB advances in late 2002, and expect to continue to use this funding source, along with out-of-area certificates of deposit, as part of our wholesale funding program.
Shareholders' equity increased $13.5 million and equaled 8.7% of average assets during 2005. The increase was primarily attributable to net income from operations. Net income from operations totaled $17.9 million during 2005. Negatively impacting shareholders' equity during 2005 was the payment of cash dividends, which totaled $3.2 million. Also negatively impacting shareholders' equity was a $1.5 million mark-to-market adjustment for available for sale securities as defined in SFAS No. 115.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
SUMMARY
We recorded strong earnings performance during 2005. Net income was $17.9 million, or $2.36 per basic share and $2.31 per diluted share. This earnings performance compares favorably to net income of $13.7 million, or $1.82 per basic share and $1.78 per diluted share, recorded in 2004. The $4.2 million improvement in net income represents an increase of 30.5%, while diluted earnings per share were up 29.8%. The earnings improvement during 2005 over that of 2004 is primarily attributable to higher net interest income and a lower provision expense, which more than offset an increase in overhead costs.
Net income for 2004 includes an $845,000 ($548,000 after-tax) write-off associated with the unamortized balance of issuance costs related to the redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. Excluding this one-time expense, net income for 2004 was $14.3 million ($1.89 per basic share and $1.85 per diluted share). We believe excluding the impact of the one-time charge from 2004 operating results and performance measures allows a more meaningful comparison of 2005 results to 2004 results; therefore, the following discussion of our results of operations for the years ended December 31, 2005 and December 31, 2004 includes both GAAP and non-GAAP facts and figures where appropriate.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2005 and 2004.
NET INTEREST INCOME
Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings. Interest income (adjusted for tax-exempt income) and interest expense totaled $103.2 million and $46.8 million during 2005, respectively, providing for net interest income of $56.4 million. This performance compares favorably to that of 2004 when interest income and interest expense were $70.0 million and $26.6 million, respectively, providing for net interest income of $43.4 million. In comparing 2005 with 2004, interest income increased 47.4%, interest expense was up 76.0% and net interest income increased 30.0%. The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types of assets and liabilities, interest rate risk, common stock sales, liquidity, and customer behavior also impact net interest income as well as the net interest margin. The net interest margin improved from 3.30% in 2004 to 3.50% in 2005, an increase of 6.1%, primarily due to earning assets repricing faster than interest-bearing liabilities during the increasing interest rate environment that existed during virtually all of 2005.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets, liabilities and shareholders' equity during 2005, 2004 and 2003 (dollars in thousands). The table also depicts the dollar amount of change in interest income and interest expense of interest-earning assets and interest-bearing liabilities, segregated between change due to volume and change due to rate. For tax-exempt investment securities, interest income and yield have been computed on a tax equivalent basis using a marginal tax rate of 35%. Securities interest income was increased by $1.1 million, $1.0 million and $0.8 million in 2005, 2004 and 2003, respectively.
Interest income is primarily generated from the loan portfolio, and to a lesser degree from securities, federal funds sold and short term investments. Interest income increased $33.3 million during 2005 from that earned in 2004, totaling $103.2 million in 2005 compared to $70.0 million in the previous year. The increase is primarily due to the growth in earning assets and a higher interest rate environment during 2005 when compared to 2004. Reflecting the higher interest rates, the yield on average earning assets increased from 5.32% recorded in 2004 to 6.40% in 2005.
The growth in interest income is primarily attributable to an increase in earning assets and an increase in earning asset yields. During 2005, average earning assets increased $298.9 million, increasing from $1,314.5 million in 2004 to $1,613.4 million during 2005. Growth in average total loans and leases, totaling $255.0 million, comprised 85.3% of the increase in average earning assets during 2005. Interest income generated from the loan and lease portfolio increased $30.9 million during 2005 over the level earned in 2004, comprised of an increase of $15.1 million from the growth in the loan and lease portfolio and an increase of $15.8 million due to the increase in the yield earned on the loan portfolio to 6.54% from 5.33%. The increase in the loan and lease portfolio yield is primarily due to a higher interest rate environment during 2005 than in 2004.
Growth in the securities portfolio, partially offset by a slightly lower yield, also added to the increase in interest income during 2005 over that of 2004. Average securities increased by $41.7 million in 2005, increasing from $130.4 million in 2004 to $172.1 million in 2005. The growth equated to an increase in interest income of $2.2 million, while a decrease in the yield earned on the securities portfolio from 5.45% to 5.40% reduced interest income by $0.1 million. Interest income earned on federal funds sold increased by $0.2 million due to a small increase in the average balance and a higher yield during 2005.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree from repurchase agreements, FHLB advances and subordinated debentures. Interest expense increased $20.2 million during 2005 from that expensed in 2004, totaling $46.8 million in 2005 compared to $26.6 million in the previous year. The increase in interest expense is primarily attributable to the impact of an increase in interest-bearing liabilities and a higher interest rate environment during 2005 when compared to 2004. Interest-bearing liabilities averaged $1,429.2 million during 2005, or $282.7 million higher than the average interest-bearing liabilities of $1,146.5 million during 2004. This growth resulted in increased interest expense of $8.5 million. An increase in interest expense of $11.7 million was recorded during 2005 primarily due to a higher interest rate environment during 2005 than in 2004. The cost of average interest-bearing liabilities increased from the 2.32% recorded in 2004 to 3.28% in 2005.
Growth in average certificates of deposits, totaling $255.6 million, comprised 90.4% of the increase in average interest-bearing liabilities between 2005 and 2004. Average FHLB advances increased $18.2 million, or 6.4% of the increase in average interest-bearing liabilities in 2005. The certificate of deposit growth during 2005 equated to an increase in interest expense of $7.2 million, with an additional $9.1 million expensed due to the increase in the average rate paid as lower-rate certificates of deposit matured and were either renewed or replaced with higher-costing certificates of deposit during most of 2005. FHLB advance growth during 2005 equated to an increase in interest expense of $0.4 million, with an increased average rate adding an additional $1.3 million to interest expense.
A decline in average savings deposits, totaling $22.3 million, equated to a decrease in interest expense of $0.5 million; however, interest expense of $0.9 million was recorded due to an increase in the average rate paid during 2005. Growth in average interest-bearing checking accounts of $3.3 million equated to a less than $0.1 million increase in interest expense, with an additional $0.2 million of interest expense recorded due to a higher average rate paid during 2005. Average short term borrowings, comprised of repurchase agreements and federal funds purchased, increased $11.0 million during 2005, resulting in increased interest expense of $0.2 million, with an additional interest expense of $0.7 million recorded due to an increase in the average rate paid during 2005.
Growth of $16.1 million in average long-term borrowings, comprised primarily of subordinated debentures but also including deferred director and officer compensation programs, equated to an increase in interest expense of $1.0 million during 2005; however, a decline in the average rate paid on subordinated debentures resulting from the September 2004 refinance, equated to a $0.5 million reduction of interest expense during 2005.
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses totaled $3.8 million during 2005, compared to the $4.7 million expensed during 2004. The decline primarily reflects lower loan and lease growth and a decline in the volume of loan and lease net charge-offs during 2005 when compared to 2004. The allowance as a percentage of total loans outstanding as of December 31, 2005 was 1.31%, compared to 1.35% at year-end 2004. Loan and lease growth during 2005 equaled $244.7 million, compared to loan and lease growth of $281.2 million during 2004. Net loan and lease charge-offs during 2005 totaled $1.1 million, or 0.08% of average total loans and leases. Net loan and lease charge-offs during 2004 totaled $1.2 million, or 0.10% of average total loans and leases.
In each accounting period the allowance for loan and lease losses ("allowance") is adjusted to the amount believed necessary to maintain the allowance at adequate levels. Through the loan review and credit departments, we attempt to allocate specific portions of the allowance based on specifically identifiable problem loans and leases. The evaluation of the allowance is further based on, although not limited to, consideration of the internally prepared Loan Loss Reserve Analysis ("Reserve Analysis"), composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and portfolio and general economic conditions. In addition, the rapid commercial loan and lease growth is taken into account.
The Reserve Analysis, used since the inception of our bank and completed monthly, applies reserve allocation factors to outstanding loan and lease balances to calculate an overall allowance dollar amount. For commercial loans and leases, which continue to comprise a vast majority of our total loans, reserve allocation factors are based upon the loan ratings as determined by our loan rating paradigm that is administered by our loan review function. For retail loans, reserve allocation factors are based upon the type of credit. Adjustments for specific loan relationships, including impaired loans, are made on a case-by-case basis. The reserve allocation factors are primarily based on the experience of senior management making similar loans for almost 20 years. The Reserve Analysis is reviewed regularly by senior management and the Board of Directors and is adjusted periodically based upon identifiable trends and experience.
NONINTEREST INCOME
Noninterest income totaled $5.7 million in 2005, an increase of $1.4 million from the $4.3 million earned in 2004. Deposit and repurchase agreement service charges increased $0.1 million in 2005, primarily reflecting the growth in the number of deposit accounts and modest increases in the deposit fee structure. The cash surrender value of bank owned life insurance policies increased $0.3 million in 2005, primarily reflecting a higher balance from the purchase of additional policies during the year. Primarily reflecting an increase in volume of activity, residential mortgage banking fees increased $0.2 million during 2005. Other noninterest income includes a gain of $0.7 million which was recognized during 2005 from the sale of state tax credits derived from the construction of the new main office in downtown Grand Rapids.
NONINTEREST EXPENSE
Noninterest expense during 2005 totaled $31.1 million, an increase of $7.9 million over the $23.2 million expensed in 2004. Noninterest expense during 2004 includes an $845,000 write-off associated with the unamortized balance of issuance costs related to the redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by the MBWM Capital Trust I. Excluding this one-time write-off, noninterest expense during 2004 totaled $22.4 million, with the growth in overhead costs during 2005 equating to $8.7 million.
Of the $8.7 million growth in overhead costs, $4.7 million (54.0%) was in salaries and benefits, which primarily reflects the increase in full-time equivalent employees from 194 at year-end 2004 to 273 at year-end 2005 and annual pay increases. Occupancy, furniture and equipment costs increased $1.6 million (18.4% of total) in 2005, primarily reflecting the opening of our Holland banking office in October of 2004, the opening of our new main office in downtown Grand Rapids during the second quarter of 2005, the opening of our new leased facilities in Lansing and Ann Arbor during the third quarter of 2005 and our increased staffing level.
While the dollar volume of noninterest costs has increased, the growth of net interest income and fee income has increased by a much higher degree. Noninterest costs during 2005 were $8.7 million higher than the level of overhead costs expensed during 2004; however, net interest income and fee income increased a combined $14.2 million during the same time period. Monitoring and controlling our noninterest costs, while at the same time providing high quality service to our customers, is one of our priorities. The efficiency ratio, a banking industry standardized calculation that attempts to reflect the utilization of overhead costs, declined during 2004 but remained well below banking industry averages. Computed by dividing noninterest expenses by net interest income plus noninterest income, the efficiency ratio was 51.1% during 2005, compared to 49.6% during 2004. If the one-time write-off addressed above is excluded from the calculation, our 2004 efficiency ratio improves to 47.8%. The decline in the efficiency ratio is primarily related to the initial overhead costs associated with our expansion into Lansing and Ann Arbor, especially salary and benefit and occupancy expenses.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $8.1 million in 2005, an increase of $3.0 million over the $5.1 million expensed during 2004. The increase during 2005 is primarily due to the growth in our pre-federal income tax profitability and an increase in the effective tax rate, the latter of which reflects a lower level of tax-exempt income as a percent of total income.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
SUMMARY
We recorded strong earnings performance during 2004. Net income was $13.7 million, or $1.82 per basic share and $1.78 per diluted share. This earnings performance compares favorably to net income of $10.0 million, or $1.57 per basic share and $1.53 per diluted share, recorded in 2003. The $3.7 million improvement in net income represents an increase of 37.0%, while diluted earnings per share were up 16.1%, with the difference primarily reflecting the impact of our common stock sale during 2003 and resulting increases in average common shares outstanding during 2004. The earnings improvement during 2004 over that of 2003 is primarily attributable to increased net interest income and improved operating efficiencies resulting from asset growth, strong credit culture and controlled overhead expenses.
Net income for 2004 includes an $845,000 ($548,000 after-tax) write-off associated with the unamortized balance of issuance costs related to the redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. Excluding this one-time expense, net income for 2004 was $14.3 million ($1.89 per basic share and $1.84 per diluted share), which represents a 42.5% increase over net income of $10.0 million ($1.57 per basic share and $1.53 per diluted share) recorded during 2003. We believe excluding the impact of the one-time charge from 2004 operating results and performance measures allows a more meaningful comparison of 2004 results to 2003 results; therefore, the following discussion of our results of operations for the years ended December 31, 2004 and December 31, 2003 includes both GAAP and non-GAAP facts and figures where appropriate.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2004 and 2003.
NET INTEREST INCOME
Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings. Interest income (adjusted for tax-exempt income) and interest expense totaled $70.0 million and $26.6 million during 2004, respectively, providing for net interest income of $43.4 million. This performance compares favorably to that of 2003 when interest income and interest expense were $55.5 million and $23.4 million, respectively, providing for net interest income of $32.1 million. In comparing 2004 with 2003, interest income increased 26.2%, interest expense was up 13.7% and net interest income increased 35.3%. The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types of assets and liabilities, interest rate risk, common stock sales, liquidity, and customer behavior also impact net interest income as well as the net interest margin. The net interest margin improved from 3.21% in 2003 to 3.30% in 2004, an increase of 2.8%.
Interest income is primarily generated from the loan portfolio, and to a lesser degree from securities, federal funds sold and short term investments. Interest income increased $14.5 million during 2004 from that earned in 2003, totaling $70.0 million in 2004 compared to $55.5 million in the previous year. The increase is primarily due to the growth in earning assets, which more than offset the impact of a lower interest rate environment during 2004 when compared to 2003. Reflecting the lower interest rates, the yield on average earning assets decreased from 5.55% recorded in 2003 to 5.32% in 2004.
The growth in interest income is primarily attributable to an increase in earning assets. During 2004, earning assets averaged $1,314.5 million, a level substantially higher than the average earning assets of $998.6 million during 2003. Growth in average total loans and leases, totaling $290.1 million, comprised 91.8% of the increase in average earnings assets during 2004. Interest income generated from the loan and lease portfolio increased $13.1 million during 2004 over the level earned in 2003, comprised of an increase of $15.6 million from the growth in the loan and lease portfolio which was partially offset by a decrease of $2.5 million due to the decline in the yield earned on the loan portfolio to 5.33% from 5.60%. The decline in the loan and lease portfolio yield is primarily due to lower market interest rates during 2004 than in 2003, and a higher percentage of loans and leases at the lower floating rate pricing arrangement versus a higher fixed interest rate arrangement.
Growth in the securities portfolio, combined with a slight increase in yield, also added to the increase in interest income during 2004 over that of 2003. Average securities increased by $24.7 million in 2004, increasing from $105.7 million in 2003 to $130.4 million in 2004. The growth equated to an increase in interest income of $1.3 million, while an increase in the yield earned on the securities portfolio from 5.40% to 5.45% added an additional $0.1 million to interest income. Interest income earned on federal funds sold increased by $18,000 due to a $0.9 million increase in the average balance and a slightly higher yield during 2004.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree from repurchase agreements, FHLB advances and subordinated debentures. Interest expense increased $3.2 million during 2004 from that paid in 2003, totaling $26.6 million in 2004 compared to $23.4 million in the previous year. The increase in interest expense is primarily attributable to the impact of an increase in interest-bearing liabilities during 2004, which was only partially offset by a lower interest rate environment during 2004 when compared to 2003. Interest-bearing liabilities averaged $1,146.5 million during 2004, a level substantially higher than the average interest-bearing liabilities of $885.4 million during 2003. This growth resulted in increased interest expense of $6.0 million. A decrease in interest expense of $2.8 million was recorded during 2004 due to lower interest rates on certificates of deposit and subordinated debentures, which more than offset the impact of higher interest rates on all other interest-bearing liabilities. The cost of average interest-bearing liabilities decreased from the 2.64% recorded in 2003 to 2.32% in 2004.
Growth in average certificates of deposits, totaling $128.7 million, comprised 49.3% of the increase in average interest-bearing liabilities between 2004 and 2003. Average FHLB advances increased $66.2 million, or 25.4% of the increase in average interest-bearing liabilities. The certificate of deposit growth during 2004 equated to an increase in interest expense of $3.3 million; however, a decrease in interest expense of $2.8 million was recorded due to the decline in the average rate paid as higher-rate certificates of deposit matured and were either renewed or replaced with lower-costing certificates of deposit during most of 2004. FHLB advance growth during 2004 equated to an increase in interest expense of $1.4 million, with an increased average rate adding an additional $0.1 million to interest expense.
Growth in average savings deposits, totaling $53.5 million, equated to an increase in interest expense of $1.0 million, with an additional interest expense of $0.1 million recorded due to an increase in the average rate paid during 2004. Growth in average interest-bearing checking accounts and money market accounts, totaling a combined $4.9 million, equated to an increase in interest expense of $0.1 million, with only a nominal amount of additional interest expense recorded due to a slightly higher average rate paid during 2004. Average short term borrowings, comprised of repurchase agreements and federal funds purchased, increased $6.3 million during 2004, resulting in increased interest expense of $0.1 million, with an additional interest expense of $0.1 million recorded due to an increase in the average rate paid during 2004.
Growth of $1.5 million in average long-term borrowings, comprised primarily of subordinated debentures but also including deferred director and officer compensation programs, equated to an increase in interest expense of $0.1 million during 2004; however, a decline in the average rate paid on subordinated debentures resulting from the September 2004 refinance equated to a $0.3 million reduction of interest expense during 2004.
PROVISION FOR LOAN AND LEASE LOSSES
Primarily reflecting continued loan and lease growth, combined with an increase in net loan and lease losses, the provision for loan and lease losses totaled $4.7 million during 2004, compared to the $3.8 million expensed during 2003. The allowance as a percentage of total loans outstanding as of December 31, 2004 was 1.35%, compared to 1.39% at year-end 2003. Loan and lease growth during 2004 equaled $281.2 million, compared to loan and lease growth of $264.4 million during 2003. Net loan and lease charge-offs during 2004 totaled $1.2 million, or 0.10% of average total loans and leases. Net loan and lease charge-offs during 2003 totaled $0.3 million, or 0.04% of average total loans and leases.
In each accounting period the allowance is adjusted to the amount believed necessary to maintain the allowance at adequate levels. Through the loan review and credit departments, we attempt to allocate specific portions of the allowance based on specifically identifiable problem loans and leases. The evaluation of the allowance is further based on, although not limited to, consideration of the internally prepared Reserve Analysis, composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and portfolio and general economic conditions. In addition, the rapid commercial loan and lease growth is taken into account.
The Reserve Analysis, used since the inception of our bank and completed monthly, applies reserve allocation factors to outstanding loan and lease balances to calculate an overall allowance dollar amount. For commercial loans and leases, which continue to comprise a vast majority of our total loans, reserve allocation factors are based upon the loan ratings as determined by our loan rating paradigm that is administered by our loan review function. For retail loans, reserve allocation factors are based upon the type of credit. Adjustments for specific loan relationships, including impaired loans, are made on a case-by-case basis. The reserve allocation factors are primarily based on the experience of senior management making similar loans for almost 20 years. The Reserve Analysis is reviewed regularly by senior management and the Board of Directors and is adjusted periodically based upon identifiable trends and experience.
NONINTEREST INCOME
Noninterest income totaled $4.3 million in 2004, a slight decline from the $4.4 million earned in 2003. Increased fee income on virtually all non-mortgage-related products and services was just shy of offsetting a large decline in residential mortgage-related fee income. Deposit and repurchase agreement service charges increased $0.1 million in 2004 from the amount earned in 2003, primarily reflecting the growth in the number of deposit accounts and modest increases in the deposit fee structure which was partially offset by a lower deposit earnings credit rate during 2004. Fees on commercial letters of credit increased during 2004 when compared to 2003, although the increase generally reflects the change in recognizing the fees that occurred in early 2003 whereby fees had to be recognized into income over the life of the letter of credit instead of immediately upon issuing the letter of credit, rather than an increase in the level of letters of credit outstanding. Reflecting a decrease in volume of refinance activity resulting from a higher interest rate environment, fees earned on referring residential mortgage loan applicants to various third parties totaled $0.4 million in 2004, down from the $1.0 million earned in 2003. Aggregate net gains on the sale of loans and securities during 2004 virtually equaled the level of net gains on the sale of loans and securities during 2003.
NONINTEREST EXPENSE
Noninterest expense during 2004 totaled $23.2 million, an increase of 28.4% over the $18.1 million expensed in 2003. Of the $5.1 million growth in overhead costs, $2.6 million (51.0%) was in salaries and benefits, which primarily reflects the increase in full-time equivalent employees from 161 at year-end 2003 to 194 at year-end 2004 and annual pay increases. Occupancy, furniture and equipment costs increased $0.3 million (11.9%) in 2004 over that expensed in 2003, primarily reflecting the opening of our Holland banking office in October of 2004 and our increased staffing level.
Noninterest expense during 2004 includes an $845,000 write-off associated with the unamortized balance of issuance costs related to the redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by the MBWM Capital Trust I. Excluding this one-time write-off, noninterest expense during 2004 totaled $22.4 million, an increase of 23.7% over the $18.1 million expensed in 2003.
While the dollar volume of noninterest costs has increased, the growth of net interest income and fee income has increased by a much higher degree. Noninterest costs during 2004 were $5.1 million higher than the level of overhead costs expensed during 2003; however, net interest income and fee income increased a combined $11.1 million during the same time period. Monitoring and controlling our noninterest costs, while at the same time providing high quality service to our customers, is one of our priorities. The efficiency ratio, a banking industry standardized calculation that attempts to reflect the utilization of overhead costs, reflected improvement during 2004 and remained well below banking industry averages. Computed by dividing noninterest expenses by net interest income plus noninterest income, the efficiency ratio was 49.6% during 2004, compared to 50.7% during 2003. If the one-time write-off addressed above is excluded from the calculation, our 2004 efficiency ratio improves to 47.8%.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $5.1 million in 2004, an increase of $1.4 million, or 35.7% over the $3.8 million expensed during 2003. The increase is primarily due to the growth in our pre-federal income tax profitability. Our effective tax rate in 2004 was 27.2%, compared to 27.4% in 2003.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides support for our asset growth. Shareholders' equity was $155.1 million and $141.6 million at December 31, 2005 and 2004, respectively. The $13.5 million increase during 2005 is primarily attributable to net income from operations. Net income from operations totaled $17.9 million during 2005. Negatively impacting shareholders' equity during 2005 was the payment of cash dividends, which totaled $3.2 million. Also negatively impacting shareholders' equity was a $1.5 million mark-to-market adjustment for available for sale securities as defined in SFAS No. 115.
We and our bank are subject to regulatory capital requirements administered by the State of Michigan and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Our and our bank's capital ratios as of December 31, 2005 and 2004 are disclosed under Note 16 on pages and of the Notes to Consolidated Financial Statements.
Our ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On July 6, 2005, we declared a 5% common stock dividend, payable on August 1, 2005 to record holders as of July 18, 2005. This represented the fifth straight year we had declared and paid a 5% stock dividend. Also, during 2005, we paid a cash dividend on our common stock each calendar quarter. These cash dividends totaled $0.43 per share for 2005, and $3.2 million in aggregate amount. On January 10, 2006, we declared a $0.12 per common share cash dividend that will be paid on March 10, 2006 to shareholders of record on February 10, 2006.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment of loans and investment securities. These funds are used to meet deposit withdrawals, maintain reserve requirements, fund loans and operate our company. Liquidity is primarily achieved through the growth of deposits (both local and out-of-area) and liquid assets such as securities available for sale, matured securities, and federal funds sold. Asset and liability management is the process of managing the balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.
Our liquidity strategy is to fund loan growth with deposits, repurchase agreements and other borrowed funds and to maintain an adequate level of short- and medium-term investments to meet typical daily loan and deposit activity. Although net deposit and repurchase agreement growth from depositors located in our market areas increased by $84.4 million, or 19.0%, during 2005, the growth was not sufficient to meet the substantial loan growth of $244.7 million and provide monies for additional investing activities. To assist in providing the additional needed funds, we regularly obtained certificates of deposit from customers outside of our market areas. As of December 31, 2005, out-of-area deposits totaled $962.4 million, or 64.6% of combined deposits and repurchase agreements, an increase in dollar volume from the $771.2 million outstanding, and an increase from the 63.4% level of combined deposits and repurchase agreements, as of December 31, 2004.
As a member of the Federal Home Loan Bank of Indianapolis, our bank has access to the FHLB advance borrowing programs. As of December 31, 2005, advances totaled $130.0 million, compared to $120.0 million outstanding as of December 31, 2004. Our borrowing line of credit at December 31, 2005 totaled $205.8 million, with availability of approximately $64.1 million.
We have the ability to borrow money on a daily basis through correspondent banks using established federal funds purchased lines. During 2005, our federal funds purchased position averaged $6.1 million, compared to an average federal funds sold position of $8.2 million. At December 31, 2005, our established unsecured federal funds purchased lines totaled $62.0 million.
The following table reflects, as of December 31, 2005, significant fixed and determinable contractual obligations to third parties by payment date.
In addition to normal loan funding and deposit flow, we also need to maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. At December 31, 2005, we had a total of $433.0 million in unfunded loan commitments and $59.0 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $349.7 million were commitments available as lines of credit to be drawn at any time as customers' cash needs vary, and $83.3 million were for loan commitments scheduled to close and become funded within the next twelve months. We monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.
The following table depicts our loan commitments at the end of the past three years.
MARKET RISK ANALYSIS
Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates. We derive our income primarily from the excess of interest collected on interest-earning assets over the interest paid on interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk we assess the existing and potential future effects of changes in interest rates on our financial condition, including capital adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest-sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to the net interest margin during periods of changing market interest rates.
The following table depicts our GAP position as of December 31, 2005 (dollars in thousands).
(1) Floating rate loans that are currently at interest rate ceilings are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.
(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2005.
The following table depicts our GAP position as of December 31, 2004 (dollars in thousands).
(1) Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.
(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2004.
The second interest rate risk measurement used is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, it serves as our primary interest rate risk measurement technique. The simulation model assesses the direction and magnitude of variations in net interest income resulting from potential changes in market interest rates. Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest-sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment; therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions and our strategies, among other factors.
We conducted multiple simulations as of December 31, 2005, in which it was assumed that changes in market interest rates occurred ranging from up 200 basis points to down 200 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested impact on net interest income over the next twelve months, which is well within our policy parameters established to manage and monitor interest rate risk.
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; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders Mercantile Bank Corporation Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of Mercantile's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercantile Bank Corporation as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Mercantile Bank Corporation's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 23, 2006 expressed an unqualified opinion thereon.
/s/ Crowe Chizek and Company LLC ---------------------------------------- Crowe Chizek and Company LLC
Grand Rapids, Michigan February 23, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders Mercantile Bank Corporation Grand Rapids, Michigan
We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Mercantile Bank Corporation maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Mercantile Bank Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Mercantile Bank Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Mercantile Bank Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Mercantile Bank Corporation and our report dated February 23, 2006 expressed an unqualified opinion on those consolidated financial statements.
/s/ Crowe Chizek and Company LLC ---------------------------------------- Crowe Chizek and Company LLC
Grand Rapids, Michigan February 23, 2006
February 23, 2006
REPORT BY MERCANTILE BANK CORPORATION'S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting presented in conformity with generally accepted accounting principles. The system contains monitoring mechanisms, and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Management assessed the Company's systems of internal control over financial reporting presented in conformity with generally accepted principles as of December 31, 2005. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2005, Mercantile Bank Corporation maintained effective control over financial reporting presented in conformity with generally accepted accounting principles based on those criteria.
The Company's independent auditors have issued an audit report on our assessment of the Company's internal control over financial reporting.
Mercantile Bank Corporation
/s/ Gerald R. Johnson, Jr. - ------------------------------------- Gerald R. Johnson, Jr. Chairman and Chief Executive Officer
/s/ Charles E. Christmas - ------------------------------------- Charles E. Christmas Senior Vice President - Chief Financial Officer
MERCANTILE BANK CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 2005 and 2004
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2005, 2004 and 2003
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years ended December 31, 2005, 2004 and 2003
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued) Years ended December 31, 2005, 2004 and 2003
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2005, 2004 and 2003
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the accounts of Mercantile Bank Corporation ("Mercantile") and its subsidiary, Mercantile Bank of Michigan ("Bank"), and of Mercantile Bank Mortgage Company, LLC ("Mortgage Company"), Mercantile BIDCO, Inc. ("Mercantile BIDCO"), Mercantile Bank Real Estate Co., L.L.C. ("Mercantile Real Estate") and Mercantile Insurance Center, Inc. ("Mercantile Insurance"), subsidiaries of our bank, after elimination of significant intercompany transactions and accounts.
Mercantile Bank Capital Trust I ("Mercantile Trust"), a business trust formed by the company, was incorporated in 2004 for the purpose of issuing Series A and Series B Preferred Securities. On September 16, 2004, the Mercantile Trust sold the Series A Preferred Securities in a private sale for $16.0 million, and also sold $495,000 of Series A Common Securities to Mercantile. The proceeds of the Series A Preferred Securities and the Series A Common Securities were used by Mercantile Trust to purchase $16,495,000 of Series A Floating Rate Notes that were issued by Mercantile on September 16, 2004. Mercantile used the proceeds of the Series A Floating Rate Notes to finance the redemption on September 17, 2004 of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. On December 10, 2004, Mercantile Trust sold the Series B Preferred Securities in a private sale for $16.0 million, and also sold $495,000 of Series B Common Securities to Mercantile. The proceeds of the Series B Preferred Securities and the Series B Common Securities were used by Mercantile Trust to purchase $16,495,000 of Series B Floating Rate Notes that were issued by Mercantile on December 10, 2004. Substantially all of the net proceeds of the Series B Floating Rate Notes were contributed to the Bank as capital to provide support for asset growth, fund investments in loans and securities and for general corporate purposes.
The only significant assets of Mercantile Trust are the Series A and Series B Floating Rate Notes, and the only significant liabilities of Mercantile Trust are the Series A and Series B Preferred Securities. The Series A and Series B Floating Rate Notes are categorized on the company's consolidated balance sheet as subordinated debentures and the interest expense is recorded on the company's consolidated statement of income under interest expense on long-term borrowings.
Nature of Operations: Mercantile was incorporated on July 15, 1997 to establish and own the Bank based in Grand Rapids, Michigan. The Bank is a community-based financial institution. The Bank began operations on December 15, 1997. The Bank's primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial loans, commercial leases, residential mortgage loans, and instalment loans. Substantially all loans and leases are secured by specific items of collateral including business assets, real estate and consumer assets. Commercial loans and leases are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by both commercial and residential real estate. The Bank's loan accounts are primarily with customers located in the Grand Rapids, Holland, Lansing and Ann Arbor metropolitan areas. The Bank's retail deposits are also from customers located within those areas. As an alternative source of funds, the Bank has also issued certificates to depositors outside of the Bank's primary market areas. Substantially all revenues are derived from banking products and services and investment securities.
Mercantile Trust was formed during 2004. All of the common securities of this special purpose trust are owned by Mercantile. Mercantile Trust exists solely to issue capital securities.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Mercantile Bank Mortgage Company was formed during 2000. A subsidiary of the Bank, Mercantile Bank Mortgage Company had been established to increase the profitability and efficiency of the mortgage loan operations. Mercantile Bank Mortgage Company initiated business on October 24, 2000 via the Bank's contribution of most of its residential mortgage loan portfolio and participation interests in certain commercial mortgage loans. On the same date the Bank also transferred its residential mortgage origination function to Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile Bank Mortgage Company was reorganized as Mercantile Bank Mortgage Company, LLC, a limited liability company, which is 99% owned by the Bank and 1% owned by Mercantile Insurance. Mortgage loans originated and held by the Mercantile Bank Mortgage Company are serviced by the Bank pursuant to a servicing agreement.
On February 7, 2002, Mercantile BIDCO, a wholly-owned subsidiary of the Bank, was granted a license by the Michigan Office of Financial and Insurance Services to operate as a Michigan Business and Industrial Development Company, a non-depository Michigan financial institution. Mercantile BIDCO offered equipment lease financing, asset based loans, junior debt facilities and other financing where equity features may be part of the facility pricing. At our request the license was rescinded and the BIDCO was dissolved in late 2005. The assets of the BIDCO, primarily comprised of two commercial loan relationships, were transferred to our Bank.
Mercantile Insurance was formed during 2002 through the acquisition of an existing shelf insurance agency. Insurance products are offered through an Agency and Institutions Agreement among Mercantile Insurance, the Bank and Hub International. The insurance products are marketed through a central facility operated by the Michigan Bankers Insurance Association, members of which include the insurance subsidiaries of various Michigan-based financial institutions and Hub International. Mercantile Insurance receives commissions based upon written premiums produced under the Agency and Institutions Agreement.
Mercantile Real Estate was organized on July 21, 2003, principally to develop, construct, and own a new facility in downtown Grand Rapids that serves as our bank's main office and Mercantile Bank Corporation's headquarters. This facility was placed into service during the second quarter of 2005.
Mercantile filed an election to become a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board regulations effective March 23, 2000.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan and lease losses and the fair values of financial instruments are particularly subject to change.
Cash Flow Reporting: Cash and cash equivalents include cash on hand, demand deposits with other financial institutions, short-term investments (including securities with daily put provisions) and federal funds sold. Cash flows are reported net for customer loan and deposit transactions, interest-bearing time deposits with other financial institutions and short-term borrowings with maturities of 90 days or less.
Securities: Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold prior to maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Other securities such as Federal Home Loan Bank stock are carried at cost.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Interest income includes amortization of purchase premiums or discounts. Premiums and discounts on securities are amortized 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 trade date and determined using the specific identification method.
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 cost, (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 sufficient to allow for any anticipated recovery in fair value.
Loans and Leases: Loans and leases that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs and an allowance for loan and lease losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.
Interest income on commercial loans and leases and mortgage loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged-off no later than 120 days past due. Past due status is based on the contractual terms of the loan or lease. In all cases, loans and leases are placed on nonaccrual or charged-off at an earlier date if collection of principal and interest is considered doubtful.
All interest accrued but not received for loans and leases placed on nonaccrual is reversed against interest income. Interest received on such loans and leases is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans and leases are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Such loans are sold service released. Residential mortgage banking fees include fees on direct brokered mortgage loans and the net gain on sale of mortgage loans originated for sale.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is a valuation allowance for probable incurred credit losses. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan or lease balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan and lease loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions and other factors. Allocations of the allowance may be made for specific loans and leases, but the entire allowance is available for any loan or lease that, in management's judgment, should be charged-off.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
A loan or lease is considered impaired when, based on current information and events, it is probable the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan or lease and the borrower, including the length of delay, the reasons for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans and leases and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price or the fair value of collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. The Company does not separately identify individual residential and consumer loans for impairment disclosures.
Transfer of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 33 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur and major improvements are capitalized.
Long-term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Foreclosed Assets: Assets acquired through or instead of foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.
Bank Owned Life Insurance: The Bank has purchased life insurance policies on certain key officers. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.
Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Stock Compensation: Employee compensation expense under stock option plans is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement 123, Accounting for Stock-Based Compensation.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
Financial Instruments and Loan Commitments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit that are considered financial guarantees in accordance with FASB Interpretation No. 45, are recorded at fair value.
Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed separately. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments.
Earnings Per Share: Basic earnings per share is based on weighted average common shares outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under stock options. Earnings per share are restated for all stock dividends, including the 5% stock dividends paid on August 1, 2005, May 3, 2004 and February 3, 2003. The fair value of shares issued in stock dividends is transferred from retained earnings to common stock.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.
New Accounting Pronouncements: FAS 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options. This will apply to awards granted or modified in fiscal years beginning 2006. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. Existing options that will vest after adoption date are expected to result in additional compensation expense of approximately $200,000 during 2006, and $27,000 in 2007 and $17,000 in 2008. There will be no significant effect on financial position as total equity will not change.
Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.
Operating Segments: While management monitors the revenue streams of the various products and services offered, the identifiable segments are not material and operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all of Mercantile's financial service operations are considered by management to be aggregated in one reportable operating segment.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 2 - SECURITIES
The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows:
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 2 - SECURITIES (Continued)
Securities with unrealized losses at year-end 2005 and 2004, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows:
We evaluate securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer's financial condition.
At December 31, 2005, $113.4 million in debt securities and a mutual fund have unrealized losses with aggregate depreciation of 2.0% from the amortized cost basis. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to an increasing interest rate environment. As we have the ability to hold debt securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other than temporary.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 2 - SECURITIES (Continued)
The amortized cost and fair values of debt securities at year-end 2005, by contractual maturity, are shown below. The contractual maturity is utilized below for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage backed securities, are shown separately.
The maturities of securities and their weighted average yields at December 31, 2005 are shown in the following table. The yields for municipal securities are shown at their tax equivalent yield.
During 2005, there were no securities sold. During 2004, securities with an aggregate amortized cost basis of $1.7 million were sold, resulting in a gross realized gain of $78,000. During 2003, securities with an aggregate amortized cost basis of $15.7 million were sold, resulting in a gross realized gain of $324,000 and a gross realized loss of $3,000.
At year-end 2005 and 2004, the amortized cost of securities issued by the state of Michigan and all its political subdivisions totaled $60.8 million and $52.3 million, with an estimated market value of $62.9 million and $54.6 million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies, did not exceed 10% of shareholders' equity.
The carrying value of securities that are pledged to repurchase agreements and other deposits was $81.7 million and $70.9 million at December 31, 2005 and 2004, respectively.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 3 - LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Year-end loans and leases are as follows:
Activity in the allowance for loan and lease losses is as follows:
Impaired loans and leases were as follows:
The Bank recognized no interest income on impaired loans during 2005, 2004 or 2003. Nonperforming loans include both smaller balance homogenous loans that are collectively evaluated for impairment and individually classified impaired loans.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 3 - LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Nonperforming loans and leases were as follows:
Concentrations within the loan portfolio were as follows at year-end:
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment are as follows:
Depreciation expense in 2005, 2004 and 2003 totaled $2,043,000, $1,248,000, and $1,162,000, respectively.
We entered into lease arrangements for our banking facilities in East Lansing and Ann Arbor, Michigan during 2005. Rent expense for these two facilities totaled $144,000 during 2005. Minimum rent commitments under the operating leases were as follows, before considering renewal options that generally are present:
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 5 - DEPOSITS
Deposits at year-end are summarized as follows:
Out-of-area certificates of deposit consist of certificates obtained from depositors outside of the primary market area. As of December 31, 2005, out-of-area certificates of deposit totaling $946.9 million were obtained through deposit brokers, with the remaining $15.9 million obtained directly from the depositors.
The following table depicts the maturity distribution for time deposits at year-end.
The following table depicts the maturity distribution for certificates of deposit with balances of $100,000 or more at year-end.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 6 - SHORT-TERM BORROWINGS
Information relating to short-term borrowings, comprised entirely of securities sold under agreements to repurchase, at year-end is summarized below:
Securities sold under agreements to repurchase (repurchase agreements) generally have original maturities of less than one year. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the repurchase agreements are recorded as assets of the Bank and are primarily held in safekeeping by correspondent banks. Repurchase agreements are offered principally to certain large deposit customers as uninsured deposit equivalent investments. Repurchase agreements were secured by securities with a market value of $80.7 million and $69.9 million at year-end 2005 and 2004, respectively.
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows.
Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of the Bank, under a blanket lien arrangement. Our borrowing line of credit as of December 31, 2005 totaled $205.8 million.
Maturities over the next five years are:
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 8 - FEDERAL INCOME TAXES
The consolidated provision for income taxes is as follows:
Income tax expense was less than the amount computed by applying the statutory federal income tax rate to income before income taxes. The reasons for the difference are as follows:
The net deferred tax asset recorded includes the following amounts of deferred tax assets and liabilities:
A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized. Management has determined that no valuation allowance was required at year-end 2005 or 2004.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 9 - STOCK OPTION PLANS
Stock option plans are used to reward directors and employees and provide them with additional equity interest. Stock options granted to non-employee directors are at 125% of the market price on the date of grant, fully vest after five years and expire ten years from the date of grant. Stock options granted to employees are granted at the market price on the date of grant, generally fully vest after one year and expire ten years from the date of grant. Stock options granted to non-executive officers during 2005 vested about three weeks after being granted. At year-end 2005, there were 231,791 shares authorized for future option grants. Information about option grants follows.
A summary of the activity in the plan is as follows.
Options outstanding at year-end 2005 were as follows:
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 9 - STOCK OPTION PLANS (Continued)
Options outstanding at year-end 2005, 2004 and 2003 were as follows:
NOTE 10 - RELATED PARTIES
Certain directors and executive officers of the Bank, including their immediate families and companies in which they are principal owners, were loan customers of the Bank. At year-end 2005 and 2004, the Bank had $14.0 million and $14.2 million in loan commitments to directors and executive officers, of which $8.9 million and $10.2 million were outstanding at year-end 2005 and 2004, respectively, as reflected in the following table.
Related party deposits and repurchase agreements totaled $13.3 million and $15.5 million at year-end 2005 and 2004, respectively.
NOTE 11 - COMMITMENTS AND OFF-BALANCE-SHEET RISK
The 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 the Bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. The 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. The 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, property and equipment, is generally obtained based on management's credit assessment of the borrower. If required, estimated loss exposure resulting from these instruments is expensed and recorded as a liability. The balance of the liability account related to loan commitments was $0.5 million and $0.2 million at year-end 2005 and 2004, respectively.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 11 - COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
At year-end 2005 and 2004, the rates on existing off-balance sheet instruments were substantially equivalent to current market rates, considering the underlying credit standing of the counterparties.
The Bank's maximum exposure to credit losses for loan commitments and standby letters of credit outstanding at year-end was as follows:
Commitments to make loans generally reflect our binding obligations to existing and prospective customers to extend credit, including line of credit facilities secured by accounts receivable and inventory, and term debt secured by either real estate or equipment. In most instances, line of credit facilities are for a one year term and are at a floating rate tied to the prime rate. For term debt secured by real estate, customers are generally offered a floating rate tied to the prime rate and a fixed rate currently ranging from 7.00% to 8.00%. These credit facilities generally balloon within five years, with payments based on amortizations ranging from 10 to 25 years. For term debt secured by non-real estate collateral, customers are generally offered a floating rate tied to the prime rate and a fixed rate currently ranging from 7.00% to 8.00%. These credit facilities generally mature and fully amortize within five years.
The following instruments are considered financial guarantees under FASB Interpretation 45. These instruments are carried at fair value.
The Bank was required to have $8.6 million and $7.7 million of cash on hand or on deposit with the Federal Reserve Bank of Chicago to meet regulatory reserve and clearing requirements at year-end 2005 and 2004, respectively. These balances do not earn interest.
NOTE 12 - BENEFIT PLANS
Mercantile has a 401(k) benefit plan that covers substantially all of its employees. Mercantile's 2005, 2004 and 2003 matching 401(k) contribution charged to expense was $554,000, $413,000 and $327,000, respectively. The percent of Mercantile's matching contributions to the 401(k) is determined annually by the Board of Directors. The 401(k) benefit plan allows employee contributions up to 15% of their compensation, which are matched at 100% of the first 5% of the compensation contributed. Matching contributions are immediately vested.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 12 - BENEFIT PLANS (Continued)
Mercantile has a deferred compensation plan in which all persons serving on the Board of Directors may defer all or portions of their annual retainer and meeting fees, with distributions to be paid only upon termination of service as a director. The deferred amounts are categorized on Mercantile's financial statements as other borrowed money. The deferred balances are paid interest at a rate equal to the prime rate, adjusted at the beginning of each calendar quarter. Interest expense for the plan during 2005, 2004 and 2003 was $43,000, $21,000 and $15,000, respectively.
Mercantile has a non-qualified deferred compensation program in which selected officers may defer all or portions of salary and bonus payments. The deferred amounts are categorized on Mercantile's financial statements as other borrowed money. The deferred balances are paid interest at a rate equal to the prime rate, adjusted at the beginning of each calendar quarter. Interest expense for the plan during 2005, 2004 and 2003 was $79,000, $38,000 and $22,000, respectively.
The Mercantile Bank Corporation Employee Stock Purchase Plan of 2002 ("Stock Purchase Plan") is a non-compensatory plan intended to encourage full- and part-time employees of Mercantile and its subsidiaries to promote the best interests of Mercantile and to align employees' interests with the interests of Mercantile's shareholders by permitting employees to purchase shares of Mercantile common stock through regular payroll deductions. Shares are purchased on the last business day of each calendar quarter at a price equal to the average, rounded to the nearest whole cent, of the highest and lowest sales prices of Mercantile's common stock reported on The Nasdaq Stock Market. Originally, 25,000 shares of common stock may be issued under the Stock Purchase Plan; however, the number of shares has been and may continue to be adjusted in the future to reflect stock dividends and other changes in Mercantile's capitalization. The numbers of shares issued under the Stock Purchase Plan totaled 2,373 and 2,275 in 2005 and 2004, respectively. As of December 31, 2005, there were 22,220 shares available under the Stock Purchase Plan.
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as follows at year-end.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, accrued interest receivable and payable, bank owned life insurance policies, demand deposits, securities sold under agreements to repurchase, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of subordinated debentures and Federal Home Loan Bank advances is based on current rates for similar financing. Fair value of off balance sheet items is estimated to be nominal.
NOTE 14 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow.
Stock options for 6,825, 48,350 and 37,730 shares of common stock were not considered in computing diluted earnings per common share for 2005, 2004 and 2003, respectively, because they were antidilutive.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 15 - SUBORDINATED DEBENTURES
Mercantile Trust, a business trust formed by the company, was incorporated in 2004 for the purpose of issuing Series A and Series B Preferred Securities. On September 16, 2004, Mercantile Trust sold the Series A Preferred Securities in a private sale for $16.0 million, and also sold $495,000 of Series A Common Securities to Mercantile. The proceeds of the Series A Preferred Securities and the Series A Common Securities were used by Mercantile Trust to purchase $16,495,000 of Series A Floating Rate Notes that were issued by Mercantile on September 16, 2004. Mercantile used the proceeds of the Series A Floating Rate Notes to finance the redemption on September 17, 2004 of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. On December 10, 2004, Mercantile Trust sold the Series B Preferred Securities in a private sale for $16.0 million, and also sold $495,000 of Series B Common Securities to Mercantile. The proceeds of the Series B Preferred Securities and the Series B Common Securities were used by Mercantile Trust to purchase $16,495,000 of Series B Floating Rate Notes that were issued by Mercantile on December 10, 2004. Substantially all of the net proceeds of the Series B Floating Rate Notes were contributed to our bank as capital to provide support for asset growth, fund investments in loans and securities and for general corporate purposes.
The only significant assets of Mercantile Trust are the Series A and Series B Floating Rate Notes, and the only significant liabilities of Mercantile Trust are the Series A and Series B Preferred Securities. The Series A and Series B Floating Rate Notes are categorized on the company's consolidated balance sheet as subordinated debentures and the interest expense is recorded on the company's consolidated statement of income under interest expense on long-term borrowings.
NOTE 16 - REGULATORY MATTERS
Mercantile and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is adequately capitalized, regulatory approval is required to accept brokered deposits. If an institution is undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. At year-end 2005 and 2004, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that we believe has changed the Bank's category.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 16 - REGULATORY MATTERS (Continued)
At year end, actual capital levels (in thousands) and minimum required levels for Mercantile and the Bank were:
Federal and state banking laws and regulations place certain restrictions on the amount of dividends the Bank can transfer to Mercantile and on the capital levels that must be maintained. At year-end 2005, under the most restrictive of these regulations (to remain well capitalized), the Bank could distribute approximately $26.9 million to Mercantile as dividends without prior regulatory approval.
The capital levels as of year-end 2005 and 2004 include $32.0 million of trust preferred securities issued by Mercantile Trust in September 2004 and December 2004 subject to certain limitations. Federal Reserve guidelines limit the amount of trust preferred securities which can be included in Tier 1 capital of Mercantile to 25% of total Tier 1 capital. At year-end 2005 and 2004, all $32.0 million of the trust preferred securities were included as Tier 1 capital of Mercantile.
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 17 - OTHER COMPREHENSIVE INCOME/(LOSS)
Other comprehensive income/(loss) components and related taxes were as follows.
NOTE 18 - QUARTERLY FINANCIAL DATA (UNAUDITED)
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 19 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company only financial statements.
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
(Continued)
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004
NOTE 19 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 23, 2006.
MERCANTILE BANK CORPORATION
/s/ Gerald R. Johnson, Jr. ---------------------------------------- Gerald R. Johnson, Jr. Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 23, 2006.
/s/ Betty S. Burton /s/ Susan K. Jones - ------------------------------------- ---------------------------------------- Betty S. Burton, Director Susan K. Jones, Director
/s/ David M. Cassard /s/ Lawrence W. Larsen - ------------------------------------- ---------------------------------------- David M. Cassard, Director Lawrence W. Larsen, Director
/s/ Edward J. Clark /s/ Calvin D. Murdock - ------------------------------------- ---------------------------------------- Edward J. Clark, Director Calvin D. Murdock, Director
/s/ Peter A. Cordes /s/ Michael H. Price - ------------------------------------- ---------------------------------------- Peter A. Cordes, Director Michael H. Price, Director, President and Chief Operating Officer
/s/ C. John Gill /s/ Merle J. Prins - ------------------------------------- ---------------------------------------- C. John Gill, Director Merle J. Prins, Director
/s/ Doyle A. Hayes /s/ Dale J. Visser - ------------------------------------- ---------------------------------------- Doyle A. Hayes, Director Dale J. Visser, Director
/s/ David M. Hecht /s/ Donald Williams, Sr. - ------------------------------------- ---------------------------------------- David M. Hecht, Director Donald Williams, Sr., Director
/s/ Gerald R. Johnson, Jr. /s/ Charles E. Christmas - ------------------------------------- ---------------------------------------- Gerald R. Johnson, Jr., Chairman of Charles E. Christmas, Senior Vice the Board and Chief Executive President, Chief Financial Officer and Officer (principal executive officer) Treasurer (principal financial and accounting officer)
EXHIBIT INDEX
* Management contract or compensatory plan