10-Q 1 mbwm20140930_10q.htm FORM 10-Q mbwm20140930_10q.htm Table Of Contents

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

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

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

 

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

SECURITIES EXCHANGE ACT OF 1934

For the transition period from       to       .

 

Commission File No. 000-26719

 

MERCANTILE BANK CORPORATION

(Exact name of registrant as specified in its charter)

 

Michigan     

 

38-3360865

(State or other jurisdiction of

 

(IRS Employer Identification No.)

incorporation or organization)

 

 

 

      310 Leonard Street, NW, Grand Rapids, MI 49504

(Address of principal executive offices) (Zip Code)

 

(616) 406-3000

(Registrant’s telephone number, including area code)

 

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

Yes   X       No ___

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes   X        No ___

 

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

 

 Large accelerated filer ___

 Accelerated filer X 

 Non-accelerated filer        

 Smaller reporting company __

                         

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

Yes           No   X  

 

At November 7, 2014, there were 16,862,799 shares of common stock outstanding.

 

 

 

MERCANTILE BANK CORPORATION

INDEX

 


 

PART I.

Financial Information

  Page No.
     
 

Item 1. Financial Statements

 
     
 

Condensed Consolidated Balance Sheets - September 30, 2014 (Unaudited) and December 31, 2013

1

     
 

Condensed Consolidated Statements of Income - Three and Nine Months Ended September 30, 2014 (Unaudited) and September 2013 (Unaudited)

2
     
 

Condensed Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2014 (Unaudited) and September 30, 2013 (Unaudited)

3
     
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity - Nine Months Ended September 30, 2014 (Unaudited) and September 30, 2013 (Unaudited)

4
     
 

Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2014 (Unaudited) and September 30, 2013 (Unaudited)

6
     
 

Notes to Condensed Consolidated Financial Statements (Unaudited)

8
     
 

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

63
     
 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

82
     
 

Item 4. Controls and Procedures

85
     

PART II.

Other Information

 
     
 

Item 1.    Legal Proceedings

86
     
 

Item 1A. Risk Factors

86
     
 

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

86
     
 

Item 3.    Defaults Upon Senior Securities

86
     
 

Item 4.    Mine Safety Disclosures

86
     
 

Item 5.    Other Information

86
     
 

Item 6.   Exhibits

87
     
 

Signatures

88

 

 

 

MERCANTILE BANK CORPORATION

PART I --- FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

 


 

 

 

September 30,

2014

   

December 31,

2013

 
   

(Unaudited)

   

(Audited)

 
ASSETS            

Cash and due from banks

  $ 49,707,000     $ 17,149,000  

Interest-bearing deposits

    72,443,000       6,389,000  

Federal funds sold

    10,102,000       123,427,000  

Total cash and cash equivalents

    132,252,000       146,965,000  
                 

Securities available for sale

    454,009,000       131,178,000  

Federal Home Loan Bank stock

    19,226,000       11,961,000  
                 

Loans

    2,068,265,000       1,053,243,000  

Allowance for loan losses

    (20,374,000 )     (22,821,000 )

Loans, net

    2,047,891,000       1,030,422,000  
                 

Premises and equipment, net

    48,570,000       24,898,000  

Bank owned life insurance

    55,992,000       51,377,000  

Goodwill

    50,870,000       0  

Core deposit intangible

    16,418,000       0  

Accrued interest and other assets

    37,876,000       30,165,000  
                 

Total assets

  $ 2,863,104,000     $ 1,426,966,000  
                 

LIABILITIES AND SHAREHOLDERS' EQUITY

               

Deposits

               

Noninterest-bearing

  $ 535,101,000     $ 224,580,000  

Interest-bearing

    1,736,607,000       894,331,000  

Total deposits

    2,271,708,000       1,118,911,000  
                 

Securities sold under agreements to repurchase

    142,869,000       69,305,000  

Federal Home Loan Bank advances

    57,033,000       45,000,000  

Subordinated debentures

    54,301,000       32,990,000  

Accrued interest and other liabilities

    16,200,000       7,435,000  

Total liabilities

    2,542,111,000       1,273,641,000  
                 

Shareholders' equity

               

Preferred stock, no par value; 1,000,000 shares authorized; none issued

    0       0  

Common stock, no par value; 40,000,000 shares authorized; 16,862,583 shares outstanding at September 30, 2014 and 8,739,108 shares outstanding at December 31, 2013

    317,374,000       162,999,000  

Retained earnings (deficit)

    5,948,000       (4,101,000 )

Accumulated other comprehensive income (loss)

    (2,329,000 )     (5,573,000 )

Total shareholders’ equity

    320,993,000       153,325,000  
                 

Total liabilities and shareholders’ equity

  $ 2,863,104,000     $ 1,426,966,000  

 


 

See accompanying notes to condensed consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 


 

 

 

Three Months

Ended

Sept 30, 2014

   

Three Months

Ended

Sept 30, 2013

   

Nine Months

Ended

Sept 30, 2014

   

Nine Months

Ended

Sept 30, 2013

 
Interest income                                

Loans, including fees

  $ 26,323,000     $ 13,411,000     $ 55,079,000     $ 38,944,000  

Securities, taxable

    1,992,000       1,003,000       4,619,000       3,017,000  

Securities, tax-exempt

    553,000       211,000       1,110,000       763,000  

Federal funds sold

    7,000       38,000       117,000       127,000  

Interest-bearing deposits

    25,000       4,000       46,000       17,000  

Total interest income

    28,900,000       14,667,000       60,971,000       42,868,000  
                                 

Interest expense

                               

Deposits

    1,971,000       2,190,000       6,279,000       6,733,000  

Short-term borrowings

    34,000       19,000       83,000       57,000  

Federal Home Loan Bank advances

    166,000       141,000       472,000       379,000  

Other borrowings

    740,000       323,000       1,532,000       938,000  

Total interest expense

    2,911,000       2,673,000       8,366,000       8,107,000  
                                 

Net interest income

    25,989,000       11,994,000       52,605,000       34,761,000  
                                 

Provision for loan losses

    (400,000 )     (1,700,000 )     (3,000,000 )     (4,700,000 )
                                 

Net interest income after provision for loan losses

    26,389,000       13,694,000       55,605,000       39,461,000  
                                 

Noninterest income

                               

Services charges on accounts

    807,000       397,000       1,749,000       1,155,000  

Earnings on bank owned life insurance

    299,000       337,000       880,000       1,025,000  

Mortgage banking activities

    569,000       194,000       981,000       671,000  

Other income

    1,224,000       755,000       3,085,000       2,430,000  

Total noninterest income

    2,899,000       1,683,000       6,695,000       5,281,000  
                                 

Noninterest expense

                               

Salaries and benefits

    10,685,000       5,256,000       23,393,000       15,094,000  

Occupancy

    1,515,000       639,000       3,141,000       1,921,000  

Furniture and equipment

    560,000       242,000       1,175,000       754,000  

FDIC insurance costs

    331,000       184,000       733,000       604,000  

Problem asset costs

    235,000       373,000       179,000       783,000  

Merger-related costs

    1,250,000       719,000       5,081,000       779,000  

Other expense

    6,165,000       2,509,000       12,312,000       7,383,000  

Total noninterest expenses

    20,741,000       9,922,000       46,014,000       27,318,000  
                                 

Income before federal income tax expense

    8,547,000       5,455,000       16,286,000       17,424,000  
                                 

Federal income tax expense

    2,600,000       2,002,000       5,248,000       5,554,000  
                                 

Net income

  $ 5,947,000     $ 3,453,000     $ 11,038,000     $ 11,870,000  
                                 

Basic earnings per share

  $ 0.35     $ 0.40     $ 0.89     $ 1.36  

Diluted earnings per share

  $ 0.35     $ 0.40     $ 0.89     $ 1.36  

Cash dividends per share

  $ 0.12     $ 0.12     $ 2.36     $ 0.33  
                                 

Average basic shares outstanding

  $ 16,852,050     $ 8,707,038     $ 12,362,316     $ 8,706,133  

Average diluted shares outstanding

  $ 16,926,249     $ 8,725,268     $ 12,399,009     $ 8,719,956  

 


 

See accompanying notes to condensed consolidated financial statements. 

 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) 


 

   

Three Months

Ended

Sept 30, 2014

   

Three Months

Ended

Sept 30, 2013

   

Nine Months

Ended

Sept 30, 2014

   

Nine Months

Ended

Sept 30, 2013

 
                                 

Net income

  $ 5,947,000     $ 3,453,000     $ 11,038,000     $ 11,870,000  
                                 

Other comprehensive income (loss):

                               

Unrealized holding gains (losses) on securities available for sale

    712,000       (5,376,000 )     4,861,000       (10,165,000 )

Fair value of interest rate swap

    255,000       (79,000 )     128,000       718,000  
      967,000       (5,455,000 )     4,989,000       (9,447,000 )
                                 

Tax effect of unrealized holding gains (losses) on securities available for sale

    (220,000 )     1,841,000       (1,701,000 )     3,517,000  

Tax effect of fair value of interest rate swap

    (90,000 )     (25,000 )     (44,000 )     (251,000 )
      (310,000 )     1,816,000       (1,745,000 )     3,266,000  
                                 

Other comprehensive income (loss), net of tax

    657,000       (3,639,000 )     3,244,000       (6,181,000 )
                                 

Comprehensive income (loss)

  $ 6,604,000     $ (186,000 )   $ 14,282,000     $ 5,689,000  

 

 


 

See accompanying notes to condensed consolidated financial statements. 

 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 


 

                   

Retained

   

Accumulated

Other

   

Total

 

($ in thousands)

 

Preferred

   

Common

   

Earnings

   

Comprehensive

   

Shareholders’

 
   

Stock

   

Stock

   

(Deficit)

   

Income (Loss)

   

Equity

 
                                         

Balances, January 1, 2014

  $ 0     $ 162,999     $ (4,101 )   $ (5,573 )   $ 153,325  
                                         

Employee stock purchase plan (523 shares)

            10                       10  
                                         

Dividend reinvestment plan (4,695 shares)

            90                       90  
                                         

Stock option exercises (24,110 shares)

            229                       229  
                                         

Stock grants to directors for retainer fees (7,375 shares)

            155                       155  
                                         

Stock-based compensation expense

            364                       364  
                                         

Cash dividends ($2.36 per common share)

            (21,447 )     (989 )             (22,436 )
                                         

Common stock issued in connection with Firstbank merger (8,087,272 shares)

            173,310                       173,310  
                                         

Stock options issued to replace existing Firstbank options at merger date

            1,664                       1,664  
                                         

Net income for the nine months ended September 30, 2014

                    11,038               11,038  
                                         

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

                            3,160       3,160  
                                         

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

                            84       84  
                                         

Balances, September 30, 2014

  $ 0     $ 317,374     $ 5,948     $ (2,329 )   $ 320,993  

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

 


 

                   

Retained

   

Accumulated

Other

   

Total

 

($ in thousands)

 

Preferred

   

Common

   

Earnings

   

Comprehensive

   

Shareholders’

 
   

Stock

   

Stock

   

(Deficit)

   

Income (Loss)

   

Equity

 
                               

Balances, January 1, 2013

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

Employee stock purchase plan (1,098 shares)

            19                       19  
                                         

Dividend reinvestment plan (1,954 shares)

            33                       33  
                                         

Stock option exercises (2,950 shares)

            52                       52  
                                         

Stock tendered for stock option exercises (2,419 shares)

            (52 )                     (52 )
                                         

Stock-based compensation expense

            354                       354  
                                         

Cash dividends ($0.33 per common share)

            (2,851 )                     (2,851 )
                                         

Net income for the nine months ended September 30, 2013

                    11,870               11,870  
                                         

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

                            (6,648 )     (6,648 )
                                         

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

                            467       467  
                                         

Balances, September 30, 2013

  $ 0     $ 163,629     $ (9,264 )   $ (4,531 )   $ 149,834  

 

 

 


 

See accompanying notes to condensed consolidated financial statements.             

 

 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 


 

   

Nine Months

Ended

Sept 30, 2014

   

Nine Months

Ended

Sept 30, 2013

 
Cash flows from operating activities                

Net income

  $ 11,038,000     $ 11,870,000  

Adjustments to reconcile net income to net cash from operating activities

               

Depreciation and amortization

    4,734,000       1,629,000  

Accretion of acquired loans

    (1,687,000 )     0  

Provision for loan losses

    (3,000,000 )     (4,700,000 )

Stock-based compensation expense

    364,000       354,000  

Proceeds from sales of mortgage loans held for sale

    41,246,000       43,789,000  

Origination of mortgage loans held for sale

    (40,481,000 )     (41,147,000 )

Net gain from sales of mortgage loans held for sale

    (935,000 )     (550,000 )

Net gain from sales and valuation write-down of foreclosed assets

    (721,000 )     (1,024,000 )

Earnings on bank owned life insurance

    (880,000 )     (1,025,000 )

Net change in:

               

Accrued interest receivable

    (269,000 )     97,000  

Other assets

    184,000       13,451,000  

Accrued interest and other liabilities

    (5,155,000 )     (776,000 )

Net cash from operating activities

    4,438,000       21,968,000  
                 

Cash flows from investing activities

               

Cash received in merger

    91,806,000       0  

Loan originations and payments, net

    (70,034,000 )     (37,232,000 )

Purchases of securities available for sale

    (14,379,000 )     (37,492,000 )

Proceeds from maturities, calls and repayments of securities available for sale

    46,445,000       31,578,000  

Proceeds from sales of securities available for sale

    0       10,310,000  

Proceeds from sales of foreclosed assets

    3,184,000       6,505,000  

Purchases of premises and equipment

    (1,167,000 )     (250,000 )

Net cash from (for) investing activities

    55,855,000       (26,581,000 )
                 

Cash flows from financing activities

               

Net decrease in time deposits

    (40,963,000 )     (13,871,000 )

Net increase (decrease) in all other deposits

    (35,065,000 )     176,000  

Net increase in securities sold under agreements to repurchase

    19,080,000       915,000  

Proceeds from Federal Home Loan Bank advances

    0       10,000,000  

Net increase in other borrowed money

    3,894,000       107,000  

Proceeds from stock option exercises

    229,000       0  

Employee stock purchase plan

    10,000       19,000  

Dividend reinvestment plan

    90,000       33,000  

Stock grants to directors for retainer fee

    155,000       0  

Payment of cash dividends to common shareholders

    (22,436,000 )     (2,851,000 )

Net cash for financing activities

    (75,006,000 )     (5,472,000 )
                 

Net change in cash and cash equivalents

    (14,713,000 )     (10,085,000 )

Cash and cash equivalents at beginning of period

    146,965,000       136,003,000  

Cash and cash equivalents at end of period

  $ 132,252,000     $ 125,918,000  

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

 


 

   

Nine Months

Ended

Sept 30, 2014

   

Nine Months

Ended

Sept 30, 2013

 

Supplemental disclosures of cash flows information

               

Cash paid during the period for:

               

Interest

  $ 8,574,000     $ 8,779,000  

Federal income tax

    1,575,000       0  

Noncash financing and investing activities:

               

Transfers from loans to foreclosed assets

    1,084,000       2,060,000  

 

 

 


  

See accompanying notes to condensed consolidated financial statements.

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


1.

SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation: The unaudited financial statements for the nine months ended September 30, 2014 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance center”). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended September 30, 2014 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2013.

 

We have five separate business trusts that were formed to issue trust preferred securities. Subordinated debentures were issued to the trusts in return for the proceeds raised from the issuance of the trust preferred securities. The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as a liability.

 

Earnings Per Share: Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans and are determined using the treasury stock method. Our unvested restricted shares, which contain non-forfeitable rights to dividends whether paid or accrued (i.e., participating securities), are included in the number of shares outstanding for both basic and diluted earnings per share calculations. In the event of a net loss, our unvested restricted shares are excluded from the calculation of both basic and diluted earnings per share.

 

Stock options for approximately 141,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2014. Stock options for approximately 175,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2014.

 

Approximately 64,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2013. In addition, stock options for approximately 54,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2013. Stock options for approximately 94,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2013.

 

 


 (Continued) 

 

 
8. 

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


1.

SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans: Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

 

Interest income on commercial loans and mortgage loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged-off no later than when they are 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal and interest is considered doubtful.

 

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Loan Losses: The allowance for loan losses (“allowance”) is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when we believe the uncollectability of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. We estimate the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

 

A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of delay, the reasons for delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.

 

 


 (Continued)

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


1.

SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Troubled Debt Restructurings: A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.

 

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans. Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described above under “Allowance for Loan Losses.” Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

 

Investments: Investments are presented at fair value as required by accounting principles. Our investment portfolio is classified as available for sale, as such: adjustments to the fair value are reported as a change in equity. If a security is deemed to be other than temporarily impaired, the adjustment to fair value is recorded through the income statement.

 

Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value and the related unrealized holding gain or loss (the difference between the fair value and amortized cost of the securities so classified) is reported in other comprehensive income. Other securities such as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premium or accretion of purchase discount. Premiums and discounts on securities are amortized or accreted on the level-yield method. Gains and losses on sales are recorded on the trade date and are 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 carrying value; (2) the financial condition and near-term prospects of the issuer; and (3) the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

 

 


 

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


1.

SIGNIFICANT ACCOUNTING POLICIES (Continued)      

 

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. As of September 30, 2014 and December 31, 2013, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $2.1 million and $1.1 million, respectively.

 

Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the loan at the same time we make a rate commitment to the borrower. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives is included in the gain on sale of loans. Mortgage loans serviced for others totaled approximately $592 million as of September 30, 2014.

 

Mortgage Banking Activities: Servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans as to interest rates, types of loans, loan size, term and other factors. Any temporary impairment of a grouping is reported as a valuation allowance which is recovered when impairment no longer exists. Other-than-temporary impairments are recorded as a direct write-down to the carrying value of the servicing assets.

 

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage servicing rights is netted against loan servicing income in the income statement.

 

Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have generally consisted of interest rate swap agreements that qualified for hedge accounting. In February 2012, we entered into an interest rate swap agreement that qualifies for hedge accounting. The current outstanding interest rate swap is discussed in more detail in Note 10. We do not use derivatives for trading purposes.

 

Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various loans and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.

 

 


(Continued)

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


1.

SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

If designated as a hedge, we formally document the relationship between derivatives as hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet. If designated as a hedge, we also formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in cash flows of the hedged items. Ineffective hedge gains and losses are recognized immediately in current earnings as noninterest income or expense. We discontinue hedge accounting when we determine the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or terminates, or treatment of the derivative as a hedge is no longer appropriate or intended.

 

Goodwill and Core Deposit Intangible: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur. We use a discounted income approach and a market valuation model, which compares the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill has been impaired.

 

The core deposit intangible that arose from the Firstbank Corporation acquisition was initially measured at fair value and is being amortized into noninterest expense over a ten-year period using the sum-of-the-years-digits methodology.

 

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

 

In August 2014, the FASB issued ASU 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure. This ASU requires that certain government-guaranteed mortgage loans, including those guaranteed by the Federal Housing Administration, be derecognized and that a separate other receivable be recognized upon foreclosure if certain conditions are met. Upon foreclosure on the loans that meet these criteria, a separate receivable should be recorded based on the amount of the loan balance expected to be recovered from the guarantor. The amendments are effective for annual periods, and interim periods within those years, beginning after December 15, 2014. The adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 

 


(Continued) 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


1.

SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. This ASU is effective for annual and interim periods beginning after December 15, 2016 with three transition methods available – full retrospective, retrospective and cumulative effect approach. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This ASU requires two accounting changes. First, repurchase-to-maturity transactions will be accounted for as secured borrowing transactions on the balance sheet, rather than sales. Second, for repurchase financing arrangements, the ASU requires separate accounting for a transfer of a financial asset executed contemporaneously with (or in contemplation of) a repurchase agreement with the same counterparty, which also will generally result in secured borrowing accounting for the repurchase agreement. The ASU also introduces new disclosures to increase transparency about the types of collateral pledged for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The ASU also requires a transferor to disclose information about transactions accounted for as a sale in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets through an agreement with the transferee. The accounting changes and disclosure for certain transactions accounted for as a sale are effective for the first interim or annual period beginning after December 15, 2014. The disclosure for transactions accounted for as secured borrowings is required for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 

 

2.

BUSINESS COMBINATION

 

We completed the merger of Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $1.5 billion in total assets and 46 branch locations, into Mercantile Bank Corporation as of June 1, 2014 (“Merger Date”). The results of operations due to the Firstbank transaction have been included in Mercantile’s financial results since the Merger Date. All of Firstbank’s common stock was converted into the right to receive one share of Mercantile common stock for each share of Firstbank common stock. The conversion of Firstbank’s common stock into Mercantile’s common stock resulted in Mercantile issuing 8,087,272 shares of its common stock. The merger provided an expanded geographic footprint for the Company and increased the size of the balance sheet. In conjunction with the completion of the merger, Mercantile assumed the obligations of Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III and Firstbank Capital Trust IV.

 

 


(Continued)

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


2.

BUSINESS COMBINATION (Continued)

 

The Firstbank transaction was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Merger Date. Preliminary goodwill of $50.9 million was calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created from combining the two banking organizations as well as the economies of scale expected from combining the operations of the two companies. None of the goodwill is deductible for income tax purposes as the merger is accounted for as a tax-free exchange.

 

The following table provides the purchase price calculation as of the Merger Date and the identifiable assets purchased and the liabilities assumed at their estimated fair values. These fair value measurements are provisional based on third-party valuations that are currently under review and are subject to refinement for up to one year after the Merger Date based on additional information that may be obtained by us that existed as of the Merger Date.

 

Purchase Price:

Mercantile common shares issued for Firstbank common shares

    8,087,272  

Price per share, based on Mercantile closing price on May 30, 2014

  $ 21.43  

Value of common stock issued

    173,310,000  

Replacement stock options

    1,664,000  

Total purchase price

  $ 174,974,000  

 

Preliminary Statement of Net Assets Acquired at Fair Value:

Assets

               

Cash and cash equivalents

  $ 91,806,000          

Securities

    358,599,000          

Total loans

    943,662,000          

Premises and equipment

    24,049,000          

Core deposit intangible

    17,478,000          

Mortgage servicing rights

    7,389,000          

Other assets

    8,500,000          

Total Assets

  $ 1,451,483,000          

Liabilities

               

Deposits

  $ 1,229,609,000          

Borrowings

    87,615,000          

Other liabilities

    10,155,000          

Total Liabilities

  $ 1,327,379,000          

Net Identifiable Assets Acquired

          $ 124,104,000  

Goodwill

          $ 50,870,000  

 

 


(Continued) 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


2.

BUSINESS COMBINATION (Continued)

 

The fair value of mortgage servicing rights was $7.4 million at the Merger Date. During the four months ended September 30, 2014, new servicing rights of $0.2 million and amortization expense of $0.6 million were recorded.

 

Firstbank’s results of operations prior to the Merger Date are not included in our consolidated statements of income or consolidated statements of comprehensive income. We recorded merger-related expenses of $1.3 million and $5.1 million during the three month and nine month periods ended September 30, 2014, respectively. We recorded merger-related expenses of $0.7 million and $0.8 million during the three month and nine month periods ended September 30, 2013, respectively. Such expenses were generally for professional services, costs related to termination of existing contractual arrangements for various services, retention and severance compensation costs, marketing and promotional expenses, travel costs, and printing and supplies costs.

 

The following table provides the unaudited pro forma information for the results of operations for the three and nine month periods ended September 30, 2014 and 2013, as if the acquisition had occurred on January 1 of each year. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily comprised of Firstbank’s loan and deposit portfolios. In addition, the $5.1 million in merger-related expenses noted earlier are included in each period presented. We expect to achieve further operating cost savings and other business synergies as a result of the merger which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes only and are not intended to represent or be indicative of the actual results of operations of the combined banking organization that would have been achieved had the merger occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.

 

   

Three months ended Sept 30,

    Nine months ended Sept 30,  
   

2014

   

2013

   

2014

   

2013

 
                                 

Net interest income

  $ 25,989,000     $ 11,994,000     $ 54,924,000     $ 37,080,000  

Noninterest expense

    24,572,000       14,284,000       47,338,000       32,944,000  

Net income

    3,281,000       693,000       11,711,000       9,617,000  

Net income per diluted share

    0.19       0.04       0.69       0.57  

 

In most instances, determining the fair value of the acquired assets and assumed liabilities required us to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Firstbank’s previously established allowance for loan losses.

 

 


 (Continued) 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


2.

BUSINESS COMBINATION (Continued)

 

The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (“acquired impaired”), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (“acquired non-impaired”). In addition, the loans are further categorized into different loan pools based primarily on the type and purpose of the loan.

 

The provisional fair value of loans at the Merger Date is presented in the following table:

 

   

Acquired

   

Acquired

    Acquired  
   

Impaired

   

Non-Impaired

    Total Loans  

Commercial Loans:

                       

Commercial & industrial

  $ 878,000     $ 163,316,000     $ 164,194,000  

Commercial real estate

    12,973,000       378,016,000       390,989,000  

Construction & development

    1,289,000       33,726,000       35,015,000  

Total Commercial Loans

  $ 15,140,000     $ 575,058,000     $ 590,198,000  
                         

Consumer Loans:

                       

Residential mortgages

  $ 9,694,000     $ 216,653,000     $ 226,347,000  

Instalment

    167,000       61,657,000       61,824,000  

Home equity lines

    288,000       52,054,000       52,342,000  

Construction

    76,000       12,875,000       12,951,000  

Total Consumer Loans

  $ 10,225,000     $ 343,239,000     $ 353,464,000  

Total Loans

  $ 25,365,000     $ 918,297,000     $ 943,662,000  

  

The following table presents data on acquired impaired loans at the Merger Date:

 

    Acquired  
    Impaired  
         

Contractual required payments

  $ 44,936,000  

Nonaccretable difference

    17,057,000  

Expected cash flows

    27,879,000  

Accretable yield

    2,514,000  

Carrying balance

  $ 25,365,000  

  

The nonaccretable difference includes $10.4 million in principal cash flows not expected to be collected, $2.8 million of pre-acquisition charge-offs and $3.9 million of future interest not expected to be collected. The unpaid principal balance of acquired performing loans was $926.4 million at the Merger Date, and the unaccreted discount on such loans was $8.1 million.

 

 


 (Continued) 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


2.

BUSINESS COMBINATION (Continued)

 

We also assumed obligations under junior subordinated debentures with an aggregate balance of $36.1 million and an aggregate fair value of $21.1 million as of the Merger Date, payable to four unconsolidated trusts (Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III, and Firstbank Capital Trust IV) that have issued trust preferred securities. The junior subordinated debentures are the sole assets of each trust. Interest rates on all trust preferred securities issued by the trusts are tied to the 90 Day Libor rate with spreads ranging from 127 basis points to 199 basis points, and reset quarterly. The trust preferred securities have maturity dates ranging from October, 2034 to July, 2037, and are callable by us in whole or in part quarterly. The junior subordinated debentures are unsecured obligations of Mercantile, who has guaranteed that interest payments on the junior subordinated debentures made to the trust will be distributed by the trust to the holders of the trust preferred securities. The trust preferred securities currently fully qualify as Tier 1 Capital, and under current risk-based capital guidelines, will remain fully qualified as Tier 1 Capital until maturity unless called by us at an earlier date.

 

In conjunction with the Merger, all of our outstanding restricted stock awards, which were schedule to cliff vest in full in November, 2014, became fully vested as of June 1, 2014, resulting in the recognition of compensation expense of $0.2 million in the second quarter of 2014 to reflect the accelerated vesting of the restricted stock awards.

 

Also in conjunction with the Merger, we assumed, and issued Mercantile stock options in replacement of, all outstanding stock option grants that had been issued to Firstbank employees under the Firstbank Corporation Stock Option and Restricted Stock Plan of 1997 and the Firstbank Corporation 2006 Stock Compensation Plan. There were approximately 282,200 Mercantile stock options issued as a result of the Merger, with about 258,400 of the stock option grants fully vested and exercisable, on the Merger Date. The remaining 23,800 stock options vest over the next six to 18 months. Unrecognized compensation cost related to the unvested stock options was less than $100,000 as of September 30, 2014, which is expected to be fully recognized by November, 2015.

 

The aggregate intrinsic value of all stock options issued as a result of the Merger outstanding and exercisable at September 30, 2014 was $2.0 million.

 

 


(Continued)

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


3.

SECURITIES

 

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

  

   

 

    Gross     Gross        
   

Amortized

   

Unrealized

   

Unrealized

    Fair  
   

Cost

   

Gains

   

Losses

    Value  

September 30, 2014

                               

U.S. Government agency debt obligations

  $ 209,371,000     $ 823,000     $ (5,717,000 )   $ 204,477,000  

Mortgage-backed securities

    99,574,000       1,083,000       (399,000 )     100,258,000  

Municipal general obligation bonds

    135,575,000       1,003,000       (328,000 )     136,250,000  

Municipal revenue bonds

    11,022,000       112,000       (17,000 )     11,117,000  

Other Investments

    1,916,000       0       (9,000 )     1,907,000  
                                 
    $ 457,458,000     $ 3,021,000     $ (6,470,000 )   $ 454,009,000  
                                 

December 31, 2013

                               

U.S. Government agency debt obligations

  $ 108,279,000     $ 263,000     $ (10,065,000 )   $ 98,477,000  

Mortgage-backed securities

    12,456,000       1,102,000       0       13,558,000  

Municipal general obligation bonds

    16,488,000       388,000       (4,000 )     16,872,000  

Municipal revenue bonds

    878,000       38,000       0       916,000  

Mutual funds

    1,386,000       0       (31,000 )     1,355,000  
                                 
    $ 139,487,000     $ 1,791,000     $ (10,100,000 )   $ 131,178,000  

 

 


(Continued) 

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


3.

SECURITIES (Continued)

 

Securities with unrealized losses at September 30, 2014 and December 31, 2013, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

 

   

Less than 12 Months

    12 Months or More     Total  
    Fair     Unrealized    

Fair

    Unrealized     Fair     Unrealized  
    Value     Loss     Value     Loss    

Value

    Loss  
                                                 

September 30, 2014

                                               

U.S. Government agency debt obligations

  $ 83,379,000     $ (436,000 )   $ 71,673,000     $ (5,281,000 )   $ 155,052,000     $ (5,717,000 )

Mortgage-backed securities

    72,205,000       (399,000 )     0       0       72,205,000       (399,000 )

Municipal general obligation bonds

    24,844,000       (328,000 )     0       0       24,844,000       (328,000 )

Municipal revenue bonds

    5,438,000       (17,000 )     0       0       5,438,000       (17,000 )

Other investments

    0       0       1,399,000       (9,000 )     1,399,000       (9,000 )
                                                 
    $ 185,866,000     $ (1,180,000 )   $ 73,072,000     $ (5,290,000 )   $ 258,938,000     $ (6,470,000 )
                                                 
                                                 

December 31, 2013

                                               

U.S. Government agency debt obligations

  $ 57,117,000     $ (5,798,000 )   $ 29,679,000     $ (4,267,000 )   $ 86,796,000     $ (10,065,000 )

Mortgage-backed securities

    0       0       0       0       0       0  

Municipal general obligation bonds

    295,000       (4,000 )     0       0       295,000       (4,000 )

Municipal revenue bonds

    0       0       0       0       0       0  

Mutual funds

    1,355,000       (31,000 )     0       0       1,355,000       (31,000 )
                                                 
    $ 58,767,000     $ (5,833,000 )   $ 29,679,000     $ (4,267,000 )   $ 88,446,000     $ (10,100,000 )

   

 


 (Continued)

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


3.

SECURITIES (Continued)

 

We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.

 

At September 30, 2014, 452 debt securities and one mutual fund with fair values totaling $258.9 million have unrealized losses aggregating $6.5 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.

 

The amortized cost and fair value of debt securities at September 30, 2014, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

 

   

Weighted

                 
    Average     Amortized     Fair  
    Yield     Cost     Value  
                         

Due in 2014

    1.01%     $ 11,072,000     $ 11,082,000  

Due in 2015 through 2019

    1.26       182,997,000       182,029,000  

Due in 2020 through 2024

    3.01       71,801,000       71,698,000  

Due in 2025 and beyond

    3.63       90,098,000       87,035,000  

Mortgage-backed securities

    1.61       99,574,000       100,258,000  

Other investments

    1.55       1,916,000       1,907,000  
                         
      2.08%     $ 457,458,000     $ 454,009,000  

 


 (Continued)

 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


3.

SECURITIES (Continued)

 

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $114.5 million and $17.4 million at September 30, 2014 and December 31, 2013, respectively, with estimated market values of $115.2 million and $17.8 million, respectively. Securities issued by all other states and their political subdivisions had a combined amortized cost of $32.1 million and estimated market value of $32.2 million at September 30, 2014. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, did not exceed 10% of shareholders’ equity.

 

The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $163.1 million and $94.4 million at September 30, 2014 and December 31, 2013, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

 

 

4.

LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans originated for investment are stated at their principal amount outstanding adjusted for partial charge-offs, the allowance, and net deferred loan fees and costs. Interest income on loans is accrued over the term of the loans primarily using the simple interest method based on the principal balance outstanding. Interest is not accrued on loans where collectability is uncertain. Accrued interest is presented separately in the consolidated balance sheet. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.

 

Acquired loans are those purchased in the Firstbank merger (See Note 2 – Business Combination for further information). These loans were recorded at estimated fair value at the Merger Date with no carryover of the related allowance. The acquired loans were segregated between those considered to be performing (“acquired non-impaired loans”) and those with evidence of credit deterioration (“acquired impaired loans”). Acquired loans are considered impaired if there is evidence of credit deterioration and if it is probable, at acquisition, all contractually required payments will not be collected. Acquired loans restructured after acquisition are not considered or reported as troubled debt restructurings if the loans evidenced credit deterioration as of the Merger Date and are accounted for in pools.

 

The fair value estimates for acquired loans are based on expected prepayments and the amount and timing of discounted expected principal, interest and other cash flows. Credit discounts representing the principal losses expected over the life of the loan are also a component of the initial fair value. In determining the Merger Date fair value of acquired impaired loans, and in subsequent accounting, we have generally aggregated acquired commercial and consumer loans into pools of loans with common risk characteristics.

 

 


 (Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


4.

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The difference between the fair value of an acquired non-impaired loan and contractual amounts due at the Merger Date is accreted into income over the estimated life of the loan. Contractually required payments represent the total undiscounted amount of all uncollected principal and interest payments. Acquired non-impaired loans are placed on nonaccrual status and reported as nonperforming or past due using the same criteria applied to the originated loan portfolio.

 

The excess of an acquired impaired loan’s contractually required payments over the amount of its undiscounted cash flows expected to be collected is referred to as the non-accretable difference. The non-accretable difference, which is neither accreted into income nor recorded on the consolidated balance sheet, reflects estimated future credit losses and uncollectible contractual interest expected to be incurred over the life of the acquired impaired loan. The excess cash flows expected to be collected over the carrying amount of the acquired loan is referred to as the accretable yield. This amount is accreted into interest income over the remaining life of the acquired loans or pools using the level yield method. The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment speed assumptions and changes in expected principal and interest payments over the estimated lives of the acquired impaired loans.

 

We evaluate quarterly the remaining contractual required payments receivable and estimate cash flows expected to be collected over the lives of the impaired loans. Contractually required payments receivable may increase or decrease for a variety of reasons, for example, when the contractual terms of the loan agreement are modified, when interest rates on variable rate loans change, or when principal and/or interest payments are received. Cash flows expected to be collected on acquired impaired loans are estimated by incorporating several key assumptions similar to the initial estimate of fair value. These key assumptions include probability of default, loss given default, and the amount of actual prepayments after the Merger Date. Prepayments affect the estimated lives of loans and could change the amount of interest income, and possibly principal, expected to be collected. In re-forecasting future estimated cash flows, credit loss expectations are adjusted as necessary. The adjustments are based, in part, on actual loss severities recognized for each loan type, as well as changes in the probability of default. For periods in which estimated cash flows are not re-forecasted, the prior reporting period’s estimated cash flows are adjusted to reflect the actual cash received and credit events that transpired during the current reporting period.

 

Increases in expected cash flows of acquired impaired loans subsequent to the Merger Date are recognized prospectively through adjustments of the yield on the loans or pools over their remaining lives, while decreases in expected cash flows are recognized as impairment through a provision for loan losses and an increase in the allowance.

 

Our total loans at September 30, 2014 were $2.07 billion compared to $1.05 billion at December 31, 2013, an increase of 1.02 billion, or 96.4%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at September 30, 2014 and December 31, 2013, and the percentage change in loans from the end of 2013 to the end of the third quarter of 2014, are as follows:

 

 


 (Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


4.

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

  

                                Percent  
   

September 30, 2014

    December 31, 2013     Increase  
    Balance     %     Balance     %     (Decrease)  

Originated loans

                                       

Commercial: