MBWM 10-Q Quarterly Report Sept. 30, 2022

MERCANTILE BANK CORP

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mbwm20220930_10q.htm

Table of Contents

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022

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

SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File No. 000-26719

MERCANTILE BANK CORPORATION

(Exact name of registrant as specified in its charter)

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

310 Leonard Street, NW , Grand Rapids , MI 49504

(Address of principal executive offices) (Zip Code)

( 616 ) 406-3000

(Registrant’s telephone number, including area code)

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

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

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

Large accelerated filer ☐	Accelerated filer ☒
Non-accelerated filer ☐	Smaller reporting company ☐
Emerging growth company ☐

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	MBWM	The Nasdaq Stock Market LLC

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Yes ☐ No ☐

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

Yes ☐ No ☒

At October 31, 2022, there were 15,866,185 shares of common stock outstanding.

Table of Contents

MERCANTILE BANK CORPORATION

INDEX

PART I.	Financial Information	Page No.

	Item 1. Financial Statements

	Consolidated Balance Sheets (Unaudited) – September 30, 2022 and December 31, 2021	1

	Consolidated Statements of Income (Unaudited) - Three and Nine Months Ended September 30, 2022 and September 30, 2021	2

	Consolidated Statements of Comprehensive Income/(Loss) (Unaudited) - Three and Nine Months Ended September 30, 2022 and September 30, 2021	3

	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) – Three and Nine Months Ended September 30, 2022 and September 30, 2021	4

	Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2022 and September 30, 2021	8

	Notes to Consolidated Financial Statements (Unaudited)	10

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	55

	Item 3. Quantitative and Qualitative Disclosures About Market Risk	75

	Item 4. Controls and Procedures	78

PART II.	Other Information

	Item 1. Legal Proceedings	79

	Item 1A. Risk Factors	79

	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	79

	Item 3. Defaults Upon Senior Securities	79

	Item 4. Mine Safety Disclosures	79

	Item 5. Other Information	79

	Item 6. Exhibits	80

	Signatures	81

Table of Contents

MERCANTILE BANK CORPORATION

PART I --- FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	September 30, 2022			December 31, 2021
ASSETS
Cash and due from banks	$	63,105,000		$	59,405,000
Interest-earning deposits		220,909,000			915,755,000
Total cash and cash equivalents		284,014,000			975,160,000

Securities available for sale		582,999,000			592,743,000
Federal Home Loan Bank stock		17,721,000			18,002,000
Mortgage loans held for sale		14,411,000			16,117,000

Loans		3,880,958,000			3,453,459,000
Allowance for credit losses		( 39,120,000	)		( 35,363,000	)
Loans, net		3,841,838,000			3,418,096,000

Premises and equipment, net		52,117,000			57,298,000
Bank owned life insurance		75,880,000			75,242,000
Goodwill		49,473,000			49,473,000
Core deposit intangible, net		741,000			1,351,000
Other assets		97,740,000			54,267,000
Total assets	$	5,016,934,000		$	5,257,749,000

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing	$	1,716,904,000		$	1,677,952,000
Interest-bearing		2,129,181,000			2,405,241,000
Total deposits		3,846,085,000			4,083,193,000

Securities sold under agreements to repurchase		198,605,000			197,463,000
Federal Home Loan Bank advances		338,263,000			374,000,000
Subordinated debentures		48,787,000			48,244,000
Subordinated notes		88,542,000			73,646,000
Accrued interest and other liabilities		80,391,000			24,644,000
Total liabilities		4,600,673,000			4,801,190,000

Commitments and contingent liabilities (Note 8)

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; 15,866,243 shares issued and outstanding at September 30, 2022 and 15,839,944 shares issued and outstanding at December 31, 2021		289,219,000			285,752,000
Retained earnings		199,505,000			174,536,000
Accumulated other comprehensive gain/(loss)		( 72,463,000	)		( 3,729,000	)
Total shareholders’ equity		416,261,000			456,559,000
Total liabilities and shareholders’ equity	$	5,016,934,000		$	5,257,749,000

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended Sept 30, 2022		Three Months Ended Sept 30, 2021		Nine Months Ended Sept 30, 2022		Nine Months Ended Sept 30, 2021

Interest income
Loans, including fees	$	43,807,000	$	33,656,000	$	113,061,000	$	100,430,000
Securities, taxable		2,005,000		1,341,000		5,568,000		3,580,000
Securities, tax-exempt		697,000		600,000		1,928,000		1,795,000
Other interest-earning assets		1,620,000		291,000		3,004,000		642,000
Total interest income		48,129,000		35,888,000		123,561,000		106,447,000

Interest expense
Deposits		2,299,000		2,184,000		5,997,000		7,247,000
Short-term borrowings		53,000		46,000		153,000		122,000
Federal Home Loan Bank advances		1,755,000		2,072,000		5,530,000		6,149,000
Subordinated debt and other borrowings		1,646,000		462,000		4,294,000		1,401,000
Total interest expense		5,753,000		4,764,000		15,974,000		14,919,000

Net interest income		42,376,000		31,124,000		107,587,000		91,528,000

Provision for credit losses		2,900,000		1,900,000		3,500,000		( 900,000	)

Net interest income after provision for credit losses		39,476,000		29,224,000		104,087,000		92,428,000

Noninterest income
Service charges on deposit and sweep accounts		1,579,000		1,324,000		4,489,000		3,687,000
Mortgage banking income		1,764,000		6,554,000		6,991,000		23,049,000
Credit and debit card income		2,086,000		1,947,000		6,101,000		5,545,000
Interest rate swap fees		566,000		3,938,000		2,347,000		6,086,000
Payroll services income		533,000		412,000		1,635,000		1,374,000
Earnings on bank owned life insurance		238,000		298,000		1,310,000		872,000
Gain on sale of branch		0		0		0		1,058,000
Other income		487,000		1,095,000		1,399,000		1,916,000
Total noninterest income		7,253,000		15,568,000		24,272,000		43,587,000

Noninterest expense
Salaries and benefits		16,656,000		15,975,000		47,842,000		47,255,000
Occupancy		2,001,000		2,030,000		6,168,000		6,021,000
Furniture and equipment depreciation, rent and maintenance		953,000		929,000		2,822,000		2,719,000
Data processing costs		3,139,000		2,746,000		9,203,000		8,138,000
Charitable foundation contribution		4,000		0		509,000		0
Other expense		4,003,000		4,530,000		12,896,000		13,386,000
Total noninterest expenses		26,756,000		26,210,000		79,440,000		77,519,000

Income before federal income tax expense		19,973,000		18,582,000		48,919,000		58,496,000

Federal income tax expense		3,943,000		3,531,000		9,659,000		11,114,000

Net income	$	16,030,000	$	15,051,000	$	39,260,000	$	47,382,000

Basic earnings per share	$	1.01	$	0.95	$	2.48	$	2.95
Diluted earnings per share	$	1.01	$	0.95	$	2.48	$	2.95
Cash dividends per share	$	0.32	$	0.30	$	0.94	$	0.88

Average basic shares outstanding		15,861,551		15,859,955		15,850,422		16,084,806
Average diluted shares outstanding		15,861,551		15,860,314		15,850,439		16,085,274

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)

(Unaudited)

	Three Months Ended Sept 30, 2022			Three Months Ended Sept 30, 2021			Nine Months Ended Sept 30, 2022			Nine Months Ended Sept 30, 2021


Net income	$	16,030,000		$	15,051,000		$	39,260,000		$	47,382,000

Other comprehensive income/(loss):
Unrealized holding gains/(losses) on securities available for sale		( 31,387,000	)		( 2,281,000	)		( 87,006,000	)		( 7,318,000	)
Tax effect of unrealized holding gains/(losses) on securities available for sale		6,592,000			479,000			18,272,000			1,536,000
Other comprehensive income/(loss), net of tax		( 24,795,000	)		( 1,802,000	)		( 68,734,000	)		( 5,782,000	)

Comprehensive income/(loss)	$	( 8,765,000	)	$	13,249,000		$	( 29,474,000	)	$	41,600,000

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

The following table depicts the change in shareholders’ equity for the three months ended September 30, 2022:

($ in thousands except per share amounts)	Preferred Stock		Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, June 30, 2022	$	0	$	288,199	$	188,452		$	( 47,668	)	$	428,983

Employee stock purchase plan ( 412 shares)				12								12

Dividend reinvestment plan ( 6,733 shares)				218								218

Stock-based compensation expense				790								790

Cash dividends ($ 0.32 per common share)						( 4,977	)					( 4,977	)

Net income for the three months ended September 30, 2022						16,030						16,030

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect									( 24,795	)		( 24,795	)

Balances, September 30, 2022	$	0	$	289,219	$	199,505		$	( 72,463	)	$	416,261

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

The following table depicts the change in shareholders’ equity for the nine months ended September 30, 2022:

($ in thousands except per share amounts)	Preferred Stock		Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, January 1, 2022	$	0	$	285,752	$	174,536		$	( 3,729	)	$	456,559

Adoption of ASU 2016-13						316						316

Employee stock purchase plan ( 1,029 shares)				33								33

Dividend reinvestment plan ( 19,403 shares)				653								653

Stock grants to directors for retainer fees ( 10,837 shares)				347								347

Stock option exercises ( 1,355 shares)				36								36

Stock-based compensation expense				2,398								2,398

Cash dividends ($ 0.94 per common share)						( 14,607	)					( 14,607	)

Net income for the nine months ended September 30, 2022						39,260						39,260

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect									( 68,734	)		( 68,734	)

Balances, September 30, 2022	$	0	$	289,219	$	199,505		$	( 72,463	)	$	416,261

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

The following table depicts the change in shareholders’ equity for the three months ended September 30, 2021:

($ in thousands except per share amounts)	Preferred Stock		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, June 30, 2021	$	0	$	293,232		$	157,150		$	1,506		$	451,888

Employee stock purchase plan ( 404 shares)				13									13

Dividend reinvestment plan ( 7,904 shares)				237									237

Stock option exercises ( 2,000 shares)				50									50

Stock-based compensation expense				448									448

Share repurchase program ( 288,863 shares)				( 8,947	)								( 8,947	)

Cash dividends ($ 0.30 per common share)							( 4,660	)					( 4,660	)

Net income for the three months ended September 30, 2021							15,051						15,051

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect										( 1,802	)		( 1,802	)

Balances, September 30, 2021	$	0	$	285,033		$	167,541		$	( 296	)	$	452,278

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

The following table depicts the change in shareholders’ equity for the nine months ended September 30, 2021:

($ in thousands except per share amounts)	Preferred Stock		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, January 1, 2021	$	0	$	302,029		$	134,039		$	5,486		$	441,554

Employee stock purchase plan ( 1,106 shares)				35									35

Dividend reinvestment plan ( 20,814 shares)				648									648

Stock grants to directors for retainer fees ( 10,489 shares)				344									344

Stock option exercises ( 2,000 shares)				50									50

Stock-based compensation expense				1,725									1,725

Share repurchase program ( 635,773 shares)				( 19,798	)								( 19,798	)

Cash dividends ($ 0.88 per common share)							( 13,880	)					( 13,880	)

Net income for the nine months ended September 30, 2021							47,382						47,382

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect										( 5,782	)		( 5,782	)

Balances, September 30, 2021	$	0	$	285,033		$	167,541		$	( 296	)	$	452,278

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended Sept 30, 2022			Nine Months Ended Sept 30, 2021

Cash flows from operating activities
Net income	$	39,260,000		$	47,382,000
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		9,855,000			10,200,000
Accretion of acquired loans		0			( 102,000	)
Provision for credit losses		3,500,000			( 900,000	)
Stock-based compensation expense		2,398,000			1,725,000
Stock grants to directors for retainer fee		347,000			344,000
Proceeds from sales of mortgage loans held for sale		195,374,000			509,763,000
Origination of mortgage loans held for sale		( 186,881,000	)		( 510,571,000	)
Net gain from sales of mortgage loans held for sale		( 6,787,000	)		( 23,551,000	)
Net gain from sales and valuation write-downs of foreclosed assets		( 47,000	)		( 74,000	)
Net loss from sales and valuation write-downs of former bank premises		275,000			243,000
Net (gain) loss from sales and write-downs of fixed assets		( 18,000	)		246,000
Earnings on bank owned life insurance		( 1,310,000	)		( 872,000	)
Change in fair value of derivative asset		( 23,836,000	)		( 3,865,000	)
Change in fair value of derivative liability		23,687,000			4,060,000
Gain on sale of branch		0			( 1,058,000	)
Net change in:
Accrued interest receivable		( 4,677,000	)		853,000
Other assets		( 407,000	)		( 11,504,000	)
Accrued interest payable and other liabilities		32,060,000			( 3,150,000	)
Net cash from operating activities		82,793,000			19,169,000

Cash flows from investing activities
Loan originations and payments, net		( 426,842,000	)		( 129,522,000	)
Purchases of securities available for sale		( 91,200,000	)		( 257,967,000	)
Proceeds from maturities, calls and repayments of securities available for sale		13,262,000			77,531,000
Proceeds from sales of foreclosed assets		47,000			181,000
Proceeds from sales of former bank premises		2,994,000			270,000
Proceeds from Federal Home Loan Bank stock redemption		281,000			0
Proceeds from bank owned life insurance death benefits claim		628,000			0
Net cash transferred in branch sale		0			( 2,679,000	)
Net purchases of premises and equipment and lease activity		( 2,166,000	)		( 4,250,000	)
Net cash for investing activities		( 502,996,000	)		( 316,436,000	)

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

	Nine Months Ended Sept 30, 2022			Nine Months Ended Sept 30, 2021

Cash flows from financing activities
Net decrease in time deposits		( 53,239,000	)		( 113,842,000	)
Net (decrease) increase in all other deposits		( 183,869,000	)		585,924,000
Net increase in securities sold under agreements to repurchase		1,142,000			57,485,000
Maturities of Federal Home Loan Bank advances		( 64,000,000	)		0
Proceeds from Federal Home Loan Bank advances		28,263,000			0
Net proceeds from subordinated notes issuance		14,645,000			0
Proceeds from stock option exercises, net of cashless exercises		36,000			50,000
Employee stock purchase plan		33,000			35,000
Dividend reinvestment plan		653,000			648,000
Repurchases of common stock shares		0			( 19,798,000	)
Payment of cash dividends to common shareholders		( 14,607,000	)		( 13,880,000	)
Net cash (for) from financing activities		( 270,943,000	)		496,622,000

Net change in cash and cash equivalents		( 691,146,000	)		199,355,000
Cash and cash equivalents at beginning of period		975,160,000			626,006,000
Cash and cash equivalents at end of period	$	284,014,000		$	825,361,000

Supplemental disclosures of cash flows information
Cash paid during the period for:
Interest	$	15,372,000		$	15,826,000
Federal income tax		6,000,000			14,450,000
Noncash financing and investing activities:
Transfers from premises and equipment to other assets		2,847,000			0
Transfers from loans to foreclosed assets		0			30,000

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation : The unaudited financial statements for the nine months ended September 30, 2022 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank (“our bank”) and our bank’s subsidiary, Mercantile Insurance Center, Inc. These consolidated financial statements have been prepared in accordance with the instructions for Form 10 -Q and Item 303 (b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended September 30, 2022 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, 2021.

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.

Coronavirus Pandemic : Although there has been an easing of Covid- 19 pandemic-related restrictions, there remains a significant amount of stress and uncertainty across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid- 19” ) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). This uncertainty is heightened as certain geographic areas continue to experience surges in Covid- 19 cases and governments at all levels continue to react to changes in circumstances, including vaccine hesitancy, booster shot efficacy, supply chain disruptions and inflationary pressures. In addition, this uncertainty is further heightened by the possibility that new and highly infectious variants and subvariants of Covid- 19 might arise which are capable of evading vaccinations, booster shots and prior immunity.

The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations. Additionally, the consequences of the unprecedented economic impact of the Coronavirus Pandemic may produce declining asset quality, reflected by a higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which may necessitate additional provisions for our allowance and reduce net income.

The following section summarizes the primary measures that directly impact us and our customers.

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Paycheck Protection Program

The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7 (a) loan program. The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee paid by the Small Business Administration. The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology. The program ended on August 8, 2020. We originated approximately 2,200 loans aggregating $ 553 million. As of September 30, 2022, we recorded forgiveness transactions on all but five loans aggregating $ 0.5 million. Net loan origination fees of less than $ 0.1 million were recorded during the first nine months of 2022.

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The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in Second Draw PPP loans (“Second Draw”). The program ended on May 31, 2021. Under the Second Draw, we originated approximately 1,200 loans aggregating $ 209 million. As of September 30, 2022, we recorded forgiveness transactions on all but seven loans aggregating $ 2.1 million. Net loan origination fees of $ 0.9 million were recorded during the first nine months of 2022 under the Second Draw.

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Individual Economic Impact Payments

The Internal Revenue Service made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks. In general, and subject to adjusted gross income limitations, qualifying individuals received payments of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.

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Troubled Debt Restructuring Relief

From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid- 19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. We elected to suspend GAAP principles and regulatory determinations as permitted. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022.

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Current Expected Credit Loss ( “ CECL ” ) Methodology Delay

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022. We adopted the CECL methodology effective January 1, 2022.

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. As of September 30, 2022 and December 31, 2021, all of our debt securities were designated 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. Federal Home Loan Bank stock is carried at cost.

Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

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For available for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance. For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors. In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when we believe the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At September 30, 2022, there was no allowance for credit losses related to the available for sale debt securities portfolio. Accrued interest receivable on available for sale debt securities totaled $ 3.1 million at September 30, 2022 and was excluded from the estimate of credit losses as any accrued interest that is not expected to be collected is reversed against interest income.

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 credit losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

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

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

Loans Held for Sale : Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of September 30, 2022 and December 31, 2021, we determined that the fair value of our mortgage loans held for sale was $ 14.7 million and $ 16.7 million, respectively.

Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives, which is generally nominal in dollar amount, is included in the gain on sale of loans and recorded as part of mortgage banking income. Mortgage loans serviced for others totaled about $ 1.38 billion and $ 1.34 billion as of September 30, 2022 and December 31, 2021, respectively.

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Allowance for Credit Losses ( “ Allowance ” ) : In June 2016, the FASB issued ASU No. 2016 - 13, Measurement of Credit Losses on Financial Instruments . This ASU (as subsequently amended by ASU 2018 - 19 ) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the CECL model, applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU was effective for interim and annual reporting periods beginning after December 15, 2019.

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continued to experience an unprecedented economic environment whereby a sizable portion of the economy had been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus was provided to businesses, individuals and state and local governments and financial institutions offered businesses and individuals payment relief options, economic forecasts were regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL until January 1, 2022, and continued to use our incurred loan loss reserve model as permitted through December 31, 2021.

We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $ 0.4 million, which included a $ 0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $ 0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.

Accrued interest receivable for loans is included in other assets on our Consolidated Balance Sheet. We elected not to measure an allowance for accrued interest receivable and instead elected to reverse interest income on loans that are placed on nonaccrual status, which is generally when the loan becomes 90 days past due, or earlier if we believe the collection of interest is doubtful. We believe this policy results in the timely reversal of uncollectible interest.

The allowance is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged-off against the allowance when we believe the uncollectibility of a loan balance is confirmed.

The allowance is measured on a collective pool basis when similar risk characteristics exist. Loans with similar risk characteristics are grouped into homogenous segments, or pools, for analysis. Commercial loans are divided among five segments based primarily on collateral type, risk characteristics, and primary and secondary sources of repayment. These segments are then further stratified based on the commercial loan grade that is assigned using our standard loan grading paradigm. Retail loans are divided into one of two groups based on if the loan is secured by residential real estate or not.

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Our loan portfolio segments as of September 30, 2022 were as follows:

Commercial Loans

	■	Commercial and Industrial : Risks to this loan category include industry concentration and the practical limitations associated with monitoring the condition of the collateral which often consists of inventory, accounts receivable, and other non-real estate assets. Equipment and inventory obsolescence can also pose a risk. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.
	■	Owner Occupied Commercial Real Estate : Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category.
	■	Non-Owner Occupied Commercial Real Estate : Loans in this category are susceptible to declines in occupancy rates, business failure, and general economic conditions. Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category.
	■	Multi-Family and Residential Rental : Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral. Loans in this category are susceptible to weakening general economic conditions and increases in unemployment rates, as well as market demand and supply of similar property and the resulting impact on occupancy rates, market rents, cash flow, and income-based real estate values. Also, the lack of a suitable alternative use for the properties is a risk for loans in this category.
	■	Vacant Land, Land Development and Residential Construction : Risks common to commercial construction loans are cost overruns, changes in market demand for property, inadequate long-term financing arrangements, and declines in real estate values. Residential construction loans are susceptible to those same risks as well as those associated with residential mortgage loans. Changes in market demand for property could lead to longer marketing times resulting in higher carrying costs, declining values, and higher interest rates.

Retail Loans

	■	1 - 4 Family Mortgages : Residential mortgage loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.
	■	Other Consumer Loans : Risks common to these loans include regulatory risks, unemployment, and changes in local economic conditions as well as the inability to monitor collateral consisting of personal property.

The “remaining life methodology” is utilized for substantially all loan pools. This non-discounted cash flow approach projects an estimated future amortized cost basis based on current loan balance and repayment terms. Our historical loss rate is then applied to future loan balances at the instrument level based on remaining contractual life adjusted for amortization, prepayment and default to develop a baseline lifetime loss. The baseline lifetime loss is adjusted for changes in macroeconomic conditions over the reasonable and supportable forecast and reversion periods via a series of macroeconomic forecast inputs, such as gross domestic product, unemployment rates, interest rates, credit spreads, stock market volatility and property price indices, to quantify the impact of current and forecasted economic conditions on expected loan performance.

We use migration to determine historical loss rates for commercial loans given the comprehensive loan grading process employed by the bank for over two decades, while an open pool approach is best suited for retail loans given the smaller dollar size of the segments. A baseline loss rate is produced at each reporting date for each loan portfolio segment using bank-specific loan charge-off and recovery data over a defined historical look-back period. The look-back period represents the number of data periods that will be used to calculate a baseline loss rate for each loan portfolio segment. We determined that the look-back period commencing on January 1, 2011 through the current reporting date was reasonable and appropriate.

Reasonable and supportable economic forecasts have to be incorporated in determining expected credit losses. The forecast period represents the time frame from the current period end through the point in time that we can reasonably forecast and support entity and environmental factors that are expected to impact the performance of our loan portfolio. Ideally, the economic forecast period would encompass the contractual terms of all loans; however, the ability to produce a forecast that is considered reasonable and supportable becomes more difficult or may not be possible in later periods. Subsequent to the end of the forecast period, we revert to historical loan data based on an ongoing evaluation of each economic forecast in relation to then current economic conditions as well as any developing loan loss activity and resulting historical data. As of September 30, 2022, we used a one -year reasonable and supportable economic forecast period, with a six -month straight-line reversion period.

We are not required to develop and use our own economic forecast model, and elected to utilize economic forecasts from third -party providers that analyze and develop forecasts of the economy for the entire United States at least quarterly. The economic forecasts used for our September 30, 2022 allowance calculation reflected a $ 1.0 million allowance balance increase compared to the forecasts used for our June 30, 2022 allowance calculation, in large part reflecting lower economic growth and higher unemployment conditions. Our methodology does provide for a potential qualitative factor that can be used in the event of local or regional conditions that depart from the conditions and forecasts for the entire country.

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During each reporting period, we also consider the need to adjust historical loss information to reflect the extent to which we expect current conditions and reasonable and supportable economic forecasts to differ from the conditions that existed for the period over which the historical loss information was determined. These qualitative adjustments may increase or decrease our estimate of expected future credit losses.

Traditional qualitative factors include:

Changes in lending policies and procedures

Changes in the nature and volume of the loan portfolio and in the terms of loans

Changes in the experience, ability and depth of lending management and other relevant staff

Changes in the volume and severity of past due loans, nonaccrual loans and adversely classified loans

Changes in the quality of the loan review program

Changes in the value of underlying collateral dependent loans

Existence and effect of any concentrations of credit and any changes in such

Effect of other factors such as competition and legal and regulatory requirements

The estimation of future credit losses should reflect consideration of all significant factors that affect the collectibility of the loan portfolio at each evaluation date. While our methodology considers both the historical loss rates as well as the traditional qualitative factors, there may be instances or situations where additional qualitative factors need to be considered.

As of September 30, 2022, we employed two additional qualitative factors:

The Coronavirus Pandemic Factor was established effective June 30, 2020 to address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic.

The Historical Loss Information Factor was established effective January 1, 2022 to address the low level of loan losses during the look-back period.

Expected credit losses are estimated over the contractual terms of the loans, adjusted for expected prepayments when appropriate. The contractual term generally excludes potential extensions, renewals and modifications.

We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.

A provision for credit losses of $ 2.9 million was recorded during the third quarter of 2022, compared to a provision expense of $ 1.9 million during the third quarter of 2021. A provision for credit losses of $ 3.5 million was recorded during the first nine months of 2022, compared to a negative provision of $ 0.9 million during the first nine months of 2021. The provision expense recorded during the current-year third quarter mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, and a decline in forecasted economic conditions. The provision expense recorded during the first nine months of 2022 primarily resulted from these factors, along with a higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio. The increases were partially mitigated by the recording of net loan recoveries and ongoing strong loan quality metrics during the periods. In addition, reflecting improvement in overall Covid- 19 conditions, including increased vaccination rates, the availability of booster shots, and the lifting of many economic growth-restraining restrictions, we reduced the allocation amounts associated with the Covid- 19 environmental factor during the second quarter of 2022.

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1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

Mortgage Banking Activities : Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.

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

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

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

The federal banking agencies issued an “ Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus ” on March 22, 2020, which was subsequently revised on April 7, 2020. This guidance encourages financial institutions to work prudently with borrowers that are or may be unable to meet their contractual obligations because of the effects of the Coronavirus Pandemic. Pursuant to the guidance, the federal banking agencies concluded, in consultation with FASB staff, that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current prior to any relief are not troubled debt restructurings. This guidance complements Section 4013 of the CARES Act, which specified that Coronavirus-related modifications made on loans that were current as of December 31, 2019 and that occur between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency declared by President Trump on March 13, 2020 ( the “National Emergency”) or December 31, 2020, as applicable, are not troubled debt restructurings. As part of the Consolidated Appropriations Act that was enacted in late 2020, this guidance was extended to January 1, 2022.

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1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 qualify for hedge accounting. We do not use derivatives for speculative purposes.

Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense. We had no derivative instruments designated as hedges as of September 30, 2022 and December 31, 2021.

Goodwill and Core Deposit Intangible : Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We conducted an annual test during 2021, with no impairment recognized, and no circumstances have arisen in 2022 to warrant an additional impairment analysis beyond the annual test in 2022. We may elect to perform a qualitative assessment for the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value.

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

Revenue from Contracts with Customers : We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “ Revenue from Contracts with Customers ” (“Topic 606” ). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary.

We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

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1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

The following table depicts our sources of noninterest income that are scoped within Topic 606:

	Three Months Ended Sept 30, 2022		Three Months Ended Sept 30, 2021		Nine Months Ended Sept 30, 2022		Nine Months Ended Sept 30, 2021

Service charges on deposit and sweep accounts	$	1,579,000	$	1,324,000	$	4,489,000	$	3,687,000
Credit and debit card fees		2,086,000		1,947,000		6,101,000		5,545,000
Payroll processing		533,000		412,000		1,635,000		1,374,000
Customer service fees		210,000		241,000		654,000		650,000

Service Charges on Deposit and Sweep Accounts: We earn fees from deposit and sweep customers for account maintenance, transaction-based and overdraft services. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of the month reflecting the period over which we satisfy the performance obligation. Transaction-based fees, which include services such as stop payment and returned item charges, are recognized at the time the transaction is executed as that is the point in time we fulfill the customer request. Service charges on deposit and sweep accounts are withdrawn from the customer account balance.

Credit and Debit Card Fees: We earn interchange income on our cardholder debit and credit card usage. Interchange income is primarily comprised of fees whenever our debit and credit cards are processed through card payment networks such as Visa. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

Payroll Processing Fees: We earn fees from providing payroll processing services for our commercial clients. Fees are assessed for processing weekly or bi-weekly payroll files, reports and documents, as well as year-end tax-related files, reports and documents. Fees are recognized and collected as payroll processing services are completed for each payroll run and year-end processing activities.

Customer Service Fees: We earn fees by providing a variety of other services to our customers, such as wire transfers, check ordering, sales of cashier checks and money orders, and rentals of safe deposit boxes. Generally, fees are recognized and collected daily, concurrently with the point in time we fulfill the customer request. Safe deposit box rentals are on annual contracts, with fees generally earned at the time of the contract signing or renewal. Customer service fees are recorded as other noninterest income on our Consolidated Statements of Income.

Newly Issued Not Yet Effective Standards : ASU No. 2022 - 02 Financial Instruments – Credit Losses (Topic 326 ): Troubled Debt Restructurings and Vintage Disclosures . This ASU eliminates the accounting guidance for troubled debt restructurings (“TDRs”) by creditors in Subtopic 310 - 40, Receivables – Troubled Debt Restructurings by Creditors, while adding disclosures for certain loan restructurings by creditors when a borrower is experiencing financial difficulty. This guidance requires an entity to determine whether the modification results in a new loan or a continuation of an existing loan. Additionally, the ASU requires disclosures of current period gross charge-offs by year of origination for financing receivables. This ASU is effective for fiscal years beginning after December 15, 2022. We do not believe the adoption of this ASU will have a material impact on our financial results. The required disclosures for gross charge-offs on our financial statements will be added upon adoption of this new standard.

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2. SECURITIES

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2022
U.S. Government agency debt obligations	$	453,675,000	$	0	$	( 68,219,000	)	$	385,456,000
Mortgage-backed securities		39,011,000		12,000		( 6,366,000	)		32,657,000
Municipal general obligation bonds		155,294,000		31,000		( 13,304,000	)		142,021,000
Municipal revenue bonds		26,245,000		0		( 3,880,000	)		22,365,000
Other investments		500,000		0		0			500,000

	$	674,725,000	$	43,000	$	( 91,769,000	)	$	582,999,000

December 31, 2021
U.S. Government agency debt obligations	$	398,874,000	$	266,000	$	( 8,769,000	)	$	390,371,000
Mortgage-backed securities		41,906,000		549,000		( 652,000	)		41,803,000
Municipal general obligation bonds		133,894,000		4,092,000		( 392,000	)		137,594,000
Municipal revenue bonds		22,289,000		331,000		( 145,000	)		22,475,000
Other investments		500,000		0		0			500,000

	$	597,463,000	$	5,238,000	$	( 9,958,000	)	$	592,743,000

Securities with unrealized losses at September 30, 2022 and December 31, 2021, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
September 30, 2022
U.S. Government agency debt obligations	$	110,145,000	$	16,096,000	$	275,311,000	$	52,123,000	$	385,456,000	$	68,219,000
Mortgage-backed securities		31,918,000		6,365,000		13,000		1,000		31,931,000		6,366,000
Municipal general obligation bonds		108,512,000		8,687,000		26,039,000		4,617,000		134,551,000		13,304,000
Municipal revenue bonds		13,504,000		1,759,000		8,861,000		2,121,000		22,365,000		3,880,000

	$	264,079,000	$	32,907,000	$	310,224,000	$	58,862,000	$	574,303,000	$	91,769,000

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(Unaudited)

2. SECURITIES (Continued)

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
December 31, 2021
U.S. Government agency debt obligations	$	274,287,000	$	5,274,000	$	110,053,000	$	3,495,000	$	384,340,000	$	8,769,000
Mortgage-backed securities		23,184,000		652,000		24,000		0		23,208,000		652,000
Municipal general obligation bonds		40,748,000		392,000		0		0		40,748,000		392,000
Municipal revenue bonds		12,843,000		137,000		414,000		8,000		13,257,000		145,000

	$	351,062,000	$	6,455,000	$	110,491,000	$	3,503,000	$	461,553,000	$	9,958,000

We evaluate securities in an unrealized loss position at least quarterly. Consideration is given to 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, 2022, 774 debt securities with estimated fair values totaling $ 574 million had unrealized losses aggregating $ 91.8 million. At December 31, 2021, 333 debt securities with estimated fair values totaling $ 462 million had unrealized losses aggregating $ 10.0 million. At September 30, 2022, unrealized losses aggregating $ 74.6 million were attributable to bonds issued or guaranteed by agencies of the U.S. federal government, while unrealized losses totaling $ 17.2 million were associated with bonds issued by state-based municipalities. After considering the issuers of the bonds, and taking into account the fact that no municipal issuer had been subject to a credit rating downgrade by bond credit rating agencies, we determined that the unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.

The amortized cost and fair value of debt securities at September 30, 2022, 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.

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(Unaudited)

2. SECURITIES (Continued)

	Weighted Average Yield		Amortized Cost		Fair Value

Due in 2022		1.35 %	$	3,739,000	$	3,732,000
Due in 2023 through 2027		1.15		267,809,000		242,952,000
Due in 2028 through 2032		1.86		316,237,000		264,643,000
Due in 2033 and beyond		2.58		47,429,000		38,515,000
Mortgage-backed securities		2.09		39,011,000		32,657,000
Other investments		4.33		500,000		500,000

Total available for sale securities		1.64 %	$	674,725,000	$	582,999,000

Securities issued by the State of Michigan and all its political subdivisions had combined amortized costs of $ 181 million and $ 155 million at September 30, 2022 and December 31, 2021, respectively, with estimated market values of $ 164 million and $ 158 million, respectively. Securities issued by all other states and their political subdivisions had combined amortized costs of $ 0.2 million and $ 1.7 million and estimated market values of $ 0.3 million and $ 1.7 million at September 30, 2022 and December 31, 2021, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, did not exceed 10% of shareholders’ equity.

The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $ 199 million and $ 197 million at September 30, 2022 and December 31, 2021, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

3. LOANS AND ALLOWANCE FOR CREDIT 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 collectibility 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Our total loans at September 30, 2022 were $ 3.88 billion compared to $ 3.45 billion at December 31, 2021, an increase of $ 427 million, or 12.4 %. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at September 30, 2022 and December 31, 2021, and the percentage change in loans from the end of 2021 to the end of the third quarter of 2022, are as follows:

											Percent
	September 30, 2022					December 31, 2021					Increase
	Balance		%			Balance		%			(Decrease)

Commercial:
Commercial and industrial (1)	$	1,213,630,000		31.3	%	$	1,137,419,000		32.9	%		6.7	%
Vacant land, land development, and residential construction		60,970,000		1.6			43,239,000		1.3			41.0
Real estate – owner occupied		643,577,000		16.6			565,758,000		16.4			13.8
Real estate – non-owner occupied		1,002,638,000		25.8			1,027,415,000		29.7			( 2.4	)
Real estate – multi-family and residential rental		224,248,000		5.7			176,593,000		5.1			27.0
Total commercial		3,145,063,000		81.0			2,950,424,000		85.4			6.6

Retail:
1-4 family mortgages		705,441,000		18.2			442,547,000		12.8			59.4
Other consumer loans (2)		30,454,000		0.8			60,488,000		1.8			( 49.7	)
Total retail		735,895,000		19.0			503,035,000		14.6			46.3

Total loans	$	3,880,958,000		100.0	%	$	3,453,459,000		100.0	%		12.4	%

( 1 )

For September 30, 2022, and December 31, 2021, includes $ 2.6 million and $ 40.1 million in loans originated under the Paycheck Protection Program, respectively.

( 2 )

In conjunction with the adoption of the CECL methodology effective January 1, 2022, home equity lines of credit were reclassified to 1 - 4 family mortgage loans from other consumer loans. Home equity lines of credit totaled $ 35.6 million and $ 29.5 million as of September 30, 2022 and December 31, 2021, respectively.

Nonperforming loans as of September 30, 2022 and December 31, 2021 were as follows:

	September 30, 2022		December 31, 2021

Loans past due 90 days or more still accruing interest	$	0	$	155,000
Nonaccrual loans		1,416,000		2,313,000

Total nonperforming loans	$	1,416,000	$	2,468,000

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The recorded principal balance of nonperforming loans was as follows:

	September 30, 2022		December 31, 2021
Commercial:
Commercial and industrial	$	249,000	$	663,000
Vacant land, land development, and residential construction		0		0
Real estate – owner occupied		0		0
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		249,000		663,000

Retail:
1-4 family mortgages		1,167,000		1,686,000
Other consumer loans		0		119,000
Total retail		1,167,000		1,805,000

Total nonperforming loans	$	1,416,000	$	2,468,000

An age analysis of past due loans is as follows as of September 30, 2022:

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

Commercial:
Commercial and industrial	$	16,000	$	0	$	249,000	$	265,000	$	1,213,365,000	$	1,213,630,000	$	0
Vacant land, land development, and residential construction		32,000		0		0		32,000		60,938,000		60,970,000		0
Real estate – owner occupied		0		0		0		0		643,577,000		643,577,000		0
Real estate – non-owner occupied		0		0		0		0		1,002,638,000		1,002,638,000		0
Real estate – multi-family and residential rental		0		0		0		0		224,248,000		224,248,000		0
Total commercial		48,000		0		249,000		297,000		3,144,766,000		3,145,063,000		0

Retail:
1-4 family mortgages		53,000		31,000		141,000		225,000		705,216,000		705,441,000		0
Other consumer loans		1,000		0		0		1,000		30,453,000		30,454,000		0
Total retail		54,000		31,000		141,000		226,000		735,669,000		735,895,000		0

Total past due loans	$	102,000	$	31,000	$	390,000	$	523,000	$	3,880,435,000	$	3,880,958,000	$	0

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

An age analysis of past due loans is as follows as of December 31, 2021:

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

Commercial:
Commercial and industrial	$	14,000	$	0	$	193,000	$	207,000	$	1,137,212,000	$	1,137,419,000	$	155,000
Vacant land, land development, and residential construction		13,000		0		0		13,000		43,226,000		43,239,000		0
Real estate – owner occupied		0		0		0		0		565,758,000		565,758,000		0
Real estate – non-owner occupied		0		0		0		0		1,027,415,000		1,027,415,000		0
Real estate – multi-family and residential rental		0		0		0		0		176,593,000		176,593,000		0
Total commercial		27,000		0		193,000		220,000		2,950,204,000		2,950,424,000		155,000

Retail:
Home equity and other		132,000		2,000		20,000		154,000		60,334,000		60,488,000		0
1-4 family mortgages		1,265,000		241,000		82,000		1,588,000		440,959,000		442,547,000		0
Total retail		1,397,000		243,000		102,000		1,742,000		501,293,000		503,035,000		0

Total past due loans	$	1,424,000	$	243,000	$	295,000	$	1,962,000	$	3,451,497,000	$	3,453,459,000	$	155,000

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on an internal watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on distressed lending relationships, as well as on foreclosed and repossessed assets, are reviewed periodically. We also have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions. Under CECL for collateral dependent loans in instances where the borrower is experiencing financial difficulties, we adopted the practical expedient to measure the allowance based on the fair value of collateral. The allowance is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral and the recorded principal balance. If the fair value of the collateral exceeds the recorded principal balance, no allowance is required.

Collateral dependent loans, representing the entire amount of loans on nonaccrual, totaled $ 1.4 million as of September 30, 2022. Residential real estate served as collateral on $ 1.2 million in loans categorized as 1 - 4 family mortgages, with non-real estate business assets serving as collateral on $ 0.2 million in loans categorized as commercial and industrial loans. Specific reserve allocations on nonaccrual loans totaled less than $ 0.1 million as of September 30, 2022. No interest income was recognized on nonaccrual loans during the third quarter and first nine months of 2022. Lost interest income on nonaccrual loans totaled less than $ 0.1 million and $ 0.1 million during the third quarter and first nine months of 2022, respectively.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Impaired loans as of December 31, 2021, and average impaired loans for the three and nine months ended September 30, 2021, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Third Quarter Average Recorded Principal Balance		Year-To- Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	2,893,000	$	2,818,000		$	2,759,000	$	3,836,000
Vacant land, land development and residential construction		0		0			0		0
Real estate – owner occupied		9,674,000		9,674,000			12,674,000		13,374,000
Real estate – non-owner occupied		0		0			0		163,000
Real estate – multi-family and residential rental		91,000		91,000			46,000		23,000
Total commercial		12,658,000		12,583,000			15,479,000		17,396,000
Retail:
Home equity and other		1,173,000		1,107,000			1,223,000		1,093,000
1-4 family mortgages		3,166,000		2,025,000			2,256,000		2,403,000
Total retail		4,339,000		3,132,000			3,479,000		3,496,000

Total with no related allowance recorded	$	16,997,000	$	15,715,000		$	18,958,000	$	20,892,000

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Third Quarter Average Recorded Principal Balance		Year-To- Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	2,192,000	$	2,192,000	$	266,000	$	2,888,000	$	1,617,000
Vacant land, land development and residential construction		0		0		0		0		0
Real estate – owner occupied		761,000		761,000		84,000		994,000		813,000
Real estate – non-owner occupied		146,000		146,000		4,000		152,000		156,000
Real estate – multi-family and residential rental		0		0		0		0		0
Total commercial		3,099,000		3,099,000		354,000		4,034,000		2,586,000
Retail:
Home equity and other		160,000		140,000		123,000		197,000		232,000
1-4 family mortgages		412,000		412,000		69,000		472,000		569,000
Total retail		572,000		552,000		192,000		669,000		801,000

Total with an allowance recorded	$	3,671,000	$	3,651,000	$	546,000	$	4,703,000	$	3,387,000

Total impaired loans:
Commercial	$	15,757,000	$	15,682,000	$	354,000	$	19,513,000	$	19,982,000
Retail		4,911,000		3,684,000		192,000		4,148,000		4,297,000
Total impaired loans	$	20,668,000	$	19,366,000	$	546,000	$	23,661,000	$	24,279,000

Impaired commercial loans for which no allocation of the allowance has been made in large part consist of performing troubled debt restructurings where the estimated collateral fair value exceeds the recorded principal balance, while impaired retail loans with no allowance allocation generally reflect situations whereby the recorded principal balances have been charged-down to estimated collateral fair value. Interest income recognized on accruing troubled debt restructurings totaled $ 0.4 million and $ 1.2 million during the third quarter and first nine months of 2021, respectively. No interest income was recognized on nonaccrual loans during the third quarter and first nine months of 2021. Lost interest income on nonaccrual loans totaled less than $ 0.1 million and $ 0.1 million during the third quarter and first nine months of 2021, respectively.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Credit Quality Indicators. We utilize a comprehensive grading system for our commercial loans. All commercial loans are graded on a ten grade rating system. The rating system utilizes standardized grade paradigms that analyze several critical factors such as cash flow, operating performance, financial condition, collateral, industry condition and management. All commercial loans are graded at inception and reviewed and, if appropriate, re-graded at various intervals thereafter. The risk assessment for retail loans is primarily based on the type of collateral.

Credit quality indicators were as follows as of September 30, 2022:

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

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

Internal credit risk grade groupings:
Grades 1 – 4 (1)	$	740,682,000	$	42,738,000	$	385,604,000	$	499,327,000	$	138,694,000
Grades 5 – 7		455,801,000		18,123,000		254,827,000		490,785,000		85,502,000
Grades 8 – 9		17,147,000		109,000		3,146,000		12,526,000		52,000
Total commercial	$	1,213,630,000	$	60,970,000	$	643,577,000	$	1,002,638,000	$	224,248,000

Retail credit exposure – credit risk profiled by collateral type:

	Other Consumer Loans		Retail 1-4 Family Mortgages

Performing	$	30,454,000	$	704,274,000
Nonperforming		0		1,167,000
Total retail	$	30,454,000	$	705,441,000

( 1 )

Included in Commercial and Industrial Loans Grades 1 – 4 are $ 2.6 million of loans originated under the Paycheck Protection Program.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Credit quality indicators were as follows as of December 31, 2021:

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

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

Internal credit risk grade groupings:
Grades 1 – 4 (1)	$	729,224,000	$	28,390,000	$	346,082,000	$	503,482,000	$	119,473,000
Grades 5 – 7		398,378,000		14,730,000		208,060,000		511,280,000		56,968,000
Grades 8 – 9		9,817,000		119,000		11,616,000		12,653,000		152,000
Total commercial	$	1,137,419,000	$	43,239,000	$	565,758,000	$	1,027,415,000	$	176,593,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages

Performing	$	60,369,000	$	440,861,000
Nonperforming		119,000		1,686,000
Total retail	$	60,488,000	$	442,547,000

( 1 )

Included in Commercial and Industrial Loans Grades 1 – 4 are $ 40.1 million of loans originated under the Paycheck Protection Program.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

All commercial loans are graded using the following criteria:

Grade 1.

“Exceptional” Loans with this rating contain very little, if any, risk.

Grade 2.

“Outstanding” Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.

Grade 3.

“Very Good” Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are acceptable.

Grade 4.

“Good” Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are modest.

Grade 5.

“Acceptable” Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements. These are loans for which repayment risks are satisfactory.

Grade 6.

“Monitor” Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report.

Grade 7.

“Special Mention” Loans with this rating have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Grade 8.

“Substandard” Loans with this rating are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any. A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Grade 9.

“Doubtful” Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.

Grade 10.

“Loss” Loans with this rating are considered uncollectable, and of such little value that continuance as an active asset is not warranted.

The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments; loans 90 days or more past due are considered nonperforming. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3 . LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The following table reflects loan balances as of September 30, 2022 based on year of origination (dollars in thousands):

	2022		2021		2020		2019		2018		Prior		Term Total		Revolving Loans		Grand Total
Commercial:
Commercial and Industrial:
Grades 1 – 4	$	84,723	$	172,209	$	49,083	$	12,173	$	2,826	$	10,313	$	331,327	$	409,355	$	740,682
Grades 5 – 7		144,180		46,989		34,404		9,322		1,866		238		236,999		218,802		455,801
Grades 8 – 9		3,849		249		0		0		51		36		4,185		12,962		17,147
Total	$	232,752	$	219,447	$	83,487	$	21,495	$	4,743	$	10,587	$	572,511	$	641,119	$	1,213,630

Vacant Land, Land Development and Residential Construction:
Grades 1 – 4	$	26,719	$	11,956	$	3,432	$	0	$	0	$	343	$	42,450	$	288	$	42,738
Grades 5 – 7		8,274		8,519		558		52		0		718		18,121		2		18,123
Grades 8 – 9		0		0		0		0		16		93		109		0		109
Total	$	34,993	$	20,475	$	3,990	$	52	$	16	$	1,154	$	60,680	$	290	$	60,970

Real Estate – Owner Occupied:
Grades 1 – 4	$	129,640	$	159,735	$	58,119	$	19,107	$	9,589	$	9,414	$	385,604	$	0	$	385,604
Grades 5 – 7		120,184		60,281		37,008		11,893		22,890		2,571		254,827		0		254,827
Grades 8 – 9		2,689		250		45		0		162		0		3,146		0		3,146
Total	$	252,513	$	220,266	$	95,172	$	31,000	$	32,641	$	11,985	$	643,577	$	0	$	643,577

Real Estate – Non-Owner Occupied:
Grades 1 – 4	$	88,916	$	182,620	$	132,805	$	68,453	$	10,300	$	16,233	$	499,327	$	0	$	499,327
Grades 5 – 7		117,989		167,936		122,665		22,901		14,092		45,202		490,785		0		490,785
Grades 8 – 9		6,780		5,746		0		0		0		0		12,526		0		12,526
Total	$	213,685	$	356,302	$	255,470	$	91,354	$	24,392	$	61,435	$	1,002,638	$	0	$	1,002,638

Real Estate – Multi-Family and Residential Rental:
Grades 1 – 4	$	31,627	$	56,824	$	37,519	$	5,387	$	3,067	$	4,270	$	138,694	$	0	$	138,694
Grades 5 – 7		38,003		26,696		13,441		3,249		3,131		982		85,502		0		85,502
Grades 8 – 9		0		0		0		0		0		52		52		0		52
Total	$	69,630	$	83,520	$	50,960	$	8,636	$	6,198	$	5,304	$	224,248	$	0	$	224,248
Total Commercial	$	803,573	$	900,010	$	489,079	$	152,537	$	67,990	$	90,465	$	2,503,654	$	641,409	$	3,145,063

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

	2022		2021		2020		2019		2018		Prior		Term Total		Revolving Loans		Grand Total
Retail:
1-4 Family Mortgages:
Performing	$	258,124	$	243,023	$	95,502	$	12,576	$	15,111	$	44,741	$	669,077	$	35,197	$	704,274
Nonperforming		20		86		0		0		0		1,061		1,167		0		1,167
Total	$	258,144	$	243,109	$	95,502	$	12,576	$	15,111	$	45,802	$	670,244	$	35,197	$	705,441
Other Consumer Loans:
Performing	$	3,810	$	3,251	$	1,264	$	1,247	$	497	$	549	$	10,618	$	19,836	$	30,454
Nonperforming		0		0		0		0		0		0		0		0		0
Total	$	3,810	$	3,251	$	1,264	$	1,247	$	497	$	549	$	10,618	$	19,836	$	30,454
Total Retail	$	261,954	$	246,360	$	96,766	$	13,823	$	15,608	$	46,351	$	680,862	$	55,033	$	735,895

Grand Total	$	1,065,527	$	1,146,370	$	585,845	$	166,360	$	83,598	$	136,816	$	3,184,516	$	696,442	$	3,880,958

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity in the allowance for credit losses during the three months and nine months ended September 30, 2022 is as follows (dollars in thousands):

	Commercial and industrial			Commercial vacant land, land development and residential construction			Commercial real estate – owner occupied			Commercial real estate – non-owner occupied			Commercial real estate – multi-family and residential rental			1-4 family mortgages			Other consumer loans			Unallocated			Total
Allowance for credit losses:
Balance at 6-30-22	$	8,608		$	446		$	5,578		$	9,614		$	1,274		$	10,267		$	165		$	22		$	35,974
Provision for credit losses		1,110			21			372			( 108	)		( 21	)		1,530			( 13	)		9			2,900
Charge-offs		0			0			0			0			0			0			0			0			0
Recoveries		22			1			22			0			23			154			24			0			246
Ending balance	$	9,740		$	468		$	5,972		$	9,506		$	1,276		$	11,951		$	176		$	31		$	39,120

Balance at 12-31-21	$	10,782		$	420		$	6,045		$	13,301		$	1,695		$	2,449		$	626		$	45		$	35,363
Adoption of ASU 2016-13		( 1,571	)		( 43	)		( 560	)		( 2,534	)		( 621	)		5,395			( 411	)		( 55	)		( 400	)
Provision for credit losses		518			117			407			( 1,261	)		165			3,587			( 74	)		41			3,500
Charge-offs		( 170	)		( 29	)		0			0			0			( 2	)		( 18	)		0			( 219	)
Recoveries		181			3			80			0			37			522			53			0			876
Ending balance	$	9,740		$	468		$	5,972		$	9,506		$	1,276		$	11,951		$	176		$	31		$	39,120

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity in the allowance for loan losses during the three months and nine months ended September 30, 2021 and the recorded investments in loans as of December 31, 2021 are as follows (dollars in thousands):

	Commercial and industrial			Commercial vacant land, land development and residential construction			Commercial real estate – owner occupied			Commercial real estate – non-owner occupied		Commercial real estate – multi-family and residential rental		Home equity and other			1 – 4 family mortgages			Unallocated		Total
Allowance for loan losses:
Balance at 6-30-21	$	9,340		$	479		$	7,701		$	12,785	$	1,787	$	742		$	2,894		$	185	$	35,913
Provision for loan losses		1,518			( 180	)		( 1,151	)		1,523		157		( 64	)		97			0		1,900
Charge-offs		( 690	)		0			0			0		0		( 23	)		( 30	)		0		( 743	)
Recoveries		10			127			76			0		0		42			98			0		353
Ending balance	$	10,178		$	426		$	6,626		$	14,308	$	1,944	$	697		$	3,059		$	185	$	37,423

Balance at 12-31-20	$	9,424		$	679		$	8,246		$	13,611	$	1,819	$	889		$	3,240		$	59	$	37,967
Provision for loan losses		647			307			( 2,028	)		697		125		( 271	)		( 503	)		126		( 900	)
Charge-offs		( 54	)		( 705	)		( 12	)		0		0		( 30	)		( 64	)		0		( 865	)
Recoveries		161			145			420			0		0		109			386			0		1,221
Ending balance	$	10,178		$	426		$	6,626		$	14,308	$	1,944	$	697		$	3,059		$	185	$	37,423

Ending balance: individually evaluated for impairment	$	449		$	0		$	89		$	6	$	0	$	142		$	79		$	0	$	765

Ending balance: collectively evaluated for impairment	$	9,729		$	426		$	6,537		$	14,302	$	1,944	$	555		$	2,980		$	185	$	36,658

Total loans (*):
Ending balance	$	1,097,309		$	43,239		$	565,758		$	1,027,415	$	176,593	$	60,488		$	442,547				$	3,413,349

Ending balance: individually evaluated for impairment	$	5,010		$	0		$	10,435		$	146	$	91	$	1,247		$	2,437				$	19,366

Ending balance: collectively evaluated for impairment	$	1,092,299		$	43,239		$	555,323		$	1,027,269	$	176,502	$	59,241		$	440,110				$	3,393,983

(*) Excludes $40.1 million in loans originated under the Paycheck Protection Program.

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Loans modified as troubled debt restructurings generally reflect other than insignificant payment delays and below market interest rates.

Loans modified as troubled debt restructurings during the three months ended September 30, 2022 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Commercial:
Commercial and industrial		1	$	19,000	$	19,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		0		0		0
Total commercial		1		19,000		19,000
Retail:
1-4 family mortgages		2		289,000		289,000
Other consumer loans		0		0		0
Total retail		2		289,000		289,000

Total loans		3	$	308,000	$	308,000

Loans modified as troubled debt restructurings during the nine months ended September 30, 2022 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Commercial:
Commercial and industrial		3	$	6,593,000	$	6,593,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		0		0		0
Total commercial		3		6,593,000		6,593,000
Retail:
1-4 family mortgages		5		501,000		500,000
Other consumer loans		0		0		0
Total retail		5		501,000		500,000

Total loans		8	$	7,094,000	$	7,093,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Loans modified as troubled debt restructurings during the three months ended September 30, 2021 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Commercial:
Commercial and industrial		2	$	186,000	$	185,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		1		93,000		93,000
Total commercial		3		279,000		278,000
Retail:
Home equity and other		0		0		0
1-4 family mortgages		0		0		0
Total retail		0		0		0

Total loans		3	$	279,000	$	278,000

Loans modified as troubled debt restructurings during the nine months ended September 30, 2021 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Commercial:
Commercial and industrial		10	$	3,017,000	$	3,016,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		1		692,000		692,000
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		1		93,000		93,000
Total commercial		12		3,802,000		3,801,000
Retail:
Home equity and other		4		485,000		482,000
1-4 family mortgages		2		46,000		46,000
Total retail		6		531,000		528,000

Total loans		18	$	4,333,000	$	4,329,000

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

We had no loans modified as troubled debt restructurings within the previous twelve months that became over 30 days past due within the three months or nine months ended September 30, 2022.

We had one loan with a balance of less than $ 0.1 million modified as a troubled debt restructuring within the previous twelve months that became over 30 days past due within the three months ended September 30, 2021; this loan was the only troubled debt restructured loan that became over 30 days past due within the first nine months of 2021.

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2022 is as follows:

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

Commercial Loan Portfolio:
Beginning Balance	$	9,938,000		$	0	$	87,000		$	139,000		$	88,000
Charge-Offs		0			0		0			0			0
Payments (net)		( 891,000	)		0		( 3,000	)		( 4,000	)		( 88,000	)
Transfers to ORE		0			0		0			0			0
Net Additions/Deletions		19,000			0		0			0			0
Ending Balance	$	9,066,000		$	0	$	84,000		$	135,000		$	0

	Retail			Retail
	1-4 Family			Other Consumer
	Mortgages			Loans
Retail Loan Portfolio:
Beginning Balance	$	2,339,000		$	3,000
Charge-Offs		0			0
Payments (net)		( 84,000	)		( 1,000	)
Transfers to ORE		0			0
Net Additions/Deletions		289,000			0
Ending Balance	$	2,544,000		$	2,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the nine months ended September 30, 2022 is as follows:

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

Commercial Loan Portfolio:
Beginning Balance	$	4,973,000		$	0	$	10,435,000		$	146,000		$	91,000
Charge-Offs		( 95,000	)		0		0			0			0
Payments (net)		( 378,000	)		0		( 9,682,000	)		( 11,000	)		( 91,000	)
Transfers to ORE		0			0		0			0			0
Net Additions/Deletions		4,566,000			0		( 669,000	)		0			0
Ending Balance	$	9,066,000		$	0	$	84,000		$	135,000		$	0

	Retail			Retail
	1-4 Family			Other Consumer
	Mortgages			Loans
Retail Loan Portfolio:
Beginning Balance	$	627,000		$	1,202,000
Charge-Offs		0			0
Payments (net)		( 253,000	)		( 13,000	)
Transfers to ORE		0			0
Net Additions/Deletions (1)		2,170,000			( 1,187,000	)
Ending Balance	$	2,544,000		$	2,000

( 1 )

Includes $ 1.2 million in the transfer of home equity lines of credit from other consumer loans to 1 - 4 family mortgages in association with the adoption of the CECL methodology effective January 1, 2022.

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2021 is as follows:

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

Commercial Loan Portfolio:
Beginning Balance	$	5,563,000		$	0	$	13,888,000		$	153,000		$	0
Charge-Offs		( 17,000	)		0		0			0			0
Payments (net)		( 75,000	)		0		( 439,000	)		( 2,000	)		0
Transfers to ORE		0			0		0			0			0
Net Additions/Deletions		184,000			0		0			0			92,000
Ending Balance	$	5,655,000		$	0	$	13,449,000		$	151,000		$	92,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	1,396,000		$	699,000
Charge-Offs		0			0
Payments (net)		( 91,000	)		( 51,000	)
Transfers to ORE		0			0
Net Additions/Deletions		0			0
Ending Balance	$	1,305,000		$	648,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the nine months ended September 30, 2021 is as follows:

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

Commercial Loan Portfolio:
Beginning Balance	$	6,414,000		$	0	$	14,797,000		$	480,000		$	0
Charge-Offs		( 17,000	)		0		0			0			0
Payments (net)		( 3,596,000	)		0		( 2,034,000	)		( 329,000	)		0
Transfers to ORE		0			0		0			0			0
Net Additions/Deletions		2,854,000			0		686,000			0			92,000
Ending Balance	$	5,655,000		$	0	$	13,449,000		$	151,000		$	92,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	1,146,000		$	806,000
Charge-Offs		0			0
Payments (net)		( 323,000	)		( 204,000	)
Transfers to ORE		0			0
Net Additions/Deletions		482,000			46,000
Ending Balance	$	1,305,000		$	648,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4. PREMISES AND EQUIPMENT, NET

Premises and equipment are comprised of the following:

	September 30, 2022		December 31, 2021

Land and improvements	$	13,517,000	$	15,111,000
Buildings		52,960,000		56,168,000
Furniture and equipment		23,006,000		22,974,000
		89,483,000		94,253,000
Less: accumulated depreciation		37,366,000		36,955,000

Premises and equipment, net	$	52,117,000	$	57,298,000

Depreciation expense totaled $ 1.5 million during the third quarters of 2022 and 2021. Depreciation expense totaled $ 4.5 million during the first nine months of 2022, compared to $ 4.3 million during the first nine months of 2021.

We enter into facility leases in the normal course of business. As of September 30, 2022 and December 31, 2021, we were under lease contracts for ten of our banking facilities. The leases had maturity dates ranging from June, 2023 through December, 2026, with a weighted average life of 2.7 years and 2.8 years as of September 30, 2022 and December 31, 2021, respectively. All of our leases have multiple three - to five -year extensions; however, those were not factored in the lease maturities and weighted average lease term as it is not reasonably certain we will exercise the options.

Leases are classified as either operating or finance leases at the lease commitment date, with all of our current leases determined to be operating leases. Lease expense for operating leases is recognized on a straight-line basis over the lease term. Right-of-use assets represent our right to use an underlying asset for the lease term, while lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the lease commencement date at the estimated present value of lease payments over the lease term. We use our incremental borrowing rate, on a collateralized basis, at lease commencement to calculate the present value of lease payments. The weighted average discount rate for leases was 5.40 % and 4.70 % as of September 30, 2022 and December 31, 2021, respectively.

The right-of-use assets, included in premises and equipment, net on our Consolidated Balance Sheets, and the lease liabilities, included in other liabilities on our Consolidated Balance Sheets, each totaled $ 4.1 million as of September 30, 2022, and $ 3.6 million as of December 31, 2021. As permitted by applicable accounting standards, we have elected not to recognize short-term leases with original terms of twelve months or less on our Consolidated Balance Sheets. Total operating lease expense associated with the leases aggregated $ 0.2 million during the third quarters of 2022 and 2021, and $ 0.6 million and $ 0.5 million during the first nine months of 2022 and 2021, respectively.

Future lease payments at September 30, 2022 totaled $ 4.7 million, comprised of $ 1.0 million in one year, $ 1.4 million in one to three years, $ 0.7 million in three to five years and $ 1.6 million in over five years. Future lease payments at December 31, 2021 totaled $ 3.6 million, comprised of $ 0.8 million in one year, $ 1.4 million in one to three years, $ 0.3 million in three to five years and $ 1.1 million in over five years.

As part of the relocation of our Lansing operations, we completed the sale of our Lansing facility on July 14, 2022. Net proceeds totaled $ 2.9 million, with a $ 0.3 million loss on sale recorded during the second quarter of 2022.

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. DEPOSITS

Our total deposits at September 30, 2022 totaled $ 3.85 billion, a decrease of $ 237 million, or 5.8 %, from December 31, 2021. The components of our outstanding balances at September 30, 2022 and December 31, 2021, and percentage change in deposits from the end of 2021 to the end of the third quarter of 2022, are as follows:

	September 30, 2022					December 31, 2021					Percent Increase
	Balance		%			Balance		%			(Decrease)

Noninterest-bearing demand	$	1,716,904,000		44.6	%	$	1,677,952,000		41.1	%		2.3	%
Interest-bearing checking		529,297,000		13.8			538,838,000		13.2			( 1.8	)
Money market		808,734,000		21.0			1,040,176,000		25.5			( 22.3	)
Savings		412,491,000		10.7			394,330,000		9.7			4.6
Time, under $100,000		114,751,000		3.0			132,776,000		3.2			( 13.6	)
Time, $100,000 and over		263,908,000		6.9			275,208,000		6.7			( 4.1	)
Total local deposits		3,846,085,000		100.0			4,059,280,000		99.4			( 5.3	)

Out-of-area time, $100,000 and over		0		0.0			23,913,000		0.6		NA

Total deposits	$	3,846,085,000		100.0	%	$	4,083,193,000		100.0	%		( 5.8	%)

Total time deposits of more than $250,000 totaled $ 187 million and $ 207 million at September 30, 2022 and December 31, 2021, respectively.

6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

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

	Nine Months Ended September 30, 2022			Twelve Months Ended December 31, 2021

Outstanding balance at end of period	$	198,605,000		$	197,463,000
Average interest rate at end of period		0.14	%		0.11	%

Average daily balance during the period	$	198,639,000		$	158,855,000
Average interest rate during the period		0.10	%		0.11	%
Maximum daily balance during the period	$	232,959,000		$	209,093,000

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

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

7. FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $ 310 million at September 30, 2022, and were expected to mature at varying dates from October 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 1.92 %. FHLBI bullet advances totaled $ 374 million at December 31, 2021, and were expected to mature at varying dates from January 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 2.00 %.

Maturities of FHLBI bullet advances as of September 30, 2022 were as follows:

2022	$	30,000,000
2023		80,000,000
2024		80,000,000
2025		50,000,000
2026		30,000,000
Thereafter		40,000,000

FHLBI amortizing advances totaled $ 28.3 million as of September 30, 2022, with an average rate of 2.52 %. We had no FHLBI amortizing advances outstanding as of December 31, 2021. FHLBI amortizing advances are obtained periodically to assist in managing interest rate risk associated with certain longer-term fixed rate commercial loans, with annual principal payments that closely align with the scheduled amortization of the underlying commercial loans.

Scheduled principal payments on FHLBI amortizing advances as of September 30, 2022 were as follows:

2022	$	0
2023		353,000
2024		826,000
2025		862,000
2026		899,000
Thereafter		25,323,000

Each advance is payable at its maturity date and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit as of September 30, 2022 totaled $ 1.0 billion, with remaining availability based on collateral equaling $ 659 million.

8. COMMITMENTS AND OFF-BALANCE SHEET RISK

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on our credit assessment of the borrower.

We are required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.

We have determined that our commercial-related lending commitments are unconditionally cancellable. Additionally, the vast majority of unfunded commercial loan commitments consist of revolving lines of credit wherein the aggregate amounts outstanding and available remain relatively stable, and any seasonality of line usage is nominal. Line of credit draws, irrespective of the maximum credit or individual note amount, are governed by borrowing or advance formulas, while draws off of commercial and residential construction loans are governed by the receipt and satisfactory review of contractor and subcontractor sworn statements, lien waivers and title insurance company endorsements. Letters of credit are rarely drawn. For retail lines of credit, including home equity lines of credit, overdraft protection lines of credit and personal unsecured lines of credit, and credit cards, average outstanding balances as a percent of total available credit have remained relatively steady over the past several years. We determined allowance requirements for these credit types by calculating the difference between the average percent outstanding of the funded commitments over the past several years to actual percent outstanding as of September 30, 2022 and applying the respective expected loss allocation factors to the difference as this difference represents the average of unfunded commitments we expect to eventually be drawn upon. The calculated allowance for the retail lines of credit and credit cards as of September 30, 2022 was $ 0.3 million.

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at September 30, 2022 and December 31, 2021 follows:

	September 30, 2022		December 31, 2021

Commercial unused lines of credit	$	1,179,856,000	$	1,098,951,000
Unused lines of credit secured by 1 – 4 family residential properties		69,637,000		64,313,000
Credit card unused lines of credit		118,125,000		92,146,000
Other consumer unused lines of credit		90,470,000		64,876,000
Commitments to make loans		308,781,000		212,476,000
Standby letters of credit		24,503,000		33,109,000
	$	1,791,372,000	$	1,565,871,000

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9. DERIVATIVES AND HEDGING ACTIVITIES

We are exposed to certain risks arising from both business operations and economic conditions. We principally manage the exposure to a wide variety of operational risks through core business activities. Economic risks, including interest rate, liquidity and credit risk, are primarily administered via the amount, sources and duration of assets and liabilities. Derivative financial instruments may also be used to assist in managing economic risks.

Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers. We execute interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with correspondent banks to offset the impact of the interest rate swaps with the commercial banking customers. The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent banks are recognized directly to earnings. Fees paid to us by the correspondent banks are recognized as noninterest income on our Consolidated Statements of Income on the settlement date.

The fair values of derivative instruments as of September 30, 2022 are reflected on a gross basis in the following table.

	Notional Amount		Balance Sheet Location	Fair Value

Derivative Assets
Interest rate swaps	$	359,936,000	Other Assets	$	28,445,000

Derivative Liabilities
Interest rate swaps		359,936,000	Other Liabilities		28,544,000

The effect of interest rate swaps that are not designated as hedging instruments resulted in income of $ 0.2 million during the first nine months of 2022 that was recorded in other noninterest expense on our Consolidated Statements of Income. The value of interest rate swaps in a liability position, which includes accrued interest, was $ 28.5 million as of September 30, 2022. We have master netting arrangements with our correspondent banks. Cash collateral totaling $ 28.0 million was provided to us by the counterparty correspondent banks as of September 30, 2022. Cash collateral amounts, which are based on daily fair value calculations, are adjusted daily if fair value changes exceed an aggregate of $250,000.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 360 million as of September 30, 2022. Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instruments.

The fair values of derivative instruments as of December 31, 2021 are reflected on a gross basis in the following table.

	Notional Amount		Balance Sheet Location	Fair Value

Derivative Assets
Interest rate swaps	$	279,419,000	Other Assets	$	4,609,000

Derivative Liabilities
Interest rate swaps		279,419,000	Other Liabilities		4,857,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9. DERIVATIVES AND HEDGING ACTIVITIES (Continued)

The effect of interest rate swaps that are not designated as hedging instruments resulted in expense of $ 0.2 million during the year-ended December 31, 2021 recognized in other noninterest expense on our Consolidated Statements of Income. The fair value of interest rate swaps in a liability position, which includes accrued interest, was $ 4.9 million as of December 31, 2021. We have master netting arrangements with our correspondent banks. Cash collateral totaling $ 3.6 million was provided to the counterparty correspondent banks as of December 31, 2021. Cash collateral amounts, which are based on daily fair value calculations, are adjusted daily if fair value changes exceed an aggregate of $250,000.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 279 million as of December 31, 2021. Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instruments.

10. FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of September 30, 2022 and December 31, 2021 ( dollars in thousands):

	Level in	September 30, 2022				December 31, 2021
	Fair Value	Carrying		Fair		Carrying		Fair
	Hierarchy	Values		Values		Values		Values
Financial assets:
Cash	Level 1	$	17,016	$	17,016	$	17,872	$	17,872
Cash equivalents	Level 1		266,998		266,998		957,288		957,288
Securities available for sale	(1)		582,999		582,999		592,743		592,743
FHLBI stock	(2)		17,721		17,721		18,002		18,002
Loans, net	Level 3		3,841,838		3,803,053		3,418,096		3,498,345
Mortgage loans held for sale	Level 2		14,411		14,709		16,117		16,707
Mortgage servicing rights	Level 2		12,088		17,014		12,248		15,445
Accrued interest receivable	Level 2		13,988		12,988		9,311		9,311
Interest rate swaps	Level 2		28,445		28,445		4,609		4,609

Financial liabilities:
Deposits	Level 2		3,846,085		3,434,643		4,083,193		4,028,249
Repurchase agreements	Level 2		198,605		198,605		197,463		197,463
FHLBI advances	Level 2		338,263		318,419		374,000		384,927
Subordinated debentures	Level 2		48,787		49,854		48,244		48,284
Subordinated notes	Level 2		88,542		78,828		73,646		73,646
Accrued interest payable	Level 2		1,995		1,995		1,393		1,393
Interest rate swaps	Level 2		28,544		28,544		4,857		4,857

( 1 )

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

( 2 )

It is not practical to determine the fair value of FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10. FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. Fair value for loans is based on an exit price model as required by ASU 2016 - 01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposit accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The fair values of subordinated debentures, subordinated notes, and FHLBI advances are based on current rates for similar financing. The fair values of interest rate swaps are based on discounted cash flows using forecasted yield curves, along with insignificant unobservable inputs, such as borrower credit spreads. The fair value of other off-balance sheet items is estimated to be nominal.

11. FAIR VALUES

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

We are required to use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources, or unobservable, meaning those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.

Level 3: Significant unobservable inputs that reflect our own conclusions about the assumptions that market participants would use in pricing an asset or liability.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11. FAIR VALUES (Continued)

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

Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal general obligation and revenue bonds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment. There was no such impairment as of September 30, 2022 or December 31, 2021. We have no Level 1 securities available for sale.

Derivatives . We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves. Insignificant unobservable inputs, such as borrower credit spreads, are also utilized.

Mortgage loans held for sale . Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors, and are measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics. As of September 30, 2022 and December 31, 2021, we determined the fair value of our mortgage loans held for sale to be $ 14.7 million and $ 16.7 million, respectively.

Loans . We do not record loans at fair value on a recurring basis. However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge-off. The fair values of impaired loans are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.

Foreclosed Assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed and repossessed assets, establishing a new cost basis. We subsequently adjust estimated fair value of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11. FAIR VALUES (Continued)

The balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2022 are as follows:

	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government agency debt obligations	$	385,456,000	$	0	$	385,456,000	$	0
Mortgage-backed securities		32,657,000		0		32,657,000		0
Municipal general obligation bonds		142,021,000		0		141,398,000		623,000
Municipal revenue bonds		22,365,000		0		22,365,000		0
Other investments		500,000		0		500,000		0
Interest rate swaps		28,445,000		0		28,445,000		0
Total assets	$	611,444,000	$	0	$	610,821,000	$	623,000

Interest rate swaps		28,544,000		0		28,544,000		0
Total liabilities	$	28,544,000	$	0	$	28,544,000	$	0

There were no sales, purchases or transfers in or out of Level 3 during the first nine months of 2022. The less than $ 0.1 million reduction in Level 3 municipal general obligation bonds during the first nine months of 2022 reflects the scheduled maturities of such bonds.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11. FAIR VALUES (Continued)

The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2021 are as follows:

	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government agency debt obligations	$	390,371,000	$	0	$	390,371,000	$	0
Mortgage-backed securities		41,803,000		0		41,803,000		0
Municipal general obligation bonds		137,594,000		0		136,917,000		677,000
Municipal revenue bonds		22,475,000		0		22,475,000		0
Other investments		500,000		0		500,000		0
Interest rate swaps		4,609,000		0		4,609,000		0
Total assets	$	597,352,000	$	0	$	596,675,000	$	677,000

Interest rate swaps		4,857,000		0		4,857,000		0
Total liabilities	$	4,857,000	$	0	$	4,857,000	$	0

There were no sales, purchases or transfers in or out of Level 3 during 2021. The less than $ 0.1 million reduction in Level 3 municipal general obligation bonds during 2021 reflects the scheduled maturities of such bonds.

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2022 are as follows:

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

Collateral dependent loans	$	1,416,000	$	0	$	0	$	1,416,000
Foreclosed assets		0		0		0		0
Total	$	1,416,000	$	0	$	0	$	1,416,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11. FAIR VALUES (Continued)

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2021 are as follows:

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

Impaired Loans	$	3,807,000	$	0	$	0	$	3,807,000
Foreclosed assets		0		0		0		0
Total	$	3,807,000	$	0	$	0	$	3,807,000

The carrying values are based on the estimated value of the property or other assets. Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. For real estate dependent loans and foreclosed assets, we generally assign a 15 % to 25 % discount factor for commercial-related properties, and a 25 % to 50 % discount factor for residential-related properties. In a vast majority of cases, we assign a 10 % discount factor for estimated selling costs.

12. EARNINGS PER SHARE

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

Approximately 319,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2022. In addition, stock options for approximately 1,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2022. Stock options for approximately 5,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2022.

Approximately 260,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2021. In addition, stock options for approximately 3,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2021. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2021.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

13. REGULATORY MATTERS

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

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if, after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator. At September 30, 2022 and December 31, 2021, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since September 30, 2022 that we believe have changed our bank’s categorization.

Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:

	Actual					Minimum Required for Capital Adequacy Purposes					Minimum Required to be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2022
Total capital (to risk weighted assets)
Consolidated	$	613,161		13.7	%	$	358,335		8.0	%	$	NA		NA	%
Bank		597,717		13.4			358,165		8.0			447,706		10.0
Tier 1 capital (to risk weighted assets)
Consolidated		485,499		10.8			268,751		6.0			NA		NA
Bank		558,597		12.5			268,624		6.0			358,165		8.0
Common equity tier 1 (to risk weighted assets)
Consolidated		438,786		9.8			201,563		4.5			NA		NA
Bank		558,597		12.5			201,468		4.5			291,009		6.5
Tier 1 capital (to average assets)
Consolidated		485,499		9.6			201,731		4.0			NA		NA
Bank		558,597		11.1			201,648		4.0			252,059		5.0

(Continued)

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(Unaudited)

13. REGULATORY MATTERS (Continued)

	Actual					Minimum Required for Capital Adequacy Purposes					Minimum Required to be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2021
Total capital (to risk weighted assets)
Consolidated	$	565,143		14.0	%	$	324,101		8.0	%	$	NA		NA	%
Bank		551,760		13.6			323,928		8.0			404,910		10.0
Tier 1 capital (to risk weighted assets)
Consolidated		456,133		11.3			243,076		6.0			NA		NA
Bank		516,397		12.8			242,946		6.0			323,928		8.0
Common equity tier 1 (to risk weighted assets)
Consolidated		409,963		10.1			182,307		4.5			NA		NA
Bank		516,397		12.8			182,210		4.5			263,192		6.5
Tier 1 capital (to average assets)
Consolidated		456,133		9.2			198,574		4.0			NA		NA
Bank		516,397		10.4			198,510		4.0			248,137		5.0

Our consolidated capital levels as of September 30, 2022 and December 31, 2021 include $ 46.7 million and $ 46.2 million, respectively, of trust preferred securities. Under applicable Federal Reserve guidelines, the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate amount of restricted core elements that may be included in our Tier 1 capital must not exceed 25 % of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Our ability to include the trust preferred securities in Tier 1 capital in accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated assets as of December 31, 2009 were less than $ 15.0 billion. As of September 30, 2022 and December 31, 2021, all $ 46.7 million and $ 46.2 million, respectively, of the trust preferred securities were included in our consolidated Tier 1 capital.

Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5 % of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0 %, the Tier 1 capital ratio to 8.5 % and the total capital ratio to 10.5 % on a fully phased-in basis on January 1, 2019. We believe that, as of September 30, 2022, our bank met all capital adequacy requirements under the BASEL III capital rules.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

13. REGULATORY MATTERS (Continued)

Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On January 13, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.31 per share that was paid on March 16, 2022 to shareholders of record as of March 4, 2022. On April 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $0.31 per share that was paid on June 15, 2022 to shareholders of record as of June 3, 2022. On July 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.32 per share that was paid on September 14, 2022 to shareholders of record as of September 2, 2022.

As of September 30, 2022, we had the ability to repurchase up to $ 6.8 million in common stock shares from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations as part of a $ 20.0 million common stock repurchase program announced in May 2021. No shares were repurchased during the first nine months of 2022. Historically, stock repurchases have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.

14. SUBORDINATED NOTES

On December 15, 2021, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $ 75.0 million in aggregate principal amount of its 3.25 % fixed-to-floating rate subordinated notes (“Notes”). The Notes have a stated maturity of January 30, 2032, are redeemable by us at our option, in whole or in part, on or after January 30, 2027 on any interest payment date at a redemption of price of 100 % of the principal amount of the Notes being redeemed. The Notes are not subject to redemption at the option of the holder. The Notes will bear interest at a fixed rate of 3.25 % per year until January 29, 2027. Commencing on January 30, 2027 and through the stated maturity date of January 30, 2032, the interest rate will resent quarterly at a variable rate equal to the then-current Three-Month Term SOFR plus 212 basis points. On December 15, 2021, we injected $ 70.0 million of the issuance proceeds to our bank as an increase to equity capital.

On January 14, 2022, we issued an additional $ 15.0 million of its Notes to certain institutional accredited investors, reflecting an expansion of the $75.0 million issuance completed on December 15, 2021. The additional $ 15.0 million issuance was completed on the same terms as the prior offering and under the existing indenture. On January 14, 2022, we injected $ 15.0 million of the issuance proceeds to our bank as an increase to equity capital.

15. SUBSEQUENT EVENTS

On October 13, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.32 per share that will be paid on December 14, 2022 to shareholders of record as of December 2, 2022.

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

Forward Looking Statements

This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “is likely,” “plans,” “projects,” “indicates,” “strategy,” “future,” “likely,” “may,” “should,” “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.

Future Factors include, among others, adverse changes in interest rates and interest rate relationships; increasing rates of inflation and slower growth rates; significant declines in the value of commercial real estate; market volatility; demand for products and services; the degree of competition by traditional and non-traditional financial service companies; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; potential cyber-attacks, information security breaches, and other criminal activities on our computer systems; litigation liabilities; governmental and regulatory policy changes; the outcomes of existing or future contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, and the failure to meet client expectations and other facts; adoption of SOFR and changes in the method of determining SOFR; direct and indirect climate change matters; changes in the national and local economies, including the ongoing disruption to financial markets and other economic activity caused by the Coronavirus Pandemic and unstable political and economic environments; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2021. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.

Introduction

The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank (“our bank”) and our bank’s subsidiary Mercantile Insurance Center, Inc., at September 30, 2022 and December 31, 2021 and the results of operations for the three months and nine months ended September 30, 2022 and September 30, 2021. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.

Critical Accounting Policies

Accounting principles generally accepted in the United States of America (“GAAP”) are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting policies, see Note 1 of the Notes to our Consolidated Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2021 (Commission file number 000-26719). Our critical accounting policies are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements, and actual results may differ from those estimates. We have reviewed the application of these policies with the Audit Committee of our Board of Directors.

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Allowance for Credit Losses ( “ Allowance ” ) : The allowance is maintained at a level we believe is adequate to absorb estimated credit losses identified and inherent in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Credit losses are charged against the allowance when we believe the uncollectibility of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. The allowance is increased through a provision charged to operating expense. Uncollectible loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments . This ASU (as subsequently amended by ASU 2018-19) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU was effective for interim and annual reporting periods beginning after December 15, 2019.

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continued to experience an unprecedented economic environment whereby a sizable portion of the economy had been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus was provided to businesses, individuals and state and local governments and financial institutions offered businesses and individuals payment relief options, economic forecasts were regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL until January 1, 2022, and continued to use our incurred loan loss reserve model as permitted through December 31, 2021.

We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022, are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.

See Note 1 - Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.

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Income Tax Accounting : Current income tax assets and liabilities are established for the amount of taxes payable or refundable for the current year. In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws for which the outcome may be uncertain. We periodically review and evaluate the status of our tax positions and make adjustments as necessary. Deferred income tax assets and liabilities are also established for the future tax consequences of events that have been recognized in our financial statements or tax returns. A deferred income tax asset or liability is recognized for the estimated future tax effects attributable to temporary differences that can be carried forward (used) in future years. The valuation of our net deferred income tax asset is considered critical as it requires us to make estimates based on provisions of the enacted tax laws. The assessment of the realizability of the net deferred income tax asset involves the use of estimates, assumptions, interpretations and judgments concerning accounting pronouncements, federal and state tax codes and the extent of future taxable income. There can be no assurance that future events, such as court decisions, positions of federal and state tax authorities, and the extent of future taxable income will not differ from our current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.

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

Debt Securities Available for Sale : Debt securities available for sale consist of bonds which might be sold prior to maturity due to a number of factors, including changes in interest rates, prepayment risks, yield and availability of alternative investments or liquidity needs. Debt securities classified as available for sale are reported at their fair value. For available for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance. For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors. In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Changes in the allowance for credit losses under CECL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when we believe the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At September 30, 2022, there was no allowance for credit losses related to the available for sale debt securities portfolio.

Mortgage Servicing Rights : Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from servicing each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.

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Goodwill : GAAP requires us to determine the fair value of all of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value. In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as goodwill.

Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur.

Coronavirus Pandemic

Although there has been an easing of Covid-19 pandemic-related restrictions, there remains a significant amount of stress and uncertainty across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances, including vaccine hesitancy, booster shot efficacy, supply chain disruptions and inflationary pressures. In addition, this uncertainty is further heightened by the possibility that new and highly infectious variants and subvariants of Covid-19 might arise which are capable of evading vaccinations, booster shots and prior immunity.

The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations. Additionally, the consequences of the unprecedented economic impact of the Coronavirus Pandemic may produce declining asset quality, reflected by a higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which may necessitate additional provisions for our allowance and reduce net income.

The following section summarizes the primary measures that directly impact us and our customers.

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Paycheck Protection Program

The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee paid by the Small Business Administration. The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology. The program ended on August 8, 2020. We originated approximately 2,200 loans aggregating $553 million. As of September 30, 2022, we recorded forgiveness transactions on all but five loans aggregating $0.5 million. Net loan origination fees of less than $0.1 million were recorded during the first nine months of 2022.

The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in Second Draw PPP loans (“Second Draw”). The program ended on May 31, 2021. Under the Second Draw, we originated approximately 1,200 loans aggregating $209 million. As of September 30, 2022, we recorded forgiveness transactions on all but seven loans aggregating $2.1 million. Net loan origination fees of $0.9 million were recorded during the first nine months of 2022.

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Individual Economic Impact Payments

The Internal Revenue Service made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks. In general, and subject to adjusted gross income limitations, qualifying individuals received payments of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.

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Troubled Debt Restructuring Relief

From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022. We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021.

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Current Expected Credit Loss Methodology Delay

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022. We adopted the CECL methodology effective January 1, 2022.

Financial Overview

We reported net income of $16.0 million, or $1.01 per diluted share, for the third quarter of 2022, compared with net income of $15.1 million, or $0.95 per diluted share, during the third quarter of 2021. Net income for the first nine months of 2022 totaled $39.3 million, or $2.48 per diluted share, compared to $47.4 million, or $2.95 per diluted share, during the first nine months of 2021. Higher net interest income, stemming from an improving net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and increases in several key fee income revenue streams, in large part mitigated a significant decline in residential mortgage banking revenue as industry-wide originations come off of the record levels of 2020 and 2021, which were driven by low residential mortgage rates and resulting refinance activity. Our earnings performance in the 2021 periods also benefited from lower loan loss provisions reflecting improved economic conditions and expectations during those time periods.

Commercial loans increased $195 million during the first nine months of 2022, reflecting the net impact of growth in core commercial loans and payment activities under the PPP. Core commercial loans increased $232 million, or almost 11% on an annualized basis, while PPP payment activities aggregated $37.5 million, during the first nine months of 2022. Core commercial and industrial loans increased $114 million, owner-occupied commercial real estate (“CRE”) loans grew $77.8 million, multi-family and residential rental property loans increased $47.7 million, and vacant land, land development and residential construction loans increased $17.7 million, while non-owner occupied CRE loans were down $24.8 million. As a percentage of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 59.0% as of September 30, 2022, compared to 57.1% at December 31, 2021. The new commercial loan pipeline remains strong, and at September 30, 2022, we had $169 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

Residential mortgage loans, excluding home equity lines of credit, increased $227 million during the first nine months of 2022, representing a growth rate of over 68% on an annualized basis. With the increase in residential mortgage loan rates during the first nine months of 2022, we have witnessed a shift in borrowers primarily now selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in the previous couple of years. Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet. During the first nine months of 2022, approximately 29% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to about 61% during the first nine months of 2021. The shift in product mix impacts the timing of revenue recognition; it takes an estimated 24 months for the amount of interest income earned on a residential mortgage loan that is retained on our balance sheet to approximate the amount of the immediately recorded gain on sale of a residential mortgage loan that has been sold to an investor.

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The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.04% of total loans as of September 30, 2022. Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties as of September 30, 2022. We had no loan charge-offs during the third quarter of 2022, and an aggregated $0.2 million for the first nine months of the year, while recoveries of prior period loan charge-offs equaled $0.2 million and $0.9 million during the respective time periods. A net loan recovery, as a percentage of average total loans, equaled an annualized 0.03% and 0.02% during the third quarter and first nine months of 2022, respectively.

A provision for credit losses of $2.9 million was recorded during the third quarter of 2022, compared to a provision expense of $1.9 million during the third quarter of 2021. A provision for credit losses of $3.5 million was recorded during the first nine months of 2022, compared to a negative provision of $0.9 million during the first nine months of 2021. The provision expense recorded during the current-year third quarter mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, and a decline in forecasted economic conditions. The provision expense recorded during the first nine months of 2022 primarily resulted from these factors, along with a higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio. The required reserve allocations resulting from these factors were partially mitigated by the positive impact of a change in the Covid-19 environmental factor during the second quarter, along with the recording of net loan recoveries and ongoing strong loan quality metrics during the periods. Our adoption of Accounting Standards Update No. 2016-13, Measurement of Credit Losses on Financial Instruments , on January 1, 2022, resulted in a $0.4 million one-time reduction to the allowance for credit losses. The lower provision expense recorded in the 2021 periods was mainly comprised of a reduced reserve allocation associated with the economic and business conditions environmental factor, reflecting improvement in both current and forecasted economic conditions.

Interest-earning balances, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During the first nine months of 2022, the average balance of these funds equaled $535 million, or 11.2% of average earning assets, compared to $649 million, or 14.6% of average earning assets, during the first nine months of 2021; these levels are substantially higher than our typical average balance of $75 million, or approximately 2% of average earning assets. The elevated levels during 2021 and through the first nine months of 2022 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus payments and reduced business and consumer investing and spending, and have had a significant negative impact on our net interest margin. The level of interest-earning balances has been on a declining trend during 2022, as excess monies have been used to fund loan growth as well as brokered deposit and Federal Home Loan Bank of Indianapolis (“FHLBI”) advance maturities. Average interest-earning balances equaled $295 million during the third quarter of 2022, compared to $531 million and $784 million during the second and first quarters of 2022, respectively.

Net interest income increased $11.3 million and $16.1 million during the third quarter and first nine months of 2022, respectively, compared to the respective time periods in 2021. Interest income was $12.2 million and $17.1 million higher during the third quarter and first nine months of 2022, respectively, when compared to the same time periods in 2021, in large part reflecting an increasing interest rate environment and higher average balances of earning assets. Interest expense was $1.0 million and $1.1 million higher during the third quarter and first nine months of 2022, respectively, when compared to the corresponding time periods in 2021, generally reflecting the net impact of lower deposit interest costs and increased costs on borrowed funds mainly resulting from a higher cost of subordinated debentures and the issuance of $90.0 million in subordinated notes in December 2021 and January 2022.

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Noninterest income decreased $8.3 million and $19.3 million during the third quarter and first nine months of 2022, respectively, compared to the corresponding time periods in 2021. Mortgage banking income was $4.8 million and $16.1 million lower during the third quarter and first nine months of 2022, respectively, when compared to the same time periods in 2021, in large part reflecting increased residential mortgage loan rates which substantially reduced the volume of refinance activity. We continued to record growth in treasury management-related fee income categories, such as service charges on accounts, credit and debit card income and payroll processing. Combined, we recorded growth of approximately 15% when comparing the third quarter and first nine months of 2022 with the respective time periods in 2021.

Noninterest expense increased $0.5 million and $1.9 million during the third quarter and first nine months of 2022, respectively, compared to the respective time periods in 2021. During the second quarter of 2022, we contributed $0.5 million to The Mercantile Bank Foundation. Excluding the charitable contribution, overhead costs were up slightly during the 2022 periods when compared to the 2021 periods, in large part reflecting increased compensation costs.

Financial Condition

Our total assets decreased $241 million during the first nine months of 2022, and totaled $5.02 billion as of September 30, 2022. Total loans increased $427 million, while interest-earning deposits declined $695 million and securities available for sale were down $9.7 million. Total deposits decreased $237 million.

Commercial loans increased $195 million during the first nine months of 2022, reflecting the net impact of growth in core commercial loans and payment activities under the PPP. Core commercial loans increased $232 million, or almost 11% on an annualized basis, while PPP payment activities aggregated $37.5 million, during the first nine months of 2022. Core commercial and industrial loans increased $114 million, owner-occupied CRE loans grew $77.8 million, multi-family and residential rental property loans increased $47.7 million, and vacant land, land development and residential construction loans increased $17.7 million, while non-owner occupied CRE loans were down $24.8 million. As a percentage of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 59.0% as of September 30, 2022, compared to 57.1% at December 31, 2021.

As of September 30, 2022, availability on existing commercial construction and development loans totaled $169 million, with most of those funds expected to be drawn over the next 12 to 18 months. Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including approximately $309 million in new lending commitments, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial lenders also report ongoing additional opportunities they are currently discussing with existing and potentially new borrowers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. Usage of existing commercial lines of credit averaged 36% during the first nine months of 2022. Historically, the level of commercial lines of credit usage equaled 40% to 45%; however, the level averaged approximately 32% since the onset of the Coronavirus Pandemic through the end of the third quarter of 2021.

Residential mortgage loans, excluding home equity lines of credit, increased $227 million during the first nine months of 2022, totaling $670 million, or 17.3% of total loans, as of September 30, 2022. The increasing interest rate environment has had a significant impact on our residential mortgage banking operations, especially in regards to the volume of refinance activity and the borrower selection of fixed rate versus adjustable rate residential mortgage products which combined have resulted in a material decline in the volume of residential mortgage loans being sold. Residential mortgage loan volume totaled $523 million during the first nine months of 2022, compared to $742 million during the same time period in 2021, a decline of $219 million, or almost 30%. Refinance volume declined $249 million, while home purchase and construction loan activity increased $30.1 million. Residential mortgage loans originated for sale generally consist of longer-term fixed rate residential mortgage loans, while adjustable rate residential mortgage loans are maintained in the residential mortgage loan portfolio. We have experienced a significant pattern shift as it pertains to the type of residential mortgage loan product selected by our borrowers with a majority now selecting adjustable rate offerings compared to the past couple of years when a longer-term fixed rate was the most popular selection. During the first nine months of 2022, approximately 29% of residential mortgage loan production consisted of longer-term fixed rate loans, compared to a level of about 61% during the first nine months of 2021.

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Home equity lines of credit and other consumer-related loans increased $5.6 million during the first nine months of 2022, and at September 30, 2022 totaled $66.1 million, or 1.7% of total loans. Home equity lines of credit and other consumer-related loans comprised 1.8% of total loans as of December 31, 2021. We expect the dollar volume of this loan portfolio segment to remain relatively stable in future periods.

The following table summarizes our loan portfolio over the past twelve months:

	9/30/22		6/30/22		3/31/22		12/31/21		9/30/21
Commercial:
Commercial & Industrial (1)	$	1,213,630,000	$	1,187,650,000	$	1,153,814,000	$	1,137,419,000	$	1,074,394,000
Land Development & Construction		60,970,000		57,808,000		52,693,000		43,239,000		38,380,000
Owner Occupied Commercial RE		643,577,000		598,593,000		582,732,000		565,758,000		551,762,000
Non-Owner Occupied Commercial RE		1,002,638,000		1,003,118,000		1,007,361,000		1,027,415,000		998,697,000
Multi-Family & Residential Rental		224,248,000		224,591,000		207,962,000		176,593,000		179,126,000
Total Commercial		3,145,063,000		3,071,760,000		3,004,562,000		2,950,424,000		2,842,359,000

Retail (2):
1-4 Family Mortgages		705,441,000		623,599,000		522,556,000		442,547,000		411,618,000
Other Consumer Loans		30,454,000		28,441,000		28,672,000		60,488,000		59,732,000
Total Retail		735,895,000		652,040,000		551,228,000		503,035,000		471,350,000

Total	$	3,880,958,000	$	3,723,800,000	$	3,555,790,000	$	3,453,459,000	$	3,313,709,000

(1)

Includes $2.6 million, $2.9 million, $12.2 million, $40.1 million, and $116 million in loans originated under the Paycheck Protection Program for September 30, 2022, June 30, 2022, March 31, 2022, December 31, 2021, and September 30, 2021, respectively.

(2)

For September 30, 2022, June 30, 2022, and March 31, 2022, home equity lines of credit balances are included in 1-4 family mortgage loans. For prior periods, home equity lines of credit balances are included in other consumer loans.

Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to provide effective loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur quickly because of changing economic conditions. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on an internal watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on impaired loans, as well as on foreclosed and repossessed assets, are reviewed periodically. We also have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions.

Nonperforming loans, comprised of nonaccrual loans and loans past due 90 days or more and accruing interest, totaled $1.4 million (less than 0.1% of total loans) as of September 30, 2022, compared to $2.5 million (less than 0.1% of total loans) as of December 31, 2021. Given the low levels of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with the manageable and steady level of watch list credits and what we believe are strong credit administration practices, we remain pleased with the overall quality of the loan portfolio. We had no foreclosed properties as of September 30, 2022 or December 31, 2021.

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MERCANTILE BANK CORPORATION

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

NONPERFORMING LOANS

	9/30/22		6/30/22		3/31/22		12/31/21		9/30/21
Residential Real Estate:
Land Development	$	30,000	$	30,000	$	31,000	$	32,000	$	33,000
Construction		0		0		0		0		0
Owner Occupied / Rental		1,138,000		1,508,000		1,579,000		1,768,000		2,052,000
		1,168,000		1,538,000		1,610,000		1,800,000		2,085,000

Commercial Real Estate:
Land Development		0		0		0		0		0
Construction		0		0		0		0		0
Owner Occupied		0		0		0		0		0
Non-Owner Occupied		0		0		0		0		0
		0		0		0		0		0

Non-Real Estate:
Commercial Assets		248,000		248,000		0		662,000		673,000
Consumer Assets		0		1,000		2,000		6,000		8,000
		248,000		249,000		2,000		668,000		681,000

Total	$	1,416,000	$	1,787,000	$	1,612,000	$	2,468,000	$	2,766,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

	9/30/22		6/30/22		3/31/22		12/31/21		9/30/21
Residential Real Estate:
Land Development	$	0	$	0	$	0	$	0	$	0
Construction		0		0		0		0		0
Owner Occupied / Rental		0		0		0		0		11,000
		0		0		0		0		11,000

Commercial Real Estate:
Land Development		0		0		0		0		0
Construction		0		0		0		0		0
Owner Occupied		0		0		0		0		100,000
Non-Owner Occupied		0		0		0		0		0
		0		0		0		0		100,000

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

Total	$	0	$	0	$	0	$	0	$	111,000

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MERCANTILE BANK CORPORATION

The following tables provide a reconciliation of nonperforming assets:

NONPERFORMING LOANS RECONCILIATION

	3rd Qtr			2nd Qtr			1st Qtr			4th Qtr			3rd Qtr
	2022			2022			2022			2021			2021

Beginning balance	$	1,787,000		$	1,612,000		$	2,468,000		$	2,766,000		$	2,746,000
Additions, net of transfers to ORE		0			309,000			93,000			218,000			361,000
Returns to performing status		(159,000	)		0			(213,000	)		0			(50,000	)
Principal payments		(212,000	)		(134,000	)		(641,000	)		(377,000	)		(291,000	)
Loan charge-offs		0			0			(95,000	)		(139,000	)		0

Total	$	1,416,000		$	1,787,000		$	1,612,000		$	2,468,000		$	2,766,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

	3rd Qtr		2nd Qtr		1st Qtr		4th Qtr			3rd Qtr
	2022		2022		2022		2021			2021

Beginning balance	$	0	$	0	$	0	$	111,000		$	404,000
Additions		0		0		0		0			0
Sale proceeds		0		0		0		(111,000	)		(209,000	)
Valuation write-downs		0		0		0		0			(84,000	)

Total	$	0	$	0	$	0	$	0		$	111,000

We had no loan charge-offs during the third quarter of 2022, and an aggregated $0.2 million during the first nine months of 2022. Recoveries of prior period loan charge-offs equaled $0.2 million and $0.9 million during the respective time periods. A net loan recovery, as a percentage of average total loans, equaled an annualized 0.03% and 0.02% during the third quarter and first nine months of 2022, respectively. We continue our collection efforts on charged-off loans, and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. The allowance equaled $39.1 million, or 1.01% of total loans, and over 2,700% of nonperforming loans as of September 30, 2022.

We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, which included a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.

The allowance for loan loss accounting in effect at December 31, 2021 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date (“incurred loss” methodology). Under the CECL methodology, our allowance is based on the total amount of credit losses that are expected over the remaining life of the loan portfolio. Our estimate of credit losses under CECL is determined using a complex model that relies on historical loss information, reasonable and supportable economic forecasts, and various qualitative factors.

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MERCANTILE BANK CORPORATION

The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers, and we have a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential mortgage loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.

See Note 1 - Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 - Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.

As of September 30, 2022, the allowance was comprised of $37.6 million in general reserves relating to performing loans and $1.5 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. Specific reserve allocations relating to nonaccrual loans were nominal in amount. Troubled debt restructurings totaled $11.8 million at September 30, 2022, consisting of $0.4 million that are on nonaccrual status and $11.4 million that are on accrual status. The latter are not included in our nonperforming loan totals. Loans with an aggregate carrying value of $0.4 million as of September 30, 2022 had been subject to previous partial charge-offs aggregating $0.4 million over the past several years. As of September 30, 2022, there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.

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

	9/30/22		6/30/22		3/31/22		12/31/21		9/30/21

Performing	$	11,408,000	$	12,174,000	$	5,131,000	$	16,728,000	$	20,518,000
Nonperforming		423,000		420,000		379,000		746,000		782,000

Total	$	11,831,000	$	12,594,000	$	5,510,000	$	17,474,000	$	21,300,000

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

Securities available for sale decreased $9.7 million during the first nine months of 2022, totaling $583 million as of September 30, 2022. Purchases of U.S. Government agency bonds totaled $54.5 million during the first nine months of 2022. Purchases of U.S. Government agency guaranteed mortgage-backed securities totaled $2.1 million during the first nine months of 2022, consisting of investments in CRA-qualified securities, generally reflecting the partial reinvestment of $4.9 million from principal paydowns on U.S. Government agency guaranteed mortgage-backed securities. Purchases of municipal bonds totaled $34.6 million during the first nine months of 2022; proceeds from matured and called municipal bonds totaled $8.3 million. At September 30, 2022, the portfolio was primarily comprised of U.S. Government agency bonds (66%), municipal bonds (28%) and U.S. Government agency guaranteed mortgage-backed securities (6%). All of our securities are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at September 30, 2022 totaled $583 million, including a net unrealized loss of $91.8 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that the unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary. We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations. In addition, the securities portfolio serves a primary interest rate risk management function. We expect purchases during the remainder of 2022 to generally consist of municipal bonds, with the securities portfolio maintained at about 12% of total assets.

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MERCANTILE BANK CORPORATION

Market values on our U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies and municipal bonds are generally determined on a monthly basis with the assistance of a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes and issuer spreads. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.

FHLBI stock totaled $17.7 million as of September 30, 2022, compared to $18.0 million as of December 31, 2021. The reduction reflects the FHLBI’s repurchase of excess stock. Our investment in FHLBI stock is necessary to engage in their advance and other financing programs. We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.

Interest-earning balances, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During the first nine months of 2022, the average balance of these funds equaled $535 million, or 11.2% of average earning assets, compared to $649 million, or 14.6% of average earning assets, during the first nine months of 2021; these levels are substantially higher than our typical average balance of $75 million, or approximately 2% of average earning assets. The elevated levels during 2021 and through the first nine months of 2022 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus payments and reduced business and consumer investing and spending, and have had a significant negative impact on our net interest margin. The level of interest-earning balances has been on a declining trend during 2022, as excess monies have been used to fund loan growth as well as brokered deposit and FHLBI advance maturities. Average interest-earning balances equaled $295 million during the third quarter of 2022, compared to $531 million and $784 million during the second and first quarters of 2022, respectively.

Net premises and equipment equaled $52.1 million at September 30, 2022, representing a decrease of $5.2 million during the first nine months of 2022. The decline primarily reflects the sale of a branch facility located in Lansing, Michigan as part of a branch relocation project whereby we are moving our operations to a leased facility that better aligns with our operations in the greater Lansing area and provides for lower operating costs, along with depreciation expense. We had no foreclosed or repossessed assets as of September 30, 2022, unchanged from December 31, 2021.

Other assets equaled $97.7 million at September 30, 2022, reflecting an increase of $43.5 million during the first nine months of 2022. The increase is primarily associated with $23.8 million of growth in the fair value of interest rates swaps and an $18.3 million increase in a deferred tax benefit related to unrealized losses on available for sale securities.

Total deposits decreased $237 million during the first nine months of 2022, totaling $3.85 billion at September 30, 2022. Local deposits decreased $213 million and out-of-area deposits declined $23.9 million. The reduced level of local deposits primarily reflected a single customer’s expected withdrawal of a majority of funds that were obtained from the sale of a business and deposited in late 2021; excluding this withdrawal, total local deposits were relatively steady during the first nine months of 2022. Noninterest-bearing deposits increased $39.0 million and savings deposits were up $18.2 million, while interest-bearing checking accounts were down $9.5 million, during the first nine months of 2022. Money market deposit balances were down $231 million, in large part reflecting the large withdrawal from a single customer. Local time deposits declined $29.3 million during the first nine months of 2022. We had no out-of-area deposits as of September 30, 2022, compared to $23.9 million as of December 31, 2021.

Sweep accounts increased $1.1 million during the first nine months of 2022, totaling $199 million as of September 30, 2022. The aggregate balance of this funding type is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances maintained by many of the customers. The average balance of sweep accounts equaled $199 million during the first nine months of 2022, with a high balance of $233 million and a low balance of $173 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings.

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MERCANTILE BANK CORPORATION

FHLBI advances decreased $35.7 million during the first nine months of 2022, totaling $338 million as of September 30, 2022. Amortizing FHLBI advances aggregating $28.3 million were obtained, while bullet advances aggregating $64.0 million matured. Amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit as of September 30, 2022 totaled $1.0 billion, with remaining availability based on collateral equaling $659 million.

On January 14, 2022, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $15.0 million in aggregate principal amount of its 3.25% fixed-to-floating rate subordinated notes (“Notes”). The Notes have a stated maturity date of January 30, 2032, are redeemable by us at our option, in whole or in part, on or after January 30, 2027 on any interest payment date at a redemption price of 100% of the principal amount of the Notes being redeemed. The Notes are not subject to redemption at the option of the holder. The Notes will bear interest at a fixed rate of 3.25% per year until January 29, 2027. Commencing on January 30, 2027 and through the stated maturity date of January 30, 2032, the interest rate will reset quarterly at a variable rate equal to the then-current Three-Month Term SOFR plus 212 basis points. On January 14, 2022, we injected $15.0 million of the issuance proceeds into our bank as an increase to equity capital. This $15.0 million issuance was a follow-on to the $75.0 million issuance that was completed on December 15, 2021, in which $70.0 million of the issuance proceeds were injected into our bank as an increase to equity capital.

Shareholders’ equity was $416 million at September 30, 2022, compared to $457 million at December 31, 2021. Shareholders’ equity was positively impacted by net income of $39.3 million, which was partially offset by payments of cash dividends totaling $14.6 million. A $68.7 million after-tax decline in the market value of our available for sale securities portfolio, reflecting significant increases in market interest rates, negatively impacted shareholders’ equity during the first nine months of 2022.

Liquidity

Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and capital, or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-earning deposits. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.

To assist in providing needed funds and managing interest rate risk, we periodically obtain monies from wholesale funding sources. Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $338 million, or 7.7% of combined deposits and borrowed funds, as of September 30, 2022, compared to $398 million, or 8.5% of combined deposits and borrowed funds, as of December 31, 2021.

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MERCANTILE BANK CORPORATION

Information regarding our repurchase agreements as of September 30, 2022 and during the first nine months of 2022:

Outstanding balance at September 30, 2022	$	198,605,000
Weighted average interest rate at September 30, 2022		0.14	%
Maximum daily balance nine months ended September 30, 2022	$	232,959,000
Average daily balance for nine months ended September 30, 2022	$	198,639,000
Weighted average interest rate for nine months ended September 30, 2022		0.10	%

We also have the ability to borrow up to an aggregate $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. We did not access these lines of credit during the first nine months of 2022. In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged $528 million during the first nine months of 2022. We also have a line of credit through the Discount Window of the Federal Reserve Bank of Chicago. Using certain municipal bonds as collateral, we could have borrowed up to $26.2 million as of September 30, 2022. We did not utilize this line of credit during the first nine months of 2022 or at any time during the previous 13 fiscal years, and do not plan to access this line of credit in future periods.

The following table reflects, as of September 30, 2022, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

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

Deposits without a stated maturity	$	3,467,426,000	$	0	$	0	$	0	$	3,467,426,000
Time deposits		189,188,000		91,454,000		98,017,000		0		378,659,000
Short-term borrowings		198,605,000		0		0		0		198,605,000
Federal Home Loan Bank advances		80,353,000		151,689,000		81,838,000		24,383,000		338,263,000
Subordinated debentures		0		0		0		48,787,000		48,787,000
Subordinated notes		0		0		0		88,542,000		88,542,000
Other borrowed money		0		0		0		1,134,000		1,134,000
Property leases		991,000		1,386,000		651,000		1,662,000		4,690,000

In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of September 30, 2022, we had a total of $1.77 billion in unfunded loan commitments and $24.5 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.46 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $309 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.

We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, changes in economic or market conditions, a reduction in earnings performance, declining capital levels or situations beyond our control could cause liquidity challenges. While we believe it is unlikely that a funding crisis of any significant degree is likely to materialize, we have developed a comprehensive contingency funding plan that provides a framework for meeting liquidity disruptions.

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MERCANTILE BANK CORPORATION

Capital Resources

We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of September 30, 2022, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.

As of September 30, 2022, our bank’s total risk-based capital ratio was 13.4%, compared to 13.6% at December 31, 2021. Our bank’s total regulatory capital increased $46.0 million during the first nine months of 2022, in large part reflecting net income totaling $46.0 million and a $15.0 million equity injection associated with the Notes issuance, which was partially offset by cash dividends paid to us aggregating $19.5 million. Our bank’s total risk-based capital ratio was also impacted by a $428 million increase in total risk-weighted assets, primarily resulting from net growth in commercial loans and residential mortgage loans. As of September 30, 2022, our bank’s total regulatory capital equaled $598 million, or $150 million in excess of the 10.0% minimum that is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of September 30, 2022 and December 31, 2021 are disclosed in Note 13 of the Notes to Consolidated Financial Statements.

Results of Operations

We recorded net income of $16.0 million, or $1.01 per basic and diluted share, for the third quarter of 2022, compared to net income of $15.1 million, or $0.95 per basic and diluted share, for the third quarter of 2021. We recorded net income of $39.3 million, or $2.48 per basic and diluted share, for the first nine months of 2022, compared to net income of $47.4 million, or $2.95 per basic and diluted share, for the first nine months of 2021.

The higher level of net income during the third quarter of 2022 compared to the third quarter of 2021 resulted from increased net interest income, which more than offset decreased noninterest income, a higher credit loss provision, and increased overhead costs during the quarter. The lower level of net income during the first nine months of 2022 compared to the first nine months of 2021 reflected decreased noninterest income, a higher credit loss provision, and increased overhead costs, which more than offset improved net interest income during the nine-month period. The higher levels of net interest income during the 2022 periods resulted from an increased net interest margin and earning asset growth. The reduction in noninterest income during the current-year periods primarily reflected decreased mortgage banking income and interest rate swap income, which outweighed increases in several key fee income categories. The credit loss provisions recorded during the 2022 periods mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, a higher reserve for residential mortgage loans resulting from an increase in the average life of the portfolio, and a deterioration in forecasted economic conditions. A negative loan loss provision was recorded during the first nine months of 2021, primarily reflecting a reduced allocation associated with the economic and business conditions environmental factor. The slight increase in overhead costs during the third quarter of 2022 mainly reflected higher compensation costs. Excluding nonrecurring transactions, overhead costs during the first nine months of 2022 were up less than 3% compared to the respective 2021 period, primarily reflecting higher data processing and compensation costs.

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MERCANTILE BANK CORPORATION

Interest income during the third quarter of 2022 was $48.1 million, an increase of $12.2 million, or 34.1%, from the $35.9 million earned during the third quarter of 2021. Interest income during the first nine months of 2022 was $124 million, an increase of $17.1 million, or 16.1%, from the $106 million earned during the respective 2021 period. The increases resulted from a higher yield on, and growth in, average earning assets. The yield on average earning assets was 4.04% and 3.45% during the third quarter and first nine months of 2022, respectively, up from 3.13% and 3.21% during the respective prior-year periods. The higher yields primarily resulted from increased yields on loans and other interest-earning assets, reflecting the rising interest rate environment, and a change in earning asset mix, comprised of a decrease in lower-yielding other interest-earning assets and an increase in higher-yielding loans as a percentage of earning assets. The yield on loans was 4.56% and 4.15% during the third quarter and first nine months of 2022, respectively, up from 4.07% and 4.06% during the respective 2021 periods mainly due to higher interest rates on variable-rate commercial loans stemming from the Federal Open Market Committee (“FOMC”) significantly raising the targeted federal funds rate in an effort to curb elevated inflation levels. The FOMC increased the targeted federal funds rate by 300 basis points during the period of March 2022 through September 2022. As of September 30, 2022, approximately 64% of the commercial loan portfolio consisted of variable-rate loans. The increases in loan yield were achieved despite significant reductions in PPP net loan fee accretion. A nominal level of net loan fee accretion was recorded during the current-year third quarter, compared to $2.8 million during the third quarter of 2021; accretion totaled $1.0 million during the first nine months of 2022, down from $8.5 million during the respective 2021 period. On average, lower-yielding other interest-earning assets represented 6.2% and 11.2% of earning assets during the third quarter and first nine months of 2022, respectively, down from 16.1% and 14.6% during the respective prior-year periods, while higher-yielding loans represented 80.7% and 76.0% of earning assets during the current-year third quarter and year-to-date period, respectively, up from 71.9% and 74.5% during the respective 2021 periods. Average earning assets equaled $4.73 billion during the current-year third quarter, up $169 million, or 3.7%, from the level of $4.56 billion during the respective 2021 period; average loans and average securities were up $537 million and $70.7 million, respectively, while average other interest-earning assets decreased $439 million. Average earning assets equaled $4.80 billion during the first nine months of 2022, up $355 million, or 8.0%, from the level of $4.44 billion during the respective prior-year period; average loans and average securities were up $337 million and $132 million, respectively, while average other interest-earning assets declined $114 million.

A significant volume of excess on-balance sheet liquidity, which initially surfaced in the second quarter of 2020 as a result of the Covid-19 environment and has persisted since that time, negatively impacted the yield on average earning assets by 10 basis points and 51 basis points during the third quarters of 2022 and 2021, respectively, and 29 basis points and 46 basis points during the first nine months of 2022 and 2021, respectively. The excess funds, consisting almost entirely of low-yielding deposits with the Federal Reserve Bank of Chicago, are mainly a product of local deposit growth and PPP loan forgiveness activities.

Interest expense during the third quarter of 2022 was $5.8 million, an increase of $1.0 million, or 20.8%, from the $4.8 million expensed during the third quarter of 2021. The increase is attributable to a higher average weighted cost of, and to a much lesser extent, growth in, interest-bearing liabilities. The weighted average cost of interest-bearing liabilities was 0.81% during the third quarter of 2022, up from 0.69% during the third quarter of 2021 mainly due to higher costs of borrowings and non-time deposits. The cost of borrowed funds increased from 1.67% during the third quarter of 2021 to 1.99% during the third quarter of 2022 primarily due to a higher cost of subordinated debentures and the issuance of $90.0 million in subordinated notes in December of 2021 and January of 2022. The cost of subordinated debentures was 6.57% during the third quarter of 2022, up from 3.70% during the respective 2021 period due to increases in the 90-Day Libor Rate. The cost of non-time deposits increased from 0.20% during the third quarter of 2021 to 0.30% during the current-year third quarter, reflecting the increasing interest rate environment. Average interest-bearing liabilities totaled $2.83 billion during the current-year third quarter compared to $2.74 billion during the prior-year third quarter, representing an increase of $93.2 million, or 3.4%.

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MERCANTILE BANK CORPORATION

Interest expense during the first nine months of 2022 was $16.0 million, an increase of $1.1 million, or 7.1%, from the $14.9 million expensed during the first nine months of 2021. The increase is attributable to growth in interest-bearing liabilities, which more than offset a slight decrease in the weighted average cost of interest-bearing liabilities. Average interest-bearing liabilities were $2.94 billion during the first nine months of 2022, up $265 million, or 9.9%, from the $2.67 billion average during the respective 2021 period. The weighted average cost of interest-bearing liabilities decreased slightly from 0.75% during the first nine months of 2021 to 0.73% during the respective current-year period mainly due to a lower cost of time deposits, which more than offset increases in the costs of borrowings and non-time deposits. The cost of time deposits decreased from 1.30% during the first nine months of 2021 to 0.90% during the first nine months of 2022 primarily due to lower interest rates paid on local time deposits.

Net interest income during the third quarter of 2022 was $42.4 million, an increase of $11.3 million, or 36.2%, from the $31.1 million earned during the respective 2021 period. The increase resulted from an improved net interest margin, and to a much lesser extent, growth in average earning assets. The net interest margin increased from 2.71% in the third quarter of 2021 to 3.56% in the current-year third quarter due to a higher yield on average earning assets. The higher yield primarily resulted from increased yields on loans and other interest-earning assets, reflecting the rising interest rate environment, and a change in earning asset mix, comprised of a decrease in lower-yielding other interest-earning assets and an increase in higher-yielding loans as a percentage of earning assets. The cost of funds equaled 0.48% in the third quarter of 2022, up from 0.42% during the prior-year third quarter mainly due to increased costs of borrowings and non-time deposits. The significant level of excess on-balance sheet liquidity negatively impacted the net interest margin by 7 basis points and 44 basis points during the third quarters of 2022 and 2021, respectively.

Net interest income during the first nine months of 2022 was $108 million, an increase of $16.1 million, or 17.5%, from the $91.5 million earned during the first nine months of 2021. The increase resulted from a higher net interest margin and growth in average earning assets. The net interest margin improved from 2.76% in the first nine months of 2021 to 3.00% in the respective 2022 period due to a higher yield on average earning assets. The increased yield primarily resulted from higher yields on loans and other interest-earning assets, reflecting the rising interest rate environment, and a change in earning asset mix, consisting of a decline in lower-yielding other interest-earning assets and an increase in higher-yielding loans as a percentage of earning assets. The cost of funds equaled 0.45% during the first nine months of 2022, unchanged from the respective prior-year period as increases in the costs of borrowings and non-time deposits were offset by a lower cost of time deposits. The significant level of excess on-balance sheet liquidity negatively impacted the net interest margin by 24 basis points and 40 basis points during the first nine months of 2022 and 2021, respectively.

The following tables set forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflect the average yield on assets and average cost of liabilities for the third quarters and first nine months of 2022 and 2021. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. Tax-exempt securities interest income and yield for the third quarters and first nine months of 2022 and 2021 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%. Securities interest income was increased by $60,000 in the third quarter of both 2022 and 2021 and $180,000 in the first nine months of both 2022 and 2021 for this non-GAAP, but industry standard, adjustment. These adjustments equated to increases in our net interest margin of less than one basis point for each of the 2022 and 2021 periods.

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	Quarters ended September 30,
	2 0 2 2								2 0 2 1
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	3,814,338		$	43,807		4.56	%	$	3,276,863		$	33,656		4.07	%
Investment securities		618,043			2,762		1.79			547,336			2,001		1.46
Other interest-earning assets		294,969			1,620		2.15			733,801			291		0.16
Total interest - earning assets		4,727,350			48,189		4.04			4,558,000			35,948		3.13

Allowance for credit losses		(36,924	)							(36,369	)
Other assets		335,572								334,980

Total assets	$	5,025,998							$	4,856,611


LIABILITIES AND SHAREHOLDERS ’ EQUITY
Interest-bearing deposits	$	2,144,047		$	2,299		0.43	%	$	2,125,920		$	2,184		0.41	%
Short-term borrowings		203,431			53		0.10			170,528			46		0.11
Federal Home Loan Bank advances		347,328			1,755		1.98			394,000			2,072		2.06
Other borrowings		138,332			1,646		4.72			49,533			462		3.65
Total interest-bearing liabilities		2,833,138			5,753		0.81			2,739,981			4,764		0.69

Noninterest-bearing deposits		1,723,609								1,641,158
Other liabilities		39,158								19,569
Shareholders’ equity		430,093								455,903

Total liabilities and shareholders’ equity	$	5,025,998							$	4,856,611

Net interest income				$	42,436							$	31,184

Net interest rate spread							3.23	%							2.44	%
Net interest spread on average assets							3.35	%							2.55	%
Net interest margin on earning assets							3.56	%							2.71	%

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MERCANTILE BANK CORPORATION

	Nine months ended September 30,
	2 0 2 2								2 0 2 1
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	3,645,061		$	113,061		4.15	%	$	3,308,119		$	100,430		4.06	%
Investment securities		615,715			7,676		1.66			484,020			5,555		1.53
Other interest-earning assets		534,786			3,004		0.74			648,780			642		0.13
Total interest - earning assets		4,795,562			123,741		3.45			4,440,919			106,627		3.21

Allowance for credit losses		(35,970	)							(37,977	)
Other assets		330,558								327,540

Total assets	$	5,090,150							$	4,730,482


LIABILITIES AND SHAREHOLDERS ’ EQUITY
Interest-bearing deposits	$	2,235,952		$	5,997		0.36	%	$	2,076,221		$	7,247		0.47	%
Short-term borrowings		198,721			153		0.10			151,522			122		0.11
Federal Home Loan Bank advances		364,541			5,530		2.00			394,000			6,149		2.06
Other borrowings		137,451			4,294		4.18			49,584			1,401		3.73
Total interest-bearing liabilities		2,936,665			15,974		0.73			2,671,327			14,919		0.75

Noninterest-bearing deposits		1,685,497								1,590,969
Other liabilities		31,784								19,671
Shareholders’ equity		436,204								448,515

Total liabilities and shareholders’ equity	$	5,090,150							$	4,730,482

Net interest income				$	107,767							$	91,708

Net interest rate spread							2.72	%							2.46	%
Net interest spread on average assets							2.83	%							2.59	%
Net interest margin on earning assets							3.00	%							2.76	%

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A provision for credit losses of $2.9 million was recorded during the third quarter of 2022, compared to a provision expense of $1.9 million during the third quarter of 2021. A provision for credit losses of $3.5 million was recorded during the first nine months of 2022, compared to a negative provision of $0.9 million during the first nine months of 2021. The provision expense recorded during the current-year third quarter mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, and a decline in forecasted economic conditions. The provision expense recorded during the first nine months of 2022 primarily resulted from these factors, along with a higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio. The required reserve allocations resulting from these factors were partially mitigated by the positive impact of a change in the Covid-19 environmental factor during the second quarter, along with the recording of net loan recoveries and ongoing strong loan quality metrics during the periods. The Covid-19 environmental factor was added in the second quarter of 2020 to address the unique challenges and economic uncertainty resulting from the pandemic and its potential impact on the collectability of the loan portfolio. Improvement in overall Covid-19 conditions, including increased vaccination rates, the availability of booster shots, and the lifting of many economic growth-restraining restrictions, lessened the required credit reserve amount related to the Covid-19 environmental factor. The provision expense recorded during the third quarter of 2021 primarily reflected allocations associated with commercial loan growth, while the negative provision expense recorded during the first nine months of 2021 mainly reflected a reduced allocation associated with the economic and business conditions environmental factor, reflecting improvement in both current and forecasted economic conditions, and the recording of net loan recoveries, which more than offset required reserve allocations necessitated by growth in commercial loans.

We adopted CECL effective January 1, 2022, using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022, are presented under CECL, while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a $0.4 million decrease in the allowance and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.

During the third quarter of 2022, no loans were charged off, while recoveries of prior period loan charge-offs were $0.2 million, providing for net loan recoveries of $0.2 million, or an annualized 0.03% of average total loans. During the third quarter of 2021, loan charge-offs totaled $0.8 million, while recoveries of prior period loan charge-offs equaled $0.4 million, providing for net loan charge-offs of $0.4 million, or an annualized 0.05% of average total loans. During the first nine months of 2022, loan charge-offs totaled $0.2 million, while recoveries of prior period loan charge-offs equaled $0.9 million, providing for net loan recoveries of $0.7 million, or an annualized 0.02% of average total loans. During the first nine months of 2021, loan charge-offs totaled $0.9 million, while recoveries of prior period loan charge-offs equaled $1.2 million, providing for net loan recoveries of $0.3 million, or an annualized 0.01% of average total loans. The allowance for credit losses, as a percentage of total loans, was 1.0% as of September 30, 2022 and December 31, 2021, and 1.1% as of September 30, 2021.

Noninterest income during the third quarter of 2022 was $7.3 million, down $8.3 million from the $15.6 million recorded during the prior-year third quarter. Noninterest income during the third quarter of 2021 included a recovery of loan collection costs totaling $0.6 million. Excluding the impact of this transaction, noninterest income decreased $7.7 million during the third quarter of 2022 compared to the respective 2021 period. Noninterest income during the first nine months of 2022 was $24.3 million, compared to $43.6 million during the first nine months of 2021. During the first nine months of 2022, noninterest income included a $0.5 million bank owned life insurance claim, while noninterest income during the respective prior-year period included a $1.1 million gain on the sale of a branch and the aforementioned recovery of loan collection costs. Excluding the impacts of these transactions, noninterest income decreased $18.2 million during the first nine months of 2022 compared to the respective 2021 period. The lower levels of noninterest income almost exclusively reflected decreased mortgage banking income and interest rate swap income, which more than offset increases in several key fee income sources, including service charges on accounts, credit and debit card income, and payroll service fees. Continued strength in purchase residential mortgage loan originations during the third quarter and first nine months of 2022 partially mitigated the negative impacts of higher interest rates, reduced refinance activity, lower sold percentages, and decreased gain on sale rates on mortgage banking income during the periods when compared to the respective prior-year periods.

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The residential mortgage loan sold percentage declined from approximately 69% during the second quarter and first nine months of 2021 to approximately 36% during the respective current-year periods. The decreased sold percentages in large part reflect customers’ preferences for adjustable-rate loans in the current interest rate environment and construction loans representing an increased percentage of overall loan production. The declines in interest rate swap income reflect lower transaction volumes. In aggregate, service charges on accounts, credit and debit card income, and payroll processing fees were up 14% and 15% during the third quarter and first nine months of 2022, respectively, compared to the corresponding prior-year periods.

Noninterest expense totaled $26.8 million during the third quarter of 2022, up from $26.2 million during the prior-year third quarter. Noninterest expense during the first nine months of 2022 was $79.4 million, compared to $77.5 million during the respective prior-year period. Overhead costs during the first nine months of 2022 included a $0.5 million contribution to The Mercantile Bank Foundation and a $0.3 million net loss on the sale of a former branch facility, while overhead costs during the first nine months of 2021 included $0.6 million in net losses on sales and write-downs of former branch facilities. Excluding these transactions, noninterest expense increased $1.7 million in the first nine months of 2022 compared to the respective 2021 period. The higher levels of expense in the 2022 periods mainly reflected increased salary costs, in large part reflecting annual employee merit pay increases, a larger bonus accrual, and higher stock-based compensation costs, which more than offset higher residential mortgage loan deferred salary costs as well as decreased residential mortgage lender commissions and associated incentives. The increased residential mortgage loan deferred salary costs reflected the outcome of an updated loan origination cost study and resulting higher allocated cost per loan, while the decreased residential mortgage lender commissions and associated incentives resulted from reduced loan production, in large part reflecting lower refinance activity. Data processing costs, primarily reflecting higher transaction volume and software support costs, and other employee costs, consisting mainly of meals, entertainment, training, travel, and mileage, increased in the 2022 periods. The higher level of other employee costs primarily reflected the easing of Covid-19 pandemic-related restrictions.

During the third quarter of 2022, we recorded income before federal income tax of $20.0 million and a federal income tax expense of $3.9 million. During the third quarter of 2021, we recorded income before federal income tax of $18.6 million and a federal income tax expense of $3.5 million. During the first nine months of 2022, we recorded income before federal income tax of $48.9 million and a federal income tax expense of $9.7 million. During the first nine months of 2021, we recorded income before federal income tax of $58.5 million and a federal income tax expense of $11.1 million. The increased federal income tax expense in the third quarter of 2022 resulted from the higher level of income before federal income tax, while the decreased federal income tax expense in the first nine months of 2022 stemmed from the lower level of income before federal income tax. Our effective tax rate was 19.8% during the third quarter and first nine months of 2022 and 19.0% during the respective 2021 periods.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

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

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

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The following table depicts our GAP position as of September 30, 2022:

	Within			Three to			One to			After
	Three			Twelve			Five			Five
	Months			Months			Years			Years			Total
Assets:
Commercial loans (1)	$	1,967,510,000		$	67,875,000		$	909,717,000		$	251,375,000		$	3,196,477,000
Residential real estate loans		68,635,000			15,581,000			140,279,000			446,526,000			671,021,000
Consumer loans		2,555,000			543,000			9,905,000			457,000			13,460,000
Securities (2)		21,954,000			10,854,000			216,908,000			351,004,000			600,720,000
Other interest-earning assets		230,819,000			1,750,000			2,751,000			0			235,320,000
Allowance for credit losses		0			0			0			0			(39,120,000	)
Other assets		0			0			0			0			339,056,000
Total assets		2,291,473,000			96,603,000			1,279,560,000			1,049,362,000		$	5,016,934,000

Liabilities:
Interest-bearing checking		529,297,000			0			0			0			529,297,000
Savings deposits		412,491,000			0			0			0			412,491,000
Money market accounts		808,734,000			0			0			0			808,734,000
Time deposits under $100,000		23,563,000			48,192,000			42,996,000			0			114,751,000
Time deposits $100,000 & over		40,748,000			76,686,000			146,474,000			0			263,908,000
Short-term borrowings		198,605,000			0			0			0			198,605,000
Federal Home Loan Bank advances		30,000,000			50,353,000			233,527,000			24,383,000			338,263,000
Other borrowed money		49,921,000			0			88,542,000			0			138,463,000
Noninterest-bearing checking		0			0			0			0			1,716,904,000
Other liabilities		0			0			0			0			79,257,000
Total liabilities		2,093,359,000			175,231,000			511,539,000			24,383,000			4,600,673,000
Shareholders' equity		0			0			0			0			416,261,000
Total liabilities & shareholders' equity		2,093,359,000			175,231,000			511,539,000			24,383,000		$	5,016,934,000

Net asset (liability) GAP	$	198,114,000		$	(78,628,000	)	$	768,021,000		$	1,024,979,000

Cumulative GAP	$	198,114,000		$	119,486,000		$	887,507,000		$	1,912,486,000

Percent of cumulative GAP to total assets		3.9	%		2.4	%		17.7	%		38.1	%

⁽¹⁾	Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.

⁽²⁾	Mortgage-backed securities are categorized by average life calculations based upon prepayment trends as of September 30, 2022.

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The second interest rate risk measurement we use is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, it serves as our primary interest rate risk measurement technique. The simulation model assesses the direction and magnitude of variations in net interest income resulting from potential changes in market interest rates.

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 September 30, 2022, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 300 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $197 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of September 30, 2022. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.

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

Interest rates down 300 basis points	$	(24,200,000	)		(12.3%)
Interest rates down 200 basis points		(16,000,000	)		(8.1)
Interest rates down 100 basis points		(6,400,000	)		(3.3)
Interest rates up 100 basis points		6,300,000			3.2
Interest rates up 200 basis points		13,000,000			6.6
Interest rates up 300 basis points		19,700,000			10.0

The resulting estimates have been significantly impacted by the current interest rate and economic environments, as adjustments have been made to critical model inputs with regards to traditional interest rate relationships. This is especially important as it relates to floating rate commercial loans, which comprise a sizable portion of our balance sheet.

In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; level of nonperforming assets; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors.

Item 4. Controls and Procedures

As of September 30, 2022, 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 September 30, 2022.

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 1A. Risk Factors.

There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K for the year ended December 31, 2021.

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

We made no unregistered sales of equity securities during the quarter ended September 30, 2022.

Issuer Purchases of Equity Securities

On May 27, 2021, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. The actual timing, number and value of shares repurchased under the program will be determined by management in its discretion and will depend on a number of factors, including the market price of our stock, general market and economic conditions, our capital position, financial performance and alternative uses of capital, and applicable legal requirements. The program may be discontinued at any time. No shares were repurchased during the first nine months of 2022. As of September 30, 2022, repurchases aggregating $6.8 million were available to be made under the current repurchase program.

Repurchases made during the third quarter of 2022 are detailed in the table below.

Period	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares or Approximate Dollar Value that May Yet Be Purchased Under the Plans or Programs
July 1 – 31		0	$	0		0	$	6,818,000
August 1 – 31		0		0		0		6,818,000
September 1 – 30		0		0		0		6,818,000
Total		0	$	0		0	$	6,818,000

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

Not applicable.

Table of Contents

MERCANTILE BANK CORPORATION

Item 6. Exhibits

EXHIBIT NO.	EXHIBIT DESCRIPTION

3.1	Articles of Incorporation of Mercantile Bank Corporation, including all amendments thereto, incorporated by reference to Exhibit 3.1 of our Form S-4 Registration Statement filed February 16, 2022

3.2	Our Amended and Restated Bylaws dated as of February 26, 2015 are incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed February 26, 2015

31	Rule 13a-14(a) Certifications

32.1	Section 1350 Chief Executive Officer Certification

32.2	Section 1350 Chief Financial Officer Certification

101	The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2022, formatted in Inline XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements

104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 4, 2022.

	MERCANTILE BANK CORPORATION



	By: /s/ Robert B. Kaminski, Jr.
	Robert B. Kaminski, Jr.
	President and Chief Executive Officer (Principal Executive Officer)



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

TABLE OF CONTENTS

Part I --- Financial Information Item 1. Financial Statements Item 2. Management S Discussion and Analysis Of Financial Condition and Results Of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures Part II Other Information Part II Item 1. Legal Proceedings Item 1A. Risk Factors Item 2. Unregistered Sales Of Equity Securities and Use Of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Mine Safety Disclosures Item 5. Other Information Item 6. Exhibits

Exhibits

3.1 Articles of Incorporation of Mercantile Bank Corporation, including all amendments thereto, incorporated by reference to Exhibit 3.1 of our Form S-4 Registration Statement filed February 16, 2022 3.2 Our Amended and Restated Bylaws dated as of February 26, 2015 are incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed February 26, 2015 31 Rule 13a-14(a) Certifications 32.1 Section 1350 Chief Executive Officer Certification 32.2 Section 1350 Chief Financial Officer Certification

MBWM 10-Q Quarter ended Sept. 30, 2022

Exhibits