- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-32434

MERCANTILE BANCORP, INC.

(Exact name of registrant as specified in its charter)

Delaware		37-1149138
(State or other jurisdiction of Incorporation or organization)		(I.R.S. Employer Identification No.)

200 North 33rd Street

Quincy, ILLINOIS 62301

(Address of principal executive offices including zip code)

(217) 223-7300

(Registrant’s telephone number, including area code)

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

Yes x No ¨ .

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File requested to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files). Yes ¨ No ¨

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

¨ Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer x Smaller Reporting Company

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

Yes ¨ No x .

As of May 6, 2011 the number of outstanding shares of Common Stock, par value $0.4167 per share was 8,748,330.

MERCANTILE BANCORP, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Operations	4

	Condensed Consolidated Statements of Cash Flows	5

	Notes to Condensed Consolidated Financial Statements	6-26


Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27-45

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46

Item 4.	Controls and Procedures	46

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 5.	Other Information	47
Item 6.	Exhibits	48

	Signatures	49

Exhibits

	Section 302 Certifications
	Section 906 Certifications

PART I

FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements .

MERCANTILE BANCORP, INC.

Condensed Consolidated Balance Sheets

(In thousands, except par value and share data)

	March 31, 2011			December 31, 2010
	(Unaudited)

Assets
Cash and due from banks	$	10,268		$	10,585
Interest-bearing demand deposits		86,587			75,593
Federal funds sold		15,870			11,370
Cash and cash equivalents		112,725			97,548
Available-for-sale securities		111,358			107,250
Held-to-maturity securities (fair values of $1,028 and $1,246)		998			1,208
Loans held for sale		8,527			7,513
Loans, net of allowance for loan losses of $24,142 and $28,199		589,551			632,963
Interest receivable		3,060			3,328
Foreclosed assets held for sale, net		25,665			21,040
Federal Home Loan Bank stock		2,886			2,885
Cost method investments in common stock		1,190			1,392
Mortgage servicing rights		767			784
Cash surrender value of life insurance		15,709			15,572
Premises and equipment		23,608			23,993
Core deposit and other intangibles		459			492
Other assets		7,508			13,213
Total assets	$	904,011		$	929,181

Liabilities
Deposits
Demand	$	122,916		$	111,741
Savings, NOW and money market		215,507			227,850
Time		413,535			406,539
Brokered time		65,853			87,084
Total deposits		817,811			833,214
Short-term borrowings		10,135			13,660
Long-term debt		7,000			15,000
Junior subordinated debentures		61,858			61,858
Interest payable		7,706			6,986
Other liabilities		4,817			4,498
Total liabilities		909,327			935,216

Commitments and Contingent Liabilities

Stockholders’ Deficit
Mercantile Bancorp, Inc. stockholders’ deficit
Common stock, $0.42 par value; authorized 30,000,000 shares;
Issued — 8,887,113 shares at March 31, 2011 and December 31, 2010
Outstanding — 8,748,330 shares at March 31, 2011 and 8,703,330 shares at December 31, 2010		3,648			3,629
Additional paid-in capital		12,184			11,738
Retained deficit		(18,269	)		(19,524	)
Accumulated other comprehensive income		1,759			2,994
		(678	)		(1,163	)
Treasury stock, at cost
Common; 138,783 shares at March 31, 2011 and 183,783 shares at December 31, 2010		(1,760	)		(2,295	)

Total Mercantile Bancorp, Inc. stockholders’ deficit		(2,438	)		(3,458	)

Noncontrolling interest		(2,878	)		(2,577	)

Total stockholders’ deficit		(5,316	)		(6,035	)

Total liabilities and stockholders’ deficit	$	904,011		$	929,181

See accompanying notes to condensed consolidated financial statements

MERCANTILE BANCORP, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

	Three Months Ended March 31,
	2011			2010
Interest and Dividend Income
Loans, including fees
Taxable	$	8,222		$	10,002
Tax exempt		226			236
Securities
Taxable		761			970
Tax exempt		204			210
Federal funds sold		5			8
Dividends on Federal Home Loan Bank Stock		3			4
Deposits with financial institutions and other		32			78
Total interest and dividend income		9,453			11,508

Interest Expense
Deposits		3,169			4,171
Short-term borrowings		35			187
Long-term debt and junior subordinated debentures		1,010			1,013
Total interest expense		4,214			5,371

Net Interest Income		5,239			6,137

Provision (Credit) for Loan Losses		(963	)		3,990

Net Interest Income After Provision For Loan Losses		6,202			2,147

Noninterest Income
Fiduciary activities		614			581
Brokerage fees		263			299
Customer service fees		334			365
Other service charges and fees		179			139
Net gains on sales of assets		-			8
Net gains on loan sales		99			92
Net gains on sale of available-for-sale securities		433			-
Loan servicing fees		123			124
Net increase in cash surrender value of life insurance		137			138
Other		18			187
Total noninterest income		2,200			1,933

Noninterest Expense
Salaries and employee benefits		3,838			4,405
Net occupancy expense		602			598
Equipment expense		518			563
Deposit insurance premium		661			471
Professional fees		430			491
Postage and supplies		144			148
Losses on foreclosed assets, net		250			212
Amortization of mortgage servicing rights		55			39
Other than temporary impairment losses on cost method investments		202			-
Other		1,567			1,489
Total noninterest expense		8,267			8,416

Income (Loss) from Continuing Operations Before Income Taxes		135			(4,336	)

Income Tax Expense (Benefit)		2			(1,190	)

Income (Loss) from Continuing Operations		133			(3,146	)

Discontinued Operations
Income from discontinued operations (including gain on sale in 2010 of $4,254), net of income tax expense of $0 and $2,045, respectively		821			3,197

Net Income		954			51

Less: Net loss attributable to noncontrolling interest		(301	)		(933	)

Net Income attributable to Mercantile Bancorp, Inc.	$	1,255		$	984

Weighted Average Shares Outstanding		8,716,830			8,703,330
Basic Earnings (Loss) Per Share
Continuing operations	$	0.05		$	(0.25	)
Discontinued operations		0.09			0.36
Total Basic Earnings Per Share	$	0.14		$	0.11

See accompanying notes to condensed consolidated financial statements

MERCANTILE BANCORP, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

Three Months Ended March 31	2011			2010
Operating Activities
Net income before attribution of noncontrolling interest	$	954		$	51
Net loss attributable to noncontrolling interest		(301	)		(933	)
Net income attributable to Mercantile Bancorp, Inc.		1,255			984
Items not requiring (providing) cash
Depreciation		395			454
Provision (credit) for loan losses		(963	)		4,038
Amortization (accretion) of premiums and discounts on securities		159			169
Amortization of core deposit intangibles and other purchase accounting adjustments		27			38
Deferred income taxes		-			616
Net realized gains on sale of available-for-sale securities		(433	)		-
Other than temporary impairment losses on cost method investments		202			-
Losses on foreclosed assets		250			212
Gains on loan sales		(100	)		(101	)
Amortization of mortgage servicing rights		55			39
Gain on sale of Marine Bank & Trust and Brown County State Bank		(821	)		(4,254	)
Gains on sale of premises and equipment		-			(8	)
Federal Home Loan Bank stock dividends		(1	)		(2	)
Net increase in cash surrender value of life insurance		(137	)		(177	)
Changes in
Loans originated for sale		(8,892	)		(6,601	)
Proceeds from sales of loans		7,940			6,556
Interest receivable		268			279
Other assets		5,705			1,981
Interest payable		720			424
Other liabilities		319			(62	)
Noncontrolling interest in subsidiary		(301	)		(933	)
Net cash provided by operating activities		5,647			3,652

Investing Activities
Cash received from sales of Marine Bank & Trust and Brown County State Bank		3			14,706
Purchases of available-for-sale securities		(16,817	)		(3,156	)
Proceeds from maturities of available-for-sale securities		10,505			11,814
Proceeds from the sales of available-for-sale securities		2,069			-
Proceeds from maturities of held-to-maturity securities		210			371
Net change in loans		37,675			13,652
Purchases of premises and equipment		(19	)		(23	)
Proceeds from sales of foreclosed assets		1,829			4,235
Net cash provided by investing activities		35,455			41,599

Financing Activities
Net decrease in demand deposits, money market, NOW and savings accounts		(1,168	)		(34,968	)
Net decrease in time and brokered time deposits		(14,232	)		(41,242	)
Net increase (decrease) in short-term borrowings		(3,525	)		5,945
Repayments of long-term debt		(8,000	)		(10,172	)
Purchase by Mercantile Bancorp, Inc. of Mid-America debenture of $1,000,000 by the issuance of 45,000 shares of common stock:
- Increase in additional paid-in-capital		446			-
- Issuance of treasury stock		535			-
- Issuance of common stock		19			-
Net cash used in financing activities		(25,925	)		(80,437	)

Increase (Decrease) In Cash and Cash Equivalents		15,177			(35,186	)
Cash and Cash Equivalents, Beginning of Period		97,548			123,391

Cash and Cash Equivalents, End of Period	$	112,725		$	88,205

Supplemental Cash Flows Information
Interest paid	$	3,494		$	6,077
Income taxes received	$	(5,028	)	$	(530	)
Real estate acquired in settlement of loans	$	6,653		$	6,152
Purchase of Mid-America debenture from minority shareholders	$	(1,000	)	$	-

See accompanying notes to condensed consolidated financial statements

MERCANTILE BANCORP, INC.

Notes to Condensed Consolidated Financial Statements

(table dollar amounts in thousands)

1. BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements include the accounts of Mercantile Bancorp, Inc. (the “Company”) and its wholly and majority owned subsidiaries, Mercantile Bank, Royal Palm Bancorp, Inc. (the sole shareholder of Royal Palm Bank) and Mid-America Bancorp, Inc. (the sole shareholder of Heartland Bank), (“Banks”). All material inter-company accounts and transactions have been eliminated in the accompanying unaudited condensed consolidated financial statements of the Company. These financial statements also include the accounts of Marine Bank & Trust and Brown County State Bank prior to their sales in February 2010.

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the Company’s unaudited condensed consolidated financial statements for the three months ended March 31, 2011 and 2010. Interim period results are not necessarily indicative of results of operations or cash flows for a full-year period. The December 31, 2010 condensed consolidated balance sheet data was derived from the audited financial statements, but certain information and disclosures required by accounting principles generally accepted in the United States of America have been condensed or omitted.

These unaudited condensed consolidated financial statements and the notes thereto should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2010, appearing in the Company’s Annual Report on Form 10-K filed in 2011.

2. EARNINGS (LOSS) PER COMMON SHARE

Basic and diluted earnings (loss) per share have been computed by the weighted-average number of common shares outstanding during the period.

3. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

FASB ASC Topic 820, “Fair Value Measurements and Disclosures – Improving Disclosures about Fair Value Measurements.” New authoritative accounting guidance (Accounting Standards Update 2010-06) in this update requires new disclosures about significant transfers in and out of Level 1 and Level 2 fair value measurements. The amendments also require a reporting entity to provide information about activity for purchases, sales, issuances, and settlements in Level 3 fair value measurements and clarify disclosures about the level of disaggregation and disclosures about inputs and valuation techniques. This update became effective for the Company for interim and annual reporting periods beginning after December 15, 2009 and did not have a significant impact on the Company’s financial statements. The disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements became effective for the Company after December 15, 2010 and did not have a material effect on the Company’s financial statements.

FASB ASC Topic 310, “Receivables: Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” On July 21, 2010, new authoritative accounting guidance (Accounting Standards Update No. 2010-20) under ASC Topic 310 was issued which requires an entity to provide more information in their disclosures about the credit quality of their financing receivables and the credit reserves held against them. This statement addresses only disclosures and does not change recognition or measurement. The new authoritative accounting guidance under ASC Topic 310 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. This amendment did not have a significant impact on the Company’s financial results, but it has significantly expanded the disclosures that the Company is required to provide.

FASB Accounting Standards Update 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.” In April 2011, new authoritative accounting guidance was issued to provide additional guidance related to determining whether a creditor has granted a concession, include factors and examples for creditors to consider in evaluating whether a restructuring results in a delay in payment that is insignificant, prohibit creditors from using the borrower’s effective rate test to evaluate whether a concession has been granted to the borrower, and add factors for creditors to use in determining whether a borrower is experiencing financial difficulties. A provision in ASU No. 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by ASU No. 2010-20. The provisions of ASU No. 2011-02 are effective for the Company’s reporting period ending September 30, 2011. The adoption of ASU 2011-02 is not expected to have a material impact on the Company’s financial statements.

4. FEDERAL HOME LOAN BANK STOCK

Federal Home Loan Bank stock is stated at cost and is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in the common stock is based on a predetermined formula. As of March 31, 2011, and December 31, 2010, the Company owned approximately $2.9 million of Federal Home Loan Bank stock, including $1.9 million of stock (1,931,404.94 shares) in the Federal Home Loan Bank of Chicago (“FHLB of Chicago”). During the third quarter of 2007, the FHLB of Chicago received a Cease and Desist Order (“Order”) from their regulator, the Federal Housing Finance Board. The FHLB of Chicago could continue to provide liquidity and funding through advances, but the Order prohibits capital stock repurchases until a time to be determined by the Federal Housing Finance Board. With regard to dividends, the FHLB of Chicago continues to assess its dividend capacity each quarter and make appropriate requests for approval from its regulator. The FHLB of Chicago did not pay a dividend during 2010; however, a dividend at an annualized rate of 10 basis points per share was paid on February 14, 2011. Management performed an impairment analysis and, based on currently available information, determined the investment in the FHLB of Chicago stock was ultimately recoverable as of March 31, 2011 or December 31, 2010.

5. SECURITIES

The amortized cost and fair values of securities are as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-sale Securities:
March 31, 2011:
U.S. Government agencies	$	3,449	$	75	$	—		$	3,524
Mortgage-backed securities: GSE residential		72,725		1,590		(49	)		74,266
State and political subdivisions		32,629		701		(543	)		32,787
Equity securities		679		160		(58	)		781

	$	109,482	$	2,526	$	(650	)	$	111,358

Available-for-sale Securities:
December 31, 2010:
U.S. Government agencies	$	3,649	$	78	$	—		$	3,727
Mortgage-backed securities: GSE residential		65,094		1,860		(6	)		66,948
State and political subdivisions		33,906		714		(658	)		33,962
Equity securities		2,314		390		(91	)		2,613

	$	104,963	$	3,042	$	(755	)	$	107,250

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Held-to-maturity Securities:
March 31, 2011:
Mortgage-backed securities: GSE residential	$	998	$	30	$	—	$	1,028

December 31, 2010:
Mortgage-backed securities: GSE residential	$	1,208	$	38	$	—	$	1,246

The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at March 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available-for-sale				Held-to-maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Within one year	$	5,142	$	10,649	$	—	$	—
One to five years		15,928		11,162		—		—
Five to ten years		12,959		12,596		—		—
After ten years		2,049		1,904		—		—
		36,078		36,311		—		—
Mortgage-backed securities: GSE residential		72,725		74,266		998		1,028
Equity securities		679		781		—		—

Totals	$	109,482	$	111,358	$	998	$	1,028

The carrying value of securities pledged as collateral, to secure public deposits, Federal Home Loan Bank advances, repurchase agreements and for other purposes, amounted to approximately $61.2 million at March 31, 2011 and $29.0 million at December 31, 2010.

During the three months ended March 31, 2011 and 2010, the Company did not recognize other-than-temporary impairment charges on any of its investments in stock of other financial institutions which are carried as available-for-sale equity securities. Impairments are determined based on the difference between the Company’s carrying value and quoted market prices for the stocks as of March 31, 2011. In making the determination of impairment for each of its investments, the Company considered the duration of the loss, prospects for recovery in a reasonable period of time and the significance of the loss compared to carrying value.

The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2011 and December 31, 2010:

	Less Than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

March 31, 2011
Mortgage-backed securities: GSE residential	$	9,555	$	(49	)	$	—	$	—		$	9,555	$	(49	)
State and political subdivisions		10,720		(543	)		—		—			10,720		(543	)
Equity securities		320		(58	)		—		—			320		(58	)

Total temporarily impaired securities	$	20,595	$	(650	)	$	—	$	—		$	20,595	$	(650	)

December 31, 2010
Mortgage-backed securities: GSE residential	$	2,303	$	(6	)	$	—	$	—		$	2,303	$	(6	)
State and political subdivisions		10,608		(657	)		114		(1	)		10,722		(658	)
Equity securities		287		(91	)		—		—			287		(91	)

Total temporarily impaired securities	$	13,198	$	(754	)	$	114	$	(1	)	$	13,312	$	(755	)

At March 31, 2011, securities in an unrealized loss position in the investment portfolio are minimal. The Company’s mortgage-backed securities and state and political subdivision securities are in a loss position due to interest rate changes, not credit events. Those unrealized losses are considered temporary and the Company has the ability and intent to hold them for the foreseeable future. Their fair value is expected to recover as the investments approach their maturity date or there is a downward shift in interest rates. The Company has one equity security with an unrealized loss due to the downturn in the market of the financial services industry. The Company sold this security in April 2011, recording a loss on the sale of approximately $93 thousand.

6. COST METHOD INVESTMENTS IN COMMON STOCK

The Company has minority investments in the common stock of other community banks, which are not publicly traded, that are recorded under the cost method of accounting. The Company had investments in three community banks at March 31, 2011 and December 31, 2010 with carrying values of approximately $1.2 million and $1.4 million, respectively.

The Company’s cost method investments are reviewed for impairment based on each investee’s earnings performance, asset quality, changes in the economic environment, and current and projected future cash flows. Based on this review, the Company determined one of its investments to be other-than-temporarily impaired due to poor earnings and asset quality as of March 31, 2011. The Company recognized an impairment charge of approximately $202 thousand during the first quarter of 2011 on this cost method investment based on the difference between the Company’s cost and the investee’s book value, which was determined to be a reasonable estimate of fair value. No impairment charges were deemed necessary based on the Company’s review of its cost method investments during 2010.

7. LOANS AND ALLOWANCE FOR LOAN LOSSES

Categories of loans, including loans held for sale within residential real estate of $8,527,000 and $7,513,000, at March 31, 2011 and December 31, 2010, respectively, include:

	March 31, 2011		December 31, 2010

Commercial and financial	$	132,595	$	146,463
Agricultural		9,612		11,708
Real estate - farmland		14,884		15,528
Real estate - construction		78,892		91,553
Real estate - commercial		141,978		153,767
Real estate - residential		188,469		189,479
Consumer		55,790		60,177

Total loans		622,220		668,675

Less
Allowance for loan losses		24,142		28,199

Net loans	$	598,078	$	640,476

The Company believes that sound loans are a necessary and desirable means of employing funds available for investment. Recognizing the Company’s obligations to its depositors and to the communities it serves, authorized personnel are expected to seek to develop and make sound, profitable loans that resources permit and that opportunity affords. The Company maintains lending policies and procedures which focus lending efforts on the types, locations, and duration of loans most appropriate for the Company’s business model and markets. The Company’s principal lending activity is the origination of commercial loans and commercial real estate (“CRE”) loans, 1-4 family residential mortgage loans and consumer loans, but also includes multi-family residential mortgage loans, and home equity lines of credit. The Company will also consider construction loans, but generally only in relation to 1-4 family homes in core markets, and commercial construction loans the subsidiary banks are willing to put into their regular CRE portfolios. The primary lending market includes the areas surrounding each of the subsidiary banks. This includes the Quincy, Illinois, Saint Joseph and Savannah, Missouri and Carmel, Indiana markets for Mercantile Bank, the Kansas City area for Heartland Bank, and the Southwest Florida communities of Naples, Marco Island and Fort Myers for Royal Palm Bank. Generally, loans are collateralized by assets of the borrowers, while individuals also guarantee loans to business entities. The loans are expected to be repaid from cash flows of the borrowers or from proceeds from the sale of selected assets of the borrowers.

Management reviews and approves the Company’s lending policies and procedures on a routine basis. Management routinely (at least quarterly) evaluates the adequacy of the allowance for loan losses and reviews reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. The Company’s underwriting standards are designed to encourage relationship banking. Relationship banking implies a primary banking relationship with the borrower that includes, at minimum, an active deposit banking relationship in addition to the lending relationship. The integrity and character of the borrower are significant factors in the Company’s loan underwriting. As a part of underwriting, tangible positive or negative evidence of the borrower’s integrity and character are sought out. Additional significant underwriting factors beyond location, duration, the sound and profitable cash flow basis underlying the loan and the borrower’s character are the quality of the borrower’s financial history, the liquidity of the underlying collateral and the reliability of the valuation of the underlying collateral. In limited circumstances, the Company’s subsidiary banks will consider transactional lending if it is profitable and in a line of business in which the bank has experience. This includes indirect automobile lending in the Quincy, Illinois market and conservatively underwritten commercial real estate in all markets.

The Company’s policies and loan approval limits are established by the board of directors at each subsidiary bank. The Company’s lending activities reflect an underwriting strategy that emphasizes asset quality and fiscal prudence in order to keep capital resources available for the most attractive lending opportunities in the Company’s markets. Lending officers are assigned various levels of loan approval authority based upon their respective levels of experience and expertise. When the amount of loans to a borrower exceeds an officer’s lending limit, the loan request goes to either an officer with a higher limit or the Board of Directors loan committee for approval. The Company’s strategy for approving or disapproving loans is to follow conservative loan policies and underwriting practices, which include:

● granting loans on a sound and collectible basis;

●

investing funds properly for the benefit of the Company’s shareholders and the protection of its depositors;

●

serving the legitimate needs of the communities in the Company’s markets while obtaining a balance between maximum yield and minimum risk;

●

ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan; and

●

developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each category

The Company’s lending policies prohibit a customer’s total borrowing relationship exceeding the subsidiary bank’s regulatory lending limit. Loans to related parties, including executive officers, the Company’s directors, and the subsidiary banks’ directors are reviewed for compliance with regulatory guidelines at least annually.

The Company employs an external consulting firm to conduct quarterly loan reviews that validate loans on a sample basis against the Company’s loan policies. In addition to compliance with the policies, the loan review process evaluates the risk assessments for specific loans made by the Company’s credit department, lenders and loan committees. Results of these reviews are presented to management and the boards of directors.

The Company’s objective is to offer the commercial, agricultural, residential and consumer customers in its markets a variety of products and services, including a full array of loan products. The Company’s bank subsidiaries make real estate loans (including farmland, construction and mortgage loans); commercial, financial and agricultural loans; and consumer loans. Total loans include loans held for sale. The Company strives to do business in the areas served by its banks and their branches, and all of the Company’s marketing efforts and the vast majority of its loan customers are located within its existing market areas. The following is a discussion of each major type of lending.

Commercial, Financial and Agricultural Loans . These loans are primarily made within the Company’s market areas and are underwritten on the basis of the borrower’s ability to service the debt from income. As a general practice, the Company’s banks take as collateral a lien on any available equipment, accounts receivables or other assets owned by the borrower and often obtain the personal guaranty of the borrower. In general, these loans involve more credit risk than residential mortgage loans and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in commercial, financial and agricultural loans is due to the type of collateral securing these loans. The increased risk also derives from the expectation that commercial, financial and agricultural loans generally will be serviced principally from the operations of the business, and those operations may not be successful. As a result of these additional complexities, variables and risks, commercial, financial and agricultural loans require more thorough underwriting and servicing than other types of loans.

Real Estate Loans . The Company’s banks make real estate loans for farmland, construction and mortgage purposes as more thoroughly described below. Collectively, these loans, which include loans held for sale, comprise the largest category of the Company’s loans.

Farmland Real Estate Loans . Farmland real estate loans are collateralized by owner-occupied and investment properties located in the Company’s market areas. The Company’s banks offer a variety of mortgage loan products that generally are amortized over five to twenty years. The loans generally have rates fixed for up to a five year period, with the loans either having an adjustable rate feature or a balloon at the maturity of the term. Loans secured by farmland real estate are generally originated in amounts of no more than 80% of the lower of cost or appraised value. The bank underwrites and seeks Farm Service Agency guarantees to enhance the credit structure of some farmland real estate loans.

The banks secure a valid lien on farmland real estate loans and obtain a mortgage title insurance policy that insures that the property is free of encumbrances prior to the banks’ lien. The banks require hazard insurance if the farm property has improvements, and if the property is in a flood plain as designated by FEMA or HUD, the banks require flood insurance.

Construction Real Estate Loans . The Company’s banks also make loans to finance the construction of residential and non-residential properties. Construction loans generally are secured by first liens on real estate. The Company’s banks conduct periodic inspections, either directly or through an agent, prior to approval of periodic draws on these loans. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If a bank is forced to foreclose on a project prior to completion, there is no assurance that the bank will be able to recover all of the unpaid portion of the loan. In addition, the bank may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While the Company’s banks have underwriting procedures designed to identify what management believes to be acceptable levels of risk in construction lending, these procedures may not prevent losses from the risks described above.

The banks secure a valid lien on construction real estate loans and obtain a mortgage title insurance policy that insures that the property is free of encumbrances prior to the banks lien. The banks require hazard insurance if the construction property has improvements, insurance bonding on a contractor, and if the property is in a flood plain as designated by FEMA or HUD, the banks require flood insurance.

Residential Real Estate Loans . A significant portion of the Company’s lending activity consists of the origination of mortgage loans collateralized by properties located in the Company’s market areas. The Company’s banks offer a variety of residential mortgage loan products that generally are amortized over five to twenty-five years. Residential loans collateralized by mortgage real estate generally have been originated in amounts of no more than 90% of the lower of cost or appraised value or the bank requires private mortgage insurance. Of the residential mortgage real estate loans originated, the Company generally retains on its books shorter-term loans with fixed or variable rates, and sells into the secondary mortgage market longer-term, fixed-rate loans to either Fannie Mae or a regional Federal Home Loan Bank, and retains the loan servicing rights.

The Company’s banks offer a variety of commercial real estate mortgage loan products that generally are amortized up to twenty years. The rates on these loans usually range from a daily variable rate to a fixed rate for no more than five years. The commercial real estate mortgage loans are collateralized by owner/operator real estate mortgages, as well as investment real estate mortgages. Loans collateralized by commercial real estate mortgages are generally originated in amounts of no more than 80% of the lower of cost or appraised value.

The banks secure a valid lien on mortgage real estate loans and obtain a mortgage title insurance policy that insures that the property is free of encumbrances prior to the bank’s lien. The banks require hazard insurance in the amount of the loan and, if the property is in a flood plain as designated by FEMA or HUD, the banks require flood insurance.

Consumer Loans . The Company provides a wide variety of consumer loans (also referred to in this report as installment loans to individuals) including motor vehicle, watercraft, education, personal (collateralized and non-collateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 72 months and vary based upon the nature of collateral and size of loan. Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws may limit the amount that can be recovered on such loans.

At March 31, 2011 and December 31, 2010, the Company held a concentration in commercial real estate loans amounting to $235,754,000 and $260,847,000, respectively.

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of and for the three-month periods ended March 31, 2011 and 2010:


	March 31, 2011

	Commercial & Financial			Agricultural			Real Estate- Farmland			Real Estate- Construction		Real Estate- Commercial		Real Estate- Residential			Installment Loans to Individuals			Total
	(dollars in thousands)
Allowance for loan losses:
Balance, beginning of year	$	4,540		$	44		$	73		$	12,288	$	4,625	$	5,126		$	1,503		$	28,199
Provision (Credit) charged to expense		(99	)		(10	)		(7	)		300		32		(930	)		(249	)		(963	)
Losses charged off		1,298			4			-			1,559		89		218			94			3,262
Recoveries		13			4			-			2		77		45			27			168
Balance, end of period	$	3,156		$	34		$	66		$	11,031	$	4,645	$	4,023		$	1,187		$	24,142

Ending balance:
Individually evaluated for impairment	$	1,180		$	-		$	-		$	6,541	$	2,106	$	1,091		$	766		$	11,684
Ending balance:
Collectively evaluated for impairment	$	1,976		$	34		$	66		$	4,490	$	2,539	$	2,932		$	421		$	12,458

Loans:
Ending balance	$	132,595		$	9,612		$	14,884		$	78,892	$	141,978	$	188,469		$	55,790		$	622,220
Ending balance:
Individually evaluated for impairment	$	2,752		$	230		$	-		$	43,580	$	24,852	$	5,048		$	2,263		$	78,725
Ending balance:
Collectively evaluated for impairment	$	129,843		$	9,382		$	14,884		$	35,312	$	117,126	$	183,421		$	53,527		$	543,495


	December 31, 2010

	Commercial & Financial		Agricultural			Real Estate- Farmland			Real Estate- Construction		Real Estate- Commercial		Real Estate- Residential		Installment Loans to Individuals		Total
	(dollars in thousands)
Allowance for loan losses:
Balance, beginning of year	$	3,023	$	200		$	300		$	5,840	$	2,974	$	4,956	$	1,558	$	18,851
Provision (Credit) charged to expense		8,845		(157	)		(188	)		19,452		3,003		3,359		653		34,967
Losses charged off		7,411		18			39			13,057		1,355		3,247		788		25,915
Recoveries		83		19			-			53		3		58		80		296
Balance, end of period	$	4,540	$	44		$	73		$	12,288	$	4,625	$	5,126	$	1,503	$	28,199

Ending balance:
Individually evaluated for impairment	$	2,497	$	-		$	-		$	8,509	$	2,207	$	1,346	$	804	$	15,363
Ending balance:
Collectively evaluated for impairment	$	2,043	$	44		$	73		$	3,779	$	2,418	$	3,780	$	699	$	12,836

Loans:
Ending balance	$	146,463	$	11,708		$	15,528		$	91,553	$	153,767	$	189,479	$	60,177	$	668,675
Ending balance:
Individually evaluated for impairment	$	4,726	$	-		$	-		$	52,375	$	24,279	$	6,004	$	2,348	$	89,732
Ending balance:
Collectively evaluated for impairment	$	141,737	$	11,708		$	15,528		$	39,178	$	129,488	$	183,475	$	57,829	$	578,943

Management’s opinion as to the ultimate collectability of loans is subject to estimates regarding future cash flows from operations and the value of property, real and personal, pledged as collateral. These estimates are affected by changing economic conditions and the economic prospects of borrowers.

For the three months ended March 31, 2011, provision for loan loss expense was negative $963 thousand, compared with expense of $4.0 million for the same period in 2010. The negative provision in the first quarter of 2011 resulted from the Company’s analysis of the adequacy of its ALL as of March 31, 2011. That analysis reflected, prior to recording the negative provision, an excess balance in the ALL, primarily due to the reduction in total loans, stabilization of non-performing loan balances and receipt of an updated appraisal in April 2011 to support a substantial reduction of a specific reserve on a commercial real estate loan that was added in the fourth quarter of 2010.

Allowance for Loan Losses . In originating loans, the Company recognizes that loan losses will be experienced and the risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for such loan. Management has established an allowance for loan losses (“ALL”), which it believes is adequate to cover probable losses inherent in the loan portfolio. Loans are charged off against the ALL when the loans are deemed to be uncollectible. Although the Company believes the ALL is adequate to cover probable losses inherent in the loan portfolio, the amount of the ALL is based upon the judgment of management, and future adjustments may be necessary if economic or other conditions differ from the assumptions used by management in making the determinations. In addition, the Company’s subsidiary banks periodically undergo regulatory examinations, and future adjustments to the ALL could occur based on these examinations.

Based on an evaluation of the loan portfolio, management presents a quarterly review of the ALL to the board of directors, indicating any change in the ALL since the last review and any recommendations as to adjustments in the ALL. In making its evaluation, management considers the diversification by industry of the commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security, and the present level of the ALL.

A model is utilized to determine the specific and general portions of the ALL. Through the loan review process, management assigns a risk weighting to each loan, according to payment history, collateral values and financial condition of the borrower. The loan grades aid management in monitoring the overall quality of the loan portfolio. Specific reserves are allocated for loans in which management has determined that deterioration has occurred. In addition, a general allocation is made for each loan category in an amount determined based on general economic conditions, historical loan loss experience, and amount of past due loans. Management maintains the ALL based on the amounts determined using the procedures set forth above.

Activity in the ALL for the three months ended March 31, 2010 was as follows:

Balance, beginning of year	$	18.851
Provision charged to expense		3,990
Losses charged off, net of recoveries of $78		3,924
Balance, end of period	$	18,917

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on all loans at origination. In addition, lending relationships over $500,000, new commercial and commercial real estate loans, and watch list credits are reviewed at least annually by the management in order to verify risk ratings. The Company uses the following definitions for risk ratings:

Pass – Loans classified as pass are well protected by the ability of the borrower to pay or by the value of the asset or underlying collateral.

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the bank’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss – Loans classified as loss are the portion of the loan that is considered uncollectible so that its continuance as an asset is not warranted. The amount of the loss determined will be charged-off.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of March 31, 2011 and December 31, 2010:


	Commercial & Agricultural				Commercial Real Estate				Residential Real Estate
Rating:	March 31, 2011		December 31, 2010		March 31, 2011		December 31, 2010			March 31, 2011		December 31, 2010

Pass	$	119,600	$	133,363	$	149,393	$	167,302		$	170,584	$	171,904
Special Mention		16,429		15,076		17,698		17,523			3,898		3,988
Substandard		1,399		2,130		66,893		74,252			5,048		6,074
Doubtful		1,353		2,712		1,770		1,770			—		—
Total	$	138,781	$	153,281	$	235,754	$	260,847		$	179,530	$	181,966


	Consumer				Loans Held for Sale				Floor Plan Loans
Rating:	March 31, 2011		December 31, 2010		March 31, 2011		December 31, 2010			March 31, 2011		December 31, 2010

Pass	$	53,465	$	57,760	$	8,527	$	7,513		$	3,426	$	4,891
Special Mention		62		70		—		—			—		—
Substandard		2,263		2,345		—		—			—		—
Doubtful		—		2		—		—			—		—
Total	$	55,790	$	60,177	$	8,527	$	7,513		$	3,426	$	4,891

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at the earlier date if collection of principal and interest is considered doubtful.

All interest accrued but not collected for loans that are placed on non-accrual or charged-off are reversed against interest income. After collection of the full principal balance on these loans, interest 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 principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present the Company’s loan portfolio aging analysis as of March 31, 2011 and December 31, 2010:


	March 31, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days & Accruing

Commercial and financial	$	517	$	167	$	1,116	$	1,800	$	130,795	$	132,595	$	-
Agricultural		67		-		-		67		9,545		9,612		-
Real estate - farmland		134		-		409		543		14,341		14,884		-
Real estate - construction		4,532		-		20,986		25,518		53,374		78,892		-
Real estate - commercial		6,183		2,133		9,208		17,524		124,454		141,978		-
Real estate - residential		1,301		2,018		2,298		5,617		182,852		188,469		51
Installment loans to individuals		394		42		23		459		55,331		55,790		13
Total	$	13,128	$	4,360	$	34,040	$	51,528	$	570,692	$	622,220	$	64

	December 31, 2010
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days & Accruing
Commercial and financial	$	112	$	243	$	2,284	$	2,639	$	143,824	$	146,463	$	—
Agricultural		—		—		2		2		11,706		11,708		2
Real estate - farmland		357		—		—		357		15,171		15,528		—
Real estate - construction		2,606		5,480		21,816		29,902		61,651		91,553		—
Real estate - commercial		1,878		1,779		9,133		12,790		140,977		153,767		—
Real estate - residential		1,632		2,496		3,347		7,475		182,004		189,479		262
Installment loans to individuals		220		150		43		413		59,764		60,177		27
Total	$	6,805	$	10,148	$	36,625	$	53,578	$	615,097	$	668,675	$	291

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when, based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loans and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan-by-loan basis by either the present value of the expected future cash flows, the loan’s observable market value, or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. Significant restructured loans are considered impaired in determining the adequacy of the allowance for loan losses.

The Company actively seeks to reduce its investment in impaired loans. The primary tools to work through impaired loans are settlement with the borrowers or guarantors, foreclosure of the underlying collateral, or restructuring.

The Company will restructure loans when the borrower demonstrates the inability to comply with the terms of the loan, but can demonstrate the ability to meet acceptable restructured terms. Restructurings generally include one or more of the following restructuring options; reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection. Restructured loans in compliance with modified terms are classified as impaired.

At March 31, 2011 the Company had approximately $6.4 million in troubled debt restructurings that were classified as impaired including $2.3 million in construction real estate loans, $183 thousand in residential real estate loans, $3.4 million in commercial real estate loans, and $419 in commercial loans. In addition to these amounts, the Company had troubled debt restructurings totaling approximately $6.9 million, also classified as impaired, that were performing in accordance with their modified terms including $3.4 million in construction real estate loans, $539 thousand in residential real estate loans, and $2.9 million in commercial real estate loans.

The following tables present impaired loans as of March 31, 2011 and December 31, 2010:


	March 31, 2011
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance:

Commercial and agriculture	$	377	$	377	$	—	$	682	$	15
Commercial real estate		24,873		24,873		—		26,857		148
Residential real estate		2,118		2,118		—		2,932		11
Consumer		—		—		—		—		—

Loans with a specific valuation allowance:

Commercial and agriculture		2,376		2,376		1,180		3,057		40
Commercial real estate		43,788		43,790		8,647		44,802		246
Residential real estate		2,930		2,929		1,091		3,594		29
Consumer		2,263		2,263		766		2,305		14

Total:

Commercial	$	71,414	$	71,416	$	9,827	$	75,398	$	449
Residential	$	5,048	$	5,047	$	1,091	$	6,526	$	40
Consumer	$	2,263	$	2,263	$	766	$	2,305	$	14

	December 31, 2010
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance:

Commercial and agriculture	$	987	$	987	$	—	$	2,283	$	177
Commercial real estate		25,984		25,984		—		46,808		1,489
Residential real estate		1,626		1,626		—		4,784		41
Consumer		—		—		—		—		—

Loans with a specific valuation allowance:

Commercial and agriculture		3,739		3,739		2,497		2,927		171
Commercial real estate		50,670		50,670		10,716		37,726		1,402
Residential real estate		4,378		4,378		1,346		4,293		63
Consumer		2,348		2,348		804		1,930		104

Total:

Commercial	$	81,380	$	81,380	$	13,213	$	89,744	$	3,239
Residential	$	6,004	$	6,004	$	1,346	$	9,077	$	104
Consumer	$	2,348	$	2,348	$	804	$	1,930	$	104

Interest income recognized on impaired loans includes interest accrued and collected on the outstanding balances of accruing impaired loans as well as interest cash collections on non-accruing impaired loans for which the ultimate collectability of principal is not uncertain.

The following table presents the Company’s nonaccrual loans at March 31, 2011 and December 31, 2010:

	March 31,		December 31,
	2011		2010

Commercial and financial	$	1,623	$	2,579
Agricultural		—		—
Real estate - farmland		540		134
Real estate - construction		25,518		29,892
Real estate - commercial		12,870		9,134
Real estate - residential		2,613		4,041
Installment loans to individuals		228		216
Total	$	43,392	$	45,996

For the three month period ended March 31, 2011 and year ended December 31, 2010, the Company recognized interest income on impaired loans of $503,000 and $3,447,000, respectively. On a cash basis, the Company recognized interest income on impaired loans of $565,000 and $4,475,000 for the three month period ended March 31, 2011 and year ended December 31, 2010, respectively.

8. CAPITAL AND OPERATING MATTERS

Stockholders’ deficit at March 31, 2011 was $(5,316,000) compared to $(6,035,000) as of December 31, 2010, an increase of $719,000 or 11.9%. The increase was due to the net income recorded during the three months ended March 31, 2011.

The Company and Bank’s actual capital amounts and ratios at March 31, 2011 and December 31, 2010 are presented in the following tables:

	Actual						Minimum for Capital Adequacy Purposes					Minimum Capital Requirement per Formal Agreement
	Amount			Ratio			Amount		Ratio			Amount		Ratio
As of March 31, 2011
Total capital (to risk-weighted assets)
Consolidated		(4,732	)		(0.7	)%		52,089		8.0	%		N/A		N/A
Mercantile Bank		51,554			10.9	%		37,775		8.0	%		56,663		12.0	%
Heartland Bank		7,464			7.3	%		8,158		8.0	%		13,256		13.0	%
Royal Palm Bank of Florida		3,864			5.2	%		6,005		8.0	%		9,007		12.0	%

Tier 1 capital (to risk-weighted assets)
Consolidated		(4,732	)		(0.7	)%		26,045		4.0	%		N/A		N/A
Mercantile Bank		45,502			9.6	%		18,888		4.0	%		N/A		N/A
Heartland Bank		5,360			5.3	%		4,079		4.0	%		N/A		N/A
Royal Palm Bank of Florida		2,841			3.8	%		3,002		4.0	%		7,506		10.0	%

Tier 1 capital (to average assets)
Consolidated		(4,732	)		(0.5	)%		36,059		4.0	%		N/A		N/A
Mercantile Bank		45,502			6.8	%		26,689		4.0	%		53,378		8.0	%
Heartland Bank		5,360			4.2	%		5,156		4.0	%		11,602		9.0	%
Royal Palm Bank of Florida		2,841			2.5	%		4,589		4.0	%		9,179		8.0	%

	Actual						Minimum for Capital Adequacy Purposes					Minimum Capital Requirement per Formal Agreement
	Amount			Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2010
Total capital (to risk-weighted assets)
Consolidated		(7,021	)		(1.0	)%		55,900		8.00	%		N/A		N/A
Mercantile Bank		50,215			9.9	%		40,783		8.00	%		61,175		12.00	%
Heartland Bank		8,198			7.7	%		8,507		8.00	%		12,760		13.00	%
Royal Palm Bank of Florida		2,332			3.0	%		6,409		8.00	%		9,614		12.00	%

Tier 1 capital (to risk-weighted assets)
Consolidated		(7,021	)		(1.0	)%		27,950		4.00	%		N/A		N/A
Mercantile Bank		43,701			8.6	%		20,392		4.00	%		N/A		N/A
Heartland Bank		6,024			5.7	%		4,253		4.00	%		N/A		N/A
Royal Palm Bank of Florida		1,237			1.6	%		3,205		4.00	%		8,012		10.00	%

Tier 1 capital (to average assets)
Consolidated		(7,021	)		(0.7	)%		38,894		4.00	%		N/A		N/A
Mercantile Bank		43,701			6.2	%		28,027		4.00	%		56,055		8.00	%
Heartland Bank		6,024			4.1	%		5,847		4.00	%		11,693		9.00	%
Royal Palm Bank of Florida		1,237			1.0	%		4,954		4.00	%		9,908		8.00	%

The capital ratios disclosed in the middle column of the table above are minimum requirements. The Company has entered into a Written Agreement with the Federal Reserve Bank and the Banks have each entered into Consent Orders with the FDIC and their respective state banking agencies. Mercantile Bank’s Consent Order was effective in March 2011, while Royal Palm Bank and Heartland Bank were already operating under their Consent Orders, and the Company under its Written Agreement as of December 31, 2010. These formal enforcement actions convey specific actions needed to address certain findings from their regulatory examinations and to address each entity’s condition. For further discussion, see the “Regulatory Matters” section in Part I, Item 2 of this filing.

Applicable federal prompt corrective action regulations for banks provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Based on regulatory capital ratios, as of March 31, 2011, Mercantile Bank is well-capitalized, Royal Palm Bank is significantly undercapitalized, and Heartland Bank is undercapitalized. Undercapitalized institutions are subject to close monitoring by their federal bank regulator, restrictions on asset growth and expansion, and other significantly greater regulatory restrictions than apply to well-capitalized or adequately capitalized institutions.

The Company estimates the need to raise approximately $20 million to return each of the Banks to compliance with its Consent Order. Given the current economic environment, there can be no assurance the Company will be able to raise the estimated capital needed.

Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, action by the regulators that, if undertaken, could have a direct material effect on the Company’s financial statements and raise substantial doubt about the Company’s ability to continue as a going concern.

9. FAIR VALUE MEASUREMENT

ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

In accordance with ASC 820, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1

Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2

Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Recurring Basis

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet.

Available-for-sale securities - The fair values of available-for-sale securities are determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1. Level 1 securities include exchange-traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models or quoted prices of securities with similar characteristics. For these investments, the inputs used by the pricing service to determine fair value may include one or a combination of observable inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, bench mark securities, bids, offers and reference data market research publications and are classified within Level 2 of the valuation hierarchy. Level 2 securities include obligations of U.S. government corporations and agencies, obligations of states and political subdivisions, mortgage-backed securities, collateralized mortgage obligations and corporate bonds. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include local state and political subdivisions, debentures, and other illiquid equity securities.

The following table presents the Company’s assets that are measured at fair value on a recurring basis and the level within the ASC 820 hierarchy in which their fair value measurements fall as of March 31, 2011 and December 31, 2010 (in thousands):

			Fair Value Measurements Using
March 31, 2011	Fair Value		Quotes Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

U.S. Government agencies	$	3,524	$	—	$	3,524	$	—
Mortgage-backed securities: GSE residential		74,266		—		74,266		—
State and political subdivisions		32,787		—		32,787		—
Equity securities – common stock in other financial institutions		781		683		—		98

	$	111,358	$	683	$	110,577	$	98

			Fair Value Measurements Using
December 31, 2010	Fair Value		Quotes Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

U.S. Government agencies	$	3,727	$	—	$	3,727	$	—
Mortgage-backed securities: GSE residential		66,948		—		66,948		—
State and political subdivisions		33,962		—		33,962		—
Equity securities - common stock in other financial institutions		2,613		2,516		—		97

	$	107,250	$	2,516	$	104,637	$	97

Management values Level 3 securities based on exit prices for which management believes it could receive if they were to sell these securities. This value approximates costs for a majority of these investments. There were no changes in valuation techniques for the Level 3 securities during the period. The change in fair value of assets measured using significant unobservable (Level 3) inputs on a recurring basis for the three months ended March 31, 2011 and 2010 is summarized as follows (in thousands):

	For the Three Months Ended March 31
	2011		2010

Beginning balance	$	97	$	135
Total realized and unrealized gains and losses:
Included in net income		—		—
Included in other comprehensive income		—		—
Purchases		1		—
Settlements		—		(38	)
Transfers in and/or out of Level 3		—		—

Balance, March 31	$	98	$	97

Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	—	$	—

Nonrecurring Basis

Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired loans (Collateral Dependent) - Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy. Fair value adjustments on impaired loans were $5.4 million at March 31, 2011 compared to $15.3 million at December 31, 2010, and $2.9 million at March 31, 2010.

Foreclosed Assets Held for Sale – Other real estate consists of properties obtained through foreclosure or in satisfaction of loans. These properties are reported at the lower of cost or fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for selling costs. At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is recorded as a charge against the allowance for loan losses. Gains or losses on sale and any subsequent adjustments to the value are recorded as a component of the income statement. Fair value adjustments on foreclosed assets held for sale were $141 thousand at March 31, 2011 compared to $6.7 million at December 31, 2010, and $260 thousand at March 31, 2010.

Mortgage Servicing Rights – Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

Cost Method Investments – Cost method investments do not trade in an active, open market with readily observable prices. The cost method investments are periodically reviewed for impairment based on each investee’s earnings performance, asset quality, changes in the economic environment, and current and projected future cash flows. Due to the nature of the valuation inputs, cost method investments are classified within Level 3 of the hierarchy.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis during the period and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall at March 31, 2011 and December 31, 2010:

			Fair Value Measurements Using
Carrying value at March 31, 2011	Fair Value		Quotes Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	15,732	$	—	$	—	$	15,732
Foreclosed assets held for sale		613		—		—		613
Cost method investments		202		—		—		202

			Fair Value Measurements Using
Carrying value at December 31, 2010	Fair Value		Quotes Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	48,611	$	—	$	—	$	48,611
Foreclosed assets held for sale		12,860		—		—		12,860
Mortgage servicing rights		784		—		—		784

ASC 825, formerly Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments”, and FSP FAS 107-1, requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in ASC 825. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Company’s general practice and intent to hold its financial instruments to maturity and to not engage in trading or sales activities except for loans held-for-sale and available-for-sale securities. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Company for the purposes of this disclosure.

Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instruments. For those loans and deposits with floating interest rates, it is presumed that estimated fair values generally approximate the recorded book balances.

The estimation methodologies used, the estimated fair values, and the recorded book balances at March 31, 2011 and December 31, 2010, were as follows:

	March 31, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	112,723	$	112,725	$	97,548	$	97,548
Available-for-sale securities		113,358		113,358		104,963		107,250
Held-to-maturity securities		998		1,028		1,208		1,246
Loans held for sale		8,527		8,527		7,513		7,513
Loans, net of allowance for loan losses		589,551		605,299		632,963		657,110
Federal Home Loan Bank stock		2,886		2,886		2,885		2,885
Cost method investments in common stock		1,190		1,190		1,392		1,392
Interest receivable		3,060		3,060		3,327		3,328

Financial liabilities
Deposits		817,811		813,377		833,214		827,922
Short-term borrowings		10,135		10,135		13,660		13,660
Long-term debt and junior subordinated debentures		68,858		38,377		76,858		46,449
Interest payable		7,706		7,706		6,986		6,986

Unrecognized financial instruments (net of contract amount)
Commitments to originate loans		—		—		—		—
Letters of credit		—		—		—		—
Lines of credit		—		—		—		—

The following methods and assumptions were used to estimate the fair value of each class of financial instruments.

Cash and Cash Equivalents, Federal Home Loan Bank Stock, Interest Receivable, and Cost Method Investments in Common Stock - The carrying amount approximates fair value.

Held-to-Maturity Securities - Fair values equal quoted market prices if available. If quoted market prices are not available, fair value is estimated based on quoted market prices of similar securities.

Loans Held for Sale - For homogeneous categories of loans, such as mortgage loans held for sale, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.

Loans - The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans with similar characteristics were aggregated for purposes of the calculations. The carrying amount of accrued interest approximates its fair value.

Deposits - For demand deposits, savings accounts, NOW accounts, and money market deposits, the carrying amount approximates fair value. The fair value of fixed-maturity time and brokered time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Short-Term Borrowings and Interest Payable - The carrying amount approximates fair value.

Long-Term Debt and Junior Subordinated Debentures - Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

Commitments to Originate Loans, Letters of Credit, and Lines of Credit - The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of forward sale commitments is estimated based on current market prices for loans of similar terms and credit quality. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.

The Company’s remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting.

Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include the Company’s fiduciary services department, brokerage operations, deferred taxes, and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Management believes that reasonable comparability between financial institutions may not be likely, due to the wide range of permitted valuation techniques and numerous estimates that must be made, given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

10. INCOME TAXES

A reconciliation of income tax expense (benefit) on continuing operations at the statutory rate to the Company’s actual income tax expense (benefit) is shown below:

	Three Months Ended March 31, 2011			Twelve Months Ended December 31, 2010

Computed at the statutory rate (35%)	$	47		$	(14,924	)
Increase (decrease) resulting from
Graduated tax rates		(1	)		426
Tax exempt income		(140	)		(620	)
State income taxes		(198	)		(2,190	)
Increase in cash surrender value of life insurance		(47	)		(193	)
Changes in the deferred tax asset valuation allowance		386			29,767
Other		(45	)		(19	)

Actual tax expense	$	2		$	12,247

The tax effects of temporary differences related to deferred taxes shown on the balance sheets were:

	March 31, 2011			December 31, 2010
Deferred tax assets
Allowance for loan losses	$	9,009		$	9,708
Accrued compensated absences		129			135
Deferred compensation		824			801
Accrued postretirement benefits		138			132
Deferred loss on investments		2,416			2,304
Capital loss carryforward on disposal of HNB		3,036			3,465
Net operating loss carryforward		17,775			16,617
Deferred loan fees		52			48
Alternative minimum tax credits		1,074			1,074
Other		3,367			3,475

		37,820			37,759

Deferred tax liabilities
Federal Home Loan Bank stock dividends		255			251
Depreciation		496			510
State taxes		1,031			1,031
Mortgage servicing rights		301			302
Unrealized gains on available-for-sale securities		661			822
Purchase accounting adjustments		91			89
Other		166			165

		3,001			3,170

Net deferred tax asset before valuation allowance	$	34,819		$	34,589

Valuation allowance
Beginning balance	$	(34,589	)	$	(5,590	)
Increase during the period		(386	)		(29,767	)
Decrease during the period resulting from the elimination to discontinuing operations		316			-
(Increase) decrease during the period		(160	)		768

Ending balance		(34,819	)		(34,589	)

Net deferred tax asset	$ __-			$	-

As of March 31, 2011, the Company had $42.5 million of net operating loss carryforwards relating to Mid-America Bancorp, Inc. The carryforwards expire in 15-20 years. The Company has recognized a valuation allowance on a portion of the operating losses that have been determined not to be utilizable based on management’s analysis.

As of March 31, 2011, the Company had $1.1 million of alternative minimum tax credits available to offset future federal income taxes. The credits have no expiration date.

11. DISCONTINUED OPERATIONS

The Company completed the sale of Marine Bank & Trust (“Marine Bank”) and Brown County State Bank (“Brown County”) to United Community Bancorp, Inc. (“United”), of Chatham, Illinois for approximately $25.8 million on February 26, 2010.The transaction originally resulted in a pre-tax gain of approximately $4,500,000. However, at the time of the sale, the Company entered into a letter agreement with United whereby the Company would be entitled to a portion of principal payments on two specified loan participations received by United subsequent to the sale. As of March 31, 2011, the Company has received approximately $803,000 in accordance with the letter agreement, increasing the pre-tax gain to approximately $5,303,000. Certain adjustments were recorded relating to the sale resulting in a gain of $818,000 during the three month period ended March 31, 2011.

The following table summarizes the estimated fair values of the assets and liabilities at the date the Company sold Marine Bank and Brown County:

Cash and cash equivalents	$	4,343
Available-for-sale securities		39,306
Held-to-maturity securities		1,027
Loans, net of allowance for loan losses of $1,183		206,872
Interest receivable		2,300
Federal Home Loan Bank stock		1,574
Premises and equipment		3,698
Other assets		19,465

Total assets disposed		278,585

Deposits		232,330
Long-term debt		13,500
Interest payable		559
Other liabilities		10,469

Total liabilities released		256,858

Net assets disposed	$	21,727

The following table summarizes the income and expenses of the discontinued operations for the periods ended March 31, 2011 and 2010 including Marine Bank and Brown County:

	Three Months Ended March 31,
	2011		2010

Interest and dividend income	$	-	$	2,206
Interest expense		-		572
Net interest margin		-		1,634

Provision for loan loss		-		48
Noninterest income		821		4,522
Noninterest expense		-		866

Net income before taxes		821		5,242

Income tax expense		-		2,045

Net income	$	821	$	3,197

12. OFF BALANCE SHEET CREDIT COMMITMENTS

In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States of America, are not included in its consolidated balance sheets. These transactions are referred to as “off balance-sheet commitments.” The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheet. The Company minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Company’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for loan losses. Commitments to originate loans totaled $5.3 million at March 31, 2011 and $13.7 million at December 31, 2010. The commitments extend over varying periods of time with the majority being disbursed within a one-year period. At March 31, 2011 and December 31, 2010, the Company had granted unused lines of credit to borrowers totaling $86.1 million and $76.8 million, respectively, for commercial lines and open-end consumer lines.

Standby letters of credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that standby letters of credit arrangements contain collateral and debt covenants similar to those contained in loan agreements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Company would be entitled to seek recovery from the customer. Standby letters of credit totaled $7.4 million at March 31, 2011 and $7.6 million at December 31, 2010. At March 31, 2011, the outstanding standby letters of credit had a weighted average term of approximately one year. As of March 31, 2011 and December 31, 2010, no liability for the fair value of the Company’s potential obligations under these guarantees has been recorded since the amount is deemed immaterial.

13. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) components and related taxes were as follows:

	For the Three Months Ended March 31,
	2011			2010

Net income	$	954		$	51

Other comprehensive income (loss):
Unrealized appreciation (depreciation) on available-for-sale securities:
Unrealized appreciation (depreciation) on available-for- sale securities, net of tax expense (benefit) of $(73) for 2011 and $206 for 2010		(113	)		303
Less reclassification adjustment for the sale of Marine Bank & Trust and Brown County State Bank		818			—
Less reclassification adjustment for realized gains included in income net of tax expense of $164 for 2011		268			—
Less reclassification adjustment for other than temporary losses included in income net of tax benefit of $(77) for 2011		(125	)		—
Total unrealized appreciation (depreciation) on available-for- sale securities, net of tax expense (benefit) of $(160) for 2011 and $206 for 2010		(1,074	)		303
Plus valuation allowance on deferred tax liability on available-for-sale securities		(160	)		—

Total other comprehensive income (loss), net of tax		(1,234	)		303

Comprehensive income (loss)		(280	)		354

Comprehensive income (loss) attributable to the noncontrolling interest		(301	)		(933	)

Comprehensive income attributable to Mercantile Bancorp, Inc.	$	21		$	1,287

14. GOING CONCERN CONSIDERATIONS

As a result of the effects of the economic downturn and the record losses generated by the Company, the capital of the Company and the Banks has been significantly depleted. The Banks and Company have experienced significant increases in non-performing assets, impaired loans and loan loss provisions, resulting in the imposition of Consent Orders at each of the Banks and a Written Agreement at the Company. For further discussion of these regulatory enforcement actions, see Part 1, Item 2 of this filing under the heading “Regulatory Matters.” Management is currently attempting to raise additional capital that will provide the Company with the necessary liquidity to return the Banks to compliance with regulatory capital requirements of the Consent Orders. The Company’s ability to raise capital is contingent on the current capital markets and the Company’s financial performance. Available capital markets are not currently favorable and the Company cannot be certain of its ability to raise capital on any terms.

The losses reported by the Company during the recent three years were primarily due to large provisions for loan losses, other-than-temporary impairment losses on available-for-sale and cost method investments, goodwill impairment charges and the establishment of a valuation allowance against the Company’s deferred tax asset. Prior to sustaining these losses in 2010, 2009 and 2008, the Company had a history of profitable operations. The return to profitable operations is contingent on the overall economic recovery and the stability of collateral values of the real estate that secures many of the Company’s loans.

While the Company believes that it may be able to raise sufficient capital to meet its capital requirements and manage loan losses in the near term until such time that the overall economy improves without having to liquidate assets, the realization of assets in other-than-normal course of business in order to provide liquidity could result in additional losses to be reflected in the Company’s financial statements.

15. SUBSEQUENT EVENTS

In addition to its equity interest in Mid-America Bancorp, Inc. (“Mid-America”), the Company also held convertible debentures issued by Mid-America totaling $11,925,000 as of March 31, 2011. Included in the total of $11,925,000 was $1,000,000 of debentures previously held by several minority shareholders of Mid-America. In March 2011, the Company entered into agreements to purchase the debentures held by the minority shareholders in exchange for issuance of a total of 45,000 shares of the Company’s common stock, valued at approximately $45,000. The debentures paid interest at a rate of 5% per annum, had a maturity date of March 31, 2011 and were convertible at the holder’s option into common stock of Mid-America. Because these instruments represented inter-company transactions, they were eliminated on a consolidated basis and excluded from the Company’s financial statements. The purchase of the debenture at a discount was reflected as an increase in Mercantile Bancorp, Inc. stockholders’ deficit of approximately $1,000,000.

On April 4, 2011, the Company exercised its option to convert all of the debentures into additional shares of Mid-America common stock, thereby increasing its equity ownership of Mid-America to 91.5%. Pursuant to the State of Kansas Corporation Code, a corporation owning at least 90% of the outstanding shares of each class of stock of a subsidiary may merge such subsidiary into itself. On February 25, 2011, the Company’s board of directors had approved the merger of Mid-America into the Company and directed the Company’s officers to file the required Certificate of Ownership and Merger with the Kansas Secretary of State as soon as practicable. The Company’s board of directors had further authorized the payment of a total of $5,000 for the surrender and cancellation of all shares of Mid-America common stock not owned by the Company, on a pro rata basis to the holders of such shares. On April 5, 2011, the Company completed the merger of Mid-America into the Company, Mid-America was dissolved and Heartland Bank became a wholly-owned subsidiary of the Company.

As a result of the merger of Mid-America into the Company, total Mercantile Bancorp, Inc. stockholders’ equity decreased by approximately $2,800,000, representing the acquisition of the minority shareholders’ interest in the negative equity capital of Mid-America that was reported as Noncontrolling interest on the Company’s balance sheet prior to the merger. Beginning April 5, 2011, the Company’s consolidated statements of operations will include 100% of the net income or loss of Heartland Bank.

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

Special Cautionary Notice Regarding Forward-looking Statements

Statements and financial discussion and analysis contained in the Form 10-Q that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of invoking these safe harbor provisions. These forward-looking statements include information about possible or assumed future results of the Company’s operations or performance. Use of the words “believe,” “expect”, “anticipate”, “estimate”, “continue”, “intend”, “may”, “will”, “should”, or similar expressions, identifies these forward-looking statements. Examples of forward-looking statements include, but are not limited to, estimates or projections with respect to the Company’s future financial condition, results of operations or business, such as:

·	projections of revenues, income, earnings per share, capital expenditures, assets, liabilities, dividends, capital structure, or other financial items;

·	descriptions of plans or objectives of management for future operations, products, or services, including pending acquisition transactions;

·	forecasts of future economic performance; and

·	descriptions of assumptions underlying or relating to any of the foregoing.

Many possible factors or events could affect the future financial results and performance of the Company and could cause those financial results or performance to differ materially from those expressed in the forward-looking statement. These possible events or factors include, without limitation:

•

the effects of current and future business and economic conditions in the markets the Company serves change or are less favorable than it expected;

•

deposit attrition, operating costs, customer loss and business disruption are greater than the Company expected;

•

competitive factors including product and pricing pressures among financial services organizations may increase;

•

the effects of changes in interest rates on the level and composition of deposits, loan demand, the values of loan collateral, securities and interest sensitive assets and liabilities may lead to a reduction in the Company’s net interest margins;

•

changes in market rates and prices may adversely impact securities, loans, deposits, mortgage servicing rights, and other financial instruments;

•

the legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry, such as the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), and the extensive rule making it requires to be undertaken by various regulatory agencies may adversely affect the Company’s business, financial condition and results of operations;

•

personal or commercial bankruptcies increase;

•

the Company’s ability to expand and grow its business and operations, including the establishment of additional branches and acquisition of additional banks or branches of banks, may be more difficult or costly than the Company expected;

•

changes in accounting principles, policies or guidelines;

•

credit risks, including credit risks resulting from the devaluation of collateral debt obligations and/or structured investment vehicles on the capital markets to which the Company currently has no direct exposure;

•

the failure of assumptions underlying the Company’s deferred tax valuation assumptions;

•

the failure of assumptions underlying the establishment of the Company’s allowance for loan losses;

•

construction and development loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate, and cause the Company to be exposed to more losses on these projects than on other loans;

•

changes occur in the securities markets;

•

technology-related changes may be harder to make or more expensive than the Company anticipated;

•

worldwide political and social unrest, including acts of war and terrorism;

•

changes occur in monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board;

•

impairment of the goodwill and core deposit intangibles the Company has recorded with acquisitions and the resulting adverse impact on the Company’s profitability; and

•

the occurrence of any event, change or other circumstance that could result in the Company’s failure to develop and implement successfully capital raising and debt restructuring plans.

A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen the assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. Any forward-looking statements made or incorporated by reference in this report are made as of the date of this report, and, except as required by applicable law, the Company assumes no obligation to update such statements or to update the reasons why actual results could differ from those projected in such statements. You should consider these risks and uncertainties in evaluating forward-looking statements and you should not place undue reliance on these statements.

General

Mercantile Bancorp, Inc. is a three-bank holding company headquartered in Quincy, Illinois with 12 banking facilities (11 full service offices and 1 stand-alone drive-up facility) serving 9 communities located throughout west-central Illinois, central Indiana, western Missouri, eastern Kansas and southwestern Florida. The Company is focused on meeting the financial needs of its markets by offering competitive financial products, services and technologies. It is engaged in retail, commercial and agricultural banking, and its core products include loans, deposits, trust and investment management. The Company derives substantially all of its net income from its subsidiary banks.

Wholly-Owned Subsidiaries . As of March 31, 2011, the Company was the sole shareholder of the following banking subsidiaries:

·	Mercantile Bank (“Mercantile Bank”), located in Quincy, Illinois; and

·	Royal Palm Bancorp, Inc. (“Royal Palm”), the sole shareholder of Royal Palm Bank of Florida (“Royal Palm Bank”), located in Naples, Florida.

Majority-Owned Subsidiary . As of March 31, 2011, the Company was the majority, but not sole, shareholder of Mid-America Bancorp, Inc. (“Mid-America”), the sole shareholder of Heartland Bank (“Heartland”), located in Leawood, Kansas, in which the Company owns 55.5% (84,600 shares) of the outstanding voting stock. The Company’s percentage ownership of Mid-America was also 55.5% as of December 31, 2010.

In addition to its equity interest in Mid-America, the Company also held convertible debentures issued by Mid-America totaling $11.9 million as of March 31, 2011. Included in the total of $11,9 million was $1 million of debentures previously held by several minority shareholders of Mid-America. In March 2011, the Company entered into agreements to purchase the debentures held by the minority shareholders in exchange for issuance of a total of 45 thousand shares of the Company’s common stock, valued at approximately $45 thousand. The debentures paid interest at a rate of 5% per annum, had a maturity date of March 31, 2011 and were convertible at the holder’s option into common stock of Mid-America. Because these instruments represented inter-company transactions, they were eliminated on a consolidated basis and excluded from the Company’s financial statements.

On April 4, 2011, the Company exercised its option to convert the debentures into additional shares of Mid-America common stock, thereby increasing its equity ownership of Mid-America to 91.5%. Pursuant to the State of Kansas Corporation Code, a corporation owning at least 90% of the outstanding shares of each class of stock of a subsidiary may merge such subsidiary into itself. On February 25, 2011, the Company’s board of directors had approved the merger of Mid-America into the Company and directed the Company’s officers to file the required Certificate of Ownership and Merger with the Kansas Secretary of State as soon as practicable. The Company’s board of directors further authorized the payment of a total of $5,000 for the surrender and cancellation of all shares of Mid-America common stock not owned by the Company, on a pro rata basis to the holders of such shares. On April 5, 2011, the Company completed the merger of Mid-America into the Company, Mid-America was dissolved and Heartland became a wholly-owned subsidiary of the Company.

As a result of the merger of Mid-America into the Company, total Mercantile Bancorp, Inc. stockholders’ equity decreased by approximately $2.8 million, representing the acquisition of the minority shareholders’ interest in the negative equity capital of Mid-America that was reported as Noncontrolling interest on the Company’s balance sheet prior to the merger. Beginning April 5, 2011, the Company’s consolidated statements of operations will include 100% of the net income or loss of Heartland Bank.

Other Investments in Financial Institutions . As of March 31, 2011, the Company had less than majority ownership interests in several additional banking organizations located throughout the United States. Specifically, the Company owned the following percentages of the outstanding voting stock of these banking entities:

Cost Method Investments:

·	2.5% of Premier Community Bank of the Emerald Coast (“Premier Community”), located in Crestview, Florida;

·	4.9% of Brookhaven Bank (“Brookhaven”), located in Atlanta, Georgia;

Available-for-Sale Equity Investments:

·	3.7% of Paragon National Bank (“Paragon”), located in Memphis, Tennessee;

·	4.1% of Solera National Bancorp, Inc. (“Solera”), the sole shareholder of Solera National Bank, located in Lakewood, Colorado;

During the first quarter of 2011, the Company sold its remaining ownership interests in Enterprise Financial Services Corp. and Manhattan Bancorp, Inc., along with 14 thousand shares (of the Company’s total of 135 thousand shares) of Paragon for a total of approximately $2.1 million, recognizing gains on the sales of approximately $433 thousand. Subsequent to March 31, 2011, the Company sold its ownership interest in Solera, along with an additional 1 thousand shares of Paragon for a total of approximately $287 thousand, recognizing a net loss on the sales of approximately $93 thousand.

In June 2009, the Company elected to defer regularly scheduled interest payments on its outstanding junior subordinated debentures relating to its trust preferred securities. The terms of the junior subordinated debentures and the trust documents allow the Company to defer payments of interest for up to 20 consecutive quarterly periods without default or penalty. During the deferral period, the respective trusts will likewise suspend the declaration and payment of dividends on the trust preferred securities. Also during the deferral period, the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock nor make any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated debentures. As of March 31, 2011, the accumulated deferred interest payments totaled $6.6 million.

In November 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009. The FDIC is also scheduled to increase the normal assessment rates with the intent being to replenish the Deposit Insurance Fund to the statutory limit of 1.15% of insured deposits by December 31, 2013. The December 30, 2009 prepayment from continuing operations totaled approximately $3.9 million, and is being amortized based on the actual quarterly assessment invoices received from the FDIC. As of March 31, 2011, the prepaid FDIC assessment balance is approximately $1.9 million.

On March 14, 2011, Heartland Bank entered into an updated Consent Order with the FDIC and on March 31, 2011, Mercantile Bank entered into a new Consent Order with the FDIC and the Illinois Department of Financial and Professional Regulation, Division of Banking. For further discussion of the Company’s regulatory enforcement actions, see the “Regulatory Matters” section of this filing.

Results of Operations

Comparison of Operating Results for the Three Months Ended March 31, 2011 and 2010

Overview . Unless otherwise indicated, discussions below regarding income and expense for the three months ended March 31, 2011 and 2010 refer to the Company’s continuing operations. Net income for the three months ended March 31, 2011 from both continuing and discontinued operations was $1.3 million, an increase of $271 thousand compared with net income of $984 thousand for the same period in 2010. The primary factors contributing to the increase in net income were a decrease in provision for loan losses of $5.0 million, an increase in noninterest income of $267 thousand, and a decrease in noninterest expense of $149 thousand, primarily offset by a decrease in net interest income of $898 thousand, an increase in income tax expense of $1.2 million, a decrease in income from discontinued operations of $2.4 million, and a decrease in net loss attributable to noncontrolling interest of $632 thousand. Basic earnings (loss) per share (EPS) from continuing operations for the three months ended March 31, 2011 was $0.05 compared with $(0.25) for the same period in 2010.

Total assets at March 31, 2011 were $904.0 million compared with $929.2 million at December 31, 2010, a decrease of $25.2 million or 2.7%, primarily attributable to decreases in loans and other assets, partially offset by increases in cash and cash equivalents and foreclosed assets held for sale. Total loans, including loans held for sale, at March 31, 2011 were $622.2 million compared with $668.7 million at December 31, 2010, a decrease of $46.5 million or 6.9%. Total deposits at March 31, 2011 were $817.8 million compared with $833.2 million at December 31, 2010, a decrease of $15.4 million or 1.8%. Total Mercantile Bancorp, Inc. stockholders’ deficit at March 31, 2011 was $(2.4) million compared with a deficit of $(3.5) million at December 31, 2010, an increase to stockholders’ equity of $1.0 million or 29.5%.

The Company’s annualized return on average assets was 0.56% for the three months ended March 31, 2011, compared with 0.32% for the same period in 2010. The annualized return on average stockholders’ equity was (113.43)% for the three months ended March 31, 2011, compared to 9.22% for the same period in 2010.

Discontinued Operations . As a result of the sale of two of the Company’s wholly-owned subsidiaries, Marine Bank and Trust and Brown County State Bank, to United Community Bancshares, Inc. on February 26, 2010, the income and expenses of those two banks for the period January 1 through February 26, 2010 are included in “Income (loss) from discontinued operations” in the Company’s consolidated statements of operations.

Net Interest Income . For the three months ended March 31, 2011, net interest income decreased $898 thousand, or 14.6%, to $5.2 million compared with $6.1 million for the same period in 2010. The decrease was primarily due to decreased volumes and yields on loans and securities, partially offset by decreased volumes and rates of most categories of interest-bearing liabilities. For the three months ended March 31, 2011 and 2010, the net interest margin increased by 3 basis points to 2.49% from 2.46% while the net interest spread increased by 6 basis points to 2.36% from 2.30%, respectively.

Interest and dividend income for the three months ended March 31, 2011 decreased $2.1 million, or 17.9%, to $9.5 million compared with $11.5 million for the same period in 2010. This decrease was due primarily to a decrease in loan interest income of $1.8 million. Average total loans for the three months ended March 31, 2011 decreased $129.0 million, or 16.7%, to $643.8 million compared with $772.8 million for the same period in 2010, while the average yield on total loans decreased 5 basis points to 5.25% for the same period. Average total investments for the three months ended March 31, 2011 decreased $17.8 million, or 13.8%, to $110.8 million compared with $128.6 million for the same period in 2010, while the average yield on investments decreased 18 basis points to 3.49% for the same period. For the three months ended March 31, 2011, compared to the same period in 2010, the yield on total average earning assets decreased by 12 basis points to 4.50%.

Interest expense for the three months ended March 31, 2011 decreased $1.2 million, or 21.5%, to $4.2 million compared with $5.4 million for the same period in 2010. This decrease was due primarily to decreases in interest expense on deposits of $1.0 million and interest expense on short-term borrowings of $152 thousand. Average total interest-bearing deposits for the three months ended March 31, 2011 decreased $119.2 million, or 14.5%, to $704.1 million compared with $823.3 million for the same period in 2010, while the average cost of funds on total interest-bearing deposits decreased 23 basis points to 1.80% for the same period. The average cost of funds on all categories of deposits decreased in the three months ended March 31, 2011, compared to the same period in 2010, primarily due to the Company reducing deposit rates to align with competitors in an inelastic rate environment. Average total long-term debt for the three months ended March 31, 2011 decreased $3.6 million, or 4.61%, to $75.3 million compared with $78.9 million for the same period in 2010, primarily due to the paydowns of FHLB advances, while the average cost of funds on long-term debt increased 24 basis points to 5.37% for the same period. For the three months ended March 31, 2011, compared to the same period in 2010, the cost of funds on total average interest-bearing liabilities decreased by 10 basis points to 2.13%.

The following table sets forth for the periods indicated an analysis of net interest income by each major category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding and the interest earned or paid on such amounts. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities and the net interest margin on average total interest-earning assets for the same periods. All average balances are daily average balances and nonaccruing loans have been included in the table as loans carrying a zero yield.

	For the three months ended March 31
	2011								2010
	Average Balance			Income/ Expense		Yield/Rate			Average Balance			Income/ Expense		Yield/Rate
Assets	(dollars in thousands)
Interest-bearing demand deposits	$	72,821		$	32		0.18	%	$	78,271		$	78		0.40	%
Federal funds sold		10,684			5		0.19	%		13,695			8		0.23	%
Securities:
Taxable
U.S. treasuries and government agencies		3,567			21		2.35	%		-			-		0.00	%
Mortgage-backed securities: GSE residential		33,046			241		2.92	%		34,183			290		3.39	%
Other securities		50,641			499		3.94	%		65,639			680		4.14	%
Total taxable		87,254			761		3.49	%		99,822			970		3.89	%
Non-taxable — State and political subdivision (3)		23,518			204		3.47	%		28,755			210		2.92	%
Loans (net of unearned discount ) (1)(2)		643,819			8,448		5.25	%		772,837			10,238		5.30	%
Federal Home Loan Bank stock		2,885			3		0.42	%		2,900			4		0.55	%
Total interest-earning assets		840,981		$	9,453		4.50	%		996,280		$	11,508		4.62	%

Cash and due from banks		9,779								10,010
Interest receivable		3,366								3,797
Foreclosed assets held for sale, net		22,806								14,833
Cost method investments in common stock		1,325								1,392
Cash surrender value of life insurance		15,638								15,083
Premises and equipment		23,804								25,444
Other		10,878								22,867
Goodwill		-								-
Intangible assets		1,238								1,922
Allowance for loan loss		(27,803	)							(19,001	)
Discontinued operations, Assets held for sale		-								172,547

Total assets	$	902,012							$	1,245,174

Liabilities and Stockholders’ Equity
Interest-bearing transaction deposits	$	69,638		$	36		0.21	%	$	68,745		$	46		0.27	%
Savings deposits		45,645			23		0.20	%		48,104			45		0.37	%
Money-market deposits		102,085			131		0.51	%		133,485			201		0.60	%
Time and brokered time deposits		486,747			2,979		2.45	%		572,973			3,879		2.71	%
Short-term borrowings		10,773			35		1.30	%		25,426			187		2.94	%
Long term debt		13,428			132		3.93	%		17,063			220		5.16	%
Junior subordinated debentures		61,858			878		5.68	%		61,858			793		5.13	%

Total interest-bearing liabilities		790,174		$	4,214		2.13	%		927,654		$	5,371		2.32	%

Demand deposits		107,451								99,303
Interest payable		7,468								4,475
Other liabilities		4,147								4,728
Discontinued operations, Liabilities held for sale		-								162,217
Noncontrolling interest		(2,741	)							3,517
Stockholders’ equity		(4,487	)							43,280

Total liabilities and stockholders’ equity	$	902,012							$	1,245,174

Interest spread							2.36	%							2.30	%
Net interest income				$	5,239							$	6,137
Net interest margin							2.49	%							2.46	%
Interest-earning assets to interest-bearing liabilities		106.43	%							107.40	%
(1) Non-accrual loans have been included in average loans, net of unearned discount
(2) Includes loans held for sale
(3) The tax exempt income for state and political subdivisions is not recorded on a tax equivalent basis.

The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) attributable to changes in volume and changes in interest rates. For purposes of this table, changes attributable to both volume and rate have been allocated proportionately to the change due to volume and rate.

	For the three months ended March 31, 2011 vs. 2010
	Increase (Decrease) Due to Change in
	Volume			Rate			Total

Increase (decrease) in interest income:
Interest-bearing bank deposits	$	(5	)	$	(41	)	$	(46	)
Federal funds sold		(2	)		(1	)		(3	)
Investment securities:
U.S. Treasuries and Agencies		21			-			21
Mortgage-backed securities: GSE residential		(9	)		(40	)		(49	)
States and political subdivision (1)		(42	)		36			(6	)
Other securities		(149	)		(32	)		(181	)
Loans (net of unearned discounts)		(1,694	)		(96	)		(1,790	)
Federal Home Loan Bank stock		-			(1	)		(1	)
Change in interest income		(1,880	)		(175	)		(2,055	)
Increase (decrease) in interest expense:
Interest-bearing transaction deposits		1			(11	)		(10	)
Savings deposits		(2	)		(20	)		(22	)
Money-market deposits		(43	)		(27	)		(70	)
Time and brokered time deposits		(550	)		(350	)		(900	)
Short-term borrowings		(77	)		(75	)		(152	)
Long-term debt and junior subordinated debentures		(48	)		45			(3	)
Change in interest expense		(719	)		(438	)		(1,157	)

Increase (decrease) in net interest income	$	(1,161	)	$	263		$	(898	)

(1) The tax exempt income for state and political subdivisions is not recorded on a tax equivalent basis.

Provision for Loan Losses . Provisions for loan losses are charged against income to bring the Company’s allowance for loan losses (“ALL”) to a level deemed appropriate by management. For the three months ended March 31, 2011, the provision was a negative $963 thousand, compared with expense of $4.0 million for the same period in 2010. The negative provision in the first quarter of 2011 resulted from the Company’s analysis of the adequacy of its ALL as of March 31, 2011. That analysis reflected, prior to recording the negative provision, an excess balance in the ALL, primarily due to the reduction in total loans, stabilization of non-performing loan balances and receipt of an updated appraisal in April 2011 to support a substantial reduction of a specific reserve on a commercial real estate loan that was added in the fourth quarter of 2010. The allowance for loan losses at March 31, 2011 was $24.1 million, or 3.88% of total loans, a decrease of $4.1 million from $28.2 million or 4.2% of total loans at December 31, 2010. Nonperforming loans were $50.3 million, or 8.09% of total loans as of March 31, 2011, compared with $53.3 million, or 6.54% of total loans as of December 31, 2010. Impaired loans decreased from $89.7 million at December 31, 2010 to $78.7 million at March 31, 2011. Approximately $3.4 million of this decrease is attributable to one foreclosure on a loan to a commercial real estate developer by both Mercantile Bank and Royal Palm Bank and the subsequent transfer of the property to foreclosed assets held for sale. The remainder of the decrease was partially due to charge-offs at Royal Palm Bank and Heartland Bank, as well as payments received on impaired loans. The Company anticipates a portion of the impaired loans will eventually be charged off, but believes it has adequately reserved for these losses based on circumstances existing as of March 31, 2011.

Management has a process in place to review each subsidiary bank’s loan portfolio on a quarterly basis by an independent consulting firm that reports directly to the Audit Committee of the Board of Directors. The purpose of these quarterly reviews is to assist management in its evaluation of the adequacy of the ALL. In light of the elevated levels of nonperforming and impaired loans over the past two years, management has increased the frequency and scope of the reviews in areas deemed to have the greatest risk of potential losses. Management’s goal is to identify problems loans as soon as possible, with the hope that early detection and attention to these loans will minimize the amount of the loss.

Noninterest Income . Noninterest income for the three months ended March 31, 2011 increased $267 thousand to $2.2 million compared with $1.9 million for the same period in 2010. The increase in noninterest income was primarily due to increases in net gains on investments in common stock, partially offset by a decrease in other noninterest income.

The following table presents, for the periods indicated, the major categories of noninterest income:

	For the Three Months Ended March 31
	2011		2010

Fiduciary activities	$	614	$	581
Brokerage fees		263		299
Customer service fees		334		365
Other service charges and fees		179		139
Net gains (losses) on sales of assets		-		8
Net gains on loan sales		99		92
Net gains on sale of available-for-sale securities		433		-
Loan servicing fees		123		124
Net increase in cash surrender value of life insurance		137		138
Other		18		187

Total noninterest income	$	2,200	$	1,933

Net gains on sale of available-for-sale securities for the three months ended March 31, 2011 was $433 thousand compared to $0 for the same period in 2010, due to the first quarter 2011 sales of the Company’s remaining equity investments in the common stock of Enterprise Financial Services Corp. and Manhattan Bancorp, Inc., along with 14 thousand shares (of the Company’s total of 135 thousand shares) of the common stock of Paragon National Bank.

Other noninterest income for the three months ended March 31, 2011 decreased $169 thousand to $18 thousand compared with $187 thousand for the same period in 2010, primarily due to fees for providing data processing services to the three former subsidiaries that were sold in December 2009 and February 2010. The last of these services were terminated in the fourth quarter of 2010.

Noninterest Expense . For the three months ended March 31, 2011, noninterest expense decreased $149 thousand, or 1.8% to $8.3 million compared with $8.4 million for the same period in 2010, primarily due to decreases in salaries and employee benefits, partially offset by increases in FDIC deposit insurance premiums and other than temporary losses on available-for-sale and cost method investments.

The following table presents, for the periods indicated, the major categories of noninterest expense:

	For the Three Months Ended March 31
	2011		2010

Salaries and employee benefits	$	3,838	$	4,405
Net occupancy expense		602		598
Equipment expense		518		563
Deposit insurance premium		661		471
Professional fees		430		491
Postage and supplies		144		148
Losses on foreclosed assets, net		250		212
Amortization of mortgage servicing rights		55		39
Other than temporary impairment losses on cost method investments		202		-
Other		1,567		1,489

Total noninterest expense	$	8,267	$	8,416

Salaries and employee benefits decreased $567 thousand for the three months ended March 31, 2011 to $3.8 million, from $4.4 million for the same period in 2010, primarily due to an early retirement and reduction in force initiative by the Company in 2010 that resulted in the elimination of 22 full time positions, representing approximately 7.7% of the Company’s workforce prior to implementation of these actions. The Company had 250 full-time equivalent employees at March 31, 2011 compared to 274 at March 31, 2010, restated to exclude discontinued operations.

Deposit insurance premiums increased $190 thousand for the three months ended March 31, 2011 to $661 thousand, from $471 thousand for the same period in 2010, primarily due to increased FDIC assessment rates for all financial institutions in order to replenish the Deposit Insurance Fund to statutory levels, along with increases in the risk-based components of the assessments for each of the Company’s subsidiary banks attributable to the banks’ weakened financial condition.

Other than temporary losses on cost method investments for the three months ended March 31, 2011 was $202 thousand, compared to $0 for the same period in 2010, due to an impairment charge on one of the Company’s cost method investments in the first quarter of 2011. This impairment was determined based on the difference between the Company’s carrying value and the book value of the investee as of March 31, 2011.

Because the investee’s stock does not trade in an active, open market with readily observable prices, the Company considered book value to be a reasonably accurate estimate of fair value.

Income Taxes Expense (Benefit) . Income tax expense for the three months ended March 31, 2011was $2 thousand compared to a benefit of $1.2 million for the same period in 2010, primarily due to an increase in the valuation allowance related to the Company’s deferred tax assets. During the third quarter of 2010, the Company’s evaluation of the adequacy of the valuation allowance determined that it was no longer more likely than not that it could generate sufficient taxable income to realize the deferred tax assets in future near-term periods as defined by generally accepted accounting principles. Accordingly, the Company recorded an additional valuation allowance in the amount of $10.3 million, representing the full remaining balance of the Company’s and each of its subsidiary banks’ deferred tax assets as of September 30, 2010. As of March 31, 2011 and December 31, 2010, the Company recorded further increases to the valuation allowance of $230 thousand and $8.9 million, respectively, to reduce its net deferred tax assets to $0. For the three months ended March 31, 2011, the Company’s income tax expense based on taxable income before income taxes was offset by an increase in the valuation allowance related to deferred tax assets.

The Company has recognized no increase in its liability for unrecognized tax benefits. The Company files income tax returns in the U.S. federal jurisdiction and the states of Illinois, Missouri, Kansas and Florida jurisdictions. With a few exceptions, the Company is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2007.

Financial Condition

March 31, 2011 Compared to December 31, 2010

Loan Portfolio . Total loans, including loans held for sale, decreased $46.5 million or 6.9% to $622.2 million as of March 31, 2011 from $668.7 million as of December 31, 2010. The Company’s subsidiary banks experienced decreased loan balances in the first three months of 2011 due to seasonal fluctuations, debt paydowns, charge-offs, foreclosures, stricter underwriting standards, and the uncertain economy and the fear of continued recession causing potential borrowers to reduce their spending. At March 31, 2011 and December 31, 2010, the ratio of total loans to total deposits was 76.1% and 80.3%, respectively. For the same periods, total loans represented 68.8% and 72.0% of total assets, respectively.

The following table summarizes the loan portfolio of the Company by type of loan at the dates indicated:

	March 31, 2011					December 31, 2010
	Amount		Percent			Amount		Percent
	(dollars in thousands)
Commercial and financial	$	132,595		21.31	%	$	146,463		21.90	%
Agricultural		9,612		1.54	%		11,708		1.75	%
Real estate — farmland		14,884		2.39	%		15,528		2.32	%
Real estate — construction		78,892		12.68	%		91,553		13.69	%
Real estate — commercial		141,978		22.82	%		153,767		23.00	%
Real estate — residential (1)		188,469		30.29	%		189,479		28.34	%
Installment loans to individuals		55,790		8.97	%		60,177		9.00	%

Total loans		622,220		100.00	%		668,675		100.00	%

Allowance for loan losses		24,142					28,199
Total loans, including loans held for sale, net of allowance for loan losses	$	598,078				$	640,476

(1) Includes loans held for sale

Nonperforming Assets . Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due, restructured loans, repossessed assets and other assets acquired in satisfaction of debts previously contracted. It is management’s policy to place loans on nonaccrual status when interest or principal is 90 days or more past due. Such loans may continue on accrual status only if they are both well-secured and in the process of collection.

Total nonperforming loans decreased to $50.3 million as of March 31, 2011 from $53.3 million as of December 31, 2010, while total nonperforming loans and nonperforming other assets increased to $76.0 million as of March 31, 2011 from $74.4 million as of December 31, 2010. Impaired loans decreased from $89.7 million at December 31, 2010 to $78.7 million at March 31, 2011. Approximately $3.4 million of this decrease is attributable to the foreclosure on one loan to a commercial real estate developer by both Mercantile Bank and Royal Palm Bank and the subsequent transfer of the property to foreclosed assets held for sale. The remainder of the decrease was partially due to charge-offs at Royal Palm Bank and Heartland Bank, as well as payments received on impaired loans. The Company anticipates a portion of the impaired loans will eventually be charged off, but believes it has adequately reserved for these losses based on circumstances existing as of March 31, 2011.

Nonperforming other assets is comprised primarily of the carrying value of several foreclosed commercial real estate properties in the Midwest and Florida that the Company intends to sell, with the carrying value representing management’s assessment of the net realizable value in the current market. The ratio of nonperforming loans to total loans increased to 8.09% as of March 31, 2011, from 7.97% as of December 31, 2010. The ratio of nonperforming loans and nonperforming other assets to total loans increased to 12.21% as of March 31, 2011 from 11.12% as of December 31, 2010.

The following table presents information regarding nonperforming assets at the dates indicated:

	March 31, 2011			December 31, 2010

Nonaccrual loans
Commercial and financial	$	1,623		$	2,579
Agricultural		—			—
Real estate — farmland		540			134
Real estate — construction		25,518			29,892
Real estate — commercial		12,870			9,134
Real estate — residential		2,613			4,041
Installment loans to individuals		228			216

Total nonaccrual loans		43,392			45,996

Loans 90 days past due and still accruing		64			290
Restructured loans		6,870			6,995

Total nonperforming loans		50,326			53,281

Other real estate owned		25,613			21,091
Other foreclosed assets		52			—
Other assets acquired in satisfaction of debt previously contracted		—			—

Total nonperforming other assets		25,665			21,091

Total nonperforming loans and nonperforming other assets	$	75,991		$	74,372
Nonperforming loans to loans, before allowance for loan losses		8.09	%		7.97	%
Nonperforming loans and nonperforming other assets to loans, before allowance for loan losses		12.21	%		11.12	%

Based on an evaluation of the loan portfolio, management presents a quarterly review of the ALL to the board of directors, indicating any change in the balance since the last review and any recommendations as to adjustments to the balance. In making its evaluation, management considers the diversification by industry of the commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security, and the present level of the ALL.

A model is utilized to determine the specific and general portions of the ALL. Through the loan review process, management assigns one of six loan grades to each loan, according to payment history, collateral values and financial condition of the borrower. The loan grades aid management in monitoring the overall quality of the loan portfolio. Specific reserves are allocated for loans in which management has determined that deterioration has occurred. In addition, a general allocation is made for each loan category in an amount determined based on general economic conditions, historical loan loss experience, and amount of past due loans. Management maintains the ALL based on the amounts determined using the procedures set forth above.

The ALL decreased $4.1 million to $24.1 million as of March 31, 2011 from $28.2 million as of December 31, 2010. Provision for loan losses was a negative $963 thousand and net charge-offs were $3.1 million for the three months ended March 31, 2011. The negative provision resulted from the Company’s analysis of the adequacy of its ALL as of March 31, 2011. That analysis reflected, prior to recording the negative provision, an excess balance in the ALL, primarily due to the reduction in total loans, stabilization of non-performing loan balances and receipt of an updated appraisal in April 2011 to support a substantial reduction of a specific reserve on a commercial real estate loan that was added in the fourth quarter of 2010. The ALL as a percent of total loans decreased to 3.88% as of March 31, 2011 from 4.22% as of December 31, 2010. As a percent of nonperforming loans, the allowance for loan losses decreased to 47.97% as of March 31, 2011 from 52.93% as of December 31, 2010 attributable to the decrease in the ALL. The Company believes it has adequately reserved for potential losses based on circumstances existing as of March 31, 2011.

The following table presents for the periods indicated an analysis of the allowance for loan losses and other related data:

	As of and for the Three Months Ended March 31, 2011			As of and for the Year Ended December 31, 2010

Average loans outstanding during year	$	643,819		$	731,460

Allowance for loan losses:
Balance at beginning of year	$	28,199		$	18,851

Loans charged-off:
Commercial and financial		1,298			7,411
Agricultural		4			18
Real estate — farmland		—			39
Real estate — construction		1,559			13,057
Real estate — commercial		89			1,355
Real estate — residential		218			3,247
Installment loans to individuals		94			788

Total charge-offs		3,262			25,915

Recoveries:
Commercial and financial		13			83
Agricultural		4			19
Real estate — farmland		—			—
Real estate — construction		2			53
Real estate — commercial		77			3
Real estate — residential		45			58
Installment loans to individuals		27			80

Total recoveries		168			296

Net charge-offs		3,094			25,619
Provision for loan losses		(963	)		34,967

Balance at end of year	$	24,142		$	28,199

Allowance for loan losses as a percent of total loans outstanding at year end		3.88	%		4.22	%

Allowance for loan losses as a percent of total nonperforming loans		47.97	%		52.93	%

Ratio of net charge-offs to average total loans		0.48	%		3.50	%

Concentration of Credit Risk . Included in the Company’s loan portfolio as of March 31, 2011 and December 31, 2010, are approximately $15.3 million and $15.7 million, respectively, of purchased participation loans to borrowers located in areas outside the Company’s normal markets. Although the Company applies the same underwriting standards to these loans, there may be additional risk associated with those out of the Company’s normal territory.

At March 31, 2011, Heartland had approximately $2.7 million in loans with various customers collateralized by stock in a financial institution closed by regulators in October, 2010. The Company is currently working with these customers to increase collateral to acceptable levels and believes there are adequate reserves placed against the loans.

S ecurities . The Company uses its securities portfolio to ensure liquidity for cash requirements, to manage interest rate risk, to provide a source of income, to ensure collateral is available for municipal pledging requirements and to manage asset quality. Where the Company has less than majority ownership interests in banking organizations that are publicly traded, it continuously adjusts its common stock investments to their current market value through the securities portfolio as an unrealized gain or loss on available-for-sale securities.

The Company has classified securities as both available-for-sale and held-to-maturity as of March 31, 2011. Available-for-sale securities are held with the option of their disposal in the foreseeable future to meet investment objectives, liquidity needs or other operational needs. Securities available-for-sale are carried at fair value. Held-to-maturity securities are those securities for which the Company has the positive intent and ability to hold until maturity, and are carried at historical cost adjusted for amortization of premiums and accretion of discounts.

As of March 31, 2011, the fair value of the available for-sale securities was $111.4 million and the amortized cost was $109.5 million for an unrealized gain of $1.9 million. As of December 31, 2010, the fair value of the available-for-sale securities was $107.3 million and the amortized cost was $105.0 million for an unrealized gain of $2.3 million. Fluctuations in net unrealized gains and losses on available-for-sale securities are due primarily to increases or decreases in prevailing interest rates for the types of securities held in the portfolio.

As of March 31, 2011, the amortized cost of held-to-maturity securities was $998 thousand, a decrease of $210 thousand from the December 31, 2010 amortized cost of $1.2 million.

As of March 31, 2011, the Company owned approximately $2.9 million of Federal Home Loan Bank stock, including $1.9 million of stock in the Federal Home Loan Bank of Chicago (“FHLB of Chicago”). During the third quarter of 2007, the FHLB of Chicago received a Cease and Desist Order (“Order”) from their regulator, the Federal Housing Finance Board. The FHLB of Chicago could continue to provide liquidity and funding through advances, but the Order prohibits capital stock repurchases and redemptions until a time to be determined by the Federal Housing Finance Board. With regard to dividends, the FHLB of Chicago continues to assess its dividend capacity each quarter and make appropriate request for approval. There were no dividends paid by the FHLB of Chicago during 2010; however, a dividend at an annualized rate of 10 basis points per share was paid on February 14, 2011.

Foreclosed Assets Held for Sale . At March 31, 2011, foreclosed assets increased $4.6 million or 21.7% to $25.6 million from $21.0 million as of December 31, 2010, primarily attributable to the default of several of Royal Palm Bank’s loans in the Florida market, several of Heartland Bank’s purchased participation loans in the Georgia and Arkansas markets, and several of Mercantile Bank’s purchased participation loans in various Midwest markets that resulted in foreclosure on the properties collateralizing the loans.

Other Assets . At March 31, 2011, other assets decreased $5.7 million or 43.2% to $7.5 million from $13.2 million as of December 31, 2010, primarily attributable to the receipt of federal income tax refunds in the first quarter of 2011 relating to the carryback of net operating losses from 2009.

Deposits . Total deposits decreased $15.4 million or 1.8% to $817.8 million as of March 31, 2011 from $833.2 million as of December 31, 2010. Noninterest-bearing deposits increased $11.2 million or 10.0% to $122.9 million as of March 31, 2011 from $111.7 million as of December 31, 2010, while interest-bearing deposits decreased $26.6 million or 3.7% to $694.9 million as of March 31, 2011 from $721.5 million as of December 31, 2010. The majority of the overall decrease in deposits during the first quarter of 2011 was attributable to reduced funding required in the loan portfolio.

Borrowings . The Company utilizes borrowings to supplement deposits in funding its lending and investing activities. Short-term borrowings consist of federal funds purchased, securities sold under agreements to repurchase, US Treasury demand notes, short-term advances from the Federal Home Loan Bank (“FHLB”). Long-term debt consists of long-term advances from the FHLB and junior subordinated debentures.

As of March 31, 2011, short-term borrowings were $10.1 million, a decrease of $3.5 million from $13.7 million as of December 31, 2010. The decrease in short-term borrowings is primarily attributable to withdrawals by the government of US Treasury demand notes and the purchase by the Company of convertible debentures issued by Mid-America to minority shareholders of Mid-America.

Long-term borrowings were $7.0 million as of March 31, 2011, a decrease of $8.0 million from $15.0 million as of December 31, 2010, attributable to a reduction in advances from the FHLB as part of the Company’s overall funding strategy. Included in long-term borrowings as of March 31, 2011 were long-term FHLB borrowings totaling $7.0 million, with maturities ranging from the years 2012 to 2013 and interest rates ranging from 3.25% to 4.52%.

Junior subordinated debentures were $61.9 million at March 31, 2011 and December 31, 2010. Maturities ranged from the years 2035 to 2037 (callable at the Company’s option in 2011, 2015 and 2017), and interest rates ranged from 1.96% to 7.17%. In June 2009, the Company decided to defer regularly scheduled interest payments on its outstanding $61.9 million of junior subordinated notes relating to its trust preferred securities. The terms of the junior subordinated notes and the trust documents allow the Company to defer payments of interest for up to 20 consecutive quarterly periods without default or penalty. During the deferral period, the respective trusts will likewise suspend the declaration and payment of dividends on the trust preferred securities. Also during the deferral period, the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock or make any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated notes. As previously disclosed, the Company had suspended the payment of cash dividends on its outstanding common stock. As of March 31, 2011, the accumulated deferred interest payments totaled $6.6 million.

Liquidity

Liquidity management is the process by which the Company ensures that adequate liquid funds are available to meet the present and future cash flow obligations arising in the daily operations of the business in a timely and efficient manner. These financial obligations consist of needs for funds to meet commitments to borrowers for extensions of credit, funding capital expenditures, withdrawals by customers, maintaining deposit reserve requirements, servicing debt, paying dividends to shareholders, and paying operating expenses. Management believes that adequate liquidity exists to meet all projected cash flow obligations.

The Company achieves a satisfactory degree of liquidity through actively managing both assets and liabilities. Asset management guides the proportion of liquid assets to total assets, while liability management monitors future funding requirements and prices liabilities accordingly.

The Company’s most liquid assets are cash and due from banks, interest-bearing demand deposits, and federal funds sold. The balances of these assets are dependent on the Company’s operating, investing, lending, and financing activities during any given period. As of March 31, 2011, cash and cash equivalents totaled $112.7 million, an increase of $15.2 million from $97.5 million as of December 31, 2010. This increase was primarily attributable to additional balances maintained by Mercantile Bank at the Federal Reserve Bank in order to avoid the incurrence of any daylight overdrafts.

The Company’s primary sources of funds consist of deposits, investment maturities and sales, loan principal repayment, sales of loans, and capital funds. Additional liquidity is provided by repurchase agreements, junior subordinated debentures and the ability to borrow from the Federal Reserve Bank and Federal Home Loan Bank.

Capital Resources

Other than the issuance of common stock, the Company’s primary source of capital is net income retained by the Company. During the three months ended March 31, 2011, the Company had net income of $1.3 million and paid no dividends. During the year ended December 31, 2010, the Company incurred a net loss of $44.6 million and paid no dividends. As of March 31, 2011, total Mercantile Bancorp, Inc. stockholders’ deficit was $(2.4) million, an increase of $1.0 million from $(3.5) million as of December 31, 2010.

In recent regulatory guidance, the Board of Governors of the Federal Reserve System has emphasized that voting common stockholders’ equity generally should be the dominant element within Tier 1 capital for bank holding companies and that it is the most desirable element of capital from a supervisory standpoint. The Board of Governors has reiterated that bank holding companies should place primary reliance on common equity and has cautioned bank holding companies against over-reliance on non-common-equity capital elements.

The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies and their subsidiary banks. Risk-based capital ratios are established by allocating assets and certain off-balance sheet commitments into four risk-weighted categories. These balances are then multiplied by the factor appropriate for that risk-weighted category. The guidelines require bank holding companies and their subsidiary banks to maintain a total capital to total risk-weighted asset ratio of not less than 8.00%, of which at least one half must be Tier 1 capital, and a Tier 1 leverage ratio of not less than 4.00%.

As of March 31, 2011, the Company’s total risk-based capital ratio was (0.73)%, Tier 1 risk-based capital ratio was (0.73)%, and its Tier 1 leverage ratio was (0.52)%. The capital ratios fell below the adequately capitalized levels primarily due to continued operating losses at each of its subsidiary banks. The regulatory capital ratios are further reduced by the limitation on trust preferred securities includible in Tier 1 capital, based on the decreased level of core capital.

Without prior approval, the subsidiary banks are restricted as to the amount of dividends that they may declare to the balance of the retained earnings account, adjusted for defined bad debts. In addition, the FDIC has authority to prohibit or to limit the payment of dividends by a bank if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the banking organization. The Company and its subsidiary banks are each prohibited from paying any dividends without regulatory consent, pursuant to various regulatory enforcement actions taken at each entity. For further discussion, see the “Regulatory Matters” section of this filing.

The Company has generated net losses in each of the last three years, with $44.6 million in 2010, $58.5 million in 2009 and $8.8 million in 2008. The 2008 and 2009 losses were largely due to the operating losses at Royal Palm Bank and Heartland Bank. Both of those banks continued to generate losses in 2010, as did Mercantile Bank, the Company’s largest subsidiary. Each bank has experienced significant increases in non-performing assets, impaired loans and loan loss provisions, resulting in each bank’s primary regulator imposing a Consent Order. For further discussion of these regulatory enforcement actions, see the “Regulatory Matters” section of this filing.

Mercantile Bank’s net loss in 2010 was primarily due to charge-offs of purchased participations in large commercial real estate developments in various parts of the country. Royal Palm Bank’s operating losses (excluding goodwill impairment) over the past three years were primarily attributable to the severe decline in real estate values in its southwest Florida market, creating both loan losses and write-downs of foreclosed assets. Heartland Bank’s losses over the past three years were largely due to charge-offs of purchased participations from, or loans secured by stock in, unrelated financial institutions banks that have been closed by the FDIC. Although the banks are confident that they have identified the bulk of their asset quality issues and will see improved operating performance in 2011, there can be no assurance that they will not experience additional losses. Due to the net losses incurred by the Company in the last three years, equity capital has been reduced to a level that leaves the Company with very little capacity to absorb further losses. Mercantile Bank is the Company’s largest subsidiary bank, representing approximately 73% of total consolidated assets at March 31, 2011, and although operating under a regulatory Consent Order due to elevated levels of impaired loans, its actual loan losses over the past three years have been lower than the other two banks and it retains significant earnings capacity. However, it is unlikely that Mercantile Bank could generate sufficient earnings to offset continued losses at Royal Palm Bank and Heartland Bank.

In June 2009, the Company’s Board of Directors initiated a process to identify and evaluate a broad range of strategic alternatives to strengthen the Company’s capital base and enhance shareholder value. These strategic alternatives have included and may include asset sales, rationalization of non-business operations, consolidation of operations, closing of branches, mergers of subsidiaries, capital raising and other recapitalization transactions. As part of this process, the Board created a special committee (the “Special Committee”) of independent directors to develop, evaluate and oversee any strategic alternatives that the Company may pursue. The Special Committee retained outside financial and legal advisors to assist with its evaluation and oversight.

In November 2009, as a part of a capital-raising plan developed by the Special Committee and its advisors, the Company reached agreements to sell three of its subsidiary banks for cash or in exchange for the cancellation of indebtedness owed by the Company. The first of these transactions closed in December 2009, and the other two in February 2010, serving to reduce debt and provide liquidity to support the capital requirements of its remaining subsidiaries.

The Special Committee also developed and executed a plan to raise additional equity through a shareholder rights offering. On July 12, 2010, the Company filed a Registration Statement on Form S-1 with the Securities and Exchange Commission (“SEC”), to register units comprised of shares of the Company’s common stock and warrants to acquire the Company’s common stock. Holders of the Company’s common stock would receive one subscription right for each share of Company common stock held as of September 23, 2010, the record date. The offering period expired on October 29, 2010. On November 3, 2010, the Company terminated the offering without acceptance of any of the subscriptions exercised thereunder. The Company’s Board of Directors determined that in light of the Company’s stock price trading substantially below the subscription price, it was appropriate not to accept the subscriptions that were exercised.

If the Company is unsuccessful in assessing and implementing other strategic and capital-raising options, and if a liquidity crisis would develop, the Company has various alternatives, which could include selling or closing certain branches or subsidiary banks, packaging and selling high-quality commercial loans, executing sale/leaseback agreements on its banking facilities, and other options. If executed, these transactions would decrease the various banks’ assets and liabilities, generate taxable income, improve capital ratios, and reduce general, administrative and other expense. In addition, the affected subsidiary banks would dividend the funds to the Company to provide liquidity, assuming such dividends receive the requisite regulatory approval. The Company is continuing to explore and evaluate all strategic and capital-raising options with its financial and legal advisors.

Regulatory Matters

In connection with regular examinations of the Company, Mercantile Bank, Royal Palm Bank, Royal Palm Bancorp, Heartland Bank and Mid-America Bancorp by the Federal Reserve Bank of St. Louis (“FRB”), the FDIC, the Illinois Department of Financial and Professional Regulation (“IDFPR”) and Florida Office of Financial Regulation (“FOFR”), various actions were taken by the regulatory agencies, none of which resulted in the imposition of fines or penalties.

A Consent Order (“Order”) is a formal action by the FDIC requiring a bank to take corrective measures to address deficiencies identified by the FDIC. The bank can continue to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions. All customer deposits remain fully insured to the maximum limits set by the FDIC.

A Memorandum of Understanding (“MOU”) agreement is characterized by regulatory authorities as an informal action that is neither published nor made publicly available by the agencies and is used when circumstances warrant a milder form of action than a formal supervisory action, such as an Order.

A Written Agreement (“WA”) is a formal enforcement action by the FRB, similar in nature to an MOU, but is legally binding and will be published and made public.

The Company. In March 2009, the Company entered into a MOU with the FRB. Under the terms of the MOU, the Company was expected to, among other things, provide its subsidiary banks with financial and managerial resources as needed, submit capital and cash flow plans to the FRB and provide periodic performance updates to the FRB. In addition, the Company was prohibited from paying any special salaries or bonuses to insiders, paying dividends, paying interest related to trust preferred securities, or incurring any additional debt, without the prior written approval of the FRB. On July 31, 2009, the Company submitted to the FRB a three-year strategic and capital plan designed to strengthen the Company’s and its subsidiaries’ operations and capital position going forward. The plan reflected the current challenges with respect to capital and the difficulties in projecting the impact of the economic weakness in the Company’s markets on its loan portfolio, as well as strategies to maintain the financial strength of the Company and its subsidiaries. A significant part of the plan was the initiative by the Company to sell one or more subsidiary banks in order to generate liquidity to reduce debt, improve capital ratios and provide necessary capital contributions to its remaining subsidiary banks. The result of this initiative was the exchange for debt of HNB National Bank in December 2009 and the sale of Marine Bank & Trust and Brown County State Bank in February 2010.

In February 2010, the Company entered into a WA with the FRB, replacing the previously issued MOU. The terms of the WA are generally consistent with the MOU, with a requirement that an updated capital and cash flow plan be submitted to the FRB. On May 19, 2010, the Company submitted to the FRB a revised three-year strategic and capital plan that outlined the proposed strategies to maintain its regulatory capital status of at least “adequately capitalized”, maintain positive cash balances at the parent company level, ensure that each of its subsidiaries meets the capital requirements directed by their respective regulatory orders, and meet its debt service requirements, including distributions on its trust preferred securities. On December 15, 2010, the Company submitted to the FRB an updated three-year strategic and capital plan that outlines the revised proposed strategies to meet the objectives outlined in the May 19, 2010 capital plan.

In March 2011, the FRB conducted a target inspection of the Company that used financial information as of December 31, 2010 and focused on the financial condition and future prospects of the Company as well as compliance with the WA. The FRB’s report was dated April 4, 2011 and noted continued deterioration in financial condition, citing the classification of each of the subsidiary banks as “troubled institutions,” volume of adversely classified assets, net losses incurred in each of the last three years, deficit capital balance and excessive leverage position. Although the Company met most of the requirements of the WA, it was not in full compliance with the provisions related to source of strength and capital, due to the lack of success in implementing its capital-raising initiatives. The FRB report stated that it is imperative that the board and management pursue every opportunity to recapitalize the organization and that the WA will remain in place. See the “Capital Resources” section of this filing for discussion of the Company’s efforts to raise capital through a shareholder rights offering and other strategies.

Mercantile Bank. In March 2010, Mercantile Bank entered into a MOU with the FDIC and the IDFPR. Under the terms of the MOU, Mercantile Bank agreed, among other things, to provide certain information to each supervisory authority including, but not limited to, financial performance updates, loan performance updates, written plan for reducing classified assets and concentrations of credit, written plan to improve liquidity and reduce dependency on volatile liabilities, written capital plan, and written reports of progress. In addition, the bank agreed not to declare any dividends or make any distributions of capital without the prior approval of the supervisory authorities, and within 30 days of the date of the MOU, to maintain its Tier 1 leverage capital ratio at no less than 8.0% and total risk based capital ratio at no less than 12.0%.

In March 2011, following receipt of the results of an examination conducted jointly by the FDIC and IDFPR that documented continued deterioration in the financial condition of the bank, including failure to comply with certain provisions of the March 2010 MOU, Mercantile Bank entered into an Order with the FDIC and IDFPR. The terms of the Order, which is a stronger enforcement action than the MOU, include substantially all of the requirements mandated by the MOU. In addition, the Order obligates Mercantile Bank to, among other things, obtain an independent analysis of the bank’s management needs, hire and retain qualified management, increase the board of directors’ participation in the affairs of the bank and refrain from extending additional credit to classified borrowers.

As of March 31, 2011, Mercantile Bank had a Tier 1 leverage capital ratio of 6.82%, Tier 1 risk based capital ratio of 9.64% and a total risk based capital ratio of 10.92%. As of December 31, 2010, Mercantile Bank had a Tier 1 leverage ratio of 6.24%, a Tier 1 risk based capital ratio of 8.57% and a total risk based capital ratio of 9.85% These ratios fell below the level required by the MOU and the Order primarily due to additional provisions for loan losses, and the Company elected not to inject any capital into Mercantile Bank until it determines a course of action to raise capital at the Company level. The FDIC has been notified of the non-compliance, and requested the bank to provide a plan to restore the ratios to the required levels. The Company and Mercantile Bank, with the assistance of their legal and other professional advisors, submitted a plan to the FDIC and IDFPR on April 29, 2011. The primary focus of the plan involves the Company’s capital-raising initiatives, which, if successful, will provide sufficient liquidity for the Company to make capital contributions that will restore the bank’s capital to the levels mandated by the MOU and the Order.

Royal Palm Bank. In October 2008, Royal Palm Bank entered into a MOU with the FDIC and FOFR. Under the terms of the MOU, Royal Palm Bank agreed, among other things, to provide certain information to each supervisory authority including, but not limited to, financial performance updates, loan performance updates, written plan for improved earnings, written capital plan, review and assessment of all officers who head departments of the bank, and written reports of progress. In addition, Royal Palm Bank agreed not to declare any dividends or make any distributions of capital without the prior approval of the supervisory authorities, and to maintain its Tier 1 leverage capital ratio at no less than 8.0%, the Tier 1 risk based capital ratio at no less than 10.0%, and total risk based capital ratio at no less than 12.0%.

In May 2009, Royal Palm Bank entered into an Order with the FDIC and FOFR. The terms of the Order, which is a stronger enforcement action than the MOU, include substantially all of the requirements mandated by the MOU. In addition, the Order obligates Royal Palm Bank to, among other things, notify each supervisory authority of plans to add any individual to the board of directors or employ any individual as a senior executive officer.

At September 30, 2009, Royal Palm Bank’s Tier 1 leverage ratio was 1.51% and total risk based capital ratio was 3.61%, and as a result, the bank was not in compliance with the Order requirements for capital ratios. As specified in the Order, Royal Palm Bank notified the supervisory authorities within 10 days of the determination of the ratios. On October 7, 2009, the FDIC notified the bank that it was critically undercapitalized and subject to certain mandatory requirements under the Federal Deposit Insurance Act (“FDIA”). Royal Palm Bank was also required to submit a capital restoration plan to the FDIC by October 30, 2009, along with certain other disclosures related to the mandatory requirements under FDIA for critically undercapitalized banks. On October 9, 2009, the Company injected $2 million of additional capital into Royal Palm Bank and as a result, as of that date, the bank had a Tier 1 leverage capital ratio of 2.69%, a Tier 1 risk based capital ratio of 4.24% and a total risk based capital ratio of 5.58%.

On October 23, 2009, the FOFR notified Royal Palm Bank that the bank was required to have a Tier 1 leverage capital ratio of at least 6.0% as of November 30, 2009, as well as a Tier 1 leverage capital ratio of at least 8.0% and a total risk based capital ratio of at least 12.0% as of December 31, 2009. The Company injected $11.0 million of capital into Royal Palm Bank on December 1, 2009, with the proceeds from a short-term loan from Great River Bancshares, Inc. As of December 31, 2009, Royal Palm Bank had a Tier 1 leverage capital ratio of 8.90%, Tier 1 risk based capital ratio of 13.79% and a total risk based capital ratio of 15.11%, and was in compliance with all requirements of the Order.

As of December 31, 2010, Royal Palm Bank had a Tier 1 leverage capital ratio of 1.00%, Tier 1 risk based capital ratio of 1.57% and a total risk based capital ratio of 2.96%. These capital ratios fell below the level required by the Order primarily due to additional provisions for loan losses. Due to the Tier 1 leverage ratio falling below 2% as of December 31, 2010, the bank was classified as critically undercapitalized under prompt corrective action guidelines. To address this situation, the Company injected $1.5 million into Royal Palm Bank in February 2011, which increased the capital ratios to the significantly undercapitalized level. The FDIC was notified of the non-compliance with the Order as of December 31, 2010, and requested the bank to provide a plan to restore the ratios to the required levels. The Company and Royal Palm Bank, with the assistance of their legal and other professional advisors, submitted a plan to the FDIC and FOFR on March 15, 2011. The primary focus of the plan involved the Company’s attempts to recapitalize Royal Palm Bank through a sale of the bank. The FDIC deemed the plan to be unacceptable as filed and requested that a revised plan be submitted by May 25, 2011, incorporating alternative actions to address the bank’s capital deficiencies if the Company is unsuccessful at selling the bank. The Company and Royal Palm Bank intend to submit a revised plan by the due date. The plan will incorporate the Company’s capital-raising initiatives, which, if successful, will provide sufficient liquidity for the Company to make capital contributions that will restore the bank’s capital to the levels mandated by the Order.

As of March 31, 2011, Royal Palm Bank had a Tier 1 leverage capital ratio of 2.48%, Tier 1 risk based capital ratio of 3.79% and a total risk based capital ratio of 5.15%. The FDIC was again notified of the non-compliance with the Order. Due to continuing operating losses projected for the second quarter of 2011, the bank is at risk of its capital ratios dropping to the critically undercapitalized level as of June 30, 2011, without further capital contributions. The Company injected an additional $300 thousand into Royal Palm Bank in April 2011, but has elected not to make any further capital injections until it determines a course of action to raise capital at the Company level.

Royal Palm Bancorp. In September 2009, Royal Palm Bancorp entered into a MOU with the FRB. As a one-bank holding company, this MOU primarily reflected regulatory concerns related to Royal Palm Bancorp’s subsidiary (Royal Palm Bank). Under the terms of the MOU, Royal Palm Bancorp agreed, among other things, to provide certain information to the FRB including, but not limited to, financial performance updates and written reports of progress. In addition, Royal Palm Bancorp agreed to assist Royal Palm Bank in addressing weaknesses identified in the bank examination, and not to pay any salaries or bonuses to insiders, incur any debt, declare any dividends or make any distributions of capital without the prior approval of the supervisory authorities.

Heartland Bank. In March 2009, Heartland Bank entered into an Order with the FDIC. Under the terms of the Order, Heartland Bank agreed to, among other things, prepare and submit plans and reports to the FDIC regarding certain matters including, but not limited to, progress reports detailing actions taken to secure compliance with all provisions of the order, loan performance updates as well as a written plan for the reduction of adversely classified assets, a revised comprehensive strategic plan, and a written profit plan and comprehensive budget. In addition, Heartland Bank agreed not to declare any dividends without the prior consent of the FDIC and to maintain its Tier 1 leverage capital ratio at no less than 8.0% and maintain its total risk based capital at no less than 12.0%.

In March 2011, following receipt of the results of an examination conducted by the FDIC that documented continued deterioration in the financial condition of the bank, including failure to comply with certain provisions of the March 2009 Order, Heartland Bank entered into an updated Order with the FDIC. The terms of the March 2011 Order include substantially all of the requirements mandated by the March 2009 Order. In addition, the March 2011 Order obligates Heartland Bank to, among other things, maintain its Tier 1 capital ratio at no less than 9.0% and maintain its total risk based capital ratio at no less than 13.0%.

As of March 31, 2011, Heartland had a Tier 1 leverage capital ratio of 4.16%, Tier 1 capital ratio of 5.26%, and total risk based capital ratio of 7.32%. As of December 31, 2010, Heartland had a Tier 1 leverage capital ratio of 4.12%, Tier 1 capital ratio of 5.67%, and total risk based capital ratio of 7.71%. These ratios fell below the level required by the Order primarily due to additional provisions for loan losses, and the Company elected not to inject any capital into Heartland until it determines a course of action to raise capital at the Company level. The FDIC has been notified of the non-compliance, and has requested the bank to provide a plan to restore the ratios to the required levels. The Company and Heartland are working with their legal and other professional advisors to develop a plan, which is expected to be implemented by June 30, 2011. The primary focus of the plan will involve the Company’s capital-raising initiatives, which, if successful, will provide sufficient liquidity for the Company to make capital contributions that will restore the bank’s capital to the levels mandated by the Order.

Mid-America Bancorp. In September 2009, Mid-America Bancorp entered into a MOU with the FRB. As a one-bank holding company, this MOU primarily reflected regulatory concerns related to Mid-America’s subsidiary (Heartland Bank). Under the terms of the MOU, Mid-America Bancorp agreed, among other things, to provide certain information to the FRB including, but not limited to, financial performance updates and written reports of progress. In addition, Mid-America Bancorp agreed to assist Heartland Bank in addressing weaknesses identified in the bank examination, and not to pay any salaries or bonuses to insiders, incur any debt, declare any dividends or make any distributions of capital without the prior approval of the supervisory authorities.

On April 5, 2011, the Company completed the merger of Mid-America Bancorp into the Company, Mid-America Bancorp was dissolved and Heartland Bank became a wholly-owned subsidiary of the Company. See further discussion in the “General” section of this filing.

Effect of Inflation and Changing Prices.

The condensed consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting procedures generally accepted in the United States of America which require the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Critical Accounting Estimates

Critical accounting estimates are those that are critical to the portrayal and understanding of the Company’s financial condition and results of operations, and require management to make assumptions that are difficult, subjective, or complex. These estimates involve judgments, estimates, and uncertainties that are susceptible to change. In the event that different assumptions of conditions were to prevail, and depending on the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

The Company’s significant accounting policies are integral to understanding the results reported. The Company’s significant accounting policies are described in detail in Note 1 to its consolidated financial statements included in its Annual Report on Form 10-K filed with the SEC on April 15, 2011. The majority of these accounting policies do not require management to make difficult, subjective, or complex judgments or estimates, or the variability of the estimates is not material. However, management has identified the following critical policies.

Allowance for Loan Losses. The allowance for loan losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogeneous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of the exposures. The estimates are based upon the Company’s evaluation of imprecision risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

Deferred Taxes. The Company has maintained significant net deferred tax assets for deductible temporary differences, the largest of which relates to the net operating loss carryforward and the allowance for loan losses. For income tax return purposes, only net charge-offs are deductible, not the provision for loan losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the recoverability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of the current and future economic and business conditions. Management considers both positive and negative evidence regarding the ultimate recoverability of the deferred tax assets. Positive evidence includes the existence of taxes paid in available carryback years, available tax planning strategies and the probability that taxable income will be generated in future periods, while negative evidence includes a cumulative loss in the current year and prior year and general business and economic trends. As of March 31, 2011, management has evaluated the recoverability of the net deferred tax asset and established a full valuation allowance for certain federal and state net operating losses and credit carryforwards that are not expected to be fully realized.

Item 3. Quantitative and Qualitative Disclosures About Market Risk .

There have been no material changes since December 31, 2010. For more information regarding quantitative and qualitative disclosures about market risk, please refer to the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2010, and in particular, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Rate Sensitive Assets and Liabilities” and Item 7A “Quantitative and Qualitative Disclosures About Market Risk.”

Item 4. Controls and Procedures .

Evaluation of disclosure controls and procedures . The Company carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported to the Company’s management within the time periods specified in the Securities and Exchange Commission’s rules and forms.

Changes in internal controls over financial reporting . There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

In addition to the risk factors previously discussed in Part 1, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, the Company also faces the risk set forth below:

Compliance with NYSE Amex’s continued listing standards. The Company received a notice of noncompliance with the exchanged continued listing standards regarding stockholders’ equity, losses from continuing operations, and net losses. The Company has been requested to submit a plan of compliance to the exchange by May 25, 2011 that demonstrates the Company’s ability to regain compliance with the standards. There is no assurance the Company will be able to submit a plan acceptable to the exchange or, if accepted, to implement such plan successfully.

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

There were the following issuer purchases of equity securities (i.e., the Company’s common stock) during the three months ended March 31, 2011:

First Quarter 2011 Calendar Month	Total Number of Shares Purchased (1)	Average Price Paid per Share (1)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)	Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (3)

January	0	N/A	0	$ 8,128,000
February	0	N/A	0	$ 8,128,000
March	0	N/A	0	$ 8,128,000
Total	0	N/A	0

(1) The total number of shares purchased and the average price paid per share include, in addition to other purchases, shares purchased in the open market and through privately negotiated transactions by the Company’s 401(k) Profit Sharing Plan. For the months indicated, there were no shares purchased by the Plan.

(2) Includes only shares subject to publicly announced stock repurchase program, i.e. the $10 million stock repurchase program approved by the Board on August 15, 2005 and announced on August 17, 2005 (the “2005 Repurchase Program”). Does not include shares purchased by the Company’s 401(k) Profit Sharing Plan.

(3) Dollar amount of repurchase authority remaining at month-end under the 2005 Repurchase Program, the Company’s only publicly announced repurchase program in effect at such dates. The 2005 Repurchase Program is limited to 883,656 shares (10% of the number of outstanding shares on the date the Board approved the program, adjusted for the three-for-one stock split in June of 2006 and the three-for-two split in December of 2007) but not to exceed $10 million in repurchases.

Item 3. Defaults Upon Senior Securities

None

Item 5. Other Information

None

Item 6. Exhibits


Exhibit Number		Identification of Exhibit

31.1		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

31.2		Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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.


Date: May 16, 2011	By:	/s/ Ted T. Awerkamp
		Ted T. Awerkamp
		President and Chief Executive Officer (principal executive officer)

Date: May 16, 2011	By:	/s/ Michael P. McGrath
		Michael P. McGrath
		Executive Vice President, Treasurer, Secretary and
		Chief Financial Officer
		(principal financial officer/ principal accounting officer)