MBWM Mercantile Bank Corporation

 

1.    SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation: The unaudited financial statements for the three months ended March 31, 2020 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance center”). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended March 31, 2020 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2019.

 

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

 

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

 

Approximately 256,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2020. In addition, stock options for approximately 4,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2020. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2020.

 

Approximately 263,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2019. In addition, stock options for approximately 12,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2019. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2019.

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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1.    SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Securities: Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold prior to maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Federal Home Loan Bank stock is carried at cost.

 

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

 

Declines in the fair value of debt securities below their amortized cost that are other-than-temporary impairment (“OTTI”) are reflected in earnings or other comprehensive income, as appropriate. For those debt securities whose fair value is less than their amortized cost, we consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and whether we expect to recover the entire amortized cost of the security based on our assessment of the issuer’s financial condition. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies, and whether downgrades by bond rating agencies have occurred. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) OTTI related to other factors, such as liquidity conditions in the market or changes in market interest rates, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.

 

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

 

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

 

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

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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1.    SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of March 31, 2020 and December 31, 2019, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $24.7 million and $5.0 million, respectively. Loans held for sale are reported as part of our total loans on the balance sheet.

 

Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives is included in the gain on sale of loans. Mortgage loans serviced for others totaled approximately $742 million and $727 million as of March 31, 2020 and December 31, 2019, respectively.

 

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

 

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

 

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

 

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

 

On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and reporting for Financial Institutions Working with Customers Affected by the Coronavirus.”  This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of the Coronavirus.  The guidance goes on to explain that in consultation with the FASB staff that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not troubled debt restructurings.  Section 4013 of the CARES Act also addressed Coronavirus-related modifications and specified that Coronavirus-related modifications on loans that were current as of December 31, 2019 are not troubled debt restructurings.

 

In early April 2020, we developed internal programs of loan payment deferments for commercial and retail borrowers.  For commercial borrowers, we offer 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments.  Under the latter program, borrowers are extended a 12-month single payment note at 0% interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments.  As of April 30, 2020, we had processed over 400 interest only amendments with loan balances aggregating $342 million and 125 principal and interest payment deferments with loan balances totaling $247 million and resulting single payment loans aggregating $5.4 million.  For retail borrowers, we offer 90-day (three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan.  As of April 30, 2020, we had processed almost 300 principal and interest payment deferments with loan balances totaling $34.0 million.

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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1.	SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

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

 

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

 

Financial institutions are not required to comply with the Current Expected Credit Loss (“CECL”) methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020.  An economic forecast is a key component of the CECL methodology.  As we enter into an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by shelter in place declarations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments, financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly updated and there is no economic forecast consensus.  Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.

 

Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have generally consisted of interest rate swap agreements that qualified for hedge accounting. We do not use derivatives for trading purposes.

 

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

 

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

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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1.	SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Goodwill and Core Deposit Intangible: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We may elect to perform a qualitative assessment for the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value. In 2019, we elected to perform a qualitative assessment for our annual impairment test and concluded it is more likely than not our fair value was greater than its carrying amount; therefore, no further testing was required.

 

Due to the stressed economic and market conditions created by the Coronavirus Pandemic, we assessed goodwill for impairment as of March 31, 2020. We used a discounted income approach and a market valuation model, which compared the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill has been impaired. It was determined that our goodwill was not impaired as of March 31, 2020.

 

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

 

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

 

Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

Recent Events:  The U.S. economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing pandemic of coronavirus disease 2019 (“COVID-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”).  The outbreak was initially identified in Wuhan, China in December 2019.  The World Health Organization declared the outbreak to be a Public Health Emergency Concern on January 30, 2020, and then recognized it as a pandemic on March 11, 2020.  The first known case in the United States was identified in the State of Washington on January 20, 2020.  The White House Coronavirus Task Force was established on January 29, 2020.  President Trump declared a Public Health Emergency on January 31, 2020, which was elevated by the President’s declaration of a National Emergency on March 13, 2020 (the “National Emergency”). 

 

The first known case in the State of Michigan was identified on March 10, 2020, which triggered a State of Emergency response from Governor Whitmer.  Soon thereafter, Governor Whitmer ordered the closure of all K-12 school buildings until early April, which was later amended to suspend all face-to-face instruction for the remainder of the 2019-2020 school year.  In mid-March, Governor Whitmer ordered all bars, restaurants, entertainment venues and other similar businesses to partially close for two weeks, and banned all gatherings of more than 50 people for the period of mid-March into early April.  On March 24, 2020, Governor Whitmer issued a state-wide stay-at-home order limiting all non-essential travel and discontinuing all non-essential business services and operations.  The order was originally set to expire on April 13, 2020; however, the order was extended, and expanded with additional restrictions, until April 30, 2020.  On April 24, 2020, Governor Whitmer issued an amended stay-at-home order that expires on May 15, 2020 to replace the stay-at-home order that was scheduled to expire on April 30, 2020.  On May 7, 2020, Governor Whitmer issued an amended stay-at-home order that expires on May 28, 2020 to replace the stay-at-home order that was scheduled to expire on May 15, 2020.  The amended orders reduced some of the restrictions from the previous orders, permitting certain activities in limited or restricted capacities.  Governor Whitmer requested a major disaster declaration on March 26, 2020, which was granted by President Trump on March 28, 2020.

 

COVID-19 is primarily spread between people during close contact, often via small droplets produced by coughing, sneezing or talking.  People may also become infected by touching a contaminated surface and then touching their eyes, nose or mouth.  There is currently no known vaccine or specific antiviral treatment, with the primary treatment being symptomatic and supportive therapies.  Recommended preventive measures include hand washing, covering one’s mouth when coughing and maintaining distance from other people, as well as self-isolation for people who suspect they are infected.

 

The Coronavirus Pandemic has caused severe global socioeconomic disruptions.  It has led to the postponement or cancellation of sporting, religious, political and cultural events, as well as widespread supply shortages exacerbated by panic buying.  Service industry businesses, such as restaurants, hotels, airlines, cruise lines and movie theaters, have been particularly negatively impacted by the restrictions and stay-at-home orders issued by authorities around a vast majority of the world.  The health care industry has also been significantly impacted, from a combination of treating infected patients to the cancellation of medical appointments and elective surgeries.  At the current time, it is highly uncertain as to when conditions will begin to return to normal.  Most agree that a return to normal conditions will be accomplished in phases, taking into account factors such as regional rates and trends of infections, types of businesses and required social distancing measures.  Human behavior will also likely play a significant role as people make individual choices to re-engage in permissible activities.

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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1.	SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Responding to the Coronavirus Pandemic and Governor Whitmer’s stay-at-home orders, by March 23, 2020, over 75% of our employees were working from home.  In addition, beginning on March 18, 2020 our branch lobbies were allowing face-to-face contact with customers by appointment only.  On March 25, 2020, we enhanced our social distancing response by closing our branch lobbies to all customers.  Our customers are conducting banking transactions via drive-thru, virtual banking machines, online banking and our call center. 

 

In response to the substantial negative impact of the Coronavirus Pandemic and the associated social distancing orders and measures on the United States and global economies, Congress passed the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which was signed by President Trump on March 27, 2020.  The CARES Act is in large part a $1.8 trillion spending bill that builds upon two earlier and considerably smaller federal government support measures in the wake of the Coronavirus Pandemic and associated economic fallout.  The CARES Act is comprehensive and touches on many facets of federal government assistance and banking regulatory requirements.  In addition, the Federal Open Market Committee lowered the targeted federal funds rate by 50 basis points on March 3, 2020 and by another 100 basis points on March 15, 2020, and announced the resumption of quantitative easing.

 

The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a negative material impact on our financial condition and results of operations.  We are in an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income.  Additionally, the consequences of the unprecedented economic impact of the Coronavirus Pandemic is likely to result in declining asset quality, reflected by a higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which will necessitate additional provisions for our allowance and reduced net income.

 

Subsequent Event: The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program.  The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors.  The PPP provides 100% guaranteed loans to cover specific operating costs, with the maximum loan size capped at the lesser of 250% of the average monthly payroll costs or $10.0 million. PPP loans are eligible to be forgiven based upon certain criteria.  In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during the eight-week period beginning on the loan origination date.  Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan.  The loan tenor is 24 months, with deferred payments for the first six months, and fully amortizing monthly payments for the following 18 months.  The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee ranging from 1% to 5% of the loan amount paid by the Small Business Administration. Participation in the PPP will likely have a significant impact on our asset mix and net interest income for the remainder of 2020. As of April 30, 2020, we had originated over 1,750 loans aggregating $523 million in loans under the PPP.

 

Congress passed, and on April 24, 2020 President Trump signed, legislation which added $300 billion to the PPP.  Included in the legislation was a specific allocation of $30 billion for financial institutions under $10 billion.

 

Under the CARES Act, a PPP loan is assigned a risk weight of 0% under the risk-based capital rules of the federal banking agencies.  On April 9, 2020, the federal banking agencies issued an interim final rule allowing financial institutions to exclude PPP loans from the average asset calculation to the degree the PPP loans are financed through the Paycheck Protection Program Lending Facility (“PPPLF”) for the Tier 1 Leverage Capital Ratio.

 

In April, 2020, the Federal Reserve initiated the PPPLF, which is designed to facilitate lending by financial institutions to small businesses under the PPP.  Only PPP loans are eligible to serve as collateral for the PPPLF, with each dollar of PPP loans providing one dollar of advance availability.  The maturity date of an extension of credit under the PPPLF will equal the maturity date of the pool of PPP loans pledged to secure the extension of credit.  Any principal payments received by the financial institution on the PPP loans, such as PPP loan forgiveness payments from the Small Business Administration or principal payments from the borrower after the initial six-month deferment period, must be used to pay down the PPPLF advance by the same dollar amount, maintaining the dollar-for-dollar advance amount and PPP aggregate loan balance relationship.  The interest rate on PPPLF advances is fixed at 0.35%.  No PPPLF advances can be obtained after September 30, 2020.  As of April 30, 2020, our advances under the PPPLF totaled $43.7 million.  In general, we plan to obtain additional PPPLF advances as our borrowers utilize PPP loan proceeds for permissible purposes.  It is expected that aggregate PPPLF advances will total 90% to 100% of the aggregate PPP loans at a point during the second quarter.

 

Adoption of New Accounting Standards: In February 2016, the FASB issued ASU 2016-02, Leases. This ASU (as subsequently amended by ASU 2018-01, ASU 2018-10, ASU 2018-11 and ASU 2018-20) establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The ASU was effective for annual and interim periods beginning after December 15, 2018. The adoption of this new standard as of January 1, 2019 resulted in the recording of a ROU asset and associated lease liability of approximately $1.3 million.

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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1.	SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended by ASU 2018-19) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (i) financial assets subject to credit losses and measured at amortized cost, and (ii) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans, and expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019. Financial institutions are not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. An economic forecast is a key component of the CECL methodology.  As we enter into an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by shelter in place declarations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments, financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly updated and there is no economic forecast consensus.  Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted. Had we adopted CECL on January 1, 2020, the allowance would have decreased by $1.0 million, resulting in an increase to retained earnings of $0.8 million.

 

 

 

2.	SECURITIES

  

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

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
March 31, 2020
U.S. Government agency debt obligations		$	161,931,000			$	1,893,000			$	0			$	163,824,000
Mortgage-backed securities			38,514,000				1,258,000				(3,000	)			39,769,000
Municipal general obligation bonds			101,006,000				2,880,000				(21,000	)			103,865,000
Municipal revenue bonds			4,129,000				61,000				(1,000	)			4,189,000
Other investments			500,000				0				0				500,000
		$	306,080,000			$	6,092,000			$	(25,000	)		$	312,147,000
December 31, 2019
U.S. Government agency debt obligations		$	185,103,000			$	2,449,000			$	(1,142,000	)		$	186,410,000
Mortgage-backed securities			41,998,000				554,000				(82,000	)			42,470,000
Municipal general obligation bonds			98,245,000				2,864,000				(30,000	)			101,079,000
Municipal revenue bonds			4,133,000				63,000				0				4,196,000
Other investments			500,000				0				0				500,000
		$	329,979,000			$	5,930,000			$	(1,254,000	)		$	334,655,000

 

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(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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2.    SECURITIES (Continued)

  

Securities with unrealized losses at March 31, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

   

		Less than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss				Value				Loss
March 31, 2020
U.S. Government agency debt obligations		$	0			$	0			$	0			$	0			$	0			$	0
Mortgage-backed securities			1,487,000				2,000				26,000				1,000				1,513,000				3,000
Municipal general obligation bonds			3,894,000				19,000				713,000				2,000				4,607,000				21,000
Municipal revenue bonds			0				0				554,000				1,000				554,000				1,000
		$	5,381,000			$	21,000			$	1,293,000			$	4,000			$	6,674,000			$	25,000

 

 

		Less than 12 Months								12 Months or More								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
December 31, 2019
U.S. Government agency debt obligations		$	25,650,000			$	349,000			$	73,913,000			$	793,000			$	99,563,000			$	1,142,000
Mortgage-backed securities			2,838,000				28,000				10,423,000				54,000				13,261,000				82,000
Municipal general obligation bonds			3,755,000				18,000				994,000				12,000				4,749,000				30,000
Municipal revenue bonds			0				0				0				0				0				0
		$	32,243,000			$	395,000			$	85,330,000			$	859,000			$	117,573,000			$	1,254,000

 

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

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

2.    SECURITIES (Continued) 

 

At March 31, 2020, 30 debt securities with fair values totaling $6.7 million have unrealized losses aggregating to less than $0.1 million. At December 31, 2019, 107 debt securities with fair values totaling $118 million had unrealized losses aggregating $1.3 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that the unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.

 

The amortized cost and fair value of debt securities at March 31, 2020, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

 

		Weighted
		Average			Amortized				Fair
		Yield (%)			Cost				Value
Due in 2020		2.15			$	13,522,000			$	13,531,000
Due in 2021 through 2025		2.02				68,273,000				68,995,000
Due in 2026 through 2030		2.43				114,339,000				116,535,000
Due in 2031 and beyond		3.05				70,932,000				72,817,000
Mortgage-backed securities		2.69				38,514,000				39,769,000
Other investments		5.25				500,000				500,000
Total available for sale securities		2.51			$	306,080,000			$	312,147,000

 

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $100 million and $96.5 million at March 31, 2020 and December 31, 2019, respectively, with estimated market values of $103 million and $99.4 million, respectively. Securities issued by all other states and their political subdivisions had a combined amortized cost of $5.2 million and $5.9 million at March 31, 2020 and December 31, 2019, respectively, with estimated market values of $5.4 million and $5.9 million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, did not exceed 10% of shareholders’ equity.

 

The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $133 million and $103 million at March 31, 2020 and December 31, 2019, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

 

 

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES

 

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

 

Our total loans at March 31, 2020 were $2.90 billion compared to $2.86 billion at December 31, 2019, an increase of $44.9 million, or 1.6%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at March 31, 2020 and December 31, 2019, and the percentage change in loans from the end of 2019 to the end of the first quarter of 2020, are as follows:

 

																		Percent
		March 31, 2020								December 31, 2019								Increase
		Balance				%				Balance				%				(Decrease)
Commercial:
Commercial and industrial		$	873,679,000				30.1	%		$	846,551,000				29.6	%			3.2	%
Vacant land, land development, and residential construction			62,908,000				2.2				56,119,000				2.0				12.1
Real estate – owner occupied			579,229,000				20.0				579,003,000				20.3				0.1
Real estate – non-owner occupied			823,366,000				28.3				835,346,000				29.2				(1.4	)
Real estate – multi-family and residential rental			133,148,000				4.6				124,525,000				4.4				6.9
Total commercial			2,472,330,000				85.2				2,441,544,000				85.5				1.3
Retail:
Home equity and other			72,875,000				2.5				75,374,000				2.6				(3.3	)
1-4 family mortgages			356,338,000				12.3				339,749,000				11.9				4.9
Total retail			429,213,000				14.8				415,123,000				14.5				3.4
Total loans		$	2,901,543,000				100.0	%		$	2,856,667,000				100.0	%			1.6	%

 

Nonperforming loans as of March 31, 2020 and December 31, 2019 were as follows:

 

		March 31,				December 31,
		2020				2019
Loans past due 90 days or more still accruing interest		$	0			$	0
Nonaccrual loans			3,469,000				2,284,000
Total nonperforming loans		$	3,469,000			$	2,284,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The recorded principal balance of nonperforming loans was as follows:

 

		March 31,				December 31,
		2020				2019
Commercial:
Commercial and industrial		$	156,000			$	0
Vacant land, land development, and residential construction			326,000				0
Real estate – owner occupied			287,000				134,000
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			1,000				2,000
Total commercial			770,000				136,000
Retail:
Home equity and other			279,000				255,000
1-4 family mortgages			2,420,000				1,893,000
Total retail			2,699,000				2,148,000
Total nonperforming loans		$	3,469,000			$	2,284,000

 

An age analysis of past due loans is as follows as of March 31, 2020:

 

		30 – 59 Days Past Due				60 – 89 Days Past Due				Greater Than 89 Days Past Due				Total Past Due				Current				Total Loans				Recorded Balance > 89 Days and Accruing
Commercial:
Commercial and industrial		$	123,000			$	579,000			$	0			$	702,000			$	872,977,000			$	873,679,000			$	0
Vacant land, land development, and residential construction			482,000				0				43,000				525,000				62,383,000				62,908,000				0
Real estate – owner occupied			0				0				232,000				232,000				578,997,000				579,229,000				0
Real estate – non-owner occupied			0				0				0				0				823,366,000				823,366,000				0
Real estate – multi-family and residential rental			181,000				0				0				181,000				132,967,000				133,148,000				0
Total commercial			786,000				579,000				275,000				1,640,000				2,470,690,000				2,472,330,000				0
Retail:
Home equity and other			172,000				27,000				58,000				257,000				72,618,000				72,875,000				0
1-4 family mortgages			514,000				0				381,000				895,000				355,443,000				356,338,000				0
Total retail			686,000				27,000				439,000				1,152,000				428,061,000				429,213,000				0
Total past due loans		$	1,472,000			$	606,000			$	714,000			$	2,792,000			$	2,898,751,000			$	2,901,543,000			$	0

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

An age analysis of past due loans is as follows as of December 31, 2019:

 

		30 – 59 Days Past Due				60 – 89 Days Past Due				Greater Than 89 Days Past Due				Total Past Due				Current				Total Loans				Recorded Balance > 89 Days and Accruing
Commercial:
Commercial and industrial		$	0			$	0			$	0			$	0			$	846,551,000			$	846,551,000			$	0
Vacant land, land development, and residential construction			191,000				0				0				191,000				55,928,000				56,119,000				0
Real estate – owner occupied			0				0				134,000				134,000				578,869,000				579,003,000				0
Real estate – non-owner occupied			0				0				0				0				835,346,000				835,346,000				0
Real estate – multi-family and residential rental			0				0				0				0				124,525,000				124,525,000				0
Total commercial			191,000				0				134,000				325,000				2,441,219,000				2,441,544,000				0
Retail:
Home equity and other			171,000				65,000				20,000				256,000				75,118,000				75,374,000				0
1-4 family mortgages			745,000				29,000				529,000				1,303,000				338,446,000				339,749,000				0
Total retail			916,000				94,000				549,000				1,559,000				413,564,000				415,123,000				0
Total past due loans		$	1,107,000			$	94,000			$	683,000			$	1,884,000			$	2,854,783,000			$	2,856,667,000			$	0

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Impaired loans as of March 31, 2020, and average impaired loans for the three months ended March 31, 2020, were as follows:

 

														First Quarter
		Unpaid												Average
		Contractual				Recorded								Recorded
		Principal				Principal				Related				Principal
		Balance				Balance				Allowance				Balance
With no related allowance recorded:
Commercial:
Commercial and industrial		$	10,167,000			$	10,167,000			$	0			$	9,148,000
Vacant land, land development and residential construction			199,000				199,000				0				142,000
Real estate – owner occupied			4,905,000				4,857,000				0				2,762,000
Real estate – non-owner occupied			0				0				0				89,000
Real estate – multi-family and residential rental			26,000				5,000				0				7,000
Total commercial			15,297,000				15,228,000				0				12,148,000
Retail:
Home equity and other			1,359,000				1,273,000				0				1,241,000
1-4 family mortgages			4,851,000				2,683,000				0				2,325,000
Total retail			6,210,000				3,956,000				0				3,566,000
Total with no related allowance recorded		$	21,507,000			$	19,184,000			$	0			$	15,714,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

  

														First Quarter
		Unpaid												Average
		Contractual				Recorded								Recorded
		Principal				Principal				Related				Principal
		Balance				Balance				Allowance				Balance
With an allowance recorded:
Commercial:
Commercial and industrial		$	2,172,000			$	2,172,000			$	1,071,000			$	1,315,000
Vacant land, land development and residential construction			385,000				385,000				85,000				192,000
Real estate – owner occupied			203,000				203,000				13,000				640,000
Real estate – non-owner occupied			0				0				0				0
Real estate – multi-family and residential rental			0				0				0				0
Total commercial			2,760,000				2,760,000				1,169,000				2,147,000
Retail:
Home equity and other			414,000				396,000				289,000				440,000
1-4 family mortgages			613,000				613,000				154,000				485,000
Total retail			1,027,000				1,009,000				443,000				925,000
Total with an allowance recorded		$	3,787,000			$	3,769,000			$	1,612,000			$	3,072,000
Total impaired loans:
Commercial		$	18,057,000			$	17,988,000			$	1,169,000			$	14,295,000
Retail			7,237,000				4,965,000				443,000				4,491,000
Total impaired loans		$	25,294,000			$	22,953,000			$	1,612,000			$	18,786,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Impaired loans as of December 31, 2019, and average impaired loans for the three months ended March 31, 2019, were as follows:

 

														First Quarter
		Unpaid												Average
		Contractual				Recorded								Recorded
		Principal				Principal				Related				Principal
		Balance				Balance				Allowance				Balance
With no related allowance recorded:
Commercial:
Commercial and industrial		$	8,129,000			$	8,129,000			$	0			$	9,487,000
Vacant land, land development and residential construction			85,000				85,000				0				92,000
Real estate – owner occupied			715,000				667,000				0				1,582,000
Real estate – non-owner occupied			178,000				178,000				0				31,000
Real estate – multi-family and residential rental			29,000				9,000				0				26,000
Total commercial			9,136,000				9,068,000				0				11,218,000
Retail:
Home equity and other			1,279,000				1,209,000				0				1,062,000
1-4 family mortgages			3,272,000				1,968,000				0				2,191,000
Total retail			4,551,000				3,177,000				0				3,253,000
Total with no related allowance recorded		$	13,687,000			$	12,245,000			$	0			$	14,471,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.   LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

														First Quarter
		Unpaid												Average
		Contractual				Recorded								Recorded
		Principal				Principal				Related				Principal
		Balance				Balance				Allowance				Balance
With an allowance recorded:
Commercial:
Commercial and industrial		$	460,000			$	458,000			$	202,000			$	5,416,000
Vacant land, land development and residential construction			0				0				0				0
Real estate – owner occupied			1,078,000				1,078,000				982,000				2,823,000
Real estate – non-owner occupied			0				0				0				199,000
Real estate – multi-family and residential rental			0				0				0				135,000
Total commercial			1,538,000				1,536,000				1,184,000				8,573,000
Retail:
Home equity and other			502,000				485,000				356,000				775,000
1-4 family mortgages			358,000				356,000				83,000				748,000
Total retail			860,000				841,000				439,000				1,523,000
Total with an allowance recorded		$	2,398,000			$	2,377,000			$	1,623,000			$	10,096,000
Total impaired loans:
Commercial		$	10,674,000			$	10,604,000			$	1,184,000			$	19,791,000
Retail			5,411,000				4,018,000				439,000				4,776,000
Total impaired loans		$	16,085,000			$	14,622,000			$	1,623,000			$	24,567,000

 

Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated collateral value. Interest income recognized on accruing troubled debt restructurings totaled $0.3 million during the first quarter of 2020 and 2019. No interest income was recognized on nonaccrual loans during either the first quarter of 2020 or 2019. Lost interest income on nonaccrual loans totaled less than $0.1 million during the first quarter of 2020 and 2019.

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

 

Credit quality indicators were as follows as of March 31, 2020:

 

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

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Internal credit risk grade groupings:
Grades 1 – 4		$	528,288,000			$	24,943,000			$	340,680,000			$	562,617,000			$	74,923,000
Grades 5 – 7			333,023,000				37,263,000				233,258,000				260,617,000				58,088,000
Grades 8 – 9			12,368,000				702,000				5,291,000				132,000				137,000
Total commercial		$	873,679,000			$	62,908,000			$	579,229,000			$	823,366,000			$	133,148,000

                 

Retail credit exposure – credit risk profiled by collateral type:

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Performing			72,596,000				353,918,000
Nonperforming			279,000				2,420,000
Total retail		$	72,875,000			$	356,338,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Credit quality indicators were as follows as of December 31, 2019:

 

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

        

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Internal credit risk grade groupings:
Grades 1 – 4		$	521,920,000			$	26,065,000			$	351,671,000			$	563,087,000			$	85,152,000
Grades 5 – 7			309,824,000				29,716,000				220,980,000				272,124,000				39,203,000
Grades 8 – 9			14,807,000				338,000				6,352,000				135,000				170,000
Total commercial		$	846,551,000			$	56,119,000			$	579,003,000			$	835,346,000			$	124,525,000

 

Retail credit exposure – credit risk profiled by collateral type:

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Performing			75,119,000				337,856,000
Nonperforming			255,000				1,893,000
Total retail		$	75,374,000			$	339,749,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.	LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

All commercial loans are graded using the following criteria:

 

	Grade 1.	“Exceptional” Loans with this rating contain very little, if any, risk.
	Grade 2.	“Outstanding” Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.
	Grade 3.	“Very Good” Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are acceptable.
	Grade 4.	“Good” Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are modest.
	Grade 5.	“Acceptable” Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements. These are for loans for which repayment risks are satisfactory.
	Grade 6.	“Monitor” Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report.
	Grade 7.	“Special Mention” Loans with this rating have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.
	Grade 8.	“Substandard” Loans with this rate are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any. A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility of loss if the deficiencies are not corrected.
	Grade 9.	“Doubtful” Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.
	Grade 10.	“Loss” Loans with this rating are considered uncollectable, and of such little value that continuance as an active asset is not warranted.

 

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

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity in the allowance for loan losses and the recorded investments in loans as of and during the three months ended March 31, 2020 are as follows:

 

		Commercial				Retail
		Loans				Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	21,070,000			$	2,749,000			$	70,000			$	23,889,000
Provision for loan losses			573,000				247,000				(70,000	)			750,000
Charge-offs			(13,000	)			(27,000	)			0				(40,000	)
Recoveries			120,000				109,000				0				229,000
Ending balance		$	21,750,000			$	3,078,000			$	0			$	24,828,000
Ending balance: individually evaluated for impairment		$	1,169,000			$	443,000			$	0			$	1,612,000
Ending balance: collectively evaluated for impairment		$	20,581,000			$	2,635,000			$	0			$	23,216,000
Total loans:
Ending balance		$	2,472,330,000			$	429,213,000							$	2,901,543,000
Ending balance: individually evaluated for impairment		$	17,988,000			$	4,965,000							$	22,953,000
Ending balance: collectively evaluated for impairment		$	2,454,342,000			$	424,248,000							$	2,878,590,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity in the allowance for loan losses for loans during the three months ended March 31, 2019 and the recorded investments in loans as of December 31, 2019 are as follows:

 

		Commercial				Retail
		Loans				Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	19,619,000			$	2,717,000			$	44,000			$	22,380,000
Provision for loan losses			562,000				104,000				184,000				850,000
Charge-offs			0				(174,000	)			0				(174,000	)
Recoveries			30,000				49,000				0				79,000
Ending balance		$	20,211,000			$	2,696,000			$	228,000			$	23,135,000
Ending balance: individually evaluated for impairment		$	936,000			$	411,000			$	0			$	1,347,000
Ending balance: collectively evaluated for impairment		$	19,275,000			$	2,285,000			$	228,000			$	21,788,000
Total loans:
Ending balance		$	2,441,544,000			$	415,123,000							$	2,856,667,000
Ending balance: individually evaluated for impairment		$	10,986,000			$	4,070,000							$	15,056,000
Ending balance: collectively evaluated for impairment		$	2,430,558,000			$	411,053,000							$	2,841,611,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Loans modified as troubled debt restructurings during the three months ended March 31, 2020 were as follows:

 

						Pre-				Post-
						Modification				Modification
						Recorded				Recorded
		Number of				Principal				Principal
		Contracts				Balance				Balance
Commercial:
Commercial and industrial			6			$	6,539,000			$	6,536,000
Vacant land, land development and residential construction			0				0				0
Real estate – owner occupied			8				3,661,000				4,259,000
Real estate – non-owner occupied			0				0				0
Real estate – multi-family and residential rental			0				0				0
Total commercial			14				10,200,000				10,795,000
Retail:
Home equity and other			3				65,000				52,000
1-4 family mortgages			0				0				0
Total retail			3				65,000				52,000
Total loans			17			$	10,265,000			$	10,847,000

 

Loans modified as troubled debt restructurings during the three months ended March 31, 2019 were as follows:

 

						Pre-				Post-
						Modification				Modification
						Recorded				Recorded
		Number of				Principal				Principal
		Contracts				Balance				Balance
Commercial:
Commercial and industrial			11			$	3,164,000			$	3,164,000
Vacant land, land development and residential construction			0				0				0
Real estate – owner occupied			2				760,000				749,000
Real estate – non-owner occupied			0				0				0
Real estate – multi-family and residential rental			0				0				0
Total commercial			13				3,924,000				3,913,000
Retail:
Home equity and other			4				70,000				70,000
1-4 family mortgages			1				32,000				32,000
Total retail			5				102,000				102,000
Total loans			18			$	4,026,000			$	4,015,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

---

  

3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2020 (amounts as of period end):

            

						Recorded
		Number of				Principal
		Contracts				Balance
Commercial:
Commercial and industrial			0			$	0
Vacant land, land development and residential construction			0				0
Real estate – owner occupied			1				97,000
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			1				97,000
Retail:
Home equity and other			0				0
1-4 family mortgages			0				0
Total retail			0				0
Total			1			$	97,000

   

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2019 (amounts as of period end):

 

						Recorded
		Number of				Principal
		Contracts				Balance
Commercial:
Commercial and industrial			0			$	0
Vacant land, land development and residential construction			0				0
Real estate – owner occupied			0				0
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			0				0
Retail:
Home equity and other			2				54,000
1-4 family mortgages			0				0
Total retail			2				54,000
Total			2			$	54,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

  

Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2020 is as follows:

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Commercial Loan Portfolio:
Beginning Balance		$	8,587,000			$	85,000			$	1,145,000			$	178,000			$	7,000
Charge-Offs			0				0				0				0				0
Payments			(2,832,000	)			(3,000	)			(988,000	)			(4,000	)			(4,000	)
Transfers to ORE			0				0				0				0				0
Net Additions/Deletions			6,449,000				0				3,654,000				0				0
Ending Balance		$	12,204,000			$	82,000			$	3,811,000			$	174,000			$	3,000

 

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Retail Loan Portfolio:
Beginning Balance		$	1,415,000			$	724,000
Charge-Offs			0				0
Payments			(29,000	)			(9,000	)
Transfers to ORE			0				0
Net Additions/Deletions			66,000				0
Ending Balance		$	1,452,000			$	715,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2019 is as follows:

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Commercial Loan Portfolio:
Beginning Balance		$	14,138,000			$	0			$	3,100,000			$	210,000			$	24,000
Charge-Offs			0				0				0				0				0
Payments			(1,666,000	)			0				(48,000	)			(21,000	)			(3,000	)
Transfers to ORE			0				0				(97,000	)			0				0
Net Additions/Deletions			3,138,000				0				740,000				0				0
Ending Balance		$	15,610,000			$	0			$	3,695,000			$	189,000			$	21,000

 

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Retail Loan Portfolio:
Beginning Balance		$	1,402,000			$	578,000
Charge-Offs			0				0
Payments			(28,000	)			(11,000	)
Transfers to ORE			0				0
Net Additions/Deletions			70,000				32,000
Ending Balance		$	1,444,000			$	599,000

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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3.    LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)  

 

The allowance related to loans categorized as troubled debt restructurings was as follows: 

 

		March 31,				December 31,
		2020				2019
Commercial:
Commercial and industrial		$	953,000			$	202,000
Vacant land, land development, and residential construction			1,000				0
Real estate – owner occupied			3,000				982,000
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			957,000				1,184,000
Retail:
Home equity and other			246,000				311,000
1-4 family mortgages			154,000				83,000
Total retail			400,000				394,000
Total related allowance		$	1,357,000			$	1,578,000

 

 

In general, our policy dictates that a renewal or modification of an 8- or 9-rated commercial loan meets the criteria of a troubled debt restructuring, although we review and consider all renewed and modified loans as part of our troubled debt restructuring assessment procedures. Loan relationships rated 8 contain significant financial weaknesses, resulting in a distinct possibility of loss, while relationships rated 9 reflect vital financial weaknesses, resulting in a highly questionable ability on our part to collect principal. We believe borrowers warranting such ratings would have difficulty obtaining financing from other market participants. Thus, due to the lack of comparable market rates for loans with similar risk characteristics, we believe 8- or 9-rated loans renewed or modified were done so at below market rates. Loans that are identified as troubled debt restructurings are considered impaired and are individually evaluated for impairment when assessing these credits in our allowance for loan losses calculation.

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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