MERCANTILE BANK : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

Forward Looking Statements

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



Future Factors include, among others, adverse changes in interest rates and
interest rate relationships; increasing rates of inflation and slower growth
rates; significant declines in the value of commercial real estate; market
volatility; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation or
actions by bank regulators; changes in the method of determining Libor and the
phase out of Libor; changes in tax laws; changes in prices, levies, and
assessments; the impact of technological advances; risks associated with
cyber-attacks on our computer systems; governmental and regulatory policy
changes; our participation in the Paycheck Protection Program administered by
the Small Business Administration; the outcomes of contingencies; trends in
customer behavior as well as their ability to repay loans; changes in local real
estate values; damage to our reputation resulting from adverse publicity,
regulatory actions, litigation, operational failures, the failure to meet client
expectations and other facts; changes in the national and local economies,
including the significant disruption to financial market and other economic
activity caused by the outbreak and continuance of the Coronavirus Pandemic; and
risk factors described in our annual report on Form 10-K for the year ended
December 31, 2020, our March 31, 2021 Form 10-Q or in this report. These are
representative of the Future Factors that could cause a difference between an
ultimate actual outcome and a forward-looking statement.

Introduction

The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, including Mercantile Bank of
Michigan ("our bank") and our bank's subsidiary, Mercantile Insurance Center,
Inc. ("our insurance company"), at June 30, 2021 and December 31, 2020 and the
results of operations for the three months and six months ended June 30, 2021
and June 30, 2020. This discussion should be read in conjunction with the
interim consolidated financial statements and footnotes included in this report.
Unless the text clearly suggests otherwise, references in this report to "us,"
"we," "our" or "the company" include Mercantile Bank Corporation and its
consolidated subsidiaries referred to above.

Critical Accounting Policies

GAAP is complex and requires us to apply significant judgment to various
accounting, reporting and disclosure matters. We must use assumptions and
estimates to apply these principles where actual measurements are not possible
or practical. This Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our unaudited
financial statements included in this report. For a discussion of our
significant accounting policies, see Note 1 of the Notes to our Consolidated
Financial Statements included in our Form 10-K for the fiscal year ended
December 31, 2020 (Commission file number 000-26719). Our critical accounting
policies are highly dependent upon subjective or complex judgments, assumptions
and estimates. Changes in such estimates may have a significant impact on the
financial statements, and actual results may differ from those estimates. We
have reviewed the application of these policies with the Audit Committee of our
Board of Directors.

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Allowance for Loan Losses: The allowance for loan losses ("allowance") is
maintained at a level we believe is adequate to absorb probable incurred losses
identified and inherent in the loan portfolio. Our evaluation of the adequacy of
the allowance is an estimate based on past loan loss experience, the nature and
volume of the loan portfolio, information about specific borrower situations and
estimated collateral values, guidance from bank regulatory agencies, and
assessments of the impact of current and anticipated economic conditions on the
loan portfolio. Allocations of the allowance may be made for specific loans, but
the entire allowance is available for any loan that, in our judgment, should be
charged-off. Loan losses are charged against the allowance when we believe the
uncollectability of a loan is likely. The balance of the allowance represents
our best estimate, but significant downturns in circumstances relating to loan
quality or economic conditions could result in a requirement for an increased
allowance in the future. Likewise, an upturn in loan quality or improved
economic conditions may result in a decline in the required allowance in the
future. In either instance, unanticipated changes could have a significant
impact on the allowance and operating results. Loans made under the Payment
Protection Program are fully guaranteed by the Small Business Administration;
therefore, such loans do not have an associated allowance.



The allowance is increased through a provision charged to operating expense.
Uncollectable loans are charged-off through the allowance. Recoveries of loans
previously charged-off are added to the allowance. A loan is considered impaired
when it is probable that contractual interest and principal payments will not be
collected either for the amounts or by the dates as scheduled in the loan
agreement. Impairment is evaluated on an individual loan basis. If a loan is
impaired, a portion of the allowance is allocated so that the loan is reported,
net, at the present value of estimated future cash flows using the loan's
existing rate or at the fair value of collateral if repayment is expected solely
from the collateral. The timing of obtaining outside appraisals varies,
generally depending on the nature and complexity of the property being
evaluated, general breadth of activity within the marketplace and the age of the
most recent appraisal. For collateral dependent impaired loans, in most cases we
obtain and use the "as is" value as indicated in the appraisal report, adjusting
for any expected selling costs. In certain circumstances, we may internally
update outside appraisals based on recent information impacting a particular or
similar property, or due to identifiable trends (e.g., recent sales of similar
properties) within our markets. The expected future cash flows exclude potential
cash flows from certain guarantors. To the extent these guarantors provide
repayments, a recovery would be recorded upon receipt. Loans are evaluated for
impairment when payments are delayed, typically 30 days or more, or when serious
deficiencies are identified within the credit relationship. Our policy for
recognizing income on impaired loans is to accrue interest unless a loan is
placed on nonaccrual status. We put loans into nonaccrual status when the full
collection of principal and interest is not expected.



Financial institutions were not required to comply with the Current Expected
Credit Loss ("CECL") methodology requirements from the enactment date of the
Coronavirus Aid, Relief and Economic Security Act ("CARES Act") until the
earlier of the end of the President's declaration of a National Emergency or
December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted
in December 2020, provided for an extension of the required CECL adoption date
to January 1, 2022, which is the date we expect to adopt. An economic forecast
is a key component of the CECL methodology. As we continue to experience an
unprecedented economic environment whereby a sizable portion of the economy has
been significantly impacted by government-imposed activity limitations and
similar reactions by businesses and individuals, substantial government stimulus
has been provided to businesses, individuals and state and local governments and
financial institutions have offered businesses and individuals payment relief
options, economic forecasts are regularly revised. 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.

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



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



Securities and Other Financial Instruments: Securities available for sale
consist of bonds and notes which might be sold prior to maturity due to changes
in interest rates, prepayment risks, yield and availability of alternative
investments, liquidity needs or other factors. Securities classified as
available for sale are reported at their fair value. Declines in the fair value
of securities below their cost that are other-than-temporary are reflected as
realized losses. In estimating other-than-temporary losses, management
considers: (1) the length of time and extent that fair value has been less than
carrying value? (2) the financial condition and near term prospects of the
issuer? and (3) the Company's ability and intent to hold the security for a
period of time sufficient to allow for any anticipated recovery in fair value.
Fair values for securities available for sale are obtained from outside sources
and applied to individual securities within the portfolio. The difference
between the amortized cost and the current fair value of securities is recorded
as a valuation adjustment and reported in other comprehensive income.



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



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



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





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Coronavirus Pandemic

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"). While the economic fallout
has stabilized somewhat and the adult population in the United States is in the
process of being vaccinated, there remains a significant amount of stress and
uncertainty across national and global economies. This uncertainty is heightened
as certain geographic areas continue to experience surges in Covid-19 cases and
governments at all levels continue to react to changes in circumstances.



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

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

  ? Paycheck Protection Program


The Paycheck Protection Program ("PPP") reflects a substantial expansion of the
Small Business Administration's 100% guaranteed 7(a) loan program. The CARES Act
authorized up to $350 billion in loans to businesses with fewer than 500
employees, including non-profit organizations, tribal business concerns,
self-employed and individual contractors. The PPP provides 100% guaranteed loans
to cover specific operating costs. PPP loans are eligible to be forgiven based
upon certain criteria. In general, the amount of the loan that is forgivable is
the sum of the payroll costs, interest payments on mortgages, rent and utilities
incurred or paid by the business during a prescribed period beginning on the
loan origination date. Any remaining balance after forgiveness is maintained at
the 100% guarantee for the duration of the loan. The interest rate on the loan
is fixed at 1.00%, with the financial institution receiving a loan origination
fee paid by the Small Business Administration. The loan origination fees, net of
the direct origination costs, are accreted into interest income on loans using
the level yield methodology. The program ended on August 8, 2020. We originated
approximately 2,200 loans aggregating $553 million. As of June 30, 2021, we
recorded forgiveness transactions on approximately 1,900 loans aggregating $487
million. Net loan origination fees of $3.5 million were recorded during the
first six months of 2021.



The Consolidated Appropriations Act, 2021 authorized an additional $284 billion
in Second Draw PPP loans ("Second Draw"). The program ended on May 31, 2021.
Under the Second Draw, we originated approximately 1,200 loans aggregating $209
million. As of June 30, 2021, we recorded forgiveness transactions on
approximately 200 loans aggregating $29.2 million. Net loan origination fees of
$2.2 million were recorded during the first six months of 2021 under the Second
Draw.

A PPP loan is assigned a risk weight of 0% under the risk-based capital rules of the federal banking agencies.

  ? Individual Economic Impact Payments


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





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? Troubled Debt Restructuring Relief

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



  ? Current Expected Credit Loss Methodology Delay


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. The Consolidated Appropriations Act, 2021 extended the
adoption deferral date to January 1, 2022.



In early April 2020, in response to the early stages of the Coronavirus Pandemic
and its pervasive impact across the economy and financial markets, we developed
internal programs of loan payment deferments for commercial and retail
borrowers. For commercial borrowers, we offered 90-day (three payments) interest
only amendments as well as 90-day (three payments) principal and interest
payment deferments. Under the latter program, borrowers were 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. The single payment notes
receive a loan grade equal to the loan grade of each respective borrowing
relationship. Certain of our commercial loan borrowers subsequently requested
and received an additional 90-day (three payments) interest only amendment or
90-day (three payments) principal and interest payment deferment. Under the
latter program, the amount equal to the three payments was added to the original
deferment note which has nine months remaining to maturity; however, the
original 0% interest rate is modified to equal the rate associated with each
borrower's traditional lending relationship with us for the remainder of the
term. At the peak of activity in mid-2020, nearly 750 borrowers with loan
balances aggregating $719 million were participating in the commercial loan
payment deferment program. As of June 30, 2021, we had no loans in the
commercial loan payment deferment program.



For retail borrowers, we offered 90-day (three payments) principal and interest
payment deferments, with deferred amounts added to the end of the loan. As of
June 30, 2020, we had processed 260 principal and interest payment deferments
with loan balances totaling $23.8 million. As of June 30, 2021, only six
borrowers with loan balances aggregating $0.5 million remained in the retail
loan payment deferment program.

Financial Overview

We reported net income of $18.1 million, or $1.12 per diluted share, for the
second quarter of 2021, compared to net income of $8.7 million, or $0.54 per
diluted share, during the second quarter of 2020. Net income for the first six
months of 2021 totaled $32.3 million, or $2.00 per diluted share, compared to
$19.4 million, or $1.19 per diluted share, during the first six months of 2020.



Commercial loans increased $16.3 million during the first six months of 2021,
reflecting the combined net growth of core commercial loans and net activity
under the PPP. Core commercial loans increased $135 million, or approximately
11% on an annualized basis, during the first six months of 2021. Net PPP loans
declined $119 million during the first six months of 2021, comprised of $209 in
million PPP loans extended and $328 million in forgiveness transactions. As a
percentage of total commercial loans, commercial and industrial loans (excluding
PPP loans) and owner occupied commercial real estate ("CRE") loans combined
equaled 54.9% as of June 30, 2021, compared to 53.9% at December 31, 2020. The
new commercial loan pipeline remains strong, and at June 30, 2021, we had $167
million in unfunded loan commitments on commercial construction and development
loans that are in the construction phase.





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The overall quality of our loan portfolio remains strong, with nonperforming
loans equaling only 0.08% of total loans as of June 30, 2021. Accruing loans
past due 30 to 89 days remain very low. Gross loan charge-offs totaled less than
$0.1 million during the second quarter of 2021, and aggregated $0.1 million for
the first six months of the year, while recoveries of prior period loan
charge-offs equaled $0.4 million and $0.9 million during the respective time
periods. A net loan recovery, as a percentage of average total loans, equaled an
annualized 0.04% and 0.05% during the second quarter and first six months of
2021, respectively.



We recorded a negative loan loss provision expense of $3.1 million during the
second quarter of 2021, compared to a provision expense of $7.6 million during
the second quarter of 2020. We recorded a negative loan loss provision expense
of $2.8 million during the first six months of 2021, compared to a provision
expense of $8.4 million during the first six months of 2020. The negative
provision expense recorded in the 2021 periods was mainly comprised of a reduced
reserve allocation associated with the economic and business conditions
environmental factor, reflecting improvement in both current and forecasted
economic conditions. The provision expense recorded during the 2020 periods
mainly consisted of an allocation associated with a newly created Coronavirus
Pandemic environmental factor ("Covid-19 factor") and an increased allocation
related to the existing economic and business conditions environmental factor.
The Covid-19 factor was added to address the unique challenges and economic
uncertainty resulting from the Coronavirus Pandemic and its potential impact on
the collectability of the loan portfolio.



Interest-earning balances, primarily consisting of funds deposited at the
Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and
interest rate risk sensitivity. During the first six months of 2021, the average
balance of these funds equaled $606 million, or 13.8% of average earning assets,
compared to $203 million, or 5.6% of average earning assets, during the first
six months of 2020, and a more typical $81.3 million, or 2.5% of average earning
assets, during the first six months of 2019. The elevated level during 2020 and
into the first half of 2021 primarily reflects increased local deposits stemming
from federal government stimulus payments and reduced business and consumer
investing and spending. The excess level of funds on deposit with the Federal
Reserve Bank of Chicago had a negative impact of 35 to 40 basis points on our
net interest margin during the second quarter and first six months of 2021.



Total local deposits increased $276 million during the first six months of 2021,
and are up $1.1 billion since year-end 2019, equating to growth rates of about
8% and 42%, respectively. Approximately two-thirds of the deposit increase
during the first six months of 2021 and the last 18 months is comprised of
increased noninterest-bearing checking account balances.



Net interest income increased $0.3 million during the second quarter of 2021
compared to the second quarter of 2020, while decreasing $0.5 million during the
first six months of 2021 compared to the first six months of 2020. Interest
income and interest expense declined during the 2021 periods compared to the
prior-year periods primarily due to Federal Open Market Committee's ("FOMC")
federal funds rate cuts totaling 150 basis points in March of 2020 and a low
interest rate environment since that time. Interest income declined by $1.4
million during the second quarter of 2021 from the second quarter of 2020, and
was down $4.5 million during the first six months of 2021 compared to the first
six months of 2020. During the same time periods, interest expense was down $1.7
million and $4.1 million, respectively.



Noninterest income during the second quarter of 2021 was $14.6 million, compared
to $11.0 million during the prior-year second quarter. Noninterest income during
the first six months of 2021 was $28.0 million, compared to $17.5 million during
the same time period in 2020. The improved level mainly resulted from increased
mortgage banking income and fee income generated from a commercial lending
interest rate swap program that was introduced in the latter part of 2020. In
addition, a gain on the sale of a branch totaling $1.1 million was recorded
during the second quarter of 2021.



Noninterest expense during the second quarter of 2021 was $26.2 million,
compared to $23.2 million during the prior-year second quarter. Noninterest
expense during the first six months of 2021 was $51.3 million, compared to $46.2
million during the same time period in 2020. A majority of the increase is in
salary and benefit costs, in large part reflecting increased health insurance
costs, annual employee merit pay increases, and a lower level of deferred salary
costs associated with PPP loan originations. In addition, we accrued for our
bonus programs during the 2021 periods, which we did not do during the 2020
periods due to the onset of the Coronavirus Pandemic.



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Financial Condition

Our total assets increased $320 million during the first six months of 2021, and
totaled $4.76 billion as of June 30, 2021. Total loans increased $55.4 million,
securities available for sale were up $119 million and interest-earning deposits
grew by $120 million, while total deposits increased $260 million and sweep
accounts were up $51.4 million, during the first six months of 2021.



Commercial loans increased $16.3 million during the first six months of 2021,
and at June 30, 2021 totaled $2.81 billion, or 86.5% of the loan portfolio. As
of December 31, 2020, the commercial loan portfolio comprised 87.5% of total
loans. The increase in commercial loans reflects the combined net growth of core
commercial loans and net activity under the PPP. Core commercial loans increased
$135 million, or approximately 11% on an annualized basis, while PPP loans
declined $119 million, comprised of $209 million in PPP loans extended and $328
million in forgiveness transactions, during the first six months of 2021. Core
commercial and industrial loans increased $135 million, non-owner occupied CRE
loans grew $33.6 million, owner occupied CRE loans were up $20.6 million and
multi-family and residential rental property loans increased $15.8 million,
while vacant land, land development and residential construction loans declined
$11.9 million. As a percentage of total commercial loans, commercial and
industrial loans (excluding PPP loans) and owner occupied CRE loans combined
equaled 54.9% as of June 30, 2021, compared to 53.9% at December 31, 2020.



As of June 30, 2021, availability on existing construction and development loans
totaled $167 million, with most of those funds expected to be drawn over the
next 12 to 18 months. Our current pipeline reports indicate continued strong
commercial loan funding opportunities in future periods, including $161 million
in new lending commitments, a majority of which we expect to be accepted and
funded over the next 12 to 18 months. Our commercial lenders also report ongoing
additional opportunities they are currently discussing with existing and
potential new borrowers. We remain committed to prudent underwriting standards
that provide for an appropriate yield and risk relationship, as well as
concentration limits we have established within our commercial loan portfolio.



Residential mortgage loans increased $42.4 million during the first six months
of 2021, totaling $380 million, or 11.7% of total loans, as of June 30, 2021.
Activity within the residential mortgage loan function was very active during
the first half of 2021, primarily reflecting refinance transactions spurred by
low residential mortgage loan interest rates, strength in home purchase
activity, and the continuing success of strategic initiatives that have been
implemented over the past several years to gain market share and increase
production. We originated $482 million in residential mortgage loans during the
first six months of 2021, an increase of over 18% compared to originations
during the first six months of 2020. The production composition during the first
six months of 2021 was almost equal between purchase and refinance residential
mortgage loans; however, the mix changed significantly between the first and
second quarters. Refinance residential mortgage loans comprised approximately
67% of production during the first three months of 2021, but dropped to about
39% during the second quarter. Residential mortgage loans originated for sale,
generally consisting of longer-term fixed rate residential mortgage loans,
during the first six months of 2021 totaled $336 million, or approximately 70%
of total residential mortgage loans originated. During the first six months of
2020, residential mortgage loans originated for sale totaled $321 million, or
about 79% of total mortgage loans originated. Residential mortgage loans
originated not sold are generally comprised of adjustable rate residential
mortgage loans. We are pleased with the results of our strategic initiatives
associated with the growth of our residential mortgage banking operation over
the past few years, and remain optimistic that origination volumes will remain
solid in future periods.



Other consumer-related loans declined $3.4 million during the first six months
of 2021, and at June 30, 2021 totaled $58.2 million, or 1.8% of total loans.
Other consumer-related loans comprised 1.9% of total loans as of December 31,
2020. We expect this loan portfolio segment to decline in future periods as
scheduled principal payments exceed anticipated new loan origination volumes.

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



                                           6/30/21             3/31/21            12/31/20             9/30/20             6/30/20
Commercial:
Commercial & Industrial                $ 1,103,807,000     $ 1,284,507,000

$ 1,145,423,000 $ 1,321,419,000 $ 1,307,455,000 Land Development & Construction

             43,111,000          58,738,000  

55,055,000 50,941,000 52,984,000 Owner Occupied Commercial RE

               550,504,000         544,342,000  

529,953,000 549,364,000 567,621,000 Non-Owner Occupied Commercial RE

           950,993,000         932,334,000  

917,436,000 878,897,000 841,145,000 Multi-Family & Residential Rental 161,894,000 147,294,000

       146,095,000         137,740,000         132,047,000
Total Commercial                         2,810,309,000       2,967,215,000       2,793,962,000       2,938,361,000       2,901,252,000

Retail:
1-4 Family Mortgages                       380,292,000         337,844,000 

337,888,000 348,460,000 367,061,000 Home Equity & Other Consumer Loans 58,240,000 59,311,000

        61,620,000          63,723,000          64,743,000
Total Retail                               438,532,000         397,155,000         399,508,000         412,183,000         431,804,000

Total                                  $ 3,248,841,000     $ 3,364,370,000     $ 3,193,470,000     $ 3,350,544,000     $ 3,333,056,000




(*) Includes $246 million, $455 million, $365 million, $555 million and $549
million in loans originated under the Paycheck Protection Program for June 30,
2021, March 31, 2021, December 31, 2020, September 30, 2020, and June 30, 2020,
respectively.



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



Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or
more and accruing interest and foreclosed properties, totaled $3.2 million (0.1%
of total assets) as of June 30, 2021, compared to $4.1 million (0.1% of total
assets) as of December 31, 2020. Given the low level of nonperforming loans and
accruing loans 30 to 89 days delinquent, combined with the manageable and steady
level of watch list credits and what we believe are strong credit administration
practices, we remain pleased with the overall quality of the loan portfolio.



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



         NONPERFORMING LOANS




                                    6/30/21         3/31/21        12/31/20         9/30/20         6/30/20
Residential Real Estate:
Land Development                  $    34,000     $    34,000     $    35,000     $    36,000     $    36,000
Construction                                0               0               0         198,000         198,000
Owner Occupied / Rental             2,096,000       2,294,000       2,519,000       2,399,000       2,552,000
                                    2,130,000       2,328,000       2,554,000       2,633,000       2,786,000

Commercial Real Estate:
Land Development                            0               0               0               0               0
Construction                                0               0               0               0               0
Owner Occupied                              0         283,000         619,000       1,262,000         275,000
Non-Owner Occupied                          0               0          22,000          23,000          25,000
                                            0         283,000         641,000       1,285,000         300,000

Non-Real Estate:
Commercial Assets                     606,000         169,000         172,000         198,000          98,000
Consumer Assets                        10,000          13,000          17,000          25,000          28,000
                                      616,000         182,000         189,000         223,000         126,000

Total                             $ 2,746,000     $ 2,793,000     $ 3,384,000     $ 4,141,000     $ 3,212,000






          OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS




                            6/30/21       3/31/21      12/31/20       9/30/20       6/30/20
Residential Real Estate:
Land Development           $       0     $       0     $       0     $       0     $       0
Construction                       0             0             0             0             0
Owner Occupied / Rental       41,000        11,000        88,000       198,000       198,000
                              41,000        11,000        88,000       198,000       198,000

Commercial Real Estate:
Land Development                   0             0             0             0             0
Construction                       0             0             0             0             0
Owner Occupied               363,000       363,000       613,000       314,000             0
Non-Owner Occupied                 0             0             0             0             0
                             363,000       363,000       613,000       314,000             0

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

Total                      $ 404,000     $ 374,000     $ 701,000     $ 512,000     $ 198,000

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The following tables provide a reconciliation of nonperforming assets:

NONPERFORMING LOANS RECONCILIATION

                                       2nd Qtr         1st Qtr         4th Qtr          3rd Qtr         2nd Qtr
                                        2021            2021             2020            2020            2020

Beginning balance                    $ 2,793,000     $ 3,384,000     $  4,141,000     $ 3,212,000     $ 3,469,000
Additions, net of transfers to ORE       492,000         116,000          538,000       1,301,000         220,000
Returns to performing status                   0        (115,000 )              0         (72,000 )       (26,000 )
Principal payments                      (484,000 )      (559,000 )     (1,064,000 )      (249,000 )      (278,000 )
Loan charge-offs                         (55,000 )       (33,000 )       (231,000 )       (51,000 )      (173,000 )

Total                                $ 2,746,000     $ 2,793,000     $  3,384,000     $ 4,141,000     $ 3,212,000

          OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

                         2nd Qtr       1st Qtr        4th Qtr        3rd Qtr       2nd Qtr
                          2021           2021           2020          2020          2020

Beginning balance $ 374,000 $ 701,000 $ 512,000 $ 198,000 $ 271,000 Additions

                  30,000              0        434,000       314,000             0
Sale proceeds                   0        (77,000 )     (245,000 )           0       (49,000 )
Valuation write-downs           0       (250,000 )            0             0       (24,000 )

Total                   $ 404,000     $  374,000     $  701,000     $ 512,000     $ 198,000






Gross loan charge-offs totaled less than $0.1 million during the second quarter
of 2021, and aggregated $0.1 million for the first six months of the year, while
recoveries of prior period loan charge-offs equaled $0.4 million and $0.9
million during the respective time periods. A net loan recovery, as a percentage
of average total loans, equaled an annualized 0.04% and 0.05% during the second
quarter and first six months of 2021, respectively. We continue our collection
efforts on charged-off loans, and expect to record recoveries in future periods;
however, given the nature of these efforts, it is not practical to forecast the
dollar amount and timing of the recoveries. The allowance equaled $35.9 million,
or 1.11% of total loans (1.20% of total loans excluding PPP loans), and over
1,300% of nonperforming loans as of June 30, 2021.



In each accounting period, we adjust the allowance to the amount we believe is
necessary to maintain the allowance at an adequate level. Through the loan
review and credit departments, we establish portions of the allowance based on
specifically identifiable problem loans. The evaluation of the allowance is
further based on, but not limited to, consideration of the internally prepared
allowance analysis, loan loss migration analysis, composition of the loan
portfolio, third party analysis of the loan administration processes and
portfolio, and general economic conditions.





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Financial institutions were not required to comply with the CECL methodology
requirements from the enactment date of the CARES Act until the earlier of the
end of the President's declaration of a National Emergency or December 31, 2020.
The Consolidated Appropriations Act, 2021, that was enacted in December 2020,
provided for an extension of the required CECL adoption date to January 1, 2022,
which is the date we plan to adopt. An economic forecast is a key component of
the CECL methodology. As we continue to experience an unprecedented economic
environment whereby a sizable portion of the economy has been significantly
impacted by government-imposed activity limitations and similar reactions by
businesses and individuals, substantial government stimulus has been provided to
businesses, individuals and state and local governments and financial
institutions have offered businesses and individuals payment relief options,
economic forecasts are regularly revised. 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.



The allowance analysis applies reserve allocation factors to non-impaired
outstanding loan balances, the result of which is combined with specific
reserves to calculate an overall allowance dollar amount. For non-impaired
commercial loans, reserve allocation factors are based on the loan ratings as
determined by our standardized grade paradigms and by loan purpose. Our
commercial loan portfolio is segregated into five classes: 1) commercial and
industrial loans; 2) vacant land, land development and residential construction
loans; 3) owner occupied real estate loans; 4) non-owner occupied real estate
loans; and 5) multi-family and residential rental property loans. The reserve
allocation factors are primarily based on the historical trends of net loan
charge-offs through a migration analysis whereby net loan losses are tracked via
assigned grades over various time periods, with adjustments made for
environmental factors reflecting the current status of, or recent changes in,
items such as: lending policies and procedures; economic conditions; nature and
volume of the loan portfolio; experience, ability and depth of management and
lending staff; volume and severity of past due, nonaccrual and adversely
classified loans; effectiveness of the loan review program; value of underlying
collateral; loan concentrations; and other external factors such as competition
and regulatory environment.



We established a Covid-19 reserve allocation factor to address the Coronavirus
Pandemic and its potential impact on the collectability of the loan portfolio
during the second quarter of 2020. The creation of this factor reflected our
belief that the traditional nine environmental factors did not sufficiently
capture and address the unique circumstances, challenges and uncertainties
associated with the Coronavirus Pandemic, which include unprecedented federal
government stimulus and interventions, statewide mandatory closures on
nonessential businesses and periodic changes to such, and our ability to provide
payment deferral programs to commercial and retail borrowers without the
interjection of troubled debt restructuring accounting rules. We review a myriad
of items assessing this new environmental factor, including virus infection
rates, vaccine inoculation trends, economic outlooks, employment data, business
closures, foreclosures, payment deferments and government-sponsored stimulus
programs.



We recorded a negative loan loss provision expense of $3.1 million during the
second quarter of 2021, compared to a provision expense of $7.6 million during
the second quarter of 2020. We recorded a negative loan loss provision expense
of $2.8 million during the first six months of 2021, compared to a provision
expense of $8.4 million during the first six months of 2020. The negative
provision expense recorded in the 2021 periods was mainly comprised of a reduced
reserve allocation associated with the economic and business conditions
environmental factor, reflecting improvement in both current and forecasted
economic conditions. This change resulted in a reduced required allowance
balance of $3.6 million. The provision expense recorded during the 2020 periods
mainly consisted of an allocation associated with a newly created Covid-19
factor and an increased allocation related to the existing economic and business
conditions environmental factor. The Covid-19 factor was added to address the
unique challenges and economic uncertainty resulting from the Coronavirus
Pandemic and its potential impact on the collectability of the loan portfolio.



Adjustments for specific lending relationships, particularly impaired loans, are
made on a case-by-case basis. Non-impaired retail loan reserve allocations are
determined in a similar fashion as those for non-impaired commercial loans,
except that retail loans are segmented by type of credit and not a grading
system. We regularly review the allowance analysis and make needed adjustments
based upon identifiable trends and experience.



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A migration analysis is completed quarterly to assist us in determining
appropriate reserve allocation factors for non-impaired commercial loans. Our
migration analysis takes into account various time periods, with most weight
placed on the time frame from December 31, 2010 through June 30, 2021. We
believe this time period represents an appropriate range of economic conditions,
and that it provides for an appropriate basis in determining reserve allocation
factors given current economic conditions and the general consensus of economic
conditions in the near future. We are actively monitoring our loan portfolio and
assessing reserve allocation factors in light of the Coronavirus Pandemic and
its impact on the U.S. economic environment and our customers in particular.



Although the migration analysis provides a historical accounting of our net loan
losses, it is not able to fully account for environmental factors that will also
very likely impact the collectability of our commercial loans as of any
quarter-end date. Therefore, we incorporate the environmental factors as
adjustments to the historical data. Environmental factors include both internal
and external items. We believe the most significant internal environmental
factor is our credit culture and the relative aggressiveness in assigning and
revising commercial loan risk ratings, with the most significant external
environmental factor being the assessment of the current economic environment
and the resulting implications on our commercial loan portfolio.



The primary risk elements with respect to commercial loans are the financial
condition of the borrower, the sufficiency of collateral, and timeliness of
scheduled payments. We have a policy of requesting and reviewing periodic
financial statements from commercial loan customers, and we have a disciplined
and formalized review of the existence of collateral and its value. The primary
risk element with respect to each residential 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 creditors' rights in
order to preserve our collateral position.



As of June 30, 2021, the allowance was comprised of $35.1 million in general
reserves relating to non-impaired loans and $0.8 million in specific reserves on
other loans, primarily accruing loans designated as troubled debt
restructurings. Troubled debt restructurings totaled $21.7 million at June 30,
2021, consisting of $0.9 million that are on nonaccrual status and $20.8 million
that are on accrual status. The latter, while considered and accounted for as
impaired loans in accordance with accounting guidelines, are not included in our
nonperforming loan totals. Impaired loans with an aggregate carrying value of
$0.7 million as of June 30, 2021 had been subject to previous partial
charge-offs aggregating $1.0 million over the past ten years. As of June 30,
2021, there were no specific reserves allocated to impaired loans that had been
subject to a previous partial charge-off.



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



                  6/30/21          3/31/21          12/31/20         9/30/20          6/30/20

Performing      $ 20,840,000     $ 19,606,000     $ 23,133,000     $ 11,522,000     $ 16,018,000
Nonperforming        859,000          431,000          510,000        1,113,000          521,000

Total           $ 21,699,000     $ 20,037,000     $ 23,643,000     $ 12,635,000     $ 16,539,000




Although we believe the allowance is adequate to absorb loan losses in our
originated loan portfolio as they arise, there can be no assurance, especially
given the current uncertainties related to the Coronavirus Pandemic and its
impact on the U.S. economic environment, that we will not sustain loan losses in
any given period that could be substantial in relation to, or greater than, the
size of the allowance.

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Securities available for sale increased $119 million during the first six months
of 2021, totaling $506 million as of June 30, 2021. Purchases of U.S. Government
agency bonds totaled $114 million during the first six months of 2021, in part
reflecting the reinvestment of proceeds from called U.S. Government agency bonds
that totaled $33.4 million. Purchases of U.S. Government agency guaranteed
mortgage-backed securities totaled $18.7 million during the first six months of
2021, consisting of investments in CRA-qualified securities, in part reflecting
the reinvestment of $5.7 million from principal paydowns on U.S. Government
agency guaranteed mortgage-backed securities. Purchases of municipal bonds
totaled $35.7 million during the first six months of 2021; proceeds from matured
municipal bonds totaled $5.5 million. At June 30, 2021, the portfolio was
primarily comprised of U.S. Government agency bonds (63%), municipal bonds (29%)
and U.S. Government agency issued or guaranteed mortgage-backed securities (8%).
All of our securities are currently designated as available for sale, and are
therefore stated at fair value. The fair value of securities designated as
available for sale at June 30, 2021 totaled $506 million, including a net
unrealized gain of $1.9 million. We maintain the securities portfolio at levels
to provide adequate pledging and secondary liquidity for our daily operations.
In addition, the securities portfolio serves a primary interest rate risk
management function. We expect purchases during the remainder of 2021 to
generally consist of U.S. Government agency bonds and municipal bonds, with the
securities portfolio maintained at about 12% of total assets.



FHLBI stock totaled $18.0 million as of June 30, 2021, unchanged from the
balance at December 31, 2020. Our investment in FHLBI stock is necessary to
engage in their advance and other financing programs. We have regularly received
quarterly cash dividends, and we expect a cash dividend will continue to be paid
in future quarterly periods.



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



Interest-earning balances, primarily consisting of funds deposited at the
Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and
interest rate sensitivity. During the first six months of 2021, the average
balance of these funds equaled $606 million, or 13.8% of average earning assets,
compared to $203 million, or 5.6% of average earning assets, during the first
six months of 2020, and a more typical $81.3 million, or 2.5% of average earning
assets, during the first six months of 2019. The elevated level during 2020 and
into the first half of 2021 primarily reflects increased local deposits stemming
from federal government stimulus payments and reduced business and consumer
investing and spending. The excess level of funds on deposit with the Federal
Reserve Bank of Chicago had a negative impact of 35 to 40 basis points on our
net interest margin during the second quarter and first six months of 2021. We
expect the level of interest-earning deposit balances to remain elevated through
the remainder of 2021 and into 2022.



Net premises and equipment equaled $58.3 million at June 30, 2021, representing
a decrease of $0.7 million during the first six months of 2021. An aggregate
increase of $5.6 million stems from facility remodeling and new lease
activities, while a decline of $3.5 million was recorded from the sale of a
branch facility (along with the associated loans and deposits) to another
financial institution and the sale of a former branch facility. Depreciation
expense totaled $2.8 million during the first six months of 2021. Foreclosed and
repossessed assets equaled $0.4 million as of June 30, 2021, a reduction of $0.3
million from December 31, 2020.



Total deposits increased $260 million during the first six months of 2021,
totaling $3.67 billion at June 30, 2021. Local deposits increased $276 million,
while out-of-area deposits decreased $16.0 million. As a percentage of total
deposits, out-of-area deposits equaled 0.8% as of June 30, 2021, compared to
1.4% as of December 31, 2020.





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Noninterest-bearing checking accounts increased $187 million during the first
six months of 2021, while interest-bearing checking accounts and money market
deposit accounts grew $4.1 million and $114 million, respectively. The increases
in these transactional deposit products largely reflect federal government
stimulus, especially the PPP, as well as lower business investing and spending.
Savings deposits were up $49.7 million, primarily reflecting the impact of
federal government stimulus programs and lower consumer investing and spending.
Local time deposits decreased $79.3 million during the first six months of 2021,
primarily reflecting the maturity and withdrawal of funds from certain public
unit time deposits and time deposits that were opened as part of a special time
deposit campaign we ran during early 2019. The reduction in out-of-area deposits
during the first six months of 2021 reflects maturities during the period that
were not replaced as the funds were no longer needed.



Total local deposits have increased $1.08 billion since December 31, 2019.
Noninterest-bearing checking accounts have grown $696 million during this time
period, while interest-bearing checking accounts and money market deposit
accounts are up $145 million and $216 million, respectively. The increases in
these transactional deposit products largely reflect federal government
stimulus, especially the PPP, as well as lower business investing and spending.
Savings deposits are up $118 million, primarily reflecting the impact of federal
government stimulus programs and lower consumer investing and spending.



Sweep accounts increased $51.4 million during the first six months of 2021,
totaling $170 million as of June 30, 2021. The aggregate balance of this funding
type can be subject to relatively large fluctuations given the nature of the
customers utilizing this product and the sizable balances of many of the
customers. The average balance of sweep accounts equaled $142 million during the
first six months of 2021, with a high balance of $181 million and low balance of
$113 million. Our sweep account program entails transferring collected funds
from certain business noninterest-bearing checking accounts and savings deposits
into over-night interest-bearing repurchase agreements. Such sweep accounts are
not deposit accounts and are not afforded federal deposit insurance, and are
accounted for as secured borrowings.



FHLBI advances aggregated $394 million as of June 30, 2021, unchanged from the
year-end 2020 balance. The advances are collateralized by residential mortgage
loans, first mortgage liens on multi-family property loans, first mortgage liens
on commercial real estate loans, and substantially all other assets of our bank,
under a blanket lien arrangement. Our borrowing line of credit as of June 30,
2021 totaled $807 million, with remaining availability based on collateral
equaling $407 million.



Shareholders' equity was $452 million at June 30, 2021, compared to $442 million
at December 31, 2020. The $10.3 million increase during the first six months of
2021 primarily reflects the positive impact of net income totaling $32.3
million, partially offset by the negative impact of cash dividends and common
stock repurchases totaling $9.2 million and $10.9 million, respectively.
Reflecting an increase in market interest rates, the change in net unrealized
holding gain/loss on securities available for sale, net of tax effect, had a
$4.0 million negative impact on shareholders' equity during the first six months
of 2021.



Liquidity

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



To assist in providing needed funds, we have regularly obtained monies from
wholesale funding sources. Wholesale funds, primarily comprised of deposits from
customers outside of our market areas and advances from the FHLBI, totaled $425
million, or 10.0% of combined deposits and borrowed funds, as of June 30, 2021,
compared to $441 million, or 11.2% of combined deposits and borrowed funds, as
of December 31, 2020.

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Sweep accounts increased $51.4 million during the first six months of 2021,
totaling $170 million as of June 30, 2021. The aggregate balance of this funding
type can be subject to relatively large fluctuations given the nature of the
customers utilizing this product and the sizable balances of many of the
customers. The average balance of sweep accounts equaled $142 million during the
first six months of 2021, with a high balance of $181 million and low balance of
$113 million. Our sweep account program entails transferring collected funds
from certain business noninterest-bearing checking accounts and savings deposits
into over-night interest-bearing repurchase agreements. Such sweep accounts are
not deposit accounts and are not afforded federal deposit insurance, and are
accounted for as secured borrowings.

Information regarding repurchase agreements as of June 30, 2021 and during the first six months of 2021 is as follows:

Outstanding balance at June 30, 2021                                $ 

169,737,000

Weighted average interest rate at June 30, 2021                              0.11 %
Maximum daily balance six months ended June 30, 2021                $ 

180,719,000

Average daily balance for six months ended June 30, 2021            $ 

141,861,000

Weighted average interest rate for six months ended June 30, 2021

 0.11 %




FHLBI advances aggregated $394 million as of June 30, 2021, unchanged from the
year-end 2020 balance. The advances are collateralized by residential mortgage
loans, first mortgage liens on multi-family property loans, first mortgage liens
on commercial real estate loans, and substantially all other assets of our bank,
under a blanket lien arrangement. Our borrowing line of credit as of June 30,
2021 totaled $807 million, with remaining availability based on collateral
equaling $407 million.



We also have the ability to borrow up to $70.0 million on a daily basis through
correspondent banks using established unsecured federal funds purchased lines of
credit. We did not access the lines of credit during the first six months of
2021. In contrast, our interest-earning deposit balance with the Federal Reserve
Bank of Chicago averaged $564 million during the first six months of 2021. We
also have a line of credit through the Discount Window of the Federal Reserve
Bank of Chicago. Using certain municipal bonds as collateral, we could have
borrowed up to $35.2 million as of June 30, 2021. We did not utilize this line
of credit during the first six months of 2021 or at any time during the previous
twelve fiscal years, and do not plan to access this line of credit in future
periods.



The following table reflects, as of June 30, 2021, significant fixed and
determinable contractual obligations to third parties by payment date, excluding
accrued interest:



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

Deposits without a stated maturity   $ 3,211,444,000     $           0     $           0     $          0     $ 3,211,444,000
Time deposits                            271,352,000       136,357,000        52,118,000                0         459,827,000
Short-term borrowings                    169,737,000                 0                 0                0         169,737,000
Federal Home Loan Bank advances           60,000,000       174,000,000       110,000,000       50,000,000         394,000,000
Subordinated debentures                            0                 0                 0       47,904,000          47,904,000
Other borrowed money                               0                 0                 0        1,565,000           1,565,000
Property leases                              777,000         1,521,000           481,000        1,173,000           3,952,000




In addition to normal loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of June 30, 2021, we had a total of $1.47 billion in unfunded loan
commitments and $26.2 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $1.31 billion were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $161
million were for loan commitments generally expected to close and become funded
within the next 12 to 18 months. We regularly monitor fluctuations in loan
balances and commitment levels, and include such data in our overall liquidity
management.

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

Capital Resources

Shareholders' equity was $452 million at June 30, 2021, compared to $442 million
at December 31, 2020. The $10.3 million increase during the first six months of
2021 primarily reflects the positive impact of net income totaling $32.3
million, partially offset by the negative impact of cash dividends and common
stock repurchases totaling $9.2 million and $10.9 million, respectively.
Reflecting an increase in market interest rates, the change in net unrealized
holding gain/loss on securities available for sale, net of tax effect, had a
$4.0 million negative impact on shareholders' equity during the first six months
of 2021.



In May 2021, we announced that our Board of Directors had authorized a program
to repurchase up to $20.0 million of our common stock from time to time in open
market transactions at prevailing market prices or by other means in accordance
with applicable regulations. This program replaces a similar $20.0 million
program that had been announced in May 2019 that was nearing exhaustion. During
the first six months of 2021, we repurchased a total of approximately 347,000
shares at a total price of $10.9 million, at an average price per share of
$31.28. Availability under the repurchase plan totaled $17.3 million as of June
30, 2021. The stock buybacks have been funded from cash dividends paid to us
from our bank. Additional repurchases may be made in future periods under the
authorized plan or a new plan, which would also likely be funded from cash
dividends paid to us from our bank.



We and our bank are subject to regulatory capital requirements administered by
state and federal banking agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. Under the final BASEL III capital rules that
became effective on January 1, 2015, there is a requirement for a common equity
Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in
addition to the other minimum risk-based capital standards in the rule.
Institutions that do not meet this required capital buffer will become subject
to progressively more stringent limitations on the percentage of earnings that
can be paid out in cash dividends or used for stock repurchases and on the
payment of discretionary bonuses to senior executive management. The capital
buffer requirement was phased in over three years beginning in 2016. The capital
buffer requirement raised the minimum required common equity Tier 1 capital
ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to
10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of June
30, 2021, our bank met all capital adequacy requirements under the BASEL III
capital rules on a fully phased-in basis.



As of June 30, 2021, our bank's total risk-based capital ratio was 13.0%,
compared to 13.5% at December 31, 2020. Our bank's total regulatory capital
increased $20.5 million during the first six months of 2021, in large part
reflecting the net impact of net income totaling $34.9 million and cash
dividends paid to us aggregating $13.0 million. Our bank's total risk-based
capital ratio was also impacted by a $285 million increase in total
risk-weighted assets, primarily resulting from growth in core commercial loans
and securities available for sale. As of June 30, 2021, our bank's total
regulatory capital equaled $478 million, or $110 million in excess of the 10.0%
minimum which is among the requirements to be categorized as "well capitalized."
Our and our bank's capital ratios as of June 30, 2021 and December 31, 2020 are
disclosed in Note 12 of the Notes to Consolidated Financial Statements.

Results of Operations

We recorded net income of $18.1 million, or $1.12 per basic and diluted share,
for the second quarter of 2021, compared to net income of $8.7 million, or $0.54
per basic and diluted share, for the second quarter of 2020. We recorded net
income of $32.3 million, or $2.00 per basic and diluted share, for the first six
months of 2021, compared to net income of $19.4 million, or $1.19 per basic and
diluted share, for the first six months of 2020.



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The improved levels of net income during the second quarter and first six months
of 2021 compared to the respective prior-year periods primarily resulted from
lower provision expense and increased noninterest income, which more than offset
higher noninterest expense. Negative loan loss provisions were recorded during
the second quarter and first six months of 2021, primarily reflecting a reduced
allocation associated with the economic and business conditions environmental
factor. Growth in noninterest income during the current-year second quarter
mainly resulted from fee income generated from an interest rate swap program
that was introduced during the fourth quarter of 2020, a gain on the sale of a
branch, and increased credit and debit card income, while growth in noninterest
income during the first six months of 2021 primarily reflected improved mortgage
banking income, along with increases in the aforementioned revenue streams. The
higher levels of noninterest expense mainly reflected increased compensation
costs.



Interest income during the second quarter of 2021 was $35.8 million, a decrease
of $1.4 million, or 3.7%, from the $37.2 million earned during the second
quarter of 2020. The decrease resulted from a lower yield on average earning
assets, which more than offset the impact of growth in average earning assets.
The yield on average earning assets was 3.20% during the second quarter of 2021,
compared to 3.85% during the second quarter of 2020. The decline primarily
resulted from a change in earning asset mix. On average, lower-yielding
interest-earning deposits represented 13.9% of earning assets during the second
quarter of 2021, up from 6.6% during the second quarter of 2020, while
higher-yielding loans represented 75.3% of earning assets during the
current-year second quarter, down from 84.8% during the prior-year second
quarter. A significant volume of excess on-balance sheet liquidity, which
initially surfaced in the second quarter of 2020 as a result of the Covid-19
environment and persisted during the remainder of 2020 and the first six months
of 2021, negatively impacted the yield on average earning assets by 42 basis
points during the second quarter of 2021. The excess funds, consisting primarily
of low-yielding deposits with the Federal Reserve Bank of Chicago, are mainly a
product of federal government stimulus programs, lower business and consumer
spending and investing, and PPP loan forgiveness activities.



Decreased yields on securities and loans also contributed to the lower yield on
average earning assets in the current-year second quarter compared to the
respective 2020 period. The yield on securities was 1.54% during the second
quarter of 2021, down from 3.37% during the prior-year second quarter mainly due
to decreased accelerated discount accretion on called U.S. Government agency
bonds and lower yields on newly purchased bonds, reflecting the declining
interest rate environment. Accelerated discount accretion totaled $0.9 million
during the second quarter of 2020; no accelerated discount accretion was
recorded during the second quarter of 2021. As part of our interest rate risk
management program, U.S. Government agency bonds are periodically purchased at
discounts during rising interest rate environments; if these bonds are called
during decreasing interest rate environments, the remaining unaccreted discount
amounts are immediately recognized as interest income. The yield on loans was
3.99% during the current-year second quarter, down from 4.18% during the second
quarter of 2020 primarily due to a decreased yield on commercial loans. The
lower yield on commercial loans, which declined from 4.20% during the prior-year
second quarter to 4.04% during the second quarter of 2021, mainly stemmed from
the origination of new loans and renewal of maturing loans in the decreased
interest rate environment. Average earning assets equaled $4.47 billion during
the current-year second quarter, up $628 million, or 16.4%, from the level of
$3.84 billion during the respective 2020 period; average interest-earning
deposits were up $367 million, average securities increased $150 million, and
average loans were up $111 million.





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Interest income during the first six months of 2021 was $70.6 million, a
decrease of $4.5 million, or 6.0%, from the $75.1 million earned during the
first six months of 2020. The decrease resulted from a lower yield on average
earning assets, which more than offset the impact of growth in average earning
assets. The yield on average earning assets was 3.23% during the first six
months of 2021, compared to 4.17% during the respective 2020 period. The decline
primarily resulted from a change in earning asset mix and lower yields on loans
and securities. On average, lower-yielding interest-earning deposits represented
13.8% of earning assets during the first six months of 2021, up from 5.6% during
the first six months of 2020, while higher-yielding loans represented 75.9% and
84.9% of earning assets during the respective periods. The previously mentioned
significant volume of excess on-balance sheet liquidity negatively impacted the
yield on average earning assets by 43 basis points during the first six months
of 2021. The yield on loans declined from 4.42% during the first six months of
2020 to 4.01% during the first six months of 2021 mainly due to a lower yield on
commercial loans, which equaled 4.46% and 4.06% during the respective periods.
The decreased yield on commercial loans primarily reflected reduced interest
rates on variable-rate commercial loans resulting from the FOMC significantly
decreasing the targeted federal funds rate by a total of 150 basis points in
March of 2020, along with the origination of new loans and renewal of maturing
loans in the lower interest rate environment. The yield on securities was 1.57%
during the first six months of 2021, down from 4.06% during the respective 2020
period mainly due to decreased accelerated discount accretion on called U.S.
Government agency bonds and lower yields on newly purchased bonds, reflecting
the declining interest rate environment. Accelerated discount accretion totaled
$2.7 million during the first six months of 2020; accelerated discount accretion
of less than $0.1 million was recorded during the first six months of 2021. A
decreased yield on interest-earning deposits also contributed to the lower yield
on average earning assets during the first six months of 2021 compared to the
first six months of 2020. The yield on interest-earning deposits was 0.12%
during the first six months of 2021, down from 0.55% during the respective 2020
period, mainly reflecting the decreased interest rate environment. Average
earning assets equaled $4.38 billion during the first six months of 2021, up
$787 million, or 21.9%, from the level of $3.59 billion during the first six
months of 2020; average interest-earning deposits were up $403 million, average
loans increased $272 million, and average securities were up $112 million.



Interest expense during the second quarter of 2021 was $4.9 million, a decrease
of $1.7 million, or 25.6%, from the $6.6 million expensed during the second
quarter of 2020. The decrease is attributable to a lower weighted average cost
of interest-bearing liabilities, which equaled 0.74% in the current-year second
quarter compared to 1.11% in the prior-year second quarter. The decline mainly
reflected lower rates paid on local time deposits and a change in funding mix,
consisting of an increase in average lower-cost interest-bearing non-time
deposits and a decrease in average higher-cost time deposits as a percentage of
average total interest-bearing liabilities. The cost of time deposits declined
from 2.04% during the second quarter of 2020 to 1.24% during the current-year
second quarter due to lower interest rates paid on local time deposits,
reflecting the decreasing interest rate environment, and a change in
composition, primarily reflecting a decrease in higher-cost brokered funds. On
average, lower-cost non-time deposits represented 60.0% of total
interest-bearing liabilities during the second quarter of 2021, up from 49.4%
during the second quarter of 2020, while higher-cost time deposits represented
17.7% and 25.0% of total interest-bearing liabilities during the respective
periods. A lower cost of borrowed funds also contributed to the decreased
weighted average cost of interest-bearing liabilities in the second quarter of
2021 compared to the prior-year second quarter. The cost of borrowed funds
decreased from 1.91% during the second quarter of 2020 to 1.73% during the
second quarter of 2021, mainly reflecting lower costs of FHLBI advances and
subordinated debentures. The cost of FHLBI advances was 2.06% during the second
quarter of 2021, down from 2.22% during the prior-year second quarter, primarily
reflecting the impact of a blend and extend transaction that was executed in
June 2020 with the FHLBI to extend the duration of our advance portfolio as part
of our interest rate risk management program and the declining interest rate
environment. The cost of subordinated debentures was 3.79% during the second
quarter of 2021, down from 5.10% during the respective 2020 period due to
decreases in the 90-Day Libor Rate. Average interest-bearing liabilities were
$2.67 billion during the second quarter of 2021, up $294 million, or 12.4%, from
the $2.38 billion average during the second quarter of 2020.





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Interest expense during the first six months of 2021 was $10.1 million, a
decrease of $4.1 million, or 28.5%, from the $14.2 million expensed during the
first six months of 2020. The decrease is attributable to a lower weighted
average cost of interest-bearing liabilities, which equaled 0.78% in the first
six months of 2021 compared to 1.23% in the respective 2020 period. The decrease
in the weighted average cost of interest-bearing liabilities reflected lower
costs of time deposits, non-time deposit accounts, and borrowed funds and a
change in funding mix, consisting of an increase in average lower-cost
interest-bearing non-time deposits and a decrease in average higher-cost time
deposits as a percentage of average total interest-bearing liabilities. The cost
of time deposits declined from 2.13% during the first six months of 2020 to
1.37% during the respective 2021 period due to lower rates paid on local time
deposits, reflecting the decreased interest rate environment, and a change in
composition, primarily reflecting a decline in higher-cost brokered funds. The
cost of interest-bearing non-time deposit accounts decreased from 0.34% during
the first six months of 2020 to 0.21% during the first six months of 2021,
primarily reflecting lower interest rates paid on money market accounts; the
reduced interest rates mainly reflect the decreasing interest rate environment.
The cost of borrowed funds decreased from 2.09% during the first six months of
2020 to 1.75% during the respective 2021 period, primarily reflecting lower
costs of FHLBI advances and subordinated debentures. The cost of FHLBI advances
was 2.06% during the first six months of 2021, down from 2.31% during the first
six months of 2020, primarily reflecting the impact of the aforementioned blend
and extend transaction that was executed in June 2020 with the FHLBI and the
lower interest rate environment. The cost of subordinated debentures was 3.82%
during the first six months of 2021, down from 5.50% during the respective 2020
period due to decreases in the 90-Day Libor Rate. On average, lower-cost
non-time deposits represented 58.8% of total interest-bearing liabilities during
the first six months of 2021, up from 49.5% during the first six months of 2020,
while higher-cost time deposits represented 19.0% and 26.1% of total
interest-bearing liabilities during the respective periods. Average
interest-bearing liabilities were $2.64 billion during the first six months of
2021, up $328 million, or 14.2%, from the $2.31 billion average during the first
six months of 2020.



Net interest income during the second quarter of 2021 was $30.9 million, an
increase of $0.3 million, or 1.0%, from the $30.6 million earned during the
respective 2020 period. The increase resulted from the positive impact of an
increase in average earning assets, which more than offset a lower net interest
margin. The net interest margin decreased from 3.17% in the second quarter of
2020 to 2.76% in the current-year second quarter due to a lower yield on average
earning assets, which more than offset a reduction in the cost of funds. The
decreased yield on average earning assets primarily reflected a change in
earning asset mix, along with lower yields on securities and commercial loans,
while the decreased cost of funds mainly reflected lower rates paid on local
time deposits and a change in funding mix. The previously discussed significant
level of excess on-balance sheet liquidity negatively impacted the net interest
margin by 37 basis points during the second quarter of 2021.



Net interest income during the first six months of 2021 was $60.4 million, a
decrease of $0.5 million, or 0.8%, from the $60.9 million earned during the
first six months of 2020. The decrease resulted from a lower net interest
margin, which more than offset the positive impact of an increase in average
earning assets. The net interest margin decreased from 3.38% in the first six
months of 2020 to 2.76% in the respective 2021 period due to a lower yield on
average earning assets, which more than offset a reduction in the cost of funds.
The decreased yield on average earning assets primarily reflected a change in
earning asset mix and lower yields on commercial loans and securities, while the
decreased cost of funds mainly reflected lower costs of deposits and borrowed
funds and a change in funding mix. The aforementioned significant level of
excess on-balance sheet liquidity negatively impacted the net interest margin by
37 basis points during the first six months of 2021.



The following tables set forth certain information relating to our consolidated
average interest-earning assets and interest-bearing liabilities and reflect the
average yield on assets and average cost of liabilities for the second quarters
and first six months of 2021 and 2020. Such yields and costs are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the period presented. Tax-exempt securities
interest income and yield for the second quarters and first six months of 2021
and 2020 have been computed on a tax equivalent basis using a marginal tax rate
of 21.0%. Securities interest income was increased by $60,000 in the second
quarter of both 2021 and 2020 and $120,000 in the first six months of both 2021
and 2020 for this non-GAAP, but industry standard, adjustment. These adjustments
equated to one basis point increases in our net interest margin for each of the
2021 and 2020 periods.

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                                                          Quarters ended June 30,
                                           2 0 2 1                                       2 0 2 0
                            Average                       Average         Average                       Average
                            Balance        Interest         Rate          Balance        Interest         Rate
                                                          (dollars in thousands)
ASSETS
Loans                     $ 3,365,686     $   33,789           3.99 %   $ 3,254,985     $   34,322           4.18 %
Investment securities         483,805          1,862           1.54         333,843          2,809           3.37
Other interest-earning
assets                        619,358            183           0.12         251,833             93           0.15
Total interest -
earning assets              4,468,849         35,834           3.20       3,840,661         37,224           3.85

Allowance for loan
losses                        (39,406 )                                     (26,538 )
Other assets                  323,415                                       305,450

Total assets              $ 4,752,858                                   $ 4,119,573


LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
deposits                  $ 2,074,759     $    2,346           0.45 %   $ 1,767,986     $    3,700           0.84 %
Short-term borrowings         150,778             40           0.11         163,339             55           0.14
Federal Home Loan Bank
advances                      394,000          2,050           2.06         394,000          2,214           2.22
Other borrowings               49,421            467           3.74          49,735            624           4.96
Total interest-bearing
liabilities                 2,668,958          4,903           0.74       2,375,060          6,593           1.11

Noninterest-bearing
deposits                    1,619,976                                     1,304,986
Other liabilities              17,995                                        17,297
Shareholders' equity          445,929                                       422,230

Total liabilities and
shareholders' equity      $ 4,752,858                                   $ 4,119,573

Net interest income                       $   30,931                                    $   30,631

Net interest rate
spread                                                         2.46 %                                        2.74 %
Net interest spread on
average assets                                                 2.61 %                                        2.98 %
Net interest margin on
earning assets                                                 2.76 %                                        3.17 %

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                                                         Six months ended June 30,
                                           2 0 2 1                                       2 0 2 0
                            Average                       Average         Average                       Average
                            Balance        Interest         Rate          Balance        Interest         Rate
                                                          (dollars in thousands)
ASSETS
Loans                     $ 3,324,006     $   66,774           4.01 %   $ 3,052,441     $   67,764           4.42 %
Investment securities         451,837          3,554           1.57         339,374          6,886           4.06
Other interest-earning
assets                        605,564            351           0.12         202,735            568           0.55
Total interest -
earning assets              4,381,407         70,679           3.23       3,594,550         75,218           4.17

Allowance for loan
losses                        (38,794 )                                     (25,124 )
Other assets                  323,759                                       291,753

Total assets              $ 4,666,372                                   $ 3,861,179


LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
deposits                  $ 2,050,959     $    5,063           0.50 %   $ 1,746,008     $    8,342           0.96 %
Short-term borrowings         141,861             76           0.11         133,095             94           0.14
Federal Home Loan Bank
advances                      394,000          4,077           2.06         379,714          4,427           2.31
Other borrowings               49,610            939           3.76          49,709          1,348           5.36
Total interest-bearing
liabilities                 2,636,430         10,155           0.78       2,308,526         14,211           1.23

Noninterest-bearing
deposits                    1,565,458                                     1,114,406
Other liabilities              19,723                                        17,326
Shareholders' equity          444,761                                       420,921

Total liabilities and
shareholders' equity      $ 4,666,372                                   $ 3,861,179

Net interest income                       $   60,524                                    $   61,007

Net interest rate
spread                                                         2.45 %                                        2.94 %
Net interest spread on
average assets                                                 2.62 %                                        3.17 %
Net interest margin on
earning assets                                                 2.76 %                                        3.38 %




A negative loan loss provision expense of $3.1 million was recorded during the
second quarter of 2021, compared to a provision expense of $7.6 million during
the second quarter of 2020. A negative loan loss provision expense of $2.8
million was recorded during the first six months of 2021, compared to a
provision expense of $8.4 million during the first six months of 2020. The
negative provision expense recorded during the 2021 periods was mainly comprised
of a reduced allocation associated with the economic and business conditions
environmental factor, reflecting improvement in both current and forecasted
economic conditions. The provision expense recorded during the 2020 periods
primarily reflected an allocation associated with a newly created Covid-19
factor and an increased allocation related to the existing economic and business
conditions environmental factor. The Covid-19 factor was added to address the
unique challenges and economic uncertainty resulting from the pandemic and its
potential impact on the collectability of the loan portfolio.



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During the second quarter of 2021, loan charge-offs totaled $0.1 million, while
recoveries of prior period loan charge-offs equaled $0.4 million, providing for
net loan recoveries of $0.3 million, or an annualized 0.04% of average total
loans. During the second quarter of 2020, loan charge-offs totaled $0.3 million,
while recoveries of prior period loan charge-offs equaled $0.1 million,
providing for net loan charge-offs of $0.2 million, or an annualized 0.02% of
average total loans. During the first six months of 2021, loan charge-offs
totaled $0.1 million, while recoveries of prior period loan charge-offs equaled
$0.8 million, providing for net loan recoveries of $0.7 million, or an
annualized 0.05% of average total loans. During the first six months of 2020,
loan charge-offs and recoveries of prior period loan charge-offs both
approximated $0.4 million, providing for a nominal level of net loan recoveries.
The allowance for loans, as a percentage of total loans, was 1.1% as of June 30,
2021, 1.2% as of December 31, 2020, and 1.0% as of June 30, 2020. Excluding PPP
loans, the allowance for loans, as a percentage of total loans, equaled 1.2% as
of June 30, 2021 and June 30, 2020, and 1.3% as of December 31, 2020.



Noninterest income during the second quarter of 2021 was $14.6 million, compared
to $11.0 million during the prior-year second quarter. Noninterest income during
the first six months of 2021 was $28.0 million, compared to $17.5 million during
the respective 2020 period. Noninterest income during the second quarter and
first six months of 2021 included a $1.1 million gain on the sale of a branch
facility. Excluding the impact of this transaction, noninterest income increased
$2.5 million, or 22.9%, during the second quarter of 2021 and $9.4 million, or
53.8%, during the first six months of 2021 compared to the respective 2020
periods. The higher level of noninterest income in the second quarter of 2021
mainly reflected fee income generated from an interest rate swap program that
was introduced during the fourth quarter of 2020 and increased credit and debit
card income. The interest rate swap program provides certain commercial
borrowers with a longer-term fixed-rate option and assists Mercantile in
managing associated longer-term interest rate risk. Growth in service charges on
accounts and payroll service fees also contributed to the increased level of
noninterest income during the second quarter of 2021. Mortgage banking income
remained solid during the second quarter of 2021, slightly exceeding the amount
recorded during the prior-year second quarter as an increase in purchase
mortgage loans and a higher gain on sale rate offset a decline in refinance
mortgage loans. Purchase transactions totaled $144 million during the second
quarter of 2021 compared to $58.0 million during the prior-year second quarter.
Refinance transactions totaled $92.8 million during the current-year second
quarter, compared to $217 million during the second quarter of 2020.



The higher level of noninterest income in the first six months of 2021 primarily
resulted from increased mortgage banking income, mainly reflecting increased
production and a higher gain on sale rate. Residential mortgage loan
originations totaled $482 million during the first six months of 2021,
approximately 18% higher than originations during the first six months of 2020.
Purchase transactions totaled $226 million during the first six months of 2021,
compared to $105 million during the respective 2020 period, representing an
increase of $121 million, or approximately 116%. Refinance transactions totaled
$256 million during the first six months of 2021, compared to $304 million
during the first six months of 2020, representing a decrease of $47.3 million,
or approximately 16%. Residential mortgage loans originated for sale, generally
consisting of longer-term fixed rate residential mortgage loans, totaled $336
million, or approximately 70% of total mortgage loans originated, during the
first six months of 2021. During the first six months of 2020, residential
mortgage loans originated for sale totaled $321 million, or nearly 79% of total
mortgage loans originated. Fee income generated from the interest rate swap
program and growth in credit and debit card income, service charges on accounts,
and payroll service fees also contributed to the higher level of noninterest
income during the first six months of 2021.



Noninterest expense totaled $26.2 million during the second quarter of 2021, up
$3.0 million, or 12.8%, from the prior-year second quarter. Noninterest expense
during the first six months of 2021 was $51.3 million, an increase of $5.2
million, or 11.2%, from the $46.1 million expensed during the first six months
of 2020. The higher level of expense in both periods primarily resulted from
increased compensation costs, mainly reflecting a bonus accrual, increased
health insurance costs, and annual employee merit pay increases. A lower level
of deferred salary expense related to PPP loan originations also contributed to
the increased noninterest expense during the second quarter of 2021, while
higher residential mortgage loan originator commissions and associated
incentives contributed to the increased noninterest expense in the first six
months of 2021. Federal Deposit Insurance Corporation deposit insurance premiums
were up $0.1 million in the current-year second quarter and $0.3 million in the
first six months of 2021 compared to the respective 2020 periods, reflecting an
increased assessment base and rate. Noninterest expense during the first six
months of 2021 includes $0.5 million in net losses on sales and write-downs of
former branch facilities.

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During the second quarter of 2021, we recorded income before federal income tax
of $22.3 million and a federal income tax expense of $4.2 million. During the
second quarter of 2020, we recorded income before federal income tax of $10.7
million and a federal income tax expense of $2.0 million. During the first six
months of 2021, we recorded income before federal income tax of $39.9 million
and a federal income tax expense of $7.6 million. During the first six months of
2020, we recorded income before federal income tax of $23.9 million and a
federal income tax expense of $4.5 million. The increased federal income tax
expense in both 2021 periods resulted from higher levels of income before
federal income tax. Our effective tax rate was 19.0% during both the second
quarter and first six months of 2021 and the respective 2020 periods.

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