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; 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, or the replacement of Libor with an alternative reference rate; 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 Covid-19; and risk factors described in our annual
report on Form 10-K for the year ended December 31, 2020 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 March 31, 2021 and December 31, 2020 and the
results of operations for the three months ended March 31, 2021 and March 31,
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.

--------------------------------------------------------------------------------


                                       47
--------------------------------------------------------------------------------

MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


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 Paycheck
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 with no economic forecast
consensus. Given the high degree of uncertainty surrounding economic
forecasting, we have elected to postpone the adoption of CECL, and will continue
to use our incurred loan loss reserve model as permitted.



--------------------------------------------------------------------------------


                                       48

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


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
servicing each grouping of loans. These cash flows are then discounted based on
current interest rate assumptions to arrive at the fair value of the right to
service those loans. Impairment is evaluated quarterly based on the fair value
of the servicing rights, using groupings of the underlying loans classified by
interest rates. Any impairment of a grouping is reported as a valuation
allowance.



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.



--------------------------------------------------------------------------------


                                       49

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------

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 March 31, 2021, we
recorded forgiveness transactions on approximately 1,600 loans aggregating $302
million.



The Consolidated Appropriations Act, 2021 authorized an additional $284 billion
in second draw PPP loans ("round 2 PPP loans"). The program is scheduled to end
on May 31, 2021. Through March 31, 2021, we originated approximately 1,100 loans
aggregating $203 million.

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.



  ? 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.

--------------------------------------------------------------------------------


                                       50

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------

? 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 deferment
program. As of March 31, 2021, only two borrowers with loan balances aggregating
$1.8 million remained in the commercial loan 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. These payment deferral transactions largely
applied to the borrowers' April, May and June of 2020 loan payments. As of March
31, 2021, only ten borrowers with loan balances aggregating $0.8 million
remained in the retail loan payment deferment program.

First Quarter 2021 Financial Overview

We reported net income of $14.2 million, or $0.87 per diluted share, for the
first quarter of 2021, compared with net income of $10.7 million, or $0.65 per
diluted share, during the first quarter of 2020.



The overall quality of our loan portfolio remains strong, with nonperforming
loans equaling only 0.08% of total loans as of March 31, 2021. Accruing loans
past due 30 to 89 days remain very low. Gross loan charge-offs totaled $0.1
million during the first quarter of 2021, while recoveries of prior period loan
charge-offs totaled $0.5 million, providing for net loan recoveries of $0.4
million, or 0.05% of average total loans on an annualized basis. 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. Provision expense
during the first quarter of 2021 totaled $0.3 million, which combined with net
loan recoveries provided for a $0.7 million increase in the balance of the loan
loss reserve.



Commercial loans increased $173 million during the first three months of 2021,
reflecting the combined net growth of core commercial loans and net activity
under the PPP. Core commercial loans increased $83.7 million, or about 14% on an
annualized basis, during the first three months of 2021. Commercial and
industrial loans increased $49.5 million, non-owner occupied commercial real
estate ("CRE") loans grew $14.9 million, owner occupied CRE loans were up $14.4
million, vacant land, land development and residential construction loans
increased $3.7 million and multi-family and residential rental property loans
grew $1.2 million. As a percent of total commercial loans, commercial and
industrial loans (excluding PPP loans) and owner occupied CRE loans combined
equaled 54.7% as of March 31, 2021, compared to 53.9% at December 31, 2020.
Origination of second round PPP loans during the first quarter totaled $203
million, while PPP loan forgiveness payments from the Small Business
Administration of first round PPP loans totaled $113 million, providing for net
increase in PPP loans of $89.6 million.



--------------------------------------------------------------------------------


                                       51

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


Total deposits increased $233 million during the first three months of 2021,
totaling $3.64 billion at March 31, 2021. Local deposits increased $249 million,
while out-of-area deposits decreased $16.0 million. Noninterest-bearing deposits
increased $172 million during the first three months of 2021, while
interest-bearing checking accounts and money market deposit accounts increased
$21.4 million and $62.0 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 $33.3 million during the first quarter of 2021, primarily
reflecting the impact of federal government stimulus programs and lower consumer
investing and spending. Local time deposits declined $39.4 during the first
three months of 2021, in large part reflecting the maturity of certain time
deposits that were not renewed during the quarter as we did not aggressively
seek to renew these time deposits which were opened as part of a special time
deposit campaign that primarily ran during the latter half of the first quarter
of 2019. The reduction of out-of-area deposits during the first three months of
2021 reflects maturities not replaced as the funds were no longer needed.



Interest-earning balances, primarily consisting of excess funds deposited at the
Federal Reserve Bank of Chicago and a correspondent bank, are used to manage
daily liquidity needs and interest rate sensitivity. During the first three
months of 2021, the average balance of these funds equaled $592 million, or
13.7% of average earning assets, compared to $357 million, or 9.2% of average
earning assets, during 2020, and a more typical $115 million, or 3.4% of average
earning assets, during 2019. The elevated level during 2020 and into the first
quarter of 2021, in large part reflecting increased local deposit balances, has
had a significant negative impact on our net interest margin.



Net interest income totaled $29.5 million during the first quarter of 2021,
compared to $30.3 million during the same time period in 2020. The decline
reflects a lower net interest margin primarily resulting from the Federal Open
Market Committee's ("FOMC") decision to lower the targeted federal funds rate by
a total of 150 basis points at the onset of the Coronavirus Pandemic in early
March of 2020 and substantial excess liquidity, which more than offset the
positive impact of an increase in average earning assets.



Noninterest income totaled $13.5 million during the first quarter of 2021, up
approximately 106% from the first quarter in 2020. The improved level mainly
resulted from increased mortgage banking income stemming from a substantial
upturn in refinance activity driven by a lower interest rate environment, an
increase in home purchase activity and the ongoing success of strategic
initiatives that have been implemented to gain market share. Fee income
generated from an interest rate swap program that was initiated within our
commercial lending function during the fourth quarter of 2020 also contributed
to the increased level of noninterest income during the first three months of
2021.



Noninterest expense totaled $25.1 million during the first quarter of 2021,
compared to $22.9 million during the same time period in 2020. The increased
level of noninterest expense primarily reflects increased employee compensation
costs, mainly depicting higher mortgage lender commissions and annual merit
employee pay increases, higher employee health insurance costs and a bonus
accrual. The higher level of mortgage lending commissions and associated
incentives primarily reflects the significant increase in residential mortgage
loan originations during the first quarter of 2021, which were up nearly 85%
compared to the respective 2020 period. We did not accrue monies for the bonus
programs during the first quarter of 2020 due to the onset of the Coronavirus
Pandemic. Valuation write-downs of two former branch facilities totaled $0.5
million during the first three months of 2021.

Financial Condition

Our total assets increased $273 million during the first three months of 2021,
and totaled $4.71 billion as of March 31, 2021. Total loans increased $171
million, securities available for sale grew $46.9 million and cash and cash
equivalents increased $26.3 million. Total deposits increased $233 million and
sweep accounts grew $22.9 million during the first three months of 2021.



--------------------------------------------------------------------------------


                                       52

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


Commercial loans increased $173 million during the first three months of 2021,
and at March 31, 2021 totaled $2.97 billion, or 88.2% of the loan portfolio. As
of December 31, 2020, the commercial loan portfolio comprised 87.5% of total
loans. The increase in commercial loans during the first quarter reflects
combined net growth of core commercial loans of $83.7 million and net activity
under PPP. Origination of second round PPP loans during the first quarter
totaled $203 million, while PPP loan forgiveness payments from the Small
Business Administration of first round PPP loans totaled $113 million, providing
for a net increase in PPP loans of $89.6 million. Core commercial loans
increased $83.7 million, or about 14% on an annualized basis, during the first
three months of 2021. Commercial and industrial loans increased $49.5 million,
non-owner occupied CRE loans grew $14.9 million, owner occupied CRE loans were
up $14.4 million, vacant land, land development and residential construction
loans increased $3.7 million and multi-family and residential rental property
loans grew $1.2 million. As a percent of total commercial loans, commercial and
industrial loans (excluding PPP loans) and owner occupied CRE loans combined
equaled 54.7% as of March 31, 2021, compared to 53.9% at December 31, 2020.



As of March 31, 2021, availability on existing construction and development
loans totaled $135 million, with most of those funds expected to be drawn over
the next 12 to 18 months. Our current pipeline reports indicate continued strong
commercial loan funding opportunities in future periods, including approximately
$177 million in new lending commitments, a majority of which we expect to be
accepted and funded over the next 12 to 18 months. Our commercial lenders also
report ongoing additional opportunities they are currently discussing with
existing and potentially new borrowers. We remain committed to prudent
underwriting standards that provide for an appropriate yield and risk
relationship, as well as concentration limits we have established within our
commercial loan portfolio. Usage of existing commercial lines of credit remained
relatively steady during the first quarter of 2021, similar to levels during the
last six months of 2020.



Residential mortgage loans decreased less than $0.1 million during the first
quarter of 2021, totaling $338 million, or 10.0% of total loans, as of March 31,
2021. Activity within the residential mortgage function was very active,
primarily reflecting ongoing significant refinance transactions spurred by low
residential mortgage loan interest rates, ongoing 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. Residential mortgage loan originations totaled $245 million during
the first three months of 2021, an almost 85% increase over the $133 million
originated during the same time period in 2020. Refinance mortgage loans
originated comprised about 67% of the total mortgage loans originated during the
first quarter of 2021, compared to almost 65% during the first quarter of 2020.
Residential mortgage loans originated for sale, generally consisting of
longer-term fixed rate residential mortgage loans, totaled $196 million during
the first quarter of 2021, or almost 80% of the total residential mortgage loans
originated. Residential mortgage loans originated not sold are generally
comprised of adjustable rate residential mortgage loans. We remain 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 $2.3 million during the first quarter of
2021, and at March 31, 2021 totaled $59.3 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 origination volumes.



--------------------------------------------------------------------------------


                                       53

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


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



                                           3/31/21            12/31/20             9/30/20             6/30/20             3/31/20
Commercial:
Commercial & Industrial *              $ 1,284,507,000     $ 1,145,423,000

$ 1,321,419,000 $ 1,307,455,000 $ 873,679,000 Land Development & Construction

             58,738,000          55,055,000  

50,941,000 52,984,000 62,908,000 Owner Occupied Commercial RE

               544,342,000         529,953,000  

549,364,000 567,621,000 579,229,000 Non-Owner Occupied Commercial RE

           932,334,000         917,436,000  

878,897,000 841,145,000 823,366,000 Multi-Family & Residential Rental 147,294,000 146,095,000

       137,740,000         132,047,000         133,148,000
Total Commercial                         2,967,215,000       2,793,962,000       2,938,361,000       2,901,252,000       2,472,330,000

Retail:
1-4 Family Mortgages                       337,844,000         337,888,000 

348,460,000 367,061,000 356,338,000 Home Equity & Other Consumer Loans 59,311,000 61,620,000

        63,723,000          64,743,000          72,875,000
Total Retail                               397,155,000         399,508,000         412,183,000         431,804,000         429,213,000

Total                                  $ 3,364,370,000     $ 3,193,470,000     $ 3,350,544,000     $ 3,333,056,000     $ 2,901,543,000




(*) Includes $455 million, $365 million, $555 million, and $549 million in loans
originated under the Paycheck Protection Program for 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 March 31, 2021, compared to $4.1 million (0.1% of total
assets) as of December 31, 2020.



--------------------------------------------------------------------------------


                                       54

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


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



                              NONPERFORMING LOANS



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

Residential Real Estate:
Land Development                  $    34,000     $    35,000     $    36,000     $    36,000     $    37,000
Construction                                0               0         198,000         198,000         283,000
Owner Occupied / Rental             2,294,000       2,519,000       2,399,000       2,552,000       2,651,000
                                    2,328,000       2,554,000       2,633,000       2,786,000       2,971,000

Commercial Real Estate:
Land Development                            0               0               0               0          43,000
Construction                                0               0               0               0               0
Owner Occupied                        283,000         619,000       1,262,000         275,000         287,000
Non-Owner Occupied                          0          22,000          23,000          25,000               0
                                      283,000         641,000       1,285,000         300,000         330,000

Non-Real Estate:
Commercial Assets                     169,000         172,000         198,000          98,000         156,000
Consumer Assets                        13,000          17,000          25,000          28,000          12,000
                                      182,000         189,000         223,000         126,000         168,000

Total                             $ 2,793,000     $ 3,384,000     $ 4,141,000     $ 3,212,000     $ 3,469,000

                  OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

                            3/31/21      12/31/20       9/30/20       6/30/20       3/31/20
Residential Real Estate:
Land Development           $       0     $       0     $       0     $       0     $       0
Construction                       0             0             0             0             0
Owner Occupied / Rental       11,000        88,000       198,000       198,000       271,000
                              11,000        88,000       198,000       198,000       271,000

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

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

Total                      $ 374,000     $ 701,000     $ 512,000     $ 198,000     $ 271,000

--------------------------------------------------------------------------------


                                       55

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------

The following tables provide a reconciliation of nonperforming assets:

NONPERFORMING LOANS RECONCILIATION

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

Beginning balance                    $ 3,384,000     $  4,141,000     $ 3,212,000     $ 3,469,000     $ 2,284,000
Additions, net of transfers to ORE       116,000          538,000       1,301,000         220,000       1,302,000
Returns to performing status            (115,000 )              0         (72,000 )       (26,000 )        (7,000 )
Principal payments                      (559,000 )     (1,064,000 )      (249,000 )      (278,000 )      (110,000 )
Loan charge-offs                         (33,000 )       (231,000 )       (51,000 )      (173,000 )             0

Total                                $ 2,793,000     $  3,384,000     $ 4,141,000     $ 3,212,000     $ 3,469,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

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

Beginning balance $ 701,000 $ 512,000 $ 198,000 $ 271,000 $ 452,000 Additions

                        0        434,000       314,000             0         11,000
Sale proceeds              (77,000 )     (245,000 )           0       (49,000 )     (192,000 )
Valuation write-downs     (250,000 )            0             0       (24,000 )            0

Total                   $  374,000     $  701,000     $ 512,000     $ 198,000     $  271,000




During the first quarter of 2021, loan charge-offs totaled $0.1 million while
recoveries of prior period loan charge-offs equaled $0.5 million, providing for
net loan recoveries of $0.4 million, or an annualized 0.05% of average total
loans. 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 $38.7 million, or 1.15% of total loans (1.33% of total
loans excluding PPP loans), and 1,385% of nonperforming loans as of March 31,
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.



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 with no economic forecast consensus.
Given the high degree of uncertainty surrounding economic forecasting, we have
elected to postpone the adoption of CECL, and will continue to use our incurred
loan loss reserve model as permitted.



--------------------------------------------------------------------------------


                                       56

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


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.

No changes were made to the environmental factor ratings during the first quarter of 2021.

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.



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 March 31, 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.



--------------------------------------------------------------------------------


                                       57
--------------------------------------------------------------------------------

MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


As of March 31, 2021, the allowance was comprised of $38.2 million in general
reserves relating to non-impaired loans and $0.5 million in specific reserves on
other loans, primarily accruing loans designated as troubled debt
restructurings. There were no specific reserve allocations relating to
nonaccrual loans. Troubled debt restructurings totaled $20.0 million at March
31, 2021, consisting of $0.4 million that are on nonaccrual status and $19.6
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 $0.9 million as of March 31, 2021 had been subject to previous partial
charge-offs aggregating $1.0 million. Those partial charge-offs were primarily
recorded during the time period of 2010 through 2020, averaging approximately
$0.1 million per year. As of March 31, 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:



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

Performing      $ 19,606,000     $ 23,133,000     $ 11,522,000     $ 16,018,000     $ 17,975,000
Nonperforming        431,000          510,000        1,113,000          521,000          466,000

Total           $ 20,037,000     $ 23,643,000     $ 12,635,000     $ 16,539,000     $ 18,441,000




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.



Securities available for sale increased $46.9 million during the first three
months of 2021, totaling $434 million as of March 31, 2021. Purchases of U.S.
Government agency bonds totaled $58.9 million during the first quarter of 2021,
in part reflecting the reinvestment of the proceeds from called U.S. Government
agency bonds that totaled $27.4 million during the quarter. Purchases of U.S.
Government agency guaranteed mortgage-backed securities totaled $14.4 million
during the first three months of 2021, primarily reflecting investments in
CRA-qualified securities and to a lesser degree the reinvestment of $3.0 million
from principal paydowns on U.S. Government agency guaranteed mortgage-backed
securities. Purchases of municipal bonds totaled $14.1 million during the first
quarter of 2021; proceeds from matured municipal bonds totaled $0.6 million. At
March 31, 2021, the portfolio was primarily comprised of U.S. Government agency
bonds (62%), municipal bonds (30%) and U.S. Government agency 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 March 31, 2021 totaled $434
million, including a net unrealized loss of $2.2 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 10% of total
assets.



FHLBI stock totaled $18.0 million as of March 31, 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.

--------------------------------------------------------------------------------


                                       58

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


Interest-earning balances, primarily consisting of excess funds deposited at the
Federal Reserve Bank of Chicago and a correspondent bank, are used to manage
daily liquidity needs and interest rate sensitivity. During the first three
months of 2021, the average balance of these funds equaled $592 million, or
13.7% of average earning assets, compared to $357 million, or 9.2% of average
earning assets, during 2020, and a more typical $115 million, or 3.4% of average
earning assets, during 2019. The elevated level during 2020 and into the first
quarter of 2021 reflects increased local deposit balances, primarily a product
of federal government stimulus programs as well as lower business and individual
investing and spending. We anticipate the level of interest-earning deposit
balances to remain elevated throughout 2021 given the conditions associated with
the Coronavirus Pandemic.



Net premises and equipment equaled $55.4 million at March 31, 2021, representing
a decrease of $3.6 million during the first three months of 2021. The decline
was primarily attributable to the transfer of $3.5 million associated with two
branch locations from net premises and equipment to assets held for sale,
combined with depreciation expense of $1.4 million. Leasehold improvements and
equipment purchases during the first quarter of 2021 aggregated $1.3 million.
Foreclosed and repossessed assets equaled $0.4 million as of March 31, 2021,
down $0.3 million from year-end 2020.



Total deposits increased $233 million during the first three months of 2021,
totaling $3.64 billion at March 31, 2021. Local deposits increased $249 million,
while out-of-area deposits decreased $16.0 million during the first three months
of 2021. As a percent of total deposits, out-of-area deposits equaled 0.8% as of
March 31, 2021, compared to 1.4% as of December 31, 2020.



Noninterest-bearing deposits increased $172 million during the first three
months of 2021, while interest-bearing checking accounts and money market
deposit accounts increased $21.4 million and $62.0 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 $33.3 million during the first quarter of
2021, primarily reflecting the impact of federal government stimulus programs
and lower consumer investing and spending. Local time deposits declined $39.4
during the first three months of 2021, in large part reflecting the maturity of
certain time deposits that were not renewed during the quarter as we did not
aggressively seek to renew these time deposits which were opened as part of a
special time deposit campaign that primarily ran during the latter half of the
first quarter of 2019. The reduction of out-of-area deposits during the first
three months of 2021 reflects maturities not replaced as the funds were no
longer needed.



Sweep accounts increased $22.9 million during the first three months of 2021,
totaling $141 million as of March 31, 2021. The aggregate balance of this
funding type is subject to relatively large daily fluctuations given the nature
of the customers utilizing this product and the sizable balances maintained by
many of the customers. The average balance of sweep accounts equaled $133
million during the first quarter of 2021, with a high balance of $169 million
and a 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 March 31, 2021, unchanged from the
year-end 2020 balance. The advances are collateralized by residential mortgage
loans, first mortgage liens on multi-family residential property loans, first
mortgage liens on commercial real estate property loans, and substantially all
other assets of our bank, under a blanket lien arrangement. Our borrowing line
of credit as of March 31, 2021 totaled $737 million, with remaining availability
based on collateral equaling $373 million.



Shareholders' equity was $441 million at March 31, 2021, compared to $442
million at December 31, 2020. Shareholders' equity was positively impacted by
first quarter net income of $14.2 million, which was offset by the $4.6 million
payment of a cash dividend, stock repurchases aggregating $3.5 million, and a
$7.2 million after-tax decline in the market value of our available for sales
securities portfolio. The latter reflects the impact of increasing interest
rates during the first three months of 2021.



--------------------------------------------------------------------------------


                                       59

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------

Liquidity

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



To assist in providing needed funds, we periodically obtain monies from
wholesale funding sources. Wholesale funds, primarily comprised of deposits from
customers outside of our market areas and advances from the FHLBI, totaled $425
million, or 10.1% of combined deposits and borrowed funds, as of March 31, 2021,
compared to $441 million, or 11.2% of combined deposits and borrowed funds, as
of December 31, 2020.



Sweep accounts increased $22.9 million during the first three months of 2021,
totaling $141 million as of March 31, 2021. The aggregate balance of this
funding type is subject to relatively large daily fluctuations given the nature
of the customers utilizing this product and the sizable balances maintained by
many of the customers. The average balance of sweep accounts equaled $133
million during the first quarter of 2021, with a high balance of $169 million
and a 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 our repurchase agreements as of March 31, 2021 and during
the first three months of 2021 is as follows:



Outstanding balance at March 31, 2021                                  $ 

141,310,000

Weighted average interest rate at March 31, 2021                                0.11 %
Maximum daily balance three months ended March 31, 2021                $ 

169,102,000

Average daily balance for three months ended March 31, 2021            $ 

132,845,000

Weighted average interest rate for three months ended March 31, 2021

    0.11 %




FHLBI advances aggregated $394 million as of March 31, 2021, unchanged from the
year-end 2020 balance. The advances are collateralized by residential mortgage
loans, first mortgage liens on multi-family residential property loans, first
mortgage liens on commercial real estate property loans, and substantially all
other assets of our bank, under a blanket lien arrangement. Our borrowing line
of credit as of March 31, 2021 totaled $737 million, with remaining availability
based on collateral equaling $373 million.



We also have the ability to borrow up to an aggregate $70.0 million on a daily
basis through correspondent banks using established unsecured federal funds
purchased lines of credit. We did not access these lines of credit during the
first three months of 2021. In contrast, our interest-earning deposit balance
with the Federal Reserve Bank of Chicago and a correspondent bank averaged an
aggregate $587 million during the first three 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 March 31, 2021. We did not utilize this line of credit
during the first three 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.



--------------------------------------------------------------------------------


                                       60

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


The following table reflects, as of March 31, 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   $ 3,145,254,000     $           0     $           0     $          0     $ 3,145,254,000
Time deposits                            303,175,000       166,642,000        29,891,000                0         499,708,000
Short-term borrowings                    141,310,000                 0                 0                0         141,310,000
Federal Home Loan Bank advances           40,000,000       174,000,000       120,000,000       60,000,000         394,000,000
Subordinated debentures                            0                 0                 0       47,733,000          47,733,000
Other borrowed money                               0                 0                 0        1,629,000           1,629,000
Property leases                              634,000         1,272,000           373,000        1,182,000           3,461,000




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 March 31, 2021, we had a total of $1.40 billion in unfunded loan
commitments and $25.9 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $1.22 billion were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $177
million were for loan commitments generally expected to close and become funded
within the next 12 to 18 months. We regularly monitor fluctuations in loan
balances and commitment levels, and include such data in our overall liquidity
management.



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

Capital Resources

Shareholders' equity was $441 million at March 31, 2021, compared to $442
million at December 31, 2020. Shareholders' equity was positively impacted by
first quarter net income of $14.2 million, which was offset by the $4.6 million
payment of a cash dividend, stock repurchases aggregating $3.5 million, and a
$7.2 million after-tax decline in the market value of our available for sales
securities portfolio. The latter reflects the impact of increasing interest
rates during the first three months of 2021.



As part of a $20 million common stock repurchase program announced in May of
2019, we repurchased approximately 118,000 shares for $3.5 million, at a
weighted average all-in cost per share of $29.91, during the first quarter of
2021. Since the beginning of the common stock repurchase program through March
31, 2021, we had repurchased approximately 469,000 shares for $13.7 million, at
a weighted average all-in cost of $29.24. The stock buybacks have been funded
from cash dividends paid to us from our bank. Additional repurchases may be made
during in future periods under the authorized 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
March 31, 2021, our bank met all capital adequacy requirements under the BASEL
III capital rules on a fully phased-in basis.



--------------------------------------------------------------------------------


                                       61

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


As of March 31, 2021, our bank's total risk-based capital ratio was 13.3%,
compared to 13.5% at December 31, 2020. Our bank's total regulatory capital
increased $10.1 million during the first three months of 2021, in large part
reflecting the net impact of net income totaling $15.5 million and cash
dividends paid to us aggregating $6.5 million. Our bank's total risk-based
capital ratio was also impacted by a $135 million increase in total
risk-weighted assets, primarily resulting from net growth in commercial loans
and the securities portfolio. As of March 31, 2021, our bank's total regulatory
capital equaled $467 million, or $115 million in excess of the 10.0% minimum
that is among the requirements to be categorized as "well capitalized." Our and
our bank's capital ratios as of March 31, 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 $14.2 million, or $0.87 per basic and diluted share,
for the first quarter of 2021, compared to net income of $10.7 million, or $0.65
per basic and diluted share, for the first quarter of 2020. The improved level
of net income primarily resulted from increased noninterest income, which more
than offset decreased net interest income and higher noninterest expense. The
increased noninterest income primarily reflected higher mortgage banking income.
The decline in net interest income depicted a lower yield on earning assets,
which more than offset growth in earning assets, while the higher level of
noninterest expense mainly resulted from increased compensation costs.



Interest income during the first quarter of 2021 was $34.8 million, a decrease
of $3.1 million, or 8.3%, from the $37.9 million earned during the first 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 3.26% during the first quarter of 2021, compared
to 4.54% during the prior-year first quarter. The decreased yield primarily
resulted from a lower yield on loans, which declined from 4.69% during the first
quarter of 2020 to 4.03% during the current-year first quarter. The decrease in
loan yield was mainly due to a lower yield on commercial loans, which equaled
4.07% in the first quarter of 2021 compared to 4.76% in the prior-year first
quarter. The lower yield 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.



A change in earning asset mix and decreased yields on securities and
interest-earning deposits also contributed to the lower yield on average earning
assets in the current-year first quarter compared to the respective 2020 period.
On average, lower-yielding interest-earning deposits represented 13.7% of
earning assets during the first quarter of 2021, up from 4.6% during the first
quarter of 2020, while higher-yielding loans represented 76.6% of earning assets
during the current-year first quarter, down from 85.2% during the prior-year
first 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 three
months of 2021, negatively impacted the yield on average earning assets by 44
basis points during the first 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 as well as lower
business and consumer spending and investing. The yield on securities was 1.61%
during the first three months of 2021, down from 4.73% 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 less than $0.1 million during the first quarter of 2021,
compared to $1.8 million during the prior-year first quarter. 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 interest-earning deposits was 0.11% during the first
quarter of 2021, down from 1.22% during the first quarter of 2020, primarily
reflecting the decreased interest rate environment. Average earning assets
equaled $4.33 billion during the current-year first quarter, up $970 million, or
28.9%, from the level of $3.36 billion during the respective 2020 period;
average loans were up $457 million, average interest-earning deposits were up
$438 million, and average securities were up $74.6 million.



--------------------------------------------------------------------------------


                                       62

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


Interest expense during the first quarter of 2021 was $5.3 million, a decrease
of $2.3 million, or 31.0%, from the $7.6 million expensed during the first
quarter of 2020. The decrease in interest expense is attributable to a lower
weighted average cost of interest-bearing liabilities, which equaled 0.82% in
the current-year first quarter compared to 1.36% in the prior-year first
quarter. The decrease in the weighted average cost of interest-bearing
liabilities mainly reflected lower costs of deposit accounts and borrowed funds.
The cost of interest-bearing non-time deposit accounts decreased from 0.46%
during the first quarter of 2020 to 0.21% during the first quarter 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 time deposits declined from 2.21% during the first quarter of 2020
to 1.49% during the current-year first 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. The cost of borrowed funds decreased from 2.31% during the first quarter
of 2020 to 1.78% during the first quarter of 2021, mainly reflecting lower costs
of FHLBI advances and subordinated debentures. The cost of FHLBI advances was
2.06% during the first quarter of 2021, down from 2.40% during the prior-year
first quarter, primarily reflecting the declining interest rate environment and
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. The cost of subordinated debentures was
3.85% during the first quarter of 2021, down from 5.90% during the respective
2020 period due to decreases in the 90-Day Libor Rate. 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, also contributed to the lower
weighted average cost of interest-bearing liabilities during the first quarter
of 2021 compared to the prior-year first quarter. Average interest-bearing
liabilities were $2.60 billion during the first quarter of 2021, up $362
million, or 16.1%, from the $2.24 billion average during the first quarter of
2020.



Net interest income during the first quarter of 2021 was $29.5 million, a
decrease of $0.8 million, or 2.6%, from the $30.3 million earned during the
respective 2020 period. The decline in net interest income resulted from a
decreased net interest margin, which more than offset the positive impact of an
increase in average earning assets. The net interest margin decreased from 3.63%
in the first quarter of 2020 to 2.77% in the current-year first 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
lower interest rates on variable-rate commercial loans stemming from the
aforementioned FOMC rate cuts, while the decreased cost of funds mainly
reflected lower rates paid on local deposit accounts and borrowed funds, along
with the previously mentioned change in funding mix.



The decrease in the net interest margin from 3.00% in the fourth quarter of 2020
to 2.77% in the first quarter of 2021 reflected a lower yield on average earning
assets, which more than offset a decline in the cost of funds. The yield on
average earning assets was 3.26% during the first quarter of 2021, down from
3.55% during the fourth quarter of 2020, mainly due to a decreased yield on
commercial loans, which equaled 4.07% and 4.41% in the respective periods. The
decreased yield on commercial loans primarily reflected reduced PPP net loan fee
accretion stemming from a lower level of forgiveness activity. Net PPP loan fee
accretion totaled $2.8 million in the first quarter of 2021, compared to $5.4
million during the fourth quarter of 2020. The cost of funds declined from 0.55%
during the fourth quarter of 2020 to 0.49% during the first quarter of 2021,
mainly due to lower rates paid on renewed time deposits, reflecting the
declining interest rate environment, and a change in funding mix, consisting of
an increase in lower-costing non-time deposits as a percentage of total funding
sources.

--------------------------------------------------------------------------------


                                       63
--------------------------------------------------------------------------------

MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


The following table sets forth certain information relating to our consolidated
average interest-earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the first
quarters 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 first quarters 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 first quarter of both 2021 and 2020 for this non-GAAP, but
industry standard, adjustment. This adjustment equated to a one basis point
increase in our net interest margin during both the first quarter of 2021 and
the respective 2020 period.





                                                                 Quarters ended March 31,
                                                    2 0 2 1                                     2 0 2 0
                                      Average                      Average        Average                      Average
                                      Balance       Interest        Rate          Balance       Interest        Rate
                                                                  (dollars in thousands)
ASSETS
Loans                               $ 3,318,281     $  32,985          4.03 %   $ 2,861,047     $  33,442          4.69 %
Investment securities                   419,514         1,692          1.61         344,906         4,077          4.73
Other interest-earning assets           591,617           168          0.11         153,638           475          1.22

Total interest - earning assets 4,329,412 34,845 3.26

      3,359,591        37,994          4.54

Allowance for loan losses               (38,467 )                                   (23,710 )
Other assets                            287,942                                     266,903

Total assets                        $ 4,578,887                                 $ 3,602,784


LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest-bearing deposits           $ 2,026,896     $   2,717          0.54 %   $ 1,724,030     $   4,641          1.08 %
Short-term borrowings                   132,845            36          0.11         102,850            40          0.15

Federal Home Loan Bank advances 394,000 2,027 2.06

         365,429         2,212          2.40
Other borrowings                         49,801           472          3.79          49,682           724          5.77
Total interest-bearing
liabilities                           2,603,542         5,252          0.82 

2,241,991 7,617 1.36

Noninterest-bearing deposits          1,510,334                                     923,827
Other liabilities                        21,463                                      17,355
Shareholders' equity                    443,548                                     419,611

Total liabilities and
shareholders' equity                $ 4,578,887                                 $ 3,602,784

Net interest income                                 $  29,593                                   $  30,377

Net interest rate spread                                               2.44 %                                      3.18 %
Net interest spread on average
assets                                                                 2.62 %                                      3.38 %
Net interest margin on earning
assets                                                                 2.77 %                                      3.63 %

--------------------------------------------------------------------------------


                                       64
--------------------------------------------------------------------------------

MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------


A loan loss provision expense of $0.3 million was recorded during the first
quarter of 2021, compared to $0.8 million during the first quarter of 2020. The
provision expense recorded during both periods primarily reflected net loan
growth. The recording of net loan recoveries in both periods reduced the
required provision amounts. During the first quarter of 2021, loan charge-offs
totaled $0.1 million, while recoveries of prior period loan charge-offs equaled
$0.5 million, providing for net loan recoveries of $0.4 million, or an
annualized 0.05% of average total loans. During the first quarter of 2020, loan
charge-offs totaled less than $0.1 million, while recoveries of prior period
loan charge-offs equaled $0.2 million, providing for net loan recoveries of $0.2
million, or an annualized 0.03% of average total loans. The allowance for loans,
as a percentage of total loans, was 1.2% as of March 31, 2021, and December 31,
2020, and 0.9% as of March 31, 2020. Excluding PPP loans, the allowance for
loans represented 1.3% of total loans as of March 31, 2021, and December 31,
2020.



Noninterest income during the first quarter of 2021 was $13.5 million, an
increase of $6.9 million, or approximately 106%, from the prior-year first
quarter. The improved level of noninterest income primarily resulted from
increased mortgage banking income, reflecting a significant increase in
refinance activity driven by a decrease in residential mortgage loan interest
rates, a higher level of purchase activity, the continuing success of strategic
initiatives that were implemented to increase market share, including new lender
hires and loan production office openings, an increase in the percentage of
originated loans being sold, and a higher gain on sale margin influenced by
market dynamics. Mortgage banking income totaled $8.8 million during the first
quarter of 2021, representing an increase of $6.2 million, or nearly 235%, from
the $2.6 million earned during the respective 2020 period. We originated $245
million in residential mortgage loans during the first three months of 2021,
which was approximately 85% higher than originations during the first three
months of 2020. Refinance transactions totaled $164 million during the first
quarter of 2021, compared to $86.3 million during the respective 2020 period,
representing an increase of $77.4 million, or approximately 90%. Purchase
transactions totaled $81.5 million during the first three months of 2021,
compared to $46.5 million during the first three months of 2020, representing an
increase of $35.0 million, or approximately 75%. Residential mortgage loans
originated for sale, generally consisting of longer-term fixed rate residential
mortgage loans, totaled $196 million, or approximately 80% of total mortgage
loans originated, during the first quarter of 2021. During the prior-year first
quarter, residential mortgage loans originated for sale totaled $95.3 million,
or nearly 72% of total mortgage loans originated. Fee income generated from an
interest rate swap program that was implemented during the fourth quarter of
2020 and growth in credit and debit card income also contributed to the
increased level of noninterest income. The interest rate swap program provides
certain commercial borrowers with a longer-term fixed-rate option and assists us
in managing associated longer-term interest rate risk. Increased customer
deposit account balances, in large part reflecting federal government stimulus
programs and reduced business and consumer investing and spending and resulting
in a higher level of account fees being waived, have continued to negatively
impact service charges on accounts, which were down 5.5% in the first quarter of
2021 compared to the prior-year first quarter. Payroll processing fees declined
3.5% during the first three months of 2021 compared to the respective 2020
period, mainly reflecting decreased transaction volume stemming from the
Coronavirus Pandemic-related increase in the unemployment rate.



Noninterest expense totaled $25.1 million during the first quarter of 2021,
compared to $22.9 million during the first quarter of 2020. Overhead costs
during the first three months of 2021 included write-downs of former branch
facilities totaling $0.5 million. Excluding these transactions, noninterest
expense increased $1.6 million, or 7.1%, during the first quarter of 2021
compared to the respective 2020 period. The higher level of expense primarily
resulted from increased compensation costs, mainly depicting higher residential
mortgage lender commissions and related incentives, annual employee merit pay
increases, increased health insurance costs, and a bonus accrual. The higher
level of commissions and associated incentives primarily reflected the
significant increase in residential mortgage loan originations during the first
quarter of 2021, which were up nearly 85% compared to the respective 2020
period. No bonus accrual was recorded during the first quarter of 2020 due to
the Coronavirus Pandemic and associated weakened economic environment. An
increase in Federal Deposit Insurance Corporation deposit insurance premiums
from $0.2 million during the first quarter of 2020 to $0.4 million during
current-year first quarter, mainly reflecting the impacts of a higher assessment
rate and base, also contributed to the increased level of noninterest expense.



During the first quarter of 2021, we recorded income before federal income tax
of $17.6 million and a federal income tax expense of $3.3 million. During the
first quarter of 2020, we recorded income before federal income tax of $13.2
million and a federal income tax expense of $2.5 million. The increase in
federal income tax expense during the first quarter of 2021 compared to the
prior-year first quarter resulted from the higher level of income before federal
income tax. Our effective tax rate was 19.0% during both the first three months
of 2021 and the respective 2020 period.



--------------------------------------------------------------------------------


                                       65

--------------------------------------------------------------------------------

  Table of Contents



                          MERCANTILE BANK CORPORATION

--------------------------------------------------------------------------------

© Edgar Online, source Glimpses