Mercantile Bank Corp: Form 10-Q for the period ended Mar 31, 2025

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,” “plans,” “projects,” “indicates,” “strategy,” “future,” “likely,” “may,” “should,” “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.

Future Factors include, among others, adverse changes in interest rates and interest rate relationships; increasing rates of inflation and slower growth rates or recession; significant declines in the value of commercial real estate; market volatility; demand for products and services; climate impacts; labor markets; the degree of competition by traditional and non-traditional financial services companies; changes in banking regulation or actions by bank regulators; changes in tax laws and other laws and regulations applicable to us; changes in prices, levies, and assessments; the impact of technological advances; potential cyber-attacks, information security breaches, and other criminal activities; litigation liabilities; governmental and regulatory policy changes; the outcomes of existing or future contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, and the failure to meet client expectations and other facts; changes in the national and local economies; unstable political and economic environments; disease outbreaks, such as the Covid-19 pandemic or similar public health threats, and measures implemented to combat them; and other risk factors, including those described in our annual report on Form 10-K for the year ended December 31, 2024. 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 Community Partners, LLC ("MCP") and Mercantile Bank (“our bank”) and its subsidiaries, including Mercantile Insurance Center, Inc. at March 31, 2025 and December 31, 2024 and the results of operations for the three months ended March 31, 2025 and 2024. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.

Critical Accounting Policies

Accounting principles generally accepted in the United States of America (“GAAP”) are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting estimates, see Note 1 of the Notes to our Consolidated Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2024 (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.

Allowance for Credit Losses (“allowance”): The allowance is maintained at a level we believe is adequate to absorb estimated credit losses identified and expected in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on historical credit loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Credit losses are charged against the allowance when we believe the 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. The allowance is increased through a provision charged to operating expense. Uncollectable loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.

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

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 loan prepayment speeds, the remaining life of the mortgage loan 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: Accounting rules require us to determine the fair value of all the assets and liabilities of an acquired entity, and to record their fair value on the date of acquisition. We employ a variety of means in determining fair value, including the use of discounted cash flow analysis, market comparisons and projected future revenue streams. For those items for which we conclude that we have the appropriate expertise to determine fair value, we may choose to use our own calculation of fair value. In other cases, where the fair value is not readily determined, consultation with outside parties is used to determine fair value. Once valuations have been determined, the net difference between the price paid for the acquired entity and the fair value of the balance sheet is recorded as goodwill. Goodwill is assessed at least annually for impairment, with any such impairment recognized in the period identified. A more frequent assessment is performed if there are material changes in the market place or within the organizational structure.

Financial Overview

We reported net income of $19.5 million, or $1.21 per diluted share, for the first quarter of 2025, compared with net income of $21.6 million, or $1.34 per diluted share, during the first quarter of 2024. Although net interest income increased, net income was negatively impacted by lower noninterest income, increased noninterest costs and a higher provision expense.

Commercial loans increased $44.3 million during the first three months of 2025, providing for an annualized growth rate of about 5%. Non-owner occupied commercial real estate (“CRE”) loans grew $55.3 million, commercial and industrial loans increased $27.1 million, multi-family and residential rental property loans were up $3.2 million and land development and construction loans expanded by $1.9 million, while owner occupied CRE loans declined $43.2 million. As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 53.8% as of March 31, 2025, compared to 54.9% as of December 31, 2024. While the “in discussion” segment of our commercial loan pipeline remains strong, the “committed and accepted” segment is relatively low, the latter generally reflecting customer reaction to the uncertain economic environment associated with United States tariff changes and negotiations. As of March 31, 2025, we had $210 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

Residential mortgage loans decreased $10.4 million during the first three months of 2025, as aggregate payoffs and scheduled monthly payments exceeded new loans added to the portfolio during the first quarter. Residential mortgage loan originations totaled $100 million during the first three months of 2025, of which about 80% were originated with the intent to sell.

The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.12% of total loans as of March 31, 2025. Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties at quarter end. Gross loan charge-offs totaled $0.1 million during the first three months of 2025, while recoveries of prior period loan charge-offs aggregated $0.2 million, providing for a net loan recovery of $0.1 million. We recorded a provision expense of $2.1 million during the first three months of 2025, primarily reflecting an increased allocation necessitated by changes to the economic forecast and loan growth.

Interest-earning deposits, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, averaged $267 million during the first three months of 2025, compared to $150 million during the first three months of 2024. The higher average balance primarily reflects our strategy to reduce the loan-to-deposit ratio via local deposit growth exceeding loan and investment growth, as well as our desire to maintain higher levels of on-balance sheet liquidity.

Total deposits declined $16.6 million during the first three months of 2025. Aggregate net growth in almost all interest-bearing deposit types offset a significant portion of the reduction in business noninterest-bearing checking accounts primarily reflecting the customary level of customers’ tax and bonus payments and partnership distributions during the early part of each first quarter. Securities sold under agreements to repurchase (“sweep accounts”) increased $121 million during the first quarter of 2025, largely reflecting the return of funds that had been withdrawn during the fourth quarter of 2024. Federal Home Loan Bank of Indianapolis (“FHLBI”) advances declined $20.9 million during the first three months of 2025. Wholesale funds, comprised of out-of-area deposits and FHLBI advances, totaled $516 million, or about 10% of total funds, as of March 31, 2025.

Net interest income increased $1.2 million during the first three months of 2025 compared to the first quarter of 2024, reflecting the net impact of $3.6 million and $2.4 million increases in interest income and interest expense, respectively. Our net interest margin during the first quarter of 2025 was 27 basis points lower than during the first quarter of 2024. Our yield on earning assets declined 32 basis points while our cost of funds was down 5 basis points during that time period. The lower yield on earning assets largely reflected the aggregate 100 basis point reduction in the federal funds rate during the last four months of 2024. Despite the reduction in the net interest margin, net interest income increased primarily due to significant loan growth between the first quarters of 2024 and 2025. Total loans averaged $4.63 billion and $4.30 billion during the first quarters of 2025 and 2024, respectively, reflecting growth of $330 million, or about 8%.

Noninterest income totaled $8.7 million during the first three months of 2025, compared to $10.9 million during the first quarter of 2024. Growth in treasury management fees, mortgage banking income and payroll service fees was more than offset by lower levels of interest rate swap income, revenue generated from a private equity fund investment and bank owned life insurance income.

Noninterest expense totaled $31.1 million during the first three months of 2025, compared to $29.9 million during the first quarter of 2024. The higher level of noninterest expense primarily resulted from increased compensation and benefit costs along with higher data processing expenses.

Financial Condition

Our total assets increased $89.0 million during the first three months of 2025, and totaled $6.14 billion as of March 31, 2025. Securities available for sale grew $57.2 million and total loans increased $35.8 million, while interest-earning deposits declined $20.9 million during the first quarter of 2025. Sweep accounts grew $121 million, while total deposits declined $16.6 million and FHLBI advances decreased $20.9 million during the first three months of 2025.

Commercial loans totaled $3.75 billion, or 80.9% of total loans, as of March 31, 2025. Commercial loans increased $44.3 million during the first three months of 2025, providing for an annualized growth rate of about 5%. Non-owner occupied CRE loans grew $55.3 million, commercial and industrial loans increased $27.1 million, multi-family and residential rental property loans were up $3.2 million and land development and construction loans expanded by $1.9 million, while owner occupied CRE loans declined $43.2 million. As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 53.8% as of March 31, 2025, compared to 54.9% as of December 31, 2024.

As of March 31, 2025, we had $210 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase, which we expect to be drawn over the next 12 to 18 months. While the “in discussion” segment of our commercial loan pipeline remains strong, the “committed and accepted” segment is relatively low, the latter generally reflecting customer reaction to the uncertain economic environment associated with United States tariff changes and negotiations. Our current pipeline reports indicate approximately $234 million in new lending opportunities of which we expect a majority to be accepted and funded over the next 12 to 18 months. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. Usage of existing commercial lines of credit averaged about 45% during the first three months of 2025, compared to approximately 42% during all of 2024.

Residential mortgage loans totaled $817 million, or 17.6% of total loans, as of March 31, 2025. Residential mortgage loans decreased $10.4 million during the first three months of 2025, as aggregate payoffs and scheduled monthly payments exceeded new loans added to the portfolio during the first quarter. Residential mortgage loan originations totaled $100 million during the first three months of 2025, of which about 80% were originated with the intent to sell.

Other consumer-related loans totaled $67.7 million, or 1.5% of total loans, as of March 31, 2025, compared to $65.9 million, or 1.4% of total loans, as of December 31, 2024. We expect this loan portfolio segment to remain relatively stable in dollar amount but decline as a percentage of total loans in future periods as the commercial loan segment grows.

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 or other factors. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require modification 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 nonperforming 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 $5.4 million (0.1% of total assets) as of March 31, 2025, compared to $5.7 million (0.1% of total assets) as of December 31, 2024. The volume of nonperforming assets has remained under 0.3% of total assets since year-end 2015. Given the low levels of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with what we believe are strong credit administration practices, we are pleased with the overall quality of the loan portfolio.

Loan charge-offs totaled $0.1 million, while recoveries of prior period loan charge-offs equaled $0.2 million, providing for a net loan recovery of $0.1 million during the first three months of 2025. 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. We recorded a provision expense of $2.1 million during the first three months of 2025, primarily reflecting an increased allocation necessitated by changes to the economic forecast and loan growth.

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

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

The allowance equaled $56.7 million, or 1.22% of total loans and 1,057% of nonperforming loans, as of March 31, 2025. The allowance was comprised of $54.3 million in general reserves relating to performing loans and $2.4 million in specific reserves on other loans, primarily nonperforming loans, as of March 31, 2025. Loans with an aggregate carrying value of $0.3 million as of March 31, 2025 had been subject to previous partial charge-offs aggregating $4.1 million over the past several years. There were no specific reserves allocated to loans that had been subject to a previous partial charge-off as of March 31, 2025.

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

The following table reflects the composition of our allowance for credit losses, nonaccrual loans, and net charge-offs as of and for the three months ended March 31, 2025.

(Dollars in thousands)

50

Securities available for sale increased $57.2 million during the first three months of 2025, totaling $788 million as of March 31, 2025. Purchases of U.S. Government agency bonds during the first three months of 2025 aggregated $46.0 million, while proceeds from maturities totaled $6.0 million. There were no purchases of U.S. Government agency guaranteed mortgage-backed securities during the first three months of 2025, while proceeds from principal paydowns aggregated $0.8 million. Purchases of municipal bonds totaled $5.7 million during the first three months of 2025; there were no maturities. As of March 31, 2025, the portfolio was primarily comprised of U.S. Government agency bonds (70%), municipal bonds (27%) and U.S. Government agency guaranteed mortgage-backed securities (3%). 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 as of March 31, 2025, totaled $788 million, including a net unrealized loss of $51.5 million. The net unrealized loss equaled $63.1 million as of December 31, 2024. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that the unrealized losses were due to changing interest rate environments. 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 any upcoming purchases to generally consist of U.S. Government agency bonds and municipal bonds, with the securities portfolio maintained at about 13% to 16% of total assets.

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

FHLBI stock totaled $21.5 million as of March 31, 2025, unchanged from December 31, 2024. Our investment in FHLBI stock is necessary to engage in the FHLBI’s advance and other financing programs. We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.

Interest-earning deposits, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, averaged $267 million during the first three months of 2025, compared to $150 million during the first three months of 2024. The higher average balance primarily reflects our strategy to reduce the loan-to-deposit ratio via local deposit growth exceeding loan and investment growth, as well as our desire to maintain higher levels of on-balance sheet liquidity.

Net premises and equipment equaled $53.7 million as of March 31, 2025, compared to $53.4 million as of December 31, 2024. Depreciation expense totaled $1.3 million during the first three months of 2025, while investments associated with renovations of existing facilities and equipment purchases aggregated $1.6 million.

Total deposits declined $16.6 million during the first three months of 2025. Aggregate net growth in almost all interest-bearing deposit types offset a significant portion of the reduction in business noninterest-bearing checking accounts primarily reflecting the expected large withdrawal of funds that had been deposited in late 2024 and the customary level of customers’ tax and bonus payments and partnership distributions during the early part of each first quarter. Out-of-area deposits were unchanged, while FHLBI advances declined $20.9 million during the first three months of 2025. Wholesale funds, comprised of out-of-area deposits and FHLBI advances, totaled $516 million, or about 10% of total funds, as of March 31, 2025.

Uninsured deposits totaled approximately $2.5 billion, or about 53% of total deposits, as of March 31, 2025, compared to approximately $2.2 billion, or 46% of total deposits, as of December 31, 2024. The uninsured amounts are estimates based on the methodologies and assumptions we use for regulatory reporting requirements.

Sweep accounts increased $121 million during the first quarter of 2025, largely reflecting the return of funds that had been withdrawn during the fourth quarter of 2024. In addition, the aggregate balance of sweep accounts is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that many of the customers maintain. The average balance of sweep accounts equaled $221 million during the first three months of 2025, with a high daily balance of $284 million and a low daily balance of $115 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into overnight interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.

FHLBI advances declined $20.9 million during the first three months of 2025, totaling $366 million as of March 31, 2025. Bullet advance maturities aggregated $20.0 million, while no new bullet advances were obtained, during the first three months of 2025. Payments on amortizing FHLBI advances totaled $0.9 million. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit totaled $1.06 billion, with remaining availability based on collateral equaling $674 million, as of March 31, 2025.

Shareholders’ equity increased $23.8 million during the first three months of 2025, equaling $608 million as of March 31, 2025. Positively impacting shareholders’ equity during the first three months of 2025 was net income of $19.5 million, which was partially offset by the payment of cash dividends totaling $5.9 million. Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by $1.0 million. A $9.2 million after-tax increase in the market value of our available for sale securities portfolio, reflecting a decline in market interest rates, positively impacted shareholders’ equity during the first three months of 2025.

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, and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-earning deposits. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.

To assist in providing needed funds and managing interest rate risk, we periodically obtain monies from wholesale funding sources. Wholesale funds, comprised of out-of-area deposits and FHLBI advances, totaled $516 million, or about 10% of total funds, as of March 31, 2025, compared to $537 million, or about 10% of total funds, as of December 31, 2024.

Sweep accounts increased $121 million during the first quarter of 2025, largely reflecting the return of funds that had been withdrawn during the fourth quarter of 2024. In addition, the aggregate balance of sweep accounts is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that many of the customers maintain. The average balance of sweep accounts equaled $221 million during the first three months of 2025, with a high daily balance of $284 million and a low daily balance of $115 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into overnight interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.

Information regarding our repurchase agreements as of March 31, 2025 and during the first three months of 2025 is as follows:

(Dollars in thousands)

FHLBI advances declined $20.9 million during the first three months of 2025, totaling $366 million as of March 31, 2025. Bullet advance maturities aggregated $20.0 million, while no new bullet advances were obtained, during the first three months of 2025. Payments on amortizing FHLBI advances totaled $0.9 million. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit totaled $1.06 billion, with remaining availability based on collateral equaling $674 million, as of March 31, 2025.

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 2025. In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged $248 million during the first three months of 2025. 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 $153 million as of March 31, 2025. We did not utilize this line of credit during the first three months of 2025 or at any time during the previous 16 fiscal years, and do not plan to access this line of credit in future periods.

The following table reflects, as of March 31, 2025, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

(Dollars in thousands)

The balance of certificates of deposit exceeding the FDIC insured limit and their maturity profile as of March 31, 2025 and December 31, 2024 were as follows:

(Dollars in thousands)

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, 2025, we had a total of $2.01 billion in unfunded loan commitments and $27.2 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.78 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $234 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. We have developed contingency funding plans that provide a framework for meeting liquidity disruptions.

Capital Resources

Shareholders’ equity increased $23.8 million during the first three months of 2025, equaling $608 million as of March 31, 2025. Positively impacting shareholders’ equity during the first three months of 2025 was net income of $19.5 million, which was partially offset by the payment of cash dividends totaling $5.9 million. Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by $1.0 million. A $9.2 million after-tax increase in the market value of our available for sale securities portfolio, reflecting a decline in market interest rates, positively impacted shareholders’ equity during the first three months of 2025.

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. As of March 31, 2025, our bank’s total risk-based capital ratio was 14.0%, compared to 13.9% as of December 31, 2024. Our bank’s total regulatory capital increased $3.0 million during the first three months of 2025, in large part reflecting net income totaling $22.3 million, which was partially offset by cash dividends paid to us aggregating $20.8 million. As of March 31, 2025, our bank’s total regulatory capital equaled $762 million, or $217 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, 2025 and December 31, 2024 are disclosed in Note 13 of the Notes to Consolidated Financial Statements.

Results of Operations

We recorded net income of $19.5 million, or $1.21 per basic and diluted share, for the first quarter of 2025, compared with net income of $21.6 million, or $1.34 per basic and diluted share, for the first quarter of 2024. Diluted earnings per share decreased $0.13, or 9.7%, during the first quarter of 2025, compared with the prior-year first quarter.

The decrease in net income during the first three months of 2025 compared to the respective 2024 period reflected lower noninterest income and higher levels of noninterest expense and provisions for credit losses, which more than offset increased net interest income. Net interest income increased as earning asset expansion and a decrease in the cost of funds outpaced a lower yield on earning assets and growth in interest-bearing liabilities. Noninterest income declined as increases in treasury management fees, mortgage banking income, and payroll service fees were outweighed by reductions in interest rate swap income, revenue generated from an investment in a private equity fund, and bank owned life insurance income. Noninterest expense was up primarily due to increased salary and benefit and data processing costs. The provision expense recorded during the current-year first quarter mainly reflected an increased allocation necessitated by changes to the economic forecast.

Interest income during the first quarter of 2025 was $80.3 million, an increase of $3.6 million, or 4.7%, from the $76.7 million earned during the first quarter of 2024. The increase resulted from growth in average earning assets, which more than offset a lower yield on average earning assets. Average earning assets equaled $5.68 billion during the first quarter of 2025, up $597 million, or 11.7%, from the level of $5.08 billion during the prior-year first quarter; average loans were up $330 million, average securities increased $150 million, and average interest-earning deposits grew $117 million. The yield on average earning assets was 5.74% during the current-year first quarter, a decrease from 6.06% during the respective 2024 period. The lower yield mainly resulted from a decreased yield on loans and a change in earning asset mix, which more than offset an enhanced yield on securities stemming from reinvestment and portfolio expansion activities in a higher interest rate environment. The yield on loans was 6.31% during the first quarter of 2025, down from 6.65% during the first quarter of 2024 primarily due to lower interest rates on variable-rate commercial loans resulting from the Federal Open Market Committee (“FOMC”) lowering the targeted federal funds rate. The FOMC decreased the targeted federal funds rate by 50 basis points in September of 2024 and 25 basis points in each of November and December of 2024, during which time average variable-rate commercial loans represented approximately 73% of average total commercial loans. Signifying the success of a strategic initiative to reduce the loan-to-deposit ratio and increase on-balance sheet liquidity, higher-yielding loans represented a reduced percentage of earning assets and lower-yielding securities and interest-earning deposits accounted for increased percentages of earning assets in the first quarter of 2025 compared to the first quarter of 2024. The yield on securities equaled 2.79% during the first three months of 2025, up from 2.20% during the first three months of 2024.

Interest expense during the first quarter of 2025 was $31.8 million, an increase of $2.4 million, or 8.3%, from the $29.4 million expensed during the first quarter of 2024. The higher level of interest expense resulted from growth in average interest-bearing liabilities, which more than offset a decline in the weighted average cost of these funds. Average interest-bearing liabilities totaled $4.18 billion during the first three months of 2025, compared to $3.61 billion during the respective 2024 period, representing an increase of $575 million, or 15.9%. The average weighted cost of interest-bearing liabilities declined from 3.27% during the first quarter of 2024 to 3.08% during the first quarter of 2025 mainly due to lower rates paid on money market accounts, reflecting the decreased interest rate environment that began in September of 2024 in conjunction with the FOMC’s lowering of the targeted federal funds rate. A change in funding mix, primarily consisting of a decrease in average noninterest-bearing checking accounts and growth in average higher-cost money market accounts and time deposits, negatively impacted the weighted average cost of interest-bearing liabilities during the first three months of 2025. The increases in money market accounts and time deposits reflected new deposit relationships, growth in existing deposit relationships, and deposit migration.

Net interest income during the first quarter of 2025 was $48.5 million, an increase of $1.2 million, or 2.5%, from the $47.3 million earned during the respective 2024 period. The increase reflected growth in earning assets, which more than offset a lower net interest margin. The net interest margin was 3.47% in the first quarter of 2025, down from 3.74% in the prior-year first quarter due to a decreased yield on earning assets, which more than offset a decline in the cost of funds. The lower yield on average earning assets mainly resulted from a decreased yield on commercial loans, largely reflecting the impact of the previously mentioned FOMC rate cuts. The cost of funds equaled 2.27% in the first quarter of 2025, down from 2.32% in the first quarter of 2024 primarily due to lower costs of money market accounts, reflecting the decreasing interest rate environment over the last four months of 2024.

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 2025 and 2024. 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 2025 and 2024 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 quarters of 2025 and 2024 for this non-GAAP, but industry standard, adjustment. These adjustments equated to increases in our net interest margin of less than one basis point for both periods.

MERCANTILE BANK CORPORATION

(dollars in thousands)

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Provisions for credit losses of $2.1 million and $1.3 million were recorded during the first quarters of 2025 and 2024, respectively. The provision expense recorded during the first three months of 2025 mainly reflected an increased allocation dictated by changes to the economic forecast. The provision expense recorded during the first three months of 2024 primarily reflected an individual allocation for a nonperforming commercial loan relationship, allocations necessitated by net loan growth, and a change in a commercial loan environmental factor, which more than offset the impacts of an improved economic forecast and changes to the loan portfolio composition. Sustained strength in loan quality metrics and the recording of net loan recoveries during both periods largely mitigated additional reserves associated with loan growth.

Noninterest income totaled $8.7 million during the first quarter of 2025, down from $10.9 million during the respective 2024 period as growth in treasury management fees, mortgage banking income, and payroll service fees was more than offset by lower levels of interest rate swap income, revenue generated from an investment in a private equity fund, and bank owned life insurance income. The increase in treasury management fees mainly reflected customers’ expanded use of products and services and the successful marketing of these offerings to existing and new clients. The higher level of mortgage banking income primarily resulted from increases in the percentage of loans originated with the intent to sell, which equaled approximately 80% during the current-year first quarter compared to approximately 74% during the first quarter of 2024, and total loan originations, which were up approximately 26% during the first quarter of 2025 compared to the corresponding 2024 period. During the first quarter of 2025, interest rate swap income, which sometimes varies greatly from period to period due to the timing of closing transactions, was negatively impacted by the ongoing uncertainty surrounding economic and operating conditions and the associated reduction in commercial loan activity. Noninterest income during the first three months of 2024 included bank owned life insurance claims totaling $0.7 million.

Noninterest expense totaled $31.1 million during the first quarter of 2025, compared to $29.9 million during the prior-year first quarter. The increase primarily resulted from higher salary and benefit costs, largely reflecting annual merit pay increases and market adjustments. A higher level of data processing costs, mainly reflecting increased software support costs, also contributed to the rise in noninterest expense. Lower depreciation expense, largely reflecting facility expansion and leasehold improvement projects becoming fully depreciated during 2024, and a reduced reserve for commercial loan commitments positively impacted noninterest expense during the first three months of 2025. Noninterest expense during the first quarter of 2024 included contributions to The Mercantile Bank Foundation totaling $0.7 million.

During the first quarter of 2025, we recorded income before federal income tax of $24.0 million and a federal income tax expense of $4.5 million. During the first quarter of 2024, we recorded income before federal income tax of $27.0 million and a federal income tax expense of $5.4 million. The $0.9 million decrease in federal income tax expense in the first three months of 2025 compared to the respective 2024 period primarily resulted from the lower level of income before federal income tax. The aforementioned bank owned life insurance claims, substantially all of which were nontaxable, positively impacted the effective tax rate in the first three months of 2024.

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

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

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

The following table depicts our GAP position as of March 31, 2025:

(Dollars in thousands)

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

(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of March 31, 2025.

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

Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment; therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions and our strategies, among other factors.

We conducted multiple simulations as of March 31, 2025, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 400 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $225 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of March 31, 2025. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.

(Dollars in thousands)

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

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

As of March 31, 2025, an evaluation was performed under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of March 31, 2025.

There have been no changes in our internal control over financial reporting during the quarter ended March 31, 2025 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K for the year ended December 31, 2024.