Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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,” “forecasts,” “intends,” “is likely,” “plans,” “projects,” 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, changes in interest rates and interest rate relationships; 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 tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; changes in the method of determining Libor, or the replacement of Libor with an alternative reference rate; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economies; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2018 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 two subsidiaries, Mercantile Bank Real Estate Co., LLC and Mercantile Insurance Center, Inc., at September 30, 2019 and December 31, 2018 and the results of operations for the three months and nine months ended September 30, 2019 and September 30, 2018. 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 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. 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, 2018 (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.
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.
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.
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.
MERCANTILE BANK CORPORATION
Accounting guidance requires that we assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors which may impact future operating results. Significant weight is given to evidence that can be objectively verified.
Securities and Other Financial Instruments: Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other than temporary losses, management considers: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near term prospects of the issuer; and (3) the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Fair values for securities available for sale are obtained from outside sources and applied to individual securities within the portfolio. The difference between the amortized cost and the current fair value of securities is recorded as a valuation adjustment and reported in other comprehensive income.
Mortgage Servicing Rights: Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from serving each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.
Goodwill: Generally accepted accounting principles require 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. We use a discounted income approach and a market valuation model, which compares the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill has been impaired.
MERCANTILE BANK CORPORATION
Financial Overview
We reported net income of $12.6 million, or $0.77 per diluted share, for the third quarter of 2019, compared to net income of $10.1 million, or $0.61 per diluted share, during the third quarter of 2018. Net income during the first nine months of 2019 totaled $36.1 million, or $2.20 per diluted share, compared to $30.5 million, or $1.83 per diluted share, during the first nine months of 2018.
Bank owned life insurance claims and a gain on the sale of a former branch facility increased net income during the first nine months of 2019 by $3.1 million, or $0.19 per diluted share. Interest income related to purchased loan accounting entries increased net income during the first nine months of 2019 by $0.9 million, or $0.05 per diluted share, and net income during the first nine months of 2018 by $2.7 million, or $0.16 per diluted share. Excluding the impacts of these specific transactions, diluted earnings per share increased $0.29, or over 17%, during the first nine months of 2019 compared to the respective 2018 period.
The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.09% of total loans as of September 30, 2019. Gross loan charge-offs totaled $0.5 million during the third quarter of 2019, and aggregated $0.8 million for the first nine months of the year, while recoveries of prior period loan charge-offs equaled $0.2 million and $0.4 million during the respective time periods. Net loan charge-offs, as a percent of average total loans, equaled an annualized 0.05% during the third quarter and 0.02% during the first nine months of 2019. 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.
New commercial term loan originations totaled $153 million during the third quarter of 2019, bringing the year-to-date total to $412 million. The new commercial loan pipeline remains strong, and at September 30, 2019, we had $91 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase. We believe our loan portfolio remains well diversified, with both commercial and industrial loans and non-owner occupied commercial real estate (“CRE”) loans equaling 30%, owner occupied CRE loans equaling 19% and residential mortgage and consumer loans aggregating 15% of total loans at September 30, 2019. As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 58% at September 30, 2019. We recorded a provision for loan losses of $0.7 million during the third quarter of 2019, bringing the year-to-date total to $2.5 million. The provision for loan losses recorded during 2019 primarily reflects commercial loan growth.
We believe our funding structure also remains well diversified. As of September 30, 2019, noninterest-bearing checking accounts comprised 30% of total funds, interest-bearing checking and securities sold under agreements to repurchase (“sweep accounts”) combined for 13%, savings deposits and money market accounts aggregated to 25% and local time deposits accounted for 16%. Wholesale funds, comprised of brokered deposits and Federal Home Loan Bank of Indianapolis (“FHLBI”) advances, represented 16% of total funds.
Financial Condition
Our total assets increased $346 million during the first nine months of 2019, and totaled $3.71 billion as of September 30, 2019. Total loans increased $180 million, interest-earning deposits grew by $134 million and securities available for sale increased $8.2 million, while total deposits increased $303 million and FHLBI advances were up $14.0 million during the first nine months of 2019.
Commercial loans increased $148 million during the first nine months of 2019, and at September 30, 2019 totaled $2.51 billion, or 85.5% of the loan portfolio. As of December 31, 2018, the commercial loan portfolio comprised 85.7% of total loans. The increase in commercial loans during the first nine months of 2019 primarily reflects new commercial term loans to existing and new borrowers. Commercial and industrial loans were up $60.0 million, non-owner occupied CRE loans increased $66.8 million, owner occupied CRE loans were up $18.6 million, and vacant land, land development and residential construction loans were up $3.5 million, while multi-family and residential rental loans decreased $0.7 million. As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 57.8% as of September 30, 2019, compared to 58.1% at December 31, 2018.
MERCANTILE BANK CORPORATION
We are very pleased with the $2.6 billion in new commercial term loan fundings since the beginning of 2015, including $412 million during the first nine months of 2019. As of September 30, 2019, availability on existing construction and development loans totaled $91 million, with most of those funds expected to be drawn over the next 12 to 18 months. Our loan pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including $165 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 substantial additional opportunities they are currently discussing with existing and potentially new borrowers.
We continue to experience commercial loan principal paydowns and payoffs. While a portion of the principal paydowns and payoffs received have been welcomed, such as on stressed loan relationships, we have also experienced instances where well-performing relationships have been refinanced at other financial institutions or non-bank entities, and other situations where the borrower has sold the underlying asset. In many of those instances where the loans were refinanced elsewhere, we believed the terms and conditions of the new lending arrangements were too aggressive, generally reflecting the very competitive banking environment in our markets. 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 has remained relatively steady.
Residential mortgage loans increased $38.6 million during the first nine months of 2019, totaling $346 million, or 11.8% of total loans, as of September 30, 2019. We originated $258 million in residential mortgage loans during the first nine months of 2019, which was almost 52% higher than originations during the first nine months of 2018. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, during the first nine months of 2019 totaled $176 million, or about 68% of total mortgage loans originated. The remaining portion, in large part comprised of adjustable rate residential mortgage loans, was added to our balance sheet. Despite the headwinds of an ongoing housing inventory shortage in most of our larger markets, we are pleased with the success of our strategic initiative to grow our residential mortgage banking operation over the past few years, and remain optimistic that origination volumes will remain strong. As of September 30, 2019, the level of residential mortgage loan pre-qualifications remained at a high level. Other consumer-related loans declined $6.9 million during the first nine months of 2019, and at September 30, 2019 totaled $78.6 million, or 2.7% of total loans. Other consumer-related loans comprised 3.1% of total loans as of December 31, 2018. We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed anticipated new loan origination volumes.
The following table summarizes our loan portfolio over the past twelve months:
|
|
9/30/19
|
|
|
6/30/19
|
|
|
3/31/19
|
|
|
12/31/18
|
|
|
9/30/18
|
|
Commercial:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial & Industrial
|
|
$
|
882,748,000
|
|
|
$
|
881,196,000
|
|
|
$
|
839,207,000
|
|
|
$
|
822,723,000
|
|
|
$
|
818,112,000
|
|
Land Development & Construction
|
|
|
48,417,000
|
|
|
|
45,158,000
|
|
|
|
45,892,000
|
|
|
|
44,885,000
|
|
|
|
39,396,000
|
|
Owner Occupied Commercial RE
|
|
|
567,267,000
|
|
|
|
556,868,000
|
|
|
|
551,518,000
|
|
|
|
548,619,000
|
|
|
|
542,731,000
|
|
Non-Owner Occupied Commercial RE
|
|
|
883,080,000
|
|
|
|
852,844,000
|
|
|
|
835,678,000
|
|
|
|
816,282,000
|
|
|
|
811,767,000
|
|
Multi-Family & Residential Rental
|
|
|
126,855,000
|
|
|
|
128,489,000
|
|
|
|
127,903,000
|
|
|
|
127,597,000
|
|
|
|
94,101,000
|
|
Total Commercial
|
|
|
2,508,367,000
|
|
|
|
2,464,555,000
|
|
|
|
2,400,198,000
|
|
|
|
2,360,106,000
|
|
|
|
2,306,107,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1-4 Family Mortgages
|
|
|
346,094,000
|
|
|
|
335,618,000
|
|
|
|
316,314,000
|
|
|
|
307,540,000
|
|
|
|
301,765,000
|
|
Home Equity & Other Consumer Loans
|
|
|
78,552,000
|
|
|
|
81,320,000
|
|
|
|
83,127,000
|
|
|
|
85,439,000
|
|
|
|
89,545,000
|
|
Total Retail
|
|
|
424,646,000
|
|
|
|
416,938,000
|
|
|
|
399,441,000
|
|
|
|
392,979,000
|
|
|
|
391,310,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,933,013,000
|
|
|
$
|
2,881,493,000
|
|
|
$
|
2,799,639,000
|
|
|
$
|
2,753,085,000
|
|
|
$
|
2,697,417,000
|
|
MERCANTILE BANK CORPORATION
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; however, we 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 $2.9 million (0.1% of total assets) as of September 30, 2019, compared to $5.0 million (0.2% of total assets) as of December 31, 2018. Given the low level of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with the manageable and steady level of watch list credits and what we believe are strong credit administration practices, we remain pleased with the overall quality of the loan portfolio.
The following tables provide a breakdown of nonperforming assets by collateral type:
NONPERFORMING LOANS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9/30/19
|
|
|
6/30/19
|
|
|
3/31/19
|
|
|
12/31/18
|
|
|
9/30/18
|
|
Residential Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Development
|
|
$
|
32,000
|
|
|
$
|
33,000
|
|
|
$
|
45,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
Construction
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Owner Occupied / Rental
|
|
|
2,390,000
|
|
|
|
2,779,000
|
|
|
|
3,032,000
|
|
|
|
3,157,000
|
|
|
|
3,498,000
|
|
|
|
|
2,422,000
|
|
|
|
2,812,000
|
|
|
|
3,077,000
|
|
|
|
3,157,000
|
|
|
|
3,498,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Development
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Construction
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Owner Occupied
|
|
|
183,000
|
|
|
|
642,000
|
|
|
|
767,000
|
|
|
|
950,000
|
|
|
|
1,005,000
|
|
Non-Owner Occupied
|
|
|
26,000
|
|
|
|
26,000
|
|
|
|
62,000
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
209,000
|
|
|
|
668,000
|
|
|
|
829,000
|
|
|
|
950,000
|
|
|
|
1,005,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Assets
|
|
|
0
|
|
|
|
2,000
|
|
|
|
207,000
|
|
|
|
17,000
|
|
|
|
331,000
|
|
Consumer Assets
|
|
|
13,000
|
|
|
|
23,000
|
|
|
|
25,000
|
|
|
|
17,000
|
|
|
|
18,000
|
|
|
|
|
13,000
|
|
|
|
25,000
|
|
|
|
232,000
|
|
|
|
34,000
|
|
|
|
349,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,644,000
|
|
|
$
|
3,505,000
|
|
|
$
|
4,138,000
|
|
|
$
|
4,141,000
|
|
|
$
|
4,852,000
|
|
MERCANTILE BANK CORPORATION
OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9/30/19
|
|
|
6/30/19
|
|
|
3/31/19
|
|
|
12/31/18
|
|
|
9/30/18
|
|
Residential Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Development
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
Construction
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Owner Occupied / Rental
|
|
|
186,000
|
|
|
|
446,000
|
|
|
|
372,000
|
|
|
|
398,000
|
|
|
|
410,000
|
|
|
|
|
186,000
|
|
|
|
446,000
|
|
|
|
372,000
|
|
|
|
398,000
|
|
|
|
410,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land Development
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Construction
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Owner Occupied
|
|
|
57,000
|
|
|
|
0
|
|
|
|
24,000
|
|
|
|
413,000
|
|
|
|
538,000
|
|
Non-Owner Occupied
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
57,000
|
|
|
|
0
|
|
|
|
24,000
|
|
|
|
413,000
|
|
|
|
538,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Real Estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Assets
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Consumer Assets
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
243,000
|
|
|
$
|
446,000
|
|
|
$
|
396,000
|
|
|
$
|
811,000
|
|
|
$
|
948,000
|
|
The following tables provide a reconciliation of nonperforming assets:
NONPERFORMING LOANS RECONCILIATION
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3rd Qtr
|
|
|
2nd Qtr
|
|
|
1st Qtr
|
|
|
4th Qtr
|
|
|
3rd Qtr
|
|
|
|
2019
|
|
|
2019
|
|
|
2019
|
|
|
2018
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
3,505,000
|
|
|
$
|
4,138,000
|
|
|
$
|
4,141,000
|
|
|
$
|
4,852,000
|
|
|
$
|
4,965,000
|
|
Additions, net of transfers to ORE
|
|
|
338,000
|
|
|
|
(85,000
|
)
|
|
|
525,000
|
|
|
|
1,181,000
|
|
|
|
748,000
|
|
Returns to performing status
|
|
|
(126,000
|
)
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Principal payments
|
|
|
(1,014,000
|
)
|
|
|
(512,000
|
)
|
|
|
(382,000
|
)
|
|
|
(1,835,000
|
)
|
|
|
(857,000
|
)
|
Loan charge-offs
|
|
|
(59,000
|
)
|
|
|
(36,000
|
)
|
|
|
(146,000
|
)
|
|
|
(57,000
|
)
|
|
|
(4,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,644,000
|
|
|
$
|
3,505,000
|
|
|
$
|
4,138,000
|
|
|
$
|
4,141,000
|
|
|
$
|
4,852,000
|
|
OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3rd Qtr
|
|
|
2nd Qtr
|
|
|
1st Qtr
|
|
|
4th Qtr
|
|
|
3rd Qtr
|
|
|
|
2019
|
|
|
2019
|
|
|
2019
|
|
|
2018
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
446,000
|
|
|
$
|
396,000
|
|
|
$
|
811,000
|
|
|
$
|
948,000
|
|
|
$
|
842,000
|
|
Additions
|
|
|
57,000
|
|
|
|
145,000
|
|
|
|
15,000
|
|
|
|
65,000
|
|
|
|
257,000
|
|
Sale proceeds
|
|
|
(252,000
|
)
|
|
|
(74,000
|
)
|
|
|
(429,000
|
)
|
|
|
(128,000
|
)
|
|
|
(147,000
|
)
|
Valuation write-downs
|
|
|
(8,000
|
)
|
|
|
(21,000
|
)
|
|
|
(1,000
|
)
|
|
|
(74,000
|
)
|
|
|
(4,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
243,000
|
|
|
$
|
446,000
|
|
|
$
|
396,000
|
|
|
$
|
811,000
|
|
|
$
|
948,000
|
|
MERCANTILE BANK CORPORATION
Gross loan charge-offs totaled $0.5 million during the third quarter of 2019, and aggregated $0.8 million for the first nine months of the year, while recoveries of prior period loan charge-offs equaled $0.2 million and $0.4 million during the respective time periods. Net loan charge-offs, as a percent of average total loans, equaled an annualized 0.05% during the third quarter and 0.02% during the first nine months of 2019. 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.
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.
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. 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 loans. Our migration analysis takes into account various time periods, with most weight placed on the time frame from December 31, 2010 through September 30, 2019. 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.
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 creditor’s rights in order to preserve our collateral position.
MERCANTILE BANK CORPORATION
The allowance for originated loans equaled $23.7 million as of September 30, 2019, or 0.9% of total originated loans outstanding, compared to $21.6 million, or 0.9% of total originated loans outstanding at December 31, 2018. We also had an allowance for acquired loans as of September 30, 2019 and December 31, 2018, equaling $0.7 million and $0.8 million, respectively. The allowance equaled 923% of nonperforming loans as of September 30, 2019, compared to 540% as of December 31, 2018. The increase in this coverage ratio during the first nine months of 2019 in large part reflects a combination of a $1.5 million reduction in nonperforming loans and a $2.0 million balance increase in the allowance.
As of September 30, 2019, the allowance for originated loans was comprised of $21.7 million in general reserves relating to non-impaired loans and $2.0 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. Troubled debt restructurings totaled $28.3 million at September 30, 2019, consisting of $0.2 million that are on nonaccrual status and $28.1 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 $0.2 million as of September 30, 2019 had been subject to previous partial charge-offs aggregating $0.5 million. Those partial charge-offs were recorded as follows: less than $0.1 million in 2018, 2017, 2016 and 2013, $0.1 million in 2015 and $0.3 million in 2011. As of September 30, 2019, 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 originated and acquired loans categorized as troubled debt restructurings:
|
|
9/30/19
|
|
|
6/30/19
|
|
|
3/31/19
|
|
|
12/31/18
|
|
|
9/30/18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performing
|
|
$
|
28,102,000
|
|
|
$
|
28,129,000
|
|
|
$
|
20,363,000
|
|
|
$
|
19,223,000
|
|
|
$
|
11,300,000
|
|
Nonperforming
|
|
|
225,000
|
|
|
|
877,000
|
|
|
|
1,195,000
|
|
|
|
229,000
|
|
|
|
1,129,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
28,327,000
|
|
|
$
|
29,006,000
|
|
|
$
|
21,558,000
|
|
|
$
|
19,452,000
|
|
|
$
|
12,429,000
|
|
Although we believe the allowance is adequate to absorb loan losses in our originated loan portfolio as they arise, there can be no assurance 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 $8.2 million during the first nine months of 2019, totaling $346 million as of September 30, 2019. Purchases during the first nine months of 2019, consisting of U.S. Government agency bonds ($34.0 million), U.S. Government agency issued or guaranteed mortgage-backed securities ($5.6 million) and municipal bonds ($13.8 million), totaled $53.4 million. Proceeds from matured and called U.S. Government agency bonds and municipal bonds during the first nine months of 2019 totaled $34.5 million and $19.0 million, respectively, with another $7.0 million from principal paydowns on mortgage-backed securities. At September 30, 2019, the portfolio was primarily comprised of U.S. Government agency bonds (57%), municipal bonds (30%) and U.S. Government agency issued or guaranteed mortgage-backed securities (13%). 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 September 30, 2019 totaled $346 million, including a net unrealized gain of $5.4 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 2019 to generally consist of U.S. Government agency bonds, U.S. Government agency issued or guaranteed mortgage-backed securities and municipal bonds, with the securities portfolio maintained at about 10% of total assets.
FHLBI stock totaled $18.0 million as of September 30, 2019, an increase of $2.0 million compared to the balance at December 31, 2018. The increase reflects additional FHLBI stock purchased in conjunction with an increase in advances outstanding. 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.
MERCANTILE BANK CORPORATION
Market values on our U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies and municipal bonds are generally determined on a monthly basis with the assistance of a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes and issuer spreads. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.
Interest-earning deposit balances, primarily consisting of excess funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate sensitivity. During the first nine months of 2019, the average balance of these funds equaled $93.8 million, or 2.8% of average earning assets. We expect the level of these funds to average approximately 1% to 2% of average earning assets in future quarters.
Net premises and equipment equaled $54.6 million at September 30, 2019, an increase of $6.3 million during the first nine months of 2019. The increase was attributable to net purchases of $9.1 million, in large part associated with an expansion project at our bank’s main office. Depreciation expense totaled $2.8 million during the first nine months of 2019. Foreclosed and repossessed assets equaled $0.2 million as of September 30, 2019, compared to $0.8 million as of December 31, 2018. While we expect further transfers from loans to foreclosed and repossessed assets in future periods reflecting our collection efforts on some impaired lending relationships, we believe the overall strong quality of our loan portfolio will limit any overall increase in, and average balance of, this particular nonperforming asset category in future periods.
Total deposits increased $303 million during the first nine months of 2019, totaling $2.77 billion at September 30, 2019. Local deposits and out-of-area deposits increased $263 million and $40.2 million, respectively, during the first nine months of 2019. As a percent of total deposits, out-of-area deposits equaled 5.5% as of September 30, 2019, compared to 4.6% as of December 31, 2018.
Noninterest-bearing checking accounts increased $77.4 million during the first nine months of 2019, reflecting deposit balance increases from existing commercial lending relationships and deposit account openings as part of recently established commercial lending relationships. Interest-bearing checking accounts decreased $11.4 million and savings deposits were down $47.1 million, primarily reflecting the cyclical nature of deposit balances in the operational accounts of many local governmental depositors. Money market deposit accounts increased $88.4 million, primarily reflecting new funds being deposited into relatively high-paying accounts from current customers. Local time deposits increased $156 million during the first nine months of 2019, generally reflecting a new money time deposit campaign we ran during February, March and early April, as well as increased deposits from certain local governmental depositors.
Sweep accounts increased $0.5 million during the first nine months of 2019, totaling $104 million as of September 30, 2019. The aggregate balance of this funding type can be subject to relatively large fluctuations given the nature of the customers utilizing this product and the sizable balances of many of the customers. The average balance of sweep accounts was $106 million during the first nine months of 2019, while the actual balance varied from a high of $133 million to a low of $89.7 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 increased $14.0 million during the first nine months of 2019, reflecting new advances obtained primarily to replace maturities and fund loan growth. As of September 30, 2019, FHLBI advances totaled $364 million. The FHLBI advances are generally collateralized by a blanket lien on our residential mortgage loan portfolio and certain commercial real estate loans. Our borrowing line of credit as of September 30, 2019 totaled $777 million, with remaining availability of $407 million.
MERCANTILE BANK CORPORATION
Shareholders’ equity was $407 million at September 30, 2019, compared to $375 million at December 31, 2018. The $32.0 million increase during the first nine months of 2019 primarily reflects the positive impact of net income totaling $36.1 million, compared to the negative impact of cash dividends and common stock repurchases totaling $12.7 million and $7.1 million, respectively. Reflecting the decline in market interest rates, the change in net unrealized holding gain/loss on securities available for sale, net of tax effect, had a $12.5 million positive impact on shareholders’ equity during the first nine months of 2019.
Liquidity
Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and capital, or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-earning deposit balances. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.
To assist in providing needed funds, we have regularly obtained monies from wholesale funding sources. Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $517 million, or 16.0% of combined deposits and borrowed funds, as of September 30, 2019, compared to $474 million, or 16.2% of combined deposits and borrowed funds, as of December 31, 2018.
Sweep accounts increased $0.5 million during the first nine months of 2019, totaling $104 million as of September 30, 2019. The aggregate balance of this funding type can be subject to relatively large fluctuations given the nature of the customers utilizing this product and the sizable balances of many of the customers. The average balance of sweep accounts was $106 million during the first nine months of 2019, while the actual balance varied from a high of $133 million to a low of $89.7 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 September 30, 2019 and during the first nine months of 2019 is as follows:
Outstanding balance at September 30, 2019
|
|
$
|
103,990,000
|
|
Weighted average interest rate at September 30, 2019
|
|
|
0.21
|
%
|
Maximum daily balance nine months ended September 30, 2019
|
|
$
|
133,411,000
|
|
Average daily balance for nine months ended September 30, 2019
|
|
$
|
106,396,000
|
|
Weighted average interest rate for nine months ended September 30, 2019
|
|
|
0.25
|
%
|
As a member of FHLBI, we have access to FHLBI advance borrowing programs. FHLBI advances increased $14.0 million during the first nine months of 2019, reflecting new advances obtained to replace maturing advances and assist in funding loan growth. As of September 30, 2019, FHLBI advances totaled $364 million, and based on available collateral we could borrow an additional $407 million.
We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. We accessed a line of credit on several occasions during the initial part of the first quarter of 2019 to provide short-term assistance in funding strong loan growth and business checking account withdrawals. Federal funds purchased averaged $1.9 million during the first nine months of 2019, compared to our interest-earning deposit balance with the Federal Reserve Bank of Chicago that averaged $82.3 million. 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 $32.9 million as of September 30, 2019. We did not utilize this line of credit during the first nine months of 2019 or at any time during the previous ten fiscal years, and do not plan to access this line of credit in future periods.
MERCANTILE BANK CORPORATION
The following table reflects, as of September 30, 2019, 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
|
|
$
|
2,087,568,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
2,087,568,000
|
|
Time deposits
|
|
|
367,365,000
|
|
|
|
275,203,000
|
|
|
|
36,955,000
|
|
|
|
0
|
|
|
|
679,523,000
|
|
Short-term borrowings
|
|
|
103,990,000
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
103,990,000
|
|
Federal Home Loan Bank advances
|
|
|
40,000,000
|
|
|
|
144,000,000
|
|
|
|
140,000,000
|
|
|
|
40,000,000
|
|
|
|
364,000,000
|
|
Subordinated debentures
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
46,710,000
|
|
|
|
46,710,000
|
|
Other borrowed money
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
2,823,000
|
|
|
|
2,823,000
|
|
Property leases
|
|
|
403,000
|
|
|
|
644,000
|
|
|
|
529,000
|
|
|
|
1,271,000
|
|
|
|
2,847,000
|
|
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 September 30, 2019, we had a total of $1.03 billion in unfunded loan commitments and $22.1 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $869 million were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $165 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 $407 million at September 30, 2019, compared to $375 million at December 31, 2018. The $32.0 million increase during the first nine months of 2019 primarily reflects the positive impact of net income totaling $36.1 million, compared to the negative impact of cash dividends and common stock repurchases totaling $12.7 million and $7.1 million, respectively. Reflecting the decline in market interest rates, the change in net unrealized holding gain/loss on securities available for sale, net of tax effect, had a $12.5 million positive impact on shareholders’ equity during the first nine months of 2019.
We announced on January 30, 2015 that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. On April 19, 2016, we announced a $15.0 million expansion of the stock repurchase program. On May 7, 2019, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. This latest authorization included a termination of the existing authorization as detailed above. During the first nine months of 2019, we repurchased a total of approximately 231,000 shares of common stock at a total price of $7.1 million, at an average price per share of $30.78. Since January 30, 2015 through September 30, 2019, we repurchased a total of approximately 1,390,000 shares of common stock at a total price of $32.6 million, at an average price per share of $23.47. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan, which would also likely be funded from cash dividends paid to us from our bank.
MERCANTILE BANK CORPORATION
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 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 September 30, 2019, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis as if all such requirements were currently in effect.
As of September 30, 2019, our bank’s total risk-based capital ratio was 12.5%, compared to 12.3% at December 31, 2018. Our bank’s total regulatory capital increased $27.7 million during the first nine months of 2019, in large part reflecting the net impact of net income totaling $40.9 million and cash dividends paid to us aggregating $16.6 million. Our bank’s total risk-based capital ratio was also impacted by a $159 million increase in total risk-weighted assets, primarily resulting from commercial loan growth. As of September 30, 2019, our bank’s total regulatory capital equaled $416 million, or $83.8 million in excess of the 10.0% minimum which is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of September 30, 2019 and December 31, 2018 are disclosed in Note 11 of the Notes to Condensed Consolidated Financial Statements.
Results of Operations
We recorded net income of $12.6 million, or $0.77 per basic and diluted share, for the third quarter of 2019, compared to net income of $10.1 million, or $0.61 per basic and diluted share, for the third quarter of 2018. We recorded net income of $36.1 million, or $2.20 per basic and diluted share, for the first nine months of 2019, compared to net income of $30.5 million, or $1.83 per basic and diluted share, for the first nine months of 2018.
Bank owned life insurance claims and a gain on the sale of a former branch facility increased net income during the first nine months of 2019 by $3.1 million, or $0.19 per diluted share. Interest income related to purchased loan accounting entries increased net income during the first nine months of 2019 by $0.9 million, or $0.05 per diluted share, and net income during the first nine months of 2018 by $2.7 million, or $0.16 per diluted share. Excluding the impacts of these transactions, diluted earnings per share increased $0.29, or 17.4%, during the first nine months of 2019 compared to the respective 2018 period.
The higher level of net income during the third quarter of 2019 compared to the prior-year third quarter resulted from increased net interest income and noninterest income, which more than offset increased noninterest expense and provision expense. The growth in net interest income stemmed from a higher level of earning assets, and the improved noninterest income primarily resulted from increased mortgage banking activity income. Growth in credit and debit card income, service charges on accounts, and payroll processing fees also contributed to the higher level of noninterest income. The increased noninterest expense mainly resulted from higher salary costs.
The improved net income in the first nine months of 2019 compared to the respective prior-year period reflects increased net interest income and noninterest income, which more than offset higher noninterest expense and provision expense. The increase in net interest income resulted from a higher level of earning assets. Noninterest income during the first nine months of 2019 included bank owned life insurance claims and a gain on the sale of a former branch facility. Excluding these transactions, noninterest income during the first nine months of 2019 increased compared to the respective 2018 period, mainly reflecting higher mortgage banking activity income. Increased credit and debit card income, service charges on accounts, and payroll processing revenue also contributed to the growth in noninterest income. The higher level of noninterest expense primarily reflects increased salary costs.
MERCANTILE BANK CORPORATION
Interest income during the third quarter of 2019 was $40.3 million, an increase of $4.8 million, or 13.6%, from the $35.5 million earned during the third quarter of 2018. The increase in interest income resulted from growth in, and a higher yield on, average earning assets. Average earning assets equaled $3.38 billion during the third quarter of 2019, up $322 million, or 10.5%, from the level of $3.06 billion during the third quarter of 2018; average loans increased $245 million, average interest-earning deposit balances were up $56.5 million, and average securities increased $20.8 million. The yield on average earning assets was 4.73% during the third quarter of 2019, compared to 4.60% during the prior-year third quarter. The increased yield on average earning assets primarily resulted from a higher yield on loans. The increase in the yield on loans from 4.91% during the third quarter of 2018 to 5.06% during the third quarter of 2019 was primarily due to a higher yield on commercial loans, which equaled 5.15% in the current-year third quarter compared to 5.01% during the prior-year third quarter. The improved yield on commercial loans primarily reflected the positive impact of higher interest rates on variable-rate commercial loans stemming from the Federal Open Market Committee’s (“FOMC”) raising of the targeted federal funds rate by 25 basis points in both September and December 2018. The impact of these rate increases more than offset the negative impact of lower interest rates on variable-rate commercial loans resulting from the FOMC’s lowering of the targeted federal funds rate by 25 basis points in both July and September 2019.
Interest income during the first nine months of 2019 was $119 million, an increase of $14.0 million, or 13.3%, from the $105 million earned during the first nine months of 2018. The increase in interest income resulted from growth in, and a higher yield on, average earning assets. Average earning assets equaled $3.30 billion during the first nine months of 2019, up $270 million, or 8.9%, from the level of $3.03 billion during the respective 2018 period; on an average basis, loans were up $244 million, securities increased $14.6 million, and interest-earning deposit balances were up $11.1 million. The yield on average earning assets was 4.82% during the first nine months of 2019, compared to 4.63% during the first nine months of 2018. The higher yield on average earning assets primarily resulted from an increased yield on loans, which equaled 5.15% during the first nine months of 2019, compared to 4.99% during the respective 2018 period. Excluding interest income related to purchased loan accounting entries, the yield on loans equaled 5.09% during the first nine months of 2019, compared to 4.81% during the respective 2018 period. Interest income related to purchased loan accounting entries totaled $1.1 million during the first nine months of 2019, compared to $3.4 million during the respective prior-year period. The increased yield on loans mainly stemmed from a higher yield on commercial loans, which equaled 5.25% and 5.07% during the first nine months of 2019 and 2018, respectively. The higher yield on commercial loans primarily resulted from higher interest rates on variable-rate commercial loans resulting from the FOMC raising the targeted federal funds by 25 basis points in each of March, June, September, and December 2018. The positive impact of these rate increases more than offset the negative impact of decreased interest rates on variable-rate commercial loans stemming from the FOMC lowering the targeted federal funds rate by 25 basis points in both July and September 2019.
Interest expense during the third quarter of 2019 was $8.7 million, an increase of $3.1 million, or 54.3%, from the $5.6 million expensed during the third quarter of 2018. The increase in interest expense is primarily attributable to a higher weighted average cost of interest-bearing liabilities, which equaled 1.52% in the third quarter of 2019, compared to 1.11% in the third quarter of 2018. The increase in the weighted average cost of interest-bearing liabilities primarily reflects a higher cost of time deposits and a change in funding mix. The cost of time deposits increased from 1.64% during the prior-year third quarter to 2.34% during the current-year third quarter, mainly reflecting the rising interest rate environment during 2018. A higher-costing time deposit special campaign, which was introduced in mid-first quarter 2019 and ended in early April 2019, also contributed to the increased cost of time deposits. On an average basis, higher-costing time deposits and borrowed funds represented 29.2% and 23.3%, respectively, of average interest-bearing liabilities during the third quarter of 2019, compared to 23.3% and 19.1%, respectively, during the prior-year third quarter. Increased reliance on more costly wholesale funds during the twelve months ended September 30, 2019, most of which occurred in the fourth quarter of 2018 and January 2019, was necessitated by various funding requirements, including ongoing loan growth and seasonal deposit withdrawals by certain business customers for bonus and tax payments. Average lower-costing interest-bearing non-time deposits represented 47.5% of average interest-bearing liabilities during the current-year third quarter, down from 57.6% during the respective 2018 period. An increase in average interest-bearing liabilities also contributed to the higher level of interest expense during the third quarter of 2019 compared to the prior-year third quarter. Average interest-bearing liabilities were $2.27 billion during the third quarter of 2019, up $259 million, or 12.9%, from the $2.01 billion average during the third quarter of 2018.
MERCANTILE BANK CORPORATION
Interest expense during the first nine months of 2019 was $25.4 million, an increase of $9.9 million, or 63.7%, from the $15.5 million expensed during the first nine months of 2018. The increase in interest expense is primarily attributable to a higher weighted average cost of interest-bearing liabilities, which equaled 1.52% during the first nine months of 2019 compared to 1.02% during the respective 2018 period. The increase in the weighted average cost of interest-bearing liabilities primarily reflects higher costs of time deposits, borrowed funds, and certain non-time deposit account categories and a change in funding mix. The cost of time deposits increased from 1.50% during the first nine months of 2018 to 2.27% during the respective current-year period, primarily reflecting the rising interest rate environment during 2018. The previously-mentioned higher-costing time deposit special also contributed to the increased cost. The cost of borrowed funds increased from 2.00% during the first nine months of 2018 to 2.39% during the first nine months of 2019, mainly reflecting a higher cost of FHLBI advances, which equaled 2.38% during the first nine months of 2019 compared to 1.83% during the respective 2018 period. The higher cost primarily reflects the rising interest rate during 2018 and the lengthening of the average weighted maturity of the advance portfolio. Longer-term FHLBI advances totaling $194 million were obtained during the last eight months of 2018 and first month of 2019 to meet various funding needs. The cost of interest-bearing non-time deposit accounts increased from 0.52% during the first nine months of 2018 to 0.63% during the first nine months of 2019, mainly reflecting higher rates paid on money market accounts and a change in funding mix. The increased rates mainly reflect the rising interest rate environment during 2018. On an average basis, higher-costing money market accounts represented 44.1% of interest-bearing non-time deposits during the first nine months of 2019, up from 40.4% during the respective 2018 period. Average higher-costing time deposits and average borrowed funds represented 28.4% and 23.7%, respectively, of average interest-bearing liabilities during the first nine months of 2019, compared to 23.8% and 18.5%, respectively, during the first nine months of 2018. As noted previously, most of the increased reliance on more costly wholesale funds, which was necessitated by certain funding requirements, occurred in late 2018 and January 2019. Average lower-costing interest-bearing non-time deposits represented 47.9% of average interest-bearing liabilities during the first nine months of 2019, down from 57.7% during the respective 2018 period. An increase in interest-bearing liabilities also contributed to the higher level of interest expense during the first nine months of 2019 compared to the same time period in 2018. Average interest-bearing liabilities were $2.24 billion during the first nine months of 2019, up $215 million, or 10.6%, from the $2.03 billion average during the first nine months of 2018.
Net interest income during the third quarter of 2019 was $31.6 million, an increase of $1.8 million, or 5.9%, from the $29.8 million earned during the third quarter of 2018. The increase was due to growth in average earning assets. The net interest margin was 3.71% in the third quarter of 2019, compared to 3.87% in the prior-year third quarter. The yield on average earning assets equaled 4.73% during the third quarter of 2019, up from 4.60% during the respective 2018 period mainly due to an increased yield on commercial loans. The improved yield on commercial loans primarily reflects the positive impact of higher interest rates on variable-rate commercial loans stemming from the FOMC’s raising of the targeted federal funds rate by 25 basis points in both September and December 2018. The impact of these rate increases more than offset the negative impact of decreased rates on variable-rate commercial loans resulting from the FOMC’s lowering of the targeted federal funds rate in both July and September 2019. The cost of funds equaled 1.02% during the third quarter of 2019, up from 0.73% during the prior-year third quarter mainly due to an increased cost of time deposits and a change in funding mix.
Net interest income during the first nine months of 2019 was $93.4 million, an increase of $4.1 million, or 4.6%, from the $89.3 million earned during the first nine months of 2018. The increase was due to a higher level of average earning assets. The net interest margin was 3.79% during the first nine months of 2019, compared to 3.95% during the respective 2018 period. The yield on average earning assets equaled 4.82% during the first nine months of 2019, up from 4.63% during the respective 2018 period mainly due to an increased yield on commercial loans. The improved yield on commercial loans primarily reflects the positive impact of higher interest rates on variable-rate commercial loans stemming from the FOMC’s raising of the targeted federal funds rate by 25 basis points in each of March, June, September, and December 2018. The impact of these rate increases more than offset the negative impact of decreased rates on variable-rate commercial loans resulting from the FOMC’s lowering of the targeted federal funds rate by 25 basis points in both July and September 2019. The cost of funds equaled 1.03% during the first nine months of 2019, up from 0.68% during the respective prior-year period primarily due to increased costs of time deposits, borrowed funds, and certain non-time deposit account categories and a change in funding mix. Excluding interest income associated with purchased loan accounting entries, our core net interest margin was 3.75% during the first nine months of 2019, compared to 3.80% during the first nine months of 2018.
MERCANTILE BANK CORPORATION
The following tables set 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 third quarters and first nine months of 2019 and 2018. 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 third quarters and first nine months of 2019 and 2018 have been computed on a tax equivalent basis using a marginal tax rate of 21%. Securities interest income was increased by $60,000 in both the third quarter of 2019 and the third quarter of 2018, and $180,000 and $210,000 in the first nine months of 2019 and 2018, respectively, for this non-GAAP, but industry standard, adjustment. These adjustments equated to one basis point increases in our net interest margin for each of the 2019 and 2018 periods.
MERCANTILE BANK CORPORATION
|
|
Quarters ended September 30,
|
|
|
|
2 0 1 9
|
|
|
2 0 1 8
|
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
|
(dollars in thousands)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
2,903,161
|
|
|
$
|
37,005
|
|
|
|
5.06
|
%
|
|
$
|
2,658,092
|
|
|
$
|
32,918
|
|
|
|
4.91
|
%
|
Investment securities
|
|
|
363,394
|
|
|
|
2,720
|
|
|
|
2.99
|
|
|
|
342,593
|
|
|
|
2,315
|
|
|
|
2.70
|
|
Other interest-earning assets
|
|
|
118,314
|
|
|
|
651
|
|
|
|
2.15
|
|
|
|
61,810
|
|
|
|
313
|
|
|
|
1.98
|
|
Total interest - earning assets
|
|
|
3,384,869
|
|
|
|
40,376
|
|
|
|
4.73
|
|
|
|
3,062,495
|
|
|
|
35,546
|
|
|
|
4.60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses
|
|
|
(24,498
|
)
|
|
|
|
|
|
|
|
|
|
|
(21,661
|
)
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
261,797
|
|
|
|
|
|
|
|
|
|
|
|
254,295
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
3,622,168
|
|
|
|
|
|
|
|
|
|
|
$
|
3,295,129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
$
|
1,741,562
|
|
|
$
|
5,573
|
|
|
|
1.22
|
%
|
|
$
|
1,628,346
|
|
|
$
|
3,574
|
|
|
|
0.87
|
%
|
Short-term borrowings
|
|
|
112,739
|
|
|
|
71
|
|
|
|
0.25
|
|
|
|
97,090
|
|
|
|
63
|
|
|
|
0.26
|
|
Federal Home Loan Bank advances
|
|
|
367,370
|
|
|
|
2,257
|
|
|
|
2.40
|
|
|
|
237,609
|
|
|
|
1,201
|
|
|
|
1.98
|
|
Other borrowings
|
|
|
49,482
|
|
|
|
810
|
|
|
|
6.41
|
|
|
|
49,131
|
|
|
|
808
|
|
|
|
6.44
|
|
Total interest-bearing liabilities
|
|
|
2,271,153
|
|
|
|
8,711
|
|
|
|
1.52
|
|
|
|
2,012,176
|
|
|
|
5,646
|
|
|
|
1.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing deposits
|
|
|
930,851
|
|
|
|
|
|
|
|
|
|
|
|
893,181
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
16,814
|
|
|
|
|
|
|
|
|
|
|
|
12,198
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity
|
|
|
403,350
|
|
|
|
|
|
|
|
|
|
|
|
377,574
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders’ equity
|
|
$
|
3,622,168
|
|
|
|
|
|
|
|
|
|
|
$
|
3,295,129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
31,665
|
|
|
|
|
|
|
|
|
|
|
$
|
29,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest rate spread
|
|
|
|
|
|
|
|
|
|
|
3.21
|
%
|
|
|
|
|
|
|
|
|
|
|
3.49
|
%
|
Net interest spread on average assets
|
|
|
|
|
|
|
|
|
|
|
3.47
|
%
|
|
|
|
|
|
|
|
|
|
|
3.60
|
%
|
Net interest margin on earning assets
|
|
|
|
|
|
|
|
|
|
|
3.71
|
%
|
|
|
|
|
|
|
|
|
|
|
3.87
|
%
|
MERCANTILE BANK CORPORATION
|
|
Nine months ended September 30,
|
|
|
|
2 0 1 9
|
|
|
2 0 1 8
|
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
|
(dollars in thousands)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
2,846,735
|
|
|
$
|
109,559
|
|
|
|
5.15
|
%
|
|
$
|
2,602,718
|
|
|
$
|
97,087
|
|
|
|
4.99
|
%
|
Investment securities
|
|
|
358,557
|
|
|
|
7,767
|
|
|
|
2.89
|
|
|
|
343,983
|
|
|
|
6,838
|
|
|
|
2.65
|
|
Other interest-earning assets
|
|
|
93,800
|
|
|
|
1,627
|
|
|
|
2.32
|
|
|
|
82,700
|
|
|
|
1,071
|
|
|
|
1.73
|
|
Total interest - earning assets
|
|
|
3,299,092
|
|
|
|
118,953
|
|
|
|
4.82
|
|
|
|
3,029,401
|
|
|
|
104,996
|
|
|
|
4.63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses
|
|
|
(23,598
|
)
|
|
|
|
|
|
|
|
|
|
|
(20,824
|
)
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
256,347
|
|
|
|
|
|
|
|
|
|
|
|
250,576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
3,531,841
|
|
|
|
|
|
|
|
|
|
|
$
|
3,259,153
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
$
|
1,710,120
|
|
|
$
|
15,906
|
|
|
|
1.24
|
%
|
|
$
|
1,651,186
|
|
|
$
|
9,921
|
|
|
|
0.80
|
%
|
Short-term borrowings
|
|
|
108,262
|
|
|
|
244
|
|
|
|
0.30
|
|
|
|
100,165
|
|
|
|
181
|
|
|
|
0.24
|
|
Federal Home Loan Bank advances
|
|
|
373,436
|
|
|
|
6,751
|
|
|
|
2.38
|
|
|
|
226,154
|
|
|
|
3,134
|
|
|
|
1.83
|
|
Other borrowings
|
|
|
49,375
|
|
|
|
2,506
|
|
|
|
6.69
|
|
|
|
48,988
|
|
|
|
2,286
|
|
|
|
6.15
|
|
Total interest-bearing liabilities
|
|
|
2,241,193
|
|
|
|
25,407
|
|
|
|
1.52
|
|
|
|
2,026,493
|
|
|
|
15,522
|
|
|
|
1.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing deposits
|
|
|
886,536
|
|
|
|
|
|
|
|
|
|
|
|
849,337
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
14,484
|
|
|
|
|
|
|
|
|
|
|
|
12,318
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity
|
|
|
389,628
|
|
|
|
|
|
|
|
|
|
|
|
371,005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders’ equity
|
|
$
|
3,531,841
|
|
|
|
|
|
|
|
|
|
|
$
|
3,259,153
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
93,546
|
|
|
|
|
|
|
|
|
|
|
$
|
89,474
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest rate spread
|
|
|
|
|
|
|
|
|
|
|
3.30
|
%
|
|
|
|
|
|
|
|
|
|
|
3.61
|
%
|
Net interest spread on average assets
|
|
|
|
|
|
|
|
|
|
|
3.54
|
%
|
|
|
|
|
|
|
|
|
|
|
3.67
|
%
|
Net interest margin on earning assets
|
|
|
|
|
|
|
|
|
|
|
3.79
|
%
|
|
|
|
|
|
|
|
|
|
|
3.95
|
%
|
A loan loss provision expense of $0.7 million was recorded during the third quarter of 2019, compared to $0.4 million during the third quarter of 2018. A loan loss provision expense of $2.5 million was recorded during the first nine months of 2019, compared to $1.1 million during the first nine months of 2018. The provision expense recorded during the 2019 and 2018 periods primarily reflects ongoing net loan growth; in addition, the provision expense recorded during the first nine months of 2018 depicts an increased allocation related to our “competitive environment” environmental factor. The amount of provision expense necessitated by net loan growth during the first nine months of 2018 was partially mitigated by net loan recoveries being recorded during the period.
MERCANTILE BANK CORPORATION
Net loan charge-offs of $0.3 million and $0.4 million were recorded during the third quarter and first nine months of 2019, respectively, compared to net loan recoveries of $0.1 million and $1.1 million during the respective 2018 periods. The allowance for originated loans, as a percentage of total originated loans, was 0.9% as of both September 30, 2019, and September 30, 2018. Our allowances for originated loans and acquired loans totaled $23.7 million and $0.7 million, respectively, as of September 30, 2019, compared to $21.1 million and $0.6 million, respectively, as of September 30, 2018.
Noninterest income during the third quarter of 2019 was $6.7 million, up $2.0 million, or nearly 42%, from the prior-year third quarter. The improved level of noninterest income primarily reflected increased mortgage banking activity income stemming from the success of continuing strategic initiatives designed to increase market presence, along with a higher percentage of originated residential mortgage loans being sold and an increased level of refinance activity resulting from a recent decrease in residential mortgage loan interest rates. Residential mortgage loan originations totaled $133 million during the third quarter of 2019 compared to $66.8 million during the prior-year third quarter, representing an increase of $66.0 million, or nearly 99%. Sold residential mortgage loans represented approximately 79% of total originations during the third quarter of 2019, up from approximately 46% during the third quarter of 2018. Increased credit and debit card income, service charges on accounts, and payroll processing fees also contributed to the higher level of noninterest income.
Noninterest income during the first nine months of 2019 was $19.6 million, compared to $13.6 million during the same time period in 2018. Noninterest income during the first nine months of 2019 included bank owned life insurance claims aggregating $2.6 million and a gain on the sale of a former branch facility of $0.6 million. Excluding the impacts of these transactions, noninterest income increased $2.8 million, or 20.7%, in the first nine months of 2019 compared to the respective 2018 period. The increase in noninterest income primarily reflects higher mortgage banking activity. As noted previously, ongoing strategic initiatives intended to increase market penetration, along with a higher percentage of loans being sold and increased refinance activity stemming from interest rate declines, have enhanced mortgage banking activity income. Residential mortgage loan originations totaled $258 million during the first nine months of 2019, up $88.2 million, or approximately 52%, from the $170 million in originations during the first nine months of 2018. As a percentage of total originations, sold residential mortgage loans equaled approximately 68% during the first nine months of 2019, up from about 44% during the respective 2018 period. Growth in credit and debit card income, service charges on accounts, and payroll processing revenue also contributed to the higher level of noninterest income.
Noninterest expense totaled $22.0 million during the third quarter of 2019, up $0.4 million, or 1.7%, from the prior-year third quarter. Noninterest expense during the first nine months of 2019 was $65.9 million, an increase of $1.7 million, or 2.7%, from the $64.2 million expensed during the first nine months of 2018. The higher level of expense in both periods primarily resulted from increased salary costs, mainly reflecting annual employee merit pay increases, higher mortgage loan lender commissions, and increased stock-based compensation expense. Pay increases for all hourly employees, which went into effect on April 1, 2018, also contributed to the higher level of salary costs during the first nine months of 2019. Federal Deposit Insurance Corporation deposit insurance premiums were down $0.5 million in both the third quarter and first nine months of 2019 compared to the respective 2018 periods as a result of deposit insurance credits being applied against regular assessments.
During the third quarter of 2019, we recorded income before federal income tax of $15.6 million and a federal income tax expense of $3.0 million. During the third quarter of 2018, we recorded income before federal income tax of $12.5 million and a federal income tax expense of $2.4 million. During the first nine months of 2019, we recorded income before federal income tax of $44.6 million and a federal income tax expense of $8.5 million. During the first nine months of 2018, we recorded income before federal income tax of $37.6 million and a federal income tax expense of $7.1 million. The increased federal income tax expense in the 2019 periods compared to the respective 2018 periods resulted from higher levels of income before federal income tax. Our effective tax rate was 19.0% during both the third quarter and first nine months of 2019 and the respective 2018 periods.
MERCANTILE BANK CORPORATION