U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June~~September 30, 2020

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File No. 000-26719

MERCANTILE BANK CORPORATION

(Exact name of registrant as specified in its charter)

Michigan	38-3360865
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

310 Leonard Street, NW, Grand Rapids, MI 49504

(Address of principal executive offices) (Zip Code)

(616) 406-3000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒
Non-accelerated filer ☐	Smaller reporting company ☐
Emerging growth company ☐

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	MBWM	The Nasdaq Stock Market LLC

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Yes ☐ No ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

At ~~July 31,~~November 6, 2020, there were ~~16,231,049~~16,233,596 shares of common stock outstanding.

Table of Contents

MERCANTILE BANK CORPORATION

INDEX

PART I.	Financial Information	Page No.

	Item 1. Financial Statements

	Consolidated Balance Sheets (Unaudited) – ~~June~~September 30, 2020 and December 31, 2019	1

	Consolidated Statements of Income (Unaudited) - Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2020 and ~~June~~September 30, 2019	2

	Consolidated Statements of Comprehensive Income (Unaudited) - Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2020 and ~~June~~September 30, 2019	3

	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) – Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2020 and ~~June~~September 30, 2019	4

	Consolidated Statements of Cash Flows (Unaudited) – ~~Six~~Nine Months Ended ~~June~~September 30, 2020 and ~~June~~September 30, 2019	8

	Notes to Consolidated Financial Statements (Unaudited)	10

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	53 52

	Item 3. Quantitative and Qualitative Disclosures About Market Risk	7775

	Item 4. Controls and Procedures	7977

PART II.	Other Information

	Item 1. Legal Proceedings	8078

	Item 1A. Risk Factors	8078

	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	8078

	Item 3. Defaults Upon Senior Securities	8078

	Item 4. Mine Safety Disclosures	8078

	Item 5. Other Information	8078

	Item 6. Exhibits	8179

	Signatures	8280

Table of Contents

MERCANTILE BANK CORPORATION

PART I --- FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	June 30, 2020			December 31, 2019			September 30, 2020			December 31, 2019

ASSETS
Cash and due from banks	$	84,516,000		$	53,262,000		$	59,283,000		$	53,262,000
Interest-earning deposits		386,711,000			180,469,000			495,308,000			180,469,000
Total cash and cash equivalents		471,227,000			233,731,000			554,591,000			233,731,000

Securities available for sale		307,661,000			334,655,000			312,424,000			334,655,000
Federal Home Loan Bank stock		18,002,000			18,002,000			18,002,000			18,002,000

Loans		3,333,056,000			2,856,667,000			3,350,544,000			2,856,667,000
Allowance for loan losses		(32,246,000	)		(23,889,000	)		(35,572,000	)		(23,889,000	)
Loans, net		3,300,810,000			2,832,778,000			3,314,972,000			2,832,778,000

Premises and equipment, net		59,155,000			57,327,000			60,446,000			57,327,000
Bank owned life insurance		70,900,000			70,297,000			71,170,000			70,297,000
Goodwill		49,473,000			49,473,000			49,473,000			49,473,000
Core deposit intangible, net		3,072,000			3,840,000			2,754,000			3,840,000
Other assets		34,079,000			32,812,000			36,778,000			32,812,000

Total assets	$	4,314,379,000		$	3,632,915,000		$	4,420,610,000		$	3,632,915,000

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing	$	1,445,620,000		$	924,916,000		$	1,449,879,000		$	924,916,000
Interest-bearing		1,816,660,000			1,765,468,000			1,922,155,000			1,765,468,000
Total deposits		3,262,280,000			2,690,384,000			3,372,034,000			2,690,384,000

Securities sold under agreements to repurchase		167,527,000			102,675,000			157,017,000			102,675,000
Federal Home Loan Bank advances		394,000,000			354,000,000			394,000,000			354,000,000
Subordinated debentures		47,222,000			46,881,000			47,392,000			46,881,000
Accrued interest and other liabilities		18,129,000			22,414,000			18,267,000			22,414,000
Total liabilities		3,889,158,000			3,216,354,000			3,988,710,000			3,216,354,000

Commitments and contingent liabilities (Note 8)

Shareholders' equity
Preferred stock, no par value; 1,000,000 shares authorized; none issued		0			0			0			0
Common stock, no par value; 40,000,000 shares authorized; 16,230,649 shares issued and outstanding at June 30, 2020 and 16,425,136 shares issued and outstanding at December 31, 2019		300,897,000			305,035,000
Common stock, no par value; 40,000,000 shares authorized; 16,243,124 shares issued and outstanding at September 30, 2020 and 16,425,136 shares issued and outstanding at December 31, 2019								301,896,000			305,035,000
Retained earnings		118,239,000			107,831,000			124,451,000			107,831,000
Accumulated other comprehensive gain/(loss)		6,085,000			3,695,000			5,553,000			3,695,000
Total shareholders’ equity		425,221,000			416,561,000			431,900,000			416,561,000

Total liabilities and shareholders’ equity	$	4,314,379,000		$	3,632,915,000		$	4,420,610,000		$	3,632,915,000

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended June 30, 2020		Three Months Ended June 30, 2019		Six Months Ended June 30, 2020		Six Months Ended June 30, 2019		Three Months Ended Sept 30, 2020		Three Months Ended Sept 30, 2019		Nine Months Ended Sept 30, 2020		Nine Months Ended Sept 30, 2019

Interest income
Loans, including fees	$	34,322,000	$	36,765,000	$	67,764,000	$	72,555,000	$	33,664,000	$	37,005,000	$	101,428,000	$	109,559,000
Securities, taxable		2,187,000		1,945,000		5,628,000		3,825,000		1,212,000		2,104,000		6,840,000		5,930,000
Securities, tax-exempt		562,000		540,000		1,138,000		1,101,000		576,000		556,000		1,714,000		1,657,000
Other interest-earning assets		93,000		569,000		568,000		976,000		142,000		651,000		711,000		1,627,000
Total interest income		37,164,000		39,819,000		75,098,000		78,457,000		35,594,000		40,316,000		110,693,000		118,773,000

Interest expense
Deposits		3,700,000		5,529,000		8,342,000		10,334,000		3,466,000		5,573,000		11,808,000		15,906,000
Short-term borrowings		55,000		68,000		94,000		173,000		38,000		71,000		132,000		244,000
Federal Home Loan Bank advances		2,214,000		2,261,000		4,427,000		4,494,000		2,072,000		2,257,000		6,499,000		6,751,000
Subordinated debentures and other borrowings		624,000		845,000		1,348,000		1,695,000		509,000		810,000		1,857,000		2,506,000
Total interest expense		6,593,000		8,703,000		14,211,000		16,696,000		6,085,000		8,711,000		20,296,000		25,407,000

Net interest income		30,571,000		31,116,000		60,887,000		61,761,000		29,509,000		31,605,000		90,397,000		93,366,000

Provision for loan losses		7,600,000		900,000		8,350,000		1,750,000		3,200,000		700,000		11,550,000		2,450,000

Net interest income after provision for loan losses		22,971,000		30,216,000		52,537,000		60,011,000		26,309,000		30,905,000		78,847,000		90,916,000

Noninterest income
Services charges on deposit and sweep accounts		1,045,000		1,143,000		2,267,000		2,220,000		1,135,000		1,185,000		3,401,000		3,406,000
Mortgage banking income		7,640,000		1,345,000		10,267,000		2,402,000		9,479,000		2,889,000		19,746,000		5,291,000
Credit and debit card income		1,374,000		1,513,000		2,735,000		2,850,000		1,636,000		1,547,000		4,371,000		4,397,000
Payroll services income		370,000		355,000		947,000		860,000		399,000		367,000		1,346,000		1,227,000
Earnings on bank owned life insurance		307,000		1,608,000		643,000		3,238,000		290,000		330,000		933,000		3,567,000
Other income		248,000		370,000		675,000		1,397,000		368,000		358,000		1,042,000		1,755,000
Total noninterest income		10,984,000		6,334,000		17,534,000		12,967,000		13,307,000		6,676,000		30,839,000		19,643,000

Noninterest expense
Salaries and benefits		14,126,000		13,286,000		27,654,000		26,302,000		16,734,000		13,680,000		44,388,000		39,982,000
Occupancy		1,862,000		1,629,000		3,921,000		3,391,000		2,023,000		1,697,000		5,944,000		5,089,000
Furniture and equipment depreciation, rent and maintenance		851,000		621,000		1,629,000		1,257,000		871,000		629,000		2,500,000		1,885,000
Data processing costs		2,633,000		2,295,000		5,117,000		4,511,000		2,676,000		2,342,000		7,793,000		6,854,000
Other expense		3,744,000		4,256,000		7,835,000		8,456,000		4,119,000		3,679,000		11,954,000		12,134,000
Total noninterest expenses		23,216,000		22,087,000		46,156,000		43,917,000
Total noninterest expense										26,423,000		22,027,000		72,579,000		65,944,000

Income before federal income tax expense		10,739,000		14,463,000		23,915,000		29,061,000		13,193,000		15,554,000		37,107,000		44,615,000

Federal income tax expense		2,041,000		2,748,000		4,545,000		5,522,000		2,507,000		2,954,000		7,051,000		8,476,000

Net income	$	8,698,000	$	11,715,000	$	19,370,000	$	23,539,000	$	10,686,000	$	12,600,000	$	30,056,000	$	36,139,000

Basic earnings per share	$	0.54	$	0.71	$	1.19	$	1.43	$	0.66	$	0.77	$	1.85	$	2.20
Diluted earnings per share	$	0.54	$	0.71	$	1.19	$	1.43	$	0.66	$	0.77	$	1.85	$	2.20
Cash dividends per share	$	0.28	$	0.26	$	0.56	$	0.52	$	0.28	$	0.27	$	0.84	$	0.79

Average basic shares outstanding		16,212,500		16,428,187		16,281,391		16,428,875		16,233,196		16,390,203		16,265,208		16,415,843
Average diluted shares outstanding		16,213,264		16,434,714		16,282,341		16,434,941		16,233,666		16,393,078		16,265,986		16,420,845

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

Three Months
Ended
June 30, 2020

Three Months
Ended
June 30, 2019

Six Months
Ended
June 30, 2020

Six Months
Ended
June 30, 2019

Net income
$ 8,698,000 $ 11,715,000 $ 19,370,000 $ 23,539,000

Other comprehensive income/(loss):

Unrealized holding gains/(losses) on securities available for sale
1,636,000 9,562,000 3,027,000 14,011,000
Tax effect of unrealized holding gains/(losses) on securities available for sale
(344,000
)
(2,008,000
)
(637,000
)
(2,942,000
)
Other comprehensive income/(loss), net of tax
1,292,000 7,554,000 2,390,000 11,069,000

Comprehensive income
$ 9,990,000 $ 19,269,000 $ 21,760,000 $ 34,608,000

	Three Months Ended Sept 30, 2020			Three Months Ended Sept 30, 2019			Nine Months Ended Sept 30, 2020			Nine Months Ended Sept 30, 2019


Net income	$	10,686,000		$	12,600,000		$	30,056,000		$	36,139,000

Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale		(675,000	)		1,809,000			2,352,000			15,821,000
Tax effect of unrealized holding gains (losses) on securities available for sale		143,000			(380,000	)		(494,000	)		(3,323,000	)
Other comprehensive income (loss), net of tax		(532,000	)		1,429,000			1,858,000			12,498,000

Comprehensive income	$	10,154,000		$	14,029,000		$	31,914,000		$	48,637,000

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

The following table depicts the change in shareholders’ equity for the three months ended ~~June~~September 30, 2020:

($ in thousands except per share amounts)	Preferred Stock		Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)		Total Shareholders’ Equity			Preferred Stock		Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, March 31, 2020	$	0	$	299,584	$	114,012		$	4,793	$	418,389
Balances, June 30, 2020													$	0	$	300,897	$	118,239		$	6,085		$	425,221

Employee stock purchase plan (487 shares)				11							11
Employee stock purchase plan (692 shares)																12								12

Dividend reinvestment plan (9,307 shares)				212							212
Dividend reinvestment plan (10,327 shares)																206								206

Stock grants to directors for retainer fees (15,648 shares)				349							349
Stock grants to directors for retainer fees (2,068 shares)																45								45

Stock-based compensation expense				741							741					736								736

Cash dividends ($0.28 per common share)						(4,471	)				(4,471	)						(4,474	)					(4,474	)

Net income for the three months ended June 30, 2020						8,698					8,698
Net income for the three months ended September 30, 2020																		10,686						10,686

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect									1,292		1,292										(532	)		(532	)

Balances, June 30, 2020	$	0	$	300,897	$	118,239		$	6,085	$	425,221
Balances, September 30, 2020													$	0	$	301,896	$	124,451		$	5,553		$	431,900

See accompanying notes to consolidated financial statements.

Table of Contents

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

The following table depicts the change in shareholders’ equity for the ~~six~~nine months ended ~~June~~September 30, 2020:

($ in thousands except per share amounts)

Preferred
Stock

Common
Stock

Retained
Earnings

Accumulated
Other
Comprehensive
Income (Loss)

Total
Shareholders’
Equity

Balances, January 1, 2020
$ 0 $ 305,035 $ 107,831 $ 3,695 $ 416,561

Employee stock purchase plan (1,129 shares)
25 25

Dividend reinvestment plan (17,380 shares)
404 404

Stock grants to directors for retainer fees (15,648 shares)
349 349

Stock-based compensation expense
1,366 1,366

Share repurchase program (222,385 shares)
(6,282
)
(6,282
)

Cash dividends ($0.56 per common share)
(8,962
)
(8,962
)

Net income for the six months ended June 30, 2020
19,370 19,370

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect
2,390 2,390

Balances, June 30, 2020
$ 0 $ 300,897 $ 118,239 $ 6,085 $ 425,221

($ in thousands except per share amounts)	Preferred Stock		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)		Total Shareholders’ Equity

Balances, January 1, 2020	$	0	$	305,035		$	107,831		$	3,695	$	416,561

Employee stock purchase plan (1,821 shares)				37								37

Dividend reinvestment plan (27,707 shares)				610								610

Stock grants to directors for retainer fees (17,716 shares)				394								394

Stock-based compensation expense				2,102								2,102

Share repurchase program (222,385 shares)				(6,282	)							(6,282	)

Cash dividends ($0.84 per common share)							(13,436	)				(13,436	)

Net income for the nine months ended September 30, 2020							30,056					30,056

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect										1,858		1,858

Balances, September 30, 2020	$	0	$	301,896		$	124,451		$	5,553	$	431,900

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

The following table depicts the change in shareholders’ equity for the three months ended ~~June~~September 30, 2019:

($ in thousands except per share amounts)

Preferred
Stock

Common
Stock

Retained
Earnings

Accumulated
Other
Comprehensive
Income (Loss)

Total
Shareholders’
Equity

Balances, March 31, 2019
$ 0 $ 305,346 $ 83,107 $ (4,724
)
$ 383,729

Employee stock purchase plan (383 shares)
12 12

Dividend reinvestment plan (5,522 shares)
179 179

Stock option exercises (2,000 shares)
14 14

Stock grants to directors for retainer fees (11,905 shares)
374 374

Stock-based compensation expense
744 744

Cash dividends ($0.26 per common share)
(4,204
)
(4,204
)

Net income for the three months ended June 30, 2019
11,715 11,715

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect
7,554 7,554

Balances, June 30, 2019
$ 0 $ 306,669 $ 90,618 $ 2,830 $ 400,117

($ in thousands except per share amounts)	Preferred Stock		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)		Total Shareholders’ Equity

Balances, June 30, 2019	$	0	$	306,669		$	90,618		$	2,830	$	400,117

Employee stock purchase plan (402 shares)				13								13

Dividend reinvestment plan (5,445 shares)				180								180

Stock-based compensation expense				711								711

Share repurchase program (111,893 shares)				(3,508	)							(3,508	)

Cash dividends ($0.27 per common share)							(4,342	)				(4,342	)

Net income for the three months ended September 30, 2019							12,600					12,600

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect										1,429		1,429

Balances, September 30, 2019	$	0	$	304,065		$	98,876		$	4,259	$	407,200

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

The following table depicts the change in shareholders’ equity for the ~~six~~nine months ended ~~June~~September 30, 2019:

($ in thousands except per share amounts)	Preferred Stock		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity			Preferred Stock		Common Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity

Balances, January 1, 2019	$	0	$	308,005		$	75,483		$	(8,239	)	$	375,249		$	0	$	308,005		$	75,483		$	(8,239	)	$	375,249

Employee stock purchase plan (799 shares)				26									26
Employee stock purchase plan (1,201 shares)																		39									39

Dividend reinvestment plan (10,947 shares)				361									361
Dividend reinvestment plan (16,392 shares)																		541									541

Stock option exercises (2,500 shares)				16									16					16									16

Stock grants to directors for retainer fees (11,905 shares)				374									374					375									375

Stock-based compensation expense				1,488									1,488					2,199									2,199

Share repurchase program (119,120 shares)				(3,601	)								(3,601	)
Share repurchase program (231,013 shares)																		(7,110	)								(7,110	)

Cash dividends ($0.52 per common share)							(8,404	)					(8,404	)
Cash dividends ($0.79 per common share)																					(12,746	)					(12,746	)

Net income for the six months ended June 30, 2019							23,539						23,539
Net income for the nine months ended September 30, 2019																					36,139						36,139

Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect										11,069			11,069											12,498			12,498

Balances, June 30, 2019	$	0	$	306,669		$	90,618		$	2,830		$	400,117
Balances, September 30, 2019															$	0	$	304,065		$	98,876		$	4,259		$	407,200

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended June 30, 2020			Six Months Ended June 30, 2019			Nine Months Ended Sept 30, 2020			Nine Months Ended Sept 30, 2019

Cash flows from operating activities
Net income	$	19,370,000		$	23,539,000		$	30,056,000		$	36,139,000
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		3,385,000			4,723,000			6,262,000			6,997,000
Accretion of acquired loans		(225,000	)		(314,000	)		(337,000	)		(522,000	)
Provision for loan losses		8,350,000			1,750,000			11,550,000			2,450,000
Stock-based compensation expense		1,366,000			1,488,000			2,102,000			2,199,000
Stock grants to directors for retainer fee		349,000			374,000			394,000			375,000
Proceeds from sales of mortgage loans held for sale		291,485,000			67,859,000			505,602,000			163,056,000
Origination of mortgage loans held for sale		(317,417,000	)		(69,107,000	)		(506,683,000	)		(169,661,000	)
Net gain from sales of mortgage loans held for sale		(9,856,000	)		(2,129,000	)		(20,055,000	)		(5,032,000	)
Net gain from sales and valuation write-downs of foreclosed assets		(183,000	)		(31,000	)		(183,000	)		(132,000	)
Net gain from sales and valuation write-downs of former bank premises		(27,000	)		(558,000	)		(27,000	)		(559,000	)
Net loss from sales and write-downs of fixed assets		54,000			1,000			54,000			5,000
Earnings on bank owned life insurance		(643,000	)		(3,238,000	)		(933,000	)		(3,567,000	)
Net change in:
Accrued interest receivable		654,000			(534,000	)		(1,080,000	)		(609,000	)
Other assets		(4,766,000	)		(1,278,000	)		(6,269,000	)		(7,163,000	)
Accrued interest payable and other liabilities		(4,285,000	)		(8,628,000	)		(4,147,000	)		(3,843,000	)
Net cash (for) from operating activities		(12,389,000	)		13,917,000
Net cash from operating activities								16,306,000			20,133,000

Cash flows from investing activities
Loan originations and payments, net		(440,380,000	)		(124,964,000	)		(472,417,000	)		(168,412,000	)
Purchases of securities available for sale		(188,630,000	)		(24,182,000	)		(270,119,000	)		(53,353,000	)
Proceeds from maturities, calls and repayments of securities available for sale		220,916,000			27,258,000			296,895,000			60,617,000
Proceeds from sales of foreclosed assets		313,000			270,000			313,000			632,000
Proceeds from sales of former bank premises		162,000			854,000			162,000			854,000
Purchases of Federal Home Loan Bank stock		0			(1,980,000	)		0			(1,980,000	)
Purchases of bank owned life insurance		0			(2,500,000	)		0			(2,500,000	)
Proceeds from bank owned life insurance cash value release and death benefits		0			7,708,000			0			7,708,000
Net purchases of premises and equipment		(4,429,000	)		(5,359,000	)		(7,201,000	)		(9,109,000	)
Net cash for investing activities		(412,048,000	)		(122,895,000	)		(452,367,000	)		(165,543,000	)

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

	Six Months Ended June 30, 2020			Six Months Ended June 30, 2019			Nine Months Ended Sept 30, 2020			Nine Months Ended Sept 30, 2019

Cash flows from financing activities
Net increase (decrease) in time deposits		(64,081,000	)		175,869,000			(65,389,000	)		196,035,000
Net increase (decrease) in all other deposits		635,977,000			(20,368,000	)
Net increase in all other deposits								747,039,000			107,348,000
Net increase in securities sold under agreements to repurchase		64,852,000			16,150,000			54,342,000			471,000
Maturities of Federal Home Loan Bank advances		(20,000,000	)		(20,000,000	)		(20,000,000	)		(30,000,000	)
Proceeds from Federal Home Loan Bank advances		60,000,000			44,000,000			60,000,000			44,000,000
Proceeds from stock option exercises		0			16,000			0			16,000
Employee stock purchase plan		25,000			26,000			37,000			39,000
Dividend reinvestment plan		404,000			361,000			610,000			541,000
Repurchases of common stock shares		(6,282,000	)		(3,601,000	)		(6,282,000	)		(7,110,000	)
Payment of cash dividends to common shareholders		(8,962,000	)		(8,404,000	)		(13,436,000	)		(12,746,000	)
Net cash from financing activities		661,933,000			184,049,000			756,921,000			298,594,000

Net change in cash and cash equivalents		237,496,000			75,071,000			320,860,000			153,184,000
Cash and cash equivalents at beginning of period		233,731,000			75,354,000			233,731,000			75,354,000
Cash and cash equivalents at end of period	$	471,227,000		$	150,425,000		$	554,591,000		$	228,538,000

Supplemental disclosures of cash flows information
Cash paid during the period for:
Interest	$	15,149,000		$	14,956,000		$	21,798,000		$	23,361,000
Federal income tax		5,300,000			6,275,000			7,950,000			8,875,000
Noncash financing and investing activities:
Transfers from loans to foreclosed assets		11,000			170,000			146,000			227,000
Transfers from bank premises to other real estate owned		0			0			179,000			0

See accompanying notes to consolidated financial statements.

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation: The unaudited financial statements for the ~~six~~nine months ended ~~June~~September 30, 2020 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC and Mercantile Insurance Center, Inc. These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended ~~June~~September 30, 2020 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2019.

We have 5 separate business trusts that were formed to issue trust preferred securities. Subordinated debentures were issued to the trusts in return for the proceeds raised from the issuance of the trust preferred securities. The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as a liability.

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

Approximately ~~256,000~~255,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2020. In addition, stock options for approximately 2,000 shares of common stock were included in determining diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2020. Stock options for approximately 9,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2020.

Approximately ~~261,000~~260,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2019. In addition, stock options for approximately ~~10,000~~4,000 shares of common stock were included in determining diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2019. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2019.

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

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

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

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

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

Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of ~~June~~September 30, 2020 and December 31, 2019, we determined the fair value of our mortgage loans held for sale to be ~~$42.8~~$27.8 million and $5.0 million, respectively. Loans held for sale are reported as part of our total loans on the balance sheet.

Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the loan at the same time we make an interest rate commitment to the borrower. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives is included in the gain on sale of loans. Mortgage loans serviced for others totaled approximately ~~$846~~$958 million and $727 million as of ~~June~~September 30, 2020, and December 31, 2019, respectively.

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

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

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

The federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” on March 22, 2020, which was subsequently revised on April 7, 2020. This guidance encourages financial institutions to work prudently with borrowers that are or may be unable to meet their contractual obligations because of the effects of the ~~Coronavirus.~~ongoing pandemic of coronavirus disease 2019 ("COVID-19") caused by severe acute respiratory syndrome coronavirus 2 (the "Coronavirus Pandemic"). Pursuant to the guidance, the federal banking agencies ~~have~~ concluded, in consultation with FASB staff, that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current prior to any relief are not troubled debt restructurings. This guidance complements Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (“CARES ~~Act,~~Act”), which specified that Coronavirus-related modifications made on loans that were current as of December 31, 2019 and that occur between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency declared by President Trump on March 13, 2020 (the “National Emergency”) or December 31, 2020, as applicable, are not troubled debt restructurings. The National Emergency is still in effect as of November 6, 2020.

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

In early April 2020, in response to the early stages of the Coronavirus Pandemic and its pervasive impact across the economy and financial markets, we developed internal programs of loan payment deferments for commercial and retail borrowers. For commercial borrowers, we ~~offer~~offered 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments. Under the latter program, borrowers ~~are~~were extended a 12-month single payment note at 0% interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments. ~~As of~~ ~~June 30, 2020,~~ we had processed 463 interest only amendments with loan balances aggregating $421 million and 242 principal and interest payment deferments with loan balances totaling $298 million and resulting single payment loans aggregating $8.1 million. The single payment notes receive a loan grade equal to the ~~current~~ loan grade of each respective borrowing relationship. Certain of our commercial loan borrowers subsequently requested and received an additional 90-day (three payments) interest only amendment or 90-day (three payments) principal and interest payment deferment. Under the latter program, the amount equal to the three payments was added to the original deferment note which has nine months remaining to maturity; however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.

At the peak of activity in mid- July, nearly 750 borrowers with loan balances aggregating $719 million were participating in the commercial loan deferment program. However, as of October 30, 2020, only 5 borrowers with loan balances aggregating $7.0 million remained in the commercial loan deferment program. For retail borrowers, we ~~offer 90-day~~offered 90-day (three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan. As of June 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $23.8 million. These payment deferral transactions largely applied to the borrowers’ April, May and June of ~~2020~~loan payments.

~~We have also had some instances where commercial borrowers have subsequently requested and received an additional~~ 90~~-day (~~~~three~~ ~~payments) interest only amendment or~~ 90~~-day (~~~~three~~ ~~payments) principal and interest payment deferment. Under the latter program, the amount equal to the~~ ~~three~~ ~~payments is added to the original deferment note which has~~ ~~nine~~ ~~months remaining to maturity; however, the original~~ 0% ~~interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.~~ As of ~~July 31,~~October 30, 2020, ~~we had processed an additional 16 interest~~ only ~~amendments~~20 borrowers with loan balances aggregating ~~$31.0~~$1.0 million ~~and 21 principal and interest~~remained in the retail loan payment ~~deferments with loan balances totaling $117 million and resulting single payment loans aggregating $4.2 million. Additional~~ 90~~-day (~~~~three~~ ~~payments) principal and interest payment deferments for retail borrowers have been nominal with loan balances aggregating less than $2.0 million through~~ ~~July 31, 2020.~~

deferment program.

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

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

~~(Continued)~~

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~~MERCANTILE BANK CORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

1.~~SIGNIFICANT ACCOUNTING POLICIES~~ ~~(Continued)~~

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

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

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

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

~~(Continued)~~

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~~MERCANTILE BANK CORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

1.~~SIGNIFICANT ACCOUNTING POLICIES~~ ~~(Continued)~~

Due to current stressed economic and market conditions, we assessed goodwill for impairment as of March 31, 2020, June 30, 2020 and ~~June~~September 30, 2020. For March 31, 2020, we used a discounted income approach and a market valuation model, which compared the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill had been impaired. ~~It was~~Using this quantitative methodology, we determined goodwill was not impaired as of March 31, 2020. For June 30, 2020 and September 30, 2020, we used the Step 0 qualitative methodology for which we assessed the macro and microeconomic conditions, industry and market conditions, financial performance, and our underlying stock performance. We concluded it was more likely than not our fair value was greater than its carrying amount; therefore, no further testing was required.

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

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

Recent Events: The U.S. economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing ~~pandemic~~Coronavirus Pandemic. While the economic fallout has stabilized somewhat, there remains a significant amount of ~~coronavirus disease~~ ~~2019~~ ~~(“COVID-~~~~19”~~~~) caused by severe acute respiratory syndrome coronavirus~~ 2 ~~(the “Coronavirus Pandemic”).~~stress and uncertainty across national and global economies. This uncertainty is heightened as certain geographic areas continue to experience surges in COVID-19 ~~is primarily spread between people during close contact, often via small droplets produced by coughing, sneezing or talking. People~~ ~~may~~ ~~also become infected by touching a contaminated surface~~cases and ~~then touching their eyes, nose or mouth. There is currently~~ no known vaccine or specific antiviral treatment, with the primary treatment being symptomatic and supportive therapies. Recommended preventive measures include hand washing, covering one’s mouth when coughing and maintaining distance from other people, as well as self-isolation for people who suspect they are infected.governments at all levels continue to react to changes in circumstances.

The ~~outbreak was initially identified in Wuhan, China in~~Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and ~~December 2019.~~may ~~The World Health Organization declared~~have a material negative impact on our financial condition and results of operations. We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income. Additionally, the ~~outbreak to be~~consequences of the unprecedented economic impact of the Coronavirus Pandemic may produce declining asset quality, reflected by a ~~Public Health Emergency Concern on~~higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which ~~January 30, 2020,~~may necessitate additional provisions for our allowance and ~~then recognized it as a pandemic on~~ ~~March 11, 2020.~~ ~~The~~ ~~first~~ ~~known case in the United States was identified in the State of Washington on~~ ~~January 20, 2020.~~ ~~The White House Coronavirus Task Force was established on~~ ~~January 29, 2020.~~ ~~President Trump declared a Public Health Emergency on~~ ~~January 31, 2020,~~ ~~which was elevated by the President’s declaration of a National Emergency on~~ ~~March 13, 2020 (~~~~the “National Emergency”).~~reduced net income.

(Continued)

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES(Continued)

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

~~The~~ ~~first~~ ~~known case in the State of Michigan was identified on~~ ~~March 10, 2020,~~ ~~which triggered a State of Emergency response from Governor Whitmer. Soon thereafter, Governor Whitmer ordered the closure of all K-~~12 ~~school buildings until early~~ ~~April,~~ ~~which was later amended to suspend all face-to-face instruction for the remainder of the~~ ~~2019~~-~~2020~~ ~~school year. In mid-~~ ~~March,~~ ~~Governor Whitmer ordered all bars, restaurants, entertainment venues and other similar businesses to partially close for~~ ~~two~~ ~~weeks, and banned all gatherings of more than~~ 50 ~~people for the period of mid-~~ ~~March~~ ~~into early~~ ~~April.~~ On ~~March 24, 2020,~~ Governor Whitmer issued a state-wide stay-at-home order limiting all non-essential travel and discontinuing all non-essential business services and operations. The order was originally set to expire on ~~April 13, 2020;~~ ~~however, the order was extended, and expanded with additional restrictions, until~~ ~~April 30, 2020.~~ On ~~April 24, 2020,~~ ~~Governor Whitmer issued an amended stay-at-home order that was scheduled to expire on~~ ~~May 15, 2020~~ ~~to replace the stay-at-home order that was scheduled to expire on~~ ~~April 30, 2020.~~ On ~~May 7, 2020,~~ ~~Governor Whitmer issued an amended stay-at-home order that expired on~~ ~~May 28, 2020~~ ~~to replace the stay-at-home order that was scheduled to expire on~~ ~~May 15, 2020.~~ ~~The amended orders reduced some of the restrictions from the previous orders, permitting certain activities in limited or restricted capacities. The stay-at-home order was lifted effective~~ ~~June 5, 2020;~~ however, restrictions on indoor and outdoor gatherings remain, businesses are required to ensure CDC-recommended guidelines are followed and certain industries remain significantly impacted. An increase in COVID-19 ~~cases in Michigan near the end of the~~ ~~second~~ ~~quarter and into the~~ ~~third~~ ~~quarter has temporarily delayed further re-opening activities, and Governor Whitmer has indicated a willingness to reinstitute restrictions on activities of businesses and consumers.~~

~~Responding to the Coronavirus Pandemic and Governor Whitmer’s stay-at-home orders, by~~ ~~March 23, 2020,~~ ~~over 75% of our employees were working from home. In addition, beginning on~~ ~~March 18, 2020~~ ~~our branch lobbies were allowing face-to-face contact with customers by appointment only. On~~ ~~March 25, 2020,~~ we enhanced our social distancing response by closing our branch lobbies to all customers, with all banking transactions conducted via drive-thru, virtual banking machines, online banking and our call center. We have developed comprehensive social distancing guidelines and associated protocols using information provided by the CDC and other federal and state government agencies, and started to return our employees to their work locations in mid- ~~June.~~ On ~~June 26, 2020,~~ ~~we re-opened our branch lobbies, and virtually all of our employees were back to their physical work locations by~~ ~~July 1, 2020.~~

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

~~(Continued)~~

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~~MERCANTILE BANK CORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

1.~~SIGNIFICANT ACCOUNTING POLICIES~~ ~~(Continued)~~

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

The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs, with the maximum loan size capped at the lesser of 250% of the average monthly payroll costs or $10.0 million. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The loan tenor is 24 months for loans originated prior to June 5, 2020 and 60 months for loans originated on or after June 5, 2020. Loans originated prior to June 5, 2020 can be modified to a tenor of 60 months upon the mutual agreement of the lender and borrower. To date, we have not modified the maturity date of any loans made prior to June 5, 2020. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee ranging from 1% to 5% of the loan amount paid by the Small Business Administration. The loan origination fees, net of the direct origination costs, have totaled ~~$14.7~~approximately $15.0 million ~~during the~~ ~~second~~ ~~quarter of~~ ~~2020~~ and are being accreted into interest income on loans using the level yield methodology. The program was originally scheduled to end on June 30, 2020, but was ~~recently~~subsequently modified to ~~now~~ end ~~effective~~on August 8, 2020. Participation in the PPP ~~has~~ had a significant impact on the composition of our loan and deposit portfolios and our net interest income starting during the second quarter of 2020, which is expected to remain for ~~at least most of~~ the remainder of ~~2020.~~2020 Asand into at least the initial part of ~~July 31, 2020,~~ 2021.~~we had~~ We originated ~~almost~~approximately 2,200 loans aggregating ~~$550~~$555 million under the ~~PPP.~~

~~Congress passed,~~PPP, with 0 customer payment and on$37.1 million in forgiveness transactions recorded through ~~April 24, 2020~~ November 4, 2020.~~President Trump signed, legislation which added~~ ~~$300~~ ~~billion to the PPP. Included in the legislation was a specific allocation of~~ ~~$30~~ ~~billion for financial institutions under~~ ~~$10~~ ~~billion.~~

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

In April, 2020, the Federal Reserve initiated the PPPLF, which is designed to facilitate lending by financial institutions to small businesses under the PPP. Only PPP loans are eligible to serve as collateral for the PPPLF, with each dollar of PPP loans providing one dollar of advance availability. The maturity date of an extension of credit under the PPPLF will equal the maturity date of the pool of PPP loans pledged to secure the extension of credit. Any principal payments received by the financial institution on the PPP loans, such as PPP loan forgiveness payments from the Small Business Administration or principal payments from the borrower after the initial six-month deferment period, must be used to pay down the PPPLF advance by the same dollar amount, maintaining the dollar-for-dollar advance amount and PPP aggregate loan balance relationship. The interest rate on PPPLF advances is fixed at 0.35%. No PPPLF advances ~~can~~could be obtained after September 30, 2020. We obtained a PPPLF advance in the amount of $43.7 million in late April 2020 and paid it off in full in early June 2020. As of ~~June~~September 30, 2020, we had 0 advances outstanding under the PPPLF. We ~~may~~ ~~obtain additional PPPLF advances as our borrowers utilize PPP loan proceeds for permissible purposes.~~

Subsequent Event: On October 26, 2020, we announced that Lake Trust Credit Union had agreed to purchase our branch located in the City of Hastings, Michigan. The sale will include the 4,300 square-foot branch footprint and all associated assets, including approximately $16 million in deposits. The transaction is expected to close in early 2021, subject to regulatory approvals and customary closing conditions. The total purchase price for the transaction is expected to be approximately $11.8 million, which will be finalized at closing based upon cash on hand, outstanding balance and accrued interest on transferred loans, a deposit premium of 5.25% on transferred deposits and a fixed cash payment of $1.5 million for real and personal property.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended by ASU 2018-19) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (i) financial assets subject to credit losses and measured at amortized cost, and (ii) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans, and expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019.

Financial institutions are not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. An economic forecast is a key component of the CECL methodology. As we continue to experience an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by ~~shelter in place declarations~~government activity limitations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments, and financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly updated and there is no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted. Had we adopted CECL on January 1, 2020, the allowance would have decreased by $1.0 million, resulting in an increase to retained earnings of $0.8 million.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. SECURITIES

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2020
September 30, 2020
U.S. Government agency debt obligations	$	161,575,000	$	957,000	$	(35,000	)	$	162,497,000	$	170,970,000	$	658,000	$	(497,000	)	$	171,131,000
Mortgage-backed securities		34,765,000		1,269,000		(1,000	)		36,033,000		27,816,000		1,088,000		(1,000	)		28,903,000
Municipal general obligation bonds		97,171,000		5,296,000		0			102,467,000		95,725,000		5,399,000		0			101,124,000
Municipal revenue bonds		5,947,000		217,000		0			6,164,000		10,385,000		398,000		(17,000	)		10,766,000
Other investments		500,000		0		0			500,000		500,000		0		0			500,000

	$	299,958,000	$	7,739,000	$	(36,000	)	$	307,661,000	$	305,396,000	$	7,543,000	$	(515,000	)	$	312,424,000

December 31, 2019
U.S. Government agency debt obligations	$	185,103,000	$	2,449,000	$	(1,142,000	)	$	186,410,000	$	185,103,000	$	2,449,000	$	(1,142,000	)	$	186,410,000
Mortgage-backed securities		41,998,000		554,000		(82,000	)		42,470,000		41,998,000		554,000		(82,000	)		42,470,000
Municipal general obligation bonds		98,245,000		2,864,000		(30,000	)		101,079,000		98,245,000		2,864,000		(30,000	)		101,079,000
Municipal revenue bonds		4,133,000		63,000		0			4,196,000		4,133,000		63,000		0			4,196,000
Other investments		500,000		0		0			500,000		500,000		0		0			500,000

	$	329,979,000	$	5,930,000	$	(1,254,000	)	$	334,655,000	$	329,979,000	$	5,930,000	$	(1,254,000	)	$	334,655,000

Securities with unrealized losses at ~~June~~September 30, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

	Less than 12 Months				12 Months or More				Total				Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
June 30, 2020
September 30, 2020
U.S. Government agency debt obligations	$	16,370,000	$	35,000	$	0	$	0	$	16,370,000	$	35,000	$	67,172,000	$	497,000	$	0	$	0	$	67,172,000	$	497,000
Mortgage-backed securities		0		0		26,000		1,000		26,000		1,000		0		0		32,000		1,000		32,000		1,000
Municipal general obligation bonds		0		0		0		0		0		0		0		0		0		0		0		0
Municipal revenue bonds		0		0		0		0		0		0		830,000		17,000		0		0		830,000		17,000

	$	16,370,000	$	35,000	$	26,000	$	1,000	$	16,396,000	$	36,000	$	68,002,000	$	514,000	$	32,000	$	1,000	$	68,034,000	$	515,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. SECURITIES (Continued)

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

	$	32,243,000	$	395,000	$	85,330,000	$	859,000	$	117,573,000	$	1,254,000

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

At ~~June~~September 30, 2020, 1038 debt securities with fair values totaling ~~$16.4~~$68.0 million ~~have~~had unrealized losses aggregating ~~less than $0.1~~$0.5 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that the unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, 0 unrealized losses ~~are~~were deemed to be other-than-temporary.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2.SECURITIES (Continued)

The amortized cost and fair value of debt securities at ~~June~~September 30, 2020, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

~~(Continued)~~

~~Table of Contents~~

~~MERCANTILE BANK CORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

2.~~SECURITIES~~ ~~(Continued)~~

	Weighted Average Yield	Amortized Cost		Fair Value		Weighted Average Yield	Amortized Cost		Fair Value

Due in 2020	4.11%	$	410,000	$	412,000	4.08%	$	410,000	$	411,000
Due in 2021 through 2025	1.97		60,097,000		61,369,000	1.63		70,413,000		71,694,000
Due in 2026 through 2030	2.13		133,632,000		137,347,000	1.89		138,085,000		141,743,000
Due in 2031 and beyond	2.64		70,554,000		72,000,000	2.27		68,172,000		69,173,000
Mortgage-backed securities	2.57		34,765,000		36,033,000	2.19		27,816,000		28,903,000
Other investments	4.50		500,000		500,000	4.25		500,000		500,000

Total available for sale securities	2.27%	$	299,958,000	$	307,661,000	1.95%	$	305,396,000	$	312,424,000

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of ~~$98.5~~$102 million and $96.5 million at ~~June~~September 30, 2020 and December 31, 2019, respectively, with estimated market values of ~~$104~~$107 million and $99.4 million, respectively. Securities issued by all other states and their political subdivisions had a combined amortized cost of ~~$4.6~~$4.4 million and $5.9 million at ~~June~~September 30, 2020 and December 31, 2019, respectively, with estimated market values of ~~$4.6~~$4.5 million and $5.9 million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, did not exceed 10% of shareholders’ equity.

The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was ~~$168~~$157 million and $103 million at ~~June~~September 30, 2020 and December 31, 2019, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

3. LOANS AND ALLOWANCE FOR LOAN LOSSES

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

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(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Our total loans at ~~June~~September 30, 2020 were ~~$3.33~~$3.35 billion compared to $2.86 billion at December 31, 2019, an increase of ~~$476~~$494 million, or ~~16.7%~~17.3%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at ~~June~~September 30, 2020 and December 31, 2019, and the percentage change in loans from the end of 2019 to the end of the ~~second~~third quarter of 2020, are as follows:

											Percent													Percent
	June 30, 2020					December 31, 2019					Increase			September 30, 2020					December 31, 2019					Increase
	Balance		%			Balance		%			(Decrease)			Balance		%			Balance		%			(Decrease)

Commercial:
Commercial and industrial (1)	$	1,307,455,000		39.2	%	$	846,551,000		29.6	%		54.4	%	$	1,321,419,000		39.5	%	$	846,551,000		29.6	%		56.1	%
Vacant land, land development, and residential construction		52,984,000		1.6			56,119,000		2.0			(5.6	)		50,941,000		1.5			56,119,000		2.0			(0.9	)
Real estate – owner occupied		567,621,000		17.0			579,003,000		20.3			(2.0	)		549,364,000		16.4			579,003,000		20.3			(5.1	)
Real estate – non-owner occupied		841,145,000		25.2			835,346,000		29.2			0.7			878,897,000		26.2			835,346,000		29.2			5.2
Real estate – multi-family and residential rental		132,047,000		4.0			124,525,000		4.4			6.0			137,740,000		4.1			124,525,000		4.4			10.6
Total commercial		2,901,252,000		87.0			2,441,544,000		85.5			18.8			2,938,361,000		87.7			2,441,544,000		85.5			20.3

Retail:
Home equity and other		64,743,000		2.0			75,374,000		2.6			(14.1	)		63,723,000		1.9			75,374,000		2.6			(15.5	)
1-4 family mortgages		367,061,000		11.0			339,749,000		11.9			8.0			348,460,000		10.4			339,749,000		11.9			2.6
Total retail		431,804,000		13.0			415,123,000		14.5			4.0			412,183,000		12.3			415,123,000		14.5			(0.7	)

Total loans	$	3,333,056,000		100.0	%	$	2,856,667,000		100.0	%		16.7	%	$	3,350,544,000		100.0	%	$	2,856,667,000		100.0	%		17.3	%

(1)

For ~~June~~September 30, 2020, includes ~~$549~~$555 million in loans originated under the Paycheck Protection Program.

Nonperforming loans as of ~~June~~September 30, 2020 and December 31, 2019 were as follows:

	June 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019

Loans past due 90 days or more still accruing interest	$	0	$	0	$	0	$	0
Nonaccrual loans		3,212,000		2,284,000		4,141,000		2,284,000

Total nonperforming loans	$	3,212,000	$	2,284,000	$	4,141,000	$	2,284,000

(Continued)

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(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The recorded principal balance of nonperforming loans was as follows:

	June 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019
Commercial:
Commercial and industrial	$	98,000	$	0	$	213,000	$	0
Vacant land, land development, and residential construction		198,000		0		198,000		0
Real estate – owner occupied		275,000		134,000		1,248,000		134,000
Real estate – non-owner occupied		25,000		0		23,000		0
Real estate – multi-family and residential rental		0		2,000		0		2,000
Total commercial		596,000		136,000		1,682,000		136,000

Retail:
Home equity and other		250,000		255,000		265,000		255,000
1-4 family mortgages		2,366,000		1,893,000		2,194,000		1,893,000
Total retail		2,616,000		2,148,000		2,459,000		2,148,000

Total nonperforming loans	$	3,212,000	$	2,284,000	$	4,141,000	$	2,284,000

An age analysis of past due loans is as follows as of ~~June~~September 30, 2020:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing		30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing

Commercial:
Commercial and industrial	$	0	$	0	$	38,000	$	38,000	$	1,307,417,000	$	1,307,455,000	$	0	$	39,000	$	35,000	$	30,000	$	104,000	$	1,321,315,000	$	1,321,419,000	$	0
Vacant land, land development, and residential construction		0		22,000		198,000		220,000		52,764,000		52,984,000		0		16,000		22,000		198,000		236,000		50,705,000		50,941,000		0
Real estate – owner occupied		0		0		181,000		181,000		567,440,000		567,621,000		0		342,000		518,000		92,000		952,000		548,412,000		549,364,000		0
Real estate – non-owner occupied		0		25,000		0		25,000		841,120,000		841,145,000		0		0		23,000		0		23,000		878,874,000		878,897,000		0
Real estate – multi-family and residential rental		0		0		0		0		132,047,000		132,047,000		0		0		0		0		0		137,740,000		137,740,000		0
Total commercial		0		47,000		417,000		464,000		2,900,788,000		2,901,252,000		0		397,000		598,000		320,000		1,315,000		2,937,046,000		2,938,361,000		0

Retail:
Home equity and other		49,000		39,000		90,000		178,000		64,565,000		64,743,000		0		50,000		3,000		52,000		105,000		63,618,000		63,723,000		0
1-4 family mortgages		238,000		96,000		429,000		763,000		366,298,000		367,061,000		0		203,000		253,000		251,000		707,000		347,753,000		348,460,000		0
Total retail		287,000		135,000		519,000		941,000		430,863,000		431,804,000		0		253,000		256,000		303,000		812,000		411,371,000		412,183,000		0

Total past due loans	$	287,000	$	182,000	$	936,000	$	1,405,000	$	3,331,651,000	$	3,333,056,000	$	0	$	650,000	$	854,000	$	623,000	$	2,127,000	$	3,348,417,000	$	3,350,544,000	$	0

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

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

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing

Commercial:
Commercial and industrial	$	0	$	0	$	0	$	0	$	846,551,000	$	846,551,000	$	0
Vacant land, land development, and residential construction		191,000		0		0		191,000		55,928,000		56,119,000		0
Real estate – owner occupied		0		0		134,000		134,000		578,869,000		579,003,000		0
Real estate – non-owner occupied		0		0		0		0		835,346,000		835,346,000		0
Real estate – multi-family and residential rental		0		0		0		0		124,525,000		124,525,000		0
Total commercial		191,000		0		134,000		325,000		2,441,219,000		2,441,544,000		0

Retail:
Home equity and other		171,000		65,000		20,000		256,000		75,118,000		75,374,000		0
1-4 family mortgages		745,000		29,000		529,000		1,303,000		338,446,000		339,749,000		0
Total retail		916,000		94,000		549,000		1,559,000		413,564,000		415,123,000		0

Total past due loans	$	1,107,000	$	94,000	$	683,000	$	1,884,000	$	2,854,783,000	$	2,856,667,000	$	0

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans as of ~~June~~September 30, 2020, and average impaired loans for the three and ~~six~~nine months ended ~~June~~September 30, 2020, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance		Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Third Quarter Average Recorded Principal Balance		Year-To- Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	8,784,000	$	8,753,000		$	9,460,000	$	9,016,000	$	6,109,000	$	6,078,000		$	7,416,000	$	8,282,000
Vacant land, land development and residential construction		538,000		453,000			326,000		246,000		283,000		198,000			326,000		234,000
Real estate – owner occupied		4,434,000		4,375,000			4,316,000		3,100,000		2,923,000		2,915,000			3,645,000		3,053,000
Real estate – non-owner occupied		25,000		25,000			12,000		67,000		593,000		592,000			309,000		199,000
Real estate – multi-family and residential rental		21,000		0			2,000		4,000		0		0			0		3,000
Total commercial		13,802,000		13,606,000			14,116,000		12,433,000		9,908,000		9,783,000			11,696,000		11,771,000
Retail:
Home equity and other		1,359,000		1,274,000			1,273,000		1,252,000		1,423,000		1,336,000			1,305,000		1,273,000
1-4 family mortgages		4,561,000		2,571,000			2,627,000		2,407,000		4,443,000		2,439,000			2,505,000		2,415,000
Total retail		5,920,000		3,845,000			3,900,000		3,659,000		5,866,000		3,775,000			3,810,000		3,688,000

Total with no related allowance recorded	$	19,722,000	$	17,451,000		$	18,016,000	$	16,092,000	$	15,774,000	$	13,558,000		$	15,506,000	$	15,459,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance		Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Third Quarter Average Recorded Principal Balance		Year-To- Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	1,331,000	$	1,330,000	$	1,006,000	$	1,751,000	$	1,320,000	$	557,000	$	551,000	$	242,000	$	940,000	$	1,128,000
Vacant land, land development and residential construction		0		0		0		192,000		128,000		0		0		0		0		96,000
Real estate – owner occupied		49,000		49,000		2,000		126,000		443,000		850,000		823,000		235,000		436,000		538,000
Real estate – non-owner occupied		170,000		170,000		3,000		85,000		57,000		166,000		166,000		3,000		168,000		84,000
Real estate – multi-family and residential rental		1,000		1,000		0		0		0		0		0		0		0		0
Total commercial		1,551,000		1,550,000		1,011,000		2,154,000		1,948,000		1,573,000		1,540,000		480,000		1,544,000		1,846,000
Retail:
Home equity and other		596,000		577,000		339,000		486,000		486,000		379,000		363,000		277,000		470,000		455,000
1-4 family mortgages		662,000		662,000		162,000		638,000		544,000		644,000		644,000		153,000		653,000		569,000
Total retail		1,258,000		1,239,000		501,000		1,124,000		1,030,000		1,023,000		1,007,000		430,000		1,123,000		1,024,000

Total with an allowance recorded	$	2,809,000	$	2,789,000	$	1,512,000	$	3,278,000	$	2,978,000	$	2,596,000	$	2,547,000	$	910,000	$	2,667,000	$	2,870,000

Total impaired loans:
Commercial	$	15,353,000	$	15,156,000	$	1,011,000	$	16,270,000	$	14,381,000	$	11,481,000	$	11,323,000	$	480,000	$	13,240,000	$	13,617,000
Retail		7,178,000		5,084,000		501,000		5,024,000		4,689,000		6,889,000		4,782,000		430,000		4,933,000		4,712,000
Total impaired loans	$	22,531,000	$	20,240,000	$	1,512,000	$	21,294,000	$	19,070,000	$	18,370,000	$	16,105,000	$	910,000	$	18,173,000	$	18,329,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans as of December 31, 2019, and average impaired loans for the three and ~~six~~nine months ended ~~June~~September 30, 2019, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance		Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Third Quarter Average Recorded Principal Balance		Year-To- Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	8,129,000	$	8,129,000		$	10,214,000	$	9,810,000	$	8,129,000	$	8,129,000		$	15,474,000	$	12,480,000
Vacant land, land development and residential construction		85,000		85,000			90,000		91,000		85,000		85,000			88,000		90,000
Real estate – owner occupied		715,000		667,000			2,083,000		1,996,000		715,000		667,000			1,883,000		1,733,000
Real estate – non-owner occupied		178,000		178,000			175,000		117,000		178,000		178,000			209,000		120,000
Real estate – multi-family and residential rental		29,000		9,000			89,000		68,000		29,000		9,000			81,000		54,000
Total commercial		9,136,000		9,068,000			12,651,000		12,082,000		9,136,000		9,068,000			17,735,000		14,477,000
Retail:
Home equity and other		1,279,000		1,209,000			1,360,000		1,222,000		1,279,000		1,209,000			1,342,000		1,202,000
1-4 family mortgages		3,272,000		1,968,000			2,201,000		2,214,000		3,272,000		1,968,000			2,021,000		2,106,000
Total retail		4,551,000		3,177,000			3,561,000		3,436,000		4,551,000		3,177,000			3,363,000		3,308,000

Total with no related allowance recorded	$	13,687,000	$	12,245,000		$	16,212,000	$	15,518,000	$	13,687,000	$	12,245,000		$	21,098,000	$	17,785,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Third Quarter Average Recorded Principal Balance		Year-To- Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	460,000	$	458,000	$	202,000	$	8,629,000	$	7,022,000
Vacant land, land development and residential construction		0		0		0		0		0
Real estate – owner occupied		1,078,000		1,078,000		982,000		818,000		1,820,000
Real estate – non-owner occupied		0		0		0		0		100,000
Real estate – multi-family and residential rental		0		0		0		0		67,000
Total commercial		1,538,000		1,536,000		1,184,000		9,447,000		9,009,000
Retail:
Home equity and other		502,000		485,000		356,000		628,000		701,000
1-4 family mortgages		358,000		356,000		83,000		723,000		736,000
Total retail		860,000		841,000		439,000		1,351,000		1,437,000

Total with an allowance recorded	$	2,398,000	$	2,377,000	$	1,623,000	$	10,798,000	$	10,446,000

Total impaired loans:
Commercial	$	10,674,000	$	10,604,000	$	1,184,000	$	27,182,000	$	23,486,000
Retail		5,411,000		4,018,000		439,000		4,714,000		4,745,000
Total impaired loans	$	16,085,000	$	14,622,000	$	1,623,000	$	31,896,000	$	28,231,000

Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated fair value. Interest income recognized on accruing troubled debt restructurings totaled $0.2 million and $0.5 million during the third quarters of 2020 and 2019, respectively, and $0.8 million and $0.9 million during the firstnine months of 2020 and 2019, respectively. No interest income was recognized on nonaccrual loans during the third quarter and firstnine months of 2020 or during the respective 2019 periods. Lost interest income on nonaccrual loans totaled $0.1 million during the third quarters of 2020 and 2019, and $0.2 million and $0.1 million during the firstnine months of 2020 and 2019, respectively.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Unpaid
Contractual
Principal
Balance

Recorded
Principal
Balance

Related
Allowance

Second
Quarter
Average
Recorded
Principal
Balance

Year-To-Date
Average
Recorded
Principal
Balance

With an allowance recorded

Commercial:

Commercial and industrial
$ 460,000 $ 458,000 $ 202,000 $ 9,687,000 $ 8,184,000
Vacant land, land development and residential construction
0 0 0 0 0
Real estate – owner occupied
1,078,000 1,078,000 982,000 1,384,000 1,858,000
Real estate – non-owner occupied
0 0 0 47,000 101,000
Real estate – multi-family and residential rental
0 0 0 65,000 90,000
Total commercial
1,538,000 1,536,000 1,184,000 11,183,000 10,233,000
Retail:

Home equity and other
502,000 485,000 356,000 572,000 672,000
1-4 family mortgages
358,000 356,000 83,000 639,000 663,000
Total retail
860,000 841,000 439,000 1,211,000 1,335,000

Total with an allowance recorded
$ 2,398,000 $ 2,377,000 $ 1,623,000 $ 12,394,000 $ 11,568,000

Total impaired loans:

Commercial
$ 10,674,000 $ 10,604,000 $ 1,184,000 $ 23,834,000 $ 22,315,000
Retail
5,411,000 4,018,000 439,000 4,772,000 4,771,000
Total impaired loans
$ 16,085,000 $ 14,622,000 $ 1,623,000 $ 28,606,000 $ 27,086,000

~~Impaired loans for which~~ no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated fair value. Interest income recognized on accruing troubled debt restructurings totaled $0.4 million and $0.2 million during the ~~second~~ ~~quarters of~~ ~~2020~~ ~~and~~ ~~2019,~~ ~~respectively, and $0.6 million and $0.5 million during the~~ ~~first~~~~six~~ ~~months of~~ ~~2020~~ ~~and~~ ~~2019,~~ ~~respectively.~~ No ~~interest income was recognized on nonaccrual loans during the~~ ~~second~~ ~~quarter and~~ ~~first~~~~six~~ ~~months of~~ ~~2020~~ ~~or during the respective~~ ~~2019~~ ~~periods. Lost interest income on nonaccrual loans totaled less than $0.1 million during the~~ ~~second~~ ~~quarters of~~ ~~2020~~ ~~and~~ ~~2019,~~ ~~and $0.1 million and less than $0.1 million during the~~ ~~first~~~~six~~ ~~months of~~ ~~2020~~ ~~and~~ ~~2019,~~ ~~respectively.~~

~~(Continued)~~

~~Table of Contents~~

~~MERCANTILE BANK CORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

3.~~LOANS AND ALLOWANCE FOR LOAN LOSSES~~ ~~(Continued)~~

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

Credit quality indicators were as follows as of ~~June~~September 30, 2020:

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

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental		Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4 ⁽¹⁾	$	1,008,010,000	$	21,500,000	$	309,221,000	$	545,764,000	$	73,394,000	$	1,006,636,000	$	18,892,000	$	320,364,000	$	367,023,000	$	79,501,000
Grades 5 – 7		289,342,000		30,914,000		253,695,000		294,423,000		58,461,000		306,131,000		31,488,000		198,754,000		510,922,000		57,957,000
Grades 8 – 9		10,103,000		570,000		4,705,000		958,000		192,000		8,652,000		561,000		30,246,000		952,000		282,000
Total commercial	$	1,307,455,000	$	52,984,000	$	567,621,000	$	841,145,000	$	132,047,000	$	1,321,419,000	$	50,941,000	$	549,364,000	$	878,897,000	$	137,740,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages		Retail Home Equity and Other		Retail 1-4 Family Mortgages

Performing		64,493,000		364,695,000		63,458,000		346,266,000
Nonperforming		250,000		2,366,000		265,000		2,194,000
Total retail	$	64,743,000	$	367,061,000	$	63,723,000	$	348,460,000

(1)

Included in Commercial and Industrial Loans Grades 1 – 4 are ~~$549~~$555 million of loans originated under the Paycheck Protection Program.

(Continued)

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(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Credit quality indicators were as follows as of December 30, 2019:

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

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	521,920,000	$	26,065,000	$	351,671,000	$	563,087,000	$	85,152,000
Grades 5 – 7		309,824,000		29,716,000		220,980,000		272,124,000		39,203,000
Grades 8 – 9		14,807,000		338,000		6,352,000		135,000		170,000
Total commercial	$	846,551,000	$	56,119,000	$	579,003,000	$	835,346,000	$	124,525,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages

Performing		75,119,000		337,856,000
Nonperforming		255,000		1,893,000
Total retail	$	75,374,000	$	339,749,000

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

All commercial loans are graded using the following criteria:

Grade 1.

“Exceptional” Loans with this rating contain very little, if any, risk.

Grade 2.

“Outstanding” Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.

Grade 3.

“Very Good” Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are acceptable.

Grade 4.

“Good” Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are modest.

Grade 5.

“Acceptable” Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements. These are loans for which repayment risks are satisfactory.

Grade 6.

“Monitor” Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report.

Grade 7.

“Special Mention” Loans with this rating have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Grade 8.

“Substandard” Loans with this rating are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any. A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Grade 9.

“Doubtful” Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.

Grade 10.

“Loss” Loans with this rating are considered uncollectable, and of such little value that continuance as an active asset is not warranted.

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

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity in the allowance for loan losses and the recorded investments in loans as of and during the three and ~~six~~nine months ended ~~June~~September 30, 2020 are as follows:

	Commercial Loans			Retail Loans			Unallocated			Total			Commercial Loans			Retail Loans			Unallocated			Total

Allowance for loan losses:
Balance at March 31, 2020	$	21,750,000		$	3,078,000		$	0		$	24,828,000
Balance at June 30, 2020													$	27,962,000		$	4,224,000		$	60,000		$	32,246,000
Provision for loan losses		6,466,000			1,074,000			60,000			7,600,000			3,499,000			(266,000	)		(33,000	)		3,200,000
Charge-offs		(301,000	)		(34,000	)		0			(335,000	)		(45,000	)		(78,000	)		0			(123,000	)
Recoveries		47,000			106,000			0			153,000			194,000			55,000			0			249,000
Ending balance	$	27,962,000		$	4,224,000		$	60,000		$	32,246,000		$	31,610,000		$	3,935,000		$	27,000		$	35,572,000


Allowance for loan losses:
Balance at December 31, 2019	$	21,070,000		$	2,749,000		$	70,000		$	23,889,000		$	21,070,000		$	2,749,000		$	70,000		$	23,889,000
Provision for loan losses		7,039,000			1,321,000			(10,000	)		8,350,000			10,539,000			1,054,000			(43,000	)		11,550,000
Charge-offs		(314,000	)		(61,000	)		0			(375,000	)		(360,000	)		(139,000	)		0			(499,000	)
Recoveries		167,000			215,000			0			382,000			361,000			271,000			0			632,000
Ending balance	$	27,962,000		$	4,224,000		$	60,000		$	32,246,000		$	31,610,000		$	3,935,000		$	27,000		$	35,572,000

Ending balance: individually evaluated for impairment	$	1,011,000		$	501,000		$	0		$	1,512,000		$	480,000		$	430,000		$	0		$	910,000

Ending balance: collectively evaluated for impairment	$	26,951,000		$	3,723,000		$	60,000		$	30,734,000		$	31,130,000		$	3,505,000		$	27,000		$	34,662,000


Total loans:
Ending balance	$	2,901,252,000		$	431,804,000					$	3,333,056,000		$	2,938,361,000		$	412,183,000					$	3,350,544,000

Ending balance: individually evaluated for impairment	$	15,156,000		$	5,084,000					$	20,240,000		$	11,323,000		$	4,782,000					$	16,105,000

Ending balance: collectively evaluated for impairment	$	2,886,096,000		$	426,720,000					$	3,312,816,000		$	2,927,038,000		$	407,401,000					$	3,334,439,000

(Continued)

3231

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity in the allowance for loan losses for loans during the three and ~~six~~nine months ended ~~June~~September 30, 2019 and the recorded investments in loans as of December 31, 2019 are as follows:

	Commercial Loans			Retail Loans			Unallocated			Total			Commercial Loans			Retail Loans			Unallocated		Total

Allowance for loan losses:
Balance at March 31, 2019	$	20,211,000		$	2,696,000		$	228,000		$	23,135,000
Balance at June 30, 2019													$	21,271,000		$	2,685,000		$	97,000	$	24,053,000
Provision for loan losses		1,015,000			16,000			(131,000	)		900,000			499,000			132,000			69,000		700,000
Charge-offs		(2,000	)		(75,000	)		0			(77,000	)		(405,000	)		(114,000	)		0		(519,000	)
Recoveries		47,000			48,000			0			95,000			96,000			84,000			0		180,000
Ending balance	$	21,271,000		$	2,685,000		$	97,000		$	24,053,000		$	21,461,000		$	2,787,000		$	166,000	$	24,414,000


Allowance for loan losses:
Balance at December 31, 2018	$	19,619,000		$	2,717,000		$	44,000		$	22,380,000		$	19,619,000		$	2,717,000		$	44,000	$	22,380,000
Provision for loan losses		1,579,000			118,000			53,000			1,750,000			2,077,000			251,000			122,000		2,450,000
Charge-offs		(2,000	)		(250,000	)		0			(252,000	)		(407,000	)		(364,000	)		0		(771,000	)
Recoveries		75,000			100,000			0			175,000			172,000			183,000			0		355,000
Ending balance	$	21,271,000		$	2,685,000		$	97,000		$	24,053,000		$	21,461,000		$	2,787,000		$	166,000	$	24,414,000

Ending balance: individually evaluated for impairment	$	2,149,000		$	387,000		$	0		$	2,536,000		$	1,792,000		$	553,000		$	0	$	2,345,000

Ending balance: collectively evaluated for impairment	$	19,122,000		$	2,298,000		$	97,000		$	21,517,000		$	19,669,000		$	2,234,000		$	166,000	$	22,069,000


Total loans:
Ending balance	$	2,441,544,000		$	415,123,000					$	2,856,667,000		$	2,441,544,000		$	415,123,000				$	2,856,667,000

Ending balance: individually evaluated for impairment	$	10,986,000		$	4,070,000					$	15,056,000		$	10,986,000		$	4,070,000				$	15,056,000

Ending balance: collectively evaluated for impairment	$	2,430,558,000		$	411,053,000					$	2,841,611,000		$	2,430,558,000		$	411,053,000				$	2,841,611,000

(Continued)

3332

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans modified as troubled debt restructurings during the three months ended ~~June~~September 30, 2020 were as follows:

	Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance

Commercial:
Commercial and industrial	2	$	6,000	$	6,000	2	$	7,000	$	7,000
Vacant land, land development and residential construction	0		0		0	0		0		0
Real estate – owner occupied	0		0		0	1		56,000		56,000
Real estate – non-owner occupied	0		0		0	2		571,000		571,000
Real estate – multi-family and residential rental	0		0		0	0		0		0
Total commercial	2		6,000		6,000	5		634,000		634,000

Retail:
Home equity and other	7		438,000		439,000	5		82,000		83,000
1-4 family mortgages	1		20,000		20,000	2		68,000		67,000
Total retail	8		458,000		459,000	7		150,000		150,000

Total loans	10	$	464,000	$	465,000	12	$	784,000	$	784,000

Loans modified as troubled debt restructurings during the ~~six~~nine months ended ~~June~~September 30, 2020 were as follows:

	Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance

Commercial:
Commercial and industrial	8	$	6,545,000	$	6,542,000	8	$	6,485,000	$	6,491,000
Vacant land, land development and residential construction	0		0		0	0		0		0
Real estate – owner occupied	8		4,261,000		3,659,000	7		3,508,000		2,906,000
Real estate – non-owner occupied	0		0		0	2		571,000		571,000
Real estate – multi-family and residential rental	0		0		0	0		0		0
Total commercial	16		10,806,000		10,201,000	17		10,564,000		9,968,000

Retail:
Home equity and other	10		503,000		505,000	14		422,000		423,000
1-4 family mortgages	1		20,000		20,000	3		88,000		87,000
Total retail	11		523,000		525,000	17		510,000		510,000

Total loans	27	$	11,329,000	$	10,726,000	34	$	11,074,000	$	10,478,000

(Continued)

3433

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MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans modified as troubled debt restructurings during the three months ended ~~June~~September 30, 2019 were as follows:

	Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance

Commercial:
Commercial and industrial	3	$	14,040,000	$	14,337,000	1	$	28,000	$	28,000
Vacant land, land development and residential construction	0		0		0	1		87,000		87,000
Real estate – owner occupied	1		1,567,000		1,567,000	1		102,000		102,000
Real estate – non-owner occupied	0		0		0	0		0		0
Real estate – multi-family and residential rental	0		0		0	0		0		0
Total commercial	4		15,607,000		15,904,000	3		217,000		217,000

Retail:
Home equity and other	4		93,000		94,000	5		62,000		61,000
1-4 family mortgages	3		122,000		122,000	1		49,000		49,000
Total retail	7		215,000		216,000	6		111,000		110,000

Total loans	11	$	15,822,000	$	16,120,000	9	$	328,000	$	327,000

Loans modified as troubled debt restructurings during the ~~six~~nine months ended ~~June~~September 30, 2019 were as follows:

	Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance

Commercial:
Commercial and industrial	6	$	14,429,000	$	14,726,000	7	$	14,457,000	$	14,754,000
Vacant land, land development and residential construction	0		0		0	1		87,000		87,000
Real estate – owner occupied	2		2,257,000		2,246,000	2		1,669,000		1,669,000
Real estate – non-owner occupied	0		0		0	0		0		0
Real estate – multi-family and residential rental	0		0		0	0		0		0
Total commercial	8		16,686,000		16,972,000	10		16,213,000		16,510,000

Retail:
Home equity and other	8		163,000		164,000	13		225,000		225,000
1-4 family mortgages	4		154,000		154,000	5		202,000		203,000
Total retail	12		317,000		318,000	18		427,000		428,000

Total loans	20	$	17,003,000	$	17,290,000	28	$	16,640,000	$	16,938,000

(Continued)

3534

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

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

	Number of Contracts	Recorded Principal Balance
Commercial:
Commercial and industrial	0	$	0
Vacant land, land development and residential construction	0		0
Real estate – owner occupied	0		0
Real estate – non-owner occupied	0		0
Real estate – multi-family and residential rental	0		0
Total commercial	0		0

Retail:
Home equity and other	0		0
1-4 family mortgages	0		0
Total retail	0		0

Total	0	$	0

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the ~~six~~nine months ended ~~June~~September 30, 2020 (amounts as of period end):

	Number of Contracts	Recorded Principal Balance		Number of Contracts	Recorded Principal Balance
Commercial:
Commercial and industrial	0	$	0	0	$	0
Vacant land, land development and residential construction	0		0	0		0
Real estate – owner occupied	0		0	0		0
Real estate – non-owner occupied	0		0	0		0
Real estate – multi-family and residential rental	0		0	0		0
Total commercial	0		0	0		0

Retail:
Home equity and other	0		0	0		0
1-4 family mortgages	1		32,000	1		31,000
Total retail	1		32,000	1		31,000

Total	1	$	32,000	1	$	31,000

(Continued)

3635

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

	Number of Contracts	Recorded Principal Balance
Commercial:
Commercial and industrial	0	$	0
Vacant land, land development and residential construction	0		0
Real estate – owner occupied	0		0
Real estate – non-owner occupied	0		0
Real estate – multi-family and residential rental	0		0
Total commercial	0		0

Retail:
Home equity and other	0		0
1-4 family mortgages	0		0
Total retail	0		0

Total	0	$	0

	Number of Contracts	Recorded Principal Balance		Number of Contracts	Recorded Principal Balance
Commercial:
Commercial and industrial	0	$	0	0	$	0
Vacant land, land development and residential construction	0		0	0		0
Real estate – owner occupied	0		0	0		0
Real estate – non-owner occupied	0		0	0		0
Real estate – multi-family and residential rental	0		0	0		0
Total commercial	0		0	0		0

Retail:
Home equity and other	0		0	0		0
1-4 family mortgages	0		0	1		6,000
Total retail	0		0	1		6,000

Total	0	$	0	1	$	6,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2020 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	10,067,000		$	80,000		$	3,791,000		$	170,000		$	1,000
Charge-Offs		0			0			0			0			0
Payments		(3,537,000	)		(80,000	)		(827,000	)		(4,000	)		(1,000	)
Transfers to ORE		0			0			0			0			0
Net Additions/Deletions		7,000			0			55,000			569,000			0
Ending Balance	$	6,537,000		$	0		$	3,019,000		$	735,000		$	0

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	1,715,000		$	715,000
Charge-Offs		0			0
Payments		(220,000	)		(17,000	)
Transfers to ORE		0			0
Net Additions/Deletions		82,000			69,000
Ending Balance	$	1,577,000		$	767,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the ~~three~~nine months ended ~~June~~September 30, 2020 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental			Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	12,204,000		$	82,000		$	3,811,000		$	174,000		$	3,000		$	8,587,000		$	85,000		$	1,145,000		$	178,000		$	7,000
Charge-Offs		0			0			0			0			0			0			0			0			0			0
Payments		(2,143,000	)		(2,000	)		(20,000	)		(4,000	)		(2,000	)		(8,512,000	)		(85,000	)		(1,836,000	)		(12,000	)		(7,000	)
Transfers to ORE		0			0			0			0			0			0			0			0			0			0
Net Additions/Deletions		6,000			0			0			0			0			6,462,000			0			3,710,000			569,000			0
Ending Balance	$	10,067,000		$	80,000		$	3,791,000		$	170,000		$	1,000		$	6,537,000		$	0		$	3,019,000		$	735,000		$	0

Retail
Home Equity
and Other

Retail
1-4 Family
Mortgages

Retail Loan Portfolio:

Beginning Balance
$ 1,452,000 $ 715,000
Charge-Offs
0 0
Payments
(175,000
)
(20,000
)
Transfers to ORE
0 0
Net Additions/Deletions
438,000 20,000
Ending Balance
$ 1,715,000 $ 715,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	1,415,000		$	724,000
Charge-Offs		0			0
Payments		(423,000	)		(46,000	)
Transfers to ORE		0			0
Net Additions/Deletions		585,000			89,000
Ending Balance	$	1,577,000		$	767,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the ~~six~~three months ended ~~June~~September 30, ~~2020~~2019 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental			Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	8,587,000		$	85,000		$	1,145,000		$	178,000		$	7,000		$	24,134,000		$	0	$	2,498,000		$	185,000		$	17,000
Charge-Offs		0			0			0			0			0			0			0		0			0			0
Payments		(4,975,000	)		(5,000	)		(1,008,000	)		(8,000	)		(6,000	)		(85,000	)		0		(827,000	)		(4,000	)		(5,000	)
Transfers to ORE		0			0			0			0			0			0			0		0			0			0
Net Additions/Deletions		6,455,000			0			3,654,000			0			0			2,000			87,000		102,000			0			0
Ending Balance	$	10,067,000		$	80,000		$	3,791,000		$	170,000		$	1,000		$	24,051,000		$	87,000	$	1,773,000		$	181,000		$	12,000

Retail
Home Equity
and Other

Retail
1-4 Family
Mortgages

Retail Loan Portfolio:

Beginning Balance
$ 1,415,000 $ 724,000
Charge-Offs
0 0
Payments
(203,000
)
(29,000
)
Transfers to ORE
0 0
Net Additions/Deletions
503,000 20,000
Ending Balance
$ 1,715,000 $ 715,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	1,466,000		$	706,000
Charge-Offs		0			0
Payments		(45,000	)		(13,000	)
Transfers to ORE		0			0
Net Additions/Deletions		60,000			49,000
Ending Balance	$	1,481,000		$	742,000

(Continued)

Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the ~~three~~nine months ended ~~June~~September 30, 2019 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental			Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	15,610,000		$	0	$	3,695,000		$	189,000		$	21,000		$	14,138,000		$	0	$	3,100,000		$	210,000		$	24,000
Charge-Offs		0			0		0			0			0			0			0		0			0			0
Payments		(3,148,000	)		0		(2,377,000	)		(4,000	)		(4,000	)		(4,899,000	)		0		(3,252,000	)		(29,000	)		(12,000	)
Transfers to ORE		0			0		0			0			0			0			0		(97,000	)		0			0
Net Additions/Deletions		11,672,000			0		1,180,000			0			0			14,812,000			87,000		2,022,000			0			0
Ending Balance	$	24,134,000		$	0	$	2,498,000		$	185,000		$	17,000		$	24,051,000		$	87,000	$	1,773,000		$	181,000		$	12,000

Retail
Home Equity
and Other

Retail
1-4 Family
Mortgages

Retail Loan Portfolio:

Beginning Balance
$ 1,444,000 $ 600,000
Charge-Offs
(18,000
)
0
Payments
(62,000
)
(14,000
)
Transfers to ORE
0 0
Net Additions/Deletions
102,000 120,000
Ending Balance
$ 1,466,000 $ 706,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	1,402,000		$	578,000
Charge-Offs		(18,000	)		0
Payments		(137,000	)		(38,000	)
Transfers to ORE		0			0
Net Additions/Deletions		234,000			202,000
Ending Balance	$	1,481,000		$	742,000

(Continued)

~~Table of Contents~~

~~MERCANTILE BANK CORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

3.~~LOANS AND ALLOWANCE FOR LOAN LOSSES~~ ~~(Continued)~~

~~Activity for loans categorized as troubled debt restructurings during the~~ ~~six~~ ~~months ended~~ ~~June 30, 2019~~ ~~is as follows:~~

Commercial
and
Industrial

Commercial
Vacant Land,
Land
Development,
and
Residential
Construction

Commercial
Real Estate -
Owner
Occupied

Commercial
Real Estate -
Non-Owner
Occupied

Commercial
Real Estate -
Multi-Family
and
Residential
Rental

Commercial Loan Portfolio:

Beginning Balance
$ 14,138,000 $ 0 $ 3,100,000 $ 210,000 $ 24,000
Charge-Offs
0 0 0 0 0
Payments
(4,814,000
)
0 (2,425,000
)
(25,000
)
(7,000
)
Transfers to ORE
0 0 (97,000
)
0 0
Net Additions/Deletions
14,810,000 0 1,920,000 0 0
Ending Balance
$ 24,134,000 $ 0 $ 2,498,000 $ 185,000 $ 17,000

Retail
Home Equity
and Other

Retail
1-4 Family
Mortgages

Retail Loan Portfolio:

Beginning Balance
$ 1,402,000 $ 578,000
Charge-Offs
(18,000
)
0
Payments
(90,000
)
(24,000
)
Transfers to ORE
0 0
Net Additions/Deletions
172,000 152,000
Ending Balance
$ 1,466,000 $ 706,000

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(Unaudited)

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

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

	June 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019

Commercial:
Commercial and industrial	$	946,000	$	202,000	$	74,000	$	202,000
Vacant land, land development, and residential construction		0		0		0		0
Real estate – owner occupied		2,000		982,000		31,000		982,000
Real estate – non-owner occupied		3,000		0		2,000		0
Real estate – multi-family and residential rental		0		0		0		0
Total commercial		951,000		1,184,000		107,000		1,184,000

Retail:
Home equity and other		288,000		311,000		230,000		311,000
1-4 family mortgages		154,000		83,000		153,000		83,000
Total retail		442,000		394,000		383,000		394,000

Total related allowance	$	1,393,000	$	1,578,000	$	490,000	$	1,578,000

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

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(Unaudited)

4. PREMISES AND EQUIPMENT, NET

Premises and equipment are comprised of the following:

	June 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019

Land and improvements	$	17,218,000	$	17,039,000	$	17,032,000	$	17,039,000
Buildings		55,580,000		52,847,000		57,275,000		52,847,000
Furniture and equipment		21,790,000		22,712,000		22,580,000		22,712,000
		94,588,000		92,598,000		96,887,000		92,598,000
Less: accumulated depreciation		35,433,000		35,271,000		36,441,000		35,271,000

Premises and equipment, net	$	59,155,000	$	57,327,000	$	60,446,000	$	57,327,000

Depreciation expense totaled $1.3 million and $0.9 million during the ~~second~~third quarters of 2020 and 2019, respectively. Depreciation expense totaled ~~$2.5~~$3.8 million during the first ~~six~~nine months of 2020, compared to ~~$1.9~~$2.8 million during the first ~~six~~nine months of 2019.

5. DEPOSITS

Our total deposits at ~~June~~September 30, 2020 totaled ~~$3.26~~$3.37 billion, an increase of ~~$572~~$682 million, or ~~21.3%~~25.3%, from December 31, 2019. The components of our outstanding balances at ~~June~~September 30, 2020 and December 31, 2019, and percentage change in deposits from the end of 2019 to the end of the ~~second~~third quarter of 2020, are as follows:

	June 30, 2020					December 31, 2019					Percent Increase			September 30, 2020					December 31, 2019					Percent Increase
	Balance		%			Balance		%			(Decrease)			Balance		%			Balance		%			(Decrease)

Noninterest-bearing demand	$	1,445,620,000		44.3	%	$	924,916,000		34.4	%		56.3	%	$	1,449,879,000		43.0	%	$	924,916,000		34.4	%		56.8	%
Interest-bearing checking		382,522,000		11.7			332,373,000		12.3			15.1			439,925,000		13.0			332,373,000		12.3			32.4
Money market		541,929,000		16.6			509,368,000		18.9			6.4			575,077,000		17.1			509,368,000		18.9			12.9
Savings		301,881,000		9.2			269,318,000		10.0			12.1			318,132,000		9.4			269,318,000		10.0			18.1
Time, under $100,000		178,838,000		5.5			198,123,000		7.4			(9.7	)		173,193,000		5.1			198,123,000		7.4			(12.6	)
Time, $100,000 and over		334,781,000		10.3			322,827,000		12.0			3.7			349,867,000		10.4			322,827,000		12.0			8.4
Total local deposits		3,185,571,000		97.6			2,556,925,000		95.0			24.6			3,306,073,000		98.0			2,556,925,000		95.0			29.3

Out-of-area time, under $100,000		0	NA				0	NA			NA				0	NA				0	NA			NA
Out-of-area time, $100,000 and over		76,709,000		2.4			133,459,000		5.0			(42.5	)		65,961,000		2.0			133,459,000		5.0			(50.6	)
Total out-of-area deposits		76,709,000		2.4			133,459,000		5.0			(42.5	)		65,961,000		2.0			133,459,000		5.0			(50.6	)

Total deposits	$	3,262,280,000		100.0	%	$	2,690,384,000		100.0	%		21.3	%	$	3,372,034,000		100.0	%	$	2,690,384,000		100.0	%		25.3	%

Total time deposits of more than $250,000 totaled ~~$289~~$294 million and $320 million at ~~June~~September 30, 2020 and December 31, 2019, respectively.

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(Unaudited)

6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase (“repurchase agreements”) are offered principally to certain large deposit customers. Information relating to our repurchase agreements follows:

	Six Months Ended June 30, 2020			Twelve Months Ended December 31, 2019			Nine Months Ended September 30, 2020			Twelve Months Ended December 31, 2019

Outstanding balance at end of period	$	167,527,000		$	102,675,000		$	157,017,000		$	102,675,000

Average interest rate at end of period		0.10	%		0.17	%		0.11	%		0.17	%

Average daily balance during the period	$	123,486,000		$	105,234,000		$	129,091,000		$	105,234,000
Average interest rate during the period		0.13	%		0.24	%		0.12	%		0.24	%

Maximum daily balance during the period	$	167,527,000		$	133,411,000		$	173,142,000		$	133,411,000

Repurchase agreements generally have maturities of one business day. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank. Repurchase agreements are secured by securities with an aggregate market value equal to the aggregate outstanding balance.

7. FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $394 million at ~~June~~September 30, 2020, and mature at varying dates from November 2021 through June 2027, with fixed rates of interest from 0.55% to 3.18% and averaging 2.06%. FHLBI advances totaled $354 million at December 31, 2019, and were scheduled to mature at varying dates from April 2020 through June 2025, with fixed rates of interest from 1.36% to 3.18% and averaging 2.45%. In June 2020, we executed a blend and extend transaction with the FHLBI to extend the duration of the FHLBI advance portfolio as part our interest rate risk management program. We prepaid seven advances aggregating $70.0 million with maturities ranging from August 2020 through October 2021 and fixed interest rates from 1.36% to 2.84% and averaging 1.97%, using the proceeds from seven new advances aggregating $70.0 million with maturities ranging from June 2024 through June 2027 and fixed interest rates from 0.55% to 1.18% and averaging 0.84%. Prepayment fees totaling $0.9 million were embedded into the fixed rates on the newly obtained advances, equating to 0.22% of the 0.84% average rate of the new advances.

Each advance is payable at its maturity date and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit as of ~~June~~September 30, 2020 totaled ~~about $775~~$737 million, with remaining availability based on collateral ~~approximating $375~~of $337 million.

~~Maturities of currently outstanding FHLBI advances are as follows:~~

2020
$ 0
2021
20,000,000
2022
94,000,000
2023
80,000,000
2024
80,000,000
Thereafter
120,000,000

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(Unaudited)

7.FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES (Continued)

Maturities of currently outstanding FHLBI advances are as follows:

2020	$	0
2021		20,000,000
2022		94,000,000
2023		80,000,000
2024		80,000,000
Thereafter		120,000,000

8. COMMITMENTS AND OFF-BALANCE SHEET RISK

Our bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by our bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on our credit assessment of the borrower. If required, estimated loss exposure resulting from these instruments is expensed and recorded as a liability. There was 0 liability balance for these instruments as of ~~June~~September 30, 2020 and December 31, 2019.

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at ~~June~~September 30, 2020 and December 31, 2019 follows:

	June 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019

Commercial unused lines of credit	$	862,725,000	$	776,493,000	$	956,030,000	$	776,493,000
Unused lines of credit secured by 1 – 4 family residential properties		60,196,000		60,858,000		59,996,000		60,858,000
Credit card unused lines of credit		63,951,000		58,199,000		67,880,000		58,199,000
Other consumer unused lines of credit		23,080,000		18,135,000		25,599,000		18,135,000
Commitments to make loans		175,951,000		101,961,000		231,895,000		101,961,000
Standby letters of credit		21,427,000		22,798,000		20,018,000		22,798,000
	$	1,207,330,000	$	1,038,444,000	$	1,361,418,000	$	1,038,444,000

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(Unaudited)

9. FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of ~~June~~September 30, 2020 and December 31, 2019 (dollars in thousands):

	Level in	June 30, 2020				December 31, 2019				Level in	September 30, 2020				December 31, 2019
	Fair Value Hierarchy	Carrying Values		Fair Values		Carrying Values		Fair Values		Fair Value Hierarchy	Carrying Values		Fair Values		Carrying Values		Fair Values

Financial assets:
Cash	Level 1	$	18,930	$	18,930	$	16,430	$	16,430	Level 1	$	18,771	$	18,771	$	16,430	$	16,430
Cash equivalents	Level 2		452,297		452,297		217,301		217,301	Level 2		535,820		535,820		217,301		217,301
Securities available for sale	(1)		307,661		307,661		334,655		334,655	(1)		312,424		312,424		334,655		334,655
FHLBI stock	(2)		18,002		18,002		18,002		18,002	(2)		18,002		18,002		18,002		18,002
Loans, net	Level 3		3,259,673		3,346,702		2,827,800		2,887,168	Level 3		3,288,630		3,408,267		2,827,800		2,887,168
Loans held for sale	Level 2		41,137		42,806		4,978		4,978	Level 2		26,342		27,813		4,978		4,978
Mortgage servicing rights	Level 2		5,636		8,418		4,652		7,375	Level 2		7,103		9,161		4,652		7,375
Accrued interest receivable	Level 2		9,290		9,290		9,944		9,944	Level 2		11,025		11,025		9,944		9,944

Financial liabilities:
Deposits	Level 2		3,262,280		3,237,888		2,690,384		2,600,452	Level 2		3,372,034		3,353,217		2,690,384		2,600,452
Repurchase agreements	Level 2		167,527		167,527		102,675		102,675	Level 2		157,017		157,017		102,675		102,675
FHLBI advances	Level 2		394,000		413,915		354,000		361,887	Level 2		394,000		412,940		354,000		361,887
Subordinated debentures	Level 2		47,222		46,172		46,881		46,140	Level 2		47,392		47,392		46,881		46,140
Accrued interest payable	Level 2		3,011		3,011		3,949		3,949	Level 2		2,447		2,447		3,949		3,949

(1)

See Note 10 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities.

(2)

It is not practical to determine the fair value of FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount.

Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. Fair value for loans is based on an exit price model as required by ASU 2016-01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposits accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The fair values of subordinated debentures and FHLBI advances are based on current rates for similar financing. The fair value of off-balance sheet items is estimated to be nominal.

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(Unaudited)

10. FAIR VALUES

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

We are required to use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources, or unobservable, meaning those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.

Level 3: Significant unobservable inputs that reflect our own conclusions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities that are recorded at fair value on a recurring or nonrecurring basis:

Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal general obligation and revenue bonds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment. There was 0 such impairment as of ~~June~~September 30, 2020 or December 31, 2019. We have 0 Level 1 securities available for sale.

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(Unaudited)

10. FAIR VALUES (Continued)

Derivatives. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves.

Mortgage loans held for sale. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors, and are measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics. As of ~~June~~September 30, 2020 and December 31, 2019, we determined the fair value of our mortgage loans held for sale to be ~~$42.8~~$27.8 million and $5.0 million, respectively.

Loans. We do not record loans at fair value on a recurring basis. However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge-off. The fair values of impaired loans are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.

Foreclosed Assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed and repossessed assets, establishing a new cost basis. We subsequently adjust estimated fair value of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The balances of assets and liabilities measured at fair value on a recurring basis as of ~~June~~September 30, 2020 are as follows:

	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government agency debt obligations	$	162,497,000	$	0	$	162,497,000	$	0	$	171,131,000	$	0	$	171,131,000	$	0
Mortgage-backed securities		36,033,000		0		36,033,000		0		28,903,000		0		28,903,000		0
Municipal general obligation bonds		102,467,000		0		101,661,000		806,000		101,124,000		0		100,318,000		806,000
Municipal revenue bonds		6,164,000		0		6,164,000		0		10,766,000		0		10,766,000		0
Other investments		500,000		0		500,000		0		500,000		0		500,000		0
Total	$	307,661,000	$	0	$	306,855,000	$	806,000	$	312,424,000	$	0	$	311,618,000	$	806,000

~~There were~~ no ~~transfers in or out of Level~~ 1, ~~Level~~ 2 ~~or Level~~ 3 ~~during the~~ ~~first~~~~six~~ ~~months of~~ ~~2020.~~ ~~The $1.2 million reduction in Level~~ 3 ~~municipal general obligation bonds during the~~ ~~first~~~~six~~ ~~months of~~ ~~2020~~ ~~reflects the scheduled maturities of such bonds.~~

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(Unaudited)

10. FAIR VALUES (Continued)

There were no transfers in or out of Level 1, Level 2 or Level 3 during the firstnine months of 2020. The $1.2 million reduction in Level 3 municipal general obligation bonds during the firstnine months of 2020 reflects the scheduled maturities of such bonds.

The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2019 are as follows:

	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government agency debt obligations	$	186,410,000	$	0	$	186,410,000	$	0
Mortgage-backed securities		42,470,000		0		42,470,000		0
Municipal general obligation bonds		101,079,000		0		99,029,000		2,050,000
Municipal revenue bonds		4,196,000		0		4,196,000		0
Other investments		500,000		0		500,000		0
Total	$	334,655,000	$	0	$	332,605,000	$	2,050,000

There were no transfers in or out of Level 1, Level 2 or Level 3 during 2019. The $1.7 million reduction in Level 3 municipal general obligation bonds during 2019 reflects the scheduled maturities of such bonds.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of ~~June~~September 30, 2020 are as follows:

	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	3,082,000	$	0	$	0	$	3,082,000	$	3,227,000	$	0	$	0	$	3,227,000
Foreclosed assets		198,000		0		0		198,000		512,000		0		0		512,000
Total	$	3,280,000	$	0	$	0	$	3,280,000	$	3,739,000	$	0	$	0	$	3,739,000

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(Unaudited)

10. FAIR VALUES (Continued)

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2019 are as follows:

	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	1,107,000	$	0	$	0	$	1,107,000
Foreclosed assets		452,000		0		0		452,000
Total	$	1,559,000	$	0	$	0	$	1,559,000

The carrying values are based on the estimated value of the property or other assets. Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. For real estate dependent loans and foreclosed assets, we generally assign a 15% to 25% discount factor for commercial-related properties, and a 25% to 50% discount factor for residential-related properties. In a vast majority of cases, we assign a 10% discount factor for estimated selling costs.

11. REGULATORY MATTERS

We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if, after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator. At ~~June~~September 30, 2020 and December 31, 2019, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since ~~June~~September 30, 2020 that we believe have changed our bank’s categorization.

(Continued)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11. REGULATORY MATTERS (Continued)

Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:

	Actual					Minimum Required for Capital Adequacy Purposes					Minimum Required to be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2020
Total capital (to risk weighted assets)
Consolidated	$	455,797		13.8	%	$	263,844		8.0	%	NA		NA
Bank		446,072		13.5			263,787		8.0			329,734		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		420,225		12.7			197,883		6.0		NA		NA
Bank		410,500		12.5			197,840		6.0			263,787		8.0
Common equity tier 1 (to risk weighted assets)
Consolidated		374,907		11.4			148,413		4.5		NA		NA
Bank		410,500		12.5			148,380		4.5			214,327		6.5
Tier 1 capital (to average assets)
Consolidated		420,225		9.8			171,494		4.0		NA		NA
Bank		410,500		9.6			171,466		4.0			214,333		5.0

December 31, 2019
Total capital (to risk weighted assets)
Consolidated	$	429,038		13.1	%	$	262,141		8.0	%	NA		NA
Bank		424,917		13.0			262,088		8.0			327,610		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		405,148		12.4			196,606		6.0		NA		NA
Bank		401,027		12.2			196,566		6.0			262,088		8.0
Common equity tier 1 (to risk weighted assets)
Consolidated		360,342		11.0			147,454		4.5		NA		NA
Bank		401,027		12.2			147,425		4.5			212,947		6.5
Tier 1 capital (to average assets)
Consolidated		405,148		11.3			143,689		4.0		NA		NA
Bank		401,027		11.2			143,670		4.0			179,588		5.0

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11. REGULATORY MATTERS (Continued)

~~Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:~~

Actual

Minimum Required
for Capital
Adequacy Purposes

Minimum Required
to be Well
Capitalized Under
Prompt Corrective
Action Regulations

Amount

Ratio

Amount

Ratio

Amount

Ratio

June 30, 2020

Total capital (to risk weighted assets)

Consolidated
$ 444,772 13.7 % $ 259,076 8.0 % $ NA NA
Bank
436,832 13.5 259,017 8.0 323,771 10.0 %
Tier 1 capital (to risk weighted assets)

Consolidated
412,526 12.7 194,307 6.0 NA NA
Bank
404,587 12.5 194,263 6.0 259,017 8.0
Common equity tier 1 (to risk weighted assets)

Consolidated
367,379 11.3 145,730 4.5 NA NA
Bank
404,587 12.5 145,697 4.5 210,452 6.5
Tier 1 capital (to average assets)

Consolidated
412,526 10.2 161,668 4.0 NA NA
Bank
404,587 10.0 161,639 4.0 202,048 5.0

December 31, 2019

Total capital (to risk weighted assets)

Consolidated
$ 429,038 13.1 % $ 262,141 8.0 % $ NA NA
Bank
424,917 13.0 262,088 8.0 327,610 10.0 %
Tier 1 capital (to risk weighted assets)

Consolidated
405,148 12.4 196,606 6.0 NA NA
Bank
401,027 12.2 196,566 6.0 262,088 8.0
Common equity tier 1 (to risk weighted assets)

Consolidated
360,342 11.0 147,454 4.5 NA NA
Bank
401,027 12.2 147,425 4.5 212,947 6.5
Tier 1 capital (to average assets)

Consolidated
405,148 11.3 143,689 4.0 NA NA
Bank
401,027 11.2 143,670 4.0 179,588 5.0

~~(Continued)~~

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~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~(Unaudited)~~

11. ~~REGULATORY MATTERS~~ ~~(Continued)~~

Our consolidated capital levels as of ~~June~~September 30, 2020 and December 31, 2019 include ~~$45.1~~$45.3 million and $44.8 million, respectively, of trust preferred securities. Under applicable Federal Reserve guidelines, the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate amount of restricted core elements that may be included in our Tier 1 capital must not exceed 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Our ability to include the trust preferred securities in Tier 1 capital in accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated assets as of December 31, 2009 were less than $15.0 billion. As of ~~June~~September 30, 2020 and December 31, 2019, all ~~$45.1~~$45.3 million and $44.8 million, respectively, of the trust preferred securities were included in our consolidated Tier 1 capital.

Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of ~~June~~September 30, 2020, our bank meets all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.

Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On January 16, 2020, our Board of Directors declared a cash dividend on our common stock in the amount of $0.28 per share that was paid on March 18, 2020 to shareholders of record as of March 6, 2020. On April 16, 2020, our Board of Directors declared a cash dividend on our common stock in the amount of ~~$0.28~~$0.28 per share that was paid on June 17, 2020 to shareholders of record as of June 5, 2020. On July 16, 2020, our Board of Directors declared a cash dividend on our common stock in the amount of $0.28 per share that ~~will be~~was paid on September 16, 2020 to shareholders of record as of September 4, 2020. On October 15, 2020, our Board of Directors declared a cash dividend on our common stock in the amount of $0.28 per share that will be paid on December 16, 2020 to shareholders of record as of December 4, 2020.

In May 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 stock repurchase plan was instituted in conjunction with the completion of our existing program that was introduced in January 2015 and later expanded in April 2016. During the first ~~six~~ ~~months~~quarter of 2020, we repurchased a total of 222,385 shares at a total price of $6.3 million, at an average price per share of ~~$28.25.~~$28.25; 0 shares were repurchased during the second and third quarters of 2020. During the period of January 2015 through March 31, 2020, we repurchased a total of about 1.6 million shares at a total price of $38.9 million, at an average price per share of $24.13. Availability under our current repurchase plan totals $10.1 million. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.

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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,” “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, adverse changes in interest rates and interest rate relationships; significant declines in the value of commercial real estate; market volatility; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation or actions by bank regulators; changes in the method of determining Libor, or the replacement of Libor with an alternative reference rate; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; risks associated with cyber-attacks on our computer systems; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, the failure to meet client expectations and other facts; changes in the national and local economies, including the significant disruption to financial market and other economic activity caused by the outbreak of COVID-19; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2019, Form 10-Q for the quarter ended March 31, 2020, or in this report. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.

Introduction

The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC and Mercantile Insurance Center, Inc., at ~~June~~September 30, 2020 and December 31, 2019 and the results of operations for the three months and ~~six~~nine months ended ~~June~~September 30, 2020 and ~~June~~September 30, 2019. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.

Critical Accounting Policies

GAAP is complex and requires us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. 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, 2019 (Commission file number 000-26719). Our critical accounting policies are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements, and actual results may differ from those estimates. We have reviewed the application of these policies with the Audit Committee of our Board of Directors.

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

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

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

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.

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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.

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

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

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

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

Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur. Due to current stressed economic and market conditions, we assessed goodwill for impairment as of March 31, 2020, June 30, 2020, and ~~June~~September 30, 2020. For March 31, 2020, we used a discounted income approach and a market valuation model, which compared the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill had been impaired. ItUsing this quantitative methodology, it was determined goodwill was not impaired as of March 31, 2020. For June 30, 2020, and September 30, 2020, we used the Step 0 qualitative methodology for which we assessed the macro and microeconomic conditions, industry and market conditions, financial performance, and our underlying stock performance. We concluded it was more likely than not our fair value was greater than its carrying amount; therefore, no further testing was required.

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Coronavirus Pandemic

The U.S. economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing pandemic of coronavirus disease 2019 (“COVID-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). COVID-19 is primarily spread between people during close contact, often via small droplets produced by coughing, sneezing or talking. People may also become infected by touching a contaminated surface and then touching their eyes, nose or mouth. There is currently no known vaccine or specific antiviral treatment, withWhile the primary treatment being symptomatic and supportive therapies. Recommended preventive measures include hand washing, covering one’s mouth when coughing and maintaining distance from other people, as well as self-isolation for people who suspect they are infected.

The outbreak was initially identified in Wuhan, China in December 2019. The World Health Organization declared the outbreak to be a Public Health Emergency Concern on January 30, 2020, and then recognized it as a pandemic on March 11, 2020. The first known case in the United States was identified in the State of Washington on January 20, 2020. The White House Coronavirus Task Force was established on January 29, 2020. President Trump declared a Public Health Emergency on January 31, 2020, which was elevated by the President’s declaration of a National Emergency on March 13, 2020 (the “National Emergency”).

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

The first known case in the State of Michigan was identified on March 10, 2020, which triggered a State of Emergency response from Governor Whitmer. Soon thereafter, Governor Whitmer ordered the closure of all K-12 school buildings until early April, which was later amended to suspend all face-to-face instruction for the remainder of the 2019-2020 school year. In mid-March, Governor Whitmer ordered all bars, restaurants, entertainment venues and other similar businesses to partially close for two weeks, and banned all gatherings of more than 50 people for the period of mid-March into early April. On March 24, 2020, Governor Whitmer issued a state-wide stay-at-home order limiting all non-essential travel and discontinuing all non-essential business services and operations. The order was originally set to expire on April 13, 2020; however, the order was extended, and expanded with additional restrictions, until April 30, 2020. On April 24, 2020, Governor Whitmer issued an amended stay-at-home order that was scheduled to expire on May 15, 2020 to replace the stay-at-home order that was scheduled to expire on April 30, 2020. On May 7, 2020, Governor Whitmer issued an amended stay-at-home order that expired on May 28, 2020 to replace the stay-at-home order that was scheduled to expire on May 15, 2020. The amended orders reduced some of the restrictions from the previous orders, permitting certain activities in limited or restricted capacities. The stay-at-home order was lifted effective June 5, 2020; however, restrictions on indoor and outdoor gatherings remain, businesses are required to ensure CDC-recommended guidelines are followed and certain industries remain significantly impacted. An increaseexperience surges in COVID-19 cases and governments at all levels continue to react to changes in Michigan near the end of the second quarter and into the third quarter has temporarily delayed further re-opening activities, and Governor Whitmer has indicated a willingness to reinstitute restrictions on activities of businesses and consumers.

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Responding to the Coronavirus Pandemic and Governor Whitmer’s stay-at-home orders, by March 23, 2020, over 75% of our employees were working from home. In addition, beginning on March 18, 2020 our branch lobbies were allowing face-to-face contact with customers by appointment only. On March 25, 2020, we enhanced our social distancing response by closing our branch lobbies to all customers, with all banking transactions conducted via drive-thru, virtual banking machines, online banking and our call center. We have developed comprehensive social distancing guidelines and associated protocols using information provided by the CDC and other federal and state government agencies, and started to return our employees to their work locations in mid-June. On June 26, 2020, we re-opened our branch lobbies, and virtually all of our employees were back to their physical work locations by July 1, 2020.

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

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

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

●

Paycheck Protection Program

The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs, with the maximum loan size capped at the lesser of 250% of the average monthly payroll costs or $10.0 million. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The loan tenor is 24 months for loans originated prior to June 5, 2020 and 60 months for loans originated on or after June 5, 2020. Loans originated prior to June 5, 2020 can be modified to a tenor of 60 months upon the mutual agreement of the lender and borrower. To date, we have not modified the maturity date of any loans made prior to June 5, 2020. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee ranging from 1% to 5% of the loan amount paid by the Small Business Administration. The loan origination fees, net of the direct origination costs, have totaled ~~$14.7~~approximately $15.0 million ~~during the second quarter of 2020~~ and are being accreted into interest income on loans using the level yield methodology. The program was originally scheduled to end on June 30, 2020, but was ~~recently~~subsequently modified to ~~now~~ end ~~effective~~on August 8, 2020. Participation in the PPP has had a significant impact on the composition of our loan and deposit portfolios and our net interest income starting during the second quarter of 2020, which is expected to remain for ~~at least most of~~ the remainder of ~~2020. As~~2020 and into at least the initial part of ~~July 31, 2020, we had~~2021. We originated ~~almost~~approximately 2,200 loans aggregating ~~$550~~$555 million under the ~~PPP.~~

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~~Congress passed,~~PPP, with no customer payment and ~~on April 24, 2020 President Trump signed, legislation which added $300 billion to the PPP. Included~~$37.1 million in ~~the legislation was a specific allocation of $30 billion for financial institutions under $10 billion.~~forgiveness transactions recorded through November 4, 2020.

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

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●

Individual Economic Impact Payments

The Internal Revenue Service began making Individual Economic Impact Payments in mid-April via direct deposit or mailed checks. Individuals with adjusted gross income of $75,000 or less received payments of $1,200, with a reduction formula for those individuals with adjusted gross income over $75,000 but less than $99,000. Individuals with adjusted gross income of over $99,000 did not receive a payment. Married couples filing jointly with adjusted gross income of $150,000 or less received payments of $2,400, with a reduction formula for those married couples filing jointly with adjusted gross income over $150,000 but less than $198,000. Married couples filing jointly with adjusted gross income of over $198,000 did not receive a payment.

●

Troubled Debt Restructuring Relief

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

●

Current Expected Credit Loss Methodology Delay

In early April 2020, in response to the early stages of the Coronavirus Pandemic and its pervasive impact across the economy and financial markets, we developed internal programs of loan payment deferments for commercial and retail borrowers. For commercial borrowers, we ~~offer~~offered 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments. Under the latter program, borrowers ~~are~~were extended a 12-month single payment note at 0% interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments. As of June 30, 2020, we had processed 463 interest only amendments with loan balances aggregating $421 million and 242 principal and interest payment deferments with loan balances totaling $298 million and resulting single payment loans aggregating $8.1 million. The single payment notes receive a loan grade equal to the ~~current~~ loan grade of each respective borrowing relationship. Certain of our commercial loan borrowers subsequently requested and received an additional 90-day (three payments) interest only amendment or 90-day (three payments) principal and interest payment deferment. Under the latter program, the amount equal to the three payments was added to the original deferment note which has nine months remaining to maturity; however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.

At the peak of activity in mid-July, nearly 750 borrowers with loan balances aggregating $719 million were participating in the commercial loan deferment program. However, as of October 30, 2020, only five borrowers with loan balances aggregating $7.0 million remained in the commercial loan deferment program. For retail borrowers, we ~~offer~~offered 90-day (three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan. As of June 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $23.8 million. These payment deferral transactions largely applied to the borrowers’ April, May and June ~~of 2020~~ loan payments. As of October 30, 2020, only 20 borrowers with loan balances aggregating $1.0 million remained in the retail loan payment deferment program.

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We have also had some instances where commercial borrowers have subsequently requested and received an additional 90-day (three payments) interest only amendment or 90-day (three payments) principal and interest payment deferment. Under the latter program, the amount equal to the three payments is added to the original deferment note which has nine months remaining to maturity; however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term. As of July 31, 2020, we had processed an additional 16 interest only amendments with loan balances aggregating $31.0 million and 21 principal and interest payment deferments with loan balances totaling $117 million and resulting single payment loans aggregating $4.2 million. Additional 90-day (three payments) principal and interest payment deferments for retail borrowers have been nominal with loan balances aggregating less than $2.0 million through July 31, 2020.

In April, 2020, the Federal Reserve initiated the PPPLF, which is designed to facilitate lending by financial institutions to small businesses under the PPP. Only PPP loans are eligible to serve as collateral for the PPPLF, with each dollar of PPP loans providing one dollar of advance availability. The maturity date of an extension of credit under the PPPLF will equal the maturity date of the pool of PPP loans pledged to secure the extension of credit. Any principal payments received by the financial institution on the PPP loans, such as PPP loan forgiveness payments from the Small Business Administration or principal payments from the borrower after the initial six-month deferment period, must be used to pay down the PPPLF advance by the same dollar amount, maintaining the dollar-for-dollar advance amount and PPP aggregate loan balance relationship. The interest rate on PPPLF advances is fixed at 0.35%. No PPPLF advances ~~can~~could be obtained after September 30, 2020. We obtained a PPPLF advance in the amount of $43.7 million in late April ~~2020; however, the PPPLF advance was paid-off~~2020 and paid it off in full in early June 2020. As of ~~June~~September 30, 2020, we had no advances outstanding under the PPPLF. ~~We may obtain additional PPPLF advances as our borrowers utilize PPP loan proceeds for permissible purposes.~~

Subsequent Event

On October 26, 2020, we announced that Lake Trust Credit Union had agreed to purchase our branch located in the City of Hastings, Michigan. The sale will include the 4,300 square-foot branch footprint and all associated assets, including approximately $16 million in deposits. The transaction is expected to close in early 2021, subject to regulatory approvals and customary closing conditions. The total purchase price for the transaction is expected to be approximately $11.8 million, which will be finalized at closing based upon cash on hand, outstanding balance and accrued interest on transferred loans, a deposit premium of 5.25% on transferred deposits and a fixed cash payment of $1.5 million for real and personal property.

Financial Overview

We reported net income of ~~$8.7~~$10.7 million, or ~~$0.54~~$0.66 per diluted share, for the ~~second~~third quarter of 2020, compared to net income of ~~$11.7~~$12.6 million, or ~~$0.71~~$0.77 per diluted share, during the ~~second~~third quarter of 2019. Net income for the first ~~six~~nine months of 2020 totaled ~~$19.4~~$30.1 million, or ~~$1.19~~$1.85 per diluted share, compared to ~~$23.5~~$36.1 million, or ~~$1.43~~$2.20 per diluted share, during the first ~~six~~nine months ~~of 2019.~~

Proceeds from a bank owned life insurance claim during the second quarter of 2019 increased net income by $1.3 million, or $0.08 per diluted share. Excluding the impact of this transaction, diluted earnings per share decreased $0.09, or 14.3%, during the second quarter of 2020 compared to the second quarter of 2019. Proceeds from bank owned life insurance claims and a gain on the sale of a former branch facility during the first ~~six~~nine months of 2019 increased reported net income by $3.1 million, or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased ~~$0.05,~~$0.16, or ~~4.0%~~about 8.0%, during the first ~~six~~nine months of 2020 compared to the first ~~six~~nine months of 2019.

We believe the overall quality of our loan portfolio remains strong, with nonperforming loans equaling only ~~0.10%~~0.12% of total loans as of ~~June~~September 30, 2020. Gross loan charge-offs totaled ~~$0.3~~$0.1 million during the ~~second~~third quarter of 2020, and totaled ~~$0.4~~$0.5 million for the first ~~six~~nine months of the year, while recoveries of prior period loan charge-offs equaled ~~$0.2~~$0.3 million and ~~$0.4~~$0.6 million during the respective time periods. Net loan ~~charge-offs,~~recoveries, as a percentage of average total loans, equaled an annualized 0.02% during the ~~second~~third quarter ~~while a net loan recovery equaled an annualized less than~~of 2020 and 0.01% during the first ~~six~~nine months of 2020. 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.

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Commercial loans increased ~~$460~~$497 million during the first ~~six~~nine months of 2020, and at ~~June~~September 30, 2020 totaled ~~$2.90~~$2.94 billion, or ~~87.0%~~87.7% of our loan portfolio. As of December 31, 2019, the commercial loan portfolio comprised 85.5% of total loans. The increase in commercial loans during the first ~~six~~nine months of 2020 primarily reflects PPP loan originations totaling ~~$549~~$555 million, partially offset by a $109 million reduction in lines of credit balances. Commercial and industrial loans, which include PPP loans, were up ~~$461~~$475 million, non-owner occupied commercial real estate (“CRE”) loans increased ~~$5.8~~$43.6 million and multi-family and residential rental loans grew ~~$7.5~~$13.2 million, while owner occupied CRE loans decreased ~~$11.4~~$29.6 million and vacant land, land development and residential construction loans were down ~~$3.1~~$5.2 million. We believe our loan portfolio remains well diversified. As a percentage of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled ~~56.3%~~55.2% as of ~~June~~September 30, 2020, compared to 58.4% at December 31, 2019. The ~~new~~current commercial loan pipeline remains strong, and at ~~June~~September 30, 2020, we had ~~$78~~almost $100 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

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We recorded a loan loss provision expense of ~~$7.6~~$3.2 million during the ~~second~~third quarter of 2020, compared to ~~$0.9~~$0.7 million during the ~~second~~third quarter of 2019. We recorded a loan loss provision expense of ~~$8.4~~$11.6 million during the first ~~six~~nine months of 2020, compared to ~~$1.8~~$2.5 million during the first ~~six~~nine months of 2019. The significantly increased provision expense recorded during the 2020 periods primarily ~~reflected~~reflects the continuing impact of the Coronavirus Pandemic on the economic environment. The provision expense level during the third quarter of 2020 was primarily determined through a wide-ranging review of risk ratings assigned to many commercial loan relationships. This review resulted in downgrades, and consequential additional reserves, on 159 of the reviewed relationships, eight of which were moved to our watch list. Provision expense totaled $7.6 million during the second quarter of 2020, in large part reflecting an allocation associated with a newly-created Coronavirus Pandemic environmental factor (“COVID-19 factor”) and an increased allocation related to the existing economic and business conditions environmental factor. The COVID-19 factor was added to address the unique challenges and economic uncertainty resulting from the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio.

Noninterest income during the ~~second~~third quarter of 2020 was ~~$11.0~~$13.3 million, compared to ~~$6.3~~$6.7 million during the prior-year ~~second~~third quarter. Noninterest income during the second quarter of 2019 included a bank owned life insurance claim of $1.3 million. Excluding the impact of this transaction, noninterest income increased $5.9 million, or nearly 118%, during the current-year second quarter compared to the respective 2019 period. Noninterest income during the first ~~six~~nine months of 2020 was ~~$17.5~~$30.8 million, compared to ~~$13.0~~$19.6 million during the same time period in 2019. Noninterest income during the first ~~six~~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 ~~$7.7~~$14.4 million, or ~~79.2%~~87.3%, in the first ~~six~~nine months of 2020 compared to the respective 2019 period. The higher level of noninterest income in both 2020 periods primarily reflected increased mortgage banking income. We originated ~~$408~~$646 million in residential mortgage loans during the first ~~six~~nine months of 2020, which was about ~~225%~~150% higher than originations during the first ~~six~~nine months of 2019. The increase is primarily attributable to significant refinance activity stemming from the decreased interest rate environment coupled with the ongoing success of strategic initiatives that were designed to expand market penetration, enhance gain activities and operate more efficiently. Almost ~~75%~~70% of the residential mortgage loans originated during the first ~~six~~nine months of 2020 consisted of refinance transactions, compared to about ~~43%~~48% during the first ~~six~~nine months of 2019. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, during the first ~~six~~nine months of 2020 totaled ~~$321~~$512 million, or about 79% of total mortgage loans originated. During the first ~~six~~nine months of 2019, residential mortgage loans originated for sale totaled ~~$70.9~~$176 million, or about ~~57%~~68% of total mortgage loans originated.

Noninterest expense during the third quarter of 2020 was $26.4 million, compared to $22.0 million during the prior-year third quarter. Noninterest expense during the first nine months of 2020 was $72.6 million, compared to $65.9 million during the same time period in 2019. The higher level of noninterest expense in both 2020 periods primarily reflected higher compensation costs. Salary and benefit costs were up $3.1 million, or about 22%, during the third quarter of 2020 when compared to the third quarter of 2019. Mortgage banking-related compensation costs were up $1.3 million, while bonus accruals increased $1.2 million. The bonus accruals recorded during the third quarter of 2020 equated to three quarters-worth of accrual, as no bonus accruals were recorded during the first and second quarters due to the economic environment. Salary and benefits costs were up $4.4 million, or approximately 11%, during the first nine months of 2020 compared to the first nine months of 2019. Mortgage banking-related compensation costs were up $3.7 million, with bonus expense essentially unchanged.

Financial Condition

Our total assets increased ~~$681~~$788 million during the first ~~six~~nine months of 2020, and totaled ~~$4.31~~$4.42 billion as of ~~June~~September 30, 2020. Total loans increased ~~$476~~$494 million and interest-earning deposits grew by ~~$206~~$315 million, while securities available for sale decreased ~~$27.0~~$22.2 million. Total deposits increased ~~$572~~$682 million, sweep accounts were up ~~$64.9~~$54.3 million and ~~FHLBI~~Federal Home Loan Bank of Indianapolis (“FHLBI”) advances increased $40.0 million during the first ~~six~~nine months of 2020.

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Commercial loans increased ~~$460~~$497 million during the first ~~six~~nine months of 2020, and at ~~June~~September 30, 2020 totaled ~~$2.90~~$2.94 billion, or ~~87.0%~~87.7% of ~~the~~our loan portfolio. As of December 31, 2019, the commercial loan portfolio comprised 85.5% of total loans. The increase in commercial loans during the first ~~six~~nine months of 2020 primarily reflects PPP loan originations totaling ~~$549~~$555 million, partially offset by a $109 million reduction in lines of credit balances. Commercial and industrial loans, which include PPP loans, were up ~~$461~~$475 million, non-owner occupied CRE loans increased ~~$5.8~~$43.6 million and multi-family and residential rental loans grew ~~$7.5~~$13.2 million, while owner occupied CRE loans decreased ~~$11.4~~$29.6 million and vacant land, land development and residential construction loans were down ~~$3.1~~$5.2 million. We believe our loan portfolio remains well diversified. As a percentage of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled ~~56.3%~~55.2% as of ~~June~~September 30, 2020, compared to 58.4% at December 31, 2019.

As of ~~June~~September 30, 2020, availability on existing construction and development loans totaled approximately ~~$78~~$100 million, with most of those funds expected to be drawn over the next 12 to 18 months. Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including ~~$176~~$232 million in new lending commitments, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial lenders also report ongoing additional opportunities they are currently discussing with existing and potential new borrowers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. Usage of existing commercial lines of credit was relatively stable during the third quarter of 2020, after having declined during the second quarter ~~of 2020,~~ largely reflecting the Coronavirus Pandemic and associated weakened economic conditions.

Residential mortgage loans increased ~~$27.3~~$8.7 million during the first ~~six~~nine months of 2020, totaling ~~$367~~$348 million, or ~~11.0%~~10.4% of total loans, as of ~~June~~September 30, 2020. We originated ~~$408~~$646 million in residential mortgage loans during the first ~~six~~nine months of 2020, which was about ~~225%~~150% higher than originations during the first ~~six~~nine months of 2019. The increase was primarily attributable to significant refinance activity stemming from the decreased interest rate environment coupled with the ongoing success of strategic initiatives that were designed to expand market penetration, enhance gain activities and operate more efficiently. Almost ~~75%~~70% of the residential mortgage loans originated during the first ~~six~~nine months of 2020 consisted of refinance transactions, compared to approximately ~~43%~~48% during the first ~~six~~nine months of 2019. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, during the first ~~six~~nine months of 2020 totaled ~~$321~~$512 million, or approximately 79% of total mortgage loans originated. During the first ~~six~~nine months of 2019, residential mortgage loans originated for sale totaled ~~$70.9~~$176 million, or approximately ~~57%~~68% of total mortgage loans originated. Residential mortgage loans originated not sold are generally comprised of adjustable rate residential mortgage loans. We are pleased with the results of our strategic initiatives associated with the growth of our residential mortgage banking operation over the past few years, and remain optimistic that origination volumes will continue to be solid in future periods. We experienced an increase in the origination of purchase residential mortgage loans during the latter part of the second quarter, and as of June 30, 2020, the pipeline for purchase residential mortgage loan applications was at a record level.

Other consumer-related loans declined ~~$10.6~~$11.7 million during the first ~~six~~nine months of 2020, and at ~~June~~September 30, 2020 totaled ~~$64.7~~$63.7 million, or ~~2.0%~~1.9% of total loans. Other consumer-related loans comprised 2.6% of total loans as of December 31, 2019. We expect this loan portfolio segment to continue to decline in future periods as scheduled principal payments exceed anticipated new loan origination volumes.

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

	6/30/20		3/31/20		12/31/19		9/30/19		6/30/19		9/30/20		6/30/20		3/31/20		12/31/19		9/30/19
Commercial:
Commercial & Industrial	$	1,307,455,000	$	873,679,000		846,551,000		882,748,000	$	881,196,000	$	1,321,419,000	$	1,307,455,000		873,679,000		846,551,000	$	882,748,000
Land Development & Construction		52,984,000		62,908,000		56,119,000		48,417,000		45,158,000		50,941,000		52,984,000		62,908,000		56,119,000		48,417,000
Owner Occupied Commercial RE		567,621,000		579,229,000		579,003,000		567,267,000		556,868,000		549,364,000		567,621,000		579,229,000		579,003,000		567,267,000
Non-Owner Occupied Commercial RE		841,145,000		823,366,000		835,346,000		883,080,000		852,844,000		878,897,000		841,145,000		823,366,000		835,346,000		883,080,000
Multi-Family & Residential Rental		132,047,000		133,148,000		124,525,000		126,855,000		128,489,000		137,740,000		132,047,000		133,148,000		124,525,000		126,855,000
Total Commercial		2,901,252,000		2,472,330,000		2,441,544,000		2,508,367,000		2,464,555,000		2,938,361,000		2,901,252,000		2,472,330,000		2,441,544,000		2,508,367,000

Retail:
1-4 Family Mortgages		367,061,000		356,338,000		339,749,000		346,094,000		335,618,000		348,460,000		367,061,000		356,338,000		339,749,000		346,094,000
Home Equity & Other Consumer Loans		64,743,000		72,875,000		75,374,000		78,552,000		81,320,000		63,723,000		64,743,000		72,875,000		75,374,000		78,552,000
Total Retail		431,804,000		429,213,000		415,123,000		424,646,000		416,938,000		412,183,000		431,804,000		429,213,000		415,123,000		424,646,000

Total	$	3,333,056,000	$	2,901,543,000		2,856,667,000		2,933,013,000	$	2,881,493,000	$	3,350,544,000	$	3,333,056,000		2,901,543,000		2,856,667,000	$	2,933,013,000

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 ~~$3.4~~$4.7 million (0.1% of total assets) as of ~~June~~September 30, 2020, compared to $2.7 million (0.1% of total assets) as of December 31, 2019. 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 ~~at the initial stages of~~as we continue to work our way through the Coronavirus Pandemic.

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

NONPERFORMING LOANS	NONPERFORMING LOANS											NONPERFORMING LOANS

		6/30/20		3/31/20		12/31/19		9/30/19		6/30/19			9/30/20		6/30/20		3/31/20		12/31/19		9/30/19
Residential Real Estate:
Land Development		$	36,000	$	37,000	$	34,000	$	32,000	$	33,000		$	36,000	$	36,000	$	37,000	$	34,000	$	32,000
Construction			198,000		283,000		0		0		0			198,000		198,000		283,000		0		0
Owner Occupied / Rental			2,552,000		2,651,000		2,104,000		2,390,000		2,779,000			2,399,000		2,552,000		2,651,000		2,104,000		2,390,000
			2,786,000		2,971,000		2,138,000		2,422,000		2,812,000			2,633,000		2,786,000		2,971,000		2,138,000		2,422,000

Commercial Real Estate:
Land Development			0		43,000		0		0		0			0		0		43,000		0		0
Construction			0		0		0		0		0			0		0		0		0		0
Owner Occupied			275,000		287,000		134,000		183,000		642,000			1,262,000		275,000		287,000		134,000		183,000
Non-Owner Occupied			25,000		0		0		26,000		26,000			23,000		25,000		0		0		26,000
			300,000		330,000		134,000		209,000		668,000			1,285,000		300,000		330,000		134,000		209,000

Non-Real Estate:
Commercial Assets			98,000		156,000		0		0		2,000			198,000		98,000		156,000		0		0
Consumer Assets			28,000		12,000		12,000		13,000		23,000			25,000		28,000		12,000		12,000		13,000
			126,000		168,000		12,000		13,000		25,000			223,000		126,000		168,000		12,000		13,000

Total		$	3,212,000	$	3,469,000	$	2,284,000	$	2,644,000	$	3,505,000		$	4,141,000	$	3,212,000	$	3,469,000	$	2,284,000	$	2,644,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

6/30/20

3/31/20

12/31/19

9/30/19

6/30/19

Residential Real Estate:

Land Development
$ 0 $ 0 $ 0 $ 0 $ 0
Construction
0 0 0 0 0
Owner Occupied / Rental
198,000 271,000 260,000 186,000 446,000
198,000 271,000 260,000 186,000 446,000

Commercial Real Estate:

Land Development
0 0 0 0 0
Construction
0 0 0 0 0
Owner Occupied
0 0 192,000 57,000 0
Non-Owner Occupied
0 0 0 0 0
0 0 192,000 57,000 0

Non-Real Estate:

Commercial Assets
0 0 0 0 0
Consumer Assets
0 0 0 0 0
0 0 0 0 0

Total
$ 198,000 $ 271,000 $ 452,000 $ 243,000 $ 446,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

	9/30/20		6/30/20		3/31/20		12/31/19		9/30/19
Residential Real Estate:
Land Development	$	0	$	0	$	0	$	0	$	0
Construction		0		0		0		0		0
Owner Occupied / Rental		198,000		198,000		271,000		260,000		186,000
		198,000		198,000		271,000		260,000		186,000

Commercial Real Estate:
Land Development		0		0		0		0		0
Construction		0		0		0		0		0
Owner Occupied		314,000		0		0		192,000		57,000
Non-Owner Occupied		0		0		0		0		0
		314,000		0		0		192,000		57,000

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

Total	$	512,000	$	198,000	$	271,000	$	452,000	$	243,000

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The following tables provide a reconciliation of nonperforming assets:

NONPERFORMING LOANS RECONCILIATION	NONPERFORMING LOANS RECONCILIATION																NONPERFORMING LOANS RECONCILIATION

		2nd Qtr			1st Qtr			4th Qtr			3rd Qtr			2nd Qtr				3rd Qtr			2nd Qtr			1st Qtr			4th Qtr			3rd Qtr
		2020			2020			2019			2019			2019				2020			2020			2020			2019			2019

Beginning balance		$	3,469,000		$	2,284,000		$	2,644,000		$	3,505,000		$	4,138,000			$	3,212,000		$	3,469,000		$	2,284,000		$	2,644,000		$	3,505,000
Additions, net of transfers to ORE			220,000			1,302,000			(80,000	)		338,000			(85,000	)			1,301,000			220,000			1,302,000			(80,000	)		338,000
Returns to performing status			(26,000	)		(7,000	)		0			(126,000	)		0				(72,000	)		(26,000	)		(7,000	)		0			(126,000	)
Principal payments			(278,000	)		(110,000	)		(232,000	)		(1,014,000	)		(512,000	)			(249,000	)		(278,000	)		(110,000	)		(232,000	)		(1,014,000	)
Loan charge-offs			(173,000	)		0			(48,000	)		(59,000	)		(36,000	)			(51,000	)		(173,000	)		0			(48,000	)		(59,000	)

Total		$	3,212,000		$	3,469,000		$	2,284,000		$	2,644,000		$	3,505,000			$	4,141,000		$	3,212,000		$	3,469,000		$	2,284,000		$	2,644,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

2nd Qtr

1st Qtr

4th Qtr

3rd Qtr

2nd Qtr

2020

2020

2019

2019

2019

Beginning balance
$ 271,000 $ 452,000 $ 243,000 $ 446,000 $ 396,000
Additions
0 11,000 245,000 57,000 145,000
Sale proceeds
(49,000
)
(192,000
)
(36,000
)
(252,000
)
(74,000
)
Valuation write-downs
(24,000
)
0 0 (8,000
)
(21,000
)

Total
$ 198,000 $ 271,000 $ 452,000 $ 243,000 $ 446,000

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

	3rd Qtr		2nd Qtr			1st Qtr			4th Qtr			3rd Qtr
	2020		2020			2020			2019			2019

Beginning balance	$	198,000	$	271,000		$	452,000		$	243,000		$	446,000
Additions		314,000		0			11,000			245,000			57,000
Sale proceeds		0		(49,000	)		(192,000	)		(36,000	)		(252,000	)
Valuation write-downs		0		(24,000	)		0			0			(8,000	)

Total	$	512,000	$	198,000		$	271,000		$	452,000		$	243,000

Gross loan charge-offs equaled ~~$0.3~~$0.1 million during the ~~second~~third quarter of 2020, and totaled ~~$0.4~~$0.5 million for the first ~~six~~nine months of the year, while recoveries of prior period loan charge-offs equaled ~~$0.2~~$0.3 million and ~~$0.4~~$0.6 million during the respective time periods. Net loan ~~charge-offs,~~recoveries, as a percentage of average total loans, equaled an annualized 0.02% and 0.01% during the ~~second~~third quarter of ~~2020. A nominal net loan recovery was recorded during the~~2020 and first ~~six~~nine months of ~~2020.~~2020, respectively. We continue our collection efforts on charged-off loans, and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. The allowance equaled ~~$32.2~~$35.6 million, or ~~1.16%~~1.27% of total loans (excluding PPP loans), and over ~~1,000%~~eight times the level of nonperforming loans as of ~~June~~September 30, 2020.

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

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

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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 commercial loans. Our migration analysis takes into account various time periods, with most weight placed on the time frame from December 31, 2010 through ~~June~~September 30, 2020. We believe this time period represents an appropriate range of economic conditions, and that it provides for an appropriate basis in determining reserve allocation factors given current economic conditions and the general consensus of economic conditions in the near future. We are actively monitoring our loan portfolio and assessing reserve allocation factors in light of the Coronavirus Pandemic and its impact on the U.S. economic environment and our customers in particular.

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

During the third quarter of 2020, we completed a wide-ranging review of risk ratings assigned to many commercial loan relationships, resulting in downgrades on 159 of the reviewed relationships (eight of which were moved to our watch list) and an increase to the allowance level of about $3.0 million. During the second quarter of 2020, we changed the impact rating of the economic and business conditions environmental factor from moderate to high due to the ongoing and expected stressed economic environment resulting from the Coronavirus Pandemic. This modification impacted all loan portfolio segments, adding almost $4.0 million to the required reserve level. During the first quarter of 2020, we changed the trend rating on the economic and business conditions environmental factor from slightly deteriorating to severely deteriorating due to the initial and expected stressed economic environment resulting from the Coronavirus Pandemic. This modification impacted all loan portfolio segments, adding approximately $4.0 million to the required allowance during the quarter. Also during the first quarter of 2020, we improved the trend rating on the lending policies environmental factor from slightly deteriorating to relatively stable to reflect the duration since the Firstbank merger in 2014 and recent loan policy enhancements. This modification impacted all loan portfolio segments, subtracting $2.6 million from the required allowance level. We also, during the first quarter of 2020, improved the trend rating on the changes in the experience, ability and depth of lending management and staff environmental factor from slightly deteriorating to relatively stable to reflect the duration since personnel changes were made as part of the Firstbank merger and personnel changes necessitated by the retirement of our former CEO two years ago. This modification impacted the commercial loan portfolio segment, subtracting $1.7 million from the required allowance.

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During the second quarter of 2020, we also established a COVID-19 pandemic environmental factor to address the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio. The creation of this factor reflects our belief that the traditional nine qualitative factors did not sufficiently capture and address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic, which include unprecedented federal government stimulus and interventions, statewide mandatory closures of nonessential businesses and periodic changes to such and our ability to provide payment deferral programs to commercial and retail borrowers without the interjection of troubled debt restructuring accounting rules. We review a myriad of items when assessing this new environmental factor, including virus infection rates, economic outlooks, unemployment, business closures, foreclosures, payment deferments and government-sponsored stimulus programs. Impacting all loan portfolio segments, the establishment of the COVID-19 pandemic environmental factor added almost $4.0 million to the required reserve level.

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

As of ~~June~~September 30, 2020, the allowance was comprised of ~~$30.7~~$34.7 million in general reserves relating to non-impaired loans, ~~$0.1~~$0.4 million in specific reserve allocations relating to nonaccrual loans, and ~~$1.4~~$0.5 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. Troubled debt restructurings totaled ~~$16.5~~$12.6 million at ~~June~~September 30, 2020, consisting of ~~$0.5~~$1.1 million that are on nonaccrual status and ~~$16.0~~$11.5 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 ~~$1.3~~$1.2 million as of ~~June~~September 30, 2020 had been subject to previous partial charge-offs aggregating ~~$1.3~~$1.2 million. Those partial charge-offs were recorded as follows: $0.3 million in 2011, and $0.1 million in ~~2020, 2019, 2018, 2017, $0.2 million in 2016, $0.1 million in 2015, 2014, 2013 and~~the years 2012 ~~and $0.3 million in 2011.~~through 2020. As of ~~June~~September 30, 2020, there were no specific reserves allocated to impaired loans that had been subject to a previous partial charge-off.

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

	6/30/20		3/31/20		12/31/19		9/30/19		6/30/19		9/30/20		6/30/20		3/31/20		12/31/19		9/30/19

Performing	$	16,018,000	$	17,975,000	$	11,788,000	$	28,102,000	$	28,129,000	$	11,522,000	$	16,018,000	$	17,975,000	$	11,788,000	$	28,102,000
Nonperforming		521,000		466,000		353,000		225,000		877,000		1,113,000		521,000		466,000		353,000		225,000

Total	$	16,539,000	$	18,441,000	$	12,141,000	$	28,327,000	$	29,006,000	$	12,635,000	$	16,539,000	$	18,441,000	$	12,141,000	$	28,327,000

Although we believe the allowance is adequate to absorb loan losses in our originated loan portfolio as they arise, there can be no assurance, especially given the current uncertainties related to the Coronavirus Pandemic and its impact on the U.S. economic environment, that we will not sustain loan losses in any given period that could be substantial in relation to, or greater than, the size of the allowance. Further, our analysis does not utilize the CECL model for the measurement of credit losses. For more information on CECL, please refer to Note 1 – “Significant Accounting Policies” in the Notes to Consolidated Financial Statements and to the risk factor titled “We have elected to postpone adoption of the CECL methodology…” under the heading “Risk Factors” in Part II, Item 1A of our Quarterly Report on Form 10-Q dated March 31, 2020.

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Securities available for sale ~~increased $27.0~~decreased $22.2 million during the first ~~six~~nine months of 2020, totaling ~~$308~~$312 million as of ~~June~~September 30, 2020. Purchases during the first ~~six~~nine months of 2020, consisting of U.S. Government agency bonds ($~~176~~253 million) and municipal bonds ($~~13.3~~16.8 million), totaled ~~$189~~$270 million. Proceeds from matured and called U.S. Government agency bonds and municipal bonds during the first ~~six~~nine months of 2020 totaled ~~$202~~$271 million and ~~$12.2~~$12.5 million, respectively, with another ~~$7.0~~$13.8 million from principal paydowns on mortgage-backed securities. At ~~June~~September 30, 2020, the portfolio was primarily comprised of U.S. Government agency bonds ~~(53%~~(55%), municipal bonds ~~(35%~~(36%) and U.S. Government agency issued or guaranteed mortgage-backed securities ~~(12%~~(9%). All of our securities are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at ~~June~~September 30, 2020 totaled ~~$308~~$312 million, including a net unrealized gain of ~~$7.7~~$7.0 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 2020 to generally consist of U.S. Government agency bonds and municipal bonds, with the securities portfolio maintained at about 10% of total assets.

FHLBI stock totaled $18.0 million as of ~~June~~September 30, 2020, unchanged from the balance at December 31, 2019. Our investment in FHLBI stock is necessary to engage in their advance and other financing programs. We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.

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

Interest-earning deposit balances, primarily consisting of excess funds deposited at the Federal Reserve Bank of Chicago and a correspondent bank, are used to manage daily liquidity needs and interest rate sensitivity. During the first ~~six~~nine months of 2020, the average balance of these funds equaled ~~$203~~$288 million, or ~~5.6%~~7.6% of average earning assets, compared to a more-typical ~~$81.3~~$93.8 million, or ~~2.5%~~2.8% of average earning assets, during the first ~~six~~nine months of 2019. The higher level during 2020 over 2019 largely reflects increased local deposit balances, primarily a product of federal government stimulus programs as well as lower business and consumer investing and spending. We expect the level of interest-earning deposit balances to remain elevated through the remainder of 2020 and into 2021 given the conditions associated with the Coronavirus Pandemic.

Net premises and equipment equaled ~~$59.2~~$60.4 million at ~~June~~September 30, 2020, an increase of ~~$1.8~~$3.1 million during the first ~~six~~nine months of 2020. The increase was primarily attributable to net purchases of ~~$4.4~~$7.2 million, in large part associated with a new regional banking center in Mt. Pleasant, Michigan. Depreciation expense totaled ~~$2.5~~$3.8 million during the first ~~six~~nine months of 2020. Foreclosed and repossessed assets equaled ~~$0.2~~$0.5 million as of ~~June 30,~~September, 2020, ~~compared to $0.5 million as of~~unchanged from December 31, 2019.

Total deposits increased ~~$572~~$682 million during the first ~~six~~nine months of 2020, totaling ~~$3.26~~$3.37 billion at ~~June~~September 30, 2020. Local deposits increased ~~$629~~$749 million, while out-of-area deposits decreased ~~$56.8~~$67.5 million during the first ~~six~~nine months of 2020. As a percentage of total deposits, out-of-area deposits equaled ~~2.4%~~2.0% as of ~~June~~September 30, 2020, compared to 5.0% as of December 31, 2019. Noninterest-bearing checking accounts increased ~~$521~~$525 million during the first ~~six~~nine months of 2020, while interest-bearing checking accounts and money market deposit accounts grew ~~$50.1~~$108 million and ~~$32.6~~$65.7 million, respectively, during the same time period. The increases in these transactional deposit products largely reflect federal government stimulus, especially the PPP, as well as lower business investing and spending. Savings deposits were up ~~$32.6~~$48.8 million, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending. Local time deposits ~~decreased $7.3~~increased $2.1 million during the first ~~six~~nine months of 2020, primarily reflecting new time deposits from several municipal deposit customers, which more than offset the ~~maturity~~maturities of certain time deposits that were not renewed as we did not aggressively seek to renew these time deposits which were opened as part of a special time deposit campaign we ran during February, March and early April of ~~2019, that was not fully mitigated by new time deposits from one municipal deposit customer.~~2019. The reduction in out-of-area deposits during the first ~~six~~nine months of 2020 reflects maturities during the period that were not replaced as the funds were no longer needed.

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Sweep accounts increased ~~$64.9~~$54.3 million during the first ~~six~~nine months of 2020, totaling ~~$168~~$157 million as of ~~June~~September 30, 2020. 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 ~~balance at June 30, 2020 was the maximum~~average balance during the first ~~six~~nine months of 2020 ~~compared to an average balance of $123 million during the period.~~was $129 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 $40.0 million during the first ~~six~~nine months of 2020, reflecting new advances obtained primarily to replace maturities and manage interest rate risk. As of ~~June~~September 30, 2020, FHLBI advances totaled $394 million. In June 2020, we executed a blend and extend transaction with the FHLBI to extend the duration of the FHLBI advance portfolio as part our interest rate risk management program. We prepaid seven advances aggregating $70.0 million with maturities ranging from August 2020 through October 2021 and fixed interest rates from 1.36% to 2.84% and averaging 1.97%, using the proceeds from seven new advances aggregating $70.0 million with maturities ranging from June 2024 through June 2027 and fixed interest rates from 0.55% to 1.18% and averaging 0.84%. Prepayment fees totaling $0.9 million were embedded into the fixed rates on the newly obtained advances, equating to 0.22% of the 0.84% average rate of the new advances. 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 ~~June~~September 30, 2020 totaled ~~$775~~$737 million, with remaining availability based on collateral of ~~$375~~$337 million.

Shareholders’ equity was ~~$425~~$432 million at ~~June~~September 30, 2020, compared to $417 million at December 31, 2019. The ~~$8.7~~$15.3 million increase during the first ~~six~~nine months of 2020 primarily reflects the positive impact of net income totaling ~~$19.4~~$30.1 million, compared to the negative impact of cash dividends and common stock repurchases totaling ~~$9.0~~$13.4 million and $6.3 million, respectively. Reflecting a decline in market interest rates, the change in net unrealized holding gain/loss on securities available for sale, net of tax effect, had a ~~$2.4~~$1.9 million positive impact on shareholders’ equity during the first ~~six~~nine months of 2020.

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 ~~$471~~$460 million, or ~~12.3%~~11.7% of combined deposits and borrowed funds, as of ~~June~~September 30, 2020, compared to $487 million, or 15.5% of combined deposits and borrowed funds, as of December 31, 2019.

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Information regarding our repurchase agreements as of ~~June~~September 30, 2020 and during the first ~~six~~nine months of 2020 is as follows:

Outstanding balance at June 30, 2020
$ 167,527,000
Weighted average interest rate at June 30, 2020
0.10
%
Maximum daily balance six months ended June 30, 2020
$ 167,527,000
Average daily balance for six months ended June 30, 2020
$ 123,486,000
Weighted average interest rate for six months ended June 30, 2020
0.13
%

Outstanding balance at September 30, 2020	$	157,017,000
Weighted average interest rate at September 30, 2020		0.11	%
Maximum daily balance nine months ended September 30, 2020	$	173,142,000
Average daily balance for nine months ended September 30, 2020	$	129,091,000
Weighted average interest rate for nine months ended September 30, 2020		0.12	%

We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. We did not access the lines of credit during the first ~~six~~nine months of 2020. Conversely, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged ~~$175~~$257 million during the first ~~six~~nine months of 2020. 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 ~~$33.3~~$35.6 million as of ~~June~~September 30, 2020. We did not utilize this line of credit during the first ~~six~~nine months of 2020 or at any time during the previous eleven fiscal years, and do not plan to access this line of credit in future periods.

The following table reflects, as of ~~June~~September 30, 2020, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

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

Deposits without a stated maturity	$	2,671,952,000	$	0	$	0	$	0	$	2,671,952,000	$	2,783,013,000	$	0	$	0	$	0	$	2,783,013,000
Time deposits		348,542,000		207,563,000		34,223,000		0		590,328,000		336,947,000		197,768,000		54,306,000		0		589,021,000
Short-term borrowings		167,527,000		0		0		0		167,527,000		157,017,000		0		0		0		157,017,000
Federal Home Loan Bank advances		0		154,000,000		160,000,000		80,000,000		394,000,000		0		164,000,000		150,00,000		80,000,000		394,000,000
Subordinated debentures		0		0		0		47,222,000		47,222,000		0		0		0		47,392,000		47,392,000
Other borrowed money		0		0		0		2,550,000		2,550,000		0		0		0		2,483,000		2,483,000
Property leases		658,000		1,153,000		747,000		1,221,000		3,779,000		632,000		1,151,000		619,000		1,208,000		3,610,000

In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of ~~June~~September 30, 2020, we had a total of ~~$1.19~~$1.34 billion in unfunded loan commitments and ~~$21.4~~$20.0 million in unfunded standby letters of credit. Of the total unfunded loan commitments, ~~$1.01~~$1.11 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and ~~$176~~$232 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.

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

Capital Resources

As part of a $20 million common stock repurchase program announced in May 2019 and instituted in conjunction with the completion of our existing program that was introduced in January 2015 and later expanded in April 2016, we repurchased approximately 222,000 shares for $6.3 million, or a weighted average all-in cost per share of $28.25, during the first quarter of 2020. No shares were repurchased during the second ~~quarter~~or third quarters of 2020. During the period of January 2015 through March 2020, we repurchased approximately 1,612,000 shares for $38.9 million, or a weighted average all-in cost per share of $24.13, under the original and new programs on a combined basis. In March 2020, we elected to suspend stock repurchases to preserve capital for lending and other purposes while we assess the potential impacts of the Coronavirus Pandemic. We have the ability to reinstate the repurchase program as circumstances warrant. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made ~~during~~ in future periods under the authorized plan, which would also likely be funded from cash dividends paid to us from our bank.

We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Under the BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of ~~June~~September 30, 2020, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.

As of ~~June~~September 30, 2020, our bank’s total risk-based capital ratio was 13.5%, compared to 13.0% at December 31, 2019. Our bank’s total regulatory capital increased ~~$11.9~~$21.2 million during the first ~~six~~nine months of 2020, in large part reflecting the net impact of net income totaling ~~$22.3~~$34.4 million and cash dividends paid to us aggregating ~~$19.5~~$26.0 million. Our bank’s total risk-based capital ratio was also impacted by a ~~$38.4~~$21.2 million ~~decrease~~increase in total risk-weighted ~~assets, primarily resulting from a reduction in commercial line of credit balances.~~assets. As of ~~June~~September 30, 2020, our bank’s total regulatory capital equaled ~~$437~~$446 million, or ~~$113~~$116 million in excess of the 10.0% minimum which is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of ~~June~~September 30, 2020 and December 31, 2019 are disclosed in Note 11 of the Notes to Consolidated Financial Statements.

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Results of Operations

We recorded net income of ~~$8.7~~$10.7 million, or ~~$0.54~~$0.66 per basic and diluted share, for the ~~second~~third quarter of 2020, compared to net income of ~~$11.7~~$12.6 million, or ~~$0.71~~$0.77 per basic and diluted share, for the ~~second~~third quarter of 2019. We recorded net income of ~~$19.4~~$30.1 million, or ~~$1.19~~$1.85 per basic and diluted share, for the first ~~six~~nine months of 2020, compared to net income of ~~$23.5~~$36.1 million, or ~~$1.43~~$2.20 per basic and diluted share, for the first ~~six~~nine months of 2019.

Proceeds from a bank owned life insurance claim increased net income during the second quarter of 2019 by approximately $1.3 million, or $0.08 per diluted share. Excluding the impact of this transaction, diluted earnings per share decreased $0.09, or 14.3%, during the second quarter of 2020 compared to the prior-year second quarter. Proceeds from bank owned life insurance claims and a gain on the sale of a former branch facility increased net income during the first ~~six~~nine months of 2019 by approximately $3.1 million, or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased ~~$0.05,~~$0.16, or ~~4.0%~~8.0%, during the first ~~six~~nine months of 2020 compared to the respective prior-year period.

The lower levels of net income during the ~~second~~third quarter and first ~~six~~nine months of 2020 compared to the respective ~~prior-year~~2019 periods resulted from higher provision expense and noninterest expense and decreased net interest income, which more than offset increased noninterest income. The provision expense recorded during the first nine months of 2020 was mainly comprised of allocations related to changes in environmental factors in the first and second quarters and the downgrading of certain non-impaired commercial loan relationships in the third quarter. The loan loss reserve build during the ~~current-year~~ second quarter of 2020, which primarily reflected an allocation associated with a newly-created Coronavirus Pandemic environmental factor (“COVID-19 factor”) and an increased allocation related to an existing economic and business conditions environmental factor, was viewed as a precautionary measure to guard against any potential deterioration in the loan portfolio stemming from the Coronavirus Pandemic and associated weakened economic conditions. The higher levels of noninterest expense mainly reflected increased compensation, occupancy, furniture and equipment, and ~~data processing~~Federal Deposit Insurance Corporation (“FDIC”) insurance premium costs, and the declines in net interest income depicted lower yields on earning assets, which more than offset growth in earning assets. The improved noninterest income primarily reflected increased mortgage banking income.

Interest income during the ~~second~~third quarter of 2020 was ~~$37.2~~$35.6 million, a decrease of ~~$2.6~~$4.7 million, or ~~6.7%~~11.7%, from the ~~$39.8~~$40.3 million earned during the ~~second~~third quarter of 2019. The decrease resulted from a lower yield on average earning assets, which more than offset the impact of growth in average earning assets. The yield on average earning assets was ~~3.85%~~3.45% during the ~~second~~third quarter of 2020, compared to ~~4.85%~~4.73% during the ~~second~~third quarter of 2019. The decreased yield ~~on average earning assets~~ primarily resulted from a lower yield on loans, which declined from ~~5.18%~~5.06% during the ~~second~~third quarter of 2019 to ~~4.18%~~4.03% during the current-year ~~second~~third quarter. The decrease in loan yield was mainly due to a lower yield on commercial loans, which equaled ~~4.20%~~4.06% in the ~~second~~third quarter of 2020 compared to ~~5.27%~~5.15% in the prior-year ~~second~~third quarter. The lower yield primarily reflected reduced interest rates on variable-rate commercial loans resulting from the ~~Federal Open Market Committee (“FOMC”)~~FOMC significantly decreasing the targeted federal funds rate by a total of 225 basis points during the second half of 2019 and first three months of 2020.

~~The negative impact of the decreased yield on commercial loans was partially mitigated by an improved yield on securities, which equaled 3.37%~~A change in earning asset mix and 2.85% during the second quarters of 2020 and 2019, respectively. The increased yield on securities mainly reflected the recording of $0.9 million in accelerated discount accretion on called U.S. Government agency bonds as interest income during the second quarter of 2020. No accelerated discount accretion was recorded during the prior-year second quarter. As part of our interest rate risk management program, U.S. Government agency bonds are periodically purchased at discounts during rising interest rate environments; if these bonds are called during decreasing interest rate environments, the remaining unaccreted discount amounts are immediately recognized as interest income.

Aa decreased yield on interest-earning deposits ~~and a change in earning asset mix~~ also contributed to the lower yield on average earning assets in the current-year ~~second~~third quarter compared to the respective 2019 period. On average, lower-yielding interest-earning deposits represented 11.1% of earning assets during the third quarter of 2020, up from 3.5% during the third quarter of 2019, while higher-yielding loans represented 80.9% of earning assets during the current-year third quarter, down from 85.8% during the prior-year third quarter. The yield on interest-earning deposits was ~~0.15%~~0.12% during the ~~second~~third quarter of 2020, down from ~~2.38%~~2.15% during the ~~second~~third quarter of 2019, primarily reflecting the decreased interest rate environment. On average, lower-yielding interest-earning deposits represented 6.5% of earning assets during the second quarter of 2020, up from 2.9% during the second quarter of 2019, while higher-yielding loans represented 84.9% of earning assets during the current-year second quarter, down from 86.3% during the respective 2019 period. Average earning assets equaled ~~$3.88~~$4.10 billion during the current-year ~~second~~third quarter, up ~~$580~~$716 million, or ~~17.6%~~21.2%, from the level of ~~$3.30~~$3.38 billion during the ~~prior-year second quarter;~~respective 2019 period; average loans were up ~~$447~~$413 million, average interest-earning deposits were up ~~$157~~$339 million, and average securities were down ~~$23.9~~$35.7 million.

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Interest income during the first ~~six~~nine months of 2020 was ~~$75.1~~$111 million, a decrease of ~~$3.4~~$8.1 million, or ~~4.3%~~6.8%, from the ~~$78.5~~$119 million earned during the first ~~six~~nine months of 2019. The decrease resulted from a lower yield on average earning assets, which more than offset the impact of growth in average earning assets. The yield on average earning assets was ~~4.17%~~3.91% during the first ~~six~~nine months of 2020, compared to ~~4.87%~~4.82% during the respective 2019 period. The decreased yield ~~on average earning assets~~ primarily resulted from a lower yield on loans, which declined from ~~5.19%~~5.15% during the first ~~six~~nine months of 2019 to ~~4.42%~~4.28% during the first ~~six~~nine months of 2020. The ~~decrease~~decreased loan yield was mainly due to a lower yield on commercial loans, which equaled ~~4.46%~~4.32% in the first ~~six~~nine months of 2020 compared to ~~5.30%~~5.25% in the respective ~~2019~~prior-year period. The lower yield primarily reflected reduced interest rates on variable-rate commercial loans stemming from the previously-mentioned FOMC rate reductions.

The negative impact of the decreased yield on commercial loans was partially mitigated by an improved yield on securities, which equaled 4.06% and 2.83% during the first six months of 2020 and 2019, respectively. The increased yield on securities mainly reflected the recording of $2.7 million in accelerated discount accretion on called U.S. Government agency bonds as interest income during the first six months of 2020. No accelerated discount accretion was recorded during the respective 2019 period.

A change in earning asset mix and a decreased yield on interest-earning deposits also contributed to the lower yield on average earning assets during the first ~~six~~nine months of 2020 compared to the first ~~six~~nine months of 2019. On average, lower-yielding interest-earning deposits represented 7.6% of earning assets during the first nine months of 2020, up from 2.8% during the first nine months of 2019, while higher-yielding loans represented 83.5% of earning assets during the first nine months of 2020, down from 86.3% during the respective 2019 period. The yield on interest-earning deposits was ~~0.55%~~0.32% during the first ~~six~~nine months of 2020, down from ~~2.42%~~2.29% during the respective 2019 period, mainly reflecting the decreased interest rate environment. ~~On average, lower-yielding interest-earning deposits represented 5.6% of~~Average earning assets equaled $3.78 billion during the first ~~six~~nine months of 2020, up from 2.5% during the first six months of 2019, while higher-yielding loans represented 85.0% of earning assets during the first six months of 2020, down from 86.6% during the respective 2019 period. Average earning assets equaled $3.62 billion during the first six months of 2020, up $365$482 million, or ~~11.2%~~14.6%, from the level of ~~$3.26~~$3.30 billion during the first ~~six~~nine months of 2019; average loans were up ~~$260~~$311 million, average interest-earning deposits were up ~~$121~~$195 million, and average securities were down ~~$16.7~~$23.1 million.

The negative impacts of the decreased yields on commercial loans and interest-earning deposits and the change in earning asset mix were partially mitigated by an improved yield on securities, which equaled 3.47% and 2.89% during the first nine months of 2020 and 2019, respectively. The increased yield on securities mainly reflected the recording of $3.0 million in accelerated discount accretion on called U.S. Government agency bonds as interest income during the first nine months of 2020; accelerated discount accretion totaled $0.2 million during the first nine months of 2019.

Interest expense during the ~~second~~third quarter of 2020 was ~~$6.6~~$6.1 million, a decrease of ~~$2.1~~$2.6 million, or ~~24.2%~~30.1%, from the $8.7 million expensed during the ~~second~~third quarter of 2019. The decrease in interest expense is attributable to a lower weighted average cost of interest-bearing liabilities, which equaled ~~1.11%~~0.99% in the current-year ~~second~~third quarter compared to ~~1.55%~~1.52% in the prior-year ~~second~~third quarter. The decrease in the weighted average cost of interest-bearing liabilities mainly reflected lower costs of ~~non-time~~ deposit accounts and borrowed ~~funds, and time deposits.~~funds. The cost of interest-bearing non-time deposit accounts decreased from ~~0.65%~~0.61% during the ~~second~~third quarter of 2019 to 0.23% during the ~~second~~third quarter of 2020, primarily reflecting lower interest rates paid on money market accounts; the reduced interest rates mainly reflect the decreasing interest rate environment. The cost of borrowed funds decreased from ~~2.40%~~2.35% during the ~~second~~third quarter of 2019 to ~~1.91%~~1.78% during the current-year ~~second~~third quarter, mainly reflecting ~~a change in borrowing mix and~~ lower costs of FHLBI advances and subordinated ~~debentures and~~debentures. The cost of FHLBI ~~advances. Average lower-cost sweep accounts represented 23.7% and 20.2% of average total borrowings~~advances was 2.06% during the ~~second quarters~~third quarter of 2020, ~~and 2019, respectively, while average higher-cost FHLBI advances represented 64.9% and 70.5% of average total borrowings~~down from 2.40% during the ~~current-year second~~prior-year third quarter, primarily reflecting the declining interest rate environment and ~~prior-year second quarter, respectively.~~the impact of the aforementioned blend and extend transaction that was executed in June 2020. The cost of subordinated debentures was ~~5.10%~~4.08% during the ~~second~~third quarter of 2020, down from ~~6.94%~~6.56% during the respective 2019 period due to decreases in the 90-Day Libor Rate. The cost of time deposits declined from ~~2.31%~~2.34% during the ~~second~~third quarter of 2019 to ~~2.04%~~1.86% during the current-year ~~second~~third quarter due to lower interest rates paid on local time deposits, reflecting the ~~lower~~decreasing interest rate environment, and a change in composition, primarily reflecting a decrease in higher-cost brokered funds. A change in funding mix, consisting of an increase in average lower-cost interest-bearing non-time deposits and a decrease in average higher-cost time deposits as a percentage of average total interest-bearing liabilities, also contributed to the lower weighted average cost of interest-bearing liabilities during the ~~second~~third quarter of 2020 compared to the respective 2019 period. Average interest-bearing liabilities were ~~$2.38~~$2.45 billion during the ~~second~~third quarter of 2020, up ~~$125~~$176 million, or ~~5.5%~~7.8%, from the ~~$2.25~~$2.27 billion average during the ~~second~~third quarter of 2019.

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Interest expense during the first ~~six~~nine months of 2020 was ~~$14.2~~$20.3 million, a decrease of ~~$2.5~~$5.1 million, or ~~14.9%~~20.1%, from the ~~$16.7~~$25.4 million expensed during the first ~~six~~nine months of 2019. The decrease in interest expense is attributable to a lower weighted average cost of interest-bearing liabilities, which equaled ~~1.23%~~1.15% in the first ~~six~~nine months of 2020 compared to ~~1.51%~~1.52% in the respective 2019 period. The decrease in the weighted average cost of interest-bearing liabilities primarily reflected lower costs of ~~non-time~~ deposit accounts and borrowed ~~funds, and time deposits.~~funds. The cost of interest-bearing non-time deposit accounts decreased from ~~0.65%~~0.63% during the first ~~six~~nine months of 2019 to ~~0.34%~~0.30% during the first ~~six~~nine months of 2020, primarily reflecting lower interest rates paid on money market accounts; the reduced interest rates mainly reflect the decreasing interest rate environment. The cost of borrowed funds decreased from ~~2.41%~~2.39% during the first ~~six~~nine months of 2019 to ~~2.09%~~1.98% during the respective 2020 period, mainly reflecting a lower ~~cost~~costs of subordinated debentures and FHLBI advances, along with a change in borrowing mix. The cost of subordinated debentures was ~~5.50%~~5.02% during the first ~~six~~nine months of 2020, down from ~~7.02%~~6.86% during the respective 2019 period due to decreases in the 90-Day Libor Rate. The cost of FHLBI advances was 2.22% during the first nine months of 2020, down from 2.38% during the first nine months of 2019, primarily reflecting the declining interest rate environment and the impact of the previously-mentioned blend and extend transaction that was executed in June 2020. Average lower-cost sweep accounts represented ~~21.9%~~22.7% and ~~19.4%~~20.0% of average total borrowings during the first ~~six~~nine months of 2020 and 2019, respectively, while average higher-cost FHLBI advances represented 67.5% and ~~70.8%~~70.3% of average total borrowings during the respective time periods. The cost of time deposits declined from ~~2.24%~~2.27% during the first ~~six~~nine months of 2019 to ~~2.13%~~2.04% during the respective 2020 period due to lower rates paid on local time deposits, depicting the ~~lower~~decreasing interest rate environment, and a change in composition, mainly reflecting a ~~decrease~~decline in higher-cost brokered funds. A change in funding mix, consisting of an increase in average lower-cost interest-bearing non-time deposits and a decrease in average higher-cost time deposits as a percentage of average total interest-bearing liabilities, also contributed to the lower weighted average cost of interest-bearing liabilities during the first ~~six~~nine months of 2020 compared to the first ~~six~~nine months of 2019. Average interest-bearing liabilities were ~~$2.31~~$2.36 billion during the first ~~six~~nine months of 2020, up ~~$82.6~~$114 million, or ~~3.7%~~5.1%, from the ~~$2.23~~$2.24 billion average during the respective 2019 period.

Net interest income during the ~~second~~third quarter of 2020 was ~~$30.6~~$29.5 million, a decrease of ~~$0.5~~$2.1 million, or ~~1.8%~~6.6%, from the ~~$31.1~~$31.6 million earned during the ~~second~~third quarter of 2019. The decline in net interest income resulted from a decreased net interest margin, which more than offset the positive impact of an increase in average earning assets. The net interest margin decreased from ~~3.79%~~3.71% in the ~~second~~third quarter of 2019 to ~~3.17%~~2.86% in the current-year ~~second~~third quarter due to a lower yield on average earning assets, which more than offset a reduction in the cost of funds. The decreased yield on average earning assets primarily reflected lower interest rates on variable-rate commercial loans stemming from the aforementioned FOMC rate cuts, while the decreased cost of funds mainly reflected lower costs of ~~non-time~~ deposit accounts and borrowed funds, and time deposits. As previously mentioned, the recording of accelerated discount accretion on called U.S. Government agency bonds partially mitigated the negative impact of the decreased yield on commercial loans on the yield on average earning assets during the second quarter of 2020. The accelerated discount accretion recorded during the second quarter of 2020 positively impacted the net interest margin by ten basis points.funds.

Net interest income during the first ~~six~~nine months of 2020 was ~~$60.9~~$90.4 million, a decrease of ~~$0.9~~$3.0 million, or ~~1.4%~~3.2%, from the ~~$61.8~~$93.4 million earned during the first ~~six~~nine months of 2019. The decrease in net interest income resulted from a lower net interest margin, which more than offset the positive impact of an increase in average earning assets. The net interest margin decreased from ~~3.83%~~3.79% in the first ~~six~~nine months of 2019 to ~~3.38%~~3.19% in the respective 2020 period due to a lower yield on average earning assets, which more than offset a reduction in the cost of funds. The decreased yield on average earning assets primarily reflected lower interest rates on variable-rate commercial loans stemming from the previously-mentioned FOMC rate cuts, while the decreased cost of funds mainly reflected lower costs of ~~non-time~~ deposit accounts and borrowed ~~funds, and time deposits.~~funds. As previously mentioned, ~~the recording of~~ accelerated discount accretion on called U.S. Government agency bonds ~~partially mitigated the negative impact of the decreased yield on commercial loans on the yield on average earning assets~~totaling $3.0 million was recorded as interest income during the first ~~six~~nine months of 2020. The accelerated discount accretion ~~recorded during the first six months of 2020~~ positively impacted the net interest margin during the first nine months of 2020 by 1511 basis points.

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The following tables set forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflect the average yield on assets and average cost of liabilities for the ~~second~~third quarters and first ~~six~~nine months of 2020 and 2019. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. Tax-exempt securities interest income and yield for the ~~second~~third quarters and first ~~six~~nine months of 2020 and 2019 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%. Securities interest income was increased by $60,000 in the ~~second~~third quarter of both 2020 and 2019 and ~~$120,000~~$180,000 in the first ~~six~~nine months of both 2020 and 2019 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 2020 and 2019 periods.

	Quarters ended September 30,
	2 0 2 0								2 0 1 9
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	3,315,741		$	33,664		4.03	%	$	2,903,161		$	37,005		5.06	%
Investment securities		327,668			1,848		2.26			363,394			2,720		2.99
Other interest-earning assets		457,598			142		0.12			118,314			651		2.15
Total interest - earning assets		4,101,007			35,654		3.45			3,384,869			40,376		4.73

Allowance for loan losses		(33,580	)							(24,498	)
Other assets		279,197								261,797

Total assets	$	4,346,624							$	3,622,168


LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing deposits	$	1,863,302		$	3,466		0.74	%	$	1,741,562		$	5,573		1.27	%
Short-term borrowings		140,180			38		0.11			112,739			71		0.25
Federal Home Loan Bank advances		394,000			2,072		2.06			367,370			2,257		2.40
Other borrowings		49,814			509		4.00			49,482			810		6.41
Total interest-bearing liabilities		2,447,296			6,085		0.99			2,271,153			8,711		1.52

Noninterest-bearing deposits		1,454,887								930,851
Other liabilities		14,576								16,814
Shareholders’ equity		429,865								403,350

Total liabilities and shareholders’ equity	$	4,346,624							$	3,622,168

Net interest income				$	29,569							$	31,665

Net interest rate spread							2.46	%							3.21	%
Net interest spread on average assets							2.70	%							3.47	%
Net interest margin on earning assets							2.86	%							3.71	%

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	Nine months ended September 30,
	2 0 2 0								2 0 1 9
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	3,157,802		$	101,428		4.28	%	$	2,846,735		$	109,559		5.15	%
Investment securities		335,443			8,734		3.47			358,557			7,767		2.89
Other interest-earning assets		288,310			711		0.32			93,800			1,627		2.29
Total interest - earning assets		3,781,555			110,873		3.91			3,299,092			118,953		4.82

Allowance for loan losses		(27,963	)							(23,598	)
Other assets		270,583								256,347

Total assets	$	4,024,175							$	3,531,841


LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing deposits	$	1,785,391		$	11,808		0.88	%	$	1,710,120		$	15,906		1.24	%
Short-term borrowings		135,474			132		0.13			108,262			244		0.30
Federal Home Loan Bank advances		384,511			6,499		2.22			373,436			6,751		2.38
Other borrowings		49,744			1,857		4.90			49,375			2,506		6.69
Total interest-bearing liabilities		2,355,120			20,296		1.15			2,241,193			25,407		1.52

Noninterest-bearing deposits		1,228,729								886,536
Other liabilities		16,402								14,484
Shareholders’ equity		423,924								389,628

Total liabilities and shareholders’ equity	$	4,024,175							$	3,531,841

Net interest income				$	90,577							$	93,546

Net interest rate spread							2.76	%							3.30	%
Net interest spread on average assets							3.00	%							3.54	%
Net interest margin on earning assets							3.19	%							3.79	%

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Quarters ended June 30,

2 0 2 0

2 0 1 9

Average

Average

Average

Average

Balance

Interest

Rate

Balance

Interest

Rate

(dollars in thousands)

ASSETS

Loans
$ 3,294,883 $ 34,322 4.18 % $ 2,848,343 $ 36,765 5.18 %
Investment securities
333,843 2,809 3.37 357,718 2,545 2.85
Other interest-earning assets
251,833 93 0.15 94,616 569 2.38
Total interest - earning assets
3,880,559 37,224 3.85 3,300,677 39,879 4.85

Allowance for loan losses
(26,538
)
(23,549
)

Other assets
265,552 252,470

Total assets
$ 4,119,573 $ 3,529,598

LIABILITIES AND SHAREHOLDERS’ EQUITY

Interest-bearing deposits
$ 1,767,986 $ 3,700 0.84 % $ 1,719,433 $ 5,529 1.29 %
Short-term borrowings
163,339 55 0.14 107,423 68 0.26
Federal Home Loan Bank advances
394,000 2,214 2.22 374,000 2,261 2.39
Other borrowings
49,735 624 4.96 49,379 845 6.77
Total interest-bearing liabilities
2,375,060 6,593 1.11 2,250,235 8,703 1.55

Noninterest-bearing deposits
1,304,986 875,645
Other liabilities
17,297 14,586
Shareholders’ equity
422,230 389,132

Total liabilities and shareholders’ equity
$ 4,119,573 $ 3,529,598

Net interest income
$ 30,631 $ 31,176

Net interest rate spread
2.74 % 3.30 %
Net interest spread on average assets
2.98 % 3.54 %
Net interest margin on earning assets
3.17 % 3.79 %

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~~MERCANTILE BANK CORPORATION~~

Six months ended June 30,

2 0 2 0

2 0 1 9

Average

Average

Average

Average

Balance

Interest

Rate

Balance

Interest

Rate

(dollars in thousands)

ASSETS

Loans
$ 3,077,965 $ 67,764 4.42 % $ 2,818,055 $ 72,555 5.19 %
Investment securities
339,374 6,886 4.06 356,098 5,046 2.83
Other interest-earning assets
202,735 568 0.55 81,339 976 2.42
Total interest - earning assets
3,620,074 75,218 4.17 3,255,492 78,577 4.87

Allowance for loan losses
(25,124
)
(23,140
)

Other assets
266,229 253,577

Total assets
$ 3,861,179 $ 3,485,929

LIABILITIES AND SHAREHOLDERS’ EQUITY

Interest-bearing deposits
$ 1,746,008 $ 8,342 0.96 % $ 1,694,138 $ 10,334 1.23 %
Short-term borrowings
133,095 94 0.14 105,987 173 0.33
Federal Home Loan Bank advances
379,714 4,427 2.31 376,519 4,494 2.37
Other borrowings
49,709 1,348 5.36 49,321 1,695 6.84
Total interest-bearing liabilities
2,308,526 14,211 1.23 2,225,965 16,696 1.51

Noninterest-bearing deposits
1,114,406 864,011
Other liabilities
17,326 13,299
Shareholders’ equity
420,921 382,654

Total liabilities and shareholders’ equity
$ 3,861,179 $ 3,485,929

Net interest income
$ 61,007 $ 61,881

Net interest rate spread
2.94 % 3.36 %
Net interest spread on average assets
3.17 % 3.58 %
Net interest margin on earning assets
3.38 % 3.83 %

A loan loss provision expense of ~~$7.6~~$3.2 million was recorded during the ~~second~~third quarter of 2020, compared to ~~$0.9~~$0.7 million during the ~~second~~third quarter of 2019. A loan loss provision expense of ~~$8.4~~$11.6 million was recorded during the first ~~six~~nine months of 2020, compared to ~~$1.8~~$2.5 million during the first ~~six~~nine months of 2019. The provision expense recorded during the third quarter of 2020 ~~periods~~was primarily ~~reflected~~comprised of increased allocations associated with the downgrading of certain non-impaired commercial loan relationships. The provision expense recorded during the first nine months of 2020 mainly consisted of increased allocations related to changes in the existing economic and business conditions environmental factor during the first and second quarters and an allocation associated with ~~a newly-created Coronavirus Pandemic environmental~~the COVID-19 factor ~~(“COVID-19 factor”) and an~~during the second quarter, along with the increased ~~allocation related to~~allocations resulting from the ~~existing economic conditions environmental factor.~~aforementioned commercial loan downgrades. The COVID-19 factor was added to address the unique challenges and economic uncertainty resulting from the pandemic and its potential impact on the collectability of the loan portfolio. The provision expense recorded during the 2019 periods mainly reflected ongoing net loan growth.

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During the ~~second~~third quarter of 2020, loan charge-offs totaled ~~$0.3~~$0.1 million, while recoveries of ~~prior period~~prior-period loan charge-offs equaled ~~$0.1~~$0.2 million, providing for net loan ~~charge-offs~~recoveries of ~~$0.2~~$0.1 million, or an annualized 0.02% of average total loans. During the ~~second~~third quarter of 2019, loan charge-offs and recoveries of prior period loan charge-offs were both less than $0.1 million, providing for a nominal net loan recovery. During the first six months of 2020, loan charge-offs and recoveries of prior period loan charge-offs both approximated $0.4 million, providing for a nominal net loan recovery. During the first six months of 2019, loan charge-offs totaled ~~$0.3~~$0.5 million, while recoveries of ~~prior period~~prior-period loan charge-offs equaled $0.2 million, providing for net loan charge-offs of $0.3 million, or an annualized 0.05% of average total loans. During the first nine months of 2020, loan charge-offs totaled $0.5 million, while recoveries of prior-period loan charge-offs equaled $0.6 million, providing for net loan recoveries of $0.1 million, or an annualized 0.01% of average total loans. During the first nine months of 2019, loan charge-offs totaled $0.8 million, while recoveries of prior-period loan charge-offs equaled $0.4 million, providing for net loan charge-offs of $0.4 million, or an annualized 0.02% of average total loans. The allowance for loans, as a percentage of total loans, was ~~1.0%~~1.1% as of ~~June~~September 30, 2020, and 0.9% as of December 31, 2019, and ~~June~~September 30, 2019. Excluding PPP loans, the allowance for loans represented ~~1.2%~~1.3% of total loans as of ~~June~~September 30, 2020.

Noninterest income during the ~~second~~third quarter of 2020 was ~~$11.0~~$13.3 million, ~~compared to $6.3~~an increase of $6.6 million, ~~during~~or 99.3%, from the prior-year ~~second~~third quarter. Noninterest income during the second quarter of 2019 included a bank owned life insurance claim of $1.3 million. Excluding the impact of this transaction, noninterest income increased $5.9 million, or nearly 118%, during the current-year second quarter compared to the respective 2019 period. Noninterest income during the first ~~six~~nine months of 2020 was ~~$17.5~~$30.8 million, compared to ~~$13.0~~$19.6 million during the same time period in 2019. Noninterest income during the first ~~six~~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 ~~$7.7~~$14.4 million, or ~~79.2%~~87.3%, in the first ~~six~~nine months of 2020 compared to the respective 2019 period. The higher level of noninterest income in both 2020 periods primarily ~~reflected~~resulted from increased mortgage banking ~~income. The improved mortgage banking~~ income, ~~mainly reflected~~reflecting a significant increase in refinance activity spurred by a decrease in residential mortgage loan interest rates, a higher level of purchase activity, the continuing success of strategic initiatives that were implemented to increase market share, and an increase in the percentage of originated loans being sold. Service charges on accounts ~~declined in the current-year second quarter compared to the prior-year second quarter, primarily reflecting reduced transaction volume in business accounts,~~ and credit and debit card income, ~~was down in both 2020 periods compared to the respective 2019 periods, mainly depicting lower card usage. Both of these revenue streams~~which were negatively impacted by Coronavirus Pandemic-related events, including business shutdowns and stay-at-home ~~orders.~~

~~Noninterest expense totaled $23.2 million~~orders, rebounded during the third quarter of 2020 and surpassed the amounts recorded during the second quarter of 2020 in light of certain pandemic-related restrictions being lifted. Service charges on accounts during the third quarter of 2020 were slightly below the level recorded during the prior-year third quarter, while credit and debit card income during the current-year third quarter increased in comparison to the respective 2019 period. The levels of both of these revenue streams recorded during the first nine months of 2020 approximated the levels recorded during the first nine months of 2019. Growth in payroll processing fees also contributed to the higher levels of noninterest income in both 2020 periods.

Noninterest expense totaled $26.4 million during the third quarter of 2020, up ~~$1.1~~$4.4 million, or ~~5.1%~~20.0%, from the prior-year ~~second~~third quarter. Noninterest expense during the first ~~six~~nine months of 2020 was ~~$46.1~~$72.6 million, an increase of ~~$2.2~~$6.6 million, or ~~5.1%~~10.1%, from the ~~$43.9~~$66.0 million expensed during the first ~~six~~nine months of 2019. The higher level of expense in both periods primarily resulted from increased compensation costs, mainly reflecting higher residential mortgage loan originator commissions and associated ~~incentives.~~ incentives, along with employee merit pay increases. An increased bonus accrual, in large part reflecting a catch-up entry as no accruals were recorded during the first and second quarters of 2020 due to the weakened economic environment, also contributed to the higher level of compensation costs during the third quarter of 2020 compared to the prior-year third quarter.

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Higher occupancy and furniture costs, mainly reflecting increased depreciation expense associated with an expansion of our main office, ~~and~~ data processing costs, primarily depicting growth in transaction volume and new product offerings, and FDIC deposit insurance premiums, also contributed to the increased level of noninterest expense during both 2020 periods. FDIC deposit insurance premiums were up $0.5 million in both the third quarter and first nine months of 2020 compared to the respective 2019 periods as a result of deposit insurance credits being applied against regular assessments during the third quarter of 2019.

As part of a branch network efficiency plan, we announced in June 2020 that we are planning on closing three branches during the fourth quarter of 2020. As a result of these branch network efficiency actions, we recorded a pre-tax charge of approximately $0.3 million during the second quarter of 2020 for severance-related payments and expect to record approximately $1.5 million in valuation adjustment costs on the branch facilities during the fourth quarter of 2020. Annual pre-tax savings of approximately $0.7 million are anticipated as a result of these actions.

During the ~~second~~third quarter of 2020, we recorded income before federal income tax of ~~$10.7~~$13.2 million and a federal income tax expense of ~~$2.0~~$2.5 million. During the ~~second~~third quarter of 2019, we recorded income before federal income tax of ~~$14.5~~$15.6 million and a federal income tax expense of ~~$2.8~~$3.0 million. During the first ~~six~~nine months of 2020, we recorded income before federal income tax of ~~$23.9~~$37.1 million and a federal income tax expense of ~~$4.5~~$7.0 million. During the first ~~six~~nine months of 2019, we recorded income before federal income tax of ~~$29.0~~$44.6 million and a federal income tax expense of ~~$5.5~~$8.5 million. The decreased federal income tax expense in both 2020 periods resulted from lower levels of income before federal income tax. Our effective tax rate was 19.0% during ~~both~~ the ~~second~~third quarter and first ~~six~~nine months of 2020 and the respective 2019 periods.

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~~MERCANTILE BANK CORPORATION~~

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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.

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The following table depicts our GAP position as of ~~June~~September 30, 2020:

	Within			Three to			One to			After						Within			Three to			One to			After
	Three			Twelve			Five			Five						Three			Twelve			Five			Five
	Months			Months			Years			Years			Total			Months			Months			Years			Years			Total
Assets:
Commercial loans ⁽¹⁾	$	590,203,000		$	205,130,000		$	1,718,204,000		$	373,560,000		$	2,887,097,000		$	462,236,000		$	254,368,000		$	1,765,062,000		$	451,264,000		$	2,932,930,000
Residential real estate loans		13,462,000			19,389,000			156,892,000			237,082,000			426,825,000			12,624,000			18,580,000			155,553,000			213,485,000			400,242,000
Consumer loans		1,263,000			590,000			16,121,000			1,160,000			19,134,000			995,000			604,000			14,839,000			934,000			17,372,000
Securities ⁽²⁾		18,502,000			6,992,000			87,307,000			212,862,000			325,663,000			18,931,000			6,434,000			93,975,000			211,086,000			330,426,000
Other interest-earning assets		382,961,000			1,500,000			2,250,000			0			386,711,000			491,808,000			1,000,000			2,500,000			0			495,308,000
Allowance for loan losses		0			0			0			0			(32,246,000	)		0			0			0			0			(35,572,000	)
Other assets		0			0			0			0			301,195,000			0			0			0			0			279,904,000
Total assets		1,006,391,000			233,601,000			1,980,774,000			824,664,000		$	4,314,379,000			986,594,000			280,986,000			2,031,929,000			876,769,000		$	4,420,610,000

Liabilities:
Interest-bearing checking		382,522,000			0			0			0			382,522,000			439,925,000			0			0			0			439,925,000
Savings deposits		301,881,000			0			0			0			301,881,000			318,132,000			0			0			0			318,132,000
Money market accounts		541,929,000			0			0			0			541,929,000			575,077,000			0			0			0			575,077,000
Time deposits under $100,000		24,289,000			78,096,000			76,453,000			0			178,838,000			26,593,000			69,102,000			77,498,000			0			173,193,000
Time deposits $100,000 & over		66,001,000			180,157,000			165,332,000			0			411,490,000			70,146,000			171,107,000			174,575,000			0			415,828,000
Short-term borrowings		167,527,000			0			0			0			167,527,000			157,017,000			0			0			0			157,017,000
Federal Home Loan Bank advances		0			0			314,000,000			80,000,000			394,000,000			0			0			314,000,000			80,000,000			394,000,000
Other borrowed money		49,771,000			0			0			0			49,771,000			49,875,000			0			0			0			49,875,000
Noninterest-bearing checking		0			0			0			0			1,445,620,000			0			0			0			0			1,449,879,000
Other liabilities		0			0			0			0			15,580,000			0			0			0			0			15,784,000
Total liabilities		1,533,920,000			258,253,000			555,785,000			80,000,000			3,889,158,000			1,636,765,000			240,209,000			566,073,000			80,000,000			3,988,710,000
Shareholders' equity		0			0			0			0			425,221,000			0			0			0			0			431,900,000
Total liabilities & shareholders' equity		1,533,920,000			258,253,000			555,785,000			80,000,000		$	4,314,379,000			1,636,765,000			240,209,000			566,073,000			80,000,000		$	4,420,610,000

Net asset (liability) GAP	$	(527,529,000	)	$	(24,652,000	)	$	1,424,989,000		$	744,664,000					$	(650,171,000	)	$	40,777,000		$	1,465,856,000		$	796,769,000

Cumulative GAP	$	(527,529,000	)	$	(552,181,000	)	$	872,808,000		$	1,617,472,000					$	(650,171,000	)	$	(609,394,000	)	$	856,462,000		$	1,653,231,000

Percent of cumulative GAP to total assets		(12.2	%)		(12.8	%)		20.2	%		37.5	%					(14.7	)%		(13.8	)%		19.4	%		37.4	%

⁽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 average life calculations based upon prepayment trends as of ~~June~~September 30, 2020.

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.

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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 ~~June~~September 30, 2020, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 100 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 ~~$121~~$123 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of ~~June~~September 30, 2020. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.

Dollar Change

Percent Change

In Net

In Net

Interest Rate Scenario

Interest Income

Interest Income

Interest rates down 100 basis points
$ (710,000
)
(0.6 %)
Interest rates up 100 basis points
4,940,000 4.1
Interest rates up 200 basis points
9,440,000 7.8
Interest rates up 300 basis points
13,880,000 11.5

	Dollar Change			Percent Change
	In Net			In Net
Interest Rate Scenario	Interest Income			Interest Income

Interest rates down 100 basis points	$	(600,000	)		(0.5	%)
Interest rates up 100 basis points		4,740,000			3.9
Interest rates up 200 basis points		9,240,000			7.5
Interest rates up 300 basis points		13,700,000			11.2

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.

Item 4. Controls and Procedures

As of ~~June~~September 30, 2020, 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 ~~June~~September 30, 2020.

There have been no changes in our internal control over financial reporting during the quarter ended ~~June~~September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we may be involved in various legal proceedings that are incidental to our business. In our opinion, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate.

Item 1A. Risk Factors.

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, 2019 and our March 31, 2020 Form 10-Q.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

We made no unregistered sales of equity securities during the quarter ended ~~June~~September 30, 2020.

Issuer Purchases of Equity Securities

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 stock repurchase plan was instituted in conjunction with the completion of our existing repurchase program that was introduced in January 2015 and later expanded in April 2016. As reflected in the table below, no shares were repurchased during the ~~second~~third quarter of 2020. In light of the significant disruption caused by the Coronavirus Pandemic and the evolving nature of its impact on our business and the broader economy, we elected to temporarily cease stock repurchases beginning in late March 2020 in order to preserve capital for lending and other purposes. We have the ability to reinstate the buyback program as circumstances warrant.

Period

(a) Total
Number of
Shares
Purchased

(b) Average
Price Paid Per
Share

(c) Total Number
of
Shares Purchased
as
Part of Publicly
Announced Plans
or
Programs

(d) Maximum
Number
of Shares or
Approximate
Dollar
Value that May Yet
Be
Purchased Under
the
Plans or Programs

April 1 – 30
0 $
NA
$ 0 $ 10,135,000
May 1 – 31
0
NA
0 10,135,000
June 1 – 30
0
NA
0 10,135,000
Total
0 $
NA
$ 0 $ 10,135,000

Period	(a) Total Number of Shares Purchased		(b) Average Price Paid Per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number of Shares or Approximate Dollar Value that May Yet Be Purchased Under the Plans or Programs
July 1 – 31		0	$	NA	$	0	$	10,135,000
August 1 – 31		0		NA		0		10,135,000
September 1 – 30		0		NA		0		10,135,000
Total		0	$	NA	$	0	$	10,135,000

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

Not applicable.

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Item 6. Exhibits

Exhibit No.	EXHIBIT DESCRIPTION

3.1	Our Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2009

3.2	Our Amended and Restated Bylaws dated as of February 26, 2015 are incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed February 26, 2015

31	Rule 13a-14(a) Certifications

32.1	Section 1350 Chief Executive Officer Certification

32.2	Section 1350 Chief Financial Officer Certification

101	The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended ~~June~~September 30, 2020, formatted in Inline XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements

104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on ~~August 7,~~November 6, 2020.

	MERCANTILE BANK CORPORATION



	By:	/s/ Robert B. Kaminski, Jr.
	Robert B. Kaminski, Jr.
	President and Chief Executive Officer (Principal Executive Officer)



	By:	/s/ Charles E. Christmas
	Charles E. Christmas
	Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

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Outstanding balance at June 30, 2020	$	167,527,000
Weighted average interest rate at June 30, 2020		0.10	%
Maximum daily balance six months ended June 30, 2020	$	167,527,000
Average daily balance for six months ended June 30, 2020	$	123,486,000
Weighted average interest rate for six months ended June 30, 2020		0.13	%

	Quarters ended June 30,
	2 0 2 0								2 0 1 9
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	3,294,883		$	34,322		4.18	%	$	2,848,343		$	36,765		5.18	%
Investment securities		333,843			2,809		3.37			357,718			2,545		2.85
Other interest-earning assets		251,833			93		0.15			94,616			569		2.38
Total interest - earning assets		3,880,559			37,224		3.85			3,300,677			39,879		4.85

Allowance for loan losses		(26,538	)							(23,549	)
Other assets		265,552								252,470

Total assets	$	4,119,573							$	3,529,598


LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing deposits	$	1,767,986		$	3,700		0.84	%	$	1,719,433		$	5,529		1.29	%
Short-term borrowings		163,339			55		0.14			107,423			68		0.26
Federal Home Loan Bank advances		394,000			2,214		2.22			374,000			2,261		2.39
Other borrowings		49,735			624		4.96			49,379			845		6.77
Total interest-bearing liabilities		2,375,060			6,593		1.11			2,250,235			8,703		1.55

Noninterest-bearing deposits		1,304,986								875,645
Other liabilities		17,297								14,586
Shareholders’ equity		422,230								389,132

Total liabilities and shareholders’ equity	$	4,119,573							$	3,529,598

Net interest income				$	30,631							$	31,176

Net interest rate spread							2.74	%							3.30	%
Net interest spread on average assets							2.98	%							3.54	%
Net interest margin on earning assets							3.17	%							3.79	%

	Six months ended June 30,
	2 0 2 0								2 0 1 9
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
	(dollars in thousands)
ASSETS
Loans	$	3,077,965		$	67,764		4.42	%	$	2,818,055		$	72,555		5.19	%
Investment securities		339,374			6,886		4.06			356,098			5,046		2.83
Other interest-earning assets		202,735			568		0.55			81,339			976		2.42
Total interest - earning assets		3,620,074			75,218		4.17			3,255,492			78,577		4.87

Allowance for loan losses		(25,124	)							(23,140	)
Other assets		266,229								253,577

Total assets	$	3,861,179							$	3,485,929


LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing deposits	$	1,746,008		$	8,342		0.96	%	$	1,694,138		$	10,334		1.23	%
Short-term borrowings		133,095			94		0.14			105,987			173		0.33
Federal Home Loan Bank advances		379,714			4,427		2.31			376,519			4,494		2.37
Other borrowings		49,709			1,348		5.36			49,321			1,695		6.84
Total interest-bearing liabilities		2,308,526			14,211		1.23			2,225,965			16,696		1.51

Noninterest-bearing deposits		1,114,406								864,011
Other liabilities		17,326								13,299
Shareholders’ equity		420,921								382,654

Total liabilities and shareholders’ equity	$	3,861,179							$	3,485,929

Net interest income				$	61,007							$	61,881

Net interest rate spread							2.94	%							3.36	%
Net interest spread on average assets							3.17	%							3.58	%
Net interest margin on earning assets							3.38	%							3.83	%