MERCANTILE BANK CORP

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Management’s Discussion and Analysis included in this Annual Report is incorporated here by reference.

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MANAGEMENT**’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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FORWARD-LOOKING STATEMENTS

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

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Future Factors include, among others, adverse changes in interest rates and interest rate relationships; increasing rates of inflation and slower growth rates; significant declines in the value of commercial real estate; market volatility; demand for products and services; climate impacts; labor markets; the degree of competition by traditional and non-traditional financial services companies; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; potential cyber-attacks, information security breaches, and other criminal activities; litigation liabilities; governmental and regulatory policy changes; the outcomes of existing or future contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, and the failure to meet client expectations and other facts; changes in the national and local economies, and unstable political and economic environments; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2024. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.

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Discussions of 2022 items and year-to-year comparisons between 2023 and 2022 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

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CRITICAL ACCOUNTING ESTIMATES

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) is based on Mercantile Bank Corporation’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our critical accounting estimates are highly dependent upon subjective or complex judgments and assumptions, and changes in such may have a significant impact on the financial statements, just as actual results may differ. We have reviewed the application of our critical accounting estimates with the Audit Committee of our Board of Directors.

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Allowance For Credit Losses (“allowance”): The allowance is maintained at a level we believe is adequate to absorb estimated credit losses identified and expected in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on historical credit loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. While historical credit loss experience provides the basis for the estimation of expected credit losses, our qualitative model adjusts for risk factors that are not inherently considered in the quantitative modeling process, but are nonetheless relevant in assessing the expected credit losses within the loan portfolio. These adjustments may increase or decrease the estimate of expected credit losses based upon the assessed level of risk for each qualitative factor. The various risks that may be considered in making qualitative adjustments include, among other things, the impact of (i) changes in lending policies and procedures, (ii) changes in the nature and volume of the loan portfolio and in the terms of loans, (iii) changes in the experience, ability and depth of lending management and staff, (iv) changes in the volume and severity of past due loans, nonaccrual loans and adversely classified loans, (v) changes in the quality of the credit review function, (vi) changes in the value of underlying collateral dependent loans, (vii) existence and effect of any concentrations of credit and any changes in such, and (viii) effect of other factors such as competition and legal and regulatory requirements.

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Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Credit losses are charged against the allowance when we believe the uncollectibility of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. The allowance is increased through a provision charged to operating expense. Uncollectible loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.

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See Note 1 – Significant Accounting Policies in the Notes to our Consolidated Financial Statements in this Form 10-K for additional information on our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in the Notes to our Consolidated Financial Statements in this Form 10-K for further information regarding our loan portfolio and allowance.

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

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

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INTRODUCTION

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This Management’s Discussion and Analysis should be read in conjunction with the consolidated financial statements contained in this Annual Report. This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiaries, Mercantile Bank (“our bank”) and Mercantile Community Partners LLC ("MCP"), and Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank. Unless the text clearly suggests otherwise, references to “us,” “we,” “our,” or “the company” include Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.

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CLIMATE CHANGE

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The potential impact of climate changes on our operations and the needs of our customers remains uncertain. Scientists have proposed that the impacts of climate change could include changes in rainfall patterns, water shortages, changes to the water levels of lakes and other bodies of water, changing storm patterns and intensities, and changing temperature levels. These changes could be severe and vary by geographic location. Climate change may also affect the occurrence of certain natural events, the incidence and severity of which are inherently unpredictable, and may impact our borrowers or the value of our loan collateral.

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ENVIRONMENTAL, SOCIAL, AND GOVERNANCE MATTERS

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Our Sustainability Committee supports our ongoing commitment to environmental, health and safety, corporate social responsibility, corporate governance, sustainability, and other public policy matters relevant to our organization. The Sustainability Committee is a cross-functional management committee, with oversight from the Governance and Nominating Committee and the Board of Directors, that assists us in: (1) setting general strategies relating to ESG matters; (2) developing, implementing, and monitoring initiatives and policies based on those strategies; (3) recommending communications with employees, investors, and shareholders with respect to ESG matters; and (4) monitoring and assessing developments relating to, and improving our understanding of, ESG matters. The committee met three times during 2024. Highlights for 2024 included expanding the impact of Mercantile Community Partners LLC to facilitate low-income housing tax credits, the completion and posting of the 2024 Corporate Sustainability Report, hiring a fulltime Director of Enterprise Excellence at the end of 2024 to oversee all ongoing ESG and sustainability efforts, implementation of a sustainability reporting platform, increased support of first-time home buyers mortgage programs, and over 27,500 hours of volunteering in the community completed by employees. Our bank maintains a Clawback Policy; an Insider Trading Policy; Code of Ethics; Corporate Governance Guidelines; an Anti-Bribery and Anti-Corruption Policy; an Anti-Money Laundering, Bank Secrecy Act, Customer Identification and Due Diligence Programs Letter; Vendor and Supplier Code of Conduct; Environmental Policy; Human Rights Policy; and Supplier Diversity Program Policy; these policies are reviewed and approved by our Board of Directors at least annually and can be found on our website.

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FINANCIAL OVERVIEW

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We recorded net income of $79.6 million, or $4.93 per basic and diluted share, for 2024, compared with net income of $82.2 million, or $5.13 per basic and diluted share, for 2023. While noninterest income increased during 2024, net income was negatively impacted by expected lower net interest income and higher noninterest expenses.

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Commercial loans increased $292 million, or approximately 9%, during 2024. Multi-family and residential rental property loans were up $143 million, nonowner-occupied commercial real estate (“CRE”) loans grew $92.7 million, commercial and industrial loans increased $32.7 million, and owner-occupied CRE loans were up $31.2 million, while vacant land, land development, and residential construction loans decreased $7.8 million. As a percentage of total commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 54.9% at December 31, 2024, compared to 57.7% at year-end 2023. The new commercial loan pipeline remains strong, and at December 31, 2024, we had $245 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

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Residential mortgage loans decreased $9.8 million, or approximately 1%, during 2024. Residential mortgage loan originations totaled $485 million during 2024, compared to $386 million in 2023. Approximately 78% of the residential mortgage loans originated during 2024 were done so with the intent to sell, compared to about 53% in 2023. The increases in volume of loans originated and percentage of loans sold had a positive impact on mortgage banking income.

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The overall quality of our loan portfolio remains strong, with nonperforming loans equaling 0.12% of total loans as of December 31, 2024. Accruing loans past due 30 to 89 days remain low, with little foreclosed property activity throughout 2024. Loan charge-offs totaled $3.8 million during 2024, while recoveries of prior period loan charge-offs totaled $0.9 million, providing for net loan charge-offs of $2.9 million, or 0.06% of average total loans, for the year.

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Interest-earning deposits, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. The average balance of these funds equaled $237 million during 2024, compared to $107 million in 2023. The higher average balance primarily reflects an increase in deposits associated with our strategic initiative to lower the loan-to-deposit ratio.

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Total deposits increased $797 million during 2024, providing for a growth rate of approximately 20%. A majority of the growth was in money market and time deposit products. Federal Home Loan Bank of Indianapolis (“FHLBI”) advances declined $80.8 million during 2024. Wholesale funds, comprised of out-of-area deposits and FHLBI advances, totaled $537 million, or about 10% of total funds, as of December 31, 2024.

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Net interest income decreased $2.5 million during 2024 compared to 2023. Interest income was up $50.1 million, in large part reflecting $569 million of growth in average earning assets and a 34 basis point increase in the yield on average earning assets. Interest expense was up $52.6 million, primarily reflecting $699 million growth in average interest-bearing liabilities and a 91 basis point increase in the cost of interest-bearing liabilities.

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We recorded a credit loss provision expense of $7.4 million during 2024, compared to $7.7 million during 2023. The provision expense recorded during 2024 was generally necessitated by increased required reserve levels stemming from loan growth, slower residential mortgage loan prepayment speeds and specific allocations for two nonperforming nonreal-estate-related commercial loan relationships.

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Noninterest income increased $8.2 million during 2024 compared to 2023, primarily reflecting higher mortgage banking income and service charges on deposit accounts, the latter stemming from growth in treasury management fees. Growth in payroll service income and revenue associated with a private equity investment also benefited noninterest income during 2024, as well as benefit claims on bank owned life insurance policies.

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Noninterest expense increased $10.5 million during 2024 compared to 2023. Aggregate salary and benefit costs grew $9.1 million, primarily reflecting annual merit pay increases, market adjustments, higher bonus/incentive accruals and residential mortgage lender commissions, lower residential mortgage loan deferred salary costs and increased medical insurance expenses. Increased data processing costs were also recorded during 2024, largely reflecting higher transaction volumes and software support costs, along with the introduction of new treasury management products and services.

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FINANCIAL CONDITION

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Our total assets increased $699 million during 2024, and totaled $6.05 billion as of December 31, 2024. Total loans increased $297 million, securities available for sale were up $113 million and interest-earning deposits grew $276 million. Total deposits increased $797 million and shareholders’ equity grew $62.4 million, while securities sold under agreements to repurchase (“sweep accounts) decreased $108 million and FHLBI advances declined $80.8 million.

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Earning Assets

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Average earning assets equaled 94.4% of average total assets during both 2024 and 2023. The loan portfolio continued to comprise a majority of earning assets, followed by securities and interest-earning deposits. Average total loans equaled 82.9% of average earning assets during 2024, compared to 84.7% in 2023, while average securities and interest-earning deposits comprised 12.7% and 4.4% of average earning assets during 2024 and 13.1% and 2.2% of average earning assets during 2023, respectively.

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Our loan portfolio has historically been primarily comprised of commercial loans. Commercial loans increased $292 million, or approximately 9%, during 2024. Multi-family and residential rental property loans were up $143 million, nonowner-occupied CRE loans grew $92.7 million, commercial and industrial loans increased $32.7 million, and owner-occupied CRE loans were up $31.2 million, while vacant land, land development, and residential construction loans decreased $7.8 million. As a percentage of total commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 54.9% at December 31, 2024, compared to 57.7% at year-end 2023. We believe our commercial loan portfolio remains well diversified.

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As of December 31, 2024, availability on commercial construction and development loans that are in the construction phase totaled $245 million, with most of the 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 $296 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 additional opportunities they are currently discussing with existing borrowers and potential new customers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we established within our commercial loan portfolio. Usage of existing commercial lines of credit was relatively stable during 2024 at approximately 42%, a small increase from 2023 but similar to our historical average.

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Residential mortgage loans decreased $9.8 million, or approximately 1%, during 2024. Residential mortgage loan originations totaled $485 million during 2024, compared to $386 million in 2023. Approximately 78% of the residential mortgage loans originated during 2024 were done so with the intent to sell, compared to about 53% in 2023. In mid-2023, we altered our residential mortgage loan pricing strategy to encourage borrowers to select fixed rate residential loan products that we could sell rather than selecting adjustable rate residential mortgage loan products that we had to fund on our balance sheet. The strategy not only provided for less residential mortgage loans being funded on our balance sheet, but also resulted in higher mortgage banking income. The increased volume of loans originated also benefited mortgage banking income.

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

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The following table presents total loans outstanding as of December 31, 2024, according to scheduled repayments of principal on fixed rate loans and repricing frequency on variable rate loans. Floating rate commercial loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.

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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 items could occur quickly because of changing economic conditions or other factors. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on the internal loan watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on nonperforming loans, as well as on foreclosed and repossessed assets, are reviewed periodically. We 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.

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Nonperforming loans totaled $5.7 million, or 0.12% of total loans, as of December 31, 2024, compared to $3.4 million, or 0.08% of total loans, as of December 31, 2023. Accruing loans past due 30 to 89 days remain low, with little foreclosed property activity throughout 2024. The volume of nonperforming assets has remained under 0.3% of total assets since year-end 2015, and has averaged 0.1% over the past six years. Given the low level of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with what we believe are strong credit administration practices, we are pleased with the overall quality of the loan portfolio.