MERCANTILE BANK CORP (MBWM) FY 2024 MD&A

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

FORWARD-LOOKING STATEMENTS

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.

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.

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.

CRITICAL ACCOUNTING ESTIMATES

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.

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.

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.

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.

INTRODUCTION

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.

CLIMATE CHANGE

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.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE MATTERS

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

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.

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.

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.

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.

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.

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.

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.

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.

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.

FINANCIAL CONDITION

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

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.

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.

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.

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.

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.

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.

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.

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.  Loan charge-offs totaled $0.9 million during 2023, while recoveries of prior period loan charge-offs totaled $0.8 million, providing for net loan charge-offs of $0.1 million, or less than 0.01% of average total loans, for the year.  We continue our collection efforts on charged-off loans, and we 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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The following table reflects the composition of our allowance for credit losses, nonaccrual loans, and net charge-offs as of and for the year ended December 31, 2024.

The following table reflects the composition of our allowance for credit losses, nonaccrual loans, and net charge-offs as of and for the year ended December 31, 2023.

The following table reflects the composition of our allowance for loan losses, nonaccrual loans, and net charge-offs as of and for the year ended December 31, 2022.

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The following table depicts the ratio of our allowance to nonperforming loans:

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

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

The allowance equaled $54.5 million, or 1.18% of total loans, and over 900% of nonperforming loans, as of December 31, 2024.  The allowance was comprised of $52.3 million in general reserves relating to performing loans and $2.2 million in specific reserves on other loans, primarily nonperforming loans, at year-end 2024.  Loans with an aggregate carrying value of $1.1 million as of December 31, 2024 had been subject to previous partial charge-offs aggregating $4.0 million over the past several years, including $3.8 million during 2024.  As of December 31, 2024, there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.

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

Securities available for sale increased $113 million during 2024, totaling $730 million as of December 31, 2024.  Purchases of U.S. Government agency bonds during 2024 aggregated $143 million, while proceeds from matured U.S. Government agency bonds totaled $44.0 million.  There were no purchases of U.S. Government agency guaranteed mortgage-backed securities during 2024; principal paydowns on U.S. Government agency guaranteed mortgage-backed securities totaled $3.4 million.  Purchases of municipal bonds totaled $31.1 million during 2024; proceeds from matured municipal bonds totaled $14.4 million.  At December 31, 2024, the portfolio was primarily comprised of U.S. Government agency bonds (68%), municipal bonds (29%), and U.S. Government agency guaranteed mortgage-backed securities (3%).  All of our securities are currently designated as available for sale and are therefore stated at fair value. The fair value of securities designated as available for sale at December 31, 2024 totaled $730 million, including a net unrealized loss of $63.1 million.  The net unrealized loss equaled $63.9 million as of December 31, 2023.  After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that the unrealized losses were due to changing interest rate environments.  We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations.  In addition, the securities portfolio serves a primary interest rate risk management function.  We expect upcoming purchases to generally consist of U.S. Government agency and municipal bonds, with the securities portfolio maintained at about 12% to 15% of total assets.

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

FHLBI stock totaled $21.5 million as of December 31, 2024, unchanged from December 31, 2023.  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.

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The following table shows by class of maturities as of December 31, 2024 the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities:

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.

Non-Earning Assets

Cash and due from bank balances averaged 1.1% of total assets during 2024, similar to the average level during 2023, with no significant changes expected in future periods.  Net premises and equipment equaled $53.4 million at December 31, 2024, representing an increase of $2.5 million during 2024.  Aggregate investments in new and existing offices totaled $8.5 million, while depreciation expense aggregated $6.0 million.  We had no other real estate owned as of December 31, 2024.

Other assets equaled $148 million at December 31, 2024, reflecting an increase of $22.8 million from year-end 2023.  The growth is primarily associated with an aggregate $13.6 million increase in low-income housing and historical tax credit investments and a $7.0 million purchase of additional bank owned life insurance.

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Source of Funds

Total deposits increased $797 million, or over 20%, during 2024, and totaled $4.70 billion at December 31, 2024.  Local deposits increased $816 million, while out-of-area deposits declined $18.7 million, during 2024.  Sweep accounts decreased $108 million, and FHLBI advances declined $80.8 million.  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.

Money market, local time deposit and interest-bearing checking accounts increased $559 million, $178 million and $103 million, respectively, during 2024, largely reflecting growth in deposits from existing customers and initial deposits from new customers stemming from our strategic initiative to grow local deposits to lower the loan-to-deposit ratio.  Savings deposits declined $40.7 million, primarily reflecting transfers to higher-paying money market and time deposit products.  Noninterest-bearing checking accounts grew $16.9 million; however, that includes a business deposit of approximately $90 million made near the end of 2024 that was withdrawn in early 2025.  On an average basis, noninterest-bearing checking accounts declined $199 million during 2024 compared to 2023, largely reflecting transfers to higher-paying deposit accounts.

Uninsured deposits totaled approximately $2.5 billion, or about 54% of total deposits, as of December 31, 2024, compared to approximately $1.9 billion, or about 48% of total deposits, as of December 31, 2023.  The uninsured amounts are estimates based on the methodologies and assumptions we use for regulatory reporting requirements.  Our level of uninsured deposits, which has remained relatively stable as a percentage of total deposits, is generally higher than industry averages given our focus on commercial lending.

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

Sweep accounts declined $108 million during 2024, totaling $122 million as of December 31, 2024.  The aggregate balance of this funding type can be subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that several of the customers maintain.  In addition, we had one customer withdraw a large amount of funds near the end of 2024 that were returned in early 2025.  The average balance of sweep accounts equaled $225 million during 2024 with a high balance of $278 million and a low balance of $118 million.  Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements.  Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance.  All of our sweep accounts are accounted for as secured borrowings.

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FHLBI advances declined $80.8 million during 2024, totaling $387 million as of December 31, 2024.  Bullet advances aggregating $10.0 million were obtained during 2024, while bullet advance maturities aggregated $90.0 million.  Payments on amortizing advances totaled $0.8 million during 2024.  Bullet advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans.  Advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement.  Our borrowing line of credit at year-end 2024 totaled $1.0 billion, with remaining availability based on collateral of $634 million.

Shareholders’ equity increased $62.4 million during 2024, totaling $585 million as of December 31, 2024.  Positively impacting shareholders’ equity was net income of $79.6 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $22.5 million.  Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by a total of $4.6 million.  Positively impacting shareholders’ equity during 2024 was a $0.7 million decline in the after-tax net unrealized loss on available for sale securities.

RESULTS OF OPERATIONS

FOR THE YEARS ENDED December 31, 2024 and 2023

Summary

We recorded net income of $79.6 million, or $4.93 per basic and diluted share, for 2024, compared to net income of $82.2 million, or $5.13 per basic and diluted share, for 2023. Diluted earnings per share decreased $0.20, or 3.9%, during 2024 compared to 2023.

The decrease in net income during 2024 compared to 2023 reflected increased noninterest expense and lower net interest income, which more than offset higher noninterest income and a reduced provision for credit losses.  Noninterest expense was up in 2024 primarily due to increased salary and benefit and data processing costs.  Net interest income declined during 2024 as growth in earning assets, most notably in loans, and a higher yield on earning assets were more than offset by growth in interest-bearing liabilities and an increased cost of funds.  The provision expense recorded during 2024 and 2023 included allocations necessitated by net loan growth, slower residential mortgage loan prepayment rates and the associated extended average life of the portfolio, and changes in environmental factors.  Individual allocations created for two deteriorated commercial loan relationships also contributed to the provision expense recorded during 2024.  Noninterest income increased significantly during 2024, largely reflecting growth in mortgage banking income, treasury management fees, bank owned life insurance income, and payroll services fees, along with revenue associated with an investment in a private equity fund.

Net Interest Income

Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings.  Interest income (adjusted for tax-exempt income) and interest expense totaled $321 million and $130 million, respectively, during 2024, providing for net interest income of $191 million.  During 2023, interest income and interest expense equaled $272 million and $77.8 million, respectively, providing for net interest income of $194 million.  In comparing 2024 with 2023, interest income increased 18.5%, interest expense was up 67.6%, and net interest income decreased 1.3%.  The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types and levels of assets and liabilities, the interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact net interest income as well as the net interest margin.  The $2.5 million decline in net interest income in 2024 compared to 2023 resulted from a decreased net interest margin, which more than offset an increase in earning assets, particularly in loans.

During 2024, the net interest margin equaled 3.58%, down from 4.05% during 2023 due to a higher cost of funds, which more than offset an increase in the yield on average earning assets.  The cost of funds rose from 1.63% in 2023 to 2.44% in 2024 mainly due to higher costs of deposits and borrowed funds, largely reflecting the impact of a rising interest rate environment.  A change in funding mix, primarily consisting of a decrease in average noninterest-bearing and lower-cost deposits and an increase in average higher-cost money market accounts and time deposits, also contributed to the higher cost of funds.  The increases in money market accounts and time deposits stemmed from new deposit relationships, growth in existing deposit relationships, and deposit migration.  The yield on average earning assets was 6.02% during 2024, an increase from 5.68% during the prior year.  The higher yield primarily resulted from an increased yield on loans.  The yield on loans was 6.61% during 2024, up from 6.25% during 2023 mainly due to higher interest rates on variable-rate commercial loans stemming from the Federal Reserve’s Federal Open Market Committee (“FOMC”) raising the targeted federal funds rate in an effort to reduce elevated inflation levels and a significant level of commercial loans being originated over the past 24 months in the higher interest rate environment.  The FOMC increased the targeted federal funds rate by 100 basis points during the period of February 2023 through July 2023, during which time average variable-rate commercial loans represented approximately 65% of average total commercial loans.  The positive impact of the rate hikes was partially mitigated by the FOMC’s lowering of the targeted federal funds rate by 100 basis points during the last four months of 2024.  An improved yield on securities, reflecting the increased interest rate environment, also contributed to the enhanced yield on average earning assets.  During 2024, earning assets averaged $5.35 billion, up $569 million, or 11.9%, from $4.78 billion during 2023.  Average loans increased $386 million, average interest-earning deposits were up $131 million, and average securities grew $52.6 million.

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The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets, liabilities, and shareholders’ equity during 2024, 2023, and 2022.  The subsequent table portrays the dollar amount of change in interest income and interest expense of interest-earning assets and interest-bearing liabilities, respectively, segregated between change due to volume and change due to rate.  Tax-exempt securities interest income and yield for 2024, 2023, and 2022 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%. Securities interest income was increased by $0.2 million in 2024, 2023, and 2022 for this non-GAAP, but industry standard, adjustment. These adjustments equated to increases in our net interest margin of less than one basis point during all three years.

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Interest income, which is primarily generated from the loan portfolio, increased $50.1 million during 2024 from that earned in 2023, totaling $321 million in 2024 compared to $272 million in 2023.  The increase in interest income is attributable to growth in, and a higher yield on, average earning assets.  During 2024 and 2023, earning assets had an average yield (tax equivalent-adjusted basis) of 6.02% and 5.68%, respectively.  The improved yield on average earning assets primarily resulted from an increased yield on loans, mainly reflecting higher interest rates on variable-rate commercial loans stemming from the previously mentioned FOMC rate hikes.   An enhanced yield on securities, reflecting the increased interest rate environment, also contributed to the improved yield on average earning assets.

Interest income generated from the loan portfolio increased $40.1 million in 2024 compared to the level earned in 2023.  Growth in the loan portfolio during 2024 resulted in a $25.0 million increase in interest income, while an upturn in loan yield from 6.25% in 2023 to 6.61% in 2024 resulted in a $15.1 million increase in interest income.  The higher yield on loans primarily resulted from an improved yield on commercial loans, which increased from 6.84% during 2023 to 7.13% during 2024 mainly due to the aforementioned FOMC rate increases and a significant level of commercial loans being originated in the past 24 months in the higher interest rate environment.  An improved yield on residential mortgage loans, reflecting the increasing interest rate environment, also contributed to the higher yield on loans.

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Interest income generated from the securities portfolio increased $3.3 million in 2024 compared to the level earned in 2023.  A rise in the yield on securities from 2.06% during 2023 to 2.40% during 2024 resulted in a $2.2 million increase in interest income, while growth in the average balance of the securities portfolio during 2024 resulted in an increase in interest income of $1.1 million.  Reflecting a higher average balance, interest income on interest-earning deposits increased $6.8 million in 2024 from the level earned in 2023.  The growth in average securities and interest-earning deposits during 2024 compared to 2023 primarily reflected the success of our strategic initiatives to grow local deposits and decrease our loan-to-deposit ratio.

Interest expense is generated from interest-bearing deposits and borrowed funds.  Interest expense increased $52.6 million during 2024 from that expensed in 2023, totaling $130 million in 2024 compared to $77.8 million in 2023.  Growth in the average balance of interest-bearing liabilities during 2024 compared to 2023 resulted in a $27.9 million increase in interest expense, while a rise in the cost of these liabilities from 2.47% during 2023 to 3.38% during 2024 resulted in an increase in interest expense of $24.7 million.  During 2024, interest-bearing liabilities averaged $3.85 billion, representing an increase of $699 million, or 22.1%, from the $3.16 billion average during 2023; average interest-bearing deposits and borrowings were up $674 million and $24.7 million, respectively.  The higher average cost of interest-bearing liabilities mainly resulted from increased costs of deposit accounts.  An increased cost of borrowings, along with a change in interest-bearing liability mix, also contributed to the higher average cost of interest-bearing liabilities.  The cost of interest-bearing non-time deposit accounts increased from 1.94% during 2023 to 2.76% during 2024, primarily reflecting a change in mix, consisting of an increase in higher-paying money market accounts, and higher interest rates paid on business money market and checking accounts, reflecting the increased interest rate environment.  The cost of time deposits rose from 3.55% during 2023 to 4.72% during 2024 mainly due to higher rates paid on local time deposits, reflecting the increased interest rate environment.  The cost of borrowed funds increased from 2.90% during 2023 to 3.65% during 2024, primarily reflecting higher costs of sweep accounts and FHLBI advances stemming from the increased interest rate environment.  Average higher-cost money market accounts and time deposits represented an increased percentage of average interest-bearing liabilities during 2024 compared to 2023, with the growth in these deposits reflecting new deposit relationships, increases in existing deposit relationships, and deposit migration.

Growth in the average balance of interest-bearing non-time deposits during 2024 compared to 2023 resulted in a $14.6 million increase in interest expense, while a higher average rate paid on these deposits during 2024 equated to a $10.6 million increase in interest expense.  An increase in the average balance of time deposits during 2024 compared to 2023 resulted in a $12.8 million increase in interest expense, while a higher average rate paid on these deposits during 2024 resulted in an $8.0 million increase in interest expense.  A higher average rate paid on short-term borrowings during 2024 resulted in a $4.6 million increase in interest expense, while growth in the average balance of these borrowings equated to a $0.3 million increase in interest expense.  An increased average rate paid on FHLBI advances during 2024 resulted in a $1.5 million increase in interest expense, while growth in the average balance of advances resulted in a $0.2 million increase in interest expense.  The $0.1 million increase in interest expense on other borrowings resulted almost evenly from growth in, and a higher average rate paid on, these borrowings.

Provision for Credit Losses

Provisions for credit losses of $7.4 million and $7.7 million were recorded during 2024 and 2023, respectively.  The provision expense recorded during 2024 mainly reflected allocations necessitated by net loan growth, individual allocations made for two deteriorated commercial loan relationships, changes in qualitative factors, and an increased allocation stemming from slower prepayments speeds on residential mortgage loans, which were partially offset by lower loan loss rates.  The provision expense recorded during 2023 primarily reflected allocations necessitated by net loan growth, slower residential mortgage loan prepayment rates and the associated extended average life of the portfolio, and changes in environmental factors reflecting heightened inherent risk in the commercial construction loan portfolio. Sustained strength in loan quality metrics, including low levels of loan charge-offs, during 2024 and 2023 significantly mitigated the amount of additional reserves imposed by the previously mentioned factors. Economic forecasts were relatively stable during 2024 and 2023.

Noninterest Income

Noninterest income totaled $40.4 million during 2024, compared to $32.1 million during 2023.  Noninterest income during 2024 included bank owned life insurance death benefit claims and gains on the sales of other real estate owned totaling $0.7 million and $0.4, respectively, while noninterest income during 2023 included gains on the sales of other real estate owned totaling $0.4 million.  Excluding these transactions, noninterest income increased $7.5 million, or 23.8%, in 2024 compared to 2023.  The growth mainly reflected increases in mortgage banking income, treasury management fees, and payroll service fees, along with revenue generated from an investment in a private equity fund.  The higher level of mortgage banking income primarily resulted from increases in the percentage of loans originated with the intent to sell, which equaled approximately 78% in 2024 compared to approximately 53% in 2023, and total loan originations, which were up approximately 25% in 2024 compared to 2023.  The increase in treasury management fees in large part reflected customers’ expanded use of cash management products and services.  The growth in noninterest income related to these factors was partially offset by a decline in interest rate swap income mainly stemming from reduced borrower demand in light of shifting future interest rate expectations.  Credit and debit card income declined marginally in 2024 compared to 2023; when adjusting for the receipt of a one-time payment from our vendor in association with a contract renewal in 2023, credit and debit card income was up slightly in 2024.

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Noninterest Expense

Noninterest expense during 2024 was $126 million, compared to $115 million during 2023.  Overhead costs during 2024 included contributions to The Mercantile Bank Foundation (the “Foundation”) totaling $1.7 million, while overhead costs during 2023 included contributions to the Foundation, a write-down of a former branch facility, and one-time employee benefit and facility-related costs totaling $1.8 million.  Excluding these transactions, the increase in noninterest expense during 2024 primarily resulted from larger salary and benefit costs, reflecting annual merit pay increases, market adjustments, higher residential mortgage lender commissions and incentives, lower residential mortgage loan deferred salary costs, an increased bonus accrual and associated payroll taxes, higher health insurance claims, and increased 401(k) matching contributions.  The increase in residential mortgage lender commissions and incentives mainly stemmed from a higher level of loan production.  Increased data processing costs, primarily reflecting higher transaction volume and software support costs, also contributed to the rise in noninterest expense during 2024.  A reduced credit reserve for unfunded loan commitments, along with lower levels of interest rate swap credit reserves and collateral holding costs, core deposit intangible asset amortization expense, and occupancy costs, during 2024 partially mitigated the increases in overhead costs noted above.  The decrease in occupancy costs mainly reflected lower building rent stemming from branch-related efficiency initiatives.

Federal Income Tax Expense

During 2024, we recorded income before federal income tax of $98.3 million and a federal income tax expense of $18.7 million, compared to income before federal income tax of $103 million and a federal income tax expense of $20.5 million during 2023.  The $1.8 million decrease in federal income tax expense in 2024 compared to 2023 primarily resulted from the lower level of income before federal income tax.  We recorded net benefits from investments in tax credit structures of $0.2 million and $0.1 million during 2024 and 2023, respectively.  The aforementioned bank owned life insurance death benefit claims, substantially all of which were nontaxable, positively impacted the effective tax rate in 2024.

CAPITAL RESOURCES

Shareholders’ equity increased $62.4 million during 2024, totaling $585 million as of December 31, 2024.  Positively impacting shareholders’ equity was net income of $79.6 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $22.5 million.  Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by a total of $4.6 million.  Positively impacting shareholders’ equity during 2024 was a $0.7 million decline in the after-tax net unrealized loss on available for sale securities.

We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.  As of December 31, 2024, our bank’s total risk-based capital ratio was 13.9%, compared to 13.4% at December 31, 2023.  Our bank’s total regulatory capital increased $64.7 million during 2024, primarily reflecting the net impact of net income totaling $89.6 million and cash dividends paid to us aggregating $29.1 million.  Our bank’s total risk-based capital ratio was also impacted by a $272 million increase in total risk-weighted assets, in large part reflecting growth within the commercial lending function.  As of December 31, 2024, our bank’s total regulatory capital equaled $759 million, or approximately $214 million in excess of the amount necessary to attain the 10.0% minimum total risk-based capital ratio, which is among the requirements to be categorized as “well capitalized.”

We maintain a stock repurchase program, which is discussed in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in this Annual Report.

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LIQUIDITY

Liquidity is measured by our ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment of loans and securities.  These funds are used to fund loans, meet deposit withdrawals, and operate our company.  Liquidity is essential to our business.  An inability to maintain sufficient funds through deposits, borrowings, the sales of assets, and other sources could have a material adverse effect on our liquidity.  Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general.  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 the 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, comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $537 million, or 10.3% of combined deposits and borrowed funds as of December 31, 2024, compared to $636 million, or 13.8% of combined deposits and borrowed funds, as of December 31, 2023.

Sweep accounts declined $108 million during 2024, totaling $122 million as of December 31, 2024.  The aggregate balance of this funding type can be subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that several of the customers maintain.  In addition, we had one customer withdraw a large amount of funds near the end of 2024 that were returned in early 2025.  The average balance of sweep accounts equaled $225 million during 2024, with a high balance of $278 million and a low balance of $118 million.  Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements.  Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance.  All of our sweep accounts are accounted for as secured borrowings.

Information regarding our repurchase agreements as of December 31, 2024 and during 2024 is as follows:

FHLBI advances declined $80.8 million during 2024, totaling $387 million as of December 31, 2024.  Bullet advances aggregating $10.0 million were obtained during 2024, while bullet advance maturities aggregated $90.0 million.  Payments on amortizing advances totaled $0.8 million during 2024.  Bullet advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans.  Advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement.  Our borrowing line of credit at year-end 2024 totaled $1.0 billion, with remaining availability based on collateral of $634 million.

We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit; the average balance of these funds was less than $0.1 million during 2024.  In contrast, our interest-earning deposit account at the Federal Reserve Bank of Chicago averaged $221 million during 2024.  We have a line of credit through the Discount Window of the Federal Reserve Bank of Chicago.  Based on pledged municipal bonds, we could have borrowed up to $153 million at December 31, 2024.  We have not utilized this line of credit in over 15 years, and we do not plan to access this line of credit in future periods.

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The following table reflects, as of December 31, 2024, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

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.  At December 31, 2024, we had a total of $2.07 billion in unfunded loan commitments and $26.5 million in unfunded standby letters of credit.  Of the total unfunded loan commitments, $1.78 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $296 million were for loan commitments generally expected to be accepted 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 liquidity management.

The following table depicts our loan commitments at the end of the past three years:

We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, economic or market conditions, reductions 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.

MARKET RISK ANALYSIS

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and inflation 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.

Inflation risk is the risk that the values of assets or income from investments will be worth less in the future as inflation decreases the value of money.  During 2022 and 2023, there was a pronounced rise in inflation.  As a result, the FOMC significantly increased interest rates in an effort to combat inflation.  As inflation increased, the value of our investment securities, particularly those with fixed rates and longer maturities, declined.  In addition, inflation increased salary and benefit costs, as well as the costs of goods and services we use in our business operations, such as electricity and other utilities, which increased our noninterest expenses.  Furthermore, our customers were also affected by inflation and the rising costs of goods and services used in their households and businesses.

Inflationary pressures started to ease during 2024, prompting the FOMC to lower interest rates by an aggregate 100 basis points during the last four months of the year.  The lower interest rate environment positively impacted the value of our investment securities.  However, inflation levels remain above the FOMC’s stated goal and interest rates remain higher than they were prior to 2022.  Higher than traditional cost increases continue throughout the economy, but at lower levels than experienced in 2022 and 2023.

We derive our income primarily from the excess of interest collected on interest-earning assets over the interest paid on 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.

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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 controls 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 the net interest margin during periods of changing market interest rates.

The following table depicts our GAP position as of December 31, 2024:

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

Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest-sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain and 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 December 31, 2024, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 400 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $222 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of December 31, 2024. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.

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 interest-earning deposits 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.

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