Michigan-based regional bank Mercantile Bank (NASDAQ:MBWM) reported tepid fourth-quarter results, and forecast a tough competitive environment ahead.

For the quarter, net interest income, or the difference between what Mercantile earned on its assets minus what it paid on its liabilities, increased 2.2% to $15.3 million. Non-interest income fell to $1.4 million from $1.9 million a year ago, and net income increased 1% to $4.6 million. The lackluster results dragged down Mercantile's performance measures, with return on assets down 11 basis points from the year-ago period to 0.89%, return on equity down 98 basis points to 10.78%, and net interest margin down 35 basis points to 3.19%. On the bright side, Mercantile successfully shaved some costs -- partly because the poor results decreased bonus payments -- and cut its efficiency ratio 306 basis points to 49.15%.

Regional banking is a tough business nowadays. Because of a surplus of liquidity and the easy credit environment, banks are now competing fiercely for both deposits and loans, and the flat yield curve is squeezing their spread lending business on both sides. In other words, banks are competing fiercely by offering ever-higher interest rates on deposits and certificates of deposits (CDs) to get your business. However, banks are also lowering the rates on their loans, resulting in a squeeze on regional banking profitability.

Mercantile management believes that the tough environment will continue at least through the first half of 2007. They also noted that some competitors were pricing loans at absurdly low rates -- often favoring volume over profitability. Although management didn't name names, it mentioned that the culprits tended to be large banks. The top five banks in Michigan by deposit market share -- LaSalle Bank, Comerica (NYSE:CMA), JPMorgan Chase (NYSE:JPM), Fifth Third Bancorp (NYSE:FITB), and National City (NYSE:NCC) -- could be the perpetrators.

Mercantile is in an especially tough spot because it derives almost all of its income from spread lending vs. fee-based income, leaving it at the mercy of the shape of the yield curve. Mercantile's funding base should also get more expensive as its liabilities reprice at higher rates. It's hard to fault Mercantile's management for the lackluster results. They've worked to keep expenses low and credit quality high, with non-performing assets less than the industry average. In the end, though, it's hard to get excited about this regional bank.

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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. The Motley Fool has a disclosure policy. Emil appreciates comments, concerns, and complaints.