Back to GetFilings.com
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NUMBER 0-11595
MERCHANTS BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Incorporated in the Employer Identification
State of Delaware No. 03-0287342
164 College St., Burlington, Vermont 05401
(Address of principal executive office) (Zip Code)
Registrant's telephone number: (802) 658-3400
Securities registered pursuant to Section 12(b) of the Act:
(Not Applicable)
Securities registered pursuant to Section 12(g) of the Act:
Title of Class: Common Stock (Par Value $.01 a share)
Name of Exchange on which listed: NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
X Contained herein Not contained herein
----- -----
The aggregate market value of the voting stock held by non-affiliates is
$101,568,581 as computed using the average bid and asked prices of stock, as
of March 6, 1998.
The number of shares outstanding for each of the registrant's
classes of common stock, as of March 6, 1998 is:
Class: Common stock, par value $.01 per share
Outstanding: 4,430,294 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the year ended
December 31, 1997 are incorporated herein by reference to Parts I and II.
Portions of the Proxy Statement to Shareholders for the year ended
December 31, 1997 are incorporated herein by reference to Part III.
================================================================================
TABLE OF CONTENTS Page
Independent Auditors' Report 3
Consolidated Balance Sheets 4
Consolidated Statements of Operations 5
Consolidated Statements of Changes in Stockholders' Equity 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Summary of Unaudited Quarterly Financial Information 29
Five Year Selected Financial Data 32
Management's Discussion and Analysis of Financial Condition
and Results of Operations 33
Form 10-K 43
Signatures 65
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF
MERCHANTS BANCSHARES, INC.
We have audited the accompanying consolidated balance sheets of Merchants
Bancshares, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Merchants Bancshares, Inc. and subsidiaries as of December 31, 1997 and
1996, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
Boston, Massachusetts
January 21, 1998
Merchants Bancshares, Inc.
Consolidated Balance Sheets
December 31, December 31,
(In thousands except share and per share data) 1997 1996
- ---------------------------------------------------------------------------------------
ASSETS
Cash and Due from Banks $ 20,139 $ 29,726
Investments:
Debt Securities Available for Sale 44,241 57,656
Debt Securities Held to Maturity 111,458 86,904
Trading Securities 1,031 500
Marketable Equity Securities -- 230
- -------------------------------------------------------------------------------------
Total Investments 156,730 145,290
- -------------------------------------------------------------------------------------
Loans 390,388 387,233
Reserve for Possible Loan Losses 15,831 15,700
- -------------------------------------------------------------------------------------
Net Loans 374,557 371,533
- -------------------------------------------------------------------------------------
Federal Home Loan Bank Stock 2,296 2,841
Bank Premises and Equipment, Net 13,428 13,791
Investments in Real Estate Limited Partnerships 1,972 2,499
Other Real Estate Owned 591 1,925
Other Assets 14,539 14,031
- -------------------------------------------------------------------------------------
Total Assets $584,252 $581,636
=====================================================================================
LIABILITIES
Deposits:
Demand $ 76,712 $ 80,576
Savings, NOW and Money Market Accounts 267,396 263,882
Time Deposits $100 thousand and Greater 23,307 20,370
Other Time 138,429 143,452
- -------------------------------------------------------------------------------------
Total Deposits 505,844 508,280
- -------------------------------------------------------------------------------------
Demand Note Due U.S. Treasury 4,000 3,599
Other Short-Term Borrowings 4,000 6,000
Other Liabilities 11,057 11,087
Long-Term Debt 6,415 6,420
- -------------------------------------------------------------------------------------
Total Liabilities 531,316 535,386
- -------------------------------------------------------------------------------------
Commitments and Contingencies (Note 13)
STOCKHOLDERS' EQUITY
Preferred Stock Class A Non-Voting
Authorized - 200,000, Outstanding 0 -- --
Preferred Stock Class B Voting
Authorized - 1,500,000, Outstanding 0 -- --
Common Stock, $.01 Par Value 44 44
Shares Authorized 7,500,000
Outstanding: Current Period 4,290,698
Previous Period 4,290,342
Treasury Stock (At Cost): 143,922 current period
144,278 prior period (2,220) (2,038)
Capital in Excess of Par Value 33,223 33,155
Retained Earnings 21,537 14,845
Unearned Compensation-Restricted Stock Awards (10) --
Unrealized Gain on Securities Available For Sale, Net 362 244
- -------------------------------------------------------------------------------------
Total Stockholders' Equity 52,936 46,250
- -------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $584,252 $581,636
=====================================================================================
Book Value Per Common Share $ 11.95 $ 10.78
=====================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
Merchants Bancshares, Inc.
Consolidated Statements of Operations
Years Ended December 31,
(In thousands except per share data) 1997 1996 1995
- --------------------------------------------------------------------------------------------
INTEREST AND DIVIDEND INCOME:
Interest and Fees on Loans $38,543 $39,953 $46,067
Interest and Dividends on Investments:
U.S. Treasury and Agency Obligations 9,433 7,588 4,525
Other 182 463 723
- --------------------------------------------------------------------------------------------
Total Interest and Dividend Income 48,158 48,004 51,315
- --------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Savings, NOW and Money Market Accounts 8,403 8,216 9,077
Time Deposits $100 Thousand and Greater 1,428 1,397 1,433
Other Time Deposits 7,485 8,112 8,981
Other Borrowed Funds 509 345 257
Debt 413 602 3,254
- --------------------------------------------------------------------------------------------
Total Interest Expense 18,238 18,672 23,002
- --------------------------------------------------------------------------------------------
Net Interest Income 29,920 29,332 28,313
Provision for Possible Loan Losses (1,862) 3,150 12,100
- --------------------------------------------------------------------------------------------
Net Interest Income after Provision for Possible Loan Losses 31,782 26,182 16,213
- --------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Trust Company Income 1,635 1,493 1,796
Service Charges on Deposits 3,075 3,347 3,184
Merchant Discount Fees 1,537 1,696 1,861
Gains on Sale of Investment Securities, Net 784 33 352
Gain on Curtailment of Pension Plan -- -- 1,563
FDIC Assistance Received-Loss Sharing -- 407 2,951
Other 885 2,387 1,059
- --------------------------------------------------------------------------------------------
Total Noninterest Income 7,916 9,363 12,766
- --------------------------------------------------------------------------------------------
NONINTEREST EXPENSES:
Salaries and Wages 8,682 8,222 10,729
Employee Benefits 1,992 1,791 2,705
Occupancy Expense 2,171 2,054 2,178
Equipment Expense 2,325 2,024 2,069
Legal and Professional Fees 3,888 1,961 1,617
Provision for Impairmement of Investment Security 229 -- --
Losses on and Writedowns of Other Real Estate Owned 314 3,400 2,987
Equity in Losses of Real Estate Limited Partnerships 641 846 646
Losses and Write-downs of Segregated Assets -- 407 2,951
Reengineering Expenses and Related Consultants' Fees -- -- 4,056
Loss (Gain) on Disposition of Fixed Assets 1,088 (565) --
Other 7,152 7,349 6,668
- --------------------------------------------------------------------------------------------
Total Noninterest Expenses 28,482 27,489 36,606
- --------------------------------------------------------------------------------------------
Income (Loss) Before Provision (Benefit) for Income Taxes 11,216 8,056 (7,627)
Provision (Benefit) for Income Taxes 2,383 1,832 (3,785)
- --------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 8,833 $ 6,224 $(3,842)
============================================================================================
BASIC EARNINGS (LOSS) PER COMMON SHARE $ 2.00 $ 1.45 $ (0.90)
DILUTED EARNINGS (LOSS) PER COMMON SHARE 1.99 1.45 (0.90)
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For Each of the Three Years in the Period Ended December 31, 1997
Net Unrealized
Unearned Appreciation
Capital in Compensation- (Depreciation)
Common Excess of Retained Treasury Restricted of Investment
(In thousands) Stock Par Value Earnings Stock Stock Awards Securities Total
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 $42 $30,647 $12,463 $ (179) $ -- $ (674) $42,299
Net Loss -- -- (3,842) -- -- -- (3,842)
Sale of Treasury Stock -- (44) -- 179 -- -- 135
Purchase of Treasury Stock -- -- -- (2,038) -- -- (2,038)
Issuance of Common Stock 2 2,552 -- -- -- -- 2,554
Change in Net Unrealized
Appreciation (Depreciation) of
Securities Available for Sale,
Net of Tax -- -- -- -- -- 1,141 1,141
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 44 33,155 8,621 (2,038) -- 467 40,249
Net Income -- -- 6,224 -- -- -- 6,224
Change in Net Unrealized
Appreciation (Depreciation) of
Securities Available for Sale,
Net of Tax -- -- -- -- -- (359) (359)
Change in Net Unrealized
Appreciation of Securities
Transferred to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- 136 136
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 44 33,155 14,845 (2,038) -- 244 46,250
Net Income -- -- 8,833 -- -- -- 8,833
Purchase of Treasury Stock -- -- -- (1,390) -- -- (1,390)
Sales of Treasury Stock -- 219 -- 1,015 -- -- 1,234
Issuance of Stock under
Employee Stock Option Plans -- (151) -- 193 -- -- 42
Dividends Paid -- -- (2,141) -- -- -- (2,141)
Unearned Compensation--
Restricted Stock Awards -- -- -- -- (10) -- (10)
Change in Net Unrealized
Appreciation (Depreciation) of
Securities Available for Sale,
Net of Tax -- -- -- -- -- 108 108
Change in Net Unrealized
Appreciation of Securities
Transferred to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- 10 10
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 $44 $33,223 $21,537 $(2,220) $(10) $ 362 $52,936
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statement of Cash Flows
Years Ended December 31,
(In thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ 8,833 $ 6,224 $ (3,842)
Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by
Operating Activities:
Provision for Possible Loan Losses (1,862) 3,150 12,100
Provision for Possible Losses on Other Real Estate Owned 34 2,495 1,365
Provision for Impairment of Investment Security 229 -- --
Provision for Depreciation and Amortization 2,377 2,667 4,358
Deferred (Prepaid) Income Taxes 884 (1,475) (693)
Net Gains on Sales of Investment Securities (784) (33) (352)
Net Gains on Sales of Loans and Leases (11) (505) (464)
Net (Gains) Losses on Sales of Premises and Equipment 1,088 (565) (223)
Net Gains on Sales of Other Real Estate Owned (138) (328) --
Equity in Losses of Real Estate Limited Partnerships 641 846 646
Changes in Assets and Liabilities:
(Increase) Decrease in Interest Receivable (63) 936 1,099
Increase (Decrease) in Interest Payable 14 (313) 170
Decrease in Other Assets (1,328) 7,002 8,811
Increase (Decrease) in Other Liabilities (44) (724) 1,567
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 9,870 19,377 24,542
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from Sales of Investment Securities Available for Sale 18,907 42,522 50,377
Proceeds from Maturities of Investment Securities Available for Sale 13,985 16,000 59,000
Proceeds from Sales of Loans and Leases 3,131 19,576 35,574
Proceeds from Sales of FHLB Stock 545 334 3,682
Proceeds from Sales of Premises and Equipment 6 1,818 328
Proceeds from Sales of Other Real Estate Owned 2,112 6,144 8,378
Purchases of Available for Sale Investment Securities (10,005) (105,929) (102,823)
Purchases of Held to Maturity Investment Securities (33,278) -- --
Principal Repayments in Excess of (Less than) Loan Originations (4,364) 37,292 4,030
Investments in Real Estate Limited Partnerships (102) (111) --
Purchases of Premises and Equipment (4,099) (4,688) (793)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities (13,162) 12,958 57,753
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Decrease in Deposits (2,436) (36,234) (37,710)
Net Increase (Decrease) in Other Borrowed Funds (1,599) 4,263 (12,959)
Principal Payments on Debt (5) (9,005) (28,805)
Cash Dividends Paid (2,141) -- --
Acquisition of Treasury Stock (1,390) -- (2,038)
Issuance of Common Stock -- -- 2,554
Proceeds From Exercise of Employee Stock Options 42 -- --
Sale of Treasury Stock 1,234 -- 179
- ---------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (6,295) (40,976) (78,779)
- ---------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents (9,587) (8,641) 3,516
Cash and Cash Equivalents Beginning of Year 29,726 38,367 34,851
- ---------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $20,139 $ 29,726 $ 38,367
=========================================================================================================
Total Interest Payments $18,224 $ 18,985 $ 22,831
Total Income Tax Payments 3,820 -- --
Transfer of Loans and Premises to Other Real Estate Owned 515 2,815 2,777
Transfer of Securities Available for Sale to Held to Maturity Portfolio -- 87,509 --
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Notes to Consolidated Financial Statements
December 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Merchants Bancshares, Inc. (the "Company") and its wholly owned
subsidiaries, Merchants Bank (the "Bank") (including the Bank's wholly owned
subsidiaries Merchants Trust Company (the "Trust Company"), and certain
trusts; Queneska Capital Corporation, formerly a wholly owned subsidiary of
the Bank was dissolved in December 1997), and Merchants Properties, Inc.,
after elimination of all material intercompany accounts and transactions.
The Bank and the Trust Company offer a full range of deposit, loan, cash
management and trust services to meet the financial needs of individual
consumers, businesses and municipalities at 33 full-service banking
locations throughout the State of Vermont.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the
reporting periods. Operating results in the future could vary from the
amounts derived from management's estimates and assumptions.
Investment Securities
The Company classifies certain of its investments in debt securities as held
to maturity which are carried at amortized cost if the Company has the
positive intent and ability to hold such securities to maturity. Investments
in debt securities that are not classified as held to maturity and equity
securities that have readily determinable fair values are classified as
trading securities or available for sale securities. Trading securities are
investments purchased and held principally for the purpose of selling in the
near term; available for sale securities are investments not classified as
trading or held to maturity. Available for sale securities are carried at
market value measured at each reporting date. The resulting unrealized gain
or loss is reflected in Stockholders' Equity net of the associated tax
effect.
Transfers from securities available for sale to securities held to maturity
are recorded at the securities' fair values on the date of the transfer. Any
net unrealized gains or losses continue to be reported as a separate
component of stockholders' equity, on a net of tax basis as long as the
securities are carried in the held to maturity portfolio, and are amortized
over the estimated remaining life of the transferred securities as an
adjustment to yield in a manner consistent with the amortization of premiums
and discounts.
Dividend and interest income, including amortization of premiums and
discounts, is recorded in earnings for all categories of investment
securities. Discounts and premiums related to debt securities are amortized
using a method which approximates the level-yield method. The gain or loss
recognized on the sale of an investment security is based upon the adjusted
cost of the specific security.
Management reviews all reductions in fair value below book value to
determine whether the impairment is other than temporary. If the impairment
is determined to be other than temporary in nature, the carrying value of
the security is written down to the appropriate level by a charge to
earnings.
Loan Origination and Commitment Fees
Loan origination and commitment fees and certain direct loan origination
costs are deferred and amortized over the lives of the related loans. Net
deferred origination fees were $859 thousand and $947 thousand at December
31, 1997 and 1996, respectively.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using straight-line
and accelerated methods at rates that depreciate the original cost of the
premises and equipment over their estimated useful lives. Expenditures for
maintenance, repairs and renewals of minor items are generally charged to
expense as incurred. When premises and equipment are replaced, retired, or
deemed no longer useful they are valued at estimated selling price less
costs to sell, and to the extent the net book value exceeds this value the
difference is charged to current earnings.
Gains and Losses on Sales of Loans
Gains and losses on sales of loans are recognized based upon the difference
between the selling price and the carrying amount of loans sold. Gains and
losses are adjusted for excess servicing rights resulting from the sale of
certain loans with servicing rights retained. Excess servicing rights are
recorded at the net present value of estimated future servicing revenue when
such amounts are greater than normal servicing fees. Deferred excess
servicing is amortized over the period of estimated net servicing income.
Origination fees collected, net of commitment fees paid in connection with
the sales of loans and net of the direct cost of originating the loans, are
recognized at the time such loans are sold.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted
income tax rates applicable to the period in which the deferred tax assets
or liabilities are expected to be realized or settled. As changes in tax
laws or rates are enacted, deferred tax assets and liabilities are adjusted
through the provision for income taxes. Low-income housing tax credits are
recognized in the year in which they are earned.
Investments in Real Estate Limited Partnerships
The Bank has investments in various real estate limited partnerships that
acquire, develop, own and operate low and moderate-income housing. The
Bank's ownership interest in these limited partnerships varies from 35% to
99% as of December 31, 1997. The Bank consolidates the financial statements
of the limited partnership in which the Company is the general partner and
is actively involved in management and has a controlling interest. The Bank
accounts for investments in limited partnerships where the Bank neither
actively participates nor has a controlling interest under the equity method
of accounting.
Management periodically reviews the results of operations of the various
real estate limited partnerships to determine if the partnerships generate
sufficient operating cash flow to fund their current obligations. In
addition, management reviews the current value of the underlying property
compared to the outstanding debt obligations. If it is determined that the
investment suffers from a permanent impairment, the carrying value is
written down to the estimated realizable value. The Bank recognized losses
of $97 thousand due to the impairment of an investment in a real estate
limited partnership in 1996.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand, amounts due from banks
and federal funds sold in the accompanying consolidated statements of cash
flows. At December 31, 1997 and 1996, cash and cash equivalents included
$2.2 million and $4.7 million, respectively, held to satisfy the reserve
requirements of the Federal Reserve Bank.
Other Real Estate Owned
Collateral acquired through foreclosure is recorded at the lower of cost or
fair value, less estimated costs to sell, at the time of acquisition. Bank
premises held for sale are recorded at the lower of cost or market, less
estimated costs to sell, at the date of transfer. A valuation allowance is
established for the estimated costs to sell and is charged to expense.
Subsequent changes in the fair value of other real estate owned are
reflected as a write-down and charged to expense. Net operating income or
expense related to foreclosed property and Bank premises held for sale is
included in noninterest expense in the accompanying consolidated statements
of operations. There are inherent uncertainties in the assumptions with
respect to the estimated fair value of other real estate owned. Because of
these inherent uncertainties, the amount ultimately realized on other real
estate owned ("OREO") may differ from the amounts reflected in the
consolidated financial statements. The Bank recognized losses due to
additions to the valuation allowance of $34 thousand, $2,495 thousand and
$1,365 thousand during 1997, 1996 and 1995, respectively. At December 31,
1997 the balance in the OREO portfolio, net of valuation allowances,
consisted of foreclosed real estate of $36 thousand and Bank premises held
for sale of $555 thousand.
Intangible Assets
Premiums paid for the purchase of core deposits are recorded as other assets
and amortized on a straight-line method over the estimated period of 15
years. Management reviews the value of the intangible asset by comparing
purchased deposit levels to the current level of acquired deposits in the
branches purchased. If any significant deposit runoff has occurred and is
determined to be permanent in nature, the asset is written down accordingly.
Mortgage Servicing Rights
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 122 "Accounting for Mortgage Servicing Rights" ("SFAS No.
122"). SFAS No. 122 requires that entities engaging in mortgage banking
activities recognize the rights to service mortgage loans for others,
regardless of the manner in which the servicing rights are acquired, as
separate assets when the related loans are sold and the mortgage servicing
rights are retained. The amount capitalized is based on an allocation of the
total cost of the mortgage loans to the mortgage servicing rights and the
loan (without the mortgage servicing rights) based on their relative fair
values. In addition, capitalized mortgage servicing rights are required to
be assessed for impairment based on the relative fair value of those rights.
Effective January 1, 1997, SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," ("SFAS
No. 125"), superseded SFAS No. 122. SFAS No. 127 "Deferral of the Effective
Date of Certain Provisions of FASB Statement No. 125," is effective for
transactions occurring after December 31, 1996.
On January 1, 1997, the Company adopted SFAS No. 125. This statement
requires transfers of financial assets in which the Bank surrenders control
over those financial assets to be accounted for as a sale to the extent that
consideration other than beneficial interests in the transferred assets is
received in exchange. Each time a bank undertakes an obligation to service
financial assets it recognizes either a servicing asset or a servicing
liability for that contract, unless it securitizes the asset, retains all of
the securities, and classifies them as debt securities held to maturity. The
implementation of this statement has not had a material effect on the
Company's results of operations of financial condition. The carrying value
of capitalized mortgage servicing rights as of December 31, 1997 and 1996
were $85 thousand and $118 thousand, respectively.
Stock-based Compensation Plans
The Company applies Accounting Principles Bulletin ("APB") No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock-based compensation plans. Accordingly, no
accounting recognition is given to stock options granted at fair market
value until they are exercised. Upon exercise, net proceeds, including tax
benefits realized, are credited to equity. Refer to Note 6 for additional
information.
Earnings Per Share
In 1997, The Company adopted the provisions of SFAS N0. 128, "Earnings Per
Share" ("SFAS No. 128"). This statement was issued by the Financial
Accounting Standards Board ("FASB") in March 1997 and establishes the
standards for computing and presenting earnings per share ("EPS") and
applies to entities with publicly held common stock or potential common
stock. This statement replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the income statement for all entities with
complex capital structures and requires a reconciliation of the numerators
and denominators of the basic and diluted EPS computations for all prior-
period EPS data presented. Refer to Note 11 for additional information.
Accounting for Impairment of Long-Lived Assets
In 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of." This
statement requires a review for impairment of long-lived assets and certain
identifiable intangibles to be held and used by an entity when events or
changes in circumstances indicate that the carrying amount of the assets may
not be recoverable. If the sum of the undiscounted future cash flows
expected to result from the use and eventual disposition of the asset is
less than the carrying amount of the asset, an impairment loss is
recognized. Measurement of the impairment loss is determined by comparing
the carrying amount of the asset to its fair value. For certain long-lived
assets to be disposed of, the cost to sell the asset is deducted from the
asset's fair value in determining the impairment loss, if any. This
statement does not apply to financial instruments, core deposit intangibles,
mortgage and other servicing rights, or deferred tax assets.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". This statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and
losses). Components of comprehensive income are net income and all other
non-owner changes in equity. This statement requires that an enterprise (a)
classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in capital in
the equity section of a statement of financial position. This statement is
effective for the Company's financial statements issued for the fiscal year
ended December 31, 1998. Reclassification of financial statements for
earlier periods provided for comparative purposes is required.
Segment Information
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information" ("SFAS No. 131"). This statement
establishes the standards for reporting information about segments in annual
and interim financial statements. SFAS No. 131 introduces a new model for
segment reporting; the "management approach". The management approach is
based on the way the chief operating decision-maker organizes segments
within a company for making operating decisions and assessing performance.
Reportable segments are based on products and services, geography, legal
structure, management structure--any manner in which management
disaggregates a company. This statement is effective and will be adopted for
the Company's financial statements for the fiscal year ended December 31,
1998 and requires the restatement of previously reported segment information
for all periods presented.
Reclassification
Certain amounts reported for prior periods have been reclassified to be
consistent with the current period presentation.
(2) INVESTMENT SECURITIES
Investments in debt securities are classified as trading, available for sale
or held to maturity as of December 31, 1997 and 1996. The amortized cost and
fair values of the debt securities classified as available for sale and held
to maturity as of December 31, 1997 and 1996 are as follows:
SECURITIES AVAILABLE FOR SALE:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------
1997 (In thousands)
- ---------------------------------------------------------------------------
U.S. Agency Obligations $31,058 $271 $-- $31,329
Mortgage-backed securities 12,825 105 18 12,912
- ---------------------------------------------------------------------------
$43,883 $376 $18 $44,241
===========================================================================
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------
1996 (In thousands)
- ---------------------------------------------------------------------------
U.S. Treasury Obligations $18,146 $ 14 $36 $18,124
U.S. Agency Obligations 23,099 178 -- 23,277
Mortgage-backed Securities 16,218 97 60 16,255
- ---------------------------------------------------------------------------
$57,463 $289 $96 $57,656
===========================================================================
SECURITIES HELD TO MATURITY:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------
1997 (In thousands)
- ---------------------------------------------------------------------------
U.S. Treasury Obligations $ 200 $ -- $ -- $ 200
U.S. Agency Obligations 12,526 94 4 12,616
Mortgage-backed Securities 98,732 960 41 99,651
- ---------------------------------------------------------------------------
$111,458 $1,054 $ 45 $112,467
===========================================================================
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------
1996 (In thousands)
- ---------------------------------------------------------------------------
U.S. Agency Obligations $ 2,504 $-- $ 52 $ 2,452
Mortgage-backed Securities 84,400 23 871 83,552
- ---------------------------------------------------------------------------
$ 86,904 $23 $923 $ 86,004
===========================================================================
Marketable equity securities are classified as available for sale at
December 31, 1997 and 1996 and are stated at their fair value of $0 and $230
thousand, respectively. Gross unrealized losses on equity securities were
$30 thousand at December 31, 1997 and 1996.
The fair value of securities held for trading was $1,031 thousand and $500
thousand at December 31, 1997 and 1996 respectively. Unrealized gains on
securities held for trading were $267 thousand and $0 as of December 31,
1997 and 1996, respectively.
The contractual maturities of all debt securities held at December 31, 1997
are as follows:
Amortized Fair
(In thousands) Cost Value
-----------------------------------------------------------------
Due within one year $ 4,021 $ 4,038
Due after one year through five years 29,758 30,083
Due after five years through ten years 30,470 30,869
Due after ten years 91,092 91,718
-----------------------------------------------------------------
$155,341 $156,708
=================================================================
Proceeds from sales of available for sale debt securities, including
principal repayments on mortgage-backed securities, were $18.9 million and
$42.5 million during 1997 and 1996, respectively. Gross gains of $840
thousand, $120 thousand and $660 thousand and gross losses of $56 thousand,
$87 thousand and $308 thousand were realized from sales of debt and equity
securities in 1997, 1996 and 1995, respectively.
On November 29, 1996, $87.5 million of securities available for sale were
transferred to the held to maturity portfolio. Net unrealized gains of $202
thousand associated with these securities are being amortized over the
remaining lives of the individual securities.
At December 31, 1997, securities with a face value of $14.3 million were
pledged to secure public deposits, and for other purposes required by law.
(3) LOANS
The composition of the loan portfolio at December 31, 1997 and 1996 is as
follows:
(In thousands) 1997 1996
-------------------------------------------------------------
Commercial, Financial and Agricultural $ 73,523 $ 61,091
Real Estate--Commercial 155,983 178,780
Real Estate--Residential 136,305 128,577
Real Estate--Construction 8,695 3,420
Installment Loans to individuals 15,450 14,831
All Other Loans (including overdrafts) 432 534
-------------------------------------------------------------
$390,388 $387,233
=============================================================
In connection with an acquisition, the Bank received financial assistance
(loss sharing) with respect to certain acquired loans charged-off by the
Bank during the three-year period ended June 30, 1996. The FDIC reimbursed
the Bank, on a quarterly basis, 80% of net charge-offs and certain expenses
related to loans subject to loss sharing aggregating $41.1 million. Charge-
offs and eligible expenses on Segregated Assets, net of recoveries,
aggregated $2.2 million and $3.7 million for 1996 and 1995. The Bank
received $407 thousand and $2,951 thousand from the FDIC for eligible
charge-offs, net of recoveries and eligible expenses, related to 1996 and
1995, respectively, in accordance with the loss sharing arrangement.
Expenses and charge-offs relating to the Segregated Assets had an
insignificant effect on the Bank's noninterest expenses for 1996 and 1995.
The Bank's share of the charge-offs was charged to the allowance for losses
on the Segregated Assets (such allowance being a component of the Bank's
overall allowance for loan losses), which was established in conjunction
with the acquisition. All future losses on these loans will be charged to
the Bank's allowance for loan losses. The Bank continues to be obligated to
compensate the FDIC for a portion of recoveries received through June 1998
on loans previously charged off and for which the Bank received
reimbursement from the FDIC. The Bank reimbursed the FDIC $133 thousand for
such recoveries during 1997.
The Bank originates primarily residential real estate loans, commercial and
installment loans, and to a lesser extent commercial real estate loans to
customers throughout the state of Vermont. There were no loans held for sale
at December 31, 1997 and 1996. Substantially all of the Bank's loan
portfolio is based in the state of Vermont. There are no known significant
industry concentrations in the loan portfolio. Loans serviced for others at
December 31, 1997 and 1996 amounted to $230 million and $313 million,
respectively.
The reserve for possible loan losses is based on management's estimate of
the amount required to reflect the risks in the loan portfolio, based on
circumstances and conditions known or anticipated at each reporting date.
There are inherent uncertainties with respect to the final outcome of
certain of the Bank's loans and nonperforming assets. Because of these
inherent uncertainties, actual losses may differ from the amounts reflected
in these consolidated financial statements. Factors considered in evaluating
the adequacy of the reserve include previous loss experience, current
economic conditions and their effect on the borrowers, the performance of
individual loans in relation to contract terms and estimated fair values of
properties to be foreclosed. Losses are charged against the reserve for loan
losses when management believes that the collectibility of principal is
doubtful.
Key elements of the above estimates, including those used in independent
appraisals, are dependent upon the economic conditions prevailing at the
time of the estimates. Accordingly, uncertainty exists as to the final
outcome of certain of the valuation judgments as a result of the difficult
and unpredictable conditions in the region. The inherent uncertainties in
the assumptions relative to the projected sales prices or rental rates may
result in the ultimate realization of amounts on certain loans that are
different from the amounts reflected in these consolidated financial
statements.
An analysis of the reserve for possible loan losses for the years ended
December 31, 1997 and 1996 is as follows:
(In thousands) 1997 1996
---------------------------------------------------------
Balance, Beginning of Year $15,700 $16,235
Provision for Possible Loan Losses (1,862) 3,150
Loans Charged Off (1,696) (5,135)
Recoveries 3,689 1,450
---------------------------------------------------------
Balance, End of Year $15,831 $15,700
=========================================================
Loan recoveries include $133 thousand and $247 thousand on Segregated Assets
for 1997 and 1996, respectively. Loans charged off include $158 thousand on
segregated assets for 1996.
The allowance for possible loan losses related to loans that are identified
as impaired is based on discounted cash flows using the loan's effective
interest rate or the fair value of the collateral for certain collateral
dependent loans. The Company has determined that commercial and commercial
real estate loans recognized by the Company as nonaccrual, loans past due
over 90 days and still accruing, restructured troubled debt and certain
internally adversely classified loans are generally equivalent to impaired
loans.
Total impaired loans at December 31, 1997 and 1996 with a related allowance
were $4.8 million and $8.4 million respectively, and the allowance
associated with such loans was $665 thousand and $875 thousand,
respectively. Interest payments on impaired loans are generally recorded as
principal reductions if the remaining loan balance is not expected to be
paid in full. If full collection of the remaining loan balance is expected,
payments are recognized as interest income on a cash basis. During 1997 and
1996, the Company recorded interest income on impaired loans of
approximately $394 thousand and $505 thousand, respectively. The average
balance of impaired loans was $7.9 million in 1997 and $16.4 million in
1996.
Nonperforming assets at December 31, 1997 and 1996 were as follows:
(In thousands) 1997 1996
--------------------------------------------------
Nonaccrual loans $2,686 $4,091
Restructured Loans 215 2,403
Loans Past Due 90 Days or More
and Still Accruing Interest 403 216
--------------------------------------------------
Total Nonperforming Loans 3,304 6,710
Other Real Estate Owned, Net 591 1,925
--------------------------------------------------
$3,895 $8,635
==================================================
The Bank had $215 thousand and $2,403 thousand of restructured loans that
were performing in accordance with the modified agreement at December 31,
1997 and 1996, respectively.
The Bank's policy is to discontinue the accrual of interest and reverse
uncollected interest receivable on loans when scheduled payments become
contractually past due in excess of 90 days or, in the judgment of
management, the ultimate collectibility of principal or interest becomes
doubtful.
The amount of interest which was not earned but which would have been earned
had the nonaccrual and restructured loans performed in accordance with their
original terms and conditions was approximately $395 thousand, $1,493
thousand and $3,466 thousand in 1997, 1996 and 1995, respectively.
During 1997, the Bank consumated two transactions involving sales of loans,
including certain impaired loans. The aggregate net book balue of loans sold
was approximately $2.7 million. The Bank recognized a recovery of $396
thousand from the sale of these loans. During 1996, the Bank consummated
three such transactions, including certain impaired loans. The aggregate net
book value of loans sold in 1996 was approximately $13.2 million, resulting
in a total loss on sales of $556 thousand, which was charged against the
allowance for possible loan losses. All loans were sold without recourse.
An analysis of loans to directors, executive officers and associates of such
persons for the year ended December 31, 1997 is as follows:
(In thousands)
--------------------------------------
Balance, December 31, 1996 $8,802
Additions 732
Repayments 584
--------------------------------------
Balance, December 31, 1997 $8,950
======================================
It is the policy of the Bank to grant such loans on substantially the same
terms, including interest rates and collateral, as those prevailing for
comparable lending transactions with other persons. The December 31, 1996
balance has been adjusted to reflect changes in status of directors and
executive officers during 1997.
(4) PREMISES AND EQUIPMENT
The components of premises and equipment included in the accompanying
consolidated balance sheets are as follows:
(In thousands) 1997 1996
---------------------------------------------------------
Land and Buildings $12,601 $12,139
Leasehold Improvements 1,288 962
Furniture, Equipment, and Software 10,617 14,223
---------------------------------------------------------
24,506 27,324
Less: Accumulated Depreciation
and Amortization 11,078 13,533
---------------------------------------------------------
$13,428 $13,791
=========================================================
Depreciation and amortization expense related to premises and equipment
amounted to $2.0 million, $1.7 million and $1.9 million in 1997, 1996, and
1995, respectively.
The Bank leases certain properties for branch operations. Rent expense on
these properties totaled $263 thousand, $240 thousand and $213 thousand for
the years ended December 31, 1997, 1996 and 1995, respectively. Minimum
lease payments for these properties subsequent to December 31, 1997 are as
follows: 1998 - $220 thousand; 1999 - $168 thousand; 2000 - $137 thousand;
2001 - $135 thousand, 2002 - $101 thousand and $221 thousand thereafter.
During 1996, the Bank began a capital improvement project to upgrade its
branch facilities and to make further investments in technology. At December
31, 1997, approximately $6.9 million has been capitalized related to these
projects and will be depreciated over the estimated useful lives of the
individual assets once they are placed in service. Additionally, the Bank
has retired assets with a total net book value of $1.2 million in
conjunction with these projects. Losses realized on dispositions have been
charged against current earnings, $596 thousand in 1997 and $602 thousand in
1996.
During December 1997, a branch building and associated property located in
Brattleboro, VT were transferred to the Other Real Estate Owned portfolio.
The assets were valued at their fair market value of $450 thousand at the
time of transfer which resulted in a $478 thousand charge to current
earnings.
(5) EMPLOYEE BENEFIT PLANS
Pension Plan
Prior to January 1995, the Company maintained a noncontributory defined
benefit plan covering all eligible employees. The plan was a final average
pay plan with benefits based on the average salary rates over the five
consecutive plan years out of the last ten consecutive plan years that
produce the highest average. It was the Company's policy to fund the cost of
benefits expected to accrue during the year plus amortization of any
unfunded accrued liability that had accumulated prior to the valuation date
based on IRS regulations for funding. During 1994, the Company made the
decision to freeze the plan beginning on January 1, 1995. During 1995, the
plan was curtailed. Accordingly, all accrued benefits were fully vested and
no additional years of service or age will be accrued. As a result of the
curtailment, the Bank recognized a gain in the amount of $1.6 million in
1995.
The plan's funded status and amounts recognized in the accompanying
consolidated balance sheets and statements of operations as of December 31,
1997 and 1996 are as follows:
(In thousands) 1997 1996
-----------------------------------------------------------------
Projected Benefit Obligation for Service
Rendered Through December 31, 1994 $6,610 $5,180
Plan Assets 7,308 6,778
-----------------------------------------------------------------
Excess of Plan Assets Over
Projected Benefit Obligation 698 1,598
Unrecognized Net Asset at January 1, 1987
Being Amortized over 13.4 Years (54) (99)
Unrecognized Net Loss (Gain) 602 (364)
-----------------------------------------------------------------
Prepaid Pension Costs Included
In Other Assets $1,246 $1,135
=================================================================
A summary of (income) expense relating to the Company's pension fund for
each of the three years in the period ended December 31, 1997 is as follows:
(In thousands) 1997 1996 1995
------------------------------------------------------------------
Interest Cost on Projected Benefit
Obligation $ 452 $ 402 $ 394
Actual Return on Plan Assets (996) (692) (816)
Net Amortization and Deferral 433 119 172
------------------------------------------------------------------
$(111) $(171) $(250)
==================================================================
The actuarial present value of the projected benefit obligation was
determined using a weighted average discount rate of 7%, 7.6% and 7.5% as of
December 31, 1997, 1996 and 1995, respectively. For 1997, 1996 and 1995
there was no assumed rate of increase in future compensation due to the
freeze on plan benefits. The expected long-term rate of return on assets
used was 8% in 1997, 9% in 1996 and 8% in 1995.
Employee Stock Ownership Plan/401(k) Plan
Under the terms of the Company's Employee Stock Ownership Plan (ESOP),
eligible employees are entitled to contribute up to 15% of their
compensation to the ESOP, and the Company contributes a percentage of the
amounts contributed by the employees, as authorized by the Company's Board
of Directors. The Company contributed approximately 126% and 120%,
respectively, of the amounts contributed by the employees (200% of up to
4.5% of individual employee compensation in 1997 and 1996) in 1997 and 1996.
Substantially all employer contributions to the ESOP are funded with cash
and are used to purchase the Company's common stock.
Deferred Compensation Plans
Through December 1995, the Bank maintained an Executive Salary Continuation
Plan and a Deferred Compensation Plan for Directors. In December 1995, the
Bank and participants in its Executive Salary Continuation Plan and in the
Fixed Growth Program of its Deferred Compensation Plan for Directors agreed
to amend or terminate the existing plans. In satisfaction of all liabilities
under those plans, the Bank agreed to make payments to, or credits for, the
participants. Pursuant to these agreements, the Bank established several new
plans (the "New Plans") and established certain trusts (the "Trusts") with
Merchants Trust Company, to which it contributed an amount sufficient to
cover the Bank's obligations under the New Plans. The New Plans used those
payments, in part, to purchase newly issued common stock of the Company at
its market price. The purchases have been accounted for as treasury stock
transactions in the Company's consolidated financial statements. The
portions of the payments made to the New Plans that were not invested in the
common stock of the Company are included as investments in the consolidated
financial statements and are classified as trading. In conjunction with the
amendment and termination of the existing plans, the Bank either sold or
surrendered certain life insurance policies and used the proceeds as a
partial source to fund the lump sum payments made to the New Plans. As a
result of these transactions, the Bank recognized increased earnings of $673
thousand in 1995. To the extent the obligations of the Company under the New
Plans are based on investments by the New Plans in other than shares of the
Company, the investments will be revalued at each reporting date with a
corresponding adjustment to compensation expense. In addition, the
obligation related to certain Company shares, originally purchased for $200
thousand, were revalued at each reporting date, with a corresponding
adjustment to compensation expense. These Company shares were sold during
December 1997.
Until July 1, 1997, Directors of the Bank were entitled to defer a portion
of their compensation into a Deferred Compensation Plan for Directors known
as the "Floating Growth (savings)" program. The Board of Directors voted at
their February 1997 meeting to amend the Plan to provide that no additional
compensation may be deferred into the Floating Growth (savings) program
after July 1, 1997. Benefits accrue based on a monthly allowance for
interest at a rate that is fixed from time to time at the discretion of the
Board of Directors. The benefits under the Floating Growth (savings) program
of the Deferred Compensation Plan for Directors and the New Plans are
generally payable starting on the January 2 following a participant's 65th
birthday or earlier death, and will be distributed to the participant (or
upon the participant's death, to the participant's designated beneficiary)
in accordance with the Plan.
Phantom Stock Plan
The Company maintained a Phantom Stock Plan, wherein certain key officers of
the Bank were entitled to receive an annual award of phantom shares of stock
for up to five consecutive years. All such awards were granted by
June 30, 1993. In December 1995, the Bank entered into agreements with
certain participants in the Bank's Phantom Stock Plan. The Bank agreed to
pay, and those participants agreed to accept, lump sum amounts in full
satisfaction of the Bank's obligations under the Plan.
A summary of (income) expense relating to the Company's various employee
benefit plans for each of the three years in the period ended December 31,
1997 is as follows:
(In thousands) 1997 1996 1995
----------------------------------------------------------------
Pension Plan $(150) $(144) $(250)
Employee Stock Ownership
Plan/401(k) Plan 685 653 808
Deferred Compensation Plans 20 27 25
Phantom Stock Plan 0 (16) 68
----------------------------------------------------------------
Total $ 555 $ 520 $ 651
================================================================
(6) STOCK BASED COMPENSATION PLANS
Stock Option Plans
The Company has granted stock options to certain key employees. The options
granted vest after two years and are immediately exercisable upon vesting.
Nonqualified stock options may be granted at any price determined by the
Compensation Committee of the Board of Directors. All stock options have
been granted at or above fair market value at the date of grant.
A summary of the Company's stock option activity is as follows
1997 1996 1995
- -------------------------------------------------------------------------------------
Weighted Weighted Option
Number Average Number Average Number Price
Of Exercise Of Exercise of Per
Shares Price Shares Price Shares Share
- -------------------------------------------------------------------------------------
(In thousands except per share data)
Options outstanding,
beginning of year 50 $12.45 40 $11.72 20 $11.00
Granted 71 $25.69 10 $15.38 20 $12.44
Exercised 18 10.72 -- -- -- --
- -------------------------------------------------------------------------------------
Options outstanding,
end of year 103 $21.88 50 $12.45 40 $11.72
Options exercisable 22 $12.53 20 $11.00 -- --
Weighted average fair value
per option of options
granted during year $ 6.71 $ 6.83 $ 6.72
- -------------------------------------------------------------------------------------
As of December 31, 1997, the exercisable options outstanding were
exercisable at prices ranging from $10.00 to $14.88 and had a weighted-
average remaining contractual life of 4.2 years.
In October, 1995 the FASB issued SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS No. 123") which establishes a fair value based method
of recognizing stock-based compensation expense. As permitted by SFAS No.
123, the Company has elected to continue to apply APB No. 25 to account for
its stock-based compensation plans. Had compensation cost for awards under
the Company's stock-based compensation plans been determined consistent with
the method set forth under SFAS No. 123, the effect on the Company's net
income and earnings per share would have been as follows:
1997 1996
- ------------------------------------------------------------------------------------
As Reported Pro Forma As Reported Pro Forma
- ------------------------------------------------------------------------------------
(In thousands except per share data)
Net Income $8,833 $8,679 $6,224 $6,063
Basic Earnings per Share $ 2.00 $ 1.97 $ 1.45 $ 1.41
Diluted Earnings per Share $ 1.99 $ 1.96 $ 1.45 $ 1.41
- ------------------------------------------------------------------------------------
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma
compensation expense may not be representative of the amount to be expected
in future years. Pro forma compensation expense for options granted is
reflected over the vesting period; therefore, future pro forma compensation
expense may be greater as additional options are granted.
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1997 and 1996, respectively: Risk-free
interest rates of 6.00% for 1997 and 1996; Expected lives of options of 4
years for 1997 and 1996; Expected volatility of stock of 34.37% and 31.40%;
Rate of dividends of 2.48% and 2.08%; and Pro-forma after tax compensation
expense of $308 thousand for 1997 and $161 thousand for 1996.
The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option-pricing models require the input of
highly subjective assumptions. Because the Company's employee stock options
have characteristics significantly different from those of traded options,
and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models
do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
Restricted Stock Plans
The Company and the Bank adopted new compensation plans for non-employee
directors during 1997. Under the terms of the plans participating directors
may elect to have all or a specified percentage of his or her compensation
for a given year paid in the form of cash or deferred in the form of shares
of restricted common stock of the Company. Directors who elect to have their
compensation deferred shall be credited with a number of shares of the
Company's stock equal in value to the amount of fees deferred plus a risk
premium of not more than 25% of the amount deferred. The participating
director may not generally sell, transfer or otherwise dispose of these
shares, prior to the fifth anniversary of the date of the grant of such
shares. With respect to shares of common stock issued or otherwise
transferred to a participating director, the participating director will
have the right to vote the shares and receive dividends or other
distributions thereon. If a participating director resigns under certain
circumstances the director shall forfeit all of his or her restricted shares
which are risk premium shares. During 1997, 2,604 shares of common stock of
the Company were distributed to a trust established under the terms of the
new compensation plan. The "risk premium" is treated as an offset to
stockholder's equity labeled "Unearned Compensation" and will be recognized
as an expense ratably over the five-year restriction period.
(7) INCOME TAXES
The provision (benefit) for income taxes for each of the three years in the
period ended December 31, 1997 consists of the following:
(In thousands) 1997 1996 1995
--------------------------------------------------------
Current $1,499 $ 3,307 $(3,092)
Deferred (Prepaid) 884 (1,475) (693)
--------------------------------------------------------
$2,383 $ 1,832 $(3,785)
========================================================
Prepaid and deferred income taxes result from differences between the income
(loss) for financial reporting and tax reporting relating primarily to the
provision for possible loan losses. The net deferred tax asset amounted to
approximately $4.4 million and $5.4 million at December 31, 1997 and 1996,
respectively. This tax asset is included in other assets in the accompanying
consolidated balance sheets.
The components of the net deferred tax asset as of December 31, 1997 and
1996 are as follows:
(In thousands) 1997 1996
----------------------------------------------------------------
Reserve for Possible Loan Losses $ 5,605 $ 6,261
Deferred Compensation 1,335 1,278
Unrealized Securities Gains (197) (129)
Loan Fees 191 191
Depreciation (599) (481)
Accrued Liabilities (335) 291
Capital Loss Carryforwards 618 937
Investments in Limited Partnerships (712) (668)
Excess Servicing Right (31) (43)
Loan Market Adjustment (4,505) (3,368)
Other (1,131) (1,526)
Tax Credit Carryforwards 4,293 3,150
Core Deposit Intangible 526 434
----------------------------------------------------------------
5,058 6,327
Valuation Allowance (618) (937)
----------------------------------------------------------------
$ 4,440 $ 5,390
================================================================
A valuation allowance is provided when it is more likely than not that some
portion of the net prepaid tax asset will not be realized. The Company has
established a valuation allowance for capital loss carryforwards since such
losses may only be utilized against future capital gains.
The following is a reconciliation of the federal income tax provision
(benefit), calculated at the statutory rate, to the recorded provision
(benefit) for income taxes:
(In thousands) 1997 1996 1995
- ------------------------------------------------------------------------------
Applicable Statutory Federal Income
Tax (Benefit) $ 3,779 $2,739 $(2,593)
(Reduction) Increase in Taxes
Resulting From:
Gain / (Loss) on Investment Securities (134) 27 (114)
Tax-exempt Income (55) (74) (87)
Tax Credits (1,089) (980) (851)
Other, Net (118) 46 (227)
- ------------------------------------------------------------------------------
$ 2,383 $1,832 $(3,785)
==============================================================================
The state of Vermont assesses a franchise tax for banks in lieu of income
tax. The franchise tax is assessed based on deposits and amounted to
approximately $386 thousand, $255 thousand, and $277 thousand in 1997, 1996,
and 1995, respectively. These amounts are included in other expenses in the
accompanying consolidated statements of operations. The Company received
refunds of its 1995, 1994, and 1993 Vermont Franchise Taxes of $272
thousand, $285 thousand, and $240 thousand, respectively, during 1996.
(8) OTHER BORROWED FUNDS
Other borrowed funds consist of the following at December 31, 1997 and 1996:
(In thousands) 1997 1996
-------------------------------------------------------
Treasury Tax and Loan Notes $4,000 $3,599
Short Term Borrowing 4,000 6,000
-------------------------------------------------------
$8,000 $9,599
=======================================================
As of December 31, 1997, the Bank may borrow up to $20 million in federal
funds on an unsecured basis.
The following table provides certain information regarding other borrowed
funds for the two years ended December 31, 1997 and 1996:
Maximum Weighted
Month-End Average Average Rate Weighted
Amount Amount During Average Rate
(In thousands) Outstanding Outstanding the Year at Year End
- -----------------------------------------------------------------------------------------
1997
Treasury Tax and Loan Notes $ 4,182 $2,413 5.39% 5.27%
Federal Funds Purchased 3,850 906 5.99 --
Short Term Borrowing 15,000 4,880 5.87 6.16
- -----------------------------------------------------------------------------------------
1996
Treasury Tax and Loan Notes $ 4,572 $2,134 5.06% 5.37%
Federal Funds Purchased 11,500 703 4.59 --
Short Term Borrowing 11,500 774 5.46 5.90
Repurchase Agreements 7,660 2,366 5.79 4.48
- -----------------------------------------------------------------------------------------
(9) DEBT
Debt consists of the following at December 31, 1997 and 1996:
(In thousands) 1997 1996
- -------------------------------------------------------------------------------
9% Mortgage Note, Payable in Monthly Installments of
$1.7 thousand (Principal and Interest) Through 2020 $ 200 $ 203
8.75% Mortgage Note, payable in Monthly Installments of
$2.5 thousand (Principal and Interest) Through 2039 1,185 1,187
Federal Home Loan Bank Notes Payable, Interest Rates
From 7.52% to 8.66% Due in 2001 5,030 5,030
- -------------------------------------------------------------------------------
$6,415 $6,420
===============================================================================
The 8.75% mortgage note relates to a low-income housing project. The monthly
installments are subsidized by the U.S. Department of Agriculture, which
pays $76 thousand annually so as to reduce the monthly principal and
interest payments to an amount equivalent to a loan at a basis rate of 1%.
Maturities of debt subsequent to December 31, 1997 are as follows: 1998--$6
thousand; 1999--$6 thousand; 2000--$7 thousand; 2001--$5,038 thousand; 2002--$8
thousand and $1,350 thousand thereafter.
As of December 31, 1997, the Company is in compliance with all of the
covenants of the Federal Home Loan Bank ("FHLB") agreements.
(10) STOCKHOLDERS' EQUITY
Vermont state law requires the Bank to appropriate a minimum of 10% of net
income to surplus until such time as appropriated amounts equal 10% of
deposits and other liabilities. The Company's stockholders' equity includes
$8.1 million as of December 31, 1997 and $7.2 million as of December 31,
1996 of such appropriations. Vermont state law also restricts the payment of
dividends under certain circumstances.
(11) EARNINGS PER SHARE
The following table presents a reconciliation of the calculations of basic
and diluted earnings per share for the year ended December 31, 1997:
Per Share
Income Shares Amount
- ---------------------------------------------------------------------------------------------
(In thousands except share and per share data)
Basic Earnings Per Share:
Income Available to Common Shareholders $8,833 4,423,153 $2.00
Diluted Earnings Per Share:
Options issued to Executives (See Note 6) -- 23,256
Income Available to Common Shareholders
plus Assumed Conversions $8,833 4,446,409 $1.99
=============================================================================================
Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
year. Upon adoption of SFAS No. 128 the Company's reported earnings per
share for 1996 and 1995 were restated. There was no effect on earnings per
share for prior periods.
(12) REENGINEERING
The Company began a reengineering project during 1995 to reduce ongoing
operating costs. As a result, the Bank implemented a plan to reduce its
workforce by approximately 250 employees. All employees were offered the
opportunity to voluntarily terminate their employment, which would entitle
them to a severance package equal to one week's pay for each year of service
plus four additional weeks. Employees whose age plus years of service with
the Company equalled at least 60 were offered an early retirement option
whereby, in lieu of the plan described above, five years would be added to
both their years of service and their age for purposes of determining vested
benefits through the pension plan. The total severance charges incurred by
the Company as a result of the reengineering project were approximately $1.3
million. The incremental cost of the enhanced early retirement benefit
realized during 1995 was approximately $728 thousand.
In conjunction with the reengineering project, the Company engaged a
consulting firm to assist in the identification of possible workforce
reductions and the implementation of the reengineering plan. The fee earned
by these consultants was, in part, contingent upon actual future operating
cost reductions and the increase in noninterest income. The Company
recognized all expenses associated with fees to these consultants of
approximately $2 million in 1995. Pursuant to an agreement with these
consultants, the Company made final payment to the consultants in 1997.
(13) COMMITMENTS AND CONTINGENCIES
The Bank is a counterclaim defendant in a litigation entitled Pasquale and
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim
Defendant, now pending in the United States Bankruptcy Court for the
District of Vermont.
In this litigation, the Vescios have made a number of "lender liability"
claims dealing with a commercial development known as Brattleboro West in
Brattleboro, Vermont. The pending litigation arose out of a suit to
foreclose on several real estate mortgages and personal property originally
granted to the Bank by the Vescios in connection with the financing of a
supermarket in the Brattleboro West project and various other projects.
Among other things, the Vescios have alleged that the Bank or its
representatives violated supposed oral promises in connection with the
origination and funding of the financing, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition,
the plaintiffs have contended that the Bank breached some kind of duty of
care they believe it owed to them, and have claimed that the Bank should not
have exercised its contract rights when the loan went into default, but
should have worked out the default in a way that was more favorable to the
borrowers. The parties have conducted extensive discovery and the matter is
now being tried in the Bankruptcy Court for the District of Vermont.
Although it is not possible at this stage to predict the outcome of this
litigation, the Bank believes that it has meritorious defenses to the
plaintiffs' allegations. The Bank intends to vigorously defend itself
against these claims.
The Company, the Bank, the Trust Company (the "Companies") and certain of
their directors are defendants in a lawsuit filed in November of 1994 (the
"Vermont Proceedings"). The Vermont Proceedings arose from certain
investments managed for Trust Company customers and placed into the Piper
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In
December of 1994, the Companies made payments to the Trust Company customers
in amounts that the Companies believe reimbursed those customers fully for
Portfolio losses. The United States District Court for the District of
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings with
prejudice, as moot, and has ordered payment of approximately $99,000 in
attorneys fees to the attorneys representing the Plaintiff. The Plaintiff
and his attorneys have appealed to the Second Circuit Court of Appeals the
District Court's orders, and the Companies have appealed on certain limited
issues.
The Companies have separately pursued claims against others on account of
the losses suffered as a result of the investments in the Portfolio. Claims
against Piper Jaffray Companies, Inc. were joined with the claims of others
in a class action in the United States District Court for the District of
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were
settled by the parties and in February of 1997 the District Court ordered
the net share of the settlement proceeds attributable to the Trust Company's
investments to be paid to the Trust Company, starting approximately sixty
days after the Court's order becomes final, except to the extent, if at all,
any other court with jurisdiction has sooner given leave for some or all of
those payments to be deposited with such other court pursuant to applicable
rules. The attorneys representing the Plaintiff in the Vermont Proceedings
and also representing, in the Minnesota Proceedings, the beneficiaries of
four other Trust Company accounts, have appealed that order to the Eighth
Circuit Court of Appeals. Those attorneys have taken the position that
notwithstanding the payments made by the Companies to the Trust Company
customers in December of 1994, any amounts paid under the Minnesota
Proceedings on account of the Trust Company's Portfolio investments should
be paid directly to the affected Trust Company customers (net of legal fees
to be paid to those attorneys). Any recovery by the Companies from the
Minnesota Proceedings is subject to the terms of an agreement between the
Companies and their insurance carrier, which reimbursed the Companies, in
part, for the December, 1994 payments.
Merchants Bancshares, Inc. and certain of its subsidiaries have been named
as defendants in various legal proceedings arising from their normal
business activities. Although the amount of any ultimate liability with
respect to such proceedings cannot be determined, in the opinion of
management, based upon the opinion of counsel on the outcome of such
proceedings, any such liability will not have a material effect on the
consolidated financial position of Merchants Bancshares, Inc. and its
subsidiaries.
(14) PARENT COMPANY
The Parent Company's investments in its subsidiaries are recorded using the
equity method of accounting. Summarized financial information relative to
the Parent Company only balance sheets at December 31, 1997 and 1996 and
statements of operations and cashflows for each of the three years in the
period ended December 31, 1997 are as follows:
(In thousands)
Balance Sheets as of December 31, 1997 1996
- ----------------------------------------------------------------------------
Assets:
Investment in and Advances to Subsidiaries* $54,703 $47,999
Other Assets 1,337 860
- ----------------------------------------------------------------------------
Total Assets $56,040 $48,859
============================================================================
Liabilities and Equity Capital:
Other Liabilities $ 3,104 $ 2,610
Equity Capital 52,936 46,250
- ----------------------------------------------------------------------------
Total Liabilities and Equity Capital $56,040 $48,860
============================================================================
(In thousands)
Statements of Operations for the Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------------------------
Dividends from Merchants Bank* $2,267 $ -- $ --
Equity in Undistributed Earnings (Losses) of Subsidiaries 6,652 6,306 (4,021)
Other Income (Expense), Net (130) (125) 72
(Provision) Benefit from Income Taxes (44) 43 107
- ------------------------------------------------------------------------------------------
Net Income (Loss) $8,833 $6,224 $(3,842)
==========================================================================================
Account balances are partially or fully eliminated in consolidation.
(In thousands)
Statements of Cash Flows for the Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Income (Loss) $8,833 $6,224 $(3,842)
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by Operating Activities:
Gains on Investment Securities -- -- (309)
(Increase) Decrease in Miscellaneous Receivables 116 99 (613)
Increase in Miscellaneous Payables 40 -- 2,528
Equity in Undistributed (Income)
Losses of Subsidiaries (6,679) (6,306) 4,021
- ------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 2,310 17 1,785
- ------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Repayment of Advances from Subsidiaries -- -- 1,035
Proceeds from Sales of Investment Securities -- -- 644
- ------------------------------------------------------------------------------------------
Net Cash Provided by Investing Activities -- -- 1,679
- ------------------------------------------------------------------------------------------
Cash Flows From Financing Activities:
Sale of Treasury Stock 1,234 -- 179
Acquisition of Treasury Stock (1,390) -- (2,083)
Proceeds from Exercise of Employee Stock Options 42 -- --
Issuance of Common Stock -- -- 2,554
Principal Payments on Debt -- -- (4,800)
Dividends Paid (2,217) -- --
Other, Net (35) -- --
- ------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (2,366) -- (4,150)
- ------------------------------------------------------------------------------------------
Increase (decrease) in Cash and Cash Equivalents (56) 17 (686)
Cash and Cash Equivalents at Beginning of Year 318 301 987
- ------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 262 $ 318 $ 301
==========================================================================================
Total Interest Payments $ -- $ -- $ 333
Taxes Paid 3,820 -- --
- ------------------------------------------------------------------------------------------
(15) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Commitments and Off-Balance Sheet Risk
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments primarily include commitments to extend credit
and financial guarantees. Such instruments involve, to varying degrees,
elements of credit and interest rate risk that are not recognized in the
accompanying consolidated balance sheets.
Exposure to credit loss in the event of nonperformance by the other party to
the financial instruments for commitments to extend credit and financial
guarantees written is represented by the contractual amount of those
instruments. The Bank uses the same credit policies in making commitments as
it does for on-balance sheet instruments. The contractual amounts of these
financial instruments at December 31, 1997 and 1996 are as follows:
(In thousands) Contractual Amount
-------------------------------------------------------------------
1997
Financial Instruments Whose Contract Amounts
Represent Credit Risk:
Commitments to Extend Credit $81,762
Standby Letters of Credit 5,650
Loans Sold with Recourse 1,182
-------------------------------------------------------------------
(In thousands) Contractual Amount
-------------------------------------------------------------------
1996
Financial Instruments Whose Contract Amounts
Represent Credit Risk:
Commitments to Extend Credit $80,756
Standby Letters of Credit 6,104
Loans Sold with Recourse 1,219
-------------------------------------------------------------------
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since a portion of the commitments
are expected to expire without being drawn upon, the total commitment amount
does not necessarily represent a future cash requirement. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained by the Bank upon extension of credit is based on
management's credit evaluation of the counterparty, and an appropriate
amount of real and/or personal property is obtained as collateral.
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Bank to guarantee performance of a customer to a
third party. Those guarantees are primarily issued to support public and
private borrowing arrangements. Most guarantees extend for less than two
years, and approximately 75% are for less than $100 thousand. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank obtains real
and/or personal property as collateral for those commitments for which
collateral is deemed to be necessary.
The Bank may enter into commitments to sell loans, which involve market and
interest rate risk. There were no such commitments at December 31, 1997 or
1996.
Interest Rate Floor Contracts
Interest rate floor transactions generally involve the exchange of fixed and
floating rate interest payments without the exchange of the underlying
principal amounts. The Company uses floor contracts to mitigate the effects
on net interest income in the event interest rates on floating rate loans
decline. The Company is exposed to risk should the counterparty default in
its responsibility to pay interest under the terms of the floor agreement,
but minimizes this risk by performing normal credit reviews on the
counterparties, by limiting its exposure to any one counterparty, and by
utilizing well known national investment firms as counterparties. Notional
principal amounts are a measure of the volume of agreements transacted, but
the level of credit risk is significantly less. At December 31, 1997 and
December 31, 1996, the notional principal amounts of such contracts
outstanding was $30 million and $20 million respectively. At December 31,
1997 and December 31, 1996, the amortized cost of such contracts was $69
thousand and $74 thousand respectively. No amounts have been received with
respect to these contracts.
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
Investments
The carrying amounts reported in the consolidated balance sheets for cash
and cash equivalents and stock in the Federal Home Loan Bank of Boston
approximate fair values. Fair value for investment securities is determined
from quoted market prices, when available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
An analysis of the fair value of the investment securities as of December
31, 1997 and 1996 is as follows:
1997 1996
- ----------------------------------------------------------------------------------
Carrying Carrying
(In thousands) Amount Fair Value Amount Fair Value
- ----------------------------------------------------------------------------------
Securities Available for Sale $ 44,241 $ 44,241 $ 57,656 $ 57,656
Securities Held to Maturity 111,458 112,467 86,904 86,004
Marketable Equity Securities -- -- 230 230
- ----------------------------------------------------------------------------------
$155,699 $156,708 $144,790 $143,890
==================================================================================
Loans
The fair value of variable rate loans that reprice frequently and have no
significant credit risk is based on carrying values. The fair value of fixed
rate (one-to-four family residential) mortgage loans, and other consumer
loans, is based on quoted market prices of similar loans sold in conjunction
with securitization transactions, adjusted for differences in loan
characteristics. The fair value for other loans is estimated using
discounted cash flow analyses, using interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality.
An analysis of the fair value of the loan portfolio as of December 31, 1997
and 1996 is as follows:
1997 1996
- ----------------------------------------------------------------------------------
Carrying Carrying
(In thousands) Amount Fair Value Amount Fair Value
- ----------------------------------------------------------------------------------
Net Loans $374,557 $378,093 $371,533 $371,187
- ----------------------------------------------------------------------------------
Deposits
The fair value of demand deposits approximates the amount reported in the
consolidated balance sheets. The fair value of variable rate, fixed term
certificates of deposit also approximate the carrying amount reported in the
consolidated balance sheets. The fair value of fixed rate and fixed term
certificates of deposit is estimated using a discounted cash flow which
applies interest rates currently being offered for deposits of similar
remaining maturities.
An analysis of the fair value of deposits as of December 31, 1997 and 1996
is as follows:
1997 1996
- ----------------------------------------------------------------------------------
Carrying Carrying
(In thousands) Amount Fair Value Amount Fair Value
- ----------------------------------------------------------------------------------
Demand Deposits $ 76,712 $ 76,712 $ 80,576 $ 80,576
Savings, NOW and Money Market 267,396 268,380 263,882 263,967
Time Deposits $100 thousand
and greater 23,307 23,540 20,370 20,522
Other Time Deposits 138,429 139,812 143,452 144,516
- ----------------------------------------------------------------------------------
$505,844 $508,444 $508,280 $509,581
==================================================================================
Debt
The fair value of debt is estimated using current market rates for
borrowings of similar remaining maturity.
An analysis of the fair value of the borrowings of the Company as of
December 31, 1997 and 1996 is as follows:
1997 1996
- -----------------------------------------------------------------------------
Carrying Carrying
(In thousands) Amount Fair Value Amount Fair Value
- -----------------------------------------------------------------------------
Other Borrowed Funds $8,000 $8,000 $9,599 $9,599
- -----------------------------------------------------------------------------
Debt 6,415 6,645 6,420 6,732
- -----------------------------------------------------------------------------
Commitments to Extend Credit And Standby Letters Of Credit
The fair value of commitments to extend credit is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counterparties. For fixed rate loan commitments, fair value also considers
the difference between current levels of interest rates and the committed
rates. The fair value of financial standby letters of credit is based on
fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the counterparties.
The fair value of commitments to extend credit and standby letters of credit
is $65 thousand and $88 thousand as of December 31, 1997 and 1996,
respectively.
Interest Rate Floors
The fair value of the interest rate floors associated with variable rate
commercial loans approximates the book carrying value. Management bases
estimates on quotes, from qualified investment brokers, of the market value
of the floor at the reporting date. The fair value of the interest rate
floor contracts at December 31, 1997 was $49 thousand, the amortized cost
was $69 thousand.
(17) SUMMARY OF UNAUDITED FINANCIAL INFORMATION:
(In thousands except per share data) 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
Q4 Q3 Q2 Q1 Year Q4 Q3 Q2 Q1 Year
- -------------------------------------------------------------------------------------------------------------------------------
Interest and Fee
Income $12,120 $12,137 $12,017 $11,884 $48,158 $11,909 $11,901 $11,990 $12,204 $48,004
Interest Expense 4,616 4,578 4,576 4,468 18,238 4,599 4,573 4,642 4,858 18,672
- -------------------------------------------------------------------------------------------------------------------------------
Net Interest
Income 7,504 7,559 7,441 7,416 29,920 7,310 7,328 7,348 7,346 29,332
Provision for
Possible Loan
Losses(1) (2,162) -- -- 300 (1,862) 450 900 900 900 3,150
Noninterest
Income(2) 2,700 1,740 1,715 1,761 7,916 1,972 1,897 2,174 2,913 8,956
Noninterest
Expense(3) 9,057 6,445 6,468 6,512 28,482 6,582 6,215 6,639 7,646 27,082
- -------------------------------------------------------------------------------------------------------------------------------
Income Before
Provision for
Income Taxes 3,309 2,854 2,688 2,365 11,216 2,250 2,110 1,983 1,713 8,056
Provision For
Income Taxes 607 665 610 501 2,383 548 501 439 344 1,832
- -------------------------------------------------------------------------------------------------------------------------------
Net Income $ 2,702 $ 2,189 $ 2,078 $ 1,864 $ 8,833 $ 1,702 $ 1,609 $ 1,544 $ 1,369 $ 6,224
===============================================================================================================================
Basic Earnings
Per Share $ 0.61 $ 0.50 $ 0.47 $ 0.42 $ 2.00 $ 0.40 $ 0.37 $ 0.36 $ 0.32 $ 1.45
===============================================================================================================================
Cash Dividends
Declared Per
Share $ 0.15 $ 0.15 $ 0.10 $ 0.10 $ 0.50 $ -- $ -- $ -- $ -- $ --
===============================================================================================================================
During the fourth quarter of 1997 the Bank recognized recoveries on
two previously charged off loans of $2.2 million. This amount was credited
to income through the provision for loan losses.
During the fourth quarter of 1997 the Bank recognized a gain of $840
on a security it held with a zero basis.
During the fourth quarter of 1997 the Bank recognized losses
resulting from its conversion to the Windows NT platform totaling $590
thousand; the Bank incurred or accrued legal and professional expenses in
conjunction with a lawsuit brought by a former customer totaling $1.2
million; the Bank made a one-time contribution to the Merchants Bank
Foundation of $400 thousand; and a $478 thousand write-down was taken
against one of the Bank's branch properties, based on the decision to sell
the property.
(18) REGULATORY ENVIRONMENT
The Bank and the Company are subject to various regulatory capital
requirements administered by federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possible
additional discretionary, actions by regulators that, if undertaken, could
have a direct material effect on the Bank's and the Company's financial
statements. Under capital adequacy guidelines, the Bank and the Company must
meet specific capital guidelines that involve quantitative measures of the
Bank's and the Company's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The Bank is also
subject to the regulatory framework for prompt corrective action that
requires the Bank to meet specific capital guidelines to be considered well
capitalized. The Bank's and the Company's capital amounts and classification
are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank and the Company to maintain minimum ratios (set forth in
the table below) of total and Tier-1 capital (as defined in the regulations)
to risk-weighted assets (as defined) and of Tier-1 capital (as defined) to
average assets (as defined). Management believes, as of December 31, 1997,
that the Bank and the Company meet all capital adequacy requirements to
which it is subject.
As of December 31, 1997, the most recent notification from the FDIC
categorized the Bank as well-capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since that
notification that management believes have changed the institution's
category. To be considered well capitalized under the regulatory framework
for prompt corrective action, the Bank must maintain minimum Tier-1
Leverage, Tier-1 Risk-Based, and Total Risk-Based Capital ratios as set
forth in the table below.
To Be Well-
Capitalized Under
For Capital Prompt Corrective
(In thousands) Actual Adequacy Purposes Action Provisions
- ------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
- ------------------------------------------------------------------------------------------
As of December 31, 1997:
Merchants Bancshares, Inc.:
Tier 1 Risk-Based Capital $50,596 12.49% $16,201 4.00% N/A
Total Risk-Based Capital 55,806 13.78 32,401 8.00 N/A
Tier 1 Leverage Capital 50,596 8.70 23,266 4.00 N/A
Merchants Bank:
Tier 1 Risk-Based Capital $52,536 12.94% $16,246 4.00% $24,369 6.00%
Total Risk-Based Capital 57,746 14.22 32,491 8.00 40,614 10.00
Tier 1 Leverage Capital 52,536 9.01 23,313 4.00 29,141 5.00
- ------------------------------------------------------------------------------------------
As of December 31, 1996:
Merchants Bancshares, Inc.:
Tier 1 Risk-Based Capital $43,814 11.08% $15,811 4.00% N/A
Total Risk-Based Capital 48,888 12.37 31,623 8.00 N/A
Tier 1 Leverage Capital 43,814 7.50 23,381 4.00 N/A
Merchants Bank:
Tier 1 Risk-Based Capital $45,517 11.56% $15,757 4.00% $23,635 6.00%
Total Risk-Based Capital 50,574 12.84 31,513 8.00 39,392 10.00
Tier 1 Leverage Capital 45,517 7.80 23,330 4.00 29,163 5.00
- ------------------------------------------------------------------------------------------
Merchants Bancshares, Inc. and Subsidiaries
Interest Management Analysis
(In thousands, taxable equivalent) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------
Interest % of Interest % of Interest % of
Income/ Average Income/ Average Income/ Average
Expense Assets Expense Assets Expense Assets
- --------------------------------------------------------------------------------------------------------
NET INTEREST INCOME:
Total Interest Income, Including
Fees on Loans $ 48,254 8.35% $ 48,140 8.29% $ 51,315 7.99%
Interest Expense 18,238 3.15 18,672 3.21 23,002 3.58
- --------------------------------------------------------------------------------------------------------
Net Interest Income Before Provision
for Possible Loan Losses 30,016 5.19 29,468 5.07 28,313 4.41
Provision for Possible Loan Losses (1,862) -0.32 3,150 0.54 12,100 1.88
- --------------------------------------------------------------------------------------------------------
Net Interest Income $ 31,878 5.51% $ 26,318 4.53% $ 16,213 2.52%
========================================================================================================
OPERATING EXPENSE ANALYSIS:
Noninterest Expense
Personnel $ 10,674 1.85% $ 10,013 1.72% $ 13,434 2.09%
Occupancy Expense 2,171 0.38 2,054 0.35 2,178 0.34
Equipment Expense 2,325 0.40 2,024 0.35 2,069 0.32
Loss/(Gain) on Disposition of Fixed
Assets 1,088 0.19 (565) 0
Other 12,224 2.11 13,556 2.33 15,974 2.49
- --------------------------------------------------------------------------------------------------------
Total Noninterest Expense 28,482 4.93 27,082 4.66 33,655 5.24
- --------------------------------------------------------------------------------------------------------
Less Noninterest Income
Service Charges on Deposits 3,075 0.53 3,347 0.58 3,184 0.50
Other, Including Securities Gains 4,841 0.84 5,609 0.96 6,632 1.03
- --------------------------------------------------------------------------------------------------------
Total Noninterest Income 7,916 1.37 8,956 1.54 9,816 1.53
- --------------------------------------------------------------------------------------------------------
Net Operating Expense $ 20,566 3.56% $ 18,126 3.13% $ 23,839 3.71%
========================================================================================================
SUMMARY:
Net Interest Income $ 31,878 5.51% $ 26,318 4.53% $ 16,213 2.52%
Less: Net Overhead 20,566 3.56 18,126 3.13 23,839 3.71
- --------------------------------------------------------------------------------------------------------
Profit Before Taxes-
Taxable Equivalent Basis 11,312 1.96 8,192 1.41 (7,626) -1.19
Net Profit (Loss) After Taxes $ 8,833 1.53% $ 6,224 1.07% $ (3,842) -0.60%
- --------------------------------------------------------------------------------------------------------
TOTAL AVERAGE ASSETS: $578,090 $580,860 $642,487
========================================================================================================
Merchants Bancshares, Inc.
Five Year Summary of Operations
(Not Covered by Report of Independent Public Accountants)
For the Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------
(In thousands except per share data) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT
Interest and Investment Income $ 48,158 $ 48,004 $ 51,315 $ 53,319 $ 51,474
Interest Expense 18,238 18,672 23,002 22,377 21,956
- ------------------------------------------------------------------------------------------------------------------
Net Interest Income 29,920 29,332 28,313 30,942 29,518
Provision for Possible Loan Losses (1,862) 3,150 12,100 10,000 23,822
- ------------------------------------------------------------------------------------------------------------------
Net Interest Income after Provision for Loan Losses 31,782 26,182 16,213 20,942 5,696
- ------------------------------------------------------------------------------------------------------------------
Other Income 7,916 9,363 12,766 15,038 12,128
Other Expense 28,482 27,489 36,606 41,712 28,016
- ------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES 11,216 8,056 (7,627) (5,732) (10,192)
Provision (benefit) for Income Taxes 2,383 1,832 (3,785) (2,842) (4,410)
- ------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 8,833 $ 6,224 $ (3,842) $ (2,890) $ (5,782)
==================================================================================================================
SELECTED AVERAGE BALANCES
Total Assets $578,090 $580,860 $642,487 $709,077 $705,516
Average Earning Assets 540,830 533,192 575,551 620,070 627,049
Loans 394,289 406,514 481,047 514,843 515,805
Total Deposits 505,987 513,923 556,242 598,305 570,957
Long-Term Debt 6,418 8,925 28,707 45,433 47,835
Shareholders' Equity 49,140 43,111 40,848 46,331 48,511
Shareholders' Equity plus Loan Loss Reserve 65,407 59,094 58,794 65,322 59,999
SELECTED RATIOS
Net Income (Loss) to:
Average Stockholders' Equity 17.98% 14.44% (9.41)% (6.24)% (11.92)%
Average Assets 1.53 1.07 (0.60) (0.41) (0.82)
Average Stockholders' Equity to Average Total Assets 8.50 7.42 (6.36) (6.53) (6.88)
Common Dividend Payout Ratio 25.00 -- -- -- --
Loan Loss Reserve to Total Loans at Year End 4.06 4.05 3.61 3.90 3.50
Net Charge-Offs to Average Loans (0.51) 1.26 3.28 1.97 1.95
PER SHARE
Basic Earnings per Common Share $ 2.00 $ 1.45 $ (0.90) $ (0.68) $ (1.37)
Diluted Earnings Per Common Share 1.99 1.45 (0.90) (0.68) (1.37)
Cash Dividends Paid 0.50 -- -- -- 0.20
Year End Book Value 11.95 10.78 9.38 10.00 10.74
OTHER
Cash Dividends Paid $ 2,141 $ -- $ -- $ -- $ 848
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein, this Annual Report
on Form 10-K may contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Investors are cautioned that forward-looking
statements are inherently uncertain. Actual performance and results of
operations may differ materially from those projected or suggested in the
forward-looking statements due to certain risks and uncertainties,
including, without limitation, (i) the fact that the Company's success is
dependent to a significant extent upon general economic conditions in
Vermont and Vermont's ability to attract new business, (ii) the fact that
the Company's earnings depend to a great extent upon the level of net
interest income (the difference between interest income earned on loans and
investments and the interest expense paid on deposits and other borrowings)
generated by the Bank, and the level of net interest income and thus the
Bank's results of operations may be adversely affected by increases or
decreases in interest rates, (iii) the fact that the banking business is
highly competitive and the profitability of the Company depends upon the
Bank's ability to attract loans and deposits in Vermont, where the Bank
competes with a variety of traditional banking and nontraditional
institutions such as credit unions and finance companies, and (iv) the fact
that at December 31, 1997, the Company's balance sheet loan portfolio was
$390 million of which commercial loans represented 58.8%, exposing the
Company to the risks inherent in financings based upon analyses of credit
risk, the value of underlying collateral, including real estate, and other
more intangible factors which are considered in making commercial loans.
Accordingly, the Company's profitability may be negatively impacted by
errors in risk analyses and by loan defaults and the ability of certain
borrowers to repay such loans may be adversely affected by any downturn in
general economic conditions. These factors, as well as general economic and
market conditions, may materially and adversely affect the market price of
the Company's common shares. Because of these and other factors, past
financial performance should not be considered an indicator of future
performance. The forward-looking statements contained herein represent the
Company's judgment as of the date of this Form 10-K, and the Company
cautions readers not to place undue reliance on such statements.
The following discussion and analysis of financial condition and results of
operations of the Company and its subsidiaries for the three years ended
December 31, 1997 should be read in conjunction with the consolidated
financial statements and notes thereto and selected statistical information
appearing elsewhere in this Annual Report on From 10-K. The information is
discussed on a fully taxable equivalent basis. Particular attention should
be given to the Interest Management Analysis and Five Year Summary of
Operations tables immediately preceding this discussion upon which this
discussion is primarily based. The financial condition and operating results
of the Company essentially reflect the operations of its principal
subsidiary, Merchants Bank.
RESULTS OF OPERATIONS: OVERVIEW
The Company recognized net income of $8.8 million for the year ended
December 31, 1997, an increase of $2.6 million from 1996. There were a
number of significant events during 1997 that contributed to this increase.
Due to the continued strength of the Bank's asset quality, and management's
assessment of the adequacy of the loan loss reserve as an indicator of that
strength, the Bank discontinued providing for loan losses during the second
quarter of 1997, after taking a $300 thousand provision in the first quarter
of the year. During the fourth quarter of 1997 the Company recognized
recoveries on two previously charged down loans of $2.2 million. This amount
was credited to income through the provision for loan losses. The Company
also recognized a gain of $840 thousand on an investment held in conjunction
with one of the above transactions. Conversely, the Company incurred legal
and professional expenses in conjunction with a lawsuit brought by a former
customer totaling $1.9 million during 1997 (See "Noninterest Income and
Expenses"). The Company also recognized losses resulting from the
disposition of certain fixed assets in conjunction with its conversion to
the Windows NT platform totaling $400 thousand, as well as training and
project management costs of $395 thousand. An additional significant event
during 1997 was a one-time contribution of $400 thousand to the Merchants
Bank Foundation, a charitable organization created during the 1980s to
promote community activities in Vermont. Finally, the Company made the
decision to market for sale one of its branch properties, and plans to lease
back the portion of the building used for the branch. A loss of $478
thousand was recognized in conjunction with this decision in the fourth
quarter of 1997. Core earnings (pretax earnings excluding the provision for
loan losses and certain one-time events) increased from approximately $11.2
million in 1996 to $12.1 million in 1997. The increase in core earnings is
due primarily to an overall increase in earning assets from $533 million in
1996 to $540 million in 1997, coupled with an overall decrease in interest
bearing liabilities from $451 million in 1996 to $446 million in 1997. These
factors coupled with the overall interest rate environment have had the
effect of slightly increasing the Bank's net interest margin from 5.53% in
1996 to 5.55% in 1997.
The Company recognized net income of $6.2 million for the year ended
December 31, 1996. Core earnings (pretax earnings, excluding the provision
for loan losses) increased from approximately $8.5 million in 1995 to $10.1
million in 1996. This increase is attributable to several factors. The
Company's portfolio of nonperforming loans decreased by $20.6 million from
$27.3 million at year-end 1995 to $6.7 million at year-end 1996.
Additionally, the Company's OREO portfolio decreased by $5.9 million from
$7.8 million at year-end 1995 to $1.9 million at year-end 1996. The
reductions in nonperforming asset levels allowed the Company to redeploy
funds into earning assets and reduce administrative efforts associated with
a nonperforming asset portfolio. Also, the Company began a reengineering
project during 1995 to reduce ongoing operating costs through a reduction in
workforce and improved operating efficiencies. The Company estimates that
the changes made as a result of the reengineering have reduced noninterest
expenses by approximately $4.6 million, and have had a marginal effect on
noninterest income.
The Company recognized a net loss of $3.8 million for the year ended
December 31, 1995, due primarily to the substantial provision for possible
loan losses of $12.1 million (refer to the discussion under "Provision for
Possible Loan Losses" that follows), and $4 million in reengineering charges
and related consultants fees. Substantially all costs incurred and actions
associated with the reengineering project occurred during 1995. Core
earnings (pretax earnings excluding the provision for loan losses and
reengineering expenses) showed slight improvement from 1994 to 1995 due
primarily to reductions in nonperforming assets.
Basic earnings (losses) per share were $2.00, $1.45 and $(0.90) for the
years ended December 31, 1997, 1996 and 1995, respectively. Fully diluted
earnings per share were $1.99, $1.45 and $(0.90) for the years ended
December 31, 1997, 1996 and 1995, respectively. In January 1997 the Company
declared a dividend, its first since April of 1993. The Company continued
dividends for the rest of 1997 declaring and distributing a total of $.50
per share during 1997. In January 1998, the Company declared a dividend of
$0.17 per share.
The net income (loss) as a percentage of average equity capital was 17.98%,
14.44% and (9.41%) for 1997, 1996 and 1995, respectively. The ten-year
average return on equity is 8.75% at December 31, 1997. The net income
(loss) as a percentage of average assets was 1.53%, 1.07% and (.60%) in
1997, 1996 and 1995, respectively. The ten-year average return on assets is
.64% at December 31, 1997.
YEAR 2000
The Bank is taking measures to address the impact of the Year 2000 issue on
its information systems. The Year 2000 issue, which is common to most
corporations, and especially important to banks, concerns the inability of
information systems, primarily computer software programs, to properly
recognize and process date sensitive information as the year 2000
approaches. Since the middle of 1997, a Year 2000 Committee (the Committee)
has been meeting and planning the actions the Bank needs to take to verify
that the Bank, all of its' vendors, and largest borrowing customers are in
compliance with Year 2000 requirements in advance of this millenium change.
The Committee is chaired by the Bank's Senior Operations Officer, and
includes the Chief Financial Officer, Chief Auditor/Risk Management Officer,
Information Systems Manager, Senior Loan Underwriter, a Trust Company
Officer and Facilities/Administration Manager. The Committee provides
progress reports to the Bank's senior management and reports at least
quarterly to the Board of Directors. The Committee has established an
assessment process that includes contacting and requesting a Year 2000 plan
and testing information from all vendors and the Bank's largest borrowing
customers. The Committee has contacted 175 vendors and service providers and
has received responses from critical vendors and service providers. The goal
is to complete programming changes and to have testing well underway for
mission-critical systems by December 31, 1998. Decisions regarding
replacement of any known non-compliant equipment or software will be made as
early in 1998 as possible. The Bank will seek to ensure that future system
installations will be year 2000 compliant. The Bank's core software provider
has been working to solve the Year 2000 issue for over two years, and has
reported to the Bank that, in its' opinion, the bulk of the reprogramming is
complete. This core software is the Bank's most significant Year 2000 risk.
Merchants Bank is regulated by the Federal Deposit Insurance Corporation
("FDIC"), which reviewed the Year 2000 plans during the fourth quarter of
1997. The FDIC intends to monitor the Bank's compliance efforts on a
quarterly basis through the year 2000. Current plans do not include the use
of outside vendors or temporary employees. The Committee currently estimates
that there will be costs associated with replacing certain non-compliant
software and/or hardware. The Bank plans to replace many of its ATMs as well
as upgrade certain software and equipment. The cost of these replacements is
estimated to be $1.1 million, these costs will be capitalized and
depreciated over the estimated useful lives of the assets, as such assets
represent replacement of existing equipment. Additional expenses are
estimated to be $135 thousand and will be expensed as incurred
NET INTEREST INCOME
Net interest income before the provision for possible loan losses is the
difference between total interest, loan fees and investment income, and
total interest expense. Net interest income before the provision for
possible loan losses is a key indicator of a bank's performance in managing
its assets and liabilities. Maximization and stability of net interest
income is a primary objective of the Bank. From 1996 to 1997, total interest
and dividend income increased $154 thousand (0.3%) and total interest
expense decreased $434 thousand (2.32%). This resulted in an increase to net
interest income before provision for possible loan losses on a fully taxable
equivalent basis of $588 thousand (1.97%) from $29.3 million in 1996 to
$29.9 million in 1997. A number of factors contributed to these changes.
First, the Company's portfolio of nonperforming loans continued to decrease,
from $6.7 million at year-end 1996 to $3.3 million at year-end 1997, and the
Company's OREO portfolio decreased by $1.3 million from $1.9 million at
year-end 1996 to $591 thousand at year-end 1997. Second, the Bank's overall
loan portfolio increased by $3.2 million (0.8%), while the Bank's investment
portfolio increased by $11.4 million (7.87%). Finally, deposits have
decreased by $2.5 million from year-end 1996 to year-end 1997 (see "Balance
Sheet Analysis" for a more comprehensive discussion of changes in the
balance sheet). The yield on total interest earning assets has decreased
from 9.03% for the year 1996 to 8.92% for the year 1997, as a result of the
change in the composition of interest earnings assets discussed above, and
increased competition from both bank and non-bank competitors. The cost of
interest bearing liabilities has decreased slightly from 4.14% for the year
1996 to 4.09% for the year 1997. This decrease in cost results from the
Bank's continuing strategies to encourage the movement of balances from time
deposits to money market accounts and NOW accounts. The Bank has seen its
FreedomLYNX accounts increase by $7.3 million over the course of 1997. These
accounts pay interest using a tiered rate structure, the current cost of
these funds is approximately 1.76%. Rates on money market accounts were
increased in the early part of 1997 to place the bank more competitively in
the marketplace, and to make these types of accounts more attractive to
investors. As interest rates fluctuate, money market accounts tend to move
in lock step with the changes instead of lagging the market as time deposits
typically do. Because the Bank's net interest income is more sensitive to a
decline in rates the Bank is better served to have more of its' core funding
in variable rate deposits. The combination of the changes discussed above
lead to a small increase in the overall net interest margin from 5.53% for
the year 1996 to 5.55% for the year 1997.
From 1995 to 1996, total interest income decreased $3.3 million (6.45%), and
total interest expense decreased $4.3 million (18.8%). This resulted in an
increase in net interest income before the provision for possible loan
losses on a fully taxable equivalent basis of $1 million (4.20%) from $28.5
million in 1995 to $29.5 million in 1996. A number of factors contributed to
this change. First, the Bank's overall loan portfolio decreased by $62
million (13.8%), while the Bank's investment portfolio increased by $46
million (47%) (See "Balance Sheet Analysis" for a more comprehensive
discussion of changes in the balance sheet.) This shift of funds from the
loan portfolio to the lower yielding investment portfolio decreased the
Bank's overall net interest income. However, the Bank decreased its
nonperforming loan portfolio by $20.6 million (75%), which created earning
assets and increased the yield on the overall loan portfolio from 9.61% to
9.86%. Second, during 1995, the Company paid off $20.4 million in long term
debt accruing at an average interest rate of 9.81%, resulting in a reduction
in the Company's cost of funds from 4.51% in 1995 to 4.14% in 1996. Finally,
the Bank made a strategic decision to lower the rates paid on certain
interest-bearing checking and money market accounts, which reduced its cost
of deposits from 4.16% in 1995 to 4.07% in 1996. These factors combined to
increase the Company's net interest margin from 4.95% in 1995 to 5.53% in
1996.
Total fees on loans decreased $714 thousand from $2,333 thousand in 1996 to
$1,619 thousand in 1997. This decrease is due primarily to a strategic
decision made by the Bank's Asset/Liability Committee a year ago to hold
many of its originated mortgages in portfolio rather than sell them in the
secondary market. The Bank has historically had a disproportionately low
allocation of residential real estate mortgages in its portfolio. The
retention of these credits in portfolio, while decreasing servicing revenue,
will result in higher interest revenue than could be earned in the Bank's
investment portfolio. Total fees on loans changed by an immaterial amount
from 1995 to 1996 and had a minimal effect on the change in net interest
income.
NONINTEREST INCOME AND EXPENSES
Net operating expense (net overhead) is total noninterest expense reduced by
noninterest income. Operating expense includes all costs associated with
staff, occupancy, equipment, supplies and all other noninterest expenses.
Noninterest income consists primarily of fee income on deposit accounts,
trust services, credit card, corporate and data processing services and
gains or losses on investment securities.
Excluding the FDIC assistance received pursuant to the loss sharing
agreement (see "FDIC Assisted Acquisition") of $407 thousand during 1996,
noninterest income decreased $1 million (11.6%) from 1996 to 1997. There are
three one-time events in the two years that effected this change. First,
during 1997, the Bank recognized an $840 thousand gain on an investment it
had with a zero basis. Second, during 1996, the Bank recognized a net gain
on the sale of a bank branch of $300 thousand, and third, during 1996, the
Bank received refunds of Vermont Franchise Tax paid in prior years of $885
thousand. Trust Company revenue has increased $142 thousand (9.51%) in 1997
over 1996, the result of increased marketing efforts by the Trust Company.
Service charges on deposits have decreased $272 thousand from 1996 to 1997
as the Bank continues to increase FreedomLYNX account balances. These
accounts charge no fees to customers who have a direct deposit, a debit card
or an automatic loan payment. Although there are generally no fees on these
accounts, the average interest cost is approximately 1.76% and the average
balance maintained by the customer is higher than a regular checking
account. Fees received related to merchants discounts on credit cards have
decreased by $159 thousand as a result of lower transaction volumes during
1997.
Excluding the FDIC assistance received pursuant to the loss sharing
agreement (see "FDIC Assisted Acquisition"), the gain on the curtailment of
the pension plan recognized in 1995, and net gains on investment securities,
noninterest income increased $1 million (13.35%) from 1995 to 1996. There
were two nonrecurring items comprising the majority of the net increase: a
net gain on the sale of a branch of $300 thousand and refunds of Vermont
Franchise Taxes paid in prior years of $800 thousand.
Noninterest expenses increased $1.4 million (5.17%) in 1997 from 1996,
excluding losses and write-downs on Segregated Assets reimbursed by the
FDIC. There were several significant nonrecurring events contributing to
this increase. The first such expense is the expenses recognized in
conjunction with the Company's conversion to the Windows NT platform. The
significant expenses recognized in conjunction with this conversion were
$395 thousand in costs associated with project management and training, and
$400 thousand recognized in conjunction with the retirement of certain not
yet fully depreciated assets. The Company is committed to the use of
technology to both increase efficiencies and to improve overall customer
service. The Company plans to convert the teller system to the Windows NT
platform during 1998, enabling our front line personnel to perform a
multitude of tasks and access extensive customer information without leaving
their stations. Recognizing that technology changes almost daily in the
current environment, the Company has made the decision to depreciate current
investments in technology based fixed assets and related software over a
three year schedule. The second significant expense during 1997 was a $478
thousand write-down of the Bank's branch in Brattleboro, VT when the Bank
made the decision to sell the property and lease back the portion used for a
branch office. One of the strategic decisions that the Company has made over
the last year is to reduce the substantial administrative costs associated
with being the lessor of real estate by decreasing its owned real estate
portfolio in situations where there are large portions of the building that
are leased to outside tenants. A third nonrecurring expense recognized
during 1997 was a $400 thousand contribution to the Merchants Bank
Foundation, a charitable organization established in the 1980s to support
community activities in Vermont. Additionally, during 1997, an investment
held by a subsidiary of the Bank was written down by $229 thousand.
Another significant factor contributing to the overall increase in
noninterest expenses was an increase of $2 million in legal and professional
fees, from $1.5 million for the year ended December 31, 1996 to $3.5 million
for the year ended December 31, 1997. The increase is due primarily to
expenses incurred by the Bank as it defended itself in litigation entitled
Pasquale and Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank,
Counterclaim Defendant, now pending in the United States Bankruptcy Court
for the District of Vermont. For further information on this litigation see
Part I, Item 3, Legal Proceedings.
The Bank has seen a substantial decrease in its expenses associated with
Other Real Estate Owned (OREO), from $3.4 million in 1996 to $314 thousand
in 1997 (90.8%). This is a direct result of the decrease in the OREO
portfolio from $1.9 million at year-end 1996 to $591 thousand at year-end
1997. Salaries and Wages, and associated benefits have increased from $10
million for the year 1996 to $10.7 million for the year 1997 (6.7%). This
increase is primarily attributable to the Company's incentive program begun
in 1996. This program is designed to compensate employees based on their
individual performance, as well as the performance of their individual
divisions. The program focuses on our improved efficiency for employees in
the service center, and on increased sales in the branches and sales
division.
Noninterest expenses decreased $6.6 million (19.5%) in 1996 from 1995,
excluding losses and write-downs on Segregated Assets reimbursed by the
FDIC. Contributing significantly to this reduction were an absence of
reengineering expenses in 1996 compared to $4.1 million in reengineering and
related costs recognized in 1995 (see Note 10 and discussion following).
Additionally, salaries and benefits decreased by $3.4 million (25.5%) in
1996 from 1995 as a result of the reengineering project begun in 1995.
Losses and write-downs of OREO increased $413 thousand from 1995 to 1996.
This increase is due primarily to the Bank's aggressive marketing of its
OREO portfolio and necessary adjustments to bring the value of the remaining
properties in line with the market.
The Company recognized $1,089 thousand in low-income housing tax credits as
a reduction in the provision for income taxes during 1997, $980 thousand
during 1996 and $851 thousand during 1995. As a consequence of the operating
losses incurred during 1995, the Company recognized a tax benefit of $3.8
million, including the $851 thousand in low-income housing tax credits.
Additionally, as of December 31, 1997, the Company has a cumulative deferred
prepaid tax asset of approximately $4.4 million arising from timing
differences between the Company's book and tax reporting. The prepaid tax
asset is included in other assets.
CREDIT QUALITY AND RESERVE FOR POSSIBLE LOAN LOSSES
Improving credit quality has been a major strategic focus of the Bank since
1994. The success of this program is evidenced by the Bank's aggressive
reduction in the level of problem assets over the last three years.
Nonperforming assets (loans past due 90 days or more and still accruing
interest, nonaccruing loans, restructured loans and other real estate owned)
decreased $4.7 million (54.65%) to $3.9 million at December 31, 1997 from
$8.6 million at December 31, 1996. Nonperforming assets decreased 75% to
$8.6 million at December 31, 1996 from $35.1 million at December 31, 1995.
The reserve for possible loan losses ("RPLL") was $15.8 million at December
31, 1997 and $15.7 million at December 31, 1996. As a percentage of loans
outstanding, the RPLL was 4.06% at year-end 1997 and 4.05% at year-end 1996.
The provision for possible loan losses was $(1.9) million in 1997, $3.2
million in 1996 and $12.1 million in 1995. Net charge-offs were $(2.0)
million in 1997 and $3.7 million in 1996. The negative loan loss provision
in 1997 resulted from a $2.16 million principal recovery received by the
Bank during the fourth quarter of 1997 on two previously charged down
credits. The continued high level of the RPLL reflects management's current
strategies and efforts to maintain the reserve at a level adequate to
provide for loan losses based on an evaluation of known and inherent risks
in the loan portfolio. Among the factors that management considers in
establishing the level of the reserve are overall findings from an analysis
of individual loans, the overall risk characteristics and size of the loan
portfolio, past credit loss history, management's assessment of current
economic and real estate market conditions and estimates of the current
value of the underlying collateral.
The Company takes all appropriate measures to restore nonperforming assets
to performing status or otherwise liquidate these assets in an orderly
fashion so as to maximize their value to the Company. There can be no
assurances that the Bank will be able to complete the disposition of
nonperforming assets without incurring further losses, or that the Bank will
continue to recognize substantial recoveries such as those received during
1997.
RISK MANAGEMENT
Management and the Board of Directors are committed to sound risk management
practices throughout the organization. In 1997, the Company developed and
implemented a centralized risk management monitoring program. Risks
associated with the Company's business activities and products were
identified and measured as to probability of occurrence and impact on the
institution (low, moderate or high), and the control or other activities in
place to manage those risks were identified and assessed. Periodically,
department-level and senior managers re-evaluate and report on the risk
management processes for which they are responsible. This documented program
provides management with a comprehensive framework for monitoring the
Company's risk profile from a macro perspective, while also serving as a
tool for assessing internal controls over financial reporting as required
under the FDIC Improvement Act.
Market Risk
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates/prices such as interest rates, foreign
currency exchange rates, commodity prices, and equity prices. The Company's
primary market risk exposure is interest rate risk. The ongoing monitoring
and management of this risk is an important component of the Company's
asset/liability management process which is governed by policies established
by its Board of Directors that are reviewed and approved annually. The Board
of Directors delegates responsibility for carrying out the asset/liability
management policies to the Asset/Liability Committee ("ALCO"). In this
capacity ALCO develops guidelines and strategies impacting the Company's
asset/liability management related activities based upon estimated market
risk sensitivity, policy limits and overall market interest rate
levels/trends.
Interest Rate Risk
Interest rate risk is the exposure to a movement in interest rates, which
could affect the Company's net interest income. It is the responsibility of
the Company's ALCO to manage interest rate risk, which arises naturally from
imbalances in repricing, maturity and/or cash flow characteristics of the
Company's assets and liabilities. The Committee is responsible for
developing asset/liability management strategies and tactics, and for
ensuring that the Board of Directors receives timely, accurate information
regarding the Bank's interest rate risk position at least quarterly.
Techniques used by the ALCO take into consideration the cash flow and
repricing attributes of balance sheet and off-balance sheet items and their
relation to possible changes in interest rates. The ALCO considers the use
of, and uses, interest rate floors to help to minimize the Bank's exposure
to changes in interest rates. Through the use of computerized modeling
systems, and with the assistance of outside consultants, the effect on the
Company's net interest income of a possible 200 basis point change in
interest rates, in rising and declining scenarios, is determined and
evaluated by management. The Bank has established a target range for the
change in net interest income, given a 200 basis point change in interest
rates, of zero to 5%. As of December 31, 1997, through the use of such
computer models, the change in net interest income for the 12 months ending
December 31, 1998 from the Company's expected or "most likely" forecast is
as follows:
Net Interest
Rate Change Income Sensitivity
-----------------------------------------------
Up 200 basis points (.46)%
Down 200 basis points 1.35%
-----------------------------------------------
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including:
the nature and timing of interest rate levels, including yield curve shape,
prepayments on loans and securities, deposit run-off rates, pricing
decisions on loans and deposits, reinvestment/replacement of asset and
liability cashflows, and others. While assumptions are developed based upon
current economic and local market conditions, the Company cannot make any
assurances as to the predictive nature of these assumptions including how
customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity
analysis, actual results will also differ due to: prepayment and refinancing
levels likely deviating from those assumed, the varying impact of interest
rate change caps or floors on adjustable rate assets, the potential effect
of changes in debt service levels of customers with adjustable rate loans,
depositor early withdrawals and product preference changes, and other
internal or external variables. Furthermore, the sensitivity analysis does
not reflect all actions that ALCO might take in responding to or
anticipating changes in interest rates.
The model used to perform the simulation assumes a parallel shift of the
yield curve over twelve months and reprices every interest-bearing asset and
liability on the Bank's balance sheet. The model uses contractual repricing
dates for variable products, contractual maturities for fixed rate products,
and product-specific assumptions for deposits such as NOW accounts and Money
Market accounts which are subject to repricing based on current market
conditions. Investment securities with call provisions are examined on an
individual basis in each rate environment to estimate the likelihood of a
call. The model also assumes that the rate at which certain mortgage related
assets prepay will vary as rates rise and fall, prepayment estimates are
derived from the Office of Thrift Supervision Net Portfolio Value Model.
The Company has entered into interest rate floor contracts to mitigate the
effects on net interest income in the event interest rates on floating rate
loans decline. The notional principal amounts of contracts outstanding were
$30 million, the amortized cost of such contracts was $69 thousand and the
fair value of the contracts was $49 thousand as of December 31, 1997. There
is little or no impact on the Company's net interest income as a result of
the interest rate floors in a rising rate environment. However, in a falling
rate environment the Company would receive payments under these contracts.
The Company's interest rate sensitivity gap ("gap") is pictured below. Gap
is defined as the difference between assets and liabilities repricing or
maturing within specified periods. An asset-sensitive position (positive
gap) indicates that there are more rate-sensitive assets than rate-sensitive
liabilities repricing or maturing within a specified time period, which
would imply a favorable impact on net interest income during periods of
rising interest rates. Conversely, a liability-sensitive position (negative
gap) generally implies a favorable impact on net interest income during
periods of falling interest rates. The Company's balance sheet is very
closely matched, as shown below.
Repricing Date
- --------------------------------------------------------------------------------------------------
One Day Over Six One Year
To Six Months To To Five Over Five
(In thousands) Months One Year Years Years Total
- --------------------------------------------------------------------------------------------------
Assets
Loans $169,467 $34,902 $139,473 $ 40,434 $384,276
Mortgage Backed Securities 13,123 10,033 42,377 46,357 111,890
US Treasury & Agency Securities 10,505 9,021 24,258 -- 43,784
Other Securities 2,296 -- -- -- 2,296
Other Assets -- -- -- 42,006 42,006
- --------------------------------------------------------------------------------------------------
Total Assets $195,391 $53,956 $206,108 $128,797 $584,252
==================================================================================================
Liabilities and Stockholders' Equity
Noninterest-bearing Deposits -- -- -- $ 77,054 $ 77,054
Interest-bearing Deposits $199,340 $54,445 $171,266 6,673 431,724
Borrowed Funds 8,000 -- -- 6,415 14,415
Other Liabilities -- -- -- 7,551 7,551
Stockholders' Equity -- -- -- 53,508 53,508
- --------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders'
Equity $207,340 $54,445 $171,266 $151,201 $584,252
==================================================================================================
Cumulative Gap (11,949) (12,438) 22,404
Gap as a % of Total Earning Assets (2.20)% (2.29)% 4.13%
- --------------------------------------------------------------------------------------------------
Based on historical experience and the Bank's internal repricing policies,
it is the Bank's practice to present repricing of statement savings, savings
deposits, FreedomLYNX and NOW account balances divided into two repricing
categories: 8% of such deposits are repriced in the "over six months to one
year" category, and the balance is repriced in the "one to five year"
category. The Bank's experience has shown that the rates on these deposits
tend to be less rate-sensitive than other types of deposits.
Credit Risk
Credit risk is managed by a network of loan officers, with review by the
Bank's Credit Department and oversight by the Board of Directors. The Board
of Directors grants each loan officer the authority to originate loans on
behalf of the Bank and establishes policies regarding loan portfolio
diversification and loan officer lending limits. The Bank's loan portfolio
is continuously monitored, through the use of a variety of management
reports and with the assistance of an external loan review firm, for
performance, creditworthiness and strength of documentation. Credit ratings
are assigned to commercial loans and are routinely reviewed. When necessary,
loan officers or the loan workout function take remedial actions to assure
full and timely payment of loan balances. The Bank's policy is to
discontinue the accrual of interest on loans when scheduled payments become
contractually past due in excess of 90 days and the ultimate collectibility
of principal or interest becomes doubtful. Credit card balances 90 days past
due are charged off and consumer installment loans are charged off when they
reach 120 days past due.
Liquidity and Capital Resource Management
Liquidity, as it pertains to banking, can be defined as the ability to
generate cash in the most economical way to satisfy loan and deposit
withdrawal demand, and to meet other business opportunities that require
cash. Sources of liquidity for banks include short-term liquid assets, cash
generated from loan repayments and amortization, borrowing, deposit
generation and earnings. The Merchants Bank has a number of sources of
liquid funds, including $20 million in available Federal Funds lines of
credit at year-end 1997; an overnight line of credit with the Federal Home
Loan Bank (FHLB) of $15 million; an estimated additional borrowing capacity
with FHLB of $42 million; and the ability to borrow $100 million through the
use of repurchase agreements, collateralized by the Bank's investments, with
certain approved counterparties. Additionally, the Bank's investment
portfolio is actively managed by the ALCO and is a strong source of cash
flow for the Bank. The portfolio is fairly liquid, with a weighted average
life of 3.5 years, and is available to be used as a source of funds, if
needed.
BALANCE SHEET ANALYSIS
The Bank's overall balance sheet has not changed significantly from year-end
1996 to year-end 1997. Total assets at December 31, 1997 increased $2.6
million from the previous year-end. The Company's earning assets have
increased $13.5 million (2.52%) from $534.9 million to $548.4 million. This
increase is due to an increase in the Bank's investment portfolio (including
FHLB stock) of $10.4 million from $147.6 million to $158 million (7.02%).
Additionally, the Company's total loan portfolio increased $3.2 million
(.8%) from 1996 to 1997. The composition of the Bank's loan portfolio has
changed. Commercial mortgages have decreased $22.8 million, while commercial
loans have increased $12.4 million and residential mortgage loans have
increased $7.7 million. This change in the composition of the Bank's loan
portfolio reflects the Bank's strategy to deemphasize the commercial
mortgage portfolio as it more actively pursues small business and commercial
credits, as well as residential mortgage loans. As part of this strategy,
the Bank introduced a new streamlined portfolio mortgage product during the
first quarter of 1998 which will shorten the turnaround time on residential
mortgages with reduced documentation from borrowers. Additionally, the Bank
introduced a new fixed rate homeline product during 1997. The balances bear
interest at a competitive fixed rate for five years. The homeline product is
one of the Bank's most profitable products, the risk profile is low, and the
back office costs are lower than most of our other loan types. Additionally,
these balances will help to mitigate the Bank's sensitivity to falling
interest rates. The Bank's interest bearing liabilities have decreased
slightly from $443.7 million to $443.5 million. The overall composition of
deposits has changed somewhat year over year. Total demand deposits have
decreased by $3.9 million, Savings, NOW and Money Market accounts have
increased by $3.5 million, while time deposits have decreased $2.1 million.
This shift is due primarily to the introduction of the Bank's FreedomLYNX
account in late 1996. This account bears interest at a slight premium to the
NOW rate on balances over $750 and requires no minimum balance. The account
encourages the use of technology and has no maintenance fees if the
depositor has a direct deposit, a debit card or an automatic loan payment.
Total assets at December 31, 1996 decreased $33 million (5.43%) from the
previous year-end. The net decrease is attributable to two major factors.
The first factor is a decrease in the Bank's loan portfolio by $62.5 million
over the course of 1996. Of this amount, $6.5 million resulted from the sale
of the Bank's branch located in Danville, VT in January of 1996.
Additionally, loans totaling $5.1 million were charged off, and the Bank
sold loans totaling $13.2 million in bulk loan sales. The remainder of the
decrease ($37.7 million) was the result of payouts of nonperforming
obligations and scheduled amortization greater than the level of new loan
originations as the Bank moved through the last phases of its reengineering
project. The second factor contributing to the net change in total assets is
the increase in the Bank's investment portfolio. As dollars previously
employed in the loan portfolio became available the Bank redeployed these
assets into its investment portfolio, resulting in a $46.5 million increase
in the investment portfolio over the course of 1996. During 1996, the
nonperforming loan portfolio decreased by $20.6 million (75%) and the Bank's
OREO portfolio decreased by $5.8 million (75%). It is important to note that
the Bank's year-end earning assets (net of nonperforming loans) increased by
$4 million during 1996. Total deposit balances declined during 1996 by $36.2
million (6.65%). This decrease in total assets is attributable to several
factors. In conjunction with the sale of the Bank's branch in Danville, VT,
$8.8 million in deposits was assumed by the buyer. Additionally, the
uncertainty created by the combination of the announced reengineering
project and the existing regulatory agreements, from which the Bank was
removed in October 1996, also contributed to the total deposit balance
decline.
The Bank began a capital improvement project to upgrade its branch
facilities and to make further investments in technology during 1996.
Approximately $2.8 million in 1997 and $4.1 million in 1996 was capitalized
and will be depreciated over the estimated useful lives of the individual
assets. Additionally, the Bank retired assets with a net book value of
approximately $596 thousand in 1997 and $600 thousand in 1996 in connection
with the projects; these amounts were charged to expense during the period
in which the assets were retired.
CAPITAL RESOURCES
Capital growth is essential to support deposit and asset growth and to
ensure strength and safety of the Company. Net income increased, and net
losses reduced, the Company's capital by $8.8 million in 1997, $6.2 million
in 1996 and ($3.8) million in 1995.
The Bank and the Company are subject to various regulatory capital
requirements administered by banking regulatory agencies. To be considered
adequately capitalized under the regulatory framework for prompt corrective
action, the Bank and the Company must maintain minimum Tier-1 Leverage,
Tier-1 Risk-Based and Total Risk-Based Capital. The Bank and the Company
were above all regulatory minimums and considered well capitalized by the
regulators at December 31, 1997. The ratios for the Company are set forth
below:
Minimum to be
Well-Capitalized
Under Regulatory
(In thousands) Amount Percentage Guidelines
- -----------------------------------------------------------------------
Tier-1 Risk-Based Capital $50,596 12.49% 6.0%
Total Risk-Based Capital 55,806 13.78 10.0
Tier-1 Leverage Capital 50,596 8.70 5.0
- -----------------------------------------------------------------------
EFFECTS OF INFLATION
The financial nature of the Company's balance sheet and statement of
operations is more clearly affected by changes in interest rates than by
inflation, but inflation does affect the Company because as prices increase
the money supply tends to increase, the size of loans requested tends to
increase, total bank assets increase, and interest rates are affected by
inflationary expectations. In addition, operating expenses tend to increase
without a corresponding increase in productivity. There is no precise
method; however, to measure the effects of inflation on the Company's
financial statements. Accordingly, any examination or analysis of the
financial statements should take into consideration the possible effects of
inflation.
FORM 10-K
The following is a copy, except for the exhibits, of the Annual Report of
Merchants Bancshares, Inc. (the "Company") on Form 10-K for the year ended
December 31, 1997, filed with the Securities and Exchange Commission (the
"Commission").
Certain information included herein is incorporated by reference from the
Company's 1997 Annual Report to Shareholders ("Annual Report") as indicated
below. Except for those portions of the Annual Report which are expressly
incorporated herein by reference, the Annual Report is not to be deemed
filed with the Commission. The Annual Report and Form 10-K have not been
approved or disapproved by the Commission, nor has the Commission passed
upon the accuracy or adequacy of the same.
TABLE OF CONTENTS
Part I Page Reference
- -----------------------------------------------------------------------------
Item 1--Business 44
Item 2--Properties 50--51
Item 3--Legal Proceedings 51--52
Item 4--Submission of Matters to a Vote of Security Holders 52
Part II
- -----------------------------------------------------------------------------
Item 5--Market for Registrant's Common Equity and Related
Stockholder Matters 53
Item 6--Selected Financial Data 53--61
Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations 33--42
Item 7a--Quantitative and Qualitative Disclosures about
Market Risk 38
Item 8--Financial Statements and Supplementary Data 3--32
Item 9--Changes in and Disagreements with Accountants
on Accounting and Financial Disclosures 62
Part III *
- -----------------------------------------------------------------------------
Item 10--Directors and Executive Officers of the Registrant
Item 11--Executive Compensation
Item 12--Security Ownership of Certain Beneficial Owners and Management
Item 13--Certain Relationships and Related Party Transactions
Part IV **
- -----------------------------------------------------------------------------
Item 14--Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Signatures
- --------------------
The information required by Part III is incorporated herein by
reference from the Company's Proxy Statement for the Annual Meeting of
Shareholders to be held on April 21, 1998.
A list of exhibits in the Form 10-K is set forth on the Exhibit Index
included in the Form 10-K filed with the Commission and incorporated
herein by reference. Copies of any exhibit to the Form 10-K may be
obtained from the Company by contacting Shareholder Communications,
Merchants Bancshares, Inc., P.O. Box 1009, Burlington, VT 05402. All
financial statement schedules are omitted since the required
information is included in the consolidated financial statements of
the Company and notes thereto in the Annual Report.
PART I
ITEM 1--BUSINESS
Merchants Bancshares, Inc. (The "Company") is a bank holding company
originally organized under Vermont law in 1983 for the purposes of owning
all of the outstanding capital stock of Merchants Bank (the "Bank"), and
providing greater flexibility in helping the Bank achieve its business
objectives. Merchants Bank, which is the Company's primary subsidiary, is a
Vermont Commercial Bank with 33 full-service offices.
The most significant event during 1997 was the beginning of the
simplification of the Bank's retail product line with our new FreedomLYNX
account serving as the foundation. Simple products that are easy to deliver
and geared to the needs of our customers is the hallmark of our strategy.
This product line has been designed to encourage our customers to make the
fullest use of our technology, while the completion of the Bank's retail
branch redesign, and the conversion to a common bank-wide computer platform,
has enabled Bank employees to work far more effectively and efficiently.
This combination of technology, simplification and efficiency has resulted
in significant increases in retail sales. The Bank believes that its
continued emphasis on providing personalized and customized service to the
communities it serves, while taking full advantage of the technology
available, gives it an advantage over the competition.
A chronology of events, including acquisitions, relating to MERCHANTS
BANCSHARES, INC., is as follows:
July 1, 1983: Merchants Bancshares, Inc. was organized as a Vermont
corporation, for the purpose of acquiring, investing in or holding
stock in any subsidiary enterprise under the Bank Holding Company
Act of 1956.
January 24, 1984: The Company acquired The Merchants Bank, a Vermont
chartered commercial bank.
June 2, 1987: Company shareholders approved a resolution to change
the state of incorporation of the Company from Vermont to Delaware.
October 4, 1988: The Company organized Merchants Properties, Inc.,
whose mission is described below.
MERCHANTS BANK, was organized in 1849, and assumed a national bank charter
in 1865, becoming The Merchants National Bank of Burlington, Vermont. On
September 6, 1974 the Bank converted its national charter to a state-bank
charter, becoming known as The Merchants Bank. Since 1971 the Bank has
acquired by merger seven Vermont banking institutions, and has acquired the
deposits of an eighth bank located in St. Johnsbury, Vermont. The last such
acquisition occurred on June 4, 1993 at which time the Bank acquired the New
First National Bank of Vermont, with thirteen banking offices, from the
Federal Deposit Insurance Corporation Division of Liquidation. As of
December 31, 1997 the Bank was one of the largest commercial banking
operations in Vermont, with deposits totaling $505.8 million, net loans of
$374.6 million, and total assets of $584.3 million, on a consolidated basis.
Since September 30, 1988, the Bank has participated as an equity partner in
the development of several affordable housing partnerships, which were
formed to provide residential housing units within the State of Vermont.
During the past four years these partnerships have developed 727 units of
residential housing, 494 (68%) of which qualify as "affordable housing units
for eligible low-income owners or renters", and 233 (32%) of which are
"market rate units." These partnerships have invested in 16 affordable and
elderly housing projects within 13 Vermont communities: St. Albans,
Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington,
Springfield, St. Johnsbury, Colchester, Swanton, Bradford and Hardwick.
MERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was
organized for the purpose of developing and owning affordable rental housing
units throughout the state of Vermont. As of December 31, 1997 Merchants
Properties, Inc. owned one development located in Enosburg, Vermont,
consisting of a 24-unit low-income family rental housing project, which was
completed and rented during 1989. This housing development is fully occupied
at this time. Total assets of this corporation at December 31, 1997 were
$1.2 million.
MERCHANTS TRUST COMPANY (the "Trust Company"), a wholly owned subsidiary of
Merchants Bank, is a Vermont corporation chartered in 1870 for the purpose
of offering fiduciary services such as estate settlement, testamentary
trusts, guardianships, agencies, intervivos trusts, employee benefit plans
and corporate trust services. The Trust Company also operates a discount
brokerage office through Olde Discount Corporation, enabling investors to
purchase or sell stocks and bonds on a discounted commission schedule. As of
December 31, 1997, the Trust Company had fiduciary responsibilities for
assets valued at market in excess of $333 million, of which more than $199
million were managed assets. Total revenue for 1997 was $1.6 million; total
expenses were $1.3 million resulting in pretax net income of $354 thousand
for the year. This net income is included in the consolidated tax return of
its parent company, the Merchants Bank.
QUENESKA CAPITAL CORPORATION, previously a wholly owned subsidiary of
Merchants Bank was established on April 4, 1988 as a Federal licensee under
the Small Business Act of 1958 to provide small business enterprises with
loans and/or capital. In December 1997 the corporation was dissolved.
RETAIL SERVICES
The Bank offers a variety of consumer financial products and services
designed to satisfy the deposit and loan needs of its retail customers. The
Bank's retail products include interest-bearing and noninterest-bearing
checking accounts, money market accounts, passbook and statement savings,
club accounts, and short-term and long-term certificates of deposit. The
Bank also offers customary check collection services, wire transfers, safe
deposit box rentals, and automated teller machine (ATM) cards and services.
In 1997, the Bank continued its commitment to automation by introducing a
debit card and by expanding its automated overdraft protection. Using the
BankLYNX Check Card, customers can pay for purchases at locations that
accept VISA, and can also use the card for standard ATM transactions. With
expanded automated overdraft protection, customers can use a savings account
and/or a home equity line of credit as overdraft protection for a checking
account. The customer may choose either or both accounts to cover
overdrafts.
During 1997, Merchants Bank expanded the qualifications for its FreedomLYNX
checking account. FreedomLYNX checking is available with no service charges
to customers who have, at least monthly, an automatic deposit to the account
or an automatic debit from the account to pay a Merchants Bank loan and to
customers who qualify for a BankLYNX Check Card or who use PhoneLYNX or
PCLYNX Bill Payment Services. The account pays interest on higher balances
with a tiered rate structure. No minimum balance is required. The Bank
continues to offer Bottom Line Checking, an account that provides for a flat
service charge up to a maximum number of checks.
The Bank continues to offer ATM cards, ATF (automatic transfer of funds) to
cover overdrafts, EFT (electronic funds transfer) to automate transfers
between accounts, PCLYNX bill payment services and the PCLYNX telephone
banking system. In 1998, the Bank plans to expand its automated services by
introducing a retail home banking system.
The Bank continues to provide strong customer service via 33 full-service
banking office and 35 ATM locations throughout Vermont.
COMMERCIAL SERVICES
The restructuring of the Sales organization has been completed. Each branch
office is led by a branch president or manager who has consumer lending
authority for the full range of retail credit services. Additionally, branch
presidents are being given small business lending authority up to a
prescribed limit. All 33 of our full service branches are led by branch
presidents. The eleven corporate banking officers and eight corporate
banking administrators provide commercial credit services throughout the
state of Vermont to customers requiring business credit above the prescribed
authorities of the branch presidents.
Merchants Bank offers a variety of commercial checking accounts. Commercial
Checking uses an earnings credit rate to help offset service charges. Small
Business Checking is designed for the smaller business carrying lower
balances and reduced account activity.
Investment opportunities are available to businesses in the form of savings
accounts and money market accounts. The Bank's cash management services
provide additional investment opportunities through the Cash Sweep Program.
Other cash management services include funds concentration.
The Bank offers on-line banking services through PCLYNX Corporate and PCLYNX
Small Business. These products allow businesses to view their account
histories, order stop payments, transfer between accounts, transmit ACH
batches and order both domestic and foreign wire transfers.
Other miscellaneous commercial banking services include night depository,
coin and currency handling, lockbox and balance reporting services. Employee
benefits management and related fiduciary services are available through the
Merchants Trust Company.
TYPES OF CREDIT OFFERINGS
Consumer Loans:
- ---------------
Financing is provided for new or used automobiles, boats, airplanes,
recreational vehicles and new mobile homes. Home improvement and home equity
lines of credit, Master Card credit cards and various collateral loans and
personal loans are also available.
Real Estate Loans:
- ------------------
Financing is available for one-to-four-family residential mortgages;
multifamily mortgages; residential construction; mortgages for seasonal
dwellings; and commercial real estate mortgages. The Bank offers both fixed
rate and adjustable rate mortgages for residential properties. Biweekly
payment and graduated (two-step) payment products are offered. Loans under
the Farmers Home Administration Rural Guaranteed Housing Program provide up
to 100% financing. The Bank also participates with the Vermont Housing
Finance Agency (VHFA) in providing mortgage financing for low- to moderate-
income Vermonters. Most mortgage loan products are offered with as little as
a 5% down payment to assist borrowers who qualify, provided that the
mortgagor(s) acquires private mortgage insurance.
Commercial Loans:
- -----------------
Financing for business inventory, accounts receivable, fixed assets, lines
of credit for working capital, community development, irrevocable letters of
credit, business credit cards and U.S. Small Business Administration loans
are available.
COMPETITION
The Bank competes for deposit and loan business with numerous other
commercial and savings banks, savings and loan associations, credit unions,
and other non-bank financial providers. As of December 31, 1997, there were
more than 30 state and national banking institutions operating in Vermont.
In addition, the number of other financial service providers competing in
Vermont has increased dramatically. As a bank holding company and state-
chartered bank, respectively, the Company and the Bank are subject to
extensive regulation and supervision, including, in many cases, regulation
which limits the type and scope of their activities. These non-financial
institutions who compete with the Company and the Bank are not subject to
such extensive regulation and supervision.
At year-end 1997, the Bank was one of the largest state chartered banks in
Vermont, enjoying a strong competitive franchise within the state, with 34
banking offices as identified in Item 2 (A).
Consolidation within the overall banking industry continues to change the
competitive environment in which we operate. Competition from nationwide
banks, as well as local institutions, is expected to be aggressive. However,
there may be opportunities for business development by the Bank in shared
market communities as a result of the continued consolidation in the banking
industry.
No material part of the Bank's business is dependent upon one, or a few,
customers, or upon a particular market segment, the loss of which would have
a materially adverse impact on the operations of the Bank.
NUMBER OF EMPLOYEES
As of December 31, 1997, Merchants Bancshares, Inc. had three officers:
Joseph L. Boutin, President and Chief Executive Officer; Jennifer L. Varin,
Secretary; and Janet P. Spitler, Treasurer. No officer of the Company is on
a salary basis.
As of December 31, 1997, Merchants Bank employed 216 full-time and 87 part-
time employees, representing a full-time equivalent complement of 243.14
employees; the Merchants Trust Company employed 14 full-time and 1 part-time
employees, representing a full-time equivalent complement of 14.6 employees.
The Bank and the Trust Company maintain comprehensive employee benefits
programs which provide major medical insurance, hospitalization, dental
insurance, long-term and short-term disability insurance, life insurance and
a 401(k) Employee Stock Ownership Plan. Employee benefits offered by the
Bank and the Trust Company are very competitive with comparable plans
provided by similar Vermont institutions.
REGULATION AND SUPERVISION
General
As a bank holding company registered under the Bank Holding Company Act of
1956, as amended (the "BHCA"), the Company is subject to substantial
regulation and supervision by the Federal Reserve Board. As a state-
chartered bank, the Bank is subject to substantial regulation and
supervision by the Federal Deposit Insurance Corporation (the "FDIC") and by
applicable state regulatory agencies. To the extent that the following
information describes statutory or regulatory provisions, it is qualified in
its entirety by reference to those particular statutory provisions. Any
change in applicable law or regulation may have a material effect on the
business and prospects of the Company and the Bank.
The Company is required by the BHCA to file with the Federal Reserve Board
an annual report and such additional reports as the Federal Reserve Board
may require. The Federal Reserve Board also makes periodic inspections of
the Company and its subsidiaries. The BHCA requires every bank holding
company to obtain the prior approval of the Federal Reserve Board before it
may acquire substantially all of the assets of any bank, or ownership or
control of any voting shares of an bank, if, after such acquisition, it
would own or control, directly or indirectly, more than 5% of the voting
shares of such bank. Additionally, as a bank holding company, the Company is
prohibited from acquiring ownership or control of 5% or more of any company
not a bank or from engaging in activities other than banking or controlling
banks except where the Federal Reserve Board has determined that such
activities are so closely related to banking as to be a "proper incident
thereto."
Dividends
General. The Company is a legal entity separate and distinct from the Bank
and its other nonbank subsidiaries. The revenue of the Company (on a parent
company only basis) is derived primarily from interest and dividends paid to
the corporation by its subsidiaries. The right of the Company, and
consequently the right of stockholders of the Company, to participate in any
distribution of the assets or earnings of any subsidiary through the payment
of such dividends or otherwise is necessarily subject to the prior claims of
creditors of the subsidiary (including depositors, in the case of banking
subsidiaries), except to the extent that certain claims of the Company in a
creditor capacity may be recognized.
The payment of dividends by the Company is determined by its board of
directors based on the Company's liquidity, asset quality profile, capital
adequacy, and recent earnings history, as well as economic conditions and
other factors, including applicable government regulations and policies and
the amount of dividends payable to the Company by its subsidiaries.
It is the policy of the Federal Reserve Board that banks and bank holding
companies, respectively, should pay dividends only out of current earnings
and only if after paying such dividends the bank or bank holding company
would remain adequately capitalized. Federal banking regulators also have
authority to prohibit banks and bank holding companies from paying dividends
if they deem such payment to be unsafe or unsound practice. In addition, it
is the position of the Federal Reserve Board that a bank holding company is
expected to act as a source of financial strength to its subsidiary banks.
State law requires the approval of state bank regulatory authorities if the
dividends declared by state banks exceed prescribed limits. The payment of
any dividends by the Company's subsidiaries will be determined based on a
number of factors, including the subsidiary's liquidity, asset quality
profile, capital adequacy and recent earnings history.
Legislation and Related Matters
General. In addition to extensive existing government regulation, federal
and state statutes and regulations are subject to changes that may have
significant impact on the way in which banks may conduct business. The
likelihood and potential effects of any such changes cannot be predicted.
Legislation enacted in recent years has substantially increased the level of
competition among commercial banks, thrift institutions and non-banking
institutions, including insurance companies, brokerage firms, mutual funds,
investment banks, finance companies and major retailers. In addition, the
existence of banking legislation such as the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA") have affected the banking
industry by, among other things, broadening the regulatory powers of the
federal banking agencies in a number of areas. The following summary is
qualified in its entirety by the text of the relevant statutes and
regulations.
FDICIA. The FDICIA, which was enacted on December 19, 1991, provides for,
among other things, increased funding for the Bank Insurance Fund ("BIF") of
the FDIC and expanded regulation of depository institutions and their
affiliates, including parent holding companies. A summary of certain
material provisions of FDICIA and its regulations is provided below.
Prompt Corrective Action. The FDICIA provides the federal banking agencies
with broad powers to take prompt corrective action to resolve problems of
insured depository institutions, depending upon a particular institution's
level of capital. The FDICIA establishes five tiers of capital measurement
for regulatory purposes ranging from "well-capitalized" to "critically
undercapitalized." A depository institution may be deemed to be in a
capitalization category that is lower than is indicated by its actual
capital position under certain circumstances. As of December 31, 1997, the
Bank was classified as "well-capitalized" under the applicable prompt
corrective action regulations.
Brokered Deposits. Under the FDICIA, a depository institution that is well-
capitalized may accept brokered deposits. A depository institution that is
adequately capitalized may accept brokered deposits only if it obtains a
waiver from the FDIC, and may not offer interest rates on deposits
"significantly higher" than the prevailing rate in its market. An
undercapitalized depository institution may not accept brokered deposits.
Safety and Soundness Standards. The FDICIA, as amended, directs each federal
banking agency to prescribe safety and soundness standards for depository
institutions relating to internal controls, information systems, internal
audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, asset-quality, earnings and stock
valuation. The Community Development and Regulatory Improvement Act of 1994
amended FDICIA by allowing federal banking activities to publish guidelines
rather than regulations concerning safety and soundness.
The Federal Reserve Board has finalized these safety and soundness
guidelines. These guidelines relate to the management policies of financial
institutions and are designed, in large part, to implement the safety and
soundness criteria outlined in FDICIA. These guidelines will be published
after the other federal bank regulatory agencies have developed their
guidelines. At this time, it is not known what effect the applicable
guidelines will have on the current practices of the Company or the Bank.
FDICIA also contains a variety of other provisions that may affect the
Company's and the Bank's operations, including reporting requirements,
regulatory guidelines for real estate lending, "truth in savings"
provisions, and the requirement that a depository institution give 90 days'
prior notice to customers and regulatory authorities before closing any
branch. Certain of the provisions in FDICIA have recently been or will be
implemented through the adoption of regulations by the various federal
banking agencies and, therefore, their precise impact cannot be assessed at
this time.
Capital Guidelines. Under the uniform capital guidelines adopted by the
federal banking agencies, a well-capitalized institution must have a minimum
ratio of total capital to risk-adjusted assets (including certain off-
balance sheet items, such as standby letters of credit) of 10%, a minimum
Tier 1 (comprised of common equity, retained earnings, minority interests in
the equity accounts of consolidated subsidiaries and a limited amount of
noncumulative perpetual preferred stock, less deductible intangibles)
capital-to-total risk based assets of 6% and a minimum leverage ratio (Tier
1 capital to average quarterly assets, net of goodwill), of 5%.
Under federal banking laws, failure to meet the minimum regulatory capital
requirements could subject a banking institution to a variety of enforcement
remedies available to federal regulatory authorities, including the
termination of deposit insurance by the FDIC and seizure of the institution.
Community Investment Act. Pursuant to the Community Reinvestment Act ("CRA")
and similar provisions of Vermont law, regulatory authorities review the
performance of the Company and the Bank in meeting the credit needs of the
communities served by the Bank. The applicable regulatory authorities
consider compliance with this law in connection with the applications for,
among other things, approval of branches, branch relocations and
acquisitions of banks and bank holding companies. The Bank received a
"satisfactory" rating at its most recent CRA examination.
Interstate Banking As of September 29, 1995, the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the "RNA") permitted
adequately capitalized and managed bank holding companies to acquire control
of banks in any state. Additionally, beginning on June 1, 1997, the RNA
provides for banks to branch across state lines, although individual states
are authorized to permit interstate branches earlier or to elect to opt out
entirely.
Other Proposals
Other legislative and regulatory proposals regarding changes in banking, and
the regulation of banks and other financial institutions, are regularly
considered by the executive branch of the federal government, Congress and
various state governments, including Vermont, and state and federal
regulatory authorities. It cannot be predicted what additional legislative
and/or regulatory proposals, if any, will be considered in the future,
whether any such proposals will be adopted or, if adopted, how any such
proposals would affect the Company or the Bank.
ITEM 2--PROPERTIES
A. SCHEDULE OF BANKING OFFICES BY LOCATION
Merchants Bank operates thirty-five banking facilities as indicated in
Schedule A below. Corporate administrative offices and the operations data
processing center are located at 275 Kennedy Drive, South Burlington,
Vermont.
Burlington 164 College Street Merchants Trust Company
172 College Street Branch office
1014 North Avenue Branch office
Essex Junction 54 Pearl Street Branch office
South Burlington 50 White Street Branch office
929 Shelburne Road(1) Branch office
275 Kennedy Drive Service Center
Corporate Offices
Branch office
Burlington International Airport(1) ATM
Bristol 15 West Street Branch office
Barre 105 North Main Street(2) Branch office
Northfield 47 Depot Square(2) Branch office
South Hero South St. & Route 2 Branch office
Hardwick Wolcott Street & Route 15 Branch office
Hinesburg Route 116/Shelburne Falls Rd Branch office
Vergennes Monkton Road Branch office
Winooski 364 Main Street Branch office
Shelburne 200 Wake Robin Drive(2) Branch office
Johnson Main Street, Route 15 Branch office
Colchester 8 Porters Point Road(2) Branch office
Jericho Route 15 Branch office
Enosburg Falls 155 Main Street Branch office
No. Bennington Bank Street Branch office
Manchester Center Route 7A Branch office
Brattleboro 205 Main Street(3) Branch office
Fairfield Plaza(2) ATM
Wilmington West Main Street Branch office
Bennington Putnam Square(2) Branch office
Wallingford Route 7(2) Branch office
St. Johnsbury 90 Portland Street Branch office
Bradford 1 Main Street & Operations Building Branch office
Fairlee U.S. Route #5(2) Branch office
Groton 258 Scott Highway Branch office
East Thetford U.S. Route #5 & VT 113(2) Branch office
Newbury U.S. Route #5 Branch office
Fair Haven 97 Main Street Branch office
Washington Street Grand Union(1) ATM
Springfield Springfield Shopping Plaza Branch office
56 Main Street(2) ATM
Windsor 160 Main Street Branch office
- --------------------
Facilities owned by the Bank are located on leased land.
Facilities located on leased land with improvements also leased.
As of December 31, 1997, a mortgage with an unpaid principal balance
of $200 thousand is outstanding on the Brattleboro office. This
mortgage is being amortized at $2 thousand per month, at a rate of 9%
through the year 2020.
ITEM 3--LEGAL PROCEEDINGS
The Bank is a counterclaim defendant in a litigation entitled Pasquale and
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim
Defendant, now pending in the United States Bankruptcy Court for the
District of Vermont.
In this litigation, the Vescios have made a number of "lender liability"
claims dealing with a commercial development known as Brattleboro West in
Brattleboro, Vermont. The pending litigation arose out of a suit to
foreclose on several real estate mortgages and personal property originally
granted to the Bank by the Vescios in connection with the financing of a
supermarket in the Brattleboro West project and various other projects.
Among other things, the Vescios have alleged that the Bank or its
representatives violated supposed oral promises in connection with the
origination and funding of the financing, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition,
the plaintiffs have contended that the Bank breached some kind of duty of
care they believe it owed to them, and have claimed that the Bank should not
have exercised its contract rights when the loan went into default, but
should have worked out the default in a way that was more favorable to the
borrowers. The parties have conducted extensive discovery and the matter is
now being tried in the Bankruptcy Court for the District of Vermont.
Although it is not possible at this stage to predict the outcome of this
litigation, the Bank believes that it has meritorious defenses to the
plaintiffs' allegations. The Bank intends to vigorously defend itself again
these claims.
The Company, the Bank, the Trust Company (the "Companies") and certain of
their directors are defendants in a lawsuit filed in November of 1994 (the
"Vermont Proceedings"). The Vermont Proceedings arose from certain
investments managed for Trust Company customers and placed into the Piper
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In
December of 1994, the Companies made payments to the Trust Company customers
in amounts that the Companies believe reimbursed those customers fully for
Portfolio losses. The United States District Court for the District of
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings with
prejudice, as moot, and has ordered payment of approximately $99,000 in
attorneys fees to the attorneys representing the Plaintiff. The Plaintiff
and his attorneys have appealed to the Second Circuit Court of Appeals the
District Court's orders, and the Companies have appealed on certain limited
issues.
The Companies have separately pursued claims against others on account of
the losses suffered as a result of the investments in the Portfolio. Claims
against Piper Jaffray Companies, Inc. were joined with the claims of others
in a class action in the United States District Court for the District of
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were
settled by the parties and in February of 1997 the District Court ordered
the net share of the settlement proceeds attributable to the Trust Company's
investments to be paid to the Trust Company, starting approximately sixty
days after the Court's order becomes final, except to the extent, if at all,
any other court with jurisdiction has sooner given leave for some or all of
those payments to be deposited with such other court pursuant to applicable
rules. The attorneys representing the Plaintiff in the Vermont Proceedings
and also representing, in the Minnesota Proceedings, the beneficiaries of
four other Trust Company accounts, have appealed that order to the Eighth
Circuit Court of Appeals. Those attorneys have taken the position that
notwithstanding the payments made by the Companies to the Trust Company
customers in December of 1994, any amounts paid under the Minnesota
Proceedings on account of the Trust Company's Portfolio investments should
be paid directly to the affected Trust Company customers (net of legal fees
to be paid to those attorneys). Any recovery by the Companies from the
Minnesota Proceedings is subject to the terms of an agreement between the
Companies and their insurance carrier, which reimbursed the Companies, in
part, for the December, 1994 payments.
Merchants Bancshares, Inc. and certain of its subsidiaries have been named
as defendants in various legal proceedings arising from their normal
business activities. Although the amount of any ultimate liability with
respect to such proceedings cannot be determined, in the opinion of
management, based upon the opinion of counsel on the outcome of such
proceedings, any such liability will not have a material effect on the
consolidated financial position of Merchants Bancshares, Inc. and its
subsidiaries.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of calendar year 1997 no matters were submitted to
a vote of security holders through a
solicitation of proxies or otherwise.
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The common stock of the Company is traded on the over-the-counter market and
the price is quoted on the Nasdaq National Market Stock Exchange under the
trading symbol MBVT. Quarterly stock prices during the last eight quarters
are as indicated below based upon quotations as provided by the National
Association of Securities Dealers, Inc. Prices of transactions between
private parties may vary from the ranges quoted below.
Quarter Ended High Low
--------------------------------------------------
December 31, 1997 33.500 26.000
September 30, 1997 29.000 20.500
June 30, 1997 21.125 18.000
March 31, 1997 21.250 18.250
December 31, 1996 19.375 15.000
September 30, 1996 16.000 15.000
June 30, 1996 16.375 14.250
March 31, 1996 16.000 13.250
--------------------------------------------------
As of March 6, 1998, Merchants Bancshares, Inc. had 1,281 registered
shareholders. In January 1997, the Company declared a dividend, its first
since April 1993. The Company continued dividends for the rest of 1997,
declaring and distributing a total of $.50 per share during 1997. In January
1998, the Company declared a dividend of $.0.17 per share. Future dividends
will depend upon the financial condition and earnings of the Company and its
subsidiaries, their need for funds and other factors, including applicable
government regulations.
ITEM 6--SELECTED FINANCIAL DATA
The supplementary financial data presented in the following tables and
narrative contain information highlighting certain significant trends in the
Company's financial condition and results of operations over an extended
period of time.
The following information should be analyzed in conjunction with the year-
end audited consolidated financial statements as contained in the 1997
Annual Report to Shareholders, a copy of which is attached as an addendum to
this Form 10-K.
The five-year summary of operations, interest management analysis and
management's discussion and analysis, all as contained on pages 31 through
42 of the 1997 Annual Report to Shareholders, are herein incorporated by
reference.
Tables included on the following pages 53 through 57 concern the following:
Deposits; return on equity and assets; short-term borrowings; distribution
of assets, liabilities, and stockholders' equity; analysis of changes in net
interest income; and the composition and maturity of the loan portfolio.
DEPOSITS
The following schedule shows the average balances of various classifications
of deposits:
(In thousands) 1997 1996 1995
--------------------------------------------------------------
Demand Deposits $ 75,972 $ 78,873 $ 87,434
Savings, Money Market and
Now Accounts 265,578 264,611 279,906
Time Deposits $100,000 and
Greater 19,750 20,059 20,927
Other Time Deposits 144,687 150,380 167,975
--------------------------------------------------------------
Total Average Deposits $505,987 $513,923 $556,242
==============================================================
Time Deposits $100 thousand and greater at December 31, 1997 had the
following schedule of maturities:
(In thousands)
----------------------------------
Three Months or Less $ 4,431
Three to Six Months 3,512
Six to Twelve Months 4,436
Over Twelve Months 4,254
Over Five Years 6,674
----------------------------------
$23,307
==================================
RETURN ON EQUITY AND ASSETS
The return on average assets, return on average equity, dividend payout
ratio and average equity to average assets ratio for the three years ended
December 31, 1997 were as follows:
1997 1996 1995
- ---------------------------------------------------------------------
Return on Average Total Assets 1.53% 1.07% (0.60%)
Return on Average Stockholders' Equity 17.98% 14.44% (9.41%)
Dividend Payout Ratio 25% N/A N/A
Average Stockholders' Equity to
Average Total Assets 8.5% 7.42% 6.36%
- ---------------------------------------------------------------------
SHORT-TERM BORROWINGS
Refer to Note 8 to the Financial Statements for this information.
The following table presents the condensed annual average balance sheets for
1997, 1996 and 1995. The total dollar amount of interest income from assets
and the subsequent yields calculated on a taxable equivalent basis as well
as the interest paid on interest bearing liabilities, expressed in dollars
and rates are also shown in the table.
Merchants Bancshares, Inc.
Distribution of Assets, Liabilities and Stockholders' Equity; Interest
Rates and Interest Differential
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(In thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Investment Securities:
U.S. Treasury and Agencies $142,070 $ 9,443 6.65% $117,908 $ 7,588 6.44% $ 83,749 $ 4,525 5.40%
Other, Including FHLB Stock 2,435 172 7.06% 2,865 148 5.17% 4,416 357 8.08%
- ---------------------------------------------------------------------------------------------------------------------------------
Total Investment Securities 144,505 9,615 6.65% 120,773 7,736 6.41% 88,165 4,882 5.54%
- ---------------------------------------------------------------------------------------------------------------------------------
Loans, Including Fees on
Loans(a)(b):
Commercial 68,036 7,479 10.99% 68,783 7,281 10.59% 87,009 9,236 10.61%
Real Estate 311,490 29,286 9.40% 322,690 31,135 9.65% 378,433 35,094 9.27%
Consumer 14,763 1,763 11.94% 15,041 1,673 11.12% 15,605 1,902 12.19%
- ---------------------------------------------------------------------------------------------------------------------------------
Total Loans 394,289 38,528 9.77% 406,514 40,089 9.86% 481,047 46,232 9.61%
Federal Funds Sold 2,036 111 5.45% 5,905 315 5.33% 6,339 366 5.77%
- ---------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 540,830 48,254 8.92% 533,192 48,140 9.03% 575,551 51,480 8.94%
- ---------------------------------------------------------------------------------------------------------------------------------
Reserve for Possible Loan Losses (16,267) (15,983) (17,946)
Cash and Due From Banks 22,833 28,907 34,099
Premises and Equipment 14,513 13,298 15,365
Other Assets 16,181 21,446 35,418
- ---------------------------------------------------------------------------------------------------------------------------------
Total Assets $578,090 $580,860 $642,487
=================================================================================================================================
LIABILITIES AND
STOCKHOLDERS' EQUITY:
Time Deposits:
Savings, Money Market &
NOW Accounts $265,578 $ 8,452 3.18% $264,611 $ 8,217 3.11% $279,906 $ 9,077 3.24%
Time Deposits $100 thousand
and Greater 19,750 821 4.16% 20,059 1,396 6.96% 20,927 1,433 6.85%
Other Time 144,687 8,043 5.56% 150,380 8,112 5.39% 167,975 8,981 5.35%
- ---------------------------------------------------------------------------------------------------------------------------------
Total Time Deposits 430,015 17,316 4.03% 435,050 17,725 4.07% 468,808 19,491 4.16%
Federal Funds Purchased 906 54 5.96% 704 32 4.59% 975 58 5.95%
Demand Notes Due U.S. Treasury 2,463 130 5.28% 2,134 108 5.04% 3,229 173 5.36%
Other Short-Term Borrowings 5,925 307 5.18% 4,206 205 4.88% 4,524 44 0.97%
Long-Term Debt 6,417 431 6.72% 8,925 602 6.75% 32,819 3,236 9.86%
- ---------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities 445,726 18,238 4.09% 451,019 18,672 4.14% 510,355 23,002 4.51%
- ---------------------------------------------------------------------------------------------------------------------------------
Demand Deposits 75,972 78,873 87,434
Other Liabilities 7,252 7,857 3,850
Stockholders' Equity 49,140 43,111 40,848
- ---------------------------------------------------------------------------------------------------------------------------------
Total Liabilities & Stockholders'
Equity $578,090 $580,860 $642,487
======== ======== ========
Net Interest Income (a) $30,016 $29,468 $28,478
======= ======= =======
Yield Spread 4.83% 4.89% 4.44%
====== ====== ======
NET INTEREST INCOME TO
EARNING ASSETS 5.55% 5.53% 4.95%
================================================================================================================================
Tax exempt interest has been converted to a tax equivalent basis
using the Federal tax rate of 34%.
Includes nonaccruing loans.
The following table sets forth, for each major category of interest earning
assets and interest bearing liabilities, the dollar amounts of fully taxable
equivalent interest income and interest expense and changes therein for 1997
as compared with 1996.
Merchants Bancshares, Inc.
Analysis of Changes in Net Interest Income
1997 vs 1996 1996 vs 1995
- ----------------------------------------------------------------------------------------------------------------------------------
Increase --Due to (a) -- Increase --Due to (a) --
(In thousands) 1997 1996 (Decrease) Volume Rate 1996 1995 (Decrease) Volume Rate
- ----------------------------------------------------------------------------------------------------------------------------------
Interest Income: $38,528 $40,089 ($1,561) $ 0 ($1,561) $40,089 $46,232 ($6,143) ($7,371) $1,228
Loans (b)
Investment Income:
Taxable 9,615 7,736 1,879 (30) 1,909 7,736 4,882 2,854 2,090 764
Federal Funds Sold 111 315 (204) 0 (204) 315 366 (51) (23) (28)
- ----------------------------------------------------------------------------------------------------------------------------------
Total $48,254 $48,140 $ 114 ($ 30) $ 144 $48,140 $51,480 ($3,340) ($5,304) $1,964
- ----------------------------------------------------------------------------------------------------------------------------------
Less Interest Expense:
Savings, Money Market &
NOW Accounts $ 8,452 $ 8,217 $ 235 $ 0 $ 235 $ 8,217 $ 9,077 ($ 860) ($ 474) ($ 386)
Time Deposits $100 thousand
and Greater 821 1,396 (575) 31 (606) 1,396 1,433 (37) (60) 23
Other Time 8,043 8,112 (69) (13) (56) 8,112 8,981 (869) (948) 79
Federal Funds Purchased 54 32 22 0 22 32 58 (26) (12) (14)
Demand Note--U.S. Treasury 130 108 22 12 10 108 173 (65) (55) (10)
Debt and Other Borrowings 738 807 (69) 106 (175) 807 3,280 (2,473) (1,600) (873)
- ----------------------------------------------------------------------------------------------------------------------------------
Total $18,238 $18,672 ($ 434) $136 ($ 570) $18,672 $23,002 ($4,330) ($3,149) ($1,181)
- ----------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $30,016 $29,468 $ 548 ($167) $ 715 $29,468 $28,478 $ 990 ($2,155) $3,145
==================================================================================================================================
The dollar amount of changes in interest income and interest expense
attributable to changes in rate and volume has been allocated
between rate and volume based upon the changes in rates times the
first year's volume and the changes in volume times the current
year's rate.
Includes balances of non-accruing loans.
Note: Included in Interest Income are fees on loans totaling $1,619 and
$2,333 for the years ended December 31, 1997 and 1996, respectively.
LOAN PORTFOLIO
The following tables display the composition of the Bank's loan portfolio
for the consecutive five year period 1993 through 1997, along with a
schedule profiling the loan maturity distribution over the next five years.
COMPOSITION OF LOAN PORTFOLIO
The table below presents the composition of the Bank's loan portfolio by
type of loan as of December 31 for each of the past five years. Amounts are
shown gross of net deferred loan fees of $859 thousand in 1997, $947
thousand in 1996, $956 thousand in 1995, $1,132 thousand in 1994 and $1,310
in 1993, which principally relate to real estate mortgages.
As of December 31,
Type of Loan 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------
(In thousands)
Commercial, Financial &
Agricultural $ 73,523 $ 61,091 $ 76,925 $ 92,612 $105,631
Real Estate--Construction 8,695 3,420 9,644 21,992 30,526
Real Estate--Commercial 155,983 178,780 197,591 204,023 236,666
Real Estate--Residential 136,305 128,577 148,611 173,406 176,446
Installment 15,450 14,831 16,560 18,086 22,836
Lease Financing -- -- -- -- 42
All Other Loan 432 534 393 436 1,324
- ---------------------------------------------------------------------------------
$390,388 $387,233 $449,724 $510,555 $573,471
=================================================================================
PROFILE OF LOAN MATURITY DISTRIBUTION
The table below presents the distribution of the varying maturities or
repricing opportunities of the loan portfolio at December 31, 1997. All
dollar amounts are expressed in thousands.
Over One
One Year Through Over Five
Type of Loan Or Less 5 Years Years Total
- -----------------------------------------------------------------------------
(In thousands)
Commercial Loans, Industrial
Revenue Bonds, Lease Financing
and All Other Loans $ 50,887 $ 12,269 $10,800 $ 73,956
Real Estate Loans 138,761 89,012 73,209 300,982
Installment Loans 3,595 4,983 6,872 15,450
- -----------------------------------------------------------------------------
$193,243 $106,264 $90,881 $390,388
=============================================================================
Loans maturing or repricing after one year which have predetermined interest
rates totaled $196.0 million. Loans maturing or repricing after one year
which have floating or adjustable interest rates totaled $1.1 million.
In 1997, a total of 366 one-to-four family residential mortgage loans were
closed by the bank, totaling $26.7 million. Substantially all of these
originations were placed in the Bank's portfolio. The Bank currently
services $193.3 million in residential mortgage loans for other investors
such as federal government agencies (FNMA and FHLMC) and for financial
investors such as insurance companies and pension funds located outside
Vermont.
During 1997, the Bank remained an active participant in the U.S. Small
Business Administration guaranteed loan program. 28 new SBA loans totaling
$3.4 million were originated during 1997 with SBA guarantees ranging from
70% to 85%. This volume of new lending activity represents a decrease of 21%
from that experienced in 1996.
Substantially all of the SBA and residential mortgage loans originated in
1997 have remained in portfolio. SBA guarantees are advantageous to the Bank
because they reduce risk in the Bank's loan portfolio and allow the Bank to
increase its commercial loan base and market share with minimal impact on
capital. The Bank's ALCO made the decision a year ago to hold most of its
originated loans in portfolio instead of selling them on the secondary
market. This strategic decision will help the Bank in its efforts to
diversify the loan portfolio, with greater emphasis on small business,
commercial and residential home mortgage lending and less on commercial real
estate.
During 1997, the Bank originated 520 commercial loans, totaling $74.4
million. This lending activity represented an increase of approximately 13%
of new loan volume from that experienced in 1996. Commercial loans were
originated throughout Vermont.
LOAN PORTFOLIO MONITORING
The Bank's Board of Directors grants each loan officer the authority to
originate loans on behalf of the Bank. The Board also establishes
restrictions regarding the types of loans that may be granted and the
distribution of loan types within the portfolio, and sets loan authority
limits for each lender. These authorized lending limits are established at
least annually and are based upon the lender's knowledge and experience.
Loan requests that exceed a lender's authority are referred to the Credit
Department. All extensions of credit of $2.5 million to any one borrower, or
related party interest, are reviewed and approved by the Directors Loan
Committee.
By using a variety of management reports, the Bank's loan portfolio is
continuously monitored by the Board of Directors and Credit Department. The
loan portfolio as a whole, as well as individual loans, are reviewed for
loan performance, creditworthiness, and strength of documentation. The Bank
has hired an external loan review firm to assist in portfolio monitoring.
Credit risk ratings are assigned to commercial loans and are routinely
reviewed.
All loan officers are required to service their own loan portfolios and
account relationships. As necessary, loan officers or the loan workout
function takes remedial actions to assure full and timely payment of loan
balances.
LOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES
Merchants Bank reviews the adequacy of the Reserve for Possible Loan Losses
("RPLL") at least quarterly. The method used in determining the amount of
the RPLL is not based on maintaining a specific percentage of RPLL to total
loans or total nonperforming assets, but rather a comprehensive analytical
process of assessing the credit risk inherent in the loan portfolio. This
assessment incorporates a broad range of factors, which indicate both
general and specific credit risk, as well as a consistent methodology for
quantifying probable credit losses. As part of the Bank's analysis of
specific credit risk, a detailed and extensive review is done on larger
credits and problematic credits identified on the watched asset list,
nonperforming asset listings and credit rating reports. Loans deemed
impaired at December 31, 1997 totaled $4.8 million. Impaired loans have been
allocated $665 thousand of the RPLL.
On June 4, 1993, the Bank acquired New First National Bank of Vermont
(NFNBV). The terms of the Purchase and Assumption Agreement (the
"Agreement") required the FDIC to reimburse the Bank 80% of the net charge-
offs up to $41 million on any acquired loans that qualify as loss-sharing
loans, for a period of three years from the date of acquisition. Losses in
excess of $41 million would be reimbursed at 95%. The Agreement expired
effective June 30, 1996, with respect to the reimbursement of losses. The
Bank is required to return to the FDIC 80% of any reimbursed losses
recovered, during the two year period following the expiration date.
As of June 30, 1996, the remaining balance of loss-sharing loans aggregated
$48.2 million; included in that balance was $2.9 million in nonperforming
loans. Due to the expiration of the loss-sharing agreement, management
adjusted the analysis of the RPLL to account for 100% of the loss exposure
associated with acquired loans that qualified as loss-sharing. The RPLL
analysis prepared the quarter ended March 31, 1996 showed an increase in the
reserve requirement of approximately $1.4 million, due to the expiration of
the Agreement. Management maintained the RPLL at a level adequate to offset
the required increase in the reserve requirement; therefore, no additional
provision was necessary due to the expiration of the Agreement.
Overall, management believes that the RPLL is maintained at an adequate
level, in light of historical, current and prospective factors, to reflect
the level of risk in the loan portfolio. Loan loss experience and
nonperforming asset data are presented and discussed in relation to their
impact on the adequacy of the RPLL.
The table below reflects the Bank's loan loss experience and activity in the
RPLL for the past five years.
Loan Losses and Reserve for Possible Loan Losses Reconciliation
December 31, 1997
(In thousands) 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------
Average Loans Outstanding $393,737 $406,514 $481,047 $514,843 $515,805
- -----------------------------------------------------------------------------------------
RPLL Beginning of Year 15,700 16,234 19,929 20,060 7,412
Charge-Off :
Commercial, Lease Financing
and all Other Loans (483) (907) (3,671) (3,356) (5,567)
Real Estate--Construction (78) (602) (1,485) (1,159) (275)
Real Estate--Mortgage (763) (3,206) (12,942) (7,673) (7,651)
Installment & Credit Cards (372) (405) (263) (462) (459)
- -----------------------------------------------------------------------------------------
Total Loans Charged Off (1,696) (5,120) (18,361) (12,650) (13,952)
- -----------------------------------------------------------------------------------------
Recoveries:
Commercial, Lease Financing
and all Other Loans 615 391 1,232 1,187 392
Real Estate--Construction -- 63 32 400 --
Real Estate--Mortgage 2,996 856 1,224 769 301
Installment & Credit Cards 78 125 78 163 85
- -----------------------------------------------------------------------------------------
Total Recoveries 3,689 1,435 2,566 2,519 778
- -----------------------------------------------------------------------------------------
Net Loan Losses 1,993 (3,685) (15,795) (10,131) (13,174)
- -----------------------------------------------------------------------------------------
Provision for Loan Losses:
Charged to Operations(1) (1,862) 3,150 12,100 10,000 23,882
Loan Loss Reserve (2) 2,000
- -----------------------------------------------------------------------------------------
RPLL End of Year $ 15,831 $ 15,700 $ 16,234 $ 19,929 $ 20,060
=========================================================================================
RPLL to Total Loans 4.06% 4.05% 3.61% 3.90% 3.50%
Net Losses to Average Loans -0.51% 0.91% 3.28% 1.97% 2.28%
- -----------------------------------------------------------------------------------------
The loan loss provision is charged to operating expense. When actual
losses differ from these estimates, and if adjustments are considered
necessary, they are reported in operations in the periods in which
they become known.
See Note 3 to the consolidated financial statements regarding the
acquisition of New First National Bank of Vermont.
The RPLL increased from $15.7 million at December 31, 1996 to $15.8 million
at December 31, 1997. Due to the continued strength of the Bank's asset
quality, and management's assessment of the adequacy of the loan loss
reserve as an indicator of that strength, the Bank discontinued providing
for loan losses during the second quarter of 1997, after taking a $300
thousand provision in the first quarter of the year. The total provision for
loan losses in 1996 was $3.1 million. During the fourth quarter of 1997, the
Bank recognized recoveries on two previously charged down loans of $2.2
million. This amount was credited to income through the provision for loan
losses. This discontinuation of loan loss provisions and the stable reserve
balances reflect the improvement in asset quality. These improvements are
further noted in the reduction of net loan losses and nonperforming assets,
as noted in the following tables:
NONPERFORMING ASSETS
The following tables summarize the Bank's nonperforming assets (NPAs) as of
December 31, 1993 through 1997.
(In thousands) 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------
Nonaccrual Loans $2,686 $4,091 $25,617 $32,200 $47,069
Loans Past Due 90 Days or
More and Still Accruing 403 216 237 668 715
Restructured Loans 215 2,403 1,430 5,083 2,841
- --------------------------------------------------------------------------------------
Total Nonperforming Loans: 3,304 6,710 27,284 37,951 50,625
- --------------------------------------------------------------------------------------
Other Real Estate Owned 591 1,925 7,772 13,231 13,674
- --------------------------------------------------------------------------------------
Total Nonperforming Assets: $3,895 $8,635 $35,056 $51,182 $64,299
======================================================================================
NPL to Total Loans 0.85% 1.70% 3.61% 3.90% 3.50%
NPA to Total Loans plus OREO 1.00% 2.20% 3.28% 1.97% 2.28%
- --------------------------------------------------------------------------------------
Excluded from the 1997 balances above are approximately $12.7 million of
internally classified loans. These loans have well-defined weaknesses which,
if left unattended, could lead to collection problems. Management maintains
an internal listing, which includes these loans, which is reviewed and
updated monthly. The oversight process on these loans includes an active
risk management approach. A management committee reviews the status of these
loans each quarter and determines or confirms the appropriate risk rating
and accrual status. The findings of this review process are instrumental in
determining the adequacy of the loan loss reserve.
DISCUSSION OF 1997 EVENTS AFFECTING NONPERFORMING ASSETS
Historically, the Company has worked closely with borrowers and also pursued
vigorous collection efforts. The Company continued its efforts to collect
troubled assets during 1997. The Company's enhanced Credit Department and
Loan Workout functions provided resources to address collection strategies
for nonperforming assets.
(In thousands) 12-31-97 9-30-97 6-30-97 3-31-97 12-31-96
- ----------------------------------------------------------------------------------
Nonaccrual Loans $2,686 $3,175 $3,295 $3,316 $4,091
Loans Past Due 90 days or
more and still Accruing 403 707 634 80 216
Restructured Loans 215 2,157 2,198 2,362 2,403
Other Real Estate Owned 591 225 330 516 1,925
- ---------------------------------------------------------------------------------
Total $3,895 $6,264 $6,457 $6,274 $8,635
=================================================================================
The more significant events affecting NPAs are discussed below.
Nonaccrual Loans
Nonaccrual loans declined from $4.1 million at December 31, 1996 to $2.7
million at December 31, 1997. Management continued its efforts to
proactively identify and resolve loans, which present significant risk of
loss to the Bank. During 1997, management identified approximately $4.5
million in accounts, which were transferred to nonaccrual status. These
transfers were offset by continued resolution of nonaccrual accounts;
approximately $1.0 million in loans were returned to accrual status;
principal payments of approximately $1.5 million were collected;
nonperforming loan sales were completed during the first and fourth quarters
reducing nonaccruing loans by approximately $2.7 million. In addition,
charges of approximately $800 thousand further decreased the balance of
nonaccruing loans.
Loans Past Due 90 Days or More and Still Accruing Interest
The Bank generally places loans that become 90 or more days past due in
nonaccrual status. If the ultimate collectibility of principal and interest
is assured, loans may continue to accrue and be left in this category.
Included in this category are loans which have reached maturity and have not
been renewed on a timely basis, for reasons other than financial capacity to
pay. Balances of loans past due 90 days have increased $187 thousand from
year end 1996 to year end 1997. Approximately 70% of these balances carried
a guaranty from the U.S. Small Business Administration.
Restructured Loans
Restructured loans (TDRs) decreased from $2.4 million at December 31, 1996
to $215 thousand at December 31, 1997. A single transaction was the primary
reason for the decrease. During the fourth quarter of 1997, a $2.0 million
commercial real estate loan was paid off in conjunction with the sale of the
underlying collateral. This loan was a restructured obligation, and
contributed to the $2.2 million decrease in the restructured portfolio.
Other Real Estate Owned and In-substance Forclosure
The Bank continued its success in 1997 in disposing of OREO and continues to
aggressively market such properties. The balance of OREO, net of reserves,
decreased from $1.9 million at December 31, 1996 to $591 thousand at
December 31, 1997. Of the total balance $36 thousand represents foreclosed
real estate. The balance of $555 thousand are bank owned properties that the
Bank has made the strategic decision to sell. In cases where these
properties house operating branches the Bank generally plans to sell the
real estate and lease back the portion of the building used for branch
purposes.
POLICIES AND PROCEDURES RELATING TO THE ACCRUAL OF INTEREST INCOME
The Bank normally recognizes income on earning assets on the accrual basis,
which calls for the recognition of income as earned, as opposed to when it
is collected. The Company's policy is to classify a loan more than 90 days
past due with respect to principal or interest as a nonaccruing loan, unless
the ultimate collectibility of principal and interest is assured. Income
accruals are suspended on all nonaccruing loans, and all previously accrued
and uncollected interest is typically charged against current income. A loan
remains on nonaccruing status until the factors which suggest doubtful
collectibility no longer exist, the loan is liquidated, or when the loan is
determined to be uncollectible and is charged off against the reserve for
possible loan losses. In those cases where a nonaccruing loan is secured by
real estate, the Company can, and usually does, initiate foreclosure
proceedings. The result of such action is to force repayment of the loan
through the proceeds of a foreclosure sale or to allow the Company to take
possession of the collateral in order to manage a future resale of the real
estate. Foreclosed property is recorded at the lower of its cost or
estimated fair value, less any estimated costs to sell. Any cost in excess
of the estimated fair value on the transfer date is charged to the reserve
for possible loan losses, while further declines in market values are
recorded as an expense in other noninterest expense in the statement of
operations. As of December 31, 1997 and 1996, the Company had valuation
reserves against the other real estate owned portfolio carrying values of
$653 thousand and $2.7 million, respectively.
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Please refer to pages 33-42 for Management's Discussion and Analysis of
Financial Condition and Results of Operations.
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated balance sheets of Merchants Bancshares, Inc. as of December
31, 1997 and 1996, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1997, together with the related notes and
the opinion of Arthur Andersen LLP, independent public accountants, all as
contained on pages 2 through 30 of the Company's 1997 Annual Report to
Shareholders on Form 10-K, are incorporated herein by reference.
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
Part III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11--EXECUTIVE COMPENSATION
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Reference is hereby made to pages 3 through 5, pages 8 through 10, page 13,
and page 15 of the Company's Proxy Statement to Shareholders dated March 6,
1998, wherein pursuant to Regulation 14A information concerning the above
subjects (Items 10 through 13) is incorporated by reference.
Pursuant to Rule 12b-23, definitive copies of the Proxy Statement will be
filed within 120 days subsequent to the end of the Company's fiscal year
covered by Form 10-K.
PART IV
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(1) The following consolidated financial statements, as included in the
1997 Annual Report to Shareholders, are incorporated herein by reference:
Consolidated Balance Sheets, December 31, 1997 and December 31, 1996.
Consolidated Statements of Operations for years ended December 31,
1997, 1996 and 1995.
Consolidated Statements of Changes in Stockholders' Equity for years
ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995.
Notes to Consolidated Financial Statements, December 31, 1997.
(2) The following exhibits are either filed or attached as part of this
report, or are incorporated herein by reference.
Exhibit Description
3.1 Restated Certificate of Incorporation of the Company
(Incorporated by reference to Exhibit B to Pre-Effective Amendment
No. 1 to Company's Definitive Proxy Statement for the Annual Meeting
of the Stockholders of the Company, filed on April 25, 1987)
3.2 Amended By-Laws of the Company (Incorporated by reference to
Exhibit C to Company's Definitive Proxy Statement for the Annual
Meeting of the Stockholders of the Company, filed on April 25,
1987).
4 Instruments defining the rights of security holders, including
indentures:
4.1 Specimen of the Company's Common Stock Certificate (Incorporated
by Reference to Exhibit 7 to the Company's Registration Statement
on Form S-14 (Registration Number 2-86108) filed on August 22, 1983)
4.2 Description of the rights of holders of the Company's Common Stock
(appearing on page 9 of the Company's Registration Statement on
Form S-14 (Registration No. 2-86108) filed on August 22, 1983)
10.1 Merchants Bancshares, Inc. Dividend Reinvestment and Stock Purchase
Plan (Incorporated by reference to Exhibit 4.1 to Company's
Registration Statement on Form S-3 (Registration No. 333-20375)
filed on January 22, 1997)
10.2 401(k) Employee Stock Ownership Plan of the Company, dated January
1, 1990, as amended (Incorporated by reference to Company's
Registration Statement on Form S-8 (Registration Number 33-3274)
filed on November 16, 1989)
10.3 Amended and Restated Merchants Bank Pension Plan dated as of January
1, 1994 (Incorporated by Reference to Exhibit 10.6 to Post-Effective
Amendment Number 1 to Company's Registration Statement on Form S-8
(Registration Number 333-18845) filed on December 26, 1996)
10.5 Employment Agreement dated as of January 1, 1997, by and between the
Company, Merchants Bank and Joseph L. Boutin (Incorporated by
reference to the Registrant's Annual Report on Form 10-K for the
Year Ended December 31, 1996)
10.7 Employment Agreement dated as of January 1, 1997, by and between
Merchants Bank and Michael R. Tuttle (Incorporated by reference to
the Registrant's Annual Report on Form 10-K for the Year Ended
December 31, 1996)
10.9 Employment Agreement dated as of January 1, 1997, by and between
Merchants Bank and Thomas R. Havers (Incorporated by reference to
the Registrant's Annual Report on Form 10-K for the Year Ended
December 31, 1996)
10.11 Employment Agreement dated as of January 1, 1997, by and between
Merchants Bank and Thomas S. Leavitt. (Incorporated by reference to
the Registrant's Annual Report on Form 10-K for the Year Ended
December 31, 1996)
10.12 Employment Agreement, dated as of January 1, 1998 by and between
Merchants Bank and Janet P. Spitler.
10.13 Employment Agreement, dated as of January 1, 1997, by and between
Merchants Bank and Merchants Trust Company and William R. Heaslip
(Incorporated by reference to the Registrant's Annual Report on Form
10-K for the Year Ended December 31, 1996).
10.14 The Merchants Bank Amended and Restated Deferred Compensation Plan
for Directors (Incorporated by reference to the Registrant's
Annual Report on Form 10-K for the Year Ended December 31, 1996).
10.14.1 Trust Under the Merchants Bank Amended and Restated
Deferred Compensation Plan for Directors (Incorporated
by reference to the Registrant's Annual Report on Form
10-K for the Year Ended December 31, 1996).
10.15 Agreement among the Merchants Bank and Kathryn T. Boardman, Thomas
R. Havers and Susan D. Struble dated as of December 20, 1995
(Incorporated by reference to the Registrant's Annual Report on
Form 10-K for the Year Ended December 31, 1996).
10.15.1 Trust Under the Agreement among the Merchants Bank and
Kathryn T. Boardman, Thomas R. Havers and Susan D.
Struble dated as of December 20, 1995 (Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the Year Ended December 31, 1996).
10.16 Agreement between the Merchants Bank and Dudley H. Davis dated
December 20, 1995 (Incorporated by reference to the Registrant's
Annual Report on Form 10-K for the Year Ended December 31, 1996).
10.16.1 Fixed Trust under Agreement between the Merchants Bank
and Dudley H. Davis dated December 20, 1995 (Incorporated
by reference to the Registrant's Annual Report on Form
10-K for the Year Ended December 31, 1996).
10.16.2 Variable Trust under Agreement between the Merchants
Bank and Dudley H. Davis dated December 21, 1995
(Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the Year Ended December 31,
1996).
11 Statement re: computation of per share earnings. See 1997 Annual
Report to Shareholders, Note 11.
13 1997 Annual Report to Shareholders
21 Subsidiaries of the Company
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
(3) Reports on Form 8-K: NONE
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on it's behalf by the undersigned, thereunto duly authorized.
Merchants Bancshares, Inc.
Date February 20, 1998 By /s/ Joseph L. Boutin
------------------------- ---------------------------------
Joseph L. Boutin, President & CEO
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of MERCHANTS
BANCSHARES, INC., and in the capacities and on the date as indicated.
By /s/ Joseph L. Boutin By /s/ Raymond C. Pecor, Jr.
------------------------------------- ----------------------------------
Joseph L. Boutin, Director, President Raymond C. Pecor, Jr. Director
& CEO of the Company and the Bank Chairman of the Board of Directors
By By
------------------------------------- ----------------------------------
Peter A. Bouyea, Director Charles A. Davis, Director
By /s/ Robert A. Skiff By /s/ Jeffrey L. Davis
------------------------------------- ----------------------------------
Robert A. Skiff, Director Jeffrey L. Davis, Director
By /s/ Michael G. Furlong By
------------------------------------- ----------------------------------
Michael G. Furlong, Director Benjamin F. Schweyer, Director
By /s/ Janet P. Spitler By /s/ Leo O'Brien, Jr.
------------------------------------- ----------------------------------
Janet P. Spitler, Treasurer of the Leo O'Brien, Jr, Director
Company, Vice President, CFO,
and Treasurer of the Bank
By /s/ Patrick S. Robins
-------------------------------------
Patrick S. Robins, Director