MERCHANTS BANCORP INC/OH - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003
OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from ___________ to __________

COMMISSION FILE NUMBER: 0-49771

MERCHANTS BANCORP, INC.
(Exact name of registrant as specified in its charter)

Ohio 31-1467303
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

100 North High Street, Hillsboro, Ohio 45133
(Address of principal executive offices) (Zip Code)

(937) 393-1993
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [X]

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock -- 3,000,000 shares outstanding at August 13, 2003

1

PART I - FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

The accompanying information has not been audited by independent public
accountants; however, in the opinion of management such information reflects all
adjustments necessary for a fair presentation of the results for the interim
period. All such adjustments are of a normal and recurring nature.

The accompanying financial statements are presented in accordance with the
requirements of Form 10-Q and consequently do not include all of the disclosures
normally required by accounting principles generally accepted in the United
States of America or those made in the Registrant's Form 10-K. Accordingly, the
reader of the Form 10-Q should refer to the Registrant's Form 10-K for the year
ended December 31, 2002 for further information in this regard.

2

MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2003 and DECEMBER 31, 2002 (in thousands except share data)

- ------------------------------------------------------------------------------------------------------
June 30, December 31,
2003 2002
ASSETS (unaudited)

CASH AND CASH EQUIVALENTS:

Cash and due from banks $ 11,971 $ 13,852
Federal funds sold 10,375 8,350
--------- ---------
Total cash and cash equivalents 22,346 22,202
--------- ---------

SECURITIES AVAILABLE FOR SALE
(amortized cost of $33,554 and $38,596 respectively) 35,334 40,012
--------- ---------

LOANS 274,975 248,270
Less allowance for loan losses (2,294) (2,106)
--------- ---------
Net loans 272,681 246,164
--------- ---------

OTHER ASSETS:
Bank premises and equipment, net 4,162 4,349
Accrued interest receivable 3,243 3,088
Deferred Income Tax 111
Other 3,646 2,873
--------- ---------
Total other assets 11,051 10,421
--------- ---------
TOTAL $ 341,412 $ 318,799
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY

LIABILITIES:
Deposits:
Noninterest bearing $ 29,906 $ 30,195
Interest bearing 234,578 232,521
--------- ---------
Total deposits 264,484 262,716
--------- ---------
Repurchase agreements 2,787 3,365
FHLB borrowings 37,537 17,470
Other liabilities 1,588 1,740
--------- ---------
Total liabilities 306,396 285,291
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock - no par value; 4,500,000 shares authorized
and 3,000,000 shares issued and outstanding 2,000 2,000
Additional paid-in capital 2,000 2,000
Retained earnings 29,950 28,682
Accumulated other comprehensive income 1,066 826
--------- ---------
Total shareholders' equity 35,016 33,508
--------- ---------
TOTAL $ 341,412 $ 318,799
========= =========

See notes to condensed consolidated financial statements.

3

MERCHANTS BANCORP, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data)

- ----------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2003 2002 2003 2002
(unaudited) (unaudited)
INTEREST INCOME:

Interest and fees on loans $ 4,853 $ 4,609 $ 9,462 $ 9,139
Interest and dividends on securities:
Taxable 180 387 393 775
Exempt from income taxes 249 252 499 433
Interest on federal funds sold and other short-term investments 56 22 102 90
-------- -------- -------- --------
Total interest income 5,338 5,270 10,456 10,437
-------- -------- -------- --------

INTEREST EXPENSE:
Interest on deposits 1,335 1,734 2,727 3,737
Interest on repurchase agreements and federal funds purchased 21 21 52 38
Interest on FHLB borrowings 356 219 592 440
-------- -------- -------- --------
Total interest expense 1,712 1,974 3,371 4,215
-------- -------- -------- --------
NET INTEREST INCOME 3,626 3,296 7,085 6,222

PROVISION FOR LOAN LOSSES (262) (145) (666) (229)
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,364 3,151 6,419 5,993
-------- -------- -------- --------

NONINTEREST INCOME - Service charges and fees 370 379 741 731
-------- -------- -------- --------
NONINTEREST EXPENSE:
Salaries and employee benefits 1,015 853 2,031 1,746
Occupancy 311 278 617 552
Legal and professional services 103 226 218 319
Franchise tax 60 68 144 152
Data processing 85 67 167 131
Advertising 49 46 90 94
Other 304 259 624 538
-------- -------- -------- --------
Total noninterest expense 1,927 1,797 3,891 3,532
-------- -------- -------- --------

INCOME BEFORE INCOME TAXES 1,807 1,733 3,269 3,192

INCOME TAXES (584) (555) (1,041) (1,019)
-------- -------- -------- --------

NET INCOME $ 1,223 $ 1,178 $ 2,228 $ 2,173
======== ======== ======== ========
BASIC AND DILUTED EARNINGS PER SHARE $ 0.41 $ 0.39 $ 0.74 $ 0.72
======== ======== ======== ========

See notes to condensed consolidated financial statements.

4

MERCHANTS BANCORP, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2003 and 2002 (in thousands)

- --------------------------------------------------------------------------------------------------
2003 2002
(unaudited)
OPERATING ACTIVITIES:

Net income $ 2,228 $ 2,173
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 450 443
Provision for loan losses 666 229
Gain on sale of mortgage loans (120) (89)
Proceeds from sale of mortgage loans 8,982 6,355
Mortgage loans originated for sale (8,862) (6,266)
Changes in assets and liabilities:
Accrued interest receivable (155) (141)
Other assets (774) (372)
Accrued interest, taxes and other liabilities (164) (625)
-------- --------
Net cash provided by operating activities 2,251 1,707
-------- --------

INVESTING ACTIVITIES:
Proceeds from sales and maturities of securities available for sale 5,166 6,527
Purchases of securities available for sale (200) (14,978)
Net increase in loans (27,183) (14,874)
Capital expenditures (187) (304)
-------- --------
Net cash used in investing activities (22,404) (23,629)
-------- --------

FINANCING ACTIVITIES:
Net (decrease) increase in deposits 1,768 (13,402)
Net (decrease) increase in repurchase agreements (578) 498
Net federal funds purchased 2,250
Net FHLB borrowings 20,067 8,488
Dividends paid to stockholders (960) (840)
-------- --------
Net cash (used in) provided by financing activities 20,297 (3,006)
-------- --------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 144 (24,928)

CASH AND CASH EQUIVALENTS:
Beginning of year 22,202 34,788
-------- --------
End of period $ 22,346 $ 9,860
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for federal income taxes $ 1,175 $ 1,356
======== ========
Cash paid during the period for interest $ 3,397 $ 4,316
======== ========

5

See notes to condensed consolidated financial statements.

MERCHANTS BANCORP, INC. AND SUBSIDIARY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
- --------------------------------------------------------------------------------

1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

The unaudited condensed consolidated financial statements include the
accounts of Merchants Bancorp, Inc. and its wholly-owned subsidiary,
Merchants National Bank (collectively, the "Company"). All significant
intercompany balances and transactions have been eliminated in
consolidation.

In the opinion of management, these condensed consolidated financial
statements include all adjustments (which consist of normal recurring
accruals) necessary to present the condensed consolidated financial
position as of June 30, 2003, the results of operations for the three and
six months ended June 30, 2003 and 2002, and of cash flows for the
six-months ended June 30, 2003 and 2002. These condensed consolidated
financial statements have been prepared in accordance with instructions
to Form 10-Q, and therefore do not include all information and footnote
disclosures necessary for a fair presentation of financial position,
results of operations and cash flows in conformity with accounting
principles generally accepted in the United States of America. Financial
information as of December 31, 2002 has been derived from the audited
consolidated financial statements of Merchants Bancorp, Inc. and
subsidiary. The results of operations for the three and six months ended
June 30, 2003 and 2002 and cash flows for the six months ended June 30,
2003 and 2002 are not necessarily indicative of the results to be
expected for the full year. For further information, refer to the
consolidated financial statements and footnotes thereto for the year
ended December 31, 2002, included in the Company's Form 10-K.

Earnings per Share - Basic earnings per share is computed using the
weighted average number of shares of common stock outstanding during the
period. For the three and six months ended June 30, 2003 and 2002, the
Company had three million shares outstanding. There were no common stock
equivalents or potentially diluted securities outstanding during the
respective periods.

New Accounting Pronouncements - In April 2003, the FASB issued SFAS No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain embedded
derivatives, and for hedging activities under SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities." This Statement amends
SFAS No. 133 to reflect the decisions made as part of the Derivatives
Implementation Group (DIG) and in other FASB projects or deliberations.
SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003, and for hedging relationships designated after June 30,
2003. Adoption of this standard is not expected to have a material effect
on the Company's Consolidated Financial Statements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity." This Statement establishes standards for how an entity
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. This Statement is
effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. Adoption of this standard
did not have a material effect on the Company's Consolidated Financial
Statements.

Reclassifications - The Company has reclassified certain prior year
amounts to conform with the current year presentation.

6

2. LOANS

Major classifications of loans are summarized as follows (in thousands):

The Company did not have any loans held for sale at June 30, 2003 or
December 31, 2002.

3. FHLB BORROWINGS

All stock in the Federal Home Loan Bank ("FHLB") and qualifying first
mortgage residential loans are pledged as collateral on FHLB borrowings.
Maturities and interest rates of advances from the FHLB at June 30, 2003
are as follows (in thousands):

7

The maximum amount available to the Company under FHLB borrowings was
approximately $68.9 million and $57.8 million as of June 30, 2003 and
December 31, 2002, respectively.

4. SUBSEQUENT EVENT

On July 23, 2003 the Company became aware of a probable credit loss with a
significant borrower. The Company is assessing its collateral position and
anticipates recording an additional loan loss provision of approximately $1.5
million in the third quarter.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

Merchants Bancorp, Inc. (the "Company") is a bank holding company and sole
shareholder of Merchants National Bank (the "Bank"), headquartered in Hillsboro,
Ohio. At June 30, 2003, the Company had total assets of approximately $341.4
million and total shareholders' equity of approximately $35 million.

The Company, through its banking affiliate, offers a broad range of banking
services to the commercial, industrial and consumer market segments which it
serves. The primary business of the Bank consists of accepting deposits through
various consumer and commercial deposit products, and using such deposits to
fund various loan products. The Bank's primary loan products are as follows: (1)
loans secured by residential real estate, including loans for the purchase of
one to four family residences which are secured by 1st and 2nd mortgages and
home equity loans; (2) consumer loans, including new and used automobile loans,
loans for the purchase of mobile homes and debt consolidation loans; (3)
agricultural loans, including loans for the purchase of real estate used in
connection with agricultural purposes, operating loans and loans for the
purchase of equipment; and (4) commercial loans, including loans for the
purchase of real estate used in connection with office or retail activities,
loans for the purchase of equipment and loans for the purchase of inventory.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the appropriate
application of certain accounting policies, many of which require us to make
estimates and assumptions about future events and their impact on amounts
reported in our financial statements and related notes. Since future events and
their impact cannot be determined with certainty, the actual results will
inevitably differ from our estimates. Such differences could be material to the
financial statements.

The Company believes the application of accounting policies and the estimates
required therein are reasonable. These accounting policies and estimates are
constantly reevaluated, and adjustments are made when facts and circumstances
dictate a change. Historically, the Company has found its application of
accounting policies to be appropriate, and actual results have not differed
materially from those determined using necessary estimates.

The Company's accounting policies are more fully described in Note 1 to the
condensed consolidated financial statements.

Management believes that the determination of the allowance for loan losses
represents a critical accounting policy. The Company maintains an allowance for
loan losses to absorb probable loan losses inherent in the portfolio. The
allowance for loan losses is maintained at a level management considers to be
adequate to absorb probable loan losses inherent in the portfolio, based on
evaluations of the collectibility and historical loss experience of loans.
Credit losses are charged and recoveries are credited to the allowance.
Provisions for loan losses are based on management's review of the historical
loan loss experience and such factors which, in management's judgment, deserve
consideration under existing economic conditions in estimating probable credit
losses. The allowance is based on ongoing assessments of the probable estimated
losses inherent in the loan

8

portfolio. The Company's methodology for assessing the appropriate allowance
level consists of several key elements, as described below.

Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and available legal options. Included in the review of individual loans are
those that are impaired as provided in Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as
amended. Any specific reserves for impaired loans are measured based on the fair
value of the underlying collateral. The Company evaluates the collectibility of
both principal and interest when assessing the need for a specific reserve.
Historical loss rates are applied to other commercial loans not subject to
specific reserve allocations.

Homogenous loans, such as consumer installment and residential mortgage loans,
are not individually reviewed by management. Reserves are established for each
pool of loans based on the expected net charge-offs. Loss rates are based on the
average five-year net charge-off history by loan category.

Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgment, reflect the impact of any
current conditions on loss recognition. Factors which management considers in
the analysis include the effects of the local economy, trends in the nature and
volume of loans (delinquencies, charge-offs, nonaccrual and problem loans),
changes in the internal lending policies and credit standards, collection
practices, and examination results from bank regulatory agencies and the
Company's internal credit review function.

An unallocated reserve is maintained to recognize the imprecision in estimating
and measuring loss when evaluating reserves for individual loans or pools of
loans.

Specific reserves on individual loans and historical loss rates are reviewed
throughout the year and adjusted as necessary based on changing borrower and/or
collateral conditions and actual collection and charge-off experience.

The Company has not substantively changed any aspect of its overall approach in
the determination of the allowance for loan losses since January 1, 2003. There
have been no material changes in assumptions or estimation techniques as
compared to prior years that impacted the determination of the current year
allowance.

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE, 2003 AND 2002

The Company reported net income of $1,223,000 and $1,178,000 for the three
months ended June 30, 2003 and 2002, respectively. During the same periods,
basic and diluted earnings per share were $.41 and $.39, respectively. On an
annualized basis, return on average assets was 1.44% and return on average
equity was 14.19% for the three months ended June 30, 2003, compared to 1.57%
and 14.97%, respectively, for the comparable period in 2002.

Net interest income for the three months ended June 30, 2003, was $3,626,000, an
increase of $330,000, or 10.0%, compared to net interest income of $3,296,000
for the comparable period in 2002. Net interest margin was 4.54% for the three
months ended June 30, 2003, compared to 4.71% for the comparable period in 2002.
The average annualized yield on earning assets decreased to 6.69% for the three
months ended June 30, 2003, from 7.54% for the comparable period in 2002. The
average cost of interest-bearing funds was 2.50% for the three months ended June
30, 2003, a decrease from 3.29% for the comparable period in 2002. Management
attributes the decrease in net interest margin to the contractual repricing of
one, three and five year adjustable rate mortgages in the loan portfolio. While
many of the Company's mortgage loan customers have refinanced to a lower
interest rate, other customers have not, but are expected to when their lending
terms mature.

The provision for loan losses was $262,000 and $145,000 for the three months
ended June 30, 2003 and 2002, respectively, representing an increase of 80.7%.
Net charge-offs for the three months ended June 30, 2003 were

9

$283,000, compared to $69,000 experienced during the three months ended June 30,
2002. Management increased the provision for loan losses during the three month
period ending June 30, 2003 to reflect the increased estimate of probable loan
losses in 2003, primarily related to certain borrowers within the agricultural
portfolio, which have been identified by management. Drought conditions, reduced
government program payments, and average to below-average grain prices have
affected the repayment opportunities for these certain borrowers. Management has
reviewed the borrowing and provided a specific reserve during the three months
ending June 30, 2003. Management has conducted a review of its agricultural
lending approval process and made modifications where necessary to strengthen
its underwriting process of agricultural operating loans. Management believes
its review process has adequately identified probable loans within its portfolio
on a timely basis.

Total noninterest income was $370,000 for the three months ended June 30, 2003,
a decrease of $9,000, or 2.6%, from $379,000 for the comparable period in 2002.
The decrease is due to a decrease in return check charges on customers' deposit
account transactions.

Total noninterest expense was $1,927,000 for the three months ended June 30,
2003, an increase of $130,000, or 7.2%, from $1,797,000 for the comparable
period in 2002. Salaries and benefits expense comprises the largest component of
noninterest expense, with totals of $1,015,000 and $853,000 for the three months
ended June 30, 2003 and 2002, respectively. The increase in salaries and
benefits expense is primarily attributable to the additional employees at the
new branch opened during 2002 and the hiring of a mortgage loan officer.

COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002

The Company reported net income of $2,228,000 and $2,173,000 for the six months
ended June 30, 2003 and 2002, respectively. During each of the same periods,
basic and diluted earnings per share were $.74 and $.72, respectively. On an
annualized basis, return on average assets was 1.34% and return on average
equity was 12.87% for the six months ended June 30, 2003, compared to 1.44% and
13.88%, respectively, for the comparable period in 2002.

Net interest income for the six months ended June 30, 2003, was $7,085,000, an
increase of $863,000, or 13.9%, compared to net interest income of $6,222,000
for the comparable period in 2002. Net interest margin was 4.49% for the six
months ended June 30, 2003, compared to 4.34% for the comparable period in 2002.
The average annualized yield on earning assets decreased to 6.63% for the six
months ended June 30, 2003, from 7.28% for the comparable period in 2002. The
average cost of interest-bearing funds was 2.52% for the six months ended June
30, 2003, a decrease from 3.48% for the comparable period in 2002. Management
attributes the improved net interest margin to the relatively short maturity of
its certificates of deposit, which have repriced downward relatively quickly in
the current interest rate environment, as well as the contractual repricing
within the mortgage loan portfolio. While many of the Company's mortgage loan
customers have refinanced to a lower interest rate, other customers have not,
but are expected to when their lending terms mature

The provision for loan losses was $666,000 and $229,000 for the six months ended
June 30, 2003 and 2002, respectively, representing an increase of 190.8%. Net
charge-offs for the six months ended June 30, 2003 were $477,000, compared to
$127,000 experienced during the six months ended June 30, 2002. Management
increased the provision for loan losses during the six month period ending June
30, 2003 to reflect the increased estimate of probable loan losses in 2003,
primarily related to certain borrowers within the agricultural portfolio, which
have been identified by management. Drought conditions, reduced government
program payments, and average to below-average grain prices have affected the
repayment opportunities for these certain borrowers. Management has reviewed the
borrowing and provided a specific reserve during the six months ending June 30,
2003. Management has conducted a review of its agricultural lending approval
process and made modifications where necessary to strengthen its underwriting
process of agricultural operating loans. Management believes its review process
has adequately identified probable loans within its portfolio on a timely basis.

Total noninterest income was $741,000 for the six months ended June 30, 2003, an
increase of $10,000, or 1.4%, from $731,000 for the comparable period in 2002.
The increase is due to service charges on customers' deposit account
transactions.

10

Total noninterest expense was $3,891,000 for the six months ended June 30, 2002,
an increase of $359,000, or 10.16%, from $3,532,000 for the comparable period in
2002. Salaries and benefits expense comprises the largest component of
noninterest expense, with totals of $2,031,000 and $1,746,000 for the six months
ended June 30, 2003 and 2002, respectively. The increase in salaries and
benefits expense is primarily attributable to the additional employees at the
new branch opened during 2002 and the hiring of a mortgage loan officer.

FINANCIAL CONDITION

The Company's total assets increased to $341.4 million as of June 30, 2003 from
$318.8 million as of December 31, 2002, an increase of 7.1%. An increase of
$26.7 million in loans was partially offset by a decrease of $4.7 million in
securities. The increase in FHLB borrowings of $20.1 funded the increase in
loans, which was driven by increases in the residential mortgage portfolio due
to the continued historically low interest rates.

LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company reported total loans of $275.0 million as of June 30, 2003 and
$248.3 million as of December 31, 2002, an increase of $26.7 million, or 10.8%.
The portfolio composition has remained consistent during the period.

Federal regulations and generally accepted accounting principles require that
the Company establish prudent allowances for loan losses. The Company maintains
an allowance for loan losses to absorb probable loan losses inherent in the
portfolio, based on evaluations of the collectibility and historical loss
experience of loans. Loan losses are charged and recoveries are credited to the
allowance. Provisions for loan losses are based on management's review of the
historical loan loss experience and such factors which, in management's
judgment, deserve consideration under existing economic conditions in estimating
probable loan losses. The allowance is based on ongoing assessments of the
probable estimated losses inherent in the loan portfolio. The Company has not
substantively changed any aspect of its overall approach in the determination of
the allowance for loan losses during 2003. There have been no material changes
in assumptions or estimation techniques as compared to prior years that impacted
the determination of the current year allowance.

The allowance for loan losses was 0.83% of total loans as of June 30, 2003 and
0.85% as of December 31, 2002.

The amount of nonaccrual loans increased to $573,000 as of June 30, 2003,
compared to $307,000 as of March 31, 2003, and $476,000 at December 31, 2002. As
a percentage of total loans, nonaccrual loans represented 0.21% as of June 30,
2003, 0.12% as of March 31, 2003, and 0.19% as of December 31, 2001.

The category of accruing loans which are past due 90 days or more was $2,772,000
as of June 30, 2003, $2,223,000 as of March 31, 2003, and $1,133,000 as of
December 31, 2002. As a percentage of total loans, loans past due 90 days and
still accruing interest represented 1.0% as of June 30, 2003, 0.86% as of March
31, 2003, and 0.46% as of December 31, 2002. The increase of $549,000 from March
2003 is primarily made up of four loans. One loan with a balance of $219,000 is
a business loan that is being held in an estate. Once the estate is settled and
liquidated the Company is expected to receive full payment of loan. The other
loans are one-four family residential loans currently in the foreclosure
process. Management believes liquidation of underlying collateral will be
sufficient to mitigate any significant loss on the loans.

On July 23, 2003 the Company became aware of a probable credit loss with a
significant borrower. The Company is assessing its collateral position and
anticipates recording an additional loan loss provision of approximately $1.5
million in the third quarter.

As a percentage of the allowance for loan losses, total nonaccrual loans and
loans past due 90 days or more were 145.8% as of June 30, 2003, 109.2% as of
March 31, 2003, and 76.4% as of December 31, 2002.

DEPOSITS

11

Deposits totaled $264.5 million as of June 30, 2003, an increase of $1.8
million, or .67%, from $262.7 million as of December 31, 2002.

FHLB BORROWINGS

Federal Home Loan Bank borrowings increased $20.1 million to $37.5 million as of
June 30, 2003 from $17.5 million as of December 31, 2002. The additional
borrowings were primarily used to fund the lending of 1-4 family fixed rate
loans made and held by the bank for additional loan funding.

LIQUIDITY AND CAPITAL RESOURCES

The declaration and payment of dividends by the Company are subject to the
discretion of the Board of Directors and to the earnings and financial condition
of the Company and applicable laws and regulations. The Company paid $960,000
and $840,000 in dividends during the six months ended June 30, 2003 and 2002,
respectively.

At June 30, 2003, consolidated Tier 1 risk based capital was 13.2%, and total
risk-based capital was 14.1%. The minimum Tier 1 and total risk-based capital
ratios required by the Board of Governors of the Federal Reserve are 4% and 8%,
respectively.

Effective liquidity management ensures that the cash flow requirements of
depositors and borrowers, as well as company cash needs, are met. The Company
manages liquidity on both the asset and liability sides of the balance sheet.
Community bank liquidity management currently involves the challenge of
attracting deposits while maintaining positive loan growth at a reasonable
interest rate spread. The loan to deposit ratio at June 30, 2003 was 104.0%
compared to 94.5% as of December 31, 2002. Loans to total assets were 80.5% at
June 30, 2003 compared to 77.9% at the end of 2002. The securities portfolio is
available for sale and consists of securities that are readily marketable.
Approximately 70% of the available for sale portfolio is pledged to secure
public deposits, short-term and long-term borrowings and for other purposes as
required by law. The balance of the available for sale securities could be sold
if necessary for liquidity purposes. Also, a stable deposit base, consisting of
88.8% core deposits, makes the Company less susceptible to large fluctuations in
funding needs. The Company also has both short- and long-term borrowings
capacity available through FHLB with unused available credit of approximately
$11.4 million as of June 30, 2003. The Company has the ability to obtain
deposits in the brokered certificate of deposit market to help provide liquidity
to fund loan growth, if necessary. Generally, the Company uses short-term
borrowings to fund overnight and short-term funding needs in the Company's
balance sheet. Longer-term borrowings have been primarily used to fund
mortgage-loan originations. This has occurred when FHLB longer-term rates are a
more economical source of funding than traditional deposit gathering activities.
Additionally, the Company occasionally uses FHLB borrowings to fund larger
commercial loans.

As of June 30, 2003, management is not aware of any current recommendations by
banking regulatory authorities which, if they were to be implemented, would
have, or would be reasonably likely to have, a material adverse impact on the
Company's liquidity, capital resources, or operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to variations in interest rates, exchange rates,
equity price risk and commodity prices. The Company does not maintain a trading
account for any class of financial instrument, and is not currently subject to
currency exchange rate risk, equity price risk or commodity price risk. The
Company's market risk is composed primarily of interest rate risk.

The major source of the Company's interest rate risk is the difference in the
maturity and repricing characteristics between the Company's core banking assets
and liabilities -- loans and deposits. This difference, or mismatch, poses a
risk to net interest income. Most significantly, the Company's core banking
assets and liabilities are

12

mismatched with respect to repricing frequency, maturity and/or index. Most of
the Company's commercial loans, for example, reprice rapidly in response to
changes in short-term interest rates. In contrast, many of the Company's
consumer deposits reprice slowly, if at all, in response to changes in market
interest rates.

The Company's Senior Management is responsible for reviewing the interest rate
sensitivity position of the Company and establishing policies to monitor and
limit exposure to interest rate risk. The guidelines established by senior
management are approved by the Company's Board of Directors. The primary goal of
the asset/liability management function is to maximize net interest income
within the interest rate risk limits set by approved guidelines. Techniques used
include both interest rate gap management and simulation modeling that measures
the effect of rate changes on net interest income and market value of equity
under different rate scenarios.

In the Company's simulation models, each asset and liability balance is
projected over a time horizon. Net interest income is then projected based on
expected cash flows and projected interest rates under a stable rate scenario
and analyzed. The results of this analysis are factored into decisions made
concerning pricing strategies for loan and deposits, balance sheet mix,
securities portfolio strategies, liquidity and capital adequacy.

Simulation models are also performed under an instantaneous parallel 200 basis
point increase or decrease in interest rates. The model includes assumptions as
to repricing and expected prepayments, anticipated calls, and expected decay
rates of transaction accounts under the different rate scenarios. The results of
these simulations include changes in both net interest income and market value
of equity.

The Company's rate shock simulation models provide results in extreme interest
rate environments and results are used accordingly. Reacting to changes in
economic conditions, interest rates and market forces, the Company has been able
to alter the mix of short and long-term loans and investments, and increase or
decrease the emphasis on fixed and variable rate products in response to
changing market conditions. By managing the interest rate sensitivity of its
asset composition in this manner, the Company has been able to maintain a fairly
stable flow of net interest income.

Complicating management's efforts to control non-trading exposure to interest
rate risk is the fundamental uncertainty of the maturity, repricing, and/or
runoff characteristics of some of the Company's core banking assets and
liabilities. This uncertainty often reflects options embedded in these financial
instruments. The most important embedded options are contained in consumer
deposits and loans.

For example, many of the Company's interest bearing retail deposit products
(e.g., interest checking, savings and money market deposits) have no contractual
maturity. Customers have the right to withdraw funds from these deposit accounts
freely. Deposit balances may therefore run off unexpectedly due to changes in
competitive or market conditions. To forestall such runoff, rates on interest
bearing deposits may have to be increased more (or reduced less) than expected.
Such repricing may not be highly correlated with the repricing of prime
rate-based or U.S. Treasury-based loans. Finally, balances that leave the
banking franchise may have to be replaced with other more expensive retail or
wholesale deposits. Given the uncertainties surrounding deposit runoff and
repricing, the interest rate sensitivity of core bank liabilities cannot be
determined precisely.

Management believes as of June 30, 2003, there have been no material changes in
the Company's interest rate sensitive instruments which would cause a material
change in the market risk exposures which affect the quantitative and
qualitative risk disclosures as presented in the Company's Form 10-K filed for
the period ended December 31, 2002.

ITEM 4. CONTROLS AND PROCEDURES

The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
June 30, 2003, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective as of June 30, 2003,
in timely

13

alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic SEC
filings.

There was no change in the Company's internal control over financial reporting
that occurred during the Company's fiscal quarter ended June 30, 2003, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.

FORWARD-LOOKING STATEMENTS

Certain of the statements contained herein that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act. Economic circumstances, the Company's operation and the
Company's actual results could differ significantly from those discussed in the
forward-looking statements. Forward-looking statements are typically identified
by words or phrases such as "believe," "expect," "anticipate," "intend,"
"estimate," "may increase," "may fluctuate," and similar expressions or future
or conditional verbs such as "will," "should," "would" and "could." These
forward-looking statements involve risks and uncertainties including, but not
limited to, economic conditions, portfolio growth, the credit performance of the
portfolios, including bankruptcies, and seasonal factors; changes in general
economic conditions including the performance of financial markets, the prices
of crops, prevailing inflation and interest rates, and losses on lending
activities; results of various investment activities; the effects of
competitors' pricing policies, of changes in laws and regulations on competition
and of demographic changes on target market populations' savings and financial
planning needs; industry changes in information technology systems on which we
are dependent; and the resolution of legal proceedings and related matters. In
addition, the policies and regulations of the various regulatory authorities
could affect the Company's results. These statements are representative only on
the date hereof, and the Company undertakes no obligation to update any
forward-looking statements made.

PART II - OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The annual meeting of the shareholders of Merchants Bancorp, Inc. was held on
April 22, 2003. At the meeting, the following individuals were elected as
members to Class III of the Company's board of directors: Donald Fender and
Richard Carr. There were no other individuals nominated for membership to the
board, and no other matters were submitted for a vote at the meeting. The
following individuals' terms as directors of the Company continued after the
meeting: Paul W. Pence, Jr.; James R. Vanzant; Robert Hammond: William Butler;
Charles A. Davis; and Jack Walker.

Shareholders of the Company are permitted to vote cumulatively in the election
of directors. As of the record dated established for the determination of shares
entitled to vote at the meeting, the Company had 3,000,000 common shares issued
and outstanding. 245,522 of the Company's common shares were not voted at the
meeting. Following is a break-down of the votes case "for" or "withheld" as to
each individual nominated to Class III of the Company's board of directors:

Donald Fender For: 2,753,403
Withheld: 1,585

Richard Carr For: 2,752,383
Withheld: 1,585

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ITEM 5. OTHER INFORMATION

On July 23, 2003 the Company became aware of a probable credit loss with a
significant borrower. The Company is assessing its collateral position and
anticipates recording an additional loan loss provision of approximately $1.5
million in the third quarter.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) EXHIBITS - The following exhibits are filed as a part of this report:

Exhibit No. Exhibit
----------- -------

3.1 Amended and Restated Articles of Incorporation of
Merchants Bancorp, Inc. (Incorporated by reference to
the Registration Statement on Form 10 filed on April
30, 2002.)

3.2 Code of Regulations of Merchants Bancorp, Inc.
(Incorporated by reference to the Registration
Statement on Form 10 filed on April 30, 2002.)

4. Instruments Defining the Rights of Security Holders.
(See Exhibit 3.)

31.1 Certification of Principal Executive and Financial
Officer Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.

32.1 Certification pursuant to 18 U.S.C. section 1350,
as enacted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002.

(b) REPORTS ON FORM 8-K - None

SIGNATURES

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

MERCHANTS BANCORP, INC.

Date: August 14, 2003 By: /s/ Paul W. Pence, Jr.
Paul W. Pence, Jr., President and
Principal Financial Officer

15

EXHIBIT INDEX

Exhibit No. Description
----------- -----------

3.1 Amended and Restated Articles of Incorporation
of Merchants Bancorp, Inc. (Incorporated by
reference to the Registration Statement on Form 10
filed on April 30, 2002.)
3.2 Code of Regulations of Merchants Bancorp, Inc.
(Incorporated by reference to the Registration
Statement on Form 10 filed on April 30, 2002.)

4. Instruments Defining the Rights of Security Holders.
(See Exhibit 3.)

31.1 Certification of Principal Executive and Financial
Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.

32.1 Certification pursuant to 18 U.S.C. section 1350,
as enacted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002.

16