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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, 2004
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 - 2,666,650 shares outstanding at August 13, 2004
1
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
The accompanying information has not been audited by a registered independent
public accounting firm; 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, 2003 for further information in this regard.
2
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2004 AND DECEMBER 31, 2003 (IN THOUSANDS EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2004 2003
(UNAUDITED)
ASSETS
CASH AND CASH EQUIVALENTS:
Cash and due from banks $ 12,108 $ 13,770
Federal funds sold 5,675 8,625
------------ ------------
Total cash and cash equivalents 17,783 22,395
------------ ------------
SECURITIES AVAILABLE FOR SALE
(amortized cost of $31,824 and $31,835 respectively) 32,464 33,085
------------ ------------
LOANS 294,584 288,624
Less allowance for loan losses (2,492) (2,432)
------------ ------------
Net loans 292,092 286,192
------------ ------------
OTHER ASSETS:
Bank premises and equipment, net 3,607 3,844
Accrued interest receivable 2,512 3,112
Deferred Income Tax 470 262
Other 4,784 3,531
------------ ------------
Total other assets 11,373 10,749
------------ ------------
TOTAL $ 353,712 $ 352,421
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest bearing $ 31,380 $ 31,693
Interest bearing 246,439 238,739
------------ ------------
Total deposits 277,819 270,432
------------ ------------
Repurchase agreements 3,631 2,784
FHLB borrowings 41,452 43,706
Other liabilities 1,604 7,272
------------ ------------
Total liabilities 324,506 324,194
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock - no par value; 4,500,000 shares authorized
and 3,000,000 shares issued, outstanding shares of 2,666,650
and 2,945,000 at June 30, 2004 and December 31, 2003,
respectively 2,000 2,000
Additional paid-in capital 2,000 2,000
Retained earnings 31,953 30,571
Accumulated other comprehensive income 253 656
Treasury Stock, at cost 333,350 shares and 55,000 shares at
June 30, 2004 and December 31, 2003, respectively (7,000) (7,000)
------------ ------------
Total shareholders' equity 29,206 28,227
------------ ------------
TOTAL $ 353,712 $ 352,421
============ ============
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,
---------- ---------- ---------- ----------
2004 2003 2004 2003
(UNAUDITED) (UNAUDITED)
INTEREST INCOME:
Interest and fees on loans $ 4,699 $ 4,853 $ 9,385 $ 9,462
Interest and dividends on securities:
Taxable 131 180 270 393
Exempt from income taxes 243 249 487 499
Interest on federal funds sold and other short-term investments 37 56 68 102
---------- ---------- ---------- ----------
Total interest income 5,110 5,338 10,210 10,456
---------- ---------- ---------- ----------
INTEREST EXPENSE:
Interest on deposits 1,202 1,335 2,378 2,727
Interest on repurchase agreements and federal funds purchased 26 21 52 52
Interest on FHLB borrowings 433 356 880 592
---------- ---------- ---------- ----------
Total interest expense 1,661 1,712 3,310 3,371
---------- ---------- ---------- ----------
NET INTEREST INCOME 3,449 3,626 6,900 7,085
PROVISION FOR LOAN LOSSES (181) (262) (334) (666)
---------- ---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,268 3,364 6,566 6,419
---------- ---------- ---------- ----------
NONINTEREST INCOME - Service charges and fees 390 370 780 741
---------- ---------- ---------- ----------
NONINTEREST EXPENSE:
Salaries and employee benefits 1,030 1,015 2,048 2,031
Occupancy 255 311 519 617
Legal and professional services 144 103 256 218
Franchise tax 61 60 127 144
Data processing 79 85 153 167
Advertising 72 49 140 90
Other 362 304 757 624
---------- ---------- ---------- ----------
Total noninterest expense 2,003 1,927 4,000 3,891
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES 1,655 1,807 3,346 3,269
INCOME TAXES (523) (584) (1,057) (1,041)
---------- ---------- ---------- ----------
NET INCOME $ 1,132 $ 1,223 $ 2,289 $ 2,228
========== ========== ========== ==========
BASIC AND DILUTED EARNINGS PER SHARE $ 0.42 $ 0.41 $ 0.86 $ 0.74
========== ========== ========== ==========
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, 2004 AND 2003 (IN THOUSANDS)
2004 2003
(UNAUDITED)
OPERATING ACTIVITIES:
Net income $ 2,289 $ 2,228
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 295 450
Provision for loan losses 334 666
Gain on sale of mortgage loans (102) (120)
Proceeds from sale of mortgage loans 8,438 8,982
Mortgage loans originated for sale (8,336) (8,862)
Changes in assets and liabilities:
Accrued interest receivable 600 (155)
Other assets (1,253) (774)
Accrued interest, taxes and other liabilities (5,669) (164)
---------- ----------
Net cash used in operating activities (3,404) 2,251
---------- ----------
INVESTING ACTIVITIES:
Proceeds from sales and maturities of securities available for sale 4,963 5,166
Purchases of securities available for sale (4,988) (200)
Net increase in loans (6,234) (27,183)
Capital expenditures (23) (187)
---------- ----------
Net cash used in investing activities (6,282) (22,404)
---------- ----------
FINANCING ACTIVITIES:
Net increase in deposits 7,387 1,768
Net increase in repurchase agreements 847 (578)
FHLB borrowings 20,250
FHLB payments (2,254) (183)
Dividends paid to stockholders (906) (960)
---------- ----------
Net cash provided by financing activities 5,074 20,297
---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,612) 144
CASH AND CASH EQUIVALENTS:
Beginning of year 22,395 22,202
---------- ----------
End of period $ 17,783 $ 22,346
========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for federal income taxes $ 425 $ 1,175
========== ==========
Cash paid during the period for interest $ 3,309 $ 3,397
========== ==========
See notes to condensed consolidated financial statements.
5
MERCHANTS BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
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, 2004, the results of operations for the three and
six months ended June 30, 2004 and 2003, and of cash flows for the
six-months ended June 30, 2004 and 2003. 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, 2003 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, 2004 and 2003 and cash flows for the six months ended June 30,
2004 and 2003 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,
2003, 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, 2004 the Company had
2,672,768 and 2,666,650 shares outstanding, respectively. For the three
and six months ended June 30, 2003 the Company had 3,000,000 shares
outstanding. There were no common stock equivalents or potentially diluted
securities outstanding during the respective periods.
2. NEW ACCOUNTING PRONOUNCEMENTS
In March 2004, the Securities and Exchange Commission staff released Staff
Accounting Bulletin (SAB) No. 105, "Application of Accounting Principles
to Loan Commitments." This SAB disallows the inclusion of expected future
cash flows related to the servicing of a loan in the determination of the
fair value of a loan commitment. Further, no other internally developed
intangible asset should be recorded as part of the loan commitment
derivative. Recognition of intangible assets would only be appropriate in
a third-party transaction, such as a purchase of a loan commitment or in a
business combination. The SAB is effective for all loan commitments
entered into after March 31, 2004, but does not require retroactive
adoption for loan commitments entered into, on or before March 31, 2004.
Adoption of this SAB did not have a material effect on the Company's
Condensed Consolidated Financial Statements.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." The EITF reached a consensus on an
other-than temporary impairment model for debt and equity securities
accounted for under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," and cost method investments. The basic model
developed to evaluate whether an investment within the scope of Issue 03-1
is other-than temporarily impaired involves a three-step process
including, determining whether an investment is impaired (fair value less
than cost), evaluating whether the impairment is other-than-temporary and,
if
6
other-than-temporary, requiring recognition of an impairment loss equal to
the difference between the investment's cost and its fair value. The
three-step model used to determine other-than-temporary impairments shall
be applied prospectively to all current and future investments in interim
or annual reporting periods beginning after June 15, 2004. The amount of
any other-than-temporary impairment that may need to be recognized in the
future will be dependent on market conditions, the occurrence of certain
events or changes in circumstances relative to an investee and the
Registrant's intent and ability to hold the impaired investments at the
time of the valuation.
3. LOANS
Major classifications of loans are summarized as follows (in thousands):
JUNE 30, DECEMBER 31,
2004 2003
(unaudited)
Commercial real estate $ 61,928 $ 60,833
Commercial and industrial 25,990 25,165
Agricultural 41,432 40,362
Residential real estate 135,827 131,656
Installment 26,651 27,827
Other 2,756 2,781
------------ ------------
Total 294,584 288,624
Less allowance for loan losses (2,492) (2,432)
------------ ------------
$ 292,092 $ 286,192
============ ============
4. FHLB BORROWINGS
All stock in the Federal Home Loan Bank ("FHLB") and qualifying first
mortgage residential loans are pledged as collateral on FHLB borrowings.
Interest rates of advances from the FHLB at June 30, 2004 are as follows
(in thousands):
INTEREST
RATE AMOUNT
4.78%-5.39% $ 4,000
6.26 % 3,000
5.23 % 172
4.64 % 10,000
2.82%-3.13% 2,024
2.95%-4.04% 7,607
3.02%-4.24% 14,649
-------
Total $41,452
=======
The maximum amount available to the Company under FHLB borrowings was
approximately $67.9 million and $78.0 million as of June 30, 2004 and
December 31, 2003, respectively.
5. TREASURY STOCK
On August 28, 2003, the Company entered into a stock redemption agreement with
three shareholders. Under the terms of the agreement, the redemption occurred
over two separate dates. The first settlement was for $1,155,000 for 55,000
shares and occurred on September 5, 2003. The second settlement was for
$5,845,349 for 278,350 shares and occurred on January 5, 2004.
7
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, 2004, the Company had total assets of approximately $353.7
million and total shareholders' equity of approximately $29.2 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 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
8
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, 2004. 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, 2004 AND 2003
The Company reported net income of $1,132,000 and $1,223,000 for the three
months ended June 30, 2004 and 2003, respectively. During the same periods,
basic and diluted earnings per share were $.42 and $.41, respectively. On an
annualized basis, return on average assets was 1.27% and return on average
equity was 15.25% for the three months ended June 30, 2004, compared to 1.44%
and 14.19%, respectively, for the comparable period in 2003. The large increase
in the return on average equity is primarily due to a treasury stock transaction
which occurred in August, 2003 and resulted in capital reduction of
approximately $7,000,000.
Net interest income for the three months ended June 30, 2004, was $3,449,000, a
decrease of $177,000, or 4.9%, compared to net interest income of $3,626,000 for
the comparable period in 2003. Net interest margin was 4.10% for the three
months ended June 30, 2004, compared to 4.54% for the comparable period in 2003.
The average annualized yield on earning assets decreased to 6.07% for the three
months ended June 30, 2004, from 6.69% for the comparable period in 2003. The
average cost of interest-bearing funds was 2.25% for the three months ended June
30, 2004, a decrease from 2.50% for the comparable period in 2003. Management
attributes the decrease in net interest margin to the recording of lower
yielding 1-4 family loans and to loans continuing to reprice downward. Higher
yielding loans have continued to pay off through out the last few years or
refinance at a lower rate. The loan portfolio has substantially lower yielding
loans than one year ago. Additionally, while loan rates continue to reprice or
refinance downward, deposits have little room for downward repricing. For these
reasons the net interest margins continues to fall.
The provision for loan losses was $181,000 and $262,000 for the three months
ended June 30, 2004 and 2003, respectively, representing a decrease of 30.9%.
Net charge-offs for the three months ended June 30, 2004 were $189,000, compared
to $283,000 experienced during the three months ended June 30, 2003. 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
were identified by management. The loan loss provision is significantly less in
2004 than in 2003 because the conditions and potential losses in the loan
portfolio have improved considerably from second quarter 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 $390,000 for the three months ended June 30, 2004,
an increase of $20,000, or 5.4%, from $370,000 for the comparable period in
2003. The increase is due to an overall increase in the noninterest income
accounts.
9
Total noninterest expense was $2,003,000 for the three months ended June 30,
2004, an increase of $76,000, or 3.9%, from $1,927,000 for the comparable period
in 2003. It is typically expected for non-interest expense to increase 5-10%
each year. The increase is significantly less due to a reduction in depreciation
expense as a result of some assets becoming fully depreciated while the salaries
and benefits have remained consistent compared to the same period last year.
Salaries and benefits expense comprises the largest component of noninterest
expense, with totals of $1,030,000 and $1,015,000 for the three months ended
June 30, 2004 and 2003, respectively.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
The Company reported net income of $2,289,000 and $2,228,000 for the six months
ended June 30, 2004 and 2003, respectively. During each of the same periods,
basic and diluted earnings per share were $.86 and $.74, respectively. On an
annualized basis, return on average assets was 1.29% and return on average
equity was 15.81% for the six months ended June 30, 2004, compared to 1.34% and
12.87%, respectively, for the comparable period in 2003. The large increase in
the return on average equity is primarily due to a treasury stock transaction
which occurred in August, 2003 and resulted in capital reduction of
approximately $7,000,000.
Net interest income for the six months ended June 30, 2004, was $6,900,000, a
decrease of $185,000, or 2.61%, compared to net interest income of $7,085,000
for the comparable period in 2003. Net interest margin was 4.08% for the six
months ended June 30, 2004, compared to 4.49% for the comparable period in 2003.
The average annualized yield on earning assets decreased to 6.39% for the six
months ended June 30, 2004, from 6.63% for the comparable period in 2003. The
average cost of interest-bearing funds was 2.26% for the six months ended June
30, 2004, a decrease from 2.52% for the comparable period in 2003. Management
attributes the decrease in net interest margin to the recording of lower
yielding 1-4 family loans and to loans continuing to reprice downward. Higher
yielding loans have continued to pay off through out the last few years or
refinance at a lower rate. The loan portfolio has substantially lower yielding
loans than one year ago. Additionally, while loan rates continue to reprice or
refinance downward, deposits have little room for downward repricing. For these
reasons the net interest margins continues to fall.
The provision for loan losses was $334,000 and $666,000 for the six months ended
June 30, 2004 and 2003, respectively, representing a decrease of 49.9%. Net
charge-offs for the six months ended June 30, 2004 were $274,000, compared to
$477,000 experienced during the six months ended June 30, 2003. 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
were identified by management. 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. The loan loss provision is significantly less in
2004 than in 2003 because the conditions and potential losses in the loan
portfolio have improved considerably from 2003.
Total noninterest income was $780,000 for the six months ended June 30, 2004, an
increase of $39,000, or 5.3%, from $741,000 for the comparable period in 2003.
The increase is due to an overall increase in the noninterest income accounts.
Total noninterest expense was $4,000,000 for the six months ended June 30, 2003,
an increase of $109,000, or 2.8%, from $3,891,000 for the comparable period in
2003. Salaries and benefits expense comprises the largest component of
noninterest expense, with totals of $2,048,000 and $2,031,000 for the six months
ended June 30, 2004 and 2003, respectively. It is typically expected for
non-interest expense to increase 5-10% each year. The increase is significantly
less due to a reduction in depreciation expense as a result of some assets
becoming fully depreciated while the salaries and benefits have remained
consistent compared to the same period last year.
FINANCIAL CONDITION
The Company's total assets increased to $353.7 million as of June 30, 2004 from
$352.4 million as of December
10
31, 2003, an increase of .37%. The largest change in the balance sheet is a
change in the mix of the assets. The two main areas affected by change in
balance sheet mix were loans, which increased $6.0 million and cash and due from
banks, which decreased $4.6 million.
LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company reported total loans of $294.6 million as of June 30, 2004 and
$288.6 million as of December 31, 2003, an increase of $6.0 million, or 2.06%.
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 2004. 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 0.85% of total loans as of June 30, 2004 and
0.84% as of December 31, 2003.
The amount of nonaccrual loans decreased to $735,000 as of June 30, 2004,
compared to $1,585,000 as of March 31, 2004, and $1,462,000 at December 31,
2003. As a percentage of total loans, nonaccrual loans represented 0.25% as of
June 30, 2004, 0.55% as of March 31, 2004, and 0.51% as of December 31, 2003.
The decrease in non accrual loans is mainly due to the transfer of loan balances
of $574,000 to Other Real Estate Owned ("OREO") and the remaining difference was
either charged-off or liquidated.
The category of accruing loans which are past due 90 days or more was $843,000
as of June 30, 2004, $2,064,000 as of March 31, 2004, and $1,441,000 as of
December 31, 2003. As a percentage of total loans, loans past due 90 days and
still accruing interest represented .29% as of June 30, 2004, 0.71% as of March
31, 2004, and 0.51% as of December 31, 2003. The decrease of $1,221,000 from
March 2004 is primarily made up of four loans totalling $1,129,000. One loan
with a balance of $290,000 was moved to OREO and the bank is in the liquidation
process. One loan totaling $142,000 was charged off. The other two loan
customers, totaling $697,000 have become current. One of the two loans was a
farm mortgage that had lower than expected cash flow. The cosigner made the
payment to bring current. The collateral is in the process of being sold by the
customer. Management believes liquidation of underlying collateral will be
sufficient to mitigate any significant loss on the loans.
As a percentage of the allowance for loan losses, total nonaccrual loans and
loans past due 90 days or more were 63.3% as of June 30, 2004, 146.0% as of
March 31, 2004, and 119.5% as of December 31, 2003.
DEPOSITS
Deposits totaled $277.8 million as of June 30, 2004, an increase of $7.4
million, or 2.7%, from $270.4 million as of December 31, 2003. Deposit growth
has increased in all major areas of the deposit base.
FHLB BORROWINGS
Federal Home Loan Bank borrowings decreased $2.2 million to $41.5 million as of
June 30, 2004 from $43.7 million as of December 31, 2003. The decrease in
borrowings was primarily a result of principal loan payments made on the
borrowings.
11
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 $906,661
and $960,000 in dividends during the six months ended June 30, 2004 and 2003,
respectively.
At June 30, 2004, consolidated Tier 1 risk based capital was 10.72%, and total
risk-based capital was 11.64%. 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.
National banking laws restrict the maximum amount of dividends that a bank may
pay in any calendar year. Dividends are limited tot he Bank's retained profits
(as defined by the Office of the Comptroller of the Currency) for that year and
the two preceeding years. During 2003 and as a result of tax planning efforts,
the Bank made a special dividend totaling $8,000,000. As a result, the Bank
exceeded the amount of retained earnings available for cash dividends and must
obtain approval from the Office of the Comptroller of the Currency for
additional future dividends.
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, 2004 was 106.0%
compared to 106.7% as of December 31, 2003. Loans to total assets were 83.3% at
June 30, 2004 compared to 81.4% at the end of 2003. The securities portfolio is
available for sale and consists of securities that are readily marketable.
Approximately 86.7% 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
89% 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
$12.5 million as of June 30, 2004. The Company has the ability to obtain
deposits in the brokered certificate of deposit market to help provide liquidity
to fund loan growth, if necessary. Generally, the Company uses short-term
borrowings to fund overnight and short-term funding needs in the Company's
balance sheet. Longer-term borrowings have been primarily used to fund
mortgage-loan originations. This has occurred when FHLB longer-term rates are a
more economical source of funding than traditional deposit gathering activities.
Additionally, the Company occasionally uses FHLB borrowings to fund larger
commercial loans.
As of June 30, 2004, management is not aware of any current recommendations by
banking regulatory authorities which, if they were to be implemented, would
have, or would be reasonably likely to have, a material adverse impact on the
Company's liquidity, capital resources, or operations.
CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
The Company has certain obligations and commitments to make future payments
under contracts. At June 30, 2004, the aggregate contractual obligations and
commercial commitments are:
12
Payments Due by Period
Less than 1-3 3-5 After 5
Contractual Obligations Total One Year Years Years Years
($ in thousands) ------------ ------------ ------------ ------------ ------------
Total Deposits $ 277,819 $ 235,677 $ 41,701 $ 429 $ 12
FHLB Borrowings 41,452 3,928 5,723 8,395 23,406
Repurchase Agreements 3,631 3,631 0 0 0
------------ ------------ ------------ ------------ ------------
Total $ 322,902 $ 243,236 $ 47,424 $ 8,824 $ 23,418
Payments Due by Period
Less than 1-3 3-5 After 5
Other Commercial Commitments Total One Year Years Years Years
($ in thousands) ------------ ------------ ------------ ------------ ------------
Commitments to Extend Credit $ 27,063 $ 11,422 $ 3,151 $ 2,214 $ 10,276
Letters of Credit 16 16 0 0 0
------------ ------------ ------------ ------------ ------------
Total $ 27,079 $ 11,438 $ 3,151 $ 2,214 $ 10,276
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 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 Asset/Liability Committee 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
Asset/Liability Committee 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 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.
13
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, 2004, 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, 2003.
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 President and
Principal Financial Officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures as of June 30, 2004, 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, 2004, in timely 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, 2004, 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.
14
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
ISSUER PURCHASES OF EQUITY SECURITIES
Maximum Number
Total Number of (Approximate Dollar
Shares Purchased Value) of Shares that
Average Price as Part of Publicly May yet be Purchased
Total Number of Paid per Announced Plans Under the Plans or
Date Shares Purchased Share or Programs Programs
- --------------------------------- ---------------- ------------- ------------------- ---------------------
Jan. 1, 2004 thru Jan. 31, 2004 278,350 $ 21.00 None None
Feb 1, 2004 thru Feb 29, 2004 0 NA NA NA
March 1, 2004 thru March 31, 2004 0 NA NA NA
April 1, 2004 thru April 30, 2004 0 NA NA NA
May 1, 2004 thru May 31, 2004 0 NA NA NA
June 1, 2004 thru June 30, 2004 0 NA NA NA
------- ------- ---- ----
Total 278,350 $ 21.00 None None
The Company did not repurchase any of its common shares during the quarter ended
June 30, 2004. For more information on the repurchases made by the Company
during the quarter ended March 31, 2004, see the Company's report on Form 10-Q
filed with the Commission on May 17, 2004.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Voting results from the Company's Annual Meeting of Shareholders held on April
27, 2004 can be found under Part II, Item 4 of the Company's report on Form 10-Q
filed with the Commission on May 17, 2004.
15
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 Articles of Incorporation of Merchants Bancorp, Inc. filed as
Exhibit (3)(I) to the Form 10 filed with SEC on April 30, 2002
and incorporated herein by reference.
3.2 Code of Regulations filed as Exhibit (3)(II) to the Form 10
filed with the SEC on April 30, 2002 and incorporated herein
by reference.
4. Instruments Defining the Rights of Security Holders. (See
Exhibit 3.1 and 3.2)
31 Rule 13a-14(a) Certification
32 Section 1350 Certification
(b) REPORTS ON FORM 8-K -
The Company filed no reports on Form 8-K with the Commission during the
quarter ended June 30, 2004.
16
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 13, 2004 By: /s/ Paul W. Pence, Jr.
Paul W. Pence, Jr., President and
Principal Financial Officer
17
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
3.1 Articles of Incorporation of Merchants Bancorp, Inc. filed as
Exhibit (3)(I) to the Form 10 filed with SEC on April 30, 2002
and incorporated herein by reference.
3.2 Code of Regulations filed as Exhibit (3)(II) to the Form 10
filed with the SEC on April 30, 2002 and incorporated herein
by reference.
4. Instruments Defining the Rights of Security Holders. (See
Exhibit 3.1 and 3.2)
31 Rule 13a-14(a) Certification
32 Section 1350 Certification