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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
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 0-14484
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MERCHANTS BANCORP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 36-3182868
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(State of Incorporation) (I.R.S. Employer Identification Number)
34 SOUTH BROADWAY, AURORA, ILLINOIS 60507
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(Address of principal executive offices, including Zip Code)
(630) 896-9000
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(Registrant's telephone number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of each exchange on which registered
NONE NONE
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Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $1.00 PAR VALUE
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(Title of Class)
PREFERRED STOCK PURCHASE RIGHTS
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(Title of Class)
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
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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]
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As of March 3, 1997, the aggregate market value of the registrant's common
stock held by non-affiliates of the registrant was approximately $94,797,434*
based upon the price of the last sale on that date. (This determination includes
427,334 shares of the registrant's common stock held by the trust department of
the registrant's subsidiary, The Merchants National Bank of Aurora.)
The number of shares outstanding of the registrant's common stock, par
value $1 per share, was 2,579,522 at March 3, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's 1996 Annual Report are incorporated by reference
into Parts I, II and IV.
Portions of the Company's Proxy Statement for the 1997 Annual Meeting of
Stockholders are incorporated by reference into Part III.
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* Based on the last reported price of an actual transaction in registrant's
common stock on March 3, 1997, and reports of beneficial ownership filed by
directors and executive officers of registrant and by beneficial owners of
more than 5% of the outstanding shares of common stock of registrant;
however, such determination of shares owned by affiliates does not
constitute an admission of affiliate status or beneficial interest in
shares of registrant's common stock.
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MERCHANTS BANCORP, INC.
FORM 10-K
INDEX
PART I PAGE NO.
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Item 1 Business 1 - 15
Item 2 Properties 16
Item 3 Legal Proceedings 17
Item 4 Submission of Matters to a Vote of Security Holders 17
PART II
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Item 5 Market for the Registrant's Common Stock and
Related Security Holder Matters 17
Item 6 Selected Financial Data 17
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
Item 8 Financial Statements and Supplementary Data 17
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 17
PART III
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Item 10 Directors and Executive Officers of the Registrant 18
Item 11 Executive Compensation 18
Item 12 Security Ownership of Certain Beneficial Owners and
Management 18
Item 13 Certain Relationships and Related Transactions 19
PART IV
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Item 14 Exhibits, Financial Statement Schedules and
Reports on Form 8-K 19 - 20
Signatures 21 - 22
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PART I
ITEM 1. BUSINESS
THE CORPORATION
OVERVIEW
Merchants Bancorp, Inc. (the "Corporation" or the "Registrant") was
organized under the laws of Delaware on July 1, 1981. It is a registered bank
holding company under the Bank Holding Company Act of 1956 (the "Act"). The
Corporation's office is located at 34 South Broadway, Aurora, Illinois 60507,
and its telephone number is 630/896-9000.
The Corporation conducts a full service community banking and trust
business through its wholly-owned subsidiary banks, The Merchants National Bank
of Aurora ("Merchants Bank"), and Valley Banc Services Corp. ("Valley"), and
Valley's wholly owned subsidiaries, Hinckley State Bank and V.B.H. Corporation
and V.B.H. Corporation's wholly-owned subsidiary, Fox Valley Bank. Merchants
Bank, Hinckley State Bank, and Fox Valley Bank are collectively referred to
herein as the "Banks."
On January 3, 1996, the Company purchased 100% of the outstanding common
stock of Valley for $24,889,000, comprised of $20.5 million in cash, assumption
of Valley's debt of approximately $3.5 million, $304,000 of capitalized
acquisition costs and $532,000 of capitalized incremental interest costs during
the holding period of acquired subsidiaries held for sale. As of the acquisition
date, Valley's wholly-owned subsidiaries included Hinckley State Bank, State
Bank of Osco, Anchor Bank and V.B.H. Corporation and V.B.H. Corporation's
wholly-owned subsidiary, Fox Valley Bank. The acquisition was accounted for
using the purchase method of accounting and, accordingly, the assets and
liabilities have been recorded at their estimated fair values at the date of
acquisition. In addition, when Valley was acquired, the Company's intent was to
sell State Bank of Osco and Anchor Bank. Accordingly, those banks were
classified as held for sale until they were sold on December 12, 1996, and
December 19, 1996, respectively.
Merchants Bank is a national banking association with its main office
located at 34 South Broadway, Aurora, Illinois 60507. Merchants Bank operates
full service banking facilities located at 2998 Ogden Avenue, Aurora, Illinois
60505, 1851 West Galena Boulevard, Aurora, Illinois 60506, One Merchants Plaza,
Oswego, Illinois 60543, 55 Constitution Drive, Aurora, Illinois 60506, 1771
Merchants Drive, Geneva, Illinois 60134 and Route 31, Mooseheart, Illinois
60539. The Bank operates loan production offices located at 3 North Smith
Street, Aurora, Illinois, 60507, and 520 Countryside Center, Yorkville, Illinois
60560.
Hinckley State Bank is an Illinois banking association with its main office
located at 101 W. Lincoln, Hinckley, Illinois 60520, and a full service facility
located at 80 N. Dugan Road, Sugar Grove, Illinois 60554. Fox Valley Bank is a
an Illinois banking association with its main office located at 1600 East Main
Street, St. Charles, Illinois 60174, and full service facilities located at 1525
West Main Street, St. Charles, Illinois 60174, and 629 West State Street,
Geneva, Illinois 60134.
Aurora is located in the Fox River Valley approximately 40 miles west of
Chicago, Illinois. Hinckley is located approximately 17 miles west of Aurora,
and St. Charles is located approximately 13 miles north of Aurora. Aurora and
its surrounding communities, including Hinckley and St. Charles, are in one of
the fastest growing areas in northeastern Illinois. Aurora's population based
upon the 1990 census was approximately 100,000, an increase of approximately 22%
from the community's population recorded in the 1980 census. The Northeastern
Illinois Planning Commission estimates that Aurora's population will grow by a
further 60% in the 1990's to almost 160,000 by the year 2000.
The major contributor to this growth in the Aurora area has been the
expansion of the boundaries of metropolitan Chicago. As the Chicago suburbs have
expanded, Aurora has experienced a considerable influx of people as well as a
number of new employers. The local economy has experienced growth as a new
service-oriented business sector has developed to supplement Aurora's historical
manufacturing base. Aurora is located on U.S. Interstate Highway 88 which
provides easy access to the city of Chicago and is a major corridor of suburban
growth for Chicago.
As a large, community-oriented, independent financial institution in the
Aurora area, the Corporation is well positioned to take advantage of the growth
of Aurora and its surrounding communities. Merchants Bank has continuously
served the Aurora community since it was chartered in 1888. The Corporation's
local management, coupled with its long record of service, has allowed it to
compete successfully in Aurora's banking market. The Corporation operates its
subsidiaries as traditional community banks with conveniently located facilities
and professional, highly motivated staffs which are active in the community,
focus on long-term relationships with customers and provide individualized
quality service.
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SUBSIDIARY OPERATIONS
The Banks' full service banking businesses include the customary consumer
and commercial products and services which banks provide, including the
following: demand, savings, time deposit, individual retirement and Keogh
deposit accounts; commercial, industrial, consumer and real estate lending,
including installment loans, student loans, farm loans, lines of credit and
overdraft checking; safe deposit operations; trust services, through Merchants
Bank; and an extensive variety of additional services tailored to the needs of
individual customers, such as the acquisition of U.S. Treasury notes and bonds,
the sale of traveler's checks, money orders, cashier's checks and foreign
currency, direct deposit, discount brokerage debit cards, credit cards, and
other special services.
Commercial and consumer loans are made to corporations, partnerships and
individuals, primarily on a secured basis. Commercial lending focuses on
business, capital, construction, inventory and real estate lending. Installment
lending includes direct and indirect loans to consumers and commercial
customers. The mortgage division of Merchants Bank originates and services
residential mortgages on behalf of the Banks, and handles the secondary
marketing of those mortgages.
MARKET AREAS
Merchants Bank's primary market area is Aurora, Illinois, and its
surrounding communities. The city of Aurora is located in northeastern Illinois,
approximately 40 miles west of Chicago. Strategically situated on U.S.
Interstate 88 (the East-West Tollway), Aurora is near the center of the four
county area comprised of DuPage, Kane, Kendall and Will counties. Based upon the
1990 census, these counties together represent a market of more than 1.4 million
people. The city of Aurora has a current reported population of approximately
100,000 residents which is forecast by the Northeastern Illinois Planning
Commission to grow by more than 60% through the rest of the decade.
The median income for households within a five mile radius of Aurora was
approximately $44,000, compared to an Illinois average of approximately $32,000,
as reported from 1990 census data. Major employers in Merchants Bank's market
area include Caterpillar Inc., Hollywood Casino Aurora, Metropolitan Life, Dial
Corporation, Farmers Insurance, and Lyon Metal Products. Retail sales declared
for tax purposes in Aurora reached $989 million in 1990.
Hinckley is a rural community located approximately 17 miles west of
Aurora. Located along a significant east-west corridor, it is well positioned to
participate in the growth moving west through the Chicago suburbs. Many people
who are employed by the major employers in the Aurora area are buying or
building homes in the Hinckley area.
St. Charles, like Aurora, is located along the Fox River Valley, and has
experienced similar growth in recent years. As of 1992, median household income
was $66,000, more than double the Illinois average reported in the 1990 census.
Major employers include Central DuPage Hospital, System Sensor, Delnor Community
Hospital, DuKane Corp., and Arthur Andersen.
ACQUISITION AND EXPANSION STRATEGY
The Corporation seeks to diversify both its market area and asset base
while increasing profitability through acquisitions and expansion. The
Corporation's goal, as reflected by its acquisition policy, is to expand through
the acquisition of established financial service organizations, primarily
commercial banks or thrifts, to the extent suitable candidates can be identified
and acceptable business terms negotiated.
The Corporation's acquisition strategy is focused on traditional community
banks or thrifts located in potentially high growth areas within 15 miles to the
east of Aurora and up to 30 miles from Aurora in all other directions. At this
time, a large number of such financial institutions are located within this
geographic area. It is possible that as a result of consolidation within the
banking industry generally, as well as in the Aurora area, the Corporation may
in the future look beyond these geographic areas for acquisition opportunities.
In addition to price and terms, other factors considered by the Corporation in
determining the desirability of an acquisition candidate are financial
condition, earnings potential, quality of management, market area and
competitive environment.
The Corporation will also consider establishing branches, loan production
offices or other business facilities as a means of expanding its presence in
current or new market areas. An example of this is the Corporation's opening a
new branch facility in Geneva in 1996, entry into "supermarket banking" with the
opening of a branch inside the Cub Foods store in Aurora in 1993, and the
opening of two loan production offices in 1994. The Corporation will also
consider the expansion into other lines of business closely related to banking
if it believes these lines could be profitable without undue risk to the
Corporation and if the Corporation can be competitive.
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OPERATING STRATEGY
Corporate policy, strategy and goals are established by the Board of
Directors of the Corporation. Pursuant to the Corporation's philosophy,
operational and administrative policies for the Banks are also established by
the Corporation. Within this framework, the Banks focus on providing
personalized services and quality products to its customers to meet the needs of
the communities in which they operate.
Recognizing the substantial changes and growth opportunities in its market,
beginning in 1989, the Corporation redirected its existing resources and
personnel to create an aggressive sales environment within the organization. In
addition to promotions from within the organization, the Corporation hired
experienced senior bank executives who were already familiar with the Aurora
market area, with an emphasis on the commercial lending and trust areas. These
changes have allowed the Corporation to continue to grow with the community and
compete successfully in Aurora's banking market.
The Corporation operates its subsidiaries as traditional community banks
with conveniently located facilities and professional, highly motivated staffs
which are active in the communities they serve, focusing on long-term
relationships with customers and providing individualized quality service. As
part of its community banking approach, the Corporation encourages officers of
the Banks to actively participate in community organizations. In addition,
within credit and rate of return parameters, the Corporation attempts to ensure
that the Banks meet the credit needs of their communities and that the Banks
invest in local municipal securities.
The Corporation uses a variety of marketing strategies to attract and
retain customers, the most important of which is its officer call program.
Officers of the Banks regularly call on customers and potential customers to
maintain and develop deposit and other special service relationships, including
payroll, discount brokerage, cash management, lock box and trust services.
The Corporation has an internal data processing division and has attempted
to remain at the forefront of the banking industry in new technological
innovations. The Corporation believes that retaining control of its data
processing leads to decreased operating costs, more effective service to its
customers and increased efficiencies. To provide a high level of customer
service and to manage effectively its growth, acquisition and operating
strategies, the Corporation also focuses on continued improvement of its
internal operating systems.
LENDING ACTIVITIES
GENERAL. The Banks provide a range of commercial and retail lending
services to corporations, partnerships and individuals, including, but not
limited to, commercial business loans, commercial and residential real estate
construction and mortgage loans, loan participations, consumer loans, revolving
lines of credit and letters of credit. The Banks make direct and indirect loans
to consumers and commercial customers, and the mortgage division of Merchants
Bank originates and services residential mortgages and handles the secondary
marketing of those mortgages. Through Merchants Bank, mortgage products are also
made available to Hinckley State Bank and Fox Valley Bank customers.
The Banks aggressively market their services to qualified lending customers
in both the commercial and consumer sectors. The Banks' commercial lending
officers actively solicit the business of new companies entering their market
areas as well as longstanding members of their business community. Through
personalized professional service and competitive pricing, the Banks have been
successful in attracting new commercial lending customers. At the same time, the
Banks actively advertise their consumer loan products and continuously attempt
to make their lending officers more accessible. Through convenient locations and
regular advertising, the Banks have been successful in capitalizing on the
growing population of their market areas, particularly with regard to
residential mortgages, home equity loans, and installment loans.
COMMERCIAL LOANS. The Banks aggressively seek new commercial loans in their
market areas and much of the increase in these loans in recent years can be
attributed to the successful solicitation of new business. The Banks' areas of
emphasis include, but are not limited to, loans to wholesalers, manufacturers,
building contractors, developers, business services companies and retailers. The
Banks provide a wide range of commercial business loans, including lines of
credit for working capital purposes and term loans for the acquisition of
equipment and other purposes. Collateral for these loans generally includes
accounts receivable, inventory, equipment and real estate. Loans may be made on
an unsecured basis where warranted by the overall financial condition of the
borrower. Terms of commercial business loans generally range from one to five
years. The majority of the Banks' commercial business loans have floating
interest rates or reprice within one year. Management has also generated loans
which are guaranteed by the U.S. Small Business Administration. Management
believes that making such loans helps the local community as well as providing
the Banks with a source of income and solid future lending relationships as such
businesses grow and prosper. The primary repayment risk for commercial loans is
the failure of the business due to economic or financial factors. In most cases,
the Banks have collateralized these loans and/or taken personal guarantees to
help assure repayment.
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The Banks regularly provide financing to developers who have demonstrated a
favorable record of performance for the construction of pre-sold homes. Home
sales have remained very strong in the greater Aurora area, including Hinckley
and St. Charles, due to the growth in population. Although development and
construction lending has been a significant portion of the commercial loan
activity, these types of loans represented less than 12% of the outstanding
balance of the Banks' loan portfolios as of December 31, 1996. No construction
or development loan was on nonaccrual status as of December 31, 1996.
During recent years, the Merchants Bank has undertaken several initiatives
to improve asset quality, and these practices have been instituted at Hinckley
State Bank and Fox Valley Bank. Each Bank's Board of Directors reviews, on a
monthly basis, a report of all criticized assets and considers all requests for
new loans of over $3.5 million at Merchants Bank, and $100,000 at Hinckley State
Bank and Fox Valley Bank. The directors' loan committees of Hinckley State Bank
and Fox Valley Bank may approve loans to the same levels as the full board of
these banks. Requests for new loans over $1 million are reviewed by the
directors' loan committee at Merchants Bank. Loan review is centralized for all
three Banks, and loan review personnel and commercial lenders interact with the
Banks' Boards of Directors each month. Management has attempted to identify
problem loans at an early stage and to aggressively seek a resolution of these
situations. The result has been a below average level of problem loans compared
to the Banks' industry peer groups in recent years.
MORTGAGE BANKING. Merchants Bank conducts a mortgage origination operation
through its mortgage division, and also makes these services available to
Hinckley State Bank and Fox Valley Bank customers. Prior to 1993, Merchants Bank
generally did not hold newly originated residential mortgage loans in its
portfolio, preferring instead to originate the loans for outside investors and
have the outside investors fund and service the loans. Beginning in 1993,
Merchants Bank began funding all residential mortgage loans and selling the
majority of them in the secondary market with servicing retained. In addition,
in June, 1993, Merchants Bank purchased the servicing on most of the residential
mortgage loans it originated in prior periods. In 1995, Merchants Bank purchased
the servicing rights to approximately $62.6 million of mortgage loans. As a
result of such actions, Merchants Bank has built its mortgage servicing
portfolio to approximately $255 million at December 31, 1996. Management
believes that the retention of mortgage servicing provides Merchants Bank with a
relatively steady source of fee income as compared to fees generated solely from
mortgage origination operations.
CONSUMER LENDING. The Banks' consumer lending department provide all types
of consumer loans including motor vehicle, home improvement, home equity,
student, signature and small personal credit lines. The Banks have designated
funds to support various special programs to benefit the first time borrower.
During 1994, Merchants Bank entered the credit card market by issuing its own
Visa Card, and offers this product to Hinckley State Bank and Fox Valley Bank
customers. Merchants Bank has entered into a contract with a non-affiliated
third party to provide credit card processing for its operations. Through this
program, Merchants Bank hopes to increase profits and augment its cross-selling
opportunities by increasing its marketing base. The "Phone for a Loan," program
at Merchants Bank will provide easy means for customers to apply for a loan 24
hours a day.
TRUST DEPARTMENT
Merchants Bank's trust department has been providing trust services to the
Aurora community for over 60 years. Currently, Merchants Bank has over $361
million of assets under management and provides a full complement of trust
services for individuals and corporations. Merchants Bank has targeted the trust
department as one of its primary areas for future growth. Trust services are
also offered to Hinckley State Bank and Fox Valley Bank customers.
To build on the trust department's mainstay of personal trust
administration, its current focus will be in two major areas: (i) investment
management for individuals and (ii) administration and investment services for
employee benefit plans. In late 1992 and early 1993, the trust department hired
a staff of professionals with expertise in the employee benefit administration
and new business development areas. This group provides expanded employee
benefit retirement plan administration and investment services to sole
proprietors and corporations. The trust department has also converted its data
processing and delivery system to enhance the department's ability to continue
to provide a quality, highly personalized trust product to its customers.
COMPETITION
The Corporation's market area is highly competitive. Many financial
institutions based in Aurora's surrounding communities and in Chicago, Illinois,
operate banking offices in the greater Aurora area or actively compete for
customers within the Corporation's market areas. The Banks also face competition
from finance companies, insurance companies, mortgage companies, securities
brokerage firms, money market funds, loan production offices and other providers
of financial services.
The Corporation competes for loans principally through the range and
quality of the services it provides, interest rates and loan fees. The
Corporation believes that its long-standing presence in the community and
personal service philosophy enhances its ability to compete favorably in
attracting and retaining individual and business customers. The Corporation
actively solicits deposit-related clients and competes for deposits by offering
customers personal attention, professional service and competitive interest
rates.
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EMPLOYEES
At December 31, 1996, the Corporation employed 341 full-time equivalent
employees. The Corporation places a high priority on staff development which
involves extensive training, including customer service training. New employees
are selected on the basis of both technical skills and customer service
capabilities. None of the Corporation's employees are covered by a collective
bargaining agreement with the Corporation. The Corporation offers a variety of
employee benefits and management considers its employee relations to be
excellent.
SUPERVISION AND REGULATION
GENERAL
Financial institutions and their holding companies are extensively
regulated under federal and state law. As a result, the growth and earnings
performance of the Corporation can be affected not only by management decisions
and general economic conditions, but also by the requirements of applicable
state and federal statutes and regulations and the policies of various
governmental regulatory authorities including, but not limited to, the Board of
Governors of the Federal Reserve System (the "FRB"), the Federal Deposit
Insurance Corporation (the "FDIC"), the Office of the Comptroller of the
Currency (the "OCC"), the Illinois Commissioner of Banks and Real Estate (the
"Commissioner"), the Internal Revenue Service and state taxing authorities and
the Securities and Exchange Commission (the "SEC"). The effect of such statutes,
regulations and policies can be significant, and cannot be predicted with a high
degree of certainty.
Federal and state laws and regulations generally applicable to financial
institutions, such as the Corporation and its subsidiaries, regulate, among
other things, the scope of business, investments, reserves against deposits,
capital levels relative to operations, the nature and amount of collateral for
loans, the establishment of branches, mergers, consolidations and dividends. The
system of supervision and regulation applicable to the Corporation and its
subsidiaries establishes a comprehensive framework for their respective
operations and is intended primarily for the protection of the FDIC's deposit
insurance funds and the depositors, rather than the shareholders, of financial
institutions.
The following references to material statutes and regulations affecting the
Corporation and its subsidiaries are brief summaries thereof and do not purport
to be complete, and are qualified in their entirety by reference to such
statutes and regulations. Any change in applicable law or regulations may have
a material effect on the business of the Corporation and its subsidiaries.
RECENT REGULATORY DEVELOPMENTS
On September 30, 1996, President Clinton signed into law the "Economic
Growth and Regulatory Paperwork Reduction Act of 1996" (the "Regulatory
Reduction Act"). Subtitle G of the Regulatory Reduction Act consists of the
"Deposit Insurance Funds Act of 1996" (the "DIFA"). The DIFA provides for a
one-time special assessment on each depository institution holding deposits
subject to assessment by the FDIC for the Savings Association Insurance Fund
(the "SAIF") in an amount which, in the aggregate, will increase the designated
reserve ratio of the SAIF (I.E., the ratio of the insurance reserves of the SAIF
to total SAIF-insured deposits) to 1.25% on October 1, 1996. Subject to certain
exceptions, the special assessment was payable in full on November 27, 1996.
None of Merchants Bank, Hinckley State Bank or Fox Valley Bank (collectively,
the "Banks") holds any SAIF-assessable deposits and, therefore, none of the
Banks was subject to the special assessment.
Prior to the enactment of the DIFA, a substantial amount of the SAIF
assessment revenue was used to pay the interest due on bonds issued by the
Financing Corporation ("FICO"), the entity created in 1987 to finance the
recapitalization of the Federal Savings and Loan Insurance Corporation (the
"FSLIC"), the SAIF's predecessor insurance fund. Pursuant to the DIFA, the
interest due on outstanding FICO bonds will be covered by assessments against
both SAIF and Bank Insurance Fund ("BIF") member institutions beginning January
1, 1997. Between January 1, 1997 and December 31, 1999, FICO assessments
against BIF-member institutions cannot exceed 20% of the FICO assessments
charged SAIF-member institutions. From January 1, 2000 until the FICO bonds
mature in 2019, FICO assessments will be shared by all FDIC-insured institutions
on a PRO RATA basis. It has been estimated that the FICO assessments for the
period January 1, 1997 through December 31, 1999 will be approximately 0.013% of
deposits for BIF members versus approximately 0.064% of deposits for SAIF
members, and will be less than 0.025% of deposits thereafter.
The DIFA also provides for a merger of the BIF and the SAIF on January 1,
1999, provided there are no state or federally chartered, FDIC-insured savings
associations existing on that date. To facilitate the merger of the BIF and the
SAIF, the DIFA directs the Treasury Department to conduct a study on the
development of a common charter and to submit a report, along with appropriate
legislative recommendations, to the Congress by March 31, 1997.
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In addition to the DIFA, the Regulatory Reduction Act includes a number of
statutory changes designed to eliminate duplicative, redundant or unnecessary
regulatory requirements. Among other things, the Regulatory Reduction Act
establishes streamlined notice procedures for the commencement of new nonbanking
activities by bank holding companies, eliminates the need for national banks to
obtain OCC approval to establish off-site ATMs, excludes ATM closures and
certain branch office relocations from the prior notice requirements applicable
to branch closings, significantly expands the authority of well-capitalized and
well-managed national banks to invest in office premises without prior
regulatory approval and establishes time frames within which the FDIC must act
on applications by state banks to engage in activities which, although permitted
for state banks under applicable state law, are not permissible activities for
national banks. The Regulatory Reduction Act also clarifies the liability of a
financial institution, when acting as a lender or in a fiduciary capacity, under
the federal environmental laws. Although the full impact of the Regulatory
Reduction Act on the operations of the Corporation and the Banks cannot be
determined at this time, management believes that the legislation may reduce
compliance costs to some extent and allow the Corporation and the Banks somewhat
greater operating flexibility.
THE CORPORATION
GENERAL. The Corporation, as the sole shareholder of the Banks, is a bank
holding company. As a bank holding company, the Corporation is registered with,
and is subject to regulation by, the FRB under the Bank Holding Company Act, as
amended (the "BHCA"). In accordance with FRB policy, the Corporation is
expected to act as a source of financial strength to the Banks and to commit
resources to support the Banks in circumstances where the Corporation might not
do so absent such policy. Under the BHCA, the Corporation is subject to
periodic examination by the FRB and is required to file with the FRB periodic
reports of its operations and such additional information as the FRB may
require. The Corporation is also subject to the requirements of the Illinois
Bank Holding Company Act, as amended.
INVESTMENTS AND ACTIVITIES. Under the BHCA, a bank holding company must
obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (ii) acquiring all or
substantially all of the assets of another bank; or (iii) merging or
consolidating with another bank holding company. Subject to certain conditions
(including certain deposit concentration limits established by the BHCA), the
FRB may allow a bank holding company to acquire banks located in any state of
the United States without regard to whether the acquisition is prohibited by the
law of the state in which the target bank is located. In approving interstate
acquisitions, however, the FRB is required to give effect to applicable state
law limitations on the aggregate amount of deposits that may be held by the
acquiring bank holding company and its insured depository institution affiliates
in the state in which the target bank is located or which require that the
target bank have been in existence for a minimum period of time (not to exceed
five years) before being acquired by an out-of-state bank holding company.
The BHCA also prohibits, with certain exceptions, the Corporation from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank and from engaging in any business
other than that of banking, managing and controlling banks or furnishing
services to banks and their subsidiaries. The principal exception to this
prohibition allows bank holding companies to engage in, and to own shares of
companies engaged in, certain businesses found by the FRB to be "so closely
related to banking ... as to be a proper incident thereto." Under current
regulations of the FRB, the Corporation and its non-bank subsidiaries are
permitted to engage in, among other activities, such banking-related businesses
as the operation of a thrift, sales and consumer finance, equipment leasing, the
operation of a computer service bureau, including software development, and
mortgage banking and brokerage. The BHCA generally does not place territorial
restrictions on the activities of non-bank subsidiaries of bank holding
companies.
Federal legislation also prohibits acquisition of "control" of a bank or
bank holding company, such as the Corporation, without prior notice to certain
federal bank regulators. "Control" is defined in certain cases as acquisition
of 10% of the outstanding shares of a bank or bank holding company.
CAPITAL REQUIREMENTS. Bank holding companies are required to maintain
minimum levels of capital in accordance with FRB capital adequacy guidelines.
If capital falls below minimum guideline levels, a bank holding company, among
other things, may be denied approval to acquire or establish additional banks or
non-bank businesses.
The FRB's capital guidelines establish the following minimum regulatory
capital requirements for bank holding companies: a risk-based requirement
expressed as a percentage of total risk-weighted assets, and a leverage
requirement expressed as a percentage of total assets. The risk-based
requirement consists of a minimum ratio of total capital to total risk-weighted
assets of 8%, of which at least one-half must be Tier 1 capital. The leverage
requirement consists of a minimum ratio of Tier 1 capital to total assets of 3%
for the most highly rated companies, with minimum requirements of 4% to 5% for
all others. For purposes of these capital standards, Tier 1 capital consists
primarily of permanent stockholders' equity less intangible assets (other than
certain mortgage servicing rights and purchased credit card relationships) and
total capital means Tier 1 capital plus certain other debt and equity
instruments which do not qualify as Tier 1 capital and a portion of the
company's allowance for loan and lease losses.
6
<PAGE>
The risk-based and leverage standards described above are minimum
requirements, and higher capital levels will be required if warranted by the
particular circumstances or risk profiles of individual banking organizations.
Further, any banking organization experiencing or anticipating significant
growth would be expected to maintain capital ratios, including tangible capital
positions (I.E., Tier 1 capital less all intangible assets), well above the
minimum levels.
As of December 31, 1996, the Corporation had regulatory capital in excess
of the FRB's minimum requirements, with a risk-based capital ratio of 10.26% and
a leverage ratio of 6.90%.
DIVIDENDS. The FRB has issued a policy statement with regard to the
payment of cash dividends by bank holding companies. In the policy statement,
the FRB expressed its view that a bank holding company should not pay cash
dividends exceeding its net income or which can only be funded in ways that
weaken the bank holding company's financial health, such as by borrowing.
Additionally, the FRB possesses enforcement powers over bank holding companies
and their non-bank subsidiaries to prevent or remedy actions that represent
unsafe or unsound practices or violations of applicable statutes and
regulations. Among these powers is the ability to proscribe the payment of
dividends by banks and bank holding companies. In addition to the restrictions
on dividends that may be imposed by the FRB, the Delaware General Corporation
Law would allow the Corporation to pay dividends only out of its surplus or, if
the Corporation has no such surplus, out of its net profits for the fiscal year
in which the dividend is declared and/or the preceding fiscal year.
FEDERAL SECURITIES REGULATION. The Corporation's common stock is
registered with the SEC under the Securities Act of 1933, as amended, and the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently,
the Corporation is subject to the information, proxy solicitation, insider
trading and other restrictions and requirements of the SEC under the Exchange
Act.
THE BANKS
GENERAL. Hinckley State Bank and Fox Valley Bank (collectively the "State
Banks") are Illinois-chartered banks, subject to the examination, supervision,
reporting and enforcement requirements of the Commissioner, as the chartering
authority for Illinois banks. Merchants Bank is a national bank, chartered by
the OCC under the National Bank Act, and as such is subject to the examination,
supervision, reporting and enforcement requirements of the OCC. Merchants Bank
is also a member of the Federal Reserve System. The deposit accounts of each of
the Banks are insured by the BIF of the FDIC. As BIF-insured banks, the Banks
are also subject to the examination, supervision, reporting and enforcement
requirements of the FDIC, as administrator of the BIF.
DEPOSIT INSURANCE. As FDIC-insured institutions, the Banks are required to
pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a
risk-based assessment system under which all insured depository institutions are
placed into one of nine categories and assessed insurance premiums based upon
their respective levels of capital and supervisory evaluations. Institutions
classified as well-capitalized (as defined by the FDIC) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered of substantial supervisory
concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
During the year ended December 31, 1996, BIF assessments ranged from 0% of
deposits to 0.27% of deposits. The FDIC has announced that for the semi-annual
assessment period beginning January 1, 1997, BIF assessment rates will continue
to range from 0% of deposits to 0.27% of deposits.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, order, or any condition imposed in writing by, or written agreement
with, the FDIC. The FDIC may also suspend deposit insurance temporarily during
the hearing process for a permanent termination of insurance if the institution
has no tangible capital. Management of the Corporation is not aware of any
activity or condition that could result in termination of the deposit insurance
of any of the Banks.
FICO ASSESSMENTS. Since 1987, a portion of the deposit insurance
assessments paid by SAIF members has been used to cover interest payments due on
the outstanding obligations of the FICO, the entity created to finance the
recapitalization of the FSLIC, the SAIF's predecessor insurance fund. Pursuant
to federal legislation enacted September 30, 1996, commencing January 1, 1997,
both SAIF members and BIF members will be subject to assessments to cover the
interest payment on outstanding FICO obligations. Such FICO assessments will be
in addition to amounts assessed by the FDIC for deposit insurance. Until
January 1, 2000, the FICO assessments made against BIF members may not exceed
20% of the amount of the FICO assessments made against SAIF members. It is
estimated that SAIF members will pay FICO assessments equal to 0.064% of
deposits while BIF members will pay FICO assessments equal to 0.013% of
deposits. Between January 1, 2000 and the maturity of the outstanding FICO
obligations in 2019, BIF members and SAIF members will share the cost of the
interest on the FICO bonds on a PRO RATA basis. It is estimated that FICO
assessments during this period will be less than 0.025% of deposits.
7
<PAGE>
SUPERVISORY ASSESSMENTS. Illinois banks and national banks are required to
pay supervisory fees to the Commissioner and the OCC, respectively, to fund the
operations of each agency. The amount of such supervisory fees is based upon
each institution's total assets, including consolidated subsidiaries, as
reported to the agency. During the year ended December 31, 1996, the State
Banks paid supervisory fees to the Commissioner totaling $15,000, and Merchants
Bank paid supervisory assessments to the OCC totaling $120,000.
CAPITAL REQUIREMENTS. Federal regulations require the Banks to meet the
following minimum capital standards: a leverage requirement consisting of a
minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated
banks with minimum requirements of 4% to 5% for all others, and a risk-based
capital requirement consisting of a minimum ratio of total capital to total
risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital.
For purposes of these capital standards, Tier 1 capital and total capital
consist of substantially the same components as Tier 1 capital and total capital
under the FRB's capital guidelines for bank holding companies (SEE "--The
Corporation--Capital Requirements").
The capital requirements described above are minimum requirements. Higher
capital levels will be required if warranted by the particular circumstances or
risk profiles of individual institutions. For example, federal regulations
provide that additional capital may be required to take adequate account of
interest rate risk or the risks posed by concentrations of credit,
nontraditional activities or securities trading activities.
During the year ended December 31, 1996, none of the Banks was required by
its primary federal regulator to increase its capital to an amount in excess of
the minimum regulatory requirements. As of December 31, 1996, each of the Banks
exceeded its minimum regulatory capital requirements, as follows:
RISK-BASED LEVERAGE
CAPITAL RATIO RATIO
------------- ----------
Merchants Bank 11.61% 7.82%
Hinckley State Bank 12.17% 7.29%
Fox Valley Bank 11.31% 7.68%
Federal law provides the federal banking regulators with broad power to
take prompt corrective action to resolve the problems of undercapitalized
institutions. The extent of the regulators' powers depends on whether the
institution in question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Depending upon the capital category to which an institution
is assigned, the regulators' corrective powers include: requiring the
submission of a capital restoration plan; placing limits on asset growth and
restrictions on activities; requiring the institution to issue additional
capital stock (including additional voting stock) or to be acquired; restricting
transactions with affiliates; restricting the interest rate the institution may
pay on deposits; ordering a new election of directors of the institution;
requiring that senior executive officers or directors be dismissed; prohibiting
the institution from accepting deposits from correspondent banks; requiring the
institution to divest certain subsidiaries; prohibiting the payment of principal
or interest on subordinated debt; and ultimately, appointing a receiver for the
institution.
Additionally, institutions insured by the FDIC may be liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC in connection
with the default of commonly controlled FDIC insured depository institutions or
any assistance provided by the FDIC to commonly controlled FDIC insured
depository institutions in danger of default.
DIVIDENDS. Under the Illinois Banking Act, Illinois-chartered banks, such
as the State Banks, may not pay, without prior regulatory approval, dividends in
excess of their net profits. Similarly the National Bank Act imposes
limitations on the amount of dividends that may be paid by a national bank, such
as Merchants Bank. Generally, a national bank may pay dividends out of its
undivided profits in such amounts and at such times as the bank's board of
directors deems prudent. Without prior OCC approval, however, a national bank
may not pay dividends in any calendar year that exceed the bank's year-to-date
net income plus the bank's adjusted retained net income for the two preceding
years.
The payment of dividends by any financial institution is affected by the
requirement to maintain adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and a financial institution generally is prohibited
from paying any dividends if, following payment thereof, the institution would
be undercapitalized. As described above, each of the Banks exceeded its minimum
capital requirements under applicable guidelines as of December 31, 1996. As of
December 31, 1996, approximately $15.6 million was available to be paid as
dividends to the Corporation by the Banks. Notwithstanding the availability of
funds for dividends, however, the federal banking regulators may prohibit the
payment of any dividends by the Banks if they determine such payment would
constitute an unsafe or unsound practice.
INSIDER TRANSACTIONS. The Banks are subject to certain restrictions
imposed by the Federal Reserve Act on extensions of credit to the Corporation
and its subsidiaries, on investments in the stock or other securities of the
Corporation and its subsidiaries and the
8
<PAGE>
acceptance of the stock or other securities of the Corporation or its
subsidiaries as collateral for loans. Certain limitations and reporting
requirements are also placed on extensions of credit by the Banks to their
respective directors and officers, to directors and officers of the Corporation
and its subsidiaries, to principal stockholders of the Corporation, and to
"related interests" of such directors, officers and principal stockholders. In
addition, such legislation and regulations may affect the terms upon which any
person becoming a director or officer of the Corporation or one of its
subsidiaries or a principal stockholder of the Corporation may obtain credit
from banks with which one of the Banks maintains a correspondent relationship.
SAFETY AND SOUNDNESS STANDARDS. The FDIC and the OCC have adopted
guidelines which establish operational and managerial standards to promote the
safety and soundness of state non-member banks and national banks, respectively.
The guidelines set forth standards for internal controls, information systems,
internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, fees and benefits, asset quality and
earnings. In general, the guidelines prescribe the goals to be achieved in each
area, and each institution is responsible for establishing its own procedures to
achieve those goals. If an institution fails to comply with any of the
standards set forth in the guidelines, the agency may require the institution to
submit a plan for achieving and maintaining compliance. The preamble to the
guidelines states that the agencies expect to require a compliance plan from an
institution whose failure to meet one or more of the guidelines is of such
severity that it could threaten the safety and soundness of the institution.
Failure to submit an acceptable plan, or failure to comply with a plan that has
been accepted by the agency, would constitute grounds for further enforcement
action.
BRANCHING AUTHORITY. Illinois banks, such as the State Banks, have the
authority under Illinois law to establish branches anywhere in the State of
Illinois, subject to receipt of all required regulatory approvals. National
banks headquartered in Illinois, such as Merchants Bank, have the same branching
rights in Illinois as banks chartered under Illinois law.
Effective June 1, 1997 (or earlier if expressly authorized by applicable
state law), the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "Riegle-Neal Act") allows banks to establish interstate branch
networks through acquisitions of other banks, subject to certain conditions,
including certain limitations on the aggregate amount of deposits that may be
held by the surviving bank and all of its insured depository institution
affiliates. The establishment of DE NOVO interstate branches or the acquisition
of individual branches of a bank in another state (rather than the acquisition
of an out-of-state bank in its entirety) is allowed by the Riegel-Neal Act only
if specifically authorized by state law. The legislation allows individual
states to "opt-out" of certain provisions of the Riegle-Neal Act by enacting
appropriate legislation prior to June 1, 1997. Illinois has enacted legislation
permitting interstate mergers beginning on June 1, 1997.
STATE BANK ACTIVITIES. Under federal law and FDIC regulations, FDIC
insured state banks, such as the State Banks, are prohibited, subject to certain
exceptions, from making or retaining equity investments of a type, or in an
amount, that are not permissible for a national bank. Federal law and FDIC
regulations also prohibit FDIC insured state banks and their subsidiaries,
subject to certain exceptions, from engaging as principal in any activity that
is not permitted for a national bank or its subsidiary, respectively, unless the
bank meets, and continues to meet, its minimum regulatory capital requirements
and the FDIC determines the activity would not pose a significant risk to the
deposit insurance fund of which the bank is a member. Impermissible investments
and activities must be divested or discontinued within certain time frames set
by the FDIC. These restrictions have not had, and are not currently expected to
have, a material impact on the operations of the State Banks.
FEDERAL RESERVE SYSTEM. FRB regulations, as presently in effect, require
depository institutions to maintain non-interest earning reserves against their
transaction accounts (primarily NOW and regular checking accounts), as follows:
for transaction accounts aggregating $49.3 million or less, the reserve
requirement is 3% of total transaction accounts; and for transaction accounts
aggregating in excess of $49.3 million, the reserve requirement is $1.479
million plus 10% of the aggregate amount of total transaction accounts in excess
of $49.3 million. The first $4.4 million of otherwise reservable balances are
exempted from the reserve requirements. These reserve requirements are subject
to annual adjustment by the FRB. The Banks are in compliance with the foregoing
requirements.
STATISTICAL DATA
The statistical data required by Guide 3 of the Guides for Preparation and
Filing of Reports and Registration Statements under the Securities Exchange Act
of 1934 is set forth in the following pages. This data should be read in
conjunction with the consolidated financial statements, related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as set forth in the 1996 Annual Report herein incorporated by
reference (attached hereto as Exhibit 13). All dollars in the tables are
expressed in thousands.
9
<PAGE>
The following table sets forth certain information relating to the Corporation's
average consolidated balance sheets and reflects the yield on average earning
assets and cost of average liabilities for the years indicated. Such yields and
costs are derived by dividing income or expense by the average balance of assets
or liabilities. Average balances are derived from daily balances.
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------- ------------------------- -------------------------
Average Rate Average Rate Average Rate
Balance Interest (%) Balance Interest (%) Balance Interest (%)
------- -------- ----- ------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Securities:
Taxable $156,701 $10,119 6.42 $128,963 $8,123 6.23 $105,681 $5,851 5.64
Non-taxable (tax equivalent) 52,662 4,177 8.09 51,042 4,264 8.37 46,285 4,005 8.62
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total securities 209,363 14,296 6.83 180,005 12,387 6.83 151,966 9,856 7.05
Federal funds sold 7,776 415 5.34 11,883 732 6.16 1,584 79 4.99
Loans held for sale 4,106 245 5.97 2,408 224 9.30 4,089 207 5.06
Net loans (tax equivalent) 399,546 37,074 9.28 291,181 28,034 9.63 278,819 24,476 8.78
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest earning assets 620,791 52,030 8.38 485,477 41,377 8.50 436,458 34,618 7.96
Cash and due from banks 32,139 - - 25,376 - - 28,676 - -
Allowance for loan losses (6,534) - - (5,314) - - (5,089) - -
Premises and equipment, net 12,056 - - 9,353 - - 9,110 - -
Accrued interest and other assets 25,326 - - 6,543 - - 6,094 - -
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total assets $683,778 52,030 7.91 $521,435 41,377 7.91 $475,249 34,618 7.31
-------- ------- ----- -------- ------- ----- -------- ------- -----
-------- ------- ----- -------- ------- ----- -------- ------- -----
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest bearing deposits:
NOW accounts $74,319 1,777 2.39 $66,687 1,571 2.36 $70,565 1,577 2.23
Money market accounts 54,535 1,759 3.23 31,604 1,138 3.60 33,196 885 2.67
Savings 67,425 1,890 2.80 54,263 1,480 2.73 57,567 1,527 2.65
Time, $100,000 and over 80,483 4,450 5.53 59,964 3,323 5.54 43,246 1,922 4.44
Other time 205,321 12,036 5.86 153,214 8,988 5.87 119,839 5,880 4.91
Federal funds purchased and securities
sold under repurchase agreements 35,366 1,773 5.01 32,848 1,776 5.41 34,166 1,285 3.76
Notes payable 14,567 453 3.11 3,000 147 4.90 3,104 152 4.90
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest bearing liabilities 532,016 24,138 4.54 401,580 18,423 4.59 361,683 13,228 3.66
Noninterest bearing deposits 95,293 - - 69,167 - - 67,947 - -
Accrued interest and other liabilities 2,709 - - 2,406 - - 1,552 - -
Stockholders' equity 53,760 - - 48,282 - - 44,067 - -
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total liabilities and
stockholders' equity $683,778 24,138 3.53 $521,435 18,423 3.53 $475,249 13,228 2.78
-------- ------- ----- -------- ------- ----- -------- ------- -----
-------- ----- -------- ----- --------
Net interest income (tax equivalent) $27,892 $22,954 $21,390
------- ------- -------
------- ------- -------
Net interest income (tax equivalent)
to total earning assets 4.49 4.73 4.92
----- ----- -----
----- ----- -----
Interest bearing liabilities to
earnings assets 85.70% 82.72% 82.87%
------- -------- --------
------- -------- --------
</TABLE>
Notes: Nonaccrual loans are included in the above stated average balances.Tax
equivalent basis is calculated using a marginal tax rate of 34%.
Yields on securities available for sale are based on amortized cost.
10
<PAGE>
The following table allocates the changes in net interest income to changes in
either average balances or average rates for earnings assets and interest
bearing liabilities. The changes in interest due to both volume and rate have
been allocated proportionately to the change due to balance and due to rate.
Interest income is measured on a tax equivalent basis using a 34% rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
<TABLE>
<CAPTION>
1996 Compared to 1995 1995 Compared to 1994
------------------------------------ ------------------------------------
Change Due to Change Due to
----------------------- ------------------------
Volume Rate Net Volume Rate Net
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS/INTEREST INCOME
Securities:
Taxable $1,774 $222 $1,996 $1,398 $874 $2,272
Tax-exempt 134 (221) (87) 402 (143) 259
Federal funds sold (228) (89) (317) 631 22 653
Loans and loans held for sale 10,209 (1,148) 9,061 1,010 2,565 3,575
------ ------ ------ ------ ------ ------
TOTAL EARNING ASSETS 11,889 (1,236) 10,653 3,441 3,318 6,759
------ ------ ------ ------ ------ ------
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits:
NOW accounts 183 23 206 (90) 84 (6)
Money market accounts 751 (130) 621 (44) 297 253
Savings 368 42 410 (89) 42 (47)
Time, $100,000 and over 1,134 (7) 1,127 855 546 1,401
Other time 3,055 (7) 3,048 1,826 1,282 3,108
Federal funds purchased and securities
sold under repurchase agreements 131 (134) (3) (52) 543 491
Notes payable 378 (72) 306 (5) - (5)
------ ------ ------ ------ ------ ------
TOTAL INTEREST BEARING LIABILITIES 6,000 (285) 5,715 2,401 2,794 5,195
------ ------ ------ ------ ------ ------
NET INTEREST INCOME $5,889 $ (951) $4,938 $1,040 $524 $1,564
------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------
</TABLE>
Differences in the repricing dates of assets and liabilities are a primary
component of risk to net interest income. A positive sensitivity gap implies
that net interest income will increase as interest rates increase and decline as
interest rates decline, assuming other factors remain unchanged. The repricing
gap of earning assets and interest bearing liabilities as of December 31, 1996,
is as follows:
INTEREST SENSITIVITY ANALYSIS
<TABLE>
<CAPTION>
0-3 Months 4-12 Months 1-5 Years Over 5 Years Total
---------- ---------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
EARNING ASSETS:
Securities $ 29,962 $ 26,104 $ 95,980 $ 42,734 $ 194,780
Federal funds sold 2,613 - - - 2,613
Loans held for sale 4,149 - - - 4,149
Total loans 155,758 72,633 180,364 48,047 456,802
---------- ---------- ---------- --------- ---------
TOTAL EARNING ASSETS $ 192,482 $ 98,737 $ 276,344 $ 90,781 $ 658,344
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
INTEREST BEARING
LIABILITIES:
Interest-bearing
deposits:
NOW accounts $ 75,991 $ - $ - $ - $ 75,991
Money market accounts 58,061 - - - 58,061
Savings 67,232 - - - 67,232
Time, $100,000 and over 34,521 22,862 21,831 - 79,214
Other time 43,329 58,780 106,160 - 208,269
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
TOTAL INTEREST BEARING DEPOSITS 279,134 81,642 127,991 - 488,767
Federal funds purchased and
securities sold under repurchase
agreements 34,794 9,731 - - 44,525
Note payable 7,000 - 3,500 3,500 14,000
---------- ---------- ---------- --------- ---------
TOTAL INTEREST BEARING $ 320,928 $ 91,373 $ 131,491 $ 3,500 $ 547,292
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
Interest sensitivity gap $(128,446) $ 7,364 $ 144,853 $ 87,281 $ 111,052
Cumulative gap (128,446) (121,082) 23,771 111,052 111,052
Interest sensitivity gap
to total assets -17.7% 1.0% 20.0% 12.1% 15.3%
Cumulative sensitivity
gap to total assets -17.7% -16.7% 3.3% 15.3% 15.3%
</TABLE>
Note: Callable investment securities are reported at the earlier of maturity
or call date.Loans are placed in the earliest time frame in which
maturity or repricing may occur.
11
<PAGE>
The following table presents the composition of the securities portfolio by
major category as of December 31, of each year indicated:
SECURITIES PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
1996 1995 1994
--------------------- ------------------------ --------------------
% of % of % of
Amount Portfolio Amount Portfolio Amount Portfolio
------- --------- ------- --------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities $ 17,640 9.05% $ 24,860 13.28% $ 29,854 17.90%
U.S. Government agencies 76,980 39.52 53,481 28.57 41,540 24.90
U.S. Government agency mortgage backed securities 34,022 17.47 45,175 24.14 37,243 22.32
States and political subdivisions 54,827 28.15 51,820 27.69 10,400 6.23
Collateralized mortgage obligations 8,720 4.48 9,960 5.32 7,503 4.50
Equity securities 2,591 1.33 1,873 1.00 1,786 1.07
-------- ------ -------- ------ -------- -----
194,780 100.00 187,169 100.00 128,326 76.92
-------- ------ -------- ------ -------- -----
SECURITIES HELD TO MATURITY
States and political subdivisions - - - - 38,505 23.08
-------- ------ -------- ------ -------- -----
Total $194,780 100.00% $187,169 100.00% $166,831 100.00%
-------- ------ -------- ------ -------- -----
-------- ------ -------- ------ -------- -----
</TABLE>
Mortgage-backed securities are comprised of investments in pools of residential
mortgages. The mortgage pools are issued and guaranteed by the Federal Home Loan
Mortgage Corporation ("FHLMC"), the Government National Mortgage Association
("GNMA"), or the Federal National Mortgage Association ("FNMA"). Collateralized
mortgage obligations are secured by FHLMC, GNMA, or FNMA certificates.
As of December 31, 1996, and 1995, the Corporation held structured notes carried
ar fair values of $4,236,000 and $6,415,000. The amortized cost of these
securities was $4,250,000 and $6,462,000 as of December 31, 1996, and 1995.
These securities were issued by the FHLB, and the FNMA.
The following table presents the maturities and weighted average yield of
securities by major category as of December 31, 1996. Yields are calculated on a
tax equivalent basis using a 34% rate.
SECURITIES PORTFOLIO - MATURITY AND YIELDS
<TABLE>
<CAPTION>
After One But After Five But
Within Within Within After
One Year Five Years Ten Years Ten Years Total
---------------- ---------------- ----------------- ------------------ ----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ------ -------- ------ --------- ------ ------ --------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities $ 8,539 4.71% $ 9,101 5.53% $ - -% - -% $ 17,640 5.13%
U.S. government agencies 32,296 7.03 41,767 6.80 2,917 6.59 - - 76,980 6.89
U.S. government agency mortgage
backed securities 1,608 5.96 16,345 6.27 16,069 6.64 - - 34,022 6.43
States and political
subdivisions 1,454 5.71 20,391 5.62 32,982 5.71 - - 54,827 5.68
Collateralized mortgage
obligations - - - - 8,720 6.15 - - 8,720 6.15
Other securities 2,512 5.74 - - 79 9.73 - - 2,591 5.86
------- ----- ------- ----- ------- ------ ------ --------- -------- -----
Total $46,409 6.45% $87,604 6.29% $60,767 6.07% $ - -% $194,780 6.26%
------- ----- ------- ----- ------- ------ ------ --------- -------- -----
</TABLE>
Standard, securities available for sale are carried at market value, with
related unrealized gains or losses, net of deferred income taxes, recorded as an
adjustment to equity capital. As of December 31, 1996, net unrealized gains of
approximately $429,000, reduced by deferred income taxes of $112,000, resulted
in an increase in equity capital of approximately $317,000. As of December 31,
1995, net unrealized gains of approximately $2.2 million, reduced by deferred
income taxes of approximately $747,000, resulted in an increase in equity
capital of approximately $1.5 million.
As permitted by "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities," the Corporation exercised a
one time opportunity to reassess the appropriateness of the classifications of
all securities held. Based on this review, in order to enhance liquidity and tax
planning opportunities, the Corporation reclassified securities having an
amortized cost of $39,664,000 and a net unrealized gain of $1,461,000 at
December 15, 1995 from held to maturity to available for sale.
12
<PAGE>
There were no significant concentrations of investments (greater than 10% of the
Corporation's stockholders' equity) in any individual security issue except for
U.S. Treasury securities and obligations of U.S. Government agencies and
corporations. Although the Corporation held securities issued by municipalities
within the states of Illinois and Wisconsin which in the aggregate exceeded 10%
of stockholders' equity, none of the holdings from individual municipal issuers
exceeded this threshold.
The following table presents the composition of the loan portfolio at December
31, in the years indicated:
<TABLE>
<CAPTION>
LOAN PORTFOLIO
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Commercial and industrial $161,847 $109,872 $112,828 $104,711 $103,265
Real estate - commercial 75,449 67,739 72,305 53,334 33,149
Real estate - construction 54,513 40,510 24,470 35,249 22,873
Real estate - residential 85,107 31,673 19,549 11,356 7,796
Installment 73,918 50,489 53,806 73,861 78,416
Credit card receivables 6,697 5,644 4,119 - -
Other loans 1,188 455 937 293 438
-------- -------- -------- -------- --------
Gross loans 458,719 306,382 288,014 278,804 245,937
Unearned discount (1,535) (1,743) (2,054) (3,807) (5,849)
Deferred loan fees (382) (312) (387) (330) (111)
-------- -------- -------- -------- --------
Total loans 456,802 304,327 285,573 274,667 239,977
Allowance for loan losses (7,274) (5,176) (5,140) (4,705) (4,161)
-------- -------- -------- -------- --------
Loans, net $449,528 $299,151 $280,433 $269,962 $235,816
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The following table sets forth the remaining contractual maturities for certain
loan categories at December 31, 1996:
MATURITY AND RATE SENSITIVITY OF LOANS
<TABLE>
<CAPTION>
Over 1 Year
Through 5 Years Over 5 Years
------------------- --------------------
One Year Fixed Floating Fixed Floating
or Less Rate Rate Rate Rate Total
-------- -------- -------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Commercial and industrial $ 91,403 $ 39,361 $ 18,430 $ 8,043 $ 4,228 $161,465
Real estate - commercial 24,584 37,617 3,502 6,566 3,180 75,449
Real estate - construction 39,209 7,188 8,011 105 - 54,513
Real estate - residential 651 3,640 57 6,170 74,589 85,107
Installment 23,937 37,305 2,166 4,253 4,722 72,383
Credit card receivables 6,697 - - - - 6,697
Other loans 1,188 - - - - 1,188
-------- -------- -------- ------- ------- --------
Total $187,669 $125,111 $ 32,166 $25,137 $86,719 $456,802
-------- -------- -------- ------- ------- --------
-------- -------- -------- ------- ------- --------
</TABLE>
The following table sets forth the amounts of nonperforming assets at December
31, of the years indicated:
<TABLE>
<CAPTION>
NONPERFORMING ASSETS
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans $2,970 $1,135 $1,397 $1,956 $2,065
Loans past due 90 days or more
and still accruing interest - - - - -
Restructured loans 359 1,047 2,102 - -
------ ------ ------ ------ ------
Total nonperforming loans 3,329 2,182 3,499 1,956 2,065
Other real estate 333 566 845 223 164
------ ------ ------ ------ ------
Total nonperforming assets $3,662 $2,748 $4,344 $2,179 $2,229
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
Other problem assets - At December 31, 1996, there were no classified assets,
other than the loans shown above.
During 1994, Merchants Bank agreed to modify the terms of three loans to one
borrower totaling $3,077,000. Under the modified terms, Merchants Bank accepted
a parcel of real estate in partial settlement and rewrote the remaining loan
balances into two notes which have a total carrying value of $276,000 and
$1,047,000 at December 31, 1996 and 1995, and fixed interest rates of 8.5% on
each note, which was the market rate of interest for similar borrowers at the
restructure date. Both notes were performing as agreed at December 31, 1996.
These modifications resulted in a $168,000 loss charged to the allowance for
loan losses in 1994. No interest income was recognized on
13
<PAGE>
the loan in 1994 prior to the modifications. Total restructured loans were
$359,000 as of December 31, 1996 and $1,047,000 as of December 31, 1995. After
the restructuring, interest income recorded on the restructured loans was
$117,000 for 1996 and $110,000 for 1995.
Impaired loans were as follows:
1996 1995
------ ------
Year-end loans with no allowance for loan losses allocated $ 523 $ -
Year-end loans with allowance for loan losses allocated 905 921
Amount of the allowance allocated 363 631
Average of impaired loans during the year 1,480 2,378
Interest income recognized during impairment 191 305
Cash-basis interest income recognized 89 302
Accrual of interest is discontinued on a loan when principal or interest is
ninety days or more past due, unless the loan is well secured and in the process
of collection. When a loan is placed on nonaccrual status, interest previously
accrued but not collected in the current period is reversed against current
period interest income. Interest accrued in prior years but not collected is
charged against the allowance for possible loan losses. Interest income of
approximately $101,000 was recorded during 1996 on loans in nonaccrual status at
December 31, 1996. Interest income which would have been recognized during 1996
had these loans been on an accrual basis throughout the year was approximately
$335,000.
The following table summarizes, for the years indicated, activity in the
allowance for loan losses, including amounts charged off, amounts of recoveries,
additions to the allowance charged to operating expense, and the ratio of net
charge-offs to average loans outstanding:
<TABLE>
<CAPTION>
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Average total loans (exclusive of
loans held for sale) $ 399,546 $ 291,181 $ 278,819 $ 256,888 $ 221,762
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Allowance at beginning of year $ 5,176 $ 5,140 $ 4,705 $ 4,161 $ 2,879
Increase due to the acquisition 798 - - - -
of Valley
Charge-offs:
Commercial and industrial 1,193 1,248 1,321 839 938
Real estate - commercial 126 272 393 375 374
Real estate - construction - - 20 - -
Real estate - residential 5 - 150 * *
Installment and other loans 917 993 1,058 1,367 1,187
--------- --------- --------- --------- ---------
Total charge-offs 2,241 2,513 2,942 2,581 2,499
--------- --------- --------- --------- ---------
Recoveries:
Commercial and industrial 509 223 384 147 372
Real estate - commercial 658 83 236 147 50
Real estate - construction - - - - -
Real estate - residential - - 13 * *
Installment and other loans 360 460 446 408 297
--------- --------- --------- --------- ---------
Total recoveries 1,527 766 1,079 702 719
--------- --------- --------- --------- ---------
Net charge-offs 714 1,747 1,863 1,879 1,780
Provision for loan losses 2,014 1,783 2,298 2,423 3,062
--------- --------- --------- --------- ---------
Allowance at end of period $ 7,274 $ 5,176 $ 5,140 $ 4,705 $ 4,161
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net charge-offs to average loans 0.18% 0.60% 0.67% 0.73% 0.80%
Allowance at year end to average
loans 1.82% 1.78% 1.84% 1.83% 1.88%
</TABLE>
*Charge-offs and recoveries of real estate - residential loans are reported
above in real estate - commercial for years prior to 1994.
The provision for loan losses is based upon management's estimate of anticipated
loan losses and its evaluation of the adequacy of the allowance for loan losses.
Factors which influence management's judgement in estimating loan losses are the
composition of the portfolio, past loss experience, loan delinquencies,
nonperforming loans, and other factors that, in management's judgment, deserve
evaluation in estimating loan losses.
14
<PAGE>
The following table shows the Corporation's allocation of the allowance for loan
losses by types of loans and the amount of unallocated allowance, at December
31, of the years indicated:
<TABLE>
<CAPTION>
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
1996 1995 1994 1993 1992
------------------ ------------------- ------------------- ----------------- ----------------
Loan Loan Loan Loan Loan
Type Type Type Type Type
to to to to to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and
industrial $ 2,316 35.3% $ 3,441 36.1% $ 3,227 39.2% $ 3,369 37.6% $ 2,874 42.0%
Real estate -
commercial 117 16.4 152 22.3 199 25.1 213 19.1 26 13.5
Real estate -
construction 265 11.9 193 13.3 193 8.5 70 12.6 32 9.3
Real estate -
residential 383 18.6 135 10.4 55 6.8 - 4.1 - 3.2
Installment and
other loans 1,209 17.8 594 17.9 865 20.4 966 26.6 923 32.0
Unallocated 2,984 661 601 87 306
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total $ 7,274 100.0% $ 5,176 100.0% $ 5,140 100.0% $ 4,705 100.0% $ 4,161 100.0%
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
</TABLE>
Notes: Allocations of the allowance for loan losses for real estate -
residential loans are reported above in real estate - commercial for
years prior to 1994.
The following table sets forth the amount and maturities of deposits of $100,000
or more at December 31, 1996:
TIME DEPOSITS OF $100,000 OR MORE
3 months or less $ 43,970
Over 3 months through 6 months 11,211
Over 6 months through 12 months 12,348
Over 12 months 11,685
--------
$ 79,214
--------
--------
The following table reflects categories of short-term borrowings having average
balances during the year greater than 30% of stockholders' equity of the Company
at the end of the year. During each year reported, securities sold under
repurchase agreements are the only category meeting this criteria. Information
presented is as of or for the year ended December 31, for the years indicated:
SHORT-TERM BORROWINGS
1996 1995 1994
-------- -------- --------
Balance at end of year $ 19,225 $ 22,626 $ 29,725
Weighted average interest rate 5.52% 5.26% 4.97%
Maximum month-end amount
outstanding during the year $ 30,975 $ 47,892 $ 29,860
Average amount outstanding during the year $ 26,587 $ 31,298 $ 27,103
Weighted average interest rate during the year 4.94% 5.33% 3.59%
The following table presents selected financial ratios as of or for the year
ended December 31, for the years indicated:
SELECTED RATIOS
1996 1995 1994
------ ------ ------
Return on average total assets 0.95% 1.19% 1.15%
Return on average equity 12.14% 12.83% 12.39%
Average equity to average assets 7.86% 9.26% 9.27%
Tier 1 capital to risk-adjusted assets 9.02% 14.54% 13.92%
Total capital to risk adjusted assets 10.26% 15.79% 15.18%
Tier 1 leverage ratio 6.90% 10.31% 9.91%
Dividend payout ratio 22.13% 19.91% 17.40%
Note: Unrealized gains (losses) on securities available for sale are included in
the average balances used to calculate these ratios.
15
<PAGE>
ITEM 2. PROPERTIES
The principal offices of both the Corporation and Merchants Bank are
located in Merchants Bank's main office building located at 34 South Broadway,
Aurora, Illinois. The location is owned by Merchants Bank and consists of a
four-story building built in 1872. It is constructed of brick exterior walls and
in the early 1970's a granite, limestone and metal exterior was added to the
south and west sides. The west side facade was extended to include three
additional buildings north of the building. The entire office complex currently
comprises approximately 60,500 square feet. Merchants Bank also owns three
adjacent parking lots which can accommodate approximately 210 cars.
Management is currently studying alternatives regarding the future of
Merchants Bank's main office building. The building is in need of renovation to
improve work flow and effectively serve customers. As part of this process, some
departments may be relocated to other Corporation-owned facilities or to an as
yet unidentified location. Additional investment in the Corporation's properties
is anticipated, but specific plans, including costs and timing, have not yet
been determined.
Merchants Bank's downtown drive-up facility is located at 205 East
Downer Place in Aurora and comprises approximately 9,950 square feet. The one-
story building is owned by Merchants Bank and has eight drive-up windows. The
basement of this facility houses the data processing department.
Merchants Bank's Fox Valley Villages branch is a full-service facility
located at Long Grove Drive and Route 34 in Aurora. The one-story building is
owned by Merchants Bank and comprises approximately 3,400 square feet. The
branch has three drive-up lanes and four teller stations. The basement of this
building contains a safe deposit vault and is also being used for storage, a
conference room and rental space.
Merchants Bank's Douglas Square branch is a full-service facility
located at 1 Merchants Plaza in Oswego, Illinois. The 16,300 square foot
building is owned by Merchants Bank and was built in 1989. The three-story brick
building has six drive-in lanes and six teller stations. The basement of this
building is being used as a training room, an employee lounge and for storage.
There is a parking lot which can accommodate a total of approximately 85 cars.
Merchants Bank's West Plaza branch is a full-service facility with six
drive-up lanes located at 1851 West Galena Boulevard in Aurora. The two-story,
28,100 square foot building is owned by Merchants Bank and was constructed in
1962. During 1994, the entire first and second floors of this building were
remodeled to provide space for the trust department and mortgage division.
Merchants Bank also rents 5,000 square feet of space available at this location.
There are two parking lots which can accommodate 90 cars.
Merchants Bank also has a branch located in the Cub Foods store in
Aurora at 55 Constitution Drive. A Facility License and Construction Agreement
with International Banking Technologies, Inc. was entered into in June, 1992,
under which the Merchants Bank is permitted to operate a bank branch in the Cub
Foods store for a term of 20 years, ending January 25, 2013.
Merchants Bank's Randall Square branch is a full service facility with
4 drive-up lanes located at 1771 Merchants Drive in Geneva, Illinois. The one-
story, 6,200 square foot building is owned by Merchants Bank and construction
was completed in the first quarter of 1996.
Merchants Bank has a loan production office located at 3 North Smith
Street in Aurora. Merchants Bank leases approximately 1,200 square feet under a
three year lease entered into in September, 1994, which may be extended for an
additional three years at the option of Merchants Bank.
Merchants Bank has a loan production office located in Yorkville,
Illinois, at 520 Countryside Center. Approximately 1,100 square feet are leased
under a three year agreement entered into in June, 1994, which may be extended
for an additional three years at the option of the Merchants Bank.
Hinckley State Bank's main office is located in Hinckley Illinois, at
101 W. Lincoln. The two story, 10,900 square foot building is owned and occupied
entirely by Hinckley State Bank. A full service facility is located at 80 N.
Dugan Road, Sugar Grove. This 1,900 square foot facility was built by Hinckley
State Bank in 1993.
Fox Valley Bank's main office is located at 1600 East Main Street, in
St. Charles. The location consists of 5,100 square feet of leased office space.
Fox Valley Bank leases a 1,800 square foot full service facility located at 1525
West Main Street, in St. Charles, Illinois. A full service facility is located
in 1,200 square feet of leased office space located at 629 West State Street,
Geneva, Illinois.
16
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The Banks have certain collection suits in the ordinary course of
business against their debtors and are defendants in legal actions arising from
normal business activities. Management, after consultation with legal counsel,
believes that the ultimate liabilities, if any, resulting from these actions
will not have a material adverse effect on the financial position of the Banks
or on the consolidated financial position of the Corporation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED SECURITY HOLDER MATTERS
The Corporation incorporates by reference the information contained on
page 40 of the 1996 Annual Report (attached hereto as Exhibit 13) under the
caption "Market for the Registrant's Common Stock and Related Security Holder
Matters." As of March 3, 1997, there were 785 holders of record of the
Corporation's common stock.
The Corporation also incorporates by reference the information
contained on page 26 of the 1996 Annual Report (attached hereto as Exhibit 13)
under the "Notes to Consolidated Financial Statements Note 17 - Stockholder
Rights Plan."
The Corporation also incorporates by reference the information
contained on page 25 of the 1996 Annual Report (attached hereto as Exhibit 13)
under the "Notes to Consolidated Financial Statements Note 16 - Capital
Matters."
ITEM 6. SELECTED FINANCIAL DATA
The Corporation incorporates by reference the information contained on
page 8 of the 1996 Annual Report (attached hereto as Exhibit 13) under the
caption "Merchants Bancorp, Inc. and Subsidiary Financial Highlights."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Corporation incorporates by reference the information contained on
pages 30 - 39 of the 1996 Annual Report (attached hereto as Exhibit 13) under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Corporation incorporates by reference the following financial
statements and related notes from the 1996 Annual Report (attached hereto as
Exhibit 13):
ANNUAL REPORT
PAGE NO.
-------------
Consolidated Balance Sheets 9
Consolidated Statements of Income 10
Consolidated Statements of Cash Flows 11
Consolidated Statements of Stockholders' Equity 12
Notes to Consolidated Financial Statements 13-28
Independent Auditors' Report 29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
17
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Corporation incorporates by reference the information contained on
pages 1,2 and 3 of the Proxy Statement for the 1997 Annual Meeting of
Stockholders (attached hereto as exhibit 99) under the caption "Election of
Directors."
EXECUTIVE OFFICERS OF THE REGISTRANT AND SUBSIDIARY
NAME, AGE AND YEAR POSITIONS WITH REGISTRANT AND
BECAME EXECUTIVE OFFICER BUSINESS EXPERIENCE DURING
OF THE REGISTRANT PAST FIVE YEARS
- ------------------------ -----------------------------
Calvin R. Myers Chairman of the Board, President and Chief Executive
Age 54 1982 Officer (1987-present), Director of the Corporation
(1986-present); Chairman of the Board and CEO
(1987-1991), Director of First American Bank
(1985-1991); Chairman of the Board and CEO
(1987-present), President (1989-present),
Director of the Bank (1986-present).
Frank K. Voris Vice President of the Corporation (1993-present);
Age 57 1985 Executive Vice President and Chief Operating Officer
(1990-present), Senior Vice President (1985-1987),
Director of the Bank (1990-present); President of
First American Bank (1987-1991).
Randal A. Wright Executive Vice President, Commercial Banking Division
Age 45 1989 (1993-present); Senior Vice President and Director of
Commercial Banking of the Bank (1989-1993);
President and CEO of First National Bank of Oelwein,
Iowa (1985-1989).
Terence L. Kothe Executive Vice President, Trust and Financial
Age 53 1992 Services (1992-present) of the Bank; Vice President,
Senior Trust and Investment Officer (1973-1992) of
Old Second National Bank of Aurora.
J. Douglas Cheatham Vice President and Chief Financial Officer of the
Age 40 1990 Corporation (1993-present); Vice President and
Financial Officer (1990-present), Financial Officer
(1988-1990), Analyst of the Bank (1987-1988).
Gerald M. Lanigan Senior Vice President and Trust Officer of the Bank
Age 47 1984 (1985-present).
Scott B. Everhart Senior Vice President of Operations (1990-present),
Age 45 1988 Director of Operations (1988-present), Management
Analysis Director of the Bank (1986-1988).
There are no arrangements or understandings between any of the executive
officers or any other persons pursuant to which any of the executive officers
have been selected for their respective positions.
ITEM 11. EXECUTIVE COMPENSATION
The Corporation incorporates by reference the information contained on
page 3 of the Proxy Statement for the 1997 Annual Meeting of Stockholders
(attached hereto as exhibit 99) under the caption "Compensation of Directors,"
and on pages 5 - 10 under the caption "Executive Compensation." The sections in
the Proxy Statement marked "Board Compensation Committee Report on Executive
Compensation" and "Stockholder Return Performance Presentation" are furnished
for the information of the Commission and are not deemed to be "filed" as part
of this Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Corporation incorporates by reference the information contained on
pages 3 - 5 of the Proxy Statement for the 1997 Annual Meeting of Stockholders
(attached hereto as exhibit 99) under the caption "Security Ownership of Certain
Beneficial Owners and Management."
18
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Corporation incorporates by reference the information contained on
page 11 of the Proxy Statement for the 1997 Annual Meeting of Stockholders
(attached hereto as exhibit 99) under the caption "Transactions with
Management."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) INDEX TO FINANCIAL STATEMENTS
The following consolidated financial statements and related notes
are incorporated by reference from the 1996 Annual Report (attached hereto as
Exhibit 13).
ANNUAL REPORT
PAGE NO.
-------------
Consolidated Balance Sheets 9
Consolidated Statements of Income 10
Consolidated Statements of Cash Flows 11
Consolidated Statements of Stockholders' Equity 12
Notes to Consolidated Financial Statements 13-28
Independent Auditors' Report 29
(a)(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules as required by Item 8 and Item 14 of
Form 10-K have been omitted because the information requested is either not
applicable or has been included in the consolidated financial statements or
notes thereto.
(a)(3) EXHIBITS
The following exhibits required by Item 601 of Regulation S-K are
included along with this 10-K filing:
ITEM 601
TABLE II. NO.
-------------
(3)(a) Its Restated Certificate of Incorporation (filed
as an exhibit to the Corporation's Registration
Statement on Form S-14, No.2-96562, which was
filed with the Securities and Exchange
Commission on March 21, 1985; a Certificate of
Amendment to the Certificate of Incorporation as
filed as an exhibit to the Corporation's Form
8-A, which was filed with the Securities and
Exchange Commission on April 30, 1986 and a
Certificate of Amendment to the Certificate of
Incorporation as filed as Exhibit 3(b) of the
Corporation's 10-K for the fiscal year ended
December 31, 1987, a Certificate of Designation,
Preferences and Rights of Series A Junior
Participating Preferred Stock filed as Exhibit A
to Exhibit 1 to the Corporation's Form 10-K,
which was filed with the Securities and Exchange
Commission on January 12, 1989, and a
Certificate of Designation, Preferences and
Rights of Series A Junior Participating
Preferred Stock filed as Exhibit 4.4 to the
Corporation's Amendment 1 to Form S-2, No. 33-68684,
which was filed with the Securities and Exchange
Commission on October 8, 1993, all of which are
incorporated herein by reference)
(3)(b) By-laws of Merchants Bancorp, Inc. (filed as
Exhibit 3(c) of the Corporation's 10-K for the
fiscal year ended December 31, 1987, and
incorporated herein by reference)
(4)(a) Article Fourth of its Restated Certificate of
Incorporation (filed as Exhibit 3(a) to its
Registration Statement on Form S-14, No.
2-96562, which was filed with the Securities and
Exchange Commission on March 21, 1985, and
incorporated herein by reference)
19
<PAGE>
(4)(b) Article II and Article VII, Section 1, of its
By-laws, as amended February 17, 1987 (filed as
Exhibit 3(c) of the Corporation's 10-K for the
year ended December 31, 1987, and incorporated
herein by reference)
(4)(c) Rights Agreement dated January 4, 1989, between
the Corporation and The Merchants National Bank
of Aurora (filed as Exhibit 1 on the
Corporation's Form 8-K as filed with the
Securities and Exchange Commission on January 12, 1989,
and incorporated herein by reference)
(10)(a) Rights Agreement dated January 4, 1989 between
the Corporation and The Merchants Bank of
Aurora (filed as Exhibit 1 to the Corporation's
Form 8-K as filed with the Securities and
Exchange Commission on January 12, 1989, and
incorporated herein by reference)
(10) (b) Agreement for Facility License and Construction
Agreement dated June 18, 1992, between
International Banking Technologies, Inc., a
Georgia corporation, and The Merchants National
Bank of Aurora (filed as Exhibit 10(g) of the
Corporation's Form 10-K for the year ended
December 31, 1992, and incorporated herein by
reference)
(10) (c) Employment Agreement dated August 30, 1993,
between the Corporation and Calvin R. Myers
(filed as Exhibit 10.8 to its Registration
Statement on Form S-2, No. 33-68684, which was
filed with the Securities and Exchange
Commission on October 8, 1993, and incorporated
herein by reference)
(13) The Corporation's 1996 Annual Report to
Stockholders
(22) A list of all subsidiaries of the Corporation
(23) Consent of Crowe, Chizek & Company LLP
(27) Financial Data Schedule
(99) The Corporation's Proxy Statement for the annual
meeting of stockholders to be held April 15,
1997. The sections marked "Board Compensation
Committee Report on Executive Compensation" and
"Stockholder Return Performance Presentation"
are furnished for the information of the
Commission and are not deemed to be "filed" as
part of this 10-K.
(b) REPORTS ON FORM 8-K
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
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.
BY: /s/Calvin R. Myers
---------------------------------
Calvin R. Myers, Chairman of the Board,
President and Chief Executive Officer
BY: /s/J. Douglas Cheatham
---------------------------------
J. Douglas Cheatham,
Vice President and Chief Financial
Officer
DATE: March 27, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/Calvin R. Myers Chairman of the Board; Director; March 27, 1997
- ---------------------- President and Chief Executive Officer
Calvin R. Myers
/s/C. Tell Coffey Director March 27, 1997
- ----------------------
C. Tell Coffey
/s/William C. Glenn Director March 27, 1997
- ----------------------
William C. Glenn
/s/William F. Hejna Director March 27, 1997
- ----------------------
William F. Hejna
/s/John M. Lies Director March 27, 1997
- ----------------------
John M. Lies
/s/James D. Pearson Director March 27, 1997
- ----------------------
James D. Pearson
/s/Frank A. Sarnecki Director March 27, 1997
- ----------------------
Frank A. Sarnecki
/s/John J. Swalec Director March 27, 1997
- ----------------------
John J. Swalec
21
<PAGE>
SIGNATURE TITLE DATE
--------- ----- ----
/s/Norman L. Titiner Director March 27, 1997
- ----------------------
Norman L. Titiner
/s/William S. Wake Director March 27, 1997
- ----------------------
William S. Wake
/s/J. Douglas Cheatham Vice President and Chief Financial March 27, 1997
- ---------------------- Officer
J. Douglas Cheatham
22
<PAGE>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION OF EXHIBITS PAGE NO.
- ------- ----------------------- ----------
(3)(a) Its Restated Certificate of Incorporation (filed as an --
exhibit to the Corporation's Registration Statement on
Form S-14, No.2-96562, which was filed with the
Securities and Exchange Commission on March 21, 1985; a
Certificate of Amendment to the Certificate of
Incorporation as filed as an exhibit to the Corporation's
Form 8-A, which was filed with the Securities and
Exchange Commission on April 30, 1986 and a Certificate
of Amendment to the Certificate of Incorporation as filed
as Exhibit 3(b) of the Corporation's 10-K for the fiscal
year ended December 31, 1987, a Certificate of
Designation, Preferences and Rights of Series A Junior
Participating Preferred Stock filed as Exhibit A to
Exhibit 1 to the Corporation's Form 10-K, which was
filed with the Securities and Exchange Commission on
January 12, 1989, and a Certificate of Designation,
Preferences and Rights of Series A Junior Participating
Preferred Stock filed as Exhibit 4.4 to the Corporation's
Amendment 1 to Form S-2, No. 33-68684, which was filed
with the Securities and Exchange Commission on
October 8, 1993, all of which are incorporated herein
by reference)
(3)(b) By-laws of Merchants Bancorp, Inc. (filed as Exhibit 3(c) --
of the Corporation's 10-K for the fiscal year ended
December 31, 1987, and incorporated herein by reference)
(4)(a) Article Fourth of its Restated Certificate of --
Incorporation (filed as Exhibit 3(a) to its Registration
Statement on Form S-14, No. 2-96562, which was filed with
the Securities and Exchange Commission on March 21, 1985,
and incorporated herein by reference)
(4)(b) Article II and Article VII, Section 1, of its By-laws, as --
amended February 17, 1987 (filed as Exhibit 3(c) of the
Corporation's 10-K for the year ended December 31, 1987,
and incorporated herein by reference)
(4)(c) The Rights Agreement dated January 4, 1989, between the --
Corporation and The Merchants National Bank of Aurora
(filed as Exhibit 1 on the Corporation's Form 8-K as
filed with the Securities and Exchange Commission on
January 12, 1989, and incorporated herein by reference)
(10)(a) Rights Agreement dated January 4, 1989 between the --
Corporation and The Merchants Bank of Aurora (filed as
Exhibit 1 to the Corporation's Form 8-K as filed with the
Securities and Exchange Commission on January 12, 1989,
and incorporated herein by reference)
(10)(b Agreement for Facility License and Construction Agreement --
dated June 18, 1992, between International Banking
Technologies, Inc., a Georgia corporation, and The
Merchants National Bank of Aurora (filed as Exhibit 10(g)
of the Corporation's Form 10-K for the year ended
December 31, 1992, and incorporated herein by reference)
(10)(c) Employment Agreement dated August 30, 1993, between the --
Corporation and Calvin R. Myers (filed as Exhibit 10.8 to
its Registration Statement on Form S-2, No. 33-68684,
which was filed with the Securities and Exchange
Commission on October 8, 1993, and incorporated herein by
reference)
(13) The Corporation's 1996 Annual Report to Stockholders 24 - 67
(22) A list of all subsidiaries of the Corporation 68
(23) Consent of Crowe, Chizek & Company LLP 69
(27) Financial Data Schedule --
(99) The Corporation's Proxy Statement for the annual meeting 70 - 84
of stockholders to be held April 15, 1997. The sections
marked "Board Compensation Committee Report on Executive
Compensation" and "Stockholder Return Performance
Presentation" are furnished for the information of the
Commission and are not deemed to be "filed" as part of
this 10-K.
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
FINANCIAL HIGHLIGHTS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT SUMMARY
Interest income............... $ 50,460 $ 39,875 $ 33,233 $ 29,546 $ 28,323
Interest expense.............. 24,138 18,423 13,228 11,681 12,000
---------- ---------- ---------- ---------- ----------
Net interest income........... 26,332 21,452 20,005 17,865 16,323
Provision for loan losses..... 2,014 1,783 2,298 2,423 3,062
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan losses... 24,308 19,669 17,707 15,442 13,261
Noninterest income............ 9,541 6,918 6,564 6,606 5,794
Noninterest expenses.......... 24,865 17,889 16,733 16,177 13,893
---------- ---------- ---------- ---------- ----------
Income before income
taxes and cumulative
effect of a change in
accounting principle........ 8,984 8,698 7,538 5,871 5,162
Provision for income taxes.... 2,456 2,502 2,079 1,437 1,112
---------- ---------- ---------- ---------- ----------
Income before cumulative
effect of a change in
accounting principle........ 6,528 6,196 5,459 4,434 4,050
Cumulative effect of a
change in accounting
principle................... -- -- -- 300 --
---------- ---------- ---------- ---------- ----------
Net income.................... $ 6,528 $ 6,196 $ 5,459 $ 4,734 $ 4,050
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
PER SHARE INFORMATION*
Income before cumulative
effect of a change in
accounting principle........ $ 2.53 $ 2.41 $ 2.13 $ 2.11 $ 2.03
Cumulative effect of a
change in accounting
principle................... -- -- -- 0.14 --
---------- ---------- ---------- ---------- ----------
Net income.................... $ 2.53 $ 2.41 $ 2.13 $ 2.25 $ 2.03
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Dividends..................... $ 0.56 $ 0.48 $ 0.37 $ 0.34 $ 0.28
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average shares
outstanding................. 2,575,720 2,570,453 2,567,282 2,103,309 1,992,282
*Restated to reflect a three-for-one stock split in 1993.
BALANCE SHEET SUMMARY -- END OF YEAR
Total assets.................. $ 724,409 $ 539,761 $ 496,289 $ 462,483 $ 386,849
Total deposits................ 600,970 453,771 413,741 383,600 335,056
Total stockholders' equity.... 58,198 54,094 43,456 44,308 28,338
Allowance for loan losses..... 7,274 5,176 5,140 4,705 4,161
</TABLE>
8
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1996 and 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Cash and due from banks............................ $ 42,455 $ 28,166
Federal funds sold................................. 2,613 --
-------- --------
Cash and cash equivalents..................... 45,068 28,166
Securities available for sale...................... 194,780 187,169
Loans held for sale................................ 4,149 4,340
Loans.............................................. 456,802 304,327
Allowance for loan losses.......................... (7,274) (5,176)
-------- --------
Loans, net.................................... 449,528 299,151
Premises and equipment, net........................ 12,100 9,504
Other real estate owned............................ 333 566
Mortgage servicing rights, net..................... 1,438 1,165
Goodwill, net...................................... 6,977 --
Core deposit intangible assets, net................ 2,452 329
Accrued interest and other assets.................. 7,584 9,371
-------- --------
Total assets.................................. $724,409 $539,761
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing.............................. $112,203 $ 76,008
Interest-bearing................................. 488,767 377,763
-------- --------
Total deposits................................ 600,970 453,771
Federal funds purchased and securities sold
under repurchase agreements...................... 44,525 22,726
Notes payable...................................... 14,000 3,000
Accrued interest and other liabilities............. 6,716 6,170
-------- --------
Total liabilities............................. 666,211 485,667
-------- --------
STOCKHOLDERS' EQUITY
Preferred stock: $1 par value; authorized
500,000 shares; none issued...................... -- --
Common stock: $1 par value; authorized
6,000,000 shares; issued 2,606,690............... 2,607 2,607
Surplus............................................ 18,468 18,344
Retained earnings.................................. 36,962 31,877
Unrealized gain on securities available for
sale, net........................................ 317 1,450
Treasury stock, at cost, 28,607 and 33,687 shares
in 1996 and 1995................................. (156) (184)
-------- --------
Total stockholders' equity.................... 58,198 54,094
-------- --------
Total liabilities and stockholders' equity.... $724,409 $539,761
-------- --------
-------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
Years Ended December 31, 1996, 1995, and 1994
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees................................. $ 36,924 $ 28,046 $ 24,453
Loans held for sale................................... 245 161 207
Securities:
Taxable............................................ 10,119 8,122 5,851
Tax-exempt......................................... 2,757 2,814 2,643
Federal funds sold.................................... 415 732 79
---------- ---------- ----------
Total interest income........................... 50,460 39,875 33,233
---------- ---------- ----------
INTEREST EXPENSE
Deposits.............................................. 21,912 16,500 11,791
Federal funds purchased and securities
sold under repurchase agreements................... 1,773 1,769 1,285
Notes payable......................................... 453 154 152
---------- ---------- ----------
Total interest expense.......................... 24,138 18,423 13,228
---------- ---------- ----------
Net interest income................................ 26,322 21,452 20,005
Provision for loan losses............................. 2,014 1,783 2,298
---------- ---------- ----------
Net interest income after provision
for loan losses................................ 24,308 19,669 17,707
---------- ---------- ----------
NONINTEREST INCOME
Trust income.......................................... 2,028 1,925 1,722
Mortgage banking income............................... 2,202 1,267 1,153
Service charges and fees.............................. 3,796 2,713 2,472
Securities gains, net................................. 196 133 373
Other income.......................................... 1,319 880 844
---------- ---------- ----------
Total noninterest income........................ 9,541 6,918 6,564
---------- ---------- ----------
NONINTEREST EXPENSES
Salaries and employee benefits........................ 12,924 9,893 9,180
Occupancy expenses, net............................... 1,612 1,030 944
Furniture and equipment expenses...................... 1,650 1,238 1,090
Amortization of goodwill.............................. 385 - -
Amortization of core deposit intangible assets........ 405 101 101
Other expenses........................................ 7,889 5,627 5,418
---------- ---------- ----------
Total noninterest expenses...................... 24,865 17,889 16,733
---------- ---------- ----------
Income before income taxes............................ 8,984 8,698 7,538
Provision for income taxes............................ 2,456 2,502 2,079
---------- ---------- ----------
Net income...................................... $ 6,528 $ 6,196 $ 5,459
---------- ---------- ----------
---------- ---------- ----------
Net income per share.................................. $ 2.53 2.41 2.13
Weighted average shares outstanding................... 2,575,720 2,570,453 2,567,282
</TABLE>
See accompanying notes to financial statements.
10
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 1996, 1995, and 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income........................................... $ 6,528 $ 6,196 $ 5,459
Adjustments to reconcile net income to
net cash from operating activities:
Depreciation................................... 1,620 1,236 1,106
Amortization of mortgage servicing rights...... 295 123 68
Provision for loan losses...................... 2,014 1,783 2,298
Net change in mortgage loans held for sale..... 604 (1,966) (6,159)
Net gains on sales of loans.................... (981) (341) (491)
Provision for deferred taxes................... (668) (72) 90
Change in net income taxes payable............. (572) (415) (419)
Change in accrued interest and other assets.... (531) (1,031) (710)
Change in accrued interest and other
liabilities................................. 601 2,578 (1,091)
Premium amortization and discount accretion
on securities............................... 402 696 878
Securities gains, net.......................... (196) (133) (373)
Amortization of goodwill....................... 385 - -
Amortization of core deposit intangible assets. 405 101 101
Other, net..................................... - - (130)
---------- ---------- ----------
Net cash from operating activities................ 9,906 8,755 12,945
---------- ---------- ----------
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from matured securities available for sale.. 59,136 36,681 11,226
Proceeds from sales of securities available for sale. 32,395 23,804 17,886
Purchases of securities available for sale........... (74,282) (75,481) (59,733)
Proceeds from matured securities held to maturity.... - - 1,119
Purchases of securities held to maturity............. - (1,209) (4,693)
Net principal disbursed on loans..................... (79,331) (20,589) (14,189)
Proceeds from sales of other real estate............. 360 268 773
Acquisition of Valley Banc Services Corp., net of
cash and cash equivalents acquired................ (13,622) - -
Proceeds from sale of net assets held for sale....... 8,831 - -
Property and equipment expenditures.................. (2,678) (1,403) (1,946)
---------- ---------- ----------
Net cash from investing activities................ (69,191) (37,929) (49,557)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits............................... 49,310 40,030 30,141
Net change in short-term borrowings.................. 20,666 (10,573) 6,691
Payments on notes payable............................ (6,550) - (450)
Proceeds from notes payable.......................... 14,000 - -
Dividends paid, net of dividend reinvestments........ (1,239) (1,039) (911)
---------- ---------- ----------
Net cash from financing activities................... 76,187 28,418 35,471
---------- ---------- ----------
Net change in cash and cash equivalents.............. 16,902 (756) (1,141)
Cash and cash equivalents at beginning of year....... 28,166 28,922 30,063
---------- ---------- ----------
Cash and cash equivalents at end of year............. $ 45,068 $ 28,166 $ 28,922
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1996, 1995, and 1994
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Unrealized
Gain
(Loss) on
Securities Total
Available Stock-
Common Retained For Treasury holders'
Stock Surplus Earnings Sale, Net Stock Equity
------ ------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993................ $2,607 $18,232 $22,406 $ 1,278 $(215) $44,308
Net income.................................. - - 5,459 - - 5,459
Cash dividends declared, $.37 per share..... - - (950) - - (950)
Net change in unrealized gain (loss) on
securities available for sale............. - - - (5,361) - (5,361)
------ ------- -------- ---------- -------- --------
Balance at December 31, 1994................ 2,607 18,232 26,915 (4,083) (215) 43,456
Net income.................................. - - 6,196 - - 6,196
Cash dividends declared, $.48 per share..... - - (1,234) - - (1,234)
Issuance of 5,721 shares of treasury
common stock in connection with
dividend reinvestment plan................ - 112 - - 31 143
Net change in unrealized gain (loss)
due to transfer of securities from
held to maturity to available for sale.... - - - 964 - 964
Net change in unrealized gain (loss)
on securities available for sale.......... - - - 4,569 - 4,569
------ ------- -------- ---------- -------- --------
Balance at December 31, 1995................ 2,607 18,344 31,877 1,450 (184) 54,094
Net income.................................. - - 6,528 - - 6,528
Cash dividends declared, $.56 per share..... - - (1,443) - - (1,443)
Issuance of 5,080 shares of treasury
common stock in connection with
dividend reinvestment plan................ - 124 - - 28 152
Net change in unrealized gain (loss)
on securities available for sale.......... - - - (1,133) - (1,133)
------ ------- -------- ---------- -------- --------
Balance at December 31, 1996................ $2,607 $18,468 $36,962 $ 317 $(156) $58,198
------ ------- -------- ---------- -------- --------
------ ------- -------- ---------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1996, 1995, and 1994
(DOLLAR AMOUNTS IN TABLES IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial
statements of Merchants Bancorp, Inc. ("Company") include the accounts of the
Company and its wholly-owned subsidiaries, The Merchants National Bank of
Aurora ("Merchants Bank") and, since January 3, 1996, (see Note 2), Valley
Banc Services Corp. ("Valley"), and Valley's wholly-owned subsidiaries
Hinckley State Bank and V.B.H. Corporation and V.B.H. Corporation's
wholly-owned subsidiary, Fox Valley Bank. Merchants Bank, Hinckley State
Bank, and Fox Valley Bank are collectively referred to herein as the "Banks."
Significant intercompany transactions have been eliminated.
NATURE OF OPERATIONS: The Company's and the Banks' revenues, operating
income, and assets are primarily from the banking industry. Loan customers
are mainly located in Aurora, Hinckley, St. Charles and Geneva, Illinois and
in the western Chicago suburbs and surrounding areas, and include a wide
range of individuals, businesses, and other organizations. A major portion of
loans are secured by various forms of collateral including real estate,
business assets, consumer property, and other items, although borrower cash
flow may also be a primary source of repayment. Merchants Bank also engages
in mortgage banking operations.
ESTIMATES: To prepare financial statements in conformity with generally
accepted accounting principles, management makes estimates and assumptions
based on available information. These estimates and assumptions affect the
amounts reported in the financial statements and the disclosures provided,
and future results could differ. The collectibility of loans, fair values of
financial instruments, and status of contingencies are particularly subject
to change.
SECURITIES: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold
them to maturity. Securities are classified as available for sale when they
might be sold before maturity. Securities available for sale are carried at
fair value, with unrealized holding gains and losses reported separately in
stockholders' equity, net of tax. Securities are written down to fair value
with a charge to expense when a decline in fair value is not temporary.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest income includes amortization of purchase
premiums and discounts.
As permitted by "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities," the Company exercised a
one time opportunity to reassess the appropriateness of the classifications
of all securities held. Based on this review, in order to enhance liquidity
and tax planning opportunities, the Company reclassified securities having an
amortized cost of $39,664,000 and a net unrealized gain of $1,461,000 at
December 15, 1995, from held to maturity to available for sale.
LOANS HELD FOR SALE: Loans held for sale are reported at the lower of cost or
market value in the aggregate.
LOANS, INTEREST INCOME AND FEES: Loans are stated at the amount of unpaid
principal, reduced by unearned discount, deferred loan fees and the allowance
for loan losses. Interest on discounted loans is recognized based on the
interest method and includes amortization of net deferred loan fees and costs
over the term of the loan.
The accrual of interest income is discontinued on a loan when principal or
interest is ninety days or more past due, unless the loan is well secured and
in the process of collection. Payments received on such loans are reported as
principal reductions.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is established
through provisions charged to expense. Loans are charged against the
allowance when management believes that the collectibility of the principal
is unlikely. The allowance is an amount that management believes will be
adequate to absorb losses on existing loans that may become uncollectible,
based on evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such factors as changes
in the nature and volume of the loan portfolio, overall portfolio quality,
review of specific problem loans, and current economic conditions that may
affect the borrowers' ability to pay. Although management may periodically
allocate portions of the allowance for specific problem loan situations, the
whole allowance is available for any loan charge-offs that occur.
13
<PAGE>
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Banks' allowances
for loan losses. Such agencies may require the Banks to provide additions to
the allowance based on their judgments at the time of their examinations.
Statements of Financial Accounting Standards No. 114 and No. 118 became
effective January 1, 1995, and require recognition of loan impairment. Loans
are considered impaired if full principal or interest payments are not
anticipated. Impaired loans are carried at the present value of expected cash
flows discounted at the loan's effective interest rate or at the fair value
of the collateral if the loan is collateral dependent. A portion of the
allowance for loan losses is allocated to an impaired loan if the present
value of cash flows or collateral value indicate the need for an allowance.
The effect of adopting these standards is included in 1995 bad debt expense,
and was not material.
Smaller-balance homogeneous loans are evaluated for impairment in total. Such
loans include residential first mortgage loans secured by one-to-four family
residences, residential construction loans, and automobile, home equity and
second mortgage loans. Commercial loans and mortgage loans secured by other
properties are evaluated individually for impairment.
Loans evaluated individually for impairment are rated on a scale of 1 to 6,
with 4 being special mention, 5 substandard, and 6 doubtful. Loans are
moved to nonaccrual status when 90 days or more past due. Loans graded 6,
all commercial and non-residential mortgage nonaccrual loans, and loans
restructured after January 1, 1995, are defined as impaired loans. Impaired
loans, or portions thereof, are charged off when deemed uncollectible.
The nature of disclosures for impaired loans is considered generally
comparable to prior nonaccrual and renegotiated loans and non-performing and
past-due asset disclosures. Increases or decreases in the carrying value of
impaired loans are reported as reductions or increases in provisions for loan
losses.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less
accumulated depreciation and amortization which are computed on the
straight-line method over the estimated useful lives of the assets.
OTHER REAL ESTATE OWNED: Real estate acquired in settlement of loans is
initially reported at estimated fair value at acquisition. After acquisition,
a valuation allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell.
TRUST ASSETS AND FEES: Assets held in fiduciary or agency capacities are not
included in the consolidated balance sheets because such amounts are not
assets of the Company or the Banks. Income from trust fees is recorded on the
accrual basis.
MORTGAGE SERVICING RIGHTS: Prior to adopting Financial Accounting Standard
No. 122 at the start of 1996, servicing right assets were recorded only for
purchased rights to service mortgage loans. Subsequent to adopting this
standard, servicing rights represent both purchased rights and the allocated
value of servicing rights retained on loans sold. Servicing rights are
amortized in proportion to, and over the period of, estimated net servicing
revenues. Impairment is evaluated based on the fair value of the rights,
using groupings of the underlying loans as to interest rates and then,
secondarily, as to geographic and prepayment characteristics. Any impairment
of a grouping is reported as a valuation allowance.
GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS: Goodwill is the excess of
purchase price over identified net assets in the acquisition of Valley. The
goodwill is being amortized on the straight-line basis over 20 years. The
core deposit intangibles recorded in conjunction with the acquisition of
Valley are being amortized using an accelerated method over 10 years. The
core deposit intangible recorded in conjunction with the acquisition of First
American Bank of Aurora in 1984, which was subsequently merged into Merchants
Bank in 1990, is being amortized on the straight-line basis over 15 years.
Accumulated amortization of goodwill was $385,000 as of December 31, 1996,
and accumulated amortization of core deposit intangible assets was $1,616,000
as of December 31, 1996, and $1,211,000 as of December 31, 1995.
PENSION PLAN: The Company has a noncontributory pension plan covering
substantially all full-time employees of the Company and Merchants Bank. It
is the Company's policy to make contributions to the plan that are
actuarially determined and are tax deductible. The actuarially determined
expense of the plan is recorded annually. On January 5, 1996, all pension plan
benefits were frozen, with the intent of considering alternative methods of
providing retirement benefits to employees. In December, 1996, the Company
approved terminating the pension plan, which is expected to be completed
during 1997.
14
<PAGE>
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
STOCK COMPENSATION: Expense for employee compensation under stock option plans
is based on Opinion 25, with expense reported only if options are granted
below market price at grant date. Pro forma disclosures of net income and
earnings per share are provided as if the fair value method of Financial
Accounting Standard No. 123 were used for stock-based compensation.
INCOME TAXES: Income tax expense is the sum of the current year income tax
due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are the expected future tax consequences
of temporary differences between the carrying amounts and tax bases of assets
and liabilities, computed using enacted tax rates. A valuation allowance, if
needed, reduces deferred tax assets to the amount expected to be realized.
EARNINGS PER SHARE: The computation of earnings per share is based on the
weighted average number of common shares outstanding. When dilutive, stock
options are included as share equivalents using the treasury stock method.
Primary and fully diluted earnings per share are the same for each of these
years.
STATEMENT OF CASH FLOWS: For purposes of the statement of cash flows, the
Company considers cash and due from banks and Federal funds sold to be cash
and cash equivalents. Generally Federal funds are sold for one-day periods.
The Company reports net cash flows for short term investments, and for
customer loan, deposit and repurchase agreement transactions.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments
are estimated using relevant market information and other assumptions, as
more fully disclosed separately. Fair value estimates involve uncertainties
and matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets
for particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on-
and off-balance sheet financial instruments does not include the value of
anticipated future business or the values of assets and liabilities not
considered financial instruments.
NOTE 2 - ACQUISITION
On January 3, 1996, the Company purchased 100% of the outstanding common stock
of Valley for $24,889,000, comprised of $20.5 million in cash, assumption of
Valley's debt of approximately $3.5 million, $304,000 of capitalized
acquisition costs and $532,000 of capitalized incremental interest costs
during the holding period of acquired subsidiaries held for sale. As of the
acquisition date, Valley's wholly-owned subsidiaries included Hinckley State
Bank, State Bank of Osco, Anchor Bank and V.B.H. Corporation and V.B.H.
Corporation's wholly-owned subsidiary, Fox Valley Bank.
The acquisition has been accounted for using the purchase method of
accounting and, accordingly, the assets and liabilities have been recorded at
their estimated fair values at the date of acquisition. In addition, when
Valley was acquired, the Company's intent was to sell State Bank of Osco and
Anchor Bank. Accordingly, those banks were classified as held for sale until
they were sold on December 12, 1996, and December 19, 1996, respectively. The
net asset valuations of State Bank of Osco and Anchor Bank were initially
determined by the Company's management based upon recent sales prices of
similar financial institutions and after consideration of estimated 1996
earnings and capitalized interest expense during the estimated holding
period, neither of which were included in 1996 earnings of the Company.
The actual 1996 operating results of State Bank of Osco and Anchor Bank, from
January 3, through their respective sale dates, of $280,000 and $170,000,
were not included in the Company's 1996 consolidated operating results. The
$343,000 difference between the $8,831,000 that these banks were sold for and
the $8,488,000 purchase price assigned to these held for sale subsidiaries
was treated as a purchase price allocation adjustment and was not included in
the Company's 1996 consolidated operating results.
The purchase price of Valley was assigned to the assets and liabilities
assumed based upon estimated fair market values, as follows:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . $ 7,714
Securities . . . . . . . . . . . . . . . . . . . . . . . . . 23,147
Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,060
Goodwill and core deposit intangibles. . . . . . . . . . . . 9,890
Net assets of acquired subsidiaries held for sale. . . . . . 8,831
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . (97,889)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . 136
----------
$ 24,889
----------
----------
15
<PAGE>
NOTE 2 - ACQUISITION - (CONTINUED)
The following unaudited pro forma financial information for the Company gives
effect to the Valley acquisition as if it had occurred on January 1, 1995.
These pro forma results have been prepared for comparative purposes only and
do not purport to be indicative of the results of operations which actually
would have resulted had the acquisition occurred on the date indicated, or
which may result in the future. This pro forma financial information does not
include operating results for State Bank of Osco or Anchor Bank.
Pro forma financial information for the year ended December 31, 1995:
Net interest income. . . . . . . . . . . . . . . . . . . . . $ 25,485
Net income . . . . . . . . . . . . . . . . . . . . . . . . . 5,982
Net income per share . . . . . . . . . . . . . . . . . . . . 2.33
NOTE 3 - SECURITIES
Year-end securities available for sale were as follows:
<TABLE>
<CAPTION>
1996
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Treasury. . . . . . . . . . . . . . . . . $ 17,685 $ 28 $ (73) $ 17,640
U.S. Government agencies . . . . . . . . . . . 76,998 396 (414) 76,980
U.S. Government agency mortgage backed
securities . . . . . . . . . . . . . . . . . 34,148 134 (260) 34,022
States and political subdivisions . . . . . . 53,864 1,419 (456) 54,827
Collateralized mortgage obligations. . . . . . 8,878 -- (158) 8,720
Other securities . . . . . . . . . . . . . . . 2,778 -- (187) 2,591
---------- ----------- ---------- ---------
$ 194,351 $ 1,977 $ (1,548) $ 194,780
---------- ----------- ---------- ---------
---------- ----------- ---------- ---------
1995
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ----------- ---------- ---------
U.S. Treasury. . . . . . . . . . . . . . . . . $ 24,968 $ 48 $ (156) $ 24,860
U.S. Government agencies . . . . . . . . . . . 53,044 542 (105) 53,481
U.S. Government agency mortgage backed
securities . . . . . . . . . . . . . . . . . 44,804 493 (122) 45,175
States and political subdivisions . . . . . . 50,239 1,998 (417) 51,820
Collateralized mortgage obligations. . . . . . 10,044 11 (95) 9,960
Other securities . . . . . . . . . . . . . . . 1,873 -- -- 1,873
---------- ----------- ---------- ---------
$ 184,972 $ 3,092 $ (895) $ 187,169
---------- ----------- ---------- ---------
---------- ----------- ---------- ---------
</TABLE>
Mortgage-backed securities are comprised of investments in pools of
residential mortgages. The mortgage pools are issued and guaranteed by the
Federal Home Loan Mortgage Corporation ("FHLMC"), the Government National
Mortgage Association ("GNMA") or the Federal National Mortgage Association
("FNMA"). Collateralized mortgage obligations are secured by FHLMC, GNMA, or
FNMA certificates. Equity securities consist of Federal Home Loan Bank
("FHLB") stock and Federal Reserve Bank stock.
As of December 31, 1996, and 1995, the Company held structured notes carried at
fair values of $4,236,000 and $6,415,000. The amortized cost of these
securities was $4,250,000 and $6,462,000 as of December 31, 1996, and 1995.
These securities were issued by the FHLB and FNMA.
16
<PAGE>
NOTE 3 - SECURITIES - (CONTINUED)
Contractual maturities of debt securities at December 31, 1996, were as
follows. (Securities not due at a single maturity date, primarily mortgage
backed securities, collateralized mortgage obligations and equity securities,
are shown separately):
Amortized Fair
Cost Value
---------- ----------
Due in one year or less. . . . . . . . . . . . . . $ 16,054 $ 16,100
Due after one year through five years. . . . . . . 67,596 67,686
Due after five years through ten years . . . . . . 56,503 57,253
Due after ten years. . . . . . . . . . . . . . . . 8,932 8,946
---------- ----------
149,085 149,985
Mortage-backed securities and collateralized
mortgage obligations . . . . . . . . . . . . . 43,026 42,742
Equity securities. . . . . . . . . . . . . . . . . 2,240 2,053
---------- ----------
$ 194,351 $ 194,780
---------- ----------
---------- ----------
Sales of securities available for sale were as follows:
1996 1995 1994
---------- ---------- ----------
Proceeds of sales . . . . . . . . . $ 32,395 $ 23,804 $ 17,886
Gross realized gains. . . . . . . . 385 219 405
Gross realized losses . . . . . . . 189 86 32
There were no significant concentrations of investments (greater than 10% of
stockholders' equity) in any individual security issue except for U.S.
Treasury securities and obligations of U. S.-Government agencies and
corporations. Although the Company holds securities issued by municipalities
within the states of Illinois and Wisconsin which in the aggregate exceed 10%
of stockholders' equity, none of the holdings from individual municipal
issuers exceed this threshold.
Securities with a carrying amount of approximately $125,269,000 and
$124,873,000 at December 31, 1996 and 1995, were pledged to secure public
deposits and securities sold under repurchase agreements and for other
purposes required or permitted by law. Amounts owed to brokers for securities
purchased in December and settled in the following January, are included in
accrued interest and other liabilities. These amounts were $305,000 and
$1,560,000 as of December 31, 1996 and 1995. Amounts due to the Company for
securities that matured in December, with proceeds received in January, are
included in accrued interest and other assets. This amount was $3,687,000 at
December 31, 1995.
NOTE 4 - LOANS
Major classifications of loans were as follows:
1996 1995
---------- ----------
Commercial and industrial. . . . . . . . . . . . . $ 161,847 $ 109,872
Real estate - commercial . . . . . . . . . . . . . 75,449 67,739
Real estate - construction . . . . . . . . . . . . 54,513 40,510
Real estate - residential. . . . . . . . . . . . . 85,107 31,673
Installment. . . . . . . . . . . . . . . . . . . . 73,918 50,489
Credit card receivables. . . . . . . . . . . . . . 6,697 5,644
Other loans. . . . . . . . . . . . . . . . . . . . 1,188 455
---------- ----------
458,719 306,382
Unearned discount. . . . . . . . . . . . . . . . . (1,535) (1,743)
Deferred loan fees . . . . . . . . . . . . . . . . (382) (312)
---------- ----------
$ 456,802 $ 304,327
---------- ----------
---------- ----------
Loans on which accrual of interest has been discontinued or reduced amounted to
approximately $2,970,000 and $1,135,000 at December 31, 1996 and 1995.
Interest income recorded on these loans amounted to approximately $101,000,
$83,000, and $65,000 in 1996, 1995, and 1994. Interest income which would
have been recognized had these loans been on an accrual basis throughout the
year was approximately $335,000, $167,000, and $159,000 in 1996, 1995, and
1994.
17
<PAGE>
NOTE 4 -- LOANS -- (CONTINUED)
Impaired loans were as follows:
<TABLE>
<CAPTION>
1996 1995
------ ------
<S> <C> <C>
Year-end loans with no allowance for loan losses allocated........ $ 523 $ -
Year-end loans with allowance for loan losses allocated........... 905 921
Amount of the allowance allocated................................. 363 631
Average of impaired loans during the year......................... 1,480 2,378
Interest income recognized during impairment...................... 191 305
Cash-basis interest income recognized............................. 89 302
</TABLE>
During 1994, Merchants Bank agreed to modify the terms of three loans to one
borrower totaling $3,077,000. Under the modified terms, Merchants Bank
accepted a parcel of real estate in partial settlement and rewrote the
remaining loan balances into two notes which have a total carrying value of
$276,000 and $1,047,000 at December 31, 1996 and 1995, and fixed interest
rates of 8.5% on each note, which was the market rate of interest for similar
borrowers at the restructure date. Both notes were performing as agreed at
December 31, 1996. These modifications resulted in a $168,000 loss charged to
the allowance for loan losses in 1994. No interest income was recognized on
the loan in 1994 prior to the modifications. Total restructured loans were
$359,000 as of December 31, 1996 and $1,047,000 as of December 31, 1995.
After the restructuring, interest income recorded on the restructured loans
was $117,000 for 1996 and $110,000 for 1995.
NOTE 5 -- ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Balance at beginning of year........................... $ 5,176 $ 523 $ -
Increase due to the acquisition of Valley.............. 798 - -
Provision charged to operations........................ 2,014 1,783 2,298
Charge-offs............................................ (2,241) (2,513) (2,942)
Recoveries............................................. 1,527 766 1,079
------- ------- -------
Balance at end of year................................. $ 7,274 $ 5,176 $ 5,140
------- ------- -------
------- ------- -------
</TABLE>
NOTE 6 -- MORTGAGE BANKING
Mortgage loans serviced for others are not reported as assets. The unpaid
principal balances of these loans and related escrow deposit balances are
summarized as follows as of December 31:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Mortgage loan portfolios serviced for:
Federal Home Loan Mortgage Corporation......................... $168,610 $152,473
Federal National Mortgage Association.......................... 81,927 79,061
Other investors................................................ 4,232 3,938
-------- --------
$254,769 $235,472
-------- --------
-------- --------
Related escrow deposit balances................................... $ 2,744 $ 2,167
-------- --------
-------- --------
</TABLE>
During 1995, the Company purchased the servicing rights to approximately
$62,599,000 of one to four family mortgage loans. These loans are comprised
of mortgages on properties located in the Company's market area. Prior to
adopting Financial Accounting Standard No. 122 at the start of 1996,
servicing right assets were recorded only for purchased rights to service
mortgage loans. Subsequent to adopting this standard, servicing rights
represent both purchased rights and the allocated value of servicing rights
retained on loans sold.
Servicing rights are amortized in proportion to, and over the period of,
estimated net servicing revenues. Impairment is evaluated based on the fair
value of the rights, using groupings of the underlying loans as to interest
rates and then, secondarily, as to geographic and prepayment characteristics.
Any impairment of a grouping is reported as a valuation allowance; there was
no such allowance recorded at year-end 196 or 1995. The unamortized cost of
mortgage servicing rights are classified as an asset on the consolidated
balance sheets.
18
<PAGE>
NOTE 6 -- MORTGAGE BANKING -- (CONTINUED)
Following is a summary of the changes in the unamortized cost of purchased
and originated mortgage servicing rights:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Balance at beginning of year........................... $ 1,165 $ 412 $ 480
Origination of mortgage servicing rights............... 568 - -
Purchase price of mortgage servicing rights............ - 876 -
Amortization........................................... (295) (123) (68)
------- ------- -------
Balance at end of year................................. $ 1,438 $ 1,165 $ 412
------- ------- -------
------- ------- -------
</TABLE>
The Company sells most fixed rate residential real estate loans it originates
and funds, with servicing retained by the Company. Selected information
related to loans sold follows:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Interest on loans held for sale........................ $ 245 $ 161 $ 207
Net gains on sales of loans............................ 981 341 491
Loan servicing income.................................. 785 559 432
Amortization of purchased mortgage servicing rights.... 295 123 68
</TABLE>
NOTE 7 -- PREMISES AND EQUIPMENT
Major classification of premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
1996 1995
-------- -------
<S> <C> <C>
Land............................................................... $ 1,531 $ 1,158
Premises........................................................... 13,152 10,112
Furniture and equipment............................................ 8,892 6,432
Construction in progress........................................... - 705
-------- -------
23,575 18,407
Accumulated depreciation........................................... (11,475) (8,903)
-------- -------
$ 12,100 $ 9,504
-------- -------
-------- -------
</TABLE>
Depreciation expense amounted to approximately $1,620,000, $1,236,000, and
$1,106,000 for years ended December 31, 1996, 1995, and 1994.
NOTE 8 -- DEPOSITS
The major components of deposits are summarized as follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Noninterest-bearing -- demand and other............................ $112,203 $ 76,008
Interest-bearing:
NOW accounts.................................................... 75,991 63,027
Money market accounts........................................... 58,061 33,808
Savings......................................................... 67,232 51,935
Time, $100,000 and over......................................... 79,214 62,628
Other time...................................................... 208,269 166,365
-------- --------
$600,970 $453,771
-------- --------
-------- --------
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
NOW accounts........................................... $ 1,776 $ 1,571 $ 1,577
Money market accounts.................................. 1,759 1,139 885
Savings................................................ 1,891 1,480 1,527
Time, $100,000 and over................................ 4,450 3,323 1,922
Other time............................................. 12,036 8,987 5,880
------- ------- -------
$21,912 $16,500 $11,791
------- ------- -------
------- ------- -------
</TABLE>
19
<PAGE>
NOTE 8 -- DEPOSITS-(CONTINUED)
At year-end 1996, stated maturities of time deposits were:
1997............................................................$ 156,719
1998............................................................ 39,830
1999............................................................ 41,020
2000............................................................ 4,164
2001............................................................ 1,372
Thereafter...................................................... 44,378
---------
Total.........................................................$ 287,483
---------
---------
NOTE 9 -- BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase, and
treasury tax and loan deposits are financing arrangements. Securities sold
under repurchase agreements with the State of Illinois are held by the State
of Illinois. Physical control is maintained for all other securities sold under
repurchase agreements. Information concerning Federal funds purchased and
securities sold under agreements to repurchase is summarized as follows:
<TABLE>
1996 1995
-------- --------
<S> <C> <C>
Federal funds purchased:
Average daily balance during the year...............$ 8,114 $ 1,550
Average interest rate during the year............... 5.75% 6.93%
Maximum month-end balance during the year...........$ 25,200 $ 7,900
Securities sold under repurchase agreements:
Average daily balance during the year...............$ 26,587 $ 31,298
Average interest rate during the year............... 4.94% 5.33%
Maximum month-end balance during the year...........$ 30,975 $ 47,892
</TABLE>
Notes payable at December 31, 1996, consists of two notes of $7 million each,
the proceeds of which were used to finance the acquisition of Valley on
January 3, 1996. A revolving note bears interest at the prevailing Federal
funds rate or 1% above LIBOR, at the quarterly election of the Company. This
variable rate was 6.56% at December 31, 1996. A fixed rate note bears
interest at a rate of 7.03%. At year-end 1996, scheduled principal reductions
on notes payable were:
1998............................................................$ 875
1999............................................................ 875
2000............................................................ 875
2001............................................................ 875
Thereafter...................................................... 10,500
---------
Total.........................................................$ 14,000
---------
---------
Notes payable at December 31, 1995, consisted of a FHLB advance which matured
and was repaid on February 26, 1996, with a fixed interest rate of 4.83%,
and, pursuant to a collateral agreement with the FHLB, was secured by all
stock in the FHLB and a blanket lien on the Bank's qualifying first mortgage
loans in an amount equal to 167% of the principal of the advance.
NOTE 10 -- INCOME TAXES
A summary of Federal and state income taxes on operations is as follows:
<TABLE>
Year ended December 31,
------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Federal:
Current..................................$ 2,672 $ 2,179 $ 1,685
Deferred................................. (544) (47) 74
State:
Current.................................. 452 395 304
Deferred................................. (124) (25) 16
-------- -------- --------
$ 2,456 $ 2,502 $ 2,079
-------- -------- --------
-------- -------- --------
</TABLE>
20
<PAGE>
NOTE 10 -- INCOME TAXES-(CONTINUED)
In addition to the preceding taxes on operations, taxes allocated for net
unrealized gains (losses) on securities available for sale were ($635,000),
$2,851,000 and ($2,762,000) in 1996, 1995, and 1994. These amounts include
the tax effect of transfers into available for sale in 1995.
The following are the components of the deferred tax assets and liabilities
at December 31, 1996 and 1995. The net deferred tax liability is included in
accrued interest and other liabilities.
<TABLE>
1996 1995
-------- --------
<S> <C> <C>
Gross deferred tax liabilities:
Depreciation........................................$ (349) $ (442)
Unrealized gain on securities available for sale.... (112) (747)
Discount accretion.................................. (195) (35)
Intangible assets................................... (996) (64)
Mortgage servicing rights........................... (202) -
Other liabilities................................... (485) (273)
-------- --------
Gross deferred tax liabilities..................... (2,339) (1,561)
-------- --------
Gross deferred tax assets:
Allowance for loan losses........................... 1,975 1,016
Deferred loan fees.................................. 54 52
Other assets........................................ 135 156
-------- --------
Gross deferred tax assets.......................... 2,164 1,224
-------- --------
Net deferred tax liability......................... (175) (337)
Valuation allowance for deferred tax assets........ - -
-------- --------
Net deferred tax liability..........................$ (175) $ (337)
-------- --------
-------- --------
</TABLE>
A reconciliation of the statutory Federal income tax of 34% to the income tax
provision included in the consolidated statements of income is as follows:
<TABLE>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Tax at statutory Federal income tax
rate....................................$ 3,055 $ 2,957 $ 2,563
Nontaxable interest income, net of
disallowed interest deduction........... (901) (856) (815)
State income taxes, net of Federal
benefit................................. 216 244 211
Other, net............................... 86 157 120
-------- -------- --------
$ 2,456 $ 2,502 $ 2,079
-------- -------- --------
-------- -------- --------
</TABLE>
NOTE 11 -- BENEFIT PLANS
The Company maintains a noncontributory pension plan covering substantially
all full-time employees of the Company and Merchants Bank who have completed
age and service requirements. On January 5, 1996, all pension plan benefits
were frozen, with the intent of considering alternative methods of providing
retirement benefits to employees. In December, 1996, the Company approved
terminating the pension plan, which is expected to be completed during 1997.
A discretionary contribution to the employee contributory thrift plan
(discussed below) was increased in order to mitigate the impact of this
decision on employees. Management is continuing to evaluate other ways in
which retirement benefits may be enhanced. The total pension expense (income)
under the pension plan approximated ($181,000), $28,000, and ($5,000) for the
years ended December 31, 1996, 1995, and 1994.
<TABLE>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Service cost-benefit earned during
the year................................$ - $ 134 $ 142
Interest cost on projected benefit
obligation.............................. 262 288 275
Actual return on plan assets............. (916) (801) 74
Net amortization and deferral............ 473 407 (496)
-------- -------- --------
$ (181) $ 28 $ (5)
-------- -------- --------
-------- -------- --------
</TABLE>
21
<PAGE>
NOTE 11 - BENEFIT PLANS - (CONTINUED)
The following table sets forth the pension plan's funded status and amounts
recognized in the Company's consolidated financial statements at December 31:
1996 1995
------ ------
Vested benefit obligation $4,704 $3,674
------ ------
------ ------
Accumulated benefit obligation $4,704 $3,733
------ ------
------ ------
Projected benefit obligation $4,704 $4,455
Plan assets at fair value 4,832 4,129
------ ------
Plan assets greater (less) than projected
benefit obligation 128 (326)
Unrecognized net asset (38) (222)
Unrecognized net loss 629 595
Unrecognized prior service cost (185) (43)
------ ------
Net pension asset at December 31 $ 534 $ 4
------ ------
------ ------
Plan assets consist primarily of common stocks and corporate bonds and
included approximately $681,000 and $626,000 of the Company's common stock at
December 31, 1996 and 1995. Other selected information as of December 31
related to the pension plan is summarized as follows:
1996 1995
------ ------
Discount rate: Retirees 6.75% 8.50%
Discount rate: Participants who will retire on or
before December 31, 1999 6.75 8.50
Discount rate: All other participants 6.48 8.50
Expected long-term rate of return on plan assets 10.00 10.00
Expected annual compensation increase N/A 4.00
The Company also maintains an Employee Contributory Thrift Plan (the "Thrift
Plan"). The Thrift Plan covers employees who work a minimum of 1,000 hours
per year and have been with the Company at least one year. Vesting in Company
contributions to the Thrift Plan is scheduled over seven years from the date
of employment. Hinckley State Bank and Fox Valley Bank employees were given
full credit for past employment service. The Company contributes an amount
determined by the Board of Directors to all eligible participants. This amount
was increased in 1996 in order to mitigate the impact of the termination of
the pension plan (discussed above). In addition, for each dollar the
participant deposits up to 6% of annual salary, the Company will contribute
an additional fifty cents. Total contributions under the Thrift Plan amounted
to approximately $581,000, $259,000, and $245,000 for the years ended
December 31, 1996, 1995, and 1994.
NOTE 12 - STOCK OPTIONS
In April, 1994 the stockholders approved a Stock Incentive Plan (the
"Incentive Plan"), which authorizes the issuance of up to 250,000 shares of
the Company's common stock, including the granting of qualified stock options
("Incentive Stock Options"), nonqualified stock options, restricted stock and
stock appreciation rights. Subject to the terms and provisions of the
Incentive Plan, stock based awards may be granted to selected directors and
officers or employees at the discretion of the Board of Directors. The
Incentive Plan requires the exercise price of any incentive stock option
issued to an employee to be at least equal to the fair market value of
Company common stock on the date the option is granted. In addition, all
stock options are granted for a maximum term of ten years.
Nonqualified stock options may be granted to directors based upon a formula.
These and other awards under the Incentive Plan may be granted subject to a
vesting requirement and would become fully vested upon a merger or change in
control of the Company. As of December 31, 1996, there were no nonqualified
stock options, stock appreciation rights, or restricted stock issued under
the Incentive Plan.
Financial Accounting Standard No. 123, which became effective for 1996,
requires pro forma disclosures for companies that do not adopt its fair value
accounting method for stock-based employee compensation. Accordingly, the
following pro forma information presents net income and earnings per share had
the Standard's fair value method been used to measure compensation cost for
stock option plans. There was no compensation expense recorded for stock
options in 1996 and 1995.
22
<PAGE>
NOTE 12 - STOCK OPTIONS (CONTINUED)
1996 1995
------ ------
Net income as reported $6,528 $6,196
Pro forma net income 6,493 6,170
Earnings per share as reported 2.53 2.41
Pro forma earnings per share 2.52 2.40
In future years, the pro forma effect of not applying this standard is
expected to increase as additional options are granted.
Stock option plans are used to reward employees and provide them with an
additional equity interest. Options are issued for 10 year periods, with
vesting occurring over the first three years. The fair value of options
granted in 1996 and 1995 were $2.93 and $2.25. At year-end 1996, 193,810
shares were authorized for future grants. Information about option grants
follows.
Weighted
Number of Average
Options Exercise Price
--------- --------------
Outstanding, December 31, 1993 - $ -
Granted 18,373 24.63
------ ------
Outstanding, December 31, 1994 18,373 24.63
Granted 18,579 24.75
------ ------
Outstanding, December 31, 1995 36,952 24.69
Granted 19,238 31.00
------ ------
Outstanding, December 31, 1996 56,190 $26.85
------ ------
------ ------
Options exercisable at year-end are as follows:
Weighted
Number of Average
Options Exercise Price
--------- --------------
1994 6,126 $24.63
1995 18,446 24.67
1996 37,176 25.77
All options granted are at market price. The fair value of options granted
during 1996 and 1995 is estimated using the following weighted-average
information: risk-free interest rate of 6.54% and 5.78%, expected life of 10
years, expected volatility of stock price of 1.65% and 1.68%, and expected
dividends of 1.75% and 1.68% per year.
At year-end 1996, options outstanding were as follows:
Number of options 56,190
Range of exercise price $24.63 - $31.00
Weighted average exercise price $26.85
Weighted average remaining options life 8.4 years
Number of options now exercisable 37,176
Weighted average exercise price of options
now exercisable $25.77
NOTE 13 - COMMITMENTS AND CONTINGENT LIABILITIES
The Company and its subsidiaries are defendants in legal actions arising from
normal business activities. Management, after consultation with legal
counsel, believes that the ultimate liability, if any, resulting from these
actions will not have an adverse material effect on the Company's
consolidated financial position, liquidity, or results of operations.
The Company 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 include commitments to extend credit
and standby letters of credit. Loan commitments and guarantees written have
off-balance-sheet risk because only origination fees and accruals for
probable losses are recognized in the statement of financial position until
the commitments are fulfilled or the guarantees expire. Credit risk
represents the accounting loss that would be recognized at the reporting
date if counter parties failed completely to perform as contracted. The
credit risk amounts are equal to the contractual amounts, assuming that the
amounts are fully advanced and that collateral or other security is of no
value.
23
<PAGE>
Note 13 - COMMITMENTS AND CONTINGENT LIABILITIES - (CONTINUED)
The Company has entered into agreements to sell mortgage loans to the FHLMC
and the FNMA. The amounts remaining with the FHLMC, under these agreements,
at December 31, 1996 and 1995 were as follows:
1996 1995
---------- ----------
Federal Home Loan Mortgage Corporation. . . . $ 9,289 $ 6,365
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for on-balance-sheet investments. At
December 31, 1996 and 1995, the contract amounts of such commitments and
conditional obligations were as follows:
1996 1995
---------- ----------
Commitments to extend credit
Fixed rate. . . . . . . . . . . . . . . . . $ 40,862 $ 17,585
Variable rate . . . . . . . . . . . . . . . 89,083 74,479
Standby letters of credit . . . . . . . . . . 26,466 19,150
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 of up to one year or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Company evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the
borrower. Collateral held varies, but may include real estate, accounts
receivable, inventory, property, plant, equipment, and income producing
properties.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance of a customer to a third party. Those standby
letters of credit are primarily used in favor of municipalities and insurance
companies. The credit risk involved in issuing standby letters of credit is
essentially the same as that involved in extending loan facilities to
customers.
The Banks maintained reserves in accordance with Federal Reserve requirements
of approximately $12,321,000 and $8,829,000 at December 31, 1996, and 1995.
NOTE 14 - RELATED PARTY TRANSACTIONS
A summary of loans made by the Banks in the ordinary course of business to or
for the benefit of directors, executive officers, or principal holders of
equity securities of the Company is as follows for the year ended December
31, 1996:
Balance at beginning of year. . . . . . . . . . . . . . . . . . . . $ 10,726
New loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,087
Repayments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (29,399)
Changes in directorships of the Company . . . . . . . . . . . . . . 4,609
---------
Balance at end of year. . . . . . . . . . . . . . . . . . . . . . . $ 15,023
---------
---------
NOTE 15 - SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures to the consolidated statements of cash flows are as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . $ 3,562 $ 1,552 $ 1,871
Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . 23,821 17,952 12,925
Noncash transfers from loans to other real estate owned . . . . 106 88 1,420
Noncash transfer of securities held to maturity to securities
available for sale, at fair value . . . . . . . . . . . . . . - 41,125 -
Purchase of Valley Banc Services Corp.:
Fair value of assets acquired . . . . . . . . . . . . . . . . $ 129,126 $ - -
Debt assumed. . . . . . . . . . . . . . . . . . . . . . . . . (3,550) - -
Purchase price. . . . . . . . . . . . . . . . . . . . . . . . (21,339) - -
----------
Liabilities assumed . . . . . . . . . . . . . . . . . . . . . $ 104,237 - -
----------
----------
</TABLE>
24
<PAGE>
NOTE 16 - CAPITAL MATTERS
The Company and the Banks are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and
prompt corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weights, and other
factors, and the regulators can lower classifications in certain cases.
Failure to meet various capital requirements can initiate regulatory action
that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent over financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
Minimum capital requirements are:
<TABLE>
<CAPTION>
Total Capital to Risk Tier I Capital to Risk Tier I Capital to
Weighted Assets Weighted Assets Average Assets
--------------------- ---------------------- -----------------
<S> <C> <C> <C>
Well capitalized 10% 6% 5%
Adequately capitalized 8% 4% 4%
Undercapitalized 6% 3% 3%
</TABLE>
The Company and the Banks were categorized as well capitalized as of December
31, 1996. Management is not aware of any conditions or events since the most
recent regulatory notification that would change the Company's or the Banks'
categories.
Capital levels and minimum required levels (in thousands):
<TABLE>
<CAPTION>
Minimum Required Minimum Required
for Capital to be Well
Actual Adequacy Purposes Capitalized
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------- --------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
1996:
Total capital to risk weighted assets
Consolidated . . . . . . . . . . . . $ 54,487 10.26% $ 42,477 8.00% $ 53,097 10.00%
Merchants Bank . . . . . . . . . . . 51,000 11.61 35,148 8.00 43,935 10.00
Tier I capital to risk weighted assets
Consolidated . . . . . . . . . . . . 47,872 9.02 21,239 4.00 31,858 6.00
Merchants Bank . . . . . . . . . . . 45,494 10.35 17,574 4.00 26,361 6.00
Tier I capital to average assets
Consolidated . . . . . . . . . . . . 47,872 6.90 27,768 4.00 34,709 5.00
Merchants Bank . . . . . . . . . . . 45,494 7.82 23,262 4.00 29,078 5.00
1995:
Total capital to risk weighted assets
Consolidated . . . . . . . . . . . . 58,399 15.79 29,588 8.00 36,985 10.00
Merchants Bank . . . . . . . . . . . 47,762 12.87 29,683 8.00 37,103 10.00
Tier I capital to risk weighted assets
Consolidated . . . . . . . . . . . . 53,765 14.54 14,794 4.00 22,191 6.00
Merchants Bank . . . . . . . . . . . 43,113 11.62 14,841 4.00 22,262 6.00
Tier I capital to average assets
Consolidated . . . . . . . . . . . . 53,765 10.31 20,857 4.00 26,072 5.00
Merchants Bank . . . . . . . . . . . 43,113 8.27 20,860 4.00 26,076 5.00
</TABLE>
Dividends from the Banks are the Company's primary source of funds. National
and state bank regulations and capital guidelines limit the amount of
dividends that may be paid by the Banks without prior regulatory approval. At
January 1, 1997, approximately $15,561,000 was available for the payment of
dividends by the Banks to the Company.
25
<PAGE>
NOTE 17 -- STOCKHOLDER RIGHTS PLAN
Pursuant to a plan adopted by the Company in January, 1989, each share of the
Company's common stock carries one-third of a right (referred to as a
"Right") to purchase one hundredth of a share of Series A Preferred Stock,
$1.00 par value ("Preferred Stock"), at a price of $125.00 (subject to
adjustment). The Rights are tradeable only with the Company's common stock
until they become exercisable. The Rights become exercisable ten business
days after the earlier of the date a person acquires or commences a tender
offer to acquire 15% or more of the Company's common stock. The Rights are
subject to redemption by the Company at a price of $0.01 per Right, subject
to certain limitations, and will expire on January 13, 1999. The Preferred
Stock Right carries preferential dividend and liquidation rights and certain
voting and other rights.
If after the Rights become exercisable, the Company or its assets are
acquired in certain merger or other transactions, except under certain
circumstances, each holder of a Right may purchase at the exercise price of
the Right shares of common stock of the acquiring or surviving company having
a market value of two times the exercise price of the Right. In addition, if
after the Rights become exercisable, any person becomes the owner of 20% of
the Company's outstanding common stock, or the Company is involved in certain
"self-dealing" transactions involving any person owning 15% or more of the
Company's outstanding common stock, each holder of a Right may purchase at
the exercise price of the Right, shares of the Company's common stock (or in
certain cases, cash, property, or other securities of the Company) having a
market value of twice the exercise price of the Right. Rights held by an
acquiring person become void upon the occurrence of such events.
NOTE 18 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practical to estimate
that value. Considerable judgement is required to develop the estimates of
fair value and, therefore, the estimates provided below are not necessarily
indicative of the amount that could be realized in a current market exchange.
SHORT-TERM FINANCIAL INSTRUMENTS: These instruments are valued at their
carrying amounts included in the balance sheets, which are reasonable
estimates of fair value due to the relatively short period to maturity of
these instruments. This approach applies to cash and cash equivalents,
accrued receivables and payables and certain other assets and liabilities.
SECURITIES: Fair value for these instruments equals quoted market prices or
dealer quotes.
LOANS HELD FOR SALE: The fair value of loans held for sale is estimated based
upon the anticipated sale price of each loan.
LOANS: The fair value of loans is estimated by discounting future cash flows
using current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities. Loan
prepayments are assumed to occur at the same rate as in previous periods when
interest rates were at levels similar to current levels. The fair value of
nonaccrual loans is also estimated on a present value basis, using higher
discount rates appropriate to the higher risk involved.
DEPOSITS: The fair value of demand deposits, savings accounts, and money
market deposits is the amount payable on demand at the reporting date. The
fair value of certificates of deposit is estimated by discounting future cash
flows using the current rates for deposits of similar remaining maturities.
The intangible value of long-term relationships with depositors is not taken
into account in estimating the fair values disclosed.
FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS:
Federal funds purchased are for a term of one day and the carrying amount is
a reasonable estimate of fair value. The fair value of securities sold under
repurchase agreements is estimated by discounting future cash flows using the
current rates for funds of similar remaining maturities.
NOTES PAYABLE: The fair value of the fixed rate note payable is estimated
using the current rates for advances of similar remaining maturities. The
carrying value of the floating rate note payable is a reasonable estimate of
fair value.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT: The fee that
would be charged to enter similar commitments today is the fair value. All
commitments to extend credit and standby letters of credit are issued on a
short-term or floating rate basis. The fair values of these instruments is
not material.
26
<PAGE>
NOTE 18 -- DISCLOSURES ABOUT FAIR VALUE
OF FINANCIAL INSTRUMENTS -- (CONTINUED)
The carrying values and estimated fair values of the Company's financial
instruments as of December 31 are as follows:
<TABLE>
<CAPTION>
1996 1995
--------------------- ---------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks . . . . . . . . . . . . . $ 42,455 $ 42,455 $ 28,166 $ 28,166
Federal funds sold . . . . . . . . . . . . . . . 2,613 2,613 - -
Securities available for sale . . . . . . . . . . 194,780 194,780 187,169 187,169
Loans held for sale . . . . . . . . . . . . . . . 4,149 4,149 4,340 4,340
Loans . . . . . . . . . . . . . . . . . . . . . . 456,802 459,323 304,327 301,077
Allowance for loan losses . . . . . . . . . . . . (7,274) (7,274) (5,176) (5,176)
Accrued interest receivable . . . . . . . . . . . 4,975 4,975 4,063 4,063
Due from broker . . . . . . . . . . . . . . . . . - - 3,687 3,687
Financial liabilities:
Deposits . . . . . . . . . . . . . . . . . . . . $(600,970) $(600,888) $(453,771) $(455,875)
Federal funds purchased and securities sold under
repurchase agreements . . . . . . . . . . . . . (44,525) (44,525) (22,726) (22,726)
Notes payable . . . . . . . . . . . . . . . . . . (14,000) (14,000) (3,000) (3,000)
Accrued interest payable . . . . . . . . . . . . (2,020) (2,020) (1,703) (1,703)
Due to broker . . . . . . . . . . . . . . . . . . (305) (305) (1,560) (1,560)
</TABLE>
NOTE 19 -- CONDENSED FINANCIAL INFORMATION -- COMPANY ONLY
Presented below are the condensed balance sheets and condensed statements of
income and cash flows for Merchants Bancorp, Inc.
CONDENSED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
1996 1995
------- -------
ASSETS
Repurchase agreement with bank subsidiary . . . . . . . $ - $ 9,631
Noninterest-bearing deposit with bank subsidiaries . . . 861 919
Investment in subsidiaries, at equity . . . . . . . . . 71,582 43,442
Other assets . . . . . . . . . . . . . . . . . . . . . . 149 480
------- -------
$72,592 $54,472
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable . . . . . . . . . . . . . . . . . . . . . $14,000 $ -
Accrued interest and other liabilities . . . . . . . . . 394 378
Stockholders' equity . . . . . . . . . . . . . . . . . . 58,198 54,094
------- -------
$72,592 $54,472
------- -------
------- -------
27
<PAGE>
NOTE 19 -- CONDENSED FINANCIAL INFORMATION -- COMPANY ONLY -- (CONTINUED)
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
OPERATING INCOME
Cash dividends received from subsidiaries . . . . . . . . . . . . . $ 2,625 $ 1,395 $ 1,001
Interest income on repurchase agreement with Merchants Bank . . . . - 457 291
---------- ---------- ----------
2,625 1,852 1,292
---------- ---------- ----------
OPERATING EXPENSES
Interest on notes payable . . . . . . . . . . . . . . . . . . . . . 422 - 5
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 367 280 227
---------- ---------- ----------
789 280 232
---------- ---------- ----------
Income before income taxes and equity in undistributed net
income of subsidiaries . . . . . . . . . . . . . . . . . . . . . 1,836 1,572 1,060
Income tax expense (benefit) . . . . . . . . . . . . . . . . . . . (309) 73 24
---------- ---------- ----------
Income before equity in undistributed net income of
subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . 2,145 1,499 1,036
Equity in undistributed net income of subsidiaries . . . . . . . . 4,383 4,697 4,423
---------- ---------- ----------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,528 $ 6,196 $ 5,459
---------- ---------- ----------
---------- ---------- ----------
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,528 $ 6,196 $ 5,459
Adjustments to reconcile net income to net cash from
operating activities:
Equity in undistributed net income of subsidiaries . . . . . . (4,383) (4,697) (4,423)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . 291 (251) (158)
---------- ---------- ----------
Net cash from operating activities . . . . . . . . . . . . . . 2,436 1,248 878
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Acquisition of Valley Banc Services Corp., net of debt assumed . . (21,336) - -
---------- ---------- ----------
Net cash from financing activities . . . . . . . . . . . . . . (21,336) - -
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds of notes payable . . . . . . . . . . . . . . . . . . . . . 14,000 - -
Principal payments on notes payable . . . . . . . . . . . . . . . . (3,550) - (450)
Dividends paid, net of dividend reinvestments . . . . . . . . . . . (1,239) (1,039) (911)
---------- ---------- ----------
Net cash from financing activities . . . . . . . . . . . . . . 9,211 (1,039) (1,361)
---------- ---------- ----------
Net change in cash and cash equivalents . . . . . . . . . . . . (9,689) 209 (483)
Cash and cash equivalents at beginning of year . . . . . . . . 10,550 10,341 10,824
---------- ---------- ----------
Cash and cash equivalents at end of year . . . . . . . . . . . $ 861 $ 10,550 $ 10,341
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
NOTE 20 -- PENDING ACCOUNTING CHANGES
Financial Accounting Standard No. 125, "Accounting for Transfer and Servicing
of Financial Assets and Extinguishment of Liabilities," was issued by the
Financial Accounting Standards Board in 1996. It revises the accounting for
transfers of financial assets, such as loans and securities, and for
distinguishing between sales and secured borrowings. It is effective for
some transactions in 1997 and others in 1998. The effect on the financial
statements has not yet been determined.
28
<PAGE>
[LOGO]
[LETTERHEAD]
Independent Auditors' Report
Stockholders and Board of Directors
Merchants Bancorp, Inc.
Aurora, Illinois
We have audited the accompanying consolidated balance sheets of Merchants
Bancorp, Inc. and Subsidiaries as of December 31, 1996 and 1995 and the
related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1996.
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
Bancorp, Inc. and Subsidiaries as of December 31, 1996 and 1995 and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996 in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted a new method of accounting for originated mortgage servicing rights
in 1996.
/s/ Crowe, Chizek and Company LLP
- ---------------------------------
Crowe, Chizek and Company LLP
Oak Brook, Illinois
February 5, 1997
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Merchants Bancorp, Inc. ("Company"), a bank holding company headquartered in
Aurora, Illinois, is one of the leading commercial banking and trust
institutions in Aurora and surrounding communities. The Company conducts a
full service community banking and trust business through its wholly-owned
subsidiary banks. The Merchants National Bank of Aurora ("Merchants Bank")
has its main office and three locations in Aurora, one location in Oswego,
Illinois, and a new branch in Geneva, Illinois, which opened in early 1996.
On January 3, 1996, the Company purchased Valley Banc Services, Corp.,
("Valley") a $167 million bank holding company with banks located in St.
Charles, Hinckley, Osco, and Grayslake, Illinois. The banks in Osco and
Grayslake were each sold to separate purchasers in December, 1996.
As a large, community-oriented, independent financial institution in the
greater Aurora area, the Company is well positioned to take advantage of the
growth of Aurora and its surrounding communities. The oldest and largest
bank in the Company, Merchants Bank has continuously served the Aurora
community since it was chartered in 1888. Each bank operates as a
traditional community bank with local management, conveniently located
facilities and a professional, highly motivated staff which is active in the
community, focuses on long-term relationships with customers and provides
individualized quality service. The Company's local management in each of
its banks, coupled with its long record of service, has allowed it to compete
successfully in each banking market it serves.
On January 3, 1996, the Company purchased 100% of the outstanding common
stock of Valley, as described in detail in Note 2 to the consolidated
financial statements. As of the acquisition date, Valley's wholly-owned
subsidiaries included Hinckley State Bank, State Bank of Osco, Anchor Bank
and V.B.H. Corporation and V.B.H. Corporation's wholly-owned subsidiary, Fox
Valley Bank. When Valley was acquired, the Company's intent was to sell
State Bank of Osco and Anchor Bank. Accordingly, those banks were classified
as held for sale until they were sold on December 12, 1996, and December 19,
1996. The net asset valuations of State Bank of Osco and Anchor Bank were
initially determined by the Company's management based upon recent sales
prices of similar financial institutions and after consideration of estimated
1996 earnings and capitalized interest expense during the estimated holding
period, neither of which were included in 1996 earnings of the Company. The
actual 1996 operating results of State Bank of Osco and Anchor Bank, from
January 3, through their respective sale dates, of $280,000 and $170,000,
were not included in the Company's 1996 consolidated operating results.
Net income was $6,528,000, or $2.53 per share in 1996, which compares with
$6,196,000, or $2.41 per share in 1995, and $5,459,000 or $2.13 per share in
1994. Increases in both net interest income and noninterest income
contributed to these record levels. Net interest income grew $4.8
million (22.3%) to $26.3 million in 1996, largely due to an increase in
earning assets. Noninterest income grew $2.6 million (37.7%) to $9.5
million, primarily based on increases in mortgage banking income and service
charges and fees. The Valley acquisition also had a significant impact on
many areas of the financial statements, as is discussed in detail below.
Results of Operations
Net Interest Income
Net interest income is the difference between interest income earned on
earning assets and interest expense paid on interest-bearing liabilities. As
such, net interest income is affected by changes in the volume and yields on
earning assets, and the volume and rates paid on interest-bearing
liabilities. Net interest margin is the ratio of tax equivalent net interest
income to average earning assets.
A review of overall trends shows that net interest income grew during each of
the last three years. The primary cause for these increases was the growth in
earning assets and deposits of the Company. Net interest income was $26.3
million, $21.5 million, and $20.0 million in 1996, 1995, and 1994. Net
interest income to average total earning assets on a fully tax equivalent
basis was 4.49% in 1996, 4.73% in 1995, and 4.92% in 1994.
The net interest margin declined in 1996, as the yield on earning assets
declined from 7.91% to 7.61% while the average rate on interest bearing
liabilities remained unchanged, at 3.51%. from 1995. Most of the decline was
directly related to the Valley acquisition. Historically, the Valley
subsidiary banks have had a lower net interest margin than Merchants Bank.
Management is working to bring the Valley subsidiary banks to the Company's
past levels of performance to the extent possible. In addition, the growth
in adjustable rate residential mortgage loans caused a decline in average
earning asset yield in 1996, but the average rate on these loans is expected
to be responsive to changes in interest rates in the future. The tax
equivalent yield on earning assets increased from 7.96% in 1994, to 9.08%
in 1995, as interest rates were generally higher in 1995 than in 1994. The
average
30
<PAGE>
interest rate paid on interest bearing liabilities increased from 3.66% in
1994 to 4.59% in 1995.
Management has consistently managed the balance sheet with the objective of
maintaining a stable net interest margin over the long term, regardless of
changes in market interest rates, so that asset growth results in a
corresponding increase in net interest income. Average interest rates are the
result of the volume and interest rates of new assets and liabilities and the
volume and interest rates of matured, sold, or repaid assets and liabilities.
The table below demonstrates that most of the growth in net interest income
has come as a direct result of balance sheet growth, rather than changes in
interest rates. This table allocates the changes in tax equivalent net
interest income to changes in either average balances or average rates for
earning assets and interest-bearing liabilities. The change in net interest
income due to both volume and rate has been allocated proportionately to the
change due to balance and due to rate. Tax-exempt interest income is measured
on a tax equivalent basis using a 34% rate.
PROVISION FOR LOAN LOSSES
The Company's provision for loan losses was $2,014,000 in 1996, $1,783,000 in
1995, and $2,298,000 in 1994. Provisions for loan losses are made to
recognize current period net charge off activity, and to provide for future
losses on loans which are identified as possible in the loan review process.
The allowance for loan losses as a percentage of total loans was 1.59%, 1.70%
and 1.80% as of December 31, 1996, 1995, and 1994. The addition of the Valley
subsidiary banks, which carried lower levels of allowances for loan losses,
together with the rate of loan growth at Merchants Bank, contributed to the
decline in this ratio. Net charge-offs were $714,000, $1,747,000, and
$1,863,000, in 1996, 1995, and 1994. Net charge-offs as a percentage of
average loans has declined each year, to 0.18% in 1996, from 0.60% in 1995,
and 0.67% in 1994.
NONINTEREST INCOME
The table on page 32 shows the Company's noninterest income for the years
indicated.
Total noninterest income increased $2,623,000 (38%), from 1995 to 1996, after
increasing $354,000 (5%) during 1995. Noninterest income in all categories
except securities gains increased from 1994 to 1995, and from 1995 to 1996.
Trust income increased $103,000 (5%) to $2,028,000 in 1996 from $1,925,000 in
1995, and grew $203,000 (12%) during 1995, from $1,722,000 in 1994. The rate
of change in total assets under management is not the same as the rate of
change in trust income because some services are not be based on the amount
of assets under management. Assets under management decreased slightly to
$361 million at December 31, 1996, from $371 million at December 31, 1995,
after increasing from $326 million at December 31, 1994.
Mortgage banking noninterest income was $2,202,000 in 1996, compared with
$1,267,000 in 1995, and $1,153,000 in 1994. Servicing income was $432,000 in
1994 and grew to $559,000 in 1995 and $785,000 in 1996. Unamortized mortgage
servicing rights totaled $1,438,000 and $1,165,000 at December 31, 1996 and
1995. Amortization of this asset was $295,000, $123,000, and $68,000 in 1996,
1995, and 1994. The total servicing portfolio, including purchased and
originated loans, was $255 million and $235 million at December 31, 1996 and
1995. Management's plans are to continue increasing the size of the servicing
portfolio. The Company adopted Statement of Financial Accounting Standards
No. 122, "Accounting for Mortgage Servicing Rights" ("SFAS 122") on
January 1, 1996. Under SFAS 122, the Company recognizes a separate asset for
both purchased and originated mortgage servicing rights. The implementation
of this standard contributed $568,000, prior to amortization, to the increase
in mortgage servicing rights when compared with periods prior to its
implementation.
- -------------------------------------------------------------------------------
ANALYSIS OF CHANGES IN INTEREST INCOME (In thousands)
Change Due to
-------------------------
Total Average Average
Change Balance Rate
------- ------- -------
1996 Compared to 1995:
Earning assets. . . . . . . . . $10,653 $11,889 $(1,236)
Interest bearing liabilities. . 5,715 6,000 (285)
------- ------- -------
Net interest income . . . . . . $ 4,938 $ 5,889 $ (951)
------- ------- -------
------- ------- -------
1995 Compared to 1994:
Earning assets. . . . . . . . . $ 6,759 $ 3,441 $ 3,318
Interest bearing liabilities. . 5,195 2,401 2,794
------- ------- -------
Net interest income . . . . . . $ 1,564 $ 1,040 $ 524
------- ------- -------
------- ------- -------
31
<PAGE>
Service charges and fees totaled $3,796,000, $2,713,000, and $2,472,000 in
1996, 1995, and 1994. Of the $1,083,000 (39.9%) increase in 1996, $420,000
resulted from the Valley acquisition, and $663,000 was from income at
Merchants Bank. At Merchants Bank, overdraft and returned check fees
increased $417,000, and commercial checking fees increased $170,000, due to
changes in fee structure and increased overdraft activity. The increase in
service charges and fees from 1994 and 1995 was primarily a result of deposit
growth.
Sales of securities available for sale totaled $32.4 million during 1996,
$23.8 million during 1995, and $17.9 million in 1994, resulting in net gains
of $196,000, $133,000, and $373,000. These securities were sold due to
changes in interest rates, availability of alternative investments, liquidity
needs, and other factors.
Other noninterest income was $1,319,000, $880,000, and $844,000 in 1996,
1995, and 1994. Of the $439,000 increase in 1996, $121,000 was attributed to
Valley. During 1996, debit card transaction fees increased $175,000, to
$192,000, and ATM fees increased $49,000, to $513,000. In 1995, fees related
to ATMs remained stable at $465,000 as compared to $456,000 in 1994. In 1995,
debit card fees, a new source of income introduced in late 1995, totaled
$17,000.
Noninterest Expenses
The table on page 33 shows the Company's noninterest expenses for the years
indicated.
Noninterest expenses increased $6,976,000 (39%) in 1996, compared to $17.9
million in 1995. This followed a $1,156,000 increase (6.9%) in 1995, compared
to 1994 noninterest expense of $16.7 million. As in other areas, the Valley
acquisition had a significant impact on year to year comparisons. The
noninterest expenses attributed to Valley and its subsidiaries are shown in
the table on page 33, in addition to the consolidated expenses of the Company
including Valley.
Salaries and benefits increased $3.0 (30.6%) to $12.9 million in 1996,
compared to $9.9 million in 1995, and $9.2 million in 1994. Commissions and
incentives, which are included in salaries and benefits, increased $314,000
(35.0%), to $1,212,000 in 1996. Much of this is associated with the increased
income in mortgage banking, principally due to commissions paid. Also in
1996, life and health insurance expense increased $159,999 (32.9%) to
$642,000, and contributions to the Company's Thrift Plan totaled $526,000, an
increase of $267,000 (103.1%), as discussed in Note 11 to the consolidated
financial statements. In December, 1996, the Company approved terminating the
defined benefit pension plan and the Company's discretionary contribution to
the Thrift Plan was increased in order to mitigate the impact of this
decision on employees. The full time equivalent number of employees was 341
(including 46 for Valley), 261, and 265 as of December 31, 1996, 1995, and
1994. The increased expense in 1995 included a one-time charge of $234,000 to
recognize the cost of an early retirement plan offered to employees meeting
certain service requirements.
Occupancy expenses were $582,000 (56.5%) higher in 1996 than in 1995, after
an increase of $86,000 (9.1%) in 1995, compared to 1994. In addition to the
Valley acquisition, a new branch was opened in Geneva, Illinois, during 1996,
and was reflected in 1996 operating results.
Furniture and equipment expenses increased $412,000 (33.3%) in 1996, and
$148,000 (13.6%) in 1995. Management believes strongly in the use of
technology to achieve operational efficiency and quality of results.
Investment in new systems to manage information has contributed to the
increase in equipment expenses during the years presented. Some of these
projects have involved specific product areas, such as the introduction of
the debit card in 1995, and some are designed to improve operational
efficiency and customer service. The addition of Valley and the new branch
during 1996 also contributed to the increase in furniture and equipment
expenses.
As discussed in Note 1 to the consolidated financial statements, the Valley
acquisition resulted in goodwill and core deposit intangible assets which
will be amortized to expense in future years. The goodwill is being amortized
on the straight-line basis over 20 years. The core deposit intangible assets
are being amortized using an accelerated method over 10 years. The core
deposit intangible recorded assets are being amortized using an accelerated
method over 10 years. The core deposit intangible recorded in conjunction
with the acquisition of First American Bank of Aurora in 1984, which was
subsequently merged into Merchants Bank in
- -------------------------------------------------------------------------------
NONINTEREST INCOME (In thousands)
Consolidated
---------------------------
Valley
1996 1996 1995 1994
-------- ------- ------- -------
Trust income . . . . . . . . . . . . . $ - $2,028 $1,925 $1,722
Mortgage banking income. . . . . . . . 20 2,202 1,267 1,153
Service charges and fees . . . . . . . 420 3,796 2,713 2,472
Securities gains, net. . . . . . . . . - 196 133 373
Other income . . . . . . . . . . . . . 121 1,319 880 844
---- ------ ------ ------
Total noninterest income $561 $9,541 $6,918 $6,564
---- ------ ------ ------
---- ------ ------ ------
32
<PAGE>
1990, is being amortized on the straight-line basis over 15 years.
Other expenses increased $2.3 million (40%) to $7.8 million in 1996, from
$5.6 million in 1995. Valley accounted for approximately half of the
increase. Increased mortgage activity resulted in increases in related
expenses, including amortization of servicing rights, up $172,000 (140%) to
$295,000, and correspondent mortgage fees, up $264,000 to $309,000.
Correspondent business has been pursued as a strategy for increasing the
amount of mortgage business. Other increases across the organization included
telephone expense, up $153,000 to $383,000, and software expense, up $115,000
to $383,000 in 1996.
The cost of insurance premiums assessed by the Federal Deposit Insurance
Corporation ("FDIC"), included in other expenses, was $16,000 in 1996,
compared to $475,000 in 1995, and $846,000 in 1994. The Banks were all at the
lowest assessment rate as of year-end 1996. The lowest assessment rate is
applied to well capitalized institutions in the supervisory group
representing the least risk.
Other expenses increased $580,000 (12.4%) in 1995, compared to 1994.
Consulting fees increased $176,000, to $245,000 in 1995, from $69,000 in
1994. Most of the increase in consulting fees was the result of an initiative
in which a consulting firm was engaged to work with management to increase
earnings through changes in a wide array of areas, including product pricing,
operating procedures, and staffing. Management believes the changes that have
been implemented, or will be implemented, as a result of this initiative will
result in significant earnings improvement over time. Loss on disposition of
other real estate owned was $86,000 in 1995, compared to $4,000 in 1994.
Amortization of mortgage servicing increased $55,000, from $68,000 in 1994 to
$123,000 in 1995.
Income Taxes
The Company's provision for income taxes was $2,456,000, $2,502,000, and
$2,079,000 for the years ended December 31, 1996, 1995, and 1994. The average
effective income tax rate for these years was 27.34%, 28.77%, and 27.58%.
Financial Condition
Lending Activities
The Company's major source of income is interest on loans, and the
composition of the portfolio reflects the communities served by the Banks.
The table on page 34 presents the composition of the Company's loan portfolio
at the end of the periods indicated.
Total loans increased $152.5 million, or 50.1%, to $456.8 million as of
December 31, 1996, from $304.3 million at December 31, 1995. Approximately
50% of this increase was attributable to Valley. This compares with an
increase of $18.7 million or 6.5% in 1995.
The commercial loan portfolio increased $51.9 million (47.2%) in 1996, $37.7
million of which was attributable to the Valley acquisition, after declining
$2.9 million (2.6%) during 1995, to $109.9 million as of December 31, 1995.
Commercial real estate loans increased $7.7 million (11.4%) from $67.7
million as of December 31, 1995, to $75.4 million as of December 31, 1996.
Almost all of the 1996 increase was attributable to Valley. This compares
with a balance of $72.3 million as of December 31, 1994. These loans are made
on the basis of borrowers' cash flows and do not rely upon the sale of the
property to repay the loans. As added security, these loans are backed by the
value of the collateral properties, which are supported by recent appraisals.
Real estate construction loans increased $14.0 million (34.6%) from $40.5
million as of December 31, 1995, to $54.5 million as of December 31, 1996.
This compares with a balance of $24.5 million as of December 31, 1994. These
loans are typically of a short duration and reflect the continued growth of
the Aurora area. The majority of these loans were to experienced developers
of pre-sold homes in the price range of $100,000 to $150,000.
The Company's residential real estate loans consist of loans secured by one
to four family homes. This category increased $53.4 million (168.5%) in 1996
and $12.1 million (62.0%) in 1995, primarily as a result of adjustable rate
mortgages added to the portfolio and the addition of Valley loans, which
contributed
- ------------------------------------------------------------------------------
NONINTEREST EXPENSES (In thousands)
Consolidated
----------------------------
Valley
1996 1996 1995 1994
-------- ------- ---------- --------
Salaries and employee benefits. . . . . $1,496 $12,924 $ 9,893 $ 9,180
Occupancy expenses, net . . . . . . . . 371 1,612 1,030 944
Furniture and equipment expenses. . . . 195 1,650 1,238 1,090
Amortization of goodwill. . . . . . . . 385 385 - -
Amortization of core deposit
intangible assets . . . . . . . . . 304 405 101 101
Other expenses. . . . . . . . . . . . . 1,138 7,889 5,627 5,418
------ ------- ------- -------
Total noninterest expenses . . . . . $3,889 $24,865 $17,889 $16,733
------ ------- ------- -------
------ ------- ------- -------
33
<PAGE>
approximately one fifth of the growth. The Company sells most fixed rate
residential real estate loans, primarily to the FHLMC and to the FNMA. Loans
held for sale were $4.1 million and $4.3 million as of December 31, 1996 and
1995. In addition, the Company has entered into agreements to sell loans to
the FHLMC and the FNMA. Minimum commitments under these agreements to sell
loans to the FHLMC were $9.3 as of December 31, 1996, and $6.4 million as of
December 31, 1995, and no commitments were outstanding to the FNMA as of
either date.
Installment loans increased $23.4 million (46.3%) in 1996, after declining
$3.3 million (6.1%) in 1995. $12.9 million of the increase in 1996 was
related to Valley loans. The primary source of installment lending has been
in single pay and amortizing loans used to finance automobiles, recreation
vehicles, home improvements, durable goods and other consumer uses, with the
most common of these being automobile financing.
Nonperforming Loans and Assets
The Company utilizes a loan review function which is separate from the
lending function and is responsible for the review of new and existing loans.
Potential problem credits are monitored by the loan review staff and are
submitted for review to a credit committee consisting of loan officers and
board members.
The loan review department rates all commercial loans and mortgage loans
secured by commercial properties or five-plus family residences. These loans
are rated 1 to 6, with 4 being special mention, 5 substandard, and 6
doubtful. Loans over 90 days past due are normally either charged off or, if
well secured and in the process of collection, placed in nonaccrual status.
The Company adopted Statements of Financial Accounting Standards No. 114 and
No. 118 for impaired loans effective January 1, 1995. Under these standards,
the Company defined loans that will be individually evaluated for impairment
to include commercial loans and mortgages secured by commercial properties or
five-plus family residences. All other smaller balance homogeneous loans are
evaluated for impairment in total.
The Company defines impaired loans to include all commercial loans and
mortgage loans secured by commercial properties or five-plus family
residences that are graded 6, in nonaccrual status, or restructured after
January 1, 1995.
Impaired loans totaled $1,428,000 as of December 31, 1996, and $921,000 as of
December 31, 1995. Impaired loans with no allowance for loan losses allocated
were $523,000 as of December 31, 1996, and there were no such loans as of
December 31, 1995. Impaired loans with an allowance for loan losses
allocation, and the related allocation, were $905,000 and $363,000 as of
December 31, 1996, and were $921,000 and $631,000 as of December 31, 1995.
There were no loans past due ninety days or more and still accruing, as of
December 31, 1996, or 1995. Restructured loans totaled $359,000 and
$1,047,000 as of December 31, 1996, and December 31, 1995. The majority of
these balances consisted of loans to a single borrower. Nonaccrual loans were
$2,970,000 as of December 31, 1996, compared with $1,135,000 as of December
31, 1995. Other real estate owned decreased from $566,000 at December 31,
1995, to $333,000 at December 31, 1996. Values placed on properties are based
on current independent appraisals. The ratio of nonaccrual and restructured
loans to total loans was 0.73% and 0.72% as of December 31, 1996 and 1995.
The restructured loans were performing in accordance
- -------------------------------------------------------------------------------
LOAN PORTFOLIO (IN THOUSANDS)
CONSOLIDATED
VALLEY -------------------------------
1996 1996 1995 1994
-------- --------- --------- ---------
Commercial and industrial . . . . . $ 37,689 $ 161,847 $ 109,872 $ 112,828
Real estate - commercial. . . . . . 10,806 75,449 67,739 72,305
Real estate - construction. . . . . 1,589 54,513 40,510 24,470
Real estate - residential . . . . . 12,784 85,107 31,673 19,549
Installment . . . . . . . . . . . . 12,917 73,918 50,489 53,806
Credit card receivables . . . . . . 792 6,697 5,644 4,119
Other loans . . . . . . . . . . . . 117 1,188 455 937
-------- --------- --------- ---------
Gross loans . . . . . . . . . . . 76,694 458,719 306,382 288,014
Unearned discount . . . . . . . . . (126) (1,535) (1,743) (2,054)
Deferred loan fees . . . . . . . . (195) (382) (312) (387)
-------- --------- --------- ---------
Total loans . . . . . . . . . . . 76,373 456,802 304,327 285,573
Allowance for loan losses . . . . . (867) (7,274) (5,176) (5,140)
-------- --------- --------- ---------
Loans, net. . . . . . . . . . . . $ 75,506 $ 449,528 $ 299,151 $ 280,433
-------- --------- --------- ---------
-------- --------- --------- ---------
34
<PAGE>
with the terms of the new agreements. The ratio of nonaccrual loans to total
loans was 0.65% and 0.37% as of December 31, 1996 and 1995.
Allowance for Loan Losses
The adequacy of the allowance for loan losses is determined by management
based on factors that include the overall composition of the loan portfolio,
types of loans, past-loss experience, loan delinquencies, potential
substandard and doubtful credits, and other factors that, in management's
judgment, deserve evaluation in estimating loan losses. The adequacy of the
allowance for loan losses is monitored by the loan review staff, and reported
to management and the board of directors. The ratio of the allowance for loan
losses to total loans was 1.59% and 1.70% as of December 31, 1996, and
December 31, 1995. The allowance for loan losses to total nonperforming loans
(generally considered to be nonaccrual, restructured, or past due ninety days
and still accruing) was 218.5% and 237.2% as of December 31, 1996, and
December 31, 1995.
While there can be no assurance that the allowance for loan losses will be
adequate to cover all losses, management believes that the allowance for loan
losses was adequate at December 31, 1996. While management uses available
information to provide for losses on loans, the ultimate collectibility of a
substantial portion of the loan portfolio and the need for future additions
to the allowance will be based upon changes in economic conditions. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to make additional provisions
to the allowance based upon their judgments about information available to
them at the time of their examinations.
Securities
The objectives regarding the securities portfolio are to provide the Company
with a source of liquidity and earnings. Securities available for sale are
carried at fair value, with related unrealized gains or losses, net of
deferred income taxes, recorded as an adjustment to equity capital. In
addition, as permitted by the SFAS 115 implementation guide released in 1995,
the Company exercised a one time opportunity to reassess the appropriateness
of the classifications of all securities held. Based on the review, the
Company reclassified securities having an amortized cost of $39.7 million and
a net unrealized gain of $1.5 million at December 15, 1995, from held to
maturity to available for sale.
As of December 31, 1996, net unrealized gains of $429,000, reduced by
deferred income taxes of $112,000 resulted in an increase in equity capital
of approximately $317,000. As of December 31, 1995, net unrealized gains of
approximately $2.2 million, reduced by deferred income taxes approximately
$747,000, resulted in an increase in equity capital of approximately $1.5
million.
During 1996, the securities portfolio grew $9.4 million (5.1%), as measured
by amortized cost, to $194 million as of December 31, 1996, from $185 million
as of December 31, 1995. During 1996 there was a general reallocation within
the securities portfolio, from Treasury securities and U.S. Government agency
mortgage backed securities to U.S. Government agency securities. U.S.
Treasury securities declined by 29.2% to $17.7 million, or 9.1% of the
portfolio as of December 31, 1996, from $25.0 million, or 13.5% of the
portfolio as of December 31, 1995. U.S. Government agency mortgage backed
securities decreased from $44.8 million, or 24.2% of the portfolio, as of
December 31, 1995, to $34.2 million, or 17.6% of the portfolio as of December
31, 1996. Over the same period, U.S. Government agency securities increased
from $53.0 million, or 28.7% of the portfolio, to $77.0 million, or 39.6% of
the portfolio. The increase in the proportion of the total portfolio invested
in U.S. Government agency securities was based upon considerations of yield,
security, and suitability as collateral for deposits and borrowings requiring
pledged securities.
As of December 31, 1996, and 1995, the Company held structured notes carried
at fair values of $4.3 million and $6.5 million. These securities were issued
by the FHLB, the FNMA, and the Student Loan Marketing Association ("SLMA").
These obligations offer the investor periodic coupon increases over a given
time horizon, and are generally subject to call after the first coupon
readjustment date. All such securities are stress tested, to assess the
probable price sensitivity in response to an immediate and sustained changed
in market interest rates. In addition, each security's total return is
computed to each call date, as if it were to be called on that date, and the
resulting annual return is compared with other investments with maturities
similar to the call dates of the security.
Deposits and Borrowed Funds
The table on page 36 shows the major components of deposits as of December
31, of the years indicated.
The Company has a relatively stable deposit base from within its market
areas. Deposits of $601.0 million reflected growth of $147.2 million (32.4%)
during 1996, when compared to $453.8 million as of December 31, 1995. The
Valley acquisition added $102.1 million to total deposits as of December 31,
1996. Noninterest bearing deposits grew $36.2 million (47.6%), while interest
bearing deposits increased $111.0 million (29.4%). Most of the growth was in
time deposits, as time deposits under $100,000 grew $41.9 million (25.2%) and
time deposits in denominations of
35
<PAGE>
$100,000 or more grew $16.6 million (26.5%), during 1996. Interest-bearing
transaction accounts and savings accounts increased 35.2% in the aggregate,
at $201.3 million as of December 31, 1996, compared to $148.8 million as of
December 31, 1995.
Notes payable at December 31, 1996, consists of two notes of $7 million each,
the proceeds of which were used to finance the acquisition of Valley on
January 3, 1996. A revolving note bears interest at the prevailing Federal
funds rate of 1% above LIBOR, at the quarterly election of the Company. This
variable rate was 6.56% at December 31, 1996. A fixed rate note bears
interest at a rate of 7.03%. As more fully discussed in Note 2 to the
consolidated financial statements, the Company capitalized $532,000 of
incremental interest costs during the holding period of the acquired Valley
subsidiaries held for sale.
The Company also utilizes securities sold under repurchase agreements as a
source of funds. Most local municipalities, and osme other orgainzations,
hust have funds insured or collateralized as a matter of their own policies.
Regulations land do not increase the Company's reserve requirements or
create an expense related to FDIC insurance on deposits. Although the balance
of repurchase agreements is subject to variation, particularly seasonal
variation, the account relationships represented by these balances are local
businesses and municipalities that have other account relationships with the
Banks.
Capital Resources
Total stockholder's equity increased $4.1 million during 1996, from $54.1
million as of December 31, 1995, to $58.2 million as of December 31, 1996.
Net income of approximately $6.5 million, reduced by dividends of $1.4
million, caused an increase in retained earnings of $5.1 million during 1996.
Other factors influencing the year to year change in total stockholders'
equity were an increase of $152,000 from the insurance of common stock in
connection with the dividend reinvestment plan offset by a reduction of $1.1
million as a result of the change in the net unrealized gains on securities
available for sale, as previously discussed in "Securities."
Bank regulatory bodies have adopted capital standards by which all banks and
bank holding companies will be evaluated (discussed in Note 16 to the
consolidated financial statements). The Company and the Banks were
categorized as well capitalized as of December 31, 1996. Management is not
aware of any conditions or events since the most recent regulatory
notification that would change the Company's or the Bank's categories. See
Note 16 to the consolidated financial statements for a calculation of the
Company's capital ratios.
Liquidity
Liquidity measures the ability of the Company to meet maturing obligations
and its existing commitments, to withstand fluctuations in deposit levels, to
fund its operations and to provide for customers' credit needs. The liquidity
of the Company principally depends on cash flows from operating activities,
investment in and maturity of assets, changes in balances of deposits and
borrowings and its ability to borrow funds in the money or capital markets.
Cash inflows from operating activities exceeded operating outflows by $9.9
million in 1996, by $8.8 million in 1995, and by $12.9 million in 1994.
Changes in the amount of mortgage loans held for sale as of December 31, of
each year resulted in operating cash inflows of $604,000 in 1996, outflows of
$2.0 million in 1995, and inflows of $6.2 million in 1994. Net gains on
sales of mortgage loans were $981,000 in 1996, $341,000 in 1995, and $491,000
in 1994. Interest received net of interest paid is the principal source of
net operating cash inflows in all periods reported. Management of investing
and financing activities, and market conditions, determine the level and the
stability of net interest cash flows. Management's policy is to mitigate the
impact of changes in market interest rates to the extent possible, so that
balance sheet growth is the principal determinant of growth in net interest
cash flows.
Net cash outflows from investing activities were $69.2 million in 1996,
compared to $37.9 million in 1995, and $49.6 million in 1994. Securities
purchases, net of securities matured or sold, resulted in net cash inflows of
$17.2 million in 1996, outflows of $16.2 million in
- -------------------------------------------------------------------------------
DEPOSITS (IN THOUSANDS)
CONSOLIDATED
VALLEY -------------------------------
1996 1996 1995 1994
-------- --------- --------- ---------
Noninterest-bearing deposits . . . . $ 17,011 $ 112,203 $ 76,008 $ 74,931
NOW accounts . . . . . . . . . . . . 9,434 75,991 63,027 65,686
Money market accounts . . . . . . . 9,935 58,061 33,808 31,443
Savings . . . . . . . . . . . . . . 12,812 67,232 51,935 56,822
Time, $100,000 and over . . . . . . 9,970 79,214 62,628 49,477
Other time . . . . . . . . . . . . . 42,896 208,269 166,365 135,382
-------- --------- --------- ---------
$102,058 $ 600,970 $453,771 $ 413,741
-------- --------- --------- ---------
-------- --------- --------- ---------
36
<PAGE>
1995, and outflows of $34.2 million in 1994. Net principal disbursed on loans
totaled $79.3 million in 1996, $20.6 million in 1995, and $14.2 million in
1994. The Valley acquisition resulted in net investing cash outflows, net of
cash and cash equivalents acquired, of $13.6 million in 1996. In addition, the
sale of acquired Valley subsidiaries during 1996 resulted in investing cash
inflows of $8.8 million.
Cash inflows from financing activities in 1996, 1995, and 1994, were primarily
associated with deposit growth. Deposits grew $49.3 million in 1996, compared
to an increase of $40.0 million in 1995, and $30.1 million in 1994. Short-term
borrowings resulted in net cash inflows of $20.7 million in 1996, outflows of
$10.6 million in 1995, and inflows of $6.7 million 1994. Cash outflows from
payments on notes payable related to $3,550,000 in debt assumed in the Valley
acquisition, which was repaid, and a $3.0 million advance from the FHLB which
was also repaid. Cash inflows of $14.0 million from proceeds of notes payable
is associated with the financing of the Valley acquisition.
In the event of short-term liquidity needs, the Banks may purchase Federal
funds from correspondent banks. This source is used from time to time on a
limited basis. The Bank may borrow funds from the Federal Reserve Bank of
Chicago, but have not done so during any period covered in this report.
Merchants Bank's membership in the FHLB system gives it the ability to
borrow funds from the FHLB for short or long-term purposes under a variety of
programs.
Asset/Liability Management
Movements in general market interest rates are a key element in changes in
the net interest margin. The impact on earnings of changes in interest rates,
known as interest rate risk, must be measured and managed to avoid
unacceptable levels of risk. This process is aided by analysis of the
interest sensitivity of assets relative to that of liabilities. The Company
uses two approaches to analyze the effect of changes in interest rates on net
interest income and to manage interest rate risk. First, the Company uses
computer simulation to estimate changes in net interest income in response to
various interest rate scenarios. This analysis considers current portfolio
rates, existing maturities, repricing opportunities, and market interest
rates, and accommodates management assumptions regarding anticipated growth
and prepayments. The computer simulation indicates that the balance sheet is
structured such that changes in net interest income in response to changes in
market interest rates would be minimal, all other factors held constant.
Second, interest rate risk is analyzed by examining the extent to which
assets and liabilities are interest rate sensitive. The interest sensitivity
gap is defined as the difference between the amount of interest earning
assets maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that time period.
A gap is considered positive when the amount of interest sensitive assets
exceeds the amount of interest sensitive liabilities. A gap is considered
negative when the amount of interest sensitive liabilities exceeds the amount
of interest sensitive assets. Gap analysis implicitly assumes that all assets
and liabilities would reprice by the same magnitude in the event of a change
in market interest rates. During a period of rising interest rates, a
negative gap would tend to result in a decrease in net interest income while
a positive gap would tend to positively affect net interest income.
The Company's policy is to manage the balance sheet such that fluctuations in
the net interest margin are minimized regardless of the level of interest
rates. Reports to management and the board of directors include both of the
above described analytical approaches. Computer simulation provides a
quantified view of all known or assumed factors, while gap analysis provides an
objective, less analytical, perspective. The Company has positioned its
balance sheet so that the impact of changes in interest rates on the net
interest margin has been minimized to the extent possible.
The table "Analysis of Changes in Interest Income," included under "Interest
Income" in this discussion, demonstrates the effectiveness of interest rate
risk management. During 1996, the change in tax equivalent net interest
income attributable to changes in interest rates was a reduction of $951,000,
or 3.4%, of tax equivalent net interest income of $27.9 million. The change
in tax equivalent net interest income attributable to changes in interest
rates was $524,000 in 1995, or about 2% of the tax equivalent net interest
income of approximately $23.0 million for the year.
The table on page 38 does not necessarily indicate the future impact of
general interest rate movements on the Company's net interest income because
the repricing of certain assets and liabilities is discretionary and is
subject to competitive and other pressures. As a result, assets and
liabilities indicated as repricing within the same period may in fact reprice
at different times and at different rate levels. Assets and liabilities are
reported in the earliest time frame in which maturity or repricing may occur.
Although securities available for sale are reported in the earliest time
frame in which maturity or repricing may occur, these securities may be sold
in response to changes in interest rates or liquidity needs.
Effects of Inflation
Consolidated financial data included herein has been prepared in accordance
with generally accepted accounting principles. Changes in the relative value
of money due to inflation or recession are generally not considered.
37
<PAGE>
In management's opinion, changes in interest rates affect the financial
condition of a financial institution to a far greater degree than changes in
the inflation rate. While interest rates are greatly influenced by changes in
the inflation rate, they do not change at the same rate or in the same
magnitude as the inflation rate. Rather, interest rate volatility is based on
changes in the expected rate of inflation, as well as on changes in monetary
and fiscal policies. A financial institution's ability to be relatively
unaffected by changes in interest rates is a good indicator of its capability
to perform in today's volatile economic environment. The Company seeks to
insulate itself from interest rate volatility by ensuring that rate sensitive
assets and rate sensitive liabilities respond to changes in interest rates in
a similar time frame and to a similar degree.
Pending Accounting Changes
Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities," was issued by the Financial Accounting Standards Board in 1996.
It revises the accounting for transfers of financial assets, such as loans
and securities, and for distinguishing between sales and secured borrowings.
It is effective for some transactions in 1997 and others in 1998. The effect
on the financial statements has not yet been determined.
Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995
This report, including the Chairman's Letter to Stockholders, contains
certain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The Company intends such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Reform Act of 1995, and is
including this statement for purposes of these safe harbor provisions.
Forward-looking statements, which are based on certain assumptions and
describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies
is
- ------------------------------------------------------------------------------
INTEREST SENSITIVITY GAP ANALYSIS (1) (In thousands)
<TABLE>
<CAPTION>
December 31, 1996
-----------------------------------------------------------------
0-3 Mos. 4-12 Mos. 1-5 Years Over 5 Yrs. Total
--------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Earning Assets
Securities. . . . . . . . . . . . . . . . . . . . . $ 29,962 $ 26,104 $ 95,980 $ 42,734 $ 194,780
Federal funds sold. . . . . . . . . . . . . . . . . 2,613 -- -- -- 2,613
Loans held for sale . . . . . . . . . . . . . . . . 4,149 -- -- -- 4,149
Total loans . . . . . . . . . . . . . . . . . . . . 155,758 72,633 180,364 48,047 456,802
---------- ----------- ----------- ---------- ---------
Total Earning Assets. . . . . . . . . . . . . . . . . $ 192,482 $ 98,737 $ 276,344 $ 90,781 $ 658,344
---------- ----------- ----------- ---------- ---------
---------- ----------- ----------- ---------- ---------
Interest-Bearing Liabilities
Interest-bearing deposits:
NOW accounts. . . . . . . . . . . . . . . . . . $ 75,991 $ -- $ -- $ -- $ 75,991
Money market accounts . . . . . . . . . . . . . 58,061 -- -- -- 58,061
Savings . . . . . . . . . . . . . . . . . . . . 67,232 -- -- -- 67,232
Time, $100,000 and over . . . . . . . . . . . . 34,521 22,862 21,831 -- 79,214
Other time. . . . . . . . . . . . . . . . . . . 43,329 58,780 106,160 -- 208,269
---------- ----------- ----------- ---------- ---------
Total interest-bearing deposits . . . . . . .. . . 279,134 81,642 127,991 -- 488,767
Federal funds purchased and securities
sold under repurchase agreements. . . . . . . . 34,794 9,731 -- -- 44,525
Notes payable . . . . . . . . . . . . . . . . . . 7,000 -- 3,500 3,500 14,000
---------- ----------- ----------- ---------- ---------
Total Interest-Bearing Liabilities. . . . . . . . . . $ 320,928 $ 91,373 $ 131,491 $ 3,500 $ 547,292
---------- ----------- ----------- ---------- ---------
---------- ----------- ----------- ---------- ---------
Interest sensitivity gap. . . . . . . . . . . . . . . $ (128,446) $ 7,364 $ 144,853 $ 87,281 $ 111,052
Cumulative gap. . . . . . . . . . . . . . . . . . . . (128,446) (121,082) 23,771 111,052 111,052
Interest sensitivity gap to total assets. . . . . . . -17.73% 1.02% 20.00% 12.05% 15.33%
Cumulative sensitivity gap to total assets. . . . . . -17.73% -16.71 3.28 15.33 15.33
</TABLE>
(1) Callable investment securities are reported at the earlier of maturity or
call date, and prepayments of mortgage-backed securities are assumed to
occur. Loans are placed in the earliest time frame in which maturity or
repricing may occur.
38
<PAGE>
inherently uncertain. Factors which could have a material adverse affect on
the operations and future prospects of the Company and the subsidiaries
include, but are not limited to, changes in: interest rates, general economic
conditions, legislative/regulatory changes, monetary and fiscal policies of
the U.S. Government, including policies of the U.S. Treasury and the Federal
Reserve Board, the quality or composition of the loan or securities
portfolios, demand for loan products, deposit flows, competition, demand for
financial services in the Company's market areas and accounting principles,
policies, and guidelines. These risks and uncertainties should be considered
in evaluating forward-looking statements and undue reliance should not be
placed on such statements. Further information concerning the Company and its
business, including additional factors that could materially affect the
Company's financial results, is included in the Company's filings with the
Securities and Exchange Commission.
39
<PAGE>
MARKET FOR THE COMPANY'S COMMON STOCK
AND RELATED SECURITY HOLDER MATTERS
The Company's common stock trades on the Nasdaq Stock Market under the symbol
"MBIA." Harris Trust and Savings Bank acts as the transfer agent for the
common stock. As of December 31, 1996, the Company had 785 holders of record
of its common stock.
The table below indicates the reported high and low prices and the dividends
paid per share for the common stock during the periods indicated.
<TABLE>
<CAPTION>
High Low Cash Dividends
-------- -------- --------------
<S> <C> <C> <C>
1995 First quarter . . . . . . . . . . . . . $ 24.25 $ 21.50 $ 0.10
Second quarter. . . . . . . . . . . . . 25.75 23.75 0.12
Third quarter . . . . . . . . . . . . . 27.50 24.94 0.12
Fourth quarter. . . . . . . . . . . . . 28.50 26.75 0.12
1996 First quarter . . . . . . . . . . . . . 29.75 27.75 0.12
Second quarter. . . . . . . . . . . . . 33.50 28.00 0.14
Third quarter . . . . . . . . . . . . . 33.50 29.75 0.14
Fourth quarter. . . . . . . . . . . . . 32.00 30.25 0.14
1997 First quarter (through February 26) . . 37.50 31.00 0.14
</TABLE>
The holders of the common stock are entitled to receive dividends as declared
by the board of directors of the Company, which considers payment of
dividends quarterly. The ability of the Company to pay dividends is dependent
upon its receipt of dividends from the Banks. In determining cash dividends,
the Company's board of directors considers the earnings, capital
requirements, debt servicing requirements, financial ratio guidelines
established by the board of directors, financial condition of the Company,
and other relevant factors. The Bank's ability to pay dividends to the
Company and the Company's ability to pay dividends to its stockholders are
also subject to certain regulatory restrictions.
The Company has paid regular quarterly cash dividends on the common stock
since it commenced operations in 1982. The Company currently anticipates that
cash dividends comparable to those that have been paid in the past will
continue to be paid in the future. There can be no assurance, however, that
any such dividends will be paid by the Company or that such dividends will
not be reduced or eliminated in the future. The timing and amount of
dividends will depend upon the earnings, capital requirements, and financial
condition of the Company and the Banks. The Company has a dividend
reinvestment plan which permits stockholders to reinvest cash dividends in
common stock and to purchase additional shares in amounts up to $3,000 per
quarter.
REPORT ON FORM 10-K
A copy of the Company's 1996 Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission, will be furnished without charge to each
stockholder upon written request to: J. Douglas Cheatham, Vice President and
Chief Financial Officer, Merchants Bancorp, Inc., 34 South Broadway, P.O.
Box 289, Aurora, Illinois 60507.
40
<PAGE>
Exhibit 22
LIST OF SUBSIDIARIES
SUBSIDIARIES OF THE CORPORATION
The Merchants National Bank of Aurora, a bank chartered under the laws of
the United States.
Merserco, Inc., a Delaware corporation.
Valley Banc Service Corp., an Illinois corporation.
Hinckley State Bank, an Illinois-chartered Bank.
VBH Corporation, an Iowa corporation.
Fox Valley Bank, an Illinois-chartered Bank.
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement on
Form S-3 of Merchants Bancorp, Inc. to the Merchants Bancorp, Inc. Dividend
Reinvestment and Stock Purchase Plan and in the Registration Statement on Form
S-8 of Merchants Bancorp, Inc. to the Merchants Bancorp, Inc. 1993 Stock
Incentive Plan, of our report dated February 5, 1997 on the Company's 1996
consolidated financial statements included in the Form 10-K of Merchants
Bancorp, Inc. for the year ended December 31, 1996.
Crowe, Chizek and Company LLP
Oak Brook, Illinois
March 25, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 42,455
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 2,613
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 194,780
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 456,802
<ALLOWANCE> 7,274
<TOTAL-ASSETS> 724,409
<DEPOSITS> 600,970
<SHORT-TERM> 44,525
<LIABILITIES-OTHER> 6,716
<LONG-TERM> 14,000
0
0
<COMMON> 2,607
<OTHER-SE> 55,591
<TOTAL-LIABILITIES-AND-EQUITY> 724,409
<INTEREST-LOAN> 36,924
<INTEREST-INVEST> 12,876
<INTEREST-OTHER> 660
<INTEREST-TOTAL> 50,460
<INTEREST-DEPOSIT> 21,912
<INTEREST-EXPENSE> 24,138
<INTEREST-INCOME-NET> 26,322
<LOAN-LOSSES> 2,014
<SECURITIES-GAINS> 196
<EXPENSE-OTHER> 24,865
<INCOME-PRETAX> 8,984
<INCOME-PRE-EXTRAORDINARY> 8,984
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,528
<EPS-PRIMARY> 2.53
<EPS-DILUTED> 2.53
<YIELD-ACTUAL> 4.49
<LOANS-NON> 2,970
<LOANS-PAST> 0
<LOANS-TROUBLED> 359
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5,176
<CHARGE-OFFS> 2,241
<RECOVERIES> 1,527
<ALLOWANCE-CLOSE> 7,274
<ALLOWANCE-DOMESTIC> 7,274
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
