<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period from___________to________
Commission File Number 0 -14484
MERCHANTS BANCORP, INC.
----------------------------------------------------
(Exact name of Registrant as specified in its charter)
DELAWARE 36-3182868
- -------------------------------- --------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
P.O. BOX 289, AURORA, ILLINOIS 60507
----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(630) 896-9000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date: As of November 30, 1998, the
Registrant had outstanding 5,181,071 shares of common stock, $1.00 par value per
share.
<PAGE>
MERCHANTS BANCORP, INC.
Form 10-Q Quarterly Report
Table of Contents
PART I
Page Number
Item 1. Financial Statements...................................................1
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..........................7
PART II
Item 1. Legal Proceedings.....................................................15
Item 2. Changes in Securities.................................................15
Item 3. Defaults Upon Senior Securities.......................................15
Item 4. Submission of Matters to a Vote of Security Holders...................15
Item 5. Other Information.....................................................15
Item 6. Exhibits and Reports on Form 8-K......................................15
Form 10-Q Signature Page......................................................16
<PAGE>
PART I - FINANCIAL INFORMATION
MERCHANTS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
<S> <C> <C>
ASSETS
Cash and due from banks $ 34,710 $ 35,914
Federal funds sold 17,049 7,080
Securities available for sale 192,018 204,761
Loans held for sale 7,039 2,833
Loans 585,985 565,348
Allowance for loan losses (9,185) (8,360)
--------- ---------
Net loans 576,800 556,988
Premises and equipment, net 11,712 11,295
Other real estate owned 395 178
Mortgage servicing rights 2,237 1,674
Goodwill, net 6,491 6,773
Core deposit intangible assets, net 1,768 2,055
Accrued interest and other assets 9,852 9,420
--------- ---------
Total assets $ 860,071 $ 838,971
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 127,366 $ 118,187
Interest-bearing 574,917 532,531
--------- ---------
Total deposits 702,283 650,718
Federal funds purchased and overnight borrowings 12,600 23,100
Securities sold under repurchase agreements 14,105 21,754
Federal Home Loan Bank term advances 42,250 59,750
Notes payable 13,344 14,000
Accrued interest and other liabilities 4,130 4,332
--------- ---------
Total liabilities 788,712 773,654
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value;
Authorized 500,000 shares; none issued - -
Common stock, $1 par value authorized 6,000,000 shares;
issued 5,222,392 in 1998 and 5,213,380 in 1997 5,222 5,213
Surplus 16,272 16,028
Retained earnings 47,124 42,544
Unrealized net gain on securities available for sale 2,832 1,653
Treasury stock, at cost, 41,321 shares in 1998 and
46,910 shares in 1997 (91) (121)
--------- ---------
Total stockholders' equity 71,359 65,317
--------- ---------
Total liabilities and stockholders' equity $ 860,071 $ 838,971
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $ 12,867 $ 11,692 $ 38,177 $ 32,843
Loans held for sale 87 39 278 104
Securities:
Taxable 1,971 2,256 6,231 6,844
Tax-exempt 843 737 2,458 2,139
Federal funds sold 159 43 369 121
-------- -------- ------- --------
Total interest income 15,927 14,767 47,513 42,051
INTEREST EXPENSE
Deposits 6,789 6,159 19,465 17,763
Federal funds purchased and overnight borrowings 327 233 1,127 683
Securities sold under repurchase agreements 167 326 803 882
Federal Home Loan Bank term advances 664 618 2,306 618
Notes payable 236 245 714 724
-------- -------- ------- --------
Total interest expense 8,183 7,581 24,415 20,670
-------- -------- ------- --------
Net interest income 7,744 7,186 23,098 21,381
Provision for loan losses 443 519 1,719 1,702
-------- -------- ------- --------
Net interest income after provision for loan losses 7,301 6,667 21,379 19,679
OTHER INCOME
Trust income 660 587 1,970 1,736
Mortgage banking income 940 638 3,101 1,619
Service charges and fees 1,115 1,079 3,106 3,142
Securities gains (losses), net 0 (239) 96 (192)
Other income 388 386 920 869
-------- -------- ------- --------
Total other income 3,103 2,451 9,193 7,174
OTHER EXPENSE
Salaries and employee benefits 3,951 3,454 11,496 10,248
Occupancy expense, net 499 522 1,558 1,436
Furniture and equipment expense 564 454 1,680 1,301
Amortization of goodwill 94 91 282 275
Amortization of core deposit intangible assets 96 99 287 298
Other expense 2,213 2,016 6,654 6,071
-------- -------- ------- --------
Total other expense 7,417 6,636 21,957 19,629
-------- -------- ------- --------
Income before income taxes 2,987 2,482 8,615 7,224
Provision for income taxes 842 646 2,404 1,900
-------- -------- ------- --------
Net income $ 2,145 $ 1,836 $ 6,211 $ 5,324
-------- -------- ------- --------
-------- -------- ------- --------
Basic earnings per share $ 0.41 $ 0.36 $ 1.20 $ 1.03
Diluted earnings per share $ 0.41 $ 0.35 $ 1.18 $ 1.02
</TABLE>
2
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income $2,145 $1,836 $6,211 $5,324
Change in net unrealized gains on securities 1,232 698 1,179 658
------ ------- ------ ------
Comprehensive income $3,377 $2,534 $7,390 $5,982
------ ------- ------ ------
------ ------- ------ ------
</TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 1998 and 1997
(In thousands)
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 6,211 $ 5,324
Adjustments to reconcile net income to cash from operating activities:
Depreciation 1,464 1,286
Amortization of mortgage servicing rights 557 288
Provision for loan losses 1,719 1,702
Net change in mortgage loans held for sale (3,574) 1,712
Net gain on sales of loans (1,752) (310)
Change in net income taxes payable (42) (1,126)
Change in accrued interest and other assets (432) (2,176)
Change in accrued interest and other liabilities (767) (2,199)
Premium amortization and discount accretion on securities 196 43
Securities losses (gains), net (96) 192
Amortization of goodwill 282 275
Amortization of core deposit intangible assets 287 298
------- -------
Net cash from operating activities 4,053 5,309
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from matured securities available for sale 47,677 27,248
Proceeds from sales of securities available for sale 14,134 14,375
Purchases of securities available for sale (47,382) (43,447)
Net principal disbursed or repaid on loans (21,606) (71,907)
Proceeds from sales of other real estate (142) 116
Property and equipment expenditures (1,881) (1,073)
------- -------
Net cash from investing activities (9,200) (74,688)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 51,565 43,402
Net change in short term borrowings (18,149) (18,629)
Proceeds from Federal Home Loan Bank term advances - 47,250
Payments on Federal Home Loan Bank term advances (17,500) -
Payments on notes payable (656) -
Proceeds from exercise of incentive stock options 111 -
Dividends paid, net of dividend reinvestments (1,459) (1,175)
------- -------
Net cash from financing activities 13,912 70,848
------- -------
Net change in cash and cash equivalents 8,765 1,469
Cash and cash equivalents at beginning of period 42,994 45,068
------- -------
Cash and cash equivalents at end of period $ 51,759 $ 46,537
------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(TABLE AMOUNTS IN THOUSANDS)
NOTE 1: BASIS OF PRESENTATION
The financial information of Merchants Bancorp, Inc. (the "Company") included
herein is unaudited; however, such information reflects all adjustments
(consisting of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair statement of results for the interim
periods. The results of the interim periods ended September 30, 1998 are not
necessarily indicative of the results expected for the year ending
December 31, 1998.
Under a new accounting standard, comprehensive income is now reported for all
periods. Comprehensive income includes both other income and other
comprehensive income. Other comprehensive income includes the change in
unrealized gains and losses on securities available for sale.
NOTE 2: SECURITIES
Securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
September 30, 1998:
U.S. Treasury $ 4,016 $ 74 $ -- $ 4,090
U.S. Government agencies 90,353 1,385 -- 91,738
U.S. Government agency
mortgage backed securities 18,382 185 (28) 18,539
States and political subdivisions 66,287 2,766 (8) 69,045
Collateralized mortgage obligations 4,683 30 (8) 4,705
Other securities 4,006 - (105) 3,901
----------- ----------- ----------- ---------
$ 187,727 $ 4,440 $ (149) $ 192,018
----------- ----------- ----------- ---------
----------- ----------- ----------- ---------
December 31, 1997:
U.S. Treasury $ 14,063 $ 48 $ (19) $ 14,092
U.S. Government agencies 85,973 405 (124) 86,254
U.S. Government agency
mortgage backed securities 25,886 281 (75) 26,092
States and political subdivisions 60,840 2,176 (35) 62,981
Collateralized mortgage obligations 8,319 45 (54) 8,310
Equity securities 7,172 - (140) 7,032
----------- ----------- ----------- ---------
$ 202,253 $ 2,955 $ (447) $ 204,761
----------- ----------- ----------- ---------
----------- ----------- ----------- ---------
</TABLE>
4
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 3: LOANS
Major classifications of loans are as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- -----------
<S> <C> <C>
Commercial and industrial $ 166,126 $ 168,899
Real estate - commercial 87,692 95,755
Real estate - construction 83,986 69,901
Real estate - residential 132,931 122,732
Installment 107,953 100,869
Credit card receivables 8,018 8,100
Other loans 574 813
------------- -----------
587,280 567,069
Unearned discount (989) (1,324)
Deferred loan fees (306) (397)
------------- -----------
Total loans $ 585,985 $ 565,348
------------- -----------
------------- -----------
</TABLE>
NOTE 4: ALLOWANCE FOR LOAN LOSSES
Allowance for loan losses as of September 30, is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -----------
<S> <C> <C>
Balance, January 1 $ 8,360 $ 7,274
Provision for loan losses 1,719 1,184
Loans charged-off (1,345) (959)
Recoveries 451 276
------------- -----------
Balance, end of period $ 9,185 $ 7,775
------------- -----------
------------- -----------
</TABLE>
NOTE 5: EMPLOYEE BENEFIT PLANS
Prior to 1997, the Company maintained a noncontributory pension plan covering
substantially all full-time employees of the Company and Merchants National
Bank who had 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. During 1997, plan participants
were given the option to receive their vested benefits under the plan in the
form of lump sums, annuities, or rollovers to either the Company's Employee
Contributory Thrift Plan (the "Thrift Plan") or to an individual retirement
account. In addition, 25% of the excess assets remaining in the plan after
the vested benefits were paid were transferred to the Thrift Plan, a
"qualified benefit plan," as allowed in the Internal Revenue Code of 1986. As
of December 31, 1997, all vested benefit obligations had been settled and the
transfer to the Thrift Plan had been completed.
As a result of the termination and amendment of the plan, at December 31,
1997 the Company has recorded a receivable and income of approximately
$214,000 and accrued an excise tax liability of approximately $43,000, which
were received and paid in January 1998. No pension cost was recorded in 1997.
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. The Company contributes an amount determined by the Board of
Directors to all eligible participants. 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 $708,000, and $613,000 for the nine months ended
September 30, 1998, and 1997.
5
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 6: BORROWINGS
Merchants National Bank's membership in the Federal Home Loan Bank ("FHLB")
System gives it the ability to borrow funds from the FHLB of Chicago for short
or long-term purposes under a variety of programs. The Company has pledged first
mortgage loans on residential property in an amount equal to at least 167% of
the outstanding advances. An open-line advance of $12.5 million is included in
overnight borrowings as of September 30, 1998.
Notes payable consists of two notes of $7 million each, the proceeds of which
were used to finance the acquisition of Valley Banc Services Corp. ("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. A fixed rate
note bears interest at a rate of 7.03%.
NOTE 7: EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Weighted-average common shares outstanding 5,180,453 5,163,302 5,174,254 5,160,782
Net income available to common stockholders $ 2,145 $ 1,836 $ 6,211 $ 5,324
Basic earnings per share $ 0.41 $ 0.36 $ 1.20 $ 1.03
Diluted Earnings Per Share:
Weighted-average common shares outstanding 5,180,453 5,163,302 5,174,254 5,160,782
Dilutive effect of stock options 66,657 53,345 69,722 37,506
---------- ---------- ---------- ----------
Diluted average common shares outstanding 5,247,110 5,216,647 5,243,976 5,198,288
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income available to common stockholders $ 2,145 $ 1,836 $ 6,211 $ 5,324
Diluted earnings per share $ 0.41 $ 0.35 $ 1.18 $ 1.02
</TABLE>
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the third quarter of 1998 was $2,145,000, or diluted earnings
per share of 41 cents, a 16.8% increase in net income compared to $1,836,000,
or 35 cents per share, in the third quarter of 1997. The increase in net
income for the quarter was primarily a result of increases in net interest
income and mortgage banking income, offset by an increase in noninterest
income. During the nine months ended September 30, 1998, net income was
$6,211,000, or diluted earnings per share of $1.18, compared to $5,324,000,
or $1.02 per share, during the first nine months of 1997. This 16.7% increase
in net income for the nine month period was attributable to an increase in
net interest income of $1,717,000, or 8.0%, and an increase in noninterest
income of $2,019000, or 28.1%, while noninterest expenses increased
$2,328,000, or 11.9%.
NET INTEREST INCOME
Net interest income was $7.744 million and $7.186 million during the three
months ended September 30, 1998 and 1997, an increase of 7.8%. The Company's
net interest margin was 4.15% for the three months ended September 30, 1998,
and 4.20% a year earlier. Net interest income was $23.1 million and $21.4
million during the nine months ended September 30, 1998 and 1997, an increase
of 8.0%. The Company's net interest margin was 4.18% for the nine months
ended September 30, 1998, and 4.41% a year earlier. The decline in this ratio
has resulted from a decline in average earning asset yields which exceeded
the decline in the average cost of funds. Continued historically low interest
rates have resulted in a decline in the average yield on earning assets from
8.38% in the third quarter of 1997, to 8.25% in the third quarter of 1998. At
the same time, the average cost of funds has risen from 4.17% in the third
quarter of 1997 to 4.10% in the third quarter of 1998. For both the third
quarter and the year to date, interest bearing sources of funds, such as
borrowed funds and certificates of deposit, have grown faster than
noninterest deposits.
OTHER INCOME
Noninterest income was $3,103,000 during the third quarter of 1998 and
$2,451,000 in the third quarter of 1997, an increase of $652,000, or 26.6%.
Noninterest income was $9,193,000 during the nine months ended September 30,
1998 and $7,174,000 during the nine months ended September 30, 1997, an
increase of $2,019,000, or 28.1%. Mortgage banking income was the primary
source of the increase in noninterest income for the third quarter and the
nine-month period. Mortgage banking income was $940,000 in the third quarter
of 1998 and $638,000 in the third quarter of 1997, an increase of $302,000,
or 47.3%. During the first nine months of the year, mortgage banking income
was $3,101,000 in 1998 and $1,619,000 in 1997, an increase of $1,482,000, or
91.5%. Mortgage banking income is seasonal and is also sensitive to interest
rate levels and expectations. Most fixed rate mortgages that the Company
originates are sold and the servicing is retained. The portfolio of loans
serviced for others totaled $311 million as of September 30, 1998 compared to
$267 million a year earlier.
Trust income of $660,000 in the third quarter of 1998 was $73,000, or 12.4%
higher than the third quarter 1997 level. For the nine months ended September
30, 1998, trust income was $1,970,000, compared to $1,736,000 in the nine
months ended September 30, 1997, an increase of $234,000, or 13.5%. Service
charges and fees increased $36,000 (3.3%) from $1,079,000 in the third
quarter of 1997, to $1,115,000 in the third quarter of 1998. Service charges
and fees were $3,106,000 in the nine months ended September 30, 1998,
compared to $3,142,000 in the nine months ended September 30, 1997, a decline
of $36,000, or 1.1%. There were no significant changes in the fee structure
for deposit accounts.
Sales of securities available for sale resulted in gains of $96,000 in the
first nine months of 1998, of which none occurred in the third quarter. In
1997, securities losses were $192,000 in the first nine months, and $239,000
in the third quarter. Securities available for sale are held for indefinite
periods of time, and include securities that will be used as a part of the
Company's asset/liability management strategy. Such securities may be sold in
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
response to changes in interest rates, liquidity needs, or significant
prepayment risk.
OTHER EXPENSE
Salary and benefit expenses increased from $3.454,000 during the three months
ended September 30, 1997, to $3,951,000 for the same period in 1998, an
increase of $497,000 (14.4%). Salaries and benefits were $11,496,000 and
$10,248,000 during the nine months ended September 30, 1998 and 1997, an
increase of $1,248,000 (12.2%). The full-time equivalent number of employees
was 344 as of September 30, 1998, and 333 as of September 30, 1997.
Commissions were $348,000 in the third quarter of 1998, compared with
$257,000 in the third quarter of 1997. During the nine months ended September
30, commissions were $967,000 in 1998 and $651,000 in 1997, a $316,000
(48.5%) increase. Most of the increase in commissions was directly associated
with the increase in mortgage banking activity.
Occupancy expenses of $499,000 during the third quarter of 1998 were $23,000
(4.4%) lower than in the third quarter of 1997. Occupancy expenses were
$1,558,000 in the nine months ended September 30, 1998, a $122,000 (8.5%)
increase. Furniture and equipment expenses were $110,000 (24.2%) higher
during the third quarter of 1998, and 379,000 (29.1%) higher for the nine
months ended September 30, 1998, compared to the same periods in 1997. Most
of the increases in both occupancy and furniture and equipment expenses were
the result of moving to a new administration center in late 1997, and the
move of the commercial banking department of Merchants National Bank from the
downtown location to the West Plaza Branch location in 1998. Other capital
purchases involving computer and related equipment also contributed to the
increased costs.
Other expenses were $2,213,000, or $197,000 (9.8%) higher in the third
quarter of 1998, than in the third quarter of 1997. Other expenses were
$6,654,000 and $6,071,000 during the nine months ended September 30, 1998 and
1997, an increase of $583,000 (9.6%). For the nine month period ended
September 30, other expenses in the mortgage banking area were $3,206,000, an
increase of $1,125,000 compared to the first nine months of 1997. The
increase in mortgage expenses was associated with the $1,482,000 increase in
noninterest mortgage banking income for the nine month period, discussed
above, and an 8.3% increase in the residential mortgage portfolio during the
first nine months of 1998. These expenses included volume-related expenses
such as credit reports, appraisals and correspondent mortgage fees. Other
expenses outside of the mortgage department declined when comparing the first
nine months of 1998 to the first nine months of 1997.
FINANCIAL CONDITION
LOANS, LOANS HELD FOR SALE, AND PROVISION FOR LOAN LOSSES
Total loans increased $20.6 million (3.7%) to $586.0 million as of September
30, 1998, from $565.3 million as of December 31, 1997. Commercial loans
decreased to $166.1 million as of September 30, 1998, from $168.9 million as
of December 31, 1997, a $2.8 million (1.6%) decrease. Commercial real estate
loans decreased to approximately $87.7 million as of September 30, 1998, from
$95.8 million as of December 31, 1997, declining $8.1 million (8.4%) as
repayments were received on loans. Construction loans increased $14.1 million
(20.1%) to $84.0 million as of September 30, 1998. Residential real estate
loans increased $10.2 million (8.3%), to $132.9 million, from $122.7 million
as of December 31, 1997. Residential real estate loans are primarily
adjustable rate mortgages. These increases reflect the continued strength of
the Fox Valley economy, the low interest rate environment, and the strong
real estate market.
Most of the residential mortgage loans originated by the Company's mortgage
banking department are sold in the secondary market, with servicing rights
retained. A portion of the loans originated, typically adjustable rate
mortgages, are retained in Merchants National Bank's portfolio, as reflected
in the increase in residential real estate loans. At any point in time, loans
will be at various stages of the mortgage banking process. Loans held
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
for sale were $7.0 million as of September 30, 1998, and $2.8 million as of
December 31, 1997. The carrying value of these loans approximated the market
value at that time.
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 judgement, 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.
Provisions for loan losses were $443,000 in the third quarter of 1998 and
$519,000 in the third quarter of 1997. Net charge-offs for the three months
ended September 30, were $180,000 and $423,000 in 1998 and 1997. Provisions for
loan losses were $1,719,000 in the nine months ended September 30, 1998 and
$1,702,000 in the nine months ended September 30, 1997. Net charge-offs for the
nine months ended September 30, were $894,000 and $1,105,000 in 1998 and 1997.
The decrease in the provision for loan losses in 1998 was closely tied to the
slower loan growth in 1998, compared to the loan growth in 1997. One measure of
the adequacy of the allowance for loan losses is the ratio of the allowance to
total loans. Although some decline in the ratio is natural when loan volume
increases substantially, additional provisions have been made to ensure that an
adequate level has been maintained. The allowance for loan losses as a
percentage of total loans was 1.57% as of September 30, 1998 and 1.49% as of
September 30, 1997. In management's judgment, an adequate allowance for possible
future losses has been established.
Nonaccrual loans increased to $6,142,000 as of September 30, 1998, from
$4,623,000 as of December 31, 1997. The change in nonaccrual loans was primarily
associated with a single collateralized commercial loan. Nonaccrual loans
principally consist of loans that are well-collateralized and are not expected
to result in material losses. There were no loans past due ninety days or more
and still accruing interest as of either September 30, 1998, or December 31,
1997. Other real estate owned increased from $178,000 as of December 31, 1997,
to $395,000 as of September 30, 1998, as some property was transferred from the
loan portfolio. The recorded values of these properties were supported by
current appraisals.
SECURITIES
Securities are classified as available for sale if they may be sold as part of
the Company's asset/liability management strategy in response to changes in
interest rates, liquidity needs, or significant prepayment risk. Securities
available for sale are carried at fair value, with related unrealized net gains
or losses, net of deferred income taxes, recorded as an adjustment to equity
capital. As of September 30, 1998, net unrealized gains of $4,291,000, reduced
by deferred income taxes of $1,459,000, resulted in an increase in equity
capital of $2,832,000. As of December 31, 1997, net unrealized gains of
$2,508,000, net of deferred income taxes of $855,000, resulted in an increase in
equity capital of $1,653,000.
The fair value of securities available for sale decreased $12.8 million (6.2%)
during the first nine months of 1998, to $192.0 million as of September 30,
1998, from $204.8 million as of December 31, 1997. U.S. Treasury securities
declined from $14.1 million as of December 31, 1997, to $4.1 million as of
September 30, 1998, a 71.1% decline which was primarily associated with a
matured repurchase agreement. U.S. government agency securities increased from
$86.3 million as of December 31, 1997, to $91.7 million as of September 30,
1998, an increase of $4.4 million (5.1%). U.S. government agency mortgage backed
securities declined $7.5 million (29.0%), from $26.1 million as of December 31,
1997, to $18.5 million as of September 30, 1998. The size of the portfolio
declined as funds were redirected to fund loan growth and to offset a reduction
in borrowed funds.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
DEPOSITS AND BORROWED FUNDS
Total deposits of $702.3 million as of September 30, 1998, represented an
increase of $51.6 million (7.9%) from $650.7 million as of December 31, 1997.
Noninterest-bearing deposits were $127.4 million as of September 30, 1998, an
increase of $9.2 million (7.8%) from $118.2 million as of December 31, 1997.
At the same time, interest-bearing deposits increased $42.4 million (8.0%).
There were no significant changes in deposit structure or management's
strategies in acquiring deposits in the first nine months of 1998.
The Company also utilizes securities sold under repurchase agreements as a
source of funds. Most local municipalities, and some other organizations,
must have funds insured or collateralized as a matter of their own policies.
Repurchase agreements provide a source of funds and do not increase the
Company's reserve requirement. Although the balance of repurchase agreements
is subject to variation, particularly seasonal variation, the account
relationships represented by these balances are principally local and have
been maintained for relatively long periods of time.
During the nine months ended September 30, 1998, Merchants repaid $17.5
million in term advances from the FHLB to reduce FHLB term advances to $32.3
million at September 30, 1998. The FHLB Open-Line, which is included in
Federal fund sold and overnight borrowings, was $12.5 million as of
September 30, 1998.
CAPITAL RESOURCES
The Company completed a two-for-one split of its common stock during the
third quarter of 1997. The split was in the form of a stock dividend and was
payable on September 30, 1997, to the stockholders of record at the close of
business on September 15, 1997.
The Company and its three subsidiary banks (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 overall 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.
The Company and the Banks were categorized as well capitalized as of
September 30, 1998. 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.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
Capital levels and minimum required levels (dollars 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>
September 30, 1998:
Total capital to risk weighted assets
Consolidated $68,133 10.92% $49,918 8.00% $62,398 10.00%
Merchants National Bank 60,551 11.32% 42,808 8.00% 53,510 10.00%
Tier 1 capital to risk weighted assets
Consolidated 60,222 9.65% 24,959 4.00% 37,439 6.00%
Merchants National Bank 53,845 10.06% 21,404 4.00% 32,106 6.00%
Tier 1 capital to average assets
Consolidated 60,222 7.19% 33,501 4.00% 41,877 5.00%
Merchants National Bank 53,845 7.67% 28,067 4.00% 35,084 5.00%
December 31, 1997:
Total capital to risk weighted assets
Consolidated 63,285 10.42% 48,594 8.00% 60,743 10.00%
Merchants National Bank 56,965 10.89% 41,842 8.00% 52,303 10.00%
Tier 1 capital to risk weighted assets
Consolidated 55,583 9.15% 24,297 4.00% 36,446 6.00%
Merchants National Bank 50,415 9.64% 20,921 4.00% 31,382 6.00%
Tier 1 capital to average assets
Consolidated 55,583 6.91% 32,166 4.00% 40,207 5.00%
Merchants National Bank 50,415 7.44% 27,097 4.00% 33,871 5.00%
</TABLE>
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.
Net cash outflows from investing activities were $9.2 million in the nine months
ended September 30, 1998, compared to $74.7 million a year earlier. In the first
nine months of 1998, net principal disbursed on loans accounted for net outflows
of $21.6 million, and securities transactions aggregated a net inflow of $14.4
million. In the first nine months of 1997, net principal disbursed or repaid on
loans accounted for a net outflow of $71.9 million, and securities transactions
resulted in net outflows of $1.8 million.
Cash inflows from financing activities in the first nine months of 1998
associated with an increase in deposits were $13.9 million. This compares with a
net inflow of $70.8 million for the same period in 1997. Short-term borrowings
resulted in net cash outflows of $18.1 million in the first nine months of 1998,
and outflows of $18.6 million in the first nine months of 1997. FHLB term
advances declined $17.5 million in the first nine months of 1998, and increased
$47.25 million in the first nine months of 1997.
In the event of short-term liquidity needs, the Banks may purchase Federal funds
from correspondent banks. The Merchants National Bank may also borrow funds from
the Federal Reserve Bank of Chicago. The Merchants National Bank's membership in
the FHLB System gives it the ability to borrow funds from the FHLB of Chicago
for short or long term purposes under a variety of programs. Merchants National
Bank had term advances of $42.25 million outstanding as of September 30, 1998.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
Origination of mortgage loans held for sale resulted in operating net cash
outflows of $5.3 million during the first nine months of 1998, compared to
inflows of $1.4 million in 1997. Total cash outflows from operating activities
exceeded operating outflows by $4.1 million during the nine months ended
September 30, 1998. During the nine months ended September 30, 1997, net cash
inflows from operating activities were $5.3 million. Interest received net of
interest paid was a principal source of operating cash inflows in both 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.
RECENT REGULATORY DEVELOPMENTS/YEAR 2000
The federal banking regulators recently issued guidelines establishing
minimum safety and soundness standards for achieving Year 2000 compliance.
The guidelines, which took effect October 15, 1998 and apply to all
FDIC-insured depository institutions, establish standards for developing and
managing Year 2000 project plans, testing remediation efforts and planning
for contingencies. The guidelines are based upon guidance previously issued
by the agencies under the auspices of the Federal Financial Institutions
Examination Council (the "FFIEC"), but are not intended to replace or
supplant the FFIEC guidance which will continue to apply to all federally
insured depository institutions.
The guidelines were issued under section 39 of the Federal Deposit Insurance
Act, as amended (the "FDIA"), which requires the federal banking regulators
to establish standards for the safe and sound operation of federally insured
depository institutions. Under section 39 of the FDIA, if an institution
fails to meet any of the standards established in the guidelines, the
institution's primary federal regulator may require the institution to submit
a plan for achieving compliance. If an institution fails to submit an
acceptable compliance plan, or fails in any material respect to implement a
compliance plan that has been accepted by its primary federal regulator, the
regulator is required to issue an order directing the institution to cure the
deficiency. Such an order is enforceable in court in the same manner as a
cease and desist order. Until the deficiency cited in the regulator's order
is cured, the regulator may restrict the institution's rate of growth,
require the institution to increase its capital, restrict the rates the
institution pays on deposits or require the institution to take any action
the regulator deems appropriate under the circumstances. In addition to the
enforcement procedures established in section 39 of the FDIA, noncompliance
with the standards established by the guidelines may also be grounds for
other enforcement action by the federal banking regulators, including cease
and desist orders and civil money penalty assessments.
The Year 2000 has posed a unique set of challenges to those industries
reliant on information technology. As a result of methods employed by earlier
programmers, many software applications and operational programs may be
unable to distinguish the Year 2000 from the Year 1900. If not effectively
addressed, this problem could result in the production of inaccurate data,
or, in the worst cases, the inability of the systems to continue to function
altogether. Financial institutions are particularly vulnerable during the
industry's dependence on electronic data processing systems.
In early 1997, the Company began developing their Year 2000 Plan, following
the guidelines established by the FFIEC. The plan was approved by the Board
of Directors of the Company and reviewed by the Office of the Comptroller of
the Currency. An integral part of the plan was to utilize the Company's
Technology Planning Committee, which is comprised of representatives from the
key areas throughout the organization. The each area must identify, for the
Committee, issues related to the Year 2000 and initiate remedial measures
designed to eliminate any adverse effects on the Company's operations. The
Committee reviews all Year 2000 related issues and the progress toward
implementation of the plan. The Committee has developed a comprehensive,
prioritized inventory of all hardware, software, and material third party
providers that may be adversely affected by the Year 2000 date change, and
has contacted vendors requesting their status as it relates to the Year 2000.
This inventory includes both information technology ("IT") and non-IT
systems, such as alarms, building access, elevators and
12
<PAGE>
heating and cooling systems, which typically contain embedded technology such
as microcontrollers. This inventory is periodically reevaluated to ensure
that previously assigned priorities remain accurate and to track the progress
each vendor is making in resolving the problems associated with the issue.
The Company relies on software purchased from third-party vendors rather than
internally-generated software. The Company is currently in the process of
upgrading systems and testing to validate Year 2000 compliance. The Company
expects to have all mission critical systems renovated and tested prior to
March 31, 1999. The Company is currently operating on the Year 2000 compliant
releases for core systems supported by its third party data processor.
The Technology Planning Committee has also developed a communication plan
that updates the Board of Directors, management, and employees on the
Company's Year 2000 status. In addition, the Committee has developed a
separate plan in order to manage the Year 2000 risks posed by commercial
borrowing customers. This plan will identify material loan customers, assess
their preparedness, evaluate their credit risk to the Company, and implement
appropriate controls to mitigate the risk.
In accordance with regulatory guidelines, the Company is developing a
comprehensive contingency plan, which will be completed by December 31, 1998, in
the event that Year 2000 related failures are experienced. The plan lists the
various strategies and resources available to restore core business process.
These strategies include relying on back-up systems that do not utilize
computers and, in some cases, switching vendors. In the case of utility
providers, the Company is researching the alternative of utilizing an electric
power generator at it's main processing facility.
Management anticipates that the total out-of-pocket expenditures required for
bringing the systems into compliance for the Year 2000 will be approximately
$100,000, of which approximately one half has been expended through
September 30, 1998. Management believes that these required expenditures will
not have a material adverse impact on operations, cash flow, or financial
condition. This amount, including costs for upgrading equipment specifically
for the purpose of Year 2000 compliance, fees to outside consulting firms, and
certain administrative expenditures, has been provided for in the Company's
Year 2000 budget. Although management is confident that the Company has
identified all necessary upgrades, and budgeted accordingly, no assurance can
be made that Year 2000 compliance can be achieved without additional
unanticipated expenditures. It is not possible at this time to quantify the
estimated future costs due to business disruption caused by vendors, suppliers,
customers or even the possible loss of electric power or telephone service;
however, such costs could be substantial. As a result of the Year 2000 project,
the Company has not had any material delay regarding its information systems
projects.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report 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
inherently uncertain. Factors which could have a material adverse affect on the
operations and future prospects of the Company and its 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 investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area 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
13
<PAGE>
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.
SENSITIVITY TO MARKET RISK
The impact of movements in general market interest rates on a financial
institution's financial condition, including capital adequacy, earnings, and
liquidity, is known as interest rate risk. Interest rate risk is the
Company's primary market risk. As a financial institution, accepting and
managing this risk is an inherent aspect of the Company's business. However,
safe and sound management of interest rate risk requires that it be
maintained at prudent levels.
The Company's interest rate risk exposure is reviewed by management and the
board of directors. 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. 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. In the following table, deposits that do not have specified maturities
are assumed to have a 15% decay rate. Loans, which include loans held for
sale, represent management judgements regarding prepayment. The following
table presents the expected maturity of interest-earning assets and
interest-bearing liabilities as of September 30, 1998.
EXPECTED MATURITY OF INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
<TABLE>
<CAPTION>
Expected Maturity Dates
---------------------------------------------------------------------------- Fair
1 Year 2 Years 3 Years 4 Years 5 Years Thereafter Total Value
<S> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Fixed rate loans $ 98,352 $ 44,601 $ 51,673 $ 48,972 $ 65,066 $ 20,809 $329,473 $333,591
Average interest rate 10.22% 8.92% 8.69% 8.87% 8.26% 7.66%
Adjustable Rate Loans $141,016 $ 30,167 $ 25,019 $ 21,646 $ 20,621 $ 18,043 $256,512 $256,512
Average interest rate 8.66% 8.55% 9.26% 8.97% 8.55% 7.61%
Securities $ 51,623 $ 46,661 $ 21,045 $ 22,321 $ 20,417 $ 29,951 $192,018 $192,018
Average interest rate 6.50% 6.34% 6.22% 6.30% 6.04% 6.10%
Federal Funds Sold $ 17,049 $ - $ - $ - $ - $ - $ 17,049 $ 17,049
Average interest rate 5.75%
--------- -------- -------- -------- -------- -------- -------- --------
Total $308,040 $121,429 $ 97,737 $ 92,939 $106,104 $ 68,803 $795,052 $799,170
--------- -------- -------- -------- -------- -------- -------- --------
--------- -------- -------- -------- -------- -------- -------- --------
INTEREST-BEARING LIABILITIES
Interest-bearing deposits $261,030 $101,788 $ 43,923 $ 32,416 $ 33,088 $102,672 $574,917 $577,792
Average interest rate 5.19% 5.59% 4.26% 4.05% 4.29% 3.00%
Borrowed Funds $ 14,980 $ 13,375 $ 13,375 $ 5,625 $ 13,375 $ 8,969 $ 69,699 $ 70,239
Average interest rate 5.39% 5.85% 6.03% 6.32% 5.93% 6.90%
--------- -------- -------- -------- -------- -------- -------- --------
Total $276,010 $115,163 $ 57,298 $ 38,041 $ 46,463 $111,641 $644,616 $648,031
--------- -------- -------- -------- -------- -------- -------- --------
--------- -------- -------- -------- -------- -------- -------- --------
</TABLE>
14
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
or its subsidiaries are a party other than ordinary routine litigation
incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
27. Financial Data Schedule
Reports on Form 8-K
None
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCHANTS BANCORP, INC.
(Registrant)
/s/ Calvin R. Myers
---------------------------------------
Calvin R. Myers
President, Chairman of the Board and
Chief Executive Officer
/s/ J. Douglas Cheatham
---------------------------------------
J. Douglas Cheatham
Vice President and Chief Financial Officer
Date: November 13, 1998
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 34,710
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 17,049
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 192,018
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 585,985
<ALLOWANCE> 9,185
<TOTAL-ASSETS> 860,071
<DEPOSITS> 702,283
<SHORT-TERM> 26,705
<LIABILITIES-OTHER> 4,130
<LONG-TERM> 55,594
0
0
<COMMON> 5,222
<OTHER-SE> 66,137
<TOTAL-LIABILITIES-AND-EQUITY> 860,071
<INTEREST-LOAN> 38,177
<INTEREST-INVEST> 8,689
<INTEREST-OTHER> 647
<INTEREST-TOTAL> 47,513
<INTEREST-DEPOSIT> 19,465
<INTEREST-EXPENSE> 24,415
<INTEREST-INCOME-NET> 23,098
<LOAN-LOSSES> 1,719
<SECURITIES-GAINS> 96
<EXPENSE-OTHER> 21,957
<INCOME-PRETAX> 8,615
<INCOME-PRE-EXTRAORDINARY> 6,211
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,211
<EPS-PRIMARY> 1.20
<EPS-DILUTED> 1.18
<YIELD-ACTUAL> 4.18
<LOANS-NON> 6,142
<LOANS-PAST> 0
<LOANS-TROUBLED> 442
<LOANS-PROBLEM> 6,584
<ALLOWANCE-OPEN> 8,360
<CHARGE-OFFS> 1,345
<RECOVERIES> 451
<ALLOWANCE-CLOSE> 9,185
<ALLOWANCE-DOMESTIC> 9,185
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>