<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 June 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 June 30,
1998, the Registrant had outstanding 5,179,237 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. . . . . . . . . . .9
PART II
ITEM 1. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . . . 17
ITEM 2. CHANGES IN SECURITIES. . . . . . . . . . . . . . . . . . . . . . 17
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. . . . . . . . . . . . . . . . . 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . 17
ITEM 5. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . . . . 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . 17
FORM 10-Q SIGNATURE PAGE . . . . . . . . . . . . . . . . . . . . . . . . . 18
<PAGE>
PART I - FINANCIAL INFORMATION
MERCHANTS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
<S> <C> <C>
ASSETS
Cash and due from banks $43,594 $35,914
Federal funds sold 6,658 7,080
Securities available for sale 189,187 204,761
Loans held for sale 7,088 2,833
Loans 581,894 565,348
Allowance for loan losses (8,922) (8,360)
-------- ---------
Net loans 572,972 556,988
Premises and equipment, net 11,754 11,295
Other real estate owned 190 178
Mortgage servicing rights 2,109 1,674
Goodwill, net 6,585 6,773
Core deposit intangible assets, net 1,863 2,055
Accrued interest and other assets 9,350 9,420
-------- --------
Total assets $851,350 $838,971
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $125,274 $118,187
Interest-bearing 553,168 532,531
-------- --------
Total deposits 678,442 650,718
Federal funds purchased and overnight borrowings 21,600 23,100
Securities sold under repurchase agreements 13,081 21,754
Federal Home Loan Bank term advances 54,750 59,750
Notes payable 13,563 14,000
Accrued interest and other liabilities 1,468 4,332
------- -------
Total liabilities 782,904 773,654
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 16,226 16,028
Retained earnings 45,499 42,544
Unrealized net gain on securities available for sale 1,600 1,653
Treasury stock, at cost, 43,155 shares in 1998 and
46,910 shares in 1997 (101) (121)
--------- --------
Total stockholders' equity 68,446 65,317
--------- --------
Total liabilities and stockholders' equity $851,350 $838,971
--------- --------
--------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $12,563 $11,019 $25,310 $21,151
Loans held for sale 102 23 191 65
Securities:
Taxable 2,092 2,310 4,260 4,588
Tax-exempt 817 729 1,615 1,402
Federal funds sold 127 40 210 78
------- ------- ------- -------
Total interest income 15,701 14,121 31,586 27,284
INTEREST EXPENSE
Deposits 6,389 5,962 12,676 11,604
Federal funds purchased and overnight borrowings 327 256 800 450
Securities sold under repurchase agreements 335 276 636 556
Federal Home Loan Bank term advances 821 0 1,642 0
Notes payable 235 242 478 479
------- ------- ------- -------
Total interest expense 8,107 6,736 16,232 13,089
------- ------- ------- -------
Net interest income 7,594 7,385 15,354 14,195
Provision for loan losses 393 697 1,276 1,183
------- ------- ------- -------
Net interest income after provision for loan
losses 7,201 6,688 14,078 13,012
OTHER INCOME
Trust income 660 597 1,310 1,149
Mortgage banking income 1,212 489 2,161 981
Service charges and fees 1,023 1,068 1,991 2,063
Securities gains (losses), net 20 5 96 47
Other income 301 251 532 483
------- ------- ------- -------
Total other income 3,216 2,410 6,090 4,723
OTHER EXPENSE
Salaries and employee benefits 3,782 3,541 7,545 6,794
Occupancy expense, net 529 443 1,059 914
Furniture and equipment expense 558 427 1,116 847
Amortization of goodwill 94 92 188 184
Amortization of core deposit intangible assets 95 100 191 199
Other expense 2,497 2,065 4,441 4,055
------- ------- ------- -------
Total other expense 7,555 6,668 14,540 12,993
------- ------- ------- -------
Income before income taxes 2,862 2,430 5,628 4,742
Provision for income taxes 758 672 1,562 1,254
------- ------- ------- -------
Net income $2,104 $1,758 $4,066 $3,488
------- ------- ------- -------
------- ------- ------- -------
Basic earnings per share $0.41 $0.34 $0.79 $0.68
Diluted earnings per share $0.40 $0.34 $0.77 $0.67
</TABLE>
4
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income $2,104 $1,759 $4,066 $3,488
Change in net unrealized gains on securities 38 1,037 (53) 40
------- ------- ------- -------
Comprehensive income $2,142 $2,796 $4,013 $3,528
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1998 and 1997
(In thousands)
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $4,066 $3,488
Adjustments to reconcile net income to cash from operating activities:
Depreciation 974 824
Amortization of mortgage servicing rights 392 189
Provision for loan losses 1,276 1,183
Net change in mortgage loans held for sale (3,841) 2,082
Net gain on sales of loans (1,241) (406)
Change in net income taxes payable (463) (792)
Change in accrued interest and other assets 71 (960)
Change in accrued interest and other liabilities (2,374) (3,417)
Premium amortization and discount accretion on securities 121 (7)
Securities losses (gains), net (96) (47)
Amortization of goodwill 188 184
Amortization of core deposit intangible assets 191 199
------- -------
Net cash from operating activities (736) 2,520
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities
Proceeds from matured securities available for sale 36,280 16,203
Proceeds from sales of securities available for sale 14,134 10,857)
Purchases of securities available for sale (34,945) (30,155)
Net principal disbursed or repaid on loans (17,335) (55,162)
Proceeds from sales of other real estate 63 152
Property and equipment expenditures (1,433) 489
------- -------
Net cash from investing activities (3,236) (57,616)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 27,724 41,518
Net change in short term borrowings (10,173) 18,802
Payments on Federal Home Loan Bank term advances (5,000) -
Payments on notes payable (437) -
Proceeds from exercise of incentive stock options 111 -
Dividends paid, net of dividend reinvestments (995) (785)
------ ------
Net cash from financing activities 11,230 59,535
------- -------
Net change in cash and cash equivalents 7,258 4,439
Cash and cash equivalents at beginning of period 42,994 45,068
------- -------
Cash and cash equivalents at end of period $50,252 $49,507
------- -------
------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
5
<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 June 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>
June 30, 1998:
U.S. Treasury $ 4,027 $ 35 $ - $ 4,062
U.S. Government agencies 88,412 402 (94) 88,720
U.S. Government agency
mortgage backed securities 21,035 299 (50) 21,284
States and political subdivisions 63,402 1,975 (42) 65,335
Collateralized mortgage obligations 5,864 46 (28) 5,882
Other securities 4,020 - (116) 3,904
--------- ------- ------- --------
$186,760 $ 2,757 $ (330) $189,187
--------- ------- ------- --------
--------- ------- ------- --------
December 31, 1997:
Fair Value
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>
6
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Note 3: LOANS
Major classifications of loans are as follows: June 30, December 31,
1998 1997
--------- ------------
Commercial and industrial $167,967 $168,899
Real estate - commercial 82,986 95,755
Real estate - construction 86,277 69,901
Real estate - residential 131,871 122,732
Installment 105,189 100,869
Credit card receivables 8,086 8,100
Other loans 915 813
--------- ------------
583,291 567,069
Unearned discount (1,113) (1,324)
Deferred loan fees (284) (397)
--------- ------------
Total loans $581,894 $565,348
--------- ------------
--------- ------------
Note 4: ALLOWANCE FOR LOAN LOSSES
Allowance for loan losses as of June 30, is summarized as follows:
1998 1997
--------- ------------
Balance, January 1 $8,360 $7,274
Provision for loan losses 1,276 1,184
Loans charged-off (999) (959)
Recoveries 285 276
--------- ------------
Balance, end of period $8,922 $7,775
--------- ------------
--------- ------------
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.
7
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 5: EMPLOYEE BENEFIT PLANS - CONTINUED
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. This amount was increased starting 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
$431,000, and $420,000 for the six months ended June 30, 1998, and 1997.
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 June 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 Six Months Ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Weighted-average common shares outstanding 5,174,462 5,160,932 5,171,103 5,159,500
Net income available to common stockholders $2,104 $1,759 $4,066 $3,488
Basic earnings per share $ 0.41 $ 0.34 $ 0.79 $ 0.68
Diluted Earnings Per Share:
Weighted-average common shares outstanding 5,174,462 5,160,932 5,171,103 5,159,500
Dilutive effect of stock options 108,175 31,754 103,868 27,310
---------- ---------- ---------- ----------
Diluted average common shares outstanding 5,282,637 5,192,686 5,274,971 5,186,810
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income available to common stockholders $2,104 $1,759 $4,066 $3,488
Diluted earnings per share $ 0.40 $ 0.34 $ 0.77 $ 0.67
</TABLE>
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the second quarter of 1998 was $2,104,000, or diluted earnings
per share of 40 cents, a 19.7% increase in net income compared to $1,758,000,
or 34 cents per share, in the second 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, coupled with a decrease in the provision
for loan losses. During the six months ended June 30, 1998, net income was
$4,066,000, or diluted earnings per share of 77 cents, compared to
$3,487,000, or 68 cents per share, during the first six months of 1997. This
16.6% increase in net income for the six month period was attributable to an
increase in net interest income of $1,160,000, or 8.2%, and an increase in
noninterest income of $1,367,000, or 28.9%, while noninterest expenses
increased $1,547,000, or 11.9%.
NET INTEREST INCOME
Net interest income was $7.6 million and $7.4 million during the three months
ended June 30, 1998 and 1997, an increase of about 3%. The Company's net
interest margin was 4.13% for the three months ended June 30, 1998, and 4.59%
a year earlier. Net interest income was $15.4 million and $14.2 million
during the six months ended June 30, 1998 and 1997, an increase of about 8%.
The Company's net interest margin was 4.19% for the six months ended June 30,
1998, and 4.52% a year earlier. The decline in this ratio has resulted from a
decline in average earning asset yields and an increase in the average cost
of funds. Continued historically low interest rates have resulted in a
decline in the average yield on earning assets from 8.54% in the second
quarter of 1997, to 8.26% in the second quarter of 1998. At the same time,
the average cost of funds has risen from 3.96% in the second quarter of 1997
to 4.13% in the second quarter of 1998. This increased cost has resulted from
continued increases in interest bearing sources of funds, such as borrowed
funds and certificates of deposit, while noninterest deposits have grown more
slowly.
OTHER INCOME
Noninterest income was $3,216,000 during the second quarter of 1998 and
$2,410,000 in the second quarter of 1997, an increase of $806,000, or 33.4%.
Noninterest income was $6,090,000 during the six months ended June 30, 1998
and $4,723,000 during the six months ended June 30, 1997, an increase of
$1,367,000, or 28.9%. Mortgage banking income was the primary source of the
increase in noninterest income for the second quarter and the six-month
period. Mortgage banking income was $1,212,000 in the second quarter of 1998
and $489,000 in the second quarter of 1997, an increase of $723,000, or 148%.
During the first half of the year mortgage banking income was $2,161,000 in
1998 and $981,000 in 1997, and increase of $1,180,000, or 120%. 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 $304 million as of June 30, 1998 compared to $263 million a year
earlier.
Trust income of $660,000 in the second quarter of 1998 was $63,000, or 10.6%
higher than the second quarter 1997 level. For the six months ended June 30,
1998, trust income was $1,310,000, compared to $1,149,000 in the six months
ended June 30, 1997, an increase of $161,000, or 14%. Service charges and
fees decreased $45,000 (4.2%) from $1,068,000 in the second quarter of 1997,
to $1,023,000 in the second quarter of 1998. Service charges and fees were
$1,991,000 in the six months ended June 30, 1998, compared to $2,063,000 in
the six months ended June 30, 1997, a decline of $72,000, or 3.5%. 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 half of 1998, of which $20,000 occurred in the second
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
quarter. In 1997, securities gains were $47,000 in the first half, and
$5,000 in the second 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 response to changes in interest rates, liquidity needs, or
significant prepayment risk.
OTHER EXPENSE
Salary and benefit expenses increased from $3,541,000 during the three months
ended June 30, 1997, to $3,782,000 for the same period in 1998, an increase
of $241,000 (6.8%). Salaries and benefits were $7,545,000 and $6,794,000
during the six months ended June 30, 1998 and 1997, an increase of $751,000
(11.1%). The full-time equivalent number of employees was 351 as of June 30,
1998, and 336 as of June 30, 1997. Commissions were $327,000 in the second
quarter of 1998, compared with $262,000 in the second quarter of 1997. During
the six months ended June 30, commissions were $619,000 in 1998 and $394,000
in 1997, a $225,000 (57.1%) increase. Most of the increase in commissions was
directly associated with the increase in mortgage banking activity.
Occupancy expenses of $529,000 during the second quarter of 1998 were $86,000
(19.4%) higher than in the second quarter of 1997. Occupancy expenses were
$1,059,000 in the six months ended June 30, 1998, a $145,000 (15.9%)
increase. Furniture and equipment expenses were $131,000 (30.7%) higher
during the second quarter of 1998, and 269,000 (31.8%) higher for the six
months ended June 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 $2,497,000, or $432,000 (20.9%) higher in the second
quarter of 1998, than in the second quarter of 1997. Other expenses were
$4,441,000 and $4,055,000 during the six months ended June 30, 1998 and 1997,
an increase of $386,000 (9.5%). For the six month period ended June 30, other
expenses in the mortgage banking area were $1,284,000, an increase of
$609,000 compared to the first six months of 1997. The increase in mortgage
expenses was associated with the $1,180,000 increase in noninterest mortgage
banking income for the six month period, discussed above, and a 7.4% increase
in the residential mortgage portfolio during the first six months of 1998.
These expenses include volume-related expenses such as credit reports,
appraisals and correspondent mortgage fees. Other expenses outside of the
mortgage department have declined when comparing the first half of 1998 to
the first half of 1997. While the mortgage expenses are necessary for the
development of mortgage banking income, there has been continued improvement
in controlling operating expenses throughout the Company.
FINANCIAL CONDITION
LOANS, LOANS HELD FOR SALE, AND PROVISION FOR LOAN LOSSES
Total loans increased $16.5 million (2.9%) to $581.9 million as of June 30,
1998, from $565.3 million as of December 31, 1997. Commercial loans decreased
to $168.0 million as of June 30, 1998, from $168.9 million as of December 31,
1997, a $900,000 (0.6%) decrease. Commercial real estate loans decreased to
approximately $83.0 million as of June 30, 1998, from $95.8 million as of
December 31, 1997, declining $12.8 million (13.3%) as repayments were
received on loans. Construction loans increased $16.4 million (23.4%) to
$86.3 million as of June 30, 1998. Residential real estate loans increased
$9.1 million (7.4%), to $131.8 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 in general, and the real estate market in particular.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
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 for
sale were $7.1 million as of June 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 $393,000 in the second quarter of 1998 and
$697,000 in the second quarter of 1997. Net charge-offs for the three months
ended June 30, were $563,000 and $360,000 in 1998 and 1997. Provisions for
loan losses were $1,276,000 in the six months ended June 30, 1998 and
$1,183,000 in the six months ended June 30, 1997. Net charge-offs for the six
months ended June 30, were $714,000 and $682,000 in 1998 and 1997. The
increase in the provision for loan losses in 1998 was closely tied to the
increase in the loan portfolio. 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 1.53% as of June 30, 1998 and 1.52% as of June 30, 1997. In management's
judgment, an adequate allowance for possible future losses has been
established.
Nonaccrual loans increased to $6,085,000 as of June 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 June 30, 1998, or
December 31, 1997. Other real estate owned increased from $178,000 as of
December 31, 1997, to $190,000 as of June 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 June 30, 1998, net unrealized gains of
$2,425,000, reduced by deferred income taxes of $825,000, resulted in an
increase in equity capital of $1,600,000. 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 $15.6 million (8%)
during the first six months of 1998, to $189.2 million as of June 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
June 30, 1998, a 71% decline. U.S. government agency securities increased
from $86.2 million as of December 31, 1997, to $88.7 million as of June 30,
1998, an increase of $2.5 million (3%). U.S. government agency mortgage
backed securities declined $4.8 million (18%), from $26.1 million as of
December 31, 1997, to $21.3 million as of June 30, 1998. The size of the
portfolio declined as funds were redirected to fund loan growth and to offset
a reduction in borrowed funds.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
DEPOSITS AND BORROWED FUNDS
Total deposits of $678.4 million as of June 30, 1998, represented an increase
of $27.7 million (4.3%) from $650.7 million as of December 31, 1997.
Noninterest-bearing deposits were $125.3 million as of June 30, 1998, an
increase of $7.1 million (6.0%) from $118.2 million as of December 31, 1997.
At the same time, interest-bearing deposits increased $20.6 million (3.9%).
There were no significant changes in deposit structure or management's
strategies in acquiring deposits in the first three 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 six months ended June 30, 1998, Merchants repaid a $5 million term
advance from the FHLB that matured in June of 1998. The FHLB Open-Line was
$12.5 million as of June 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 June 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.
12
<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>
June 30, 1998:
Total capital to risk weighted assets
Consolidated $66,909 10.85% $49,322 8.00% $61,652 10.00%
Merchants National Bank 59,209 11.23% 42,197 8.00% 52,746 10.00%
Tier 1 capital to risk weighted assets
Consolidated 59,092 9.58% 24,661 4.00% 36,991 6.00%
Merchants National Bank 52,600 9.97% 21,098 4.00% 31,647 6.00%
Tier 1 capital to average assets
Consolidated 59,092 7.08% 33,376 4.00% 41,720 5.00%
Merchants National Bank 52,600 7.49% 28,098 4.00% 35,123 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 $3.2 million in the six
months ended June 30, 1998, compared to $57.6 million a year earlier. In the
first half of 1998, net principal disbursed on loans accounted for net
outflows of $17.3 million, and securities transactions aggregated a net
inflow of $15.5 million. In the first half of 1997, net principal disbursed
or repaid on loans accounted for a net outflow of $55.2 million, and
securities transactions resulted in net outflows of $3.1 million.
Cash inflows from financing activities in the first six months of 1998
associated with an increase in deposits were $27.7 million. This compares
with a net inflow of $41.5 million for the same period in 1997. Short-term
borrowings resulted in net cash outflows of $10.2 million in the first half
of 1998, and inflows of $18.8 million in the first half of 1997. FHLB term
advances declined $5 million in the first half of 1998, and were unchanged in
the first half 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 $54.8 million outstanding as of
June 30, 1998.
13
<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 $5,082,000 million during the first six months of 1998, compared
to inflows of $1.7 million in 1997. Total cash outflows from operating
activities exceeded operating outflows by $736,000 during the six months
ended June 30, 1998. During the six months ended June 30, 1997, net cash
inflows from operating activities were $2,520,000. 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.
YEAR 2000 COMPLIANCE
The federal banking regulators have issued several statements providing
guidance to financial institutions on the steps the regulators expect
financial institutions to take to become Year 2000 compliant. Each of the
federal banking regulators is also examining the financial institutions under
its jurisdiction to assess each institution's compliance with the outstanding
guidance. If an institution's progress in addressing the Year 2000 problem is
deemed by its primary federal regulator to be less than satisfactory, the
institution will be required to enter into a memorandum of understanding with
the regulator which will, among other things, require the institution to
promptly develop and submit an acceptable plan for becoming Year 2000
compliant and to provide periodic reports describing the institution's
progress in implementing the plan. Failure to satisfactorily address the Year
2000 problem may also expose a financial institution to other forms of
enforcement action that its primary federal regulator deems appropriate to
address the deficiencies in the institution's Year 2000 remediation program.
The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The data processing systems and software
include those developed and maintained by the Company's data processing
provider and purchased software which is run on in-house computer networks.
In 1997, the Company initiated a review and assessment of all hardware and
software to confirm that it will function properly in the Year 2000. The
Company's data processing provider and those vendors who have been contacted
indicate that their hardware and/or software will be Year 2000 compliant by
the end of 1998. This will allow time for compliance testing. Additionally,
alarms, heating and cooling systems and other computer controlled mechanical
devices on which the Company relies have been evaluated. Those found not to
be in compliance would be modified or replaced with a compliant product.
Management estimates that Year 2000 expenses thus far, including staff time
and replacement of certain non-critical programs, have totaled approximately
$100,000. While there will be some expenses incurred during the next two
years, the Company has not identified any situations at this time that will
require material cost expenditures to become fully compliant. The Company has
initiated a program to communicate with key bank customers to ensure that
they are properly prepared for the Year 2000 and will not suffer serious
adverse consequences. Nevertheless, if not properly addressed, Year 2000
related computer issues could result in interruptions to the operations of
the Banks and have a material adverse effect on the Company's results of
operations.
14
<PAGE>
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 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 June 30, 1998.
15
<PAGE>
SENSITIVITY TO MARKET RISK - CONTINUED
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
INTEREST-EARNING ASSETS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed rate loans $103,810 $ 40,254 $42,224 $53,962 $ 64,315 $17,093 $321,658 $325,127
Average interest rate 10.22% 9.22% 8.98% 8.64% 8.36% 7.65%
Adjustable Rate Loans $140,403 $ 34,427 $29,932 $22,722 $ 21,226 $18,614 $267,324 $267,324
Average interest rate 9.36% 9.11% 8.88% 9.38% 9.31% 7.68%
Securities $ 59,451 $ 46,913 $19,669 $18,974 $ 14,569 $29,611 $189,187 $189,187
Average interest rate 6.43% 6.55% 6.31% 6.01% 5.62% 5.44%
Federal Funds Sold $ 6,658 $ - $ - $ - $ - $ - $ 6,658 $ 6,658
Average interest rate 5.89%
--------- --------- -------- -------- --------- -------- --------- ---------
Total $310,322 $121,594 $91,825 $95,658 $100,110 $65,318 $784,827 $788,296
--------- --------- -------- -------- --------- -------- --------- ---------
--------- --------- -------- -------- --------- -------- --------- ---------
INTEREST-BEARING LIABILITIES
Interest-bearing deposits $236,967 $107,295 $42,867 $30,486 $32,625 $102,928 $553,168 $555,934
Average interest rate 5.02% 5.79% 4.34% 3.91% 4.30% 3.01%
Borrowed Funds $ 35,556 $ 13,375 $13,375 $ 5,625 $13,375 $ 9,188 $ 90,494 $ 91,127
Average interest rate 5.81% 5.85% 6.03% 6.32% 5.93% 6.90%
--------- --------- -------- -------- --------- -------- --------- ---------
Total $272,523 $120,670 $56,242 $36,111 $46,000 $112,116 $643,662 $647,061
--------- --------- -------- -------- --------- -------- --------- ---------
--------- --------- -------- -------- --------- -------- --------- ---------
</TABLE>
16
<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
Meeting of Stockholders.
The Annual Meeting of Stockholders was held on April 21, 1998.
Election of Directors.
Messrs. William C. Glenn, John M. Lies, and Norman L. Titiner
were elected to serve as Class B directors of the Company (term
expiring at the 2001 Annual Meeting of Stockholders). Continuing
as Class C directors (term expires in 1999) are Messrs. C. Tell
Coffey, Calvin R. Myers, and John J. Swalec. Continuing as Class
A directors (term expires in 2000) are Messrs. William F. Hejna,
James D. Pearson, and Frank A. Sarnecki.
Matters Voted Upon at the Meeting.
In addition to the election of directors, stockholders ratified
the adoption of Crowe, Chizek & Company, LLP as independent
public accountants for the Company for the year ending December
31, 1998. The voting on each item at the Annual Meeting was as
follows:
<TABLE>
<CAPTION>
For Withheld Total
--- -------- -----
<S> <C> <C> <C>
Election of Directors
William C. Glenn 4,223,693.0600 14,409.8880 4,238,102.9480
John M. Lies 4,224,293.0600 13,809.8880 4,238,102.9480
Norman L. Titiner 4,216,683.0600 21,419.8880 4,238,102.9480
</TABLE>
<TABLE>
<CAPTION>
For Not For Abstain Non-votes Total
--- ------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Ratification of Accountants 4,214,062.2830 8,754.9440 15,285.7210 0 4,238,102.9480
</TABLE>
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
17
<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: August 13, 1998
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 43,594
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 6,658
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 189,187
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 581,894
<ALLOWANCE> 8,922
<TOTAL-ASSETS> 851,350
<DEPOSITS> 678,442
<SHORT-TERM> 34,681
<LIABILITIES-OTHER> 1,468
<LONG-TERM> 68,313
0
0
<COMMON> 5,222
<OTHER-SE> 63,224
<TOTAL-LIABILITIES-AND-EQUITY> 851,350
<INTEREST-LOAN> 25,310
<INTEREST-INVEST> 5,875
<INTEREST-OTHER> 401
<INTEREST-TOTAL> 31,586
<INTEREST-DEPOSIT> 12,676
<INTEREST-EXPENSE> 16,232
<INTEREST-INCOME-NET> 15,354
<LOAN-LOSSES> 1,276
<SECURITIES-GAINS> 96
<EXPENSE-OTHER> 14,540
<INCOME-PRETAX> 5,628
<INCOME-PRE-EXTRAORDINARY> 4,066
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,066
<EPS-PRIMARY> .79
<EPS-DILUTED> .77
<YIELD-ACTUAL> 4.19
<LOANS-NON> 6,085
<LOANS-PAST> 0
<LOANS-TROUBLED> 458
<LOANS-PROBLEM> 6,543
<ALLOWANCE-OPEN> 8,360
<CHARGE-OFFS> 999
<RECOVERIES> 285
<ALLOWANCE-CLOSE> 8,922
<ALLOWANCE-DOMESTIC> 8,922
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
