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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _______________
Commission file number 0-14484
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MERCHANTS BANCORP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 36-3182868
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(State of Incorporation) (I.R.S. Employer Identification Number)
1851 WEST GALENA BOULEVARD, AURORA, ILLINOIS 60507
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(Address of principal executive offices, including Zip Code)
(630) 896-9000
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(Registrant's telephone number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of each exchange on which registered
NONE NONE
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Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $1.00 PAR VALUE
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(Title of Class)
PREFERRED STOCK PURCHASE RIGHTS
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by Reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
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As of March 9, 1998, the aggregate market value of the registrant's common
stock held by non-affiliates of the registrant was approximately $154,410,640*
based upon the price of the last sale on that date. (This determination includes
841,029 shares of the registrant's common stock held by the trust department of
the registrant's subsidiary, The Merchants National Bank of Aurora.)
The number of shares outstanding of the registrant's common stock, par
value $1 per share, was 5,168,557 at March 9, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's 1997 Annual Report are incorporated by reference
into Parts I, II and IV.
Portions of the Company's Proxy Statement for the 1998 Annual Meeting of
Stockholders are incorporated by reference into Part III.
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* Based on the last reported price of an actual transaction in registrant's
common stock on March 4, 1998, and reports of beneficial ownership filed by
directors and executive officers of registrant and by beneficial owners of
more than 5% of the outstanding shares of common stock of registrant;
however, such determination of shares owned by affiliates does not
constitute an admission of affiliate status or beneficial interest in
shares of registrant's common stock.
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MERCHANTS BANCORP, INC.
FORM 10-K
INDEX
PART I PAGE NO.
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Item 1 Business 1 - 15
Item 2 Properties 16
Item 3 Legal Proceedings 16
Item 4 Submission of Matters to a Vote of Security Holders 17
PART II
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Item 5 Market for the Registrant's Common Stock and
Related Security Holder Matters 17
Item 6 Selected Financial Data 17
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 7A Quantitative and Qualitative Disclosures about Market Risk 17
Item 8 Financial Statements and Supplementary Data 17
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 17
PART III
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Item 10 Directors and Executive Officers of the Registrant 18
Item 11 Executive Compensation 18
Item 12 Security Ownership of Certain Beneficial Owners and
Management 18
Item 13 Certain Relationships and Related Transactions 19
PART IV
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Item 14 Exhibits, Financial Statement Schedules and
Reports on Form 8-K 19 - 20
Signatures 21 - 22
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PART I
ITEM 1. BUSINESS
THE CORPORATION
OVERVIEW
Merchants Bancorp, Inc. (the "Corporation" or the "Registrant") was
organized under the laws of Delaware on July 1, 1981. It is a registered bank
holding company under the Bank Holding Company Act of 1956 (the "Act"). The
Corporation's office is located at 1851 West Galena Boulevard, Aurora, Illinois
60507, and its telephone number is 630/896-9000.
The Corporation conducts a full service community banking and trust
business through its wholly-owned subsidiary banks, The Merchants National Bank
of Aurora ("Merchants Bank"), and Valley Banc Services Corp. ("Valley"), and
Valley's wholly owned subsidiaries, Hinckley State Bank and V.B.H. Corporation
and V.B.H. Corporation's wholly-owned subsidiary, Fox Valley Bank. Merchants
Bank, Hinckley State Bank, and Fox Valley Bank are collectively referred to
herein as the "Banks."
On January 3, 1996, the Company purchased 100% of the outstanding common
stock of Valley for $24,889,000, comprised of $20.5 million in cash, assumption
of Valley's debt of approximately $3.5 million, $304,000 of capitalized
acquisition costs and $532,000 of capitalized incremental interest costs during
the holding period of acquired subsidiaries held for sale. As of the acquisition
date, Valley's wholly-owned subsidiaries included Hinckley State Bank, State
Bank of Osco, Anchor Bank and V.B.H. Corporation and V.B.H. Corporation's
wholly-owned subsidiary, Fox Valley Bank. The acquisition was accounted for
using the purchase method of accounting and, accordingly, the assets and
liabilities have been recorded at their estimated fair values at the date of
acquisition. In addition, when Valley was acquired, the Company's intent was to
sell State Bank of Osco and Anchor Bank. Accordingly, those banks were
classified as held for sale until they were sold on December 12, 1996, and
December 19, 1996, respectively.
Merchants Bank is a national banking association with its main office
located at 1851 West Galena Boulevard, Aurora, Illinois 60507. Merchants Bank
operates full service banking facilities located at 2998 Ogden Avenue, Aurora,
Illinois 60505, 1851 West Galena Boulevard, Aurora, Illinois 60506, One
Merchants Plaza, Oswego, Illinois 60543, 55 Constitution Drive, Aurora, Illinois
60506, 1771 Merchants Drive, Geneva, Illinois 60134 and Route 31, Mooseheart,
Illinois 60539. The Bank operates a loan production office located at 520
Countryside Center, Yorkville, Illinois 60560. The administration center for
Merchants Bank, in which all operational and support functions are located, is
located at 2255 West Sullivan Road, Aurora, Illinois, 60507.
Hinckley State Bank is an Illinois banking association with its main office
located at 101 W. Lincoln, Hinckley, Illinois 60520, and a full service facility
located at 80 N. Dugan Road, Sugar Grove, Illinois 60554. Fox Valley Bank is an
Illinois banking association with its main office located at 1600 East Main
Street, St. Charles, Illinois 60174, and full service facilities located at 1525
West Main Street, St. Charles, Illinois 60174, and 629 West State Street,
Geneva, Illinois 60134.
Aurora is located in the Fox River Valley approximately 40 miles west of
Chicago, Illinois. Hinckley is located approximately 17 miles west of Aurora,
and St. Charles is located approximately 13 miles north of Aurora. Aurora and
its surrounding communities, including Hinckley and St. Charles, are in one of
the fastest growing areas in northeastern Illinois. Aurora's population based
upon the 1990 census was approximately 100,000, an increase of approximately 22%
from the community's population recorded in the 1980 census. The Northeastern
Illinois Planning Commission estimates that Aurora's population will grow by a
further 60% in the 1990's to almost 160,000 by the year 2000.
The major contributor to this growth in the Aurora area has been the
expansion of the boundaries of metropolitan Chicago. As the Chicago suburbs have
expanded, Aurora has experienced a considerable influx of people as well as a
number of new employers. The local economy has experienced growth as a new
service-oriented business sector has developed to supplement Aurora's historical
manufacturing base. Aurora is located on U.S. Interstate Highway 88 which
provides easy access to the city of Chicago and is a major corridor of suburban
growth for Chicago.
As a large, community-oriented, independent financial institution in the
Aurora area, the Corporation is well positioned to take advantage of the growth
of Aurora and its surrounding communities. Merchants Bank has continuously
served the Aurora community since it was chartered in 1888. The Corporation's
local management, coupled with its long record of service, has allowed it to
compete successfully in Aurora's banking market. The Corporation operates its
subsidiaries as traditional community banks with conveniently located facilities
and professional, highly motivated staffs which are active in the community,
focus on long-term relationships with customers and provide individualized
quality service.
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SUBSIDIARY OPERATIONS
The Banks' full service banking businesses include the customary consumer
and commercial products and services which banks provide, including the
following: demand, savings, time deposit, individual retirement and Keogh
deposit accounts; commercial, industrial, consumer and real estate lending,
including installment loans, student loans, farm loans, lines of credit and
overdraft checking; safe deposit operations; trust services, through Merchants
Bank; and an extensive variety of additional services tailored to the needs of
individual customers, such as the acquisition of U.S. Treasury notes and bonds,
the sale of traveler's checks, money orders, cashier's checks and foreign
currency, direct deposit, discount brokerage debit cards, credit cards, and
other special services.
Commercial and consumer loans are made to corporations, partnerships and
individuals, primarily on a secured basis. Commercial lending focuses on
business, capital, construction, inventory and real estate lending. Installment
lending includes direct and indirect loans to consumers and commercial
customers. The mortgage division of Merchants Bank originates and services
residential mortgages on behalf of the Banks, and handles the secondary
marketing of those mortgages.
MARKET AREAS
Merchants Bank's primary market area is Aurora, Illinois, and its
surrounding communities. The city of Aurora is located in northeastern Illinois,
approximately 40 miles west of Chicago. Strategically situated on U.S.
Interstate 88 (the East-West Tollway), Aurora is near the center of the four
county area comprised of DuPage, Kane, Kendall and Will counties. Based upon the
1990 census, these counties together represent a market of more than 1.4 million
people. The city of Aurora has a current reported population of approximately
100,000 residents which is forecast by the Northeastern Illinois Planning
Commission to grow by more than 60% through the rest of the decade.
The median income for households within a five mile radius of Aurora was
approximately $44,000, compared to an Illinois average of approximately $32,000,
as reported from 1990 census data. Major employers in Merchants Bank's market
area include Caterpillar Inc., Hollywood Casino Aurora, Metropolitan Life, Dial
Corporation, Farmers Insurance, and Lyon Metal Products. Retail sales declared
for tax purposes in Aurora reached $989 million in 1990.
Hinckley is a rural community located approximately 17 miles west of
Aurora. Located along a significant east-west corridor, it is well positioned to
participate in the growth moving west through the Chicago suburbs. Many people
who are employed by the major employers in the Aurora area are buying or
building homes in the Hinckley area.
St. Charles, like Aurora, is located along the Fox River, and has
experienced similar growth in recent years. As of 1992, median household income
was $66,000, more than double the Illinois average reported in the 1990 census.
Major employers include Central DuPage Hospital, System Sensor, Delnor Community
Hospital, DuKane Corp., and Arthur Andersen.
ACQUISITION AND EXPANSION STRATEGY
The Corporation seeks to diversify both its market area and asset base
while increasing profitability through acquisitions and expansion. The
Corporation's goal, as reflected by its acquisition policy, is to expand through
the acquisition of established financial service organizations, primarily
commercial banks or thrifts, to the extent suitable candidates can be identified
and acceptable business terms negotiated.
The Corporation's acquisition strategy is focused on traditional community
banks or thrifts located in potentially high growth areas within 15 miles to the
east of Aurora and up to 30 miles from Aurora in all other directions. At this
time, a large number of such financial institutions are located within this
geographic area. It is possible that as a result of consolidation within the
banking industry generally, as well as in the Aurora area, the Corporation may
in the future look beyond these geographic areas for acquisition opportunities.
In addition to price and terms, other factors considered by the Corporation in
determining the desirability of an acquisition candidate are financial
condition, earnings potential, quality of management, market area and
competitive environment.
The Corporation will also consider establishing branches, loan production
offices or other business facilities as a means of expanding its presence in
current or new market areas. An example of this is the Corporation's opening a
new branch facility in Geneva in 1996, entry into "supermarket banking" with the
opening of a branch inside the Cub Foods store in Aurora in 1993, and the
opening of its loan production office in 1994. The Corporation will also
consider the expansion into other lines of business closely related to banking
if it believes these lines could be profitable without undue risk to the
Corporation and if the Corporation can be competitive.
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OPERATING STRATEGY
Corporate policy, strategy and goals are established by the Board of
Directors of the Corporation. Pursuant to the Corporation's philosophy,
operational and administrative policies for the Banks are also established by
the Corporation. Within this framework, the Banks focus on providing
personalized services and quality products to its customers to meet the needs of
the communities in which they operate.
Recognizing the substantial changes and growth opportunities in its market,
the Corporation has created an aggressive sales environment within the
organization. In addition to promotions from within the organization, the
Corporation has hired experienced senior bank executives who were already
familiar with the Aurora market area, with an emphasis on the commercial lending
and trust areas. This has allowed the Corporation to continue to grow with the
community and compete successfully in Aurora's banking market.
The Corporation operates its subsidiaries as traditional community banks
with conveniently located facilities and professional, highly motivated staffs
which are active in the communities they serve, focusing on long-term
relationships with customers and providing individualized quality service. As
part of its community banking approach, the Corporation encourages officers of
the Banks to actively participate in community organizations. In addition,
within credit and rate of return parameters, the Corporation attempts to ensure
that the Banks meet the credit needs of their communities and that the Banks
invest in local municipal securities.
The Corporation uses a variety of marketing strategies to attract and
retain customers, the most important of which is its officer call program.
Officers of the Banks regularly call on customers and potential customers to
maintain and develop deposit and other special service relationships, including
payroll, discount brokerage, cash management, lock box and trust services.
The Corporation has an internal data processing division and has attempted
to remain at the forefront of the banking industry in new technological
innovations. The Corporation believes that retaining control of its data
processing leads to decreased operating costs, more effective service to its
customers and increased efficiencies. To provide a high level of customer
service and to manage effectively its growth, acquisition and operating
strategies, the Corporation also focuses on continued improvement of its
internal operating systems.
LENDING ACTIVITIES
GENERAL. The Banks provide a range of commercial and retail lending
services to corporations, partnerships and individuals, including, but not
limited to, commercial business loans, commercial and residential real estate
construction and mortgage loans, loan participations, consumer loans, revolving
lines of credit and letters of credit. The Banks make direct and indirect loans
to consumers and commercial customers, and the mortgage division of Merchants
Bank originates and services residential mortgages and handles the secondary
marketing of those mortgages. Through Merchants Bank, mortgage products are also
made available to Hinckley State Bank and Fox Valley Bank customers.
The Banks aggressively market their services to qualified lending customers
in both the commercial and consumer sectors. The Banks' commercial lending
officers actively solicit the business of new companies entering their market
areas as well as longstanding members of their business community. Through
personalized professional service and competitive pricing, the Banks have been
successful in attracting new commercial lending customers. At the same time, the
Banks actively advertise their consumer loan products and continuously attempt
to make their lending officers more accessible. Through convenient locations and
regular advertising, the Banks have been successful in capitalizing on the
growing population of their market areas, particularly with regard to
residential mortgages, home equity loans, and installment loans.
COMMERCIAL LOANS. The Banks aggressively seek new commercial loans in their
market areas and much of the increase in these loans in recent years can be
attributed to the successful solicitation of new business. The Banks' areas of
emphasis include, but are not limited to, loans to wholesalers, manufacturers,
building contractors, developers, business services companies and retailers. The
Banks provide a wide range of commercial business loans, including lines of
credit for working capital purposes and term loans for the acquisition of
equipment and other purposes. Collateral for these loans generally includes
accounts receivable, inventory, equipment and real estate. Loans may be made on
an unsecured basis where warranted by the overall financial condition of the
borrower. Terms of commercial business loans generally range from one to five
years. The majority of the Banks' commercial business loans have floating
interest rates or reprice within one year. Management has also generated loans
which are guaranteed by the U.S. Small Business Administration. Management
believes that making such loans helps the local community as well as providing
the Banks with a source of income and solid future lending relationships as such
businesses grow and prosper. The primary repayment risk for commercial loans is
the failure of the business due to economic or financial factors. In most cases,
the Banks have collateralized these loans and/or taken personal guarantees to
help assure repayment.
The Banks regularly provide financing to developers who have demonstrated a
favorable record of performance for the construction of pre-sold homes. Home
sales have remained very strong in the greater Aurora area, including Hinckley
and St. Charles,
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due to the growth in population. Although development and construction
lending has been a significant portion of the commercial loan activity, these
types of loans represented approximately 12% of the outstanding balance of
the Banks' loan portfolios as of December 31, 1997. No construction or
development loan was on nonaccrual status as of December 31, 1997.
Each Bank's Board of Directors reviews, on a monthly basis, a report of all
criticized assets and considers all requests for new loans of over $8 million at
Merchants Bank, and $100,000 at Hinckley State Bank and Fox Valley Bank. The
directors' loan committees of Hinckley State Bank and Fox Valley Bank may
approve loans to the same levels as the full board of these banks. Requests for
new loans over $4 million are reviewed by the directors' loan committee at
Merchants Bank. Loan review is centralized for all three Banks, and loan review
personnel and commercial lenders interact with the Banks' Boards of Directors
each month. Management has attempted to identify problem loans at an early stage
and to aggressively seek a resolution of these situations. The result has been a
below average level of problem loans compared to the Banks' industry peer groups
in recent years.
MORTGAGE BANKING. Merchants Bank conducts a mortgage origination operation
through its mortgage division, and also makes these services available to
Hinckley State Bank and Fox Valley Bank customers. Prior to 1993, Merchants Bank
generally did not hold newly originated residential mortgage loans in its
portfolio, preferring instead to originate the loans for outside investors and
have the outside investors fund and service the loans. Beginning in 1993,
Merchants Bank began funding all residential mortgage loans and selling the
majority of them in the secondary market with servicing retained. In addition,
in June, 1993, Merchants Bank purchased the servicing on most of the residential
mortgage loans it originated in prior periods. In 1995, Merchants Bank purchased
the servicing rights to approximately $62.6 million of mortgage loans. As a
result of such actions, Merchants Bank has built its mortgage servicing
portfolio to approximately $275 million at December 31, 1997. Management
believes that the retention of mortgage servicing provides Merchants Bank with a
relatively steady source of fee income as compared to fees generated solely from
mortgage origination operations.
CONSUMER LENDING. The Banks' consumer lending department's provide all
types of consumer loans including motor vehicle, home improvement, home equity,
student, signature and small personal credit lines. The Banks have designated
funds to support various special programs to benefit the first time borrower.
During 1994, Merchants Bank entered the credit card market by issuing its own
Visa Card, and offers this product to Hinckley State Bank and Fox Valley Bank
customers. Merchants Bank has entered into a contract with a non-affiliated
third party to provide credit card processing for its operations. Through this
program, Merchants Bank hopes to increase profits and augment its cross-selling
opportunities by increasing its marketing base. The "Phone for a Loan" program
at Merchants Bank will provide easy means for customers to apply for a loan 24
hours a day.
TRUST DEPARTMENT
Merchants Bank's trust department has been providing trust services to the
Aurora community for over 60 years. Currently, Merchants Bank has over $440
million of assets under management and provides a full complement of trust
services for individuals and corporations. Merchants Bank has targeted the trust
department as one of its primary areas for future growth. Trust services are
also offered to Hinckley State Bank and Fox Valley Bank customers through
Merchants Bank.
The trust department's current focus is in two major areas: (i) investment
management for individuals and (ii) administration and investment services for
employee benefit plans. The trust department has a staff of professionals with
expertise in the employee benefit administration and new business development
areas. This group provides expanded employee benefit retirement plan
administration and investment services to sole proprietors and corporations. The
trust department has also converted its data processing and delivery system to
enhance the department's ability to continue to provide a quality, highly
personalized trust product to its customers.
COMPETITION
The Corporation's market area is highly competitive. Many financial
institutions based in Aurora's surrounding communities and in Chicago, Illinois,
operate banking offices in the greater Aurora area or actively compete for
customers within the Corporation's market areas. The Banks also face competition
from finance companies, insurance companies, mortgage companies, securities
brokerage firms, money market funds, loan production offices and other providers
of financial services.
The Corporation competes for loans principally through the range and
quality of the services it provides, interest rates and loan fees. The
Corporation believes that its long-standing presence in the community and
personal service philosophy enhances its ability to compete favorably in
attracting and retaining individual and business customers. The Corporation
actively solicits deposit-related clients and competes for deposits by offering
customers personal attention, professional service and competitive interest
rates.
EMPLOYEES
At December 31, 1997, the Corporation employed 347 full-time equivalent
employees. The Corporation places a high priority on staff development which
involves extensive training, including customer service training. New employees
are selected on the basis
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of both technical skills and customer service capabilities. None of the
Corporation's employees are covered by a collective bargaining agreement with
the Corporation. The Corporation offers a variety of employee benefits and
management considers its employee relations to be excellent.
SUPERVISION AND REGULATION
GENERAL
Financial institutions and their holding companies are extensively
regulated under federal and state law. As a result, the growth and earnings
performance of the Corporation can be affected not only by management decisions
and general economic conditions, but also by the requirements of applicable
state and federal statutes and regulations and the policies of various
governmental regulatory authorities including, but not limited to, the Office of
the Comptroller of the Currency (the "OCC"), the Illinois Commissioner of Banks
and Real Estate (the "Commissioner"), the Board of Governors of the Federal
Reserve System (the "FRB"), the Federal Deposit Insurance Corporation (the
"FDIC"), the Internal Revenue Service and state taxing authorities and the
Securities and Exchange Commission (the "SEC"). The effect of such statutes,
regulations and policies can be significant, and cannot be predicted with a high
degree of certainty.
Federal and state laws and regulations generally applicable to financial
institutions, such as the Corporation and its subsidiaries, regulate, among
other things, the scope of business, investments, reserves against deposits,
capital levels relative to operations, the nature and amount of collateral for
loans, the establishment of branches, mergers, consolidations and dividends. The
system of supervision and regulation applicable to the Corporation and its
subsidiaries establishes a comprehensive framework for their respective
operations and is intended primarily for the protection of the FDIC's deposit
insurance funds and the depositors, rather than the shareholders, of financial
institutions.
The following references to material statutes and regulations affecting the
Corporation and its subsidiaries are brief summaries thereof and do not purport
to be complete, and are qualified in their entirety by reference to such
statutes and regulations. Any change in applicable law or regulations may have
a material effect on the business of the Corporation and its subsidiaries.
RECENT REGULATORY DEVELOPMENTS
PENDING LEGISLATION. Legislation is pending in the Congress that would
allow bank holding companies to engage in a wider range of nonbanking
activities, including greater authority to engage in securities and insurance
activities. The expanded powers generally would be available to a bank holding
company only if the bank holding company and its bank subsidiaries remain
well-capitalized and well-managed. Additionally, the pending legislation would
eliminate the federal thrift charter and merge the FDIC's Bank Insurance Fund
("BIF") and Savings Association Insurance Fund ("SAIF"). At this time, the
Corporation is unable to predict whether the proposed legislation will be
enacted and, therefore, is unable to predict the impact such legislation may
have on the operations of the Corporation and the Bank.
THE CORPORATION
GENERAL. The Corporation, as the sole stockholder of the Banks, is a bank
holding company. As a bank holding company, the Corporation is registered with,
and is subject to regulation by, the FRB under the Act. In accordance with FRB
policy, the Corporation is expected to act as a source of financial strength to
the Banks and to commit resources to support the Banks in circumstances where
the Corporation might not do so absent such policy. Under the Act, the
Corporation is subject to periodic examination by the FRB and is required to
file with the FRB periodic reports of its operations and such additional
information as the FRB may require. The Corporation is also subject to
regulation by the Commissioner under the Illinois Bank Holding Company Act, as
amended.
INVESTMENTS AND ACTIVITIES. Under the Act, a bank holding company must
obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (ii) acquiring all or
substantially all of the assets of another bank; or (iii) merging or
consolidating with another bank holding company. Subject to certain conditions
(including certain deposit concentration limits established by the Act), the FRB
may allow a bank holding company to acquire banks located in any state of the
United States without regard to whether the acquisition is prohibited by the law
of the state in which the target bank is located. In approving interstate
acquisitions, however, the FRB is required to give effect to applicable state
law limitations on the aggregate amount of deposits that may be held by the
acquiring bank holding company and its insured depository institution affiliates
in the state in which the target bank is located (provided that those limits do
not discriminate against out-of-state depository institutions or their holding
companies) or which require that the target bank have been in existence for a
minimum period of time (not to exceed five years) before being acquired by an
out-of-state bank holding company.
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The Act also prohibits, with certain exceptions, the Corporation from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank and from engaging in any business
other than that of banking, managing and controlling banks or furnishing
services to banks and their subsidiaries. The principal exception to this
prohibition allows bank holding companies to engage in, and to own shares of
companies engaged in, certain businesses found by the FRB to be "so closely
related to banking ... as to be a proper incident thereto." Under current
regulations of the FRB, the Corporation and its non-bank subsidiaries are
permitted to engage in, among other activities, such banking-related businesses
as the operation of a thrift, sales and consumer finance, equipment leasing, the
operation of a computer service bureau, including software development, and
mortgage banking and brokerage. The Act generally does not place territorial
restrictions on the domestic activities of non-bank subsidiaries of bank holding
companies.
Federal law also prohibits acquisition of "control" of a bank or bank
holding company, such as the Corporation, without prior notice to certain
federal bank regulators. "Control" is defined in certain cases as acquisition
of 10% of the outstanding shares of a bank or bank holding company.
CAPITAL REQUIREMENTS. Bank holding companies are required to maintain
minimum levels of capital in accordance with FRB capital adequacy guidelines.
If capital falls below minimum guideline levels, a bank holding company, among
other things, may be denied approval to acquire or establish additional banks or
non-bank businesses.
The FRB's capital guidelines establish the following minimum regulatory
capital requirements for bank holding companies: a risk-based requirement
expressed as a percentage of total risk-weighted assets, and a leverage
requirement expressed as a percentage of total assets. The risk-based
requirement consists of a minimum ratio of total capital to total risk-weighted
assets of 8%, at least one-half of which must be Tier 1 capital. The leverage
requirement consists of a minimum ratio of Tier 1 capital to total assets of 3%
for the most highly rated companies, with minimum requirements of 4% to 5% for
all others. For purposes of these capital standards, Tier 1 capital consists
primarily of permanent stockholders' equity less intangible assets (other than
certain mortgage servicing rights and purchased credit card relationships) and
total capital means Tier 1 capital plus certain other debt and equity
instruments which do not qualify as Tier 1 capital and a portion of the
Corporation's allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum
requirements, and higher capital levels will be required if warranted by the
particular circumstances or risk profiles of individual banking organizations.
For example, the FRB's capital guidelines contemplate that additional capital
may be required to take adequate account of, among other things, interest rate
risk, or the risks posed by concentrations of credit, nontraditional activities
or securities trading activities. Further, any banking organization
experiencing or anticipating significant growth would be expected to maintain
capital ratios, including tangible capital positions (i.e., Tier 1 capital less
all intangible assets), well above the minimum levels.
As of December 31, 1997, the Corporation had regulatory capital in excess
of the FRB's minimum requirements, with a risk-based capital ratio of 10.42% and
a leverage ratio of 6.91%.
DIVIDENDS. The FRB has issued a policy statement with regard to the
payment of cash dividends by bank holding companies. In the policy statement,
the FRB expressed its view that a bank holding company should not pay cash
dividends which exceed its net income or which can only be funded in ways that
weaken the bank holding company's financial health, such as by borrowing.
Additionally, the FRB possesses enforcement powers over bank holding companies
and their non-bank subsidiaries to prevent or remedy actions that represent
unsafe or unsound practices or violations of applicable statutes and
regulations. Among these powers is the ability to proscribe the payment of
dividends by banks and bank holding companies. In addition to the restrictions
on dividends that may be imposed by the FRB, the Delaware General Corporation
Law (the "DGCL") allows the Corporation to pay dividends only out of its surplus
(as defined and computed in accordance with the provisions of the DGCL), or if
the Corporation has no such surplus, out of its net profits for the fiscal year
in which the dividend is declared and/or the preceding fiscal year.
FEDERAL SECURITIES REGULATION. The Corporation's common stock is
registered with the SEC under the Securities Act of 1933, as amended, and the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently,
the Corporation is subject to the information, proxy solicitation, insider
trading and other restrictions and requirements of the SEC under the Exchange
Act.
THE BANKS
GENERAL. Merchants Bank is a national bank, chartered by the OCC under the
National Bank Act. The deposit accounts of Merchants Bank are insured by the
BIF of the FDIC, and Merchants Bank is a member of the Federal Reserve System.
As a BIF-insured national bank, Merchants Bank is subject to the examination,
supervision, reporting and enforcement requirements of the OCC, as the
chartering authority for national banks, and the FDIC, as administrator of the
BIF.
6
<PAGE>
Hinckley State Bank and Fox Valley Bank (the "State Banks") are
Illinois-chartered banks, the deposit accounts of which are insured by the BIF
of the FDIC. As a BIF-insured, Illinois-chartered banks, the State Banks are
subject to the examination, supervision, reporting and enforcement requirements
of the Commissioner, as the chartering authority for Illinois banks, and the
FDIC, as administrator of the BIF.
DEPOSIT INSURANCE. As FDIC-insured institutions, the Banks are required
to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted
a risk-based assessment system under which all insured depository institutions
are placed into one of nine categories and assessed insurance premiums based
upon their respective levels of capital and results of supervisory evaluations.
Institutions classified as well-capitalized (as defined by the FDIC) and
considered healthy pay the lowest premium while institutions that are less than
adequately capitalized (as defined by the FDIC) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
During the year ended December 31, 1997, BIF assessments ranged from 0% of
deposits to 0.27% of deposits. For the semi-annual assessment period beginning
January 1, 1998, BIF assessment rates will continue to range from 0% of deposits
to 0.27% of deposits.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, order, or any condition imposed in writing by, or written agreement
with, the FDIC. The FDIC may also suspend deposit insurance temporarily during
the hearing process for a permanent termination of insurance if the institution
has no tangible capital. Management of the Corporation is not aware of any
activity or condition that could result in termination of the deposit insurance
of any of the Banks.
FICO ASSESSMENTS. Since 1987, a portion of the deposit insurance
assessments paid by SAIF members has been used to cover interest payments due on
the outstanding obligations of the FICO, the entity created to finance the
recapitalization of the Federal Savings and Loan Insurance Corporation, the
SAIF's predecessor insurance fund. Pursuant to federal legislation enacted
September 30, 1996, commencing January 1, 1997, both SAIF members and BIF
members became subject to assessments to cover the interest payments on
outstanding FICO obligations. Such FICO assessments are in addition to amounts
assessed by the FDIC for deposit insurance. Until January 1, 2000, the FICO
assessments made against BIF members may not exceed 20% of the amount of the
FICO assessments made against SAIF members. Between January 1, 2000 and the
maturity of the outstanding FICO obligations in 2019, BIF members and SAIF
members will share the cost of the interest on the FICO bonds on a pro rata
basis. During the year ended December 31, 1997, the FICO assessment rate for
SAIF members was approximately 0.063% of deposits while the FICO assessment rate
for BIF members was approximately 0.013% of deposits. During the year ended
December 31, 1997, the Banks paid FICO assessments totaling $92,000.
SUPERVISORY ASSESSMENTS. All Illinois banks and national banks are
required to pay supervisory assessments to the Commissioner and the OCC,
respectively, to fund the operations of such agencies. The amount of such
supervisory fees is based upon each institution's total assets, including
consolidated subsidiaries. During the year ended December 31, 1997, the Banks
paid supervisory assessments totaling $156,000.
CAPITAL REQUIREMENTS. Under federal regulations, the Banks are subject to
the following minimum capital standards: a leverage requirement consisting of a
minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated
banks with minimum requirements of 4% to 5% for all others, and a risk-based
capital requirement consisting of a minimum ratio of total capital to total
risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital.
For purposes of these capital standards, Tier 1 capital and total capital
consist of substantially the same components as Tier 1 capital and total capital
under the FRB's capital guidelines for bank holding companies (see "--The
Corporation--Capital Requirements").
The capital requirements described above are minimum requirements. Higher
capital levels will be required if warranted by the particular circumstances or
risk profiles of individual institutions. For example, federal regulations
provide that additional capital may be required to take adequate account of,
among other things, interest rate risk or the risks posed by concentrations of
credit, nontraditional activities or securities trading activities.
7
<PAGE>
During the year ended December 31, 1997, none of the Banks was required by
its primary federal regulator to increase its capital to an amount in excess of
the minimum regulatory requirements. As of December 31, 1997, each of the
Banks exceeded its minimum regulatory capital requirements. As of December 31,
1997, the capital ratios were as follows:
<TABLE>
<CAPTION>
RISK-BASED LEVERAGE
CAPITAL RATIO RATIO
------------- --------
<S> <C> <C>
Merchants Bank 10.89% 7.44%
Hinckley State Bank 13.47% 7.84%
Fox Valley Bank 12.37% 7.77%
</TABLE>
Federal law provides the federal banking regulators with broad power to
take prompt corrective action to resolve the problems of undercapitalized
institutions. The extent of the regulators' powers depends on whether the
institution in question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Depending upon the capital category to which an
institution is assigned, the regulators' corrective powers include:
requiring the submission of a capital restoration plan; placing limits on
asset growth and restrictions on activities; requiring the institution to
issue additional capital stock (including additional voting stock) or to be
acquired; restricting transactions with affiliates; restricting the interest
rate the institution may pay on deposits; ordering a new election of
directors of the institution; requiring that senior executive officers or
directors be dismissed; prohibiting the institution from accepting deposits
from correspondent banks; requiring the institution to divest certain
subsidiaries; prohibiting the payment of principal or interest on
subordinated debt; and ultimately, appointing a receiver for the institution.
Additionally, institutions insured by the FDIC may be liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC in connection
with the default of commonly controlled FDIC insured depository institutions or
any assistance provided by the FDIC to commonly controlled FDIC insured
depository institutions in danger of default.
DIVIDENDS. The National Bank Act imposes limitations on the amount of
dividends that may be paid by a national bank, such as Merchants Bank.
Generally, a national bank may pay dividends out of its undivided profits, in
such amounts and at such times as the bank's board of directors deems prudent.
Without prior OCC approval, however, a national bank may not pay dividends in
any calendar year which, in the aggregate, exceed the bank's year-to-date net
income plus the bank's adjusted retained net income for the two preceding years.
Under the Illinois Banking Act, Illinois-chartered banks, such as the State
Banks, may not pay dividends in excess of their adjusted profits.
The payment of dividends by any financial institution or its holding
company is affected by the requirement to maintain adequate capital pursuant to
applicable capital adequacy guidelines and regulations, and a financial
institution generally is prohibited from paying any dividends if, following
payment thereof, the institution would be undercapitalized. As described above,
each of the Banks exceeded its minimum capital requirements under applicable
guidelines as of December 31, 1997. As of December 31, 1997, approximately
$11.7 million was available to be paid as dividends to the Corporation by the
Banks. Notwithstanding the availability of funds for dividends, however, the
bank regulatory agencies may prohibit the payment of any dividends by the Banks
if such payment is deemed to constitute an unsafe or unsound practice.
INSIDER TRANSACTIONS. The Banks are subject to certain restrictions
imposed by the Federal Reserve Act on extensions of credit to the Corporation
and its subsidiaries, on investments in the stock or other securities of the
Corporation and its subsidiaries and the acceptance of the stock or other
securities of the Corporation or its subsidiaries as collateral for loans.
Certain limitations and reporting requirements are also placed on extensions of
credit by each of the Banks to its directors and officers, to directors and
officers of the Corporation and its subsidiaries, to principal stockholders of
the Corporation, and to "related interests" of such directors, officers and
principal stockholders. In addition, federal law and regulations may affect the
terms upon which any person becoming a director or officer of the Corporation or
one of its subsidiaries or a principal stockholder of the Corporation may obtain
credit from banks with which any of the Banks maintains a correspondent
relationship.
SAFETY AND SOUNDNESS STANDARDS. The federal banking agencies have adopted
guidelines which establish operational and managerial standards to promote the
safety and soundness of federally insured depository institutions. The
guidelines set forth standards for internal controls, information systems,
internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, fees and benefits, asset quality and
earnings. In general, the guidelines prescribe the goals to be achieved in each
area, and each institution is responsible for establishing its own procedures to
achieve those goals. If an institution fails to comply with any of the
standards set forth in the guidelines, the institution's primary federal
regulator may require the institution to submit a plan for achieving and
maintaining compliance. The preamble to the guidelines states that the agencies
expect to require a compliance plan from an institution whose failure to meet
one or more of the guidelines is of such severity that it could threaten the
safety and soundness of the institution. Failure to submit an acceptable plan,
or failure to comply with a plan that has been accepted by the appropriate
federal regulator, would constitute grounds for further enforcement action.
8
<PAGE>
BRANCHING AUTHORITY. Illinois banks, such as the State Banks, have the
authority under Illinois law to establish branches anywhere in the State of
Illinois, subject to receipt of all required regulatory approvals. National
banks headquartered in Illinois, such as Merchants Bank, have the same branching
rights in Illinois as banks chartered under Illinois law.
Effective June 1, 1997 (or earlier if expressly authorized by applicable
state law), the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "Riegle-Neal Act") allows banks to establish interstate branch
networks through acquisitions of other banks, subject to certain conditions,
including certain limitations on the aggregate amount of deposits that may be
held by the surviving bank and all of its insured depository institution
affiliates. The establishment of de novo interstate branches or the acquisition
of individual branches of a bank in another state (rather than the acquisition
of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only
if specifically authorized by state law. The legislation allows individual
states to "opt-out" of certain provisions of the Riegle-Neal Act by enacting
appropriate legislation prior to June 1, 1997. Illinois has enacted legislation
permitting interstate mergers beginning on June 1, 1997, subject to certain
conditions, including a prohibition against interstate mergers unless any
Illinois bank involved has been in existence and continuous operation for more
than five years.
STATE BANK ACTIVITIES. Under federal law and FDIC regulations, FDIC
insured state banks are prohibited, subject to certain exceptions, from making
or retaining equity investments of a type, or in an amount, that are not
permissible for a national bank. Federal law and FDIC regulations also prohibit
FDIC insured state banks and their subsidiaries, subject to certain exceptions,
from engaging as principal in any activity that is not permitted for a national
bank or its subsidiary, respectively, unless the bank meets, and continues to
meet, its minimum regulatory capital requirements and the FDIC determines the
activity would not pose a significant risk to the deposit insurance fund of
which the bank is a member. Impermissible investments and activities must be
divested or discontinued within certain time frames set by the FDIC. These
restrictions have not had, and are not currently expected to have, a material
impact on the operations of the State Banks.
FEDERAL RESERVE SYSTEM. FRB regulations, as presently in effect, require
depository institutions to maintain non-interest earning reserves against their
transaction accounts (primarily NOW and regular checking accounts), as follows:
for transaction accounts aggregating $47.8 million or less, the reserve
requirement is 3% of total transaction accounts; and for transaction accounts
aggregating in excess of $47.8 million, the reserve requirement is $1.434
million plus 10% of the aggregate amount of total transaction accounts in excess
of $47.8 million. The first $4.7 million of otherwise reservable balances are
exempted from the reserve requirements. These reserve requirements are subject
to annual adjustment by the FRB. The Banks are in compliance with the foregoing
requirements.
STATISTICAL DATA
The statistical data required by Guide 3 of the Guides for Preparation and
Filing of Reports and Registration Statements under the Securities Exchange Act
of 1934 is set forth in the following pages. This data should be read in
conjunction with the consolidated financial statements, related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as set forth in the 1997 Annual Report herein incorporated by
reference (attached hereto as Exhibit 13). All dollars in the tables are
expressed in thousands.
9
<PAGE>
The following table sets forth certain information relating to the Corporation's
average consolidated balance sheets and reflects the yield on average earning
assets and cost of average liabilities for the years indicated. Such yields and
costs are derived by dividing income or expense by the average balance of assets
or liabilities. Average balances are derived from daily balances.
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------ ------------------------------ ----------------------------
Average Rate Average Rate Average Rate
Balance Interest (%) Balance Interest (%) Balance Interest (%)
--------- ------- ---- ---------- -------- ---- --------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Securities:
Taxable $ 139,803 $ 9,177 6.50 $ 156,701 $ 10,119 6.42 $ 128,963 $ 8,122 6.23
Non-taxable (tax equivalent) 56,773 4,387 8.07 52,662 4,177 8.09 51,042 4,264 8.37
--------- ------- ---- --------- ------- ---- --------- ------- ----
Total securities 196,576 13,564 6.94 209,363 14,296 6.83 180,005 12,386 6.83
Federal funds sold 4,399 254 5.77 7,776 415 5.34 11,883 732 6.16
Loans held for sale 2,208 141 6.39 4,106 245 5.97 2,408 161 9.30
Net loans (tax equivalent) 500,634 45,248 9.04 399,546 37,074 9.28 291,181 28,098 9.63
--------- ------- ---- --------- ------- ---- --------- ------- ----
Total interest earning assets 703,817 59,207 8.42 620,791 52,030 8.38 485,477 41,377 8.50
Cash and due from banks 34,734 - - 32,139 - - 25,376 - -
Allowance for loan losses (7,718) - - (6,534) - - (5,314) - -
Premises and equipment, net 11,925 - - 12,056 - - 9,353 - -
Accrued interest and other assets 19,102 - - 25,326 - - 6,543 - -
--------- ------- ---- --------- ------- ---- --------- ------- ----
Total assets $ 761,860 59,207 7.78 $ 683,778 52,030 7.91 $ 521,435 41,377 7.91
--------- ------- ---- --------- ------- ---- --------- ------- ----
--------- --------- ---------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest bearing deposits:
NOW accounts $ 76,664 1,798 2.35 $ 74,319 1,777 2.39 $ 66,687 1,571 2.36
Money market accounts 65,446 2,618 4.00 54,535 1,759 3.23 31,604 1,138 3.60
Savings 66,316 1,839 2.77 67,425 1,890 2.80 54,263 1,480 2.73
Time, $100,000 and over 88,467 4,987 5.64 80,483 4,450 5.53 59,964 3,323 5.54
Other time 218,045 12,840 5.89 205,321 12,036 5.86 153,214 8,988 5.87
Federal funds purchased and other
borrowed funds 62,411 3,508 5.62 35,366 1,773 5.01 32,848 1,776 5.41
Notes payable 14,000 969 6.92 14,567 453 3.11 3,000 147 4.90
--------- ------- ---- --------- ------- ---- --------- ------- ----
Total interest bearing
liabilities 591,349 28,559 4.83 532,016 24,138 4.54 401,580 18,423 4.59
Noninterest bearing deposits 105,688 - - 95,293 - - 69,167 - -
Accrued interest and other
liabilities 3,884 - - 2,709 - - 2,406 - -
Stockholders' equity 60,939 - - 53,760 - - 48,282 - -
--------- ------- ---- --------- ------- ---- --------- ------- ----
Total liabilities and
stockholders' equity $ 761,860 28,559 3.75 $ 683,778 24,138 3.53 $ 521,435 18,423 3.53
--------- ------- ---- --------- ------- ---- --------- ------- ----
--------- --------- ---------
Net interest income (tax equivalent) $30,648 $ 27,892 $ 22,954
------- ------- -------
------- ------- -------
Net interest income (tax equivalent)
to total earning assets 4.35 4.49 4.73
---- ---- ----
---- ---- ----
Interest bearing liabilities to
earnings assets 84.02% 85.70% 82.72%
--------- --------- ---------
--------- --------- ---------
</TABLE>
Notes: Nonaccrual loans are included in the above stated average balances.
Tax equivalent basis is calculated using a marginal tax rate of 34%.
Yields on securities available for sale are based on amortized cost.
10
<PAGE>
The following table allocates the changes in net interest income to changes
in either average balances or average rates for earnings assets and interest
bearing liabilities. The changes in interest due to both volume and rate have
been allocated proportionately to the change due to balance and due to rate.
Interest income is measured on a tax equivalent basis using a 34% rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
<TABLE>
<CAPTION>
1997 Compared to 1996 1996 Compared to 1995
----------------------------------- ----------------------------------
Change Due to Change Due to
--------------------- ---------------------
Volume Rate Net Volume Rate Net
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS/INTEREST INCOME
Securities:
Taxable $ (1,107) $ 165 $ (942) $ 1,774 $ 222 $ 1,996
Tax-exempt 320 (110) 210 134 (221) (87)
Federal funds sold (193) 32 (161) (228) (89) (317)
Loans and loans held for sale 9,039 (969) 8,070 10,209 (1,148) 9,061
-------- -------- -------- -------- -------- --------
TOTAL EARNING ASSETS 8,059 (882) 7,177 11,889 (1,236) 10,653
-------- -------- -------- -------- -------- --------
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits:
NOW accounts 55 (34) 21 183 23 206
Money market accounts 391 468 859 751 (130) 621
Savings (31) (20) (51) 368 42 410
Time, $100,000 and over 449 88 537 1,134 (7) 1,127
Other time 749 55 804 3,055 (7) 3,048
Federal funds purchased and other
borrowed funds 1,498 237 1,735 131 (134) (3)
Notes payable (19) 535 516 378 (72) 306
-------- -------- -------- -------- -------- --------
TOTAL INTEREST BEARING LIABILITIES 3,092 1,329 4,421 6,000 (285) 5,715
-------- -------- -------- -------- -------- --------
NET INTEREST INCOME $ 4,967 $ (2,211) $ 2,756 $ 5,889 $ (951) $ 4,938
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
</TABLE>
The following table presents the composition of the securities portfolio by
major category as of December 31, of each year indicated:
SECURITIES PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
1997 1996 1995
--------------------- ----------------------- ----------------------
% of % of % of
Amount Portfolio Amount Portfolio Amount Portfolio
---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities $ 14,092 6.88% $ 17,640 9.05% $ 24,860 13.28%
U.S. Government agencies 86,254 42.13 76,980 39.52 53,481 28.57
U.S. Government agency mortgage backed securities 26,092 12.74 34,022 17.47 45,175 24.14
States and political subdivisions 62,981 30.76 54,827 28.15 51,820 27.69
Collateralized mortgage obligations 8,310 4.06 8,720 4.48 9,960 5.32
Equity securities 7,032 3.43 2,591 1.33 1,873 1.00
---------- ------ ---------- ------ ---------- ------
Total $ 204,761 100.00% $ 194,780 100.00% $ 187,169 100.00%
---------- ------ ---------- ------ ---------- ------
---------- ------ ---------- ------ ---------- ------
</TABLE>
Mortgage-backed securities are comprised of investments in pools of
residential mortgages. The mortgage pools are issued and guaranteed by the
Federal Home Loan Mortgage Corporation ("FHLMC"), the Government National
Mortgage Association ("GNMA"), or the Federal National Mortgage Association
("FNMA"). Collateralized mortgage obligations are secured by FHLMC, GNMA, or
FNMA certificates. Other securities consist of FHLB stock and Federal Reserve
Bank Stock.
As of December 31, 1997, and 1996, the Company held structured notes carried
at fair values of $2,247,000 and $4,236,000. The amortized cost of these
securities was $2,250,000 and $4,250,000 as of December 31, 1997, and 1996.
These securities were issued by the FHLB and FNMA.
11
<PAGE>
The following table presents the maturities and weighted average yield of
securities by major category as of December 31, 1997. Securities with call
options are listed according to the earlier of call date or maturity date.
Yields are calculated on a tax equivalent basis using a 34% rate.
SECURITIES PORTFOLIO - MATURITY AND YIELDS
<TABLE>
<CAPTION>
After One But After Five But
Within Within Within After
One Year Five Years Ten Years Ten Years Total
---------------- ---------------- ----------------- -------------- -----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- -------- ----- -------- ------ ------- ----- --------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities $ 8,011 5.44% $ 6,081 5.94% $ - -% $ - -% $ 14,092 5.66%
U.S. government agencies 49,160 6.54 35,115 6.75 1,979 6.55 - - 86,254 6.63
U.S. government agency
mortgage backed securities 3,445 6.11 13,458 6.65 4,078 6.98 5,111 7.09 26,092 6.72
States and political subdivisions 1,367 8.98 31,528 8.24 28,950 7.58 1,136 8.57 62,981 7.96
Collateralized mortgage obligations 4,257 5.71 2,475 6.69 - - 1,578 6.84 8,310 6.22
Other securities 7,032 6.00 - - - - - - 7,032 6.00
-------- ---- -------- ---- -------- ---- ------- ---- --------- ----
Total $ 73,272 6.35% $ 88,657 7.21% $ 35,007 7.45% $ 7,825 7.25% $ 204,761 6.94%
-------- ---- -------- ---- -------- ---- ------- ---- --------- ----
-------- ---- -------- ---- -------- ---- ------- ---- --------- ----
</TABLE>
As of December 31, 1997, net unrealized gains of approximately $2.5 million,
reduced by deferred income taxes of approximately $855,000, resulted in an
increase in equity capital of approximately $1.7 million. As of December 31,
1996, net unrealized gains of $429,000, reduced by deferred income taxes of
$112,000, resulted in an increase in equity capital of $317,000.
There were no significant concentrations of investments (greater than 10% of
the Corporation's stockholders' equity) in any individual security issue
except for U.S. Treasury securities and obligations of U.S. Government
agencies and corporations. Although the Corporation held securities issued by
municipalities within the states of Illinois and Wisconsin which in the
aggregate exceeded 10% of stockholders' equity, none of the holdings from
individual municipal issuers exceeded this threshold.
The following table presents the composition of the loan portfolio at
December 31, in the years indicated:
LOAN PORTFOLIO
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Commercial and industrial $ 168,899 $ 161,847 $ 109,872 $ 112,828 $ 104,711
Real estate - commercial 95,755 75,449 67,739 72,305 53,334
Real estate - construction 69,901 54,513 40,510 24,470 35,249
Real estate - residential 122,732 85,107 31,673 19,549 11,356
Installment 100,869 73,918 50,489 53,806 73,861
Credit card receivables 8,100 6,697 5,644 4,119 -
Other loans 813 1,188 455 937 293
--------- --------- --------- --------- ---------
Gross loans 567,069 458,719 306,382 288,014 278,804
Unearned discount (1,324) (1,535) (1,743) (2,054) (3,807)
Deferred loan fees (397) (382) (312) (387) (330)
--------- --------- --------- --------- ---------
Total loans 565,348 456,802 304,327 285,573 274,667
Allowance for loan losses (8,360) (7,274) (5,176) (5,140) (4,705)
--------- --------- --------- --------- ---------
Loans, net $ 556,988 $ 449,528 $ 299,151 $ 280,433 $ 269,962
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
12
<PAGE>
The following table sets forth the remaining contractual maturities for
certain loan categories at December 31, 1997:
MATURITY AND RATE SENSITIVITY OF LOANS
<TABLE>
<CAPTION>
Over 1 Year
Through 5 Years Over 5 Years
---------------------- ---------------------
One Year Fixed Floating Fixed Floating
or Less Rate Rate Rate Rate Total
--------- --------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Commercial and industrial $ 84,512 $ 39,825 $ 20,057 $ 14,018 $ 10,487 $ 168,899
Real estate - commercial 18,498 57,724 10,142 7,717 1,674 95,755
Real estate - construction 58,998 7,212 2,683 1,008 - 69,901
Real estate - residential 3,305 8,096 193 6,588 104,550 122,732
Installment 38,506 59,463 1,001 1,707 192 100,869
Credit card receivables 8,100 - - - - 8,100
Other loans 813 - - - - 813
--------- --------- -------- -------- --------- ---------
Total $ 212,732 $ 172,320 $ 34,076 $ 31,038 $ 116,903 $ 567,069
--------- --------- -------- -------- --------- ---------
--------- --------- -------- -------- --------- ---------
</TABLE>
The following table sets forth the amounts of nonperforming assets at
December 31, of the years indicated:
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans $ 4,623 $ 2,970 $ 1,135 $ 1,397 $ 1,956
Loans past due 90 days or more
and still accruing interest - - - - -
Restructured loans 485 359 1,047 2,102 -
------- ------- ------- ------- -------
Total nonperforming loans 5,108 3,329 2,182 3,499 1,956
Other real estate 178 333 566 845 223
------- ------- ------- ------- -------
Total nonperforming assets $ 5,286 $ 3,662 $ 2,748 $ 4,344 $ 2,179
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
Impaired loans were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Year-end loans with no allowance for loan losses allocated $ 2,234 $ 523 $ -
Year-end loans with allowance for loan losses allocated 1,325 905 921
Amount of the allowance allocated 473 363 631
Average of impaired loans during the year 2,705 1,480 2,378
Interest income recognized during impairment 277 191 305
Cash-basis interest income recognized 174 89 302
</TABLE>
Accrual of interest is discontinued on a loan when principal or interest is
ninety days or more past due, unless the loan is well secured and in the
process of collection. When a loan is placed on nonaccrual status, interest
previously accrued but not collected in the current period is reversed
against current period interest income. Interest accrued in prior years but
not collected is charged against the allowance for loan losses. Interest
income of approximately $225,000 was recorded during 1997 on loans in
nonaccrual status at December 31, 1997. Interest income which would have been
recognized during 1997 had these loans been on an accrual basis throughout
the year was approximately $356,000.
13
<PAGE>
The following table summarizes, for the years indicated, activity in the
allowance for loan losses, including amounts charged off, amounts of
recoveries, additions to the allowance charged to operating expense, and the
percentage of net charge-offs to average loans outstanding:
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Average total loans (exclusive of loans held for sale) $ 500,634 $ 399,546 $ 291,181 $ 278,819 $ 256,888
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Allowance at beginning of year $ 7,274 $ 5,176 $ 5,140 $ 4,705 $ 4,161
Increase due to the acquisition of Valley - 798 - - -
Charge-offs:
Commercial and industrial 650 1,193 1,248 1,321 839
Real estate - commercial 164 126 272 393 375
Real estate - construction - - - 20 -
Real estate - residential 80 5 - 150 *
Installment and other loans 1,228 917 993 1,058 1,367
--------- --------- --------- --------- ---------
Total charge-offs 2,122 2,241 2,513 2,942 2,581
--------- --------- --------- --------- ---------
Recoveries:
Commercial and industrial 162 509 223 384 147
Real estate - commercial 23 658 83 236 147
Real estate - construction - - - - -
Real estate - residential 54 - - 13 *
Installment and other loans 333 360 460 446 408
--------- --------- --------- --------- ---------
Total recoveries 572 1,527 766 1,079 702
--------- --------- --------- --------- ---------
Net charge-offs 1,550 714 1,747 1,863 1,879
Provision for loan losses 2,636 2,014 1,783 2,298 2,423
--------- --------- --------- --------- ---------
Allowance at end of period $ 8,360 $ 7,274 $ 5,176 $ 5,140 $ 4,705
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net charge-offs to average loans 0.31% 0.18% 0.60% 0.67% 0.73%
Allowance at year end to average loans 1.67% 1.82% 1.78% 1.84% 1.83%
</TABLE>
*Charge-offs and recoveries of real estate - residential loans are reported
above in real estate - commercial for 1993.
The provision for loan losses is based upon management's estimate of
anticipated loan losses and its evaluation of the adequacy of the allowance
for loan losses. Factors which influence management's judgement in
estimating loan losses are the composition of the portfolio, past loss
experience, loan delinquencies, nonperforming loans, and other factors that,
in management's judgment, deserve evaluation in estimating loan losses.
The following table shows the Corporation's allocation of the allowance for
loan losses by types of loans and the amount of unallocated allowance, at
December 31, of the years indicated:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------------------- ----------------- ----------------- ------------------ -----------------
Loan Type Loan Type Loan Type Loan Type Loan Type
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- --------- ------ --------- ------ --------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and industrial $ 2,259 29.8% $2,316 35.3% $3,441 36.1% $3,227 39.2% $3,369 37.6%
Real estate - commercial 436 16.9 117 16.4 152 22.3 199 25.1 213 19.1
Real estate - construction 341 12.3 265 11.9 193 13.3 193 8.5 70 12.6
Real estate - residential 270 21.6 383 18.6 135 10.4 55 6.8 - 4.1
Installment and other loans 2,299 19.4 1,209 17.8 594 17.9 865 20.4 966 26.6
Unallocated 2,755 2,984 661 601 87
------- ----- ------ ----- ------ ----- ------ ----- ------ -----
Total $ 8,360 100.0% $7,274 100.0% $5,176 100.0% $5,140 100.0% $4,705 100.0%
------- ----- ------ ----- ------ ----- ------ ----- ------ -----
------- ----- ------ ----- ------ ----- ------ ----- ------ -----
</TABLE>
14
<PAGE>
The following table sets forth the amount and maturities of deposits of
$100,000 or more at December 31, 1997:
TIME DEPOSITS OF $100,000 OR MORE
<TABLE>
<S> <C>
3 months or less $ 44,679
Over 3 months through 6 months 17,908
Over 6 months through 12 months 18,078
Over 12 months 10,555
--------
$ 91,220
--------
--------
</TABLE>
The following table reflects categories of short-term borrowings having
average balances during the year greater than 30% of stockholders' equity of
the Company at the end of the year. During each year reported, securities
sold under repurchase agreements are the only category meeting this criteria.
Information presented is as of or for the year ended December 31, for the
years indicated:
SHORT-TERM BORROWINGS
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ -------
<S> <C> <C> <C>
Balance at end of year $21,754 $19,225 $22,626
Weighted average interest rate 5.76% 5.52% 5.26%
Maximum month-end amount outstanding during the year $28,179 $30,975 $47,892
Average amount outstanding during the year $23,849 $26,587 $31,298
Weighted average interest rate during the year 5.13% 4.94% 5.33%
</TABLE>
The following table presents selected financial ratios as of or for the year
ended December 31, for the years indicated:
SELECTED RATIOS
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Return on average total assets 0.96% 0.95% 1.19%
Return on average equity 12.05% 12.14% 12.83%
Average equity to average assets 8.00% 7.86% 9.26%
Tier 1 capital to risk-adjusted assets 9.15% 9.02% 14.54%
Total capital to risk adjusted assets 10.42% 10.26% 15.79%
Tier 1 leverage ratio 6.91% 6.90% 10.31%
Dividend payout ratio 23.96% 22.13% 19.91%
</TABLE>
Note: Unrealized gains (losses) on securities available for sale are included
in the average balances used to calculate these ratios.
15
<PAGE>
ITEM 2. PROPERTIES
The principal offices of the Corporation and Merchants Bank are located in
Merchants Bank's West Plaza location at 1851 West Galena Boulevard in Aurora.
The two-story, 28,100 square foot building is owned by Merchants Bank and was
constructed in 1962. During 1994, the entire first and second floors of this
building were remodeled to provide space for the trust department and mortgage
division. There are two parking lots which can accommodate 90 cars.
The Merchants Bank's former main office building is located at 34 South
Broadway, Aurora, Illinois. During 1997, Merchants Bank donated the 60,500
square foot building with a carrying value of $850,000, to a charitable
organization. Merchants Bank will lease a portion of the building for a full
service branch. The building was appraised at $4,130,000, which resulted in
charitable contribution tax credits of $1,504,000, which were recorded in 1997.
Merchants Bank's downtown drive-up facility is located at 205 East Downer
Place in Aurora and comprises approximately 9,950 square feet. The one-story
building is owned by Merchants Bank and has eight drive-up windows.
In 1997, the Company moved its administrative and operations functions to a
leased location at 2255 West Sullivan Road in Aurora. The Company leases a
single story office wing of approximately 31,000 square feet.
Merchants Bank's Fox Valley Villages branch is a full-service facility
located at Long Grove Drive and Route 34 in Aurora. The one-story building is
owned by Merchants Bank and comprises approximately 3,400 square feet. The
branch has three drive-up lanes and four teller stations. The basement of this
building contains a safe deposit vault and is also being used for storage, a
conference room and rental space.
Merchants Bank's Douglas Square branch is a full-service facility located
at 1 Merchants Plaza in Oswego, Illinois. The 16,300 square foot building is
owned by Merchants Bank and was built in 1989. The three-story brick building
has six drive-in lanes and six teller stations. The basement of this building is
being used as a training room, an employee lounge and for storage. There is a
parking lot which can accommodate a total of approximately 85 cars.
Merchants Bank also has a branch located in the Cub Foods store in
Aurora at 55 Constitution Drive. A Facility License and Construction
Agreement with International Banking Technologies, Inc. was entered into in
June, 1992, under which the Merchants Bank is permitted to operate a bank
branch in the Cub Foods store for a term of 20 years, ending January 25, 2013.
Merchants Bank's Randall Square branch is a full service facility with 4
drive-up lanes located at 1771 Merchants Drive in Geneva, Illinois. The
one-story, 6,200 square foot building is owned by Merchants Bank and
construction was completed in the first quarter of 1996.
Merchants Bank has a loan production office located at 3 North Smith
Street in Aurora. Merchants Bank leases approximately 1,200 square feet under
a three year lease entered into in September, 1994, which may be extended for
an additional three years at the option of Merchants Bank.
Merchants Bank has a loan production office located in Yorkville,
Illinois, at 520 Countryside Center. Approximately 1,100 square feet are
leased under a three year agreement entered into in June, 1994, which may be
extended for an additional three years at the option of the Merchants Bank.
Hinckley State Bank's main office is located in Hinckley Illinois, at
101 W. Lincoln. The two story, 10,900 square foot building is owned and
occupied entirely by Hinckley State Bank. A full service facility is located
at 80 N. Dugan Road, Sugar Grove. This 1,900 square foot facility was built
by Hinckley State Bank in 1993.
Fox Valley Bank's main office is located at 1600 East Main Street, in
St. Charles. The location consists of 5,100 square feet of leased office
space. Fox Valley Bank leases a 1,800 square foot full service facility
located at 1525 West Main Street, in St. Charles, Illinois. A full service
facility is located in 1,200 square feet of leased office space located at
629 West State Street, Geneva, Illinois.
ITEM 3. LEGAL PROCEEDINGS
The Banks have certain collection suits in the ordinary course of
business against their debtors and are defendants in legal actions arising
from normal business activities. Management, after consultation with legal
counsel, believes that the ultimate liabilities, if any, resulting from these
actions will not have a material adverse effect on the financial position of
the Banks or on the consolidated financial position of the Corporation.
16
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY
HOLDER MATTERS
The Corporation incorporates by reference the information contained on page
39 of the 1997 Annual Report (attached hereto as Exhibit 13) under the caption
"Market for the Company's Common Stock and Related Security Holder Matters." As
of March 9, 1998, there were 732 holders of record of the Corporation's common
stock.
The Corporation also incorporates by reference the information contained on
page 23 of the 1997 Annual Report (attached hereto as Exhibit 13) under the
"Notes to Consolidated Financial Statements Note 16: Stockholder Rights Plan."
The Corporation also incorporates by reference the information contained on
pages 22 and 23 of the 1997 Annual Report (attached hereto as Exhibit 13) under
the "Notes to Consolidated Financial Statements Note 15: Capital Matters."
ITEM 6. SELECTED FINANCIAL DATA
The Corporation incorporates by reference the information contained on page
8 of the 1997 Annual Report (attached hereto as Exhibit 13) under the caption
"Merchants Bancorp, Inc. and Subsidiaries Financial Highlights."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Corporation incorporates by reference the information contained on
pages 29 - 37 of the 1997 Annual Report (attached hereto as Exhibit 13) under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Corporation incorporates by reference the information contained on page
38 of the 1997 Annual Report (attached hereto as Exhibit 13) under the caption
"Sensitivity to Market Risk."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Corporation incorporates by reference the following financial
statements and related notes and independent auditors' report from the 1997
Annual Report (attached hereto as Exhibit 13):
<TABLE>
<CAPTION>
ANNUAL REPORT
PAGE NO.
<S> <C>
Consolidated Balance Sheets 9
Consolidated Statements of Income 10
Consolidated Statements of Cash Flows 11
Consolidated Statements of Stockholders' Equity 12
Notes to Consolidated Financial Statements 13-27
Independent Auditors' Report 28
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
17
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Corporation incorporates by reference the information contained on
pages 1,2 and 3 of the Proxy Statement for the 1998 Annual Meeting of
Stockholders (attached hereto as exhibit 99) under the caption "Election of
Directors."
EXECUTIVE OFFICERS OF THE REGISTRANT AND SUBSIDIARY
<TABLE>
<CAPTION>
NAME, AGE AND YEAR POSITIONS WITH REGISTRANT AND
BECAME EXECUTIVE OFFICER BUSINESS EXPERIENCE DURING
OF THE REGISTRANT PAST FIVE YEARS
- ------------------------ -----------------------------
<S> <C>
Calvin R. Myers Chairman of the Board, President and Chief
Age 55 1982 Executive Officer (1987-present), Director of the
Corporation (1986-present); Chairman of the
Board and CEO (1987-1991), Director of First
American Bank (1985-1991); Chairman of the
Board and CEO (1987-present), President
(1989-present), Director of the Bank
(1986-present).
Frank K. Voris Vice President of the Corporation
Age 58 1985 (1993-present); Executive Vice President and
Chief Operating Officer (1990-present), Senior
Vice President (1985-1987), Director of the
Bank (1990-present); President of First
American Bank (1987-1991).
Randal A. Wright Executive Vice President, Commercial Banking
Age 46 1989 Division (1993-present); Senior Vice President
and Director of Commercial Banking of the Bank
(1989-1993); President and CEO of First
National Bank of Oelwein, Iowa (1985-1989).
Terence L. Kothe Executive Vice President, Trust and Financial
Age 54 1992 Services (1992-present) of the Bank; Vice
President, Senior Trust and Investment Officer
(1973-1992) of Old Second National Bank of
Aurora.
J. Douglas Cheatham Vice President and Chief Financial Officer of
Age 41 1990 the Corporation (1993-present); Vice President
and Financial Officer (1990-present), Financial
Officer (1988-1990), Analyst of the Bank
(1987-1988).
Gerald M. Lanigan Senior Vice President and Trust Officer of the
Age 48 1984 Bank (1985-present).
Scott B. Everhart Senior Vice President of Operations
Age 46 1988 (1990-present), Director of Operations
(1988-present), Management Analysis Director of
the Bank (1986-1988).
</TABLE>
There are no arrangements or understandings between any of the executive
officers or any other persons pursuant to which any of the executive officers
have been selected for their respective positions.
ITEM 11. EXECUTIVE COMPENSATION
The Corporation incorporates by reference the information contained on page
3 of the Proxy Statement for the 1998 Annual Meeting of Stockholders (attached
hereto as exhibit 99) under the caption "Compensation of Directors," and on
pages 6 - 9 under the caption "Executive Compensation." The sections in the
Proxy Statement marked "Board Compensation Committee Report on Executive
Compensation" and "Stockholder Return Performance Presentation" are furnished
for the information of the Commission and are not deemed to be "filed" as part
of this Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Corporation incorporates by reference the information contained on
pages 3 - 5 of the Proxy Statement for the 1998 Annual Meeting of Stockholders
(attached hereto as exhibit 99) under the caption "Security Ownership of Certain
Beneficial Owners and Management."
18
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Corporation incorporates by reference the information contained on page
10 of the Proxy Statement for the 1998 Annual Meeting of Stockholders (attached
hereto as exhibit 99) under the caption "Transactions with Management."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) INDEX TO FINANCIAL STATEMENTS
The Corporation incorporates by reference the following financial
statements and related notes and independent auditors' report from the 1997
Annual Report (attached hereto as Exhibit 13):
<TABLE>
<CAPTION>
ANNUAL REPORT
PAGE NO.
-------------
<S> <C>
Consolidated Balance Sheets 9
Consolidated Statements of Income 10
Consolidated Statements of Cash Flows 11
Consolidated Statements of Stockholders' Equity 12
Notes to Consolidated Financial Statements 13-27
Independent Auditors' Report 28
</TABLE>
(a)(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules as required by Item 8 and Item 14 of Form
10-K have been omitted because the information requested is either not
applicable or has been included in the consolidated financial statements or
notes thereto.
(a)(3) EXHIBITS
The following exhibits required by Item 601 of Regulation S-K are included
along with this 10-K filing:
ITEM 601
TABLE II. NO.
(3)(a) Its Restated Certificate of Incorporation (filed as an exhibit
to the Corporation's Registration Statement on Form S-14,
No. 2-96562, which was filed with the Securities and Exchange
Commission on March 21, 1985; a Certificate of Amendment to the
Certificate of Incorporation as filed as an exhibit to the
Corporation's Form 8-A, which was filed with the Securities and
Exchange Commission on April 30, 1986 and a Certificate of
Amendment to the Certificate of Incorporation as filed as
Exhibit 3(b) of the Corporation's 10-K for the fiscal year ended
December 31, 1987, a Certificate of Designation, Preferences and
Rights of Series A Junior Participating Preferred Stock filed as
Exhibit A to Exhibit 1 to the Corporation's Form 10-K, which was
filed with the Securities and Exchange Commission on January 12,
1989, and a Certificate of Designation, Preferences and Rights
of Series A Junior Participating Preferred Stock filed as
Exhibit 4.4 to the Corporation's Amendment 1 to Form S-2, No.
33-68684, which was filed with the Securities and Exchange
Commission on October 8, 1993, all of which are incorporated
herein by reference)
(3)(b) By-laws of Merchants Bancorp, Inc. (filed as Exhibit 3(c) of the
Corporation's 10-K for the fiscal year ended December 31, 1987,
and incorporated herein by reference)
(4)(a) Article Fourth of its Restated Certificate of Incorporation
(filed as Exhibit 3(a) to its Registration Statement on Form
S-14, No. 2-96562, which was filed with the Securities and
Exchange Commission on March 21, 1985, and incorporated herein
by reference)
19
<PAGE>
(4)(b) Article II and Article VII, Section 1, of its By-laws, as
amended February 17, 1987 (filed as Exhibit 3(c) of the
Corporation's 10-K for the year ended December 31, 1987, and
incorporated herein by reference)
(4)(c) Rights Agreement dated January 4, 1989, between the Corporation
and The Merchants National Bank of Aurora (filed as Exhibit 1 on
the Corporation's Form 8-K as filed with the Securities and
Exchange Commission on January 12, 1989, and incorporated herein
by reference)
(10)(a) Rights Agreement dated January 4, 1989 between the Corporation
and The Merchants Bank of Aurora (filed as Exhibit 1 to the
Corporation's Form 8-K as filed with the Securities and Exchange
Commission on January 12, 1989, and incorporated herein by
reference)
(10)(b) Agreement for Facility License and Construction Agreement dated
June 18, 1992, between International Banking Technologies, Inc.,
a Georgia corporation, and The Merchants National Bank of Aurora
(filed as Exhibit 10(g) of the Corporation's Form 10-K for the
year ended December 31, 1992, and incorporated herein by
reference)
(10)(c) Employment Agreement dated August 30, 1993, between the
Corporation and Calvin R. Myers (filed as Exhibit 10.8 to its
Registration Statement on Form S-2, No. 33-68684, which was
filed with the Securities and Exchange Commission on October 8,
1993, and incorporated herein by reference)
(13) The Corporation's 1997 Annual Report to Stockholders
(22) A list of all subsidiaries of the Corporation
(23) Consent of Crowe, Chizek & Company LLP
(27) Financial Data Schedule
(99) The Corporation's Proxy Statement for the annual meeting of
stockholders to be held April 21, 1998. The sections marked
"Board Compensation Committee Report on Executive Compensation"
and "Stockholder Return Performance Presentation" are furnished
for the information of the Commission and are not deemed to be
"filed" as part of this 10-K.
(b) REPORTS ON FORM 8-K
None
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
MERCHANTS BANCORP, INC.
BY: /S/ CALVIN R. MYERS
-------------------------------
Calvin R. Myers, Chairman of the Board,
President and Chief Executive Officer
BY: /S/ J. DOUGLAS CHEATHAM
-------------------------------
J. Douglas Cheatham,
Vice President and Chief Financial Officer
DATE: March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/S/ CALVIN R. MYERS Chairman of the Board; Director; March 30, 1998
- ------------------------- President and Chief Executive
Calvin R. Myers Officer
/S/ C. TELL COFFEY Director March 30, 1998
- -------------------------
C. Tell Coffey
/S/ WILLIAM C. GLENN Director March 30, 1998
- -------------------------
William C. Glenn
/S/ WILLIAM F. HEJNA Director March 30, 1998
- -------------------------
William F. Hejna
/S/ JOHN M. LIES Director March 30, 1998
- -------------------------
John M. Lies
/S/ JAMES D. PEARSON Director March 30, 1998
- -------------------------
James D. Pearson
/S/ FRANK A. SARNECKI Director March 30, 1998
- -------------------------
Frank A. Sarnecki
/S/ JOHN J. SWALEC Director March 30, 1998
- -------------------------
John J. Swalec
21
<PAGE>
SIGNATURE TITLE DATE
--------- ----- ----
/S/ NORMAN L. TITINER Director March 30, 1998
- -------------------------
Norman L. Titiner
/S/ J. DOUGLAS CHEATHAM Vice President and Chief Financial March 30, 1998
- ------------------------- Officer
J. Douglas Cheatham
22
<PAGE>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION OF EXHIBITS PAGE NO.
- ---------------------------------------------------------------------------
(3)(a) Its Restated Certificate of Incorporation (filed as an --
exhibit to the Corporation's Registration Statement on
Form S-14, No.2-96562, which was filed with the
Securities and Exchange Commission on March 21, 1985; a
Certificate of Amendment to the Certificate of
Incorporation as filed as an exhibit to the
Corporation's Form 8-A, which was filed with the
Securities and Exchange Commission on April 30, 1986 and
a Certificate of Amendment to the Certificate of
Incorporation as filed as Exhibit 3(b) of the
Corporation's 10-K for the fiscal year ended December
31, 1987, a Certificate of Designation, Preferences and
Rights of Series A Junior Participating Preferred Stock
filed as Exhibit A to Exhibit 1 to the Corporation's
Form 10-K, which was filed with the Securities and
Exchange Commission on January 12, 1989, and a
Certificate of Designation, Preferences and Rights of
Series A Junior Participating Preferred Stock filed as
Exhibit 4.4 to the Corporation's Amendment 1 to Form S-2,
No. 33-68684, which was filed with the Securities and
Exchange Commission on October 8, 1993, all of which are
incorporated herein by reference)
- ---------------------------------------------------------------------------
(3)(b) By-laws of Merchants Bancorp, Inc. (filed as Exhibit --
3(c) of the Corporation's 10-K for the fiscal year ended
December 31, 1987, and incorporated herein by reference)
- ---------------------------------------------------------------------------
(4)(a) Article Fourth of its Restated Certificate of --
Incorporation (filed as Exhibit 3(a) to its Registration
Statement on Form S-14, No. 2-96562, which was filed
with the Securities and Exchange Commission on March 21,
1985, and incorporated herein by reference)
- ---------------------------------------------------------------------------
(4)(b) Article II and Article VII, Section 1, of its By-laws, --
as amended February 17, 1987 (filed as Exhibit 3(c) of
the Corporation's 10-K for the year ended December 31,
1987, and incorporated herein by reference)
- ---------------------------------------------------------------------------
(4)(c) The Rights Agreement dated January 4, 1989, between the --
Corporation and The Merchants National Bank of Aurora
(filed as Exhibit 1 on the Corporation's Form 8-K as
filed with the Securities and Exchange Commission on
January 12, 1989, and incorporated herein by reference)
- ---------------------------------------------------------------------------
(10)(a) Rights Agreement dated January 4, 1989 between the --
Corporation and The Merchants Bank of Aurora (filed as
Exhibit 1 to the Corporation's Form 8-K as filed with
the Securities and Exchange Commission on January 12,
1989, and incorporated herein by reference)
- ---------------------------------------------------------------------------
(10)(b) Agreement for Facility License and Construction --
Agreement dated June 18, 1992, between International
Banking Technologies, Inc., a Georgia corporation, and
The Merchants National Bank of Aurora (filed as Exhibit
10(g) of the Corporation's Form 10-K for the year ended
December 31, 1992, and incorporated herein by reference)
- ---------------------------------------------------------------------------
(10)(c) Employment Agreement dated August 30, 1993, between the --
Corporation and Calvin R. Myers (filed as Exhibit 10.8
to its Registration Statement on Form S-2, No. 33-68684,
which was filed with the Securities and Exchange
Commission on October 8, 1993, and incorporated herein
by reference)
- ---------------------------------------------------------------------------
(13) The Corporation's 1997 Annual Report to Stockholders 24 - 55
- ---------------------------------------------------------------------------
(22) A list of all subsidiaries of the Corporation 56
- ---------------------------------------------------------------------------
(23) Consent of Crowe, Chizek & Company LLP 57
- ---------------------------------------------------------------------------
(27) Financial Data Schedule --
- ---------------------------------------------------------------------------
(99) The Corporation's Proxy Statement for the annual meeting 58 - 70
of stockholders to be held April 21, 1998. The sections
marked "Board Compensation Committee Report on Executive
Compensation" and "Stockholder Return Performance
Presentation" are furnished for the information of the
Commission and are not deemed to be "filed" as part of
this 10-K.
- ---------------------------------------------------------------------------
23
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
FINANCIAL HIGHLIGHTS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT SUMMARY
Interest income $ 57,519 $ 50,460 $ 39,875 $ 33,233 $ 29,546
Interest expense 28,559 24,138 18,423 13,228 11,681
-------- -------- -------- -------- --------
Net interest income 28,960 26,322 21,452 20,005 17,865
Provision for loan losses 2,636 2,014 1,783 2,298 2,423
-------- -------- -------- -------- --------
Net interest income after
provision for loan losses 26,324 24,308 19,669 17,707 15,442
Noninterest income 9,660 9,541 6,918 6,564 6,606
Noninterest expenses 27,754 24,865 17,889 16,733 16,177
-------- -------- -------- -------- --------
Income before income
taxes and cumulative
effect of a change in
accounting principle 8,230 8,984 8,698 7,538 5,871
Provision for income taxes 889 2,456 2,502 2,079 1,437
-------- -------- -------- -------- --------
Income before cumulative
effect of a change in
accounting principle 7,341 6,528 6,196 5,459 4,434
Cumulative effect of a change
in accounting principle - - - - 300
-------- -------- -------- -------- --------
Net income $ 7,341 $ 6,528 $ 6,196 $ 5,459 $ 4,734
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
PER SHARE INFORMATION*
Income before cumulative
effect of a change in
accounting principle $ 1.42 $ 1.27 $ 1.21 $ 1.06 $ 1.05
Cumulative effect of a
change in accounting
principle - - - - 0.08
-------- -------- -------- -------- --------
Basic earnings per share $ 1.42 $ 1.27 $ 1.21 $ 1.06 $ 1.13
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Diluted earnings per share $ 1.41 $ 1.26 $ 1.20 $ 1.06 $ 1.13
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Dividends $ 0.36 $ 0.28 $ 0.24 $ 0.19 $ 0.17
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
*Restated to reflect a two-for-one stock split in 1997.
BALANCE SHEET SUMMARY -- END OF YEAR
Total assets $838,971 $724,409 $539,761 $496,289 $462,483
Total deposits 650,718 600,970 453,771 413,741 383,600
Long term debt 73,750 14,000 3,000 3,000 3,450
Total stockholders' equity 65,317 58,198 54,094 43,456 44,308
Allowance for loan losses 8,360 7,274 5,176 5,140 4,705
</TABLE>
8
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1997 and 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Cash and due from banks $ 35,914 $ 42,455
Federal funds sold 7,080 2,613
-------- --------
Cash and cash equivalents 42,994 45,068
Securities available for sale 204,761 194,780
Loans held for sale 2,833 4,149
Loans 565,348 456,802
Allowance for loan losses (8,360) (7,274)
-------- --------
Loans, net 556,988 449,528
Premises and equipment, net 11,295 12,100
Other real estate owned 178 333
Mortgage servicing rights, net 1,674 1,438
Goodwill, net 6,773 6,977
Core deposit intangible assets, net 2,055 2,452
Accrued interest and other assets 9,420 7,584
-------- --------
Total assets $838,971 $724,409
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $118,187 $112,203
Interest-bearing 532,531 488,767
-------- --------
Total deposits 650,718 600,970
Federal funds purchased and overnight borrowings 23,100 25,200
Securities sold under repurchase agreements 21,754 19,325
Federal Home Loan Bank term advances 59,750 -
Notes payable 14,000 14,000
Accrued interest and other liabilities 4,332 6,716
-------- --------
Total liabilities 773,654 666,211
-------- --------
STOCKHOLDERS' EQUITY
Preferred stock: $1 par; authorized 500,000; none issued - -
Common stock: $1 par; authorized 6,000,000; issued 5,213,380 and 2,606,690 5,213 2,607
Surplus 16,028 18,468
Retained earnings 42,544 36,962
Unrealized gain on securities available for sale, net 1,653 317
Treasury stock, at cost, 51,782 and 28,607 (121) (156)
-------- --------
Total stockholders' equity 65,317 58,198
-------- --------
Total liabilities and stockholders' equity $838,971 $724,409
-------- --------
-------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
Years Ended December 31, 1997, 1996, and 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees $45,052 $36,924 $28,046
Loans held for sale 141 245 161
Securities:
Taxable 9,177 10,119 8,122
Tax-exempt 2,895 2,757 2,814
Federal funds sold 254 415 732
------- ------- -------
Total interest income 57,519 50,460 39,875
------- ------- -------
INTEREST EXPENSE
Deposits 24,082 21,912 16,500
Federal funds purchased and overnight borrowings 1,360 466 107
Securities sold under repurchase agreements 1,224 1,307 1,662
Federal Home Loan Bank term advances 924 23 147
Notes payable 969 430 7
------- ------- -------
Total interest expense 28,559 24,138 18,423
------- ------- -------
Net interest income 28,960 26,322 21,452
Provision for loan losses 2,636 2,014 1,783
------- ------- -------
Net interest income after provision for loan losses 26,324 24,308 19,669
------- ------- -------
NONINTEREST INCOME
Trust income 2,315 2,028 1,925
Mortgage banking income 2,358 2,202 1,267
Service charges and fees 4,235 3,796 2,713
Securities gains (losses), net (380) 196 133
Other income 1,132 1,319 880
------- ------- -------
Total noninterest income 9,660 9,541 6,918
------- ------- -------
NONINTEREST EXPENSES
Salaries and employee benefits 13,598 12,924 9,893
Occupancy expenses, net 1,907 1,612 1,030
Furniture and equipment expenses 1,838 1,650 1,238
Amortization of goodwill 367 385 -
Amortization of core deposit intangible assets 397 405 101
Building contribution 850 - -
Other expenses 8,797 7,889 5,627
------- ------- -------
Total noninterest expenses 27,754 24,865 17,889
------- ------- -------
Income before income taxes 8,230 8,984 8,698
Provision for income taxes 889 2,456 2,502
------- ------- -------
Net income $ 7,341 $ 6,528 $ 6,196
------- ------- -------
------- ------- -------
Basic earnings per share $ 1.42 $ 1.27 $ 1.21
Diluted earnings per share $ 1.41 $ 1.26 $ 1.20
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 1997, 1996, and 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,341 $ 6,528 $ 6,196
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation 1,798 1,620 1,236
Amortization of mortgage servicing rights 397 295 123
Provision for loan losses 2,636 2,014 1,783
Net change in mortgage loans held for sale 1,789 604 (1,966)
Net gains on sales of loans (1,106) (981) (341)
Provision for deferred taxes (2,053) (668) (72)
Change in net income taxes payable (705) (572) (415)
Change in accrued interest and other assets (1,999) (531) (1,031)
Change in accrued interest and other liabilities (366) 601 2,578
Premium amortization and discount accretion
on securities 69 402 696
Securities gains (losses), net 380 (196) (133)
Amortization of goodwill 367 385 -
Amortization of core deposit intangible assets 397 405 101
Building contribution 850 - -
--------- -------- --------
Net cash from operating activities 9,795 9,906 8,755
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from matured securities available for sale 35,833 59,136 36,681
Proceeds from sales of securities available for sale 31,957 32,395 23,804
Purchases of securities available for sale (76,144) (74,282) (75,481)
Purchases of securities held to maturity - - (1,209)
Net principal disbursed on loans (110,277) (79,331) (20,589)
Proceeds from sales of other real estate 336 360 268
Acquisition of Valley Banc Services Corp.,
net of cash and cash equivalents acquired - (13,459) -
Proceeds from sale of net assets held for sale - 8,668 -
Property and equipment expenditures (1,843) (2,678) (1,403)
--------- -------- --------
Net cash from investing activities (120,138) (69,191) (37,929)
--------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 49,748 49,310 40,030
Net change in short-term borrowings 329 20,666 (10,573)
Federal Home Loan Bank term advances 59,750 - -
Payments on notes payable - (6,550) -
Proceeds from notes payable - 14,000 -
Dividends paid, net of dividend reinvestments (1,558) (1,239) (1,039)
--------- -------- --------
Net cash from financing activities 108,269 76,187 28,418
--------- -------- --------
Net change in cash and cash equivalents (2,074) 16,902 (756)
Cash and cash equivalents at beginning of year 45,068 28,166 28,922
--------- -------- --------
Cash and cash equivalents at end of year $ 42,994 $ 45,068 $ 28,166
--------- -------- --------
--------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1997, 1996, and 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Unrealized
Gain
(Loss) on
Securities Total
Available Stock-
Common Retained For Sale, Treasury holders'
Stock Surplus Earnings Net Stock Equity
------ ------- -------- --------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $2,607 $18,232 $26,915 $(4,083) $(215) $43,456
Net income - - 6,196 - - 6,196
Cash dividends declared, $.24 per share - - (1,234) - - (1,234)
Issuance of 5,721 shares of treasury
common stock in connection with
dividend reinvestment plan - 112 - - 31 143
Net change in unrealized gain (loss) due
to transfer of securities from held to
maturity to available for sale - - - 964 - 964
Net change in unrealized gain (loss)
on securities available for sale - - - 4,569 - 4,569
------ ------- ------- ------- ----- -------
Balance at December 31, 1995 2,607 18,344 31,877 1,450 (184) 54,094
Net income - - 6,528 - - 6,528
Cash dividends declared, $.28 per share - - (1,443) - - (1,443)
Issuance of 5,080 shares of treasury
common stock in connection with
dividend reinvestment plan - 124 - - 28 152
Net change in unrealized gain (loss)
on securities available for sale - - - (1,133) - (1,133)
------ ------- ------- ------- ----- -------
Balance at December 31, 1996 2,607 18,468 36,962 317 (156) 58,198
Net income - - 7,341 - - 7,341
Cash dividends declared, $.36 per share - - (1,759) - - (1,759)
Issuance of 6,370 shares of treasury
common stock in connection with
dividend reinvestment plan - 166 - - 35 201
Two-for-one stock split at par value
(Additional shares issued of
2,606,690 including 24,673 of
treasury shares) 2,606 (2,606) - - - -
Net change in unrealized gain (loss)
on securities available for sale - - - 1,336 - 1,336
------ ------- ------- ------- ----- -------
Balance at December 31, 1997 $5,213 $16,028 $42,544 $ 1,653 $(121) $65,317
------ ------- ------- ------- ----- -------
------ ------- ------- ------- ----- -------
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
MERCHANTS BANCORP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997, 1996, and 1995
(DOLLAR AMOUNTS IN TABLES IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial statements
of Merchants Bancorp, Inc. ("Company") include the accounts of the Company and
its wholly owned subsidiaries, The Merchants National Bank of Aurora ("Merchants
Bank") and, since January 3, 1996, (see Note 19), Valley Banc Services Corp.
("Valley"), and Valley's wholly owned subsidiaries Hinckley State Bank and Fox
Valley Bank. Merchants Bank, Hinckley State Bank, and Fox Valley Bank are
collectively referred to herein as the "Banks." Significant intercompany
transactions have been eliminated.
NATURE OF OPERATIONS: The Company's and the Banks' revenues, operating income,
and assets are primarily from the banking industry. Loan customers are mainly
located in Aurora, Hinckley, St. Charles and Geneva, Illinois and in the western
Chicago suburbs and surrounding areas, and include a wide range of individuals,
businesses, and other organizations. A major portion of loans are secured by
various forms of collateral including real estate, business assets, consumer
property, and other items, although borrower cash flow may also be a primary
source of repayment. Merchants Bank also engages in mortgage banking operations.
ESTIMATES: To prepare financial statements in conformity with generally accepted
accounting principles, management makes estimates and assumptions based on
available information. These estimates and assumptions affect the amounts
reported in the financial statements and the disclosures provided, and future
results could differ. The allowance for loan losses, fair values of financial
instruments, and status of contingencies are particularly subject to change.
SECURITIES: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with unrealized holding gains and losses reported separately in stockholders'
equity, net of tax. Realized gains and losses are determined based on the
amortized cost of the specific security sold. Securities are written down to
fair value when a decline in fair value is not temporary. Interest income
includes amortization of purchase premium or discount. Other securities such as
Federal Home Loan Bank stock are carried at cost. A transfer of securities to
available for sale was made in 1995, as permitted by the Statement of Financial
Accounting Standards ("SFAS") No. 115 implementation guide released in 1995.
LOANS HELD FOR SALE, LOANS AND LOAN INCOME: Loans are reported at the principal
balance outstanding, net of unearned interest, deferred loan fees and costs, and
an allowance for loan losses. Loans held for sale are reported at the lower of
cost or market, on an aggregate basis.
The accrual of interest income is discontinued on a loan when principal or
interest is ninety days or more past due, unless the loan is well secured and in
the process of collection. Payments received on such loans are reported as
principal reductions.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation
allowance for probable credit losses, increased by the provision for loan losses
and decreased by charge-offs less recoveries. Management estimates the allowance
balance required based on past loan loss experience, known and inherent risks in
the portfolio, information about specific borrower situations and estimated
collateral values, economic conditions, and other factors. Allocations of the
allowance may be made for specific loans, but the entire allowance is available
for any loan that, in management's judgment, should be charged-off.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage, consumer, and credit card loans, and on an
individual loan basis for other loans. If a loan is impaired, a portion of the
allowance is allocated so that the loan is reported, net, at the present value
of estimated future cash flows using the loan's existing rate or at the fair
value of collateral if repayment is expected solely from the collateral. Loans
are evaluated for impairment when payments are delayed, typically 90 days or
more, or when it is probable that all principal and interest amounts will not be
collected according to the original terms of the loan.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less
accumulated depreciation which is computed on the straight-line method over the
estimated useful lives of the assets.
13
<PAGE>
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER REAL ESTATE OWNED: Real estate acquired in settlement of loans is
initially reported at estimated fair value at acquisition. After acquisition, a
valuation allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell.
TRUST ASSETS AND FEES: Assets held in fiduciary or agency capacities are not
included in the consolidated balance sheets because such amounts are not assets
of the Company or the Banks. Income from trust fees is recorded on the accrual
basis.
MORTGAGE SERVICING RIGHTS: Servicing rights represent both purchased rights and
the allocated value of servicing rights retained on loans sold. Servicing rights
are amortized in proportion to, and over the period of, estimated net servicing
revenues. Impairment is evaluated based on the fair value of the rights, using
groupings of the underlying loans as to interest rates and then, secondarily, as
to geographic and prepayment characteristics. Any impairment of a grouping is
reported as a valuation allowance. There was no such valuation allowance
recorded at year-end 1997 or 1996.
GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS: Goodwill is the excess of purchase
price over identified net assets in the acquisition of Valley. The goodwill is
being amortized on the straight line basis over 20 years. The core deposit
intangibles recorded in conjunction with the acquisition of Valley are being
amortized using an accelerated method over 10 years. The core deposit intangible
recorded in conjunction with the acquisition of First American Bank of Aurora in
1984, which was subsequently merged into Merchants Bank in 1990, is being
amortized on the straight-line basis over 15 years.
LONG-TERM ASSETS: These assets are reviewed for impairment when events indicate
their carrying amount may not be recoverable from future undiscounted cash
flows. If impaired, the assets are recorded at discounted amounts.
INCOME TAXES: Income tax expense is the sum of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax consequences of temporary
differences between the carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.
STOCK OPTIONS: No expense for stock options is recorded, as the grant price
equals the market price of the stock at grant date. Pro-forma disclosures show
the effect on income and earnings per share had the options' fair value been
recorded using an option pricing model. The pro-forma effect is expected to
increase in the future.
COMMON STOCK SPLIT: The board of directors declared a two-for-one stock split on
the Company's common stock effective on September 30, 1997. Par value remained
unchanged at $1. The effect of the stock split has been reflected since
September 30, 1997, in the consolidated balance sheet and statement of
stockholders' equity. All references to the number of common shares and per
share amounts elsewhere in the consolidated financial statements and related
footnotes have been restated as appropriate to reflect the effect of the split
for all periods presented.
EARNINGS PER SHARE: Basic earnings per share is based on weighted-average common
shares outstanding. Diluted earnings per share further assumes issue of any
potentially dilutive common shares. The accounting standard for computing
earnings per share was revised for 1997, and all earnings per share previously
reported are restated to follow the new standard. Earnings per share are
restated for all stock splits.
STATEMENT OF CASH FLOWS: For purposes of the statement of cash flows, the
Company considers cash and due from banks and Federal funds sold to be cash and
cash equivalents. Generally, Federal funds are sold for one-day periods. The
Company reports net cash flows for short term investments and customer loan,
deposit and repurchase agreement transactions. Net cash flows are also reported
for Federal funds purchased and overnight funds. Inflows and outflows are
reported separately for Federal Home Loan Bank ("FHLB") term advances.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in a separate note. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates.
FUTURE ACCOUNTING CHANGES: New accounting standards have been issued which will
require future reporting of comprehensive income (net income plus changes in
holding gains and losses on available for sale securities) and may require
redetermination of industry segment financial information.
14
<PAGE>
NOTE 2: SECURITIES
Year-end securities available for sale were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
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
Other securities 7,172 - (140) 7,032
-------- ------ ------- --------
$202,253 $2,955 $ (447) $204,761
-------- ------ ------- --------
-------- ------ ------- --------
1996:
U.S. Treasury $ 17,685 $ 28 $ (73) $ 17,640
U.S. Government agencies 76,998 396 (414) 76,980
U.S. Government agency
mortgage-backed securities 34,148 134 (260) 34,022
States and political subdivisions 53,864 1,419 (456) 54,827
Collateralized mortgage obligations 8,878 - (158) 8,720
Other securities 2,778 - (187) 2,591
-------- ------ ------- --------
$194,351 $1,977 $(1,548) $194,780
-------- ------ ------- --------
-------- ------ ------- --------
</TABLE>
Mortgage-backed securities are comprised of investments in pools of residential
mortgages. The mortgage pools are issued and guaranteed by the Federal Home Loan
Mortgage Corporation ("FHLMC"), the Government National Mortgage Association
("GNMA") or the Federal National Mortgage Association ("FNMA"). Collateralized
mortgage obligations are secured by FHLMC, GNMA, or FNMA certificates. Other
securities consist of FHLB stock and Federal Reserve Bank stock.
As of December 31, 1997, and 1996, the Company held structured notes carried at
fair values of $2,247,000 and $4,236,000. The amortized cost of these securities
was $2,250,000 and $4,250,000 as of December 31, 1997, and 1996. These
securities were issued by the FHLB and FNMA.
Contractual maturities of debt securities at December 31, 1997, were as follows.
Securities not due at a single maturity date, primarily mortgage-backed
securities, collateralized mortgage obligations and equity securities, are shown
separately.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
-------- --------
<S> <C> <C>
Due in one year or less $ 18,824 $ 18,877
Due after one year through five years 53,473 54,134
Due after five years through ten years 78,610 80,076
Due after ten years 9,969 10,240
-------- --------
160,876 163,327
Mortgage-backed securities and collateralized mortgage obligations 34,205 34,402
Other securities 7,172 7,032
-------- --------
$202,253 $204,761
-------- --------
-------- --------
</TABLE>
Sales of securities available for sale were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Proceeds of sales $31,957 $32,395 $23,804
Gross realized gains 88 385 219
Gross realized losses 468 189 86
</TABLE>
The 1997, gross losses of $468,000 shown in the table above includes $168,000
related to the write-off of a municipal security which is of doubtful
collectibility. There were no significant concentrations of investments (greater
than 10% of stockholders' equity) in any individual security issue except for
U.S. Treasury securities and obligations of U.S. Government agencies and
corporations. Although at December 31, 1997, the Company held securities issued
by municipalities within the states of Illinois and Wisconsin which in the
aggregate exceeded 10% of stockholders' equity, none of the holdings from
individual municipal issuers exceeded this threshold.
15
<PAGE>
NOTE 2: SECURITIES (CONTINUED)
Securities with a carrying amount of approximately $144,325,000 and $125,269,000
at December 31, 1997, and 1996, were pledged to secure public deposits and
securities sold under repurchase agreements and for other purposes required or
permitted by law. Amounts owed to brokers for securities purchased in December
and settled in the following January, are included in accrued interest and other
liabilities. These amounts were $442,000 and $305,000 as of December 31, 1997,
and 1996.
NOTE 3: LOANS
Major classifications of loans were as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Commercial and industrial $168,899 $161,847
Real estate - commercial 95,755 75,449
Real estate - construction 69,901 54,513
Real estate - residential 122,732 85,107
Installment 100,869 73,918
Credit card receivables 8,100 6,697
Other loans 813 1,188
-------- --------
567,069 458,719
Unearned discount (1,324) (1,535)
Deferred loan fees (397) (382)
-------- --------
$565,348 $456,802
-------- --------
-------- --------
</TABLE>
Loans on which accrual of interest has been discontinued or reduced amounted to
approximately $4,623,000 and $2,970,000 at December 31, 1997, and 1996. Interest
income recorded on these loans amounted to approximately $225,000, $101,000, and
$83,000 in 1997, 1996, and 1995. Interest income which would have been
recognized had these loans been on an accrual basis throughout the year was
approximately $356,000, $335,000, and $167,000 in 1997, 1996, and 1995.
Impaired loans were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Year-end loans with no allowance for loan losses allocated $2,234 $ 523 $ -
Year-end loans with allowance for loan losses allocated 1,325 905 921
Amount of the allowance allocated 473 363 631
Average of impaired loans during the year 2,705 1,480 2,378
Interest income recognized during impairment 277 191 305
Cash-basis interest income recognized 174 89 302
</TABLE>
NOTE 4: ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Balance at beginning of year $ 7,274 $ 5,176 $ 5,140
Increase due to the acquisition of Valley - 798 -
Provision charged to operations 2,636 2,014 1,783
Charge-offs (2,122) (2,241) (2,513)
Recoveries 572 1,527 766
------- ------- -------
Balance at end of year $ 8,360 $ 7,274 $ 5,176
------- ------- -------
------- ------- -------
</TABLE>
16
<PAGE>
NOTE 5: MORTGAGE BANKING
Mortgage loans serviced for others are not reported as assets. The unpaid
principal balances of these loans and related escrow deposit balances are
summarized as follows as of December 31:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Mortgage loan portfolios serviced for:
Federal Home Loan Mortgage Corporation $190,516 $168,610
Federal National Mortgage Association 80,061 81,927
Other investors 4,915 4,232
-------- --------
$275,492 $254,769
-------- --------
-------- --------
Related escrow deposit balances $ 3,196 $ 2,744
-------- --------
-------- --------
</TABLE>
Following is a summary of the changes in the unamortized cost of purchased and
originated mortgage servicing rights. The effect of adopting SFAS 122 in 1996,
is also reflected in the following table:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Balance at beginning of year $1,438 $1,165 $ 412
Origination of mortgage servicing rights 633 568 -
Purchase price of mortgage servicing rights - - 876
Amortization (397) (295) (123)
------ ------ ------
Balance at end of year $1,674 $1,438 $1,165
------ ------ ------
------ ------ ------
</TABLE>
The Company sells most fixed rate residential real estate loans it originates
and funds with servicing retained by the Company. Selected information related
to loans sold follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ---- ----
<S> <C> <C> <C>
Interest on loans held for sale $ 141 $245 $161
Net gains on sales of loans 1,106 981 341
Loan servicing income 845 785 559
Amortization of purchased mortgage servicing rights 397 295 123
</TABLE>
NOTE 6: PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Land $ 1,194 $ 1,531
Premises 10,690 13,152
Furniture and equipment 9,558 8,892
-------- --------
21,442 23,575
Accumulated depreciation (10,147) (11,475)
-------- --------
$ 11,295 $ 12,100
-------- --------
-------- --------
</TABLE>
Depreciation expense amounted to approximately $1,798,000, $1,620,000, and
$1,236,000 for years ended December 31, 1997, 1996, and 1995. During 1997,
Merchants Bank contributed its building in downtown Aurora, Illinois, to a
charitable organization. At the time of the donation, the building was carried
at a net depreciated amount of $850,000.
NOTE 7: DEPOSITS
At year-end 1997, stated maturities of time deposits were:
<TABLE>
<S> <C>
1998 $207,516
1999 49,776
2000 33,393
2001 11,222
2002 12,179
--------
Total $314,086
--------
--------
</TABLE>
17
<PAGE>
NOTE 8: BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase, and
treasury tax and loan deposits are financing arrangements. Securities sold under
repurchase agreements with the State of Illinois are held by the State of
Illinois. Physical control is maintained for all other securities sold under
repurchase agreements.
At December 31, 1997, securities sold under agreements to repurchase with the
State of Illinois totaled $7.2 million, including accrued interest payable, are
collateralized by securities with a carrying value of $10 million, and have a
weighted maturity average of less than one month. There were no other securities
sold under agreements to repurchase with an individual counterparty which
exceeded 10% of stockholders' equity at December 31, 1997.
Advances from the FHLB at December 31, 1997, consisted of $7.5 million in
overnight funds, included in Federal funds purchased and overnight borrowings,
and term advances of $59,750,000. The Company has pledged first mortgage loans
on residential property in an amount equal to at least 167% of the outstanding
advances. Maturities and fixed interest rates on FHLB term advances at December
31, 1997, were as follows:
<TABLE>
<CAPTION>
Amount Interest Rate
------- -------------
<S> <C> <C>
1998 $17,500 5.75%
1999 12,500 5.97
2000 12,500 6.02
2001 4,750 6.21
2002 12,500 5.86
------- ----
Total and weighted average interest rate $59,750 5.91%
------- ----
------- ----
</TABLE>
Notes payable at December 31, 1997, consisted of two notes of $7 million each,
the proceeds of which were used to finance the acquisition of Valley. One of the
notes is a revolving note which bears interest at the prevailing Federal funds
rate or 1% above LIBOR, at the quarterly election of the Company. This variable
rate was 6.77% at December 31, 1997. A fixed rate note bears interest at a rate
of 7.03%. At year-end 1997, scheduled principal reductions on notes payable
were:
<TABLE>
<S> <C>
1998 $ 875
1999 875
2000 875
2001 875
2002 875
Thereafter 9,625
-------
Total $14,000
-------
-------
</TABLE>
NOTE 9: INCOME TAXES
A summary of Federal and state income taxes on operations is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Federal:
Current $ 2,416 $2,672 $2,179
Deferred (1,720) (544) (47)
State:
Current 526 452 395
Deferred (333) (124) (25)
------- ------ ------
$ 889 $2,456 $2,502
------- ------ ------
------- ------ ------
</TABLE>
In addition to the preceding taxes on operations, taxes allocated for net
unrealized gains (losses) on securities available for sale were $743,000,
($635,000), and $2,851,000 in 1997, 1996, and 1995. These amounts include the
tax effect of transfers into securities available for sale in 1995.
As noted previously, during 1997, Merchants Bank donated its former main office
building with a carrying value of $850,000 to a charitable organization. The
building was appraised at $4,130,000 during 1997. The Company recorded a tax
benefit of $1,504,000 during 1997, related to the charitable contribution tax
credits generated as a result of the contribution, which the Company projects
will all be utilized. At December 31, 1997, the Company had $3,205,000 of
charitable contribution carryforwards, which expire in 2002.
18
<PAGE>
NOTE 9: INCOME TAXES (CONTINUED)
The following are the components of the deferred tax assets and liabilities at
December 31, 1997, and 1996. Net deferred taxes are included in accrued interest
and other liabilities.
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Gross deferred tax liabilities:
Depreciation $ (339) $ (349)
Unrealized gain on securities available for sale (855) (112)
Discount accretion (232) (195)
Intangible assets (840) (996)
Mortgage servicing rights (378) (202)
Other liabilities (253) (485)
------- -------
Gross deferred tax liabilities (2,897) (2,339)
------- -------
Gross deferred tax assets:
Allowance for loan losses 2,742 1,975
Deferred loan fees 28 54
Charitable contribution carryover 1,232 -
Other assets 30 135
------- -------
Gross deferred tax assets 4,032 2,164
------- -------
Net deferred tax asset (liability) 1,135 (175)
Valuation allowance for deferred tax assets - -
------- -------
Net deferred tax asset (liability) $ 1,135 $ (175)
------- -------
------- -------
</TABLE>
A reconciliation of the statutory Federal income tax rate of 34% to the income
tax provision included in the consolidated statements of income is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Tax at statutory Federal income tax rate $ 2,798 $3,055 $2,957
Nontaxable interest income,
net of disallowed interest deduction (947) (901) (856)
Tax benefit of building donation (1,031) - -
State income taxes, net of Federal benefit 119 216 244
Other, net (50) 86 157
------- ------ ------
$ 889 $2,456 $2,502
------- ------ ------
------- ------ ------
</TABLE>
NOTE 10: BENEFIT PLANS
Prior to 1997, the Company maintained a noncontributory pension plan covering
substantially all full-time employees of the Company and Merchants 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 total
pension expense (income) under the pension plan approximated ($181,000) and
$28,000 for the years ended December 31, 1996, and 1995, and was composed of the
following components:
19
<PAGE>
NOTE 10: BENEFIT PLANS (CONTINUED)
<TABLE>
<CAPTION>
1996 1995
----- -----
<S> <C> <C>
Service cost - benefits earned during the year $ - $ 134
Interest cost on projected benefit obligation 262 288
Actual return on plan assets (916) (801)
Net amortization and deferral 473 407
----- -----
$(181) $ 28
----- -----
----- -----
</TABLE>
The following table sets forth the pension plan's funded status and amounts
recognized in the Company's consolidated financial statements at December 31,
1996:
<TABLE>
<S> <C>
Vested benefit obligation $4,704
------
------
Accumulated benefit obligation $4,704
------
------
Projected benefit obligation $4,704
Plan assets at fair value 4,832
------
Plan assets greater than projected benefit obligation 128
Unrecognized net asset (38)
Unrecognized net loss 629
Unrecognized prior service cost (185)
------
Net pension asset recorded in the balance sheet $ 534
------
------
</TABLE>
Plan assets consisted primarily of common stocks and corporate bonds and
included approximately $681,000 of the Company's common stock at December 31,
1996. Other selected information as of December 31, 1996, related to the pension
plan is summarized as follows:
<TABLE>
<S> <C>
Discount rate: Retirees 6.75%
Discount rate: Participants who will retire on or before December 31, 1999 6.75
Discount rate: All other participants 6.48
Expected long-term rate of return on plan assets 10.00
</TABLE>
The Thrift Plan covers employees who work a minimum of 1,000 hours per year and
have been with the Company at least one year. Vesting in Company contributions
to the Thrift Plan is scheduled over seven years from the date of employment.
Hinckley State Bank and Fox Valley Bank employees were given full credit for
past employment service. The Company contributes an amount determined by the
Board of Directors to all eligible participants. This amount was increased
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
$665,000, $581,000, and $259,000 for the years ended December 31, 1997, 1996,
and 1995.
NOTE 11: COMMITMENTS AND CONTINGENT LIABILITIES
The Company and its subsidiaries are defendants in legal actions arising from
normal business activities. Management, after consultation with legal counsel,
believes that the ultimate liability, if any, resulting from these actions will
not have a material adverse effect on the Company's consolidated financial
position, liquidity, or results of operations.
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Loan commitments and guarantees written have
off-balance-sheet risk because only origination fees and accruals for probable
losses are recognized in the statement of financial position until the
commitments are fulfilled or the guarantees expire. Credit risk represents the
accounting loss that would be recognized at the reporting date if
counter-parties failed completely to perform as contracted. The credit risk
amounts are equal to the contractual amounts, assuming that the amounts are
fully advanced and that collateral or other security is of no value.
The Company has entered into agreements to sell mortgage loans to the FHLMC. The
amounts remaining with FHLMC, under these agreements, at December 31, 1997, and
1996 were $19,623,000 and $9,289,000.
20
<PAGE>
NOTE 11: COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet investments. At December
31, 1997, and 1996, the contract amounts of such commitments and conditional
obligations were as follows:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Commitments to extend credit
Fixed rate $ 33,807 $40,862
Variable rate 115,501 89,083
Standby letters of credit 24,682 26,466
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates of up to one year or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on management's credit evaluation of the borrower. Collateral held varies, but
may include real estate, accounts receivable, inventory, property, plant,
equipment, and income producing properties.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those standby letters
of credit are primarily issued in favor of municipalities and insurance
companies. The credit risk involved in issuing standby letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Banks maintained reserves in accordance with Federal Reserve requirements of
approximately $800,000 and $12,321,000 at December 31, 1997, and 1996.
The Company leases office space in two locations. One location has annual base
rent of $65,000 in 1998, $59,000 in 1999, $62,000 in 2000, and indexed
thereafter to the Consumer Price Index through the year 2013. The other location
is leased at a market rate from a company in which a director of the Company has
an ownership interest. Obligations under this lease are as follows:
<TABLE>
<S> <C>
1998 $ 205
1999 209
2000 214
2001 218
2002 222
Thereafter 310
------
Total $1,378
------
------
</TABLE>
NOTE 12: RELATED PARTY TRANSACTIONS
A summary of loans made by the Banks in the ordinary course of business to or
for the benefit of directors, executive officers, or principal holders of equity
securities of the Company is as follows for the year ended December 31, 1997:
<TABLE>
<S> <C>
Balance at beginning of year $ 15,023
New loans 34,751
Repayments (28,794)
--------
Balance at end of year $ 20,980
--------
--------
</TABLE>
21
<PAGE>
NOTE 13: SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures to the consolidated statements of cash flows are as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Income taxes paid $ 3,593 $ 3,562 $ 1,552
Interest paid 27,969 23,821 17,952
Noncash transfers from loans to other real estate owned 181 106 88
Noncash transfer of securities held to maturity to securities
available for sale, at fair value - - 41,125
Purchase of Valley Banc Services Corp.:
Fair value of assets acquired - $129,126 -
Debt assumed - (3,550) -
Purchase price - (21,339) -
--------
Liabilities assumed - $104,237 -
--------
--------
</TABLE>
NOTE 14: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value approximates carrying amount for all items except those
described below. Estimated fair value for loans is based on the rates charged at
year end for new loans with similar maturities, applied until the loan is
assumed to reprice or be paid. Estimated fair value for time deposits and
repurchase agreements is based on the rates paid at year end for new deposits or
borrowings, applied until maturity. Estimated fair value of the fixed rate note
payable and term advances of the FHLB of Chicago are estimated using the current
rates for advances of similar remaining maturities. Estimated fair value for
other financial instruments and off-balance-sheet loan commitments are
considered nominal.
The carrying values and fair values of the Company's financial instruments as of
December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------- ---------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 35,914 $ 35,914 $ 42,455 $ 42,455
Federal funds sold 7,080 7,080 2,613 2,613
Securities available for sale 204,761 204,761 194,780 194,780
Loans held for sale 2,833 2,833 4,149 4,149
Loans, net 556,988 562,647 449,528 452,049
Accrued interest receivable 5,260 5,260 4,975 4,975
Financial liabilities:
Deposits $(650,718) $(650,968) $(600,970) $(600,888)
Federal funds purchased and securities
sold under repurchase agreements (44,854) (44,854) (44,525) (44,525)
Notes payable (14,000) (14,000) (14,000) (14,000)
Accrued interest payable (2,610) (2,610) (2,020) (2,020)
Due to broker (442) (442) (305) (305)
FHLB term advances (59,750) (59,418) - -
</TABLE>
NOTE 15: CAPITAL MATTERS
The Company and the Banks are subject to regulatory capital requirements
administered by Federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weights, and other
factors, and the regulators can lower classifications in certain cases. Failure
to meet various capital requirements can initiate regulatory action that could
have a direct material effect on the financial statements.
22
<PAGE>
NOTE 15: CAPITAL MATTERS (CONTINUED)
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.
As of the Company's and the Banks' most recent regulatory notifications, the
Company and the Banks were categorized as well capitalized. Management is not
aware of any conditions or events since the most recent regulatory notification
that would change the Company's or the Bank's categories.
Capital levels and minimum required levels:
<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>
1997:
Total capital to risk weighted assets
Consolidated $63,285 10.42% $48,594 8.00% $60,743 10.00%
Merchants 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 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 Bank 50,415 7.44 27,097 4.00 33,871 5.00
1996:
Total capital to risk weighted assets
Consolidated $54,487 10.26% $42,477 8.00% $53,097 10.00%
Merchants Bank 51,000 11.61 35,148 8.00 43,935 10.00
Tier 1 capital to risk weighted assets
Consolidated 47,872 9.02 21,239 4.00 31,858 6.00
Merchants Bank 45,494 10.35 17,574 4.00 26,361 6.00
Tier 1 capital to average assets
Consolidated 47,872 6.90 27,768 4.00 34,709 5.00
Merchants Bank 45,494 7.82 23,262 4.00 29,078 5.00
</TABLE>
Dividends from the Banks are the Company's primary source of funds. National and
state bank regulations and capital guidelines limit the amount of dividends that
may be paid by the Banks without prior regulatory approval. At January 1, 1998,
approximately $11,724,000 was available for the payment of dividends by the
Banks to the Company.
NOTE 16: STOCKHOLDER RIGHTS PLAN
Pursuant to a plan adopted by the Company in January, 1989, each share of the
Company's common stock carries one-sixth of a right (referred to as a "Right")
to purchase one hundredth of a share of Series A Preferred Stock, $1.00 par
value ("Preferred Stock"), at a price of $125.00 (subject to adjustment). The
Rights are tradeable only with the Company's common stock until they become
exercisable. The Rights become exercisable ten business days after the earlier
of the date a person acquires or commences a tender offer to acquire 15% or more
of the Company's common stock. The Rights are subject to redemption by the
Company at a price of $0.01 per Right, subject to certain limitations, and will
expire on January 13, 1999. The Preferred Stock Right carries preferential
dividend and liquidation rights and certain voting and other rights.
23
<PAGE>
NOTE 16: STOCKHOLDER RIGHTS PLAN (CONTINUED)
If after the Rights become exercisable, the Company or its assets are acquired
in certain merger or other transactions, except under certain circumstances,
each holder of a Right may purchase at the exercise price of the Right shares of
common stock of the acquiring or surviving company having a market value of two
times the exercise price of the Right. In addition, if after the Rights become
exercisable, any person becomes the owner of 20% of the Company's outstanding
common stock, or the Company is involved in certain "self-dealing" transactions
involving any person owning 15% or more of the Company's outstanding common
stock, each holder of a Right may purchase at the exercise price of the Right,
shares of the Company's common stock (or in certain cases, cash, property, or
other securities of the Company) having a market value of twice the exercise
price of the Right. Rights held by an acquiring person become void upon the
occurrence of such events.
NOTE 17: STOCK OPTIONS
In April, 1994 the stockholders approved a Stock Incentive Plan (the "Incentive
Plan"), which authorizes the issuance of up to 250,000 shares of the Company's
common stock, including the granting of qualified stock options ("Incentive
Stock Options"), nonqualified stock options, restricted stock and stock
appreciation rights. Subject to the terms and provisions of the Incentive Plan,
stock based awards may be granted to selected directors and officers or
employees at the discretion of the board of directors. The Incentive Plan
requires the exercise price of any incentive stock option issued to an employee
to be at least equal to the fair market value of Company common stock on the
date the option is granted. In addition, all stock options are granted for a
maximum term of ten years.
Nonqualified stock options may be granted to directors based upon a formula.
These and other awards under the Incentive Plan may be granted subject to a
vesting requirement and would become fully vested upon a merger or change in
control of the Company. As of December 31, 1997, there were no nonqualified
stock options, stock appreciation rights, or restricted stock issued under the
Incentive Plan.
SFAS 123, which became effective for 1996, requires pro forma disclosures for
companies that do not adopt its fair value accounting method for stock-based
employee compensation. There was no compensation expense recorded for stock
options in 1997, 1996, and 1995. The following pro forma information presents
net income and earnings per share had the Standard's fair value method been used
to measure compensation cost for stock option plans:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Net income $7,081 $6,493 $6,170
Basic earnings per share 1.37 1.26 1.20
Diluted earnings per share 1.36 1.26 1.20
</TABLE>
Stock option plans are used to reward employees and provide them with an
additional equity interest. Options are issued for 10 year periods, with vesting
occurring over the first three years. Weighted-average grant date fair values of
options granted in 1997, 1996, and 1995 were $10.61, $1.47, and $1.13. Shares
authorized for future grants were 97,710 at year-end 1997. Information about
option grants follows:
<TABLE>
<CAPTION>
Number of Weighted-Average
Options Exercise Price
--------- ----------------
<S> <C> <C>
Outstanding, December 31, 1994 36,746 $12.31
Granted 37,158 12.37
------- ------
Outstanding, December 31, 1995 73,904 12.34
Granted 38,476 15.50
------- ------
Outstanding, December 31, 1996 112,380 13.42
Granted 39,910 18.25
------- ------
Outstanding, December 31, 1997 152,290 $14.69
------- ------
------- ------
</TABLE>
Options exercisable at year-end are as follows:
<TABLE>
<CAPTION>
Number of Weighted-Average
Options Exercise Price
--------- ----------------
<S> <C> <C>
1995 36,892 $12.33
1996 74,352 12.88
1997 112,872 13.76
</TABLE>
24
<PAGE>
NOTE 17: STOCK OPTIONS (CONTINUED)
All options granted are at market price. The fair value of options granted
during 1997, 1996, and 1995, is estimated using the following weighted-average
information: risk-free interest rate of 5.50%, 6.54%, and 5.78%, expected life
of 10 years, expected volatility of stock price of 17.28%, 1.65%, and 1.68%, and
expected dividends of 1.75%, 1.75%, and 1.68% per year. The weighted-average
remaining life of the stock options was 7.9 years and 8.4 years at December 31,
1997, and 1996.
NOTE 18: EARNINGS PER SHARE
The following table presents a reconciliation of the components used to compute
basic and diluted earnings per share for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Basic Earnings Per Share:
Weighted-average common shares outstanding 5,162,009 5,151,440 5,140,906
Net income available to common shareholders $ 7,341 $ 6,528 $ 6,196
Basic earnings per share $ 1.42 $ 1.27 $ 1.21
Diluted Earnings Per Share:
Weighted-average common shares outstanding 5,162,009 5,151,440 5,140,906
Dilutive effect of stock options 44,839 12,372 2,038
---------- ---------- ----------
Diluted weighted average common shares outstanding 5,206,848 5,163,812 5,142,944
---------- ---------- ----------
---------- ---------- ----------
Net income available to common shareholders $ 7,341 $ 6,528 $ 6,196
Diluted earnings per share $ 1.41 $ 1.26 $ 1.20
</TABLE>
NOTE 19: ACQUISITION
On January 3, 1996, the Company purchased 100% of the outstanding common stock
of Valley for $24,889,000, comprised of $20.5 million in cash, assumption of
Valley's debt of approximately $3.5 million, $304,000 of capitalized acquisition
costs and $532,000 of capitalized incremental interest costs during the holding
period of acquired subsidiaries held for sale. As of the acquisition date,
Valley's wholly-owned subsidiaries included Hinckley State Bank, State Bank of
Osco, Anchor Bank and V.B.H. Corporation and V.B.H. Corporation's wholly-owned
subsidiary, Fox Valley Bank.
The acquisition has been accounted for using the purchase method of accounting
and, accordingly, the assets and liabilities have been recorded at their
estimated fair values at the date of acquisition. In addition, when Valley was
acquired, the Company's intent was to sell State Bank of Osco and Anchor Bank.
Accordingly, those banks were classified as held for sale until they were sold
on December 12, 1996, and December 19, 1996, respectively. The net asset
valuations of State Bank of Osco and Anchor Bank were initially determined by
the Company's management based upon recent sales prices of similar financial
institutions and after consideration of estimated 1996 earnings and capitalized
interest expense during the estimated holding period, neither of which were
included in 1996 earnings of the Company.
The actual 1996 operating results of State Bank of Osco and Anchor Bank, from
January 3, through their respective sale dates, of $280,000 and $170,000, were
not included in the Company's 1996 consolidated operating results. The $180,000
difference between the $8,668,000 that these banks were sold for and the
$8,488,000 purchase price assigned to these held for sale subsidiaries was
treated as a purchase price allocation adjustment and was not included in the
Company's 1996 consolidated operating results.
The following unaudited pro forma financial information for the Company gives
effect to the Valley acquisition as if it had occurred on January 1, 1995. These
pro forma results have been prepared for comparative purposes only and do not
purport to be indicative of the results of operations which actually would have
resulted had the acquisition occurred on the date indicated, or which may result
in the future. This pro forma financial information does not include operating
results for State Bank of Osco or Anchor Bank.
Pro forma financial information for the year ended December 31, 1995:
<TABLE>
<S> <C>
Net interest income $25,485
Net income 5,982
Net income per share 1.16
</TABLE>
25
<PAGE>
NOTE 20: CONDENSED FINANCIAL INFORMATION - COMPANY ONLY
Presented below are the condensed balance sheets and condensed statements of
income and cash flows for Merchants Bancorp, Inc.
CONDENSED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
ASSETS
Noninterest-bearing deposit with bank subsidiaries $ 1,395 $ 861
Investment in subsidiaries, at equity 78,370 71,582
Other assets 167 149
------- -------
$79,932 $72,592
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $14,000 $14,000
Accrued interest and other liabilities 615 394
Stockholders' equity 65,317 58,198
------- -------
$79,932 $72,592
------- -------
------- -------
</TABLE>
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
OPERATING INCOME
Cash dividends received from subsidiaries $2,678 $2,625 $1,395
Interest income on repurchase agreement with
Merchants Bank - - 457
------ ------ ------
2,678 2,625 1,852
------ ------ ------
OPERATING EXPENSES
Interest on notes payable 969 422 -
Other expenses 373 367 280
------ ------ ------
1,342 789 280
------ ------ ------
Income before income taxes and equity in
undistributed net income of subsidiaries 1,336 1,836 1,572
Income tax expense (benefit) (553) (309) 73
------ ------ ------
Income before equity in undistributed
net income of subsidiaries 1,889 2,145 1,499
Equity in undistributed net income of subsidiaries 5,452 4,383 4,697
------ ------ ------
Net income $7,341 $6,528 $6,196
------ ------ ------
------ ------ ------
</TABLE>
26
<PAGE>
NOTE 20: CONDENSED FINANCIAL INFORMATION - COMPANY ONLY - (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,341 $ 6,528 $ 6,196
Adjustments to reconcile net income to net cash
from operating activities:
Equity in undistributed net income of subsidiaries (5,452) (4,383) (4,697)
Other, net 121 291 (251)
------- -------- -------
Net cash from operating activities 2,010 2,436 1,248
------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Acquisition of Valley Banc Services Corp., net of debt assumed - (21,336) -
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds of notes payable - 14,000 -
Principal payments on notes payable - (3,550) -
Dividends paid, net of dividend reinvestments (1,476) (1,239) (1,039)
------- -------- -------
Net cash from financing activities (1,476) 9,211 (1,039)
------- -------- -------
Net change in cash and cash equivalents 534 (9,689) 209
Cash and cash equivalents at beginning of year 861 10,550 10,341
------- -------- -------
Cash and cash equivalents at end of year $ 1,395 $ 861 $10,550
------- -------- -------
------- -------- -------
</TABLE>
27
<PAGE>
[LOGO]
CROWE CHIZEK
Independent Auditors' Report
Stockholders and Board of Directors
Merchants Bancorp, Inc.
Aurora, Illinois
We have audited the accompanying consolidated balance sheets of Merchants
Bancorp, Inc. and Subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Merchants Bancorp,
Inc. and Subsidiaries as of December 31, 1997 and 1996 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
As discussed in Note 5 to the consolidated financial statements the Company
adopted a new method of accounting for originated mortgage servicing rights in
1996.
/s/ Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
Oak Brook, Illinois
February 3, 1998
28
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Merchants Bancorp, Inc. ("Company"), a bank holding company headquartered in
Aurora, Illinois, is one of the leading commercial banking and trust
institutions in Aurora and surrounding communities. The Company conducts a
full service community banking and trust business through its wholly-owned
subsidiary banks. The Merchants National Bank of Aurora ("Merchants Bank")
has its main office and three locations in Aurora, one location in Oswego,
and a branch in Geneva, Illinois. Fox Valley Bank has two offices in St.
Charles, and a branch in Geneva, Illinois. Hinckley State Bank has offices in
Hinckley and Sugar Grove, Illinois.
As a large, community-oriented, independent financial institution in the greater
Aurora area, the Company is well positioned to take advantage of the growth of
Aurora and its surrounding communities. The oldest and largest bank in the
Company, Merchants Bank has continuously served the Aurora community since it
was chartered in 1888. Each bank operates as a traditional community bank with
local management, conveniently located facilities and a professional, highly
motivated staff which is active in the community, focuses on long-term
relationships with customers and provides individualized quality service. The
Company's local management in each of its banks, coupled with its long record of
service, has allowed it to compete successfully in each banking market it
serves.
On January 3, 1996, the Company purchased 100% of the outstanding common stock
of Valley Banc Services, Corp., ("Valley"), as described in detail in Note 19 to
the consolidated financial statements. As of the acquisition date, Valley's
wholly-owned subsidiaries included Hinckley State Bank, State Bank of Osco,
Anchor Bank and V.B.H. Corporation and V.B.H. Corporation's wholly-owned
subsidiary, Fox Valley Bank. When Valley was acquired, the Company's intent was
to sell State Bank of Osco and Anchor Bank. Accordingly, those banks were
classified as held for sale until they were sold on December 12, 1996, and
December 19, 1996.
The Board of Directors declared a two-for-one stock split on the Company's
common stock effective September 30, 1997. Par value remained unchanged at $1.
The Company also adopted Statement of Financial Accounting Standard ("SFAS") No.
128 during 1997. References to earnings per share for all periods have been
restated to reflect the stock split and adoption of SFAS 128.
Net income was $7,341,000, or $1.42 per share in 1997, which compares with
$6,528,000, or $1.27 per share in 1996, and $6,196,000 or $1.21 per share in
1995. Increases in both net interest income and noninterest income contributed
to these record levels. Net interest income grew $2.6 million (10.0%) to $29.0
million in 1997, largely due to an increase in earning assets. Noninterest
income excluding securities gains and losses grew $695,000 (7.4%) to $10.0
million, primarily based on increases in trust income and service charges and
fees. In comparing 1996 and 1995 results, the Valley acquisition also had a
significant impact on many areas of the financial statements, as is discussed in
detail below.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between interest income earned on earning
assets and interest expense paid on interest bearing liabilities. As such, net
interest income is affected by changes in the volume and yields on earning
assets, and the volume and rates paid on interest bearing liabilities. Net
interest margin is the ratio of tax equivalent net interest income to average
earning assets.
A review of overall trends shows that net interest income grew during each of
the last three years. The primary cause for these increases was the growth in
earning assets and deposits of the Company, including the 1996 acquisition of
Valley. Net interest income was $29.0 million, $26.3 million, and $21.5 million
in 1997, 1996, and 1995. Net interest income to average total earning assets on
a fully tax equivalent basis was 4.35% in 1997, 4.49% in 1996, and 4.73% in
1995.
The net interest margin declined from 4.49% in 1996 to 4.35% in 1997. Although
the average yield on earning assets increased from 7.61% in 1996 to 7.78% in
1997, the average rate of interest bearing liabilities increased from 4.54% in
1996 to 4.83% in 1997. The net interest margin declined in 1996, as the yield on
earning assets declined from 7.91% to 7.61% while the average rate on interest
bearing liabilities declined slightly from 4.59% in 1995 to 4.54% in 1996. The
liabilities which have grown the most over the periods being discussed are time
deposits and borrowed funds, which generally bear higher interest rates than
other sources, such as checking and savings accounts.
29
<PAGE>
Management has consistently managed the balance sheet with the objective of
maintaining a stable net interest margin over the long term, regardless of
changes in market interest rates, so that asset growth results in a
corresponding increase in net interest income. Average interest rates are the
result of the volume and interest rates of new assets and liabilities and the
volume and interest rates of matured, sold, or repaid assets and liabilities.
The table below demonstrates that most of the growth in net interest income has
come as a direct result of balance sheet growth, rather than changes in interest
rates. This table allocates the changes in tax equivalent net interest income to
changes in either average balances or average rates for earning assets and
interest bearing liabilities. The change in net interest income due to both
volume and rate has been allocated proportionately to the change due to balance
and due to rate. Tax exempt interest income is measured on a tax equivalent
basis using a 34% rate.
PROVISION FOR LOAN LOSSES
The Company's provision for loan losses was $2,636,000 in 1997, $2,014,000 in
1996, and $1,783,000 in 1995. Provisions for loan losses are made to recognize
current period net charge off activity, and to provide for future losses on
loans which are identified as possible in the loan review process. The allowance
for loan losses as a percentage of total loans was 1.48%, 1.59%, and 1.70% as of
December 31, 1997, 1996, and 1995. The addition of the Valley subsidiary banks
in 1996, and the rate of loan growth at Merchants Bank in all years presented,
contributed to the decline in this ratio. Net charge-offs were $1,550,000,
$714,000, and $1,747,000, in 1997, 1996, and 1995. Net charge-offs as a
percentage of average loans was 0.31% in 1997, from 0.18% in 1996, and 0.60% in
1995.
NONINTEREST INCOME
The table on page 31 shows the Company's noninterest income for the years
indicated.
Noninterest income excluding securities gains and losses grew $695,000 (7.4%) to
$10.0 million in 1997, primarily based on increases in trust income, mortgage
banking income and service charges and fees. Noninterest income in all
categories increased from 1995 to 1996. Trust income increased $287,000 (14%) to
$2,315,000 in 1997, and increased $103,000 (5%) to $2,028,000 in 1996, from
$1,925,000 in 1995. The rate of change in trust assets under management is not
the same as the rate of change in trust income because some services are not
based on the amount of assets under management. Assets under management
increased to $440 million at December 31, 1997, after decreasing slightly to
$361 million at December 31, 1996, from $371 million at December 31, 1995.
Mortgage banking noninterest income was $2,358,000 in 1997, compared with
$2,202,000 in 1996, and $1,267,000 in 1995. Of those amounts, net gains on sales
of loans were $1,106,000, $981,000, and $341,000 in 1997, 1996, and 1995.
Mortgage servicing income was $845,000 in 1997, $785,000 in 1996, and $559,000
in 1995. During 1996, the Company implemented SFAS 122. In accordance with this
standard, servicing rights represent both purchased servicing rights and the
allocated value of servicing retained on loans sold. Unamortized mortgage
servicing rights totaled $1,674,000 and $1,438,000 at December 31, 1997, and
1996. The total servicing portfolio, including purchased and originated loans,
was $275 million and $255 million at December 31, 1997, and 1996. Management's
plans are to continue increasing the size of the servicing portfolio, primarily
through retention of the servicing rights of mortgages originated by the
Company.
- --------------------------------------------------------------------------------
ANALYSIS OF CHANGES IN INTEREST INCOME (In thousands)
<TABLE>
<CAPTION>
Change Due to
-------------------
Total Average Average
Change Balance Rate
------- ------- ------
<S> <C> <C> <C>
1997 Compared to 1996:
Earning assets $ 7,177 $ 8,059 $ (882)
Interest bearing liabilities 4,421 3,092 1,329
------- ------- -------
Net interest income $ 2,756 $ 4,967 $(2,211)
------- ------- -------
------- ------- -------
1996 Compared to 1995:
Earning assets $10,653 $11,889 $(1,236)
Interest bearing liabilities 5,715 6,000 (285)
------- ------- -------
Net interest income $ 4,938 $ 5,889 $ (951)
------- ------- -------
------- ------- -------
</TABLE>
30
<PAGE>
Service charges and fees totaled $4,235,000, $3,796,000, and $2,713,000 in 1997,
1996, and 1995. The $439,000 (11.6%) increase in 1997 was attributable to
service charges on deposits. In 1997, overdraft and returned check fees
increased $324,000, and checking fees, including commercial and personal
accounts, increased $167,000, due to changes in fee structure and increased
overdraft activity. Of the $1,083,000 (39.9%) increase in 1996, $420,000
resulted from the Valley acquisition, and $663,000 was from income at Merchants
Bank. At Merchants Bank, 1996 overdraft and returned check fees increased
$417,000, and commercial checking fees increased $170,000, due to changes in fee
structure and increased overdraft activity.
Sales of securities available for sale totaled $32.0 million during 1997, $32.4
million during 1996, and $23.8 million in 1995, resulting in net losses of
$380,000 in 1997, and net gains of $196,000 and $133,000 in 1996, and 1995.
Securities were sold due to changes in interest rates, availability of
alternative investments, liquidity needs, and other factors.
Other noninterest income was $1,132,000, $1,319,000, and $880,000 in 1997, 1996,
and 1995. The decline of $187,000 (14.2%) from 1996 to 1997 was primarily the
result of a recovery of prior period income which occurred in 1996 of
approximately $179,000. Of the $439,000 increase in 1996, $121,000 was
attributed to Valley. During 1996, debit card transaction fees, introduced in
late 1995, increased $175,000, to $192,000, and ATM fees increased $49,000, to
$513,000.
NONINTEREST EXPENSES
The table on page 32 shows the Company's noninterest expenses for the years
indicated.
Noninterest expenses increased $2,889,000 (11.6%) to $27.8 million in 1997,
compared to $24.9 million in 1996. Excluding the building contribution in 1997,
all other noninterest expenses increased $2,039,000 (8.2%) in 1997. Noninterest
expenses increased $6,976,000 (39.0%) to $24.9 million in 1996, compared to 1995
noninterest expenses of $17.9 million. As in other areas, the Valley acquisition
had a significant impact on year to year comparisons from 1995 to 1996.
Salaries and employee benefits increased $674,000 (5.2%) to $13.6 million in
1997, compared to $12.9 million in 1996, and $9.9 million in 1995. Commissions
and incentives, which are included in salaries and benefits, increased $216,000
(17.8%) to $1,428,000 in 1997 and increased $314,000 (35.0%), to $1,212,000 in
1996. The Company has an employee compensation strategy which emphasizes
achieving performance objectives. In December, 1996, the Company approved
terminating its defined benefit pension plan and the Company's discretionary
contribution to the Thrift Plan was increased in order to mitigate the impact of
this decision on employees. Upon completing the defined benefit pension plan
termination in 1997, income of approximately $214,000 was recorded, reflecting a
reversion of plan assets to the Company. Contributions to the Company's Thrift
Plan totaled $665,000 and $581,000 in 1997, and 1996, compared to $259,000 in
1995. The full time equivalent number of employees was 347, 341, and 261 as of
December 31, 1997, 1996, and 1995, with most of the increase in 1996
attributable to the Valley acquisition.
Occupancy expenses were $295,000 (18.3%) higher in 1997 than in 1996, after an
increase of $582,000 (56.5%) in 1996, compared to 1995. In 1997 the Company
moved its administrative and operations functions to a leased location in
Aurora, Illinois. The costs associated with the move and the lease cost of the
new administration center were the primary causes of the increase in occupancy
expenses in 1997. It is anticipated that operating efficiencies will result from
this move. Related functions which were previously spread among multiple
locations are now performed at a single, modern facility. In addition to the
Valley acquisition, a new branch was opened in Geneva, Illinois, during 1996,
and was reflected in 1996 operating results.
Furniture and equipment expenses increased $188,000 (11.4%) in 1997, and
$412,000 (33.3%) in 1996. While the move described above added
- --------------------------------------------------------------------------------
NONINTEREST INCOME (In thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Trust income $2,315 $2,028 $1,925
Mortgage banking income 2,358 2,202 1,267
Service charges and fees 4,235 3,796 2,713
Securities gains (losses), net (380) 196 133
Other income 1,132 1,319 880
------ ------ ------
Total noninterest income $9,660 $9,541 $6,918
------ ------ ------
------ ------ ------
</TABLE>
31
<PAGE>
some furniture, most of the increase was associated with investments in
equipment. Investment in new systems to manage information has contributed to
the increase in equipment expenses during the years presented. Management
believes strongly in the use of technology to achieve operational efficiency and
quality of results. The addition of Valley and the new branch during 1996 also
contributed to the increase in furniture and equipment expenses.
As discussed in Note 19 to the consolidated financial statements, the Valley
acquisition resulted in goodwill and core deposit intangible assets which will
be amortized to expense in future years. The goodwill is being amortized on the
straight-line basis over 20 years. The core deposit intangible assets are being
amortized using an accelerated method over 10 years. The core deposit intangible
recorded in conjunction with the acquisition of First American Bank of Aurora in
1984, which was subsequently merged into Merchants Bank in 1990, is being
amortized on the straight-line basis over 15 years.
Other expenses increased $908,000 (11.5%) in 1997, from $7.9 million in 1996. An
increase in mortgage activity resulted in an increase of $310,000 in other
expenses, including an increase of $102,000 in amortization of mortgage
servicing rights. Costs associated with the building contribution and the move
to the administration center, included in other expenses, also resulted in
one-time expenses in 1997. Other expenses increased $2.3 million (40%) in 1996,
from $5.6 million in 1995. Valley accounted for approximately half of the
increase. Increased mortgage activity in 1996 over 1995 resulted in increases in
related expenses, including amortization of servicing rights, up $172,000 (140%)
to $295,000, and correspondent mortgage fees, up $264,000 to $309,000.
Correspondent business has been pursued as a strategy for increasing the amount
of mortgage business.
During 1997, Merchants Bank donated its former main office building, with a
carrying value of $850,000, to a charitable organization. Merchants Bank will
lease a portion of the building for a full service branch. The building was
appraised at $4,130,000, which resulted in charitable contribution tax credits
of $1,504,000, which were recorded in 1997.
The cost of insurance premiums assessed by the Federal Deposit Insurance
Corporation ("FDIC"), included in other expenses, was $92,000 in 1997, compared
to $16,000 in 1996, and $475,000 in 1995. The Banks were all at the lowest
assessment rate as of year-end 1997. The lowest assessment rate is applied to
well capitalized institutions in the supervisory group representing the least
risk.
INCOME TAXES
The Company's provision for income taxes was $889,000, $2,456,000, and
$2,502,000 for the years ended December 31, 1997, 1996, and 1995. The average
effective income tax rate for these years was 10.80%, 27.34%, and 28.77%. The
Company recorded a tax benefit of $1,504,000 during 1997 related to the
charitable contribution tax credits generated as a result of the contribution of
the former Merchants Bank main office building, all of which credits the Company
projects will be utilized. At December 31, 1997, the Company had $3,205,000 of
charitable contribution carryforwards, which expire in 2002.
FINANCIAL CONDITION
LENDING ACTIVITIES
The Company's major source of income is interest on loans, and the composition
of the portfolio reflects the communities served by the Banks. The table on page
33 presents the composition of the Company's loan portfolio at the end of the
periods indicated.
Total loans increased $108.5 million, or 23.8%, to $565.3 million as of December
31, 1997, from $456.8 million at December 31, 1996. The commercial loan
portfolio increased $7.1 million (4.4%) in 1997, from $161.8 million as of
December 31, 1996, and $109.9 million as of December 31, 1995. Commercial real
estate loans increased $20.3 million (26.9%) from $75.4 million as of December
31, 1996, to $95.7 million as of
- --------------------------------------------------------------------------------
NONINTEREST EXPENSES (In thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Salaries and employee benefits $13,598 $12,924 $ 9,893
Occupancy expenses, net 1,907 1,612 1,030
Furniture and equipment expenses 1,838 1,650 1,238
Amortization of goodwill 367 385 -
Amortization of core deposit intangible assets 397 405 101
Building contribution 850 - -
Other expenses 8,797 7,889 5,627
------- ------- -------
Total noninterest expenses $27,754 $24,865 $17,889
------- ------- -------
------- ------- -------
</TABLE>
32
<PAGE>
December 31, 1997. This compares to $67.7 million as of December 31, 1995. The
growth has resulted from an aggressive commercial calling effort, coupled with a
growing market. These loans are made on the basis of borrowers' cash flows and
do not rely upon the sale of the property to repay the loans. As added security,
these loans are backed by the value of the collateral properties, which are
supported by recent appraisals.
Real estate construction loans increased $15.4 million (28.2%) from $54.5
million as of December 31, 1996, to $69.9 million as of December 31, 1997. This
compares with a balance of $40.5 million as of December 31, 1995. These loans
are typically of a short duration and reflect the continued growth of the Aurora
area. The majority of these loans were to experienced developers of pre-sold
homes in the price range of $100,000 to $150,000.
The Company's residential real estate loans consist of loans secured by one to
four family homes. This category increased $37.6 million (44.2%) in 1997 and
$53.4 million (168.5%) in 1996, primarily as a result of adjustable rate
mortgages added to the portfolio and the addition of Valley loans, which
contributed approximately one fifth of the growth in 1996. The Company
originates a full line of mortgage products, but sells most fixed rate
residential real estate loans, primarily to the Federal Home Loan Mortgage
Corporation ("FHLMC") and to the Federal National Mortgage Association ("FNMA").
Loans held for sale were $2.8 million and $4.1 million as of December 31, 1997
and 1996. In addition, the Company has entered into agreements to sell loans to
the FHLMC and the FNMA. Minimum commitments under these agreements to sell loans
to FHLMC were $19.6 as of December 31, 1997, and $9.3 million as of December 31,
1996, and no commitments were outstanding to the FNMA as of either date.
Installment loans increased $27.0 million (36.5%) in 1997, after increasing
$23.4 million (46.4%) in 1996. $12.9 million of the increase in 1996 was related
to Valley loans. The primary source of installment lending has been in single
pay and amortizing loans used to finance automobiles, recreation vehicles, home
improvements, durable goods and other consumer uses, with the most common of
these being automobile financing.
NONPERFORMING LOANS AND ASSETS
The Company utilizes a loan review function which is separate from the lending
function and is responsible for the review of new and existing loans. Potential
problem credits are monitored by the loan review staff and are submitted for
review to a credit committee consisting of loan officers and Board members.
The loan review department rates all commercial loans and mortgage loans secured
by commercial properties or five-plus family residences. These loans are rated 1
to 6, with 4 being special mention, 5 substandard, and 6 doubtful. Loans over 90
days past due are normally either charged off or, if well secured and in the
process of collection, placed in nonaccrual status. The Company designates loans
that will be individually evaluated for impairment to include commercial loans
and mortgages secured by commercial properties or five-plus family residences.
All other smaller balance homogeneous loans are evaluated for impairment in
total. The Company defines impaired loans to include all commercial loans and
mortgage loans secured by commercial properties or five-plus family residences
that are graded 6 or in nonaccrual status.
Impaired loans totaled $3,559,000 as of December 31, 1997, and $1,428,000 as of
December 31, 1996. Impaired loans with no allowance for loan losses allocated
were $2,234,000 as of December 31,
- --------------------------------------------------------------------------------
LOAN PORTFOLIO (In thousands)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Commercial and industrial $168,899 $161,847 $109,872
Real estate - commercial 95,755 75,449 67,739
Real estate - construction 69,901 54,513 40,510
Real estate - residential 122,732 85,107 31,673
Installment 100,869 73,918 50,489
Credit card receivables 8,100 6,697 5,644
Other loans 813 1,188 455
-------- -------- --------
Gross loans 567,069 458,719 306,382
Unearned discount (1,324) (1,535) (1,743)
Deferred loan fees (397) (382) (312)
-------- -------- --------
Total loans 565,348 456,802 304,327
Allowance for loan losses (8,360) (7,274) (5,176)
-------- -------- --------
Loans, net $556,988 $449,528 $299,151
-------- -------- --------
-------- -------- --------
</TABLE>
33
<PAGE>
1997, and were $523,000 as of December 31, 1996. Impaired loans with an
allowance for loan losses allocation, and the related allocation, were
$1,325,000 and $473,000 as of December 31, 1997, and were $905,000 and $363,000
as of December 31, 1996.
There were no loans past due ninety days or more and still accruing, as of
December 31, 1997, or 1996. Nonaccrual loans were $4,623,000 as of December 31,
1997, compared with $2,970,000 as of December 31, 1996. The ratio of nonaccrual
loans to total loans was 0.82% and 0.65% as of December 31, 1997 and 1996.
ALLOWANCE FOR LOAN LOSSES
The adequacy of the allowance for loan losses is determined by management based
on factors that include the overall composition of the loan portfolio, types of
loans, past loss experience, loan delinquencies, potential substandard and
doubtful credits, and other factors that, in management's judgment, deserve
evaluation in estimating loan losses. The adequacy of the allowance for loan
losses is monitored by the loan review staff, and reported to management and the
board of directors. The ratio of the allowance for loan losses to total loans
was 1.48% and 1.59% as of December 31, 1997, and 1996. The allowance for loan
losses to total nonperforming loans (generally considered to be nonaccrual,
restructured, or past due ninety days and still accruing) was 164.9% and 218.5%
as of December 31, 1997, and 1996.
While there can be no assurance that the allowance for loan losses will be
adequate to cover all losses, management believes that the allowance for loan
losses was adequate at December 31, 1997. While management uses available
information to provide for losses on loans, the ultimate collectibility of a
substantial portion of the loan portfolio and the need for future additions to
the allowance will be based upon changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to make additional provisions to the allowance based upon
their judgments about information available to them at the time of their
examinations.
SECURITIES
The objectives regarding the securities portfolio are to provide the Company
with a source of liquidity and earnings. Securities available for sale are
carried at fair value, with related unrealized gains or losses, net of deferred
income taxes, recorded as an adjustment to equity capital. In addition, a
transfer of securities to available for sale was made in 1995, as permitted by
the SFAS 115 implementation guide released in 1995.
As of December 31, 1997, net unrealized gains of $2.5 million, reduced by
deferred income taxes of $855,000, resulted in an increase in equity capital of
$1.7 million. As of December 31, 1996, net unrealized gains of $429,000, reduced
by deferred income taxes of $112,000, resulted in an increase in equity capital
of $317,000.
During 1997, the securities portfolio grew $7.9 million (4.1%), as measured by
amortized cost, to $202.3 million as of December 31, 1997, from $194.4 million
as of December 31, 1996. U.S. Treasury securities declined by 20.5% to $14.1
million, or 7.0% of the portfolio as of December 31, 1997, from $17.7 million,
or 9.1% of the portfolio as of December 31, 1996. U.S. Government agency
mortgage-backed securities decreased from $34.1 million, or 17.6% of the
portfolio as of December 31, 1996, to $25.9 million, or 12.8% of the portfolio
as of December 31, 1997. Over the same period, U.S. Government agency securities
increased from $77.0 million, or 39.6% of the portfolio, to $86.0 million, or
42.5% of the portfolio. Municipal securities increased from $53.9 million or
27.7% of the portfolio, to $60.8, or $30.1% of the portfolio. U.S. Government
agency and municipal securities were increased in order to manage the Federal
and state income tax obligations of the Company. The increase in the proportion
of the total portfolio invested in U.S. Government agency securities was also
based upon considerations of yield, security, and suitability as collateral for
deposits and borrowings requiring pledged securities.
As of December 31, 1997, and 1996, the Company held structured notes carried at
fair values of $2.2 million and $4.3 million. These securities were issued by
the FHLB and FNMA. These obligations offer the investor periodic coupon
increases over a given time horizon, and are generally subject to call after the
first coupon readjustment date. All such securities are stress tested, to assess
the probable price sensitivity in response to an immediate and sustained change
in market interest rates. In addition, each security's total return is computed
to each call date, as if it were to be called on that date, and the resulting
annual return is compared with other investments with maturities similar to the
call dates of the security.
DEPOSITS AND BORROWED FUNDS
The Company has a relatively stable deposit base from within its market areas.
Total deposits grew $49.7 million (8.3%) during 1997, to $650.7 million as of
December 31, 1997. This growth
34
<PAGE>
resulted from the Company's well-established presence in markets with growing
economies. During 1997, noninterest deposits grew $6.0 million (5.3%), while
interest bearing deposits grew $43.7 million (8.9%). During 1997, time deposits
under $100,000 grew $14.6 million (7.0%) and time deposits in denominations of
$100,000 or more grew $12.0 million (15.2%). Interest-bearing transaction
accounts and savings accounts increased 8.5% in the aggregate, at $218.4 million
as of December 31, 1997, compared to $201.3 million as of December 31, 1996.
Deposits of $601.0 million as of December 31, 1996, reflected growth of $147.2
million (32.4%) during 1996. The Valley acquisition added $102.1 million to
total deposits as of December 31, 1996.
Advances from the FHLB at December 31, 1997, consisted of $7.5 million in
overnight funds, included in Federal funds purchased and overnight borrowings,
and term advances of $59,750,000. The Company has pledged first mortgage loans
on residential property in an amount equal to at least 167% of the outstanding
advances. The term advances are used to finance mortgage lending, and are
scheduled to mature as detailed in Note 8 to the consolidated financial
statements.
Notes payable at December 31, 1997, and December 31, 1996, consisted of two
notes of $7 million each, the proceeds of which were used to finance the
acquisition of Valley on January 3, 1996. One of the notes is a revolving note
which bears interest at the prevailing Federal funds rate or 1% above LIBOR, at
the quarterly election of the Company. This variable rate was 6.77% at December
31, 1997. A fixed rate note bears interest at a rate of 7.03%.
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 requirements or create an expense related to FDIC insurance on
deposits. Although the balance of repurchase agreements is subject to variation,
particularly seasonal variation, the account relationships represented by these
balances are local businesses and municipalities that have other account
relationships with the Banks.
CAPITAL RESOURCES
The board of directors declared a two-for-one stock split on the Company's
common stock effective on September 30, 1997. Par value remained unchanged at
$1. The effect of the stock split has been reflected since September 30, 1997 in
the consolidated balance sheet and statement of stockholders' equity.
Total stockholders' equity increased $7.1 million during 1997, from $58.2
million as of December 31, 1996, to $65.3 million as of December 31, 1997. Net
income of $7,341,000, reduced by dividends of $1,759,000, caused an increase in
retained earnings of $5.6 million during 1997. Other factors influencing the
year to year change in total stockholders' equity were an increase of $201,000
from the issuance of common stock in connection with the dividend reinvestment
plan, offset by an increase of $1.3 million as a result of the change in the net
unrealized gains on securities available for sale, as discussed in "Securities"
above.
Bank regulatory agencies have adopted capital standards by which all banks and
bank holding companies will be evaluated (discussed in Note 15 to the
consolidated financial statements). As of the Company's and the Banks' most
recent regulatory notifications, the Company and the Banks were categorized as
well capitalized. Management is not aware of any conditions or events since the
most recent regulatory notification that would change the Company's or the
Bank's categories.
LIQUIDITY
Liquidity measures the ability of the Company to meet maturing obligations and
its existing commitments, to withstand fluctuations in deposit levels, to fund
its operations and to provide for customers' credit needs. The liquidity of the
Company principally depends on cash flows from operating activities, investment
in and maturity of assets, changes in balances of deposits and borrowings and
its ability to borrow funds in the money or capital markets.
Cash inflows from operating activities exceeded operating outflows by $9.8
million in 1997, by $9.9 million in 1996, and by $8.8 million in 1995. Changes
in the amount of mortgage loans held for sale as of December 31 of each year,
resulted in operating cash inflows of $1,789,000 in 1997, inflows of $604,000 in
1996, and outflows of $1,966,000 in 1995. Net gains on sales of mortgage loans
were $1,106,000 in 1997, $981,000 in 1996, and $341,000 in 1995. Interest
received net of interest paid is the principal source of net operating cash
inflows in all periods reported. Management of investing and financing
activities, and market conditions, determine the level and the stability of net
interest cash flows. Management's policy is to mitigate the impact of changes in
market interest rates to the extent possible, so that balance sheet growth is
the principal determinant of growth in net interest cash flows.
Net cash outflows from investing activities were $120.1 million in 1997,
compared to $69.2 million
35
<PAGE>
in 1996, and $37.9 million in 1995. Securities purchases, net of securities
matured or sold, resulted in net cash outflows of $8.4 million in 1997, inflows
of $17.2 million in 1996, and outflows of $16.2 million in 1995. Net principal
disbursed on loans totaled $110.3 million in 1997, $79.3 million in 1996, and
$20.6 million in 1995. The Valley acquisition resulted in net investing cash
outflows, net of cash and cash equivalents acquired and debt assumed, of $13.5
million in 1996. In addition, the sale of acquired Valley subsidiaries during
1996 resulted in investing cash inflows of $8.7 million.
Cash inflows from financing activities in 1997, 1996, and 1995, were primarily
associated with deposit growth. Deposits grew $49.7 million in 1997, $49.3
million in 1996, and $40.0 million in 1995. Short-term borrowing resulted in net
cash inflows of $329,000 in 1997, inflows of $20.7 million in 1996, and outflows
of $10.6 million in 1995. Cash inflows from FHLB term advances were $59.8
million during 1997. Cash outflows from payments on notes payable in 1996 were
related to $3,550,000 in debt assumed in the Valley acquisition, which was
repaid, and a $3.0 million advance from the FHLB which was also repaid. Cash
inflows of $14.0 million from proceeds of notes payable in 1996 were associated
with the financing of the Valley acquisition.
In the event of short-term liquidity needs, the Banks may purchase Federal funds
from correspondent banks. This source is used from time to time on a limited
basis. The Banks may borrow funds from the Federal Reserve Bank of Chicago, but
have not done so during any period covered in this report. Merchants Bank's
membership in the FHLB system gives it the ability to borrow funds from the FHLB
for short or long-term purposes under a variety of programs.
EFFECTS OF INFLATION
Consolidated financial data included herein has been prepared in accordance with
generally accepted accounting principles. Changes in the relative value of money
due to inflation or recession are generally not considered.
In management's opinion, changes in interest rates affect the financial
condition of a financial institution to a far greater degree than changes in the
inflation rate. While interest rates are greatly influenced by changes in the
inflation rate, they do not change at the same rate or in the same magnitude as
the inflation rate. Rather, interest rate volatility is based on changes in the
expected rate of inflation, as well as on changes in monetary and fiscal
policies. A financial institution's ability to be relatively unaffected by
changes in interest rates is a good indicator of its capability to perform in
today's volatile economic environment. The Company seeks to insulate itself from
interest rate volatility by ensuring that rate sensitive assets and rate
sensitive liabilities respond to changes in interest rates in a similar time
frame and to a similar degree.
YEAR 2000 COMPLIANCE
Critical issues facing the financial institution industry are concerns over
computer systems' ability to process year-date data beyond the year 1999. Except
in year 2000 compliant programs, computer programmers have often abbreviated
dates by eliminating the first two digits of a year, with the assumption that
these two digits would always be "19." Unless corrected, this situation may
cause problems for some financial institutions on January 1, 2000, when computer
systems may recognize this date as January 1, 1900, and process data incorrectly
or stop processing altogether. The Company has developed a plan which was
reviewed by the Office of the Comptroller of the Currency, whereby, all software
applications and hardware will be assessed for "Year 2000" compliance before the
end of 1998. Many vendors have already been contacted. Additionally, alarms,
elevators, heating and cooling systems and other computer controlled mechanical
devices on which the Company relies are being evaluated. Those found not to be
in compliance will be modified or replaced with a compliant product. Based on
the responses received to date, management anticipates having fully compliant
systems in place before the end of the millennium. At the present time, no
situations that will require material cost expenditures to become fully
compliant have been identified.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
This report, including the Chairman's Letter to Stockholders, contains certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. The Company intends such forward-looking statements to be covered by
the safe harbor provisions for forward-looking statements contained in the
Private Securities Reform Act of 1995, and is including this statement for
purposes of these safe harbor provisions. Forward-looking statements, which are
based on certain assumptions and describe future plans, strategies and
expectations of the Company, are generally identifiable by use of the words,
"believe," "expect," "intend," "anticipate," "estimate," "project," or similar
expressions. The Company's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which could have a
material
36
<PAGE>
adverse affect on the operations and future prospects of the Company and the
subsidiaries include, but are not limited to, changes in: Interest rates,
general economic conditions, legislative/regulatory changes, monetary and fiscal
policies of the U.S. Government, including policies of the U.S. Treasury and the
Federal Reserve Board, the quality or composition of the loan or 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.
37
<PAGE>
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.
The table "Analysis of Changes in Interest Income," included under "Interest
Income" in the Management Discussion, demonstrates the effectiveness of interest
rate risk management. During 1997, the change in tax equivalent net interest
income attributable to changes in interest rates was a decrease of $2.2 million,
or 7%, of tax equivalent net interest income of $30.6 million. The change in tax
equivalent net interest income attributable to changes in interest rates was a
reduction of $951,000 in 1996, or 3.4% of the tax equivalent net interest income
of approximately $27.9 million for the year.
In the following table, deposits which 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 December 31, 1997:
- --------------------------------------------------------------------------------
EXPECTED MATURITY OF INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
<TABLE>
<CAPTION>
Expected Maturity Dates Fair
1998 1999 2000 2001 2002 Thereafter Total Value
-------- -------- ------- ------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning Assets
Fixed rate loans $114,440 $ 52,809 $50,784 $32,957 $ 63,311 $ 18,986 $333,287 $338,946
Average interest rate 10.44% 8.91% 9.14% 9.24% 8.60% 7.73%
Adjustable rate loans $126,555 $ 36,981 $21,507 $17,757 $ 18,256 $ 13,838 $234,894 $234,894
Average interest rate 8.64% 9.37% 9.54% 9.61% 9.39% 9.80%
Securities $ 51,201 $ 18,159 $16,697 $24,651 $ 29,405 $ 64,648 $204,761 $204,761
Average interest rate 5.84% 6.59% 5.87% 6.34% 6.36% 6.26%
Federal funds sold $ 7,080 $ - $ - $ - $ - $ - $ 7,080 $ 7,080
Average interest rate 5.27%
-------- -------- ------- ------- -------- -------- -------- --------
Total $299,276 $107,949 $88,988 $75,365 $110,972 $ 97,472 $780,022 $785,681
-------- -------- ------- ------- -------- -------- -------- --------
-------- -------- ------- ------- -------- -------- -------- --------
Interest-bearing Liabilities
Interest-bearing
deposits $231,876 $ 84,865 $57,060 $31,492 $ 29,283 $ 97,955 $532,531 $532,781
Average interest rate 5.28% 5.13% 5.25% 4.14% 4.33% 3.03%
Borrowed funds $ 63,229 $ 13,375 $13,375 $ 5,625 $ 13,375 $ 9,625 $118,604 $118,272
Average interest rate 5.80% 6.03% 6.08% 6.32% 5.93% 6.90%
-------- -------- ------- ------- -------- -------- -------- --------
Total $295,105 $ 98,240 $70,435 $37,117 $ 42,658 $107,580 $651,135 $651,053
-------- -------- ------- ------- -------- -------- -------- --------
-------- -------- ------- ------- -------- -------- -------- --------
</TABLE>
38
<PAGE>
MARKET FOR THE COMPANY'S COMMON STOCK
AND RELATED SECURITY HOLDER MATTERS
The Company's common stock trades on the Nasdaq Stock Market under the symbol
"MBIA." Harris Trust and Savings Bank acts as the transfer agent for the common
stock. As of December 31, 1997, the Company had 734 holders of record of its
common stock.
The table below indicates the reported high and low prices and the dividends
paid per share for the common stock during the periods indicated, and reflects
the 1997 two-for-one stock split.
<TABLE>
<CAPTION>
Cash
High Low Dividends
------ ------ ---------
<S> <C> <C> <C>
1996 First quarter $14.88 $13.88 $0.060
Second quarter 16.75 14.00 0.070
Third quarter 16.75 14.88 0.070
Fourth quarter 16.00 15.13 0.070
1997 First quarter 19.25 15.50 0.070
Second quarter 19.63 18.00 0.085
Third quarter 24.69 19.13 0.085
Fourth quarter 28.38 22.75 0.085
1998 First quarter (through March 4) 30.00 27.25 0.100
</TABLE>
The holders of the common stock are entitled to receive dividends as declared by
the board of directors of the Company, which considers payment of dividends
quarterly. The ability of the Company to pay dividends is dependent upon its
receipt of dividends from the Banks. In determining cash dividends, the
Company's board of directors considers the earnings, capital requirements, debt
servicing requirements, financial ratio guidelines established by the board of
directors, financial condition of the Company, and other relevant factors. The
Banks' ability to pay dividends to the Company and the Company's ability to pay
dividends to its stockholders are also subject to certain regulatory
restrictions.
The Company has paid regular quarterly cash dividends on the common stock since
it commenced operations in 1982. The Company currently anticipates that cash
dividends comparable to those that have been paid in the past will continue to
be paid in the future. There can be no assurance, however, that any such
dividends will be paid by the Company or that such dividends will not be reduced
or eliminated in the future. The timing and amount of dividends will depend upon
the earnings, capital requirements, and financial condition of the Company and
the Banks. The Company has a dividend reinvestment plan which permits
stockholders to reinvest cash dividends in common stock and to purchase
additional shares in amounts up to $3,000 per quarter.
REPORT ON FORM 10-K
A copy of the Company's 1997 Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission, will be furnished without charge to each
stockholder upon written request to: J. Douglas Cheatham, Vice President and
Chief Financial Officer, Merchants Bancorp, Inc., P.O. Box 289, Aurora, Illinois
60507.
39
<PAGE>
Exhibit 22
LIST OF SUBSIDIARIES
SUBSIDIARIES OF THE CORPORATION
The Merchants National Bank of Aurora, a bank chartered under the laws of
the United States.
Merserco, Inc., a Delaware corporation.
Valley Banc Service Corp., an Illinois corporation.
Hinckley State Bank, an Illinois-chartered Bank.
VBH Corporation, an Iowa corporation.
Fox Valley Bank, an Illinois-chartered Bank.
56
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement on
Form S-3 of Merchants Bancorp, Inc. to the Merchants Bancorp, Inc. Dividend
Reinvestment and Stock Purchase Plan and in the Registration Statement on Form
S-8 of Merchants Bancorp, Inc. to the Merchants Bancorp, Inc. 1993 Stock
Incentive Plan of our report dated February 3, 1998 on the Company's 1997
consolidated financial statements included in the Form 10-K of Merchants
Bancorp, Inc. for the year ended December 31, 1997.
Crowe, Chizek and Company LLP
Oak Brook, Illinois
March 27, 1998
57
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 35,914
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 2,080
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 204,761
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 565,348
<ALLOWANCE> 8,360
<TOTAL-ASSETS> 838,971
<DEPOSITS> 650,718
<SHORT-TERM> 44,854
<LIABILITIES-OTHER> 4,332
<LONG-TERM> 73,750
0
0
<COMMON> 5,213
<OTHER-SE> 60,104
<TOTAL-LIABILITIES-AND-EQUITY> 838,971
<INTEREST-LOAN> 45,052
<INTEREST-INVEST> 12,072
<INTEREST-OTHER> 395
<INTEREST-TOTAL> 57,519
<INTEREST-DEPOSIT> 24,082
<INTEREST-EXPENSE> 28,559
<INTEREST-INCOME-NET> 28,960
<LOAN-LOSSES> 2,636
<SECURITIES-GAINS> (380)
<EXPENSE-OTHER> 27,754
<INCOME-PRETAX> 8,230
<INCOME-PRE-EXTRAORDINARY> 8,230
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,341
<EPS-PRIMARY> 1.42
<EPS-DILUTED> 1.41
<YIELD-ACTUAL> 4.35
<LOANS-NON> 4,623
<LOANS-PAST> 0
<LOANS-TROUBLED> 485
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,274
<CHARGE-OFFS> 2,122
<RECOVERIES> 572
<ALLOWANCE-CLOSE> 8,360
<ALLOWANCE-DOMESTIC> 8,360
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
