<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period from____ to____
Commission File Number 0 -14484
MERCHANTS BANCORP, INC.
-----------------------
(Exact name of Registrant as specified in its charter)
DELAWARE 36-3182868
-------- ----------
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
P.O. BOX 289, AURORA, ILLINOIS 60507
-----------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(630) 896-9000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date: As of September 30,
1999, the Registrant had outstanding 5,199,254 shares of common stock, $1.00 par
value per share.
<PAGE>
MERCHANTS BANCORP, INC.
Form 10-Q Quarterly Report
Table of Contents
PART I
<TABLE>
<CAPTION>
Page Number
<S> <C>
Item 1. Financial Statements................................................................................1
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................................................6
Item 3. Quantitative and Qualitative Disclosure about Market Risk..........................................13
PART II
Item 1. Legal Proceedings..................................................................................16
Item 2. Changes in Securities..............................................................................16
Item 3. Defaults Upon Senior Securities....................................................................16
Item 4. Submission of Matters to a Vote of Security Holders................................................16
Item 5. Other Information..................................................................................16
Item 6. Exhibits and Reports on Form 8-K...................................................................16
Form 10-Q Signature Page.........................................................................................17
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
MERCHANTS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 35,171 $ 38,679
Federal funds sold - 5,000
Securities available for sale 232,165 198,759
Loans held for sale 1,421 9,678
Loans 688,790 607,927
Allowance for loan losses (7,819) (8,507)
--------- --------
Net loans 680,971 599,420
Premises and equipment, net 11,454 11,872
Other real estate owned 250 297
Mortgage servicing rights 2,693 2,440
Goodwill, net 6,115 6,397
Core deposit intangible assets, net 1,448 1,673
Accrued interest and other assets 12,860 9,647
--------- --------
Total assets $984,548 $883,862
--------- --------
--------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $126,778 $132,153
Interest-bearing 617,718 609,904
--------- --------
Total deposits 744,496 742,057
Federal funds purchased and overnight borrowings 54,600 -
Securities sold under repurchase agreements 17,303 13,320
Federal Home Loan Bank term advances 87,250 42,250
Notes payable 5,469 6,125
Accrued interest and other liabilities 2,063 7,928
--------- --------
Total liabilities 911,181 811,680
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value;
Authorized 500,000 shares; none issued - -
Common stock, $1 par value authorized 6,000,000 shares;
issued 5,240,575 in 1999 and 5,222,392 in 1998 5,240 5,222
Surplus 16,613 16,348
Retained earnings 53,707 48,809
Accumulated other comprehensive income (loss) (2,102) 1,894
Treasury stock, at cost, 41,321 shares (91) (91)
--------- --------
Total stockholders' equity 73,367 72,182
--------- --------
Total liabilities and stockholders' equity $984,548 $883,862
--------- --------
--------- --------
</TABLE>
See accompanying notes to the consolidated financial statements.
1
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $13,530 $12,867 $38,906 $38,177
Loans held for sale 35 87 243 278
Securities:
Taxable 2,293 1,971 6,191 6,231
Tax-exempt 1,042 843 2,956 2,458
Federal funds sold 6 159 34 369
------- ------- ------- -------
Total interest income 16,906 15,927 48,330 47,513
INTEREST EXPENSE
Deposits 6,910 6,789 20,368 19,465
Federal funds purchased and overnight borrowings 345 327 529 1,127
Securities sold under repurchase agreements 204 167 561 803
Federal Home Loan Bank term advances 1,072 664 2,342 2,306
Notes payable 101 236 307 714
------- ------- ------- -------
Total interest expense 8,632 8,183 24,107 24,415
------- ------- ------- -------
Net interest income 8,274 7,744 24,223 23,098
Provision for loan losses 825 443 1,815 1,719
------- ------- ------- -------
Net interest income after provision for loan losses 7,449 7,301 22,408 21,379
NON INTEREST INCOME
Trust income 736 660 2,271 1,970
Mortgage banking income 619 940 2,597 3,101
Service charges and fees 1,191 1,115 3,440 3,106
Securities gains, net 3 0 15 96
Other income 571 388 1,348 920
------- ------- ------- -------
Total income 3,120 3,103 9,671 9,193
NON INTEREST EXPENSE
Salaries and employee benefits 4,063 3,951 11,970 11,496
Occupancy expense, net 504 499 1,585 1,558
Furniture and equipment expense 512 564 1,571 1,680
Amortization of goodwill 94 94 282 282
Amortization of core deposit intangible assets 67 96 224 287
Other expense 2,635 2,213 7,238 6,654
------- ------- ------- -------
Total expense 7,875 7,417 22,870 21,957
------- ------- ------- -------
Income before income taxes 2,694 2,987 9,209 8,615
Provision for income taxes 745 842 2,445 2,404
------- ------- ------- -------
Net income $1,949 $2,145 $6,764 $6,211
------- ------- ------- -------
------- ------- ------- -------
Basic earnings per share $0.38 $0.41 $1.31 $1.20
Diluted earnings per share $0.37 $0.41 $1.29 $1.18
</TABLE>
2
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net income $1,949 $2,145 $ 6,764 $6,211
Change in net unrealized gains (losses) on securities (29) 1,232 (3,996) 1,179
------ ------ ------ ------
Comprehensive income $1,920 $3,377 $ 2,768 $7,390
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 6,764 $ 6,211
Adjustments to reconcile net income to cash from operating activities:
Depreciation 1,492 1,464
Amortization of mortgage servicing rights 623 557
Provision for loan losses 1,815 1,719
Net change in mortgage loans held for sale 8,700 (3,574)
Net gain on sales of loans (1,319) (1,752)
Change in net income taxes payable 358 (42)
Change in accrued interest and other assets (3,213) (432)
Change in accrued interest and other liabilities (4,788) (767)
Premium amortization and discount accretion on securities 298 196
Securities losses (gains), net (15) (96)
Amortization of goodwill 282 282
Amortization of core deposit intangible assets 224 287
-------- -------
Net cash from operating activities 11,221 4,053
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from matured securities available for sale 29,018 47,677
Proceeds from sales of securities available for sale 4,078 14,134
Purchases of securities available for sale (72,839) (47,382)
Net principal disbursed or repaid on loans (83,366) (21,606)
Proceeds from sales of other real estate 47 (142)
Property and equipment expenditures (1,074) (1,881)
-------- -------
Net cash from investing activities (124,136) (9,200)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 2,439 51,565
Net change in short term borrowings 58,583 (18,149)
Payments on Federal Home Loan Bank term advances - (17,500)
Proceeds from Federal Home Loan Bank term advances 45,000 -
Payments on notes payable (656) (656)
Proceeds from exercise of incentive stock options 284 111
Dividends paid, net of dividend reinvestments (1,243) (1,459)
-------- -------
Net cash from financing activities 104,407 13,912
-------- -------
Net change in cash and cash equivalents (8,508) 8,765
Cash and cash equivalents at beginning of period 43,679 42,994
-------- -------
Cash and cash equivalents at end of period $35,171 $51,759
-------- -------
-------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE & PER SHARE DATA)
NOTE 1: BASIS OF PRESENTATION
The financial information of Merchants Bancorp, Inc. (the "Company") included
herein is unaudited; however, such information reflects all adjustments
(consisting of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair statement of results for the interim periods.
The results of the interim periods ended September 30, 1999 are not necessarily
indicative of the results expected for the year ending December 31, 1999.
NOTE 2: SECURITIES
Securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
September 30, 1999:
U.S. Treasury $ 1,004 $ 11 $ - $ 1,015
U.S. Government agencies 130,375 5 (2,773) 127,607
U.S. Government agency
mortgage backed securities 12,369 123 (54) 12,438
States and political subdivisions 84,943 907 (1,355) 84,495
Collateralized mortgage obligations 1,581 13 (3) 1,591
Other securities 5,078 - (59) 5,019
-------- ------ ------- --------
$235,350 $1,059 $(4,244) $232,165
-------- ------ ------- --------
-------- ------ ------- --------
December 31, 1998:
U.S. Treasury $ 3,009 $ 51 $ - $ 3,060
U.S. Government agencies 96,521 550 (243) 96,828
U.S. Government agency
mortgage backed securities 16,351 187 (50) 16,488
States and political subdivisions 74,134 2,492 (43) 76,583
Collateralized mortgage obligations 2,834 23 (5) 2,852
Equity securities 3,041 - (93) 2,948
-------- ------ ------- --------
$195,890 $3,303 $ (434) $198,759
-------- ------ ------- --------
-------- ------ ------- --------
</TABLE>
4
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 3: LOANS
<TABLE>
<CAPTION>
Major classifications of loans are as follows: September 30, December 31,
1999 1998
------------- ------------
<S> <S> <S>
Commercial and industrial $146,172 $175,402
Real estate - commercial 106,477 87,035
Real estate - construction 111,764 92,897
Real estate - residential 177,732 134,009
Installment 138,476 109,970
Credit card receivables 8,140 8,483
Other loans 582 1,233
-------- --------
689,343 609,029
Unearned discount (396) (869)
Deferred loan fees (157) (233)
-------- --------
Total loans $688,790 $607,927
-------- --------
-------- --------
</TABLE>
NOTE 4: ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses as of September 30, is summarized as follows:
<TABLE>
<CAPTION>
1999 1998
-------- -------
<S> <S> <S>
Balance, January 1 $8,507 $8,360
Provision for loan losses 1,815 1,719
Loans charged-off (3,160) (1,345)
Recoveries 657 451
------- -------
Balance, end of period $7,819 $9,185
------- -------
------- -------
</TABLE>
NOTE 5: EMPLOYEE BENEFIT PLANS
The Company maintains an Employee Contributory Thrift Plan (the "Thrift Plan"),
which covers employees who work a minimum of 1,000 hours per year and have been
with the Company at least one year. Vesting in Company contributions to the
Thrift Plan is scheduled over seven years from the date of employment. The
Company contributes an amount determined by the Board of Directors to all
eligible participants. In addition, for each dollar the participant deposits up
to 6% of annual salary, the Company will contribute an additional fifty cents.
Total contributions under the Thrift Plan were approximately $665,000, and
$708,000 for the nine months ended September 30, 1999, and 1998.
NOTE 6: BORROWINGS
Merchants National Bank's membership in the Federal Home Loan Bank ("FHLB")
System gives it the ability to borrow funds from the FHLB of Chicago for short
or long-term purposes under a variety of programs. The Company has pledged first
mortgage loans on residential property in an amount equal to at least 167% of
the outstanding advances.
Notes payable at September 30, 1999, consisted of a $5,468,750 fixed rate note
that bears interest at a rate of 7.03%. Scheduled principal reductions on the
note are $218,750 per quarter.
5
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 7: EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- -------- --------- ----------
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Weighted-average common shares outstanding 5,195,301 5,180,453 5,185,867 5,174,254
Net income available to common stockholders $1,949 $2,145 $6,764 $6,211
Basic earnings per share $0.38 $0.41 $1.31 $1.20
Diluted Earnings Per Share:
Weighted-average common shares outstanding 5,195,301 5,180,453 5,185,867 5,174,254
Dilutive effect of stock options 67,002 66,657 60,045 69,722
--------- -------- --------- ----------
Diluted average common shares outstanding 5,262,303 5,247,110 5,245,912 5,243,976
--------- -------- --------- ----------
--------- -------- --------- ----------
Net income available to common stockholders $1,949 $2,145 $6,764 $6,211
Diluted earnings per share $0.37 $0.41 $1.29 $1.18
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the third quarter of 1999 was $1,949,000, or diluted earnings per
share of 37 cents, a 9.1% decrease in net income compared to $2,145,000, or 41
cents per diluted share, in the third quarter of 1998. The decrease in net
income for the quarter was primarily a result of $415,000 in expenses associated
with the pending merger with Old Kent Financial Corporation.
During the nine months ended September 30, 1999, net income was $6,764,000, or
diluted earnings per share of $1.29, compared to $6,211,000, or $1.18 per
diluted share, during the first nine months of 1998. This 8.9% increase in net
income for the nine month period was attributable primarily to an increase in
net interest income of $1,125,000, or 4.9%, and an increase in noninterest
income of $478,000, or 5.2%, while noninterest expense increased $913,000, or
4.2%. Year to date earnings, excluding the merger related expenses of $415,000
($253,000, net of tax), would have been $7,017,000, with diluted earnings per
share would have been $1.34 or 13.6% ahead of the first nine months of 1998.
NET INTEREST INCOME
Net interest income was $8.3 million and $7.7 million during the three months
ended September 30, 1999 and 1998, an increase of 6.8%. The Company's net
interest margin was, on a tax-equivalent basis, 3.95% for the three months ended
September 30, 1999, and 4.15% a year earlier. Net interest income was $24.2
million and $23.1 million during the nine months ended September 30, 1999 and
1998, an increase of 4.90%. The Company's net interest margin was 4.09% for the
nine months ended September 30, 1999, and 4.18% a year earlier. The average
yield on earning assets was 7.90% in the third quarter of 1999, down from 8.25%
in the third quarter of 1998. At the same time, the average cost of funds was
3.85% in the third quarter of 1999, a decrease from 4.10% in the third quarter
of 1998. The tightening of the net interest margin was driven by competitive
pressures throughout the Company's market areas.
6
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
While the net interest margins for these periods have remained somewhat
consistent, the average balances of interest-earning assets and interest-bearing
liabilities have increased. The average balance of interest-earning assets for
the three and nine month periods ended September 30, 1999 were $894.6 million
and $850.4 million compared to $791.0 million and $788.4 million for the same
periods in 1998. Similarly, the average balance of interest-bearing liabilities
for the three and nine month periods ended September 30, 1999 were $753.3
million and $742.4 million compared to $683.0 million and $662.3 million for the
same periods in 1998.
OTHER INCOME
Noninterest income was $3,120,000 during the third quarter of 1999 and
$3,103,000 in the third quarter of 1998, an increase of $17,000, or .5%.
Noninterest income was $9,671,000 during the nine months ended September 30,
1999 and $9,193,000 during the nine months ended September 30, 1998, an increase
of $478,000, or 5.2%.
Service charges and fees increased $76,000 (6.8%) during 1999 to $1,191,000 from
$1,115,000 in the third quarter of 1998. Service charges and fees were
$3,440,000 in the nine months ended September 30, 1999, compared to $3,106,000
in the nine months ended September 30, 1998, an increase of $334,000, or 10.8%.
There were no significant changes in the fee structure for deposit accounts.
Mortgage banking income was $619,000 in the third quarter of 1999 and $940,000
in the third quarter of 1998, a decrease of $321,000, or 34.1%. During the first
nine months of the year, mortgage banking income was $2,597,000 in 1999 and
$3,101,000 in 1998, a decrease of $504,000, or 16.3%. Mortgage banking income is
seasonal and is also sensitive to interest rate levels and expectations. Most
fixed rate mortgages that the Company originates are sold and the servicing is
retained. The portfolio of loans serviced for others totaled $337 million as of
September 30, 1999 compared to $311 million a year earlier.
Trust income of $736,000 in the third quarter of 1999 was $76,000, or 11.5%
higher than the third quarter 1998 level. For the nine months ended September
30, 1999, trust income was $2,271,000, compared to $1,970,000 in the nine months
ended September 30, 1998, an increase of $301,000, or 15.3%. The increase in
trust income was a result of a slightly higher fee structure and increased
assets under management.
Sales of securities available for sale resulted in gains of $3,000 in the third
quarter of 1999 and $15,000 in the first nine months of 1999. In the nine months
ended September 30, 1998, securities gains were $96,000. Securities available
for sale are held for indefinite periods of time, and include securities that
will be used as a part of the Company's asset/liability management strategy.
Such securities may be sold in response to changes in interest rates, liquidity
needs, or significant prepayment risk.
OTHER EXPENSE
Salary and benefit expenses increased to $4,063,000 in the third quarter of
1999, from $3,951,000 during the three months ended September 30, 1998, an
increase of $112,000 (2.8%). Salaries and benefits were $11,970,000 and
$11,496,000 during the nine months ended September 30, 1999 and 1998, an
increase of $474,000 (4.1%). The full-time equivalent number of employees was
323 as of September 30, 1999, and 344 as of September 30, 1998. The increase in
salary and benefit expenses was the result of increased medical insurance,
severance, and general salary adjustments. Commissions were $367,000 in the
third quarter of 1999, compared with $348,000 in the third quarter of 1998.
During the nine months ended September 30, commissions were $937,000 in 1999 and
$967,000 in 1998, a $30,000 (3.2%) decrease. Most of the decrease in commissions
was directly associated with a decrease in mortgage banking activity.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
Other expenses were $2,635,000, or $422,000 (19.1%) higher in the third quarter
of 1999, than in the third quarter of 1998. Other expenses were $7,238,000 and
$6,654,000 during the nine months ended September 30, 1999 and 1998, an increase
of $584,000 (8.8%). The primary cause for both of the increases was expenses
related to the Company's pending merger with Old Kent Financial Corporation.
Merger related expenses during the third quarter 1999 were $415,000.
FINANCIAL CONDITION
LOANS, LOANS HELD FOR SALE, AND PROVISION FOR LOAN LOSSES
Total loans increased by $81 million (13.3%) to $689 million as of September 30,
1999, from $608 million as of December 31, 1998. Commercial loans decreased to
$146.1 million as of September 30, 1999, from $175.4 million as of December 31,
1998, a $29.2 million (16.7%) decrease. Commercial real estate loans increased
to approximately $106.4 million as of September 30, 1999, from $87.0 million as
of December 31, 1998, increasing $19.4 million (22.3%). Construction loans
increased $18.9 million (20.3%) to $111.8 million as of September 30, 1999.
Residential real estate loans increased $43.7 million (32.6%), to $177.7
million, from $134.0 million as of December 31, 1998. Residential real estate
loans are primarily adjustable rate mortgages. These increases reflect the
continued strength of the Fox Valley economy in general, and the real estate
market in particular.
Most of the residential fixed rate mortgage loans originated by the Company's
mortgage banking department are sold in the secondary market, with servicing
rights retained. A portion of the loans originated, typically adjustable rate
mortgages, are retained in Merchants National Bank's portfolio, as reflected in
the increase in residential real estate loans. At any point in time, loans will
be at various stages of the mortgage banking process. Loans held for sale were
$1.4 million as of September 30, 1999, and $9.7 million as of December 31, 1998.
The carrying value of these loans approximated the market value at that time.
The adequacy of the allowance for loan losses is determined by management based
on factors that include the overall composition of the loan portfolio, types of
loans, past loss experience, loan delinquencies, potential substandard and
doubtful credits, and other factors that, in management's judgement, deserve
evaluation in estimating loan losses. The adequacy of the allowance for loan
losses is monitored regularly by management and the Board of Directors.
Provisions for loan losses in the third quarter of 1999 were $825,000 compared
with $443,000 in the third quarter of 1998. Net charge-offs for the three months
ended September 30, were $1,813,000 and $180,000 in 1999 and 1998, respectively.
Provisions for loan losses were $1,815,000 in the nine months ended September
30, 1999 and $1,719,000 in the nine months ended September 30, 1998. Net
charge-offs for the nine months ended September 30, were $2,503,000 and $894,000
in 1999 and 1998, respectively. One measure of the adequacy of the allowance for
loan losses is the ratio of the allowance to total loans. Although some decline
in
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
the ratio is natural when loan volume increases substantially, an adequate level
has been maintained. The allowance for loan losses as a percentage of total
loans was 1.14% as of September 30, 1999, and 1.47% as of December 31, 1998. In
management's judgment, an adequate allowance for loan losses has been
established.
Nonaccrual loans increased to $5,663,000 as of September 30, 1999, from
$5,568,000 as of December 31, 1998. Nonaccrual loans principally consist of
loans that are well-collateralized and are not expected to result in material
losses. There were no loans past due ninety days or more and still accruing
interest as of either September 30, 1999, or December 31, 1998. Other real
estate owned decreased from $297,000 as of December 31, 1998, to $250,000 as of
September 30, 1999. The recorded values of these properties were supported by
current appraisals.
SECURITIES
All securities held in the bond portfolio are classified as available for sale
and may be sold as part of the Company's asset/liability management strategy in
response to changes in interest rates, liquidity needs, or significant
prepayment risk. Securities available for sale are carried at fair value, with
related unrealized net gains or losses, net of deferred income taxes, recorded
as an adjustment to equity capital. As of September 30, 1999, net unrealized
losses of $3,185,000, reduced by deferred income taxes of $1,083,000, resulted
in a decrease in equity capital of $2,102,000. As of December 31, 1998, net
unrealized gains of $2,869,000, net of deferred income taxes of $975,000,
resulted in an increase in equity capital of $1,894,000.
The fair value of securities available for sale increased $33.4 million (16.8%)
during the first nine months of 1999, to $232.2 million as of September 30,
1999, from $198.8 million as of December 31, 1998. Increased fair value is due
to net purchases in 1999, which have been offset be the net unrealized
gains/losses discussed above. U.S. government agency securities increased from
$96.8 million as of December 31, 1998, to $127.6 million as of September 30,
1999, an increase of $33.8 million (35.1%). U.S. government agency mortgage
backed securities declined $4.0 million (24.4%), from $16.5 million as of
December 31, 1998, to $12.5 million as of September 30, 1999. Exposure to
callable agency securities increased during the third quarter of 1999 in an
attempt to take advantage of the increased interest rate spreads that became
available, while continuing to maintain a high level of liquidity within the
portfolio. The market values of these types of securities are particularly
sensitive to fluctuations in interest rates.
DEPOSITS AND BORROWED FUNDS
Total deposits of $744.5 million as of September 30, 1999, represented an
increase of $2.4 million (.3%) from $742.1 million as of December 31, 1998.
Noninterest-bearing deposits were $126.8 million as of September 30, 1999, a
decrease of $5.4 million (4.1%) from $132.2 million as of December 31, 1998. At
the same time, interest-bearing deposits increased $7.8 million (1.3%).
The Company also utilizes securities sold under repurchase agreements as a
source of funds which grew by $3,983,000 in the first nine months of 1999. Most
local municipalities, and some other organizations, must
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
have funds insured or collateralized by law or as a matter of their own
policies. Repurchase agreements provide a source of funds and do not increase
the Company's reserve requirement. Although the balance of repurchase agreements
is subject to variation, particularly seasonal, the account relationships
represented by these balances are principally local and have been maintained for
relatively long periods.
During the nine months ended September 30, 1999, term advances from the Federal
Home Loan Bank increased by $45.0 million to $87.3 million.
CAPITAL RESOURCES
The Company and its subsidiary bank 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 regulators can lower classifications in certain
cases. Failure to meet various capital requirements can initiate regulatory
action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
The Company and the Bank were categorized as well capitalized as of September
30, 1999. 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
classification.
10
<PAGE>
Capital levels and minimum required levels (dollars in thousands) were as
follows:
<TABLE>
<CAPTION>
Minimum Required Minimum Required
for Capital to be Well
Actual Adequacy Purposes Capitalized
------------------- ----------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
September 30, 1999:
Total capital to risk weighted assets
Consolidated $76,286 10.72% $56,954 8.00% $71,193 10.00%
Merchants National Bank 81,100 11.39% 56,954 8.00% 71,193 10.00%
Tier 1 capital to risk weighted assets
Consolidated 68,467 9.62% 28,477 4.00% 42,716 6.00%
Merchants National Bank 73,281 10.29% 28,477 4.00% 42,716 6.00%
Tier 1 capital to average assets
Consolidated 68,467 7.24% 37,814 4.00% 47,267 5.00%
Merchants National Bank 73,281 7.75% 37,814 4.00% 47,267 5.00%
December 31, 1998:
Total capital to risk weighted assets
Consolidated $70,947 10.98% $51,697 8.00% $64,621 10.00%
Merchants National Bank 74,376 11.64% 51,137 8.00% 63,921 10.00%
Tier 1 capital to risk weighted assets
Consolidated 62,859 9.73% 25,848 4.00% 38,773 6.00%
Merchants National Bank 66,288 10.37% 25,568 4.00% 38,353 6.00%
Tier 1 capital to average assets
Consolidated 62,859 7.30% 34,423 4.00% 43,029 5.00%
Merchants National Bank 66,288 7.70% 34,423 4.00% 43,029 5.00%
</TABLE>
LIQUIDITY
Liquidity measures the ability of the Company to meet maturing obligations and
its existing commitments, to withstand fluctuations in deposit levels, to fund
its operations, and to provide for customers' credit needs. The liquidity of the
Company principally depends on cash flows from operating activities, investment
in and maturity of assets, changes in balances of deposits and borrowings, and
its ability to borrow funds in the money or capital markets.
Net cash outflows from investing activities were $124.1 million in the nine
months ended September 30, 1999, compared to $9.2 million a year earlier. In the
first nine months of 1999, net principal disbursed on loans accounted for net
outflows of $83.4 million, and securities transactions aggregated a net outflow
of $39.7 million. In the first nine months of 1998, net principal disbursed or
repaid on loans accounted for a net outflow of $21.6 million, and securities
transactions resulted in net inflows of $14.4 million.
Cash inflows from financing activities in the first nine months of 1999
associated with an increase in deposits were $2.4 million. This compares with a
net inflow of $51.6 million for the same period in 1998. Short-term borrowings
resulted in net cash inflows of $58.6 million in the first nine months of 1999,
and outflows of $18.1 million in the first nine months of 1998. FHLB term
advances were increased by $45.0 million in the first nine months of 1999, and
declined $17.5 million in the first nine months of 1998.
In the event of short-term liquidity needs, the Bank may purchase Federal Funds
from correspondent banks. The Bank may also borrow funds from the Federal
Reserve Bank of Chicago. The Bank's membership in the FHLB
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
system gives it the ability to borrow funds from the FHLB of Chicago for short
or long term purposes under a variety of programs. The Bank had term advances of
$87.3 million outstanding as of September 30, 1999.
Origination of mortgage loans held for sale resulted in operating net cash
inflows of $7.4 million during the first nine months of 1999, compared to
outflows of $5.3 million in 1998. Total cash inflows from operating activities
exceeded operating outflows by $11.2 million during the nine months ended
September 30, 1999. During the nine months ended September 30, 1998, net cash
outflows from operating activities were $4.1 million.
YEAR 2000
The Year 2000 has posed a unique set of challenges to those industries reliant
on information technology. As a result of methods employed by earlier
programmers, many software applications and operational programs may be unable
to distinguish the Year 2000 from the Year 1900. If not effectively addressed,
this problem could result in the production of inaccurate data, or, in the worst
cases, the inability of the systems to continue to function altogether.
Financial institutions are particularly vulnerable due to the industry's
dependence on electronic data processing systems.
In early 1997, the Company began developing its Year 2000 Plan, following the
guidelines established by the FFIEC. The plan was approved by the Board of
Directors of the Company and reviewed by the Office of the Comptroller of the
Currency. An integral part of the plan was to utilize the Company's Technology
Planning Committee, which is comprised of representatives from the key areas
throughout the organization. Each area identified, for the Committee, issues
related to the Year 2000 and initiated remedial measures designed to eliminate
any adverse effects on the Company's operations. The Committee reviews all Year
2000 related issues and the progress toward implementation of the plan. The
Committee has developed a comprehensive, prioritized inventory of all hardware,
software, and material third party providers that may be adversely affected by
the Year 2000 date change, and has contacted vendors requesting their status as
it relates to the Year 2000. This inventory includes both information technology
("IT") and non-IT systems, such as alarms, building access, elevators and
heating and cooling systems, which typically contain embedded technology such as
microcontrollers. This inventory is periodically reevaluated to ensure that
previously assigned priorities remain accurate and to track the progress each
vendor is making in resolving the problems associated with the issue. The
Company relies on software purchased from third-party vendors rather than
internally-generated software. The Company has upgraded systems and tested to
validate Year 2000 compliance. The Company has had all mission critical systems
renovated and tested prior to June 30, 1999. The Company is currently operating
on Year 2000 compliant releases for core systems supported by its third party
data processors.
The Technology Planning Committee has also developed a communication plan that
updates the Board of Directors, management, and employees on the Company's Year
2000 status. In addition, the Committee has developed a separate plan in order
to manage the Year 2000 risks posed by commercial borrowing customers.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
This plan has identified material loan customers, assessed their preparedness,
evaluated their credit risk to the Company, and implemented appropriate controls
to mitigate the risk. In accordance with regulatory guidelines, the Company has
developed a comprehensive contingency plan, which was tested prior to June 30,
1999. The plan lists the various strategies and resources available to restore
core business process. These strategies include relying on back-up systems that
do not utilize computers and, in some cases, switching vendors. The Company has
a gas powered generator at its main processing facility.
Management anticipates that the total out-of-pocket expenditures required for
bringing the systems into compliance for the Year 2000 will be approximately
$150,000, most of which has been expended through September 30, 1999. Management
believes that these required expenditures will not have a material adverse
impact on operations, cash flow, or financial condition of the company. This
amount includes costs for upgrading equipment for Year 2000 compliance, fees to
outside consulting firms, and certain administrative expenditures. Although
management is confident that the Company has identified all necessary upgrades,
and budgeted accordingly, no assurance can be made that Year 2000 compliance can
be achieved without additional unanticipated expenditures. It is not possible at
this time to quantify the estimated future costs due to business disruption
caused by vendors, suppliers, customers or the possible loss of electric power
or telephone service; however, such costs could be substantial. As a result of
the Year 2000 project, the Company has not had any material delay regarding its
information systems projects.
ITEM 3. QUANITITIVE AND QUALITATIVE DISCLOSURES ABOUT 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 regularly by management
and the Board of Directors. Interest rate risk is analyzed by examining the
extent to which assets and liabilities are interest rate sensitive. The interest
sensitivity gap is defined as the difference between the amount of interest
earning assets maturing or repricing within a specific time period and the
amount of interest-bearing liabilities maturing or repricing within that time
period. A gap is considered positive when the amount of interest sensitive
assets exceeds the amount of interest sensitive liabilities. A gap is considered
negative when the amount of interest sensitive liabilities exceeds the amount of
interest sensitive assets. During a period of rising interest rates, a negative
gap would tend to result in a decrease in net interest income while a positive
gap would tend to positively affect net interest income.
The Company's policy is to manage the balance sheet such that fluctuations in
the net interest margin are minimized regardless of the level of interest rates.
In the following table, deposits that do not have specified maturities are
assumed to have a 15% decay rate. Loans, which include loans held for sale,
represent management judgements regarding prepayment. The following table
presents the expected maturity of interest-earning assets and interest-bearing
liabilities as of September 30, 1999.
13
<PAGE>
EXPECTED MATURITY OF INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
<TABLE>
<CAPTION>
Expected Maturity Dates
---------------------------------------------------------------------------
Fair
1 Year 2 Years 3 Years 4 Years 5 Years Thereafter Total Value
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Fixed rate loans $100,610 $ 35,042 $ 54,578 $ 69,839 $122,081 $ 42,459 $424,609 $428,887
Average interest rate 7.88% 8.60% 8.63% 8.20% 7.82% 7.60%
Adjustable Rate Loans $106,347 $ 33,999 $ 36,932 $ 30,755 $ 33,949 $ 22,200 $264,182 $264,182
Average interest rate 8.35% 8.23% 8.32% 8.54% 8.59% 8.53%
Securities $ 83,612 $ 34,307 $ 32,845 $ 18,166 $ 16,841 $ 46,394 $232,165 $232,165
Average interest rate 6.07% 5.67% 5.55% 6.17% 5.50% 5.29%
-------- -------- -------- -------- -------- -------- ------- --------
Total $290,569 $103,348 $124,355 $118,760 $172,871 $111,053 $920,956 $925,234
-------- -------- -------- -------- -------- -------- ------- --------
-------- -------- -------- -------- -------- -------- ------- --------
INTEREST-BEARING
LIABILITIES
Interest-bearing deposits $318,660 $ 69,908 $ 47,597 $ 47,842 $ 45,573 $ 88,138 $617,718 $619,722
Average interest rate 5.22% 4.51% 3.90% 3.82% 3.72% 3.01%
Borrowed Funds $112,975 $ 18,125 $875 $875 $ 13,375 $ 1,094 $147,319 $148,090
Average interest rate 5.53% 5.85% 5.92% 5.61% 5.58% 4.85%
-------- -------- -------- -------- -------- -------- ------- --------
Total $431,635 $ 88,033 $ 48,472 $ 48,717 $ 58,948 $ 89,232 $765,037 $767,812
-------- -------- -------- -------- -------- -------- ------- --------
-------- -------- -------- -------- -------- -------- ------- --------
</TABLE>
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words, "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse affect on the
operations and future prospects of the Company and its subsidiaries include, but
are not limited to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area and accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Further
information concerning the Company and its business, including additional
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
RECENT DEVELOPMENTS
On July 29, 1999, the Company and Old Kent Financial Corporation entered into an
Agreement and Plan of Merger, pursuant to which the Company will be acquired by
Old Kent Financial Corporation through a merger into a wholly-owned subsidiary.
The consummation of the merger is subject to certain conditions and the
occurrence of certain events, such as the approval of the Company's stockholders
and the receipt of required regulatory approvals. The parties currently
anticipate that the merger will close during the first quarter of 2000.
RECENT REULATORY DEVELOPMENTS
PENDING LEGISLATION. On November 4, 1999, the United States Congress approved
legislation 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. Under the Gramm-Leach-Bliley Act (the "Act"), a bank
holding company that elects to become a financial holding company may engage in
any activity that the Board of Governors of the Federal Reserve System (the
"Federal Reserve") in consultation with the Secretary of the Treasury,
determines by regulation or order (i) financial in nature, (ii) incidental to
any such financial activity, or (iii) complementary to any such financial
activity and does not pose a substantial risk to the safety or soundness of
depository institutions or the financial system generally. The Act specifies
certain activities that are deemed to be financial in nature, including lending,
exchanging, transferring, investing for others, or safeguarding money or
securities; underwriting and selling insurance; providing financial, investment,
or economic advisory services; underwriting, dealing in or making a market in,
securities; and any activity currently permitted for bank holding companies by
the Federal Reserve under section 4(c)(8) of the Bank Holding Company Act. A
bank holding company may elect to be treated as a financial holding company only
it all depository institution subsidiaries of the holding company are
well-capitalized, well-managed and have at least a satisfactory rating under the
Community Reinvestment Act.
National banks are also authorized by the Act to engage, though "financial
subsidiaries," in any activity that is permissible for a financial holding
company (as described above) and any activity that the Secretary of the
Treasury, in consultation with the Federal Reserve, determines is financial in
nature or incidental to any such financial activity, except (i) insurance
underwriting, (ii) real estate development or real estate investment activities
(unless otherwise permitted by law), (iii) insurance company portfolio
investments and (iv) merchant banking. The authority of a national bank to
invest in a financial subsidiary is subject to a number of conditions,
including, among other things, requirements that the bank must be well-managed
and well-capitalized (after deducting from the bank's outstanding investments in
financial subsidiaries). The Act provides that state banks may invest in
financial subsidiaries (assuming they have the requisite investment authority
under applicable state law (subject to the same conditions that apply to
national bank investments in financial subsidiaries.
The President must sign the Act before it will take effect. At this time, the
Company is unable to predict the impact the Act may have on the Company and its
subsidiaries.
15
<PAGE>
PART II
<TABLE>
<S> <C>
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
or its subsidiaries are a party other than ordinary routine litigation
incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
27. Financial Data Schedule
Reports on Form 8-K
A Form 8-K was filed on August 5, 1999, which reported under Item 5
that an Agreement and Plan of Merger with Old Kent Financial
Corporation had been executed on July 29, 1999.
</TABLE>
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCHANTS BANCORP, INC.
(Registrant)
/S/ CALVIN R. MYERS
-------------------------------------
Calvin R. Myers
President, Chairman of the Board and
Chief Executive Officer
/S/ FRANK K. VORIS
-------------------------------------
Frank K. Voris
Vice President, Chief Operating Officer and
Principal Accounting Officer
Date: November 12, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 35,171
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 232,165
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 688,790
<ALLOWANCE> 7,819
<TOTAL-ASSETS> 984,548
<DEPOSITS> 744,496
<SHORT-TERM> 61,903
<LIABILITIES-OTHER> 1,439
<LONG-TERM> 92,917
0
0
<COMMON> 5,240
<OTHER-SE> 68,751
<TOTAL-LIABILITIES-AND-EQUITY> 984,548
<INTEREST-LOAN> 38,906
<INTEREST-INVEST> 9,147
<INTEREST-OTHER> 277
<INTEREST-TOTAL> 48,330
<INTEREST-DEPOSIT> 20,368
<INTEREST-EXPENSE> 24,107
<INTEREST-INCOME-NET> 24,223
<LOAN-LOSSES> 1,815
<SECURITIES-GAINS> 15
<EXPENSE-OTHER> 22,870
<INCOME-PRETAX> 9,209
<INCOME-PRE-EXTRAORDINARY> 6,764
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,764
<EPS-BASIC> 1.31
<EPS-DILUTED> 1.29
<YIELD-ACTUAL> 4.09
<LOANS-NON> 5,312
<LOANS-PAST> 0
<LOANS-TROUBLED> 351
<LOANS-PROBLEM> 5,663
<ALLOWANCE-OPEN> 8,507
<CHARGE-OFFS> 3,159
<RECOVERIES> 657
<ALLOWANCE-CLOSE> 7,819
<ALLOWANCE-DOMESTIC> 7,819
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
