<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 June 30, 1999,
the Registrant had outstanding 5,181,071 shares of common stock, $1.00 par value
per share.
<PAGE>
MERCHANTS BANCORP, INC.
Form 10-Q Quarterly Report
Table of Contents
PART I
Page Number
Item 1. Financial Statements...............................................1
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................6
Item 3. Quantitative and Qualitative Disclosure about Market Risk.........12
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..................................17
Form 10-Q Signature Page....................................................18
<PAGE>
PART I - FINANCIAL INFORMATION
MERCHANTS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 40,998 $ 38,679
Federal funds sold 3,000 5,000
Securities available for sale 217,964 198,759
Loans held for sale 3,640 9,678
Loans 630,843 607,927
Allowance for loan losses (8,807) (8,507)
-------------- ------------
Net loans 622,036 599,420
Premises and equipment, net 11,798 11,872
Other real estate owned 340 297
Mortgage servicing rights 2,744 2,440
Goodwill, net 6,209 6,397
Core deposit intangible assets, net 1,516 1,673
Accrued interest and other assets 10,716 9,647
-------------- ------------
Total assets $920,961 $883,862
-------------- ------------
-------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $142,123 $132,153
Interest-bearing 636,218 609,904
-------------- ------------
Total deposits 778,341 742,057
Federal funds purchased and overnight borrowings - -
Securities sold under repurchase agreements 18,882 13,320
Federal Home Loan Bank term advances 42,250 42,250
Notes payable 5,688 6,125
Accrued interest and other liabilities 4,019 7,928
-------------- ------------
-------------- ------------
Total liabilities $849,180 811,680
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value;
Authorized 500,000 shares; none issued - -
Common stock, $1 par value authorized 6,000,000 shares;
issued 5,222,392 in 1999 and in 1998 5,222 5,222
Surplus 16,348 16,348
Retained earnings 52,375 48,809
Accumulated other comprehensive income/(loss) (2,073) 1,894
Treasury stock, at cost, 41,321 shares (91) (91)
-------------- ------------
Total stockholders' equity 71,781 72,182
-------------- ------------
Total liabilities and stockholders' equity $920,961 $883,862
-------------- ------------
-------------- ------------
See accompanying notes to consolidated financial statements.
</TABLE>
1
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------- ------- -------- --------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $12,830 $12,563 $25,376 $25,310
Loans held for sale 74 102 208 191
Securities:
Taxable 1,971 2,092 3,898 4,260
Tax-exempt 970 817 1,914 1,615
Federal funds sold 22 127 28 210
-------- -------- --------- ---------
Total interest income 15,867 15,701 31,424 31,586
INTEREST EXPENSE
Deposits 6,733 6,389 13,458 12,676
Federal funds purchased and overnight borrowings 77 327 184 800
Securities sold under repurchase agreements 196 335 357 636
Federal Home Loan Bank term advances 638 821 1,270 1,642
Notes payable 103 235 206 478
-------- -------- --------- ---------
Total interest expense 7,747 8,107 15,475 16,232
-------- -------- --------- ---------
Net interest income 8,120 7,594 15,949 15,354
Provision for loan losses 615 393 990 1,276
-------- -------- --------- ---------
Net interest income after provision for
loan losses 7,505 7,201 14,959 14,078
OTHER INCOME
Trust income 792 660 1,535 1,310
Mortgage banking income 861 1,212 1,978 2,161
Service charges and fees 1,161 1,023 2,249 1,991
Securities gains, net 0 20 12 96
Other income 341 301 777 532
-------- -------- --------- ---------
Total other income 3,155 3,216 6,551 6,090
OTHER EXPENSE
Salaries and employee benefits 3,913 3,782 7,907 7,545
Occupancy expense, net 504 529 1,081 1,059
Furniture and equipment expense 514 558 1,059 1,116
Amortization of goodwill 94 94 188 188
Amortization of core deposit intangible assets 68 95 157 191
Other expense 2,249 2,497 4,603 4,441
-------- -------- --------- ---------
Total other expense 7,342 7,555 14,995 14,540
-------- -------- --------- ---------
Income before income taxes 3,318 2,862 6,515 5,628
Provision for income taxes 871 758 1,700 1,562
-------- -------- --------- ---------
Net income $ 2,447 $ 2,104 $ 4,815 $ 4,066
-------- -------- --------- ---------
-------- -------- --------- ---------
Basic earnings per share $0.47 $0.41 $0.93 $0.79
Diluted earnings per share $0.47 $0.40 $0.92 $0.77
</TABLE>
2
<PAGE>
MERCHANTS BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Net income $ 2,447 $ 2,104 $ 4,815 $ 4,066
Change in net unrealized gains (losses) on securities (3,147) 38 (3,967) (53)
------------- ------------ ------------- -------------
Comprehensive income (loss) $ (700) $ 2,142 $ 848 $ 4,013
------------- ------------ ------------- -------------
------------- ------------ ------------- -------------
</TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,815 $ 4,066
Adjustments to reconcile net income to cash from operating activities:
Depreciation 1,015 974
Amortization of mortgage servicing rights 423 392
Provision for loan losses 990 1,276
Net change in mortgage loans held for sale 6,400 (3,841)
Net gain on sales of loans (1,089) (1,241)
Change in net income taxes payable 633 (463)
Change in accrued interest and other assets (1,068) 71
Change in accrued interest and other liabilities (2,499) (2,374)
Premium amortization and discount accretion on securities 198 121
Securities losses (gains), net (12) (96)
Amortization of goodwill 188 188
Amortization of core deposit intangible assets 157 191
-------- --------
Net cash from operating activities 10,151 (736)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from matured securities available for sale 20,500 36,280
Proceeds from sales of securities available for sale 3,018 14,134
Purchases of securities available for sale (48,919) (34,945)
Net principal disbursed or repaid on loans (23,785) (17,335)
Proceeds from sales of other real estate 135 63
Property and equipment expenditures (941) (1,433)
--------- ---------
Net cash from investing activities (49,992) (3,236)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 36,284 27,724
Net change in short term borrowings 5,562 (10,173)
Payments on Federal Home Loan Bank term advances - (5,000)
Payments on notes payable (437) (437)
Proceeds from exercise of incentive stock options - 111
Dividends paid, net of dividend reinvestments (1,249) (995)
--------- ---------
Net cash from financing activities 40,160 11,230
--------- ---------
Net change in cash and cash equivalents 319 7,258
Cash and cash equivalents at beginning of period 43,679 42,994
--------- ---------
Cash and cash equivalents at end of period $ 43,998 $50,252
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
MERCHANTS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(TABLE AMOUNTS IN THOUSANDS)
NOTE 1: BASIS OF PRESENTATION
The financial information of Merchants Bancorp, Inc. (the "Company") included
herein is unaudited; however, such information reflects all adjustments
(consisting of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair statement of results for the interim periods.
The results of the interim periods ended June 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>
June 30, 1999:
U.S. Treasury $ 1,004 $ 6 $ - $ 1,010
U.S. Government agencies 120,173 16 (3,093) 117,096
U.S. Government agency
mortgage backed securities 13,561 140 (61) 13,640
States and political subdivisions 81,419 1,044 (1,145) 81,318
Collateralized mortgage obligations 1,829 24 (2) 1,851
Other securities 3,119 - (70) 3,049
-------------- ----------- ------------ -----------
$ 221,105 $ 1,230 $(4,371) $ 217,964
-------------- ----------- ------------ -----------
-------------- ----------- ------------ -----------
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: June 30, December 31,
1999 1998
--------- ---------
<S> <C> <C>
Commercial and industrial $152,272 $175,402
Real estate - commercial 92,352 87,035
Real estate - construction 100,958 92,897
Real estate - residential 154,897 134,009
Installment 121,536 109,970
Credit card receivables 8,112 8,483
Other loans 1,353 1,233
-------- --------
631,480 609,029
Unearned discount (520) (869)
Deferred loan fees (117) (233)
---------- ---------
Total loans $630,843 $607,927
---------- ---------
---------- ---------
</TABLE>
NOTE 4: ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
The allowance for loan losses as of June 30, is summarized as follows:
1999 1998
--------- --------
<S> <C> <C>
Balance, January 1 $ 8,507 $ 8,360
Provision for loan losses 990 1,276
Loans charged-off (1,105) (999)
Recoveries 415 285
--------- --------
Balance, end of period $ 8,807 $ 8,922
--------- --------
--------- --------
</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 $440,000, and
$431,000 for the six months ended June 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 June 30, 1999, consisted of a $5,687,500 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 Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Weighted-average common shares outstanding 5,181,071 5,174,462 5,181,071 5,171,103
Net income available to common stockholders $ 2,447 $ 2,104 $ 4,815 $ 4,066
Basic earnings per share $ 0.47 $ 0.41 $ 0.93 $ 0.79
Diluted Earnings Per Share:
Weighted-average common shares outstanding 5,181,071 5,174,462 5,181,071 5,171,103
Dilutive effect of stock options 62,530 108,175 63,943 103,868
------------- ------------ ------------- -------------
Diluted average common shares outstanding 5,243,601 5,282,637 5,245,014 5,274,971
------------- ------------ ------------- -------------
------------- ------------ ------------- -------------
Net income available to common stockholders $ 2,447 $ 2,104 $ 4,815 $ 4,066
Diluted earnings per share $ 0.47 $ 0.40 $ 0.92 $ 0.77
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the second quarter of 1999 was $2,447,000, or diluted earnings
per share of 47 cents, a 16.3% increase in net income compared to $2,104,000, or
40 cents per diluted share, in the second quarter of 1998. The increase in net
income for the quarter was primarily a result of the increase in net interest
income of $526,000, or 6.9%, which offset decreased mortgage banking income and
a $222,000 increase in the provision for loan losses.
During the six months ended June 30, 1999, net income was $4,815,000, or diluted
earnings per share of 92 cents, compared to $4,066,000, or 77 cents per diluted
share, during the first six months of 1998. This 18.4% increase in net income
for the six month period was attributable primarily to an increase in net
interest income of $595,000, or 3.9%, and an increase in noninterest income of
$461,000, or 7.6%, while noninterest expenses increased $455,000, or 3.2%.
NET INTEREST INCOME
Net interest income was $8.1 million and $7.6 million during the three months
ended June 30, 1999 and 1998, an increase of 6.9%. The Company's net interest
margin was, on a tax-equivalent basis, 4.18% for the three months ended June 30,
1999, and 4.13% a year earlier. Net interest income was $15.9 million and $15.4
million during the six months ended June 30, 1999 and 1998, an increase of 3.9%.
The Company's net interest margin was 4.17% for the six months ended June 30,
1999, and 4.19% a year earlier. The decline in the six month ratio resulted from
a decline in average earning asset yields and a decrease in the average cost of
funds. The average yield on earning assets was 7.9% in the second quarter of
1999, down from 8.26% in the second quarter of 1998. At the same time, the
average cost of funds was 3.72% in the second quarter of 1999, a decrease from
4.13% in the second quarter of 1998.
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 six month periods ended June 30, 1999 were $836.0 million and
$828.1 million compared to $787.4 million and $787.1 million for the same
periods in 1998. Similarly, the average balance of interest-bearing liabilities
for the three and six month periods ended June 30, 1999 were $696.4 million and
$691.8 million compared to $664.5 million and $665.9 million for the same
periods in 1998.
OTHER INCOME
Noninterest income was $3,155,000 during the second quarter of 1999 and
$3,216,000 in the second quarter of 1998, a decrease of $61,000, or 1.9%.
Noninterest income was $6,551,000 during the six months ended June 30, 1999 and
$6,090,000 during the six months ended June 30, 1998, an increase of $461,000,
or 7.6%. The primary reason for the slight increase in the second quarter of
1999 compared to 1998 was the $351,000 reduction in mortgage banking income as
refinancings slowed in 1999.
Service charges and fees increased $138,000 (13.5%) from $1,023,000 in the
second quarter of 1998, to $1,161,000 in the second quarter of 1999. Service
charges and fees were $2,249,000 in the six months ended June 30, 1999, compared
to $1,991,000 in the six months ended June 30, 1998, an increase of $258,000, or
13.0%. There were no significant changes in the fee structure for deposit
accounts.
Mortgage banking income was $861,000 in the second quarter of 1999 and
$1,212,000 in the second quarter of 1998, a decrease of $351,000, or 29.0%.
During the first half of the year, mortgage banking income was $1,978,000 in
1999 and $2,161,000 in 1998, a decrease of $183,000, or 8.5%. Mortgage banking
income is seasonal and is also sensitive to interest rate levels and
expectations. Most fixed rate mortgages that the Company originates are sold and
the servicing is retained. The portfolio of loans serviced for others totaled
$340 million as of June 30, 1999 compared to $304 million a year earlier.
Trust income of $792,000 in the second quarter of 1999 was $132,000, or 20.0%
higher than the second quarter 1998 level. For the six months ended June 30,
1999, trust income was $1,535,000, compared to $1,310,000 in the six months
ended June 30, 1998, an increase of $225,000, or 17.2%. The increase in trust
income was a result of a slightly higher fee structure and increased activity.
Sales of securities available for sale resulted in gains of $12,000 in the first
half of 1999. In 1998, securities gains were $96,000 in the first half and
$20,000 in the second quarter. Securities available for sale are held for
indefinite periods of time, and include securities that will be used as a part
of the Company's asset/liability management strategy. Such securities may be
sold in response to changes in interest rates, liquidity needs, or significant
prepayment risk.
OTHER EXPENSE
Salary and benefit expenses increased to $3,913,000 in the second quarter of
1999, from $3,782,000 during the three months ended June 30, 1998,, an increase
of $131,000 (3.5%). Salaries and benefits were $7,907,000 and $7,545,000 during
the six months ended June 30, 1999 and 1998, an increase of $362,000 (4.8%). The
full-time equivalent number of employees was 336 as of June 30, 1999, and 351 as
of June 30, 1998. The increase in salary and benefit expenses was the result of
increased medical insurance, severance, and general salary adjustments.
Commissions were $286,000 in the second quarter of 1999, compared with $327,000
in the second quarter of 1998. During the six months ended June 30, commissions
were $570,000 in 1999 and $619,000 in 1998, a $49,000 (7.9%) 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
Occupancy expenses of $504,000 during the second quarter of 1999 were $25,000
(4.7%) lower than in the second quarter of 1998. Occupancy expenses were
$1,081,000 in the six months ended June 30, 1999, a $22,000 (2.1%) increase over
the same period in 1998. Furniture and equipment expenses were $44,000 (7.9%)
lower during the second quarter of 1999, and 57,000 (5.1%) lower for the six
months ended June 30, 1999, compared to the same periods in 1998.
Other expenses were $2,249,000, or $248,000 (9.9%) lower in the second quarter
of 1999, than in the second quarter of 1998. Other expenses were $4,603,000 and
$4,441,000 during the six months ended June 30, 1999 and 1998, an increase of
$162,000 (3.6%). A significant portion of these expenses were related to the
mortgage department and were volume-related expenses such as credit reports,
appraisals and correspondent mortgage fees. The volume of mortgage originations
slowed during the second quarter of 1999 as interest rates increased. Other
expenses outside of the mortgage department declined when comparing the first
half of 1999 to the first half of 1998. While the mortgage expenses are
necessary for the development of mortgage banking income, there has been
continued improvement in controlling operating expenses throughout the Company.
FINANCIAL CONDITION
LOANS, LOANS HELD FOR SALE, AND PROVISION FOR LOAN LOSSES
Total loans increased $23 million (3.8%) to $631 million as of June 30, 1999,
from $608 million as of December 31, 1998. Commercial loans decreased to $152.3
million as of June 30, 1999, from $175.4 million as of December 31, 1998, a
$23.1 million (13.2%) decrease. The decrease in commercial loans was a result of
the reclassification of $8.0 million of loans to commercial real estate and to
normal roll off. Commercial real estate loans increased to approximately $92.4
million as of June 30, 1999, from $87.0 million as of December 31, 1998,
increasing $5.4 million (6.2%). Construction loans increased $8.1 million (8.7%)
to $101.0 million as of June 30, 1999. Residential real estate loans increased
$20.9 million (15.6%), to $154.9 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
$3.6 million as of June 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 by management and the Board of Directors.
Provisions for loan losses in the second quarter of 1999 were $615,000 compared
with $393,000 in the second quarter of 1998. Net charge-offs for the three
months ended June 30, were $264,000 and $563,000 in 1999 and
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
1998, respectively. Provisions for loan losses were $990,000 in the six months
ended June 30, 1999 and $1,276,000 in the six months ended June 30, 1998. Net
charge-offs for the six months ended June 30, were $690,000 and $714,000 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
the ratio is natural when loan volume increases substantially, additional
provisions have been made to ensure that an adequate level has been maintained.
The allowance for loan losses as a percentage of total loans was 1.40% as of
June 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 $5,750,000 as of June 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 June 30, 1999, or December 31, 1998. Other real estate owned increased
from $297,000 as of December 31, 1998, to $340,000 as of June 30, 1999, as
property was transferred from the loan portfolio. 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 June 30, 1999, net unrealized losses
of $3,141,000, reduced by deferred income taxes of $1,068,000, resulted in an
decrease in equity capital of $2,073,000. 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 $19.2 million (9.7%)
during the first six months of 1999, to $218.0 million as of June 30, 1999, from
$198.8 million as of December 31, 1998. U.S. government agency securities
increased from $96.8 million as of December 31, 1998, to $117.1 million as of
June 30, 1999, an increase of $20.3 million (21.0%). U.S. government agency
mortgage backed securities declined $2.9 million (17.6%), from $16.5 million as
of December 31, 1998, to $13.6 million as of June 30, 1999. Exposure to Agency
securities increased during the second 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.
DEPOSITS AND BORROWED FUNDS
Total deposits of $778.3 million as of June 30, 1999, represented an increase of
$36.3 million (4.9%) from $742.1 million as of December 31, 1998.
Noninterest-bearing deposits were $142.1 million as of June 30, 1999, an
increase of $9.9 million (7.5%) from $132.2 million as of December 31, 1998.
Noninterest deposits were up as a result of activity in official check accounts.
At the same time, interest-bearing deposits increased $26.3 million (4.3%).
The Company also utilizes securities sold under repurchase agreements as a
source of funds which grew by $5,562,000 in the first six months of 1999. Most
local municipalities, and some other organizations, must have
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
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 of time.
During the six months ended June 30, 1999, term advances from the FHLB remained
unchanged at $42.3 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 June 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
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>
June 30, 1999:
Total capital to risk weighted assets
Consolidated $74,980 11.23% $53,397 8.00% $66,746 10.00%
Merchants National Bank 78,918 11.95% 52,837 8.00% 66,046 10.00%
Tier 1 capital to risk weighted assets
Consolidated 66,717 10.00% 26,698 4.00% 40,048 6.00%
Merchants National Bank 70,655 10.70% 26,418 4.00% 39,628 6.00%
Tier 1 capital to average assets
Consolidated 66,717 7.52% 35,467 4.00% 44,334 5.00%
Merchants National Bank 70,655 7.97% 35,467 4.00% 44,334 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 $50.0 million in the six months
ended June 30, 1999, compared to $3.2 million a year earlier. In the first half
of 1999, net principal disbursed on loans accounted for net outflows of $23.6
million, and securities transactions aggregated a net outflow of $25.4 million.
In the first half of 1998, net principal disbursed or repaid on loans accounted
for a net outflow of $17.3 million, and securities
transactions resulted in net inflows of $15.5 million.
Cash inflows from financing activities in the first six months of 1999
associated with an increase in deposits were $36.3 million. This compares with a
net inflow of $27.7 million for the same period in 1998. Short-term borrowings
resulted in net cash inflows of $5.6 million in the first half of 1999, and
outflows of $10.2 million in the first half of 1998. FHLB term advances were
unchanged in the first half of 1999, and declined $5.0 million in the first half
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
$42.3 million outstanding as of June 30, 1999.
Origination of mortgage loans held for sale resulted in operating net cash
inflows of $5.3 million during the first six months of 1999, compared to
outflows of $5.1 million in 1998. Total cash inflows from operating activities
exceeded operating outflows by $10.2 million during the six months ended June
30, 1999. During the six months ended June 30, 1998, net cash outflows from
operating activities were $736,000. Interest received net of interest paid was a
principal source of operating cash inflows in both periods reported. Management
of investing and financing activities, and market conditions, determine the
level and the stability of net interest cash flows. Management's policy is to
mitigate the impact of changes in market interest rates to the extent possible,
so that balance sheet growth is the principal determinant of growth in net
interest cash flows.
YEAR 2000
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 their Year 2000 Plan, following the
guidelines established by the FFIEC. The plan was approved by the Board of
Directors of the Company and reviewed by the Office of the Comptroller of the
Currency. An integral part of the plan was to utilize the Company's Technology
Planning Committee, which is comprised of representatives from the key areas
throughout the organization. Each area has identified, for the Committee, issues
related to the Year 2000 and initiate remedial measures designed to eliminate
any adverse effects on the Company's operations. The Committee reviews all Year
2000 related issues and the progress toward implementation of the plan. The
Committee has developed a comprehensive, prioritized inventory of all hardware,
software, and material third party providers that may be adversely affected by
the Year 2000 date change, and has contacted vendors requesting their status as
it relates to the Year 2000. This inventory includes both information technology
("IT") and non-IT systems, such as alarms, building access, elevators and
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.
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
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - CONTINUED
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 it's main processing facility.
Management anticipates that the total out-of-pocket expenditures required for
bringing the systems into compliance for the Year 2000 will be approximately
$150,000, most of which has been expended through June 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, including 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 June 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>
INTEREST-EARNING ASSETS
Fixed rate loans $ 86,393 $ 33,146 $ 50,818 $ 63,636 $106,273 $ 39,499 $379,765 $384,043
Average interest rate 8.44% 8.63% 8.71% 8.35% 7.42% 7.42%
Adjustable Rate Loans $109,196 31,760 $ 31,150 $ 26,973 $ 29,689 $ 22,310 $251,078 $251,078
Average interest rate 8.26% 8.15% 8.34% 8.53% 8.49% 8.23%
Securities $ 71,594 $ 33,898 $ 24,587 $ 19,528 $ 16,499 $ 51,858 $217,964 $217,964
Average interest rate 6.10% 5.90% 578.00% 5.62% 5.19% 5.05%
Federal Funds Sold $ 3,000 $ - $ - $ - $ - $ - $ 3,000 $ 3,000
Average interest rate 4.75%
-------- -------- -------- -------- -------- -------- -------- --------
Total $270,183 $ 98,804 $106,555 $110,137 $152,461 $113,667 $851,807 $856,085
-------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- --------
INTEREST-BEARING LIABILITIES
Interest-bearing deposits $326,705 $ 83,445 $ 47,552 $ 48,012 $ 41,316 $ 89,188 $636,218 $638,222
Average interest rate 5.37% 4.66% 3.89% 3.74% 3.59% 3.00%
Borrowed Funds $ 13,475 $ 13,375 $ 5,625 $ 13,375 $ 875 $ 1,313 $ 48,038 $ 48,809
Average interest rate 5.99% 6.09% 6.34% 5.94% 7.03%
-------- -------- -------- -------- -------- -------- -------- --------
Total $340,180 $ 96,820 $ 53,177 $ 61,387 $ 42,191 $ 90,501 $684,256 $687,031
-------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- --------
</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. 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.
15
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries are a party other than ordinary routine
litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Meeting of Stockholders.
The Annual Meeting of Stockholders was held on April 20, 1999.
Election of Directors.
Ms. Jacqueline E. Henning and Messrs. Calvin R. Myers and
Frank K. Voris were elected to serve as Class C directors of
the Company (term expiring at the 2002 Annual Meeting of
Shareholders). Continuing as Class A directors (term expires
in 2000) are Messrs. William F. Henja, James D. Pearson, and
Frank A. Sarnecki. Continuing as Class B directors (term
expires in 2001) are Messrs. William C. Glenn, John M. Lies
and Norman L. Titiner. Mr. Sarnecki announced his retirement
from the Board subsequent to the meeting.
Matters Voted Upon at the Meeting.
In addition to the election of directors, stockholders
ratified the adoption of Crowe, Chizek and Company LLP as
independent public accountants for the Company for the year
ending December 31, 1999. The voting on each item at the
Annual Meeting was as follows:
<TABLE>
<CAPTION>
For Withheld Total
--- -------- -----
Election of Directors
<S> <C> <C> <C>
Jacqueline E. Henning 3,850,931 56,202 3,907,133
Calvin R. Myers 3,856,347 50,786 3,907,133
Frank K. Voris 3,856,347 50,786 3,907,133
For Not For Abstain Non-Votes Total
--- ------- ------- --------- -----
Ratification of Accountants 3,887,365 13,492 6,276 0 3,907,133
</TABLE>
ITEM 5. OTHER INFORMATION
None
16
<PAGE>
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.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCHANTS BANCORP, INC.
(Registrant)
/s/ Calvin R. Myers
-------------------------------------------
Calvin R. Myers
President, Chairman of the Board and
Chief Executive Officer
/s/ Frank K. Voris
-------------------------------------------
Frank K. Voris
Vice President, Chief Operating Officer and
Principal Accounting Officer
Date: August 12, 1998
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<EXCHANGE-RATE> 1
<CASH> 40,998
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 3,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 217,964
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 630,843
<ALLOWANCE> 8,807
<TOTAL-ASSETS> 920,961
<DEPOSITS> 778,341
<SHORT-TERM> 18,882
<LIABILITIES-OTHER> 4,019
<LONG-TERM> 47,938
0
0
<COMMON> 5,222
<OTHER-SE> 66,559
<TOTAL-LIABILITIES-AND-EQUITY> 920,961
<INTEREST-LOAN> 25,376
<INTEREST-INVEST> 5,812
<INTEREST-OTHER> 236
<INTEREST-TOTAL> 31,424
<INTEREST-DEPOSIT> 13,458
<INTEREST-EXPENSE> 15,475
<INTEREST-INCOME-NET> 15,949
<LOAN-LOSSES> 990
<SECURITIES-GAINS> 12
<EXPENSE-OTHER> 14,995
<INCOME-PRETAX> 6,515
<INCOME-PRE-EXTRAORDINARY> 4,815
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,815
<EPS-BASIC> .93
<EPS-DILUTED> .92
<YIELD-ACTUAL> 4.17
<LOANS-NON> 5,382
<LOANS-PAST> 0
<LOANS-TROUBLED> 368
<LOANS-PROBLEM> 5,750
<ALLOWANCE-OPEN> 8,507
<CHARGE-OFFS> 1,105
<RECOVERIES> 415
<ALLOWANCE-CLOSE> 8,807
<ALLOWANCE-DOMESTIC> 8,807
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
