SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 1998
COMMISSION FILE NUMBER 0-11595
MERCHANTS BANCSHARES, INC.
(A DELAWARE CORPORATION)
EMPLOYER IDENTIFICATION NO. 03-0287342
164 College Street, Burlington, VT 05401
Telephone: (802) 658-3400
Indicate by check mark whether the registrant 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 has been subject to such filing
requirement for the past 90 days.
YES [X] NO [ ]
4,427,797 Shares Common Stock $.01 Par Outstanding March 31, 1998
MERCHANTS BANCSHARES, INC.
INDEX TO FORM 10-Q
PART I
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997 1
Consolidated Statements of Operations
For the three months ended March 31, 1998 and 1997 2
Consolidated Statements of Comprehensive Income
For the three months ended March 31, 1998 and 1997 3
Consolidated Statement of Stockholders' Equity
For the three months ended March 31, 1998 and 1997 and the
Year ended December 31, 1997 4
Consolidated Statements of Cash Flows
For the three months ended March 31, 1998 and 1997 5
Footnotes to Financial Statements as of March 31, 1998 6-7
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-12
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 13
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 NONE
SIGNATURES 14
Merchants Bancshares, Inc.
Consolidated Balance Sheets
Unaudited
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
- ------------------------------------------------------------------------------------------
(In thousands except share and per share data)
<S> <C> <C>
ASSETS
Cash and Due from Banks $ 20,925 $ 20,139
Investments:
Debt Securities Available for Sale 53,103 44,241
Debt Securities Held to Maturity 110,897 111,458
Trading Securities 1,061 1,031
- ----------------------------------------------------------------------------------------
Total Investments 165,061 156,730
- ----------------------------------------------------------------------------------------
Loans 387,289 390,388
Reserve for Possible Loan Losses 15,684 15,831
- ----------------------------------------------------------------------------------------
Net Loans 371,605 374,557
- ----------------------------------------------------------------------------------------
Federal Home Loan Bank Stock 2,482 2,296
Bank Premises and Equipment, Net 13,245 13,428
Investments in Real Estate Limited Partnerships 1,961 1,972
Other Real Estate Owned 598 591
Other Assets 13,636 14,539
- ----------------------------------------------------------------------------------------
Total Assets $ 589,513 $ 584,252
========================================================================================
LIABILITIES
Deposits:
Demand $ 72,954 $ 76,712
Savings, NOW and Money Market Accounts 272,785 267,396
Time Deposits $100 thousand and Greater 23,965 23,307
Other Time 137,502 138,429
- ----------------------------------------------------------------------------------------
Total Deposits 507,206 505,844
- ----------------------------------------------------------------------------------------
Demand Note Due U.S. Treasury 1,565 4,000
Other Short-Term Borrowings 10,000 4,000
Other Liabilities 9,907 11,057
Long-Term Debt 6,413 6,415
- ----------------------------------------------------------------------------------------
Total Liabilities 535,091 531,316
- ----------------------------------------------------------------------------------------
Commitments and Contingencies (Note 13)
STOCKHOLDERS' EQUITY
Preferred Stock Class A Non-Voting Authorized - 200,000,
Outstanding 0 -- --
Preferred Stock Class B Voting Authorized - 1,500,000,
Outstanding 0 -- --
Common Stock, $.01 Par Value 44 44
Shares Authorized 7,500,000
Outstanding: Current Period 4,297,785
Prior Period 4,290,698
Treasury Stock (At Cost): Current Period 136,835
Prior Period 143,922 (2,218) (2,220)
Capital in Excess of Par Value 33,222 33,223
Retained Earnings 23,051 21,537
Unearned Compensation-Restricted Stock Awards (16) (10)
Unrealized Gain on Securities Available For Sale, Net 339 362
- ----------------------------------------------------------------------------------------
Total Stockholders' Equity 54,422 52,936
- ----------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 589,513 $ 584,252
========================================================================================
Book Value Per Common Share $ 12.29 $ 11.95
========================================================================================
</TABLE>
Note: As of March 31, 1998, the Bank had off-balance sheet liabilities in the
form of standby letters of credit to customers in the amount of $5,896.
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Operations
Unaudited
<TABLE>
<CAPTION>
Quarter Ended March 31,
1998 1997
- --------------------------------------------------------------------------------
(In thousands except per share data)
<S> <C> <C>
INTEREST AND DIVIDEND INCOME:
Interest and Fees on Loans $ 9,243 $ 9,469
Interest and Dividends on Investments
U.S. Treasury and Agency Obligations 2,587 2,342
Other 63 73
- -------------------------------------------------------------------------------
Total Interest and Dividend Income 11,893 11,884
- -------------------------------------------------------------------------------
INTEREST EXPENSE:
Savings, NOW and Money Market Accounts 2,186 2,043
Time Deposits $100 Thousand and Greater 386 339
Other Time Deposits 1,768 1,833
Other Borrowed funds 96 146
Debt 114 107
- -------------------------------------------------------------------------------
Total Interest Expense 4,550 4,468
- -------------------------------------------------------------------------------
Net Interest Income 7,343 7,416
Provision for Possible Loan Losses -- 300
- -------------------------------------------------------------------------------
Net Interest Income after Provision for Possible Loan
Losses 7,343 7,116
- -------------------------------------------------------------------------------
NONINTEREST INCOME:
Trust Company Income 547 386
Service Charges on Deposits 699 787
Merchant Discount Fees 343 425
Gain (Loss) on Sale of Investment Securities, Net -- (40)
Other 168 203
- -------------------------------------------------------------------------------
Total Noninterest Income 1,757 1,761
- -------------------------------------------------------------------------------
NONINTEREST EXPENSES:
Salaries and Wages 2,200 2,124
Employee Benefits 569 596
Occupancy Expense 532 597
Equipment Expense 624 535
Provision for Impairmement of Investment Security -- 229
Equity in Losses of Real Estate Limited Partnerships 94 172
Expenses - Other Real Estate Owned 117 112
Loss on Disposition of Fixed Assets 27 156
Other 1,932 1,991
- -------------------------------------------------------------------------------
Total Noninterest Expenses 6,095 6,512
- -------------------------------------------------------------------------------
Income Before Provision for Income Taxes 3,005 2,365
Provision for Income Taxes 759 501
- -------------------------------------------------------------------------------
NET INCOME $ 2,246 $ 1,864
===============================================================================
BASIC EARNINGS PER COMMON SHARE (Note 2) $ 0.51 $ 0.42
DILUTED EARNINGS PER COMMON SHARE (Note 2) 0.50 0.42
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Comprehensive Income
Unaudited
<TABLE>
<CAPTION>
For the quarter ended March 31, 1998 1997
- -----------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Net Income as Reported $ 2,246 $ 1,864
Change in Net Unrealized Appreciation (Depreciation)
of Securities Available for Sale, Net of Tax (18) (153)
Change in Net Unrealized Appreciation of Securities
Transferred to the Held to Maturity Portfolio, Net
of Tax (5) 4
- -----------------------------------------------------------------------------
Comprehensive Net Income $ 2,223 $ 1,715
=============================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Year Ended December 31, 1997 and
the three months ended March 31, 1998 and 1997
Unaudited
<TABLE>
<CAPTION>
Net Unrealized
Unearned Appreciation
Capital in Compensation- (Depreciation)
Common Excess of Retained Treasury Restricted of Investment
(In thousands) Stock Par Value Earnings Stock Stock Awards Securities Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 44 $ 33,155 $ 14,845 $(2,038) $ -- $ 244 $ 46,250
Net Income -- -- 1,864 -- -- -- 1,864
Purchase of Treasury Stock -- -- -- (402) -- -- (402)
Sale of Treasury Stock -- 2 -- 423 -- -- 425
Dividends Paid -- -- (443) -- -- -- (443)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- (149) (149)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance March 31, 1997 44 33,157 16,266 (2,017) -- 95 47,545
Net Income -- -- 6,969 -- -- -- 6,969
Purchase of Treasury Stock -- -- -- (988) -- -- (988)
Sales of Treasury Stock -- 217 -- 592 -- -- 809
Issuance of Stock under Employee Stock
Option Plans -- (151) -- 193 -- -- 42
Dividends Paid -- -- (1,698) -- -- -- (1,698)
Unearned Compensation -- Restricted Stock
Awards -- -- -- -- (10) -- (10)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- 267 267
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 44 33,223 21,537 (2,220) (10) 362 52,936
Net Income -- -- 2,246 -- -- -- 2,246
Purchase of Treasury Stock -- -- -- (176) -- -- (176)
Sales of Treasury Stock -- 7 -- 159 -- -- 166
Issuance of Stock under Employee Stock
Option Plans -- (8) -- 19 -- -- 11
Dividends Paid -- -- (732) -- -- -- (732)
Unearned Compensation -- Restricted Stock
Awards -- -- -- -- (6) -- (6)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- (23) (23)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1998 $ 44 $ 33,222 $ 23,051 $(2,218) $ (16) $ 339 $ 54,422
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statement of Cash Flows
Unaudited
<TABLE>
<CAPTION>
For the three months ended March 31, 1998 1997
- ------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,246 $ 1,864
Adjustments to Reconcile Net Income to Net Cash Provided by
Operating Activities:
Provision for Possible Loan Losses -- 300
Provision for Possible Losses on Other Real Estate Owned -- 10
Provision for Impairment of Investment Security -- 230
Provision for Depreciation and Amortization 639 545
Net Gains on Sales of Investment Securities -- 40
Net (Gains) Losses on Sales of Premises and Equipment (27) 77
Net Gains (Losses) on Sales of Other Real Estate Owned (5) 17
Equity in Losses of Real Estate Limited Partnerships 94 172
Changes in Assets and Liabilities:
(Increase) Decrease in Interest Receivable (394) 283
Increase (Decrease) in Interest Payable (96) (107)
Decrease in Other Assets (394) (677)
Increase in Other Liabilities 834 163
- ------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 2,897 2,917
- ------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from Sales of Investment Securities Available for Sale -- 20,727
Proceeds from Maturities of Investment Securities 6,690 --
Proceeds from Sales of Loans and Leases 1,678 2,211
Proceeds from Sales of Premises and Equipment -- 6
Proceeds from Sales of Other Real Estate Owned 35 1,574
Purchases of Available for Sale Investment Securities (10,087) --
Purchases of Held to Maturity Investment Securities (4,980) (18,098)
Principal Repayments in Excess of (Less than) Loan Originations 722 (3,236)
Investments in Real Estate Limited Partnerships (178) (130)
Purchases of Premises and Equipment (183) (1,159)
- ------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities (6,303) 1,895
- ------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase (Decrease) in Deposits 1,362 (8,181)
Net Increase in Other Borrowed Funds 3,565 2,551
Principal Payments on Debt (3) (1)
Cash Dividends Paid (732) (444)
Acquisition of Treasury Stock (176) (402)
Sale of Treasury Stock 165 426
Proceeds From Exercise of Employee Stock Options 11 --
- ------------------------------------------------------------------------------------------
Net Cash Used in (Provided by) Financing Activities 4,192 (6,051)
- ------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents 786 (1,239)
Cash and Cash Equivalents Beginning of Year 20,139 29,726
- ------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $ 20,925 $ 28,487
==========================================================================================
Total Interest Payments $ 4,646 $ 4,575
Total Income Tax Payments 445 --
Transfer of Loans and Premises to Other Real Estate Owned 48 --
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
MERCHANTS BANCSHARES, INC.
MARCH 31, 1998
NOTES TO FINANCIAL STATEMENTS:
See the Form 10-K filed as of December 31, 1997 for additional information.
NOTE 1: RECENT ACCOUNTING DEVELOPMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income". This statement establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses). Components of comprehensive income are net income and all other
non-owner changes in equity. This statement requires that an enterprise (a)
classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in capital in the
equity section of a statement of financial position. This statement is
effective for interim and annual periods beginning after December 15, 1997,
and has been adopted by the Company.
In March of 1998 the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
software Developed or Obtained for Internal Use". This statement provides
guidance on accounting for the costs of computer software developed or
obtained for internal use. The SOP requires that software costs incurred in
the preliminary project stage should be expensed as incurred until the
capitalization criteria of the SOP have been met. Once the capitalization
criteria have been met subsequent costs associated with internal use software
shall be capitalized in accordance with the guidance in the SOP. The SOP is
effective for financial statements for fiscal years beginning after December
15, 1998.
NOTE 2: EARNINGS PER SHARE
The following table presents a reconciliation of the calculations of basic and
diluted earnings per share for the quarter ended March 31, 1998:
<TABLE>
<CAPTION>
Per Share
Income Shares Amount
------ --------- ---------
(In thousands except share and
per share data)
<S> <C> <C> <C>
Basic Earnings Per Share:
Income Available to Common Shareholders $2,246 4,429,646 $0.51
Diluted Earnings Per Share:
Options issued to Executives -- 21,716
Income available to Common Shareholders
Plus Assumed Conversions $2,246 4,451,362 $0.50
</TABLE>
Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
quarter. After adoption of SFAS No. 128, "Earnings Per Share", the Company is
required to restate all prior period EPS data. There was no effect on
earnings per share for the quarter ended March 31, 1997.
NOTE 3: COMMITMENTS AND CONTINGENCIES:
Merchants Bank (the "Bank") is a counterclaim defendant in a litigation
entitled Pasquale and Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants
Bank, Counterclaim Defendant, now pending in the United States Bankruptcy
Court for the District of Vermont.
In this litigation, the Vescios have made a number of "lender liability"
claims dealing with a commercial development known as Brattleboro West in
Brattleboro, Vermont. The pending litigation arose out of a suit to foreclose
on several real estate mortgages and personal property originally granted to
the Bank by the Vescios in connection with the financing of a supermarket in
the Brattleboro West project and various other projects.
Among other things, the Vescios have alleged that the Bank or its
representatives violated supposed oral promises in connection with the
origination and funding of the financing, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition, the
plaintiffs have contended that the Bank breached some kind of duty of care
they believe it owed to them, and have claimed that the Bank should not have
exercised its contract rights when the loan went into default, but should have
worked out the default in a way that was more favorable to the borrowers. The
parties have conducted extensive discovery and the matter is now being tried
in the Bankruptcy Court for the District of Vermont. Although it is not
possible at this stage to predict the outcome of this litigation, the Bank
believes that it has meritorious defenses to the plaintiffs' allegations. The
Bank intends to vigorously defend itself against these claims.
NOTE 4: RECLASSIFICATION:
Certain prior period amounts reported in the financial statements have been
reclassified to be consistent with the current period presentation.
MERCHANTS BANCSHARES, INC.
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
All adjustments necessary for a fair statement of the three months ended March
31, 1998 and 1997 have been included in the financial statements. The
information was prepared from the books of Merchants Bancshares, Inc. (the
Company) and its subsidiaries, the Merchants Bank (the Bank) and Merchants
Properties, Inc., without audit.
In the ordinary course of business, the Merchants Bank makes commitments for
possible future extensions of credit. On March 31, 1998, the Bank was
obligated for $5.9 million of standby letters of credit. No losses are
anticipated in connection with these commitments.
RESULTS OF OPERATIONS
Net income for the first quarter of 1998 was $2.2 million, or diluted earnings
per share of $.50, compared to $1.86 million, or diluted earnings per share of
$.42 per share for the same period a year earlier. First quarter net interest
income before the provision for possible loan losses was $7.34 million for the
first quarter of 1998 as compared to $7.42 million for the year earlier
quarter. This slight decrease is due primarily to two factors. The Bank has
seen its yield on interest earning assets decrease slightly from 8.96% to
8.75% as a result of the Bank's continuing strategy to reposition the loan
portfolio and reduce concentration in commercial real estate loans. The
portfolio mix is being shifted more toward commercial and residential real
estate loans. Commercial real estate credits, because of their perceived risk,
are generally higher yielding than residential mortgage loans and have
historically made up a large portion of the Bank's loan portfolio.
Additionally, the Bank has seen a slight increase in its cost of interest-
bearing deposits over the course of the last year, from 4.02% at March 31,
1997, to 4.06% at March 31, 1998. This increase is due primarily to the
introduction of the Bank's FreedomLYNX account, which pays interest on
balances over $750 using a tiered rate structure. The average interest cost on
these accounts is approximately 1.70%.
Due to the continued strength of the Bank's asset quality, and management's
assessment of the adequacy of the loan loss reserve as an indicator of that
strength, there was no provision taken for loan losses in the first quarter of
1998, compared to a $300 thousand provision in the first quarter of 1997.
Reserve coverage continues to be very strong at 4.04% of total loans and 371%
of non-performing loans. The improved asset quality achieved over the last two
years will be maintained as the portfolio grows by adhering to the strong
underwriting standards that have been established.
Total non-interest income has remained virtually flat from the first quarter
of 1997 to the first quarter of 1998. Merchants Trust Company (the "Trust
Company") has shown increased revenue of approximately $161 thousand, a 42%
increase. Of this increase, $120 thousand is attributable to proceeds from a
settlement of litigation brought by the Trust Company in 1996. The balance of
the increase is due to a combination of new business development,
implementation of a new fee schedule, and a favorable market environment.
Offsetting this increase in revenue was a decrease in service charges on
deposits of approximately $88 thousand (11%). The decrease in service charge
revenue is due primarily to the Bank's FreedomLYNX checking account product,
an account which generally charges no fees if the customer has a direct
deposit, an automatic loan payment or a debit card. Merchant discount fees
decreased by approximately $82 thousand (19%), due primarily to lower
transaction volumes.
Total non-interest expenses have decreased approximately $417 thousand (6.4%)
from the first quarter of 1997 to the first quarter of 1998. This decrease is
due primarily to a charge off of an investment during the first quarter of
1997 totaling $229 thousand. Additionally, in conjunction with its conversion
to the Windows NT platform the Bank recognized expenses associated with the
retirement of certain assets, totaling $156 thousand, during the first quarter
of 1997. Losses recognized in conjunction with the disposition of fixed assets
during the first quarter of 1998 totaled $27 thousand.
YEAR 2000
The Bank is taking measures to address the impact of the Year 2000 issue on
its information systems. The Year 2000 issue, which is common to most
corporations, and especially important to banks, concerns the inability of
information systems, primarily computer software programs, to properly
recognize and process date sensitive information as the year 2000 approaches.
Since the middle of 1997, a Year 2000 Committee (the Committee) has been
meeting and planning the actions the Bank needs to take to verify that the
Bank, all of its' vendors, and largest borrowing customers are in compliance
with Year 2000 requirements in advance of this millenium change. The Committee
is chaired by the Bank's Senior Operations Officer, and includes the Chief
Financial Officer, Chief Auditor/Risk Management Officer, Information Systems
Manager, Senior Loan Underwriter, a Trust Company Officer and
Facilities/Administration Manager. The Committee provides progress reports to
the Bank's senior management and reports at least quarterly to the Board of
Directors. The Committee has established an assessment process that includes
contacting and requesting a Year 2000 plan and testing information from all
vendors and the Bank's largest borrowing customers. The Committee has
contacted 175 vendors and service providers and has received responses from
critical vendors and service providers. The goal is to complete programming
changes and to have testing well underway for mission-critical systems by
December 31, 1998. Decisions regarding replacement of any known non-compliant
equipment or software will be made as early in 1998 as possible. The Bank will
seek to ensure that future system installations will be year 2000 compliant.
The Bank's core software provider has been working to solve the Year 2000
issue for over two years, and has reported to the Bank that, in its' opinion,
the bulk of the reprogramming is complete. This core software is the Bank's
most significant Year 2000 risk. Merchants Bank is regulated by the Federal
Deposit Insurance Corporation ("FDIC"), which reviewed the Year 2000 plans
during an on site visit in the fourth quarter of 1997, and again via telephone
in April of 1998. The FDIC intends to monitor the Bank's compliance efforts on
a quarterly basis through the year 2000. The Committee currently estimates
that there will be costs associated with replacing certain non-compliant
software and/or hardware. The Bank plans to replace many of its ATMs as well
as upgrade certain software and equipment. The cost of these replacements is
estimated to be $1.1 million, these costs will be capitalized and depreciated
over the estimated useful lives of the assets, as such assets represent
replacement of existing equipment. Additional expenses are estimated to be
$175 thousand and will be expensed as incurred.
BALANCE SHEET ANALYSIS
Total assets increased approximately $5.3 million (0.9%) from December 31,
1997 to March 31, 1998. This increase is primarily comprised of an $8.3
million increase in the Company's investment portfolio. The increase in the
investment portfolio was partially funded by a $3.1 million decrease in the
loan portfolio. The Bank is continuing to experience the planned decrease of
its commercial real estate portfolio. As part of its strategy to replace these
balances the Bank introduced a new, streamlined portfolio mortgage product
during the first quarter of 1998. The product is designed to shorten the
turnaround time on residential mortgages with reduced documentation
requirements from borrowers. Balances of residential mortgages increased $6.4
million during the first quarter of 1998. Additionally, the Bank introduced a
new fixed rate home equity line of credit product during 1997. The balances
bear interest at a competitive fixed rate for five years. The home equity line
of credit product is one of the Bank's most profitable products, the risk
profile is low, and the back office costs are lower than most of our other
loan types. Outstanding balances in the new home equity line of credit product
at March 31, 1998 were $11.5 million. The Bank has taken steps to protect its
source of funds for this increase in fixed rate lending. During the first
quarter of 1998 the Bank entered into three-year interest rate cap contracts
to mitigate the effects on net interest income in the event interest rates on
variable rate deposits increase. The notional amount of these contracts is $20
million. The Bank has also entered into three-year interest rate floors to
mitigate the effect of net interest income in the event interest rates on
floating rate loans decline. The notional amount of these contracts is $30
million.
Deposits at March 31, 1998 have increased by $1.4 million (0.3%) from December
31, 1997. Historically the Bank's deposits decrease for the first few months
of the year. Much of the increase in 1998 is due to the success of our new
FreedomLYNX product. Balances in this product at March 31, 1998 were $12.3
million. As discussed under "Results of Operations", above, the FreedomLYNX
product has had a negative short-term impact on our margin and on service
charge revenue. But, as the bank's overall balance sheet grows the FreedomLYNX
accounts will prove to be a very economical source of funds.
The schedule on page 12 shows the yield analysis for the periods reported.
RISK MANAGEMENT
There have been no significant changes in the Company's risk profile, or
management's risk management practices, since year-end.
INCOME TAXES
The Company recognized $240 thousand in low income housing tax credits during
the quarters ended March 31, 1998 and 1997, representing the amount of the
income tax credits earned during those quarters. The recognition of these low
income housing tax credits has reduced the Company's effective tax rate to 25%
at March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity, as it pertains to banking, can be defined as the ability to
generate cash in the most economical way to satisfy loan demand, deposit
withdrawal demand, and to meet other business opportunities which require
cash. The Bank has a number of sources of liquid funds; including $20 million
in available Federal Funds lines of credit at March 31, 1998; an overnight
line of credit with the Federal Home Loan Bank (FHLB) of $15 million; an
estimated additional borrowing capacity with FHLB of $41 million; and the
ability to borrow $60 million through the use of repurchase agreements,
collateralized by the Bank's investments, with certain approved
counterparties.
LOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES (RPLL)
Merchants Bancshares, Inc. reviews the adequacy of the RPLL quarterly. The
method used in determining the amount of the RPLL is not based upon
maintaining a specific percentage of RPLL to total loans or total non-
performing assets, but rather a comprehensive analytical process of assessing
the credit risk inherent in the loan portfolio. This assessment incorporates a
broad range of factors that are indicative of both general and specific credit
risk, as well as a consistent methodology for quantifying probable credit
loss. As part of the Merchants Bancshares, Inc.'s analysis of specific credit
risk, a detailed and extensive review is completed on larger credits and
problematic credits identified on the watched asset list, non-performing asset
listings, and risk rating reports.
Overall, management maintains the RPLL at a level deemed to be adequate, in
light of historical, current and prospective factors, to reflect the level of
risk in the loan portfolio.
NON-PERFORMING ASSETS
The following tables summarize the Bank's non-performing assets as of March
31, 1998 December 31, 1997, and March 31, 1997:
<TABLE>
<CAPTION>
March 31, December 31, March 31,
(In thousands) 1998 1997 1997
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Nonaccrual Loans $ 3,700 $ 2,686 $ 3,316
Loans Past Due 90 Days or More and
Still Accruing 309 403 80
Restructured Loans 214 215 2,362
- -----------------------------------------------------------------------------
Total Non-performing Loans 4,223 3,304 5,578
Other Real Estate Owned 599 591 516
- -----------------------------------------------------------------------------
Total Non-performing Assets $ 4,822 $ 3,895 $ 6,274
=============================================================================
</TABLE>
Note: Included in nonaccrual loans are certain loans whose terms have
been substantially modified in troubled debt restructuring.
<TABLE>
<CAPTION>
March 31, December 31, March 31,
1998 1997 1997
--------- ------------ ---------
<S> <C> <C> <C>
Percentage of Non-performing Loans to Total Loans 1.09% 0.85% 1.48%
Percentage of Non-performing Assets to Total Loans
plus Other Real Estate Owned 1.24% 1.00% 1.61%
Percentage of RPLL to Total Loans 4.05% 4.06% 4.15%
Percentage of RPLL to NPL 371% 479% 280%
Percentage of RPLL to NPA 325% 406% 257%
</TABLE>
Loans deemed impaired totaled $8.3 million, of this total $2.3 million are
included as non-performing assets in the table above. Impaired loans have been
allocated $2.5 million of the RPLL.
Approximately 84% of the NPL are secured by real estate, which significantly
reduces the Company's exposure to loss. Based upon the secured nature of a
significant portion of the NPL, the strength of the local real estate market,
and management's assessment of the current and prospective level of risk in
the loan portfolio, the balance of the RPLL is considered adequate at March
31, 1998. Management's assessment of the adequacy of the RPLL concluded that a
provision was not necessary during the first quarter of 1998.
DISCUSSION OF EVENTS AFFECTING NPA
Significant events affecting the categories of NPA are discussed below:
Nonaccrual Loans:
- -----------------
During the first quarter of 1998 approximately $480 thousand in
reductions to nonaccrual loans were offset in part by approximately $1.5
million of additions. Approximately $1.2 million of the additions were
concentrated in four accounts.
Loans Past Due 90 Days:
- -----------------------
Loans past due 90 days decreased $94 thousand from December 31, 1997 to
March 31, 1998.
Restructured Loans:
- -------------------
The decrease in restructured loans was due to amortization of the subject
loans.
MERCHANTS BANCSHARES, INC.
SUPPLEMENTAL INFORMATION
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------------
March 31, 1998 March 31, 1997
(In thousands except share and per share data) ----------------------------- -----------------------------
Interest Interest
Average Income/ Average Average Income/ Average
(Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate
-------- -------- ------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Loans (1) $390,413 $ 9,262 9.62% $387,633 $ 9,397 9.83%
Taxable Investments 159,560 2,624 6.67 145,981 2,403 6.68
Federal Funds Sold 1,902 26 5.54 915 12 5.30
--------------------------------------------------------------
Total Interest Earning Assets $551,875 $ 11,912 8.75% $534,529 $ 11,812 8.96%
==============================================================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $271,518 $ 2,186 3.27% $262,122 $ 2,043 3.16%
Time Deposits 161,788 2,154 5.40 163,279 2,172 5.40
--------------------------------------------------------------
Total Savings and Time Deposits 433,306 4,340 4.06 425,401 4,215 4.02
Federal Funds Purchased 1,214 17 5.83 1,616 25 6.18
Short Term Borrowings 3,639 50 5.60 6,338 83 5.33
Other Borrowed Funds 8,762 143 6.61 9,799 145 5.99
--------------------------------------------------------------
Total Interest Bearing Liabilities 446,921 4,550 4.13 443,154 4,468 4.09
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 104,954 91,375
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $551,875 $534,529
======== ========
Rate Spread 4.62% 4.87%
===== =====
Net Yield on Interest Earning Assets 5.41% 5.57%
===== =====
<FN>
<F1> Includes principal balance of non-accrual loans and fees on loans
</FN>
</TABLE>
MERCHANTS BANCSHARES, INC.
MARCH 31, 1998
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Reference is made to the Form 10-K filed for the year ended December 31, 1997
for disclosure of current legal proceedings against the Company, the Bank, the
Merchants Trust Company (the "Trust Company") (the "Companies") and certain
directors and trustees of the Companies.
Merchants Bank is a counterclaim defendant in a litigation entitled Pasquale
and Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank,
Counterclaim Defendant, now pending in the United States Bankruptcy Court for
the District of Vermont. There have been no material developments in the first
quarter of 1998. For further information please refer to the Form 10-K filed
for the year ended December 31, 1997
The Company, the Bank, Merchants Trust Company and certain of their
directors are defendants in a lawsuit filed in November of 1994 (the
"Vermont Proceedings"). The Vermont Proceedings arose from certain
investments managed for Trust Company customers and placed in the Piper
Jaffray Institutional Government Income Portfolio. There have been no
material developments in the first quarter of 1998. For further information
please refer to the Form 10-K filed for the year ended December 31, 1997.
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 Issues - NONE
Item 6 - Exhibits and Reports on Form 8-K - NONE
MERCHANTS BANCSHARES, INC.
FORM 10-Q
MARCH 31, 1998
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 Bancshares, Inc.
/s/ JOSEPH L. BOUTIN
---------------------------------------
Joseph L. Boutin, President
/s/ JANET P. SPITLER
---------------------------------------
Janet P. Spitler, Treasurer
May 13, 1998
---------------------------------------
Date
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 20,911
<INT-BEARING-DEPOSITS> 14
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 1,061
<INVESTMENTS-HELD-FOR-SALE> 53,103
<INVESTMENTS-CARRYING> 110,897
<INVESTMENTS-MARKET> 112,129
<LOANS> 387,289
<ALLOWANCE> 15,684
<TOTAL-ASSETS> 589,513
<DEPOSITS> 507,206
<SHORT-TERM> 11,565
<LIABILITIES-OTHER> 9,907
<LONG-TERM> 6,413
0
0
<COMMON> 44
<OTHER-SE> 54,378
<TOTAL-LIABILITIES-AND-EQUITY> 589,513
<INTEREST-LOAN> 9,243
<INTEREST-INVEST> 2,650
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 11,893
<INTEREST-DEPOSIT> 4,340
<INTEREST-EXPENSE> 210
<INTEREST-INCOME-NET> 7,343
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 6,095
<INCOME-PRETAX> 3,005
<INCOME-PRE-EXTRAORDINARY> 3,005
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,246
<EPS-PRIMARY> .51
<EPS-DILUTED> .50
<YIELD-ACTUAL> 5.41
<LOANS-NON> 3,700
<LOANS-PAST> 309
<LOANS-TROUBLED> 214
<LOANS-PROBLEM> 10,784
<ALLOWANCE-OPEN> 15,831
<CHARGE-OFFS> 435
<RECOVERIES> 288
<ALLOWANCE-CLOSE> 15,684
<ALLOWANCE-DOMESTIC> 15,684
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 5,643
</TABLE>
