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 SEPTEMBER 30, 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
----- -----
4,417,777 Shares Common Stock $.01 Par Outstanding September 30, 1998
MERCHANTS BANCSHARES, INC.
INDEX TO FORM 10-Q
PART I
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 1
Consolidated Statements of Operations
For the three months ended September 30, 1998 and 1997 and
the nine months ended September 30, 1998 and 1997 2
Consolidated Statements of Comprehensive Income
For the three months ended September 30, 1998 and 1997 and
the nine months ended September 30, 1998 and 1997 3
Consolidated Statement of Changes in Stockholders' Equity
For the nine months ended September 30, 1998 and 1997 and
the Year ended December 31, 1997 4
Consolidated Statements of Cash Flows
For the nine months ended September 30, 1998 and 1997 5
Footnotes to Financial Statements as of September 30, 1998 6-8
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-16
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 17
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 18
Merchants Bancshares, Inc.
Consolidated Balance Sheets
Unaudited
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands except share and per share data) 1998 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and Due from Banks $ 18,207 $ 20,139
Investments:
Debt Securities Held for Sale 65,374 44,241
Debt Securities Held to Maturity 103,344 111,458
Trading Securities 1,075 1,031
- -------------------------------------------------------------------------------------------------------
Total Investments 169,793 156,730
- -------------------------------------------------------------------------------------------------------
Loans 394,868 390,388
Reserve for possible loan losses 13,723 15,831
- -------------------------------------------------------------------------------------------------------
Net Loans 381,145 374,557
- -------------------------------------------------------------------------------------------------------
Federal Home Loan Bank Stock 2,482 2,296
Federal Funds Sold 5,000 --
Bank Premises and Equipment, Net 13,364 13,428
Investment in Real Estate Limited Partnerships 2,014 1,972
Other Real Estate Owned 818 591
Other Assets 13,827 14,539
- -------------------------------------------------------------------------------------------------------
Total Assets $606,650 $584,252
=======================================================================================================
LIABILITIES
Deposits:
Demand $ 80,062 $ 76,712
Savings, NOW and Money Market Accounts 293,182 267,396
Time Deposits $100 thousand and Greater 24,565 23,307
Other Time 134,208 138,429
- -------------------------------------------------------------------------------------------------------
Total Deposits 532,017 505,844
- -------------------------------------------------------------------------------------------------------
Demand Note Due U.S. Treasury 1,377 4,000
Other Short-Term Borrowings -- 4,000
Other Liabilities 7,352 11,057
Long-Term Debt 6,410 6,415
- -------------------------------------------------------------------------------------------------------
Total Liabilities 547,156 531,316
- -------------------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 3)
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 4,284,323
Prior Period 4,290,698
Treasury Stock (At Cost) (2,521) (2,220)
Current Period 150,297
Prior Period 143,922
Capital in Excess of Par Value 33,086 33,223
Retained Earnings 26,210 21,537
Deferred Compensation Arrangements 2,107 (10)
Unrealized Gains on Securities Available for Sale, Net 568 362
- -------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 59,494 52,936
- -------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $606,650 $584,252
=======================================================================================================
Book Value Per Common Share $ 13.47 $ 11.95
=======================================================================================================
</TABLE>
Note: As of September 30, 1998, the Bank had off-balance sheet liabilities
in the form of standby letters of credit to customers in the amount of
$6,178
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Operations
Unaudited
<TABLE>
<CAPTION>
Quarter Ended September 30, Nine months ended September 30,
(In thousands except per share data) 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST AND DIVIDEND INCOME
Interest and Fees on Loans $ 9,073 $ 9,778 $27,692 $28,850
Interest and Dividends on Investments
U.S. Treasury and Agency Obligations 2,701 2,290 7,987 6,971
Other 195 69 338 218
- --------------------------------------------------------------------------------------------------------
Total Interest Income 11,969 12,137 36,017 36,039
- --------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Savings, NOW and Money Market Accounts 2,393 2,147 6,814 6,275
Time Deposits $100 Thousand and Greater 401 256 1,182 1,037
Other Time Deposits 1,751 1,983 5,290 5,592
Other Borrowed Funds 26 48 271 281
Debt 116 144 344 437
- --------------------------------------------------------------------------------------------------------
Total Interest Expense 4,687 4,578 13,901 13,622
- --------------------------------------------------------------------------------------------------------
Net Interest Income 7,282 7,559 22,116 22,417
Provision for Possible Loan Losses -- -- (119) 300
- --------------------------------------------------------------------------------------------------------
Net Interest Income after Provision
for Loan Losses 7,282 7,559 22,235 22,117
- --------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Trust Company Income 410 370 1,449 1,143
Service Charges on Deposits 649 762 2,072 2,331
Merchant Discount Fees 395 399 1,060 1,139
Gain (Loss) on Sale of Investments, Net 44 -- 44 (56)
Other 272 209 878 658
- --------------------------------------------------------------------------------------------------------
Total Noninterest Income 1,770 1,740 5,503 5,215
- --------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSES
Salaries and Wages 2,309 2,069 6,767 6,333
Employee Benefits 420 435 1,527 1,501
Occupancy Expense, Net 473 519 1,513 1,634
Equipment Expense 636 597 1,895 1,662
Legal and Professional Fees 323 806 1,626 1,925
Provision for Impairment of Investment
Securities -- -- -- 229
Equity in Losses of Real Estate
Limited Partnerships 94 172 263 516
Expenses - Other Real Estate Owned 51 61 175 421
Loss on Disposition of Fixed Assets 45 132 100 418
Other 1,580 1,654 4,649 4,786
- --------------------------------------------------------------------------------------------------------
Total Noninterest Expenses 5,931 6,445 18,515 19,425
- --------------------------------------------------------------------------------------------------------
Income Before Income Taxes 3,122 2,854 9,223 7,907
Provision for Income Taxes 789 665 2,337 1,776
- --------------------------------------------------------------------------------------------------------
NET INCOME $ 2,333 $ 2,189 $ 6,886 $ 6,131
========================================================================================================
Basic and Diluted Earnings Per Common Share $ 0.53 $ 0.50 $ 1.55 $ 1.39
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Comprehensive Income
Unaudited
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Income as Reported $2,333 $2,189 $6,886 $6,131
Change in Net Unrealized Appreciation
of Securities, Net of Tax 307 84 206 68
- ----------------------------------------------------------------------------------
Comprehensive Net Income $2,640 $2,273 $7,092 $6,199
==================================================================================
</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 Nine Months Ended September 30, 1998 and 1997
Unaudited
<TABLE>
<CAPTION>
Net Unrealized
Appreciation
Capital in Deferred (Depreciation)
Common Excess of Retained Treasury Compensation of Investment
(In thousands) Stock Par Value Earnings Stock Arrangements 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 -- -- 6,131 -- -- -- 6,131
Purchase of Treasury Stock -- -- -- (1,271) -- -- (1,271)
Sale of Treasury Stock -- (171) -- 941 -- -- 770
Dividends Paid -- -- (1,502) -- -- -- (1,502)
Unearned Compensation -
Restricted Stock Awards -- -- -- -- (4) -- (4)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- 68 68
- --------------------------------------------------------------------------------------------------------------------------------
Balance September 30, 1997 44 32,984 19,474 (2,368) (4) 312 50,442
Net Income -- -- 2,702 -- -- -- 2,702
Purchase of Treasury Stock -- -- -- (119) -- -- (119)
Sales of Treasury Stock -- 390 -- 74 -- -- 464
Issuance of Stock under
Employee Stock Option Plans -- (151) -- 193 -- -- 42
Dividends Paid -- -- (639) -- -- -- (639)
Unearned Compensation -
Restricted Stock Awards -- -- -- -- (6) -- (6)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- 50 50
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 44 33,223 21,537 (2,220) (10) 362 52,936
Net Income -- -- 6,886 -- -- -- 6,886
Purchase of Treasury Stock -- -- -- (846) -- -- (846)
Sales of Treasury Stock -- (61) -- 344 -- -- 283
Issuance of Stock under
Employee Stock Option Plans -- (76) 225 -- -- 149
Dividends Paid -- -- (2,213) (24) -- -- (2,237)
Unearned Compensation -
Restricted Stock Awards (14) (14)
Compensation Arrangements -- -- -- -- 2,131 -- 2,131
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- 206 206
- --------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1998 $44 $33,086 $26,210 $(2,521) $2,107 $568 $59,494
================================================================================================================================
</TABLE>
Merchants Bancshares, Inc.
Consolidated Statement of Cash Flows
Unaudited
<TABLE>
<CAPTION>
For the Nine Months Ended September 30, 1998 1997
- -----------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 6,886 $ 6,131
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Provision for Possible Loan Losses (119) --
Provision for Possible Losses on Other Real Estate Owned 7 --
Provision for Impairment of Investment Security -- 229
Provision for Depreciation and Amortization 1,967 1,716
Net Gains on Sales of Investment Securities (44) (40)
Net Gains on Sales of Loans and Leases (213) --
Net Losses on Sales of Premises and Equipment 100 418
Net Gains on Sales of Other Real Estate Owned (73) (147)
Equity in Losses of Real Estate Limited Partnerships 224 516
Changes in Assets and Liabilities:
(Increase) in Interest Receivable (369) (610)
Decrease in Interest Payable (143) (53)
(Increase) Decrease in Other Assets (3,920) (83)
Decrease in Other Liabilities (3,563) (1,272)
- -------------------------------------------------------------------------------------------
Net Cash Provided by (Used In) Operating Activities 740 6,805
- -------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from Sales of Investment Securities Available for Sale 14,053 18,065
Proceeds from Maturities of Investment Securities 26,505 10,524
Proceeds from Sales of Loans and Leases 14,231 --
Proceeds from Sales of FHLB Stock -- 545
Proceeds from Sales of Premises and Equipment -- 6
Proceeds from Sales of Other Real Estate Owned 731 2,300
Purchases of Available for Sale Investment Securities (48,157) --
Purchases of Held to Maturity Investment Securities (5,232) (23,254)
Purchases of FHLB Stock (186) --
Loan Originations in Excess of Principal Payments (20,547) (9,398)
Investments in Real Estate Limited Partnerships (418) (114)
Purchases of Premises and Equipment (1,099) (3,578)
- -------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (20,119) (4,904)
- -------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase (Decrease) in Deposits 26,173 (2,994)
Net Decrease in Other Borrowed Funds (6,623) (2,501)
Principal Payments on Debt (4) (4)
Cash Dividends Paid (2,237) (1,550)
Acquisition of Treasury Stock (294) (1,271)
Proceeds From Sales of Treasury Stock 283 434
Proceeds From Exercise of Employee Stock Options 149 193
- -------------------------------------------------------------------------------------------
Net Cash Provided by (Used In) Financing Activities 17,447 (7,693)
- -------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents (1,932) (5,792)
Cash and Cash Equivalents Beginning of Year 20,139 29,726
- -------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $ 18,207 $ 23,934
===========================================================================================
Total Interest Payments $ 14,044 $ 13,675
Total Income Tax Payments 1,420 3,570
Transfer of Loans and Premises to Other Real Estate Owned 381 206
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
MERCHANTS BANCSHARES, INC.
SEPTEMBER 30, 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 July 1998, the Emerging Issues Task Force ("EITF") issued guidance on
Issue No. 97-14, "Accounting for Deferred Compensation Arrangements Where
Amounts Earned Are Held in a Rabbi Trust and Invested" (the "Guidance").
This Guidance establishes standards for reporting and accounting for certain
deferred compensation agreements between Merchants Bancshares, Inc. (the
"Company") and certain directors of the Company. This Guidance requires that
the deferred compensation obligation be classified in the "Stockholders'
Equity" section of the balance sheets. These amounts were previously
classified as other liabilities in the "Liabilities" section of the Balance
Sheets. The Company adopted this guidance prospectively on September 30,
1998 and has reclassified deferred compensation obligations totaling $2.13
million into the Stockholders' Equity section of the balance sheet as
required.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities". This statement
establishes standards for reporting and accounting for derivative
instruments ("derivatives") and hedging activities. The statement requires
that derivatives be reported as assets or liabilities in the Consolidated
Balance Sheets and that derivatives be reported at fair value. The statement
establishes criteria for accounting for changes in the fair value of
derivatives based on the intended use of the derivatives. The statement is
effective for all fiscal quarters of fiscal years beginning after June 15,
1999. Based on the Bank's current use of derivatives the Company does not
expect the adoption of SFAS No. 133 to have a material impact on the
company's financial position or results of operations.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). This statement
provides guidance on accounting for the costs of computer software developed
or obtained for internal use. Under SOP 98-1 software costs incurred in the
preliminary project stage are expensed as incurred. Once the capitalization
criteria have been met subsequent costs associated with internal use
software shall be capitalized in accordance with the guidance in SOP 98-1.
Prior to the issuance of SOP 98-1 it has been the Company's policy to
expense all such costs. SOP 98-1 is effective for financial statements for
fiscal years beginning after December 15, 1998. The company does not expect
that the adoption of SOP 98-1 will have a material impact on the Company's
financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information" ("SFAS No. 131"). This statement
establishes the standards for reporting information about segments in annual
and interim financial statements. SFAS No. 131 introduces a new model for
segment reporting; the "management approach". The management approach is
based on the way the chief operating decision-maker organizes segments
within a company for making operating decisions and assessing performance.
Reportable segments are based on products and services, geography, legal
structure, management structure - any manner in which management
disaggregates a company. This statement is effective and will be adopted for
the Company's financial statements for the fiscal year ended December 31,
1998 and requires the restatement of previously reported segment information
for all periods presented.
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 September 30, 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 $2,332 4,428,638 $0.53
Diluted Earnings Per Share:
Options issued to Executives -- 10,850
Income available to Common Shareholders
Plus Assumed Conversions $2,332 4,439,488 $0.53
- --------------------------------------------------------------------------------------------
</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. The computation of diluted earnings per share for the quarter ended
September 30, 1998 excludes the effect of assuming the exercise of certain
outstanding stock options because the effect would be anti-dilutive. As of
September 30, 1998 there were 48,346 of such options outstanding with an
exercise price of $30.50.
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 September 30, 1997.
NOTE 3: STOCK REPURCHASE PROGRAM
On September 3, 1998 the Company announced that its Board of Directors had
authorized the company to repurchase, through September 4, 1999, up to $2.2
million of its own securities, approximately 2% of outstanding shares at its
then market value. The stock buyback was authorized to take place
periodically, subject to prevailing market conditions. Purchases are to be
made on the open market and funded from available cash. As of November 9,
1998 the Company had repurchased 25,000 shares of its common stock at a
total cost of approximately $574 thousand.
NOTE 4: 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.
The company, the bank, the 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 (the "Portfolio"). In December of
1994, the Companies made payments to the Trust Company customers in amounts
that the Companies believed reimbursed those customers fully for Portfolio
losses. The United States District Court for the District of Vermont has
dismissed the Plaintiff's claims in the Vermont Proceedings with prejudice,
as moot, and has ordered payment of approximately $99,000 in attorney's fees
to the attorney's representing the plaintiff. The Plaintiff and his
attorneys have appealed to the Second Circuit Court of Appeals the District
Court's orders, and the Companies have appealed on certain limited issues.
The companies have separately pursued claims against others on account of
the losses suffered as a result of the investments in the Portfolio. Claims
against Piper Jaffray companies, Inc. were joined with the claims of others
in a class action in the United States District Court for the District of
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were
settled by the parties and in February of 1997 the District Court ordered
the net share of the settlement proceeds attributable to the Trust Company's
investments to be paid to the Trust Company, starting approximately 60 days
after the Court's order becomes final, except to the extent, if at all, any
other court with jurisdiction has sooner given leave for some or all of
those payments to be deposited with such other court pursuant to applicable
rules. The attorneys representing the Plaintiff in the Vermont Proceedings
and also representing, in the Minnesota Proceedings, the beneficiaries of
four other Trust Company accounts, appealed that order to the Eighth Circuit
Court of Appeals. Those attorneys took the position that notwithstanding the
payments made by the companies to the Trust Company customers in December of
1994, any amounts paid under the Minnesota Proceedings on account of the
Trust Company's Portfolio investments should be paid directly to the
affected Trust Company customers (net of legal fees to be paid to those
attorneys). On July 24, 1998, the United States Circuit Court of Appeals for
the Eighth Circuit issued a Per Curiam decision affirming the Order and on
August 27, 1998 it denied a petition for rehearing. The same attorneys have
separately stated that they intend to bring further proceedings, seeking to
intercept the payments to the Trust Company, or otherwise to require the
Companies to pay such amounts directly to the affected Trust Company clients
(net of legal fees to those attorneys). Any recovery by the Companies from
the Minnesota Proceedings is subject to the terms of an agreement between
the Companies and their insurance carrier, which reimbursed the Companies,
in part, for the December, 1994 payments.
NOTE 5: 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 nine months ended
September 30, 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, Merchants Bank (the Bank) and Merchants
Properties, Inc., without audit.
In the ordinary course of business, Merchants Bank makes commitments for
possible future extensions of credit. On September 30, 1998, the Bank was
obligated for $6.2 million of standby letters of credit. No losses are
anticipated in connection with these commitments.
OVERVIEW
Merchants Bancshares, Inc. recorded net income of $2.33 million, or basic
and diluted earnings per share of $.53 for the quarter ended September 30,
1998, compared to $2.19 million, or basic and diluted earnings per share of
$.50 per share for the same period a year earlier. Net income for the nine
months ended September 30, 1998 was $6.89 million, or basic and diluted
earnings per share of $1.55, compared to $6.13 million or basic and diluted
earnings per share of $1.39 for the nine months ended September 30, 1997.
The return on average assets and return on average equity for the third
quarter of 1998 were 1.54% and 16.52%, respectively, compared to 1.51% and
17.55% for the third quarter of 1997. The return on average assets and
return on average equity for the nine months ended September 30, 1998 were
1.54% and 16.71%, respectively, compared to 1.42% and 16.95% for the nine
months ended September 30, 1997.
BALANCE SHEET ANALYSIS
Total deposits increased by $26.17 million (5.2%) during the nine months
ended September 30, 1998. Redesign and simplification of the Bank's product
line, coupled with focused sales efforts, fueled this growth. The sales
program, LYNX Banking, has as its' foundation fewer products that have
potential lifetime appeal to the Bank's customers. The Bank's FreedomLYNX
checking account has no minimum balance requirements, pays interest on
balances over a minimum amount, and generally charges no fees. As the
customer's needs change and balances grow they can move into the higher
yielding MoneyLYNX money market product. Money market account balances
overall have grown $32 million over the course of 1998 at a cost of funds of
approximately 4.65%. Since the launch of the FreedomLYNX account in the
fourth quarter of 1996 the Bank has opened accounts with total balances in
excess of $15 million at a cost of funds of approximately 1.7%.
Total loans have increased $4.48 million (1.15%) during the nine months.
This increase is noteworthy because the Bank sold approximately $15 million
in loans during the first and second quarters of 1998. Substantially all of
the sold loans were commercial real estate credits. Total loans increased by
$15.65 million over the course of the third quarter. As part of its strategy
to replace runoff in the commercial real estate portfolio the Bank has
revamped its residential real estate products over the last year. A new,
streamlined portfolio mortgage product, ReaLYNX, was introduced during the
first quarter of 1998. ReaLYNX was designed to shorten the turnaround time
on residential mortgages with reduced documentation requirements from
borrowers. Additionally, the Bank introduced a new fixed rate home equity
line of credit product, HomeLYNX, 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 other types of loans.
Outstanding balances in the new home equity line of credit product at
September 30, 1998 were $17 million. The result of these efforts can be seen
in the changes in the portfolio mix during the first nine months of the
year. During the first nine months of 1998 the Bank's residential real
estate portfolio increased by $26.03 million, while the commercial real
estate portfolio decreased by $17.12 million, and the commercial loan
portfolio decreased by $3.26 million. The Bank has taken steps to protect
its variable rate funding sources. During the first nine months 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 $50 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.
In July 1998, the Emerging Issues Task Force (EITF) issued guidance on Issue
No. 97-14, "Accounting for Deferred Compensation Arrangements Where amounts
Earned Are Held in a Rabbi Trust and Invested" (the "Guidance"). This
Guidance establishes standards for reporting and accounting for certain
deferred compensation agreements between Merchants Bancshares, Inc. and
certain directors of the Company. This Guidance requires that the deferred
compensation obligation, totaling $2.13 million, be classified in the equity
section of the balance sheet. These amounts were previously classified as
other liabilities in the "Liabilities" section of the Balance Sheets. The
Company adopted this guidance prospectively on September 30, 1998.
RESULTS OF OPERATIONS
Third quarter net interest income before the provision for possible loan
losses decreased $277 thousand from 1997 to 1998. Year to date net interest
income before the provision for possible loan losses was $301 thousand less
in 1998 than the comparable period in 1997. This decrease in net interest
income is primarily attributable to the current interest rate environment.
Although the Bank's average net interest earning assets have increased $13
million from the third quarter of 1997 to the third quarter of 1998 and $12
million for the first nine months of the year, the average spread on those
assets has decreased by 51 basis points quarter over quarter, and 34 basis
points for the first nine months of the year. During the third quarter the
Company saw its' net interest margin decrease 24 basis points, from 5.35% to
5.11%, the margin has decreased 28 basis points year over year. Many of the
bank's funding sources are tied to short-term rates, which have not fallen
as rapidly as long-term rates. The Bank's average cost of funds has remained
virtually unchanged from 1997 to 1998, while the average yield on interest
earning assets has decreased by 57 basis points quarter over quarter, and 35
basis points year over year. The recent rate cuts by the Federal Reserve
Bank may benefit the Bank by helping to decrease its cost of funds. The
schedule on pages 15 and 16 shows the yield analysis for the periods
reported.
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 third quarter
of 1998 or 1997. During the second quarter of 1998 the Company recognized a
recovery on loan that had previously been charged down of $119 thousand.
This amount was credited to income through the provision for loan losses.
Reserve coverage continues to be very strong at 3.47% of total loans and
256% 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 increased $30 thousand from the same quarter a
year earlier, and $288 thousand (5.52%) for the first nine months of 1998.
Merchants Trust Company (the "Trust Company") has shown increased revenue of
approximately $40 thousand (11%) for the quarter, and $306 thousand (27%)
for the first nine months of 1998. Of the year to date 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 $113
thousand (15%) for the quarter and $259 thousand (11%) year to date. 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 remained virtually unchanged for the
quarter, and decreased $79 thousand (7%) year to date, due primarily to
lower transaction volumes. These changes are consistent with the Bank's
strategy to emphasize margin dollars over fee income.
Total non-interest expenses for the third quarter have decreased $514
thousand (8%) year over year, and have decreased by $910 thousand (5%) for
the first nine months. Salaries, wages and employee benefits have increased
by $225 thousand (9%) for the third quarter and $460 thousand (6%) for the
first nine months of the year. The Bank has increased staff by 11 full time
equivalent employees over the last year, 10 of which are in the sales
departments. This additional staff will support the Bank's sales efforts and
will help to fuel continued balance sheet growth. Legal and professional
fees have decreased $482 thousand (60%) for the third quarter and $325
thousand (17%) for the first nine months of 1998. This decrease is due
primarily to the timing of expenses incurred by the Bank as it defends
itself in certain litigation. For more information on this litigation see
Part II, Item 1, Legal Proceedings. Expenses associated with Other Real
Estate Owned ("OREO") decreased $10 thousand (16%) for the quarter ended
September 30, 1998 versus the prior year quarter and $246 thousand (58%) for
the first nine months of 1998 versus the first nine months of 1997. This
decrease is due primarily to reimbursement of expenses and gains recognized
upon the sale of certain properties. Additionally, in conjunction with its
conversion to the Windows NT platform and other capital improvements the
Bank recognized expenses associated with the retirement of certain assets
totaling $132 thousand for the second quarter of 1997, and $418 thousand for
the first nine months of last year. Losses recognized in conjunction with
the disposition of fixed assets during the third quarter of 1998 totaled $45
thousand and $100 thousand year to date.
YEAR 2000
Introduction: The Company, like most users of computers, computer software
and equipment utilizing computer software faces a critical challenge
regarding the Year 2000 date change. 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. If not corrected, many computer applications could fail or
create inaccurate results. The bank regulatory agencies which regulate the
conduct of the Company, the Bank and the Trust Company, through the auspices
of the Federal Financial Institutions Examination Council (FFIEC) have
issued compliance guidelines requiring financial institutions to develop and
implement plans to address the Year 2000 issues. During the past fifteen
months, the Company has devoted substantial time and resources toward
ensuring that the Company's and its subsidiaries' operations will not be
adversely impacted by the pending date change. The Bank's primary
regulator, the Federal Deposit Insurance Corporation has been monitoring,
and continues to monitor, the Bank's planning and implementation process on
a regular basis. The Company has also contracted with Arthur Andersen LLP
to perform an independent review of the Company's Year 2000 preparations.
These reviews will commence during the fourth quarter of 1998 and will
continue into 1999. The Company's management remains committed to the
continued deployment of the necessary internal and external resources toward
addressing the Year 2000 issue.
State of Readiness: As required by the Company's and its subsidiaries'
regulatory agencies, the Company, through its Year 2000 Committee (the
Committee) has developed a Year 2000 compliance plan. The Company's plan
addresses the five basic phases of achieving Year 2000 compliance; (i)
project management, (ii) awareness, (iii) assessment, (iv) testing and (v)
renovation and implementation. Project management began in the middle of
1997 as the Committee was formed. Since its formation, the Committee has
met on a regular basis to discuss and plan the specific actions that the
Company, the Bank and the Trust Company need to take to verify that the
Company and its subsidiaries will be prepared for the date change. In
addition, the Company has developed a strategy to ensure that its software
vendors are also taking steps to address the millennium change. The
Committee is comprised of senior executive officers of the Company, the Bank
and the Trust Company. The Committee is chaired by the Bank's Senior
Operations Officer, and includes the Company's Chief Financial Officer, the
Bank's Chief Auditor/Risk Management Officer, the Bank's Information Systems
Manager, the Bank's Senior Loan Underwriter, the Bank's Deposit Operations
Manager, a Trust Company Officer and the Bank's Facilities/Administration
Manager. The Committee provides progress reports to the Company's senior
management and reports at least quarterly to the Company's Board of
Directors.
Through the Committee, the Company has also taken steps to promote awareness
of the Year 2000 problem throughout its entire organization. In addition,
the Company has sought to raise the awareness of its vendors, service
providers and larger borrowing customers as to the Year 2000 problem in
light of the critical role these entities play in the operations of the
Company. The Committee has contacted each of these entities and requested a
Year 2000 plan and testing information. The Company has received responses
from substantially all of its vendors and service providers. The majority
of the Company's borrowers have also responded. The Committee intends to
follow-up with these customers frequently throughout the next year and into
the Year 2000.
Assessment is the process of identifying all mission-critical applications
that could be adversely affected by the date change. The Company's
assessment phase is substantially complete. Throughout its history,
independently of the Year 2000 issue, the Company has sought to purchase its
critical core hardware and software from vendors who it perceives as having
strong reputations as leading financial industry service providers. The
Company has received and installed Year 2000 compliant software upgrades
from all but one of these mission critical vendors. Management expects to
have all critical Year 2000 software upgrades installed prior to December
31, 1998. Substantial progress has been made with respect to the fourth
phase of the Company's Year 2000 plan, testing. Testing of the Company's
core computer and peripheral equipment infrastructure has been successfully
completed and substantial progress has been made in the testing of the
infrastructure of the Company's personal computer desktop network. Testing
of critical customer accounting software applications has begun and is
targeted for completion by April 1999, well in advance of the FFIEC
suggested testing completion date. All other systems and applications have
been scheduled for testing prior to September 30, 1999. In the Plan, each
of these non-mission critical systems has an established target date by
which steps must be taken to replace any non-compliant systems. The Company
is confident that all tests will be completed well in advance of those
target dates.
The final phase of the Plan, renovation and implementation, involves
obtaining and implementing renovated software applications provided by the
Company's vendors. As noted above, this phase of the Plan has already
commenced and will continue throughout 1999. To date, the Company has not
identified any system which presents a material risk of not being Year 2000
compliant in a timely fashion or for which a suitable alternative cannot be
implemented.
Costs to Address the Year 2000 Issue: The total financial costs associated
with the Year 2000 problem cannot be predicted at this time with absolute
certainty. As may be expected, the Committee currently estimates that there
will be costs associated with replacing certain non-compliant software
and/or hardware. The Company has hired a full-time project coordinator to
oversee the testing phase of the Year 2000 project. Although no other staff
additions are currently planned, the Committee estimates that about 30-35
people are spending some portion of their time working on the Year 2000
project. Additionally, the Company has hired a third party to evaluate the
Bank's loan loss reserve adequacy in light of Year 2000 concerns. At this
time, the Company does not anticipate a need for any additional loan loss
provision related specifically to Year 2000 risks. The Company plans to
replace many of the Bank's ATMs as well as upgrade certain software and
equipment. Management had approved the replacement of the ATMs prior to
Year 2000 budget planning since most of them were 15 to 20 years old. Out
of the total estimated $1.26 million in capital costs $890 thousand is
budgeted to upgrade the ATM network. The Bank has spent $568 thousand for
ATM and other Year 2000 upgrades in 1998. These costs have been, and when
incurred in the future will be, capitalized and depreciated over the
estimated useful lives of the assets, as such assets represent replacement
of existing equipment. Direct (non-capital expenditures) Year 2000 expenses
incurred year to date total approximately $126 thousand and have been
charged to expense as incurred. Additional expenses related to the project
are currently estimated to be $230 thousand and will be charged to expense
as incurred.
Risks of Year 2000 Issues: The Year 2000 problem presents potential risks to
the Company, its subsidiaries and their operations. As stated above, the
Company purchases substantially all of its technology applications from
third parties that face the same Year 2000 challenge as the Company. Thus,
the Company's operations could be adversely affected if the operations of
these third parties are adversely affected by the Year 2000 problem. Most
significantly, the Company faces risks that are specific to the business of
banking. Included among these risks is the risk that the Year 2000 date
change may result in the inability to process and underwrite loan
applications, to credit deposits and withdrawals from customer accounts, to
credit loan payments or track delinquencies, to properly reconcile and
record daily activity or to engage in similar normal banking activities.
Additionally, if the Bank's commercial loan customers are not Year 2000
compliant and suffer adverse effects with respect to their own operations,
their ability to meet their obligations to the Bank could be adversely
affected. Furthermore, as a commercial bank, the Bank could potentially
experience deposit run-off prior to the Year 2000 date change as a result of
customer concern about the potential availability of their funds or a change
in interest rates. Moreover, to the extent that the risks posed by the Year
2000 problem are pervasive in data processing and transmission and
communications services worldwide, the Company cannot predict with any
certainty that its operations will remain materially unaffected after
January 1, 2000 or on dates preceding this date at which time post-January
1, 2000 dates become significant within the Bank's systems. Finally, to the
extent that certain utility and communication services used by the Company
face Year 2000 problems, the Company's operations could be disrupted.
Contingency Plans: In light of these risks and uncertainties, the Company is
developing contingency plans to mitigate the risks associated with the Year
2000 date change and to provide a business continuity strategy. The Company
is developing these plans through building on its internal disaster
Recovery/Contingency plans, which were updated during the second quarter of
1998. This planning effort included a Business Impact Analysis relating to
mission critical systems and is the foundation documentation that will be
used to finalize the Year 2000 mission critical service provider Contingency
plans.
The discussion above contains certain forward-looking statements. The costs
of the Year 2000 conversion, the date which the Company has set to complete
its Year 2000 project and statements about anticipated compliance are based
on the Company's current estimates and are subject to various uncertainties
that could cause actual results to differ materially from the Company's
expectations. Such uncertainties include, among others, the success of the
Company in identifying systems that are not Year 2000 compliant, the nature
and amount of programming required to upgrade or replace each of the
affected systems, the availability of qualified personnel, consultants and
other resources, and the success of the Year 2000 compliance efforts of
others. Readers are cautioned not to place undue reliance on these forward
looking statements.
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 for
each of the first three quarters of 1997 and 1998, 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% for the quarter and nine months ended September 30, 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 June 30, 1998; an
overnight line of credit with the Federal Home Loan Bank (FHLB) of $15
million; an estimated additional borrowing capacity with FHLB of $62
million; and the ability to borrow through the use of repurchase agreements,
collateralized by the Bank's investments, with certain approved
counterparties.
NON-PERFORMING ASSETS
The following tables summarize the Bank's non-performing assets as of
September 30, 1998, December 31, 1997, and September 30, 1997:
<TABLE>
<CAPTION>
(In thousands) September 30, 1998 December 31, 1997 September 30, 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Nonaccrual Loans $4,752 $2,686 $3,175
Loans Past Due 90 Days or
More and Still Accruing 279 403 707
Restructured Loans 327 215 2,157
- ---------------------------------------------------------------------------------------
Total Non-performing Loans 5,358 3,304 6,039
Other Real Estate Owned 818 591 225
- ---------------------------------------------------------------------------------------
Total Non-performing Assets $6,176 $3,895 $6,264
=======================================================================================
</TABLE>
Note: Included in nonaccrual loans are certain loans whose terms have been
substantially modified in troubled debt restructuring.
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997 September 30, 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Percentage of Non-performing
Loans to Total Loans 1.36% 0.85% 1.52%
Percentage of Non-performing
Assets to Total Loans plus Other
Real Estate Owned 1.56% 1.00% 1.58%
Percentage of RPLL to Total Loans 3.47% 4.06% 4.07%
Percentage of RPLL to NPL 256% 479% 268%
Percentage of RPLL to NPA 222% 406% 258%
- -------------------------------------------------------------------------------------------------
</TABLE>
Loans deemed impaired totaled $5.9million, of this total $4.7million are
included as non-performing assets in the table above. Impaired loans have
been allocated $664 thousand of the Reserve for Possible Loan Losses (RPLL).
Approximately 77% of the Non-Performing Loans (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 September 30, 1998. Management's assessment of the
adequacy of the RPLL concluded that a provision was not necessary during the
first three quarters of 1998.
DISCUSSION OF EVENTS AFFECTING NPA
Significant events affecting the categories of NPA are discussed below:
Nonaccrual Loans:
- -----------------
During the third quarter of 1998 there was a $101 thousand decrease in
this category. The increase since December 31, 1997 is concentrated in
two relationships.
Loans Past Due 90 Days:
- -----------------------
Loans past due 90 days decreased $125 thousand from December 31, 1997
to September 30, 1998. Approximately 46% of the balances at September
30, 1998 carry guarantees from the U.S. Small Business Administration.
Restructured Loans:
- -------------------
The reported increase was driven by the addition of a single
relationship.
Other Real Estate Owned (OREO)
- ------------------------------
The Bank made the decision, during the quarter, to dispose of a former
Bank facility and a building that houses one of the Bank's branches.
These two buildings were reclassified as OREO during the third quarter
of 1998. The buildings were sold during October of 1998, reducing OREO
balances by $368 thousand.
Merchants Bancshares, Inc.
Supplemental Information
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------
September 30, 1998 September 30, 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) $386,026 $ 9,092 9.34% $396,140 $ 9,778 9.79%
Taxable Investments 170,403 2,744 6.39% 139,277 2,320 6.61%
Federal Funds Sold and Securities Purchased
Under Agreements to Resell 10,963 153 5.54% 2,821 39 5.48%
------------------------------- -------------------------------
Total Interest Earning Assets $567,392 $11,989 8.38% $538,238 $12,137 8.95%
=============================== ===============================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $292,303 $ 2,393 3.25% $266,012 $ 2,147 3.20%
Time Deposits 158,674 2,153 5.38% 164,802 2,239 5.39%
------------------------------- -------------------------------
Total Savings and Time Deposits 450,977 4,546 4.00% 430,814 4,386 4.04%
Federal Funds Purchased -- -- 328 4 5.32%
Other Borrowed Funds 2,372 26 4.35% 3,087 44 5.60%
Debt 6,411 116 7.18% 9,445 144 6.04%
------------------------------- -------------------------------
Total Interest Bearing Liabilities 459,760 4,688 4.05% 443,674 4,578 4.09%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 107,632 94,564
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $567,392 $538,238
======== ========
Rate Spread 4.34% 4.85%
===== =====
Net Yield on Interest Earning Assets 5.11% 5.57%
===== =====
<F1> Includes principal balance of non-accrual loans and fees on loans
</TABLE>
Merchants Bancshares, Inc.
Supplemental Information
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------------------------------------------------
September 30, 1998 September 30, 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) $386,091 $27,758 9.54% $393,643 $28,849 9.80%
Taxable Investments 165,759 8,096 6.53% 142,518 7,113 6.67%
Federal Funds Sold and Securities Purchased
Under Agreements to Resell 5,061 220 5.81% 1,892 77 5.44%
------------------------------- -------------------------------
Total Interest Earning Assets $559,911 $36,074 8.61% $538,053 $36,039 8.96%
=============================== ===============================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $281,533 $ 6,814 3.24% $264,572 $ 6,275 3.17%
Time Deposits 160,547 6,472 5.39% 164,370 6,629 5.39%
------------------------------- -------------------------------
Total Savings and Time Deposits 442,080 13,286 4.02% 428,942 12,904 4.02%
Federal Funds Purchased 735 32 5.82% 913 40 5.90%
Other Borrowed Funds 6,020 239 5.31% 5,796 241 5.55%
Debt 6,412 344 7.18% 9,735 437 6.00%
------------------------------- -------------------------------
Total Interest Bearing Liabilities 455,247 13,901 4.08% 445,386 13,622 4.09%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 104,664 92,667
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $559,911 $538,053
======== ========
Rate Spread 4.53% 4.87%
===== =====
Net Yield on Interest Earning Assets 5.29% 5.57%
===== =====
<F1> Includes principal balance of non-accrual loans and fees on loans
</TABLE>
MERCHANTS BANCSHARES, INC.
SEPTEMBER 30, 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
third 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, the 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 (the "Portfolio"). In December of
1994, the Companies made payments to the Trust Company customers in amounts
that the Companies believed reimbursed those customers fully for Portfolio
losses. The United States District Court for the District of Vermont has
dismissed the Plaintiff's claims in the Vermont Proceedings with prejudice,
as moot, and has ordered payment of approximately $99,000 in attorney's fees
to the attorney's representing the plaintiff. The Plaintiff and his
attorney's have appealed to the Second Circuit Court of Appeals the District
Court's orders, and the Companies have appealed on certain limited issues.
The companies have separately pursued claims against others on account of
the losses suffered as a result of the investments in the Portfolio. Claims
against Piper Jaffray companies, Inc. were joined with the claims of others
in a class action in the United States District Court for the District of
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were
settled by the parties and in February of 1997 the District Court ordered
the net share of the settlement proceeds attributable to the Trust Company's
investments to be paid to the Trust Company, starting approximately 60 days
after the Court's order becomes final, except to the extent, if at all, any
other court with jurisdiction has sooner given leave for some or all of
those payments to be deposited with such other court pursuant to applicable
rules. The attorneys representing the Plaintiff in the Vermont Proceedings
and also representing, in the Minnesota Proceedings, the beneficiaries of
four other Trust Company accounts, appealed that order to the Eighth Circuit
Court of Appeals. Those attorneys took the position that notwithstanding the
payments made by the companies to the Trust Company customers in December of
1994, any amounts paid under the Minnesota Proceedings on account of the
Trust Company's Portfolio investments should be paid directly to the
affected Trust Company customers (net of legal fees to be paid to those
attorneys). On July 24, 1998, the United States Circuit Court of Appeals for
the Eighth Circuit issued a Per Curiam decision affirming the Order and on
August 27, 1998 it denied a petition for rehearing. The same attorneys have
separately stated that they intend to bring further proceedings, seeking to
intercept the payments to the Trust Company, or otherwise to require the
Companies to pay such amounts directly to the affected Trust Company clients
(net of legal fees to those attorneys). Any recovery by the Companies from
the Minnesota Proceedings is subject to the terms of an agreement between
the Companies and their insurance carrier, which reimbursed the Companies,
in part, for the December, 1994 payments.
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
SEPTEMBER 30, 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
November 12, 1998
-----------------
Date
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 18,194
<INT-BEARING-DEPOSITS> 13
<FED-FUNDS-SOLD> 5,000
<TRADING-ASSETS> 1,075
<INVESTMENTS-HELD-FOR-SALE> 65,374
<INVESTMENTS-CARRYING> 103,344
<INVESTMENTS-MARKET> 105,060
<LOANS> 394,868
<ALLOWANCE> 13,723
<TOTAL-ASSETS> 606,650
<DEPOSITS> 532,017
<SHORT-TERM> 1,377
<LIABILITIES-OTHER> 7,352
<LONG-TERM> 6,410
0
0
<COMMON> 44
<OTHER-SE> 59,450
<TOTAL-LIABILITIES-AND-EQUITY> 606,650
<INTEREST-LOAN> 27,692
<INTEREST-INVEST> 8,325
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 36,017
<INTEREST-DEPOSIT> 13,286
<INTEREST-EXPENSE> 615
<INTEREST-INCOME-NET> 22,116
<LOAN-LOSSES> (119)
<SECURITIES-GAINS> 44
<EXPENSE-OTHER> 18,515
<INCOME-PRETAX> 9,223
<INCOME-PRE-EXTRAORDINARY> 2,337
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,886
<EPS-PRIMARY> 1.55
<EPS-DILUTED> 1.55
<YIELD-ACTUAL> 5.29
<LOANS-NON> 4,752
<LOANS-PAST> 279
<LOANS-TROUBLED> 327
<LOANS-PROBLEM> 6,257
<ALLOWANCE-OPEN> 15,831
<CHARGE-OFFS> 2,827
<RECOVERIES> 838
<ALLOWANCE-CLOSE> 13,723
<ALLOWANCE-DOMESTIC> 13,723
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 6,220
</TABLE>
