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 JUNE 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 [ ]
4,433,716 Shares Common Stock $.01 Par Outstanding June 30, 1998
MERCHANTS BANCSHARES, INC.
INDEX TO FORM 10-Q
PART I
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets June 30, 1998 and December 31, 1997 1
Consolidated Statements of Operations For the three months ended
June 30, 1998 and 1997 and the six months ended June 30, 1998
and 1997 2
Consolidated Statements of Comprehensive Income For the three
months ended June 30, 1998 and 1997 and the six months ended
June 30, 1998 and 1997 3
Consolidated Statement of Changes in Stockholders' Equity For
the six months ended June 30, 1998 and 1997 and the Year ended
December 31, 1997 4
Consolidated Statements of Cash Flows For the six months ended
June 30, 1998 and 1997 5
Footnotes to Financial Statements as of June 30, 1998 6-7
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 8-13
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 14
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 15
Merchants Bancshares, Inc.
Consolidated Balance Sheets
Unaudited
<TABLE>
<CAPTION>
June 30, December 31,
(In thousands except share and per share data) 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and Due from Banks $ 24,040 $ 20,139
Investments:
Debt Securities Held for Sale 58,272 44,241
Debt Securities Held to Maturity 107,152 111,458
Trading Securities 1,064 1,031
- --------------------------------------------------------------------------------------------
Total Investments 166,488 156,730
- --------------------------------------------------------------------------------------------
Loans 379,214 390,388
Reserve for possible loan losses 13,787 15,831
- --------------------------------------------------------------------------------------------
Net Loans 365,427 374,557
- --------------------------------------------------------------------------------------------
Federal Home Loan Bank Stock 2,482 2,296
Federal Funds Sold 6,000 --
Bank Premises and Equipment, Net 13,270 13,428
Investment in Real Estate Limited Partnerships 1,881 1,972
Other Real Estate Owned 377 591
Other Assets 15,066 14,539
- --------------------------------------------------------------------------------------------
Total Assets $595,031 $584,252
============================================================================================
LIABILITIES
Deposits:
Demand $ 81,130 $ 76,712
Savings, NOW and Money Market Accounts 278,593 267,396
Time Deposits $100 thousand and Greater 24,200 23,307
Other Time 135,209 138,429
- --------------------------------------------------------------------------------------------
Total Deposits 519,132 505,844
- --------------------------------------------------------------------------------------------
Demand Note Due U.S. Treasury 4,000 4,000
Other Short-Term Borrowings -- 4,000
Other Liabilities 9,497 11,057
Long-Term Debt 6,412 6,415
- --------------------------------------------------------------------------------------------
Total Liabilities 539,041 531,316
- --------------------------------------------------------------------------------------------
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 4,302,100
Prior Period 4,292,763
Treasury Stock (At Cost) (2,100) (2,220)
Current Period 132,520
Prior Period 139,857
Capital in Excess of Par Value 33,153 33,223
Retained Earnings 24,651 21,537
Unearned Compensation - Restricted Stock Awards (19) (10)
Unrealized Gains on Securities Available for Sale, Net 261 362
- --------------------------------------------------------------------------------------------
Total Stockholders' Equity 55,990 52,936
- --------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $595,031 $584,252
============================================================================================
Book Value Per Common Share $ 12.63 $ 11.95
============================================================================================
<FN>
Note: As of June 30, 1998, the Bank had off-balance sheet liabilities in the
form of standby letters of credit to customers in the amount of $5,999
</FN>
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
Merchants Bancshares, Inc.
Consolidated Statements of Operations
Unaudited
<TABLE>
<CAPTION>
Quarter Ended Six months ended
June 30, June 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 $ 9,376 $ 9,602 $18,619 $19,071
Interest and Dividends on Investments
U.S. Treasury and Agency Obligations 2,698 2,339 5,285 4,681
Other 80 76 143 149
- -----------------------------------------------------------------------------------------------------
Total Interest Income 12,154 12,017 24,047 23,901
- -----------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Savings, NOW and Money Market Accounts 2,235 2,085 4,421 4,128
Time Deposits $100 Thousand and Greater 395 343 781 681
Other Time Deposits 1,770 1,875 3,538 3,709
Other Borrowed Funds 149 165 245 311
Debt 114 108 228 214
- -----------------------------------------------------------------------------------------------------
Total Interest Expense 4,663 4,576 9,213 9,043
- -----------------------------------------------------------------------------------------------------
Net Interest Income 7,491 7,441 14,834 14,858
Provision for Possible Loan Losses (119) -- (119) 300
- -----------------------------------------------------------------------------------------------------
Net Interest Income after Provision for Loan Losses 7,610 7,441 14,953 14,558
- -----------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Trust Company Income 492 386 1,039 773
Service Charges on Deposits 724 782 1,423 1,569
Merchant Discount Fees 322 425 665 740
Loss on Sale of Investments, Net -- (15) -- (56)
Other 438 137 606 449
- -----------------------------------------------------------------------------------------------------
Total Noninterest Income 1,976 1,715 3,733 3,475
- -----------------------------------------------------------------------------------------------------
NONINTEREST EXPENSES
Salaries and Wages 2,258 2,140 4,458 4,264
Employee Benefits 538 470 1,107 1,066
Occupancy Expense, Net 508 517 1,040 1,114
Equipment Expense 635 530 1,259 1,065
Legal and Professional Fees 750 506 1,277 879
Provision for Impairment of Investment Securities -- -- -- 229
Equity in Losses of Real Estate Limited Partnerships 75 172 169 344
Expenses - Other Real Estate Owned 7 248 124 360
Loss on Disposition of Fixed Assets 28 130 55 286
Other 1,690 1,755 3,095 3,373
- -----------------------------------------------------------------------------------------------------
Total Noninterest Expenses 6,489 6,468 12,584 12,980
- -----------------------------------------------------------------------------------------------------
Income Before Income Taxes 3,097 2,688 6,102 5,053
Provision for Income Taxes 789 610 1,548 1,111
- -----------------------------------------------------------------------------------------------------
NET INCOME $ 2,308 $ 2,078 $ 4,554 $ 3,942
=====================================================================================================
Basic Earnings Per Common Share $ 0.52 $ 0.47 $ 1.03 $ 0.89
Diluted Earnings Per Common Share 0.52 0.47 1.02 0.89
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
Merchants Bancshares, Inc.
Consolidated Statements of Comprehensive Income
Unaudited
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
---------------- ----------------
(In thousands) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Income as Reported $2,308 $2,078 $4,454 $3,942
Change in Net Unrealized Appreciation (Depreciation)
of Securities, Net of Tax (78) 133 (101) (16)
- ----------------------------------------------------------------------------------------------
Comprehensive Net Income $2,230 $2,211 $4,353 $3,926
==============================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
Merchants Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Year Ended December 31, 1997 and
the Six Months Ended June 30, 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 -- -- 3,942 -- -- -- 3,942
Purchase of Treasury Stock -- -- -- (402) -- -- (402)
Sale of Treasury Stock -- (25) -- 459 -- -- 434
Dividends Paid -- 27 (887) -- -- -- (860)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- (16) (16)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance June 30, 1997 44 33,157 17,900 (1,981) -- 228 49,348
Net Income -- -- 4,891 -- -- -- 4,891
Purchase of Treasury Stock -- -- -- (988) -- -- (988)
Sales of Treasury Stock -- 244 -- 556 -- -- 800
Issuance of Stock under Employee Stock
Option Plans -- (178) -- 193 -- -- 15
Dividends Paid -- -- (1,254) -- -- -- (1,254)
Unearned Compensation--Restricted Stock
Awards -- -- -- -- (10) -- (10)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- 134 134
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 44 33,223 21,537 (2,220) (10) 362 52,936
Net Income -- -- 4,554 -- -- -- 4,554
Purchase of Treasury Stock -- -- -- (294) -- -- (294)
Sales of Treasury Stock -- (61) -- 189 -- -- 128
Issuance of Stock under Employee Stock
Option Plans -- (9) -- 225 -- -- 216
Dividends Paid -- -- (1,440) -- -- -- (1,440)
Unearned Compensation--Restricted Stock
Awards -- -- -- -- (9) -- (9)
Change in Net Unrealized Appreciation
(Depreciation) of Securities, Net of Tax -- -- -- -- -- (101) (101)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1998 $44 $ 33,153 $ 24,651 $(2,100) $ (19) $ 261 $ 55,990
==================================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
Merchants Bancshares, Inc.
Consolidated Statement of Cash Flows
Unaudited
<TABLE>
<CAPTION>
For the six months ended June 30, 1998 1997
- -----------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 4,554 $ 3,942
Adjustments to Reconcile Net Income to Net Cash Provided by
Operating Activities:
Provision for Possible Loan Losses (119) 300
Provision for Possible Losses on Other Real Estate Owned 7 --
Provision for Impairment of Investment Security -- 229
Provision for Depreciation and Amortization 1,288 1,172
Net Gains on Sales of Investment Securities -- (173)
Net Gains on Sales of Loans and Leases (213) --
Net Losses on Sales of Premises and Equipment 55 25
Net Gains on Sales of Other Real Estate Owned (69) (298)
Equity in Losses of Real Estate Limited Partnerships 169 344
Changes in Assets and Liabilities:
(Increase) Decrease in Interest Receivable (225) 364
Decrease in Interest Payable (160) (242)
(Increase) Decrease in Other Assets (6,302) 302
Decrease in Other Liabilities (1,400) (453)
- -----------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities (2,415) 5,512
- -----------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from Sales of Investment Securities Available for Sale -- 18,067
Proceeds from Maturities of Investment Securities 20,510 --
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 657 2,144
Purchases of Available for Sale Investment Securities (27,816) --
Purchases of Held to Maturity Investment Securities (5,232) (18,098)
Purchases of FHLB Stock (186) --
Loan Originations in Excess of Principal Payments (3,209) (6,449)
Investments in Real Estate Limited Partnerships (192) (130)
Purchases of Premises and Equipment (342) (2,291)
- -----------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (1,579) (6,206)
- -----------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase (Decrease) in Deposits 13,288 (3,951)
Net Increase (Decrease) in Other Borrowed Funds (4,000) 1,478
Principal Payments on Debt (3) (1)
Cash Dividends Paid (1,440) (860)
Acquisition of Treasury Stock (294) (402)
Proceeds From Sales of Treasury Stock 128 434
Proceeds From Exercise of Employee Stock Options 216 --
- -----------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities 7,895 (3,302)
- -----------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents 3,901 (3,996)
Cash and Cash Equivalents Beginning of Year 20,139 29,726
- -----------------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $ 24,040 $ 25,730
=====================================================================================================
Total Interest Payments $ 4,823 $ 9,360
Total Income Tax Payments 1,270 1,000
Transfer of Loans and Premises to Other Real Estate Owned 381 189
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
MERCHANTS BANCSHARES, INC.
JUNE 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 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 June 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 $2,308 4,432,827 $0.52
Diluted Earnings Per Share:
Options issued to Executives -- 20,399
Income available to Common Shareholders Plus
Assumed Conversions $2,308 4,453,226 $0.52
</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 June 30, 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 six months ended June 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, 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 June 30, 1998, the Bank was obligated
for $6.0 million of standby letters of credit. No losses are anticipated in
connection with these commitments.
OVERVIEW
Merchants Bancshares, Inc. recorded net income of $2.31 million, or basic and
diluted earnings per share of $.52 for the quarter ended June 30, 1998,
compared to $2.08 million, or basic and diluted earnings per share of $.47 per
share for the same period a year earlier. Net income for the six months ended
June 30, 1998 was $4.55 million, or basic earnings per share of $1.03 and
diluted earnings per share of $1.02, compared to $3.94 million or basic and
diluted earnings per share of $.89 for the six months ended June 30, 1997. The
return on average assets and return on average equity for the second quarter of
1998 were 1.54% and 16.72%, respectively, compared to 1.45% and 17.31% for the
second quarter of 1997. The return on average assets and return on average
equity for the six months ended June 30, 1998 were 1.54% and 16.81%,
respectively, compared to 1.37% and 16.63% for the six months ended June 30,
1997.
BALANCE SHEET ANALYSIS
Total deposits increased by $13.29 million (2.6%) during the six months ended
June 30, 1998. The deposit growth was fueled by the success of the Bank's
redesign and simplification of its product line, coupled with the focused
efforts by the sales staff. 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. The Bank's MoneyLYNX money market account pays interest at a
competitive rate on balances over $1,500. So, as the customer's needs change
and balances grow they can move into the higher yielding product. Since the
launch of the FreedomLYNX account in the 4th quarter of 1996 the Bank has
opened 8,500 accounts with total balances in excess of $15 million at a cost of
funds of approximately 1.7%.
Total loans have decreased $11.17 million (2.86%) during the six months. These
funds were, primarily, redeployed into the Bank's investment portfolio, which
increased by $9.76 million (6.22%) during the six months ended June 30, 1998.
This decrease in the loan portfolio is primarily attributable to the sale of
$12.98 million in loans; substantially all of which were commercial real estate
credits. The Bank continues to shift the loan portfolio toward non-real estate
commercial loans and residential real estate loans. The loan sale was part of
the Bank's ongoing effort to reposition the loan portfolio and reduce
concentration in commercial real estate loans. The Bank does not anticipate
that there will be loan sales of this magnitude in the future. As part of its
strategy to replace balances running off in the commercial real estate
portfolio, the Bank has revamped its residential real estate products, and
introduced a new streamlined 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. The result of these
efforts can be seen in the changes in the portfolio mix during the first six
months of the year. During the first six months of 1998 the Bank's commercial
real estate portfolio decreased by $28.58 million, while the residential real
estate portfolio increased by $15.77 million and the commercial loan portfolio
increased by $2.15 million. 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 other types of loans. Outstanding
balances in the new home equity line of credit product at June 30, 1998 were
$13 million. The Bank has taken steps to protect its source of funds for this
increase in fixed rate lending. During the first six 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 $30 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.
RESULTS OF OPERATIONS
Second quarter net interest income before the provision for possible loan
losses was $7.49 million as compared to $7.44 million for the year earlier
quarter. Net interest income was $14.83 million for the first six months of
1998 compared to $14.86 million for the first six months of 1997. Net interest
income has remained stable over the last year despite a decrease in the Bank's
net interest margin from 5.57% to 5.39%. This stability is attributable to
certain shifts in the balance sheet. Average year to date interest earning
assets have increased by $21.32 million from June 30, 1997 to June 30, 1998.
This increase was primarily funded by an increase in average interest bearing
liabilities of $7.76 million, an increase in average demand deposits of $2.98
million, and a decrease in non-interest earning assets of $6.01 million. The
Company continues to experience decreases in the average yield on loans, partly
as a result of the Bank's continuing strategy to reposition the loan portfolio
and reduce concentration in potentially higher-yielding commercial real estate
loans, and partly as a result of an increasingly competitive marketplace.
Additionally, the Bank has seen a slight increase in its cost of
interest-bearing deposits over the course of the last year, from 4.06% at June
30, 1997, to 4.10% at June 30, 1998. This increase is due primarily to
increased balances in the Bank's FreedomLYNX interest-bearing checking account,
at a cost of approximately 1.7%, and increased balances in the Bank's money
market accounts at an interest cost of approximately 4.62%. The schedule on
page 12 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 second quarter of
1998 or 1997. During the second quarter of 1998 the Company recognized a
recovery on a previously charged down loan of $119 thousand. This amount was
credited to income through the provision for loan losses. Reserve coverage
continues to be very strong at 3.64% of total loans and 245% 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 $261 thousand (15.22%) from the same
quarter a year earlier, and $258 thousand (7.42%) for the first six months of
1998. This change is principally due to a gain of $223 thousand recognized on
the loan sale mentioned above. This amount is included in Other Noninterest
Income in the corresponding Statements of Operations. Merchants Trust Company
(the "Trust Company") has shown increased revenue of approximately $106
thousand (27%) for the quarter, and $266 thousand (34%) for the first six
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 $58 thousand (7%) for the quarter and $146
thousand (9.3%) 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 decreased by approximately
$103 thousand for the quarter (24%), and $75 thousand (10.13%) 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 second quarter have remained flat year over
year, and have decreased by $396 thousand (3.05%) for the first six months.
Salaries, wages and employee benefits have increased by $186 thousand (7.1%)
for the second quarter and $235 thousand (4.4%) for the first six 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 overall balance
sheet growth. Legal and professional fees have increased $245 thousand (48.4%)
for the second quarter and $398 thousand (45%) for the first six months of
1998. This increase is due primarily to expenses incurred by the Bank as it
defended 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 $241 thousand (97%) for the quarter ended June
30, 1998 versus the prior year quarter and $236 thousand (81%) for the first
six months of 1998 versus the first six months of 1997. This decrease is due
primarily to reimbursement of expenses and gains recognized upon the sale of
certain properties, coupled with an overall smaller OREO portfolio.
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 $130 thousand, for the second quarter of
1997, and $286 thousand for the first six months of last year. Losses
recognized in conjunction with the disposition of fixed assets during the
second quarter of 1998 totaled $28 thousand, and are $55 thousand year to date.
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 millennium 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. The Bank has updated
our internal Disaster Recovery/Contingency plans during the second quarter.
This planning effort included a Business Impact Analysis relating to our
mission critical systems and is the foundation documentation that we will use
to finalize our Year 2000 mission critical service provider Contingency plans.
These Contingency Plans are being developed to mitigate the risks associated
with the Year 2000 date change and to provide a business continuity strategy.
We are in the process of establishing a "trigger date" or timeline for each
service provider that can be used to activate the respective Contingency Plan
should it be necessary to do so. 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 $1.32 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 $319 thousand and
will be expensed as incurred.
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 two 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 six months ended June 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 $58 million; and the ability to borrow $60
million 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 June 30,
1998, December 31, 1997, and June 30, 1997:
<TABLE>
<CAPTION>
(In thousands) June 30, 1998 December 31, 1997 June 30, 1997
------------- ----------------- -------------
<S> <C> <C> <C>
Nonaccrual Loans $4,853 $2,686 $3,295
Loans Past Due 90 Days or More and Still Accruing 438 403 634
Restructured Loans 333 215 2,198
- --------------------------------------------------------------------------------------------------------
Total Non-performing Loans 5,624 3,304 6,127
Other Real Estate Owned 377 591 330
- --------------------------------------------------------------------------------------------------------
Total Non-performing Assets $6,001 $3,895 $6,457
- --------------------------------------------------------------------------------------------------------
<FN>
Note: Included in nonaccrual loans are certain loans whose terms have been
substantially modified in troubled debt restructuring.
</FN>
</TABLE>
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997 June 30, 1997
------------- ----------------- -------------
<S> <C> <C> <C>
Percentage of Non-performing Loans to Total Loans 1.48% 0.85% 1.55%
Percentage of Non-performing Assets to Total Loans
plus Other Real Estate Owned 1.58% 1.00% 1.63%
Percentage of RPLL to Total Loans 3.64% 4.06% 4.08%
Percentage of RPLL to NPL 245% 479% 263%
Percentage of RPLL to NPA 230% 406% 249%
</TABLE>
Loans deemed impaired totaled $9.6 million, of this total $4.7 million are
included as non-performing assets in the table above. Impaired loans have been
allocated $1.6 million of the RPLL.
Approximately 80% 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 June 30,
1998. Management's assessment of the adequacy of the RPLL concluded that a
provision was not necessary during the first two quarters of 1998.
DISCUSSION OF EVENTS AFFECTING NPA
Significant events affecting the categories of NPA are discussed below:
Nonaccrual Loans:
During the second quarter of 1998 approximately $3.1 million in additions
to nonaccrual loans were offset in part by approximately $1.9 million of
reductions. Of the reported increase, approximately $2.5 million was
concentrated in two relationships.
Loans Past Due 90 Days:
Loans past due 90 days increased $35 thousand from December 31, 1997 to
June 30, 1998. Approximately 36% of the remaining balances carry
guarantees from the U.S. Small Business Administration.
Restructured Loans:
The reported increase was driven by the addition of a single relationship
Merchants Bancshares, Inc.
Supplemental Information
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------
June 30, 1998 June 30, 1997
---------------------------- ----------------------------
Interest Interest
Average Income/ Average Average Income/ Average
(Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate
-------- ------- ------- -------- ------- -------
(In thousands except share and per share data)
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Loans (1) $391,538 $ 9,395 9.62% $391,723 $ 9,626 9.83%
Taxable Investments 168,205 2,738 6.53% 142,670 2,389 6.70%
Federal Funds Sold 2,918 40 5.50% 1,868 26 5.57%
---------------------------------------------------------
Total Interest Earning Assets $562,661 $12,173 8.68% $536,261 $12,041 8.98%
=========================================================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $278,265 $ 2,235 3.22% $262,489 $ 2,086 3.18%
Time Deposits 160,885 2,164 5.40% 165,585 2,218 5.36%
---------------------------------------------------------
Total Savings and Time Deposits 439,150 4,399 4.02% 428,074 4,304 4.02%
Federal Funds Purchased 997 15 6.05% 805 11 5.68%
Other Borrowed Funds 9,670 135 5.59% 11,522 155 5.36%
Debt 6,412 114 7.13% 5,230 106 8.13%
---------------------------------------------------------
Total Interest Bearing Liabilities 456,229 4,663 4.10% 445,631 4,576 4.11%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 106,432 90,630
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $562,661 $536,261
======== ========
Rate Spread 4.58% 4.89%
==== ====
Net Yield on Interest Earning Assets 5.35% 5.57%
==== ====
<FN>
<F1> Includes principal balance of non-accrual loans and fees on loans
</FN>
</TABLE>
Merchants Bancshares, Inc.
Supplemental Information
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
-----------------------------------------------------------
June 30, 1998 June 30, 1997
---------------------------- ----------------------------
Interest Interest
Average Income/ Average Average Income/ Average
(Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate
-------- ------- ------- -------- ------- -------
(In thousands except share and per share data)
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Loans (1) $390,864 $18,657 9.63% $389,620 $19,120 9.81%
Taxable Investments 163,409 5,362 6.62% 144,317 4,792 6.64%
Federal Funds Sold 2,407 66 5.53% 1,420 38 5.35%
---------------------------------------------------------
Total Interest Earning Assets $556,680 $24,085 8.72% $535,357 $23,950 8.95%
=========================================================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $276,087 $ 4,421 3.23% $263,842 $ 4,128 3.13%
Time Deposits 161,336 4,319 5.40% 164,151 4,390 5.35%
---------------------------------------------------------
Total Savings and Time Deposits 437,423 8,740 4.03% 427,993 8,518 3.98%
Federal Funds Purchased 1,108 32 5.82% 1,210 36 6.20%
Other Borrowed Funds 7,885 213 5.44% 10,639 275 5.23%
Debt 6,414 228 7.18% 5,232 214 8.24%
---------------------------------------------------------
Total Interest Bearing Liabilities 452,830 9,213 4.10% 445,074 9,043 4.06%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 103,850 90,283
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $556,680 $535,357
======== ========
Rate Spread 4.62% 4.89%
==== ====
Net Yield on Interest Earning Assets 5.39% 5.57%
==== ====
<FN>
<F1> Includes principal balance of non-accrual loans and fees on loans
</FN>
</TABLE>
MERCHANTS BANCSHARES, INC.
JUNE 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 second 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. There have been no material developments in the second
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
JUNE 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
August 12, 1998
--------------------------------------
Date
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 24,027
<INT-BEARING-DEPOSITS> 13
<FED-FUNDS-SOLD> 6,000
<TRADING-ASSETS> 1,064
<INVESTMENTS-HELD-FOR-SALE> 58,272
<INVESTMENTS-CARRYING> 107,152
<INVESTMENTS-MARKET> 108,198
<LOANS> 379,214
<ALLOWANCE> 13,787
<TOTAL-ASSETS> 595,031
<DEPOSITS> 519,132
<SHORT-TERM> 4,000
<LIABILITIES-OTHER> 9,497
<LONG-TERM> 6,412
0
0
<COMMON> 44
<OTHER-SE> 55,946
<TOTAL-LIABILITIES-AND-EQUITY> 595,031
<INTEREST-LOAN> 18,619
<INTEREST-INVEST> 5,285
<INTEREST-OTHER> 143
<INTEREST-TOTAL> 24,047
<INTEREST-DEPOSIT> 8,740
<INTEREST-EXPENSE> 473
<INTEREST-INCOME-NET> 14,834
<LOAN-LOSSES> (119)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 12,584
<INCOME-PRETAX> 6,102
<INCOME-PRE-EXTRAORDINARY> 4,554
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,554
<EPS-PRIMARY> 0.52
<EPS-DILUTED> 0.52
<YIELD-ACTUAL> 5.39
<LOANS-NON> 4,853
<LOANS-PAST> 438
<LOANS-TROUBLED> 333
<LOANS-PROBLEM> 7,043
<ALLOWANCE-OPEN> 15,831
<CHARGE-OFFS> 2,647
<RECOVERIES> 722
<ALLOWANCE-CLOSE> 13,787
<ALLOWANCE-DOMESTIC> 13,787
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 7,225
</TABLE>
