U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File No.: 000-24715
MERRILL MERCHANTS BANCSHARES, INC.
(Name of Small Business Issuer in its charter)
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Maine 01-0471507
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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201 Main Street, Bangor, Maine 04401
(Address of principal executive offices)
(207) 942-4800
(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to section 12(g) of the Exchange Act:
Common Stock, par value $1.00 per share
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No __
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10- KSB. [ ]
The revenues for the issuer's fiscal year ended December 31, 1998 are
$16,797,000.
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was sold, as of a specified date within the last 60 days. On December 31,
1998: $16,477,459
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. The Company had 2,432,214
shares outstanding as of March 1, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement pursuant to Regulation 14A,
which was delivered to the Commission for filing on March 15, 1999, and the 1998
Annual Report to Shareholders for the fiscal year ended December 31, 1998, are
incorporated by reference into Part II and III of this report.
Transitional Small Business Disclosure Format (check one):
Yes No X
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TABLE OF CONTENTS
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PART I
ITEM 1. BUSINESS...................................................1
ITEM 2. DESCRIPTION OF PROPERTY...................................20
ITEM 3. LEGAL PROCEEDINGS.........................................21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......21
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS.....................................21
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.......................21
ITEM 7. FINANCIAL STATEMENTS......................................22
ITEM 8. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.......................22
PART III
ITEM 9. DIRECTORS AND PRINCIPAL OFFICERS OF THE COMPANY;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.........22
ITEM 10. EXECUTIVE COMPENSATION....................................22
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................22
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............22
ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K....................23
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SIGNATURES
Forward Looking Statements
This Annual Report on Form 10-KSB contains certain forward looking statements
consisting of estimates with respect to the financial condition, results of
operations and business of the Bank and the Company that are subject to various
factors which could cause actual results to differ materially from these
estimates. These factors include: changes in general, economic and market
conditions, or the development of an adverse interest rate environment that
adversely affects the interest rate spread or other income anticipated from the
Bank's or the Company's operations and investments.
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PART I
ITEM 1. BUSINESS
General
Merrill Merchants Bancshares, Inc. (the "Company"), a Maine corporation
organized in March 1992, is a registered bank holding company under the Bank
Holding Company Act of 1956, as amended ("BHCA"). In October 1992, the Company
became the bank holding company for Merrill Merchants Bank (the "Bank") and
holds 100% of the Bank's outstanding common stock (the "Bank Stock"). The
Company, through its ownership of the Bank, is engaged in a general commercial
and retail banking business, along with trust and investment services. Unless
the context otherwise requires, references herein to the Company shall include
the Company and the Bank, on a consolidated basis.
The Company is an entity legally separate and distinct from the Bank. The
only sources of the Company's income and cash flow are any dividends paid on the
Bank Stock, tax benefits received by the Company and earnings from amounts
deposited by the Company in interest bearing accounts and investments.
The Bank was established in 1992 to purchase certain assets and assume
certain liabilities of certain branch banking offices formerly held by a large
out of state bank. Merrill Merchants Bank is headquartered in Bangor, Maine,
which is located 76 miles north of Augusta, Maine, the state capital. Presently,
the Bank maintains seven branch banking offices (collectively, the "Branch
Banks") in five area communities. The three Bangor offices provide city-wide
convenience and are complemented by: (i) an office in Brewer, Bangor's sister
city located on the eastern shore of the Penobscot River; (ii) a branch in
Orono, home of the University of Maine, the State's flagship campus; (iii) a
branch in Pittsfield, a small rural town of 4,000 people located about 30 miles
southwest of Bangor; and (iv) a supermarket branch in Newport, a small town
neighboring Pittsfield, approximately 25 miles southwest of Bangor. The Newport
Branch is located at the juncture of Interstate 95 and Route 2, which is the
main travel route to the winter and summer tourist area of the Moosehead Lake
Region. In addition to the Branch Banks, the Bank has seven ATM locations in its
primary market area.
The Bank conducts a general commercial and retail banking business that
includes the acceptance of deposits from the general public and the application
of those funds to the origination of a variety of commercial loans, commercial
and residential real estate loans and consumer loans. The Bank has also
established a Trust and Investment Services Department, which has grown since
inception in April 1994 to $136.5 million in assets under management as of
December 31, 1998. As of December 31, 1998, the Company had total assets of
$199.7 million, loans net of allowances of $128.5 million, total deposits of
$164.1 million and shareholders' equity of $20.7 million.
The Bank's income is derived principally from interest and fees earned in
connection with its lending activities, interest and dividends on investment
securities, and service charges and fees on deposit and trust accounts. Its main
expenses are the interest paid on deposits and operating expenses. The Bank's
customer deposits are insured, up to the applicable limits, by the Federal
Deposit Insurance Corporation ("FDIC").
Community Banking Strategy
Having identified the need for community banking services in its market
area, the Bank has worked to position itself as a service-oriented community
bank. The Bank is staffed by experienced management personnel, most of whom
reside in the area and who know the Bank's customers and are able to provide
personalized service for these customers. This strategy has been deliberately
developed and implemented at a time when consolidation within the industry has
resulted in an increasing depersonalization among the larger
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financial institutions. The Bank has focused on fostering banking relationships
with customers which include multiple financial services that range from basic
checking to investment management accounts.
As a part of this strategy, the Company and the Bank have attracted local
business people, who actively promote the Bank in the community, to serve on
their Boards of Directors. In an effort to broaden the community's awareness of
the Bank and attract new business, the Company has also obtained additional
investments in and support for the Bank from local investors.
The Bank is active in small business lending and has earned the designation
"Preferred Lender" by the Small Business Administration (SBA). The Bank is the
only community bank in the State to have been awarded this distinction. The Bank
is also active in residential mortgage lending, and a number of products,
including government insured loan programs, are available to meet the demands of
both the consumer and the commercial market. The Company's affiliations with
third party data processors have enabled the Bank to deliver high technology
products such as automated telephone banking, banking by personal computer, and
check imaging while maintaining a local, friendly flavor in its Branch Banks.
This same strategy has been implemented by the Trust and Investment Services
Department which is also serving many clients who appreciate the personal
attention and custom service provided locally. The depository custody services
and investment advisory services provided by the Trust Department are supported
through its affiliation with The Northern Trust Company.
Market Area and Competition
The Bank's primary market area, Greater Bangor, is at the center of
commercial activity for the northeastern and central region of the State of
Maine. Nearly 100,000 people live in the Bank's primary market area. The Bank is
part of a strategic link to Canada, as Bangor is the closest U.S. metropolitan
area to Eastern Quebec and the Canadian Maritime provinces. Many regional and
national companies site their operations in the Bangor area. Services, trades,
manufacturing and government are the four largest fields of employment in the
metropolitan Bangor region. Bangor is also a healthcare center for central,
eastern and northern Maine. The City is a regional financial center and is also
serviced by several statewide and regional accounting firms, law firms,
insurance companies and security and investment firms. Bangor is also a hub for
government services, with many local, state and federal offices located within
the city. Bangor is accessible by multiple exits from Interstate 95, a major
interstate highway which transits the eastern seaboard of the United States.
Major routes to all regions of the state bisect Bangor from various directions.
Bangor International Airport provides domestic and international passenger and
cargo service for a significant portion of the state. The Bank has targeted this
same area as its focus for possible expansion of the franchise. Any such
expansion would occur with carefully selected de novo branching or taking
advantage of opportunities created as the large regional banks consolidate and
sell or close branches.
The financial services landscape has changed considerably over the past
five years in the Bank's primary market area, Greater Bangor. Two large out of
state banks have continued to experience local change as a result of mergers and
acquisitions at the regional and national level. The State's largest Maine-based
bank, with a strong presence in the local market, has also experienced
considerable change as it has acquired greater market share through acquisitions
in-state and out-of-state. A large locally-based bank has expanded its line of
financial services and acquired an extensive branch network beyond the local
market. Credit unions have continued to expand their membership and the scope of
banking services offered. Non-banking entities such as brokerage houses,
mortgage companies and insurance companies are offering very competitive
products. Many of these entities and institutions have resources substantially
greater than those available to the Bank and are not subject to the same
regulatory restrictions as the Company and the Bank. Interstate banking also
could intensify competition if out of state institutions increasingly take
advantage of recent legislation liberalizing interstate banking and branching
opportunities in Maine.
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Over the past decade, due to more liberal interstate banking laws,
northeastern and central Maine has seen an increase in acquisitions of
locally-owned Maine-based banks, including Maine-based banks in the Bank's
primary market area, by non-local entities. It has been the observation of the
Company's management that these acquisitions often result in customer
dissatisfaction as the decision-making on loans, marketing, and other aspects of
the acquired banks' businesses are shifted from local bank management possessing
independent decision-making power to management operating under policies and
guidelines from corporate headquarters in other states. The Company believes
that this shift often results in delayed decision-making by management which is
not familiar with the needs of the acquired bank's customers or the communities
they serve. Individuals and small businesses are particularly sensitive to these
changes since they may not fit the product parameters established by the larger
banks.
Thus, the Company believes that there will continue to be a need for a bank
in the Bank's primary market area with local management having decision-making
power and emphasizing loans to small and medium sized businesses and to
individuals. The Bank has concentrated on extending business loans to such
customers in the Bank's primary market area and to extending trust services to
clients with accounts of all sizes. The Bank's management also makes decisions
based upon, among other things, the knowledge of the Bank's employees regarding
the communities and customers in the Bank's primary market area. The individuals
employed by the Bank, to a large extent, reside near the Branch Banks and thus
are generally familiar with the Branch Banks' communities and customers. This is
important in local decision-making and allows the Bank to respond to customer
questions and concerns on a timely basis and fosters quality customer service.
The Trust and Investment Services Department of the Bank has taken
advantage of opportunities created as the larger banks have altered their
personal service commitment to clients not meeting established account criteria.
The Bank is able to offer a comprehensive array of trust and investments
services to individuals, businesses, non-profit organizations and municipalities
of varying asset size and to provide the highest level of personal service. The
staff includes attorneys as well as investment and employee benefits
professionals with trust and banking experience.
The Bank has worked and will continue to work to position itself to be
competitive in its market area. The Bank's ability to make decisions close to
the marketplace, management's commitment to providing quality banking products,
the caliber of the professional staff, and the community involvement of the
Bank's employees are all factors affecting the Bank's ability to be competitive.
If the Company and the Bank are unable to compete successfully, however, the
business and operations could be adversely affected.
Lending Activities
The Bank has experienced loan growth since it was established in October
1992. One of the primary factors contributing to the growth has been an
experienced local lending group. Many commercial lending relationships have been
developed by the Bank as a result of long standing business associations over
many years. Many of the Bank's officers have held lending positions with Bangor
area banks for in excess of fifteen years. Management believes that these
relationships have been not only instrumental in loan growth but in developing
quality customers.
The Company strives to provide a full range of financial products and
services to small and medium-sized businesses and consumers. The Bank has an
established Officer Loan Committee which meets weekly to review and approve
credits and a Director Loan Committee which meets monthly, or as necessary, to
approve credits in excess of $250,000. The Bank's loan mix is subject to the
discretion of its Board of Directors and the demands of the local marketplace.
Management has established relationships with local area legal and accounting
professionals to cultivate referrals by hosting informational meetings at the
Bank. Asset quality is a top priority for the Bank and a significant
consideration in business development efforts.
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Commercial and Commercial Real Estate Lending
Loans in this category principally include loans to service, retail,
medical, wholesale and light manufacturing businesses. Commercial loans are made
based on the management, financial strength and repayment ability of the
borrower. As of December 31, 1998, commercial and commercial real estate loans
represented the largest class of loans at $77.2 million or 60% of total loans.
The Bank participates in government guaranteed lending including programs with
the Finance Authority of Maine (FAME) and Rural Development (RD). The Bank had
originated the second highest number of SBA loans in the State of Maine for the
SBA Maine District Office during their 1998 fiscal year. The Bank is the only
community bank in the state to have been awarded designation as a Preferred
Lender by the SBA.
The Bank's commercial real estate loans are ordinarily made at variable
rates of interest, and amortized up to fifteen years, although some loans are
originated for terms of five years or less at fixed rates of interest. A broad
range of short-to-medium term commercial loans, both collateralized and
uncollateralized are made available to businesses for working capital (including
inventory and receivables), business expansion (including acquisition and
development of real estate and improvements) and the purchase of equipment and
machinery. The purpose of a particular loan generally determines its structure.
The commercial real estate loans are secured by a variety of properties,
including buildings occupied by small-to-medium sized businesses, apartment
complexes and non-owner/user office and retail business.
The Bank's commercial loans primarily are underwritten in the Bank's
primary market area on the basis of the borrowers' ability to service such debt
from income. Many of these loans involve lines of credit written at variable
rates of interest on a demand basis, or for terms not exceeding one year, while
others are written on a term basis typically for up to five years, generally at
variable rates of interest. As a general practice, the Bank takes as collateral
a security interest in any available real estate, equipment or other chattel
although such loans may also be made on an uncollateralized basis. As additional
security for commercial loans, the Bank normally requires the personal guarantee
of the principals and may require financial performance covenants.
Commercial loans generally present a higher level of risk than
one-to-four-family residences due to the concentration of principal in a limited
number of loans and borrowers, the effect of general economic considerations in
commercial properties and the increased difficulty of evaluating and monitoring
these types of loans. In addition, the repayment of loans secured by commercial
real estate is typically dependent on the successful operation of the related
business activities.
Residential Mortgage Lending
The Bank endeavors to meet the needs of its individual customers by making
residential mortgage loans. Residential loans include the origination of
conventional mortgages, residential lot loans and residential acquisition,
development and construction loans for the purchase or construction of
single-family housing or lots. The Bank offers fixed and adjustable rate
mortgages ("ARMs"). With these loans, the real estate normally constitutes the
primary collateral.
Loans in this category include both portfolio loans which are held by the
Bank until maturity and loans which are sold on the secondary market. In the
case of secondary market loans, all servicing rights are retained by the Bank
which maintains the service connection to the customer. The Bank participates in
government guaranteed programs and has also helped coordinate several innovative
programs including a partnership with Penquis Community Action Program in their
"Own Me" program which assists low income women in the purchase of a home, and
housing workshops for the hearing impaired.
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As of December 31, 1998, residential loans accounted for a total of $25.2
million representing 19% of total loans. The Bank's secondary market servicing
portfolio stands at $56.8 million.
The Bank offers one-year ARMs with rate adjustments tied to the weekly
average rate of U.S. Treasury securities adjusted to a constant one-year
maturity with specified minimum and maximum interest rate adjustments. The
interest rates on a majority of these mortgages are adjusted yearly with
limitations on upward adjustments of 2% per adjustment period and 6% over the
life of the loan. The Bank generally charges a higher interest rate if the
property is not owner-occupied. It has been the Bank's experience that the
proportion of fixed-rate and adjustable-rate loan originations depends in large
part on the level of interest rates. As interest rates fall, there is generally
a reduced demand for ARMs and, as interest rates rise, there is generally an
increased demand for ARMs.
Fixed and adjustable rate mortgage loans collateralized by single family
residential real estate generally have been originated in amounts of no more
than 80% of appraised value. However, in some instances, the Bank may lend in
excess of 80% of the value of the property collateralizing the loan. The Bank,
in most cases, requires title, fire and extended casualty insurance to be
obtained by the borrower, and, where required by applicable regulations, flood
insurance. The Bank maintains its own errors and omissions insurance policy to
protect against loss in the event of failure of a mortgagor to pay premiums on
fire and other hazard insurance policies. Although the contractual loan payment
period for single family residential real estate loans is generally for a 15 to
30 year period, such loans often remain outstanding for significantly shorter
periods than their contractual terms. The Bank charges no penalty for prepayment
of mortgage loans. Mortgage loans originated by the Bank customarily include a
"due on sale" clause giving the Bank the right to declare a loan immediately due
and payable in the event, among other matters, that the borrower sells or
otherwise disposes of the real property subject to a mortgage. In general, the
Bank enforces due on sale clauses.
Home Equity Lending
The Bank originates home equity loans on a fixed and variable interest rate
basis. At December 31, 1998, fixed rate loans totaled $10.9 million and variable
rate loans amounted to $8.5 million. Fixed rate loans are for terms of 5 to 10
years with monthly amortization required and interest rates ranging from 8.5% to
12.5%. Interest rates on variable rate loans are 1.50% to 2.00% over the prime
interest rate. These home equity loans are generally secured by a second
mortgage on the principal residential property.
Consumer Lending
Consumer loans made by the Bank have included home improvement, automobile,
boat and recreation vehicle loans, credit cards and overdraft protection
accounts. The Bank's consumer loan portfolio consists primarily of loans to
individuals for various consumer purposes. A majority of these loans are for
terms of less than 60 months and although generally collateralized by liens on
various personal assets of the borrower may be made uncollateralized. Consumer
loans are made at fixed and variable interest rates.
Consumer loans are attractive to the Bank because they typically have a
shorter term and carry higher interest rates than that charged on other types of
loans. Consumer loans, however, do pose additional risks of collectability when
compared to traditional types of loans granted by commercial banks, such as
residential mortgage loans. In many instances, the Bank is required to rely on
the borrower's ability to repay since the collateral may be of reduced value at
the time of collection. Accordingly, the initial determination of the borrower's
ability to repay is of primary importance in the underwriting of consumer loans.
Consumer loans totaled approximately $7.0 million and represented 5% of the
Bank's loan portfolio at December 31, 1998. Such loans bear interest at fixed
rates ranging from 9% to 18%.
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M&M Joint Venture
In 1996, the Bank and MSB Leasing, Inc. (a subsidiary of Machias Savings
Bank, a state chartered mutual savings bank) formed M&M Consulting Limited
Liability Company ("M&M"), a jointly owned subsidiary. M&M was established to
provide a review of various internal bank risk control functions. M&M, which has
a former FDIC examiner as one of its principals, provides the Bank, Machias
Savings Bank and approximately 17 other financial institutions in Maine access
to experienced individuals who are highly trained in loan review, regulatory
compliance, training and internal auditing in a cost-efficient and timely
manner.
Maine Acceptance Corporation
In January, 1999, the Company established Maine Acceptance Corporation
("MAC"), a finance company, as a wholly-owned subsidiary under the Maine
Consumer Credit Code. MAC will provide credit products commonly referred to as
"sub-prime" lending, which usually denotes a weakness in credit history or a
high loan-to-value on collateral. MAC will engage in indirect auto lending, as
well as provide other types of loans, including personal unsecured loans,
recreational vehicle loans, auto loans, mobile home loans and home equity loans.
MAC has engaged in minimal business to date.
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SELECTED CONSOLIDATED FINANCIAL DATA
(Dollars in thousands, except per share data)
The following table presents selected consolidated financial data for the
Company. The data for the fiscal years ended December 31, 1998, 1997, 1996, 1995
and 1994 are derived from audited consolidated financial statements of the
Company. The selected financial data should be read in conjunction with, and is
qualified in its entirety by, the Consolidated Financial Statements and Notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations included in the Annual Report.
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At or for the Year Ended December 31,
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1998 1997 1996 1995 1994
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Financial Condition Data: (Dollars in Thousands)
Total assets ........................................ $ 199,743 $ 178,619 $ 158,425 $ 135,744 $ 113,231
Cash and cash equivalents ........................... 7,627 10,164 8,591 6,723 6,683
Investment securities ............................... 55,909 45,321 41,014 30,257 21,692
Loans receivable, net (1) ........................... 128,507 117,679 104,320 95,256 81,137
Deposits ............................................ 164,128 146,312 126,704 111,340 91,812
Repurchase agreements ............................... 11,747 11,897 12,164 10,173 7,827
Other borrowed funds ................................ 1,461 5,144 2,832 192 1,000
Long-term debt ...................................... -- 2,895 3,695 4,000 4,000
Mandatory convertible debentures .................... 300 300 300 300 300
Shareholders' equity ................................ 20,655 10,967 9,671 8,761 7,675
Income Statement Data:
Interest and dividend income ........................ $ 14,586 $ 13,215 $ 11,826 $ 10,349 $ 7,445
Interest expense .................................... 6,554 6,060 5,383 4,371 2,774
Net interest income ................................. 8,032 7,155 6,443 5,978 4,671
Provision for loan losses ........................... 360 355 360 355 150
Net interest income after provision for loan losses . 7,672 6,800 6,083 5,623 4,521
Non-interest income ................................. 2,211 1,724 1,489 1,302 911
Non-interest expense ................................ 6,939 6,357 5,813 5,407 4,840
Income before income taxes .......................... 2,944 2,167 1,759 1,518 592
Income tax expense .................................. 1,028 765 639 551 219
Net income .......................................... 1,916 1,402 1,120 967 373
Per Share Data:
Earnings per share-basic (2) ........................ .96 .82 .65 .55 .19
Earnings per share-diluted (2) ...................... .78 .71 .58 .52 .19
Cash dividends on Common Stock (2) .................. .14 .03 -- -- --
Book value (2)(3) ................................... 8.61 6.77 5.98 5.33 4.79
Weighted average shares outstanding (2) ............. 1,925,595 1,619,226 1,619,226 1,619,226 1,619,226
Selected Financial Ratios and Other Data:
Return on average assets ............................ 1.05% 0.86% 0.78% 0.80% 0.37%
Return on average equity (3) ........................ 12.97 13.63 12.28 11.83 4.95
Net interest margin (4) ............................. 4.66 4.67 4.72 5.25 4.99
Net interest spread ................................. 3.89 3.98 3.97 4.48 4.34
Non-performing assets to total assets (5) ........... 0.08 0.13 0.45 0.33 0.63
Non-performing loans to total loans (5) ............. 0.12 0.15 0.36 0.15 0.87
Allowance for loan losses to total loans ............ 1.55 1.44 1.37 1.18 1.17
Allowance for loan losses to non-performing loans (5) 1330.92 933.15 384.62 760.40 133.80
Net loan charge-offs to average loans ............... 0.04 0.08 0.04 0.21 0.02
Efficiency ratio (6) ................................ 67.74 71.60 73.29 74.27 86.71
Capital Ratios:
Tier 1 risk-based capital (7) ....................... 16.39 9.77 9.53 9.03 8.83
Total risk-based capital (7) ........................ 17.89 11.30 11.10 10.63 10.46
Leverage ratio (7) (8) .............................. 10.31% 6.06% 5.98% 5.84% 6.31%
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(1) Includes loans held for sale.
(2) Adjusted to reflect the 9:1 Stock Split, 5% stock dividends in 1998 and
1997 and a 3% stock dividend in 1996.
(3) Excludes unrealized gain or loss on securities available for sale net of
taxes.
(4) Represents net interest income as a percentage of average interest earning
assets. Calculation is shown tax-effected for tax exempt interest income
assuming a federal tax rate of 34%.
(5) Non-performing assets consist of non-performing loans and other real estate
owned. Non-performing loans consist of non-accrual loans and accruing loans
90 days or more past due while other real estate owned consists of real
estate acquired through foreclosure and real estate acquired by acceptance
of a deed-in-lieu of foreclosure.
(6) Non-interest expense divided by the sum of net interest income plus
non-interest income.
(7) The minimum regulatory capital ratios in order for the Company to be
adequately capitalized are: Tier 1 capital - 4.00%; total risk-based
capital -- 8.00%; and leverage ratio -- 4.00%
(8) The leverage ratio is defined as the ratio of Tier 1 capital to average
total assets.
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Lending Activities
The following table summarizes the composition of the Bank's loan portfolio
by type of loan at the dates indicated:
Loan Portfolio Composition
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At December 31,
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1998 1997
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Amount % Amount %
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(Dollars in thousands)
Real Estate
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Commercial .............. $ 48,896 38% $40,984 34%
Construction ............ 1,833 1 3,012 3
Residential ............. 22,279 17 26,638 22
Home equity ............. 19,362 15 20,036 17
Loans held for sale ..... 2,875 2 508 --
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Total real estate ....... 95,245 73 91,178 76
Commercial ................... 28,322 22 20,757 18
Consumer ..................... 6,963 5 7,461 6
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Total loans ............. 130,530 100% 119,396 100%
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Less allowance for loan losses (2,023) (1,717)
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Total ........................ $ 128,507 $117,679
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The following table sets forth as of December 31, 1998, loans by scheduled
due date for the periods indicated. Loans maturing after one year are further
distinguished between those with predetermined interest rates and loans which
have floating or adjustable interest rates.
Loan Maturity Schedule
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At December 31, 1998
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Due in
one year or Due after one year Due after 5
less but before 5 years years Total
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(Dollars in thousands)
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Real estate ......................... $ 19,430 $ 30,229 $ 42,711 $ 92,370
Loans held for sale ................. 2,875 -- -- 2,875
Commercial .......................... 16,080 9,523 2,719 28,322
Consumer ............................ 2,704 3,031 1,228 6,963
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Total loans ......................... $ 41,089 $ 42,783 $ 46,658 $130,530
======== ======== ======== ========
Loans maturing after one year:
Predetermined interest rates ........ $ 43,701
Floating or adjustable interest rates 45,740
--------
Total ............................... $ 89,441
========
</TABLE>
-8-
<PAGE>
The following is a summary of non-performing assets at December 31, 1998
and 1997:
Non-Performing Assets
<TABLE>
<CAPTION>
At December 31,
-----------------------------------
1998 1997
-----------------------------------
(Dollars in thousands)
<S> <C> <C>
Loans:
Non-accrual loans ................................ $148 $181
Loans 90 days or more past due but still accruing 4 3
Restructured loans ............................... -- --
---- ----
Non-performing loans .......................... 152 184
OREO ................................................. 12 43
----
Non-performing assets ......................... $164 $227
==== ====
Non-performing loans as a percentage of total loans ......... 0.12% 0.15%
Non-performing assets as a percentage of total assets ....... 0.08% 0.13%
Non-performing assets as a percentage of total loans and OREO 0.13% 0.19%
</TABLE>
At December 31, 1998, loans on non-accrual status totaled $148,000.
Interest income not recognized on non-accrual loans was $27,000 in 1998. There
was no interest income recognized on non-accrual loans in 1998.
Adversely Classified Assets
The Bank's management adversely classifies certain assets as "doubtful" or
"loss" based on criteria established under banking regulations. An asset is
considered substandard if inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are not
corrected. Assets classified as doubtful have all the weaknesses inherent in
those classified substandard with the added characteristic that the weaknesses
present make "collection or liquidation in full," on the basis of currently
existing facts, conditions, and values, "highly questionable and improbable."
Assets classified as loss are those considered "uncollectible" and of such
little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted.
At December 31, 1998, the Bank had $1.3 million of loans that were
classified as substandard and $341,000 classified as doubtful. This compares to
$2.2 million and $307,000 of loans that were classified as substandard and
doubtful at December 31, 1997. The Bank had no loans which were classified as
loss at either date. Delinquent loans may or may not be adversely classified
depending upon management's judgment with respect to each individual loan. As of
December 31, 1998 and 1997, the portion of loans guaranteed by either the SBA,
RD or FAME amounted to approximately 25% and 44% of the total loan balances
adversely classified, respectively. At December 31, 1998, included in the $1.6
million of loans that were classified as substandard and doubtful were $1.5
million of performing loans. This compares to $2.3 million of adversely
classified performing loans as of December 31, 1997. These amounts constitute
loans that, in the opinion of management, could potentially migrate to
non-performing or loss status.
-9-
<PAGE>
Allowance for Loan Losses
The following table sets forth activity in the Bank's allowance for
loan losses during the years indicated:
Summary of Loan Loss Experience
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
-----------------------
(Dollars in thousands)
<S> <C> <C>
Total net loans outstanding at the end of year (1) ... $ 128,507 $ 117,679
Average net loans outstanding during the year (1) ... $ 120,070 $ 109,427
Allowance for loan losses, beginning of year ......... $ 1,717 $ 1,450
Loans charged off during the period:
Real estate:
Commercial ............................. -- (6)
Residential ............................ (20) (16)
Home equity ............................ (7) --
Loans held for sale .................... -- --
Commercial ................................ (20) (23)
Consumer .................................. (31) (55)
--------- ---------
Total ............................... (78) (100)
--------- ---------
Recoveries of loans previously charged off:
Real estate:
Commercial ............................. -- --
Residential ............................ 22 12
Home equity ............................ -- --
Loans held for sale .................... -- --
Commercial ................................ -- --
Consumer .................................. 2 --
--------- ---------
Total ............................... 24 12
--------- ---------
Net loans charged off during the year ................ (54) (88)
--------- ---------
Provisions charged to income statement ............... 360 355
--------- ---------
Allowance for loan losses, end of year ............... $ 2,023 $ 1,717
========= =========
Ratios:
Net charge-offs to average loans outstanding ......... 0.04% 0.08%
Net charge-offs to loans, end of period .............. 0.04% 0.07%
Allowance for loan losses to average loans outstanding 1.68% 1.57%
Allowance for loan losses to loans, end of year ...... 1.55% 1.44%
Allowance for loan losses to non-performing loans .... 1330.92% 933.15%
</TABLE>
- ------------------------------------
(1) Includes loans held for sale.
-10-
<PAGE>
The following table sets forth the breakdown of the allowance for loan
losses by loan category for the periods indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of an allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any other category.
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------
1998 1997
-------------------------------- --------------------------------
% of Loans to % of Loans to
Amount Total Loans Amount Total Loans
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and Commercial Real Estate (1) $ 999 60% $ 989 52%
Construction ............................ 9 1 15 3
Residential ............................. 120 17 134 22
Home equity ............................. 193 15 199 17
Loans held for sale (2) ................. -- 2 -- --
Consumer ................................ 179 5 200 6
Unallocated ............................. 523 -- 180 --
------ --- ------ ---
Total allowance for loan losses $2,023 100% $1,717 100%
====== === ====== ====
</TABLE>
- -------------------
(1) Commercial and commercial real estate loans have been combined in
allocating the allowance for loan losses as the Bank utilizes an internal
risk rating system for these loans on a consolidated basis.
(2) No allowance has been allocated to loans held for sale as these loans are
sold without recourse within approximately ten days after the loan closing
resulting in minimal loan loss risk to the Bank.
The unallocated portion of the allowance for loan losses increased to $523
at December 31, 1998 from $180 at December 31, 1997. Management determined an
increase in the unallocated portion of the allowance to be necessary in 1998 due
to a number of factors impacting the local economy that have not yet been fully
reflected in the financial information provided by borrowers. These factors
include a continued deterioration in trade with Canada, due to the currency
exchange rate imbalance and provincial sales taxes; another relatively weak
holiday season for retailers; and depressed conditions in certain natural
resource-based industries, such as commercial fishing, timber and agriculture.
While these factors are not yet identifiable with respect to specific borrowers,
the Bank has determined an overall increase in the allowance for loan losses to
be necessary to provide for resultant expected losses.
Investment Activities
The Company's investment portfolio serves three important functions: first,
it enables the adjustment of the balance sheet's sensitivity to changes in
interest rate movements; second, it provides an outlet for investing excess
funds; and third, it provides liquidity. The investment portfolio is structured
to maximize the return on invested funds within conservative risk guidelines.
The composition of the investment portfolio as of December 31, 1998 was 44%
U.S. Treasury notes and U.S. Government agencies and corporations, 38%
mortgage-backed securities and collateralized mortgage obligations and 18% other
securities. The comparable distributions for December 31, 1997 was 54% U.S.
Treasury notes and U.S. Government agencies and corporations, 39%
mortgage-backed securities and collateralized mortgage obligations and 7% other
securities.
-11-
<PAGE>
The following table sets forth the composition of the Company's investment
portfolio at the dates indicated:
Investment Securities Portfolio Composition
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------
1998 1997
-------------------- ----------------------
<S> <C> <C>
Securities held to maturity (1):
Mortgage-backed securities and collateralized mortgage obligations . $ 668 $ 1,962
======= =======
Securities available for sale (2):
U.S. Treasury securities ........................................... $20,304 $21,043
U.S. Government agencies and corporations .......................... 4,034 3,579
Mortgage-backed securities and collateralized mortgage obligations . 20,647 15,851
State and local government debt securities ......................... 621 1,402
U.S. Government and agency money market funds ...................... 5,081 166
Certificates of deposit ........................................... 3,664 495
Other securities (3) ............................................... 890 823
------- -------
Total .............................................................. $55,241 $43,359
======= =======
</TABLE>
- ------------------------------
(1) Carried at amortized cost.
(2) Carried at estimated market value.
(3) Includes FHLB stock, Federal Reserve stock and FNMA stock.
Maturity Schedule of Securities Available for Sale
<TABLE>
<CAPTION>
At December 31, 1998
(At Market Value)
----------------------------------------------------------------------------------------------
One year Over one year Over 5 years
or less through 5 years through 10 years Over 10 years Total
------------------- ------------------ ----------------- ----------------- ----------------
Weighted Weighted Weighted Weighted Weighted
Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)
------------------- ------------------ ----------------- ----------------- ----------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities ............ $10,077 5.99% $10,227 5.14% $ -- -- $ -- -- $20,304 5.56%
U.S. Government agencies and
corporations ...................... -- -- 4,034 5.37% -- -- -- -- 4,034 5.37%
Mortgaged-backed securities and
collateralized mortgage obligations -- -- 1,355 5.97% 7,428 6.16% 11,864 6.04% 20,647 6.08%
States and local government
debt securities ................... -- -- 390 5.14% 231 7.14% -- -- 621 5.89%
U.S. Government and agency
money market funds ............... 5,081 4.80% -- -- -- -- -- -- 5,081 4.80%
Certificates of deposit ............. 3,664 5.67% -- -- -- -- -- -- 3,664 5.67%
Other securities .................... 890 6.35% -- -- -- -- -- -- 890 6.35%
------- ---- ------- ---- ------ ---- ---------- ---- ------- ----
Total ............................... $19,712 5.64% $16,006 5.27% $7,659 6.19% $11,864 6.04% $55,241 5.70%
======= ==== ======= ==== ====== ==== ========== ==== ======= ====
</TABLE>
- ------------------------
(1) Yield is adjusted for the effect of tax-exempt securities assuming a
Federal tax rate of 34%.
-12-
<PAGE>
Maturity Schedule of Securities Held to Maturity
<TABLE>
<CAPTION>
At December 31, 1998
(At Amortized Cost)
----------------------------------------------------------------------------------------------
One year Over one year Over 5 years
or less through 5 years through 10 years Over 10 years Total
------------------- ------------------ ----------------- ----------------- ----------------
Weighted Weighted Weighted Weighted Weighted
Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)
------------------- ------------------ ----------------- ----------------- ----------------
Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities
and collateralized
mortgage obligations.... -- -- -- -- $ 668 5.91% -- -- $668 5.91%
</TABLE>
Deposit Activities
The following table sets forth the average balances and weighted average
rates for the Bank's categories of deposits for the periods indicated:
Average Deposit Balances and Rates
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------
1998 1997
-------------------------------------------------------------------------
Average Average % of Total Average Average % of Total
Balance Rate Deposits Balance Rate Deposits
-------- --------- ------------ --------- --------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Non-interest checking .............. $ 23,593 -- 16% $ 20,631 -- 15%
Interest checking and money market 25,772 2.32% 17% 23,794 2.29% 18%
Savings ............................ 43,007 4.36% 29% 32,717 4.40% 25%
Certificates of deposit ............ 57,220 5.66% 38% 55,306 5.68% 42%
------ --- ------ ---
Total .............................. $149,592 100% $132,448 100%
======== === ======== ===
</TABLE>
The Bank does not have a concentration of deposits from any one source, the
loss of which would have a material adverse effect on the business of the Bank.
Management believes that substantially all the Bank's depositors are residents
in its primary market area. The Bank has not sought brokered deposits and does
not intend to do so in the future.
The following table summarizes at December 31, 1998 the Bank's certificates
of deposit of $100,000 or more by time remaining until maturity:
<TABLE>
<CAPTION>
December 31, 1998
--------------------------
<S> <C>
Maturity Period:
Less than three months.............................. $ 3,323
Over three months through six months................ 2,107
Over six months through twelve months............... 1,632
Over twelve months.................................. 3,702
--------
Total............................................ $ 10,764
=========
</TABLE>
-13-
<PAGE>
Short-Term Borrowings
The borrowings utilized by the Bank primarily have been securities sold
under agreements to repurchase. Other short-term borrowings generally include
federal funds purchased, FHLB advances, treasury tax and loan deposits and
interest-bearing demand notes due to the U.S. Treasury, which are repaid upon
notification by the U.S. Treasury.
The following table sets forth certain information regarding securities
sold under agreement to repurchase for the dates indicated:
<TABLE>
<CAPTION>
At or for the
Year Ended December 31,
------------------------------------------------
1998 1997
---------------------- ------------------------
<S> <C> <C>
Average balances outstanding....................... $12,163 $11,931
Maximum amount outstanding at any month-
end during the year............................. $13,554 $12,991
Balance outstanding at end of year................. $11,747 $11,897
Weighted average rate during the year.............. 4.28% 4.23%
Weighted average rate at end of year............... 3.60% 4.30%
</TABLE>
Federal and State Taxation
General
The Company and the Bank file a consolidated federal income tax return on a
fiscal year basis. Consolidated returns have the effect of eliminating
intercompany distributions, including dividends, from the computation of
consolidated taxable income for the taxable year in which the distributions
occur. Banks and bank holding companies are subject to federal income taxes in
the same manner as other corporations. In accordance with an income tax sharing
agreement, income tax charges or credits will be allocated to the Company and
the Bank on the basis of their respective taxable income or loss included in the
consolidated income tax return.
Federal Income Taxation
Although the Bank's income tax liability is determined under provisions
of the Internal Revenue Code of 1986, as amended (the "Code"), which is
applicable to all taxpayers or corporations, Sections 581 through 597 of the
Code apply specifically to financial institutions.
The two primary areas in which the treatment of financial institutions
differ from the treatment of other corporations under the Code are in the areas
of bond gains and losses and bad debt deductions. Bond gains and losses
generated from the sale or exchange of portfolio instruments are generally
treated for financial institutions as ordinary gains and losses as opposed to
capital gains and losses for other corporations, as the Code considers bond
portfolios held by banks to be inventory in a trade or business rather than
capital assets. Banks are allowed a statutory method for calculating a reserve
for bad debt deductions. Based on the asset size of the Bank, it is permitted to
maintain a bad debt reserve calculated on an experience method, based on
charge-offs for the current and preceding five years or a "grandfathered" base
year reserve, if larger.
-14-
<PAGE>
State and Local Taxation
The Company on a consolidated basis is subject to a separate state
franchise tax in lieu of state corporate income tax. The amount of the tax is
the sum of 1% of Maine net income and $.08 per $1,000 of Maine assets as defined
in Maine law. Maine assets are the corporation's total end of the year assets as
reported on the federal income tax return. Maine net income is the corporation's
net income or loss as reported on the federal income tax return which is
apportioned to Maine under Maine law.
SUPERVISION AND REGULATION
Bank holding companies and state banks are extensively regulated under both
federal and state law. These laws and regulations are intended to protect
depositors, not shareholders. To the extent that the following information
describes statutory and regulatory provisions, it is qualified in its entirety
by reference to the particular statutory and regulatory provisions. Any change
in the applicable law or regulation may have a material effect on the business
and prospects of the Company and the Bank.
General
As a bank holding company, the Company is subject to the regulation and
supervision of the Federal Reserve under the BHCA. The Company is also subject
to the regulation and supervision of the Maine Bureau of Banking by virtue of
provisions of Maine law which govern financial institution holding companies
such as the Company. Under applicable federal law, the Company must obtain the
approval of the Federal Reserve Board before it acquires all or substantially
all of the assets of a bank or another bank holding company, merges or
consolidates with another bank holding company, or acquires direct or indirect
ownership or control of any voting shares of a bank or bank holding company if,
after such acquisition, it would own or control more than 5% of any class of
voting shares of such bank or bank holding company (unless it already owns or
controls a majority of such shares). Similarly, under applicable Maine law, the
Company must obtain the prior approval of the Maine Superintendent of the Bureau
of Banking before acquiring more than 5% of the voting shares of a Maine
financial institution or of any financial institution holding company which
directly or indirectly controls a Maine financial institution. Under certain
circumstances, the Company may be required to obtain Federal Reserve Board
approval before redeeming any of its equity securities in an amount in excess of
10% of its net worth in any twelve-month period. Furthermore, under certain
circumstances, any redemptions, dividends, or distributions with respect to the
Company's Common Stock and Preferred Stock may be considered an unsafe or
unsound practice by the Federal Reserve Board.
Before any "company," as defined in the BHCA, may acquire "control," as
defined in the BHCA, over the Company, the prior approval of the Federal Reserve
Board generally is required. In addition, before any individual or entity which
is not required to seek prior approval from the Federal Reserve Board may
acquire control of the Company, prior notice to the Federal Reserve Board
generally is required. Similarly, notice to and approval by the Maine
Superintendent of the Bureau of Banking is required before any "financial
institution holding company," as defined in the Maine Banking Code, may acquire
more than 5% of a Maine financial institution or Maine financial institution
holding company.
Under the BHCA and the Maine Banking Code, the Company is permitted,
directly or through subsidiaries, to engage in a variety of financial activities
deemed by the Federal Reserve Board to be so closely related to banking, or
managing or controlling banks, as to be a proper incident thereto. A bank
holding company normally is not permitted, however, to acquire direct or
indirect control of any company which is not a bank or not engaged in activities
determined by the Federal Reserve Board to be closely related to banking.
Certain exemptions are available with respect to subsidiaries engaged in
activities that have been determined by regulation to be closely related to
banking such as making or servicing loans, underwriting credit life
-15-
<PAGE>
insurance, performing certain data processing services, acting as an investment
or financial advisor, and providing securities brokerage services.
As a condition to the approval by the Federal Reserve of the Company's
application to become a bank holding company, the Federal Reserve imposed
additional requirements on the Company, including the following: (i) the Company
may not incur any debt in addition to that evidenced by the Debentures without
the prior approval of the Federal Reserve Bank of Boston; and (ii) except with
the prior approval of the Federal Reserve Bank of Boston, the Company cannot
repurchase any outstanding Common Stock if the proposed stock repurchase would
cause its debt to equity ratio to exceed 30%. The Federal Reserve Board
possesses cease and desist powers over bank holding companies to prevent or
remedy unsafe or unsound practices or violations of law. These and other
restrictions limit how the Company may conduct its business and obtain
financing.
The Bank is also subject to continued regular supervision and examination
by applicable federal and state banking agencies. The Bank is a Maine
state-chartered bank that is a member of the Federal Reserve System. The Federal
Reserve exercises primary supervision over the Bank through periodic
examination. The Bank is also subject to regulation by the FDIC as well as the
Bureau. The FDIC has authority to terminate insurance for accounts pursuant to
procedures established for that purpose. The Bank must comply with various
requirements and restrictions under federal and state law, including
requirements to maintain reserves against deposits, restrictions on the types
and amounts of loans that may be granted and the interest that may be charged
thereon and limitations on the types of investments that may be made and the
types of services that may be offered. Various consumer laws and regulations
also affect the operations of the Bank. In addition to the impact of regulation,
commercial banks are affected significantly by the actions of the Federal
Reserve Board as it attempts to control the money supply and credit availability
in order to influence the economy.
Payment of Dividends
The Company is a legal entity separate and distinct from the Bank. The
principal source of cash flow of the Company, including cash flow to pay
dividends on its stock or principal and interest on debt, if any, is dividends
from the Bank. There are statutory and regulatory limitations on the payment of
dividends by the Bank to the Company, as well as by the Company to its
shareholders.
In addition to the statutory prohibition against the withdrawal of any
portion of the Bank's capital and certain statutory limitations on the payment
of dividends, under Maine law the Bank may not pay dividends if it is insolvent
or if the payment of such dividends would render the Bank insolvent. In
addition, Maine law generally requires that dividends may be paid only out of
either unreserved and unrestricted earned surplus or out of the unreserved and
unrestricted net earnings of the then current and preceding fiscal years. If the
dividends are to be paid only out of net earnings, shareholders must be notified
of the source of the dividend and of the fact that there was no earned surplus
from which to pay the dividend.
The payment of dividends by any state bank that is a member of the Federal
Reserve System is affected by the requirement to maintain adequate capital
pursuant to the capital adequacy guidelines issued by the Federal Reserve Board.
The regulations and restrictions on dividends paid by the Bank may limit the
Company's ability to obtain funds from such dividends for its cash needs,
including funds for payment of operating expenses, and dividends on the Common
Stock.
If, in the opinion of the applicable federal bank regulatory authority, a
depository institution or holding company is engaged in or is about to engage in
an unsafe or unsound practice (which, depending on the financial condition of
the depository institution or holding company, could include the payment of
dividends), such authority may require, after notice and hearing (except in the
case of an emergency proceeding where
-16-
<PAGE>
there is no notice or hearing), that such institution or holding company cease
and desist from such practice. The federal banking agencies have indicated that
paying dividends that deplete a depository institution's or holding company's
capital base to an inadequate level would be such an unsafe and unsound banking
practice. Moreover, the Federal Reserve and the FDIC have issued policy
statements which provide that bank holding companies and insured depository
institutions generally should only pay dividends out of current operating
earnings. In addition, under the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), a FDIC-insured depository institution may
not pay any dividend if payment would cause it to become undercapitalized or
once it is undercapitalized. See "FDICIA."
The payment of dividends by the Company and the Bank also may be affected
or limited by other factors, such as the requirement to maintain adequate
capital above regulatory guidelines.
Transactions With Affiliates and Insiders
The Bank is subject to Section 23A of the Federal Reserve Act, which places
limits on the amount of loans or extensions of credit to, or investments in, or
certain other transactions with, affiliates, including the Company. In addition,
limits are placed on the amount of advances to third parties collateralized by
the securities or obligations of affiliates. Most of these loans and certain
other transactions must be secured in prescribed amounts. The Bank is also
subject to Section 23B of the Federal Reserve Act, which, among other things,
prohibits an institution from engaging in transactions with certain affiliates
unless the transactions are on terms substantially the same, or at least as
favorable to such institution or its subsidiaries, as those prevailing at the
time for comparable transactions with non-affiliated companies.
Capital Adequacy
The federal banking agencies have adopted risk-based capital guidelines
for banks and bank holding companies. The minimum guideline for the ratio of
total capital to risk-weighted assets ("Total Risk Based Capital" ratio) for
"adequately capitalized" institutions is 8%. The minimum adequate capitalization
guideline for the ratio of Tier 1 Capital to risk-weighted assets ("Tier 1 Risk
Based Capital" ratio) is 4%.
In addition, the federal banking agencies have established minimum leverage
ratio guidelines for banks and bank holding companies. Their guidelines provide
for a minimum ratio of Tier 1 Capital to average assets, less goodwill and
certain other intangible assets (the "Leverage Ratio"), of 3% for banks that
meet certain specific criteria and 4% for other institutions. The Company's
Leverage Ratio at December 31, 1998 was 10.3%. Failure to meet capital
guidelines could subject a bank to a variety of enforcement remedies, including
the termination of deposit insurance by the FDIC, and to certain restrictions on
its business. See "FDICIA."
Holding Company Structure and Support of the Bank
Because the Company is the parent holding company of the Bank, its right to
participate in the assets of any subsidiary upon the Bank's liquidation or
reorganization will be subject to the prior claims of the subsidiary's creditors
(including depositors in the case of bank subsidiaries) except to the extent
that the Company may itself be a creditor with recognized claims against the
subsidiary.
Under the Federal Deposit Insurance Act (the "FDIA"), a depository
institution insured by the FDIC can be held liable for any loss incurred by, or
reasonably expected to be incurred by the FDIC in connection with (i) the
default of a commonly-controlled FDIC-insured depository institution or (ii) any
assistance provided by the FDIC to any commonly-controlled FDIC-insured
depository institution "in danger of default." "Default" is defined generally as
the appointment of a conservator or receiver and "in danger of default" is
defined generally as the existence of certain conditions indicating that a
default is likely to occur in the absence
-17-
<PAGE>
of regulatory assistance. The FDIC's claim for damages is superior to claims of
depositors, secured creditors and holders of subordinated debt (other than
affiliates) of the commonly controlled insured depository institution. The Bank
is subject to these cross-guarantee provisions.
The following table sets forth capital ratios required by the Federal
Reserve to be maintained by the Company in order for the Company to be
adequately capitalized, and the Company's actual ratios of capital to total
regulatory or risk-weighted assets, as applicable, at December 31, 1998.
<TABLE>
<CAPTION>
Company Regulatory
Minimum Company Bank
------------------------- ----------------- --------------
<S> <C> <C> <C>
Tier 1 capital............... 4.00% 16.39% 12.23%
Total risk-based capital..... 8.00% 17.89% 13.49%
</TABLE>
FDICIA
The FDICIA requires the federal banking regulators to take "prompt
corrective action" in respect of FDIC insured depository institutions that do
not meet minimum capital requirements. FDICIA established five capital tiers:
"well capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." An FDIC-insured depository
institution is well capitalized if it maintains a Leverage Ratio of at least 5%,
a risk adjusted Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of
at least 10% and is not subject to a directive, order or written agreement to
meet and maintain specific capital levels. An insured depository institution is
defined to be adequately capitalized if it meets all of its minimum capital
requirements as described above. In addition, an insured depository institution
will be considered undercapitalized if it fails to meet any minimum required
measure, significantly undercapitalized if it is significantly below any such
measure and critically undercapitalized if it fails to maintain a level of
tangible equity equal to not less than 2% of total assets. An insured depository
institution may be deemed to be in a capitalization category that is lower than
is indicated by its actual capital position if it receives an unsatisfactory
examination rating.
The capital-based prompt corrective action provisions of FDICIA and their
implementing regulations apply to FDIC-insured depository institutions and are
not directly applicable to holding companies which control such institution.
However, the Federal Reserve Board has indicated that, in regulating bank
holding companies, it will take appropriate action at the holding company level
based on an assessment of the effectiveness of supervisory actions imposed upon
subsidiary depository institutions pursuant to such provisions and regulations.
FDICIA generally prohibits an FDIC-insured depository institution from
making any capital distribution (including payment of dividends) or paying any
management fee to its holding company if the depository institution would
thereafter be undercapitalized.
Undercapitalized depository institutions are subject to restrictions on
borrowing from the Federal Reserve. In addition, undercapitalized depository
institutions are subject to growth limitations and are required to submit
capital restoration plans. A depository institution's holding company must
guarantee the capital plan, up to an amount equal to the lesser of 5% of the
depository institution's assets at the time it becomes undercapitalized or the
amount of the capital deficiency when the institution fails to comply with the
plan. The federal banking agencies may not accept a capital plan without
determining, among other things, that the plan is based on realistic assumptions
and is likely to succeed in restoring the depository institution's capital. If a
depository institution fails to submit an acceptable plan, it is treated as if
it is significantly undercapitalized.
-18-
<PAGE>
Significantly undercapitalized depository institutions may be subject to a
number of requirements and restrictions, including orders to sell sufficient
voting stock to become adequately capitalized, requirements to reduce total
assets and cessation of receipt of deposits from correspondent banks. Critically
undercapitalized depository institutions are subject to appointment of a
receiver or conservator.
The Company and the Bank, at December 31, 1998 and 1997, were "well
capitalized" under the criteria discussed above.
FDIC Insurance Premiums
The Bank is required to pay semiannual FDIC deposit insurance assessments.
Each financial institution is assigned to one of three capital groups -- well
capitalized, adequately capitalized or undercapitalized -- and further assigned
to one of three subgroups within a capital group, on the basis of supervisory
evaluations by the institution's primary federal and, if applicable, state
supervisors and other information relevant to the institution's financial
condition and the risk posed to the FDIC deposit insurance fund. The actual
assessment rate applicable to a particular institution (and any applicable
refund) will, therefore, depend in part upon the risk assessment classification
so assigned to the institution by the FDIC. The FDIC is authorized by federal
law to raise insurance premiums in certain circumstances. Any increase in
premiums would have an adverse effect on the Bank and the Company's earnings.
Under the FDIA, insurance of deposits may be terminated by the FDIC upon a
finding that the institution has engaged in unsafe and unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by a federal bank
regulatory agency.
Interstate Banking
The acquisition by the Company of more than 5% of the outstanding voting
securities or substantially all of the assets of a bank located outside of the
State of Maine is regulated by the BHCA. Such acquisition is also subject to the
law of the state in which the bank to be acquired is located. Under certain
circumstances, the Company might not be permitted to acquire an interest in
another bank located outside Maine. Further, any company attempting to acquire
control of the Company or the Bank also may be subject to certain limitations on
interstate banking. Even assuming that the law of the state in which the bank is
located permits acquisition, the Maine Banking Code requires prior approval of
the Superintendent of the Bureau of Banking for certain acquisitions of more
than 5% of a financial institution having operations conducted outside of Maine.
The status of interstate banking legislation adopted by individual states
has been in a constant state of change in recent years. While federal law has
substantially liberalized interstate banking, a number of states have adopted
some form of legislation which limits interstate banking by bank holding
companies.
Interstate Act
Subject to certain conditions and exceptions, the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 ("Interstate Act"), (i) permits
bank holding company acquisitions of banks of a minimum age of up to five years
as established by state law in any state, (ii) permits mergers of national and
state banks across state lines unless the state has opted out of the interstate
bank merger provisions, (iii) permits branching de novo by national and state
banks into other states and (iv) permits certain interstate bank agency
activities one year after enactment. Subject to certain limitations, Maine law
permits out of state financial institutions, federal associations and national
banks to establish de novo branches or to acquire branches in Maine.
-19-
<PAGE>
Community Reinvestment Act
The Community Reinvestment Act requires that, in connection with
examinations of financial institutions within their jurisdiction, the Federal
Reserve, the FDIC, the Office of the Comptroller of the Currency and the Office
of Thrift Supervision evaluate the record of such financial institutions in
meeting the credit needs of their local communities, including low and moderate
income neighborhoods, consistent with the safe and sound operation of those
institutions. These factors are also considered in evaluating mergers,
acquisitions and applications to open a branch or facility.
Other Regulations
Interest and certain other charges collected or contracted for by banks are
subject to state usury laws and certain federal laws concerning interest rates.
The Bank's loan operations are also subject to certain federal laws applicable
to credit transactions, such as the federal Truth-In-Lending Act governing
disclosures of credit terms to consumer borrowers, the Home Mortgage Disclosure
Act of 1975 requiring financial institutions to provide information to enable
the public and public officials to determine whether a financial institution is
fulfilling its obligation to help meet the housing needs of the community it
serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis
of race, creed or other prohibited factors in extending credit, the Fair Credit
Reporting Act of 1978 governing the use and provision of information to credit
reporting agencies, the Fair Debt Collection Act governing the manner in which
consumer debts may be collected by collection agencies and the rules and
regulations of the various federal agencies charged with the responsibility of
implementing such federal laws. The deposit operations of the Bank also are
subject to the Right to Financial Privacy Act, which imposes a duty to maintain
confidentiality of consumer financial records and prescribes procedures for
complying with administrative subpoenas of financial records, and the Electronic
Funds Transfer Act and Regulation E issued by the Federal Reserve Board to
implement that act, which govern automatic deposits to and withdrawals from
deposit accounts and customers' rights and liabilities arising from the use of
automated teller machines and other electronic banking services.
ITEM 2. DESCRIPTION OF PROPERTY
Over the past six years, the Company has made improvements to or relocated
from nearly all of the properties it acquired in connection with the Bank's
formation. The most significant project being the 1997 two-story expansion and
renovation of its headquarters building at 201 Main Street. This increased the
size of the structure from 8,000 to a total of 17,000 square feet, and includes
a large branch, commercial, trust and administrative offices as well as a board
room and two conference rooms. The property is located at the gateway to
downtown Bangor and the enhancements to the site have significantly improved the
area. The site suits the Company's present needs and further expansion is
available on the premises if the needs of the Company change in the future.
992 Union Street Branch, Bangor
The Bank's most recent project, completed in late 1997, was the relocation
of this office from a small, outdated facility at 559 Union Street to a new
branch at the Airport Plaza Mall located at 992 Union Street. This branch
includes a spacious lobby, three comfortable offices, a conference room and
kitchen. Adequate parking and convenient access to the multi-lane drive up and
ATM are added benefits.
920 Stillwater Avenue, Bangor
In 1994, the Bank relocated from an office within the Bangor Mall to a
spacious facility located in the CrossRoads Plaza. This office includes the
branch and the Residential Mortgage Department and its
-20-
<PAGE>
operational staff. This location features a multi-lane drive up and ATM and
provides service to another ATM located inside the Bangor Mall.
366 Wilson Street, Brewer
In 1995, the Company sold the original Brewer branch building on North Main
Street and relocated to the present location. This is a leased facility which
had been recently renovated by another bank. It features a multi-lane drive-up
and ATM and is conveniently located at the center of the Brewer business
district.
69 Main Street, Orono
The Orono branch is also located near the center of town on the first floor
of a former bank building. The Company assumed this lease in 1992 and has made
some cosmetic improvements to the facility since that time. In 1998 an ATM was
installed at the site to complement the existing drive-up services.
27 Main Street, Pittsfield
The Pittsfield branch, which was acquired by the Bank as part of the
start-up, is a historic two story Main Street building with approximately 12,600
square feet of space.
Newport Plaza, Newport
In 1997, the Company opened its first branch in a locally owned supermarket
in Newport. This facility is unlike most supermarket banks in that it includes a
drive-up as well as in-store tellers and loan and customer service personnel.
ITEM 3. LEGAL PROCEEDINGS
Although the Bank and the Company, from time to time, are involved in
various legal proceedings in the normal course of business, there are no
material legal proceedings to which the Bank or the Company, its directors or
its officers is a party or to which any of its property is subject as of the
date of this Form 10-KSB.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The following information included in the Merrill Merchants Bancshares,
Inc. 1998 Annual Report to Stockholders (the "Annual Report") is incorporated
herein by reference: "Market for Common Stock."
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information included in the Annual Report is incorporated
herein by reference: "Selected Financial Highlights" on page 1 and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" on
pages 5 through 14 of the Annual Report.
-21-
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
The following information included in the Annual Report is incorporated
herein by reference: "Audited Financial Statements and Notes to Consolidated
Financial Statements" on pages 15 through 33 of the Annual Report.
ITEM 8. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND PRINCIPAL OFFICERS OF THE COMPANY; COMPLIANCE WITH SECTION
16(a) OF THE EXCHANGE ACT
The following information included in the Company's 1998 Proxy Statement
for the 1999 Annual Meeting of Shareholders ("Proxy Statement") is incorporated
herein by reference: "Election of Directors," "Nominees, Continuing and Retiring
Directors," "Executive Officers," and "Section 16(a) Beneficial Ownership
Reporting Compliance."
ITEM 10. EXECUTIVE COMPENSATION
The following information included in the Proxy Statement is incorporated
herein by reference: "Proposal 1 -- Election of Directors -- Directors'
Compensation," "-- Compensation Table," "-- Stock Option Plan" and "--
Transactions with Certain Related Persons."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included in the Proxy Statement is incorporated
herein by reference: "Security Ownership of Certain Beneficial Owners and
Management."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included in the Proxy Statement is incorporated
herein by reference: "Transactions with Certain Related Persons."
-22-
<PAGE>
ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K
(a) The following financial statements included in the 1998 Annual Report
are incorporated herein by reference:
Consolidated Statements of Financial Condition -- December 31, 1998
and 1997; Consolidated Statements of Income -- Years Ended December
31, 1998 and 1997; Consolidated Statements of Changes in Shareholders
Equity -- December 31, 1998 and 1997; Consolidated Statements of Cash
Flows -- Years Ended December 31, 1998 and 1997; and Notes to
Consolidated Financial Statements -- Years Ended December 31, 1998 and
1997.
(b) Exhibits. The following exhibits are either filed as part of this
report or are incorporated herein by reference:
3.1 Articles of Incorporation of Merrill Merchants Bancshares, Inc.*
3.2 By-laws of Merrill Merchants Bancshares, Inc.*
4 Specimen Stock Certificate of Merrill Merchants Bancshares, Inc.*
10.1 Operating Agreement between the Company and M&M Consulting Limited
Liability Company.*
10.2 Services Agreements between the Company and M&M Consulting Limited
Liability Company.*
10.3 Data Processing Services Agreement between the Company and M&I Data
Services, a Division of Marshall & Ilsley Corporation.*
10.4 Financial Services Agreement with Financial Institutions Service
Corporation.*
10.5 Form of Life Insurance Endorsement Method Split Dollar Plan Agreement.*
10.6 Form of Unfunded Deferred Compensation Agreement.*
10.7 Form of Executive Supplemental Retirement Plan.*
10.8 Form of Mandatory Convertible Debentures.*
10.9 Correspondent Trust Services Agreement with Northern Trust Company.*
10.10 Stock Option Plan, as amended.*
10.11 Form of Stock Option Agreement.*
10.12 1998 Directors' Deferred Compensation Plan.*
13 Annual Report to Shareholders for the Year Ended December 31, 1998.
21 Subsidiaries of the Registrant.
23 Consent of Berry Dunn McNeil & Parker.
27 Financial Data Schedule.**
-23-
<PAGE>
99 1999 Proxy Statement (previously filed on March 12, 1999).
- -----------
* Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-56197), and any amendments thereto filed with the
Securities and Exchange Commission.
** Filed in electronic format only.
(c) Reports on Form 8-K.
None.
-24-
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
MERRILL MERCHANTS BANCSHARES, INC.
By: /s/ Edwin N. Clift
-------------------------------------
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ Edwin N. Clift Director, President and March 25, 1999
- ------------------------------------------ Chief Executive Officer
Edwin N. Clift (Principal executive officer)
/s/ Deborah A. Jordan Treasurer (Principal March 25, 1999
- ------------------------------------------ financial officer)
Deborah A. Jordan
/s/ William C. Bullock, Jr. Chairman of the Board March 25, 1999
- ------------------------------------------
William C. Bullock, Jr.
/s/ Joseph H. Cyr Director March 25, 1999
- ------------------------------------------
Joseph H. Cyr
/s/ Perry B. Hansen Director March 25, 1999
- ------------------------------------------
Perry B. Hansen
/s/ Leonard E. Minsky Director March 25, 1999
- ------------------------------------------
Leonard E. Minsky
/s/ Joseph Sewall Director March 25, 1999
- ------------------------------------------
Joseph Sewall
/s/ Dennis L. Shubert, M.D. Director March 25, 1999
- ------------------------------------------
Dennis L. Shubert, M.D.
/s/ Susan B. Singer Director March 25, 1999
- ------------------------------------------
Susan B. Singer
/s/ Harold S. Wright Director March 25, 1999
- ------------------------------------------
Harold S. Wright
</TABLE>
-25-
Contents
Financial Highlights 1
Letter to Shareholders 2
Management's
Analysis of Operations 5
Independent
Auditors' Report 15
Audited Financial Statements 16
Employees 33
Corporate Directory 34
Corporate Information 36
[LOGO]
Merrill Merchants Bancshares, Inc.
<PAGE>
SELECTED FINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
FOR THE YEAR 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net income $ 1,916 $ 1,402 $ 1,120 $ 967 $ 373
Net interest income 8,032 7,155 6,443 5,978 4,671
Non-interest income 2,211 1,724 1,489 1,302 911
Non-interest expense 6,939 6,357 5,813 5,407 4,840
- ------------------------------------------------------------------------------------------------------
PER COMMON SHARE
- ------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $ 0.96 $ 0.82 $ 0.65 $ 0.55 $ 0.19
Diluted 0.78 0.71 0.58 0.52 0.19
Dividends per share 0.14 0.03 -- -- --
Book value per share (1) 8.61 6.77 5.98 5.33 4.79
Dividend payout ratio 15.34% 3.37% -- -- --
- ------------------------------------------------------------------------------------------------------
KEY RATIOS
- ------------------------------------------------------------------------------------------------------
Return on average assets 1.05% 0.86% 0.78% 0.80% 0.37%
Return on average equity (1) 12.97 13.63 12.28 11.83 4.95
Equity to assets at year end (1) 10.30 6.14 6.11 6.36 6.84
Non-performing assets to total assets 0.08 0.13 0.45 0.33 0.63
Net charge-offs to average loans 0.04 0.08 0.04 0.21 0.02
- ------------------------------------------------------------------------------------------------------
AT YEAR END
- ------------------------------------------------------------------------------------------------------
Total assets $ 199,743 $ 178,619 $158,425 $135,744 $113,231
Loans receivable, net (2) 128,507 117,679 104,320 95,256 81,137
Investment securities 55,909 45,321 41,014 30,257 21,692
Deposits 164,128 146,312 126,704 111,340 91,812
Borrowed funds 13,508 20,236 18,991 14,665 13,127
Shareholders' equity 20,655 10,967 9,671 8,761 7,675
</TABLE>
(1) Excludes effect of unrealized gains or losses on securities (2) Includes
loans held for sale
1
<PAGE>
Dear Shareholder:
We are pleased to report that 1998 was a very good year for our
Company. Highlighting the year was our successful initial public offering of
690,000 shares of Common Stock in August, at which time there was a 9:1 stock
split. The offering generated $7.7 million of net proceeds, bringing the total
equity at year end to $20.7 million or 10.3 % of total assets. The capital
raised will support our growth as we move forward into the next millennium. We
are also pleased to report that since our first dividend payout of $ .03 per
share in the fourth quarter of 1997 we have increased the dividend by 67% to $
.05 per share in the fourth quarter of 1998.
Our success over the past six years has been built on understanding
the banking needs of Maine people and Maine businesses, and being able to
provide prompt and personal service. Banking is a people business and as
regional banks continue to streamline their operations in Maine, there will be
opportunities for us to expand our franchise and increase market share.
We believe that we have an excellent staff providing the best possible
service in the most cost efficient manner. We are fortunate to have an
enthusiastic, experienced team of bankers who always strive to exceed customer
expectations. As participants in the Stock Option Plan they are also thinking
like owners and keeping a close eye on operating efficiency and return on
assets.
Lending Activities
Lending activity was brisk in 1998, particularly in the residential
mortgage area. We originated $39.3 million in residential mortgage loans,
compared with $15.7 million in 1997. The Bank sold 77% of the mortgages
originated in 1998 on the secondary market. We do, however, retain the servicing
rights on all mortgages as a part of our commitment to ongoing customer service.
Our secondary market servicing portfolio is now nearly $57 million.
While lower rates spurred increased loan volume, we also experienced a
decrease in the dollar value of residential mortgages held in the Bank's
portfolio due to refinancing among current mortgage customers. This was offset
by new business on the refinance side as well as additional fee income totaling
in excess of $300,000.
According to the Maine Credit Bureau, which performs quarterly
Registry of Deeds reviews, our Bank ranks third among all institutions in
Penobscot County, in the dollar volume of loans originated during the quarter
ending September 30, 1998.
Our commercial loan portfolio is growing at a healthy pace, and we are
committed to meeting the credit needs of Maine's small businesses. At year end
our commercial loan portfolio totaled $77.2 million compared with $61.8 million
at year end 1997. We are experiencing increasingly aggressive competition on
loan pricing, and
2
<PAGE>
anticipate this will remain a challenge. The Bank is a very active lender with
the Small Business Administration (SBA), and is the only community bank in the
state of Maine to have been granted Preferred Lender status by the SBA. The Bank
was recently recognized as the number two lender in number of loans originated
for the SBA Maine District Office during their 1998 fiscal year. According to
Mary McAleney, District Director, "This participation in lending to the small
business community is considered a mark of excellence."
We are committed to maintaining high credit standards, and are pleased
with the quality of our loan assets. Non-performing loans totaled $152,000 or
.12% of total loans at the end of the year. This is a credit to our lenders who
also serve as our collection staff. The loan loss reserve as of December 31,
1998 was $2 million representing 1.55% of total loans.
Trust & Investment Services
Our Company is committed to providing trust and investment services to
a broad range of personal, corporate and institutional clients. In 1998 we
experienced outstanding asset and revenue growth. The market value of client
assets under administration increased by more than $46 million or 51% over the
previous year. We were able to achieve diversified growth through new business
development efforts; excellent referrals from existing clients; shareholders and
community professionals; the expansion of existing relationships; and favorable
investment results.
We will be focusing on these same areas going forward with
enhancements to our services and further expansion of our referral networks. We
anticipate more moderate returns from the capital markets, and will be working
diligently to provide superior service to our clients.
Community Building
We are fortunate to have employees who bring the same level of caring
to the community as they do to our customers. Merrill Merchants employees serve
as directors of many community boards such as: United Way of Eastern Maine;
Eastern Maine Healthcare; Bangor-Brewer YWCA; Multiple Handicap Center of
Penobscot Valley; and the Warren Center for Communication & Learning. They have
chaired various capital and annual campaigns such as St. Joseph Hospital and the
Bangor YMCA. They work on committees providing support to organizations such as:
Brewer Housing Authority; the Orono Public Library; Penquis Community Action
Program; and the Eastern Maine Children's Museum. They coordinate the Company's
participation in many charitable activities such as: March of Dimes Walk
America; the Red Cross Real Heroes Breakfast; and the National Kidney Foundation
of Maine Golf Tournament.
3
<PAGE>
In addition to their hard work and dedicated service, our employees
and the Company provide charitable financial support to many worthy endeavors in
our communities. The combined corporate/employee contribution to the United Way
of Eastern Maine increases each year, and the Company's campaign regularly ranks
among the United Way's most successful. In 1998, 98% of our employees
contributed to the campaign. Other notable charitable contributions have been
made to Maine Central Institute (Pittsfield); University of Maine; Bangor Public
Library; Shaw House; Bangor Symphony Orchestra; Bangor Humane Society; Maine
Audubon Society/Field's Pond; Spruce Run; Katahdin Boy Scout Council; and Abnaki
Girl Scout Council. We are proud to be helping improve the quality of life for
Maine people and Maine communities.
Looking Ahead
The upcoming turn of the century will provide an additional challenge
this year. We are working diligently with our vendors and the banking regulators
in preparation for the Year 2000. We have implemented testing procedures and are
adopting appropriate contingencies for all mission critical systems. We
anticipate a smooth transition, and will continue to do everything in our power
to accomplish this. Phase one of our customer communication plan has been
completed, and we will continue answering questions and updating customers
throughout the year.
Our goal for the coming year is to build on our success in 1998. We
will be focusing on ways to increase market share and differentiate ourselves
from the competition. We intend to maintain our commitment to customer service
while seeking new ways to achieve profitability for our shareholders.
The continuing efforts of our employees and ongoing wise counsel of
our Board of Directors will provide a strong advantage as we position our
Company for the future. We will miss the wit and wisdom of Joseph Sewall and
Norman Minsky who are retiring this year. We thank them for their guidance in
shaping our Company over the past six years.
The values which have been so instrumental in building our Company
will continue to serve us well. Our goal is to always be an organization which
values our employees and customers as individuals. We believe this is the best
way to ensure our future success and to increase value for our shareholders.
Thank you for your ongoing confidence in the future of our Company.
Sincerely,
Edwin N. Clift William C. Bullock, Jr.
President and Chief Executive Officer Chairman
January 31, 1999
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
Management's discussion and analysis may contain forward-looking
statements that are provided to assist in the understanding of anticipated
future financial performance. However, such performance involves risk and
uncertainties which may cause actual results to differ materially from those
expressed in forward-looking statements. For a discussion of these risks and
uncertainties, see the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1998.
GENERAL
Merrill Merchants Bancshares, Inc., a Maine corporation organized in
March 1992, is a one-bank holding company for Merrill Merchants Bank, a
full-service community bank headquartered in Bangor, Maine. The bank provides a
wide range of consumer, commercial, and trust and investment services through
its seven branches located in central and eastern Maine.
Merrill Merchants Bank is committed to providing outstanding customer
service and building long term banking relationships with customers. Delivery on
this commitment through local decision-making and personal service has helped
distinguish Merrill Merchants from its competitors. This will continue to be
strategically significant as larger banks consolidate and their service delivery
channels become more depersonalized.
The Company's goal is to sustain profitable, controlled growth by
focusing on increased loan and deposit market share; managing yields on earning
assets and rates on interest-bearing liabilities; increasing non-interest
income; and being prepared for acquisition opportunities within the financial
services industry.
REVIEW OF FINANCIAL STATEMENT
In 1998, the Company declared a 5% stock dividend and completed a
9-for-1 split of its common stock. All financial data included herein has been
restated to reflect the impact of the stock dividend and split.
The discussion and analysis that follows focuses on the factors
affecting the Company's financial condition at December 31, 1998 and 1997 and
financial results of operations during 1998 and 1997. This discussion should be
read in conjunction with the consolidated financial statements and notes
included elsewhere in this report.
RESULTS OF OPERATIONS
Overview
The Company ended 1998 with consolidated assets just under $200
million representing growth of $21.1 million or 12%. The Company reported net
income of $1.9 million or $.96 per basic share and $.78 per diluted share in
1998, as compared to $1.4 million or $.82 per basic share and $.71 per diluted
share in 1997. This represented earnings growth of 37% and basic earnings per
share growth of 17%. Return on average assets amounted to 1.05% in 1998 compared
to .86% in 1997. The improved operating results were attributable to growth in
both the loan and investment portfolios and an increase in non-interest income.
Return on average equity declined from 13.63% in 1997 to 12.97% in 1998 as a
result of the initial public offering in August 1998, which provided the Company
with additional capital of $7.7 million.
5
<PAGE>
Average Balance Sheets and Analysis of Net Interest Income
The following table sets forth, for the years indicated, information regarding
(i) the total dollar amount of interest income of the Company from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average costs; (iii) net interest income; (iv) net interest rate spread; and (v)
net interest margin.
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997
-------------------------------------- -------------------------------------
Average Average
(In Thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate
-------------------------------------- -------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans (1) $ 121,955 $ 11,655 9.56% $ 111,006 $ 10,669 9.61%
Investment securities (2) 48,371 2,831 5.85% 39,050 2,378 6.09%
Other earning assets 2,113 111 5.25% 3,187 171 5.37%
--------------------------------- ---------------------------------
Total interest-earning assets 172,439 14,597 8.47% 153,243 13,218 8.63%
Non-earning assets 10,571 9,062
========= =========
Total assets $ 183,010 $ 162,305
========= =========
Liabilities and Shareholders' Equity:
Interest-bearing liabilities:
Savings deposits and interest-bearing
checking 68,779 2,474 3.60% 56,511 1,983 3.51%
Certificates of deposit 57,220 3,236 5.66% 55,306 3,143 5.68%
Securities sold under agreement to
repurchase 12,163 514 4.23% 11,931 511 4.28%
Short-term borrowings 1,922 106 5.52% 2,364 124 5.25%
Long-term borrowings 3,135 224 7.15% 4,109 299 7.28%
--------------------------------- ---------------------------------
Total interest-bearing liabilities 143,219 6,554 4.58% 130,221 6,060 4.65%
--------------------------------- ---------------------------------
Other liabilities 24,947 21,836
Shareholders' equity 14,844 10,248
========= =========
Total liabilities and shareholders' equity $ 183,010 $ 162,305
========= =========
Net interest income $ 8,043 $ 7,158
======= =======
Net interest rate spread 3.89% 3.98%
==== ====
Net interest margin 4.66% 4.67%
==== ====
</TABLE>
(1) Non-accruing loans included in computation of average balance. (2) Income
from investment securities and net interest income is presented on a
tax-equivalent basis by adjusting income and yields earned on tax-exempt
securities assuming a federal tax of 34%.
6
<PAGE>
Analysis of Changes in Net Interest Income
The following table presents the components of the Company's net interest income
as attributed to volume and rate on a tax-equivalent basis assuming a Federal
tax rate of 34%. The net change attributable to the combined impact of volume
and rate has been solely allocated to the change in volume.
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997
(In Thousands) --------------------------------------- ----------------------------------------
Increase (Decrease) Due to Change in: Increase (Decrease) Due to Change in:
---------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
--------- --------- ------------- ------------ -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $ 1,046 $ (60) $ 986 $ 993 $ (7) $ 986
Investment securities 546 (93) 453 389 6 395
Other earning assets (56) (4) (60) 5 6 11
--------- --------- ------------- ------------ -------- ----------
Total interest income 1,536 (157) 1,379 1,387 5 1,392
--------- --------- ------------- ------------ -------- ----------
Interest-bearing liabilities:
Savings deposits and interest-bearing
liabilities 441 50 491 443 182 625
Certificates of deposit 108 (15) 93 126 (53) 73
Securities sold under agreement to
repurchase 10 (7) 3 7 (16) (9)
Short-term borrowings (24) 6 (18) 31 4 35
Long-term borrowings (70) (5) (75) 2 (49) (47)
--------- --------- ------------- ------------ -------- -----------
Total interest expense 465 29 494 609 68 677
--------- --------- ------------- ------------ -------- -----------
Change in net interest income $ 1,071 $ (186) $ 885 $ 778 $ (63) $ 715
========= ========= ============= ============ ======== ===========
</TABLE>
Net Interest Income
The Company's primary source of operating income is net interest
income. Net interest income on a taxable equivalent basis was $8.0 million for
1998 and $7.2 million for 1997. Net interest income is the difference between
the income earned on earning assets and the interest paid on interest-bearing
liabilities. Both net interest income and the net interest margin, which is net
interest income expressed as a percentage of average earning assets, are
affected by the volume and mix of earning assets and interest-bearing
liabilities and the interest rates earned or paid on them.
Net interest income increased by $885,000 or 12%, on a taxable
equivalent basis in 1998 compared to 1997. This increase was due to growth in
the loan portfolio and investment securities. The Company's net interest margin
remained stable at 4.66% for 1998 and 4.67% for 1997 despite a period of
declining interest rates. The Federal Reserve reduced the Federal Funds rate
from 5.50% to 4.75% during the 4th quarter of 1998.
7
<PAGE>
Interest income increased to $14.6 million or 10% in 1998. The increase
was driven by growth in the average earning assets of $19.2 million or 12.5%
while the Company experienced a decrease in the yield on average earning assets
to 8.47% in 1998 from 8.63% in 1997.
Interest expense increased to $6.6 million in 1998 from $6.1 million in
1997 representing an 8% increase. This increase was a result of growth in
average interest-bearing liabilities of $13.0 million or 10% which was offset by
a decline in the cost of funds to 4.58% in 1998 from 4.65% in 1997.
Management currently anticipates that net interest income will increase in
1999 due to expected growth in earning assets (primarily loans) although a
decline in the net interest margin is expected due to the low interest rate
environment and industry-wide pricing pressure on loans and deposits.
Non-Interest Income
Non-interest income was $2.2 million for 1998 and $1.7 million for 1997.
The $487,000 or 28% increase during 1998 was largely attributable to increases
in gains on sale of mortgage loans of $206,000 and trust fees of $128,000.
Lower interest rates on the national level have resulted in increased
secondary market loan activity. The Company's portfolio of residential mortgages
of $56.8 million serviced for secondary market investors increased by $18.5
million or 48% from December 31, 1997 to December 31, 1998. Gains resulting from
the sale of mortgages amounted to $297,000 in 1998 compared to $91,000 for 1997.
Trust fees increased to $662,000 in 1998 compared to $534,000 in 1997. The
market value of client assets under administration increased $46.2 million or
51% to $136.5 million at December 31, 1998 compared with trust assets of $90.3
million at December 31, 1997. The increase in trust assets was achieved through
new business development and market value appreciation.
The generation of mortgage sale gains and trust fees is dependent on the
market and economic conditions and, as a result, there can be no assurance that
income levels reported in prior periods can be achieved in the future.
Non-Interest Expense
Non-interest expense increased $582,000 or 9% for 1998. The increase was
primarily related to the increase in salaries and employee benefits of $389,000.
The Company's efficiency ratio (non-interest expense divided by the sum of net
interest income and fee income) improved to 67.8% for 1998 compared to 71.6% for
1997.
Salaries and employee benefits of $3.5 million increased 12% during 1998
due primarily to the addition of employees. The Company increased staffing to
90.5 full-time equivalents at December 31, 1998 compared with 86 full-time
equivalents at December 31, 1997. Data processing expense increased by $66,000
or 11% to $671,000 for 1998 due to increased volume in loan and deposit
transactions. Merchant and credit card processing expense increased to $251,000
for 1998 from $191,000 for 1997 as a result of attracting new business accounts.
Annual operating expenses are also expected to increase in future periods
due to future branching and product expansion and the increased cost of
operating as a public stock institution.
BALANCE SHEET REVIEW
Loans
The Bank offers a broad range of personal and business loan products.
Total loans (which includes loans held for sale) of $130.5 million grew 9% from
$119.4 million at December 31, 1997. Management is pleased with the overall
growth rate considering the refinancing boom experienced during 1998. Secondary
market mortgage lending was exceptionally strong. Many customers consolidated
consumer debt and refinanced
8
<PAGE>
existing mortgages at lower rates. This resulted in a decline in portfolio
residential and construction real estate, home equity and consumer loan balances
of $4.4 million in 1998.
Commercial real estate balances increased $7.9 million or 19% in 1998 and
now represent 37% of the total loan portfolio compared to 34% in 1997.
Commercial loans grew $7.6 million in 1998, a 36% increase. Commercial loans
represent 22% of the total loan portfolio compared to 17% in 1997. Growth in
commercial real estate and commercial loans is consistent with the Bank's focus
on lending to small and medium size business customers within our geographic
markets.
The average yield on loans declined to 9.56% in 1998 from 9.61% in 1997.
The decrease is the result of declining interest rates (prime rate decreased
.75% during 1998) and competitive pressure. Management anticipates a continued
decline in yields on loans given the current interest rate environment and
increased competition from banks and non-traditional credit providers.
Investment Securities
The investment portfolio provides liquidity, diversification and earnings
to the Company. The investment portfolio represents 28% of the Company's total
assets which has increased slightly from 25% at December 31, 1997. The portfolio
is comprised primarily of U.S. Treasury securities and collateralized mortgage
obligations. Substantially all securities are AAA or equivalently rated.
The increase in the securities portfolio of $10.6 million to $55.9 million
at December 31, 1998 resulted primarily from investment of proceeds from the
initial public offering. The Company has $5.1 million invested in U.S.
Government money market funds that provide liquidity for future
expansion/acquisition opportunities. The average yield on the investment
portfolio decreased to 5.85% in 1998 compared to 6.09% in 1997 as a result of
maturing investments being reinvested at lower interest rates.
Deposits
Deposits are the major source of the Company's funds for lending,
investing and other general business purposes. Deposits are attracted
principally from within the Company's primary market area through the offering
of a broad variety of deposit products, including checking accounts, money
market accounts, savings accounts, certificates of deposit (including jumbo
certificates in denominations of $100,000 or more) and retirement savings plans.
Total average deposits were $149.6 million for 1998 compared to $132.4
million for 1997, an increase of $17.2 million or 13%. The Company experienced
growth in all deposit categories with a 14% increase in non-interest checking
balances and a 31% increase in savings accounts. The Company's deposit mix has
shifted slightly as the result of a passbook savings product offered at a
premium interest rate. Savings accounts represent 29% of the total deposits at
December 31, 1998 compared to 25% at December 31, 1997 and certificates of
deposit as a percentage of total deposits decreased to 38% in 1998 from 42% in
1997.
The average yield on savings deposits and interest-bearing checking
balances increased to 3.60% in 1998 from 3.51% in 1997 primarily due to the
growth in the higher yielding passbook savings product. The average yield on
certificates of deposit declined slightly to 5.66% in 1998 from 5.68% in 1997.
The introduction of new products and the continued focus on quality
customer service contributed to strong deposit growth. The Company continues to
develop consumer and commercial deposit relationships through referrals and
additional contacts within its market area.
9
<PAGE>
Borrowings
The Company's primary source of funding, other than deposits, is
securities sold under agreement to repurchase. Average balances for securities
sold under repurchase agreements were $12.2 million in 1998 and $11.9 million in
1997. These are collateralized by U.S. government obligations. Other short-term
borrowings include federal funds purchased, FHLB advances, treasury tax and loan
deposits and interest-bearing demand notes due to the U.S. Treasury. The Company
paid off its long-term debt of $2.9 million from proceeds received from the
initial public offering.
ASSET QUALITY
Management seeks to maintain a high quality of assets through prudent
underwriting and sound lending practices. Approximately 26% of the Bank's loan
portfolio is collateralized by first liens on primarily owner-occupied
residential homes which have historically carried a relatively low credit risk.
The Bank also maintains a commercial real estate portfolio comprised primarily
of owner-occupied commercial businesses.
The Bank participates in government guaranteed loan programs including
the Small Business Administration ("SBA"), Rural Development ("RD") and the
Finance Authority of Maine ("FAME"). At December 31, 1998, total loans under
these programs totaled $10.9 million of which $8.2 million, or 6% of the total
loan portfolio outstanding, is guaranteed by the various federal and state
government entities.
The Company continues to focus on asset quality issues and has placed
emphasis on loan review and underwriting procedures. The Bank utilizes the
services of a consultant, M&M Consulting, LLC, (a 50% joint venture), to perform
periodic loan and documentation review. Management has established a risk rating
and review process with the objective of quickly identifying, evaluating and
initiating necessary corrective action for all commercial and commercial real
estate loans. The goal of the risk rating process is to address the watch list,
substandard and non-performing loans as early as possible. These components of
risk management are integral elements of the Bank's loan program which have
contributed to the loan portfolio performance to date. Nonetheless, management
maintains a cautious outlook in attempting to anticipate the potential effects
of uncertain economic conditions (both locally and nationally).
Nonperforming Assets
Nonperforming assets consist of non-accrual loans, other loans past
due over 90 days and other real estate owned. Total nonperforming assets as a
percentage of total assets decreased to .08% at December 31, 1998 compared to
.13% at December 31, 1997.
Loans are placed on non-accrual status when, in the judgment of
management, principal repayment is doubtful, whether current or past due. When a
loan is placed on non-accrual status, previously accrued but unpaid interest is
deducted from interest income. As a matter of policy, interest is generally not
accrued on loans past due 90 days or more. The Bank does not return a loan to
accrual status until it is brought current with respect to both principal and
interest, future payments are no longer in doubt and the loan has been
performing for at least six consecutive months.
Provision and Allowance for Loan Losses
The provision for loan losses was $360,000 for 1998 and $355,000 for 1997.
The allowance for loan losses represented 1.55% of loans outstanding at December
31, 1998, as compared to 1.44% at December 31, 1997. Net charge-offs were
$54,000 during 1998 or .04% of average loans outstanding, as compared to $88,000
in 1997 or .08%. The low level of net loan charge-offs is indicative of the
Bank's loan quality and credit administra-
10
<PAGE>
tion standards and the generally good economic environment existing in the
Company's primary market area.
The allowance for loan losses is maintained at a level determined to be
adequate by management to absorb future charge-offs of loans deemed
noncollectible. This allowance is increased by provisions charged to operating
expense and by recoveries on loans previously charged off. A high degree of
judgment is necessary to determine the appropriate level of allowance for loan
losses and requires management's ongoing evaluation of adequacy. The evaluation
process includes, among other things, industry standards, management's
experience, the Bank's historical loan loss experience, evaluation of economic
conditions and regular reviews of delinquencies and loan portfolio quality.
Although management believes it uses the best information available to make
determinations with respect to the allowance for loan losses, future adjustments
may be necessary if economic conditions differ from the economic conditions in
the assumptions used in making the final determinations.
Future provisions for loan losses depend on such factors as asset quality,
net loan charge-offs, loan growth and other criteria discussed above. The
appropriate level of the allowance for loan losses and the corresponding
provision will continue to be determined quarterly. Management anticipates that
there will be a provision for loan losses in 1999; however, the specific amount
cannot be determined at this time. Changes in circumstances affecting the
various factors of the Company's methodology will determine the provision amount
in 1999.
YEAR 2000
The Company utilizes various computer software programs to provide banking
products and services to its customers. Many existing computer programs use only
two digits to identify a year in the date field and were not designed to
consider the impact of the upcoming change in the century. If not corrected,
many computer applications could fail or create erroneous results by or at the
Year 2000. The Year 2000 issue affects virtually all companies and
organizations.
The Company adopted a plan to minimize the Year 2000 risk. The plan
included the formation of a Year 2000 Committee to assess, monitor and review
vendor compliance and certification and to identify all systems and equipment
used in the daily operations of the Company that might be affected. The scope of
the project covers all computer systems including PC and network hardware and
software and mainframe software. It also covers all equipment and other systems
utilized in bank operations or in the premises from which the Company operates.
During 1998, the Company completed the awareness and assessment phase,
identified mission-critical systems, developed a testing strategy, worked on
contingency plans and undertook steps to verify that significant vendors,
suppliers and other related business parties will be ready for the year 2000.
Testing and validation of all mission-critical systems is scheduled for
completion by March 31, 1999.
The Company is currently conducting tests of its mission critical systems
and is in compliance with the Federal Financial Institutions Examination
Council's time frames. The following table identifies each phase and the
estimated timetable for completion by the Company:
<TABLE>
<CAPTION>
Phase Status
<S> <C>
1. Awareness Completed
2. Assessment Completed
3. Renovation Completed for mission critical applications
4. Validation/Testing Completion by March 31,1999
5. Implementation/Monitoring Through year 2000
6. Contingency Planning Completion by March 31, 1999
</TABLE>
11
<PAGE>
The Company utilizes various third party service providers to perform
its most mission critical applications. Each service provider has informed the
Company that the software programming for its applications has been completed.
The following identifies each mission critical application and the current
status of testing:
Loans, Deposits and General Ledger
Testing of programs commenced in October 1998 and proxy testing and
validation are expected to be completed by March 31, 1999. Interface
and on-line connectivity tests are scheduled for March 1999.
Item Processing/Cash Letter Presentment
Renovations were completed by the service provider in September 1998.
Validation was completed in December 1998 and implementation is
expected to be completed by March 31, 1999. Interface testing is
scheduled for March 1999.
Wire Transfer Function
Century roll-over and leap year testing have been successfully
completed.
Merchant and Credit Card Processing
Renovation of all critical systems was completed in November 1998.
Testing by the service provider is scheduled to be completed by March
1, 1999. Proxy testing is being performed and the results are expected
to be published in March 1999.
Trust and Investment Operations
Renovation has been completed. Implementation and validation are
scheduled to be completed by March 31, 1999. Proxy testing is being
performed and the results are expected to be published in February
1999.
The Company has a formal customer due-diligence plan. The Company has
communicated with its large borrowers and corporate customers to determine the
extent to which the Company is vulnerable to those third parties if they fail to
resolve their Year 2000 issues. The Company has performed an initial assessment
of each major borrower and has established an ongoing assessment as part of the
Company's credit granting and loan renewal and monitoring process.
The Company has estimated that total costs directly related to Year 2000
issues, such as software modification and system testing, will not have a
material effect on the performance of the Company. The Year 2000 budget for 1999
is $50,000. Total direct costs to date are less than $14,000 (excluding employee
hours). Purchased hardware and software will be capitalized in accordance with
normal policy. The majority of costs associated with new software or upgraded
hardware would have been incurred in the normal course of operations regardless
of the year 2000 issue.
The Company's potentially worst case Year 2000 scenarios may include the
failure of a vendor or third party provider, which is beyond the Company's
control. In the event a failure occurs, the Company expects to be able to
implement manual contingency systems without serious impact on the Company's
financial condition. The Company has created several basic contingency plans and
is currently in the process of assessing these plans for the possible impact of
Year 2000 failures. It will adjust its existing contingency plans where
appropriate and possible for those scenarios that may have the most severe
impact on its operations. This activity is expected to be substantially complete
in the first quarter of 1999. Management believes the Company is adequately
addressing the Year 2000 issue and that the current preparations and testing
being conducted all seek to minimize any potential adverse effect on the Company
or its customers.
12
<PAGE>
ASSET/LIABILITY MANAGEMENT
Market Risk
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates/prices such as interest rates, foreign currency
exchange rates, commodity prices and equity prices. The Company's primary market
risk exposure is interest rate risk. The ongoing monitoring and management of
this risk is an important component of the Company's asset/liability management
process which is governed by policies established by its Board of Directors that
are reviewed and approved annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to its
Asset/Liability Committee ("ALCO"). In this capacity, ALCO develops guidelines
and strategies impacting the Company's asset/liability management process based
upon estimated market risk sensitivity, policy limits and overall market
interest rate levels/trends.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in
market interest rates. As interest rates change, the interest income and expense
streams associated with the Company's financial instruments also change thereby
impacting net interest income ("NII"), the primary component of the Company's
earnings. ALCO utilizes the results of a detailed and dynamic simulation model
to quantify the estimated exposure of NII to sustained interest rate changes.
While ALCO routinely monitors simulated NII sensitivity over a rolling two-year
horizon, it also utilizes additional tools to monitor potential longer-term
interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all assets and liabilities
reflected on the Company's statement of financial condition. This sensitivity
analysis is compared to ALCO policy limits which specify a maximum tolerance
level for NII exposure over a one year horizon, assuming no balance sheet
growth, given both a 200 basis point (bp) upward and downward shift in interest
rates. A parallel and pro rata shift in rates over a 12 month period is assumed.
Liquidity
Liquidity represents the ability to meet both asset growth and deposit
withdrawals. Many factors affect a company's ability to meet liquidity needs,
including changes in the markets served, its asset-liability mix, its reputation
and credit standing in the market and general economic conditions. In addition
to traditional in-market deposit sources, the Company has other sources of
liquidity, including proceeds from maturing investment securities and loans, the
sale of investment securities, Federal Funds through correspondent bank
relationships and FHLB borrowings. Additional liquidity is available in the loan
portfolio through sale of residential mortgages and the guaranteed portion of
SBA loans. Management believes that the level of liquidity is sufficient to meet
current and future funding requirements.
CAPITAL
At December 31, 1998, shareholders' equity totaled $20.7 million or 10.3%
of total assets, as compared to $11.0 million or 6.1% at December 31, 1997. The
increase in shareholders' equity was due to net income of $1.9 million and the
Company's initial public offering in August 1998 resulting in the issuance of
690,000 shares of common stock which produced additional capital of $7.7
million.
Capital guidelines issued by the Federal Reserve Board require the Company
to maintain certain ratios. The Company's risk based capital ratios for Tier 1
and Tier 2 Capital (as defined by federal banking agency regulations) at
December
13
<PAGE>
31, 1998 of 16.39% and 17.89%, respectively, exceed regulatory guidelines for a
"well capitalized" financial institution. The Company's Tier 1 and Tier 2 risk
based capital ratios at December 31, 1997 were 9.77% and 11.30%, respectively.
The Bank is also subject to federal regulatory capital requirements. At December
31, 1998, the Bank was deemed to be "well capitalized" under the applicable
regulations.
IMPACT OF NEW ACCOUNTING STANDARDS
The Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income," in 1998. The
statement contains certain presentation and disclosure requirements concerning
the components of comprehensive income and the changes therein. The consolidated
statement of changes in shareholders' equity has been presented in accordance
with the requirements of the statement.
In 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) No. 98-5, "Reporting on the Costs of Start-Up
Activities." The SOP requires costs of start-up activities to be expensed as
incurred. The SOP is effective for years beginning after December 15, 1998.
Adoption of the SOP is expected to have no effect on net income for 1999.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," is effective for years beginning after December 31, 1997. This
statement requires a company to disclose certain income statement and balance
sheet information by operating segment. Since the Company's operations include
only its banking activities, no additional disclosure standards will be imposed
on the Company.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," is effective for years beginning January 1, 2000. This statement
sets accounting and reporting standards for derivative instruments and hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at fair
value. This statement is expected to have no impact on the Company.
MARKET FOR COMMON STOCK
The common stock of Merrill Merchants Bancshares, Inc. (ticker symbol
"MERB") began trading on the Nasdaq National Market System in August 1998. Prior
to that date, the stock was not traded on any exchange and the common stock was
subject to trading restrictions. Market prices for the Company's common stock
(since the initial public offering) and dividends declared per quarter during
1998 are as follows:
<TABLE>
<CAPTION>
Dividends Declared Market Prices
1998 Quarters Per Share High Low
<S> <C> <C> <C>
First $.03 - -
Second .03 - -
Third .03 $15.25 $12.50
Fourth .05 $13.75 $11.25
</TABLE>
The Company declared its first cash dividend to shareholders in the
fourth quarter of 1997 of $.03 per common share.
As of December 31, 1998, the Company had approximately 1,021
shareholders of record and 2,388,036 shares outstanding.
There are significant regulatory limitations on the Company's ability
to pay dividends depending on the dividends it receives from its subsidiary,
Merrill Merchants Bank, which are subject to regulations and the Bank's
continued compliance with all regulatory capital requirements and the overall
health of the institution. In addition, the Company has a class of cumulative
preferred stock, meaning that if dividends are not paid when declared, they will
accumulate and be payable in full before any dividends are paid on common stock.
See notes 14 and 16 of the notes to the consolidated financial statements for a
discussion of the preferred stock and the Bank's regulatory matters,
respectively.
14
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Merrill Merchants Bancshares, Inc.
We have audited the consolidated statements of financial condition of
Merrill Merchants Bancshares, Inc. and Subsidiary as of December 31, 1998 and
1997 and the related consolidated statements of income, changes in shareholders'
equity and cash flows for the years then ended. These consolidated financial
statements are the responsibility of management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Merrill Merchants Bancshares, Inc. and Subsidiary at December 31,
1998 and 1997 and the consolidated results of their operations and their
consolidated cash flows for the years then ended in conformity with generally
accepted accounting principles.
/s/ BERRY DUNN MCNEIL & PARKER
BERRY DUNN MCNEIL & PARKER
Bangor, Maine
January 11, 1999
15
<PAGE>
MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
(In Thousands, Except Number of Shares and per Share Data) 1998 1997
<S> <C> <C>
ASSETS
Cash and due from banks $ 6,081 $ 7,486
Interest-bearing deposits with banks 46 28
Federal funds sold 1,500 2,650
-------- --------
Total cash and cash equivalents 7,627 10,164
Investment securities
Available for sale 55,241 43,359
To be held to maturity 668 1,962
Loans held for sale 2,875 508
Loans receivable 127,655 118,888
Less allowance for loan losses 2,023 1,717
-------- --------
Net loans receivable 125,632 117,171
Other real estate owned 12 43
Properties and equipment, net 2,777 2,806
Deferred income tax benefit 189 129
Accrued income and other assets 4,722 2,477
-------- --------
Total assets $199,743 $178,619
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Demand deposits $ 25,207 $ 25,018
Savings and NOW deposits 79,737 64,513
Certificates of deposit 59,184 56,781
-------- --------
Total deposits 164,128 146,312
Securities sold under agreements to repurchase (term and demand) 11,747 11,897
Other borrowed funds 1,461 5,144
Accrued expenses and other liabilities 1,452 1,104
Long-term debt -- 2,895
Mandatory convertible debentures 300 300
-------- --------
Total liabilities 179,088 167,652
Commitments (Notes 6, 7, 13, 16 and 18)
Shareholders' equity
Convertible cumulative preferred stock, par value $1; authorized
50,000 shares, issued and outstanding 19,566 shares 20 20
Common stock, par value $1; authorized 4,000,000 shares, issued and
outstanding 2,388,036 and 1,542,123 shares in 1998 and 1997, respectively 2,388 1,542
Capital surplus 15,527 7,754
Retained earnings 2,638 1,647
Unrealized gain on securities available for sale, net of tax of $43 and $2 in
1998 and 1997, respectively 82 4
-------- --------
Total shareholders' equity 20,655 10,967
-------- --------
Total liabilities and shareholders' equity $199,743 $178,619
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
16
<PAGE>
MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
(In Thousands, Except Number of Shares and per Share Data) 1998 1997
<S> <C> <C>
Interest and dividend income
Interest and fees on loans $ 11,655 $ 10,669
Interest on investment securities 2,512 2,172
Dividends on investment securities 216 203
Interest on federal funds sold 203 171
-------- --------
Total interest and dividend income 14,586 13,215
-------- --------
Interest expense
Interest on deposits 5,710 5,126
Interest on borrowed funds 844 934
-------- --------
Total interest expense 6,554 6,060
-------- --------
Net interest income 8,032 7,155
Provision for loan losses 360 355
-------- --------
Net interest income after provision for loan losses 7,672 6,800
-------- --------
Other income
Service charges on deposit accounts 516 476
Other service charges and fees 523 485
Trust fees 662 534
Net gain on sale of mortgage loans 297 91
Other 213 138
-------- --------
Total other income 2,211 1,724
Other expense
Salaries and employee benefits 3,510 3,121
Occupancy expense 635 626
Equipment expense 511 524
Data processing 671 605
Other 1,612 1,481
-------- --------
Total other expense 6,939 6,357
-------- --------
Income before income taxes 2,944 2,167
Income tax expense 1,028 765
-------- --------
Net income $ 1,916 $ 1,402
======== ========
Per share data
Basic earnings per common share $ 0.96 $ 0.82
======== ========
Diluted earnings per common share $ 0.78 $ 0.71
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
17
<PAGE>
MERRILL MERCHANTS BANCSHARES,INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In Thousands, Except Number of Shares and per Share Data)
<TABLE>
<CAPTION>
Unrealized
Gain (Loss) on
Convertible Securities Total
Cumulative Common Capital Retained Available Shareholders'
Preferred Stock Stock Surplus Earnings for Sale Equity
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $ 20 $ 1,469 $ 7,331 $ 861 $ (10) $ 9,671
Net income -- -- -- 1,402 -- 1,402
Change in unrealized gain (loss) on
securities available for sale, net of
deferred income taxes of $7 -- -- -- -- 14 14
-------- -------- -------- -------- -------- --------
Total comprehensive income -- -- -- 1,402 14 1,416
5% common stock dividend declared -- 73 423 (497) -- (1)
Common stock cash dividend declared,
$.03 per share -- -- -- (43) -- (43)
Convertible cumulative preferred stock
dividends declared, $3.88 per share -- -- -- (76) -- (76)
-------- -------- -------- -------- -------- --------
Balance at December 31, 1997 $ 20 $ 1,542 $ 7,754 $ 1,647 $ 4 $ 10,967
Net income -- -- -- 1,916 -- 1,916
Change in unrealized gain on
securities available for sale, net
of deferred income taxes of $41 -- -- -- -- 78 78
-------- -------- -------- -------- -------- --------
Total comprehensive income -- -- -- 1,916 78 1,994
Common stock options exercised -- 77 309 -- -- 386
5% common stock dividend declared -- 79 489 (569) -- (1)
Common stock offering -- 690 7,448 -- -- 8,138
Offering cost -- -- (473) -- -- (473)
Common stock cash dividend declared,
$.14 per share -- -- -- (281) -- (281)
Convertible cumulative preferred stock
dividends declared, $3.84 per share -- -- -- (75) -- (75)
-------- -------- -------- -------- -------- --------
Balance at December 31, 1998 $ 20 $ 2,388 $ 15,527 $ 2,638 $ 82 $ 20,655
======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
18
<PAGE>
MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(In Thousands) YEARS ENDED DECEMBER 31,
1998 1997
<S> <C> <C>
Cash flows from operating activities
Net income $ 1,916 $ 1,402
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 375 379
Amortization 59 83
Net amortization (accretion) on investment securities 3 (69)
Deferred income taxes (101) 18
Originations of loans held for sale (32,927) (7,173)
Proceeds from sale of loans held for sale 30,666 7,026
Increase in accrued income and other assets (182) (154)
Increase in accrued expenses and other liabilities 348 140
Decrease in deferred loan fees, net (22) (33)
Provision for loan losses 360 355
Provision for losses on other real estate owned 5 2
Net gain on sale of mortgage loans and property
and equipment (295) (83)
-------- --------
Net cash provided by operating activities 205 1,893
-------- --------
Cash flows from investing activities
Net loans made to customers (8,781) (13,407)
Acquisition of premises and equipment (348) (927)
Purchase of investment securities available for sale (54,590) (40,005)
Proceeds from sales and maturities of investment securities
Sales and maturities of available for sale securities 42,824 32,538
Maturities of held to maturity securities 1,293 1,157
Proceeds from sale of other real estate owned 38 190
Acquisition of life insurance policies (1,960) (599)
-------- --------
Net cash used in investing activities (21,524) (21,053)
-------- --------
Cash flows from financing activities
Net increase in demand, savings and NOW deposits 15,413 16,046
Net increase in certificates of deposit 2,403 3,562
Net decrease in securities sold under agreement to repurchase (150) (267)
Net increase (decrease) in other borrowed funds (3,683) 2,312
Payment of long-term debt (2,895) (800)
Dividends paid on convertible cumulative preferred stock
and common stock (357) (120)
Proceeds from stock issuance, net of cost 8,051 --
-------- --------
Net cash provided by financing activities 18,782 20,733
-------- --------
Net (decrease) increase in cash and cash equivalents (2,537) 1,573
Cash and cash equivalents, beginning of year 10,164 8,591
-------- --------
Cash and cash equivalents, end of year $ 7,627 $ 10,164
======== ========
Supplemental disclosures of cash flow information
Cash paid for interest $ 6,633 $ 6,058
Transfers to other real estate owned 12 70
Income tax paid 1,118 773
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
19
<PAGE>
MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(Presented in Thousands, except Number of Shares and per Share Data)
1. Summary of Significant Accounting Policies
The accounting and reporting policies conform to generally accepted
accounting principles and to general practice within the banking industry. The
following is a summary of the significant accounting and reporting policies.
Nature of Business
Merrill Merchants Bancshares, Inc. is a one-bank holding company that owns
all of the common stock of Merrill Merchants Bank (Bank). The Bank operates
branches in Bangor (three offices), Brewer, Orono, Pittsfield, and Newport,
Maine.
The Bank's lending activities are conducted principally in central Maine.
The Bank grants single family and multi-family residential loans, commercial
real estate loans, commercial loans, and a variety of consumer loans. In
addition, the Bank grants loans for the construction of residential homes,
multi-family properties and commercial real estate properties. Most loans
granted by the Bank are either collateralized by real estate or guaranteed by
federal and local governmental authorities. The ability and willingness of the
single family residential and consumer borrowers to honor their repayment
commitments is generally dependent on the level of overall economic activity
within the borrowers' geographic areas and real estate values. The ability and
willingness of commercial real estate, commercial and construction loan
borrowers to honor their repayment commitments is generally dependent on the
health of the real estate economic sector in the borrowers' geographic areas and
the general economy.
The Bank is under the supervision of the Board of Governors of the Federal
Reserve System and the Maine Bureau of Banking, and its deposits are insured by
the Federal Deposit Insurance Corporation (FDIC).
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of the allowance for loan losses
and the valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowance for
loan losses and the carrying value of real estate owned, management obtains
independent appraisals for significant properties.
Financial Statement Presentation
The accompanying consolidated financial statements include the accounts of
Merrill Merchants Bancshares, Inc. and its wholly-owned subsidiary, Merrill
Merchants Bank, a state-chartered bank. All intercompany accounts and
transactions have been eliminated in the consolidated financial statements.
Investment Securities
Investment debt securities that management has the ability and intent to
hold to maturity are classified as held to
20
<PAGE>
maturity and carried at amortized cost. Other marketable securities are
classified as available for sale and are carried at fair value. Unrealized gains
and losses on securities available for sale, net of income taxes, are recognized
as direct increases or decreases in shareholders' equity. Cost of securities
sold is recognized using the specific identification method.
Premiums are amortized and discounts are accreted using methods
approximating the interest method.
Loans Held for Sale
Residential mortgage loans originated and intended for sale in the secondary
market are carried at the lower of aggregate cost or estimated market value.
Gains or losses on sales of loans are recognized at the time of sale and are
based upon the difference between the selling price and the carrying amount of
loans sold.
Other Real Estate Owned
Other real estate owned (OREO) includes real estate and repossessed personal
property held for sale which have been acquired principally through foreclosure
or a similar conveyance of title. Real estate may be considered to be
in-substance foreclosed and included in OREO, prior to the conveyance of title
when specific criteria are met. Both foreclosed and in-substance foreclosed real
estate, as well as repossessed personal property, are carried at the lower of
their recorded amounts or fair value less estimated costs of disposal. Any
write-downs at, or prior to, the dates of acquisition are charged to the
allowance for loan losses. Subsequent write-downs are recorded in noninterest
expense. Expenses incurred in connection with holding such assets and gains and
losses upon sale are included in other expenses or other income.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal adjusted for any charge-offs, the allowance for loan
losses, and any deferred fees or costs.
Interest on loans is accrued and credited to income based on the principal
amount outstanding. The accrual of interest on loans is discontinued when, in
the opinion of management, there is an indication that the borrower may be
unable to meet payments as they become due or the loan becomes past due 90 days
or more. Upon such discontinuance, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received.
The allowance for loan losses is maintained at a level adequate to absorb
probable losses. Management determines the adequacy of the allowance based upon
reviews of individual credits, recent loss experience, current economic
conditions, the risk characteristics of the various categories of loans and
other pertinent factors. Loans deemed uncollectible are charged to the
allowance. Provisions for loan losses and recoveries on loans previously charged
off are added to the allowance.
Loans considered to be impaired are reduced to the present value of expected
future cash flows or to the fair value of collateral, by allocating a portion of
the allowance for loan losses to such loans. If these allocations cause the
allowance for loan losses to require an increase, such increase is included in
the provision for loan losses.
Loan Servicing
The cost of mortgage servicing rights is amortized in proportion to, and
over the period of, estimated net servicing revenues. Impairment of mortgage
servicing rights is assessed based on the fair value of those rights. Fair
values are estimated using discounted cash flows based on a current market
interest rate. For purposes of measuring impairment, the rights are stratified
based on loan type, investor type, and interest rate. The amount of impairment
recognized is the amount by which the capitalized mortgage servicing rights for
a stratum exceed their fair value.
21
<PAGE>
Properties and Equipment
Properties and equipment are stated at cost, less accumulated depreciation.
The provision for depreciation is computed principally by accelerated methods.
Organization Costs and Goodwill
Organization costs and goodwill are being amortized using the straight-line
method over seven and fifteen years, respectively.
Loan Origination Fees and Costs
Loan origination fees and certain direct origination costs are capitalized
and recognized as an adjustment of the yield on the related loan.
Income Taxes
The Company records deferred tax assets and liabilities for future tax
consequences attributable to differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit, letters of credit and unadvanced commitments under commercial and home
equity lines of credit, credit cards, and overdraft protection accounts. Such
financial instruments are recorded in the consolidated financial statements when
they become payable.
Cash and Cash Equivalents
For the purpose of presentation in the consolidated statements of cash
flows, cash and cash equivalents are defined as cash and due from banks,
interest-bearing deposits with banks and federal funds sold.
Earnings Per Share
The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 128, "Earnings Per Share." SFAS 128 specifies the computation and disclosure
requirements for earnings per share for entities with publicly held common stock
or potential common stock. The effect of SFAS No. 128 on the Company's financial
statements is to retroactively present basic and diluted earnings per share.
The basic earnings per share computation is based upon the weighted-average
number of shares of stock outstanding during the period. Potential common stock
is considered in the calculation of weighted-average shares outstanding for
diluted earnings per share.
The Company declared 5% stock dividends in 1998 and 1997. Earnings and cash
dividends per share and weighted-average shares outstanding have been
retroactively restated to reflect the stock dividends, as well as the stock
split effected in the form of an 800% stock dividend with an effective date of
July 20, 1998.
Impact of Recently Issued Accounting Standards
The Company adopted SFAS No. 129, "Disclosure of Information about Capital
Structure," in 1997. This statement has no effect on the Company's financial
statements as the capital disclosures meet the requirements of SFAS No. 129.
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," in 1998.
The statement contains certain presentation and disclosure requirements
concerning the components of comprehensive income and the changes therein. The
consolidated statement of changes in shareholders' equity has been presented in
accordance with the requirements of the statement.
In 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) No. 98-5, "Reporting on the Costs of Start-Up
Activities." The SOP
22
<PAGE>
requires costs of start-up activities to be expensed as incurred. The SOP is
effective for years beginning after December 15, 1998. Adoption of the SOP is
expected to have no effect on net income for 1999.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," is effective for years beginning after December 15, 1997. This
statement requires a company to disclose certain income statement and balance
sheet information by operating segment. Since the Company's operations include
only its banking activities, no additional disclosure standards will be imposed
on the Company.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," is effective for years beginning after June 15, 1999. This
statement sets accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. This statement is expected to have no impact on the Company as it
has not engaged in any derivative transactions.
2. Cash and Cash Equivalents
The Federal Reserve Board requires the Bank to maintain a rolling average
compensating balance of $400 in amounts on deposit. The Company maintains its
cash in bank deposit accounts which, at times, may exceed federally insured
limits. The Company has not experienced any losses in such accounts. The Company
believes it is not exposed to any significant risk with respect to these
accounts.
3. Investment Securities
The carrying amounts of investment securities as shown in the consolidated
statements of financial condition and their approximate fair values at December
31, 1998, and 1997 were as follows:
Securities available for sale
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1998
U.S. Treasury securities $ 20,181 $ 136 $ (13) $ 20,304
U.S. Government agencies
and corporations 4,028 10 (4) 4,034
Mortgage-backed securities
and collateralized
mortgage obligations 20,650 54 (57) 20,647
State and local government
debt securities 621 -- -- 621
U.S. Government and agency
money market funds 5,081 -- -- 5,081
Certificates of deposit 3,664 -- -- 3,664
Other securities 890 -- -- 890
--------------------------------------------------
$ 55,115 $ 200 $ (74) $ 55,241
--------------------------------------------------
</TABLE>
Securities held to maturity
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1998
Mortgage-backed securities
and collateralized
mortgage obligations $668 $ 1 $ -- $669
--------------------------------------------------
</TABLE>
Securities available for sale
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1997
U.S. Treasury securities $20,973 $ 79 $ (9) $21,043
U.S. Government agencies
and corporations 3,581 2 (4) 3,579
Mortgage-backed securities
and collateralized
mortgage obligations 15,912 20 (81) 15,851
State and local government
debt securities 1,402 -- -- 1,402
U.S. Government and agency
money market funds 166 -- -- 166
Certificates of deposit 495 -- -- 495
Other securities 823 -- -- 823
--------------------------------------------------
$43,352 $101 $(94) $43,359
--------------------------------------------------
</TABLE>
23
<PAGE>
Securities held to maturity
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1997
Mortgage-backed securities
and collateralized
mortgage obligations $1,962 $ -- $ (4) $1,958
--------------------------------------------------
</TABLE>
At December 31, 1998, investment securities with amortized cost of $28,215
and fair value of $28,372 were pledged to secure public deposits, treasury tax
and loan deposits and borrowings and for other purposes required or permitted by
law.
The amortized cost and fair value of debt securities at December 31, 1998,
by contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Securities available for sale Securities held to maturity
Amortized Fair Amortized Fair
Cost Value Cost Value
<S> <C> <C> <C> <C>
Due in one year or less $ 13,679 $ 13,741 $ -- $ --
Due from one to five years 15,937 16,006 -- --
Due from five to ten years 7,639 7,659 668 669
Due after ten years 11,889 11,864 -- --
--------------------------------------------------
$ 49,144 $ 49,270 $ 668 $ 669
--------------------------------------------------
</TABLE>
Mortgage-backed securities and collateralized mortgage obligations are
allocated among the above maturity groupings based on their final maturity
dates.
During 1998 and 1997, the Company sold U.S. Government and agency money
market funds securities available for sale for total proceeds of $25,019 and
$27,302, respectively. The sales resulted in no gains or losses for 1998 and
1997.
4. Loans Receivable
The components of loans receivable were as follows:
1998 1997
Commercial $ 28,352 $ 20,819
Commercial real estate 48,896 40,984
Construction 1,833 3,012
Residential real estate 22,279 26,638
Home equity 19,362 20,036
Consumer 6,963 7,461
Less deferred loan fees (30) (62)
-----------------------------
Total $127,655 $118,888
-----------------------------
The Bank services residential mortgage loans sold to investors under
nonrecourse agreements amounting to $56,759 and $38,301 at December 31, 1998,
and 1997, respectively. Mortgage servicing rights of $191 and $69 were
capitalized in 1998 and 1997, respectively. Amortization of mortgage servicing
rights was $47 and $24 in 1998 and 1997, respectively.
Impaired loans recorded in conformity with SFAS No. 114, as amended by SFAS
No. 118, totaled $549 and $502 at December 31, 1998, and 1997, respectively. The
total allowance for loan losses related to these loans was $215 and $186 at
December 31, 1998, and 1997, respectively. The average balance of outstanding
impaired loans was $554 and $368 for 1998 and 1997, respectively. Interest
income recognized for cash payments on impaired loans during 1998 and 1997 was
not material to the consolidated financial statements.
5. Allowance for Loan Losses
An analysis of the allowance for loan losses at December 31, 1998 and 1997
is as follows:
1998 1997
Balance at beginning of year $ 1,717 $ 1,450
Add: Provision for loan losses 360 355
Recoveries of previous charge-offs 24 12
Less: Loans charged off (78) (100)
-------------------------
Balance at end of year $ 2,023 $ 1,717
-------------------------
24
<PAGE>
6. Properties and Equipment
Properties and equipment are comprised of the following:
1998 1997
Land $ 435 $ 245
Bank premises 1,861 1,862
Furniture and equipment 2,152 2,029
Leasehold improvements 197 195
--------------------------
Total cost 4,645 4,331
Less accumulated depreciation 1,868 1,525
--------------------------
Net properties and equipment $ 2,777 $ 2,806
--------------------------
Certain Bank facilities and equipment are leased under various operating
leases. Rental expense was approximately $235 and $217 for 1998 and 1997,
respectively. Future minimum rental commitments under noncancelable leases at
December 31, 1998 are:
1999 $234
2000 244
2001 242
2002 187
2003 147
Thereafter 255
------
$1,309
======
7. Employee Benefit Plans
The Company has established a defined contribution pension plan under
Section 401(k) of the Internal Revenue Code. Plan participants, who consist of
all employees meeting minimum age and service requirements who elect to
participate, are permitted to contribute a percentage of their wages to the plan
on a pre-tax basis. The Company matches a portion of each employee's
contribution, resulting in an expense of $60 and $39 for 1998 and 1997,
respectively.
In 1997, the Company adopted a nonqualified supplemental executive
retirement plan for the benefit of key employees. In connection with this plan,
the previously existing nonqualified deferred compensation arrangement was
terminated. Life insurance polices were acquired for the purpose of serving as
the primary funding source. The amount of each annual benefit is indexed to the
financial performance of each insurance policy owned by the Bank over the Bank's
cost of funds expense. The present value of these benefits is being accrued over
the employment service period which amounted to $25 for 1998 and $0 for 1997.
The cash value of these policies was $2,559 and $599 at December 31, 1998, and
1997, respectively.
8. Deposits
The aggregate amount of certificates of deposit with a minimum denomination
of $100 was $10,764 and $10,522 at December 31, 1998, and 1997, respectively.
At December 31, 1998, the scheduled maturities of certificates of deposit
are as follows:
1999 $34,033
2000 16,209
2001 2,479
2002 6,103
2003 and thereafter 360
-------
$59,184
-------
9. Borrowed Funds
Securities sold under agreements to repurchase generally mature within one
to four days from the transaction date. Other borrowed funds consist of Federal
Home Loan Bank (FHLB) advances and treasury, tax and loan deposits. Treasury tax
and loan deposits are repaid upon notification by the U.S. Treasury.
Information concerning securities sold under agreements to repurchase is
summarized as follows:
1998 1997
Average balance during the year $12,163 $11,931
Average interest rate during the year 4.23% 4.28%
Average interest rate at end of the year 3.60% 4.30%
Maximum month-end balance during the year 13,554 12,991
25
<PAGE>
The Bank is required to own stock of the FHLB in order to borrow from the
FHLB. FHLB advances are collateralized by a pledge of certain mortgage loans and
by a lien on the Bank's FHLB stock of $557 at December 31, 1998, which is
included in investment securities available for sale in the consolidated
statements of financial condition.
A summary of borrowing from the FHLB at December 31, 1998, is as follows:
Final Maturity Interest Rate Amount
September 1999 5.79% $ 117
April 2001 5.81 12
September 2002 6.18 234
September 2007 6.47 634
-----
$ 997
-----
Maturities on FHLB borrowings are as follows:
1999 $ 230
2000 120
2001 140
2002 119
2003 72
Thereafter 316
-----
Total $ 997
-----
10. Mandatory Convertible Debentures
The Company issued $300 of mandatory convertible debentures which bear
interest at 1% per annum in excess of the prime rate of interest of the Bank of
Boston N.A. Interest is payable on March 31, June 30, September 30, and December
31 of each year until the debentures are paid in full or converted into shares
of common stock. On or prior to September 30, 2002, the holders of the
debentures must convert the entire principal amount into shares of common stock
of Merrill Merchants Bancshares, Inc. at a conversion rate equal to $4.50 of
principal amount of debentures for one share of common stock, subject to
adjustment for any recapitalization of common stock, such as a split or reverse
split of common stock.
The debentures are unsecured and any payment of interest or principal will
be subordinated to the timely payment of principal and interest on all existing
and future obligations of the Company for borrowed money from any bank, trust
company, insurance company or other financial institution engaged in the
business of lending money.
11. Income Taxes
The current and deferred components of income tax expense are as follows:
1998 1997
Current
Federal $1,093 $722
State 36 25
------ ----
1,129 747
Deferred (101) 18
------ ----
$1,028 $765
------ ----
The actual tax expense differs from the expected tax expense computed by
applying the applicable U.S. federal corporate income tax rate to income before
income taxes as follows:
1998 1997
Computed tax expense $1,001 $737
Increase in income tax expense resulting from:
State taxes, net of federal benefit 24 16
Other 3 12
------ ----
$1,028 $765
------ ----
The tax effects of temporary differences that give rise to deferred income
tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1998 1997
Asset Liability Asset Liability
<S> <C> <C> <C> <C>
Allowance for loan losses $276 $-- $153 $--
Unrealized gain on securities available for sale -- 43 -- 2
Start-up costs -- 22 -- 49
Mortgage servicing rights -- 88 -- 39
Deferred compensation 22 -- 29 --
Other 55 11 37 --
---------------------------------
$353 $164 $219 $90
---------------------------------
</TABLE>
26
<PAGE>
Management expects the Company will realize all deferred income tax benefits
to offset the income tax liabilities arising from the reversal of taxable
temporary differences and taxable income generated in future years. Accordingly,
the Company has not established a valuation allowance for deferred income tax
benefits.
12. Related Parties
The Bank has entered into loan transactions with its directors, executive
officers, significant shareholders and their affiliates (related parties). Such
transactions were made in the ordinary course of business on substantially the
same terms and conditions, including interest rates and collateral, as those
prevailing at the same time for comparable transactions with other customers,
and did not, in the opinion of management, involve more than normal credit risk
or present other unfavorable features. Loans to related parties which in
aggregate exceed $60 were as follows:
1998 1997
Balance, January 1 $2,562 $3,190
Loans made/advanced 3,041 77
Repayments (604) (705)
------ ------
Balance, December 31 $4,999 $2,562
------ ------
Commitments, as described in Note 13, to related parties which in aggregate
exceed $60 totaled $4,004 and $4,240 at December 31, 1998, and 1997,
respectively.
13. Financial Instruments With Off-Balance-Sheet Risk
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers which
involve, to varying degrees, elements of credit risk in excess of the amount
recognized in the consolidated statements of financial condition. The Bank's
exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit is represented by the
contractual notional amount of those instruments. The Bank follows the same
credit policies in making commitments and conditional obligations as it does for
on- balance-sheet instruments, including requiring collateral or other security
to support financial instruments with credit risk.
The Bank's commitments at December 31, 1998, and 1997 are as follows:
1998 1997
Commitments to extend credit $6,735 $4,392
Letters of credit 1,153 804
Unadvanced commitments
Commercial lines of credit 15,529 14,741
Construction lines of credit 774 893
Home equity lines of credit 10,193 10,421
Overdraft protection accounts 1,507 1,397
Credit card lines 2,386 2,157
14. Shareholders' Equity
On February 28, 1998, the Company declared a 5% stock dividend on its common
stock. Earnings per share for 1998 and 1997 have been restated to reflect this
stock dividend.
In 1998, the Company increased the number of authorized shares of common
stock and declared a stock split effected in the form of an 800% stock dividend,
with an effective date of July 20, 1998. All share and per share information
presented in the accompanying consolidated financial statements has been
retroactively adjusted for the stock split.
Holders of preferred stock are entitled to dividends equal to the total
stated value of $46.00 per share multiplied by the prime rate in effect from
time to time as announced by Bank of Boston. The dividends payable on the
preferred stock are cumulative, meaning that if dividends are not paid when
declared, they will accumulate and be payable in full before any dividends are
paid on common stock. However, the pay-
27
<PAGE>
ment of any dividends on or the redemption of the preferred stock is subordinate
to the payment of any debt by the Company. The preferred stock is non-voting.
Each share of preferred stock is convertible into 10.22 shares of common
stock, adjusted for recapitalization of the common stock (such as a split or
stock dividends). After October 1, 2002, and to the extent not previously
converted into common stock, the preferred stock may be redeemed by the Company
for a price equal to the sum of its stated value plus unpaid and accrued
dividends. However, the preferred stock may not be called or redeemed by the
Company unless approved in advance by the Federal Reserve Bank of Boston.
15. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except for number of shares and per share data):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Basic earnings per share
Net income, as reported $ 1,916 $ 1,402
Preferred stock dividends declared (75) (76)
--------------------------------
Income available to common shareholders $ 1,841 $ 1,326
================================
Weighted-average shares outstanding 1,925,595 1,619,226
================================
Basic earnings per share $ 0.96 $ 0.82
================================
Diluted earnings per share
Net income, as reported $ 1,916 $ 1,402
Interest on mandatory convertible
debentures, net of tax 19 19
--------------------------------
Income available to common shareholders $ 1,935 $ 1,421
================================
Weighted-average shares outstanding 1,925,595 1,619,226
Effect of stock options, net of assumed
treasury stock purchases 280,367 118,170
Effect of convertible preferred stock 199,935 199,935
Effect of mandatory convertible debentures 66,654 66,654
--------------------------------
Adjusted weighted-average
shares outstanding 2,472,551 2,003,985
================================
Diluted earnings per share $ 0.78 $ 0.71
================================
</TABLE>
16. Regulatory Matters
The Company and Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Company and Bank's consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and Bank must meet specific capital guidelines
that involve quantitative measures of the Company's and Bank's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Company's and Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and Bank to maintain minimum amounts and ratios (set forth
in the table below) of total and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes as of December 31, 1998, that
the Company and Bank meet all capital adequacy requirements to which they are
subject.
As of December 31, 1998, the most recent notification from the Federal
Reserve Bank categorized the Company and Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized "well
capitalized," the Company and Bank must maintain minimum total risk-based, Tier
I risk-based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed this category.
The Company's and Bank's actual capital amounts and ratios are also
presented in the table. No deduction was made from capital for interest-rate
risk in 1998 and 1997.
28
<PAGE>
<TABLE>
<CAPTION>
To Be Well Capitalized Under
Actual For Capital Adequacy Purposes Prompt Corrective Action Provisions
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
As of December 31, 1998 -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk weighted assets)
Consolidated $ 22,099 17.89% $ 9,883 8.00% N/A
Bank 16,510 13.49 9.791 8.00 $ 12,239 10.00%
Tier I capital (to risk weighted assets)
Consolidated 20,249 16.39 4,942 4.00 N/A
Bank 14,974 12.23 4,896 4.00 7,343 6.00
Tier I capital (to average assets)
Consolidated 20,249 10.31 7,854 4.00 N/A
Bank 14,974 7.84 7,636 4.00 9,545 5.00
As of December 31, 1997
Total capital (to risk weighted assets)
Consolidated $ 12,201 11.30% $ 8,635 8.00% N/A
Bank 14,974 13.88 8,632 8.00 $ 10,790 10.00%
Tier I capital (to risk weighted assets)
Consolidated 10,547 9.77 4,318 4.00 N/A
Bank 13,621 12.62 4,316 4.00 6,474 6.00
Tier I capital (to average assets)
Consolidated 10,547 6.06 6,981 4.00 N/A
Bank 13,621 7.85 6,960 4.00 8,700 5.00
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
17. Other Expense
Other expense amounts are summarized as follows for 1998 and 1997:
1998 1997
Professional fees $254 $215
Merchant and credit card processing 251 191
Advertising and promotion 204 191
Other 216 211
Printing, postage, stationery and supplies 197 189
Trust expense 110 106
Travel, meetings, conventions and employee education 109 101
Amortization 107 107
Telephone 99 86
Insurance 65 84
----------------
Total $1,612 $1,481
----------------
18. Stock Options
Under the Employee and Director Stock Option Plan, the incentive stock
option plan (ISO) for officers and employees and the nonstatutory stock option
plan (Non-ISO) for directors provide for the issuance of up to 645,900 shares of
common stock. The purchase price of the stock covered by each option shall be
its fair market value, which must be equal to at least 100% of the book value of
common stock, on the date such option is granted. Substantially all the options
were granted subject to an initial vesting period which ended on December 31,
1997, after which options become exercisable until May 26, 2003.
The Company accounts for these options in accordance with Accounting
Principles Board Opinion No. 25, "Accounting
29
<PAGE>
for Stock Issued to Employees." As the exercise price of each option equals the
market price of the Company's stock on the date of grant, no compensation cost
has been recognized for the plan. Had compensation cost for the plan been
determined based on the fair value of the options at the grant dates consistent
with the method described in SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's 1998 and 1997 net income and earnings per share
would have been reduced to the pro forma amounts indicated below.
(In thousands except for per-share data) Earnings per Share
Net Income Basic Diluted
1998 As reported $1,916 $0.96 $0.78
Pro forma 1,848 0.92 0.75
1997 As reported 1,402 0.82 0.71
Pro forma 1,371 0.80 0.69
The fair value of each option is estimated on the date of grant using the
Black-Scholes options-pricing model with the following weighted-average
assumptions used for all grants in 1998 and 1997: dividend yield of 1.78% in
1998 and 0% in 1997, risk-free interest rate of 6%, expected lives of one year,
and expected volatility of 27%.
A summary of the status of the plan as of December 31, 1998, and 1997, and
changes during the years then ended, is presented below.
<TABLE>
<CAPTION>
1998 1997
Weighted Weighted
Number Average Number Average
of Shares Exercise Price of Shares Exercise Price
<S> <C> <C> <C> <C>
Outstanding at beginning
of year 469,917 $5.09 421,218 $5.24
Granted during the year 81,900 6.84 27,900 6.59
Exercised during the year (77,244) 5.01 -- --
Forfeited during the year (4,500) 6.87 -- --
Additional shares for which
options are exercisable
due to stock dividends 23,058 -- 20,799 --
-----------------------------------------------------
Outstanding at end of year 493,131 $5.16 469,917 $5.09
--------- -------
</TABLE>
The following information applies to options outstanding at December 31,
1998:
Number outstanding 493,131
Range of exercise prices $4.59-$6.87
Weighted-average exercise price $5.16
Weighted-average remaining contractual life Less than one year
19. Fair Value of Financial Instruments
Fair value estimates, methods and assumptions are set forth below for the
Company's financial instruments.
Cash and Cash Equivalents
The fair value of cash and due from banks, interest-bearing deposits with
banks and federal funds sold approximates their relative book values at December
31, 1998, and 1997, as these financial instruments have short maturities.
Investment Securities
The fair values of investment securities are estimated based on bid prices
published in financial newspapers or bid quotations received from securities
dealers.
Loans Held for Sale
The fair values of loans held for sale are based on quoted market prices
from the Federal National Mortgage Association.
Loans Receivable
Fair values are estimated for portfolios of loans receivable with similar
financial characteristics. The fair values approximate carrying value for all
loans with variable interest rates.
The fair values of fixed rate loans are calculated by discounting scheduled
cash flows through the estimated maturity using estimated market discount rates
that reflect the risk inherent in the loan. The estimates of maturity are based
on the Bank's historical experience with repayments for each loan
classification, modified, as required, by an estimate
30
<PAGE>
of the effect of current economic and lending conditions, and the effects of
estimated prepayments.
Management has made estimates of fair value using discount rates that it
believes to be reasonable. However, because there is no market for many of these
financial instruments, management has no basis to determine whether the fair
value presented below would be indicative of the value negotiated in the actual
sale.
Cash Surrender Value of Life Insurance
The fair value is based on the actual cash surrender value of life insurance
policies.
Accrued Interest Receivable
The fair value approximates the carrying value as this financial instrument
has a short maturity. It is the Bank's policy to stop accruing interest on loans
for which it is probable that the interest is not collectible. Therefore, the
fair value of this financial instrument has been adjusted to reflect credit
risk.
Capitalized Mortgage Servicing Rights
The fair value of mortgage servicing rights is based on the expected present
value of future mortgage servicing income, net of estimated servicing costs,
considering market consensus loan prepayment predictions.
Deposits
The fair value of deposits with no stated maturity, such as
noninterest-bearing demand deposits, savings, NOW accounts and money market
accounts, is equal to the amount payable on demand. The fair value of
certificates of deposit is based on the discounted value of contractual cash
flows. The discount rate is estimated using the rates currently offered for
deposits of similar remaining maturities.
The fair value estimates do not include the benefit that results from the
low-cost funding provided by the deposits compared to the cost of borrowing
funds in the market. If that value were considered, the fair value of the Bank's
net assets could increase.
Borrowed Funds
The fair value approximates the carrying value as these financial
instruments have short maturities, variable interest rates, or both.
Accrued Interest Payable
The fair value approximates the book value as this financial instrument has
a short maturity.
Off-Balance Sheet Instruments
The Company's off-balance sheet instruments consist of loan commitments.
Fair values for loan commitments have not been presented as the future revenue
derived from such financial instruments is not significant.
Limitations
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These values
do not reflect any premium or discount that could result from offering for sale
at one time the Company's entire holdings of a particular financial instrument.
Because no market exists for a significant portion of the Company's financial
instruments, fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments, and other factors. These estimates are subjective
in nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based on existing on and off balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value
31
<PAGE>
of assets and liabilities that are not considered financial instruments. Other
significant assets and liabilities that are not considered financial instruments
include property and equipment and other real estate owned. In addition, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in any of the estimates.
A summary of the estimated fair values for the Company's significant
financial instruments at December 31, 1998, and 1997 follows:
Carrying Estimate of
December 31, 1998 Value Fair Value
Financial Assets
Cash and cash equivalents $ 7,627 $ 7,627
Investment securities 55,909 55,910
Loans held for sale 2,875 2,895
Loans receivable, net 125,632 126,835
Cash surrender value of life insurance 2,559 2,559
Accrued interest receivable 1,152 1,152
Capitalized mortgage servicing rights 259 334
Financial Liabilities
Deposits 164,128 164,486
Accrued interest payable 148 148
Borrowed funds 13,508 13,508
December 31, 1997
Financial Assets
Cash and cash equivalents $ 10,164 $ 10,164
Investment securities 45,321 45,317
Loans held for sale 508 511
Loans receivable, net 117,171 117,372
Cash surrender value of life insurance 599 599
Accrued interest receivable 1,109 1,109
Capitalized mortgage servicing rights 115 115
Financial Liabilities
Deposits 146,312 146,842
Accrued interest payable 227 227
Borrowed funds 20,236 20,236
20. Parent Company Financial Information
The following is summarized financial statement information for Merrill
Merchants Bancshares, Inc. as of December 31, 1998, and 1997 and for the years
then ended:
SUMMARIZED BALANCE SHEET INFORMATION
1998 1997
ASSETS
Cash $ 1 $ 1
Investment securities (fair value of $5,576 and $166
at December 31, 1998, and 1997, respectively) 5,576 166
Investment in Merrill Merchants Bank 15,381 14,041
Accrued income and other assets 22 1
Deferred income tax benefit 524 498
-----------------------
Total assets $21,504 $14,707
-----------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accrued expenses and other liabilities $ 549 $ 545
Long-term debt -- 2,895
Mandatory convertible debentures 300 300
-----------------------
Total liabilities 849 3,740
Shareholders' equity
Convertible cumulative preferred stock 20 20
Common stock 2,388 1,542
Capital surplus 15,527 7,754
Retained earnings 2,638 1,647
Unrealized gain on securities available for sale 82 4
-----------------------
Total shareholders' equity 20,655 10,967
-----------------------
Total liabilities and shareholders' equity $21,504 $14,707
-----------------------
32
<PAGE>
SUMMARIZED STATEMENTS OF INCOME INFORMATION
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Dividends from bank subsidiary $ 705 $ 701
Interest and dividend income on investments 111 12
-----------------------
Total income 816 713
Interest expense on borrowed funds 153 270
Operating expenses 33 5
-----------------------
Total expenses 186 275
-----------------------
Income before income tax benefit 630 438
Income tax benefit 25 91
-----------------------
Income before equity in undistributed net income of subsidiary 655 529
Equity in undistributed net income of subsidiary 1,261 873
-----------------------
Net income $ 1,916 $ 1,402
-----------------------
SUMMARIZED STATEMENTS OF CASH FLOWS INFORMATION
1998 1997
Cash flows from operating activities
Net income $ 1,916 $ 1,402
Adjustments to reconcile net income to net cash
provided by operating activities
Deferred income tax benefit (27) (91)
Equity in undistributed net income of subsidiary (1,261) (873)
(Increase) decrease in accrued income and other assets (21) 1
Increase in accrued expenses and other liabilities 4 73
-----------------------
Net cash provided by operating activities 611 512
-----------------------
Cash flows from investing activities
Proceeds from sale of investment securities 3,019 602
Purchase of investment securities (8,429) (220)
-----------------------
Net cash (used) provided by investing activities (5,410) 382
-----------------------
Cash flows from financing activities
Dividends paid on convertible cumulative preferred stock (75) (76)
Dividends paid on common stock (282) (44)
Payment of long-term debt (2,895) (800)
Proceeds from stock issuance 8,524 --
Payment of offering cost (473) --
-----------------------
Net cash provided (used) by financing activities 4,799 (920)
-----------------------
Net decrease in cash and cash equivalents 0 (26)
Cash and cash equivalents, beginning of year 1 27
-----------------------
Cash and cash equivalents, end of year $ 1 $ 1
-----------------------
</TABLE>
Employees
Cindy L. Allen Marilyn M. Harlow Donna M. Poland
Alison J. Bailey Renee D. Hawthorne Kathleen G. Prescott*
Nancy L. Bellfleur Diane Hewett Andrew C. Reed*
Scott D. Bennett Bonita L. Hodgins Cindy L. Rickman
Albert C. Blanchard Jody E. Holmes Carole L. Robinson
Alena J. Bonenfant Sherry Horn Micheline K. Ross
Jacqueline A. Bouchey* Jerry C. Jarrell* Yvon L. Routhier
Pamela J. Bowerman Judith D. Kelly Dianne L. Roy
Cynthia J. Brawn Julie A. Kelly Patricia A. Roy
Darleen M. Brown Linda J. Kenney Kim A. Ryan
Angela T. Butler* Janet L. Kochis Mary L. Scott
Judy M. Byram Jennifer D. Lander Stacie A. Severance
Eva M. Charity Jonathan S. Lander Kelly A. Shorey
Alyson A. Coffin Ronald J. Landry Tanya M. Sibley
Jodi L. Cook Janet L. Lane Betsy A. Simpson*
Jennifer C. Coutts Cynthia L. Leighton Valrie G. Smith
Kathy Crossman* Floyd W. Libby* Leona A. Soule
George Dandaneau* Carol Littlefield Christine A. Spearing
Jayne T. Dickey Linda M. Lizotte Kathleen Spruce
David P. Doane* Mary Elizabeth Long John P. Thayer*
Marjorie J. Downing James A. MacLeod* Lorraine M. Therrien*
Patricia L. Eldridge Marian McClure Marlene D. Thomas*
Linda G. England Suzanne M. Mercier Thomas A. Tilley*
Valerie G. Enos Michael J. Moody Tricia J. Tilton
Tabatha M. Estes Kimberly A. Morrison Jerina K. Warner*
Jill B. Gardner Pamela J. Mugnai Jessica L. Welch
Barbara Giovino* Holly A. O'Halloran Danelle L. Weston
Heidi L. Gogan Deanna L. Ouellette Victoria Page Wood*
Lynne M. Gray Mary L. Page Stacey Young
Clarice J. Hannan Kim Patoka Ellen N. Ziobron
33
<PAGE>
Merrill Merchants Bancshares, Inc.
Board of Directors
William C. Bullock, Jr. Chairman
Merrill Merchants Bancshares, Inc.
Bangor, Maine
Edwin N. Clift President & Chief Executive Officer
Merrill Merchants Bancshares, Inc.
Bangor, Maine
Joseph H. Cyr President
John T. Cyr & Sons, Inc.
Old Town, Maine
Perry B. Hansen Investor
Rock Island, Illinois
Leonard E. Minsky Investor
Bangor, Maine
Joseph Sewall Chairman
James W. Sewall Company
Old Town, Maine
Dennis L. Shubert, M.D. President
Maine Neurosurgery, P.A.
Bangor, Maine
Susan B. Singer Vice President & Comptroller
MTL, Inc.
Hermon, Maine
Harold S. Wright Investor
Bangor, Maine
Officers
Chairman
William C. Bullock, Jr.
President & Chief Executive Officer
Edwin N. Clift
Treasurer
Deborah A. Jordan
Secretary
James A. MacLeod
Clerk
Norman Minsky
34
<PAGE>
Merrill Merchants Bank
Board of Directors
William C. Bullock, Jr. Chairman
Merrill Merchants Bank
Bangor, Maine
Edwin N. Clift President & Chief Executive Officer
Merrill Merchants Bank
Bangor, Maine
John S. Bacon President
Bacon Printing Company
Bangor, Maine
Joseph H. Cyr President
John T. Cyr & Sons, Inc.
Old Town, Maine
John R. Graham III President
Automatic Distributors
Bangor, Maine
Perry B. Hansen Investor
Rock Island, Illinois
Joseph P. Irish President
Waldo County Oil
Troy, Maine
Robert E. Knowles Investor
Pittsfield, Maine
J. Donald Mackintosh Investor
Lamoine, Maine
Leonard E. Minsky Investor
Bangor, Maine
Norman Minsky, Esquire Of Counsel
Gross, Minsky, Mogul & Singal
Bangor, Maine
Frederick A. Oldenburg, Jr., M.D. President
Penobscot Respiratory, P.A.
Bangor, Maine
Lloyd D. Robinson Investor
Carmel, Maine
Dennis L. Shubert, M.D. President
Maine Neurosurgery, P.A.
Bangor, Maine
Susan B. Singer Vice President & Comptroller
MTL, Inc.
Hermon, Maine
Harold S. Wright Vice Chairman
Merrill Merchants Bank
Bangor, Maine
Senior Management
Chairman
William C. Bullock, Jr.
President & Chief Executive Officer
Edwin N. Clift
Vice President, Compliance & Security
Sara E. Carr
Senior Vice President, Retail Banking
Charles W. Hart
Senior Vice President, Chief Financial Officer
Deborah A. Jordan
Senior Vice President, Commercial Banking
William P. Lucy
Senior Vice President, Marketing & Human Resources
Jane H. Madigan
Senior Vice President, Trust & Investment Services
George H. Moore, Jr.
Vice President, Systems Administration
Susan L. Rush
Senior Vice President, Mortgage Banking
Lynne A. Spooner
Senior Vice President, Operations
Reginald C. Williams, Jr.
35
<PAGE>
CORPORATE INFORMATION
Corporate Headquarters
Merrill Merchants Bancshares, Inc.
201 Main Street
Bangor, Maine 04401
207-942-4800
Inquiries and Financial Information
Analysts, shareholders and other investors seeking financial information
including our 1998 Annual Report on Form 10-KSB should contact Deborah Jordan,
Chief Financial Officer and Manager of Investor Relations at 207-942-2494.
News media and others seeking general information should contact Jane
Madigan, Senior Vice President and Manager of Media Relations at 207-990-4075.
Internet
Our internet address is: www.merrillmerchants.com or via electronic mail:
[email protected]
Stock Listing
Merrill Merchants Bancshares, Inc. is traded over the counter on the NASDAQ
National Market System under the symbol MERB.
Transfer Agent
Shareholder inquiries regarding change of address or title should be
directed to:
Trust & Investment Services Department
Merrill Merchants Bank
201 Main Street
Bangor, Maine 04401
207-990-4070
Independent Certified Public Accountants
Berry Dunn McNeil and Parker
36 Pleasant Street
Bangor, Maine 04401
Annual Shareholder Meeting
The annual meeting of shareholders will be at 5:30 p.m. on Thursday, April
15, 1999, at the Holiday Inn Civic Center, 500 Main Street, Bangor, Maine.
BRANCH LOCATIONS
Bangor
201 Main Street
920 Stillwater Avenue
992 Union Street
Brewer
366 Wilson Street
Orono
69 Main Street
Pittsfield
27 Main Street
Newport
Newport Plaza
36
Exhibit 21
Subsidiaries of Merrill Merchants Bancshares, Inc.
The following organizations are wholly-owned subsidiaries of Merrill
Merchants Bancshares, Inc.:
Name State of Incorporation
- ---- ----------------------
/s/ Merrill Merchants Bank
Merrill Merchants Bank Maine
Maine Acceptance Corporation Maine
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the incorporation by reference in the registration statement
(No. 333-63781) on Form S-8 of Merrill Merchants Bancshares, Inc. of our report
dated January 11, 1999, relating to the consolidated statements of financial
condition of Merrill Merchants Bancshares, Inc. and Subsidiary as of December
31, 1998 and 1997 and the related consolidated statements of income, changes in
shareholders' equity and cash flows for the years then ended, which report is
included in the December 31, 1998 annual report on Form 10-KSB of Merrill
Merchants Bancshares, Inc.
Bangor, Maine
March 24, 1999
/s/ Berry, Dunn, McNeil & Parker
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated Balance Sheet as of December 31, 1998 and the consolidated
statement of income for the year ended December 31, 1998 for the Company and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 6,081
<INT-BEARING-DEPOSITS> 46
<FED-FUNDS-SOLD> 1,500
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 55,241
<INVESTMENTS-CARRYING> 668
<INVESTMENTS-MARKET> 669
<LOANS> 130,530
<ALLOWANCE> 2,023
<TOTAL-ASSETS> 199,743
<DEPOSITS> 164,128
<SHORT-TERM> 13,208
<LIABILITIES-OTHER> 1,452
<LONG-TERM> 300
0
20
<COMMON> 2,388
<OTHER-SE> 18,247
<TOTAL-LIABILITIES-AND-EQUITY> 199,743
<INTEREST-LOAN> 11,655
<INTEREST-INVEST> 2,728
<INTEREST-OTHER> 203
<INTEREST-TOTAL> 14,586
<INTEREST-DEPOSIT> 5,710
<INTEREST-EXPENSE> 6,554
<INTEREST-INCOME-NET> 8,032
<LOAN-LOSSES> 360
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 6,939
<INCOME-PRETAX> 2,944
<INCOME-PRE-EXTRAORDINARY> 1,916
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,916
<EPS-PRIMARY> 0.96
<EPS-DILUTED> 0.78
<YIELD-ACTUAL> 4.66
<LOANS-NON> 148
<LOANS-PAST> 4
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,717
<CHARGE-OFFS> 78
<RECOVERIES> 24
<ALLOWANCE-CLOSE> 2,023
<ALLOWANCE-DOMESTIC> 1,500
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 523
</TABLE>
