UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-11595
Merchants Bancshares, Inc.
(Exact name of registrant as specified in its charter)
| | |
Delaware | | 03-0287342 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | |
275 Kennedy Drive, South Burlington, Vermont | | 05403 |
(Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code: (802) 658 – 3400
Securities registered pursuant to Section 12(b) of the Act:
| | |
Title of each class | | Name of each exchange on which registered |
Common Stock, par value $0.01 per share | | The NASDAQ Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [ ] Yes [X] No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.[ ] Yes [X] No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not 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-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ] Accelerated Filer [X] Nonaccelerated Filer [ ] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
The aggregate market value of the registrant’s common stock held by non-affiliates was $181,652,814 as computed using the per share price, as reported on the NASDAQ, as of market close on June 30, 2016.
As of February 24, 2017, there were 6,909,187 shares of the registrant’s common stock, par value $0.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
MERCHANTS BANCSHARES, INC. AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2016
TABLE OF CONTENTS
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties. These statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions. These statements include, among others, statements regarding our intent, belief or expectations with respect to economic conditions, trends affecting our financial condition or results of operations, and our exposure to market, interest rate and credit risk.
Forward-looking statements are based on the current assumptions and beliefs of Management and are only expectations of future results. Our actual results could differ materially from those projected in the forward-looking statements as a result of, among other factors, adverse conditions in the capital and debt markets; changes in interest rates; competitive pressures from other financial institutions and non-bank entities; weakness in general economic conditions on a national basis or in the local markets in which we operate, including changes which adversely affect borrowers’ ability to service and repay our loans; changes in the value of securities and other assets; changes in loan default and charge-off rates; the adequacy of loan loss reserves; reductions in deposit levels necessitating increased borrowing to fund loans and investments; changes in government regulation; failure to obtain the approval of our stockholders in connection with our proposed merger with Community Bank System, Inc. (“Community”); the timing to consummate the proposed merger with Community; the risk that a condition to closing of the proposed merger may not be satisfied; the risk that a regulatory approval that may be required for the proposed merger is not obtained or is obtained subject to conditions that are not anticipated; the parties’ ability to achieve the synergies and value creation contemplated by the proposed merger; the parties’ ability to successfully integrate operations in the proposed merger; the effect of the announcement of the proposed merger on our ability to maintain relationships with our key partners, customers and employees, and on our operating results and business generally; and changes in assumptions used in making such forward-looking statements, as well as the other risks and uncertainties detailed in Item 1A. “Risk Factors,” beginning on page 14 of this Annual Report on Form 10-K. Forward-looking statements speak only as of the date on which they are made. We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statement is made.
USE OF NON-GAAP FINANCIAL MEASURES
Certain information in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We use these non-GAAP measures in our analysis of our performance and believe that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods as well as demonstrating the effects of significant gains and charges in the current period. We believe that a meaningful analysis of our financial performance requires an understanding of the factors underlying that performance. We believe that investors may use these non-GAAP financial measures to analyze financial performance without the impact of unusual items that may obscure trends in our underlying performance. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
In several places net interest income is presented on a fully taxable equivalent basis. Specifically included in interest income is tax-exempt interest income from certain tax-exempt loans. An amount equal to the tax benefit derived from this tax exempt income is added back to the interest income total, to produce net interest income on a fully taxable equivalent basis. We believe the disclosure of taxable equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in our results of operations. Other financial institutions commonly present net interest income on a fully taxable equivalent basis. This adjustment is considered helpful in the comparison of one financial institution’s net interest income to that of another, as each will have a different proportion of taxable exempt interest from its earning assets. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio
of net interest income to average earning assets. A reconciliation of taxable equivalent financial information to our consolidated financial statements prepared in accordance with GAAP appears at the bottom of the table entitled “Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Net Interest Margin” on page 35.
The tangible capital ratio is the ratio of tangible stockholders’ equity (total stockholders’ equity less goodwill and core deposit intangible (“CDI”) related to the acquisition of NUVO Bank & Trust Company) divided by tangible assets (total assets less goodwill and CDI related to the NUVO acquisition). Tangible book value per share is calculated by dividing tangible stockholders’ equity by period end shares outstanding. A reconciliation of the tangible capital ratio and tangible book value per share appears on page 32 and is titled “Tangible Book Value Non-GAAP Reconciliation.”
Additionally, in several places adjusted financial measures are presented. Adjusted noninterest expense excludes non-recurring expenses not considered integral to the Company’s normal operations. Specifically excluded in adjusted noninterest expense are NUVO acquisition costs, Community merger costs, conversion costs and severance and retirement costs. Adjusted net income is GAAP net income adjusted for these non-recurring elements of noninterest expense. These adjustments are considered helpful in the comparison of noninterest expense and net income. Reconciliations of adjusted net income and adjusted noninterest expense to our consolidated financial statements prepared in accordance with GAAP appear on page 32 and 33 and are titled “Adjusted Net Income non-GAAP Reconciliation” and “Adjusted Noninterest Expense Non-GAAP Reconciliation,” respectively.
A 35.0% tax rate was used in 2016, 2015 and 2014.
PART I
ITEM 1 – BUSINESS
OVERVIEW
Merchants Bancshares, Inc. (“Merchants”) is a bank holding company originally organized under Vermont law in 1983 (and subsequently reincorporated in Delaware in 1987) for the purpose of owning all of the outstanding capital stock of Merchants Bank. Merchants Bank, which is Merchants’ primary subsidiary, is a Vermont-based commercial bank with thirty-one full-service banking offices located throughout the state of Vermont and one full-service banking office in Massachusetts.
Merchants Bank was organized in 1849; and as of December 31, 2016, is the sole remaining independent statewide commercial banking operation headquartered in Vermont, with deposits totaling $1.53 billion, gross loans of $1.51 billion, and total assets of $2.06 billion. On December 4, 2015, Merchants completed the acquisition of NUVO Bank & Trust Company, which was merged with and into Merchants Bank. As used herein, “Merchants,” “the “Company,” “we,” “us,” and “our” shall mean Merchants Bancshares, Inc. and our subsidiaries unless otherwise noted or the context otherwise requires.
Merchants Bank’s trust division offers investment management, financial planning and trustee services. As of December 31, 2016, this division had fiduciary responsibility for assets having a market value in excess of $541 million, of which more than $516 million constituted managed assets.
MBVT Statutory Trust I (the “Trust”) was formed on December 15, 2004 as part of our private placement of an aggregate of $20.62 million of trust preferred securities through a pooled trust preferred program. The Trust was formed for the sole purpose of issuing non-voting capital securities. The proceeds from the sale of the capital securities were loaned to us under junior subordinated debentures issued to the Trust. The debentures are the only asset of the Trust and payments under the debentures are the sole revenue of the Trust.
On October 22, 2016, the Company entered into a definitive merger agreement to be acquired by Community Bank System, Inc. The merger is subject to the approval by the stockholders of Merchants Bancshares, Inc. and regulatory authorities and is expected to close in the late second or early third quarter of 2017.
EMPLOYEES
As of December 31, 2016, we employed 278 full-time and 23 part-time employees. We maintain comprehensive employee benefits programs for employees, including major medical and dental insurance, long-term and short-term disability insurance, life insurance and a 401(k) plan. We believe that relations with our employees are favorable.
COMPETITION
Merchants Bank’s primary market areas are Vermont (statewide) and Western Massachusetts (Hamden County). Based upon the FDIC deposit market share data report for June 30, 2016, Merchants Bank had 10.78% of the Vermont deposit market, representing the third largest market share of deposits in Vermont; NUVO, a division of Merchants Bank, held 0.04% of the Massachusetts deposit market, with a 0.98% market share in their primary market of Hamden County. Merchants Bank and its divisions compete for commercial loans, deposits, trust and investment services, and mortgages, primarily with commercial banks, savings institutions, mortgage banking companies, and credit unions. Presently, there are eleven independent banks headquartered in the state of Vermont and twelve regional or national banks have operations in Vermont. Merchants Bank remains the only independent statewide bank headquartered in Vermont.
We believe the growth in average loans and deposits between 2006 and 2016 contributed to Merchants Bank remaining the largest Vermont-based independent bank. Customers have cited the local management and decision-making as important considerations when choosing our bank. This structure allows Merchants Bank to enter the market with a premier service offering to our customers. Our approach for deposit and loan growth is the interest rate paid, related fees,
access to services through convenient delivery channels, and development of relationships. Customer behavior necessitates increased technology in delivery channels for banking services which operate without the traditional costs of a local retail infrastructure; this has compelled Merchants Bank to compete in mobile and online technologies.
No material part of our business is dependent upon one, or a few, customers, or upon a particular industry segment, the loss of which would have a material adverse impact on our operations.
REGULATION AND SUPERVISION
General
As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”), we are subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the “FRB”). As an FDIC-insured state-chartered commercial bank, Merchants Bank is subject to regulation and supervision by the Federal Deposit Insurance Corporation (the “FDIC”) and by the Commissioner of the Department of Financial Regulation of the State of Vermont (the “Commissioner”). This regulatory framework is intended to protect depositors, the federal deposit insurance fund, consumers and the banking system as a whole, and not necessarily investors in the Company. The following discussion is qualified in its entirety by reference to the full text of the statutes, regulations, policies and guidelines described below.
Bank Holding Company Regulation
Source of Strength. Under the BHCA, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the ���Dodd-Frank Act”), the Company is required to serve as a source of financial strength for Merchants Bank. This support may be required at times when the Company may not have the resources to provide support to Merchants Bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Acquisitions and Activities. The BHCA prohibits a bank holding company, without prior approval of the FRB, from acquiring all or substantially all the assets of a bank, acquiring control of a bank, merging or consolidating with another bank holding company, or acquiring direct or indirect ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, the acquiring bank holding company would control more than 5% of any class of the voting shares of such other bank or bank holding company. The BHCA also prohibits a bank holding company from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks. However, a bank holding company may engage in and may own shares of companies engaged in certain activities that the FRB had determined to be closely related to banking or managing and controlling banks.
Limitations on Acquisitions of Company Common Stock. The Change in Bank Control Act prohibits a person or group of persons acting in concert from acquiring “control” of a bank holding company unless the FRB has been notified and has not objected to the transaction. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a bank holding company, such as the Company, with a class of securities registered under Section 12 of the Exchange Act, would, under the circumstances set forth in the presumption, constitute the acquisition of control of a bank holding company. In addition, the BHCA prohibits any company from acquiring control of a bank or bank holding company without first having obtained the approval of the FRB. Among other circumstances, under the BHCA, a company has control of a bank or bank holding company if the company owns, controls or holds with power to vote 25% or more of a class of voting securities of the bank or bank holding company, controls in any manner the election of a majority of directors or trustees of the bank or bank holding company, or the FRB has determined, after notice and opportunity for hearing, that the company has the power to exercise a controlling influence over the management or policies of the bank or bank holding company.
Enforcement Powers. The FRB has the authority to issue orders to bank holding companies to cease and desist from unsafe or unsound banking practices and violations of law and regulations or conditions imposed by, or violations of agreements
with, or commitments to, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company.
Regulation of Merchants Bank
As an FDIC-insured state-chartered bank, Merchants Bank is subject to the supervision of and regulation by the Commissioner and the FDIC. This supervision and regulation is for the protection of depositors, the Deposit Insurance Fund (“DIF”) of the FDIC, and consumers, and is not for the protection of Merchants’ stockholders. The prior approval of the FDIC and the Commissioner is required, among other things, for Merchants Bank to establish or relocate an additional branch office, assume deposits, or engage in any merger, consolidation, purchase or sale of all or substantially all of the assets of any bank. Under the Dodd-Frank Act, the FRB may directly examine the subsidiaries of Merchants, including Merchants Bank.
Deposit Insurance. The deposit obligations of Merchants Bank are insured up to applicable limits by the DIF and are subject to deposit insurance assessments to maintain the DIF. The Dodd-Frank Act permanently increased the FDIC deposit insurance limit to $250,000 per depositor for deposits maintained in the same right and capacity at a particular insured depository institution. The Federal Deposit Insurance Act (the “FDIA”), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to take steps as may be necessary to cause the ratio of deposit insurance reserves to estimated insured deposits – the designated reserve ratio – to reach 1.35% by September 30, 2020, and it mandates that the reserve ratio designated by the FDIC for any year may not be less than 1.35%. Further, the Dodd-Frank Act required that, in setting assessments, the FDIC offset the effect of the increase in the minimum reserve ratio from 1.15% to 1.35% on banks with less than $10 billion in assets.
To satisfy these requirements, on March 15, 2016, the FDIC’s Board of Directors approved a final rule to increase the DIF’s reserve ratio to the statutorily required minimum ratio of 1.35% of estimated insured deposits. The final rule imposes on large banks a surcharge of 4.5 basis points of their assessment base, after making certain adjustments. Large banks will pay quarterly surcharges in addition to their regular risk-based assessments. Overall, regular risk-based assessment rates will decline once the reserve ratio reaches 1.15%. Small banks, such as the Bank, will receive credits to offset the portion of their assessments that help to raise the reserve ratio from 1.15% to 1.35%. After the reserve ratio reaches 1.38%, the FDIC will automatically apply a small bank’s credits to reduce its regular assessment up to the entire amount of the assessment. The final rule provided that these changes would become effective July 1, 2016 if the reserve ratio reached 1.15% prior to that date. On June 30, 2016, the reserve ratio rose to 1.17%, which resulted in the revised deposit insurance assessment pricing becoming effective on July 1, 2016.
Deposit premiums are based on assets. To determine its deposit insurance premium, the Bank computes the base amount of its average consolidated assets less its average tangible equity (defined as the amount of Tier 1 capital) and the applicable assessment rate. On April 26, 2016, the FDIC’s Board of Directors adopted a final rule that changed the manner in which deposit insurance assessment rates are calculated for established small banks, generally those banks with less than $10 billion of assets that have been insured for at least five years. The rule updated the data and methodology that the FDIC uses to determine risk-based assessment rates for these institutions with the intent of better reflecting risks and ensuring that banks that take on greater risks pay more for deposit insurance than their less risky counterparts. The rule revised the financial ratios method used to determine assessment rates for these banks so that it is based on a statistical model that estimates the probability of failure over three years. The rule eliminated risk categories for established small banks and uses the financial ratios method. Under this method each of seven financial ratios and a weighted average of CAMELS component ratings will be multiplied by a corresponding pricing multiplier. The sum of these products will be added to a uniform amount, with the resulting sum being an institution’s initial base assessment rate (subject to minimum or maximum assessment rates based on a bank’s CAMELS composite rating). This method takes into account various measures that are similar to the factors that the FDIC previously considered in assigning institutions to risk categories, including an institution’s leverage ratio, brokered deposit ratio, one year asset growth, the ratio of net income before taxes to total assets and considerations related to asset quality. Under the small bank pricing rule, beginning the first assessment period after June 30, 2016, where the DIF’s reserve ratio has reached 1.15%, assessments for established small banks with a CAMELS rating of 1 or 2 will range from 1.5 to 16 basis points, after adjustments, while assessment rates for established small banks
with a CAMELS composite rating of 4 0r 5 may range from 11 to 30 basis points, after adjustments. Assessments for established small banks with a CAMLES rating of 3 will range from 3 to 30 basis points.
The FDIC has the power to adjust deposit insurance assessment rates at any time. In addition, under the FDIA, the FDIC may terminate deposit insurance 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 the FDIC. Merchants Bank’s FDIC insurance expense in 2016 was $916 thousand.
Acquisitions and Branching. Merchants Bank must seek prior regulatory approval from the Commissioner and the FDIC to acquire another bank or establish a new branch office. Well capitalized and well managed banks may acquire other banks in any state, subject to certain deposit concentration limits and other conditions, pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended by the Dodd-Frank Act. In addition, the Dodd-Frank Act authorizes a state-chartered bank, such as Merchants Bank; to establish new branches on an interstate basis to the same extent a bank chartered by the host state may establish branches.
Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA generally limits the types of equity investments an FDIC-insured state-chartered bank, such as Merchants Bank, may make and the kinds of activities in which such a bank may engage, as a principal, to those that are permissible for national banks. Further, the Gramm-Leach-Bliley Act of 1999 (the “GLBA”) permits national banks and state banks, to the extent permitted under state law, to engage – via financial subsidiaries – in certain activities that are permissible for subsidiaries of a financial holding company. In order to form a financial subsidiary, a state-chartered bank must be well capitalized, and such banks would be subject to certain capital deduction, risk management and affiliate transaction rules, among other things.
Lending Restrictions. Federal law limits a bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital. The Dodd-Frank Act explicitly provides that an extension of credit to an insider includes credit exposure arising from a derivatives transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction. Additionally, the Dodd-Frank Act requires that asset sale transactions with insiders must be on market terms, and if the transaction represents more than 10% of the capital and surplus of Merchants Bank, be approved by a majority of the disinterested directors of Merchants Bank.
Brokered Deposits. Section 29 of the FDIA and FDIC regulations generally limit the ability of an insured depository institution to accept, renew or roll over any brokered deposit unless the institution’s capital category is “well capitalized” or, with the FDIC’s approval, “adequately capitalized.” Depository institutions that have brokered deposits in excess of 10% of total assets will be subject to increased FDIC deposit insurance premium assessments. However, for institutions that are well capitalized and have a CAMELS composite rating of 1 or 2, reciprocal deposits are deducted from brokered deposits.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to evaluate Merchants Bank’s performance in helping to meet the credit needs of the entire communities it serves, including low and moderate-income neighborhoods, consistent with its safe and sound banking operations, and to take this record into consideration when evaluating certain applications. The FDIC’s CRA regulations are generally based upon objective criteria of the performance of institutions under three key assessment tests: (i) a lending test, to evaluate the institution’s record of making loans in its service areas; (ii) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs, and other offices. Failure of an institution to receive at least a “Satisfactory” rating could inhibit Merchants Bank or the Company from undertaking certain activities, including engaging in activities permitted as a financial holding company under GLBA and acquisitions of other financial institutions. Merchants Bank has achieved a rating of “Satisfactory” on its most recent examination dated February 17, 2015.
Enforcement Powers. The FDIC and the Commissioner have the authority to issue orders to banks under their supervision to cease and desist from unsafe or unsound banking practices and violations of law and regulation or conditions imposed by, or violations of agreements with, or commitments to, the FDIC or Commissioner. The FDIC and the Commissioner are also empowered to assess civil money penalties against companies or individuals who violate banking laws, orders or regulations.
Massachusetts Banking Regulation. As a result of the acquisition of NUVO Bank, Merchants Bank now operates a branch office in Massachusetts. As a result, Merchants Bank is also subject to supervision and regulation by the Massachusetts Commissioner of Banks and to various Massachusetts statutes and regulations, including Massachusetts consumer protection and civil rights laws and regulations.
Capital Adequacy and Safety and Soundness
Regulatory Capital Requirements. The FRB and the FDIC have issued substantially similar risk-based and leverage capital rules applicable to U.S. banking organizations such as the Company and the Bank. These rules are intended to reflect the relationship between the banking organization’s capital and the degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet items. The FRB and the FDIC may from time to time require that a banking organization maintain capital above the minimum levels discussed below, due to the banking organization’s financial condition or actual or anticipated growth.
The capital adequacy rules define qualifying capital instruments and specify minimum amounts of capital as a percentage of assets that banking organizations are required to maintain. Common equity Tier I capital generally includes common stock and related surplus, retained earnings and, in certain cases and subject to certain limitations, minority interest in consolidated subsidiaries, less goodwill, other non-qualifying intangible assets and certain other deductions. Tier I capital for banks and bank holding companies generally consists of the sum of common equity Tier I capital, non-cumulative perpetual preferred stock, and related surplus and, in certain cases and subject to limitations, minority interest in consolidated subsidiaries that does not qualify as common equity Tier I capital, less certain deductions. Tier II capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities, cumulative perpetual preferred stock, term subordinated debt and intermediate-term preferred stock, and, subject to limitations, allowances for loan losses. The sum of Tier I and Tier II capital less certain required deductions represents qualifying total risk-based capital. Prior to the effectiveness of certain provisions of the Dodd-Frank Act, bank holding companies were permitted to include trust preferred securities and cumulative perpetual preferred stock in Tier I capital, subject to limitations. However, the FRB’s capital rule applicable to bank holding companies permanently grandfathers non-qualifying capital instruments, including trust preferred securities, issued before May 19, 2010 by depository institution holding companies with less than $15 billion in total assets as of December 31, 2009, subject to a limit of 25% of Tier I capital. In addition, under rules that became effective January 1, 2015, accumulated other comprehensive income (positive or negative) must be reflected in Tier I capital; however, the Company was permitted to make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. The Company has made this election.
Under the capital rules, risk-based capital ratios are calculated by dividing common equity Tier I capital, Tier I capital and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned a risk weight based primarily on relative credit risk.
Under the Federal Reserve’s (FRB) capital rules applicable to the Company and the FDIC’s capital rules applicable to the Bank, the Company and the Bank are each required to maintain a minimum common equity Tier I capital to risk-weighted assets ratio of 4.5%, a minimum Tier I capital to risk-weighted assets ratio of 6%, a minimum total capital to risk-weighted assets ratio of 8% and a minimum leverage ratio of 4%. Additionally, subject to a transition schedule, the capital rules require an institution to establish a capital conservation buffer of common equity Tier I capital in an amount above the minimum risk-based capital requirements for “adequately capitalized” institutions equal to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases.
Under rules effective January 1, 2015, a bank holding company, such as Merchants Bancshares, is considered well capitalized if the bank holding company (i) has a total risk based capital ratio of at least 10%, (ii) has a Tier 1 risk-based capital ratio of at least 8%, and (iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. In addition, the FDIC has amended its prompt corrective action rules to reflect the new capital rules. Under the FDIC’s revised rules, which became effective January 1, 2015, an FDIC supervised institution, such as Merchants Bank is considered well capitalized if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of at least 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
Generally, a bank, upon receiving notice that it is not adequately capitalized (i.e., that it is “undercapitalized”), becomes subject to the prompt corrective action provisions of Section 38 of FDIA that, for example, (i) restrict payment of capital distributions and management fees, (ii) require that is federal bank regulator monitor the condition of the institution and its efforts to restore its capital, (iii) require submission of a capital restoration plan, (iv) restrict the growth of the institution’s assets and (v) require prior regulatory approval of certain expansion proposals. A bank that is required to submit a capital restoration plan must concurrently submit a performance guarantee by each company that controls the bank. A bank that is “critically undercapitalized” (i.e., has a ratio of tangible equity to total assets that is equal to or less than 2.0%) will be subject to further restrictions, and generally will be placed in conservatorship or receivership within 90 days.
The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. Merchants elected to opt-out of this regulatory capital provision. By opting out of the provision, Merchants retains what is known as the accumulated other comprehensive income filter. The final rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” in addition to the amount necessary to meet its minimum risk-based capital requirements. The phase-in period for the “capital conservation buffer” requirement began January 1, 2016 with a requirement to be 0.625% above the minimum risk-based capital requirements. When fully phased in on January 1, 2019, banks must maintain a “capital conservation buffer” of 2.50%.
The Company and Merchants Bank are considered “well capitalized” under all regulatory definitions.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, risk management, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, these guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the federal banking agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order restricting asset growth, requiring an institution to increase its ration of tangible equity to assets or directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of the FDIA. See “—Regulatory Capital Requirements” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Dividend Restrictions
We are a legal entity separate and distinct from Merchants Bank. Our revenue (on a parent company only basis) is derived primarily from interest and dividends paid to us by Merchants Bank. Our right, and consequently the right of our stockholders, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors, in the case of Merchants Bank), except to the extent that certain claims of Merchants in a creditor capacity may be recognized.
It is the policy of the FRB that bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends; the bank holding company would remain adequately capitalized. The FRB has the authority to prohibit a bank holding company, such as us, from paying dividends if it deems such payment to be an unsafe or unsound practice. The FRB has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. Further, our ability to pay dividends would be restricted if we do not maintain the capital conservation buffer. See “—Capital Adequacy and Safety and Soundness—Regulatory Capital Requirements” above.
The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Vermont law requires the approval of state bank regulatory authorities if the dividends declared by state banks exceed prescribed limits.
Certain Transactions by Bank Holding Companies with their Affiliates
There are various statutory restrictions on the extent to which bank holding companies and their non-bank subsidiaries may borrow, obtain credit from or otherwise engage in “covered transactions” with their insured depository institution subsidiaries. The Dodd-Frank Act amended the definition of affiliate to include an investment fund for which the depository institution or one of its affiliates is an investment adviser. An insured depository institution (and its subsidiaries) may not lend money to, or engage in covered transactions with, its non-depository institution affiliates if the aggregate amount of covered transactions outstanding involving the bank, plus the proposed transaction, exceeds the following limits: (i) in the case of any one such affiliate, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 10% of the capital stock and surplus of the insured depository institution; and (ii) in the case of all affiliates, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 20% of the capital stock and surplus of the insured depository institution. For this purpose, “covered transactions” are defined by statute to include a loan or extension of credit to an affiliate; a purchase of or investment in securities issued by an affiliate; a purchase of assets from an affiliate unless, exempted by the FRB; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company; the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate; securities borrowing or lending transactions with an affiliate that creates a credit exposure to such affiliate; or a derivatives transaction with an affiliate that creates a credit exposure to such affiliate. Covered transactions are also subject to certain collateral security requirements. Covered transactions as well as other types of transactions between a bank and a bank holding company must be on market terms and not otherwise unduly favorable to the holding company or an affiliate of the holding company. Moreover, the Bank Holding Company Act Amendments of 1970 provide that, to further competition, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property of any kind, or furnishing of any service.
Consumer Protection Regulation
We are subject to a number of federal and state laws designed to protect consumers and prohibit unfair or deceptive business practices, including the Equal Credit Opportunity Act, the Fair Housing Act, Home Ownership Protection Act, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”), the GLBA, the Truth in Lending Act, the CRA, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act and various state law counterparts. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must interact with customers when taking
deposits, making loans, collecting loans and providing other services. Further, the Dodd-Frank Act established the CFPB, which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair, deceptive or abusive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The FDIC examines Merchants Bank for compliance with CFPB rules and enforces CFPB rules with respect to Merchants Bank.
Mortgage Reform. The Dodd-Frank Act prescribes certain standards that mortgage lenders must consider before making a residential mortgage loan, including verifying a borrower’s ability to repay such mortgage loan, and allows borrowers to assert violations of certain provisions of the Truth in Lending Act as a defense to foreclosure proceedings. Under the Dodd-Frank Act, prepayment penalties are prohibited for certain mortgage transactions and creditors are prohibited from financing insurance policies in connection with a residential mortgage loan or home equity line of credit. In addition, the Dodd-Frank Act prohibits mortgage originators from receiving compensation based on the terms of residential mortgage loans and generally limits the ability of a mortgage originator to be compensated by others if compensation is received from a consumer. The Dodd-Frank Act requires mortgage lenders to make additional disclosures prior to the extension of credit, in each billing statement and for negative amortization loans and hybrid adjustable rate mortgages.
Privacy and Customer Information Security. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, we must provide our customers with an initial and annual disclosure that explains our policies and procedures regarding the disclosure of such nonpublic personal information and, except as otherwise required or permitted by law, we are prohibited from disclosing such information except as provided in such policies and procedures. However, an annual disclosure is not required to be provided by a financial institution if the financial institution only discloses information under exceptions from GLBA that do not require an opt out to be provided and if there has been no change in its privacy policies and practices since its most recent disclosure provided to consumers. The GLBA also requires that we develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information (as defined under the GLBA), to protect against anticipated threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We are also required to send a notice to customers whose sensitive information has been compromised if unauthorized use of this information is reasonably possible. Most of the states, including the states where we operate, have enacted legislation concerning breaches of data security and our duties in response to a data breach. Congress continues to consider federal legislation that would require consumer notice of data security breaches. Pursuant to the FACT Act, we must develop and implement a written identity theft prevention program to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.
Anti-Money Laundering
The Bank Secrecy Act. Under the Bank Secrecy Act (“BSA”) a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report to the United States Treasury any cash transactions involving more than $10,000. In addition, financial institutions are required to file suspicious activity reports for any transaction or series of transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), which amended the BSA, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions, such as Merchants Bank, to adopt and implement additional policies or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity, currency transaction reporting, customer identity verification and customer risk analysis. In evaluating an application under Section 3 of the BHCA to acquire a bank or an application under the Bank Merger Act to merge banks or affect a purchase of assets and assumption of deposits
and other liabilities, the applicable federal banking regulator must consider the anti-money laundering compliance record of both the applicant and the target.
OFAC. The U.S. has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These sanctions, which are administered by the U.S. Treasury’s Office of Foreign Assets Control (“OFAC”), take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial or other transactions relating to a sanctioned country or with certain designated persons and entities; (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons); and (iii) restrictions on transactions with or involving certain persons or entities. Blocked assets (for example, property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences for the Company.
Volcker Rule Restrictions on Proprietary Trading and Sponsorship of Hedge Funds and Private Equity Funds
The Dodd-Frank Act bars banking organizations, such as the Company, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain circumstances, in a provision commonly referred to as the “Volcker Rule.” Under the Dodd-Frank Act, proprietary trading generally means trading by a banking entity or its affiliate for its trading account. Hedge funds and private equity funds are described by the Dodd-Frank Act as funds that would be registered under the Investment Company Act but for certain enumerated exemptions. The Volcker Rule restrictions apply to the Company, Merchants Bank and all of their subsidiaries and affiliates.
Federal Home Loan Bank System
Merchants Bank is a member of the Federal Home Loan Bank (the “FHLB”) of Boston, which is one of the regional Federal Home Loan Banks comprising the Federal Home Loan Bank System. Each Federal Home Loan Bank provides a central credit facility primarily for member institutions. A member institution is required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year and 4.5% of its advances (borrowings) from the FHLB. We were in compliance with this requirement at December 31, 2016 with an investment in FHLB stock as of December 31, 2016 of $4.98 million. We receive dividends on our FHLB stock. As of December 31, 2016, the year to date dividend rate was 3.57%. Dividend income on FHLB stock of $212 thousand was recorded during 2016.
Any advances from the FHLB must be secured by specified types of collateral, and long-term advances may be used for the purpose of providing funds for residential housing finance, commercial lending and to purchase investments. Long term advances may also be used to help alleviate interest rate risk for asset and liability management purposes. As of December 31, 2016, we had $40.00 million in FHLB advances.
AVAILABLE INFORMATION
We file annual, quarterly, and current reports, proxy statements, and other documents with the SEC. The public may read and copy any materials that we have filed with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we have filed with the SEC at the SEC website at www.sec.gov.
We also make available free of charge on or through our Internet website at www.mbvt.com our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after Merchants electronically files such materials with or furnishes them to the SEC. We also make all filed insider transactions available
through our website free of charge. In addition, our Audit Committee, Compensation Committee, and Nominating and Governance Committee charters as well as our Code of Business Conduct and Ethics Policy for Senior Financial Officers, are available free of charge on our website.
ITEM 1A – RISK FACTORS
Sustained low interest rates and interest rate volatility may reduce our profitability.
Our consolidated earnings and financial condition are primarily dependent upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of that difference could adversely affect our earnings and financial condition. We cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the FRB, affect interest income and interest expense. While we have ongoing policies and procedures designed to manage the risks associated with changes in market interest rates, changes in interest rates may have an adverse effect on our profitability. Increases in interest rates could affect the amount of loans that we originate, because higher rates could cause customers to apply for fewer loans. Higher interest rates could also cause depositors to shift funds from accounts that have a comparatively lower cost, to accounts with a higher cost. If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets, net interest income will be negatively affected.
Our loan portfolio is concentrated in Vermont and we may be adversely affected by regional economic conditions and real estate values.
Because our loan portfolio is concentrated in Vermont, we may be adversely affected by regional economic conditions. Further, because a substantial portion of our loan portfolio is secured by real estate in Vermont, the value of the associated collateral is also subject to regional real estate market conditions. If these areas experience adverse economic, political or business conditions, we would likely experience higher rates of loss and delinquency on our loan portfolio than if it was more geographically diverse.
Our financial condition and results of operations have been adversely affected, and may continue to be adversely affected, by general market and economic conditions.
We have been, and continue to be, impacted by general business and economic conditions in the United States and, to a lesser extent, abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, unemployment and investor confidence, all of which are beyond our control. While in recent years there has been gradual improvement in the U.S. economy, deterioration in any of these conditions could result in increases in loan delinquencies and nonperforming assets, decreases in loan collateral values, the value of our investment portfolio and demand for our products and services. Furthermore, while the U.S. economy is improving, the recovery has been slow and there continues to be some uncertainty regarding its sustainability.
Loss of deposits or a change in deposit mix could increase our cost of funding.
Deposits are a low cost and stable source of funding. We compete with banks and other financial institutions for deposits. Funding costs may increase if we may deposits and are forced to replace them with more expensive sources of funding, if clients shift their deposits into higher cost products or if we need to raise interest rates to avoid losing deposits. Higher funding costs reduce our net interest margin, net interest income and net income.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our loan customers may not repay their loans according to the terms of the loans, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We therefore may experience significant loan losses, which could have a material adverse effect on our operating results. Material additions to our allowance for loan losses also would materially decrease our net income, and the charge-off of loans may cause us to increase the allowance.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to our allowance. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, which may have a material adverse effect on our financial condition and results of operations.
Our commercial, commercial real estate and construction loan portfolio may expose us to increased credit risks.
At December 31, 2016, approximately 62% of our loan portfolio was comprised of commercial, commercial real estate, and construction loans with four of those relationships exceeding $21 million, exposing us to the risks inherent in financings based upon analyses of credit risk, the value of underlying collateral, including real estate, and other more intangible factors, which are considered in making commercial loans. In general, commercial and commercial real estate loans historically pose greater credit risks than owner occupied residential mortgage loans. The repayment of commercial real estate loans depends on the business and financial condition of borrowers, and a number of our borrowers have more than one commercial real estate loan outstanding with us. Economic events and changes in government regulations, which we and our borrowers cannot control or reliably predict, could have an adverse impact on the cash flows generated by properties securing our commercial real estate loans and on the values of the properties securing those loans. Repayment of commercial loans depends substantially on the borrowers’ underlying business, financial condition and cash flows. Commercial loans are generally collateralized by equipment, inventory, accounts receivable and other fixed assets. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed.
Environmental liability associated with our lending activities could result in losses.
In the course of business, we may acquire, through foreclosure, properties securing loans we have originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that material environmental violations could be discovered at these properties. In this event, we might be required to remedy these violations at the affected properties at our sole cost and expense. The cost of remedial action could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on our financial condition and results of operations.
We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
We are subject to regulation and supervision by the FRB and Merchants Bank is subject to regulation and supervision by the FDIC and the Commissioner. Federal and state laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms of extensions of credit and investments, permissible nonbanking activities, the level of reserves against deposits and restrictions on dividend payments. The FDIC and the Commissioner possess the power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the FRB possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we may conduct business and obtain financing.
The laws, rules, regulations, and supervisory guidance and policies applicable to us are subject to regular modification and change. These changes could adversely and materially impact us. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes in light of government intervention in the financial services sector. Other changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, revocation of a
banking charter, other sanctions by regulatory agencies, civil money penalties, and/or reputational damage, which could have a material adverse effect on our business, financial condition, and results of operations. See Item 1, “Business—Regulation and Supervision.”
We have become subject to new capital and liquidity standards that require banks and bank holding companies to maintain more and higher quality capital and greater liquidity than has historically been the case.
We became subject to new capital requirements in 2015. These new standards, which now apply and will be fully phased-in over the next several years, force bank holding companies and their bank subsidiaries to maintain substantially higher levels of capital as a percentage of their assets, with a greater emphasis on common equity as opposed to other components of capital. The need to maintain more and higher quality capital, as well as greater liquidity, and generally increased regulatory scrutiny with respect to capital levels, may at some point limit our business activities, including lending, and our ability to expand. It could also result in our being required to take steps to increase our regulatory capital and may dilute shareholder value or limit our ability to pay dividends or otherwise return capital to our investors through stock repurchases. Pursuant to the Dodd-Frank Act, we were permitted to make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. We made this election.
We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose community investment and nondiscriminatory lending requirements on financial institutions. The Consumer Financial Protection Bureau, the Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act or other fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions, restrictions on expansion and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.
We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or unintentional violations.
The financial services industry is subject to intense scrutiny from bank supervisors in the examination process and aggressive enforcement of federal and state regulations, particularly with respect to mortgage-related practices and other consumer compliance matters, and compliance with anti-money laundering, Bank Secrecy Act and Office of Foreign Assets Control regulations, and economic sanctions against certain foreign countries and nationals. Enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations; however, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there were systems and procedures designed to ensure compliance in place at the time. Failure to comply with these and other regulations, and supervisory expectations related thereto, may result in fines, penalties, lawsuits, regulatory sanctions, reputation damage, or restrictions on our business.
We face significant legal risks, both from regulatory investigations and proceedings and from private actions brought against us.
From time to time we are named as a defendant or are otherwise involved in various legal proceedings, including class actions and other litigation or disputes with third parties. There is no assurance that litigation with private parties will not increase in the future. Actions currently pending against us may result in judgments, settlements, fines, penalties or other results adverse to us, which could materially adversely affect our business, financial condition or results of operations, or cause serious reputational harm to us. As a participant in the financial services industry, it is likely that we will continue to experience a high level of litigation related to our businesses and operations.
Our businesses and operations are also subject to increasing regulatory oversight and scrutiny, which may lead to additional regulatory investigations or enforcement actions. These and other initiatives from federal and state officials may subject us to further judgments, settlements, fines or penalties, or cause us to be required to restructure our operations and activities, all of which could lead to reputational issues, or higher operational costs, thereby reducing our revenue.
Competition in the local banking industry may impair our ability to attract and retain customers at current levels.
Competition in the markets in which we operate may limit our ability to attract and retain customers. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization, as well as financial intermediaries not subject to bank regulatory restrictions, have larger lending limits and are able to serve the credit and investment needs of larger customers. There is also increased competition by out-of-market competitors through the Internet. If we are unable to attract and retain customers, we may be unable to continue our loan growth and our results of operations and financial condition may otherwise be negatively impacted.
Market changes may adversely affect demand for our services and impact results of operations.
Channels for servicing our customers are evolving rapidly, with less reliance on traditional branch facilities, more use of online and mobile banking, and increased demand for universal bankers and other relationship managers who can service multiples product lines. We compete with larger providers that are rapidly evolving their service channels and escalating the costs of evolving the service process. We have a process for evaluating the profitability of our branch system and other office and operational facilities. The identification of unprofitable operations and facilities can lead to restructuring charges and introduce the risk of disruptions to revenues and customer relationships.
Prepayments of loans may negatively impact our business.
Generally, our customers may prepay the principal amount of their outstanding loans at any time. The speeds at which such prepayments occur, as well as the size of such prepayments, are within our customers’ discretion. If customers prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, our interest income will be reduced. A significant reduction in interest income could have a negative impact on our results of operations and financial condition.
Potential downgrades of U.S. government securities by one or more of the credit ratings agencies could have a material adverse effect on our operations, earnings and financial condition.
A possible future downgrade of the sovereign credit ratings of the U.S. government and a decline in the perceived creditworthiness of U.S. government-related obligations could impact our ability to obtain funding that is collateralized by affected instruments, as well as affect the pricing of that funding when it is available. A downgrade may also adversely affect the market value of such instruments. We cannot predict if, when or how any changes to the credit ratings or perceived creditworthiness of these organizations will affect economic conditions. Such ratings actions could result in a significant adverse impact on us. Among other things, a further downgrade in the U.S. government’s credit rating could adversely impact the value of our securities portfolio and may trigger requirements that we post additional collateral for trades relative to these securities. A downgrade of the sovereign credit ratings of the U.S. government or the credit ratings of related institutions, agencies or instruments would significantly exacerbate the other risks to which we are subject and any related adverse effects on the business, financial condition and results of operation.
We may incur significant losses as a result of ineffective risk management processes and strategies.
We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review processes and other mechanisms. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application may not be effective and may not anticipate every economic and financial outcome in all market environments or the specifics and timing of such
outcomes. Market conditions over the last several years have involved unprecedented dislocations and highlight the limitations inherent in using historical data to manage risk.
We face security risks, including denial of service attacks, hacking and identity theft that could result in the disclosure of confidential information, including information we maintain relating to our customers, adversely affect our business or reputation and create significant legal and financial exposure.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our business and to store sensitive data, including financial information regarding customers. Our computer systems and network infrastructure are subject to potential security risks and could be targeted by cyber-attacks, such as denial of service attacks, hacking, terrorist activities or identity theft. Financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks and other means. Denial of service attacks have been launched against a number of large financial services institutions. We expect to be subject to similar attacks in the future. Hacking and identity theft risks, in particular, could cause serious reputational harm. Cyber threats are rapidly evolving and we may not be able to anticipate or prevent all such attacks and could be held liable for any security breach or loss. We have implemented and regularly review and update extensive systems of internal controls and procedures as well as corporate governance policies and procedures intended to protect our business operations, including the security and privacy of all confidential customer information.
Despite efforts to ensure the integrity of our systems, we will not be able to anticipate all security breaches of these types, nor will we be able to implement guaranteed preventive measures against such security breaches. Persistent attackers may succeed in penetrating defenses given enough resources, time and motive. The techniques used by cyber criminals change frequently, may not be recognized until launched and can originate from a wide variety of sources, including outside groups such as external service providers, organized crime affiliates, terrorist organizations or hostile foreign governments. These risks may increase in the future as we continue to increase our mobile and internet-based product offerings and expand our internal usage of web-based products and applications.
Even the most advanced internal control environment may be vulnerable to compromise. Targeted social engineering attacks are becoming more sophisticated and are extremely difficult to prevent. The successful social engineer will attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to its data or that of its clients.
We regularly assess and test our security systems and disaster preparedness, including back-up systems, but the risks are substantially escalating. As a result, cyber security and the continued enhancement of our controls and processes to protect our systems, data and networks from attacks, unauthorized access or significant damage remain a priority. Accordingly, we may be required to expend additional resources to enhance our protective measures or to investigate and remediate any information security vulnerabilities or exposures. A successful penetration or circumvention of system security could cause us serious negative consequences, including significant disruption of operations, misappropriation of confidential information, or damage to our computers or systems or those of our customers and counterparties. A successful security breach could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on the Company.
We may be unable to attract and retain key personnel.
Our success depends, in large part, on our ability to attract and retain key personnel. Competition for qualified personnel in the financial services industry and in the Vermont marketplace can be intense and we may not be able to hire or retain the key personnel that we depend upon for success. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of the markets in which we operate, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Our ability to attract and retain customers and employees, and maintain relationships with vendors, third-party service providers and others, could be adversely affected to the extent our reputation is harmed.
We are dependent on our reputation within our market area, as a trusted and responsible financial company, for all aspects of our relationships with customers, employees, vendors, third-party service providers, and others, with whom we conduct business or potential future business. Our ability to attract and retain customers and employees, and maintain relationships with vendors, third-party service providers and others, could be adversely affected to the extent our reputation is damaged. Our actual or perceived failure to address various issues could give rise to reputational risk that could cause harm to us and our business prospects, including failure to properly address operational risks. These issues also include, but are not limited to, legal and regulatory requirements; privacy; properly maintaining customer and associate personal information; record keeping; money-laundering; sales and trading practices; ethical issues; appropriately addressing potential conflicts of interest; and the proper identification of the legal, reputational, credit, liquidity and market risks inherent in our products. Failure to appropriately address any of these issues could also give rise to additional regulatory restrictions, reputational harm and legal risks, which could, among other consequences, increase the size and number of litigation claims and damages asserted or subject us to enforcement actions, fines and penalties and cause us to incur related costs and expenses.
We may suffer losses as a result of operational risk or technical system failures.
The potential for operational risk exposure exists throughout our organization. Integral to our performance is the continued efficacy of our internal processes, systems, relationships with third parties and the associates and executives in our day-to-day and ongoing operations. Operational risk also encompasses the failure to implement strategic objectives in a successful, timely and cost-effective manner. Failure to properly manage operational risk subjects us to risks of loss that may vary in size, scale and scope, including loss of customers, operational or technical failures, unlawful tampering with our technical systems, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure on the part of key individuals to perform properly. Although we seek to mitigate operational risk through a system of internal controls, losses from operational risk could take the form of explicit charges, increased operational costs, harm to our reputation or foregone opportunities.
We may not be able to successfully implement future information technology system enhancements, which could adversely affect our business operations and profitability.
We invest significant resources in information technology system enhancements in order to provide functionality and security at an appropriate level. We may not be able to successfully implement and integrate future system enhancements, which could adversely impact the ability to provide timely and accurate financial information in compliance with legal and regulatory requirements, which could result in sanctions from regulatory authorities. Such sanctions could include fines and suspension of trading in our stock, among others. In addition, future system enhancements could have higher than expected costs and/or result in operating inefficiencies, which could increase the costs associated with the implementation as well as ongoing operations.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.
The market price and trading volume of our common stock may be volatile.
The market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in
fluctuations in the price or trading volume of our common stock include:
| · | | quarterly variations in our operating results or the quality of our assets; |
| · | | operating results that vary from the expectations of Management, securities analysts and investors; |
| · | | changes in expectations as to our future financial performance; |
| · | | announcements of innovations, new products, strategic developments, significant contracts, acquisitions and other material events by us or our competitors; |
| · | | reputational issues or events; |
| · | | the operating and securities price performance of other companies that investors believe are comparable to us; |
| · | | our past and future dividend practices; |
| · | | future sales of our equity or equity-related securities; and |
| · | | changes in global financial markets and global economies and general market conditions, such as interest or foreign exchange rates, stock, commodity or real estate valuations or volatility. |
We are a holding company and depend on Merchants Bank for dividends, distributions and other payments.
We are legal entity that is separate and distinct from Merchants Bank. Our revenue (on a parent company only basis) is derived primarily from interest and dividends paid to us by Merchants Bank. Our right, and consequently the right of our stockholders, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors, in the case of Merchants Bank), except to the extent that certain claims of Merchants in a creditor capacity may be recognized. See Item 1, “Business—Regulation and Supervision—Capital Adequacy and Safety and Soundness.”
Our stockholders may not receive dividends on our common stock.
Holders of our common stock are entitled to receive dividends only when, as and if declared by our board of directors. Although we have historically declared cash dividends on our common stock, we are not required to do so and our board of directors may reduce or eliminate our common stock dividend in the future. It is the policy of the FRB that bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends, the bank holding company would remain adequately capitalized. The FRB has the authority to prohibit a bank holding company, such as us, from paying dividends if it deems such payment to be an unsafe or unsound practice. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Further, when the Final Capital Rule comes into effect our ability to pay dividends would be restricted if we do not maintain a capital conservation buffer. A reduction or elimination of dividends could adversely affect the market price of our common stock. See Item 1, “Business—Regulation and Supervision—Dividend Restrictions” and “Business—Regulation and Supervision—Capital Adequacy and Safety and Soundness —Regulatory Capital Requirements.”
Changes in accounting standards can be difficult to predict and can materially impact how we record and report our financial condition and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board (“FASB”) changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to anticipate and implement and can materially impact how we record and report our financial condition and results of operations.
Differences in interpretation of tax laws and regulations and any potential resulting litigation may adversely impact our financial statements.
Local, state or federal tax authorities may interpret tax laws and regulations differently than we do and challenge tax positions that we have taken on tax returns. This may result in differences in the treatment of revenues, deductions, credits and/or differences in the timing of these items. The differences in treatment may result in payment of additional taxes, interest or penalties that could have a material adverse effect on our results.
Our financial statements are based in part on assumptions and estimates, which, if wrong, could cause unexpected losses in the future.
Pursuant to GAAP, we are required to use certain assumptions and estimates in preparing our financial statements, including in determining credit loss reserves, reserves related to litigation and the fair value of certain assets and liabilities, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses. For additional information, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies.”
We may need to raise additional capital in the future and such capital may not be available when needed.
As a bank holding company, we are required by regulatory authorities to maintain adequate levels of capital to support our operations. We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. We cannot assure you that such capital will be available to us on acceptable terms or at all. Our inability to raise sufficient additional capital on acceptable terms when needed could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital and the termination of deposit insurance by the FDIC.
If our merger with Community Bank System, Inc. is not completed, we will have incurred substantial expenses without our stockholders realizing the expected benefits.
On October 22, 2016, we entered into an Agreement and Plan of Merger with Community Bank System, Inc., or “Community,” pursuant to which we will merge with and into Community, with Community as the surviving corporation. Completion of the merger is subject to closing conditions including, but not limited to, various regulatory approvals and the approval of our stockholders. We currently expect that the merger will be completed in the late second or early third quarter of 2017. It is possible, however, that factors outside of our control could require the parties to complete the merger at a later time, or not to complete the merger at all. In the event that the merger is not consummated for any reason, we will be subject to many risks, including the costs related to the merger, such as legal, accounting and advisory fees, which must be paid even if the merger is not completed, and, potentially, the payment of a termination fee under certain circumstances. If the merger is not consummated, the market price of our common stock could decline. We also could be subject to litigation related to any failure to complete the merger or related to any enforcement proceeding commenced against us to perform our obligations under the merger agreement.
Our stockholders will receive a fixed consideration of cash and/or Community common stock for each share of our common stock, regardless of any changes in the market value of our common stock or Community common stock before the completion of the merger.
Upon completion of the merger, each share of our common stock will be converted into the right to receive a fix ratio of cash and/or shares of Community common stock. There will be no adjustment to the exchange ratio (except for (i) adjustments to reflect the effect of any stock split, reverse stock split, stock dividend, recapitalization, reclassification or other similar transaction with respect to our common stock or (ii) any adjustment for proration in accordance with the merger agreement to maintain an overall 70% stock consideration and 30% cash consideration ratio), and we do not have a right to terminate the merger agreement based upon changes in the market price of Community common stock, subject
to the limited exception described below. Accordingly, the dollar value of Community common stock that our stockholders will receive upon completion of the merger will depend upon the market value of Community common stock at the time of completion of the merger, which may be lower or higher than the closing price of Community common stock on the last full trading day preceding public announcement that Community and we entered into the merger agreement, the last full trading day prior to the date that our proxy statement is delivered to our stockholders, or the date of the stockholder meeting. The market values of Community’s common stock and our common stock have varied since Community and we entered into the merger agreement and will continue to vary in the future due to changes in the business, operations or prospects of Community and us, market assessments of the merger, regulatory considerations, market and economic considerations, and other factors, most of which are beyond our control.
If, on the date on which all regulatory approvals for the merger have been received, the average closing price of Community common stock for the 20-trading period ending three days prior to such date is less than $35.78, and since the date of the merger agreement the percentage decrease in the market price of the Community common stock is more than 20% greater than any percentage decrease in the average market price of a prescribed index, we may elect to terminate the merger agreement. If we provide notice of our intent to terminate, Community will have the option of paying additional consideration, as specified in the merger agreement, in order to proceed with the merger.
We will be subject to business uncertainties and contractual restrictions while the merger is pending.
Uncertainty about the effect of the merger on employees, suppliers and customers may have an adverse effect on us. These uncertainties may impair our ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers, suppliers and others who deal with us to seek to change existing business relationships with us. Our employee retention and recruitment may be particularly challenging prior to the effective time of the merger, as employees and prospective employees may experience uncertainty about their future roles with the combined company.
The pursuit of the merger and the preparation for the integration may place a significant burden on management and internal resources. Any significant diversion of management attention away from ongoing business and any difficulties encountered in the transition and integration process could affect our financial results. In addition, the merger agreement generally requires that we operate in the usual, regular and ordinary course of business and restricts us from taking certain actions prior to the effective time of the merger or termination of the merger agreement without Community’s consent in writing. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the merger.
Regulatory approvals may not be received, may take longer than expected or impose conditions that are not presently anticipated.
Before the merger may be completed, certain approvals or consents must be obtained from the various bank regulatory and other authorities in the United States. There can be no assurance as to whether regulatory approval will be received or the timing of the approvals. Community is not obligated to complete the merger if the regulatory approvals received in connection with the completion of the merger include any conditions or restrictions that would constitute a “Material Adverse Effect” as defined in the merger agreement. There can be no assurance that regulatory approvals will not include such conditions or restrictions and such conditions or restrictions could have the effect of delaying completion of the merger.
The termination fee and the restrictions on solicitation contained in the merger agreement may discourage other companies from trying to acquire us.
Until the completion of the merger, we are prohibited from soliciting, initiating, encouraging, or with some exceptions, considering any inquiries or proposals that may lead to a proposal or offer for a merger or other business combination transaction with any person other than Community. In addition, we have agreed to pay a termination fee of $10.7 million to Community in specified circumstances. These provisions could discourage other companies from trying to acquire us even though those other companies might be willing to offer greater value to our stockholders than Community has offered in the merger. The payment of the termination fee also could have a material adverse effect on our results of operations.
ITEM 1B – UNRESOLVED STAFF COMMENTS
None.
ITEM 2 – PROPERTIES
As of December 31, 2016, we operated thirty one full-service banking offices and thirty seven ATMs throughout the state of Vermont and one full-service banking office in Massachusetts. Our headquarters are located at 275 Kennedy Drive, South Burlington, Vermont, which also houses our operations and administrative offices and our Trust division.
We lease certain premises from third parties, including our headquarters, under current market terms and conditions. All offices are in good physical condition with modern equipment and facilities considered adequate to meet the banking needs of customers in the communities served. Additional information relating to our properties is set forth in Note 8 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
ITEM 3 – LEGAL PROCEEDINGS
We are involved in various legal proceedings arising from our normal business activities. In the opinion of Management, based upon input from counsel on the anticipated outcome of such proceedings, final disposition of these proceedings will not have a material adverse effect on our consolidated financial position.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5 – MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock and Dividends
The common stock of Merchants is traded on the NASDAQ Global Select Market under the trading symbol “MBVT”. Merchants currently pays dividends on a quarterly basis. Quarterly stock prices and dividends per share paid for each quarterly period during the last two years were as follows:
| | | | | | | | | | |
| | | | | | | | Dividends | |
Quarter Ended | | High | | Low | | Paid | |
December 31, 2016 | | $ | 54.80 | | $ | 32.00 | | $ | 0.28 | |
September 30, 2016 | | | 34.00 | | | 30.01 | | | 0.28 | |
June 30, 2016 | | | 32.00 | | | 28.16 | | | 0.28 | |
March 31, 2016 | | | 31.22 | | | 27.00 | | | 0.28 | |
December 31, 2015 | | | 34.00 | | | 28.63 | | | 0.28 | |
September 30, 2015 | | | 33.49 | | | 27.56 | | | 0.28 | |
June 30, 2015 | | | 33.50 | | | 28.60 | | | 0.28 | |
March 31, 2015 | | | 31.18 | | | 26.40 | | | 0.28 | |
High and low stock prices are based upon quotations as reported by the NASDAQ Global Select Market. Prices of transactions between private parties may vary from the ranges quoted above.
As of February 10, 2017, Merchants had 852 stockholders of record. Merchants declared and distributed dividends totaling $1.12 per share during 2016. In January 2017, Merchants declared a dividend of $0.28 per share for the fourth quarter of 2016, which was paid on February 23, 2017, to stockholders of record as of February 9, 2017. Future dividends will depend upon the financial condition and earnings of Merchants and its subsidiaries, its need for funds and other factors, including applicable government regulations.
Merchants Bancshares, Inc. is a legal entity that is separate and distinct from Merchants Bank. The revenue of Merchants (on a parent company-only basis) is derived primarily from interest and dividends paid to it by Merchants Bank. See “Business—Regulation and Supervision—Dividend Restrictions” above, which is incorporated herein by reference, for a discussion on statutory restrictions on the payment of dividends by Merchants Bancshares, Inc. and Merchants Bank.
Performance Graph
The line-graph presentation below compares cumulative five-year stockholder returns with the NASDAQ Bank Index and the Russell 2000 Index. The comparison assumes the investment, on December 31, 2011, of $100 in Merchants’ common stock and each of the foregoing indices and reinvestment of all dividends.
| | | | | | | | | | | | | | | | | | |
| | Period Ending |
Index | | 12/31/2011 | | 12/31/2012 | | 12/31/2013 | | 12/31/2014 | | 12/31/2015 | | 12/31/2016 |
Merchants Bancshares, Inc. | | $ | 100.00 | | $ | 95.45 | | $ | 123.94 | | $ | 117.65 | | $ | 125.56 | | $ | 223.78 |
NASDAQ Bank | | | 100.00 | | | 118.69 | | | 168.21 | | | 176.48 | | | 192.08 | | | 265.02 |
Russell 2000 | | | 100.00 | | | 116.35 | | | 161.52 | | | 169.43 | | | 161.95 | | | 196.45 |
The performance graph and related information furnished under Item 5 of this Annual Report on Form 10-K shall not be deemed to be “soliciting material” or to be “filed” with the SEC, or subject to Regulation 14A or 14C, other than as provided in Item 201 of Regulation S-K, or to the liabilities of Section 18 of the Exchange Act. Such information shall not be incorporated by reference into any future filing under the Securities Act or Exchange Act except to the extent that Merchants specifically incorporates it by reference into such filing.
Securities Authorized for Issuance under Equity Compensation Plans
We maintain two equity compensation plans: the 2008 Deferred Compensation Plan for Non-Employee Directors and Trustees and the Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan. Each of these plans has
been approved by our stockholders. The following table includes information as of December 31, 2016 about these plans. See Note 15 to the consolidated financial statements included in Item 8 for a description of these plans.
| | | | | | | | |
| | | | | | | Number of Securities | |
| | | | | | | Remaining Available | |
| | Number of Securities | | | | | for Future Issuance | |
| | to be Issued Upon | | | | | Under Equity | |
| | Exercise of | | Weighted-Average | | Compensation Plans | |
| | Outstanding | | Price of Outstanding | | (Excluding Securities | |
| | Options, Warrants | | Options, Warrants and | | Reflected in First | |
Plan Category | | and Rights | | Rights | | Column) | |
Equity Compensation Plans Approved by Security Holders | | 26,520 | (a) | $ | 22.50 | (b) | 526,206 | |
Equity Compensation Plans Not Approved by Security Holders | | — | | | — | | — | |
Total | | 26,520 | | $ | 22.50 | | 526,206 | |
| (a) | | This number relates to the Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan. |
| (b) | | This price reflects the weighted-average exercise price of outstanding stock options under the Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan. |
ITEM 6 – SELECTED FINANCIAL DATA
The supplementary financial data presented in the following tables contain information highlighting certain significant trends in our financial condition and results of operations over an extended period of time.
The following information should be analyzed in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with the audited consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K.
Merchants Bancshares, Inc.
Five Year Summary of Financial Data
| | | | | | | | | | | | | | | | |
| | At or For the Year Ended December 31, | |
(In thousands except share and per share data) | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | |
Results For The Year | | | | | | | | | | | | | | | | |
Interest and dividend income | | $ | 59,740 | | $ | 52,116 | | $ | 50,972 | | $ | 53,967 | | $ | 56,857 | |
Interest expense | | | 4,500 | | | 4,052 | | | 4,525 | | | 5,070 | | | 6,883 | |
Net interest income | | | 55,240 | | | 48,064 | | | 46,447 | | | 48,897 | | | 49,974 | |
Provision for loan losses | | | 1,105 | | | 250 | | | 150 | | | 800 | | | 950 | |
Net interest income after provision for loan losses | | | 54,135 | | | 47,814 | | | 46,297 | | | 48,097 | | | 49,024 | |
Noninterest income | | | 12,688 | | | 11,960 | | | 11,574 | | | 11,630 | | | 12,613 | |
Noninterest expense | | | 47,251 | | | 43,971 | | | 42,214 | | | 39,534 | | | 40,950 | |
Income before income taxes | | | 19,572 | | | 15,803 | | | 15,657 | | | 20,193 | | | 20,687 | |
Provision for income taxes | | | 4,689 | | | 3,185 | | | 3,532 | | | 5,062 | | | 5,493 | |
Net income | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | | $ | 15,131 | | $ | 15,194 | |
Share Data | | | | | | | | | | | | | | | | |
Basic earnings per common share | | $ | 2.17 | | $ | 1.98 | | $ | 1.92 | | $ | 2.40 | | $ | 2.43 | |
Diluted earnings per common share | | $ | 2.16 | | $ | 1.98 | | $ | 1.91 | | $ | 2.40 | | $ | 2.42 | |
Cash dividends declared per common share | | $ | 1.12 | | $ | 1.12 | | $ | 1.12 | | $ | 1.12 | | $ | 1.12 | |
Weighted average common shares outstanding (1) | | | 6,871,372 | | | 6,373,115 | | | 6,326,142 | | | 6,302,494 | | | 6,258,832 | |
Period end common shares outstanding (2) | | | 6,896,474 | | | 6,855,294 | | | 6,327,226 | | | 6,318,708 | | | 6,282,385 | |
Year-end book value per share | | $ | 22.72 | | $ | 21.59 | | $ | 19.89 | | $ | 18.93 | | $ | 18.82 | |
Key Performance Ratios | | | | | | | | | | | | | | | | |
Return on average stockholder' equity | | | 9.61 | % | | 9.69 | % | | 9.84 | % | | 12.97 | % | | 13.37 | % |
Return on average assets | | | 0.76 | % | | 0.71 | % | | 0.73 | % | | 0.90 | % | | 0.92 | % |
Average equity to average assets | | | 7.86 | % | | 7.33 | % | | 7.39 | % | | 6.95 | % | | 6.89 | % |
Total risk based capital | | | 15.14 | % | | 15.80 | % | | 15.70 | % | | 16.12 | % | | 16.00 | % |
Tier 1 leverage ratio | | | 8.71 | % | | 8.77 | % | | 8.76 | % | | 8.44 | % | | 8.08 | % |
Tangible equity ratio (5) | | | 7.22 | % | | 6.94 | % | | 7.30 | % | | 6.93 | % | | 6.92 | % |
Dividend payout ratio | | | 51.85 | % | | 56.57 | % | | 58.64 | % | | 46.67 | % | | 46.28 | % |
Allowance for loan losses to total loans at year-end (4) | | | 0.84 | % | | 0.85 | % | | 1.00 | % | | 1.03 | % | | 1.07 | % |
Nonperforming loans as a percentage of total loans | | | 0.21 | % | | 0.28 | % | | 0.06 | % | | 0.06 | % | | 0.25 | % |
Net interest margin | | | 3.04 | % | | 2.94 | % | | 3.03 | % | | 3.15 | % | | 3.28 | % |
Average Balances (4) | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,970,871 | | $ | 1,775,496 | | $ | 1,667,665 | | $ | 1,677,342 | | $ | 1,648,393 | |
Earning assets | | | 1,891,981 | | | 1,708,153 | | | 1,603,460 | | | 1,617,225 | | | 1,587,190 | |
Gross loans | | | 1,446,443 | | | 1,240,386 | | | 1,165,586 | | | 1,133,637 | | | 1,057,446 | |
Investments (3) | | | 395,186 | | | 385,806 | | | 358,274 | | | 455,679 | | | 509,384 | |
Total deposits | | | 1,508,113 | | | 1,383,537 | | | 1,320,389 | | | 1,299,449 | | | 1,222,423 | |
Stockholders' equity | | | 154,948 | | | 130,220 | | | 123,283 | | | 116,640 | | | 113,621 | |
At Year-End (4) | | | | | | | | | | | | | | | | |
Total assets | | $ | 2,062,658 | | $ | 2,021,237 | | $ | 1,723,464 | | $ | 1,725,469 | | $ | 1,708,550 | |
Gross loans | | | 1,514,209 | | | 1,414,280 | | | 1,182,334 | | | 1,166,233 | | | 1,082,923 | |
Allowance for loan losses | | | 12,659 | | | 12,040 | | | 11,833 | | | 12,042 | | | 11,562 | |
Investments (3) | | | 424,778 | | | 406,925 | | | 346,272 | | | 400,835 | | | 517,233 | |
Total deposits | | | 1,527,470 | | | 1,551,439 | | | 1,308,772 | | | 1,323,576 | | | 1,271,080 | |
Stockholders' equity | | | 156,503 | | | 148,054 | | | 125,821 | | | 119,611 | | | 118,221 | |
| (1) | | Weighted average common shares outstanding include an average of 282,474; 292,676; 301,757; 312,606; and 316,920 shares held in Rabbi Trusts for deferred compensation plans for directors for 2016, 2015, 2014, 2013 and 2012, respectively. |
| (2) | | Period end common shares outstanding and year-end book value include 288,800; 299,360; 308,670; 319,854; and 324,515 shares held in Rabbi Trusts for deferred compensation plans for directors for 2016, 2015, 2014, 2013 and 2012, respectively. |
| (3) | | Average investment balances include Federal Home Loan Bank stock of $5.64 million, $4.18 million; $5.78 million; $7.62 million; and $8.24 million for 2016, 2015, 2014, 2013 and 2012, respectively. Period end investment balances include Federal Home Loan Bank stock of $4.98 million, $3.80 million; $4.38 million; $7.50 million; and $8.15 million for 2016, 2015, 2014, 2013 and 2012, respectively. |
| (4) | | Year-end balances for 2015 reflect the inclusion of NUVO, 2015 average balances reflect NUVO balances for only 28 days. Additionally, the Allowance for loan losses to total loans in 2015 declined due to the inclusion of NUVO loan balances and no carryover of allowance. |
| (5) | | Refer to our non-GAAP tangible book value calculation on page 32. |
Merchants Bancshares, Inc.
Summary of Quarterly Financial Information
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2016 | | 2015 | |
(In thousands except per share data) | | Q4 | | Q3 | | Q2 | | Q1 | | Year | | Q4 | | Q3 | | Q2 | | Q1 | | Year | |
Interest and dividend income | | $ | 14,985 | | $ | 14,930 | | $ | 14,943 | | $ | 14,882 | | $ | 59,740 | | $ | 13,697 | | $ | 13,041 | | $ | 12,772 | | $ | 12,606 | | $ | 52,116 | |
Interest expense | | | 1,105 | | | 1,133 | | | 1,112 | | | 1,150 | | | 4,500 | | | 1,005 | | | 968 | | | 1,027 | | | 1,052 | | | 4,052 | |
Net interest income | | | 13,880 | | | 13,797 | | | 13,831 | | | 13,732 | | | 55,240 | | | 12,692 | | | 12,073 | | | 11,745 | | | 11,554 | | | 48,064 | |
Provision for loan losses | | | 200 | | | 500 | | | 200 | | | 205 | | | 1,105 | | | — | | | 150 | | | 100 | | | — | | | 250 | |
Noninterest income | | | 3,412 | | | 3,131 | | | 3,221 | | | 2,924 | | | 12,688 | | | 3,087 | | | 3,449 | | | 2,753 | | | 2,671 | | | 11,960 | |
Noninterest expense | | | 13,079 | | | 11,420 | | | 10,833 | | | 11,919 | | | 47,251 | | | 12,892 | | | 10,591 | | | 10,481 | | | 10,007 | | | 43,971 | |
Income before income taxes | | | 4,013 | | | 5,008 | | | 6,019 | | | 4,532 | | | 19,572 | | | 2,887 | | | 4,781 | | | 3,917 | | | 4,218 | | | 15,803 | |
Provision for income taxes | | | 897 | | | 1,097 | | | 1,653 | | | 1,042 | | | 4,689 | | | 579 | | | 925 | | | 801 | | | 880 | | | 3,185 | |
Net income | | $ | 3,116 | | $ | 3,911 | | $ | 4,366 | | $ | 3,490 | | $ | 14,883 | | $ | 2,308 | | $ | 3,856 | | $ | 3,116 | | $ | 3,338 | | $ | 12,618 | |
Basic earnings per share | | $ | 0.45 | | $ | 0.57 | | $ | 0.64 | | $ | 0.51 | | $ | 2.17 | | $ | 0.36 | | $ | 0.61 | | $ | 0.49 | | $ | 0.52 | | $ | 1.98 | |
Diluted earnings per share | | $ | 0.45 | | $ | 0.57 | | $ | 0.63 | | $ | 0.50 | | $ | 2.16 | | $ | 0.36 | | $ | 0.61 | | $ | 0.49 | | $ | 0.52 | | $ | 1.98 | |
Cash dividends declared and paid per share | | $ | 0.28 | | $ | 0.28 | | $ | 0.28 | | $ | 0.28 | | $ | 1.12 | | $ | 0.28 | | $ | 0.28 | | $ | 0.28 | | $ | 0.28 | | $ | 1.12 | |
ITEM 7 – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of our financial condition and results of operations is based on the consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States. The preparation of such consolidated financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management evaluates its estimates on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about financial statement amounts. Actual results could differ from the amount derived from Management’s estimates and assumptions under different conditions.
Our significant accounting policies are described in more detail in Note 1 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. Management believes the following accounting policies are the most critical to the preparation of the consolidated financial statements.
Allowance for Credit Losses: The allowance for credit losses (“Allowance”) includes the allowance for loan losses and the reserve for undisbursed lines of credit and standby letters of credit. The Allowance, which is established through the provision for credit losses, is based on Management’s evaluation of the level of allowance required in relation to probable incurred losses in the loan portfolio and undisbursed lines of credit and standby letters of credit. Management believes the Allowance is a significant estimate and therefore evaluates its adequacy each quarter. When determining the appropriate amount of the Allowance, Management considers factors such as previous loss experience, the size and composition of the loan portfolio, current economic and real estate market conditions, the performance of individual loans in relation to contract terms, and the estimated fair value of collateral that secures the loans. The use of different estimates or assumptions could produce a different Allowance.
Acquired Loans: Loans acquired from our acquisition of NUVO were recorded at fair value with no carryover of the related allowance for loan losses at the time of acquisition. Determining the fair value of the loans marks was based upon calculating collateral shortfalls.
Merchant’s management selected loans covering 73% of the commercial loan portfolio for review including:
| · | | Watch-listed and nonperforming |
| · | | Relationships over $500,000 total exposure |
In addition, management reviewed samples of consumer, residential and home equity loans. Based on these reviews, management determined those acquired loans that had evidence of deterioration in credit quality and were therefore within the scope of FASB Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.
For acquired loans accounted for under ASC 310-30, individual acquired loans determined to have evidence of deterioration in credit quality are accounted for individually. Acquired loans that were not individually in the scope of ASC 310-30 were accounted for under ASC 310-20, Nonrefundable Fees and Other Costs.
For acquired loans accounted for under ASC 310-30, the excess of expected cash flows from acquired loans over the estimated fair value of acquired loans at acquisition is called the accretable discount and is recognized into interest income over the remaining life of the acquired loans using the interest method. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses expected to be incurred over the life of the acquired loans. Subsequent decreases to the expected cash flows require us to evaluate the need for an addition to the allowance for loan losses. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the non-accretable discount which we then reclassify as accretable discount. We recognize the accretable
discount that is recognized in interest income over the remaining life of the loan using the interest method. Our evaluation of the amount of future cash flows that we expect to collect takes into account actual credit performance of the acquired loans to date and our best estimates for the expected lifetime credit performance of the loans using currently available information. Charge offs of the principal amount on acquired loans would be first applied to the non-accretable discount portion of the fair value adjustment. To the extent that we experience a deterioration in credit quality in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.
In accordance with ASC 310-30, recognition of income is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected. We perform an evaluation on a quarterly basis on our acquired loans individually accounted for under ASC 310-30. To the extent that we cannot reasonably estimate cash flows, interest income recognition is discontinued.
Payoffs on loans that had partial charge offs at the time of acquisition are reported in the consolidated statements of income in interest income on loans, including fees, after retirement of principal.
Income Taxes: We estimate our income taxes for each period for which a statement of income is presented. This involves estimating our actual current tax exposure, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and, to the extent that recovery is not likely, a valuation allowance must be established. Significant Management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2016, we determined that no valuation allowance for deferred tax assets was necessary.
Valuation of Investment Securities: Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. When an other-than-temporary impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether we intend to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. To determine whether impairment is other‑than‑temporary, we consider all available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable forecasts when developing estimates of cash flows expected to be collected. Factors considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year‑end, forecasted performance of the investee, and the general market conditions in the geographic area or industry the investee operates in.
If we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the impairment is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total impairment related to other factors is recognized in other comprehensive income, net of applicable income taxes.
Goodwill and Other Acquisition-Related Intangible Assets: An acquirer in a business combination is required, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration, if any, is also recognized and measured at fair value on the date of acquisition. In addition, the accounting standards for business combinations require that: (i) acquisition-related transaction costs be expensed as incurred; (ii) specific requirements be met in order to accrue for a restructuring plan as part of the acquisition; (iii) certain pre-acquisition contingencies be recognized at fair value; and (iv) acquired loans be recorded at fair value as of the acquisition date without recognition of an allowance for loan losses.
Intangible assets are recognized in an amount equal to the excess of the purchase price over the fair value of the tangible net assets acquired. “Acquisition-related intangible assets” are separately identified and recognized, where appropriate, for assets such as trade names and the estimated values of acquired core deposits and/or customer relationships. The remaining intangible asset is recognized as goodwill.
Goodwill and indefinite-lived intangible assets are not amortized but, rather, are reviewed for impairment at least annually, with impairment losses recognized as a charge to expense when they occur. Acquisition-related intangible assets other than goodwill and indefinite-lived intangible assets are amortized to expense over their estimated useful lives and are periodically reviewed by management to assess recoverability, with impairment losses recognized as a charge to expense if carrying amounts exceed fair values.
Goodwill is evaluated for impairment at the reporting unit level. The impairment evaluation is performed as of an annual date or more frequently if a triggering event indicates that impairment may have occurred. Entities have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, based on this qualitative assessment, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test is not required.
The first step (Step 1) in the two-step impairment test is used to identify potential impairment, and involves comparing each reporting unit’s estimated fair value to its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill is not deemed to be impaired.
The second step involves calculating the implied fair value of goodwill for each reporting unit for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to how the amount is determined in a business acquisition. If the implied fair value of the goodwill exceeds the carrying amount of goodwill assigned to the reporting unit, no impairment exists.
GENERAL
The following discussion and analysis of financial condition and results of operations of Merchants and its subsidiaries for the three years ended December 31, 2016 should be read in conjunction with the consolidated financial statements and Notes thereto and selected statistical information appearing elsewhere in this Annual Report on Form 10-K. The financial condition and results of operations of Merchants essentially reflect the operations of its principal subsidiary, Merchants Bank. Certain statements contained in this section are forward-looking statements subject to certain risks and uncertainties described in this Annual Report on Form 10-K under the headings “Forward-Looking Statements” and “Risk Factors.”
Non-GAAP Financial Measures
Certain measurements contained in this section that are presented on a fully taxable equivalent basis constitute non-GAAP financial measures as described in this Annual Report on Form 10-K under the heading “Use of Non-GAAP Financial Measures” above. Additionally, in several places in this section we discuss adjusted financial measures. Reconciliations of these adjusted measures to our consolidated financial statements prepared in accordance with GAAP are listed below. These reconciliations include a reconciliation of the tangible capital ratio and tangible book value per share titled “Tangible Book Value Non-GAAP Reconciliation” and reconciliations of adjusted net income and adjusted noninterest expense to our consolidated financial statements prepared in accordance with GAAP titled “Adjusted Net Income non-GAAP Reconciliation” and “Adjusted Noninterest Expense Non-GAAP Reconciliation,” respectively.
Tangible Book Value Non-GAAP Reconciliation
| | | | | | | |
| Period Ended |
| December 31, | | December 31, |
(In thousands except per share data) | 2016 | | 2015 |
Total assets | $ | 2,062,658 | | | $ | 2,021,237 | |
Core deposit intangible | | 1,156 | | | | 1,360 | |
Goodwill | | 7,011 | | | | 6,967 | |
Tangible assets | $ | 2,054,491 | | | $ | 2,012,910 | |
| | | | | | | |
Total stockholders' equity | | 156,503 | | | | 148,054 | |
Core deposit intangible | | 1,156 | | | | 1,360 | |
Goodwill | | 7,011 | | | | 6,967 | |
Tangible stockholders' equity | $ | 148,336 | | | $ | 139,727 | |
| | | | | | | |
Period end common shares outstanding | | 6,888 | | | | 6,855 | |
| | | | | | | |
Tangible book value per share | $ | 21.54 | | | $ | 20.38 | |
Tangible capital ratio | | 7.22 | % | | | 6.94 | % |
Adjusted Net Income Non-GAAP Reconciliation
| | | | | | | | | |
| | Twelve Months Ended |
| | December 31, |
(In thousands except per share data) | | 2016 | | 2015 | | 2014 |
Community Bank System, Inc. merger costs | | $ | 3,019 | | $ | — | | $ | — |
NUVO Bank & Trust Company acquisition costs | | | 61 | | | 1,875 | | | — |
Conversion costs | | | — | | | — | | | 1,319 |
Severance and retirement costs | | | 162 | | | 1,007 | | | 925 |
Tax effect | | | 777 | | | 576 | | | 506 |
Adjustments, net of tax | | $ | 2,465 | | $ | 2,306 | | $ | 1,738 |
| | | | | | | | | |
GAAP net income as reported | | | 14,883 | | | 12,618 | | | 12,125 |
Adjusted net income | | $ | 17,348 | | $ | 14,924 | | $ | 13,863 |
| | | | | | | | | |
Weighted average common shares outstanding | | | 6,871 | | | 6,373 | | | 6,326 |
Weighted average diluted shares outstanding | | | 6,896 | | | 6,386 | | | 6,344 |
| | | | | | | | | |
Adjusted basic earnings per common share | | $ | 2.52 | | $ | 2.34 | | $ | 2.19 |
Adjusted diluted earnings per common share | | $ | 2.52 | | $ | 2.34 | | $ | 2.19 |
Adjusted Noninterest Expense Non-GAAP Reconciliation
| | | | | | | | | |
| | Twelve Months Ended |
| | December 31, |
(In thousands) | | 2016 | | 2015 | | 2014 |
Noninterest expense | | $ | 47,251 | | $ | 43,971 | | $ | 42,214 |
Less: | | | | | | | | | |
Community Bank System, Inc. merger costs | | | 3,019 | | | — | | | — |
NUVO Bank & Trust Company acquisition costs | | | 61 | | | 1,875 | | | — |
Conversion costs | | | — | | | — | | | 1,319 |
Severance and retirement costs | | | 162 | | | 1,007 | | | 925 |
Adjusted noninterest expense | | $ | 44,009 | | $ | 41,089 | | $ | 39,970 |
RESULTS OF OPERATIONS
Overview
We realized net income of $14.88 million, $12.62 million and $12.13 million for the years ended December 31, 2016, 2015 and 2014, respectively. Basic earnings per share were $2.17, $1.98 and $1.92 and diluted earnings per share were $2.16, $1.98, and $1.91 for the years ended December 31, 2016, 2015 and 2014, respectively. Adjusted net income was $17.35 million, $14.92 million and $13.86 million for the years ended December 31, 2016, 2015 and 2014, respectively. On an adjusted basis, basic earnings per share were $2.52, $2.34 and $2.19 and adjusted diluted earnings per share were $2.52, $2.34, and $2.19 for the years ended December 31, 2016, 2015 and 2014, respectively. Refer to our Adjusted Net Income Non-GAAP table on page 32.
We declared and distributed total dividends of $1.12 per share each year during 2016, 2015 and 2014. On January 26, 2017, we declared a dividend of $0.28 per share for the fourth quarter of 2016, which was paid on February 23, 2017, to stockholders of record as of February 9, 2017.
Total assets were $2.06 billion at December 31, 2016, an increase of 2.1% over the balance at December 31, 2015. Total stockholders’ equity was $156.50 million at December 31, 2016, an increase of 5.7% over the balance at December 31, 2015. The return on average assets was 0.76%, 0.71% and 0.73% for 2016, 2015 and 2014, respectively. The return on average stockholders’ equity was 9.61%, 9.69% and 9.84% for 2016, 2015 and 2014, respectively.
Year-end book value per share increased to $22.72, an increase of $1.13 from $21.59 in the prior year. Year-end tangible book value per share increased to $21.54 per share, an increase of $1.16 per share from $20.38 in the prior year. Our capital ratios remain strong at December 31, 2016, with a common Tier 1 equity ratio of 12.42%, a leverage capital ratio of 8.71%, a total risk-based capital ratio of 15.14% and a non-GAAP tangible capital ratio of 7.22%. Refer to our non-GAAP tangible book value reconciliation on page 32.
| · | | Net interest income: Our net interest income was $55.24 million for 2016, an increase of $7.18 million from 2015 and an increase of $8.79 million from 2014. Our fully taxable equivalent net interest income was $57.46 million for 2016, an increase of $7.31 million from 2015 and an increase of $8.94 million from 2014. Our net interest margin for 2016 was 3.04%, a 10 basis point increase from 2015 and a 1 basis point increase from 2014. |
| · | | Provision for Credit Losses: We recorded a $1.11 million provision for credit losses during 2016 compared to a $250 thousand and $150 thousand provision for credit losses for 2015 and 2014, respectively. |
| · | | Noninterest income: Noninterest income for 2016 was $12.69 million, an increase of $728 thousand and $1.11 million from 2015 and 2014, respectively. |
| · | | Noninterest expense: Noninterest expense was $47.25 million for 2016, an increase of $3.28 million and $5.04 million from 2015 and 2014, respectively. Excluding NUVO acquisition costs, Community Bank System, Inc. merger costs, conversion costs and severance and retirement costs, adjusted noninterest expense was $44.01 |
million for 2016, compared to $41.09 million and $39.97 million for 2015 and 2014, respectively. Refer to our Adjusted Noninterest Expense Non-GAAP reconciliation on page 33. |
| · | | Loans: Gross loans at December 31, 2016 were $1.51 billion, an increase of $99.93 million, or 7.07%, over the gross loans at December 31, 2015. Average gross loans increased $206.06 million to $1.45 billion during 2016 from $1.24 billion during 2015. |
| · | | Investments: The investment portfolio, which includes FHLB stock, at December 31, 2016, totaled $424.67 million, an increase of $17.74 million from December 31, 2015. |
| · | | Deposits: Total deposits at year end 2016 were $1.53 billion, a decrease of $23.97 million over the balance at year end 2015. Average deposits increased $124.58 million to $1.51 billion during 2016 from $1.38 billion during 2015. |
Net Interest Income
2016 compared with 2015
As shown on the table on page 35, our fully taxable equivalent net interest income was $57.46 million for the year ended December 31, 2016 compared to $50.15 million for 2015. The increase in net interest income is primarily attributable to the inclusion of NUVO for the entire year, compared to 28 days in 2015 as well as new growth in total commercial and commercial real estate loans. Average gross loans increased $206.06 million from 2015. Our fully taxable equivalent net interest margin increased 10 basis points to 3.04% for 2016 from 2.94% for 2015. The increase in the net interest margin from the same period in 2015 was driven by higher loan yields and changes in the loan mix. Average interest bearing liabilities was $1.19 billion for 2016, an increase of $136.55 million from 2015. Total average interest bearing deposits increased $92.82 million to $887.66 million during 2016 and total average noninterest bearing deposits increased $31.76 million to $620.46 million during 2016. The overall deposit mix remained consistent with 2015.
2015 compared with 2014
As shown on the table on page 35, our fully taxable equivalent net interest income was $50.15 million for the year ended December 31, 2015 compared to $48.53 million for 2014. The increase in net interest income is attributable to growth in total commercial loans. Average loans increased $74.80 million from 2014. Our fully taxable equivalent net interest margin decreased 9 basis points to 2.94% for 2015 from 3.03% for 2014. The decline in the margin was primarily due to the decline in asset yields, which decreased 14 basis points during 2015. Average interest bearing deposits declined $132.20 million from 2014. The decrease in interest bearing transaction accounts was solely the result of converting certain deposit products from interest bearing to non-interest bearing. Average noninterest bearing deposits increased $195.34 million from 2014. The mix of deposits continued to change during the year from interest bearing to non-interest bearing.
The following table presents an analysis of net interest income and illustrates interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. Yields/rates are computed on a fully taxable-equivalent (“FTE”) basis, using a 35% rate. Nonaccrual loans are included in the average loan balance outstanding.
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Net Interest Margin
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2016 | | 2015 | | 2014 | |
| | | | Interest | | Average | | | | Interest | | Average | | | | Interest | | Average | |
Taxable equivalent | | Average | | Income/ | | Yield/ | | Average | | Income/ | | Yield/ | | Average | | Income/ | | Yield/ | |
(In thousands) | | Balance | | Expense | | Rate | | Balance | | Expense | | Rate | | Balance | | Expense | | Rate | |
ASSETS: | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans, including fees on loans | | $ | 1,446,443 | | $ | 54,152 | | 3.74 | % | $ | 1,240,386 | | $ | 46,176 | | 3.72 | % | $ | 1,165,586 | | $ | 44,893 | | 3.85 | % |
Investments | | | 395,186 | | | 7,555 | | 1.91 | % | | 385,806 | | | 7,779 | | 2.02 | % | | 358,274 | | | 7,965 | | 2.22 | % |
Federal funds sold, securities sold under agreements to repurchase and interest bearing deposits with banks | | | 50,352 | | | 256 | | 0.51 | % | | 81,961 | | | 250 | | 0.31 | % | | 79,599 | | | 192 | | 0.24 | % |
Total earning assets | | | 1,891,981 | | $ | 61,963 | | 3.27 | % | | 1,708,153 | | $ | 54,205 | | 3.17 | % | | 1,603,459 | | $ | 53,050 | | 3.31 | % |
Allowance for loan losses | | | (12,349) | | | | | | | | (12,116) | | | | | | | | (12,123) | | | | | | |
Cash and cash equivalents | | | 29,529 | | | | | | | | 25,901 | | | | | | | | 27,351 | | | | | | |
Premises and equipment | | | 14,126 | | | | | | | | 15,271 | | | | | | | | 15,616 | | | | | | |
Bank owned life insurance | | | 10,652 | | | | | | | | 10,426 | | | | | | | | 10,150 | | | | | | |
Other assets | | | 36,932 | | | | | | | | 27,861 | | | | | | | | 23,213 | | | | | | |
Total assets | | $ | 1,970,871 | | | | | | | $ | 1,775,496 | | | | | | | $ | 1,667,666 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY: | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | | |
Savings, interest bearing checking and money market accounts | | $ | 667,613 | | $ | 1,719 | | 0.26 | % | $ | 590,988 | | $ | 1,433 | | 0.24 | % | $ | 668,815 | | $ | 1,647 | | 0.25 | % |
Time deposits | | | 220,044 | | | 1,347 | | 0.61 | % | | 203,851 | | | 1,312 | | 0.64 | % | | 258,220 | | | 1,725 | | 0.67 | % |
Total interest bearing deposits | | | 887,657 | | | 3,066 | | 0.35 | % | | 794,839 | | | 2,745 | | 0.35 | % | | 927,035 | | | 3,372 | | 0.36 | % |
Federal funds purchased and Federal Home Loan Bank short-term borrowings | | | 25,425 | | | 126 | | 0.48 | % | | 3,953 | | | 13 | | 0.33 | % | | 212 | | | 1 | | 0.47 | % |
Securities sold under agreements to repurchase, short-term | | | 247,610 | | | 454 | | 0.18 | % | | 226,913 | | | 497 | | 0.22 | % | | 192,868 | | | 352 | | 0.18 | % |
Other long-term debt | | | 4,090 | | | 66 | | 1.58 | % | | 2,529 | | | 50 | | 1.97 | % | | 2,358 | | | 48 | | 2.04 | % |
Junior subordinated debentures issued to unconsolidated subsidiary trust | | | 20,619 | | | 788 | | 3.82 | % | | 20,619 | | | 747 | | 3.62 | % | | 20,619 | | | 752 | | 3.65 | % |
Total borrowed funds | | | 297,744 | | | 1,434 | | 0.48 | % | | 254,014 | | | 1,307 | | 0.51 | % | | 216,057 | | | 1,153 | | 0.53 | % |
Total interest bearing liabilities | | | 1,185,401 | | $ | 4,500 | | 0.38 | % | | 1,048,853 | | $ | 4,052 | | 0.39 | % | | 1,143,092 | | $ | 4,525 | | 0.40 | % |
Demand deposits | | | 620,456 | | | | | | | | 588,698 | | | | | | | | 393,355 | | | | | | |
Other liabilities | | | 10,066 | | | | | | | | 7,725 | | | | | | | | 7,936 | | | | | | |
Stockholders' equity | | | 154,948 | | | | | | | | 130,220 | | | | | | | | 123,283 | | | | | | |
Total liabilities & stockholders' equity | | $ | 1,970,871 | | | | | | | $ | 1,775,496 | | | | | | | $ | 1,667,666 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income, FTE | | | | | $ | 57,463 | | | | | | | $ | 50,153 | | | | | | | $ | 48,525 | | | |
Tax equivalent adjustment | | | | | | (2,223) | | | | | | | | (2,089) | | | | | | | | (2,078) | | | |
Net interest income, GAAP | | | | | $ | 55,240 | | | | | | | $ | 48,064 | | | | | | | $ | 46,447 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Yield spread | | | | | | | | 2.89 | % | | | | | | | 2.78 | % | | | | | | | 2.91 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest margin | | | | | | | | 3.04 | % | | | | | | | 2.94 | % | | | | | | | 3.03 | % |
The following table presents the extent to which changes in interest rates and changes in the volume of earning assets and interest bearing liabilities have affected interest income and interest expense during the periods indicated. Information is presented in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume) and (iii) changes in volume/rate (change in volume multiplied by change in rate).
Analysis of Changes in Fully Taxable Equivalent Net Interest Income
| | | | | | | | | | | | | | | | | | | |
2016 Compared to 2015 |
| | | | | | | Due to | |
| | | | Increase | | | | | | | | Volume/ | |
(In thousands) | | 2016 | | 2015 | | (Decrease) | | Volume | | Rate | | Rate | |
Fully taxable equivalent interest income: | | | | | | | | | | | | | | | | | | | |
Loans, including fees on loans | | $ | 54,152 | | $ | 46,176 | | $ | 7,976 | | $ | 7,665 | | $ | 295 | | $ | 16 | |
Investments | | | 7,555 | | | 7,779 | | | (224) | | | 192 | | | (419) | | | 3 | |
Federal funds sold, securities sold under agreements to repurchase and interest bearing deposits with banks | | | 256 | | | 250 | | | 6 | | | (98) | | | 163 | | | (59) | |
Total interest income | | | 61,963 | | | 54,205 | | | 7,758 | | | 7,759 | | | 39 | | | (40) | |
Less interest expense: | | | | | | | | | | | | | | | | | | | |
Savings, interest bearing checking and money market accounts | | | 1,719 | | | 1,433 | | | 286 | | | 184 | | | 103 | | | (1) | |
Time deposits | | | 1,347 | | | 1,312 | | | 35 | | | 104 | | | (57) | | | (12) | |
Federal funds purchased and Federal Home Loan Bank short-term borrowings | | | 126 | | | 13 | | | 113 | | | 71 | | | 6 | | | 36 | |
Securities sold under agreements to repurchase, short-term | | | 454 | | | 497 | | | (43) | | | 46 | | | (83) | | | (6) | |
Other long-term debt | | | 66 | | | 50 | | | 16 | | | 31 | | | (10) | | | (5) | |
Junior subordinated debentures issued to unconsolidated subsidiary trust | | | 788 | | | 747 | | | 41 | | | — | | | 41 | | | — | |
Total interest expense | | | 4,500 | | | 4,052 | | | 448 | | | 436 | | | — | | | 12 | |
Net interest income | | $ | 57,463 | | $ | 50,153 | | $ | 7,310 | | $ | 7,323 | | $ | 39 | | $ | (52) | |
| | | | | | | | | | | | | | | | | | | |
2015 Compared to 2014 |
| | | | | | | Due to | |
| | | | Increase | | | | | | | | Volume/ | |
(In thousands) | | 2015 | | 2014 | | (Decrease) | | Volume | | Rate | | Rate | |
Fully taxable equivalent interest income: | | | | | | | | | | | | | | | | | | | |
Loans, including fees on loans | | $ | 46,176 | | $ | 44,893 | | $ | 1,283 | | $ | 2,880 | | $ | (1,484) | | $ | (113) | |
Investments | | | 7,779 | | | 7,965 | | | (186) | | | 611 | | | (730) | | | (67) | |
Federal funds sold, securities sold under agreements to repurchase and interest bearing deposits with banks | | | 250 | | | 192 | | | 58 | | | 6 | | | 52 | | | — | |
Total interest income | | | 54,205 | | | 53,050 | | | 1,155 | | | 3,497 | | | (2,162) | | | (180) | |
Less interest expense: | | | | | | | | | | | | | | | | | | | |
Savings, interest bearing checking and money market accounts | | | 1,433 | | | 1,647 | | | (214) | | | (195) | | | (50) | | | 31 | |
Time deposits | | | 1,312 | | | 1,725 | | | (413) | | | (364) | | | (68) | | | 19 | |
Federal funds purchased and Federal Home Loan Bank short-term borrowings | | | 13 | | | 1 | | | 12 | | | 19 | | | — | | | (7) | |
Securities sold under agreements to repurchase, short-term | | | 497 | | | 352 | | | 145 | | | 61 | | | 76 | | | 8 | |
Other long-term debt | | | 50 | | | 48 | | | 2 | | | (2) | | | 3 | | | 1 | |
Junior subordinated debentures issued to unconsolidated subsidiary trust | | | 747 | | | 752 | | | (5) | | | — | | | (5) | | | — | |
Total interest expense | | | 4,052 | | | 4,525 | | | (473) | | | (481) | | | (44) | | | 52 | |
Net interest income | | $ | 50,153 | | $ | 48,525 | | $ | 1,628 | | $ | 3,978 | | $ | (2,118) | | $ | (232) | |
Allowance for Loan Losses
The allowance for loan losses at December 31, 2016 was $12.66 million, or 0.84% of total loans and 398% of nonperforming loans, compared to the December 31, 2015 balance of $12.04 million, or 0.85% of total loans and 302% of nonperforming loans. We recorded a provision of $1.11 million during 2016 compared to $250 thousand during 2015. Our credit quality remains strong. The increase in the provision for credit losses during 2016 was primarily due to new loan growth. Performing loans past due 31-90 days were 0.03% of total loans at December 31, 2016 compared to 0.05% at December 31, 2015. Nonperforming loans as a percent of total loans were 0.21% at December 31, 2016 compared to 0.28% at December 31, 2015. Accruing substandard loans increased to 2.12% of total loans at December 31, 2016 compared to 1.32% at December 31, 2015. Net charge-offs for 2016 totaled $381 thousand, compared to net charge-offs of $109 thousand during 2015. All of these factors are taken into consideration during Management’s quarterly review of the Allowance. For a more detailed discussion of our Allowance and nonperforming assets, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Credit Quality and Allowance for Credit Losses” below.
NONINTEREST INCOME AND EXPENSES
Noninterest income
2016 compared to 2015
Total noninterest income increased $728 thousand to $12.69 million for 2016 compared to $11.96 million in 2015. This increase is primarily driven by an increase of $609 thousand in overdraft income, an increase of $184 thousand in trust fees and a $195 thousand increase in service charges on deposits. These increases were offset by a decrease in other noninterest income in 2016 as 2015 income was higher due to recognizing non-recurring miscellaneous income of $440 thousand.
2015 compared to 2014
Total noninterest income increased $386 thousand to $11.96 million for 2015 compared to $11.57 million in 2014. Excluding non-recurring miscellaneous income recognized in the third quarter of 2015 of $440 thousand, total noninterest income declined $54 thousand. The increase in debit card income offset reductions in overdraft fees. Trust division income increased $132 thousand to $3.5 million for 2015 compared to 2014.
Noninterest expense
2016 compared to 2015
Total noninterest expense increased $3.28 million to $47.25 million for 2016 compared to $43.97 million in 2015. This increase is primarily due to Community merger costs.
Excluding NUVO acquisition costs, Community merger costs, severance and retirement costs for 2016, and NUVO acquisition costs, severance and retirement costs for 2015, noninterest expense was $44.01 million compared to $41.09 million in 2015. This increase is primarily due to recognizing a full year impact of NUVO during 2016 compared to 28 days in 2015. Refer to the “Adjusted Noninterest Expense Non-GAAP Reconciliation” on page 33 for additional information.
2015 compared to 2014
Total noninterest expense increased $1.76 million to $43.97 million for 2015 compared to $42.21 million in 2014. The increase in 2015 is primarily due to NUVO acquisition costs and an increase in severance and retirement costs. The higher severance and retirement expense in 2015 is primarily related to a strategic initiative to align our resources with customer needs and behavior, which resulted in a reduction of branch staffing.
Excluding NUVO acquisition costs, severance and retirement costs for 2015, and core processing conversion, severance and retirement expenses for 2014, noninterest expense was $41.09 million compared to $39.97 million in 2014. This increase was primarily driven by an increase in total compensation and benefits of $1.44 million and an increase in other expenses of $221 thousand, partially offset by a $616 thousand decrease in marketing expense. The increase in compensation and benefits was primarily attributable to higher commission and incentive expense and higher pension expense. The 2014 marketing expense included costs for a new marketing campaign. Refer to our Adjusted Noninterest Expense Non-GAAP Reconciliation on page 33 for additional information.
Income Taxes
We recognized $3.04 million, $2.26 million and $2.53 million, respectively, during 2016, 2015, and 2014, in low-income housing, historic rehabilitation and qualified school construction bond tax credits as a reduction in the provision for income taxes. These credits, combined with tax-exempt income earned on our municipal loan portfolio, resulted in an effective tax rate of 24%, 20% and 23% for 2016, 2015, and 2014, respectively. During the first quarter of 2014 Merchants adopted, ASU 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects” retrospectively. This adoption allows low income housing tax credit that meet certain conditions to be accounted for in income tax expense.
BALANCE SHEET ANALYSIS
Our total assets increased to $2.06 billion at December 31, 2016 from $2.02 billion at December 31, 2015, while our average earning assets also increased to $1.89 billion at December 31, 2016 from $1.71 billion at December 31, 2015.
Loans
Average loans for 2016 were $1.45 billion, a $206.06 million, or 16.6%, increase over average loans for 2015 of $1.24 billion. Loans at December 31, 2016 were $1.51 billion, a $99.93 million increase over 2015 ending balance of $1.41 billion. Growth for 2016 was driven by the commercial, financial & agricultural and real estate – commercial portfolios.
The composition of our loan portfolio is shown in the following table:
| | | | | | | | | | | | | | | | |
| | Ending Loan Balances as of December 31, | |
(In thousands) | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | |
Commercial, financial & agricultural | | $ | 257,078 | | $ | 237,451 | | $ | 177,597 | | $ | 172,810 | | $ | 165,023 | |
Municipal | | | 114,509 | | | 105,421 | | | 94,366 | | | 94,007 | | | 84,689 | |
Real estate – residential | | | 447,527 | | | 468,443 | | | 469,529 | | | 489,706 | | | 460,395 | |
Real estate – commercial | | | 636,755 | | | 558,004 | | | 412,447 | | | 371,319 | | | 357,178 | |
Real estate – construction | | | 52,533 | | | 34,802 | | | 23,858 | | | 31,841 | | | 10,561 | |
Installment | | | 5,790 | | | 10,115 | | | 4,504 | | | 5,655 | | | 4,701 | |
All other loans | | | 17 | | | 44 | | | 33 | | | 895 | | | 376 | |
Total | | $ | 1,514,209 | | $ | 1,414,280 | | $ | 1,182,334 | | $ | 1,166,233 | | $ | 1,082,923 | |
Totals above are shown net of deferred loans fees of $1.19 million, $1.20 million, $734 thousand, $618 thousand, and $250 thousand for 2016, 2015, 2014, 2013, and 2012, respectively. No reclassifications were necessary in 2016, 2015, 2014 or 2013. Ending loan balances for 2012 in the table above reflect the reclassification of $29.56 million in non-owner occupied residential real estate loans from the residential real estate category to the commercial real estate category. This presentation more accurately presents the risk profile of these loans.
At December 31, 2016, we serviced $8.04 million in residential mortgage loans for investors such as the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), Federal Home Loan Bank of Boston (“FHLB”) and other financial investors and government agencies.
The following table presents the contractual maturities of our loan portfolio at December 31, 2016:
| | | | | | | | | | | | | |
| | | | | Over One | | | | | | | |
| | One Year | | Through | | Over Five | | | | |
(In thousands) | | Or Less | | 5 Years | | Years | | Total | |
Commercial, financial & agricultural | | $ | 72,159 | | $ | 126,892 | | $ | 58,027 | | $ | 257,078 | |
Municipal | | | 57,915 | | | 9,221 | | | 47,373 | | | 114,509 | |
Real estate – residential | | | 7,587 | | | 21,420 | | | 418,520 | | | 447,527 | |
Real estate – commercial | | | 48,207 | | | 184,653 | | | 403,895 | | | 636,755 | |
Real estate – construction | | | 22,389 | | | 7,488 | | | 22,656 | | | 52,533 | |
Installment | | | 884 | | | 4,906 | | | — | | | 5,790 | |
All other loans | | | 17 | | | — | | | — | | | 17 | |
Total | | $ | 209,158 | | $ | 354,580 | | $ | 950,471 | | $ | 1,514,209 | |
The following table presents loans maturing after one year which have predetermined interest rates and floating or adjustable interest rates as of December 31, 2016:
| | | | | | | |
(In thousands) | | Fixed | | Adjustable | |
Commercial, financial & agricultural | | $ | 129,585 | | $ | 55,334 | |
Municipal | | | 56,594 | | | — | |
Real estate – residential | | | 391,692 | | | 48,248 | |
Real estate – commercial | | | 408,443 | | | 180,105 | |
Real estate – construction | | | 25,259 | | | 4,885 | |
Installment | | | 4,906 | | | — | |
Other | | | — | | | — | |
Total | | $ | 1,016,479 | | $ | 288,572 | |
It is our policy to make loans to directors, executive officers, and associates of such persons on substantially the same terms, including interest rates and collateral, as those prevailing for comparable lending transactions with other persons.
Investments
The investment portfolio is used to generate interest income, manage liquidity and mitigate interest rate sensitivity. Our investment portfolio totaled $419.69 million at December 31, 2016, an increase of $16.56 million from the December 31, 2015 ending balance of $403.13 million. The portfolio increased due to bond purchases with a total book value of $95.40 million, offset by principal payments for bonds that matured during the current year. We manage our portfolio to ensure the securities were valued greater than the amount required to secure public deposits, securities sold under agreements to repurchase and for other purposes required by law.
During 2014 and 2013, securities were transferred from available for sale to held to maturity. The amortization of the unamortized net holding loss reported in accumulated other comprehensive income offsets the effect on interest income of the discount for the transferred securities. The remaining unamortized balance of the losses for the securities transferred from available for sale to held to maturity, net of tax was $1.41 million at December 31, 2016.
The composition of our investment portfolio at carrying amounts is shown in the following table:
| | | | | | | | | | |
| | As of December 31, | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Available for Sale: | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 25,183 | | $ | 25,113 | | $ | 25,093 | |
U.S. Government Sponsored Enterprises (“U.S. GSEs”) | | | 93,353 | | | 20,794 | | | — | |
FHLB Obligations | | | 67,006 | | | 51,111 | | | — | |
Residential Real Estate Mortgage-backed Securities (“Agency MBSs”) | | | 75,209 | | | 97,249 | | | 95,407 | |
Agency Commercial Mortgage Backed Securities ("Agency CMBSs") | | | 23,608 | | | 24,553 | | | 21,704 | |
Agency Collateralized Mortgage Obligations (“Agency CMOs”) | | | 49,333 | | | 64,279 | | | 60,882 | |
Asset Backed Securities (“ABSs”) | | | 306 | | | 355 | | | 387 | |
Total available for sale | | | 333,998 | | | 283,454 | | | 203,473 | |
Held to Maturity: | | | | | | | | | | |
U.S. Agency Obligations | | | 17,849 | | | 20,084 | | | 22,072 | |
U.S. GSEs | | | — | | | 9,556 | | | 9,498 | |
FHLB Obligations | | | — | | | 4,758 | | | 4,720 | |
Agency MBSs | | | 5,787 | | | 7,027 | | | 8,109 | |
Agency CMOs | | | 62,058 | | | 78,249 | | | 94,022 | |
Total held to maturity | | | 85,694 | | | 119,674 | | | 138,421 | |
Total securities | | $ | 419,692 | | $ | 403,128 | | $ | 341,894 | |
Agency MBSs and Agency CMOs consist of pools of residential mortgages which are guaranteed by the FNMA, FHLMC, or Government National Mortgage Association (“GNMA”) with various origination dates and maturities. Agency CMBS consists of bonds backed by commercial real estate which are guaranteed by FNMA and GNMA.
We use external pricing services to obtain fair market values for our investment portfolio. We have obtained and reviewed the service providers’ pricing and reference data documentation. Evaluations are based on market data and vary by asset class and incorporate available trade, bid and other market information. Because many fixed income securities do not trade on a daily basis, the service provider’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, model processes such as the Option Adjusted Spread model are used to assess interest rate impact and develop prepayment scenarios with inputs determined based on knowledge of the market. We periodically test the values provided to us by the pricing service through a combination of back testing on actual sales of securities and by obtaining prices on all bonds from an alternative pricing source.
We do not intend to sell the investment securities that are in an unrealized loss position and it is unlikely that we will be required to sell the investment securities before recovery of their amortized cost basis, which may be maturity.
The contractual final maturity distribution of the debt securities classified as available for sale and held to maturity as of December 31, 2016, was as follows:
SECURITIES AVAILABLE FOR SALE (at fair value):
| | | | | | | | | | | | | | | | | | | |
| | | | | After One | | | | | | | | | | | | | |
| | | | | But | | After Five | | | | | Securities not | | | | |
| | Within | | Within | | But Within | | After Ten | | due at a Single | | | | |
(In thousands) | | One Year | | Five Years | | Ten Years | | Years | | Maturity | | Total | |
U.S. Treasury Obligations | | $ | 15,109 | | $ | 10,074 | | $ | — | | $ | — | | $ | N/A | | $ | 25,183 | |
U.S. GSEs | | | — | | | 93,353 | | | — | | | — | | | N/A | | | 93,353 | |
FHLB Obligations | | | — | | | 61,005 | | | 6,001 | | | — | | | N/A | | | 67,006 | |
Agency MBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 75,209 | | | 75,209 | |
Agency CMBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 23,608 | | | 23,608 | |
Agency CMOs | | | N/A | | | N/A | | | N/A | | | N/A | | | 49,333 | | | 49,333 | |
ABSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 306 | | | 306 | |
Total | | $ | 15,109 | | $ | 164,432 | | $ | 6,001 | | $ | — | | $ | 148,456 | | $ | 333,998 | |
Weighted average investment yield | | | 0.96 | % | | 1.45 | % | | 2.38 | % | | — | % | | 2.02 | % | | | |
SECURITIES HELD TO MATURITY (at amortized cost):
| | | | | | | | | | | | | | | | | | | |
| | | | | After One | | | | | | | | | | | | | |
| | | | | But | | After Five | | | | | Securities not | | | | |
| | Within | | Within | | But Within | | After Ten | | due at a Single | | | | |
(In thousands) | | One Year | | Five Years | | Ten Years | | Years | | Maturity | | Total | |
U.S. Agency Obligations | | $ | — | | $ | — | | $ | — | | $ | 17,849 | | $ | N/A | | $ | 17,849 | |
Agency MBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 5,787 | | | 5,787 | |
Agency CMOs | | | N/A | | | N/A | | | N/A | | | N/A | | | 62,058 | | | 62,058 | |
Total | | $ | — | | $ | — | | $ | — | | $ | 17,849 | | $ | 67,845 | | $ | 85,694 | |
Weighted average investment yield | | | — | % | | — | % | | — | % | | 2.94 | % | | 2.53 | % | | | |
Actual maturities will differ from contractual maturities because borrowers may have rights to call or prepay obligations. Maturities of mortgage-backed securities and collateralized mortgage obligations are based on final contractual maturities.
As a member of the Federal Home Loan Bank system, we are required to invest in stock of the FHLB in an amount determined based on our borrowings from the FHLB. At December 31, 2016, our investment in FHLB stock totaled $4.98 million. Dividend income on FHLB stock of $212 thousand and $124 thousand was recorded during 2016 and 2015, respectively. The FHLB continues to be classified as “adequately capitalized” by its primary regulator. Based on current available information, we have concluded that our investment in FHLB stock is not impaired. We will continue to monitor our investment in FHLB stock.
Other Assets
Bank premises and equipment decreased to $13.08 million at December 31, 2016 from $15.03 million at December 31, 2015. During 2016, we recorded depreciation of $1.97 million and a loss on disposals of $57 thousand.
Investments in real estate limited partnerships increased $669 thousand to $6.36 million at December 31, 2016 due to additional investments made. These partnerships provide affordable housing in the communities in which we do business and provide us with tax credits and a high targeted rate of return on our investment.
As of December 31, 2016, the primary components of other assets are interest receivable of $4.72 million and prepaid pension of $3.32 million, an increase of $813 thousand and a decrease of $382 thousand from 2015, respectively.
Deposits
Our deposit balance at December 31, 2016 decreased $23.97 million, or 1.54%, to $1.53 billion from $1.55 billion at December 31, 2015. Total average deposits for 2016 were $1.51 billion, a $124.58 million increase over average balances for 2015. This represents a 9.00% annualized growth rate. Time deposit balanced decreased from 2015 primarily due to planned run-off of high-cost NUVO time deposits.
The composition of our deposit balance is shown in the following table:
| | | | | | | | | | |
| | As of December 31, | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Demand | | $ | 640,922 | | $ | 631,244 | | $ | 566,366 | |
Savings, interest bearing checking & money market accounts | | | 687,340 | | | 665,623 | | | 530,722 | |
Time deposits | | | 199,208 | | | 254,572 | | | 211,684 | |
Total | | $ | 1,527,470 | | $ | 1,551,439 | | $ | 1,308,772 | |
Time deposits of $250 thousand and greater at December 31, 2016 and 2015 had the following schedule of maturities:
| | | | | | | |
| | As of December 31, | |
(In thousands) | | 2016 | | 2015 | |
Three months or less | | $ | 12,090 | | $ | 16,386 | |
Three to six months | | | 7,602 | | | 6,421 | |
Six to twelve months | | | 3,649 | | | 8,858 | |
One to five years | | | 9,015 | | | 11,672 | |
Total | | $ | 32,356 | | $ | 43,337 | |
Other Liabilities
Securities sold under agreement to repurchase, which represent collateralized customer accounts increased $25.48 million to $312.12 million at December 31, 2016 compared to $286.64 million at December 31, 2015. The increase is primarily a result of the success in growing the municipal business.
On December 15, 2004, we closed our private placement of an aggregate of $20.62 million of trust preferred securities. The placement occurred through a newly-formed Delaware statutory trust affiliate, MBVT Statutory Trust I (the “Trust”) as part of a pooled trust preferred program. The Trust was formed for the sole purpose of issuing capital securities; these securities are non-voting. We own all of the common securities of the Trust. The proceeds from the sale of the capital securities were loaned to us under subordinated debentures issued to the Trust. The debentures are the only asset of the Trust and payments under the debentures are the sole revenue of the Trust. Our primary source of funds to pay interest on the debentures held by the Trust is current dividends from our principal subsidiary, Merchants Bank. Accordingly, our ability to service the debentures is dependent upon the continued ability of Merchants Bank to pay dividends to us.
These hybrid securities qualify as regulatory capital, up to certain regulatory limits. At the same time, they are considered debt for tax purposes, and as such, interest payments are fully deductible. The trust preferred securities total $20.62 million, and carried a fixed rate of interest through December 2009, at which time the rate became variable and adjusts quarterly at three-month LIBOR plus 1.95%. We entered into an interest rate swap arrangement for $10 million of our trust preferred issuance. The swap fixed the rate on $10 million at 5.23% and expired on December 15, 2016. The impact on net interest income for 2016, 2015 and 2014 from the interest expense on the trust preferred securities was $788 thousand, $746 thousand and $752 thousand per year, respectively. The trust preferred securities mature on December 31, 2034, and are redeemable without penalty at our option, subject to prior approval by the FRB.
CREDIT QUALITY AND ALLOWANCE FOR CREDIT LOSSES
Recent statistics on the United States economy showed real gross domestic product increased 1.6% in 2016 compared to an increase of 2.6% in 2015. Nationwide unemployment rates have declined slightly from 5.0% at December 31, 2015 to 4.7% at December 31, 2016.
In Vermont, the seasonally adjusted statewide unemployment rate was 3.1% at December 31, 2016 down from 3.5% at December 31, 2015, and is currently the seventh lowest unemployment rate in the country. At December 31, 2016, the Massachusetts seasonally adjusted statewide unemployment rate was 2.8%, down from 4.9% at December 31, 2015, and is currently the second lowest unemployment rate in the country.
Credit quality
Credit quality is a major strategic focus and strength of our company. Although we actively manage current nonperforming and classified loans, there is no assurance that we will not have increased levels of problem assets in the future. The composition of the nonperforming pool is dynamic with accounts moving in and out of this category over time. The following table summarizes our nonperforming loans (“NPL”) and nonperforming assets (“NPA”) as of December 31, 2012, through December 31, 2016:
| | | | | | | | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | |
Nonaccrual loans | | $ | 3,163 | | $ | 3,513 | | $ | 598 | | $ | 425 | | $ | 2,355 | |
Loans past due greater than 90 days and accruing | | | 19 | | | — | | | — | | | 75 | | | — | |
Troubled debt restructurings (“TDR”) | | | — | | | 472 | | | 63 | | | 235 | | | 374 | |
Total nonperforming loans | | | 3,182 | | | 3,985 | | | 661 | | | 735 | | | 2,729 | |
OREO | | | 76 | | | 12 | | | — | | | 108 | | | — | |
Total nonperforming assets | | $ | 3,258 | | $ | 3,997 | | $ | 661 | | $ | 843 | | $ | 2,729 | |
Nonperforming loans at December 31, 2016 were $3.18 million, which included $905 thousand in nonperforming loans acquired from NUVO. Of the $3.18 million in nonperforming loans in the table above, there were $2.07 million in commercial and commercial real estate loans, $1.10 million in residential mortgages, and $12 thousand in installment loans. Nonperforming loans, as of December 31, 2015, December 31, 2014, December 31, 2013, and December 31, 2012 were adjusted $210 thousand, $130 thousand, $171 thousand and $183 thousand, respectively, for accruing TDRs reflecting the Company’s updated policy classifying these loans as performing loans.
We originate traditional mortgage and home equity products that are fully documented and underwritten. We take a proactive risk management approach by conducting periodic stress-testing of the existing residential loan portfolio and adjusting underwriting requirements, if necessary, based upon the results of the analysis. The assumptions used in the stress testing include: credit score migration; calculation of possible losses using conservative assumptions of market decline; review of life-of-loan delinquency levels relative to loan size and credit score; analysis of the portfolio by loan size, and distribution within the portfolio by loan-to-value ratios. Based upon the results of assessments of the residential loan portfolio, Management concluded that current reserve levels were adequate.
Our analysis indicates that, through a combination of estimated collateral value and, where needed, an appropriately allocated reserve, any additional loss exposure on current non-accruing loans is minimal.
TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. There were three restructured residential mortgages at December 31, 2016 with balances totaling $110 thousand. There was one restructured commercial loan and one commercial real estate loan at December 31, 2016 with a balance of $78 thousand and $405 thousand, respectively. At December 31, 2016 all five of the TDRs continue to pay as agreed according to the modified terms and are considered well-secured.
Excluded from the nonperforming balances previously discussed are our loans that are 31 to 90 days past due, which are not necessarily considered classified or impaired. Accruing loans 31 to 90 days past due as a percentage of total loans as of the periods indicated are presented in the following table:
| | | |
Year Ended | | 31-90 Days | |
December 31, 2016 | | 0.03 | % |
December 31, 2015 | | 0.05 | % |
December 31, 2014 | | 0.04 | % |
December 31, 2013 | | 0.03 | % |
December 31, 2012 | | — | % |
Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days. If a loan or a portion of a loan is internally classified as impaired or is partially charged-off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 91 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Income accruals are suspended on all non-accruing loans, and all previously accrued and uncollected interest is charged against current income.
Loans may be returned to accrual status when there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms of the loans and all principal and interest amounts contractually due, including arrearages, are reasonably assured of repayment within an acceptable period of time.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is uncertain, any payments received are generally applied to reduce the principal balance. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Interest collections in excess of that amount are recorded as a reduction of principal.
A loan remains in non-accruing status until the factors which suggest doubtful collectability no longer exist, the loan is liquidated, or when the loan is determined to be uncollectible, and is charged off against the allowance for loan losses. In those cases where a non-accruing loan is secured by real estate, we can, and may, initiate foreclosure proceedings. The result of such action will either be to cause repayment of the loan with the proceeds of a foreclosure sale or to give us possession of the collateral in order to manage a future resale of the real estate. Foreclosed property is recorded at the lower of its cost or estimated fair value, less any estimated costs to sell and is actively marketed. Any cost in excess of the estimated fair value on the transfer date is charged to the allowance for loan losses, while further declines in market values are recorded as OREO expense in the consolidated statements of income. Nonperforming loans, which primarily consist of non-accruing residential mortgage, commercial, and commercial real estate loans and non-accruing TDRs, totaled $3.18 million and $3.99 million at December 31, 2016 and 2015, respectively. At December 31, 2016, $1.01 million of nonperforming loans had specific reserve allocations totaling $184 thousand.
Substandard loans at December 31, 2016 totaled $35.16 million, of which $32.07 million in loans continue to accrue interest. Loans identified as substandard have well-defined weaknesses that, if not addressed, could result in a loss. These accruing substandard loans have generally continued to pay promptly and Management conducts regularly scheduled comprehensive reviews of the borrowers’ financial condition, payment performance, accrual status and collateral. These reviews also ensure that these troubled accounts are properly administered with a focus on loss mitigation and that any potential loss exposures are appropriately quantified, and reserved for. The findings of this review process are a key component in assessing the adequacy of our loan loss reserve.
Accruing substandard loans at December 31, 2016 reflect a $12.48 million increase in balances since December 31, 2015. At December 31, 2016, accruing substandard loans related to owner-occupied commercial real estate totaled $13.71 million, investor commercial real estate loans totaled $1.07 million, residential investment real estate loans totaled $839 thousand, residential mortgage loans totaled $72 thousand and $16.38 million in substandard loans are outstanding to
corporate borrowers in a variety of different industries. Nineteen borrowers in a variety of industries account for 98% of the total accruing substandard loans.
To date, with very few exceptions, payments due from accruing substandard borrowers have been made as agreed and Management’s ongoing evaluation of these borrowers’ financial condition and collateral indicates a reasonable certainty that these exposures are adequately secured.
Management monitors asset quality closely and continuously performs detailed and extensive reviews on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings and internal credit rating reports. In addition to frequent financial analysis and review of well-rated and adversely graded loans, Management incorporates active monitoring of key credit and non-credit risks for each customer, assessing risk through the daily reviews of overdrafts, delinquencies and usage of electronic banking products and tracking for timely receipt of all required financial statements.
Allowance for Credit Losses
The allowance for credit losses is made up of two components: the allowance for loan losses (“ALL”) and the reserve for undisbursed lines and standby letters of credit. The ALL is based on Management's estimate of the amount required to reflect the probable incurred losses in the loan portfolio, based on circumstances and conditions known at each reporting date. We review the adequacy of the ALL quarterly. Factors considered in evaluating the adequacy of the ALL include previous loss experience, the size and composition of the portfolio, risk rating composition, current economic and real estate market conditions and their effect on the borrowers, the performance of individual loans in relation to contractual terms and estimated fair values of properties that secure impaired loans.
The adequacy of the ALL is determined using a consistent, systematic methodology, consisting of a review of both specific reserves for loans identified as impaired and general reserves for the various loan portfolio classifications. When a loan is impaired, we determine its impairment loss by comparing the excess, if any, of the loan’s carrying amount over (1) the present value of expected future cash flows discounted at the loan’s original effective interest rate, (2) the observable market price of the impaired loan, or (3) the fair value of the collateral securing a collateral-dependent loan. When a loan is deemed to have an impairment loss, the loan is either charged down to its estimated net realizable value, or a specific reserve is established as part of the overall allowance for loan losses if Management needs more time to evaluate all of the facts and circumstances relevant to that particular loan.
The general allowance for loan losses is a percentage-based reflection of historical loss experience adjusted for qualitative factors and assigns a required allocation by loan classification based on a fixed percentage of all outstanding loan balances. The general allowance for loan losses employs a risk-rating model that grades loans based on their general characteristics of credit quality and relative risk. Appropriate reserve levels are estimated based on Management’s judgments regarding the historical loss experience, current economic trends, trends in the portfolio mix, volume and trends in delinquencies and non-accrual loans.
The following table summarizes the allowance for loan losses allocated by loan type:
| | | | | | | | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | |
Commercial, financial & agricultural | | $ | 2,946 | | $ | 2,696 | | $ | 2,583 | | $ | 2,740 | | $ | 2,915 | |
Municipal | | | 593 | | | 590 | | | 623 | | | 758 | | | 494 | |
Real estate – residential | | | 2,575 | | | 2,882 | | | 3,038 | | | 2,995 | | | 3,333 | |
Real estate – commercial | | | 5,922 | | | 5,386 | | | 5,209 | | | 5,040 | | | 4,605 | |
Real estate – construction | | | 534 | | | 420 | | | 325 | | | 481 | | | 187 | |
Installment | | | 89 | | | 66 | | | 13 | | | 18 | | | 17 | |
All other loans | | | — | | | — | | | 42 | | | 10 | | | 11 | |
Allowance for loan losses | | $ | 12,659 | | $ | 12,040 | | $ | 11,833 | | $ | 12,042 | | $ | 11,562 | |
Losses are charged against the ALL when Management believes that the collectability of principal is doubtful. To the extent Management determines the level of anticipated losses in the portfolio increased or diminished, the ALL is adjusted through current earnings. Overall, Management believes that the ALL is maintained at an adequate level, in light of historical and current factors, to reflect the level of credit risk in the loan portfolio. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the ALL.
The following table reflects our loan loss experience and activity in the allowance for loan losses for the past five years:
| | | | | | | | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | |
Average loans outstanding | | $ | 1,446,443 | | $ | 1,240,386 | | $ | 1,165,586 | | $ | 1,133,637 | | $ | 1,057,446 | |
Allowance beginning of year | | | 12,040 | | | 11,833 | | | 12,042 | | | 11,562 | | | 10,619 | |
Charge-offs: | | | | | | | | | | | | | | | | |
Commercial, financial & agricultural and all other loans | | | (125) | | | (29) | | | (34) | | | (20) | | | (9) | |
Real estate – residential | | | (215) | | | (112) | | | (25) | | | (289) | | | (20) | |
Real estate – commercial | | | — | | | — | | | — | | | (1) | | | (32) | |
Real estate – construction | | | — | | | — | | | — | | | — | | | — | |
Installment, other | | | (168) | | | (108) | | | (172) | | | (102) | | | — | |
Total charge-offs | | | (508) | | | (249) | | | (231) | | | (412) | | | (61) | |
Recoveries: | | | | | | | | | | | | | | | | |
Commercial, financial & agricultural and all other loans | | | 5 | | | 34 | | | 10 | | | 62 | | | 30 | |
Real estate – residential | | | 35 | | | 52 | | | 24 | | | 6 | | | 14 | |
Real estate – commercial | | | 4 | | | 2 | | | 1 | | | 40 | | | 1 | |
Real estate – construction | | | — | | | — | | | — | | | 1 | | | 25 | |
Installment, other | | | 83 | | | 52 | | | 33 | | | 19 | | | — | |
Total recoveries | | | 127 | | | 140 | | | 68 | | | 128 | | | 70 | |
Net (charge-offs) recoveries | | | (381) | | | (109) | | | (163) | | | (284) | | | 9 | |
Provision (credit) for loan losses | | | 1,000 | | | 316 | | | (46) | | | 764 | | | 934 | |
| | | | | | | | | | | | | | | | |
Allowance end of year | | $ | 12,659 | | $ | 12,040 | | $ | 11,833 | | $ | 12,042 | | $ | 11,562 | |
Ratio of net (charge-offs) recoveries to average loans outstanding | | | (0.03) | % | | (0.01) | % | | (0.01) | % | | (0.02) | % | | — | % |
| | | | | | | | | | | | | | | | |
Components: | | | | | | | | | | | | | | | | |
Provision for allowance for loan losses | | $ | 1,000 | | $ | 316 | | $ | (46) | | $ | 764 | | $ | 934 | |
Provision for reserve for undisbursed lines of credit | | | 105 | | | (66) | | | 196 | | | 36 | | | 16 | |
Provision for credit losses | | $ | 1,105 | | $ | 250 | | $ | 150 | | $ | 800 | | $ | 950 | |
The following table reflects our nonperforming asset and coverage ratios as of the dates indicated:
| | | | | | | | | | | |
| | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | |
NPL to total loans | | 0.21 | % | 0.28 | % | 0.06 | % | 0.06 | % | 0.25 | % |
NPA to total assets | | 0.16 | % | 0.20 | % | 0.04 | % | 0.05 | % | 0.16 | % |
Allowance for loan losses to total loans | | 0.84 | % | 0.85 | % | 1.00 | % | 1.03 | % | 1.07 | % |
Allowance for loan losses to NPL | | 398 | % | 302 | % | 1,791 | % | 1,637 | % | 424 | % |
We will continue to take all appropriate measures to restore nonperforming assets to performing status or otherwise liquidate these assets in an orderly fashion so as to maximize their value. There can be no assurances that we will be able to complete the disposition of nonperforming assets without incurring further losses.
Loan Portfolio Monitoring
Our Board of Directors grants loan officers the authority to originate loans on our behalf, subject to certain limitations. The Board of Directors also establishes restrictions regarding the types of loans that may be granted and the distribution of loan types within our portfolio, and sets loan authority limits for lenders. These authorized lending limits are reviewed at least annually and are based upon the lender's knowledge and experience. Loan requests that exceed a lender's authority require the signature of our Senior Lender, the Senior Credit Officer, and/or our President. With the exception of certain municipal loans, all extensions of credit of $5 million or greater to any one borrower, or related party interest, are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Short-term Revenue Anticipation and Tax Anticipation extensions of credit of $8 million or greater to a municipality are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors.
The Loan Committee and the credit department regularly monitor our loan portfolio. The entire loan portfolio, as well as individual loans, is reviewed for loan performance, compliance with internal policy requirements and banking regulations, creditworthiness, and strength of documentation. We monitor loan concentrations by individual borrowers, industries and loan types. As part of the annual credit policy review process, targets are set by loan type for the total portfolio. Credit risk ratings assessing inherent risk in individual loans are assigned to commercial loans at origination and are reviewed by lenders and Management on a periodic basis according to total exposure and risk rating. These internal reviews assess the adequacy of all aspects of credit administration, additionally; we maintain an on-going active monitoring process of loan performance during the year. We have also hired external loan review firms to assist in monitoring the loan portfolio. The loan review firm reviews a minimum threshold of our loan portfolio each year. These comprehensive reviews assessed the accuracy of our risk rating system as well as the effectiveness of credit administration in managing overall credit risks.
All loan officers are required to service their loan portfolios and account relationships. Loan officers, a commercial workout officer, or collection personnel take remedial actions to assure full and timely payment of loan balances as necessary, with the supervision of the Senior Lender and the Senior Credit Officer.
EFFECTS OF INFLATION
The financial nature of our consolidated balance sheet and statement of income is more clearly affected by changes in interest rates than by inflation, but inflation does affect us because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total company assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effects of inflation on our financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation.
Liquidity and Capital Resource Management
General
Liquid assets are maintained at levels considered adequate to meet our liquidity needs. Liquidity is adjusted as appropriate to meet asset and liability management objectives. Liquidity is monitored by the Asset and Liability Committee (“ALCO”) of Merchants Bank’s Board of Directors, based upon Merchants Bank’s policies. Our primary sources of liquidity are deposits, amortization and prepayment of loans, maturities of investment securities and other short-term investments, periodic principal repayments on mortgage-backed and other amortizing securities, advances from the FHLB, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. Interest rates on deposits are priced to maintain a desired level of total deposits.
As of December 31, 2016, we could borrow up to $55 million in overnight funds through unsecured borrowing lines established with correspondent banks. In addition, we have established both overnight and longer-term lines of credit with the FHLB. These borrowings are secured by residential mortgage loans. At December 31, 2016, we pledged
loans with a carrying value of $363.55 million which carries a $256.98 million borrowing capacity at the FHLB, less borrowings and letters of credit of $62.06 million, resulting in quarter-end capacity of $194.92 million. At December 31,
2015, we pledged loans with a carrying value of $371.58 million, which carried a $262.96 million borrowing capacity at the FHLB, less borrowings and letters of credit of $17.81 million, resulting in year-end capacity of $245.15 million. We also have the ability to borrow through the use of repurchase agreements, collateralized by our investments, with certain approved counterparties. Our investment portfolio, which is managed by the ALCO, had a carrying amount of $419.69 million at December 31, 2016, of which $370.81 million was pledged. The portfolio is a reliable source of cash flow for us. We closely monitor our short-term cash position. Any excess funds are either left on deposit at the Federal Reserve Bank, or are in a fully insured account with one of our correspondent banks.
Presented below are our short-term borrowings during the periods indicated:
| | | | | | | |
| | Year Ended | | Year Ended | |
(Dollars in thousands) | | December 31, 2016 | | December 31, 2015 | |
FHLB and other short-term borrowings | | | | | | | |
Amount outstanding at end of period | | $ | 40,000 | | $ | — | |
Maximum during the period amount outstanding | | | 110,000 | | | 63,000 | |
Average amount outstanding | | | 26,053 | | | 3,953 | |
Weighted average-rate during the period | | | 0.48 | % | | 0.33 | % |
Weighted average rate at period end | | | 0.77 | % | | — | % |
Securities sold under agreement to repurchase, short-term | | | | | | | |
Amount outstanding at end of period | | $ | 312,118 | | $ | 286,639 | |
Maximum during the period amount outstanding | | | 334,023 | | | 318,788 | |
Average amount outstanding | | | 247,610 | | | 226,913 | |
Weighted average-rate during the period | | | 0.18 | % | | 0.22 | % |
Weighted average rate at period end | | | 0.20 | % | | 0.19 | % |
Contractual Obligations
We have certain long-term contractual obligations, including long-term debt agreements, operating leases for branch operations, and time deposits. The maturity schedules for these obligations are as follows:
| | | | | | | | | | | | | | | | |
| | | | | One Year | | Three | | | | | | | |
| | Less than | | To Three | | Years To | | Over Five | | | | |
(In thousands) | | One year | | Years | | Five Years | | Years | | Total | |
Debt maturities | | $ | 1,587 | | $ | 180 | | $ | 186 | | $ | 1,698 | | $ | 3,651 | |
Junior subordinated debentures | | | — | | | — | | | — | | | 20,619 | | | 20,619 | |
Operating lease payments | | | 1,356 | | | 3,025 | | | 1,923 | | | 3,002 | | | 9,306 | |
Time deposits | | | 132,326 | | | 41,546 | | | 25,336 | | | — | | | 199,208 | |
Total | | $ | 135,269 | | $ | 44,751 | | $ | 27,445 | | $ | 25,319 | | $ | 232,784 | |
Commitments and Off-Balance Sheet Risk
We are a party to financial instruments with off‑balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to extend credit and financial guarantees. Such instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the accompanying consolidated balance sheets.
Exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and financial guarantees written is represented by the contractual amount of those instruments. We use the
same credit policies in making commitments as we do for on‑balance sheet instruments. The contractual amounts of these financial instruments at December 31, 2016 are as follows:
| | | |
| | Contractual | |
(In thousands) | | Amount | |
Financial instruments whose contract amounts represent credit risk: | | | |
Commitments to originate loans | $ | 31,403 | |
Unused lines of credit | | 216,815 | |
Standby letters of credit | | 5,954 | |
Loans sold with recourse | | 7,354 | |
Equity commitments to affordable housing limited partnerships | | 3,677 | |
Commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments to originate loans generally have expiration dates within 60 to 180 days of the commitment. Unused lines of credit have expiration dates ranging from one to two years from the date of the commitment. A portion of the commitments are expected to expire without being drawn upon, therefore the total commitment amount does not necessarily represent a future cash requirement. We evaluate each customer's creditworthiness on a case‑by‑case basis. Upon extension of credit, we obtain an appropriate amount of real and/or personal property as collateral based on our credit evaluation of the counterparty.
We do not issue any guarantees that would require liability-recognition or disclosure, other than standby letters of credit. We have issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $5.95 million and $6.30 million at December 31, 2016 and 2015, respectively, and represent the maximum potential future payments we could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Our policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value (“LTV”) ratios are generally consistent with LTV requirements for other commercial loans secured by similar types of collateral. The fair values of our standby letters of credit at December 31, 2016 and 2015 were insignificant.
Equity commitments to affordable housing partnerships represent funding commitments for certain limited partnerships. These partnerships were created for the purpose of acquiring, constructing and/or redeveloping affordable housing projects. The funding of these commitments is generally contingent upon substantial completion of the project and none extend beyond the fifth anniversary of substantial completion.
Capital Resources
In general, capital growth is essential to support deposit and asset growth and to ensure our strength and safety. Net income increased our capital by $14.88 million in 2016, $12.62 million in 2015 and $12.13 million in 2014. Payment of dividends decreased our capital by $7.70 million in 2016, $7.10 million in 2015 and $7.09 million in 2014. In December 2004, we privately placed $20.62 million in capital securities as part of a pooled trust preferred program. The securities qualify as regulatory capital under regulatory adequacy guidelines.
Changes in the market value of our available for sale investment portfolio, net of tax, decreased capital by $717 thousand in 2016 and decreased capital by $1.31 million in 2015. The unrecognized net actuarial loss in our pension plan, net of taxes, decreased capital by $86 thousand. The unrealized loss on our interest rate swaps, net of taxes, at December 31, 2016, decreased capital by a cumulative $155 thousand. We recognized $889 thousand and $519 thousand of amortization of unrealized holding losses of securities transferred from available for sale to held to maturity, net of taxes, in 2016 and 2015, respectively.
ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
RISK MANAGEMENT
General
Our Management and Board of Directors are committed to sound risk management practices throughout the organization. We have developed and implemented a risk management monitoring program. Risks associated with our business activities and products are identified and measured as to probability of occurrence and impact on us (low, moderate, or high), and the control or other activities in place to manage those risks are identified and assessed. Periodically, department-level and senior managers re-evaluate and report on the risk management processes for which they are responsible. This documented program provides us with a comprehensive framework for monitoring our risk profile from a macro perspective. It also serves as a tool for assessing internal controls over financial reporting as required under the FDIA and the Sarbanes-Oxley Act of 2002.
Effective May 26, 2016, the Bank Board of Directors established the Enterprise Risk Management Committee. The Enterprise Risk Management Committee assists the Board in oversight of the Bank’s enterprise-wide risk management framework and associated policies and practices, risk profile and risk appetite and tolerance, and regulatory compliance program.
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. Our primary market risk exposure is interest rate risk. An important component of our asset and liability management process is the ongoing monitoring and management of this risk, which is governed by established policies that are reviewed and approved annually by our Board of Directors. Our Investment Policy details the types of securities that may be purchased, and establishes portfolio limits and maturity limits for the various sectors. The Investment Policy also establishes specific investment quality limits. Our Board of Directors has established a Board-level Asset/Liability Committee, which delegates responsibility for carrying out the asset/liability management policies to the Management-level Asset/Liability Committee (the “Management ALCO”). The Management ALCO, chaired by the Interim Principal Financial Officer and composed of members of senior management, develops guidelines and strategies that affect our asset and liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. The Management ALCO manages the investment portfolio. As the portfolio has grown, the Management ALCO has used portfolio diversification as a way to mitigate the risk of being too heavily invested in any single asset class. We continued to work to maximize net interest income while mitigating risk during the year through further repositioning of the investment portfolio, as well as carefully monitoring the overall duration and average life of the portfolio, and monitoring individual securities, among other strategies.
Liquidity Risk
Our liquidity is measured by our ability to raise cash when needed at a reasonable cost. We must be capable of meeting expected and unexpected obligations to customers at any time. Given the uncertain nature of customer demands as well as the need to maximize earnings, we must have available reasonably priced sources of funds, on- and off-balance sheet, which can be accessed quickly in time of need. As discussed above under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resource Management,” we have several sources of readily available funds, including the ability to borrow using our investment portfolio as collateral. We also monitor our liquidity on a quarterly basis in compliance with our Liquidity Contingency Plan. Our liquidity monitoring process identifies early liquidity stress triggers, and also allows us to model worst case liquidity scenarios, and various responses to those scenarios.
Financial markets have been volatile and challenging for many financial institutions. Because of our favorable credit quality and strong balance sheet, we did not experience any liquidity constraints through the end of 2016. During the past
several quarters, our liquidity position has been strong, as depositors and investors in the wholesale funding markets seek strong financial institutions.
Interest Rate Risk
Interest rate risk is the exposure to a movement in interest rates, which, as previously described, affects our net interest income. Asset and liability management is governed by policies reviewed and approved annually by Merchants Bank’s Board of Directors. The ALCO meets frequently to review and develop asset/liability management strategies and tactics.
The ALCO is responsible for evaluating and managing the interest rate risk which arises naturally from imbalances in repricing, maturity and cash flow characteristics of our assets and liabilities. Techniques used by the ALCO take into consideration the cash flow and repricing attributes of balance sheet and off-balance sheet items and their relation to possible changes in interest rates. The ALCO manages interest rate exposure by using a combination of on-balance sheet and off-balance sheet strategies. On-balance sheet strategies generally consist of management of the duration, rate sensitivity and average lives of our various investments, and by extending or shortening maturities of borrowed funds, as well as carefully managing and monitoring the pricing and average lives of loans and the pricing and maturity of deposits. We also use off-balance sheet strategies, such as interest rate swaps and interest rate caps and floors, to help minimize our exposure to changes in interest rates. By using derivative financial instruments to hedge exposures to changes in interest rates we are exposed to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, creating credit risk. We minimize credit risk in derivative instruments by entering into transactions only with high-quality counterparties. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
The ALCO is responsible for ensuring that our Board of Directors receives accurate information regarding our interest rate risk position at least quarterly. The investment advisory firm and ALCO consultant meet collectively with the board and Management-level ALCOs on a quarterly basis. During these meetings the ALCO consultant reviews our current position and discusses future strategies, as well as reviewing the result of rate shocks of our balance sheet and a variety of other analyses. The investment advisor reports on the overall performance of the portfolio and performs modeling of the cash flow, effective duration, and yield characteristics of the portfolio under various interest rate scenarios; and also reviews and provides detail on individual holdings in the portfolio.
The ALCO consultant’s most recent review was as of December 31, 2016. The consultant ran a base simulation assuming no changes in rates as well as a 200 basis point rising and a 200 basis point flat up scenario, because rates continue to be very low. The consultant also ran a 100 basis point falling interest rate scenario that assumed a parallel and pro rata shift of the yield curve over a one-year period, with no growth assumptions. Additionally, the consultants ran a 400 basis point rising simulation that assumed a parallel shift of the curve over 24 months which assumed the increase in rates was delayed by two years. A summary of the results is as follows:
Current/Flat Rates: If market rates remain unchanged, NII is projected to trend relatively flat over the simulation as asset yields are maintained (due to the aforementioned higher assumed asset replacement yields) while the assumed funding cost relief is minimal.
Falling Rates: Should market rates decline (e.g. -100bps 12 months), NII is projected to trend downward and below the Current Rates scenario throughout the simulation as the earning asset base resets into the low rate environment (accelerated by faster assumed prepayment speeds) while funding cost relief becomes limited as actual and implied floors are quickly met.
Rising Rates: As a result of the composition of the Bank’s balance sheet (strong core funding base supporting a shorter-term loan portfolio), the Bank’s asset sensitive posture results in NII levels beginning above the Current/Flat Rates scenario and trending upwards for the life of the simulation in all ramped, rising rate scenarios tested, regardless of the shape of the yield curve or the duration in which market rates rise. It should be noted a flattening yield curve results in less benefit when compared to a parallel shift, as assets tied to the longer end of the curve do not reset with the same incremental spread as in a parallel curve.
We have established a target range for the change in net interest income in year one of zero to 7.5%. The net interest income simulation as of December 31, 2016 showed that the change in net interest income for the next 12 months from our expected or “most likely” forecast was as follows:
| | | |
| | Percent Change in Net | |
Rate Change | | Interest Income | |
Up 200 basis points | | 0.85 | % |
Down 100 basis points | | (3.24) | % |
The change in net interest income in the second year of the simulation shows a more pronounced downward trend of (11.45)% in the down 100 basis points scenario, while the flat scenario shows a change of 0.00% and the up 200 basis points simulation produces an increase of 6.88%. The degree to which this exposure materializes will depend, in part, on our ability to manage our balance sheet as interest rates rise or fall.
Actual results may differ materially from those projected. The analysis assumes a static balance sheet. All rate changes are ramped over a 12 month time horizon based upon a parallel yield curve shift. In the down 100 basis points scenario, Federal funds and Treasury yields are floored at 0.01% while Prime is floored at 3.00%. All other market rates (e.g. LIBOR, FHLB and Brokered CD) are floored at the lesser of either the current rate or 0.25% to reflect credit spreads. The model used to perform the balance sheet simulation assumes a parallel shift of the yield curve over 12 months and reprices every interest-bearing asset and liability on our balance sheet. The model incorporates product specific loan prepayment assumptions and uses contractual repricing dates for variable rate loan products and contractual maturities for fixed rate products. The model uses product-specific assumptions for deposits which are subject to repricing based on current market conditions. The model uses the Yield Book, Inc. system to analyze the investment portfolio, which produces bond specific cash flow forecasts for each rate scenario tested in the analysis. The analysis details bond maturity, amortization, repricing characteristics, and optionality. The cash flow forecasts take into consideration assumptions for absolute rate movements, the period over which rates are assumed to shift and assumed changes in the shape of the yield curve. The model also assumes that the rate at which residential mortgage related assets prepay will vary as rates rise and fall, based on prepayment estimates derived from Applied Financial Technologies.
The preceding sensitivity analysis does not represent our forecast and should not be relied upon as being indicative of expected operating results. These estimates are based upon numerous assumptions including without limitation: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit run-off rates, pricing decisions on loans and deposits and reinvestment/replacement of asset and liability cash flows, among others. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. As market conditions vary from those assumed in the sensitivity analysis, actual results will likely differ due to: the varying impact of changes in the balances and mix of loans and deposits differing from those assumed, the impact of possible off balance sheet hedging strategies, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect all actions that the ALCO might take in responding to or anticipating changes in interest rates.
The most significant ongoing factor affecting market risk exposure of net interest income during the year ended December 31, 2016 was the sustained low interest rate environment. Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curves, and changes in the size and composition of the loan, investment and deposit portfolios. During 2016, the two year Constant Maturity Treasury (“CMT”) note increased 16 basis points to 1.22%. The spread between the two year CMT and the ten year CMT at December 31, 2016 was 120 basis points, compared to 121 basis points at December 31, 2015.
Credit Risk
The Board of Directors reviews and approves our loan policy on an annual basis. Among other things, the loan policy establishes restrictions regarding the types of loans that may be granted, and the distribution of loan types within our portfolio. Our loan portfolio is continuously monitored for performance, creditworthiness and strength of documentation through the use of a variety of management reports and the assistance of an external loan review firm. Credit ratings are
assigned to commercial loans and are routinely reviewed. Loan officers, under the supervision of the Senior Lender and Senior Credit Officer, take remedial actions to assure full and timely payment of loan balances when necessary. Our policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due 91 or more days and the ultimate collectability of principal or interest become doubtful. In certain instances the accrual of interest is discontinued prior to 91 days past due if Management determines that the borrower will not be able to continue making timely payments.
ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Merchants Bancshares, Inc.
Consolidated Balance Sheets
| | | | | | | |
| | December 31, | | December 31, | |
(In thousands except share and per share data) | | 2016 | | 2015 | |
ASSETS | | | | | | | |
Cash and due from banks | | $ | 26,116 | | $ | 30,605 | |
Interest earning deposits with banks and other short-term investments | | | 56,837 | | | 119,578 | |
Total cash and cash equivalents | | | 82,953 | | | 150,183 | |
Investments: | | | | | | | |
Securities available for sale, at fair value (amortized cost of $334,846 and $283,185) | | | 333,998 | | | 283,454 | |
Securities held to maturity (fair value of $85,749 and $120,093) | | | 85,694 | | | 119,674 | |
Total investments | | | 419,692 | | | 403,128 | |
Loans | | | 1,514,209 | | | 1,414,280 | |
Less: Allowance for loan losses | | | 12,659 | | | 12,040 | |
Net loans | | | 1,501,550 | | | 1,402,240 | |
Federal Home Loan Bank stock | | | 4,976 | | | 3,797 | |
Bank premises and equipment, net | | | 13,078 | | | 15,030 | |
Investment in real estate limited partnerships | | | 6,356 | | | 5,687 | |
Bank owned life insurance | | | 10,758 | | | 10,551 | |
Core deposit intangible | | | 1,156 | | | 1,360 | |
Goodwill | | | 7,011 | | | 6,967 | |
Other assets | | | 15,128 | | | 22,294 | |
Total assets | | $ | 2,062,658 | | $ | 2,021,237 | |
LIABILITIES | | | | | | | |
Deposits: | | | | | | | |
Demand (noninterest bearing) | | $ | 640,922 | | $ | 631,244 | |
Savings, interest bearing checking and money market accounts | | | 687,340 | | | 665,623 | |
Time deposits | | | 199,208 | | | 254,572 | |
Total deposits | | | 1,527,470 | | | 1,551,439 | |
Short-term borrowings | | | 40,000 | | | — | |
Securities sold under agreement to repurchase, short-term | | | 312,118 | | | 286,639 | |
Other long-term debt | | | 3,651 | | | 5,238 | |
Junior subordinated debentures issued to unconsolidated subsidiary trust | | | 20,619 | | | 20,619 | |
Other liabilities | | | 2,297 | | | 9,248 | |
Total liabilities | | | 1,906,155 | | | 1,873,183 | |
STOCKHOLDERS' EQUITY | | | | | | | |
Preferred stock | | | | | | | |
Class A non-voting shares authorized - 200,000, none outstanding | | | — | | | — | |
Class B voting shares authorized - 1,500,000, none outstanding | | | — | | | — | |
Common stock, $.01 par value | | | 72 | | | 72 | |
Authorized: 10,000,000 shares; Issued: 7,184,922 at December 31, 2016 and 7,168,869 at December 31, 2015 | | | | | | | |
Outstanding: 6,887,856 at December 31, 2016 and 6,855,294 at December 31, 2015 | | | | | | | |
Capital in excess of par value | | | 55,806 | | | 55,063 | |
Retained earnings | | | 113,407 | | | 106,219 | |
Treasury stock, at cost: 585,866 shares including 288,800 shares held by the Deferred Compensation Plans for Non-Employee Directors and Trustees at December 31, 2016 and 612,935 shares including 299,360 shares held by the Deferred Compensation Plans for Non-Employee Directors and Trustees at December 31, 2015 | | | (13,670) | | | (13,798) | |
Deferred compensation arrangements: 288,800 shares at December 31, 2016 and 299,360 shares at December 31, 2015 | | | 6,670 | | | 6,521 | |
Accumulated other comprehensive loss | | | (5,782) | | | (6,023) | |
Total stockholders' equity | | | 156,503 | | | 148,054 | |
Total liabilities and stockholders' equity | | $ | 2,062,658 | | $ | 2,021,237 | |
See accompanying notes to consolidated financial statements
Merchants Bancshares, Inc.
Consolidated Statements of Income
| | | | | | | | | | |
| | Twelve Months Ended | |
| | December 31, | |
(In thousands except per share data) | | 2016 | | 2015 | | 2014 | |
INTEREST AND DIVIDEND INCOME | | | | | | | | | | |
Interest and fees on loans | | $ | 51,929 | | $ | 44,087 | | $ | 42,815 | |
Investment income: | | | | | | | | | | |
Interest and dividends on investment securities | | | 7,555 | | | 7,779 | | | 7,965 | |
Interest on interest earning deposits with banks and other short-term investments | | | 256 | | | 250 | | | 192 | |
Total interest and dividend income | | | 59,740 | | | 52,116 | | | 50,972 | |
INTEREST EXPENSE | | | | | | | | | | |
Savings, interest bearing checking and money market accounts | | | 1,719 | | | 1,433 | | | 1,647 | |
Time deposits | | | 1,347 | | | 1,312 | | | 1,725 | |
Short-term borrowings | | | 126 | | | 13 | | | 1 | |
Securities sold under agreement to repurchase, short-term | | | 454 | | | 497 | | | 353 | |
Long-term debt | | | 854 | | | 797 | | | 799 | |
Total interest expense | | | 4,500 | | | 4,052 | | | 4,525 | |
Net interest income | | | 55,240 | | | 48,064 | | | 46,447 | |
Provision for credit losses | | | 1,105 | | | 250 | | | 150 | |
Net interest income after provision for credit losses | | | 54,135 | | | 47,814 | | | 46,297 | |
NONINTEREST INCOME | | | | | | | | | | |
Trust division income | | | 3,709 | | | 3,525 | | | 3,393 | |
Net debit card income | | | 3,028 | | | 3,080 | | | 2,660 | |
Overdraft income | | | 2,613 | | | 2,004 | | | 2,473 | |
Service charges on deposits | | | 1,699 | | | 1,504 | | | 1,369 | |
Net gains on investment securities | | | — | | | — | | | 107 | |
Other | | | 1,639 | | | 1,847 | | | 1,572 | |
Total noninterest income | | | 12,688 | | | 11,960 | | | 11,574 | |
NONINTEREST EXPENSE | | | | | | | | | | |
Compensation and benefits | | | 22,976 | | | 21,879 | | | 20,440 | |
Occupancy expense | | | 4,342 | | | 4,251 | | | 4,292 | |
Equipment expense | | | 2,734 | | | 2,971 | | | 2,882 | |
Telephone expense | | | 736 | | | 789 | | | 895 | |
Legal and professional fees | | | 2,607 | | | 1,991 | | | 1,924 | |
Mobile & internet banking | | | 1,380 | | | 1,597 | | | 1,452 | |
Core / Item processing | | | 1,897 | | | 1,765 | | | 1,876 | |
Marketing | | | 801 | | | 561 | | | 1,177 | |
State franchise taxes | | | 1,585 | | | 1,503 | | | 1,435 | |
FDIC insurance | | | 916 | | | 886 | | | 857 | |
Conversion costs | | | — | | | — | | | 1,319 | |
Community Bank System, Inc. merger costs | | | 3,019 | | | — | | | — | |
NUVO Bank & Trust Company acquisition costs | | | 61 | | | 1,875 | | | — | |
Amortization of core deposit intangible | | | 204 | | | 17 | | | — | |
Other | | | 3,993 | | | 3,886 | | | 3,665 | |
Total noninterest expense | | | 47,251 | | | 43,971 | | | 42,214 | |
Income before provision for income taxes | | | 19,572 | | | 15,803 | | | 15,657 | |
Provision for income taxes | | | 4,689 | | | 3,185 | | | 3,532 | |
NET INCOME | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | |
| | | | | | | | | | |
Basic earnings per common share | | $ | 2.17 | | $ | 1.98 | | $ | 1.92 | |
Diluted earnings per common share | | $ | 2.16 | | $ | 1.98 | | $ | 1.91 | |
See accompanying notes to consolidated financial statements
Merchants Bancshares, Inc.
Consolidated Statements of Comprehensive Income
| | | | | | | | | | |
| | Twelve Months Ended | |
| | December 31, | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Net income | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | |
Other comprehensive income, net of tax: | | | | | | | | | | |
Unrealized holding (loss) gain on securities available for sale, net of taxes of $(400), $(704) and $921 | | | (717) | | | (1,308) | | | 1,705 | |
Unrealized holding gains arising during the period for securities transferred from available for sale to held to maturity, net of taxes of $0, $0 and $4 | | | — | | | — | | | 8 | |
Accretion of unrealized holding losses of securities transferred from available for sale to held to maturity, net of taxes of $492, $279 and $254 | | | 889 | | | 519 | | | 472 | |
Reclassification adjustments for net securities gains included in net income, net of taxes of $0, $0 and $(38) | | | — | | | — | | | (69) | |
Change in net unrealized loss on interest rate swaps, net of taxes of $84, $84 and $86 | | | 155 | | | 156 | | | 161 | |
Pension liability adjustment, net of taxes of $(48), $(183) and $(863) | | | (86) | | | (342) | | | (1,605) | |
Other comprehensive income (loss) | | | 241 | | | (975) | | | 672 | |
Comprehensive income | | $ | 15,124 | | $ | 11,643 | | $ | 12,797 | |
See accompanying notes to consolidated financial statements
Merchants Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2016, 2015, and 2014
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | Accumulated | | | | |
| | | | | Capital in | | | | | | | | Deferred | | Other | | | | |
| | Common | | Excess of | | Retained | | Treasury | | Compensation | | Comprehensive | | | | |
(In thousands except per share data) | | Stock | | Par Value | | Earnings | | Stock | | Arrangements | | Income (loss) | | Total | |
Balance at December 31, 2013 | | $ | 67 | | $ | 37,129 | | $ | 95,657 | | $ | (14,043) | | $ | 6,521 | | $ | (5,720) | | $ | 119,611 | |
Net income | | | — | | | — | | | 12,125 | | | — | | | — | | | — | | | 12,125 | |
Dividends paid ($1.12 per share) | | | — | | | — | | | (7,085) | | | — | | | — | | | — | | | (7,085) | |
Purchase of treasury stock | | | — | | | — | | | — | | | (82) | | | — | | | — | | | (82) | |
Distribution of stock under deferred compensation arrangements | | | — | | | — | | | — | | | 553 | | | (553) | | | — | | | — | |
Shares granted under stock plans and deferral of director fees, including excess tax benefit | | | — | | | 275 | | | — | | | 164 | | | 22 | | | — | | | 461 | |
Share based compensation expense | | | — | | | — | | | — | | | (122) | | | 241 | | | — | | | 119 | |
Dividend reinvestment plan | | | — | | | — | | | — | | | (335) | | | 335 | | | — | | | — | |
Other comprehensive income | | | — | | | — | | | — | | | — | | | — | | | 672 | | | 672 | |
Balance at December 31, 2014 | | $ | 67 | | $ | 37,404 | | $ | 100,697 | | $ | (13,865) | | $ | 6,566 | | $ | (5,048) | | $ | 125,821 | |
Net income | | | — | | | — | | | 12,618 | | | — | | | — | | | — | | | 12,618 | |
Dividends paid ($1.12 per share) | | | — | | | — | | | (7,096) | | | — | | | — | | | — | | | (7,096) | |
Common stock and warrants issued for acquisition (517,109 shares and 90,756 warrants) | | | 5 | | | 17,428 | | | — | | | — | | | — | | | — | | | 17,433 | |
Purchase of treasury stock | | | — | | | — | | | — | | | (41) | | | — | | | — | | | (41) | |
Distribution of stock under deferred compensation arrangements & stock plans | | | — | | | — | | | — | | | 514 | | | (514) | | | — | | | — | |
Shares granted under stock plans and deferral of director fees, including excess tax benefit | | | — | | | 231 | | | — | | | (81) | | | 108 | | | — | | | 258 | |
Share based compensation expense | | | — | | | — | | | — | | | — | | | 36 | | | — | | | 36 | |
Dividend reinvestment plan | | | — | | | — | | | — | | | (325) | | | 325 | | | — | | | — | |
Other comprehensive loss | | | — | | | — | | | — | | | — | | | — | | | (975) | | | (975) | |
Balance at December 31, 2015 | | $ | 72 | | $ | 55,063 | | $ | 106,219 | | $ | (13,798) | | $ | 6,521 | | $ | (6,023) | | $ | 148,054 | |
Net income | | | — | | | — | | | 14,883 | | | — | | | — | | | — | | | 14,883 | |
Dividends paid ($1.12 per share) | | | — | | | — | | | (7,695) | | | — | | | — | | | — | | | (7,695) | |
Exercise of warrants | | | — | | | 324 | | | — | | | — | | | — | | | — | | | 324 | |
Purchase of treasury stock | | | — | | | — | | | — | | | (155) | | | — | | | — | | | (155) | |
Distribution of stock under deferred compensation arrangements & stock plans | | | — | | | — | | | — | | | 559 | | | (559) | | | — | | | — | |
Shares granted under stock plans and deferral of director fees, including excess tax benefit | | | — | | | 148 | | | — | | | 193 | | | 136 | | | — | | | 477 | |
Share based compensation expense | | | — | | | 271 | | | — | | | 103 | | | — | | | — | | | 374 | |
Dividend reinvestment plan | | | — | | | — | | | — | | | (572) | | | 572 | | | — | | | — | |
Other comprehensive income (loss) | | | — | | | — | | | — | | | — | | | — | | | 241 | | | 241 | |
Balance at December 31, 2016 | | $ | 72 | | $ | 55,806 | | $ | 113,407 | | $ | (13,670) | | $ | 6,670 | | $ | (5,782) | | $ | 156,503 | |
See accompanying notes to consolidated financial statements
Merchants Bancshares, Inc.
Consolidated Statements of Cash Flows
| | | | | | | | | | |
| | Twelve Months Ended December 31, | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | | |
Net income | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | |
Provision for credit losses | | | 1,105 | | | 250 | | | 150 | |
Deferred tax expense (benefit) | | | 3,981 | | | 1,799 | | | (175) | |
Depreciation and amortization | | | 2,081 | | | 2,110 | | | 2,452 | |
Amortization of investment security premiums and accretion of discounts, net | | | 1,281 | | | 1,244 | | | 707 | |
Amortization of deferred loan costs | | | 670 | | | 486 | | | 580 | |
Amortization of core deposit intangible | | | 204 | | | 17 | | | — | |
Accretion of unfavorable lease liability | | | (67) | | | (6) | | | — | |
Stock based compensation | | | 374 | | | 36 | | | 119 | |
Net gains on sales of investment securities | | | — | | | — | | | (107) | |
Net losses on sale of premises, equipment and other assets | | | 56 | | | — | | | 104 | |
Deferred gain on sale of premises | | | (517) | | | (517) | | | (517) | |
(Gain) loss on sale of other real estate owned | | | (20) | | | — | | | 35 | |
Equity in losses of real estate limited partnerships, net | | | 1,664 | | | 1,104 | | | 1,257 | |
Increase in cash surrender value of bank owned life insurance | | | (207) | | | (240) | | | (311) | |
Changes in assets and liabilities: | | | | | | | | | | |
Net change in interest receivable | | | (348) | | | (219) | | | 195 | |
Net change in other assets | | | 3,294 | | | 146 | | | 790 | |
Net change in interest payable | | | (42) | | | (54) | | | (49) | |
Net change in other liabilities | | | (6,192) | | | 1,792 | | | (860) | |
Net cash provided by operating activities | | | 22,200 | | | 20,566 | | | 16,495 | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | |
Proceeds from sales of investment securities available for sale | | | — | | | 4,263 | | | 56,889 | |
Proceeds from maturities of investment securities available for sale | | | 42,736 | | | 50,171 | | | 37,235 | |
Proceeds from maturities of investment securities held to maturity | | | 35,084 | | | 19,244 | | | 15,486 | |
Net (purchases) redemptions of Federal Home Loan Bank stock | | | (1,179) | | | 957 | | | 3,118 | |
Purchases of investment securities available for sale | | | (95,401) | | | (133,137) | | | (55,495) | |
Loan originations in excess of principal payments | | | (101,116) | | | (83,666) | | | (16,844) | |
Proceeds from sales of other real estate owned | | | 92 | | | — | | | 68 | |
Real estate limited partnership investments | | | (2,333) | | | (1,595) | | | (1,822) | |
Purchases of bank premises and equipment | | | (185) | | | (1,206) | | | (2,477) | |
Cash and cash equivalents acquired in acquisition of NUVO Bank | | | — | | | 7,070 | | | — | |
Cash consideration paid in acquisition of NUVO Bank | | | — | | | (5,988) | | | — | |
Net cash (used in) provided by investing activities | | | (122,302) | | | (143,887) | | | 36,158 | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | |
Net change in deposits | | | (23,969) | | | 98,186 | | | (14,804) | |
Net increase in short-term borrowings | | | 40,000 | | | — | | | — | |
Net increase in securities sold under agreement to repurchase | | | 25,479 | | | 28,175 | | | 8,150 | |
Principal payments on long-term debt | | | (1,587) | | | (1,083) | | | (83) | |
Cash dividends paid | | | (7,695) | | | (7,096) | | | (7,085) | |
Purchase of Treasury Stock | | | (155) | | | (41) | | | (82) | |
Proceeds from the exercise of stock warrants | | | 324 | | | — | | | — | |
Increase in deferred compensation arrangements | | | 281 | | | 461 | | | — | |
Proceeds from exercise of stock options, net of withholding taxes | | | 144 | | | 328 | | | 225 | |
Tax benefit from exercise of stock options and distribution of shares in deferred compensation arrangements | | | 50 | | | 115 | | | 14 | |
Net cash provided by (used in) financing activities | | | 32,872 | | | 119,045 | | | (13,665) | |
(Decrease) increase in cash and cash equivalents | | | (67,230) | | | (4,276) | | | 38,988 | |
Cash and cash equivalents beginning of period | | | 150,183 | | | 154,459 | | | 115,471 | |
Cash and cash equivalents end of period | | $ | 82,953 | | $ | 150,183 | | $ | 154,459 | |
| | | | | | | |
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | | | | | | | | | | |
Total interest payments | | $ | 4,542 | | $ | 4,065 | | $ | 4,457 | |
Total income tax payments | | | 1,797 | | | — | | | — | |
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: | | | | | | | | | | |
Distribution of stock under deferred compensation arrangements | | $ | 559 | | $ | 514 | | $ | 553 | |
Non-cash exercise of stock options and warrants | | | 161 | | | — | | | 124 | |
Transfer of loans to other real estate owned | | | 136 | | | — | | | — | |
Transfer of securities from available for sale to held to maturity | | | — | | | — | | | 12,626 | |
| | | | |
| | Twelve Months Ended | |
(In thousands) | | December 31, 2015 | |
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | | | | |
Acquisition of NUVO Bank: | | | | |
Non-cash assets acquired: | | | | |
Interest bearing time deposits with banks | | $ | 110 | |
Investment securities | | | 4,344 | |
Restricted investment in bank stock | | | 376 | |
Loans | | | 149,360 | |
Premises and equipment , net | | | 580 | |
Accrued interest receivable | | | 369 | |
Deferred tax asset | | | 1,993 | |
Other assets | | | 356 | |
Total non- cash assets acquired | | | 157,488 | |
| | | | |
Liabilities assumed: | | | | |
Deposits | | | 144,482 | |
Federal Home Loan Bank advances | | | 4,001 | |
Accrued interest payable | | | 42 | |
Other liabilities | | | 183 | |
Total liabilities assumed | | | 148,708 | |
Net non-cash assets acquired | | $ | 8,780 | |
| | | | |
Net cash and cash equivalents acquired | | $ | 7,070 | |
| | | | |
Goodwill | | | 7,011 | |
Core deposit intangible | | | 1,377 | |
Tax effect of acquisition fair value adjustments | | | (705) | |
Value of shares of common stock issued in acquisition | | | 17,545 | |
Cash consideration paid in acquisition | | | 5,988 | |
See accompanying notes to consolidated financial statements
Merchants Bancshares, Inc.
Notes to Consolidated Financial Statements
December 31, 2016, 2015 and 2014
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Merchants Bancshares, Inc. (the “Company”), and its wholly-owned subsidiary Merchants Bank (the “Bank,” and collectively with the Company, “Merchants”, “we,” “us,” or “our”). All material intercompany accounts and transactions are eliminated in consolidation. We offer a full range of deposit, loan, cash management, and trust services to meet the financial needs of individual consumers, businesses and municipalities at 31 full-service banking offices throughout the state of Vermont and one full-service banking office in Massachusetts as of December 31, 2016.
Management’s Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) 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 income and expenses during the reporting periods. The most significant estimates include those used in determining the allowance for credit losses, income taxes, interest income recognition on loans and investments and analysis of other-than-temporary impairment of our investment securities portfolio. Operating results in the future may vary from the amounts derived from Management's estimates and assumptions.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand, amounts due from banks, Federal Funds sold and other short-term investments, with maturities at time of purchase of less than 90 days, in the accompanying consolidated statements of cash flows.
Investment Securities
We classify certain of our investments in debt securities as held to maturity, which are carried at amortized cost, if we have the positive intent and ability to hold such securities to maturity. Investments in debt securities that are not classified as held to maturity and equity securities that have readily determinable fair values are classified as available for sale securities or trading securities. Available for sale securities are investments not classified as trading or held to maturity. Available for sale securities are carried at fair value which is measured at each reporting date. The resulting unrealized gain or loss is reflected in accumulated other comprehensive income (loss) net of the associated tax effects. Gains and losses on sales of investment securities are recognized through the statement of income using the specific identification method.
Transfers from securities available for sale to securities held to maturity are recorded at the securities’ fair values on the date of the transfer. Any net unrealized gains or losses continue to be included as a separate component of accumulated other comprehensive income (loss), on a net of tax basis. As long as the securities are carried in the held to maturity portfolio, such amounts are amortized (accreted) over the estimated remaining life of the transferred securities as an adjustment to yield in a manner consistent with the amortization of premiums and discounts.
Interest and dividend income, including amortization of premiums and discounts, are recorded in earnings for all categories of investment securities. Discounts and premiums related to debt securities are amortized using the level-yield method which anticipates prepayments for amortizing securities.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects
of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement and (2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Federal Home Loan Bank System
We are a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank (“FHLB”) of Boston provides a central credit facility primarily for member institutions. Member institutions are required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year. We were in compliance with this requirement at December 31, 2016. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Bank Owned Life Insurance
We purchased life insurance policies on certain key executives where the Bank is the beneficiary. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value (“CSV”) adjusted for other charges or other amounts due that are probable at settlement. Increases in the CSV of the policies, as well as death benefits received, net of any CSV, are recorded in noninterest income, and are not subject to income taxes.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.
Allowance for Loan Losses (“ALL”)
The ALL is based on Management’s estimate of the amount required to reflect probable incurred credit losses in the loan portfolio. Factors considered in evaluating the adequacy of the ALL include previous loss experience, the size and composition of the portfolio, risk rating composition, current economic and real estate market conditions and their effect on the borrowers, the performance of individual loans in relation to contractual terms and estimated fair values of properties that secure impaired loans.
The ALL consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDR”) and classified as impaired.
Commercial and commercial real estate loans are individually evaluated for impairment when a loan meets any of the specific criteria identified in our methodology. If a loan is impaired, the loan is either charged down, or a portion of the ALL is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered TDRs. Concessions that result in a loan being considered a TDR usually consists of a reduction in interest rate to a below market rate, taking into account the credit quality of the note, or a deferment or reduction of payments, principal or interest, which alters the Bank’s position or significantly extends the note’s maturity date, such that the present value of cash flows to be received is less than those contractually established at the loan’s origination. TDRs are measured at the present value of estimated future cash flows using the loans effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, we determine the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
The general component covers non-impaired loans and loans collectively evaluated for impairment and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by us over the most recent 5 years. This actual loss experiences is supplemented with other factors based on the risks present for each portfolio segment. These factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. Due to the added risks associated with loans which are graded as pass-watch, special mention, and substandard that are not classified as impaired, an additional analysis is performed to determine whether an allowance is needed that is not fully captured by the historical loss experience. While historical loss experience by loan segment and migration of loans into higher risk classifications are considered, the following factors are also considered in determining the level of needed allowance on such loans: the historical loss rates of loans specifically classified as pass-watch, special mention, or substandard; and the trends in the collateral on the loans included within these classifications. This analysis created an additional $108 thousand at December 31, 2016 compared to $543 thousand at December 31, 2015 in needed allowance for loan losses.
We have divided the loan portfolio into portfolio segments, each with different risk characteristics and methodologies for assessing risk. Each portfolio segment is broken down into class segments where appropriate. Class segments contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan and lease losses. Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class segment. Descriptions of the segments are as follows:
Commercial, financial and agricultural: We offer a variety of loan options to meet the specific needs of commercial customers including term loans and lines of credit. Such loans are made available to businesses for working capital such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment, receivables, inventory or other assets owned by the borrower. These loans carry a higher risk than commercial real estate loans by the nature of the underlying collateral, and the collateral value may change daily. To reduce the risk, management generally employs enhanced monitoring requirements, obtains personal guarantees and, where appropriate, may also attempt to secure real estate as collateral.
Municipal: Municipal loans primarily consist of term and time loans issued on a tax-exempt and taxable basis which are general obligations of the municipality. These loans are viewed as lower risk as municipalities can utilize taxing power to meet financial obligations.
Real Estate – Residential: Residential real estate loans consist primarily of loans secured by first or second mortgages on primary residences. We originate adjustable-rate and fixed-rate, one- to four-family residential real estate loans for the construction, purchase or refinancing of a mortgage. These loans are generally collateralized by owner-occupied properties located in our market area. Loans on one- to four-family residential real estate are generally originated in amounts of no more than 80% of the purchase price or appraised value (whichever is lower). Hazard insurance is required. Mortgage title insurance is also required for all first mortgages and for second mortgages in excess of $100,000.
Real Estate – Commercial: We offer commercial real estate loans to finance real estate purchases and refinancing of existing commercial properties. These commercial real estate loans are generally secured by first liens on the real estate, which may include both owner occupied and non-owner occupied facilities. The types of facilities financed include apartments, hotels, warehouses, retail facilities, manufacturing facilities and office buildings. Our underwriting analysis includes credit verification, independent appraisals, a review of the borrower's financial condition, and a detailed analysis of the borrower’s underlying cash flows.
Real Estate – Construction: We offer construction loans for the construction, expansion and improvement of residential and commercial properties which are secured by the real estate being developed. A review of all plans and budgets is performed prior to approval, third party progress documents are required during construction, and an independent approval process for all draw and release requests is maintained to ensure that funding is prudently administered and that funds are sufficient to complete the project.
Installment: We offer traditional direct consumer installment loans for various personal needs, including vehicle and boat financing. The vast majority of these loans are secured by a lien on the purchased vehicle and are underwritten using credit scores and income verification. We do not provide any indirect consumer lending activities.
Income Recognition on Impaired and Nonaccrual Loans
Interest income on mortgage and commercial loans is discontinued and placed on non-accrual status at the time the loan is 91 days delinquent unless the loan is well-secured and in process of collection. Mortgage loans, and commercial loans are charged off to the extent principal or interest is deemed uncollectible. Installment loans continue to accrue interest until they are charged off no later than 120 days past due unless the loan is well secured and are in the process of collection. Past-due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans and loans past due 91 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
All interest accrued but not received for loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans may be returned to accrual status when there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms of the loans and all principal and interest amounts contractually due, including arrearages, are reasonably assured of repayment within an acceptable period of time.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is uncertain, any payments received are generally applied to reduce the principal balance. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Interest collections in excess of that amount are recorded as a reduction of principal.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using straight-line and accelerated methods at rates that depreciate the original
cost of the premises and equipment over the shorter of their estimated useful lives or the expected lease term in the case of leasehold improvements. Expenditures for maintenance, repairs and renewals of minor items are generally charged to expense as incurred. When premises and equipment are replaced, retired, or deemed no longer useful they are written down to estimated selling price less costs to sell by a charge to current earnings.
Investments in Real Estate Limited Partnerships
We have investments in various real estate limited partnerships that acquire, develop, own and operate low and moderate-income housing. Our ownership interest in these limited partnerships ranges from 5.36% to 99.9% as of December 31, 2016. These investments are made directly in Low Income Housing Tax Credit, or LIHTC, partnerships formed by third parties. As a limited partner in these operating partnerships, we receive tax credits and tax deductions for losses incurred by the underlying properties.
Effective January 1, 2014, the Company adopted Accounting Standards Update (“ASU”) 2014-01, “Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects.” The amendment permits an entity to amortize the initial cost of the investment in proportion to the amount of the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense. Merchants has unfunded commitments of $3.68 million at year-end related to qualified affordable housing project investments, which will be fulfilled in 2018. There were no impairment losses during the year resulting from the forfeiture or ineligibility of tax credits related to qualified affordable housing project investments.
Goodwill and Other Acquisition-Related Intangible Assets
An acquirer in a business combination is required, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration, if any, is also recognized and measured at fair value on the date of acquisition. In addition, the accounting standards for business combinations require that: (i) acquisition-related transaction costs be expensed as incurred; (ii) specific requirements be met in order to accrue for a restructuring plan as part of the acquisition; (iii) certain pre-acquisition contingencies be recognized at fair value; and (iv) acquired loans be recorded at fair value as of the acquisition date without recognition of an allowance for loan losses.
Goodwill is recognized in an amount equal to the excess of the purchase price over the fair value of the assets acquired and liabilities assumed. “Acquisition-related intangible assets” are separately identified and recognized, where appropriate, for assets such as trade names and the estimated values of acquired core deposits and/or customer relationships. The remaining intangible asset is recognized as goodwill.
Goodwill and indefinite-lived intangible assets are not amortized but, rather, are reviewed for impairment at least annually, with impairment losses recognized as a charge to expense when they occur. Acquisition-related intangible assets other than goodwill and indefinite-lived intangible assets are amortized to expense over their estimated useful lives and are periodically reviewed by management to assess recoverability, with impairment losses recognized as a charge to expense if carrying amounts exceed fair values.
Goodwill is evaluated for impairment at the reporting unit level. The impairment evaluation is performed as of an annual date or more frequently if a triggering event indicates that impairment may have occurred. Entities have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, based on this qualitative assessment, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test is not required.
The first step (Step 1) of the two-step impairment test is used to identify potential impairment, and involves comparing each reporting unit’s estimated fair value to its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill is not deemed to be impaired.
The second step involves calculating the implied fair value of goodwill for each reporting unit for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to how the amount is determined
in a business acquisition. If the implied fair value of the goodwill exceeds the carrying amount of goodwill assigned to the reporting unit, no impairment exists.
Other intangibles consist of core deposit intangible assets, which are amortized on an accelerated method over its estimated useful life of 10 years.
Other Real Estate Owned
Collateral acquired through foreclosure is initially recorded at the lower of cost or fair value, less estimated costs to sell, at the time of acquisition, establishing a new cost basis. Any cost in excess of the estimated fair value on the transfer date is charged to the allowance for credit losses. Subsequent decreases in the fair value of other real estate owned (“OREO”) are reflected as a write-down and charged to expense. Net operating income or expense related to foreclosed property is included in noninterest expense in the accompanying consolidated statements of income.
Repurchase Agreements
Repurchase agreements are accounted for as secured financing transactions since we maintain effective control over the transferred securities and the transfer meets the other criteria for such accounting. Obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheets. The securities underlying the agreements are delivered to a custodial account for the benefit of the repurchase agreement holders. The repurchase agreement holders, who may sell, loan or otherwise dispose of such securities to other parties in the normal course of their operations, agree to resell to us the same securities at the maturities of the agreements.
Stock-Based Compensation
The Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan provides grants of up to 600,000 stock options or restricted stock awards to certain key employees. We recognize compensation expense for services received in a share-based payment transaction over the required service period, generally defined as the vesting period. The compensation cost is based on the grant-date fair value of the award (as determined by quoted market prices). Stock awards are granted at fair market value on the date of the grant and typically vest based on a three year service period. Due to the pending merger with Community Bank System, Inc., Merchants accelerated the vesting date for the 2014, 2015 and 2016 grant years for select individuals.
The fair value of an option grant is estimated on the grant date using the Black-Scholes option-pricing model that requires us to develop estimates for assumptions used in the model. The Black-Scholes valuation model uses the following assumptions: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed by us based on historical volatility of our stock. We use historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date.
Employee Benefit Costs
Prior to 1995, we maintained a non-contributory pension plan covering substantially all employees that met eligibility requirements. The plan was curtailed in 1995. The cost of this plan, based on actuarial computations of current and future benefits, is charged to current operating expenses. We recognize the overfunded or underfunded status of a single employer defined benefit post retirement plan as an asset or liability on the consolidated balance sheets and recognize changes in the funded status in comprehensive income in the year in which the change occurred.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Low-income housing tax credits and historic rehabilitation credits are recognized as a reduction of income tax expense in the year in which they are earned. We
recognize interest and/or penalties related to income tax matters in other noninterest expense in our consolidated statements of income. Penalties and/or interest were zero or immaterial for 2016, 2015 and 2014. Our policy is to reduce deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
Earnings Per Share
Basic earnings per share are calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share are computed in a manner similar to that of basic earnings per share except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares (such as stock options) were issued during the period, computed using the treasury stock method. Shares held in rabbi trusts related to deferred compensation plans are considered outstanding for purposes of computing earnings per share.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, unrealized gains and losses on cash flow hedges and changes in the funded status of the pension plan, which are also recognized as separate components of equity.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.
Restrictions on Cash
Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements.
Derivative Financial Instruments and Hedging Activities
At the inception of a derivative contract, we designate the derivative as one of three types based on our intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. For both types of hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest income.
Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.
We formally document the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. We also formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued, but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
Segment Reporting
Our operations are solely in the financial services industry and include providing to our customers traditional banking and other financial services. We operate primarily in the state of Vermont and Western Massachusetts. Management makes operating decisions and assesses performance based on an ongoing review of our consolidated financial results. Therefore, we have a single operating segment for financial reporting purposes.
Fair Value Measurements
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
Reclassifications
Reclassifications are made to prior years’ consolidated financial statements whenever necessary to conform to the current year’s presentation. Reclassifications had no effect on prior year net income or stockholders’ equity.
NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
ASU 2014-09 – Revenue from Contracts with Customers – In May 2014, the Financial Accounting Standards Board (“FASB”) amended existing guidance related to revenue from contracts with customers. This amendment supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this amendment specifies the accounting for some costs to obtain or fulfill a contract with a customer.
This amendment was originally effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. In July 2015, the FASB issued ASU 2015-14, which deferred the effective date to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Early adoption is permitted as of the original effective date. The amendments should be applied retrospectively to all periods presented or retrospectively with the cumulative effect recognized at the date of initial application.
In March, April, May and December 2016, the FASB issued ASU 2016-08, ASU 2016-10, ASU 2016-12 and ASU 2016-20 to help to improve the operability and understandability of the implementation guidance. The amendments in these Updates do not change the core principles of the guidance outlined in ASU 2014-09 and do not change the effective dates outlined in ASU 2015-14. The Company continues to evaluate the impact of these new requirements on the consolidated financial statements.
ASU 2016-01 – Financial Instruments – In January 2016, the FASB released this Update to address certain aspects of recognition, presentation and disclosure of financial instruments. For public companies, the Update (1) requires that equity investments be measured at fair value with changes in fair value recognized in net income, (2) simplifies the impairment assessment of equity investments without readily determinable fair values by permitting a qualitative assessment to identify impairment, (3) eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (4) requires entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (5) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements and (8) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently evaluating the impact of this new requirement on the consolidated financial statements.
ASU 2016-02 – Leases – In February 2016, the FASB released this Update to increase the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. For lessees, all leases will be required to be recognized on the balance sheet by recording a right-of-use asset and a lease liability. The accounting applied by a lessor is largely unchanged from that applied under the existing guidance. The ASU requires additional qualitative and quantitative disclosures with the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The guidance is effective for fiscal years beginning after December 15, 2018, including the interim periods. The Company is currently evaluating the impact of this new requirement on the consolidated financial statements, but the expectation is that this new requirement will result in a significant increase to assets for the right-of-use asset recognition and a significant increase to total liabilities for the lease liability.
ASU 2016-09 – Stock Compensation – In March 2016, the FASB released this Update to simplify the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. The update requires all excess tax benefits and tax deficiencies related to share-based awards to be recognized as income tax expense or benefit in the income statement. In addition, the update includes changes to the classification of excess tax benefits on the statement of cash flows, an election related to the accounting for forfeitures, minimum statutory tax withholding requirements, as well as the classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The guidance became effective on January 1, 2017 and did not have a significant impact on the Company’s consolidated financial statements.
ASU 2016-13 – Credit Losses – In June 2016, the FASB released this Update to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this Update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this Update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the impact of this new requirement on the consolidated financial statements.
ASU 2016-15 – Statement of Cash Flows – In August 2016, the FASB released this Update with the objective of
eliminating the diversity in practice related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This Update addresses eight specific cash flow issues: (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, (3) contingent consideration payments made after a business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, (6) distributions received from equity method investees, (7) beneficial interests in securitization transactions and (8) separately identifiable cash flows and application of the predominance principle. These amendments are effective for public business entities for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company is currently evaluating the impact of this new requirement on the consolidated financial statements.
NOTE 3: ACQUISITION OF NUVO BANK & TRUST COMPANY
On December 4, 2015, the Company completed the acquisition of NUVO Bank & Trust Company (“NUVO”), Springfield, Massachusetts. NUVO's banking business operates as a division of Merchants Bank. Total consideration paid by Merchants for NUVO's outstanding stock comprised 517,109 shares of common stock and $5.11 million in cash. Merchants also paid an aggregate of $878,718 to cash out NUVO stock options and a portion of its common stock warrants and issued replacement warrants to purchase an aggregate of 90,756 shares of Merchants common stock on adjusted terms, consisting of warrants expiring in April 2017 to purchase 56,386 shares at an exercise price of $20.69 and warrants expiring in April 2018 to purchase 34,370 shares at an exercise price of $41.39 per share.
The acquisition of NUVO expands the Company’s New England footprint beyond Vermont and into the Springfield and greater Western Massachusetts commercial banking market.
The acquisition of NUVO was accounted for using the purchase method of accounting and, accordingly, assets acquired, liabilities assumed and consideration paid were recorded at their estimated fair values as of the acquisition date. The excess of consideration paid of $7.01 million over the fair value of net assets acquired has been reported as goodwill in the Company’s consolidated statements of financial condition as of December 31, 2016. Goodwill created in the acquisition is not deductible for income tax purposes. This goodwill consists largely of the synergies and cost savings arising from the combining of the operations of the two companies.
In connection with the acquisition, the consideration paid and the fair value of identifiable assets acquired and liabilities assumed as of the date of acquisition are summarized in the following table:
| | | |
(In thousands) | | | Amount |
Consideration paid: | | | |
Common stock issued in exchange for NUVO shares | | $ | 16,889 |
Cash paid for NUVO shares | | | 5,988 |
Stock warrants issued | | | 656 |
Total consideration paid | | $ | 23,533 |
| | | |
Assets acquired: | | | |
Cash and cash equivalents | | $ | 7,070 |
Interest bearing time deposits with banks | | | 110 |
Investments | | | 4,344 |
Restricted investment in bank stock | | | 376 |
Loans | | | 149,360 |
Premises and equipment , net | | | 580 |
Accrued interest receivable | | | 369 |
Core deposit intangible | | | 1,377 |
Deferred tax asset | | | 1,993 |
Other assets | | | 356 |
Total assets acquired | | | 165,935 |
Liabilities assumed: | | | |
Deposits | | | 144,482 |
Federal Home Loan Bank advances | | | 4,001 |
Accrued interest payable | | | 42 |
Tax effect of acquisition fair value adjustments | | | 705 |
Other liabilities | | | 183 |
Total liabilities assumed | | | 149,413 |
Net assets acquired | | $ | 16,522 |
| | | |
Goodwill | | $ | 7,011 |
The following table details the changes in fair value of the consideration paid and the net assets acquired as of December 4, 2015 from the amounts originally reported in the Company’s 2015 Form 10-K:
| | | |
(In thousands) | | | Amount |
Goodwill reported as of December 31, 2015 | | $ | 6,967 |
| | | |
Effect of adjustments to: | | | |
Stock warrants issued | | | 112 |
Deferred tax asset | | | (68) |
Adjusted goodwill as of December 31, 2016 | | $ | 7,011 |
The changes to goodwill during the year ended December 31, 2016 are primarily due to changes in the final market value for assets acquired and consideration paid. In many cases, the fair values of assets acquired and liabilities assumed were determined by estimating the cash flows expected to result from those assets and liabilities and discounting them at appropriate market rates. These changes had no impact on current year or previously reported income.
The following table presents pro forma information as if the acquisition had occurred at the beginning of 2014. The pro forma information includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, depreciation expense on property acquired, interest expense on deposits acquired, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations
that would have occurred had the transactions been effected on the assumed dates.
| | | | | | |
(In thousands except per share data) | | 2015 | | 2014 |
Net interest income | | $ | 53,275 | | $ | 51,732 |
Net income | | | 14,073 | | | 11,512 |
Basic earnings per share | | | 2.05 | | | 1.68 |
Diluted earnings per share | | $ | 2.05 | | $ | 1.68 |
NOTE 4: GOODWILL AND INTANGIBLE ASSETS
The goodwill and intangible balances presented below resulted from the Company’s acquisition of NUVO. The acquisition of NUVO resulted in goodwill of $7.01 million and core deposit intangible (“CDI”) of $1.38 million. For further information regarding goodwill and other intangible assets recorded in connection with the acquisition of NUVO, including the effect of adjustments to goodwill, please refer to Note 3.
Goodwill
Goodwill is deemed to have an indefinite life and therefore is not amortized, but is instead subject to impairment tests. There was no impairment during 2016 or the period from the date of the acquisition through December 31, 2015. There was no goodwill recorded prior to 2015.
The change in goodwill during the year is as follows:
| | | | | | |
| | December 31, | | December 31, |
(In thousands) | | 2016 | | 2015 |
Beginning of period | | $ | 6,967 | | $ | — |
Effect of adjustments | | | 44 | | | — |
Goodwill recorded in acquisition | | | — | | | 6,967 |
Impairment | | | — | | | — |
End of period | | $ | 7,011 | | $ | 6,967 |
Impairment exists when the carrying value of goodwill exceeds its fair value. NUVO was consolidated into Merchants Bank which is considered the reporting unit. At December 31, 2016, the Bank reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the Bank reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not the fair value of the Bank reporting unit exceeded its carrying value, resulting in no impairment.
Other Intangible Assets
Acquired CDI were as follows:
| | | | | | |
| | | December 31, | | | December 31, |
(In thousands) | | | 2016 | | | 2015 |
Beginning of period | | $ | 1,360 | | $ | — |
Additions | | | — | | | 1,377 |
Amortization | | | 204 | | | 17 |
End of period | | $ | 1,156 | | $ | 1,360 |
Aggregate amortization expense for the CDI was $204 thousand for 2016 and $17 thousand for 2015.
Estimated amortization expense for each of the next five years:
| | | |
(In thousands) | | | Amount |
2017 | | $ | 173 |
2018 | | | 147 |
2019 | | | 126 |
2020 | | | 120 |
2021 | | | 120 |
Thereafter | | | 470 |
NOTE 5: INVESTMENT SECURITIES
Investments in securities are classified as available for sale or held to maturity as of December 31, 2016 and 2015. The amortized cost and fair values of the securities classified as available for sale and held to maturity as of December 31, 2016 are as follows:
| | | | | | | | | | | | | |
| | | | | Gross | | Gross | | | | |
| | Amortized | | Unrealized | | Unrealized | | Fair | |
(In thousands) | | Cost | | Gains | | Losses | | Value | |
Available for Sale: | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 25,079 | | $ | 104 | | $ | — | | $ | 25,183 | |
U.S. Government Sponsored Enterprises ("U.S. GSEs") | | | 93,883 | | | 106 | | | (636) | | | 93,353 | |
Federal Home Loan Bank ("FHLB") Obligations | | | 67,362 | | | 100 | | | (456) | | | 67,006 | |
Residential Real Estate Mortgage-backed Securities ("Agency MBSs") | | | 74,573 | | | 1,101 | | | (465) | | | 75,209 | |
Agency Commercial Mortgage Backed Securities ("Agency CMBSs") | | | 23,972 | | | — | | | (364) | | | 23,608 | |
Agency Collateralized Mortgage Obligations ("Agency CMOs") | | | 49,694 | | | 46 | | | (407) | | | 49,333 | |
Asset Backed Securities ("ABSs") | | | 283 | | | 23 | | | — | | | 306 | |
Total Available for Sale | | $ | 334,846 | | $ | 1,480 | | $ | (2,328) | | $ | 333,998 | |
| | | | | | | | | | | | | |
| | | | | Gross | | Gross | | | | |
| | Amortized | | Unrecognized | | Unrecognized | | Fair | |
(In thousands) | | Cost | | Gains | | Losses | | Value | |
Held to Maturity: | | | | | | | | | | | | | |
U.S. Agency Obligations | | $ | 17,849 | | $ | 119 | | $ | (33) | | $ | 17,935 | |
Agency MBSs | | | 5,787 | | | 92 | | | — | | | 5,879 | |
Agency CMOs | | | 62,058 | | | 208 | | | (331) | | | 61,935 | |
Total Held to Maturity | | $ | 85,694 | | $ | 419 | | $ | (364) | | $ | 85,749 | |
The amortized cost and fair values of the securities classified as available for sale and held to maturity as of December 31, 2015 are as follows:
| | | | | | | | | | | | | |
| | | | | Gross | | Gross | | | | |
| | Amortized | | Unrealized | | Unrealized | | Fair | |
(In thousands) | | Cost | | Gains | | Losses | | Value | |
Available for Sale: | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 25,064 | | $ | 61 | | $ | (12) | | $ | 25,113 | |
U.S. GSEs | | | 20,895 | | | 3 | | | (104) | | | 20,794 | |
FHLB Obligations | | | 51,230 | | | 107 | | | (226) | | | 51,111 | |
Agency MBSs | | | 96,073 | | | 1,688 | | | (512) | | | 97,249 | |
Agency CMBSs | | | 24,950 | | | — | | | (397) | | | 24,553 | |
Agency CMOs | | | 64,648 | | | 74 | | | (443) | | | 64,279 | |
ABSs | | | 325 | | | 30 | | | — | | | 355 | |
Total Available for Sale | | $ | 283,185 | | $ | 1,963 | | $ | (1,694) | | $ | 283,454 | |
| | | | | | | | | | | | | |
| | | | | Gross | | Gross | | | | |
| | Amortized | | Unrecognized | | Unrecognized | | Fair | |
(In thousands) | | Cost | | Gains | | Losses | | Value | |
Held to Maturity: | | | | | | | | | | | | | |
U.S. Agency Obligations | | $ | 20,084 | | $ | 486 | | $ | — | | $ | 20,570 | |
U.S. GSEs | | | 9,556 | | | 166 | | | — | | | 9,722 | |
FHLB Obligations | | | 4,758 | | | 76 | | | — | | | 4,834 | |
Agency MBSs | | | 7,027 | | | 154 | | | — | | | 7,181 | |
Agency CMOs | | | 78,249 | | | 253 | | | (716) | | | 77,786 | |
Total Held to Maturity | | $ | 119,674 | | $ | 1,135 | | $ | (716) | | $ | 120,093 | |
The contractual final maturity distribution of the debt securities classified as available for sale of December 31, 2016, are as follows:
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | Securities | | | | |
| | | | | After One | | After Five | | | | | not due | | | | |
| | Within | | But Within | | But Within | | After Ten | | at a Single | | | | |
(In thousands) | | One Year | | Five Years | | Ten Years | | Years | | Maturity | | Total | |
Available for Sale (at fair value): | | | | | | | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 15,109 | | $ | 10,074 | | $ | — | | $ | — | | $ | N/A | | $ | 25,183 | |
U.S. GSEs | | | — | | | 93,353 | | | — | | | — | | | N/A | | | 93,353 | |
FHLB Obligations | | | — | | | 61,005 | | | 6,001 | | | — | | | N/A | | | 67,006 | |
Agency MBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 75,209 | | | 75,209 | |
Agency CMBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 23,608 | | | 23,608 | |
Agency CMOs | | | N/A | | | N/A | | | N/A | | | N/A | | | 49,333 | | | 49,333 | |
ABSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 306 | | | 306 | |
Total Available for Sale | | $ | 15,109 | | $ | 164,432 | | $ | 6,001 | | $ | — | | $ | 148,456 | | $ | 333,998 | |
Available for Sale (at amortized cost): | | | | | | | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 15,091 | | $ | 9,988 | | $ | — | | $ | — | | $ | N/A | | $ | 25,079 | |
U.S. GSEs | | | — | | | 93,883 | | | — | | | — | | | N/A | | | 93,883 | |
FHLB Obligations | | | — | | | 61,439 | | | 5,923 | | | — | | | N/A | | | 67,362 | |
Agency MBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 74,573 | | | 74,573 | |
Agency CMBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 23,972 | | | 23,972 | |
Agency CMOs | | | N/A | | | N/A | | | N/A | | | N/A | | | 49,694 | | | 49,694 | |
ABSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 283 | | | 283 | |
Total Available for Sale | | $ | 15,091 | | $ | 165,310 | | $ | 5,923 | | $ | — | | $ | 148,522 | | $ | 334,846 | |
The contractual final maturity distribution of the debt securities classified as held to maturity of December 31, 2016, are as follows:
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | Securities | | | | |
| | | | | After One | | After Five | | | | | not due | | | | |
| | Within | | But Within | | But Within | | After Ten | | at a Single | | | | |
(In thousands) | | One Year | | Five Years | | Ten Years | | Years | | Maturity | | Total | |
Held to Maturity (at fair value): | | | | | | | | | | | | | | | | | | | |
U.S. Agency Obligations | | $ | — | | $ | — | | $ | — | | $ | 17,935 | | $ | N/A | | $ | 17,935 | |
Agency MBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 5,879 | | | 5,879 | |
Agency CMOs | | | N/A | | | N/A | | | N/A | | | N/A | | | 61,935 | | | 61,935 | |
Total Held to Maturity | | $ | — | | $ | — | | $ | — | | $ | 17,935 | | $ | 67,814 | | $ | 85,749 | |
Held to Maturity (at amortized cost): | | | | | | | | | | | | | | | | | | | |
U.S. Agency Obligations | | $ | — | | $ | — | | $ | — | | $ | 17,849 | | $ | N/A | | $ | 17,849 | |
Agency MBSs | | | N/A | | | N/A | | | N/A | | | N/A | | | 5,787 | | | 5,787 | |
Agency CMOs | | | N/A | | | N/A | | | N/A | | | N/A | | | 62,058 | | | 62,058 | |
Total Held to Maturity | | $ | — | | $ | — | | $ | — | | $ | 17,849 | | $ | 67,845 | | $ | 85,694 | |
Actual maturities will differ from contractual maturities because borrowers may have rights to call or prepay obligations.
The following table presents the proceeds, gross gains and gross losses on available for sale securities.
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Proceeds | | $ | — | | $ | 4,263 | | $ | 56,889 | |
Gross gains | | | — | | | — | | | 303 | |
Gross losses | | | — | | | — | | | (196) | |
Net gains | | $ | — | | $ | — | | $ | 107 | |
In 2016 and in 2015, we did not record any securities gains or losses related to the available for sale portfolio. The tax provision related to the net realized gains and losses in 2014 was $(38) thousand.
The proceeds recorded in 2015 were related to NUVO’s investment portfolio. At the time of acquisition, NUVO’s investment portfolio of fixed rate agency securities was valued at $4.3 million with a yield of 1.96%. Following the completion of the acquisition, the portfolio was sold.
Securities with a carrying value of $370.81 million and $335.81 million at December 31, 2016 and 2015, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, and for other purposes required by law.
Gross unrealized losses on investment securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at December 31, 2016, were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or More | | Total | |
(In thousands) | | Number of Issues | | Fair Value | | Unrealized Loss | | Number of Issues | | Fair Value | | Unrealized Loss | | Number of Issues | | Fair Value | | Unrealized Loss | |
Available for Sale: | | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. GSEs | | 8 | | $ | 42,404 | | $ | (636) | | — | | $ | — | | $ | — | | 8 | | $ | 42,404 | | $ | (636) | |
FHLB Obligations | | 9 | | | 45,870 | | | (456) | | — | | | — | | | — | | 9 | | | 45,870 | | | (456) | |
Agency MBSs | | 16 | | | 48,777 | | | (465) | | — | | | — | | | — | | 16 | | | 48,777 | | | (465) | |
Agency CMBSs | | 6 | | | 23,608 | | | (364) | | — | | | — | | | — | | 6 | | | 23,608 | | | (364) | |
Agency CMOs | | 15 | | | 33,935 | | | (332) | | 2 | | | 2,227 | | | (75) | | 17 | | | 36,162 | | | (407) | |
Total | | 54 | | $ | 194,594 | | $ | (2,253) | | 2 | | $ | 2,227 | | $ | (75) | | 56 | | $ | 196,821 | | $ | (2,328) | |
Gross unrecognized losses on investment securities held to maturity and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrecognized loss position, at December 31, 2016, were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or More | | Total | |
(In thousands) | | Number of Issues | | Fair Value | | Unrecognized Loss | | Number of Issues | | Fair Value | | Unrecognized Loss | | Number of Issues | | Fair Value | | Unrecognized Loss | |
Held to Maturity: | | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. Agency Obligations | | 1 | | $ | 7,230 | | $ | (33) | | — | | $ | — | | $ | — | | 1 | | $ | 7,230 | | $ | (33) | |
Agency CMOs | | 13 | | | 26,480 | | | (212) | | 1 | | | 3,162 | | | (119) | | 14 | | | 29,642 | | | (331) | |
Total | | 14 | | $ | 33,710 | | $ | (245) | | 1 | | $ | 3,162 | | $ | (119) | | 15 | | $ | 36,872 | | $ | (364) | |
Gross unrealized losses on investment securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at December 31, 2015, were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or More | | Total | |
(In thousands) | | Number of Issues | | Fair Value | | Unrealized Loss | | Number of Issues | | Fair Value | | Unrealized Loss | | Number of Issues | | Fair Value | | Unrealized Loss | |
Available for Sale: | | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. Treasury Obligations | | 3 | | $ | 15,068 | | $ | (12) | | — | | $ | — | | $ | — | | 3 | | $ | 15,068 | | $ | (12) | |
U.S. GSEs | | 3 | | | 14,817 | | | (104) | | — | | | — | | | — | | 3 | | | 14,817 | | | (104) | |
FHLB Obligations | | 8 | | | 39,094 | | | (226) | | — | | | — | | | — | | 8 | | | 39,094 | | | (226) | |
Agency MBSs | | 17 | | | 60,748 | | | (512) | | — | | | — | | | — | | 17 | | | 60,748 | | | (512) | |
Agency CMBSs | | 5 | | | 19,608 | | | (331) | | 1 | | | 4,761 | | | (66) | | 6 | | | 24,369 | | | (397) | |
Agency CMOs | | 15 | | | 42,235 | | | (283) | | 3 | | | 6,089 | | | (160) | | 18 | | | 48,324 | | | (443) | |
Total | | 51 | | $ | 191,570 | | $ | (1,468) | | 4 | | $ | 10,850 | | $ | (226) | | 55 | | $ | 202,420 | | $ | (1,694) | |
Gross unrecognized losses on investment securities held to maturity and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrecognized loss position, at December 31, 2015, were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or More | | Total | |
(In thousands) | | Number of Issues | | Fair Value | | Unrecognized Loss | | Number of Issues | | Fair Value | | Unrecognized Loss | | Number of Issues | | Fair Value | | Unrecognized Loss | |
Held to Maturity: | | | | | | | | | | | | | | | | | | | | | | | | | |
Agency CMOs | | 14 | | $ | 51,713 | | $ | (623) | | 2 | | $ | 5,287 | | $ | (93) | | 16 | | $ | 57,000 | | $ | (716) | |
Total | | 14 | | $ | 51,713 | | $ | (623) | | 2 | | $ | 5,287 | | $ | (93) | | 16 | | $ | 57,000 | | $ | (716) | |
There were no securities classified as trading at December 31, 2016 or 2015.
Unrealized losses on investment securities result from the cost basis of the security being higher than its current fair value. These differences generally occur because of changes in interest rates since the time of purchase, or because the credit quality of the issuer has deteriorated. We perform a quarterly analysis of each security in our portfolio to determine if impairment exists, and if it does, whether that impairment is other-than-temporary.
At December 31, 2016, all of our MBSs and CMOs held were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”), institutions which the government has affirmed its commitment to support. As the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and we do not intend to sell these securities and it is not likely that we will be required to sell the securities before their anticipated recovery, we do not consider these securities to be other-than-temporarily impaired at December 31, 2016.
Agency MBSs and Agency CMOs consist of pools of residential mortgages which are guaranteed by FNMA, FHLMC, or Government National Mortgage Association (“GNMA”) with various origination dates and maturities. Agency CMBS consists of bonds backed by commercial real estate which are guaranteed by FNMA and GNMA.
During 2014 and 2013, securities were transferred from available for sale to held to maturity. The amortization of the unamortized net holding loss reported in accumulated other comprehensive income offsets the effect on interest income of the discount for the transferred securities. The remaining unamortized balance of the net losses for the securities transferred from available for sale to held to maturity was $2.17 million or $1.41 million, net of tax at December 31, 2016.
NOTE 6: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES
Loans
The composition of our loan portfolio was as follows:
| | | | | | | |
(In thousands) | | December 31, 2016 | | December 31, 2015 | |
Commercial, financial and agricultural | | $ | 257,078 | | $ | 237,451 | |
Municipal loans | | | 114,509 | | | 105,421 | |
Real estate loans – residential | | | 447,527 | | | 468,443 | |
Real estate loans – commercial | | | 636,755 | | | 558,004 | |
Real estate loans – construction | | | 52,533 | | | 34,802 | |
Installment loans | | | 5,790 | | | 10,115 | |
All other loans | | | 17 | | | 44 | |
Total loans | | $ | 1,514,209 | | $ | 1,414,280 | |
We primarily originate commercial, commercial real estate, municipal obligations and residential real estate loans to customers throughout the states of Vermont and Massachusetts. There are no significant industry concentrations in the loan portfolio. Total loans included $1.19 million and $1.20 million of net deferred loan origination costs at December 31,
2016 and 2015, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $297 thousand and $308 thousand at December 31, 2016 and 2015, respectively.
Additionally, residential and commercial loans serviced for others at December 31, 2016 and 2015 amounted to approximately $34.63 million and $27.87 million, respectively.
The following table reflects our loan loss experience and activity in the allowance for loan losses for the year ended December 31, 2016:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial, | | | | | | | | | | | | | | | | | | | | | | |
| | financial | | | | | Real | | Real | | Real | | | | | | | | | | |
| | and | | | | | estate- | | estate- | | estate- | | | | | | | | | | |
(In thousands) | | agricultural | | Municipal | | residential | | commercial | | construction | | Installment | | All other | | Totals | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,696 | | $ | 590 | | $ | 2,882 | | $ | 5,386 | | $ | 420 | | $ | 66 | | $ | — | | $ | 12,040 | |
Charge-offs | | | (125) | | | — | | | (215) | | | — | | | — | | | (168) | | | — | | | (508) | |
Recoveries | | | 5 | | | — | | | 35 | | | 4 | | | — | | | 83 | | | — | | | 127 | |
Provision (credit) | | | 370 | | | 3 | | | (127) | | | 532 | | | 114 | | | 108 | | | — | | | 1,000 | |
Ending balance | | $ | 2,946 | | $ | 593 | | $ | 2,575 | | $ | 5,922 | | $ | 534 | | $ | 89 | | $ | — | | $ | 12,659 | |
The following table reflects our loan loss experience and activity in the allowance for loan losses for the year ended December 31, 2015:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial, | | | | | | | | | | | | | | | | | | | | | | |
| | financial | | | | | Real | | Real | | Real | | | | | | | | | | |
| | and | | | | | estate- | | estate- | | estate- | | | | | | | | | | |
(In thousands) | | agricultural | | Municipal | | residential | | commercial | | construction | | Installment | | All other | | Totals | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,583 | | $ | 623 | | $ | 3,038 | | $ | 5,209 | | $ | 325 | | $ | 13 | | $ | 42 | | $ | 11,833 | |
Charge-offs | | | (29) | | | — | | | (112) | | | — | | | — | | | (108) | | | — | | | (249) | |
Recoveries | | | 34 | | | — | | | 52 | | | 2 | | | — | | | 52 | | | — | | | 140 | |
Provision (credit) | | | 108 | | | (33) | | | (96) | | | 175 | | | 95 | | | 109 | | | (42) | | | 316 | |
Ending balance | | $ | 2,696 | | $ | 590 | | $ | 2,882 | | $ | 5,386 | | $ | 420 | | $ | 66 | | $ | — | | $ | 12,040 | |
The following table reflects our loan loss experience and activity in the allowance for loan losses for the year ended December 31, 2014:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial, | | | | | | | | | | | | | | | | | | | | | | |
| | financial | | | | | Real | | Real | | Real | | | | | | | | | | |
| | and | | | | | estate- | | estate- | | estate- | | | | | | | | | | |
(In thousands) | | agricultural | | Municipal | | residential | | commercial | | construction | | Installment | | All other | | Totals | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,740 | | $ | 758 | | $ | 2,995 | | $ | 5,040 | | $ | 481 | | $ | 18 | | $ | 10 | | $ | 12,042 | |
Charge-offs | | | (34) | | | — | | | (25) | | | — | | | — | | | (2) | | | (170) | | | (231) | |
Recoveries | | | 10 | | | — | | | 24 | | | 1 | | | — | | | 2 | | | 31 | | | 68 | |
Provision (credit) | | | (133) | | | (135) | | | 44 | | | 168 | | | (156) | | | (5) | | | 171 | | | (46) | |
Ending balance | | $ | 2,583 | | $ | 623 | | $ | 3,038 | | $ | 5,209 | | $ | 325 | | $ | 13 | | $ | 42 | | $ | 11,833 | |
In addition to the provision for loan losses include above, there was a provision (credit) for the reserve for undisbursed lines of $105 thousand, $(66) thousand and $196 thousand for 2016, 2015 and 2014, respectively, included in the provision for credit losses in the consolidated statements of income.
The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2016:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial, | | | | | | | | | | | | | | | | | | | | | | |
| | financial and | | | | | Real estate- | | Real estate- | | Real estate- | | | | | | | | | | |
(In thousands) | | agricultural | | Municipal | | residential | | commercial | | construction | | Installment | | All other | | Totals | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance individually evaluated for impairment | | $ | — | | $ | — | | $ | 184 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 184 | |
Ending balance collectively evaluated for impairment | | | 2,946 | | | 593 | | | 2,391 | | | 5,922 | | | 534 | | | 89 | | | — | | | 12,475 | |
Ending balance acquired with deteriorated credit quality | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Totals | | $ | 2,946 | | $ | 593 | | $ | 2,575 | | $ | 5,922 | | $ | 534 | | $ | 89 | | $ | — | | $ | 12,659 | |
Financing receivables: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance individually evaluated for impairment | | $ | 97 | | $ | — | | $ | 1,213 | | $ | 1,634 | | $ | — | | $ | 12 | | $ | — | | $ | 2,956 | |
Ending balance collectively evaluated for impairment | | | 256,239 | | | 114,509 | | | 446,314 | | | 633,217 | | | 52,533 | | | 5,778 | | | 17 | | | 1,508,607 | |
Ending balance acquired with deteriorated credit quality | | | 742 | | | — | | | — | | | 1,904 | | | — | | | — | | | — | | | 2,646 | |
Totals | | $ | 257,078 | | $ | 114,509 | | $ | 447,527 | | $ | 636,755 | | $ | 52,533 | | $ | 5,790 | | $ | 17 | | $ | 1,514,209 | |
The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2015:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial, | | | | | | | | | | | | | | | | | | | | | | |
| | financial and | | | | | Real estate- | | Real estate- | | Real estate- | | | | | | | | | | |
(In thousands) | | agricultural | | Municipal | | residential | | commercial | | construction | | Installment | | All other | | Totals | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance individually evaluated for impairment | | $ | — | | $ | — | | $ | 137 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 137 | |
Ending balance collectively evaluated for impairment | | | 2,696 | | | 590 | | | 2,745 | | | 5,386 | | | 420 | | | 66 | | | — | | | 11,903 | |
Ending balance acquired with deteriorated credit quality | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Totals | | $ | 2,696 | | $ | 590 | | $ | 2,882 | | $ | 5,386 | | $ | 420 | | $ | 66 | | $ | — | | $ | 12,040 | |
Financing receivables: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance individually evaluated for impairment | | $ | 595 | | $ | — | | $ | 706 | | $ | 647 | | $ | — | | $ | 22 | | $ | — | | $ | 1,970 | |
Ending balance collectively evaluated for impairment | | | 235,652 | | | 105,421 | | | 467,737 | | | 555,323 | | | 34,802 | | | 10,093 | | | 44 | | | 1,409,072 | |
Ending balance acquired with deteriorated credit quality | | | 1,204 | | | — | | | — | | | 2,034 | | | — | | | — | | | — | | | 3,238 | |
Totals | | $ | 237,451 | | $ | 105,421 | | $ | 468,443 | | $ | 558,004 | | $ | 34,802 | | $ | 10,115 | | $ | 44 | | $ | 1,414,280 | |
The table below presents the recorded investment of loans segregated by class, with delinquency aging as of December 31, 2016:
| | | | | | | | | | | | | | | | | | | | | | |
| | 31-60 | | 61-90 | | 91 Days | | Total | | | | | | | | | | |
| | Days | | Days | | or More | | Past | | | | | | | | | | |
(In thousands) | | Past Due | | Past Due | | Past Due | | Due | | Current | | | Nonperforming | | Total | |
Commercial, financial and agricultural | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 256,894 | | $ | 184 | | $ | 257,078 | |
Municipal | | | — | | | — | | | — | | | — | | | 114,509 | | | — | | | 114,509 | |
Real estate-residential: | | | | | | | | | | | | | | | | | | | | | | |
First mortgage | | | 164 | | | 71 | | | — | | | 235 | | | 408,597 | | | 1,104 | | | 409,936 | |
Second mortgage | | | 32 | | | — | | | — | | | 32 | | | 37,559 | | | — | | | 37,591 | |
Real estate-commercial: | | | | | | | | | | | | | | | | | | | | | | |
Owner occupied | | | — | | | — | | | — | | | — | | | 224,691 | | | 1,882 | | | 226,573 | |
Non-owner occupied | | | — | | | — | | | — | | | — | | | 410,182 | | | — | | | 410,182 | |
Real estate-construction: | | | | | | | | | | | | | | | | | | | | | | |
Residential | | | — | | | — | | | — | | | — | | | 2,530 | | | — | | | 2,530 | |
Commercial | | | — | | | — | | | — | | | — | | | 50,003 | | | — | | | 50,003 | |
Installment | | | 123 | | | — | | | — | | | 123 | | | 5,655 | | | 12 | | | 5,790 | |
Other | | | — | | | — | | | — | | | — | | | 17 | | | — | | | 17 | |
Total | | $ | 319 | | $ | 71 | | $ | — | | $ | 390 | | $ | 1,510,637 | | $ | 3,182 | | $ | 1,514,209 | |
Of the total nonperforming loans in the aging table above, $1.75 million were past due of which $0 were restructured loans, $819 thousand were purchase credit impaired, and $19 thousand were 91 days or more past due and accruing. In the third quarter of 2016, the Company’s policy was updated to classify accruing TDRs as performing loans to more accurately represent the characteristics of the loans. Prior period amounts have been reclassified to be consistent with the current period presentation. Nonperforming loans as of December 31, 2015 were reduced $210 thousand for accruing TDRs.
The table below presents the recorded investment of loans segregated by class, with delinquency aging as of December 31, 2015:
| | | | | | | | | | | | | | | | | | | | | | |
| | 31-60 | | 61-90 | | 91 Days | | Total | | | | | | | | | | |
| | Days | | Days | | or More | | Past | | | | | | | | | | |
(In thousands) | | Past Due | | Past Due | | Past Due | | Due | | Current | | | Nonperforming | | Total | |
Commercial, financial and agricultural | | $ | — | | $ | 251 | | $ | — | | $ | 251 | | $ | 235,905 | | $ | 1,295 | | $ | 237,451 | |
Municipal | | | — | | | — | | | — | | | — | | | 105,421 | | | — | | | 105,421 | |
Real estate-residential: | | | | | | | | | | | | | | | | | | | | | | |
First mortgage | | | 50 | | | — | | | — | | | 50 | | | 425,645 | | | 581 | | | 426,276 | |
Second mortgage | | | — | | | 8 | | | — | | | 8 | | | 42,159 | | | — | | | 42,167 | |
Real estate-commercial: | | | | | | | | | | | | | | | | | | | | | | |
Owner occupied | | | 323 | | | — | | | — | | | 323 | | | 219,080 | | | 1,605 | | | 221,008 | |
Non-owner occupied | | | — | | | — | | | — | | | — | | | 336,514 | | | 482 | | | 336,996 | |
Real estate-construction: | | | | | | | | | | | | | | | | | | | | | | |
Residential | | | — | | | — | | | — | | | — | | | 2,422 | | | — | | | 2,422 | |
Commercial | | | — | | | — | | | — | | | — | | | 32,380 | | | — | | | 32,380 | |
Installment | | | 61 | | | 9 | | | — | | | 70 | | | 10,023 | | | 22 | | | 10,115 | |
Other | | | — | | | — | | | — | | | — | | | 44 | | | — | | | 44 | |
Total | | $ | 434 | | $ | 268 | | $ | — | | $ | 702 | | $ | 1,409,593 | | $ | 3,985 | | $ | 1,414,280 | |
Of the total nonperforming loans in the aging table above, $2.65 million were past due of which $472 thousand were restructured loans, $1.05 million were purchased credit impaired, and $0 were 91 days or more past due and accruing.
Impaired loans by class at December 31, 2016 are as follows:
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Interest |
| | Recorded | | Unpaid Principal | | Related | | Average Recorded | | Income |
(In thousands) | | Investment | | Balance | | Allowance | | Investment | | Recognized |
With no related allowance recorded | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | $ | 97 | | $ | 97 | | $ | — | | $ | 243 | | $ | 4 |
Real estate – residential: | | | | | | | | | | | | | | | |
First mortgage | | | 208 | | | 266 | | | — | | | 253 | | | 6 |
Second mortgage | | | — | | | — | | | — | | | 1 | | | — |
Real estate – commercial: | | | | | | | | | | | | | | | |
Owner occupied | | | 1,229 | | | 1,229 | | | — | | | 525 | | | — |
Non-owner occupied | | | 405 | | | 432 | | | — | | | 508 | | | — |
Installment | | | 12 | | | 12 | | | — | | | 7 | | | — |
With related allowance recorded | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | — | | | — | | | — | | | 298 | | | — |
Real estate – residential: | | | | | | | | | | | | | | | |
First mortgage | | | 1,005 | | | 1,026 | | | 184 | | | 514 | | | — |
Second mortgage | | | — | | | — | | | — | | | — | | | — |
Real estate – commercial: | | | | | | | | | | | | | | | |
Owner occupied | | | — | | | — | | | — | | | 10 | | | — |
Installment | | | — | | | — | | | — | | | — | | | — |
Total | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | 97 | | | 97 | | | — | | | 541 | | | 4 |
Real estate – residential | | | 1,213 | | | 1,292 | | | 184 | | | 768 | | | 6 |
Real estate – commercial | | | 1,634 | | | 1,661 | | | — | | | 1,043 | | | — |
Installment | | | 12 | | | 12 | | | — | | | 7 | | | — |
Total | | $ | 2,956 | | $ | 3,062 | | $ | 184 | | $ | 2,359 | | $ | 10 |
Impaired loans by class at December 31, 2015 are as follows:
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Interest |
| | Recorded | | Unpaid Principal | | Related | | Average Recorded | | Income |
(In thousands) | | Investment | | Balance | | Allowance | | Investment | | Recognized |
With no related allowance recorded | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | $ | 595 | | $ | 599 | | $ | — | | $ | 374 | | $ | 11 |
Real estate – residential: | | | | | | | | | | | | | | | |
First mortgage | | | 264 | | | 322 | | | — | | | 227 | | | 5 |
Second mortgage | | | — | | | — | | | — | | | 52 | | | — |
Real estate – commercial: | | | | | | | | | | | | | | | |
Owner occupied | | | 165 | | | 165 | | | — | | | 13 | | | — |
Non-owner occupied | | | 482 | | | 482 | | | — | | | 43 | | | — |
Installment | | | 22 | | | 22 | | | — | | | 2 | | | — |
With related allowance recorded | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | — | | | — | | | — | | | 124 | | | — |
Real estate – residential: | | | | | | | | | | | | | | | |
First mortgage | | | 442 | | | 442 | | | 137 | | | 484 | | | — |
Second mortgage | | | — | | | — | | | — | | | 4 | | | — |
Real estate – commercial: | | | | | | | | | | | | | | | |
Owner occupied | | | — | | | — | | | — | | | — | | | — |
Installment | | | — | | | — | | | — | | | — | | | — |
Total | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | 595 | | | 599 | | | — | | | 498 | | | 11 |
Real estate – residential | | | 706 | | | 764 | | | 137 | | | 767 | | | 5 |
Real estate – commercial | | | 647 | | | 647 | | | — | | | 56 | | | — |
Installment | | | 22 | | | 22 | | | — | | | 2 | | | — |
Total | | $ | 1,970 | | $ | 2,032 | | $ | 137 | | $ | 1,323 | | $ | 16 |
Impaired loans by class at December 31, 2014 are as follows:
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Interest |
| | Recorded | | Unpaid Principal | | Related | | Average Recorded | | Income |
(In thousands) | | Investment | | Balance | | Allowance | | Investment | | Recognized |
With no related allowance recorded | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | $ | 134 | | $ | 136 | | $ | — | | $ | 86 | | $ | 3 |
Real estate – residential: | | | | | | | | | | | | | | | |
First mortgage | | | 147 | | | 257 | | | — | | | 256 | | | 8 |
Second mortgage | | | 79 | | | 79 | | | — | | | 136 | | | 1 |
Real estate – commercial: | | | | | | | | | | | | | | | |
Owner occupied | | | — | | | — | | | — | | | 12 | | | 1 |
Non-owner occupied | | | — | | | — | | | — | | | — | | | — |
Installment | | | — | | | — | | | — | | | — | | | — |
With related allowance recorded | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | — | | | — | | | — | | | 12 | | | — |
Real estate – residential: | | | | | | | | | | | | | | | |
First mortgage | | | 431 | | | 432 | | | 63 | | | 204 | | | — |
Second mortgage | | | — | | | — | | | — | | | — | | | — |
Real estate – commercial: | | | | | | | | | | | | | | | |
Non-owner occupied | | | — | | | — | | | — | | | 119 | | | — |
Installment | | | — | | | — | | | — | | | — | | | — |
Total | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | 134 | | | 136 | | | — | | | 98 | | | 3 |
Real estate – residential | | | 657 | | | 768 | | | 63 | | | 596 | | | 9 |
Real estate – commercial | | | — | | | — | | | — | | | 131 | | | 1 |
Installment and other | | | — | | | — | | | — | | | — | | | — |
Total | | $ | 791 | | $ | 904 | | $ | 63 | | $ | 825 | | $ | 13 |
Nonperforming loans were as follows:
| | | | | | | |
(In thousands) | | December 31, 2016 | | December 31, 2015 | |
Nonaccrual loans | | $ | 3,163 | | $ | 3,513 | |
Loans greater than 90 days and accruing | | | 19 | | | — | |
Troubled debt restructurings | | | — | | | 472 | |
Total nonperforming loans | | $ | 3,182 | | $ | 3,985 | |
There was one commercial real estate loan restructured with a balance of $405 thousand in 2016 and is considered to be a TDR. This loan was individually evaluated for impairment and it was determined that no reserve was required. In 2015, there were two commercial loans restructured with a total balance of $556 thousand and were considered to be TDRs.
TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. At December 31, 2016, there were three restructured residential mortgages with balances totaling $110 thousand, one restructured commercial loan with a balance of $78 thousand and one restructured commercial real estate loan with a balance of $405 thousand. All of the five of the TDRs at December 31, 2016 continue to pay as agreed according to the modified terms, are accruing, and are considered performing loans. At December 31, 2015, there were three restructured residential mortgages with balances totaling $125 thousand and three restructured commercial loans with balances totaling $557 thousand.
At December 31, 2016, there were no commitments to lend additional funds to borrowers whose loans have been modified in a troubled debt restructuring. We had no commitments to lend additional funds to borrowers whose loans were in nonaccrual status or to borrowers whose loans were 91 days past due and still accruing at December 31, 2016. Interest income on restructured loans during years ended December 31, 2016 and 2015 was insignificant.
Nonaccrual loans by class as of December 31, 2016 and 2015 are as follows:
| | | | | | | |
(In thousands) | | December 31, 2016 | | December 31, 2015 | |
Commercial, financial and agricultural | | $ | 165 | | $ | 823 | |
Real estate - residential: | | | | | | | |
First mortgage | | | 1,104 | | | 581 | |
Second mortgage | | | — | | | — | |
Real estate - commercial: | | | | | | | |
Owner occupied | | | 1,882 | | | 1,605 | |
Non owner occupied | | | — | | | 482 | |
Installment | | | 12 | | | 22 | |
Total nonaccruing non-TDR loans | | $ | 3,163 | | $ | 3,513 | |
Nonaccruing TDR’s | | | | | | | |
Commercial, financial and agricultural | | | — | | | 472 | |
Real estate – residential: | | | | | | | |
First mortgage | | | — | | | — | |
Real estate - commercial: | | | | | | | |
Non owner occupied | | | — | | | — | |
Total nonaccrual loans including TDRs | | $ | 3,163 | | $ | 3,985 | |
Commercial Grading System
We use risk rating definitions for our commercial loan portfolios and certain residential loans which are generally consistent with regulatory and banking industry norms. Loans are assigned a credit quality grade which is based upon management’s ongoing assessment of risk based upon an evaluation of the quantitative and qualitative aspects of each credit. This assessment is a dynamic process and risk ratings are adjusted as each borrower’s financial situation changes. This process is designed to provide timely recognition of a borrower’s financial condition and appropriately focus management resources.
Pass rated loans exhibit acceptable risk to the bank in terms of financial capacity to repay their loans as well as possessing acceptable fallback repayment sources, typically collateral and personal guarantees. Pass rated commercial loan relationships with a total exposure of $1 million or greater are subject to a formal annual review process; additionally, Management reviews the risk rating at the time of any late payments, overdrafts or other sign of deterioration in the interim.
Loans rated Pass-Watch require more than usual attention and monitoring by the account officer, though not to the extent that a formal remediation plan is warranted. Borrowers can be rated Pass-Watch based upon a weakened capital structure, marginally adequate cash flow and/or collateral coverage or early-stage declining trends in operations or financial condition.
Loans rated Special Mention possess potential weakness that may expose the bank to some risk of loss in the future. These loans require more frequent monitoring and formal reporting to Management.
Substandard loans reflect well-defined weaknesses in the current repayment capacity, collateral or net worth of the borrower with the possibility of some loss to the bank if these weaknesses are not corrected. Action plans are required for these loans to address the inherent weakness in the credit and are formally reviewed.
Residential real estate and consumer loans
We do not use a grading system for our performing residential real estate and consumer loans. Credit quality for these loans is based on performance and payment status.
Below is a summary of loans by credit quality indicator as of December 31, 2016:
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | Pass- | | Special | | Sub- | | | |
(In thousands) | | Unrated | | Pass | | Watch | | Mention | | Standard | | Total | |
Commercial, financial and agricultural | | $ | 102 | | $ | 215,891 | | $ | 24,215 | | $ | 322 | | $ | 16,548 | | $ | 257,078 | |
Municipal | | | — | | | 110,864 | | | 2,824 | | | 821 | | | — | | | 114,509 | |
Real estate – residential: | | | | | | | | | | | | | | | | | | | |
First mortgage | | | 400,961 | | | 7,392 | | | 481 | | | — | | | 1,102 | | | 409,936 | |
Second mortgage | | | 37,367 | | | — | | | 224 | | | — | | | — | | | 37,591 | |
Real estate – commercial: | | | | | | | | | | | | | | | | | | | |
Owner occupied | | | — | | | 186,494 | | | 25,492 | | | — | | | 14,587 | | | 226,573 | |
Non-owner occupied | | | — | | | 369,566 | | | 38,706 | | | — | | | 1,910 | | | 410,182 | |
Real estate – construction: | | | | | | | | | | | | | | | | | | | |
Residential | | | 412 | | | 2,118 | | | — | | | — | | | — | | | 2,530 | |
Commercial | | | 152 | | | 41,373 | | | 7,476 | | | — | | | 1,002 | | | 50,003 | |
Installment | | | 5,778 | | | — | | | — | | | — | | | 12 | | | 5,790 | |
All other loans | | | 17 | | | — | | | — | | | — | | | — | | | 17 | |
Total | | $ | 444,789 | | $ | 933,698 | | $ | 99,418 | | $ | 1,143 | | $ | 35,161 | | $ | 1,514,209 | |
Below is a summary of loans by credit quality indicator as of December 31, 2015:
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | Pass- | | Special | | Sub- | | | | |
(In thousands) | | Unrated | Pass | Watch | | Mention | | Standard | | Total | |
Commercial, financial and agricultural | | $ | 116 | | $ | 179,932 | | $ | 45,977 | | $ | 4,177 | | $ | 7,249 | | $ | 237,451 | |
Municipal | | | — | | | 92,069 | | | 13,352 | | | — | | | — | | | 105,421 | |
Real estate – residential: | | | | | | | | | | | | | | | | | | | |
First mortgage | | | 420,798 | | | 4,733 | | | 164 | | | — | | | 581 | | | 426,276 | |
Second mortgage | | | 42,167 | | | — | | | — | | | — | | | — | | | 42,167 | |
Real estate – commercial: | | | | | | | | | | | | | | | | | | | |
Owner occupied | | | — | | | 162,106 | | | 41,477 | | | 5,959 | | | 11,466 | | | 221,008 | |
Non-owner occupied | | | — | | | 290,503 | | | 44,485 | | | 444 | | | 1,564 | | | 336,996 | |
Real estate – construction: | | | | | | | | | | | | | | | | | | | |
Residential | | | 477 | | | 1,945 | | | — | | | — | | | — | | | 2,422 | |
Commercial | | | 134 | | | 27,310 | | | 3,136 | | | — | | | 1,800 | | | 32,380 | |
Installment | | | 10,093 | | | — | | | — | | | — | | | 22 | | | 10,115 | |
All other loans | | | 44 | | | — | | | — | | | — | | | — | | | 44 | |
Total | | $ | 473,829 | | $ | 758,598 | | $ | 148,591 | | $ | 10,580 | | $ | 22,682 | | $ | 1,414,280 | |
The carrying amount of loans purchased with evidence of credit deterioration accounted for under FASB ASC 310-30 acquired in the NUVO acquisition totaled $2.65 million and $3.24 million at December 31, 2016 and 2015, respectively.
NOTE 7: FAIR VALUE OF FINANCIAL INSTRUMENTS
We record certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. We use quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments are used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate Management’s estimates of the assumptions a market participant would use in pricing the asset or liability.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
| · | | Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. |
| · | | Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. |
| · | | Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity). |
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The types of instruments valued based on quoted market prices in active markets include most U.S. government and Agency securities, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy. We do not adjust the quoted price for such instruments.
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid Agency securities, less liquid listed equities, state, municipal and provincial obligations, and certain physical commodities. Such instruments are generally classified within Level 2 of the fair value hierarchy.
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions; valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, Management’s best estimate will be used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Subsequent to inception, Management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
Financial instruments on a recurring basis
The table below presents the balance of financial assets and liabilities at December 31, 2016 measured at fair value on a recurring basis:
| | | | | | | | | | | | | |
| | | | | Fair Value Measurements at Reporting Date Using | |
| | | | | Quoted Prices in | | | | | |
| | | | | Active Markets for | | Significant Other | | Significant | |
| | | | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
(In thousands) | | Total | | (Level 1) | | (Level 2) | | (Level 3) | |
Assets | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 25,183 | | $ | — | | $ | 25,183 | | $ | — | |
U.S. GSEs | | | 93,353 | | | — | | | 93,353 | | | — | |
FHLB Obligations | | | 67,006 | | | — | | | 67,006 | | | — | |
Agency MBSs | | | 75,209 | | | — | | | 75,209 | | | — | |
Agency CMBSs | | | 23,608 | | | — | | | 23,608 | | | — | |
Agency CMOs | | | 49,333 | | | — | | | 49,333 | | | — | |
ABSs | | | 306 | | | — | | | 306 | | | — | |
Interest rate swap agreements | | | 422 | | | — | | | 422 | | | — | |
Total assets | | $ | 334,420 | | $ | — | | $ | 334,420 | | $ | — | |
Liabilities | | | | | | | | | | | | | |
Interest rate swap agreements | | | 194 | | | — | | | 194 | | | — | |
Total liabilities | | $ | 194 | | $ | — | | $ | 194 | | $ | — | |
The table below presents the balance of financial assets and liabilities at December 31, 2015 measured at fair value on a recurring basis:
| | | | | | | | | | | | | |
| | | | | Fair Value Measurements at Reporting Date Using | |
| | | | | Quoted Prices in | | | | | | | |
| | | | | Active Markets for | | Significant Other | | Significant | |
| | | | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
(In thousands) | | Total | | (Level 1) | | (Level 2) | | (Level 3) | |
Assets | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 25,113 | | $ | — | | $ | 25,113 | | $ | — | |
U.S. GSEs | | | 20,794 | | | — | | | 20,794 | | | — | |
FHLB Obligations | | | 51,111 | | | — | | | 51,111 | | | — | |
Agency MBSs | | | 97,249 | | | — | | | 97,249 | | | — | |
Agency CMBSs | | | 24,553 | | | — | | | 24,553 | | | — | |
Agency CMOs | | | 64,279 | | | — | | | 64,279 | | | — | |
ABSs | | | 355 | | | — | | | 355 | | | — | |
Interest rate swap agreements | | | 1,084 | | | — | | | 1,084 | | | — | |
Total assets | | $ | 284,538 | | $ | — | | $ | 284,538 | | $ | — | |
Liabilities | | | | | | | | | | | | | |
Interest rate swap agreements | | | 1,004 | | | — | | | 1,004 | | | — | |
Total liabilities | | $ | 1,004 | | $ | — | | $ | 1,004 | | $ | — | |
Investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participant with whom we have historically transacted both purchases and sales of investment securities. Prices obtained from these sources include market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. More information regarding our investment securities can be found in Note 5 to these consolidated financial statements.
The interest rate swaps are reported at their fair value utilizing Level 2 inputs from third parties. The fair value of our interest rate swaps are determined using prices obtained from a third party advisor. The fair value measurement of the interest rate swap is determined by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates derived from observed market interest rate curves.
There were no transfers between Level 1 and Level 2 during the year ended December 31, 2016 or 2015. There were no Level 3 assets measured at fair value on a recurring basis during the year ended December 31, 2016 or 2015.
Financial instruments on a non-recurring basis
Certain financial assets are also measured at fair value on a non-recurring basis, however they were not material at December 31, 2016 or 2015. These financial assets include impaired loans and OREO.
Fair value of financial instruments
The fair value of Merchants’ financial instruments as of December 31, 2016 are summarized in the table below:
| | | | | | | | | | | | | | | | |
| | Carrying | | | | | | | | | | | | | |
(In thousands) | | Amount | | Fair Value | | Level 1 | | Level 2 | | Level 3 | |
Cash and cash equivalents | | $ | 82,953 | | $ | 82,953 | | $ | 82,953 | | $ | — | | $ | — | |
Securities available for sale | | | 333,998 | | | 333,998 | | | — | | | 333,998 | | | — | |
Securities held to maturity | | | 85,694 | | | 85,749 | | | — | | | 85,749 | | | — | |
FHLB stock | | | 4,976 | | | N/A | | | N/A | | | N/A | | | N/A | |
Loans, net of allowance for loan losses | | | 1,501,550 | | | 1,484,718 | | | — | | | — | | | 1,484,718 | |
Interest rate swap agreement | | | 422 | | | 422 | | | — | | | 422 | | | — | |
Accrued interest receivable | | | 4,722 | | | 4,722 | | | — | | | 1,232 | | | 3,490 | |
Total | | $ | 2,014,315 | | $ | 1,992,562 | | $ | 82,953 | | $ | 421,401 | | $ | 1,488,208 | |
Deposits | | $ | 1,527,470 | | $ | 1,526,626 | | $ | 1,328,262 | | $ | 198,364 | | $ | — | |
Short-term borrowings | | | 40,000 | | | 40,000 | | | — | | | 40,000 | | | — | |
Securities sold under agreement to repurchase | | | 312,118 | | | 312,019 | | | — | | | 312,019 | | | — | |
Other long-term debt | | | 3,651 | | | 3,600 | | | — | | | 3,600 | | | — | |
Junior subordinated debentures issued to unconsolidated subsidiary trust | | | 20,619 | | | 14,775 | | | — | | | 14,775 | | | — | |
Interest rate swap agreement | | | 194 | | | 194 | | | — | | | 194 | | | — | |
Accrued interest payable | | | 110 | | | 110 | | | 11 | | | 99 | | | — | |
Total | | $ | 1,904,162 | | $ | 1,897,324 | | $ | 1,328,273 | | $ | 569,051 | | $ | — | |
The fair value of Merchants’ financial instruments as of December 31, 2015 are summarized in the table below:
| | | | | | | | | | | | | | | | |
| | Carrying | | | | | | | | | | | | | |
(In thousands) | | Amount | | Fair Value | | Level 1 | | Level 2 | | Level 3 | |
Cash and cash equivalents | | $ | 150,183 | | $ | 150,183 | | $ | 150,183 | | $ | — | | $ | — | |
Securities available for sale | | | 283,454 | | | 283,454 | | | — | | | 283,454 | | | — | |
Securities held to maturity | | | 119,674 | | | 120,093 | | | — | | | 120,093 | | | — | |
FHLB stock | | | 3,797 | | | N/A | | | N/A | | | N/A | | | N/A | |
Loans, net of allowance for loan losses | | | 1,402,240 | | | 1,397,877 | | | — | | | — | | | 1,397,877 | |
Interest rate swap agreement | | | 1,084 | | | 1,084 | | | — | | | 1,084 | | | — | |
Accrued interest receivable | | | 4,374 | | | 4,374 | | | — | | | 1,085 | | | 3,289 | |
Total | | $ | 1,964,806 | | $ | 1,957,065 | | $ | 150,183 | | $ | 405,716 | | $ | 1,401,166 | |
Deposits | | $ | 1,551,439 | | $ | 1,551,046 | | $ | 1,296,867 | | $ | 254,179 | | $ | — | |
Short-term borrowings | | | — | | | — | | | — | | | — | | | — | |
Securities sold under agreement to repurchase | | | 286,639 | | | 286,586 | | | — | | | 286,586 | | | — | |
Other long-term debt | | | 5,238 | | | 5,191 | | | — | | | 5,191 | | | — | |
Junior subordinated debentures issued to unconsolidated subsidiary trust | | | 20,619 | | | 14,975 | | | — | | | 14,975 | | | — | |
Interest rate swap agreement | | | 1,004 | | | 1,004 | | | — | | | 1,004 | | | — | |
Accrued interest payable | | | 152 | | | 152 | | | 13 | | | 139 | | | — | |
Total | | $ | 1,865,091 | | $ | 1,858,954 | | $ | 1,296,880 | | $ | 562,074 | | $ | — | |
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accrued interest receivable and accrued interest payable approximate fair value. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
The methodologies for other financial assets and financial liabilities are discussed below.
Loans - The fair value for loans is estimated using discounted cash flow analyses, using interest rates and spreads currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
Deposits - The fair value of deposits with no stated maturity, which includes demand, savings, interest bearing checking and money market accounts, is equal to the amount payable on demand resulting in a Level 1 classification. The fair value of variable rate, fixed term certificates of deposit also approximates the carrying amount reported in the consolidated balance sheets. The fair value of fixed rate and fixed term certificates of deposit is estimated using a discounted cash flow method which applies interest rates currently being offered for deposits of similar remaining maturities resulting in a Level 2 classification.
Debt - The fair value of debt is estimated using current market rates for borrowings of similar remaining maturity resulting in a Level 2 classification.
Commitments to Extend Credit and Standby Letters of Credit - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The fair value of commitments to extend credit and standby letters of credit is not material as of December 31, 2016 and 2015.
NOTE 8: PREMISES AND EQUIPMENT
The components of premises and equipment included in the accompanying consolidated balance sheets at December 31, are as follows:
| | | | | | | | | |
| | | | | | | | Estimated | |
| | | | | | | | Useful Lives | |
(In thousands) | | 2016 | | 2015 | | (In years) | |
Land | | $ | 332 | | $ | 332 | | N/A | |
Bank premises | | | 6,799 | | | 6,812 | | 39 | |
Leasehold improvements | | | 10,394 | | | 10,789 | | 5 – 20 | |
Furniture, equipment, and software | | | 20,122 | | | 21,040 | | 3 – 7 | |
Total gross fixed assets | | | 37,647 | | | 38,973 | | | |
Less: accumulated depreciation and amortization | | | 24,569 | | | 23,943 | | | |
Total net fixed assets | | $ | 13,078 | | $ | 15,030 | | | |
Depreciation and amortization expense related to premises and equipment amounted to $1.97 million, $2.11 million and $2.45 million in 2016, 2015 and 2014, respectively.
We occupy certain banking offices under non-cancellable operating lease agreements expiring at various dates over the next 20 years. The majority of leases have multiple options with escalation clauses for increases associated with the cost of living or other variable expenses over time. Rent expense on these properties totaled $1.45 million, $1.30 million and $1.32 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Minimum lease payments on these properties subsequent to December 31, 2016 are as follows:
| | | | |
(In thousands) | | Amount | |
2017 | | $ | 1,356 | |
2018 | | | 1,673 | |
2019 | | | 1,352 | |
2020 | | | 1,246 | |
2021 | | | 677 | |
Thereafter | | | 3,002 | |
Total | | $ | 9,306 | |
We entered into a sale leaseback arrangement for our principal office in South Burlington, Vermont, in June 2008. The deferred gain on the sale leaseback transaction resulted in a $423 thousand offset to rent expense per year through 2017 and $212 thousand in 2018. The deferred gain included in other liabilities totaled $635 thousand and $1.06 million at December 31, 2016 and 2015, respectively.
We entered into a sale leaseback arrangement for one of our branch locations in Burlington, Vermont in December 2013. The deferred gain on the sale leaseback transaction resulted in a $93 thousand offset to rent expense per year through 2023. The deferred gain included in other liabilities totaled $654 thousand and $747 thousand at December 31, 2016 and 2015.
NOTE 9: TIME DEPOSITS
Time deposits that meet or exceed the FDIC Insurance limit of $250,000 at year-end 2016 and 2015 were $32.36 million and $43.34 million, respectively.
Scheduled maturities of time deposits for the next five years were as follows:
| | | | |
(In thousands) | | | Amount | |
2017 | | $ | 132,326 | |
2018 | | | 30,860 | |
2019 | | | 10,686 | |
2020 | | | 14,904 | |
2020 | | | 10,432 | |
Total time deposits | | $ | 199,208 | |
NOTE 10: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER SHORT-TERM DEBT
Securities sold under agreements to repurchase mature daily. Securities sold under agreements to repurchase are collateralized by mortgage-backed securities and collateralized mortgage-backed obligations. We maintain effective control over the securities underlying the agreements.
As of December 31, 2016, we could borrow up to $55 million in overnight funds through unsecured borrowing lines established with correspondent banks. In addition, we have established both overnight and longer term lines of credit with the FHLB. These borrowings are secured by residential mortgage loans. At December 31, 2016, we pledged loans with a carrying value of $363.55 million which carries a $256.98 million borrowing capacity at the FHLB, less borrowings and letters of credit of $62.06 million, resulting in year-end capacity of $194.92 million. At December 31, 2015, we pledged loans with a carrying value of $371.58 million, which carried a $262.96 million borrowing capacity at the FHLB, less borrowings and letters of credit of $17.81 million, resulting in year-end capacity of $245.15 million. We also have the ability to borrow through the use of repurchase agreements, collateralized by our investments, with certain approved counterparties.
The following table provides certain information regarding other borrowed funds for each of the years ended December 31, 2016, 2015 and 2014:
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
FHLB and other short-term borrowings | | | | | | | | | | |
Amount outstanding at year end | | $ | 40,000 | | $ | — | | $ | — | |
Maximum amount outstanding during the year | | | 110,000 | | | 63,000 | | | 18,900 | |
Average amount outstanding during the year | | | 25,425 | | | 3,953 | | | 212 | |
Weighted average-rate during the year | | | 0.48 | % | | 0.33 | % | | 0.31 | % |
Weighted average rate at year-end | | | 0.77 | % | | — | % | | — | % |
Securities sold under agreement to repurchase | | | | | | | | | | |
Amount outstanding at year end | | $ | 312,118 | | $ | 286,639 | | $ | 258,464 | |
Maximum amount outstanding during the year | | | 334,023 | | | 318,788 | | | 292,692 | |
Average amount outstanding during the year | | | 247,610 | | | 226,913 | | | 192,868 | |
Weighted average-rate during the year | | | 0.18 | % | | 0.22 | % | | 0.18 | % |
Weighted average rate at year-end | | | 0.20 | % | | 0.19 | % | | 0.26 | % |
The following table presents the contractual maturity of our secured borrowings and class of collateral pledged at December 31, 2016:
| | | | | | | | | | | | | | | | |
| | Remaining Contractual Maturity of the Agreements | |
| | Overnight and | | | | | | | | Greater Than | | | | |
(In thousands) | | Continuous | | Up to 30 Days | | 30-90 Days | | 90 Days | | Total | |
Repurchase Agreements | | | | | | | | | | | | | | | | |
Available for Sale: | | | | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 24,207 | | $ | — | | $ | — | | $ | — | | $ | 24,207 | |
U.S. GSEs | | | 51,847 | | | — | | | — | | | — | | | 51,847 | |
FHLB Obligations | | | 59,505 | | | — | | | — | | | — | | | 59,505 | |
Agency MBSs | | | 44,736 | | | — | | | — | | | — | | | 44,736 | |
Agency CMBSs | | | 21,662 | | | — | | | — | | | — | | | 21,662 | |
Agency CMOs | | | 40,007 | | | — | | | — | | | — | | | 40,007 | |
Total Available for Sale | | $ | 241,964 | | $ | — | | $ | — | | $ | — | | $ | 241,964 | |
| | | | | | | | | | | | | | | | |
(In thousands) | | | | | | | | | | | | | | | | |
Held to Maturity: | | | | | | | | | | | | | | | | |
U.S. Agency Obligations | | $ | 16,646 | | $ | — | | $ | — | | $ | — | | $ | 16,646 | |
Agency CMOs | | | 53,508 | | | — | | | — | | | — | | | 53,508 | |
Total Held to Maturity | | $ | 70,154 | | $ | — | | $ | — | | $ | — | | $ | 70,154 | |
The following table presents the contractual maturity of our secured borrowings and class of collateral pledged at December 31, 2015:
| | | | | | | | | | | | | | | | |
| | Remaining Contractual Maturity of the Agreements | |
| | Overnight and | | | | | | | | Greater Than | | | | |
(In thousands) | | Continuous | | Up to 30 Days | | 30-90 Days | | 90 Days | | Total | |
Repurchase Agreements | | | | | | | | | | | | | | | | |
Available for Sale: | | | | | | | | | | | | | | | | |
U.S. Treasury Obligations | | $ | 23,902 | | $ | — | | $ | — | | $ | — | | $ | 23,902 | |
U.S. GSEs | | | 21,719 | | | — | | | — | | | — | | | 21,719 | |
FHLB Obligations | | | 42,681 | | | — | | | — | | | — | | | 42,681 | |
Agency MBSs | | | 49,162 | | | — | | | — | | | 430 | | | 49,592 | |
Agency CMBSs | | | 14,957 | | | — | | | — | | | — | | | 14,957 | |
Agency CMOs | | | 33,112 | | | — | | | — | | | — | | | 33,112 | |
Total Available for Sale | | $ | 185,533 | | $ | — | | $ | — | | $ | 430 | | $ | 185,963 | |
| | | | | | | | | | | | | | | | |
(In thousands) | | | | | | | | | | | | | | | | |
Held to Maturity: | | | | | | | | | | | | | | | | |
U.S. Agency Obligations | | $ | 14,524 | | $ | — | | $ | — | | $ | — | | $ | 14,524 | |
Agency CMOs | | | 66,889 | | | — | | | — | | | — | | | 66,889 | |
Agency MBSs | | | 19,263 | | | — | | | — | | | — | | | 19,263 | |
Total Held to Maturity | | $ | 100,676 | | $ | — | | $ | — | | $ | — | | $ | 100,676 | |
The fair value of securities pledged to secure repurchase agreements may decline. The Company manages this risk by having a policy to pledge securities valued greater than the gross outstanding balance of repurchase agreements. Securities sold under agreements to repurchase are secured by securities with a carrying value of $312.23 million and $287.27 million at December 31, 2016 and 2015, respectively.
NOTE 11: LONG-TERM DEBT
Long-term debt consisted of the following at December 31, 2016 and 2015:
| | | | | | | |
(In thousands) | | 2016 | | 2015 | |
Federal Home Loan Bank Amortizing Notes, payable through March 2029, Rates ranging from 1.50% to 2.50% | | | 2,151 | | | 2,237 | |
Federal Home Loan Bank Advance, maturing November 2017, rate of 1.35% at December 31, 2016 and maturities ranging from January 2016 to November 2017 and rates ranging from 0.80% to 1.35% at December 31, 2015 | | | 1,500 | | | 3,001 | |
Total | | $ | 3,651 | | $ | 5,238 | |
There were no prepayment penalties incurred during 2016, 2015 or 2014.
Contractual maturities and amortization of long-term debt subsequent to December 31, 2016, are as follows:
| | | | |
(In thousands) | | Amount | |
2017 | | $ | 1,587 | |
2018 | | | 89 | |
2019 | | | 91 | |
2020 | | | 92 | |
2021 | | | 94 | |
2022 and after | | | 1,698 | |
Total due | | $ | 3,651 | |
NOTE 12: TRUST PREFERRED SECURITIES
On December 15, 2004, we closed our private placement of an aggregate of $20.62 million of trust preferred securities. The placement occurred through a newly formed Delaware statutory trust affiliate, MBVT Statutory Trust I (the “Trust”), as part of a pooled trust preferred program. The Trust was formed for the sole purpose of issuing capital securities which are non-voting. We own all of the common securities of the Trust. The proceeds from the sale of the capital securities were loaned to us under subordinated debentures issued to the Trust. The debentures are the only asset of the Trust and payments under the debentures are the sole revenue of the Trust. Our primary source of funds to pay interest on the debentures held by the Trust is current dividends from our principal subsidiary, Merchants Bank. Accordingly, our ability to service the debentures is dependent upon the continued ability of Merchants Bank to pay dividends to us.
These hybrid securities currently qualify as regulatory capital, up to certain regulatory limits. At the same time they are considered debt for tax purposes, and as such, interest payments are fully deductible. The trust preferred securities total $20.62 million, and carried a fixed rate of interest through December 2009 at which time the rate became variable and adjusts quarterly at three month LIBOR plus 1.95%. We entered into an interest rate swap arrangement for $10 million of our trust preferred issuance which was effective beginning on December 15, 2009. The swap fixed the rate on $10 million at 5.23% and expired on December 15, 2016. The impact on net interest income for 2016, 2015 and 2014 from the interest expense on the trust preferred securities was $788 thousand, $747 thousand and $752 thousand per year, respectively. The trust preferred securities mature on December 31, 2034, and are redeemable without penalty at our option, subject to prior approval by the FRB.
NOTE 13: INCOME TAXES
The components of the provision for income taxes were as follows for the years ended December 31, 2016, 2015 and 2014:
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Current | | $ | 708 | | $ | 1,386 | | $ | 3,707 | |
Deferred | | | 3,981 | | | 1,799 | | | (175) | |
Provision for income taxes | | $ | 4,689 | | $ | 3,185 | | $ | 3,532 | |
Not included in the above table is the income tax impact associated with the unrealized gain or loss on securities available for sale and the income tax impact associated with the funded status of the pension plan, which are recorded directly in stockholders’ equity as a component of accumulated other comprehensive loss.
The tax effects of temporary differences and tax credits that give rise to deferred tax assets and liabilities at December 31, 2016 and 2015 are presented below:
| | | | | | | |
(In thousands) | | 2016 | | 2015 | |
Deferred tax assets: | | | | | | | |
Allowance for loan losses | | $ | 4,900 | | $ | 4,497 | |
Postretirement benefit obligation | | | 2,045 | | | 1,986 | |
Deferred compensation | | | 1,454 | | | 1,466 | |
Accrued expenses | | | 333 | | | 565 | |
Organizational/start-up expenses | | | 376 | | | 434 | |
Capital loss carryforward | | | 89 | | | 206 | |
Interest rate swap | | | — | | | 83 | |
Qualified school bond tax credits | | | 921 | | | — | |
Affordable housing/other tax credits | | | 74 | | | — | |
Other | | | 595 | | | 649 | |
Net operating loss | | | 356 | | | 606 | |
Investment in real estate limited partnerships, net | | | — | | | 158 | |
Unrealized loss on securities available for sale | | | 295 | | | — | |
Unrealized loss on securities held to maturity | | | 755 | | | 1,205 | |
Total deferred tax assets | | $ | 12,193 | | $ | 11,855 | |
Deferred tax liabilities: | | | | | | | |
Loan mark-to-market adjustment | | $ | (8,218) | | $ | (3,410) | |
Installment sales | | | (224) | | | (128) | |
Unrealized gain on securities available for sale | | | — | | | (93) | |
Depreciation | | | (743) | | | (998) | |
Core deposit intangible | | | (403) | | | (471) | |
Other | | | (206) | | | (227) | |
Accrued pension cost | | | (3,200) | | | (3,181) | |
Total deferred tax liabilities | | $ | (12,994) | | $ | (8,508) | |
Net deferred tax (liability) asset | | $ | (801) | | $ | 3,347 | |
In assessing the realizability of our total deferred tax assets, Management considers whether it is more likely than not that some portion or all of those assets will not be realized. Based upon Management’s consideration of historical and anticipated future pre-tax income, as well as the reversal period for the items giving rise to the deferred tax assets and liabilities, a valuation allowance for deferred tax assets was not considered necessary at December 31, 2016 and 2015. However, factors beyond management’s control, such as the general state of the economy, can affect future levels of taxable income and there can be no assurances that sufficient taxable income will be generated to fully realize the deferred tax assets in the future.
The following is a reconciliation of the federal income tax provision, calculated at the statutory rate of 35%, to the recorded provision for income taxes:
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Applicable statutory Federal income tax | | $ | 6,753 | | $ | 5,452 | | $ | 5,402 | |
Increase (reduction) in taxes resulting from: | | | | | | | | | | |
Low Income Housing Projects | | | 1,206 | | | 779 | | | 858 | |
Tax-exempt income | | | (823) | | | (736) | | | (729) | |
Tax credits | | | (2,444) | | | (1,771) | | | (1,936) | |
Bank owned life insurance | | | (71) | | | (83) | | | (107) | |
State tax | | | 70 | | | 17 | | | — | |
Other, net | | | (2) | | | (473) | | | 44 | |
Provision for income taxes | | $ | 4,689 | | $ | 3,185 | | $ | 3,532 | |
We have not identified any of our tax positions that contain significant uncertainties. Housing tax credits are recognized using the flow through method. We are subject to federal and state income tax examinations for years after December 31, 2013.
The State of Vermont assesses a franchise tax for banks in lieu of income tax. The franchise tax is assessed based on deposits. Vermont franchise taxes, net of state credits amounted to approximately $1.59 million, $1.50 million and $1.43 million in 2016, 2015 and 2014, respectively, which is included as noninterest expense in the accompanying consolidated statements of income.
NOTE 14: EMPLOYEE BENEFIT PLANS
Pension Plan
Prior to January 1995, we maintained a noncontributory defined benefit plan (the “Pension Plan”) covering all eligible employees. During 1995, the Pension Plan was curtailed. Accordingly, all accrued benefits were fully vested and no additional years of service or age will be accrued.
We recognize the overfunded or underfunded status of a single employer defined benefit post retirement plan as an asset or liability on the consolidated balance sheets and recognize changes in the funded status in comprehensive income in the year in which the change occurred.
The following tables provide a reconciliation of the changes in the Pension Plan’s benefit obligations and fair value of assets over the two year period ending December 31, 2016, and a statement of the funded status as of December 31 of both years:
| | | | | | | |
(In thousands) | | 2016 | | 2015 | |
Reconciliation of benefit obligation | | | | | | | |
Benefit obligation at beginning of year | | $ | 10,708 | | $ | 11,556 | |
Service cost including expenses | | | 59 | | | 53 | |
Interest cost | | | 469 | | | 442 | |
Actuarial loss (gain) | | | 94 | | | (735) | |
Benefits paid and expected expenses | | | (657) | | | (608) | |
Benefit obligation at year-end | | $ | 10,673 | | $ | 10,708 | |
Reconciliation of fair value of plan assets | | | | | | | |
Fair value of plan assets at beginning of year | | $ | 14,157 | | $ | 15,350 | |
Actual return (loss) on plan assets | | | 487 | | | (579) | |
Employer contributions | | | — | | | — | |
Benefits paid and actual expenses | | | (655) | | | (614) | |
Fair value of plan assets at year-end | | $ | 13,989 | | $ | 14,157 | |
Funded status at year end | | $ | 3,316 | | $ | 3,449 | |
We had no minimum required contribution for 2016.
The accumulated benefit obligation is equal to the projected benefit obligation and was $10.67 million and $10.71 million at December 31, 2016 and 2015, respectively. Amounts recognized in accumulated other comprehensive income for net actuarial losses totaled $5.9 million and $5.7 million at December 31, 2016 and 2015, respectively.
The following tables summarize the components of net periodic benefit cost and other changes in Pension Plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31, 2016, 2015 and 2014, respectively:
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Interest cost | | $ | 469 | | $ | 442 | | $ | 464 | |
Expected return on plan assets | | | (967) | | | (1,052) | | | (1,059) | |
Service costs | | | 59 | | | 53 | | | 44 | |
Net loss amortization | | | 437 | | | 377 | | | 137 | |
Net periodic pension benefit | | $ | (2) | | $ | (180) | | $ | (414) | |
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Net loss | | $ | 571 | | $ | 902 | | $ | 2,606 | |
Net loss amortization | | | (437) | | | (377) | | | (137) | |
Total recognized in other comprehensive income | | $ | 134 | | $ | 525 | | $ | 2,469 | |
Total recognized in net periodic pension cost and other comprehensive income | | $ | 132 | | $ | 345 | | $ | 2,055 | |
The estimated net actuarial loss for the Pension Plan that will be amortized from accumulated other comprehensive income into net periodic pension cost for 2017 is $441 thousand.
The following table summarizes the assumptions used to determine the benefit obligations and net periodic benefit costs for the years ended December 31, 2016, 2015 and 2014:
| | | | | | | |
| | 2016 | | 2015 | | 2014 | |
Benefit obligations | | | | | | | |
Discount rate | | 4.34 | % | 4.48 | % | 3.97 | % |
Net periodic benefit cost | | | | | | | |
Discount rate | | 4.48 | % | 3.97 | % | 4.98 | % |
Expected long-term return on plan assets | | 7.00 | % | 7.00 | % | 7.00 | % |
The discount rate reflects the rates at which pension benefits could be effectively settled. We look to rates of return on high-quality fixed income investments currently available and expected to be available during the period of maturity of the pension benefits. Consideration was given to the rates that would be used to settle plan obligations as of December 31, 2016 and to the rates of other indices at year-end. Our actuary constructed a hypothetical high quality bond portfolio with cash flows that match the expected monthly benefit payments under the pension plan and calculated a discount rate based upon that portfolio. The expected long-term rate of return on plan assets reflects long-term earnings expectations on existing plan assets and those contributions expected to be received during the current plan year. In estimating that rate, appropriate consideration was given to historical returns earned by plan assets in the fund and the rates of return expected to be available for reinvestment. Rates of return were adjusted to reflect current capital market assumptions and changes in investment allocations, if any.
Effective June 1, 2016, SageView Advisory Group replaced our Trust division as the Pension Plan’s investment manager. During 2016, the investment objectives of the Pension Plan were modified from those intended to provide both income and capital appreciation to one that provides a level of current income consistent with the preservation of capital while meeting the current and future spending needs of the Pension Plan and minimizing the risks of investing. The investment target of the Pension Plan is to achieve a total annual rate of return in excess of the change in the Consumer Price Index for the aggregate investments of the Pension Plan evaluated over a period of five years. A certain amount of risk must be assumed to achieve the Pension Plan's investment target rate of return. During 2016, the Pension Plan transitioned to a multi-sector portfolio of low risk fixed income instruments of varying maturities from a balanced portfolio of equity and fixed income securities with a 5-15 year time horizon and was considered moderate risk. During 2016, the portfolio strategy followed by the Pension Plan was transitioned to a baseline allocation of 100% fixed income securities. In 2015, the portfolio strategy had a baseline allocation of 60% stock and 40% fixed income securities, but the investment manager could allocate funds within certain specified ranges. The range for equities was 35% to 75% and for fixed income securities, the range was 25% to 60%. The allocation among categories varied from the baseline allocation when opportunities were identified to improve returns and/or reduce risk.
The fair value of Pension Plan assets at December 31, 2016 by asset category are as follows:
| | | | | | | | | | | | | |
| | | | | Fair Value Measurements at Reporting Date Using: | |
| | | | | Quoted Prices in | | | | | |
| | | | | Active Markets for | | Significant Other | | Significant | |
| | | | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
(In thousands) | | Total | | (Level 1) | | (Level 2) | | (Level 3) | |
Cash | | $ | 19 | | $ | 19 | | $ | — | | $ | — | |
Money Market Funds | | | 888 | | | 888 | | | — | | | — | |
Fixed Income: | | | | | | | | | | | | | |
Taxable Bond Mutual Funds | | | 13,082 | | | 13,082 | | | — | | | — | |
Total | | $ | 13,989 | | $ | 13,989 | | $ | — | | $ | — | |
The fair value of Pension Plan assets at December 31, 2015 by asset category are as follows:
| | | | | | | | | | | | | |
| | | | | Fair Value Measurements at Reporting Date Using: | |
| | | | | Quoted Prices in | | | | Significant | |
| | | | | Active Markets for | | Significant Other | | Unobservable | |
| | | | | Identical Assets | | Observable Inputs | | Inputs | |
(In thousands) | | Total | | (Level 1) | | (Level 2) | | (Level 3) | |
Cash | | $ | 4 | | $ | 4 | | $ | — | | $ | — | |
Money Market Funds | | | 403 | | | 403 | | | — | | | — | |
Equity Securities: | | | | | | | | | | | | | |
Large Cap Equity Mutual Funds | | | 2,831 | | | 2,831 | | | — | | | — | |
Small Cap Equity Mutual Funds | | | 94 | | | 94 | | | — | | | — | |
Global Equity Mutual Funds | | | 882 | | | 882 | | | — | | | — | |
International Equity Mutual Funds | | | 3,019 | | | 3,019 | | | — | | | — | |
Absolute Return Funds | | | 1,305 | | | 1,305 | | | — | | | — | |
EFT - International Equity | | | 729 | | | 729 | | | — | | | — | |
Fixed Income: | | | | | | | | | | | | | |
Taxable Bond Mutual Funds | | | 4,890 | | | 4,890 | | | — | | | — | |
Total | | $ | 14,157 | | $ | 14,157 | | $ | — | | $ | — | |
Large Cap Equity Mutual Funds: Funds in this category have a diversified, index and actively managed multi-manager approach to investing in domestic stocks. There are multiple fund managers that are included in the portfolio with multiple categories of industries being invested in by the managers in mid-size, to large-size publicly traded firms with a majority of funds invested in large companies.
Small Cap Equity Mutual Funds: Funds in this category have a diversified, active fund manager approach to investing in small company domestic stocks.
Global Equity Mutual Funds: Funds in this category are diversified, active global equity funds that have exposure to both large company domestic stocks as well as large company developed country international stocks.
International Equity Mutual Funds: Funds in this category have a diversified, index and actively managed multi-manager approach to investing in international developed country stocks and emerging market stocks.
Absolute Return Funds: Funds in this category are invested in a diversified portfolio of stocks, preferred stocks, convertible bonds, and bonds. The portfolio manager’s objective is to take advantage of inefficiencies in the stock and bond markets to capture a return on investment by using specialized trading strategies. The goal of these trading strategies is to provide investors with consistent, positive returns that are not necessarily correlated to the general equity markets.
International Bond Mutual Funds: Funds in this category have a diversified, actively managed approach to investing in international bonds, with an average credit rating for the majority of the portfolio being investment grade.
Taxable Bond Mutual Funds: Funds in this category have a diversified, actively managed multi-manager approach to investing in domestic and international bonds. A majority of funds are invested in domestic bonds with an average credit rating for the majority of the portfolio being investment grade.
The following table summarizes the estimated future benefit payments expected to be paid under the Pension Plan:
| | | | |
| | Pension | |
(In thousands) | | Benefits | |
2017 | | $ | 632 | |
2018 | | | 676 | |
2019 | | | 682 | |
2020 | | | 704 | |
2021 | | | 709 | |
Following five years | | | 3,580 | |
The estimated future benefit payments expected to be paid under the Pension Plan are based on the same assumptions used to measure our benefit obligation at December 31, 2016. No future service estimates were included due to the frozen status of the Pension Plan.
401(k) Employee Stock Ownership Plan
Under the terms of our 401(k) Employee Stock Ownership Plan (“401(k)”) eligible employees are entitled to contribute up to 75% of their compensation, subject to IRS limitations, to the 401(k), and we contribute a percentage of the amounts contributed by the employees as authorized by Merchants’ Bank’s Board of Directors. We contributed approximately 48%, 46% and 48% of the amounts contributed by the employees in 2016, 2015 and 2014, respectively.
Summary of Expense
A summary of expense relating to our various employee benefit plans for each of the years in the three year period ended December 31, 2016 is as follows:
| | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Pension plan | | $ | (2) | | $ | (180) | | $ | (414) | |
401(k) | | | 662 | | | 573 | | | 585 | |
Total | | $ | 660 | | $ | 393 | | $ | 171 | |
NOTE 15: STOCK-BASED COMPENSATION PLANS
Merchants has established stock based compensation plans for directors and for certain employees. The Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan (the “Plan”) allows us to grant stock options and restricted stock grants to certain employees. The Plan allows for the issuance of up to 600,000 shares of stock. As of December 31, 2016, 442,789 shares remain available for future grants under the Plan.
The Merchants Bancshares, Inc. and Subsidiaries Amended and Restated 2008 Compensation Plan for Non-Employee Directors and Trustees (“Deferred Compensation Plan”) allows for the issuance of up to 150,000 shares of stock. As of December 31, 2016, 66,583 shares were issued with 83,417 shares available for future issuance under the Deferred Compensation Plan. Additionally, as of December 31, 2016, 222,217 shares were issued under previous non-employee directors and trustees compensation plans that are now expired.
The fair value of stock option and restricted stock awards, measured at the grant date are amortized to compensation expense on a straight-line basis over the vesting period. The total compensation cost related to stock option awards and restricted stock awards was $374 thousand, $36 thousand and $119 thousand for 2016, 2015 and 2014, respectively. Compensation cost related to stock option and restricted stock awards is included in salary expense in the accompanying consolidated statements of income. There is no remaining compensation expense relating to stock option grants. Remaining
compensation expense related to current outstanding restricted stock awards is $132 thousand, which will be recognized as of the date of the pending merger.
Deferred Compensation Plan for Non-Employee Directors and Trustees
Under the terms of the Deferred Compensation Plan participating directors can elect to have all, or a specified percentage, of their director’s fees for a given year paid in the form of cash or deferred in the form of restricted shares of Merchants’ common stock. These shares are held in a rabbi trust and are considered outstanding for purposes of computing earnings per share. Directors who elect to have their compensation deferred are credited with a number of shares of Merchants’ common stock equal in value to the amount of fees deferred. The participating director may not sell, transfer or otherwise dispose of these shares prior to distribution. With respect to shares of common stock issued or otherwise transferred to a participating director, the participating director will have the right to receive dividends or other distributions thereon. Deferred director’s fees are recognized as an expense in the year incurred.
Restricted Stock
Restricted stock provides grantees with rights to shares of common stock upon completion of a service period. During the service period, all shares are considered outstanding and dividends are paid on the restricted stock. We made a grant of 9,106, 3,521 and 7,120 restricted shares in 2016, 2015 and 2014, respectively. The shares typically vest three years after the grant date. Due to the pending merger, Merchants accelerated the vesting date for the 2014, 2015 and 2016 grant years for select individuals. The grant date fair value of restricted stock granted during 2016, 2015 and 2014 was $30.73, $29.85 per share and $28.60 per share, respectively. A summary of Merchants’ restricted stock awards is as follows:
| | | | | | |
| | | | Weighted Average Grant | |
| | Shares | Date Fair Value | |
Non-Vested Shares at January 1, 2016 | | 8,648 | | $ | 29.19 | |
Granted | | 9,106 | | | 30.73 | |
Vested | | (7,964) | | | 30.19 | |
Forfeited | | (2,433) | | | 29.31 | |
Non-Vested Shares at December 31, 2016 | | 7,357 | | $ | 30.08 | |
The total fair value of shares vested during the year ending December 31, 2016, 2015, and 2014 was $402 thousand, $111 thousand, and $282 thousand, respectively.
Stock Options
Stock options were granted at 100% of fair market value and vest over three years. The last option granted was in May 2010. The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model that requires Merchants to develop estimates for assumptions used in the model. The Black-Scholes valuation model uses the following assumptions: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed based on historical volatility of our stock. We use historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date. The dividend yield represents the expected dividends on our stock.
A summary of Merchants’ stock option plan as of December 31, 2016, 2015 and 2014 and changes during the years then ended are as follows, with numbers of shares in thousands:
| | | | | | | | | | | | | | | | |
| | 2016 | | 2015 | | 2014 | |
| | | | Weighted | | | | Weighted | | | | Weighted | |
| | | | Average | | | | Average | | | | Average | |
| | Number | | Exercise | | Number | | Exercise | | Number | | Exercise | |
| | of | | Price | | of | | Price | | of | | Price | |
| | Shares | | Per Share | | Shares | | Per Share | | Shares | | Per Share | |
Options outstanding, beginning of year | | 39 | | $ | 22.43 | | 82 | | $ | 23.00 | | 88 | | $ | 22.95 | |
Granted | | — | | | — | | — | | | — | | — | | | — | |
Exercised | | 13 | | | 22.30 | | 43 | | | 23.52 | | 6 | | | 22.07 | |
Forfeited | | — | | | — | | — | | | — | | — | | | — | |
Expired | | — | | | — | | — | | | — | | — | | | — | |
Options outstanding, end of year | | 26 | | $ | 22.50 | | 39 | | $ | 22.43 | | 82 | | $ | 23.00 | |
Options exercisable | | 26 | | $ | 22.50 | | 39 | | $ | 22.43 | | 82 | | $ | 23.00 | |
As of December 31, 2016, there were options outstanding within the following ranges: 26 thousand at an exercise price within the range of $22.07 to $22.93.
The total intrinsic value of options exercised was $144 thousand, $328 thousand and $41 thousand for the three years ended December 31, 2016, 2015 and 2014, respectively. We generally use shares held in treasury for option exercises. Options exercisable at December 31, 2016 had an intrinsic value of $841 thousand and expire upon the closing date of the merger with Community. All options outstanding at December 31, 2016 were exercised during February 2017. The total cash received from employees, net of withholding taxes, as a result of employee stock option exercises was $10 thousand, $0 and $0 for the years ended December 31, 2016, 2015 and 2014, respectively. The tax benefit realized as a result of the stock option exercises was approximately $50 thousand, $115 thousand and $14 thousand for the years ended December 31, 2016, 2015 and 2014, respectively.
NOTE 16: EARNINGS PER SHARE
The following table presents reconciliations of the calculations of basic and diluted earnings per share for the years ended December 31, 2016, 2015 and 2014:
| | | | | | | | | | |
| | Twelve Months Ended | |
| | December 31, | |
(In thousands except per share data) | | 2016 | | 2015 | | 2014 | |
Net income | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | |
Weighted average common shares outstanding | | | 6,871 | | | 6,373 | | | 6,326 | |
Dilutive effect of common stock equivalents | | | 25 | | | 13 | | | 18 | |
Weighted average common and common equivalent shares outstanding | | | 6,896 | | | 6,386 | | | 6,344 | |
Basic earnings per common share | | $ | 2.17 | | $ | 1.98 | | $ | 1.92 | |
Diluted earnings per common share | | $ | 2.16 | | $ | 1.98 | | $ | 1.91 | |
Basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per common share were computed by including potentially dilutive shares on the weighted average share count. Anti-dilutive average warrants totaling 34,370 and 2,864 have been excluded from the calculation of diluted EPS for years ended December 31, 2016 and 2015, respectively. There were no anti-dilutive shares excluded in 2014.
NOTE 17: PARENT COMPANY
Merchants Bancshares, Inc.’s (the “Parent Company”) investments in its subsidiaries are recorded using the equity method of accounting. Summarized financial information relative to the Parent Company only balance sheets at December 31, 2016 and 2015, and statements of income and cash flows for each of the years in the three year period ended December
31, 2016, are shown in the following tables. The statement of changes in stockholders' equity for the Parent Company are not reported because they are identical to the consolidated financial statements.
| | | | | | | |
Balance Sheets as of December 31, | | | | | | | |
(In thousands) | | 2016 | | 2015 | |
Assets: | | | | | | | |
Investment in subsidiaries* | | $ | 173,909 | | $ | 167,164 | |
Cash* | | | 2,424 | | | 1,554 | |
Other assets | | | 1,911 | | | 1,009 | |
Total assets | | $ | 178,244 | | $ | 169,727 | |
Liabilities and stockholders’ equity: | | | | | | | |
Other liabilities | | $ | 1,122 | | $ | 1,054 | |
Long term debt | | | 20,619 | | | 20,619 | |
Stockholders’ equity | | | 156,503 | | | 148,054 | |
Total liabilities and stockholders’ equity | | $ | 178,244 | | $ | 169,727 | |
| | | | | | | | | | |
Statements of Income for the Years Ended December 31, | | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Dividends from Merchants Bank* | | $ | 7,695 | | $ | 7,096 | | $ | 7,085 | |
Equity in undistributed earnings of subsidiaries* | | | 9,602 | | | 7,242 | | | 5,857 | |
Other expense, net | | | (3,976) | | | (2,646) | | | (1,276) | |
Benefit from income taxes | | | 1,562 | | | 926 | | | 459 | |
Net income | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | |
| | | | | | | | | | |
Statement of Cash Flows for the Years Ended December 31, | | | | | | | | | | |
(In thousands) | | 2016 | | 2015 | | 2014 | |
Cash flow from operating activities: | | | | | | | | | | |
Net income | | $ | 14,883 | | $ | 12,618 | | $ | 12,125 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | |
Net change in other assets | | | (902) | | | (686) | | | 138 | |
Net change in other liabilities | | | 68 | | | 444 | | | (67) | |
Equity in undistributed earnings of subsidiaries* | | | (9,602) | | | (7,242) | | | (5,857) | |
Net cash provided by operating activities | | | 4,447 | | | 5,134 | | | 6,339 | |
Cash flows from financing activities: | | | | | | | | | | |
Tax benefit from exercises of stock options | | | — | | | 115 | | | 14 | |
Cash dividends paid | | | (7,695) | | | (7,096) | | | (7,167) | |
Other, net | | | 4,118 | | | 1,204 | | | 214 | |
Net cash used in financing activities | | | (3,577) | | | (5,777) | | | (6,939) | |
Increase (decrease) in cash and cash equivalents | | | 870 | | | (643) | | | (600) | |
Cash and cash equivalents at beginning of year | | | 1,554 | | | 2,197 | | | 2,797 | |
Cash and cash equivalents at end of year | | $ | 2,424 | | $ | 1,554 | | $ | 2,197 | |
*Account balances are partially or fully eliminated in consolidation
NOTE 18: COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-Balance Sheet Risk
Merchants 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. These financial instruments primarily include commitments to extend credit and financial guarantees. Such instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the accompanying consolidated balance sheets.
Exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and financial guarantees written is represented by the contractual amount of those instruments. We use the same credit policies in making commitments as we do for on-balance sheet instruments.
The contractual amounts of these financial instruments at December 31, 2016 and 2015 were as follows:
| | | | | | | |
(In thousands) | | 2016 | | 2015 | |
Financial instruments whose contract amounts represent credit risk: | | | | | | | |
Commitments to originate loans | | $ | 31,403 | | $ | 32,133 | |
Unused lines of credit | | | 216,815 | | | 210,304 | |
Standby letters of credit | | | 5,954 | | | 6,296 | |
Equity commitments to affordable housing limited partnerships | | | 3,677 | | | 6,010 | |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitment is expected to expire without being drawn upon, the total commitment amount does not necessarily represent a future cash requirement. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained by us upon extension of credit is based on Management's credit evaluation of the counterparty, and an appropriate amount of real and/or personal property is typically obtained as collateral.
Disclosures are required regarding liability-recognition for the fair value at issuance of certain guarantees. We do not issue any guarantees that would require liability-recognition or disclosure, other than our standby letters of credit. We have issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $5.95 million and $6.30 million at December 31, 2016 and 2015, respectively, and represent the maximum potential future payments we could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Our policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral.
We may enter into commitments to sell loans, which involve market and interest rate risk. There were no such commitments at December 31, 2016 or 2015.
Balances at the Federal Reserve Bank
At December 31, 2016 and 2015, amounts at the Federal Reserve Bank included $32.72 million and $30.52 million, respectively, held to satisfy certain reserve requirements of the Federal Reserve Bank.
Legal Proceedings
We have been named as defendants in various legal proceedings arising from our normal business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of Management, based upon input from counsel on the anticipated outcome of such proceedings, any such liability will not have a material effect on our consolidated financial position.
NOTE 19: ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents changes in accumulated other comprehensive income (loss) by component, net of tax for the year ending December 31, 2016.
| | | | | | | | | | | | | | | | |
| | Unrealized | | Unrealized Gains | | | | | | | | | | |
| | Gains (Losses) | | (Losses) on Securities | | | | | | | | | | |
| | on Securities | | Transferred From | | | | | | | | Accumulated Other | |
| | Available-For- | | Available-For-Sale to | | | | | Interest Rate | | Comprehensive | |
(In thousands) | | Sale | | Held-To-Maturity | | Pension Plan | | Swaps | | Income (Loss) | |
Beginning Balance December 31, 2015 | | $ | 166 | | $ | (2,297) | | $ | (3,737) | | $ | (155) | | $ | (6,023) | |
Other comprehensive (loss) income before reclassifications | | | (717) | | | — | | | (371) | | | 155 | | | (933) | |
Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income | | | — | | | 889 | | | — | | | — | | | 889 | |
Reclassification adjustments for losses reclassified into income | | | — | | | ��� | | | 285 | | | — | | | 285 | |
Net current period other comprehensive (loss) income | | | (717) | | | 889 | | | (86) | | | 155 | | | 241 | |
Balance December 31, 2016 | | $ | (551) | | $ | (1,408) | | $ | (3,823) | | $ | — | | $ | (5,782) | |
The following table presents changes in accumulated other comprehensive income (loss) by component, net of tax for the year ending December 31, 2015.
| | | | | | | | | | | | | | | | |
| | Unrealized | | Unrealized Gains | | | | | | | | | | |
| | Gains (Losses) | | (Losses) on Securities | | | | | | | | | | |
| | on Securities | | Transferred From | | | | | | | | Accumulated Other | |
| | Available-For- | | Available-For-Sale to | | | | | Interest Rate | | Comprehensive | |
(In thousands) | | Sale | | Held-To-Maturity | | Pension Plan | | Swaps | | Income (Loss) | |
Beginning Balance December 31, 2014 | | $ | 1,474 | | $ | (2,816) | | $ | (3,395) | | $ | (311) | | $ | (5,048) | |
Other comprehensive (loss) income before reclassifications | | | (1,308) | | | — | | | (587) | | | 156 | | | (1,739) | |
Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income | | | — | | | 519 | | | — | | | — | | | 519 | |
Reclassification adjustments for losses reclassified into income | | | — | | | — | | | 245 | | | — | | | 245 | |
Net current period other comprehensive (loss) income | | | (1,308) | | | 519 | | | (342) | | | 156 | | | (975) | |
Balance December 31, 2015 | | $ | 166 | | $ | (2,297) | | $ | (3,737) | | $ | (155) | | $ | (6,023) | |
The following table presents changes in accumulated other comprehensive income (loss) by component, net of tax for the year ending December 31, 2014.
| | | | | | | | | | | | | | | | |
| | Unrealized | | Unrealized Gains | | | | | | | | | | |
| | Gains (Losses) | | (Losses) on Securities | | | | | | | | | | |
| | on Securities | | Transferred From | | | | | | | | Accumulated Other | |
| | Available-For- | | Available-For-Sale to | | | | | Interest Rate | | Comprehensive | |
(In thousands) | | Sale | | Held-To-Maturity | | Pension Plan | | Swaps | | Income (Loss) | |
Beginning Balance December 31, 2013 | | $ | (162) | | $ | (3,296) | | $ | (1,790) | | $ | (472) | | $ | (5,720) | |
Other comprehensive income (loss) before reclassifications | | | 1,713 | | | — | | | (1,694) | | | 161 | | | 180 | |
Transfer of securities from available-for-sale to held-to-maturity | | | (8) | | | 8 | | | — | | | — | | | — | |
Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income | | | — | | | 472 | | | — | | | — | | | 472 | |
Reclassification adjustments for losses (gains) reclassified into income | | | (69) | | | — | | | 89 | | | — | | | 20 | |
Net current period other comprehensive (loss) income | | | 1,636 | | | 480 | | | (1,605) | | | 161 | | | 672 | |
Balance December 31, 2014 | | $ | 1,474 | | $ | (2,816) | | $ | (3,395) | | $ | (311) | | $ | (5,048) | |
Details of the reclassification adjustments in the above table for the year ended December 31, 2016 are presented below:
| | | | | | |
| | Amount Reclassified | | | |
Details about Accumulated Other Comprehensive | | from Accumulated | | | |
Income Components | | Other Comprehensive | | Affected Line Item in the Statement Where Net | |
(In thousands) | | Income | | Income is Presented | |
Amortization of defined benefit pension plan | | | | | | |
| | $ | 437 | | Compensation and benefits | |
| | | 437 | | Total before tax | |
| | | (152) | | Provision for income taxes | |
| | $ | 285 | | Net of tax | |
| | | | | | |
Total reclassification adjustments | | $ | 285 | | | |
Details of the reclassification adjustments in the above table for the year ended December 31, 2015 are presented below:
| | | | | | |
| | Amount Reclassified | | | |
Details about Accumulated Other | | from Accumulated | | | |
Comprehensive Income Components | | Other Comprehensive | | Affected Line Item in the Statement Where Net | |
(In thousands) | | Income | | Income is Presented | |
Amortization of defined benefit pension plan | | | | | | |
| | | 377 | | Compensation and benefits | |
| | | 377 | | Total before tax | |
| | | (132) | | Provision for income taxes | |
| | $ | 245 | | Net of tax | |
| | | | | | |
Total reclassification adjustments | | $ | 245 | | | |
Details of the reclassification adjustments in the above table for the year ended December 31, 2014 are presented below:
| | | | | | |
| | Amount Reclassified | | | |
Details about Accumulated Other | | from Accumulated | | | |
Comprehensive Income Components | | Other Comprehensive | | Affected Line Item in the Statement Where Net | |
(In thousands) | | Income | | Income is Presented | |
Unrealized gains on investment securities | | | | | | |
| | $ | (107) | | Net gains on investment securities | |
| | | (107) | | Total before tax | |
| | | 38 | | Provision for income taxes | |
| | $ | (69) | | Net of tax | |
| | | | | | |
Amortization of defined benefit pension plan | | | | | | |
| | | 137 | | Compensation and benefits | |
| | | 137 | | Total before tax | |
| | | (48) | | Provision for income taxes | |
| | $ | 89 | | Net of tax | |
| | | | | | |
Total reclassification adjustments | | $ | 20 | | | |
NOTE 20: REGULATORY CAPITAL REQUIREMENTS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel Committee on Banking Supervision's capital guidelines for U.S. banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer is being phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2016 is 0.625%. The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Management believes as of December 31, 2016, the Company and Bank meet all capital adequacy requirements to which they are subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2016 and 2015, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution's category.
The following table summarizes Merchants’ and Merchants Bank’s capital ratios in comparison to the regulatory requirements:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | To Be Well- | | | | | | | |
| | | | | | | | | | | | | | | Capitalized Under | | Fully Phased-in, |
| | | | | | | | For Capital | | Prompt Corrective | | with Capital |
| | Actual | | Adequacy Purposes | | Action Provisions | | Conservation Buffers |
(In thousands) | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent | | Amount | | | Percent |
As of December 31, 2016 | | | | | | | | | | | | | | | | | | | | | | | | | |
Merchants Bancshares, Inc.: | | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Capital | | $ | 173,945 | | 8.71 | % | | $ | 79,903 | | 4.00 | % | | $ | N/A | | N/A | % | | $ | 79,903 | | (1) | 4.00 | % |
Tier 1 Risk-Based Capital | | | 173,945 | | 14.04 | % | | | 74,360 | | 6.00 | % | | | N/A | | N/A | % | | | 105,344 | | | 8.50 | % |
Total Risk-Based Capital | | | 187,624 | | 15.14 | % | | | 99,147 | | 8.00 | % | | | N/A | | N/A | % | | | 130,130 | | | 10.50 | % |
Common Equity Tier 1 Capital | | | 153,945 | | 12.42 | % | | | 55,770 | | 4.50 | % | | | N/A | | N/A | % | | | 86,754 | | | 7.00 | % |
Merchants Bank: | | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Capital | | $ | 170,732 | | 8.53 | % | | $ | 80,028 | | 4.00 | % | | $ | 100,035 | | 5.00 | % | | $ | 80,028 | | (1) | 4.00 | % |
Tier 1 Risk-Based Capital | | | 170,732 | | 13.72 | % | | | 74,662 | | 6.00 | % | | | 99,550 | | 8.00 | % | | | 105,771 | | | 8.50 | % |
Total Risk-Based Capital | | | 184,411 | | 14.82 | % | | | 99,550 | | 8.00 | % | | | 124,437 | | 10.00 | % | | | 130,659 | | | 10.50 | % |
Common Equity Tier 1 Capital | | | 170,732 | | 13.72 | % | | | 55,997 | | 4.50 | % | | | 80,884 | | 6.50 | % | | | 87,106 | | | 7.00 | % |
As of December 31, 2015 | | | | | | | | | | | | | | | | | | | | | | | | | |
Merchants Bancshares, Inc.: | | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Capital | | $ | 165,799 | | 8.77 | % | | $ | 75,646 | | 4.00 | % | | $ | N/A | | N/A | % | | $ | 75,646 | | (1) | 4.00 | % |
Tier 1 Risk-Based Capital | | | 165,799 | | 14.63 | % | | | 68,005 | | 6.00 | % | | | N/A | | N/A | % | | | 96,341 | | | 8.50 | % |
Total Risk-Based Capital | | | 178,754 | | 15.77 | % | | | 90,673 | | 8.00 | % | | | N/A | | N/A | % | | | 119,009 | | | 10.50 | % |
Common Equity Tier 1 Capital | | | 145,799 | | 12.86 | % | | | 51,004 | | 4.50 | % | | | N/A | | N/A | % | | | 79,339 | | | 7.00 | % |
Merchants Bank: | | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Capital | | $ | 164,446 | | 8.64 | % | | $ | 76,112 | | 4.00 | % | | $ | 95,139 | | 5.00 | % | | $ | 76,112 | | (1) | 4.00 | % |
Tier 1 Risk-Based Capital | | | 164,446 | | 14.44 | % | | | 68,352 | | 6.00 | % | | | 91,136 | | 8.00 | % | | | 96,832 | | | 8.50 | % |
Total Risk-Based Capital | | | 177,401 | | 15.57 | % | | | 91,136 | | 8.00 | % | | | 113,920 | | 10.00 | % | | | 119,616 | | | 10.50 | % |
Common Equity Tier 1 Capital | | | 164,446 | | 14.44 | % | | | 51,264 | | 4.50 | % | | | 74,048 | | 6.50 | % | | | 79,744 | | | 7.00 | % |
(1) Capital conservation buffer does not directly affect the required leverage ratio. Institutions must still maintain the required ratio for capital adequacy purposes.
Capital amounts for Merchants Bancshares, Inc. include $20.62 million in trust preferred securities issued in December 2004. These hybrid securities qualify as Tier 2 regulatory capital up to certain regulatory limits.
NOTE 21: DERIVATIVE FINANCIAL INSTRUMENTS
At December 31, 2015, we had an interest rate swap with a notional amount of $10 million that was designated as a cash flow hedge. The swap was used to convert a portion of the floating rate interest on our trust preferred issuance to a fixed rate of interest. Each quarter we assess the effectiveness of the hedging relationships by comparing the changes in cash flows of the derivative hedging instruments with the changes in cash flows of the designated hedged item. There was no ineffective portion recognized in earnings during 2016, 2015 or 2014. The interest rate swap expired on December 15, 2016, therefore there was no balance reflected in other liabilities in the accompanying consolidated balance sheet at December 31, 2016. The fair value of $(239) thousand was reflected in other liabilities in the accompanying consolidated balance sheets at December 31, 2015.
We have interest rate swaps with a notional amount of $40.73 million with certain commercial customers. In order to minimize our risk, these customer derivatives (pay floating/receive fixed swaps) have been offset with essentially matching interest rate swaps with our counterparty totaling $40.73 million (pay fixed/receive floating swaps). At December 31, 2016, the weighted average receive rate of these interest rate swaps was 2.66%, the weighted average pay rate was 3.85%
and the weighted average maturity was 7.5 years. The fair values of $194 thousand and $194 thousand were reflected in other assets and other liabilities, respectively, in the accompanying consolidated balance sheets at December 31, 2016. At December 31, 2015 the weighted average receive rate of these interest rate swaps was 2.13%, the weighted average pay rate was 3.60% and the weighted average maturity was 10.2 years. The fair values of $765 thousand and $765 thousand were reflected in other assets and other liabilities, respectively, in the accompanying consolidated balance sheets at December 31, 2015. Hedge accounting has not been applied for these derivatives. Since the terms of the swaps with our customer and the other financial institution offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact our results of operations.
We have interest rate swaps with notional amounts totaling $7.48 million at December 31, 2016, and $9.8 million at December 31, 2015, that were designated as fair value hedges of certain fixed rate loans with municipalities. At December 31, 2016, the weighted average receive rate of these interest rate swaps was 2.09%, the weighted average pay rate was 3.11% and the weighted average maturity was 16.5 years. The fair value of $228 thousand at December 31, 2016, was reflected as a reduction to loans and an increase to other assets. At December 31, 2015 the weighted average receive rate of these interest rate swaps was 1.78%, the weighted average pay rate was 3.25% and the weighted average maturity was 16.6 years. The fair value of $319 thousand at December 31, 2015, was reflected as a reduction to loans and an increase to other assets. The ineffective portion of the interest swaps was immaterial and as such, amounts are not recognized in earnings.
We assessed our counterparty risk at December 31, 2016 and determined any credit risk inherent in our derivative contracts was insignificant. Information about the fair value of derivative financial instruments can be found in Note 7 to these consolidated financial statements.
NOTE 22: QUALIFIED AFFORDABLE HOUSING PROJECT INVESTMENTS
The Company invests in qualified affordable housing projects. At December 31, 2016 and 2015, the balance of the investment for qualified affordable housing projects was $6.36 million and $5.69 million. Total unfunded commitments related to the investments in qualified affordable housing projects totaled $3.68 million and $6.01 million at December 31, 2016 and 2015. The Company expects to fulfill these commitments during the year ending 2018.
During the years ended December 31, 2016, 2015 and 2014, the Company recognized amortization expense of $1.66 million, $1.10 million and $1.26 million, respectively, which was included within income tax expense on the consolidated statements of income.
Additionally, during the years ended December 31, 2016, 2015 and 2014, the Company recognized tax credits and other benefits from its investment in affordable housing tax credits of $3.04 million, $2.26 million and $2.53 million, respectively. The Company incurred no impairment losses during 2016, 2015 and 2014.
NOTE 23: SUBSEQUENT EVENTS
On October 22, 2016, the Company entered into a definitive merger agreement to be acquired by Community Bank System, Inc. for approximately $304 million in Community Bank System, Inc. stock and cash. The merger is subject to the approval by the stockholders of Merchants Bancshares, Inc. and regulatory authorities and is expected to close in the late second or early third quarter of 2017.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Merchants Bancshares, Inc.
Burlington, Vermont
We have audited the accompanying consolidated balance sheets of Merchants Bancshares, Inc. as of December 31, 2016 and 2015 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited Merchants Bancshares, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Merchants Bancshares, Inc.’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on Merchants Bancshares, Inc.’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Merchants Bancshares, Inc. as of December 31, 2016 and 2015 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Merchants Bancshares, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
|
/s/ Crowe Horwath, LLP |
|
Crowe Horwath LLP |
|
Cleveland, Ohio |
March 15, 2017 |
ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures – Our principal executive officer, interim principal financial officer and other members of our senior management have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) as of December 31, 2016. Based on this evaluation, our principal executive officer and interim principal financial officer have concluded that our disclosure controls and procedures effectively ensure that information required to be disclosed in our filings and submissions with the SEC under the Exchange Act is accumulated and communicated to our management (including the principal executive officer and interim principal financial officer), and is recorded, processed, summarized and reported within the time periods specified by the SEC.
Management’s Report on Internal Control Over Financial Reporting – Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) or 15d-15(f). Our internal control system is designed to provide reasonable assurances to our Management and board of directors regarding the preparation and fair presentation of published financial statements. Under the supervision and with the participation of our Management, including our principal executive officer and interim principal financial officer, an evaluation of the effectiveness of our internal control over financial reporting was conducted, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the evaluation under the framework in Internal Control – Integrated Framework, Management concluded that our internal control over financial reporting was effective as of December 31, 2016.
Crowe Horwath LLP, the independent registered public accounting firm that audited our consolidated financial statements, has issued an attestation report on our internal control over financial reporting as of December 31, 2016. This report can be found on page 109.
Changes in Internal Controls over Financial Reporting – During the fourth quarter of 2016, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B – OTHER INFORMATION
None.
PART III
ITEM 10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Our charter and bylaws provide that the size of our Board of Directors shall be determined by the Board or stockholders at the Annual Meeting. Our Board of Directors currently consists of eleven directors and is divided into three classes. Based on its review of the relationships between the directors, the Company and our subsidiaries, our Board of Directors has determined that a majority of our directors are independent under the Nasdaq Listing Rules and in accordance with our Principles of Governance.
Information about our Board of Directors
The following table sets forth certain information about our current directors. Except where otherwise noted below the table, all of the directors listed have been employed in their principal occupations for the last five years.
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Term of | |
| | | | | | | | | | | | Independence | | | Director | | | Office to | |
Class | | | Name | | | Age | | | Principal Occupation | | | Status | | | Since | | | Expire | |
I | | | Scott F. Boardman | | | 57 | | | President, Hickok & Boardman, Inc. | | | Y | | | 2008 | | | 2018 | |
I | | | Janette K. Bombardier | | | 58 | | | Director of Site Operations and Senior Location Manager, GlobalFoundries | | | Y | | | 2013 | | | 2018 | |
I | | | Raymond C. Pecor, III | | | 48 | | | President, Lake Champlain Transportation Company | | | Y | | | 2012 | | | 2018 | |
II | | | Donald R. Chase | | | 70 | | | Owner of Central New England Ag Services, Inc., Chase Ranch LLC, and Chase Enterprises Corp. | | | Y | | | 2015 | | | 2019 | |
II | | | Karen J. Danaher | | | 61 | | | Partner, Danaher Attig & Plante PLC | | | Y | | | 2010 | | | 2019 | |
II | | | Jeffrey L. Davis | | | 64 | | | President, J.L. Davis, Inc. | | | Y | | | 1993 | | | 2019 | |
II | | | Geoffrey R. Hesslink | | | 52 | | | President and Chief Executive Officer, Merchants and Merchants Bank | | | N | | | 2016 | | | 2019 | |
III | | | Michael G. Furlong | | | 66 | | | Attorney, Sheehey Furlong & Behm P.C. | | | Y | | | 1991 | | | 2017 | |
III | | | Joseph F. Larkin | | | 39 | | | Vice President, Larkin Realty | | | Y | | | 2016 | | | 2017 | |
III | | | Lorilee A. Lawton | | | 69 | | | Owner & President, Firetech Sprinkler Corporation | | | Y | | | 2003 | | | 2017 | |
III | | | Michael R. Tuttle | | | 62 | | | Former President and Chief Executive Officer, Merchants | | | N | | | 2007 | | | 2017 | |
The biographical descriptions below for each director include the specific experience, qualifications, attributes and skills that the Board of Directors would expect to consider if it were making a conclusion currently as to whether such person should serve as a director. The Board of Directors did not currently evaluate whether these directors should serve as directors, as the terms for which they have been previously elected continue beyond the Annual Meeting.
Scott F. Boardman was elected to our Board in 2008. He has been a member of the Board of Directors of Merchants Bank since 2004. Mr. Boardman is the President of Hickok & Boardman, Inc., a retail insurance agency in Burlington, Vermont. He serves on the boards of A.N. Deringer, Inc., the Lake Mansfield Trout Club, Mercy Connections, and PC Construction Company. Mr. Boardman is a former trustee of Trinity College in Burlington, Vermont, and is a former board member and past president of the Vermont Insurance Agents Association. He is also past president of the Vermont chapter of the Casualty & Property Insurance Underwriters Society. Mr. Boardman brings experience in business management, credit, risk management, customer service and leadership, as well as industry knowledge to the Board.
Janette K. Bombardier has served as a member of our Board, and the Board of Directors of Merchants Bank, since February 2013. She is the GlobalFoundries Vice President of Facilities Engineering for the Vermont and East Fishkill Semiconductor Manufacturing Locations, as well as Senior Location Executive for the GlobalFoundries Vermont facility. She is a licensed Professional Engineer in the State of Vermont. Prior to joining GlobalFoundries in 2015 she worked for IBM and held a variety of positions including construction management, manufacturing engineering, product development and quality, as well as positions in cost reduction and continuous improvement. Ms. Bombardier brings experience in business management, leadership, risk management and strategic planning to the Board.
Raymond C. Pecor, III was elected to our Board in 2012. He has served as a member of the Board of Directors of Merchants Bank since 2009. He is President of Lake Champlain Transportation Company in Burlington, Vermont, and
serves on the board of the Champlain Valley Expo. Mr. Pecor, III brings experience in business management, customer service, crisis response, leadership, credit and risk management to the Board.
Donald R. Chase was appointed to our Board and the Board of Merchants Bank in 2015. Mr. Chase was Chairman of the Board of NUVO Bank and Trust Company in Springfield, Massachusetts. He also served as President and Chief Executive Officer, Vice Chairman, and Director of Westbank Corporation and its wholly-owned subsidiary, Westbank. Mr. Chase is the owner of Central New England Ag Services, Inc. in West Halifax, Vermont, Chase Ranch LLC, in Midland, South Dakota, and Chase Enterprises Corporation in Northampton, Massachusetts. Mr. Chase is Chairman of the Board of Trustees for the Eastern States Exposition in West Springfield, Massachusetts, and also serves on the Board of Public Safety for the City of West Springfield, Massachusetts. Mr. Chase brings a finance background, business and management experience, industry knowledge, leadership experience and credit knowledge to the Board.
Karen J. Danaher was elected to our Board of Directors in 2010 and has served as a Director of Merchants Bank since 2008. She is a partner in Danaher Attig & Plante PLC, a public accounting firm located in South Burlington, Vermont. Ms. Danaher is a certified public accountant and brings accounting and finance experience, business management experience, industry knowledge, customer-based experience, crisis and risk management experience and leadership experience to the Board.
Jeffrey L. Davis has served as a member of our Board and the Board of Merchants Bank since 1993, and has served as Chairman of our Board of Directors since February 2015. He is President of J.L. Davis, Inc., a construction and development firm, President of The Champlain Valley Exposition and President of Taft Corners Associates, a development firm. He is also a trustee emeritus of the University of Vermont in Burlington, Vermont, and a former president of the Vermont Special Olympics. Mr. Davis brings business and management experience, industry knowledge, customer-based experience, knowledge of credit, crisis and risk management experience, leadership experience and strategic planning experience to the Board.
Geoffrey R. Hesslink was appointed to our Board in 2016 and the Board of Merchants Bank in 2015. He serves as President, Chief Executive Officer and Director of Merchants and Merchants Bank. Mr. Hesslink joined Merchants Bank in 1995 as Vice President and Commercial Banker working on business development and problem loan resolution. Mr. Hesslink was promoted to Senior Vice President and Senior Lender, managing Commercial Banking, Problem Loan Resolution, Government Banking and Mortgage Banking in 2006. He was promoted to Chief Operating Officer in 2013, to President and Chief Executive Officer of Merchants Bank in 2015 and was appointed to his current role as President and Chief Executive Officer of Merchants effective January 1, 2016. He serves on the board of the Greater Burlington Industrial Corporation and is a member of the Vermont Business Roundtable. Mr. Hesslink brings experience in business management, finance and accounting, industry knowledge, customer service, crisis response, leadership, strategic planning, credit and risk management to the Board.
Michael G. Furlong has served as a member of our Board and the Board of Merchants Bank since 1991. Mr. Furlong has served as Chairman of Merchants Bank's Board of Directors since 2001. He is a member of the Burlington, Vermont law firm of Sheehey Furlong & Behm P.C., and is a former President of the Chittenden County Bar Association. He is a director of Lake Champlain Transportation Company, an emeritus director of Wake Robin Corporation and has served on the boards of several Vermont nonprofit organizations. Mr. Furlong brings experience in business management, customer service, crisis response, leadership, credit and risk management to the Board.
Joseph F. Larkin was appointed to our Board and the Board of Merchants Bank in 2016. He has been Vice President of Larkin Realty since 2010. From 2007 to 2010, he was Vice President of Credit Research at Dwight Asset Management, a Fixed Income Asset Manager. Mr. Larkin currently serves as the Chairman of the Advisory Board at Rice Memorial High School. He was a 2nd Lieutenant in the United States Air Force. Mr. Larkin brings credit and risk management experience, industry knowledge, accounting and finance experience, customer based experience, strategic planning experience and leadership to the Board.
Lorilee A. Lawton has been a member of our Board since 2003 and has served as a Director of Merchants Bank since 1995. Ms. Lawton is the owner and President of Firetech Sprinkler Corporation, a contractor specializing in the design, fabrication and installation of fire sprinkler systems, located in Colchester, Vermont. Ms. Lawton brings experience in
business management, finance and accounting, customer service, crisis response, leadership, strategic planning and risk management to the Board.
Michael R. Tuttle has served as a member of our Board since 2007 and the Board of Merchants Bank since 2006. He is the former President and Chief Executive Officer of Merchants (2007-2015) and Merchants Bank (2006-2014). Mr. Tuttle also serves on the board of the Federal Home Loan Bank of Boston and is a member of the Vermont Economic Development Authority. He is a former Director of Vermont Banker’s Association, Vermont Business Roundtable, Flynn Center for the Performing Arts and Fairpoint Communications, Inc. Mr. Tuttle brings experience in business management, finance and accounting, industry knowledge, customer service, crisis response, leadership, strategic planning, credit and risk management to the Board.
Committees of the Boards of Directors
Our Board of Directors has designated the following committees: Audit Committee, Compensation Committee, and Nominating and Governance Committee. There have been no material changes to the procedures by which our stockholders may recommend nominees to the Board since those procedures were last disclosed in our 2016 Proxy Statement under the title “Nominating and Governance Committee.”
Audit Committee
The Audit Committee currently consists of four members: Donald R. Chase, Karen J. Danaher (Chair), Jeffrey L. Davis and Lorilee A. Lawton. Each member of the Audit Committee is independent under the Nasdaq Listing Rules. Our Board of Directors has determined that Ms. Danaher qualifies as an “audit committee financial expert” as defined by the SEC rules.
Code of Business Conduct and Ethics Policy
We have adopted a Code of Business Conduct and Ethics Policy (“Code”) for all employees and directors. Part of the Code includes additional rules for the Chief Executive Officer, Chief Financial Officer and other senior financial officers. This Code is available on our website at www.mbvt.com, under “Investor Relations” and any waivers under it will also be available on our website. We have a confidential telephone and Internet hotline system for anonymous reporting of complaints and concerns regarding financial reporting. This system may be accessed by telephone at 1-866-850-1442 or via the Internet at www.ethicspoint.com.
Executive Officers
The names, ages and positions of our current executive officers are listed below.
| | | | | | | |
Name | | | Age | | | Positions | |
Geoffrey R. Hesslink | | | 52 | | | President and Chief Executive Officer, Merchants and Merchants Bank | |
Marie A. Thresher | | | 50 | | | Executive Vice President and Chief Operating Officer, Merchants Bank | |
Richard M. Donovan | | | 52 | | | Interim PFO, PAO and Treasurer, Merchants and Merchants Bank | |
Laura M. Abbott | | | 52 | | | Senior Vice President and Senior Credit Officer, Merchants Bank | |
Bruce A. Bernier | | | 48 | | | Senior Vice President and Senior Lender, Merchants Bank | |
Anita L. Bourgeois | | | 45 | | | Senior Vice President and Senior Director, Deposit Growth and Profitability, Merchants Bank | |
Michael J. Cataldo | | | 66 | | | Senior Vice President and Director of Operations, Merchants Bank | |
Jacqueline S. Dragon | | | 53 | | | Senior Vice President and Director of Human Resources, Merchants Bank | |
Jonathan D. Watson | | | 37 | | | Senior Vice President and Chief Risk Officer, Merchants Bank | |
Mr. Hesslink serves as President, Chief Executive Officer and Director of Merchants and Merchants Bank. Mr. Hesslink joined Merchants Bank in 1995 as Vice President and Commercial Banker working on business development and problem loan resolution. Mr. Hesslink was promoted to Senior Vice President and Senior Lender, managing Commercial Banking, Problem Loan Resolution, Government Banking and Mortgage Banking in 2006. He was promoted to Chief Operating Officer in 2013, to President and Chief Executive Officer of Merchants Bank in 2015 and was appointed to his current role as President and Chief Executive Officer of Merchants effective January 1, 2016. He serves on the board of the Greater Burlington Industrial Corporation and is a member of the Vermont Business Roundtable. Mr. Hesslink graduated
cum laude, with a bachelor’s degree in business administration-finance from the University of Vermont in 1987 and completed a management training program at Manufacturers Hanover Trust Company in 1989.
Ms. Thresher joined the Company in December 2013 and serves as the Chief Operating Officer, responsible for operations, information technology, human resources, risk management and marketing. Prior to this role Ms. Thresher served as Senior Vice President and Chief Risk Officer. Ms. Thresher brings 25 years of experience in financial services and risk management at regional and national financial institutions. Prior to joining Merchants Bank, she was the Senior Vice President and Chief Auditor for People’s United Bank (acquired Chittenden Corporation). She began her banking career at Fleet Financial Group (now Bank of America) holding various positions, including Vice President of Retail Delivery and Consumer/Small Business Lending, Audit in 1999. Ms. Thresher holds a Bachelor of Science degree in Finance from Central Connecticut University. She serves on the board of directors of Vermont CARES.
Mr. Donovan is the Interim Principal Financial Officer, Interim Principal Accounting Officer and Interim Treasurer of Merchants Bank and Merchants Bancshares. Mr. Donovan joined the Company in September 2016 as its Interim Controller. Mr. Donovan has more than 25 years of accounting experience including 12 years in public accounting as a practicing CPA. From February 2007 to December 2014, Mr. Donovan was the Vice President of accounting and Human Resources at Wave Systems Corp. Mr. Donovan attended Siena College where he earned a BBA in Accounting.
Ms. Abbott has served as Senior Credit Officer since December 2012 and was appointed to her current role as Senior Vice President and Senior Credit Officer in January 2015. Ms. Abbott previously served as Vice President and Credit Operations and Loan Compliance Officer from 2001 through 2012 and has been with Merchants Bank for over 25 years. Ms. Abbott holds a Bachelor of Science degree in Business from the University of Vermont.
Mr. Bernier is Senior Lender and Senior Vice President of Merchants Bank. Mr. Bernier joined Merchants Bank in 2007 as a Corporate Banking Officer, and was promoted to the position of Northern Regional Manager Commercial Banking in 2011. Mr. Bernier has over 20 years in commercial banking experience with local banking institutions and holds a Bachelor of Science degree in business administration with a concentration in accounting from University of Maine at Orono. Mr. Bernier was appointed to his current role as Senior Lender effective January 1, 2015.
Ms. Bourgeois was appointed Senior Vice President and Senior Director, Deposit Growth and Profitability of Merchants Bank in May 2016. Ms. Bourgeois joined the Company in 2008 as the Manager of Government Banking. In 2010, she assumed responsibility for the Cash Management Sales group and in 2015 became accountable for the marketing division. Ms. Bourgeois has over 20 years in banking experience with local banking institutions.
Mr. Cataldo was appointed Senior Vice President, Director of Operations in June 2015. Mr. Cataldo came to Merchants with over 30 years’ experience in the financial services industry, specializing in Bank Operations. Prior to joining Merchants Bank, Mr. Cataldo worked for Webster Bank where he was responsible for operating and managing back office operations for the $17 billion bank. He attended Sacred Heart University and is a graduate of Penn State’s executive management program.
Ms. Dragon has served as Senior Vice President and Director of Human Resources since June 2013. She has over 25 years of human resources management and organizational development experience. Prior to joining Merchants Bank, she operated her own independent consulting business. Ms. Dragon holds a Master of Science degree from Springfield College and currently serves on the Board of Technology for Tomorrow.
Mr. Watson was appointed Senior Vice President and Chief Risk Officer in March 2015. Mr. Watson has over 12 years of internal audit and risk advisory services experience at regional financial institutions. Prior to joining Merchants Bank as Vice President, Audit Director in September 2014, he worked at People’s United Bank (acquired Chittenden Corporation) for 10 years. Mr. Watson holds a Bachelor of Science degree in Business Administration from the University of Vermont. He serves on the board of directors of ANEW Place.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Exchange Act requires our executive officers, directors, and 10% stockholders to file reports of ownership (Form 3) and changes of ownership (Forms 4 and 5) with respect to our common stock with the SEC. Executive officers, directors and 10% stockholders are required to furnish us with copies of all Section 16(a) forms they file. Based solely on our review of the copies of such reports furnished to us with respect to 2016, all Section 16(a) filing requirements applicable to our executive officers and directors during 2016 were met, other than Mr. Tuttle and Mr. Hesslink, who each filed one late Form 4, and Mr. Donovan, Mr. Ripley Jr. and Ms. Bourgeois, who each filed one late Form 3.
ITEM 11 – EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
The Compensation Committee of our Board of Directors, which is comprised entirely of independent directors, oversees our executive compensation program and approves all compensation for our executive officers other than the Chief Executive Officer and reviews and recommends Chief Executive Officer compensation for approval by our Board. The term “Named Executive Officers” (“NEOs”) refers to those individuals who served as our Chief Executive Officer, our Chief Financial Officer and our next three highest paid executive officers in 2016.
In January 2016, Thomas J. Meshako resigned as Chief Financial Officer and Treasurer of Merchants and Merchants Bank. Eric A. Segal served as Interim Principal Financial Officer, Interim Principal Accounting Officer and Interim Treasurer of Merchants and Merchants Bank from January 2016 until December 2016. Effective December 19, 2016, Richard M. Donovan was appointed as the Interim Principal Financial Officer, Interim Principal Accounting Officer and Interim Treasurer of Merchants and Merchants Bank.
This Compensation Discussion and Analysis describes our executive compensation program for 2016, and certain elements of the 2017 executive compensation program. In particular, this section explains how the Compensation Committee made decisions related to compensation for our executives, including our NEOs, during 2016.
Executive Summary
Performance Summary
Key performance highlights for 2016 are as follows:
| · | | Completion of Chief Executive Officer succession, with the promotion of Mr. Hesslink to President and Chief Executive Officer of Merchants in 2016. |
| · | | Other key senior management appointments in 2016 further strengthened the leadership team, contributing to successful 2016 results. |
| · | | Return on average equity was 9.61% for 2016 compared to 9.69% in 2015. |
| · | | Continued strong asset quality. |
| · | | Continued commitment to drive value for our stockholders – we declared our 81th consecutive quarterly dividend in January 2017 and our 45th consecutive quarter at the existing level of $0.28. |
These accomplishments are significant given the slow economic recovery and the low interest rate environment throughout 2016.
Creation of Stockholder Value
We prioritize building stockholder value. Dividends paid per share during each of the past eleven years totaled $1.12 per share, and we have maintained a quarterly cash dividend since 1997.
Effect of 2016 Advisory Vote on NEO Compensation
We provide our stockholders with the opportunity to cast an annual advisory vote on executive compensation (“say-on-pay”). At our 2016 Annual Meeting of Stockholders, 94% of the votes cast on the say-on-pay proposal at that meeting were voted in favor of the proposal. The Compensation Committee believes this affirms stockholders’ support of our approach to executive compensation, and therefore did not significantly change its approach in 2016. The Compensation Committee will continue to consider the outcome of our say-on-pay vote, regulatory changes and emerging best practices when making future recommendations regarding compensation for the NEOs.
2016 Compensation Highlights
We develop our programs to attract, motivate and retain the talent necessary to help us achieve our objectives. Ultimately our compensation programs are designed to achieve overarching goals that motivate and reward performance, ensure sound risk management, and deliver long-term value to our stockholders. To achieve these objectives, the Compensation Committee regularly reviews and modifies our compensation and incentive programs to ensure they align with these core objectives. We assess our program from the perspective of our stockholders and regulators, considering best practices and making improvements as appropriate.
Highlights of Compensation Program and 2016 Results:
| · | | NEOs received base salary increases in 2016 ranging between 21% and 45%. These increases were made to recognize various promotions among the executive team as well as market adjustments in order to align base salaries closer to market in light of executives’ experience, performance and contributions. |
| · | | For 2016 performance, our NEOs received annual cash incentives at the target level. The Compensation Committee at their discretion approved incentive awards valued at the target level for NEOs that was paid in December 2016. The Committee recognized that senior management had contributed significantly to the Bank’s results by improving adjusted earnings (non-GAAP) as well as contributing to the Bank’s overall performance in 2016. |
| · | | In May 2016, the Compensation Committee recommended and the Board approved restricted stock grants for our NEOs with values ranging from 20% to 30% of base salary. These grants typically vest three years after the grant date. Executives are required to hold 40% or, in the case of the Chief Executive Officer, 60% of the after-tax value of the restricted stock until, at least, the date that the executive’s employment with the company terminates. Due to the pending merger, and in order to mitigate potential excise taxes triggered by the merger, Merchants accelerated the vesting date for these grants of restricted stock held by select executives, subject to repayment of any after-tax proceeds if the executive’s employment terminates prior to the merger. |
Our Executive Compensation Program
The Compensation Committee strives to ensure our executive compensation program reflects evolving executive compensation best practices while ensuring it attracts, motivates and retains the talent that will help us achieve our objectives. Ultimately, our compensation programs are designed to (1) ensure sound risk management, (2) motivate and reward performance, and (3) deliver long-term value to our stockholders. Our programs provide a balanced and risk appropriate view of performance across our short and long-term incentive plans and provide a significant portion of executive compensation in performance-based pay.
The Executive Annual Incentive Plan was implemented in 2009 and continues to appropriately reward and motivate our executives while incorporating various risk-mitigating features:
| · | | plan activation is tied to achievement of an established net income target and acceptable ratings on internal and regulatory agency audits; |
| · | | target incentive opportunities for executives are aligned with market; |
| · | | various risk mitigation features are used, including balanced financial performance metrics and appropriate maximum caps on incentive earnings; and |
| · | | a comparable index of banks (commercial banks located in the Northeast with assets ranging between approximately $1.1 billion to $4.5 billion) has been established that will be used to measure our relative performance to peers in regards to ROAE. |
Our long-term incentive plan strategy and equity grant allocation guidelines for key executives continues to be based upon their role and our desired total compensation philosophy. The objectives of our long-term incentive plan are to:
| · | | create strong alignment with stockholder interests; |
| · | | enable us to retain and motivate key executive officers who will contribute to our long-term growth and profitability; |
| · | | ensure awards are properly focused on long-term performance and do not encourage inappropriate risk taking; and |
| · | | enhance equity retention and ownership throughout the executive team (through holding requirements for Chief Executive Officer and key executives). |
Compensation Philosophy
Our compensation program and philosophy for executive officers was developed by the Compensation Committee and approved by our Board of Directors. The objectives of our executive compensation program are to:
| · | | attract, motivate and retain highly qualified and dedicated executive officers with competitive levels of compensation aligned with banks of similar size and complexity in our region; |
| · | | reward above-average corporate performance and recognize individual initiative and achievements; |
| · | | integrate pay with our strategic annual and long-term performance goals; |
| · | | align executive officers’ incentive with the promotion of stockholder value; and |
| · | | provide a balanced approach that helps mitigate the influence of any one element of compensation which might be considered to drive excessive risk taking. |
To meet our executive compensation objectives, our program is designed to provide the following:
| · | | competitive base salaries that are targeted at the market median (50th percentile), while allowing the flexibility to recognize each executive’s individual role, responsibilities, experience and performance; |
| · | | a short-term cash incentive program which focuses our executives on critical annual goals and objectives aligned with our strategic plan. Target incentive opportunities (as a percent of base salary) are structured to be competitive with the market median with the ability to pay above market for superior performance; |
| · | | long-term incentives, delivered in restricted stock, that align our executives��� interests with those of stockholders, reward stock price appreciation and provide a means for retaining our top performers; and |
| · | | benefits that are, by design, conservatively competitive. While they do not comprise a major part of our total compensation program, they allow us to attract and retain key executives. |
Executive Compensation Mix
In summary, we strive to provide a total compensation program that is competitive, performance oriented, stockholder aligned, balanced, and reflects sound risk management practices. We have historically set specific performance goals that align with our strategy and support our annual plans, but also recognize the need to be responsive and flexible in today’s challenging environment. We believe this approach also helps to ensure our program does not motivate our executives to take undue risks.
Our Principles of Governance, which are approved by our Board of Directors, require compensation for the Chief Executive Officer to be linked to the achievement of strategic goals that improve our long-term performance. Accordingly, a meaningful portion of the Chief Executive Officer’s compensation depends upon the Bank’s performance.
The Compensation Committee will continue to review, evaluate, and revise the compensation philosophy as appropriate to meet its desired objectives and adhere to emerging regulations.
Role of the Compensation Consultant
The Compensation Committee has the sole authority to retain and terminate a compensation consultant and to approve the consultant’s fees and all other terms of the engagement. The Compensation Committee has direct access to outside advisors and consultants throughout the year as they relate to executive compensation. The Compensation Committee has direct access to and meets periodically with the compensation consultant independently of management.
In 2016, the Compensation Committee retained the services of Pearl Meyer, an independent outside consulting firm specializing in executive and board compensation, to assist the Committee. Pearl Meyer reports directly to the Compensation Committee and carries out its responsibilities to the Compensation Committee in coordination with both the Chief Executive Officer and the Human Resources Director. Services include conducting benchmarking studies, establishing compensation guidelines, designing incentive programs, assisting with the proxy disclosure and providing insight on emerging regulations and best practices.
The Compensation Committee regularly reviews the services provided by its outside consultants and believes that Pearl Meyer is independent in providing executive compensation consulting services. The Committee conducted a specific review of its relationship with Pearl Meyer in 2016, and determined that Pearl Meyer’s work for the Committee did not raise any conflicts of interest. In making this determination, the Compensation Committee noted that during 2016:
| · | | Pearl Meyer did not provide any services to the Company or our management other than services to the Compensation Committee and its services were limited to executive compensation consulting; |
| · | | fees paid by the Company were less than 1% of Pearl Meyer’s total revenue for 2016; |
| · | | Pearl Meyer maintains a Conflicts Policy which details specific policies and procedures designed to ensure independence; |
| · | | none of the Pearl Meyer consultants had any business or personal relationship with Committee members; |
| · | | none of the Pearl Meyer consultants had any business or personal relationship with executive officers of the Company; and |
| · | | none of the Pearl Meyer consultants directly own our stock. |
The Compensation Committee continues to monitor the independence of Pearl Meyer and its other compensation advisers on a periodic basis.
Role of Management
Although the Compensation Committee makes independent recommendations to the Board of Directors on all matters related to compensation of the NEOs, certain members of management are requested to attend and provide input to the Compensation Committee throughout the year. Input may be sought from the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer (or equivalent), Human Resources Director, Chief Risk Officer and others as needed to ensure the Compensation Committee has the information and perspective it needs to carry out its duties.
The Compensation Committee meets with the Chief Executive Officer for input regarding his performance and compensation package, but ultimately decisions regarding his package are made based upon the Compensation Committee’s deliberations, as recommended and reported to the Board, as well as input from the compensation consultant, as requested. The Compensation Committee considers recommendations from the Chief Executive Officer, as well as input from the compensation consultant as requested, to make compensation package decisions for other executives.
Inputs to Committee Decision Making
Performance Evaluation
The Compensation Committee evaluates the performance of the Chief Executive Officer annually in the following four categories:
| 1. | | Development of specific strategic plan objectives; |
| 2. | | Operational impact on company morale, customer satisfaction, public image, company efficiency and flexibility, and research and development of leading edge products, services and technologies; |
| 3. | | Management style and effectiveness in relation to customers, stockholders, employees, executive officers, board and committee members, and the media and community; and |
| 4. | | Effectiveness of leadership in: |
| a. | | developing appropriate strategies and gaining support from our Board of Directors and its committees to achieve these strategies; |
| b. | | setting the “tone at the top” for ethics, customer relations, reputation and ensuing results; fostering an environment for leadership development at all levels within the company; and |
| c. | | working collaboratively with our Board of Directors and committees and communicating information in a timely manner to ensure full and informed consent regarding matters of governance. |
The Chief Executive Officer evaluates the performance of our other executive officers annually. Each executive officer’s annual performance review serves as the basis for adjustments to his or her base salary. Individual performance evaluations are tied closely to achievement of short and long-term goals and objectives, individual initiative, team-building skills, level of responsibility and above average corporate performance.
The Chief Executive Officer makes annual recommendations to the Compensation Committee for changes to executive officer salaries (other than his own) for the following year. These recommendations are based on individual performance within their respective areas of expertise, the Chief Executive Officer’s assessment of their contributions to our earnings and growth during the year, as well as their management style and effectiveness in relation to our customers, stockholders, employees, fellow executive officers, board and committee members and the community. The Compensation Committee reviews these recommendations and makes its final decisions regarding compensation for executive officers. Decisions regarding compensation for the Chief Executive Officer are approved by our Board of Directors based on recommendations from the Compensation Committee.
Benchmarking
The Compensation Committee typically engages Pearl Meyer to conduct a competitive review of our executive compensation program every two years. The last competitive analysis was completed in the Fall of 2015. A primary data source used in setting market-competitive guidelines for the executive officers is the information publicly disclosed by a peer group of other publicly traded banks and thrifts. Our peer group is developed by Pearl Meyer using objective parameters that reflect banks of similar asset size and region. When developing the peer group, Pearl Meyer includes financial institutions ranging from approximately one half to two times our asset size that are located in the New England and New York region of the United States (excluding Boston and the New York City metro area, as well as banks with unique business models). The peer group is also designed to position us at approximately the 50th percentile in regards to assets.
The following is the 2015 peer group used by the Compensation Committee to make decisions related to 2016 executive compensation.
| |
Arrow Financial Corporation | First Bancorp, Inc. |
Bar Harbor Bankshares, Inc. | First Connecticut Bancorp, Inc. |
Camden National Corporation | Hingham Institution for Savings |
Century Bancorp, Inc. | Lake Sunapee Bank Group |
Chemung Financial Corporation | Meridian Bancorp, Inc. |
Enterprise Bancorp, Inc. | SI Financial Group, Inc. |
Evans Bancorp, Inc. | Washington Trust Bancorp, Inc. |
Financial Institutions, Inc. | Western New England Bancorp, Inc. |
In addition to the peer group data, Pearl Meyer used additional banking compensation surveys as part of the analysis focusing on banks similar to us in asset size and region.
Information from the competitive analysis is used by the consultant to provide market-competitive guidelines that support our total compensation philosophy. Guidelines for base salary, short and long-term incentive targets and estimated total direct compensation are provided with ranges for performance. This allows the Compensation Committee to see the potential pay, and range of pay, for each executive role. These guidelines provided a framework for consideration by the Compensation Committee in setting pay levels.
Risk Oversight of Compensation Programs
We believe that the compensation program is structured to be reasonably unlikely to present a material adverse risk to us based on the following factors:
| · | | as a community bank regulated by the FDIC and the Commissioner of the Vermont Department of Financial Regulation, among others, our main operating subsidiary, Merchants Bank, adheres to defined risk guidelines, practices and controls to ensure the safety and soundness of the organization; |
| · | | our management and Board of Directors conduct regular reviews of our business to ensure we remain within appropriate regulatory guidelines and practices that are monitored and supplemented by our internal audit function, as well as our external auditors; |
| · | | our incentive plan provides a maximum cap on payment and does not have highly leveraged payout curves and steep payout cliffs at specific performance levels that could encourage short-term actions to meet payout thresholds; and |
| · | | our restricted stock grants are subject to clawbacks in the event of accounting restatement due to fraud or misconduct or in the event of material violations of our Code. |
Components of Executive Compensation and 2016 Decisions
Our compensation program for all executive officers, including the Chief Executive Officer, consists of four key components, which are reviewed regularly by the Committee:
| · | | long-term incentive/equity; and |
| · | | employment contracts/other benefits. |
We offer no perquisites of any kind to any of our executive officers. Executive officers are not entitled to severance or change-in-control payments beyond those described in the “Employment Agreements” section on page 124 of this document.
The following section summarizes the role of each component, how decisions are made and the resulting 2016 decision process as it relates to the executive officers.
Base Salary
We believe the purpose of base salary is to provide competitive and fair base compensation that recognizes the executives’ role, responsibilities, experience and performance. Base salary represents fixed compensation that is targeted to be competitive with our peer group.
Typically, the Compensation Committee reviews and sets base pay for each executive in December of each year following the performance evaluation process. Competitive markets for similar roles are considered, as well as each individual’s experience, performance and contributions. Promotional pay increases are also considered by the Compensation Committee. In completion of the Chief Executive Officer succession, Mr. Hesslink was promoted to President and Chief Executive Officer of Merchants on January 1, 2016.
The Compensation Committee approved the following 2016 and 2017 base salary adjustments for the NEOs that were intended to recognize each executive’s contribution and performance and, if needed, bring salaries more in line with market.
The 2016 adjustments reflect the organizational changes discussed in the preceding paragraph. In determining 2016 pay adjustments, the Compensation Committee utilized the competitive pay analysis conducted by Pearl Meyer for the Chief Executive Officer and other key executive officers. The results for this study indicated that base pay levels for a number of the key officers, including the Chief Executive Officer, Chief Operating Officer, Senior Lender and Chief Risk Officer were at, or below the 50th percentile of the market. As a result, the Committee recommended that the Chief Executive Officer and other key officer base salaries be increased according to competitive market pay levels consistent with our compensation philosophy and to ensure the retention of these key senior executive positions considered integral to the continued success of the organization. The 2017 adjustments reflect modest increases to base compensation for all executives.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | January | | | January | | | Percent | | | January | | | Percent | |
| | | | | | 2015 Base | | | 2016 Base | | | Increase in | | | 2017 Base | | | Increase in | |
Name | | | Title | | | Salary | | | Salary | | | January 2016 | | | Salary | | | January 2017 | |
Geoffrey R. Hesslink | | | President and Chief Executive Officer, Merchants and Merchants Bank | | | $ | 295,000 | | | $ | 427,000 | | | 44.75 | % | (1)(2) | | | $ | 427,000 | | | — | % | | |
Marie A. Thresher | | | Executive Vice President, Chief Operating Officer | | | $ | 240,000 | | | $ | 290,000 | | | 20.83 | % | (2) | | | $ | 305,000 | | | 5.17 | % | | |
Richard M. Donovan | | | Interim Principal Financial Officer, Interim Principal Accounting Officer and Interim Treasurer of Merchants and Merchants Bank | | | $ | — | | | $ | — | | | — | % | | | | $ | 225,000 | | | — | % | (3) | |
Eric A. Segal | | | Interim Principal Financial Officer, Interim Principal Accounting Officer and Interim Treasurer of Merchants and Merchants Bank (resigned December 2016) | | | $ | — | | | $ | 355,288 | | | — | % | | | | $ | — | | | — | % | | |
Thomas J. Meshako | | | Senior Vice President, Chief Financial Officer and Treasurer (resigned January 2016) | | | $ | — | | | $ | 220,000 | | | — | % | | | | $ | — | | | — | % | | |
Bruce A. Bernier | | | Senior Vice President and Senior Lender, Merchants Bank | | | $ | — | | | $ | 250,000 | | | 35.01 | % | (2) | | | $ | 260,000 | | | 4.00 | % | | |
Jonathan D. Watson | | | Senior Vice President and Chief Risk Officer | | | $ | — | | | $ | 163,000 | | | 20.70 | % | (2) | | | $ | 171,000 | | | 4.91 | % | | |
| (1) | | This increase recognizes Mr. Hesslink’s promotion to President and Chief Executive Officer of Merchants. |
| (2) | | This increase reflects a market adjustment in order to align base pay closer to the 50th percentile of peers based upon the executive pay study completed by Pearl Meyer in 2015. |
| (3) | | Mr. Donovan was not eligible for a base salary adjustment. |
Annual Incentive
The objective of our Executive Annual Incentive Plan is to motivate and reward key members of management, including the Chief Executive Officer, for achieving specific company performance goals and/or division/individual goals that support the strategic plan. Rewards under this Plan represent compensation that must be earned (and re-earned each year) based upon company and division/individual performance.
Our proposed performance goals for the incentive plan are based on budget projections and typically presented by the Chief Executive Officer to the Compensation Committee during the first quarter of the year. Once the Compensation Committee finalizes and approves the performance goals, the goals are presented to the full Board for final approval. The following details the framework of the 2016 Executive Annual Incentive Plan (the “2016 Plan”):
Incentive Opportunity: Each participant has a target award (expressed as a percentage of base salary during the fiscal year) and range that defines the incentive opportunity. The Chief Executive Officer’s target is 35% of base salary and the Chief Operating Officer’s target is 30% and all other executive officers’ target is 25% of base salary. Actual awards vary based on performance and range from 0% of target (not achieving minimal performance for a goal) to 150% of target for exceptional performance. These incentive plan levels and ranges have not changed since the plan was implemented in 2009.
Performance Measures: The 2016 performance measures were aligned with our strategy and business plan. The 2016 Plan was approved by the Compensation Committee on February 17, 2016. In order for the 2016 Plan to activate, the Company was required to achieve a net income target of $16.5 million in 2016 and maintain acceptable ratings on internal and regulatory agency audits. The awards for Mr. Hesslink, Mr. Meshako, Ms. Thresher and Mr. Watson were based upon achieving targets with respect to our return on assets, return on equity relative to a peer group index, efficiency ratio, Tier 1 Leverage Ratio, and net interest income on a fully taxable equivalent basis, or “FTE”(1). The award for Mr. Bernier was based upon one to three company goals as well as two divisional and/or individual performance goals. Minimum (threshold) and maximum (stretch) levels of performance were defined for the 2016 Plan and are summarized in the table below. Mr. Donovan and Mr. Segal were not eligible for participation in the 2016 Plan. No awards are paid for performance below threshold (minimum) for a particular performance measure. Actual payouts for each goal are based upon final performance between threshold and stretch levels. Actual payouts for each performance goal are pro-rated for any level of performance between threshold and stretch using interpolation to reward incremental improvement.
The Compensation Committee has the discretion to adjust any payouts to reflect the business environment and market conditions.
| (1) | | Net interest on a fully taxable equivalent basis includes tax benefit from certain tax exempt loans. Refer to page 35 for additional information. |
The 2016 performance measures for Mr. Hesslink, Ms. Thresher and Mr. Watson were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | Threshold | | | | | | | | Stretch | |
| | | | | | | (Minimum) Goal | | | Target Goal | | | (Maximum) Goal | |
| | | | | | | Funds 40% | | | Funds 100% | | | Funds 150% | |
Performance Measure | | | Weighting | | | of target award | | | of target award | | | of target award | |
ROAA | | | 20 | % | | | | 0.83 | % | | | | 0.86 | % | | | | 0.89 | % | |
ROAE – Relative to Peer Group Performance | | | 20 | % | | | | 70th | percentile | | | | 80th | percentile | | | | 90th | percentile | |
Efficiency Ratio | | | 20 | % | | | | 61.62 | % | | | | 60.12 | % | | | | 59.37 | % | |
Net Interest Income (FTE) | | | 20 | % | | | $ | 59,080 | | | | $ | 61,443 | | | | $ | 63,901 | | |
Tier 1 Leverage Ratio | | | 20 | % | | | | 8.57 | % | | | | 8.59 | % | | | | 8.62 | % | |
The 2016 performance measures for Mr. Bernier were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | Threshold | | | | | | | | Stretch | |
| | | | | | | (Minimum) Goal | | | Target Goal | | | (Maximum) Goal | |
| | | | | | | Funds 40% | | | Funds 100% | | | Funds 150% | |
Performance Measure | | | Weighting | | | of target award | | | of target award | | | of target award | |
ROAA | | | 20 | % | | | | 0.83 | % | | | | 0.86 | % | | | | 0.89 | % | |
ROAE – Relative to Peer Group Performance | | | 20 | % | | | | 70th | percentile | | | | 80th | percentile | | | | 90th | percentile | |
Net Interest Income (FTE) | | | 20 | % | | | $ | 59,080 | | | | $ | 61,433 | | | | $ | 63,901 | | |
Gross Loans at 12/31/2016 ($ in thousands) | | | 20 | % | | | $ | 1,280 | | | | $ | 1,304 | | | | $ | 1,325 | | |
2016 Gross Loan Production ($ in thousands) | | | 20 | % | | | $ | 80 | | | | $ | 110 | | | | $ | 130 | | |
At the end of the calendar year, the Compensation Committee assesses performance relative to each of the performance measures and determines the awards based upon the attainment of each goal. The Compensation Committee retains the
discretion to recommend to the Board modification of executives’ incentive payouts based on significant individual performance or company performance shortfalls. Our Board of Directors has the discretion to determine the amount and manner of executive incentive payments and to make adjustments.
2016 Performance Results
Merchants’ 2016 net income was $14.88 million. The net income target for 2016 did not take into account adjustments for one-time expenses for the pending merger. In connection with the pending merger, the Compensation Committee at their discretion approved a fixed calculation and a timing change for the 2016 Plan payouts. Overall, target level payments were awarded under the 2016 plan for all participants, and awards were made in December 2016. The Committee recognized in a discretionary decision that senior management has contributed significantly to improving adjusted earnings (non-GAAP) as well as contributing to the Bank’s performance in 2016.
2017 Plan Design
In connection with the pending merger with Community, the Compensation Committee approved deferral of the formulation of the Executive Annual Incentive Plan (the “2017 Plan”) which historically has been based on five annual performance metrics. Should the merger be cancelled, the Company will develop these incentive plans and present them to the Compensation Committee for approval.
Long-Term Compensation
We award long-term incentives in the form of restricted stock grants to our executive officers, although an annual stock grant is not guaranteed. These awards are consistent with our pay-for-performance principles and align the interests of our executive officers with the interests of our stockholders while creating a powerful retention feature for our top executives. The Compensation Committee reviews and approves the amount of each award to be granted to each executive officer and makes a recommendation for approval by our Board of Directors for the Chief Executive Officer. In making these determinations, the Compensation Committee takes a holistic approach including considerations such as performance relative to our strategic and financial objectives, the previous year’s individual performance of each executive officer and the market pay level for the executive officer. These grants are subject to clawbacks in the event of accounting restatement due to fraud or misconduct or in the event of material violation of our Code. These awards typically are granted in May of each year and vest after three years. In light of the pending merger, the restricted stock awards to be granted in May 2017, based upon 2016 performance, were awarded in January 2017 to those officers whose employment is expected to terminate in connection with the merger, as an added retention incentive for such employees.
Stock Ownership Guidelines
The Compensation Committee believes that Merchants’ executive officers should maintain a material personal financial stake in the company to promote a long-term perspective in managing the company and to align stockholder and executive interests. Therefore, executive officers are required to retain a percentage of their after tax full value stock until termination or retirement. The table below summarizes these holding requirements.
| | | | | |
| | | Holding Requirement | |
Role | | | (after tax, full value shares) | |
Chief Executive Officer | | | 60 | % | |
Key Executives | | | 40 | % | |
If an executive experiences personal economic hardship, the Compensation Committee will have the authority to decide whether the holding requirements will be waived for that particular award or if the executive will be allowed to sell more stock than the holding requirements permit.
Employment Agreements
Beginning as a practice in January 2011, each of our executive officers enters into employment agreements with us. Our executives entered into new employment agreements effective as of January 1, 2015. These agreements contain standard terms and conditions customarily found in employment agreements for comparable executives. If an executive officer is terminated without “cause” (as defined in such agreements) or the executive officer resigns for “good reason” (as defined in such agreements), we agree to pay, over 12 months, that executive officer’s salary for one year from the date of termination. For a termination without cause or with “Good Reason” not in connection with a change in control we agree to pay a prorated bonus if the termination occurs after March 31 and the executive shall also be entitled to receive health continuation for 12 months at our expense. In return, each executive has agreed to be subject to restrictive covenants (non-competition and non-solicitation) during the severance period. There are no tax “gross up” provisions in the employment agreements. We believe it is appropriate to provide a higher level of severance in exchange for restrictive covenants which protect the company. For a termination without cause or with “Good Reason” within 24 months following a change in control, each executive is entitled to a lump sum cash payment equal to 24 months of pay, 36 months for Mr. Hesslink, plus a prorated bonus if the termination occurs after March 31. The executive shall also be entitled to receive health continuation for 18 months at our expense. Mr. Meshako’s employment ended in January 2016 and he received a severance payment as described in the Summary Compensation Table on page 126.
In December 2016, Merchants entered into an employment agreement with Richard M. Donovan as interim Principal Accounting Officer, Interim Principal Financial Officer, and Interim Treasurer. The employment agreement provides that Mr. Donovan’s employment will automatically terminate upon the closing of the pending merger. If Mr. Donovan’s employment is terminated without cause prior to the closing of the pending merger, he shall receive the base salary he otherwise would have received had he remained employed until the earliest of (1) the end of the 90 day period following his termination date, (2) the closing of the merger, or (3) the date that Merchants determines to be the end of the merger process. Mr. Donovan could receive severance in the form of base salary continuation for up to 90 days as described in the Potential Payments upon Termination Table or Change in Control on page 128.
The agreements include certain covenants, including: (i) a covenant to maintain the confidentiality of the Company’s business, customer and related information during the course of the executive’s employment with the Company and at all times thereafter; (ii) a non-solicitation covenant to refrain from soliciting the Company’s employees, customers and suppliers to terminate their relationship with the Company; and (iii) a non-competition covenant to refrain from engaging in a competing business, which is defined as any financial institution that maintains an office within a 50 mile radius of the Company’s main office in South Burlington, Vermont. The non-solicitation and non-competition covenants apply during the course of the executive’s employment with the Company and throughout the period during which he or she is receiving severance benefits, except that the non-solicitation and non-competition covenants will not apply if the executive’s employment with the Company is terminated within two years after a change in control of the Company.
Other Benefits
Our executive officers are also eligible for other benefits available to all other employees on substantially the same terms, such as our 401(k) plan, and health, dental, life insurance and short- and long-term disability plans.
| · | | We match individual plan contributions for participating employees, including the executive officers, on a dollar-for-dollar basis, up to 3% of annual salary, and on a $0.50 per dollar basis up to the next 3% of annual salary up to annual IRS maximums. |
Impact of Accounting and Tax on the Form of Compensation
The Compensation Committee and management consider the accounting and tax (individual and corporate) consequences of the compensation plans prior to making changes to the plans.
Section 162(m) of the Internal Revenue Code limits deduction of compensation paid to NEOs to $1,000,000 unless the compensation is “performance-based.” Based on current compensation levels, we do not believe the section 162(m) cap
on compensation will be triggered for our Chief Executive Officer or other executive officers, but may consider this in future years.
Compensation Committee Report
The Compensation Committee reviewed and discussed the above Compensation Discussion and Analysis with our management. Based on the review and discussion, the Committee recommended to our Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report.
Submitted by the Compensation Committee
Jeffrey L. Davis, Chair
Raymond C. Pecor, III
Donald R. Chase
Karen J. Danaher
Executive Compensation
Summary Compensation Table
The following table sets forth a summary of compensation paid to each NEO during 2016, 2015 and 2014.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
SUMMARY COMPENSATION TABLE |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Name and | | | | | | | | | | | | | | | | | | Non-Equity | | | | | | | | | |
Principal | | | | | | | | | | | | | | Stock | | | Incentive | | | All Other | | | | | |
Position | | | Year | | | Salary (1) | | | Bonus | | | Awards (2) | | | Plan Comp. (3) | | | Comp. (4) | | | Total | |
Geoffrey R. Hesslink, | | | 2016 | | | $ | 424,972 | | | $ | 103,250 | | | $ | 88,502 | | | $ | — | | | $ | 11,925 | | | $ | 628,649 | |
President and Chief Executive Officer, | | | 2015 | | | $ | 303,103 | | | $ | — | | | $ | 51,760 | | | $ | 51,301 | | | $ | 26,031 | | | $ | 432,195 | |
Merchants and Merchants Bank | | | 2014 | | | $ | 229,545 | | | $ | — | | | $ | 44,015 | | | $ | — | | | $ | 20,469 | | | $ | 294,029 | |
Marie A. Thresher, | | | 2016 | | | $ | 289,733 | | | $ | 72,000 | | | $ | 48,000 | | | $ | — | | | $ | 11,925 | | | $ | 421,658 | |
Executive Vice President and | | | 2015 | | | $ | 246,242 | | | $ | — | | | $ | 40,506 | | | $ | 34,224 | | | $ | 12,135 | | | $ | 333,107 | |
Chief Operating Officer | | | 2014 | | | $ | 175,395 | | | $ | 2,500 | | | $ | 7,522 | | | $ | — | | | $ | 4,215 | | | $ | 189,632 | |
Richard M. Donovan | | | 2016 | | | $ | 4,327 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 4,327 | |
Interim Principal Financial Officer, | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Principal Accounting Officer and Treasurer (5) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Eric A. Segal | | | 2016 | | | $ | 355,288 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 355,288 | |
Interim Principal Financial Officer, | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Principal Accounting Officer and Treasurer (5) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Thomas J. Meshako, | | | 2016 | | | $ | 11,846 | | | $ | — | | | $ | — | | | $ | — | | | $ | 110,000 | | | $ | 121,846 | |
Former Senior Vice President, | | | 2015 | | | $ | 228,463 | | | $ | 25,000 | | | $ | — | | | $ | — | | | $ | — | | | $ | 253,463 | |
Chief Financial Officer and Treasurer (5) | | | 2014 | | | $ | 25,385 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 25,385 | |
Bruce A. Bernier | | | 2016 | | | $ | 249,016 | | | $ | 46,250 | | | $ | 36,999 | | | $ | — | | | $ | 13,728 | | | $ | 345,993 | |
Senior Vice President and | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Senior Lender (5) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Jonathan D. Watson | | | 2016 | | | $ | 162,579 | | | $ | 33,750 | | | $ | 27,012 | | | $ | — | | | $ | 12,221 | | | $ | 235,562 | |
Senior Vice President and | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Chief Risk Officer (5) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | | Reflects cash payments made in the calendar year and may include pay period carry-over from the prior year. |
| (2) | | The amounts shown in this column represent the aggregate grant date fair value of the shares of restricted stock granted to the NEOs. Refer to note 15 to the consolidated financial statements for additional information. |
| (3) | | The amounts shown in this column represent two cash awards made to the NEOs pursuant to our annual incentive plan. The annual incentive plan awards were made in March 2016 for 2015 performance. Additionally, in connection with the pending merger with Community, the Compensation Committee approved a timing change for payment of the annual 2016 Plan awards. Payouts were made in December 2016. Mr. Donovan and Mr. Segal were not eligible to participate in the annual incentive plan. |
| (4) | | The amounts shown in this column reflect contributions made by us on behalf of the NEOs to the Merchants Bank 401(k) Plan: $11,925 for Mr. Hesslink, $11,925 for Ms. Thresher, $11,925 for Mr. Bernier, and $9,869 for Mr. Watson. Mr. Donovan and Mr. Segal were not eligible for contributions. A combined time off cash out amount of $2,970 for Mr. Bernier and $2,351 for Mr. Watson were included. The amount of $110,000 for Mr. Meshako reflects his severance. |
Grants of Plan-Based Awards
| | | | | | | | | | | | | | | | | | | | | | | |
GRANTS OF PLAN-BASED AWARDS |
| | | | | | | | | | | | | | | | | | All Other Stock | | | | | |
| | | | | | Estimated Future Payouts Under | | | Awards: Number of | | | Grant Date Fair | |
| | | | | | Non-Equity Incentive Plan | | | Shares of Stock or | | | Value of Stock and | |
Name | | | Grant Date | | | Awards | | | Units (1)(2) | | | Option Awards | |
| | | | | | | Threshold | | | | Target | | | | Maximum | | | | | | | | |
Geoffrey R. Hesslink | | | 5/27/2016 | | | $ | 41,300 | | | $ | 103,250 | | | $ | 154,875 | | | 2,880 | | | $ | 88,502 | |
Marie A. Thresher | | | 5/27/2016 | | | $ | 28,800 | | | $ | 72,000 | | | $ | 108,000 | | | 1,562 | | | $ | 48,000 | |
Richard M. Donovan (3) | | | 5/27/2016 | | | $ | — | | | $ | — | | | $ | — | | | — | | | $ | — | |
Eric A. Segal (3) | | | 5/27/2016 | | | $ | — | | | $ | — | | | $ | — | | | — | | | $ | — | |
Thomas J. Meshako (3) | | | 5/27/2016 | | | $ | — | | | $ | — | | | $ | — | | | — | | | $ | — | |
Bruce A. Bernier | | | 5/27/2016 | | | $ | 18,500 | | | $ | 46,250 | | | $ | 69,375 | | | 1,204 | | | $ | 36,999 | |
Jonathan D. Watson | | | 5/27/2016 | | | $ | 13,500 | | | $ | 33,750 | | | $ | 50,625 | | | 879 | | | $ | 27,012 | |
| (1) | | There are no specific Company or individual performance goals tied to equity grants. Awards are granted based on the Compensation Committee’s holistic assessment of performance (the Company and/or individual) for the prior year(s). The Committee will determine the equity components for each plan year on an annual basis (i.e. stock options only, mix of stock options and restricted stock etc.). |
| (2) | | Reflects the number of shares of restricted stock granted by Merchants during 2016 pursuant to the Amended and Restated 2008 Stock Incentive Plan. The restricted stock grants made on May 27, 2016 to each of the executive officers vest on the third anniversary date of the grant, subject to acceleration upon consummation of the merger with Community. |
| (3) | | Mr. Donovan, Mr. Segal and Mr. Meshako were not eligible for participation in the 2016 Plan. |
Outstanding Equity Awards at Year-End 2016
The following table sets forth outstanding equity awards to our NEOs at December 31, 2016.
| | | | | | | | | | | | | | |
OUTSTANDING EQUITY AWARDS AT YEAR-END |
| | | Stock Awards | |
| | | | | | | | | | | | | | |
| | | | | | | | | Number of | | | Market Value | |
| | | | | | | | | Shares or | | | of Shares or | |
| | | | | | | | | Units of Stock | | | Units of Stock | |
| | | Grant | | | Vesting | | | That Have | | | That Have | |
Name (1) | | | Date | | | Date | | | Not Vested | | | Not Vested | |
Geoffrey R. Hesslink | | | 5/15/2014 | | | 5/15/2017 | | | 1,539 | | | $ | 83,414 | |
| | | 5/28/2015 | | | 5/28/2018 | | | 1,734 | | | $ | 93,983 | |
| | | 5/27/2016 | | | 5/27/2019 | | | 2,880 | | | $ | 156,096 | |
Bruce A. Bernier | | | 5/27/2016 | | | 5/27/2019 | | | 1,204 | | | $ | 65,257 | |
| (1) | | Due to the pending merger and in order to mitigate potential excise taxes triggered by the merger, Merchants accelerated the vesting date for the stock awards granted in 2014, 2015 and 2016 for Ms. Thresher and Mr. Watson. |
Options Exercises and Stock Vested 2016
The following table sets forth information with respect to the aggregate amount of options exercised and stock awards vesting during the last fiscal year and the value realized thereon.
| | | | | | | | |
OPTIONS EXERCISED AND STOCK VESTED |
| | | Stock Awards (1) | |
| | | Number of Shares | | | | | |
| | | Acquired on | | | Value Realized on | |
Name | | | Vesting | | | Vesting | |
Geoffrey R. Hesslink | | | 1,219 | | | $ | 34,997 | |
Marie A. Thresher | | | 3,182 | | | $ | 91,355 | |
Jonathan D. Watson | | | 879 | | | $ | 25,236 | |
| (1) | | Value is based on the number of shares that vested on May 16, 2016 multiplied by the market price per share on the vest date, which was $28.71. |
Retirement Benefits
Prior to January 1995, we maintained a noncontributory defined benefit plan covering all eligible employees. During 1995, this plan was curtailed. Accordingly, all accrued benefits were fully vested and no additional years of service or increases in compensation will be taken into account in determining the benefit. Due to the frozen status of the plan, no further years of service will accrue. None of the current NEOs were participants of the noncontributory defined benefit plan.
Potential Payments upon Termination or Change in Control
The following table summarizes payments and benefits that would be payable to each of the NEOs pursuant to each individual’s employment agreement in the event of his or her termination of employment, including termination following or upon the occurrence of a change in control. The amounts shown in the table below assume that the effective date of the NEO’s termination of employment was December 31, 2016. The closing market price of our common stock on December 31, 2016 was $54.20.
| | | | | | | | | |
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE-IN-CONTROL |
| | | Discharge without | | | | | |
| | | cause or Resignation | | | Change in | |
Form of Compensation | | | with Good Reason (1) | | | Control (2) | |
Geoffrey R. Hesslink | | | | | | | | | |
Cash Severance (3) | | | $ | 427,000 | | | $ | 1,384,250 | |
Value of accelerated vesting of equity awards | | | $ | — | | | $ | 333,493 | |
Estimated value of benefits continuation | | | $ | 23,148 | | | $ | 34,721 | |
Total | | | $ | 450,148 | | | $ | 1,752,464 | |
Marie A. Thresher | | | | | | | | | |
Cash Severance | | | $ | 305,000 | | | $ | 682,000 | |
Value of accelerated vesting of equity awards (4) | | | $ | — | | | $ | 123,468 | |
Estimated value of benefits continuation | | | $ | — | | | $ | — | |
Total | | | $ | 305,000 | | | $ | 805,468 | |
Richard M. Donovan (5) | | | | | | | | | |
Cash Severance | | | $ | 55,479 | | | $ | — | |
Value of accelerated vesting of equity awards | | | $ | — | | | $ | — | |
Estimated value of benefits continuation | | | $ | — | | | $ | — | |
Total | | | $ | 55,479 | | | $ | — | |
Bruce A. Bernier | | | | | | | | | |
Cash Severance | | | $ | 260,000 | | | $ | 566,250 | |
Value of accelerated vesting of equity awards (4) | | | $ | — | | | $ | 65,257 | |
Estimated value of benefits continuation | | | $ | 21,444 | | | $ | 32,166 | |
Total | | | $ | 281,444 | | | $ | 663,673 | |
Jonathan Watson | | | | | | | | | |
Cash Severance | | | $ | 171,000 | | | $ | 375,750 | |
Value of accelerated vesting of equity awards (4) | | | $ | — | | | $ | 20,162 | |
Estimated value of benefits continuation | | | $ | 21,444 | | | $ | 32,166 | |
Total | | | $ | 192,444 | | | $ | 428,078 | |
| (1) | | For a termination without cause or with “Good Reason” not in connection with a change in control severance benefits equal to one times base salary plus a prorated bonus if the termination occurs after March 31 are payable in substantially equal installments over 12 months for all executive officers. The executive shall also be entitled to receive health continuation for 12 months at our expense. The agreements require the executives to furnish a written release of claims prior to payment of severance benefits. Under the agreements, “Cause” means, among other things, illegal acts, gross misconduct or the executive’s failure to perform in any material respect his or her obligations under the agreement; and “Good Reason” means, among other things, a material diminution of responsibility or salary; a change in location of more than 50 miles from the executive’s current location; or the inability of the Company to perform its obligations under the agreement. |
| (2) | | Except if termination occurs after a change in control, the total amount of the benefit is subject to reduction under Sections 280G and 4999 of the Internal Revenue Code to the extent necessary to avoid the payment of “excess parachute payments” subject to excise tax. For a termination without cause or with “Good Reason” within 24 months following a change in control, each executive is entitled to lump sum cash payment equal to 24 months of pay, and 36 months for Mr. Hesslink, plus a prorated bonus if the termination occurs after March 31. The executive shall also be entitled to receive health continuation for 18 months at our expense. |
| (3) | | Effective January 1, 2016, Mr. Hesslink was promoted to President and Chief Executive Officer of Merchants. The cash severance payments listed above reflect his new base salary. |
| (4) | | Under the Company’s long-term equity incentive plan, upon a change in control of the Company, all outstanding stock options become exercisable and all unvested restricted stock awards subject to time-based vesting conditions vest fully. The amount shown in the table reflects |
the value of accelerated vesting of unvested restricted stock awards valued at $54.20 per share (the closing price of the Company’s common stock on December 31, 2016, as reported on Nasdaq). All outstanding options are currently vested and exercisable. |
| (5) | | Effective December 19, 2016 Mr.Donovan entered into an employment agreement with Merchants. The amounts shown in the table reflect the payment he would receive if terminated without cause prior to the closing of the pending merger. |
Compensation of Directors
Only non-employee members of our Board of Directors received fees with respect to their services on our Board of Directors in 2016. The following table reflects the fee schedule for our Board of Directors for 2016:
| | | | | | | | | | | | | | | | | |
| | | Chairperson | | | Member | | | Fee per Meeting | | | Fee per Meeting | |
| | | Retainer | | | Retainer | | | (in person) | | | (via telephone) | |
Board of Directors | | | $ | 5,000 | | | $ | 10,000 | | | $ | 500 | | | $ | 250 | |
Audit Committee | | | $ | 7,000 | | | $ | — | | | $ | 700 | | | $ | 250 | |
Compensation Committee | | | $ | 5,000 | | | $ | — | | | $ | 600 | | | $ | 250 | |
Nominating and Governance Committee | | | $ | 3,000 | | | $ | — | | | $ | 500 | | | $ | 250 | |
The following table reflects the fee schedule for Merchants Bank’s Board of Directors for 2016:
| | | | | | | | | | | | | | | | | |
| | | Chairperson | | | Member | | | Fee per Meeting | | | Fee per Meeting | |
| | | Retainer | | | Retainer | | | (in person) | | | (via telephone) | |
Board of Directors | | | $ | 5,000 | | | $ | 10,000 | | | $ | 800 | | | $ | 250 | |
Audit Committee | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Compensation Committee | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Directors' Loan Committee | | | $ | 2,000 | | | $ | — | | | $ | 250 | | | $ | 125 | |
Nominating and Governance Committee | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Other Committees | | | $ | 1,000 | | | $ | — | | | $ | 250 | | | $ | 250 | |
Committee meeting on the same day as a Board meeting | | | $ | — | | | $ | — | | | $ | 125 | | | $ | 125 | |
Although our Audit Committee, Nominating and Governance Committee, and Compensation Committee also act as Merchants Bank-level committees, the committee chairperson and members are paid at the holding company level only. All retainers and chairperson fees are paid in quarterly installments.
In 2008, our Board of Directors and stockholders voted to adopt the 2008 Compensation Plan for Non-Employee Directors and Trustees. This plan permits non-employee directors to defer receipt of their annual retainer and meeting fees by receiving those fees at a later date in the form of our common stock. If a participating director elects to have all or a specified percentage of his or her compensation for a given year deferred, that director is credited with a number of shares of our common stock equal in value to the amount deferred.
Director Compensation
The following table sets forth information about fees earned by our directors for their service during 2016. The table includes compensation paid to directors who serve on our Board of Directors, as well as compensation paid for service on the board of our subsidiary, Merchants Bank.
| | | | | | | | | | |
| | | Fees Earned | | | | | | |
| | | or Paid in | | | | | | |
Name | | | Cash (1) | | | | Total | |
Geoffrey R. Hesslink | | | $ | – | | | | $ | – | |
Scott F. Boardman | | | $ | 42,333 | | | | $ | 42,333 | |
Janette K. Bombardier | | | $ | 37,875 | | | | $ | 37,875 | |
Donald R. Chase | | | $ | 51,150 | | | | $ | 51,150 | |
Karen J. Danaher | | | $ | 57,200 | | | | $ | 57,200 | |
Jeffrey L. Davis | | | $ | 66,250 | | | | $ | 66,250 | |
Michael G. Furlong | | | $ | 45,700 | | | | $ | 45,700 | |
Joseph F. Larkin | | | $ | 28,350 | | | | $ | 28,350 | |
Lorilee A. Lawton | | | $ | 43,600 | | | | $ | 43,600 | |
Bruce M. Lisman | | | $ | 15,950 | | | | $ | 15,950 | |
Raymond C. Pecor, Jr. | | | $ | 15,150 | | | | $ | 15,150 | |
Raymond C. Pecor, III | | | $ | 43,317 | | | | $ | 43,317 | |
Patrick S. Robins | | | $ | 18,800 | | | | $ | 18,800 | |
Michael R. Tuttle | | | $ | 42,750 | | | | $ | 42,750 | |
TOTAL | | | | | | | | $ | 508,425 | |
| (1) | | Includes all fees earned, whether paid in cash or deferred under the 2008 Compensation Plan for Non-Employee Directors and Trustees. |
Compensation Committee Interlocks and Insider Participation
Janette K. Bombardier, Donald R. Chase, Karen J. Danaher, Jeffrey L. Davis, and Lorilee A. Lawton served as members of the Compensation Committee from January 1, 2016 through May 26, 2016. Donald R. Chase, Karen J. Danaher, Jeffrey L. Davis, and Raymond C. Pecor III served as members of the Compensation Committee effective May 26, 2016 through December 31, 2016. None of the members of the Compensation Committee have ever been an employee of the Company or any of its subsidiaries.
ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth, as of February 2, 2017, certain information concerning the beneficial ownership of our common stock by (i) each person known by us to own beneficially five percent (5%) or more of the outstanding shares of our common stock; (ii) each of our directors, director nominees and the NEO’s; and (iii) all executive officers and directors as a group.
The number of shares beneficially owned by each 5% stockholder, director or executive officer is determined under SEC rules, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under those rules, beneficial ownership includes any shares as to which the individual or entity has sole or shared voting power or investment power and also any shares which the individual or entity has the right to acquire within 60 days after February 2, 2017 through the exercise of any stock option or other right. Unless otherwise indicated, each person or entity has sole investment and voting power (or shares such power with his or her spouse) with respect to the shares set forth in the following table. The inclusion herein of any shares deemed beneficially owned does not constitute an admission of beneficial ownership of those shares.
| | | | | | | | | |
| | | | | | Percentage of | |
| | | Amount and Nature of | | | Common Stock | |
Name of Beneficial Owner (1) | | | Beneficial Ownership (2)(3) | | | Beneficially Owned (4) | |
5% Stockholders | | | | | | | | | |
Charles A. Davis | | | 462,883 | (5) | | | 6.7 | % | |
Stone Point Capital LLC | | | | | | | | | |
20 Horseneck Lane | | | | | | | | | |
Greenwich, Connecticut 06830 | | | | | | | | | |
BlackRock, Inc. | | | 436,324 | (6) | | | 6.3 | % | |
55 East 52nd Street | | | | | | | | | |
New York, NY 10022 | | | | | | | | | |
Chicago Capital Management LLC | | | 397,823 | (7) | | | 5.8 | | |
311 South Wacker Drive | | | | | | | | | |
Chicago, IL 60606 | | | | | | | | | |
| | | | | | | | | |
Directors, Director Nominees and Executive Officers | | | | | | | | | |
Laura M. Abbott | | | 474 | | | | * | | |
Scott F. Boardman | | | 22,734 | (8) | | | * | | |
Janette K. Bombardier | | | 650 | | | | * | | |
Anita L. Bourgeois | | | 234 | | | | * | | |
Michael J. Cataldo | | | 451 | | | | * | | |
Donald R. Chase | | | 29,648 | | | | * | | |
Karen J. Danaher | | | 4,765 | | | | * | | |
Jeffrey L. Davis | | | 30,040 | (9) | | | * | | |
Jacqueline S. Dragon | | | 448 | | | | * | | |
Michael G. Furlong | | | 8,008 | | | | * | | |
Geoffrey R. Hesslink | | | 23,470 | | | | * | | |
Joseph F. Larkin | | | — | | | | * | | |
Lorilee A. Lawton | | | 10,720 | (10) | | | * | | |
Raymond C. Pecor, III | | | 18,467 | (11) | | | * | | |
Marie A. Thresher | | | 904 | | | | * | | |
Michael R. Tuttle | | | 81,306 | (12) | | | 1.2 | % | |
Jonathan D. Watson | | | 507 | | | | * | | |
Directors and Executive Officers as a Group (eighteen persons) | | | 232,826 | | | | 3.4 | % | |
*Stockholdings represent less than 1.0% of class.
| (1) | | The address for all executive officers and directors is c/o Merchants Bancshares, Inc., 275 Kennedy Drive, South Burlington, Vermont 05403. |
| (2) | | Includes the following number of shares of common stock issuable upon the exercise of outstanding stock options which were exercisable within 60 days after March 10, 2017 as follows: |
| | | | |
Directors and Executive Officers | | | Vested Options | |
Michael R. Tuttle | | | 26,520 | |
| (3) | | Does not include the following number of shares of common stock which certain directors and executive officers have the right to receive on a deferred basis pursuant to our prior and current deferred compensation plans for directors and executive salary continuation plan: |
| | | | |
Directors and Executive Officers | | | Deferred Shares | |
Scott F. Boardman | | | 18,533 | |
Janette K. Bombardier | | | 4,004 | |
Jeffrey L. Davis | | | 56,724 | |
Michael G. Furlong | | | 10,386 | |
Joseph F. Larkin | | | 776 | |
Lorilee A. Lawton | | | 32,208 | |
Raymond C. Pecor, III | | | 8,444 | |
Total Deferred Shares | | | 131,075 | |
The individuals named above do not have the power to vote or dispose of these deferred shares. Merchants has the authority to vote these deferred shares.
| (4) | | The total number of shares outstanding used in calculating this percentage assumes the exercise of all options to acquire shares of common stock that are exercisable on or within 60 days after February 2, 2017 held by the beneficial owner and that no options held by other beneficial owners are exercised. Shares outstanding as of February 2, 2017 include 131,074 deferred shares held in various trusts related to our former and current deferred compensation plans for directors and executive salary continuation plan (See note 3). Merchants has the authority to vote these deferred shares. |
| (5) | | Until February 21, 2008, Mr. C. Davis was a member of our Board of Directors. |
| (6) | | Information has been obtained from Schedule 13G/A filed January 25, 2017 with the SEC by BlackRock, Inc. BlackRock, Inc. has sole voting power over 445,155 shares and sole dispositive power over 462,883 shares. |
| (7) | | Information has been obtained from Schedule 13F filed December 31, 2016 with the SEC by Chicago Capital Management LLC. Chicago Capital Management LLC has sole voting power over 380,949 shares. |
| (8) | | Includes 22,717 shares owned by Mr. Boardman’s spouse. |
| (9) | | Includes 6,912 shares held in trust for Mr. J. Davis’ children, 724 shares held directly by Mr. J. Davis’ son and 1,260 shares held directly by Mr. J. Davis’ spouse. Also includes 595 shares held by a family trust, of which Mr. J. Davis is trustee. Mr. J. Davis disclaims beneficial ownership of these shares. |
| (10) | | Includes 8,959 shares held in the Lorilee A. Lawton Trust. |
| (11) | | Includes 9,386 shares held in trust for Mr. Pecor, III’s niece and nephew, for which Mr. Pecor, III is trustee. Mr. Pecor, III disclaims beneficial ownership of shares held in these trusts. |
| (12) | | Includes 46,863 shares held in the Michael R. Tuttle Trust. |
ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Our Board of Directors has determined that all of the following directors are independent under the Nasdaq Listing Rules and in accordance with the Principles of Governance adopted by our Board of Directors: Scott F. Boardman, Janette K. Bombardier, Donald R. Chase, Karen J. Danaher, Jeffrey L. Davis, Michael G. Furlong, Joseph F. Larkin, Lorilee A. Lawton and Raymond C. Pecor, III.
Certain of our directors and executive officers, as well as members of their immediate families and the companies, organizations, trusts, and other entities with which they are associated, are, or during 2016 were, also customers of Merchants Bank in the ordinary course of business. As permitted by applicable law, these persons may have had loans outstanding during 2016, and it is anticipated that these persons and their associates will continue to be customers of and indebted to Merchants Bank in the future. All of these loans were made in the ordinary course of business, and did not involve more than normal risk of collectability or present other unfavorable features, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unaffiliated persons and, where required by law, received prior approval by Merchants Bank’s Board of Directors. At December 31, 2016, these loans totaled approximately $17.8 million (11.4% of total stockholders’ equity). None of these loans to directors, executive officers, or their associates are nonperforming.
We have established guidelines for review of third party contracted services including insider relationships, which are reviewed annually by the Audit Committee. Our officers are assigned responsibility for review of service levels of outsourced technology service providers and vendors that pose the highest risk exposure within the guidelines established by the Federal Financial Institutions Examination Council (“FFIEC”). New service relationships considered for engagement with our insiders of Merchants Bank (defined by the FFIEC as individuals, their direct family members and business associates who are executive officers or directors of us and/or Merchants Bank) must be bid on by at least one
other service provider. Merchants Bank’s Board of Directors may require a third party analysis or review to substantiate the results of a new service contract with an insider.
Renewals of existing contracts with insiders of Merchants or Merchants Bank do not require re-bidding or a third party analysis. However, the Chief Executive Officer or the Board of Directors of Merchants Bank may require either or both prior to reviewing a recommendation for a contract renewal.
We obtained legal services during 2016 from the firm of Sheehey Furlong & Behm P.C., of which Michael G. Furlong is a principal member. Mr. Furlong is a member of our Board of Directors and is the Chairman of Merchants Bank’s Board of Directors. We paid fees totaling approximately $69,965 to Mr. Furlong’s firm in 2016.
We obtained insurance during 2016 through an insurance agency, of which Scott F. Boardman, a member of our Board of Directors and the Board of Directors of Merchants Bank, is president. In 2016, commissions paid to this insurance agency totaled approximately $52,520.
These transactions were approved pursuant to the policies and procedures set forth above. In the opinion of our management, the terms of these transactions were no less favorable to us than those we could have obtained from an unrelated party providing comparable premises or services.
ITEM 14 – PRINCIPAL ACCOUNTING FEES AND SERVICES
Principal Accounting Fees and Services
The Audit Committee has selected the firm of Crowe Horwath LLP as Merchants’ independent registered public accounting firm for 2016. We have been advised by Crowe Horwath LLP and by the directors themselves that neither it nor any of its members or associates has any relationship with us or our subsidiaries, other than as independent auditors.
The following tables present fees for professional audit services rendered by Crowe Horwath LLP for the audit of our annual consolidated financial statements for the fiscal years ended December 31, 2016 and 2015, and fees billed for other services provided by Crowe Horwath LLP during 2016 and 2015, respectively.
| | | | | | | | | |
Fees paid to Crowe Horwath LLP | | | 2016 | | | | 2015 | |
Audit Fees (1) | | | $ | 240,325 | | | $ | 245,840 | |
Audit Related Fees | | | | — | | | | — | |
Tax Fees | | | | — | | | | — | |
All Other Fees (2)(3) | | | | 64,050 | | | | 58,200 | |
| (1) | | Audit Fees consist of fees billed for professional services rendered for the audit of our consolidated annual financial statements and review of the interim consolidated financial statements included in the quarterly reports and services that are normally provided by Crowe Horwath LLP in connection with statutory and regulatory filings or engagements. |
| (2) | | Crowe Horwath rendered additional audit services to us associated with the definitive merger agreement Merchants Bancshares, Inc entered into with Community Bank System, Inc. on October 22, 2016. |
| (3) | | Crowe Horwath rendered additional audit services to us associated with Merchants Bancshares, Inc. acquisition of NUVO Bank & Trust during the year ended December 31, 2015. |
Report of the Audit Committee
The Audit Committee has reviewed and discussed our audited financial statements for the year ended December 31, 2016 with our management.
The Audit Committee has discussed with Crowe Horwath LLP, our independent registered public accounting firm, the matters required to be discussed by the Statement on Auditing Standards No. 16, as amended, as adopted by the Public Company Accounting Oversight Board in Rule 3200T.
The Audit Committee has received the written disclosures and the letter from Crowe Horwath LLP by the applicable requirements of the Public Company Accounting Oversight Board regarding the independent accountant’s communications with the Audit Committee concerning independence, and has discussed with the independent accountant the independent accountant’s independence.
Based on the review and discussions with management and Crowe Horwath LLP described above, the Audit Committee recommended to our Board of Directors that the audited consolidated financial statements be included in our Annual Report on Form 10-K for the year ended December 31, 2016 and for filing with the SEC.
Submitted by the Audit Committee
Karen J. Danaher, Chair
Donald R. Chase
Jeffrey L. Davis
Lorilee A. Lawton
PART IV
ITEM 15 – EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(1)The following consolidated financial statements are included:
Consolidated Balance Sheets, December 31, 2016, and December 31, 2015
Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
Notes to Consolidated Financial Statements
(2)The following exhibits are either filed or attached as part of this report, or are incorporated herein by reference:
| | |
Exhibit | | Description |
| | |
2.1 | | Agreement and Plan of Merger dated as of April 27, 2015, between Merchants and NUVO Bank & Trust Company (Incorporated by reference to Exhibit 2.1 to Merchants’ Current Report on Form 8-K filed on April 27, 2015) |
| | |
2.2 | | Bank Merger Agreement dated as of July 2, 2015, between Merchants Bank and NUVO Bank & Trust Company, and joined in for certain limited purposes by Merchants (Incorporated by reference to Exhibit 2.1 to Merchants’ Current Report on Form 8-K filed on July 9, 2015) |
| | |
2.3 | | Agreement and Plan of Merger dated as of October 22, 2016, between Community and Merchants (Incorporated by reference to Exhibit 2.1 to Merchants’ Current Report on Form 8-K filed on October 24, 2016) |
| | |
3.1.1 | | Certificate of Incorporation, filed on April 20, 1987 (Incorporated by reference to Exhibit 3.1.1 to Merchants’ Annual Report on Form 10-K filed March 8, 2012) |
| | |
3.1.2 | | Certificate of Merger, filed on June 5, 1987 (Incorporated by reference to Exhibit 3.1.2 to Merchants’ Annual Report on Form 10-K filed on March 16, 2007) |
| | |
3.1.3 | | Certificate of Amendment, filed on May 11, 1988 (Incorporated by reference to Exhibit 3.1.3 to Merchants’ Annual Report on Form 10-K filed on March 16, 2007) |
| | |
3.1.4 | | Certificate of Amendment, filed on April 29, 1991 (Incorporated by reference to Exhibit 3.1.4 to Merchants’ Annual Report on Form 10-K filed on March 16, 2007) |
| | |
3.1.5 | | Certificate of Amendment, filed on August 29, 2006 (Incorporated by reference to Exhibit 3.1.5 to Merchants’ Annual Report on Form 10-K filed on March 16, 2007) |
| | |
3.1.6 | | Certificate of Amendment, filed August 29, 2006 (Incorporated by reference to Exhibit 3.1.6 to Merchants’ Annual Report on Form 10-K filed on March 16, 2007) |
| | |
3.2 | | Amended and Restated Bylaws of Merchants Bancshares, Inc. (Incorporated by reference to Exhibit 3.2 to Merchants’ Annual Report on Form 10-K filed on March 10, 2014) |
| | |
4.1 | | Specimen of Merchants’ Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to Merchants’ Annual Report on Form 10-K filed on March 13, 2008) |
| | |
4.2 | | Form of Replacement Organizers’ Warrant to Purchase Merchants Common Stock, to be issued in connection with the Merger (Incorporated by reference to Exhibit 4.2 to Merchants’ Registration Statement on Form S-4/A (Registration No. 333-206021) filed on August 13, 2015) |
| | |
4.3 | | Form of Replacement 2013 Warrant to Purchase Merchants Common Stock, to be issued in connection with the Merger (Incorporated by reference to Exhibit 4.3 to Merchants’ Registration Statement on Form S-4/A (Registration No. 333-206021) filed on August 13, 2015) |
| | |
10.1 | | Merchants Bancshares, Inc. Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Exhibit 4.1 to Merchants’ Registration Statement on Form S-3 (Registration No. 333-151572) filed on June 11, 2008) |
| | |
10.2 | | Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 to Merchants’ Current Report on Form 8-K filed on May 6, 2011) + |
| | |
10.3 | | First Amendment to Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan (Incorporated by reference to Exhibit 10.3 to Merchants’ Annual Report on Form 10-K filed on March 8, 2012) + |
| | |
10.4 | | Form of Restricted Stock Agreement (Incorporated by reference to Exhibit 10.4 to Merchants’ Annual Report on Form 10-K filed on March 8, 2012) + |
| | |
10.5 | | The Merchants Bancshares, Inc. and Subsidiaries Amended and Restated 1996 Compensation Plan for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 to Merchants’ Annual Report on Form 10-K filed on March 15, 2011) + |
| | |
10.6 | | The Merchants Bancshares, Inc. and Subsidiaries Amended and Restated 2008 Compensation Plan for Non-Employee Directors and Trustees (Incorporated by reference to Exhibit 10.4 to Merchants’ Annual Report on Form 10-K filed on March 15, 2011) + |
| | |
10.7 | | Merchants Bancshares, Inc. Executive Annual Incentive Plan (Incorporated by reference to Exhibit 10.1 to Merchants’ Report on Form 8-K filed on March 2, 2011) + |
| | |
10.8 | | Employment Agreement by and among Merchants Bancshares and Michael R. Tuttle, dated February 27, 2015 (Incorporated by reference to Exhibit 10.8 to Merchants’ Annual Report on Form 10-K filed on March 13, 2015) + |
10.9 | | General Release and Separation Agreement by and between Merchants, Merchants Bank and Michael R. Tuttle, dated January 21, 2016 and effective as of January 29, 2016 (Incorporated by reference to Exhibit 10.9 to Merchants’ Annual Report on Form 10-K filed on March 14, 2016)+ |
10.10 | | The Merchants Bank Amended and Restated Deferred Compensation Plan for Directors (Incorporated by reference to Exhibit 10.7 to Merchants’ Annual Report on Form 10-K filed on March 15, 2011) + |
| | |
10.11 | | Trust under the Merchants Bank Amended and Restated Deferred Compensation Plan for Directors (Incorporated by reference to Exhibit 10.8 to Merchants’ Annual Report on Form 10-K filed on March 15, 2011) + |
| | |
10.12 | | Indenture, dated December 15, 2004, by and between Merchants Bancshares, Inc. and Wilmington Trust Company, as trustee (Incorporated by reference to Exhibit 10.5 to Merchants’ Annual Report on Form 10-K filed on March 9, 2005) |
| | |
10.13 | | Guarantee Agreement, dated December 15, 2004, by and between Merchants Bancshares, Inc. and Wilmington Trust Company dated December 15, 2004 for the benefit of the holders from time to time of the Capital Securities of MBVT Statutory Trust I (Incorporated by reference to Exhibit 10.5.3 to Merchants’ Annual Report on Form 10-K filed on March 9, 2005) |
| | |
10.14 | | Declaration of Trust of MBVT Statutory Trust I, dated December 2, 2004 (Incorporated by reference to Exhibit 10.5.2 to Merchants’ Annual Report on Form 10-K filed on March 9, 2005) |
| | |
10.15 | | Subscription Agreement, dated December 15, 2004, by and among MBVT Statutory Trust I, Merchants and Preferred Term Securities XVI, Ltd. (Incorporated by reference to Exhibit 10.5.1 to Merchants’ Annual Report on Form 10-K filed on March 9, 2005) |
| | |
10.16 | | Placement Agreement, dated December 7, 2004, by and among Merchants Bancshares, Inc., FTN Financial Capital Markets and Keefe, Bruyette & Woods, Inc. (Incorporated by reference to Exhibit 10.5.4 to Merchants’ Annual Report on Form 10-K filed on March 9, 2005) |
| | |
10.17 | | Purchase and Sale Agreement between Merchants Bank and Eastern Avenue Properties, L.L.C., dated as of June 27, 2008 (Incorporated by reference to Exhibit 10.18.1 to Merchants’ Quarterly Report on Form 10-Q filed on August 7, 2008) |
| | |
10.18 | | Leaseback Agreement between Merchants Bank and Farrell Exchange, L.L.C., dated as of June 27, 2008 (Incorporated by reference to Exhibit 10.18.2 to Merchants’ Quarterly Report on Form 10-Q filed on August 7, 2008) |
| | |
10.19 | | Employment Agreement by and between Merchants Bank and Thomas J. Meshako, dated November 10, 2014 (Incorporated by reference to Exhibit 10.20 to Merchants’ Annual Report on Form 10-K filed on March 13, 2015)+ |
| | |
10.20 | | Employment Agreement by and between Merchants Bank and Marie Thresher, dated December 19, 2013 (Incorporated by reference to Exhibit 10.22 to Merchants’ Annual Report on Form 10-K filed on March 13, 2015)+ |
| | |
10.21 | | Employment Agreement by and between Merchants, Merchants Bank and Geoffrey R. Hesslink, entered into on April 23, 2015 and effective as of April 16, 2015 (Incorporated by reference to Exhibit 10.1 to Merchants’ Current Report on Form 8-K filed on April 29, 2015) + |
| | |
10.22 10.23 | | Employment Agreement by and between Merchants, Merchants Bank and Thomas J. Meshako, entered into on April 23, 2015 and effective as of April 16, 2015 (Incorporated by reference to Exhibit 10.2 to Merchants’ Current Report on Form 8-K filed on April 29, 2015) + General Release and Separation Agreement by and between Merchants, Merchants Bank and Thomas J. Meshako, dated as of January 7, 2016 and effective as of January 15, 2016 (Incorporated by reference to Exhibit 10.25 to Merchants’ Annual Report on Form 10-K filed on March 14, 2016)+ |
| | |
10.24 | | Form of Employment Agreement by and between Merchants, Merchants Bank and certain executive officers, entered into on April 23, 2015 (Incorporated by reference to Exhibit 10.3 to Merchants’ Current Report on Form 8-K filed on April 29, 2015) + |
| | |
10.25 | | Employment Agreement by and between Merchants, Merchants Bank and Richard M. Donovan, entered into on December 16, 2016 (Incorporated by reference to Exhibit 10.1 to Merchants’ Current Report on Form 8-K filed on December 21, 2016)+ |
| | |
10.26 | | Letter Agreement by and between Merchants and Marie Thresher, entered into on December 16, 2016 (Incorporated by reference to Exhibit 10.1 to Merchants’ Current Report on Form 8-K filed on December 21, 2016) |
| | |
10.27 | | Employment Agreement by and between Merchants, Merchants Bank and Anita L. Bourgeois, entered into on May 26, 2016 (Incorporated by reference to Exhibit 10.1 to Merchants’ Quarterly Report on Form 10-Q filed on August 3, 2016)+ |
| | |
10.28 | | Employment Agreement by and between Merchants Bank and Robert G. Ripley, Jr., entered into on October 3, 2016 (Incorporated by reference to Exhibit 10.2 to Merchants’ Quarterly Report on Form 10-Q filed on November 7, 2016)+ |
| | |
10.29 | | Employment Agreement by and between Merchants, Merchants Bank and CFO Consulting Partners LLC, entered into on January 7, 2016+* |
| | |
10.30 | | Amendment to the Employment Agreement by and between Merchants, Merchants Bank and CFO Consulting Partners LLC, entered into on January 7, 2016+* |
| | |
10.31 | | Employment Agreement by and between Merchants, Merchants Bank and Bruce A. Bernier, entered into on April 15, 2015+* |
| | |
10.32 | | Employment Agreement by and between Merchants, Merchants Bank and Jonathan D. Watson, entered into on April 16, 2015+* |
| | |
21 | | Subsidiaries of Merchants (Incorporated by reference to Exhibit 21 to Merchants’ Annual Report on Form 10-K filed on March 8, 2012) |
| | |
23.1 | | Consent of Crowe Horwath LLP* |
| | |
31.1 | | Certification of Chief Executive Officer Pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended* |
| | |
31.2 | | Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended* |
| | |
32.1 | | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002** |
| | |
32.2 | | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002** |
| | |
101 | | The following materials from Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2015 formatted in XBRL: (i) Consolidated Balance Sheets at December 31, 2016 and December 31, 2015; (ii) Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014; and (vi) Notes to Consolidated Financial Statements* |
+Management contract or compensatory plan or agreement
*Filed herewith
**Furnished herewith
ITEM 16 – FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirement of Section 13 or 15 (d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Merchants Bancshares, Inc.
| | | | |
Date | March 15, 2017 | | By | /s/ Geoffrey R. Hesslink |
| | | | Geoffrey R. Hesslink, President and CEO |
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MERCHANTS BANCSHARES, INC., and in the capacities and on the date as indicated.
| | |
/s/ Geoffrey R. Hesslink | | March 15, 2017 |
Geoffrey R. Hesslink, Director, | | Date |
President & CEO of Merchants | | |
| | |
/s/ Scott F. Boardman | | March 15, 2017 |
Scott F. Boardman, Director | | Date |
| | |
/s/Janette K. Bombardier | | March 15, 2017 |
Janette Bombardier, Director | | Date |
| | |
/s/ Donald R. Chase | | March 15, 2017 |
Donald R. Chase, Director | | Date |
| | |
/s/ Karen J. Danaher | | March 15, 2017 |
Karen J. Danaher, Director | | Date |
| | |
/s/ Jeffrey L. Davis | | March 15, 2017 |
Jeffrey L. Davis, Director | | Date |
Chairman of the Board of Directors | | |
| | |
/s/ Michael G. Furlong | | March 15, 2017 |
Michael G. Furlong, Director | | Date |
| | |
/s/ Joseph F. Larkin | | March 15, 2017 |
Joseph F. Larkin, Director | | Date |
| | |
/s/ Lorilee A. Lawton | | March 15, 2017 |
Lorilee A. Lawton, Director | | Date |
| | |
/s/ Raymond C. Pecor III | | March 15, 2017 |
Raymond C. Pecor III, Director | | Date |
| | |
/s/ Michael R. Tuttle | | March 15, 2017 |
Michael R. Tuttle, Director | | Date |
| | |
/s/ Richard M. Donovan | | March 15, 2017 |
Richard M. Donovan, Interim Principal Financial Officer, | | Date |
Principal Accounting Officer and Treasurer | | |
