SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
COMMISSION FILE NUMBER 0-11595
MERCHANTS BANCSHARES, INC.
(A DELAWARE CORPORATION)
EMPLOYER IDENTIFICATION NO. 03-0287342
164 College Street, Burlington, VT 05401
Telephone: (802) 658-3400
Indicate by check mark whether the registrant has filed all reports required
to be filed by section 13 or 15(D) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and has been subject to such
filing requirement for the past 90 days.
YES X NO
----- -----
4,154,784 Shares Common Stock $.01 Par Outstanding November 10, 2000
MERCHANTS BANCSHARES, INC.
INDEX TO FORM 10-Q
PART I
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets
September 30, 2000 and December 31, 1999 1
Consolidated Statements of Operations
For the three months ended September 30, 2000 and 1999 and
the nine months ended September 30, 2000 and 1999 2
Consolidated Statements of Comprehensive Income
For the three months ended September 30, 2000 and 1999 and
the nine months ended September 30, 2000 and 1999 3
Consolidated Statement of Changes in Stockholders' Equity
For the year ended December 31, 1999, and the nine months
ended September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows
For the nine months ended September 30, 2000 and 1999 5
Footnotes to Financial Statements as of September 30, 2000 6-8
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-14
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 15-16
ITEM 2 Changes in Securities NONE
ITEM 3 Defaults upon Senior Securities NONE
ITEM 4 Submission of Matters to a Vote of Security Holders NONE
ITEM 5 Other Information NONE
ITEM 6 Exhibits and Reports on Form 8-K NONE
SIGNATURES 17
Merchants Bancshares, Inc.
Consolidated Balance Sheets
September 30, December 31,
(In thousands except share and per share data) 2000 1999
- ----------------------------------------------------------------------------------------------
Unaudited
ASSETS
Cash and Due from Banks $ 32,529 $ 23,746
Investments:
Debt Securities Held for Sale 86,687 72,229
Debt Securities Held to Maturity 121,249 126,281
(Fair Value of $118,896 and $122,305)
Trading Securities 1,083 1,075
- ----------------------------------------------------------------------------------------------
Total Investments 209,019 199,585
- ----------------------------------------------------------------------------------------------
Loans 477,282 453,692
Reserve for possible loan losses 10,536 11,189
- ----------------------------------------------------------------------------------------------
Net Loans 466,746 442,503
- ----------------------------------------------------------------------------------------------
Federal Home Loan Bank Stock 3,362 2,951
Federal Funds Sold 7,500 --
Bank Premises and Equipment, Net 12,853 13,175
Investment in Real Estate Limited Partnerships 2,770 2,751
Other Real Estate Owned 444 133
Other Assets 12,200 16,519
- ----------------------------------------------------------------------------------------------
Total Assets $747,423 $701,363
==============================================================================================
LIABILITIES
Deposits:
Demand $ 93,449 $ 86,160
Savings, NOW and Money Market Accounts 407,938 369,929
Time Deposits $100 thousand and Greater 29,245 25,590
Other Time 136,793 131,564
- ----------------------------------------------------------------------------------------------
Total Deposits 667,425 613,243
- ----------------------------------------------------------------------------------------------
Demand Note Due U.S. Treasury 3,596 4,000
Other Short-Term Borrowings -- 7,000
Other Liabilities 7,765 6,013
Long-Term Debt 1,536 6,371
- ----------------------------------------------------------------------------------------------
Total Liabilities 680,322 636,627
- ----------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 4)
STOCKHOLDERS' EQUITY
Preferred Stock Class A Non-Voting
Authorized - 200,000, Outstanding 0 -- --
Preferred Stock Class B Voting
Authorized - 1,500,000, Outstanding 0 -- --
Common Stock, $.01 Par Value 44 44
Shares Authorized 7,500,000
Outstanding, Current Period 4,031,576
Prior Period 4,194,810
Capital in Excess of Par Value 33,072 33,072
Retained Earnings 40,497 35,368
Treasury Stock (At Cost) (7,990) (4,699)
Current Period 403,044
Prior Period 239,810
Deferred Compensation Arrangements 2,493 2,372
Unrealized losses on Securities Available for Sale, Net (1,015) (1,421)
- ----------------------------------------------------------------------------------------------
Total Stockholders' Equity 67,101 64,736
- ----------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $747,423 $701,363
=============================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Operations
Unaudited
Quarter Ended September 30, Nine Months Ended September 30,
(In thousands except per share data) 2000 1999 2000 1999
- --------------------------------------------------------------------------------------------------------------
INTEREST AND DIVIDEND INCOME
Interest and Fees on Loans $10,601 $ 9,312 $30,901 $27,267
Interest and Dividends on Investments
U.S. Treasury and Agency Obligations 3,005 2,603 8,821 7,890
Other 604 431 1,760 974
- ---------------------------------------------------------------------------------------------------------
Total Interest Income 14,210 12,346 41,482 36,131
- ---------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Savings, NOW and Money Market Accounts 3,605 2,555 10,028 7,313
Time Deposits $100 Thousand and Greater 439 366 1,244 1,028
Other Time Deposits 1,703 1,449 4,848 4,549
Other Borrowed Funds 78 79 450 373
Debt 14 118 184 351
- ---------------------------------------------------------------------------------------------------------
Total Interest Expense 5,839 4,567 16,754 13,614
- ---------------------------------------------------------------------------------------------------------
Net Interest Income 8,371 7,779 24,728 22,517
Provision for Possible Loan Losses (128) (134) (542) (134)
- ---------------------------------------------------------------------------------------------------------
Net Interest Income after Provision
for Loan Losses 8,499 7,913 25,270 22,651
- ---------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Trust Company Income 415 426 1,328 1,339
Service Charges on Deposits 893 774 2,639 2,171
Settlement proceeds -- -- -- 1,326
Gain on Sale of Investments, Net -- -- 1 --
Other 460 325 1,191 889
- ---------------------------------------------------------------------------------------------------------
Total Noninterest Income 1,768 1,525 5,159 5,725
- ---------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSES
Salaries and Wages 2,759 2,508 8,040 7,185
Employee Benefits 596 547 2,053 1,806
Occupancy Expense, Net 550 473 1,661 1,714
Equipment Expense 626 568 1,901 1,690
Legal and Professional Fees 242 587 859 1,579
Marketing 262 315 907 889
Equity in Losses of Real Estate
Limited Partnerships 158 143 443 397
Expenses (Income) - Other Real Estate
Owned, net 21 (280) 96 (133)
Other 1,334 1,197 4,031 3,411
- ---------------------------------------------------------------------------------------------------------
Total Noninterest Expenses 6,548 6,058 19,991 18,538
- ---------------------------------------------------------------------------------------------------------
Income Before Income Taxes 3,719 3,380 10,438 9,838
Provision for Income Taxes 942 779 2,638 2,249
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 2,777 $ 2,601 $ 7,800 $ 7,589
=========================================================================================================
Basic Earnings Per Common Share $ 0.66 $ 0.59 $ 1.84 $ 1.73
Diluted Earnings Per Common Share $ 0.66 $ 0.59 $ 1.84 $ 1.73
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Comprehensive Income
Unaudited
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2000 1999 2000 1999
- ------------------------------------------------------------------------------------------------------
Net Income as Reported $2,777 $2,601 $7,800 $7,589
Change in Net Unrealized Appreciation (Depreciation)
of Securities, Net of Tax 524 557 337 (845)
- ------------------------------------------------------------------------------------------------------
Comprehensive Income Before Transfers
From Available for Sale to Held to Maturity 3,301 3,158 8,137 6,744
Impact of transfer of Securities from Available
for Sale to Held to Maturity 22 (648) 69 (650)
- ------------------------------------------------------------------------------------------------------
Comprehensive Income $3,323 $2,510 $8,206 $6,094
======================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Year Ended December 31, 1999 and
the Nine Months ended September 30, 2000 and 1999
Unaudited
Net Unrealized
Appreciation
Capital in Deferred (Depreciation)
Common Excess of Retained Treasury Compensation of Investment
(In thousands) Stock Par Value Earnings Stock Arrangements Securities Total
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $44 $33,073 $28,308 $(3,133) $2,166 $ 371 $60,829
Net Income -- -- 7,589 -- -- -- 7,589
Purchase of Treasury Stock -- -- -- (1,127) -- -- (1,127)
Issuance of Stock under Deferred
Compensation Arrangements -- -- -- 31 (31) -- --
Dividends Paid -- -- (2,504) -- -- -- (2,504)
Deferred Compensation
Arrangements -- -- -- -- 190 -- 190
Unearned Compensation --
Restricted Stock Awards -- -- -- -- (8) -- (8)
Change in Net Unrealized
Appreciation (Depreciation) of
Securities Available for Sale,
Net of Tax -- -- -- -- -- (845) (845)
Change in Net Unrealized
Appreciation of Securities
Transferred to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- (650) (650)
- ----------------------------------------------------------------------------------------------------------------------------
Balance September 30, 1999 44 33,073 33,393 (4,229) 2,317 (1,124) 63,474
Net Income -- -- 2,861 -- -- -- 2,861
Purchase of Treasury Stock -- -- -- (493) -- -- (493)
Issuance of Stock under Employee
Stock Option Plans -- (1) -- 23 -- -- 22
Dividends Paid -- -- (886) -- -- -- (886)
Deferred Compensation Arrangements -- -- -- -- 61 -- 61
Unearned Compensation --
Restricted Stock Awards -- -- -- -- (6) -- (6)
Change in Net Unrealized
Appreciation (Depreciation) of
Securities Available for Sale,
Net of Tax -- -- -- -- -- (322) (322)
Effect of transfers of Securities
Available for sale to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- (665) (665)
Change in Net Unrealized
Appreciation of Securities
Transferred to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- 690 690
- ----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 44 33,072 35,368 (4,699) 2,372 (1,421) 64,736
Net Income -- -- 7,800 -- -- -- 7,800
Purchase of Treasury Stock -- -- -- (3,341) -- -- (3,341)
Issuance of Stock under
Deferred Compensation Arrangements -- -- -- 50 (50) -- --
Dividends Paid -- -- (2,671) -- -- -- (2,671)
Deferred Compensation Arrangements -- -- -- -- 179 -- 179
Unearned Compensation --
Restricted Stock Awards -- -- -- -- (8) -- (8)
Change in Net Unrealized
Appreciation (Depreciation) of
Securities Available for Sale,
Net of Tax -- -- -- -- -- 337 337
Change in Net Unrealized
Appreciation of Securities
Transferred to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- 69 69
- ----------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 2000 $44 $33,072 $40,497 $(7,990) $2,493 $(1,015) $67,101
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statement of Cash Flows
Unaudited
For the nine months ended September 30, 2000 1999
- -----------------------------------------------------------------------------------------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 7,800 $ 7,589
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Provision for Possible Loan Losses (542) (134)
Provision for Depreciation and Amortization 1,998 1,862
Net Gains on Sales of Investment Securities (1) --
Net Gains on Sales of Loans and Leases (6) --
Net Losses on Sales of Premises and Equipment 37 148
Net Gains on Sales of Other Real Estate Owned (7) (330)
Equity in Losses of Real Estate Limited Partnerships 443 396
Changes in Assets and Liabilities:
Increase in Interest Receivable (421) (336)
Increase (Decrease) in Interest Payable 46 (501)
Decrease (Increase) in Other Assets 4,740 (596)
Increase (Decrease) in Other Liabilities 1,705 (1,556)
- -----------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 15,792 6,542
- -----------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from Sales of Investment Securities Available for Sale 8,998 --
Proceeds from Maturities of Securities Available for Sale 9,495 9,507
Proceeds from Maturities of Securities Held to Maturity 7,556 21,894
Purchases of Available for Sale Investment Securities (32,383) (23,303)
Purchases of Held to Maturity Investment Securities (2,487) (21,919)
Loan Originations in Excess of Principal Repayments (25,256) (20,595)
Proceeds from Sales of Loans and Leases 1,191 --
Purchases of Federal Home Loan Bank Stock (411) (468)
Proceeds from Sales of Other Real Estate Owned 7 947
Investments in Real Estate Limited Partnerships (440) (416)
Purchases of Premises and Equipment (1,527) (694)
- -----------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (35,257) (35,047)
- -----------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase in Deposits 54,182 27,414
Net Increase (Decrease) in Other Borrowed Funds (7,404) 3,717
Principal Payments on Debt (5,068) (35)
Cash Dividends Paid (2,671) (2,504)
Acquisition of Treasury Stock (3,291) (1,104)
- -----------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 35,748 27,488
- -----------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents 16,283 (1,017)
Cash and Cash Equivalents Beginning of Year 23,746 30,528
- -----------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $ 40,029 $ 29,511
===============================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Total Interest Payments $ 16,709 $ 14,115
Total Income Tax Payments -- 3,800
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Distribution of Stock Under Deferred Compensation Arrangements 50 31
The accompanying notes are an integral part of these consolidated financial
statements.
MERCHANTS BANCSHARES, INC.
SEPTEMBER 30, 2000
NOTES TO FINANCIAL STATEMENTS:
See the Form 10-K filed as of December 31, 1999, for additional information.
NOTE 1: RECENT ACCOUNTING DEVELOPMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended by SFAS No. 137 and SFAS No.
138. This statement establishes standards for reporting and accounting for
derivative instruments ("derivatives") and hedging activities. The statement
requires that derivatives be reported as assets or liabilities in the
Consolidated Balance Sheets and that derivatives be reported at fair value.
The statement establishes criteria for accounting for changes in the fair
value of derivatives based on the intended use of the derivatives. The
statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 2000. Based on Merchants Bank's (the Bank's) current use of
derivatives Merchants Bancshares, Inc. (the Company) does not expect the
adoption of SFAS No. 133, as amended, to have a material impact on the
Company's financial position or results of operations.
NOTE 2: EARNINGS PER SHARE
The following table presents a reconciliation of the calculations of basic
and diluted earnings per share for the quarter and nine-months ended
September 30, 2000:
Net Per Share
Quarter Ended September 30, 2000 Income Shares Amount
-------------------------------- ------ ------ ---------
(In thousands except share and per share data)
Basic Earnings Per Common Share:
Income Available to Common
Shareholders $2,777 4,185,313 $0.66
Diluted Earnings Per Common Share:
Options issued to Executives -- 4,489
Income available to Common Shareholders
Plus Assumed Conversions $2,777 4,189,802 $0.66
Net Per Share
Nine Months Ended September 30, 2000 Income Shares Amount
------------------------------------ ------ ------ ---------
(In thousands except share and per share data)
Basic Earnings Per Common Share:
Income Available to Common
Shareholders $7,800 4,244,241 $1.84
Diluted Earnings Per Common Share:
Options issued to Executives -- 3,908
Income available to Common Shareholders
Plus Assumed Conversions $7,800 4,248,149 $1.84
Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
quarter. The computation of diluted earnings per share for the quarter and
nine months ended September 30, 2000, excludes the effect of assuming the
exercise of certain outstanding stock options because the effect would be
anti-dilutive. As of September 30, 2000, there were 210,344 of such options
outstanding with exercise prices ranging from $20.438 to $30.500.
NOTE 3: STOCK REPURCHASE PROGRAM
On April 20, 2000, the Company announced that its Board of Directors had
decided to rescind the existing stock repurchase plan. The Board adopted a
new stock repurchase program, which authorized the Company to repurchase,
through April 2001, up to 200 thousand shares of its own securities. Under
the repurchase plan the stock may be purchased from time to time, subject to
prevailing market conditions. Purchases are to be made on the open market
and funded from available cash. The Company purchased 83 thousand of its own
shares at a total cost of $1.8 million under the former program. The Company
had repurchased 110 thousand of its own shares, at a total cost of $2.2
million, under the new repurchase program, as of October 31, 2000.
NOTE 4: COMMITMENTS AND CONTINGENCIES:
The Bank is a counterclaim defendant in a litigation entitled "Pasquale and
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim
Defendant", now pending in the United States Bankruptcy Court for the
District of Vermont.
In this litigation, the Vescios have made a number of "lender liability"
claims dealing with a commercial development known as Brattleboro West in
Brattleboro, Vermont. The pending litigation arose out of a suit to
foreclose on several real estate mortgages and personal property delivered
to the Bank as collateral by the Vescios in connection with the financing of
a supermarket in the Brattleboro West project and various other projects.
Among other things, the Vescios have alleged that the Bank or its
representatives violated supposed oral promises in connection with the
origination and funding of the project, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition,
the plaintiffs have contended that the Bank breached a duty of care they
believe it owed to them, and have claimed that the Bank should not have
exercised its contract rights when the loan went into default, but should
have resolved the default in a way that was more favorable to the borrowers.
Trial concluded in United States Bankruptcy Court in November 1998. In June
1999 before entry of any findings or a decision on the merits, the trial
judge recused himself from all cases involving the Bank. He completed his
term as bankruptcy judge on July 31, 1999. On September 30, 1999, United
States District Court Judge William Sessions withdrew the reference of the
case to the Bankruptcy Court and ruled that he would decide the case himself
on the basis of a combination of the Bankruptcy Court trial record and
rehearing certain testimony of certain witnesses. The parties subsequently
stipulated to waive any rehearing of testimony and submission of further
evidence and to submit the case to the District Court for a decision on the
merits based on the existing trial record. The timing of a decision on the
merits of the case at the trial level cannot be predicted at this time.
Although it is not possible at this stage to predict the outcome of this
litigation, the Bank believes that it has meritorious defenses to the
plaintiffs' allegations. The Bank intends to vigorously defend itself
against these claims.
On March 25, 1999, Merchants Trust Company received, as trustee, a recovery
of $4.8 million on account of settlement of a 1994 class action suit filed
in the United States District Court for the District of Minnesota relating
to investments made by the Trust Company and others in the so-called Piper
Jaffray Institutional Government Income Portfolio ("Piper Jaffray"). In the
first quarter of 1999, the Company realized $1.3 million as the result of
that payment. During the third quarter of 1999, the Trust Company disbursed
the amount received, partly to itself and the balance in accordance with
instructions provided by the Company's insurance carrier pursuant to an
agreement made with the carrier in December, 1994, in each case in partial
reimbursement of payments made by the Trust Company and the carrier in 1994,
totaling an aggregate of approximately $9.2 million, on account of losses
suffered by Trust Company customers on Piper Jaffray investments.
On March 22, 2000, lawyers representing the beneficiaries of two Trust
Company accounts filed an action in Chittenden, Vermont Superior Court
against Merchants Bancshares and others, asserting that their clients and
others similarly situated were not fully reimbursed for damages allegedly
suffered in connection with certain investments made by Merchants Trust
Company in Piper Jaffray during 1993 and 1994, and complaining, among other
matters, that the disbursement described in the immediately-preceding
paragraph was improper. The Complaint asserts, among other matters, that the
Trust Company and others violated the Vermont Consumer Fraud Act, were
negligent and made negligent misrepresentations, and breached duties of
trust. The Complaint seeks certification of the action as a class action,
unspecified damages, and other relief. The litigation is at an early stage.
While it is not possible to predict its outcome, the Company believes full
reimbursement of any Piper Jaffray losses was provided, that such
disbursement was proper, that class certification is inappropriate, and that
the claims for relief lack merit.
The Company and certain of its subsidiaries have been named as defendants in
various other legal proceedings arising from their 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 the opinion of counsel on the outcome of such proceedings, any such
liability will not have a material effect on the consolidated financial
position of the Company and its subsidiaries.
NOTE 5: RECLASSIFICATION
Certain amounts reported for prior periods have been reclassified to be
consistent with the current period presentation.
MERCHANTS BANCSHARES, INC.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
All adjustments necessary for a fair statement of the three and nine months
ended September 30, 2000 and 1999, have been included in the financial
statements. The information was prepared from the unaudited financial
statements of Merchants Bancshares, Inc. (the Company) and its subsidiaries,
Merchants Bank (the Bank) and Merchants Properties, Inc.
OVERVIEW
Merchants Bancshares, Inc. earned net income of $2.78 million, or basic and
diluted earnings per share of $.66 for the quarter ended September 30, 2000,
compared to $2.60 million, or basic and diluted earnings per share of $.59
for the same period a year earlier. The return on average assets and return
on average equity for the third quarter of 2000 were 1.51% and 16.89%,
respectively, compared to 1.58% and 16.58% for the third quarter of 1999.
The Company earned net income of $7.80 million, or basic and diluted
earnings per share of $1.84 for the nine months ended September 30, 2000,
compared to $7.59 million, or basic and diluted earnings per share of $1.73
for the same period in 1999. The return on average assets and return on
average equity for the nine months ended September 30, 2000 were 1.44% and
16.03%, respectively.
RESULTS OF OPERATIONS
Net Interest Income: Net interest income for the first nine months of 2000
was $24.7 million, compared to $22.5 million for the first nine months of
1999. The Bank has continued to experience margin compression resulting from
the interest rate environment during 2000. Many of the Bank's deposits are
priced at the short end of the yield curve, which has increased by 50-75
basis points over the course of 2000. At the same time the Bank's interest
earning assets are generally priced out toward the longer end of the curve,
which has decreased 40-70 basis points over the course of the year. The
Bank's net interest margin has decreased by 19 basis points from the quarter
ended September 30, 1999, to the quarter ended September 30, 2000, and has
decreased by 13 basis points for the comparable nine month periods. The
increase in net interest income is a result of higher levels of average
earning assets, which helped to offset the decline in the spread and the
margin. The Bank's average interest earning assets were $75 million higher
for the first nine months of 2000 than they were for the first nine months
of 1999 and were $76 million higher for the third quarter of 2000 compared
to the third quarter of 1999. At the same time, the Bank's interest bearing
liabilities were $67 million higher for the first nine months of 2000
compared to the same period in 1999, and were $64 million higher for the
third quarter of 2000 compared to 1999. The Bank's average yield on interest
earning assets increased 23 basis points and 13 basis points for the quarter
and nine months ended September 30, 2000, compared to the same periods in
1999; while the cost of funds for the same periods has increased by 50 basis
points and 28 basis points, respectively. These changes have resulted in a
decrease in the interest rate spread of 27 basis points when comparing the
quarter ended September 30, 2000, to the same period one year earlier, and
16 basis points when comparing the first nine months of 2000 to the first
nine months of 1999. The schedule on pages 12 and 13 shows the yield
analysis for the periods reported.
Provision for Loan Losses: The improved asset quality achieved over the last
few years continues to be maintained as the portfolio grows in adherence to
the strong underwriting standards that have been established. Management's
analysis of the reserve adequacy concluded that a provision for possible
loan losses was not necessary during the first nine months of 2000.
Additionally, the Bank recorded $128 thousand and $542 thousand,
respectively, for the quarter and nine months ended September 30, 2000, as a
credit loan loss provision. These amounts represent individual recoveries on
previous obligations, which were partially charged off. It is the Bank's
practice to record significant recoveries as an offset to the loan loss
provision in the income statement. See the discussion of Non-Performing
Assets on pages 10 to 11 for more information on the loan loss reserve.
Non-interest income: Excluding certain litigation settlement proceeds of
$1.3 million received in 1999, non-interest income increased by $760
thousand for the first nine months of 2000 compared to 1999 and by $243
thousand for the third quarter. (For more information on the settlement
proceeds see Part II, Item 1, Legal Proceedings.) The increase in
noninterest income is primarily a result of increases in the Bank's
overdraft revenue and increases in ATM and debit card usage and fees. The
increase in overdraft revenue has been partially offset by a decrease in
monthly service charge revenue. Monthly service charges decreased by $81
thousand for the first nine months of 2000 compared to 1999, and by $20
thousand for the third quarter; while net overdraft revenue increased by
$128 thousand and $501 thousand for the three and nine months ended
September 30, 2000. The decrease in monthly service charge revenue is due
primarily to the success of the Bank's FreedomLYNX(R) checking account
product, which generally charges no monthly fees. Other noninterest income
increased by $302 thousand for the first nine months of 2000 compared to
1999, and by $135 thousand for the third quarter, primarily due to increased
ATM and debit card transaction volumes and resultant fees.
Non-interest expenses: Total non-interest expenses for the three and nine
month periods have increased $490 thousand and $1.45 million over the same
periods in 1999. Salaries and wages and Employee benefits have increased by
$300 thousand for the quarter and $1.1 million for the first nine months of
2000 compared to 1999. The Bank completed its purchase of its two new
locations in Rutland and Bellows Falls, Vermont, during the fourth quarter
of 1999, resulting in the addition of 11 new full-time equivalent employees.
Additionally, the Bank has experienced higher wage and incentive costs as a
result of its successful sales efforts and overall increased profitability
of its core activities. Other non-interest expenses increased $187 thousand
for the third quarter and $731 thousand for the first nine months of 2000.
This increase is primarily attributable to the Bank's amortization of the
core deposit intangible created in conjunction with the branch purchase
mentioned above. Core Deposit intangible amortization, a component of Other
non-interest expenses, increased $107 thousand for the third quarter and
$319 thousand for the first nine months of the year. Legal and professional
fees have decreased $720 thousand for the first nine months of the year and
$345 thousand for the third quarter. The higher amount during 1999 resulted
primarily from the timing of expenses incurred by the Bank as it defends
itself in certain litigation. For more information on this litigation see
Part II, Item 1, Legal Proceedings.
BALANCE SHEET ANALYSIS
Average deposits for the third quarter of 2000 were $48.5 million higher
than during the fourth quarter of 1999. Deposit balances at quarter-end were
$54.2 million higher than balances at December 31, 1999. The Bank has
continued to see strong and sustained deposit growth over the course of
2000. The Bank's continued focused sales efforts have fueled this growth.
Due to the efforts of our sales staff more than 19,000 new FreedomLYNX(R)
and MoneyLYNX(TM) deposit accounts were opened during the first nine months
of the year.
Total loans, net of loan sales of $1.2 million, have increased $23.6 million
for the first nine months of the year. The Bank's commercial loan portfolio
increased $5.2 million for the nine months ended September 30. This increase
is due to the Bank's continued emphasis on lending to operating businesses
and the ramping up of the Bank's CommerceLYNX(TM) program, which is designed
to appeal to small businesses. The Bank's commercial mortgage portfolio
increased $11.3 million during the first nine months of the year. The Bank
also continued to experience growth in its streamlined portfolio mortgage
product, ReaLYNX(TM), during the third quarter. Balances grew $3.9 million
during the first nine months of the year. Installment loans and Homelines
increased by a small amount during the first nine months of the year, a
reflection of the current highly competitive environment for these types of
credits. The Bank's investment portfolio has grown $9.4 million during 2000
as a portion of the deposit growth has been deployed into the investment
portfolio.
In the ordinary course of business, Merchants Bank makes commitments for
possible future extensions of credit. On September 30, 2000, the Bank was
obligated to fund $8.7 million of standby letters of credit. No losses are
anticipated in connection with these commitments.
YEAR 2000
The Company, like most users of computers, computer software, and equipment
utilizing computer software, faced a critical challenge regarding the Year
2000 date change. The bank regulatory agencies which regulate the conduct of
the Company and the Bank, through the auspices of the Federal Financial
Institutions Examination Council (FFIEC) issued compliance guidelines
requiring financial institutions to develop and implement plans to address
the Year 2000 issue. During the past two and a half years, the Company
devoted substantial time and resources toward ensuring that the Company's
and its subsidiaries' operations would not be adversely impacted by the
pending date change. The Bank's primary regulator, the Federal Deposit
Insurance Corporation monitored the Bank's planning and implementation
process on a regular basis. The Company also contracted with a national
accounting firm to perform independent reviews of the Company's Year 2000
preparations. These reviews were completed during 1998 and 1999.
The Company is pleased to report that the Year 2000 date change was managed
with no reported problems. Computer systems all functioned as expected and
there were no interruptions in service. The Bank experienced no substantial
deposit run-off, and none of the Bank's contingency plans had to be
implemented. The Bank is not aware of any significant borrowers who have
been negatively impacted by the Year 2000 date change such that it would
impair their ability to repay their loans. The Bank's Year 2000 preparedness
plan includes monitoring certain key dates in 2000. The Bank has experienced
no problems to date.
RISK MANAGEMENT
There have been no significant changes in the Company's risk profile, or
management's risk management practices, since year-end.
INCOME TAXES
The Company recognized $920 thousand in low income housing tax credits for
the first nine months of 2000 and $1.1 million for the same period in 1999,
representing the amount of the income tax credits earned during those
quarters. The recognition of low income housing tax credits has reduced the
Company's effective tax rate to 25% for the nine months ended September 30,
2000.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity, as it pertains to banking, can be defined as the ability to
generate cash in the most economical way to satisfy loan demand, deposit
withdrawal demand, and to meet other business opportunities, which require
cash. The Bank has a number of sources of liquid funds; including $25
million in available Federal Funds lines of credit at September 30, 2000; an
overnight line of credit with the Federal Home Loan Bank (FHLB) of $15
million; an estimated additional borrowing capacity with FHLB of $100
million; and the ability to borrow through the use of repurchase agreements,
collateralized by the Bank's investments, with certain approved
counterparties.
NON-PERFORMING ASSETS AND THE RESERVE FOR POSSIBLE LOAN LOSSES
- --------------------------------------------------------------
The following tables summarize the Bank's non-performing assets as of
September 30, 2000, December 31, 1999, and September 30, 1999:
(In thousands) September 30, 2000 December 31, 1999 September 30, 1999
-------------- ------------------ ----------------- ------------------
Nonaccrual Loans $3,261 $2,800 $2,021
Loans Past Due 90 Days or More and
Still Accruing 93 199 24
Restructured Loans 217 689 703
-------------------------------------------------
Total Non-performing Loans (NPL) 3,571 3,688 2,748
Other Real Estate Owned 444 133 28
-------------------------------------------------
Total Non-performing Assets (NPA) $4,015 $3,821 $2,776
=================================================
<FN>
Note: Included in nonaccrual loans are certain loans whose terms have been
substantially modified in troubled debt restructuring.
</FN>
Discussion of events affecting NPA: Significant events affecting the
categories of NPA are discussed below:
Nonaccrual Loans:
- -----------------
During the third quarter of 2000 approximately $600 thousand in
reductions to nonaccrual loans were offset in part by approximately
$1.9 million of additions. Of the reported increase $1.6 million was
concentrated in one commercial account. The $1.6 million addition is
attributable to an assisted living facility located in southern
Vermont. Lease up on the facility has been slower than expected. At
present the loan appears to be well secured.
Loans Past Due 90 Days:
- -----------------------
Loans past due 90 days increased $23 thousand in the third quarter,
after dropping $53 thousand in the quarter ended June 30, 2000.
Restructured Loans:
- -------------------
There was a net decrease of $93 thousand in restructured loans during
the third quarter of 2000 primarily attributable to the transfer of
one loan to nonaccrual and scheduled amortization of loan balances.
Other Real Estate Owned:
- ------------------------
During the third quarter Other Real Estate Owned ("OREO") increased
$272 thousand. The increase was primarily attributable to the transfer
of the Bank's branch building located in Bellows Falls, Vermont, to
OREO, which resulted from management's decision to sell, and lease
back the branch area of, the building.
The reserve for possible loan losses is based on management's estimate of
the amount required to reflect the risks in the loan portfolio, based on
circumstances and conditions at each reporting date. Merchants Bank reviews
the adequacy of the Reserve for Possible Loan Losses ("RPLL") at least
quarterly. Factors considered in evaluating the adequacy of the reserve
include previous loss experience, current economic conditions and their
effect on the borrowers, the performance of individual loans in relation to
contract terms and estimated fair values of properties to be foreclosed. The
method used in determining the amount of the RPLL is not based on
maintaining a specific percentage of RPLL to total loans or total
nonperforming assets. Rather, the methodology is a comprehensive analytical
process of assessing the credit risk inherent in the loan portfolio. This
assessment incorporates a broad range of factors, which indicate both
general, and specific credit risk, as well as a consistent methodology for
quantifying probable credit losses. Losses are charged against the RPLL when
management believes that the collectibility of principal is doubtful. To the
extent management determines the level of anticipated losses in the
portfolio have significantly increased or diminished, the RPLL is adjusted
through current earnings. As part of the Bank's analysis of specific credit
risk, detailed and extensive reviews are done on larger credits and
problematic credits identified on the watched asset list, nonperforming
asset listings and internal credit rating reports. Loans deemed impaired at
September 30, 2000, totaled $2.9 million, of this total $2.6 million are
included as non-performing assets in the table above. Impaired loans have
been allocated $479 thousand of the RPLL.
The continued high level of the RPLL reflects management's current
strategies and efforts to maintain the reserve at a level adequate to
provide for loan losses based on an evaluation of known and inherent risks
in the loan portfolio. Among the factors that management considers in
establishing the level of the reserve are overall findings from an analysis
of individual loans, the overall risk characteristics and size of the loan
portfolio, past credit loss history, management's assessment of current
economic and real estate market conditions and estimates of the current
value of the underlying collateral.
The following table reflects the Bank's non-performing asset and coverage
ratios as of September 30, 2000, December 31, 1999, and September 30, 1999:
September 30, 2000 December 31, 1999 September 30, 1999
------------------ ----------------- ------------------
Percentage of Non-performing Loans
to Total Loans 0.74% 0.81% 0.64%
Percentage of Non-performing Assets
to Total Loans plus Other Real Estate
Owned 0.84% 0.84% 0.65%
Percentage of RPLL to Total Loans 2.21% 2.47% 2.66%
Percentage of RPLL to NPL 295% 303% 413%
Percentage of RPLL to NPA 262% 293% 409%
Management considers the balance of the RPLL adequate at September 30, 2000.
Management's assessment of the adequacy of the RPLL concluded that a
provision was not necessary during the third quarter of 2000.
Merchants Bancshares, Inc.
Supplemental Information
Unaudited
Three Months Ended
-----------------------------------------------------------------------
(In thousands except share and per share data) September 30, 2000 September 30, 1999
Interest Interest
Average Income/ Average Average Income/ Average
(Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate
--------------------------------- ---------------------------------
INTEREST EARNING ASSETS
Loans (1) $474,066 $10,626 8.92% $425,230 $ 9,326 8.70%
Taxable Investments 213,041 3,569 6.66% 185,648 2,992 6.39%
Federal Funds Sold and Securities Purchased
Under Agreements to Resell 2,417 40 6.58% 3,307 42 5.04%
------------------------------- -------------------------------
Total Interest Earning Assets $689,524 $14,235 8.21% $614,185 $12,360 7.98%
=============================== ===============================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $400,974 $3,605 3.58% $346,892 $ 2,555 2.92%
Time Deposits 163,509 2,142 5.21% 147,825 1,815 4.87%
------------------------------- -------------------------------
Total Savings and Time Deposits 564,483 5,747 4.05% 494,717 4,370 3.50%
Federal Funds Purchased 1,183 20 6.73% 932 13 5.53%
Other Borrowed Funds 3,584 58 6.44% 5,192 67 5.08%
Debt (2) 1,537 14 3.62% 6,637 117 6.99%
------------------------------- -------------------------------
Total Interest Bearing Liabilities 570,787 5,839 4.07% 507,478 4,567 3.57%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 118,737 106,707
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $689,524 $614,185
======== ========
Rate Spread 4.14% 4.41%
==== ====
Net Yield on Interest Earning Assets 4.84% 5.03%
==== ====
<FN>
- --------------------
<F1> Includes principal balance of non-accrual loans and fees on loans.
<F2> Excludes prepayment fee of $102 related to the early repayment of
certain long-term debt.
</FN>
Merchants Bancshares, Inc.
Supplemental Information
Unaudited
Nine Months Ended
-----------------------------------------------------------------------
(In thousands except share and per share data) September 30, 2000 September 30, 1999
Interest Interest
Average Income/ Average Average Income/ Average
(Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate
--------------------------------- ---------------------------------
INTEREST EARNING ASSETS
Loans (1) $465,206 $30,801 8.84% $416,966 $27,311 8.76%
Taxable Investments 209,189 10,439 6.67% 183,118 8,791 6.42%
Federal Funds Sold and Securities Purchased
Under Agreements to Resell 3,085 142 6.15% 2,012 73 4.85%
------------------------------- -------------------------------
Total Interest Earning Assets $677,480 $41,382 8.16% $602,096 $36,175 8.03%
=============================== ===============================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $389,078 $10,028 3.44% $330,535 $ 7,313 2.96%
Time Deposits 161,523 6,092 5.04% 149,025 5,578 5.00%
------------------------------- -------------------------------
Total Savings and Time Deposits 550,601 16,120 3.91% 479,560 12,891 3.59%
Federal Funds Purchased 1,038 50 6.43% 1,499 58 5.17%
Other Borrowed Funds 8,756 400 6.10% 8,530 315 4.94%
Debt (2) 2,240 81 4.83% 6,655 350 7.04%
------------------------------- -------------------------------
Total Interest Bearing Liabilities 562,635 16,651 3.95% 496,244 13,614 3.67%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 114,845 105,852
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $677,480 $602,096
======== ========
Rate Spread 4.21% 4.37%
==== ====
Net Yield on Interest Earning Assets 4.88% 5.01%
==== ====
<FN>
- --------------------
<F1> Includes principal balance of non-accrual loans and fees on loans.
<F2> Excludes prepayment fee of $102 related to the early repayment of
certain long-term debt.
</FN>
MERCHANTS BANCSHARES, INC.
SEPTEMBER 30, 2000
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
The Bank is a counterclaim defendant in a litigation entitled "Pasquale and
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim
Defendant", now pending in the United States Bankruptcy Court for the
District of Vermont.
In this litigation, the Vescios have made a number of "lender liability"
claims dealing with a commercial development known as Brattleboro West in
Brattleboro, Vermont. The pending litigation arose out of a suit to
foreclose on several real estate mortgages and personal property delivered
to the Bank as collateral by the Vescios in connection with the financing of
a supermarket in the Brattleboro West project and various other projects.
Among other things, the Vescios have alleged that the Bank or its
representatives violated supposed oral promises in connection with the
origination and funding of the project, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition,
the plaintiffs have contended that the Bank breached a duty of care they
believe it owed to them, and have claimed that the Bank should not have
exercised its contract rights when the loan went into default, but should
have resolved the default in a way that was more favorable to the borrowers.
Trial concluded in United States Bankruptcy Court in November 1998. In June
1999 before entry of any findings or a decision on the merits, the trial
judge recused himself from all cases involving the Bank. He completed his
term as bankruptcy judge on July 31, 1999. On September 30, 1999, United
States District Court Judge William Sessions withdrew the reference of the
case to the Bankruptcy Court and ruled that he would decide the case himself
on the basis of a combination of the Bankruptcy Court trial record and
rehearing certain testimony of certain witnesses. The parties subsequently
stipulated to waive any rehearing of testimony and submission of further
evidence and to submit the case to the District Court for a decision on the
merits based on the existing trial record. The timing of a decision on the
merits of the case at the trial level cannot be predicted at this time.
Although it is not possible at this stage to predict the outcome of this
litigation, the Bank believes that it has meritorious defenses to the
plaintiffs' allegations. The Bank intends to vigorously defend itself
against these claims.
On March 25, 1999, Merchants Trust Company received, as trustee, a recovery
of $4.8 million on account of settlement of a 1994 class action suit filed
in the United States District Court for the District of Minnesota relating
to investments made by the Trust Company and others in the so-called Piper
Jaffray Institutional Government Income Portfolio ("Piper Jaffray"). In the
first quarter of 1999, the Company realized $1.3 million as the result of
that payment. During the third quarter of 1999, the Trust Company disbursed
the amount received, partly to itself and the balance in accordance with
instructions provided by the Company's insurance carrier pursuant to an
agreement made with the carrier in December, 1994, in each case in partial
reimbursement of payments made by the Trust Company and the carrier in 1994,
totaling an aggregate of approximately $9.2 million, on account of losses
suffered by Trust Company customers on Piper Jaffray investments.
On March 22, 2000, lawyers representing the beneficiaries of two Trust
Company accounts filed an action in Chittenden, Vermont Superior Court
against Merchants Bancshares and others, asserting that their clients and
others similarly situated were not fully reimbursed for damages allegedly
suffered in connection with certain investments made by Merchants Trust
Company in Piper Jaffray during 1993 and 1994, and complaining, among other
matters, that the disbursement described in the immediately-preceding
paragraph was improper. The Complaint asserts, among other matters, that the
Trust Company and others violated the Vermont Consumer Fraud Act, were
negligent and made negligent misrepresentations, and breached duties of
trust. The Complaint seeks certification of the action as a class action,
unspecified damages, and other relief. The litigation is at an early stage.
While it is not possible to predict its outcome, the Company believes full
reimbursement of any Piper Jaffray losses was provided, that such
disbursement was proper, that class certification is inappropriate, and that
the claims for relief lack merit.
The Company and certain of its subsidiaries have been named as defendants in
various other legal proceedings arising from their 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 the opinion of counsel on the outcome of such proceedings, any such
liability will not have a material effect on the consolidated financial
position of the Company and its subsidiaries.
Item 2 - Changes in Securities - NONE
Item 3 - Defaults upon Senior Securities - NONE
Item 4 - Submission of Matters to a Vote of Security Holders - NONE
Item 5 - Other Issues - NONE
Item 6 - Exhibits and Reports on Form 8-K - NONE
MERCHANTS BANCSHARES, INC.
FORM 10-Q
SEPTEMBER 30, 2000
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Merchants Bancshares, Inc.
/s/ Joseph L. Boutin
--------------------
Joseph L. Boutin, President
/s/ Janet P. Spitler
--------------------
Janet P. Spitler, Treasurer
November 10, 2000
-----------------
Date