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 MARCH 31, 1999
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
----- -----
4,375,997 Shares Common Stock $.01 Par Outstanding March 31, 1999
MERCHANTS BANCSHARES, INC.
INDEX TO FORM 10-Q
PART I
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets
March 31, 1999 and December 31, 1998 1
Consolidated Statements of Operations
For the three months ended March 31, 1999 and 1998 2
Consolidated Statements of Comprehensive Income
For the three months ended March 31, 1999 and 1998 3
Consolidated Statement of Changes in Stockholders' Equity
For the three months ended March 31, 1999 and 1998 and
the Year ended December 31, 1998 4
Consolidated Statements of Cash Flows
For the three months ended March 31, 1999 and 1998 5
Footnotes to Financial Statements as of March 31, 1999 6-8
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-13
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 14-15
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 16
Merchants Bancshares, Inc.
Consolidated Balance Sheets
Unaudited
March 31, December 31,
(In thousands except share and per share data) 1999 1998
- ---------------------------------------------------------------------------------------
ASSETS
Cash and Due from Banks $ 19,902 $ 30,528
Investments:
Debt Securities Held for Sale 82,707 72,205
Debt Securities Held to Maturity 99,584 103,851
(Fair Value of $100,918 and $105,717)
Trading Securities 1,014 1,095
- -------------------------------------------------------------------------------------
Total Investments 183,305 177,151
- -------------------------------------------------------------------------------------
Loans 410,787 405,492
Reserve for possible loan losses 11,290 11,300
- -------------------------------------------------------------------------------------
Net Loans 399,497 394,192
- -------------------------------------------------------------------------------------
Federal Home Loan Bank Stock 2,951 2,482
Bank Premises and Equipment, Net 12,979 13,185
Investment in Real Estate Limited Partnerships 3,162 2,860
Other Real Estate Owned 57 470
Other Assets 13,642 14,005
- -------------------------------------------------------------------------------------
Total Assets $635,495 $634,873
=====================================================================================
LIABILITIES
Deposits:
Demand 74,161 $ 85,998
Savings, NOW and Money Market Accounts 321,029 309,897
Time Deposits $100 thousand and Greater 21,563 22,746
Other Time 127,052 131,821
- -------------------------------------------------------------------------------------
Total Deposits 543,805 550,462
- -------------------------------------------------------------------------------------
Demand Note Due U.S. Treasury 1,304 283
Other Short-Term Borrowings 15,000 9,000
Other Liabilities 6,559 7,890
Long-Term Debt 6,811 6,409
- -------------------------------------------------------------------------------------
Total Liabilities 573,479 574,044
- -------------------------------------------------------------------------------------
Commitments and Contingencies (Note 3)
STOCKHOLDERS' EQUITY
Preferred Stock Class A Non-Voting
Authorized - 200,000, Outstanding 0 -- --
Preferred Stock Class B Voting
Authorized - 1,500,000, Outstanding 0 -- --
Common Stock, $.01 Par Value 44 44
Shares Authorized 7,500,000
Outstanding, Current Period 4,239,377
Prior Period 4,297,785
Treasury Stock (At Cost) (3,645) (3,133)
Current Period 175,342
Prior Period 136,835
Capital in Excess of Par Value 33,078 33,073
Retained Earnings 30,222 28,308
Deferred Compensation Arrangements 2,190 2,166
Unrealized Gains on Securities Available for Sale, Net 127 371
- -------------------------------------------------------------------------------------
Total Stockholders' Equity 62,016 60,829
- -------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $635,495 $634,873
=====================================================================================
Book Value Per Common Share $ 14.17 $ 13.84
=====================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Operations
Unaudited
Quarter Ended March 31,
(In thousands except per share data) 1999 1998
- ---------------------------------------------------------------------
INTEREST AND DIVIDEND INCOME
Interest and Fees on Loans $ 8,949 $ 9,243
Interest and Dividends on Investments
U.S. Treasury and Agency Obligations 2,697 2,587
Other 220 63
- -------------------------------------------------------------------
Total Interest Income 11,866 11,893
- -------------------------------------------------------------------
INTEREST EXPENSE
Savings, NOW and Money Market Accounts 2,323 2,186
Time Deposits $100 Thousand and Greater 339 386
Other Time Deposits 1,578 1,768
Other Borrowed Funds 162 96
Debt 116 114
- -------------------------------------------------------------------
Total Interest Expense 4,518 4,550
- -------------------------------------------------------------------
Net Interest Income 7,348 7,343
Provision for Possible Loan Losses -- --
- -------------------------------------------------------------------
Net Interest Income after Provision
for Loan Losses 7,348 7,343
- -------------------------------------------------------------------
NONINTEREST INCOME
Trust Company Income 443 427
Service Charges on Deposits 655 699
Merchant Discount Fees 340 343
Settlement proceeds 1,326 120
Other 221 168
- -------------------------------------------------------------------
Total Noninterest Income 2,985 1,757
- -------------------------------------------------------------------
NONINTEREST EXPENSES
Salaries and Wages 2,360 2,200
Employee Benefits 633 569
Occupancy Expense, Net 732 532
Equipment Expense 565 624
Legal and Professional Fees 637 545
Equity in Losses of Real Estate
Limited Partnerships 129 94
Expenses - Other Real Estate Owned 87 117
Loss on Disposition of Fixed Assets 52 27
Other 1,546 1,387
- -------------------------------------------------------------------
Total Noninterest Expenses 6,741 6,095
- -------------------------------------------------------------------
Income Before Income Taxes 3,592 3,005
Provision for Income Taxes 869 759
- -------------------------------------------------------------------
NET INCOME $ 2,723 $ 2,246
===================================================================
Basic Earnings Per Common Share $ 0.62 $ 0.51
Diluted Earnings Per Common Share $ 0.62 $ 0.50
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statements of Comprehensive Income
Unaudited
Three Months Ended
March 31,
(In thousands) 1999 1998
- -----------------------------------------------------------------
Net Income as Reported $2,723 $2,246
Change in Net Unrealized Appreciation
of Securities, Net of Tax (241) (18)
Less: Reclassification Adjustments for
Securities Gains Included in Net Income,
Net of Taxes - -
- ----------------------------------------------------------------
Comprehensive Income Before Transfers
From Available for Sale to
Held to Maturity 2,482 2,228
Impact of transfer from Available for Sale
to Held to Maturity (3) (5)
- ----------------------------------------------------------------
Comprehensive Income $2,479 $2,223
================================================================
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, 1998 and
the three months ended March 31, 1999 and 1998
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, 1997 $44 $33,223 $21,537 $(2,220) $(10) $362 $52,936
Net Income -- -- 2,246 -- -- -- 2,246
Purchase of Treasury Stock -- -- -- (176) -- -- (176)
Sale of Treasury Stock -- 7 -- 159 -- -- 166
Issuance of Stock under
Employee Stock Option Plans -- (8) -- 19 -- -- 11
Dividends Paid -- -- (732) -- -- -- (732)
Unearned Compensation --
Restricted Stock Awards -- -- -- -- (6) -- (6)
Change in Net Unrealized Appreciation
(Depreciation) of Securities
Available for Sale, Net of Tax -- -- -- -- -- (18) (18)
Change in Net Unrealized Appreciation
of Securities Transferred to the Held
to Maturity Portfolio, Net of Tax -- -- -- -- -- (5) (5)
- -------------------------------------------------------------------------------------------------------------------------------
Balance March 31, 1998 44 33,222 23,051 (2,218) (16) 339 54,422
Net Income -- -- 7,576 -- -- -- 7,576
Purchase of Treasury Stock -- -- -- (1,244) -- -- (1,244)
Sales of Treasury Stock -- (7) -- (159) -- -- (166)
Issuance of Stock under
Employee Stock Option Plans -- (202) -- 355 -- -- 153
Tax Benefit Related to Stock Option
Exercises -- 60 -- -- -- -- 60
Issuance of Stock under
Deferred Compensation Arrangements -- -- -- 133 -- -- 133
Dividends Paid -- -- (2,319) -- -- -- (2,319)
Unearned Compensation --
Restricted Stock Awards -- -- -- -- (14) -- (14)
Deferred Compensation -- -- -- -- 2,196 -- 2,196
Change in Net Unrealized Appreciation
(Depreciation) of Securities
Available for Sale, Net of Tax -- -- -- -- -- 29 29
Change in Net Unrealized Appreciation
of Securities Transferred to the Held
to Maturity Portfolio, Net of Tax -- -- -- -- -- 3 3
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 44 33,073 28,308 (3,133) 2,166 371 60,829
Net Income -- -- 2,723 -- -- -- 2,723
Purchase of Treasury Stock -- -- -- (513) -- -- (513)
Issuance of Stock under
Deferred Compensation Arrangements -- -- -- 1 28 -- 29
Dividends Paid -- -- (809) -- -- -- (809)
Unearned Compensation --
Restricted Stock Awards -- 5 -- -- (4) -- 1
Change in Net Unrealized Appreciation
(Depreciation) of Securities
Available for Sale, Net of Tax -- -- -- -- -- (241) (241)
Change in Net Unrealized Appreciation
of Securities Transferred to the Held to
Maturity Portfolio, Net of Tax -- -- -- -- -- (3) (3)
- -------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 $44 $33,078 $30,222 $(3,645) $2,190 $127 $62,016
The accompanying notes are an integral part of these consolidated financial
statements.
Merchants Bancshares, Inc.
Consolidated Statement of Cash Flows
Unaudited
For the three months ended March 31, 1999 1998
- ----------------------------------------------------------------------------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,723 $ 2,246
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Provision for Depreciation and Amortization 615 639
Net Losses (Gains) on Sales of Premises and Equipment 52 (27)
Net Gains on Sales of Other Real Estate Owned (61) (5)
Equity in Losses of Real Estate Limited Partnerships 129 94
Changes in Assets and Liabilities:
Increase in Interest Receivable (20) (394)
Decrease in Interest Payable (340) (96)
(Increase) Decrease in Other Assets 381 (394)
Increase (Decrease) in Other Liabilities (991) 834
- ----------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 2,488 2,897
- ----------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from Maturities of Investment Securities 12,356 6,690
Proceeds from Sales of Loans and Leases -- 1,678
Purchases of Federal Home Loan Bank Stock (468) --
Proceeds from Sales of Other Real Estate Owned 486 35
Purchases of Available for Sale Investment
Securities (14,044) (10,087)
Purchases of Held to Maturity Investment Securities (4,969) (4,980)
Principal Repayments in Excess of (Less than) Loan
Originations (4,913) 722
Investments in Real Estate Limited Partnerships (430) (178)
Purchases of Premises and Equipment (147) (183)
- ----------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing
Activities (12,129) (6,303)
- ----------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase (Decrease) in Deposits (6,657) 1,362
Net Increase in Other Borrowed Funds 7,022 3,565
Principal Payments on Debt (2) (3)
Cash Dividends Paid (835) (732)
Acquisition of Treasury Stock (513) (176)
Proceeds From Sales of Treasury Stock -- 165
Proceeds From Exercise of Employee Stock Options -- 11
- ----------------------------------------------------------------------------------
Net Cash Provided by (Used In) Financing
Activities (985) 4,192
- ----------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents (10,626) 786
Cash and Cash Equivalents Beginning of Year 30,528 20,139
- ----------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $ 19,902 $ 20,925
==================================================================================
Total Interest Payments $ 4,859 $ 4,646
Total Income Tax Payments 1,600 445
Transfer of Loans and Premises to Other Real Estate Owned -- 48
The accompanying notes are an integral part of these consolidated financial
statements.
MERCHANTS BANCSHARES, INC.
MARCH 31, 1999
NOTES TO FINANCIAL STATEMENTS:
See the Form 10-K filed as of December 31, 1998 for additional information.
NOTE 1: RECENT ACCOUNTING DEVELOPMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities". This statement
establishes standards for reporting and accounting for derivative
instruments ("derivatives") and hedging activities. The statement requires
that derivatives be reported as assets or liabilities in the Consolidated
Balance Sheets and that derivatives be reported at fair value. The
statement establishes criteria for accounting for changes in the fair value
of derivatives based on the intended use of the derivatives. The statement
is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. Based on the Bank's current use of derivatives the Company does
not expect the adoption of SFAS No. 133 to have a material impact on the
company's financial position or results of operations.
NOTE 2: EARNINGS PER SHARE
The following table presents a reconciliation of the calculations of basic
and diluted earnings per share for the quarter ended March 31, 1999:
Net Per Share
Income Shares Amount
- ----------------------------------------------------------------------------------
(In thousands except share and per share data)
Basic Earnings Per Share:
Income Available to Common Shareholders $2,723 4,384,990 $0.62
Diluted Earnings Per Share:
Options issued to Executives -- 6,944
Income available to Common Shareholders
Plus Assumed Conversions $2,723 4,391,934 $0.62
Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
quarter. The computation of diluted earnings per share for the quarter
ended March 31, 1999 excludes the effect of assuming the exercise of
certain outstanding stock options because the effect would be anti-
dilutive. As of March 31, 1999 there were 51,070 of such options
outstanding with an exercise price of $27.75 and 48,346 of such options
outstanding with an exercise price of $30.50.
NOTE 3: STOCK REPURCHASE PROGRAM
On September 3, 1998 the Company announced that its Board of Directors
authorized the Company to repurchase up to $2.2 million of its own
securities, approximately 2% of outstanding shares at its then market
value, through September 4, 1999. The stock buyback was authorized to take
place periodically, subject to prevailing market conditions. Purchases are
to be made on the open market and funded from available cash. As of May 10,
1999 the Company had repurchased 61,000 shares of its common stock at a
total cost of approximately $1.5 million.
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 financing, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition,
the plaintiffs have contended that the Bank breached 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 worked out the default in a way that was more favorable to the
borrowers. Trial concluded in United States Bankruptcy Court in November
1998. Although it is not possible at this stage to predict the outcome of
this litigation, the Bank believes that it has meritorious defenses to the
plaintiffs' allegations. The Bank intends to vigorously defend itself
against these claims.
The Company, the Bank, the Trust Company (the "Companies") and certain of
their directors are defendants in a lawsuit filed in November 1994 (the
"Vermont Proceedings"). The Vermont Proceedings arose from certain
investments managed for Trust company customers and placed in the Piper
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In
December 1994, the Companies made payments to the Trust Company customers
in amounts that the Companies believed reimbursed those customers fully for
Portfolio losses. The United States District Court for the District of
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings
with prejudice, as moot, and ordered payment of approximately $99,000 in
attorney's fees. The Plaintiff and his attorneys appealed those District
Court orders to the Second circuit court of Appeals, and the Companies
appealed on certain limited issues. By Order dated January 28, 1999 the
Second Court affirmed those District Court orders in all material respects
and remanded the case to the District Court with instructions to clarify
whether the dismissal of the claims as moot was to be with prejudice. Still
pending before the Second Circuit is a separate appeal from the District
Court's denial of Plaintiff's requests for sanctions and other relief based
on asserted improprieties in the defense of the litigation. The Companies
believe the Plaintiff's assertions in that regard are groundless and will
continue to seek denial of Plaintiff's requests.
The Companies separately pursued claims against others on account of the
losses suffered as a result of the investments in the Portfolio. Claims
against Piper Jaffray Companies, Inc. were joined with the claims of others
in a class action in the United States District Court for the District of
Minnesota (the "Minnesota Proceedings"). On March 25, 1999, the Trust
Company received, as trustee, a recovery of $4.8 million as a result of
those proceedings. The recovery is subject to the terms of an agreement
between the Companies and their insurance carrier, which reimbursed the
Companies, in part for the December, 1994 payments. The Company realized
income of $1.3 million as a result of the recovery, the balance of $3.5
million is due to the insurance company. During the course of the Minnesota
proceedings and the Vermont proceedings, the attorneys representing the
Plaintiff in the Vermont Proceedings and also representing, in the
Minnesota Proceedings, the beneficiaries of four other Trust Company
accounts, announced their intention to seek to deprive the Companies of at
least a portion of the reimbursement that otherwise could be available.
Merchants Bancshares, Inc. 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 Merchants Bancshares, Inc. and its
subsidiaries.
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 months ended
March 31, 1999 and 1998 have been included in the financial statements. The
information was prepared from the books of Merchants Bancshares, Inc. (the
Company) and its subsidiaries, Merchants Bank (the Bank) and Merchants
Properties, Inc., without audit.
In the ordinary course of business, Merchants Bank makes commitments for
possible future extensions of credit. On March 31, 1999, the Bank was
obligated for $5.5 million of standby letters of credit. No losses are
anticipated in connection with these commitments.
OVERVIEW
Merchants Bancshares, Inc. earned net income of $2.72 million, or diluted
earnings per share of $.62 for the quarter ended March 31, 1999, compared to
$2.25 million, or basic and diluted earnings per share of $.50 per share for
the same period a year earlier. The return on average assets and return on
average equity for the first quarter of 1999 were 1.72% and 17.78%,
respectively, compared to 1.53% and 16.90% for the first quarter of 1998.
BALANCE SHEET ANALYSIS
Average deposits increased by $1.2 million during the three months ended
March 31, 1999. The growth in average deposits, although small, is
significant. The first quarter is generally the Bank's weakest quarter and
is usually a time of deposit shrinkage, not growth. The Bank's continued
focused sales efforts have fueled this growth. The sales program, LYNX
Banking, has as its foundation fewer products that have potential lifetime
appeal to the Bank's customers. The Bank's FreedomLYNX(R) checking account
has no minimum balance requirements, pays interest on balances over a
minimum amount, and generally charges no fees. The Bank launched its "Free
for life" campaign during the first quarter. Through May 31, 1999 the Bank
will drop all electronic requirements for its FreedomLYNX(R) account and
offer the account free for life. Due to the efforts of our sales staff more
than 2,000 new FreedomLYNX(R) accounts were opened during the first quarter
and total balances at March 31, 1999 were $22 million. The cost of funds
for this product is approximately 1.35%. MoneyLYNX(TM) Money Market accounts
have also been a great success. This product, although not yet a year old,
had $65 million in balances at quarter end. Money market account balances
overall have grown $19 million over the course of the first quarter at a
cost of funds of approximately 4.09%.
Total loans have increased $5.3 million (1.3%) during the first quarter.
The Bank continued to experience growth in its streamlined portfolio
mortgage product, RealLYNX(TM), during the first quarter of 1999. Balances
grew $6.8 million (5.6%) during the first three months of the year. The Bank
is re-focusing its efforts on small business development, the results can be
seen in the $4 million (6.2%) growth in the commercial loan portfolio. At
the same time the Bank continues to de-emphasize its commercial real estate
portfolio, which decreased $2.5 million during the first quarter.
Installment loans decreased $1.3 million during the first quarter. The Bank
has taken steps to protect its variable rate funding sources. The Bank has
entered into three-year interest rate cap contracts to mitigate the effects
on net interest income in the event interest rates on variable rate deposits
increase. The notional amount of these contracts is $50 million. The Bank
has also entered into three-year interest rate floors to mitigate the effect
of net interest income in the event interest rates on floating rate loans
decline. The notional amount of these contracts is $30 million.
RESULTS OF OPERATIONS
First quarter net interest income before the provision for possible loan
losses was flat from 1998 to 1999. Although the Bank's quarter end balance
sheet has grown $46 million (7.8%) year over year, the Bank is continuing to
experience margin compression as a result of the continued flat yield curve
environment. The Bank's average interest earning assets increased $40
million and average interest bearing liabilities increased $37 million from
the first quarter of 1998 to the first quarter of 1999, the average spread
on those assets has decreased by 26 basis points quarter over quarter.
During the first quarter the Bank's net interest margin remained flat at
5.05%, the margin has decreased 36 basis points from the first quarter of
1998 to the first quarter of 1999. Many of the bank's funding sources are
tied to short-term rates, which have not fallen as rapidly as long-term
rates. The Bank's average cost of funds has decreased by 34 basis points
quarter over quarter, while the average yield on interest earning assets has
decreased 60 basis points. This decrease in yield on interest earning
assets is attributable to both the continuing flat yield curve and also to
the Bank's ongoing efforts to de-emphasize higher risk commercial real
estate loans in favor of lower risk, and generally lower yielding,
residential real estate. The schedule on page 13 shows the yield analysis
for the periods reported.
Due to the continued strength of the Bank's asset quality, and management's
assessment of the adequacy of the loan loss reserve as an indicator of that
strength, there was no provision taken for loan losses in the first quarter
of 1999 or 1998. Reserve coverage continues to be very strong at 2.75% of
total loans and 379% of non-performing loans. The improved asset quality
achieved over the last few years will be maintained as the portfolio grows
by adhering to the strong underwriting standards that have been established.
Excluding certain litigation settlement proceeds of $1.3 million received in
1999 and $120 thousand received in 1998; non-interest income has remained
flat year over year. For more information on the settlement proceeds see
Part II, Item 1, Legal Proceedings. Trust Company Income has increased by a
modest amount ($16 thousand) quarter over quarter. Other noninterest income
increased by $53 thousand (31.5%) from the first quarter of 1998 to the
first quarter of 1999, primarily a result of increases in ATM and debit card
fee income. Offsetting this increase in revenue was a decrease in service
charges on deposits of approximately $44 thousand (6.3%) for the quarter.
The decrease in service charge revenue is due primarily to the success of
the Bank's FreedomLYNX(R) checking account product, an account that
generally charges no fees. Merchant discount fees remained virtually
unchanged for the quarter. These changes are consistent with the Bank's
strategy to emphasize margin dollars over fee income.
Total non-interest expenses for the first quarter have increased $646
thousand (10.6%) quarter over quarter. Salaries, wages and employee
benefits have increased by $224 thousand (8.1%) from the first quarter of
1998 to the first quarter of 1999. The Bank has increased staff by three
full time equivalent employees over the last year, all of whom are in the
sales departments. This additional staff will support the Bank's sales
efforts and will help to fuel continued balance sheet growth. Additionally,
the Bank has seen incremental increases in salary costs related to Year 2000
testing and preparation. Occupancy expenses have increased $200 thousand
(37.6%) from the first quarter of last year to the first quarter of 1999.
This increase is due primarily to the impact of the Bank's vacating a
property under lease. Legal and professional fees have increased $92
thousand (16.8%) quarter over quarter. This increase is due primarily to
the timing of expenses incurred by the Bank as it defends itself in certain
litigation. For more information on this litigation see Part II, Item 1,
Legal Proceedings.
YEAR 2000
Introduction: The Company, like most users of computers, computer software,
and equipment utilizing computer software, faces a critical challenge
regarding the Year 2000 date change. The Year 2000 issue, which is common to
most corporations, and especially important to banks, concerns the inability
of information systems, primarily computer software programs, to properly
recognize and process date sensitive information as the Year 2000
approaches. If not corrected, many computer applications could fail or
create inaccurate results. The bank regulatory agencies which regulate the
conduct of the Company, the Bank and the Trust Company, through the auspices
of the Federal Financial Institutions Examination Council (FFIEC) have
issued compliance guidelines requiring financial institutions to develop and
implement plans to address the Year 2000 issue. During the past eighteen
months, the Company has devoted substantial time and resources toward
ensuring that the Company's and its subsidiaries' operations will not be
adversely impacted by the pending date change. The Bank's primary regulator,
the Federal Deposit Insurance Corporation, has been monitoring, and
continues to monitor, the Bank's planning and implementation process on a
regular basis. The Company has also contracted with a national accounting
firm to perform an independent review of the Company's Year 2000
preparations. These reviews commenced during the fourth quarter of 1998 and
have continued into 1999. The Company's management remains committed to the
continued deployment of the necessary internal and external resources toward
addressing the Year 2000 issue.
State of Readiness: As required by the Company's and its subsidiaries'
regulatory agencies, the Company, through its Year 2000 Committee (the
Committee), has developed a Year 2000 compliance plan. The Company's plan
addresses the five basic phases of achieving Year 2000 compliance; (i)
project management, (ii) awareness, (iii) assessment, (iv) testing and (v)
renovation and implementation. Project management began in the middle of
1997 as the Committee was formed. Since its formation, the Committee has met
on a regular basis to discuss and plan the specific actions that the
Company, the Bank and the Trust Company need to take to verify that the
Company and its subsidiaries will be prepared for the date change. In
addition, the Company has developed a strategy to ensure that its software
vendors are also taking steps to address the Year 2000 date change. The
Committee is comprised of senior executive officers of the Company, the Bank
and the Trust Company. The Committee is chaired by the Bank's Senior
Operations Officer, and includes the Company's Chief Financial Officer, the
Bank's Chief Auditor/Risk Management Officer, the Bank's Information Systems
Manager, the Bank's Credit Manager, the Bank's Deposit Operations Manager, a
Trust Company Officer and the Bank's Facilities/Administration Manager. The
Committee provides progress reports to the Company's senior management and
reports at least quarterly to the Company's Board of Directors.
Through the Committee, the Company has also taken steps to promote awareness
of the Year 2000 issue throughout its entire organization. In addition, the
Company has sought to raise the awareness of its vendors, service providers
and larger borrowing customers as to the Year 2000 issue in light of the
critical role these entities play in the operations of the Company. The
Committee has contacted each of these entities and requested a Year 2000
plan and testing information. The Company has received responses from 100%
of its vendors and service providers. The majority (94%) of the Company's
significant borrowers have also responded. The Committee intends to follow-
up with these customers throughout the next year and into the Year 2000.
Assessment is the process of identifying all mission-critical applications
that could be adversely affected by the date change. The Company's
assessment phase is substantially complete. Throughout its history,
independent of Year 2000 issues, the Company has sought to purchase its
critical core hardware and software from vendors who it perceives as having
strong reputations as leading financial industry service providers. The
Company has received and installed Year 2000 compliant software upgrades
from all mission critical vendors. Substantial progress has been made with
respect to the fourth phase of the Company's Year 2000 plan, testing.
Testing of the Company's core computer and peripheral equipment
infrastructure and the infrastructure of the Company's personal computer
desktop network has been successfully completed. Testing of mission critical
customer accounting software applications has begun and is targeted for
completion in advance of the June 30, 1999 FFIEC suggested testing
completion date. All other systems and applications have been scheduled for
testing prior to September 30, 1999. In the Plan, each of these non-mission
critical systems has an established target date by which steps must be taken
to replace any non-compliant systems. The Company is confident that all
tests will be completed in advance of those target dates.
The final phase of the Plan, renovation and implementation involves
obtaining and implementing renovated software applications provided by the
Company's vendors. As noted above, this phase of the Plan has already
commenced and will continue throughout 1999. To date, the Company has not
identified any system which presents a material risk of not being Year 2000
compliant in a timely fashion or for which a suitable alternative cannot be
implemented.
Costs to Address the Year 2000 Issue: The total financial costs associated
with the Year 2000 problem cannot be predicted at this time with absolute
certainty. As may be expected, the Committee currently estimates that there
will be costs associated with replacing certain non-compliant software
and/or hardware. The Company has hired a full-time project coordinator to
oversee the testing phase of the Year 2000 project. Although no other staff
additions are currently planned, the Committee estimates that approximately
30-35 people (about 10% of our staff) are spending some portion of their
time working on the Year 2000 project. Additionally, the Company has hired a
third party to evaluate the Bank's loan loss reserve adequacy in light of
Year 2000 concerns. At this time, the Company does not anticipate a need for
any additional loan loss provision related specifically to Year 2000 risks.
The Company plans to replace many of the Bank's ATMs as well as upgrade
certain software and equipment. Management had approved the replacement of
the ATMs prior to Year 2000 budget planning since most were 15 to 20 years
old. Out of the total estimated $1.22 million in capital costs $862 thousand
is budgeted to upgrade the ATM network. The Bank spent $680 thousand for ATM
and other Year 2000 upgrades during 1998 and $149 thousand for the first
quarter of 1999. These costs have been, and when incurred in the future will
be, capitalized and depreciated over the estimated useful lives of the
assets, as such assets represent replacement of existing equipment, which
are not mainly being remediated for Year 2000. The Bank has incurred direct
(non-capital expenditures) Year 2000 expenses totaling $49 thousand for the
first quarter of 1999, and $168 thousand for all of 1998, these expenses
have been charged to expense as incurred. Additional expenses related to the
project are currently estimated to be $81 thousand and will be charged to
expense as incurred.
Risks of Year 2000 Issues: The Year 2000 issue presents potential risks to
the Company, its subsidiaries and their operations. As stated above, the
Company purchases substantially all of its technology applications from
third parties that face the same Year 2000 challenge as the Company. Thus,
the Company's operations could be adversely affected if the Year 2000 issue
adversely affects the operations of these third parties. Most significantly,
the Company faces risks that are specific to the business of banking.
Included among these risks is the risk that the Year 2000 date change may
result in the inability to process and underwrite loan applications, to
credit deposits and withdrawals from customer accounts, to credit loan
payments or track delinquencies, to properly reconcile and record daily
activity or to engage in similar normal banking activities. Additionally, if
the Bank's commercial loan customers are not Year 2000 compliant and suffer
adverse effects with respect to their own operations, their ability to meet
their obligations to the Bank could be adversely affected. Furthermore, as a
commercial bank, the Bank could potentially experience deposit run-off prior
to the Year 2000 date change as a result of customer concern about the
potential availability of their funds or a change in interest rates.
Moreover, to the extent that the risks posed by the Year 2000 problem are
pervasive in data processing and transmission and communications services
worldwide, the Company cannot predict with any certainty that its operations
will remain materially unaffected after January 1, 2000 or on dates
preceding this date at which time post-January 1, 2000 dates become
significant within the Bank's systems. Finally, to the extent that certain
utility and communication services used by the Company face Year 2000
problems, the Company's operations could be disrupted.
Contingency Plans: In light of these risks and uncertainties, the Company
has developed and will continue to monitor contingency plans to mitigate the
risks associated with the Year 2000 date change and to provide a business
continuity strategy. The Company has developed these plans through building
on its internal Disaster Recovery/Contingency plans, which were updated
during the second quarter of 1998. This planning effort included a Business
Impact Analysis relating to mission critical systems and is the foundation
documentation that was used to finalize the Year 2000 mission critical
service provider Contingency plans.
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 $355 thousand in low income housing tax credits for
the first quarter of 1999 and $240 thousand for 1998, representing the
amount of the income tax credits earned during those quarters. The
recognition of these low income housing tax credits has reduced the
Company's effective tax rate to 24% for the quarter ended March 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity, as it pertains to banking, can be defined as the ability to
generate cash in the most economical way to satisfy loan demand, deposit
withdrawal demand, and to meet other business opportunities, which require
cash. The Bank has a number of sources of liquid funds; including $20
million in available Federal Funds lines of credit at March 31, 1999; an
overnight line of credit with the Federal Home Loan Bank (FHLB) of $15
million; an estimated additional borrowing capacity with FHLB of $64
million; and the ability to borrow through the use of repurchase agreements,
collateralized by the Bank's investments, with certain approved
counterparties.
NON-PERFORMING ASSETS
The following tables summarize the Bank's non-performing assets as of March
31, 1999, December 31, 1998, and March 31, 1998:
(In thousands) March 31, 1999 December 31, 1998 March 31, 1998
-------------- ----------------- --------------
Nonaccrual Loans $2,433 $2,103 $3,700
Loans Past Due 90 Days or
More and Still Accruing 63 170 309
Restructured Loans 479 320 214
-------------------------------------------------
Total Non-performing Loans (NPL) 2,975 2,593 4,223
Other Real Estate Owned 57 470 599
-------------------------------------------------
Total Non-performing Assets (NPA) $3,032 $3,063 $4,822
=================================================
Note: Included in nonaccrual loans are certain loans whose terms have been
substantially modified in troubled debt restructuring.
March 31, 1999 December 31, 1998 March 31, 1998
-------------- ----------------- --------------
Percentage of Non-performing Loans
to Total Loans 0.72% 0.64% 1.09%
Percentage of Non-performing Assets
to Total Loans plus Other Real
Estate Owned 0.74% 0.75% 1.24%
Percentage of RPLL to Total Loans 2.75% 2.79% 4.05%
Percentage of RPLL to NPL 379% 436% 371%
Percentage of RPLL to NPA 372% 369% 325%
Loans deemed impaired at march 31, 1999 totaled $2.8 million, of this total
$1.5 million are included as non-performing assets in the table above.
Impaired loans have been allocated $207 thousand of the RPLL.
Approximately 80% of NPL are secured by real estate, which significantly
reduces the Company's exposure to loss. Based upon the secured nature of a
significant portion of NPL, the strength of the local real estate market,
and management's assessment of the current and prospective level of risk in
the loan portfolio, the balance of the RPLL is considered adequate at March
31, 1999. Management's assessment of the adequacy of the RPLL concluded
that a provision was not necessary during the first quarter of 1999.
DISCUSSION OF EVENTS AFFECTING NPA
Significant events affecting the categories of NPA are discussed below:
Nonaccrual Loans:
During the first quarter of 1999 approximately $347 thousand in
reductions to nonaccrual loans were offset in part by approximately
$677 thousand of additions. Of the reported increase, approximately
$300 thousand was concentrated in two accounts.
Loans Past Due 90 Days:
Loans past due 90 days decreased $107 thousand from December 31, 1998
to March 31, 1999.
Restructured Loans:
The reported increase was driven by the addition of several small
commercial relationships.
Other Real Estate Owned:
Net proceeds from sales of foreclosed real estate totaled $486
thousand for the quarter. There were no additions to this category for
the period ended March 31, 1999.
Merchants Bancshares, Inc.
Supplemental Information
Unaudited
Three Months Ended
-----------------------------------------------------------------
March 31, 1999 March 31, 1998
(In thousands except share and per share data) ------------------------------ ------------------------------
Interest Interest
Average Income/ Average Average Income/ Average
(Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate
------- -------- ------- ------- -------- -------
INTEREST EARNING ASSETS
Loans (1) $408,938 $ 8,963 8.89% $390,413 $ 9,262 9.62%
Taxable Investments 181,244 2,903 6.50% 159,560 2,624 6.67%
Federal Funds Sold and Securities
Purchased Under Agreements to Resell 1,280 14 4.44% 1,902 26 5.54%
----------------------------------------------------------------
Total Interest Earning Assets $591,462 $11,880 8.15% $551,875 $11,912 8.75%
================================================================
INTEREST BEARING LIABILITIES
Savings, NOW and Money Market Deposits $312,628 $ 2,323 3.01% $271,518 $ 2,186 3.27%
Time Deposits 151,323 1,917 5.14% 161,788 2,154 5.40%
----------------------------------------------------------------
Total Savings and Time Deposits 463,951 4,240 3.71% 433,306 4,340 4.06%
Federal Funds Purchased 2,081 26 5.07% 1,214 17 5.83%
Other Borrowed Funds 11,171 136 4.95% 3,639 50 5.60%
Debt 6,824 116 6.89% 8,762 143 6.61%
----------------------------------------------------------------
Total Interest Bearing Liabilities 484,027 4,518 3.79% 446,921 4,550 4.13%
Other Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) 107,435 104,954
-------- --------
Total Liabilities & Stockholders' Equity
(Net of Non-Interest Earning Assets) $591,462 $551,875
======== ========
Rate Spread 4.36% 4.62%
==== ----
Net Yield on Interest Earning Assets 5.05% 5.41%
==== ====
<FN>
<F1> Includes principal balance of non-accrual loans and fees on loans
</FN>
MERCHANTS BANCSHARES, INC.
MARCH 31, 1999
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Reference is made to the Form 10-K filed for the year ended December 31,
1998 for disclosure of current legal proceedings against the Company, the
Bank, the Merchants Trust Company (the "Trust Company") (the "Companies")
and certain directors and trustees of the Companies.
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 financing, and have claimed that the Bank is
liable to them for damages based on the Bank's supposed "control" of the
project and its alleged breach of covenants of "good faith" which the
plaintiffs believe are to be implied from the loan documents. In addition,
the plaintiffs have contended that the Bank breached 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 worked out the default in a way that was more favorable to the
borrowers. Trial concluded in United States Bankruptcy Court in November
1998. Although it is not possible at this stage to predict the outcome of
this litigation, the Bank believes that it has meritorious defenses to the
plaintiffs' allegations. The Bank intends to vigorously defend itself
against these claims.
The Company, the Bank, the Trust Company (the "Companies") and certain of
their directors are defendants in a lawsuit filed in November 1994 (the
"Vermont Proceedings"). The Vermont Proceedings arose from certain
investments managed for Trust company customers and placed in the Piper
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In
December 1994, the Companies made payments to the Trust Company customers in
amounts that the Companies believed reimbursed those customers fully for
Portfolio losses. The United States District Court for the District of
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings with
prejudice, as moot, and ordered payment of approximately $99,000 in
attorney's fees. The Plaintiff and his attorneys appealed those District
Court orders to the Second circuit court of Appeals, and the Companies
appealed on certain limited issues. By Order dated January 28, 1999 the
Second Court affirmed those District Court orders in all material respects
and remanded the case to the District Court with instructions to clarify
whether the dismissal of the claims as moot was to be with prejudice. Still
pending before the Second Circuit is a separate appeal from the District
Court's denial of Plaintiff's requests for sanctions and other relief based
on asserted improprieties in the defense of the litigation. The Companies
believe the Plaintiff's assertions in that regard are groundless and will
continue to seek denial of Plaintiff's requests.
The Companies separately pursued claims against others on account of the
losses suffered as a result of the investments in the Portfolio. Claims
against Piper Jaffray Companies, Inc. were joined with the claims of others
in a class action in the United States District Court for the District of
Minnesota (the "Minnesota Proceedings"). On March 25, 1999, the Trust
Company received, as trustee, a recovery of $4.8 million as a result of
those proceedings. The recovery is subject to the terms of an agreement
between the Companies and their insurance carrier, which reimbursed the
Companies, in part for the December, 1994 payments. The Company realized
income of $1.3 million as a result of the recovery, the balance of $3.5
million is due to the insurance company. During the course of the Minnesota
proceedings and the Vermont proceedings, the attorneys representing the
Plaintiff in the Vermont Proceedings and also representing, in the Minnesota
Proceedings, the beneficiaries of four other Trust Company accounts,
announced their intention to seek to deprive the Companies of at least a
portion of the reimbursement that otherwise could be available.
Merchants Bancshares, Inc. 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 Merchants Bancshares, Inc. 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
MARCH 31, 1999
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
May 14, 1999
Date