UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to __________
COMMISSION FILE NUMBER: 0-49771
MERCHANTS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Ohio 31-1467303
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
100 North High Street, Hillsboro, Ohio 45133
(Address of principal executive offices) (Zip Code)
(937) 393-1993
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock - 2,666,650 shares outstanding at August 15, 2005
1
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
The accompanying information has not been audited by a registered independent
public accounting firm; however, in the opinion of management such information
reflects all adjustments necessary for a fair presentation of the results for
the interim period. All such adjustments are of a normal and recurring nature.
The accompanying financial statements are presented in accordance with the
requirements of Form 10-Q and consequently do not include all of the disclosures
normally required by accounting principles generally accepted in the United
States of America or those made in the Registrant's Form 10-K. Accordingly, the
reader of the Form 10-Q should refer to the Registrant's Form 10-K for the year
ended December 31, 2004 for further information in this regard.
2
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2005 AND DECEMBER 31, 2004 (IN THOUSANDS EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2005 2004
----------- ------------
(UNAUDITED)
ASSETS
CASH AND CASH EQUIVALENTS:
Cash and due from banks $ 10,656 $ 12,499
Federal funds sold 7,525 16,225
----------- ------------
Total cash and cash equivalents 18,181 28,724
----------- ------------
SECURITIES AVAILABLE FOR SALE
(amortized cost of $38,054 and $30,985 respectively) 39,033 31,979
----------- ------------
LOANS 294,728 294,610
Less allowance for loan losses (2,624) (2,519)
----------- ------------
Net loans 292,104 292,091
----------- ------------
OTHER ASSETS:
Bank premises and equipment, net 3,452 3,623
Accrued interest receivable 2,728 2,679
Deferred Income Tax 283 278
Other 4,635 4,607
----------- ------------
Total other assets 11,098 11,187
----------- ------------
TOTAL $ 360,416 $ 363,981
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest bearing $ 31,925 $ 34,834
Interest bearing 253,957 252,997
----------- ------------
Total deposits 285,882 287,831
----------- ------------
Repurchase agreements 2,644 2,944
FHLB borrowings 37,862 39,920
Other liabilities 1,878 2,508
----------- ------------
Total liabilities 328,266 333,203
----------- ------------
SHAREHOLDERS' EQUITY:
Common stock - no par value; 4,500,000 shares
authorized and 2,666,650 shares outstanding at
June 30, 2005 and December 31, 2004 2,000 2,000
Additional paid-in capital 2,000 2,000
Retained earnings 34,692 33,311
Accumulated other comprehensive income 458 467
Treasury Stock, at cost 333,350 shares
June 30, 2005 and December 31, 2004, respectively (7,000) (7,000)
----------- ------------
Total shareholders' equity 32,150 30,778
----------- ------------
TOTAL $360,416 $363,981
=========== ============
See notes to condensed consolidated financial statements.
3
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
INTEREST INCOME:
Interest and fees on loans $ 4,903 $ 4,699 $ 9,616 $ 9,385
Interest and dividends on securities:
Taxable 236 131 427 270
Exempt from income taxes 226 243 451 487
Interest on federal funds sold and other short-term investments 109 37 182 68
-------- -------- -------- --------
Total interest income 5,474 5,110 10,676 10,210
-------- -------- -------- --------
INTEREST EXPENSE:
Interest on deposits 1,477 1,202 2,861 2,378
Interest on repurchase agreements and federal funds purchased 15 26 31 52
Interest on FHLB borrowings 402 433 812 880
-------- -------- -------- --------
Total interest expense 1,894 1,661 3,704 3,310
-------- -------- -------- --------
NET INTEREST INCOME 3,580 3,449 6,972 6,900
PROVISION FOR LOAN LOSSES (180) (181) (360) (334)
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,400 3,268 6,612 6,566
-------- -------- -------- --------
NONINTEREST INCOME - Service charges and fees 412 390 883 780
-------- -------- -------- --------
NONINTEREST EXPENSE:
Salaries and employee benefits 1,080 1,030 2,216 2,048
Occupancy 245 255 478 519
Legal and professional services 136 144 276 256
Franchise tax 86 61 164 127
Data processing 74 79 148 153
Advertising 53 72 104 140
Other 369 362 759 757
-------- -------- -------- --------
Total noninterest expense 2,043 2,003 4,145 4,000
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 1,769 1,655 3,350 3,346
INCOME TAXES (535) (523) (1,009) (1,057)
-------- -------- -------- --------
NET INCOME $ 1,234 $ 1,132 $ 2,341 $ 2,289
======== ======== ======== ========
BASIC AND DILUTED EARNINGS PER SHARE $ 0.46 $ 0.42 $ 0.88 $ 0.86
======== ======== ======== ========
See notes to condensed consolidated financial statements.
4
(UNAUDITED)
OPERATING ACTIVITIES:
Net income $ 2,341 $ 2,289
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 284 295
Provision for loan losses 360 334
Gain on sale of mortgage loans (93) (102)
Proceeds from sale of mortgage loans 8,520 8,438
Mortgage loans originated for sale (8,427) (8,336)
Changes in assets and liabilities:
Accrued interest receivable (49) 600
Other assets (28) (1,253)
Accrued interest, taxes and other liabilities (630) (5,669)
--------- ---------
Net cash (used in) provided by operating activities 2,278 (3,404)
--------- ---------
INVESTING ACTIVITIES:
Proceeds from sales and maturities of securities available for sale 3,272 4,963
Purchases of securities available for sale (10,375) (4,988)
Net increase in loans (373) (6,234)
Capital expenditures (78) (23)
--------- ---------
Net cash provided by investing activities (7,554) (6,282)
--------- ---------
FINANCING ACTIVITIES:
Net increase in deposits (1,949) 7,387
Net increase in repurchase agreements (300) 847
FHLB payments (2,058) (2,254)
Dividends paid to stockholders (960) (906)
--------- ---------
Net cash (used in) provided by financing activities (5,267) 5,074
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (10,543) (4,612)
CASH AND CASH EQUIVALENTS:
Beginning of year 28,724 22,395
--------- ---------
End of period $ 18,181 $ 17,783
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for federal income taxes $ 1,600 $ 425
========= =========
Cash paid during the period for interest $ 3,664 $ 3,309
========= =========
See notes to condensed consolidated financial statements.
5
MERCHANTS BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
The unaudited condensed consolidated financial statements include the
accounts of Merchants Bancorp, Inc. and its wholly-owned subsidiary,
Merchants National Bank (collectively, the "Company"). All significant
intercompany balances and transactions have been eliminated in
consolidation.
In the opinion of management, these condensed consolidated financial
statements include all adjustments (which consist of normal recurring
accruals) necessary to present the condensed consolidated financial
position as of June 30, 2005, the results of operations for the three and
six months ended June 30, 2005 and 2004, and of cash flows for the
six-months ended June 30, 2005 and 2004. These condensed consolidated
financial statements have been prepared in accordance with instructions to
Form 10-Q, and therefore do not include all information and footnote
disclosures necessary for a fair presentation of financial position,
results of operations and cash flows in conformity with accounting
principles generally accepted in the United States of America. Financial
information as of December 31, 2004 has been derived from the audited
consolidated financial statements of Merchants Bancorp, Inc. and
subsidiary. The results of operations for the three and six months ended
June 30, 2005 and 2004 and cash flows for the six months ended June 30,
2005 and 2004 are not necessarily indicative of the results to be expected
for the full year. For further information, refer to the consolidated
financial statements and footnotes as of and for the year ended December
31, 2004, included in the Company's Form 10-K.
Earnings per Share - Basic earnings per share is computed using the
weighted average number of shares of common stock outstanding during the
period. For the three and six months ended June 30, 2005 the Company had
2,666,650 shares outstanding. For the three and six months ended June 30,
2004 the Company had 2,666,650 shares outstanding. There were no common
stock equivalents or potentially diluted securities outstanding during the
respective periods.
2. NEW ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections -- a Replacement of APB Opinion No. 20 and FASB Statement No.
3." This Statement replaces APB Opinion No. 20, "Accounting Changes," and
FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements," and changes the requirements for the accounting for and
reporting of a change in accounting principle. This Statement requires
retrospective application to prior periods' financial statements of
changes in accounting principle, unless it is impracticable to determine
either the period-specific effects or the cumulative effect of the change.
This Statement applies to all voluntary changes in accounting principle.
It also applies to changes required by an accounting pronouncement in the
unusual instance that the pronouncement does not include specific
transition provisions. This Statement is effective for accounting changes
and error corrections made in fiscal years beginning after December 15,
2005. The adoption of this Statement is not expected to have a material
effect on the Registrant's Condensed Consolidated Financial Statements.
6
3. LOANS
Major classifications of loans are summarized as follows (in thousands):
JUNE 30, DECEMBER 31,
2005 2004
----------- ------------
(UNAUDITED)
Commercial real estate $ 64,199 $ 64,460
Commercial and industrial 25,101 26,350
Agricultural 42,257 39,970
Residential real estate 137,641 136,165
Installment 23,230 25,080
Other 2,300 2,585
--------- --------
Total 294,728 294,610
Less allowance for loan losses (2,624) (2,519)
--------- --------
$ 292,104 $292,091
========= ========
4. FHLB BORROWINGS
All stock in the Federal Home Loan Bank ("FHLB") and qualifying first
mortgage residential loans are pledged as collateral on FHLB borrowings.
Interest rates of advances from the FHLB at June 30, 2005 are as follows
(in thousands):
INTEREST
RATE AMOUNT
----------- --------
2008 4.78%-5.39% $ 4,000
2010 6.26 % 3,000
2011 5.23 % 84
2012 4.64 % 10,000
2013 2.82%-3.13% 1,639
2018 2.83%-4.04% 7,362
2023 3.02%-4.24% 11,777
--------
Total $ 37,862
========
The maximum amount available to the Company under FHLB borrowings was
approximately $76.7 million and $77.7 million as of June 30, 2005 and
December 31, 2004, respectively.
5. SUBSEQUENT EVENTS
On August 4, 2005, the Company announced the decision of its Board of
Directors to engage in a "going private" transaction for the purpose of
deregistering the Company's common shares under Section 12(g) of the
Securities Exchange Act of 1934. The Board has decided to structure the
going private transaction as follows:
- Shareholders owning 100 or fewer common shares of the Company will
receive $23.00 in cash for each share held;
- Shareholders owning more than 100 but fewer than 1,500 common shares of
the Company will have the option of choosing between $23.00 in cash or
the receipt of a proposed new class of non-voting preferred stock of
the Company called "Series A Preferred Stock"; and
- Shareholders owning 1,500 or more common shares of the Company will
retain their common shares without change.
7
Assuming approval by the Company's shareholders, the transaction will be
facilitated through the merger of a newly organized, wholly-owned
subsidiary with and into the Company. The Company expects to hold a
special shareholder meeting during the fourth quarter of 2005 to allow
shareholders to consider and vote on the proposed transaction. Proxy
materials discussing the proposed transaction in much greater detail will
be distributed to shareholders, which will likely occur toward the early
part of the fourth quarter. As a result of the proposed transaction
structure, all shareholders of the Company will be entitled to dissenters'
rights of appraisal in accordance with Section 1701.85 of the Ohio Revised
Code. The Company expects to repurchase approximately 150,000 to 160,000
of its Common Shares as part of the proposed transaction. However, the
Board has expressly reserved the right to reevaluate the desirability of
completing the transaction in the event the Company is directed by its
shareholders to repurchase more than 160,000 of its Common Shares for
cash.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Merchants Bancorp, Inc. (the "Company") is a bank holding company and sole
shareholder of Merchants National Bank (the "Bank"), headquartered in Hillsboro,
Ohio. At June 30, 2005, the Company had total assets of approximately $360.4
million and total shareholders' equity of approximately $32.1 million.
The Company, through its banking affiliate, offers a broad range of banking
services to the commercial, industrial and consumer market segments which it
serves. The primary business of the Bank consists of accepting deposits through
various consumer and commercial deposit products, and using such deposits to
fund various loan products. The Bank's primary loan products are as follows: (1)
loans secured by residential real estate, including loans for the purchase of
one to four family residences which are secured by 1st and 2nd mortgages and
home equity loans; (2) consumer loans, including new and used automobile loans,
loans for the purchase of mobile homes and debt consolidation loans; (3)
agricultural loans, including loans for the purchase of real estate used in
connection with agricultural purposes, operating loans and loans for the
purchase of equipment; and (4) commercial loans, including loans for the
purchase of real estate used in connection with office or retail activities,
loans for the purchase of equipment and loans for the purchase of inventory.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the appropriate
application of certain accounting policies, many of which require us to make
estimates and assumptions about future events and their impact on amounts
reported in our financial statements and related notes. Since future events and
their impact cannot be determined with certainty, the actual results will
inevitably differ from our estimates. Such differences could be material to the
financial statements.
The Company believes the application of accounting policies and the estimates
required therein are reasonable. These accounting policies and estimates are
constantly reevaluated, and adjustments are made when facts and circumstances
dictate a change. Historically, the Company has found its application of
accounting policies to be appropriate, and actual results have not differed
materially from those determined using necessary estimates.
The Company's accounting policies are more fully described in Note 1 to the
condensed consolidated financial statements.
8
Management believes that the determination of the allowance for loan losses
represents a critical accounting policy. The Company maintains an allowance for
loan losses to absorb probable loan losses inherent in the portfolio. The
allowance for loan losses is maintained at a level management considers to be
adequate to absorb probable loan losses inherent in the portfolio, based on
evaluations of the collectibility and historical loss experience of loans.
Credit losses are charged and recoveries are credited to the allowance.
Provisions for loan losses are based on management's review of the historical
loan loss experience and such factors which, in management's judgment, deserve
consideration under existing economic conditions in estimating probable credit
losses. The allowance is based on ongoing assessments of the probable estimated
losses inherent in the loan portfolio. The Company's methodology for assessing
the appropriate allowance level consists of several key elements, as described
below.
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and available legal options. Included in the review of individual loans are
those that are impaired as provided in Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as
amended. Any specific reserves for impaired loans are measured based on the fair
value of the underlying collateral. The Company evaluates the collectibility of
both principal and interest when assessing the need for a specific reserve.
Historical loss rates are applied to other commercial loans not subject to
specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans,
are not individually reviewed by management. Reserves are established for each
pool of loans based on the expected net charge-offs. Loss rates are based on the
average two-year net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgment, reflect the impact of any
current conditions on loss recognition. Factors which management considers in
the analysis include the effects of the local economy, trends in the nature and
volume of loans (delinquencies, charge-offs, nonaccrual and problem loans),
changes in the internal lending policies and credit standards, collection
practices, and examination results from bank regulatory agencies and the
Company's internal credit review function.
An unallocated reserve is maintained to recognize the imprecision in estimating
and measuring loss when evaluating reserves for individual loans or pools of
loans.
Specific reserves on individual loans and historical loss rates are reviewed
throughout the year and adjusted as necessary based on changing borrower and/or
collateral conditions and actual collection and charge-off experience.
The Company has not substantively changed any aspect of its overall approach in
the determination of the allowance for loan losses. Excluding the refinement
from a five year to a two year trend in the calculation of the allowance for
loan loss for homogeneous loans, there have been no material changes in
assumptions or estimation techniques as compared to prior years that impacted
the determination of the current year allowance.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE, 2005 AND 2004
The Company reported net income of $1,234,000 and $1,132,000 for the three
months ended June 30, 2005 and 2004, respectively. During the same periods,
basic and diluted earnings per share were $.46 and $.42, respectively. On an
annualized basis, return on average assets was 1.36% and return on average
equity was 15.26% for the three months ended June 30, 2005, compared to 1.27%
and 15.25%, respectively, for the comparable period in 2004.
Net interest income for the three months ended June 30, 2005, was $3,580,000, an
increase of $131,000, or 3.8%, compared to net interest income of $3,449,000 for
the comparable period in 2004. Net interest margin was 4.11% for the three
months ended June 30, 2005, compared to 4.07% for the comparable period in 2004.
The average annualized yield on earning assets increased to 6.29% for the three
months ended June 30, 2005, from 6.03% for the comparable period in 2004. The
average cost of interest-bearing funds was 2.59% for the three months ended June
30, 2005, an increase from 2.25% for the comparable period in 2004. The net
interest margin has remained
9
relatively constant for the same time period as last year. The slight change is
a result of fluctuations in various balance sheet categories.
The provision for loan losses was $180,000 and $181,000 for the three months
ended June 30, 2005 and 2004, respectively. Net charge-offs for the three months
ended June 30, 2005 were $114,000, compared to $189,000 experienced during the
three months ended June 30, 2004. Management does not foresee any large losses
in the portfolio at this time but continues to monitor any exposure which could
arise in the agricultural loan portfolio due to adverse weather conditions.
Total noninterest income was $412,000 for the three months ended June 30, 2005,
an increase of $22,000, or 5.6%, from $390,000 for the comparable period in
2004. The increase can be attributed to growth in transaction volumes.
Total noninterest expense was $2,043,000 for the three months ended June 30,
2005, an increase of $40,000, or 2.0%, from $2,003,000 for the comparable period
in 2004. It is typically expected for non-interest expense to increase 5-10%
each year. The increase is significantly less due to a reduction in depreciation
expense as a result of some assets becoming fully depreciated and the collection
expense being considerably less than in the previous year. Salaries and benefits
have increased $50,000 or 4.9%. The increase is mainly due to the hiring of
additional staff in the loan area. Salaries and benefits expense comprises the
largest component of noninterest expense, with totals of $1,080,000 and
$1,030,000 for the three months ended June 30, 2005 and 2004, respectively.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
The Company reported net income of $2,341,000 and $2,289,000 for the six months
ended June 30, 2005 and 2004, respectively. During each of the same periods,
basic and diluted earnings per share were $.88 and $.86, respectively. On an
annualized basis, return on average assets was 1.29% and return on average
equity was 14.58% for the six months ended June 30, 2005, compared to 1.29% and
15.81%, respectively, for the comparable period in 2004.
Net interest income for the six months ended June 30, 2005, was $6,972,000, an
increase of $72,000, or 1.04%, compared to net interest income of $6,900,000 for
the comparable period in 2004. Net interest margin was 4.04% for the six months
ended June 30, 2005, compared to 4.08% for the comparable period in 2004. The
average annualized yield on earning assets decreased to 6.18% for the six months
ended June 30, 2005, from 6.39% for the comparable period in 2004. The average
cost of interest-bearing funds was 2.50% for the six months ended June 30, 2005,
an increase from 2.26% for the comparable period in 2004. Management attributes
the decrease in net interest margin to the recording of lower yielding 1-4
family loans. Additionally, while prime rates continue to reprice upward,
deposits are repricing upwards faster than loan rates. The longer term treasury
yields are remaining at a historically low yield which is what is used to price
mortgage rates. For these reasons the net interest margin continues to fall but
at a slower rate than in recent past.
The provision for loan losses was $360,000 and $334,000 for the six months ended
June 30, 2005 and 2004, respectively, representing an increase of 7.8%. Net
charge-offs for the six months ended June 30, 2005 were $254,000, compared to
$274,000 experienced during the six months ended June 30, 2004. Management does
not foresee any large losses in the portfolio at this time but continues to
monitor any exposure which could arise in the agricultural loan portfolio due to
adverse weather conditions.
Total noninterest income was $883,000 for the six months ended June 30, 2005, an
increase of $103,000, or 13.1%, from $780,000 for the comparable period in 2004.
The increase is due increased volumes of transactions, resulting in higher
service charges on customers' deposit transactions account and the recording of
miscellaneous fee income during the first quarter.
10
Total noninterest expense was $4,145,000 for the six months ended June 30, 2005,
an increase of $145,000, or 3.6%, from $4,000,000 for the comparable period in
2004. Salaries and benefits expense comprises the largest component of
noninterest expense, with totals of $2,216,000 and $2,048,000, an increase of
8.2%, for the six months ended June 30, 2005 and 2004, respectively. The
salaries and benefits have increased due to the hiring of additional staff in
the loan area. It is typically expected for non-interest expense to increase
5-10% each year. The overall increase is significantly less due to a reduction
in depreciation expense as a result of some assets becoming fully depreciated
and because of collection expense being significantly less in the current year.
FINANCIAL CONDITION
The Company's total assets decreased to $360.4 million as of June 30, 2005 from
$363.9 million as of December 31, 2004, a decrease of .98%. The largest change
in the balance sheet is a change in the mix of the assets. The two main areas
affected by change in balance sheet mix were securities, which increased $7.0
million and fed funds sold, which decreased $8.7 million. Another significant
change was a decrease in deposits of $2.0 million dollars. Loans remained
unchanged and this can be attributed to economic conditions and the timing of
the loan pool.
LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company reported total loans of $294.7 million as of June 30, 2005 and
$294.6 million as of December 31, 2004, an increase of $114,000, or 0.04%. The
portfolio composition has remained consistent during the period.
Federal regulations and generally accepted accounting principles require that
the Company establish prudent allowances for loan losses. The Company maintains
an allowance for loan losses to absorb probable loan losses inherent in the
portfolio, based on evaluations of the collectibility and historical loss
experience of loans. Loan losses are charged and recoveries are credited to the
allowance. Provisions for loan losses are based on management's review of the
historical loan loss experience and such factors which, in management's
judgment, deserve consideration under existing economic conditions in estimating
probable loan losses. The allowance is based on ongoing assessments of the
probable estimated losses inherent in the loan portfolio. The Company has not
substantively changed any aspect of its overall approach in the determination of
the allowance for loan losses from year end. There have been no material changes
in assumptions or estimation techniques as compared to prior years that impacted
the determination of the current year allowance.
The allowance for loan losses was 0.89% of total loans as of June 30, 2005 and
0.86% as of December 31, 2004.
The amount of nonaccrual loans decreased to $685,000 as of June 30, 2005,
compared to $747,000 as of March 31, 2005, and $728,000 at December 31, 2004. As
a percentage of total loans, nonaccrual loans represented 0.23% as of June 30,
2005, 0.25% as of March 31, 2005, and 0.25% as of December 31, 2004.
The category of accruing loans which are past due 90 days or more was $1,260,000
as of June 30, 2005, $847,000 as of March 31, 2005, and $452,000 as of December
31, 2004. As a percentage of total loans, loans past due 90 days and still
accruing interest represented .43% as of June 30, 2005, 0.29% as of March 31,
2005, and 0.15% as of December 31, 2004. The increase of $413,000 from March
2005 is primarily made up of one borrower with loan balances totaling $434,000.
The collateral for these loans include a residential property with a current
loan balance of $137,000 which is in the process of being sold and no loss is
anticipated. The remaining $297,000 loan balance is collateralized by vehicles
and a second residential property. The vehicles are being liquidated and the
backup residential collateral is more than sufficient to cover any loss from the
sale of the vehicles.
As a percentage of the allowance for loan losses, total nonaccrual loans and
loans past due 90 days or more were 74.1% as of June 30, 2005, 62.3% as of March
31, 2005, and 46.8% as of December 31, 2004.
DEPOSITS
Deposits totaled $285.9 million as of June 30, 2005, a decrease of $1.9 million,
or .68%, from $287.8 million as of
11
December 31, 2004. The slight decrease is considered normal in the day to day
operations of a bank.
FHLB BORROWINGS
Federal Home Loan Bank borrowings decreased $2.1 million to $37.9 million as of
June 30, 2005 from $39.9 million as of December 31, 2004. The decrease in
borrowings was primarily a result of principal loan payments made on the
borrowings.
LIQUIDITY AND CAPITAL RESOURCES
The declaration and payment of dividends by the Company are subject to the
discretion of the Board of Directors and to the earnings and financial condition
of the Company and applicable laws and regulations. The Company paid $ 959,994
and $906,661 in dividends during the six months ended June 30, 2005 and 2004,
respectively.
At June 30, 2005, consolidated Tier 1 risk based capital was 11.89%, and total
risk-based capital was 12.87%. The minimum Tier 1 and total risk-based capital
ratios required by the Board of Governors of the Federal Reserve are 4% and 8%,
respectively.
Effective liquidity management ensures that the cash flow requirements of
depositors and borrowers, as well as company cash needs, are met. The Company
manages liquidity on both the asset and liability sides of the balance sheet.
Community bank liquidity management currently involves the challenge of
attracting deposits while maintaining positive loan growth at a reasonable
interest rate spread. The loan to deposit ratio at June 30, 2005 was 103.0%
compared to 102.4% as of December 31, 2004. Loans to total assets were 81.8% at
June 30, 2005 compared to 80.9% at the end of 2004. The securities portfolio is
available for sale and consists of securities that are readily marketable.
Approximately 83.3% of the available for sale portfolio is pledged to secure
public deposits, short-term and long-term borrowings and for other purposes as
required by law. The balance of the available for sale securities could be sold
if necessary for liquidity purposes. Also, a stable deposit base, consisting of
87% core deposits, makes the Company less susceptible to large fluctuations in
funding needs. The Company also has both short- and long-term borrowings
capacity available through FHLB with unused available credit of approximately
$27.3 million as of June 30, 2005. The Company has the ability to obtain
deposits in the brokered certificate of deposit market to help provide liquidity
to fund loan growth, if necessary. Generally, the Company uses short-term
borrowings to fund overnight and short-term funding needs in the Company's
balance sheet. Longer-term borrowings have been primarily used to fund
mortgage-loan originations. This has occurred when FHLB longer-term rates are a
more economical source of funding than traditional deposit gathering activities.
Additionally, the Company occasionally uses FHLB borrowings to fund larger
commercial loans.
As of June 30, 2005, management is not aware of any current recommendations by
banking regulatory authorities which, if they were to be implemented, would
have, or would be reasonably likely to have, a material adverse impact on the
Company's liquidity, capital resources, or operations.
CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
The Company has certain obligations and commitments to make future payments
under contracts. At June 30, 2005, the aggregate contractual obligations and
commercial commitments are:
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Payments Due by Period
Contractual Obligations Less than 1-3 3-5 After 5
($ in thousands) Total One Year Years Years Years
- ---------------------------- --------- ----------- -------- -------- ---------
Total Deposits $ 285,882 $ 231,272 $ 39,903 $ 14,707
FHLB Borrowings 37,862 3,386 9,019 6,842 18,615
FHLB interest expense 8,374 1,511 3,700 1,695 1,468
Repurchase Agreements 2,644 2,644 0 0 0
--------- ----------- -------- -------- ---------
Total $ 334,762 $ 238,813 $ 52,622 $ 23,244 $ 20,083
Payments Due by Period
Other Commercial Commitments Less than 1-3 3-5 After 5
($ in thousands) Total One Year Years Years Years
- ---------------------------- --------- ----------- -------- -------- ---------
Commitments to Extend Credit $ 27,768 $ 10,745 $ 5,948 $ 1,001 $ 10,074
Letters of Credit 78 71 7 0 0
--------- ----------- -------- -------- ---------
Total $ 27,846 $ 10,816 $ 5,955 $ 1,001 $ 10,074
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to variations in interest rates, exchange rates,
equity price risk and commodity prices. The Company does not maintain a trading
account for any class of financial instrument, and is not currently subject to
currency exchange rate risk, equity price risk or commodity price risk. The
Company's market risk is composed primarily of interest rate risk.
The major source of the Company's interest rate risk is the difference in the
maturity and repricing characteristics between the Company's core banking assets
and liabilities - loans and deposits. This difference, or mismatch, poses a risk
to net interest income. Most significantly, the Company's core banking assets
and liabilities are mismatched with respect to repricing frequency, maturity
and/or index. Most of the Company's commercial loans, for example, reprice
rapidly in response to changes in short-term interest rates. In contrast, many
of the Company's consumer deposits reprice slowly, if at all, in response to
changes in market interest rates.
The Company's Senior Management is responsible for reviewing the interest rate
sensitivity position of the Company and establishing policies to monitor and
limit exposure to interest rate risk. The guidelines established by
Asset/Liability Committee are approved by the Company's Board of Directors. The
primary goal of the asset/liability management function is to maximize net
interest income within the interest rate risk limits set by approved guidelines.
Techniques used include both interest rate risk analysis that perform simulation
modeling that measures the effect of rate changes on net interest income and
economic market value of equity under different rate scenarios. The current
policy imposes limits on earnings at risk over a twelve month period.
In the Company's simulation models, each asset and liability balance is
projected over a time horizon. Net interest income is then projected based on
expected cash flows and projected interest rates under a stable rate scenario
and analyzed. The results of this analysis are factored into decisions made
concerning pricing strategies for loan and deposits, balance sheet mix,
securities portfolio strategies, liquidity and capital adequacy.
Simulation models are also performed under an instantaneous parallel 200 basis
point increase or decrease in interest rates. The model includes assumptions as
to repricing and expected prepayments, anticipated calls, and expected decay
rates of transaction accounts under the different rate scenarios. The results of
these simulations include changes in both net interest income and market value
of equity.
The Company applies hypothetical interest rate movements for up and down
interest rate movements of 100, 200 & 300 basis points. The interest movements
move in equal amounts, known as ramping, each quarter to give a more likely and
meaningful scenario should rates change. By reacting to changes in economic
conditions, interest rates and market forces, the Company has been able to alter
the mix of short and long-term loans and investments, and
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increase or decrease the emphasis on fixed and variable rate products in
response to changing market conditions. By managing the interest rate
sensitivity of its asset composition in this manner, the Company has been able
to maintain a fairly stable flow of net interest income.
Simulation models are also performed under an instantaneous parallel 300 basis
point increase or decrease in interest rates. The model includes assumptions as
to repricing and expected prepayments, anticipated calls, and expected decay
rates of transaction accounts under the different rate scenarios. The results of
these simulations include changes in both net interest income and market value
of equity.
Complicating management's efforts to control non-trading exposure to interest
rate risk is the fundamental uncertainty of the maturity, repricing, and/or
runoff characteristics of some of the Company's core banking assets and
liabilities. This uncertainty often reflects options embedded in these financial
instruments. The most important embedded options are contained in consumer
deposits and loans.
For example, many of the Company's interest bearing retail deposit products
(e.g., interest checking, savings and money market deposits) have no contractual
maturity. Customers have the right to withdraw funds from these deposit accounts
freely. Deposit balances may therefore run off unexpectedly due to changes in
competitive or market conditions. To forestall such runoff, rates on interest
bearing deposits may have to be increased more (or reduced less) than expected.
Such repricing may not be highly correlated with the repricing of prime
rate-based or U.S. Treasury-based loans. Finally, balances that leave the
banking franchise may have to be replaced with other more expensive retail or
wholesale deposits. Given the uncertainties surrounding deposit runoff and
repricing, the interest rate sensitivity of core bank liabilities cannot be
determined precisely.
Management believes as of June 30, 2005, there have been no material changes in
the Company's interest rate sensitive instruments which would cause a material
change in the market risk exposures which affect the quantitative and
qualitative risk disclosures as presented in the Company's Form 10-K filed for
the period ended December 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
The Registrant maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Registrant's Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to the Registrant's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosures.
The Company has carried out an evaluation, under the supervision and with the
participation of the Registrant's management, including the Registrant's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Registrant's disclosure controls and procedures.
Based on the foregoing, the Registrant's Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Registrant's disclosure controls and procedures were effective, in
all material respects, to ensuring that information required to be disclosed in
the reports the Registrant files and submits under the Exchange Act is recorded,
processed, summarized and reported as and when required.
There was no change in the Company's internal control over financial reporting
that occurred during the Company's fiscal quarter ended June 30, 2005, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained herein that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act. Economic circumstances, the Company's operation and the
Company's actual results could differ significantly from those discussed in the
forward-looking statements. Forward-looking statements are typically identified
by words or phrases such as "believe," "expect," "anticipate,"
14
"intend," "estimate," "may increase," "may fluctuate," and similar expressions
or future or conditional verbs such as "will," "should," "would" and "could."
These forward-looking statements involve risks and uncertainties including, but
not limited to, economic conditions, portfolio growth, the credit performance of
the portfolios, including bankruptcies, and seasonal factors; changes in general
economic conditions including the performance of financial markets, the prices
of crops, prevailing inflation and interest rates, and losses on lending
activities; results of various investment activities; the effects of
competitors' pricing policies, of changes in laws and regulations on competition
and of demographic changes on target market populations' savings and financial
planning needs; industry changes in information technology systems on which we
are dependent; and the resolution of legal proceedings and related matters. In
addition, the policies and regulations of the various regulatory authorities
could affect the Company's results. These statements are representative only on
the date hereof, and the Company undertakes no obligation to update any
forward-looking statements made.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Voting results from the Company's Annual Meeting of Shareholders held on April
26, 2005 can be found under Part II, Item 6 of the Company's report on Form 10-Q
filed with the Commission in May 2005.
15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS - The following exhibits are filed as a part of this report:
Exhibit No. Exhibit
- ----------- -------
3.1 Articles of Incorporation of Merchants Bancorp, Inc. filed as
Exhibit (3)(I) to the Form 10 filed with SEC on April 30, 2002
and incorporated herein by reference.
3.2 Code of Regulations filed as Exhibit (3)(II) to the Form 10 filed
with the SEC on April 30, 2002 and incorporated herein by
reference.
4. Instruments Defining the Rights of Security Holders. (See Exhibit
3.1 and 3.2)
31 Rule 13a-14(a) Certification
32 Section 1350 Certification
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 BANCORP, INC.
Date: August 15, 2005 By: /s/ Paul W. Pence, Jr.
Paul W. Pence, Jr., President and Principal
Financial Officer
16
EXHIBIT INDEX
Exhibit No. Description
- ----------- ------------
31 Rule 13a-14(a) Certification
32 Section 1350 Certification