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 September 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 by check mark whether the registrant is a shell company (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 November 14, 2005
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
SEPTEMBER 30, 2005 AND DECEMBER 31, 2004 (IN THOUSANDS EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(UNAUDITED)
ASSETS
CASH AND CASH EQUIVALENTS:
Cash and due from banks $ 10,216 $ 12,499
Federal funds sold 12,875 16,225
-------- --------
Total cash and cash equivalents 23,091 28,724
-------- --------
SECURITIES AVAILABLE FOR SALE
(amortized cost of $36,065 and $30,985 respectively) 37,197 31,979
-------- --------
LOANS 296,033 294,610
Less allowance for loan losses (2,649) (2,519)
-------- --------
Net loans 293,384 292,091
-------- --------
OTHER ASSETS:
Bank premises and equipment, net 3,412 3,623
Accrued interest receivable 3,142 2,679
Deferred Income Tax 231 278
Other 4,104 4,607
-------- --------
Total other assets 10,889 11,187
-------- --------
TOTAL $364,561 $363,981
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest bearing $ 33,402 $ 34,834
Interest bearing 255,673 252,997
-------- --------
Total deposits 289,075 287,831
-------- --------
Repurchase agreements 2,642 2,944
FHLB borrowings 37,425 39,920
Other liabilities 1,889 2,508
-------- --------
Total liabilities 331,031 333,203
-------- --------
SHAREHOLDERS' EQUITY:
Common stock - no par value; 4,500,000 shares authorized
and 2,666,650 shares outstanding at September 30, 2005
and December 31, 2004 2,000 2,000
Additional paid-in capital 2,000 2,000
Retained earnings 35,971 33,311
Accumulated other comprehensive income 559 467
Treasury Stock, at cost 333,350 shares at
September 30, 2005 and December 31, 2004, respectively (7,000) (7,000)
-------- --------
Total shareholders' equity 33,530 30,778
-------- --------
TOTAL $364,561 $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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2005 2004 2005 2004
------ ------- ------- -------
(UNAUDITED) (UNAUDITED)
INTEREST INCOME:
Interest and fees on loans $5,074 $4,761 $14,690 $14,146
Interest and dividends on securities:
Taxable 231 181 658 451
Exempt from income taxes 221 239 672 726
Interest on federal funds sold and other short-term investments 83 33 265 101
------ ------ ------- -------
Total interest income 5,609 5,214 16,285 15,424
------ ------ ------- -------
INTEREST EXPENSE:
Interest on deposits 1,569 1,320 4,430 3,698
Interest on repurchase agreements and federal funds purchased 17 24 48 76
Interest on FHLB borrowings 397 428 1,209 1,308
------ ------ ------- -------
Total interest expense 1,983 1,772 5,687 5,082
------ ------ ------- -------
NET INTEREST INCOME 3,626 3,442 10,598 10,342
PROVISION FOR LOAN LOSSES (180) (160) (540) (494)
------ ------ ------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,446 3,282 10,058 9,848
------ ------ ------- -------
NONINTEREST INCOME - Service charges and fees 429 396 1,312 1,176
------ ------ ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits 1,069 980 3,285 3,028
Occupancy 251 251 729 770
Legal and professional services 149 155 425 411
Franchise tax 86 88 250 215
Data processing 84 84 232 237
Advertising 94 71 198 211
Other 316 363 1,075 1,120
------ ------ ------- -------
Total noninterest expense 2,049 1,992 6,194 5,992
------ ------ ------- -------
INCOME BEFORE INCOME TAXES 1,826 1,686 5,176 5,032
INCOME TAXES (547) (498) (1,556) (1,555)
------ ------ ------- -------
NET INCOME $1,279 $1,188 $ 3,620 $ 3,477
====== ====== ======= =======
BASIC AND DILUTED EARNINGS PER SHARE $ 0.48 $ 0.45 $ 1.36 $ 1.30
====== ====== ======= =======
See notes to condensed consolidated financial statements.
4
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (IN THOUSANDS)
(UNAUDITED)
-------------------
OPERATING ACTIVITIES:
Net income $ 3,620 $ 3,477
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 425 416
Provision for loan losses 540 494
Gain on sale of mortgage loans (148) (159)
Proceeds from sale of mortgage loans 13,363 14,860
Mortgage loans originated for sale (13,215) (14,701)
Changes in assets and liabilities:
Accrued interest receivable (463) 150
Other assets 504 (1,104)
Accrued interest, taxes and other liabilities (619) (5,390)
-------- --------
Net cash (used in) provided by operating activities 4,007 (1,957)
-------- --------
INVESTING ACTIVITIES:
Proceeds from sales and maturities of securities available for sale 5,244 8,068
Purchases of securities available for sale (10,376) (9,594)
Net increase in loans (1,833) (11,454)
Capital expenditures (162) (244)
-------- --------
Net cash used in investing activities (7,127) (13,224)
-------- --------
FINANCING ACTIVITIES:
Net increase in deposits 1,244 16,127
Net increase (decrease) in repurchase agreements (302) 750
FHLB payments (2,495) (2,740)
Dividends paid to stockholders (960) (906)
-------- --------
Net cash (used in) provided by financing activities (2,513) 13,231
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (5,633) (1,950)
CASH AND CASH EQUIVALENTS:
Beginning of year 28,724 22,395
-------- --------
End of period $ 23,091 $ 20,445
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for federal income taxes $ 2,275 $ 1,160
======== ========
Cash paid during the period for interest $ 5,653 $ 5,043
======== ========
See notes to condensed consolidated financial statements.
5
MERCHANTS BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 September 30, 2005, the results of operations for the three
and nine months ended September 30, 2005 and 2004, and of cash flows for
the nine-months ended September, 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 nine months ended
September 30, 2005 and 2004 and cash flows for the nine months ended
September 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 thereto 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 nine months ended September 30, 2005 and 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):
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(unaudited)
Commercial real estate $ 66,811 $ 64,460
Commercial and industrial 25,398 26,350
Agricultural 44,070 39,970
Residential real estate 135,332 136,165
Installment 22,247 25,080
Other 2,175 2,585
-------- --------
Total 296,033 294,610
Less allowance for loan losses (2,649) (2,519)
-------- --------
$293,384 $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 September 30, 2005 are as
follows (in thousands):
YEAR INTEREST
MATURING RATE AMOUNT
- -------- ------------ -------
2008 4.78% - 5.39% $ 4,000
2010 6.26% 3,000
2011 5.23% 82
2012 4.64% 10,000
2013 2.82% - 3.13% 1,593
2018 2.83% - 4.04% 7,170
2023 3.02% - 4.24% 11,580
-------
Total $37,425
=======
The maximum amount available to the Company under FHLB borrowings was
approximately $79.2 million and $77.7 million as of September 30, 2005 and
December 31, 2004, respectively.
5. OTHER MATTERS
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 redeemable
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 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 prior to that special meeting. As a result of the
proposed transaction structure, all shareholders of the Company will be entitled
to dissenters' right 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.
The Company expects to open a new branch in late fourth quarter in the Mt. Orab,
Ohio area. The branch will be a full service banking center with a drive-up ATM
and 3 drive-thru windows.
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 September 30, 2005, the Company had total assets of approximately
$364.6 million and total shareholders' equity of approximately $33.5 million.
The Company, through its Companying affiliate, offers a broad range of banking
services to the commercial, industrial and consumer market segments which it
serves. The primary business of the Company consists of accepting deposits
through various consumer and commercial deposit products, and using such
deposits to fund various loan products. The Company'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 summary of significant accounting and reporting policies are more
fully described in Note 1 to the condensed consolidated financial statements
filed with the December 31, 2004 Form 10-K.
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
8
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 three-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 banking 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 two year to a three 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 SEPTEMBER, 2005 AND
2004
The Company reported net income of $1,279,000 and $1,188,000 for the three
months ended September 30, 2005 and 2004, respectively. During the same periods,
basic and diluted earnings per share were $.48 and $.45, respectively. On an
annualized basis, return on average assets was 1.42% and return on average
equity was 15.69% for the three months ended September 30, 2005, compared to
1.32% and 15.94%, respectively, for the comparable period in 2004.
Net interest income for the three months ended September 30, 2005, was
$3,626,000, an increase of $184,000, or 5.35%, compared to net interest income
of $3,442,000 for the comparable period in 2004. Net interest margin was 4.21%
for the three months ended September 30, 2005, compared to 4.07% for the
comparable period in 2004. The average annualized yield on earning assets
increased to 6.51% for the three months ended September 30, 2005, from 6.16% for
the comparable period in 2004. The average cost of interest-bearing funds was
2.69% for the three months ended September 30, 2005, an increase from 2.38% for
the comparable period in 2004. The net interest margin has remained relatively
constant for the same time period as last year. The increase in yield on earning
assets and the increase on cost of funds is mainly due to the prime rate and fed
funds rate increasing 250bp over the last year. The Company expects to see a
larger increase in cost of funds, and a decrease in net interest margin, in the
fourth quarter of 2005 due to the large amount of certificate of deposits that
renewed at a much higher rate in September of this year.
9
The provision for loan losses was $180,000 and $160,000 for the three months
ended September 30, 2005 and 2004, respectively. Net charge-offs for the three
months ended September 30, 2005 were $157,000, compared to $135,000 experienced
during the three months ended September 30, 2004. No losses have been identified
for the same time period. Management does not foresee any significant losses in
the portfolio at this time.
Total noninterest income was $429,000 for the three months ended September 30,
2005, an increase of $33,000, or 8.33%, from $396,000 for the comparable period
in 2004. The increase can primarily be attributed to an increase in fees charged
by the Company.
Total noninterest expense was $2,049,000 for the three months ended September
30, 2005, an increase of $57,000, or 2.86%, from $1,992,000 for the comparable
period in 2004. It is typically expected for non-interest expense to increase
5-10% each year. Salaries and employee benefits expense comprises the largest
component of noninterest expense, with totals of $1,069,000 and $980,000 for the
three months ended September 30, 2005 and 2004, respectively. Salaries and
employee benefits have increased $89,000 or 9.1%. The increase is mainly due to
the hiring of additional staff in the loan area and hiring additional staff for
the Mt. Orab branch that is due to open fourth quarter.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND
2004
The Company reported net income of $3,620,000 and $3,477,000 for the nine months
ended September 30, 2005 and 2004, respectively. During each of the same
periods, basic and diluted earnings per share were $1.36 and $1.30 respectively.
On an annualized basis, return on average assets was 1.33% and return on average
equity was 15.10% for the nine months ended September 30, 2005, compared to
1.30% and 15.86%, respectively, for the comparable period in 2004.
Net interest income for the nine months ended September 30, 2005, was
$10,598,000, an increase of $256,000, or 2.48%, compared to net interest income
of $10,342,000 for the comparable period in 2004. Net interest margin was 4.07%
for the nine months ended September 30, 2005, compared to 4.06% for the
comparable period in 2004. The average annualized yield on earning assets
increased to 6.25% for the nine months ended September 30, 2005, from 6.06% for
the comparable period in 2004. The average cost of interest-bearing funds was
2.56% for the nine months ended September 30, 2005, an increase from 2.30% for
the comparable period in 2004. The yield on earning assets and interest bearing
deposits both increased from the comparable period last year. The reason is
primarily due to the increase in the prime rate of 250 basis points. However,
the longer term treasury yields are remaining at a historically low yield which
is what is used to price mortgage rates and help explain why the net interest
margin only increased slightly. The Company anticipates a higher cost of funds
increase in fourth quarter due to a large number of certificate of deposits
repricing at a much higher rate in September 2005.
The provision for loan losses was $540,000 and $494,000 for the nine months
ended September 30, 2005 and 2004, respectively, representing an increase of
9.31%. Net charge-offs for the nine months ended September 30, 2005 were
$410,000, compared to $409,000 experienced during the nine months ended
September 30, 2004. Approximately $177,000 has been identified as doubtful in
the loan loss provision analysis as of September 30, 2005. No losses have been
identified for the same time period. Management does not foresee any significant
losses in the portfolio at this time.
Total noninterest income was $1,312,000 for the nine months ended September 30,
2005, an increase of $136,000, or 11.56%, from $1,176,000 for the comparable
period in 2004. The increase is due to increased volumes of transactions,
resulting in higher service charges on transaction accounts. An overall increase
in the fees charged to customers during the first quarter also contributed to
the increase.
10
Total noninterest expense was $6,194,000 for the nine months ended September 30,
2005, an increase of $202,000, or 3.37%, from $5,992,000 for the comparable
period in 2004. Salaries and employee benefits expense comprises the largest
component of noninterest expense, with totals of $3,285,000 and $3,028,000, an
increase of $257,000 or 8.5%, for the nine months ended September 30, 2005. The
salaries and employee benefits have increased at a higher rate due to the hiring
of additional staff in the loan area and hiring additional staff for the Mt.
Orab branch that is due to open fourth quarter.
FINANCIAL CONDITION
The Company's total assets increased to $364.6 million as of September 30, 2005
from $363.9 million as of December 31, 2004, an increase of .16%. 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
$5.2 million and fed funds sold, which decreased $3.4 million. Loans and
deposits each fluctuated by less than $1.5 million.
LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company reported total loans of $296.0 million as of September 30, 2005 and
$294.6 million as of December 31, 2004, an increase of $1.4 million or 0.48%.
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 September 30, 2005
and 0.86% as of December 31, 2004.
The amount of nonaccrual loans increased to $1,916,000 as of September 30, 2005,
compared to $685,000 as of June 30, 2005, and $728,000 at December 31, 2004. As
a percentage of total loans, nonaccrual loans represented 0.65% as of September
30, 2005, 0.23% as of June 30, 2005, and 0.25% as of December 31, 2004. The
large increase is primarily due to one commercial borrower with a loan balance
of $1.1 million. The Company had received payments through June 2005 from the
bankruptcy court to keep the loan current. The property was sold at a sheriff's
auction in October 2005 with the Company being the purchaser of the property.
The Company is currently in negotiations with a potential buyer for the
property. Management believes proceeds from the sale of the property should be
more than adequate to cover the balance of the loan. No loss is anticipated on
this loan at this time.
The category of accruing loans which are past due 90 days or more was $1,447,000
as of September 30, 2005, $1,260,000 as of June 30, 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 .49% as of September 30, 2005, 0.43% as of
June 30, 2005, and 0.15% as of December 31, 2004. The increase of $187,000 from
June 2005 is primarily made up of two borrowers with loan balances totaling
$347,000. The collateral for one of the loans include a residential property and
equipment with a current loan balance of $147,000 and is in foreclosure and in
the process of being sold. As of September 30, 2005, the Company has
specifically reserved approximately $47,000. The second borrower has a $200,000
loan balance and is collateralized by residential property and farm land. The
collateral is sufficient to cover the loan balance. No loss is anticipated on
this loan at this time.
11
As a percentage of the allowance for loan losses, total nonaccrual loans and
loans past due 90 days or more were 127% as of September 30, 2005, 74.1% as of
June 30, 2005, and 46.8% as of December 31, 2004.
DEPOSITS
Deposits totaled $289.1 million as of September 30, 2005, an increase of $1.3
million, or .43%, from $287.8 million as of December 31, 2004. The slight
increase is considered normal in the day to day operations of a Company.
FHLB BORROWINGS
Federal Home Loan Company borrowings decreased $2.5 million or 6.3%, to $37.4
million as of September 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 nine months ended September 30, 2005 and
2004, respectively.
At September 30, 2005, consolidated Tier 1 risk based capital was 12.04%, and
total risk-based capital was 13.01%. 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 September 30, 2005 and
December 31, 2004 was 102.4%. Loans to total assets were 81.2% at September 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
91.3% 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 $30.3
million as of September 30, 2005. The Company has the ability to obtain deposits
in the brokered certificate of deposit market to help provide liquidity to fund
loan growth, if necessary. Generally, the Company uses short-term borrowings to
fund overnight and short-term funding needs. Longer-term borrowings have been
primarily used to fund mortgage-loan originations. This has occurred when FHLB
longer-term rates are a more economical source of funding than traditional
deposit gathering activities. Additionally, the Company occasionally uses FHLB
borrowings to fund larger commercial loans.
As of September 30, 2005, Management is not aware of any current recommendations
by banking regulatory authorities which, if they were to be implemented, would
have, or would be reasonably likely to have, a material adverse impact on the
Company's liquidity, capital resources, or operations.
12
CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
The Company has certain obligations and commitments to make future payments
under contracts. At September 30, 2005, the aggregate contractual obligations
and commercial commitments are:
Payments Due by Period
-------------------------------
Contractual Obligations Less than 1-3 3-5 After 5
($ in thousands) Total One Year Years Years Years
- ------------------------ -------- --------- -------- ------- --------
Total Deposits $289,075 $227,251 $ 46,865 $14,959
FHLB Borrowings 37,425 3,118 8,997 6,822 18,488
FHLB interest expense 7,979 1,479 2,560 2,654 1,286
Lease Payments 310,500 31,050 62,100 62,100 155,250
Repurchase Agreements 2,642 2,642
-------- -------- -------- ------- --------
Total $647,621 $265,540 $120,522 $86,535 $175,024
======== ======== ======== ======= ========
Payments Due by Period
----------------------------
Other Commercial Commitments Less than 1-3 3-5 After 5
($ in thousands) Total One Year Years Years Years
- ---------------------------- ------- --------- ------ ------ -------
Commitments to Extend Credit $26,599 $9,298 $4,928 $1,104 $11,269
Letters of Credit 78 71 7
------- ------ ------ ------ -------
Total $26,677 $9,369 $4,935 $1,104 $11,269
======= ====== ====== ====== =======
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
13
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 Company liabilities cannot be
determined precisely.
Management believes as of September 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 in 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 September 30, 2005, that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
14
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," "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 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
15
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: November 14, 2005 By: /s/ Paul W. Pence, Jr.
------------------------------------
Paul W. Pence, Jr., President and
Principal Financial Officer
16
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
3.3 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.
3.4 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.
5. Instruments Defining the Rights of Security Holders. (See Exhibit
3.1 and 3.2)
31 Rule 13a-14(a) Certification
32 Section 1350 Certification