10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994 COMMISSION FILE NUMBER 0-11595 MERCHANTS BANCSHARES, INC. ---------------------------------- (Exact name of registrant as specified in its charter) Incorporated in the State of Delaware Employer Identification No. 03-0287342 123 Church St, Burlington, Vermont 05401 (Address of principal executive office) (Zip Code) Registrants telephone number:(802) 658-3400 Securities registered pursuant to Section 12(b) of the Act: (Not Applicable) Securities registered pursuant to Section 12(g) of the Act: Title of Class: Common Stock (Par Value $.01 a share) Name of Exchange on which listed: NASDAQ 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Contained herein X Not contained herein The aggregate market value of the voting stock held by non-affiliates is $29,021,285 as computed using the average bid and asked prices of stock, as of February 15, 1995. The number of shares outstanding for each of the registrant's classes of common stock, as of February 15, 1995 is: Class: Common stock, par value $.01 per share Outstanding: 4,242,927 shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the year ended December 31, 1994 are incorporated herein by reference to Part II. Portions of the Proxy Statement to Shareholders for the year ended December 31, 1994 are incorporated herein by reference to Part III. FORM 10-K TABLE OF CONTENTS Part I Page Reference Item 1 - Business 1 Item 2 - Properties 6 Item 3 - Legal Proceedings 9 Item 4 - Submission of Matters to a 10 Vote of Security Holders Part II Item 5 - Market for Registrant's Common 11 Equity and Related Stockholder Matters Item 6 - Selected Financial Data 11 Item 7 - Management's Discussion and Analysis 24 of Financial Condition and Results of Operations Item 8 - Financial Statements and Supplementary 24 Data Item 9 - Changes in and Disagreements with Accountants 24 on Accounting and Financial Disclosures Part III Item 10 - Directors and Executive Officers of the 25 Registrant Item 11 - Executive Compensation 25 Item 12 - Security Ownership of Certain Beneficial 25 Owners and Management Item 13 - Certain Relationships and Related Party 25 Transactions Part IV Item 14 - Exhibits, Financial Statement 25 Schedules, and Reports on Form 8-K Indemnification Undertaking by Registrant 27 Signatures 28 PART I ITEM 1 - BUSINESS A chronology of events, including acquisitions, relating to MERCHANTS BANCSHARES, INC., (the Company) is as follows: July 1, 1983: Merchants Bancshares, Inc. was organized as a Vermont corporation, for the purpose of acquiring, investing in or holding stock in any subsidiary enterprise under the Bank Holding Company Act of 1956. January 24, 1984: Company acquired The Merchants Bank, a Vermont chartered commercial bank. June 2, 1987: Company shareholders approved a resolution to change the state of incorporation of the Company from Vermont to Delaware. October 4, 1988: Company organized Merchants Properties, Inc., whose mission is as described below. THE MERCHANTS BANK, (the Bank) was organized in 1849, and assumed a national bank charter in 1865, becoming The Merchants National Bank of Burlington, Vermont. On September 6, 1974 the Bank converted its national charter to a state-bank charter, becoming known as The Merchants Bank. Since 1971 the Bank has acquired by merger seven Vermont banking institutions, and has acquired the deposits of an eighth bank located in St. Johnsbury, Vt. The last such acquisition occurred on June 4, 1993 at which time the Bank acquired the New First National Bank of Vermont, with thirteen banking offices, from the Federal Deposit Insurance Corporation Division of Liquidation. As of December 31, 1994 the Bank was the third largest commercial banking operation in Vermont, with deposits totalling $582.2 million, net loans of $490.6 million, and total assets of $694.8 million, on a consolidated basis. Since September 30, 1988, The Merchants Bank has participated as an equity partner in the development of several AFFORDABLE HOUSING PARTNERSHIPS which were formed to provide residential housing units within the State of Vermont. During the past four years these partnerships have developed 727 units of residential housing, 470 (65%) of which qualify as "affordable housing units for eligible low income owners or renters", and 257 (35%) of which are "market rate units". These partnerships have invested in 16 affordable and elderly housing projects within 13 Vermont communities: St. Albans, Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington, Springfield, St. Johnsbury, Colchester, Swanton, Bradford and Hardwick. MERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was organized for the purpose of developing and owning affordable rental housing units throughout the state of Vermont. As of December 31, 1994 the corporation owned one development located in Enosburg, Vermont, consisting of a 24-unit low income family rental housing project, which was completed and rented during 1989. This housing development is fully occupied at this time. Total assets of this corporation at December 31, 1994 were $1,309,983. The Merchants Bank owns controlling interest in the MERCHANTS TRUST COMPANY, a Vermont corporation chartered in 1870 for the purpose of offering fiduciary services such as estate settlement, testamentary trusts, guardianships, agencies, intervivos trusts, employee benefit plans and corporate trust services. The Merchants Trust Company also operates a discount brokerage office, through Olde Discount Corporation, enabling investors to purchase or sell stocks and bonds on a discounted commission schedule. As of December 31, 1994, the Merchants Trust Company had fiduciary responsibilities for assets valued at market in excess of $365.5 million. Total revenue for 1994 was $1,809,991, total expense was $4,415,949, (including an extraordinary item totalling $3,246,100 as described in Part I, Item 4, page 9) resulting in a pre-tax net loss for the year of $2,605,958. This loss is included in the consolidated tax return of its parent company, The Merchants Bank. QUENESKA CAPITAL CORPORATION, a wholly-owned subsidiary of The Merchants Bank was established on April 4, 1988 as a Federal licensee under the Small Business Act of 1958 to provide small business enterprises with loans and/or capital. As of December 31, 1994, the corporation had assets of $1,720,961, liabilities of $109,034 due to the parent company for accrued management fees, and equity capital of $1,611,928. Queneska Capital Corporation has no employees, relying on the personnel resources of its parent company to operate. As compensation for its services Queneska pays the Bank a management fee in the amount of 1.5% on annual average assets ($23,269) in 1994. This fee is eliminated in the financial statement consolidation of the parent company. Queneska's taxable income or loss is included in the consolidated tax return of its parent company, The Merchants Bank. Queneska computes its income tax provision of benefit on an individual basis and reimburses, or is reimbursed by, the parent company an amount equal to the annual provision or benefit. RETAIL SERVICES The Merchants Bank offers a wide range of deposit and investment products including business checking accounts; Free 60 accounts; NOW checking accounts; NOW 50 accounts; regular checking and Super NOW accounts. In July 1994, the Bank offered a new type of personal account entitled "bottom line checking". This account features a flat monthly fee of $3.00 for twenty checks per statement period with no monthly minimum balance required. A charge of $.50 per check is assessed for more than twenty checks per month. The account can also be used for all electronic transactions including ATM transactions. The Bank also offers Certificates of Deposit, Money Market accounts, savings accounts, individual retirement accounts and Christmas Club accounts, all at competitive rates and terms. ATF (automatic transfer of funds) provides overdraft protection benefits for personal checking accounts through electronic funds transfer. In addition, the bank offers cash management services for commercial account depositors who may have idle overnight or longer term balances to invest. The bank provides strong customer support with thirty Automated Teller machines statewide, including one drive-up ATM; and 106 on-line electronic teller stations. The bank's expanded personal computer networks now connect each banking office to the mainframe AS/400 computer with CRT capability, as well as, electronic mail and other PC software applications. Additional retail services include safe deposit boxes, travelers and gift checks, bank drafts, personal money orders and several methods of automated money transfer, including Federal Reserve wire services. COMMERCIAL SERVICES Types of Credit Offerings: Consumer Loans: Financing is provided for new or used automobiles; boats; airplanes; recreational vehicles; new mobile homes; collateral loans, secured by savings accounts, listed equities or life insurance; personal loans. Home improvement and home equity lines of credit, as well as Master and Visa credit cards. Real Estate Loans: Financing is available for one-to-four family residential mortgages; multi- family mortgages; residential construction; mortgages for seasonal dwellings; commercial real estate mortgages. Mortgages for residential properties are offered on a long-term fixed-rate basis; alternatively, adjustable-rate mortgages are offered. Bi-weekly payment mortgages and graduated (two-step) payment mortgages are offered. Loans under the Farmers Home Administration Rural Guaranteed Housing Program provide up to 100% financing. The bank also participates with the Vermont Housing Finance Agency (VHFA) in providing mortgage financing for low- to moderate-income Vermonters. Most mortgage loan products are offered with as little as a 5% down payment to assist borrowers who qualify, providing the mortgagor(s) acquires private mortgage insurance. Commercial Loans: Financing for business inventory, accounts receivable, fixed assets, lines of credit for working capital, community development, irrevocable letters of credit, business credit cards, and U.S. Small Business Administration loans are available. Other miscellaneous commercial banking services include night depository, coin and currency handling and employee benefits management and related fiduciary services available through the Merchants Trust Company. EXPANSION EFFORTS The Merchants Bank operates thirty-eight full-service banking facilities within Vermont; and a remote ATM unit located at the Burlington International Airport. Since 1963 the Bank has established eleven de novo offices, and since 1969 has acquired seven Vermont banks by merger. The Merchants Bank's most recent acquisition occurred in June of 1993 with the acquisition of the assets and assumption of deposits of the New First National Bank of Vermont from the FDIC. Through this acquisition the Merchants Bank extended its presence on the east side of the state gaining offices in Springfield, Windsor, E. Thetford, Fairlee, Bradford, Newbury and Groton and on the west side of the state an office in Fair Haven. This acquisition also resulted in The Merchants Bank increasing market share in Hardwick, St. Johnsbury and Northfield. Each decision to expand the branch network has been based upon strategic planning and analysis indicating that the new or acquired facility would provide enhanced banking resources within the community and insure the competitive viability of the Bank through potential growth of deposits and lending activities. On March 14, 1994 The Merchants Bank opened a limited service office on the Wake Robin Retirement Community Campus in Shelburne, Vermont. During the fall of 1994, The Merchants Bank began restoration of the Old South Hero Inn on the corner of US Route 2 and South St., So. Hero, Vt. The Merchants Bank relocated its South Hero office to this historic site on January 17, 1995. COMPETITION Competition for financial services remains very strong in Vermont. As of December 31, 1994, there were eleven state chartered commercial banks, nine national banks, five savings banks and three savings and loan associations operating in Vermont. In addition, other financial intermediaries such as brokerage firms, credit unions, and out-of-state banks also compete for deposit, loan, and other ancillary financial activities. At year-end 1994 The Merchants Bank was the third largest bank in Vermont, enjoying a strong competitive franchise within the state, with thirty-nine banking offices as identified in Item 2 (A). During January 1995 the Bank of Vermont, a subsidiary of Bank of Boston, was acquired by KeyCorp, a large regional bank holding company headquartered in Cleveland, Ohio. Competition from this large regional institution is expected to be very aggressive. No material part of the Bank's business is dependent upon one, or a few customers, or upon a particular market segment, the loss of which would have a materially adverse impact on the operations of the Bank. NUMBER OF EMPLOYEES As of December 31, 1994, Merchants Bancshares, Inc. had five officers: Dudley H. Davis, Chairman of the Board; Joseph L. Boutin, President and Chief Executive Officer; Susan D. Struble, Secretary; Edward W. Haase, Treasurer; and Susan M. Verro, Assistant Secretary. No officer of the Company is on a salary basis. As of December 31, 1994, The Merchants Bank employed 399 full-time and 81 part- time employees, representing a full-time equivalent complement of 439 employees. The Bank maintains a comprehensive employee benefits program which provides major medical insurance, hospitalization, dental insurance, long-term and short-term disability insurance, life insurance and a pension plan, a 401(k) Employee Stock Ownership Plan and a Performance Progress Sharing Plan. Employee benefits offered by the Bank are very competitive with comparable plans provided by other Vermont banks. REGIONAL ECONOMY Regional economists are hopeful that the economy will begin to moderate as the result of seven Federal Reserve interest rate hikes over the past thirteen months, and that there will be a "soft landing" as opposed to a much less attractive "boom-bust" scenario. While growth in 1994 exceeded earlier forecasts, the slower predicted 1995 national economic expansion is expected to produce only moderate economic gains in New England. Job growth in New Hampshire, Massachusetts, Rhode Island, Connecticut and Vermont is expected to be in the 1 1/2 - 2% range. However, for the region to grow jobs at this predicted level there are several prerequisites. Namely, (i) U.S. real GDP Growth cannot fall much below 2 1/2%, because historically the New England states have been among the most sensitive to changes in national economic activity, (ii) growth must continue to be strong for exports and capital spending because both are important to New England (iii) and finally, defense cutbacks cannot be too severe. If several New England military bases are eventually closed as recommended by the Base Closing Commission, this could have a dramatic adverse economic impact on the region. VERMONT ECONOMY The most recent Vermont economic report published by the New England Economic Project (NEEP) dated October 1994 forecasts the following outlook for the period 1994-1995. - The Vermont economy should continue to improve if the Federal Reserve Bank can engineer a "soft landing" in 1995, whereby interest rates will not be raised by an excessive amount. - Vermont's seasonally adjusted year-end 1994 unemployment rate was 4.3% compared to the U.S. rate at 5.6%. However, the current rate of unemployment has begun to increase due to: a) rising interest rates; b) a slowdown in Canadian tourism activity; and c) industrial "mix" factors involving corporate "right sizing", budgetary constraints and related corporate actions. - Vermont exporters, specialty manufacturers, and sectors of the VT economy benefiting from the strong national expansion are expected to experience the strongest employment growth rates during the period 1995-1996. - The majority of new jobs that will be added in the Vermont economy through 1995 will be found in non- manufacturing job categories, - mostly trade and services. Service sector employment currently accounts for nearly 3 out of every 10 jobs in the state. - With the national economic recovery moving into its' third year, and based upon historical post-war business cycle data, the possibility of a recession during the next three year period is a possibility that should not be ignored. Over the past three years, 1991 - 1994, employment levels within Vermont's five industrial sectors have changed according to the following levels of job creation: Manufacturing 44,200 to 43,700 (1.1%) Construction 11,900 to 11,800 (.8%) Trade 57,400 to 60,800 5.9% Services 67,900 to 77,300 13.8% Government 43,800 to 44,800 2.3% The November 1994 Vermont Economic Newsletter published by Northern Economic Consulting, Inc. reported that actual job growth accelerated in 1994, and that all sectors of the economy posted job gains, with the service sector leading the way. However, it is noteworthy that job gains have not been accompanied by significant wage gains. Overall, incomes are probably rising at or just above the level of inflation, with median family income changing little in recent years. The Vermont economy has now come through two very long and abnormal periods; the boom of 1983 to 1988, followed by the bust of recovery of 1989 to 1994. There are many divergent opinions concerning the forecast for Vermont's economic outlook over the next three years; however, a fair consensus remains that Vermont should continue to maintain a stable, reasonably healthy economy over the next several years. ITEM 2 - PROPERTIES The Merchants Bank operates thirty-nine banking facilities as indicated in Schedule A below. Corporate administrative offices are located at 123 Church Street, Burlington, Vermont, and the operations data processing center is located at 275 Kennedy Drive, South Burlington, Vermont. Schedule B (below) indicates properties owned by the Bank as possible future expansion sites. A. SCHEDULE OF BANKING OFFICES BY LOCATION Burlington 123 Church Street Corporate offices 164 College Street Merchants Trust Co. 172 College Street Branch office 1014 North Avenue Branch office 12 Colchester Avenue *2 Branch office Essex Junction 54 Pearl Street Branch office South Burlington 50 White Street Branch office 947 Shelburne Road *1 Branch office 275 Kennedy Drive Operations Center Branch office Burlington Airport *1 ATM Bristol 15 West Street Branch office Barre 105 North Main Street Branch office Northfield Depot Square Branch office 2 Main St. Drive-up Facility South Hero South St. & Route 2 Branch office Hardwick Wolcott Street Branch office Hinesburg Route 116/Shelburne Falls Rd Branch office Vergennes Monkton Road Branch office Winooski 364 Main Street Branch office Johnson Main Street, Route 15 Branch office Colchester 8 Porters Point Road *2 Branch office Jericho Route 15 Branch office Enosburg Falls 155 Main Street Branch office No. Bennington Bank Street Branch office Manchester Ctr. 515 Main Street Branch office Brattleboro 205 Main Street *3 Branch office Wilmington West Main Street Branch office Bennington Putnam Square *2 Branch office Wallingford Route 7 *2 Branch office St. Johnsbury 90 Portland Street Branch office Bradford 1 Main Street Branch office Danville Main Street Branch office Fairlee U.S. Route #5 Branch office Groton U.S. Route #302 Branch office East Thetford U.S. Route #5 & Vt 113 Branch office Newbury U.S. Route #5 Branch office Fair Haven 97 Main Street Branch office Springfield 56 Main Street Branch office Springfield Shopping Plaza Branch office Windsor 160 Main Street Branch office Notes: *1: Facilities owned by the bank are located on leased land. *2: Facilities located on leased land with improvements also leased. *3: As of December 31, 1994 a mortgage with an unpaid principal balance of $207,860 is outstanding on the Brattleboro office. This mortgage is being amortized at $1,736 per month, at a rate of 9% through the year 2020. B. SCHEDULE OF PROPERTIES OWNED FOR FUTURE EXPANSION *1 Year Description Acquired Location Purpose ------------ -------- ----------------- ---------------- Land & Building 1973 117 Church St. Future Expansion Burlington, VT Land 1977 30 Main Street Future Expansion Burlington, VT Land 1977 45 College St. Future Expansion Burlington, VT Land & Building 1979 Plainfield, VT Future Expansion Land & Building 1981 8 White Street Future Expansion So. Burlington, VT Land & Building 1985 U.S. Route 7 Future Expansion Shelburne, VT Land & Building 1986 Pearl Street Future Expansion Essex Jct., VT Land & Building 1986 So. Summit St. Future Expansion Essex Jct., VT Land 1990 55 College Street Future Expansion Burlington, VT Land & Building 1990 60 Main Street Future Expansion Burlington, VT Land & Building 1993 Bradford Operations Future Expansion Building 1 Main St. Bradford, VT Note: *1: Buildings identified in Schedule B are all rented or leased to tenants. Leases are generally for short-term or medium term periods and are at varying rental amounts depending upon the location and the amount of space leased. ITEM 3 - LEGAL PROCEEDINGS During the fall of 1994, lawsuits were brought against the Company, the Bank, the Trust Company (collectively referred to as "the Companies") and certain directors of the Companies. These lawsuits relate to certain investments managed for Trust company clients and placed in the Piper Jaffray Institutional Government Income Portfolio. Separately, and before the suits were filed, the Companies had initiated a review of those investments. Outside consultants were retained to assist in this review. As a result of the review, the Trust Company paid to the affected Trust Company clients a total of approximately $9.2 million in December 1994. The payments do not constitute a legal settlement of any claims in the lawsuits. However, based on consultation with legal counsel, management believes that further liability, if any, of the Companies on account of matters complained of in the lawsuits will not have a material adverse affect on the consolidated financial position and results of operations of the Company. In December 1994, the Trust Company received a payment of $6,000,000 from its insurance carriers in connection with these matters. The Companies also intend to pursue all available claims against Piper Jaffray Companies, Inc. and others on account of the losses that gave rise to the $9.2 million payment by the Companies. Any recovery obtained as a result of such efforts is subject to the terms of an agreement between the Companies and the insurance carriers. The attorneys representing the plaintiffs in one of the lawsuits discussed above have asked the Court to order the Trust Company's clients to pay fees to those attorneys in an amount of up to $500,000. The Trust Company has resisted the claims for payment of such fees by its clients, and as a result, the Trust Company has been directed to place the sum of $500,000 into escrow pending a ruling by the Court. Based upon consultation with legal counsel, management believes there is no substantial basis for any liability on the part of the Companies for payment of legal fees to those attorneys and, although there is the possibility that the Companies may be required to remit all or part of these funds, such an outcome is not considered likely. The Bank is also involved in various legal proceedings arising in the normal course of business. Based upon consultation with legal counsel, management believes that the resolution of these matters will not have a material effect on the consolidated financial position and results of operations of the Company. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of calendar year 1994 no matters were submitted to a vote of security holders through a solicitation of proxies or otherwise. PART II ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock of the Company is traded on the over-the- counter NASDAQ exchange under the trading symbol MBVT. Quarterly stock prices during the last eight quarters are as indicated below based upon quotations as provided by the National Association of Securities Dealers, Inc. Prices of transactions between private parties may vary from the ranges quoted below. CASH DIVIDEND QUARTER ENDING HIGH LOW PAID PER SHARE March 31, 1993 $17.00 $14.75 .20 June 30, 1993 16.50 10.25 * September 30, 1993 16.00 11.25 * December 31, 1993 15.00 11.00 * March 31, 1994 14.75 9.00 * June 30, 1994 13.50 9.00 * September 30, 1994 17.00 11.25 * December 31, 1994 14.00 8.50 * *Cash dividends were suspended for the second, third and fourth quarters of 1993, and for all four quarters of 1994. As of December 31, 1994 Merchants Bancshares, Inc. had 1,512 shareholders. ITEM 6 - SELECTED FINANCIAL DATA The supplementary financial data presented in the following tables and narrative contains information highlighting certain significant trends in the Company's financial condition and results of operations over an extended period of time. The following information should be analyzed in conjunction with the year-end audited consolidated financial statements as contained in the 1994 Annual Report to Shareholders, a copy of which is attached as an addendum to this Form 10K. The five-year summary of operations, interest management analysis, and management's discussion and analysis, all as contained on pages 23 through 30 in the 1994 Annual Report to Shareholders are herein incorporated by reference. Tables included on the following pages 12 through 16 concern the following: Deposits; return on equity and assets; short-term borrowings; distribution of assets, liabilities, and stockholders' equity; analysis of changes in net interest income; and the composition and maturity of the loan portfolio. DEPOSITS The following schedule shows the average balances of various classifications of deposits. Dollar amounts are expressed in thousands. 1994 1993 1992 Demand Deposits $ 91,853 $ 81,761 $ 68,494 Savings, Money Market and NOW Accounts 310,613 315,254 272,729 Time Deposits Over $100,000 18,135 17,752 18,170 Other Time Deposits 177,198 155,227 132,971 -------- -------- -------- Total Average Deposits $597,799 $569,994 $492,364 ======== ======== ======== Time Deposits over $100,000 at December 31, 1994 had the following schedule of maturities (In Thousands): Three Months or Less $ 1,865 Over Three to Six Months 7,904 Over Six to Twelve Months 3,895 Over Twelve Months 2,943 Over Five Years 6,674 ------- Total $23,281 ======= RETURN ON EQUITY AND ASSETS The return on average assets, return on average equity, dividend payout ratio and average equity to average assets ratio for the three years ended December 31, 1994 were as follows: 1994 1993 1992 Return on Average Total Assets -0.41% -0.82% 0.94% Return on Average Stockholders' Equity -6.24% -11.92% 11.01% Dividend Payout Ratio N/A N/A 58.48% Average Stockholders' Equity to Average Total Assets 6.53% 6.88% 8.56% SHORT-TERM BORROWINGS For this information refer to notes 8 and 9 to the financial statements of the Company, as contained in the Annual Report to Shareholders, which is herein incorporated by reference. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential The following table presents the condensed annual average balance sheets for 1994, 1993 and 1992. The total dollar amount of interest income from assets and the subsequent yields calculated on a taxable equivalent basis as well as the interest paid on interest bearing liablilities, expressed in dollars and rates are also shown in the table.
(All Dollars are in Thousands) 1994 1993 1992 ---------------------------- ----------------------------- --------------------------- Interest Average Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ ASSETS: Balance Expense Rate Balance Expense Rate Balance Expense Rate Investment Securities: ------- -------- -------- -------- -------- -------- -------- -------- -------- U.S. Treasury and Agencies $89,183 $3,508 3.93% $98,971 $3,655 3.69% $92,184 $4,306 4.67% States & Political Subdivisions 0 0 0.00% 143 12 8.39% 10 1 10.00% Other, Including FHLB Stock 8,178 535 6.54% 8,900 667 7.49% 3,733 242 6.48% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Investment Securities $97,361 $4,043 4.15% $108,014 $4,334 4.01% $95,927 $4,549 4.74% -------- -------- -------- -------- -------- -------- -------- -------- -------- Loans, Including Fees on Loans: Commercial (a) (b) 117,948 10,128 8.59% 111,353 9,236 8.29% 105,489 10,174 9.64% Real Estate 396,176 36,959 9.33% 380,810 35,639 9.36% 317,865 32,685 10.28% Consumer 19,710 2,167 10.99% 23,642 2,728 11.54% 18,692 2,239 11.98% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Loans $533,834 $49,254 9.23% $515,805 $47,603 9.23% $442,046 $45,098 10.20% -------- -------- -------- -------- -------- -------- -------- -------- -------- Federal Funds Sold $7,865 $315 4.01% $3,230 $97 3.00% $4,939 $168 3.40% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Earning Assets $639,060 $53,612 8.39% $627,049 $52,034 8.30% $542,912 $49,815 9.18% -------- -------- -------- -------- -------- -------- -------- -------- -------- Reserve for Possible Loan Losses (18,991) (11,488) (7,480) Cash and Due From Banks 31,910 29,177 27,312 Premises and Equipment 16,349 15,166 15,279 Other Assets 40,749 45,611 24,293 -------- -------- -------- Total Assets $709,077 $705,515 $602,317 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY: Time Deposits: Savings, Money Market & NOW Accounts $309,490 $8,420 2.72% $315,254 $8,546 2.71% $277,330 $11,011 3.97% Certificates of Deposit over $100,000 22,248 1,336 6.01% 25,578 1,394 5.45% 22,173 765 3.45% Other Time 177,250 8,096 4.57% 148,364 7,109 4.79% 123,081 7,913 6.43% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Time Deposits $508,988 $17,852 3.51% $489,196 $17,049 3.49% $422,584 $19,689 4.66% -------- -------- -------- -------- -------- -------- -------- -------- -------- Federal Funds Purchased 1,167 57 4.88% 2,197 88 4.01% 1,791 94 5.25% Securities Sold Under Agreement to Repurchase 19 1 5.26% 7,688 229 2.98% 5,117 187 3.65% Demand Notes Due U.S. Treas 3,130 120 3.83% 3,540 97 2.74% 3,498 119 3.40% Other Interest Bearing Liabilities 4,555 303 6.65% 5,471 290 5.30% 3,672 264 7.19% Debt 50,575 4,044 8.00% 58,337 4,272 7.32% 42,171 3,698 8.77% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Interest Bearing Liabilities $568,434 $22,377 3.94% $566,429 $22,025 3.89% $478,833 $24,051 5.02% -------- ------- -------- -------- -------- -------- -------- -------- -------- Demand Deposits 89,318 81,761 68,324 Other Liabilities 4,994 8,814 3,612 Stockholders' Equity 46,331 48,511 51,548 -------- -------- -------- Total Liabilities & Stockholders' Equity $709,077 $705,515 $602,317 ======== ======== ======== Net Interest Income (a) $31,235 $30,009 $25,764 ======== ======== ======== Yield Spread 4.45% 4.41% 4.15% ===== ===== ===== NET INTEREST INCOME TO EARNING ASSETS 4.89% 4.79% 4.75% ===== ===== ===== (a) Tax exempt interest has been converted to a tax equivalent basis by tax effecting such interest at the Federal tax rate of 34%. (b) Includes non-accruing loans.
Merchants Bancshares, Inc Analysis of Changes in Net Interest Income The following table sets forth, for each major category of interest earning assets and interest bearing liabilities, the dollar amounts (in thousands) of interest income (calculated on a taxable equivalent basis) and interest expense and change therein for 1994 as compared with 1993 and 1993 as compared with 1992.
1994 vs 1993 1993 vs 1992 ------------------------------------------- ------------------------------------------- Increase --Due to (a)-- Increase --Due to (a)-- 1994 1993 (Decrease) Volume Rate 1993 1992 (Decrease) Volume Rate ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Interest Income: Loans $49,254 $47,603 $1,651 $1,664 ($13) $47,603 $45,098 $2,505 $6,808 ($4,303) Investment Income: Taxable 4,043 4,322 (279) (432) 153 4,322 4,548 (226) 637 (863) Non-Taxable 0 12 (12) (12) (0) 12 1 11 11 (0) Federal Funds Sol 315 97 218 186 32 97 168 (71) (51) (20) ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Total $53,612 $52,034 $1,578 $1,406 $171 $52,034 $49,815 $2,219 $7,404 ($5,186) ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Less Interest Expense: Savings, Money Market & Now Accounts $8,420 $8,546 ($126) ($157) $31 $8,546 $11,011 ($2,465) $1,028 ($3,493) Certificates of Deposit Over $100,000 1,336 1,394 (58) (200) 142 1,394 765 629 186 443 Other Time 8,096 7,109 987 1,313 (326) 7,109 7,913 (804) 1,211 (2,015) Federal Funds Purchased 57 88 (31) (50) 19 88 94 (6) 16 (22) Securities Sold Under Agreement to Repurchase 1 229 (228) (403) 175 229 187 42 77 (35) Demand Note - U.S. Treasury 120 97 23 (16) 39 97 119 (22) 1 (23) Debt and Other Borrowings 4,347 4,562 (215) (685) 470 4,562 3,962 600 1,282 (682) ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Total $22,377 $22,025 $352 ($198) $550 $22,025 $24,051 ($2,026) $3,800 ($5,827) ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Net Interest Income $31,235 $30,009 $1,226 $1,604 ($378) $30,009 $25,764 $4,245 $3,603 $640 ======= ======= ======== ======= ======= ======= ======= ======== ======= ======= (a) The dollar amount of changes in interest income and interest expense attributable to changes in rate and volume has been allocated between rate and volume based upon the changes in rates times the first year's volume and the changes in volume times the current year's rate. Note: Included in Interest Income are fees on loans totaling $3,571, $4,598 and $4,326 for the years ended December 31, 1994, 1993 and 1992, respectively.
LOAN PORTFOLIO The following tables display the composition of the Bank's loan portfolio for the consecutive five year period 1990 through 1994, along with a schedule profiling the loan maturity distribution over the next five years. COMPOSITION OF LOAN PORTFOLIO The table below presents the composition of the Bank's loan portfolio by type of loan as of December 31 for each of the past five years. All dollar amounts are expressed in thousands. Amounts are shown gross of net deferred loan fees of $1,132,494 in 1994, $1,310,416 in 1993, $1,183,400 in 1992, $1,098,100 in 1991 and $955,000 in 1990, which principally relate to real estate mortgages. ----------------As of December 31,-------------- Type of Loan 1994 1993 1992 1991 1990 Commercial, Financial & Agricultural $ 88,201 $ 98,936 $ 76,141 $120,033 $129,830 Industrial Revenue Bonds 4,411 6,695 8,721 11,968 16,296 Real Estate-Construction 21,992 30,526 18,776 16,392 23,763 Real Estate - Mortgage 377,429 413,112 305,513 294,769 288,845 Installment 18,086 22,836 18,332 20,930 25,070 Lease Financing 0 42 630 1,769 4,144 All Other Loans 436 1,324 1,422 4,287 7,452 -------- -------- -------- -------- -------- Total Loans $510,555 $573,471 $429,535 $470,148 $495,400 PROFILE OF LOAN MATURITY DISTRIBUTION The table below presents the distribution of the varying maturities or repricing opportunities of the loan portfolio at December, 1994. All dollar amounts are expressed in thousands. Over One One Year Through Over Five Or Less 5 Years Years Total --------- ---------- --------- -------- Commercial Loans, Industrial Revenue Bonds, Lease Financing and All Other Loans $ 59,012 $ 23,698 $10,338 $93,048 Real Estate Loans 237,270 96,197 65,954 399,421 Installment Loans 5,342 12,386 358 18,086 -------- -------- ------- -------- $301,624 $132,281 $76,650 $510,555 ======== ======== ======= ======== Residential mortgage lending slowed during 1994 after two years of very heavy refinancing volume. Approximately 63% of the Bank's 1994 mortgage activity was for refinancing of existing debt. In 1994, a total of 490 one-to-four family residential mortgage loans were closed by the bank, totalling $44.8 million. Approximately 93% of these originations were sold on the secondary market and the remaining 7%, or $3.5 million were placed in the bank's portfolio. The bank currently services $335 million in residential mortgage loans, $259.3 of which it services for other investors such as federal government agencies (FNMA and FHLMC) and for financial investors such as insurance companies and pension funds located outside Vermont. At the end of 1994, the bank had 130 residential mortgage loans in various stages of processing. Approximately 40% of these loans were refinancings of existing debt. During 1994, the Bank remained an active participant in the U.S. Small Business Administration guaranteed loan program. Sixty- six new SBA loans totalling $8.22 million were originated during 1994 with SBA guarantees ranging from 70% to 90%. This volume of new lending activity represents an increase of 15% over originations during 1993. Approximately 79% of all new SBA loans originated during 1994 were sold to secondary market investors located outside Vermont. This selling activity has the positive effect on Vermont of importing capital into the State from other parts of the country. SBA guarantees are advantageous to the Bank because they reduce risk in the Bank's loan portfolio and allow the bank to increase it's commercial loan base and market share with minimal impact on capital. During 1994, the Bank originated 746 commercial loans totalling $134.6 million. This lending activity represented an increase of approximately 26% of new loan volume over that experienced in 1993. Commercial loans were originated throughout Vermont. LOAN REVIEW The Bank's Board of Directors grants each loan officer the authority to originate loans on behalf of the Bank. The Board also establishes restrictions regarding the types of loans that may be granted and sets loan authority limits for each lender. These authorized lending limits are established at least annually and are based upon the lender's job assignment, training, and experience. Loan requests that exceed a lender's authority are referred to senior loan officers having higher lending authorities. All extensions of credit of $2.5 million to any one borrower, or related party interest, are reviewed and approved by the Bank's Board of Directors. By using a variety of management reports, the Bank's loan portfolio is continuously monitored by the Board of Directors, senior loan officers, and the loan review department. The loan portfolio as a whole, as well as individual loans, are reviewed for loan performance, credit worthiness, and strength of documentation. Credit ratings are assigned to commercial loans and routinely reviewed. All loan officers are required to service their own loan portfolios and account relationships. As necessary, loan officers or the loan workout function take remedial actions to assure full and timely payment of loan balances. LOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES (RPLL) Merchants Bancshares, Inc. reviews the adequacy of the RPLL at least quarterly. The method used in determining the amount of the RPLL is not based upon maintaining a specific percentage of RPLL to total loans or total nonperforming assets, but rather a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors which are indicative of both general and specific credit risk, as well as a consistent methodology for quantifying probable credit losses. As part of the Merchants Bancshares, Inc.'s analysis of specific credit risk, a detailed and extensive review is done on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings, and credit rating reports. The more significant factors considered in the evaluation of the adequacy of the RPLL based on the analysis of general and specific credit risk include: - Status of nonperforming loans - Status of adversely classified credits - Historic charge off experience by major loan category - Size and composition of the loan portfolio - Concentrations of credit risk - Renewals and extensions - Current local and general economic conditions and trends - Loan growth trends in the portfolio - Off-balance sheet credit risk relative to commitments to lend Overall, management maintains the RPLL at a level deemed to be adequate, in light of historical, current and prospective factors, to reflect the level of risk in the loan portfolio. An analysis of the allocation of the RPLL follows. Both the specific and general components of the RPLL are grouped by loan categories. The allocation of the RPLL is based upon loan loss experience, loan portfolio composition, and an assessment of possible future loan losses in the categories shown. Allocation of the Reserve for Possible Loan Losses December 31, 1994 (000's omitted) Percent of loans in each Balance at End of Period Percent category to Applicable to: Amount Allocation total Loans ---------------------------------------------------------------------- Domestic: Commercial, Financial, and Agricultural & IRB's $5,000 25% 18% Real Estate - Construction 1,500 8% 4% Real Estate - Mortgage 13,000 65% 74% Installment Loans to Individuals 350 2% 4% All Other Loans 79 0% 0% ---------------------------------------------------------------------- Total: $19,929 100% 100% ====================================================================== Key data that are used in the assessment of the loan portfolio and the analysis of the adequacy of the RPLL are presented in the tables and schedules that follow in this discussion. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the RPLL. The table below reflects the Bank's loan loss experience and activity in the RPLL for the past five years. All dollar amounts are expressed in thousands. LOAN LOSSES AND RPLL RECONCILIATION Year Ended December 31, 1994 1993 1992 1991 1990 --------- --------- --------- --------- -------- Average Loans $514,843 $515,805 $441,291 $471,141 $488,792 ======== ======== ======== ======== ======== Reserve for Possible Loan Losses at Beginning of Year 20,060 7,412 6,650 5,075 5,151 Loans Charged Off (NOTE 1): -------- -------- -------- -------- ----- Commercial, Lease Financing and all Other Loans (3,356) (5,567) (2,938) (3,367) (2,318) Real Estate - Construction (1,159) (275) (253) (1,802) 0 Real Estate - Mortgage (7,673) (7,651) (4,096) (718) (2,236) Installment & Credit Cards (462) (459) (452) (617) (575) --------- --------- --------- -------- ------- Total Loans Charged Of (12,650) (13,952) (7,739) (6,504) (5,129) --------- --------- -------- -------- ------- Recoveries on Loans: Commercial, Lease Financing and all Other Loans 1,187 392 232 366 471 Real Estate - Construction 400 0 0 379 0 Real Estate - Mortgage 769 301 108 0 3 Installment & Credit Cards 163 85 111 91 87 --------- --------- --------- -------- -------- Total Recoveries on Loans $2,519 $778 $451 $836 $561 --------- --------- --------- -------- -------- Net Loans Charged Off ($10,131) ($13,174) ($7,288) ($5,668) ($4,568) --------- --------- -------- -------- -------- Provision for Loan Losses: Charged to Operations (NOTE 2) 10,000 23,822 8,050 7,243 4,492 Loan Loss Reserve (Note 3) 2,000 ------- ------- ------ ------ ------ Reserve for Possible Loan Losses at End of Year $19,929 $20,060 $7,412 $6,650 $5,075 ======= ======= ====== ====== ====== Loan Loss Reserve to Total Loans at Year End 3.90% 3.50% 1.73% 1.41% 1.03% Ratio of Net Charge Offs During the Year to Average Loans Outstanding During the Year 1.97% 2.28% 1.63% 1.20% 0.95% NOTE 1: Prior to 1991, loans secured by real estate were not broken out between construction and permanent financing for purposes of loan charge off and recovery analysis. NOTE 2: The loan loss provision is charged to operating expense. When actual losses differ from these estimates, and if adjustments are considered necessary, they are reported in operations in the periods in which they become known. NOTE 3: See Note 10 to the consolidated financial statements regarding the acquisition of New First National Bank of Vermont. The slight decrease in the reserve for possible loan losses from $20,060,000 at December 31, 1993 to $19,929,000 at December 31, 1994, reflects management's in-depth analysis of the RPLL and efforts to maintain the reserve at an appropriate level to provide for potential loan losses based on the evaluation of known and inherent risks in the loan portfolio. The provision for loan losses decreased from $23,822,000 in 1993 to $10,000,000 in 1994. This was partly driven by net loans charged off by the Company in 1993 of $13,174,000. NONPERFORMING ASSETS The following tables summarize the Bank's nonperforming assets. The first table shows a breakout of nonperforming assets covered by a loss sharing arrangement related to the acquisition of the NFNBV on June 4, 1993. The terms of the Purchase and Assumption Agreement related to the purchase of NFNBV require that the FDIC pay the Bank 80% of net charge-offs up to $41,100,000 on any loans that qualify as loss sharing loans for a period of three years from the date of the acquisition. If net charge offs on qualifying loss sharing loans exceed $41,100,000 during the three year period, the FDIC is required to pay 95% of such qualifying charge offs. This arrangement significantly reduces the exposure that the Bank faces on NPAs that are covered by loss sharing. Nonperforming assets (NPAs) covered by loss sharing totaled $10,455,000 and $17,469,000 at December 31, 1994 and 1993, respectively. The aggregate amount of loans covered by the loss sharing arrangement at December 31, 1994 was $95,802,000 and $132,879,208 at December 31, 1993. Nonperforming assets as of December 31, 1994 were: Segregated Loans Loans Total ----------------------------------------------------------------------- Nonaccrual Loans $24,251,987 $7,948,632 $32,200,619 Restructured Loans 5,016,123 66,731 5,082,854 Loans Past Due 90 Days or More and Still Accruing 668,007 0 668,007 Other Real Estate Owned, Net 10,791,262 2,439,545 13,230,807 ----------- ----------- ----------- Total: $40,727,379 $10,454,908 $51,182,287 =========== =========== =========== The following table shows nonperforming assets as of year end 1990 through 1994 (in thousands): 1994 1993 1992 1991 1990 --------------------------------------------------------------------------- Nonaccrual Loans $32,200 $47,069 $12,148 $8,333 $2,914 Loans Past Due 90 Days or More and Still Accruing 668 715 7,251 8,613 5,908 Restructured Loans 5,083 2,841 1,838 5,679 0 ------ ------ ------ ------ ------ Total Nonperforming Loans: 37,951 50,625 21,237 22,625 8,822 ------ ------ ------ ------ ------ Other Real Estate Owned 13,231 13,674 12,662 6,110 4,652 ------ ------- ------- ------- ------- Total Nonperforming Assets: $51,182 $64,299 $33,899 $28,735 $13,474 ======= ======= ======= ======= ======= Percentage of Nonperforming Loans to Total Loans 7.43% 8.83% 4.94% 4.81% 1.78% Percentage of Nonperforming Assets to Total Loans plus Other Real Estate Owned 9.77% 10.95% 7.67% 6.03% 2.70% ======= ======= ======== ======= ======= The nonperforming assets table above showed an increasing trend in nonperforming assets until December 31, 1993. Historically, the Company has worked closely with borrowers and also pursued vigorous collection efforts. The Company continued its efforts to collect on troubled assets during 1994. The Company's enhanced Loan Review and Loan Workout functions provided resources to address collection strategies for nonperforming assets. Based upon the result of the Company's assessment of the factors affecting the RPLL, as noted in this discussion, management believes that the balance of the RPLL at December 31, 1994, is adequate. DISCUSSION OF 1994 EVENTS AFFECTING THE RESERVE FOR POSSIBLE LOAN LOSSES (RPLL) Nonperforming assets declined from $64,299,000 at December 31, 1993 to $51,182,000 at December 31, 1994. Net charge offs during 1994 were $10,131,000 which accounted for part of the reduction. Paydowns, payoffs, return to performing status, and OREO sales resulted in a further decrease in NPAs. 12-31-94 9-30-94 6-30-94 3-31-94 12-31-93 -------- -------- -------- -------- -------- Nonaccrual Loans $32,200 $28,385 $39,166 $43,091 $47,069 Loans Past Due 90 days or more and still Accruing 668 106 558 109 715 Restructured Loans 5,083 5,014 2,892 1,915 2,841 Other Real Estate Owned, Net 7,389 10,898 10,759 9,784 6,235 In-substance Foreclosure, Net 5,842 4,685 5,195 5,430 7,439 ------- ------- ------- ------- ------- Total: $51,182 $49,088 $58,570 $60,329 $64,299 ======= ======= ======= ======= ======= The more significant events affecting NPAs are discussed below: NONACCRUAL LOANS: Nonaccrual loans declined from $47,069,000 at December 31, 1993 to $32,200,000 at December 31, 1994. The decline resulted from charge offs, payments, and return to accruing status. The increase in nonaccrual loans from September 30, 1994 to December 31, 1994 is due primarily to one borrowing relationship. This $5.8 million relationship was re-analyzed in the fourth quarter as the result of a softening in the market. LOANS PAST DUE 90 DAYS OR MORE AND STILL ACCRUING: The Bank generally places loans that become 90 or more days past due on nonaccrual status. If the ultimate collectability of principal and interest is assured, loans may continue to accrue and be left in this category. The loan amount shown in this category was evaluated and full collection of principal and interest is probable. RESTRUCTURED LOANS: Restructured loans (TDRs) increased during 1994 from $2,841,000 at December 31, 1993 to $5,083,000 at December 31, 1994. Two relationships for $1,325,000 and $3,397,000, respectively, previously shown as nonaccruing were returned to accrual status. These two relationships migrated to the TDR category from non-accrual since performance after restructuring had not spanned a year end accounting period. One relationship for $1,323,000 which had performed at market rates and terms for fourteen (14) months was returned to performing status. Payoffs accounted for approximately $1 million in reduction in TDRs during 1994. OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURE: The Bank had notable success in 1994 in disposing of OREO and continues to aggressively market such properties. However, OREO increased from $6,235,000 at December 31, 1993 to $7,389,000 at December 31, 1994. Larger balance additions to OREO were: - an apartment complex for $1.5 million - a commercial building lot for $800,000 - a residential development for $2 million Larger balance reductions were: - a commercial office building for $637,000 - Five separate commercial buildings for $1,770,000 - A multi-function commercial building for $750,000 The fourth quarter reduction in OREO results from sales and from a $2.1 million provision to valuation reserves allocated against specific OREO properties. OREO includes specific assets to which legal title has been taken as the result of transactions related to real estate loans. In-substance Foreclosures (ISF) decreased from $7,439,000 at December 31, 1993 to $5,842,000 at December 31, 1994. Payments or payoffs of approximately $1.2 million were received and one ISF was transferred to OREO for $2 million. Six loans were reclassified as ISF totalling approximately $1.4 million. The criteria for designation of loans as in-substance foreclosures are that the debtor has little or no equity in the collateral, proceeds for repayment of the loan will come only from the operation or sale of the collateral, and the debtor has formally or effectively abandoned control of the assets or is not expected to rebuild equity in the collateral. The collateral underlying these loans is recorded at the lower of cost or market value less estimated selling costs. The total amount of Other Real Estate Owned and In-Substance Foreclosures at December 31 in each of the last five years is as follows: 1994 1993 1992 1991 1990 ---------------------------------------------- Other Real Estate Owned 7,389 6,235 3,874 2,650 1,968 In-Substance Foreclosure 5,842 7,439 8,787 3,460 2,684 ------- ------- ------- ------ ------ Total: $13,231 $13,674 $12,661 $6,110 $4,652 ======= ======= ======= ====== ====== POLICIES AND PROCEDURES RELATING TO THE ACCRUAL OF INTEREST INCOME The Bank normally recognizes income on earning assets on the accrual basis, which calls for the recognition of income as earned, as opposed to when it is collected. The Bank's policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due in excess of 90 days and the ultimate collectability of principal or interest becomes doubtful. Interest previously accrued is reversed if management deems the past due conditions to be an indication of uncollectability. Also, loans may be placed on a nonaccrual basis at any time prior to the period specified above if management deems such action to be appropriate. ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of the Financial Condition and Results of Operations as contained on pages 25 through 30 of the Company's 1994 Annual Report to Shareholders is incorporated herein by reference. ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated balance sheets of Merchants Bancshares, Inc. as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in stockholders' equity and cash flows, for each of the three years in the period ended December 31, 1994 together with the related notes and the opinion of Arthur Andersen LLP, independent public accountants, all as contained on pages 5 through 33 of the Company's 1994 Annual Report to Shareholders are incorporated herein by reference. ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. Part III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Section 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers, directors and ten percent shareholders to file initial reports of ownership and reports of changes of ownership of the Company's common stock with the Securities and Exchange Commission. Based upon a review of these filings, there were no late filings of SEC Form 4's during 1994. ITEM 11 - EXECUTIVE COMPENSATION ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is hereby made to pages 3 through 13 of the Company's Proxy Statement to Shareholders dated March 24, 1995, wherein pursuant to Regulation 14 A information concerning the above subjects (Items 10 through 13) is incorporated by reference. Pursuant to Rule 12 b-23, definitive copies of the Proxy Statement will be filed within 120 days subsequent to the end of the Company's fiscal year covered by Form 10-K. PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (1) The following consolidated financial statements as included in the 1994 Annual Report to Shareholders, are incorporated herein by reference: Consolidated Balance Sheets, December 31, 1994 and December 31, 1993. Consolidated Statements of Operations for years ended December 31, 1994, 1993, 1992. Consolidated Statements of Changes in Stockholder's Equity for years ended December 31, 1994, 1993, 1992. Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993, 1992. Notes to Consolidated Financial Statements, December 31, 1994. (2) The following exhibits are either filed or attached as part of this report, or are incorporated herein by reference. Exhibit Description (3a) Restated Certificate of Incorporation of the Company, filed on April 25, 1987 as Exhibit B to the Proxy Statement filed as part of the pre- effective amendment No. 1 to the Company's Registration Statement on Form S-14 (Registration No. 2-86103) is incorporated herein by reference. (3b) Amended By-Laws of the Company, filed on April 25, 1987 as Exhibit C to the Company's Proxy Statement is incorporated herein by reference. (4) Investments, defining the rights of security holders including indentures; incorporated by reference from the Registrant's Form S-14 Registration Statement (Registration No. 2-86103), as filed on September 14, 1983. (10) Material Contracts: The following are major contracts preceded by applicable number to Registrant's Form S-14 (Registration No. 2-86103) and are incorporated herein by reference. 15 (10a) Service Agreement as amended between First Data Resources, Inc., and Registrant dated June 1993 (effective through May 1998) for Mastercard Services. 17 (10c) 401(k) Employee Stock Ownership Plan of Registrant, dated January 1, 1990, for the employees of the Bank. 19 (10d) Merchants Bank Pension Plan, as amended and restated on January 1, 1989, for employees of the Bank. 20 (10e) Agreement between Specialty Underwriters, Inc., and Registrant dated January 12, 1993 for equipment maintenance services. (11) Statement re: computation of per share earnings. (13) 1994 Annual Report to Shareholders is furnished for the information of the Commission only and is not to be deemed filed as part of this report, except as expressly provided herein. (23) The Registrant's Proxy Statement to Shareholders for the calendar year ended December 31, 1994 will be filed within 120 days after the end of the Company's fiscal year. Other schedules are omitted because of the absence of conditions under which they are required, or because the required information is provided in the financial statements or notes thereto. (23a) Reports on Form 8-K The Company filed a Form 8-K with the Securities and Exchange Commission on June 4, 1993. This report detailed the terms and conditions of a Purchase and Assumption Agreement among the Federal Deposit Insurance Corporation, Receiver of the New First National Bank of Vermont, National Association, the Federal Deposit Insurance Corporation and The Merchants Bank, dated June 4, 1993. INDEMNIFICATION UNDERTAKING BY REGISTRANT In connection with Registrant's Form S-8 Registration Statement under the Securities Act of 1933 with respect to the Registrant's 401(k) Employee Stock Ownership Plan, the Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into such Registration Statement on Form S-8: Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel, the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. SIGNATURES Pursuant to the requirement of Section 13 or 15 (d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on it's behalf by the undersigned, thereunto duly authorized. Merchants Bancshares, Inc. Date March 24, 1995 by S/Joseph L. Boutin ------------------ ---------------------------- Joseph L. Boutin, President & CEO Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MERCHANTS BANCSHARES, INC., and in the capacities and on the date as indicated. by S/Joseph L. Boutin by S/ Peter A. Bouyea ------------------------------- ------------------------------ Joseph L. Boutin, Director, President Peter A. Bouyea, Director & CEO of the Company and the Bank by by S/Dudley H. Davis ------------------------------- ------------------------------ Charles A. Davis, Director Dudley H. Davis, Director Chairman of the Board of Directors by S/ Jeffrey L. Davis by S/Jack DuBrul, II ------------------------------- ------------------------------ Jeffrey L. Davis, Director Jack DuBrul,II, Director by S/Michael G. Furlong by ------------------------------- ------------------------------ Michael G. Furlong, Director Thomas F. Murphy, Director by S/Edward W. Haase by ------------------------------- ----------------------------- Edward W. Haase, Treasurer and Leo O'Brien, Jr, Director Chief Financial Officer of the Company Senior Vice President and Treasurer of the Bank by by S/Patrick S. Robins ------------------------------- ------------------------------ Raymond C. Pecor, Jr., Director Patrick S. Robins, Director by by S/Robert A. Skiff ------------------------------- ------------------------------ Benjamin F. Schweyer, Director Robert A. Skiff, Director by ------------------------------- Susan D. Struble, Director EX-13 2 Report of Independent Public Accountants To the Stockholders and Board of Directors of Merchants Bancshares, Inc.: We have audited the accompanying consolidated balance sheets of Merchants Bancshares, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in stockholders'equity and cash flows for each of the three years in the period ended December 31, 1994. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Merchants Bancshares, Inc. and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. As explained in Note 2 to the consolidated financial statements, the Company adopted, effective December 31, 1993, Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." ARTHUR ANDERSEN LLP Boston, Massachusetts January 27, 1995 Merchants Bancshares, Inc. Consolidated Balance Sheets
At December 31, 1994 1993 ------------------------------------------------------------------------------------------------ ASSETS: Cash and Due from Banks (Note 2) $ 34,851,401 $ 30,587,986 Investment Securities Available for Sale (Notes 2 and 3): Debt Securities 90,470,922 85,505,677 Marketable Equity Securities 1,195,897 1,451,793 Debt Securities Held to Maturity (Market Value $9,871,875) 10,084,646 0 ------------------------------------------------------------------------------------------------ Total Investment Securities 101,751,465 86,957,470 ------------------------------------------------------------------------------------------------ Loans (Notes 2 and 4) 414,752,749 440,592,392 Segregated Assets (Notes 4 and 10) 95,802,303 132,879,208 Reserve for Possible Loan Losses (19,928,817) (20,060,059) ------------------------------------------------------------------------------------------------ Net Loans 490,626,235 553,411,541 ------------------------------------------------------------------------------------------------ Federal Home Loan Bank Stock 6,856,200 5,573,700 Premises and Equipment, Net (Notes 2 and 5) 16,620,173 16,148,102 Investments in Real Estate Limited Partnerships (Note 2) 3,593,818 4,609,901 Other Real Estate Owned, Net 13,230,807 13,674,259 Other Assets (Note 7) 27,306,440 24,084,495 ------------------------------------------------------------------------------------------------ Total Assets $ 694,836,539 $ 735,047,454 ---------------------------------------------------------------------============---============ LIABILITIES: Deposits: Demand $ 94,467,122 $ 96,413,399 Savings, NOW and Money Market Accounts 293,655,696 321,821,034 Time Deposits Over $100,000 23,280,762 21,214,667 Other Time 170,820,804 179,860,784 ------------------------------------------------------------------------------------------------ Total Deposits 582,224,384 619,309,884 Other Borrowed Funds (Note 8) 18,294,734 14,924,081 Other Liabilities (Notes 6 and 7) 7,788,085 8,460,061 Debt (Note 9) 44,229,366 46,633,422 ------------------------------------------------------------------------------------------------ Total Liabilities $ 652,536,569 689,327,448 ------------------------------------------------------------------------------------------------ Commitments and Contingencies (Note 13) STOCKHOLDERS' EQUITY (Notes 11 and 12): Preferred Stock Class A: $.01 par value, non-voting Shares Authorized: 200,000 Shares Outstanding: None 0 0 Class B: $.01 par value, voting Shares Authorized: 1,500,000 Shares Outstanding: None 0 0 Common Stock, $.01 par value Shares Authorized: 4,700,000 Shares Issued: 4,242,927 42,429 42,429 Capital in Excess of Par Value 30,647,120 30,647,120 Retained Earnings 12,462,820 15,352,844 Treasury Stock (at Cost) 12,733 Shares (178,730) (178,730) Net Unrealized Depreciation of Investment Securities Available for Sale, Net of Taxes (673,669) (143,657) ------------------------------------------------------------------------------------------------ Total Stockholders' Equity 42,299,970 45,720,006 ------------------------------------------------------------------------------------------------ Total Liabilities and Stockholders' Equity $ 694,836,539 $ 735,047,454 ---------------------------------------------------------------------============---============ The accompanying notes are an integral part of these consolidated financial statements.
Merchants Bancshares, Inc. Consolidated Statements of Operations
For the years ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------------------------------------- INTEREST AND DIVIDEND INCOME: Interest and Fees on Loans $ 48,938,668 $ 47,268,729 $ 44,521,757 Interest and Dividends on Investments: U.S. Treasury and Agency Obligations 3,508,523 3,655,198 4,305,553 Obligations of State and Political Subdivisions 0 12,839 700 Other 872,267 537,054 410,565 ---------------------------------------------------------------------------------------------------------- Total Interest and Dividend Income 53,319,458 51,473,820 49,238,575 ------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Savings, NOW and Money Market Accounts 8,419,716 8,476,489 11,014,319 Time Deposits Over $100,000 1,335,775 1,394,307 764,656 Other Time 8,095,686 7,108,490 7,910,855 Other Borrowed Funds 495,997 733,817 663,434 Debt 4,029,479 4,242,423 3,697,715 ------------------------------------------------------------------------------------------------------------- Total Interest Expense 22,376,653 21,955,526 24,050,979 ------------------------------------------------------------------------------------------------------------- Net Interest Income 30,942,805 29,518,294 25,187,596 Provision for Possible Loan Losses (Note 4) 10,000,000 23,822,000 8,050,000 ------------------------------------------------------------------------------------------------------------- Net Interest Income after Provision for Possible Loan Losses 20,942,805 5,696,294 17,137,596 ------------------------------------------------------------------------------------------------------------- NON-INTEREST INCOME: Trust Department Income 1,729,376 1,686,561 1,399,451 Service Charges on Deposits 3,451,507 3,571,376 2,536,267 Merchant Discount Fees 2,123,526 1,741,209 1,422,674 Other 1,411,587 1,555,721 1,388,166 Gains on Investment Securities, net (Note 3) 72,884 1,898,945 3,448,531 FDIC Assistance Received-Loss Sharing (Note 10) 6,248,802 1,674,615 0 ----------------------------------------------------------------------------------------------------------- Total Non-Interest Income 15,037,682 12,128,427 10,195,089 ------------------------------------------------------------------------------------------------------------- NON-INTEREST EXPENSES: Salaries and Wages 10,664,411 9,590,775 7,827,449 Employee Benefits (Note 6) 2,531,980 2,713,988 2,367,865 Occupancy Expense 2,324,171 1,949,256 1,489,827 Equipment Expense 2,004,352 1,879,764 1,783,293 Losses on and Writedowns of Other Real Estate Owned 3,791,819 1,970,428 833,329 Equity in Losses of Real Estate Limited Partnerships 1,588,914 967,138 1,059,973 Other 9,312,413 7,270,812 5,718,930 Trust Customers' Reimbursement, Net (Note 13) 3,246,100 0 0 Losses and Write-downs of Segregated Assets (Note 10) 6,248,802 1,674,615 0 ------------------------------------------------------------------------------------------------------------- Total Non-Interest Expenses 41,712,962 28,016,776 21,080,666 ------------------------------------------------------------------------------------------------------------ Income (Loss) Before Provision (Benefit) for Income Taxes (5,732,475) (10,192,055) 6,252,019 Provision (Benefit) for Income Taxes (Notes 2 and 7) (2,842,451) (4,410,486) 575,508 ------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ (2,890,024) $ (5,781,569) $ 5,676,511 ----------------------------------------------------------------============-----============----============ EARNINGS (LOSS) PER SHARE, based upon weighted average common shares outstanding of 4,230,194 in 1994, 4,216,355 in 1993 and 4,213,941 in 1992 (Note 12): $ (0.68) $ (1.37) $ 1.39 -------------------------------------------------------------- ============-----============----============ The accompanying notes are an integral part of these consolidated financial statements.
Merchants Bancshares, Inc. Consolidated Statements of Changes in Stockholders' Equity For Each of the Three Years in the Period Ended December 31, 1994 Net Unrealized
Depreciation Common Capital in of Investment Stock Excess of Retained Securities Treasury (Note 11) Par Value Earnings (Note 2) Stock Total ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1991 $ 41,193 $ 28,649,805 $ 21,530,841 $ 0 $ (630,869) $ 49,590,970 Net Income --- --- 5,676,511 --- --- 5,676,511 Treasury Stock Transactions --- 22,061 26,821 --- 206,744 255,626 Cash Dividends ($.78 per share) --- --- (3,320,194) --- --- (3,320,194) Stock Dividends (123,580 shares issued) (Note 11) 1,236 1,963,693 (1,964,929) --- --- --- ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1992 $ 42,429 $ 30,635,559 $ 21,949,050 $ 0 $ (424,125) $ 52,202,913 Net Loss --- --- (5,781,569) --- --- (5,781,569) Treasury Stock Transactions --- 11,561 33,948 --- 245,395 290,904 Cash Dividends ($.20 per share) --- --- (848,585) --- --- (848,585) Effect of a Change in Accounting Principle (Note 2) (143,657) --- (143,657) ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1993 $ 42,429 $ 30,647,120 $ 15,352,844 $ (143,657) $ (178,730) $ 45,720,006 Net Loss --- --- (2,890,024) --- --- (2,890,024) Change in Net Unrealized Depreciation of Investment Securities Available for Sale, Net of Taxes --- --- --- (530,012) --- (530,012) ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994 $ 42,429 $ 30,647,120 $ 12,462,820 $ (673,669) $ (178,730) $ 42,299,970 ----------------------------------------------===================================================================================== Per share amounts have been restated to reflect all stock dividends. The accompanying notes are an integral part of these consolidated financial statements.
Merchants Bancshares, Inc. Consolidated Statements of Cash Flows
For the Years Ended December 31, 1994 1993 1992 CASH FLOWS FROM OPERATING ACTIVITIES: ----------- ----------- ----------- Net Income (Loss) $ (2,890,024) $ (5,781,569) $ 5,676,511 Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by Operating Activities: Provision for Possible Loan Losses 10,000,000 23,822,000 8,050,000 Provision for Depreciation and Amortization 6,685,094 4,762,037 1,646,560 Prepaid Income Taxes (1,890,304) (25,360) (2,133,353) Net Gains on Sales of Investment Securities (72,884) (1,898,945) (3,448,531) Net Gains on Sales of Loans and Leases (218,510) (818,376) (584,669) Net Losses on Sales of Premises and Equipment 0 0 52,607 Equity in Losses of Real Estate Limited Partnerships 1,588,916 967,138 1,059,973 Changes in Assets and Liabilities net of Effects From Acquisition of NFNBV (Note 10): (Increase) Decrease in Interest Receivable 40,651 (28,313) 1,333,450 Increase (Decrease) in Interest Payable 347,000 587,598 (803,012) (Increase) Decrease in Other Assets (3,336,601) (5,032,001) (5,429,789) Increase (Decrease) in Other Liabilities (1,418,975) (272,603) 2,939,600 ----------- ----------- ----------- Net Cash Provided by Operating Activities 8,834,363 16,281,606 8,359,347 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from Sales of Investment Securities 682,030 403,140,859 386,442,780 Proceeds from Maturities of Investment Securities 0 1,000,000 0 Proceeds from Sales of Loans and Leases 48,911,562 98,332,905 118,395,253 Proceeds from Sales of Premises and Equipment 39,631 0 16,839 Purchases of Available for Sale Investment Securities (10,114,063) (385,195,506) (422,915,625) Purchases of Held to Maturity Investment Securities (10,098,437) Cash and Cash Equivalents Received - Acquisition (Note 10) 0 17,102,000 0 Loans Originated, net of Principal Repayments 4,517,527 (82,277,333) (90,067,635) Investments in Real Estate Limited Partnerships (273,742) 281,821 (73,939) Purchases of Premises and Equipment (2,258,284) (1,599,220) (424,952) Decrease in Net Investment in Leveraged Leases 41,731 587,438 1,116,644 ----------- ----------- ----------- Net Cash Provided by (Used in) Investing Activities 31,447,955 51,372,964 (7,510,635) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase (Decrease) in Deposits (37,085,500) (87,773,966) 13,436,584 Net Increase (Decrease) in Other Borrowed Funds 3,370,653 6,459,269 (6,891,487) Proceeds from Debt 0 12,000,000 13,000,000 Principal Payments on Debt (2,404,056) (14,403,713) (2,644,110) Acquisition of Treasury Stock 0 (132,058) (964,717) Cash Dividends Paid 0 (838,050) (3,293,450) Sale of Treasury Stock 0 377,457 1,193,522 ----------- ----------- ----------- Net Cash Provided by (Used in) Financing Activities (36,118,903) (84,311,061) 13,836,342 ----------- ----------- ----------- Increase (Decrease) in Cash and Cash Equivalents 4,163,415 (16,656,491) 14,685,054 Cash and Cash Equivalents at Beginning of Year 30,587,986 47,244,477 32,559,423 ----------- ----------- ----------- Cash and Cash Equivalents at End of Year $ 34,751,401 $ 30,587,986 $ 47,244,477 =========== =========== =========== Total Interest Payments $ 22,029,653 $ 21,367,928 $ 24,853,992 Total Income Tax Payments $ 50,000 $ 1,190,000 $ 2,860,000 Transfer of loans to Other Real Estate Owned $ 7,899,401 $ 5,151,867 $ 13,856,598 The accompanying notes are an integral part of these consolidated financial statements.
Merchants Bancshares, Inc. Notes to Consolidated Financial Statements December 31, 1994 (1) CURRENT OPERATING ENVIRONMENT AND REGULATORY MATTERS Merchants Bancshares, Inc. (the Company), and its wholly owned subsidiaries, including the Merchants Bank and subsidiaries (the Bank), operate primarily in Vermont. Beginning in the late 1980's, this region was severely affected by a deterioration in the real estate market and an economic recession. As a result, the Bank has experienced increased levels of nonperforming assets and loan charge offs, increased the provision for possible loan losses and incurred high costs associated with troubled assets and foregone income on nonaccrual loans. Although these adverse trends appear to be abating, prospects as to the extent and timing of future improvement in the economy remain uncertain. The reserve for possible loan losses as of December 31, 1994 is deemed adequate based on management's estimate of the amount required to absorb future losses in the loan portfolio based on known current circumstances and real estate market conditions. However, if there is further deterioration in the real estate market the Company could experience increases in nonperforming assets and resultant operating losses attributable to a need for further significant provisions for loan losses and increased foregone interest income on nonaccrual loans. As of March 31, 1993, the Federal Deposit Insurance Corporation (the FDIC) and the State of Vermont Department of Banking, Insurance and Securities (the Commissioner) conducted a joint field examination of the Bank. As a result of this examination, the Bank entered into a Memorandum of Understanding (MOU) with the FDIC and the Commissioner on October 29, 1993. Under the terms of the MOU, the Bank is required to, among other things, maintain a leverage capital ratio of at least 5.5%, revise certain operating policies, enhance certain loan review procedures, refrain from declaring dividends and correct certain technical exceptions and violations of applicable regulations. The dividend limitation includes dividends paid by the Bank to the Company. The Company services senior subordinated debt (see Note 9), which requires semi-annual interest payments and an annual principal payment of $2.4 million through 1996. The MOU permits the repayment of certain advances totaling appproximately $940,000 which were outstanding as of December 31, 1994. The repayment of such advances, together with the Company's cash on hand and other assets easily convertible to cash at December 31, 1994, is sufficient to service the senior subordinated debt until May 1996. Management has revised the policies, made changes to enhance the credit review procedures and corrected the technical exceptions and violations, and believes the Bank is in substantial compliance with the provisions of the MOU as of December 31, 1994. The Bank was also directed by the FDIC to increase the reserve for possible loan losses by approximately $12 million and to charge off loans totaling approximately $8 million at the conclusion of the examination in June 1993. The Bank recorded this increase in the reserve for possible loan losses and charged off the loans in 1993. As of February 18, 1994, the Company and the Federal Reserve Bank of Boston (the Federal Reserve) entered into an agreement requiring the Company to submit to the Federal Reserve, among other things, a capital plan, a dividend policy, a debt service plan and a management assessment. In addition, under this agreement, the Company may not declare or pay a dividend or incur any debt without the approval of the Federal Reserve. As of December 31, 1994, all submissions had been made and accepted, except for the capital plan, which is still in process. Failure to maintain the minimum leverage capital ratio of 5.5% (see Note 11) included in the MOU, or compliance with other provisions of the MOU, or the agreement with the Federal Reserve, could subject the Bank or the Company to additional actions by the regulatory authorities. On December 16, 1994, the FDIC and the Commissioner completed the field work related to their examination of the Merchants Trust Company, a subsidiary of the Bank, as of September 26, 1994. On February 17, 1995 the Trust Company entered into a Memorandum of Understanding (MOU) with the FDIC and the Commissioner to effect corrective action relating to certain operating, technical and regulatory issues. Management believes that the matters noted in the MOU have subsequently been corrected or are in the process of being remediated. Management also believes that any additional actions by the regulatory authorities would not have a material impact on the Company's financial position or results of operations. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, the Bank (including its wholly owned subsidiaries Merchants Trust Company and Queneska Capital Corp.) and Merchants Properties, Inc., after elimination of all material intercompany accounts and transactions. Investment Securities In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115). This statement requires investments in debt securities to be classified as held-to-maturity and measured at amortized cost only if the Company has the positive intent and ability to hold such securities to maturity. Investments in debt securities that are not classified as held-to-maturity and equity securities that have readily determinable fair values are classified as trading securities or available-for-sale securities. Trading securities are investments purchased and held principally for the purpose of selling in the near term; available-for-sale securities are investments not classified as trading or held-to-maturity. Unrealized holding gains and losses for trading securities are included in earnings; unrealized holding gains and losses for available-for-sale securities are reported in a separate component of stockholders' equity, net of applicable income taxes. As permitted by SFAS No. 115, the Company elected to apply the accounting principle to investment securities held as of December 31, 1993. All investment securities were classified as available-for-sale at December 31, 1993 and the resulting adjustment was included in the accompanying consolidated statement of changes in stockholders' equity as the effect of a change in accounting principle. Prior to December 31, 1993, debt securities were designated at the time of purchase as either held for sale or held for investment, based on management's intentions in light of investment policy, asset/liability management policy, liquidity needs and economic factors. Debt securities held for sale were stated at the lower of amortized cost or market value while debt securities held for investment, where management had the intention and ability to hold such securities until maturity, were stated at amortized cost. Unrealized losses on debt securities held for sale were recorded as a valuation allowance against the related securities. The provision for the valuation allowance was recorded in the accompanying consolidated statements of operations. Marketable equity securities were stated at the lower of aggregate cost or market value. Net unrealized losses, considered temporary in nature, were shown as a reduction of stockholders' equity. Unrealized losses, considered other than temporary in nature, were recognized in the accompanying consolidated statements of operations. The gain or loss recognized on the sale of an investment security was based upon the adjusted cost of the specific security. Dividend and interest income, including amortization of premiums and discounts, is recorded in earnings for all categories of investment securities. Discounts and premiums related to debt securities are amortized using a method which approximates the level-yield method. Management reviews all reductions in value below book value to determine if the impairment is temporary or permanent. If the impairment is determined to be permanent in nature, the carrying value of the security is written down to the appropriate level by a charge to earnings. Loan Origination and Commitment Fees Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized over the lives of the related loans. Net deferred origination fees were $1,132,494 and $1,310,416 at December 31, 1994 and 1993, respectively. Premises and Equipment Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is provided using straight-line and accelerated methods at rates that amortize the original cost of the premises and equipment over their estimated useful lives. Expenditures for maintenance, repairs and renewals of minor items are generally charged to expense as incurred. Gains and Losses on Sales of Loans Gains and losses on sales of loans are recognized based upon the difference between the selling price and the carrying amount of loans sold. Gains and losses are adjusted for excess servicing rights resulting from the sale of loans with servicing rights retained. Excess servicing rights are recorded at the net present value of estimated future servicing revenue less expected normal servicing costs. Deferred excess servicing is amortized over the period of estimated net servicing income. Origination fees collected, net of commitment fees paid in connection with the sales of loans and net of the direct cost of loan originations, are recognized at the time such loans are sold. The net gain on sales of loans is included in interest and fees on loans and amounted to $218,510, $818,376 and $584,669 in 1994, 1993 and 1992, respectively. Income Taxes The Company provided for income taxes in accordance with the comprehensive income tax allocation method under Statement of Financial Accounting Standards No. 96 prior to 1992. Effective January 1, 1992, the Company implemented Statement of Financial Accounting Standards No. 109. There was no material effect from this change on the accompanying consolidated financial statements. This method recognizes the tax effects of all income and expense transactions in each year's consolidated statement of operations, regardless of the year in which the transactions are reported for tax purposes. Low income housing tax credits are recognized in the year in which they are earned. Investments in Real Estate Limited Partnerships The Bank has investments in various real estate limited partnerships that acquire, develop, own and operate low and moderate income housing. The Bank's ownership interest in these limited partnerships varies from 35% to 100% as of December 31, 1994. The Bank consolidates the financial statements of the limited partnership in which the Bank is actively involved in management and has a controlling interest. The Bank accounts for its investments in limited partnerships where the Bank does not actively participate or have a controlling interest under the equity method of accounting. Management periodically reviews the results of operations of the various real estate limited partnerships to determine if the partnerships generate sufficient operating cash flow to fund their current obligations. In addition, management reviews the current value of the underlying property compared to the outstanding debt obligations. If it is determined that the investment suffers from a permanent impairment, the carrying value is written down to the appropriate balance. The Bank has recognized losses due to the impairment of an investment in a real estate limited partnership of $546,000 and $296,000 in 1994 and 1993, respectively. Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand, amounts due from banks and federal funds sold in the accompanying consolidated statements of cash flows. At December 31, 1994 and 1993, cash and cash equivalents included $8,508,000 and $8,676,000, respectively, to satisfy the requirements of the Federal Reserve Bank. Other Real Estate Owned Collateral acquired through foreclosure and loans accounted for as in-substance foreclosures are recorded at the lower of cost or fair value, less estimated costs to sell, at the time of acquisition or designation as in-substance foreclosure. A valuation allowance is established for the estimated costs to sell and is charged to expense. Subsequent changes in the fair value of other real estate owned are reflected in the valuation allowance and charged or credited to expense. Net operating income or expense related to foreclosed property is included in non-interest expense in the accompanying consolidated statements of operations. Because of the present adverse market conditions, there are inherent uncertainties in the assumptions with respect to the estimated fair value of other real estate owned. Because of these inherent uncertainties, the amount ultimately realized on real estate owned may differ from the amounts reflected in the consolidated financial statements. The Bank recognized losses due to additions to the valuation allowance of $2,392,000 and $599,000 during 1994 and 1993, respectively. Intangible Assets Premiums paid for the purchase of core deposits are recorded as other assets and amortized over the estimated period of time over which value is recognizable. Management reviews the value of the intangible asset by comparing purchased deposit levels to current deposit levels in the branches purchased. If any deposit runoff has occurred and is determined to be permanent in nature, the asset is written down accordingly. Reclassification Certain amounts in the 1993 and 1992 consolidated financial statements have been reclassified to be consistent with 1994 classifications. (3) INVESTMENT SECURITIES Investments in debt securities are classified as available for sale or held to maturity as of December 31, 1994 and as available for sale as of December 31, 1993. As of December 31, 1994, a U.S. Treasury security is classified as held to maturity, having an amortized book value of $10,084,646 and a market value of $9,871,875. The amortized cost and estimated fair values of the debt securities classified as available for sale as of December 31, 1994 and 1993 are as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value 1994 U.S. Treasury and Agency Obligations $ 91,935,993 0 $1,545,368 $ 90,390,625 Other Debt Securities 90,297 0 10,000 80,297 ------------ --------- ----------- ------------ $ 92,026,290 $ 0 $1,555,368 $ 90,470,922 1993 U.S. Treasury and Agency Obligations $ 85,713,865 0 $ 438,865 $ 85,275,000 Other Debt Securities 230,677 0 0 230,677 ------------ --------- ----------- ------------ $ 85,944,542 $ 0 $ 438,865 $ 85,505,677 Marketable equity securities are classified as available for sale at December 31, 1994 and 1993 and are stated at their estimated fair value of $1,195,897 and $1,451,793, respectively. Gross unrealized gains related to marketable equity securities were $654,658 and $414,328, and gross unrealized losses were $120,000 and $193,125 at December 31, 1994 and 1993, respectively. The contractual maturities of all debt securities held at December 31, 1994 are between one month and five years. Debt securities with a maturity of less than one year totoal $81,924,278. Proceeds from sales of debt securities (all classified as available-for- sale) were $682,030 and $403,140,859 during 1994 and 1993, respectively. Gross gains of $91,780, $2,120,838 and $4,474,318 and gross losses of $18,896, $221,893 and $1,624 were realized on those sales in 1994, 1993 and 1992, respectively. At December 31, 1994, securities with a face value of $29,280,000 were pledged to secure federal funds lines, public deposits, securities sold under agreements to repurchase, and for other purposes required by law. (4) LOANS The composition of the loan portfolio at December 31, 1994 and 1993 is as follows (including Segregated Assets - Note 10): 1994 1993 ----------------------------------------------------------------- Commercial, Financial and Agricultural $ 92,611,512 $105,631,497 Real Estate - Construction 21,991,938 30,526,117 Real Estate - Mortgage 377,429,022 413,112,265 Installment Loans to Individuals 18,086,099 22,835,812 Lease Financing 0 41,731 All Other Loans (including overdrafts) 436,481 1,324,178 _________________________________________________________________ $510,555,052 $573,471,600 ================================================================= As discussed in Note 10, Segregated Assets consist of loans subject to loss sharing. The composition of the Segregated Assets portfolio at December 31, 1994 and 1993 is as follows: 1994 1993 ----------------------------------------------------------------- Commercial, Financial and Agricultural $ 16,294,045 $28,428,878 Real Estate - Commercial 41,909,959 58,856,952 Real Estate - Residential 37,534,294 45,478,471 Installment Loans to Individuals 64,005 74,031 OREO 0 40,876 Allocated Reserve for Losses (1,315,231) (2,360,232) _________________________________________________________________ $ 94,487,072 $130,518,976 ================================================================= There has been an insignificant effect on the Bank's non-interest expenses for 1994 or 1993 as a result of expenses and charge offs relating to the Segregated Assets. The Bank's share of the charge offs was charged to the allowance for losses on the Segregated Assets, which was established in conjunction with the acquisition. Management believes that the allowance for losses on the Segregated Assets is adequate to cover possible losses inherent in the Segregated Assets. Charge offs, net of recoveries, and eligible expenses on Segregated Assets aggregated $7,811,002 and $2,093,268 for 1994 and 1993. The Bank recognized net recoveries of $6,248,802 and $1,674,615 from the FDIC for eligible charge offs related to 1994 and 1993 in accordance with the loss sharing arrangement. Amounts due from the FDIC totaling $2,883,372 and $290,459 as of December 31, 1994 and 1993 are included in other assets in the accompanying consolidated balance sheets. The Company originates primarily residential and commercial real estate loans and a lesser amount of installment loans to customers throughout the state of Vermont. In order to minimize its interest rate and credit risk, the Company sells certain residential loans to the secondary market and to financial investors such as insurance companies and pension funds located in other states. Substantially all of the Company's loan portfolio is based in the state of Vermont. There are no known significant industry concentrations in the loan portfolio. Loans serviced for others at December 31, 1994 and 1993 amounted to $391,517,792 and $357,703,783, respectively. An analysis of loans in excess of $60,000 to directors and executive officers for the year ended December 31, 1994 is as follows: Balance, December 31, 1993 $16,783,132 Additions 242,672 Repayments (2,040,860) Balance, December 31, 1994 $14,984,944 It is the policy of the Bank to grant such loans on substantially the same terms, including interest rates and collateral, as those prevailing for comparable lending transactions with other persons. The reserve for possible loan losses is based on management's estimate of the amount required to reflect the risks in the loan portfolio, based on circumstances and conditions known or anticipated at each reporting date. There are inherent uncertainties with respect to the final outcome of certain of the Bank's loans and nonperforming assets. Because of these inherent uncertainties, actual losses may differ from the amounts reflected in these consolidated financial statements. Factors considered in evaluating the adequacy of the reserve include previous loss experience, current economic conditions and their effect on the borrowers, the performance of individual loans in relation to contract terms and estimated fair values of properties to be foreclosed. Losses are charged against the reserve for loan losses when management believes that the collectibility of principal is doubtful. Key elements of the above estimates, including those used in independent appraisals, are dependent upon the economic conditions prevailing at the time of the estimates. Accordingly, uncertainty exists as to the final outcome of certain of the valuation judgments as a result of the difficult and unpredictable conditions in the region. The inherent uncertainties in the assumptions relative to the projected sales prices or rental rates may result in the ultimate realization of amounts on certain loans that are different from the amounts reflected in these consolidated financial statements. An analysis of the reserve for possible loan losses for each of the three years in the period ended December 31, 1994 is as follows: 1994 1993 1992 Balance, beginning of year $20,060,059 $ 7,411,635 $6,650,217 Provision for possible loan losses 10,000,000 23,822,000 8,050,000 Reserve recorded in connection with acquisition of NFNBV --- 2,000,000 --- Loans charged off (12,649,842) (13,952,000) (7,739,000) Recoveries 2,518,600 778,424 450,418 Balance, end of year $19,928,817 $20,060,059 $7,411,635 Included in the 1993 provision for possible loan losses is $666,667 recorded as a provision for the Bank's potential share of losses on segregated assets. Also included are charge offs of $1,314,632 and $306,435 and recoveries of $25,142 and $8,249 related to Segregated Assets for 1994 and 1993, respectively. In May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 requires that impaired loans, as defined by SFAS No. 114, be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. This pronouncement amends SFAS No. 5, "Accounting for Contingencies," to clarify that a creditor should evaluate the collectibility of both contractual interest and contractual principal of all receivables when assessing the need for a loss accrual. SFAS No. 114 also amends SFAS No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings," to require a creditor to measure all loans that are restructured in a troubled debt restructuring involving a modification of terms in accordance with this statement. SFAS No. 114 is applicable to all loans (including troubled debt restructurings), uncollateralized as well as collateralized, except large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value or the lower of cost or fair value, leases and debt securities as described in SFAS No. 114. Management does not anticipate that the adoption of this statement in 1995 will have a material impact on the Bank's financial position or results of operations. Nonperforming assets at December 31, 1994 and 1993 were as follows: 1994 ----------------------------------- Segregated Loans Assets Total ----------- ----------- ----------- Nonaccrual Loans $24,251,987 $ 7,948,632 $32,200,619 Restructured Loans 5,016,123 66,731 5,082,854 Loans Past Due 90 Days or More and Still Accruing 668,007 668,007 Other Real Estate Owned, Net 10,791,262 2,439,545 13,230,807 ----------- ----------- ----------- Total $40,727,379 $10,454,908 $51,182,287 =========== =========== =========== 1993 ----------------------------------- Segregated Loans Assets Total ----------- ----------- ----------- Nonaccrual Loans $29,712,089 $17,356,607 $47,068,696 Restructured Loans 2,772,783 68,389 2,841,172 Loans Past Due 90 Days or More and Still Accruing 712,391 2,978 715,369 Other Real Estate Owned, Net 13,633,383 40,876 13,674,259 ----------- ----------- ----------- Total $46,830,646 $17,468,850 $64,299,496 =========== =========== =========== Included in nonaccrual loans is $3,526,402 and $4,543,860 of loans whose terms have been substantially modified in troubled restructurings at December 31, 1994 and 1993, respectively. Additionally, the Bank had $1,316,827 of restructured loans that were performing in accordance with the modified agreement at December 31, 1994. Other Real Estate Owned is shown net of a valuation reserve of $2,991,065 and $598,675 at December 31, 1994 and 1993. The Bank's policy is to discontinue the accrual of interest and reverse uncollected interest receivable on loans when scheduled payments become contractually past due in excess of 90 days or, in the judgement of management, the ultimate collectibility of principal or interest becomes doubtful. The amount of interest which was not earned but which would have been earned had the nonaccrual and restructured loans performed in accordance with their original terms and conditions was approximately $1,859,000, $2,688,000 and $1,268,000 in 1994, 1993 and 1992, respectively. (5) PREMISES AND EQUIPMENT The components of premises and equipment included in the accompanying consolidated balance sheets are as follows: 1994 1993 --------------------------------------------------- Land and Buildings $18,020,230 $17,835,574 Leasehold Improvements 869,444 869,444 Furniture and Equipment 11,292,724 10,421,058 ---------------------------------------------------- 30,182,398 29,126,076 Less: Accumulated Depreciation and Amortization 13,562,225 12,977,974 ---------------------------------------------------- $16,620,173 $16,148,102 ==================================================== Depreciation and amortization expense amounted to $1,786,213, $1,595,914, and $1,646,560 in 1994, 1993 and 1992, respectively. The Bank leases certain properties for branch purposes. Rent expense on these properties totaled $214,891, $163,807 and $106,739 for the years ended December 31, 1994, 1993 and 1992, respectively. Minimum lease payments for these properties subsequent to December 31, 1994 are: 1995 - $212,896; 1996 - $195,061; 1997 - $172,680; 1998 - $142,717; 1999 - $100,876 and $300,623 thereafter. (6) EMPLOYEE BENEFIT PLANS Pension Plan The Company maintains a noncontributory defined benefit plan covering all eligible employees. The plan is a final average pay plan with benefits based on the average salary rates over the five consecutive plan years out of the last ten consecutive plan years that produces the highest average. It is the Company's policy to fund the cost of benefits expected to accrue during the year plus amortization of any unfunded accrued liability that has accumulated prior to the valuation date based on IRS regulations for funding. During 1994, the Company made the decision to freeze the plan for an undetermined period of time beginning on January 1, 1995. Accordingly, the accumulation of years of service for each plan participant is suspended, and all accrued benefits are considered to have fully vested, unless the suspension of the plan is lifted. If the decision is made to curtail the plan, no further years of service will be credited for any participant. The plan's funded status and amounts recognized in the accompanying consolidated balance sheets and statements of operations as of December 31, 1994 and 1993 are as follows: 1994 1993 ----------------------------------------------------------------- Actuarial Present Value of Benefit Obligation: Vested Benefit Obligation $4,797,489 $4,827,238 Nonvested Benefits 0 155,662 ----------------------------------------------------------------- Accumulated Benefit Obligation $4,797,489 $4,982,900 Effects of Projected Future Compensation Levels 0 1,661,854 ----------------------------------------------------------------- Projected Benefit Obligation for Service Rendered to Date $4,797,489 $6,644,754 Plan Assets 6,332,824 6,544,833 ----------------------------------------------------------------- Excess (Deficiency) of Plan Assets Over (Under) Projected Benefit Obligation $1,535,335 $( 99,921) Unrecognized Net Asset at January 1, 1987 Being Amortized over 13.4 Years (171,602) (210,691) Unrecognized Net Loss 190,446 240,013 Unrecognized Prior Service Cost (1,673,616) 20,706 ------------------------------------------------------------------- Accrued Pension Costs Included in Other Liabilities $ (119,437) $ ( 49,893) =================================================================== 1994 1993 1992 ----------------------------------------------------------------- Net Pension Expense Included the Following Components: Service Cost - Benefits Earned During the Year $316,681 $257,232 $221,688 Interest Cost on Projected Benefit Obligation 486,993 432,963 387,401 Actual Return on Plan Assets 100,004 (488,860) (518,990) Net Amortization and Deferral (660,098) (24,194) 21,042 ----------------------------------------------------------------- Total $243,580 $177,141 $111,141 ================================================================= The actuarial present value of the projected benefit obligation was determined using a weighted average discount rate of 8.5%, 7.5% and 8% as of December 31, 1994, 1993, and 1992, respectively. The assumed rate of increase of future compensation levels used for 1994 was 4% for the period 1994-1995, 4.5% for the period 1996-1997 and 5% thereafter. The rate of increase in future compensation levels for 1993 was 4% and for 1992 was 4%. The expected long-term rate of return on assets used was 8% in 1994, 8% in 1993 and 8.25% in 1992. Employee Stock Ownership Plan/ 401(k) Plan Under the terms of the Company's Employee Stock Ownership Plan (ESOP), eligible employees are entitled to contribute up to 15% of their compensation to the ESOP, and the Company contributes a percentage of the amounts contributed by the employees, as authorized by the Company's Board of Directors. The Company contributed approximately 75% of the amounts contributed by the employees (up to 4.5% of individual employee compensation) in 1994, 1993 and 1992. Substantially all contributions to the ESOP are funded with cash and are used to purchase the Company's common stock. Performance Progress Sharing Plan The Company maintains a Performance Progress Sharing Plan. Substan- tially all Company employees are eligible to participate in this plan, and awards are based on performance of the Company measured against goals established by the Board of Directors. Deferred Compensation Plans The Company maintains an Executive Salary Continuation Plan and a Deferred Compensation Plan for Directors. The plans are designed to supplement the retirement benefits available to certain key employees and directors of the Company. The plans are part of the Company's overall strategy for attracting and retaining high quality management. Under the plans, each participant is entitled to receive monthly benefits for 15 years in an amount specified in each participant's contract. Benefits commence upon retirement and may be reduced in the case of early retirement. If death occurs after retirement but before all benefits have been paid, the balance of the payments will be made to the participant's designated beneficiary. The Company has purchased insurance policies on the lives of the participants to help fund benefits payable under the plans. Phantom Stock Plan The Company maintains a Phantom Stock Plan, wherein certain key officers of the Bank were entitled to receive an annual award of phantom shares of stock for up to five consecutive years. All such awards were granted by June 30, 1993. Each year, the Board of Directors reviewed the performance of the officers and made additional awards based on such reviews. The value of the phantom shares for each annual grant vested over a one-year period subject to certain early termination provisions. Benefits are payable in 60 monthly installments subsequent to the payment commencement date, as defined in the plan. The benefit level is based on the market value of the Company's stock at the determination date, as defined in the plan. A summary of expenses relating to the Company's various employee benefit plans for each of the three years in the period ended December 31, 1994 is as follows: 1994 1993 1992 ----------------------------------------------------------------- Pension Plan $ 243,580 $ 177,141 $ 111,141 Employee Stock Ownership Plan/ 401(k) Plan 348,468 285,199 267,636 Performance Progress Sharing Plan 0 264,000 360,641 Deferred Compensation Plans 303,939 272,946 233,222 Phantom Stock Plan (179,227) 249,600 259,896 ----------------------------------------------------------------- $ 716,760 $1,248,886 $1,232,536 ================================================================= (7) INCOME TAXES The provision (benefit) for income taxes for each of the three years in the period ended December 31, 1994 consists of the following: 1994 1993 1992 ------------------------------------------------------------- Current $( 952,147) $(4,385,126) $2,708,861 Prepaid (1,890,304) ( 25,360) (2,133,353) -------------------------------------------------------------- $(2,842,451) $(4,410,486) $ 575,508 ============================================================== Prepaid and deferred income taxes result from differences between income (loss) for financial reporting and tax reporting relating primarily to the provision for possible loan losses. The net prepaid tax asset amounted to approximately $5,084,000 and $3,422,000 at December 31, 1994 and 1993, respectively. In addition, as of December 31, 1993, the Bank had filed for a refund for overpayment of 1989 and 1990 taxes totaling $1,191,000, which was received during 1994. As of December 31, 1994 and 1993, the Company had tax refunds receivable of $6,211,214 and $4,499,982, respectively. These tax assets are included in other assets in the accompanying consolidated balance sheets. The following is a reconciliation of the federal income tax provision (benefit), calculated at the statutory rate, to the recorded provision (benefit) for income taxes: 1994 1993 1992 --------------------------------------------------------------------- Applicable Statutory Federal Income Tax (benefit) $(1,949,042) $(3,465,299) $2,125,686 (Reduction) Increase in Taxes Resulting From: Loss on Investment Securities (24,780) 40,018 171,074 Tax-exempt Income (187,301) (213,631) (371,334) Tax Credits (707,750) (960,750) (941,500) Other, Net 26,422 189,176 (66,270) --------------------------------------------------------------------- $(2,842,451) $(4,410,486) $ 917,656 ===================================================================== The components of the net prepaid tax asset as of December 31, 1994 and 1993 are as follows: 1994 1993 --------------------------------------------------------------------- Reserve for Possible Loan Losses $7,700,000 $6,387,000 Deferred Compensation 1,543,000 1,522,000 Unrealized Securities Losses 347,000 74,000 Loan Fees 253,000 446,000 Leveraged Leases 0 (42,000) Depreciation (428,000) (389,000) Accrued Liabilities 287,000 189,000 Capital Loss Carryforwards 545,000 576,000 Investments in Limited Partnerships (296,000) (463,000) Excess Servicing on Sold Mortgages (19,000) (60,000) Loan Market Adjustment (4,640,000) (4,274,000) Other (623,000) 32,000 Tax Credit Carryforward 960,000 0 --------------------------------------------------------------------- $5,629,000 $3,998,000 Valuation Allowance (545,000) (576,000) ---------------------------------------------------------------------- $5,084,000 $3,422,000 ====================================================================== A valuation allowance is provided when it is more likely than not that some portion of the net prepaid tax asset will not be realized. The Bank has established a valuation allowance for capital loss carryforwards since such losses may only be utilized against future capital gains. The State of Vermont assesses a franchise tax for banks in lieu of income tax. The franchise tax is assessed based on deposits and amounted to approximately $290,000, $247,000 and $234,000 in 1994, 1993 and 1992, respectively. These amounts are included in other expenses in the accompanying consolidated statements of operations. (8) OTHER BORROWED FUNDS Other borrowed funds consist of the following at December 31, 1994 and 1993: 1994 1993 -------------------------------------------------------- Treasury Tax and Loan Notes $3,294,734 $5,742,607 Securities Sold Under Agreements to Repurchase 0 1,681,474 Federal Funds Purchased 15,000,000 7,500,000 --------------------------------------------------------- $18,294,734 $14,924,081 ========================================================= The Bank may borrow up to $30,000,000 in federal funds on an unsecured basis. The following table provides certain information regarding other borrowed funds for each of the two years in the period ended December 31, 1994: Weighted Weighted Maximum Average Average Month-end Average Annual Rate Amount Amount Interest on Amounts 1994 Outstanding Outstanding Rate Outstanding ---------------------------------------------------------------------------- Treasury Tax and Loan Notes $4,723,829 $3,136,365 3.83% 5.10% Securities Sold Under Agreements to Repurchase 0 $18,225 2.70% 0.00% Federal Funds Purchased $16,900,000 $1,388,438 4.09% 6.18% 1993 ---------------------------------------------------------------------------- Treasury Tax and Loan Notes $5,742,607 $3,540,180 2.74% 3.11% Securities Sold Under Agreements to Repurchase $12,051,559 $7,669,030 2.99% 2.65% Federal Funds Purchased $14,600,000 $2,636,629 3.34% 3.50% (9) DEBT Debt outstanding consists of the following at December 31, 1994 and 1993: 1994 1993 --------------------------------------------------------------- 10% Senior Subordinated Debt Payable 1995 Through 1996 $4,800,000 $ 7,200,000 9% Mortgage Note, Payable in Monthly Installments of $1,736 (Principal and Interest) Through 2020 207,860 209,909 1% Mortgage Note, Payable in Monthly Installments of $2,542 (Principal and Interest) Through 2039 1,191,506 1,193,513 9.81% Capital Notes, Interest Payable Semiannually, Principal Payable 1995 Through 2000 10,000,000 10,000,000 9.81% Capital Notes, Interest Payable Semiannually, Principal Payable in 1997 10,000,000 10,000,000 Federal Home Loan Bank Notes Payable, Interest Rates from 4.83% to 8.66% due 1995 through 2001 18,030,000 18,030,000 --------------------------------------------------------------- $44,229,366 $46,633,422 =============================================================== Maturities of debt subsequent to December 31, 1994 are: 1995- $8,404,431; 1996 - $4,404,841; 1997 - $21,005,288; 1998 - $2,005,772; 1999 - $1,006,293 and $7,402,741 thereafter. The capital and senior subordinated note agreements contain a number of restrictive covenants including, among other things, limitations on additional indebtedness, the payment of dividends and certain other uses of cash. In addition, the agreements contain restrictions, based on defined formulas, with respect to maintaining certain financial ratios and specified levels of capital. Under the Federal Home Loan Bank agreement,the Bank pledged as collateral mortgages on 1-to-4 family residences totaling approximately $7,200,000. As of December 31, 1994, the Company is in compliance with all of the covenants of the capital notes, senior subordinated note and Federal Home Loan Bank agreements. (10) ACQUISITION On June 4, 1993, the Bank purchased certain assets and assumed the deposits and certain other liabilities of the New First National Bank of Vermont (NFNBV) from the FDIC. NFNBV was a three bank holding company conducting banking activities primarily in central and northern Vermont. NFNBV had been taken over by the FDIC in January 1993. The acquisition involved an assumption of net deposits and liabilities which resulted in the Bank receiving a cash payment from the FDIC of approximately $5.7 million. The Bank subsequently acquired certain NFNBV property and equipment from the FDIC for approximately $1.5 million which was payable to the FDIC on June 3, 1994. The acquisition was accounted for using the purchase method of accounting and, accordingly, the acquired assets and liabilities have been recorded at their estimated fair market values at the date of acquisition. The operating results related to the assets and liabilities of NFNBV are included in the Company's consolidated statement of operations since the date of the acquisition. In accordance with the purchase method of accounting, the purchase price has been allocated to the assets acquired and liabilities assumed based on their fair market value at the date of acquisition. Included in the purchase price allocation is the establishment of an allowance for possible loan losses of $2 million and a core deposit intangible of approximately $4.5 million, which is being amortized over 15 years using the straight- line method. The fair market value of the assets acquired and liabilities assumed is summarized as follows (in thousands): Cash $ 5,290 Federal Funds Sold 6,075 Investment Securities 4,118 Loans 23,909 Segregated Assets 154,537 Allowance for Possible Loan Losses (2,000) Premises and Equipment 1,509 Other Assets 1,523 Intangible Asset - Core Deposit Intangible 4,478 Deposits (203,031) Other Liabilities (537) Cash Payment From the FDIC, Net of Settlement Amount Payable for Premises and Equipment $ 4,129 ========= Summarized below are the results of operations on an unaudited pro forma basis, of the acquired NFNBV business as if NFNBV had been acquired on January 1, 1992. The pro forma information is based on the Company's audited historical results of operations for 1992 and NFNBV's unaudited historical results of operations for the period October 1, 1991 to September 30, 1992, giving effect to certain pro forma adjustments. The pro forma financial information does not purport to be indicative of the results of operations that would have occurred had the purchase been made on January 1, 1992 or of future results of operations of the combined companies. No pro forma information is presented for the period January 1, 1993 to the date of the acquisition because no accurate financial information is available relative to NFNBV's operations from the FDIC. Pro Forma 1992 (in thousands except per share data) Net Interest Income $ 36,185 Net Income 7,463 Earnings Per Share 1.83 In computing the pro forma net income, adjustments were recognized to give effect to a reduced provision for possible loan losses and other real estate owned (OREO) expenses, resulting from loss sharing and the transfer of problem loans and OREO to the FDIC Division of Liquidation prior to acquisition; amortization of the core deposit intangible; and reduced operating expenses relating to regulatory actions. Under the terms of the acquisition, the Bank will receive financial assistance (loss sharing) with respect to certain acquired loans charged off by the Bank during the three years subsequent to the acquisition. The FDIC will reimburse the Bank, on a quarterly basis, 80% of net charge-offs and certain expenses related to loans subject to loss sharing up to cumulative losses aggregating $41.1 million, after which the reimbursement rate will be 95% of net charge-offs on the loans. The Bank received $6,248,802 and $1,674,615 in reimbursements from the FDIC for the years ended December 31, 1994 and 1993, respectively. Acquired loans subject to loss sharing are classified as Segregated Assets in the accompanying consolidated balance sheets. In addition, under the terms of the acquisition approval received from the State of Vermont Department of Banking, Insurance and Securities, the Bank is required to, among other things, maintain Tier 1 leverage capital at the higher of 5.5% or the minimum regulatory leverage capital required by the FDIC, and to refrain from paying dividends from the Bank to the Company if the Bank's capital is below the minimum capital requirement. The Bank and the Company were in compliance with all the terms of the acquisition approval agreement with the State of Vermont during 1994 and through the date of this report. During 1994, the Company reviewed the status of the core deposits related to the acquisition and determined that the attrition of in an impairment in the value of the core deposit intangible. Accordingly, the Company wrote down the carrying value of the core deposit intangible by $686,296. This charge against current earnings is included in other expenses. (11) STOCKHOLDERS' EQUITY As a state-chartered bank, the Bank's primary regulator is the FDIC. The Bank is subject to regulatory capital regulations that provide for two capital requirements: a leverage requirement and a risk-based capital requirement. The leverage requirement provides for a minimum "core" capital, consisting primarily of common stockholders' equity, of 3.0% of total adjusted assets, for those institutions with the most favorable composite regulatory examination rating. As discussed in Note 1, the Bank is required to maintain a minimum leverage capital ratio of 5.5% under the MOU. As of December 31, 1994 the Bank's leverage capital was 5.958%. The minimum risk-based capital requirement provides for minimum capital levels based on risk-weighted assets of 8.0% at December 31, 1994. At December 31, 1994, the Bank exceeded the risk-based capital requirements of the FDIC. Vermont state law requires the Bank to appropriate a minimum of 10% of net income to surplus until such time as appropriated amounts equal 10% of deposits and other liabilities. The Bank's stockholders' equity includes $6,561,600 as of December 31, 1994 and 1993, respectively, of such appropriations. Debt covenants and Vermont state law restrict the payment of dividends under certain circumstances. The most restrictive of these limits dividend payments on a cumulative basis since December 31, 1985 to cumulative net income for the same period plus $2,000,000. In addition, as discussed in Note 1, the Company may not declare or pay a dividend without the approval of the Federal Reserve. (12) STOCK DIVIDENDS On November 13, 1992, the Company declared a 3% stock dividend, payable on December 11, 1992 to shareholders of record on November 30, 1992. All per share amounts were restated in prior years to reflect this activity. (13) COMMITMENTS AND CONTINGENCIES During the fall of 1994, lawsuits were brought against the Company, the Bank, the Trust Company (collectively referred to as "the Companies") and certain directors of the Companies. These lawsuits relate to certain investments managed for Trust Company clients and placed in the Piper Jaffray Institutional Government Income Portfolio. Separately, and before the suits were filed, the Companies had initiated a review of those investments. Outside consultants were retained to assist in this review. As a result of the review, the Trust Company paid to the affected Trust Company clients a total of approximately $9.2 million in December 1994. The payments do not constitute a legal settlement of any claims in the law suits. However, based on consultation with legal counsel, management believes that further liability, if any, of the Companies on account of matters complained of in the lawsuits will not have a material adverse effect on the consolidated financial position and results of operations of the Company. In December 1994, the Trust Company received a payment of $6,000,000 from its insurance carriers in connection with these matters. The Companies also intend to pursue all available claims against Piper Jaffray Companies, Inc. and others on account of the losses that gave rise to the $9.2 million payment by the Companies. Any recovery obtained as a result of such efforts is subject to the terms of an agreement between the Companies and the insurance carriers. The attorneys representing the plaintiffs in one of the lawsuits discussed above have asked the court to order the Trust Company's clients to pay fees to those attorneys in an amount of up to $500,000. The Trust Company has resisted the claims for payment of such fees by its clients, and, as a result, the Trust Company has been directed to place the sum of $500,000 into escrow pending a ruling by the Court. Based upon consultation with legal counsel, management believes there is no substantial basis for any liability on the part of the Companies for payment of legal fees to those attorneys and, although there is the possibility that the Companies may be required to remit all or part of these funds, such an outcome is not considered likely. The Bank is also involved in various legal proceedings arising in the normal course of business. Based upon consultation with legal counsel, management believes that the resolution of these matters will not have a material effect on the consolidated financial position and results of operations of the Company. (14) PARENT COMPANY The Parent Company's investments in its subsidiaries are recorded using the equity method of accounting. Summarized financial information relative to the Parent Company only balance sheets at December 31, 1994 and 1993 and statements of operations and cash flows for each of the three years in the period ended December 31, 1994 is as follows:
Balance Sheets - December 31, 1994 1993 Assets: -------------------------- Investment in and Advances to Subsidiaries $45,509,683 $51,006,872 Other Investments 585,140 1,077,035 Other Assets 1,045,147 896,099 -------------------------- Total Assets $47,139,970 $52,980,006 ========================== Liabilities and Equity Capital: Notes Payable $4,800,000 $7,200,000 Other Liabilities 40,000 60,000 Equity Capital 42,299,970 45,720,006 -------------------------- Total Liabilities and Equity Capital $47,139,970 $52,980,006 ========================== Statements of Operations for the Year Ended December 31, 1994 1993 1992 ------------------------------------ Dividends from the Merchants Bank* $0 $848,585 $3,320,194 Equity in Undistributed Earnings (Loss) of Subsidiaries* (2,679,429) (6,365,554) 2,161,917 Other Expense, Net (374,142) (450,636) (2,734) Provision for Income Taxes 163,547 186,036 197,134 ------------------------------------ Net Income (Loss) ($2,890,024)($5,781,569) $5,676,511 ==================================== Statements of Cash Flows for the Year Ended December 31, 1994 1993 1992 ------------------------------------ Cash Flows from Operating Activities: Net Income (Loss) ($2,890,024)($5,781,569) $5,676,511 Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by (Used in) Operating Activities: Amortization 6,360 15,265 18,260 Gains on Investment Securities (91,780) (76,316) (530,300) (Increase) Decrease in Miscellaneous Receivables (11,425) 998,729 (40,870) Increase (Decrease) in Miscellaneous Payables (20,000) (868,585) 396,997 Equity in Undistributed (Earnings) Losses of Subsidiaries 2,679,429 6,365,554 (2,161,917) ------------------------------------ Net Cash Provided by (Used in) Operating Activities ($327,440) $653,078 $3,358,681 ------------------------------------ Cash Flows from Investing Activities: Repayment of Advances from Subsidiaries 2,263,399 2,379,917 382,420 Proceeds from Sales of Investment Securities 682,030 271,316 2,142,410 ------------------------------------ Net Cash Provided by Investing Activities $2,945,429 $2,651,233 $2,524,830 ------------------------------------ Cash Flows From Financing Activities: Sale of Treasury Stock 0 388,998 1,193,523 Purchase of Treasury Stock 0 (132,058) (964,717) Cash Dividends Paid 0 (838,050) (3,293,450) Principal Payments on Debt (2,400,000) (2,400,000) (2,400,000) ------------------------------------ Net Cash Used in Financing Activities ($2,400,000)($2,981,110)($5,464,644) ------------------------------------ Increase in Cash and Cash Equivalents 217,989 323,201 418,867 Cash and Cash Equivalents at Beginning of Year 768,744 445,543 26,676 ------------------------------------ Cash and Cash Equivalents at End of Year $986,733 $768,744 $445,543 ==================================== Total Interest Paid $580,000 $820,000 $1,080,000 Taxes Paid 50,000 1,190,000 2,860,000 *Account balances are partially or fully eliminated in consolidation. (15) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments primarily include commitments to extend credit and financial guarantees. Such instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the accompanying consolidated balance sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and financial guarantees written is represented by the contractual amount of those instruments. The Bank generally requires collateral to support such financial instruments in excess of the contractual amount of those instruments and, therefore, is in a fully secured position. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments. The contractual amounts of these financial instruments at December 31, 1994 and 1993 were as follows: Contractual Amount ----------------------------------------------------------------- 1994 Financial Instruments Whose Contract Amounts Represent Credit Risk: Commitments to Extend Credit $107,454,000 Standby Letters of Credit 8,857,000 Loans Sold with Recourse 2,194,000 ----------------------------------------------------------------- 1993 Financial Instruments Whose Contract Amounts Represent Credit Risk: Commitments to Extend Credit $113,360,000 Standby Letters of Credit 11,721,000 Loans Sold with Recourse 2,527,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent a future cash requirement. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on management's credit evaluation of the counterparty, and an appropriate amount of real and/or personal property is obtained as collateral. Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. Most guarantees extend for less than two years, and 75% are for less than $100,000. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank obtains real and/or personal property as collateral for those commitments for which collateral is deemed to be necessary. The Bank enters into commitments to sell loans which involve market and interest rate risk. At December 31, 1994 and 1993, the remaining commitments to deliver loans pursuant to master commiments with secondary market investors amounted to approximately $30,081,000 and $51,768,000, respectively. Failure to fulfill delivery requirements of commitments may result in payment of certain fees to the investors. Individual commitments to sell loans require the Bank to make delivery at a specific future date of a specified amount, at a specified price or yield. Loans are generally sold without recourse and, accordingly, risks arise principally from movements in interest rates. (16) FAIR VALUE OF FINANCIAL INSTRUMENTS INVESTMENTS The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents and stock in the Federal Home Loan Bank of Boston (FHLB) approximate fair values. Fair value for investment securities is determined from quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. An analysis of the estimated fair value of the investment securities as of December 31, 1994 and 1993 is as follows: 1994 1993 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value ----------------------------------------------------------------- (In Thousands) Debt $102,111 $100,343 $85,946 $85,506 Marketable Equity Securities 1,661 1,196 1,230 1,451 ----------------------------------------------------------------- $102,772 $101,539 $87,176 $86,957 ================================================================= LOANS The fair value of variable rate loans that reprice frequently and have no significant credit risk is based on carrying values. The fair value of fixed rate (one-to-four family residential) mortgage loans, and other consumer loans, is based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. An analysis of the estimated fair value of the loan portfolio (including segregated assets) as of December 31, 1994 and 1993 is as follows: 1994 1993 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value ----------------------------------------------------------------- (In Thousands) Net Loans $490,626 $482,619 $553,412 $554,905 ================================================================= DEPOSITS The fair value of demand deposits approximates the amount reported in the consolidated balance sheets. The fair value of variable rate, fixed term certificates of deposit also approximate the carrying amount reported in the consolidated balance sheets. The fair value of fixed rate and term certificates of deposit is estimated using a discounted cash flow which applies interest rates currently being offered for deposits of similar remaining maturities. An analysis of the estimated fair value of deposits as of December 31, 1994 and 1993 is as follows: 1994 1993 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value ----------------------------------------------------------------- (In Thousands) Demand Deposits $ 94,467 $ 94,493 $ 96,413 $ 96,414 Savings, NOW and Money Markets 293,656 293,364 321,821 311,606 Time Deposits Over $100,000 23,281 23,127 21,215 22,617 Other Time 170,821 171,195 179,861 191,747 ----------------------------------------------------------------- $582,225 $582,179 $619,310 $622,384 ================================================================= DEBT The fair value of debt is estimated using current market rates for borrowings of similar remaining maturity. An analysis of the estimated fair value of the debt of the Company as of December 31, 1994 and 1993 is as follows: 1994 1993 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value ----------------------------------------------------------------- (In Thousands) Debt $44,229 $44,022 $46,633 $47,699 ================================================================= COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The fair value of commitments to extend credit and standby letters of credit is $116,943 and $165,468 as of December 31, 1994 and 1993, respectively.
(18) SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION (in thousands):
1994 1993 ----------------------------------------------- ---------------------------------------------- Restated (A)Restated (A) Q1 Q2 Q3 Q4 YEAR Q1 Q2 Q3 Q4 YEAR ----------------------------------------------------------------------- ---------------------------------------------- Interest and Fee Income $13,348 $13,019 $13,304 $13,648 $53,319 $11,060 $11,745 $14,357 $14,312 $51,474 Interest Expense 5,414 5,614 5,585 5,764 22,377 4,779 5,029 6,361 5,787 21,956 ----------------------------------------------------------------------- ---------------------------------------------- Net Interest Income $7,934 $7,405 $7,719 $7,884 $30,942 $6,281 $6,716 $7,996 $8,525 $29,518 Provision for Possible Loan Losses (B) 1,250 1,250 1,750 5,750 10,000 5,008 9,314 2,750 6,750 23,822 Non-Interest Income 2,104 2,235 2,219 2,231 8,789 3,221 2,126 2,617 2,490 10,454 Non-Interest Expense 7,105 7,294 7,422 13,643 35,464 5,756 5,885 7,048 7,653 26,342 ----------------------------------------------------------------------- ---------------------------------------------- Income (Loss) Before Provision (Benefit) for Taxes $1,683 $1,096 $766 ($9,278) ($5,733) ($1,262) ($6,357) $815 ($3,388)($10,192) Provision (Benefit) For Income Taxes 245 91 (13) (3,166) (2,843) (792) (2,416) (26) (1,176) (4,410) ----------------------------------------------------------------------- ---------------------------------------------- Net Income (Loss) $1,438 $1,005 $779 ($6,112) ($2,890) ($470) ($3,941) $841 ($2,212) ($5,782) ------------------------=============================================== ============================================== Earnings (Loss) Per Share $0.34 $0.24 $0.18 ($1.44) ($0.68) ($0.11) ($0.93) $0.20 ($0.53) ($1.37) ------------------------=============================================== ============================================== Dividends Per Share $0.00 $0.00 $0.00 $0.00 $0.00 $0.20 $0.00 $0.00 $0.00 $0.20 =============================================== ============================================== (A) Based on subsequent discussions with the FDIC and additional review of certain credit information in connection with the 1993 regulatory examination discussed in Note 1, management decided to amend the Bank's call reports and Forms 10-Q for the quarters ended March 31, 1993 and June 30, 1993 to allocate $3 million of the additional provision for possible loan losses originally recorded in the quarter ended June 30, 1993 to the quarter ended March 31, 1993. (B) During the fourth quarter of 1993, as a result of significant increases in nonperforming assets and the continuing weakness in the regional economy the Company provided reserves for possible loan losses of $5 million in addition to the planned provision of $1.75 million.
Five Year Summary of Operations (Not Covered by Report of Independent Public Accountants)
RESTATED For the years ended 1994 1993 1992 1991 1990 ------------------------------------------------------------- --------- --------------------- -------- Interest and Investment Income $ 53,319 $ 51,474 $ 49,239 $ 57,249 $ 62,797 Interest Expense 22,377 21,956 24,051 32,104 34,792 --------------------------------------------------------------------------------- -------------------- Net Interest Income $ 30,942 $ 29,518 $ 25,188 $ 25,145 $ 28,005 Provision for Possible Loan Losses 10,000 23,822 8,050 7,243 4,492 ------------------------------------------------------------- --------- ------------------------------ Net Interest Income after Provision for Loan Losses $ 20,942 $ 5,696 $ 17,138 $ 17,902 $ 23,513 ------------------------------------------------------------- --------- ------------------------------ Other Income $ 15,038 $ 12,128 $ 10,195 $ 9,376 $ 4,301 Other Expense 41,712 28,016 21,081 21,238 21,351 ------------------------------------------------------------- --------- ----------- --------- -------- INCOME (LOSS) BEFORE INCOME TAXES $ (5,732)$ (10,192)$ 6,252 $ 6,040 $ 6,463 Provision (benefit) for Income Taxes (Notes 2 and 4) (2,842) (4,410) 575 909 1,670 ------------------------------------------------------------- --------- ----------- --------- -------- NET INCOME (LOSS) $ (2,890)$ (5,782)$ 5,677 $ 5,131 $ 4,793 ------------------------------------------------------------- --------- ------------------------------ SELECTED AVERAGE BALANCES (IN THOUSANDS) Total Assets $ 709,077 $ 705,516 $ 602,317 $ 592,343 $ 597,385 Average Earning Assets 620,070 627,049 542,157 537,806 537,787 Loans 514,843 515,805 441,291 471,141 488,792 Total Deposits 598,305 570,957 490,908 488,831 495,299 Long-Term Debt 45,433 47,835 42,171 35,007 25,416 Shareholders' Equity 46,331 48,511 51,548 48,668 46,493 Shareholders' Equity plus Loan Loss Reserve 65,322 59,999 59,028 54,707 51,401 SELECTED RATIOS Net Income (Loss) to: Average Stockholders' Equity -6.24% -11.92% 11.01% 10.53% 10.31% Average Assets -0.41% -0.82% 0.94% 0.86% 0.80% Average Stockholders' Equity to Average Total Assets 6.53% 6.88% 8.56% 8.22% 7.78% Average Primary Capital to Average Total Assets 9.21% 8.50% 9.80% 9.24% 8.60% Common Dividend Payout Ratio 0.00% N/C 58.48% 62.69% 64.99% Loan Loss Reserve to Total Loans at Year End 3.90% 3.50% 1.73% 1.41% 1.03% Net Charge-Offs to Average Loans 1.97% 1.95% 1.65% 1.20% 0.93% PER SHARE (Note 1) Net Income (Loss) $ (0.68)$ (1.37)$ 1.39 $ 1.21 $ 1.13 Cash Dividends 0.00 0.20 0.80 0.78 0.74 Year End Book Value 10.00 10.74 12.39 11.82 11.30 OTHER Cash Dividends Paid (In Thousands) $ 0 $ 848 $ 3,320 $ 3,231 $ 3,115 Stock Dividends Issued 0.0% 0.0% 3.0% 2.0% 5.0% (Note 1): All stock dividends and splits are reflected retroactively. See Note 12 of Notes to Consolidated Financial Statements.
Interest Management Analysis
(Taxable Equivalent, in thousands) 1994 1993 1992 --------------------------------------------------------------------------------------------------------- Total Average Assets $709,077 $705,516 $602,317 --------------------------------------------------------------------------------------------------------- 1994 % of 1993 % of 1992 % of NET INTEREST INCOME: Assets Assets Assets Interest and Dividend Income $ 50,041 7.06% 47,194 6.69% $ 45,528 7.56% Fees on Loans 3,571 0.50% 4,598 0.65% 4,326 0.72% --------------------------------------------------------------------------------------------------------- Total $ 53,612 7.56% 51,792 7.34% $ 49,854 8.28% Interest Expense 22,377 3.16% 21,956 3.11% 24,051 3.99% --------------------------------------------------------------------------------------------------------- Net Interest Income Before Provision for Possible Loan Losses $ 31,235 4.41% 29,836 4.23% $ 25,803 4.28% Provision for Possible Loan Losses 10,000 1.41% 23,822 3.38% 8,050 1.34% --------------------------------------------------------------------------------------------------------- Net Interest Income $ 21,235 2.99% 6,014 0.85% $ 17,753 2.95% ----------------------------------------------=========================================================== OPERATING EXPENSE ANALYSIS: Non-Interest Expense Personnel $ 13,196 1.86% 12,305 1.74% $ 10,195 1.69% Occupancy Expense 2,324 0.33% 1,949 0.28% 1,490 0.25% Equipment Expense 2,004 0.28% 1,880 0.27% 1,783 0.30% Other 17,939 2.53% 10,208 1.45% 7,612 1.26% --------------------------------------------------------------------------------------------------------- Total Non-Interest Expense $ 35,463 5.00% 26,342 3.73% $ 21,080 3.50% --------------------------------------------------------------------------------------------------------- Less Non-Interest Income Service Charges on Deposits $ 3,452 0.49% 3,571 0.51% $ 2,536 0.42% Other, Including Securities Gains (Losses) 5,337 0.75% 6,883 0.98% 7,659 1.27% --------------------------------------------------------------------------------------------------------- Total Non-Interest Income $ 8,789 1.24% 10,454 1.48% $ 10,195 1.69% --------------------------------------------------------------------------------------------------------- Net Operating Expense $ 26,674 3.76% 15,888 2.25% $ 10,885 1.81% ----------------------------------------------=========================================================== SUMMARY: Net Interest Income $ 21,235 2.99% 6,014 0.85% $ 17,753 2.95% Less: Net Overhead 26,674 3.76% 15,888 2.25% 10,885 1.81% --------------------------------------------------------------------------------------------------------- Profit Before Taxes - Taxable Equivalent Basis $ (5,439) -0.77% (9,874) -1.40% $ 6,868 1.14% Net Profit (Loss) After Taxes $ (2,890) -0.41% (5,781) -0.82% $ 5,677 0.94% ----------------------------------------------===========================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the three years ended December 31, 1994 should be read in conjunction with the consolidated financial statements and notes thereto and selected statistical information appearing elsewhere in this annual report. The information is discussed on a fully taxable equivalent basis. Particular attention should be given to the INTEREST MANAGEMENT ANALYSIS and OPERATING EXPENSE ANALYSIS TABLES immediately preceding this discussion upon which this discussion is primarily based. The financial condition and operating results of the Company essentially reflect the operations of its principal subsidiary, The Merchants Bank. REGULATORY MATTERS During the second quarter of 1993, the FDIC and the Commissioner of the Vermont Department of Banking, Insurance and Securities performed a joint field examination of the Bank as of March 31, 1993. Additionally during the quarter, the Federal Reserve Bank of Boston (Federal Reserve) performed a field examination of the Company as of March 31, 1993. As a result of these examinations, the Bank entered into a Memorandum of Understanding (MOU) with the FDIC and the Commissioner on October 29, 1993. Under the terms of the MOU, the Bank is required to, among other things, maintain a leverage capital ratio of at least 5.5%, revise certain operating policies, enhance certain loan review procedures, refrain from declaring dividends and correct certain technical exceptions and violations of applicable regulations. Management believes the Bank is in substantial compliance with all of the provisions of the MOU as of December 31, 1994. The Bank was also directed by the FDIC to increase the reserve for possible loan losses by approximately $12 million and charge off loans totaling approximately $8 million at the conclusion of the examination in June 1993. The Bank recorded the increase in the reserve for possible loan losses as directed by the FDIC as of June 30, 1993. Based on subsequent discussions with the FDIC and additional review of certain loans, management decided to amend the Bank's call reports and Forms 10-Q for the quarters ended March 31, 1993 and June 30, 1993 to allocate $3 million of the additional provision for possible loan losses originally recorded in the quarter ended June 30, 1993 to the quarter ended March 31, 1993. Additionally, on February 18, 1994, the Company entered into a Written Agreement with the Federal Reserve which precludes the Company from declaring or paying any dividends without prior permission, directed the Company to submit a capital plan to maintain an adequate capital position at the Bank and at the Company, precludes any additional borrowings or incurrance of debt without the Federal Reserve's permission, and required the Bank to review and assess the qualifications of senior management and form a succession plan for senior management. This agreement also required the Bank to revise certain policies, and not enter into certain transactions without prior Federal Reserve permission. Management has actively responded to the agreements, and has continued to comply with the requirements of both the Mou and the Written Agreement. On March 31, 1994, the FDIC and the Commissioner completed the field work related to their most recent examination of the Bank as of December 31, 1993. The results of the examination had no significant impact with respect to the existing terms of the agreements. On December 16, 1994, the FDIC and the Commissioner completed the field work related to their examination of the Merchants Trust Company as of September 26, 1994. On February 17, 1995 the Trust Company entered into a Memorandum of Understanding with the FDIC and Commissioner to correct certain operating, technical and regulatory issues. Management believes that the matters noted in the Memorandum of Understanding have subsequently been corrected or are in the process of being remediated and that the Memorandum of Understanding will have no significant impact on the Company's financial position. FDIC ASSISTED ACQUISITION The Company expanded its banking operations through an FDIC assisted acquisition of the New First National Bank of Vermont (NFNBV), a three bank holding company conducting banking activities primarily on the eastern side of Vermont. Formerly known as Independent Bank Group and later as the First National Bank of Vermont, it was taken over by the FDIC in January 1993 as a result of inadequate capital and was subsequently run by the FDIC as a bridge bank until its sale on June 4, 1993. Prior to submitting its bid to the FDIC to acquire NFNBV, the Company was able to conduct a due diligence review of NFNBV's assets and liabilities using internal and outside consultants which the Company believes contributed to its successful bid and reduced its risks relating to the acquisition. The acquisition enabled the Company to enlarge its earning asset base and achieve economies of scale by consolidating administration and operations, standardizing policies and procedures, and providing uniform products and services. Management believes that the acquisition represented a very attractive opportunity to expand the Company's operations into a contiguous market area. The integration of operations was completed in October, 1993. Under the terms of the Purchase and Assumption Agreement between the Company and the FDIC, the Company purchased $178.4 million in performing loans, $154.5 million of which are covered under a Loss Sharing Agreement with the FDIC. Such loans are classified as "Segregated Assets" in the consolidated financial statements. Also purchased was $11.4 million in cash and cash equivalents, $4.1 million of investment securities, $1.5 million of buildings and equipment and $1.5 million of other assets. A purchase accounting adjustment was made to establish an allowance for possible loan losses in the amount of $2 million, which represents managements' estimate of general credit risks within the acquired portfolio as adjusted under the provisions of the Loss Sharing Agreement with the FDIC. The purchase price consisted of the assumption of all of the deposit liabilities ($203 million) and $537,000 in other liabilities. Additionally, the Company received cash from the FDIC in the amount of $4.1 million. Accordingly, the Company recognized a core deposit intangible at the purchase date in the amount of $4.5 million which is being amortized over 15 years using the straight-line method. During 1994, the Company reviewed the value of the core deposit intangible by comparing purchased deposit levels to current deposit levels in the branches purchased. The review indicated that approximately $35 million (17.16%) in deposit runoff had been experienced and deemed permanent in nature. Accordingly the carrying value of the core deposit intangible was written down by $686,000. This charge against earnings is reflected in Other Expenses in the Consolidated Statment of Operations. Under the terms of the Loss Sharing Agreement, the FDIC will reimburse the Company, on a quarterly basis, 80% of the net charge-offs and certain expenses relating to Segregated Assets up to cumulative losses aggregating $41.1 million, after which the rate will be 95% of net charge-offs on the loans. The Loss Sharing Agreement runs for three years, after which time the Company will reimburse the FDIC 80% of all recoveries on the charged-off loans for three years. RESULTS OF OPERATIONS The Company recognized a net loss of $2,890,024 for the year ended December 31, 1994, due primarily to three items: provisions for possible loan losses of $10,000,000 (refer to the discussion under "Provision For Possible Loan Losses" which follows), an increase in the provision for writedowns of other real estate owned of $2,392,000, and the net expenses related to the reimbursement of Trust Company clients for losses related to investments managed by the Trust Company and placed in the Piper Jaffray Institutional Government Income Portfolio. These net Trust Company expenses totaled approximately $3,200,000 after an insurance reimbursement of $6,000,000. The Company intends to pursue all available claims against Piper Jaffray Companies, Inc. and others because of the losses. Core earnings, not including the provision for possible loan losses, improved in 1994 over 1993 due to a rising interest rate environment which allowed the Bank to improve the interest margin by increasing the average yield from lending while holding the rate paid to depositors relatively flat. The Company recognized $72,884 in net gains on investment securities as compared to $1,898,945 in 1993. A net loss of $5,782,000 was recognized for the year ended December 31, 1993, due primarily to a significant increase in the provision for possible loan losses. Core earnings, not including the provision for possible loan losses, improved in 1993 over 1992 due to a lower, stable interest rate environment which allowed the Bank to improve the interest margin by reducing the average cost of funding. Net gains on investment security transactions decreased to $1,898,945 from $3,448,500 in 1992. The net loss on a per share basis was $.68 and $1.37 for the year ended December 31, 1994 and 1993, respectively. Earnings per share adjusted for all stock dividends was $1.39 in 1992. The cash dividends paid per share were $0.20 and $0.80 respectively for 1993 and 1992 after adjustments for all stock dividends. No dividends were paid in 1994. The net loss as a percentage of average equity capital was 6.24% and 11.92% for 1994 and 1993, respectively, while the net return on average equity capital was 11.0% in 1992. The ten-year average return on equity is 10.68%. The net loss as a percentage of average assets was .41% and .82% in 1994 and 1993, respectively, while the net return on average assets was .94% in 1992. The ten-year average return on assets is .76%. NET INTEREST INCOME Net interest income before the provision for possible loan losses is the difference between total interest, loan fee, and investment income and total interest expense. Net interest income before the provision for possible loan losses is the key indicator of a bank's performance in managing its assets and liabilities. Maximization and stability of this margin is the primary objective of the Company. Net interest income before the provision for possible loan losses on a fully taxable equivalent basis was $31.2 million in 1994, up 4.7% from $29.8 million the previous year. This increase is primarily due to the higher interest rate environment during 1994 and the impact of having the higher asset base from the NFNBV acquisition for the entire year as compared to seven months for 1993. Additionally, a decrease in the level of nonperforming assets increased the net interest income before the provision for possible loan losses as a percentage of total average assets to 4.41% in 1994 from 4.23% in 1993. Net interest income before the provision for possible loan losses was $29.8 million in 1993, up 15.6% from $25.8 million the previous year. This increase is primarily due to the larger asset base resulting from the NFNBV acquisition, which added approximately $84 million in earning assets and $80 million in deposit liabilities to the averages. Interest rates remained level during 1993 and 1992, however, an increased level of nonperforming assets in 1993 reduced the net interest income before the provision for possible loan losses as a percentage of total average assets to 4.23% in 1993 from 4.28% in 1992. Total interest income increased 6.0% in 1994 from 1993, while total interest expense increased 1.9% as the Company held its cost of core funding flat through fewer and smaller increases in interest rates paid to depositors. The decrease, in comparison to 1992, in total interest expense, which is primarily due to a stable, low interest rate environment during 1993 is dramatic, when the assumption of additional deposits from the NFNBV acquisition is taken into consideration. Total interest income increased 3.7% in 1993 from 1992 while total interest expense declined 8.7% from 1992 totals. Included in fees on loans and interest income are net gains on sales of loans of $219,000, $818,000 and $404,000 in 1994, 1993 and 1992, respectively. These net gains included the present value of the difference between the weighted average interest rate on the sold loans serviced by the Bank and the interest rate remitted to the investor, adjusted for a normal servicing fee. Net interest income after the provision for possible loan losses was $15.2 million higher in 1994 than 1993, which was a 66.1% decrease ($11,739,000) lower than 1992 due to a significant increase in the 1993 provision for possible loan losses. Net interest income after the provision in 1994 was 2.99% of average assets compared to .85% in 1993 and 2.95% in 1992. NET OPERATING EXPENSE Net operating expense (net overhead) is total non-interest expense reduced by non-interest income. Operating expense includes all costs associated with staff, occupancy, equipment, supplies, and all other non-interest expenses. Non-interest income consists primarily of fee income on deposit accounts, trust services, credit card, corporate and data processing services, and gains or losses on investment securities. Excluding the FDIC assistance received from loss-sharing and net gains on investment securities, non-interest income earned in 1994 increased $161,000 (1.9%) over the previous year. The Trust Company fees and all other items included under non-interest income increased 5.6%, however, service charges on deposits decreased 3.5% as the Bank adjusted its service charges to meet competition in its market place. Non-interest income increased marginally (2.5%) during 1993, to $10.5 million from $10.2 million in 1992. In 1993 Trust department income increased $287,000 (20.5%), service charges increased $1,035,000 (40.8%) due to increased charges and many more deposit accounts due to the NFNBV acquisition, all other non-interest income increased $486,000 (17.3%), while gains on the sales of investment securities decreased $1,550,000 (44.9%). Included in the 1993 investment gains is $1,024,000 recognized on the sale of U.S. Treasury issues sold during the first quarter which had been written down as of December 31, 1992 as an unrealized loss and recognized as a reduction of investment gains during 1992. Non-interest expenses increased dramatically ($9.1 million or 34.6%, not including the amount of losses and write-downs on Segregated Assets, which were reimbursed by the FDIC) in 1994 as compared to 1993 due to several large transactions. Expenses related to losses and costs to carry the Bank's other real estate owned portfolio increased $1.8 million due to an additional provision to increase the reserve on the portfolio of $2.3 million during 1994. The Company increased the provision primarily due to a change in strategy whereby the Company wants to be able to sell most of the OREO portfolio in a bulk sale or at auction during 1995. Also, the Bank wrote off the carrying value of one of its investments in real estate limited partnerships of $546,000 due to significant cash flow deficiencies experienced by the partnership which caused the Company to doubt the realizability of the investment. The net charge related to the Trust Company's reimbursement to its clients due to investments in the Piper Jaffray Institutional Government Income Portfolio totalling $3.2 million after the recognition of a $6 million reimbursement from insurance carriers also added to the increase. The Bank also wrote down the unamortized balance of the core deposit intangible related to the acquisition of NFNBV in the amount of $686,000 due to the attrition of certain deposits. Additionally, during 1994, salary and benefit expenses increased $891,000 or 7.2% due primarily to the cost of carrying an additional 10 branches for a full year as compared to only 7 months during 1993. The cost of FDIC insurance also increased by $531,000 due to the larger amount of deposits carried for first full year following the acquisition. The Company's 1993 operating expenses increased $5,261,000 or 25% over 1992, due to the costs of regulatory actions and the acquisition of NFNBV. Total personnel costs increased $2.1 million (20.7%) as the Company took on the 129 employees of NFNBV on a temporary or consulting basis while converting the new branches and associated information into the Company's computer and operating systems. By December 31, 1993, the Company had hired on a permanent basis 64 employees and paid approximately $100,000 in separation and severance pay to the employees not hired. Occupancy and equipment expenses in 1993 increased $556,000 in the aggregate, or 17%, again due to additional branches acquired in the NFNBV acquisition. Losses on and write- downs of other real estate owned increased to $1.97 million from $833,300 in 1992 due to the deterioration in the real estate market and the economic recession during the late 1980's and early 1990's. All other non-interest expenses increased $1.5 million (27.1%) in 1993 due to higher FDIC insurance premiums, legal and professional fees and amortization of the core deposit intangible arising from the NFNBV transaction and regulatory actions. When non-interest income is netted against non-interest expense, net operating expense (net overhead) increased $10.8 million (68%) in 1994 from the 1993 level. As a percent of average total managed assets, net overhead increased to 3.76% in 1994 from 2.25% in 1993. The Company recognized $708,000 in low income housing tax credits as a reduction in the provision for income taxes during 1994 and $961,000 during 1993 and 1992. As a consequence of the operating losses incurred during 1994 and 1993, the Company recognized a tax benefit of $2.8 million and $4.4 million including $708,000 and $961,000 in low income housing tax credits, respectively. Additionally, as of December 31, 1994 the Company has a cumulative prepaid tax asset of approximately $5.0 million arising from timing differences between the Company's book and tax reporting. The prepaid tax asset is included in other assets. PROVISION FOR POSSIBLE LOAN LOSSES Beginning in the late 1980's, the New England region was severely affected by a deterioration in the real estate market and an economic recession. During this period, the Company increased its provision for possible loan losses and incurred costs associated with troubled assets and lost income on nonaccrual loans. The provision for possible loan losses charged to operations was $10,000,000 in 1994, $23,822,000 in 1993 and $8,050,000 in 1992. Net charge-offs were $10,131,000 in 1994, $13,174,000 in 1993, and $7,289,000 in 1992. In addition, a reserve for possible loan losses of $2,000,000 was set up during 1993 related to the loans acquired in connection with the acquisition of NFNBV, to reflect the general credit risks within the acquired portfolio, net of the effects of the Loss Sharing Agreement with the FDIC. The reserve for possible loan losses (RPLL) was $19,929,000 at December 31, 1994, $20,060,000 at December 31, 1993, and $7,412,000 at December 31, 1992. As a percent of loans outstanding, the reserve for possible loan losses was 3.90%, 3.50%, and 1.73%, at year-end 1994, 1993, and 1992 respectively. The increased level in the reserve for possible loan losses reflects management's current strategies and efforts to maintain the reserve at a level adequate to provide for loan losses based on an evaluation of known and inherent risks in the loan portfolio. Given the continuing high levelof the Bank's nonperforming assets during 1994 (discussed below) and the continued lack of strength in the regional economy, together with other relevant economic factors, management concluded that a the reserve for possible loan losses should remaine at a level consistent with the prior year. Among the factors which management considers in establishing the level of the reserve are overall findings from an analysis of individual loans, the overall risk characteristics and size of the loan portfolio, past credit loss history, management's assessment of current economic and real estate market conditions and estimates of the current value of the underlying collateral. Further, during the fourth quarter of 1994, as a result of ongoing weakness in the regional economy, and management's ongoing strategy to resolve problem loans, the Company provided incremental reserves for possible loan losses of $4 million which supplemented the planned provision of $1.75 million for the quarter. Nonperforming assets (loans past due 90 days or more and still accruing, nonaccruing loans, restructured loans and other real estate owned) decreased 21.5% to $50,446,000 at December 31, 1994 from $64,299,000 at year-end 1993. Of the 1994 amount, $12,058,000 represents Segregated Assets, covered by the Loss Sharing Agreement with the FDIC. Excluding the FDIC's 80% exposure on the Segregated Assets ($9,646,000), adjusted nonperforming assets totaled $40,800,000, a decrease of 19% over the 1993 level. At December 31, 1992, nonperforming assets were reported to be $33,899,000. The Company's policy is to classify a loan more than 90 days past due with respect to principal or interest as a nonaccruing loan, unless the underlying collateral is deemed to be collectible as to both principal and interest and is in the process of collection. Income accruals are suspended on all nonaccruing loans, and all previously accrued and uncollected interest is reversed against current income. A loan remains on nonaccruing status until the factors which suggest doubtful collectibility no longer exist, or the loan is liquidated, or when the loan is determined to be uncollectible and is charged off against the reserve for possible loan losses. In those cases where a nonaccruing loan is secured by real estate, the Company can, and usually does, initiate foreclosure proceedings. The result of such action is to force repayment of the loan through the proceeds of a foreclosure sale or to allow the Company to take possession of the collateral in order to manage a future resale of the real estate. Foreclosed property is recorded at the lower of its cost or estimated fair value, less any estimated costs to sell. Any cost in excess of the estimated fair value on the transfer date is charged to the reserve for possible loan losses, while further declines in market values are recorded as an expense in other non-interest expense in the statement of operations. As of December 31, 1994 and 1993, the Company had valuation reserves against the other real estate owned portfolio carrying values of $2,991,000 and $599,000, respectively. The continuing effect of the downturn in the regional economy was the primary reason for the increase in nonperforming assets during 1993 and 1992. In response the Company continued to enhance its loan review and loan workout functions to provide additional resources to address nonperforming assets and maximize collections and recoveries. Historically, the Company worked closely with borrowers and pursued vigorous collection efforts. As the recession continued and property values declined further, changes in policies and procedures related to the collection of troubled assets were evaluated, especially with respect to the accrual of interest on delinquent loans. During 1993, nonaccruing loans and loans past due 90 days or more and still accruing increased $28.4 million which was principally due to the acquisition of NFNBV. $19.6 million of this increase is due to the acquisition of NFNBV and $17.4 million is covered by the Loss Sharing Agreement. Restructured loans were $2,841,000 at December 31, 1993 as compared to $1,838,000 at December 31, 1992. Other real estate owned and in-substance foreclosures grew by $1,013,000 to $13,674,000 at December 31, 1993 compared to $12,661,000 a year earlier. During 1992, the most significant change in nonperforming assets occurred in the other real estate owned/in-substance foreclosure category which grew to $12,661,000 at December 31, 1992 from $6,110,000 at December 31, 1991. Restructured loans within the nonperforming category totaled $1,838,000 at December 31, 1992. During 1992 some otherwise high quality loan relationships experienced decreasing cash flows. In such circumstances, management utilized restructuring where long term cash flow prospects appeared good, the borrower's business abilities had been historically demonstrated through successful operations and sound collateral values existed. The Company takes all appropriate measures to restore nonperforming assets to performing status or otherwise liquidate these assets in an orderly fashion so as to maximize their value to the Company. There can be no assurances that the Company will be able to complete the disposition of nonperforming assets without incurring further losses. BALANCE SHEET ANALYSIS Total assets at December 31, 1994 decreased $40.2 million (5.5%) from the previous year end. All of this shrinkage occurred in the loan and Segregated Asset portfolios, as new loan originations slowed considerably due to the higher interest rate environment and the sluggish economy. The Bank originated and sold $42.8 million in mortgages during 1994, approximately half the 1993 level. Of the decrease in loans and Segregated Assets, $13 million was due to charge offs, and the remainder of the decrease ($49.2 million) was accounted for by payoffs and scheduled amortization greater than the level of new loan originations. Total deposit balances decreased during 1994 by $37 million, as customers' savings moved to other bank and non- bank competitors. The investment portfolio, primarily U.S. Treasury debt securities with short maturities, grew $14.8 million (17.0%) as the Company invested excess funds during a period of lower loan demand. Although deposit balances continued to decrease, the Company was able to increase its liquidity position throughout the year. Total 1993 year-end assets increased $112.6 million (18.1%) over year-end 1992 due almost entirely to the NFNBV acquisition. Total assets acquired in the transaction approximated $197 million, however, due to the efforts expended in converting the systems and operations of the new branches, as well as dealing with the ongoing effects of regulatory actions, fewer loans were originated (other than residential mortgage loans, which were subsequently sold on the secondary market) by the Company in 1993 in comparison to 1992. During 1993, approximately $97.5 million of loans originated were sold to secondary market investors. As a result, the portfolio reduced in size due to scheduled amortization and charge offs. Total deposit balances at December 31, 1993 grew by $115.3 (22.9%)from the comparable amount at December 31, 1992, however, deposits totaling $203 million were purchased in the NFNBV transaction. This shrinkage was due, in part to normal runoff after an acquisition and also due to aggressive marketing by existing banks in the NFNBV marketplace following the acquisition. The investment portfolio decreased by $17.7 million as of December 31, 1993, and the cash assets including federal funds sold decreased by $16.7 million as the Company replaced the funding sources lost through the shrinkage in deposits during the year. Non-deposit liabilities grew by $3.8 million (5.8%) in 1993. For the year ended December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 (FASB 115), entitled "Accounting for Certain Debt and Equity Securities." FASB 115 establishes standards of financial accounting and reporting for investments in equity securities that have readily determinable fair values and all investments in debt securities. The effects of implementing FASB 115 was that certain investment securities were designated as available-for-sale and adjustments related to unrealized gains and losses with respect thereto (net of taxes) were made to stockholders' equity. LIQUIDITY 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. Sources of liquidity for banks include short term liquid assets, cash generated from loan repayments and amortization, borrowing, deposit generation, and earnings. The Merchants Bank has historically maintained a high percentage of its total resources in loans. Accordingly, the Bank relies on careful management of its ability to borrow money and generate deposits for liquidity. At year-end 1994, the Bank had available $30,000,000 in unused Federal Funds lines of credit. Only 3.6% of total resources were funded by large certificates of deposit at December 31, 1994 and 2.9% at December 31, 1993. EFFECTS OF INFLATION The financial nature of the Company's Balance Sheet and Statement of Operations is more clearly affected by changes in interest rates than by inflation, but inflation does affect the Company because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total bank assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effects of inflation on the Company's financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation. ACCOUNTING PRONOUNCEMENTS In May, 1993 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan. The Company is required to adopt the new standard on January 1, 1995. Management has determined that the effects of this change in accounting will have no material effect on the Company's consolidated financial statements. CAPITAL RESOURCES Capital growth is essentialto support deposit and asset growth and to ensure strength and safety of the Company. The net loss reduced the Company's capital by $2,890,000 in 1994. The net loss together with dividends paid reduced the Company's capital by $6,630,000 in 1993. Net income of $2,612,000 (after payment of cash dividends) added to equity capital in 1992. Dividend Reinvestment (DRP) and Employee Stock Ownership Plan (ESOP) requirements were satisfied by open market purchases of stock during 1993 and 1992. No new equity capital was generated from the sale of common stock to DRP and ESOP participants during 1994, 1993 or 1992 although this could be an important source of capital if management felt additional capital was necessary. Over the three year period, the equity capital of the Company has decreased $7,291,000 or 14.7%. As astate chartered bank,the Bank's primaryregulator is the Federal Deposit Insurance Corporation (FDIC). Accordingly, the Bank is affected by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) which was enacted in August 1989 the Federal Deposit Insurance Corporation Improvement Act (FDICIA) enacted in December 1992. The Bank is subject to regulatory capital regulations which provide for two capital requirements - a leverage requirement and a risk-based capital requirement. The leverage requirement provides for a minimum "core" capital consisting primarily of common stockholders' equity of 3% of total adjusted assets for those institutions with the most favorable composite regulatory rating. Under the terms of the MOU, the Bank is required to maintain a leverage capital ratio of at least 5.5% and refrain from declaring dividends without the prior approval of the FDIC. The Company is also required to refrain from declaring dividends without the Federal Reserve's prior permission. The risk-based capital requirement of FIRREA provides for minimum capital levels based on the risk weighted assets of the Bank. The guidelines require banks to meet a minimum Tier 1 risk-based capital ratio of 4.0% and a total risk-based capital ratio of 8.0% as of December 31, 1994. The Bank's leverage capital ratio is 5.96% and 5.94% at December 31, 1994 and 1993, respectively. As of December 31, 1994 and 1993, the Bank's risk-based Tier 1 capital ratios are 8.13% and 7.63% and the total risk-based ratios are 10.96% and 11.02%. All the Bank's capital measurements exceeded risk-based regulatory minimums as of December 31, 1994. At the present time, Merchants Bancshares, Inc. has the following sources of equity capital available as approved by stockholders and regulatory authority: A. Common Stock ($0.01 par value) Shares Authorized: 4,700,000 Shares Issued and Outstanding at December 31, 1994: 4,242,927 B. Preferred Stock, Class A Non-voting ($0.01 par value) Shares Authorized: 200,000 Shares Outstanding: -0- C. Preferred Stock, Class B Voting ($0.01 par value) Shares Authorized: 1,500,000 Shares Outstanding: -0- The Preferred Stock was authorized by shareholders at the Annual Meeting held on May 15, 1984. While the Company has no present intention to issue any Preferred Stock, the Board of Directors of the Company may do so in the future for any lawful purpose. The two preferred issues afford the ability to offer a broader range of securities and thus increase the ability to structure capital transactions on terms and conditions beneficial to the Company. In May, 1986 the Company issued privately $12 million of its 10% Senior Notes due in 1996 to institutional investors. The proceeds of this note issue are in use for general corporate purposes. The current balance outstanding of this issue is $4.8 million. In April, 1990, the Bank issued privately $20 million in 9.81% capital notes to institutional investors. These proceeds increased the regulatory capital of the Company and are in use for general corporate purposes. EX-27 3
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 1994 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-K. 1,000 YEAR DEC-31-1994 DEC-31-1994 34,851 487,757 0 0 91,667 10,085 9,872 510,555 (19,929) 694,837 582,224 18,295 7,788 44,229 42 0 0 42,258 694,837 48,938 4,381 0 53,319 17,851 22,376 30,943 10,000 73 41,713 (5,732) (5,732) 0 0 (5,732) ( .68) ( .68) 8.39 32,201 668 5,083 11,200 20,060 (12,650) 2,519 19,929 19,929 0 17,364