-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DdQj+MK/u6mBUAvn969uR0uEn3JXkFJKSV/hguWQ4s/mO8idMgFS5QTogDmUIpN9 UkPkfAiI/dUMJhGtUypL7g== 0000726517-96-000005.txt : 19960401 0000726517-96-000005.hdr.sgml : 19960401 ACCESSION NUMBER: 0000726517-96-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960329 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCHANTS BANCSHARES INC CENTRAL INDEX KEY: 0000726517 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 030287342 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-11595 FILM NUMBER: 96540770 BUSINESS ADDRESS: STREET 1: 123 CHURCH ST CITY: BURLINGTON STATE: VT ZIP: 05401 BUSINESS PHONE: 8026583400 MAIL ADDRESS: STREET 1: PO BOX 1009 CITY: BURLINGTON STATE: VT ZIP: 05401 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, 1995 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. X Contained herein Not contained herein The aggregate market value of the voting stock held by non-affiliates is $42,205,531 as computed using the average bid and asked prices of stock, as of February 15, 1996. The number of shares outstanding for each of the registrant's classes of common stock, as of February 15, 1996 is: Class: Common stock, par value $.01 per share Outstanding: 4,434,620 shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the year ended December 31, 1995 are incorporated herein by reference to Part II. Portions of the Proxy Statement to Shareholders for the year ended December 31, 1995 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 8 Item 4 - Submission of Matters to a 8 Vote of Security Holders Part II Item 5 - Market for Registrant's Common 9 Equity and Related Stockholder Matters Item 6 - Selected Financial Data 9 Item 7 - Management's Discussion and Analysis 20 of Financial Condition and Results of Operations Item 8 - Financial Statements and Supplementary 21 Data Item 9 - Changes in and Disagreements with Accountants 21 on Accounting and Financial Disclosures Part III Item 10 - Directors and Executive Officers of the 22 Registrant Item 11 - Executive Compensation 22 Item 12 - Security Ownership of Certain Beneficial 22 Owners and Management Item 13 - Certain Relationships and Related Party 22 Transactions Part IV Item 14 - Exhibits, Financial Statement 22 Schedules, and Reports on Form 8-K Indemnification Undertaking by Registrant 24 Signatures 25 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 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, 1995 the Bank was the fifth largest commercial banking operation in Vermont, with deposits totalling $544.5 million, net loans of $433.5 million, and total assets of $615.0 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, 1995 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, 1995 were $1,292,170. 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, 1995, the Merchants Trust Company had fiduciary responsibilities for assets valued at market in excess of $265.3 million. Total revenue for 1995 was $1,844,936, total expense was $1,607,946, resulting in pre-tax net income for the year of $236,990. This net income 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, 1995, the corporation had assets of $1,716,887, liabilities of $16,887 due to the parent company for accrued management fees, and equity capital of $1,700,000. 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, ($16,887 in 1995), in the amount of 1.5% on annual average assets. 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 or 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 retail deposit and investment products including Regular checking, Free 60 checking, NOW checking accounts, and NOW 50 checking accounts. The Bottom Line checking account is designed as a low cost checking option for customers who write fewer checks. All retail deposit products can be accessed with an ATM (Automated Teller Machine) card for additional convenience after normal banking hours or when outside the Bank's regular service area. The Bank also offers, as investment options, savings accounts, Certificates of Deposit, Individual Retirement Accounts (IRAs), Money Market accounts, and our Preferred Investment Money Market account, all at competitive rates and terms. Additional retail services include safe deposit boxes, travelers checks, bank drafts, personal money orders, and several methods of automated money transfer, including Federal Reserve wire transfer services. The Bank has made a significant investment in automation to assist customers. In addition to the ATM card, the Bank offers ATF (automatic transfer of funds) to cover checking overdrafts on personal accounts and EFT (electronic funds transfer) by which money can be transferred between accounts for funds management or for making loan payments automatically. In 1995, the Bank introduced PhoneLynx. This voice response system allows customers to access their accounts by telephone at any time of the day or night. Through PhoneLynx, customers can check balances on any type of deposit or loan account, can check interest rates on deposits and loans, can transfer funds between accounts, and can make loan payments. Customers may also reorder checks, enter stop payments, order a statement copy "faxed" to them, obtain interest paid or earned information for tax purposes, confirm deposits/withdrawals, and search to determine if a check has been paid. In 1996, the Bank will offer electronic bill payment capabilities by phone or PC through PhoneLynx and PC Lynx. With these services, customers will be able to pay any type of bill electronically from their own PC or from a telephone at any time that fits their schedule. The Bank provides strong customer support with thirty three ATMs statewide, including one drive-up ATM; and on-line teller stations in all branches. 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. 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; multifamily mortgages; residential construction; mortgages for seasonal dwellings; and 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. On January 12, 1996, the Passumpsic Savings Bank purchased certain assets and assumed certain liabilities of the Bank's branch located in Danville, VT. The Merchants Bank received an 8% deposit premium on deposits sold in accordance with the purchase and assumption agreement. COMPETITION Competition for financial services remains very strong in Vermont. As of December 31, 1995, there were sixteen state chartered commercial banks, ten national commercial banks, five state chartered savings banks and one state chartered savings and loan association operating in Vermont. Also, there is one federally chartered savings bank, as well as, one federally chartered savings and loan association. 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 1995, The Merchants Bank was the fifth largest state chartered 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, 1995, Merchants Bancshares, Inc. had five officers: Dudley H. Davis, Chairman of the Board; Joseph L. Boutin, President and Chief Executive Officer; Jennifer L. Varin, Secretary; Janet P. Spitler, Treasurer; and Susan M. Verro and Janet L. Lussier, Assistant Secretaries. No officer of the Company is on a salary basis. As of December 31, 1995, The Merchants Bank employed 247 full-time and 43 part-time employees, representing a full-time equivalent complement of 270 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, 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. ECONOMY The latest New England Economic Project (NEEP) Report dated October, 1995 expects the Vermont economy to continue along its generally expansionary path throughout the calendar 1995-99 forecast period. Still, Vermont's economic performance after more than four years of recovery/expansion remains decidedly mixed. Although the national economy continued to rebound in 1995, there have yet to be any tangible signs of a marked resurgence in the Vermont or regional economies. The current climate of uneasiness in Vermont threatens to continue, given uncertainty as to the capacity of the national economy for further expansion. Unemployment in Vermont ended the year at 4.2%, the second lowest rate in the New England region. In addition, the Burlington Labor Market Area continued to have the lowest rate of unemployment among the nineteen major Labor Market Areas in the New England region. But sluggish wage growth, especially in key upper-income categories, continued to limit increases in state tax revenues. Although the manufacturing sector is not in a position to take a leading role in the state's economic landscape, Vermont enjoys above average manufacturing job growth (+1.4% over previous year July data versus 0.6% for the nation as a whole), and ranks first among all states in the New England region over the July 1994-1995 period. The size and frequency of cyclically-adjusted employment restructurings in Vermont s manufacturing sector have decreased considerably, leading to positive employment movements among the state's successful manufacturing employers and categories. Unfortunately, several of Vermont s non-manufacturing categories have not been able to escape the corporate cost-cutting and downsizing that previously plagued the manufacturing sector. The Public Utilities, Higher Education and Financial Services sectors have all seen announcements of significant employment reductions, and similar reductions in the Government sector have either occurred or are underway at both the federal and state government levels. Against the backdrop of a slowing Vermont expansion is a national economic forecast scenario that is generally synonymous with the successful completion of a much-heralded "soft landing". Even though the U.S. economy has been operating at near full capacity, it appears that the improving trend should continue for at least the next calendar year. ITEM 2 - PROPERTIES A. SCHEDULE OF BANKING OFFICES BY LOCATION The Merchants Bank operates thirty-eight 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. 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 929 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 47 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 Operations Building Danville Main Street *4 Branch office Fairlee U.S. Route #5 Branch office Groton 258 Scott Highway 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, 1995 a mortgage with an unpaid principal balance of $205,441 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. *4 On January 12, 1996, in conjunction with the sale of certain assets of its Danville Branch, the Bank sold the building located in Danville, VT. ITEM 3 - LEGAL PROCEEDINGS 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 related 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. 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 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 their insurance carriers. The attorneys representing the plaintiffs in one of the lawsuits discussed above have taken the position that amounts recovered by the Companies on these claims should be paid to the affected Trust Company clients (net of legal fees paid to attorneys), in addition to the $9.2 million already paid. The matter is presently before the United States District Court for the District of Minnesota. The attorneys representing the plaintiffs in one of the lawsuits discussed above requested an award of attorneys' fees for allegedly causing the Companies to make the $9.2 million payment and asked the court to order the Trust Company to withhold payment of $500,000. The Trust Company has resisted the claims for payment of such fees by its clients, and, as a result, the Trust Company was directed to place the sum of $500,000 into escrow pending a ruling by the Court. There is the possibility that the Companies may be required to remit all of part of these funds to those attorneys, but based upon consultation with legal counsel, management believes there is no substantial basis for any liability on the part of the Companies for the payment of such fees. 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 1995 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. QUARTER ENDING HIGH LOW 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 8.25 March 31, 1995 11.75 9.25 June 30, 1995 12.50 10.00 September 30, 1995 15.00 10.50 December 31, 1995 15.00 13.25 As of December 31, 1995 Merchants Bancshares, Inc. had 1,435 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 1995 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 29 in the 1995 Annual Report to Shareholders are herein incorporated by reference. Tables included on the following pages 10 through 13 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. 1995 1994 1993 Demand Deposits $ 87,434 $ 91,853 $ 81,761 Savings, Money Market and NOW Accounts 279,906 310,613 315,254 Time Deposits Over $100,000 20,927 18,135 17,752 Other Time Deposits 167,975 177,198 155,227 ------- ------- ------- Total Average Deposits $556,242 $597,799 $569,994 ======= ======= ======= Time Deposits over $100,000 at December 31, 1995 had the following schedule of maturities (In Thousands): Three Months or Less $ 2,335 Three to Six Months 4,596 Six to Twelve Months 3,728 Over Twelve Months 3,143 Over Five Years 6,674 ------ Total $20,473 ====== 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, 1995 were as follows: 1995 1994 1993 Return on Average Total Assets -0.60% -0.41% -0.82% Return on Average Stockholders' Equity -9.41% -6.24% -11.92% Dividend Payout Ratio N/A N/A N/A Average Stockholders' Equity to Average Total Assets 6.36% 6.53% 6.88% SHORT-TERM BORROWINGS Refer to Notes 8 and 9 to the Financial Statements for this information. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential The following table presents the condensed annual average balance sheets for 1995, 1994 and 1993. 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) 1995 1994 1993 ----------------------------- ----------------------------- ----------------------------- 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 $83,749 $4,525 5.40% $89,183 $3,508 3.93% $98,971 $3,655 3.69% States & Political Subdivisions 0 0 0.00% 0 0 0.00% 143 12 8.39% Other, Including FHLB Stock 4,416 357 8.08% 8,178 535 6.54% 8,900 667 7.49% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Investment Securities $88,165 $4,882 5.54% $97,361 $4,043 4.15% $108,014 $4,334 4.01% -------- -------- -------- -------- -------- -------- -------- -------- -------- Loans, Including Fees on Loans: Commercial (a) (b) 87,009 9,236 10.61% 117,948 10,128 8.59% 111,353 9,236 8.29% Real Estate 378,433 35,094 9.27% 396,176 36,959 9.33% 380,810 35,639 9.36% Consumer 15,605 1,902 12.19% 19,710 2,167 10.99% 23,642 2,728 11.54% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Loans $481,047 $46,232 9.61% $533,834 $49,254 9.23% $515,805 $47,603 9.23% -------- -------- -------- -------- -------- -------- -------- -------- -------- Federal Funds Sold $6,339 $366 5.77% $7,865 $315 4.01% $3,230 $97 3.00% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Earning Assets $575,551 $51,480 8.94% $639,060 $53,612 8.39% $627,049 $52,034 8.30% -------- -------- -------- -------- -------- -------- -------- -------- -------- Reserve for Possible Loan Losses (17,946) (18,991) (11,488) Cash and Due From Banks 34,099 31,910 29,177 Premises and Equipment 15,365 16,349 15,166 Other Assets 35,418 40,749 45,611 -------- -------- -------- Total Assets $642,487 $709,077 $705,515 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY: Time Deposits: Savings, Money Market & NOW Accounts $279,906 $9,077 3.24% $309,490 $8,420 2.72% $315,254 $8,546 2.71% Certificates of Deposit over $100,000 20,927 1,433 6.85% 22,248 1,336 6.01% 25,578 1,394 5.45% Other Time 167,975 8,981 5.35% 177,250 8,096 4.57% 148,364 7,109 4.79% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Time Deposits $468,808 $19,491 4.16% $508,988 $17,852 3.51% $489,196 $17,049 3.49% -------- -------- -------- -------- -------- -------- -------- -------- -------- Federal Funds Purchased 975 58 5.95% 1,167 57 4.88% 2,197 88 4.01% Securities Sold Under Agreement to Repurchase 0 0 0.00% 19 1 5.26% 7,688 229 2.98% Demand Notes Due U.S. Treasury 3,229 173 5.36% 3,130 120 3.83% 3,540 97 2.74% Other Interest Bearing Liabilities 4,524 44 0.97% 4,555 303 6.65% 5,471 290 5.30% Debt 32,819 3,236 9.86% 50,575 4,044 8.00% 58,337 4,272 7.32% -------- -------- -------- -------- -------- -------- -------- -------- -------- Total Interest Bearing Liabilities $510,355 $23,002 4.51% $568,434 $22,377 3.94% $566,429 $22,025 3.89% -------- -------- -------- -------- -------- -------- -------- -------- -------- Demand Deposits 87,434 89,318 81,761 Other Liabilities 3,850 4,994 8,814 Stockholders' Equity 40,848 46,331 48,511 -------- -------- -------- Total Liabilities & Stockholders' Equity $642,487 $709,077 $705,515 ======== ======== ======== Net Interest Income (a) $28,478 $31,235 $30,009 ======== ======== ======== Yield Spread 4.44% 4.45% 4.41% ===== ===== ===== NET INTEREST INCOME TO EARNING ASSETS 4.95% 4.89% 4.79% ===== ===== ===== (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 1995 as compared with 1994 and 1994 as compared with 1993.
1995 vs 1994 1994 vs 1993 ------------------------------------------- ------------------------------------------- Increase --Due to (a)-- Increase --Due to (a)-- 1995 1994 (Decrease) Volume Rate 1994 1993 (Decrease) Volume Rate ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Interest Income: Loans $46,232 $49,254 ($3,022) ($5,073) $2,051 $49,254 $47,603 $1,651 $1,664 ($13) Investment Income: Taxable 4,882 4,043 839 (597) 1,436 4,043 4,322 (279) (432) 153 Non-Taxable 0 0 0 0 0 0 12 (12) (12) (0) Federal Funds Sold 366 315 51 (88) 139 315 97 218 186 32 ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Total $51,480 $53,612 ($2,132) ($5,758) $3,626 $53,612 $52,034 $1,578 $1,406 $171 ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Less Interest Expense: Savings, Money Market & Now Accounts $9,077 $8,420 $657 ($959) $1,616 $8,420 $8,546 ($126) ($157) $31 Certificates of Deposit Over $100,000 1,433 1,336 97 (90) 187 1,336 1,394 (58) (200) 142 Other Time 8,981 8,096 885 (496) 1,381 8,096 7,109 987 1,313 (326) Federal Funds Purchased 58 57 1 (11) 12 57 88 (31) (50) 19 Securities Sold Under Agreement to Repurchase 0 1 (1) (1) (0) 1 229 (228) (403) 175 Demand Note - U.S. Treasury 173 120 53 5 48 120 97 23 (16) 39 Debt and Other Borrowings 3,280 4,347 (1,067) (1,751) 684 4,347 4,562 (215) (685) 470 ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Total $23,002 $22,377 $625 ($3,303) $3,928 $22,377 $22,025 $352 ($198) $550 ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Net Interest Income $28,478 $31,235 ($2,757) ($2,455) ($302) $31,235 $30,009 $1,226 $1,604 ($378) ======= ======= ======== ======= ======= ======= ======= ======== ======= ======= (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 $2,492, $3,571 and $4,598 for the years ended December 31, 1995, 1994 and 1993, respectively.
LOAN PORTFOLIO The following tables display the composition of the Bank's loan portfolio for the consecutive five year period 1991 through 1995, 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 $956,333 in 1995, $1,132,494 in 1994, $1,310,416 in 1993, $1,183,400 in 1992, and $1,098,100 in 1991, which principally relate to real estate mortgages. ----------------As of December 31,-------------- Type of Loan 1995 1994 1993 1992 1991 Commercial, Financial & Agricultural $ 73,915 $ 88,201 $ 98,936 $ 76,141 $120,033 Industrial Revenue Bonds 3,010 4,411 6,695 8,721 11,968 Real Estate-Construction 9,644 21,992 30,526 18,776 16,392 Real Estate - Mortgage 346,202 377,429 413,112 305,513 294,769 Installment 16,560 18,086 22,836 18,332 20,930 Lease Financing 0 0 42 630 1,769 All Other Loans 393 436 1,324 1,422 4,287 ------- ------- ------- ------- ------- Total Loans $449,724 $510,555 $573,471 $429,535 $470,148 ======= ======= ======= ======= ======= PROFILE OF LOAN MATURITY DISTRIBUTION The table below presents the distribution of the varying maturities or repricing opportunities of the loan portfolio at December, 1995. 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 $ 55,871 $ 11,858 $ 9,589 $ 77,318 Real Estate Loans 225,597 66,181 64,068 $355,846 Installment Loans 4,399 11,830 331 $ 16,560 ------- ------- ------ -------- $285,867 $ 89,869 $73,988 $449,724 ======= ====== ====== ======= In 1995, a total of 439 one-to-four family residential mortgage loans were closed by the bank, totalling $36.9 million. Approximately 82% of these originations were sold on the secondary market and the remaining 18%, or $6.7 million were placed in the bank's portfolio. The bank currently services $322 million in residential mortgage loans, $250 million 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. During 1995, the Bank remained an active participant in the U.S. Small Business Administration guaranteed loan program. Seventy new SBA loans totalling $9.7 million were originated during 1995 with SBA guarantees ranging from 70% to 90%. This volume of new lending activity represents an increase of 18% over originations during 1994. Approximately 23% of all new SBA loans originated during 1995 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 1995, the Bank originated 648 commercial loans totalling $77.2 million. This lending activity represented a decrease of approximately 43% of new loan volume from that experienced in 1994. Commercial loans were originated throughout Vermont. LOAN PORTFOLIO MONITORING 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, distribution of loan types within the portfolio, and sets loan authority limits for each lender. Theseauthorized lending limits are established at least annually and are based upon the lender's knowledge and experience. Loan requests that exceed a lender's authority are referred to the Credit Department. 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 and Credit Department. The loan portfolio as a whole, as well as individual loans, are reviewed for loan performance, credit worthiness, and strength of documentation. The Bank has hired an external loan review firm to assist in portfolio monitoring. Credit ratings are assigned to commercial loans and are 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 Financial Accounting Standards Board ( FASB ) issued revised accounting guidance which affected the RPLL. Statement of Financial Accounting Standards No. 114 ( SFAS No. 114"), Accounting by Creditors for Impairment of a Loan, requires, among other things, that the creditors measure impaired loans at the present value of expected future cash flows, discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. For purposes of this statement a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The FASB also issued SFAS No. 118, which amended SFAS No. 114, by allowing creditors to use their existing methods of recognizing interest income on impaired loans. Merchants Bancshares, Inc. adopted the methodology of SFAS No. 114, incorporating the amendments of SFAS No. 118, on January 1, 1995. 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 impaired loans as defined under SFAS No. 114 * Status of non-performing 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 In accordance with SFAS No. 114 management has defined an impaired loan as meeting any of the following criteria: * A loan which is 90 days past due and still accruing * A loan which has been placed in non-accrual and is 45 days past due * A loan which is rated Substandard and is 45 days past due * A loan which is rated Doubtful or Loss * A loan which has been classified as a Troubled Debt Restructuring * A loan which has been assigned a specific allocation 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. 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, 1995 (000's omitted) Category Balance Reserve Percent Allocation Impaired $29,630 $2,724 9.19% Adversely Rated Credits $20,543 $1,975 9.61% General Allocation: Commercial Real Estate $204,578 $4,967 2.43% Other Commercial $78,236 $1,875 2.40% Residential Real Estate $66,773 $155 0.23% Consumer $51,363 $455 0.89% Undisbursed Commitments $101,823 $2,139 2.10% Unallocated $1,944 ------ TOTAL $16,234 ====== 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. LOAN LOSSES AND RPLL RECONCILIATION December 31, 1995 (000's omitted) 1995 1994 1993 1992 1991 - ----------------------------------------------------------------------- Average Loans Outstanding $481,047 $514,843 $515,805 $441,291 $471,141 RPLL Beginning of Year 19,929 20,060 7,412 6,650 5,075 Charge-Off : Commercial, Lease Financing and all Other Loans (3,671) (3,356) (5,567) (2,938) (3,367) Real Estate - Construction (1,485) (1,159) (275) (253) (1,802) Real Estate - Mortgage (12,942) (7,673) (7,651) (4,096) (718) Installment & Credit Cards (263) (462) (459) (452) (617) ------------------------------------------------- Total Loans Charged Off (18,361) (12,650) (13,952) (7,739) (6,504) Recoveries: Commercial, Lease Financing and all Other Loans 1,232 1,187 392 232 366 Real Estate - Construction 32 400 0 0 379 Real Estate - Mortgage 1,224 769 301 108 0 Installment & Credit Cards 78 163 85 111 91 Total Recoveries $2,566 $2,519 $778 $451 $836 - ----------------------------------------------------------------------- Net Loan Losses ($15,795) ($10,131) ($13,174) ($7,288) ($5,668) Provision for Loan Losses: Charged to Operations (NOTE 1) 12,100 10,000 23,882 8,050 7,243 Loan Loss Reserve (NOTE 2) 2,000 - ----------------------------------------------------------------------- RPLL End of Year $16,234 $19,929 $20,060 $7,412 $6,650 ======================================================================= RPLL to Total Loans 3.61% 3.90% 3.50% 1.73% 1.41% Net Losses to Average Loans 3.28% 1.97% 2.28% 1.63% 1.20% NOTE 1: 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 2: See Note 2 to the consolidated financial statements regarding the acquisition of New First National Bank of Vermont. The reserve for possible loan losses decreased from $19,929,000 at December 31, 1994 to $16,234,000 at December 31, 1995. At the same time, the provision for loan losses increased from $10,000,000 to $12,100,000. These two trends reflect management s continuing efforts to charge-off any loss exposure in the portfolio while maintaining the reserve at an appropriate level to provide for potential losses. This effort is reflected in the increase in total loan losses from $12,650,000 during 1994 to $18,361,000 during 1995. NONPERFORMING ASSETS The following tables summarize the Bank's nonperforming assets (NPAs). The first table shows a breakout of NPAs 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 covered by loss sharing totaled $6,650,000 and $10,455,000 at December 31, 1995 and 1994, respectively. The aggregate amount of loans covered by the loss sharing arrangement at December 31, 1995 was $69,794,000 and $95,802,000 at December 31, 1994. NPA Regular Loss Sharing Total (000's omitted) Assets Assets - ---------------------------------------------------------------- Nonaccrual Loans* $19,581 $6,036 $25,617 Restructured Loans $1,364 $66 $1,430 Loans past due 90 days or more and still accruing $237 $0 $237 Other Real Estate Owned $7,224 $548 $7,772 - ---------------------------------------------------------------- Total $28,406 $6,650 $35,056 ================================================================ *Included in Nonaccrual loans are certain loans whose terms have been substantially modified in troubled debt restructurings at December 31, 1995. The second table shows nonperforming assets as of year end 1990 through 1995 (in thousands): 1995 1994 1993 1992 1991 - ----------------------------------------------------------------------- Nonaccrual Loans* $25,617 $32,200 $47,069 $12,148 $8,333 Loans Past Due 90 Days or More and Still Accruing 237 668 715 7,251 8,613 Restructured Loans 1,430 5,083 2,841 1,838 5,679 - ----------------------------------------------------------------------- Total Nonperforming Loans: 27,284 37,951 50,625 21,237 22,625 Other Real Estate Owned 7,772 13,231 13,674 12,662 6,110 - ----------------------------------------------------------------------- Total Nonperforming Assets: $35,056 $51,182 $64,299 $33,899 $28,735 ======================================================================= NPL to Total Loans 6.06% 7.43% 8.83% 4.94% 4.18% NPA to Total Loans plus OREO 7.67% 9.77% 10.95% 7.67% 6.03% *Included in Nonaccrual loans are certain loans whose terms have been substantially modified in troubled debt restructurings at December 31, 1995. DISCUSSION OF 1995 EVENTS AFFECTING NON-PERFORMING ASSETS Historically, the Company has worked closely with borrowers and also pursued vigorous collection efforts. The Company continued its efforts to collect troubled assets during 1995. The Company's enhanced Credit Department 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, 1995, is adequate. 12-31-95 9-30-95 6-30-95 3-31-95 12-31-94 - ----------------------------------------------------------------------------- Nonaccrual Loans $25,617 $25,812 $41,134 $43,637 $32,200 Loans Past Due 90 days or more and still Accruing 237 805 545 108 668 Restructured Loans 1,430 1,437 2,673 2,667 5,083 Other Real Estate Owned 7,772 6,204 7,709 9,336 7,389 In-substance Foreclosure (NOTE 3) 5,842 - ---------------------------------------------------------------------------- Total: $35,056 $34,258 $52,061 $55,748 $51,182 ============================================================================ NOTE 3: In-substance Foreclosure classification was eliminated by SFAS 114, effective 1/1/95. The more significant events affecting NPAs are discussed below: NONACCRUAL LOANS: Nonaccrual loans declined from $32,200,000 at December 31, 1994 to $25,617,000 at December 31, 1995. The balance of nonaccrual loans actually increased during the year, before declining to the present level. Management continued its efforts to proactively identify and resolve loans which present significant risk of loss to the bank. These efforts included a sale of non-performing assets and a significant level of charge-offs and restructurings. LOANS PAST DUE 90 DAYS OR MORE AND STILL ACCRUING: The Bank generally places loans that become 90 or more days past due in nonaccrual status. If the ultimate collectability of principal and interest is assured, loans may continue to accrue and be left in this category. The steady decline in this category reflects management s commitment to early problem loan detection and increased collection efforts. RESTRUCTURED LOANS: Restructured loans (TDRs) decreased during 1995 from $5,083,000 at December 31, 1994 to $1,430,000 at December 31, 1995. A review of the more significant restructured loans noted transfers out of restructure status of $2.4 million; charge-offs of $574 thousand; and payments of $655 thousand. OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURE: The Bank had notable success in 1995 in disposing of OREO and continues to aggressively market such properties. The December 31, 1995 balance, of $7,772,000, in OREO remained relatively static as compared to the December 31, 1994 balance of $7,389,000. During the year $9.3 million in properties were transferred to OREO. Approximately $2.7 million of these properties were transferred from fixed assets to OREO during the fourth quarter of 1995. These transfers were offset by sales of $8.4 million. During the second quarter the Bank held an auction to sell properties held as OREO. Twenty-three properties were sold, which decreased the OREO balance by $1.3 million. 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 29 of the Company's 1995 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, 1995 and 1994, 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, 1995 together with the related notes and the opinion of Arthur Andersen LLP, independent public accountants, all as contained on pages 5 through 24 of the Company's 1995 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 for 1995, the Company notes that Patrick S. Robins filed a Form 4 report three (3) months late with respect to the purchase of 2,100 shares. 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 26, 1996, 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 1995 Annual Report to Shareholders, are incorporated herein by reference: Consolidated Balance Sheets, December 31, 1995 and December 31, 1994. Consolidated Statements of Operations for years ended December 31, 1995, 1994, 1993. Consolidated Statements of Changes in Stockholder's Equity for years ended December 31, 1995, 1994, 1993. Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994, 1993. Notes to Consolidated Financial Statements, December 31, 1995. (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. (10a) Service Agreement as amended between First Data Resources, Inc., and Registrant dated June 1993 (effective through May 1998) for Mastercard Services. (10b) 401(k) Employee Stock Ownership Plan of Registrant, dated January 1, 1990, for the employees of the Bank. (10c) Merchants Bank Pension Plan, as amended and restated on September 30, 1995, for employees of the Bank. (10d) Agreement between Specialty Underwriters, Inc., and Registrant dated January 1, 1995 for equipment maintenance services. (11) Statement re: computation of per share earnings. (13) 1995 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, 1995 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. 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 29, 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 Charles A. Davis, Director Dudley H. Davis, Director Chairman of the Board of Directors by s/Jeffrey L. Davis by Jeffrey L. Davis, Director Jack DuBrul, II, Director by s/Michael G. Furlong by Michael G. Furlong, Director Thomas F. Murphy, Director by s/Janet P. Spitler by s/Leo O'Brien, Jr. Janet P. Spitler, Treasurer of the Leo O'Brien, Jr, Director Company, Vice President, Controller 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 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, 1995 and 1994, 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, 1995. 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 financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 financial position of Merchants Bancshares, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 25, 1996 Merchants Bancshares, Inc. Consolidated Balance Sheets
At December 31, 1995 1994 - -------------------------------------------------------------------------------------- --------------- ASSETS: Cash and Due from Banks (Note 2) $ 38,366,772 $ 34,851,401 Trading Securities (at market value) (Notes 2 and 3) 500,000 0 Securities Available for Sale (Notes 2 and 3): Debt Securities 97,943,234 90,470,922 Marketable Equity Securities 309,508 1,195,897 Debt Securities Held to Maturity (Market Value of $9,871,875 in 1994) 0 10,084,646 - -------------------------------------------------------------------------------------- --------------- Total Investment Securities 98,252,742 101,751,465 - -------------------------------------------------------------------------------------- --------------- Loans (Notes 2 and 4) 379,930,413 414,752,749 Segregated Assets (Notes 4 and 10) 69,793,604 95,802,303 Reserve for Possible Loan Losses (16,234,481) (19,928,817) - -------------------------------------------------------------------------------------- --------------- Net Loans 433,489,536 490,626,235 - -------------------------------------------------------------------------------------- --------------- Federal Home Loan Bank Stock 3,174,400 6,856,200 Premises and Equipment, Net (Notes 2 and 5) 12,454,708 16,620,173 Investments in Real Estate Limited Partnerships (Note 2) 3,141,245 3,593,818 Other Real Estate Owned, Net (Note 2) 7,772,067 13,230,807 Other Assets (Note 7) 17,896,993 27,306,440 - -------------------------------------------------------------------------------------- --------------- Total Assets $ 615,048,463 $ 694,836,539 - --------------------------------------------------------------------------============ ---============ LIABILITIES: Deposits: Demand $ 85,417,465 $ 94,467,122 Savings, NOW and Money Market Accounts 278,241,601 293,655,696 Time Deposits Over $100,000 20,473,321 23,280,762 Other Time 160,381,588 170,820,804 - -------------------------------------------------------------------------------------- --------------- Total Deposits 544,513,975 582,224,384 Other Borrowed Funds (Note 8) 5,335,422 18,294,734 Other Liabilities (Notes 6 and 7) 9,525,446 7,788,085 Debt (Note 9) 15,424,757 44,229,366 - -------------------------------------------------------------------------------------- --------------- Total Liabilities $ 574,799,600 652,536,569 - -------------------------------------------------------------------------------------- --------------- Commitments and Contingencies (Note 13) STOCKHOLDERS' EQUITY (Note 11): 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 in 1995 and 1994 Shares Issued: 4,434,620 in 1995 and 4,242,927 in 1994 44,346 42,429 Capital in Excess of Par Value 33,154,407 30,647,120 Retained Earnings 8,620,881 12,462,820 Treasury Stock (at Cost) 144,278 Shares in 1995 and 12,733 Shares in 1994 (2,037,927) (178,730) Net Unrealized Appreciation (Depreciation) of Investment Securities Available for Sale, Net of Taxes 467,156 (673,669) - ---------------------------------------------------------------------------------------- -------------- Total Stockholders' Equity 40,248,863 42,299,970 - --------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 615,048,463 $ 694,836,539 - --------------------------------------------------------------------------==============---============== 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, 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------- INTEREST AND DIVIDEND INCOME: Interest and Fees on Loans $ 46,067,109 $ 48,938,668 $ 47,268,729 Interest and Dividends on Investments: U.S. Treasury and Agency Obligations 4,525,095 3,508,523 3,655,198 Obligations of State and Political Subdivisions 0 0 12,839 Other 722,539 872,267 537,054 - ----------------------------------------------------------------------------------------------------------- Total Interest and Dividend Income 51,314,743 53,319,458 51,473,820 - ----------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Savings, NOW and Money Market Accounts 9,077,337 8,419,716 8,476,489 Time Deposits Over $100,000 1,432,520 1,335,775 1,394,307 Other Time 8,981,211 8,095,686 7,108,490 Other Borrowed Funds 256,439 495,997 733,817 Debt 3,254,128 4,029,479 4,242,423 - ----------------------------------------------------------------------------------------------------------- Total Interest Expense 23,001,635 22,376,653 21,955,526 - ----------------------------------------------------------------------------------------------------------- Net Interest Income 28,313,108 30,942,805 29,518,294 Provision for Possible Loan Losses (Note 4) 12,100,000 10,000,000 23,822,000 - ----------------------------------------------------------------------------------------------------------- Net Interest Income after Provision for Possible Loan Losses 16,213,108 20,942,805 5,696,294 - ----------------------------------------------------------------------------------------------------------- NON-INTEREST INCOME: Trust Department Income 1,796,138 1,729,376 1,686,561 Service Charges on Deposits 3,183,525 3,451,507 3,571,376 Merchant Discount Fees 1,861,313 2,123,526 1,741,209 Gains on Sale of Investment Securities, net (Note 3) 351,771 72,884 1,898,945 Gain on Curtailment of Pension Plan (Note 6) 1,562,670 0 0 FDIC Assistance Received-Loss Sharing (Note 10) 2,950,840 6,248,802 1,674,615 Other 1,059,660 1,411,587 1,555,721 - ----------------------------------------------------------------------------------------------------------- Total Non-Interest Income 12,765,917 15,037,682 12,128,427 - ----------------------------------------------------------------------------------------------------------- NON-INTEREST EXPENSES: Salaries and Wages 10,728,741 10,664,411 9,590,775 Employee Benefits (Note 6) 2,705,164 2,531,980 2,713,988 Occupancy Expense 2,177,612 2,324,171 1,949,256 Equipment Expense 2,068,991 2,004,352 1,879,764 Losses on and Writedowns of Other Real Estate Owned 2,986,555 3,791,819 1,970,428 Equity in Losses of Real Estate Limited Partnerships 645,600 1,588,914 967,138 Trust Customers' Reimbursement, Net (Note 13) 0 3,246,100 0 Losses and Write-downs of Segregated Assets (Note 10) 2,950,840 6,248,802 1,674,615 Reengineering Expenses and Related Consultants' Fees (Note 12 4,055,510 0 0 Other 8,286,836 9,312,413 7,270,812 - ----------------------------------------------------------------------------------------------------------- Total Non-Interest Expenses 36,605,849 41,712,962 28,016,776 - ----------------------------------------------------------------------------------------------------------- Loss Before Benefit for Income Taxes (7,626,824) (5,732,475) (10,192,055) Benefit for Income Taxes (Notes 2 and 7) (3,784,885) (2,842,451) (4,410,486) - ----------------------------------------------------------------------------------------------------------- NET LOSS (3,841,939) $ (2,890,024) $ (5,781,569) - --------------------------------------------------------------============----============-----============ LOSS PER SHARE, based upon weighted average common shares outstanding of 4,269,231 in 1995, 4,230,194 in 1994, and 4,216,355 in 1993 (Note 11): (0.90) $ (0.68) $ (1.37) - --------------------------------------------------------------============----============-----============ 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, 1995
Net Unrealized Appreciation (Depreciation) Common Capital in of Investment Stock Excess of Retained Securities Treasury (Note 11) Par Value Earnings (Note 2) Stock Total - --------------------------------------------------------------------------------------------------------------------- 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 Net Loss --- --- (3,841,939) --- --- (3,841,939) Sale of Treasury Stock --- --- --- --- 178,730 178,730 Purchase of Treasury Stock --- (44,598) --- --- (2,037,927) (2,082,525) Issuance of common stock 1,917 2,551,885 --- --- --- 2,553,802 Change in Net Unrealized Appreciation (Depreciation) of Investment Securities Available for Sale, Net of Taxes --- --- --- 1,140,825 --- 1,140,825 - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 $ 44,346 $ 33,154,407 $ 8,620,881 $ 467,156 $ (2,037,927)$ 40,248,863 - ----------------------------------------============================================================================= 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, 1995 1994 1993 CASH FLOWS FROM OPERATING ACTIVITIES: ----------- ----------- ----------- Net Loss $ (3,841,939) $ (2,890,024) $ (5,781,569) Adjustments to Reconcile Net Loss to Net Cash Provided by Operating Activities: Provision for Possible Loan Losses 12,100,000 10,000,000 23,822,000 Provision for Possible Losses on Other Real Estate Owned 1,365,011 2,388,469 658,123 Provision for Depreciation and Amortization 4,357,768 6,685,094 4,762,037 Prepaid Income Taxes (692,726) (1,890,304) (25,360) Net Gains on Sales of Investment Securities (351,771) (72,884) (1,898,945) Net Gains on Sales of Loans and Leases (463,919) (218,510) (818,376) Net (Gains) Losses on Sales of Premises and Equipment (222,895) 0 0 Equity in Losses of Real Estate Limited Partnerships 645,600 1,588,916 967,138 Changes in Assets and Liabilities net of Effects From Acquisition of NFNBV in 1993 (Note 10): (Increase) Decrease in Interest Receivable 1,099,212 40,651 (28,313) Increase in Interest Payable 170,331 347,000 587,598 (Increase) Decrease in Other Assets 8,810,236 (3,336,601) (5,032,001) Increase (Decrease) in Other Liabilities 1,567,069 (1,418,975) (272,603) ----------- ----------- ----------- Net Cash Provided by Operating Activities 24,541,977 11,222,832 16,939,729 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from Sales of Investment Securities 50,377,072 682,030 403,140,859 Proceeds from Maturities of Investment Securities 59,000,000 0 1,000,000 Proceeds from Sales of Loans and Leases 35,573,702 48,911,562 98,332,905 Proceeds from Sales of FHLB Stock 3,681,800 0 0 Proceeds from Sales of Premises and Equipment 327,500 39,631 0 Proceeds from Sales of Other Real Estate Owned 8,377,527 5,684,332 2,162,941 Purchases of FHLB Stock 0 (1,282,500) (2,652,400) Purchases of Available for Sale Investment Securities (102,822,744) (10,014,063) (385,195,506) Purchases of Held to Maturity Investment Securities 0 (10,098,437) 0 Cash and Cash Equivalents Received - Acquisition (Note 10) 0 0 17,102,000 Loans Originated, net of Principal Repayments 4,075,622 (2,272,774) (82,445,997) Investments in Real Estate Limited Partnerships 0 (273,742) 281,821 Purchases of Premises and Equipment (792,762) (2,258,284) (1,599,220) Decrease in Net Investment in Leveraged Leases 0 41,731 587,438 ----------- ----------- ----------- Net Cash Provided by Investing Activities 57,797,717 29,159,486 50,714,841 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase (Decrease) in Deposits (37,710,409) (37,085,500) (87,773,966) Net Increase (Decrease) in Other Borrowed Funds (12,959,312) 3,370,653 6,459,269 Proceeds from Debt 0 0 12,000,000 Principal Payments on Debt (28,804,609) (2,404,056) (14,403,713) Acquisition of Treasury Stock (2,082,525) 0 (132,058) Issuance of Common Stock 2,553,802 0 0 Cash Dividends Paid 0 0 (838,050) Sale of Treasury Stock 178,730 0 377,457 ----------- ----------- ----------- Net Cash Used in Financing Activities (78,824,323) (36,118,903) (84,311,061) ----------- ----------- ----------- Increase (Decrease) in Cash and Cash Equivalents 3,515,371 4,263,415 (16,656,491) Cash and Cash Equivalents at Beginning of Year 34,851,401 30,587,986 47,244,477 ----------- ----------- ----------- Cash and Cash Equivalents at End of Year $ 38,366,772 34,851,401 30,587,986 =========== =========== =========== Total Interest Payments $ 22,831,304 22,029,653 21,367,928 Total Income Tax Payments $ 0 50,000 1,190,000 Transfer of loans to Other Real Estate Owned $ 2,777,117 7,899,401 5,151,867 The accompanying notes are an integral part of these consolidated financial statements.
Merchants Bancshares, Inc. Notes to Consolidated Financial Statements December 31, 1995 (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 experienced increased levels of nonperforming assets and loan charge-offs, increased provisions for possible loan losses and 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, 1995 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 markets, 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. The Company and the Bank and its subsidiaries are subject to various regulatory requirements administered by the regulators. Failure to meet minimum requirements, including capital requirements, can initiate certain mandatory and possible additional discretionary actions by the regulators. The Bank and its subsidiary, Merchants Trust Company (the Trust Company), currently operate under separate Memoranda of Understanding (MOUs) with the Federal Deposit Insurance Corporation (FDIC). The Company currently operates under a Regulatory Agreement with the Federal Reserve Bank of Boston (the Federal Reserve). The specific terms of these agreements are described below. As of December 31, 1995, the most recent notification from the FDIC categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, the Bank must maintain minimum Tier 1 Risk-Based, Total Risk-Based and Tier 1 Leverage Capital ratios as set forth in the table below: Amount Percent Tier 1 Risk-Based Capital Actual $37,627 8.19% Minimum required $18,386 4.00% Total risk-based Capital Actual $43,420 9.45% Minimum required $36,772 8.00% Tier 1 Leverage Capital Actual $37,627 6.15% Minimum required $24,471 4.00% MOU Requirement $33,650 5.50% Failure to maintain the minimum leverage capital ratio of 5.5% (see Note 11) included in the MOU, or in compliance with other provisions of the the MOUs, or the agreement with the Federal Reserve, could subject the Bank, Trust Company or the Company to additional actions by the regulatory authorities. Discussion of Regulatory Actions In March, 1993, 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 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% and refrain from declaring dividends. The dividend limitation includes dividends paid by the Bank to the Company. In April, 1995, the FDIC and the Commissioner completed the field work related to their most recent examination of the Bank as of December 31, 1994. Based on this examination, the Bank is required to continue its efforts to correct certain administrative and legal violations and enhance certain operating policies before the MOU will be removed. 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, 1995. In February, 1994, the Company and the Federal Reserve entered into an agreement. Under this agreement, among other things, the Company may not declare or pay a dividend or incur any debt without the approval of the Federal Reserve. On December 29, 1995, the Federal Reserve completed the field work related to their most recent examination of the Company as of September 30, 1995. No substantive issues were brought up as a result of the examination. However, it appears that the Written Agreement will remain in place until at least the next examination. In December, 1994, the FDIC and the Commissioner completed 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 (MOU) with the FDIC and the Commissioner to affect corrective actions relating to certain operating, technical and regulatory issues. In December, 1995 the FDIC and the Commissioner completed the field work related to their examination of the Merchants Trust Company as of November 6, 1995. It appears that the MOU will remain in place until at least the next examination. (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, Queneska Capital Corp. and certain trusts) and Merchants Properties, Inc., after elimination of all material intercompany accounts and transactions. Use of Estimates in Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Operating results in the future could vary from the amounts derived from management's estimates and assumptions. Investment Securities In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 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. 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 other than temporary. If the impairment is determined to be other than temporary 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 $956,333 and $1,132,494 at December 31, 1995 and 1994, 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 $463,920, $218,510 and $818,376 in 1995, 1994, and 1993, respectively. Income Taxes The Company provides for income taxes in accordance with SFAS No. 109. 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, 1995. 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 recognized losses due to the impairment of an investment in a real estate limited partnership of $546,000 in 1994. 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, 1995 and 1994, cash and cash equivalents included $5,187,000 and $8,508,000, respectively, held to satisfy the requirements of the Federal Reserve Bank. Other Real Estate Owned Collateral acquired through foreclosure 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 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 $1,361,000, $2,392,000 and $599,000 during 1995, 1994 and 1993, respectively. Mortgage Servicing Rights In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage Servicing Rights." This statement requires a banking enterprise that sells or securitizes loans and retains the mortgage servicing rights, to allocate the total cost of the loans to the mortgage servicing rights and the loans based on their relative fair value if it is practicable to estimate those fair values. Mortgage servicing rights should be recognized as a separate asset and amortized in proportion to, and over the period of, estimated net servicing income. In addition, these servicing rights will be evaluated for impairment based on their fair value. The Bank is required to adopt the new standard prospectively on January 1, 1996. Management does not believe that the adoption of this standard will have a significant impact on the Bank's consolidated financial condition or future results of operations. 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 realized. Management reviews the value of the intangible asset by comparing purchased deposit levels to the current level of acquired deposits in the branches purchased. If any deposit runoff has occurred and is determined to be permanent in nature, the asset is written down accordingly. Accounting for Impairment of Long-Lived Assets In March 1995 the FASB issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of." This statement requires a review for impairment of long-lived assets and certain identifiable intangibles to be held and used by an entity when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. An impairment loss would be recognized if the sum of the future cash flows expected to result from the use and eventual disposition of the asset is less than the carrying amount of the asset. The amount by which the carrying amount of the asset exceeds the asset's fair value is the total impairment loss to be recognized. The statement also requires that for certain long-lived assets to be disposed of, the amount by which the carrying amount of the asset exceeds the fair value less costs to sell, is an impairment loss to be recognized. This statement does not apply to financial instruments, core deposit intangibles, mortgage and other servicing rights, or deferred tax assets. The Bank is required to adopt this new standard on January 1, 1996. Management does not believe that the adoption of this standard will have a siginficant impact on the Bank's consolidated financial condition or future results of operations. Reclassification Certain amounts in the prior year's consolidated financial statements have been reclassified to be consistent with the 1995 presentation. (3) INVESTMENT SECURITIES Investments in debt securities are classified as trading, available for sale or held to maturity as of December 31, 1995 and 1994. The amortized cost and fair values of the debt securities classified as available for sale as of December 31, 1995 and 1994 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value 1995 U.S. Treasury Obligations $ 49,644,093 $ 219,355 $ 11,835 $ 49,851,613 Mortgage-backed Securities 47,561,580 592,975 62,934 48,091,621 $ 97,205,673 $ 812,330 $ 74,769 $ 97,943,234 1994 U.S. Treasury 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 Marketable equity securities are classified as available for sale at December 31, 1995 and 1994 and are stated at their fair value of $309,508 and $1,195,897 respectively. Gross unrealized gains and losses related to marketable equity securities were $654,658 and $120,000, respectively, at December 31, 1994. Gross unrealized losses on equity securities were $20,000 at December 31, 1995. The fair value of securities held for trading was $500,000 at December 31, 1995. There were no unrealized gains or losses related to securities held for trading at December 31, 1995. In the fourth quarter of 1995, concurrent with the adoption of its implementation guide on SFAS No. 115, "Accounting for Certain Debt and Equity Securities," the FASB allowed a one-time reassessment of the SFAS No. 115 classifications of all securities currently held. Any reclassifications would be accounted for at fair value in accordance with SFAS No. 115 and any reclassifications from the held for investment portfolio that resulted from this one-time reassessment would not call into question the intent of the Bank to hold other debt securities to maturity in the future. The Bank used the opportunity under this one-time reassessment to reclassify a $10 million U.S. Treasury obligation from the held to maturity to the available-for-sale category. In connection with this reclassification an unrealized gain of $70,000 was recorded in available-for-sale securities and in stockholders' equity (on a net-of-tax basis). The security was subsequently sold and the Bank recognized a gain of a similar amount. This security was classified as held to maturity at December 31, 1994, having an amortized book value of $10,084,646 and a fair value of $9,971,975. The contractual maturities of all debt securities held at December 31, 1995 are as follows: Amortized Fair Cost Value ________________________________________________________________________ Due in one year or less $30,076,814 $30,178,505 Due after one year through five years 19,547,278 19,673,361 Mortgage-backed securities 47,581,581 48,091,368 __________________________________________________________________________ $97,205,673 $97,943,234 Proceeds from sales of available for sale debt securities were $49,383,072 and $682,030 during 1995 and 1994, respectively. Gross gains of $659,994, $91,780 and $2,120,838 and gross losses of $308,223, $18,896, and $221,893 were realized from sales of debt and equity securities in 1995, 1994 and 1993, respectively. At December 31, 1995, securities with a face value of $30,195,000 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, 1995 and 1994 is as follows (including Segregated Assets - Note 10): 1995 1994 - ----------------------------------------------------------------- Commercial, Financial and Agricultural $ 76,925,602 $ 92,611,512 Real Estate - Commercial 207,235,189 226,014,576 Real Estate - Residential 148,611,053 173,406,384 Installment Loans to Individuals 16,559,626 18,086,099 All Other Loans (including overdrafts) 392,547 436,481 _________________________________________________________________ $449,724,017 $510,555,052 ================================================================= As discussed in Note 10, Segregated Assets consist of loans subject to loss sharing. The composition of the Segregated Assets portfolio at December 31, 1995 and 1994 is as follows: 1995 1994 - ----------------------------------------------------------------- Commercial, Financial and Agricultural $ 11,793,297 $16,294,045 Real Estate - Commercial 28,625,693 41,909,959 Real Estate - Residential 29,352,150 37,534,294 Installment Loans to Individuals 22,464 64,005 _________________________________________________________________ $ 69,793,604 $ 95,802,303 ================================================================= There has been an insignificant effect on the Bank's noninterest expenses for 1995 and 1994 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 $3,688,550 and $7,811,002 for 1995 and 1994, respectively. The Bank recognized recoveries of $2,950,840, $6,248,802 and $1,674,615 from the FDIC for eligible charge-offs, net of recoveries and eligible expenses, related to 1995, 1994 and 1993, respectively, in accordance with the loss sharing arrangement. Amounts due from the FDIC totaling $663,106 and $2,883,372 as of December 31, 1995 and 1994 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. Loans held for sale at December 31, 1995 totaled $7,985,000. 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 on a non-recourse basis at December 31, 1995 and 1994 amounted to $322,292,294 and $391,517,792, respectively. 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 the two years ended December 31, 1995 and 1994 is as follows: 1995 1994 Balance, beginning of year $19,928,817 $20,060,059 Provision for possible loan losses 12,100,000 10,000,000 Reserve recorded in connection with acquisition of NFNBV --- ----- Loans charged off (18,360,790) (12,649,842) Recoveries 2,566,454 2,518,600 Balance, end of year $16,234,481 $19,928,817 Loans charged off include $749,103 and $1,314,632 and recoveries include $145,380 and $25,142 related to the Bank's portion of charge-offs and recoveries on Segregated Assets for 1995 and 1994, respectively. Effective January 1, 1995, the Company adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended. Under the standard, the allowance for possible loan losses related to loans that are identified as impaired in accordance with SFAS No. 114 is based on discounted cash flows using the loan's effective interest rate or the fair value of the collateral for certain collateral dependent loans. Prior to 1995, the allowance for possible loan losses related to these loans was based on undiscounted cash flows or the fair market value of the collateral for collateral dependent loans. A loan is considered to be impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company has determined that, after an analysis of the loan portfolio, and a review of its credit quality monitoring policies and procedures, loans recognized by the Company as nonaccrual and restructured troubled debt are generally equivalent to "impaired loans" as defined by SFAS No. 114. The Company has also determined that the allowance for possible loan losses did not require any additional provision as a result of the adoption of this Statement. Total impaired loans at December 31, 1995 with a related allowance were $29,629,572 and the specific allowance associated with such loans was $2,724,371. Interest payments on impaired loans are recorded as principal reductions if the remaining loan balance is not expected to be paid in full. If full collection of the remaining loan balance is expected, payments are recognized as interest income on a cash basis. During 1995 the Company recorded interest income on impaired loans of $949,002. Average impaired loans were $35,280,318 in 1995. SFAS No. 114 also requires that, upon adoption, in-substance foreclosures be reclassified as loans and the ISF valuation reserve be included in the reserve for possible loan losses. The effect at January 1, 1995 was an increase in loans and a decrease in Other Real Estate Owned (OREO) of $4.43 million. Nonperforming assets at December 31, 1995 and 1994 were as follows: 1995 ----------------------------------- Segregated Loans Assets Total ----------- ----------- ----------- Nonaccrual Loans $19,580,747 $ 6,035,520 $25,616,267 Restructured Loans 1,364,018 65,756 1,429,774 Loans Past Due 90 Days or More and Still Accruing 236,817 0 236,817 Other Real Estate Owned, Net 7,224,395 547,672 7,772,067 ----------- ----------- ----------- Total $28,405,977 $6,648,948 $35,054,925 =========== =========== =========== 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 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 =========== =========== =========== Included in nonaccrual loans are $8,362,454 and $3,526,402 of loans whose terms have been substantially modified in troubled restructurings at December 31, 1995 and 1994, respectively. Additionally, the Bank had $1,429,774 and $1,316,827 of restructured loans that were performing in accordance with the modified agreement at December 31, 1995 and 1994, respectively. Other Real Estate Owned is shown net of valuation reserves of $2,430,301 and $2,991,065 at December 31, 1995 and 1994. On June 25, 1995, an auction was held to sell properties held in the Other Real Estate Owned portfolio. Over forty properties were sold which reduced the carrying value of the portfolio by $1.3 million and resulted in a loss of approximately $300,000. Additionally, in 1995 the Bank entered into an agreement to sell $6.3 million in non-performing loans resulting in additional losses of $1.3 million. 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 judgment 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 $3,466,000, $1,859,000 and $2,688,000 in 1995, 1994 and 1993, respectively. An analysis of loans in excess of $60,000 to directors and executive officers for the year ended December 31, 1995 is as follows: Balance, December 31, 1994 $14,984,944 Additions 1,204,218 Repayments (3,614,503) Balance, December 31, 1995 $12,574,659 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. (5) PREMISES AND EQUIPMENT The components of premises and equipment included in the accompanying consolidated balance sheets are as follows: 1995 1994 - --------------------------------------------------- Land and Buildings $14,461,616 $18,020,230 Leasehold Improvements 867,775 869,444 Furniture and Equipment 11,373,256 11,292,724 - ---------------------------------------------------- 26,702,647 30,182,398 Less: Accumulated Depreciation and Amortization 14,247,939 13,562,225 - ---------------------------------------------------- $12,454,708 $16,620,173 ==================================================== Depreciation and amortization expense amounted to $1,932,074, $1,786,213 and $1,595,914 in 1995, 1994 and 1993, respectively. The Bank leases certain properties for branch purposes. Rent expense on these properties totaled $213,096, $214,891 and $163,807 for the years ended December 31, 1995, 1994 and 1993, respectively. Minimum lease payments for these properties subsequent to December 31, 1995 are: 1996 - $195,061; 1997 - $172,680; 1998 - $142,717; 1999 - $100,876 and $300,623 thereafter. (6) EMPLOYEE BENEFIT PLANS Pension Plan The Company maintained a noncontributory defined benefit plan covering all eligible employees. The plan was 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 was the Company's policy to fund the cost of benefits expected to accrue during the year plus amortization of any unfunded accrued liability that had accumulated prior to the valuation date based on IRS regulations for funding. During 1994, the Company made the decision to freeze the plan beginning on January 1, 1995. During 1995 the plan was curtailed. Accordingly, all accrued benefits were fully vested and no additional years of service or age will be accrued. As a result of the curtailment, the Bank recognized a gain in the amount of $1.56 million in 1995. The plan's funded status and amounts recognized in the accompanying consolidated balance sheets and statements of operations as of December 31, 1995 and 1994 are as follows: 1995 1994 - ----------------------------------------------------------------- Actuarial Present Value of Benefit Obligation: Vested Benefit Obligation $5,771,869 $4,797,489 Nonvested Benefits 0 0 - ----------------------------------------------------------------- Accumulated Benefit Obligation $5,771,869 $4,797,489 Effects of Projected Future Compensation Levels 0 0 - ----------------------------------------------------------------- Projected Benefit Obligation for Service Rendered to Date $5,771,869 $4,797,489 Plan Assets 6,835,057 6,332,824 - ----------------------------------------------------------------- Excess of Plan Assets Over Projected Benefit Obligation $1,063,188 $1,535,335 Unrecognized Net Asset at January 1, 1987 Being Amortized over 13.4 Years (132,513) (171,602) Unrecognized Net Loss 34,114 190,446 Unrecognized Prior Service Cost 0 (1,673,616) - ------------------------------------------------------------------- Accrued Pension Costs Included in Other Liabilities $ 964,789 $ (119,437) =================================================================== 1995 1994 1993 - ----------------------------------------------------------------- Net Pension Expense (Income) Included the Following Components: Service Cost - Benefits Earned During the Year $ 0 $316,681 $257,232 Interest Cost on Projected Benefit Obligation 393,901 486,993 432,963 Actual Return on Plan Assets (815,566) 100,004 (488,860) Net Amortization and Deferral 172,099 (660,098) (24,194) - ----------------------------------------------------------------- Total $(249,566) $243,580 $177,141 ================================================================= The actuarial present value of the projected benefit obligation was determined using a weighted average discount rate of 7.5%, 8.5% and 7.5% as of December 31, 1995, 1994, and 1993, respectively. For 1995 there was no assumed rate of increase in future compensation due to the freeze on plan benefits. The rate of increase of future compensation levels 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%. The expected long-term rate of return on assets used was 8% in 1995, 8% in 1994 and 1993. 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 127% of the amounts contributed by the employees (200% of up to 4.5% of individual employee compensation in 1995) and approximately 75% of the amounts contributed by employees (82% of up to 4.5% of individual employee compensation) in 1994 and 1993. Substantially all contributions to the ESOP are funded with cash and are used to purchase the Company's common stock. (6) EMPLOYEE BENEFIT PLANS (Continued) 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 Through December 1995, the Bank maintained an Executive Salary Continuation Plan and a Deferred Compensation Plan for Directors. In December 1995 the Bank and participants in its Executive Salary Continuation Plan and in the Fixed Growth Program of its Deferred Compensation Plan for Directors agreed to amend or terminate the existing plans. In satisfaction of all liabilities under those plans, the Bank agreed to make payments to, or credits for, the participants. Pursuant to these agreements, the Bank established several new plans (the New Plans), to which it made lump sum payments. The New Plans used those payments, in part, to purchase newly-issued common stock of the Company at its market price. The purchases have been accounted for as treasury stock transactions in the Company's consolidated financial statements. The portions of the payments made to the New Plans that were not invested in the common stock of the Company are included as investments in the consolidated financial statements, and are classified as trading. In conjunction with the amendment and termination of the existing plans, the Bank either sold or surrendered certain life insurance policies and used the proceeds as a partial source to fund the lump sum payments made to the New Plans. As a result of these transactions, the Bank recognized increased earnings of $673,000. To the extent the obligations of the Company under the New Plans are based on investments by the New Plans in other than shares of the Company the investments will be revalued at each reporting date with a corresponding adjustment to compensation expense. In addition, the obligation related to certain treasury shares, originally purchased for $200,000, will be revalued at each reporting date, with a corresponding adjustment to compensation expense. In addition, the Company continues to maintatin the floating growth (savings) program of the deferred compensation plan for Directors. Benefits accrue based on the Directors' fees deferred and a monthly allowance for interest at a rate that is fixed from time to time at the discretion of the Board of Directors. The benefits under the Savings Program of the Deferred Compensation Plan for Directors and the New Plans are generally payable starting on the January 2 following a participant's 65th birthday or earlier death, and will be distributed to the participant (or upon the participant's death, to the participant's designated beneficiary) in accordance with the Plan. Phantom Stock Plan The Company maintains a Phamtom 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. In December of 1995 the Bank entered into agreements with certain participants in the Bank's Phantom Stock Plan (the Plan). The Bank agreed to pay, and those participants agreed to accept, lump sum amounts in full satisfaction of the Bank's obligations under the Plan. The Bank made the agreed- upon payments in January, 1996. 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, 1995 is as follows: 1995 1994 1993 - ----------------------------------------------------------------- Pension Plan $(249,566) $ 243,580 $ 177,141 Employee Stock Ownership Plan/ 401(k) Plan 807,605 348,468 285,199 Performance Progress Sharing Plan 0 0 264,000 Deferred Compensation Plans 25,185 303,939 272,946 Phantom Stock Plan 67,677 (179,227) 249,600 - ----------------------------------------------------------------- $650,901 $ 716,760 1,248,886 ================================================================= (7) INCOME TAXES The benefit for income taxes for each of the three years in the period ended December 31, 1995 consists of the following: 1995 1994 1993 - ------------------------------------------------------------- Current $(3,092,159) $( 952,147) $(4,385,126) Prepaid ( 692,726) (1,890,304) ( 25,360) - -------------------------------------------------------------- $(3,784,885) $(2,842,451) $(4,410,486) ============================================================== Prepaid and deferred income taxes result from differences between the loss for financial reporting and tax reporting relating primarily to the provision for possible loan losses. The net deferred tax asset amounted to approximately $3,793,000 and $5,084,000 at December 31, 1995 and 1994, respectively. As of December 31, 1995 and 1994, the Company had tax refunds receivable of $682,000 and $6,211,214, respectively. These tax assets are included in other assets in the accompanying consolidated balance sheets. The components of the net deferred tax asset as of December 31, 1995 and 1994 are as follows: 1995 1994 - --------------------------------------------------------------------- Reserve for Possible Loan Losses $6,780,000 $7,700,000 Deferred Compensation 1,428,000 1,543,000 Unrealized Securities Losses (251,000) 347,000 Loan Fees 193,000 253,000 Depreciation (393,000) (428,000) Accrued Liabilities 524,000 287,000 Capital Loss Carryforwards 431,000 545,000 Investments in Limited Partnerships (542,000) (296,000) Excess Servicing on Sold Mortgages ( 8,000) (19,000) Loan Market Adjustment (8,630,000) (4,640,000) Other (706,000) (623,000) Tax Credit Carryforward 3,276,000 960,000 NOL Carryforward 1,752,000 0 Core Deposit 370,000 0 - ---------------------------------------------------------------------- $4,224,000 $5,629,000 Valuation Allowance (431,000) (545,000) - ---------------------------------------------------------------------- $3,793,000 $5,084,000 ====================================================================== 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 following is a reconciliation of the federal income tax provision (benefit), calculated at the statutory rate, to the recorded provision (benefit) for income taxes: 1995 1994 1993 - --------------------------------------------------------------------- Applicable Statutory Federal Income Tax (benefit) $(2,593,120) $(1,949,042) $(3,465,299) (Reduction) Increase in Taxes Resulting From: Loss on Investment Securities (114,226) (24,780) 40,018 Tax-exempt Income ( 86,879) (187,301) (213,631) Tax Credits (851,250) (707,750) (960,750) Other, Net (139,410) 26,422 189,176 - --------------------------------------------------------------------- $(3,784,885) $(2,842,451) $(4,410,486) ====================================================================== 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 $277,000, $290,000 and $247,000 in 1995, 1994 and 1993, 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, 1995 and 1994: 1995 1994 - -------------------------------------------------------- Treasury Tax and Loan Notes $2,085,422 $3,294,734 Federal Funds Purchased 3,250,000 15,000,000 - --------------------------------------------------------- $5,335,422 $18,294,734 ========================================================= The Bank may borrow up to $24,000,000 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, 1995: Weighted Weighted Maximum Average Average Month-end Average Annual Rate Amount Amount Interest on Amounts 1995 Outstanding Outstanding Rate Outstanding - ------------------------------------------------------------------------------ Treasury Tax and Loan Notes $4,957,123 $3,083,449 5.61% 5.16% Federal Funds Purchased $9,500,000 $975,555 5.96% 5.38% 1994 - ------------------------------------------------------------------------------ Treasury Tax and Loan Notes $4,723,829 $3,136,365 3.83% 5.10% Federal Funds Purchased $16,900,000 $1,388,438 4.09% 6.18% (9) DEBT Debt outstanding consists of the following at December 31, 1995 and 1994: 1995 1994 - --------------------------------------------------------------- 10% Senior Subordinated Debt 0 $ 4,800,000 9% Mortgage Note, payable in monthly installments of $1,736 (principal and interest) through 2020 $205,441 207,860 1% Mortgage Note, payable in monthly installments of $2,542 (principal and interest) through 2039 1,189,316 1,191,506 9.81% Capital Notes 0 10,000,000 9.81% Capital Notes 0 10,000,000 Federal Home Loan Bank Notes Payable, interest rates from 4.83% to 8.66% due 1996 through 2001 14,030,000 18,030,000 - --------------------------------------------------------------- $15,424,757 $44,229,366 =============================================================== Maturities of debt subsequent to December 31, 1995 are: 1996 - $4,841; 1997 - $9,005,288; 1998 - $5,771; 1999 - $6,293 and $6,402,564 thereafter. 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, 1995, the Company is in compliance with all of the covenants of the Federal Home Loan Bank agreements. On June 30, 1995, in accordance with a specific plan authorized by the Federal Reserve, the Bank prepaid the outstanding $18 million of Capital Notes, which carried an interest rate of 9.81%, using funds from operations. The Bank was released from any further obligations under the Capital Notes Agreement. A prepayment premium of $701,400 was paid to the noteholders. the prepayment premium is reflected in interest expense in the accompanying consolidated statement of operations. On December 20, 1995, in accordance with a specific plan authorized by the Federal Reserve, the Company prepaid $2,400,000 in obligations under the Senior Subordinated Debt Agreement which carried an interest rate of 10%, using funds provided by the issuance of common stock of the Company in conjunction with the settlement of the deferred compensation plans (see Note 6). The Company was released from any further obligations under the Senior Debt Agreement. No prepayment premium was required. The debt was contractually scheduled to be repaid on June 1, 1996. (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 eastern 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) ========= 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 $2,950,840, $6,248,802 and $1,674,615 in reimbursements from the FDIC for the years ended December 31, 1995, 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 1995. During 1995 and 1994, the Company reviewed the status of the core deposits related to the acquisition and determined that the attrition of certain deposits within the purchased branches of NFNBV resulted 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 $458,300 and $686,296 in 1995 and 1994, respectively. These charges against current earnings are included in other expenses. (11) STOCKHOLDERS' EQUITY 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 Company's stockholders' equity includes $6,561,600 as of December 31, 1995 and 1994 of such appropriations. Vermont state law also restricts the payment of dividends under certain circumstances. In addition, as discussed in Note 1, the Company may not declare or pay a dividend without the approval of the Federal Reserve. (12) RESTRUCTURING The Company began a restructuring project during 1995 to reduce ongoing operating costs and increase noninterest income. As a result, the Bank has implemented a plan to reduce its workforce by approximately 250 employees. All employees were offered the opportunity to voluntarily terminate their employment which would entitle them to a severance package equal to one week's pay for each year of service plus four additional weeks. Employees whose age plus years of service with the Company equalled at least 60 were offered an early retirement option whereby, in lieu of the plan described above, five years would be added to both their years of service and their age for purposes of determining vested benefits through the pension plan. The total severance charges realized by the Company as a result of the restructuring project were approximately $1.3 million. The incremental cost of the enhanced early retirement benefit realized during 1995 was approximately $728,000. In conjunction with the restructuring project the Company engaged a consulting firm to assist in the identification of possible workforce reductions and the implementation of the restructure plan. The fee earned by these consultants is, in part, contingent upon actual future operating cost reductions and the increase in noninterest income, and the Company has recognized expenses associated with fees to these consultants of approximately $2 million in 1995. The Company remains subject to an agreement with these consultants whereby the Company is required to remit additional funds to the consultants in the event actual cost reductions and increases in noninterest income in 1996 exceed the amounts anticipated. (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 related 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. 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 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, which was treated as a reduction in amounts reimbursed to Trust customers in the accompanying consolidated statement of operations. The Companies are separately pursuing 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 their insurance carriers. The attorneys representing the plaintiffs in one of the lawsuits discussed above have taken the position that amounts recovered by the Companies on these claims should be paid to the affected Trust Company clients (net of legal fees to those attorneys), in addition to the $9.2 million already paid. The matter is presently before the United States District Court for the District of Minnesota. The attorneys representing the plaintiffs in one of the lawsuits discussed above requested an award of attorneys' fees for allegedly causing the Companies to make the $9.2 million payment, and asked the court to order the Trust Company to withhold payment of $500,000. The Trust Company has resisted the claims for payment of such fees from its clients' funds, and, as a result, the Trust Company was directed to place the sum of $500,000 into escrow pending a ruling by the Court. There is the possibility that the Companies may be required to remit all or part of these funds to those attorneys, but based upon consultation with legal counsel, management believes there is no substantial basis for any liability on the part of the Companies for the payment of such fees. 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, 1995 and 1994 and statements of operations and cash flows for each of the three years in the period ended December 31, 1995 is as follows:
Balance Sheets - December 31, 1995 1994 Assets: -------------------------- Investment in and Advances to Subsidiaries * $41,843,980 $45,509,683 Other Investments 0 585,140 Other Assets 972,452 1,045,147 -------------------------- Total Assets $42,816,432 $47,139,970 ========================== Liabilities and Equity Capital: Notes Payable $0 $4,800,000 Other Liabilities 2,567,569 40,000 Equity Capital 40,248,863 42,299,970 -------------------------- Total Liabilities and Equity Capital $42,816,432 $47,139,970 ========================== Statements of Operations for the Year Ended December 31, 1995 1994 1993 ------------------------------------ Dividends from the Merchants Bank* $0 $0 $848,585 Equity in Undistributed Earnings (Loss) of Subsidiaries* (4,021,297) (2,679,429) (6,365,554) Other Expense, Net 72,360 (374,142) (450,636) Benefit from Income Taxes 106,998 163,547 186,036 ------------------------------------ Net Loss ($3,841,939)($2,890,024)($5,781,569) ==================================== Statements of Cash Flows for the Year Ended December 31, 1995 1994 1993 ------------------------------------ Cash Flows from Operating Activities: Net Loss ($3,841,939)($2,890,024)($5,781,569) Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by (Used in) Operating Activities: Amortization 0 6,360 15,265 Gains on Investment Securities (309,020) (91,780) (76,316) (Increase) Decrease in Miscellaneous Receivables (612,543) (11,425) 998,729 Increase (Decrease) in Miscellaneous Payables 2,527,569 (20,000) (868,585) Equity in Undistributed Losses of Subsidiaries 4,021,297 2,679,429 6,365,554 ------------------------------------ Net Cash Provided by (Used in) Operating Activities $1,785,364 ($327,440) $653,078 ------------------------------------ Cash Flows from Investing Activities: Repayment of Advances from Subsidiaries 1,035,460 2,263,399 2,379,917 Proceeds from Sales of Investment Securities 643,931 682,030 271,316 ------------------------------------ Net Cash Provided by Investing Activities $1,679,391 $2,945,429 $2,651,233 ------------------------------------ Cash Flows From Financing Activities: Sale of Treasury Stock 178,730 0 388,998 Acquisition of Treasury Stock (2,082,525) 0 (132,058) Issuance of Common Stock 2,553,802 0 0 Cash Dividends Paid 0 0 (838,050) Principal Payments on Debt (4,800,000) (2,400,000) (2,400,000) ------------------------------------ Net Cash Used in Financing Activities ($4,149,993)($2,400,000)($2,981,110) ------------------------------------ Increase (decrease) in Cash and Cash Equivalents (685,238) 217,989 323,201 Cash and Cash Equivalents at Beginning of Year 986,733 768,744 445,543 ------------------------------------ Cash and Cash Equivalents at End of Year $301,495 $986,733 $768,744 ==================================== Total Interest Paid $333,333 $580,000 $820,000 Taxes Paid 0 50,000 1,190,000 *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, 1995 and 1994 were as follows: Contractual Amount - ----------------------------------------------------------------- 1995 Financial Instruments Whose Contract Amounts Represent Credit Risk: Commitments to Extend Credit $92,596,000 Standby Letters of Credit 6,550,000 Loans Sold with Recourse 1,832,000 - --------------------------------------------------------------- 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 - ----------------------------------------------------------------- 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, 1995 and 1994, the remaining commitments to deliver loans pursuant to master commitments with secondary market investors amounted to approximately $8,947,000 and $30,081,000, 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, 1995 and 1994 is as follows: 1995 1994 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value - ----------------------------------------------------------------- (In Thousands) Debt $97,206 $97,943 $102,111 $100,343 Marketable Equity Securities 310 310 661 1,196 - ----------------------------------------------------------------- $97,516 $98,253 $102,772 $101,539 ================================================================= 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, 1995 and 1994 is as follows: 1995 1994 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value - ----------------------------------------------------------------- (In Thousands) Net Loans $433,490 $418,743 $490,626 $482,619 ================================================================= 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, 1995 and 1994 is as follows: 1995 1994 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value - ----------------------------------------------------------------- (In Thousands) Demand Deposits $85,417 $85,804 $94,467 $94,493 Savings, NOW and Money Markets 278,242 278,242 293,656 293,364 Time Deposits Over $100,000 20,473 20,792 23,281 23,127 Other Time 160,382 162,881 170,821 171,195 - ----------------------------------------------------------------- $544,514 $547,719 $582,225 $582,179 ================================================================= 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, 1995 and 1994 is as follows: 1995 1994 -------------------------------------------------- Carrying Calculated Carrying Calculated Amount Fair Value Amount Fair Value - ----------------------------------------------------------------- (In Thousands) Debt $15,425 $15,990 $44,229 $44,022 ================================================================= 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 $101,000 and $117,000 as of December 31, 1995 and 1994, respectively. (17) SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION (in thousands):
1995 1994 ---------------------------------------------- --------------------------------------------- Q1 Q2 Q3 Q4 YEAR Q1 Q2 Q3 Q4 YEAR - ----------------------------------------------------------------------- --------------------------------------------- Interest and Fee Income $13,053 $13,362 $12,460 $12,440 $51,315 $13,348 $13,019 $13,304 $13,648 $53,319 Interest Expense 5,872 6,647 5,407 5,076 23,002 5,414 5,614 5,585 5,764 22,377 - ----------------------------------------------------------------------- --------------------------------------------- Net Interest Income $7,181 $6,715 $7,053 $7,364 $28,313 $7,934 $7,405 $7,719 $7,884 $30,942 Provision for Possible Loan Losses (A) 2,700 7,600 900 900 12,100 1,250 1,250 1,750 5,750 10,000 Non-Interest Income (B) 2,210 2,094 3,524 1,987 9,815 2,104 2,235 2,219 2,231 8,789 Non-Interest Expense (C) 7,180 7,992 11,116 7,367 33,655 7,105 7,294 7,422 13,643 35,464 - ----------------------------------------------------------------------- --------------------------------------------- Income (Loss) Before Provision (Benefit) for Inc. Taxes ($489) ($6,783) ($1,439) $1,084 ($7,627) $1,683 $1,096 $766 ($9,278) ($5,733) Provision (Benefit) For Income Taxes (528) (2,732) (717) 192 (3,785) 245 91 (13) (3,166) (2,843) - ----------------------------------------------------------------------- --------------------------------------------- Net Income (Loss) $39 ($4,051) ($722) $892 ($3,842) $1,438 $1,005 $779 ($6,112) ($2,890) - -------------------------============================================== ============================================= Earnings (Loss) Per Share $0.01 ($0.95) ($0.17) $0.21 ($0.90) $0.34 $0.24 $0.18 ($1.44) ($0.68) - -------------------------============================================== ============================================= Dividends Per Share $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 ============================================== ============================================= (A) During the fourth quarter of 1994, 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. During the second quarter of 1995, the Bank provided an additional $5 million for the reserve for possible loan losses to cover further exposure identified during loan renewals and restructures. (B) The Bank recognized a gain of $1.6 million in conjunction with the curtailment of its pension plan during the third quarter of 1995. (C) During the third quarter of 1995 the Bank began a restructuring project. The Bank recognized total severance charges of $1.5 million and total fees to consultants of $2.2 million in conjunction with the restructuring.
Merchants Bancshares, Inc. Five Year Summary of Operations (Not Covered by Report of Independent Public Accountants)
For the years ended 1995 1994 1993 1992 1991 ------------------------------------------------------------------------------------------------- Interest and Investment Income $ 51,315 $ 53,319 $ 51,474 $ 49,239 $ 57,249 Interest Expense 23,002 22,377 21,956 24,051 32,104 ------------------------------------------------------------------------------------------------- Net Interest Income $ 28,313 $ 30,942 $ 29,518 $ 25,188 $ 25,145 Provision for Possible Loan Losses 12,100 10,000 23,822 8,050 7,243 ------------------------------------------------------------------------------------------------- Net Interest Inc. after Prov. for Loan Losses $ 16,213 $ 20,942 $ 5,696 $ 17,138 $ 17,902 ------------------------------------------------------------------------------------------------- Non-interest Income $ 9,815 $ 15,038 $ 12,128 $ 10,195 $ 9,376 Non-interest Expense 33,655 41,712 28,016 21,081 21,238 ------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES $ (7,627)$ (5,732)$ (10,192)$ 6,252 $ 6,040 Prov. (benefit) for Income Taxes (Nts 3 and 8) (3,785) (2,842) (4,410) 575 909 ------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ (3,842)$ (2,890)$ (5,782)$ 5,677 $ 5,131 ------------------------------------------------------------------------------------------------- SELECTED AVERAGE BALANCES (IN THOUSANDS) Total Assets $ 642,487 $ 709,077 $ 705,516 $ 602,317 $ 592,343 Average Earning Assets 575,551 620,070 627,049 542,157 537,806 Loans 481,047 514,843 515,805 441,291 471,141 Total Deposits 556,242 598,305 570,957 490,908 488,831 Debt 28,707 45,433 47,835 42,171 35,007 Stockholders' Equity 40,848 46,331 48,511 51,548 48,668 Stockholders' Equity plus Loan Loss Reserve 58,794 65,322 59,999 59,028 54,707 SELECTED RATIOS Net Income (Loss) to: Average Stockholders' Equity -9.41% -6.24% -11.92% 11.01% 10.53% Average Assets -0.60% -0.41% -0.82% 0.94% 0.86% Avg Stockholders' Equity to Avg Total Assets 6.36% 6.53% 6.88% 8.56% 8.22% Avg Primary Capital to Avg Total Assets 9.15% 9.21% 8.50% 9.80% 9.24% Common Dividend Payout Ratio 0.00% 0.00% 1.00% 58.48% 62.69% Loan Loss Reserve to Total Loans at Year End 3.61% 3.90% 3.50% 1.73% 1.41% Net Charge-Offs to Average Loans 3.28% 1.97% 1.95% 1.65% 1.20% PER SHARE (Note 1) Net Income (Loss) $ (0.90)$ (0.68)$ (1.37)$ 1.39 $ 1.21 Cash Dividends 0.00 0.00 0.20 0.80 0.78 Year End Book Value 9.38 10.00 10.74 12.39 11.82 Other Cash Dividends Paid (In Thousands) $ 0 $ 0 $ 848 $ 3,320 $ 3,231 Stock Dividends Issued 0.0% 0.0% 0.0% 3.0% 2.0% (Note 1): All stock dividends and splits are reflected retroactively. See Note 11 of Notes to Consolidated Financial Statements.
Merchants Bancshares, Inc. and Subsidiaries Interest Management Analysis
(Taxable Equivalent, in thousands) 1995 1994 1993 - ---------------------------------------------------------------------------------------------------------- Total Average Assets $642,487 $709,077 $705,516 - ---------------------------------------------------------------------------------------------------------- 1995 % of 1994 % of 1993 % of NET INTEREST INCOME: Assets Assets Assets Interest and Dividend Income $ 48,822 7.60% 50,041 7.06% 47,194 6.69% Fees on Loans 2,492 0.39% 3,571 0.50% 4,598 0.65% - ---------------------------------------------------------------------------------------------------------- Total $ 51,314 7.99% 53,612 7.56% 51,792 7.34% Interest Expense 23,002 3.58% 22,377 3.16% 21,956 3.11% - ---------------------------------------------------------------------------------------------------------- Net Interest Income Before Provision for Possible Loan Losses $ 28,312 4.40% 31,235 4.40% 29,836 4.23% Provision for Possible Loan Losses 12,100 1.88% 10,000 1.41% 23,822 3.38% - ---------------------------------------------------------------------------------------------------------- Net Interest Income $ 16,212 2.52% 21,235 2.99% 6,014 0.85% - ----------------------------------------------==================== ===================================== OPERATING EXPENSE ANALYSIS: Non-Interest Expense Personnel $ 13,434 2.09% 13,196 1.86% 12,305 1.74% Occupancy Expense 2,178 0.34% 2,324 0.33% 1,949 0.28% Equipment Expense 2,069 0.32% 2,004 0.28% 1,880 0.27% Other 15,974 2.49% 17,939 2.53% 10,208 1.45% - ---------------------------------------------------------------------------------------------------------- Total Non-Interest Expense $ 33,655 5.24% 35,463 5.00% 26,342 3.74% - ---------------------------------------------------------------------------------------------------------- Less Non-Interest Income Service Charges on Deposits $ 3,184 0.50% 3,452 0.49% 3,571 0.51% Other, Including Securities Gains (Losses) 6,632 1.03% 5,337 0.75% 6,883 0.98% - ---------------------------------------------------------------------------------------------------------- Total Non-Interest Income $ 9,816 1.53% 8,789 1.24% 10,454 1.49% - ---------------------------------------------------------------------------------------------------------- Net Operating Expense $ 23,839 3.71% 26,674 3.76% 15,888 2.25% - ----------------------------------------------==================== ===================================== SUMMARY: Net Interest Income $ 16,212 2.52% 21,235 2.99% 6,014 0.85% Less: Net Overhead 23,839 3.71% 26,674 3.76% 15,888 2.25% - ---------------------------------------------------------------------------------------------------------- Profit Before Taxes - Taxable Equivalent Basis $ (7,627) -1.19% (5,439) -0.77% (9,874) -1.40% Net Profit (Loss) After Taxes $ (3,842) -0.60% (2,890) -0.41% (5,781) -0.82% - ----------------------------------------------==================== =======================================
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, 1995 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 State of Vermont Department of Banking, Insurance and Securities (the Commissioner) performed a joint field examination of the Bank as of March 31, 1993. Additionally 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 and a Written Agreement with the Federal Reserve. Under the terms of the MOU, the Bank is required to, among other things, maintain a leverage capital ratio of at least 5.5% and refrain from declaring dividends. In April, 1995, the FDIC and the Commissioner completed the field work related to their most recent examination of the Bank as of December 31, 1994. Based on their examination the Bank is required to continue its efforts to correct certain administrative and legal violations and enhance certain operating policies before the MOU will be lifted. Management believes the Bank is in substantial compliance with all of the provisions of the MOU as of December 31, 1995. In February 1994, the Company and the Federal Reserve entered into an agreement. Under this agreement, among other things, the Company may not declare or pay a dividend or incur any debt without the approval of the Federal Reserve. On December 29, 1995, the Federal Reserve completed the field work related to their most recent examination of the Company as of September 30, 1995. No substantive issues were brought up as a result of the examination. However, it appears that the Written Agreement will remain in place until at least the next examination. 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 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. In December, 1995 the FDIC and the Commissioner completed the field work related to their examination of the Merchants Trust Company as of November 6, 1995. Management continues to work to address the issues raised in the MOU. Additionally, it appears that the MOU will remain in place until at least the next examination. Management has actively responded to the above agreements, and has continued to comply with the requirements of both the MOU and the Written Agreement. 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 in eastern Vermont. 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. Under the terms of the Purchase and Assumption Agreement between the Company and the FDIC, the Company purchased $178.4 million in 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 were $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 represented 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. As a result, 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 1995 and 1994, the Company reviewed the value of the core deposit intangible by comparing purchased deposit levels to current deposit levels in the branches purchased. These reviews indicated that significant deposit runoff had been experienced and deemed permanent in nature. Accordingly, the carrying value of the core deposit intangible was written down by $458,300 during 1995 and $686,000 during 1994. The charges against earnings are reflected in Other Expenses in the Consolidated Statements of Operations. Under the terms of the Loss Sharing Agreement, the FDIC reimbursed the Bank, 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 through June, 1996, after which time the Bank will reimburse the FDIC 80% of all recoveries on the charged-off loans for three years. Subsequent to June, 1996, the FDIC is no longer required to reimburse the Bank for additional charge-offs or expenses related to Segregated Assets. RESULTS OF OPERATIONS The Company recognized a net loss of $3,841,939 for the year ended December 31, 1995, due primarily to the provision for possible loan losses of $12.1 million (refer to the discussion under "Provision for Possible Loan Losses" which follows), and the recognition of $4 million in restructuring charges and related consultant fees. Core earnings, excluding the provision for possible loan losses, showed slight improvement from 1994 to 1995 due to substantial reductions in non-performing assets. The Company realized $351,771 in net gains on investment securities as compared to $72,884 in 1994. The Company recognized a net loss of $2,890,024 for the year ended December 31, 1994, due primarily to the following 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. The net Trust Company expenses totaled approximately $3,200,000 after an insurance reimbursement of $6,000,000. The Company continues to pursue all available claims against Piper Jaffray Companies, Inc. because of the losses. The net loss on a per share basis was $.90, $.68 and $1.37 for the years ended December 31, 1995, 1994 and 1993, respectively. The cash dividends paid per share were $0.20 in 1993. No dividends were paid in 1995 or 1994. The net loss as a percentage of average equity capital was 9.41%, 6.24% and 11.92% for 1995, 1994 and 1993, respectively. The ten-year average return on equity is 8.11%. The net loss as a percentage of average assets was .60%, .41% and .82% in 1995, 1994 and 1993, respectively. The ten-year average return on assets is .57%. 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 a 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 decreased 8.5% from $31.2 million in 1994 to $28.5 million in 1995. The primary cause for this net decline was a decrease in average assets of $66.6 million (9.39%) from 1994 to 1995. Continued decreases in the level of nonperforming assets increased net interest income before the provision for possible loan losses as a percentage of total average assets to 4.44% in 1995 from 4.40% in 1994 and the average yield on earning assets to 8.91% in 1995 from 8.60% in 1994. Net interest income before the provision for possible loan losses was $31.2 million in 1994, up 4.7% from $29.8 million the previous year. This increase was 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 7 months for 1993. Decreased levels of nonperforming assets in 1994 helped to increase net interest income before the provision for possible loan losses as a percentage of total average assets to 4.40% in 1994 from 4.23% in 1993. Total interest income decreased 8.4% in 1995 from 1994. The decrease is due primarily to a $1.1 million (30.2%) decrease in fees on loans as a result of a less favorable interest rate environment during 1995 for refinancing of home mortgages. Total interest expense increased 2.79% from 1994 to 1995 due to a higher overall interest rate environment which created a higher cost of funds in 1995 as compared to 1994. 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. Included in fees on loans and interest income are net gains on sales of loans of $ 464,000 and $219,000 in 1995 and 1994, respectively. These net gains include 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 $4.7 million lower in 1995 than 1994, due, in part, to a $2.1 million increase in the provision for loans losses from 1994 to 1995. Net interest income after the provision was $15.2 million higher in 1994 than 1993. Net interest income after the provision in 1995 was 2.52% of average assets compared to 2.99% in 1994 and .85% in 1993. NET OPERATING EXPENSE Net operating expense (net overhead) is total noninterest expense reduced by noninterest income. Operating expense includes all costs associated with staff, occupancy, equipment, supplies, and all other noninterest expenses. Noninterest 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, the gain on the curtailment of the pension plan, and net gains on investment securities, noninterest income earned in 1995 decreased $815,000 (9.35%) from 1994. The Trust Company fees and other items included in noninterest income (excluding non-recurring items) make up $547,000 of this decrease, the balance is due to a $268,000 decrease in service charge revenue. The Bank's deposit base decreased by $37 million (6.3%) during 1995 which resulted in the decreased service charge revenue. This decrease was more than offset by the $1.56 million gain recognized as a result of the Bank s curtailment of the pension plan. Excluding the FDIC assistance received from loss-sharing and net gains on investment securities, noninterest income earned in 1994 increased $161,000 (1.9%) over the previous year. The Trust Company fees and all other items included under noninterest 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. Noninterest expenses decreased $1.8 million (5.1%), not including the amount of losses and write-downs on Segregated Assets, which were reimbursed by the FDIC, in 1995 as compared to 1994. There are several large transactions which contributed to this decrease. During 1995 the Bank began a restructuring project to reduce ongoing operating costs and increase noninterest income (see Note 12). As a result the Bank has implemented a plan to reduce its workforce by approximately 250 employees. The total charge for severance realized by the Bank was $1.3 million. The incremental cost of the enhanced early retirement benefit realized during 1995 was approximately $728,000. In conjunction with the restructuring changes, the Bank engaged a consulting firm to assist in the identification of areas where the Bank could reduce expenses or enhance revenue. The fee earned by these consultants is, in part, contingent upon actual future operating cost reductions and the increase in noninterest income. The Bank has recognized expenses associated with fees to these consultants of approximately $2 million in 1995. During 1994 the Company recognized a net charge related to the Trust Company's reimbursement to its clients due to investments in the Piper Jaffray Institutional Government Income Portfolio totaling $3.2 million after the recognition of a $6 million reimbursement from insurance carriers. Losses and Write-downs of Other Real Estate Owned decreased $805,000 from 1994 to 1995, due primarily to a decrease in the amount provided for the reserve on the portfolio from $2.3 million in 1994 to $1.4 million in 1995. Additionally, during 1994 the Bank wrote off the carrying value of one of its investments in real estate limited partnerships totaling $546,000 due to significant cash flow deficiencies experienced by the partnership which caused the Bank to question the realizability of its investment. The Bank also wrote down the unamortized balance of the core deposit intangible related to the acquisition of NFNBV in the amount of $458,000 and $686,000 during 1995 and 1994, respectively. Noninterest 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 primarily to the 1994 transactions discussed above. 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 the first full year following the acquisition. When noninterest income is netted against noninterest expense, net operating expense (net overhead) decreased $2.8 million (11%) in 1995 from the 1994 level. As a percent of average total managed assets, net overhead decreased to 3.71% in 1995 from 3.76% in 1994. Net operating expense increased $10.8 million (68%) in 1994 from 1993. The Company recognized $851,000 in low-income housing tax credits as a reduction in the provision for income taxes during 1995, $708,000 during 1994 and $961,000 during 1993. As a consequence of the operating losses incurred during 1995, 1994 and 1993, the Company recognized tax benefits of $3.8 million, $2.8 million and $4.4 million including $851,000, $708,000 and $961,000 in low-income housing tax credits, respectively. Additionally, as of December 31, 1995 the Company has a cumulative prepaid tax asset of approximately $4.5 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 $12,100,000 in 1995, $10,000,000 in 1994, and $23,822,000 in 1993. Net charge-offs were $15,794,000 in 1995, $10,131,000 in 1994, and $13,174,000 in 1993. 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 $16,234,000 at December 31, 1995, $19,929,000 at December 31, 1994, and $20,060,000 at December 31, 1993. As a percent of loans outstanding, the reserve for possible loan losses was 3.61%, 3.90%, and 3.50% at year-end 1995, 1994, and 1993, 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. 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 second quarter of 1995, 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 $5 million which supplemented the planned provision of $2.6 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 31% to $35,055,000 at December 31, 1995 from $51,182,000 at year-end 1994. Of the 1995 amount, $6,649,000 represents Segregated Assets, covered by the Loss Sharing Agreement with the FDIC. Excluding the FDIC's 80% exposure on the Segregated Assets ($5,319,000), adjusted nonperforming assets totaled $29,736,000, a decrease of 31% over the adjusted 1994 level. At December 31, 1993, nonperforming assets were reported to be $64,299,000. 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 charged 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, 1995 and 1994, the Company had valuation reserves against the other real estate owned portfolio carrying values of $2,430,000 and $2,991,000, respectively. 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, 1995 decreased $79.8 million (11.4%) from the previous year end. Much of this shrinkage is attributable to steps taken by the Bank to address its portfolio of troubled assets, as well as to realignments within the portfolio. Of the $57 million decrease in loans and Segregated Assets, $18 million was due to charge offs, and $6.3 million was due to the sale of non-performing loans. The remainder of the decrease ($32.7 million) was the result of payoffs of non-performing obligations and scheduled amortization greater than the level of new loan originations. Additionally, during 1995, the Bank's OREO portfolio decreased by $5.5 million (41%) due to aggressive steps taken by the Bank to liquidate these assets. Total deposit balances decreased during 1995 by $38 million, as customers' continued to move savings balances to other bank and non-bank competitors, partly as a result of the continued low interest rate environment. Total assets at December 31, 1994 decreased $40.2 million (5.5%) from the previous year end. All of this reduction 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 nonbank competitors. The investment portfolio, primarily U.S. Treasury debt securities with short maturities, and GNMA and FNMA mortgage-backed securities, decreased by $3 million (2.9%) during 1995 as a result of an overall smaller balance sheet. Although deposit balances continued to decrease, the Company was able to maintain its liquidity position throughout the year. The investment portfolio, primarily U.S. Treasury debt securities with short maturities, grew $14.8 million (17.0%) during 1994 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. 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 a number of sources of liquid funds, among these sources are: $24,000,000 in unused Federal Funds lines of credit at year-end 1995; an overnight line of credit with the Federal Home Loan Bank (FHLB) of $15 million; and an estimated borrowing capacity with FHLB of $38 million. Only 3.6% of total resources were funded by large certificates of deposit at December 31, 1995 and 1994. 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 March, 1995 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed of. The statement would apply to fiscal years beginning after December 15, 1995. Additionally, in May, 1995, the FASB issued SFAS No. 122, Accounting for Mortgage Servicing Rights. The Bank is required to adopt the new statement prospectively on January 1, 1996. Management does not believe that the adoption of these standards will have a significant impact on the Bank's consolidated financial condition or future results of operations. CAPITAL RESOURCES Capital growth is essential to support deposit and asset growth and to ensure strength and safety of the Company. Net losses reduced the Company's capital by $3,842,000 in 1995, $2,890,000 in 1994 and (including the effect of dividends paid) by $6,630,000 in 1993. Dividend Reinvestment (DRP) and Employee Stock Ownership Plan (ESOP) requirements were satisfied by open market purchases of stock during 1993. No new equity capital was generated from the sale of common stock to DRP and ESOP participants during 1995, 1994 or 1993 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 $5,471,000 or 11.9%. As a state chartered bank, the Bank's primary regulator 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 6.15% and 5.94% at December 31, 1995 and 1994, respectively. As of December 31, 1995 and 1994, the Bank's risk-based Tier 1 capital ratios are 8.19% and 8.13% and the total risk-based ratios are 9.45% and 10.96%. All the Bank's capital measurements exceeded risk-based regulatory minimums as of December 31, 1995. 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: 4,343,620 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. EX-27 3
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 1995 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-K. 1,000 YEAR DEC-31-1995 DEC-31-1995 38,367 459,097 0 500 98,253 0 0 449,724 (16,234) 615,048 544,514 5,335 9,525 15,425 44 0 0 40,205 615,048 46,067 5,248 0 51,315 19,491 23,002 28,313 12,100 352 36,606 (7,627) (7,627) 0 0 (7,627) (0.90) (0.90) 8.94 25,616 237 1,430 0 19,929 (18,361) 2,566 16,234 16,234 0 1,944
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