-----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, Bjj7jYAx1qV0X7FVWq/5L2eEUMX0xQbxc+fTsVMYHuceKA852PsPd4diCE3YW9yI FFqm3YlNGu01mIXa+i7A2w== 0000910647-00-000091.txt : 20000327 0000910647-00-000091.hdr.sgml : 20000327 ACCESSION NUMBER: 0000910647-00-000091 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000324 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: SEC FILE NUMBER: 000-11595 FILM NUMBER: 577927 BUSINESS ADDRESS: STREET 1: 164 COLLEGE 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 BODY OF THE 10-K ============================================================================ 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, 1999 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 164 College St., Burlington, Vermont 05401 (Address of principal executive office) (Zip Code) Registrant's telephone number: (802) 658-3400 Securities registered pursuant to Section 12(b) of the Act: (Not Applicable) Securities registered pursuant to Section 12(g) of the Act: Title of Class: Common Stock (Par Value $.01 a share) Name of Exchange on which listed: NASDAQ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Contained herein X Not contained herein ----- ----- The aggregate market value of the voting stock held by non-affiliates is $85,831,729 as computed using the average bid and asked prices of stock, as of February 29, 2000. The number of shares outstanding for each of the registrant's classes of common stock, as of February 29, 2000 is: Class: Common stock, par value $.01 per share Outstanding: 4,278,217 shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement to Shareholders for the year ended December 31, 1999 are incorporated herein by reference to Part III. ============================================================================ TABLE OF CONTENTS Page Independent Auditors' Report 3 Consolidated Balance Sheets 4 Consolidated Statements of Operations 5 Consolidated Statements of Comprehensive Income 6 Consolidated Statements of Changes in Stockholders' Equity 7 Consolidated Statements of Cash Flows 8 Notes to Consolidated Financial Statements 9 Summary of Unaudited Quarterly Financial Information 31 Management's Discussion and Analysis of Financial Condition and Results of Operations 34 Form 10-K 51 Five Year Selected Financial Data 60 Signatures 64 ARTHUR ANDERSEN LLP [LETTERHEAD] 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, 1999 and 1998, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. 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 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, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Boston, Massachusetts January 18, 2000 Merchants Bancshares, Inc. Consolidated Balance Sheets
December 31, December 31, (In thousands except share and per share data) 1999 1998 - ------------------------------------------------------------------------------------------------------ ASSETS Cash and Due from Banks $ 23,746 $ 30,528 Investments: Debt Securities Available for Sale 72,229 72,205 Debt Securities Held to Maturity 126,281 103,851 (Fair Value of $122,305 and $105,717) Trading Securities 1,075 1,095 - ------------------------------------------------------------------------------------------------------ Total Investments 199,585 177,151 - ------------------------------------------------------------------------------------------------------ Loans 453,692 405,492 Reserve for Possible Loan Losses 11,189 11,300 - ------------------------------------------------------------------------------------------------------ Net Loans 442,503 394,192 - ------------------------------------------------------------------------------------------------------ Federal Home Loan Bank Stock 2,951 2,482 Bank Premises and Equipment, Net 13,175 13,185 Investment in Real Estate Limited Partnerships 2,751 2,860 Other Real Estate Owned 133 470 Other Assets 16,519 14,005 - ------------------------------------------------------------------------------------------------------ Total Assets $701,363 $634,873 ====================================================================================================== LIABILITIES Deposits: Demand $ 86,160 $ 85,998 Savings, NOW and Money Market Accounts 369,929 309,897 Time Deposits $100 thousand and Greater 25,590 22,746 Other Time 131,564 131,821 - ------------------------------------------------------------------------------------------------------ Total Deposits 613,243 550,462 - ------------------------------------------------------------------------------------------------------ Demand Note Due U.S. Treasury 4,000 283 Other Short-Term Borrowings 7,000 9,000 Other Liabilities 6,013 7,890 Long-Term Debt 6,371 6,409 - ------------------------------------------------------------------------------------------------------ Total Liabilities 636,627 574,044 - ------------------------------------------------------------------------------------------------------ Commitments and Contingencies (Note 13) STOCKHOLDERS' EQUITY Preferred Stock Class A Non-Voting Authorized-200,000, Outstanding 0 - - Preferred Stock Class B Voting Authorized-1,500,000, Outstanding 0 - - Common Stock, $.01 Par Value 44 44 Shares Authorized 7,500,000 Outstanding, Current Period 4,194,810 Prior Period 4,259,278 Capital in Excess of Par Value 33,072 33,073 Retained Earnings 35,368 28,308 Treasury Stock (At Cost) (4,699) (3,133) Current Period 239,810 Prior Period 175,342 Deferred Compensation Arrangements 2,372 2,166 Unrealized Gains (losses) on Securities Available for Sale, Net (1,421) 371 - ------------------------------------------------------------------------------------------------------ Total Stockholders' Equity 64,736 60,829 - ------------------------------------------------------------------------------------------------------ Total Liabilities and Stockholders' Equity $701,363 $634,873 ======================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statements of Operations
Years Ended December 31, (In thousands except per share data) 1999 1998 1997 - --------------------------------------------------------------------------------------------- INTEREST AND DIVIDEND INCOME: Interest and Fees on Loans $37,119 $36,796 $38,543 Interest and Dividends on Investments: U.S. Treasury and Agency Obligations 10,627 10,728 9,433 Other 1,475 499 182 - --------------------------------------------------------------------------------------------- Total Interest and Dividend Income 49,221 48,023 48,158 - --------------------------------------------------------------------------------------------- INTEREST EXPENSE: Savings, NOW and Money Market Accounts 10,171 9,175 8,403 Time Deposits $100 Thousand and Greater 1,418 1,566 1,428 Other Time Deposits 6,034 7,007 7,485 Other Borrowed Funds 536 322 509 Debt 468 460 413 - --------------------------------------------------------------------------------------------- Total Interest Expense 18,627 18,530 18,238 - --------------------------------------------------------------------------------------------- Net Interest Income 30,594 29,493 29,920 Provision for Possible Loan Losses (388) (1,737) (1,862) - --------------------------------------------------------------------------------------------- Net Interest Income after Provision for Possible Loan Losses 30,982 31,230 31,782 - --------------------------------------------------------------------------------------------- NONINTEREST INCOME: Trust Company Income 1,802 1,790 1,635 Service Charges on Deposits 3,024 2,756 3,075 Settlement Proceeds 1,326 120 - Gains on Sale of Investment Securities, Net - 44 784 Other 1,221 1,344 1,181 - --------------------------------------------------------------------------------------------- Total Noninterest Income 7,373 6,054 6,675 - --------------------------------------------------------------------------------------------- NONINTEREST EXPENSES: Salaries and Wages 9,812 9,434 8,682 Employee Benefits 2,314 2,036 1,992 Occupancy Expense, Net 2,212 1,974 2,171 Equipment Expense 2,320 2,593 2,325 Legal and Professional Fees 1,780 2,447 3,888 Marketing 1,151 957 1,450 Provision for Impairment of Investment Security - - 229 Equity in Losses of Real Estate Limited Partnerships 562 379 641 Losses on and Writedowns of Other Real Estate Owned (13) 225 314 Loss on Disposition of Fixed Assets 30 127 1,088 Other 4,582 4,042 4,461 - --------------------------------------------------------------------------------------------- Total Noninterest Expenses 24,750 24,214 27,241 - --------------------------------------------------------------------------------------------- Income Before Provision for Income Taxes 13,605 13,070 11,216 Provision for Income Taxes 3,155 3,248 2,383 - --------------------------------------------------------------------------------------------- NET INCOME $10,450 $ 9,822 $ 8,833 ============================================================================================= BASIC EARNINGS PER COMMON SHARE $ 2.39 $ 2.22 $ 2.00 DILUTED EARNINGS PER COMMON SHARE 2.39 2.21 1.99
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statements of Comprehensive Income
Twelve Months Ended December 31, (In thou sands) 1999 1998 1997 - -------------------------------------------------------------------------------------------------- Net Income as Reported $10,450 $9,822 $8,833 Change in Net Unrealized Appreciation (Depreciation) of Securities, Net of Tax (1,167) 40 625 Less: Reclassification Adjustments for Securities Gains Included in Net Income, Net of Taxes - 29 517 - -------------------------------------------------------------------------------------------------- Comprehensive Income before transfers from Available for Sale to Held to Maturity 9,283 9,833 8,941 Impact of transfer from Available for Sale to Held to Maturity (625) (2) 10 - -------------------------------------------------------------------------------------------------- Comprehensive Income $ 8,658 $9,831 $8,951 ==================================================================================================
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, 1999
Net Unrealized Appreciation Capital in Deferred (Depreciation) Common Excess of Retained Treasury Compensation of Investment (In thousands) Stock Par Value Earnings Stock Arrangements Securities Total - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1996 $44 $33,155 $14,845 $(2,038) - $ 244 $46,250 Net Income - - 8,833 - - - 8,833 Purchase of Treasury Stock - - - (1,390) - - (1,390) Sales of Treasury Stock - 219 - 1,015 - - 1,234 Issuance of Stock under Employee Stock Option Plans - (151) - 193 - - 42 Dividends Paid - - (2,141) - - - (2,141) Unearned Compensation- Restricted Stock Awards - - - - (10) - (10) Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax - - - - - 108 108 Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax - - - - - 10 10 - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1997 44 33,223 21,537 (2,220) (10) 362 52,936 Net Income - - 9,822 - - - 9,822 Purchase of Treasury Stock - - - (1,420) - - (1,420) Issuance of Stock under Employee Stock Option Plans - (210) - 374 - - 164 Tax Benefit Related to Stock Option Exercises - 60 - - - - 60 Issuance of Stock under Deferred Compensation Arrangements - - - 133 - - 133 Dividends Paid - - (3,051) - - - (3,051) Unearned Compensation- Restricted Stock Awards - - - - (20) - (20) Deferred Compensation Arrangements - - - - 2,196 - 2,196 Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax - - - - - 11 11 Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax - - - - - (2) (2) - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1998 44 33,073 28,308 (3,133) 2,166 371 60,829 Net Income - - 10,450 - - - 10,450 Purchase of Treasury Stock - - - (1,620) - - (1,620) Issuance of Stock under Employee Stock Option Plans - (1) - 23 - - 22 Issuance of Stock under Deferred Compensation Arrangements - - - 31 (31) - - Dividends Paid - - (3,390) - - - (3,390) Unearned Compensation- Restricted Stock Awards - - - - (14) - (14) Deferred Compensation Arrangements - - - - 251 - 251 Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax - - - - - (1,167) (1,167) Effect of transfers of Securities Available for Sale to the Held to Maturity Portfolio, Net of Tax - - - - - (665) (665) Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax - - - - - 40 40 - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1999 $44 $33,072 $35,368 $(4,699) $2,372 $(1,421) $64,736 ==============================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statement of Cash Flows
(In thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 10,450 $ 9,822 $ 8,833 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Possible Loan Losses (388) (1,737) (1,862) Provision for Possible Losses on Other Real Estate Owned - 20 34 Provision for Impairment of Investment Security - - 229 Provision for Depreciation and Amortization 2,485 2,632 2,377 Net Gains on Sales of Investment Securities - (44) (784) Net Gains on Sales of Loans and Leases - (213) (11) Net Losses on Sales of Premises and Equipment 30 127 1,088 Net Gains (Losses) on Sales of Other Real Estate Owned 329 101 (138) Equity in Losses of Real Estate Limited Partnerships 562 379 641 Changes in Assets and Liabilities: Increase in Interest Receivable (164) (165) (63) Increase (Decrease) in Interest Payable (291) 33 14 (Increase) Decrease in Other Assets (950) 698 (444) Decrease in Other Liabilities (1,593) (1,004) (44) - ----------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 10,470 10,649 9,870 - ----------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net Proceeds from Branch Acquisition 1,567 - - Proceeds from Sales of Investment Securities Available for Sale - 14,053 18,907 Proceeds from Maturities of Investment Securities 36,243 33,834 13,985 Proceeds from Sales of Loans and Leases 1,245 14,659 3,131 Redemptions (Purchases) of Federal Home Loan Bank Stock (468) (186) 545 Proceeds from Sales of Premises and Equipment - - 6 Proceeds from Sales of Other Real Estate Owned 995 1,179 2,112 Purchases of Available for Sale Investment Securities (35,307) (58,156) (10,005) Purchases of Held to Maturity Investment Securities (26,311) (10,272) (33,278) Loan Originations in Excess of Principal Payments (14,692) (32,990) (4,364) Investments in Real Estate Limited Partnerships (476) (1,362) (102) Purchases of Premises and Equipment (981) (2,607) (4,099) - ----------------------------------------------------------------------------------------------------------- Net Cash Used by Investing Activities (38,185) (41,848) (13,162) - ----------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase (Decrease) in Deposits 24,241 44,618 (2,436) Net Increase (Decrease) in Other Borrowed Funds 1,717 1,283 (1,599) Principal Payments on Debt (38) (6) (5) Cash Dividends Paid (3,390) (3,051) (2,141) Acquisition of Treasury Stock (1,620) (1,420) (1,390) Proceeds From Sales of Treasury Stock - - 1,234 Proceeds From Exercise of Employee Stock Options 23 164 42 - ----------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used In) Financing Activities 20,933 41,588 (6,295) - ----------------------------------------------------------------------------------------------------------- Increase (Decrease) in Cash and Cash Equivalents (6,782) 10,389 (9,587) Cash and Cash Equivalents Beginning of Year 30,528 20,139 29,726 - ----------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents End of Period $ 23,746 $ 30,528 $ 20,139 =========================================================================================================== Total Interest Payments $ 18,914 $ 18,498 $ 18,224 Total Income Tax Payments 4,525 2,170 3,820 Transfer of Loans and Premises to Other Real Estate Owned 286 954 515 Transfer of Securities Available for Sale to Held to Maturity Portfolio 26,481 - - For information on other non-cash transactions see Note 2
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Notes to Consolidated Financial Statements December 31, 1999 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of Merchants Bancshares, Inc. (the "Company") and its wholly owned subsidiaries; Merchants Bank (the "Bank") including the Bank's wholly owned subsidiaries Merchants Trust Company (the "Trust Company"), and certain trusts; and Merchants Properties, Inc., after elimination of all material intercompany accounts and transactions. The Bank and the Trust Company offer a full range of deposit, loan, cash management and trust services to meet the financial needs of individual consumers, businesses and municipalities at 35 full-service banking locations throughout the State of Vermont. 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 at 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 The Company classifies certain of its investments in debt securities as held to maturity, which are carried at amortized cost 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. Available for sale securities are carried at fair value which is measured at each reporting date. The resulting unrealized gain or loss is reflected in Comprehensive Income and Stockholders' Equity net of the associated tax effect. Trading securities are also carried at fair value; gains and losses are recognized through the Statement of Operations. Transfers from securities available for sale to securities held to maturity are recorded at the securities' fair values on the date of the transfer. Any net unrealized gains or losses continue to be reported as a separate component of stockholders' equity, on a net of tax basis as long as the securities are carried in the held to maturity portfolio, such amounts are amortized over the estimated remaining life of the transferred securities as an adjustment to yield in a manner consistent with the amortization of premiums and discounts. 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. The gain or loss recognized on the sale of an investment security is based upon the adjusted cost of the specific security. Management reviews all reductions in fair value below book value to determine whether 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 in the period of determination. 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 $709 thousand and $787 thousand at December 31, 1999 and 1998, respectively. Premises and Equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using straight-line and accelerated methods at rates that depreciate 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. When premises and equipment are replaced, retired, or deemed no longer useful they are valued at estimated selling price less costs to sell, and to the extent the net book value exceeds this value the difference is charged to current earnings. 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 certain loans with servicing rights retained. Origination fees collected, net of commitment fees paid in connection with the sales of loans and net of the direct cost of originating the loans, are recognized at the time such loans are sold. Income Taxes Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. 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 99% as of December 31, 1999. The Company consolidates the financial statements of the limited partnership in which the Company is the general partner, actively involved in management and has a controlling interest. The Bank accounts for its investments in limited partnerships, where the Bank neither actively participates nor has 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 estimated realizable value. 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, 1999 and 1998, amounts at the Federal Reserve Bank included $412 thousand and $2.5 million, respectively, held to satisfy certain reserve requirements of the Federal Reserve Bank. Other Real Estate Owned Collateral acquired through foreclosure is recorded at the lower of cost or fair value, less estimated costs to sell, at the time of acquisition. Bank premises held for sale are recorded at the lower of cost or market, less estimated costs to sell, at the date of transfer. Subsequent changes in the fair value of other real estate owned are reflected as a write-down and charged to expense. Net operating income or expense related to foreclosed property and Bank premises held for sale is included in noninterest expense in the accompanying consolidated statements of operations. 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 other real estate owned ("OREO") may differ from the amounts reflected in the consolidated financial statements. The Bank recognized losses due to write downs of $20 thousand and $34 thousand during 1998 and 1997. At December 31, 1999, the balance in the OREO portfolio, consisted of foreclosed real estate of $133 thousand. There were no losses due to write downs of OREO during 1999. Intangible Assets Premiums paid for the purchase of core deposits are recorded as other assets and amortized using straight-line and accelerated methods over 7 to 15 years. 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 significant deposit runoff has occurred and is determined to be permanent in nature, the asset is written down accordingly. Earnings Per Share In 1997 the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" which establishes new standards for computing and presenting earnings per share ("EPS"). SFAS No. 128 applies to entities with publicly held common stock or potential common stock. This statement requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerators and denominators of the basic and diluted EPS computations for all prior-period EPS data presented. Refer to Note 12 for additional information. Comprehensive Income In 1998 the Company adopted SFAS No. 130, "Reporting Comprehensive Income". This statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses). Components of comprehensive income are net income and all other non-owner changes in equity. This statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. This statement is effective, and has been adopted, for the Company's financial statements issued for the year ended December 31, 1999. Segment Information In 1998 the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information". This statement establishes the standards for reporting information about segments in annual and interim financial statements. SFAS No. 131 introduces a new model for segment reporting; the "management approach". The management approach is based on the way the chief operating decision-maker organizes segments within a company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure - any manner in which management disaggregates a company. Refer to Note 15 for additional information. Derivative Instruments and Hedging Activities In June 1998 the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This statement establishes standards for reporting and accounting for derivative instruments ("derivatives") and hedging activities. The statement requires that derivatives be reported as assets or liabilities in the consolidated balance sheets and that derivatives be reported at fair value. The statement establishes criteria for accounting for changes in the fair value of derivatives based on the intended use of the derivatives. The statement, as amended by SFAS No. 137, is effective for all quarters of years beginning after June 15, 1999. Based on the Bank's current and anticipated investment and hedging activities the Company does not expect the adoption of SFAS No. 133 to have a material impact on the Company's financial position or results of operations. Reclassification Certain amounts reported for prior periods have been reclassified to be consistent with the current period presentation. (2) BRANCH ACQUISITION On October 29, 1999, the Bank completed the purchase of two branches, located in Bellows Falls, VT and Rutland, VT from Chittenden Corporation. The purchase was made in connection with the branch divestiture required by federal regulators with respect to Chittenden Corporation's completed merger with Vermont Financial Services Corporation, the parent company of Vermont National Bank. The transaction included two branches, one remote ATM site, approximately $38.5 million in deposits, $20.8 million in commercial loans, $13.6 million in residential and consumer loans, and certain fixed assets associated with the branches. The Bank paid a deposit premium of 3.2% and the assets were purchased at book value. A core deposit intangible asset of $1.6 million was created in connection with the transaction, which is being amortized over 7 years on an accelerated basis. (3) INVESTMENT SECURITIES Investments in debt securities are classified as trading, available for sale or held to maturity as of December 31, 1999 and 1998. The amortized cost and fair values of the debt securities classified as available for sale and held to maturity as of December 31, 1999 and 1998, are as follows: SECURITIES AVAILABLE FOR SALE:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------------------------------------------------------- 1999 (In thousands) --------------------------------------------------------------------------------------- U.S. Agency Obligations $ 8,998 $ 44 $ - $ 9,042 Mortgage-backed Securities 38,274 17 552 37,739 Collateralized Mortgage Obligations 26,353 - 905 25,448 --------------------------------------------------------------------------------------- $ 73,625 $ 61 $1,457 $72,229 ======================================================================================= Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------------------------------------------------------- 1998 (In thousands) --------------------------------------------------------------------------------------- U.S. Agency Obligations $ 30,774 $ 481 $ 62 $31,193 Mortgage-backed Securities 41,058 130 176 41,012 --------------------------------------------------------------------------------------- $ 71,832 $ 611 $ 238 $72,205 ======================================================================================= SECURITIES HELD TO MATURITY: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------------------------------------------------------- 1999 (In thousands) --------------------------------------------------------------------------------------- U.S. Treasury Obligations $ 453 $ - $ 7 $ 446 U.S. Agency Obligations 34,000 - 1,186 32,814 Mortgage-backed Securities 91,828 - 2,783 89,545 --------------------------------------------------------------------------------------- $126,281 $ - $3,976 $122,305 ======================================================================================= Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------------------------------------------------------- 1998 (In thousands) --------------------------------------------------------------------------------------- U.S. Treasury Obligations $ 452 $ 13 $ - $ 465 U.S. Agency Obligations 14,979 84 - 15,063 Mortgage-backed Securities 88,420 1,786 17 90,189 --------------------------------------------------------------------------------------- $103,851 $1,883 $ 17 $105,717 =======================================================================================
The fair value of securities held for trading was $1,075 thousand and $1,095 thousand at December 31, 1999 and 1998 respectively. Gains on securities held for trading were $61 thousand and $331 thousand as of December 31, 1999 and 1998, respectively. The contractual maturities of all debt securities held at December 31, 1999 are as follows:
Amortized Fair (In thousands) Cost Value --------------------------------------------------------------- Due within one year $ 4,042 $ 4,054 Due after one year through five years 9,418 9,401 Due after five years through ten years 80,082 77,724 Due after ten years 106,364 103,355 --------------------------------------------------------------- $199,906 $194,534 ===============================================================
Proceeds from sales of available for sale debt securities were $14 million during 1998. Gross gains of $44 thousand and $840 thousand and gross losses of $0 and $56 thousand were realized from sales of securities in 1998 and 1997, respectively. There were no sales of securities during 1999. On August 27, 1999, $27.5 million of securities available for sale were transferred to the held to maturity portfolio. Net unrealized losses of $1.0 million associated with these securities are being amortized over the remaining lives of the individual securities based on the level yield method. At December 31, 1999, securities with a face value of $15.1 million were pledged to secure public deposits, and for other purposes required by law. (4) LOANS The composition of the loan portfolio at December 31, 1999 and 1998 is as follows:
(In thousands) 1999 1998 -------------------------------------------------------------- Commercial, Financial and Agricultural $ 72,333 $ 63,953 Real Estate-Commercial 171,988 170,892 Real Estate-Residential 180,906 147,348 Real Estate-Construction 12,701 8,091 Installment Loans to individuals 15,313 14,676 All Other Loans (including overdrafts) 451 532 -------------------------------------------------------------- Total Loans $453,692 $405,492 ==============================================================
The Bank currently originates primarily residential real estate loans, commercial and installment loans, and commercial real estate loans to customers throughout the state of Vermont. There were no loans held for sale at December 31, 1999 and 1998. Substantially all of the Bank's loan portfolio is based in the state of Vermont. There are no known significant industry concentrations in the loan portfolio. Loans serviced for others at December 31, 1999 and 1998 amounted to $106 million and $160 million, respectively. The reserve for possible loan losses is based on management's estimate of the amount required to cover the economic risks in the loan portfolio, based on circumstances and conditions known 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. To the extent management determines the level of anticipated losses in the portfolio have significantly increased or diminished the reserve is adjusted through current earnings. 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. 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 years ended December 31, 1999 and 1998 is as follows:
(In thousands) 1999 1998 -------------------------------------------------------- Balance, Beginning of Year $11,300 $15,831 Provision for Possible Loan Losses (388) (1,737) Loans Charged Off (874) (3,935) Recoveries 1,151 1,141 -------------------------------------------------------- Balance, End of Year $11,189 $11,300 ========================================================
The allowance for possible loan losses related to loans that are identified as impaired 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. The Company has determined that commercial and commercial real estate loans recognized by the Company as nonaccrual, loans past due over 90 days and still accruing, restructured troubled debt and certain internally adversely classified loans are generally equivalent to impaired loans. The Bank's policy is to discontinue the accrual of interest, and to 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. Total impaired loans with a related allowance at December 31, 1999 and 1998 were $4.1 million and $3.9 million respectively, and the allowance associated with such loans was $1.0 million and $400 thousand, respectively. Interest payments on impaired loans are generally 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 interest income is recognized on a cash basis. During 1999 and 1998, the Company recorded interest income on impaired loans of approximately $120 thousand and $240 thousand, respectively. The average balance of impaired loans was $3.8 million in 1999 and $6.9 million in 1998. Nonperforming assets at December 31, 1999 and 1998 are as follows:
(In thousands) 1999 1998 -------------------------------------------------- Nonaccrual loans $2,800 $2,103 Restructured Loans 689 320 Loans Past Due 90 Days or More and Still Accruing Interest 199 170 -------------------------------------------------- Total Nonperforming Loans 3,688 2,593 Other Real Estate Owned, Net 133 470 -------------------------------------------------- Total Nonperforming Assets $3,821 $3,063 ==================================================
The Bank had $689 thousand and $320 thousand of restructured loans that were performing in accordance with the modified agreement at December 31, 1999 and 1998, respectively. 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 $207 thousand, $441 thousand and $395 thousand in 1999, 1998 and 1997, respectively. During 1998 the Bank consummated transactions involving sales of loans, including certain impaired loans. The aggregate net book value of loans sold was approximately $15.1 million. The Bank recognized total income of $357 thousand from the sale of these loans. All loans were sold without recourse. An analysis of loans to directors, executive officers, and associates of such persons for the year ended December 31, 1999 is as follows:
(In thousands) ------------------------------------ Balance, December 31, 1998 $8,885 Additions 4,491 Repayments (3,574) ------------------------------------ Balance, December 31, 1999 $9,802 ====================================
It is the policy of the Bank to grant such loans on substantially the same terms, including interest rates and collateral, as those prevailing for comparable lending transactions with other persons. The December 31, 1999 balance has been adjusted to reflect changes in status of directors and executive officers during 1999. (5) PREMISES AND EQUIPMENT The components of premises and equipment included in the accompanying consolidated balance sheets are as follows:
(In thousands) 1999 1998 -------------------------------------------------------- Land and Buildings $13,484 $12,926 Leasehold Improvements 1,178 1,221 Furniture, Equipment, and Software 11,301 10,322 -------------------------------------------------------- 25,963 24,469 Less: Accumulated Depreciation and Amortization 12,787 11,284 -------------------------------------------------------- $13,176 $13,185 ========================================================
Depreciation and amortization expense related to premises and equipment amounted to $1.9 million, $2.2 million and $2.0 million in 1999, 1998, and 1997, respectively. The Bank leases certain properties for branch operations. Rent expense on these properties totaled $571 thousand, $303 thousand and $263 thousand for the years ended December 31, 1999, 1998 and 1997, respectively. Minimum lease payments for these properties subsequent to December 31, 1999 are as follows: 2000-$396 thousand; 2001-$387 thousand; 2002-$344 thousand; 2003- $282 thousand; 2004-$176 thousand and $273 thousand thereafter. (6) EMPLOYEE BENEFIT PLANS Pension Plan Prior to January 1995, 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 produce 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. The plan's funded status and amounts recognized in the accompanying consolidated balance sheets and statements of operations as of December 31, 1999 and 1998, are as follows:
(In thousands) 1999 1998 --------------------------------------------------------------------- Change in Projected Benefit Obligation Projected Benefit Obligation at Beginning of Year $7,073 $6,610 Interest Cost 459 465 Actuarial (Gain) Loss (779) 473 Benefits Paid (490) (475) --------------------------------------------------------------------- Projected Benefit Obligation at Year End $6,263 $7,073 --------------------------------------------------------------------- Change in Plan Assets Fair Value of Plan Assets at Beginning of Year $7,699 $7,308 Actuarial Return on Plan Assets 937 866 Benefits Paid (490) (475) --------------------------------------------------------------------- Fair Value of Plan Assets at Year End $8,146 $7,699 --------------------------------------------------------------------- Funded Status of the Plan Amount Over Funded $1,883 $ 626 --------------------------------------------------------------------- Unrecognized Net Actuarial (Gain) Loss (349) 771 Unrecognized Prior Service Cost - (15) --------------------------------------------------------------------- Net Amount Recognized (349) 756 --------------------------------------------------------------------- Amounts Recognized in the Statements of Financial Position Consist of the Following: Prepaid Benefit Cost $1,534 $1,382 =====================================================================
A summary of (income) expense relating to the Company's pension fund for each of the three years in the period ended December 31, 1998, is as follows:
(In thousands) 1999 1998 1997 ------------------------------------------------------------------ Interest Cost on Projected Benefit Obligation $ 459 $ 465 $ 452 Expected Return on Plan Assets (597) (530) (563) Amortization of Unrecognized Transition Asset (15) (39) (39) Recognized Net Losses - 4 - ------------------------------------------------------------------ Net Periodic Pension Costs $(153) $(100) $(150) ==================================================================
The actuarial present value of the projected benefit obligation was determined using a weighted average discount rate of 7.75%, 6.75% and 7% as of December 31, 1999, 1998 and 1997, respectively. For 1999, 1998 and 1997 there was no assumed rate of increase in future compensation due to the freeze on plan benefits. The expected long-term rate of return on assets used was 8% in 1999, 1998 and 1997. 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 126% and 128%, respectively, of the amounts contributed by the employees (200% of up to 4.5% of individual employee compensation) in 1999 and 1998. Substantially all employer contributions to the ESOP are funded with cash and are used to purchase the Company's common stock. Deferred Compensation Plans Until July 1, 1997, Directors of the Bank were entitled to defer a portion of their compensation into a Deferred Compensation Plan for Directors known as the "Floating Growth (savings)" program. No additional compensation may be deferred into the Floating Growth (savings) program. Benefits accrue based on 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 Floating Growth (savings) program 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. A summary of (income) expense relating to the Company's various employee benefit plans for each of the three years in the period ended December 31, 1999 is as follows:
(In thousands) 1999 1998 1997 -------------------------------------------------------- Pension Plan $(115) $(100) $(150) Employee Stock Ownership Plan/401(k) Plan 643 588 685 Deferred Compensation Plans 10 11 20 -------------------------------------------------------- Total $ 538 $ 499 $ 555 ========================================================
(7) STOCK-BASED COMPENSATION PLANS Stock Option Plans The Company has granted stock options to certain key employees. The options granted vest after two years and are immediately exercisable upon vesting. Nonqualified stock options may be granted at any price determined by the Compensation Committee of the Board of Directors. All stock options have been granted at or above fair market value at the date of grant. A summary of the Company's stock option activity for each of the three years for the period ended December 31, 1999 is as follows, with numbers of shares in thousands:
1999 1998 1997 ------------------------------------------------------------------------------------------------ Weighted Weighted Weighted Average Average Average Number Exercise Number Exercise Number Exercise of Price of Price of Price Shares Per Share Shares Per Share Shares Per Share ------------------------------------------------------------------------------------------------ Options outstanding, Beginning of year 138 $25.76 103 $21.88 50 $12.45 Granted 99 24.55 48 30.50 71 25.69 Exercised 1 10.00 13 12.61 18 10.72 ------------------------------------------------------------------------------------------------ Options outstanding, end of year 236 $25.36 138 $25.76 103 $21.88 Options exercisable 89 $23.37 19 $13.98 22 $12.53 Weighted average fair value per option of options granted during year $ 6.64 $ 6.92 $ 6.71 ------------------------------------------------------------------------------------------------
As of December 31, 1999, the exercisable options outstanding were exercisable at prices ranging from $10.00 to $27.75 and had a weighted- average remaining contractual life of 5.92 years. As permitted by SFAS No. 123, the Company has elected to continue to apply APB No. 25 to account for its stock-based compensation plans. Had compensation cost for awards under the Company's stock-based compensation plans been determined consistent with the method set forth under SFAS No. 123, the effect on the Company's net income and earnings per share would have been as follows:
1999 1998 1997 -------------------------------------------------------------------------------------------------------------- As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma (In thousands except per share data) -------------------------------------------------------------------------------------------------------------- Net Income $10,450 $10,233 $9,822 $9,712 $8,833 $8,679 Basic Earnings per Share $ 2.39 $ 2.34 $ 2.22 $ 2.19 $ 2.00 $ 1.97 Diluted Earnings per Share $ 2.39 $ 2.34 $ 2.21 $ 2.19 $ 1.99 $ 1.96 --------------------------------------------------------------------------------------------------------------
Because the method prescribed by SFAS No. 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation expense may not be representative of the amount to be expected in future years. Pro forma compensation expense for options granted is reflected over the vesting period; therefore, future pro forma compensation expense may be greater as additional options are granted. The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for 1999, 1998, and 1997, respectively: Risk-free interest rates of 4.53%, 4.59%, and 6.0%; expected lives of options of five years, five years, and four years; expected volatility of stock of 32.76%, 30.05%, and 34.37%; rate of dividends of 3.31%, 2.53%, and 2.48%; resulting in pro forma after tax compensation expense of $217 thousand for 1999, $110 thousand for 1998, and $308 thousand for 1997. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. Deferred Compensation Plans Through December 1995, the Bank maintained an Executive Salary Continuation Plan and a Deferred Compensation Plan for Directors. In December 1995, in satisfaction of all liabilities under those plans, the Bank agreed to make payments to, or credits for, the participants. The Bank established several plans (the "Plans") and established certain trusts (the "Trusts") with Merchants Trust Company, to which it contributed an amount sufficient to cover the Bank's obligations. The 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 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. To the extent the obligations of the Bank under the Plans are based on investments by the Plans in other than shares of the Company, the investments are revalued at each reporting date with a corresponding adjustment to compensation expense. In July 1998, the Emerging Issues Task Force ("EITF") issued guidance on Issue No. 97-14, "Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested" (the "Guidance"). This Guidance establishes standards for reporting and accounting for certain deferred compensation agreements between the Company and certain of its directors. This Guidance requires that the deferred compensation obligation be classified in the "Stockholders' Equity" section of the balance sheets. These amounts were previously classified as other liabilities in the "Liabilities" section of the balance sheets. The Company adopted this guidance prospectively on September 30, 1998 and on that date reclassified deferred compensation obligations totaling $2.13 million to a component within Stockholders' Equity labeled "Deferred Compensation Arrangements". Restricted Stock Plans The Company and the Bank have compensation plans for non-employee directors. Under the terms of the plans, participating directors may elect to have all or a specified percentage of his or her compensation for a given year paid in the form of cash or deferred in the form of shares of restricted common stock of the Company. Directors who elect to have their compensation deferred shall be credited with a number of shares of the Company's stock equal in value to the amount of fees deferred plus a risk premium of not more than 25% of the amount deferred. The participating director may not generally sell, transfer or otherwise dispose of these shares, prior to the fifth anniversary of the date of the grant of such shares. With respect to shares of common stock issued or otherwise transferred to a participating director, the participating director will have the right to vote the shares and receive dividends or other distributions thereon. If a participating director resigns under certain circumstances the director shall forfeit all of his or her restricted shares, which are risk premium shares. During 1999, 5,855 shares of common stock of the Company were distributed to a trust established under the terms of the new compensation plan. The "risk premium" is reflected within a component of Stockholders' Equity labeled "Deferred Compensation Arrangements" and will be recognized as an expense ratably over the five-year restriction period. (8) INCOME TAXES The provision for income taxes for each of the three years in the period ended December 31, 1999 consists of the following:
(In thousands) 1999 1998 1997 ------------------------------------------------ Current $ 499 $3,065 $1,499 Deferred (Prepaid) 2,656 183 884 ------------------------------------------------ $3,155 $3,248 $2,383 ================================================
Prepaid and deferred income taxes result from differences between the income for financial reporting and tax reporting relating primarily to the provision for possible loan losses. The net deferred tax asset amounted to approximately $2.5 million and $4.3 million at December 31, 1999 and 1998, respectively. This tax asset is included in other assets in the accompanying consolidated balance sheets. The components of the net deferred tax asset as of December 31, 1999 and 1998 are as follows:
(In thousands) 1999 1998 --------------------------------------------------------------------- Reserve for Possible Loan Losses $ 3,916 $ 4,064 Deferred Compensation 1,335 1,340 Unrealized Securities (Gains) Losses 743 (191) Loan Fees 107 104 Depreciation (686) (876) Accrued Liabilities (9) 46 Investments in Real Estate Limited Partnerships (1,242) (968) Excess Servicing Right - (17) Loan Market Adjustment (4,789) (2,932) Other (1,091) (975) Tax Credit Carryforwards 3,967 4,190 Core Deposit Intangible 267 472 --------------------------------------------------------------------- $ 2,518 $ 4,257 =====================================================================
The following is a reconciliation of the federal income tax provision, calculated at the statutory rate, to the recorded provision for income taxes:
(In thousands) 1999 1998 1997 -------------------------------------------------------------------- Applicable Statutory Federal Income Tax $ 4,762 $ 4,444 $ 3,779 (Reduction) Increase in Taxes Resulting From: Loss on Investment Securities - - (134) Tax-exempt Income (34) (41) (55) Tax Credits (1,631) (1,328) (1,089) Other, Net 58 173 (118) -------------------------------------------------------------------- $ 3,155 $ 3,248 $ 2,383 ====================================================================
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 $627 thousand, $590 thousand, and $386 thousand in 1999, 1998, and 1997, respectively. These amounts are included in other expenses in the accompanying consolidated statements of operations. (9) OTHER BORROWED FUNDS Other borrowed funds consist of the following at December 31, 1999 and 1998:
(In thousands) 1999 1998 ------------------------------------------------ Treasury Tax and Loan Notes $ 4,000 $ 283 Short Term Borrowing 7,000 9,000 ------------------------------------------------ $11,000 $9,283 ================================================
As of December 31, 1999, the Bank may borrow up to $40 million in overnight funds on an unsecured basis. The following table provides certain information regarding other borrowed funds for the two years ended December 31, 1999 and 1998:
Maximum Weighted Month-End Average Average Rate Weighted Amount Amount During Average Rate (In thousands) Outstanding Outstanding the Year at Year End ----------------------------------------------------------------------------------------- 1999 Treasury Tax And Loan Notes $ 4,000 $1,823 4.75% 4.54% Federal Funds Purchased 3,000 74 5.27% - Short Term Borrowing 25,000 7,190 5.23% 5.88% ----------------------------------------------------------------------------------------- 1998 Treasury Tax And Loan Notes $ 4,000 $1,939 5.14% 4.12% Federal Funds Purchased 6,000 730 5.70% - Short Term Borrowing 20,000 2,986 5.68% 5.66% -----------------------------------------------------------------------------------------
(10) DEBT Debt consists of the following at December 31, 1999 and 1998:
(In thousands) 1999 1998 ---------------------------------------------------------------------------- 9% Note Payable, Monthly Installments of $1.7 thousand (Principal and Interest), Annual Installments of $30 Thousand (Principal only) , through July 2003 $ 163 $ 197 8.75% Mortgage Note, payable in Monthly Installments of $2.5 thousand (Principal and Interest) through 2039 1,178 1,182 Federal Home Loan Bank Notes Payable, Interest Rates From 7.52% to 8.66% Due in 2001 5,030 5,030 ---------------------------------------------------------------------------- $6,371 $6,409 ============================================================================
The 8.75% mortgage note relates to a low-income housing project. The monthly installments are subsidized by the U.S. Department of Agriculture, which pays amounts annually so as to reduce the monthly principal and interest payments to an amount equivalent to a loan at a rate of 1%. Maturities of debt subsequent to December 31, 1999 are as follows: 2000-$41 thousand; 2001-$5,075 thousand; 2002-$49 thousand; 2003-$44 thousand; 2004- $5 thousand and $1,157 thousand thereafter. As of December 31, 1999, the Company is in compliance with all of the covenants of the Federal Home Loan Bank ("FHLB") agreements. (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 $10.0 million as of December 31, 1999 and $9.0 million as of December 31, 1998 of such appropriations. Vermont state law also restricts the payment of dividends under certain circumstances. (12) EARNINGS PER SHARE The following table presents a reconciliation of the calculations of basic and diluted earnings per share for the year ended December 31, 1999:
Per Share 1999 Income Shares Amount -------------------------------------------------------------------------------------------- (In thousands except share and per share data) Basic Earnings Per Share: Income Available to Common Shareholders $10,450 4,368,421 $2.39 Diluted Earnings Per Share: Options issued to Executives (See Note 7) - 6,950 Income available to Common Shareholders Plus Assumed Conversions 10,450 4,375,371 $2.39 ============================================================================================ Per Share 1998 Income Shares Amount -------------------------------------------------------------------------------------------- (In thousands except share and per share data) Basic Earnings Per Share: Income Available to Common Shareholders $9,822 4,425,031 $2.22 Diluted Earnings Per Share: Options issued to Executives (See Note 7) - 15,034 Income available to Common Shareholders Plus Assumed Conversions $9,822 4,440,065 $2.21 ============================================================================================ Per Share 1997 Income Shares Amount -------------------------------------------------------------------------------------------- (In thousands except share and per share data) Basic Earnings Per Share: Income Available to Common Shareholders $8,833 4,423,153 $2.00 Diluted Earnings Per Share: Options issued to Executives (See Note 7) - 23,256 Income available to Common Shareholders Plus Assumed Conversions $8,833 4,446,409 $1.99 ============================================================================================
Balance Sheets as of December 31, (In thousands) 1999 1998 - ------------------------------------------------------------------- Assets: Investment in and Advances to Subsidiaries* $64,107 $60,677 Other Assets 638 163 - ------------------------------------------------------------------- Total Assets $64,745 $60,840 =================================================================== Liabilities and Equity Capital: Other Liabilities $ 9 $ 11 Equity Capital 64,736 60,829 - ------------------------------------------------------------------- Total Liabilities and Equity Capital $64,745 $60,840 =================================================================== Statements of Operations for the Years Ended December 31, (In thousands) 1999 1998 1997 - ------------------------------------------------------------------------------- Dividends from Merchants Bank* $ 5,402 $4,000 $2,267 Equity in Undistributed Earnings of Subsidiaries 5,122 5,907 6,652 Other Expense, Net (112) (129) (130) Benefit from Income Taxes 38 44 44 - ------------------------------------------------------------------------------- Net Income $10,450 $9,822 $8,833 =============================================================================== - -------------------- Account balances are partially or fully eliminated in consolidation.
Statements of Cash Flows for the Years Ended December 31,
(In thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net Income $10,450 $ 9,822 $ 8,833 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Decrease in Miscellaneous Receivables 3 71 89 Increase (Decrease) in Miscellaneous Payables (1) (2) 40 Equity in Undistributed Income of Subsidiaries (5,122) (5,907) (6,652) - ----------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 5,330 3,984 2,310 - ----------------------------------------------------------------------------------- Cash Flows From Financing Activities: Sale of Treasury Stock - 80 1,234 Acquisition of Treasury Stock (1,620) (1,420) (1,390) Proceeds from Exercise of Employee Stock Options 22 164 42 Tax Benefit from Employee Stock Option Exercise 1 60 - Dividends Paid (3,390) (3,051) (2,217) Other, Net 134 75 (35) - ----------------------------------------------------------------------------------- Net Cash Used in Financing Activities (4,853) (4,092) (2,366) - ----------------------------------------------------------------------------------- Increase (Decrease) in Cash and Cash Equivalents 477 (108) (56) Cash and Cash Equivalents at Beginning of Year 154 262 318 - ----------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 631 $ 154 $ 262 =================================================================================== Total Interest Payments $ - $ - $ - Taxes paid 4,525 2,170 3,820 - -----------------------------------------------------------------------------------
(15) BUSINESS SEGMENTS On January 1, 1998 the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). The adoption of SFAS No. 131 did not have a material effect on the Company's primary financial statements. The Company has identified Community Banking as its reportable operating business segment. The Community Banking business segment consists of commercial banking and retail banking. The Community Banking business segment is managed as a single strategic unit which derives its revenues from a wide range of banking services, including lending activities, acceptance of demand, savings and time deposits, safe deposit facilities, merchant card services and mortgage servicing income from investors. Non-reportable operating segments of the Company's operations which do not have similar characteristics to the Community Banking segment and do not meet the quantitative thresholds requiring disclosure are included in the Other category in the disclosure of business segments below. These non- reportable segments include trust and investment services, as well as parent company financial information (Note 14). The following tables present the results of the Company's reportable operating business segment results as of December 31, 1999, 1998 and 1997:
Community Consolidation December 31, 1999 Banking Other Adjustment Consolidated - -------------------------------------------------------------------------------------------- Interest Income $ 49,221 $ - $ - $ 49,221 Interest Expense 18,599 28 - 18,627 Provision for Possible Loan Losses (388) - - (388) - -------------------------------------------------------------------------------------------- Net Interest Income After Provi- sion for Possible Loan Losses 31,010 (28) - 30,982 - -------------------------------------------------------------------------------------------- Noninterest Income: Trust Company Income - 1,802 - 1,802 Service Charges on Deposits 3,024 - - 3,024 Settlement Proceeds - 1,326 - 1,326 Other 1,099 122 - 1,221 - -------------------------------------------------------------------------------------------- Total Noninterest Income 4,123 3,250 - 7,373 - -------------------------------------------------------------------------------------------- Noninterest Expenses: Salaries and Employee Benefits 11,486 640 - 12,126 Occupancy and Equipment 4,459 73 - 4,532 Legal and Professional 1,348 432 - 1,780 Marketing 1,116 35 - 1,151 Other Expenses 4,607 554 - 5,161 - -------------------------------------------------------------------------------------------- Total Noninterest Expenses 23,016 1,734 - 24,750 - -------------------------------------------------------------------------------------------- Income Before Provision For Income Taxes 12,117 1,488 - 13,605 Provision for Income Taxes 2,556 599 - 3,155 - -------------------------------------------------------------------------------------------- Net Income $ 9,561 $ 889 $ - $ 10,450 ============================================================================================ End of Period Securities $198,510 $ 1,075 $ - $199,585 End of Period Net Loans 453,692 - - 453,692 End of Period Assets 699,787 74,297 (72,721) 701,363 End of Period Deposits 617,392 - (4,149) 613,243 End of Period Borrowings 16,456 1,178 - 17,634 End of Period Liabilities 638,366 4,827 (6,565) 636,628 - -------------------------------------------------------------------------------------------- Community Consolidation December 31, 1998 Banking Other Adjustment Consolidated - -------------------------------------------------------------------------------------------- Interest Income $ 47,990 $ 33 $ - $ 48,023 Interest Expense 18,501 29 - 18,530 Provision for Possible Loan Losses (1,737) - - (1,737) - -------------------------------------------------------------------------------------------- Net Interest Income After Provi- sion for Possible Loan Losses 31,226 4 - 31,230 - -------------------------------------------------------------------------------------------- Noninterest Income: Trust Company Income - 1,790 - 1,910 Service Charges on Deposits 2,756 - - 2,756 Settlement Proceeds - 120 - 120 Other 1,260 128 - 1,388 - -------------------------------------------------------------------------------------------- Total Noninterest Income 4,016 2,038 - 6,054 - -------------------------------------------------------------------------------------------- Noninterest Expenses: Salaries and Employee Benefits 10,780 690 - 11,470 Occupancy and Equipment 4,474 93 - 4,567 Legal and Professional 2,220 227 - 2,447 Marketing 1,115 35 - 1,150 Other Expenses 4,150 430 - 4,580 - -------------------------------------------------------------------------------------------- Total Noninterest Expenses 22,739 1,475 - 24,214 - -------------------------------------------------------------------------------------------- Income Before Provision For Income Taxes 12,503 567 - 13,070 Provision for Income Taxes 2,994 254 - 3,248 - -------------------------------------------------------------------------------------------- Net Income $ 9,509 $ 313 $ - $ 9,822 ============================================================================================ End of Period Securities $178,539 $ 1,094 $ - $179,633 End of Period Net Loans 394,192 - - 394,192 End of Period Assets 632,613 67,280 (65,020) 634,873 End of Period Deposits 552,351 - (1,889) 550,462 End of Period Borrowings 14,510 1,182 - 15,692 End of Period Liabilities 573,394 2,539 (1,889) 574,044 - -------------------------------------------------------------------------------------------- Community Consolidation December 31, 1997 Banking Other Adjustment Consolidated - -------------------------------------------------------------------------------------------- Interest Income $ 48,155 $ 3 $ - $ 48,158 Interest Expense 18,238 - - 18,238 Provision for Possible Loan Losses (1,862) - - (1,862) - -------------------------------------------------------------------------------------------- Net Interest Income After Provi- sion for Possible Loan Losses 31,779 3 - 31,782 - -------------------------------------------------------------------------------------------- Noninterest Income: Trust Company Income - 1,635 - 1,635 Service Charges on Deposits 3,075 - - 3,075 Other 1,895 70 - 1,965 - -------------------------------------------------------------------------------------------- Total Noninterest Income 4,970 1,705 - 6,675 - -------------------------------------------------------------------------------------------- Noninterest Expenses Salaries and Employee Benefits 9,967 707 - 10,674 Occupancy and Equipment 4,460 36 - 4,496 Legal and Professional 3,486 402 - 3,888 Marketing 1,431 19 - 1,450 Other Expenses 5,790 943 - 6,733 - -------------------------------------------------------------------------------------------- Total Noninterest Expenses 25,134 2,107 - 27,241 - -------------------------------------------------------------------------------------------- Income Before Provision For Income Taxes 11,615 (399) - 11,216 Provision for Income Taxes 2,375 8 - 2,383 - -------------------------------------------------------------------------------------------- Net Income $ 9,240 $ (407) $ - $ 8,833 ============================================================================================ End of Period Securities $157,996 $ 1,030 $ - $159,026 End of Period Net Loans 374,557 - - 374,557 End of Period Assets 583,575 62,243 (61,566) 584,252 End of Period Deposits 508,778 - (2,934) 505,844 End of Period Borrowings 13,231 1,184 - 14,415 End of Period Liabilities 529,674 4,576 (2,934) 531,316 - --------------------------------------------------------------------------------------------
(16) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Commitments and 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 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, 1999 and 1998 are as follows:
(In thousands) Contractual Amount ------------------------------------------------------------------ 1999 Financial Instruments Whose Contract Amounts Represent Credit Risk: Commitments to Extend Credit $111,033 Standby Letters of Credit 7,170 Loans Sold with Recourse 76 ------------------------------------------------------------------ (In thousands) Contractual Amount ------------------------------------------------------------------ 1998 Financial Instruments Whose Contract Amounts Represent Credit Risk: Commitments to Extend Credit $105,112 Standby Letters of Credit 5,321 Loans Sold with Recourse 1,106 ------------------------------------------------------------------
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 approximately 90% are for less than $100 thousand. 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 may enter into commitments to sell loans, which involve market and interest rate risk. There were no such commitments at December 31, 1999 or 1998. Interest Rate Cap and Floor Contracts Interest rate cap and floor transactions generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying principal amounts. The Company uses floor contracts to mitigate the effects on net interest income in the event interest rates on floating rate loans decline and uses cap contracts to mitigate the effects on net interest income should interest rates on floating rate deposits increase. The Company is exposed to risk should the counterparty default in its responsibility to pay interest under the terms of the cap or floor agreement, but minimizes this risk by performing normal credit reviews on the counterparties, by limiting its exposure to any one counterparty, and by utilizing well known national investment firms as counterparties. Notional principal amounts are a measure of the volume of agreements transacted, but the level of credit risk is significantly less. At December 31, 1999 and December 31, 1998, the notional principal amounts of such contracts outstanding was $60 million and $80 million respectively. At December 31, 1999 and December 31, 1998, the amortized cost of such contracts was $161 thousand and $302 thousand, respectively. $42 thousand of cash proceeds were received during 1999 and $2 thousand of cash proceeds were received during 1998 with respect to these contracts. (17) 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 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 fair value of the investment securities as of December 31, 1999 and 1998 is as follows:
1999 1998 --------------------------------------------------------------------------------- Carrying Carrying (In thousands) Amount Fair Value Amount Fair Value --------------------------------------------------------------------------------- Securities Available for Sale $ 72,229 $ 72,229 $ 72,205 $ 72,205 Securities Held to Maturity 126,281 122,305 103,851 105,717 --------------------------------------------------------------------------------- $198,510 $194,534 $176,056 $177,922 =================================================================================
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 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 fair value of the loan portfolio as of December 31, 1999 and 1998 is as follows:
1999 1998 ------------------------------------------------------------------ Carrying Carrying (In thousands) Amount Fair Value Amount Fair Value ------------------------------------------------------------------ Net Loans $442,503 $433,332 $394,192 $400,469 -------------------------------------------------------------------
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 fixed 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 fair value of deposits as of December 31, 1999 and 1998 is as follows:
1999 1998 --------------------------------------------------------------------------------- Carrying Carrying (In thousands) Amount Fair Value Amount Fair Value --------------------------------------------------------------------------------- Demand Deposits $ 86,160 $ 86,160 $ 85,998 $ 85,998 Savings, NOW and Money Market 369,929 369,935 309,897 311,453 Time Deposits $100 thousand and greater 25,590 26,022 22,746 24,243 Other Time Deposits 131,564 131,868 131,821 131,915 --------------------------------------------------------------------------------- $613,243 $613,985 $550,462 $553,609 =================================================================================
Debt The fair value of debt is estimated using current market rates for borrowings of similar remaining maturity. An analysis of the fair value of the borrowings of the Company as of December 31, 1999 and 1998 is as follows:
1999 1998 -------------------------------------------------------------------------- Carrying Carrying (In thousands) Amount Fair Value Amount Fair Value -------------------------------------------------------------------------- Other Borrowed Funds $11,000 $11,000 $9,283 $9,283 -------------------------------------------------------------------------- Debt 6,371 6,499 6,409 6,731 --------------------------------------------------------------------------
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 $69 thousand and $53 thousand as of December 31, 1999 and 1998, respectively. Interest Rate Caps and Floors The fair value of the interest rate cap and floor contracts at December 31, 1999 was $402 thousand, the amortized cost was $161 thousand. Management bases estimates on quotes, from qualified investment brokers, of the market value of the cap or floor at the reporting date. (18) SUMMARY OF UNAUDITED FINANCIAL INFORMATION:
(In thousands except per share data) 1999 1998 - ---------------------------------------------------------------------------------------------------------------------------- Q4 Q3 Q2 Q1 Year Q4 Q3 Q2 Q1 Year - ---------------------------------------------------------------------------------------------------------------------------- Interest and Fee Income $13,090 $12,346 $11,919 $11,866 $49,221 $12,006 $11,969 $12,154 $11,894 $48,023 Interest Expense 5,013 4,567 4,529 4,518 18,627 4,629 4,687 4,663 4,551 18,530 - ---------------------------------------------------------------------------------------------------------------------------- Net Interest Income 8,077 7,779 7,390 7,348 30,594 7,377 7,282 7,491 7,343 29,493 Provision for Possible Loan Losses (1) (254) (134) - - (388) (1,618) - (119) - (1,737) Noninterest Income (2) 1,648 1,525 1,517 2,683 7,373 1,490 1,418 1,662 1,484 6,054 Noninterest Expense 6,212 6,058 6,041 6,439 24,750 6,638 5,579 6,175 5,822 24,214 - ---------------------------------------------------------------------------------------------------------------------------- Income Before Provision for Income Taxes 3,767 3,380 2,866 3,592 13,605 3,847 3,121 3,097 3,005 13,070 Provision For Income Taxes 906 779 601 869 3,155 911 789 789 759 3,248 - ---------------------------------------------------------------------------------------------------------------------------- Net Income $ 2,861 $ 2,601 2,265 $ 2,723 $10,450 $ 2,936 $ 2,332 $ 2,308 $ 2,246 $ 9,822 ============================================================================================================================ Basic Earnings Per Share $ 0.66 $ 0.59 $ 0.52 $ 0.62 $ 2.39 $ 0.66 $ 0.53 $ 0.52 $ 0.51 $ 2.22 ============================================================================================================================ Cash Dividends Declared Per Share $ 0.21 $ 0.20 $ 0.20 $ 0.19 $ 0.80 $ 0.19 $ 0.18 $ 0.17 $ 0.17 $ 0.71 ============================================================================================================================ - -------------------- During the fourth quarter of 1998, the Bank reduced its reserve for possible loan losses by approximately $1.6 million. The reduction is primarily a result of management's determination that a lower requirement was appropriate due to a changing mix of the loan portfolio, the impact of conservative underwriting standards implemented in previous periods and the favorable resolution of a significant troubled credit. During the first quarter of 1999 the Bank recognized a $1.3 million recovery arising from the resolution of certain litigation.
(19) REGULATORY ENVIRONMENT The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank's and the Company's financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank is also subject to the regulatory framework for prompt corrective action that requires the Bank to meet specific capital guidelines to be considered well capitalized. The Company's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum ratios (set forth in the table below) of total and Tier-1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier-1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 1999, the most recent notification from the FDIC categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's category. To be considered well capitalized under the regulatory framework for prompt corrective action, the Bank must maintain minimum Tier-1 Leverage, Tier-1 Risk-Based, and Total Risk-Based Capital ratios as set forth in the table below.
To Be Well- Capitalized Under For Capital Prompt Corrective (In thousands) Actual Adequacy Purposes Action Provisions - -------------------------------------------------------------------------------------------- Amount Percent Amount Percent Amount Percent - -------------------------------------------------------------------------------------------- As of December 31, 1999: Merchants Bancshares, Inc.: Tier 1 Risk-Based Capital $63,016 14.13% $17,837 4.00% N/A Total Risk-Based Capital 68,677 15.40% 35,674 8.00% N/A Tier 1 Leverage Capital 63,016 9.09% 27,715 4.00% N/A Merchants Bank: Tier 1 Risk-Based Capital $62,454 13.96% $17,895 4.00% $26,842 6.00% Total Risk-Based Capital 68,115 15.23% 35,789 8.00% 44,737 10.00% Tier 1 Leverage Capital 62,454 9.00% 27,754 4.00% 34,692 5.00% - -------------------------------------------------------------------------------------------- As of December 31, 1998: Merchants Bancshares, Inc.: Tier 1 Risk-Based Capital $58,677 14.45% $16,248 4.00% N/A Total Risk-Based Capital 63,747 15.69% 32,496 8.00% N/A Tier 1 Leverage Capital 58,677 9.49% 24,742 4.00% N/A Merchants Bank: Tier 1 Risk-Based Capital $58,582 14.38% $16,295 4.00% $24,443 6.00% Total Risk-Based Capital 63,652 15.62% 32,591 8.00% 40,738 10.00% Tier 1 Leverage Capital 58,582 9.45% 24,791 4.00% 30,988 5.00% - --------------------------------------------------------------------------------------------
Merchants Bancshares, Inc. and Subsidiaries Interest Management Analysis
(In thousands, taxable equivalent) 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------- Interest % of Interest % of Interest % of Income/ Average Income/ Average Income/ Average Expense Assets Expense Assets Expense Assets - --------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME: Total Interest Income, Including Fees on Loans $ 49,277 7.49% $ 48,098 7.97% $ 48,254 8.35% Interest Expense 18,627 2.83 18,530 3.07 18,238 3.15 - --------------------------------------------------------------------------------------------------------------- Net Interest Income Before Provision for Possible Loan Losses 30,650 4.66 29,568 4.90 30,016 5.20 Provision for Possible Loan Losses (388) -0.06 (1,737) -0.29 (1,862) -0.32 - --------------------------------------------------------------------------------------------------------------- Net Interest Income $ 31,038 4.72% $ 31,305 5.19% $ 31,878 5.52% =============================================================================================================== OPERATING EXPENSE ANALYSIS: Noninterest Expense Personnel $ 12,126 1.84% $ 11,470 1.90% $ 10,674 1.85% Occupancy and Equipments Expense 4,532 0.69 4,567 0.76 4,496 0.78 Legal and Professional Fees 1,780 0.27 2,447 0.41 3,888 0.67 Marketing 1,151 0.18 957 0.16 1,450 0.25 Loss / (Gain) on Disposition of Fixed Assets 30 0.00 127 0.02 1,088 0.19 Other 5,131 0.78 4,646 0.77 5,645 0.98 - --------------------------------------------------------------------------------------------------------------- Total Noninterest Expense 24,750 3.76 24,214 4.01 27,241 4.71 - --------------------------------------------------------------------------------------------------------------- Less Noninterest Income Service Charges on Deposits 3,024 0.46 2,756 0.46 3,075 0.53 Other, Including Securities Gains 4,349 0.66 3,298 0.55 3,600 0.62 - --------------------------------------------------------------------------------------------------------------- Total Noninterest Income 7,373 1.12 6,054 1.01 6,675 1.15 - --------------------------------------------------------------------------------------------------------------- Net Operating Expense $ 17,377 2.64% $ 18,160 3.00% $ 20,566 3.56% =============================================================================================================== SUMMARY: Net Interest Income $ 31,038 4.72% $ 31,305 5.19% $ 31,878 5.52% Less: Net Operating Expense 17,377 2.64 18,160 3.00 20,566 3.56 - --------------------------------------------------------------------------------------------------------------- Profit Before Taxes- Taxable Equivalent Basis 13,661 2.08 13,145 2.19 11,312 1.96 Net Profit (Loss) After Taxes $ 10,450 1.59% $ 9,822 1.63% $ 8,833 1.53% - --------------------------------------------------------------------------------------------------------------- TOTAL AVERAGE ASSETS $657,523 $603,312 $578,090 ===============================================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, this Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, without limitation, (i) the fact that the Company's success is dependent to a significant extent upon general economic conditions in Vermont and Vermont's ability to attract new business, (ii) the fact that the Company's earnings depend to a great extent upon the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and other borrowings) generated by the Bank, and thus the Bank's results of operations may be adversely affected by increases or decreases in interest rates, (iii) the fact that the banking business is highly competitive and the profitability of the Company depends upon the Bank's ability to attract loans and deposits in Vermont, where the Bank competes with a variety of traditional banking and nontraditional institutions such as credit unions and finance companies, and (iv) the fact that at December 31, 1999, approximately 50% of the Company's loan portfolio was comprised of commercial loans, exposing the Company to the risks inherent in financings based upon analyses of credit risk, the value of underlying collateral, including real estate, and other more intangible factors, which are considered in making commercial loans. Accordingly, the Company's profitability may be negatively impacted by errors in risk analyses, by loan defaults, and the ability of certain borrowers to repay such loans may be adversely affected by any downturn in general economic conditions. These factors, as well as general economic and market conditions, may materially and adversely affect the market price of shares of the Company's common stock. Because of these and other factors, past financial performance should not be considered an indicator of future performance. The forward-looking statements contained herein represent the Company's judgment as of the date of this Form 10-K, and the Company cautions readers not to place undue reliance on such statements. 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, 1999 should be read in conjunction with the consolidated financial statements and notes thereto and selected statistical information appearing elsewhere in this Form 10-K. The information is discussed on a fully taxable equivalent basis. The financial condition and operating results of the Company essentially reflect the operations of its principal subsidiary, Merchants Bank. RESULTS OF OPERATIONS: OVERVIEW The Company realized net income of $10.4 million for the year ended December 31, 1999, an increase of $628 thousand from 1998. One-time charges and credits that influenced 1999 earnings included a $1.3 million recovery arising from the resolution of certain legal matters. Conversely, the Company incurred legal and professional expenses in conjunction with certain legal matters totaling $551 thousand during 1999. For a more detailed discussion of these legal matters see Part I, Item 3-"Legal Proceedings". The Bank also realized settlements related to previously charged off obligations and gains pursuant to the sale of certain foreclosed real estate totaling $748 thousand during the year. The Bank completed the purchase and integration of two new branches, located in Bellows Falls and Rutland, Vermont during the fourth quarter of 1999. The purchase was made in connection with the branch divestiture required by federal regulators with respect to Chittenden Corporation's completed merger with Vermont Financial Services Corporation, the parent company of Vermont National Bank. The transaction increased year-end assets of the Company by $35 million. Conversion costs incurred by the Bank in conjunction with this acquisition totaled $258 thousand. See "Branch Acquisition" for a more detailed discussion of this purchase. Basic earnings per share were $2.39, $2.22, and $2.00 for the years ended December 31, 1999, 1998, and 1997, respectively. Diluted earnings per share were $2.39, $2.21, and $1.99 for the years ended December 31, 1999, 1998 and 1997, respectively. The Company declared and distributed a total of $.80 per share during 1999. In January 2000, the Company declared a dividend of $0.21 per share. Net income as a percentage of average equity capital was 16.72%, 17.46% and 17.98% for 1999, 1998 and 1997, respectively. The ten-year average return on equity was 7.79% at December 31, 1999. Net income as a percentage of average assets was 1.59%, 1.63% and 1.53% in 1999, 1998 and 1997 respectively. The ten-year average return on assets was .61% at December 31, 1999. BRANCH ACQUISITION On October 29, 1999, the Bank completed the purchase of two branches, located in Bellows Falls, Vermont and Rutland, Vermont from Chittenden Corporation. The purchase was made in connection with the branch divestiture required by federal regulators with respect to Chittenden Corporation's completed merger with Vermont Financial Services Corporation, the parent company of Vermont National Bank. The transaction included two branches, one remote ATM site, approximately $38.7 million in deposits, $21.1 million in commercial loans, $13.6 million in residential and consumer loans, and certain fixed assets associated with the branches. The Bank paid a deposit premium of 3.2% and the assets were purchased at book value. A core deposit intangible asset of $1.6 million was created in connection with the transaction, which is being amortized over seven years on an accelerated basis. The Bank has expanded the remote ATM site located on Woodstock Avenue in Rutland to a drive-through facility staffed by a Bank employee. The Bank anticipated, and experienced, some run-off in the newly acquired loans and deposits. At year-end deposit balances in the two new locations were $35.1 million, year-end commercial loans were $11.1 million, and residential and consumer loans were $13.3 million. Approximately $3 million of the decrease in deposits was attributable to the Bank's cash management sweep product, where customer balances are swept daily to an off balance sheet investment product. Approximately $8.3 million of the decrease in loans was due to the loss of one large relationship. NET INTEREST INCOME Net interest income increased by $1.1 million (3.7%) from 1998 to 1999. Total interest and dividend income increased $1.2 million (2.5%), and total interest expense increased by $97 thousand (.5%). The increase in net interest income is primarily attributable to an overall increase in the size of the Company's balance sheet. Total average interest earning assets increased by $47.8 million from 1998 to 1999, and total average interest bearing liabilities increased by $49.4 million during the same period. Approximately $5.1 million of the increase in average interest earning assets and $5 million of the increase in interest bearing liabilities was due to the branch acquisition. The rate on interest earning assets decreased 47 basis points over the course of the year, from 8.50% for 1998 to 8.03% for 1999; and the rate on average interest bearing liabilities decreased 37 basis points during the same period from 4.05% for 1998 to 3.68% for 1999. The average interest rate earned on the loan portfolio decreased from 9.41% in 1998 to 8.74% in 1999, while the average balances of loans increased $33.5 million. The decrease in the average loan rate is attributable to an overall lower interest rate environment during the early part of 1999 as compared to 1998, the changing mix of the loan portfolio and continuing decreases in fees charged relating to lending activities. The largest increase in the loan portfolio was in residential real estate loans, which accounted for $33.6 million or 70% of the increase. This change in the mix of the loan portfolio was due, in large part, to the Bank's strategy to deemphasize higher risk commercial real estate, while continuing to actively pursue less risky and lower yielding residential real estate loans. The Bank's fees on loans continued to decrease in 1999; decreasing $333 thousand from 1998 to 1999. The Bank holds many of its originated mortgages in portfolio rather than sell them in the secondary market. The Bank has historically had a disproportionately low allocation of residential real estate mortgages in its portfolio. Management believes the retention of these credits in portfolio, while decreasing servicing revenue, will result in higher interest revenue than could be earned in the Bank's investment portfolio. The Bank continues to deploy excess funds in its investment portfolio, the average balance of which increased by $18.7 million. The average interest rate on those investments decreased by five basis points from 1998 to 1999. Average interest bearing deposits increased by $44.8 million during 1999, and the average rate on those deposits decreased 39 basis points, from 3.99% to 3.60%. The decrease in rates paid on deposits is attributable to the overall lower interest rate environment during the year, and is also attributable to a change in the mix of the deposit base. Average balances in Savings, Money Market and NOW accounts increased by $54 million, at an average interest rate for 1999 of 3.0%, while average balances in higher cost time deposits decreased by $9.2 million, at an average interest rate of 4.96% for 1999. Total interest and dividend income decreased $135 thousand from 1997 to 1998 (.3%) and total interest expense increased by $292 thousand (1.6%), resulting in a decrease in net interest income of $427 thousand (1.4%). The overall decrease in net interest income, and resultant decrease in net interest margin is attributable to several factors. One of these is the flat yield curve and lower interest rate environment that was prevalent during 1998. Many of the Bank's longer term assets are funded with short term, or variable rate, liabilities. As the yield curve flattened over the course of 1998 loan and investment rates dropped more quickly than deposit rates. Overall average earning assets increased by $25.3 million (4.6%) from $541 million to $566 million during 1998, but the average rate earned on those assets decreased by 42 basis points from 8.92% to 8.50%. Changes in the mix of earning assets accounted for a portion of this change. Average investments, which generally have a lower yield than loans, grew by $23.7 million during 1998. Average loans decreased by $2.5 million during 1998, and the loan mix changed as the Bank continued its strategy of moving higher risk commercial real estate loans off the balance sheet. At the same time, average interest bearing liabilities increased by $11.7 million from $446 million to $457 million (2.6%), while the average rate on those liabilities decreased by only 4 basis points, from 4.09% to 4.05%. The following table presents the condensed annual average balance sheets for 1999, 1998 and 1997. The total dollar amount of interest income from assets and the subsequent yields are calculated on a taxable equivalent basis. Merchants Bancshares, Inc. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential
1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Taxable Equivaent Interest Average Interest Average Interest Average (In thousands) 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 $164,831 $10,627 6.45% $165,071 $10,728 6.50% $142,070 $ 9,443 6.65% Other, Including FHLB Stock 22,078 1,390 6.30% 3,098 161 5.20% 2,435 172 7.06% - ----------------------------------------------------------------------------------------------------------------------------------- Total Investment Securities 186,909 12,017 6.43% 168,169 10,889 6.48% 144,505 9,615 6.65% - ----------------------------------------------------------------------------------------------------------------------------------- Loans, Including Fees on Loans: Commercial 70,935 6,465 9.11% 67,609 7,017 10.38% 68,036 7,479 10.99% Real Estate 340,330 29,099 8.55% 309,534 28,095 9.08% 311,490 29,286 9.40% Consumer 14,054 1,611 11.46% 14,671 1,759 11.99% 14,763 1,763 11.94% - ----------------------------------------------------------------------------------------------------------------------------------- Total Loans (a) (b) 425,319 37,175 8.74% 391,814 36,871 9.41% 394,289 38,528 9.77% - ----------------------------------------------------------------------------------------------------------------------------------- Federal Funds Sold, Securities Sold Under Agreements to Repurchase and Interest Bearing Deposits with Banks 1,718 85 4.95% 6,143 338 5.50% 2,036 111 5.45% - ----------------------------------------------------------------------------------------------------------------------------------- Total Earning Assets 613,946 49,277 8.03% 566,126 48,098 8.50% 540,830 48,254 8.92% - ----------------------------------------------------------------------------------------------------------------------------------- Reserve for Possible Loan Losses (11,377) (14,790) (16,267) Cash and Due From Banks 22,719 21,115 22,833 Premises and Equipment 12,852 13,358 14,513 Other Assets 19,383 17,503 16,182 - ----------------------------------------------------------------------------------------------------------------------------------- Total Assets $657,523 $603,312 $578,090 =================================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY: Interest Bearing Deposits: Savings, Money Market & NOW Accounts $339,520 $10,171 3.00% $285,489 $ 9,175 3.21% $265,578 $ 8,452 3.18% Time Deposits 150,239 7,452 4.96% 159,430 8,573 5.38% 164,437 8,864 5.39% - ----------------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 489,759 17,623 3.60% 444,919 17,748 3.99% 430,015 17,316 4.03% - ----------------------------------------------------------------------------------------------------------------------------------- Federal Funds Purchased 1,408 74 5.26% 730 42 5.75% 906 54 5.96% Demand Notes Due U.S. Treasury 1,821 87 4.78% 1,939 100 5.16% 2,463 130 5.28% Other Short-Term Borrowings 7,205 376 5.22% 2,986 170 5.69% 5,925 307 5.18% Long-Term Debt 6,649 467 7.02% 6,890 470 6.82% 6,417 431 6.72% - ----------------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 506,842 18,627 3.68% 457,464 18,530 4.05% 445,726 18,238 4.09% - ----------------------------------------------------------------------------------------------------------------------------------- Demand Deposits 81,600 80,541 75,972 Other Liabilities 6,590 9,064 7,252 Stockholders' Equity 62,491 56,243 49,140 - ----------------------------------------------------------------------------------------------------------------------------------- Total Liabilities & Stockholders' Equity $657,523 $603,312 $578,090 =================================================================================================================================== Net Interest Income (a) $30,650 $29,568 $30,016 =================================================================================================================================== Yield Spread 4.35% 4.45% 4.83% =================================================================================================================================== NET INTEREST INCOME TO EARNING ASSETS 4.99% 5.22% 5.55% =================================================================================================================================== Tax exempt interest has been converted to a tax equivalent basis using the Federal tax rate of 34%. Includes nonaccruing loans.
The following table sets forth, for each major category of interest earning assets and interest bearing liabilities, the dollar amounts of fully taxable equivalent interest income and interest expense and changes therein for 1999 as compared with 1998.
1999 vs 1998 - ----------------------------------------------------------------------------------------------------- Due to (a) Increase ------------------ (In thousands) 1999 1998 (Decrease) Volume Rate - ----------------------------------------------------------------------------------------------------- Fully Taxable Equivalent Interest Income: Loans (b) $37,175 $36,871 $ 304 $2,929 $(2,625) Investments 12,017 10,889 1,128 1,205 (77) Federal Funds Sold, Securities Sold Under Agreements to Repurchase and Interest Bearing Deposits with Banks 85 338 (253) (219) (34) - ----------------------------------------------------------------------------------------------------- Total Interest Income 49,277 48,098 1,179 3,914 (2,735) - ----------------------------------------------------------------------------------------------------- Less Interest Expense: Savings, Money Market & NOW Accounts 10,171 9,175 996 1,619 (623) Time Deposits 7,452 8,573 (1,121) (456) (665) Federal Funds Purchased 74 42 32 36 (4) Demand Note-U.S. Treasury 87 100 (13) (6) (7) Debt and Other Borrowings 843 640 203 203 (0) - ----------------------------------------------------------------------------------------------------- Total Interest Expense 18,627 18,530 97 1,396 (1,299) - ----------------------------------------------------------------------------------------------------- Net Interest Income $30,650 $29,568 $ 1,082 $2,519 $(1,437) ===================================================================================================== 1998 vs 1997 - ----------------------------------------------------------------------------------------------------- Due to (a) Increase ------------------ (In thousands) 1998 1997 (Decrease) Volume Rate - ----------------------------------------------------------------------------------------------------- Fully Taxable Equivalent Interest Income: Loans (b) $36,871 $38,528 $(1,561) $ 0 $(1,561) Investments 10,889 9,615 1,879 (30) 1,909 Federal Funds Sold, Securities Sold Under Agreements to Repurchase and Interest Bearing Deposits with Banks 338 111 (204) - (204) - ----------------------------------------------------------------------------------------------------- Total Interest Income 48,098 48,254 114 (30) 144 - ----------------------------------------------------------------------------------------------------- Less Interest Expense: Savings, Money Market & NOW Accounts 9,175 8,452 235 - 235 Time Deposits 8,573 8,864 644 18 662 Federal Funds Purchased 42 54 22 - 22 Demand Note-U.S. Treasury 100 130 22 12 10 Debt and Other Borrowings 640 738 (69) 106 (175) - ----------------------------------------------------------------------------------------------------- Total Interest Expense 18,530 18,238 (434) 136 (570) - ----------------------------------------------------------------------------------------------------- Net Interest Income $29,568 $30,016 $ 548 $ (167) $ 715 ===================================================================================================== - -------------------- 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. Includes balances of non-accruing loans. Included in Interest Income are fees on loans totaling $1,236, $1,570 and $1,619 for the years ended December 31, 1999, 1998 and 1997, respectively
RESERVE FOR POSSIBLE LOAN LOSSES Continued success at recovering previously charged off obligations allowed the Bank to cover charge off activity during 1999. Over the course of 1999 the Bank recorded $388 thousand in individual recoveries on previous obligations, which were partially charged off, as a credit loan loss provision. It is the Bank's practice to record significant recoveries as an offset to the loan loss provision in the income statement. In the fourth quarter of 1998, the Bank recorded a $1.6 million negative provision for possible loan losses resulting in an overall negative provision of $1.7 million for 1998. The 1998 reduction of the loan loss reserve was primarily the result of an internal review of the Bank's loan loss reserve requirement, which considered the changing mix and improved quality of the loan portfolio, the impact of conservative underwriting standards implemented in prior periods, general economic conditions, and the resolution of a significant troubled credit. The Bank's analysis was substantiated by a comprehensive assessment of its loan portfolio and review of its loan loss reserve requirement by its external loan review firm during the fourth quarter of 1998. For a more detailed discussion of the Bank's reserve for possible loan losses see "Credit Quality and Reserve for Possible Loan Losses". NONINTEREST INCOME AND EXPENSES Excluding certain litigation settlement proceeds of $1.3 million in 1999 and $120 thousand in 1998 (for more information on the Company's litigation see Part I, Item 3-"Legal Proceedings"), and gains on sales of investment securities of $44 thousand in 1998, noninterest income increased $157 thousand from 1998 to 1999. Service Charges on deposits increased $268 thousand from 1998 to 1999. The increase is primarily a result of increases in the Bank's overdraft charges. The increase in the overdraft charges took effect May 1, 1999; net overdraft revenue for 1999 was $390 thousand higher than 1998. This increase was offset by continued decreases in the Bank's monthly deposit service charge revenue, which decreased by $145 thousand from 1998 to 1999. This decrease in service charge revenue is due primarily to the success of the Bank's FreedomLYNX(R) checking account product, which generally charges no monthly fees. The average interest cost for the Bank's FreedomLYNX (R) accounts at December 31, 1999 was approximately 1.38% and the average balance maintained by the customer is higher than a regular checking account. This account is representative of a strategic decision made by the Bank to de-emphasize fee income in favor of collecting low interest checking account balances which will increase interest margin income over time. Other Noninterest Income decreased by $123 thousand from 1998 to 1999. The Bank sold loans totaling $15.1 million during 1998 and recognized a gain of $213 thousand on that sale; there were no gains on loan sales during 1999. This decrease in revenue was offset by increased ATM and debit card income. The Bank implemented an ATM surcharge for non-bank customers during the fourth quarter of 1998. ATM and debit card fees were $181 thousand higher in 1999 compared to 1998. The Bank changed its reporting for its merchant credit card portfolio during 1999. The credit card merchant discount fee income is presented net of assessment expenses, and is included as a component of the "Other" line item in the non-interest income section of the Consolidated Statement of Operations. All previous periods have been reclassified for consistency. Noninterest expenses increased $536 thousand (2.2%) from 1998 to 1999. Compensation expenses increased $656 thousand (5.7%) from 1998 to 1999. The increase is primarily a result of merit increases and increases in the costs of certain employee benefits, as well as the addition of 11 new employees in connection with the Bank's branch purchase discussed previously. The Company continued its incentive program during 1999. The program is designed to compensate employees based on their individual performance, as well as the performance of their division. The program for 1999 focused on increased sales and overall Bank performance for employees in the Bank's service center, and on increased sales and individual branch and portfolio profitability in the branches and sales divisions. Occupancy and Equipment expenses decreased slightly from 1998 to 1999, while legal and professional fees decreased $667 thousand. The decrease in legal and professional fees is largely due to decreases in expenses incurred by the Bank in connection with the litigation described in Part I, Item 3- "Legal Proceedings". Other Noninterest expenses increased $540 thousand; there are a number of items contributing to this increase. Costs incurred in conjunction with the conversion of the branches acquired from Chittenden totaled $258 thousand, $175 thousand of which were charged to legal and professional, and $83 thousand of which are included in other noninterest expenses. Amortization of the Bank's core deposit intangible increased by $75 thousand, a result of the intangible asset created in conjunction with the branch purchase mentioned previously. The cost of the Bank's transportation costs increased $115 thousand during 1999 primarily as a result of the outsourcing of certain of its courier services. Excluding net gains on the sale of investment securities of $44 thousand in 1998 and $784 thousand in 1997 noninterest income increased $119 thousand (2.0%) from 1997 to 1998. The increase was primarily the result of increases in Trust Company income of $155 thousand, a 9.5% increase. Service charges on deposits decreased $319 thousand during 1998, a 10.4% decrease. The decrease in service charge revenue was primarily a result of the Bank's continued FreedomLYNX(r) sales campaign. Other non-interest income increased by $163 thousand during 1998, primarily due to the recognition of gains on the sales of certain loans of $213 thousand (see Balance Sheet Analysis). Noninterest expenses decreased $3.0 million (11.1%) from 1997 to 1998. A significant contributing factor being a decrease of $1.4 million (37.1%) in legal and professional fees, from $3.9 million for the year ended December 31, 1997 to $2.4 million for the year ended December 31, 1998. This decrease was due primarily to a decrease in expenses incurred by the Bank in connection with the litigation described in Part I, Item 3, Legal Proceedings. Losses on the disposition of fixed assets also decreased $961 thousand (88%) during 1998, primarily a result of $400 thousand in expenses recognized during 1997 related to the Company's conversion to the Windows NT platform. Additionally, during 1997, the Bank wrote down its cost basis of its branch in Brattleboro, Vermont by $478 thousand in conjunction with the sale of the building. Substantially all of the 1998 expense was related to the Bank's conversion of its teller system to the Windows NT platform during 1998. Salaries and wages increased by $752 thousand (8.7%) from 1997 to 1998. This increase is primarily attributable to the Company's incentive program. Other noninterest expenses decreased by $419 thousand during 1998, primarily the result of a decrease in the contribution made to the Merchants Bank Foundation during 1998, from $400 thousand during 1997 to $150 thousand during 1998. Finally, during 1997, an investment held by a subsidiary of the Bank was written down by $229 thousand. The Company recognized $1.6 million in low-income housing tax credits as a reduction in the provision for income taxes during 1999 and $1.3 million during 1998. As of December 31, 1999, the Company has a cumulative deferred prepaid tax asset of approximately $5.3 million arising from timing differences between the Company's book and tax reporting. The prepaid tax asset is included in other assets. BALANCE SHEET ANALYSIS The Company's year-end balance sheet grew by $66 million (10.47%) during 1999, while the Company's earning assets increased by $71.1 million (12.2%) from $585.1 million to $656.2 million. The investment portfolio grew by $22.4 million (12.7%) as the Bank continued to redeploy excess funds into its investment portfolio, and the loan portfolio increased by $48.2 million (11.9%). The changes in the composition of the Bank's loan portfolio during 1999 are shown in the following table:
As of December 31, Type of Loan 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------- (In thousands) Commercial, Financial & Agricultural $ 72,333 $ 63,953 $ 73,523 $ 61,091 $ 76,925 Real Estate-Construction 12,701 8,091 8,695 3,420 9,644 Real Estate-Commercial 171,988 170,892 181,018 203,022 225,884 Real Estate-Residential 180,906 147,348 111,270 104,355 120,318 Installment 15,313 14,676 15,450 14,831 16,560 All Other Loan 451 532 432 534 393 ------------------------------------------------------------------------------------- $453,692 $405,492 $390,388 $387,233 $449,724 =====================================================================================
Year-end residential real estate loans increased by $33.6 million. $10.1 million of this increase is due to loans acquired with the branch purchase. The Bank continued to promote its RealLYNX(TM) residential real estate loan product during 1999. This product shortens the turnaround time on residential mortgages by requiring reduced documentation from borrowers. The product is priced at a slight premium to the market and requires a maximum LTV of 80%. The popularity of this product coupled with the high volume of refinancing of home mortgages during the low interest rate environment that was prevalent during the early part of 1999 helped to fuel much of the growth in the residential real estate portfolio. Substantially all of the originations in the last two years were placed in the Bank's portfolio as the Bank currently does not sell home mortgages on the secondary market. The Bank currently services $106.1 million in residential mortgage loans 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. Year-end commercial mortgage balances were $1.1 million higher at December 31, 1999 than at December 31, 1998. After netting out the $4.0 million in commercial mortgages acquired in conjunction with the branch purchase from the Chittenden Corporation, the commercial mortgage portfolio decreased by $2.9 million from 1998 to 1999. This change reflects the Bank's continuing strategy to deemphasize higher risk commercial real estate loans as it more actively pursues small business and commercial credits, as well as residential real estate loans. The Bank's commercial loan portfolio was $8.4 million higher at the end of 1999 than at the end of 1998. Excluding the $7.1 million in commercial loans acquired in conjunction with the branch purchase from the Chittenden Corporation, the commercial loan portfolio increased by $1.2 million. The Bank introduced its new CommerceLYNX(tm) program during 1999. CommerceLYNX(tm), directed at the small business community, is a package of business banking services, including low cost electronic checking, investment accounts, and a streamlined credit application. The Bank's philosophy of simplifying product offerings and minimizing fees has been applied to this program. Branch presidents are trained to offer this service, leading with the introduction of small business financing options and the value of utilizing the efficient transaction accounts. CommerceLYNX(TM) was tested in seven pilot markets throughout Vermont. The program has been enhanced and streamlined during 2000 to reflect market feedback and the arrival of technology options, and has been expanded to include all 35 branches and 11 corporate banking officers. The Bank also continues to participate in the U.S. Small Business Administration guaranteed loan program. In 1999, the Bank's Asset and Liability Management Committee ("ALCO") continued the strategy of holding most of its originated loans in portfolio instead of selling them on the secondary market. The following table presents the distribution of the varying maturities or repricing opportunities of the loan portfolio at December 31, 1999.
Over One One Year Through Over Five Type of Loan Or Less 5 Years Years Total -------------------------------------------------------------------------------- (In thousands) Commercial Loans, Industrial Revenue Bonds, Lease Financing and All Other Loans $ 36,534 $ 25,942 $ 10,315 $ 72,791 Real Estate Loans 87,583 127,765 151,685 367,033 Installment Loans 3,487 5,331 5,050 13,868 -------------------------------------------------------------------------------- $127,604 $159,038 $167,050 $453,692 ================================================================================
Loans maturing or repricing after one year which have predetermined interest rates totaled $322.9 million. Loans maturing or repricing after one year which have floating or adjustable interest rates totaled $2.9 million. The Company's interest bearing liabilities increased by $64.6 million (13.4%) from $480.1 million to $544.7 million during 1999. $30.8 million of this change is a result of the branch purchase. Excluding this branch purchase the Bank's Savings, NOW and Money Market Accounts increased by $42.9 million from $310 million at year-end 1998 to $353 million at year-end 1999, while the Bank's time deposits decreased by $11.1 million from $154.5 million at year-end 1998 to $143.4 million at year-end 1999. The Bank's deposit mix has continued to change as the Bank has targeted its marketing toward obtaining low cost transactional accounts. During 1999, the Bank continued its FreedomLYNX(R) direct mail campaign, and offered the account free for life over the course of the year. Additionally, the Bank continued to market its new MoneyLYNX(TM) and CommerceLYNX(TM) money market accounts. The balances pay interest at competitive rates based on a tiered balance structure. The average cost of funds on these money market balances at December 31, 1999 was 4.46%. Balances in these accounts totaled $138 million at year-end 1999 versus $51 million at year-end 1998. Balances in the Bank's FreedomLYNX(R) accounts continue to increase, with balances of $46.8 million at December 31, 1999 versus $19.8 million at December 31, 1998. The FreedomLYNX(R) account bears interest at a slight premium to the NOW rate on balances over $1,500 and requires no minimum balance, the average cost of these funds at year-end was 1.38%. The Bank introduced its new TimeLYNX(TM) product in late 1999; this product allows the customer, subject to certain restrictions, to make deposits to and withdrawals from their certificate of deposit prior to maturity. The following schedule shows the average balances of various classifications of deposits:
(In thousands) 1999 1998 1997 -------------------------------------------------------------- Demand Deposits $ 81,600 $ 80,541 $ 75,972 Savings, Money Market and Now Accounts 339,520 285,489 265,578 Time Deposits $100,000 and Greater 23,469 24,130 19,750 Other Time Deposits 126,771 135,300 144,687 -------------------------------------------------------------- Total Average Deposits $571,360 $525,460 $505,987 ==============================================================
Time Deposits $100 thousand and greater at December 31, 1999 had the following schedule of maturities:
(In thousands) ----------------------------------- Three Months or Less $ 5,371 Three to Six Months 6,199 Six to Twelve Months 4,541 Over Twelve Months 9,479 Over Five Years - ----------------------------------- $25,590 ===================================
CREDIT QUALITY AND RESERVE FOR POSSIBLE LOAN LOSSES Improving credit quality has been a major strategic focus of the Bank since 1994. The success of this program is evidenced by the Bank's aggressive reduction in the level of problem assets over the prior four years. The following tables summarize the Bank's nonperforming assets (NPAs) as of December 31, 1995 through December 31, 1999. Nonperforming assets were up slightly at December 31, 1999, after four years of decline. The increase was primarily due to the transfer of one commercial real estate loan relationship ($1.1 million outstanding) to nonaccrual. In general loan quality remained strong, with year end delinquencies totaling 0.38% of total loans.
(In thousands) 1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------ Nonaccrual Loans $2,800 $2,103 $2,686 $4,091 $25,617 Loans Past Due 90 Days or More and Still Accruing 199 170 403 216 237 Restructured Loans 689 320 215 2,403 1,430 - ------------------------------------------------------------------------------------ Total Nonperforming Loans: 3,688 2,593 3,304 6,710 27,284 - ------------------------------------------------------------------------------------ Other Real Estate Owned 133 470 591 1,925 7,772 - ------------------------------------------------------------------------------------ Total Nonperforming Assets: $3,821 $3,063 $3,895 $8,635 $35,056 ==================================================================================== NPL to Total Loans 0.81% 0.64% 0.85% 1.70% 3.61% NPA to Total Loans plus OREO 0.84% 0.75% 1.00% 2.20% 3.28% - ------------------------------------------------------------------------------------
Excluded from the 1999 balances above are approximately $4.0 million of internally classified loans. Management believes that these loans have well- defined weaknesses which, if left unattended, could lead to collection problems. Management maintains an internal listing, which includes these loans, which is reviewed and updated monthly. The oversight process on these loans includes an active risk management approach. A management committee reviews the status of these loans each quarter and determines or confirms the appropriate risk rating and accrual status. The findings of this review process are instrumental in determining the adequacy of the loan loss reserve. Discussion of 1999 Events affecting Nonperforming Assets Historically, the Bank has worked closely with borrowers to collect obligations and pursued more vigorous collection efforts where necessary. The Bank's Credit Department and Loan Workout functions provide resources to address collection strategies for nonperforming assets.
(In thousands) 12-31-99 9-30-99 6-30-99 3-31-99 12-31-98 - ---------------------------------------------------------------------------------- Nonaccrual Loans $2,800 $2,021 $1,979 $2,433 $2,103 Loans Past Due 90 Days or More and Still Accruing 199 24 48 63 170 Restructured Loans 689 703 469 479 320 Other Real Estate Owned 133 28 198 57 470 - ---------------------------------------------------------------------------------- Total $3,821 $2,776 $2,694 $3,032 $3,063 ==================================================================================
Significant events affecting NPAs are discussed below. Nonaccrual Loans Nonaccrual loans increased from $2.1 million at December 31, 1998 to $2.8 million at December 31, 1999, with the addition of one commercial real estate relationship ($1.1 million) to nonaccrual. During 1999, management identified approximately $3.0 million in accounts it perceived as having certain risks, which were transferred to nonaccrual status. These transfers were offset by continued resolution of nonaccrual accounts. Approximately $206 thousand in loans were returned to accrual status; principal payments of approximately $1.0 million were collected; nonaccruing loans totaling approximately $616 thousand were sold; and charge-offs totaling $495 thousand further decreased the balance of nonaccruing loans. Loans Past Due 90 Days or More and Still Accruing Interest The Bank generally places loans that become 90 or more days past due in nonaccrual status. If, in the opinion of management, the ultimate collectibility of principal and interest is assured, loans may continue to accrue interest and be left in this category. Included in this category are loans which have reached maturity and have not been renewed on a timely basis, for reasons other than financial capacity to pay. Balances of loans 90 or more days past due increased $29 thousand from year-end 1998 to year- end 1999, to $199 thousand. Restructured Loans Restructured loans (TDRs) increased from $320 thousand at December 31, 1998 to $689 thousand at December 31, 1999. One restructured commercial relationship ($286 thousand) was the primary cause of the increase. Other Real Estate Owned The Bank continued its success in 1999 in disposing of Other Real Estate Owned ("OREO") and continues to aggressively market remaining OREO. The balance of OREO decreased from $470 thousand at December 31, 1998 to $133 thousand at December 31, 1999. During the year $286 thousand in loan balances were transferred to OREO, offset by sale proceeds during 1999 of $995 thousand, which included $329 thousand in gains. Policies and Procedures Related 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, rather than when it is collected. The Bank's policy is to classify a loan 90 days or more past due with respect to principal or interest as a nonaccruing loan, unless the ultimate collectibility of principal and interest is assured. Income accruals are suspended on all nonaccruing loans, and all previously accrued and uncollected interest is typically charged against current income. A loan remains in nonaccruing status until the factors which suggest doubtful collectibility no longer exist, 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 Bank can, and usually will, initiate foreclosure proceedings. The result of such action will either be to cause repayment of the loan with the proceeds of a foreclosure sale or to give the Bank 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 noninterest expense in the statement of operations. 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 of Directors also establishes restrictions regarding the types of loans that may be granted and the distribution of loan types within the Bank's portfolio, and sets loan authority limits for each lender. These authorized 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 Bank's credit department. All extensions of credit of $2.5 million or greater to any one borrower, or related party interest, are reviewed and approved by the Loan Committee of the Bank's Board of Directors. Using a variety of management reports, the Bank's loan portfolio is regularly 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, creditworthiness, and strength of documentation. The Bank has hired an external loan review firm to assist in monitoring both the commercial and residential loan portfolios. Credit risk 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 takes remedial actions to assure full and timely payment of loan balances. Reserve for Possible Loan Losses The Reserve for Possible Loan Losses ("RPLL") is based on management's estimate of the amount required to reflect the risks in the loan portfolio, based on circumstances and conditions known at each reporting date. The Bank reviews the adequacy of the RPLL at least quarterly. 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. The method used in determining the amount of the RPLL is not based on maintaining a specific percentage of RPLL to total loans or total nonperforming assets. Rather, the methodology is a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors, which indicate both general and specific credit risk. Losses are charged against the RPLL when management believes that the collectibility of principal is doubtful. To the extent management determines the level of anticipated losses in the portfolio has significantly increased or diminished, the RPLL is adjusted through current earnings. As part of the Bank's analysis of specific credit risk, detailed and extensive reviews are done on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings and internal credit rating reports. Loans deemed impaired at December 31, 1999 totaled $4.1 million. Impaired loans have been allocated $1.0 million of the RPLL. Overall, management believes that the RPLL is maintained at an adequate level, in light of historical and current factors, to reflect the level of credit risk in the loan portfolio. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the RPLL. The following table reflects the Bank's loan loss experience and activity in the RPLL for the past five years. Loan Losses and Reserve for Possible Loan Losses Reconciliation December 31, 1999
(In thousands) 1999 1998 1997 1996 1995 - ----------------------------------------------------------------------------------------------- Average Loans Outstanding $425,319 $391,814 $394,289 $406,514 $481,047 RPLL Beginning of Year 11,300 15,831 15,700 16,234 19,929 Charge-Off: Commercial, Lease Financing and all Other Loans (363) (685) (483) (907) (3,671) Real Estate-Construction 0 (18) (78) (602) (1,485) Real Estate-Mortgage (347) (3,042) (763) (3,206) (12,942) Installment & Credit Cards (164) (190) (372) (405) (263) - ----------------------------------------------------------------------------------------------- Total Loans Charged Off (875) (3,935) (1,696) (5,120) (18,361) - ----------------------------------------------------------------------------------------------- Recoveries: Commercial, Lease Financing and all Other Loans 972 554 615 391 1,232 Real Estate-Construction 150 - - 63 32 Real Estate-Mortgage 92 451 2,996 856 1,224 Installment & Credit Cards 87 136 78 125 78 - ----------------------------------------------------------------------------------------------- Total Recoveries 1,151 1,141 3,689 1,435 2,566 - ----------------------------------------------------------------------------------------------- Net Loan Losses 277 (2,794) 1,993 (3,685) (15,795) - ----------------------------------------------------------------------------------------------- Provision for Possible Loan Losses: Charged to Operations (1) (388) (1,737) (1,862) 3,150 12,100 - ----------------------------------------------------------------------------------------------- RPLL End of Year $ 11,189 $ 11,300 $ 15,831 $ 15,700 $ 16,234 =============================================================================================== RPLL to Total Loans 2.47% 2.79% 4.06% 4.05% 3.61% Net Loan Losses to Average Loans 0.07% 0.71% 0.51% 0.91% 3.28% - ----------------------------------------------------------------------------------------------- - -------------------- 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.
As of December 31, 1999 the Company's reserve ratios were 293% of nonperforming assets and 2.47% of total loans. The unallocated portion of the RPLL was reduced to $548 thousand at December 31, 1999 as a result of management's decision to increase the general reserve allocation for "Fair" rated loans. Approximately $107 million of the Bank's commercial loans are assigned this grade, which was introduced to the Bank's grading system in 1996, so it has yet to be tested by an economic downturn. The level of the RPLL 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 that 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. 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 Bank will be able to complete the disposition of nonperforming assets without incurring further losses, or that the Bank will continue to recognize substantial recoveries such as those received during 1999 and 1998. RISK MANAGEMENT Management and the Board of Directors are committed to sound risk management practices throughout the organization. The Company has developed and implemented a centralized risk management monitoring program. Risks associated with the Company's business activities and products are identified and measured as to probability of occurrence and impact on the Company (low, moderate or high), and the control or other activities in place to manage those risks are identified and assessed. Periodically, department-level and senior managers re-evaluate and report on the risk management processes for which they are responsible. This documented program provides management with a comprehensive framework for monitoring the Company's risk profile from a macro perspective, while also serving as a tool for assessing internal controls over financial reporting as required under the FDIC Improvement Act. Market Risk Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company's primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company's asset/liability management process which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the ALCO. In this capacity the ALCO develops guidelines and strategies impacting the Company's asset/liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels/trends. Interest Rate Risk Interest rate risk is the exposure to a movement in interest rates, which could affect the Company's net interest income. It is the responsibility of the Company's ALCO to manage interest rate risk which arises naturally from imbalances in repricing, maturity and/or cash flow characteristics of the Company's assets and liabilities. The ALCO is responsible for developing asset/liability management strategies and tactics, and for ensuring that the Board of Directors receives timely, accurate information regarding the Bank's interest rate risk position at least quarterly. Techniques used by the ALCO take into consideration the cash flow and repricing attributes of balance sheet and off-balance sheet items and their relation to possible changes in interest rates. The ALCO uses interest rate caps and floors to help minimize the Bank's exposure to changes in interest rates. Through the use of computerized modeling systems, and with the assistance of outside consultants, the effect on the Company's net interest income of a possible 200 basis point change in interest rates, in rising and declining scenarios, is determined and evaluated by management. The Bank has established a target range for the change in net interest income, given a 200 basis point change in interest rates, of zero to 7.5%. As of December 31, 1999, through the use of such computer models, the change in net interest income for the 12 months ending December 31, 2000 from the Company's expected or "most likely" forecast is as follows:
Net Interest Rate Change Income Sensitivity ------------------------------------------- Up 200 basis points (2.17)% Down 200 basis points 4.91% -------------------------------------------
The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit run-off rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate caps or floors on adjustable rate assets and liabilities, the potential effect of changes in debt service levels of customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect all actions that ALCO might take in responding to or anticipating changes in interest rates. The model used to perform the simulation assumes a parallel shift of the yield curve over twelve months and reprices every interest-bearing asset and liability on the Bank's balance sheet. The model uses contractual repricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposits such as NOW accounts and Money Market accounts which are subject to repricing based on current market conditions. Investment securities with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. The model also assumes that the rate at which certain mortgage related assets prepay will vary as rates rise and fall, prepayment estimates are derived from the Office of Thrift Supervision Net Portfolio Value Model. The Company has entered into interest rate cap and floor contracts to mitigate the effects on net interest income in the event interest rates on variable rate deposits rise or rates on variable rate loans decline. The notional principal amounts of contracts outstanding were $60 million, the amortized cost of such contracts was $161 thousand and the fair value of the contracts was $402 thousand as of December 31, 1999. The Company will receive payments under these contracts in the event of specified changes in certain interest rates. As of December 31, 1999 interest rate caps with a notional amount of $40 million were in the money. The interest rate caps were sold in February of 2000, a gain of $345 thousand was realized, which will be accreted into income over the remaining life of the caps that were sold. The Company's interest rate sensitivity gap ("gap") is pictured below. Gap is defined as the difference between assets and liabilities repricing or maturing within specified periods. An asset-sensitive position (positive gap) indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or maturing within a specified time period, which would imply a favorable impact on net interest income during periods of rising interest rates. Conversely, a liability-sensitive position (negative gap) generally implies a favorable impact on net interest income during periods of falling interest rates. The Company's gap presentation may not reflect the degrees to which interest earning assets and interest bearing deposits respond to changes in market interest rates.
Repricing Date - --------------------------------------------------------------------------------------------------- One Day Over Six One Year To Six Months To To Five Over Five (In thousands) Months One Year Years Years Total - --------------------------------------------------------------------------------------------------- Assets Loans $ 126,227 $ 38,120 $208,433 $ 69,723 $442,503 Mortgage Backed Securities and Collateralized Mortgage Obligations 12,192 17,530 68,212 57,081 155,015 US Treasury & Agency Securities 1,969 1,967 9,163 30,396 43,495 Other Securities 4,026 - - - 4,026 Other Assets - - - 56,324 56,324 - --------------------------------------------------------------------------------------------------- Total Assets $ 144,414 $ 57,617 $285,808 $213,524 $701,363 =================================================================================================== Liabilities and Stockholders' Equity Noninterest-bearing Deposits - - - $ 86,160 $ 86,160 Interest-bearing Deposits $ 292,846 $ 52,562 $174,917 6,758 527,083 Borrowed Funds 11,000 - - - 11,000 Other Liabilities - - 5,030 7,354 12,384 Stockholders' Equity - - - 64,736 64,736 - --------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 303,846 $ 52,562 $179,947 $165,008 $701,363 =================================================================================================== Cumulative Gap $(159,432) $(154,377) $(48,516) Gap as a % of Total Earning Assets (24.30)% (23.52)% (7.39)% - ---------------------------------------------------------------------------------------------------
Based on historical experience and the Bank's internal repricing policies, it is the Bank's practice to present repricing of statement savings, savings deposits and NOW account balances in the "one to five year" category. The Bank's experience has shown that the rates on these deposits tend to be less rate-sensitive than other types of deposits. Credit Risk A network of loan officers manages credit risk, with review by the Bank's Credit Department and oversight by the Board of Directors. The Board of Directors grants each loan officer the authority to originate loans on behalf of the Bank and establishes policies regarding loan portfolio diversification and loan officer lending limits. The Bank's loan portfolio is continuously monitored, through the use of a variety of management reports and with the assistance of an external loan review firm, for performance, creditworthiness and strength of documentation. Credit ratings are assigned to commercial loans and are routinely reviewed. When necessary, loan officers or the loan workout function take remedial actions to assure full and timely payment of loan balances. The Bank's policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due 90 or more days and the ultimate collectibility of principal or interest becomes doubtful. Credit card balances 90 or more days past due are charged off and consumer installment loans are charged off when they reach 120 days past due. Liquidity and Capital Resource Management Liquidity, as it pertains to banking, can be defined as the ability to generate cash in the most economical way to satisfy loan and deposit withdrawal demand, and to meet other business opportunities that 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, including $25 million in available Federal Funds lines of credit with correspondent banks at year-end 1999; an overnight line of credit with the Federal Home Loan Bank ("FHLB") of $15 million; an estimated additional borrowing capacity with the FHLB of $85 million; and the ability to borrow approximately $60 million through the use of repurchase agreements, collateralized by the Bank's investments, with certain approved counterparties. Additionally, the Bank's investment portfolio is actively managed by the ALCO and is a strong source of cash flow for the Bank. The portfolio is fairly liquid, with a weighted average life of 5.5 years, and is available to be used as a source of funds, if needed. YEAR 2000 The Company, like most users of computers, computer software, and equipment utilizing computer software, faced a critical challenge regarding the Year 2000 date change. The bank regulatory agencies which regulate the conduct of the Company, the Bank and the Trust Company, through the auspices of the Federal Financial Institutions Examination Council (FFIEC) issued compliance guidelines requiring financial institutions to develop and implement plans to address the Year 2000 issue. During the past two and a half years, the Company devoted substantial time and resources toward ensuring that the Company's and its subsidiaries' operations would not be adversely impacted by the pending date change. The Bank's primary regulator, the Federal Deposit Insurance Corporation monitored the Bank's planning and implementation process on a regular basis. The Company also contracted with a national accounting firm to perform an independent review of the Company's Year 2000 preparations. These reviews were completed during 1998 and 1999. The Company is pleased to report that the Year 2000 date change was managed with no reported problems. Computer systems all functioned as expected and there were no interruptions in service. The Bank experienced no substantial deposit run-off, and none of the Bank's contingency plans had to be implemented. The Bank is not aware of any significant borrowers who have been negatively impacted by the Year 2000 date change such that it would impair their ability to repay their loans. The Bank's Year 2000 preparedness plan includes monitoring certain key dates in 2000. The Bank has experienced no problems to date. The Company hired a full-time project coordinator to oversee the testing phase of the Year 2000 project. Although there were no other staff additions, the Committee estimates that approximately 30-35 people (about 10% of our staff) spent some portion of their time working on the Year 2000 project. Additionally, the Company hired a third party to evaluate the Bank's loan loss reserve adequacy in light of Year 2000 concerns. The Company replaced all of the Bank's ATMs and upgraded certain software and equipment. Management of the Bank had approved the replacement of the ATMs prior to Year 2000 budget planning since most were 15 to 20 years old. Out of the total $1.16 million in capital costs, $835 thousand was spent to upgrade the ATM network. These costs were capitalized and depreciated over the estimated useful lives of the assets, as such assets represent replacement of existing equipment, which were not mainly being remediated for Year 2000. Direct (non-capital expenditures) Year 2000 expenses incurred since the inception of the project total $318 thousand, of which $154 thousand were incurred during 1999, and have been charged to expense as incurred. CAPITAL RESOURCES Capital growth is essential to support deposit and asset growth and to ensure the strength and safety of the Company. Net income increased the Company's capital by $10.5 million in 1999, $9.8 million in 1998, and $8.8 million in 1997. The Company and the Bank are subject to various regulatory capital requirements administered by banking regulatory agencies. To be considered adequately capitalized under the regulatory framework for prompt corrective action, the Company and the Bank must maintain minimum Tier-1 Leverage, Tier-1 Risk-Based and Total Risk-Based Capital. The Company and the Bank were above all regulatory minimums and considered well capitalized by the regulators at December 31, 1999. The ratios for the Company are set forth below:
Minimum to be Well-Capitalized Under Regulatory (In thousands) Amount Percentage Guidelines ---------------------------------------------------------------------- Tier-1 Risk-Based Capital $63,016 14.13% 6.0% Total Risk-Based Capital 68,677 15.40% 10.0% Tier-1 Leverage Capital 63,016 9.09% 5.0% ----------------------------------------------------------------------
During the third quarter of 1999, the Company's Board of Directors approved a stock repurchase program. Under the program, the Company is authorized to repurchase, through October 21, 2000 up to 120 thousand shares of its own common stock, approximately 3% of outstanding shares on the date of announcement of the program. As of December 31, 1999 the Company had purchased, under this program, 20,000 shares of stock on the open market, at a total cost of $463 thousand. The Company has continued to purchase stock during 2000, purchasing another 62,600 shares on the open market at a total cost of approximately $1.3 million. During 1998, the Company adopted a stock repurchase program pursuant to which, prior to its expiration on September 4, 1999, the Company repurchased 83,000 shares of its common stock at a total cost of approximately $2.0 million. In July 1998, the Emerging Issues Task Force ("EITF") issued guidance on Issue No. 97-14, "Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested" (the "Guidance"). This Guidance establishes standards for reporting and accounting for certain deferred compensation agreements the Company and certain directors of the Company. This Guidance requires that the deferred compensation obligation be classified in the "Stockholders' Equity" section of the balance sheets. These amounts were previously classified as other liabilities in the "Liabilities" section of the Balance Sheets. The Company adopted this guidance prospectively on September 30, 1998 and on that date reclassified deferred compensation obligations totaling $2.13 million into the Stockholders' Equity section of the balance sheet as required. 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. FORM 10-K The following is a copy, except for the exhibits, of the Annual Report of Merchants Bancshares, Inc. (the "Company") on Form 10-K for the year ended December 31, 1999, filed with the Securities and Exchange Commission (the "Commission"). TABLE OF CONTENTS
Part I Page Reference - -------------------------------------------------------------------------------------------------------------- Item 1-Business 52-57 Item 2-Properties 57-58 Item 3-Legal Proceedings 58 Item 4-Submission of Matters to a Vote of Security Holders 59 Part II - -------------------------------------------------------------------------------------------------------------- Item 5-Market for Registrant's Common Equity and Related Stockholder Matters 59 Item 6-Selected Financial Data 59 Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations 34-50 Item 7a-Quantitative and Qualitative Disclosures about Market Risk 46-48 Item 8-Financial Statements and Supplementary Data 3-33 Item 9-Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 61 Part III * - -------------------------------------------------------------------------------------------------------------- Item 10-Directors and Executive Officers of the Registrant 61 Item 11-Executive Compensation 61 Item 12-Security Ownership of Certain Beneficial Owners and Management 61 Item 13-Certain Relationships and Related Party Transactions 61 Part IV ** - -------------------------------------------------------------------------------------------------------------- Item 14-Exhibits, Financial Statement Schedules, and Reports on Form 8-K 61-63 Signatures 64 - -------------------- The information required by Part III is incorporated herein by reference from the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on April 25, 2000. A list of exhibits in the Form 10-K is set forth on the Exhibit Index included in the Form 10-K filed with the Commission and incorporated herein by reference. Copies of any exhibit to the Form 10-K may be obtained from the Company by contacting Shareholder Communications, Merchants Bancshares, Inc., P.O. Box 1009, Burlington, VT 05402. All financial statement schedules are omitted since the required information is included in the consolidated financial statements of the Company and notes thereto in the Annual Report.
PART I ITEM 1-BUSINESS Merchants Bancshares, Inc. (the "Company") is a bank holding company originally organized under Vermont law in 1983 (but reincorporated in Delaware) for the purposes of owning all of the outstanding capital stock of Merchants Bank (the "Bank") and providing greater flexibility in helping the Bank achieve its business objectives. Merchants Bank, which is the Company's primary subsidiary, is a Vermont commercial bank with 35 full-service offices. Merchants 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 Vermont state commercial bank charter, adopting its current name, Merchants Bank. Since 1971, the Bank has acquired by merger seven Vermont banking institutions, and acquired the deposits of two other Vermont banks. As of December 31, 1999 the Bank operated one of the largest commercial banking operations in Vermont, with deposits totaling $613 million, loans of $454 million, and total assets of $701 million, on a consolidated basis. The Bank is the largest independent banking company with offices exclusively in the state of Vermont. The Bank is well positioned to build market share as a result of the rapid consolidation of other banking companies currently taking place. The Bank designs its products to provide customers a clear alternative to the local, regional and national financial service providers. The Bank's simplified LYNX product line was developed using the image of the lynx feline to connote speed and agility. Lynx also implies that customers accounts can be linked and accessed via modern technology and a multi- channel delivery system. The Bank's products have all been designed to be easy for the customer to understand and for the Bank's staff to deliver. On October 29, 1999, the Bank completed the purchase of two branches, located in Bellows Falls, Vermont and Rutland, Vermont from Chittenden Corporation. The purchase was made in connection with the branch divestiture required by federal regulators with respect to Chittenden Corporation's completed merger with Vermont Financial Services Corporation, the parent company of Vermont National Bank. The transaction included two branches, one remote ATM site, approximately $38.7 million in deposits, $21.1 million in commercial loans, $13.6 million in residential and consumer loans, and certain fixed assets associated with the branches. The Bank paid a deposit premium of 3.2% and the assets were purchased at book value. A core deposit intangible asset of $1.6 million was created in connection with the transaction, which is being amortized over 7 years on an accelerated basis. The Bank has also expanded the remote ATM site located on Woodstock Avenue in Rutland to a drive-through facility staffed by a Bank employee. Merchants Trust Company (the "Trust Company"), a wholly owned subsidiary of the Bank, is a Vermont corporation chartered in 1870 for the purpose of offering fiduciary services including estate settlement, testamentary trust, guardianship, agency, intervivos trust and employee benefit plan services. The 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, 1999, the Trust Company had fiduciary responsibilities for assets having a market value in excess of $361 million, of which more than $211 million constituted managed assets. Total revenue of the Trust Company for 1999 was $3,249 thousand; total expenses were $1,376 thousand resulting in pretax net income of $1,873 thousand for the year. This net income is included in the consolidated tax return of its parent company, the Merchants Bank. 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, 1999, Merchants Properties, Inc. owned one development located in Enosburg, Vermont, consisting of a 24-unit low-income family rental housing project. Total assets of this Merchants Properties, Inc. at December 31, 1999 were $1.2 million. RETAIL SERVICES The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and loan needs of its retail customers. The Bank's retail products include interest bearing and non interest-bearing checking accounts, money market accounts, club accounts, and short-term and long-term certificates of deposit. The Bank also offers customary check collection services, wire transfers, safe deposit box rentals, and automated teller machine (ATM) cards and services. Credit programs include secured and unsecured installment lending, credit cards, home equity lines of credit, and home mortgages. In 1997, the Bank extended its commitment to automation by introducing a debit card and by expanding its automated overdraft protection. Using the BankLYNXSM Check Card, in addition to standard ATM transactions, customers can pay for purchases at locations that accept VISA(c) and can also use the card for standard ATM transactions. With expanded automated overdraft protection, customers can use a savings account and/or a home equity line of credit as overdraft protection for a checking account. The customer may choose either or both accounts to cover overdrafts. During 1998 the Bank converted all of its passbook savings accounts to statement savings accounts and introduced its MoneyLYNX(tm) Money Market Account as its primary savings vehicle. MoneyLYNX(tm) pays interest at tiered levels beginning with the first dollar in the account, and charges fees only under limited circumstances. Passbook savings accounts and statement savings accounts are no longer offered as new accounts. FreedomLYNX(r) checking is available to all applicants of good standing, and provides the benefits of being free of monthly service charges for the life of the account. The only requirement is that the customer accepts check truncation as a condition of holding the account. The account pays interest on higher balances with a tiered rate structure. No minimum balance is required. The Bank continues to offer Bottom Line Checking, an account that provides for a flat service charge up to a maximum number of checks. The Bank continues to offer ATM cards, debit cards, ATF (automatic transfer of funds) to cover overdrafts, EFT (electronic funds transfer) to automate transfers between accounts, and the PhoneLYNXSM telephone banking system. In 1999, the Bank introduced eLYNX(tm), an online banking service delivered via the Internet. It has proven to be a popular channel addition. Presently, the service is available only to retail customers. A commercial version is being tested and is targeted for market introduction in 2000. The Bank continues to provide strong customer service. Each of the Bank's 35 full-service branch offices is led by a branch president who has consumer lending authority for the full range of retail credit services. Additionally, the Bank operates 38 ATMs throughout Vermont, and maintains a customer call center with expanded hours of operation. COMMERCIAL SERVICES Branch presidents are being trained for small business lending authority up to a prescribed limit. The 11 corporate banking officers and ten corporate banking administrators provide commercial credit services throughout the state of Vermont to customers requiring business credit above the prescribed authorities of the branch presidents. In late 1998 the Bank developed a revitalized approach to small business markets in the state of Vermont. The retail branch network services approximately 75% of the commercial customers of the Bank. The Bank's corporate sales staff services the balance, primarily larger enterprises. Small business customers are being introduced to the Bank's new CommerceLYNX(tm) program. CommerceLYNX(tm) is a package of business banking services, including low cost electronic checking, investment accounts, streamlined credit application, and small business "Health Check". The Bank's philosophy of simplifying product offerings and minimizing fees has been applied to this program. Branch presidents are trained to offer this service, leading with the introduction of small business financing options and the value of utilizing the efficient transaction accounts. CommerceLYNX(tm) was tested in seven pilot markets throughout the state. The program will be enhanced during 2000 to reflect market feedback and the arrival of technology options. The Bank offers a variety of commercial checking accounts. Commercial Checking uses an earnings credit rate to help offset service charges. Small Business Checking is designed for the smaller business carrying lower balances and reduced account activity. Investment opportunities are available to businesses in the form of savings accounts and money market accounts. The Bank's cash management services provide additional investment opportunities through the Cash Sweep Program. Other cash management services include funds concentration. The Bank offers on-line banking services through PCLYNX(r) Corporate and PCLYNX(r) Small Business. These products allow businesses to view their account histories, order stop payments, transfer between accounts, transmit ACH batches and order both domestic and foreign wire transfers. An Internet-based automated banking solution is targeted for a 2000 roll-out. Other miscellaneous commercial banking services include night depository, coin and currency handling, and balance reporting services. Employee benefits management and related fiduciary services are available through the Trust Company. TYPES OF CREDIT OFFERINGS Consumer Loans: - --------------- Financing is provided for new or used automobiles, boats, airplanes, recreational vehicles and new mobile homes. Home improvement and home equity lines of credit, Visa(c) and MasterCard(c) credit cards and various collateral loans and personal loans are also available. 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. The Bank offers both fixed rate and adjustable rate mortgages for residential properties. The residential mortgage process and the product were streamlined early in 1998 to make the product easier to use and simpler for our 35 branch presidents to deliver. 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. In 1999 increased emphasis was placed on small business loans originated in our 35 branches. During the year nearly 150 loan requests, totaling $4.7 million, were processed. COMPETITION The Bank competes for deposit and loan business with numerous other commercial and savings banks, savings and loan associations, credit unions, and other non-bank financial providers. As of December 31, 1999, there were more than 25 state and national banking institutions operating in Vermont. In addition, the number of other non-bank financial service providers competing in Vermont has increased dramatically. As a bank holding company and state-chartered bank, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulation that limits the type and scope of their activities. These non- financial institutions which compete with the Company and the Bank are not subject to such extensive regulation and supervision. Competition from nationwide banks, as well as local institutions continues to be aggressive The Bank is the largest independent banking company with offices exclusively in the state of Vermont. Consolidation within the overall banking industry nationally continues to change the competitive environment in which we operate. The Bank is well positioned to build market share as a result of the rapid consolidation of other banking companies currently taking place. 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, 1999, the Company had three officers: Joseph L. Boutin, President and Chief Executive Officer; Janet Spitler, Treasurer; and Jennifer L. Varin, Secretary. No officer of the Company is on a salary basis. As of December 31, 1999, the Bank employed 232 full-time and 40 part-time employees, representing a full-time equivalent complement of 256 employees; the Merchants Trust Company employed 14 full-time employees and 1 part-time employee. The Bank and the Trust Company maintain comprehensive employee benefits programs which provide major medical insurance, hospitalization, dental insurance, long-term and short-term disability insurance, life insurance and a 401(k) Employee Stock Ownership Plan. REGULATION AND SUPERVISION General As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHCA"), the Company is subject to substantial regulation and supervision by the Federal Reserve Board. As a state- chartered bank, the Bank is subject to substantial regulation and supervision by the Federal Deposit Insurance Corporation (the "FDIC") and by applicable state regulatory agencies. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to those particular statutory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and the Bank. Financial Services Modernization On November 12, 1999, President Clinton signed into law The Gramm-Leach- Bliley Act ("Gramm-Leach") which significantly altered banking laws in the United States. Gramm-Leach enables combinations among banks, securities firms and insurance companies beginning March 11, 2000. As a result of Gramm-Leach, many of the depression-era laws which restricted these affiliations and other activities which may be engaged in by banks and bank holding companies, were repealed. Under Gramm-Leach, bank holding companies are permitted to offer their customers virtually any type of financial service that is financial in nature or incidental thereto, including banking, securities underwriting, insurance (both underwriting and agency) and merchant banking. In order to engage in these new financial activities, a bank holding company must qualify and register with the Federal Reserve Board as a "financial holding company" by demonstrating that each of its bank subsidiaries is "well capitalized," "well managed," and has at least a "satisfactory" rating under the Community Reinvestment Act of 1977 ("CRA"). These new financial activities authorized by Gramm-Leach may also be engaged in by a "financial subsidiary" of a national or state bank, except for insurance or annuity underwriting, insurance company portfolio investments, real estate investment and development and merchant banking, which must be conducted in a financial holding company. In order for the new financial activities to be engaged in by a financial subsidiary of a national or state bank, Gramm-Leach requires each of the parent bank (and its sister-bank affiliates) to be well capitalized and well managed; the aggregate consolidated assets of all of that bank's financial subsidiaries may not exceed the lesser of 45% of its consolidated total assets or $50 billion; the bank must have at least a satisfactory CRA rating; and, if that bank is one of the 100 largest national banks, it must meet certain financial rating or other comparable requirements. Gramm-Leach establishes a system of functional regulation, under which the federal banking agencies will regulate the banking activities of financial holding companies and banks' financial subsidiaries, the U.S. Securities and Exchange Commission will regulate their securities activities and state insurance regulators will regulate their insurance activities. Gramm-Leach also provides new protections against the transfer and use by financial institutions of consumers' nonpublic, personal information. Bank Holding Company Regulation Although the Company may meet the qualifications for electing to become a financial holding company under Gramm-Leach, the Company has elected to retain its pre-Gramm-Leach status for the present time under the BHCA. The Company is required by the BHCA to file with the Federal Reserve Board an annual report and such additional reports as the Federal Reserve Board may require. The Federal Reserve Board also makes periodic inspections of the Company and its subsidiaries. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire substantially all of the assets of any bank, or ownership or control of any voting shares of a bank, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. Additionally, as a bank holding company, the Company is prohibited from acquiring ownership or control of 5% or more of any company not a bank or from engaging in activities other than banking or controlling banks except where the Federal Reserve Board has determined that such activities are so closely related to banking as to be a "proper incident thereto." Dividends General. The Company is a legal entity separate and distinct from the Bank and its other non-bank subsidiaries. The revenue of the Company (on a parent company only basis) is derived primarily from interest and dividends paid to the corporation by its subsidiaries. The right of the Company, and consequently the right of stockholders of the Company, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors, in the case of banking subsidiaries), except to the extent that certain claims of the Company in a creditor capacity may be recognized. The payment of dividends by the Company is determined by its Board of Directors based on the consolidated Company's liquidity, asset quality profile, capital adequacy, and recent earnings history, as well as economic conditions and other factors, including applicable government regulations and policies and the amount of dividends payable to the Company by its subsidiaries. It is the policy of the Federal Reserve Board that banks and bank holding companies, respectively, should pay dividends only out of current earnings and only if after paying such dividends the bank or bank holding company would remain adequately capitalized. Federal banking regulators also have authority to prohibit banks and bank holding companies from paying dividends if they deem such payment to be unsafe or unsound practice. In addition, it is the position of the Federal Reserve Board that a bank holding company is expected to act as a source of financial strength to its subsidiary banks. State law requires the approval of state bank regulatory authorities if the dividends declared by state banks exceed prescribed limits. The payment of any dividends by the Company's subsidiaries will be determined based on a number of factors, including the subsidiary's liquidity, asset quality profile, capital adequacy and recent earnings history. Capital Adequacy and Safety and Soundness Capital Guidelines. Under the uniform capital guidelines adopted by the federal banking agencies, a well-capitalized institution must have a minimum ratio of total capital to risk-adjusted assets (including certain off- balance sheet items, such as standby letters of credit) of 10%, a minimum Tier 1 (comprised of common equity, retained earnings, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of noncumulative perpetual preferred stock, less deductible intangibles) capital-to-total risk based assets of 6% and a minimum leverage ratio (Tier 1 capital to average quarterly assets, net of goodwill), of 5%. Under federal banking laws, failure to meet the minimum regulatory capital requirements could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including the termination of deposit insurance by the FDIC and seizure of the institution. Prompt Corrective Action. The FDICIA provides the federal banking agencies with broad powers to take prompt corrective action to resolve problems of insured depository institutions, depending upon a particular institution's level of capital. The FDICIA establishes five tiers of capital measurement for regulatory purposes ranging from "well-capitalized" to "critically undercapitalized." A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position under certain circumstances. As of December 31, 1999, the Bank was classified as "well-capitalized" under the applicable prompt corrective action regulations. Under the FDICIA, a depository institution that is well-capitalized may accept brokered deposits. A depository institution that is adequately capitalized may accept brokered deposits only if it obtains a waiver from the FDIC, and may not offer interest rates on deposits "significantly higher" than the prevailing rate in its market. An undercapitalized depository institution may not accept brokered deposits. Safety and Soundness Standards. The FDICIA, as amended, directs each federal banking agency to prescribe safety and soundness standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, asset-quality, earnings and stock valuation. The Community Development and Regulatory Improvement Act of 1994 amended FDICIA by allowing federal banking activities to publish guidelines rather than regulations concerning safety and soundness. The Federal Reserve Board has finalized these safety and soundness guidelines. These guidelines relate to the management policies of financial institutions and are designed, in large part, to implement the safety and soundness criteria outlined in FDICIA. These guidelines will be published after the other federal bank regulatory agencies have developed their guidelines. At this time, it is not known what effect the applicable guidelines will have on the current practices of the Company or the Bank. FDICIA also contains a variety of other provisions that may affect the Company's and the Bank's operations, including reporting requirements, regulatory guidelines for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch. Certain of the provisions in FDICIA have recently been or will be implemented through the adoption of regulations by the various federal banking agencies and, therefore, their precise impact cannot be assessed at this time. Community Investment Act Pursuant to the Community Reinvestment Act ("CRA") and similar provisions of Vermont law, regulatory authorities review the performance of the Company and the Bank in meeting the credit needs of the communities served by the Bank. The applicable regulatory authorities consider compliance with this law in connection with the applications for, among other things, approval of branches, branch relocations and acquisitions of banks and bank holding companies. The Bank received a "satisfactory" rating at its most recent CRA examination. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the "Interstate Banking Act") generally permits bank holding companies to acquire banks in any state, and preempts all state laws restricting the ownership by a bank holding company of banks in more than one state. The Interstate Banking Act also permits a bank to merge with an out-of-state bank and convert any offices into branches of the resulting bank if both states have not opted out of interstate branching; permits a bank to acquire branches from an out-of-state bank if the law of the state where the branches are located permits the interstate branch acquisition; and permits banks to establish and operate de novo interstate branches whenever the host state opts-in to de novo branching. Bank holding companies and banks seeking to engage in transactions authorized by the Interstate Banking Act must be adequately capitalized and managed. Other Proposals Other legislative and regulatory proposals regarding changes in banking, and the regulation of banks and other financial institutions, are regularly considered by the executive branch of the federal government, Congress and various state governments, including Vermont, and state and federal regulatory authorities. It cannot be predicted what additional legislative and/or regulatory proposals, if any, will be considered in the future, whether any such proposals will be adopted or, if adopted, how any such proposals would affect the Company or the Bank. ITEM 2-PROPERTIES A. SCHEDULE OF BANKING OFFICES BY LOCATION As of December 31, 1999, Merchants Bank operated 35 full service banking offices, and 38 ATMs throughout the state of Vermont. The Company's headquarters are located at 164 College Street, Burlington, Vermont. The Company's administrative offices and the operations data processing center are located at 275 Kennedy Drive, South Burlington, Vermont. The Bank leases certain premises from third parties under terms and conditions considered by management to be favorable to the Company. Additional information relating to the Company's properties is set forth in Note 5 of the Company's annual report and incorporated herein by reference. ITEM 3-LEGAL PROCEEDINGS The Bank is a counterclaim defendant in a litigation entitled "Pasquale and Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim Defendant", now pending in the United States Bankruptcy Court for the District of Vermont. In this litigation, the Vescios have made a number of "lender liability" claims dealing with a commercial development known as Brattleboro West in Brattleboro, Vermont. The pending litigation arose out of a suit to foreclose on several real estate mortgages and personal property delivered to the Bank as collateral by the Vescios in connection with the financing of a supermarket in the Brattleboro West project and various other projects. Among other things, the Vescios have alleged that the Bank or its representatives violated supposed oral promises in connection with the origination and funding of the project, and have claimed that the Bank is liable to them for damages based on the Bank's supposed "control" of the project and its alleged breach of covenants of "good faith" which the plaintiffs believe are to be implied from the loan documents. In addition, the plaintiffs have contended that the Bank breached a duty of care they believe it owed to them, and have claimed that the Bank should not have exercised its contract rights when the loan went into default, but should have resolved the default in a way that was more favorable to the borrowers. Trial concluded in United States Bankruptcy Court in November 1998. In June 1999, before entry of any findings or a decision on the merits, the trial judge recused himself from all cases involving the Bank. He completed his term as bankruptcy judge on July 31, 1999. On September 30, 1999, United States District Court Judge William Sessions withdrew the reference of the case to the Bankruptcy Court and ruled that he would decide the case himself on the basis of a combination of the Bankruptcy Court trial record and rehearing certain testimony of certain witnesses. The parties subsequently stipulated to waive any rehearing of testimony and submission of further evidence and to submit the case to the District Court for a decision on the merits based on the existing trial record. The timing of a decision on the merits of the case at the trial level cannot be predicted at this time. Although it is not possible at this stage to predict the outcome of this litigation, the Bank believes that it has meritorious defenses to the plaintiffs' allegations. The Bank intends to vigorously defend itself against these claims. On March 25, 1999, Merchants Trust Company received, as trustee, a recovery of $4.8 million on account of settlement of a 1994 class action suit filed in the United States District Court for the District of Minnesota. The Trust Company's claims, and the class action, arose from investments made by the Trust Company in the so-called Piper Jaffray Institutional Government Income Portfolio ("Piper Jaffray") on behalf of the plaintiffs. In the first quarter of 1999, the Company realized $1.3 million as a result of that recovery. During the third quarter of 1999, the Trust Company disbursed the recovery, partly to itself and the balance in accordance with instructions provided by the Company's insurance carrier, pursuant to an agreement made with the carrier in December 1994. Lawyers representing the beneficiaries of five Trust Company accounts have asserted that their clients (the "Named Customers") and others similarly situated have not been fully reimbursed for damages allegedly suffered in connection with certain investments made by the Trust Company during 1993 and 1994 in Piper Jaffray on their behalf. The Company believes full reimbursement has been provided and that the Trust Company has no further liability on account of the Piper Jaffray investment. On July 15, 1999, the Trust Company filed an action with the United States District Court for the District of Vermont seeking a declaratory judgement that the Trust Company has no further liability to the Named Customers. The Named Customers filed a Motion to Dismiss the Trust Company's action, and the District Court granted that motion and declined to reconsider. The Trust Company intends to appeal the District Court's Decision. The Company and certain of its subsidiaries have been named as defendants in various other legal proceedings arising from their normal business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, based upon the opinion of counsel on the outcome of such proceedings, any such liability will not have a material effect on the consolidated financial position of the Company and its subsidiaries. ITEM 4-SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of calendar year 1999, 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 market and the price is quoted on the NASDAQ National Market Stock 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 Ended High Low ---------------------------------------- December 31, 1999 $23.911 $20.750 September 30, 1999 24.500 23.000 June 30, 1999 24.250 21.185 March 31, 1999 26.250 20.500 December 31, 1998 26.500 17.000 September 30, 1998 34.625 21.250 June 30, 1998 34.875 32.000 March 31, 1998 34.625 30.750 ----------------------------------------
As of February 3, 2000, the Company had 1,189 registered shareholders. The Company declared and distributed dividends totaling $0.80 per share during 1999. In January 2000 the Company declared a dividend of $0.21 per share. Future dividends will depend upon the financial condition and earnings of the Company and its subsidiaries, their need for funds and other factors, including applicable government regulations. ITEM 6-SELECTED FINANCIAL DATA The supplementary financial data presented in the following table 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 Management's Discussion and Analysis of Financial Condition and Results of Operations and with the year-end audited consolidated financial statements as contained in the 1999 Annual Report to Shareholders, a copy of which is attached as an addendum to this Form 10-K. Merchants Bancshares, Inc. Five Year Summary of Operations (Not Covered by Report of Independent Public Accountants)
For the Years Ended December 31, (In thousands except per share data) 1999 1998 1997 1996 1995 - --------------------------------------------------------------------------------------------------------- INCOME STATEMENT Interest and Investment Income $ 49,221 $ 48,023 $ 48,158 $ 48,004 $ 51,315 Interest Expense 18,627 18,530 18,238 18,672 23,002 - --------------------------------------------------------------------------------------------------------- Net Interest Income 30,594 29,493 29,920 29,332 28,313 Provision for Possible Loan Losses (388) (1,737) (1,862) 3,150 12,100 - --------------------------------------------------------------------------------------------------------- Net Interest Income after Provision for Loan Losses 30,982 31,230 31,782 26,182 16,213 - --------------------------------------------------------------------------------------------------------- Other Income 7,373 7,312 7,916 9,363 12,766 Other Expense 24,750 25,472 28,482 27,489 36,606 - --------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES 13,605 13,070 11,216 8,056 (7,627) Provision (benefit) for Income Taxes 3,155 3,248 2,383 1,832 (3,785) - --------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ 10,450 $ 9,822 $ 8,833 $ 6,224 $ (3,842) ========================================================================================================= SELECTED AVERAGE BALANCES - --------------------------------------------------------------------------------------------------------- Total Assets $657,523 $603,312 $578,090 $580,860 $642,487 Average Earning Assets 613,946 566,126 540,830 533,192 575,551 Loans 425,319 391,814 394,289 406,514 481,047 Total Deposits 571,359 525,460 505,987 513,923 556,242 Long-Term Debt 6,649 6,890 6,417 8,925 28,707 Shareholders' Equity 62,491 56,243 49,140 43,111 40,848 Shareholders' Equity plus Loan Loss Reserve 73,868 71,033 65,407 59,094 58,794 - --------------------------------------------------------------------------------------------------------- SELECTED RATIOS - --------------------------------------------------------------------------------------------------------- Net Income (Loss) to: Average Shareholders' Equity 16.72% 17.46% 17.98% 14.44% (9.41)% Average Assets 1.59 1.63 1.53 1.07 (0.60) Average Shareholders' Equity to Average Total Assets 9.50 9.32 8.50 7.42 6.36 Common Dividend Payout Ratio 33 32 25 - - Loan Loss Reserve to Total Loans at Year End 2.47 2.79 4.06 4.05 3.61 Net Charge-Offs to Average Loans 0.66 0.71 (0.66) 1.26 3.28 - --------------------------------------------------------------------------------------------------------- PER SHARE - --------------------------------------------------------------------------------------------------------- Basic Earnings per Common Share $ 2.39 $ 2.22 $ 2.00 $ 1.45 $ (0.90) Diluted Earnings Per Common Share 2.39 2.21 1.99 1.45 (0.90) Cash Dividends Paid 0.80 0.71 0.50 - - Year End Book Value 14.92 13.84 11.95 10.78 9.38 - --------------------------------------------------------------------------------------------------------- OTHER - --------------------------------------------------------------------------------------------------------- Cash Dividends Paid $ 3,390 $ 3,051 $ 2,141 $ - $ - - ---------------------------------------------------------------------------------------------------------
ITEM 7-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RE- SULTS OF OPERATIONS Please refer to pages 34-50 for Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 8-FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated balance sheets of Merchants Bancshares, Inc. as of December 31, 1999 and 1998, 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, 1999, together with the related notes and the opinion of Arthur Andersen LLP, independent public accountants, all as contained on pages 3 through 33 of the Company's 1999 Annual Report to Shareholders on Form 10-K, are incorporated herein by reference. ITEM 9-CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III ITEM 10-DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ITEM 11-EXECUTIVE COMPENSATION ITEM 12-SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13-CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS Reference is hereby made to pages 2-5, pages 7-8, page 10 and pages 13-15 of the Company's Proxy Statement to Shareholders dated March 24, 2000, wherein pursuant to Regulation 14 A information concerning the above subjects (Items 10 through 13) is incorporated by reference. Pursuant to Rule 12b-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 1999 Annual Report to Shareholders, are incorporated herein by reference: Consolidated Balance Sheets, December 31, 1999 and December 31, 1998. Consolidated Statements of Operations for years ended December 31, 1999, 1998 and 1997. Consolidated Statements of Changes in Stockholders' Equity for years ended December 31, 1999, 1998 and 1997. Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997. Notes to Consolidated Financial Statements, December 31, 1999. (2) The following exhibits are either filed or attached as part of this report, or are incorporated herein by reference. Exhibit Description - ------------------------------------------------------------------------------- 3.1 Restated Certificate of Incorporation of the Company (Incorporated by reference to Exhibit B to Pre-Effective Amendment No. 1 to Company's Definitive Proxy Statement for the Annual Meeting of the Stockholders of the Company, filed on April 25, 1987) 3.2 Amended By-Laws of the Company (Incorporated by reference to Exhibit C to Company's Definitive Proxy Statement for the Annual Meeting of the Stockholders of the Company, filed on April 25, 1987). 4 Instruments defining the rights of security holders, including indentures: 4.1 Specimen of the Company's Common Stock Certificate (Incorporated by Reference to Exhibit 7 to the Company's Registration Statement on Form S-14 (Registration Number 2- 86108) filed on August 22, 1983) 4.2 Description of the rights of holders of the Company's Common Stock (appearing on page 9 of the Company's Registration Statement on Form S-14 (Registration No. 2-86108) filed on August 22, 1983) 10.1 Merchants Bancshares, Inc. Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Exhibit 4.1 to Company's Registration Statement on Form S-3 (Registration No. 333-20375) filed on January 22, 1997) 10.2 401(k) Employee Stock Ownership Plan of the Company, dated January 1, 1990, as amended (Incorporated by reference to Company's Registration Statement on Form S-8 (Registration Number 33-3274) filed on November 16, 1989) 10.3 Amended and Restated Merchants Bank Pension Plan dated as of January 1, 1994 (Incorporated by Reference to Exhibit 10.6 to Post-Effective Amendment Number 1 to Company's Registration Statement on Form S-8 (Registration Number 333-18845) filed on December 26, 1996) 10.4 Form of Employment Agreement dated January 1, 1999, by and between the Company and its Subsidiaries and certain of its Executive Officers. 10.14 The Merchants Bank Amended and Restated Deferred Compensation Plan for Directors (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1997) 10.14.1 Trust Under the Merchants Bank Amended and Restated Deferred Compensation Plan for Directors (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1997) 10.15 Agreement among the Merchants Bank and Kathryn T. Boardman, Thomas R. Havers and Susan D. Struble dated as of December 20, 1995 (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1996). 10.15.1 Trust Under the Agreement among the Merchants Bank and Kathryn T. Boardman, Thomas R. Havers and Susan D. Struble dated as of December 20, 1995 (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1996). 10.16 Agreement between the Merchants Bank and Dudley H. Davis dated December 20, 1995 (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1996). 10.16.1 Fixed Trust under Agreement between the Merchants Bank and Dudley H. Davis dated December 20, 1995 (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1996). 10.16.2 Variable Trust under Agreement between the Merchants Bank and Dudley H. Davis dated December 21, 1995 (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1996). 11 Statement re: computation of per share earnings. See 1999 Annual Report to Shareholders Note 12. 13 1999 Annual Report to Shareholders 21 Subsidiaries of the Company 23 Consent of Arthur Andersen LLP 27 Financial Data Schedule (3) Reports on Form 8-K: NONE 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 February 17, 2000 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/ RAYMOND C. PECOR, JR. ---------------------- ----------------------------------- Joseph L. Boutin, Director, Raymond C. Pecor, Jr. Director, President & CEO of the Company Chairman of the Board of and the Bank Directors By /s/ PETER A. BOUYEA By /s/ CHARLES A. DAVIS ---------------------- ----------------------------------- Peter A. Bouyea, Director Charles A. Davis, Director By /s/ ROBERT A. SKIFF By /s/ JEFFREY L. DAVIS ---------------------- ----------------------------------- Robert A. Skiff, Director Jeffrey L. Davis, Director By /s/ MICHAEL G. FURLONG By /s/ PATRICK S. ROBINS ---------------------- ----------------------------------- Michael G. Furlong, Director Patrick S. Robins, Director By /s/ LEO O'BRIEN, JR. By /s/ JANET P. SPITLER ---------------------- ----------------------------------- Leo O'Brien, Jr., Director Janet P. Spitler, Treasurer of the Company, Vice President, CFO, and Treasurer of the Bank EX-10 2 EMPLOYMENT AGREEMENT EXHIBIT 10.4 EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT is made effective as of the 1st day of January, 1999, by and between MERCHANTS BANK, a state chartered bank, with principal offices at 275 Kennedy Drive, South Burlington, Vermont, (hereinafter collectively referred to as "CORPORATION") and ____________, residing at _____________ (hereinafter referred to as "EMPLOYEE"). WITNESSETH ---------- In consideration of the mutual covenants herein contained, the parties agree as follows: 1. Employment: The CORPORATION hereby employs the EMPLOYEE, and the EMPLOYEE hereby accepts employment. 2. Terms and Renewal: This Agreement shall be for a three-year term beginning on January 1, 1999, and terminating on December 31, 2001. On or before December 31, 2000, the CORPORATION shall notify EMPLOYEE if CORPORATION do not intend to renew the Agreement for a one-year term following its original term. In the event that the CORPORATION do not notify EMPLOYEE, the Agreement shall renew for a one-year term following its original term. Similarly, on each anniversary date thereafter the CORPORATION shall notify EMPLOYEE if they do not intend to renew the Agreement, and upon a failure to do so the Agreement shall automatically renew for an additional one-year term following the then applicable term. 3. Termination: 3.1 Discharge: The CORPORATION has the right to discharge the EMPLOYEE at any time with or without just cause, as herein defined. If the EMPLOYEE is discharged without just cause, the CORPORATION agree to pay in one lump sum the EMPLOYEE's salary for one year. "Just cause" shall mean (a) misconduct connected with EMPLOYEE's work, if and as defined in any written policy of the CORPORATION covering all of the CORPORATION' officers or directors which is now, or subsequently, in effect; or (b) the conviction of a felony which precludes EMPLOYEE from performing all or an essential part of his duties of employment, provided that, if such conviction is subsequently reversed, rescinded or expunged, it shall not constitute just cause for termination. 3.2 Disability: In cases of disability, either party may elect to terminate the employment, subject to the following conditions: (i) the EMPLOYEE shall receive the greater of: (a) the salary and other normal benefits plus incentive payments which the EMPLOYEE would have received had he been terminated without just cause; or (b) the benefits payable to, and actually paid to, the EMPLOYEE arising out of any disability insurance policy covering the EMPLOYEE, and paid for by the CORPORATION (if said policy benefits are paid other than in a lump sum payment, the value of the benefits, for purposes of this Agreement, shall be calculated by using a present value of all payments to be made); and (ii) EMPLOYEE has suffered a disability as defined below. "Disability" shall mean mental or physical incapacity which shall continue for six (6) months or longer after exhaustion of all sick leave benefits, or a permanent mental or physical incapacity, either of which makes the performance of substantially all of the EMPLOYEE's duties impossible, as certified in writing by the EMPLOYEE's physician. The CORPORATION, in the event of disagreement, may seek the opinion of a qualified physician to determine if such disability exists; provided, however, that such physician is Board Certified in the area of specialty pertinent to the nature and extent of such disability. In the event of further disagreement, the two physicians shall choose a third physician, qualified as above, who shall make the determination, which shall be binding upon the parties. 4. Resignation by the EMPLOYEE: The EMPLOYEE shall have the option of terminating his employment with the CORPORATION provided he gives at least 60 days advance written notice to the CORPORATION. The EMPLOYEE shall not be deemed to have resigned and, instead, shall have been deemed discharged by the CORPORATION, without just cause, if the EMPLOYEE resigns as a result of: (i) immoral, unethical or illegal acts or omissions committed by, or which reasonably appear will be committed by, any director, officer, employee, agent, or independent contractors of the CORPORATION (and the CORPORATION'S Board of Directors shall not act, after his recommendation, to terminate the offending party(s) or to cease and desist such offending activity); or (ii) acts or omissions of any director, officer, employee, agent, or independent contractors of the CORPORATION which could reasonably subject the EMPLOYEE to personal liability from any Federal, State or local government or agency, or any banking authority, including, but not limited to, the Federal Deposit Insurance Corporation, the Internal Revenue Service, or the Securities and Exchange Commission. 5. Offices and Duties: The EMPLOYEE shall be appointed and/or elected, and shall serve, as the _______________________of the CORPORATION for the term of his employment hereunder. Should the CORPORATION decide to alter the titles and/or positions, it must provide the EMPLOYEE with an essentially equivalent or better position, with equivalent or better salary and benefits. 6. Efforts: The EMPLOYEE shall devote his full-time efforts and energies to the business and affairs of the CORPORATION and shall use his best efforts, skill and abilities to promote the CORPORATION'S interests. 7. Evaluation: The EMPLOYEE shall be evaluated annually by ____________________________ and shall receive a written copy of said evaluation. Nothing herein shall allow the CORPORATION to reduce the salary, incentive payments and other benefits provided for herein, nor shall this provision be deemed to allow for the alteration of EMPLOYEE's duties and authority otherwise set forth in this Agreement. 8. Salary and Increases: The CORPORATION shall pay the EMPLOYEE for all services rendered an initial salary of __________ per annum, commencing January 1, 1999, and payable on a bi-weekly basis. The annual salary will be reviewed annually by the Board and may be increased but not decreased at the discretion of the Board. The CORPORATION may also grant the EMPLOYEE such other compensation, bonuses, benefits, etc., as they may deem proper from time to time. 9. Annual Bonus: An annual bonus will be paid to the EMPLOYEE provided the CORPORATION maintains a "CAMELS" rating of 2 or better, and the CORPORATION achieves certain objectives. 10. Benefits: The CORPORATION shall provide the EMPLOYEE with all fringe benefits (including but not limited to health, life, disability, workers compensation insurance; vacation and sick pay; pension benefits) offered to other employees of the CORPORATION in subordinate positions, but shall provide EMPLOYEE with five (5) weeks per year of vacation. 11. Long Term Incentive/Stock Option Plan: Each year, the EMPLOYEE will receive stock options with a "value" equal to 50% of his salary; provided, however, that no stock options will be awarded to the EMPLOYEE which would result in the EMPLOYEE holding unexercised stock options which exceed ____ of the issued and outstanding shares of Merchants Bancshares, Inc. The stock value is determined by calculating the "Black-Scholes" value. The exercise price will be determined annually by the CORPORATION'S Board of Directors' Compensation Committee. It is intended that the Committee will set the exercise price slightly above the then current market price for the stock of Merchants Bancshares, Inc. Options are exercisable at any time after two (2) years from their original issue date. The term of the options will expire on the earlier of (a) ten years from the issue date, while EMPLOYEE remains employed by the CORPORATION, or (b) if EMPLOYEE's employment is terminated, then twelve months after termination of employment. If the EMPLOYEE is terminated without just cause or due to his disability, or in the event that any transaction occurs which results in a change of control of the CORPORATION from that existing on the date of this Agreement, the EMPLOYEE may exercise these options immediately upon the occurrence of any such event or at any other time permitted in the preceding sub-paragraph. In the event that there is a split of the stock of Merchants Bancshares, Inc., EMPLOYEE's stock options and option price shall be adjusted accordingly, so as to leave EMPLOYEE in the same relative position as at the time of commencement of this Agreement with regard to the issued and outstanding shares of Merchants Bancshares, Inc., on the date such action is taken. In the event there is a public offering of the stock of Merchants Bancshares, Inc. other than pursuant to a stock option or an employee stock ownership plan, at any time before the options granted hereby have been fully exercised, then the number of shares subject to the options granted herein shall be increased so that the total number of shares purchased and purchasable under these options as increased will bear the same relationship to the fully-diluted capitalization of Merchants Bancshares, Inc. immediately after giving effect to completion of the public offering as the original number of shares purchasable under these option does to the fully-diluted capitalization of Merchants Bancshares, Inc. at the effective date hereof. The purchase price for additional shares covered by these options as provided in the preceding sentence shall be the greater of the purchase price provided for herein or the purchase price paid by third parties purchasing stock in the public offering. If the CORPORATION is unable to deliver the shares upon which the EMPLOYEE seeks to exercise his options, for any reason, then the CORPORATION shall pay to the EMPLOYEE, on the date of exercise, the difference between the exercise price and the trading price of Merchants Bancshares, Inc. shares on that day, as traded on the exchange on which said shares are listed. In the event that the EMPLOYEE shall become deceased during the period in which the EMPLOYEE may exercise his stock options, as provided above, then his Estate may exercise said options in the manner provided above; provided, however, that said options are exercised within six (6) months after EMPLOYEE'S demise. 12. Expenses: The EMPLOYEE shall be reimbursed for documented business expense incurred or paid by the EMPLOYEE in connection with the performance of his duties, in the manner currently required by corporate policy. 13. Indemnification: The CORPORATION agrees that, within the limits set forth in the Vermont Business Corporations Law and Delaware General Corporation Law, as applicable, they shall hold the EMPLOYEE harmless for any actions taken by the EMPLOYEE in what he reasonably believes to be in the CORPORATION'S interests or for his omission to so act or for his negligence in connection with such employment. This indemnity shall include the EMPLOYEE's reasonable attorneys' fees and costs incurred in defending any such demands, claims, or actions. The indemnity herein provided shall also include, but in no way be limited to, claims of liability arising for or on account of those acts or omissions of others described in Section 4 of this Agreement. Notwithstanding the foregoing and except to the extent insurance provides such indemnity, the CORPORATION shall have no obligation to hold the EMPLOYEE harmless from (i) any liability he may have to any governmental entity with respect to personal taxes, interest or penalties, unless that liability resulted from a liability of the CORPORATION; (ii) any claims arising out of, based upon or attributable to the gaining in fact of any personal profit or advantage to which the EMPLOYEE is not legally entitled; or (iii) any claim arising out of, based upon or attributable to the committing of any criminal or deliberately fraudulent act. Prior to receiving any purported personal profit or advantage, EMPLOYEE is entitled to receive, at the CORPORATION'S expense, an opinion of counsel that he is legally entitled to receive it. This Paragraph 13 shall not limit any immunity or indemnity provided EMPLOYEE by law or by the Articles of Association or Bylaws of the CORPORATION. 14. Binding Effect: This Agreement shall inure to the benefit of and be binding upon the EMPLOYEE, his legal representatives, heirs, and distributee(s), and upon the CORPORATION, their successors and assigns, and also any subsidiary or affiliated corporation. 15. No Waiver: The waiver of any term or condition of this Agreement shall not be deemed to constitute the waiver of any other term or condition. 16. Notices: All notices, elections hereunder and similar communication(s) shall be in writing and shall be sufficient if addressed to the EMPLOYEE at his address as shown above (or at any new address as he shall advise the CORPORATION of in writing) and mailed by certified return receipt with postage fully paid. All notices to the CORPORATION shall be given to the presiding officer of their Boards of Directors. 17. Controlling Law and Attorneys' Fees: Notwithstanding the actual place of execution, or the states of incorporation of the CORPORATION, this Agreement shall be governed by the laws of the State of Vermont and the parties hereto consent to the jurisdiction of the Courts of the State of Vermont. In the event of a breach of this Agreement, the non-breaching party shall be entitled to recover its costs and attorneys' fees from the breaching party. 18. Compliance with Law: Any and all provisions of this Agreement shall be consistent and comply with applicable laws or regulations enacted or promulgated both before and after the execution date of this Agreement, and to the extent that any provision is inconsistent or does not comply with applicable laws or regulations, that part which is inconsistent or does not comply shall be modified to comply with the applicable law or regulation. 19. Prior Agreement Superseded: This Employment Agreement replaces and supersedes an Amended Employment Agreement between the CORPORATION and the EMPLOYEE dated effective as of _______. IN WITNESS WHEREOF, the CORPORATION have caused this Agreement to be executed by directors or officers thereunto duly authorized, and the EMPLOYEE has hereunto set his hand and seal, all effective as of the day and year first above written. IN PRESENCE OF: CORPORATION MERCHANTS BANK BY: - ----------------------------- --------------------------------- MERCHANTS BANCSHARES, INC. BY: - ----------------------------- --------------------------------- EMPLOYEE - ----------------------------- --------------------------------- EX-21 3 SUBSIDIARIES OF THE COMPANY Merchants Bancshares, Inc. 1999 10-K Exhibit 21 - Subsidiaries of the Company Merchants Bank Merchants Trust Company Merchants Properties, Inc. EX-23 4 CONSENT OF ARTHUR ANDERSEN LLP CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated January 18, 2000 included in Merchants Bancshares, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1999 into Merchants Bancshares, Inc.'s previously filed Registration Statement No. 333-41051 on Form S-3, Registration Statement No. 333-34869 on Form S-8, Registration Statement No. 333-34871 on Form S-8 and Registration Statement No. 333-18845 on Form S-8, as amended by Post Effective Amendment No. 1 on Form S-8/A. /s/ Arthur Andersen LLP Boston, Massachusetts March 21, 2000 EX-27 5 FINANCIAL DATA SCHEDULE
9 1,000 12-MOS DEC-31-1999 DEC-31-1999 23,636 110 0 1,075 72,229 126,281 122,305 453,692 11,189 701,363 613,243 11,000 6,013 6,371 0 0 44 64,692 701,363 37,119 10,627 1,475 49,221 17,623 1,004 30,594 (388) 0 24,750 13,605 10,450 0 0 10,450 2.39 2.39 4.99 2,800 199 689 4,015 11,300 874 1,151 11,189 11,189 0 548
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