10-Q 1 mer1.txt FORM 10-Q FOR JUNE 30, 2000 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2000 COMMISSION FILE NUMBER 0-11595 MERCHANTS BANCSHARES, INC. (A DELAWARE CORPORATION) EMPLOYER IDENTIFICATION NO. 03-0287342 164 College Street, Burlington, VT 05401 Telephone: (802) 658-3400 Indicate by check mark whether the registrant 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 has been subject to such filing requirement for the past 90 days. YES X NO ----- ----- 4,182,650 Shares Common Stock $.01 Par Outstanding July 25, 2000 MERCHANTS BANCSHARES, INC. INDEX TO FORM 10-Q
PART I ITEM 1 FINANCIAL STATEMENTS Consolidated Balance Sheets June 30, 2000 and December 31, 1999 1 Consolidated Statements of Operations For the three months ended June 30, 2000 and 1999 and the six months ended June 30, 2000 and 1999 2 Consolidated Statements of Comprehensive Income For the three months ended June 30, 2000 and 1999 and the six months ended June 30, 2000 and 1999 3 Consolidated Statement of Changes in Stockholders' Equity For the year ended December 31, 1999, and the six months ended June 30, 2000 and 1999 4 Consolidated Statements of Cash Flows For the six months ended June 30, 2000 and 1999 5 Footnotes to Financial Statements as of June 30, 2000 6-7 ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 8-13 PART II - OTHER INFORMATION ITEM 1 Legal Proceedings 14-15 ITEM 2 Changes in Securities NONE ITEM 3 Defaults upon Senior Securities NONE ITEM 4 Submission of Matters to a Vote of Security Holders NONE ITEM 5 Other Information NONE ITEM 6 Exhibits and Reports on Form 8-K NONE SIGNATURES 16
Merchants Bancshares, Inc. Consolidated Balance Sheets
June 30, December 31, (In thousands except share and per share data) 2000 1999 ----------------------------------------------------------------------------------------------------- Unaudited ASSETS Cash and Due from Banks $ 32,006 $ 23,746 Investments: Debt Securities Held for Sale 85,623 72,229 Debt Securities Held to Maturity 123,841 126,281 (Fair Value of $119,608 and $122,305) Trading Securities 1,046 1,075 --------------------------------------------------------------------------------------------------- Total Investments 210,510 199,585 --------------------------------------------------------------------------------------------------- Loans 474,020 453,692 Reserve for possible loan losses 10,701 11,189 --------------------------------------------------------------------------------------------------- Net Loans 463,319 442,503 --------------------------------------------------------------------------------------------------- Federal Home Loan Bank Stock 3,362 2,951 Federal Funds Sold 2,000 -- Bank Premises and Equipment, Net 12,834 13,175 Investment in Real Estate Limited Partnerships 2,692 2,751 Other Real Estate Owned 172 133 Other Assets 12,616 16,519 --------------------------------------------------------------------------------------------------- Total Assets $739,511 $701,363 =================================================================================================== LIABILITIES Deposits: Demand $ 95,216 $ 86,160 Savings, NOW and Money Market Accounts 396,461 369,929 Time Deposits $100 thousand and Greater 28,307 25,590 Other Time 134,778 131,564 --------------------------------------------------------------------------------------------------- Total Deposits 654,762 613,243 --------------------------------------------------------------------------------------------------- Demand Note Due U.S. Treasury 4,000 4,000 Other Short-Term Borrowings 7,000 7,000 Other Liabilities 7,398 6,013 Long-Term Debt 1,567 6,371 --------------------------------------------------------------------------------------------------- Total Liabilities 674,727 636,627 --------------------------------------------------------------------------------------------------- Commitments and Contingencies (Note 4) 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 4,040,462 Prior Period 4,194,810 Capital in Excess of Par Value 33,072 33,072 Retained Earnings 38,607 35,368 Treasury Stock (At Cost) (7,812) (4,699) Current Period 394,158 Prior Period 239,810 Deferred Compensation Arrangements 2,433 2,372 Unrealized losses on Securities Available for Sale, Net (1,560) (1,421) --------------------------------------------------------------------------------------------------- Total Stockholders' Equity 64,784 64,736 --------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $739,511 $701,363 ===================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statements of Operations Unaudited
Quarter Ended June 30, Six Months Ended June 30, (In thousands except per share data) 2000 1999 2000 1999 -------------------------------------------------------------------------------------------------- INTEREST AND DIVIDEND INCOME Interest and Fees on Loans $10,276 $ 9,006 $20,300 $17,955 Interest and Dividends on Investments U.S. Treasury and Agency Obligations 2,937 2,590 5,816 5,287 Other 618 323 1,156 543 ------------------------------------------------------------------------------------------------ Total Interest Income 13,831 11,919 27,272 23,785 ------------------------------------------------------------------------------------------------ INTEREST EXPENSE Savings, NOW and Money Market Accounts 3,363 2,435 6,423 4,758 Time Deposits $100 Thousand and Greater 424 323 805 662 Other Time Deposits 1,591 1,522 3,145 3,100 Other Borrowed Funds 162 132 372 294 Debt 13 117 170 233 ------------------------------------------------------------------------------------------------ Total Interest Expense 5,553 4,529 10,915 9,047 ------------------------------------------------------------------------------------------------ Net Interest Income 8,278 7,390 16,357 14,738 Provision for Possible Loan Losses (57) -- (414) -- ------------------------------------------------------------------------------------------------ Net Interest Income after Provision for Loan Losses 8,335 7,390 16,771 14,738 ------------------------------------------------------------------------------------------------ NONINTEREST INCOME Trust Company Income 481 470 913 913 Service Charges on Deposits 900 742 1,746 1,397 Settlement proceeds -- -- -- 1,326 Gain on Sale of Investments, Net -- -- 1 -- Other 400 306 731 564 ------------------------------------------------------------------------------------------------ Total Noninterest Income 1,781 1,518 3,391 4,200 ------------------------------------------------------------------------------------------------ NONINTEREST EXPENSES Salaries and Wages 2,625 2,317 5,281 4,677 Employee Benefits 684 626 1,457 1,259 Occupancy Expense, Net 532 509 1,111 1,241 Equipment Expense 645 557 1,275 1,122 Legal and Professional Fees 353 355 617 992 Marketing 334 396 645 574 Equity in Losses of Real Estate Limited Partnerships 135 125 285 254 Expenses - Other Real Estate Owned 16 60 75 147 Loss on Disposition of Fixed Assets 20 50 41 102 Other 1,367 1,047 2,656 2,112 ------------------------------------------------------------------------------------------------ Total Noninterest Expenses 6,711 6,042 13,443 12,480 ------------------------------------------------------------------------------------------------ Income Before Income Taxes 3,405 2,866 6,719 6,458 Provision for Income Taxes 864 601 1,696 1,470 ------------------------------------------------------------------------------------------------ NET INCOME $ 2,541 $ 2,265 $ 5,023 $ 4,988 ================================================================================================ Basic Earnings Per Common Share $ 0.60 $ 0.52 $ 1.18 $ 1.14 Diluted Earnings Per Common Share $ 0.60 $ 0.52 $ 1.17 $ 1.14
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statements of Comprehensive Income Unaudited
Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2000 1999 2000 1999 ------------------------------------------------------------------------------------------------------- Net Income as Reported $2,541 $ 2,265 $5,023 $ 4,988 Change in Net Unrealized Appreciation (Depreciation) of Securities, Net of Tax 40 (1,162) (186) (1,403) ------------------------------------------------------------------------------------------------------- Comprehensive Income Before Transfers From Available for Sale to Held to Maturity 2,581 1,103 4,837 3,585 Impact of transfer of Securities from Available for Sale to Held to Maturity 23 1 47 (2) ------------------------------------------------------------------------------------------------------- Comprehensive Income $2,604 $ 1,104 $4,884 $ 3,583 =======================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statements of Changes in Stockholders' Equity For the Year Ended December 31, 1999 and the six months ended June 30, 2000 and 1999 Unaudited
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, 1998 $44 $33,073 $28,308 $(3,133) $2,166 $ 371 $60,829 Net Income -- -- 4,988 -- -- -- 4,988 Purchase of Treasury Stock -- -- -- (567) -- -- (567) Issuance of Stock under Deferred Compensation Arrangements -- -- -- 31 (31) -- -- Dividends Paid -- -- (1,656) -- -- -- (1,656) Deferred Compensation Arrangements -- -- -- -- 124 -- 124 Unearned Compensation -- Restricted Stock Awards -- -- -- -- (7) -- (7) Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax -- -- -- -- -- (1,403) (1,403) Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax -- -- -- -- -- (2) (2) ---------------------------------------------------------------------------------------------------------------------------- Balance June 30, 1999 44 33,073 31,640 (3,669) 2,252 (1,034) 62,306 Net Income -- -- 5,462 -- -- -- 5,462 Purchase of Treasury Stock -- -- -- (1,053) -- -- (1,053) Issuance of Stock under Employee Stock Option Plans -- (1) -- 23 -- -- 22 Dividends Paid -- -- (1,734) -- -- (1,734) Deferred Compensation Arrangements -- -- -- -- 127 -- 127 Unearned Compensation -- Restricted Stock Awards -- -- -- -- (7) -- (7) Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax -- -- -- -- -- 236 236 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 -- -- -- -- -- 42 42 ---------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1999 44 33,072 35,368 (4,699) 2,372 (1,421) 64,736 Net Income -- -- 5,023 -- -- -- 5,023 Purchase of Treasury Stock -- -- -- (3,163) -- -- (3,163) Issuance of Stock under Deferred Compensation Arrangements -- -- -- 50 (50) -- Dividends Paid -- -- (1,784) -- -- (1,784) Deferred Compensation Arrangements -- -- -- -- 114 -- 114 Unearned Compensation -- Restricted Stock Awards -- -- -- -- (3) -- (3) Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax -- -- -- -- -- (186) (186) Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax -- -- -- -- -- 47 47 ---------------------------------------------------------------------------------------------------------------------------- Balance, June 30, 2000 $44 $33,072 $38,607 $(7,812) $2,433 $(1,560) $64,784
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statement of Cash Flows Unaudited
For the six months ended June 30, 2000 1999 ------------------------------------------------------------------------------------------------ (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 5,023 $ 4,988 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Possible Loan Losses (414) -- Provision for Possible Losses on Other Real Estate Owned -- -- Provision for Depreciation and Amortization 1,357 1,248 Net Gains on Sales of Investment Securities (1) -- Net Gains on Sales of Loans and Leases (6) -- Net Losses on Sales of Premises and Equipment 41 102 Net Gains on Sales of Other Real Estate Owned (7) (61) Equity in Losses of Real Estate Limited Partnerships 285 254 Changes in Assets and Liabilities: (Increase) in Interest Receivable (476) (406) Decrease in Interest Payable (179) (420) Decrease (Increase) in Other Assets 4,377 (439) Increase (Decrease) in Other Liabilities 1,563 (1,449) ------------------------------------------------------------------------------------------------ Net Cash Provided by Operating Activities 11,563 3,817 ------------------------------------------------------------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from Sales of Investment Securities Available for Sale 8,998 -- Proceeds from Maturities of Securities Available for Sale 5,693 6,295 Proceeds from Maturities of Securities Held to Maturity 4,951 18,274 Purchases of Available for Sale Investment Securities (28,343) (19,266) Purchases of Held to Maturity Investment Securities (2,487) (8,500) Loan Originations in Excess of Principal Repayments (21,448) (14,671) Proceeds from Sales of Loans and Leases 1,191 -- Purchases of Federal Home Loan Bank Stock (411) (468) Proceeds from Sales of Other Real Estate Owned 7 491 Investments in Real Estate Limited Partnerships (256) (416) Purchases of Premises and Equipment (736) (478) ------------------------------------------------------------------------------------------------ Net Cash Used in Investing Activities (32,841) (18,739) ------------------------------------------------------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase in Deposits 41,520 7,342 Net Increase in Other Borrowed Funds -- 217 Principal Payments on Debt (5,035) (3) Cash Dividends Paid (1,784) (1,656) Acquisition of Treasury Stock (3,163) (542) ------------------------------------------------------------------------------------------------ Net Cash Provided by Financing Activities 31,538 5,358 ------------------------------------------------------------------------------------------------ Increase (Decrease) in Cash and Cash Equivalents 10,260 (9,564) Cash and Cash Equivalents Beginning of Year 23,746 30,528 ------------------------------------------------------------------------------------------------ Cash and Cash Equivalents End of Period $ 34,006 $ 20,964 ================================================================================================ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Total Interest Payments $ 11,093 $ 9,467 Total Income Tax Payments -- 2,700 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES Distribution of Stock Under Deferred Compensation Arrangements 50 31
The accompanying notes are an integral part of these consolidated financial statements. MERCHANTS BANCSHARES, INC. JUNE 30, 2000 NOTES TO FINANCIAL STATEMENTS: See the Form 10-K filed as of December 31, 1999, for additional information. NOTE 1: RECENT ACCOUNTING DEVELOPMENTS The Financial Accounting Standards Board ("FASB") has issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 137 and SFAS No. 138. 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 is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Based on Merchants Bank's (the Bank's) current use of derivatives Merchants Bancshares, Inc. (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. NOTE 2: EARNINGS PER SHARE The following table presents a reconciliation of the calculations of basic and diluted earnings per share for the quarter and six-months ended June 30, 2000:
Net Per Share Quarter Ended June 30, 2000 Income Shares Amount --------------------------- ------ ------ --------- (In thousands except share and per share data) Basic Earnings Per Common Share: Income Available to Common Shareholders $2,541 4,246,840 $0.60 Diluted Earnings Per Common Share: Options issued to Executives -- 3,279 Income available to Common Shareholders Plus Assumed Conversions $2,541 4,250,119 $0.60 Net Per Share Six Months Ended June 30, 2000 Income Shares Amount ------------------------------ ------ ------ --------- (In thousands except share and per share data) Basic Earnings Per Common Share: Income Available to Common Shareholders $5,023 4,274,048 $1.18 Diluted Earnings Per Common Share: Options issued to Executives -- 3,618 Income available to Common Shareholders Plus Assumed Conversions $5,023 4,277,666 $1.17
Basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding during the quarter. The computation of diluted earnings per share for the quarter and six-months ended June 30, 2000, excludes the effect of assuming the exercise of certain outstanding stock options because the effect would be anti-dilutive. As of June 30, 2000, there were 218,420 of such options outstanding with exercise prices ranging from $20.438 to $30.500. NOTE 3: STOCK REPURCHASE PROGRAM On April 20, 2000, the Company announced that its Board of Directors had decided to rescind the existing stock repurchase plan. The Board adopted a new stock repurchase program, which authorized the Company to repurchase, through April 2001, up to 200 thousand shares of its own securities. Under the repurchase plan the stock may be purchased from time to time, subject to prevailing market conditions. Purchases are to be made on the open market and funded from available cash. The Company purchased 83 thousand of its own shares at a total cost of $1.8 million under the former program. The Company had repurchased 99 thousand of its own shares, at a total cost of $1.9 million, under the new repurchase program, as of July 25, 2000. NOTE 4: COMMITMENTS AND CONTINGENCIES: 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. On March 22, 2000, lawyers representing the beneficiaries of two Trust Company accounts filed an action in Chittenden, Vermont Superior Court against Merchants Bancshares and others, asserting that their clients and others similarly situated were not fully reimbursed for damages allegedly suffered in connection with certain investments made by Merchants Trust Company during 1993 and 1994 in Piper Jaffray on their behalf, and complaining, among other matters, that the disbursement of the recovery as described in the immediately-preceding paragraph was improper. The Complaint asserts, among other matters, that the Trust Company and others violated the Vermont Consumer Fraud Act, were negligent and made negligent misrepresentations, and breached duties of trust. The Complaint seeks certification of the action as a class action, unspecified damages, and other relief. The litigation is at a very early stage. While it is not possible to predict its outcome, the Company believes full reimbursement has been provided, that such disbursement was proper, that class action certification is inappropriate, and that the claims for relief lack merit. 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. NOTE 5: RECLASSIFICATION Certain amounts reported for prior periods have been reclassified to be consistent with the current period presentation. MERCHANTS BANCSHARES, INC. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS All adjustments necessary for a fair statement of the three and six months ended June 30, 2000 and 1999, have been included in the financial statements. The information was prepared from the unaudited financial statements of Merchants Bancshares, Inc. (the Company) and its subsidiaries, Merchants Bank (the Bank) and Merchants Properties, Inc. OVERVIEW Merchants Bancshares, Inc. earned net income of $2.54 million, or basic and diluted earnings per share of $.60 for the quarter ended June 30, 2000, compared to $2.27 million, or basic and diluted earnings per share of $.52 for the same period a year earlier. The return on average assets and return on average equity for the second quarter of 2000 were 1.40 percent and 15.74 percent, respectively, compared to 1.41 percent and 14.63 percent for the second quarter of 1999. The Company earned net income of $5.02 million, or basic earnings per share of $1.18 and diluted earnings per share of $1.17 for the six months ended June 30, 2000, compared to $4.99 million, or basic and diluted earnings per share of $1.14 for the same period in 1999. The return on average assets and return on average equity for the six months ended June 30, 2000 were 1.40 percent and 15.60 percent, respectively. RESULTS OF OPERATIONS Net Interest Income: Net interest income for the first six months of 2000 was $16.4 million, compared to $14.7 million for the first six months of 1999. The Bank has continued to experience margin compression resulting from the rising rate environment during 2000. The margin has decreased by five basis points from the quarter ended June 30, 1999, to the quarter ended June 30, 2000, and has decreased by 11 basis points for the comparable six month periods. The increase in net interest income is a result of higher levels of average earning assets, which helped to offset the decline in the spread. The Bank's average interest earning assets were $75 million higher for the first six months of 2000 than they were for the first six months of 1999 and were $80 million higher for the second quarter of 2000 compared to the second quarter of 1999. At the same time, the Bank's interest bearing liabilities were $69 million higher for the first six months of 2000 compared to the same period in 1999, and were $68 million higher for the second quarter of 2000 compared to 1999. The Bank's average yield on interest earning assets increased 21 basis points and seven basis points for the quarter and six months ended June 30, 2000, compared to the same periods in 1999; while the cost of funds for the same periods has increased by 30 basis points and 17 basis points, respectively. These changes have resulted in a decrease in the interest rate spread of 9 basis points when comparing the quarter ended June 30, 2000, to the same period one year earlier, and 10 basis points when comparing the first six months of 2000 to the first six months of 1999. The schedule on pages 12 and 13 shows the yield analysis for the periods reported. Provision for Loan Losses: The improved asset quality achieved over the last few years continues to be maintained as the portfolio grows in adherence to the strong underwriting standards that have been established. Management's analysis of the reserve adequacy concluded that a provision for possible loan losses was not necessary during the first six months of 2000. Additionally, the Bank recorded $57 thousand and $414 thousand, respectively, for the quarter and six months ended June 30, 2000, as a credit loan loss provision. These amounts represent individual recoveries on previous obligations, which were partially charged off. It is the Bank's practice to record significant recoveries as an offset to the loan loss provision in the income statement. See the discussion of Non-Performing Assets on pages 10 to 11 for more information on the loan loss reserve. Non-interest income: Excluding certain litigation settlement proceeds of $1.3 million received in 1999, non-interest income increased by $517 thousand for the first six months of 2000 compared to 1999 and by $263 thousand for the second quarter. (For more information on the settlement proceeds see Part II, Item 1, Legal Proceedings.) The increase in noninterest income is primarily a result of increases in the Bank's overdraft revenue and increases in ATM and debit card usage and fees. The increase in overdraft revenue has been partially offset by a decrease in monthly service charge revenue. Monthly service charges decreased by $68 thousand for the first six months of 2000 compared to 1999, and by $40 thousand for the second quarter; while net overdraft revenue increased by $174 thousand and $373 thousand for the three and six months ended June 30, 2000. The decrease in monthly service charge revenue is due primarily to the success of the Bank's FreedomLYNX(R) checking account product, which generally charges no monthly fees. Other noninterest income increased by $167 thousand for the first six months of 2000 compared to 1999, and by $95 thousand for the second quarter, primarily due to increased ATM and debit card transaction volumes and resultant fees. Non-interest expenses: Total non-interest expenses for the three and six month periods have increased $669 thousand and $963 thousand over the same periods in 1999. Contributing to this increase was an increase in other non-interest expenses of $320 thousand for the second quarter and $544 thousand for the first six months of 2000. The Bank completed its purchase of its two new locations in Rutland and Bellows Falls, Vermont, during the fourth quarter of 1999, resulting in an increase in the Bank's amortization of core deposit intangible of $103 thousand for the second quarter and $212 thousand for the first six months of the year. Additionally, the Bank is in the process of converting to a document imaging system, the conversion is expected to be complete by the end of the third quarter. The Bank ordered all new "image-friendly" forms during the second quarter of 2000 resulting in a $100 thousand increase in the cost of supplies during the first six months of the year. Salaries and wages have increased by $308 thousand for the quarter and $604 thousand for the first six months of 2000 compared to 1999. The Bank completed its purchase of its two new locations, mentioned above, resulting in the addition of 11 new full-time equivalent employees. Additionally, the Bank has experienced higher wage and incentive costs as a result of its successful sales efforts and overall increased profitability of its core activities. Employee Benefits have increased by $58 thousand for the second quarter and $198 thousand for the first six months of 2000 compared to the same periods in 1999. The Bank has experienced large increases in its costs for employee health insurance, which have increased $75 thousand for the second quarter and $130 thousand for the first six months of 2000 compared to 1999 due to higher premiums. Occupancy expenses were $130 thousand lower for the first six months of 2000 compared to 1999. This decrease is due primarily to a one-time charge taken in 1999 as a result of the Bank's vacating a property under a long term lease. Legal and professional fees have decreased $375 thousand for the first six months of the year. The higher amount during 1999 resulted primarily from the timing of expenses incurred by the Bank as it defends itself in certain litigation. For more information on this litigation see Part II, Item 1, Legal Proceedings. BALANCE SHEET ANALYSIS Average deposits for the second quarter of 2000 were $34.6 million higher than during the fourth quarter of 1999. Deposit balances at quarter-end were $41.5 million higher than balances at December 31, 1999. The Bank has seen strong and sustained deposit growth at a time of year when deposits balances historically decline. The Bank's continued focused sales efforts have fueled this growth. Due to the efforts of our sales staff more than 14,000 new FreedomLYNX(R) and MoneyLYNX(tm) deposit accounts were opened during the first six months of the year. Total loans, net of loan sales of $1.2 million, have increased $20.3 million for the first six months of the year. Most of the growth in the loan portfolio was in the commercial loan portfolio, which increased by $10.1 million during the first six months of 2000. This increase is due to the Bank's continued emphasis on lending to operating businesses and the ramping up of the Bank's CommerceLYNX(tm) program, which is designed to appeal to small businesses. The Bank's commercial mortgage portfolio increased $6.5 million during the first six months of the year. The Bank also continued to experience growth in its streamlined portfolio mortgage product, ReaLYNX(tm), during the second quarter. Balances grew $4.4 million during the first six months of the year. Installment loans and Homelines increased by a small amount during the first six months of the year, a reflection of the current highly competitive environment for these types of credits. The Bank's investment portfolio has grown $10.9 million during 2000 as a portion of the deposit growth has been deployed into the investment portfolio. In the ordinary course of business, Merchants Bank makes commitments for possible future extensions of credit. On June 30, 2000, the Bank was obligated to fund $7.1 million of standby letters of credit. No losses are anticipated in connection with these commitments. 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 and the Bank, 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 independent reviews of the Company's Year 2000 preparations. These reviews were completed during 1998 and 1999. 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. RISK MANAGEMENT There have been no significant changes in the Company's risk profile, or management's risk management practices, since year-end. INCOME TAXES The Company recognized $600 thousand in low income housing tax credits for the first six months of 2000 and $730 thousand for the same period in 1999, representing the amount of the income tax credits earned during those quarters. The recognition of low income housing tax credits has reduced the Company's effective tax rate to 25% for the six months ended June 30, 2000. LIQUIDITY AND CAPITAL RESOURCES Liquidity, as it pertains to banking, can be defined as the ability to generate cash in the most economical way to satisfy loan demand, deposit withdrawal demand, and to meet other business opportunities, which require cash. The Bank has a number of sources of liquid funds; including $25 million in available Federal Funds lines of credit at June 30, 2000; an overnight line of credit with the Federal Home Loan Bank (FHLB) of $15 million; an estimated additional borrowing capacity with FHLB of $100 million; and the ability to borrow through the use of repurchase agreements, collateralized by the Bank's investments, with certain approved counterparties. NON-PERFORMING ASSETS AND THE RESERVE FOR POSSIBLE LOAN LOSSES -------------------------------------------------------------- The following tables summarize the Bank's non-performing assets as of June 30, 2000, December 31, 1999, and June 30, 1999:
(In thousands) June 30, 2000 December 31, 1999 June 30, 1999 -------------- ------------- ----------------- ------------- Nonaccrual Loans $1,995 $2,800 $1,979 Loans Past Due 90 Days or More and Still Accruing 70 199 48 Restructured Loans 310 689 469 ---------------------------------------------- Total Non-performing Loans (NPL) $2,375 3,688 $2,496 Other Real Estate Owned 172 133 198 ---------------------------------------------- Total Non-performing Assets (NPA) $2,547 $3,821 $2,694 ============================================== Note: Included in nonaccrual loans are certain loans whose terms have been substantially modified in troubled debt restructuring.
Discussion of events affecting NPA: Significant events affecting the categories of NPA are discussed below: Nonaccrual Loans: ----------------- During the second quarter of 2000 approximately $2.2 million in reductions to nonaccrual loans were offset in part by approximately $620 thousand of additions. Of the reported decrease, approximately $1.4 million was concentrated in two commercial accounts, These two commercial relationships were sold during the second quarter - one with eight loans totaling $1.04 million; the other consisting of one loan for $375 thousand. In addition, $282 thousand of the decrease was attributable to the Small Business Administration's repurchasing its share of a guaranteed loan. The increase was comprised of loans to ten different borrowers, and is considered a normal level of activity. Loans Past Due 90 Days: ----------------------- Loans past due 90 days decreased $53 thousand in the second quarter, after dropping $76 thousand in the quarter ended March 31, 2000. Restructured Loans: ------------------- There was a net decrease of $89 thousand in restructured loans during the second quarter of 2000 primarily attributable to the transfer of two loans, totaling $299 thousand, to nonaccrual. The reserve for possible loan losses is based on management's estimate of the amount required to reflect the risks in the loan portfolio, based on circumstances and conditions at each reporting date. Merchants Bank reviews the adequacy of the Reserve for Possible Loan Losses ("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, as well as a consistent methodology for quantifying probable credit losses. 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 have 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 June 30, 2000, totaled $2.4 million, of this total $2.1 million are included as non-performing assets in the table above. Impaired loans have been allocated $788 thousand of the RPLL. The continued high 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 following table reflects the Bank's non-performing asset and coverage ratios as of June 30, 2000, December 31, 1999, and June 30, 1999:
June 30, 2000 December 31, 1999 June 30, 1999 ------------- ----------------- ------------- Percentage of Non-performing Loans to Total Loans 0.50% 0.81% 0.59% Percentage of Non-performing Assets to Total Loans plus Other Real Estate Owned 0.54% 0.84% 0.64% Percentage of RPLL to Total Loans 2.26% 2.47% 2.70% Percentage of RPLL to NPL 451% 303% 455% Percentage of RPLL to NPA 420% 293% 422%
Management considers the balance of the RPLL adequate at June 30, 2000. Management's assessment of the adequacy of the RPLL concluded that a provision was not necessary during the first quarter of 2000. Merchants Bancshares, Inc. Supplemental Information Unaudited
Three Months Ended ----------------------------------------------------------------------- (In thousands except share and per share data) June 30, 2000 June 30, 1999 Interest Interest Average Income/ Average Average Income/ Average (Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate --------------------------------- --------------------------------- INTEREST EARNING ASSETS Loans(1) $466,181 $10,289 8.88% $416,731 $ 9,021 8.68% Taxable Investments 209,815 3,481 6.67% 182,462 2,896 6.37% Federal Funds Sold and Securities Purchased Under Agreements to Resell 4,952 74 6.01% 1,451 17 4.70% ------------------------------- ------------------------------- Total Interest Earning Assets $680,948 $13,844 8.18% $600,644 $11,934 7.97% =============================== =============================== INTEREST BEARING LIABILITIES Savings, NOW and Money Market Deposits $390,915 $ 3,363 3.46% $331,974 $ 2,435 2.94% Time Deposits 162,422 2,015 4.99% 147,926 1,845 5.00% ------------------------------- ------------------------------- Total Savings and Time Deposits 553,337 5,378 3.91% 479,900 4,280 3.58% Federal Funds Purchased 693 11 6.38% 1,483 19 5.14% Other Borrowed Funds 9,425 151 6.44% 9,228 113 4.89% Debt(2) 1,566 13 3.34% 6,662 117 7.04% ------------------------------- ------------------------------- Total Interest Bearing Liabilities 565,021 5,553 3.95% 497,273 4,529 3.65% Other Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) 115,927 103,371 -------- -------- Total Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) $680,948 $600,644 ======== ======== Rate Spread 4.23% 4.32% ==== ==== Net Yield on Interest Earning Assets 4.90% 4.95% ==== ==== -------------------- Includes principal balance of non-accrual loans and fees on loans. Excludes prepayment fee of $102 related to the early repayment of certain long-term debt.
Merchants Bancshares, Inc. Supplemental Information Unaudited
Six Months Ended ----------------------------------------------------------------------- (In thousands except share and per share data) June 30, 2000 June 30, 1999 Interest Interest Average Income/ Average Average Income/ Average (Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate --------------------------------- --------------------------------- INTEREST EARNING ASSETS Loans(1) $460,777 $20,175 8.81% $412,834 $17,985 8.79% Taxable Investments 207,268 6,870 6.67% 181,853 5,799 6.43% Federal Funds Sold and Securities Purchased Under Agreements to Resell 3,419 102 6.00% 1,365 31 4.58% ------------------------------- ------------------------------- Total Interest Earning Assets $671,464 $27,147 8.13% $596,052 $23,815 8.06% =============================== =============================== INTEREST BEARING LIABILITIES Savings, NOW and Money Market Deposits $383,130 $ 6,423 3.37% $322,301 $ 4,758 2.98% Time Deposits 160,531 3,950 4.95% 149,625 3,762 5.07% ------------------------------- ------------------------------- Total Savings and Time Deposits 543,661 10,373 3.84% 471,926 8,520 3.64% Federal Funds Purchased 965 31 6.46% 1,782 42 4.75% Other Borrowed Funds 10,723 341 6.40% 8,543 249 5.88% Debt(2) 2,591 68 5.28% 6,664 233 7.04% ------------------------------- ------------------------------- Total Interest Bearing Liabilities 557,940 10,813 3.90% 488,915 9,044 3.73% Other Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) 113,524 107,137 -------- -------- Total Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) $671,464 $596,052 ======== ======== Rate Spread 4.23% 4.33% ==== ==== Net Yield on Interest Earning Assets 4.89% 5.00% ==== ==== -------------------- Includes principal balance of non-accrual loans and fees on loans. Excludes prepayment fee of $102 related to the early repayment of certain long-term debt.
MERCHANTS BANCSHARES, INC. JUNE 30, 2000 PART II - OTHER INFORMATION Item 1 - 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. On March 22, 2000, lawyers representing the beneficiaries of two Trust Company accounts filed an action in Chittenden, Vermont Superior Court against Merchants Bancshares and others, asserting that their clients and others similarly situated were not fully reimbursed for damages allegedly suffered in connection with certain investments made by Merchants Trust Company during 1993 and 1994 in Piper Jaffray on their behalf, and complaining, among other matters, that the disbursement of the recovery as described in the immediately-preceding paragraph was improper. The Complaint asserts, among other matters, that the Trust Company and others violated the Vermont Consumer Fraud Act, were negligent and made negligent misrepresentations, and breached duties of trust. The Complaint seeks certification of the action as a class action, unspecified damages, and other relief. The litigation is at a very early stage. While it is not possible to predict its outcome, the Company believes full reimbursement has been provided, that such disbursement was proper, that class action certification is inappropriate, and that the claims for relief lack merit. 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 2 - Changes in Securities - NONE Item 3 - Defaults upon Senior Securities - NONE Item 4 - Submission of Matters to a Vote of Security Holders - NONE Item 5 - Other Issues - NONE Item 6 - Exhibits and Reports on Form 8-K - NONE MERCHANTS BANCSHARES, INC. FORM 10-Q JUNE 30, 2000 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Merchants Bancshares, Inc. /s/ Joseph L. Boutin -------------------- Joseph L. Boutin, President /s/ Janet P. Spitler -------------------- Janet P. Spitler, Treasurer August 11, 2000 --------------- Date