10-Q 1 merc10q2.txt BODY OF FORM 10Q 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, 2001 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 ----- ----- 4,077,109 Shares Common Stock $.01 Par Outstanding August 8, 2001 MERCHANTS BANCSHARES, INC. INDEX TO FORM 10-Q PART I ITEM 1 FINANCIAL STATEMENTS Consolidated Balance Sheets June 30, 2001 and December 31, 2001 1 Consolidated Statements of Operations For the three months ended June 30, 2001 and 2000, and the six months ended June 30, 2001 and 2000 2 Consolidated Statements of Comprehensive Income For the three months ended June 30, 2001 and 2000, and the six months ended June 30, 2001 and 2000 3 Consolidated Statement of Changes in Stockholders' Equity For the year ended December 31, 2000, and the six months ended June 30, 2001 and 2000 4 Consolidated Statements of Cash Flows For the six months ended June 30, 2001 and 2000 5 Footnotes to Financial Statements as of June 30, 2001 6-8 ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 9-14 PART II - OTHER INFORMATION ITEM 1 Legal Proceedings 15-16 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 17 Merchants Bancshares, Inc. Consolidated Balance Sheets
June 30, December 31, (In thousands except share and per share data) 2001 2000 ------------------------ Unaudited ASSETS Cash and Due from Banks $ 33,533 $ 34,192 Federal Funds Sold and Securities Purchased Under Resale Agreements 23,000 2,700 Investments: Debt Securities Available for Sale 114,596 90,110 Debt Securities Held to Maturity 84,641 118,872 (Fair Value of $85,899 and $119,355) Trading Securities 972 1,077 --------------------- Total Investments 200,209 210,059 --------------------- Loans 484,973 478,489 Reserve for Possible Loan Losses 10,007 10,494 --------------------- Net Loans 474,966 467,995 --------------------- Federal Home Loan Bank Stock 3,620 3,362 Bank Premises and Equipment, Net 11,821 12,530 Investment in Real Estate Limited Partnerships 3,188 2,977 Other Real Estate Owned 1,690 377 Other Assets 12,026 12,155 --------------------- Total Assets $764,053 $746,347 ===================== LIABILITIES Deposits: Demand $ 87,415 $ 91,417 Savings, NOW and Money Market Accounts 436,395 408,904 Time Deposits $100 thousand and Greater 25,297 26,257 Other Time 131,912 136,535 --------------------- Total Deposits 681,019 663,113 --------------------- Demand Note Due U.S. Treasury 4,000 2,816 Other Short-Term Borrowings -- 3,000 Other Liabilities 6,087 8,668 Long-Term Debt 2,294 1,300 --------------------- Total Liabilities 693,400 678,897 --------------------- 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 3,923,926 Prior Period 3,942,331 Capital in Excess of Par Value 33,115 33,076 Retained Earnings 44,827 41,902 Treasury Stock (At Cost) (10,712) (10,124) Current Period 510,694 Prior Period 492,289 Deferred Compensation Arrangements 2,683 2,575 Unrealized gains (losses) on Debt Securities Available for Sale, Net 696 (23) --------------------- Total Stockholders' Equity 70,653 67,450 --------------------- Total Liabilities and Stockholders' Equity $764,053 $746,347 =====================
The accompanying notes are an integral part of these consolidated financial statements. Merchants Bancshares, Inc. Consolidated Statements of Operations Unaudited
Three Months Ended June 30, Six Months Ended June 30, (In thousands except per share data) 2001 2000 2001 2000 -------------------------------------------------------- INTEREST AND DIVIDEND INCOME Interest and Fees on Loans $10,243 $10,276 $20,472 $20,300 Interest and Dividends on Investments U.S. Treasury and Agency Obligations 2,700 2,937 5,522 5,816 Other 892 618 1,655 1,156 ------------------------------------------------- Total Interest Income 13,835 13,831 27,649 27,272 ------------------------------------------------- INTEREST EXPENSE Savings, NOW and Money Market Accounts 2,851 3,363 6,142 6,423 Time Deposits $100 Thousand and Greater 384 424 791 805 Other Time Deposits 1,602 1,591 3,298 3,145 Other Borrowed Funds 18 162 52 372 Debt 18 13 29 170 ------------------------------------------------- Total Interest Expense 4,873 5,553 10,312 10,915 ------------------------------------------------- Net Interest Income 8,962 8,278 17,337 16,357 Provision for Possible Loan Losses (187) (57) (299) (414) ------------------------------------------------- Net Interest Income after Provision for Loan Losses 9,149 8,335 17,636 16,771 ------------------------------------------------- NONINTEREST INCOME Trust Company Income 435 481 835 913 Service Charges on Deposits 1,008 900 1,951 1,746 Gain (Loss) on Sale of Investments, Net -- -- (79) 1 Other 739 400 1,303 731 ------------------------------------------------- Total Noninterest Income 2,182 1,781 4,010 3,391 ------------------------------------------------- NONINTEREST EXPENSES Salaries and Wages 2,847 2,625 5,521 5,281 Employee Benefits 647 684 1,344 1,457 Occupancy Expense, Net 622 532 1,254 1,111 Equipment Expense 627 645 1,247 1,275 Legal and Professional Fees 611 353 952 617 Marketing 378 334 696 645 Equity in Losses of Real Estate Limited Partnerships 200 135 400 285 Vermont Franchise Taxes 191 173 372 339 Expenses - Other Real Estate Owned, net 23 16 113 75 Other 1,234 1,214 2,396 2,358 ------------------------------------------------- Total Noninterest Expenses 7,380 6,711 14,295 13,443 ------------------------------------------------- Income Before Income Taxes 3,951 3,405 7,351 6,719 Provision for Income Taxes 1,004 864 1,832 1,696 ------------------------------------------------- NET INCOME $ 2,947 $ 2,541 5,519 $ 5,023 ================================================= Basic Earnings Per Common Share $ 0.72 $ 0.60 $ 1.35 $ 1.18 Diluted Earnings Per Common Share $ 0.72 $ 0.60 $ 1.34 $ 1.17
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) 2001 2000 2001 2000 -------------------------------------- Net Income as Reported $2,947 $2,541 $5,519 $5,023 Change in Net Unrealized Appreciation (Depreciation) of Securities, Net of Tax (441) 40 250 (186) Less: Reclassification Adjustments for Securities Losses Included in Net Income, Net of Taxes -- -- 51 -- -------------------------------------- Comprehensive Income Before Transfers 2,506 2,581 5,820 4,837 Impact of transfer of Securities from Available for Sale to Held to Maturity 6 23 16 47 Impact of transfer of Securities from Held to Maturity to Available for Sale -- -- 402 -- -------------------------------------- Comprehensive Income $2,512 $2,604 $6,238 $4,884 ======================================
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, 2000, and the Six Months ended June 30, 2001 and 2000 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, 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) Unearned Compensation -- Restricted Stock Awards -- -- -- -- (3) -- (3) Deferred Compensation Arrangements -- -- -- -- 114 -- 114 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 Net Income -- -- 5,510 -- -- -- 5,510 Purchase of Treasury Stock -- -- -- (2,614) -- -- (2,614) Sale of Treasury Stock -- 4 -- 302 -- -- 306 Issuance of Stock under Deferred Compensation Arrangements -- -- -- -- -- -- -- Dividends Paid -- -- (2,215) -- -- -- (2,215) Unearned Compensation -- Restricted Stock Awards -- -- -- -- (3) -- (3) Deferred Compensation Arrangements -- -- -- -- 145 -- 145 Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax -- -- -- -- -- 1,491 1,491 Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax -- -- -- -- -- 46 46 ----------------------------------------------------------------------------------- Balance, December 31, 2000 44 33,076 41,902 (10,124) 2,575 (23) 67,450 Net Income -- -- 5,519 -- -- -- 5,519 Purchase of Treasury Stock -- -- -- (1,133) -- -- (1,133) Sale of Treasury Stock -- 42 -- 468 -- -- 510 Issuance of Stock under Deferred Compensation Arrangements -- -- -- 52 (52) -- -- Issuance of Stock Under Employee Stock Option Plans -- (3) -- 25 -- -- 22 Dividends Paid -- -- (2,594) -- -- -- (2,594) Unearned Compensation -- Restricted Stock Awards -- -- -- -- (2) -- (2) Deferred Compensation Arrangements -- -- -- -- 162 -- 162 Change in Net Unrealized Appreciation (Depreciation) of Securities Available for Sale, Net of Tax -- -- -- -- -- 301 301 Change in Net Unrealized Appreciation of Securities Transferred to the Held to Maturity Portfolio, Net of Tax -- -- -- -- -- 16 16 Impact of Transfer of Securities from the Held to Maturity Portfolio to the Available for Sale Portfolio, Net of Tax 402 402 ----------------------------------------------------------------------------------- Balance, June 30, 2001 $44 $33,115 $44,827 $(10,712) $2,683 $ 696 $70,653
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, 2001 2000 -------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 5,519 $ 5,023 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Possible Loan Losses (299) (414) Provision for Possible Losses on Other Real Estate Owned -- -- Provision for Depreciation and Amortization 1,094 1,357 Net Losses (Gains) on Sales of Investment Securities 79 (1) Net Gains on Sales of Loans and Leases -- (6) Net Losses on Disposition of Premises and Equipment 6 41 Net Gains on Sales of Other Real Estate Owned (23) (7) Equity in Losses of Real Estate Limited Partnerships 400 285 Changes in Assets and Liabilities: Decrease (Increase) in Interest Receivable 207 (476) Decrease in Interest Payable (949) (179) (Decrease) Increase in Other Assets (329) 4,377 (Decrease) Increase in Other Liabilities (1,630) 1,563 -------------------- Net Cash Provided by Operating Activities 4,075 11,563 -------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from Sales of Investment Securities Available for Sale 20,661 8,998 Proceeds from Maturities of Securities Available for Sale 12,333 5,693 Proceeds from Maturities of Securities Held to Maturity 5,297 4,951 Purchases of Available for Sale Investment Securities (27,249) (28,343) Purchases of Held to Maturity Investment Securities (204) (2,487) Loan Originations in Excess of Principal Repayments (8,100) (21,448) Proceeds from Sales of Loans and Leases -- 1,191 Purchases of Federal Home Loan Bank Stock (258) (411) Proceeds from Sales of Premises and Equipment 9 -- Proceeds from Sales of Other Real Estate Owned 148 7 Investments in Real Estate Limited Partnerships (611) (256) Purchases of Premises and Equipment (306) (736) -------------------- Net Cash Used in Investing Activities 1,720 (32,841) -------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase in Deposits 17,906 41,520 Net (Decrease) Increase in Other Borrowed Funds (1,816) -- Proceeds from Federal Home Loan Bank Advances 1,000 -- Principal Payments on Debt (7) (5,035) Cash Dividends Paid (2,126) (1,784) Acquisition of Treasury Stock (1,133) (3,163) Proceeds from the Exercise of Employee Stock Options 22 -- -------------------- Net Cash Provided by Financing Activities 13,846 31,538 -------------------- Increase (Decrease) in Cash and Cash Equivalents 19,641 10,260 Cash and Cash Equivalents Beginning of Year 36,892 23,746 -------------------- Cash and Cash Equivalents End of Period $ 56,533 $ 34,006 ==================== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Total Interest Payments $ 11,261 $ 11,093 Total Income Tax Payments 4,000 -- SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES Distribution of Stock Under Deferred Compensation Arrangements 52 50 Transfer of Securities from Held to Maturity to Available for Sale 29,125 --
The accompanying notes are an integral part of these consolidated financial statements. MERCHANTS BANCSHARES, INC. JUNE 30, 2001 NOTES TO FINANCIAL STATEMENTS: See the Form 10-K filed as of December 31, 2000, for additional information. NOTE 1: RECENT ACCOUNTING DEVELOPMENTS In June 2001 the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations (SFAS 141"), and No. 142, "Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 requires that the purchase accounting method be used for all business combinations initiated after June 30, 2001. SFAS 142 establishes new accounting and reporting standards for goodwill and intangible assets. Under the new statement, goodwill is no longer subject to amortization over its useful life. It will be subject to periodic (at least annual) assessments for impairment by applying a fair value based test. In the event that the recorded amount of goodwill exceeds its fair value, an impairment loss would be recorded. The Company will adopt SFAS 142 effective January 1, 2002. NOTE 2: EARNINGS PER SHARE The following table presents a reconciliation of the calculations of basic and diluted earnings per share for the quarter ended June 30, 2001:
Net Per Share Quarter Ended June 30, 2001 Income Shares Amount -------------------------------- (In thousands except share and per share data) Basic Earnings Per Common Share: Income Available to Common Shareholders $2,947 4,083,582 $0.72 Diluted Earnings Per Common Share: Options issued to Executives -- 15,835 Income available to Common Shareholders Plus Assumed Conversions $2,947 4,099,417 $0.72 ============================== Net Per Share Six Months Ended June 30, 2001 Income Shares Amount -------------------------------- (In thousands except share and per share data) Basic Earnings Per Common Share: Income Available to Common Shareholders $5,519 4,091,268 $1.35 Diluted Earnings Per Common Share: Options issued to Executives -- 14,359 Income available to Common Shareholders Plus Assumed Conversions $5,519 4,105,627 $1.34 ==============================
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. NOTE 3: STOCK REPURCHASE PROGRAM On January 18, 2001, the Company announced that its Board of Directors adopted a new stock repurchase program, which authorized the Company to repurchase, through January 2002, up to 200 thousand shares of its common stock. 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 had repurchased 42 thousand of its own shares, at a total cost of $1.1 million, under the new repurchase program, as of July 1, 2001. 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 relating to investments made by the Trust Company and others in the so-called Piper Jaffray Institutional Government Income Portfolio ("Piper Jaffray"). In the first quarter of 1999, the Company realized $1.3 million as the result of that payment. During the third quarter of 1999, the Trust Company disbursed the amount received, 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, in each case in partial reimbursement of payments made by the Trust Company and the carrier in 1994, totaling an aggregate of approximately $9.2 million, on account of losses suffered by Trust Company customers on Piper Jaffray investments. 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 in Piper Jaffray during 1993 and 1994, and complaining, among other matters, that the disbursement 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. By Decision and Order the Superior Court granted class certification. The litigation is at an early stage. While it is not possible to predict its outcome with certainty, the Company believes the claims for relief lack merit. On June 26, 2001, the Trust Company received, as Trustee, approximately $590 thousand in additional funds from the settlement of a related class action proceeding against Piper Jaffray's accountants. In the second quarter of 2001 the Company realized $265 thousand as a result of that payment. The Company has advised the Superior Court that it proposes to give written notice of the receipt to the relevant trust customers and provide a reasonable opportunity for comments, questions, or other actions. Assuming that no such comment, question or other action causes the Company to alter its course, the Company intends to disburse the $590 thousand to itself and its insurer, in partial reimbursement of the $9.2 million it paid to trust customers in 1994. 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 months ended June 30, 2001 and 2000, 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), Merchants Trust Company and Merchants Properties, Inc. OVERVIEW Merchants Bancshares, Inc. earned net income of $2.95 million, or basic and diluted earnings per share of $.72 for the quarter ended June 30, 2001, compared to $2.54 million, or basic and diluted earnings per share of $.60 for the same period a year ago. The return on average assets and return on average equity for the second quarter of 2001 were 1.56% and 16.87%, respectively. The Company earned $5.52 million, or basic earnings per share of $1.35 and diluted earnings per share of $1.34 for the six months ended June 30, 2001, compared to $5.02 million, or basic earnings per share of $1.18 and diluted earnings per share of $1.17 for the same period in 2000. The return on average assets and return on average equity for the six months ended June 30, 2001 were 1.48% and 16.32%, respectively. RESULTS OF OPERATIONS Net Interest Income: Net interest income for the second quarter of 2001 was $9.0 million compared to $8.3 million for the same period one year earlier, and was $17.3 million for the first half of 2001, compared to $16.4 million for the first half of 2000. After decreasing steadily throughout 2000 the Bank's net interest margin increased by 32 basis points from December 31, 2000, to June 30, 2001, to 5.10%, which is also a 20 basis point increase from the second quarter of last year. The Bank's rate spread was 4.59% for the second quarter of 2001, an increase of 49 basis points from the fourth quarter of last year, and an increase of 36 basis points from the second quarter of 2000. The increases in the Bank's net interest margin and spread are primarily a result of the 275 basis point rate reductions made by the Federal Reserve during the year. Of the Bank's quarterly average $591 million in interest bearing deposits 73% ($431 million) are in non-time products which reprice with the market. As a result of this deposit mix the Bank's average cost of deposits dropped 63 basis points from the second quarter of 2000 to the second quarter of 2001, and dropped 10 basis points for the first six months of the current year compared to the prior year. The Bank's overall cost of funds decreased 66 basis points when comparing the second quarter of the current year to the prior year, and 18 basis points when comparing the six month periods. At the same time the Bank's yield on interest earning assets decreased 31 basis points for the second quarter, and 8 basis points for the first half of the current year compared to the prior year. The Bank's average interest earning assets were $25 million higher for the second quarter of 2001 compared to the second quarter of 2000, at the same time, the Bank's interest bearing liabilities were $30 million higher. The schedule on pages 13 and 14 shows the yield analysis for the periods reported. Provision for Loan Losses: The Bank continued to have success at recovering previously charged off obligations during 2001. During the second quarter of the year the Bank recorded $187 thousand in individual recoveries on obligations, which were previously charged off, as a negative loan loss provision. It is the Bank's current practice to record loan recoveries in the income statement. See the discussion of Non-Performing Assets on pages 11 to 12 for more information on the loan loss reserve. Non-interest income: Excluding certain litigation settlement proceeds of $265 thousand realized during the second quarter of 2001 (for more information on the settlement proceeds see Part II, Item 1, Legal Proceedings) total non-interest income increased by $136 thousand for the second quarter of 2001 compared to 2000, and $354 thousand for the first six months of the year. Service charges on deposits increased $108 thousand for the second quarter of 2001 compared to 2000, and $205 thousand for the first six months of the year. This increase is primarily due to continued increases in overdraft revenue during 2001. Other noninterest income increased by $339 thousand for the second quarter of 2001 compared to 2000 and $572 thousand for the first half of the year. $265 thousand of that increase is attributable to the settlement proceeds discussed above. Increases in ATM and debit card usage and fees accounted for $92 thousand of the increase for the second quarter and $140 thousand of the six month increase. Additionally, the Bank sold a portion of its loan servicing portfolio during the first quarter; the sale generated a gain of $53 thousand. Non-interest expenses: Total non-interest expenses for the second quarter of 2001 increased $669 thousand over the comparable period in 2000, and $852 thousand for the first half of the year. Salaries and wages and Employee benefits increased $185 thousand for the second quarter and $127 thousand year to date. This increase is primarily a result of increased projected incentive payouts based on the Bank's strong earnings performance during the first half of the year. Occupancy expenses increased by $90 thousand for the second quarter of 2001 and $143 thousand for the first six months of the year compared to 2000, primarily a result of additional snow plowing and increased depreciation costs. Legal and Professional fees are $258 thousand higher for the second quarter of the current year and $335 thousand higher for the first six months of 2001 compared to 2000. This increase is due primarily to the Bank's estimates of expenses as it defends itself in certain litigation. For more information on this litigation see Part II, Item 1, Legal Proceedings. The Bank has continued its practice of investing in low income and elderly housing partnerships, these partnerships provide tangible support in our communities for those most in need, as well as providing tax benefits. The expense related to these investments increased by $65 thousand for the second quarter of this year compared to last year and $115 thousand year to date. BALANCE SHEET ANALYSIS The Bank has continued to see strong new deposit growth during 2001, but at a slower pace than 2000. More than 9,000 new FreedomLYNX(R) and MoneyLYNX(R) deposit accounts were opened during the first half of the year. Average deposits for the second quarter of 2001 were $13.3 million (2.0%) higher than during the fourth quarter of 2000. Deposit balances at quarter-end were $18 million higher than balances at December 31, 2000. Average total loans increased $2.3 million from the fourth quarter of 2000 to the second quarter of 2001; quarter end balances were $6.5 million higher than year end balances. The Bank's commercial loan portfolio increased $4.7 million (6.0%) during the first six months of 2001. This increase is due to the Bank's continued emphasis on lending to operating businesses and the ramping up of the Bank's CommerceLYNX(R) program, which is designed to appeal to small businesses. The Bank's commercial mortgage portfolio decreased $7.6 million (3.8%) during the first six months of the year primarily because scheduled amortization and prepayments of the existing portfolio exceeded new originations. Residential real estate mortgages increased by $12.2 million (8.4%) during the first six months of 2001, a reflection of a more favorable interest rate environment during much of the first half of the year. The Bank's average investment portfolio decreased by $11.6 million during the first six months of the year; a result of the Bank's decision to sell several of its callable agencies during the first quarter, and normal amortization and prepayments in the mortgage backed securities portfolio. In the ordinary course of business, Merchants Bank makes commitments for possible future extensions of credit. On June 30, 2001, the Bank was obligated to fund $6.7 million of standby letters of credit. No losses are anticipated in connection with these commitments. 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 and its subsidiaries are taxed on income by the IRS at the Federal level. The State of Vermont levies franchise taxes on banks based upon average deposit levels in lieu of taxing income. Franchise taxes are included in non-interest expenses in the consolidated statements of income. The Company recognized $392 thousand and $760 thousand for the quarter and six months ended June 30, 2001; and recognized $300 thousand and $600 thousand for the comparable periods in 2000. These amounts represent the amount of the income tax credits earned during those periods. The Company's statutory tax rate was 35% for 2001 and 34% for 2000. 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, 2001. 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, 2001; 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, 2001, December 31, 2000, and June 30, 2000:
(In thousands) June 30, 2001 December 31, 2000 June 30, 2000 --------------------------------------------------- Nonaccrual Loans $2,587 $3,240 $1,995 Loans Past Due 90 Days or More and Still Accruing 45 52 70 Restructured Loans 206 214 310 -------------------------------------------- Total Non-performing Loans (NPL) 2,838 3,506 $2,375 Other Real Estate Owned 1,690 377 172 -------------------------------------------- Total Non-performing Assets (NPA) $4,528 $3,883 $2,547 ============================================
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 2001 approximately $1.8 million in reductions to nonaccrual loans were offset in part by approximately $1.6 million of additions. The reductions resulted from the payoffs and chargeoffs of several small commercial loans, scheduled loan payments, and the transfer of a $1.4 million loan to Other Real Estate Owned ("OREO"), the details of which are described below. Two commercial relationships totaling $1.4 million were transferred to nonaccrual during the quarter. $930 thousand is attributable to the operator of several lodging and restaurant facilities in southern Vermont; the Small Business Administration participates in this relationship, reducing the Bank's direct exposure to $653 thousand. Collateral coverage appears adequate to satisfy the repayment terms of the loan at this time. A $460 thousand real estate secured loan to a hardware and building materials retailer was put into nonaccrual as a result of the closure of the business. Collateral coverage appears adequate to satisfy the repayment terms of the loan at this time. Loans Past Due 90 Days or More and still accruing: -------------------------------------------------- Loans past due 90 days decreased $7 thousand during the first six months of the year. Restructured Loans: ------------------- There was a net decrease of $8 thousand in restructured loans primarily due to scheduled amortization of loan balances. Other Real Estate Owned: ------------------------ During the second quarter OREO increased $1.4 million. The increase is solely attributable to an assisted living property in southern Vermont that was acquired through foreclosure. The property is presently contracted for sale with a closing expected during the fourth quarter. 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. An outside loan review firm examines the Bank's commercial loan portfolio three times per year. Over the course of the year, approximately 75% of commercial loan balances are reviewed, including all relationships over $750 thousand and classified loans over $100 thousand. Issues addressed by the loan review process include the accuracy of the Bank's internal risk ratings system, loan quality, and adequacy of the RPLL. Loans deemed impaired at June 30, 2001, totaled $3.2 million, of this total $2.8 million are included as non- performing assets in the table above. Impaired loans have been allocated $230 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, 2001, December 31, 2000, and June 30, 2000:
June 30, 2001 December 31, 2000 June 30, 2000 --------------------------------------------------- Percentage of Non-performing Loans to Total Loans 0.59% 0.73% 0.50% Percentage of Non-performing Assets to Total Loans plus Other Real Estate Owned 0.93% 0.81% 0.54% Percentage of RPLL to Total Loans 2.06% 2.19% 2.26% Percentage of RPLL to NPL 353% 299% 451% Percentage of RPLL to NPA 221% 270% 420%
Management considers the balance of the RPLL adequate at June 30, 2001. Management's assessment of the adequacy of the RPLL concluded that a provision was not necessary during the second quarter of 2001. Merchants Bancshares, Inc. Supplemental Information Unaudited
Three Months Ended ----------------------------------------------------------------- June 30, 2001 June 30, 2000 (In thousands except share and per share data) Interest Interest Average Income/ Average Average Income/ Average (Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate ----------------------------------------------------------------- INTEREST EARNING ASSETS Loans (1) $479,911 $10,262 8.58% $466,181 $10,289 8.88% Taxable Investments 201,080 3,282 6.55% 209,815 3,481 6.67% Federal Funds Sold and Securities Purchased Under Agreements to Resell 24,712 310 5.03% 4,952 74 6.01% -------------------------------------------------------------- Total Interest Earning Assets $705,703 $13,854 7.87% $680,948 $13,844 8.18% INTEREST BEARING LIABILITIES Savings, NOW and Money Market Deposits $431,176 $ 2,851 2.65% $390,915 $ 3,363 3.46% Time Deposits 159,900 1,986 4.98% 162,422 2,015 4.99% -------------------------------------------------------------- Total Savings and Time Deposits 591,076 4,837 3.28% 553,337 5,378 3.91% Federal Funds Purchased 55 1 7.29% 693 11 6.38% Other Borrowed Funds 1,822 17 3.74% 9,425 151 6.44% Debt 2,243 20 3.58% 1,566 13 3.34% -------------------------------------------------------------- Total Interest Bearing Liabilities 595,196 4,875 3.29% 565,021 5,553 3.95% Other Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) 110,507 115,927 -------- -------- Total Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) $705,703 $680,948 ======== ======== Rate Spread 4.59% 4.23% ==== ==== Net Yield on Interest Earning Assets 5.10% 4.90% ==== ==== Six Months Ended ----------------------------------------------------------------- June 30, 2001 June 30, 2000 (In thousands except share and per share data) Interest Interest Average Income/ Average Average Income/ Average (Fully Taxable Equivalent) Balance Expense Rate Balance Expense Rate ----------------------------------------------------------------- INTEREST EARNING ASSETS Loans (1) $477,995 $20,510 8.65% $412,834 $17,985 8.79% Taxable Investments 202,785 6,691 6.65% 181,853 5,799 6.43% Federal Funds Sold and Securities Purchased Under Agreements to Resell 18,940 486 5.17% 1,365 31 4.58% -------------------------------------------------------------- Total Interest Earning Assets $699,720 $27,687 7.98% $596,052 $23,815 8.06% INTEREST BEARING LIABILITIES Savings, NOW and Money Market Deposits $421,945 $ 6,142 2.94% $332,301 $ 4,758 2.98% Time Deposits 160,577 4,089 5.14% 149,625 3,762 5.07% -------------------------------------------------------------- Total Savings and Time Deposits 582,522 10,231 3.54% 471,926 8,520 3.64% Federal Funds Purchased 197 6 6.14% 1,782 42 4.75% Other Borrowed Funds 1,931 46 4.80% 8,543 249 5.88% Debt 1,871 33 3.56% 6,664 233 7.04% -------------------------------------------------------------- Total Interest Bearing Liabilities 586,521 10,316 3.55% 488,915 9,044 3.73% Other Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) 113,199 107,137 -------- -------- Total Liabilities & Stockholders' Equity (Net of Non-Interest Earning Assets) $699,720 $596,052 ======== ======== Rate Spread 4.43% 4.33% ==== ==== Net Yield on Interest Earning Assets 5.01% 5.00% ==== ==== Includes principal balance of non-accrual
MERCHANTS BANCSHARES, INC. JUNE 30, 2001 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 relating to investments made by the Trust Company and others in the so-called Piper Jaffray Institutional Government Income Portfolio ("Piper Jaffray"). In the first quarter of 1999, the Company realized $1.3 million as the result of that payment. During the third quarter of 1999, the Trust Company disbursed the amount received, 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, in each case in partial reimbursement of payments made by the Trust Company and the carrier in 1994, totaling an aggregate of approximately $9.2 million, on account of losses suffered by Trust Company customers on Piper Jaffray investments. 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 in Piper Jaffray during 1993 and 1994, and complaining, among other matters, that the disbursement 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. By Decision and Order the Superior Court granted class certification. The litigation is at an early stage. While it is not possible to predict its outcome with certainty, the Company believes the claims for relief lack merit. On June 26, 2001, the Trust Company received, as Trustee, approximately $590 thousand in additional funds from the settlement of a related class action proceeding against Piper Jaffray's accountants. In the second quarter of 2001 the Company realized $265 thousand as a result of that payment. The Company has advised the Superior Court that it proposes to give written notice of the receipt to the relevant trust customers and provide a reasonable opportunity for comments, questions, or other actions. Assuming that no such comment, question or other action causes the Company to alter its course, the Company intends to disburse the $590 thousand to itself and its insurer, in partial reimbursement of the $9.2 million it paid to trust customers in 1994. 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 The Company held its Annual Meeting of Shareholders on Tuesday, May 1, 2001 for the purpose of electing Jeffrey L. Davis, Raymond C. Pecor, Jr., and Patrick S. Robins for a three year term; and Michael G. Furlong for a one year term. At the time of the annual meeting there were 4,095,679 shares entitled to vote. Shares voted either in person or by proxy totaled 3,722,810 shares. There were no shares voted against the resolution. In addition, upon completion of the Annual Meeting the Director's terms continue as follows:
Name Term to Expire In ---- ----------------- Joseph L. Boutin 2003 Charles A. Davis 2003 Peter A. Bouyea 2003 Leo O'Brien, Jr. 2002 Robert A Skiff, Ph.D. 2002
Item 5 - Other Issues - NONE Item 6 - Exhibits and Reports on Form 8-K - NONE MERCHANTS BANCSHARES, INC. FORM 10-Q JUNE 30, 2001 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 10, 2001 --------------- Date