ITEM 1 - BUSINESS
Merchants Bancshares, Inc. is a one-bank holding company originally organized under Vermont law in 1983 for the purposes of owning all of the outstanding capital stock of the Merchants Bank (the "Bank") and providing greater flexibility in helping the Bank achieve its business objectives. Its primary subsidiary is Merchants Bank (the "Bank"), a Vermont Bank with 33 full-service offices.
The last two years have been a period of great change for Merchants Bank. We have undergone a reengineering project that reduced our workforce by approximately 50%. At the same time, we have decreased our nonperforming asset portfolio to its lowest level in 7 years. We have also redefined the way we do business and created a new image for our institution. We have closed corporate headquarters and deployed resources to our branch system. We have brought technological innovations to our internal operations and to our customers. These changes have allowed us to meet our goals for 1996 and have set the stage for future earnings growth.
A chronology of events, including acquisitions, relating to MERCHANTS BANCSHARES, INC., (the Company) is as follows:
July 1, 1983: Merchants Bancshares, Inc. was organized as a Vermont corporation, for the purpose of acquiring, investing in or holding stock in any subsidiary enterprise under the Bank Holding Company Act of 1956.
January 24, 1984: Company acquired The Merchants Bank, a Vermont chartered commercial bank.
June 2, 1987: Company shareholders approved a resolution to change the state of incorporation of the Company from Vermont to Delaware.
October 4, 1988: Company organized Merchants Properties, Inc., whose mission is described below.
THE MERCHANTS BANK, (the Bank) was organized in 1849, and assumed a national bank charter in 1865, becoming The Merchants National Bank of Burlington, Vermont. On September 6, 1974 the Bank converted its national charter to a state-bank charter, becoming known as The Merchants Bank. Since 1971 the Bank has acquired by merger seven Vermont banking institutions, and has acquired the deposits of an eighth bank located in St. Johnsbury, Vt. The last such acquisition occurred on June 4, 1993 at which time the Bank acquired the New First National Bank of Vermont, with thirteen banking offices, from the Federal Deposit Insurance Corporation Division of Liquidation. As of December 31, 1996 the Bank was the fifth largest commercial banking operation in Vermont, with deposits totaling $508.3 million, net loans of $371.5 million, and total assets of $579.0 million, on a consolidated basis.
Since September 30, 1988, the Merchants Bank has participated as an equity partner in the development of several AFFORDABLE HOUSING PARTNERSHIPS which were formed to provide residential housing units within the State of Vermont. During the past four years these partnerships have developed 727 units of residential housing, 470 (65%) of which qualify as "affordable housing units for eligible low-income owners or renters", and 257 (35%) of which are "market rate units." These partnerships have invested in 16 affordable and elderly housing projects within 13 Vermont communities: St. Albans, Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington, Springfield, St. Johnsbury, Colchester, Swanton, Bradford and Hardwick.
MERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was organized for the purpose of developing and owning affordable rental housing units throughout the state of Vermont. As of December 31, 1996 Merchants Properties, Inc. owned one development located in Enosburg, Vermont, consisting of a 24-unit low-income family rental housing project, which was completed and rented during 1989. This housing development is fully occupied at this time. Total assets of this corporation at December 31, 1996 were $1,276,665.
The Merchants Bank owns controlling interest in the MERCHANTS TRUST COMPANY, a Vermont corporation chartered in 1870 for the purpose of offering fiduciary services such as estate settlement, testamentary trusts, guardianships, agencies, intervivos trusts, employee benefit plans and corporate trust services. The Merchants Trust Company also operates a discount brokerage office through Olde Discount Corporation, enabling investors to purchase or sell stocks and bonds on a discounted commission schedule. As of December 31, 1996, the Merchants Trust Company had fiduciary responsibilities for assets valued at market in excess of $256 million, of which more than $174 million were managed assets. Total revenue for 1996 was $1,517,838; total expense was $1,297,445, resulting in pretax net income of $220,393 for the year. This net income is included in the consolidated tax return of its parent company, the Merchants Bank.
QUENESKA CAPITAL CORPORATION, a wholly owned subsidiary of the Merchants Bank was established on April 4, 1988 as a Federal licensee under the Small Business Act of 1958 to provide small business enterprises with loans and/or capital. As of December 31, 1996, the corporation had assets of $1,673,001, liabilities of $4,173 due to the parent company for accrued management fees, and equity capital of $1,668,828.
Queneska Capital Corporation has no employees, relying on the personnel resources of its parent company to operate. As compensation for the Bank's services, Queneska pays the Bank a management fee ($25,361 in 1996) in the amount of 1.5% on annual average assets. This fee is eliminated in the financial statement consolidation of the parent company.
RETAIL SERVICES
The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and loan needs of its retail customers. The Bank's retail products include interest-bearing and noninterest-bearing checking accounts, money market accounts, passbook and statement savings, club accounts, and short-term and long-term certificates of deposit. The Bank also offers customary check collection services, wire transfers, safe deposit box rentals, and automated teller machine (ATM) cards and services.
Merchants Bank introduced a new checking account in May of 1996. FreedomLynx checking is available with no service charges to customers who have, at least monthly, an automatic deposit to the account or an automatic debit from the account to pay a Merchants Bank loan. The account pays interest on higher balances with a tiered rate structure. Interest accrues on any day that the balance falls within one of the tiers. No minimum balance is required.
During 1996, the Bank worked to revise and simplify its retail deposit and investment products. Beginning on January 1, 1997 the Bank will offer two basic checking accounts - FreedomLynx Checking and Bottom Line Checking, an account that provides for a flat service charge up to a maximum number of checks. Other retail checking accounts will continue to be maintained but will no longer be available as new accounts.
In 1996, the Bank introduced electronic bill payment by telephone or by personal computer. With these services, customers can pay any type of bill electronically from their own PC or from a telephone at any time that fits their schedule. The Bank is committed to automation, offering ATM cards, ATF (automatic transfer of funds) to cover overdrafts, EFT (electronic funds transfer) to automate transfers between accounts, PCLynx bill payment services and the PCLynx telephone banking system. In 1997, the Bank plans to expand its automated services by introducing a debit card and a retail home banking system.
The Bank continues to provide strong customer support with 34 ATMs and 34 on-line banking offices throughout the state of Vermont. The Bank offers all of its retail services and products at its 33 full-service banking offices.
COMMERCIAL SERVICES
The 1995-1996 restructuring of the Sales organization has been completed. Each branch office is led by a branch president or manager who has consumer lending authority for the full range of retail credit services. Branch presidents additionally are being given small business lending authority up to a prescribed limit. There are 23 branch presidents and 9 managing customer representatives. The ten corporate banking officers and five corporate banking administrators provide commercial credit services throughout the state of Vermont to customers requiring business credit above the prescribed authorities of the branch presidents.
Merchants Bank offers a variety of commercial checking accounts. Commercial Checking uses an earnings credit rate to help offset service charges. Small Business Checking is designed for the smaller business carrying lower balances and reduced account activity.
Investment opportunities are available to businesses in the form of savings accounts and money market accounts. The Bank's cash management services provide additional investment opportunities through the Cash Sweep Program. Other cash management services include funds concentration.
The Bank offers on-line banking services through PCLynx Corporate and PCLynx Small Business. These products allow businesses to view their account histories, order stop payments, transfer between accounts, transmit ACH batches and order both domestic and foreign wire transfers.
Other miscellaneous commercial banking services include night depository, coin and currency handling, lockbox and balance reporting services. Employee benefits management and related fiduciary services are available through the Merchants Trust Company.
Types of Credit Offerings:
Consumer Loans: - ---------------
Financing is provided for new or used automobiles, boats, airplanes, recreational vehicles and new mobile homes. Home improvement and home equity lines of credit, Master Card credit cards and various collateral loans and personal loans are also available.
Real Estate Loans: - ------------------
Financing is available for one-to-four-family residential mortgages; multifamily mortgages; residential construction; mortgages for seasonal dwellings; and commercial real estate mortgages. Mortgages for residential properties are offered on a long-term, fixed-rate basis; alternatively, adjustable-rate mortgages are offered. Biweekly payment mortgages and graduated (two-step) payment mortgages are offered. Loans under the Farmers Home Administration Rural Guaranteed Housing Program provide up to 100% financing. The Bank also participates with the Vermont Housing Finance Agency (VHFA) in providing mortgage financing for low- to moderate-income Vermonters. Most mortgage loan products are offered with as little as a 5% down payment to assist borrowers who qualify, provided that the mortgagor(s) acquires private mortgage insurance.
Commercial Loans: - -----------------
Financing for business inventory, accounts receivable, fixed assets, lines of credit for working capital, community development, irrevocable letters of credit, business credit cards and U.S. Small Business Administration loans are available.
EXPANSION EFFORTS
Merchants Bank operates thirty-three full-service banking facilities within Vermont, one limited service facility, and a remote ATM unit located at the Burlington International Airport. Since 1963, the Bank has established eleven de novo offices, and since 1969 has acquired seven Vermont banks by merger. Merchants Bank's most recent acquisition occurred in June of 1993 with the acquisition of the assets and assumption of deposits of the New First National Bank of Vermont from the FDIC.
Each decision to expand the branch network has been based on strategic planning and analysis indicating that the new or acquired facility would provide enhanced banking resources within the community and insure the competitive viability of the Bank through potential growth of deposits and lending activities.
On January 12, 1996, the Passumpsic Savings Bank purchased certain assets and assumed certain liabilities of the Bank's branch located in Danville, VT. Merchants Bank received an 8% deposit premium on deposits sold in accordance with the purchase and assumption agreement. In the first quarter of 1996, the Colchester Avenue branch in Burlington was closed, with customer accounts consolidated to the College Street and White Street offices.
COMPETITION
Competition for financial services remains very strong in Vermont. As of December 31, 1996, there were more than 30 state and national banking institutions operating in Vermont. In addition, other financial services providers such as brokerage firms, credit unions, and out-of-state banks also compete for deposit, loan and ancillary services customers. Due to national institutions' use of aggressive direct mail marketing and the opening of more satellite offices in Vermont, Merchants Bank can expect the competitive environment of financial services to become even more aggressive.
At year-end 1996, Merchants Bank was the fifth largest state chartered bank in Vermont, enjoying a strong competitive franchise within the state, with 35 banking offices as identified in Item 2
ITEM 2 - PROPERTIES
A. SCHEDULE OF BANKING OFFICES BY LOCATION
Merchants Bank operates thirty-five banking facilities as indicated in Schedule A below. Corporate administrative offices and the operations data processing center are located at 275 Kennedy Drive, South Burlington, Vermont.
Burlington 164 College Street Merchants Trust Co. 172 College Street Branch office 1014 North Avenue Branch office
Essex Junction 54 Pearl Street Branch office
South Burlington 50 White Street Branch office 929 Shelburne Road *1 Branch office 275 Kennedy Drive Operations Center Corporate Offices Branch office Burlington Airport *1 ATM
Bristol 15 West Street Branch office
Barre 105 North Main Street Branch office
Northfield 47 Depot Square Branch office
South Hero South St. & Route 2 Branch office
Hardwick Wolcott Street Branch office
Hinesburg Route 116/Shelburne Falls Rd Branch office
Vergennes Monkton Road Branch office
Winooski 364 Main Street Branch office
Shelburne Wake Robin Branch office
Johnson Main Street, Route 15 Branch office
Colchester 8 Porters Point Road *2 Branch office
Jericho Route 15 Branch office
Enosburg Falls 155 Main Street Branch office
No. Bennington Bank Street Branch office
Manchester Ctr. 515 Main Street Branch office
Brattleboro 205 Main Street *3 Branch office
Wilmington West Main Street Branch office
Bennington Putnam Square *2 Branch office
Wallingford Route 7 *2 Branch office
St. Johnsbury 90 Portland Street Branch office
Bradford 1 Main Street & Branch office Operations Building
Fairlee U.S. Route #5 Branch office
Groton 258 Scott Highway Branch office
East Thetford U.S. Route #5 & VT 113 Branch office
Newbury U.S. Route #5 Branch office
Fair Haven 97 Main Street Branch office Washington Street Grand Union *1 ATM
Springfield Springfield Shopping Plaza Branch office
Windsor 160 Main Street Branch office
Notes: *1: Facilities owned by the Bank are located on leased land. *2: Facilities located on leased land with improvements also leased. *3: As of December 31, 1996, a mortgage with an unpaid principal balance of $202,991 is outstanding on the Brattleboro office. This mortgage is being amortized at $1,736 per month, at a rate of 9% through the year 2020.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
LEGAL PROCEEDINGS
During the fall of 1994, lawsuits were brought against the Company, the Bank, the Trust Company (collectively referred to as "the Companies") and certain directors of the Companies. These lawsuits related to certain investments managed for Trust Company clients and placed in the Piper Jaffray Institutional Government Income Portfolio. Separately, and before the suits were filed, the Companies had initiated a review of those investments. As a result of the review, the Trust Company paid to the affected Trust Company clients a total of approximately $9.2 million in December 1994. The payments do not constitute a legal settlement of any claims in the lawsuits. However, based on consultation with legal counsel, management believes that further liability, if any, of the Companies on account of matters complained of in the lawsuits will not have a material adverse effect on the consolidated financial position and results of operations of the Company. In December 1994, the Trust Company received a payment of $6,000,000 from its insurance carriers in connection with these matters. The Companies also intend to pursue all available claims against Piper Jaffray Companies, Inc. and others on account of the losses that gave rise to the $9.2 million payment by the Companies. The claims of the Trust Company, as trustee, against Piper Jaffray Companies were joined with claims of other investors in the Piper Fund in a class action in the United States District Court for the District of Minnesota. The class action was settled by the parties, and on December 14, 1995, the settlement was approved by the Court. By order dated January 11, 1996, the Court ordered the share of the settlement proceeds attributable to Merchants Trust Company investments not be paid pending further order. On February 18, 1997, the District Court entered an Order for Final Judgment. That Order provides, among other matters, that except to the extent (if at all) any other court with jurisdiction has given leave for some or all of the proceeds to be deposited with that court pursuant to Vermont Rule of Civil Procedure 67, Federal Rule of Civil Procedure 67, or such other rule as may apply, and absent an appeal, the entire net settlement proceeds attributable to the Trust Company investments are to be paid to the Trust Company starting approximately sixty-one days after the date of the Order. Any recovery of settlement proceeds is subject to the terms of an agreement between the Companies and their insurance carriers. The attorneys representing the plaintiffs in one of the lawsuits discussed above have taken the position that amounts recovered by the Companies on these claims should be paid to the affected Trust Company clients (net of legal fees paid to attorneys), in addition to the $9.2 million already paid.
The attorneys representing the plaintiffs in one of the lawsuits discussed above requested an award of attorneys' fees for allegedly causing the Companies to make the $9.2 million payment and asked the Court to order the Trust Company to withhold payment of $500,000. The Trust Company has resisted the claims for payment of such fees by its clients, and, as a result, the Trust Company was directed to place the sum of $500,000 into escrow pending a ruling by the Court. On appeal by the Companies, the United States Court of Appeals affirmed in part, vacated in part, and reversed for further proceedings the lower court's judgment. The attorneys representing the plaintiffs in that lawsuit have indicated that they intend to seek damages as well as attorneys' fees. There is the possibility that the Companies may be required to remit all or part of the escrowed funds, or to pay damages. However, based upon consultation with legal counsel, management believes that on the facts of this case there is no substantial authority for an award of such fees or damages in those proceedings.
The Bank is also involved in various legal proceedings arising in the normal course of business. Based upon consultation with legal counsel, management believes that the resolution of these matters will not have a material effect on the consolidated financial position and results of operations of the Company.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of calendar year 1996 no matters were submitted to a vote of security holders through a solicitation of proxies or otherwise.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the over-the-counter market and the price is quoted on the NASDAQ National Market Stock Exchange under the trading symbol MBVT. Quarterly stock prices during the last eight quarters are as indicated below based upon quotations as provided by the National Association of Securities Dealers, Inc. Prices of transactions between private parties may vary from the ranges quoted below.
As of January 29, 1997 Merchants Bancshares, Inc. had 1,366 shareholders. The Company did not declare or pay a dividend from April 1993 until February 1997, when the Board of Directors declared a fourth quarter, 1996 dividend payable on February 14, 1997 to shareholders of record at February 4, 1997. Future dividends will depend upon the financial condition and earnings of the Company and its subsidiaries, their need for funds and other factors, including applicable government regulations.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The supplementary financial data presented in the following tables and narrative contain information highlighting certain significant trends in the Company's financial condition and results of operations over an extended period of time.
The following information should be analyzed in conjunction with the year-end audited consolidated financial statements as contained in the 1996 Annual Report to Shareholders, a copy of which is attached as an addendum to this Form 10-K.
The five-year summary of operations, interest management analysis and management's discussion and analysis, all as contained on pages 29 through 37 of the 1996 Annual Report to Shareholders, are herein incorporated by reference.
Tables included on the following pages 49 through 52 concern the following:
Deposits; return on equity and assets; short-term borrowings; distribution of assets, liabilities, and stockholders' equity; analysis of changes in net interest income; and the composition and maturity of the loan portfolio.
DEPOSITS
The following schedule shows the average balances of various classifications of deposits. Dollar amounts are expressed in thousands.
Time Deposits over $100,000 at December 31, 1996 had the following schedule of maturities (in thousands):
Three Months or Less $ 3,137 Three to Six Months 4,098 Six to Twelve Months 3,673 Over Twelve Months 2,789 Over Five Years 6,672 ------- Total $20,369 =======
RETURN ON EQUITY AND ASSETS
The return on average assets, return on average equity, dividend payout ratio and average equity to average assets ratio for the three years ended December 31, 1996 were as follows:
SHORT-TERM BORROWINGS
Refer to Notes 7 and 8 to the Financial Statements for this information.
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential.
The following table presents the condensed annual average balance sheets for 1996, 1995 and 1994. The total dollar amount of interest income from assets and the subsequent yields calculated on a taxable equivalent basis as well as the interest paid on interest bearing liablilities, expressed in dollars and rates are also shown in the table.
(Dollars are in Thousands)
Merchants Bancshares, Inc Analysis of Changes in Net Interest Income
The following table sets forth, for each major category of interest earning assets and interest bearing liabilities, the dollar amounts (in thousands) of interest income (calculated on a taxable equivalent basis) and interest expense and changes therein for 1996 as compared with 1995 and 1995 as compared with 1994.
LOAN PORTFOLIO
The following tables display the composition of the Bank's loan portfolio for the consecutive five year period 1991 through 1995, along with a schedule profiling the loan maturity distribution over the next five years.
COMPOSITION OF LOAN PORTFOLIO
The table below presents the composition of the Bank's loan portfolio by type of loan as of December 31 for each of the past five years. All dollar amounts are expressed in thousands. Amounts are shown gross of net deferred loan fees of $946,723 in 1996, $956,333 in 1995, $1,132,494 in 1994, $1,310,416 in 1993 and $1,183,400 in 1992, which principally relate to real estate mortgages.
PROFILE OF LOAN MATURITY DISTRIBUTION
The table below presents the distribution of the varying maturities or repricing opportunities of the loan portfolio at December, 1996. All dollar amounts are expressed in thousands.
Loans maturing or repricing after one year which have predetermined interest rates totaled $155,109. Loans maturing or repricing after one year which have floating or adjustable interest rates totaled $1,372.
In 1996, a total of 425 one-to-four family residential mortgage loans were closed by the bank, totaling $33.4 million. Approximately 33% of these originations were sold on the secondary market and the remaining 67%, or $22.3 million were placed in the Bank's portfolio. The Bank currently services $322 million in residential mortgage loans, $250 million of which it services for other investors such as federal government agencies (FNMA and FHLMC) and for financial investors such as insurance companies and pension funds located outside Vermont.
During 1996, the Bank remained an active participant in the U.S. Small Business Administration guaranteed loan program. Thirty-two new SBA loans totaling $4.7 million were originated during 1996 with SBA guarantees ranging from 70% to 85%. This volume of new lending activity represents a decrease of 52% from that experienced in 1995.
Approximately 27% of all new SBA loans originated during 1996 were sold to secondary market investors located outside Vermont. This selling activity has the positive effect on Vermont of importing capital into the state from other parts of the country. SBA guarantees are advantageous to the Bank because they reduce risk in the Bank's loan portfolio and allow the Bank to increase its commercial loan base and market share with minimal impact on capital.
During 1996, the Bank originated 546 commercial loans, totaling $65.9 million. This lending activity represented a decrease of approximately 15% of new loan volume from that experienced in 1995. Commercial loans were originated throughout Vermont.
LOAN PORTFOLIO MONITORING
The Bank's Board of Directors grants each loan officer the authority to originate loans on behalf of the Bank. The Board also establishes restrictions regarding the types of loans that may be granted and the distribution of loan types within the portfolio, and sets loan authority limits for each lender. These authorized lending limits are established at least annually and are based upon the lender's knowledge and experience. Loan requests that exceed a lender's authority are referred to the Credit Department. All extensions of credit of $2.5 million to any one borrower, or related party interest, are reviewed and approved by the Directors Loan Committee.
By using a variety of management reports, the Bank's loan portfolio is continuously monitored by the Board of Directors and Credit Department. The loan portfolio as a whole, as well as individual loans, are reviewed for loan performance, creditworthiness, and strength of documentation. The Bank has hired an external loan review firm to assist in portfolio monitoring. Credit ratings are assigned to commercial loans and are routinely reviewed.
All loan officers are required to service their own loan portfolios and account relationships. As necessary, loan officers or the loan workout function takes remedial actions to assure full and timely payment of loan balances.
LOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES (RPLL)
Merchants Bancshares, Inc. reviews the adequacy of the RPLL at least quarterly. The method used in determining the amount of the RPLL is not based on maintaining a specific percentage of RPLL to total loans or total nonperforming assets, but rather a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors which are indicative of both general and specific credit risk, as well as a consistent methodology for quantifying probable credit losses. As part of the Merchants Bancshares, Inc.'s analysis of specific credit risk, a detailed and extensive review is done on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings and credit rating reports.
The Financial Accounting Standards Board ("FASB") issued revised accounting guidance which affected the RPLL. Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," requires, among other things, that the creditors measure impaired loans at the present value of expected future cash flows, discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral-dependent. For purposes of this statement, a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The FASB also issued SFAS No. 118, which amended SFAS No. 114, by allowing creditors to use their existing methods of recognizing interest income on impaired loans. Merchants Bancshares, Inc. adopted the methodology of SFAS No. 114, incorporating the amendments of SFAS No. 118, on January 1, 1995.
The more significant factors considered in the evaluation of the adequacy of the RPLL based on the analysis of general and specific credit risk include the following:
Status of impaired loans as defined under SFAS No. 114
* Status of nonperforming loans * Status of adversely classified credits * Historic charge-off experience by major loan category * Size and composition of the loan portfolio * Concentrations of credit risk o Renewals and extensions * Current local and general economic conditions and trends * Loan growth trends in the portfolio * Off-balance-sheet credit risk relative to commitments to lend
In accordance with SFAS No. 114, management has defined an impaired loan as meeting any of the following criteria:
* A loan that is 90 days past due and still accruing * A loan that has been placed in nonaccrual and is 45 days past due * A loan that is rated Substandard and is 45 days past due * A loan that is rated Doubtful or Loss * A loan that has been classified as a Troubled Debt Restructuring * A loan that has been assigned a specific allocation
Loans deemed impaired totaled $8.4 million. Impaired loans have been allocated $875,000 of the RPLL. On June 4, 1993, the Bank acquired New First National Bank of Vermont (NFNBV). The terms of the Purchase and Assumption Agreement (the "Agreement") required the FDIC to reimburse the Bank 80% of the net charge-offs up to $41 million on any loans that qualify as loss-sharing loans, for a period of three years from the date of acquisition. Losses in excess of $41 million would be reimbursed at 95%. The Agreement expired effective June 30, 1996, with respect to the reimbursement of losses. The Bank is required to return to the FDIC 80% of any reimbursed losses recovered, during the two year period following the expiration date. As of June 30, 1996, the remaining balance of loss-sharing loans aggregated $48,176,000; included in that balance was $2,928,000 in nonperforming loans.
Due to the expiration of the loss-sharing agreement, management adjusted the analysis of the RPLL to account for 100% of the loss exposure associated with loans that qualified as loss-sharing. The RPLL analysis prepared the quarter ended March 31, 1996 showed an increase in the reserve requirement of approximately $1.4 million, due to the expiration of the Agreement. Management maintained the RPLL at a level adequate to offset the required increase in the reserve requirement; therefore, no additional provision was necessary due to the expiration of the Agreement.
Overall, management maintains the RPLL at a level deemed to be adequate, in light of historical, current and prospective factors, to reflect the level of risk in the loan portfolio. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the RPLL.
The table below reflects the Bank's loan loss experience and activity in the RPLL for the past five years.
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The reserve for possible loan losses decreased from $16,234,000 at December 31, 1995 to $15,700,000 at December 31, 1996. At the same time, the provision for loan losses decreased from $12,100,000 to $3,150,000. The reduction in provision and relative stable reserve balance is reflective of the improvement in asset quality. These improvements are further noted in the reduction of net loan losses and nonperforming assets, as noted in the following tables:
NONPERFORMING ASSETS
The following tables summarize the Bank's nonperforming assets (NPAs) as of December 31, 1992 through 1996 (in thousands):
Excluded from the 1996 balances above are approximately $11 million of internally classified loans. These loans have well-defined weaknesses which, if left unattended, could lead to collection problems. Management maintains an internal listing, which includes these loans, which is reviewed and updated monthly. The oversight process on these loans includes an active risk management approach. A management committee reviews the status of these loans each quarter and determines or confirms the appropriate risk rating and accrual status. The findings of this review process are instrumental in determining the adequacy of the loan loss reserve.
DISCUSSION OF 1996 EVENTS AFFECTING NONPERFORMING ASSETS
Historically, the Company has worked closely with borrowers and also pursued vigorous collection efforts. The Company continued its efforts to collect troubled assets during 1996. The Company's enhanced Credit Department and Loan Workout functions provided resources to address collection strategies for nonperforming assets.
The more significant events affecting NPAs are discussed below.
NONACCRUAL LOANS: - -----------------
Nonaccrual loans declined from $25,617,000 at December 31, 1995 to $4,091,000 at December 31, 1996. Management continued its efforts to proactively identify and resolve loans which present significant risk of loss to the Bank. During 1996, management identified approximately $4.8 million in accounts which were transferred to nonaccrual status. These transfers were offset by continued resolution of nonaccrual accounts; approximately $8.0 million in loans were returned to accrual status; principal payments of approximately $4.2 million were collected; a nonperforming loan sale was completed during the fourth quarter reducing nonaccruing loans by approximately $5.7 million. In addition, charges of approximately $5.0 million further decreased the balance of nonaccruing loans.
LOANS PAST DUE 90 DAYS OR MORE AND STILL ACCRUING: - --------------------------------------------------
The Bank generally places loans that become 90 or more days past due in nonaccrual status. If the ultimate collectibility of principal and interest is assured, loans may continue to accrue and be left in this category. Included in this category are loans which have reached maturity and have not been renewed on a timely basis, for reasons other than financial capacity to pay. During the second quarter three significant accounts met this definition; renewal was completed during the third quarter.
RESTRUCTURED LOANS: - -------------------
Restructured loans (TDRs) increased during 1996 from $1,430,000 at December 31, 1995 to $2,403,000 at December 31, 1996. The increase was due to a reclassification of restructured, nonaccruing loans to accrual status. In addition, one large loan for approximately $1.0 million was removed from TDR status.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURE: - -----------------------------------------------------
The Bank continued its success in 1996 in disposing of OREO and continues to aggressively market such properties. The balance of OREO decreased from $7.772 million at December 31, 1995 to $1.925 million at December 31, 1996. The decrease was due to a combination of sales of approximately $4.0 million and write-downs of approximately $2.3 million.
POLICIES AND PROCEDURES RELATING TO THE ACCRUAL OF INTEREST INCOME
The Bank normally recognizes income on earning assets on the accrual basis, which calls for the recognition of income as earned, as opposed to when it is collected. The Company's policy is to classify a loan more than 90 days past due with respect to principal or interest as a nonaccruing loan, unless the ultimate collectibility of principal and interest is assured. Income accruals are suspended on all nonaccruing loans, and all previously accrued and uncollected interest is typically charged against current income. A loan remains on nonaccruing status until the factors which suggest doubtful collectibility no longer exist, the loan is liquidated, or when the loan is determined to be uncollectible and is charged off against the reserve for possible loan losses. In those cases where a nonaccruing loan is secured by real estate, the Company can, and usually does, initiate foreclosure proceedings. The result of such action is to force repayment of the loan through the proceeds of a foreclosure sale or to allow the Company to take possession of the collateral in order to manage a future resale of the real estate. Foreclosed property is recorded at the lower of its cost or estimated fair value, less any estimated costs to sell. Any cost in excess of the estimated fair value on the transfer date is charged to the reserve for possible loan losses, while further declines in market values are recorded as an expense in other non-interest expense in the statement of operations. As of December 31, 1996 and 1995, the Company had valuation reserves against the other real estate owned portfolio carrying values of $2,717,000 and $2,430,000, respectively.
SUBSEQUENT EVENT
During January, 1997, OREO balances were reduced to approximately $1.0 million. As a result, nonperforming assets were reduced to $7.6 million or 2% of total loans, plus OREO.
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Please refer to pages 31-37 for Management's Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated balance sheets of Merchants Bancshares, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996, together with the related notes and the opinion of Arthur Andersen LLP, independent public accountants, all as contained on pages 2 through 30 of the Company's 1996 Annual Report to Shareholders, are incorporated herein by reference.
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
Part III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Reference is hereby made to pages 7 through 13 and page 17of the Company's Proxy Statement to Shareholders dated March 25, 1997, wherein pursuant to Regulation 14 A information concerning the above subjects (Items 10 through 13) is incorporated by reference.
Pursuant to Rule 12b-23, definitive copies of the Proxy Statement will be filed within 120 days subsequent to the end of the Company's fiscal year covered by Form 10-K.
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(1) The following consolidated financial statements, as included in the 1996 Annual Report to Shareholders, are incorporated herein by reference:
Consolidated Balance Sheets, December 31, 1996 and December 31, 1995.
Consolidated Statements of Operations for years ended December 31, 1996, 1995 and 1994.
Consolidated Statements of Changes in Stockholders' Equity for years ended December 31, 1996, 1995 and 1994.
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994.
Notes to Consolidated Financial Statements, December 31, 1996.
(2) The following exhibits are either filed or attached as part of this report, or are incorporated herein by reference.
Exhibit Description ------- ----------- 3.1 Restated Certificate of Incorporation of the Company (Incorporated by reference to Exhibit B to Pre-Effective Amendment No. 1 to Company's Definitive Proxy Statement for the Annual Meeting of the Stockholders of the Company, filed on April 25, 1987)
3.2 Amended By-Laws of the Company (Incorporated by reference to Exhibit C to Company's Definitive Proxy Statement for the Annual Meeting of the Stockholders of the Company, filed on April 25, 1987).
4 Instruments defining the rights of security holders, including indentures:
4.1 Specimen of the Company's Common Stock Certificate (Incorporated by Reference to Exhibit 7 to the Company's Registration Statement on Form S-14 (Registration Number 2-86108) filed on August 22, 1983)
4.2 Description of the rights of holders of the Company's Common Stock (appearing on page 9 of the Company's Registration Statement on Form S-14 (Registration No. 2-86108) filed on August 22, 1983)
10.1 Merchants Bancshares, Inc. Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Exhibit 4.1 to Company's Registration Statement on Form S-3 (Registration No. 333-20375) filed on January 22, 1997)
10.2 401(k) Employee Stock Ownership Plan of the Company, dated January 1, 1990, as amended (Incorporated by reference to Company's Registration Statement on Form S-8 (Registration Number 33-3274) filed on November 16, 1989)
10.3 Amended and Restated Merchants Bank Pension Plan dated as of January 1, 1994 (Incorporated by Reference to Exhibit 10.6 to Post-Effective Amendment Number 1 to Company's Registration Statement on Form S-8 (Registration Number 333-18845) filed on December 26, 1996)
10.4 Amended Employment Agreement, dated as of October 31, 1994 by and between the Company, Merchants Bank and Joseph L. Boutin (Incorporated by reference to Exhibit 10.1 to Post-Effective Amendment No.1 to Company's Registration Statement on Form S-8 (Registration No. 333-18845) filed on December 26, 1996 (Superseded by Exhibit 10.5)
10.5 Employment Agreement dated as of January 1, 1997, by and between the Company, Merchants Bank and Joseph L. Boutin.
10.6 Amended Employment Agreement, dated as of January 23, 1995, by and between Merchants Bank and Michael R. Tuttle (Incorporated by reference to Exhibit 10.2 to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-8 (Registration No. 333-18845) filed on December 26,1996 (Superseded by Exhibit 10.7)
10.7 Employment Agreement dated as of January 1, 1997, by and between Merchants Bank and Michael R. Tuttle
10.8 Employment Agreement, dated as of December 29, 1995, by and between Merchants Bank and Thomas R. Havers (Incorporated by reference to Exhibit 10.3 to Post-Effective Amendment No. 1 to Company's Registration Statement on Form S-8 (Registration No. 333-18845) filed on December 26, 1996) (Superseded by Exhibit 10.9)
10.9 Employment Agreement dated as of January 1, 1997, by and between Merchants Bank and Thomas R. Havers.
10.10 Employment Agreement, dated as of February 1,1996, by and between Merchants Bank and Thomas S. Leavitt (Incorporated by reference to Exhibit 10.4 to Post-Effective Amendment No. 1 to Company's Registration Statement on Form S-8 (Registration No. 333-18845) filed on December 26, 1996) (Superseded by Exhibit 10.11)
10.11 Employment Agreement dated as of January 1, 1997, by and between Merchants Bank and Thomas S. Leavitt.
10.12 Employment Agreement, dated as of December 29, 1995, by and between Merchants Bank and Merchants Trust Company and William R. Heaslip (Incorporated by reference to Exhibit 10.5 to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-8 (Registration No. 333-18845) filed on December 26, 1996)(Superseded by Exhibit 10.13)
10.13 Employment Agreement, dated as of January 1, 1997, by and between Merchants Bank and Merchants Trust Company and William R. Heaslip
10.14 The Merchants Bank Amended and Restated Deferred Compensation Plan for Directors
10.14.1 Trust Under the Merchants Bank Amended and Restated Deferred Compensation Plan for Directors
10.15 Agreement among the Merchants Bank and Kathryn T. Boardman, Thomas R. Havers and Susan D. Struble dated as of December 20,
10.15.1 Trust Under the Agreement among the Merchants Bank and Kathryn T. Boardman, Thomas R. Havers and Susan D. Struble dated as of December 20, 1995
10.16 Agreement between the Merchants Bank and Dudley H. Davis dated December 20, 1995.
10.16.1 Fixed Trust under Agreement between the Merchants Bank and Dudley H. Davis dated December 20, 1995.
10.16.2 Variable Trust under Agreement between the Merchants Bank and Dudley H. Davis dated December 21, 1995.
11 Statement re: computation of per share earnings.
13 1996 Annual Report to Shareholders
21 Subsidiaries of the Company
23 Consent of Arthur Andersen LLP
(3) Reports on Form 8-K: NONE
SIGNATURES
Pursuant to the requirement of Section 13 or 15 (d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on it's behalf by the undersigned, thereunto duly authorized.
Merchants Bancshares, Inc.
Date February 20, 1997 by /s/ Joseph L. Boutin --------------------------- --------------------------------- Joseph L. Boutin, President & CEO
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MERCHANTS BANCSHARES, INC., and in the capacities and on the date as indicated.
by /s/ Joseph L. Boutin by /s/ Raymond C. Pecor, Jr. --------------------------- --------------------------------- Joseph L. Boutin, Director, President Raymond C. Pecor, Jr. Director & CEO of the Company and the Bank Chairman of the Board of Directors
by /s/ Peter A. Bouyea by --------------------------- --------------------------------- Peter A. Bouyea, Director Charles A. Davis, Director
by by /s/ Jeffrey L. Davis --------------------------- --------------------------------- Dudley H. Davis, Director Jeffrey L. Davis, Director
by /s/ Michael G. Furlong by --------------------------- --------------------------------- Michael G. Furlong, Director Thomas F. Murphy, Director
by /s/ Janet P. Spitler by /s/ Leo O'Brien, Jr --------------------------- --------------------------------- Janet P. Spitler, Treasurer of the Leo O'Brien, Jr, Director Company, Vice President, Controller and Treasurer of the Bank
by /s/ Patrick S. Robins by --------------------------- --------------------------------- Patrick S. Robins, Director Benjamin F. Schweyer, Director
by /s/ Robert A. Skiff --------------------------- Robert A. Skiff, Director