2001 ANNUAL REPORT

Merrill Merchants Bancshares, Inc.

 
| Contents                                 |   |
|------------------------------------------|--------|
|                                     |   |
| Financial Highlights                     |   |
| Letter to  Shareholders                  |   |
| Management’s Analysis of Operations |   |
| Independent Auditors’ Report        |   |
| Audited  Financial Statements            |   |
| Corporate  Directory                     |   |
| Employees                                |   |
| Corporate Information                    |   |

 

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**Selected Financial Highlights**

**(Dollars in thousands, except per share data)**

 
| **For the  Year**                                               | **2001** |    | **2000** |   | **1999** |   | **1998** |    | **1997** |   |
|-----------------------------------------------------------------|----------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
| Net income                                                      | $        | 3,254   |     | $      | 2,619    |   | $        | 2,247   |     | $      | 1,916 |   | $ | 1,402 |   |
| Net interest  income                                            | 11,542   |    | 10,026   |   | 8,885    |   | 8,032    |    | 7,155    |   |
| Non-interest  income                                            | 3,299    |    | 3,155    |   | 2,602    |   | 2,211    |    | 1,724    |   |
| Non-interest  expense                                           | 9,468    |    | 8,823    |   | 7,754    |   | 6,939    |    | 6,357    |   |
| **Per Common  Share**                                           |     |    |     |   |     |   |     |    |     |   |
| Earnings per  share:                                            |     |    |     |   |     |   |     |    |     |   |
| Basic                                                           | $        | 1.20    |     | $      | 0.95     |   | $        | 0.80    |     | $      | 0.86 |   | $ | 0.74 |   |
| Diluted                                                         | 1.04     |    | 0.84     |   | 0.70     |   | 0.70     |    | 0.64     |   |
| Dividends per  share                                            | 0.31     |    | 0.24     |   | 0.20     |   | 0.12     |    | 0.02     |   |
| Book value per  share (1)                                       | 9.52     |    | 8.74     |   | 8.12     |   | 7.73     |    | 6.08     |   |
| Dividend payout  ratio                                          | 25.87    | %       | 25.52    | %      | 24.71    | %      | 15.27    | %       | 3.23     | %      |
| **Key Ratios**                                                  |     |    |     |   |     |   |     |    |     |   |
| Return on average  assets                                       | 1.26     | %       | 1.16     | %      | 1.11     | %      | 1.05     | %       | 0.86     | %      |
| Return on  average equity (1)                                   | 13.45    |    | 11.69    |   | 10.52    |   | 12.97    |    | 13.63    |   |
| Equity to assets  at year end (1)                               | 9.12     |    | 9.45     |   | 10.15    |   | 10.30    |    | 6.14     |   |
| Non-performing  assets to total assets                          | 0.26     |    | 0.25     |   | 0.15     |   | 0.08     |    | 0.13     |   |
| Net charge-offs  to average loans                               | 0.08     |    | 0.03     |   | 0.07     |   | 0.04     |    | 0.08     |   |
| **At Year  End**                                                |     |    |     |   |     |   |     |    |     |   |
| Total assets                                                    | $        | 278,197 |     | $      | 246,413  |   | $        | 213,747 |     | $      | 199,743 |   | $ | 178,619 |   |
| Loans  receivable, net (2)                                      | 185,094  |    | 163,265  |   | 133,948  |   | 125,632  |    | 117,171  |   |
| Investment  securities                                          | 71,607   |    | 59,686   |   | 61,475   |   | 55,909   |    | 45,321   |   |
| Deposits                                                        | 219,309  |    | 200,451  |   | 168,578  |   | 164,128  |    | 146,312  |   |
| Borrowed funds                                                  | 29,792   |    | 20,076   |   | 19,069   |   | 13,508   |    | 20,236   |   |
| Shareholders’  equity                                      | 25,985   |    | 23,292   |   | 21,258   |   | 20,655   |    | 10,967   |   |
|                                                            |     |    |     |   |     |   |     |    |     |   |
|                                                                 |     |    |     |   |     |   |     |    |     |   |
| (1)Excludes  effect of unrealized gains or losses on securities |     |    |     |   |     |   |     |    |     |   |
| (2)Excludes  loans held for sale                                |     |    |     |   |     |   |     |    |     |   |

 

 

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Dear Shareholders:

2001 was a tumultuous year.  The September attacks stunned the nation and brought us togetherwith a common purpose.  Despite rapidlyfalling interest rates, volatile stock markets, and a recession, our Companywas able to achieve meaningful growth and record earnings.  We look forward to 2002 with guardedoptimism, mindful of the economic challenges, but confident in our people andour mission of providing superior banking and investment services.

 

# **FinancialPerformance**

We are pleased to report earnings of $3.3 million forthe Company, a 24% increase over last year. The Company’s loan portfolio grew 13% and total assets increased to$278.2 million at December 31, 2001. Solid asset growth and an improved net interest margin translated todiluted earnings per share of $1.04 in 2001 compared to $.84 in 2000,representing an increase of 24%. The Company increased its dividend payments to$.31 per common share from $.24 in 2000.

 

# **Expansion**

                In May 2001, theBank opened a Private Banking Office in Waterville under the leadership of ClarenceBickford , Jr., who brings over 30 years of trust and investment experience toour Bank. We have been very pleased with business development efforts and wecontinue to explore other strategic opportunities to better serve customersthere and elsewhere.

                We plan to offermutual funds, insurance and annuity products to our customers through GreenwoodFinancial Services (a division of the Bank). This division should be operatingat full capacity by the end of the second quarter in 2002.

                By purchasing a propertyadjoining our Pittsfield branch we were able to add a new drive-up facility and24-hour ATM. This expansion offers our customers added convenience as well asadditional parking.

 

# **Lending Activities**

                In spite of thesoftening economy, we experienced substantial loan demand with our outstandingloan balances increasing 13% over a year ago. Small business and residential mortgage lending continue to be a focusfor our Company.  For the fourthconsecutive year the Bank was honored by the Small Business Administration(SBA) as the leading lender among community banks in Maine. This is asignificant accomplishment for our Bank and much credit for our success in thisarea is due to the efforts of Jerry Jarrell, Vice President and CommercialLender. Our Bank was once again recognized as the number two SBA lender amongall banks in the state, regardless of asset size. We have partnered withPenquis Community Action Program on various projects, including the GrahamSchool Senior Housing Project, which, through our efforts, received a $400,000Affordable Housing Grant from the Federal Home Loan Bank.

                A favorableinterest rate environment resulted in residential mortgage lending reachingrecord levels. Total residential mortgage loan originations for 2001 were $61.5million compared to $23.1 million in 2000. The prompt, personal attention weprovide throughout the mortgage process, including local servicing, continuesto attract new and repeat customers to our Bank. We are very pleased to now bethe second leading mortgage originator in our market area.

 

# **Trust &Investment Services**

            Our Trust and Investment Groupexperienced another year of asset growth in the midst of difficult marketconditions.  Trust assets underadministration increased to $234.8 million at year-end, an increase of $10.0million over the previous year.  We arealso pleased to report that our investment performance surpassed conventionalbenchmarks.

            Our investment philosophy remainsunchanged.  We believe that qualityasset selection and diversification are both the best offense and defense andthe most appropriate means to attain the long-term financial objectives of ourcustomers.

 

# ** Community Building**

**               **Our bankers play a significant role intheir local communities. Their service on behalf of youth, economicdevelopment, cultural and community affairs is complemented by strong financialsupport from the Bank. This past year, we partnered with the United Way insponsoring *To Those Who Care,*acommunity service recognition program,**andwe continue to provide volunteer readers at various childcare sites inconjunction with the highly touted *Read forSuccess*program.  Ourcommitment to education is very strong and among the schools and colleges wesupport with charitable contributions are Eastern Maine Technical College,Husson College, Maine Central Institute, and the University of Maine.

** **

**Remembrance**

**               **People are the key to any organization’ssuccess, and our Company was saddened in October when John P. Thayer and JohnS. Bacon both passed away. John Thayer was Vice President and Manager of ourBrewer Branch and had been an officer of the Bank since its formation in 1992.John Bacon, President of Bacon Printing Company and an Honorary Director of ourCompany, had served as a founding director of the Bank and as a director of theCompany until his retirement in April 2001. We will miss their manycontributions to our Company.

 

# **Looking Ahead**

Although we anticipate challenges in the year ahead,we are optimistic about the future. Our regional economy remains relativelystable, our loan credit quality is strong, and we believe that changes withinthe local financial services arena will continue to present opportunities forfranchise growth.

During a year of stock market volatility, we were verypleased to see our stock price close the year at $11.30 per share, a 33%increase over last year. We are also pleased to report that since the offeringof our Company’s Dividend Reinvestment and Stock Purchase Plan, nearly 37% ofthe Company’s shareholders have elected to increase their investment in MerrillMerchants Bancshares, Inc.

As always, we appreciate your business and yourconfidence in our Company.

 
| Sincerely,

                        |                    |
|------------------------------------------|-------------------------|
|                                     |                    |
|                                     |                    |
| Edwin N. Clift                           | William C. Bullock, Jr. |
| *President and Chief Executive  Officer* | *Chairman*              |

** **

** **

**3**

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**MANAGEMENT’S** DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

** **

**FORWARD LOOKING STATEMENTS**

**                Management’s discussion andanalysis may contain forward-looking statements that are provided to assist inthe understanding of anticipated future financial performance.  However, such performance involves risk anduncertainties which may cause actual results to differ materially from thoseexpressed in forward-looking statements. For a discussion of these risks and uncertainties, see the Company’sAnnual Report on Form 10-KSB for the year ended December 31, 2001.  The Company disclaims any obligation topublically announce future events or developments that may affect theforward-looking statements contained herein.**

** **

**GENERAL**

Merrill Merchants Bancshares, Inc. (Company) owns allof the common stock of Merrill Merchants Bank (Bank) and Maine AcceptanceCorporation (MAC).  The Bank is afull-service community bank headquartered in Bangor, Maine, providing a widerange of consumer, commercial, and trust and investment services through itseleven locations in central and eastern Maine.

Merrill Merchants Bank is committed to providingoutstanding customer service and building long term banking relationships withcustomers. Delivery on this commitment through local decision-making andpersonal service has helped distinguish Merrill Merchants from its competitors.This will continue to be strategically significant as larger banks consolidateand their service delivery channels become more depersonalized.

Maine Acceptance Corporation, a finance company whichopened for business in Bangor on March 1, 1999, provides indirect auto andrecreational vehicle lending, as well as other types of direct loans, includingpersonal unsecured, recreational vehicle, automobile, mobile home and homeequity loans.

The Company’s goal is to sustain profitable,controlled growth by focusing on increased loan and deposit market share;managing yields on earning assets and rates on interest-bearing liabilities;increasing non-interest income; and being prepared for acquisitions andexpansion opportunities within the financial services industry.

** **

**REVIEW OF FINANCIAL STATEMENTS**

**                The Company declared a 3% stockdividend both in 2001 and 2000.   Allfinancial data included herein has been restated to reflect the impact of thestock dividends.**

**                The discussion and analysis thatfollows focuses on the factors affecting the Company’s financial condition atDecember 31, 2001, and 2000 and financial results of operations during 2001 and2000.  This discussion should be read inconjunction with the consolidated financial statements and notes includedelsewhere in this report.**

** **

**RESULTS OF OPERATIONS**

***Overview***

**                The Company ended 2001 withconsolidated assets of $278.2 million representing growth of $31.8 million or13%.  Asset growth was attributable tostrong loan demand and an increase in the investment portfolio resulting fromdeposit growth.  The Company reportednet income of $3.3 million or $1.20 per basic share and $1.04 per diluted sharein 2001, as compared to $2.6 million or $.95 per basic share and $.84 per dilutedshare in 2000.  This representedearnings growth of $635,000 or 24%. Return on average assets increased to 1.26% in 2001 compared to 1.16% in2000, and return on average equity increased to 13.45% in 2001 from 11.69% in2000.**

** **

**4**

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***AVERAGE BALANCESHEETS AND ANALYSIS OF NET INTEREST INCOME***

 

The following table sets forth, for the years indicated, informationregarding (i) the total dollar amount of interest income of the Company frominterest-earning assets and the resultant average yields; (ii) the total dollaramount of interest expense on interest-bearing liabilities and the resultantaverage costs; (iii) net interest income; (iv) net interest rate spread; and(v) net interest margin.

 
| **Year Ended  December 31,**                     |   | **2001**             |    | **2000**     |   |
|--------------------------------------------------|--------|----------------------|---------|--------------|--------|
|                                             |   | **Average  Balance** |    | **Interest** |   | **Yield/Rate** |   | **Average  Balance** |   | **Interest** |   | **Yield/Rate** |   |
|                                             |   |                 |    |         |   |   |   |   |   |   |   |   |   |
|                                             |   |                 |    |         |   | **(In Thousands)** |   |   |   |   |   |
|                                             |   |                 |    |         |   |   |   |   |   |   |   |   |   |
| Assets:                                          |   |                 |    |         |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                        |   |                 |    |         |   |   |   |   |   |   |   |   |   |
| Loans (1)                                        |   | $                    | 175,634 |         | $      | 15,731 |   | 8.96 | % | $ | 153,411 |   | $ | 14,708 |   | 9.59 | % |
| Investment  securities (2)                       |   | 64,583               |    | 3,788        |   | 5.87 | % | 56,159 |   | 3,415 |   | 6.08 | % |
| Other earning  assets                            |   | 725                  |    | 23           |   | 3.17 | % | 1,771 |   | 111 |   | 6.27 | % |
| Total  interest-earning assets                   |   | 240,942              |    | 19,542       |   | 8.11 | % | 211,341 |   | 18,234 |   | 8.63 | % |
| Non-earning  assets                              |   | 16,484               |    |         |   |   |   | 15,064 |   |   |   |   |   |
| Total assets                                     |   | $                    | 257,426 |         |   |   |   |   | $ | 226,405 |   |   |   |   |   |
|                                             |   |                 |    |         |   |   |   |   |   |   |   |   |   |
| Liabilities and  Shareholders’ Equity:      |   |                 |    |         |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |   |                 |    |         |   |   |   |   |   |   |   |   |   |
| Savings deposits  and interest-bearing checking  |   | $                    | 86,596  |         | 2,222  |   | 2.57 | % | $ | 80,178 |   | 2,867 |   | 3.58 | % |
| Certificates of  deposit                         |   | 82,160               |    | 4,534        |   | 5.52 | % | 74,223 |   | 4,318 |   | 5.82 | % |
| Securities sold  under agreement to repurchase   |   | 16,453               |    | 529          |   | 3.22 | % | 13,055 |   | 612 |   | 4.69 | % |
| Short-term  borrowings                           |   | 4,220                |    | 186          |   | 4.41 | % | 2,989 |   | 188 |   | 6.29 | % |
| Long-term  borrowings                            |   | 8,302                |    | 489          |   | 5.89 | % | 2,938 |   | 192 |   | 6.54 | % |
| Total  interest-bearing liabilities              |   | 197,731              |    | 7,960        |   | 4.03 | % | 173,383 |   | 8,177 |   | 4.72 | % |
| Other  liabilities                               |   | 35,000               |    |         |   |   |   | 31,080 |   |   |   |   |   |
| Shareholders’  equity                       |   | 24,695               |    |         |   |   |   | 21,942 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |   | $                    | 257,426 |         |   |   |   |   | $ | 226,405 |   |   |   |   |   |
| Net interest  income (2)                         |   |                 |    | $            | 11,582 |   |   |   |   |   | $ | 10,057 |   |   |   |
| Net interest  rate spread                        |   |                 |    |         |   | 4.08 | % |   |   |   |   | 3.91 | % |
| Net interest  margin                             |   |                 |    |         |   | 4.81 | % |   |   |   |   | 4.76 | % |

 

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(1) Non-accruing loans included in computation of average balance.  (2) Income from investment securities andnet interest income is presented on a tax-equivalent basis by adjusting incomeand yields earned on tax-exempt securities assuming a federal tax rate of 34%.

 

*ANALYSISOF CHANGES IN NET INTEREST INCOME*

 

The following table presents the components of the Company’s netinterest income as attributed to volume and rate on a tax-equivalent basisassuming a Federal tax rate of 34%.  Thenet change attributable to the combined impact of volume and rate has beensolely allocated to the change in volume.

 
| **Year Ended  December 31,**                    |   | **2001**                                   |   | **2000**                                   |   |
|-------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|                                            |   | **Increase  (Decrease) Due to Change in:** |   | **Increase  (Decrease) Due to Change in:** |   |
|                                            |   | **Volume**                                 |   | **Rate**                                   |   | **Total** |   | **Volume** |   | **Rate** |   | **Total** |   |
|                                            |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
|                                            |   |                                       |   |                                       |   | **(In  Thousands)** |   |   |   |   |   |
|                                            |   |                                       |   |                                       |   |   |   |   |   |   |   |
| Interest-earning  assets:                       |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Loans                                           |   | $                                          | 1,990  |                                       | $      | (967 | ) | $ | 1,023 |   | $ | 2,175 |   | $ | 501 |   | $ | 2,676 |   |
| Investment  securities                          |   | 494                                        |   | (121                                       | )      | 373 |   | (59 | ) | 345 |   | 286 |   |
| Other earning  assets                           |   | (33                                        | )      | (55                                        | )      | (88 | ) | (21 | ) | 26 |   | 5 |   |
| Total interest  income                          |   | 2,451                                      |   | (1,143                                     | )      | 1,308 |   | 2,095 |   | 872 |   | 2,967 |   |
|                                            |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                  |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Savings deposits  and interest-bearing checking |   | 165                                        |   | (810                                       | )      | (645 | ) | 100 |   | 299 |   | 399 |   |
| Certificates of  deposit                        |   | 438                                        |   | (222                                       | )      | 216 |   | 900 |   | 255 |   | 1,155 |   |
| Securities sold  under agreement to repurchase  |   | 109                                        |   | (192                                       | )      | (83 | ) | (11 | ) | 110 |   | 99 |   |
| Short-term  borrowings                          |   | 54                                         |   | (56                                        | )      | (2 | ) | 72 |   | 24 |   | 96 |   |
| Long-term  borrowings                           |   | 316                                        |   | (19                                        | )      | 297 |   | 66 |   | 3 |   | 69 |   |
| Total interest  expense                         |   | 1,082                                      |   | (1,299                                     | )      | (217 | ) | 1,127 |   | 691 |   | 1,818 |   |
|                                            |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Change in net  interest income                  |   | $                                          | 1,369  |                                       | $      | 156 |   | $ | 1,525 |   | $ | 968 |   | $ | 181 |   | $ | 1,149 |   |
|                                            |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |

 

 

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***Net InterestIncome***

**                The Company’s primary source ofoperating income is net interest income. Net interest income on a taxable equivalent basis was $11.6 million for2001 and $10.1 million for 2000.  Netinterest income is the difference between the income earned on earning assetsand the interest paid on interest-bearing liabilities.  Both net interest income and the netinterest margin, which is net interest income expressed as a percentage ofaverage earning assets, are affected by the volume and mix of earning assetsand interest-bearing liabilities and the interest rates earned or paid on them.**

**                Net interest income increased by$1.5 million or 15%, on a taxable equivalent basis, in 2001 compared to2000.  This increase was due to growthin the loan and investment portfolios and the repricing of interest-bearingliabilities faster than the repricing of earning assets.  The Company’s net interest margin increasedto 4.81% for 2001 compared to 4.76% for 2000. The Federal Reserve reduced the Federal Funds rate eleven times in 2001for a total reduction of 4.75%.   TheFederal Funds rate, as set by the Federal Reserve, averaged 3.90% in 2001 and6.24% in 2000.**

**                Interest income increased to$19.5 million, a 7% increase in 2001. The increase was driven by growth in the average earning assets of $29.6million or 14% which was offset by a decrease in the yield on average earning assetsto 8.11% in 2001 from 8.63% in 2000.**

**                Interest expense decreased to$8.0 million in 2001 from $8.2 million in 2000, representing a 3% decrease.  This decrease was a result of a decline inthe cost of funds to 4.03% in 2001 from 4.72% in 2000 which was offset bygrowth in average interest-bearing liabilities of $24.3 million or 14%.**

**                Management currently anticipatesthat net interest income will continue to increase in 2002 due to expectedgrowth in earning assets (primarily loans), although a decline in the netinterest margin is expected due to industry-wide pricing pressure on loans anddeposits and the Federal Funds rate remaining at historically low levels(currently 1.75%).**

** **

***Non-InterestIncome***

**                Non-interest income was $3.3million for 2001 compared to $3.2 million for 2000.  Non-interest income increased $404,000 in 2001 when excludinggains on sales of securities of $37,000 in 2001 and  $297,000 in 2000.** The Company continues to experience growth in all fee income categoriesincluding increases in gain on sale of mortgage loans of 103%, ATM fees of 25%and merchant processing fees of 12%.

**                Gain on the sale of mortgageloans increased to $321,000 for 2001 compared to $158,000 for 2000 due to therecord level of mortgage refinances resulting from the favorable interest rateenvironment nationally.  The Company’sportfolio of residential mortgages serviced for secondary market investors atDecember 31, 2001 of $79.1 million increased by $9.8 million, or 14%, fromDecember 31, 2000.**

**                Trust fees increased to $1.0million in 2001 compared to $967,000 in 2000. The market value of client assets under administration increased $10.0million, or 4%, to $234.8 million at December 31, 2001 compared with trust assetsof $224.8 million at December 31, 2000. The increase in trust assets wasachieved through new business development as market conditions remainedvolatile during the year.**

**                The generation of mortgage salegains and trust fees is dependent on the market and economic conditions and, asa result, there can be no assurance that income levels reported in priorperiods can be achieved in the future.**

** **

***Non-InterestExpense***

**                Non-interest expense was $9.5million for 2001 compared to $8.8 million in 2000.  The $645,000 or 7% increase was primarily related to the increasein salaries and employee benefits of $335,000 and the increase in otherexpenses of $174,000.  The Company’sefficiency ratio (non-interest expense divided by the sum of net interestincome and other income) improved to 63.8% for 2001 compared to 66.9% for 2000.**

**                Salaries and employee benefitsexpense totaled $5.0 million for 2001. Personnel costs in 2001 increased 13%, when excluding the one-timecharge of $238,000 in 2000 resulting from restructuring and amending theCompany’s**

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**6**

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**supplementalexecutive retirement plan.  The 2001increase was a result of normal annual salary increases and additional staffingrequired as a result of asset growth and market expansion.  Other non-interest expense increased 8% for2001 reflecting increases in merchant and credit card processing expenses, ATMexpenses and professional fees.**

**                Annual operating expenses arealso expected to increase in future periods due to future branching and productexpansion.**

** **

**BALANCE SHEET REVIEW**

***Loans***

**                The Bank offers a broad range ofpersonal and business loan products. Total loans (which excludes loans held for sale) of $188.1 million grew$22.2 million or 13% from December 31, 2000. Real estate lending was strong in 2001 with commercial real estate loansincreasing 17% in 2001 to $69.3 million and residential and home constructionlending increasing 36% to $41.7 million. Commercial loan balances increased 3%in 2001 to $43.5 million while consumer and home equity loans increasedslightly to $33.6 million at year-end.**

**                The average yield on loansdecreased to 8.96% in 2001 from 9.59% in 2000. This decrease is the result of lower interest rates in 2001 (the primerate average was 6.91% for 2001 and 9.24% for 2000).  Management anticipates pressure on yields on loans due to lowerinterest rates in 2002 and increased competition from banks and non-traditionalcredit providers.**

** **

***InvestmentSecurities***

**                The investment portfolioprovides liquidity, diversification and earnings to the Company.  The investment portfolio represents 26% ofthe Company’s total assets.  Theportfolio is comprised primarily of U.S. Government agencies and collateralizedmortgage obligations.  Substantially allof the Company’s securities are AAA or equivalently rated. Total investmentsecurities increased in 2001 by $11.9 million to $71.6 million at December 31,2001.  The Company changed itsinvestment mix during 2001 by increasing its holdings in mortgage-backed securitiesand collateralized mortgage obligations (which currently represent 54% of theinvestment portfolio compared to 48% at December 31, 2000) and reducing itsU.S. Treasury security holdings to 1% at December 31, 2001, compared to 12% theprevious year.  The average yield on theinvestment portfolio decreased to 5.87% in 2001 compared to 6.08% in 2000 as aresult of maturing investments being reinvested at lower interest rates.**

** **

***Deposits***

Depositsare the major source of the Company’s funds for lending, investing and othergeneral business purposes.  Deposits areattracted principally from within the Company’s primary market area through theoffering of a broad variety of deposit products, including checking accounts,money market accounts, savings accounts, certificates of deposit (includingjumbo certificates in denominations of $100,000 or more) and retirement savingsplans.  In addition, the Company usesdeposits obtained through investment banking firms which obtain funds fromtheir customers for deposit with the Company (“brokered deposits”).

In2001, total deposits increased by $18.9 million to $219.3 million, a 9%increase over 2000.  The Companyexperienced growth in all deposit categories in 2001.  Comparing year-end balances at 2001 to 2000, checking accountsincreased by $6.1 million, savings and money market accounts by $8.4 millionand certificates of deposit by $4.4 million.

Dueto the low interest rate environment, the average yield on savings deposits andinterest-bearing checking accounts decreased to 2.57% in 2001 from 3.58% in2000 and the average yield on certificates of deposit decreased to 5.52% in2001 from 5.82% in 2000.

TheCompany’s focus on quality customer service contributed to the deposit growthin 2001. The Company continues to develop consumer and commercial depositrelationships through referrals and additional contacts within its market area.

** **

***Borrowings***

**                Borrowings supplement depositsas a source of liquidity.  Borrowedfunds consist mainly of securities sold under agreement to repurchase andadvances from the Federal**

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**7**

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**HomeLoan Bank (FHLB). Total borrowings were $29.8 million at December 31, 2001compared to $20.1 million at December 31, 2000, an increase of $9.7 million.  Other short-term borrowings include federalfunds purchased, commercial lines of credit, Treasury, tax and loan depositsand interest-bearing demand notes due to the U.S. Treasury.**

** **

**ASSET QUALITY**

Managementseeks to maintain a high quality of assets through prudent underwriting andsound lending practices. Approximately 24% of the Company’s loan portfolio iscollateralized by first liens on primarily owner-occupied residential homeswhich have historically carried a relatively low credit risk.  The Bank also maintains a commercial realestate portfolio comprised primarily of owner-occupied commercial businesses.

TheBank participates in government guaranteed loan programs including the SmallBusiness Administration (“SBA”), Rural Development (“RD”) and the FinanceAuthority of Maine (“FAME”). At December 31, 2001, total loans under theseprograms totaled $16.7 million of which $12.4 million, or 7% of the total loanportfolio outstanding, is guaranteed by the various federal and stategovernment entities.

TheCompany continues to focus on asset quality issues and emphasizes loan reviewand underwriting procedures.  The Bankutilizes the services of a consultant, M&M Consulting, LLC (a joint ventureowned 50% by the Company), to perform periodic loan and documentation review.Management has established a risk rating and review process with the objectiveof quickly identifying, evaluating and initiating necessary corrective actionfor all commercial and commercial real estate loans. The goal of the riskrating process is to address the watch list, substandard and non-performingloans, as early as possible. These components of risk management are integralelements of the Bank’s loan program which have contributed to the loanportfolio performance to date. Nonetheless, management maintains a cautiousoutlook in attempting to anticipate the potential effects of uncertain economicconditions (both locally and nationally).

** **

***NonperformingAssets***

Nonperformingassets consist of non-accrual loans, other loans past due over 90 days andother real estate owned.  Totalnonperforming assets as a percentage of total assets remained consistent at..26% or $728,000 at December 31, 2001, compared to .25% or $574,000 at December31, 2000.

Loansare placed on non-accrual status when, in the judgment of management, principalrepayment is doubtful, whether current or past due. When a loan is placed onnon-accrual status, previously accrued but unpaid interest is deducted frominterest income. As a matter of policy, interest is generally not accrued onloans past due 90 days or more. The Bank does not return a loan to accrualstatus until it is brought current with respect to both principal and interest,future payments are no longer in doubt, and the loan has been performing for atleast six consecutive months.

** **

*** Provision and Allowance for Loan Losses***

**                The provision for loan losses isa result of management’s periodic analysis of the adequacy of the allowance forloan losses.  The provision for loanlosses was $474,000 for 2001 and $423,000 for 2000, an increase of $51,000 or12%.  The allowance for loan lossesrepresented 1.59% of loans outstanding at December 31, 2001, as compared to1.60% at December 31, 2000.  Netcharge-offs were $146,000 during 2001 or .08% of average loans outstanding, ascompared to $39,000 in 2000 or .03%. The low level of net loan charge-offs is indicative of the Company’sloan quality and credit administration standards and the generally stableeconomic environment existing in the Company’s primary market area.**

**                The allowance for loan losses ismaintained at a level determined to be adequate by management to absorb futurecharge-offs of loans deemed noncollectible. This allowance is increased by provisions charged to operating expenseand by recoveries on loans previously charged off.  A high degree of judgment is necessary to determine theappropriate level of allowance for loan losses and requires management’songoing evaluation of adequacy.  Theadequacy of the loan loss allowance is determined by use of a risk ratingsystem.  The evaluation processincludes, among other things, industry standards, management’s experience, the**

** **

** **

**8**

----

** **

**Bank’shistorical loan loss experience, evaluation of economic conditions and regularreviews of delinquencies and loan portfolio quality.  Although management believes it uses the best informationavailable to make determinations with respect to the allowance for loan losses,future adjustments may be necessary if economic conditions differ from theeconomic conditions in the assumptions used in making the final determinations.**

**                Future provisions for loanlosses depend on such factors as asset quality, net loan charge-offs, loangrowth and other criteria discussed above. The appropriate level of the allowance for loan losses and thecorresponding provision will continue to be determined quarterly.  Management anticipates that there will be aprovision for loan losses in 2002; however, the specific amount cannot bedetermined at this time.  Changes incircumstances affecting the various factors of the Company’s methodology willdetermine the provision amount in 2002.**

** **

**ASSET/LIABILITY MANAGEMENT**

***Market Risk***

**                Market risk is the risk of lossin a financial instrument arising from adverse changes in market rates/pricessuch as interest rates, foreign currency exchange rates, commodity prices andequity prices.  The Company’s primarymarket risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an importantcomponent of the Company’s asset/liability management process which is governedby policies established by its Board of Directors that are reviewed andapproved annually.**

**                The Board of Directors delegatesresponsibility for carrying out the asset/liability management policies to itsAsset/Liability Committee (“ALCO”).  Inthis capacity, ALCO develops guidelines and strategies impacting the Company’sasset/liability management process based upon estimated market risksensitivity, policy limits and overall market interest rate levels/trends.**

** **

***Interest RateRisk***

**                Interest rate risk representsthe sensitivity of earnings to changes in market interest rates. As interestrates change, the interest income and expense streams associated with theCompany’s financial instruments also change thereby impacting net interestincome (“NII”), the primary component of the Company’s earnings.  ALCO utilizes the results of a detailed anddynamic simulation model to quantify the estimated exposure of NII to sustainedinterest rate changes.  While ALCOroutinely monitors simulated NII sensitivity over a rolling two-year horizon,it also utilizes additional tools to monitor potential longer-term interestrate risk.**

**                The simulation model capturesthe impact of changing interest rates on the interest income earned andinterest expense incurred on all assets and liabilities reflected in theCompany’s statement of financial condition. This sensitivity analysis is compared to ALCO policy limits whichspecify a maximum tolerance level for NII exposure over a one year horizon,assuming no balance sheet growth, given both a 200 basis point (bp) upward anddownward shift in interest rates.  Aparallel and pro rata shift in rates over a 12 month period is assumed.**

** **

***Liquidity***

**                Liquidity represents the abilityto meet both asset growth and deposit withdrawals.  Many factors affect a company’s ability to meet liquidity needs,including changes in the markets served, its asset-liability mix, itsreputation and credit standing in the market and general economicconditions.  In addition to traditionalin-market deposit sources, the Company has other sources of liquidity,including proceeds from maturing investment securities and loans, the sale ofinvestment securities, Federal Funds through correspondent bank relationships,brokered deposits and FHLB borrowings. Additional liquidity is available in the loan portfolio through sale ofresidential mortgages and the guaranteed portion of SBA loans.   Management believes that the current levelof liquidity is sufficient to meet current and future funding requirements.**

** **

** **

**9**

----

** **

**CAPITAL**

**                At December 31, 2001,shareholders’ equity totaled $26.0 million or 9.3% of total assets, as comparedto $23.3 million or 9.5% at December 31, 2000. The net increase in shareholders’ equity was attributable to: net incomeof $3.3 million; change in unrealized gain on securities of $591,000; stockoption exercises of $132,000, less net share repurchases of $454,000; and$888,000 in cash dividends.**

**                Capital guidelines issued by theFederal Reserve Board require the Company to maintain certain ratios.  The Company’s risk based capital ratios forTier 1 and Tier 2 Capital (as defined by federal banking agency regulations) atDecember 31, 2001 of 13.69% and 15.11%, respectively, exceed regulatoryguidelines for a “well capitalized” financial institution.  The Company’s Tier 1 and Tier 2 risk basedcapital ratios at December 31, 2000 were 13.78% and 15.21%, respectively.  The Bank is also subject to federalregulatory capital requirements.  AtDecember 31, 2001, the Bank was deemed to be “well capitalized” under the applicableregulations.**

**               **During 2000, the Board of Directors approved a stockrepurchase program authorizing the Company to repurchase up to 255,416 sharesof the Company’s common stock of which the Company has repurchased 175,169shares.   Shares are being repurchasedinto treasury for the purpose of funding the expected exercise of stock optionspursuant to the Company’s stock option plan.

** **

**IMPACT OF NEW ACCOUNTING STANDARDS**

Statementof Financial Accounting Standards (SFAS) No. 141, “Business Combinations,”requires that the purchase method be used to account for business combinationsinitiated after June 30, 2001.

SFAS No. 142, “Goodwill and Other Intangible Assets,”and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” are effective on January 1, 2002. SFAS No. 142 requires that goodwill no longer be amortized to earnings,but instead be reviewed for impairment. The amortization of goodwill ceasesupon adoption of the Statement on January 1, 2002.  SFAS No. 144 provides guidance concerning the recognition andmeasurement of an impairment loss for certain types of long-lived assets.  These statements are expected to have nomaterial impact on the Company’s consolidated financial condition and resultsof operations.

 

**MARKET FOR COMMON STOCK**

**    Market prices (as quoted by Nasdaq) andcash dividends paid, per share of the Company’s common stock, by calendarquarter for the past two years are listed below.  Per share data information has been adjusted to reflect the 3%stock dividends in both 2001 and 2000, respectively.**

** **
|              |   | **Dividends Declared** |       | **Market Prices** |       |
|-------------------|--------|------------------------|------------|-------------------|------------|
| **2001 Quarters** |   | **Per Share**          |       | **High**          |       | **Low** |   |
| **First**         |   | **$**                  | **0.07**   | ** **        | **$**      | **11.17** | ** ** | **$** | **9.22** | ** ** |
| **Second**        |   | **0.07**               | ** ** | **11.00**         | ** ** | **10.38** | ** ** |
| **Third**         |   | **0.08**               | ** ** | **11.15**         | ** ** | **10.00** | ** ** |
| **Fourth**        |   | **0.09**               | ** ** | **11.50**         | ** ** | **10.42** | ** ** |
|                   |        |                        |            |                   |            |  |  |  |  |  |

** **
|              |   | **Dividends Declared** |       | **Market Prices** |       |
|-------------------|--------|------------------------|------------|-------------------|------------|
| **2000 Quarters** |   | **Per Share**          |       | **High**          |       | **Low** |   |
| **First**         |   | **$**                  | **0.06**   | ** **        | **$**      | **10.60** | ** ** | **$** | **6.31** | ** ** |
| **Second**        |   | **0.06**               | ** ** | **11.78**         | ** ** | **8.50** | ** ** |
| **Third**         |   | **0.06**               | ** ** | **10.92**         | ** ** | **9.71** | ** ** |
| **Fourth**        |   | **0.06**               | ** ** | **10.86**         | ** ** | **8.19** | ** ** |
|                   |        |                        |            |                   |            |  |  |  |  |  |

** **

** **

**                As of December 31, 2001, theCompany had approximately 830 shareholders of record and 2,667,217 sharesoutstanding.**

**                There are significant regulatorylimitations on the Company’s ability to pay dividends depending on thedividends it receives from its subsidiary, Merrill Merchants Bank, which aresubject to regulations and the Bank’s continued compliance with all regulatorycapital requirements and the overall health of the institution.  In addition, the Company has a class ofcumulative preferred stock, meaning that if dividends are not paid whendeclared, they will accumulate and be payable in full before any dividends arepaid on common stock.  See notes 15 and18 of the notes to the consolidated financial statements for a discussion ofthe preferred stock and the Bank’s regulatory matters, respectively.**

** **

 

10

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**INDEPENDENT****AUDITORS’ REPORT**

 

 

To the Board of Directorsand Shareholders

Merrill MerchantsBancshares, Inc.

 

We have auditedthe accompanying consolidated statements of financial condition of MerrillMerchants Bancshares, Inc. and Subsidiaries as of December 31, 2001 and 2000,and the related consolidated statements of income, changes in shareholders’equity and cash flows for the years then ended.  These consolidated financial statements are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

 

We conducted ouraudits in accordance with U.S. generally accepted auditing standards.  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the consolidated financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Merrill MerchantsBancshares, Inc. and Subsidiaries at December  31, 2001 and 2000 and theconsolidated results of their operations and their consolidated cash flows forthe years then ended in conformity with U.S. generally accepted accountingprinciples.

 

 

 
| /s/Berry, Dunn, McNeil  & Parker |
|--------------------------------------|
| BERRY DUNN MCNEIL &  PARKER      |
| Portland, Maine                      |
| January 11, 2002                     |

 

 

11

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### **MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

### **CONSOLIDATED STATEMENTS OF FINANCIALCONDITION**

**(In Thousands, Except Number of Shares and per Share Data)**

 
| **ASSETS**                                                                      |   | **DECEMBER 31,** |       |
|---------------------------------------------------------------------------------|--------|------------------|------------|
|                                                                            |   | **2001**         |       | **2000** |   |
|                                                                            |   |             |       |   |   |
| Cash and due from banks                                                         |   | $                | 9,789      |   | $ | 11,796 |   |
| Interest-bearing deposits with banks                                            |   | 55               |       | 57 |   |
| Total cash and cash equivalents                                                 |   | 9,844            |       | 11,853 |   |
| Investment securities — available for sale                                 |   | 71,607           |       | 59,686 |   |
| Loans held for sale                                                             |   | 1,060            |       | 827 |   |
| Loans receivable                                                                |   | 188,080          |       | 165,923 |   |
| Less allowance for loan losses                                                  |   | 2,986            |       | 2,658 |   |
| Net loans receivable                                                            |   | 185,094          |       | 163,265 |   |
| Other real estate owned                                                         |   | 221              |       | 90 |   |
| Properties and equipment, net                                                   |   | 3,674            |       | 3,642 |   |
| Cash surrender value of life insurance                                          |   | 2,900            |       | 2,768 |   |
| Deferred income tax benefit                                                     |   | 505              |       | 624 |   |
| Accrued income and other assets                                                 |   | 3,292            |       | 3,658 |   |
| Total assets                                                                    |   | $                | 278,197    |   | $ | 246,413 | ** ** |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                  |   |             | ** ** |   | ** ** |
| Demand deposits                                                                 |   | $                | 39,242     |   | $ | 34,209 |   |
| Savings and NOW deposits                                                        |   | 96,416           |       | 86,975 |   |
| Certificates of deposit                                                         |   | 83,651           |       | 79,267 |   |
| Total deposits                                                                  |   | 219,309          |       | 200,451 |   |
| Securities sold under agreements torepurchase (term and demand)                 |   | 19,138           |       | 14,168 |   |
| Other borrowed funds                                                            |   | 10,654           |       | 5,908 |   |
| Accrued expenses and other liabilities                                          |   | 2,811            |       | 2,294 |   |
| Mandatory convertible debentures                                                |   | 300              |       | 300 |   |
| Total liabilities                                                               |   | 252,212          |       | 223,121 |   |
| Commitments (Notes 7, 8, 14, 18 and 19)                                         |   |             |       |   |   |
| Shareholders’ equity                                                       |   |             |       |   |   |
| Convertible cumulative preferred stock, par value                               |   |             |       |   |   |
| $1; authorized 50,000 shares, issued and outstanding                            |   |             |       |   |   |
| 19,566 shares                                                                   |   | 20               |       | 20 |   |
| Common stock, $1 par value; 4,000,000 shares authorized;                        |   |             |       |   |   |
| shares issued 2,741,232 and outstanding 2,667,217 in 2001; and                  |   |             |       |   |   |
| shares issued 2,661,450 and outstanding 2,586,396 in 2000                       |   | 2,741            |       | 2,661 |   |
| Capital surplus                                                                 |   | 18,794           |       | 17,958 |   |
| Retained earnings                                                               |   | 4,601            |       | 3,436 |   |
| Accumulated other comprehensive income                                          |   |             |       |   |   |
| Unrealized gain on securities available for sale, net of tax                    |   |             |       |   |   |
| of $294 and $4 in 2001 and 2000, respectively                                   |   | 600              |       | 9 |   |
| Treasury stock, at cost — 74,015 shares in 2001 and 75,054 shares in  2000 |   | (771             | )          | (792 | ) |
| Total shareholders’ equity                                                 |   | 25,985           |       | 23,292 |   |
| Total liabilities and shareholders’ equity                                 |   | $                | 278,197    |   | $ | 246,413 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

 

12

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### **MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

 

 
| **(In Thousands, Except Number of  Shares and per Share Data)** |   | **YEARS  ENDED DECEMBER 31,** |       |
|-----------------------------------------------------------------|--------|-------------------------------|------------|
|                                                            |   | **2001**                      |       | **2000** |   |
| **Interest and dividend income**                                |   |                          | ** ** |   | ** ** |
| Interest and fees on loans                                      |   | $                             | 15,731     |   | $ | 14,708 |   |
| Interest on investment securities                               |   | 3,520                         |       | 3,271 |   |
| Dividends on investment securities                              |   | 228                           |       | 113 |   |
| Interest on federal funds sold                                  |   | 23                            |       | 111 |   |
| Total interest and dividend income                              |   | 19,502                        |       | 18,203 |   |
| Interest expense                                                |   |                          |       |   |   |
| Interest on deposits                                            |   | 6,756                         |       | 7,185 |   |
| Interest on borrowed funds                                      |   | 1,204                         |       | 992 |   |
| Total interest expense                                          |   | 7,960                         |       | 8,177 |   |
| Net interest income                                             |   | 11,542                        |       | 10,026 |   |
| Provision for loan losses                                       |   | 474                           |       | 423 |   |
| Net interest income after provision for loan losses             |   | 11,068                        |       | 9,603 |   |
| Other income                                                    |   |                          |       |   |   |
| Service charges on deposit accounts                             |   | 691                           |       | 658 |   |
| Other service charges and fees                                  |   | 964                           |       | 835 |   |
| Trust fees                                                      |   | 1,010                         |       | 967 |   |
| Net gain on sale of mortgage loans                              |   | 321                           |       | 158 |   |
| Net gain on investment securities                               |   | 37                            |       | 297 |   |
| Other                                                           |   | 276                           |       | 240 |   |
| Total other income                                              |   | 3,299                         |       | 3,155 |   |
| Other expense                                                   |   |                          |       |   |   |
| Salaries and employee benefits                                  |   | 5,000                         |       | 4,665 |   |
| Occupancy expense                                               |   | 776                           |       | 694 |   |
| Equipment expense                                               |   | 686                           |       | 637 |   |
| Data processing                                                 |   | 498                           |       | 493 |   |
| Other                                                           |   | 2,508                         |       | 2,334 |   |
| Total other expense                                             |   | 9,468                         |       | 8,823 |   |
| Income before income taxes                                      |   | 4,899                         |       | 3,935 |   |
| Income tax expense                                              |   | 1,645                         |       | 1,316 |   |
| Net income                                                      |   | $                             | 3,254      |   | $ | 2,619 |   |
|                                                            |   |                          |       |   |   |
| Per share data                                                  |   |                          |       |   |   |
| Basic earnings per common share                                 |   | $                             | 1.20       |   | $ | 0.95 |   |
| Diluted earnings per common share                               |   | $                             | 1.04       |   | $ | 0.84 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

 

13

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**MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

 
| **(In Thousands, Except Number of Shares and per Share Data)** |   |            |   |       |   |        |   |         |   |               |   |
|----------------------------------------------------------------|--------|-----------------|--------|------------|--------|-------------|--------|--------------|--------|--------------------|--------|
|                                                           |   |            |   |       |   |        |   |         |   | **Unrealized**     |   |   |   |   |   |
|                                                           |   | **Convertible** |   |       |   |        |   |         |   | **Gain  (Loss)**   |   |   |   |   |   |
|                                                           |   | **Cumulative**  |   |       |   |        |   |         |   | **on  Securities** |   |   |   | **Total** |   |
|                                                           |   | **Preferred**   |   | **Common** |   | **Capital** |   | **Retained** |   | **Available**      |   | **Treasury** |   | **Shareholders’** |   |
|                                                           |   | **Stock**       |   | **Stock**  |   | **Surplus** |   | **Earnings** |   | **for Sale**       |   | **Stock** |   | **Equity** |   |
| Balance at December 31, 1999                                   |   | $               | 20     |       | $      | 2,584       |   | $            | 17,220 |               | $      | 2,618 |   | $ | (435 | ) | $ | (749 | ) | $ | 21,258 |   |
| Net income                                                     |   | —          |   | —     |   | —      |   | 2,619        |   | —             |   | — |   | 2,619 |   |
| Change in unrealized gain (loss)                               |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| on securities available for                                    |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| sale, net of deferred income                                   |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| taxes of $228                                                  |   | —          |   | —     |   | —      |   | —       |   | 444                |   | — |   | 444 |   |
| Total comprehensive income                                     |   | —          |   | —     |   | —      |   | 2,619        |   | 444                |   | — |   | 3,063 |   |
| Common stock options exercised,                                |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| 43,949 shares                                                  |   | —          |   | —     |   | —      |   | (296         | )      | —             |   | 496 |   | 200 |   |
| 3% common stock dividend                                       |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| declared                                                       |   | —          |   | 77         |   | 697         |   | (775         | )      | —             |   | — |   | (1 | ) |
| Treasury stock purchased (52,592 shares at  an average         |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| price of $10.25)                                               |   | —          |   | —     |   | —      |   | —       |   | —             |   | (539 | ) | (539 | ) |
| Tax benefit related to exercise of                             |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| stock options                                                  |   | —          |   | —     |   | 41          |   | —       |   | —             |   | — |   | 41 |   |
| Common stock cash dividend                                     |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| declared, $.24 per share                                       |   | —          |   | —     |   | —      |   | (647         | )      | —             |   | — |   | (647 | ) |
| Convertible cumulative preferred stock  dividends              |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| declared, $5.02 per share                                      |   | —          |   | —     |   | —      |   | (83          | )      | —             |   | — |   | (83 | ) |
| Balance at December 31, 2000                                   |   | 20              |   | 2,661      |   | 17,958      |   | 3,436        |   | 9                  |   | (792 | ) | 23,292 |   |
| Net income                                                     |   | —          |   | —     |   | —      |   | 3,254        |   | —             |   | — |   | 3,254 |   |
| Change in unrealized gain                                      |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| on securities available for                                    |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| sale, net of deferred income                                   |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| taxes of $290                                                  |   | —          |   | —     |   | —      |   | —       |   | 591                |   | — |   | 591 |   |
| Total comprehensive income                                     |   | —          |   | —     |   | —      |   | 3,254        |   | 591                |   | — |   | 3,845 |   |
| Common stock options exercised,                                |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| 45,085 shares                                                  |   | —          |   | —     |   | —      |   | (343         | )      | —             |   | 475 |   | 132 |   |
| 3% common stock dividend                                       |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| declared                                                       |   | —          |   | 80         |   | 778         |   | (858         | )      | —             |   | — |   | — |   |
| Treasury stock purchased (42,319                               |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| shares at an average price of                                  |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| $10.72)                                                        |   | —          |   | —     |   | —      |   | —       |   | —             |   | (454 | ) | (454 | ) |
| Tax benefit related to exercise of                             |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| stock options                                                  |   | —          |   | —     |   | 58          |   | —       |   | —             |   | — |   | 58 |   |
| Common stock cash dividend                                     |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| declared, $.31 per share                                       |   | —          |   | —     |   | —      |   | (826         | )      | —             |   | — |   | (826 | ) |
| Convertible cumulative preferred                               |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| stock dividends declared,                                      |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| $3.18 per share                                                |   | —          |   | —     |   | —      |   | (62          | )      | —             |   | — |   | (62 | ) |
|                                                           |   |            |   |       |   |        |   |         |   |               |   |   |   |   |   |
| Balance at December 31, 2001                                   |   | $               | 20     |       | $      | 2,741       |   | $            | 18,794 |               | $      | 4,601 |   | $ | 600 |   | $ | (771 | ) | $ | 25,985 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

 

14

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**MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

### **CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| **(In Thousands)**                                             |   | **YEARS ENDED DECEMBER 31,** |       |     |       |
|----------------------------------------------------------------|--------|------------------------------|------------|----------|------------|
|                                                           |   | **2001**                     |       | **2000** |       |   |   |
| **Cash flows from operating activities**                       |   |                         | ** ** |     | ** ** |   | ** ** |
| Net income                                                     |   | $                            | 3,254      |     | $          | 2,619 |   |   |   |
| Adjustments to reconcile net income to net                     |   |                         |       |     |       |   |   |
|     cash provided by operating  activities      |   |                         |       |     |       |   |   |
| Depreciation                                                   |   | 458                          |       | 431      |       |   |   |
| Amortization                                                   |   | 483                          |       | 348      |       |   |   |
| Net (accretion) amortization on investment securities          |   | (102                         | )          | 15       |       |   |   |
| Deferred income taxes                                          |   | (181                         | )          | (282     | )          |   |   |
| Provision for loan losses                                      |   | 474                          |       | 423      |       |   |   |
| Net gain on sale of mortgage loans,                            |   |                         |       |     |       |   |   |
| investment securities, and properties and equipment            |   | (308                         | )          | (416     | )          |   |   |
| Net change in:                                                 |   |                         |       |     |       |   |   |
| Loans held for sale                                            |   | (233                         | )          | (446     | )          |   |   |
| Deferred loan fees                                             |   | 66                           |       | 2        |       |   |   |
| Accrued income and other assets                                |   | 163                          |       | (522     | )          |   |   |
| Accrued expenses and other liabilities                         |   | 277                          |       | 731      |       |   |   |
| Net cash provided by operating activities                      |   | 4,351                        |       | 2,903    |       |   |   |
| Cash flows from investing activities                           |   |                         |       |     |       |   |   |
| Net loans made to customers                                    |   | (22,805                      | )          | (27,815  | )          |   |   |
| Acquisition of properties and equipment and computer software  |   | (571                         | )          | (1,147   | )          |   |   |
| Purchase of investment securities available for sale           |   | (129,387                     | )          | (35,125  | )          |   |   |
| Proceeds from sales and maturities of investment securities    |   |                         |       |     |       |   |   |
| Sales and maturities of available for sale securities          |   | 118,485                      |       | 34,825   |       |   |   |
| Maturities of held to maturity securities                      |   | —                       |       | 262      |       |   |   |
| Proceeds from sale of other real estate owned                  |   | 314                          |       | —   |       |   |   |
| Proceeds from sale of properties and equipment                 |   | —                       |       | 19       |       |   |   |
| Net cash used in investing activities                          |   | (33,964                      | )          | (28,981  | **)**      |   | ** ** |
| **Cash flows from financing activities**                       |   |                         | ** ** |     | ** ** |   | ** ** |
| Net increase in demand, savings and NOW deposits               |   | 14,474                       |       | 12,180   |       |   |   |
| Net increase in certificates of deposit                        |   | 4,384                        |       | 13,424   |       |   |   |
| Net increase in securities sold under agreements to repurchase |   | 4,970                        |       | 111      |       |   |   |
| Net decrease in other borrowed funds                           |   | (2,556                       | )          | (52      | )          |   |   |
| Long-term advances from the Federal Home Loan Bank             |   | 8,000                        |       | 2,000    |       |   |   |
| Payments of long-term advances                                 |   | (698                         | )          | (1,318   | )          |   |   |
| Cash received in branch acquisition                            |   | —                       |       | 3,534    |       |   |   |
| Dividends paid on convertible cumulative preferred stock       |   |                         |       |     |       |   |   |
| and common stock                                               |   | (648                         | )          | (731     | )          |   |   |
| Proceeds from stock issuance                                   |   | 132                          |       | 200      |       |   |   |
| Purchase of treasury stock                                     |   | (454                         | )          | (539     | )          |   |   |
| Net cash provided by financing activities                      |   | 27,604                       |       | 28,809   |       |   |   |
| Net increase (decrease) in cash and cash equivalents           |   | (2,009                       | )          | 2,731    |       |   |   |
| Cash and cash equivalents, beginning of year                   |   | 11,853                       |       | 9,122    |       |   |   |
| Cash and cash equivalents, end of year                         |   | $                            | 9,844      |     | $          | 11,853 |   |   |   |
|                                                           |   |                         | ** ** |     | ** ** |   | ** ** |
| **Supplemental disclosures of cash flow information**          |   |                         | ** ** |     | ** ** |   | ** ** |
| Cash paid for interest                                         |   | $                            | 8,044      |     | $          | 7,875 |   |   |   |
| Transfers to other real estate owned                           |   | 456                          |       | 40       |       |   |   |
| Income tax paid                                                |   | 1,718                        |       | 1,493    |       |   |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

 

15

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**MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

**Notesto Consolidated Financial Statements**

**December31, 2001 and 2000**

**(Presentedin Thousands, except Number of Shares and per Share Data)**

 

1.                           Summary of Significant AccountingPolicies

    The accounting and reportingpolicies conform to U.S. generally accepted accounting principles and togeneral practice within the banking industry. The following is a summary of the significant accounting and reportingpolicies.

 

Nature of Business

    Merrill Merchants Bancshares,Inc. (Company) is a financial holding company that owns all of the common stockof Merrill Merchants Bank (Bank) and Maine Acceptance Corporation (MAC).  The Bank operates branches in Bangor (threeoffices), Brewer, Holden, Milford, Newport, Orono, Orrington, Pittsfield, andWaterville, Maine.

 

    The Bank’s lending activitiesare conducted principally in central Maine. The Bank grants single family and multi-family residential loans,commercial real estate loans, commercial loans, and a variety of consumerloans.  In addition, the Bank grantsloans for the construction of residential homes, multi-family properties andcommercial real estate properties.  Mostloans granted by the Bank are either collateralized by real estate orguaranteed by federal and local governmental authorities.  The ability and willingness of the singlefamily residential and consumer borrowers to honor their repayment commitmentsis generally dependent on the level of overall economic activity within theborrowers’ geographic areas and real estate values.  The ability and willingness of commercial real estate, commercialand construction loan borrowers to honor their repayment commitments isgenerally dependent on the health of the real estate economic sector in theborrowers’ geographic areas and the general economy.

 

    Maine Acceptance Corporation,a finance company located in Bangor, Maine, provides indirect auto andrecreational vehicle lending, as well as other types of loans, includingpersonal unsecured, recreational vehicles, automobiles, mobile homes, and homeequity loans.

 

    The Bank is under thesupervision of the Board of Governors of the Federal Reserve System and theMaine Bureau of Banking, and its deposits are insured by the Federal DepositInsurance Corporation (FDIC) to the fullest extent permitted by law.

 

Estimates

    The preparation of financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

    Material estimates that areparticularly susceptible to significant change in the near term relate to thedetermination of the allowance for loan losses and the valuation of real estateacquired in connection with foreclosures or in satisfaction of loans.  In connection with the determination of theallowance for loan losses and the carrying value of other real estate owned,management obtains independent appraisals for significant properties.

 

Financial Statement Presentation

    The accompanying consolidatedfinancial statements include the accounts of Merrill Merchants Bancshares, Inc.and its wholly-owned subsidiaries, Merrill Merchants Bank,

 

 

16

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a state-chartered bank, and Maine Acceptance Corporation. Allintercompany accounts and transactions have been eliminated in the consolidatedfinancial statements.

 

    Statement of FinancialAccounting Standards (SFAS) No. 131, “Disclosures about Segments of anEnterprise and Related Information,” requires a company to disclose certainincome statement and balance sheet information by operating segment. Since theCompany’s operations include only its banking and financing activities, noadditional disclosure standards are required by the Statement.

 

Investment Securities

    Investment debt securities areclassified as available for sale and are carried at fair value.  Unrealized gains and losses on securitiesavailable for sale, net of income taxes, are recognized as direct increases ordecreases in shareholders’ equity. Market values of securities are obtained from independent marketsources.  Cost of securities sold isrecognized using the specific identification method.

 

    Premiums are amortized anddiscounts are accreted using methods approximating the interest method.

 

Loans Held for Sale

    Residential mortgage loansoriginated and intended for sale in the secondary market are carried at thelower of aggregate cost or estimated market value.  Gains or losses on sales of loans are recognized at the time ofsale and are based upon the difference between the selling price and the carryingamount of loans sold.

 

Other Real Estate Owned

    Other real estate owned (OREO)includes real estate and repossessed personal property held for sale which havebeen acquired principally through foreclosure or a similar conveyance of title.  Real estate may be considered to bein-substance foreclosed and included in OREO prior to the conveyance of title whenspecific criteria are met.  Bothforeclosed and in-substance foreclosed real estate, as well as repossessedpersonal property, are carried at the lower of their recorded amounts or fairvalue less estimated costs of disposal. Any write-downs at, or prior to, the dates of acquisition are charged tothe allowance for loan losses. Subsequent write-downs are recorded in other expense.  Expenses incurred in connection with holdingsuch assets and gains and losses upon sale are included in other expense or otherincome.

 

## **Loans Receivable**

    Loans receivable thatmanagement has the intent and ability to hold for the foreseeable future oruntil maturity or pay-off are reported at their outstanding principal adjustedfor any charge-offs, the allowance for loan losses, and any deferred fees orcosts.

 

    Interest on loans is accruedand credited to income based on the principal amount outstand­ing.  The accrual of interest on loans isdiscontinued when, in the opinion of management, there is an indication thatthe borrower may be unable to meet payments as they become due or the loanbecomes past due 90 days or more unless the credit is well-secured and inprocess of collection. Upon such discontinuance, all unpaid accrued interest isreversed.  Interest income is subsequentlyrecognized only to the extent cash payments are received.

 

    The allowance for loan lossesis maintained at a level adequate to absorb probable losses.  Management determines the adequacy of theallowance based upon reviews of individual credits, recent loss experience,current economic conditions, the risk characteristics of the various categoriesof loans and other pertinent factors. Loans deemed uncollectible are charged to the allowance.  Provisions for loan losses and recoveries onloans previously charged off are added to the allowance.

 

    Loans considered to beimpaired are reduced to the present value of expected future cash flows or tothe fair value of collateral, by allocating a portion of the allowance for loanlosses to such loans. If these allocations cause the allowance for loan lossesto require an increase, such increase is included in the provision for loanlosses.

 

Loan Servicing

    The cost of mortgage servicingrights is amortized in proportion to, and over the period of, estimated netservice-

 

 

17

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ing revenues.  Impairment ofmortgage servicing rights is assessed based on the fair value of thoserights.  Fair values are estimated usingdiscounted cash flows based on a current market interest rate.  For purposes of measuring impairment, therights are stratified based on loan type, investor type, and interest rate. Theamount of impairment recognized is the amount by which the capitalized mortgageservicing rights for a stratum exceed their fair value.

 

Properties and Equipment

    Properties and equipment arestated at cost, less accumulated depreciation. The provision for depreciation is computed on the straight-line methodand by accelerated methods over the estimated useful lives of the assets.

 

Goodwill and Organization Costs

    Goodwill is being amortizedusing the straight-line method over seven and fifteen years. Upon adoption ofSFAS No. 142 on January 1, 2002, the Company will discontinue the goodwillamortization of $70 per year and will review the goodwill asset for impairmentin accordance with SFAS No. 142.

 

Loan Origination Fees and Costs

    Loan origination fees andcertain direct origination costs are capitalized and recognized as anadjustment of the yield on the related loan.

 

Income Taxes

    The Company records deferredtax assets and liabilities for future tax consequences attributable todifferences between the financial statement carrying amounts of assets andliabilities and their respective tax bases. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled.

 

Off-Balance-Sheet Financial Instruments

    In the ordinary course ofbusiness, the Bank has entered into off-balance-sheet financial instrumentsconsisting of commitments to extend credit, letters of credit and unadvancedcommitments under commercial and home equity lines of credit, credit cards, andoverdraft protection accounts.  Such financialinstruments are recorded in the consolidated financial statements when theybecome payable.

 

Cash and Cash Equivalents

    For the purpose ofpresentation in the consolidated statements of cash flows, cash and cash equivalentsare defined as cash and due from banks and interest-bearing deposits withbanks.

 

## **Earnings Per Share**

    The basic earnings per sharecomputation is based upon the weighted-average number of shares of stockoutstanding during the period. Potential common stock is considered in the calculation ofweighted-average shares outstanding for diluted earnings per share.

 

    The Company declared a 3% stock dividend in 2001 and 2000.  Earnings and cash dividends per share andweighted-average shares outstanding have been retroactively restated to reflectthe stock dividends.

 

Impact of Recently IssuedAccounting Standards

    SFAS No. 141, “Business Combinations,”requires that the purchase method be used to account for business combinationsinitiated after June 30, 2001.

 

    SFAS No. 142, “Goodwill and Other Intangible Assets,” and SFASNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” areeffective on January 1, 2002.  SFAS No.142 requires that goodwill no longer be amortized to earnings, but instead bereviewed for impairment. The amortization of goodwill ceases upon adoption ofthe Statement on January 1, 2002.  SFASNo. 144 provides guidance concerning the recognition and measurement of an impairmentloss for certain types of long-lived assets. These statements are expected to have no material impact on theCompany’s consolidated financial condition and results of operations.

 

 

18

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2.                           Cash and Cash Equivalents

    The Federal Reserve Boardrequires the Bank to maintain a rolling average compensating balance of $500 inamounts on deposit. The Company maintains its cash in bank deposit accountswhich, at times, may exceed federally insured limits. The Company has notexperienced any losses in such accounts. The Company believes it is not exposedto any significant risk with respect to these accounts.

 

3.         Investment Securities Available forSale

    The carrying amounts ofinvestment securities as shown in the consolidated statements of financialcondition and their approximate fair values at December 31, 2001, and 2000were as follows:

 
|                                      |   | **Amortized** |   | **Unrealized** |   | **Unrealized** |   | **Fair**  |   |
|-------------------------------------------|--------|---------------|--------|----------------|--------|----------------|--------|-----------|--------|
|                                      |   | **Cost**      |   | **Gains**      |   | **Losses**     |   | **Value** |   |
| **December 31, 2001**                     |   |          |   |           |   |           |   |      |   |
| U.S. Treasury securities                  |   | $             | 1,000  |           | $      | 30             |   | $         | — |   | $ | 1,030 |   |
| U.S. Government agencies and corporations |   |          |   |           |   |           |   |      |   |
| Mortgage-backed securities and            |   |          |   |           |   |           |   |      |   |
| collateralized mortgage                   |   |          |   |           |   |           |   |      |   |
| obligations                               |   | 38,123        |   | 733            |   | (172           | )      | 38,684    |   |
| State and local government                |   |          |   |           |   |           |   |      |   |
| debt securities                           |   | 5,254         |   | —         |   | —         |   | 5,254     |   |
| Certificates of deposit                   |   | 4,457         |   | —         |   | —         |   | 4,457     |   |
| U.S. Government and agency                |   |          |   |           |   |           |   |      |   |
| money market funds                        |   | 3,130         |   | —         |   | —         |   | 3,130     |   |
| Other securities                          |   | 1,699         |   | —         |   | (23            | )      | 1,676     |   |
|                                      |   | $             | 70,713 |           | $      | 1,129          |   | $         | (235   | ) | $ | 71,607 |   |
|                                      |   |          |   |           |   |           |   |      |   |
|                                      |   | **Amortized** |   | **Unrealized** |   | **Unrealized** |   | **Fair**  |   |
|                                      |   | **Cost**      |   | **Gains**      |   | **Losses**     |   | **Value** |   |
| **December 31, 2000**                     |   |          |   |           |   |           |   |      |   |
| U.S. Treasury securities                  |   | $             | 7,021  |           | $      | 12             |   | $         | (16    | ) | $ | 7,017 |   |
| U.S. Government agencies and corporations |   | 16,794        |   | 86             |   | (14            | )      | 16,866    |   |
| Mortgage-backed securities and            |   |          |   |           |   |           |   |      |   |
| collateralized mortgage                   |   |          |   |           |   |           |   |      |   |
| obligations                               |   | 28,305        |   | 185            |   | (108           | )      | 28,382    |   |
| State and local government                |   |          |   |           |   |           |   |      |   |
| debt securities                           |   | 2,514         |   | —         |   | —         |   | 2,514     |   |
| Certificates of deposit                   |   | 3,663         |   | —         |   | —         |   | 3,663     |   |
| Other securities                          |   | 1,376         |   | —         |   | (132           | )      | 1,244     |   |
|                                      |   | $             | 59,673 |           | $      | 283            |   | $         | (270   | ) | $ | 59,686 |   |

 

        At December 31, 2001 and 2000, investment securities withamortized cost of $33,848 and $30,885 and fair value of $34,727 and $30,977,respectively, were pledged to secure public deposits, Treasury, tax and loandeposits and borrowings and for other purposes required or permitted by law.

 

        The amortized cost and fair value of debt securities atDecember 31, 2001 by contractual maturity are shown below.  Expected maturities may differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.

 
|                       |   | **Amortized** |   | **Fair**  |   |
|----------------------------|--------|---------------|--------|-----------|--------|
|                       |   | **Cost**      |   | **Value** |   |
|                       |   |          |   |      |   |
| Due in one year or less    |   | $             | 15,184 |      | $      | 15,365 |   |
| Due from one to five years |   | 12,177        |   | 12,374    |   |
| Due from five to ten years |   | 9,234         |   | 9,392     |   |
| Due after ten years        |   | 29,289        |   | 29,670    |   |
|                       |   | $             | 65,884 |      | $      | 66,801 |   |

 

    Mortgage-backed securities andcollateralized mortgage obligations are allocated among the above maturitygroupings based on their final maturity dates.

 

    During 2001 and 2000, theCompany sold investment securities available for sale for total proceeds of$92,402 and $14,461, respectively. The sales resulted in gross realized gainsof $37 for 2001 and gross realized gains of $305 and gross realized losses of$8 for 2000.

 

 

19

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4.                           Loans Receivable

    The components of loansreceivable were as follows:
|                    |   | **2001** |    | **2000** |   |
|-------------------------|--------|----------|---------|----------|--------|
| Commercial              |   | $        | 43,533  |     | $      | 42,459 |   |
| Commercial real estate  |   | 69,303   |    | 59,305   |   |
| Construction            |   | 6,678    |    | 4,623    |   |
| Residential real estate |   | 35,040   |    | 26,112   |   |
| Home equity             |   | 17,675   |    | 18,830   |   |
| Consumer                |   | 15,945   |    | 14,622   |   |
| Less deferred loan fees |   | (94      | )       | (28      | )      |
| Total                   |   | $        | 188,080 |     | $      | 165,923 |   |

 

    Impaired loans recorded inconformity with SFAS No. 114, as amended by SFAS No. 118, totaled $420 and $467at December 31, 2001, and 2000, respectively. The total allowance for loan losses related to these loans was $189 and$173 at December 31, 2001, and 2000, respectively. The average balance ofoutstanding impaired loans was $460 and $403 for 2001 and 2000,respectively.  Interest incomerecognized for cash payments on impaired loans during 2001 and 2000 was notmaterial to the consolidated financial statements.

 

5.                           Allowance for Loan Losses

    An analysis of the allowancefor loan losses at December 31, 2001, and 2000 is as follows:

 
|                          |                                | **2001** |   | **2000** |   |
|-------------------------------|-------------------------------------|----------|--------|----------|--------|
| Balance at beginning of year  |                                | $        | 2,658  |     | $      | 2,274 |   |
| Add:                          | Provision for loan  losses          | 474      |   | 423      |   |
|                          | Recoveries of previous  charge-offs | 38       |   | 26       |   |
| Less:  Loans charged off |                                | (184     | )      | (65      | )      |
| Balance at end of year        |                                | $        | 2,986  |     | $      | 2,658 |   |
|                               |                                     |          |        |          |        |  |  |  |

 

6.                           Mortgage Servicing

 

    The Bank services residentialmortgage loans sold to investors under nonrecourse agreements amounting to$79,073 and $69,320 at December 31, 2001, and 2000, respectively.  Mortgage servicing rights of $340 and $314are capitalized and recorded at their estimated fair value at December 31,2001, and 2000, respectively and are included in other assets.  Mortgage servicing rights of $270 and $132were capitalized in 2001 and 2000, respectively and amortization of mortgageservicing rights was $243 in 2001 and $170 in 2000.

 

 

7.                           Properties and Equipment

    Properties and equipment arecomprised of the following:
|                          |   | **2001** |   | **2000** |   |
|-------------------------------|--------|----------|--------|----------|--------|
| Land and land improvements    |   | $        | 559    |     | $      | 461 |   |
| Bank premises                 |   | 2,327    |   | 2,228    |   |
| Furniture and equipment       |   | 2,796    |   | 2,723    |   |
| Leasehold improvements        |   | 308      |   | 254      |   |
| Total cost                    |   | 5,990    |   | 5,666    |   |
| Less accumulated depreciation |   | 2,316    |   | 2,024    |   |
| Net properties and equipment  |   | $        | 3,674  |     | $      | 3,642 |   |

 

    Certain Bank facilities and equipment areleased under various operating leases. Rental expense was approximately $289 for 2001 and $259 for 2000.   Future minimum rental commitments undernoncancelable leases at December 31, 2001 are:

 

| 2002       |   | $   | 261    |   |
|------------|--------|-----|--------|--------|
| 2003       |   | 202 |   |
| 2004       |   | 179 |   |
| 2005       |   | 84  |   |
| 2006       |   | 68  |   |
| Thereafter |   | 26  |   |
| Total      |   | $   | 820    |   |
|            |        |     |        |        |  |

 

8.                           Employee Benefit Plans

    The Company has established adefined contribution pension plan under Section 401(k) of the Internal RevenueCode.  Plan participants, who consist ofall employees meeting minimum age and service requirements who elect toparticipate, are permitted to contribute a percentage of their wages to theplan on a pre-tax basis.  The Companymatches a portion of each employee’s contribution, resulting in an expense of$90 and $76 for 2001 and 2000, respectively.

 

    In 1997, the Company adopted anonqualified supplemental executive retirement plan for the benefit of keyemployees.  The plan was restructuredand amended in 2000.  Life insurance policieswere acquired for the purpose of serving as the primary funding source. Theamount of each annual benefit is indexed to the financial performance

 

 

20

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of each insurance policy owned by the Bank over the Bank’s cost offunds expense. The present value of these benefits is being expensed over the employmentservice period which amounted to $132 for 2001 and $333 for 2000. The cashvalue of these policies was $2,900 and $2,768 at December 31, 2001, and 2000, respectively.

 

9.                           Deposits

    The aggregate amount ofcertificates of deposit with a minimum denomination of $100 was $29,409 and$25,410 at December 31, 2001, and 2000, respectively.  Certificates of deposit included brokereddeposits in the amount of $6,302 at December 31, 2001.

 

    At December 31, 2001, thescheduled maturities of certificates of deposit are as follows:

 

| 2002       |   | $      | 53,886 |   |
|------------|--------|--------|--------|--------|
| 2003       |   | 17,409 |   |
| 2004       |   | 8,607  |   |
| 2005       |   | 1,484  |   |
| 2006       |   | 2,256  |   |
| Thereafter |   | 9      |   |
|       |   | $      | 83,651 |   |

 

10.               Borrowed Funds

        Securities sold under agreements to repurchase generallymature within one to four days from the transaction date.  Other borrowed funds consist of Federal HomeLoan Bank (FHLB) advances, commercial bank line of credit advances andTreasury, tax and loan deposits. Treasury, tax and loan deposits are repaid upon notification by the U.S.Treasury.

 

        Information concerning securities sold under agreements torepurchase is summarized as follows:

 
|                                      |   | **2001** |   | **2000** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|
| Average balance during the year           |   | $        | 16,453 |     | $      | 13,055 |   |
| Maximum month-end balance during the year |   | 23,539   |   | 15,930   |   |
| Average interest rate during the year     |   | 3.21     | %      | 4.69     | %      |
| Average interest rate at end of the year  |   | 1.59     | %      | 4.82     | %      |
|                                           |        |          |        |          |        |  |  |

 

**                                   ****   **The Bank is required to own stock of theFHLB in order to borrow from the FHLB. FHLB advances are collateralized by a pledge of certain mortgage loansand by a lien on the Bank’s FHLB stock of $907 at December 31, 2001, which isincluded in investment securities available for sale in the consolidatedstatements of financial condition.  TheCompany, through its banking subsidiary, has an available line of credit withthe FHLB of $3.5 million.

 

**                                   ****   **At December 31, 2001, the Company had a$5 million commercial bank line of credit that expires in 2002.  The floating rate note is based on the onemonth London Interbank Offer Rate (1.87% at December 31, 2001) plus 1.75%.

 

    A summary of the borrowings from the FederalHome Loan Bank follows:

 

| **December 31, 2001** |                |   |                   |   |                |        |
|-----------------------|---------------------|--------|------------------------|--------|---------------------|-------------|
|                  | **Maturity  Dates** |   | **Principal  Amounts** |   | **Interest  Rates** |        |
|                  | 2002                |   | $                      | 2,825  |                | 4.67        | — 7.34 | % |
|                  | 2003                |   | 678                    |   | 4.67                | — 7.34 | % |
|                  | 2004                |   | 2,001                  |   | 4.67                | — 7.34 | % |
|                  | 2005                |   | 1,943                  |   | 4.67                | — 7.34 | % |
|                  | 2006                |   | 2,235                  |   | 4.67                | — 6.47 | % |
|                  | Thereafter          |   | 70                     |   | 6.47                | %           |   |
|                  |                |   | $                      | 9,752  |                |        |   |
|                       |                     |        |                        |        |                     |             |  |  |  |  |  |  |  |  |

 

| **December  31, 2000** |                |   |                   |   |                |        |
|------------------------|---------------------|--------|------------------------|--------|---------------------|-------------|
|                   | **Maturity  Dates** |   | **Principal  Amounts** |   | **Interest  Rates** |        |
|                   | 2001                |   | $                      | 639    |                | 5.81        | — 7.34 | % |
|                   | 2002                |   | 657                    |   | 6.18                | — 7.34 | % |
|                   | 2003                |   | 485                    |   | 6.47                | — 7.34 | % |
|                   | 2004                |   | 300                    |   | 6.47                | — 7.34 | % |
|                   | 2005                |   | 211                    |   | 6.47                | — 7.34 | % |
|                   | Thereafter          |   | 158                    |   | 6.47                | %           |   |
|                   |                |   | $                      | 2,450  |                |        |   |
|                        |                     |        |                        |        |                     |             |  |  |  |  |  |  |  |  |

 

11.                     Mandatory Convertible Debentures

    The Company issued $300 of mandatoryconvertible debentures which bear interest at 1% per annum in excess of theprime rate of interest of FleetBoston. Interest is payable on March 31, June 30, September 30, andDecember 31 of each year until the debentures are paid in full or convertedinto shares of common stock.  On or priorto September 30, 2002, the holders of the debentures must convert the entireprincipal amount into shares of common stock of Merrill Merchants Bancshares,Inc. at a conversion rate equal to $4.04 of principal amount of debentures forone share of common stock, subject to

 

 

21

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adjustment for anyrecapitalization of common stock, such as a split or reverse split of commonstock.

 

    The debentures are unsecured and any paymentof interest or principal will be subordinated to the timely payment ofprincipal and interest on all existing and future obligations of the Companyfor borrowed money from any bank, trust company, insurance company or otherfinancial institution engaged in the business of lending money.

 

12.                     Income Taxes

The current and deferred components of income taxexpense are as follows:

 
|     |   | **2001** |   | **2000** |   |
|----------|--------|----------|--------|----------|--------|
| Current  |   |     |   |     |   |
| Federal  |   | $        | 1,771  |     | $      | 1,552 |   |
| State    |   | 55       |   | 46       |   |
|     |   | 1,826    |   | 1,598    |   |
| Deferred |   | (181     | )      | (282     | )      |
|     |   | $        | 1,645  |     | $      | 1,316 |   |

 

    The actual tax expense differs from theexpected tax expense computed by applying the applicable U.S. federal corporateincome tax rate to income before income taxes as follows:

 
|                                                       |   | **2001** |   | **2000** |   |
|------------------------------------------------------------|--------|----------|--------|----------|--------|
| Computed tax expense                                       |   | $        | 1,666  |     | $      | 1,338 |   |
| Increase (reduction) in income tax expense resulting from: |   |     |   |     |   |
| Income from life insurance                                 |   | (45      | )      | (30      | )      |
| Tax exempt income                                          |   | (40      | )      | (38      | )      |
| State taxes, net of federal benefit                        |   | 36       |   | 30       |   |
| Other                                                      |   | 28       |   | 16       |   |
|                                                       |   | $        | 1,645  |     | $      | 1,316 |   |

 

The tax effects oftemporary differences that give rise to deferred income tax assets and liabilitiesare as follows:
|                                                |   | **2001**  |   | **2000**      |   |
|-----------------------------------------------------|--------|-----------|--------|---------------|--------|
|                                                |   | **Asset** |   | **Liability** |   | **Asset** |   | **Liability** |   |
|                                                |   |      |   |          |   |   |   |   |   |
| Allowance for loan losses                           |   | $         | 698    |          | $      | — |   | $ | 537 |   | $ | — |   |
| Unrealized gain  on   securities available for sale |   | —    |   | 294           |   | — |   | 4 |   |
| Deferred compensation                               |   | 250       |   | —        |   | 196 |   | — |   |
| Mortgage servicing rights                           |   | —    |   | 116           |   | — |   | 107 |   |
| Depreciation and amortization                       |   | —    |   | 92            |   | — |   | 36 |   |
| Other                                               |   | 70        |   | 11            |   | 38 |   | — |   |
|                                                |   | $         | 1,018  |          | $      | 513 |   | $ | 771 |   | $ | 147 |   |

 

        Management expects the Company willrealize all deferred income tax benefits to offset the income tax liabilitiesarising from the reversal of taxable temporary differences and taxable incomegenerated in future years.  Accordingly,the Company has not established a valuation allowance for deferred income taxbenefits.

 

13.                     Related Parties

        The Bank has entered into loantransactions with its directors, executive officers, significant shareholdersand their affiliates (related parties). Such transactions were made in the ordinary course of business onsubstantially the same terms and conditions, including interest rates and collateral,as those prevailing at the same time for comparable transac­tions with othercustomers, and did not, in the opinion of management, involve more than normalcredit risk or present other unfavorable features. Loans to related partieswhich in aggregate exceed $60 were as follows:

 
|                 |   | **2001** |   | **2000** |   |
|----------------------|--------|----------|--------|----------|--------|
| Balance, January 1   |   | $        | 8,640  |     | $      | 6,641 |   |
| Loans made/advanced  |   | 3,631    |   | 4,471    |   |
| Repayments           |   | (3,307   | )      | (2,472   | )      |
| Balance, December 31 |   | $        | 8,964  |     | $      | 8,640 |   |

 

        Commitments, as described in Note 14, torelated parties which in aggregate exceed $60 totaled $1,814 and $3,440 atDecember 31, 2001, and 2000, respectively.

 

 

14.                     Financial Instruments WithOff-Balance-Sheet Risk

        The Bank is a party to financialinstruments with off-balance-sheet risk in the normal course of business tomeet the financing needs of its customers which involve, to varying degrees, elementsof credit risk in excess of the amount recognized in the consolidatedstatements of financial condition. The Bank’s exposure to credit loss in theevent of nonperformance by the other party to the financial instrument forcommitments to extend credit is represented by the contractual notional amountof those instruments.  The Bank followsthe same credit policies in making commitments and conditional obligations asit does for on-balance-sheet instruments, including requiring

 

 

22

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collateral orother security to support financial instruments with credit risk.

 

        The Bank’s commitments at December 31,2001, and 2000 are as follows:

 
|                          |   | **2001** |   | **2000** |   |
|-------------------------------|--------|----------|--------|----------|--------|
| Commitments to extend credit  |   | $        | 15,656 |     | $      | 5,704 |   |
| Letters of credit             |   | 897      |   | 1,685    |   |
| Unadvanced commitments        |   |     |   |     |   |
| Commercial lines of credit    |   | 28,487   |   | 23,505   |   |
| Construction lines of credit  |   | 2,508    |   | 1,808    |   |
| Home equity lines of credit   |   | 11,786   |   | 10,643   |   |
| Overdraft protection accounts |   | 1,697    |   | 1,684    |   |
| Credit card lines             |   | 3,023    |   | 2,910    |   |
|                               |        |          |        |          |        |  |  |

 

15.       Shareholders’ Equity

        The Company distributed a 3% stockdividend on March 7, 2001 and a 3% stock dividend on February 29, 2000.  Earnings per share for 2001 and 2000 havebeen restated to reflect these stock dividends.

 

        Holders of preferred stock are entitledto dividends equal to the total stated value of $46.00 per share multiplied bythe prime rate in effect from time to time as announced by FleetBoston.  The dividends payable on the preferred stockare cumulative, meaning that if dividends are not paid when declared, they willaccumulate and be payable in full before any dividends are paid on commonstock.  However, the payment of anydividends on or the redemption of the preferred stock is subordinate to thepayment of any debt by the Company.  Thepreferred stock is non-voting.

 

        Each share of preferred stock isconvertible into 11.38 shares of common stock, adjusted for recapitalization ofthe common stock (such as a split or stock dividends).  After October 1, 2002, and to theextent not previously converted into common stock, the preferred stock may be redeemedby the Company for a price equal to the sum of its stated value plus unpaid andaccrued dividends.  However, thepreferred stock may not be called or redeemed by the Company unless approved inadvance by the Federal Reserve Bank of Boston.

 

16.       Other Expense

                    Other expense amounts aresummarized as follows for 2001 and 2000:

 
|                                                   |   | **2001** |   | **2000** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|
| Merchant processing                                    |   | $        | 520    |     | $      | 460 |   |
| Professional fees                                      |   | 348      |   | 310      |   |
| Printing, postage, stationery, and supplies            |   | 237      |   | 281      |   |
| Advertising and promotion                              |   | 202      |   | 226      |   |
| Trust expense                                          |   | 161      |   | 160      |   |
| Telephone                                              |   | 159      |   | 168      |   |
| ATM expense                                            |   | 144      |   | 98       |   |
| Travel, meetings, conventions, and employee  education |   | 131      |   | 111      |   |
| Other                                                  |   | 606      |   | 520      |   |
| Total                                                  |   | $        | 2,508  |     | $      | 2,334 |   |

17.  Earnings Per Share

        The following table sets forth thecomputation of basic and diluted earnings per share (in thousands, except fornumber of shares and per share data):

 
|                                          |   | **2001**  |   | **2000**  |   |
|-----------------------------------------------|--------|-----------|--------|-----------|--------|
| Basic earnings per share                      |   |      |   |      |   |
| Net income, as reported                       |   | $         | 3,254  |      | $      | 2,619 |   |
| Preferred stock dividends declared            |   | (62       | )      | (83       | )      |
| Income available to common shareholders       |   | $         | 3,192  |      | $      | 2,536 |   |
| Weighted-average shares outstanding           |   | 2,664,692 |   | 2,669,837 |   |
| Basic earnings per share                      |   | $         | 1.20   |      | $      | 0.95 |   |
|                                          |   |      |   |      |   |
| Diluted earnings per share                    |   |      |   |      |   |
| Net income, as reported                       |   | $         | 3,254  |      | $      | 2,619 |   |
| Interest on mandatory convertible debentures, |   |      |   |      |   |
| net of tax                                    |   | 16        |   | 20        |   |
| Income available to common shareholders       |   | $         | 3,270  |      | $      | 2,639 |   |
| Weighted-average shares outstanding           |   | 2,664,692 |   | 2,669,837 |   |
| Effect of stock options, net of assumed       |   |      |   |      |   |
| treasury stock purchases                      |   | 181,375   |   | 169,548   |   |
| Effect of convertible preferred stock         |   | 222,779   |   | 222,779   |   |
| Effect of mandatory convertible debentures    |   | 74,256    |   | 74,256    |   |
| Adjusted weighted-average                     |   |      |   |      |   |
| shares outstanding                            |   | 3,143,102 |   | 3,136,420 |   |
| Diluted earnings per share                    |   | $         | 1.04   |      | $      | 0.84 |   |

 

Options to purchase23,336 shares of common stock at $10.02 were outstanding at December 31, 2000but were not included in the computation of diluted earnings per share becausethe options’ exercise price was greater than the average market price of thecommon stock.

 

 

23

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18.                     Regulatory Matters

        The Company and Bank are subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory - and possibly additionaldiscretionary - actions by regulators that, if undertaken, could have a directmaterial effect on the Company and Bank’s consolidated financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and Bank mustmeet specific capital guidelines that involve quantitative measures of the Company’sand Bank’s assets, liabilities and certain off-balance-sheet items ascalculated under regulatory accounting practices.  The Company’s and Bank’s capital amounts and classification arealso subject to qualitative judgments by the regulators about components, riskweightings, and other factors.

 

        Quantitative measures established byregulation to ensure capital adequacy require the Company and Bank to maintainminimum amounts and ratios (set forth in the table below) of total and Tier Icapital (as defined in the regulations) to risk-weighted assets (as defined),and of Tier I capital (as defined) to average assets (as defined).  Management believes as of December 31, 2001,that the Company and Bank meet all capital adequacy requirements to which theyare subject.

 

        As of December 31, 2001, the mostrecent notification from the Federal Reserve Bank categorized the Company andBank as well capitalized under the regulatory framework for prompt correctiveaction.  To be categorized “wellcapitalized,” the Company and Bank must maintain minimum total risk-based, TierI risk-based, and Tier I leverage ratios as set forth in the table.  There are no conditions or events since thatnotification that management believes have changed this category.

 

        The Company’s and Banks actual capitalamounts and ratios are also presented in the table.  No deduction was made from capital for interest-rate risk in 2001and 2000.

 
|                     |   |       |   |                   |   |                              |   |                          |   | **To be well** |   |
|--------------------------|--------|------------|--------|------------------------|--------|-----------------------------------|--------|-------------------------------|--------|----------------|--------|
|                     |   |       |   |                   |   | **For  capital**                  |   | **capitalized  under prompt** |   |
|                     |   | **Actual** |   | **adequacy  purposes** |   | **corrective  action provisions** |   |
|                     |   | **Amount** |   | **Ratio**              |   | **Amount**                        |   | **Ratio**                     |   | **Amount**     |   | **Ratio** |   |
| As of December 31, 2001  |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Total capital (to risk-  |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| weighted assets)         |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Consolidated             |   | $          | 27,507 |                   | 15.11  | %                                 | $      | 14,560                        |   | 8.00           | %      | N/A |   |   |   |
| Bank                     |   | 21,021     |   | 11.97                  |   | 14,053                            |   | 8.00                          |   | $              | 17,566 |   | 10.00 | % |
| Tier I capital (to risk- |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| weighted assets)         |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Consolidated             |   | 24,923     |   | 13.69                  |   | 7,280                             |   | 4.00                          |   | N/A            |   |   |   |
| Bank                     |   | 18,819     |   | 10.71                  |   | 7,027                             |   | 4.00                          |   | 10,540         |   | 6.00 |   |
| Tier I capital (to       |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| average assets)          |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Consolidated             |   | 24,923     |   | 9.04                   |   | 11,029                            |   | 4.00                          |   | N/A            |   |   |   |
| Bank                     |   | 18,819     |   | 7.01                   |   | 8,059                             |   | 3.00                          |   | 13,431         |   | 5.00 |   |
|                     |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| As of December 31, 2000  |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Total capital (to risk-  |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| weighted assets)         |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Consolidated             |   | $          | 25,028 |                   | 15.21  | %                                 | $      | 13,161                        |   | 8.00           | %      | N/A |   |   |   |
| Bank                     |   | 19,183     |   | 12.10                  |   | 12,687                            |   | 8.00                          |   | $              | 15,859 |   | 10.00 | % |
| Tier I capital (to risk- |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| weighted assets)         |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Consolidated             |   | 22,664     |   | 13.78                  |   | 6,581                             |   | 4.00                          |   | N/A            |   |   |   |
| Bank                     |   | 17,194     |   | 10.84                  |   | 6,343                             |   | 4.00                          |   | 9,515          |   | 6.00 |   |
| Tier I capital (to       |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| average assets)          |   |       |   |                   |   |                              |   |                          |   |           |   |   |   |
| Consolidated             |   | 22,664     |   | 9.50                   |   | 9,540                             |   | 4.00                          |   | N/A            |   |   |   |
| Bank                     |   | 17,194     |   | 7.38                   |   | 6,991                             |   | 3.00                          |   | 11,652         |   | 5.00 |   |

 

24

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19.       Stock Options

        Under the Employee and Director StockOption Plan, the incentive stock option plan (ISO) for officers and employeesand the nonstatutory stock option plan (Non-ISO) for directors provide for theissuance of up to 719,497 shares of common stock.  The purchase price of the stock covered by each option shall beits fair market value, which must be equal to at least 100% of the book valueof common stock, on the date such option is granted.  Options granted through 1997 were subject to an initial vestingperiod which ended on December 31, 1997, after which options become exercisableuntil May 26, 2003.  Options grantedafter 1997 were granted subject to an initial vesting period of one or twoyears, after which options become exercisable until ten years from the grantdate.

 

        The Company accounts for these optionsin accordance with Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees.”  As theexercise price of each option equals the market price of the Company’s stock onthe date of grant, no compensation cost has been recognized for the plan.  Had compensation cost for the plan beendetermined based on the fair value of the options at the grant dates consistentwith the method described in SFAS No. 123, “Accounting for Stock-BasedCompensation,” the Company’s 2001 and 2000 net income and earnings per sharewould have been reduced to the pro forma amounts indicated below.

 

 
|     | **(In thousands except for per-share data)** |           |   |                    |
|----------|----------------------------------------------|----------------|--------|-------------------------|
|     |                                         |           |   |                    |   |
|     |                                         |           |   | **Earnings  per Share** |   |
|     |                                         | **Net Income** |   | **Basic**               |   | **Diluted** |   |
| **2001** |                                         |           |   |                    |   |   |   |
|     | As reported                                  | $              | 3,254  |                    | $ | 1.20 |   | $ | 1.04 |   |
|     | Pro forma                                    | 3,229          |   | 1.19                    |   | 1.03 |   |
| **2000** |                                         |           |   |                    |   |   |   |
|     | As reported                                  | 2,619          |   | 0.95                    |   | 0.84 |   |
|     | Pro forma                                    | 2,596          |   | 0.94                    |   | 0.83 |   |
|          |                                              |                |        |                         |  |  |  |  |  |  |

 

        The fair value of each option isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted-average assumptions used for all grants in 2001 and2000: dividend yield of 2.74% in 2001 and 2.86% in 2000, risk-free interestrate of 3% in 2001 and 5% in 2000, expected lives of two years, and expectedvolatility of 23% in 2001 and 22% in 2000.

 

        A summary of the status of the plan asof December 31, 2001, and 2000, and changes during the years then ended, ispresented below.
|                               |   | **2001**      |   | **2000**            |   |
|------------------------------------|--------|---------------|--------|---------------------|--------|
|                               |   |          |   | **Weighted**        |   |   |   | **Weighted** |   |
|                               |   | **Number**    |   | **Average**         |   | **Number** |   | **Average** |   |
|                               |   | **of Shares** |   | **Exercise  Price** |   | **of Shares** |   | **Exercise  Price** |   |
|                               |   |          |   |                |   |   |   |   |   |
| Outstanding at beginning of year   |   | 423,733       |   | $                   | 5.40   |   | 433,120 |   | $ | 5.28 |   |
| Granted during the year            |   | 9,000         |   | 10.50               |   | 35,500 |   | 8.75 |   |
| Exercised during the year          |   | (45,085       | )      | 4.55                |   | (43,949 | ) | 4.85 |   |
| Forfeited during the year          |   | (14,800       | )      | 5.56                |   | (13,388 | ) | 7.33 |   |
| Additional shares for which        |   |          |   |                |   |   |   |   |   |
| options are exercisable due to     |   |          |   |                |   |   |   |   |   |
| stock dividends                    |   | 11,834        |   | —              |   | 12,450 |   | — |   |
| Outstanding at end of year         |   | 384,682       |   | $                   | 5.44   |   | 423,733 |   | $ | 5.40 |   |
| Exercisable at end of year         |   | 345,067       |   | $                   | 5.04   |   | 367,573 |   | $ | 4.79 |   |
|                               |   |          |   |                |   |   |   |   |   |
| Weighted-average fair value        |   |          |   |                |   |   |   |   |   |
| of options granted during the year |   |          |   | $                   | 1.32   |   |   |   | $ | 1.20 |   |

           The following information applies to options outstanding at December 31,2001:

 
|                        | **Options  Outstanding** |          |       |            | **Options  Exercisable** |          |
|-----------------------------|--------------------------|---------------|------------|-----------------|--------------------------|---------------|
|                        |                     | **Wtd. Avg.** | ** ** |            |                     |          | ** ** |   | ** ** |   |   |
|                        |                     | **Number**    |       | **Remaining**   |                     | **Wtd. Avg.** |   | **Number** |   | **Wtd. Avg.** |   |
|                        |                     | **of**        | ** ** | **Contractual** | ** **               | **Exercise**  | ** ** | **of** | ** ** | **Exercise** |   |
| **Range of Exercise Price** |                     | **Shares**    | ** ** | **Life**        | ** **               | **Price**     | ** ** | **Shares** | ** ** | **Price** |   |
| $                           | 4.12 - $6.17             |          | 321,731    |            | 1.4                      |          | $ | 4.68 |   | 321,731 |   | $ | 4.68 |   |
| $                           | 8.50 - $10.50            |          | 62,951     |            | 8.3                      |          | 9.32 |   | 23,336 |   | 10.02 |   |
|                             |                          |               |            |                 |                          |               |  |  |  |  |  |  |  |  |  |  |

 

20.       Branch Acquisition

      OnFebruary 25, 2000, the Bank acquired a branch office in Holden, Maine from theFirst National Bank of Bar Harbor.  Theacquisition was accounted for under the purchase method of accounting forbusiness combinations.  Earnings of theacquired branch, from the date of acquisition, are included in the consolidatedstatement of income.  The following is asummary of the transaction:

 
| Loans and investments acquired                       |   | $      | 2,091  |   |
|------------------------------------------------------|--------|--------|--------|--------|
| Fixed assets                                         |   | 566    |   |
| Goodwill                                             |   | 338    |   |
| Deposits, repurchase agreements and accrued interest |   | (6,529 | )      |
| Net cash and cash equivalents received               |   | $      | (3,534 | )      |

 

 

25

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21.       Fair Value of Financial Instruments

        Fairvalue estimates, methods and assumptions are set forth below for the Company’sfinancial instruments.

 

Cash and Cash Equivalents

        The fairvalue of cash and due from banks and interest-bearing deposits with banksapproximates their relative book values at December 31, 2001, and 2000, asthese financial instruments have short maturities.

 

Investment Securities

        The fairvalues of investment securities are estimated based on bid prices published infinancial newspapers or bid quotations received from securities dealers.

 

Loans Held for Sale

        The fairvalues of loans held for sale are based on quoted market prices from theFederal National Mortgage Association.

 

Loans Receivable

        Fairvalues are estimated for portfolios of loans receivable with similar financialcharacteristics.  The fair valuesapproximate carrying value for all loans with variable interest rates.

 

        The fair values of fixed rate loans arecalculated by discounting scheduled cash flows through the estimated maturityusing estimated market discount rates that reflect the risk inherent in theloan. The estimates of maturity are based on the Bank’s historical experiencewith repayments for each loan classification, modified, as required, by anestimate of the effect of current economic and lending conditions, and theeffects of estimated prepayments.

 

        Managementhas made estimates of fair value using discount rates that it believes to bereasonable. However, because there is no market for many of these financialinstruments, management has no basis to determine whether the fair valuepresented below would be indicative of the value negotiated in the actual sale.

 

Cash Surrender Value of Life Insurance

        The fairvalue is based on the actual cash surrender value of life insurance policies.

 

Accrued Interest Receivable

        The fairvalue approximates the carrying value as this financial instrument has a shortmaturity.  It is the Bank’s policy tostop accruing interest on loans for which it is probable that the interest isnot collectible.  Therefore, the fairvalue of this financial instrument has been adjusted to reflect credit risk.

 

Capitalized Mortgage Servicing Rights

        The fairvalue of mortgage servicing rights is based on the expected present value offuture mortgage servicing income, net of estimated servicing costs, consideringmarket consensus loan prepayment predictions.

 

Deposits

        The fairvalue of deposits with no stated maturity, such as noninterest-bearing demanddeposits, savings, NOW accounts and money market accounts, is equal to theamount payable on demand.  The fairvalue of certificates of deposit is based on the discounted value ofcontractual cash flows.  The discountrate is estimated using the rates currently offered for deposits of similarremaining maturities.

 

        The fairvalue estimates do not include the benefit that results from the low-costfunding provided by the deposits compared to the cost of borrowing funds in themarket.  If that value were considered,the fair value of the Bank’s net assets could increase.

 

Borrowed Funds

        The fairvalue of borrowed funds is based on the discounted value of contractual cashflows.  The discount rate is estimatedusing the rates currently available for borrowings of similar remainingmaturities.

 

 

26

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Accrued Interest Payable

        The fairvalue approximates the book value as this financial instrument has a shortmaturity.

 

Off-Balance Sheet Instruments

        The Company’s off-balance sheetinstruments consist of loan commitments. Fair values for loan commitments have not been presented as the futurerevenue derived from such financial instruments is not significant.

 

Limitations

        Fairvalue estimates are made at a specific point in time, based on relevant marketinformation and information about the financial instrument.  These values do not reflect any premium ordiscount that could result from offering for sale at one time the Company’sentire holdings of a particular financial instrument.  Because no market exists for a significant portion of theCompany’s financial instruments, fair value estimates are based on judgmentsregarding future expected loss experience, current economic conditions, riskcharacteristics of various financial instruments, and other factors. Theseestimates are subjective in nature and involve uncertainties and matters of significantjudgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affectthe estimates.

 

        Fairvalue estimates are based on existing on and off-balance sheet financialinstruments without attempting to estimate the value of anticipated futurebusiness and the value of assets and liabilities that are not consideredfinancial instruments.  Othersignificant assets and liabilities that are not considered financialinstruments include property and equipment and other real estate owned.  In addition, the tax ramifications relatedto the realization of the unrealized gains and losses can have a significanteffect on fair value estimates and have not been considered in any of the estimates.

 

        A summaryof the estimated fair values for the Company’s significant financialinstruments at December 31, 2001, and 2000 follows:

                                                                                                                                                                                                              
|                                   |   |                |   | **Estimate of** |   |
|----------------------------------------|--------|---------------------|--------|-----------------|--------|
| **December 31, 2001**             |   | **Carrying  Value** |   | **Fair Value**  |   |
| Financial Assets                       |   |                |   |            |   |
| Cash and cash equivalents              |   | $                   | 9,844  |            | $      | 9,844 |   |
| Investment securities                  |   | 70,713              |   | 71,607          |   |
| Loans held for sale                    |   | 1,060               |   | 1,060           |   |
| Loans receivable, net                  |   | 185,094             |   | 188,222         |   |
| Cash surrender value of life insurance |   | 2,900               |   | 2,900           |   |
| Accrued interest receivable            |   | 1,189               |   | 1,189           |   |
| Capitalized mortgage servicing rights  |   | 340                 |   | 587             |   |
| Financial Liabilities                  |   |                |   |            |   |
| Deposits                               |   | 219,309             |   | 220,764         |   |
| Accrued interest payable               |   | 383                 |   | 383             |   |
| Borrowed funds                         |   | 30,092              |   | 30,446          |   |
|                                   |   |                |   |            |   |
|                                   |   |                |   | **Estimate of** |   |
| **December 31, 2000**             |   | **Carrying Value**  |   | **Fair Value**  |   |
| Financial Assets                       |   |                |   |            |   |
| Cash and cash equivalents              |   | $                   | 11,853 |            | $      | 11,853 |   |
| Investment securities                  |   | 59,686              |   | 59,686          |   |
| Loans held for sale                    |   | 827                 |   | 838             |   |
| Loans receivable, net                  |   | 163,265             |   | 163,170         |   |
| Cash surrender value of life insurance |   | 2,768               |   | 2,768           |   |
| Accrued interest receivable            |   | 1,441               |   | 1,441           |   |
| Capitalized mortgage servicing rights  |   | 314                 |   | 581             |   |
| Financial Liabilities                  |   |                |   |            |   |
| Deposits                               |   | 200,451             |   | 200,476         |   |
| Accrued interest payable               |   | 467                 |   | 467             |   |
| Borrowed funds                         |   | 20,376              |   | 20,408          |   |

 

22.       Parent Company Financial Information

        The following is summarized financial statement informationfor Merrill Merchants Bancshares, Inc. as of December 31, 2001, and 2000 andfor the years then ended:

 

 

27

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SUMMARIZED BALANCE SHEETINFORMATION
| ASSETS                                           |   |     |       |     |       |
|--------------------------------------------------|--------|----------|------------|----------|------------|
|                                             |   | **2001** |       | **2000** |       |
| Cash                                             |   | $        | 55         |     | $          | 9 |   |
| Investment securities at fair value              |   | 868      |       | 329      |       |
| Investment in subsidiaries                       |   | 19,989   |       | 17,853   |       |
| Loan and interest receivable from subsidiary     |   | 5,565    |       | 5,440    |       |
| Deferred income tax benefit                      |   | 33       |       | 90       |       |
| Total assets                                     |   | $        | 26,510     |     | $          | 23,721 |   |
|                                             |   |     | ** ** |     | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**   |   |     | ** ** |     | ** ** |
| Liabilities                                      |   |     |       |     |       |
| Dividend payable and accrued expenses            |   | $        | 225        |     | $          | 19 |   |
| Note payable                                     |   | —   |       | 110      |       |
| Mandatory convertible debentures                 |   | 300      |       | 300      |       |
| Total liabilities                                |   | 525      |       | 429      |       |
| Shareholders’ equity                        |   |     |       |     |       |
| Convertible cumulative preferred stock           |   | 20       |       | 20       |       |
| Common stock                                     |   | 2,741    |       | 2,661    |       |
| Capital surplus                                  |   | 18,794   |       | 17,958   |       |
| Retained earnings                                |   | 4,601    |       | 3,436    |       |
| Accumulated other comprehensive income           |   |     |       |     |       |
| Unrealized gain on securities available for sale |   | 600      |       | 9        |       |
| Treasury stock                                   |   | (771     | )          | (792     | )          |
| Total shareholders’ equity                  |   | 25,985   |       | 23,292   |       |
| Total liabilities and shareholders’ equity  |   | $        | 26,510     |     | $          | 23,721 |   |
|                                             |   |     |       |     |       |

 
| SUMMARIZED  STATEMENTS OF INCOME INFORMATION |
|----------------------------------------------|

 
|                                                             |   | **2001** | ** ** | **2000** |   |
|------------------------------------------------------------------|--------|----------|------------|----------|--------|
| Dividends from bank subsidiary                                   |   | $        | 1,526      |     | $      | 1,257 |   |
| Interest income on loan from subsidiary                          |   | 342      |       | 331      |   |
| Interest and dividend income on investments                      |   | 20       |       | 105      |   |
| Total income                                                     |   | 1,888    |       | 1,693    |   |
| Interest expense on borrowed funds                               |   | 26       |       | 39       |   |
| Operating expenses                                               |   | 119      |       | 88       |   |
| Total expenses                                                   |   | 145      |       | 127      |   |
| Income before income tax expense                                 |   | 1,743    |       | 1,566    |   |
| Income tax expense                                               |   | 65       |       | 101      |   |
| Income before equity in undistributed net income of subsidiaries |   | 1,678    |       | 1,465    |   |
| Equity in undistributed net income of subsidiaries               |   | 1,576    |       | 1,154    |   |
| Net income                                                       |   | $        | 3,254      |     | $      | 2,619 |   |

 
| SUMMARIZED  STATEMENTS OF CASH FLOWS INFORMATION |
|--------------------------------------------------|

 
|                                                        |   | **2001** |   | **2000** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|
| Cash flows from operating activities                        |   |     |   |     |   |
| Net income                                                  |   | $        | 3,254  |     | $      | 2,619 |   |
| Adjustments to reconcile net income to                      |   |     |   |     |   |
| net cash provided  by  operating activities            |   |     |   |     |   |
| Deferred income tax benefit                                 |   | 38       |   | 22       |   |
| Equity in undistributed net income of subsidiaries          |   | (1,576   | )      | (1,154   | )      |
| Decrease in accrued income and other assets                 |   | -        |   | 18       |   |
| Increase in accrued expenses                                |   | 15       |   | 6        |   |
| Net cash provided by operating activities                   |   | 1,731    |   | 1,511    |   |
| Cash flows from investing activities                        |   |     |   |     |   |
| Proceeds from sales and maturities of investment securities |   | 665      |   | 5,737    |   |
| Purchase of investment securities                           |   | (1,095   | )      | (2,314   | )      |
| Net advances to subsidiaries                                |   | (175     | )      | (3,972   | )      |
| Net cash used by investing activities                       |   | (605     | )      | (549     | )      |
|                                                        |   |     |   |     |   |
| Cash flows from financing activities                        |   |     |   |     |   |
| Dividends paid on convertible cumulative preferred stock    |   | (62      | )      | (83      | )      |
| Dividends paid on common stock                              |   | (586     | )      | (648     | )      |
| Proceeds from (payment of) note payable                     |   | (110     | )      | 110      |   |
| Proceeds from issuance of common stock                      |   | 132      |   | 200      |   |
| Purchase of treasury stock                                  |   | (454     | )      | (539     | )      |
| Net cash used by financing activities                       |   | (1,080   | )      | (960     | )      |
| Net increase in cash and cash equivalents                   |   | 46       |   | 2        |   |
| Cash and cash equivalents, beginning of year                |   | 9        |   | 7        |   |
| Cash and cash equivalents, end of year                      |   | $        | 55     |     | $      | 9 |   |

 

 

 

28

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23.       Selected Quarterly Data(unaudited)

        The following tables provides unaudited financial informationby quarter for each of the past two years:
|                                                |   | **2001**                 |   | **2000**           |   |
|-----------------------------------------------------|--------|--------------------------|--------|--------------------|--------|
|                                                |   | **Fourth  Quarter** |   | **Third  Quarter** |   | **Second  Quarter** |   | **First  Quarter** |   | **Fourth  Quarter** |   | **Third  Quarter** |   | **Second  Quarter** |   | **First   Quarter** |   |
| Interest income                                     |   | $                        | 4,795  |               | $      | 4,900 |   | $ | 4,935 |   | $ | 4,872 |   | $ | 4,912 |   | $ | 4,716 |   | $ | 4,459 |   | $ | 4,116 |   |
| Interest expense                                    |   | 1,738                    |   | 1,962              |   | 2,061 |   | 2,199 |   | 2,236 |   | 2,129 |   | 1,992 |   | 1,820 |   |
| Net interest income                                 |   | 3,057                    |   | 2,938              |   | 2,874 |   | 2,673 |   | 2,676 |   | 2,587 |   | 2,467 |   | 2,296 |   |
| Provision for loan losses                           |   | 141                      |   | 111                |   | 111 |   | 111 |   | 105 |   | 105 |   | 103 |   | 110 |   |
| Net interest income after provision for loan losses |   | 2,916                    |   | 2,827              |   | 2,763 |   | 2,562 |   | 2,571 |   | 2,482 |   | 2,364 |   | 2,186 |   |
| Other income                                        |   | 863                      |   | 806                |   | 806 |   | 787 |   | 743 |   | 720 |   | 711 |   | 684 |   |
| Security gains                                      |   | 37                       |   | —             |   | — |   | — |   | — |   | — |   | 41 |   | 256 |   |
| Other expense                                       |   | 2,459                    |   | 2,340              |   | 2,320 |   | 2,349 |   | 2,243 |   | 2,162 |   | 2,118 |   | 2,300 |   |
| Income before income taxes                          |   | 1,357                    |   | 1,293              |   | 1,249 |   | 1,000 |   | 1,071 |   | 1,040 |   | 998 |   | 826 |   |
| Income tax expense                                  |   | 459                      |   | 427                |   | 425 |   | 334 |   | 357 |   | 338 |   | 339 |   | 282 |   |
| Net income                                          |   | $                        | 898    |               | $      | 866 |   | $ | 824 |   | $ | 666 |   | $ | 714 |   | $ | 702 |   | $ | 659 |   | $ | 544 |   |
|                                                |   |                     |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Per common share                                    |   |                     |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic earnings                                      |   | $                        | 0.33   |               | $      | 0.32 |   | $ | 0.30 |   | $ | 0.24 |   | $ | 0.26 |   | $ | 0.25 |   | $ | 0.24 |   | $ | 0.20 |   |
| Diluted earnings                                    |   | $                        | 0.29   |               | $      | 0.28 |   | $ | 0.26 |   | $ | 0.21 |   | $ | 0.23 |   | $ | 0.22 |   | $ | 0.21 |   | $ | 0.17 |   |

 

 

29

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Merrill MerchantsBancshares, Inc.

 

# **Board of Directors**

William C. Bullock, Jr., Chairman

        MerrillMerchants Bank, Bangor, Maine

 

Edwin N. Clift, President & Chief ExecutiveOfficer

        MerrillMerchants Bank, Bangor, Maine

 

Joseph H. Cyr, President

        John T.Cyr & Sons, Inc., Old Town, Maine

 

Perry B. Hansen, Chairman & Chief ExecutiveOfficer

        THENational Bank, Bettendorf, Iowa

 

Robert E. Knowles, Investor

        Unity,Maine

 

Frederick A. Oldenburg, Jr., M.D., Director

        PenobscotRespiratory, P.A., Bangor, Maine

 

Lloyd D. Robinson, Investor

        Hermon,Maine

 

Dennis L. Shubert, M.D., Ph.D., Investor

        Bangor,Maine

 

Susan B. Singer, Investor

        Bangor,Maine

 

# **Officers**

William C. Bullock, Jr.,Chairman

Edwin N. Clift President& Chief Executive Officer

Deborah A. Jordan,Treasurer

James A. MacLeod,Esquire, Secretary and Clerk

 

**Maine Acceptance Corporation**

Board of Directors

Edwin N. Clift

Lloyd D. Robinson

John R. Graham

 

Officers

Charles W. Hart, President

Floyd W. Libby, Vice President

Deborah A. Jordan, Treasurer and Secretary

 

 

30

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**Merrill Merchants Bank**

# **Board of Directors**

 

William C. Bullock, Jr., Chairman

        MerrillMerchants Bank, Bangor, Maine

 

Edwin N. Clift, President & Chief ExecutiveOfficer

        MerrillMerchants Bank, Bangor, Maine

 

Joseph H. Cyr, President

        John T.Cyr & Sons, Inc., Old Town, Maine

 

John R. Graham III, President

        AutomaticDistributors, Bangor, Maine

 

Perry B. Hansen, Chairman & Chief ExecutiveOfficer

        THE NationalBank, Bettendorf, Iowa

 

Charles M. Hutchins, Vice President

        AlternativeEnergy, Inc., Bangor, Maine

 

Joseph P. Irish, President

        WaldoCounty Oil, Troy, Maine

 

Robert E. Knowles, Investor

        Unity,Maine

 

Frederick A. Oldenburg, Jr., M.D., Director

        PenobscotRespiratory, P.A., Bangor, Maine

 

Lloyd D. Robinson, Investor

        Hermon,Maine

 

Dennis L. Shubert, M.D., Ph.D., Investor

        Bangor,Maine

 

Susan B. Singer, Investor

        Bangor,Maine

# ** **

# **Honorary Directors**

J. Donald Mackintosh

Leonard E. Minsky

Norman Minsky, Esq.

Joseph Sewall

Harold S. Wright

# ** **

# ** **

31

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# **Merrill Merchants Bank**

# **Senior Management**

 

William C. Bullock, Jr.

Chairman

 

Edwin N. Clift

President & Chief Executive Officer

 

Charles W. Hart

Executive Vice President, Retail Banking

 

Deborah A. Jordan

Executive Vice President, Chief Financial Officer

 

William P. Lucy

Executive Vice President, Commercial Banking

 

James A. MacLeod, Esquire

Senior Vice President, Trust & Investment Services

 

Jane H. Madigan

Senior Vice President, Marketing & Human Resources

 

Lynne A. Spooner

Senior Vice President, Mortgage Banking

 

Reginald C. Williams, Jr.

Senior Vice President, Operations

 

Sara E. Carr

Vice President, Compliance & Security

 

Susan L. Rush

Vice President, Systems Administration

 

 

 

32

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EMPLOYEES

 
| ACCOUNTING                 |   | LOAN OPERATIONS               |
|----------------------------|--------|-------------------------------|
| Linda G. England           |   | Judith D. Kelly               |
| Deborah A. Jordan*         |   | Linda M. Libby                |
| Janet L. Kochis            |   | Michelle M. Thurston          |
| Pamela J. Mugnai           |   | Judy M. Walls                 |
| Lorraine M. Therrien*      |   | Jerina K. Warner*             |
|                       |   |                          |
| ADMINISTRATION             |   | MORTGAGE LENDING              |
| William C. Bullock, Jr.*   |   | Alison J. Bailey*             |
| Edwin N. Clift*            |   | P. David DeFroscia*           |
| Barbara I. Cochran         |   | Tami E. Farnsworth            |
| Stephen R. Crockett        |   | Roland I. Narofsky            |
| Charles W. Hart*           |   | Lynne A. Spooner*             |
|                       |   | Paula A. Taylor               |
| BANK OPERATIONS            |   | Thomas A. Tilley*             |
| Scott D. Bennett           |   | Mark A. Trapela               |
| Michael J. Moody           |   |                          |
| Donna M. Poland            |   | SYSTEMS ADMINISTRATION        |
| Reginald C. Williams, Jr.* |   | Thomas W. Austin              |
|                       |   | Susan L. Rush*                |
| COMMERCIAL LENDING         |   | Jason D. Simsay               |
| Fred A. Brown*             |   |                          |
| Angela T. Butler*          |   | TRUST & INVESTMENTS       |
| Jeremy J. Dubay            |   | Clarence E. Bickford, Jr.*    |
| Alyson A. Coffin           |   | Meris J. Bickford,  Esquire*  |
| Jerry C. Jarrell*          |   | Jacqueline A. Bouchey*        |
| Jonathan S. Lander*        |   | Betsy B. Hanscom              |
| William P. Lucy*           |   | John R. Henderson*            |
| Lewis H. Payne*            |   | Julie A. Kelly                |
| Cindy L. Rickman           |   | James A. MacLeod, Esquire*    |
|                       |   | Suzanne T. Moffat*            |
| COMPLIANCE                 |   | Valrie G. Smith               |
| Sara E. Carr*              |   | Joyce D. Toman                |
| Susan V. Terrillion        |   | Holly A. Vetelino             |
|                       |   | Ellen N. Ziobron              |
| DEPOSIT OPERATIONS         |   |                          |
| Cindy L. Allen             |   | MAINE ACCEPTANCE  CORPORATION |
| Clarice J. Hannan          |   | Kristina R. Bickford          |
| Linda M. Lizotte           |   | Robert J. Gardner             |
| Kathleen G. Prescott*      |   | Kim M. Kirchdorfer            |
|                       |   | Floyd W. Libby*               |
| HUMAN RESOURCES            |   |                          |
| Theresa M. Brooks          |   |                          |
| Cynthia L. Leighton        |   |                          |
| Jane H. Madigan*           |   |                          |
|                       |   |                          |
| BRANCH OFFICES             |   |                          |
|                       |   |                          |
| Bangor, 201 Main Street    |   | Milford                       |
| Alena J. Bonenfant         |   | Angela R. Madore              |
| Jana J. Clark              |   | Kelly A. Shorey               |
| Eunice M. Harris           |   |                          |
| Jody E. Holmes             |   | Newport                       |
| Janet L. Lane              |   | Cynthia J. Brawn              |
| Kim Patoka                 |   | Marjorie J. Downing*          |
| Priscilla A. Pullen        |   | Melissa M. Mallory            |
| Betsy A. Simpson*          |   | Debra L. Murray               |
|                       |   | Veronica E. Sylvia            |
| Bangor, Stillwater Avenue  |   |                          |
| Joseph W. Arps, III        |   | Orono                         |
| George E. Dandaneau*       |   | Julie A. Clement              |
| Lynne M. Gray              |   | Brent A. Folster*             |
| Heather L. Henderson       |   | Gwendolyn A. King             |
| Deanna L. Ouellette        |   | Darleen M. Lanphere           |
| Lori A. Pardun             |   | Kathleen Spruce               |
| Tricia T. Tibbetts         |   |                          |
| Jason R. Wilkes            |   | Orrington                     |
|                       |   | Marla J. Billings             |
| Bangor, Union Street       |   | Ronald J. Landry              |
| Terri M. Adam              |   |                          |
| Jennifer C. Coutts         |   | Pittsfield                    |
| Jayne T. Dickey            |   | Nancy L. Bellfleur            |
| Patricia L. Eldridge       |   | Suzanne M. Mercier            |
| Lynette L. Linehan         |   | Andrew C. Reed*               |
| Stacie A. Severance        |   | Carole L. Robinson            |
| Candis M. Taylor           |   | Micheline K. Ross             |
| Marlene D. Thomas*         |   | Dianne L. Roy                 |
|                       |   |                          |
| Brewer                     |   |                          |
| Eva M. Charity             |   |                          |
| Diane M. Hewett            |   | * Officers                    |
| Bonita L. Hodgins          |   |                          |
| Linda J. Kenney            |   |                          |
| Carol L. Littlefield       |   |                          |
| Jessica L. Welch           |   |                          |
| Danelle L. Weston          |   |                          |
|                       |   |                          |
| Holden                     |   |                          |
| Sandra J. Leavitt          |   |                          |
| Jacqueline M. Madore       |   |                          |
| Diane T. Pearson           |   |                          |
| Mary E. Tinto              |   |                          |

 

33

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IN MEMORY

 

 

 

 

 

 

John S. Bacon

Director

 

 

 

 

 

 

John P. Thayer

Vice President

Brewer Branch Manager

 

 

 

34

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**CORPORATE INFORMATION**

# **Corporate Headquarters**

        MerrillMerchants Bancshares, Inc.

        201 MainStreet

        Bangor,Maine 04401

        207-942-4800

 

# **Inquiries and Financial Information**

        Analysts,shareholders and other investors seeking financial information including our2001 Annual Report on Form 10-KSB should contact Deborah Jordan, ChiefFinancial Officer and Manager of Investor Relations at 207-942-2494.

        Newsmedia and others seeking general information should contact Jane Madigan,Senior Vice President and Manager of Media Relations at 207-990-4075.

 

# **Internet**

        Our internetaddress is www.merrillmerchants.com or via electronic mail: info@merrillmerchants.com

 

# **Stock Listing**

        MerrillMerchants Bancshares, Inc. is traded over the counter on the Nasdaq NationalMarket system under the symbol MERB.

 

# **Transfer Agent**

        Shareholderinquiries regarding change of address or title should be directed to:

        Registrarand Transfer Company

        10Commerce Drive

        Cranford,NJ  07016

        1-800-368-5948

 

# **Independent Certified Public Accountants**

        BerryDunn McNeil and Parker

        100Middle Street

        Portland,Maine 04104

 

# **Annual Shareholder Meeting**

        Theannual meeting of shareholders will be at 5:00 p.m. on Wednesday, April 17,2002, at Pilot’s Grill, 1528 Hammond Street, Bangor, Maine.

BRANCH LOCATIONS
| **Bangor**             |   | **Milford**    | ** ** | **Orrington**  | ** ** |
|------------------------|--------|----------------|------------|----------------|------------|
| 201  Main Street       |   | 2 Main Street  |       | 191 River Road |       |
| 920 Stillwater  Avenue |   |           |       |           |       |
| 992 Union Street       |   | **Newport**    | ** ** | **Pittsfield** | ** ** |
|                   |   | Newport Plaza  | ** ** | 27 Main Street | ** ** |
| **Brewer**             |   |           | ** ** |           | ** ** |
| 366 Wilson  Street     |   | **Orono**      | ** ** | **Waterville** | ** ** |
|                   |   | 69 Main Street |       | 58 Elm Street  |       |
| **Holden**             |   |           |       |           |       |
| Route 1A               |   |           |       |           |       |

 

 

 

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