Annual Report (Form 10-K), fiscal year 1993

ITEM 1 - BUSINESS
MERCHANTS BANCSHARES, INC., (the Company) was organized on July 1, 1983 as a Vermont corporation, for the purpose of acquiring, investing in or holding stock in any subsidiary enterprise permitted under the Bank Holding Company Act of 1956. On January 24, 1984 the Company acquired The Merchants Bank; and on October 4, 1988 the Company organized Merchants Properties, Inc. On June 2, 1987 shareholders approved a resolution to change the state of incorporation of the Company from Vermont to Delaware.
THE MERCHANTS BANK, (the Bank) was organized in 1849, and assumed a national bank charter in 1865, becoming The Merchants National Bank of Burlington, Vermont. On September 6, 1974 the Bank converted its national charter to a state-bank charter, becoming known as The Merchants Bank. As of December 31, 1993 the Bank was the third largest commercial banking operation in Vermont, with deposits totalling $619.3 million, net loans of $553.4 million, and total assets of $735.4 million, on a consolidated basis.
Since September 30, 1988, The Merchants Bank has participated as an equity partner in the development of several AFFORDABLE HOUSING PARTNERSHIPS which were formed to provide residential housing units within the State of Vermont. During the past four years these partnerships have developed 695 units of residential housing, 446 (64%) of which qualify as "affordable housing units for eligible low income owners or renters", and 249 (36%) of which are "market rate units". These partnerships have invested in 14 affordable and elderly housing projects within 11 Vermont communities: St. Albans, Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington, Springfield, St. Johnsbury, Colchester and Swanton.
MERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was organized for the purpose of developing and owning affordable rental housing units throughout the state of Vermont. As of December 31, 1993 the corporation owned one development located in Enosburg, Vermont, consisting of a 24-unit low income family rental housing project, which was completed and rented during 1989. Total assets of this corporation at December 31, 1993 were $1,328,295.
The Bank owns controlling interest in MERCHANTS TRUST COMPANY, a corporation chartered in 1870 for the purpose of offering fiduciary services such as estate settlement, testamentary trusts, guardianships, agencies, intervivos trusts, employee benefit plans and corporate trust services. The Merchants Trust Company also operates a discount brokerage office, through Olde Discount Corporation, enabling investors to purchase or sell stocks and bonds on a discounted commission schedule. As of December 31, 1993, the Merchants Trust Company had fiduciary responsibilities for assets valued at market in excess of $311 million. Total income for 1993 was $1,756,523, total expense was $1,016,153 resulting in net profit for the year of $740,370. This income is included in the consolidated tax return of its parent company, The Merchants Bank.
QUENESKA CAPITAL CORPORATION, a wholly-owned subsidiary of The Merchants Bank was established on April 4, 1988 as a Federal licensee under the Small Business Act of 1958 to provide small business enterprises with loans and/or capital. As of December 31, 1993, the corporation had assets of $1,536,668, a liability of $5,524 due to the parent company for accrued management fees, and equity capital of $1,531,144.
QUENESKA Capital Corporation has no employees, relying on the personnel resources of its parent company to operate. As compensation for its services QUENESKA pays the Bank a management fee in the amount of 1.5% on annual average assets ($21,673) in 1993. This fee is eliminated in the financial statement consolidation of the parent company.
The corporation's taxable income or loss is included in the consolidated tax return of its parent company, The Merchants Bank. QUENESKA computes its income tax provision or benefit on an individual basis and reimburses, or is reimbursed, by the parent company an amount equal to the annual provision or benefit.
RETAIL SERVICES
A variety of deposit, credit and other miscellaneous financial services are offered by the Bank, encompassing the following:
Checking accounts are offered in the form of regular, N.O.W., Super N.O.W. and senior citizen accounts. The Bank also offers a basic account called the Thrift account.
Statement savings accounts are offered with a related account feature to a number of personal checking account products which may satisfy the checking account minimum balance requirements.
ATF (automatic transfer of funds) provides overdraft protection benefits for personal checking accounts through electronic funds transfer.
Certificates of deposit provide investment opportunities with varying maturities and yields.
Money Market and Preferred Investment accounts offer competitive annual percentage yields and the ability to engage in third party transactions.
A flexible I.R.A. program offers several deposit options for retirement investment using both fixed and adjustable rate offerings with varying maturities.
A Christmas Club account is also available for the accumulation of savings with an annual disbursement.
The Consumer Credit program consists of installment loans, Mastercard, University of Vermont Affinity Mastercard, VISA, a home equity line of credit, and fixed and adjustable rate residential real estate mortgages. Four unique mortgage programs are: an accelerated amortization mortgage which allows mortgagors to make biweekly payments resulting in interest savings and an earlier payoff compared to monthly payment mortgages; a Two Step program with an affordable low fixed rate for the first five or seven years which then adjusts once based upon a specific index; a loan under the Farmers' Home Administration Rural Guaranteed Housing Program which provides for up to 100% financing, flexible qualifying ratios, and a government guarantee for loans on properties in the rural portions of the state; and a "jumbo" loan program providing salable loans for customers with requirements for larger mortgage balances. The Bank also participates in the state's housing finance agency program which assists the low to moderate income home buyer.
The Bank provides strong customer support with thirty Automated Teller machines statewide and including one drive-up machine and 106 on- line electronic teller stations. The bank's expanded personal computer networks now connect each of our thirty nine banking offices to the main frame computer with CRT capability as well as with electronic mail and other PC software. Miscellaneous retail services include safe deposit boxes, travelers and gift checks, bank drafts, personal money orders, and several methods of automated money transfer, including Federal Reserve wire services.
COMMERCIAL SERVICES
The Bank provides commercial banking services to individuals, partnerships and corporations, as well as to public and governmental organizations. Corporate Cash Management services provide several vehicles for managing and investing idle funds on a daily and weekly basis. Business Credit Card services offer full participation in Mastercard and VISA programs and feature various types of electronic deposit options. Regular and Small Business checking accounts address the need for essential deposit and disbursement services for commercial customers. Commercial loans are offered for a wide range of private and public funding needs. Included in this area is the Bank's Small Business Preferred Lender Program. Also offered are commercial real estate loans, lines of credit, business credit cards, and irrevocable letters of credit.
Other miscellaneous commercial banking services include night depository, coin and currency handling, and employee benefits management and fiduciary services available through the Merchants Trust Company.
EXPANSION EFFORTS
The Merchants Bank operates thirty-eight full-service banking facilities within Vermont; and a remote ATM unit located at the Burlington International Airport. Since 1963 the Bank has established eleven de novo offices, and since 1969 has acquired seven Vermont banks by merger. The Merchants Bank's most recent acquisition occurred in June of 1993 with the acquisition of the assets and deposits of New First National Bank of Vermont from the FDIC. Through this acquisition the Merchants Bank extended its presence on the east side of the State gaining offices in Springfield, Windsor, E. Thetford, Fairlee, Bradford, Newbury and Groton and on the west side of the State an office in Fair Haven. This acquisition also resulted in The Merchants Bank increasing market share in Hardwick, St. Johnsbury and Northfield. Each decision to expand the branch network has been based upon strategic planning and analysis indicating that the new or acquired facility would provide enhanced banking resources within the community, insure the competitive viability of the Bank through potential growth of deposits and lending activities.
On March 14, 1994 The Merchants Bank opened a limited service office on the Wake Robin Retirement Community Campus in Shelburne, Vermont.
COMPETITION
Competition for financial services remains very strong in Vermont. As of December 31, 1993, there were twelve state chartered commercial banks, nine national banks, five savings banks and three savings and loan associations operating in Vermont. In addition, other financial intermediaries such as brokerage firms, credit unions, and out-of-state banks also compete for deposit and loan activities.
At year-end 1993 The Merchants Bank was the third largest bank in Vermont, enjoying a strong competitive franchise within the state, with thirty-nine banking offices. Whereas Vermont does have a nationwide interstate banking law there was no merger or acquisition activity during 1993.
No material part of the Bank's business is dependent upon one, or a few customers, or upon a particular market segment, the loss of which would have a materially adverse impact on the operations of the Bank.
NUMBER OF EMPLOYEES
As of December 31, 1993 Merchants Bancshares, Inc. had four officers: Dudley H. Davis, President and Chief Executive Officer; Susan D. Struble, Secretary; Edward W. Haase, Treasurer; and Susan M. Verro, Assistant Secretary. No officers of the Company are on a salary basis.
As of December 31, 1993, The Merchants Bank employed 388 full-time and 80 regular part-time employees, representing a full-time equivalent complement of 432 employees. The Bank maintains a comprehensive employee benefits program which provides major medical insurance, hospitalization, dental insurance, long-term and short-term disability insurance, life insurance, a pension plan and a 401(k) Employee Stock Ownership Plan. In addition, the Bank offers a Performance Progress Sharing Plan, which is available to all eligible employees. Employee benefits offered by the Bank are very competitive with comparable plans provided by other Vermont banks.
REGIONAL ECONOMY
In New England the long and deep recession which eliminated about one out of every nine jobs, appears to be abating. The year-end 1993 forecast from the New England Economic Project (NEEP) predicts that payroll surveyed jobs will be growing in 1994 in all six New England states. However, by gradual economic improvement within the region, business activity and labor markets have not yet returned to "normal". It may take another decade for this region to regain the jobs lost since the recession which started in 1989.
Some segments of the economy are recovering better than others. For example, 1993 building permits for new home construction had risen more that 25% above their 1991 lows. By the end of 1997, NEEP predicts that permits will be up an additional 15%. Even so, the level of home building activity will still be less than half what it was in 1986, when New Englanders took out 112,000 permits at the peak of the speculative housing period.
The economy of the New England states is expected to underperform the national economy, with the economy of the southern three N.E. states expected to be weaker than the three northern states. Connecticut has been especially hard hit by defense restructuring and by restructuring in the insurance industry. Continued tough economic times for the region's richest state is not favorable news for New England.
New Hampshire is currently the bright spot in New England, because of its position as the low cost producer in the region. Non farm employment is forecast to add 9,000 jobs in 1994 (up 1.9%) and an additional 15,000 jobs in 1995 (up 2.9%).
Overall, however, it appears unlikely that any significant economic expansion is on the horizon for the New England region. Growth will need to come from the expansion of existing businesses operating within the region, and from the region's natural environmental appeal for tourism.
VERMONT ECONOMY
A conclusion of the Vermont Business Roundtable is that "not since the Great Depression has there been a period of such extended and steep decline in employment in Vermont". Many of the reasons for this decline are attributable to regional and national factors; specifically the following:
The end of the national defense build-up. The direct and indirect economic impact of defense spending in Vermont could account for as much as 10 percent of the state's total annual economic activity.
Maturation of high-technology and computer industries. There has been a decline in the high-tech, computer business in Vermont as foreign competition has been intense, and changes within the computer industry have hurt job growth since its mid-1980's employment peak.
Problems in agriculture. The dramatic decline in milk prices over the past two years has placed many Vermont dairy farmers at considerable financial risk. Over the past ten years the number of dairy farms has declined 31 percent, from 3,170 in 1984 to 2,187 this year.
Loss of Vermont's and New England's cost competitiveness to domestic competition. Vermont's businesses find themselves facing increasingly sharp cost competition from national and foreign concerns. This loss of competitiveness has resulted in numerous work-force reductions and cost-cutting initiatives among key employers across the state.
Restructuring in financial services. Ongoing employment restructuring in the banking and financial services sector in Vermont has had a negative impact on the economy as firms seek to reduce payroll and overhead costs in order to restore profitability.
Problems associated with the national recession and subsequent weak recovery. Vermont is not immune to the inevitable ups and downs associated with the national business cycle. The manufacturing sector has been negatively impacted by the slow recovery in markets for durable goods products.
In spite of the problems discussed above, Vermont's labor market has recently expanded. The Vermont unemployment rate was 4.5% in November 1993, versus 6.4% nationally. Jobs within the service sector have increased 3% over the past year, and now account for approximately 29% of all jobs in Vermont. The total state labor force expanded by 2,300 jobs between December 31, 1992 and November 30, 1993.
Many have recommended that it's time to take inventory of Vermont's advantages and disadvantages and to capitalize on the state's many attributes, while at the same time assessing and finding reasonable solutions to the problems facing Vermont's current economy.
ITEM 2



ITEM 2 - PROPERTIES
The Merchants Bank operates thirty-nine banking facilities as indicated in Schedule A below. Corporate administrative offices are located at 123 Church Street, Burlington, Vermont, and the operations data processing center is located at 275 Kennedy Drive, South Burlington, Vermont.
Schedule B (below) indicates properties owned by the Bank as possible future expansion sites.
A. SCHEDULE OF BANKING OFFICES BY LOCATION
Burlington 123 Church Street Corporate offices 164 College Street Merchants Trust Co. 172 College Street Branch office 1014 North Avenue Branch office 112 Colchester Avenue *2 Branch office
Essex Junction 54 Pearl Street Branch office
South Burlington 50 White Street Branch office 947 Shelburne Road *1 Branch office 275 Kennedy Drive Operations Center Branch office Burlington Airport *1 ATM
Bristol 15 West Street Branch office
Barre 105 North Main Street Branch office
Northfield Depot Street Branch office
South Hero Route 2 Branch office
Hardwick Wolcott Street Branch office
Hinesburg Route 116/Shelburne Falls Rd Branch office
Vergennes Monkton Road Branch office
Winooski 364 Main Street Branch office
Johnson Main Street Branch office
Colchester 8 Porters Point Road *2 Branch office
Jericho Route 15 Branch office
Enosburg Falls 155 Main Street Branch office
No. Bennington Bank Street Branch office
Manchester 515 Main Street Branch office
Brattleboro 205 Main Street *3 Branch office
Wilmington West Main Street Branch office
Bennington Putnam Square *2 Branch office
Wallingford Route 7 *2 Branch office
St. Johnsbury 90 Portland Street Branch office
Bradford 1 Main Street Branch office
Danville Main Street Branch office
Fairlee U.S. Route #5 Branch office
Groton U.S. Route #302 Branch office
East Thetford U.S. Route #5 & Vt 113 Branch office
Newbury U.S. Route #5 Branch office
Fair Haven 97 Main Street Branch office
Springfield 56 Main Street Branch office
Springfield Plaza Springfield Shopping Plaza Branch office
Windsor 160 Main Street Branch office
Notes: *1: Facilities owned by the bank are located on leased land. *2: Facilities located on leased land with improvements also leased. *3: As of December 31, 1993 a mortgage with an unpaid principal balance of $209,909 is outstanding on the Brattleboro office. This mortgage is being amortized at $1,736 per month, at a rate of 9% through the year 2020.
B. SCHEDULE OF PROPERTIES OWNED FOR FUTURE EXPANSION *1
Year Description Acquired Location Purpose
Land & Building 1973 Corner of Church Future Expansion & College Sts. Burlington, VT
Land 1977 30 Main Street Future Expansion Burlington, VT
Land & Building 1979 Plainfield, VT Future Expansion
Land & Building 1981 8 White Street Future Expansion So. Burlington, VT
Land & Building 1985 U.S. Route 7 Future Expansion Shelburne, VT
Land & Building 1986 Pearl Street Future Expansion Essex Jct., VT
Land & Building 1986 So. Summit St. Future Expansion Essex Jct., VT
Land 1990 45 College Street Future Expansion Burlington, VT
Land & Building 1990 60 Main Street Future Expansion Burlington, VT
Note:
*1: Buildings identified in Schedule B are all rented or leased to tenants. Leases are generally for short-term periods and are at varying rental amounts depending upon the location and the amount of space leased.
ITEM 3

ITEM 3 - LEGAL PROCEEDINGS
The Company is involved in various legal proceedings arising in the normal course of business. Based on consultation with legal counsel, management believes that the resolution of these matters will not have a material effect on the consolidated financial statements of the Company.
ITEM 4

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of calendar year 1993 no matters were submitted to a vote of security holders through a solicitation of proxies or otherwise.
PART II
ITEM 5

ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the over-the-counter NASDAQ exchange under the trading symbol MBVT. Quarterly stock prices during the last eight quarters are as indicated below based upon quotations as provided by the National Association of Securities Dealers, Inc. Prices of transactions between private parties may vary from the ranges quoted below.
CASH DIVIDEND QUARTER ENDING HIGH LOW PAID PER SHARE
March 31, 1992 $14.75 $11.50 .20
June 30, 1992 15.50 11.75 .20
September 30, 1992 16.50 14.00 .20
December 31, 1992 17.00 14.50 .20
March 31, 1993 17.00 14.75 .20
June 30, 1993 16.50 10.25 *
September 30, 1993 16.00 11.25 *
December 31, 1993 15.00 11.00 *
On December 11, 1992 a three percent stock dividend was issued to shareholders of record on November 30, 1992.
*Cash dividends were suspended for the second, third and fourth quarters of 1993.
As of December 31, 1993 Merchants Bancshares, Inc. had 1,630 shareholders.
ITEM 6

ITEM 6 - SELECTED FINANCIAL DATA
The supplementary financial data presented in the following tables and narrative contains information highlighting certain significant trends in the Company's financial condition and results of operations over an extended period of time.
The following information should be analyzed in conjunction with the year-end audited consolidated financial statements as contained in the 1993 Annual Report to Shareholders, a copy of which is attached as an addendum to this Form 10K.
The five-year summary of operations, interest management analysis, and management's discussion and analysis, all as contained on pages 27 through 33 in the 1993 Annual Report to Shareholders are herein incorporated by reference.
Tables included on the following pages concern the following:
Deposits; return on equity and assets; distribution of assets, liabilities, and stockholders' equity; analysis of changes in net interest income; investment securities and U.S. Treasury and Agency obligations; and the estimated maturity / repricing structure of the Company's interest earning assets and interest bearing liabilities.
DEPOSITS The following schedule shows the average balances of various classifications of deposits. Dollar amounts are expressed in thousands.
1993 1992 1991 Demand Deposits $ 81,761 $ 68,494 $ 63,986 Savings, Money Market and NOW Accounts 315,254 272,729 233,873 Time Deposits Over $100,000 17,752 18,170 9,534 Other Time Deposits 155,227 132,971 183,331 -------- -------- -------- Total Average Deposits $569,994 $492,364 $490,724 ======== ======== ======== Time Deposits over $100,000 at December 31, 1993 had the following schedule of maturities (In Thousands):
Three Months or Less $ 6,725 Three to Six Months 1,717 Six to Twelve Months 6,517 Over Twelve Months 6,255 -------- Total $ 21,214 ======== RETURN ON EQUITY AND ASSETS The return on averageassets, return on average equity,dividend payout ratio and average equity to average assets ratio for the three years ended December 31, 1993 were as follows:
1993 1992 1991
Return on Average Total Assets -0.82% 0.94% 0.86% Return on Average Stockholders' Equity -11.92% 11.01% 10.53% Dividend Payout Ratio N/A 58.48% 62.69% Average Stockholders' Equity to Average Total Assets 6.88% 8.56% 8.22%
SHORT-TERM BORROWINGS Refer to Notes 9 and 10 to the consolidated financial statements for this information.
INVESTMENT SECURITIES The Company invests in securities with short maturities, consisting primarily of U.S. government securities. The Company's investment portfolio is used primarily to fund the seasonality of loan growth and deposit run-off as well as for asset/liability management purposes. The table below showsthe classification of the investmentportfolio by type of investment security based on lower of cost or market value at December 31, 1993, 1992, and 1991, respectively. In addition, the subsequent table shows the maturity distribution and weighted average yield of the investment portfolio by security type as of December 31, 1993. All dollar amounts are expressed in thousands. December 31, 1993 1992 1991 U.S. Treasury and Agency Obligations $85,945 $103,187 $ 63,262 Other Securities 1,451 4,333 4,371 ------- -------- -------- Total Investment Securities $87,396 $107,530 $ 67,643 Net Unrealized Depreciation (439) 0 0 -------- -------- -------- Total $86,957 $107,530 $ 67,643 ======= ======== ======== The following table shows the maturity distribution and the weighted average yields of such investment portfolio and the securities as of December 31, 1993:
Book Average Value Yield U.S. Treasury and Agency Obligations(thousands) Due Within 1 Year $ 0 --- Due After 1 but Within 5 Years 85,714 3.71% Due After 5 but Within 10 Years 0 --- Due After 10 Years 231 7.67% ------- ----- Total $85,945 3.72% ------- ----- Other Securities Due Within 1 Year $ 0 --- Due After 1 but Within 5 Years 0 --- Due After 5 but Within 10 Years 0 --- Due After 10 Years 0 Equity Securities* 1,451 3.64% -------- ------ Total $ 1,451 3.64% -------- ------ Total $ 87,396 3.71% ======== ====== Total Securities Due Within 1 Year $ 0 --- Due After 1 but Within 5 Years 85,714 3.71% Due After 5 but Within 10 Years 0 --- Due After 10 Years 231 7.67% Equity Securities* 1,451 3.64% ------- ------ Total $87,396 3.71% ======= ======
* Yields are adjusted to fully taxable equivalent basis, assuming a 34% Federal tax rate.
LOAN PORTFOLIO
The following tables display the composition of the Bank's loan portfolio for the consecutive five year period 1989 through 1993, along with a schedule profiling the loan maturity distribution over the next five years.
COMPOSITION OF LOAN PORTFOLIO The table belowpresents the composition ofthe Bank's loan portfolioby type of loan as of December 31 for each of the past five years. All dollar amounts are expressed in thousands. Amounts are shown gross of net deferred loan fees of $1,310,416 in 1993, $1,183,400 in 1992, $1,098,100 in 1991, $955,000 in 1990 and $950,000 in 1989, which principally relate to real estate mortgages.
As of December 31, Type of Loan 1993 1992 1991 1990 1989 ------------ -------- -------- -------- -------- -------- Commercial, Financial & Agricultural $ 98,936 $ 76,141 $120,033 $129,830 $113,169 Industrial Revenue Bonds 6,695 8,721 11,968 16,296 19,741 Real Estate - Construction 30,526 18,776 16,392 23,763 69,282 Real Estate - Mortgage 413,112 305,513 294,769 288,845 262,723 Installment 22,836 18,332 20,930 25,070 29,124 Lease Financing 42 630 1,769 4,144 6,005 All Other Loans 1,324 1,422 4,287 7,452 2,071 -------- -------- -------- -------- -------- Total Loans $573,471 $429,535 $470,148 $495,400 $502,115 ======== ======== ======== ======== ========
PROFILE OF LOAN MATURITY DISTRIBUTION The table below presents the distribution of the varying contractual maturities or repricing opportunities of the loan portfolio at December, 1993. All dollar amounts are expressed in thousands.
Over One One Year Through Over Five Or Less 5 Years Years Total
Commercial Loans, Industrial Revenue Bonds, Lease Financing and All Other Loans $ 95,694 $ 8,313 $ 3,136 $107,143 Real Estate Loans 398,319 26,971 18,130 $443,420 Installment Loans 15,007 7,869 32 $22,908 -------- -------- -------- -------- $509,020 $ 43,153 $ 21,298 $573,471 ======== ======== ======== ========
Residential mortgage lending during 1993 was very active due to prevailing low interest rates for various mortgage products. Approximately 75% of the Bank's 1993 mortgage activity was for refinancing of existing debt. In 1993 a total of 1,098 one-to-four family residential mortgage loans were closed by the bank totaling $103.2 million. Approximately 95% of these originations were sold on the secondary market. The remaining 5%, or $4.9 million was placed in the Bank's portfolio. The Bank currently services $347.9 million in residential mortgage loans, $257.1 of which it services for other investors such as federal government agencies (FNMA and FHLMC) and for financial investors such as insurance companies and pension funds located outside Vermont. At the end of 1993, the Bank had 181 residential mortgage loans in various stages of processing. Approximately 68% of these loans were refinancings of existing debt.
During 1993 the Bank continued to be very active in the U.S. Small Business Administration guaranteed loan program. Forty new loans totaling $7.1 million were originated during 1993 with SBA guarantees ranging from 70% to 90%. This represents an approximate decrease of 13% in originations over 1992. The reason for the decline in volume is believed to be the sluggish Vermont economy.
In most instances the Bank sells the guaranteed portion of its SBA guaranteed loans to secondary investors outside Vermont. This selling activity has the positive effect on Vermont of importing capital into the State from other parts of the country. SBA guarantees are advantageous to the Bank because they reduce risk in the Bank's loan portfolio and allow the Bank to increase its commercial loan base and market share with minimal impact on capital.
In June 1993, the Bank purchased certain assets of the New First National Bank of Vermont (NFNBV) from the Federal Deposit Insurance Corporation, Division of Liquidation. The bulk of the assets purchased were loans. Therefore, the majority of the net increase in assets, by loan category, occurred as a result of this acquisition.
The Bank booked approximately $107,000,000 in new commercial loan business in 1993. This business was written primarily out of the Bank's Western Division.
LOAN REVIEW
The Bank's Board of Directors grants each loan officer the authority to originate loans on behalf of the Bank. The Board also establishes restrictions regarding the types of loans that may be granted and sets limits for each lender. These authorized lending limits are established at least annually and are based upon the lender's job assignment, training, and experience. Loan requests that exceed a lender's authority are referred to senior loan officers having higher lending authorities. All extensions of credit of $2.5 million to any one borrower, or related party interest, are reviewed and approved by the Bank's Board of Directors.
By using a variety of management reports (new loans, largest exposures, delinquencies, watched assets), the Bank's loan portfolio is continuously monitored by the Board of Directors, senior loan officers, and the loan review department. The loan portfolio as a whole, as well as individual loans, are reviewed for loan performance, credit worthiness, and strength of documentation. Credit ratings are assigned to commercial loans and routinely are reviewed.
All loan officers are required to service their own loan portfolios and account relationships. As necessary, loan officers take remedial actions to assure full and timely payment of loan balances.
LOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES (RPLL)
Merchants Bancshares, Inc. reviews the adequacy of the RPLL at least quarterly. The method used in determining the amount of the RPLL is not based upon maintaining a specific percentage of RPLL to total loans or total non-performing assets, but rather a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors which are indicative of both general and specific credit risk, as well as a consistent methodology for quantifying probable credit losses. As part of the Merchants Bancshares, Inc.'s analysis of specific credit risk, a detailed and extensive review is done on larger credits and problematic credits identified on the watched asset list, non-performing asset listings, and credit rating reports.
The more significant factors considered in the evaluation of the adequacy of the RPLL based on the analysis of general and specific credit risk include:
Status of non-performing loans Status of adversely-classified credits Historic charge-off experience by major loan category Size and composition of the loan portfolio Concentrations of credit risk Renewals and extensions Current local and general economic conditions and trends Loan growth trends in the portfolio Off balance sheet credit risk relative to commitments to lend
Overall, management maintains the RPLL at a level deemed to be adequate, in light of historical, current and prospective factors, to reflect the level of risk in the loan portfolio.
An analysis of the allocation of the RPLL follows. Both the specific and general components of the RPLL are grouped by loan categories. The allocation of the RPLL is based upon loan loss experience, loan portfolio composition, and an assessment of possible loan losses in the categories shown.
Allocation of the Reserve for Possible Loan Losses December 31, 1993 (000's omitted) Percent of loans in Balance at End of Period Percent each category Applicable to: Amount Allocation to total Loans
Domestic: Commercial, Financial, and Agricultural & IRB's $6,500 32% 19% Real Estate - Construction 2,000 10% 5% Real Estate - Mortgage 11,000 55% 72% Installment Loans to 350 2% 4% Individuals Lease Financing 25 All Other Loans 185 1% ------- ---- ---- Total: $20,060 100% 100% ======= ==== ==== Key data that are used in the assessment of the loan portfolio and the analysis of the adequacy of the RPLL are presented in the tables and schedules that follow in this discussion. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the RPLL.
The table below reflects the Bank's loan loss experience and activity in the RPLL for the past five years. All dollar amounts are expressed in thousands.
LOAN LOSSES AND RPLL RECONCILIATION
Year Ended December 31, 1993 1992 1991 1990 1989 Average Loans Outstanding $578,187 $447,652 $471,141 $482,756 $482,582 Reserve for Possible Loan Losses at Beginning of Year 7,412 6,650 5,075 5,151 4,358 Loans Charged Off (NOTE 1): Commercial, Lease Financing and all Other Loans (5,567) (2,938) (3,367) (2,318) (1,162) Real Estate - Construction (275) (253) (1,802) 0 0 Real Estate - Mortgage (7,651) (4,096) (718) (2,236) (175) Installment & Credit Cards (459) (452) (617) (575) (463) --------- -------- -------- -------- -------- Total Loans Charged Off ($13,952) ($7,739) ($6,504) ($5,129) ($1,800)
Recoveries on Loans: Commercial, Lease Financing and all Other Loans 392 232 366 471 22 Real Estate - Construction 0 0 379 0 0 Real Estate - Mortgage 301 108 0 3 5 Installment & Credit Cards 85 111 91 87 86 -------- ------- ------- ------- ------- Total Recoveries on Loans $ 778 $ 451 $ 836 $ 561 $ 113 Net Loans Charged Off (13,174) (7,288) (5,668) (4,568) (1,687) Provision for Loan Losses Charged to Operations (NOTE 2) 23,822 8,050 7,243 4,492 2,480 Loan Loss Reserve-Acquired Loans (NOTE 3) 2,000 --- --- --- --- -------- -------- -------- -------- -------- Reserve for Possible Loan Losses at End of Year $20,060 $7,412 $6,650 $5,075 $5,151 ======== ======== ======== ======== ======== Loan Loss Reserve to Total Loans at Year End 3.50% 1.73% 1.41% 1.03% 1.03% Ratio of Net Charge-Offs During the Year to Average Loans Outstanding During the Year 2.28% 1.63% 1.20% 0.95% 0.35%
NOTE 1: Prior to 1991, loans secured by real estate were not broken out between construction and permanent financing for purposes of loan charge-off and recovery analysis.
NOTE 2: The loan loss provision is charged to operations. When actual losses differ from these estimates, and if considered necessary, they are reported in operations in the periods in which they become known.
NOTE 3: See Note 2 to the consolidated financial statements regarding the acquisition of New First National Bank of Vermont.
The increase in the reserve for possible loan losses from $7,412,000 at December 31, 1992 to $20,060,000 at December 31, 1993, reflects management's efforts to maintain the reserve at an appropriate level to provide for potential loan losses based on an evaluation of known and inherent risks in the loan portfolio. Given the continued slow pace in the economy which affected many of the Company's borrowers in 1993, and the increase in nonperforming assets, management determined that a significant increase in the reserve was appropriate. The provision for possible loan losses increased from $8,050,000 for 1992 to $23,822,000 in 1993.
NON-PERFORMING ASSETS --------------------- The following tables summarize the Bank's non-performing assets. The first table shows a breakout of nonperforming assets covered by a loss sharing arrangement related to the acquisition of the NFNBV on June 4, 1993. The terms of the Purchase and Assumption Agreement related to the purchase of NFNBV require that the FDIC pay the Bank 80% of net charge-offs up to $41,100,000 on any loans that qualify as loss sharing loans for a period of three years from the date of the acquisition. If net charge offs on qualifying loss sharing loans exceed $41,100,000 during the three year period, the FDIC is required to pay 95% of such qualifying charge offs. This arrangement significantly reduces the exposure that the Bank faces on Nonperforming assets (NPAs) that are covered by loss sharing. As of December 31, 1993 NPAs covered by loss sharing totaled approximately $17,469,000. The aggregate amount of loans covered by the loss sharing arrangement at December 31, 1993 was $132,879,000.
Loss Sharing Loans Assets Total ----------- ----------- ----------- Nonaccrual loans $29,712,089 $17,356,607 $47,068,696 Restructured loans 2,772,783 68,389 2,841,172 Loans Past due 90 days or more and still accruing 712,391 2,978 715,369 Other Real Estate Owned 13,633,383 40,876 13,674,259 ----------- ----------- ----------- Total $46,830,646 $17,468,850 $64,299,496 =========== =========== ===========
The second table shows nonperforming assets as of year end 1989 through 1993 (in thousands):
1993 1992 1991 1990 1989 ------- ------- ------- ------- ------- Nonaccrual Loans $47,069 $12,148 $ 8,333 $ 2,914 $ 2,893
Loans Past Due 90 Days or More and Still Accruing 715 7,251 8,613 5,908 5,964
Renegotiated Loans 2,841 1,838 5,679 0 0 ------- ------- ------- ------ ------ Total Non-Performing Loans $50,625 $21,237 $22,625 $ 8,822 $8,857
Other Real Estate Owned 13,674 12,661 6,110 4,652 318 ------- ------- ------- ------ ------ Total Non-Performing Assets $64,299 $33,898 $28,735 $13,474 $9,175 ======= ======= ======= ====== ======
Percentage of Non-Performing Assets to Total Loans plus Other Real Estate Owned 8.83% 4.94% 4.81% 1.78% 1.76%
Percentage of Non-Performing Loans to Total Loans 10.95% 7.67% 6.03% 2.70% 1.83% ======= ======= ====== ====== ======
The nonperforming assets table above shows an increasing trend in nonperforming assets in general. Historically, the Company has worked closely with borrowers and also pursued vigorous collection efforts. As the local recession continued and property values declined further, the Company redoubled its efforts to collect troubled assets. Policies and procedures related to collection of nonaccruing assets in particular were examined. Additionally, the Company enhanced its Loan Review and Loan Workout functions to provide additional resources to address nonperforming assets. Based partly on the continued increases in nonperforming assets in 1993, management significantly increased provisions for possible loan losses during 1993, resulting in a reserve level of $20,060,000 at year end 1993. During the fourth quarter of 1993, as a result of significant increases in nonperforming assets and continuing weakness in the regional economy, the Company provided reserves for possible loan losses of $5 million in addition to the planned provision of $1.75 million for the quarter.
Based upon the result of the Company's assessment of the factors affecting the RPLL, as noted in this discussion, management determined that the balance of the RPLL at December 31, 1993, is adequate.
DISCUSSION OF 1993 EVENTS AFFECTING THE RESERVE FOR POSSIBLE LOAN LOSSES (RPLL) Non-performing assets at year end 1993 increased from $33,899,000 at December 31, 1992 to $64,299,000 at December 31, 1993. $19,637,000 of the increase was the direct result of the acquisition of NFNBV. As discussed, $17,469,000 of the NPAs at December 31, 1993 are covered under a loss sharing arrangement with the FDIC and represent significantly reduced credit exposure to the Bank. The individual categories of NPA's are shown below:
12-31-93 9-30-93 6-30-93 3-31-93 12-31-92 -------- ------- ------- ------- -------- Non-Accrual Loans $47,069 $34,280 $27,190 $6,719 $12,148
Loans Past Due 90 days 715 3,144 8,566 6,827 7,251 or more and Still Accruing Restructured Loans 2,841 3,106 763 7,992 1,838
Other Real Estate Owned 6,235 6,249 3,712 5,245 3,874
Insubstance Foreclosure 7,439 8,125 10,863 8,705 8,787 ------- ------- ------- ------- ------- Total: $64,299 $54,904 $51,094 $35,488 $33,898 ======= ======= ======= ======= =======
All categories of NPAs had significant changes during 1993. The events affecting each category of NPAs are discussed below:
NON-ACCRUAL LOANS: ------------------ The migration of loans 90 days or more overdue and still accruing, and the acquisition of NFNBV principally accounted for the increase in nonaccrual loans of $34,921,000 from December 31, 1992 to December 31, 1993. $19,525,000 is directly attributable to the acquisition of NFNBV. Of the $19,525,000 amount $17,357,000 is covered by the loss sharing arrangement with the FDIC. The remainder of the increase results from the migration of loans 90 days or more overdue.
LOANS PAST DUE 90 DAYS OR MORE AND STILL ACCRUING: -------------------------------------------------- The net decline in this category of $6,536,000 results primarily from the migration of these loans to non-accruing.
Loans Past Due 90 Days or More and Still Accruing were briefly inflated during the quarter ended June 30, 1993. This resulted from a provision in the Purchase and Assumption Agreement with the FDIC that allowed the Bank to accrue 90 days of additional interest from the June 4, 1993 acquisition date. The accrued interest associated with these loans was covered by the loss sharing arrangement previously described.
RESTRUCTURED LOANS: ------------------- The significant events affecting this category include the migration to Other Real Estate Owned (OREO) of a commercial office and retail shopping center for $2,000,000 and a commercial office building for $640,000. One loan of $955,000 was paid off. Significant charge downs in two loans were taken in the amounts of $990,000 and $798,000. The remaining balance of these two loans are included in the nonaccruing TDR amount previously mentioned.
OTHER REAL ESTATE OWNED AND INSUBSTANCE FORECLOSURE: ---------------------------------------------------- The increase in OREO resulted primarily from three properties being acquired - a retail shopping and commercial office space center for $2,000,000, a residential building development for $560,000, and a commercial office building for $640,000. The Bank had notable success in the first half of 1993 in disposing of OREO and continues to aggressively market such properties.
OREO includes specific assets to which legal title has been taken as the result of transactions related to real estate loans.
The criteria for designation of loans as in-substance foreclosure are that the debtor has little or no equity in the collateral, proceeds for repayment of the loan will come only from the operation or sale of the collateral, and the debtor has formally or effectively abandoned control of the assets or is not expected to rebuild equity in the collateral. The collateral underlying these loans is recorded at the lower of cost or market value less estimated selling costs.
The total amount of Other Real Estate Owned and In-Substance Foreclosure at December 31 in each of the last five years is as follows:
1993 1992 1991 1990 1989 ------ ------ ------ ------ ------ Other Real Estate Owned $6,235 $3,874 $2,650 $1,968 $318 In-Substance $7,439 $8,787 $3,460 $2,684 ------- ------- ------ ------ ------ Total: $13,674 $12,661 $6,110 $4,652 $318 ======= ======= ====== ====== ======
POLICIES AND PROCEDURES RELATING TO THE ACCRUAL OF INTEREST INCOME ------------------------------------------------------------------ The Bank normally recognizes income on earning assets on the accrual basis, which calls for the recognition of income as earned, as opposed to when it is collected.
The Bank's policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due in excess of 90 days and, in the judgement of management, the ultimate collectability of principal or interest becomes doubtful. The amount of interest which was not earned but which would have been earned had the nonaccrual and re- structured loans performed in accordance with their original terms and conditions was approximately $2,688,000 and $1,268,000 in 1993 and 1992, respectively.
In addition to the above policy, interest previously accrued is reversed if management deems the past due conditions to be an indication of uncollectability. Also, loans may be placed on a nonaccrual basis at any time prior to the period specified above if management deems such action to be appropriate.
ITEM 7

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of the Financial Condition and Results of Operations as contained on pages 25 through 29 of the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
ITEM 8


ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated balance sheets of Merchants Bancshares, Inc. of December 31, 1993 and 1992, and the related consolidated statements of income, changes in stockholders' equity and cash flows, for each of the three years in the period ended December 31, 1993 together with the related notes and the opinion of Arthur Andersen & Co., independent public accountants, all as contained on pages 7 through 24 of the Company's 1993 Annual Report to Shareholders are incorporated herein by reference.
ITEM 9

ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Part III --------
ITEM 10



ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers, directors and ten percent shareholders to file initial reports of ownership and reports of changes of ownership of the Company's common stock with the Securities and Exchange Commission. Based upon a review of these filings, there were no late filings of SEC Form 4's during 1993.
ITEM 11

ITEM 11 - EXECUTIVE COMPENSATION
ITEM 12

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is hereby made to pages 3 through 13 of the Company's Proxy Statement to Shareholders dated April 21, 1994, wherein pursuant to Regulation 14 A information concerning the above subjects (Items 10 through 13) is incorporated by reference.
Pursuant to Rule 12 b-23, definitive copies of the Proxy Statement will be filed within 120 days subsequent to the end of the Company's fiscal year covered by Form 10-K.
PART IV ------- ITEM 14

ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(1) The following consolidated financial statements as included in the 1993 Annual Report to Shareholders, are incorporated herein by reference:
Consolidated Balance Sheets, December 31, 1993 and December 31, 1992.
Consolidated Statements of Income for years ended December 31, 1993, 1992, 1991.
Consolidated Statements of Changes in Stockholder's Equity for years ended December 31, 1993, 1992, 1991.
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1992, 1991.
Notes to Consolidated Financial Statements, December 31, 1993.
(2) The following exhibits are either filed or attached as part of this report, or are incorporated herein by reference.
Exhibit Description
(3a) Restated Certificate of Incorporation of the Company, filed on April 25, 1987 as Exhibit B to the Proxy Statement filed as part of the pre-effective amendment No. 1 to the Company's Registration Statement on Form S-14 (Registration No. 2-86103) is incorporated herein by reference.
(3b) Amended By-Laws of the Company, filed on April 25, 1987 as Exhibit C to the Company's Proxy Statement is incorporated herein by reference.
(4) Investments, defining the rights of security holders including indentures; incorporated by reference from the Registrant's Form S-14 Registration Statement (Registration No. 2-86103), as filed on September 14, 1983.
(10) Material Contracts: The following are major contracts preceded by applicable number to Registrant's Form S-14 (Registration No. 2-86103) and are incorporated herein by reference.
15 (10a) Service Agreement as amended between First Data Resources, Inc., and Registrant dated June 1993 (effective through May 1998) for Mastercard Services.
17 (10c) 401(k) Employee Stock Ownership Plan of Registrant, dated January 1, 1990, for the employees of the Bank.
19 (10d) Merchants Bank Pension Plan, as amended and restated on January 1, 1989, for employees of the Bank.
20 (10e) Agreement between Specialty Underwriters, Inc., and Registrant dated January 12, 1993 for equipment maintenance services.
(11) Statement re: computation of per share earnings.
(13) 1993 Annual Report to Shareholders is furnished for the information of the Commission only and is not to be deemed filed as part of this report, except as expressly provided herein.
(23) The Registrant's Proxy Statement to Shareholders for the calendar year ended December 31, 1993 will be filed within 120 days after the end of the Company's fiscal year.
Other schedules are omitted because of the absence of conditions under which they are required, or because the required information is provided in the financial statements or notes thereto.
(23a) Reports on Form 8-K The Company filed a Form 8-K with the Securities and Exchange Commission on June 4, 1993.
This report detailed the terms and conditions of a Purchase and Assumption Agreement among the Federal Deposit Insurance Corporation, Receiver of the New First National Bank of Vermont, National Association, the Federal Deposit Insurance Corporation and The Merchants Bank, dated June 4, 1993.
INDEMNIFICATION UNDERTAKING BY REGISTRANT
In connection with Registrant's Form S-8 Registration Statement under the Securities Act of 1933 with respect to the Registrant's 401(k) Employee Stock Ownership Plan, the Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into such Registration Statement on Form S-8:
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel, the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
SIGNATURES ----------
Pursuant to the requirement of Section 13 or 15 (d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on it's behalf by the undersigned, thereunto duly authorized.
Merchants Bancshares, Inc.
Date March 25, 1994 By s/Dudley H. Davis -------------------------------- Dudley H. Davis, President & CEO
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MERCHANTS BANCSHARES, INC., and in the capacities and on the date as indicated.
by by s/ Dudley H. Davis ----------------------------- ------------------------------------ Charles A. Davis, Director Dudley H. Davis, Director, President & CEO of the Company and the Bank
by s/ Jeffrey L. Davis by s/ Jack DuBrul II ----------------------------- ------------------------------------ Jeffrey L. Davis, Director Jack DuBrul, II, Director
by s/ Michael G. Furlong by ----------------------------- ------------------------------------ Michael G. Furlong, Director Thomas F. Murphy, Director
by s/ Edward W. Haase by s/ Leo O'Brien, Jr. ----------------------------- ----------------------------------- Edward W. Haase, Treasurer of the Leo O'Brien, Jr, Director Company and the Bank, Senior Vice President and Controller of the Bank
by by ----------------------------- ----------------------------------- Raymond C. Pecor, Jr., Director Patrick S. Robins, Director
by by s/ Robert A. Skiff ----------------------------- ----------------------------------- Benjamin F. Schweyer, Director Robert A. Skiff, Director
by s/ Susan D. Struble ----------------------------- Susan D. Struble, Director