Annual Report (Form 10-K), fiscal year 1994

ITEM 1 - BUSINESS
A chronology of events, including acquisitions, relating to MERCHANTS BANCSHARES, INC., (the Company) is as follows:
July 1, 1983: Merchants Bancshares, Inc. was organized as a Vermont corporation, for the purpose of acquiring, investing in or holding stock in any subsidiary enterprise under the Bank Holding Company Act of 1956.
January 24, 1984: Company acquired The Merchants Bank, a Vermont chartered commercial bank.
June 2, 1987: Company shareholders approved a resolution to change the state of incorporation of the Company from Vermont to Delaware.
October 4, 1988: Company organized Merchants Properties, Inc., whose mission is as described below.
THE MERCHANTS BANK, (the Bank) was organized in 1849, and assumed a national bank charter in 1865, becoming The Merchants National Bank of Burlington, Vermont. On September 6, 1974 the Bank converted its national charter to a state-bank charter, becoming known as The Merchants Bank. Since 1971 the Bank has acquired by merger seven Vermont banking institutions, and has acquired the deposits of an eighth bank located in St. Johnsbury, Vt. The last such acquisition occurred on June 4, 1993 at which time the Bank acquired the New First National Bank of Vermont, with thirteen banking offices, from the Federal Deposit Insurance Corporation Division of Liquidation. As of December 31, 1994 the Bank was the third largest commercial banking operation in Vermont, with deposits totalling $582.2 million, net loans of $490.6 million, and total assets of $694.8 million, on a consolidated basis.
Since September 30, 1988, The Merchants Bank has participated as an equity partner in the development of several AFFORDABLE HOUSING PARTNERSHIPS which were formed to provide residential housing units within the State of Vermont. During the past four years these partnerships have developed 727 units of residential housing, 470 (65%) of which qualify as "affordable housing units for eligible low income owners or renters", and 257 (35%) of which are "market rate units". These partnerships have invested in 16 affordable and elderly housing projects within 13 Vermont communities: St. Albans, Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington, Springfield, St. Johnsbury, Colchester, Swanton, Bradford and Hardwick.
MERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was organized for the purpose of developing and owning affordable rental housing units throughout the state of Vermont. As of December 31, 1994 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. This housing development is fully occupied at this time. Total assets of this corporation at December 31, 1994 were $1,309,983.
The Merchants Bank owns controlling interest in the MERCHANTS TRUST COMPANY, a Vermont corporation chartered in 1870 for the purpose of offering fiduciary services such as estate settlement, testamentary trusts, guardianships, agencies, intervivos trusts, employee benefit plans and corporate trust services. The Merchants Trust Company also operates a discount brokerage office, through Olde Discount Corporation, enabling investors to purchase or sell stocks and bonds on a discounted commission schedule. As of December 31, 1994, the Merchants Trust Company had fiduciary responsibilities for assets valued at market in excess of $365.5 million. Total revenue for 1994 was $1,809,991, total expense was $4,415,949, (including an extraordinary item totalling $3,246,100 as described in Part I, Item 4, page 9) resulting in a pre-tax net loss for the year of $2,605,958. This loss 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, 1994, the corporation had assets of $1,720,961, liabilities of $109,034 due to the parent company for accrued management fees, and equity capital of $1,611,928.
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 ($23,269) in 1994. This fee is eliminated in the financial statement consolidation of the parent company.
Queneska'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 of 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
The Merchants Bank offers a wide range of deposit and investment products including business checking accounts; Free 60 accounts; NOW checking accounts; NOW 50 accounts; regular checking and Super NOW accounts. In July 1994, the Bank offered a new type of personal account entitled "bottom line checking". This account features a flat monthly fee of $3.00 for twenty checks per statement period with no monthly minimum balance required. A charge of $.50 per check is assessed for more than twenty checks per month. The account can also be used for all electronic transactions including ATM transactions.
The Bank also offers Certificates of Deposit, Money Market accounts, savings accounts, individual retirement accounts and Christmas Club accounts, all at competitive rates and terms. ATF (automatic transfer of funds) provides overdraft protection benefits for personal checking accounts through electronic funds transfer. In addition, the bank offers cash management services for commercial account depositors who may have idle overnight or longer term balances to invest.
The bank provides strong customer support with thirty Automated Teller machines statewide, including one drive-up ATM; and 106 on-line electronic teller stations. The bank's expanded personal computer networks now connect each banking office to the mainframe AS/400 computer with CRT capability, as well as, electronic mail and other PC software applications.
Additional 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
Types of Credit Offerings: Consumer Loans: Financing is provided for new or used automobiles; boats; airplanes; recreational vehicles; new mobile homes; collateral loans, secured by savings accounts, listed equities or life insurance; personal loans. Home improvement and home equity lines of credit, as well as Master and Visa credit cards.
Real Estate Loans: Financing is available for one-to-four family residential mortgages; multi- family mortgages; residential construction; mortgages for seasonal dwellings; commercial real estate mortgages. Mortgages for residential properties are offered on a long-term fixed-rate basis; alternatively, adjustable-rate mortgages are offered. Bi-weekly payment mortgages and graduated (two-step) payment mortgages are offered. Loans under the Farmers Home Administration Rural Guaranteed Housing Program provide up to 100% financing. The bank also participates with the Vermont Housing Finance Agency (VHFA) in providing mortgage financing for low- to moderate-income Vermonters. Most mortgage loan products are offered with as little as a 5% down payment to assist borrowers who qualify, providing the mortgagor(s) acquires private mortgage insurance.
Commercial Loans: Financing for business inventory, accounts receivable, fixed assets, lines of credit for working capital, community development, irrevocable letters of credit, business credit cards, and U.S. Small Business Administration loans are available.
Other miscellaneous commercial banking services include night depository, coin and currency handling and employee benefits management and related 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 assumption of deposits of the 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 and 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. During the fall of 1994, The Merchants Bank began restoration of the Old South Hero Inn on the corner of US Route 2 and South St., So. Hero, Vt. The Merchants Bank relocated its South Hero office to this historic site on January 17, 1995.
COMPETITION
Competition for financial services remains very strong in Vermont. As of December 31, 1994, there were eleven 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, loan, and other ancillary financial activities.
At year-end 1994 The Merchants Bank was the third largest bank in Vermont, enjoying a strong competitive franchise within the state, with thirty-nine banking offices as identified in 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 12 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 Square Branch office 2 Main St. Drive-up Facility
South Hero South St. & Route 2 Branch office
Hardwick Wolcott Street Branch office
Hinesburg Route 116/Shelburne Falls Rd Branch office
Vergennes Monkton Road Branch office
Winooski 364 Main Street Branch office
Johnson Main Street, Route 15 Branch office
Colchester 8 Porters Point Road *2 Branch office
Jericho Route 15 Branch office
Enosburg Falls 155 Main Street Branch office
No. Bennington Bank Street Branch office
Manchester Ctr. 515 Main Street Branch office
Brattleboro 205 Main Street *3 Branch office
Wilmington West Main Street Branch office
Bennington Putnam Square *2 Branch office
Wallingford Route 7 *2 Branch office
St. Johnsbury 90 Portland Street Branch office
Bradford 1 Main Street Branch office
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 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, 1994 a mortgage with an unpaid principal balance of $207,860 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 117 Church St. Future Expansion Burlington, VT
Land 1977 30 Main Street Future Expansion Burlington, VT
Land 1977 45 College St. 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 55 College Street Future Expansion Burlington, VT
Land & Building 1990 60 Main Street Future Expansion Burlington, VT
Land & Building 1993 Bradford Operations Future Expansion Building 1 Main St. Bradford, VT
Note:
*1: Buildings identified in Schedule B are all rented or leased to tenants. Leases are generally for short-term or medium term periods and are at varying rental amounts depending upon the location and the amount of space leased.
ITEM 3

ITEM 3 - LEGAL PROCEEDINGS
During the fall of 1994, lawsuits were brought against the Company, the Bank, the Trust Company (collectively referred to as "the Companies") and certain directors of the Companies. These lawsuits relate to certain investments managed for Trust company clients and placed in the Piper Jaffray Institutional Government Income Portfolio. Separately, and before the suits were filed, the Companies had initiated a review of those investments. Outside consultants were retained to assist in this review. As a result of the review, the Trust Company paid to the affected Trust Company clients a total of approximately $9.2 million in December 1994. The payments do not constitute a legal settlement of any claims in the lawsuits. However, based on consultation with legal counsel, management believes that further liability, if any, of the Companies on account of matters complained of in the lawsuits will not have a material adverse affect on the consolidated financial position and results of operations of the Company. In December 1994, the Trust Company received a payment of $6,000,000 from its insurance carriers in connection with these matters. The Companies also intend to pursue all available claims against Piper Jaffray Companies, Inc. and others on account of the losses that gave rise to the $9.2 million payment by the Companies. Any recovery obtained as a result of such efforts is subject to the terms of an agreement between the Companies and the insurance carriers.
The attorneys representing the plaintiffs in one of the lawsuits discussed above have asked the Court to order the Trust Company's clients to pay fees to those attorneys in an amount of up to $500,000. The Trust Company has resisted the claims for payment of such fees by its clients, and as a result, the Trust Company has been directed to place the sum of $500,000 into escrow pending a ruling by the Court. Based upon consultation with legal counsel, management believes there is no substantial basis for any liability on the part of the Companies for payment of legal fees to those attorneys and, although there is the possibility that the Companies may be required to remit all or part of these funds, such an outcome is not considered likely.
The Bank is also involved in various legal proceedings arising in the normal course of business. Based upon consultation with legal counsel, management believes that the resolution of these matters will not have a material effect on the consolidated financial position and results of operations of the Company.
ITEM 4

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of calendar year 1994 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, 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 *
March 31, 1994 14.75 9.00 *
June 30, 1994 13.50 9.00 *
September 30, 1994 17.00 11.25 *
December 31, 1994 14.00 8.50 *
*Cash dividends were suspended for the second, third and fourth quarters of 1993, and for all four quarters of 1994.
As of December 31, 1994 Merchants Bancshares, Inc. had 1,512 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 1994 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 23 through 30 in the 1994 Annual Report to Shareholders are herein incorporated by reference.
Tables included on the following pages 12 through 16 concern the following:
Deposits; return on equity and assets; short-term borrowings; distribution of assets, liabilities, and stockholders' equity; analysis of changes in net interest income; and the composition and maturity of the loan portfolio.
DEPOSITS
The following schedule shows the average balances of various classifications of deposits. Dollar amounts are expressed in thousands.
1994 1993 1992
Demand Deposits $ 91,853 $ 81,761 $ 68,494 Savings, Money Market and NOW Accounts 310,613 315,254 272,729 Time Deposits Over $100,000 18,135 17,752 18,170 Other Time Deposits 177,198 155,227 132,971 -------- -------- -------- Total Average Deposits $597,799 $569,994 $492,364 ======== ======== ========
Time Deposits over $100,000 at December 31, 1994 had the following schedule of maturities (In Thousands):
Three Months or Less $ 1,865 Over Three to Six Months 7,904 Over Six to Twelve Months 3,895 Over Twelve Months 2,943 Over Five Years 6,674 ------- Total $23,281 =======
RETURN ON EQUITY AND ASSETS
The return on average assets, return on average equity, dividend payout ratio and average equity to average assets ratio for the three years ended December 31, 1994 were as follows:
1994 1993 1992
Return on Average Total Assets -0.41% -0.82% 0.94% Return on Average Stockholders' Equity -6.24% -11.92% 11.01% Dividend Payout Ratio N/A N/A 58.48% Average Stockholders' Equity to Average Total Assets 6.53% 6.88% 8.56%
SHORT-TERM BORROWINGS
For this information refer to notes 8 and 9 to the financial statements of the Company, as contained in the Annual Report to Shareholders, which is herein incorporated by reference.
LOAN PORTFOLIO
The following tables display the composition of the Bank's loan portfolio for the consecutive five year period 1990 through 1994, along with a schedule profiling the loan maturity distribution over the next five years.
COMPOSITION OF LOAN PORTFOLIO
The table below presents the composition of the Bank's loan portfolio by type of loan as of December 31 for each of the past five years. All dollar amounts are expressed in thousands. Amounts are shown gross of net deferred loan fees of $1,132,494 in 1994, $1,310,416 in 1993, $1,183,400 in 1992, $1,098,100 in 1991 and $955,000 in 1990, which principally relate to real estate mortgages.
----------------As of December 31,-------------- Type of Loan 1994 1993 1992 1991 1990
Commercial, Financial & Agricultural $ 88,201 $ 98,936 $ 76,141 $120,033 $129,830 Industrial Revenue Bonds 4,411 6,695 8,721 11,968 16,296 Real Estate-Construction 21,992 30,526 18,776 16,392 23,763 Real Estate - Mortgage 377,429 413,112 305,513 294,769 288,845 Installment 18,086 22,836 18,332 20,930 25,070 Lease Financing 0 42 630 1,769 4,144 All Other Loans 436 1,324 1,422 4,287 7,452 -------- -------- -------- -------- -------- Total Loans $510,555 $573,471 $429,535 $470,148 $495,400
PROFILE OF LOAN MATURITY DISTRIBUTION
The table below presents the distribution of the varying maturities or repricing opportunities of the loan portfolio at December, 1994. 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 $ 59,012 $ 23,698 $10,338 $93,048 Real Estate Loans 237,270 96,197 65,954 399,421 Installment Loans 5,342 12,386 358 18,086 -------- -------- ------- -------- $301,624 $132,281 $76,650 $510,555 ======== ======== ======= ========
Residential mortgage lending slowed during 1994 after two years of very heavy refinancing volume. Approximately 63% of the Bank's 1994 mortgage activity was for refinancing of existing debt. In 1994, a total of 490 one-to-four family residential mortgage loans were closed by the bank, totalling $44.8 million. Approximately 93% of these originations were sold on the secondary market and the remaining 7%, or $3.5 million were placed in the bank's portfolio. The bank currently services $335 million in residential mortgage loans, $259.3 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 1994, the bank had 130 residential mortgage loans in various stages of processing. Approximately 40% of these loans were refinancings of existing debt.
During 1994, the Bank remained an active participant in the U.S. Small Business Administration guaranteed loan program. Sixty- six new SBA loans totalling $8.22 million were originated during 1994 with SBA guarantees ranging from 70% to 90%. This volume of new lending activity represents an increase of 15% over originations during 1993.
Approximately 79% of all new SBA loans originated during 1994 were sold to secondary market investors located outside Vermont. This selling activity has the positive effect on Vermont of importing capital into the State from other parts of the country. SBA guarantees are advantageous to the Bank because they reduce risk in the Bank's loan portfolio and allow the bank to increase it's commercial loan base and market share with minimal impact on capital.
During 1994, the Bank originated 746 commercial loans totalling $134.6 million. This lending activity represented an increase of approximately 26% of new loan volume over that experienced in 1993. Commercial loans were originated throughout Vermont.
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 loan authority 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, 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 reviewed.
All loan officers are required to service their own loan portfolios and account relationships. As necessary, loan officers or the loan workout function 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 nonperforming assets, but rather a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors which are indicative of both general and specific credit risk, as well as a consistent methodology for quantifying probable credit losses. As part of the Merchants Bancshares, Inc.'s analysis of specific credit risk, a detailed and extensive review is done on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings, and credit rating reports.
The 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 nonperforming loans - Status of adversely classified credits - Historic charge off experience by major loan category - Size and composition of the loan portfolio - Concentrations of credit risk - 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 future loan losses in the categories shown.
Allocation of the Reserve for Possible Loan Losses December 31, 1994 (000's omitted)
Percent of loans in each Balance at End of Period Percent category to Applicable to: Amount Allocation total Loans ---------------------------------------------------------------------- Domestic: Commercial, Financial, and Agricultural & IRB's $5,000 25% 18% Real Estate - Construction 1,500 8% 4% Real Estate - Mortgage 13,000 65% 74% Installment Loans to Individuals 350 2% 4% All Other Loans 79 0% 0% ---------------------------------------------------------------------- Total: $19,929 100% 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, 1994 1993 1992 1991 1990 --------- --------- --------- --------- -------- Average Loans $514,843 $515,805 $441,291 $471,141 $488,792 ======== ======== ======== ======== ======== Reserve for Possible Loan Losses at Beginning of Year 20,060 7,412 6,650 5,075 5,151 Loans Charged Off (NOTE 1): -------- -------- -------- -------- ----- Commercial, Lease Financing and all Other Loans (3,356) (5,567) (2,938) (3,367) (2,318) Real Estate - Construction (1,159) (275) (253) (1,802) 0 Real Estate - Mortgage (7,673) (7,651) (4,096) (718) (2,236) Installment & Credit Cards (462) (459) (452) (617) (575) --------- --------- --------- -------- ------- Total Loans Charged Of (12,650) (13,952) (7,739) (6,504) (5,129) --------- --------- -------- -------- ------- Recoveries on Loans: Commercial, Lease Financing and all Other Loans 1,187 392 232 366 471 Real Estate - Construction 400 0 0 379 0 Real Estate - Mortgage 769 301 108 0 3 Installment & Credit Cards 163 85 111 91 87 --------- --------- --------- -------- -------- Total Recoveries on Loans $2,519 $778 $451 $836 $561 --------- --------- --------- -------- -------- Net Loans Charged Off ($10,131) ($13,174) ($7,288) ($5,668) ($4,568) --------- --------- -------- -------- -------- Provision for Loan Losses: Charged to Operations (NOTE 2) 10,000 23,822 8,050 7,243 4,492 Loan Loss Reserve (Note 3) 2,000 ------- ------- ------ ------ ------ Reserve for Possible Loan Losses at End of Year $19,929 $20,060 $7,412 $6,650 $5,075 ======= ======= ====== ====== ====== Loan Loss Reserve to Total Loans at Year End 3.90% 3.50% 1.73% 1.41% 1.03% Ratio of Net Charge Offs During the Year to Average Loans Outstanding During the Year 1.97% 2.28% 1.63% 1.20% 0.95%
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 operating expense. When actual losses differ from these estimates, and if adjustments are considered necessary, they are reported in operations in the periods in which they become known.
NOTE 3: See Note 10 to the consolidated financial statements regarding the acquisition of New First National Bank of Vermont.
The slight decrease in the reserve for possible loan losses from $20,060,000 at December 31, 1993 to $19,929,000 at December 31, 1994, reflects management's in-depth analysis of the RPLL and efforts to maintain the reserve at an appropriate level to provide for potential loan losses based on the evaluation of known and inherent risks in the loan portfolio. The provision for loan losses decreased from $23,822,000 in 1993 to $10,000,000 in 1994. This was partly driven by net loans charged off by the Company in 1993 of $13,174,000.
NONPERFORMING ASSETS
The following tables summarize the Bank's nonperforming 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 NPAs that are covered by loss sharing. Nonperforming assets (NPAs) covered by loss sharing totaled $10,455,000 and $17,469,000 at December 31, 1994 and 1993, respectively. The aggregate amount of loans covered by the loss sharing arrangement at December 31, 1994 was $95,802,000 and $132,879,208 at December 31, 1993.
Nonperforming assets as of December 31, 1994 were:
Segregated Loans Loans Total ----------------------------------------------------------------------- Nonaccrual Loans $24,251,987 $7,948,632 $32,200,619 Restructured Loans 5,016,123 66,731 5,082,854 Loans Past Due 90 Days or More and Still Accruing 668,007 0 668,007 Other Real Estate Owned, Net 10,791,262 2,439,545 13,230,807 ----------- ----------- ----------- Total: $40,727,379 $10,454,908 $51,182,287 =========== =========== ===========
The following table shows nonperforming assets as of year end 1990 through 1994 (in thousands):
1994 1993 1992 1991 1990 --------------------------------------------------------------------------- Nonaccrual Loans $32,200 $47,069 $12,148 $8,333 $2,914 Loans Past Due 90 Days or More and Still Accruing 668 715 7,251 8,613 5,908 Restructured Loans 5,083 2,841 1,838 5,679 0 ------ ------ ------ ------ ------ Total Nonperforming Loans: 37,951 50,625 21,237 22,625 8,822 ------ ------ ------ ------ ------ Other Real Estate Owned 13,231 13,674 12,662 6,110 4,652 ------ ------- ------- ------- ------- Total Nonperforming Assets: $51,182 $64,299 $33,899 $28,735 $13,474 ======= ======= ======= ======= ======= Percentage of Nonperforming Loans to Total Loans 7.43% 8.83% 4.94% 4.81% 1.78% Percentage of Nonperforming Assets to Total Loans plus Other Real Estate Owned 9.77% 10.95% 7.67% 6.03% 2.70% ======= ======= ======== ======= =======
The nonperforming assets table above showed an increasing trend in nonperforming assets until December 31, 1993. Historically, the Company has worked closely with borrowers and also pursued vigorous collection efforts. The Company continued its efforts to collect on troubled assets during 1994. The Company's enhanced Loan Review and Loan Workout functions provided resources to address collection strategies for nonperforming assets.
Based upon the result of the Company's assessment of the factors affecting the RPLL, as noted in this discussion, management believes that the balance of the RPLL at December 31, 1994, is adequate.
DISCUSSION OF 1994 EVENTS AFFECTING THE RESERVE FOR POSSIBLE LOAN LOSSES (RPLL)
Nonperforming assets declined from $64,299,000 at December 31, 1993 to $51,182,000 at December 31, 1994. Net charge offs during 1994 were $10,131,000 which accounted for part of the reduction. Paydowns, payoffs, return to performing status, and OREO sales resulted in a further decrease in NPAs.
12-31-94 9-30-94 6-30-94 3-31-94 12-31-93 -------- -------- -------- -------- -------- Nonaccrual Loans $32,200 $28,385 $39,166 $43,091 $47,069 Loans Past Due 90 days or more and still Accruing 668 106 558 109 715 Restructured Loans 5,083 5,014 2,892 1,915 2,841 Other Real Estate Owned, Net 7,389 10,898 10,759 9,784 6,235 In-substance Foreclosure, Net 5,842 4,685 5,195 5,430 7,439 ------- ------- ------- ------- ------- Total: $51,182 $49,088 $58,570 $60,329 $64,299 ======= ======= ======= ======= =======
The more significant events affecting NPAs are discussed below:
NONACCRUAL LOANS:
Nonaccrual loans declined from $47,069,000 at December 31, 1993 to $32,200,000 at December 31, 1994. The decline resulted from charge offs, payments, and return to accruing status. The increase in nonaccrual loans from September 30, 1994 to December 31, 1994 is due primarily to one borrowing relationship. This $5.8 million relationship was re-analyzed in the fourth quarter as the result of a softening in the market.
LOANS PAST DUE 90 DAYS OR MORE AND STILL ACCRUING:
The Bank generally places loans that become 90 or more days past due on nonaccrual status. If the ultimate collectability of principal and interest is assured, loans may continue to accrue and be left in this category. The loan amount shown in this category was evaluated and full collection of principal and interest is probable.
RESTRUCTURED LOANS:
Restructured loans (TDRs) increased during 1994 from $2,841,000 at December 31, 1993 to $5,083,000 at December 31, 1994. Two relationships for $1,325,000 and $3,397,000, respectively, previously shown as nonaccruing were returned to accrual status. These two relationships migrated to the TDR category from non-accrual since performance after restructuring had not spanned a year end accounting period. One relationship for $1,323,000 which had performed at market rates and terms for fourteen (14) months was returned to performing status. Payoffs accounted for approximately $1 million in reduction in TDRs during 1994.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURE:
The Bank had notable success in 1994 in disposing of OREO and continues to aggressively market such properties. However, OREO increased from $6,235,000 at December 31, 1993 to $7,389,000 at December 31, 1994.
Larger balance additions to OREO were:
- an apartment complex for $1.5 million - a commercial building lot for $800,000 - a residential development for $2 million
Larger balance reductions were:
- a commercial office building for $637,000 - Five separate commercial buildings for $1,770,000 - A multi-function commercial building for $750,000
The fourth quarter reduction in OREO results from sales and from a $2.1 million provision to valuation reserves allocated against specific OREO properties.
OREO includes specific assets to which legal title has been taken as the result of transactions related to real estate loans.
In-substance Foreclosures (ISF) decreased from $7,439,000 at December 31, 1993 to $5,842,000 at December 31, 1994. Payments or payoffs of approximately $1.2 million were received and one ISF was transferred to OREO for $2 million. Six loans were reclassified as ISF totalling approximately $1.4 million.
The criteria for designation of loans as in-substance foreclosures 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 Foreclosures at December 31 in each of the last five years is as follows:
1994 1993 1992 1991 1990 ---------------------------------------------- Other Real Estate Owned 7,389 6,235 3,874 2,650 1,968 In-Substance Foreclosure 5,842 7,439 8,787 3,460 2,684 ------- ------- ------- ------ ------ Total: $13,231 $13,674 $12,661 $6,110 $4,652 ======= ======= ======= ====== ======
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 the ultimate collectability of principal or interest becomes doubtful. 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 30 of the Company's 1994 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. as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in stockholders' equity and cash flows, for each of the three years in the period ended December 31, 1994 together with the related notes and the opinion of Arthur Andersen LLP, independent public accountants, all as contained on pages 5 through 33 of the Company's 1994 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 1994.
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 March 24, 1995, 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 1994 Annual Report to Shareholders, are incorporated herein by reference:
Consolidated Balance Sheets, December 31, 1994 and December 31, 1993.
Consolidated Statements of Operations for years ended December 31, 1994, 1993, 1992.
Consolidated Statements of Changes in Stockholder's Equity for years ended December 31, 1994, 1993, 1992.
Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993, 1992.
Notes to Consolidated Financial Statements, December 31, 1994.
(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) 1994 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, 1994 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 24, 1995 by S/Joseph L. Boutin ------------------ ---------------------------- Joseph L. Boutin, President & CEO
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MERCHANTS BANCSHARES, INC., and in the capacities and on the date as indicated.
by S/Joseph L. Boutin by S/ Peter A. Bouyea ------------------------------- ------------------------------ Joseph L. Boutin, Director, President Peter A. Bouyea, Director & CEO of the Company and the Bank
by by S/Dudley H. Davis ------------------------------- ------------------------------ Charles A. Davis, Director Dudley H. Davis, Director Chairman of the Board of Directors
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 ------------------------------- ----------------------------- Edward W. Haase, Treasurer and Leo O'Brien, Jr, Director Chief Financial Officer of the Company Senior Vice President and Treasurer of the Bank
by by S/Patrick S. Robins ------------------------------- ------------------------------ Raymond C. Pecor, Jr., Director Patrick S. Robins, Director
by by S/Robert A. Skiff ------------------------------- ------------------------------ Benjamin F. Schweyer, Director Robert A. Skiff, Director
by ------------------------------- Susan D. Struble, Director