'Last real bank' Merchants to become Community Bank on Monday

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'Last real bank' Merchants to become Community Bank on Monday

Fri, 05/12/2017 - 2:24pm -- tim

by Timothy McQuiston Vermont Business Magazine Merchants Bank and Community Bank, NA will formally merge this weekend, May 12-14. Branches will close at 3 pm Friday and re-open Monday morning as Community Bank. Merchants Bank was formed in 1849. Last October 22, Merchants Bancshares, based in South Burlington, and Community Bank System, Inc of Syracuse, NY, entered into a definitive agreement under which Community would acquire Merchants in a cash and stock transaction valued at $304 million. Regulators approved the deal at the end of April.

The late Dudley Davis, who stepped down as president in 1994, was one of, if not the last, man who ran a bank with a handshake. For that reason Merchants was called "the last real bank in America" by a local businessman. Regulators wouldn't allow such financial dealings these days, of course, and haven't for more than 20 years. 

At the Kennedy Drive, South Burlington, branch, a temporary banner covers the former Merchants Bank sign. VBM photos.

The combination of these two largely small town, but widely dispersed institutions, is a natural fit for the two banks and should provide a natural market extension for both companies. The two banks are known as high-quality, low-risk franchises with long histories of service to their customers and communities.

Merchants is the last of the statewide banks based in Vermont. It has 31 branches, by far the most of any local bank in the state, and third to People's United (40) and TD Bank (32). Merchants has just over $2 billion in assets, more than double any other Vermont--based bank.

Below is a story that originally ran in the November 1994 issue of Vermont Business Magazine, on the occasion of Dudley Davis' retirement. The new president was Joe Boutin, brother to VBM Publisher John Boutin.

'The Last Real Bank in America: Merchants'

by Timothy McQuiston To look at it, Joseph L Boutin and Dudley H Davis could not be more dissimilar, except that they both do the exact same job relentlessly. Joe is a short-back-and-sides kind of guy. He's everyone's responsible older brother. He's straightforward and polite. And he rebuilds MGs.

Dudley is a full generation older, with a ruddy complexion, a ruddy disposition and a ruddy way of doing business. He makes money the old-fashioned way, by personal will. As The Merchants Bank president, Dudley held over $100 million in his personal loan portfolio, when the common standard for a bank president is zero. He's the kind of businessman that would help a struggling Ben & Jerry escape from a sheriff trying to freeze their assets, by shooing "the boys" out the back door with their cash in their pockets, or go up one side and down the other of a long-time customer.

Dudley Davis died on November 29, 2004, just days after his children announced a commitment to name the University's new student center the Dudley H Davis Center. UVM photo.

So, why would the Davis family want to hire Joseph Boutin? And equally curious, why would a conservative banker like Joseph Boutin want to work at a place where Dudley will still be chairman of the board and continue to hold, with his family, that controlling interest? At a once-invincible bank now being watched by regulators for financial weakness? And at a place that has been on the seller's block? When a bank is sold, the president usually loses his job.

"The challenge was attractive to me here," Boutin said as he sat in his quiet new office atop The Merchants Bank headquarters on Church Street in Burlington, with the polished hardwoods and view of Lake Champlain and the Adirondacks. "Most of the work I had done at the Howard over the last five years was pretty much done."

Boutin, 47, had been with The Howard Bank for 25 years, much of it in Rutland, until Banknorth Group Inc was formed in a merger of, principally, the Howard and First Vermont Bank in Brattleboro.

He was lent out for a time to the American Banking Association, where he spent time, because of the banking crisis in early 1990s, on "Nightline" with Ted Koppel. Twenty-five years previous, he graduated from St Michael's College in Colchester, where his father was president.

His father, Bernard, once ran unsuccessfully as a Democrat for governor of New Hampshire, where Joe was born, after having served in the Johnson and Kennedy administrations. Joe Boutin has been to the Kennedy Compound and met the president.

After the creation of Banknorth, Boutin served one stockholder, the holding company. Now he is the president and CEO of the bank and of the holding company. The Davis,' the directors and the public depend on him, he said. "It's a lot more responsibility."

Dudley Davis said, "All in all, it's a great opportunity."

Twenty-year Merchants director Patrick Robins, president of McAuliffe Inc in Burlington, said Boutin has been his personal banker of 20 years. He said Boutin is savvy and is a broadly trained banker.

"He knows everybody in the community. And that's a big plus, knowing the portfolio," Robins said.

"The bank," said Davis' son Jeff, president of the Burlington development company JL Davis, "has a long history of community involvement, community lending, and Joe fits into that really well. He knows the community and he knows the businesses. There is no learning curve."

Jeff Davis, also a director of the bank, was on the search committee to find a replacement for his father, who had announced his retirement last spring at the annual shareholders meeting. Dudley Davis, 73, was expected to continue as president even after regulators increased their oversight of the bank last February, following heavy loan losses in 1993 and a thin blanket of capital to cover it. The retirement came as a surprise to the Vermont business community, who had seen Dudley Davis run the bank since 1968. But it did not come as a surprise to directors.

Jeff Davis said his father had told directors in the spring of 1993 that he intended to retire at the end of 1994 because of his age.

"His intent all along was to retire," he said, "and the timing jibed with it almost exactly." Between May 24, when Davis announced his retirement, and October 21, when Joe Boutin was named his successor, Jeff Davis said the search committee looked at "a couple dozen" candidates.

Joe Boutin, older brother of Vermont Business Magazine publisher John Boutin, explained the process this way: "Back when Dudley announced his retirement in the spring, one of the directors of the bank said, "Are you interested?" And I said, I might be, but I'd like to know more. Nothing happened. Months went by and I met this director at the City Hall Park dedication and he said, "We never heard from you about the job," and I said, Well, it's not my position to do anything, I've got a job here in town. Then about a month later, somebody called me. From that call to the time they made me an offer was about two weeks. So that's how fast it happened. I think they looked at a number of different issues first. They looked at probably different candidates. They were looking at merger possibilities, as the papers disclosed. And I never pushed my candidacy. I was in a very tough position anyway, being president of The Howard Bank and being very content being president of the Howard Bank. So, they came to me toward the end of their search."

Precisely a week before the announcement, Boutin resigned from the Howard Bank. Even the Banknorth press release started with, "In a surprise announcement..."

The Burlington Free Press immediately speculated that Boutin was going to The Merchants Bank.

Banknorth President William Chadwick said later, "We were very surprised." All he wanted to add on that subject was, "He's very talented and we wish him well."

Despite the regulators, heavy loan losses and no dividend payments, Dudley Davis said Boutin has "no tough jobs" ahead of him.

INTELLECTUAL HONESTY

"Regulators are concerned about one thing, preservation of the fund, the FDIC fund. They don't want a failed institution," Boutin said.

"They felt that with Dudley being 73 it was time to address the issue of management succession. Who was going to succeed him? When the bank didn't come forward with that succession plan, I think then they started encouraging the board to look at alternatives. When they decided as a board, "We want to keep this as an independent institution, let's go out and get a president," I think that's when they went out and called me. With both the FDIC and the Federal Reserve, that was probably the biggest issue, to make sure there was something after Dudley Davis, because they recognized that he was such an important part of this organization."

In May 1993, Merchants Bancshares Inc, the holding company for The Merchants Bank and the Merchants Trust Company, purchased the New First National Bank of Vermont. The purchase price was a plus $2.4 million in a closed bid to the FDIC.

The FDIC had taken over the failed bank and renamed it. It originally was the Independent Bank Group, whose banks suffered through the recession and malfeasance of its top executives, many of whom are now in jail. The banks, the First National Bank of Vermont, the Bradford National Bank and Caledonia National Bank, merged into the one First National Bank, which was renamed by the FDIC in early 1993.

The Merchants acquired about $200 million in assets and a pile of bad loans. Vermont National Bank of Brattleboro offered a net zero bid for the bank and Banknorth Group offered a discounted, or negative, bid.

The Merchants, which had continued to show superior profits and paid dividends right through the recession of the early 1990s, while its competitors had to shift tens of millions of dollars from shareholders to allowances for loan losses, showed weakness immediately following the purchase, and stopped paying dividends after the first quarter of 1993, for the first time since 1945.

Banking analysts in Vermont, Boston and New York contacted by Vermont Business Magazine pointed out, however, that the Merchants troubles in the early 1990s were greater than it appeared to the layperson.

For instance, Banknorth Group had $1.567 billion in assets at the end of 1992 and the Merchants' had $622 million, or 40 percent the size of Banknorth. At that time, Banknorth reported nonperforming loans of $29.4 million. Merchants reported NPL of $14 million, or 47.6 percent of Banknorth's. As part of that, Banknorth reported "loans past due 90 days or more and still accruing" of $2.3 million, while Merchants reported $7.3 million, or 317.4 percent of Banknorth's.

The smaller bank reported a greater number of "still accruing" loans during the bleakest days of the recession. Banknorth reported $3 million in 1991 and $4.2 million in 1990. Merchants reported $8.6 million in 1991 and $5.9 million in 1990.

Also in 1991, while Banknorth reported 10 percent of its NPL as "sill accruing," Merchants did not report it as part of its NPL, nor, as Banknorth did, figure in "still accruing" into its allowance for possible loan loss.

Still, while Banknorth's allowance covered 75.2 percent of NPL, Merchants' covered 57.6 percent, and when the "still accruing" is added in, it is 37.9 percent. In 1991, it is 73 percent to 32 percent. The loan loss reserve, or cash outlay, for those years reveals a similar trend. Banknorth: 1992, 44.6 percent; 1991, 96.9 percent. Merchants: 1992, 34.9 percent; 1991, 29.4 percent.

The amount of nonperforming loans determines how much money has to be set aside from profits. The less needed for nonperforming loans, the greater the profit, the greater the dividend, the more profitable the bank appears, as determined by return on average assets. The 1992 ROA for Merchants (net income to assets) was .94 percent. The magic number for ROA is 1 percent, which was last achieved by Merchants in 1989 as 1.55 percent. The per share profit in 1992 was $1.39. The cash dividend for 1992 was 80 cents, which was the highest amount for the five-year period from 1999 to 1993. Banknorth didn't pay a dividend in 1991 or 1992, and its ROA was .14 percent.

Jeffrey Cohn, a banking analyst with HC Wainwright & Company in Boston, questioned whether the bank was "intellectually honest" over the "still accruing" numbers, or perhaps, he said, it was conducting "on-a-prayer" banking. Cohn spends part of his time in Vermont.

If a 75 percent allowance for possible loan losses is assumed for Merchants, as with Banknorth, and the "still accruing" is added to nonperforming loans, Merchants' 1992 net income of $5.7 million becomes a $1.6 million loss. The ROA becomes a minus .26 percent. And per share value also becomes a loss.

FINANCIAL SOUNDNESS

With the purchase of the New First National came added pressure on the Merchants' capital. Its capital ratio (shareholders equity to assets) peaked in 1992 at 8.56 percent, but by the end of the second quarter of 1993, it had fallen to 6.38 percent, and recovered some by the end of the year to 6.88 percent. Regulators look for this measure of a bank's soundness to be above 5 percent.

Under the eye of the regulators, the Merchants changed its reporting methods. By year-end 1993, the bank's nonperforming loans were reported as $49.9 million (1992, $14 million), while "still accruing" fell to $715,000 (1992, $7.3 million).

"The regulators own the bat, they own the ball, if you want to play, you have to do what they say," Cohn said.

The Federal Reserve Bank of Boston and the Merchants entered into a "Written Agreement" on February 28, 1994 "to restore and maintain the financial soundness of Merchants Bancshares Inc." The Fed makes a point of stating in the agreement that the bank's signing of the agreement does not constitute "an admission of any allegation made or implied" by the Fed.

The agreement requires that the Merchants receives approval from the Fed before paying dividends, that it document how the bank will sustain its soundness and resolve problem assets, that it maintain loan loss reserves, that it not incur new debt without approval and that it write a plan on how it will service current debt; within 60 days of the agreement the bank's board of directors must review and assess the qualifications and performance of the corporation's senior executive officers, and address "the management succession at Merchants."

The Fed also must approve single transactions in excess of $100,000, or of transactions of more than $100,000 or in excess of $250,000 in any 30-day period to any individual or entity. Nor can the bank increase compensation to any current or former senior executive officer of the Merchants, except under review.

With the signing of this agreement, Merchants was bound not to pay a quarterly dividend with regulatory approval.

Because of capital pressures on the Merchants, it became a natural target of acquisition by other banks. Both Vermont National Bank, and Key Bank, which ultimately bought Bank of Vermont from the Bank of Boston, were interested in the Merchants.

"We're not talking to anybody and we're not looking to talk to anybody," Robins said.

One banking analyst said that the regulators give a bank a few years to resolve its problems once they bring in a new CEO. But they also said that there will continue to be acquisitions or mergers in Vermont, both big and small.

John D Hashagen, president of Vermont National Bank, said it is all a matter of finding a return for the shareholders, and, right now, that is in economies of scale. The internal growth rate, dependent on net interest margin, or the difference between at what rate a bank borrows money and at what rate it lends it out, is only about 5 percent.

"You don't want to give your shareholders a 5 percent return," Hashagen said. "They're not going to be very happy with you."

"That's what's pushing this (acquisitions), and I think it's going to continue to push it," he said.

Along with acquisitions, the volatility of the banking industry can be measured by the turnover at the top. With Dudley Davis' retirement, Hashagen becomes the longest-serving president of a major bank in Vermont, at seven years. He said his company will continue to look at opportunities in and out of Vermont.

Hashagen pointed out that Vermont National holds less than 10 percent of the deposits in Chittenden County, and could use a stronger presence in the north.

Meanwhile, KeyCorp, from Cleveland, is spreading across non-urban America. Its purchase of Bank of Vermont will create the Key Bank of Vermont, and all the signs will be changed early next year.

KeyCorp, from Maine to Florida to Alaska, and most places in-between, is the 11th largest banking company in the United States with $64.5 billion in assets, bigger than Bank of Boston.

"New England is a place we're interested in and are familiar wit" said John Fuller, vice president and director of corporate communications for KeyCorp. "Bank of Vermont is the kind of community bank KeyCorp is interested in," he said.

"We try to minimize the changes as much as possible," Fuller said. "Our well-being is dependent on the community and the economic viability of Vermont." So, the money isn't exported out of the state, and the Community Reinvestment remains strong, he said.

He could not comment on specific banks, but he did say, "We'll always look at situations as they present themselves. And we'd like to expand our presence in Vermont, if that's at all possible."

Banknorth President William Chadwick, who, like Hashagen, has seen his bank weather the storm and return to robust earnings, said, "We're constantly assessing opportunities." He said the bank's acquisition focus is clear: Look at Vermont and New Hampshire banks.

Neither the bank analysts nor the bank presidents in Vermont expect the playing field to remain the same for very long. Joe Boutin expects that two of the following four banks to be acquired in the next 18 months: Banknorth, Chittenden, Vermont National, Vermont Federal.

Because of economies of scale, the bankers agreed, regional banks can reduce expenses dramatically at the local banks by bringing the backroom operations into the corporate office in Boston (Shawmut) or Providence (Fleet) or Cleveland (Key).

If KeyCorp comes in and buys, say, Vermont National, it already owns Bank of Vermont, and not only can it get rid of major duplicate branches in the same towns, as in Brattleboro and Burlington, but it can also sell or lease the associated real estate, which will go toward recouping the purchase price. In both of those towns, the bank offices are practically across the street from each other.

Or, say, Fleet comes in and buys Banknorth. Banknorth has its corporate structure as well as the structure for each of its now seven subsidiaries: First Vermont Bank and Trust Company in Brattleboro; Franklin Lamoille Bank in St Albans; Granite Savings Bank in Barre; The Howard Bank, NA, in Burlington; Woodstock National Bank in Woodstock; Vermont Mortgage Group in Brattleboro; and the North American Bank of Farmington, NH, which was bought last spring for $20.6 million.

Imagine the expense of Banknorth's Williston operations center and all the corporate employees of Banknorth, as well as the presidents and the staff of each subsidiary, just wiped off the books, how much would that save a year? Plus, it would provide statewide coverage immediately.

Merchants at this point would not be available nor would it be a reasonable option in the future, according to Boutin, because of the changes it is going through now and because it does not have the overhead of the other large banks. The regional banks also are looking for strong banks, which the Merchants is not right now. It is the only bank in the state currently engaged in a written agreement with the Fed.

There is precedent nearby. In Glens Falls, NY, the troubled Evergreen Bank also recently came under regulatory oversight. It, too, changed its president instead of selling and is no longer under the requirements of a written agreement.

The Vermont banks also have been active. Besides Banknorth's acquisition, Chittenden Corp last summer bought the Bank of Western Massachusetts in Springfield for $25.5 million. Vermont National bought United Savings Bank in Greenfield, MA.

"There will be more consolidation in New England and Vermont in the future, but it's not in the cards here for several years," Dudley Davis said.

There are 26 banks currently operating in Vermont. Local consolidation is also a possibility as the larger banks in the state look at their own economies of scale.

Still, Boutin does not buy the logic of regional banks coming in and making a go of it.

He explained it this way: "There's no one yet that's been able to prove to me that the bigger banks operate more efficiently than the smaller banks. It's just the opposite. The larger you get, the less efficient you become, the smaller you are, the more efficient you become. The reason why the insurance industry is SO Successful is that they've figured that out. Just run the main office and the independents run the local offices and buy services. So they don't have the cost of running a big branch system. And these big banks haven't figured that out and they're going to build big branch systems and it's going to cost them a lot of money. Also, they're going to have the teller report to a supervisor who reports to a branch manager who reports to a regional vice president who reports to a super-regional vice president. They'll be so many layers between the customer and the president, the president won't know what the customer wants. The General Motors of the banking industry. That'll happen."

Nor is it profitable, he said. The ROA for large banks never approaches 1 percent, which community banks achieve regularly, he said.

One bank analyst said that KeyCorp tries to "lowball" needy banks to make the purchase worthwhile for it. For instance at Evergreen, KeyCorp wanted to pay $18 per share, even though the book value was $15 per share and the capital ratio was 11 percent. In other words, he said, the bank was worth about $22 per share, and it did not sell.

THE LAST REAL BANK

One Burlington restaurateur echoes what many Vermont businesspeople have said for years, "Dudley's kept this place going." Everyone refers to him as Dudley. He conducted directors' meetings every Friday morning. You could find him on the street.

If it was, or still is, "The last real bank in America," as a Burlington financial analyst put it, The Merchants Bank almost wasn't as of earlier this year. KeyCorp and Vermont National looked at it and backed off. Neither would comment on what happened.

The typical scenario, the analysts agreed, is that a troubled bank has two ways to go to reassure the regulators, sell the bank to restore capital, or reorganize management. The Merchants, like the Evergreen Bank, looked to sell first, but eventually changed the person at the top. The question remains, as different as Joe Boutin and Dudley Davis are personally, will the character of the bank also change?

"Dudley Davis is a much different banker than I am," Boutin said. "I would like to think that I can emulate Dudley and I have emulated Dudley in some ways. The way I manage relationships I hope is the same way Dudley manages relationships. Very close contact with customers."

Here are two other stories about Dudley Davis, more recent than the one about Ben & Jerry, which happened when they were still personally scooping ice cream at the old garage: Dudley was yelling at a long-time commercial loan customer so loudly one day that everyone on the top floor came out of their offices wondering what had happened. Or this bit of gamesmanship which eventually cost the Merchants a very good customer: Dudley was working on a large loan for a potential customer, but despite repeated attempts by the customer to get Dudley to tell him what the interest rate was, Dudley didn't return the calls, even though the closing was set for a Friday and the deal had to be done by the following Monday. Dudley didn't let him know, presumably to get a higher rate because the guy would be backed into a corner with the deadline. So, the customer blew off the closing. Dudley, finally, called him to ask him why he wasn't at the closing, and the customer told Dudley he was getting another banker. He and a second banker worked all weekend, closed on Monday and made the deadline.

Dudley Davis by every account is a giant on the Vermont business scene. Unlike some of the other highly respected Burlington businessmen, like Luther Fred Hackett of Hackett, Valine & MacDonald in Burlington, or Raymond Pecor of Lake Champlain Transportation, or Antonio Pomerleau of the Pomerleau financial group, Dudley stayed out of politics, baseball and interacting with the rich and famous. His life, everyone said, is the bank.

"He manages and has managed over 800 accounts, $180 million in commitments to people. We're now transitioning all of those over to other people," Boutin said.

The banking analysts all said that the standard for a bank president is to lead, not to manage a loan portfolio. Though Davis will continue to be the Chairman of the Board of Directors, Boutin said he will have full responsibility as CEO and that Davis will transfer his entire loan portfolio to other loan officers over the next three months. Nor will Boutin manage a personal loan portfolio.

However, he added, "I think it's important in a community bank for the people on the line to have some account relationships, and at the Howard I filled the role of being active with the accounts, but not actually managing the accounts. I will continue here to be active with a big part of the portfolio."

Again, the regulators refused further comment on the Written Agreement, but the agreement not only talks about "qualifications and performance" of senior executive officers, but also addresses "the appropriateness of Merchants' organizational structure in relationship to each senior executive officer's function."

"In the old environment." Boutin said, "Dudley had no problem carrying that workload. I remember in Rutland having over 400 accounts. But, it's a little different today because of the documentation requirements that the regulators require you to do. You just can't do it. If we had someone here with 150 accounts, they start reaching the maximum in their ability to properly document those, to meet today's standards. Everything Dudley has is in his head. He has an enormous memory. He's incredible. If I need any kind of information, I pick up the phone and call up and he gives it to me. He doesn't have to look anywhere, he just says this is what happened, this is when it happened, this is why it happened. Thank you. Now we have to take that memory bank and reduce it to hard copy, and that's what we're going to be doing over the next three to four months."

"Dudley Davis is an old-fashioned character lender," Jeffrey Cohn said.

It is that "character lending" that defined Dudley Davis and The Merchants Bank as The Last Real Bank in America.

"That's a little romanticized, perhaps," said Patrick Robins. "If it was the last real bank in America, it hasn't been in the last year-and-a-half."

Robins said the federal regulators have changed the rules and the process is more scripted today.

"You can't approve loans the way you used to," Robins said.

"Personality isn't gone," Jeff Davis said, "but you can't lend on just character anymore. But personality is still a big part of it and that's why Joe is a good selection."

Boutin said: "People do business because of a relationship they establish with a banker, that's been the one constant over the last 25 years."

As far as The Merchants Bank and character lending is concerned, he said his job is to preserve the sense that it is still the Last Real Bank in America, that it is a small business lender, an entrepreneurial lender, community involved, and still meets regulatory requirements.

"We are going to try to preserve that character of the bank, and that character is the character lending," Boutin said. "It would be a mistake for me to change the bank's direction. I just want to enhance it. I want to take what we do and find a way to do it even better than the way it was done in the past, and meet regulatory constraints."

"The problems in this bank have not come in their consumer loan portfolio, their mortgage portfolio, their small business portfolio, it came primarily in one area: commercial real estate development portfolio. To Dudley's credit, he helped a lot of people build a good part of this state, we provided them with capital, it's just that we should have seen the lull coming, and we didn't, and that's the mistake that was made. Had we been able to, we would have started slowing down the projects. We would've done fewer projects. But that's hindsight."

As far as the problems that led to the bank's problems and regulatory oversight, Boutin said, "I think there's only one that you could really identify." And that is the purchase of the New First National Bank.

"That bank had significant asset quality problems. So significant that it failed. We purchased that bank at, I think, a very attractive price for the regulator, a fair price, but nonetheless, it was attractive. We were the highest bidder, and there wasn't anybody who was close to us, so there was some room there. That really took a lot of our resources. At the same time, the Burlington economy had not recovered to the extent that the directors and Dudley thought it would, and they had to address some problem loans here. When you add those two things together, problem loans in the eastern part of the state, problem loans here, it became a very big number and the regulators finally said to the board, "You've got to recognize your losses in those portfolios."

So, they decided to do it all at once. By doing that, it reduced their capital to just where it was meeting regulatory minimum standards. It was a prudent decision to make, but it forced the bank into a very precarious position. Capita] in our industry is king. We tell our customers that, you always need more capital. Clearly for us, after doing that, we needed more capital. And so we're exploring. Can we earn that capital from our good loans? Should we go out and raise more capital? And we're exploring that right now. But that is the crux of the issue, that is the financial issue."

He explained how that could be accomplished, "First thing you could do is called a Rights Offering. We could go to the market and say to the shareholders that already are out there, you have an opportunity to buy an equal amount of shares as you have now at a discounted price, so there's no delusion, everybody buys a discounted amount, or if they don't we sell that discounted amount to someone else. That's probably the easiest way. There's subordinated debt, there's preferred stock, there's issuing just regular capital stock, there are a number of options. Would it be harder for The Merchants Bank to be able to do that today? Maybe, maybe not. This bank's had a long history of good, solid earnings. So you've got one bad year, and if we can recover and establish a pattern of earnings, I think we can very easily raise the capital."

Not that you can now simply go out and buy shares of Merchants Bancshares. Boutin described the bank as "quasi-public," and Jeffrey Cohn said, "It's a stock that practically trades by appointment."

The other banks in Vermont worked out of their problems during the recession. Banknorth and Vermont National are back over the magic 1 percent ROA for the first time since 1989. Merchants' ROA right now is about .45 percent. Boutin said he hopes to be back over the magic number within two years.

"First Vermont, Vermont National, Chittenden, Bank of Vermont addressed those problems in the late '80s early '90s. And took some very aggressive positions. This bank's philosophy was, Let's work with the borrower, give him enough time, the economy will recover and we'll be able to buy our way out of it with an improved economy. As you can see, the economy just keeps delaying in its recovery. Finally the bank had to bite the bullet and say, "No more. We've been patient, we've helped you out." The problem is a lot of those borrowers aren't that happy with us because they always had the impression that we were going to stay with them forever. Well, the regulators will not let you refrigerate loans forever, you've eventually got to do something. And so the bank started that and I'm just following through on that."

Cohn said, "Restructured loans don't look good to me. Maybe they look good in the community, because it shows the bank will stick with the lender longer."

Like the "still accruing" loans, restructured loans ballooned in the early 1990s, going from zero in 1990 to $5.7 million in 1991.

For the Merchants, he said, "This is a good time for us to work out of our problems, we wouldn't want to try and work out of our problems with our economy smoking, because then we wouldn't be responding to the needs. This will give us time. Our regular customers shouldn't even notice the difference, it should be transparent to them. One of the things that has impressed me about this franchise is the strength of the franchise. The loyalty of the customers. The breadth of product. And the people that are out there servicing customers. It's amazing to me. Dudley built a culture of service. And people know it in this organization better than any other place I've ever seen. They're really focused on taking care of customers."

It also could be a good time for Joe Boutin. The banking analysts said typically the new president of a troubled situation is in a no-lose situation. In the worst case scenario, the banks fails, but he won't lose anything, nor is it his fault. If it succeeds and does well, typically the new president will make a lot of money. Typical of Joe Boutin's character, he is taking a more conservative approach.

"When I came to the bank," Boutin said, "they let me pick my compensation. And I basically told them that I did not want to be paid anywhere near what they paid the former president, one, and, two, I wanted my compensation to be long-term based on the performance of the company. So, what I've asked for and what they're negotiating are options to be able to buy stock at a price, like today's price, if I could buy it two years from now at today's price in an approved stock option plan, then I benefit from the hard work I do in building the value of that stock, so I'm less concerned about current dollars.

Most of my family's educated. To have current income is not as important as to be able to have ownership of the bank. So, my incentive package is oriented that way."

And he will have to work hard. The bank's capital and earnings problems are not its only problems. Paying dividends will have to wait for the capital picture to brighten, he said.

What will not wait is a class action lawsuit filed by an investor who lost money at the Merchants Trust Company last winter. Dorothy Kennedy, 78, lost a total of $125,000 in a derivative fund the Merchants invested in for her. The fund lost money, and the account was withdrawn, then the account was reinvested and the fund lost more money.

"Let me just tell you what I can tell you," Boutin said. "First thing is, the lawsuit says that we churned the portfolio for the benefit of the bank because we made more fees. That is entirely inaccurate and we are preparing to go back to the courts to ask that to be removed and to sanction the attorney. We don't make money on churning. The trades don't accrue to our benefit. Where we make money is how much we manage. The better job we manage, the bigger that grows the bigger our fee becomes based on the size. Conversely, if we do a poor job of managing, the fee goes down because the asset value goes down. This product that we invested in is the Piper-Jaffrey Mutual Fund. Piper-Jaffrey is a renowned mutual fund company, they have a wonderful reputation. This fund that they created back in 1988, for five years out-performed its peers. From '88 to '93, it did a wonderful job, primarily in fixed-income US government obligations, and that's what we're still into. Whether it's in direct treasury or it's some other CMO, collateralized mortgage obligation of Ginnie Mae, Fannie Mae, Freddie Mac, that's all that's in that fund. Interest rates went up. Whenever interest rates go up, the performance of a fixed-income fund goes down. The customer doesn't see any difference in terms of income, what they see is the value go down in some relationship to the rise in interest rates. So this has produced a gap at this particular point. Some of the product that was invested here are mortgage derivative products. For instance, you come in and you borrow money from the Vermont Federal Bank for a home mortgage. They take that mortgage and sell it into the market. Ginnie Mae, Fannie Mae or Freddie Mac buys that mortgage, they take it and split it into a lot of pieces. For instance, they'll take the principal part and move it into one pool, they'll take the interest that the bank expects to earn over that, they'll put it into another one, then they sell those out to these funds. This fund bought some interest strips, or inverse floaters, that behaved the opposite way that interest rates behave. Interest rates went up and these inverse floaters have gone down in value. Now the question is, should we have made that investment for our customers? I'm investigating that. I don't have a good answer for that, but we're looking at that. One thing I do know is that this trust company under its former leadership and its present leadership has had a great reputation. It does a very good job servicing its customers. So, we're taking this lawsuit very seriously, just because we don't want it to damage the reputation of this organization. This lawsuit was filed by one person and they call it a class-action lawsuit. That's a little bit unfair. They start talking about churning and malfeasance, and to this point I have not seen anything that would support the accusations made within this lawsuit, but when they start doing it to a bank that relies on trust and performance, so far our performance has been unquestioned and our trust has been unquestioned. That's a significant blow. This is priority number one for me."

The bank also is embroiled in a high-profile, $7 million foreclosure case involving Joseph Senesac, the developer of Staples Plaza at Exit 12 on Interstate 89.

"It's all said and done from the standpoint that there's still some more property needed to be rented there, that needs to be fitted up," Boutin said. "There's cash flowing and it's generating profits each month, so it's paying our debt down, but it's still unresolved. The owner of that, Moe Senesac, has sued the bank and I can't comment any further. We're negotiating with him on that suit. I don't know what will become of that."

Another concern is the number of Merchants' offices. Banknorth has 40 branches in Vermont, Vermont National has 31, and Merchants has 39.

"I think we're going to look at our branch structure to see where the appropriate markets are for us," Boutin said. 'We service a lot of communities that if we left those communities, there'd be no other bank. Hinesburg is a good example. So, there's a reluctance on my part to make any major change in our branch structure, what we may find a way to do is to control the cost of generating deposits and loans in those branches or finding a way of generating more business. I think a lot of business drives past our door in those small, remote communities to another location because we may not be managing that presence in those markets very well."

And the regulators have an open-ended agreement.

Dudley Davis said, "Things are going smoothly. No official termination date has been established, but we have an implied termination date of summer 1995."

Patrick Robins noted that the regulators never paid much attention to the Merchants, and perhaps they should have, as a matter of course.

"We have that reporting requirement to the feds," Boutin said, "it's in written form and we have to comply with it, but it's nothing I would consider to be out of the ordinary. As a matter of fact, most of the things that we are doing are things that I did in my former life at the Howard. So, it's pretty easy for me. This bank, though, didn't operate that way. And, quite frankly, the regulators didn't push it because it was such a high earning bank. But having depleted their capital to pay for their problems, they had to look at this bank differently."

Timothy McQuiston is editor of Vermont Business Magazine. Willow Older contributed to this report.

Vermont Business Magazine Nov 1994