| MERRILL MERCHANTS BANCSHARES INC ITEM 1A RISK FACTORS Our loan portfolio includes loans with a higher risk of loss |
| We originate commercial mortgage loans, commercial loans, consumer loans, and residential mortgage loans primarily within our market area |
| Commercial mortgage, commercial, and consumer loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate |
| In addition, commercial real estate and commercial business loans may also involve relatively large loan balances to individual borrowers or groups of borrowers |
| These loans also have greater credit risk than residential real estate for the following reasons: · Commercial Mortgage Loans |
| Repayment is dependent upon income being generated in amounts sufficient to cover operating expenses and debt service |
| · Commercial Loans |
| Repayment is generally dependent upon the successful operation of the borrower’s business |
| · Consumer Loans |
| Consumer loans (such as personal lines of credit) may or may not be collateralized with assets that provide an adequate source of payment of the loan due to depreciation, damage, or loss |
| Any downturn in the real estate market or local economy could adversely affect the value of the properties securing the loans or revenues from the borrower’s business thereby increasing the risk of non-performing loans |
| At this time, however, there is no downturn in the local economy or real estate market and we are not aware of any adverse effects in property values or business declines as a result of the local economy |
| If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease |
| Our loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance |
| We therefore may experience significant loan losses, which could have a material adverse effect on our operating results |
| Material additions to our allowance for loan losses also would materially decrease our net income, and the charge-off of loans may cause us to increase the allowance |
| We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans |
| We rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses |
| If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance |
| Changes in interest rates could adversely affect our results of operations and financial condition |
| Our profitability, like that of most financial institutions, depends substantially on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities |
| Increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans |
| In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits, which will result in a decrease of our net interest income |
| We also are subject to reinvestment risk associated with changes in interest rates |
| Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities as borrowers refinance to reduce borrowing costs |
| Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities |
| -14- _________________________________________________________________ [62]Back to Table of Contents Our earnings may be adversely impacted by a decrease in interest rates because a portion of our interest-earning assets are variable rate loans indexed to prime rate that will reprice as short-term interest rates decrease while a portion of our interest-bearing liabilities are expected to remain at fixed interest rates |
| Therefore, in a declining interest rate environment, our yield earned on our loan portfolio is expected to decrease more rapidly than our cost of funds |
| A declining rate environment is expected to cause a narrowing of our net interest rate spread and a decrease in our net interest income |
| Our local economy may affect our future growth possibilities |
| Our current market area is principally located in Greater Bangor |
| Our future growth opportunities depend on the growth and stability of our regional economy and our ability to expand our market area |
| A downturn in our local economy may limit funds available for deposit and may negatively affect our borrowers’ ability to repay their loans on a timely basis, both of which could have an impact on our profitability |
| We depend on our executive officers and key personnel to continue the implementation of our long-term business strategy and could be harmed by the loss of their services |
| We believe that our continued growth and future success will depend in large part upon the skills of our management team |
| The competition for qualified personnel in the financial services industry is intense, and the loss of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business |
| We cannot assure you that we will be able to retain our existing key personnel or attract additional qualified personnel |
| Although we have employment agreements with our Chairman and Chief Executive Officer, President and Executive Vice President and Treasurer that each contains a non-compete provision, the loss of the services of one or more of our executive officers and key personnel could impair our ability to continue to develop our business strategy |
| We operate in a highly regulated environment, and changes in laws and regulations to which we are subject may adversely affect our results of operations |
| We are subject to extensive regulation, supervision and examination by the Maine Bureau of Financial Institutions (the “Bureau”), as our chartering authority, and by the Federal Deposit Insurance Corporation (the “FDIC”) as the insurer of our deposits up to certain limits |
| In addition, the Federal Reserve Board (the “FRB”) regulates and oversees the Company, as the holding company of the Bank |
| We also belong to the Federal Home Loan Bank System and, as a member of such system, we are subject to certain limited regulations promulgated by the Federal Home Loan Bank of Boston |
| This regulation and supervision limits the activities in which we may engage |
| The purpose of regulation and supervision is primarily to protect our depositors and borrowers and, in the case of FDIC regulation, the FDIC’s insurance fund |
| Regulatory authorities have extensive discretion in the exercise of their supervisory and enforcement powers |
| They may, among other things, impose restrictions on the operation of a banking institution, the classification of assets by such institution and such institution’s allowance for loan losses |
| Regulatory and law enforcement authorities also have wide discretion and extensive enforcement powers under various consumer protection and civil rights laws, including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act, and the Real Estate Settlement Procedures Act |
| Any change in the laws or regulations applicable to us, or in banking regulators’ supervisory policies or examination procedures, whether by the Bureau, the FDIC, the FRB, other state or federal regulators, the United States Congress or the Maine legislature could have a material adverse effect on our business, financial condition, results of operations and cash flows |
| Competition in our primary market area may reduce our ability to attract and retain deposits and originate loans |
| We operate in a competitive market for both attracting deposits, which is our primary source of funds, and originating loans |
| Historically, our most direct competition for savings deposits has come from credit unions, community banks, large commercial banks and thrift institutions in our primary market area |
| Particularly in times of extremely low or extremely high interest rates, we have faced additional significant competition for investors’ funds from brokerage firms and other firms’ short-term money market securities and corporate and government securities |
| Our competition for loans comes principally from mortgage brokers, commercial banks, other thrift institutions, and insurance companies |
| Such competition for the origination of loans may limit our future growth and earnings prospects |
| Competition for loan originations and deposits may limit our future growth and earnings prospects |
| -15- _________________________________________________________________ [63]Back to Table of Contents If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in our financial reporting, which could adversely affect our business, the trading price of our stock and our ability to attract additional deposits |
| Beginning with our annual report for the fiscal year ending December 31, 2007, we will have to include in our annual reports filed with the Securities and Exchange Commission (the “SEC”) a report of our management regarding internal control over financial reporting |
| As a result, we recently have begun to document and evaluate our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and SEC rules and regulations, which require an annual management report on our internal control over financial reporting, including, among other matters, management’s assessment of the effectiveness of internal control over financial reporting and an attestation report by our independent auditors addressing these assessments |
| Accordingly, management has retained outside consultants to assist us in (i) assessing and documenting the adequacy of our internal control over financial reporting, (ii) improving control processes, where appropriate, and (iii) verifying through testing that controls are functioning as documented |
| If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential stockholders and depositors could lose confidence in our financial reporting, which could adversely affect our business, financial condition and results of operations, the trading price of our stock and our ability to attract additional deposits |
| Our charter and bylaws may prevent a transaction you may favor or limit our growth opportunities, which could cause the market price of our common stock to decline |
| Certain provisions of our charter and bylaws and applicable provisions of Maine and federal law and regulations may delay, inhibit or prevent an organization or person from gaining control of the Company though a tender offer, business combination, proxy context or some other method, even though you might be in favor of the transaction |
| We may not be able to pay dividends in the future in accordance with past practice |
| We pay a quarterly dividend to stockholders |
| However, we are dependent primarily upon the Bank for our earnings and funds to pay dividends on our common stock |
| The payment of dividends also is subject to legal and regulatory restrictions |
| Any payment of dividends in the future will depend, in large part, on the Bank’s earnings, capital requirements, financial condition and other factors considered relevant by our Board of Directors |