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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2002

OR

Commission file number 0-12638

F&M BANCORP
(Exact name of registrant as specified in its charter)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý    No o

        At February 7, 2003, the aggregate market value of 10,293,200 shares of Common Stock outstanding and held by non-affiliates of Registrant was $307,252,020.

FORM 10-K CROSS-REFERENCE INDEX

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Part I

Item 1. Business

General

        F&M Bancorp ("Bancorp") is a diversified financial services company headquartered in Frederick, Maryland that is organized under the laws of the State of Maryland and registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (BHC Act). Based on assets at December 31, 2002, it was the fourth largest bank holding company headquartered in Maryland. In this report, F&M Bancorp and Subsidiaries (consolidated) is referred to as the Bancorp and F&M Bancorp alone is referred to as the Parent. The Bancorp derives substantially all of its income from operation of its wholly owned subsidiary, Farmers & Mechanics Bank ("the Bank").

        The Parent's subsidiary engages in banking and a variety of related financial services businesses. Retail banking, commercial banking, mortgage banking, and trust and investment management services are provided through the Bank primarily in Maryland. Commercial and consumer insurance services are provided by the Bank's insurance agencies, Keller Stonebraker Insurance, Inc. and Potomac Basin Group Associates, Inc., primarily in Maryland, Washington D.C., and West Virginia. The Bank, through a strategic alliance with Raymond James Financial Services, provides securities brokerage services.

        On December 31, 2002, the Bancorp had consolidated assets of $2.095 billion, total loans of $1.305 billion, total deposits of $1.595 billion, and total shareholders' equity of $184 million. The principal executive offices of Bancorp are located at 110 Thomas Johnson Drive, Frederick, Maryland 21702 and its telephone number is (888) 694-4170. The Bancorp had 708 full-time equivalent team members at December 31, 2002.

        On March 13, 2003 the Bancorp announced plans to be acquired by Mercantile Bankshares Corporation (Mercantile), with assets in excess of $10 billion, is a multi bank holding company headquartered in Baltimore Maryland. It has 16 banking affiliates in Maryland, one banking affiliate in Delaware and three in Virginia. The merger, which is subject to regulatory and F&M Bancorp Shareholder approval, is expected to be completed by the end of 2003.

        The aggregate amount of consideration that Mercantile will pay in the merger has been fixed at approximately $123.5 million is cash and approximately 10.3 million shares of its common stock. These fixed pools of consideration were determined based on: (i) an aggregate of 10,740,357 shares of F&M Bancorp common stock outstanding as of the date of the merger agreement, (ii) an agreed upon purchase price of $46 per share, (iii) an exchange ratio of 1.2831 based on an agreed upon value of the Mercantile common stock of $35.85 (the average of the closing sales price on the NASDAQ National Market System during the ten consecutive trading-day period ended on the day prior to the date of the Merger agreement), and (iv) an agreement to fix 75% of such aggregate consideration in the form Mercantile common stock and 25% in cash. These pools would increase only in the event of the exercise of outstanding options to purchase shares of F&M Bancorp common stock between March 13, 2003 and the effective time of the merger. If all of such outstanding options were exercised, the aggregate amount of consideration payable in the merger would increase to approximately $130.7 million and approximately 10.9 million shares.

        Under the terms of the merger agreement, each share of F&M Bancorp common stock will be converted to either (i) an amount in cash or (ii) an equivalent value of shares in Mercantile common stock. The value of the cash or Mercantile common stock the an F&M Bancorp shareholder will receive for each share of F&M Bancorp common stock owned by it will be determined as of the ten consecutive trading-day period ending on the third calendar day immediately prior to the effective time of the merger, in accordance with a formula (including to calculation of a new exchange ratio) based

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on the average of the closing sales price of the Mercantile common stock on the NASDAQ National Market System during such ten day period. Thus, while the value of the cash or Mercantile common stock that an F&M Bancorp shareholder will receive for each share of F&M Bancorp common stock owned by it will be equal as of the calculation date, such value may be more or less than $46 per share depending upon whether or not the average closing price of the Mercantile common stock during such ten day period is more of less than $35.85.

        Each F&M Bancorp shareholder may elect to receive all cash, all Mercantile common stock, or any mixture of Mercantile common stock and cash in exchange for the total number of shares of F&M Bancorp common stock held by such stockholder. The Fixed pools of cash and stock consideration will be allocated among the F&M Bancorp stockholders in accordance with their individual election; provided, however, that to the extent there is an oversubscription for either the cash or the stock pool, the stockholders electing the oversubscribed consideration will be reduced on a pro rata basis as to the amount of such oversubscribed consideration they will be entitled to receive, and will receive an amount of the pool of consideration equivalent in value to the amount of such pro reduction.

        On November 20, 2001, Bancorp through the Bank, sold assets and liabilities associated with the Fairfield and Gettysburg, Pennsylvania branch offices to Adams County National Bank. Under the terms of the agreement, Adams County National Bank assumed responsibility for services related to checking, savings, and certificates of deposit products totaling $24.5 million and purchased the branch office and real estate located at 20 East Main Street, Fairfield, PA. Adams County National Bank also assumed the lease for the Middle St. office in Gettysburg. In connection with this transaction, the Bancorp paid cash in the aggregate amount of $23.3 million.

        On July 16, 2001, Bancorp dissolved Home Appraisals, Inc. and Founders Mortgage Co. Both businesses were acquired in previous acquisitions. The Bank has assumed the services rendered by these companies.

        On June 1, 2001, Bancorp completed the consolidation of its two banking subsidiaries into one state banking charter. Home Federal Savings Bank began operating as a division of Farmers & Mechanics Bank. The consolidation of F&M Bancorp's two banking subsidiaries into a single state-chartered institution will provide enhanced operating efficiencies for the company.

        On May 10, 2001, Bancorp consolidated two insurance affiliates into Keller Stonebraker Insurance, Inc. ("KS"), Hagerstown, MD, (Charles S. Gardner Insurance Agency, Inc. and JRH Insurance, Inc). KS operates as an independent, wholly owned subsidiary of the Bank and provides a full line of consumer and commercial business insurance products through offices in Hagerstown and Cumberland, MD and Keyser, WV. Consumer insurance products include annuities, homeowners, automobile, life and personal umbrellas. Commercial business products include property and casualty packages, workers' compensation, bonds, professional liability, umbrella, and 401(K) and other benefit plans.

        On May 10, 2001, Bancorp consolidated C&F Insurance Agency into Potomac Basin Group Associates, Inc. ("PB"), Beltsville, MD., PB operates as an independent, wholly owned subsidiary of the Bank and is an independent insurance agency specializing in corporate employee benefit plans through its offices in Beltsville and Ellicott City, MD.

        On April 26, 2001, Bancorp dissolved TBT Title VIII, Inc., Central Maryland Service Corp., CLC Associates, Inc. Family Home Insurance Agency, Inc. and Keystone General Partnership. These businesses were inactive companies that were acquired in previous acquisitions. The Bank and its affiliates have assumed any services rendered by these companies.

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History and Growth

F&M Bancorp

        F&M Bancorp was formed as a bank holding company in 1983 to provide the flexibility to expand its markets through multiple bank subsidiaries across different geographic areas. The Bancorp expands its business, in part, by acquiring banking institutions and other companies engaged in activities that are financial in nature. The Bancorp continues to explore opportunities to acquire banking institutions and other financial services companies. Discussions are periodically carried on related to possible acquisitions. The Bancorp cannot predict whether, or on what terms, such discussions will result in future acquisitions. As a matter of policy, the Bancorp generally does not comment on such discussions or possible acquisitions until a definitive acquisition agreement has been signed.

Farmers & Mechanics Bank

        Farmers & Mechanics Bank was incorporated in 1865 as a national banking association under the laws of the United States, and is the successor to Maryland state chartered banking institutions dating from 1817. In 1915, the Bank acquired trust powers. Effective April 1, 2001, Farmers & Mechanics Bank commenced operations as a Maryland state-chartered bank. Effective June 1, 2001, Home Federal Savings Bank began operating as a division of Farmers & Mechanics Bank. The Bank, the deposits of which are insured by the Federal Deposit Insurance Corporation, conducts general banking and trust company business through 48 full-service offices and 81 automated teller machines located in Frederick, Carroll, Montgomery, Baltimore, Howard, Washington and Allegany counties, in Maryland. The Bank also operates the East Coast's first full-service mobile unit, Express Bank, and delivers electronic services throughout its market with personal and business PC internet banking access and with its 24-hour telephone banking service, ExpressLine.

Competition

        The financial services industry is highly competitive. The Bancorp's subsidiaries compete with financial services providers, such as banks, savings and loan associations, credit unions, finance companies, mortgage banking companies, insurance companies and money market and mutual fund companies. They also face increased competition from nonbank institutions such as brokerage houses and insurance companies, as well as from financial services subsidiaries of commercial and manufacturing companies. Many of these competitors enjoy the benefits of fewer regulatory constraints and some have lower cost structures.

        Securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. Acquisitions of this type could significantly change the competitive environment in which the Bancorp operates. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.

        Bancorp competes successfully in its marketplace by effectively focusing its business energy and resources on meeting the specific needs of its customers with a level of sales, service and support intended to foster long-term relationships. Additionally, Bancorp has been able to expand its presence throughout the Maryland market to better serve clients who demand a statewide presence.

Regulation and Supervision

        The following discussion, together with Notes 3 (Cash, Loan and Dividend Restrictions) and Note 19 (Risk-Based Capital) to Financial Statements, sets forth the material elements of the regulatory framework applicable to bank holding companies and their subsidiaries and provides certain

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information specific to the Bancorp. This regulatory framework is intended to protect depositors, federal deposit insurance funds and the banking system as a whole, and not to protect security holders. To the extent that the information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Further, such statutes, regulations and policies are continually under review by Congress, state legislatures, and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Bancorp, including changes in interpretation or implementation thereof, could have a material effect on the Bancorp's business.

        Applicable laws and regulations could restrict the Bancorp's ability to diversify into other areas of financial services, acquire depository institutions, and pay dividends on the Bancorp's capital stock. They could also require the Bancorp to provide financial support to one or more of its subsidiaries, maintain capital balances in excess of those desired by management, and pay higher deposit insurance premiums as a result of general deterioration in the financial condition of depository institutions.

General

Parent Bank Holding Company

        As a bank holding company, the Bancorp is subject to regulation under the BHC Act and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (FRB).

Subsidiary Bank

        The Bank is subject to supervision and regulation by the State of Maryland, the FRB, and the Federal Deposit Insurance Corporation ("FDIC") as of December 31, 2002. On December 14, 2000 the Bank made application with the Maryland State Commissioner of Financial Regulation to become a state-chartered Bank. Approval from the Commissioner occurred and was effective April 1, 2001. This made the Bank subject to supervision by the State of Maryland with the FRB serving as the primary regulator.

Nonbank Subsidiaries

        The Bank's insurance subsidiaries are subject to regulation by Maryland's state insurance regulatory agency. The Bank's brokerage activities are regulated by the Securities and Exchange Commission (SEC), the National Association of Securities Dealers, Inc. and state securities regulators.

Parent Bank Holding Company Activities

        The BHC Act restricts the business activities and acquisitions that may be engaged in or made by Bancorp. Bancorp is generally prohibited from acquiring direct or indirect ownership or control of more than 5% of any class of the voting shares of any company which is not a bank, bank holding company or savings association and from engaging in any business other than that of banking or of managing or controlling banks, or of furnishing services to, or performing services for, its affiliated banks. The Act and regulations thereunder require prior approval of the FRB of the acquisition by Bancorp of more than 5% of any class of the voting shares of any additional bank, bank holding company or savings association. After prior approval or notice, Bancorp may acquire other banks, bank holding companies and savings associations and engage directly or indirectly in certain activities closely related to banking. Bancorp must give prior notice of certain purchases or redemptions of its outstanding equity securities. Bancorp and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease, sale of property, or furnishing of services.

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        The FRB may issue cease and desist orders against bank holding companies and nonbank subsidiaries to stop actions believed to present a serious threat to the Bank. The FRB also regulates certain debt obligations of bank holding companies.

Bank Regulations

        The Bank is subject to supervision and regulation by the State of Maryland, the FRB, and the Federal Deposit Insurance Corporation ("FDIC") as of December 31, 2002. On December 14, 2000 the Bank made application with the Maryland State Commissioner of Financial Regulation to become a state-chartered Bank. Approval from the Commissioner occurred and was effective April 1, 2001. This made the Bank subject to supervision by the State of Maryland with the FRB serving as the primary regulator. Deposits, reserves, investments, loans, consumer law compliance, issuance of securities, payment of dividends, establishment of branches, mergers and consolidations, changes in control, electronic funds transfers, responsiveness to community needs, management practices, compensation policies and other aspects of operations are subject to regulation by the appropriate Federal supervisory authorities and the applicable banking laws of the State of Maryland. The Bank may establish branch-banking offices and engage in certain corporate activities without geographic limitation in the state of Maryland without prior approval. Mergers of the Bank with any other bank would require approval of, and involve review by, various governmental agencies.

        Some of the aspects of the lending and deposit business of the Bank which are subject to regulation by the FRB or the FDIC include disclosure requirements in connection with personal or mortgage loans, interest on deposits and reserve requirements. In addition, the Bank is subject to numerous federal, state and local laws and regulations which set forth specific restrictions and procedural requirements with respect to extensions of credit (including to insiders), credit practices, disclosure of credit terms and discrimination in credit transactions.

        The Bank is subject to restrictions under federal law which limit the transfer of funds or other items of value from the Bank to the Parent and its nonbank subsidiaries (including affiliates) in so called "covered transactions." In general, covered transactions include loans and other extensions of credit, investments and asset purchases, as well as other transactions involving the transfer of value from the Bank to an affiliate or for the benefit of an affiliate. Unless an exemption applies, covered transactions by the Bank with a single affiliate are limited to 10% of the Bank's capital and surplus and, with respect to all covered transactions with affiliates in the aggregate, to 20% of the Bank's capital and surplus. A bank's transactions with its nonbank affiliates are also generally required to be on arm's length terms.

Source of Strength

        Under FRB policy, Bancorp is expected to act as a source of financial and managerial strength to each of its subsidiary banks and, under appropriate circumstances, to commit resources to support each such subsidiary bank. This support may be required at times when, absent of such FRB policy, Bancorp may not be inclined to provide it. Capital loans by the Parent to any of its subsidiary banks are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority in payment.

Depositor Preference

        The Federal Deposit Insurance Act (FDI Act) provides that, in the event of the "liquidation or other resolution" of an insured depository institution, the claims of depositors of the institution (including the claims of the FDIC as subrogee of insured depositors) and certain claims for

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administrative expenses of the FDIC as receiver will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, nondeposit creditors, including the Parent, with respect to any extensions of credit they have made to such insured depository institution.

Liability of Commonly Controlled Institutions

        The Bank is insured by the FDIC. FDIC-insured depository institutions can be held liable for any loss incurred by, or reasonably expected to be incurred, by the FDIC due to the default of an FDIC-insured depository institution controlled by the same bank holding company, and for any assistance provided by the FDIC to an FDIC-insured institution that is in danger of default and that is controlled by the same bank holding company. "Default" means generally the appointment of a conservator or receiver. "In danger of default" means generally the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. Liability for the losses of commonly controlled depository institutions can lead to the failure of some or all depository institutions in a holding company structure, if the remaining institutions are unable to pay the liability assessed by the FDIC. Any obligation or liability owed by a subsidiary bank to its parent company is subordinate to the subsidiary bank's cross-guarantee liability for losses of commonly controlled depository institutions.

Dividend Restrictions

        The Parent is a legal entity separate and distinct from its subsidiary bank and other subsidiaries. Its principal source of funds to pay dividends on its common stock is dividends from its subsidiaries. Various federal and state statutory provisions and regulations limit the amount of dividends the Parent's subsidiary bank and certain other subsidiaries may pay without regulatory approval. For information about the restrictions applicable to the Parent's subsidiary bank, see Note 3 (Cash, Loan and Dividend Restrictions) to Financial Statements.

        Federal bank regulatory agencies have the authority to prohibit the Parent's bank subsidiary from engaging in unsafe or unsound practices in conducting their businesses. The payment of dividends, depending on the financial condition of the bank, could be deemed an unsafe or unsound practice. The ability of the Parent's subsidiary bank to pay dividends in the future is currently, and could be further, influenced by bank regulatory policies and capital guidelines.

Capital Requirements

        The Parent is subject to risk-based capital requirements and guidelines imposed by the FRB, which are substantially similar to the capital requirements and guidelines imposed by the FRB on depository institutions under their jurisdiction. For information about these capital requirements and guidelines, see Note 19 (Risk-Based Capital) to Financial Statements.

        The FRB may set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Also, the FRB considers a "tangible Tier 1 leverage ratio" (deducting all intangibles) and other indications of capital strength in evaluating proposals for expansion or new activities.

        Capital adequacy guidelines also provide for consideration of interest rate risk in the overall determination of a bank's minimum capital requirement. The guidelines explicitly provide that a bank's exposure to declines in the economic value of its capital due to changes in interest rates is a factor to be considered in evaluating capital adequacy.

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        In December 2001, the Basel Committee on Banking Supervision updated the status of the revised draft Basel Capital Accord issued earlier in 2001. The Basel Committee continues to evaluate certain aspects of the draft Accord and expects to issue a new consultative package in the near future. The draft Basel Accord incorporates three pillars that address (a) minimum capital requirements, (b) supervisory review, which relates to an institution's capital adequacy and internal assessment process, and (c) market discipline, through effective disclosure to encourage safe and sound banking practices. Embodied within these pillars are aspects of risk assessment that relate to credit risk, interest rate risk, operational risk, among others, and certain proposed approaches by the Basel Committee to complete such assessments may be considered complex. The Bancorp continues to monitor the status of the Basel Accord, with required implementation of the new framework not anticipated prior to 2005.

        From time to time, the FRB and the Federal Financial Institutions Examination Council (FFIEC) propose changes and amendments to, and issue interpretations of, risk-based capital guidelines and related reporting instructions. Such proposals and interpretations could, if implemented in the future, affect the Bancorp's reported capital ratios and net risk-adjusted assets.

        As an additional means to identify problems in the financial management of depository institutions, the FDI Act requires federal bank regulatory agencies to establish certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator. The standards relate generally to operations and management, asset quality, interest rate exposure and executive compensation. The agencies are authorized to take action against institutions that fail to meet these standards.

        The FDI Act requires federal bank regulatory agencies to take "prompt corrective action" when a FDIC-insured institution does not meet minimum capital requirements. A depository institution's treatment for purposes of prompt corrective action provisions will depend upon how its capital level compares to various capital measures and certain other factors, as established by regulation.

Deposit Insurance Assessments

        Through the Bank Insurance Fund (BIF), the FDIC insures the deposits of the Parent's depository institution subsidiary up to prescribed limits for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution's capitalization risk category and supervisory subgroup category. An institution's capitalization risk category is based on the FDIC's determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution's supervisory subgroup category is based on the FDIC's assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required.

        The BIF assessment rate currently ranges from zero to 27 cents per $100 of domestic deposits. The BIF assessment rate for the Parent's depository institution is currently zero. The FDIC may increase or decrease the assessment rate schedule on a semiannual basis. An increase in the BIF assessment rate could have a material adverse effect on the Parent's earnings, depending on the amount of the increase. The FDIC is authorized to terminate a depository institution's deposit insurance upon a finding by the FDIC that the institution's financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound banking practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution's regulatory agency. The termination of deposit insurance for the Parent's subsidiary depository institution could have a material adverse effect on the Parent's earnings.

        All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds (commonly referred to as FICO

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bonds) were issued to capitalize the Federal Savings and Loan Insurance Corporation. FDIC-insured depository institutions paid approximately 1.8 cents per $100 of BIF-assessable deposits in 2002. The FDIC established the FICO assessment rate effective for the first quarter of 2003 at approximately 1.7 cents annually per $100 of BIF-assessable deposits.

Fiscal and Monetary Policies

        The Bancorp's business and earnings are affected significantly by the fiscal and monetary policies of the federal government and its agencies. The Bancorp is particularly affected by the policies of the FRB, which regulates the supply of money and credit in the United States. Among the instruments of monetary policy available to the FRB are (a) conducting open market operations in U.S. Government securities, (b) changing the discount rate of borrowings of depository institutions, (c) imposing or changing reserve requirements against depository institutions' deposits, and (d) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as interest rates charged on loans and paid on deposits. The policies of the FRB may have a material effect on the Bancorp's business, results of operations and financial condition.

Privacy Provisions of Gramm-Leach-Bliley Act

        Federal banking regulators, as required under Gramm-Leach-Bliley Act (the GLB Act), have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.

Future Legislation

        Various legislation, including proposals to change substantially the financial institution regulatory system, is from time to time introduced in Congress, in the states' legislatures, and before the various bank regulatory agencies. This legislation may change banking statutes and the operating environment of the Bancorp in substantial and unpredictable ways. If enacted, this legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Bancorp cannot predict whether any of this potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, would have on the Bancorp's business, results of operations or financial condition.

Item 2. Properties

        The following describes the location and general character of the principal offices and other materially important physical properties of Bancorp and its subsidiaries.

        The Bank owns a fee simple interest in its principal executive offices and main banking facility, totaling approximately 115,000 square feet, located at 110 Thomas Johnson Drive, Frederick, MD. The Bank also owns a fee simple interest in the principal executive office and main banking facility of its Home Federal division, with approximately 39,000 square feet, located at 122-128 West Washington Street, Hagerstown, MD. Keller Stonebraker leases approximately 8,000 square feet for its headquarters office located at 1120 Professional Court, Hagerstown, MD, from a partnership in which Keller Stonebraker's executive officers hold a 30% limited partnership interest. The Bancorp acquired in its

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merger with Monocacy Bancshares, Inc., a fee simple interest in the 43,500 square foot headquarters building of Taneytown Bank & Trust Company located at 222 East Baltimore Street, Taneytown, MD. Out of a total of 48 full-service branch offices of the Bank at December 31, 2002, 27 were owned and 21 were leased.

        For further information with respect to premises and equipment and commitments under noncancelable leases for premises and equipment, refer to Note 6 (Premises, Equipment and Lease Commitments) to Financial Statements.

Item 3. Legal Proceedings

In the normal course of business, the Bancorp is at all times subject to numerous pending and threatened legal actions, some for which the relief or damages sought are substantial. After reviewing pending and threatened actions with counsel, management believes that the outcome of such actions will not have a material adverse effect on the results of operations or shareholders' equity of the Bancorp. The Bancorp is not able to predict whether the outcome of such actions may or may not have a material adverse effect on results of operations in a particular future period as the timing and amount of any resolution of such actions and its relationship to the future results of operations are not known.

Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the fourth quarter of 2002.

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Part II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

        The principal market on which F&M Bancorp Common Stock is traded is The NASDAQ Stock Market. Stock price and dividend information is provided below. Shareholders received quarterly cash dividends totaling $12,374,000 in 2002 and $11,977,000 in 2001. Since 1997, dividends per share have risen at a compound annual growth rate of 7.8%.

        The ratio of dividends per share to basic earnings per share was 49.6% in 2002 compared to 56.5% for 2001. The Board of Directors establishes the dividend amount each quarter. In making its decision on dividends, the Board considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and other factors.

        Bancorp has a stock repurchase program that permits the purchase of up to 500,000 shares of its outstanding common stock. Repurchases are made in connection with shares expected to be issued under Bancorp's dividend reinvestment, stock option, and benefit plans, as well as for other corporate purposes. Shares repurchased under this program totaled 181,675 in 2002 and 178,400 in 2001.

Stock Price and Dividends

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Item 6. Selected Financial Data

Table 1:    Five-Year Summary of Selected Financial Data

(1)

The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).

(2)

Reflects the percentage relationship of cash dividends paid to basic earnings per share.

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Item 7. Management Discussion and Analysis of Financial Conditions and Results of Operations

Overview

        F&M Bancorp is the registered bank holding company for Farmers & Mechanics Bank (the "Bank"), headquartered in Frederick, Maryland. The Bancorp is a $2.1 billion diversified financial services company providing banking, insurance, wealth management, and mortgage banking through banking branches, the internet and other distribution channels to consumers and commercial businesses. The Bank operates 48 community offices in Frederick, Howard, Baltimore, Montgomery, Washington, Carroll and Alleghany Counties in Maryland, together with two insurance agencies. In this Annual Report, F&M Bancorp and Subsidiaries (consolidated) is referred to as the Bancorp and F&M Bancorp alone is referred to as the Parent.

        Certain amounts in the financial review for prior years have been reclassified to conform with the current financial statement presentation.

        Net income for 2002 reached a record $24.5 million, compared with $21.1 million in 2001. Diluted earnings per common share reached a record $2.25 per share, compared with $1.92 in 2001. The increases in net income and earnings per share were due to strong growth in business revenue and controlled expense growth.

        Return on average assets (ROA) was 1.27% and return on average equity (ROE) was 13.82% in 2002, compared with 1.18% and 12.65%, respectively, in 2001.

        Net interest income on a taxable-equivalent basis was $78.7 million in 2002, compared with $71.3 million a year ago. The Bancorp's net interest margin was 4.32% for 2002, compared with 4.22% in 2001.

        Noninterest income totaled $31.2 million in 2002, compared with $30.7 million in 2001. The growth in income was due to increases in mortgage banking income, insurance revenues and service charges on deposits.

        Revenue, the total of net interest income and noninterest income increased from $98.8 million to $106.9 million or 8%.

        Noninterest expense totaled $69.2 million in 2002, compared with $65.0 million in 2001, an increase of 6%. The increase was primarily due to an increase in salaries and incentive compensation resulting from team-based compensation and sales programs tied directly to the Bancorp's revenue and overall profitability performance. Expense growth also included the effect of additional advertising and promotions costs to support research projects in conjunction with ongoing strategic initiatives.

        The provision for credit losses was $1.3 million in 2002, compared with $3.7 million in 2001. During 2002, net charge-offs were $1.6 million, or .13% of average loans outstanding, compared with $3.0 million, or .25%, during 2001. Foreclosed assets were $414 thousand at December 31, 2002, compared with $638 thousand at December 31, 2001.

        At December 31, 2002, the ratio of shareholders' equity to total assets was 8.80%, compared with 8.90% at December 31, 2001. The Bancorp's total risk-based capital (RBC) ratio at December 31, 2002 was 12.67% and its Tier 1 RBC ratio was 11.74%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively for bank holding companies. The Bancorp's ratios at December 31, 2001 were 13.30% and 12.24%, respectively. The Bancorp's leverage ratio was 8.55% at December 31, 2002 and 8.71% at December 31, 2001, exceeding the minimum regulatory guideline of 4% for bank holding companies.

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Critical Accounting Policies

Reserve for Credit Losses

        The Bancorp has an established process to determine the adequacy of the allowance for credit losses which assesses the risk inherent in its portfolio. This process provides an allowance consisting of two components, allocated and unallocated. To arrive at the allocated component of the allowance, the Bancorp combines estimates of the allowance needed for loans analyzed individually (including impaired loans subject to Statement of Financial Accounting Standards No. 114 (SFAS No. 114), Accounting by Creditors for Impairment of a Loan) and loans analyzed on a pool basis.

        The determination of the allocated allowance for portfolios of larger commercial and commercial real estate loans involves a review of individual higher-risk transactions, focusing on the accuracy of loan grading, assessments of specific loss indicators, and in some cases, strategies for resolving problem credits. These considerations are supplemented by the application of loss factors delineated by individual loan grade to the existing distribution of risk exposures, which provides an assessment of inherent losses across the entire wholesale lending portfolio segment which respond to shifts in portfolio risk indicators. The loss factors used for this analysis have been derived from tracking historical loss experience by asset loan grade over a 5-year period. The loan loss allocations arrived at through this factor methodology are adjusted by management's judgement concerning the effect of recent economic events on portfolio performance.

        In the case of most homogeneous portfolios, such as consumer loans, residential mortgage loans, and some segments of small business lending, the determination of the allocated allowance is performed in the aggregate, or pooled, level. For such portfolios, the risk assessment process captures the net charge-offs experienced over the past year. The historic loss factors are then considered for either positive or negative adjustment by management to reflect the current risk inherent in the portfolios as of the date presented. These adjustments in the loss factors are tied to management's evaluation of a number of factors including: 1) changes in the trend of the volume and severity of past due, classified and non-accrual assets; 2) changes in the nature and volume of the portfolio; 3) changes in lending policies, underwriting standards, or collection practices; and 4) changes in the experience, ability, depth of lending management and staff.

        While coverage of one year's losses is often adequate (particularly for homogeneous pools of loans), the time period covered by the allowance may vary by portfolio, based on the Bancorp's best estimate of the inherent losses in the entire portfolio as of the evaluation date. To mitigate the imprecision inherent in most estimates of expected credit losses, the allocated component of the allowance is supplemented by an unallocated component. The unallocated component includes management's judgmental determination of the amounts necessary for concentrations, economic uncertainties and other subjective factors; correspondingly, the relationship of the unallocated component to the total allowance for credit losses may fluctuate from period to period. Although management has allocated a portion of the allowance to specific loan categories, the adequacy of the allowance must be considered in its entirety.

        The Bancorp's determination of the level of the allowance and, correspondingly, the provision for credit losses rests upon various judgements and assumptions, including general economic conditions, loan portfolio composition, prior loan loss experience and the Bancorp's ongoing examination process and that of its regulators. The Bancorp has an internal risk analysis and review staff that continuously reviews loan quality and reports the results of its examinations to the President and Chief Executive Officer, the Board of Directors and its Audit Committee. Such reviews also assist executive management in establishing the level of the allowance. The Bancorp is examined annually by the Federal Reserve Board and the State of Maryland, including specific segments of the loan portfolio.

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        The Bancorp considers the allowance for credit losses of $13.7 million adequate to cover losses inherent in loans, loan commitments and standby and other letters of credit at December 31, 2002.

Valuation of Mortgage Servicing Rights

        The Bancorp recognizes as assets the right to service mortgage loans for others that were retained upon sales of loan originations. For purposes of evaluating and measuring impairment of mortgage servicing rights, the Bancorp stratifies its portfolio on the basis of certain risk characteristics including loan type and note rate. Based upon current fair values, mortgage servicing rights are periodically assessed for impairment. Any such indicated impairment is recognized in income, during the period in which it occurs, in a mortgage servicing valuation account which is adjusted each subsequent period to reflect any increase or decrease in the indicated impairment. Mortgage servicing rights are amortized over the period of estimated net servicing income and take into account appropriate prepayment assumptions.

        Key economic assumptions used in measuring any potential impairment of the servicing rights include the prepayment speed of the underlying mortgage loans, the weighted-average life of the loan and the discount rate. The primary risk of material changes to the value of the mortgage servicing rights resides in the potential volatility in the economic assumptions used, particularly the prepayment speed. The Bancorp monitors this risk and adjusts its valuation allowance as necessary to adequately reserve for any probable impairment in the portfolio. By adjusting the allowance, as necessary each quarter, the Bancorp mitigates its risk to material adverse changes in the value of the portfolio. See further discussion in Note 1 and Note 16 to Financial Statements.

Valuation of Identifiable Intangible Assets

        Identifiable intangible assets primarily consist of core deposit intangibles acquired in branch office acquisitions. Core deposit intangible assets represent the excess of the fair value of liabilities assumed over the fair value of tangible assets acquired in branch office acquisitions. These intangible assets are amortized on an accelerated basis over an original life of 10 to 15 years. The Bancorp reviews its intangible assets periodically for other-than-temporary impairment. If such impairment is indicated, impairment is recognized by accelerating the amortization of the asset to the extent that the carrying value exceeds the estimated fair value.

Recent Accounting Standards

        In June 2001, the Financial Accounting Standards Board (FASB) issued Statement No. 141 (SFAS No. 141), Business Combinations, and Statement No. 142 (SFAS No. 142), Goodwill and Other Intangible Assets.

        SFAS No. 141, effective June 30, 2001, requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method of accounting; the use of the pooling-of-interests method of accounting is eliminated. SFAS No. 141 also establishes how the purchase method is to be applied for business combinations completed after June 30, 2001. This guidance is similar to previous generally accepted accounting principles (GAAP); however, SFAS No. 141 establishes additional disclosure requirements for transactions occurring after the effective date.

        SFAS No. 142 eliminates the amortization of goodwill associated with business combinations completed after June 30, 2001. During the transition period from July 1, 2001 through December 31, 2001, goodwill associated with business combinations completed prior to July 1, 2001 continued to be amortized through the income statement. Effective January 1, 2002, goodwill amortization expense ceased and goodwill will be assessed for impairment at least annually at the reporting unit level by

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applying a fair-value-based test. SFAS No. 142 also provides additional guidance on acquired intangibles that should be separately recognized and amortized, which could result in the recognition of additional intangible assets, as compared with previous GAAP.

        These statements are effective for the Bancorp and have been adopted as of June 30, 2001. The adoption of these standards did not have a material impact on the Bancorp's financial position or results of operation. At December 31, 2002 and 2001, the Bancorp did not carry any goodwill on its balance sheet.

        In June 2001, the FASB issued Statement No. 143 (SFAS No. 143), Accounting for Asset Retirement Obligations, which addresses the recognition and measurement of obligations associated with the retirement of tangible long-lived assets. SFAS No. 143 applies to legal obligations associated with the retirement of long-lived assets resulting from acquisition, construction, development or the normal operation of a long-lived asset. SFAS No. 143 requires that the fair value of an asset retirement obligation be recognized as a liability in the period in which it is incurred. The asset retirement obligation is to be capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective January 1, 2003, with early adoption permitted. The Bancorp plans to adopt SFAS No. 143 effective January 1, 2003 and does not expect the adoption of the statement to have a material effect on the financial statements.

        In August 2001, the FASB issued Statement No. 144 (SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes Statement No. 121 (SFAS No. 121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 carries forward from SFAS No. 121 the fundamental guidance related to the recognition and measurement of an impairment loss related to assets to be held and used and provides guidance related to the disposal of long-lived assets to be abandoned or disposed of by sale. SFAS No. 144 became effective January 1, 2002 and was required to be applied prospectively. Adoption of SFAS No. 144 did not have a material effect on the financial statements.

        In April 2002, the FASB issued Statement No. 145 (SFAS No. 145), Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 requires that any gains or losses on extinguishment of debt that were classified as an extraordinary item in prior periods that are not unusual in nature and infrequent in occurrence be reclassified to other income (expense), effective January 1, 2003, with early adoption encouraged. The Bancorp expects to adopt the requirements of SFAS No. 145 effective January 1, 2003 and does not expect the adoption of the statement to have a material effect on the financial statements.

        In June 2002, the FASB issued Statement No. 146 (SFAS No. 146), Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of commitment to an exit plan rather than when the liability is incurred. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Bancorp will adopt the provisions of SFAS No. 146 for any restructuring activities, which may be initiated after December 31, 2002.

        In October 2002, the FASB issued Statement No. 147 (SFAS No. 147), Acquisitions of Certain Financial Institutions, which provides guidance on the accounting for the acquisition of a financial institution. This statement requires that the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination represents goodwill that should be accounted for under SFAS No. 142, Goodwill and Other Intangible Assets. Thus, the specialized accounting guidance in paragraph 5 of SFAS No. 72, Accounting for Certain Acquisitions

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of Banking or Thrift Institutions, will not apply after September 30, 2002. If certain criteria in SFAS No. 147 are met, the amount of the unidentifiable intangible asset will be reclassified to goodwill upon adoption of the statement. Financial institutions meeting conditions outlined in SFAS No. 147 will be required to restate previously issued financial statements. Additionally, the scope of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, is amended to include long-term customer-relationship intangible assets such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. This statement is effective for the Bancorp and has been adopted as of October 1, 2002. The adoption of this standard did not have a material impact on the Bancorp's financial position or results of operation.

        In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34 (FIN 45). The initial recognition and measurement provision of FIN 45 are effective for guarantees issued or modified after December 31, 2002. Accounting for guarantees issued prior to this date is unaffected by FIN 45. Disclosures concerning guarantees, including those required by FIN 45 as of December 31, 2002 have been made in Note 5 to Financial Statements.

        In December 2002, the FASB issued Statement No. 148 (SFAS No. 148), Accounting for Stock-based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. This statement is effective for fiscal years ending after December 15, 2002. The Bancorp believes that the adoption of SFAS No. 148 will not have a material effect on its financial position or results of operations.

Factors That May Affect Future Results

        We make forward-looking statements in this report and from time to time in other reports and proxy statements we file with the SEC. Also, our senior management might make forward-looking statements orally to analysts, investors and others. Broadly speaking, forward-looking statements include:

•

descriptions of plans or objectives of our management for future operations, products or services;



•

descriptions of assumptions underlying or relating to critical accounting estimates and projections.

        In this report, for example, we make forward-looking statements about:

•

future credit losses and non-performing assets;



•

future cash requirements relating to commitments to extend credit;



•

future amortization expense;



•

the impact of new accounting standards;



•

and the impact of interest rate changes on our net interest income.

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        Forward-looking statements discuss matters that are not historical facts. These forward-looking statements may sometimes be identified by words such as "expect", "may". "looking forward", "we plan", "we believe", "are planned", "could be", and "currently anticipate". Although we believe these statements, as well as other oral and written forward-looking statements made by us from time to time, to be true and reasonable, we can give no assurance that these plans, intentions or expectations will be achieved. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements.

        There are several factors—many beyond our control—that could cause results to differ significantly from our expectations. Some of these factors are described below. Other factors, such as credit, market, operational, liquidity, interest rate and other risks, are described elsewhere in this report (see, for example, "Financial Review—Balance Sheet Analysis" and "Asset/Liability and Market Risk Management"). Factors relating to regulation and supervision of the Bancorp are described elsewhere in this report for the year ended December 31, 2002. Any factor described in this report could by itself, or together with other factors, adversely affect our business, results of operations and/or financial condition.

Industry Factors

As a financial services company, our earnings are significantly affected by business and economic conditions.

        Our earnings are impacted by business and economic conditions in the United States and the Maryland economic region. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the U.S. economy and Maryland economies in which we operate. Business and economic conditions that negatively impact household or business incomes could decrease demand for the Bancorp's products and increase the number of customers who fail to pay their loans.

Our earnings are significantly affected by the fiscal and monetary polices of the federal government and its agencies.

        The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies significantly impact our cost of funds for lending and investing and the return we earn on those loans and investments, both of which impact our net interest margin, and can materially affect the value of financial instruments we hold. Its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and hard to predict or anticipate.

The financial services industry is highly competitive.

        We operate in a highly competitive industry, which could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation of banks. Banks, securities firms and insurance companies can now merge by creating a new type of financial services company called a "financial holding company", which can offer virtually any type of financial service. Many of our competitors have fewer regulatory constraints and some have lower cost structures.

We are heavily regulated by federal and state agencies.

        The holding company and its subsidiaries are heavily regulated at the federal and state levels. This regulation is to protect customers, federal deposit insurance funds and the banking system as a whole, not security holders. Changes to statutes, regulations and regulatory policies, could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer and increasing the ability of non-banks to offer competing financial services and products. Also, our failure to comply with laws, regulations and policies could result in sanctions by regulatory

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agencies and damage our reputation. For more information, refer to the "Regulation and Supervision" section in this report.

Company Factors

Maintaining or increasing our market share depends on market acceptance and regulatory approval of new products and services.

        Our success depends, in part, on our ability to adapt our products and services to evolving industry standards and the changing need of our customers. There is increasing pressure on financial service companies to provide products and services at lower prices. This can reduce our net interest margin and revenues from our fee-based products and services. Also, the wide-spread adoption of new technologies, including internet-based services, could require us to make substantial investments to modify or adapt our existing products and services.

The holding company relies on dividends from its subsidiaries for most of its revenues.

        The holding company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the holding company's common stock. Various federal and state laws and regulations limit the amount of dividends that our bank and certain non-bank subsidiaries may pay to the holding company. For more information, refer to Note 3 to Financial Statements in this report.

We have businesses other than banking.

        We are a diversified financial services company. In addition to banking, we provide insurance, wealth management, and mortgages. Although we believe our diversity helps mitigate the impact to the Bancorp when downturns affect any one-business line, it also means that our earnings could be subject to different risks and uncertainties. We discuss some examples below.

Mortgage Banking

        The impact of interest rates on our mortgage banking business can be large and complex. Changes in interest rates can impact loan origination fees and gains on mortgage loans sold. A decline in mortgage rates might be expected to increase the demand for mortgages as borrowers refinance. Conversely, in a constant or increasing rate environment, we would expect fewer loans to be refinanced and a decline in our fee income.

Wealth Management

        The impact of changes in the U.S. stock market on our wealth management business can be large. As much of our fee income is derived based on assets under management, the loss in value of those assets due to stock market declines can significantly reduce our fee income. Also, if market conditions are volatile many of our investors limit their mutual fund investments and in some cases withdraw their funds to invest in safer investment alternatives.

Legislative Risk

        Various legislation, including proposals to change substantially the financial institution regulatory system, is from time to time introduced in Congress in the states' legislatures, and before the various bank regulatory agencies. This legislation may change banking statutes and the operating environment of the Bancorp in substantial and unpredictable ways. If enacted, this legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive

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balance among banks, savings associations, credit unions and other financial institutions. The Bancorp cannot predict whether any of this potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, would have on the Bancorp's business, results of operations or financial condition.

Our stock price can be volatile.

        Our stock price can fluctuate widely in response to a variety of factors including:

•

actual or anticipated variations in our quarterly operating results;



•

recommendations by security analysts;



•

operating and stock price performance of other companies that investors deem comparable to us:



•

significant acquisitions or business combinations by or involving us or our competitors;



•

news reports relating to trends, concerns and other issues in the financial services industry; and



•

changes in government regulations.

        General market fluctuations, industry factors and general economic trends, interest rate changes, or credit loss trends, also could cause our stock price to decrease regardless of our operating results.

Earnings Performance

Net Interest Income

        Net interest income is the difference between interest income (which includes yield-related loan fees) and interest expense. Net interest income on a taxable-equivalent basis was $78.7 million in 2002, compared with $71.3 million in 2001, an increase of 10%. This increase is primarily due to a 8% increase in earning assets and an improvement in the net interest margin by .10%.

        Net interest income on a taxable-equivalent basis expressed as a percentage of average total earning assets is referred to as the net interest margin, which represents the average effective yield on earning assets. For 2002, the net interest margin was 4.32%, compared with 4.22% in 2001. On average for the year 2002, the average cost of all funding sources declined at a slightly faster pace than earning asset yields, by approximately 30 basis points. Three factors account for the margin increase during the year: (a) a 27% growth in the investment securities portfolio, (b) an increase in lower cost core deposits, particularly noninterest-bearing demand deposits and (c) a faster decline in deposit and borrowing costs than in loan and investment yields as the general level of market rates declined throughout the year.

        Table 2 presents the individual components of net interest income and net interest margin. Table 3 allocates the changes in net interest income on a taxable-equivalent basis to changes in either average balances or average rates for both interest-earning assets and interest-bearing liabilities. Because of the numerous simultaneous volume and rate changes during any period, it is not possible to precisely allocate such changes between volume and rate. For this table, changes that are not solely due to either volume or rate are allocated to these categories in proportion to the percentage changes in average volume and average rate.

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TABLE 2.    Average Balances, Yields and Rates Paid (Taxable-equivalent Basis)(1)

(1)

The average prime rate was 4.75%, 7.51% and 9.25% for the years ended December 31, 2002, 2001 and 2000, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 1.80%, 3.43% and 6.54% for the years ended December 31, 2002, 2001and 2000, respectively.

(2)

Yields are based on amortized cost balances computed on a settlement day basis.

(3)

Loan fee income is included in the interest income calculation, and nonaccrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(4)

Interest and yield on obligations of state and political subdivisions and tax-exempt loans are computed on a taxable equivalent basis using U.S. statutory tax rate of 35% for 2002 and 2001 and 34% for 2000.

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TABLE 3.    Analysis of Changes in Net Interest Income

Noninterest Income

        Table 4 shows the major components of noninterest income. Service charges on deposit accounts increased in line with the growth in core consumer deposit balances, account activity fees and fee increases on overdrafts.

        Fee income in the trust and brokerage business lines declined 17% from the prior year. Trust revenues in 2002 were impacted by a net reduction in fee income to refund certain trust clients for a billing error that resulted in overcharges to those accounts. Without this fee reduction, trust and brokerage fee income would have only declined about 9% from the prior year. The Bancorp managed or maintained personal trust, employee benefit trust and agency assets of approximately $297 million and $347 million at December 31, 2002 and 2001, respectively. The reduction in assets under management is largely attributable to the decline in the stock market during 2002. Mutual fund and annuity sales increased 9% over the previous year, due to a moderate increase in investor interest in returning to the stock market.

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        Other fees declined 2% from the prior year primarily due to the receipt of $525 thousand death benefit on bank-owned life insurance in 2001. Excluding this benefit, total other fees would have increased 7% from the prior year. Cash network fees increased 11% from the prior year primarily due to increased customer acceptance and usage of the Bancorp's debit card.

TABLE 4.    Analysis of Changes in Noninterest Income

        The increase in mortgage banking fees was predominantly due to increased refinancing activity resulting from the decline in fixed-rate mortgage rates during 2002. The increase in origination and other closing fees was due to increased production volume. The decline in net gains on mortgage loan sales was due to a higher volume of production activity being held in the loan portfolio instead of sold into the secondary market.

        Insurance revenue increased 9% due to increased sales activities and increased pricing on the renewal of existing insurance policies. Team-based selling efforts between the insurance subsidiaries and the bank affiliates have brought a vast array of consumer and commercial insurance products to our community bank customer.

Noninterest Expense

        Table 5 shows the major components of noninterest expense. Salary expenses of $29.4 million for 2002 increased 3% from 2001 primarily due to normal merit increases. Salary expenses have been controlled through staff reductions associated with branch reconfigurations and sales as well as the elimination of redundant positions in support functions. Active full-time equivalent staff declined approximately 2% from the December 31, 2001 level.

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        Incentive compensation increased to $3.6 million in 2002, a 86% increase over the same period last year. These increases are directly tied to the Bancorp's revenue and overall profitability performance as measured by our team-based compensation and sales programs.

        Employee benefit costs increased 5% over the prior year primarily due to higher medical claims experienced in the first half of 2002.

        Occupancy expenses decreased 5% from the prior year due to reconfiguration of our branch network. The Bancorp reevaluated its retail branch network and incurred expenses related to the consolidation and sale of several branches in the previous year. While costs were incurred at the time of consolidation, they have resulted in lower cost and more efficient delivery in the current year.

        Professional service expenses increased 36% over 2001. This increase is due to professional services relating to expanding and growing our businesses as well as the implementation of the Bancorp's new check imaging system.

        Advertising and promotion expenses increased 69% over the prior year to support sales growth and research initiatives in conjunction with ongoing strategic initiatives.

TABLE 5.    Analysis of Changes in Noninterest Expense

Income Taxes

        Income tax expense increased by 32% to $11.8 million for 2002 from $9.0 million for 2001. This increase was primarily due to the 21% increase in pre-tax income earned in 2002. Tax expense varies with changes in the level of income before taxes, the amount of tax-exempt income realized, and the relationship of these changes to each other. Also, the amount of income tax expense differs from the amount computed at statutory rates primarily because the interest realized on state and municipal obligations and certain loans is tax-exempt.

        The effective tax rates, which is the provision for income taxes divided by income before taxes, were 32.6% for 2002 and 29.8% for 2001.

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Balance Sheet Analysis

        A comparison between the year-end 2002 and 2001 balance sheets is presented below.

Securities Available for Sale

        The Bancorp holds both debt and marketable equity securities in its securities available for sale portfolio. Debt securities available for sale are primarily held for liquidity, interest rate risk management and yield enhancement purposes. Given these purposes, the portfolio is primarily comprised of very liquid, high quality debt securities. At December 31, 2002, the Bancorp held $618 million of securities available for sale, up from $547 million at December 31, 2001. The Bancorp had a net unrealized gain of $16 million at December 31, 2002 compared with a net unrealized gain of $5 million at December 31, 2001. The net unrealized gain increased $11 million from December 31, 2001 because of the favorable impact of lower interest rates on the value of debt securities held during 2002. The weighted average expected maturity of the debt securities portion of the securities available for sale portfolio was 2 years and 6 month at December 31, 2002. Since 64% of this portfolio is held in mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because the issuers of such securities may have the right to prepay obligations with or without penalty.

        In management's opinion, no securities presented any material risk characteristics at December 31, 2002. All obligations of state and political subdivisions were rated A or higher by either Moody's Investors Service or Standard and Poors and approximately 86% were rated AAA at December 31, 2002.

        See Note 4 to Financial Statements for securities available for sale by security type.

Loan Portfolio