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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ________ to ________
Commission File Number: 1.000-26099
FARMERS & MERCHANTS BANCORP
(Exact name of registrant as specified in its charter)
Delaware 94-3327828
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 W. Pine Street, Lodi, California 95240
(Address of principal Executive offices) (Zip Code)
Registrant's telephone number, including area code (209) 367-2300
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 [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
Number of shares of common stock of the registrant: Par value $0.01, authorized
2,000,000 shares; issued and outstanding 731,021 as of April 29, 2003.
1
FARMERS & MERCHANTS BANCORP
FORM 10-Q
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION Page
Item 1 - Financial Statements
Consolidated Balance Sheets as of March 31, 2003,
December 31, 2002 and March 31, 2002. 3
Consolidated Statements of Income for the Three Months
Ended March 31, 2003 and 2002. 4
Consolidated Statements of Comprehensive Income for the Three
Months Ended March 31, 2003 and 2002. 5
Statement of Changes in Shareholders' Equity for the Three
Months Ended March 31, 2003 and 2002. 6
Consolidated Statement of Cash Flows for the Three
Months Ended March 31, 2003 and 2002. 7
Notes to Consolidated Financial Statements 8
Item 2 - Management's Discussion and Analysis 13
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 20
Item 4 - Controls and Procedures 23
PART II. - OTHER INFORMATION 27
-----------------
Signatures 28
Certifications 28
Index to Exhibits 31
2
PART I. - FINANCIAL INFORMATION
Item 1 - Financial Statements
FARMERS & MERCHANTS BANCORP
Consolidated Balance Sheets
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands) March 31, December 31, March 31,
2003 2002 2002
Assets (Unaudited) (Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents:
Cash and Due From $32,997 $45,389 $29,111
Federal Funds Sold 5,790 8,185 43,285
- ---------------------------------------------------------------------------------------------------------------------------
Total Cash and Cash Equivalents 38,787 53,574 72,396
Investment Securities:
Available-for Sale 272,239 206,063 209,624
Held-to-Maturity 44,602 27,870 29,847
- ---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities 316,841 233,933 239,471
- ---------------------------------------------------------------------------------------------------------------------------
Loans 688,802 698,693 590,322
Less: Unearned Income (1,977) (2,018) (1,116)
Less: Allowance for Loan Losses (16,871) (16,684) (12,999)
- ---------------------------------------------------------------------------------------------------------------------------
Loans, Net 669,954 679,991 576,207
- ---------------------------------------------------------------------------------------------------------------------------
Land, Buildings & Equipment 11,323 11,342 11,599
Interest Receivable and Other Assets 42,689 43,067 34,683
- ---------------------------------------------------------------------------------------------------------------------------
Total Assets $1,079,594 $1,021,907 $934,356
===========================================================================================================================
Liabilities & Shareholders' Equity
Deposits:
Demand $189,999 $205,997 $168,974
Interest Bearing Transaction 90,675 93,646 87,020
Savings 249,862 231,964 214,971
Time Deposits 319,452 318,618 315,814
- ---------------------------------------------------------------------------------------------------------------------------
Total Deposits 849,988 850,225 786,779
- ---------------------------------------------------------------------------------------------------------------------------
Fed Funds Purchased - 16,997 -
FHLB Borrowings 100,956 40,965 40,992
Other Liabilities 22,444 10,155 7,511
- ---------------------------------------------------------------------------------------------------------------------------
Total Liabilities 973,388 918,342 835,282
- ---------------------------------------------------------------------------------------------------------------------------
Shareholders' Equity
Common Stock 7 7 7
Additional Paid In Capital 64,479 64,979 57,036
Retained Earnings 40,150 36,749 39,561
Accumulated Other Comprehensive Income 1,570 1,830 2,470
- ---------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 106,206 103,565 99,074
- ---------------------------------------------------------------------------------------------------------------------------
Total Liabilities & Shareholders' Equity $1,079,594 $1,021,907 $934,356
===========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
3
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Income (Unaudited)
- -----------------------------------------------------------------------------------------------------------------
Three Months
Ended March 31,
2003 2002
- -----------------------------------------------------------------------------------------------------------------
Interest Income:
Interest & Fees on Loans $10,592 $9,902
Federal Funds Sold 79 143
Securities:
Investments Available-for-Sale:
Taxable 1,905 3,032
Non-taxable 284 237
Investments Held-to-Maturity:
Taxable 4 10
Non-taxable 335 361
- -----------------------------------------------------------------------------------------------------------------
Total Interest Income 13,199 13,685
- -----------------------------------------------------------------------------------------------------------------
Interest Expense:
Interest Bearing Transaction 49 89
Savings 345 612
Time Deposits 1,907 2,633
Interest on Borrowed Funds 577 550
- -----------------------------------------------------------------------------------------------------------------
Total Interest Expense 2,878 3,884
- -----------------------------------------------------------------------------------------------------------------
Net Interest Income 10,321 9,801
Provision for Loan Losses 200 200
- -----------------------------------------------------------------------------------------------------------------
Net Interest Income After Provision for Loan Losses 10,121 9,601
- -----------------------------------------------------------------------------------------------------------------
Non-Interest Income
Service Charges on Deposit Accounts 1,176 1,089
Net Gain (Loss) on Sale of Investment Securities 132 44
Other 1,643 1,071
- -----------------------------------------------------------------------------------------------------------------
Total Non-Interest Income 2,951 2,204
- -----------------------------------------------------------------------------------------------------------------
Non-Interest Expense
Salaries & Employee Benefits 4,939 4,180
Occupancy 405 413
Equipment 601 633
Other Operating 1,804 1,720
- -----------------------------------------------------------------------------------------------------------------
Total Non-Interest Expense 7,749 6,946
- -----------------------------------------------------------------------------------------------------------------
Net Income Before Taxes 5,323 4,859
Provision for Taxes 1,922 1,797
- -----------------------------------------------------------------------------------------------------------------
Net Income $3,401 $3,062
=================================================================================================================
Earnings Per Share $4.64 $4.10
=================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
4
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Comprehensive Income (Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands) For Three Months
Ended March 31,
2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Net Income $ 3,401 $ 3,062
Other Comprehensive Income (Loss) -
Unrealized Gains on Derivative Instruments:
Unrealized holding gains arising during the period, net
of income tax effects of $55 and $0 for the quarters ended
March 31, 2003 and 2002, respectively. 76 -
Unrealized Gains (Losses) on Securities:
Unrealized holding (losses) gains arising during the period, net of income
tax effects of $(188) and $(212) for the quarters ended March 31, 2003 and
2002, respectively. (260) (396)
Less: Reclassification adjustment for realized (gains) losses included in net
income, net of related income tax effects of $(56) and $(2) for the
quarters ended March 31, 2003 and 2002, respectively. (76) (4)
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income (Loss) (260) (400)
- ---------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 3,141 $ 2,662
===========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
5
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands except share data) Accumulated
Common Additional Other Total
Shares Common Paid-In Retained Comprehensive Shareholders'
Outstanding Stock Capital Earnings Income Equity
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 719,269 $ 7 $ 61,360 $ 36,499 $ 2,870 $ 100,736
===========================================================================================================================
Net Income - - 3,062 - 3,062
Redemption of Stock (18,021) - (4,324) - - (4,324)
Changes in Net Unrealized Gain (Loss) on
Securities Available for Sale - - - (400) (400)
- ---------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2002 701,248 $ 7 $ 57,036 $ 39,561 $ 2,470 $ 99,074
===========================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 733,021 $ 7 $ 64,979 $ 36,749 $ 1,830 $ 103,565
===========================================================================================================================
Net Income - - 3,401 - 3,401
Redemption of Stock (2,000) - (500) - - (500)
Unrealized Gains on Derivative Instruments 76 76
Changes in Net Unrealized Gain (Loss) on
Securities Available for Sale - - - (336) (336)
- ---------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2003 731,021 $ 7 $ 64,479 $ 40,150 $ 1,570 $ 106,206
===========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
6
FARMERS & MERCHANTS BANCORP
Consolidated Statement of Cash Flows (Unaudited) Three Months Ended
- ------------------------------------------------------------------------------------------------------------------
(in thousands) Mar. 31 Mar. 31
2003 2002
- ------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net Income $3,401 $3,062
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Provision for Loan Losses 200 200
Depreciation and Amortization 396 407
Provision for Deferred Income Taxes (25) (10)
Net Accretion of Investment Securities 286 (20)
Net Gain on Sale of Investment Securities (133) (13)
Net Change in Operating Assets & Liabilities:
(Increase) Decrease in Interest Receivable and Other Assets 689 (3,524)
Increase (Decrease) in Interest Payable and Other Liabilities 12,331 (1,925)
- ------------------------------------------------------------------------------------------------------------------
Net Cash Provided (Used) by Operating Activities 17,145 (1,823)
Investing Activities:
Trading Securities:
Purchased 0 0
Sold or Matured 0 0
Securities Available-for-Sale:
Purchased (113,013) (9,851)
Sold or Matured 46,087 42,485
Securities Held-to-Maturity:
Purchased (18,303) (227)
Matured 1,589 3,091
Net Loans Originated or Acquired 9,814 12,963
Principal Collected on Loans Charged Off 23 90
Net Additions to Premises and Equipment (377) (574)
- ------------------------------------------------------------------------------------------------------------------
Net Cash Provided (Used) by Investing Activities (74,180) 47,977
Financing Activities:
Net Decrease in Demand, Interest-Bearing Transaction,
and Savings Accounts (1,071) (26,576)
Increase in Time Deposits 834 (6,356)
Federal Funds Purchased (16,997) 0
Federal Home Loan Bank Borrowings:
Advances 59,991 0
Paydowns (9) (8)
Cash Dividends 0 0
Stock Redemption (500) (4,324)
- ------------------------------------------------------------------------------------------------------------------
Net Cash Provided (Used) by Financing Activities 42,248 (37,264)
Increase (Decrease) in Cash and Cash Equivalents (14,787) 8,890
Cash and Cash Equivalents at Beginning of Year 53,574 63,506
- ------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents as of March 31, 2003 and March 31, 2002 $38,787 $72,396
==================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
7
FARMERS & MERCHANTS BANCORP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
For the three months ended March 31, 2003 and March 31, 2002
Significant Accounting Policies
Farmers & Merchants Bancorp (the Company) was organized March 10, 1999. Its
primary operations are related to traditional banking activities through its
subsidiary Farmers & Merchants Bank of Central California (the Bank). The
consolidated financial statements of the Company and its subsidiaries are
prepared in conformity with generally accepted accounting principles and
prevailing practices within the banking industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
reported amounts as of the date of the balance sheet and revenues and expenses
for the period. These estimates are based on information available as of the
date of the financial statements. Therefore, actual results could differ from
those estimates. The following is a summary of the significant accounting and
reporting policies used in preparing the consolidated financial statements.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the
Company and the Company's wholly owned subsidiaries, F&M Bancorp, Inc. and the
Bank, along with the Bank's wholly owned subsidiaries, Farmers & Merchants
Investment Corporation and Farmers/Merchants Corp. The investment in the Bank is
carried at the Company's equity in the underlying net assets. Significant
intercompany transactions have been eliminated in consolidation. F & M Bancorp,
Inc. was created in March 2002 to protect the name F & M Bank, Farmers &
Merchants Investment Corporation has been dormant since 1991. Farmers/Merchants
Corp. acts as trustee on deeds of trust originated by the Bank.
Certain amounts in the prior years' financial statements and related footnote
disclosures have been reclassified to conform to the current-year presentation.
These reclassifications have no effect on previously reported income.
Cash and Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Company has
defined cash and cash equivalents as those amounts included in the balance sheet
captions Cash and Due from Banks and Federal Funds Sold and Securities Purchased
Under Agreements to Resell. Generally, these transactions are for one-day
periods. For these instruments, the carrying amount is a reasonable estimate of
fair value.
Investment Securities
Investment securities are classified at the time of purchase as held-to-maturity
if it is management's intent and the Bank has the ability to hold the securities
until maturity. These securities are carried at cost, adjusted for amortization
of premium and accretion of discount using a methodology which approximates a
level yield of interest over the estimated remaining period until maturity.
Losses, reflecting a decline in value judged by the Bank to be other than
temporary, are recognized in the period in which they become known.
Securities are classified as available-for-sale if it is management's intent, at
the time of purchase, to hold the securities for an indefinite period of time
and/or to use the securities as part of the Company's asset/liability management
strategy. Securities classified as available-for-sale include securities which
may be sold to effectively manage interest rate risk exposure, prepayment risk,
satisfy liquidity demands and other factors. These securities are reported at
fair value with aggregate, unrealized gains or losses excluded from income and
included as a separate component of shareholders' equity, net of related income
taxes. Fair values are based on quoted market prices or broker/dealer price
quotations on a specific identification basis. Gains or losses on the sale of
these securities are computed using the specific identification method.
Unrealized losses on these securities, reflecting a decline in value judged by
the Company to be other than temporary, are recognized in the period in which
they become known.
8
Trading securities, if any, are acquired for short-term appreciation and are
recorded in a trading portfolio and are carried at fair value, with unrealized
gains and losses recorded in non-interest income.
Loans
Loans are reported at the principal amount outstanding net of unearned discounts
and deferred loan fees. Interest income on loans is accrued daily on the
outstanding balances using the simple interest method. Loan origination fees,
net of related loan origination costs, are deferred and recognized over the
contractual life of the loan as an adjustment to the yield. Loans are placed on
a non-accrual status when the collection of principal or interest is in doubt or
when they become past due for 90 days or more unless they are both well-secured
and in the process of collection. For this purpose a loan is considered
well-secured if it is collateralized by property having a net realizable value
in excess of the amount of the loan or is guaranteed by a financially capable
party. When a loan is placed on non-accrual status, the accrued and unpaid
interest receivable is reversed and charged against current income, thereafter,
interest income is recognized only as it is collected in cash. Loans placed on a
non-accrual status are returned to accrual status when the loans are paid
current as to principal and interest and future payments are expected to be made
in accordance with the contractual terms of the loan.
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. When a loan is impaired, the recorded
amount of the loan in the Consolidated Balance Sheets is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or on the observable or estimated market price of the loan or the fair
value of the collateral if the loan is collateral dependent. Impaired loans are
placed on a non-accrual status with income reported accordingly. Cash payments
are first applied as a reduction of the principal balance until collection of
the remaining principal and interest can be reasonably assured.
Allowance for Loan Losses
As a financial institution which assumes lending and credit risks as a principal
element in its business, the Company anticipates that credit losses will be
experienced in the normal course of business. Accordingly, the allowance for
loan losses is maintained at a level considered adequate by management to
provide for losses that can be reasonably anticipated. The allowance is
increased by provisions charged to operating expense and reduced by net
charge-offs. Management employs a systematic methodology for determining the
allowance for loan losses. On a quarterly basis, management reviews the credit
quality of the loan portfolio in determining the adequacy of the allowance
balance
The conditions evaluated in connection with the allowance may include existing
general economic and business conditions affecting the key lending areas of the
Company, credit quality trends, collateral values, loan volumes and
concentration, seasoning of the loan portfolio, specific industry conditions,
recent loss experience, duration of the current business cycle, bank regulatory
examination results and findings of the Company's internal credit examiners.
The allowance also incorporates the results of measuring impaired loans as
provided in Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan". These accounting standards
prescribe the measurement methods, income recognition and disclosures related to
impaired loans.
While the Company utilizes a systematic methodology in determining its
allowance, the allowance is based on estimates, and ultimate losses may vary
from current estimates. The estimates are reviewed periodically and, as
adjustments become necessary, are reported in earnings in the periods in which
they become known.
9
Premises and Equipment
Premises, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed principally
by the straight-line method over the estimated useful lives of the assets.
Estimated useful lives of buildings range from 30 to 40 years, and for furniture
and equipment from 3 to 8 years. Leasehold improvements are amortized over the
lesser of the terms of the respective leases, or their useful lives, which are
generally 5 to 10 years. Remodeling and capital improvements are capitalized
while maintenance and repairs are charged directly to occupancy expense.
Other Real Estate
Other real estate owned, which is included in other assets, is comprised of
properties acquired through foreclosures in satisfaction of indebtedness. These
properties are recorded upon acquisition at fair value less estimated selling
costs. Initial losses on properties acquired through full or partial
satisfaction of debt are treated as credit losses and charged to the Allowance
for Loan Losses at the time of acquisition. Revised estimates to the fair value
less cost to sell are reported as adjustments to the carrying amount of the
asset, provided that such adjusted value is not in excess of the carrying amount
at acquisition. Subsequent declines in value from the recorded amounts, routine
holding costs, and gains or losses upon disposition, if any, are included in
non-interest income or expense as incurred.
Income Taxes
As required, the Company uses the liability method of accounting for income
taxes. This method results in the recognition of deferred tax assets and
liabilities that are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes. The
deferred provision for income taxes is the result of the net change in the
deferred tax asset and deferred tax liability balances during the year. This
amount combined with the current taxes payable or refundable results in the
income tax expense for the current year.
Earnings Per Share
The actual number of shares outstanding at March 31, 2003, was 731,021. Basic
earnings per share is calculated on the basis of the weighted average number of
shares outstanding during the period. Weighted average number of shares for the
three months ending March 31, 2003 and 2002 were 732,599 and 747,149,
respectively. Earnings per share for the three months ending March 31, 2003 and
2002 were $4.64 and $4.10, respectively. Prior periods per share amounts have
been restated for the 5% stock dividend declared during 2002.
Dividends
Farmers & Merchants Bancorp common stock is not traded on any exchange. The
shares are primarily held by local residents and are not actively traded. No
cash or stock dividends were declared during the first quarter of 2003 or 2002.
The Company has historically paid both cash and stock dividends during later
quarters of the year.
10
Segment Reporting
The Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" requires that public
companies report certain information about operating segments. It also requires
that public companies report certain information about their products and
services, the geographic areas in which they operate, and their major customers.
The Company is a community bank which offers a wide array of products and
services to its customers. Pursuant to its banking strategy, emphasis is placed
on building relationships with its customers, as opposed to building specific
lines of business. As a result, the Company is not organized around discernable
lines of business and prefers to work as an integrated unit to customize
solutions for its customers, with business line emphasis and product offerings
changing over time as needs and demands change.
Derivative Instruments and Hedging Activities
The Statement of Financial Accounting Standards, No. 133, "Accounting for
Derivative Instruments and Certain Hedging Activities" as amended by the
Statement of Financial Accounting Standards, No. 138, establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. Changes in the fair value of
those derivatives are accounted for depending on the intended use of the
derivative and the resulting designation under specified criteria. If the
derivative is designated as a fair value hedge, the changes in the fair value of
the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
designed to minimize interest rate risk, the effective portions of the change in
the fair value of the derivative are recorded in other comprehensive income.
Ineffective portions of changes in the fair value of cash flow hedges are
recognized in earnings. As required, SFAS No. 133 was adopted by the Company
effective January 1, 2001.
The Company utilizes derivative financial instruments such as interest rate
caps, floors, swaps and collars. These instruments are purchased and/or sold to
reduce the Company's exposure to changing interest rates. The Company marks to
market the value of its derivative financial instruments and reflects gain or
loss in earnings in the period of change or in other comprehensive income.
Comprehensive Income
The Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" establishes standards for the reporting and display of
comprehensive income and its components in the financial statements. Other
comprehensive income refers to revenues, expenses, gains and losses that
generally accepted accounting principles recognize as changes in value to an
enterprise but are excluded from net income. For the Company, comprehensive
income includes net income (loss) and changes in fair value of its
available-for-sale investment securities, pension plan liability adjustments and
cash flow hedges.
Recent Accounting Pronouncements
In June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement
Obligations. This Statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement requires that the fair value
of a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset.
11
This Statement is effective for financial statements issued for fiscal years
beginning after June 15, 2002. The Company does not anticipate that the adoption
of Statement No. 143 will have a material impact on the financial condition or
operating results of the Company.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". This Statement rescinds FASB Statement No. 4, Reporting Gains and
Losses from Extinguishment of Debt, and an amendment of that Statement, FASB
Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements. This Statement also rescinds FASB Statement No. 44, Accounting for
Intangible Assets of Motor Carriers. This Statement amends FASB Statement No.
13, Accounting for Leases, to eliminate an inconsistency between the required
accounting for sale-leaseback transactions and the required accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. This Statement also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions.
The provisions of this Statement related to the rescission of Statement 4 shall
be applied in fiscal years beginning after May 15, 2002. The provisions of this
Statement related to Statement 13 shall be effective for transactions occurring
after May 15, 2002. All other provisions of this statement shall be effective
for financial statements issued on or after May 15, 2002. The Company does not
anticipate that the adoption of Statement No. 145 will have a material impact on
the financial condition or operating results of the Company.
In July 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes Emerging Issues Task Force (EITF) Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3, a
liability for an exit cost as defined in EITF 94-3 was recognized at the date of
an entity's commitment to an exit plan. SFAS 146 also establishes that the
liability should initially be measured and recorded at fair value. We will adopt
the provisions of SFAS 146 for exit or disposal activities that are initiated
after December 31, 2002. The Company does not anticipate that the adoption of
Statement No. 146 will have a material impact on the financial condition or
operating results of the Company.
In October 2002, the FASB issued Statement No. 147, "Acquisitions of Certain
Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9". This Statement addresses the financial accounting and
reporting for the acquisition of all or part of a financial institution, except
for a transaction between two or more mutual enterprises. This Statement removes
acquisitions of financial institutions, other than transactions between two or
more mutual enterprises, from the scope of Statement No. 72, "Accounting for
Certain Acquisitions of Banking or Trust Institutions", and FASB Interpretation
No. 9, "Applying APB Opinions No. 16 and 17. When a Savings and Loan Association
or a Similar Institution Is Acquired in a Business Combination Accounted for by
the Purchase Method". This Statement also provides guidance on the accounting
for the impairment or disposal of acquired long-term customer-relationship
intangible assets (such as depositor- and borrower-relationship intangible
assets and credit cardholder intangible assets), including those acquired in
transactions between two or more mutual enterprises. We will adopt the
provisions of Statement No. 147 for acquisitions for which the date of
acquisition is on or after October 1, 2002. The Company does not anticipate that
the adoption of Statement No. 147 will have a material impact on the financial
condition or operating results of the Company.
12
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statements No.
123". This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We will
adopt the provisions of SFAS 148 for fiscal years ending after December 31,
2002. The Company does not anticipate that the adoption of Statement No. 148
will have a material impact on the financial condition or operating results of
the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
Management's discussion and analysis is written to provide greater insight into
the results of operations and the financial condition of Farmers & Merchants
Bancorp and its subsidiaries. Throughout this discussion, "Company" refers to
Farmers & Merchants Bancorp and its subsidiaries as a consolidated entity and
"Bank" refers to Farmers & Merchants Bank of Central California. For a more
complete understanding of the Company and its operations, reference should be
made to the financial statements included in this report and in the Company's
2002 Annual Report on Form 10-K. Certain statements in this Report on Form 10-Q
constitute "forward-looking statements" and usually contain the words
"estimate," "project," "expect," "objective," "goal," or similar expressions and
include assumptions concerning the Company's operations, future results, and
prospects. These forward-looking statements are based upon current expectations
and are subject to risk and uncertainties. In connection with the "safe-harbor"
provisions of the private Securities Litigation Reform Act of 1995, the Company
provides the following cautionary statement identifying important factors which
could cause the actual results of events to differ materially from those set
forth in or implied by the forward-looking statements and related assumptions.
Such factors include the following: (i) the effect of changing regional and
national economic conditions; (ii) significant changes in interest rates and
prepayment speeds; (iii) credit risks of commercial, real estate, consumer, and
other lending activities; (iv) changes in federal and state banking regulations;
(v) competitive pressure in the banking industry and changes in banking or other
laws and regulations or governmental fiscal or monetary policies; (vi)
uncertainty regarding the economic outlook resulting from the continuing war on
terrorism, as well as actions taken or to be taken by the U.S. or other
governments as a result of further acts or threats of terrorism or as a result
of military action in Iraq; (vii) dividend restrictions; (viii) asset/liability
pricing risks and liquidity risks; (ix) changes in the securities markets; (x)
certain operational risks involving data processing systems or fraud; and (xi)
other external developments which could materially impact the Company's
operational and financial performance. Readers are cautioned not to place undue
reliance on these forward-looking statements which speak only as of the date
hereof. The Company undertakes no obligation to update any forward-looking
statements to reflect events or circumstances arising after the date on which
they are made.
Analysis of the Results of Operations
Overview
For the three months ended March 31, 2003, Farmers & Merchants Bancorp reported
net income of $3,401,000, earnings per share of $4.64 and return on average
assets of 1.35%. Return on average shareholders' equity (net of accumulated
other comprehensive income) was 13.23% for the three months ended March 31,
2003. For the three months ended March 31, 2002, net income totaled $3,062,000,
earnings per share was $4.10 and return on average assets was 1.31%. Return on
average shareholders' equity (net of accumulated other comprehensive income) was
12.53% for the three months ended March 31, 2002.
13
The Company's improved earnings performance in 2003 was due to a combination of
(1) growth in earning assets, (2) improvement in the mix of earning assets as
reflected by an increase in loans as a percentage of average earning assets, (3)
improvement in non-interest income and (4) a reduction of the Company's
effective tax rate from 37% to 36%. These factors combined to offset a decline
in the Bank's net interest margin as a result of the declining interest rate
environment.
The following is a summary of the financial results for the three-month period
ended March 31, 2003 compared to March 31, 2002.
o Net income increased 11.1% to $3.4 million from $3.1 million.
o Net interest income increased 5.3% to $10.3 million from $9.8 million.
o The provision for loan losses totaled $200 thousand for both the quarter ended
March 31, 2003 and 2002.
o Non-interest income increased 33.9% to $2.9 million from $2.2 million.
o Non-interest expense increased 11.6% to $7.7 million from $6.9 million.
o Total assets increased 15.5% to $1.1 billion.
o Investment securities increased 32.3% to $316.8 million.
o Gross loans increased 16.7% to $688.8 million.
o Total deposits increased 8.0% to $850.0 million.
o Total shareholders' equity increased 7.2% to $106.2 million.
Net Interest Income
Net interest income is the amount by which the interest and fees on loans and
other interest earning assets exceed the interest paid on interest bearing
sources of funds. For the purpose of analysis, the interest earned on tax-exempt
investments and municipal loans is adjusted to an amount comparable to interest
subject to normal income taxes. This adjustment is referred to as "taxable
equivalent" and is noted wherever applicable. Interest income and expense are
affected by changes in the volume and mix of average interest earning assets and
average interest bearing liabilities, as well as fluctuations in interest rates.
Therefore, increases or decreases in net interest income are analyzed as changes
in volume, changes in rate and changes in the mix of assets and liabilities.
Net interest income increased 5.3% to $10.3 million during the first three
months of 2003, compared to $9.8 million at March 31, 2002. On a fully taxable
equivalent basis, net interest income increased 5.5% and totaled $10.7 million
at March 31, 2003, compared to $10.1 million for the first three months of 2002.
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 net effective yield on earning assets. For the three
months ended March 31, 2003, the net interest margin on a taxable equivalent
basis was 4.62% compared to 4.71% in 2002. This decrease in net interest margin
was primarily a result of the declining interest rate environment between the
first quarter of 2002 and the first quarter of 2003.
14
Loans, the Company's highest earning asset, increased $98.5 million as of March
31, 2003 compared to March 31, 2002. On an average balance basis, loans
increased by $101.6 million for the three months ended March 31, 2003. Due to
the decline in interest rates during 2002, the yield on the loan portfolio
decreased 61 basis points to 6.26% for the three months ended March 31, 2003
compared to 6.87% for the three ended March 31, 2002. This decrease in yield was
offset by the growth in loan balances, which resulted in interest revenue from
loans of $10.6 million for the first three months of 2003.
The investment portfolio is the other main component of the Company's earning
assets. The Company's investment policy is conservative. The Company primarily
invests in mortgage-backed securities, U.S. Treasuries, U.S. Government
Agencies, and high-grade municipals. Since the risk factor for these types of
investments is significantly lower than that of loans, the yield earned on
investments is less than that of loans.
Average investment securities decreased $17.9 million compared to the average
balance at March 31, 2002. As securities matured, the proceeds were used to fund
loan growth. The decrease in the average balance of investment securities was
followed with a corresponding decrease in interest income of $1.1 million for
the three months ended March 31, 2003. The average yield, on a taxable
equivalent basis, in the investment portfolio was 5.0% in 2003 compared to 6.4%
in 2002. Net interest income on the Average Balance Sheet is shown on a taxable
equivalent basis, which is higher than net interest income on the Consolidated
Statements of Income because of adjustments that relate to income on certain
securities that are exempt from federal income taxes.
Average interest-bearing sources of funds increased $45.0 million or 6.8%. Of
that increase, average other borrowed funds increased $8.5 million and
interest-bearing deposits increased $36.5 million. Even while growing our
deposit base, interest expense on interest bearing liabilities decreased 25.9%
as a result of declining interest rates paid for those sources of funds.
Overall, the average interest cost on deposits was 1.7% at March 31, 2003 and
2.4% at March 31, 2002.
The Company's earning assets and rate sensitive liabilities are subject to
repricing at different times, which exposes the Company to income fluctuations
when interest rates change. In order to minimize income fluctuations, the
Company attempts to match asset and liability maturities. However, some maturity
mismatch is inherent in the asset and liability mix.
During March 2003, the Bank implemented an investment strategy designed to both
increase its net interest margin and reduce the overall maturity mismatch in its
asset and liability mix. This strategy involved borrowing $60 million of
short-term advances from the Federal Home Loan Bank (FHLB) and investing
primarily in mortgage-backed securities and high-grade municipals. The Bank
intends to complete the execution of this strategy in April 2003, when an
additional $20 million will be borrowed from the FHLB.
Allowance for Loan Losses
As a financial institution that assumes lending and credit risks as a principal
element of its business, the Company anticipates that credit losses will be
experienced in the normal course of business. The allowance for loan losses is
established to absorb losses inherent in the portfolio. The allowance for loan
losses is maintained at a level considered by management to be adequate to
provide for risks inherent in the loan portfolio. In determining the adequacy of
the allowance for loan losses, management takes into consideration examinations
by the Company's supervisory authorities, results of internal credit reviews,
financial condition of borrowers, loan concentrations, prior loan loss
experience, and general economic conditions. The allowance is based on estimates
and ultimate losses may vary from the current estimates. Management reviews
these estimates periodically and, when adjustments are necessary, they are
reported in the period in which they become known.
15
The Company's written lending policies, along with applicable laws and
regulations governing the extension of credit, require risk analysis as well as
ongoing portfolio and credit management through loan product diversification,
lending limits, ongoing credit reviews and approval policies prior to funding of
any loan. The Company manages and controls credit risk through diversification,
dollar limits on loans to one borrower and by primarily restricting loans made
to its principal market area. Loans that are performing but have shown some
signs of weakness are subjected to more stringent reporting. Fixed-rate real
estate loans are comprised primarily of loans with maturities of less than five
years. Generally, long-term residential loans are originated by the Company and
sold on the secondary market.
The appropriate allowance amount is based upon growth in the loan portfolio,
management's evaluation of the credit quality of the loan portfolio, the
prevailing economic climate, and its effect on borrowers' ability to repay loans
in accordance with the terms of the notes and current loan losses. After
reviewing all factors, management concluded that the current allowance for loan
losses was adequate.
As of March 31, 2003, the allowance for loan losses was $16.9 million, which
represents 2.4% of the total loan balances. As of March 31, 2002, the allowance
was $13.0 million and 2.2% of total loans. The table below illustrates the
change in the allowance for the first three months of 2003 and 2002.
Allowance for Loan Losses (in thousands)
Balance, December 31, 2002 $ 16,684
Provision Charged to Expense 200
Recoveries of Loans Previously Charged Off 23
Loans Charged Off 36
============================================================
Balance, March 31, 2003 $ 16,871
============================================================
Balance, December 31, 2001 $ 12,709
Provision Charged to Expense 200
Recoveries of Loans Previously Charged Off 90
Loans Charged Off 0
============================================================
Balance, March 31, 2002 $ 12,999
============================================================
Non-Interest Income
Overall, non-interest income increased $747 thousand or 33.9% for the three
months ended March 31, 2003 compared to the same period of 2002. Other
non-interest income grew $572 thousand through the first quarter of 2003. The
increase was mainly the result of an increase in the cash surrender value of
life insurance contracts, which were entered into in the second quarter of 2002,
which is recognized as other non-interest income.
Non-Interest Expense
Overall, non-interest expense increased $803 thousand or 11.6% over the first
quarter of 2002, primarily as a result of a $759 increase in Salaries and
Employee Benefits. This increase was due primarily to (1) 18 month cycle salary
merit increases which occurred in October, 2002 and (2) an increased
contribution to the Bank's Profit Sharing Plan.
16
Income Taxes
The provision for income taxes increased 7.0% to $1.9 million for the first
quarter of 2003. Additionally, the Company's effective tax rate decreased for
the first three months of 2003 and was 36.1% compared to 36.9% for the same
period in 2002.
Balance Sheet Analysis
Investment Securities
The Financial Accounting Standards Board statement, Accounting for Certain
Investments in Debt and Equity Securities, requires the Company to classify its
investments as held-to-maturity, trading or available-for-sale. Securities are
classified as held-to-maturity and are carried at amortized cost when the
Company has the positive intent and ability to hold the securities to maturity.
Trading securities are securities acquired for short-term appreciation and are
carried at fair value, with unrealized gains and losses recorded in non-interest
income. Securities classified as available-for-sale include securities, which
may be sold to effectively manage interest rate risk exposure, prepayment risk,
satisfy liquidity demand and other factors. These securities are reported at
fair value with aggregate, unrealized gains or losses excluded from income and
included as a separate component of shareholders' equity, net of related income
taxes.
The investment portfolio provides the Company with an income alternative to
loans. As of March 31, 2003 the investment portfolio represented 29.3% of the
Company's total assets. Total investment securities increased $77.4 million from
a year ago and now total $316.8 million. As previously discussed (see "Net
Interest Income"), the Bank has implemented an asset/liability strategy
involving FHLB borrowings invested in investment securities. Not included in the
investment portfolio are overnight investments in Federal Funds Sold. For the
three months ended March 31, 2003, average Federal Funds Sold was $19.0 million
compared to $37.2 in 2002.
Loans
The Company's loan portfolio at March 31, 2003 increased $98.5 million from
March 31, 2002. The increase was due to strong loan demand in the Company's
market area, along with an aggressive calling program on high quality loan
prospects. Additionally, on an average balance basis loans have increased $101.6
million or 17.4%. The table following sets forth the distribution of the loan
portfolio by type as of the dates indicated.
Loan Portfolio As Of:
(in thousands) March 31, 2003 Dec. 31, 2002 March 31, 2002
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Real Estate $323,487 $322,074 $282,249
Real Estate Construction 67,607 66,467 52,973
Home Equity 47,171 45,150 24,841
Agricultural 101,162 109,130 88,995
Commercial 130,281 135,877 121,440
Consumer 19,094 19,995 19,824
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Gross Loans 688,802 698,693 590,322
Less:
Unearned Income 1,977 2,018 1,116
Allowance for Loan Losses 16,871 16,684 12,999
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Net Loans $669,954 $ 679,991 $ 576,207
======================================== ========================= ====================== =========================
17
In the ordinary course of business, the Company enters into commitments to
extend credit to its customers. These commitments are not reflected in the
accompanying consolidated financial statements. As of March 31, 2003, the
Company had entered into commitments with certain customers amounting to $295
million compared to $307 million at March 31, 2002. Letters of credit at March
31, 2003, and March 31, 2002, were $18 million and $7 million, respectively.
Non-Performing Assets
Non-performing assets are comprised of non-performing loans and other real
estate owned. As set forth in the table below, non-performing loans as of March
31, 2003 were $3.3 million compared to $1.9 million at March 31, 2002. Accrued
interest reversed from income on loans placed on a non-accrual status totaled
$333 thousand at March 31, 2003 compared to $54 thousand at March 31, 2002. The
Company reported no other real estate owned for both March 31, 2003 and March
31, 2002.
Non-Performing Assets
(dollar amounts in thousands) Mar. 31, 2003 Dec. 31, 2002 Mar. 31, 2002
- ----------------------------------------------------------------------------------------
Non-performing Loans $3,273 $2,907 $1,882
Other Real Estate Owned 0 0 0
========================================================================================
Total $3,273 $2,907 $1,882
========================================================================================
Non-Performing Assets
as a % of Total Loans 0.5% 0.4% 0.3%
Allowance for Loan Losses as a % of
Non-Performing Loans 515.5% 573.9% 690.7%
Except for non-performing loans shown in the table above, the Bank's management
is not aware of any loans as of March 31, 2003 for which known credit problems
of the borrower would cause serious doubts as to the ability of such borrowers
to comply with their present loan repayment terms, or any known events that
would result in the loan being designated as non-performing at some future date.
The Bank's management cannot, however, predict the extent to which the
deterioration in general economic conditions, real estate values, increase in
general rates of interest, change in the financial conditions or business of a
borrower may adversely affect a borrower's ability to pay.
Deposits
One of the key sources of funds to support earning assets (loans and
investments) is the generation of deposits from the Company's customer base. The
ability to grow the customer base and subsequently deposits is a significant
element in the performance of the Company.
At March 31, 2003, deposits totaled $850.0 million. This represents an increase
of 8.0% or $63.2 million from March 31, 2002. The increase was focused in demand
and savings accounts, which increased $21.0 million and $34.9 million,
respectively. The Bank's calling efforts for prospective customers includes
acquiring both loan and deposit relationships which results in new demand,
interest bearing transaction and savings accounts.
18
Federal Home Loan Bank Advances
Advances from the Federal Home Loan Bank are another key source of funds to
support earning assets. These advances are also used to manage the Bank's
interest rate risk exposure, and as opportunities exist to borrow and invest the
proceeds at a positive spread through the investment portfolio. FHLB advances as
of March 31, 2003 were $100.9 million compared to $41.0 million as of March 31,
2002. As previously discussed (see "Net Interest Income"), the Bank has
implemented an asset/liability strategy involving FHLB borrowings invested in
investment securities.
Capital
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory-and possibly additional
discretionary-actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of the Company and the Bank's assets, liabilities,
and certain off-balance-sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios set
forth in the table below of Total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined in the regulations), and of
Tier I capital (as defined in the regulations) to average assets (as defined in
the regulations). Management believes, as of March 31, 2003, that the Company
and the Bank meet all capital adequacy requirements to which it is subject.
As of June 30, 2002, the most recent notification from the Federal Reserve Bank
categorized the Company and the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Company and the Bank must maintain minimum Total risk-based, Tier I
risk-based, Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institutions' categories.
To Be Well
Capitalized Under
Regulatory Capital Prompt Corrective
(in thousands) Actual Requirements Action Provisions
- ------------------------------------------------------------------------------------------------------------------
The Company: Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
As of March 31, 2003
Total Capital to Risk Weighted Assets $116,124 12.71% $73,093 8.0% N/A N/A
Tier I Capital to Risk Weighted Assets $104,636 11.45% $36,547 4.0% N/A N/A
Tier I Capital to Average Assets $104,636 10.41% $40,220 4.0% N/A N/A
To Be Well
Capitalized Under
Regulatory Capital Prompt Corrective
(in thousands) Actual Requirements Action Provisions
- ------------------------------------------------------------------------------------------------------------------
The Bank: Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
As of March 31, 2003
Total Capital to Risk Weighted Assets $111,547 12.26% $72,789 8.0% $90,987 10.0%
Tier I Capital to Risk Weighted Assets $100,106 11.00% $36,395 4.0% $54,592 6.0%
Tier I Capital to Average Assets $100,106 10.00% $40,039 4.0% $50,049 5.0%
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management
The Company has adopted a Risk Management Plan to ensure the proper control and
management of all risk factors inherent in the operation of the Company and the
Bank. Specifically, credit risk, interest rate risk, liquidity risk, compliance
risk, strategic risk, reputation risk and price risk can all affect the market
risk of the Company. These specific risk factors are not mutually exclusive. It
is recognized that any product or service offered by the Company may expose the
Company and Bank to one or more of these risk factors.
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor's failure
to meet the terms of any contract or otherwise fail to perform as agreed. Credit
risk is found in all activities where success depends on counterparty, issuer,
or borrower performance.
Credit risk in the investment portfolio and correspondent bank accounts is
addressed through defined limits in the Bank's policy statements. In addition,
certain securities carry insurance to enhance credit quality of the bond.
Credit risk in the loan portfolio is controlled by limits on industry
concentration, aggregate customer borrowings and geographic boundaries.
Standards on loan quality also are designed to reduce loan credit risk. Senior
Management, Directors' Committees, and the Board of Directors are provided with
information to appropriately identify, measure, control and monitor the credit
risk of the Bank.
The Company's methodology for assessing the appropriateness of the allowance is
conducted on a regular basis and considers all loans. The systemic methodology
consists of two major elements. The first major element includes a detailed
analysis of the loan portfolio in two phases. The first phase is conducted in
accordance with SFAS No. 114, "Accounting by Creditors for the Impairment of a
Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a
Loan -- Income Recognition and Disclosures." Individual loans are reviewed to
identify loans for impairment. A loan is impaired when principal and interest
are deemed uncollectable in accordance with the original contractual terms of
the loan. Impairment is measured as either the expected future cash flows
discounted at each loan's effective interest rate, the fair value of the loan's
collateral if the loan is collateral dependent, or an observable market price of
the loan (if one exists). Upon measuring the impairment, the Company will insure
an appropriate level of allowance is present or established.
Central to the first phase and the Company's credit risk management is its loan
risk rating system. The originating credit officer assigns borrowers an initial
risk rating, which is based primarily on a thorough analysis of each borrower's
financial position in conjunction with industry and economic trends. Approvals
are made based upon the amount of inherent credit risk specific to the
transaction and are reviewed for appropriateness by senior credit administration
personnel. Credits are monitored by credit administration personnel for
deterioration in a borrower's financial condition, which would impact the
ability of the borrower to perform under the contract. Risk ratings are adjusted
as necessary.
Based on the risk rating system specific allowances are established in cases
where management has identified significant conditions or circumstances related
to a credit that management believes indicates the possibility of loss.
Management performs a detailed analysis of these loans, including, but not
limited to, cash flows, appraisals of the collateral, conditions of the
marketplace for liquidating the collateral and assessment of the guarantors.
Management then determines the inherent loss potential and allocates a portion
of the allowance for losses as a specific allowance for each of these credits.
20
The second phase is conducted by segmenting the loan portfolio by risk rating
and into groups of loans with similar characteristics in accordance with SFAS
No. 5, "Accounting for Contingencies". In this second phase, groups of loans are
reviewed and applied the appropriate allowance percentage to determine a
portfolio formula allowance.
The second major element in the Company's methodology for assessing the
appropriateness of the allowance consists of management's considerations of all
known relevant internal and external factors that may affect a loan's
collectibility. This includes management's estimates of the amounts necessary
for concentrations, economic uncertainties, the volatility of the market value
of collateral and other relevant factors. The relationship of the two major
elements of the allowance to the total allowance may fluctuate from period to
period.
In the second major element of the analysis which considers all known relevant
internal and external factors that may affect a loan's collectibility is based
upon management's evaluation of various conditions, the effects of which are not
directly measured in the determination of the formula and specific allowances.
The evaluation of the inherent loss with respect to these conditions is subject
to a higher degree of uncertainty because they are not identified with specific
problem credits or portfolio segments. The conditions evaluated in connection
with the second element of the analysis of the allowance include, but are not
limited to the following conditions that existed as of the balance sheet date:
|X| then-existing general economic and business conditions affecting the key
lending areas of the Company;
|X| credit quality trends (including trends in non-performing loans expected to
result from existing conditions);
|X| collateral values;
|X| loan volumes and concentrations;
|X| seasoning of the loan portfolio;
|X| specific industry conditions within portfolio segments;
|X| recent loss experience in particular segments of the portfolio;
|X| duration of the current business cycle;
|X| bank regulatory examination results and
|X| findings of the Company's internal credit examiners.
Management reviews these conditions in discussion with the Company's senior
credit officers. To the extent that any of these conditions is evidenced by a
specifically identifiable problem credit or portfolio segment as of the
evaluation date, management's estimate of the effect of such condition may be
reflected as a specific allowance applicable to such credit or portfolio
segment. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date,
management's evaluation of the inherent loss related to such condition is
reflected in the second major element allowance.
21
Implicit in lending activities is the risk that losses will and do occur and
that the amount of such losses will vary over time. Consequently, the Company
maintains an allowance for loan losses by charging a provision for loan losses
to earnings. Loans determined to be losses are charged against the allowance for
loan losses. The Company's allowance for loan losses is maintained at a level
considered by management to be adequate to provide for estimated losses inherent
in the existing portfolio along with unused commitments to provide financing
including commitments under commercial and standby letters of credit.
Management believes that the allowance for loan losses at March 31, 2003 was
adequate to provide for both recognized losses and estimated inherent losses in
the portfolio. No assurances can be given that future events may not result in
increases in delinquencies, non-performing loans or net loan chargeoffs that
would increase the provision for loan losses and thereby adversely affect the
results of operations.
Asset / Liability Management
Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities
results in uncertainty in the Company's earnings and economic value and is
referred to as interest rate risk. Farmers & Merchants Bancorp's primary
objective in managing interest rate risk is to minimize the potential for
significant loss as a result of changes in interest rates.
The Company measures interest rate risk in terms of potential impact on both its
economic value and earnings. The methods for governing the amount of interest
rate risk include: analysis of asset and liability mismatches (GAP analysis),
the utilization of a simulation model and limits on maturities of investment,
loan and deposit products to relatively short periods which reduces the market
volatility of those instruments.
The gap analysis measures, at specific time intervals, the divergence between
earning assets and interest bearing liabilities for which repricing
opportunities will occur. A positive difference, or gap, indicates that earning
assets will reprice faster than interest-bearing liabilities. This will
generally produce a greater net interest margin during periods of rising
interest rates and a lower net interest margin during periods of declining
interest rates. Conversely, a negative gap will generally produce a lower net
interest margin during periods of rising interest rates and a greater net
interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with
the rates charged on loans. In addition, the magnitude of changes in the rates
charged on loans is not always proportionate to the magnitude of changes in the
rate paid for deposits. Consequently, changes in interest rates do not
necessarily result in an increase or decrease in the net interest margin solely
as a result of the differences between repricing opportunities of earning assets
or interest bearing liabilities.
The Company also utilizes the results of a dynamic simulation model to quantify
the estimated exposure of net interest income to sustained interest rate
changes. The sensitivity of the Company's net interest income is measured over a
rolling one-year horizon.
The simulation model estimates the impact of changing interest rates on interest
income from all interest earning assets and the interest expense paid on all
interest bearing liabilities reflected on the Company's balance sheet. This
22
sensitivity analysis is compared to policy limits, which specify a maximum
tolerance level for net interest income exposure over a one-year horizon
assuming no balance sheet growth, given a 200 basis point upward and a 100 basis
point downward shift in interest rates. A shift in rates over a 12-month period
is assumed. Results that exceed policy limits, if any, are analyzed for risk
tolerance and reported to the Board with appropriate recommendations. At March
31, 2003, the Company's estimated net interest income sensitivity to changes in
interest rates, as a percent of net interest income was an increase in net
interest income of 1.44% if rates increase by 200 basis points and an increase
in net interest income of 0.32% if rates decline 100 basis points.
The estimated sensitivity does not necessarily represent a Company forecast and
the results may not be indicative of actual changes to the Company's net
interest income. These estimates are based upon a number of assumptions
including: the nature and timing of interest rate levels including yield curve
shape, prepayments on loans and securities, pricing strategies on loans and
deposits, replacement of asset and liability cashflows, and other assumptions.
While the assumptions used are based on current economic and local market
conditions, there is no assurance as to the predictive nature of these
conditions including how customer preferences or competitor influences might
change. See Note 13 of the Notes to the Consolidated Financial Statements
located in the 2002 Annual Report to Shareholders.
Liquidity Risk
Liquidity risk is the risk to earnings or capital resulting from the Bank's
inability to meet its obligations when they come due without incurring
unacceptable losses. It includes the ability to manage unplanned decreases or
changes in funding sources and to recognize or address changes in market
conditions that affect the Bank's ability to liquidate assets or acquire funds
quickly and with minimum loss of value. The Company endeavors to maintain a cash
flow adequate to fund operations, handle fluctuations in deposit levels, respond
to the credit needs of borrowers and to take advantage of investment
opportunities as they arise. The principal sources of liquidity include credit
facilities from correspondent banks, brokerage firms and the Federal Home Loan
Bank, as well as, interest and principal payments on loans and investments,
proceeds from the maturity or sale of investments, and growth in deposits.
In general, liquidity risk is managed daily by controlling the level of Fed
Funds and the use of funds provided by the cash flow from the investment
portfolio. The Company maintains overnight investments in Fed Funds as a cushion
for temporary liquidity needs. During the first quarter of 2003, Federal Funds
averaged $19.3 million. The Company maintains Federal Fund credit lines of $50
million with major banks subject to the customary terms and conditions for such
arrangements and $175 million in repurchase lines with major brokers. In
addition the Company has additional borrowing capacity of $31 million from the
Federal Home Loan Bank.
At March 31, 2003, the Company had available liquid assets, which included cash
and cash equivalents and unpledged investment securities of approximately
$139,518,000, which represents 12.9% of total assets.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains controls and procedures designed to ensure that
information is recorded and reported in all filings of financial reports. Such
information is reported to the Company's management, including its Chief
Executive Officer and its Chief Financial Officer to allow timely and accurate
disclosure based on the definition of "disclosure controls and procedures" in
Rule 13a-14(c). In designing these controls and procedures, management
recognizes that they can only provide reasonable assurance of achieving the
desired control objectives. Management also evaluated the cost-benefit
relationship of possible controls and procedures.
23
Within 90 days prior to the date of this report, the Company carried out an
evaluation of the effectiveness of Company's controls and disclosure procedures
under the supervision and with the participation of the Chief Executive Officer,
the Chief Financial Officer and other senior management of the Company. Based on
the foregoing, the Company's Chief Executive Officer and the Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date the Company completed its evaluation.
Average Balance Sheets
The tables on the following pages reflect the Company's average balance sheets
and volume and rate analysis for the three-month periods ending March 31, 2003
and 2002.
The average yields on earning assets and average rates paid on interest-bearing
liabilities have been computed on an annualized basis for purposes of
comparability with full year data. Average balance amounts for assets and
liabilities are the computed average of daily balances.
The volume and rate analysis of net interest revenue summarizes the changes in
average asset and liability balances and interest earned and paid resulting from
changes in average asset and liability balances (volume) and changes in average
interest rates and the total net change in interest income and expenses. The
changes in interest due to both rate and volume have been allocated to volume
and rate changes in proportion to the relationship of the absolute dollar amount
of the change in each.
24
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Three Months Ended March 31, Three Months Ended March 31,
2003 2002
Assets Balance Interest Rate Balance Interest Rate
- ----------------------------------------------------------------------------------------------------------------------------------
Federal Funds Sold $ 19,036 $ 79 1.68% $ 37,211 $ 143 1.56%
Investment Securities Available-for-Sale
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 32,318 266 3.34% 6,224 77 5.02%
Municipals - Taxable 1,343 21 6.34% 1,682 28 6.75%
Municipals - Non-Taxable 31,953 446 5.66% 21,701 362 6.77%
Mortgage Backed Securities 116,312 1,369 4.77% 180,479 2,769 6.22%
Other 20,428 249 4.94% 9,019 158 7.10%
- ----------------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale 202,354 2,351 4.71% 219,105 3,394 6.28%
- ----------------------------------------------------------------------------------------------------------------------------------
Investment Securities Held-to-Maturity
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 0 0 0.00% 0 0 0.00%
Municipals - Taxable 0 0 0.00% 0 0 0.00%
Municipals - Non-Taxable 28,814 522 7.34% 29,961 552 7.47%
Mortgage Backed Securities 0 0 0.00% 0 0 0.00%
Other 479 7 5.93% 546 10 7.43%
- ----------------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Held-to-Maturity 29,293 529 7.32% 30,507 562 7.46%
- ----------------------------------------------------------------------------------------------------------------------------------
Loans
Real Estate 431,262 7,029 6.61% 354,515 6,320 7.23%
Agricultural 100,195 1,289 5.22% 94,542 1,307 5.61%
Commercial 135,856 1,853 5.53% 115,659 1,826 6.40%
Consumer 13,685 303 8.98% 16,150 353 8.86%
Credit Card 4,352 102 9.51% 3,322 84 10.25%
Municipal 1,250 16 5.19% 775 12 6.28%
- ----------------------------------------------------------------------------------------------------------------------------------
Total Loans 686,600 10,592 6.26% 584,963 9,902 6.87%
- ----------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 937,283 $13,550 5.86% 871,786 $14,001 6.51%
======================= =======================
Unrealized Gain/(Loss) on Securities Available-for-Sale 4,496 5,252
Allowance for Loan Losses (16,837) (12,924)
Cash and Due From Banks 29,239 29,117
All Other Assets 54,307 43,712
- ------------------------------------------------------------------------ ------------
Total Assets $1,008,488 $936,943
======================================================================== ============
Liabilities & Shareholders' Equity
Interest Bearing Deposits
Interest Bearing DDA $89,325 $ 49 0.22% $89,210 $ 89 0.40%
Savings 243,202 345 0.58% 210,742 613 1.18%
Time Deposits 320,855 1,907 2.41% 316,919 2,632 3.37%
- ----------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Deposits 653,382 2,301 1.43% 616,871 3,334 2.19%
Other Borrowed Funds 49,493 577 4.73% 40,997 550 5.44%
- ----------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities 702,875 $2,878 1.66% 657,868 $3,884 2.39%
======================= =======================
Demand Deposits (Non-Interest Bearing) 192,794 169,686
All Other Liabilities 7,999 8,520
- ------------------------------------------------------------------------ ------------
Total Liabilities 903,668 836,074
Shareholders' Equity 104,820 100,869
- ------------------------------------------------------------------------ ------------
Total Liabilities & Shareholders' Equity $1,008,488 $936,943
======================================================================== ============
Net Interest Margin 4.62% 4.71%
===========================================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable
equivalent basis using the combined Federal and State income tax rate of 42.06%.
Loan Fees are included in interest income for loans. Unearned discount is
included for rate calculation purposes. Nonaccrual loans and lease financing
receivables have been included in the average balances. Yields on securities
available-for-sale are based on historical cost.
25
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Revenue
(Rates on a Taxable Equivalent Basis)
(in thousands) Three Months Ended
Mar. 31, 2003 compared to Mar. 31, 2002
Interest Earning Assets Volume Rate Net Chg.
- ---------------------------------------------------------------------------------------------------------------------------
Federal Funds Sold $ (134) $ 70 $ (64)
Investment Securities Available for Sale
U.S. Treasuries 0 0 0
U.S. Agencies 368 (179) 189
Municipals - Taxable (5) (2) (7)
Municipals - Non-Taxable 420 (336) 84
Mortgage Backed Securities (846) (554) (1,400)
Other 388 (297) 91
- ---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available for Sale 325 (1,368) (1,043)
- ---------------------------------------------------------------------------------------------------------------------------
Investment Securities Held to Maturity
U.S. Treasuries 0 0 0
U.S. Agencies 0 0 0
Municipals - Taxable 0 0 0
Municipals - Non-Taxable (21) (9) (30)
Mortgage Backed Securities 0 0 0
Other (1) (2) (3)
- ---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Held to Maturity (22) (11) (33)
- ---------------------------------------------------------------------------------------------------------------------------
Loans:
Real Estate 3,656 (2,947) 709
Agricultural (10) (8) (18)
Commercial 1,148 (1,121) 27
Installment (81) 31 (50)
Credit Card 55 (37) 18
Other 16 (12) 4
- ---------------------------------------------------------------------------------------------------------------------------
Total Loans 4,784 (4,094) 690
- ---------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 4,953 (5,403) (450)
- ---------------------------------------------------------------------------------------------------------------------------
Interest Bearing Liabilities
Interest Bearing Deposits:
Transaction 0 (40) (40)
Savings 527 (795) (268)
Time Deposits 224 (949) (725)
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Deposits 751 (1,784) (1,033)
Other Borrowed Funds 374 (347) 27
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities 1,125 (2,131) (1,006)
- ---------------------------------------------------------------------------------------------------------------------------
Total Change $3,828 $ (3,272) $ 556
===========================================================================================================================
Notes: Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total "net change." The above
figures have been rounded to the nearest whole number.
26
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Certain lawsuits and claims arising in the ordinary course of business have been
filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
ITEM 2. Changes in Securities
None
ITEM 3. Defaults Upon Senior Securities
Not applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
None
ITEM 5. Other Information
None
ITEM 6(a). Exhibits
See Exhibit Index on Page 32
ITEM 6(b). Reports on Form 8-K
None
27
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FARMERS & MERCHANTS BANCORP
/s/ Kent A. Steinwert
Date: May 9, 2003 ________________________
Kent A. Steinwert
President and
Chief Executive Officer
(Principal Executive Officer)
/s/ Stephen W. Haley
Date: May 9, 2003 ________________________
Stephen W. Haley
Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)
Certification
I, Kent A. Steinwert, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Farmers & Merchants
Bancorp;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
28
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Kent A. Steinwert
Date: May 9, 2003 ________________________
Kent A. Steinwert
President and
Chief Executive Officer
Certification
I, Stephen W. Haley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Farmers & Merchants
Bancorp;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
29
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Stephen W. Haley
Date: May 9, 2003 ________________________
Stephen W. Haley
Executive Vice President and
Chief Financial Officer
30
Index to Exhibits
Exhibit No. Description
2 Plan of Reorganization as filed on Form 8-K dated April 30, 1999,
are incorporated herein by reference.
3(i) Amended and Restated Certificate of Incorporation of Farmers &
Merchants Bancorp, filed as Exhibit 3(i) to Registrant's 8-K
dated April 30, 1999, is incorporated herein by reference.
3(ii) By-Laws of Farmers & Merchants Bancorp, filed as Exhibit 3(i) to
Registrant's 8-K dated April 30, 1999, is incorporated herein by
reference.
10.1 Employment Agreement dated July 8, 1997, between Farmers &
Merchants Bank of Central California and Kent A. Steinwert, filed
as Exhibit 10.1 to Registrant's 8-K dated April 30, 1999, is
incorporated herein by reference.
10.2 Employment Agreement dated July 8, 1997, between Farmers &
Merchants Bank of Central California and Richard S. Erichson,
filed as Exhibit 10.2 to Registrant's 8-K dated April 30, 1999,
is incorporated herein by reference.
10.3 Deferred Bonus Plan of Farmers & Merchants Bank of Central
California adopted as of March 2, 1999, filed as Exhibit 10.3 to
Registrant's 8-K dated April 30, 1999, is incorporated herein by
reference.
10.4 Amended and Restated Deferred Bonus Plan of Farmers & Merchants
Bank of Central California, executed May 11, 1999, filed as
Exhibit 10.4 to Registrant's 8-K dated April 30, 1999, is
incorporated herein by reference.
10.5 Employment Agreement dated December 29, 2000, between Farmers &
Merchants Bank of Central California and Deborah E. Hodkin, filed
as Exhibit 10.5 to Registrant's 10-K for the year ended December
31, 2002, is incorporated herein by reference.
10.6 Employment Agreement dated December 10, 2001, between Farmers &
Merchants Bank of Central California and Chris C. Nelson, filed
as Exhibit 10.6 to Registrant's 10-K for the year ended December
31, 2002, is incorporated herein by reference.
10.7 Employment Agreement dated March 25, 2003, between Farmers &
Merchants Bank of Central California and Stephen W. Haley, filed
as Exhibit 10.7 to Registrant's 10-K for the year ended December
31, 2002, is incorporated herein by reference
99.1 Chief Executive Officer Certification pursuant to 10 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Chief Financial Officer Certification pursuant to 10 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
31