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 June 30, 2004
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: 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 797,005 as of July 30, 2004.
1
FARMERS & MERCHANTS BANCORP
FORM 10-Q
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION Page
Item 1 - Financial Statements
Consolidated Balance Sheets as of June 30, 2004,
December 31, 2003 and June 30, 2003. 3
Consolidated Statements of Income for the Three Months
and Six Months Ended June 30, 2004 and 2003. 4
Consolidated Statements of Comprehensive Income for the Three
Months and Six Months Ended June 30, 2004 and 2003. 5
Statement of Changes in Shareholders' Equity for the Six
Months Ended June 30, 2004 and 2003. 6
Consolidated Statement of Cash Flows for the Six
Months Ended June 30, 2004 and 2003. 7
Notes to Consolidated Financial Statements 8
Item 2 - Management's Discussion and Analysis 13
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 22
Item 4 - Controls and Procedures 25
PART II. - OTHER INFORMATION 30
Signatures 32
Index to Exhibits 33
2
PART I. - FINANCIAL INFORMATION
Item 1 - Financial Statements
FARMERS & MERCHANTS BANCORP
Consolidated Balance Sheets
- ------------------------------------------------------------- -------------- -------------- --------------
(in thousands) June 30, December 31, June 30,
2004 2003 2003
Assets (Unaudited) (Unaudited)
- ------------------------------------------------------------- -------------- -------------- --------------
Cash and Cash Equivalents:
Cash and Due From $32,518 $35,800 $48,316
Federal Funds Sold 6,300 0 0
- ------------------------------------------------------------- -------------- -------------- --------------
Total Cash and Cash Equivalents 38,818 35,800 48,316
Investment Securities:
Available-for Sale 188,022 223,965 218,010
Held-to-Maturity 72,159 37,957 42,907
- ------------------------------------------------------------- -------------- -------------- --------------
Total Investment Securities 260,181 261,922 260,917
- ------------------------------------------------------------- -------------- -------------- --------------
Loans 842,736 808,998 750,137
Less: Unearned Income (2,014) (2,092) (2,168)
Less: Allowance for Loan Losses (17,776) (17,220) (17,091)
- ------------------------------------------------------------- -------------- -------------- --------------
Loans, Net 822,946 789,686 730,878
- ------------------------------------------------------------- -------------- -------------- --------------
Land, Buildings & Equipment 11,644 11,209 11,099
Interest Receivable and Other Assets 53,663 49,948 44,406
- ------------------------------------------------------------- -------------- -------------- --------------
Total Assets $1,187,252 $1,148,565 $1,095,616
============================================================= ============== ============== ==============
Liabilities & Shareholders' Equity
- ------------------------------------------------------------- -------------- -------------- --------------
Deposits:
Demand $229,809 $223,000 $196,845
Interest Bearing Transaction 92,439 96,869 88,889
Savings 284,564 276,016 243,699
Time Deposits 361,501 308,464 328,299
- ------------------------------------------------------------- -------------- -------------- --------------
Total Deposits 968,313 904,349 857,732
- ------------------------------------------------------------- -------------- -------------- --------------
Fed Funds Purchased 0 1,000 0
FHLB Borrowings 85,909 111,928 121,965
Subordinated Debentures 10,310 10,310 0
Other Liabilities 11,788 11,373 7,472
- ------------------------------------------------------------- -------------- -------------- --------------
Total Liabilities 1,076,320 1,038,960 987,169
- ------------------------------------------------------------- -------------- -------------- --------------
Commitments & Contingencies (See Note. 4)
Shareholders' Equity
Common Stock 8 8 8
Additional Paid In Capital 84,218 72,506 72,717
Retained Earnings 30,376 37,650 33,052
Accumulated Other Comprehensive (Loss) Income (3,670) (559) 2,670
- ------------------------------------------------------------- -------------- -------------- --------------
Total Shareholders' Equity 110,932 109,605 108,447
- ------------------------------------------------------------- -------------- -------------- --------------
Total Liabilities & Shareholders' Equity $1,187,252 $1,148,565 $1,095,616
============================================================= ============== ============== ==============
The accompanying notes are an integral part of these consolidated financial
statements
3
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Income (Unaudited)
- ------------------------------------------------------------------------------ ---------- ---------
(in thousands) Three Months Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Interest Income
Interest & Fees on Loans $11,983 $11,084 $23,656 $21,676
Federal Funds Sold 8 18 60 97
Securities:
Taxable 2,028 2,046 3,754 3,955
Non-taxable 546 722 1,140 1,341
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Total Interest Income 14,565 13,870 28,610 27,069
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Interest Expense
Interest Bearing Transaction 15 30 29 79
Savings 251 352 507 697
Time Deposits 1,263 1,737 2,585 3,644
Interest on Borrowed Funds 782 828 1,498 1,405
Interest on Subordinated Debentures 103 0 208 0
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Total Interest Expense 2,414 2,947 4,827 5,825
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Net Interest Income 12,151 10,923 23,783 21,244
Provision for Loan Losses 350 125 725 325
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Net Interest Income After Provision for Loan Losses 11,801 10,798 23,058 20,919
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Non-Interest Income
Service Charges on Deposit Accounts 1,269 1,228 2,458 2,404
Net Gain (Loss) on Sale of Investment Securities 106 242 747 374
Credit Card Merchant Fees 453 389 837 743
Increase in Cash Surrender Value of Life Insurance 389 390 809 773
Other 1,218 938 2,128 1,844
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Total Non-Interest Income 3,435 3,187 6,979 6,138
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Non-Interest Expense
Salaries & Employee Benefits 5,785 5,311 11,838 10,250
Occupancy 391 368 850 773
Equipment 538 497 978 1,098
Other Operating 2,016 2,144 3,762 3,948
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Total Non-Interest Expense 8,730 8,320 17,428 16,069
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Net Income Before Taxes 6,506 5,665 12,609 10,988
Provision for Taxes 2,402 2,021 4,603 3,943
- ------------------------------------------------------- ----------- ---------- ---------- ---------
Net Income $4,104 $3,644 $8,006 $7,045
======================================================= =========== ========== ========== =========
Earnings Per Share $5.14 $4.54 $10.02 $8.76
======================================================= =========== ========== ========== =========
The accompanying notes are an integral part of these consolidated financial
statements
4
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Comprehensive (Loss) Income (Unaudited)
- ----------------------------------------------------------------------------------- ----------- ---------- ----------- -----------
(in thousands) For Three Months For Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
- ----------------------------------------------------------------------------------- ----------- ---------- ----------- -----------
Net Income $ 4,104 3,644 8,006 7,045
Other Comprehensive (Loss) Income -
Unrealized (Losses) Gains on Derivative Instruments:
Unrealized holding (losses) gains arising during the period, net
of income tax effects of $(11)and $30 for the quarters ended
June 30, 2004 and 2003, respectively, and $64 and $85
for the six months ended June 30, 2004 and 2003, respectively. (16) 41 88 117
Less: Reclassification adjustment for realized losses included in net
income, net of related income tax effects of $(33) and $0 for the
quarters ended June 30, 2004 and 2003, respectively, and $(65) and
$0 for the six months ended June 30, 2004 and 2003, respectively. (45) - (89) -
Unrealized (Losses) Gains on Securities:
Unrealized holding (losses) gains arising during the period, net of
income tax effects of $(2,825) and $870 for the quarters ended June
30, 2004 and 2003, respectively, and of $(1,943) and $682
for the six months ended June 30, 2004 and 2003, respectively. (3,892) 1,200 (2,677) 940
Less: Reclassification adjustment for realized losses included
in net income, net of related income tax effects of $(44) and $(101)
for the quarters ended June 30, 2004 and 2003, respectively, and of
$(314) and $(157) for the six months ended June 30, 2004 and 2003, (61) (141) (433) (217)
respectively.
- ----------------------------------------------------------------------------------- ----------- ---------- ----------- -----------
Total Other Comprehensive (Loss) Income (4,014) 1,100 (3,111) 840
- ----------------------------------------------------------------------------------- ----------- ---------- ----------- -----------
Comprehensive Income $ 90 $ 4,744 $ 4,895 $ 7,885
=================================================================================== =========== ========== =========== ===========
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 (Loss) Equity
- ------------------------------------ ------------- --------- ----------- --------- ---------------- --------------
Balance, December 31, 2002 733,021 $ 7 $ 64,979 $36,749 $ 1,830 $ 103,565
- ------------------------------------ ------------- --------- ----------- --------- ---------------- --------------
Net Income
- - 7,045 - 7,045
Cash Dividends Declared on
Common Stock - - (1,604) - (1,604)
5% Stock Dividend 35,985 1 8,996 (8,996) - 1
Cash Paid in Lieu of Fractional
Shares Related to Stock Dividend - - (142) - (142)
Redemption of Stock (5,029) - (1,258) - - (1,258)
Unrealized Gains on Derivative Instruments 117 117
Changes in Net Unrealized Gain (Loss) on
Securities Available for Sale - - - 723 723
- ------------------------------------ ------------- --------- ----------- --------- ---------------- --------------
Balance, June 30, 2003 763,977 $ 8 $ 72,717 $33,052 $ 2,670 $ 108,447
==================================== ============= ========= =========== ========= ================ ==============
- ------------------------------------ ------------- --------- ----------- --------- ---------------- --------------
Balance, December 31, 2003 763,274 $ 8 $ 72,506 $37,650 $ (559) $ 109,605
- ------------------------------------ ------------- --------- ----------- --------- ---------------- --------------
Net Income
- - 8,006 - 8,006
Cash Dividends Declared on -
Common Stock - - (2,235) - (2,235)
5% Stock Dividend 37,429 - 12,838 (12,838) - -
Cash Paid in Lieu of Fractional
Shares Related to Stock Dividend - - (207) - (207)
Redemption of Stock (3,141) - (1,126) - - (1,126)
Unrealized Gains on
Derivitive Instruments (1) (1)
Changes in Net Unrealized Gain (Loss)
on Securities Available for Sale - - - (3,110) (3,110)
- ------------------------------------ ------------- --------- ----------- --------- ---------------- --------------
Balance, June 30, 2004 797,562 $ 8 $ 84,218 $30,376 $ (3,670) $ 110,932
==================================== ============= ========= =========== ========= ================ ==============
The accompanying notes are an integral part of these consolidated financial
statements
6
FARMERS & MERCHANTS BANCORP
Consolidated Statement of Cash Flows (Unaudited) Six Months Ended
- -------------------------------------------------------------------------------------------------- ---------------------------
(in thousands) June 30, June 30,
2004 2003
- ----- -------------------------------------------------------------------------------------------- ------------- -------------
Operating Activities:
Net Income $8,006 $7,045
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Provision for Loan Losses 725 325
Depreciation and Amortization 778 788
Provision for Deferred Income Taxes (360) (50)
Net Amortization of Investment Security Premium & Discounts 529 810
Net Gain on Sale of Investment Securities (747) (374)
Net Gain on Sale of Property & Equipment (125) -
Net Change in Operating Assets & Liabilities:
Increase in Interest Receivable and Other Assets (1,099) (1,796)
Increase (Decrease) in Interest Payable and Other Liabilities 415 (2,584)
- -------------------------------------------------------------------------------------------------- ------------- -------------
Net Cash Provided by Operating Activities 8,122 4,164
Investing Activities:
Securities Available-for-Sale:
Purchased (52,321) (139,443)
Sold or Matured 83,042 128,276
Securities Held-to-Maturity:
Purchased (37,706) (22,096)
Matured 3,577 7,091
Net Increase in Loans (34,059) (51,584)
Principal Collected on Loans Charged Off 74 372
Net Additions to Premises and Equipment (1,262) (545)
Proceeds from Sale of Property & Equipment 174 -
- -------------------------------------------------------------------------------------------------- ------------- -------------
Net Cash Used by Investing Activities (38,481) (77,929)
Financing Activities:
Net Decrease in Demand, Interest-Bearing Transaction,
and Savings Accounts 10,927 (2,174)
Increase (Decrease) in Time Deposits 53,037 9,681
Federal Funds Purchased (1,000) (16,997)
Net (Decrease) Increase in Federal Home Loan Bank Borrowings (26,019) 81,000
Cash Dividends (2,442) (1,746)
Stock Redemption (1,126) (1,257)
- -------------------------------------------------------------------------------------------------- ------------- -------------
Net Cash Provided by Financing Activities 33,377 68,507
Increase (Decrease) in Cash and Cash Equivalents 3,018 (5,258)
Cash and Cash Equivalents at Beginning of Year 35,800 53,574
- -------------------------------------------------------------------------------------------------- ------------- -------------
Cash and Cash Equivalents as of June 30, 2004 and June 30, 2003 $38,818 $48,316
================================================================================================== ============= =============
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 six months ended June 30, 2004 and June 30, 2003
1. Significant Accounting Policies
Farmers & Merchants Bancorp (the Company) was organized March 10, 1999. Primary
operations are related to traditional banking activities through its subsidiary
Farmers & Merchants Bank of Central California (the Bank) which was established
in 1916. The consolidated financial statements of the Company and its
subsidiary, the Bank, are prepared in conformity with generally accepted
accounting principles (GAAP) 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. In December
2003, the Company formed a wholly owned subsidiary, FMCB Statutory Trust I. FMCB
Statutory Trust I, is a non-consolidated subsidiary per GAAP, and was formed for
the sole purpose of issuing Trust Preferred Securities.
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 Company 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 Company to be
other than temporary, are recognized in the period in which they become known.
8
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.
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 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. Thereafter,
interest income is recognized as it is collected in cash.
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 estimated. 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 and considers problem loans, delinquencies, internal credit
reviews, current economic conditions, loan loss experience and other factors 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.
9
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" and SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan-Income Recognition and Disclosures". 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.
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 at fair value less estimated selling costs upon
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. 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. 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 June 30, 2004, was 797,562. 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
six months ending June 30, 2004 and 2003 were 799,132 and 804,400, respectively.
Earnings per share for the six months ending June 30, 2004 and 2003 were $10.02
and $8.76, respectively. Weighted average number of shares for the three months
ending June 30, 2004 and 2003 were 797,985 and 802,804, respectively. Earnings
per share for the three months ending June 30, 2004 and 2003 were $5.14 and
$4.54, respectively. Prior periods per share amounts have been restated for the
5% stock dividend declared during 2004 and 2003.
10
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.
On April 6, 2004, the Board of Directors declared a 5% stock dividend payable
May 12, 2004, to shareholders of record at the close of business on April 16,
2004. Common stock shareholders of record as of April 16, 2004 received one
share of common stock for every 20 shares of common stock owned. Fractional
shares were not issued. For common stock share lots of less than 20 shares, a
cash dividend in the amount of $17.15 per share was paid in lieu of the stock
dividend.
The Board of Directors of Farmers & Merchants Bancorp declared a cash dividend
on June 1, 2004, in the amount of $2.80 per share, an increase from the $2.10
per share paid last year. The cash dividend was paid on July 1, 2004, to
stockholders of record as of June 14, 2004.
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. Thus, all necessary requirements
of SFAS No. 131 have been met by the Company as of June 30, 2004.
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 and No. 149, 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.
11
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 GAAP
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, minimum pension
liability adjustments and cash flow hedges.
2. Recent Accounting Developments
FIN 46 may have an impact on the treatment of the trust preferred securities we
have issued and ability for those instruments to continue to provide the Company
with Tier 1 capital. FIN 46 prevents the Company from consolidating the trust
entity that issued these trust preferred securities. The Federal Reserve has
issued regulations which allow for the inclusion of these instruments in Tier 1
capital regardless of the impact of FIN 46 on the consolidation of the trusts.
There remains the potential that this determination by the Federal Reserve may
be changed at a later date. We do not expect FIN 46 to have any other material
impact on the Company's financial condition or operating results.
On March 9, 2004, the Staff of the Securities and Exchange Commission (the "SEC
Staff") issued Staff Accounting Bulletin No. 105, Application of Accounting
Principles to Loan Commitments ("SAB 105"). SAB 105 provides guidance on the
initial recognition and measurement of loan commitments that meet the definition
of a derivative, and summarizes the related disclosure requirements.
SAB 105 is effective for all loan commitments accounted for as derivatives that
are entered into, or substantially modified, on or after April 1, 2004.
SAB 105 addresses loan commitments that the Financial Accounting Standards Board
(FASB) defines as derivatives in paragraph 6 of FASB Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended by FASB
Statement No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities ("FAS 133"). These loan commitments relate to the origination
of mortgage loans that will be held for sale. SAB 105 does not apply to (1)
commitments to purchase mortgage loans that do not meet the definition of a
derivative under paragraph 6 of FAS 133 or (2) commitments that are explicitly
excluded from the scope of FAS 133 (i.e., commitments to originate mortgage
loans that will be held for investment purposes and loan commitments to
originate other types of loans).
The Company does not currently originate mortgage loans to be held for sale. If
that should change in the future, we would take SAB 105 into consideration but
do not expect it to have a material impact on the Company's financial condition
or operating results.
12
3. Interim-Period Disclosure of Employee Benefit Plans
Components of Net Periodic Pension Cost:
Six months ended June 30, Pension Benefits
-----------------------------------
(in thousands) 2004 2003
-------------- -------------
Service cost $ 12 $ 13
Interest cost 64 56
Expected return on assets (57) (32)
Amortization of (gain)/loss 126 94
Amortization of prior service cost 0 0
Amortization of transition obligation 0 0
-------------- -------------
Net periodic pension cost $ 145 $ 131
============== =============
Employer Contributions
The Company previously disclosed in its financial statements for the year ended
December 31, 2003 that it expected to contribute $222,000 to its Pension Plan in
2004. As of June 30, 2004, $0 has been contributed to the Plan. On July 13,
2004, the Company contributed $225,000 to the Plan. At the current time, the
Company does not intend to make additional 2004 contributions.
4. Commitments and Contingencies
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These instruments include commitments to extend credit, letters of credit and
financial guarantees that are not reflected in the Consolidated Balance Sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party with regard to standby letters of credit, undisbursed loan
commitments and financial guarantees is represented by the contractual notional
amount of those instruments. Commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. The Company uses the same credit policies in making commitments
and conditional obligations as it does for recorded balance sheet items. The
Company may or may not require collateral or other security to support financial
instruments with credit risk. Evaluations of each customer's creditworthiness
are performed on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to
guarantee performance of or payment for a customer to a third party. The Company
had standby letters of credit outstanding of $13.1 million June 30, 2004, and
$18.1 million at June 30, 2003. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition contained
in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Undisbursed loan
commitments totaled $323.1 million and $262.5 million as of June 30, 2004 and
2003, respectively. Since many of these commitments are expected to expire
without fully being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company does not anticipate any loss as
a result of these transactions.
In the ordinary course of business, the Company becomes involved in litigation
arising out of its normal business activities. Management, after consultation
with legal counsel, is of the opinion that the ultimate liability, if any,
resulting from the disposition of such claims would not be material in relation
to the financial position of the Company.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
Forward-Looking Statements
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. 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 2003 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 includes 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, 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 laws or
regulations; (v) competitive pressure in the banking industry; (vi) changes in
governmental fiscal or monetary policies; (vii) 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; (viii) dividend restrictions; (ix)
asset/liability pricing risks and liquidity risks; (x) changes in the securities
markets; (xi) certain operational risks involving data processing systems or
fraud; (xii) the State of California's fiscal difficulties; and (xiii) other
external developments which could materially impact the Company's operational
and financial performance. Additional information on these and other factors
that could affect financial results are included in the Company's Securities and
Exchange Commission filings.
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.
Overview
The Company's primary service area encompasses the northern Central Valley of
California, a territory that is significantly impacted by the agricultural
industry. Accordingly, any discussion of the Company's Financial Condition and
Results of Operations is influenced by the seasonal banking needs of its
customers. Comparisons of the current quarter's results, both in terms of the
balance sheet and income statement, are most meaningful to the same quarter in
the prior year, not to the prior calendar quarter.
For the three and six months ended June 30, 2004, Farmers & Merchants Bancorp
reported net income of $4,104,000 and $8,006,000, earnings per share of $5.14
and $10.02 and return on average assets of 1.41% and 1.39%. Return on average
shareholders' equity was 14.61% and 14.33% for the three and six months ended
June 30, 2004. For the three and six months ended June 30, 2003, net income
totaled $3,644,000 and $7,045,000, earnings per share was $4.54 and $8.76 and
return on average assets was 1.34% for both periods. Return on average
shareholders' equity for the three and six months ended June 30, 2003 was 13.57%
and 13.28%, respectively.
14
The Company's improved earnings performance in the first half of 2004 when
compared to the same period last year 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) an improvement in the efficiency ratio from 58.68%
for the six months ended June 30, 2003 to 56.65% for the six months ended June
30, 2004.
The following is a summary of the financial results for the six-month period
ended June 30, 2004 compared to June 30, 2003.
o Net income increased 13.6% to $8.0 million from $7.0 million.
o Earnings per share increased 14.4% to $10.02 from $8.76.
o Net interest income increased 12.0% to $23.8 million from $21.2 million.
o Total assets increased 8.4% to $1.2 billion.
o Gross loans increased 12.3% to $842.7 million.
o Total deposits increased 12.9% to $968.3 million.
o Total shareholders' equity increased 2.3% to $110.9 million after stock
repurchases of $1.1 million and cash dividends of $2.4 million.
Results of Operations
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.
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.
Net interest income increased 12.0% to $23.8 million during the first six months
of 2004, compared to $21.2 million at June 30, 2003. On a fully taxable
equivalent basis, net interest income increased 11.0% and totaled $23.8 million
at June 30, 2004, compared to $21.2 million for the first six months of 2003.
The primary reason for the increase in net interest income during the first half
of 2004 when compared to the same period last year was an improvement in the
volume and mix (as reflected by an increase in loans as a percentage of average
earning assets) of earning assets.
15
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. For the
three months ended June 30, 2004, the net interest margin on a taxable
equivalent basis was 4.58% compared to 4.47% in 2003. This is the first
quarterly increase in the net interest margin over the same period in the prior
year since the third quarter of 2002. Although the yields on the Bank's earning
assets continued to drop primarily as a result of the continuing negative impact
of declines in market interest rates during 2002 and 2003, the cost of interest
bearing sources of funds decreased even further, resulting in an increase in the
net interest margin. On June 30, 2004, the Federal Reserve Bank increased market
interest rates by 25 basis points. As a result the Bank increased its prime rate
by 25 basis points to 4.25% on July 1, 2004. As market interest rates rise, the
Bank's net interest margin is expected to improve.
Loans, generally the Company's highest earning asset, increased $92.6 million as
of June 30, 2004 compared to June 30, 2003. On an average balance basis, loans
increased by $103.9 million for the six months ended June 30, 2004. Due to the
continuing negative impact of a decline in interest rates during 2002 and 2003,
the yield on the loan portfolio decreased 34 basis points to 5.89% for the six
months ended June 30, 2004 compared to 6.23% for the six months ended June 30,
2003. This decrease in yield was offset by the growth in loan balances, which
resulted in interest revenue from loans increasing 9.1% to $23.6 million for the
first six months of 2004.
The investment portfolio is the other main component of the Company's earning
assets. The Company's investment policy is conservative. The Company invests
primarily 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 generally less than that of loans.
Average investment securities decreased $7.6 million compared to the average
balance at June 30, 2003. With the decrease in the average balance of investment
securities there was a decrease in interest income of $511,000 for the six
months ended June 30, 2004, due to the continuing negative impact of a decline
in interest rates during 2002 and 2003. The six months average yield, on a
taxable equivalent basis, in the investment portfolio was 4.40% in 2004 compared
to 4.66% in 2003. Net interest income on the Schedule of Year-to-Date Average
Balances and Interest Rates located on page 28 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 $65.5 million or 8.8%. Of
that increase, average borrowed funds (primarily FHLB Advances) increased $24.6
million, subordinated debentures increased $10.3 million and interest-bearing
deposits increased $30.6 million. Even as interest-bearing sources of funds
increased, interest expense decreased 17.1% as a result of declining interest
rates paid for those sources of funds. Overall, the average interest cost on
interest-bearing sources of funds was 1.2% at June 30, 2004 and 1.6% at June 30,
2003.
Allowance and Provision for Loan Losses
As a financial institution that assumes lending and credit risks as a principal
element of its business, 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. The allowance is increased by provisions charged to
operating expense and reduced by net charge-offs. 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.
16
After reviewing all factors, management concluded that the allowance for loan
losses as of June 30, 2004 was adequate. The Company has established credit
management policies and procedures that govern both the approval of new loans
and the monitoring of the existing portfolio. The Company manages and controls
credit risk through comprehensive underwriting and approval standards, portfolio
diversification guidelines, dollar limits on loans to one borrower and by
restricting loans made primarily to its principal market area where management
believes it is better able to assess the applicable risk. Management reports
regularly to the Board of Directors regarding trends and conditions in the loan
portfolio and regularly conducts credit reviews of individual loans. Loans that
are performing but have shown some signs of weakness are subjected to more
stringent reporting and oversight.
As of June 30, 2004, the allowance for loan losses was $17.8 million, which
represents 2.1% of the total loan balances. As of June 30, 2003, the allowance
was $17.1 million or 2.3% of total loans. The table below illustrates the change
in the allowance for the first six months of 2004 and 2003.
Allowance for Loan Losses (in thousands)
Balance, December 31, 2003 $17,220
Provision Charged to Expense 725
Recoveries of Loans Previously Charged Off 74
Loans Charged Off (243)
==========================================================================
Balance, June 30, 2004 $17,776
==========================================================================
Balance, December 31, 2002 $16,684
Provision Charged to Expense 325
Recoveries of Loans Previously Charged Off 372
Loans Charged Off (290)
==========================================================================
Balance, June 30, 2003 $17,091
==========================================================================
Non-Interest Income
Overall, non-interest income increased $841,000 or 13.7% for the six months
ended June 30, 2004 compared to the same period of 2003. Most of the growth
occurred in gain on sale of investment securities, which increased $373,000
through the first six months of 2004. The increase was mainly the result of the
Company's decision to take advantage of the decline in interest rates that began
in early January 2004 and continued through early April 2004, by selling
approximately $37 million in investment securities for a gain. As a result of
the recent increases in overall market interest rates, the Company does not
anticipate that these gains will recur during the remainder of 2004.
Non-Interest Expense
Overall, non-interest expense increased $1.3 million or 8.5% over the first six
months of 2004, primarily as a result of a $1.6 million increase in Salaries and
Employee Benefits. This increase was due primarily to officer salary merit
increases which occurred in May, 2004 and increased contributions to the Bank's
retirement plans and incentive compensation plans.
17
Income Taxes
The provision for income taxes increased 16.7% to $4.6 million for the first six
months of 2004. The Company's effective tax rate increased for the first six
months of 2004 and was 36.5% compared to 35.9% for the same period in 2003.
Financial Condition
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 June 30, 2004 the investment portfolio represented 21.9% of the
Company's total assets. Total investment securities decreased $736,000 from a
year ago and now total $260.2 million. As previously discussed (see "Non
Interest Income"), during the first quarter of 2004, the Bank took advantage of
the decline in interest rates that began in January 2004 to sell approximately
$37 million in investment securities for a gain. During the second quarter of
2004, as rates increased, the Bank reinvested these funds. Not included in the
investment portfolio are overnight investments in Federal Funds Sold. For the
six months ended June 30, 2004, average Federal Funds Sold was $11.8 million
compared to $11.6 million in 2003.
Loans
The Company's loan portfolio at June 30, 2004 increased $92.6 million from June
30, 2003. 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 $103.9 million or
14.8%. The table following sets forth the distribution of the loan portfolio by
type as of the dates indicated.
18
Loan Portfolio As Of:
(in thousands) June 30, 2004 Dec. 31, 2003 June 30, 2003
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Real Estate $420,835 $386,735 $375,413
Real Estate Construction 65,742 77,115 61,993
Home Equity 56,628 55,827 48,377
Agricultural 139,425 134,862 115,722
Commercial 143,695 136,955 128,950
Consumer 16,411 17,504 19,682
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Gross Loans 842,736 808,998 750,137
Less:
Unearned Income 2,014 2,092 2,168
Allowance for Loan Losses 17,776 17,220 17,091
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Net Loans $822,946 $ 789,686 $ 730,878
======================================== ========================= ====================== =========================
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 June 30, 2004, the Company
had entered into commitments with certain customers amounting to $323.1 million
compared to $262.5 million at June 30, 2003. Letters of credit at June 30, 2004,
and June 30, 2003, were $13.1 million and $18.1 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 June
30, 2004 were $2.5 million compared to $2.9 million at June 30, 2003. Accrued
interest reversed from income on loans placed on a non-accrual status totaled
$338,000 at June 30, 2004 compared to $386,000 at June 30, 2003. The Company
reported no other real estate owned for both June 30, 2004 and June 31, 2003.
Non-Performing Assets
(in thousands) June 30, 2004 Dec. 31, 2003 June 30, 2003
- --------------------------------------- ------------------------ ----------------------- ------------------------
Non-performing Loans $2,483 $2,584 $2,928
Other Real Estate Owned - - -
======================================= ======================== ======================= ========================
Total* $2,483 $2,584 $2,928
======================================= ======================== ======================= ========================
- --------------------------------------- ------------------------ ----------------------- ------------------------
Non-Performing Assets
as a % of Total Loans 0.3% 0.3% 0.4%
- --------------------------------------- ------------------------ ----------------------- ------------------------
Allowance for Loan Losses as a % of
Non-Performing Loans 715.9% 666.4% 583.7%
- --------------------------------------- ------------------------ ----------------------- ------------------------
* As of June 30, 2004, $1.3 million of total non-performing assets is comprised
of the guaranteed portion of Small Business Administration (SBA) loans. This
amount has been submitted to SBA for payment and there is no risk of loss.
Except for non-performing loans shown in the table above, the Bank's management
is not aware of any loans as of June 30, 2004 for which known credit problems of
the borrower would cause serious doubts as to the ability of these 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 any 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.
19
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 June 30, 2004, deposits totaled $968.3 million. This represents an increase
of 12.9% or $110.6 million from June 30, 2003. The increase was focused in
demand and savings accounts, which increased $32.9 million and $40.9 million,
respectively. The Bank's calling efforts for prospective customers include
acquiring both loan and deposit relationships which results in new demand,
interest bearing transaction and savings accounts. Additionally, in June 2004,
as part of its overall asset/liability management activities, the Bank raised
$50 million in three and six month collateralized certificates of deposit from
the State of California and used these funds to pay down 30 day Federal Home
Loan Bank (FHLB) advances.
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 June 30, 2004 were $85.9 million compared to $121.9 million as of June 30,
2003. As previously discussed (see "Deposits"), the Bank reduced its FHLB
borrowings by $50 million during June 2004 and replaced these borrowings with
$50 million of collateralized certificates of deposit from the State of
California.
Long-term Subordinated Debentures
On December 17, 2003 the Company raised $10 million through an offering of trust
preferred securities. Although this amount is reflected as subordinated debt on
the Company's balance sheet, under applicable regulatory guidelines, trust
preferred securities qualify as regulatory capital (see Capital). These
securities accrue interest at a variable rate based upon 3-month Libor plus
2.85%. Interest rates reset quarterly and were 4.41% as of June 30, 2004.
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 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 June 30, 2004, that the Company and
the Bank meet all capital adequacy requirements to which it is subject.
20
As of September 30, 2003, 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, and 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 June 30, 2004
Total Capital to Risk Weighted Assets $138,318 12.65% $87,455 8.0% N/A N/A
Tier I Capital to Risk Weighted Assets $124,602 11.40% $43,727 4.0% N/A N/A
Tier I Capital to Average Assets $124,602 10.70% $46,580 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 June 30, 2004
Total Capital to Risk Weighted Assets $133,907 12.28% $ 87,207 8.0% $ 109,009 10.0%
Tier I Capital to Risk Weighted Assets $120,230 11.03% $ 43,604 4.0% $ 65,405 6.0%
Tier I Capital to Average Assets $120,230 10.37% $ 46,384 4.0% $ 57,980 5.0%
As previously discussed (see Long-term Subordinated Debentures), in order to
supplement its regulatory capital base, during December, 2003 the Company raised
$10 million of trust preferred securities. Under applicable regulatory
guidelines, trust preferred securities qualify as Tier 1 capital up to a maximum
of 25% of Tier 1 capital. Any additional portion of trust preferred securities
would qualify as Tier 2 capital. The Company has received notification from the
Federal Reserve Bank of San Francisco that all of the Company's trust preferred
securities currently qualify as Tier 1 capital.
In accordance with the provisions of Financial Accounting Standard Board
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
the Company does not consolidate the subsidiary trust which has issued the trust
preferred securities. Previously, financing subsidiaries were generally
consolidated with their parents under GAAP. As a result of this new accounting
interpretation, on July 2, 2003, the Federal Reserve Board issued Supervisory
Letter (SR 03-13) which preserves the historical capital treatment of trust
preferred securities as Tier I Capital despite the deconsolidation of these
securities. That Supervisory Letter remained in effect at December 31, 2003 and
June 30, 2004, and the Company continues to include these securities in its Tier
I capital.
21
On May 6, 2004, the FRB issued a proposed ruling on the continuing eligibility
of trust preferred securities as Tier I capital. As drafted, the proposed ruling
retains the current 25% limit but nets goodwill from the calculation of Tier I
capital. Since the Company currently has no goodwill, if implemented, this
change would have no impact. Public comments on the proposed ruling were
required by July 11, 2004 with a final ruling to follow. The Company cannot
predict the ultimate outcome of this issue, however, even in the unlikely event
that Tier I capital treatment for the Company's trust preferred securities was
fully disallowed the Company would remain "well-capitalized". Additionally, if
Tier I capital treatment were disallowed, the Company may be able to redeem the
trust preferred securities pursuant to their terms, and have the ability to
identify and obtain alternative sources of capital.
In 1998, the Board approved the Company's first stock repurchase program which
expired on May 1, 2001. During the second quarter of 2004, the Board of
Directors of Farmers & Merchants Bancorp approved a second stock repurchase
program because it has concluded that the Company continues to have more capital
than it needs to meet present and anticipated regulatory guidelines to be
classified as "well capitalized". See Part II, Item 6(b) Reports on Form 8-K.
Repurchases under the program will be made on the open market or through private
transactions. The aggregate price to be paid by the Company for all repurchased
stock will not exceed $10,000,000 and the program will expire on May 31, 2007.
The repurchase program also requires that no purchases may be made if the
Company would not remain "well-capitalized" after the repurchase. All shares
repurchased under the repurchase program will be retired.
Since 1999, the Company has repurchased nearly 40,000 shares for total
consideration of $9.7 million.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management
The Company has adopted a Risk Management Plan which aims 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 the 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 regularly
provided with information intended to identify, measure, control and monitor the
credit risk of the Bank.
The Company's methodology for assessing the appropriateness of the allowance for
loan losses is applied on a regular basis and considers all loans. The
systematic 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 ensure an appropriate level of allowance is present
or established.
22
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.
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.
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.
23
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.
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 June 30, 2004 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.
Market Risk - 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. The Company'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 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.
24
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
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 June
30, 2004, 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 2.74% if rates increase by 200 basis points and a decrease in
net interest income of 1.47% 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 2003 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 Federal
Funds and the use of funds provided by the cash flow from the investment
portfolio. The Company maintains overnight investments in Federal Funds as a
cushion for temporary liquidity needs. During the first half of 2004, Federal
Funds averaged $11.8 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 $141.2 million from
the Federal Home Loan Bank.
At June 30, 2004, the Company had available liquid assets, which included cash
and cash equivalents and unpledged investment securities of approximately $115.2
million, which represents 9.7% of total assets.
25
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-15(e). 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.
As of the end of the period covered by 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 and six-month periods ending June 30,
2004 and 2003.
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.
26
Farmers & Merchants Bancorp
Quarterly Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Three Months Ended June 30, Three Months Ended June 30,
2004 2003
Assets Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Federal Funds Sold $ 2,967 $ 8 1.08% $ 4,348 $ 18 1.66%
Investment Securities Available-for-Sale
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 69,348 607 3.55% 43,400 372 3.48%
Municipals - Taxable 1,045 16 6.21% 1,295 20 6.26%
Municipals - Non-Taxable 17,717 280 6.41% 31,973 447 5.67%
Mortgage Backed Securities 108,091 1,012 3.80% 156,574 1,450 3.76%
Other 8,334 101 4.91% 17,803 199 4.53%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Total Investment Securities Available-for-Sale 204,535 2,016 4.00% 251,045 2,488 4.02%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Investment Securities Held-to-Maturity
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 13,526 175 5.25% 0 0 0.00%
Municipals - Taxable 0 0 0.00% 0 0 0.00%
Municipals - Non-Taxable 36,828 582 6.41% 43,280 686 6.43%
Mortgage Backed Securities 10,083 112 4.50% 0 0 0.00%
Other 354 4 4.58% 469 6 5.19%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Total Investment Securities Held-to-Maturity 60,791 873 5.82% 43,749 692 6.41%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Loans
Real Estate 481,220 7,428 6.19% 411,976 6,660 6.48%
Home Equity 55,899 648 4.65% 47,905 627 5.25%
Agricultural 132,447 1,670 5.06% 107,073 1,389 5.20%
Commercial 136,733 1,878 5.51% 130,563 1,889 5.80%
Consumer 10,856 242 8.94% 14,178 402 11.37%
Credit Card 4,498 106 9.45% 4,371 101 9.27%
Municipal 1,051 11 4.20% 1,223 16 5.25%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Total Loans 822,704 11,983 5.84% 717,289 11,084 6.20%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Total Earning Assets 1,090,997 $14,880 5.47% 1,016,431 $14,282 5.64%
========= ======== ========== =========
Unrealized Gain/(Loss) on Securities Available-for-Sale (82) 4,517
Allowance for Loan Losses (17,725) (17,111)
Cash and Due From Banks 33,098 29,182
All Other Assets 61,987 55,786
- --------------------------------------------------------- ------------ -------------
Total Assets $1,168,275 $1,088,805
========================================================= ============ =============
Liabilities & Shareholders' Equity
Interest Bearing Deposits
Interest Bearing DDA $94,713 $ 15 0.06% $89,099 $ 30 0.14%
Savings 279,282 251 0.36% 244,690 352 0.58%
Time Deposits 312,045 1,263 1.62% 322,479 1,737 2.16%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Total Interest Bearing Deposits 686,040 1,529 0.89% 656,268 2,119 1.30%
Other Borrowed Funds 123,775 782 2.53% 123,614 828 2.69%
Subordinated Debentures 10,310 103 4.02% 0 0 0.00%
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Total Interest Bearing Liabilities 820,125 $2,414 1.18% 779,882 $2,947 1.52%
========= ======== ========== =========
Interest Rate Spread 4.29% 4.12%
Demand Deposits (Non-Interest Bearing) 224,623 191,186
All Other Liabilities 11,157 10,360
- --------------------------------------------------------- ------------ -------------
Total Liabilities 1,055,905 981,428
Shareholders' Equity 112,370 107,377
- --------------------------------------------------------- ------------ -------------
Total Liabilities & Shareholders' Equity $1,168,275 $1,088,805
========================================================= ============ =============
Impact of Non-Interest Bearing Deposits and Other Liabilities 0.29% 0.35%
Net Interest Income and Margin on Total Earning Assets 12,466 4.58% 11,335 4.47%
Tax Equivalent Adjustment (315) (412)
- --------------------------------------------------------- ------------ --------- -------- ------------- ---------- ---------
Net Interest Income $12,151 4.47% $10,923 4.31%
========================================================= ============ ========= ======== ============= ========== =========
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.
27
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Six Months Ended June 30, Six Months Ended June 30,
2004 2003
Assets Balance Interest Rate Balance Interest Rate
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Federal Funds Sold $ 11,773 $ 60 1.02% $ 11,643 $ 97 1.68%
Investment Securities Available-for-Sale
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 66,179 1,184 3.63% 37,890 638 3.41%
Municipals - Taxable 1,067 33 6.27% 1,319 41 6.30%
Municipals - Non-Taxable 20,869 623 6.05% 31,963 893 5.66%
Mortgage Backed Securities 110,740 2,028 3.71% 136,569 2,819 4.19%
Other 8,177 212 5.26% 19,139 448 4.75%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Total Investment Securities Available-for-Sale 207,032 4,080 4.00% 226,880 4,839 4.32%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Investment Securities Held-to-Maturity
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 6,798 175 5.22% 0 0 0.00%
Municipals - Taxable 0 0 0.00% 0 0 0.00%
Municipals - Non-Taxable 36,569 1,172 6.50% 36,085 1,207 6.79%
Mortgage Backed Securities 5,068 112 4.48% 0 0 0.00%
Other 363 9 5.03% 474 13 5.56%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Total Investment Securities Held-to-Maturity 48,798 1,468 6.10% 36,559 1,220 6.77%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Loans
Real Estate 470,304 14,607 6.23% 398,413 13,102 6.63%
Home Equity 55,550 1,285 4.64% 47,226 1,214 5.18%
Agricultural 128,290 3,244 5.07% 103,650 2,678 5.21%
Commercial 135,008 3,762 5.59% 133,189 3,742 5.67%
Consumer 11,147 517 9.30% 13,934 705 10.20%
Credit Card 4,525 218 9.66% 4,361 203 9.39%
Municipal 1,074 23 4.29% 1,237 32 5.22%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Total Loans 805,898 23,656 5.89% 702,010 21,676 6.23%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Total Earning Assets 1,073,501 $29,264 5.47% 977,092 $27,832 5.74%
========== ======== ========== ========
Unrealized Gain/(Loss) on Securities Available-for-Sale 1,374 4,503
Allowance for Loan Losses (17,553) (16,975)
Cash and Due From Banks 32,283 29,212
All Other Assets 61,050 55,047
- ---------------------------------------------------------------- ------------- ------------
Total Assets $1,150,655 $1,048,879
================================================================ ============= ============
Liabilities & Shareholders' Equity
Interest Bearing Deposits
Interest Bearing DDA $94,426 $ 29 0.06% $89,208 $ 79 0.18%
Savings 278,333 507 0.37% 243,955 697 0.58%
Time Deposits 312,659 2,585 1.66% 321,664 3,644 2.28%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Total Interest Bearing Deposits 685,418 3,121 0.91% 654,827 4,420 1.36%
Other Borrowed Funds 111,357 1,498 2.70% 86,788 1,405 3.26%
Subordinated Debentures 10,310 208 4.06% 0 0 0.00%
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Total Interest Bearing Liabilities 807,085 $4,827 1.20% 741,615 $5,825 1.58%
========== ======== ========== ========
Interest Rate Spread 4.27% 4.16%
Demand Deposits (Non-Interest Bearing) 221,253 191,973
All Other Liabilities 10,614 9,165
- ---------------------------------------------------------------- ------------- ------------
Total Liabilities 1,038,952 942,753
Shareholders' Equity 111,703 106,126
- ---------------------------------------------------------------- ------------- ------------
Total Liabilities & Shareholders' Equity $1,150,655 $1,048,879
================================================================ ============= ============
Impact of Non-Interest Bearing Deposits and Other Liabilities 0.30% 0.38%
Net Interest Income and Margin on Total Earning Assets 24,437 4.57% 22,007 4.54%
Tax Equivalent Adjustment (654) (763)
- ---------------------------------------------------------------- ------------- ---------- -------- ------------ ---------- --------
Net Interest Income $23,783 4.47% $21,244 4.38%
================================================================ ============= ========== ======== ============ ========== ========
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.
28
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Revenue
(Rates on a Taxable Equivalent Basis)
(in thousands) Three Months Ended Six Months Ended
June 30, 2004 compared to June 30, 2003 June 30, 2004 compared to June 30, 2003
Interest Earning Assets Volume Rate Net Chg. Volume Rate Net Chg.
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Federal Funds Sold $ (5) $ (5) $ (10) $ 3 $ (40) $ (37)
Investment Securities Available for Sale
U.S. Treasuries 0 0 0 0 0 0
U.S. Agencies 227 8 235 504 42 546
Municipals - Taxable (4) 0 (4) (8) 0 (8)
Municipals - Non-Taxable (495) 328 (167) (432) 162 (270)
Mortgage Backed Securities (548) 110 (438) (495) (296) (791)
Other (202) 104 (98) (364) 128 (236)
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Investment Securities Available for Sale (1,022) 550 (472) (795) 36 (759)
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Investment Securities Held to Maturity
U.S. Treasuries 0 0 0 0 0 0
U.S. Agencies 88 87 175 88 87 175
Municipals - Taxable 0 0 0 0 0 0
Municipals - Non-Taxable (102) (2) (104) 41 (76) (35)
Mortgage Backed Securities 56 56 112 56 56 112
Other (1) (1) (2) (2) (2) (4)
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Investment Securities Held to Maturity 41 140 181 183 65 248
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Loans:
Real Estate 2,508 (1,740) 768 3,527 (2,022) 1,505
Home Equity 354 (333) 21 367 (296) 71
Agricultural 530 (249) 281 768 (202) 566
Commercial 365 (376) (11) 113 (93) 20
Consumer (84) (76) (160) (130) (58) (188)
Credit Card 3 2 5 8 7 15
Other (2) (3) (5) (4) (5) (9)
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Loans 3,674 (2,775) 899 4,649 (2,669) 1,980
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Earning Assets 2,688 (2,090) 598 4,040 (2,608) 1,432
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Interest Bearing Liabilities
Interest Bearing Deposits:
Transaction 12 (27) (15) 13 (63) (50)
Savings 263 (364) (101) 233 (423) (190)
Time Deposits (54) (420) (474) (97) (962) (1,059)
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Interest Bearing Deposits 221 (811) (590) 149 (1,448) (1,299)
Other Borrowed Funds 7 (53) (46) 668 (575) 93
Subordinated Debentures 52 51 103 104 104 208
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Interest Bearing Liabilities 280 (813) (533) 921 (1,919) (998)
- --------------------------------------------------- ---------- -------------- --------- --------- ----------- ----------
Total Change $2,408 $(1,277) $1,131 $3,119 $ (689) $2,430
=================================================== ========== ============== ========= ========= =========== ==========
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.
29
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, Use of Proceeds and Issuer Purchases of
Equity Securities
2(e) The following table indicates the number of shares repurchased by Farmers &
Merchants Bancorp during the second quarter of 2004.
Number of Shares Approximate Dollar Value
Average Purchased as Part of a of Shares that May Yet Be
Number of Price per Publicly Announced Purchased Under the Plan
Second Quarter 2004 Shares Share Plan or Program or Program
- ------------------------------- ---------------- -------------- ------------------------ ---------------------------
04/01/2004 - 04/30/2004 0 0 0 N/A
05/01/2004 - 05/31/2004 84 355 0 N/A
06/01/2004 - 06/30/2004 425 352 335 $9,800,000
- ------------------------------- ---------------- -------------- ------------------------ ---------------------------
Total 509 353 335 $9,800,000
All of the above shares were repurchased in private transactions.
The Company's common stock is not listed on any exchange, nor is it included on
the NASDAQ National Market or the NASDAQ Small Cap Market. However, trades may
be reported on the OTC Bulletin Board under the symbol "FMCB.OB". Management is
aware that there are private transactions in the Company's common stock. When
the Company repurchases shares in private transactions the price is determined
based upon the most recent transactions that have occurred between third party
shareholders.
As discussed previously (see Part I, Item 2, "Capital"), during the second
quarter of 2004, the Board of Directors of Farmers & Merchants Bancorp approved
a resolution authorizing the repurchase, from time to time, of outstanding
shares of the common stock of the Company. The Board of Directors approved the
repurchase program because it has concluded that the Company has more capital
than it needs to meet present and anticipated regulatory guidelines to be
classified as "well capitalized".
Repurchases will be made on the open market or through private transactions.
This repurchase program was announced in a press release dated June 21, 2004.
The aggregate price to be paid by the Company for all repurchased stock will not
exceed $10,000,000 and the program will expire on May 31, 2007. The repurchase
program also requires that no purchases may be made if the Company would not
remain "well-capitalized" after the repurchase. All shares repurchased under the
repurchase program will be retired.
ITEM 3. Defaults Upon Senior Securities
Not applicable
30
ITEM 4. Submission of Matters to a Vote of Security Holders
Annual Meeting of Shareholders of Farmers & Merchants Bancorp held on April 19,
2004. The business conducted at the meeting included election of directors and
ratification of PricewaterhouseCoopers LLP as the Company's independent
auditors. Following is the voting results from the 2004 annual meeting of
shareholders. As of April 21, 2004, 529,126 shares represented in person and by
proxy participated in this election and shares were voted on the two measures
before the shareholders as follows:
1. ELECTION OF DIRECTORS
Directors % For % Withheld
--------- - --- - --------
Stewart C. Adams, Jr. 99.97 528,966 0.03 160
-------------- ------------------- ----------- ----------------
Ralph Burlington 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
Edward Corum, Jr. 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
Robert F. Hunnell 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
Ole R. Mettler 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
James E. Podesta 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
Kevin Sanguinetti 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
H. C. Schumacher 99.99 529,087 0.01 39
-------------- ------------------- ----------- ----------------
Kent A. Steinwert 100.00 529,125 0.00 1
-------------- ------------------- ----------- ----------------
Calvin (Kelly) Suess 99.99 529,087 0.01 39
-------------- ------------------- ----------- ----------------
Carl A. Wishek, Jr. 99.96 528,915 0.04 211
-------------- ------------------- ----------- ----------------
2. PROPOSAL TO RATIFY THE APPOINTMENT OF PRICEWATERHOUSECOOPERS, LLP
No. of Shares %
For: 522,123 98.68
------------------------ ---------------------
Against: 77 0.01
------------------------ ---------------------
Abstain 6,926 1.31
------------------------ ---------------------
ITEM 5. Other Information
None
31
ITEM 6(a). Exhibits
See Exhibit Index on Page 33.
ITEM 6(b). Reports on Form 8-K
During the quarter ended June 30, 2004, the Company filed the following Current
Reports on Form 8-K:
Description Date of Report
First Quarter 2004 results of operations and
announcement of the Company's 5%
common stock dividend April 19, 2004
Announcement the Company's cash dividend June 3, 2004
Announcement of the Company's
Stock Repurchase Program June 21, 2004
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: August 6, 2004 __________________________
Kent A. Steinwert
President and
Chief Executive Officer
(Principal Executive Officer)
/s/ Stephen W. Haley
Date: August 6, 2004 __________________________
Stephen W. Haley
Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)
32
Index to Exhibits
Exhibit No. Description
31 Certification of the Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of the Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
33