SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

For the quarterly period ended June 30, 2002

 

OR

 

 

Commission file number 0-12638

 

F&M BANCORP

(Exact name of registrant as specified in its charter)

 

 

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

 

Common Stock of 10,026,915 shares outstanding as of August 8, 2002.

 

 

F&M BANCORP

TABLE OF CONTENTS

 

PART I				FINANCIAL INFORMATION
	Consolidated Balance Sheets June 30, 2002 (Unaudited) and December 31, 2001
	Consolidated Statements of Income and Comprehensive Income (Unaudited), Three and Six Months Ended June 30, 2002 and 2001
	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited), Six Months Ended June 30, 2002 and 2001
	Consolidated Statements of Cash Flows (Unaudited), Six Months Ended June 30, 2002 and 2001
	Notes to Consolidated Financial Statements (Unaudited)
	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Quantitative and Qualitative Disclosures about Market Risk
PART II				OTHER INFORMATION
	Item 6.  Exhibits and Reports on Form 8-K
	Signatures

 

2

 

Consolidated Balance Sheets (Unaudited)

F&M Bancorp and Subsidiaries

 

(in thousands, except per share data)		June 30, 2002			December 31, 2001
Assets
Cash and due from banks		$	55,064		$	65,570
Federal funds sold		8,327			360
Interest-bearing deposits with banks		3,668			13,178
Total cash and cash equivalents		67,059			79,108
Loans held for sale		10,655			28,773
Investment securities:
Available-for-sale, at fair value		606,826			546,522
Total investment securities		606,826			546,522
Loans, net of unearned income		1,171,946			1,162,230
Less: Allowance for credit losses		(13,999		)	(13,947		)
Net loans		1,157,947			1,148,284
Bank premises and equipment, net		34,751			35,563
Other real estate owned, net		354			638
Interest receivable		8,982			9,417
Intangible assets		3,307			3,898
Other assets		26,223			29,231
Total  other assets		73,617			78,747
Total assets		$	1,916,104		$	1,881,434
Liabilities and Stockholder’s Equity
Liabilities:
Deposits:
Noninterest-bearing		$	260,082		$	234,459
Interest-bearing		1,289,159			1,281,609
Total deposits		1,549,241			1,516,068
Short-term borrowings:
Federal funds purchased and securities sold under agreements to repurchase		93,715			114,505
Other short-term borrowings		2,722			3,040
Long-term borrowings		78,342			63,444
Accrued taxes and other liabilities		14,622			16,952
Total liabilities		1,738,642			1,714,009
Shareholders’ equity
Common stock, par value $5 per share; authorized 50,000,000 shares; issued and outstanding 10,776,315 shares in 2002 and 10,862,257 in 2001		53,882			54,311
Surplus		72,121			75,147
Retained earnings		43,657			34,782
Accumulated other comprehensive income		7,802			3,185
Total shareholders’ equity		177,462			167,425
Total liabilities and shareholders’ equity		$	1,916,104		$	1,881,434

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 

Consolidated Statements of Income and Comprehensive Income (Unaudited)

F&M Bancorp and Subsidiaries

 

(in thousands, except per share data)		Three Months Ended June 30,						Six Months Ended June 30,
		2002			2001			2002			2001
Interest Income
Interest and fees on loans		$	20,650		$	24,356		$	41,934		$	49,354
Interest on deposits with banks		20			189			42			367
Interest and dividends on investment securities:
Taxable		5,842			4,856			11,162			9,621
Tax-exempt		1,270			1,393			2,586			2,864
Interest on federal funds sold		37			198			58			437
Total interest income		27,819			30,992			55,782			62,643
Interest Expense
Interest on deposits		8,071			12,477			16,920			24,906
Interest on federal funds purchased and securities sold under agreements to repurchase		237			905			508			2,169
Interest on long-term borrowings		828			419			1,607			1,361
Interest on other short-term borrowings		92			102			133			828
Total interest expense		9,228			13,903			19,168			29,264
Net interest income		18,591			17,089			36,614			33,379
Provision for credit losses		150			1,535			975			2,630
Net interest income after provision for credit losses		18,441			15,554			35,639			30,749
Noninterest Income
Service charges on deposit accounts		2,282			2,093			4,478			4,071
Insurance income		2,540			2,257			5,190			4,796
Gains on sales of loans		849			785			1,721			1,597
Gains on sales of securities		—			33			—			33
Gains on sales of property		36			64			122			107
Alternative investment and stock brokerage income		910			932			1,831			1,847
Other operating income		1,357			1,303			2,672			3,053
Total noninterest income		7,974			7,467			16,014			15,504
Noninterest Expenses
Salaries and employee benefits		9,581			9,045			19,238			17,901
Occupancy and equipment expense		2,625			2,520			5,099			5,279
Other operating expense		5,024			4,216			9,697			8,918
Total noninterest expenses		17,230			15,781			34,034			32,098
Income before provision for income taxes		9,185			7,240			17,619			14,155
Provision for income taxes		3,069			2,029			5,726			3,964
Net Income		$	6,116		$	5,211		$	11,893		$	10,191
Other Comprehensive Income (Loss), Net of Tax:
Unrealized gains (losses) on securities available-for-sale		$	5,437		$	(50	)	$	4,617		$	4,258
Reclassification adjustment for gains included in net income		—			22			—			22
Other comprehensive income (loss)		5,437			(28		)	4,617			4,280
Comprehensive income		$	11,553		$	5,183		$	16,510		$	14,471
Earnings per Common Share – Basic
Based on weighted average shares outstanding of 10,833,329 in 2002, and 11,0020,857 in 2001		$	0.57		$	0.47		$	1.10		$	0.93
Earnings per Common Share – Diluted
Based on weighted average shares outstanding of 10,895,311 in 2002, and 11,063,047 in 2001		$	0.56		$	0.47		$	1.09		$	0.92
Dividends per Share		—			$	0.27		$	0.28		$	0.54

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

F&M Bancorp and Subsidiaries

 

(in thousands, except per share data)		Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total
Balance at December 31, 2000		$	55,073		$	78,488		$	25,857		$	(1,382	)	$	158,036
Net income		—			—			10,191			—			10,191
Dividend reinvestment plan		—			—			(154		)	—			(154		)
Cash dividends paid ($.54 per share)		—			—			(5,956		)	—			(5,956		)
Stock consideration for options exercised		(3		)	(4		)	(7		)	—			(14		)
Stock options exercised		97			282			—			—			379
Stock repurchase and retirement		(166		)	(690		)	—			—			(856		)
Other comprehensive income		—			—			—			4,280			4,280
Balance at June 30, 2001		$	55,001		$	78,076		$	29,931		$	2,898		$	165,906
Balance at December 31, 2001		$	54,311		$	75,147		$	34,782		$	3,185		$	167,425
Net income		—			—			11,893			—			11,893
Dividend reinvestment plan		—			—			(24		)	—			(24		)
Cash dividends paid ($.28 per share)		—			—			(2,984		)	—			(2,984		)
Stock consideration for options exercised		(3		)	(674		)	(9		)	—			(686		)
Stock options exercised		152			469			—			—			621
Stock repurchase and retirement		(579		)	(2,821		)	—			—			(3,400		)
Other comprehensive income		—			—			—			4,617			4,617
Balance at June 30, 2002		$	53,882		$	72,121		$	43,657		$	7,802		$	177,462

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5

 

Consolidated Statements of Cash Flows (Unaudited)

F&M Bancorp and Subsidiaries

 

		Six Months Ended June 30,
(in thousands)		2002			2001
Cash Flows from Operating Activities
Net Income		$	11,893		$	10,191
Adjustments to reconcile net income to net cash provided by operating activities
Provision for credit losses		975			2,630
Depreciation and amortization		1,939			1,779
Amortization of intangibles		591			542
Net premium amortization / accretion on investment securities		1,349			200
Decrease in interest receivable		435			1,298
Decrease in interest payable		(407		)	(844		)
Gains on sales of property		(122		)	(107		)
Gains on sales of securities		—			(33		)
Decrease (increase) in loans held for sale		18,124			(10,995		)
Decrease in other assets		373			8,871
Decrease in other liabilities		(1,923		)	(530		)
Gain on sales of loans		(1,721		)	(1,597		)
Net cash provided by operating activities		31,505			11,407
Cash Flows from Investing Activities
Purchases of investment securities available-for-sale		(159,741		)	(166,410		)
Proceeds from sales/maturities of securities available-for-sale		105,340			129,634
Net (increase) decrease in loans		(8,998		)	40,131
Purchases of premises and equipment		(1,126		)	(1,824		)
Proceeds from sales of property		481			190
Net cash provided by (used in) in investing activities		(64,044		)	1,721
Cash Flows from Financing Activities
Net increase in noninterest-bearing deposits, interest-bearing checking, savings and money market accounts		74,231			26,660
Net (decrease) increase in certificates of deposit		(41,058		)	78,573
Net decrease in federal funds purchased and securities sold under agreements to repurchase		(20,790		)	(25,116		)
Net decrease in other short-term borrowings		(318		)	(108,844		)
Net increase in long-term borrowings		14,898			24,536
Cash dividends paid		(2,984		)	(5,956		)
Dividend reinvestment plan		(24		)	(154		)
Proceeds from issuance of common stock		(65		)	365
Common stock purchased and retired		(3,400		)	(856		)
Net cash provided by (used in) by financing activities		20,491			(10,792		)
Net increase (decrease) in cash and cash equivalents		(12,049		)	2,336
Cash and cash equivalents at beginning of year		79,108			70,133
Cash and cash equivalents at end of period		$	67,059		$	72,469
Supplemental Disclosures of Cash Flow Information
Cash payments for interest		19,574			30,107
Cash payments for income tax		5,711			3,693
Non-Cash Investing and Financing Activities
Fair value adjustment for securities available-for-sale, net of income taxes		4,617			4,280

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6

 

Notes to Consolidated Financial Statements  (Unaudited)

 

Note 1.  General

 

These unaudited consolidated financial statements, which include the accounts of F&M Bancorp and its subsidiaries (Bancorp), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), and, in the opinion of management, reflect adjustments consisting only of normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements should be read in conjunction with the audited annual consolidated financial statements and notes thereto included in F&M Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.  The results shown in this interim report are not necessarily indicative of results to be expected for the full year of 2002.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities at the date of the financial statements, and the disclosure of revenues and expenses during the reporting period. These estimates and assumptions are based on information available as of the date of the financial statements and could differ from actual results.

 

Certain prior period items in these unaudited condensed consolidated financial statements have been reclassified to conform to the current period presentation.

 

Note 2.  Earnings Per Share

 

Earnings per share (“EPS”) data is computed and presented in accordance with FASB Statement No. 128, “Earnings Per Share.” As prescribed by the Statement, the presentation of primary EPS has been replaced with the dual presentation of basic and diluted EPS.  Basic EPS excludes dilution and is computed by dividing net income available to common shareholders (“numerator”) by the weighted-average number of common shares outstanding for the period after giving retroactive effect to stock dividends and stock splits (“denominator”). Diluted EPS reflects the potential dilution that could occur if outstanding stock options or other contracts to issue common stock, if any, were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of Bancorp. Diluted EPS is equal to the numerator divided by the denominator plus the dilutive effect of outstanding stock options.

 

 

(in thousands, except per share data)
		Three Months Ended June 30,						Six Months Ended June 30,
		2002			2001			2002			2001
Net income(1)		$	6,116		$	5,211		$	11,893		$	10,191
Basic EPS
Shares		10,814,183			11,019,337			10,833,329			11,020,857
EPS		$	0.57		$	0.47		$	1.10		$	0.93
Dilutive shares
Stock options		63,632			55,116			61,982			42,190
EPS		$	0.01		$	0.00		$	0.01		$	0.01
Diluted EPS
Shares including options		10,877,815			11,074,453			10,895,311			11,063,047
EPS		$	0.56		$	0.47		$	1.09		$	0.92

 

(1) The carrying value of the deposits that have created over 88% of the Bancorp’s interest expense for the first six months of 2002 and thus contributing greatly to net income are illustrated in the table below.

 

7

 

 

 

Deposits: (in thousands)		June 30, 2002			December 31, 2001
Noninterest-bearing demand deposits		$	260,082		$	234,459
Interest-bearing deposits:
Checking		216,284			200,430
Money market		304,953			296,687
Savings		178,231			153,744
Certificates of deposit:
Under $100,000		424,139			443,465
$ 100,000 and over		165,551			187,283
Total deposits		$	1,549,241		$	1,516,068

 

Note 3. Loans

 

Loans, net of unearned income, consist of the following:

 

		For the Period Ending
(in thousands)		June 30, 2002			December 31, 2001
Real Estate Loans:
Construction and land development		$	88,482		$	85,138
Secured by farmland		5,489			5,902
Residential mortgage		300,180			295,441
Other mortgage		331,993			323,643
Agricultural		318			507
Commercial and industrial loans		170,021			175,307
Consumer		274,453			274,361
Other loans		1,010			1,931
Totals		$	1,171,946		$	1,162,230

 

Loans to states and political subdivisions and industrial revenue bonds are included in other loans in the schedule above and in total loans in the balance sheet.

 

The allowance for credit losses is maintained at a level which, in management’s opinion, is considered adequate to provide for possible losses on loans currently held in the loan portfolio.

 

Note 4.  New Accounting Pronouncements

 

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations” (effective July 1, 2001) and SFAS No. 142, “Goodwill and Other Intangible Assets” (effective January 1, 2002). SFAS No. 141 prohibits pooling-of-interests accounting for acquisitions. SFAS No. 141 also specifies the criteria for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill. SFAS No. 142 specifies that goodwill and some intangible assets will no longer be amortized but instead will be subject to periodic impairment testing. SFAS 142 also requires intangible assets with definite useful lives to be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for

 

8

 

impairment in accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”.

 

The Bancorp adopted SFAS 141 and 142 on January 1, 2002 and as of June 30, 2002 had $3,307,000 in definite lived intangible assets that continue to be subject to amortization under SFAS 142. Amortization expense related to intangible assets was $543,000 and $574,000 for the six months ended June 30, 2002 and 2001, respectively.

 

Bancorp does not carry any goodwill attributable to premiums relating from prior mergers and/or acquisitions. The bank does however, have mortgage servicing rights and core deposit intangibles, which qualify as intangible assets and are subject to impairment analysis as prescribed in SFAS 142.

 

Mortgage servicing rights are an asset which represent the rights to service mortgage loans for others. At June 30, 2002, based upon the analysis of mortgage servicing rights valuations, the carrying value of this intangible asset is not impaired.

 

Core deposit intangibles represent the premium paid in the acquisition of deposit relationships and balances from other financial institutions. At June 30, 2002, based upon a valuation analysis of eight branch locations with core deposit intangibles, one location was deemed to be impaired. Bancorp has accelerated the remaining life on this location from 3.64 years to 2.26 years. That will impact 2002 earnings by approximately $45 thousand.

 

In April 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS 145 requires that any gains or losses on extinguishment of debt that were classified as an extraordinary item in prior periods that are not unusual in nature and infrequent in occurrence be reclassified to other income (expense), beginning in fiscal 2003, with early adoption encouraged. The Company expects to adopt the requirements of SFAS No. 145 in fiscal 2003.

 

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

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

OVERVIEW

 

Forward-Looking Statements

 

Statements made in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may sometimes be identified by words such as “expect”, “may”, “looking forward”, “we plan”, “we believe”, “are planned”, “could be” and “currently anticipate”. Although we believe these statements, as well as other oral and written forward-looking statements made by us from time to time, to be true and reasonable, we can give no assurance that these plans, intentions or expectations will be achieved. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in our other filings with the SEC, and in this document under the heading “Risk Factors”, beginning in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. We caution that the risks and factors discussed below and in such filings are not exclusive. We do not undertake to update any forward-looking statement that may be made from time to time by or on behalf of Bancorp.

 

Critical Accounting Policies and Estimates

 

The preparation of our financial results of operations and financial position require us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the period presented, and actual results could differ from our estimates.  The critical accounting estimates, which are both important to the portrayal of our financial condition and which require complex, subjective judgments, are accrued restructuring costs, determination of the allowance for loan losses, the classification and carrying value of investments, accounting for financial derivatives, the recognition of deferred tax assets and the valuation of goodwill; these areas are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2001.

 

F&M Bancorp is the registered bank holding company for Farmers and Mechanics Bank (the “Bank”), headquartered in Frederick, Maryland. The Bank operates 47 community offices in Frederick, Howard, Baltimore, Montgomery, Washington, Carroll and Alleghany Counties in Maryland, together with two insurance agencies. The Corporation has established a strategy of independence, and intends to establish or acquire additional offices, banking organizations and nonbanking organizations as appropriate opportunities present themselves.

 

Earnings per diluted share for the second quarter of 2002 reached a record $0.56 per share, a 19% increase over the prior year’s $0.47 per share results. Net income for the second quarter of 2002 reached a record $6.1 million, an increase of 17.4% compared with earnings of $5.2 million for the second quarter of 2001. A slight decrease in the net interest margin from 4.38% in 2001 to 4.36% in 2002 was experienced due to lower interest rates earned on average earning assets. For the six months ended June 30, 2002, earnings per diluted share reached a record $1.09, a 18.5% increase versus $0.92 per diluted share for 2001. Net income for the first six months of 2002 reached $11.9 million, compared to earnings of $10.2 million for 2001.

 

9

 

F&M Bancorp’s key performance ratios continue to be strong. Second quarter of 2002 results produced a return on average assets of 1.30% and a return on average equity of 14.14% compared to 2001 second quarter ratios of 1.19% and 12.60%, respectively. The earnings produced in the six months ended June 30, 2002 represent a return on average assets of 1.28% and a return on average equity of 13.93%. These financial performance ratios are indicative of F&M Bancorp’s earnings strength and effective balance sheet management.

 

Bancorp’s asset quality remained strong throughout the first half. Nonperforming assets as a percentage of assets stood at 0.13% at June 30, 2002. The allowance for credit losses was $14.0 million or 1.21% of total loans with net annualized charge-offs for the half representing 0.16% of average loans outstanding.

 

RESULTS OF OPERATIONS

 

Net Interest Income

 

F&M Bancorp’s principal source of revenue is net interest income, the difference between interest income on earnings assets and interest expense on deposits and borrowings. Interest income for purposes of analysis, is presented on a tax-equivalent basis to recognize associated tax benefits. The presentation provides a basis for comparison of yields with taxable earning assets. The discussion on net interest income should be read in conjunction with the following table – “Consolidated Average Balances, Interest and Average Rates.”

 

The Bancorp’s taxable-equivalent net interest income of $19.3 million in the second quarter 2002 was 8.2% higher than the comparable quarter in the prior year. The lower interest rate environment favorably impacted the Bancorp’s costs for both core deposits and wholesale funding in comparison to last year and led to a net interest margin in the second quarter of 4.36%. For the six months of 2002 taxable-equivalent net interest income was $38.1 million an increase of $3.1 million or 9% over 2001 net interest income. The net interest margin for the first six months of 2002 improved by 7 basis points due to lower interest rates paid on deposits and borrowings.

 

Interest Income

 

While the level of earning assets grew by $125 million or 7.5%, Bancorp’s tax-equivalent interest income decreased $3.2 million or 10% in the second quarter of 2002 compared to the second quarter of 2001.This decrease was directly impacted by the unprecedented reductions in interest rates. The yield on earning assets decreased from 7.79% in 2001 to 6.44% for the second quarter of 2002.

 

During the second quarter of 2002, average loans yielding 7.05% declined $14.2 million compared to the second quarter of 2001. This decrease was attributable to prepayments in residential mortgage loans, and consumer automobile loans.

 

Average total securities yielding 5.30% increased 36% to $587 million in the second quarter of 2002 compared to the second quarter of 2001. The growth in the securities portfolio was directly attributable to the significant deposit growth achieved during the past year.

 

10

 

For the six months ended June 30, 2002 tax-equivalent interest income was $57.3 million, a decrease of $7.0 million or 10.85% from the $64.2 million in the first six months of 2001. The yield on earning assets decreased from 7.84% in the first half of 2001 to 6.53% in the first half of 2002, as higher interest rate loans were refinanced or repaid and new loans were made at lower rates. The increase in balances in the investment portfolio also contributed to the decline in the earning asset yield.

 

Interest Expense

 

Interest expense declined 34% or $4.7 million in the second quarter of 2002 compared to the second quarter of 2001. This change was mainly attributable to the decreased interest rate environment which significantly lowered the overall cost of funds. Interest expense additionally benefited from a change in the composition of funding sources from high cost deposits and borrowings into lower cost transaction accounts.

 

Average interest bearing deposits increased 4.4% or $53.8 million in the second quarter of 2002 as compared to the second quarter of 2001. The average rate paid on interest-bearing deposits decreased by 159 basis points from 4.12% in 2001 to 2.53% in the second quarter of 2002 compared to 2001.

 

Average borrowed funds, typically the most expensive funding source, increased $23.1 million or 16% compared to the second quarter of 2001 as Bancorp seeks to take advantage of the low interest rate environment by obtaining longer term funding at historically low costs. The average rate paid on borrowings decreased from 4.04% in 2001 to 2.79% for 2002.

 

Interest expense was reduced $10.1 million or 34.5% from $29.3 million in the first half 2001 to $19.2 million in 2002. Average interest bearing deposits increased $77.7 million or 6.45% to in the first half of 2002 compared to that same period in 2001, while the average rate paid on those deposits decreased from 4.17% to 2.66%.

 

Total average borrowed funds for the six months decreased $7.1 million or 4.1% from $173.3 million in the first half of 2001 to $166.2 million in the comparable period of 2002. The rate paid on those borrowings also decreased from 5.07% in the first half of 2001 to 2.73% in the first half of 2002.

 

11

 

Consolidated Average Balances, Interest and Average Rates (Taxable Equivalent Basis)

 

		Three Months Ended June 30,
		2002								2001
(in thousands)		Average Balance			Interest			Average(2) Rate		Average Balance			Interest			Average(2) Rate
ASSETS
Interest earning assets:
Short-term funds		$	13,183		$	57		1.73	%	$	29,713		$	385		4.44	%
Investment securities:
Taxable		471,928			5,842			4.97	%	305,941			4,856			6.52	%
Tax-exempt(1)		115,429			1,924			6.69	%	125,980			2,111			6.80	%
Total investment securities		587,357			7,766			5.30	%	431,921			6,967			6.60	%
Loans, net, including loans held for sale(1)		1,178,170			20,722			7.05	%	1,192,353			24,409			8.30	%
Total interest-earning assets		1,778,710			28,545			6.44	%	1,653,987			31,761			7.79	%
Total noninterest-earning assets		103,301								107,595
Total assets		$	1,882,011							$	1,761,582
LIABILITIES
Interest bearing liabilities:
Interest bearing deposits
Savings		$	174,700		$	492		1.13	%	$	149,489		$	810		2.20	%
Checking		204,478			278			0.55	%	185,507			555			1.21	%
Money market accounts		308,934			1,259			1.63	%	282,739			2,356			3.38	%
Certificates of deposit		592,966			6,042			4.09	%	609,584			8,757			5.83	%
Total interest bearing deposits		1,281,078			8,071			2.53	%	1,227,319			12,478			4.12	%
Short-term borrowings
Federal funds purchased and securities sold under agreements to repurchase		88,236			237			1.08	%	95,178			905			3.86	%
Other short-term borrowings		5,880			92			6.28	%	7,842			102			5.28	%
Total short-term borrowings		94,116			329			1.40	%	103,020			1,007			3.96	%
Long-term borrowings		71,983			828			4.61	%	39,900			418			4.25	%
Total borrowed funds		166,099			1,157			2.79	%	142,920			1,425			4.04	%
Total interest bearing liabilities		1,447,177			9,228			2.56	%	1,370,239			13,903			4.11	%
Non-interest bearing liabilities:
Demand deposits		247,113								208,721
Other liabilities		14,276								16,795
Total non-interest bearing liabilities		261,389								225,516
Shareholders’ equity		173,445								165,827
Total liabilities and shareholders’ equity		$	1,882,011							$	1,761,582
Net interest income					19,317								17,858
Net interest spread								3.88	%							3.67	%
Net interest margin								4.36	%							4.38	%

 

(1)          Interest and yield on obligations of state and political subdivisions and tax-exempt loans are computed on a taxable equivalent basis using U.S. statutory tax rate of 35 percent.  In addition, loan fee income is included in the interest income calculation, and nonaccrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2)          Average balances and interest dollars are presented in thousands. Average rates are calculated using whole dollars and may differ slightly.

 

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		Six Months Ended June 30,
		2002								2001
(in thousands)		Average Balance			Interest			Average(2) Rate		Average Balance			Interest			Average(2) Rate
ASSETS
Interest earning assets:
Short-term funds		$	12,824		$	101		1.59	%	$	22,161		$	803		5.90	%
Investment securities
Taxable		457,005			11,162			4.93	%	303,263			9,621			6.50	%
Tax-exempt(1)		116,906			3,918			6.76	%	126,365			4,341			6.93	%
Total investment securities		573,911			15,080			5.30	%	429,628			13,962			6.63	%
Loans, net, including loans held for sale(1)		1,181,072			42,074			7.18	%	1,199,163			49,455			8.32	%
Total interest-earning assets		1,767,807			57,254			6.53	%	1,650,952			64,220			7.84	%
Total noninterest-earning assets		103,793								110,739
Total assets		$	1,871,600							$	1,761,691
LIABILITIES
Interest bearing liabilities:
Interest bearing deposits
Savings		$	167,613		$	943		1.13	%	$	165,482		$	1,586		1.93	%
Checking		201,139			531			0.53	%	182,923			1,411			1.56	%
Money market accounts		304,339			2,510			1.66	%	266,225			4,941			3.74	%
Certificates of deposit		609,148			12,936			4.28	%	589,891			16,968			5.80	%
Total interest bearing deposits		1,282,239			16,920			2.66	%	1,204,521			24,906			4.17	%
Short-term borrowings
Federal funds purchased and securities sold under agreements to repurchase		92,576			508			1.11	%	96,175			2,169			4.55	%
Other short-term borrowings		5,885			133			4.52	%	41,681			1,361			6.58	%
Total short-term borrowings		98,461			641			1.31	%	137,856			3,530			5.16	%
Long-term borrowings		67,730			1,607			4.78	%	35,480			828			4.71	%
Total borrowed funds		166,191			2,248			2.73	%	173,336			4,358			5.07	%
Total interest bearing liabilities		1,448,430			19,168			2.67	%	1,377,857			29,264			4.28	%
Non-interest bearing liabilities:
Demand deposits		236,028								202,575
Other liabilities		14,939								16,891
Total non-interest bearing liabilities		250,967								219,466
Shareholders’ equity		172,203								164,368
Total liabilities and shareholders’ equity		$	1,871,600							$	1,761,691
Net interest income					38,086								34,956
Net interest spread								3.86	%							3.56	%
Net interest margin								4.34	%							4.27	%

 

(1)          Interest and yield on obligations of state and political subdivisions and tax-exempt loans are computed on a taxable equivalent basis using U.S. statutory tax rate of 35 percent.  In addition, loan fee income is included in the interest income calculation, and nonaccrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2)          Average balances and interest dollars are presented in thousands. Average rates are calculated using whole dollars and may differ slightly.

 

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Provision for Credit Losses

 

In 2001, the loan loss reserve was bolstered with additional provisions being made in anticipation of increasing loan losses due to the recessionary environment. The provision for credit losses for the second quarter of 2002 was decreased by $1.4 million over the year-ago quarter. For the six-month period ended June 30, 2002, the provision decreased to $975 thousand as compared to $2.6 million for the same period last year, as the loan portfolio continued to perform extraordinarily well. In the second quarter of 2002 the credit quality of the loan portfolio continued to improve therefore additional provisions were not deemed necessary.

 

Noninterest Income

 

Noninterest income is derived from service charges and fees associated with loans and deposits, as well as income from insurance, mortgage banking, investment and brokerage activities. Noninterest income was $8.0 million in the second quarter of 2002, 6.8% higher than the $7.5 million in the second quarter of 2001.

 

Insurance income of $2.5 million increased 12.5% from the second quarter of 2001. This increase from the previous year’s quarter was due to increased sales activities and increased pricing on the renewal of existing insurance policies.

 

The mortgage banking business remained strong generating $849 thousand in quarterly revenues, an 8.15% increase from the second quarter of 2001. Traditionally low mortgage rates during the quarter of 2002 increased the levels of mortgage activities and mortgage revenues continue to benefit from the strong housing market.

 

Revenues from service charges on deposits rose $189 thousand or 9% in the second quarter of 2002 compared to 2001. This increase resulted from the increases in the overall level of new deposit account customers and inflows of additional deposits from existing relationships.

 

Commissions and fees from alternative investments and brokerage services decreased slightly compared to the second quarter of last year. With the volatility experienced in the current equity markets, and the decreased transaction volumes, revenues reflect only a 2% decrease due to our ability to provide innovative financial solutions individually designed for the affluent, emerging affluent and small business customer.

 

For the six months of 2002, noninterest income of $16 million increased 3.3% from the $15.5 million in the comparable period of the previous year. This increase was primarily driven by the increased service charge revenues and strong results in our insurance and mortgage banking business lines.

 

Noninterest Expense

 

Noninterest expense for the quarter of $17.2 million rose $1.45 million or 9.18% compared to the second quarter of 2001. Bancorp incurs additional costs to provide new services and support initiatives that generate additional revenues and growth for the company.

 

Management views the efficiency ratio (the ratio of noninterest expense to the sum of tax equivalent net interest income and noninterest income) as an important measure of overall operating expense performance and cost management. Bancorp’s efficiency ratio increased to 63.13% for the quarter compared to 62.32% for the comparable period in 2001.

 

Salary and benefit related expenses of $9.6 million for the quarter increased $536 thousand or 6% compared to the same period of 2001. This increase was primarily attributable to normal merit increases for our associates, increased commission costs on the revenues generated by fee-based lines of business and increases in employee medical insurance coverage.

 

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Occupancy expenses for the quarter of $2.6 million increased $105 thousand or 4% compared to the second quarter of 2001. Bancorp has been evaluating its retail branch network and has incurred expenses related to the consolidation of several branches. While costs are incurred at the time of consolidation, they result in lower cost and more efficient delivery going forward.

 

Other expenses for the quarter relating to corporate operating expenses increased to $808 thousand or 19% compared to the same quarter of 2001. Expenditures relating to external and internal audit services have increased due to the transition of independent public accountants. Bancorp has also incurred increased marketing related costs to provide research in conjunction with ongoing strategic growth initiatives.

 

Total noninterest expense for the first half of 2002 increased 6% or $1.9 million thousand over the prior year comparable period. Salaries and employee benefits increased 7.5%, occupancy expenses decreased 3.4% and other operating expenses increased 8.7%.

 

Income Taxes

 

Tax expense varies from one period to the next with changes in the level of income before taxes, changes in the amount of tax-exempt income, and the relationship of these changes to each other. The effective income tax expense rate differs from the amount computed at statutory rates primarily due to tax-exempt interest from certain loans and investment securities.

 

For the second quarter of 2002, provision for income taxes increased by 51.3% to $3.1 million from the previous year quarter. The second quarter 2002 effective tax rate was 33.41% compared to 28.02% in the prior year as most of the components of the increased revenues are fully taxable. For the six months ended June 30, 2002, the  provision for income taxes increased 44.5% to $5.7 million from the comparable 2001 period.  The first half of 2002 effective tax rate was 32.5% compared to 28% in the prior year.

 

Nonperforming Assets

 

The Bancorp’s asset quality continues to be sound with nonperforming assets at only 0.13% of total assets at the end of the second quarter. Total nonperforming assets at June 30, 2002 were $2.5 million, an 18.4% increase from the previous year. Although there is no direct correlation between nonperforming loans and ultimate loan losses, an analysis of nonperforming loans may provide some indication of the quality of the loan portfolio.

 

Potential Problem Loans

 

At June 30, 2002, Bancorp had $11.3 million in loans to borrowers who were currently experiencing financial difficulties such that management had reasonable concerns that such loans might become contractually past due or be classified as a nonperforming asset. These loans are subject to the same close attention and regular credit reviews as extended to loans past due 90 days or more and nonperforming assets.

 

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Nonperforming Assets and Contractually Past-Due Loans:

 

(in thousands)		June 30, 2002			December 31, 2001
Nonperforming assets:
Nonaccrual loans(1)		$	2,132		$	1,279
Other real estate owned, net of valuation allowance(2)		354			638
Total nonperforming assets		$	2,486		$	1,917
Loans past due 90 or more days as to interest or principal(3)		$	890		$	2,819
Nonperforming loans to total loans		0.18		%	0.11		%
Nonperforming assets to total loans plus other real estate owned		0.21		%	0.16		%
Nonperforming assets to total assets		0.13		%	0.10		%
Allowance for credit losses times nonperforming loans		6.57			10.90
Allowance for credit losses times nonperforming assets		5.63			7.28

 

(1)   Loans are placed on nonaccrual status when, in the opinion of management, reasonable doubt exists as to the full, timely collection of interest or principal, or a specific loan meets the criteria for nonaccrual status established by regulatory authorities. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. No interest is taken into income on nonaccrual loans unless received in cash, or until such time the borrower demonstrates sustained performance over a period of time in accordance with contractual terms.

 

(2)   Other real estate owned includes: banking premises no longer used for business purposes and real estate acquired by foreclosure (in partial or complete satisfaction of debt), or otherwise surrendered by the borrower to Bancorp’s possession. Other real estate owned is recorded at the lower of cost or fair value on the date of acquisition or transfer from loans. Write-downs to fair value at the date of acquisition are charged to the allowance for credit losses. Subsequent to transfer, these assets are adjusted through a valuation allowance to the lower of the net carrying value or the fair value (net of estimated selling expenses) based on periodic appraisals.

 

(3)   Nonaccrual loans are not included.

 

Allowance for Credit Losses

 

At June 30, 2002, the allowance for credit losses was $14.0 million or 1.19% of total loans, with net annualized charge-offs for the quarter of less than 0.08% of average loans outstanding during the second quarter of 2002. Year to date 2002 net annualized charge-offs represent 0.16% of average loans

 

The allowance for credit losses is maintained at a level, which in management’s judgment is adequate to absorb losses inherent in the loan portfolio. The adequacy of the allowance for credit losses is reviewed regularly by management. Additions to the allowance are made by charges to the provision for credit losses. On a quarterly basis, a comprehensive review of the allowance is performed considering such factors as the levels of loans outstanding, loss experience, delinquency levels, certain individual loan reviews, and an evaluation of the regional and national economic environment. The methodology for assessing the appropriateness of the allowance consists of three primary elements:

 

•      The Formula Allowance. The formula allowance is calculated by applying historically determined loss factors to outstanding business loans based on credit risk ratings and for pools of homogeneous loans. Individually risk rated loan loss factors is determined using average annual net charge-off rates for the most recent years. Pooled loans are loans that are homogeneous in nature such as consumer installment and residential mortgage loans. Pooled loan loss factors are based on net charge–offs experienced over the past year. The historic loss factors on the risk rated loans and the pooled loans are then considered for either positive or negative adjustment in an attempt to reflect the current dynamics of the portfolios. These adjustments in the loss

 

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factors are tied to management’s evaluation of a number of factors including: 1) changes in the trend of the volume and severity of past due, classified and non-accrual assets; 2) changes in the nature and volume of the portfolio; 3) changes in lending policies, underwriting standards, or collection practices; 4) changes in the experience, ability, depth of lending management and staff; 5) portfolio concentrations; and 6) changes in the national or local economy.

 

•      Specific Allowances for Identified Problem Loans. The amount of specific reserves is determined through a loan-by-loan analysis of non-performing loans. The analysis considers expected future cash flows, the value of collateral or other factors that may impact the borrower’s ability to repay.

 

•      The Unallocated Allowance. The unallocated portion of the allowance is based on loss factors that cannot be associated with specific loans or loan categories. These factors include management’s evaluation of such conditions as credit quality trends, collateral values, portfolio concentrations, specific industry conditions in the regional economy, regulatory examination results, internal audit and loan review findings, recent loss experiences in particular portfolio segments, etc. The unallocated portion of the allowance for losses reflects management’s attempt to ensure that the overall reserve appropriately reflects a margin for the imprecision necessarily inherent in estimates of credit losses.

 

While management believes the allowance for credit losses was adequate at June 30, 2002, the estimate of losses and related allowance may change in the near term due to economic and other uncertainties inherent in the estimation process.

 

Analysis of Allowance for Credit Losses:

 

		Six Months Ended
(in thousands)		June 30, 2002			June 30, 2001
Average loans outstanding
less average unearned income(1)		$	1,165,698		$	1,184,630
Allowance for credit losses at beginning of period		$	13,947		$	13,232
Charge-offs:
Real estate		18			157
Commercial and industrial		110			115
Consumer		2,166			2,588
Total loans charged-off		2,294			2,859
Recoveries:
Real estate		3			2
Commercial and industrial		193			106
Consumer		1,176			1,240
Total recoveries		1,371			1,348
Net charge-offs		923			1,512
Additions charged to operating expense		975			2,630
Allowance for credit losses at end of period		$	13,999		$	14,350
Net annualized charge-offs to average loans outstanding		0.16		%	0.26		%

 

(1)          Excludes loans held for sale

 

17

 

The following table presents an allocation of the allowance for credit losses to various loan categories.  This allocation does not limit the amount of the allowance available to absorb losses from any type of loan and should not be viewed as an indicator of the specific amount or specific loan categories in which future charge-offs may ultimately occur.

 

Allocation of Allowance for Credit Losses:

 

		For the Period Ending
		June 30, 2002					December 31, 2001
(in thousands)		Amount			% of Total Allowance		Amount			% of Total Allowance
Real estate loans
Construction and land development		$	1,670		11.9	%	$	1,655		11.9	%
Residential mortgage		393			2.8	%	481			3.4	%
Other mortgage		2,265			16.2	%	2,534			18.2	%
Commercial and industrial		2,873			20.5	%	3,131			22.4	%
Consumer		4,531			32.4	%	5,923			42.5	%
Unallocated		2,267			16.2	%	223			1.6	%
Totals		$	13,999		100.0	%	$	13,947		100.0	%

 

Capital Resources

 

It is Bancorp’s policy to maintain a level of capital sufficient to protect the company’s depositors, creditors, and shareholders, and to support Bancorp’s growth. The principal source of capital is retained earnings. Bancorp recorded a total risk-based capital ratio of 13.24% at June 30, 2002, compared to 13.30% at December 31, 2001; a tier 1 risk-based capital ratio of 12.20%, compared to 12.24%: and a capital leverage ratio of 8.81%, compared to 8.71%. Under each measure, Bancorp and its subsidiaries were substantially in excess of the minimum regulatory requirements and, by definition, were “well capitalized” at June 30, 2002 and December 31, 2001. Management believes the level of capital at June 30, 2002, is appropriate.

 

Shareholders’ equity totaled $177.5 million ( including $7.8 million reported for accumulated other comprehensive income) at June 30, 2002; an increase of 6% compared with the 2001 year-end level of $167.4 million (including $3.2 million reported for accumulated other comprehensive income). Bancorp’s accumulated comprehensive income (loss) category is comprised of net unrealized gains and losses on available-for-sale securities.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

Market risk is defined as the future changes in market prices that increase or decrease the value of financial instruments, i.e. cash, investments, loans, deposits, and debt.  Included in market risk are interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market risks.  Bancorp’s primary source of market risk is interest rate risk.  Market risk-sensitive financial instruments are entered into for purposes other than trading.

 

Interest rate risk refers to the exposure of Bancorp’s earnings and capital to changes in interest rates. This risk is driven by potential mismatches resulting in timing differences in the re-pricing of assets, liabilities and the potential impact of explicit and embedded options. The goal of asset/liability management is to maintain high-quality and consistent growth of net interest income, while maintaining acceptable levels of risk to changes in interest rates, and acceptable levels of capital and liquidity. This goal is achieved by influencing the maturity and re-pricing of assets and liabilities and by managing discretionary portfolios.

 

18

 

There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on Bancorp’s earnings and capital.  Re-pricing risk arises largely from timing differences in the pricing of assets and liabilities.  Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower rates.  Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally.  Yield curve risk refers to unequal movements in interest rates across a full range of maturities.

 

In determining the appropriate level of interest rate risk, Bancorp considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies, and other factors. The Bancorp uses a number of tools to measure interest rate risk, including simulating net interest income, monitoring the sensitivity of the net present value of the balance sheet, and monitoring the difference or gap between maturing or rate-sensitive assets and liabilities over various time periods.

 

Management believes that interest rate risk is best measured by simulation modeling which calculates expected net interest income based on projected interest-earning assets and interest-bearing liabilities.  The model projections are based upon historical trends and management’s expectations of balance sheet growth patterns, spreads to market rates, historical market rate relationships, prepayment behavior, current and expected product offerings and sales activities. Various sensitivity analyses are performed on a regular basis to segregate interest rate risk into separate components and understand the risk attributable to prepayments, caps and floors, and other options. Assumption testing is performed to understand the degree of impact from changing key assumptions such as the speed of prepayments, the interest rate elasticity of core deposit rates and balance sheet growth.  The Bancorp’s policy guideline limit for net interest income simulation is a negative impact to net interest income of 15.0 percent for the up or down 300 basis points scenarios when compared with the flat rate scenario.  Management has generally maintained a risk position well within the policy guideline level.  The model indicated the impact of a 300 basis point rise in rates over the next 12 months would cause approximately a 4.6% decrease in net interest income at June 30, 2002.  A 300 basis point decrease in rates over the next 12 months would cause approximately a 4.8% decrease in net interest income. Note that certain short-term market rates and a majority of the Bank’s deposit rates are below 3.0%.  These rates cannot move below zero in a down 300 basis point scenario.  The impact of this zero percent floor on deposit rates is the primary reason that net interest income is negatively impacted in the down 300 basis point scenario.

 

Computations of prospective effects of hypothetical interest rate changes are based on many assumptions, including relative levels of market interest rates, loan prepayments and changes in deposit levels.  They are not intended to be a forecast and should not be relied upon as indicative of actual results.  Further, the computations do not contemplate certain actions that management could take in response to changes in interest rates.

 

Effects of Changing Prices: Inasmuch as virtually all of a financial institution’s assets and liabilities are monetary in nature, changes in interest rates, or the price paid for money, may have a significant effect on earnings performance. Interest rates, though affected by inflation, do not necessarily move in the same direction, or in the same magnitude, as the prices of other goods and services. Movements in interest rates are a result of the perceived changes in the rate of inflation and the effects of monetary and fiscal policies. Reference to Net Interest Income and Market Risk in this section will assist the reader in understanding of how Bancorp is positioned to address changing interest rates.

 

Several major categories of noninterest expense are more directly affected by inflationary factors such as salaries and employee benefits and other operating expenses. Management endeavors to overcome, or mitigate, the effects of inflation by seeking opportunities to improve operating efficiency and productivity, and by developing strategies for growth that will exceed the projected rate of inflation.

 

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PART II - Other Information

 

Item 6.   Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

10.5 Post-effective amendment to F&M Bancorp Dividend Reinvestment and Stock Purchase Plan.  File as Prospectus to Registration Statement on Form S-3 (File #33-39940) and incorporated herein by reference.

 

11. Computation of per share earnings: Filed as an exhibit hereto and incorporated herein by reference.

 

99.1 CEO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed as an exhibit hereto and incorporated herein by reference

 

99.2 CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed as an exhibit hereto and incorporated herein by reference

 

(b)           Reports on Form 8-K

 

A report on Form 8-K, Item 4. Changes in Registrant’s Certifying Accountant and Item 7 Financial Statements, Pro Forma Financial Information and Exhibits. Announce its engagement of Deloitte & Touche LLP as it’s new independent public accountants, filed on April 12, 2002

 

Signatures

 

Pursuant to the requirements 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.

 

			F&M BANCORP
			(Registrant)
August 12, 2002			/s/ Faye E. Cannon
Date			FAYE E. CANNON
			PRESIDENT AND CEO
August 12, 2002			/s/ Kaye A. Simmons
Date			KAYE SIMMONS
			CFO AND TREASURER

 

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