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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended September 30, 2002

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 0-12638

 


 

F&M BANCORP

(Exact name of registrant as specified in its charter)

 

Maryland

 

52-1316473

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

110 Thomas Johnson Drive
Frederick, Maryland 21702

(Address of principal executive offices) (Zip Code)

 

 

 

(888) 694-4170

(Registrant’s telephone number, including area code)

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

NONE

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock ($5 par value)

(Title of class)

 

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 10,778,280 shares outstanding as of November 7, 2002.

 

 



 

Form 10-Q

TABLE OF CONTENTS

 

PART I

Financial Information

Item 1.

Financial Statements

 

Consolidated Statements of Income (Unaudited)

 

Consolidated Balance Sheets (Unaudited)

 

Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Unaudited)

 

Consolidated Statements of Cash Flows (Unaudited)

 

Notes to Financial Statements (Unaudited)

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)

 

Summary Financial Data

 

Overview

 

Earnings Performance

 

 

Net Interest Income

 

 

Noninterest Income

 

 

Noninterest Expense

 

Balance Sheet Analysis

 

 

Securities Available for Sale

 

 

Loan Portfolio

 

 

Nonaccrual Loans and Other Assets

 

 

Allowance for Credit Losses

 

 

Deposits

 

 

Capital Adequacy/Ratios

 

Asset/Liability and Market Risk Management

 

Capital Management

 

Evaluation of Internal Controls

 

Factors that May Affect Future Results

 

 

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

 

 

PART II

Other Information

Item 6.

Exhibits and Reports on Form 8-K

 

 

Signature

 

The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read in conjunction with F&M Bancorp’s 2001 Annual Report on Form 10-K.

 

2



 

PART I – FINANCIAL INFORMATION
F&M BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

 

 

 

Quarter ended
September 30,

 

Nine months ended
September 30,

 

(in thousands, except per share data)

 

2002

 

2001

 

2002

 

2001

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

Loans

 

$

20,961

 

$

23,534

 

$

62,399

 

$

72,346

 

Loans held for sale

 

124

 

339

 

619

 

881

 

Securities available for sale

 

7,101

 

6,244

 

20,655

 

18,494

 

Other interest income

 

116

 

352

 

411

 

1,393

 

Total interest income

 

28,302

 

30,469

 

84,084

 

93,114

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Deposits

 

7,531

 

12,046

 

24,451

 

36,952

 

Short-term borrowings

 

462

 

784

 

1,104

 

4,314

 

Long-term borrowings

 

945

 

595

 

2,551

 

1,423

 

Total interest expense

 

8,938

 

13,425

 

28,106

 

42,689

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME

 

19,364

 

17,044

 

55,978

 

50,425

 

Provision for credit losses

 

350

 

430

 

1,325

 

3,060

 

Net interest income after provision for credit losses

 

19,014

 

16,614

 

54,653

 

47,365

 

 

 

 

 

 

 

 

 

 

 

NONINTEREST INCOME

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

2,348

 

2,062

 

6,827

 

6,133

 

Insurance income

 

2,194

 

2,134

 

7,384

 

6,930

 

Gains on sales of loans

 

1,295

 

1,184

 

3,016

 

2,782

 

Trust and investment fees

 

407

 

872

 

2,238

 

2,719

 

Gains on sales of securities

 

 

19

 

 

52

 

Gains on sales of property

 

37

 

130

 

160

 

237

 

Other operating income

 

1,414

 

1,258

 

4,084

 

4,310

 

Total noninterest income

 

7,695

 

7,659

 

23,709

 

23,163

 

 

 

 

 

 

 

 

 

 

 

NONINTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Salaries

 

7,199

 

7,192

 

21,862

 

21,381

 

Incentive compensation

 

1,199

 

478

 

2,400

 

1,642

 

Employee benefits

 

1,439

 

1,795

 

4,813

 

4,343

 

Occupancy and equipment expense

 

2,345

 

2,591

 

7,444

 

7,871

 

Core deposit intangible

 

246

 

231

 

685

 

694

 

Other operating expense

 

4,797

 

4,204

 

14,055

 

12,659

 

Total noninterest expenses

 

17,225

 

16,491

 

51,259

 

48,590

 

 

 

 

 

 

 

 

 

 

 

INCOME BEFORE INCOME TAX EXPENSE

 

9,484

 

7,782

 

27,103

 

21,938

 

Income tax expense

 

3,183

 

2,269

 

8,909

 

6,235

 

NET INCOME

 

$

6,301

 

$

5,513

 

$

18,194

 

$

15,703

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER COMMON SHARE

 

 

 

 

 

 

 

 

 

Earnings per common chare

 

$

0.58

 

$

0.50

 

$

1.68

 

$

1.43

 

Diluted earnings per common share

 

$

0.58

 

$

0.50

 

$

1.67

 

$

1.42

 

 

 

 

 

 

 

 

 

 

 

DIVIDENDS DECLARED PER COMMON SHARE

 

$

0.28

 

$

0.27

 

$

0.56

 

$

0.81

 

Average common share outstanding

 

10,776,193

 

10,967,281

 

10,814,074

 

11,002,801

 

Diluted average common shares outstanding

 

10,864,211

 

11,026,378

 

10,880,984

 

11,049,532

 

 

3



 

F&M BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

(in thousands, except shares)

 

September 30,
2002

 

December 31,
2001

 

September 30,
2001

 

 

 

(Unaudited)

 

 

 

(Unaudited)

 

ASSETS

 

 

 

 

 

 

 

Cash and due from banks

 

$

67,744

 

$

65,570

 

$

58,580

 

Interest-bearing deposits with banks

 

3,062

 

13,178

 

11,749

 

Federal funds sold

 

232

 

360

 

23,095

 

Total cash and cash equivalents

 

71,038

 

79,108

 

93,424

 

Loans held for sale

 

19,750

 

28,779

 

17,086

 

Securities available for sale

 

609,926

 

546,522

 

496,429

 

FHLB / FRB stock

 

7,218

 

6,866

 

6,866

 

 

 

 

 

 

 

 

 

Loans, net of unearned income

 

1,233,792

 

1,162,225

 

1,178,949

 

Allowance for credit losses

 

(14,055

)

(13,947

)

(14,218

)

Net loans

 

1,219,737

 

1,148,278

 

1,164,731

 

 

 

 

 

 

 

 

 

Bank premises and equipment, net

 

34,365

 

35,563

 

36,334

 

Other real estate owned, net

 

323

 

638

 

667

 

Interest receivable

 

9,559

 

9,417

 

10,322

 

Core deposit intangible assets

 

2,132

 

2,817

 

3,569

 

Mortgage servicing rights

 

833

 

1,028

 

1,093

 

Cash value of life insurance

 

11,379

 

10,978

 

10,768

 

Other assets

 

6,747

 

11,440

 

10,685

 

Total assets

 

$

1,993,007

 

$

1,881,434

 

$

1,851,974

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

$

266,722

 

$

234,459

 

$

214,933

 

Interest-bearing deposits

 

1,294,196

 

1,281,609

 

1,274,659

 

Total deposits

 

1,560,918

 

1,516,068

 

1,489,592

 

 

 

 

 

 

 

 

 

Short-term borrowings

 

153,794

 

117,545

 

110,516

 

Long-term borrowings

 

78,122

 

63,444

 

65,003

 

Accrued taxes and other liabilities

 

16,886

 

16,952

 

17,908

 

Total liabilities

 

1,809,720

 

1,714,009

 

1,683,019

 

 

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Common stock - $5 par value; authorized 50,000,000 shares; issued 10,781,375 shares, 10,862,257 shares and 10,895,440 shares, respectively

 

53,907

 

54,311

 

55,477

 

Surplus

 

72,131

 

75,147

 

75,864

 

Retained earnings

 

46,940

 

34,782

 

32,461

 

Accumulated other comprehensive income

 

10,309

 

3,185

 

6,153

 

Total shareholders’ equity

 

183,287

 

167,425

 

168,955

 

Total liabilities and shareholders’ equity

 

$

1,993,007

 

$

1,881,434

 

$

1,851,974

 

 

4



 

F&M BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’
EQUITY AND COMPREHENSIVE INCOME
(Unaudited)

 

(in thousands, except shares)

 

Number
of shares

 

Common
stock

 

Additional
paid-in
capital

 

Retained
earnings

 

Cumulative
other
comprehensive
(loss) income

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2000

 

11,014,529

 

$

55,073

 

$

78,488

 

$

25,857

 

$

(1,382

)

$

158,036

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

15,703

 

 

15,703

 

Other comprehensive income net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized gains on securities available for sale, net of reclassification of $34 of net gains included in net income

 

 

 

 

 

7,535

 

7,535

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

23,238

 

Dividend reinvestment plan

 

 

 

 

(164

)

 

(164

)

Cash dividends declared $(.81 per share)

 

 

 

 

(8,928

)

 

(8,928

)

Stock consideration for options exercised

 

(624

)

(3

)

(4

)

(7

)

 

(14

)

Stock options exercised

 

23,935

 

119

 

357

 

 

 

476

 

Stock repurchase and retirement

 

(153,700

)

(712

)

(2,977

)

 

 

(3,689

)

Net change

 

(130,389

)

(596

)

(2,624

)

6,604

 

7,535

 

10,919

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2001

 

10,884,140

 

$

54,477

 

$

75,864

 

$

32,461

 

$

6,153

 

$

168,955

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2001

 

10,862,257

 

$

54,311

 

$

75,147

 

$

34,782

 

$

3,185

 

$

167,425

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

18,194

 

 

18,194

 

Other comprehensive income net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized gains on securities

 

 

 

 

 

7,124

 

7,124

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

25,318

 

Dividend reinvestment plan

 

 

 

 

(24

)

 

(24

)

Cash dividends declared $(.56 per share)

 

 

 

 

(6,001

)

 

(6,001

)

Stock consideration for options exercised

 

(678

)

(3

)

(675

)

(11

)

 

(688

)

Stock options exercised

 

40,326

 

201

 

602

 

 

 

803

 

Stock repurchase and retirement

 

(120,530

)

(602

)

(2,943

)

 

 

(3,546

)

Net change

 

(80,882

)

(404

)

(3,016

)

12,158

 

7,124

 

15,862

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2002

 

10,781,375

 

$

53,907

 

$

72,131

 

$

46,940

 

$

10,309

 

$

183,287

 

 

5



 

F&M BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)

 

 

 

Nine months ended September 30,

 

(in thousands)

 

2002

 

2001

 

Cash Flows from Operating Activities

 

 

 

 

 

Net Income

 

$

18,194

 

$

15,703

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

Provision for credit losses

 

1,325

 

3,060

 

Depreciation and amortization

 

2,805

 

2,655

 

Amortization of intangibles

 

907

 

845

 

Net premium amortization on investment securities

 

1,995

 

523

 

(Increase) decrease in interest receivable

 

(142

)

850

 

Decrease in interest payable

 

(409

)

(970

)

Gain on sales of property

 

(160

)

(237

)

Gain on sales of securities

 

 

(52

)

Decrease (increase)  in loans held for sale

 

9,029

 

(11,092

)

(Increase) decrease in other assets

 

(52

)

289

 

Increase (decrease) in other liabilities

 

343

 

(437

)

Gain on sales of loans

 

(3,016

)

(2,782

)

Net cash provided by operating activities

 

30,819

 

8,355

 

Cash Flows from Investing Activities

 

 

 

 

 

Purchases of investment securities available for sale

 

(217,069

)

(253,456

)

Proceeds from sales/maturities of securities available for sale

 

162,760

 

194,179

 

Net (increase) decrease in loans

 

(69,843

)

41,668

 

Purchases of premises and equipment

 

(1,608

)

(3,342

)

Proceeds from sales of property

 

550

 

988

 

Net cash used in investing activities

 

(125,210

)

(19,963

)

Cash Flows from Financing Activities

 

 

 

 

 

Net increase in noninterest-bearing deposits, interest-bearing checking, savings and money market accounts

 

67,533

 

27,321

 

Net (decrease) increase in certificates of deposit

 

(22,683

)

98,239

 

Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase

 

25,544

 

(18,651

)

Net increase (decrease) in other short-term borrowings

 

10,705

 

(108,904

)

Net increase in long-term borrowings

 

14,678

 

49,213

 

Cash dividends paid

 

(6,001

)

(8,928

)

Dividend reinvestment plan

 

(24

)

(164

)

Issuance of common stock

 

115

 

462

 

Common stock purchased and retired

 

(3,546

)

(3,689

)

Net cash provided by financing activities

 

86,321

 

34,899

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(8,070

)

23,291

 

Cash and cash equivalents at beginning of year

 

79,108

 

70,133

 

Cash and cash equivalents at end of period

 

$

71,038

 

$

93,424

 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

Cash payments for interest

 

$

28,515

 

$

43,659

 

Cash payments for income tax

 

7,366

 

5,711

 

Non-Cash Investing and Financing Activities

 

 

 

 

 

Fair value adjustment for securities available for sale, net of income taxes

 

$

7,124

 

$

7,535

 

 

6



 

F&M BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
(Unaudited)

 

1. Summary of Significant Accounting Policies

 

Descriptions of the significant accounting policies of F&M Bancorp and Subsidiaries (the Bancorp) are included in Note 1 (Summary of Significant Accounting Policies) to the audited consolidated financial statements included in the Bancorp’s 2001 Annual Report on Form 10-K. There have been no significant changes to these policies except for accounting policies related to goodwill discussed below.

 

Goodwill and Other Intangible Assets

 

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations under the purchase method of accounting. 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 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 No.141 on July 1, 2001 and SFAS No. 142 on January 1, 2002 and goodwill will be assessed at least annually for impairment on a reporting unit level by applying a fair-valued-based test using discounted estimated future net cash flows. The Bancorp does not currently carry any goodwill attributable to premiums relating from prior mergers and/or acquisitions. Therefore the “Adjusted” Earnings – SFAS 142 Transitional Disclosures does not apply as earnings per share and net income would be the same for all years reported.

 

Core deposit intangibles are amortized on an accelerated basis based on useful lives of up to 15 years. The Bancorp reviews other intangible assets for impairment annually (except mortgage servicing rights, which are reviewed monthly), or whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. For those intangible assets subject to amortization, impairment is indicated if the sum of undiscounted estimated future net cash flow is less than the carrying amount of the asset. Impairment is recognized by accelerating the write off of the asset to the extent that the carrying value exceeds the estimated fair value.

 

7



 

2.  Earnings Per Share

 

The table below shows dual presentation of earnings per common share and diluted earnings per common share and a reconciliation of the numerator and denominator of both earnings per common share calculations.

 

 

 

Quarter ended
September 30,

 

Nine months ended
September 30,

 

(in thousands, except per share data)

 

2002

 

2001

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stock (numerator)

 

$

6,301

 

$

5,513

 

$

18,194

 

$

15,703

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER COMMON SHARE

 

 

 

 

 

 

 

 

 

Average common shares outstanding (denominator)

 

10,776.2

 

10,967.3

 

10,814.1

 

11,002.8

 

Per share

 

$

0.58

 

$

0.50

 

$

1.68

 

$

1.43

 

 

 

 

 

 

 

 

 

 

 

DILUTED EARNINGS PER COMMON SHARE

 

 

 

 

 

 

 

 

 

Average common shares outstanding

 

10,776.2

 

10,967.3

 

10,814.1

 

11,002.8

 

Add:  Stock options

 

88.0

 

59.1

 

66.9

 

46.7

 

Diluted average common shares outstanding (denominator)

 

10,864.2

 

11,026.4

 

10,881.0

 

11,049.5

 

Per share

 

$

0.58

 

$

0.50

 

$

1.67

 

$

1.42

 

 

As allowed for under SFAS No.123, Accounting for Stock-Based Compensation, the Bancorp has elected to follow the provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, in accounting for its stock option plans for directors and employees. The Bancorp utilizes APB 25, and as such compensation expense for stock options is not recognized in net income; however, the effect of the shares that would be issued is reflected in diluted earnings per share as an increase to average common shares outstanding and results in a decrease to earnings per share. For further information see Note 9 to the audited consolidated financial statements included in the Bancorp’s 2001 Annual Report on Form 10-K.

 

3.  Operating Segments

 

Operating segments as defined by SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information are components of an enterprise with separate financial information.  The component engages in business activities, from which it derives revenues and incurs expenses and whose operating result’s management relies on for decision making and performance assessment. The Bancorp, as defined by this standard, does not have any segment whose revenues, reported profit and loss, or assets are 10% or more of the combined revenues of all reporting segments.

 

8



 

4.  Intangible Assets

 

The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2002 is presented in the following table.

 

 

 

September 30, 2002

 

(in thousands)

 

Gross
carrying amount

 

Accumulated
amortization

 

Net intangible
assets

 

 

 

 

 

 

 

 

 

Amortized intangible assets:

 

 

 

 

 

 

 

Core deposit intangible

 

$

8,565

 

$

6,433

 

$

2,132

 

Mortgage servicing rights

 

1,757

 

924

 

833

 

Total

 

$

10,322

 

$

7,357

 

$

2,965

 

 

The projections of amortization expense shown below for mortgage servicing rights are based on asset balances and the interest rate environment as of September 30, 2002. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.

 

The following table shows the current period and estimated future amortization expense for amortized intangible assets and should be read in conjunction with Note 1 regarding goodwill and other intangible assets.

 

(in thousands)

 

Core
deposit
intangibles

 

Mortgage
servicing
rights

 

Total
expense

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2002 (actual)

 

$

685

 

$

222

 

$

907

 

 

 

 

 

 

 

 

 

Three months ended December 31, 2002 (estimated)

 

246

 

65

 

311

 

 

 

 

 

 

 

 

 

Estimate for year ended December 31,

 

 

 

 

 

 

 

2003

 

819

 

260

 

1,079

 

2004

 

737

 

260

 

997

 

2005

 

330

 

248

 

578

 

2006

 

 

 

 

2007

 

 

 

 

 

9



 

5.  Recent Accounting Standards

 

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 Bancorp 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 No.146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Bancorp’s commitment to an exit plan rather than when the liability is incurred. SFAS No.146 also establishes that the liability should initially be measured and recorded at fair value.  Accordingly, SFAS No.146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Bancorp will adopt the provisions of SFAS No. 146 for any restructuring activities which may be initiated after December 31, 2002.

 

In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions, which provides guidance on the accounting for the acquisition of a financial institution.  This statement requires that the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination represents goodwill that should be accounted for under SFAS No. 142, Goodwill and Other Intangible Assets.  Thus, the specialized accounting guidance in paragraph 5 of SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, will not apply after September 30, 2002.  If certain criteria in SFAS No. 147 are met, the amount of the unidentifiable intangible asset will be reclassified to goodwill upon adoption of the statement.  Financial institutions meeting conditions outlined in SFAS No. 147 will be required to restate previously issued financial statements.  Additionally, the scope of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, is amended to include long-term customer-relationship intangible assets such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets.  This statement is effective for the Bancorp and has been adopted as of October 1, 2002.  The adoption of this standard did not have a material impact on the Bancorp’s financial position or results of operation.

 

10



 

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

SUMMARY FINANCIAL DATA

 

 

 

Quarter ended

 

% Change
Sep. 30, 2002
from

 

Nine months ended

 

 

 

(in thousands, except per share amounts)

 

Sep. 30,
2002

 

June 30,
2002

 

Sep. 30,
2001

 

June 30,
2002

 

Sep. 30,
2001

 

Sep. 30,
2002

 

Sep. 30,
2001

 

%
Change

 

For the Period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

6,301

 

$

6,116

 

$

5,513

 

3

%

14

%

$

18,194

 

$

15,703

 

16

%

Diluted earnings per common share

 

0.58

 

0.56

 

0.50

 

3

 

16

 

1.67

 

1.42

 

18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profitability ratios (annualized)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income to average total assets (ROA)

 

1.29

%

1.30

%

1.21

%

(1

)

7

 

1.28

%

1.18

%

9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stock to average common stockholders equity (ROE)

 

13.88

%

14.14

%

13.01

%

(2

)

7

 

13.91

%

12.68

%

10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Efficiency ratio(1)

 

62.02

%

63.13

%

64.79

%

(2

)

(4

)

62.61

%

64.00

%

(2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.28

 

$

0.28

 

$

0.27

 

 

4

 

$

0.56

 

$

0.81

 

(31

)

Dividends paid per common share

 

0.28

 

0.28

 

0.27

 

 

4

 

0.84

 

0.81

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average common shares outstanding

 

10,776,193

 

10,814,183

 

10,967,281

 

 

(2

)

10,814,074

 

11,002,801

 

(2

)

Diluted average common shares outstanding

 

10,864,211

 

10,877,815

 

11,026,378

 

 

(1

)

10,880,984

 

11,049,532

 

(2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

27,059

 

$

26,565

 

$

24,703

 

2

 

10

 

$

79,687

 

$

73,587

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average loans

 

1,204,657

 

1,172,164

 

1,169,779

 

3

 

3

 

1,178,828

 

1,179,625

 

 

Average assets

 

1,938,984

 

1,912,992

 

1,807,374

 

1

 

7

 

1,894,309

 

1,777,086

 

7

 

Average deposits

 

1,526,889

 

1,519,882

 

1,473,294

 

 

4

 

1,521,174

 

1,429,405

 

6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin

 

4.34

%

4.36

%

4.15

%

 

5

 

4.34

%

4.23

%

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At Period End

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities available for sale

 

$

609,926

 

$

606,826

 

$

496,429

 

1

 

23

 

$

609,926

 

$

496,429

 

23

 

Loans

 

1,233,792

 

1,171,946

 

1,178,949

 

5

 

5

 

1,233,792

 

1,178,949

 

5

 

Allowance for credit losses

 

(14,055

)

(13,999

)

(14,218

)

 

(1

)

(14,055

)

(14,218

)

(1

)

Assets

 

1,993,007

 

1,916,104

 

1,851,974

 

4

 

8

 

1,993,007

 

1,851,974

 

8

 

Deposits

 

1,560,918

 

1,549,241

 

1,489,592

 

1

 

5

 

1,560,918

 

1,489,592

 

5

 

Shareholders’ equity

 

183,287

 

177,462

 

168,955

 

3

 

8

 

183,287

 

168,955

 

8

 

Tier 1 capital(2)

 

170,479

 

167,161

 

158,932

 

2

 

7

 

170,479

 

158,932

 

7

 

Total capital(2)

 

184,534

 

181,160

 

173,151

 

2

 

7

 

184,534

 

173,151

 

7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity to assets

 

9.20

%

9.26

%

9.12

%

(1

)

1

 

9.20

%

9.12

%

1

 

Risk-based capital(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital

 

12.12

%

12.20

%

12.19

%

(1

)

 

12.12

%

12.19

%

 

Total capital

 

13.12

%

13.24

%

13.28

%

(1

)

(1

)

13.12

%

13.28

%

(1

)

Leverage(2)

 

8.80

%

8.81

%

8.81

%

 

 

8.80

%

8.81

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Book value per common share

 

$

17.00

 

$

16.47

 

$

15.51

 

3

 

10

 

$

17.00

 

$

15.51

 

10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Staff (active, full-time equivalent)

 

694

 

715

 

745

 

(3

)

(7

)

694

 

745

 

(7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

High

 

$

35.27

 

$

35.66

 

$

29.55

 

(1

)

19

 

$

35.66

 

$

29.98

 

19

 

Low

 

26.41

 

26.21

 

21.92

 

1

 

20

 

25.06

 

19.81

 

27

 

Period end

 

31.60

 

35.28

 

26.20

 

(10

)

21

 

31.60

 

26.20

 

21

 

 


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

(2)          See the Capital Adequacy/Ratios section for additional information.

 

11



 

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 the Bancorp.

 

OVERVIEW

 

F&M Bancorp is the registered bank holding company for Farmers & Mechanics Bank (the “Bank”), headquartered in Frederick, Maryland. The Bancorp is a $2 billion diversified financial services company providing banking, insurance, wealth management, and mortgage banking through banking branches, the internet and other distribution channels to consumers and commercial businesses. The Bank operates 49 community offices in Frederick, Howard, Baltimore, Montgomery, Washington, Carroll and Alleghany Counties in Maryland, together with two insurance agencies. The Bancorp has established a strategy of independence, and intends to establish or acquire additional offices, banking organizations and nonbanking organizations as appropriate opportunities present themselves.

 

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

 

Net income for the third quarter of 2002 reached a record $6.3 million, an increase of 14% compared with earnings of $5.51 million for the third quarter of 2001. Earnings per diluted share for the third quarter of 2002 reached a record $0.58 per share, a 16% increase over the prior year’s $0.50 per share results. Return on average assets (ROA) was 1.29% and return on average equity (ROE) was 13.88% for the third quarter of 2002, compared with 1.21% and 13.01%, respectively, for the same period of 2001.

 

Net income for the first nine months of 2002 reached $18.2 million, or $1.67 per diluted share, compared with $15.7 million, or $1.42 per diluted share, for the first nine months of 2001. ROA was 1.28% in the first nine months of 2002, compared with 1.18% for the first nine months of 2001. ROE was 13.91% in the first nine months of 2002, compared with 12.68% for the same period of 2001.

 

Net interest income on a taxable-equivalent basis was $20.1 million for the third quarter of 2002 and $58.2 million for the first nine months of 2002 compared with $17.8 million and $52.8 million for the same periods of 2001. The Bancorp’s net interest margin was 4.34% for the third quarter and the first nine months of 2002, compared with 4.15% and 4.23% for the same periods of 2001.

 

Noninterest income totaled $7.7 million and $23.7 million for the third quarter and the first nine months of 2002, respectively, compared with $7.7 million and $23.2 million for the same periods of 2001.

 

Noninterest expense totaled $17.2 million and $51.3 million for the third quarter and the first nine months of 2002, respectively, compared with $16.5 million and $48.6 million for the same periods of 2001.

 

12



 

The provision for credit losses was $350 thousand and $1.3 million in the third quarter and the first nine months of 2002, respectively, compared with $430 thousand and $3.1 million in the same periods in 2001. During the third quarter of 2002, net charge-offs were $294 thousand, or .10% of average loans outstanding (annualized), compared with $562 thousand, or .19%, in the third quarter of 2001. The provision for credit losses for the third quarter was $57 thousand in excess of net charge-offs largely due to a shift in the loan portfolio mix to higher levels of commercial and commercial real estate which carry higher reserves. The allowance for credit losses was $14.0 million, or 1.14% of total loans, at September 30, 2002, compared with $13.9 million, or 1.20%, at December 31, 2001 and $14.2 million, or 1.21% at September 30, 2001.

 

At September 30, 2002, total nonperforming assets were $2.7 million, or ..13% of total assets, compared with $1.9 million, or .10%, at December 31, 2001 and $2.4 million, or .13%, at September 30, 2001. Foreclosed assets amounted to $323 thousand at September 30, 2002, $698 thousand at December 31, 2001 and $667 thousand at September 30, 2001.

 

At September 30, 2002, the ratio of shareholders’ equity to total assets was 9.20%, compared with 9.12% at September 30, 2001. The Bancorp’s total risk-based capital (RBC) ratio at September 30, 2002 was 13.12% and its Tier 1 RBC ratio was 12.12%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively for bank holding companies. The Bancorp’s ratios at September 30, 2001 were 13.29% and 12.20%, respectively. The Bancorp’s leverage ratio was 8.80% at September 30, 2002 and 8.81% at September 30, 2001, exceeding the minimum regulatory guideline of 3% for bank holding companies.

 

EARNINGS PERFORMANCE

 

NET INTEREST INCOME

 

Net interest income on a taxable-equivalent basis was $20.1 million in the third quarter 2002, up 13% from the three months ended September 30, 2001, largely due to growth in earning assets and increases in net interest margin from 4.15% a year ago to 4.34% in third quarter 2002.

 

Individual components of net interest income and the net interest margin are presented in the rate/yield table on the following page.

 

Average earning assets increased $136 million in the third quarter from the same period last year due to increases in average loans and debt securities available for sale. Loans averaged $1.205 million in the third quarter of 2002 compared with $1.170 million in the third quarter of 2001. The Bancorp has continued to be successful in attracting new real estate loans, as well as commercial loans during the quarter, however the growth experienced has been offset by prepayments on its consumer auto loan portfolio. Debt securities averaged $606 million in the third quarter of 2002 compared with $473 million in the third quarter of 2001. The growth in the securities portfolio was directly attributable to the significant deposit growth achieved during the past year.

 

13



 

AVERAGE BALANCES, YIELDS AND RATES PAID (TAXABLE-EQUIVALENT BASIS)(1)

 

 

 

Quarter ended September 30,

 

 

 

2002

 

2001

 

(in thousands)

 

Average
Balance

 

Interest
income/ expense

 

Yields/
rates

 

Average
Balance

 

Interest
income/
expense

 

Yields/
rates

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term funds

 

$

6,645

 

$

26

 

1.55

%

$

27,020

 

$

238

 

3.49

%

Loans held for sale

 

11,638

 

124

 

4.23

 

19,047

 

339

 

7.06

 

Securities available for sale(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and federal agencies

 

69,386

 

775

 

4.43

 

78,412

 

1,111

 

5.62

 

U.S. States and political subdivisions

 

114,286

 

1,883

 

6.54

 

124,124

 

2,086

 

6.67

 

Mortgage-backed securities

 

386,337

 

4,745

 

4.87

 

270,012

 

3,707

 

5.45

 

Other securities

 

36,015

 

338

 

3.72

 

883

 

49

 

22.02

 

Total investment securities

 

606,024

 

7,741

 

5.07

 

473,431

 

6,953

 

5.83

 

FHLB / Federal Reserve stock

 

7,153

 

90

 

4.99

 

10,835

 

114

 

4.17

 

Loans(3):

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

161,994

 

2,639

 

6.46

 

141,385

 

2,872

 

8.06

 

Residential real estate

 

296,946

 

4,769

 

6.37

 

276,390

 

5,564

 

7.99

 

Commercial real estate

 

349,211

 

6,424

 

7.30

 

326,106

 

6,679

 

8.13

 

Real estate construction

 

105,726

 

1,595

 

5.99

 

100,076

 

1,800

 

7.14

 

Consumer installment

 

290,780

 

5,609

 

7.65

 

325,822

 

6,660

 

8.11

 

Total loans

 

1,204,657

 

21,036

 

6.93

 

1,169,779

 

23,575

 

8.00

 

Total interest-earning assets

 

1,836,117

 

29,017

 

6.27

 

1,700,112

 

31,219

 

7.29

 

Total noninterest-earning assets

 

102,867

 

 

 

 

 

107,262

 

 

 

 

 

Total assets

 

$

1,938,984

 

 

 

 

 

$

1,807,374

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings

 

$

212,613

 

$

626

 

1.17

 

$

180,244

 

$

756

 

1.66

 

Checking

 

201,470

 

243

 

0.48

 

187,940

 

506

 

1.07

 

Money market accounts

 

267,280

 

1,063

 

1.58

 

257,461

 

1,919

 

2.96

 

Certificates of deposit

 

595,712

 

5,599

 

3.73

 

631,558

 

8,865

 

5.57

 

Total interest-bearing deposits

 

1,277,075

 

7,531

 

2.34

 

1,257,203

 

12,046

 

3.80

 

Short-term borrowings

 

137,586

 

462

 

1.33

 

103,827

 

784

 

3.00

 

Long-term borrowings

 

78,165

 

945

 

4.80

 

45,990

 

595

 

5.13

 

Total interest-bearing liabilities

 

1,492,826

 

8,938

 

2.38

 

1,407,020

 

13,425

 

3.79

 

Noninterest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Checking

 

249,814

 

 

 

 

 

216,091

 

 

 

 

 

Other liabilities

 

16,224

 

 

 

 

 

16,132

 

 

 

 

 

Total noninterest-bearing liabilities

 

266,038

 

 

 

 

 

232,223

 

 

 

 

 

Shareholders’ equity

 

180,120

 

 

 

 

 

168,131

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,938,984

 

 

 

 

 

$

1,807,374

 

 

 

 

 

Net interest income and net interest margin on a taxable-equivalent basis(4)

 

 

 

$

20,079

 

4.34

%

 

 

$

17,794

 

4.15

%

 


(1)          The average prime rate of the Bancorp was 4.75% and 6.57% for the quarters ended September 30, 2002 and 2001, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 1.80% and 3.43% for the quarters ended September 30, 2002 and 2001, respectively.

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

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

(4)          Interest and yield on obligations of state and political subdivisions and tax-exempt loans are computed on a taxable equivalent basis using U.S. statutory tax rate of 34 percent.

 

14



 

 

 

Nine months ended  September 30,

 

 

 

2002

 

2001

 

(in thousands)

 

Average
Balance

 

Interest
income/
expense

 

Yields/
rates

 

Average
Balance

 

Interest
income/
expense

 

Yields/
rates

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term funds

 

$

10,742

 

$

127

 

1.58

%

$

27,500

 

$

1,042

 

5.07

%

Loans held for sale

 

14,114

 

619

 

5.86

 

16,054

 

881

 

7.34

 

Securities available for sale(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and federal agencies

 

54,746

 

1,814

 

4.43

 

120,064

 

5,362

 

5.97

 

U.S. States and political subdivisions

 

116,023

 

5,803

 

6.69

 

125,610

 

6,426

 

6.84

 

Mortgage-backed securities

 

386,929

 

14,439

 

4.99

 

180,271

 

8,709

 

6.46

 

Other securities

 

22,461

 

573

 

3.41

 

8,471

 

181

 

2.86

 

Total investment securities

 

580,159

 

22,629

 

5.21

 

434,416

 

20,678

 

6.36

 

FHLB / Federal Reserve stock

 

6,985

 

284

 

5.44

 

11,093

 

351

 

4.23

 

Loans(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

160,436

 

8,103

 

6.75

 

146,293

 

9,412

 

8.60

 

Residential real estate

 

277,103

 

14,070

 

6.79

 

283,082

 

17,339

 

8.19

 

Commercial real estate

 

339,515

 

18,777

 

7.39

 

324,125

 

19,962

 

8.23

 

Real estate construction

 

105,748

 

4,573

 

5.78

 

96,969

 

5,667

 

7.81

 

Consumer installment

 

296,026

 

17,089

 

7.72

 

329,156

 

20,109

 

8.17

 

Total loans

 

1,178,828

 

62,612

 

7.10

 

1,179,625

 

72,489

 

8.22

 

Total interest-earning assets

 

1,790,828

 

86,271

 

6.44

 

1,668,688

 

95,441

 

7.65

 

Total noninterest-earning assets

 

103,481

 

 

 

 

 

108,398

 

 

 

 

 

Total assets

 

$

1,894,309

 

 

 

 

 

$

1,777,086

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings

 

$

206,012

 

$

1,834

 

1.19

 

$

175,930

 

$

2,668

 

2.03

 

Checking

 

201,251

 

784

 

0.52

 

184,614

 

1,619

 

1.17

 

Money market accounts

 

268,617

 

3,295

 

1.64

 

257,799

 

6,832

 

3.54

 

Certificates of deposit

 

604,620

 

18,538

 

4.10

 

603,932

 

25,833

 

5.72

 

Total interest-bearing deposits

 

1,280,500

 

24,451

 

2.55

 

1,222,275

 

36,952

 

4.04

 

Short-term borrowings

 

111,646

 

1,104

 

1.32

 

120,541

 

4,314

 

4.78

 

Long-term borrowings

 

71,246

 

2,551

 

4.79

 

44,869

 

1,423

 

4.24

 

Total interest-bearing liabilities

 

1,463,392

 

28,106

 

2.57

 

1,387,685

 

42,689

 

4.11

 

Noninterest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Checking

 

240,674

 

 

 

 

 

207,130

 

 

 

 

 

Other liabilities

 

15,372

 

 

 

 

 

16,635

 

 

 

 

 

Total noninterest-bearing liabilities

 

256,046

 

 

 

 

 

223,765

 

 

 

 

 

Shareholders’ equity

 

174,871

 

 

 

 

 

165,636

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,894,309

 

 

 

 

 

$

1,777,086

 

 

 

 

 

Net interest income and net interest margin on a taxable-equivalent basis(4)

 

 

 

$

58,165

 

4.34

%

 

 

$

52,752

 

4.23

%

 


 

(1)          The average prime rate of the Bancorp was 4.75% and 7.51% for the nine months ended September 30, 2002 and 2001, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 1.85% and 4.31% for the nine months ended September 30, 2002 and 2001, respectively.

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

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

(4)          Interest and yield on obligations of state and political subdivisions and tax-exempt loans are computed on a taxable equivalent basis using U.S. statutory tax rate of 34 percent.

 

15



 

The net interest margin increased to 4.34% in third quarter 2002 from 4.15% in third quarter 2001, principally due to a faster decline in deposit and borrowing costs than loan and investment yields. The net interest margin increased to 4.34% for the first nine months of 2002 from 4.23% for the same period of 2001, primarily due to lower interest rates paid on deposits and borrowings.

 

An important contributor to the growth in net interest income and net interest margin from third quarter 2001 was a 4% increase in core deposits, the Bancorp’s lowest cost source of funding. Average core deposits were $1.527 million and $1.473 million and funded 79% and 82% of the Bancorp’s average total assets in the third quarter of 2002 and 2001, respectively. Total average interest-bearing deposits increased to $1.277 million in third quarter 2002 from $1.257 million a year ago. For the same period, total average noninterest-bearing deposits increased to $250 million from $216 million. While certificates of deposits declined on average from $632 million to $596 million, noninterest-bearing checking and other core deposit categories increased on average from $842 million to $931 million in third quarter 2002 reflecting the Bancorp’s success in growing customer relationships.

 

PROVISION FOR CREDIT LOSSES

 

In 2001, the loan loss reserve increased due to increasing probable loan losses associated with the recessionary environment. The provision for credit losses for the third quarter of 2002 decreased by $80 thousand over the year-ago quarter. This provision was $56 thousand in excess of net charge-offs largely due to a shift in the loan portfolio mix to higher levels of commercial and commercial real estate which carry higher reserves. For the nine-month period ended September 30, 2002, the provision decreased to $1.3 million as compared to $3.1 million for the same period last year, as the loan portfolio continued to improve in overall performance.

 

16



 

NONINTEREST INCOME

 

 

 

Quarter ended
September 30,

 

%
Change

 

Nine months ended
September 30,

 

%
Change

 

(in thousands)

 

2002

 

2001

 

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

$

2,348

 

$

2,062

 

14

%

$

6,827

 

$

6,133

 

11

%

Trust and investment fees:

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management and custody fees

 

157

 

642

 

(76

)

1,375

 

1,982

 

(31

)

Mutual fund and annuity sales fees

 

250

 

230

 

9

 

863

 

737

 

17

 

Total trust and invesment fees

 

407

 

872

 

(53

)

2,238

 

2,719

 

(18

)

Other fees:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash network fees

 

832

 

742

 

12

 

2,375

 

2,130

 

12

 

Charges and fees on loans

 

74

 

91

 

(19

)

265

 

229

 

16

 

Bank-owned life insurance

 

135

 

124

 

9

 

386

 

784

 

(51

)

All other fees

 

373

 

301

 

24

 

1,058

 

1,167

 

(9

)

Total other fees

 

1,414

 

1,258

 

12.4

 

4,084

 

4,310

 

(5

)

Mortgage banking fees:

 

 

 

 

 

 

 

 

 

 

 

 

 

Origination and other closing fees

 

435

 

199

 

119

 

928

 

454

 

104

 

Net gains on mortgage loan sales

 

780

 

882

 

(12

)

1,835

 

2,001

 

(8

)

Servicing fees, net of amortization

 

80

 

103

 

(22

)

253

 

327

 

(23

)

Total mortgage banking fees

 

1,295

 

1,184

 

9

 

3,016

 

2,782

 

8

 

Insurance

 

2,194

 

2,134

 

3

 

7,384

 

6,930

 

7

 

Net gains (losses) on securities sold

 

 

19

 

(100

)

 

52

 

(100

)

Net gains (losses) on sale of property

 

37

 

130

 

(72

)

160

 

237

 

(33

)

Total noninterest income

 

$

7,695

 

$

7,659

 

1

%

$

23,709

 

$

23,163

 

2

%

 

Deposit service fees increased 14% for the third quarter of 2002 over the year-ago quarter due to growth in primary accounts, price increase and increased activity.

 

Fee income in the third quarter from trust and brokerage business lines declined 53% from the prior year quarter and 55% from the previous quarter. Third quarter 2002 trust revenues included a net reduction in fee income to refund certain trust clients for a billing error that resulted in overcharges to those accounts. Without this fee reduction trust and brokerage fee income would have only declined about 19% from the prior year and 22% from the prior quarter. The Bancorp managed or maintained personal trust, employee benefit trust and agency assets of approximately $290 million and $343 million at September 30, 2002 and 2001, respectively. The reduction in assets under management is largely attributable to the decline in the stock market during 2002.

 

Other fees increased to $1.4 million, or 12% in third quarter 2002 from the prior year primarily due to increased customer acceptance and usage of the Bancorp’s debit card. For the first nine months of 2002, other fee income declined to $4.1 million, or 5% from the prior year primarily due to the receipt of $525 thousand death benefit on bank-owned life insurance in 2001. Excluding this benefit, total other fees would have increased 8% from the prior year.

 

The mortgage banking business remained strong, generating $1.3 million in quarterly revenues, a 9% increase from the third quarter of 2001. Reflecting the continued strength in the housing sector and low mortgage rates, the mortgage banking business had another strong quarter. Mortgage fundings for the quarter were $90.1 million, up 42% over the same quarter last year, bringing year-to-date fundings to $224.3 million. For the quarter, 49% of the loan fundings were held in portfolio with the remaining loans being sold which reduced the net gains on mortgage loan sales by 12% from the prior year.

 

17



 

Insurance income increased 3% from the third 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.

 

NONINTEREST EXPENSE

 

 

 

Quarter ended
September 30

 

%
Change

 

Nine months ended
September 30

 

%
Change

 

(in thousands)

 

2002

 

2001

 

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries

 

$

7,199

 

$

7,192

 

%

$

21,862

 

$

21,381

 

2

%

Incentive compensation

 

1,199

 

478

 

151

 

2,400

 

1,642

 

46

 

Employee benefits

 

1,439

 

1,795

 

(20

)

4,813

 

4,343

 

11

 

Occupancy and equipment

 

2,345

 

2,591

 

(10

)

7,444

 

7,871

 

(5

)

Professional services

 

739

 

332

 

123

 

1,593

 

967

 

65

 

Telecommunications

 

353

 

349

 

1

 

986

 

1,188

 

(17

)

Computer software and maintenance

 

690

 

531

 

30

 

1,439

 

1,436

 

 

Stationary and supplies

 

290

 

289

 

 

1,029

 

1,009

 

2

 

Advertising and promotions

 

784

 

421

 

86

 

2,184

 

1,396

 

56

 

Intangible amortization

 

281

 

266

 

6

 

791

 

800

 

(1

)

Postage

 

258

 

211

 

22

 

744

 

698

 

7

 

Other real estate owned

 

2

 

117

 

(98

)

20

 

119

 

(83

)

All other

 

1,646

 

1,919

 

(14

)

5,954

 

5,740

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

17,225

 

$

16,491

 

5

%

$

51,259

 

$

48,590

 

6

%

 

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 decreased to 62.02% for the quarter compared to 64.79% for the comparable period in 2001.

 

Salary expenses of $7.2 million for the third quarter 2002 were unchanged from the prior year’s quarter. On a year-to-date basis, salary expense increased 2% from 2001 to $21.9 million. Salary expenses have been controlled through staff reductions associated with branch reconfigurations and sales as well as the elimination of redundant positions in support functions.

 

Incentive compensation increased to $1.2 million in the third quarter of 2002, a 151% increase over the same period last year. For the first nine months of 2002, incentive compensation was $2.4 million, a 46% increase over the prior year. These increases are directly tied to the Bancorp’s revenue and overall profitability performance as measured by our team-based compensation and sale programs.

 

Employee benefit costs for the third quarter of 2002 were 20% less that the comparable quarter of 2001, due to lower medical claims incurred during the period. For the first nine months of 2002, employee benefit costs increased 11% primarily due to higher medical claims experience in the first half of 2002.

 

Occupancy expenses for the quarter of $2.3 million decreased $246 thousand or 10% compared to the third quarter of 2001. The Bancorp reevaluated its retail branch network and incurred expenses related to the consolidation of several branches in prior periods. While costs were incurred at the time of consolidation, they have resulted in lower cost and more efficient delivery in the current quarter.

 

18



 

Professional services expenses for the third quarter of 2002 were $407 thousand, or 123% higher than the prior year’s quarter. This increase is due to professional services relating to expanding and growing our businesses, increased external audit costs associated with the new Sarbanes-Oxley Act of 2002 as well as the implementation of the Bancorp’s new check imaging system.

 

Advertising and promotion expenses have increased for both the quarter and on a year-to-date basis to support sales growth and research initiatives in conjunction with ongoing strategic initiatives.

 

Other expenses relating to corporate operating expenses for the quarter increased to $5.0 million or 13.7% 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.

 

INCOME TAXES

 

For the third quarter of 2002, provision for income taxes increased by 40.3% to $3.2 million from the previous year quarter due to lower levels of tax deferred assets in relation to total assets. The third quarter 2002 effective tax rate was 33.56% compared to 29.16% in the prior year as most of the components of the increased revenues are fully taxable. For the nine months ended September 30, 2002, the provision for income taxes increased 42.9% to $8.9 million from the comparable 2001 period.  The first nine months of 2002 effective tax rate was 32.87% compared to 28.4% in the prior year.

 

BALANCE SHEET ANALYSIS

 

SECURITIES AVAILABLE FOR SALE

 

The following table provides the cost and fair value for the major components of securities available for sale carried at fair value. There were no securities classified as held to maturity or trading at the end of the periods presented.

 

 

 

September 30, 2002

 

December 31, 2001

 

September 30, 2001

 

(in thousands)

 

Cost

 

Estimated
fair
value

 

Cost

 

Estimated
fair
value

 

Cost

 

Estimated
fair
value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities of U. S. Treasury and federal agencies

 

$

66,401

 

$

68,486

 

$

42,316

 

$

43,066

 

$

57,002

 

$

58,021

 

Securities of U. S. states and political subdivisions

 

110,021

 

114,586

 

117,254

 

118,279

 

122,089

 

125,204

 

Mortgage-backed securities

 

384,129

 

391,652

 

378,341

 

380,051

 

304,118

 

308,342

 

Other

 

29,656

 

30,210

 

 

 

 

 

Total debt securities

 

590,207

 

604,934

 

537,911

 

541,396

 

483,209

 

491,567

 

Marketable equity securities

 

3,813

 

4,992

 

3,795

 

5,126

 

4,995

 

4,862

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

594,020

 

$

609,926

 

$

541,706

 

$

546,522

 

$

488,204

 

$

496,429

 

 

19



 

The following table provides the components of the estimated unrealized net gains on securities available for sale for the end of each period presented. The estimated unrealized net gain or loss on securities available for sale is reported on an after-tax basis as a component of cumulative other comprehensive income.

 

(in thousands)

 

September 30,
2002

 

December 31,
2001

 

September 30,
2001

 

 

 

 

 

 

 

 

 

Estimated unrealized gross gains

 

$

16,031

 

$

7,101

 

$

8,443

 

Estimated unrealized gross losses

 

125

 

2,285

 

218

 

Estimated unrealized net gain

 

$

15,906

 

$

4,816

 

$

8,225

 

 

The weighted average expected remaining maturity of the debt securities portion of the securities available for sale portfolio was 2 years at September 30, 2002. Expected remaining maturities will differ from contractual maturities because obligations may be prepaid.

 

LOAN PORTFOLIO

 

 

 

 

 

 

 

 

 

% Change
Sept. 30, 2002 from

 

(in thousands)

 

Sept. 30
2002

 

Dec. 31,
2001

 

Sept. 30
2001

 

Dec. 31,
2001

 

Sept. 30
2001

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial(1)

 

$

174,380

 

$

177,745

 

$

165,965

 

(2

)%

5

%

Residential real estate(2)

 

337,918

 

301,338

 

316,895

 

12

 

7

 

Commercial mortgage

 

350,125

 

323,643

 

316,157

 

8

 

11

 

Real estate construction

 

103,082

 

85,138

 

91,959

 

21

 

12

 

Consumer installment

 

268,287

 

274,361

 

287,973

 

(2

)

(7

)

 

 

 

 

 

 

 

 

 

 

 

 

Total loans (net of unearned income, including net deferred loan fees, of $531, $(30) and $(26))

 

$

1,233,792

 

$

1,162,225

 

$

1,178,949

 

6

%

5

%

 


(1)          Includes agricultural loans (loans to finance agricultural production) of $316 thousand, $507 thousand and $431 thousand at September 30, 2002, December 31, 2001 and September 30, 2001, respectively.

(2)          Includes agricultural loans that are secured by real estate of $6,529 thousand, $5,902 thousand and $5,750 thousand at September 30, 2002, December 31, 2001 and September 30, 2001, respectively.

 

NONACCRUAL LOANS AND OTHER ASSETS

 

The table on the next page presents comparative data for nonaccrual loans and other assets. Management’s classification of a loan as nonaccrual does not necessarily indicate that the principal of the loan is uncollectible in whole or in part. The Bancorp anticipates changes in the amount of nonaccrual loans that result from increases in loans outstanding, changes in borrower’s circumstances or from resolutions of loans in the nonaccrual portfolio. The performance of any individual loan can be affected by external factors, such as the interest rate environment or factors particular to a borrower such as actions taken by a borrower’s management.

 

20



 

NONACCRUAL LOANS AND OTHER REAL ESTATE OWNED

 

(in thousands)

 

Sept. 30,
2002

 

Dec. 31,
2001

 

Sept. 30,
2001

 

 

 

 

 

 

 

 

 

Nonaccrual loans:

 

 

 

 

 

 

 

Commercial

 

$

1,422

 

$

1,279

 

$

1,472

 

Residential real estate

 

127

 

 

 

Commercial mortgage

 

474

 

 

127

 

Real estate construction

 

71

 

 

40

 

Consumer installment

 

238

 

 

 

Total nonaccrual loans

 

2,332

 

1,279

 

1,639

 

As a percentage of total loans

 

0.19

%

0.11

%

0.14

%

 

 

 

 

 

 

 

 

Other real estate owned

 

323

 

638

 

667

 

Total nonaccrual loans and other real estate owned

 

$

2,655

 

$

1,917

 

$

2,306

 

As a percentage of total assets

 

0.13

%

0.10

%

0.12

%

Loans past due 90 days as to interest or principal

 

$

1,561

 

$

2,819

 

$

1,371

 

 

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 until such time the borrower demonstrates sustained performance over a period of time in accordance with contractual terms and is removed from nonaccrual status.

 

Other real estate owned includes 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

 

Loans contractually past due 90 days or more as to interest or principal, but not included in nonaccrual loans are both well-secured and in the process of collection.

 

21



 

ALLOWANCE FOR CREDIT LOSSES

 

 

 

Quarter ended
September 30,

 

Nine months ended
September 30,

 

(in thousands)

 

2002

 

2001

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

13,999

 

$

14,350

 

$

13,947

 

$

13,232

 

 

 

 

 

 

 

 

 

 

 

Provision for credit losses

 

350

 

430

 

1,325

 

3,060

 

 

 

 

 

 

 

 

 

 

 

Loan charge-offs:

 

 

 

 

 

 

 

 

 

Commercial

 

 

128

 

110

 

243

 

Residential mortgage

 

19

 

32

 

73

 

175

 

Commercial mortgage

 

4

 

 

13

 

13

 

Real estate construction

 

 

 

 

 

Consumer installment

 

914

 

1,134

 

3,035

 

3,722

 

Total loan charge-offs

 

937

 

1,294

 

3,231

 

4,153

 

 

 

 

 

 

 

 

 

 

 

Loan recoveries:

 

 

 

 

 

 

 

 

 

Commercial

 

116

 

25

 

307

 

131

 

Residential mortgage

 

6

 

 

9

 

2

 

Commercial mortgage

 

1

 

3

 

2

 

3

 

Real estate construction

 

 

 

 

 

Consumer installment

 

520

 

704

 

1,696

 

1,943

 

Total loan recoveries

 

643

 

732

 

2,014

 

2,079

 

Total net loan charge-offs

 

294

 

562

 

1,217

 

2,074

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$

14,055

 

$

14,218

 

$

14,055

 

$

14,218

 

 

 

 

 

 

 

 

 

 

 

Total net loan charge-offs as a percentage of average total loans (annualized)

 

0.10

%

0.19

%

0.10

%

0.18

%

Allowance as a percentage of total loans

 

1.14

%

1.21

%

1.14

%

1.21

%

 

The Bancorp considers the allowance for loan losses of $14.1 million adequate to cover losses inherent in loans, loan commitments and standby and other letters of credit at September 30, 2002. During the quarter 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 aggregate balance of individual risk-rated loans increased by $29.5 million from the second quarter of 2002 to the third quarter of 2002, primarily due to growth in the commercial and commercial real estate loan portfolios. This required approximately $300 thousand of additional reserves from quarter to quarter. Additionally, the qualitative factor for current economic conditions was increased due to national events such as the uncertainty of war, moderate corporate earnings and declining consumer confidence. This required approximately $600 thousand in additional assigned reserves. The effects of these additional reserves on the allowance for credit losses reduced the unallocated portion of the reserve to $1.2 million at September 30, 2002.

 

22



 

DEPOSITS

 

The following table shows comparative detail of deposits.

 

(in thousands)

 

September 30,
2002

 

December, 31
2001

 

September 30,
2001

 

 

 

 

 

 

 

 

 

Noninterest-bearing checking

 

$

266,722

 

$

234,459

 

$

214,933

 

Interest-bearing checking

 

212,126

 

200,430

 

192,545

 

Money market savings

 

261,092

 

296,687

 

259,596

 

Savings

 

212,913

 

153,744

 

181,220

 

Certificates of deposit

 

608,065

 

630,748

 

641,298

 

 

 

 

 

 

 

 

 

Total deposits

 

$

1,560,918

 

$

1,516,068

 

$

1,489,592

 

 

CAPITAL ADEQUACY/RATIOS

 

The Bancorp and its subsidiary bank are subject to various regulatory capital adequacy requirements administered by the Federal Reserve Board. Risk-based capital (RBC) guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures.

 

 

 

Actual

 

For capital
adequacy purposes

 

To be well
capitalized under
the FDICIA
prompt corrective
action provisions

 

(in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2002:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital (to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

F&M Bancorp

 

$

185

 

13.12

%

$

³112

 

³8.00

%

$

³141

 

³10.00

%

Farmers & Mechanics Bank

 

$

178

 

12.69

 

$

³112

 

³8.00

 

$

³140

 

³10.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

F&M Bancorp

 

$

170

 

12.12

%

$

³56

 

³4.00

%

$

³84

 

³6.00

%

Farmers & Mechanics Bank

 

$

164

 

11.69

 

$

³56

 

³4.00

 

$

³84

 

³6.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to average assets)
(Leverage ratio)

 

 

 

 

 

 

 

 

 

 

 

 

 

F&M Bancorp

 

$

170

 

8.80

%

$

³77

 

³4.00

%(1)

$

³97

 

³5.00

%

Farmers & Mechanics Bank

 

$

164

 

8.55

 

$

³77

 

³4.00

(1)

$

³96

 

³5.00

 

 


(1)          The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and certain other items. The minimum leverage ratio guideline is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk, excellent asset quality, high liquidity, good earnings, effective management and monitoring of market risk and, in general, are considered top-rated, strong banking organizations.

 

23



 

CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS

 

Through the normal course of operations, the Bancorp has entered into certain contractual obligations and commitments. Such obligations generally relate to the funding of operations as well as leases for premises and equipment. As a financial services provider, the Bancorp routinely enters into commitments to extend credit, including loan commitments, standby letters of credit and financial guarantees. While contractual obligations represent future cash requirements of the Bancorp, a portion of commitments to extend credit are likely to expire without being drawn upon. Such commitments are subject to the same credit policies and approval processes accorded to loans made in the regular course of business.

 

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, the recognition of deferred tax assets; 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.

 

ASSET/LIABILITY AND MARKET RISK MANAGEMENT

 

Asset/liability management comprises the evaluation, monitoring, and management of the Bancorp’s interest rate risk, market risk and liquidity and funding. The Asset/Liability Management Committee (ALCO) maintains oversight of these risks. The Committee is comprised of senior financial and senior business executives.

 

INTEREST RATE RISK

 

Interest rate risk, one of the more prominent risks in terms of potential earnings impact, is an inevitable part of being a financial intermediary. For more information, see “Market Risk and Asset/Liability Management” in the Bancorp’s 2001 Annual Report on Form 10-K.

 

Management believes that medium term (12-month horizon) interest rate risk is best measured by simulation modeling.  This analysis calculates expected net interest income based upon historical trends, spreads to market rates, historical market relationships, prepayment behavior and current and expected product offerings. As of September 30, 2002, the simulation analysis indicated that the Bancorp’s net interest income would tend to increase if rates were to rise over the next 12 months. For example, if rates were to rise 1.00% or 2.00% over the next 12 months, net interest income would increase by 1.5% and 1.7%, respectively. Conversely, if rates were to decline over the next 12 months, net interest income would decline by 1.3% and 4.1%, respectively. The principal source of net interest income risk in a falling rate scenario is that certain short-term market rates and a majority of the Bank’s deposit rates are below 2.0%. Therefore, these rates cannot decline below a floor rate of 0%.

 

 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.

 

24



 

LIQUIDITY AND FUNDING

 

The objective of effective liquidity management is to ensure that the Bancorp can meet customer loan requests, customer deposit maturities/withdrawals and other cash commitments efficiently under both normal operating conditions as well as under unforeseen and unpredictable circumstances of industry or market stress. To achieve this objective, ALCO establishes and monitors liquidity guidelines requiring sufficient asset based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding sources. The Bancorp manages liquidity at both the parent and subsidiary levels through active management of the balance sheet.

 

In addition to the immediately liquid resources of cash and due from banks and federal funds sold, asset liquidity is provided by the debt securities in the securities available for sale portfolio. Asset liquidity is further enhanced by the Bancorp’s ability to sell loans in secondary markets through whole-loan sales.

 

Core customer deposits have historically provided the Bancorp with a sizeable source of relatively stable and low-cost funds.

 

Long-term debt, and short-term borrowings (federal funds purchased and securities sold under repurchase agreements and other short-term borrowings) mostly provide the remaining funding of assets. The Bank also has extensive access to funds from its membership in the Federal Home Loan Bank of Atlanta.

 

CAPITAL MANAGEMENT

 

The Bancorp has an active program for managing shareholders’ equity. The objective of effective capital management is to produce long-term returns by opportunistically utilizing capital when returns are perceived to be high and issuing/accumulating capital when the costs of doing so is perceived to be low.

 

Uses of capital include investments for organic growth, acquisitions of banks and other financial services companies, dividends and share repurchases. During the first nine months of 2002, the Bancorp’s consolidated assets increased by $141 million, or 8%. During 2001, the Board of Directors authorized the repurchase of up to 500,000 shares of the Bancorp’s outstanding common stock. During the first nine months of 2002, the Bancorp repurchased 120.5 thousand shares of common stock for an aggregate of $3.5 million. At September 30, 2002, the total remaining common stock repurchase authority was approximately 201 thousand shares.

 

Sources of capital include retained earnings and common stock issuance. In the first nine months of 2002, total net income was $18.1 million and the change in retained earnings was $12.2 million after payment of $6.0 million in common stock dividends.

 

EVALUATION OF INTERNAL CONTROLS

 

Management is responsible for establishing and maintaining an internal control structure over financial reporting of the Bancorp that provides reasonable assurance to the Bancorp’s management and board of directors that (i) the Bancorp’s published financial statements are prepared in conformity with generally accepted accounting principles and (ii) adequate policies are in effect to safeguard the Bancorp’s assets.

 

We have performed an evaluation of the effectiveness of the Bancorp’s internal control structure over financial reporting as of September 30, 2002. Based on this evaluation, the Bancorp maintained an effective internal control structure over financial reporting as of September 30, 2002 and the published financial statements are fairly stated, in all material respects. There were no significant deficiencies noted in the design or operation of internal controls which could adversely affect the Bancorp’s ability to record, process, summarize, and report financial data and therefore no material weaknesses were reported to the Bancorp’s auditors.

 

There have been no significant changes in internal controls or in other factors that could significantly affect internal control subsequent to September 30, 2002 or deficiencies for which corrective action would be required.

 

25



 

FACTORS THAT MAY AFFECT FUTURE RESULTS

 

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

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

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

 

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

                  future credit losses and non-performing assets;

                  future cash requirements relating to commitments to extend credit;

                  future amortization expense;

                  the impact of new accounting standards;

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

 

 

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

 

There are several factors—many beyond our control—that could cause results to differ significantly from our expectations. Some of these factors are described below. Other factors, such as credit, market, operational, liquidity, interest rate and other risks, are described elsewhere in this report (see, for example, “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Balance Sheet Analysis” and –Asset/Liability and Market Risk Management”). Factors relating to regulation and supervision of the Bancorp are described in our Annual Report on Form 10-K for the year ended December 31, 2001.

 

Industry Factors

 

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

 

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

 

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

 

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

 

26



 

The financial services industry is highly competitive.

 

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

 

We are heavily regulated by federal and state agencies.

 

The holding company and its subsidiaries are heavily regulated at the federal and state levels. This regulation is to protect customers, federal deposit insurance funds and the banking system as a whole, not security holders. Changes to statutes, regulations and regulatory policies, could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer and increasing the ability of non-banks to offer competing financial services and products. Also, our failure to comply with laws, regulations and policies could result in sanctions by regulatory agencies and damage our reputation. For more information, refer to the “Regulation and Supervision” section in our Annual Report on Form 10-K for the year ended December 31, 2001.

 

Company Factors

 

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

 

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

 

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

 

The holding company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the holding company’s common stock. Various federal and state laws and regulations limit the amount of dividends that our bank and certain non-bank subsidiaries may pay to the holding company. For more information, refer to “Dividend Restrictions” in our Annual Report on Form 10-K as of December 31, 2001.

 

We have businesses other than banking.

 

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

 

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

 

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

 

27



 

Legislative Risk

 

Our business model relies heavily on our ability to share information between the team of companies owned by F&M Bancorp to better satisfy our customers’ needs. Future laws that restrict our ability to share information about customers could negatively impact our revenue and profit.

 

Our stock price can be volatile.

 

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

                  actual or anticipated variations in our quarterly operating results;

                  recommendations by security analysts;

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

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

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

                  changes in government regulations.

 

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

 

28



 

PART II - Other Information

 

Item 6.        Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

10.2 Unfunded deferred compensation plan for non-employee directors of F&M Bancorp as amended and restated effective October 15, 2002.  Filed as an exhibit hereto 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 of corporate responsibility for financial reports. Filed as an exhibit hereto and incorporated herein by reference

 

99.2 CFO Certification of corporate responsibility for financial reports. Filed as an exhibit hereto and incorporated herein by reference

 

(b)           Reports on Form 8-K

 

None

 

 

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)

 

 

 

 

November 12, 2002

 

/s/ Faye E. Cannon

Date

 

FAYE E. CANNON
PRESIDENT AND CEO

 

 

 

 

 

 

November 12, 2002

 

/s/ Kaye A. Simmons

Date

 

KAYE A. SIMMONS
CFO AND TREASURER

 

 

29



 

CERTIFICATION OF CORPORATE RESPONSIBILTY FOR FINANCIAL REPORTS

 

In connection with this Quarterly Report of F&M Bancorp (the “Bancorp”) on Form 10-Q for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Faye E. Cannon, certify, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, that:

 

1)              I have reviewed the Report;

2)              based on my knowledge, the Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading;

3)              based on my knowledge, the financial statements, and other financial information included in the Report, fairly present in all material respects the financial condition and results of operations of the Bancorp as of, and for, the periods presented in the Report;

4)              the Chief Financial Officer and I –

a)              are responsible for establishing and maintaining internal controls;

b)             have designed such internal controls to ensure that material information relating to the Bancorp and it’s consolidated subsidiaries is made known to us by others within those entities, particularly during the period in which the Report was being prepared;

c)              have evaluated the effectiveness of the Bancorp’s internal controls as of a date within 90 days prior the Report; and

d)             have presented in the Report our conclusions about the effectiveness of our internal controls based on our evaluation as of that date;

5)              the Chief Financial Officer and I have disclosed to the Bancorp’s auditors and the audit committee of the Board of directors –

a)              all significant deficiencies in the design or operation of internal controls which could adversely affect the Bancorp’s ability to record, process, summarize, and report financial data and have identified for the Bancorp’s auditors any material weaknesses in internal controls; and

b)             any fraud, whether material or not material, that involves management or other employees who have a significant role in the Bancorp’s internal controls; and

6)              the Chief Financial Officer and I have indicated in the Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal control subsequent to the date of our evaluation, including corrective actions with regard to significant deficiencies and material weaknesses.

 

 

/s/ FAYE E. CANNON

 

Faye E. Cannon

President and Chief Executive Officer

(principal executive officer)

F&M Bancorp

November 12, 2002

 

 

30



 

CERTIFICATION OF CORPORATE RESPONSIBILTY FOR FINANCIAL REPORTS

 

In connection with this Quarterly Report of F&M Bancorp (the “Bancorp”) on Form 10-Q for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Kaye A. Simmons, certify, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, that:

 

1)              I have reviewed the Report;

2)              based on my knowledge, the Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading;

3)              based on my knowledge, the financial statements, and other financial information included in the Report, fairly present in all material respects the financial condition and results of operations of the Bancorp as of, and for, the periods presented in the Report;

4)              the Chief Executive Officer and I –

a)              are responsible for establishing and maintaining internal controls;

b)             have designed such internal controls to ensure that material information relating to the Bancorp and it’s consolidated subsidiaries is made known to us by others within those entities, particularly during the period in which the Report was being prepared;

c)              have evaluated the effectiveness of the Bancorp’s internal controls as of a date within 90 days prior the Report; and

d)             have presented in the Report our conclusions about the effectiveness of our internal controls based on our evaluation as of that date;

5)              the Chief Executive Officer and I have disclosed to the Bancorp’s auditors and the audit committee of the Board of directors –

a)              all significant deficiencies in the design or operation of internal controls which could adversely affect the Bancorp’s ability to record, process, summarize, and report financial data and have identified for the Bancorp’s auditors any material weaknesses in internal controls; and

b)             any fraud, whether material or not material, that involves management or other employees who have a significant role in the Bancorp’s internal controls; and

6)              the Chief Executive Officer and I have indicated in the Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal control subsequent to the date of our evaluation, including corrective actions with regard to significant deficiencies and material weaknesses.

 

 

/s/ KAYE A. SIMMONS

 

Kaye A. Simmons

Chief Financial Officer and Treasurer

(principal financial officer)

F&M Bancorp

November 12, 2002

 

 

31