SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

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 10,768,101 shares outstanding as of April 23, 2003.

 

 

Form 10-Q

TABLE OF CONTENTS

 

PART I	Financial Information
Item 1.	Financial Statements
	Consolidated Statements of Income (Unaudited)
	Consolidated Balance Sheets
	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
	Provision for Credit Losses
	Noninterest Income
	Noninterest Expense
	Balance Sheet Analysis
	Securities Available for Sale
	Loan Portfolio
	Nonaccrual Loans and Other Assets
	Nonaccrual Loans and Other Real Estate Owned
	Allowance for Credit Losses
	Deposits
	Capital Adequacy/Ratios
	Contractual Obligations and Other Commitments
	Asset/Liability and Market Risk Management
	Capital Management
Item 3.	Quantitative and Qualitative Disclosure about Market Risk
Item 4.	Controls and Procedures
	Factors that May Affect Future Results
PART II	Other Information
Item 4.	Submission of Matters to a Vote of Security Holders
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 2002 Annual Report on Form 10-K.

 

2

 

PART I – FINANCIAL INFORMATION

F&M BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

		Quarter ended March 31,
(in thousands, except shares)		2003			2002
INTEREST INCOME
Loans		$	20,490		$	20,991
Loans held for sale		296			292
Securities available for sale		6,356			6,520
Other interest income		94			160
Total interest income		27,236			27,963
INTEREST EXPENSE
Deposits		6,451			8,849
Short-term borrowings		366			312
Long-term borrowings		946			779
Total interest expense		7,763			9,940
NET INTEREST INCOME		19,473			18,023
Provision for credit losses		525			825
Net interest income after provision for credit losses		18,948			17,198
NONINTEREST INCOME
Service charges on deposit accounts		2,113			2,196
Insurance income		2,940			2,650
Mortgage banking fees		678			845
Trust and investment fees		716			921
Gains on sales of securities		467			—
Gains on sales of property		36			86
Other operating income		1,381			1,315
Total noninterest income		8,331			8,013
NONINTEREST EXPENSE
Salaries		7,330			7,116
Incentive compensation		846			629
Employee benefits		1,436			1,912
Occupancy and equipment expense		2,231			2,474
Core deposit intangible		246			215
Other operating expense		4,607			4,431
Total noninterest expenses		16,696			16,777
INCOME BEFORE INCOME TAX EXPENSE		10,583			8,434
Income tax expense		3,384			2,657
NET INCOME		$	7,199		$	5,777
EARNINGS PER COMMON SHARE
Earnings per common share		$	0.67		$	0.53
Diluted earnings per common share		$	0.66		$	0.53
DIVIDENDS PAID PER COMMON SHARE		$	0.29		$	0.28
Average common share outstanding		10,738,234			10,852,687
Diluted average common shares outstanding		10,843,032			10,912,294

 

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F&M BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

(in thousands, except shares)		March 31, 2003			December 31, 2002			March 31, 2002
		(Unaudited)						(Unaudited)
ASSETS
Cash and due from banks		$	67,022		$	81,444		$	63,675
Federal funds sold		10,210			232			12,909
Total cash and cash equivalents		77,232			81,676			76,584
Loans held for sale		16,798			28,722			15,412
Securities available for sale		627,633			618,452			557,425
Nonmarketable equity securities		7,274			6,780			6,866
Loans		1,317,789			1,305,348			1,170,387
Less: Allowance for credit losses		(13,673		)	(13,668		)	(14,132		)
Net loans		1,304,116			1,291,680			1,156,255
Bank premises and equipment, net		35,172			36,024			34,952
Other real estate owned, net		414			414			610
Interest receivable		9,004			9,513			9,262
Core deposit intangible		1,640			1,886			2,602
Mortgage servicing rights		293			580			963
Cash value of life insurance		12,262			12,109			11,133
Other assets		6,631			7,150			11,459
Total assets		$	2,098,469		$	2,094,986		$	1,883,523
LIABILITIES & SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest-bearing		$	294,382		$	264,965		$	238,430
Interest-bearing		1,355,251			1,330,174			1,294,259
Total deposits		1,649,633			1,595,139			1,532,689
Short-term borrowings		163,636			219,060			100,568
Long-term borrowings		77,918			78,023			63,420
Accrued taxes and other liabilities		17,565			18,508			17,853
Total liabilities		1,908,752			1,910,730			1,714,530
Shareholders’ equity:
Common stock, $5 par value; authorized 50,000,000 shares; issued 10,759,402 shares, 10,729,304 shares, and 10,852,840 shares, respectively		53,797			53,647			54,264
Surplus		71,166			70,598			74,815
Retained earnings		54,197			50,178			37,549
Accumulated other comprehensive income		10,557			9,833			2,365
Total shareholders’ equity		189,717			184,256			168,993
Total liabilities and shareholders’ equity		$	2,098,469		$	2,094,986		$	1,883,523

 

4

 

F&M BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’

EQUITY AND COMPREHENSIVE INCOME (Unaudited)

 

(in thousands, except per share data)		Number of shares		Common stock			Surplus			Retained earnings			Cumulative other comprehensive (loss) income			Total
Balance at December 31, 2001		10,862,257		$	54,311		$	75,147		$	34,782		$	3,185		$	167,425
Comprehensive income:
Net income		—		—			—			5,777			—			5,777
Other comprehensive income net of tax:
Net unrealized gains on securities		—		—			—			—			(820		)	(820		)
Total comprehensive income																4,957
Dividend reinvestment plan		—		—			—			(12		)	—			(12		)
Cash dividends declared ($.28 per share)		—		—			—			(2,989		)	—			(2,989		)
Stock consideration for options exercised		(596	)	(3		)	(4		)	(9		)	—			(16		)
Stock options exercised		14,579		73			183			—			—			256
Stock repurchase and retirement		(23,400	)	(117		)	(511		)	—			—			(628		)
Net change		(9,417	)	(47		)	(332		)	2,767			(820		)	1,568
Balance at March 31, 2002		10,852,840		$	54,264		$	74,815		$	37,549		$	2,365		$	168,993
Balance at December 31, 2002		10,729,304		$	53,646		$	70,598		$	50,179		$	9,833		$	184,256
Comprehensive income:
Net income		—		—			—			7,199			—			7,199
Other comprehensive income net of tax:
Net unrealized gains on securities available for sale, net of reclassification of $287 of net gains included in net income		—		—			—			—			724			724
Total comprehensive income																7,923
Dividend reinvestment plan		—		—			—			—			—			—
Cash dividends declared ($.29 per share)		—		—			—			(3,113		)	—			(3,113		)
Stock consideration for options exercised		(2,782	)	(13		)	(18		)	(68		)	—			(99		)
Stock options exercised		32,880		164			586			—			—			750
Net change		30,098		151			568			4,018			724			5,461
Balance at March 31, 2003		10,759,402		$	53,797		$	71,166		$	54,197		$	10,557		$	189,717

 

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F&M BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)

 

		Quarter ended March 31,
(in thousands)		2003			2002
Cash Flows from Operating Activities
Net income		$	7,199		$	5,777
Adjustments to reconcile net income to net cash provided by operating activities
Provision for credit losses		525			825
Depreciation and amortization		733			976
Amortization of intangibles		533			296
Net premium amortization on investment securities		654			799
Decrease in interest receivable		509			155
Decrease in interest payable		(25		)	(300		)
Gain on sales of property		(9		)	(86		)
Gain on sales of securities		(467		)	—
Decrease in loans held for sale		11,924			13,365
(Increase) decrease in other assets		(498		)	233
(Decrease) increase in other liabilities		(916		)	1,202
Gain on sales of loans		(678		)	(845		)
Net cash provided by operating activities		19,484			22,397
Cash Flows from Investing Activities
Purchases of investment securities available for sale		(138,950		)	(61,839		)
Proceeds from sales/maturities of securities available for sale		130,673			48,867
Net increase in loans		(12,309		)	(7,972		)
Purchases of premises and equipment		(61		)	(365		)
Proceeds from sales of property		216			157
Net cash used in investing activities		(20,431		)	(21,152		)
Cash Flows from Financing Activities
Net increase in noninterest-bearing deposits, interest-bearing checking, savings and money market accounts		56,670			40,719
Net decrease in certificates of deposit		(2,176		)	(24,098		)
Net decrease in short-term borrowings		(55,424		)	(16,977		)
Gross debt maturities in long-term borrowings		(105		)	(24		)
Cash dividends paid		(3,113		)	(2,989		)
Dividend reinvestment plan		—			(12		)
Proceeds from issuance of common stock		651			240
Common stock purchased and retired		—			(628		)
Net cash used in financing activities		(3,497		)	(3,769		)
Net decrease in cash and cash equivalents		(4,444		)	(2,524		)
Cash and cash equivalents at beginning of year		81,676			79,108
Cash and cash equivalents at end of period		$	77,232		$	76,584
Supplemental Disclosures of Cash Flow Information
Cash payments for interest		7,788			10,239
Cash payments for income tax		1,795			541
Non-Cash Investing and Financing Activities
Fair value adjustment for securities available for sale, net of income taxes		724			(820		)

 

6

 

F&M BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Unaudited)

 

1.               Summary of Significant Accounting Policies

 

F&M Bancorp and Subsidiaries (consolidated) (the Bancorp) is a diversified financial services company providing banking, insurance, investments, mortgage banking and consumer finance through banking branches, the internet and other distribution channels to consumers and businesses located primarily within the State of Maryland.  F&M Bancorp (the Parent) is a bank holding company.

 

The accounting and reporting policies and practices of the Bancorp conform with accounting principles generally accepted in the United States of America (“GAAP”) and prevailing practice within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts in the financial statements for prior years have been reclassified to conform with the current financial statement presentation.

 

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 2002 Annual Report on Form 10-K. There have been no significant changes to these policies.

 

The table below reflects the fair value-based accounting of stock options under the provisions of FASB Statement No. 148, Accounting for Stock-Based Compensation.

 

		Quarter ended March 31,
(in thousands, except per share amounts)		2003			2002
Stock-based compensation cost:
As reported		$	—		$	—
Pro forma		227			56
Net income
As reported		7,199			5,777
Pro forma		7,060			5,743
Earnings per common share
As reported		$	0.67		$	0.53
Pro forma		0.66			0.53
Diluted earnings per common share
As reported		$	0.66		$	0.53
Pro forma		0.65			0.53

 

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2.               Business Combinations

 

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

 

The aggregate amount of consideration that Mercantile will pay in the merger has been fixed at approximately $123.5 million is cash and approximately 10.3 million shares of its common stock.  These fixed pools of consideration were determined based on: (i) an aggregate of 10,740,357 shares of F&M Bancorp common stock outstanding as of the date of the merger agreement, (ii) an agreed upon purchase price of $46 per share, (iii) an exchange ratio of 1.2831 based on an agreed upon value of the Mercantile common stock of $35.85 (the average of the closing sales price of on the NASDAQ National Market System during the ten consecutive trading-day period ended on the day prior to the date of the Merger agreement), and (iv) an agreement to fix 75% of such aggregate consideration in the form Mercantile common stock and 25% in cash.  These pools would increase only in the event of the exercise of outstanding options to purchase shares of F&M Bancorp common stock between March 13, 2003 and the effective time of the merger.  If all of such outstanding options were exercised, the aggregate amount of consideration payable in the merger would increase to approximately $130.7 million and approximately 10.8 million shares.

 

Under the terms of the merger agreement, each share of F&M Bancorp common stock will be converted to either (i) an amount in cash or (ii) an equivalent value of shares in Mercantile common stock.  The value of the cash or Mercantile common stock that an F&M Bancorp shareholder will receive for each share of F&M Bancorp common stock owned by it will be determined as of the ten consecutive trading-day period ending on the third calendar day immediately prior to the effective time of the merger, in accordance with a formula (including to calculation of a new exchange ratio) based on the average of the closing sales price of the Mercantile common stock on the NASDAQ National Market System during such ten day period.  Thus, while the value of the cash or Mercantile common stock that an F&M Bancorp shareholder will receive for each share of F&M Bancorp common stock owned by it will be equal as of the calculation date, such value may be more or less than $46 per share depending upon whether or not the average closing price of the Mercantile common stock such ten day period is more of less than $35.85.

 

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

 

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3.               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 March 31,
(in thousands, except per share data)		2003			2002
Net income applicable to common stock (numerator)		$	7,199		$	5,777
EARNINGS PER COMMON SHARE
Average common shares outstanding (denominator)		10,738.2			10,852.7
Per share		$	0.67		$	0.53
DILUTED EARNINGS PER COMMON SHARE
Average common shares outstanding		10,738.2			10,852.7
Add:  Stock options		104.8			59.6
Diluted average common shares outstanding (denominator)		10,843.0			10,912.3
Per share		$	0.66		$	0.53

 

4.               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 results 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.

 

5.               Intangible Assets

 

The gross carrying amount of intangible assets and the associated accumulated amortization at March 31 is presented in the following tables.

 

		March 31, 2003
(in thousands)		Gross carrying amount			Accumulated amortization			Valuation Allowance			Net intangible assets
Amortized intangible assets:
Core deposit intangible		$	8,565		$	6,925		$	—		$	1,640
Mortgage servicing rights		1,757			1,054			410			293
Total		$	10,322		$	7,979		$	410		$	1,933

 

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		March 31, 2002
(in thousands)		Gross carrying amount			Accumulated amortization			Valuation Allowance			Net intangible assets
Amortized intangible assets:
Core deposit intangible		$	8,565		$	5,963		$	—		$	2,602
Mortgage servicing rights		1,757			794			—			963
Total		$	10,322		$	6,757		$	—		$	3,565

 

The projections of amortization expense shown below for mortgage servicing rights are based on asset balances and the interest rate environment as of March 31, 2003. 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. Core deposit intangibles are amortized on useful lives of up to 15 years. The Bancorp reviews other intangible assets for impairment quarterly (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.

 

(in thousands)		Core deposit intangibles			Mortgage servicing rights			Total
Three months ended March 31, 2003 (actual)		$	214		$	65		$	279
Year ended December 31, 2003 (estimated)		700			195			895
Estimate for year ended December 31,
2004		737			98			835
2005		203			—			203
2006		—			—			—
2007		—			—			—
2008		—			—			—

 

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6.               Commitments

 

Various commitments to extend credit (lines of credit) are made in the normal course of the banking business. Total unused lines of credit approximated $171.5 million, $154.1 million and $149.7million at March 31, 2003, December 31, 2002 and March 31, 2002, respectively. In addition, letters of credit are issued for the benefit of customers. Outstanding letters of credit were $27.8 million at March 31, 2003, $23.8 million at December 31, 2002 and $24.4 million at March 31, 2002 in accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. A liability of $95 thousand for performance under standby letters of credit was recorded as of March 31, 2003. All standby letters of credit are supported by collateral or recourse provisions that are expected to cover the majority of these obligations.

 

7.               Derivative Instruments and Hedging Activities

 

FASB Statement No. 133 (SFAS No. 133), Accounting for Derivative Instruments and Hedging Activities, and FASB Statement No. 138 (SFAS No. 138), Accounting for Certain Derivative Instruments and Certain Hedging Activities — an amendment to FASB Statement No. 133, collectively (SFAS No. 133) establishes accounting and reporting standards for derivative instruments and for hedging activities. The Bancorp enters into interest rate locks with mortgage loan customers and forward commitments to sell loans to mortgage investors. These are considered derivative instruments under SFAS No. 133.

 

All derivative instruments are recognized on the balance sheet at fair value. On the date the Bancorp enters into a derivative contract, the Bancorp designates the derivative instrument as (1) a hedge of the fair value of a recognized asset or liability or of a unrecognized firm commitment (“fair value hedge”), or (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”). For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability or of an unrecognized firm commitment attributable to the hedged risk are recorded in current period net income in the same financial statement category of the hedged item. For a cash flow hedge, changes in the fair value of the derivative instrument to the extent that it is effective are recorded in other comprehensive income within stockholders’ equity and subsequently reclassified to net income in the same period(s) that the hedged transaction impacts net income in the same financial statement category as the hedged item.

 

The fair value of derivative instruments was $480 thousand recorded in other assets and $571 thousand recorded in accrued expenses and other liabilities at March 31, 2003.

 

8.               Recent Accounting Standards

 

In June 2002, the FASB issued Statement No. 146 (SFAS No. 146), Accounting for Cost Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for cost associated with exit or disposal activities.  This statement requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. This statement is effective for activities initiated after December 31, 2002.The Bancorp adopted this SFAS No. 146 as of January 1, 2003 with no material impact on the financial condition or results of operations for the quarter ended March 31, 2003.

 

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34 (FIN 45).  The initial recognition and measurement provision of FIN 45 are effective for guarantees issued or modified after December 31, 2002.  Accounting for guarantees issued prior to this date is unaffected by FIN 45. This

 

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statement is effective for the Bancorp and has been adopted as of January 1, 2003. The adoption of this statement did not have a material impact on the Bancorp’s financial position or results of operations.

 

In December 2002, the FASB issued Statement No. 148 (SFAS No. 148), Accounting for Stock-based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. This statement is effective for fiscal years ending after December 15, 2002. This statement is effective for the Bancorp and has been adopted as of January 1, 2003. The adoption of this statement did not have a material impact on the Bancorp’s financial position or results of operations.

 

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

 

SUMMARY FINANCIAL DATA

 

		Quarter ended						% Change Mar. 31, 2003 from
(in thousands, except per share amounts)		Mar 31, 2003		Dec 31, 2002		Mar 31, 2002		Dec 31, 2002		Mar 31, 2002
For the Period
Net income		7,199		6,265		5,777		15	%	25	%
Diluted earnings per common share		0.66		0.58		0.53		15		25
Profitability ratios (annualized)
Net income to average total assets (ROA)		1.42	%	1.24	%	1.26	%	15		13
Net income applicable to common stock to average common stockholders equity (ROE)		15.59	%	13.57	%	13.71	%	15		14
Efficiency ratio(1)		58.64	%	64.61	%	62.39	%	(9	)	(6	)
Dividends paid per common share		0.29		0.28		0.28		4		4
Average common shares outstanding		10,738,234		10,767,352		10,852,687		—		(1	)
Diluted average common shares outstanding		10,843,032		10,857,658		10,912,294		—		(1	)
Total revenue		27,804		27,290		26,037		2		7
Average loans		1,306,446		1,269,793		1,164,992		3		12
Average assets		2,056,449		2,012,166		1,860,937		2		11
Average deposits		1,595,580		1,569,537		1,508,003		2		6
Net interest margin		4.19	%	4.24	%	4.34	%	(1	)	(3	)
At Period End
Securities available for sale		627,633		618,452		557,425		1		13
Loans		1,317,789		1,305,348		1,170,387		1		13
Allowance for credit losses		(13,673	)	(13,668	)	(14,132	)	—		(3	)
Assets		2,098,469		2,094,986		1,883,523		—		11
Deposits		1,649,633		1,595,139		1,532,689		3		8
Shareholders’ equity		189,717		184,256		168,993		3		12
Tier 1 capital(2)		177,491		172,648		164,848		3		8
Total capital(2)		191,952		186,316		178,980		3		7
Capital ratios
Shareholders’ equity to assets		9.04	%	8.80	%	8.97	%	3		1
Risk-based capital(2)
Tier 1 capital		11.85	%	11.74	%	12.40	%	1		(4	)
Total capital		12.82	%	12.67	%	13.47	%	1		(5	)
Leverage(2)		8.64	%	8.59	%	8.87	%	1		(3	)
Book value per common share		17.67		17.11		15.57		3		13
Staff (active, full-time equivalent)		728		708		755		3		(4	)
Common Stock Price
High		44.94		35.00		28.85		28		56
Low		28.45		30.75		25.05		(7	)	14
Period end		44.01		32.00		26.99		38		63
Credit quality
Nonperforming assest / total assets		0.12	%	0.12	%	0.13	%	—		(8	)
Net chargeoffs/total loans		0.16	%	0.12	%	0.22	%	33		(27	)
Allowance for credit losses/total loans		1.05	%	1.08	%	1.21	%	(3	)	(13	)

 

(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.

 

13

 

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 $2.1 billion diversified financial services company providing banking, insurance, wealth management, and mortgage banking through banking branches, the internet and other distribution channels to consumers and commercial businesses. The Bank operates 48 community offices in Frederick, Howard, Baltimore, Montgomery, Washington, Carroll and Alleghany Counties in Maryland, together with two insurance agencies.

 

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

 

Net income for the first quarter of 2003 reached a record $7.2 million, an increase of 25% compared with earnings of $5.8 million for the first quarter of 2002. Earnings per diluted share for the first quarter of 2003 reached a record $0.66 per share, a 25% increase over the prior year’s $0.53 per share results. Return on average assets (ROA) was 1.42% and return on average equity (ROE) was 15.59% for the first quarter of 2003, compared with 1.26% and 13.71%, respectively, for the same period of 2002.

 

Net interest income on a taxable-equivalent basis was $20.1 million for the first quarter of compared with $18.8 million for the same periods of 2002. The Bancorp’s net interest margin was 4.19% for the first quarter, compared with 4.34% for the same periods of 2002.

 

Noninterest income totaled $8.3 million for the first quarter, compared with $8.0 million and for the same periods of 2002, a 4% increase. Noninterest expense totaled $16.7 million for the first quarter of 2003, compared with $16.8 million for the same periods of 2002.

 

The provision for credit losses was $525 thousand in the first quarter of 2003, compared with $825 thousand in the same periods in 2002. During the first quarter of 2003, net charge-offs were $520 thousand, or .16% of average loans outstanding (annualized), compared with $640 thousand, or .22%, in the first quarter of 2002. The provision for credit losses for the first quarter was maintained at the experience level of net charge-offs. The allowance for credit losses was $13.7 million, or 1.05% of total loans, at March 31, 2003, compared with $13.7 million, or 1.08%, at December 31, 2002 and $14.1 million, or 1.21% at March 31, 2002.

 

At March 31, 2003, total nonperforming assets were $2.6 million, or .12% of total assets, compared with $2.5 million, or .12%, at December 31, 2002 and $2.4 million, or .13%, at March 31, 2002. Foreclosed assets amounted to $414 thousand at March 31, 2003 and December 31, 2002, and $610 thousand at March 31, 2002.

 

14

 

At March 31, 2003, the ratio of shareholders’ equity to total assets was 9.04%, compared with 8.97% at March 31, 2002. The Bancorp’s total risk-based capital (RBC) ratio at March 31, 2003 was 12.82% and its Tier 1 RBC ratio was 11.85%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively for bank holding companies. The Bancorp’s ratios at March 31, 2002 were 13.47% and 12.40%, respectively. The Bancorp’s leverage ratio was 8.64% at March 31, 2003 and 8.87% at March 31, 2002, exceeding the minimum regulatory guideline of 3% for bank holding companies.

 

Critical Accounting Policies

 

Reserve for Credit Losses

 

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

 

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

 

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

management and staff.

 

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

 

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

 

15

 

The Bancorp is examined annually by the Federal Reserve Board and the State of Maryland, including specific segments of the loan portfolio.

 

The Bancorp considers the allowance for credit losses of $13.7 million adequate to cover losses inherent in loans, loan commitments and standby and other letters of credit at March 31, 2003.

 

Valuation of Mortgage Servicing Rights

 

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

 

Key economic assumptions used in measuring any potential impairment of the servicing rights include the prepayment speed of the underlying mortgage loans, the weighted-average life of the loan and the discount rate. The primary risk of material changes to the value of the mortgage servicing rights resides in the potential volatility in the economic assumptions used, particularly the prepayment speed. The Bancorp monitors this risk and adjusts its valuation allowance as necessary to adequately reserve for any probable impairment in the portfolio. By adjusting the allowance, as necessary each quarter, the Bancorp mitigates its risk to material adverse changes in the value of the portfolio. See further discussion in Note 1 and Note 16 to Financial Statements of F&M Bancorp’s 2001 Annual Report on Form 10-K.

 

Valuation of Identifiable Intangible Assets

 

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

 

16

 

EARNINGS PERFORMANCE

 

NET INTEREST INCOME

 

Net interest income on a taxable-equivalent basis was $20.1 million in first quarter 2003, up 7% from first quarter of last year. The increase in net interest income was largely due to solid earning asset and core deposit growth, offset by a decline in net interest margin from 4.34 percent a year ago to 4.19 percent in first quarter 2003. The average earning asset growth of $191 million included an increase of $141 million in the loan portfolio and $59 million in the securities portfolio, offset by a $9 million decline in short-term funds. The margin compression in the first quarter reflected the earning asset growth being funded by a greater proportion of interest-bearing liabilities rather than noninterest-bearing deposits and equity as well as asset yields declining at a faster rate than interest-bearing liability costs. Average funding costs declined 80 basis points in first quarter 2003, while average net asset yields declined 83 basis points.

 

An important contributor to the growth in net interest income from first quarter 2003 was a 6% increase in core deposits, the Bancorp’s lowest cost source of funding. Average core deposits were $1.596 million and $1.508 million and funded 78% and 81% of the Bancorp’s average total assets in the first quarter of 2003 and 2002, respectively. Total average interest-bearing deposits increased to $1.336 million in first quarter 2003 from $1.283 million a year ago. For the same period, total average noninterest-bearing deposits increased to $259 million from $225 million. While certificates of deposits declined on average from $626 million to $619 million, noninterest-bearing checking and other core deposit categories increased on average from $880 million to $1.064 million in first quarter 2003 reflecting the Bancorp’s success in growing customer relationships.

 

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

 

17

 

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

 

		Quarter ended Mar. 31,
		2003								2002
(in thousands)		Average Balance			Interest income/ expense			Yields/ rates		Average Balance			Interest income/ expense			Yields/ rates
ASSETS
Interest earning assets:
Short-term funds		$	3,150		$	10		1.29	%	$	12,360		$	44		1.44	%
Loans held for sale		19,400			296			6.19		19,082			292			6.21
Securities available for sale(2)(4);
U.S. Treasury and federal agencies		84,764			767			3.67		41,875			462			4.47
U.S. States and political subdivisions		106,327			1,711			6.53		118,421			2,025			6.93
Mortgage-backed securities		377,718			4,157			4.46		387,049			4,702			4.93
Other securities		43,086			320			3.01		5,882			41			2.83
Total investment securities		611,896			6,955			4.61		553,227			7,230			5.30
Nonmarketable equity securities		6,819			84			5.00		6,934			116			6.78
Portfolio Loans(3)(4):
Commercial		172,608			2,502			5.88		159,896			2,822			7.16
Residential real estate		356,418			5,198			5.91		264,514			4,780			7.33
Commercial real estate		406,472			6,710			6.69		335,340			6,210			7.51
Real estate construction		103,832			1,404			5.48		104,419			1,448			5.62
Consumer installment		267,116			4,743			7.20		300,823			5,802			7.82
Total loans		1,306,446			20,557			6.38		1,164,992			21,062			7.33
Total interest-earning assets		1,947,711			27,902			5.81		1,756,595			28,744			6.64
Total noninterest-earning assets		108,738								104,342
Total assets		$	2,056,449							$	1,860,937
LIABILITIES
Interest-bearing liabilities:
Interest-bearing deposits
Savings		$	226,656		$	498		0.89		$	193,596		$	581		1.22
Checking		212,000			162			0.31		197,733			260			0.53
Money market accounts		278,182			748			1.09		266,285			1,112			1.69
Certificates of deposit		619,303			5,043			3.30		625,737			6,896			4.47
Total interest-bearing deposits		1,336,141			6,451			1.96		1,283,351			8,849			2.80
Short-term borrowings		177,236			366			0.84		102,975			312			1.23
Long-term borrowings		77,954			946			4.92		63,429			779			4.98
Total interest-bearing liabilities		1,591,331			7,763			1.98	%	1,449,755			9,940			2.78	%
Noninterest bearing liabilities:
Demand deposits		259,439								224,652
Other liabilities		18,411								15,606
Total noninterest bearing liabilities		277,850								240,258
Shareholders’ equity		187,268								170,924
Total liabilities and shareholders’ equity		$	2,056,449							$	1,860,937
Net interest income and net interest margin on a taxable-equivalent basis(4)					$	20,139		4.19	%				$	18,804		4.34	%

 

(1)          The average prime rate of the Bancorp was 4.56% and 5.17% for the quarters ended March 31, 2003 and 2002, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 1.56% and 2.16% for the quarters ended March 31, 2003 and 2002, respectively.

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

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

(4)          Interest and yield on obligations of state and political subdivisions and tax-exempt loans are computed on a taxable equivalent basis using U.S. statutory tax rate of 35 percent.

 

18

 

PROVISION FOR CREDIT LOSSES

 

The provision for credit losses for the first quarter of 2003 decreased by $300 thousand over the year-ago quarter due to the improving credit quality of the loan portfolio. The provision for credit losses during the quarter represented approximately 100 percent of net charge-offs. Losses incurred in the first quarter were primarily in the consumer portfolio and were stable compared to previous quarters.

 

NONINTEREST INCOME

 

(in thousands)		Quarter ended Mar. 31						% Change
		2003			2002
Service charges on deposit accounts		$	2,113		$	2,196		(4	)%
Trust and investment fees:
Asset management and custody fees		474			611			(22	)
Mutual fund and annuity sales fees		242			310			(22	)
Total trust and investment fees		716			921			(22	)
Other fees:
Cash network fees		782			711			10
Charges and fees on loans		95			69			38
Bank-owned life insurance		175			123			42
All other fees		329			412			(20	)
Total other fees		1,381			1,315			5
Mortgage banking fees:
Origination and other closing fees		324			219			48
Net gains on mortgage loan sales		555			567			(2	)
Servicing fees, net of amortization		(201		)	59			(494	)
Total mortgage banking fees		678			845			(19	)
Insurance		2,940			2,650			11
Net gains (losses) on securities sold		467			—			100
Net gains (losses) on sale of property		36			86			(58	)
Total		$	8,331		$	8,013		4	%

 

Noninterest income was $8.3 million for first quarter 2003, up 4 percent from $8.0 million in the first quarter of last year. Fee income growth generated in the first quarter through increases in cash network fees and strong insurance sales were offset by declines in trust and investment fees. Mortgage banking fees of $678 thousand in the first quarter of 2003 were impacted by a $222 thousand charge recorded for the impairment of mortgage servicing rights. Noninterest income during the first quarter of 2003 also included $467 thousand in gains on sales of securities due to a repositioning of the investment portfolio as part of the ongoing asset/liability management strategy of the Bancorp.

 

19

 

NONINTEREST EXPENSE

 

(in thousands)		Quarter ended Mar. 31						% Change
		2003			2002
Salaries		$	7,330		$	7,116		3	%
Incentive compensation		846			629			34
Employee benefits		1,436			1,912			(25	)
Occupancy and equipment		2,231			2,474			(10	)
Professional services		566			489			16
Telecommunications		326			302			8
Advertising and promotions		367			504			(27	)
Computer software and maintenance		351			342			3
Stationary and office supplies		366			386			(5	)
Core deposit intangible amortization		246			215			14
Postage		238			260			(8	)
Other real estate owned		1			10			(90	)
All other		2,392			2,138			12
Total		$	16,696		$	16,777		(0	)%

 

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 58.64% for the quarter compared to 62.39% for the comparable period in 2002.

 

Salary expenses of $7.3 million for the first quarter 2003 were 3% higher then the prior year’s quarter due to normal merit increases. Incentive compensation increased by 34% due to Bancorp’s strong financial performance as measured by our team-based compensation and sale programs. Employee benefit costs for the first quarter of 2003 were 25% less that the comparable quarter of 2002 due to lower medical claims incurred during the period.

 

Occupancy expenses for the quarter of $2.2 million decreased $243 thousand or 10% compared to the first quarter of 2002 due to branch consolidation efforts in the previous year.

 

INCOME TAXES

 

For the first quarter of 2003, provision for income taxes increased by 27.4% to $3.4 million from the previous year quarter and was directly related to the increase in pretax operating earnings. The first quarter 2003 effective tax rate was 31.18% compared to 31.50% in the prior year as most of the components of the increased revenues are fully taxable.

 

20

 

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.

 

		March 31, 2003						December 31, 2002						March 31, 2002
(in thousands)		Cost			Estimated fair value			Cost			Estimated fair value			Cost			Estimated fair value
Securities of U. S. Treasury and federal agencies		$	74,591		$	76,866		$	77,809		$	79,830		$	44,965		$	45,388
Securities of U. S. states and political subdivisions		98,196			102,906			104,792			108,487			114,654			116,221
Mortgage-backed securities		394,172			401,335			384,530			391,988			387,462			387,578
Other		41,301			42,023			33,041			33,556			4,048			3,893
Total debt securities		608,260			623,130			600,172			613,861			551,129			553,080
Marketable equity securities		2,751			4,503			2,751			4,591			2,751			4,345
Total		$	611,011		$	627,633		$	602,923		$	618,452		$	553,880		$	557,425

 

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)		March 31, 2003		December 31, 2002		March 31, 2002
Estimated unrealized gross gains		17,276		16,433		6,587
Estimated unrealized gross losses		654		904		3,042
Estimated unrealized net gain		16,622		15,529		3,545

 

The weighted average expected remaining maturity of the debt securities portion of the securities available for sale portfolio was 2 years at March 31, 2003. Expected remaining maturities will differ from contractual maturities because obligations may be prepaid.

 

21

 

LOAN PORTFOLIO

 

											% Change Mar. 31, 2003 from
(in thousands)		Mar. 31 2003			Dec. 31, 2002			Mar. 31 2002			Dec. 31, 2002		Mar. 31 2002
Commercial(1)		$	167,746		$	174,975		$	160,211		(4	)%	5	%
Residential real estate(2)		363,708			348,289			269,936			4		35
Commercial mortgage		414,294			403,870			339,442			3		22
Real estate construction		110,824			105,047			103,309			5		7
Consumer installment		261,217			273,167			297,489			(4	)	(12	)
Total loans (net of unearned income, including net deferred loan fees, of $785, $699 and $150		$	1,317,789		$	1,305,348		$	1,170,387		1	%	13	%

 

(1)          Includes agricultural loans (loans to finance agricultural production) of $206 thousand, $308 thousand and $417 thousand at March 31, 2003, December 31, 2002 and March 31, 2002, respectively.

(2)          Includes agricultural loans that are secured by real estate of $6,778 thousand, $6,516 thousand and $5,570 thousand at March 31, 2003, December 31, 2002 and March 31, 2002, 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.

 

NONACCRUAL LOANS AND OTHER REAL ESTATE OWNED

 

(in thousands)		Mar. 31, 2003			Dec. 31, 2002			Mar. 31, 2002
Nonaccrual loans:
Commercial		$	1,397		$	1,186		$	1,667
Residential real estate		—			126			127
Commercial mortgage		481			461			2
Real estate construction		71			71			—
Consumer installment		225			233			26
Total nonaccrual loans		$	2,174		$	2,077		$	1,822
As a percentage of total loans		0.16		%	0.16		%	0.16		%
Other real estate owned		414			414			610
Total nonaccrual loans and other real estate owned		$	2,588		$	2,491		$	2,432
As a percentage of total assets		0.12		%	0.12		%	0.13		%
Loans past due 90 days as to interest & principal		$	917		$	1,191		$	1,302

 

22

 

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.

 

ALLOWANCE FOR CREDIT LOSSES

 

		Quarter ended
(in thousands)		March 31, 2003			March 31, 2002
Balance, beginning of period		$	13,668		$	13,947
Provision for credit losses		525			825
Loan charge-offs:
Commercial		62			73
Residential mortgage		133			8
Commercial mortgage		—			—
Real estate construction					—
Consumer		945			1,261
Total loans charged-off		1,140			1,342
Loan recoveries:
Commercial		125			26
Residential mortgage		2			—
Commercial mortgage		1			1
Real estate construction		—			—
Consumer		492			675
Total loan recoveries		620			702
Net charge-offs		520			640
Balance, end of period		$	13,673		$	14,132
Total net loan charge-offs as a percent of average total loans (annualized)		0.16		%	0.22		%
Allowance as a percentage of total loans		1.05		%	1.21		%

 

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The Bancorp considers the allowance for loan losses of $13.7 million adequate to cover losses inherent in loans, loan commitments and standby and other letters of credit at March 31, 2003. 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 credit quality of the loan portfolio remains exceptionally strong with very low levels of impaired loans and declining historical loss ratios which are the primary drivers of the necessary allowance for credit losses.

 

DEPOSITS

 

The following table shows comparative detail of deposits.

 

(in thousands)		March 31, 2003			December 31, 2002			March 31, 2002
Noninterest-bearing demand deposits		$	294,382		$	264,965		$	238,430
Interest-bearing deposits:
Checking		216,909			220,509			213,335
Savings		234,428			217,342			205,227
Money market		285,175			271,409			269,048
Certificates of deposit		618,739			620,914			606,649
Total deposits		$	1,649,633		$	1,595,139		$	1,532,689

 

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 March 31, 2003:
Total capital (to risk-weighted assets)
F&M Bancorp		$	192		12.82	%	$	120		8.00	%	$	150		10.00	%
Farmers & Mechanics Bank		$	184		12.35		$	119		8.00		$	149		10.00
Tier 1 capital (to risk-weighted assets)
F&M Bancorp		$	177		11.85	%	$	60		4.00	%	$	90		6.00	%
Farmers & Mechanics Bank		$	170		11.43		$	60		4.00		$	89		6.00
Tier 1 capital (to average assets) (Leverage ratio)
F&M Bancorp		$	177		8.64	%	$	82		4.00	%	$	103		5.00	%
Farmers & Mechanics Bank		$	170		8.36		$	81		4.00		$	102		5.00

 

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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. FIN 45 has been adopted by the Bancorp as of January 1, 2003 and has been applied to all such commitments that fall under this statement.

 

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 2002 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.  The bank currently maintains a modest sensitivity to changes in interest rates.  For example, if rates were to rise instantaneously by 1.00% or 2.00%, net interest income would increase by 0.3% and decline 1.0%, respectively.  Conversely, if rates were to decline instantaneously, net interest income over the next 12 months would decline by 1.7% and 7.4%, respectively. The principal source of risk to net interest income in a falling rate scenario is that certain short-term market rates and a majority of the Bank’s deposit rates are currently below 2.0%. Since these rates cannot decline below a floor rate of 0%, these liability products will not fully re-price in the down rate scenarios.

 

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.

 

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.

 

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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 three months of 2003, 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. At March 31, 2003, the total remaining common stock repurchase authority was approximately 140 thousand shares.

 

Sources of capital include retained earnings and common stock issuance. In the first three months of 2003, total net income was $7.2 million and the change in retained earnings was $4.1 million after payment of $3.1 million in common stock dividends.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Information required by this item as of December 31, 2002 is set forth in “Asset Liability and Market Risk Management” on pages 32-34 of the registrant’s 2002 Annual Report on Form 10-K for the year ended December 31, 2002. There was no material change in such information as of March 31, 2003.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Within the ninety days prior to the filing of this report, the Bancorp’s management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Bancorp’s disclosure controls and procedures. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Bancorp’s disclosure controls and procedures were effective. There were no significant changes in the Bancorp’s internal controls or in other factors subsequent to the date of the evaluation that could significantly affect those controls.

 

FACTORS THAT MAY AFFECT FUTURE RESULTS

 

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

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

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

 

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

•                  future credit losses and non-performing assets;

•                  future cash requirements relating to commitments to extend credit;

•                  future amortization expense;

•                  the impact of new accounting standards;

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

 

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

 

There are several factors—many beyond our control—that could cause results to differ significantly from our expectations. Some of these factors are described below. Other factors, such as credit, market, operational, liquidity, interest rate and other risks, are described elsewhere in this report (see, for example, “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, 2002.

 

Industry Factors

 

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

 

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

 

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

 

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

 

The financial services industry is highly competitive.

 

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

 

We are heavily regulated by federal and state agencies.

 

The holding company and its subsidiaries are heavily regulated at the federal and state levels. This regulation is to protect customers, federal deposit insurance funds and the banking system as a whole, not security holders. Changes to statutes, regulations and regulatory policies, could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer and increasing the ability of non-banks to offer competing financial services and products. Also, our failure to comply with laws, regulations and policies could result in sanctions by regulatory 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, 2002.

 

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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, 2002.

 

We have businesses other than banking.

 

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

 

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

 

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

 

Legislative Risk

 

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.

 

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PART II - Other Information

 

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

 

(d) F&M Bancorp and Mercantile Bankshares Corporation recently announced a definitive merger agreement, subject to shareholder and regulatory approval. As a result, we will not be holding our Annual Meeting of Stockholders as previously scheduled for April 15, 2003. Instead, we will provide you with a prospectus and additional information regarding the merger transaction in the coming months, including the date for a Special Meeting of Stockholders for the purpose of voting on the merger.

 

Item 6.    Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

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

 

Form 8-K, filed dated March 13, 2003, Item 5.

Form 8-K, filed dated April 21, 2003, Item 5.

Form 8-K, filed dated April 25, 2003, Item 5.

 

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)
		May 14, 2003					/s/ Faye E. Cannon
Date							FAYE E. CANNON
							PRESIDENT AND CEO
	May 14, 2003						/s/ Kaye A. Simmons
Date							KAYE A. SIMMONS
							CFO AND TREASURER

 

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