-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CWzgkGCmlL+VlLgEXZu83n9v74gGviKtkLBHhkagusvs62q7NdStV7izJdeHFwxo IY/XmKqS4fNBG7wWeIHl/w== 0000899243-02-000793.txt : 20020415 0000899243-02-000793.hdr.sgml : 20020415 ACCESSION NUMBER: 0000899243-02-000793 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020327 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FARMERS & MERCHANTS BANCORP CENTRAL INDEX KEY: 0001085913 STANDARD INDUSTRIAL CLASSIFICATION: BLANK CHECKS [6770] IRS NUMBER: 943327828 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-26099 FILM NUMBER: 02589095 BUSINESS ADDRESS: STREET 1: 121 WEST PINE ST CITY: LODI STATE: CA ZIP: 95240-2184 BUSINESS PHONE: 2093672411 MAIL ADDRESS: STREET 1: FARMERS AND MERCHANTS BANCORP STREET 2: 121 WEST PINE ST CITY: LODI STATE: CA ZIP: 95240-2184 10-K 1 d10k.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM 10-K ------------------ [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission File Number: 1.000-26099 FARMERS & MERCHANTS BANCORP (Exact name of registrant as specified in its charter) Delaware 94-3327828 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 121 W. Pine Street, Lodi, California 95240 (Address of principal Executive offices) (Zip Code) Registrant's telephone number, including area code (209) 334-1101 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, No Par Value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of March 7, 2002, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $175,312,000 based on the sales price of that day of $250.00. The number of shares of Common Stock outstanding as of March 7, 2002: 701,248 Documents Incorporated by Reference: Portions of the Annual Report to Shareholders for 2001 are incorporated by reference in Part II, Item 5 through 8, definitive proxy statement for the 2002 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A are incorporated by reference in Part III, Items 10 through 13. FARMERS & MERCHANTS BANCORP FORM 10-K TABLE OF CONTENTS ----------------- PART I Page - ------ ---- Item 1. Business 3 - General Development of the Business 3 - Service Area - Employees - Competition - Government Policies - Supervision and Regulation - Statistical Disclosure Item 2. Properties 23 Item 3. Legal Proceedings 23 Item 4. Submission of Matters to a Vote of Security Holders 23 PART II - ------- Item 5. Market for the Registrant's Common Stock and Related Security Matters 23 Item 6. Selected Financial Data 23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 8. Financial Statements and Supplementary Data 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 24 PART III - -------- Item 10. Directors and Executive Officers of the Company 24 Item 11. Executive Compensation 24 Item 12. Security Ownership of Certain Beneficial Owners and Management 24 Item 13. Certain Relationships and Related Transactions 24 Item 14. Exhibits, Financial Statement Schedules and Reports on Forms 8-k 24 Signatures 25 2 Introduction This annual report contains various forward-looking statements, usually containing the words "estimate," "project," "expect," "objective," "goal," or similar expressions and includes assumptions concerning the Company's operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risk and uncertainties. In connection with the "safe-harbor" provisions of the private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions. Such factors include the following: (i) the effect of changing regional and national economic conditions; (ii) significant changes in interest rates and prepayment speeds; (iii) credit risks of commercial, real estate, consumer, and other lending activities; (iv) changes in federal and state Banking regulations; and (v) other external developments which could materially impact the Company's operational and financial performance. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. PART I Item 1. Business General Development of the Business August 1, 1916 marked the first day of business for Farmers & Merchants Bank of Lodi. The Bank was incorporated under the laws of the State of California and was licensed by the California Department of Financial Institutions as a state-chartered bank. The Bank prospered and grew even through the Depression years. Farmers & Merchants' first venture out of Lodi occurred in response to the closure of the only bank serving the community of Galt, requiring area residents to drive miles away for the simplest banking transaction. To meet this need, the Galt office was opened in 1948. Shortly thereafter branches were opened in Linden, North Modesto and South Sacramento. On April 12, 1957, the Secretary of State granted authority to officially change the Bank's name to Farmers & Merchants Bank of Central California. The Bank continued expansion in the Lodi market area and also acquired three offices in Turlock and Hilmar in 1985. The service area was next expanded by opening a loan production office in the community of Elk Grove. This office was later converted to a full service branch. A third office was also opened in Modesto. In 1997, a loan production office was opened in the community of Walnut Grove. On April 30, 1999, Farmers & Merchants Bancorp (referred to herein on a consolidated basis as the "Company"), pursuant to a reorganization, acquired all of the voting stock of Farmers & Merchants Bank of Central California (the "Bank"). Farmers & Merchants Bank is the Company's principal asset. Farmers & Merchants Bancorp is a bank holding company incorporated in the State of Delaware on February 22, 1999, and registered under the Bank Holding Company Act of 1956, as amended. The Company's securities as of December 31, 2001, consist of 719,269 of common stock, $0.01 par value and no shares of preferred stock issued. The Bank's two wholly owned subsidiaries are Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. Both Companies were organized during 1986. Farmers & Merchants Investment Corporation is currently dormant and Farmers/Merchants Corp. acts as trustee on deeds of trust originated by the Bank. The Company's principal business is to serve as a holding company for the Bank and for other banking or banking related subsidiaries which the Company may establish or acquire. The Company has not engaged in any other activities to date. As a legal entity separate and distinct from its subsidiary, the Company's principal source of funds is, and will continue to be, dividends paid by and other funds advanced from the Bank. Legal 3 limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company. See Dividends and Other Transfer of Funds on Page 6. The Bank's deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits. The Bank is a member of the Federal Reserve System. 1999 also saw the opening of our Centralized Loan Center in Lodi. Growth will continue in 2002 with a move to new facilities for our Turlock Main Office and the addition of our Vintage Faire Office in Modesto. Service Area The Company services the northern Central Valley with 18 banking offices. The area includes Sacramento, San Joaquin, Stanislaus and Merced Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Walnut Grove, Linden, Modesto, Turlock and Hilmar. Through its network of banking offices, the Company emphasizes personalized service along with a full range of banking services to businesses and individuals located in the service areas of its offices. Although the Company focuses on marketing of its services to small and medium sized businesses, a full range of retail banking services are made available to the local consumer market. The Company offers a wide range of deposit instruments. These include checking, savings, money market, time certificates of deposit, individual retirement accounts and online banking services for both business and personal accounts. The Company also serves as a federal tax depository for its business customers. The Company provides a full complement of lending products, including commercial, real estate construction, agribusiness, installment, credit card and real estate loans. Commercial products include lines of credit and other working capital financing and letters of credit. Financing products for individuals include automobile financing, lines of credit, residential real estate, home improvement and home equity lines of credit. The Company also offers a wide range of specialized services designed for the needs of its commercial accounts. These services include a credit card program for merchants, collection services, payroll services, on-line account access, and electronic funds transfers by way of domestic and international wire and automated clearinghouse. The Company makes available investment products to customers, including mutual funds and annuities. These investment products are offered through a third party with investment advisors Employees At December 31, 2001 the Company employed a total of 304 full time equivalent employees. The Company believes that its employee relations are excellent. Competition The Banking and financial services industry in California generally, and in the Company's market areas specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial service providers. The Company competes with other major commercial banks, diversified financial institutions, savings banks, credit unions, savings and loan associations, money market and other mutual funds, mortgage companies, and a variety of other nonbanking financial services and advisory companies. Federal legislation in recent years seems to favor competition between different types of financial service providers and to foster new entrants into the financial services market, and it is anticipated that this trend will continue. Many of our competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than the Company. In order to compete with other financial service providers, the Company relies upon personal contact by its officers, directors, employees, and 4 shareholders, along with various promotional activities and specialized services. In those instances where the Company is unable to accommodate a customer's needs, the Company may arrange for those services to be provided through its correspondents. Government Policies The Company and the Bank are influenced by prevailing economic conditions, monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System. The actions and policy directives of the Federal Reserve Board determine, to a significant degree, the cost and the availability of funds obtained from money market sources for lending and investing. Federal Reserve Board policies and regulations also influence, directly and indirectly, the rates of interest paid by commercial banks on their time and savings deposits through its open market operations in U.S. Government securities and adjustments to the discount rates applicable to borrowings by depository institutions and others. The actions of the Federal Reserve Board in these areas influence the growth of Bank loans, investments and deposits and also affect the interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact of future changes in such policies on the Company of future changes in economic conditions and monetary and fiscal policies are not predictable. Supervision and Regulation General Bank holding companies and banks are extensively regulated under both federal and state law. The regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of shareholders of the Company. Set forth below is a summary description of the material laws and regulations, which relate to the operations of the Company and the Bank. This description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. In recent years significant legislative proposals and reforms affecting the financial services industry have been discussed and evaluated by Congress, the state legislature and before the various Bank regulatory agencies. These proposals may increase or decrease the cost of doing business, limiting or expanding permissible activities, or enhance the competitive position of other financial service providers. The likelihood and timing of any such proposals or bills and the impact they might have on the Company and its subsidiaries cannot be predicted. The Company The Company is a registered bank holding company and is subject to regulation under the Bank Holding Company Act of 1956 (BHCA), as amended. Accordingly, the Company's operations, and its subsidiaries are subject to extensive regulation and examination by the Board of Governors of the Federal Reserve System (FRB). The Company is required to file with the FRB quarterly and annual reports and such additional information as the FRB may require pursuant to the Bank Holding Company Act. The FRB conducts periodic examinations of the Company and its subsidiaries. The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries of affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the BHCA and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with an extension of credit, lease or sale of property or furnishing of services. For example, with certain exceptions, a 5 bank may not condition an extension of credit on a promise by its customer to obtain other services provided by it, its holding company or other subsidiaries, or on a promise by its customer not to obtain other services from a competitor. In addition, federal law imposes certain restrictions on transitions between Farmers & Merchants Bancorp and its subsidiaries. Further, the Company is required by the Federal Reserve Board to maintain certain levels of capital. See " Capital." Directors, officers and principal shareholders of Farmers & Merchants Bancorp, and the companies with which they are associated, have had and will continue to have banking transactions with the Bank in the ordinary course of business. Any loans and commitments to lend included in such transactions are made in accordance with applicable law, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness, and on terms not involving more than the normal risks of collection or presenting other unfavorable features. The Company is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting share of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company, subject to the prior approval of the Federal Reserve Board, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Removal of many of the activity limitations is currently under review by Congress, but whether any legislation liberalizing permitted bank holding company activities will be enacted is not known. Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Boards' policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. The Company's securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As such, the Company is subject to the information, proxy solicitation, insider trading and other requirements and restrictions of the Exchange Act. The Bank The Bank, as a California chartered bank, is subject to primary supervision, periodic examination and regulation by the California Department of Financial Institutions ("DFI") and the FRB. If, as a result of an examination of the Bank, the FRB should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank's operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FRB. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate the Bank's deposit insurance, which for a California chartered bank would result in a revocation of the Bank's charter. The DFI has many of the same remedial powers. 6 Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statues and regulations relate to many aspects of the Bank's operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, the Bank is required to maintain certain levels of capital. See "Capital." Dividends and Other Transfer of Funds Dividends from the Bank constitute the principal source of income to the Company. The Company is a legal entity separate and distinct from the Bank. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Company. Under such restrictions, the amount available for payment of dividends to the Company by the Bank totaled $13.3 million at December 31, 2001. The FRB and the DFI also have authority to prohibit the Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FRB and the DFI could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. Further, the FRB and the FDIC have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank or the Company may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. The DFI may impose similar limitations on the Bank. See "Prompt Corrective Regulatory Action and Other Enforcement Mechanisms" and "Capital Standards" for a discussion of these additional restrictions on capital distributions. The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Company or other affiliates, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Company or to or in any other affiliates are limited, individually, to 10% of the Bank's capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, to 20% of the Bank's capital and surplus (as defined by federal regulations). California law also imposes certain restriction with respect to transactions involving the transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See "Item 1. Business - Supervision and Regulation - Prompt Corrective Action and Other Enforcement Mechanisms." Capital The Federal Reserve Board and the FDIC have established risk-based minimum capital guidelines with respect to the maintenance of appropriate levels of capital by United States banking organizations. These guidelines are intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as commercial loans. 7 The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above minimum guidelines and ratios. As of December 31, 2001 and 2000 the Company and the Bank's risk-based capital ratios were as follows:
To Be Well Capitalized Under Regulatory Capital Prompt Corrective (in thousands) Actual Requirements Action Provisions December 31, 2001 Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------- The Bank: Total Bank Capital to Risk Weighted Assets $100,842 12.93% $ 62,391 8.00% $ 77,988 10.00% Tier I Bank Capital to Risk Weighted Assets $ 91,104 11.68% $ 31,195 4.00% $ 46,793 6.00% Tier I Bank Capital to Average Assets $ 91,104 9.57% $ 38,077 4.00% $ 47,596 5.00% The Company: Total Consolidated Capital to Risk Weighted Assets $107,591 13.76% $ 62,543 8.00% N/A N/A Tier I Consolidated Capital to Risk Weighted Assets $ 97,829 12.57% $ 31,271 4.00% N/A N/A Tier I Consolidated Capital to Average Assets $ 97,829 10.25% $ 38,159 4.00% N/A N/A
December 31, 2000 Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------- The Bank: Total Bank Capital to Risk Weighted Assets $96,150 15.22% $ 50,548 8.0% $ 63,185 10.0% Tier I Bank Capital to Risk Weighted Assets $88,203 13.96% $ 25,274 4.0% $ 37,911 6.0% Tier I Bank Capital to Average Assets $88,203 10.00% $ 35,268 4.0% $ 44,085 5.0% The Company: Total Consolidated Capital to Risk Weighted Assets $97,419 15.41% $ 50,582 8.0% N/A N/A Tier I Consolidated Capital to Risk Weighted Assets $90,092 14.25% $ 25,291 4.0% N/A N/A Tier I Consolidated Capital to Average Assets $90,092 10.21% $ 35,285 4.0% N/A N/A
Prompt Corrective Action The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective Federal regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" Company must develop a capital restoration plan. At December 31, 2001 the Company exceeded all of the required ratios for classification as "well capitalized." An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal 8 banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. Banking agencies have also adopted regulations which mandate that regulators take into consideration (i) concentrations of credit risk; (ii) interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (iii) risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. That evaluation will be made as a part of the institution's regular safety and soundness examination. In addition, the banking agencies have amended their regulatory capital guidelines to incorporate a measure for market risk. In accordance with the amended guidelines, the Company and any company with significant trading activity must incorporate a measure for market risk in its regulatory capital calculations. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the supervising agencies for unsafe or unsound practices in conducting their businesses for violations of law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions vary commensurate with the severity of the violation. Safety and Soundness Standards The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, any insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves. Premiums for Deposit Insurance The Company's deposit accounts are insured by the Bank Insurance Fund ("BIF"), as administered by the FDIC, up to the maximum permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operation, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution's primary regulator. The FDIC charges an annual assessment for the insurance of deposits, which as of December 31, 2001, ranged from 0 to 27 basis points per $100 of insured deposits, based on the risk a particular institution poses to its deposit insurance fund. The risk classification is based on an institution's capital group and supervisory subgroup assignment. An institution's risk category is based upon whether the institution is well capitalized, adequately capitalized, or less than adequately capitalized. Each insured depository institution is also assigned to one of the following "supervisory subgroups." Subgroup A, B or C. Subgroup A institutions are financially sound institutions with few minor weaknesses; Subgroup B institutions are institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration; and Subgroup C institutions are 9 institutions for which there is a substantial probability that the FDIC will suffer a loss in connection with the institution unless effective action is taken to correct the areas of weakness. Insured institutions are not allowed to disclose their risk assessment classification and no assurance can be given as to what the future level of premiums will be. The Community Reinvestment Act ("CRA") The Bank is subject to certain fair lending requirements and reporting obligations involving lending, investing and other CRA activities. CRA requires each Company to identify the communities served by the Company's offices and to identify the types of credit and investments the Company is prepared to extend within such communities including low and moderate income neighborhoods. It also requires the Company's regulators to assess the Company's performance in meeting the credit needs of its community and to take such assessment into consideration in reviewing application for mergers, acquisitions, relocation of existing branches, opening of new branches and other transactions. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with such laws and CRA in consideration when regulating and supervising other banking activities. A Bank's compliance with its CRA obligations is based on a performance based evaluation system which bases CRA ratings on an institution's lending service and investment performance. An unsatisfactory rating may be the basis for denying a merger application. The Bank's latest CRA examination was completed by the Federal Reserve Bank of San Francisco and covered the time period of January 1, 1998 through December 31, 1999. The Bank received a high satisfactory rating in the three areas of testing which include lending, investment and service. The Bank received an overall rating of satisfactory in complying with its CRA obligations. Risk Factors that May Affect Future Results The following discusses certain factors that may affect the Company's financial results and operations and should be considered in evaluating the Company. Economic Conditions and Geographic Concentration. The Company's operations are located in Sacramento, San Joaquin, Stanislaus and Merced Counties, in the Central Valley of California. As a result of this geographic concentration, the Company's results depend largely upon economic conditions in these areas. A deterioration in economic conditions in the Company's market areas could have a material adverse impact on the quality of the Company's loan portfolio, the demand for its products and services and its financial condition and results of operations. Interest Rates. The Company's earnings are impacted by changing interest rates. Changes in interest rates impact the level of loans, deposits and investments, the credit profile of existing loans and the rates received on loans and securities and the rates paid on deposits and borrowings. The Company does not attempt to predict interest rates and positions the balance sheet in a manner to minimize the affects of changing interest rates. However, significant fluctuations in interest rates may have an adverse affect on the Company's financial condition and results of operations. Government Regulations and Monetary Policy. The banking industry is subject to extensive federal and state supervision and regulation. Significant new laws or changes in existing loans, or repeals of existing laws may cause the Company's results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company and a material change in these conditions could have a material adverse impact on the Company's financial condition and results of operations. Competition. The banking and financial services business in the Company's market areas is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in 10 technology and product delivery systems, and the accelerating pace of consolidation among financial service providers. The results of the Company may differ if circumstances affecting the nature or level of completion change. Credit Quality. A significant source of risk arises from the possibility that losses will be sustained because borrowers, guarantors and related parties adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Company's credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could have a material adverse effect on the Company's results. Statistical Disclosure The tables on the following pages set forth certain statistical information for Farmers & Merchants Bancorp on a consolidated basis. Averages are computed on a daily average basis. This information should be read in conjunction with "Management's Discussion and Analysis" in the Company's 2001 Annual Report to Shareholders, located in Exhibit 13, incorporated herein by reference and with the Company's Consolidated Financial Statements and the Notes thereto included in Company's 2001 Annual Report to Shareholders, located in Exhibit 13, incorporated herein by reference. 11 Farmers & Merchants Bancorp Year-to-Date Average Balances and Interest Rates (Interest and Rates on a Taxable Equivalent Basis) (dollars in thousands)
Year Ended December 31, 2001 Assets Balance Interest Rate - ------------------------------------------------------------------------------------ Federal Funds Sold $ 51,923 $ 1,922 3.70% Investment Securities Available-for-Sale U.S. Treasuries 1,021 55 5.39% U.S. Agencies 6,813 342 5.02% Municipals - Taxable 1,909 119 6.23% Municipals - Non-Taxable 21,945 1,425 6.50% Mortgage Backed Securities 219,352 13,946 6.36% Other 6,208 454 7.31% - ------------------------------------------------------------------------------------ Total Investment Securities Available-for-Sale 257,248 16,341 6.35% - ------------------------------------------------------------------------------------ Investment Securities Held-to-Maturity U.S. Treasuries 0 0 0.00% U.S. Agencies 367 22 5.99% Municipals - Taxable 1,714 114 6.65% Municipals - Non-Taxable 32,572 2,455 7.54% Mortgage Backed Securities 0 0 0.00% Other 629 60 9.54% - ------------------------------------------------------------------------------------ Total Investment Securities Held-to-Maturity 35,282 2,651 7.51% - ------------------------------------------------------------------------------------ Loans Real Estate 308,980 26,831 8.68% Commercial 192,383 14,759 7.67% Consumer 19,331 1,930 9.98% Credit Card 3,410 363 10.65% Municipal 1,005 73 7.26% - ------------------------------------------------------------------------------------ Total Loans 525,109 43,956 8.37% - ------------------------------------------------------------------------------------ Total Earning Assets 869,562 $64,871 7.46% =============== Unrealized Gain/(Loss) on Securities Available-for-Sale 3,685 Allowance for Loan Losses (12,640) Cash and Due From Banks 28,568 All Other Assets 25,395 - ------------------------------------------------------------------ Total Assets $914,570 ================================================================== Liabilities & Shareholders' Equity Interest Bearing Deposits Interest Bearing DDA $ 78,228 $ 626 0.80% Savings 185,352 3,581 1.93% Time Deposits 338,488 16,831 4.97% - ------------------------------------------------------------------------------------ Total Interest Bearing Deposits 602,068 21,038 3.49% Other Borrowed Funds 41,017 2,242 5.47% - ------------------------------------------------------------------------------------ Total Interest Bearing Liabilities 643,085 $23,280 3.62% =============== Demand Deposits 165,938 All Other Liabilities 9,650 - ------------------------------------------------------------------ Total Liabilities 818,673 Shareholders' Equity 95,897 - ------------------------------------------------------------------ Total Liabilities & Shareholders' Equity $914,570 ================================================================== Net Interest Margin 4.78% ====================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis using the applicable Federal and State income tax rates for the period. Loan Fees are included in interest income for loans. Unearned discount is included for rate calculation purposes. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost. 12 Farmers & Merchants Bancorp Year-to-Date Average Balances and Interest Rates (Interest and Rates on a Taxable Equivalent Basis) (dollars in thousands)
Year Ended December 31, 2000 Assets Balance Interest Rate - -------------------------------------------------------------------------------------- Federal Funds Sold $ 20,481 $ 1,300 6.35% Investment Securities Available-for-Sale U.S. Treasuries 8,350 461 5.52% U.S. Agencies 7,133 416 5.83% Municipals - Taxable 2,997 189 6.31% Municipals - Non-Taxable 20,805 1,342 6.45% Mortgage Backed Securities 248,708 15,977 6.42% Other 5,340 328 6.14% - -------------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale 293,333 18,713 6.38% - -------------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Treasuries 0 0 0.00% U.S. Agencies 1,997 119 5.96% Municipals - Taxable 2,927 197 6.73% Municipals - Non-Taxable 40,199 3,003 7.47% Mortgage Backed Securities 0 0 0.00% Other 770 75 9.74% - -------------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity 45,893 3,394 7.40% - -------------------------------------------------------------------------------------- Loans Real Estate 279,313 26,374 9.44% Commercial 153,678 15,318 9.97% Consumer 20,592 2,021 9.81% Credit Card 3,340 425 12.72% Municipal 509 33 6.48% - -------------------------------------------------------------------------------------- Total Loans 457,432 44,171 9.66% - -------------------------------------------------------------------------------------- Total Earning Assets 817,139 $67,579 8.27% ================= Unrealized Gain/(Loss) on Securities Available-for-Sale (6,571) Allowance for Loan Losses (10,676) Cash and Due From Banks 26,303 All Other Assets 30,098 - ------------------------------------------------------------------ Total Assets $856,293 ================================================================== Liabilities & Shareholders' Equity Interest Bearing Deposits Interest Bearing DDA $ 65,678 $ 778 1.18% Savings 181,476 4,127 2.27% Time Deposits 306,787 16,940 5.52% - -------------------------------------------------------------------------------------- Total Interest Bearing Deposits 553,941 21,845 3.94% Other Borrowed Funds 52,017 2,912 5.60% - -------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 605,958 $24,757 4.09% ================= Demand Deposits 156,941 All Other Liabilities 8,244 - ------------------------------------------------------------------ Total Liabilities 771,143 Shareholders' Equity 85,150 - ------------------------------------------------------------------ Total Liabilities & Shareholders' Equity $856,293 ================================================================== Net Interest Margin 5.24% ======================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis using the applicable Federal and State income tax rates for the period. Loan Fees are included in interest income for loans. Unearned discount is included for rate calculation purposes. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost. 13 Farmers & Merchants Bancorp Year-to-Date Average Balances and Interest Rates (Interest and Rates on a Taxable Equivalent Basis) (dollars in thousands)
Year Ended December 31, 1999 Assets Balance Interest Rate - ------------------------------------------------------------------------------------- Federal Funds Sold $ 15,580 $ 793 5.09% Investment Securities Available-for-Sale U.S. Treasuries 21,145 1,116 5.28% U.S. Agencies 8,864 547 6.17% Municipals - Taxable 2,824 179 6.34% Municipals - Non-Taxable 21,190 1,364 6.44% Mortgage Backed Securities 242,092 14,828 6.12% Other 4,350 241 5.54% - ------------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale 300,465 18,275 6.08% - ------------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Treasuries 807 49 6.07% U.S. Agencies 1,993 93 4.67% Municipals - Taxable 3,502 235 6.71% Municipals - Non-Taxable 46,683 3,626 7.77% Mortgage Backed Securities 0 0 0.00% Other 975 110 1.28% - ------------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity 53,960 4,113 7.62% - ------------------------------------------------------------------------------------- Loans Real Estate 231,955 22,382 9.65% Commercial 111,233 10,276 9.24% Installment 16,319 1,519 9.31% Credit Card 2,917 395 13.54% Municipal 330 21 6.36% - ------------------------------------------------------------------------------------- Total Loans 362,754 34,593 9.54% - ------------------------------------------------------------------------------------- Total Earning Assets 732,759 $57,773 7.88% =============== Unrealized Gain/(Loss) on Securities Available-for-Sale (1,983) Reserve for Loan Losses (9,097) Cash and Due From Banks 25,240 All Other Assets 27,801 - ------------------------------------------------------------------ Total Assets $774,720 ================================================================== Liabilities & Shareholders' Equity Interest Bearing Deposits Transaction $ 63,298 $ 715 1.13% Savings 184,547 4,140 2.24% Time Deposits 247,352 11,645 4.71% - ------------------------------------------------------------------------------------- Total Interest Bearing Deposits 495,197 16,500 3.33% Other Borrowed Funds 43,585 2,362 5.42% - ------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 538,782 $18,862 3.50% =============== Demand Deposits 146,529 All Other Liabilities 6,418 - ------------------------------------------------------------------ Total Liabilities 691,729 Shareholders' Equity 82,991 - ------------------------------------------------------------------ Total Liabilities & Shareholders' Equity $774,720 ================================================================== Net Interest Margin 5.31% =====================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis using the applicable Federal and State income tax rates for the period. Loan Fees are included in interest income for loans. Unearned discount is included for rate calculation purposes. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost. 14 Farmers & Merchants Bancorp Volume and Rate Analysis of Net Interest Revenue (Rates on a Taxable Equivalent Basis) (in thousands)
2001 versus 2000 Amount of Increase (Decrease) Due to Change in: ----------------------------- Average Average Net Interest Earning Assets Balance Rate Change - ---------------------------------------------------------------------------------- Federal Funds Sold $ 1,342 $ (720) $ 622 Investment Securities Available-for-Sale U.S. Treasuries (395) (11) (406) U.S. Agencies (18) (56) (74) Municipals - Taxable (68) (2) (70) Municipals - Non-Taxable 74 9 83 Mortgage Backed Securities (1,868) (163) (2,031) Other 58 68 126 - ---------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale (2,217) (155) (2,372) - ---------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Treasuries 0 0 0 U.S. Agencies (98) 1 (97) Municipals - Taxable (81) (2) (83) Municipals - Non-Taxable (575) 27 (548) Mortgage Backed Securities 0 0 0 Other (14) (2) (16) - ---------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity (768) 24 (744) - ---------------------------------------------------------------------------------- Loans: Real Estate 2,673 (2,216) 457 Commercial 3,394 (3,952) (558) Installment (126) 35 (91) Credit Card 9 (70) (61) Other 35 4 39 - ---------------------------------------------------------------------------------- Total Loans 5,985 (6,199) (214) - ---------------------------------------------------------------------------------- Total Earning Assets 4,342 (7,050) (2,708) - ---------------------------------------------------------------------------------- Interest Bearing Liabilities Interest Bearing Deposits: Transaction 131 (282) (151) Savings 86 (632) (546) Time Deposits 1,661 (1,770) (109) - ---------------------------------------------------------------------------------- Total Interest Bearing Deposits 1,878 (2,684) (806) Other Borrowed Funds (603) (68) (671) - ---------------------------------------------------------------------------------- Total Interest Bearing Liabilities 1,275 (2,752) (1,477) - ---------------------------------------------------------------------------------- Total Change $ 3,067 $(4,298) $(1,231) ==================================================================================
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number. 15 Farmers & Merchants Bancorp Volume and Rate Analysis of Net Interest Income (Rates on a Taxable Equivalent Basis) (in thousands) 2000 versus 1999 Amount of Increase (Decrease) Due to Change in: --------------------------- Average Average Net Interest Earning Assets Balance Rate Change - -------------------------------------------------------------------------------- Federal Funds Sold $ 284 $ 223 $ 507 Investment Securities Available-for-Sale U.S. Treasuries (704) 49 (655) U.S. Agencies (102) (29) (131) Municipals - Taxable 11 (1) 10 Municipals - Non-Taxable (25) 4 (21) Mortgage Backed Securities 412 737 1,149 Other 59 27 86 - ------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale (349) 787 438 - ------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Treasuries (24) (25) (49) U.S. Agencies 0 26 26 Municipals - Taxable (38) 0 (38) Municipals - Non-Taxable (489) (134) (623) Mortgage Backed Securities 0 0 0 Other (21) (14) (35) - ------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity (572) (147) (719) - ------------------------------------------------------------------------------- Loans: Real Estate 4,481 (489) 3,992 Commercial 4,178 864 5,042 Installment 416 87 503 Credit Card 55 (24) 31 Other 11 0 11 - ------------------------------------------------------------------------------- Total Loans 9,141 438 9,579 - ------------------------------------------------------------------------------- Total Earning Assets 8,504 1,301 9,805 - ------------------------------------------------------------------------------- Interest Bearing Liabilities Interest Bearing Deposits: Transaction 28 35 63 Savings (70) 57 (13) Time Deposits 3,079 2,216 5,295 - ------------------------------------------------------------------------------- Total Interest Bearing Deposits 3,037 2,308 5,345 Other Borrowed Funds 470 80 550 - ------------------------------------------------------------------------------- Total Interest Bearing Liabilities 3,507 2,388 5,895 - ------------------------------------------------------------------------------- Total Change $4,997 $(1,087) $3,910 =============================================================================== Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number. 16 Farmers & Merchants Bancorp Investment Portfolio
The following table summarizes the balances and distributions of the investment securities held on the dates indicated. Available Held to Available Held to Available Held to for Sale Maturity for Sale Maturity for Sale Maturity ------------------------------------------------------------------ December 31: (in thousands) 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------------------- U. S. Treasury $ 0 $ 0 $ 5,047 $ 0 $ 11,875 $ 0 U. S. Agency 12,771 0 7,090 1,999 7,013 1,995 Municipal 24,076 32,137 23,975 38,585 23,042 46,423 Mortgage-Backed Securities 196,384 0 237,734 0 251,003 0 Other 9,621 561 5,540 684 4,647 857 - ------------------------------------------------------------------------------------------------------------------------------- Total Book Value $242,852 $32,698 $279,386 $41,268 $297,580 $49,275 =============================================================================================================================== Fair Value $242,852 $33,546 $279,386 $41,833 $297,580 $49,411 ===============================================================================================================================
Analysis of Investment Securities Available-for-Sale The following table is a summary of the relative maturities and yields of the Company's investment securities Available-for-Sale as of December 31, 2001. Municipal securities have been calculated on a fully taxable equivalent basis using the applicable Federal and State income tax rates for the period Investment Securities Available-for-Sale Fair Average December 31, 2001 (in thousands) Value Yield - ------------------------------------------------------------------------ U.S. Treasury One year or less -- -- After one year through five years -- -- After five years through ten years -- -- After ten years -- -- - ------------------------------------------------------------------------ Total U.S. Treasury Securities -- -- - ------------------------------------------------------------------------ U.S. Agency One year or less 12,771 6.67% After one year through five years -- -- After five years through ten years -- -- After ten years -- -- - ------------------------------------------------------------------------ Total U.S. Agency Securities 12,771 6.67% - ------------------------------------------------------------------------ Municipal - Non-Taxable One year or less 869 4.84% After one year through five years 13,529 4.66% After five years through ten years 6,940 5.86% After ten years 985 6.25% - ------------------------------------------------------------------------ Total Non-Taxable Municipal Securities 22,323 5.11% - ------------------------------------------------------------------------ Municipal - Taxable One year or less 126 5.90% After one year through five years -- -- After five years through ten years 1,627 6.25% After ten years -- -- - ------------------------------------------------------------------------ Total Taxable Municipal Securities 1,753 6.22% - ------------------------------------------------------------------------ Mortgage-Backed Securities One year or less 60,266 6.39% After one year through five years 136,118 6.38% After five years through ten years -- -- After ten years -- -- - ------------------------------------------------------------------------ Total Mortgage-Backed Securities 196,384 6.38% - ------------------------------------------------------------------------ Other One year or less 4,463 5.05% After one year through five years 5,158 7.34% After five years through ten years -- -- After ten years -- -- - ------------------------------------------------------------------------ Total Other Securities 9,621 6.28% - ------------------------------------------------------------------------ Total Investment Securities Available for Sale $242,852 6.28% ======================================================================== Note: The average yield for floating rate securities is calculated using the current stated yield. 17 Farmers & Merchants Bancorp Analysis of Investment Securities Held-to-Maturity The following table is a summary of the relative maturities and yields of the Company's investment securities Held-to-Maturity as of December 31, 2001. Municipal securities have been calculated on a fully taxable equivalent basis using the applicable Federal and State income tax rates for the period Investment Securities Held-to-Maturity Book Average December 31, 2001 (in thousands) Value Yield - ----------------------------------------------------------------------------- U.S. Treasury One year or less -- -- After one year through five years -- -- After five years through ten years -- -- After ten years -- -- - ----------------------------------------------------------------------------- Total U.S. Treasury Securities -- -- - ----------------------------------------------------------------------------- U.S. Agency One year or less -- -- After one year through five years -- -- After five years through ten years -- -- After ten years -- -- - ----------------------------------------------------------------------------- Total U.S. Agency Securities -- -- - ----------------------------------------------------------------------------- Municipal - Non-Taxable One year or less 4,510 5.05% After one year through five years 20,566 4.90% After five years through ten years 3,365 5.08% After ten years 3,696 6.56% - ----------------------------------------------------------------------------- Total Non-Taxable Municipal Securities 32,137 5.13% - ----------------------------------------------------------------------------- Municipal - Taxable One year or less -- -- After one year through five years -- -- After five years through ten years -- -- After ten years -- -- - ----------------------------------------------------------------------------- Total Taxable Municipal Securities -- -- - ----------------------------------------------------------------------------- Other One year or less -- -- After one year through five years -- -- After five years through ten years -- -- After ten years 561 10.63% - ----------------------------------------------------------------------------- Total Other Securities 561 10.63% - ----------------------------------------------------------------------------- Total Investment Securities $32,698 5.23% ============================================================================= 18 Farmers & Merchants Bancorp Loan Data (in thousands) The following table shows the Bank's loan composition by type of loan.
December 31, 2001 2000 1999 1998 1997 - ---------------------------------------------------------------------------------- Real Estate $304,451 $261,910 $222,354 $180,468 $150,804 Real Estate Construction 49,692 28,354 39,186 26,529 25,796 Commercial 227,909 182,611 129,969 105,403 79,977 Consumer 17,022 20,965 18,953 14,035 12,322 Credit Card 3,157 3,619 3,235 2,989 2,873 Other 954 271 60 64 128 - ---------------------------------------------------------------------------------- Total Loans 603,185 497,730 413,757 329,488 271,900 Less: Unearned Income 1,016 333 348 310 294 Allowance for Loan Losses 12,709 11,876 9,787 8,589 7,188 - ---------------------------------------------------------------------------------- Loans, Net $589,460 $485,521 $403,622 $320,589 $264,418 ==================================================================================
There were no concentrations of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans in the above table. Non-Performing Loans (in thousands)
December 31, 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------------------- Nonaccrual Loans Real Estate $1,015 $ 948 $ 754 $3,997 $4,911 Commercial 1,302 520 1,713 595 580 Installment 36 4 32 9 7 Credit Card 0 0 0 0 0 Other 0 0 0 0 0 - --------------------------------------------------------------------------------------------- Total Nonaccrual Loans 2,353 1,472 2,499 4,601 5,498 - --------------------------------------------------------------------------------------------- Accruing Loans Past Due 90 Days or More Real Estate 0 0 0 0 0 Commercial 0 0 0 0 0 Installment 0 0 0 0 0 Credit Card 56 23 12 23 6 Other 0 0 0 0 0 - --------------------------------------------------------------------------------------------- Total Accruing Loans Past Due 90 Days or More 56 23 12 23 6 - --------------------------------------------------------------------------------------------- Total Non-Performing Loans $2,409 $1,495 $2,511 $4,624 $5,504 Other Real Estate Owned $ 0 $ 88 $ 204 $ 636 $2,231 ============================================================================================= Non-Performing Loans as a Percent of Total Loans 0.40% 0.30% 0.61% 1.40% 2.02% ============================================================================================= Allowance for Loan Losses as a Percent of Total Loans 2.11% 2.39% 2.37% 2.61% 2.64% =============================================================================================
The Bank's policy is to place loans (Excluding Credit Card Loans) on nonaccrual status when the principal or interest is past due for ninety days or more unless it is both well secured and in the process of collection. Any interest accrued, but unpaid, is reversed against current income. Thereafter interest is recognized as income only as it is collected in cash. The gross interest income that would have been recorded if the loans had been current for the year ending December 31, 2001 was $26,000. For a discussion of impaired loan policy see Note 4. in the Notes to the Consolidated Financial Statements of the Company's 2001 Annual Report. 19 Farmers & Merchants Bancorp Provision and Allowance for Loan Losses (dollars in thousands) The following table summarizes the loan loss experience of the Company for the periods indicated:
2001 2000 1999 1998 1997 - ----------------------------------------------------------------------------------------------- Balance at Beginning of Year $ 11,876 $ 9,787 $ 8,589 $ 7,188 $10,031 Provision Charged to Expense 1,000 2,800 1,700 1,400 5,450 Charge Offs: Real Estate 0 45 794 194 892 Commercial 601 659 404 91 7,672 Installment 68 177 80 73 78 Credit Card 85 48 30 73 94 Other 0 0 0 0 0 - ----------------------------------------------------------------------------------------------- Total Charge Offs 754 929 1,308 431 8,736 - ----------------------------------------------------------------------------------------------- Recoveries: Real Estate 18 0 3 1 208 Commercial 525 156 775 388 201 Installment 14 53 21 36 26 Credit Card 30 9 7 7 8 Other 0 0 0 0 0 - ----------------------------------------------------------------------------------------------- Total Recoveries 587 218 806 432 443 - ----------------------------------------------------------------------------------------------- Net Recoveries (Charge-Offs) (167) (711) (502) 1 (8,293) - ----------------------------------------------------------------------------------------------- Balance at End of Year* $ 12,709 $11,876 $ 9,787 $ 8,589 $7,188 =============================================================================================== Ratios: Consolidated Allowance for Loan Losses to: Loans at Year End 2.11% 2.39% 2.37% 2.61% 2.64% Average Loans 2.42% 2.60% 2.70% 2.92% 2.74% Consolidated Net Charge-Offs to: Loans at Year End 0.03% 0.14% 0.12% 0.00% 3.05% Average Loans 0.03% 0.16% 0.14% 0.00% 3.16%
For a description of the Company's policy regarding the Allowance for Loan Losses, see Note 1. in the Notes to the Consolidated Financial Statements of the 2001 Annual Report. Allocation of the Allowance for Loan Losses (dollars in thousands) Amount of Allowance Allocation at December 31, ---------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- Real Estate $ 3,716 $ 2,875 $2,609 $3,107 $3,020 Real Estate Construction 520 311 461 456 516 Commercial 7,595 3,846 3,382 2,530 1,927 Installment 283 129 147 229 82 Other 435 86 81 73 62 Unallocated 160 4,629 3,107 2,194 1,581 - ----------------------------------------------------------------------------- Total $12,709 $11,876 $9,787 $8,589 $7,188 ============================================================================= Percent of Loans in Each Category to Total Loans at December 31, -------------------------------------- 2001 2000 1999 1998 1997 -------------------------------------- Real Estate 50.5% 52.6% 53.7% 54.8% 55.5% Real Estate Construction 8.2% 5.7% 9.5% 8.1% 9.5% Commercial 37.8% 36.7% 31.4% 32.0% 29.4% Installment 2.8% 4.2% 4.6% 4.3% 4.5% Other 0.7% 0.8% 0.8% 0.9% 1.1% - ----------------------------------------------------------------------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ======================================================================= 20 Farmers & Merchants Bancorp Maturities and Rate Sensitivity of Loans (in thousands) The following table shows the maturity distribution and interest rate sensitivity of loans of the Company on December 31, 2001 Over One Year to Over One Year Five Five or Less Years Years Total Percent - ------------------------------------------------------------------------------- Real Estate $ 25,313 $ 67,222 $211,916 $304,451 50.47% Real Estate Construction 35,584 8,847 5,261 49,692 8.24% Commercial 141,003 67,511 19,395 227,909 37.78% Consumer 7,222 12,370 1,541 21,133 3.50% - ------------------------------------------------------------------------------ Total $209,122 $155,950 $238,113 $603,185 100.00% ============================================================================== Rate Sensitivity: Predetermined Rate $ 36,104 $ 70,534 $15,031 $121,669 20.17% Floating Rate 173,018 85,416 223,082 481,516 79.83% - ------------------------------------------------------------------------------ Total $209,122 $155,950 $238,113 $603,185 100.00% ============================================================================== Percent 34.67% 25.85% 39.48% 100.00% ===================================================================== The "One Year Or Less" column includes Demand loans, Overdrafts and Past Due Loans. The Company does not have an automatic rollover policy for maturing loans. Commitments and Lines of Credit It is not the policy of the Company to issue formal commitments or lines of credit except to a limited number of well-established and financially responsible local commercial and agricultural enterprises. Such commitments can be either secured or unsecured and are typically in the form of revolving lines of credit for seasonal working capital needs. Occasionally, such commitments are in the form of letters of credit to facilitate the customer's particular business transaction. Commitment fees are generally not charged except where letters of credit are involved. Commitments and lines of credit typically mature within one year. 21 Farmers & Merchants Bancorp Analysis of Certificates of Deposit (In thousands) The following table sets forth, by time remaining to maturity, the Company's time deposits in amounts of $100,000 or more for the periods indicated. December 31, 2001 - --------------------------------------------------------------------------- Time Deposits of $100,000 or More Three Months or Less $ 67,281 Over Three Months Through Six Months 44,538 Over Six Months Through Twelve Months 21,124 Over Twelve Months 13,489 - -------------------------------------------------------------------------- Total Time Deposits of $100,000 or More $146,432 ========================================================================== Refer to the Year-To-Date Average Balances and Rate Schedules for information on separate deposit categories. Ratios Refer to the Five Year Financial Summary of Operations located on page 49 of the Farmers & Merchants Bancorp Annual Report for the year ending December 31, 2001 for calculations of Return on Average Equity (net of accumulated other comprehensive income), Return on Average Assets, Dividend Payout Ratio and Equity to Assets Ratio. Short-Term Borrowings Refer to Note 9. of the Farmers & Merchants Bancorp Annual Report for the year ending December 31, 2001. 22 Item 2. Properties Farmers & Merchants Bancorp along with its subsidiaries are headquartered in Lodi, California. Executive offices are located at 121 W. Pine Street. Banking services are provided in eighteen locations in the Company's service area. Of the eighteen locations, fourteen are owned and four are leased. The expiration of the leases occurs between the years 2002 and 2010. Item 3. Legal Proceedings Not Applicable Item 4. Submission of Matters to a Vote of Security Holders Not Applicable PART II Item 5. Market for the Registrant's Common Stock and Related Security Matters The common stock of Farmers & Merchants Bancorp is not widely held nor is it actively traded. Consequently, it is not listed on any stock exchange or sold in the over-the-counter market. The following table summarizes the actual high and low selling prices for the Company's common stock since the first quarter of 2000. These figures are based on activity posted on the Electronic Bulletin Board and on stock transactions between individual shareholders that are reported to the Company. Calendar Quarter High Low ---------------- ---- --- 2001 Fourth quarter $250.00 $250.00 Third quarter 265.00 226.00 Second quarter 250.00 219.00 First quarter 245.00 206.00 2000 Fourth quarter $245.00 $240.00 Third quarter 235.00 210.00 Second quarter 210.00 210.00 First quarter 210.00 205.00 Beginning in 1975 and continuing through 2001, the Company has issued a 5% stock dividend annually. For information regarding cash dividends declared, refer to Quarterly Financial Data which appears in the Farmers & Merchants Bancorp 2001 Annual Report, located in Exhibit 13 and incorporated herein by reference. Item 6. Selected Financial Data The selected financial data for the five years ended December 31, 2001, which appears in the Five-Year Financial Summary of the Company's 2001 Annual Report, located in Exhibit 13, is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The management's discussion and analysis section of the Company's 2001 Annual Report, located in Exhibit 13, is incorporated herein by reference. 23 Item 8. Financial Statements and Supplementary Data The Consolidated Financial Statements and the related Notes to Consolidated Financial Statements of the Company's 2001 Annual Report, located in Exhibit 13, are incorporated herein by reference. (See listing below.) Statement - --------- Report of Management Report of Independent Accountants Consolidated Statements of Income - Years ended December 31, 2001, 2000 and 1999. Consolidated Balance Sheets - December 31, 2001 and 2000. Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 2001, 2000 and 1999. Consolidated Statements of Cash Flows - Years ended December 31, 2001, 2000 and 1999. Consolidated Statements of Comprehensive Income. Notes to Consolidated Financial Statements. Five Year Financial Summary of Operations Selected Quarterly Financial Data Management's Discussion and Analysis Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures Not Applicable PART III Item 10, 11, 12, and 13. The information required by these items is contained in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 15, 2002, and is incorporated herein by reference. The definitive Proxy Statement will be filed with the Commission within 120 days after the close of the Company's fiscal year pursuant to Regulation 14A of the Securities Exchange Act of 1934. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) (1) Financial Statements: Incorporated herein by reference, are listed in Item 8 hereof. (2) Financial Statement Schedules: None (3) Exhibits: See Exhibit Index (b) Reports on form 8-K filed during the last quarter of 2001: None 24 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Farmers & Merchants Bancorp (Registrant) By: /s/ John R. Olson -------------------------------- John R. Olson Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 12, 2002 /s/ Kent A. Steinwert President and - ---------------------------------- Chief Executive Officer Kent A. Steinwert /s/ Richard S. Erichson Executive Vice President - ---------------------------------- Senior Credit Officer Richard S. Erichson /s/ Stephen A. Fleming Executive Vice President - ---------------------------------- Head of Business Banking Stephen A. Fleming /s/ Donald H. Fraser Executive Vice President - ---------------------------------- Wholesale/Retail Market Manager Donald H. Fraser /s/ Deborah E. Hodkin Executive Vice President - ---------------------------------- Chief Administrative Officer Deborah E. Hodkin /s/ Chris C. Nelson Executive Vice President - ---------------------------------- Director of Retail Banking Chris C. Nelson /s/ John R. Olson Executive Vice President & - ---------------------------------- Chief Financial Officer John R. Olson Principal Accounting Officer /s/ Ole R. Mettler /s/ George D. Scheideman - ---------------------------------- ------------------------------------- Ole R. Mettler, Chairman George D. Scheideman, Director /a/ Stewart Adams /s/ Kevin Sanguinetti - ---------------------------------- ------------------------------------- Stewart Adams, Jr., Director Kevin Sanguinetti, Director /s/ Ralph Burlington /s/ Robert F. Hunnell - ---------------------------------- ------------------------------------- Ralph Burlington, Director Robert F. Hunnell, Director /s/ Calvin Suess /s/ James E. Podesta - ---------------------------------- -------------------------------------- Calvin Suess, Director James E. Podesta, Director /s/ Carl Wishek /s/ Harry C. Schumacher - ---------------------------- -------------------------------------- Carl Wishek, Jr., Director Harry C. Schumacher, Director 25 Index to Exhibits - -----------------
Exhibit No. Description - ----------- ----------- 2 Plan of Reorganization as filed on Form 8-K dated April 30, 1999, are incorporated herein by reference. 3(i) Amended and Restated Certificate of Incorporation of Farmers & Merchants Bancorp, filed as Exhibit 3(i) to Registrant's 8-K dated April 30, 1999, is incorporated herein by reference. 3(ii) By-Laws of Farmers & Merchants Bancorp, filed as Exhibit 3(i) to Registrant's 8-K dated April 30, 1999, is incorporated herein by reference. 10.1 Employment Agreement dated July 8, 1997, between Farmers & Merchants Bank of Central California and Kent A. Steinwert, filed as Exhibit 10.1 to Registrant's 8-K dated April 30, 1999, is incorporated herein by reference. 10.2 Employment Agreement dated July 8, 1997, between Farmers & Merchants Bank of Central California and Richard S. Erichson, filed as Exhibit 10.2 to Registrant's 8-K dated April 30, 1999, is incorporated herein by reference. 10.3 Deferred Bonus Plan of Farmers & Merchants Bank of Central California adopted as of March 2, 1999, filed as Exhibit 10.3 to Registrant's 8-K dated April 30, 1999, is incorporated herein by reference. 10.4 Amended and Restated Deferred Bonus Plan of Farmers & Merchants Bank of Central California, executed May 11, 1999, filed as Exhibit 10.4 to Registrant's 8-K dated April 30, 1999, is incorporated herein by reference. 13 Annual Report to Shareholders of Farmers & Merchants Bancorp for the year ended December 31, 2001 16 Letter regarding change in certifying accountants filed as exhibit 16 to Registrants 8- K filed October 20, 2000 is incorporated herein by reference. 21 Subsidiaries of the Registrant as of February 14, 2000, filed as Exhibit 21 to Registrant's 10-K filed March 23, 2000, is incorporated herein by reference. 99 Report of Independent Public Accountants issued by Arthur Andersen LLP
26 EX-13 3 dex13.txt ANNUAL REPORT TO SHAREHOLDERS Exhibit 13 ================================================================================ Farmers & Merchants Bancorp 2001 Annual Report ================================================================================ 27 To the Shareholders: We are please to present Farmers & Merchants Bancorp's annual financial reports for 2001; another record year in the Company's 85-year history. Most key areas of financial measurement showed improvement over 2000, despite the challenging environment that arose during the year. The unfortunate and unexpected events surrounding September 11th caused the overall economy in the United States to slowdown. Agriculture further recessed due to continued soft commodity prices. In addition, the banking industry experienced a reduction in net interest margin as a result of the Federal Reserve Bank's decision to reduce the discount rate an unprecedented number of times during the year. Although it was difficult to anticipate the magnitude and impact of these events, Farmers & Merchants Bancorp still achieved record performance during 2001, because management took early action designed to grow loans outstanding, increase non-interest income, and control expenses. As a consequence, 2001 was the most profitable and successful year in Farmers & Merchants Bancorp's history. Net income after taxes totaled $12,317,000 or $17.09 per share of common stock, up 12.2% over the prior year. The growth in profits was driven by a 26% growth in non-interest income and a slight reduction in total non-interest expense over the prior year. Loans outstanding grew by 21.1% and deposits expanded by 7.2% versus 2000. Other important financial measures also showed year over year improvement. Operating leverage continued to strengthen as total revenues grew while expenses decreased. Specifically, Farmers & Merchants Bancorp improved its spread between total net revenues and total non-interest expenses by 5.3% resulting in its efficiency ratio (the amount of expense it takes to produce $1.00 of revenue) improving from 60.9% to 57.7% In addition, return on assets increased to 1.35% from 1.29% the prior year and return on equity improved by 76 basis points over 2000, to 13.14%. Several important enhancements to the company's data and operating systems were also successfully completed during 2001. The Bank's main computers were converted to state-of-the art IBM processors. In addition, the core operating software was converted to Jack Henry's Silverlake platform. A new customer service voice response unit and supporting call center were also installed providing customers with 24 hour, seven day a week transaction capability and account access. Finally, the Bank's telephones were converted to the advanced network integrated system jointly developed by Cisco and Southwestern Bell Corporation. This cutting edge technology substantially improved the quality and functionality of the Bank's telecommunications systems. In the future, your Board of Directors and management team will remain focused on increasing the Bank's market penetration, improving operating efficiency and enhancing capital management discipline. Further enhancements to the Bank's electronic delivery capability are slated for 2002. Construction of three new branch offices is also underway with grand openings planning beginning in May 2002. Several other advancements are currently being evaluated with initial implementation planned beginning in early 2003. We appreciate the Board of Director's many contributions during 2001. We wish to acknowledge their ongoing commitment and special efforts to represent the Shareholders' best interests. In addition, the many accomplishments during 2001, particularly the elaborate and extensive data and operating system conversions, would not have been possible without the extraordinary hard work and dedication of the Bank's incredible team of employees. We are extremely proud of our talented staff and extend a heartfelt `thank you' for the outstanding results they produced in 2001. Throughout the years, our shareholders have been extremely loyal to the Bank. We once again thank you for your support which contributed to the Farmers & Merchants Bancorp's success in 2001. Your continued confidence and satisfaction with your investment in Farmers & Merchants Bancorp remains of the utmost importance to us. /s/ Kent A. Steinwert /s/ Ole R. Mettler - --------------------------------------- ------------------------------- Kent A. Steinwert Ole R. Mettler President & Chief Executive Officer Chairman of the Board 28 Report of Management The management of Farmers & Merchants Bancorp (the Company) and its subsidiary has the responsibility for the preparation, integrity and reliability of the consolidated financial statements and related financial information contained in this annual report. The financial statements were prepared in accordance with generally accepted accounting principles and prevailing practices of the banking industry. Where amounts must be based on estimates and judgments, they represent the best estimates and judgments of management. Management has established and is responsible for maintaining an adequate internal control structure designed to provide reasonable, but not absolute, assurance as to the integrity and reliability of the financial statements, safeguarding of assets against loss from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. The internal control structure includes: an effective financial accounting environment; a comprehensive internal audit function; an independent audit committee of the Board of Directors; and extensive financial and operating policies and procedures. Management also recognizes its responsibility for fostering a strong ethical climate which is supported by a code of conduct, appropriate levels of management authority and responsibility, an effective corporate organizational structure and appropriate selection and training of personnel. The Board of Directors, primarily through its audit committee, oversees the adequacy of the Company's internal control structure. The audit committee, whose members are neither officers nor employees of the Company, meet periodically with management, internal auditors and internal credit examiners to review the functioning of each and to ensure that each is properly discharging its responsibilities. In addition, PricewaterhouseCoopers LLP, independent auditors, are engaged to audit the Company's financial statements. PricewaterhouseCoopers LLP, obtains and maintains an understanding of the Company's accounting and financial controls and conducts its audit in accordance with generally accepted auditing standards which includes such audit procedures as it considers necessary to express the opinion in the report that follows. Management recognizes that there are inherent limitations in the effectiveness of any internal control structure. However, management has assessed and believes that, as of December 31, 2001, the Company's internal control structure, as described above, provides reasonable assurance as to the integrity and reliability of the financial statements and related financial information. Management also is responsible for compliance with federal and state laws and regulations concerning loans to insiders and dividend restrictions designated by the FDIC as safety and soundness laws and regulations. Management assessed its compliance with the designated laws and regulations relating to safety and soundness. Based on this assessment, Management believes that the Bank complied with the designated laws and regulations relating to safety and soundness for the year ended December 31, 2001. /s/ Kent A. Steinwert /s/ John R. Olson - ---------------------------- ------------------------------ Kent A. Steinwert John R. Olson President & Executive Vice President & Chief Executive Officer Chief Financial Officer 29 [LOGO] PRICEWATERHOUSECOOPERS Pricewaterhouse LLP 331 Market Street San Francisco CA 9415-05-2119 Telephone (415) 498 5000 Facsirnilic (415) 498 7100 Report of Independent Accountants To the Board of Directors and Shareholders of Farmers & Merchants Bancorp: In our opinion, the accompanying consolidated balance sheets and the related consolidated statement of income, changes in shareholders' equity, comprehensive income and cash flows present fairly, in all material respects, the financial position of Farmers & Merchants Bancorp and its subsidiaries (the Company) at December 31, 2001 and 2000, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The financial statements of the Company as of December 31, 1999 and for the year then was audited by other independent accountants whose report dated February 4, 2000 expressed an unqualified opinion on those statements. /s/ PricewaterhouseCoopers LLP February 11, 2002 30
Consolidated Statements of Income ======================================================================================= (in thousands except per share data) Year Ended December 31, 2001 2000 1999 - --------------------------------------------------------------------------------------- Interest Income Interest and Fees on Loans $43,956 $44,171 $34,593 Interest on Federal Funds Sold and Securities Purchased Under Agreements to Resell 1,922 1,300 793 Interest on Investment Securities: Taxable 15,112 17,574 17,398 Tax-Exempt 2,540 3,082 3,271 Total Interest Income 63,530 66,127 56,055 - --------------------------------------------------------------------------------------- Interest Expense Interest on Deposits 21,038 21,845 16,500 Interest on Borrowed Funds 2,242 2,912 2,362 Total Interest Expense 23,280 24,757 18,862 - --------------------------------------------------------------------------------------- Net Interest Income 40,250 41,370 37,193 Provision for Loan Losses 1,000 2,800 1,700 Net Interest Income After Provision for Loan Losses 39,250 38,570 35,493 - --------------------------------------------------------------------------------------- Non-Interest Income Service Charges on Deposit Accounts 4,179 3,464 3,163 Net Gain (Loss) on Sale of Investment Securities 88 (120) (302) Credit Card Merchant Fees 1,207 976 783 Other 2,900 2,328 2,014 Total Non-Interest Income 8,374 6,648 5,658 - --------------------------------------------------------------------------------------- Non-Interest Expense Salaries and Employee Benefits 16,986 16,235 15,351 Occupancy Expense 1,680 1,730 1,691 Equipment Expense 2,026 1,916 2,268 Other 6,794 7,667 7,711 Total Non-Interest Expense 27,486 27,548 27,021 - --------------------------------------------------------------------------------------- Income Before Income Taxes 20,138 17,670 14,130 Provision for Income Taxes 7,821 6,650 4,914 - --------------------------------------------------------------------------------------- Net Income $12,317 $11,020 $ 9,216 ======================================================================================= Earnings Per Share $ 17.09 $ 15.23 $ 12.65 =======================================================================================
The accompanying notes are an integral part of these consolidated financial statements 31
Consolidated Balance Sheets - ------------------------------------------------------------------------------------------------------- (in thousands except per share data) December 31, Assets 2001 2000 - ------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents: Cash and Due from Banks $ 32,406 $ 33,290 Federal Funds Sold and Securities Purchased Under Agreements to Resell 31,100 41,000 Total Cash and Cash Equivalents 63,506 74,290 - ------------------------------------------------------------------------------------------------------- Investment Securities: Available-for-Sale 242,852 279,386 Held-to-Maturity 32,698 41,268 Total Investment Securities 275,550 320,654 - ------------------------------------------------------------------------------------------------------- Loans: 602,169 497,397 Less: Allowance for Loan Losses 12,709 11,876 Loans, Net 589,460 485,521 - ------------------------------------------------------------------------------------------------------- Premises and Equipment, Net 11,432 11,556 Interest Receivable and Other Assets 30,935 13,530 Total Assets $970,883 $905,551 ======================================================================================================= Liabilities Deposits: Demand $198,316 $183,779 Interest-Bearing Transaction Accounts 100,574 81,271 Savings 198,651 175,140 Time 322,170 324,488 Total Deposits 819,711 764,678 - ------------------------------------------------------------------------------------------------------- Federal Home Loan Bank Advances 41,000 41,033 Interest Payable and Other Liabilities 9,436 8,957 Total Liabilities 870,147 814,668 - ------------------------------------------------------------------------------------------------------- Shareholders' Equity Preferred Stock: No Par Value. 1,000,000 Authorized, None Issued or Outstanding -- -- Common Stock: Par Value $0.01, 2,000,000 Shares Authorized, 719,269 and 687,491 Issued and Outstanding at December 31, 2001 and 2000, Respectively 7 7 Additional Paid-In Capital 61,360 53,559 Retained Earnings 36,499 36,527 Accumulated Other Comprehensive Income (Loss) 2,870 790 Total Shareholders' Equity 100,736 90,883 - ------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $970,883 $905,551 =======================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 32
Consolidated Statements of Changes in Shareholders' Equity - ---------------------------------------------------------------------------------------------------------------------- (in thousands except per share data) Accumulated Common Additional Other Total Shares Common Paid-In Retained Comprehensive Shareholders' Outstanding Stock Capital Earnings Income(Loss) Equity Balance, December 31, 1998 632,185 $ 6 $43,576 $ 34,991 $ 832 $ 79,405 - ---------------------------------------------------------------------------------------------------------------------- Net Income 9,216 9,216 Cash Dividends Declared on Common Stock (3,273) (3,273) 5% Stock Dividend 31,110 1 4,821 (4,822) Cash Paid in Lieu of Fractional Shares Related to Stock Dividend (72) (72) Redemption of Stock (2,306) (404) (404) Change in Net Unrealized Gain (Loss) on Securities Available-for-Sale (4,671) (4,671) Balance, December 31, 1999 660,989 $ 7 $47,993 $ 36,040 $(3,839) $ 80,201 - ---------------------------------------------------------------------------------------------------------------------- Net Income 11,020 11,020 Cash Dividends Declared on Common Stock (3,609) (3,609) 5% Stock Dividend 32,496 6,824 (6,824) Cash Paid in Lieu of Fractional Shares Related to Stock Dividend (100) (100) Redemption of Stock (5,994) (1,258) (1,258) Change in Net Unrealized Gain (Loss) on Securities Available-for-Sale 4,629 4,629 Balance, December 31, 2000 687,491 $ 7 $53,559 $ 36,527 $ 790 $ 90,883 - ---------------------------------------------------------------------------------------------------------------------- Net Income 12,317 12,317 Cash Dividends Declared on Common Stock (3,923) (3,923) 5% Stock Dividend 33,831 8,289 (8,289) Cash Paid in Lieu of Fractional Shares Related to Stock Dividend (133) (133) Redemption of Stock (2,053) (488) (488) Change in Net Unrealized Gain (Loss) on Securities Available-for-Sale 2,080 2,080 Balance, December 31, 2001 719,269 $ 7 $61,360 $ 36,499 $ 2,870 $ 100,736 ======================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 33 Consolidated Statements of Comprehensive Income - -------------------------------------------------------------------------------- (in thousands)
Year Ended December 31, 2001 2000 1999 - --------------------------------------------------------------------------------------------------------- Net Income $12,317 $11,020 $ 9,216 Other Comprehensive Income (Loss) Unrealized Gains (Losses) on Securities: Unrealized holding gains (losses) arising during the period, net of income tax effects of $1,492, $3,188 and $(3,386) for the years ended December 31, 2001, 2000 and 1999, respectively. 2,131 4,558 (4,841) Less: Reclassification adjustment for realized (gains) losses included in net income, net of related income tax effects of $(37), $49 and $119 for the years ended December 31, 2001, 2000 and 1999, respectively. (51) 71 170 - --------------------------------------------------------------------------------------------------------- Total Other Comprehensive Income (Loss) 2,080 4,629 (4,671) - --------------------------------------------------------------------------------------------------------- Comprehensive Income $14,397 $15,649 $ 4,545 =========================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 34 Consolidated Statements of Cash Flows - -------------------------------------------------------------------------------- (in thousands)
Year Ended December 31, 2001 2000 1999 - ------------------------------------------------------------------------------------------------------ Operating Activities Net Income $ 12,317 $ 11,020 $ 9,216 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Loan Losses 1,000 2,800 1,700 Depreciation and Amortization 1,592 1,760 1,770 Provision for Deferred Income Taxes (38) (730) (457) Net Amortization of Investment Security Premium & Discounts (314) (435) 674 Net (Gain) Loss on Sale of Investment Securities (88) 120 302 Trading Securities: Purchased -- -- (15,490) Sold or Matured -- -- 15,478 Net (Increase) Decrease in Interest Receivable and Other Assets (18,307) (1,325) 3,338 Net Increase in Interest Payable and Other Liabilities 479 (4,516) 4,559 Net Cash Provided by (Used in) Operating Activities (3,359) 8,694 21,090 - ------------------------------------------------------------------------------------------------------ Investing Activities Securities Available-for-Sale: Purchased (26,704) (42,873) (171,788) Sold or Matured 66,548 69,161 177,675 Securities Held-to-Maturity: Purchased (6,460) (398) (2,114) Matured 15,142 8,493 12,927 Net Increase in Loans (105,526) (84,916) (85,540) Principal Collected on Loans Previously Charged Off 587 217 807 Net Additions to Premises and Equipment (1,468) (609) (2,763) Net Cash Used for Investing Activities (57,881) (50,925) (70,796) - ------------------------------------------------------------------------------------------------------ Financing Activities Net Increase in Demand, Interest-Bearing Transaction, and Savings Accounts 57,351 10,735 30,189 Net Increase in Time Deposits (2,318) 68,800 27,567 Net Increase (Decrease) in Federal Funds Purchased -- -- (2,000) Net Increase (Decrease) in Federal Home Loan Bank Advances (33) (31) (29) Stock Redemption (488) (1,258) (404) Cash Dividends (4,056) (3,709) (3,345) - ------------------------------------------------------------------------------------------------------ Net Cash Provided by Financing Activities 50,456 74,537 51,978 Increase (Decrease) in Cash and Cash Equivalents (10,784) 32,306 2,272 Cash and Cash Equivalents at Beginning of Year 74,290 41,984 39,712 Cash and Cash Equivalents at End of Year $63,506 $74,290 $41,984 ====================================================================================================== Supplementary Data Cash Payments made for Income Taxes $ 8,125 $ 8,100 $ 4,520 Interest Paid $22,995 $24,139 $18,743 ======================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 35 Notes to Consolidated Financial Statements 1. Significant Accounting Policies Farmers & Merchants Bancorp (the Company) was organized April 30, 1999. Its' primary operations are related to traditional banking activities through its subsidiary Farmers & Merchants Bank of Central California (the Bank). The consolidated financial statements of the Company and its subsidiary, the Bank, are prepared in conformity with generally accepted accounting principles and prevailing practices within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect reported amounts as of the date of the balance sheet and revenues and expenses for the period. These estimates are based on information available as of the date of the financial statements. Therefore, actual results could differ from those estimates. The following is a summary of the significant accounting and reporting policies used in preparing the consolidated financial statements. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and the Company's wholly owned subsidiary, the Bank, along with the Bank's wholly owned subsidiaries, Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. The investment in the Bank is carried at the Company's equity in the underlying net assets. Significant intercompany transactions have been eliminated in consolidation. Farmers & Merchants Investment Corporation has been dormant since 1991. Farmers/Merchants Corp. acts as trustee on deeds of trust originated by the Bank. Certain amounts in the prior years' financial statements have been reclassified to conform with the current presentation. These reclassifications have no effect on previously reported income. Information in this report dated prior to April 30, 1999 is for Farmers & Merchants Bank of Central California. Cash and Cash Equivalents For purposes of the Consolidated Statements of Cash Flows, the Company has defined cash and cash equivalents as those amounts included in the balance sheet captions Cash and Due from Banks and Federal Funds Sold and Securities Purchased Under Agreements to Resell. Generally, these transactions are for one-day periods. For these instruments, the carrying amount is a reasonable estimate of fair value. Investment Securities Investment securities are classified at the time of purchase as held-to-maturity if it is management's intent and the Bank has the ability to hold the securities until maturity. These securities are carried at cost, adjusted for amortization of premium and accretion of discount using a methodology which approximates a level yield of interest over the estimated remaining period until maturity. Losses, reflecting a decline in value judged by the Bank to be other than temporary, are recognized in the period in which they become known. Securities are classified as available-for-sale if it is management's intent, at the time of purchase, to hold the securities for an indefinite period of time and/or to use the securities as part of the Company's asset/liability management strategy. Securities classified as available-for-sale include securities which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders' equity, net of related income taxes. Fair values are based on quoted market prices or broker/dealer price quotations on a specific identification basis. Gains or losses on the sale of these securities are computed using the specific identification method. Unrealized losses on these securities, reflecting a decline in value judged by the Company to be other than temporary, are recognized in the period in which they become known. Trading securities, if any, are acquired for short-term appreciation and are recorded in a trading portfolio and are carried at fair value, with unrealized gains and losses recorded in non-interest income. Loans Loans are reported at the principal amount outstanding net of unearned discounts and deferred loan fees. Interest income on loans is accrued daily on the outstanding balances using the simple interest method. Loan origination fees are deferred and recognized over the contractual life of the loan as an adjustment to the yield. Loans are placed on a non-accrual status when the collection of principal or interest is in doubt or when they become past due for 90 days or more unless they are both well-secured and in the process of collection. For this purpose a loan is considered well-secured if it is collateralized by property having a net realizable value in excess of the amount of the loan or is guaranteed by a financially capable 36 party. When a loan is placed on non-accrual status, the accrued and unpaid interest receivable is reversed and charged against current income, thereafter, interest income is recognized only as it is collected in cash. Loans placed on a non-accrual status are returned to accrual status when the loans are paid current as to principal and interest and future payments are expected to be made in accordance with the contractual terms of the loan. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is impaired, the recorded amount of the loan in the Consolidated Balance Sheets is based on the present value of expected future cash flows discounted at the loan's effective interest rate or on the observable or estimated market price of the loan or the fair value of the collateral if the loan is collateral dependent. Impaired loans are placed on a non-accrual status with income reported accordingly. Cash payments are first applied as a reduction of the principal balance until collection of the remaining principal and interest can be reasonably assured. Allowance for Loan Losses As a financial institution which assumes lending and credit risks as a principal element in its business, the Company anticipates that credit losses will be experienced in the normal course of business. Accordingly, the allowance for loan losses is maintained at a level considered adequate by management to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Management reviews the credit quality of the loan portfolio on a quarterly basis and considers problem loans, delinquencies, internal credit reviews, current economic conditions, loan loss experience and other factors in determining the adequacy of the allowance balance. The Company's methodology for assessing the adequacy of the allowance consists of several key elements, which include the formula allowance, specific allowances and the unallocated allowance. The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments. Loss factors are based on the Company's historical loss experience and may be adjusted for significant factors that, in management's judgement, affect the collectibility of the portfolio as of the evaluation date. The Company derives the loss factors for loans from a loss migration model and the historical average net charge-offs during a business cycle. Specific allowances are established in cases where management has identified conditions or circumstances related to a credit that management believes indicate the probability a loss has been incurred in excess of the amount determined by the application of the formula allowance. The unallocated allowance is composed of attribution factors, which are based upon management's evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions evaluated in connection with the unallocated allowance may include existing general economic and business conditions affection the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentration, seasoning of the loan portfolio, specific industry conditions, recent loss experience, duration of the current business cycle, bank regulatory examination results and findings of the Company's internal credit examiners. The allowance also incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures". These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans, which are discussed more fully in Note 4. While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. Management has allocated specific reserves to various loan categories. Nevertheless, the allowance is general in nature and is available for the loan portfolio as a whole. Premises and Equipment Premises, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is computed principally by the straight line method over the estimated useful lives of the assets. Estimated useful lives of buildings range from 30 to 40 years, and for furniture and equipment from 3 to 8 years. Leasehold improvements are amortized over the lesser of the terms of the respective leases, or their useful lives, which are generally 37 5 to 10 years. Remodeling and capital improvements are capitalized while maintenance and repairs are charged directly to occupancy expense. Other Real Estate Other real estate owned, which is included in other assets, is comprised of properties acquired through foreclosures in satisfaction of indebtedness. These properties are carried at the lower of the recorded loan balance or their estimated net realizable value based on current appraisals. Initial losses on properties acquired through full or partial satisfaction of debt are treated as credit losses and charged to the Allowance for Loan Losses at the time of acquisition. Subsequent declines in value from the recorded amounts, routine holding costs, and gains or losses upon disposition, if any, are included in non-interest income or expense as incurred. Income Taxes As required, the Company uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year. Earnings Per Share Earnings per share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. Prior years have been restated for the 5% stock dividend paid in each of the years presented. Segment Reporting The Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. The Company is a community bank which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, the Company is not organized around discernable lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change. Thus, all necessary requirements of SFAS No. 131 have been met by the Company as of December 31, 2001. Derivative Instruments and Hedging Activities The Statement of Financial Accounting Standards, No. 133, "Accounting for Derivative Instruments and Certain Hedging Activities" as amended by the Statement of Financial Accounting Standards, No. 138, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivative, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. Changes in the fair values of those derivatives are accounted for depending on the intended use of the derivative and the resulting designation under specified criteria. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of the changes in the fair value of the derivative are recorded in other comprehensive income and are recognized income statement when the hedged items affect earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. As required, SFAS No. 133 was adopted by the Company effective January 1, 2001. The Company utilizes derivative financial instruments such as interest rate caps, floors, swaps and collars. These instruments are purchased and/or sold to reduce the Company's exposure to changing interest rates. The Company marks to market the value of its derivative financial instruments and reflects gain or loss in earnings in the period of change. Comprehensive Income The Statement of Financial Accounting Standards, "Reporting Comprehensive Income" establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Other comprehensive income refers to revenues, expenses, gains and losses that generally accepted accounting principles recognize as changes in value to an enterprise but are excluded from net income. For the Company, comprehensive income includes net income (loss) and changes in fair value of its available-for-sale investment securities. 38 2. Securities Purchased Under Agreements to Resell The Company enters into purchases and sales of securities under agreements to resell substantially identical securities. These types of security transactions are generally for one day periods and are primarily whole loan securities rated AA or better. During 2001 and 2000, the underlying securities purchased under resale agreements were delivered into the Bank's account at a third-party custodian that recognizes the Company's rights and interest in these securities. 3. Investment Securities The amortized cost, fair values and unrealized gains and losses of the securities available-for-sale are as follows: (in thousands)
Amortized Gross Unrealized Fair/Book ---------------- December 31, 2001 Cost Gains Losses Value - -------------------------------------------------------------------------------------------- Securities of U.S. Government Agencies $ 12,588 $ 183 $ -- $ 12,771 Obligations of States and Political Subdivisions 23,906 238 68 24,076 Mortgage-Backed Securities 191,994 4,423 33 196,384 Other 9,487 140 6 9,621 - -------------------------------------------------------------------------------------------- Total $237,975 $4,984 $107 $242,852 ============================================================================================ December 31, 2000 - -------------------------------------------------------------------------------------------- U.S. Treasury Securities $ 5,037 $ 10 $ -- $ 5,047 Securities of U.S. Government Agencies 7,108 -- 18 7,090 Obligations of States and Political Subdivisions 24,184 97 306 23,975 Mortgage-Backed Securities 236,173 1,921 360 237,734 Other 5,540 -- -- 5,540 - -------------------------------------------------------------------------------------------- Total $278,042 $2,028 $684 $279,386 ============================================================================================
The book values, estimated fair values, and unrealized gains and losses of investments classified as held-to-maturity are as follows: (in thousands)
Book Gross Unrealized Fair ---------------- December 31, 2001 Value Gains Losses Value - ---------------------------------------------------------------------------------------- Obligations of States and Political Subdivisions $32,137 $825 $13 $32,949 Other 561 36 597 - ---------------------------------------------------------------------------------------- Total $32,698 $861 $13 $33,546 ======================================================================================== December 31, 2000 - ---------------------------------------------------------------------------------------- Securities of U.S. Government Agencies $ 1,999 $ -- $ 2 $ 1,997 Obligations of States and Political Subdivisions 38,585 537 18 39,104 Other 684 48 -- 732 - ---------------------------------------------------------------------------------------- Total $41,268 $585 $20 $41,833 ========================================================================================
Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. 39 The remaining principal maturities of debt securities as of December 31, 2001 and 2000 are shown below. Expected maturities may differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
After 1 After 5 Total Securities Available-for-Sale Within but but Over Fair December 31, 2001 (in thousands) 1 Year Within 5 Within 10 10 years Value - ------------------------------------------------------------------------------------------------------- Securities of U.S. Government Agencies $12,771 $ -- $ -- $ -- $ 12,771 Obligations of States and Political Subdivisions 995 13,529 8,567 985 24,076 Mortgage-Backed Securities 60,266 136,118 -- -- 196,384 Other 4,463 5,158 -- -- 9,621 - ------------------------------------------------------------------------------------------------------- Total $78,495 $154,805 $ 8,567 $ 985 $242,852 ======================================================================================================= 2000 Totals $55,597 $192,199 $29,616 $1,974 $279,386 =======================================================================================================
After 1 After 5 Total Securities Held-to-Maturity Within but but Over Book December 31, 2001 (in thousands) 1 Year Within 5 Within 10 10 years Value - ------------------------------------------------------------------------------------------------------- Obligations of States and Political Subdivisions $ 4,510 $20,566 $3,365 $3,696 $32,137 Other -- -- -- 561 561 - ------------------------------------------------------------------------------------------------------- Total $ 4,510 $20,566 $3,365 $4,257 $32,698 ======================================================================================================= 2000 Totals $15,091 $20,534 $4,959 $ 684 $41,268 =======================================================================================================
Proceeds from sales of securities available-for-sale were as follows: (in thousands) Gross Gross Gross Proceeds Gains Losses - -------------------------------------------------------------------------------- 2001 $ 5,206 $ 88 $ -- 2000 $21,744 $506 $199 1999 $54,231 $285 $118 As of December 31, 2001, securities carried at $154,166,000 were pledged to secure public and other deposits as required by law. 4. Loans and Allowance for Loan Losses Loans as of December 31, consisted of the following: (in thousands) 2001 2000 - ------------------------------------------------------------------------------- Real Estate $304,451 $261,910 Real Estate Construction 49,692 28,354 Commercial 227,909 182,611 Consumer 21,133 24,855 - ------------------------------------------------------------------------------- 603,185 497,730 Less: Unearned Income on Loans (1,016) (333) - ------------------------------------------------------------------------------- Total Loans $602,169 $497,397 =============================================================================== Non-Accrual Loans $ 2,353 $ 1,472 =============================================================================== 40 Changes in the allowance for loan losses consisted of the following: (in thousands) 2001 2000 1999 - ------------------------------------------------------------------------------- Balance, January 1 $11,876 $ 9,787 $ 8,589 Provision Charged to Operating Expense 1,000 2,800 1,700 Recoveries of Loans Previously Charged Off 587 218 807 Loans Charged Off (754) (929) (1,309) - -------------------------------------------------------------------------------- Balance, December 31 $12,709 $11,876 $ 9,787 =============================================================================== A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is impaired, the recorded amount of the loan in the Consolidated Balance Sheets is based on the present value of expected future cash flows discounted at the loan's effective interest rate or on the observable or estimated market price of the loan or the fair value of the collateral if the loan is collateral dependent. All impaired loans have been assigned a related allowance for credit losses. As of December 31, 2001 and 2000 the total recorded investment in impaired loans was $2,353,000 and $1,472,000, respectively. The related allowance for loan losses was $190,000 and $257,000 for the years ended 2001 and 2000, respectively. For income reporting purposes, impaired loans are placed on a non-accrual status and are more fully discussed in Note 1. Cash payments are first applied as a reduction of the loan's principal balance until collection of the remaining principal and interest can be reasonably assured. Thereafter, interest income is recognized as it is collected in cash. The average balance of impaired loans was $1.1 million, $2.3million and $3.4 million for the years ended 2001, 2000 and 1999 respectively. There was no interest income reported on impaired loans in 2001 and 2000. Interest income forgone on loans placed on nonaccrual status was $26,000, $71,000 and $48,000 for the years ended December 31, 2001, 2000 and 1999 respectively. 5. Premises and Equipment Premises and equipment as of December 31, consisted of the following: (in thousands) 2001 2000 - -------------------------------------------------------------------------------- Land and Buildings $15,830 $15,723 Furniture, Fixtures and Equipment 14,429 13,180 Leasehold Improvements 835 835 - -------------------------------------------------------------------------------- 31,094 29,738 Less: Accumulated Depreciation and Amortization 19,662 18,182 - -------------------------------------------------------------------------------- Total $11,432 $11,556 ================================================================================ Depreciation and amortization on premises and equipment included in occupancy and equipment expense amounted to $1,592,000, $1,760,000 and $1,770,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Total rental expense for premises were $212,000, $207,000 and $240,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Rental income was $70,000, $81,000 and $81,000 for the years ended December 31, 2001, 2000 and 1999, respectively. 6. Other Real Estate Other real estate, included in interest receivable and other assets, totaled none and $89,000 at December 31, 2001and 2000, respectively. Other real estate includes property no longer utilized for business operations and property acquired through foreclosure proceedings. These properties are carried at the lower of cost or estimated net realizable value determined at the date acquired. Losses arising from the acquisition of these properties are charged against the allowance for loan losses. Subsequent declines in value, routine holding costs and net gains or losses on disposition are included in other operating expense as incurred. 41 7. Time Deposits Time Deposits of $100,000 or more were as follows: (in thousands) December 31, 2001 2000 - ------------------------------------------------------------------------------- Balance $146,432 $135,757 =============================================================================== At December 31, 2001, the scheduled maturities of time deposits were as follows: (in thousands) Scheduled Maturities - -------------------------------------------------------------------------------- 2002 $280,004 2003 22,859 2004 9,125 2005 -- 2006 and thereafter 10,182 - ------------------------------------------------------------------------------- Total $322,170 =============================================================================== 8. Income Taxes Current and deferred income tax expense (benefit) provided for the years ended December 31, consisted of the following: (in thousands) 2001 2000 1999 - ----------------------------------------------------------------------- Current Federal $5,673 $5,229 $3,764 State 2,186 2,151 1,607 - ----------------------------------------------------------------------- Total Current 7,859 7,380 5,371 - ----------------------------------------------------------------------- Deferred Federal (33) (493) (383) State ( 5) (237) ( 74) - ----------------------------------------------------------------------- Total Deferred (38) (730) (457) - ----------------------------------------------------------------------- Total Provision for Taxes $7,821 $6,650 $4,914 ======================================================================= The total provision for income taxes differs from the federal statutory rate as follows: (dollars in thousands)
2001 2000 1999 Amount Rate Amount Rate Amount Rate - ------------------------------------------------------------------------------------------- Tax Provision at Federal Statutory Rate $7,048 35.0% $6,185 35.0% $4,804 34.0% Interest on Obligations of States and Political Subdivisions Exempt from Federal Taxation (658) (3.3)% (740) (4.2)% (1,008) (7.1)% State and Local Income Taxes, Net of Federal Income Tax Benefit 1,418 7.0% 1,263 7.2% 1,012 7.2% Other, Net 13 0.1% (58) (0.4)% 106 0.7% - ------------------------------------------------------------------------------------------- Total Provision for Taxes $7,821 38.8% $6,650 37.6% $4,914 34.8% ===========================================================================================
42 The components of the net deferred tax assets as of December 31, are as follows: (in thousands) 2001 2000 - ------------------------------------------------------------------------------- Deferred Tax Assets Allowance for Loan Losses $5,084 $4,739 Accrued Liabilities 892 1,158 Deferred Compensation 999 827 Other Real Estate 309 309 State Franchise Tax 765 753 Interest on Non-Accrual Loans 11 85 - ------------------------------------------------------------------------------- Total Deferred Tax Assets 8,060 7,871 - ------------------------------------------------------------------------------- Deferred Tax Liabilities Depreciation (229) (320) Unrealized Gain on Securities Available-for-Sale (2,051) (565) Securities Accretion (1,039) (860) Other (425) (362) - ------------------------------------------------------------------------------- Total Deferred Tax Liabilities (3,744) (2,107) - ------------------------------------------------------------------------------- Net Deferred Tax Assets $4,316 $5,764 =============================================================================== The net deferred tax assets are reported in Interest Receivable and Other Assets on the Company's Consolidated Balance Sheets. Prior year amounts have been restated to conform with the tax return as filed. 9. Short Term Borrowings As of December 31, 2001 and 2000, the Company had unused lines of credit available for short term liquidity purposes of $136 million. Federal Funds purchased and advances from the Federal Reserve Bank are generally issued on an overnight basis. 10. Federal Home Loan Bank Advances The Company's Advances from the Federal Home Loan Bank of San Francisco consist of the following as of December 31,
(in thousands) 2001 2000 - --------------------------------------------------------------------------------------------------------------------------------- 5.35% note payable due February 4, 2008 with interest due quarterly, callable February 2, 2003 and quarterly $25,000 $25,000 thereafter. 5.38% note payable due August 12, 2008 with interest due quarterly, callable August 12, 2003 and quarterly 15,000 15,000 thereafter. 5.60% amortizing note, interest and principal payable monthly with final maturity of September 25, 2018. 1,000 1,033 - --------------------------------------------------------------------------------------------------------------------------------- Total $41,000 $41,033 =================================================================================================================================
In accordance with the Collateral Pledge and Security Agreement, advances are secured by all Federal Home Loan Bank stock held by the company and by agency and mortgage-backed securities, classified as available-for-sale, with carrying values of $52,682,000. 11. Shareholders' Equity Beginning in 1975 and continuing through 2001, the Company has issued an annual 5% stock dividend. Earnings per share amounts have been restated for each year presented to reflect the stock dividend. Dividends from the Bank constitute the principal source of cash to the Company. The Company is a legal entity separate and distinct from the Bank. Under regulations controlling California state chartered banks, the Bank is, to some extent, limited in the amount of dividends that can be paid to shareholders without prior approval of the State Department of Financial Institutions. These regulations require approval if total dividends declared by a state chartered bank in any calendar year exceed the bank's net profits for that year combined with its retained net profits for the preceding two calendar years. As of December 31, 2001, the Bank could declare dividends of $13,285,000 43 without approval of the California State Banking Department. These regulations apply to all California state chartered banks. The Accumulated Other Comprehensive Income is the result of the accounting standard, Reporting Comprehensive Income. This accounting principle requires securities classified as available-for-sale be reported at their fair values. Unrealized gains and losses are reported on a net-of-tax basis as a component of Shareholders' Equity. The Company and the Bank are subject to various regulatory capital requirements administered by the Federal Reserve Bank of San Francisco and the Federal Deposit Insurance Corporation. These guidelines are designed to make capital requirements more sensitive to differences in risk related assets among banking organizations, to take into account off-balance sheet exposures and aid in making the definition of banking capital uniform. Bank assets and off-balance sheet items are categorized by risk. The results of these regulations are that assets with a higher degree of risk require a larger amount of capital; assets, such as cash, with a low degree of risk have little or no capital requirements. Failure to meet these minimum capital requirements can initiate certain disciplinary actions by regulators. As of December 31, 2001 and 2000, the Company and the Bank meet all capital adequacy requirements to which they are subject. The following table illustrates the relationship between the Bank's regulatory capital requirements and the Bank's capital position.
Well Capitalized Regulatory Capital Under Prompt (in thousands) Actual Requirements Corrective Action December 31, 2001 Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------- Total Bank Capital to Risk Weighted Assets $100,842 12.93% $62,391 8.0% $77,988 10.0% Total Consolidated Capital to Risk Weighted Assets $107,591 13.76% $62,543 8.0% N/A N/A Tier I Bank Capital to Risk Weighted Assets $ 91,104 11.68% $31,195 4.0% $46,793 6.0% Tier I Consolidated Capital to Risk Weighted Assets $ 97,829 12.51% $31,271 4.0% N/A N/A Tier I Bank Capital to Average Assets $ 91,104 9.57% $38,077 4.0% $47,596 5.0% Tier I Consolidated Capital to Average Assets $ 97,829 10.25% $38,159 4.0% N/A N/A
December 31, 2000 Amount Ratio Amount Ratio Amount Ratio - ---------------------------------------------------------------------------------------------------------------- Total Bank Capital to Risk Weighted Assets $ 96,150 15.22% $50,548 8.0% $63,185 10.0% Total Consolidated Capital to Risk Weighted Assets $ 97,419 15.41% $50,582 8.0% N/A N/A Tier I Bank Capital to Risk Weighted Assets $ 88,203 13.96% $25,274 4.0% $37,911 6.0% Tier I Consolidated Capital to Risk Weighted Assets $ 90,092 14.25% $25,291 4.0% N/A N/A Tier I Bank Capital to Average Assets $ 88,203 10.00% $35,268 4.0% $44,085 5.0% Tier I Consolidated Capital to Average Assets $ 90,092 10.21% $35,285 4.0% N/A N/A
12. Employee Benefit Plans The Company, through the Bank, sponsors a defined benefit pension plan (the Plan) that covers employees of Farmers & Merchants Bank of Central California. Effective June 9, 2001 the Plan was amended to freeze the benefit accruals in the Plan. With the exception of employees who have reached age 55 and who have accumulated 10 years of Plan service, the effect of the amendment will be to freeze the participants' monthly pension benefit. Employees who have reached age 55 and have accumulated 10 years of Plan service as of December 31, 2000 will continue to accrue benefits under the Plan. The Plan provides benefits, up to a maximum stated in the plan, based on each covered employee's years of service and highest five-year average compensation earned while a participant in the Plan. Plan benefits are fully vested after five years of Plan service. The Company's funding policy is to contribute annually an amount that is not less than the ERISA minimum funding requirement and not in excess of the maximum tax-deductible contribution as developed in accordance with the aggregate cost method. 44 The following schedule states the change in benefit obligations for the years ended December 31: (in thousands) 2001 2000 - ----------------------------------------------------------------------------- Benefit Obligation at Beginning of Year $ 6,033 $ 5,263 Service Cost 247 572 Reduction due to Census Gain (597) -- Reduction due to Curtailment (1,749) -- Interest Cost 285 404 Benefits Paid (717) (704) Actuarial Loss -- 498 - ----------------------------------------------------------------------------- Total Benefit Obligation at End of Year $ 3,502 $ 6,033 ============================================================================= The Change in Plan Assets are as follows: (in thousands) 2001 2000 - ----------------------------------------------------------------------------- Fair Value of Plan Assets at Beginning of Year $ 5,346 $ 5,505 Employer Contribution 40 701 Benefits Paid (717) (704) Actual Return on Plan Assets (225) (156) - ----------------------------------------------------------------------------- Total Fair Value of Plan Assets at End of Year $ 4,444 $ 5,346 ============================================================================= The following table sets forth the Plan's funded status along with amounts recognized and not recognized in the Bank's Consolidated Balance Sheets for the years ended December 31: (in thousands) 2001 2000 - ---------------------------------------------------------------------- Benefit Obligation $ 3,502 $ 6,033 Fair Value of Plan Assets 4,444 5,346 - ---------------------------------------------------------------------- Funded Status 942 (687) Unrecognized Net Asset at Transition -- (85) Unrecognized Prior Service Cost (2) (63) Unrecognized Net Loss 20 1,561 - ---------------------------------------------------------------------- Net Amounts Recognized $ 960 $ 726 ====================================================================== Amounts Recognized: - ---------------------------------------------------------------------- Prepaid Benefit Cost $ 960 $ 726 Accrued Benefit Liability -- -- Intangible Asset -- -- - ---------------------------------------------------------------------- Net Amounts Recognized $ 960 $ 726 ====================================================================== The components of the net periodic benefit costs are as follows: (in thousands) 2001 2000 1999 - -------------------------------------------------------------------------- Service Cost $ 247 $ 572 $ 536 Interest Cost 284 404 360 Expected Return on Plan Assets (414) (473) (426) Amortization of Unrecognized Net Asset at Transition (11) (28) (28) Unrecognized Prior Service Cost (3) (7) (7) Unrecognized Net Loss 23 57 96 - -------------------------------------------------------------------------- Total Net Periodic Benefit Cost $ 126 $ 525 $ 531 ========================================================================== Assumptions Used in the Accounting were: Discount Rate (Settlement Rate) 7.25% 7.25% 7.50% Rate of Increase in Salary Levels 4.00% 4.00% 4.00% Expected Return on Assets 9.00% 9.00% 9.00% ========================================================================== 45 Substantially all full-time employees of the Bank with one or more years of service also participate in a defined contribution profit sharing plan and a money purchase plan. Contributions to the profit sharing plan are made at the discretion of the Board of Directors and the Board can terminate the plan at any time. The Bank contributed $545,000, $515,000 and $485,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The employees are permitted, within limitations imposed by tax law, to make pretax contributions to the 401(k) feature of the profit sharing plan. The Bank does not match employee contributions within the 401(k) feature of the profit sharing plan. The money purchase plan was established January 1, 2001 to replace the defined benefit pension plan that was frozen effective June 9, 2001. Substantially all full-time employees of the Bank participate in the money purchase plan, with the exception of employees who have reached age 55 and who have accumulated 10 years of service and are continuing to accrue benefits in the defined benefit pension plan. Contributions to the money purchase plan are made according to a predetermined set of criteria. The Board can terminate the plan at any time. The Bank contributed $491,000, for the year ended December 31, 2001 The Bank sponsors a Deferred Bonus Plan for certain employees. Deferred bonuses are granted and benefits accumulate based on the cumulative profits during the employee's participation period. The Bank contributed $175,000, $132,000 and $111,000 for the years ended December 31, 2001, 2000 and 1999 respectively. 13. Fair Value of Financial Instruments The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosure about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization. The following table summarized the book value and estimated fair value of financial instruments as of December 31:
- ------------------------------------------------------------------------------------------ 2001 2000 Carrying Estimated Carrying Estimated ASSETS: (in thousands) Amount Fair Value Amount Fair Value - ------------------------------------------------------------------------------------------ Cash and Cash Equivalents $ 63,506 $ 63,506 $ 74,290 $ 74,290 Investment Securities Held-to-Maturity 32,698 33,546 41,268 41,833 Investment Securities Available-for-Sale 242,852 242,852 279,386 279,386 Loans, Net of Unearned Income 602,169 598,817 497,397 500,036 Less: Allowance for Loan Losses 12,709 12,709 11,876 11,876 Loans, Net of Allowance 589,460 586,109 485,521 488,160 LIABILITIES: Deposits: Noninterest-bearing 198,316 198,316 183,779 183,779 Interest-bearing 621,395 597,098 580,889 581,603 Federal Home Loan Bank Advances 41,000 41,241 41,033 41,397
The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value are explained below: Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and due from bank and federal funds sold are a reasonable estimate of fair value. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. 46 Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Commitments to extend credit and standby letters of credit: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. Deposit liabilities: The fair value of demand deposits, interest bearing transaction accounts and savings accounts is the amount payable on demand as of December 31. The fair value of fixed-maturity certificates of deposit is estimated by discounting expected future cash flows utilizing interest rates currently being offered for deposits of similar remaining maturities. Borrowings: The fair value of federal funds purchased and other short-term borrowings is approximated by the book value. The fair value for Federal Home Loan Bank borrowings is determined using discounted future cash flows. Limitations: Fair value estimates presented herein are based on pertinent information available to management as of December 31, 2001 and 2000. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented above. 14. Commitments and Contingencies In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These instruments include commitments to extend credit, letters of credit and financial guarantees that are not reflected in the Consolidated Balance Sheets. The Company's exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments and financial guarantees is represented by the contractual notional amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each customer's creditworthiness are performed on a case-by-case basis. Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third party. The Company had standby letters of credit outstanding of $6,163,000 at December 31, 2001, and $5,054,000 at December 31, 2000. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition contained in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Undisbursed loan commitments totaled $245,699,000 and $164,698,000 as of December 31, 2001 and 2000, respectively. Since many of these commitments are expected to expire without fully being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company does not anticipate any loss as a result of these transactions. The Company is obligated under a number of noncancellable operating leases for premises and equipment used for banking purposes. Minimum future rental commitments under noncancellable operating leases as of December 31, 2001 were $128,000, $125,000, $125,000, $125,000, and $96,000 for the years 2002 to 2006 and $139,000 thereafter. 47 In the ordinary course of business, the Company becomes involved in litigation arising out of its normal business activities. Management, after consultation with legal counsel, is of the opinion that the ultimate liability, if any, resulting from the disposition of such claims would not be material in relation to the financial position of the Company. The Company may be required to maintain average reserves on deposit with the Federal Reserve Bank primarily based on deposits outstanding. There were no reserve requirements during 2001 or at December 31, 2001 and 2000. 15. Transactions with Related Parties The Company, in the ordinary course of business, has had, and expects to have in the future, deposit and loan transactions with Directors, executive officers and their affiliated companies. These transactions were on substantially the same terms, including interest rates, as those prevailing at the time for comparable transactions with unaffiliated parties and do not involve more than normal credit risk or other unfavorable features. Loan transactions with Directors, executive officers and their affiliated companies during the year ended December 31, 2001, were as follows: (in thousands) - --------------------------------------------------------------- Loan Balances December 31, 2000 $1,300 Disbursements During 2001 4,705 Loan Reductions During 2001 3,972 - --------------------------------------------------------------- Loan Balances December 31, 2001 $2,033 =============================================================== 16. Future Impact of Accounting Standards Not Yet Adopted In June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not expect adoption of Statement No. 143 to have a material impact on the financial condition or operating results of the Company. In August 2001, the FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In the past, two accounting models existed for long-lived assets to be disposed of. Statement No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale. This statement also broadens the presentation of discontinued operations to include more disposal transactions. Therefore, the accounting for similar events and circumstances will be the same. Additionally, the information value of reported financial information will be improved. Finally, resolving significant implementation issues will improve compliance with the requirements of this Statement and, therefore, comparability among entities and the representational faithfulness of reported financial information. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company does not expect adoption of Statement No. 144 to have a material impact on the financial condition or operating results of the Company. 48 17. Parent Company Financial Information The financial information below is presented as of December 31, 2001 and December 31, 2000. Farmers & Merchants Bancorp Balance Sheet
(in thousands) 2001 2000 - ----------------------------------------------------------------------------------- Cash $ 1,925 $ 1,261 Investment in Farmers and Merchants Bank of Central California 94,011 88,993 Investment Securities 4,380 308 Loans 87 114 Other Assets 368 207 - ----------------------------------------------------------------------------------- Total Assets $100,771 $90,883 =================================================================================== Liabilities $ 35 $ -- Shareholders' Equity 100,736 90,883 - ----------------------------------------------------------------------------------- Total Liabilities and Shareholders Equity $100,771 $90,883 ===================================================================================
Farmers & Merchants Bancorp Income Statement for the period ending December 31,
2001 2000 1999 - ----------------------------------------------------------------------------------------------------- Equity Earnings in Farmers and Merchants Bank of Central California $ 12,538 $ 11,178 $ 6,298 Interest Income 42 -- -- Other Expenses, Net (263) (158) (116) - ----------------------------------------------------------------------------------------------------- Net Income $ 12,317 $ 11,020 $ 6,182 =====================================================================================================
Farmers & Merchants Bancorp Statement of Cash Flows for the period ending December 31,
2001 2000 1999 - ---------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net Income $12,317 $11,020 $6,182 Adjustments to Reconcile Net Income to Net Cash Used in Operating Activities: Equity in Undistributed Net Earnings from Subsidiary (2,938) (5,374) (1,223) Net Increase in Interest Receivable and Other Assets (161) (122) (84) Net Increase in Interest Receivable and Other Liabilities 35 - ---------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 9,253 5,524 4,875 - ---------------------------------------------------------------------------------------------------------- Investing Activities: Securities Purchased (4,326) (308) -- Securities Sold or Matured 254 -- -- Net Loans Originated 27 (114) -- - ---------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (4,045) (422) -- - ---------------------------------------------------------------------------------------------------------- Financing Activities: Stock Redemption (488) (1,258) (404) Cash Dividends (4,056) (3,709) 3,345) - ---------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities (4,544) (4,967) (3,749) - ---------------------------------------------------------------------------------------------------------- Increase in Cash and Cash Equivalents 664 135 1,126 Cash and Cash Equivalents at Beginning of Year 1,261 1,126 -- - ---------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 1,925 $ 1,261 $1,126 ==========================================================================================================
49 Five Year Financial Summary of Operations (in thousands, except per share data)
2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------------------------------ Total Interest Income $ 63,530 $ 66,127 $ 56,055 $ 51,194 $ 45,975 Total Interest Expense 23,280 24,757 18,862 17,428 16,422 - ------------------------------------------------------------------------------------------------------ Net Interest Income 40,250 41,370 37,193 33,766 29,553 Provision for Loan Losses 1,000 2,800 1,700 1,400 5,450 - ------------------------------------------------------------------------------------------------------ Net Interest income After Provision for Loan Losses 39,250 38,570 35,493 32,366 24,103 Total Non-Interest Income 8,374 6,648 5,658 5,819 5,112 Total Non-Interest Expense 27,486 27,548 27,021 26,095 24,177 - ------------------------------------------------------------------------------------------------------ Income Before Income Taxes 20,138 17,670 14,130 12,090 5,038 Provision for Income Taxes 7,821 6,650 4,914 4,030 1,027 - ------------------------------------------------------------------------------------------------------ Net Income $ 12,317 $ 11,020 $ 9,216 $ 8,060 $ 4,011 ====================================================================================================== Balance Sheet Data Total Assets $970,883 $905,551 $819,881 $758,799 $663,316 Loans 602,169 497,397 413,409 329,178 271,606 Allowance for Loan Losses 12,709 11,876 9,787 8,589 7,188 Investment Securities 275,550 320,654 346,855 374,170 346,125 Deposits 819,711 764,678 685,143 627,387 582,033 Federal Home Loan Bank Advances 41,000 41,033 41,064 41,093 -- Shareholders' Equity 100,736 90,883 80,201 79,405 74,823 Selected Ratios Return on Average Assets 1.35% 1.29% 1.19% 1.17% .63% Return on Average Equity - Net of Accumulated 13.14% 12.38% 10.95% 10.31% 5.43% Other Comprehensive Income Dividend Payout Ratio 32.93% 33.66% 36.30% 38.91% 73.10% Average Loan to Average Deposits 68.37% 59.96% 52.93% 48.93% 47.07% Average Equity to Average Assets Ratio 10.38% 10.04% 10.86% 11.33% 11.65% Period-end Shareholders' Equity to Total Assets 10.25% 10.04% 9.78% 10.46% 11.28% Per Share Data (1) Net Income $ 17.09 $ 15.23 $ 12.65 $ 11.03 $ 5.49 Cash Dividends Declared $ 5.45 $ 5.00 $ 4.50 $ 4.20 $ 3.92
(1) Net Income per share is based on the weighted average number of shares outstanding of 720,639, 723,473, 728,595, 760,936 and 731,142 for the years ended December 31, 2001, 2000, 1999, 1998 and 1997, respectively. Prior years' per share data has been restated for the 5% stock dividend issued in each of the above years. 50 Quarterly Financial Data (in thousands, except for per share data) First Second Third Fourth 2001 Quarter Quarter Quarter Quarter Total - ------------------------------------------------------------------------------ Total Interest Income $16,590 $16,539 $15,788 $14,613 $63,530 Total Interest Expense 6,395 6,005 5,851 5,029 23,280 - ------------------------------------------------------------------------------ Net Interest Income 10,195 10,534 9,937 9,584 40,250 Provision for Loan Losses 300 300 150 250 1,000 - ------------------------------------------------------------------------------ Net Interest Income After Provision for Loan Losses 9,895 10,234 9,787 9,334 39,250 Total Non-Interest Income 1,773 2,033 2,335 2,233 8,374 Total Non-Interest Expense 6,720 7,074 6,951 6,741 27,486 - ------------------------------------------------------------------------------ Income Before Income Taxes 4,948 5,193 5,171 4,826 20,138 Provision for Income Taxes 1,908 2,032 2,009 1,872 7,821 - ------------------------------------------------------------------------------ Net Income $ 3,040 $ 3,161 $ 3,162 $ 2,954 $12,317 ============================================================================== Earnings Per Share (1) $ 4.21 $ 4.38 $ 4.39 $ 4.11 $ 17.09 ============================================================================== 2000 - ------------------------------------------------------------------------------ Total Interest Income $15,062 $16,231 $17,097 $17,737 $66,127 Total Interest Expense 5,220 5,900 6,921 6,716 24,757 - ------------------------------------------------------------------------------ Net Interest Income 9,842 10,331 10,176 11,021 41,370 Provision for Loan Losses 500 500 400 1,400 2,800 - ------------------------------------------------------------------------------ Net Interest Income After Provision for Loan Losses 9,342 9,831 9,776 9,621 38,570 Total Non-Interest Income 1,729 1,700 1,692 1,527 6,648 Total Non-Interest Expense 6,735 7,042 6,912 6,859 27,548 - ------------------------------------------------------------------------------ Income Before Income Taxes 4,336 4,489 4,556 4,289 17,670 Provision for Income Taxes 1,622 1,685 1,728 1,615 6,650 - ------------------------------------------------------------------------------ Net Income $ 2,714 $ 2,804 $ 2,828 $ 2,674 $11,020 ============================================================================== Earnings Per Share (1) $ 3.73 $ 3.87 $ 3.92 $ 3.70 $ 15.23 ============================================================================== Farmers & Merchants Bancorp stock is not traded on any exchange. The shares are primarily held by local residents and are not actively traded. Dividends declared semiannually during the past three years were for the following amounts: June 2001, 2000 and 1999, $1.95, $1.85 and $1.70 per share, respectively, and for December 2001, 2000, and 1999, $3.50, $3.40 and $3.25 per share, respectively. Based on information from shareholders and from Company stock transfer records, the prices paid in 2001, 2000 and 1999 ranged from $265.00 to $150.00 per share. (1) Prior years' per share data has been restated for the 5% stock dividend issued in each of the above years. 51 Management's Discussion and Analysis Forward-Looking Statements This annual report contains various forward-looking statements, usually containing the words "estimate," "project," "expect," "objective," "goal," or similar expressions and includes assumptions concerning the Company's operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risk and uncertainties. In connection with the "safe-harbor" provisions of the private Securities Litigation Reform Act, the Company provides the following cautionary statement identifying important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions. Such factors include the following: (i) the effect of changing regional and national economic conditions; (ii) significant changes in interest rates and prepayment speeds; (iii) credit risks of commercial, real estate, consumer, and other lending activities; (iv) changes in federal and state banking regulations; (v) other external developments which could materially impact the Company's operational and financial performance. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. Introduction The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and subsidiaries' performance during 2001 and 2000 the material changes in financial condition, operating income and expense of the Company and its subsidiaries as shown in the accompanying financial statements. Farmers & Merchants Bancorp is a bank holding company formed April 30, 1999. Its subsidiary, Farmers & Merchants Bank of Central California is a state-chartered bank with 17 offices located in Sacramento, San Joaquin and Stanislaus Counties. Virtually all of the Company's business activities are conducted within its market area. This section should be read in conjunction with the consolidated financial statements and the notes thereto, along with other financial information included in this report. Per share amounts for 2000 and 1999 have been restated to reflect the 5% stock dividend declared during 2001. Overview At the completion of our 85th year, management is pleased to present the highest reported income in the Company's history. As of December 31, 2001, Farmers & Merchants Bancorp reported net income of $12,317,000, earnings per share of $17.09, return on average assets of 1.35% and return on average equity of 13.14% (net of accumulated other comprehensive income). For the year 2000, net income totaled $11,020,000, earnings per share was $15.23, return on average assets was 1.29% and return on average equity was 12.38% (net of accumulated other comprehensive income). For the year 1999, net income totaled $9,216,000, earnings per share was $12.65 for the year, return on average assets was 1.19%, and the return on average shareholders' equity totaled 10.95% (net of accumulated other comprehensive income). As of December 31, 2001, consolidated assets were $970.9 million, gross loans were $602.2 million and deposits were $819.7 million. Total consolidated assets increased $65.3 million, gross loans increased $104.8 million and deposits grew $55.0 million. The Company's improved financial performance in 2001 was due to a combination of a change in asset mix, focus on credit quality, improvement in non-interest income and the control of non-interest expense. The following is a summary of the financial accomplishments achieved during 2001: . Net interest income after provision for loan losses increased to $39,250,000 from $38,570,000 reported during 2000. This increase was accomplished during a period of extraordinarily rapid decline in interest rates. 52 . The provision for loan losses was $1,000,000 during 2001 compared to $2,800,000 in 2000. . Non-interest income (net of securities transactions) increased 22.4% during 2001, when compared to 2000. . Non-interest expense was reduced by $62 thousand during 2001 compared to an increase of 2.0% in 2000. . Total assets increased 7.2% to $970,883,000. . Total loans increased 21.1% to $602,169,000. . Non-accrual loans were $2,353,000 which was 0.4% of total loans at December 31, 2001. . Total investment securities decreased to $275,550,000 from $320,654,000 in 2000. . Total Shareholders' Equity increased to $100,736,000 from $90,883,000 in 2000. Net Interest Income Net interest income is the amount by which the interest and fees on loans and interest earned on earning assets exceeds the interest paid on interest bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as "taxable equivalent" and is noted wherever applicable. Interest income and expense are affected by changes in the volume and mix of average interest earning assets and average interest bearing liabilities, as well as fluctuations in interest rates. Therefore, increases or decreases in net interest income are analyzed as changes in volume, changes in rate and changes in the mix of assets and liabilities. Net interest income declined 2.7% to $40.3 million during 2001. During 2000, net interest income was $41.4 million, representing an increase of 11.2% over 1999. On a fully taxable equivalent basis, net interest income decreased 2.9% and totaled $41.6 million during 2001, compared to $42.8 million for 2000. In 1999, on a taxable equivalent basis, net interest income increased 9.5% or $3.4 million from that of 1998. Net interest income on a taxable equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin, which represents the average net effective yield on earning assets. For 2001, the net interest margin was 4.78% compared to 5.24% in 2000. The decrease in net interest margin was the result of the unprecedented decline in interest rates and competitive deposit rate climate in the Bank's market area during the year 2001. The predominant reason for the decline in net interest income during 2001 was the severe decline in interest rates throughout the year. Even though average earning assets increased 6.4%, earnings on those assets decreased by $2.7 million. Average interest bearing liabilities grew by 6.1% and interest paid on those liabilities decreased by $1.5 million. The Bank's earning assets reprice more quickly than the deposit products causing the decline in net interest income. If interest rates stabilize, and as deposit products continue to reprice, the net interest margin is expected to improve during 2002. Loans, the Company's highest earning asset, increased $104.8 million as of December 31, 2001 compared to 2000. On an average balance basis, loans increased by $67.7 million during the year, which, considering unprecedented decline in interest rates, helped minimize the decrease in interest and fees on loans of $215 thousand. The average yield on the loan portfolio declined 49 basis points to 8.4% in 2001 compared to 9.7% in 2000. The investment portfolio represents a significant portion of the Company's earning assets. The Company's investment policy is conservative. The Company primarily invests in mortgage-backed securities, U.S. Treasuries, U.S. Government Agencies, and high-grade municipals. Since the risk factor for these types of investments is significantly lower than that of loans, the yield earned on investments is substantially less than that of loans. Interest income from investment securities declined $3.1 million due to a decline in average investment securities of $46.7 million during 2001. The average yield, on a taxable equivalent basis, in the investment portfolio was 6.5% for 2001 and 2000. The tax equivalent yield in 1999 was 6.3%. Net interest income on a taxable equivalent basis is 53 higher than net interest income on the Consolidated Statements of Income because it reflects adjustments that relate to income on certain securities that are exempt from federal income taxes. As a result of the decline in interest rates, interest expense on deposits decreased 3.7% or $807 thousand in 2001. In spite of the decline in market rates during 2001, the Bank was still able to grow average interest bearing deposits by $48.1 million. The increase was primarily centered in the time deposit area, which grew 10.3%. Total interest expense on deposit accounts for 2001 was $21.0 million. In 2000, interest expense on deposits was $21.8 million. The average rate paid on interest-bearing deposits was 3.5% in 2001 and 3.9% in 2000. The percentage decline in interest expense did not match the decline in loan yields due to the fact that deposit products do not reprice as quickly as loan rates. The Company's earning assets and rate sensitive liabilities are subject to repricing at different times, which exposes the Company to income fluctuations when interest rates change. In order to minimize income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. Provision and Allowance for Loan Losses As a financial institution that assumes lending and credit risks as a principal element of its business, the Company anticipates that credit losses will be experienced in the normal course of business. The provision for loan losses represents the current period credit cost of maintaining an appropriate allowance for loan losses. The allowance for loan losses is maintained at a level considered by management to be adequate to provide for risks inherent in the loan portfolio. In determining the adequacy of the allowance for loan losses, management takes into consideration examinations of bank supervisory authorities, results of internal credit reviews, financial condition of borrowers, loan concentrations, prior loan loss experience, and general economic conditions. The allowance is based on estimates and ultimate losses may vary from the current estimates. Management reviews these estimates periodically and, when adjustments are necessary, they are reported in the period in which they become known. The provision for loan losses totaled $1.0 million in 2001, compared to $2.8 million in 2000. The decrease in the provision was the result of management's evaluation of the credit quality of the loan portfolio, current loan losses, the prevailing economic climate, and its effect on borrowers' ability to repay loans in accordance with the terms of the notes. As of December 31, 2001, the allowance for loan losses was $12.7 million, which represented 2.1% of the total loan balance. At December 31, 2000 the allowance for loan losses was $11.9 million or 2.4% of the total loan balance. Non-Interest Income Non-interest income for the Company includes income derived from services offered by the Bank, such as, merchant card, investment services and other miscellaneous business services; it also includes service charges and fees from deposit accounts and net gains and losses from the sale of investment securities and other real estate owned. Before securities transactions, non-interest income increased 22.4% in 2001 over 2000. The increase was primarily due to the increase in the service charges on deposit accounts. Total non-interest income was $8.4 million, which included $88 thousand in security gains. In 2000, non-interest income was $6.6 million. In 1999, the Company recorded $5.7 million of non-interest income. Non-Interest Expense Non-interest expense totaled $27.5 million during 2001, the same as was reported in 2000. The increase in 2000 over 1999 was 2.0% with total non-interest expense reported at $27.5 million. Salaries and employee benefits, the largest component of non-interest expense, increased $751 thousand in 2001, representing an increase of 4.6% over that of 2000. During 2000, the increase was $884 thousand or 5.8% over 1999. The increase was primarily the net result of merit increases for Company employees along with incentive bonuses. At the end of 2001, the Company had 304.0 full time equivalent employees compared to 296.2 at the end of 2000. 54 Occupancy expense decreased 2.9% during 2001. Equipment expense increased $110 thousand or 5.7% and totaled $2.0 million during 2001. During 2000, equipment expense decreased 15.5% or $352 thousand over the previous year. Other operating expense totaled $6.8 million, an 11.4% decrease from the prior year. This decrease was due to an aggressive effort to contain other operating expenses during 2001. Income Taxes The provision for income taxes increased 17.6% during 2001 as a result of improved earnings and an increase in the effective tax rate. In 2000 the provision increased 35.3% due to increased earnings over 1999. The effective tax rate in 2001 was 38.8% compared to 37.6% in 2000. The increase in the effective tax rate in 2001 was due to a decline in tax advantaged investment securities, that matured and were not replaced, during the year. Current tax law causes the Company's current taxes payable to approximate or exceed the current provision for taxes on the income statement. Two provisions have had a significant effect on the Company's current income tax liability; the restrictions on the deductibility of loan losses and the mandatory use of accrual accounting for taxes rather than the cash basis method of accounting. Balance Sheet Analysis Investment Securities The Financial Accounting Standards Board statement, Accounting for Certain Investments in Debt and Equity Securities, requires the Company to classify its investments as held-to-maturity, trading or available- for-sale. As of December 31, the Company classified securities as either held-to-maturity or available-for-sale. Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income. As of December 31, there were no securities in the trading portfolio. Securities are classified as held-to-maturity and accounted for at amortized cost when the Company has the positive intent and ability to hold the securities to maturity. Securities for which the Company does not have the intent to hold to maturity are classified as available-for-sale. This portion of the investment portfolio provides the Company with liquidity that may be required to meet the needs of Company borrowers and satisfy depositor's withdrawals. The investment portfolio provides the Company with an income alternative to loans. The Company's total investment portfolio represented 28.4% of the Company's total assets during 2001 and 35.4% of the Company's total assets during 2000. Not included in the investment portfolio are overnight investments in Federal Funds Sold. In 2001, average Federal Funds Sold on a year to date basis was $51.9 million compared to $20.5 million in 2000. The Company's investment portfolio at the end of 2001 decreased $45.1 million or 14.1% from 2000. The proceeds from the decline in the investment portfolio were used to fund the Company's loan growth during 2001. On an average balance basis, the Company increased its investment in non-taxable obligations of states and political subdivisions by $1.1 million. The Company generally replaces maturities of municipal securities, to the point of a maximum tax benefit, with "qualified issues." Qualified issues are municipal obligations that are considered "small issues" and meet Internal Revenue Service requirements. By meeting these requirements, the interest earned from qualified issues is exempt from federal income taxes. Note 3 in the Notes to Consolidated Financial Statements displays the classifications of the Company's investment portfolio, the market value of the Company's investment portfolio and the maturity distribution. Loans The Company's written lending policies, along with applicable laws and regulations governing the extension of credit, require risk analysis as well as ongoing portfolio and credit management through loan product diversification, lending limits, ongoing credit reviews and approval policies prior to funding of any loan. The Company manages and controls credit risk through diversification, dollar limits on loans to one borrower and by primarily restricting loans made to its principal market area. Loans that are performing but have shown some signs of weakness are 55 subjected to more stringent reporting and oversight. Fixed-rate real estate loans are comprised primarily of loans with maturities of less than five years. Long-term residential loans are originated by the Company and sold in the secondary market. As of December 31, 2001, loans totaled $602.2 million, a 21.1% increase over that of 2000. On an average balance basis the Company's loan portfolio increased $67.7 million over the average balance in 2000. In 2000, average balances increased from the prior year by 26.1% or $94.7 million. This increase was due to strong loan demand in the Company's market area along with an aggressive calling program. Non-Performing Loans The Company's policy is to place loans on non-accrual status when, for any reason, principal or interest is past due for ninety days or more unless it is both well secured and in the process of collection. Any interest accrued, but unpaid, is reversed against current income. Thereafter, interest is recognized as income only as it is collected in cash. As a result of events beyond the Company's control, problem loans can and do occur. As of December 31, 2001, non-accrual loans were $2.4 million compared to $1.5 million at the end of 2000. Managing problem loans continues to be an important Company objective. The Company reported no foreclosed loans as other real estate in 2001, compared to the $88 thousand reported in 2000. Interest forgone on loans placed on a non-accrual status totaled $26 thousand at December 31, 2001. Non-accrual loans to total loans for the year ended 2001 was 0.4%. For the year ended 2000 the percentage was 0.3%. Although management believes that non-performing loans are generally well secured and that potential losses are provided for in the Company's allowance for loan losses, there can be no assurance that future deterioration in economic conditions or collateral values will not result in future credit losses. Deposits At December 31, 2001, deposits totaled $819.7 million. This represents an increase of $55.0 million or 7.2% from the deposit totals of $764.7 million reported in 2000. The majority of the increase was concentrated in interest-bearing transaction and savings deposits, which increased $19.3 million and $23.5 million, respectively. The Company increased its marketing efforts for deposits during 2001 and ran several successful deposit campaigns contributing to the growth in deposit balances. The change in the mix of deposits occurs as interest rates change. The expectations our customers have of future interest rates, dictates their maturity and account selections. As rates decreased during 2001, some customers locked in rates in anticipation of future declines while other customers placed their funds in transaction and savings accounts because they anticipated rates would rise and were unwilling to commit their deposits to long term investments at the current rates. The most volatile deposits in any financial institution are certificates of deposit over $100,000. The Company has not found its certificates of deposit over $100,000 to be as volatile as some other financial institutions as it does not solicit these types of deposits from brokers nor does it offer interest rate premiums. It has been the Company's experience that large depositors have placed their funds with the Company due to its strong reputation for safety, security and liquidity. Federal Home Loan Bank Advances Advances from the Federal Home Loan Bank are used to match fund long-term real estate loans and, as opportunities exist, the Bank borrows funds and invests the proceeds at a positive spread through the investment portfolio. These activities contribute to the Bank and Company's earnings as well as help offset the Bank's interest rate risk. The average rate paid for other borrowed funds was 5.5% in 2001 compared to 5.6% in 2000. Capital The Company relies on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders' Equity totaled $100.7 million at December 31, 2001 and $90.9 million at the end of 2000. 56 The Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation have adopted risk-based capital guidelines. The guidelines are designed to make capital requirements more sensitive to differences in risk related assets among banking organizations, to take into account off-balance sheet exposures and to aid in making the definition of bank capital uniform. Company assets and off-balance sheet items are categorized by risk. The results of these regulations are that assets with a higher degree of risk require a larger amount of capital; assets, such as cash, with a low degree of risk have little or no capital requirements. Under these guidelines the Company is currently required to maintain regulatory risk based capital equal to at least 8.0%. As of December 31, 2001, the Company's risk based capital was 13.8%, well above regulatory risk based capital guidelines. In 1998, the Shareholders approved a stock repurchase program. During 2001, the company repurchased 2,053 shares at an average share price of $238 per share. In 2000, the Company repurchased 5,994 shares at an average share price of $210. Risk Management The Company has adopted a Risk Management Plan to ensure the proper control and management of all risk factors inherent in the operation of the Company and the Bank. Specifically, credit risk, interest rate risk, liquidity risk, compliance risk, strategic risk, reputation risk and price risk can all affect the market risk of the Company. These specific risk factors are not mutually exclusive. It is recognized that any product or service offered by the Company may expose the Company and Bank to one or more of these risk factors. Credit Risk Credit risk is the risk to earnings or capital arising from an obligor's failure to meet the terms of any contract or otherwise fail to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance. Central to the Company's credit risk management is a proven loan risk rating system. Limitations on industry concentration aggregate customer borrowings and geographic boundaries also reduce loan credit risk. Credit risk in the investment portfolio is minimized through clearly defined limits in the Bank's policy statements. Senior Management, Directors' Committees, and the Board of Directors are provided with timely and accurate information to appropriately identify, measure, control and monitor the credit risk of the Company and the Bank. The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. The amount actually incurred with respect to these losses can vary significantly from the estimated amounts. The Company's methodology includes several features that are intended to reduce the difference between estimated and actual losses. Implicit in lending activities is the risk that losses will and do occur and that the amount of such losses will vary over time. Consequently, the Company maintains an allowance for loan losses by charging a provision for loan losses to earnings. Loans determined to be losses are charged against the allowance for loan losses. The Company's allowance for loan losses is maintained at a level considered by management to be adequate to provide for estimated losses inherent in the existing portfolio along with unused commitments to provide financing including commitments under commercial and standby letters of credit. The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowances for identified problem loans and portfolio segments and the unallocated allowance. Specific allowances are established in cases where management has identified conditions or circumstances related to credit that management believes indicate the possibility that a loss may be incurred in excess of the amount determined by the application of the formula reserve. Management performs a detailed analysis of these loans, including, but not limited to appraisals of the collateral, conditions of the marketplace for liquidating the collateral and assessment of the guarantors. Management then determines the loss potential and allocates a portion of the reserve for losses as a specific allowance for each of these credits. Management believes that the allowance for loan losses at December 31, 2001 was adequate to provide for both recognized losses and estimated inherent losses in the portfolio. No assurances can be given that future events may 57 not result in increases in delinquencies, non-performing loans or net loan chargeoffs that would increase the provision for loan losses and thereby adversely affect the results of operations. Asset / Liability Management - Interest Rate Risk The mismatch between maturities of interest sensitive assets and liabilities results in uncertainty in the Company's earnings and economic value and is referred to as interest rate risk. Farmers & Merchants Bancorp's primary objective in managing interest rate risk is to minimize the potential for significant loss as a result of changes in interest rates. The Company measures interest rate risk in terms of potential impact on both its economic value and earnings. The methods for governing the amount of interest rate risk include: analysis of asset and liability mismatches (GAP analysis), the utilization of a simulation model and limits on maturities of investment, loan and deposit products to relatively short periods which reduces the market volatility of those instruments. The gap analysis measures, at specific time intervals, the divergence between earning assets and interest bearing liabilities for which repricing opportunities will occur. A positive difference, or gap, indicates that earning assets will reprice faster than interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest rates and a lower net interest margin during periods of declining interest rates. Conversely, a negative gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates. The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans. In addition, the magnitude of changes in the rates charged on loans is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest bearing liabilities. The Company also utilizes the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of the Company's net interest income is measured over a rolling one-year horizon. The simulation model estimates the impact of changing interest rates on interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company's balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given both a 200 basis point upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed. Results that exceed policy limits, if any, are analyzed for risk tolerance and reported to the Board with appropriate recommendations. At December 31, 2001, the Bank's estimated net interest income sensitivity, as a percent of net interest income, for a parallel change in interest rates of 200 basis points was 19.2% for rates up and (19.1)% in rates down. The estimated sensitivity does not necessarily represent a Company forecast and the results may not be indicative of actual changes to the Company's net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, pricing strategies on loans and deposits, replacement of asset and liability cashflows, and other assumptions. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change. Liquidity Liquidity risk is the risk to earnings or capital resulting from the Bank's inability to meet its obligations when they come due without incurring unacceptable losses. It includes the ability to manage unplanned decreases or changes in funding sources and to recognize or address changes in market conditions that affect the Bank's ability to liquidate assets or acquire funds quickly and with minimum loss of value. The Company endeavors to maintain a cash flow adequate to fund operations, handle fluctuations in deposit levels, respond to the credit needs of borrowers and to 58 take advantage of investment opportunities as they arise. The principal sources of liquidity include interest and principal payments on loans and investments, proceeds from the maturity or sale of investments, and growth in deposits. In general, liquidity risk is managed daily by controlling the level of Fed Funds and the use of funds provided by the cash flow from the investment portfolio. The Company maintains overnight investments in Fed Funds as a cushion for temporary liquidity needs. During 2001, Federal Funds averaged $51.9 million. In addition, the Company maintains Federal Fund credit lines of $136 million with major correspondent banks subject to the customary terms and conditions for such arrangements. At December 31, 2001, the Company had available liquid assets, which included cash and cash equivalents and unpledged investment securities of approximately $217,672,000, which represents 22.4% of total assets. 59 EX-99 4 dex99.txt REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit 99 [LOGO] ANDERSON REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and the Board of Directors of Farmers & Merchants Bancorp: We have audited the consolidated statements of income, changes in shareholders' equity, cash flows and comprehensive income of Farmers & Merchants Bancorp (a Delaware Corporation) and its subsidiaries for the year ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Farmers & Merchants Bancorp and its subsidiaries for the year ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP ------------------- San Francisco, California, February 4, 2000 60 -----END PRIVACY-ENHANCED MESSAGE-----