-----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, JgxXsO1mcDDIchLwHc9CCEXFbDOM32mCVucp98hkMIKLIi7cgHvgZ0ddmSljBXwI aAUJO9sJBcHFmM1gM1e3rw== 0001085913-03-000005.txt : 20030331 0001085913-03-000005.hdr.sgml : 20030331 20030328190221 ACCESSION NUMBER: 0001085913-03-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FARMERS & MERCHANTS BANCORP CENTRAL INDEX KEY: 0001085913 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] 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: 03626776 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 form10-k_2002.txt 2002 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, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to __________. Commission File Number: 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.) 111 W. Pine Street, Lodi, California 95240 (Address of principal Executive offices) (Zip Code) Registrant's telephone number, including area code (209) 367-2300 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 Par Value Per Share 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. [X] As of March 13, 2003, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $183,255,250 based on the sales price of that day of $250.00 per share. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes [X] No [ ] The aggregate market value of the Registrant's common stock held by non-affiliates on June 28, 2002 (based on the closing sale price of the Common Stock) was $183,937,250. The number of shares of Common Stock outstanding as of March 13, 2003: 733,021 Documents Incorporated by Reference: Portions of the Annual Report to Shareholders for fiscal year ended December 31, 2002 are incorporated by reference in Part II, Items 5 through 8 and Part IV, Items 14 and 15. Portions of the definitive Proxy Statement for the 2003 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 4 - General Development of the Business - Service Area - Employees - Competition - Government Policies - Supervision and Regulation - Risk Factors - Statistical Disclosures Item 2. Properties 27 Item 3. Legal Proceedings 27 Item 4. Submission of Matters to a Vote of Security Holders 27 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters 27 Item 6. Selected Financial Data 28 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 28 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 28 Item 8. Financial Statements and Supplementary Data 28 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 28 PART III Item 10. Directors and Executive Officers of the Company 28 Item 11. Executive Compensation 29 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 29 Item 13. Certain Relationships and Related Transactions 29 2 PART IV Item 14. Controls and Procedures 29 Item 15. Exhibits, Financial Statement Schedules and Reports on Forms 8-K 29 Signatures 30 Certifications 31 Index to Exhibits 33 3 Introduction - 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 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; (v) competitive pressure in the banking industry and changes in banking or other laws and regulations or governmental fiscal or monetary policies; (vi) uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the U.S. or other governments as a result of further acts or threats of terrorism or as a result of military action in Iraq; (vii) dividend restrictions; (viii) asset/liability pricing risks and liquidity risks; (ix) changes in the securities markets; (x) certain operational risks involving data processing systems or fraud; and (xi) 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 Bank's name was changed 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. The year 2002 saw the opening of the Lincoln Center office with its state of the art Merchant Center. This is the Company's first branch in the city of Stockton. The Walnut Grove office was closed in 2002 upon the expiration of the lease. Those customers are now serviced through the Lodi Main Office. On March 10, 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"). The Bank is the Company's principal asset. Farmers & Merchants Bancorp is a bank holding company incorporated in the State of Delaware, and registered under the Bank Holding Company Act of 1956, as amended. The Company's outstanding securities as of December 31, 2002, consisted of 733,021 shares 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. 4 During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name, "F & M Bank" as part of a larger effort to enhance the Company's image and build brand name recognition. A legal review was completed by outside counsel to ensure any existing copyrights were not violated. The company is in the process of converting daily operating and image advertising to the "F & M Bank" name and the Company's logo, slogan and signage were redesigned to incorporate the trade name, "F & M Bank". A new corporation, F & M Bancorp, Inc., was established in California during 2002 to support the Company's rebranding activities and legal rights to the "F & M Bank" trade name. 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. 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 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 Item 1. Business - Dividends and Other Transfer of Funds. 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. Service Area The Company services the northern Central Valley of California with 17 banking offices. The area includes Sacramento, San Joaquin, Stanislaus and Merced Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, 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, which employs investment advisors to meet with and provide investment advice to the Company's customers. Employees At December 31, 2002, the Company employed a total of 292 full time equivalent employees. The Company believes that its employee relations are excellent. 5 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. Using the financial holding company structure, insurance companies and securities firms may compete more directly with banks and bank holding companies. 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 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 Bank's profitability, like most financial institutions, is primarily dependent on interest rate differentials. The difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on its interest-earning assets, such as loans extended to its customers and securities held in its investment portfolio, comprise the major portion of the Company's earnings. These rates are highly sensitive to many factors that are beyond the control of the Company and the Bank, such as inflation, recession and unemployment, and the impact which future changes in economic conditions might have on the Company and the Bank cannot be predicted. The business of the Company and the Bank is also influenced by the 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 "FRB"). The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact on the Company and the Bank of any future changes in monetary and fiscal policies cannot be predicted. From time to time, legislative acts, as well as regulations, are enacted which have the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions and financial services providers are frequently made in the U.S. Congress, in the state legislatures, and before various regulatory agencies. This legislation may change banking statues and the operating environment of the Company and its subsidiaries in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company or any of its subsidiaries. See Item 1. Business - Supervision and Regulation. 6 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 FRB may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries of affiliates when the FRB 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 FRB 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 FRB prior to purchasing or redeeming its equity securities. Under the BHCA and regulations adopted by the FRB, 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 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 transactions between Farmers & Merchants Bancorp and its subsidiaries. Further, the Company is required by the FRB to maintain certain levels of capital. See Item 1. Business - - Capital Standards. 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. All extensions of credit are made on substantially the same terms (including interest rates and collateral) as, and following credit-underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions by the bank with other persons not covered by 12 USC 215.1 et seq and who are not employed by the bank, and does not involve more than the normal risk of repayment or present other unfavorable features. Extensions of credit to insiders have been and may be made pursuant to a benefit or compensation program that is widely available to employees of the bank and that does not give preference to any insider of the bank over other employees. 7 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 FRB, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the FRB 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 FRB 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 FRB's 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. This support may be required at times when a bank holding company may not be able to provide such support. 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 FRB to be an unsafe and unsound banking practice or a violation of the FRB's regulations or both. The Gramm-Leach-Bliley Act of 1999 ("GLBA") eliminated many of the restrictions placed on the activities of bank holding companies that become financial holding companies. Among other things, GLBA repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the BHCA to permit bank holding companies that are financial holding companies to engage in activities, and acquire companies engaged in activities, that are: financial in nature (including insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities); incidental to financial activities; or complementary to financial activities if the FRB determines that they pose no substantial risk to the safety or soundness of depository institutions or the financial system in general. The Company has not become a financial holding company. GLBA also permits national banks to engage in activities considered financial in nature through a financial subsidiary, subject to certain conditions and limitations and with the approval of the Comptroller of the Currency. 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. 8 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 Item 1. Business - Capital Standards. The USA Patriot Act Title III of the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") includes numerous provisions for fighting international money laundering and blocking terrorist access to the U.S. financial system. The provisions of Title III of the USA Patriot Act which affect banking organizations, including the Bank, relate principally to U.S. banking organizations' relationships with foreign banks and with persons who are resident outside the United States. The USA Patriot Act does not immediately impose any new filing or reporting obligations for banking organizations, but does require certain additional due diligence and record keeping practices. Some requirements take effect without the issuance of regulations. Other provisions are to be implemented through regulations that will be promulgated by the U.S. Department of the Treasury (the "Treasury"), in consultation with the FRB and other federal financial institutions regulators. The federal banking agencies have begun proposing and implementing regulations interpreting the USA Patriot Act. Part of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA"). Among its provisions, IMLAFATA requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours. IMLAFATA also amends the BHCA and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing an application under these acts. Pursuant to IMLAFATA, the Secretary of the Treasury, in consultation with the heads of other government agencies, has adopted and proposed special measures applicable to banks, bank holding companies, and/or other financial institutions. These measures include enhanced record keeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions. Privacy Restrictions The GLBA, in addition to the previously described changes in permissible non-banking activities permitted to banks, bank holding companies and financial holding companies, also required the federal banking agencies, among others federal regulatory agencies, to adopt regulations governing the privacy of consumer financial information. The FRB adopted such regulations and required full compliance with the regulations by July 1, 2001. The Bank is subject to the FRB's regulations. 9 The regulations impose three main requirements established by the GLBA. First, a banking organization must provide initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates. Second, banking organizations must provide annual notices of their privacy policies to their customers. Third, banking organizations must provide a reasonable method for customers to "opt-out" of disclosures to nonaffiliated third parties. In connection with the regulations governing the privacy of consumer financial information, the federal banking agencies, including the FRB, adopted guidelines for safeguarding confidential customer information, effective on July 1, 2001. The guidelines require banking organizations to establish an information security program to: (1) identify and assess the risks that may threaten customer information; (2) develop a written plan containing policies and procedures to manage and control these risks; (3) implement and test the plan; and (4) adjust the plan on a continuing basis to account for changes in technology, the sensitivity of customer information, and internal or external threats. The guidelines also outline the responsibilities of directors of banking organizations in overseeing the protection of customer information. The Company complies with all provisions of the GLBA and all implementing regulations, and the Bank has developed appropriate policies and procedures to meet its responsibilities in connection with the privacy provisions of GLBA. 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 $14.5 million at December 31, 2002. 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 Item 1. Business - Prompt Corrective Action and Other Enforcement Mechanisms and Item 1. Business - Capital Standards for a discussion of these additional restrictions on capital distributions. Transactions with Affiliates 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 restrictions with respect to transactions with affiliates. Additionally, limitations involving the transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See Item 1. Business - Prompt Corrective Action and Other Enforcement Mechanisms. 10 Capital Standards 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. The federal banking agencies require a minimum ratio of qualifying total capital to risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to risk-weighted 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 4%. 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, 2002 and 2001 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, 2002 Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------------------------------------------------------------------------------- The Bank: Total Bank Capital to Risk Weighted Assets $108,191 11.73% $ 73,766 8.00% $92,208 10.00% Tier I Bank Capital to Risk Weighted Assets $ 96,602 10.48% $ 36,883 4.00% $55,325 6.00% Tier I Bank Capital to Average Assets $ 96,602 9.84% $ 39,259 4.00% $49,074 5.00% The Company: Total Consolidated Capital to Risk Weighted Assets $113,370 12.25% $ 74,058 8.00% N/A N/A Tier I Consolidated Capital to Risk Weighted Assets $101,735 10.99% $ 37,029 4.00% N/A N/A Tier I Consolidated Capital to Average Assets $101,735 10.32% $ 39,439 4.00% N/A N/A 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 12.51% $ 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
11 Prompt Corrective Action and Other Enforcement Mechanisms 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, 2002 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 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 federal banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. Additionally, a holding company's inability to serve as a source of strength to its subsidiary banking organizations could serve as an additional basis for a regulatory action against the holding company. 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 12 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, 2002, 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 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. Community Reinvestment Act ("CRA") and Fair Lending The Bank is subject to certain fair lending requirements and reporting obligations involving lending, investing and other CRA activities. CRA requires each insured depository institution to identify the communities served by the institution's offices and to identify the types of credit and investments the institution is prepared to extend within such communities including low and moderate income neighborhoods. It also requires the institution's regulators to assess the institution'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 into 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, 2000 through September 30, 2001 for the lending area and January 1, 2000 through December 31, 2001 for both the investment and service areas. The Bank received a high satisfactory rating in the lending area and an outstanding rating in the areas of investment and service. The Bank received an overall rating of outstanding in complying with its CRA obligations. 13 Recently Enacted Legislation, Regulations and Accounting Guidance On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act of 2002. This new legislation addresses accounting oversight and corporate governance matters, including: |X| the creation of a five-member oversight board that will set standards for accountants and have investigative and disciplinary powers; |X| the prohibition of accounting firms from providing various types of consulting services to public clients and requiring accounting firms to rotate partners among public client assignments every five years; |X| increased penalties for financial crimes; |X| expanded disclosure of corporate operations and internal controls and certification of financial statements; |X| enhanced controls on, and reporting of, insider trading; and |X| prohibition on lending to officers and directors of public companies, although the Bank may continue to make these loans within the constraints of existing banking regulations. 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 primarily 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 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. 14 War on Terrorism. The terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001, ongoing acts or threats of terrorism and actions taken by the U.S. or other governments as a result of such acts or threats, have contributed to the continuing downturn in U.S. economic conditions and have resulted in increased uncertainty regarding the economic outlook. Past experience suggests that shocks to American society of far less severity have resulted in a temporary loss of consumer and business confidence and a reduction in the rate of economic growth. Continual deterioration in either the U.S. or the California economy could adversely affect the Company's financial condition and results of operations. California Energy Crisis. Due to problems associated with the deregulation of the electrical power industry in California, California utilities and other energy industry participants have experienced difficulties with the supply and price of electricity and natural gas. The California energy situation continues to be fluid and subject to many uncertainties and a number of lawsuits and regulatory proceedings have been commenced concerning various aspects of the current energy situation. The long-term impact of the energy crisis in California on the Company's markets and business cannot be predicted, but could result in a sustained period of economic difficulties. This could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and, as a result, on the Company's financial condition and results of operations. Critical Accounting Policies. The Company's financial statements are presented in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). The financial information contained within our financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. Along with other factors, we use historical loss factors to determine the inherent loss that may be present in our loan and lease portfolio. Actual losses could differ significantly from the historical loss factors that we use. Other estimates that we use are fair value of our securities and expected useful lives of our depreciable assets. Other than derivative financial instruments purchased and/or sold to reduce the Company's exposure to changing interest rates, we have not entered into derivative contracts for our customers or for ourselves, which relate to interest rate, credit, equity, commodity, energy, or weather-related indices. US GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. Accounting standards and interpretation currently affecting the Company and its subsidiaries my change at any time, and the Company's financial condition and results of operations may be adversely affected. Our most significant estimates are approved by our Management team, which is comprised of our most senior officers. At each financial reporting period, a review of these estimates is then presented to our Board of Directors. As of December 31, 2002, we have not created any special purpose entities to securitize assets or to obtain off-balance sheet funding. [Although we have sold a number of loans in the past two years, those loans have been sold to third parties without recourse, subject to customary representations and warranties.] Limited Public Market; Volatility in Stock Price. The Company's common stock is not listed on any exchange, nor is it included on the NASDAQ National Market or the NASDAQ Small Cap Market. However, trades may be reported on the OTC Bulletin Board under the symbol "FMCB". Management is aware that there are private transactions in the Company's common stock. However, the limited trading market for the Company's common stock may make it difficult for stockholders to dispose of their shares. Also, the price of the Company's Common Stock may be affected by general market price movements as well as developments specifically related to the financial services sector, including interest rate movements, quarterly variations, or changes in financial estimates by securities analysts and a significant reduction in the price of the stock of another participant in the financial services industry. 15 Statistical Disclosures 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 2002 Annual Report to Shareholders, which is filed herewith as Exhibit 13, and which is incorporated herein by reference and with the Company's Consolidated Financial Statements and the Notes thereto included in Company's 2002 Annual Report to Shareholders, also contained in Exhibit 13, and which is incorporated herein by reference. 16 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, 2002 Assets Balance Interest Rate - --------------------------------------------------------------------------------------------------------- Federal Funds Sold $ 33,032 $ 555 1.68% Investment Securities Available-for-Sale U.S. Treasuries 0 0 0.00% U.S. Agencies 6,930 276 3.98% Municipals - Taxable 1,532 96 6.27% Municipals - Non-Taxable 22,265 1,549 6.96% Mortgage Backed Securities 139,628 8,292 5.94% Other 10,994 703 6.39% - --------------------------------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale 181,349 10,916 6.02% - --------------------------------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Treasuries 0 0 0.00% U.S. Agencies 0 0 0.00% Municipals - Taxable 0 0 0.00% Municipals - Non-Taxable 28,756 2,173 7.56% Mortgage Backed Securities 0 0 0.00% Other 534 32 5.99% - --------------------------------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity 29,290 2,205 7.53% - --------------------------------------------------------------------------------------------------------- Loans Real Estate 386,840 26,884 6.95% Agricultural 98,270 5,404 5.50% Commercial 132,799 7,837 5.90% Consumer 15,376 1,396 9.08% Credit Card 3,424 320 9.35% Municipal 1,122 70 6.24% - --------------------------------------------------------------------------------------------------------- Total Loans 637,831 41,911 6.57% - --------------------------------------------------------------------------------------------------------- Total Earning Assets 881,502 $55,587 6.31% ======================= Unrealized Gain/(Loss) on Securities Available-for-Sale 4,588 Allowance for Loan Losses (13,189) Cash and Due From Banks 28,934 All Other Assets 50,389 - ---------------------------------------------------------------------------------- Total Assets $952,224 ================================================================================== Liabilities & Shareholders' Equity Interest Bearing Deposits Interest Bearing DDA $87,002 $ 272 0.31% Savings 220,115 1,940 0.88% Time Deposits 312,919 9,157 2.93% - --------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 620,036 11,369 1.83% Other Borrowed Funds 41,255 2,227 5.40% - --------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 661,291 $13,596 2.06% ======================= Demand Deposits 180,163 All Other Liabilities 8,804 - ---------------------------------------------------------------------------------- Total Liabilities 850,258 Shareholders' Equity 101,966 - ---------------------------------------------------------------------------------- Total Liabilities & Shareholders' Equity $952,224 ================================================================================== Net Interest Margin 4.76% =========================================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis using the combined Federal and State income tax rate of 42.06%. Loan Fees are included in interest income for loans. Unearned discount is included for rate calculation purposes. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost. 17 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 1,426 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 16,342 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% Agricultural 88,379 6,813 7.71% Commercial 104,004 7,946 7.64% 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 combined Federal and State income tax rate of 42.06%. Loan Fees are included in interest income for loans. Unearned discount is included for rate calculation purposes. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost. 18 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% Agricultural 70,596 7,438 10.54% Commercial 83,082 7,880 9.48% 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 combined Federal and State income tax rate of 42.06%. Loan Fees are included in interest income for loans. Unearned discount is included for rate calculation purposes. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost. 19 Farmers & Merchants Bancorp Volume and Rate Analysis of Net Interest Revenue
(Rates on a Taxable Equivalent Basis) 2002 versus 2001 (in thousands) Amount of Increase (Decrease) Due to Change in: ------------------------------------- Average Average Net Interest Earning Assets Balance Rate Change - ------------------------------------------------------------------------------------------------------------------- Federal Funds Sold $ (546) $ (821) $ (1,367) Investment Securities Available for Sale U.S. Treasuries (28) (27) (55) U.S. Agencies 6 (72) (66) Municipals - Taxable (24) 1 (23) Municipals - Non-Taxable 21 102 123 Mortgage Backed Securities (4,786) (868) (5,654) Other 315 (66) 249 - ------------------------------------------------------------------------------------------------------------------- Total Investment Securities Available for Sale (4,496) (930) (5,426) - ------------------------------------------------------------------------------------------------------------------- Investment Securities Held to Maturity U.S. Treasuries 0 0 0 U.S. Agencies (11) (11) (22) Municipals - Taxable (57) (57) (114) Municipals - Non-Taxable (289) 7 (282) Mortgage Backed Securities 0 0 0 Other (8) (20) (28) - ------------------------------------------------------------------------------------------------------------------- Total Investment Securities Held to Maturity (365) (82) (446) - ------------------------------------------------------------------------------------------------------------------- Loans: Real Estate 6,008 (5,955) 53 Agricultural 701 (2,111) (1,409) Commercial (612) 503 (109) Installment (370) (164) (534) Credit Card 1 (44) (43) Other 7 (10) (3) - ------------------------------------------------------------------------------------------------------------------- Total Loans 5,737 (7,781) (2,045) - ------------------------------------------------------------------------------------------------------------------- Total Earning Assets 330 (9,614) (9,283) - ------------------------------------------------------------------------------------------------------------------- Interest Bearing Liabilities Interest Bearing Deposits: Transaction 63 (417) (354) Savings 578 (2,218) (1,641) Time Deposits (1,190) (6,484) (7,674) - ------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits (550) (9,120) (9,669) Other Borrowed Funds 13 (28) (15) - ------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities (537) (9,147) (9,684) - ------------------------------------------------------------------------------------------------------------------- Total Change $867 $ (466) $401 ===================================================================================================================
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. 20 Farmers & Merchants Bancorp Volume and Rate Analysis of Net Interest Revenue
(Rates on a Taxable Equivalent Basis) 2001 versus 2000 (in thousands) 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 Agricultural 1,631 (2,256) (625) Commercial 1,766 (1,700) 66 Installment (126) 35 (91) Credit Card 9 (70) (61) Other 35 5 40 - ------------------------------------------------------------------------------------------------------------------- Total Loans 5,988 (6,202) (214) - ------------------------------------------------------------------------------------------------------------------- Total Earning Assets 4,345 (7,053) (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 $3,070 $ (4,301) $ (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. 21 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) 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------- U. S. Treasury $ 0 $ 0 $ 0 $ 0 $5,047 $ 0 U. S. Agency 26,984 0 12,771 0 7,090 1,999 Municipal 34,352 27,351 24,076 32,137 23,975 38,585 Mortgage-Backed Securities 117,335 0 196,384 0 237,734 0 Corporate Bonds 17,703 0 0 0 0 0 Other 9,689 519 9,621 561 5,540 684 - ------------------------------------------------------------------------------------------------------------------------------- Total Book Value $206,063 $27,870 $242,852 $32,698 $279,386 $41,268 =============================================================================================================================== Fair Value $206,063 $29,111 $242,852 $33,546 $279,386 $41,833 ===============================================================================================================================
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, 2002. 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, 2002 (in thousands) Value Yield - ------------------------------------------------------------------------------------------------------------------- U.S. Agency One year or less - - After one year through five years 26,984 5.13% After five years through ten years - - After ten years - - - ------------------------------------------------------------------------------------------------------------------- Total U.S. Agency Securities 26,984 5.13% - ------------------------------------------------------------------------------------------------------------------- Municipal - Non-Taxable One year or less 2,088 5.74% After one year through five years 26,654 3.96% After five years through ten years 3,209 5.75% After ten years 972 6.25% - ------------------------------------------------------------------------------------------------------------------- Total Non-Taxable Municipal Securities 32,923 4.31% - ------------------------------------------------------------------------------------------------------------------- Municipal - Taxable One year or less - - After one year through five years - - After five years through ten years 1,429 6.25% After ten years - - - ------------------------------------------------------------------------------------------------------------------- Total Taxable Municipal Securities 1,429 6.25% - ------------------------------------------------------------------------------------------------------------------- Mortgage-Backed Securities One year or less 64,047 6.13% After one year through five years 43,030 5.17% After five years through ten years 10,257 5.00% After ten years - - - ------------------------------------------------------------------------------------------------------------------- Total Mortgage-Backed Securities 117,334 5.68% - ------------------------------------------------------------------------------------------------------------------- Corporate Bonds One year or less 8,163 1.80% After one year through five years 9,541 6.42% After five years through ten years - - After ten years - - - ------------------------------------------------------------------------------------------------------------------- Total Mortgage-Backed Securities 17,704 4.29% - ------------------------------------------------------------------------------------------------------------------- Other One year or less 4,596 7.24% After one year through five years 5,093 7.32% After five years through ten years - - After ten years - - - ------------------------------------------------------------------------------------------------------------------- Total Other Securities 9,689 7.28% - ------------------------------------------------------------------------------------------------------------------- Total Investment Securities Available for Sale 206,063 4.98%
Note: The average yield for floating rate securities is calculated using the current stated yield. 22 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, 2002. 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, 2002 (in thousands) Value Yield - ------------------------------------------------------------------------------------------------------------------- Municipal - Non-Taxable One year or less 7,234 5.05% After one year through five years 16,144 4.90% After five years through ten years 1,699 5.08% After ten years 2,274 6.56% - ------------------------------------------------------------------------------------------------------------------- Total Non-Taxable Municipal Securities 27,351 5.09% - ------------------------------------------------------------------------------------------------------------------- Other One year or less - - After one year through five years - - After five years through ten years - - After ten years 519 5.98% - ------------------------------------------------------------------------------------------------------------------- Total Other Securities 519 5.98% - ------------------------------------------------------------------------------------------------------------------- Total Investment Securities $27,870 5.11% ===================================================================================================================
23 Farmers & Merchants Bancorp Loan Data (in thousands) The following table shows the Bank's loan composition by type of loan.
December 31, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------ Real Estate $367,224 $304,451 $261,910 $222,354 $180,468 Real Estate Construction 66,467 49,692 28,354 39,186 26,529 Agricultural 109,130 110,707 83,770 67,774 55,816 Commercial 135,877 117,202 98,841 62,195 49,587 Consumer 13,948 17,022 20,965 18,953 14,035 Credit Card 4,252 3,157 3,619 3,235 2,989 Other 1,795 954 271 60 64 - ------------------------------------------------------------------------------------------------------------------ Total Loans 698,693 603,185 497,730 413,757 329,488 Less: Unearned Income 2,018 1,016 333 348 310 Allowance for Loan Losses 16,684 12,709 11,876 9,787 8,589 - ------------------------------------------------------------------------------------------------------------------ Loans, Net $679,991 $589,460 $485,521 $403,622 $320,589 ==================================================================================================================
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, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------ Nonaccrual Loans Real Estate $2,180 $1,015 $948 $754 $3,997 Commercial 452 1,302 520 1,713 595 Consumer 2 36 4 32 9 Credit Card 0 0 0 0 0 Other 263 0 0 0 0 - ------------------------------------------------------------------------------------------------------------------ Total Nonaccrual Loans 2,897 2,353 1,472 2,499 4,601 - ------------------------------------------------------------------------------------------------------------------ Accruing Loans Past Due 90 Days or More Real Estate 1 0 0 0 0 Commercial 0 0 0 0 0 Consumer 0 0 0 0 0 Credit Card 9 56 23 12 23 Other 0 0 0 0 0 - ------------------------------------------------------------------------------------------------------------------ Total Accruing Loans Past Due 90 Days or More 10 56 23 12 23 - ------------------------------------------------------------------------------------------------------------------ Total Non-Performing Loans $2,907 $2,409 $1,495 $2,511 $4,624 ================================================================================================================== Other Real Estate Owned $0 $0 $88 $204 $636 Non-Performing Loans as a Percent of Total Loans 0.42% 0.40% 0.30% 0.61% 1.40% ================================================================================================================== Allowance for Loan Losses as a Percent of Total Loans 2.39% 2.11% 2.39% 2.37% 2.61% ==================================================================================================================
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, 2002 was $331,000. For a discussion of impaired loan policy see Note 4. in the Notes to the Consolidated Financial Statements of the Company's 2002 Annual Report to Shareholders. 24 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:
2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------ Balance at Beginning of Year $ 12,709 $ 11,876 $ 9,787 $ 8,589 $ 7,188 Provision Charged to Expense 4,926 1,000 2,800 1,700 1,400 Charge Offs: Real Estate 0 0 45 794 194 Agricultural 149 94 218 0 15 Commercial 966 507 441 404 76 Consumer 78 68 177 80 73 Credit Card 93 85 48 30 73 Other 0 0 0 0 0 - ------------------------------------------------------------------------------------------------------------------ Total Charge Offs 1,286 754 929 1,308 431 - ------------------------------------------------------------------------------------------------------------------ Recoveries: Real Estate 0 18 0 3 1 Agricultural 141 0 2 16 2 Commercial 149 525 154 759 386 Consumer 34 14 53 21 36 Credit Card 11 30 9 7 7 Other 0 0 0 0 0 - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ Total Recoveries 335 587 218 806 432 - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ Net Recoveries (Charge-Offs) (951) (167) (711) (502) 1 - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ Balance at End of Year* $ 16,684 $ 12,709 $ 11,876 $ 9,787 $ 8,589 ================================================================================================================== Ratios: Consolidated Allowance for Loan Losses to: Loans at Year End 2.77% 2.55% 2.87% 2.97% 3.16% Average Loans 2.62% 2.42% 2.60% 2.70% 2.92% Consolidated Net Charge-Offs to: Loans at Year End 0.16% 0.03% 0.17% 0.15% 0.00% Average Loans 0.15% 0.03% 0.16% 0.14% 0.00%
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, ------------------------------------------------------------------ 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------ Real Estate $ 5,287 $ 3,716 $ 2,875 $2,609 $3,107 Real Estate Construction 793 520 311 461 456 Agricultural 3,702 3,722 1,769 1,759 1,341 Commercial 5,681 3,873 2,077 1,623 1,189 Consumer 427 283 129 147 229 Other 715 435 86 81 73 Unallocated 79 160 4,629 3,107 2,194 - ------------------------------------------------------------------------------------------------------------------ Total $16,684 $12,709 $11,876 $9,787 $8,589 ==================================================================================================================
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% Agricultural 18.4% 16.8% 16.4% 16.9% 0.0% Commercial 19.4% 19.9% 15.0% 15.0% 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% ==================================================================================================================
25 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 $27,739 $91,565 $247,920 $367,224 54.11% Real Estate Construction 15,685 36,627 14,155 66,467 9.79% Agricultural 77,910 22,581 8,639 109,130 16.08% Commercial 83,799 36,586 15,492 135,877 20.02% Total $205,133 $187,359 $286,206 $678,698 100.00% ================================================================================================================== Rate Sensitivity: Predetermined Rate $26,844 $62,697 $18,689 $108,230 15.95% Floating Rate 176,272 126,680 267,516 570,468 84.05% - ------------------------------------------------------------------------------------------------------------------ Total $203,116 $189,377 $286,205 $678,698 100.00% ================================================================================================================== Percent 29.93% 27.90% 42.17% 100.00% =====================================================================================================
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 transactions. Commitment fees are generally not charged except where letters of credit are involved. Commitments and lines of credit typically mature within one year. 26 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, 2002 - ------------------------------------------------------------------------------------------------ Time Deposits of $100,000 or More Three Months or Less $75,673 Over Three Months Through Six Months 37,259 Over Six Months Through Twelve Months 20,767 Over Twelve Months 14,306 - ------------------------------------------------------------------------------------------------ Total Time Deposits of $100,000 or More $148,005 ================================================================================================
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 28 of the Farmers & Merchants Bancorp Annual Report to Shareholders for the year ending December 31, 2002 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 to Shareholders for the year ending December 31, 2002. 27 Item 2. Properties Farmers & Merchants Bancorp along with its subsidiaries are headquartered in Lodi, California. Executive offices are located at 111 W. Pine Street. Banking services are provided in seventeen locations in the Company's service area. Of the eighteen locations, fourteen are owned and three are leased. The expiration of these leases occurs between the years 2003 and 2010. Item 3. Legal Proceedings Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. Based upon information available to the Company, its review of such lawsuits and claims and consultation with its counsel, the Company believes the liability relating to these actions, if any, would not have a material adverse effect on its consolidated financial statements. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the Company's stockholders during the fourth quarter of 2002. PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters The common stock of Farmers & Merchants Bancorp is not widely held, is not listed on any exchange, nor is it included on the NASDAQ National Market or the NASDAQ Small Cap Market. However, trades may be reported on the OTC Bulletin Board under the symbol "FMCB". The following table summarizes the actual high and low selling prices for the Company's common stock since the first quarter of 2001. These figures are based on activity posted on the OTC Bulletin Board and on stock transactions between individual shareholders that are reported to the Company. Calendar Quarter High Low 2002 Fourth quarter $300.00 $250.00 Third quarter 310.00 250.00 Second quarter 320.00 250.00 First quarter 259.50 238.00 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 As of December 31, 2002, there were approximately 1,200 holders of record of the Company's common stock. Beginning in 1975 and continuing through 2002, 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 2002 Annual Report to Shareholders, which is filed herewith as Exhibit 13 and which is incorporated herein by reference. There are regulatory limitations on cash dividends that may be paid by the Company under state and federal laws. See Item 1. Business - Supervision and Regulation. 28 Item 6. Selected Financial Data The selected financial data for the five years ended December 31, 2002, which appears in the Five-Year Financial Summary of the Company's 2002 Annual Report to Shareholders, which is filed herewith as Exhibit 13, and which is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations See Management's Discussion and Analysis in the Company's 2002 Annual Report to Shareholders which is filed herewith as Exhibit 13, and which is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk See "Management's Discussion and Analysis" in the Company's 2002 Annual Report to Shareholders which is filed herewith as Exhibit 13 and which is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data See Consolidated Financial Statements and the related Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Shareholders which is filed herewith as Exhibit 13, and which are incorporated herein by reference. (See table below.) FARMERS & MERCHANTS BANCORP INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES Page Report of Management 5 Report of Independent Accountants 6 Consolidated Financial Statements Consolidated Statements of Income-Years ended December 31, 2002, 2001 and 2000. 7 Consolidated Balance Sheets-December 31, 2002 and 2001. 8 Consolidated Statements of Changes in Shareholders' Equity-Years ended December 31, 2002, 2001 and 2000. 9 Consolidated Statements of Cash Flows-Years Ended December 31, 2002, 2001 and 2000 10 Consolidated Statements of Comprehensive Income. 11 Notes to Consolidated Financial Statements 12 Management's Discussion and Analysis 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None PART III Item 10. Directors and Executive Officers of the Company See "Election of Directors," "Executive Officers" and "Compliance with Section 16(a) of the Exchange Act" in the Company's definitive proxy statement for the 2002 Annual Meeting of Shareholders as filed with the Commission and which is incorporated herein by reference. 29 Item 11. Executive Compensation See "Compensation of Directors and Executive Officers," "Report of Personnel Committee of the Board of Directors on Executive Compensation," "Deferred Bonus Plan," "Profit Sharing Plan," "Defined Benefit Pension Plan," "Money Purchase Plan," "Employment Contracts and Termination of Employment and Change in Control Arrangements," "Compensation Committee Interlocks and Insider Participation" and "Performance Graph" in the Company's definitive proxy statement for the 2002 Annual Meeting of Shareholders as filed with the Commission and which is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters See "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive proxy statement for the 2002 Annual Meeting of Shareholders as filed with the Commission and which is incorporated herein by reference. The Company does not have any equity compensation plans which require disclosure under Item 201(d) of Regulation S-K. Item 13. Certain Relationships and Related Transactions See "Employment Contracts and Termination of Employment and Change in Control Arrangements" and "Certain Relationships and Related Transactions" in the Company's definitive proxy statement for the 2002 Annual Meeting of Shareholders as filed with the Commission and which is incorporated herein by reference. PART IV Item 14. Controls and Procedures See "Controls and Procedures" under "Management's Discussion and Analysis" in the Company's 2002 Annual Report to Shareholders which is filed herewith as Exhibit 13 and which is incorporated herein by reference. Item 15. 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 2002: None 30 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 ______________________________ 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 25, 2003 /s/Kent A. Steinwert ______________________________ President and Kent A. Steinwert Chief Executive Officer /s/John R. Olson _____________________________ Executive Vice President & John R. Olson Chief Financial Officer Principal Accounting Officer - ----------------------------- ------------------------------ Ole R. Mettler, Chairman James E. Podesta, Director - ---------------------------- ------------------------------ Stewart Adams, Jr., Director Kevin Sanguinetti, Director - ---------------------------- ------------------------------ Ralph Burlington, Director Harry C. Schumacher, Director - ---------------------------- ------------------------------ Edward Corum, Jr., Director Calvin Suess, Director - ---------------------------- ------------------------------ Robert F. Hunnell, Director Carl Wishek, Jr., Director 31 Certification I, Kent A. Steinwert, certify that: 1. I have reviewed this annual report on Form 10-K of Farmers & Merchants Bancorp; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) valuated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 25, 2003 /s/ Kent A. Steinwert ---------------------------- Kent A. Steinwert President & Chief Executive Officer 32 Certification I, John R. Olson, certify that: 1. I have reviewed this annual report on Form 10-K of Farmers & Merchants Bancorp; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) valuated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 25, 2003 /s/ John R. Olson ---------------------------- John R. Olson Executive Vice President & Chief Financial Officer 33 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. 10.5 Employment Agreement dated December 29, 2000, between Farmers & Merchants Bank of Central California and Deborah E. Hodkin, filed as Exhibit 10.5 to Registrant's 10-K for the year ended December 31, 2002. 10.6 Employment Agreement dated December 10, 2001, between Farmers & Merchants Bank of Central California and Chris C. Nelson, filed as Exhibit 10.6 to Registrant's 10-K for the year ended December 31, 2002. 10.7 Employment Agreement dated March 25, 2003, between Farmers & Merchants Bank of Central California and Stephen W. Haley, filed as Exhibit 10.7 to Registrant's 10-K for the year ended December 31, 2002. 13 Annual Report to Shareholders of Farmers & Merchants Bancorp for the year ended December 31, 2002 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 December 31, 2002, filed as Exhibit 21 to Registrant's 10-K for the year ended December 31, 2002. 99.1 Chief Executive Officer Certification pursuant to 10 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Chief Financial Officer Certification pursuant to 10 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 34 EX-10 3 form10k_2002exhibit10-5.txt 10-K 2002 EMPLOYMENT CONTRACT WITH HODKIN Exhibit 10.5 EMPLOYMENT AGREEMENT PART I PARTIES TO AGREEMENT Section 1.01 - Parties: This Employment Agreement is entered into as of December 29, 2000 by and between Farmers & Merchants Bank of Central California, (hereinafter referred to as "Employer") and Deborah E. Hodkin (hereinafter referred to as "Employee"). PART II EMPLOYMENT Section 2.01 - Employment: Employer hereby employs Employee and Employee hereby accepts employment with Employer in accordance with the terms and condition set forth herein. Section 2.02 - Term of Employment: This Employment Agreement shall be in full force and effect for a period of 36 months, commencing on the effective date of this Agreement between Employee and Employer. At the end of this said term, this Agreement shall renew automatically for additional one year terms, unless either party furnishes written notice of her or its intention not to renew by no later than sixty (60) days prior to the anniversary of the Effective Date of this Agreement. Section 2.03 - Regulatory Approval: The parties acknowledge that Employee's employment with the Bank is subject to review and approval of governmental regulatory authorities. The parties shall agree to take all steps necessary to cooperate fully with said regulators in order to expedite the approval process. Employee's contract under this Agreement is subject to, and shall not commence until said regulatory approvals have been obtained. PART III DUTIES OF EMPLOYEE Section 3.01 - General Duties: Subject to Bank's Board of Directors Approval, Employee is employed as Executive Vice President and Chief Administrative Officer of the Bank under the direction of the Bank's Board of Directors and Chief Executive Officer ("CEO") and shall perform and discharge well and faithfully the duties that may be assigned to her from time to time by the Bank's Board of Directors or Chief Executive Officer ("CEO") in connection with the conduct of the Bank's business. Nothing herein shall preclude the Board of Directors or CEO from changing Employee's title or duties. 1 Section 3.02 - Extent of Services: Employee shall devote her entire business time, attention and energies to the business of the Bank during the term of Employee's employment with the Bank. The foregoing however, shall not preclude Employee from engaging in appropriate civic, charitable, or religious activities or from devoting a reasonable amount of time to private investments or serving on boards of directors of other entities, as long as such activities and services do not interfere or conflict with her responsibilities to the Bank. PART IV COMPENSATION Section 4.01 - Salary: Employee shall be paid a base salary of $165,000 per year. This base salary shall be paid to Employee in such intervals and at times as other salaried executives of Employer are presently paid. In addition, upon employment, Employee shall be entitled to $45,000.00 to be paid to employee no later than on January 31, 2001 to compensate Employee for her forfeiture of her 2000 bonus with her current employer. Employee's salary may be adjusted annually beginning in 2002 at the times that other salaried executive officers of Employer are adjusted. Section 4.02 - Incentive Programs: Employee shall be entitled to participate in any Discretionary Incentive Compensation Plan adopted by the Bank from time to time which cover employees in positions comparable to that of employee. Also, subject to Bank's Board of Directors Approval, Employee shall participate in the Bank's Deferred Bonus Plan. PART V BENEFITS Section 5.01 - Benefits: Employee shall be eligible to participate in whatever vacation, medical, dental, pension, sick leave, 401(k), profit-sharing plan, disability insurance or other plans of general application to Employer's senior level employees, as may be in effect from time to time, in accordance with the rules established from time to time for individual participation in any such plans. Section 5.02 - Company Car: Employer shall provide Employee with an automobile or equal, for business and incidental personal use as per Bank policy. Section 5.03 - Membership Fees: Employer shall reimburse Employee for all appropriate and reasonable expenses incurred in performing her duties, including providing membership in local service and civic clubs and/or organizations as the Bank deems appropriate and necessary for enhancement of its presence within the local business community. In order to be eligible for reimbursement of these expenses, Employee will provide Employer with receipts and documented evidence as is required by Federal and State laws and regulations. 2 PART VI EXPENSES Section 6.01 - Travel and Entertainment Expenses: During the term of Employee's employment, Employer shall reimburse Employee for reasonable out of pocket expenses incurred in connection with Employer's business, including travel expenses, food and lodging while away from her home, subject to such policies as Employer may from time to time establish for its employees. Employee shall keep records of her travel and entertainment expenses in a form suitable to the Internal Revenue Service and the Franchise Tax Board to qualify this reimbursement as a federal and state income tax deduction for Employer. PART VII TERMINATION OF EMPLOYMENT Section 7.01 - Termination at Option of Employer: Notwithstanding any other section of this Agreement, Employer may terminate this Agreement at any time and without cause by giving Employee sixty (60) days written notice of Employer's intent to terminate this Agreement. In the event Employee's employment is terminated pursuant to Section 7.01 of this Agreement, Employee shall be paid all accrued salary, vacation, and reimbursable expenses for which expense reports have been provided to Employer in accordance with Employer's policies and this Agreement. In addition to the forgoing amounts, if Employee is terminated pursuant to this section of the Agreement, she will be entitled to receipt of additional severance payment as follows: 1. Employee shall be entitled to received up to twelve (12) monthly payments each in the amount equal to one twelfth (1/12) of Employee's then current annual base salary, less any withholding required by law. Any payments due and owing to Employee under this Section will commence on the 15th day of the first month following Employee's termination and shall continue until all payments due and owing Employee are made or until Employee obtains other comparable employment, whichever comes first. 2. For purposes of implementing subparagraph 1 of Section 7.01, Employee agrees to furnish Employer with prompt written notice describing any subsequent employment she secures (including her compensation for such employment) following any termination under this section. 3. For purposes of subparagraph 1 of Section 7.01, the term "comparable employment" shall mean any employment in which Employee's compensation (measured by any cash or non-cash payments or benefits) is comparable to her compensation under this Agreement. Any compensation comparison undertaken for the purposes of this Agreement shall be done without regard to any vested or unvested earnings from the Deferred Bonus Plan. 3 4. In addition to any severance payments due and owing under Section 7.01, Employer may, in its sole discretion, provide Employee with a performance bonus prorated for the number of months between the termination date and the end of Employer's last fiscal year. Section 7.02 - Termination by Employer for Cause: If, at any time during Employee's employment, Employer finds that Employee is found to be guilty of committing acts of dishonesty, theft, embezzlement or other acts of moral turpitude against the Bank, its subsidiaries or affiliates which adversely impact the interests of the Bank or if Employee is negligent in the performance of her assigned duties, Employer may at its option terminate this Agreement by giving written notification of such termination to Employee. In the event Employee is terminated pursuant to this Section, Employee shall be entitled only to the compensation earned by her prior to the date of termination, computed up to and including the date of termination, and shall be entitled to no further compensation or severance payment of any nature. Section 7.03 - Termination at Option of Employee: This Agreement may be terminated by Employee in her sole discretion by giving sixty (60) days written notice of termination to Employer. In the event Employee terminates her employment pursuant to this Section, Employee shall be entitled to the base compensation earned by her computed up to and including the effective date of her termination and she shall be entitled to no further compensation, or severance payment of any nature; provided, however, Employee continues productive employment until such date; and further provided that Employer may, at its option, at any time after Employee gives written notice of resignation as herein provided, pay Employee pro rata compensation as described above up through and including the effective date of termination set forth in Employee's resignation notice, and thereupon immediately release and terminate Employee. Section 7.04 - Continuation of Medical Benefits: In the event Employee's employment is terminated, Employee shall be afforded the right to continue her medical benefits as and to the extent provided in the Consolidated Omnibus Budget Reconciliation Act ("COBRA"). Section 7.05 - Termination of Employee due to Change of Control: In the event the Bank is sold during the term of this Agreement, and in the event Employee is not retained by the purchaser in the same or similar position as described in Section 3.01 of this Agreement, Employer will provide Employee with a severance package equal to one year of annual salary as set at the time the Bank is sold, as well as a pro rata annual performance bonus for the year in which the Termination occurs. In addition, the Employee will also be entitled to all vested awards under the Deferred Bonus Plan. 4 1. "Change of Control" means a change of control of the Bank of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934 (the "Act"), whether or not the Bank is then subject to such reporting requirement; provided, however, that without limitation, such a Change of Control shall be deemed to have occurred if: (a) any person or group (as such terms are used in connection with Sections 13(d) and 14(d) of the Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 and 13d-5 under the Act), directly or indirectly, of securities of the Bank representing 40% or more of the combined voting power of the Bank's then outstanding securities; or (b) the Bank is a party to a merger, consolidation, sale of assets or other reorganization, or a proxy contest, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter. Notwithstanding the foregoing provisions of this paragraph 1., a "Change of Control" will not be deemed to have occurred solely because of the acquisition of securities of the Bank (or any reporting requirement under the Act relating thereto) by an employee benefit plan maintained by the Bank for its employees. Section 7.06 - Exclusive Agreement: The agreement of Employer and Employee respecting the extent of the parties' duties, obligations and liabilities in the event of termination of employment as set forth in Part VII herein is intended to be exclusive and in lieu of any other interests, rights or remedies to which Employer or Employee may otherwise be entitled either at law, in equity, or under this Agreement. Employer and Employee expressly waive any and all such other rights and remedies. PART VIII COVENANTS Section 8.01 - Business and Trade Secrets: Employee specifically agrees that she will not at any time, whether during the period of Employee's employment by Employer or at any time thereafter, in any fashion, form or manner, unless specifically consented to in writing by Employer, either directly or indirectly use or divulge, disclose or communicate to any person, firm or corporation, in any manner whatsoever, any confidential information and trade secrets of any kind, nature or description concerning any matters affecting or relating to the business of Employer, including without limiting the generality of the foregoing, the names, contact persons, business habits or practices, and standards of the Employer, or confidential business or financial information, including the Employer's financial and planning data, compilations of business and financial data, records, reports, customer lists, (including contacts), customers' profitability, studies, manuals, memoranda, notebooks, files, documents, correspondence, and other confidential business or financial information of, about, or concerning the business of the Employer, its manner of operation, or other confidential data of any kind, nature or description, the parties hereto stipulating that as between them, the same are important, material and confidential business and trade secrets and affect the successful conduct of the Employer's business and its goodwill, and that any breach in whole or in part of the term of Part VIII of this Agreement is a material breach of this Agreement. 5 Section 8.02 - Employer's Property: All files, records, compilations, reports, studies, manuals, memoranda, notebooks, documents, correspondence, and other confidential information or records and similar items relating to the business of the Employer, whether prepared by Employee or otherwise coming into her possession, are, and shall remain, the exclusive property of the Employer, and shall be promptly delivered to the Employer in the event of Employee's termination. Section 8.03 - Separate Covenants: The covenants of Part VIII of this Agreement shall be construed as separate covenants covering their particular subject matter. In the event that any covenant shall be found to be judicially unenforceable, said covenant shall not affect the enforceability or validity of any other part of this Agreement. Section 8.04 - Continuing Obligation: Employee's obligations set forth in Part VIII of this Agreement shall expressly continue in effect beyond Employee's employment period in accordance with their terms, and such obligations shall be binding on Employee's assigns, executors, administrators and other legal representatives. Section 8.05 - Enforcement: Employer and Employee acknowledge that Employee is hereunder employed in a sensitive business position where Employee will have access to business and trade secrets as described in Part VIII hereof, and will be rendering personal services of a special, unique, unusual and extraordinary character. In recognition of these facts, Employee agrees that the breach by her of the covenants of this Agreement could not reasonably or adequately be compensated in damages in an action at law and that Employer by reason thereof shall be entitled to preliminary injunctive relief in a court of competent jurisdiction which relief shall include but shall not be limited to restraining Employee from rendering any service or taking any action that would breach such covenants pending a determination of the parties' rights and obligations in resolution/arbitration in accordance with Parts IX hereof. PART IX ARBITRATION AGREEMENT Section 9.01 - Resolution of Disputes: To resolve disputes which might otherwise become civil court cases, Employee and Employer agree to submit all disputes arising out of Employee's employment which may lawfully be the subject of pre-dispute arbitration agreements to final and binding arbitration after the conclusions of any relevant administrative proceedings. Arbitration shall be the exclusive means of resolving any such disputes and no other action will be brought in any court. 6 Section 9.02 - Notification: Employee begins the arbitration process by delivering a written request for arbitration to Employer within the time limits which would apply to the filing of a civil complaint in court. A late request will be void. Section 9.03 - Selection of Arbitrator: If Employee and Employer are unable to agree upon a neutral arbitrator, Employer will obtain a list of arbitrators from the American Arbitration Association. The arbitrator shall be bound by the arbitration procedures set forth in the Model Employment Arbitration Procedures of the American Arbitration Association, including the requirement for a written decision. Each party shall bear its own costs of arbitration except that the Employer shall bear the cost of the arbitrator and any other costs unique to arbitration as opposed to litigation. The arbitrator shall have the authority to order any legal and equitable remedy which would be available in a civil or administrative action on the claim. Section 9.04 - Effect On Other Proceedings: PLEASE NOTE: Nothing in this agreement affects National Labor Relations Board proceedings, petitions for judicial review of a decision issued by the Fair Employment and Housing Commission after an administrative hearing, California Labor Commissioner claims, workers' compensation benefit claims, or the ability of either party to seek appropriate interim injunctive relief pursuant to the California Code of Civil Procedure before or while arbitration proceedings are pending. The parties retain all rights to enter into agreements regarding arbitration after any dispute has arisen. Section 9.05 - Severability: If any court of competent jurisdiction declares that any part of this Arbitration Agreement is illegal, invalid or unenforceable, such a declaration will not affect the legality, validity or enforceability of the remaining parts of the Agreement, and the illegal, invalid or unenforceable part will no longer be part of this Agreement. Section 9.06 - Continuation: The agreements in this part IX shall survive the termination of this agreement and employee's employment with employer and remain in full force and effect thereafter. THIS ARBITRATION AGREEMENT IS A WAIVER OF SOME RIGHTS TO A CIVIL JURY TRIAL FOR CLAIMS ARISING OUT OF EMPOYEE'S EMPLOYMENT WITH THE EMPLOYER. PART X GENERAL PROVISIONS Section 10.01 - Notices: Any notice to be given to Employer under the terms of this Agreement shall be addressed to Employer at the address of its principal place of business, and any notice to be given to Employee shall be addressed to her at her mailing address as either party may hereafter designate in writing to the other. Any such notice shall be deemed to have been duly given when enclosed in a properly sealed and addressed envelope, registered or certified, and deposited (postage or registry or certification fee prepaid), in a post office or branch post office regularly maintained by the United States government. 7 Section 10.02 - Entire Agreement: This Agreement supersedes any and all other agreements or understandings, whether oral, implied, or in writing, between the parties hereto with respect to the subject matter hereof and contains all of the covenants and agreements between the parties with respect to such matters in their entirety. Each party to this Agreement acknowledges that no representations, inducements, promises or agreements, orally or otherwise, have been made by any party, or anyone acting on behalf of any party, which are not embodied herein, and that no other agreement, statement or promise not contained in this agreement shall be valid or binding. Any modification(s) to this Agreement will be effective only if it is in writing and signed by the parties hereto. Section 10.03 - Partial Invalidity: If any provision in this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remaining provisions shall nevertheless continue in full force and effect without being impaired or invalidated in any way. Section 10.04 - Continuing Obligations: Whether or not Employee's employment relationship with Employer is terminated, neither Employer or Employee shall be relieved of the continuing obligations of the covenants contained in this Agreement. Section 10.05 - Employee's Representatives: Employee represents and warrants that she is free to enter into this Agreement and to perform each of the terms and covenants in it. Employee represents and warrants that she is not restricted or prohibited, contractually or otherwise, from entering into and performing this Agreement, and that her execution and performance of this Agreement is not a violation or breach of any other agreement between Employee and any other person or entity. The effective date of employment under this Agreement is December 29, 2000. Dated December 29, 2000 Dated December 29, 2000 Farmers & Merchants Bank of Central California /s/ Deborah E. Hodkin /s/ Lamoin V. Schulz - ---------------------- ------------------------- Deborah E. Hodkin Lamoin V. Schulz Employee Senior Vice President Director of Personnel 8 EX-10 4 form10k_2002exhibit10-6.txt 10-K 2002 EMPLOYMENT CONTRACT FOR NELSON Exhibit 10.6 EMPLOYMENT AGREEMENT PART I PARTIES TO AGREEMENT Section 1.01 - Parties: This Employment Agreement is entered into by and between Farmers & Merchants Bank of Central California, (hereinafter referred to as "Employer") and Chris C. Nelson (hereinafter referred to as "Employee"). PART II EMPLOYMENT Section 2.01 - Employment: Employer hereby employs Employee and Employee hereby accepts employment with Employer in accordance with the terms and condition set forth herein. Section 2.02 - Term of Employment: This Employment Agreement shall be in full force and effect for a period of 36 months, commencing on the effective date of employment of this Employment Agreement. At the end of this said term, this Agreement shall renew automatically for additional one year terms, unless either party furnishes written notice of his or its intention not to renew by no later than sixty (60) days prior to the anniversary of the effective date of employment of this Employment Agreement. Section 2.03 - Regulatory Approval: The parties acknowledge that Employee's employment with the Bank is subject to review and approval of governmental regulatory authorities. The parties shall agree to take all steps necessary to cooperate fully with said regulators in order to expedite the approval process. Employee's contract under this Agreement is subject to, and shall not commence until said regulatory approvals have been obtained. PART III DUTIES OF EMPLOYEE Section 3.01 - General Duties: Subject to Bank's Board of Directors approval, Employee is employed as Executive Vice President and Director of Retail Banking of the Bank under the direction of the Bank's Board of Directors and Chief Executive Officer ("CEO") and shall perform and discharge well and faithfully the duties that may be assigned to him from time to time by the Bank's Board of Directors or Chief Executive Officer ("CEO") in connection with the conduct of the Bank's business. Nothing herein shall preclude the Board of Directors or CEO from changing Employee's title or duties. 1 Section 3.02 - Extent of Services: Employee shall devote his entire business time, attention and energies to the business of the Bank during the term of Employee's employment with the Bank. The foregoing however, shall not preclude Employee from engaging in appropriate civic, charitable, or religious activities or from devoting a reasonable amount of time to private investments or serving on boards of directors of other entities, as long as such activities and services do not interfere or conflict with his responsibilities to the Bank. PART IV COMPENSATION Section 4.01 - Salary: Employee shall be paid a base salary of $145,016.00 per year. This base salary shall be paid to Employee in such intervals and at times as other salaried executives of Employer are presently paid. In addition, upon employment, Employee shall be entitled to $25,000.00 to be paid to employee at the same time the Employer pays its 2001 Officer Discretionary Incentive Compensation (normally paid no later than February 10, 2002). Employee's salary may be adjusted annually beginning in 2003 at the times that other salaried executive officers of Employer are adjusted. Section 4.02 - Incentive Programs: Employee shall be entitled to participate in any Discretionary Incentive Compensation Plan adopted by the Bank from time to time which cover employees in positions comparable to that of employee. Also, subject to Bank's Board of Directors Approval, Employee shall participate in the Bank's Deferred Bonus Plan. PART V BENEFITS Section 5.01 - Benefits: Employee shall be eligible to participate in whatever vacation, medical, dental, pension, sick leave, 401(k), profit-sharing plan, disability insurance or other plans of general application to Employer's senior level employees, as may be in effect from time to time, in accordance with the rules established from time to time for individual participation in any such plans. Section 5.02 - Company Car: Employer shall provide Employee with an automobile or equal, for business and incidental personal use as per Bank policy. Section 5.03 - Membership Fees: Employer shall reimburse Employee for all appropriate and reasonable expenses incurred in performing his duties, including providing membership in local service and civic clubs and/or organizations as the Bank deems appropriate and necessary for enhancement of its presence within the local business community. In order to be eligible for reimbursement of these expenses, Employee will provide Employer with receipts and documented evidence as is required by Federal and State laws and regulations. 2 PART VI EXPENSES Section 6.01 - Travel and Entertainment Expenses: During the term of Employee's employment, Employer shall reimburse Employee for reasonable out of pocket expenses incurred in connection with Employer's business, including travel expenses, food and lodging while away from his home, subject to such policies as Employer may from time to time establish for its employees. Employee shall keep records of his travel and entertainment expenses in a form suitable to the Internal Revenue Service and the Franchise Tax Board to qualify this reimbursement as a federal and state income tax deduction for Employer. Section 6.02 - Moving Expenses: Employee shall be entitle to reimbursement for closing costs associated with the sale and purchase of employee's primary residence up to an amount of $35,000.00 and, upon prior approval by Employer of the expense amount, all reasonable expenses for moving employee's furniture, furnishings and personal items from Granite Bay, California to the Lodi, California area. No reimbursement of closing costs or other moving expenses will be paid if employee does not relocate to the Lodi, California area by August 31, 2002. PART VII TERMINATION OF EMPLOYMENT Section 7.01 - Termination at Option of Employer: Notwithstanding any other section of this Agreement, Employer may terminate this Agreement at any time and without cause by giving Employee sixty (60) days written notice of Employer's intent to terminate this Agreement. In the event Employee's employment is terminated pursuant to Section 7.01 of this Agreement, Employee shall be paid all accrued salary, vacation, and reimbursable expenses for which expense reports have been provided to Employer in accordance with Employer's policies and this Agreement. In addition to the forgoing amounts, if Employee is terminated pursuant to this section of the Agreement, he will be entitled to receipt of additional severance payment as follows: 1. Employee shall be entitled to received up to twelve (12) monthly payments each in the amount equal to one twelfth (1/12) of Employee's then current annual base salary, less any withholding required by law. Any payments due and owing to Employee under this Section will commence on the 15th day of the first month following Employee's termination and shall continue until all payments due and owing Employee are made or until Employee obtains other comparable employment, whichever comes first. 2. For purposes of implementing subparagraph 1 of Section 7.01, Employee agrees to furnish Employer with prompt written notice describing any subsequent employment he secures (including his compensation for such employment) following any termination under this section. 3 3. For purposes of subparagraph 1 of Section 7.01, the term "comparable employment" shall mean any employment in which Employee's compensation (measured by any cash or non-cash payments or benefits) is comparable to his compensation under this Agreement. Any compensation comparison undertaken for the purposes of this Agreement shall be done without regard to any vested or unvested earnings from the Deferred Bonus Plan. 4. In addition to any severance payments due and owing under Section 7.01, Employer may, in its sole discretion, provide Employee with a performance bonus prorated for the number of months between the termination date and the end of Employer's last fiscal year. Section 7.02 - Termination by Employer for Cause: If, at any time during Employee's employment, Employer finds that Employee is found to be guilty of committing acts of dishonesty, theft, embezzlement or other acts of moral turpitude against the Bank, its subsidiaries or affiliates which adversely impact the interests of the Bank or if Employee is negligent in the performance of his assigned duties, Employer may at its option terminate this Agreement by giving written notification of such termination to Employee. In the event Employee is terminated pursuant to this Section, Employee shall be entitled only to the compensation earned by him prior to the date of termination, computed up to and including the date of termination, and shall be entitled to no further compensation or severance payment of any nature. Section 7.03 - Termination at Option of Employee: This Agreement may be terminated by Employee in his sole discretion by giving sixty (60) days written notice of termination to Employer. In the event Employee terminates his employment pursuant to this Section, Employee shall be entitled to the base compensation earned by him computed up to and including the effective date of his termination and he shall be entitled to no further compensation, or severance payment of any nature; provided, however, Employee continues productive employment until such date; and further provided that Employer may, at its option, at any time after Employee gives written notice of resignation as herein provided, pay Employee pro rata compensation as described above up through and including the effective date of termination set forth in Employee's resignation notice, and thereupon immediately release and terminate Employee. Section 7.04 - Continuation of Medical Benefits: In the event Employee's employment is terminated, Employee shall be afforded the right to continue his medical benefits as and to the extent provided in the Consolidated Omnibus Budget Reconciliation Act ("COBRA"). Section 7.05 - Termination of Employee due to Change of Control: In the event the Bank is sold during the term of this Agreement, and in the event Employee is not retained by the purchaser in the same or similar position as described in Section 3.01 of this Agreement, Employer will provide Employee with a severance package equal to one year of annual salary as set at the time the Bank is sold, as well as a pro rata annual performance bonus for the year in which the Termination occurs. In addition, the Employee will also be entitled to all vested awards under the Deferred Bonus Plan. 4 1. "Change of Control" means a change of control of the Bank of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934 (the "Act"), whether or not the Bank is then subject to such reporting requirement; provided, however, that without limitation, such a Change of Control shall be deemed to have occurred if: (a) any person or group (as such terms are used in connection with Sections 13(d) and 14(d) of the Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 and 13d-5 under the Act), directly or indirectly, of securities of the Bank representing 40% or more of the combined voting power of the Bank's then outstanding securities; or (b) the Bank is a party to a merger, consolidation, sale of assets or other reorganization, or a proxy contest, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter. Notwithstanding the foregoing provisions of this paragraph 1., a "Change of Control" will not be deemed to have occurred solely because of the acquisition of securities of the Bank (or any reporting requirement under the Act relating thereto) by an employee benefit plan maintained by the Bank for its employees. Section 7.06 - Exclusive Agreement: The agreement of Employer and Employee respecting the extent of the parties' duties, obligations and liabilities in the event of termination of employment as set forth in Part VII herein is intended to be exclusive and in lieu of any other interests, rights or remedies to which Employer or Employee may otherwise be entitled either at law, in equity, or under this Agreement. Employer and Employee expressly waive any and all such other rights and remedies. PART VIII COVENANTS Section 8.01 - Business and Trade Secrets: Employee specifically agrees that he will not at any time, whether during the period of Employee's employment by Employer or at any time thereafter, in any fashion, form or manner, unless specifically consented to in writing by Employer, either directly or indirectly use or divulge, disclose or communicate to any person, firm or corporation, in any manner whatsoever, any confidential information and trade secrets of any kind, nature or description concerning any matters affecting or relating to the business of Employer, including without limiting the generality of the foregoing, the names, contact persons, business habits or practices, and standards of the Employer, or confidential business or financial information, including the Employer's financial and planning data, compilations of business and financial data, records, reports, customer lists, (including contacts), customers' profitability, studies, manuals, memoranda, notebooks, files, documents, correspondence, and other confidential business or financial information of, about, or concerning the business of the Employer, its manner of operation, or other confidential data of any kind, nature or description, the parties hereto stipulating that as between them, the same are important, material and confidential business and trade secrets and affect the successful conduct of the Employer's business and its goodwill, and that any breach in whole or in part of the term of Part VIII of this Agreement is a material breach of this Agreement. 5 Section 8.02 - Employer's Property: All files, records, compilations, reports, studies, manuals, memoranda, notebooks, documents, correspondence, and other confidential information or records and similar items relating to the business of the Employer, whether prepared by Employee or otherwise coming into his possession, are, and shall remain, the exclusive property of the Employer, and shall be promptly delivered to the Employer in the event of Employee's termination. Section 8.03 - Separate Covenants: The covenants of Part VIII of this Agreement shall be construed as separate covenants covering their particular subject matter. In the event that any covenant shall be found to be judicially unenforceable, said covenant shall not affect the enforceability or validity of any other part of this Agreement. Section 8.04 - Continuing Obligation: Employee's obligations set forth in Part VIII of this Agreement shall expressly continue in effect beyond Employee's employment period in accordance with their terms, and such obligations shall be binding on Employee's assigns, executors, administrators and other legal representatives. Section 8.05 - Enforcement: Employer and Employee acknowledge that Employee is hereunder employed in a sensitive business position where Employee will have access to business and trade secrets as described in Part VIII hereof, and will be rendering personal services of a special, unique, unusual and extraordinary character. In recognition of these facts, Employee agrees that the breach by him of the covenants of this Agreement could not reasonably or adequately be compensated in damages in an action at law and that Employer by reason thereof shall be entitled to preliminary injunctive relief in a court of competent jurisdiction which relief shall include but shall not be limited to restraining Employee from rendering any service or taking any action that would breach such covenants pending a determination of the parties' rights and obligations in resolution/arbitration in accordance with Parts IX hereof. PART IX ARBITRATION AGREEMENT Section 9.01 - Resolution of Disputes: To resolve disputes which might otherwise become civil court cases, Employee and Employer agree to submit all disputes arising out of Employee's employment which may lawfully be the subject of pre-dispute arbitration agreements to final and binding arbitration after the conclusions of any relevant administrative proceedings. Arbitration shall be the exclusive means of resolving any such disputes and no other action will be brought in any court. 6 Section 9.02 - Notification: Employee begins the arbitration process by delivering a written request for arbitration to Employer within the time limits which would apply to the filing of a civil complaint in court. A late request will be void. Section 9.03 - Selection of Arbitrator: If Employee and Employer are unable to agree upon a neutral arbitrator, Employer will obtain a list of arbitrators from the American Arbitration Association. The arbitrator shall be bound by the arbitration procedures set forth in the Model Employment Arbitration Procedures of the American Arbitration Association, including the requirement for a written decision. Each party shall bear its own costs of arbitration except that the Employer shall bear the cost of the arbitrator and any other costs unique to arbitration as opposed to litigation. The arbitrator shall have the authority to order any legal and equitable remedy that would be available in a civil or administrative action on the claim. Section 9.04 - Effect On Other Proceedings: PLEASE NOTE: Nothing in this agreement affects National Labor Relations Board proceedings, petitions for judicial review of a decision issued by the Fair Employment and Housing Commission after an administrative hearing, California Labor Commissioner claims, workers' compensation benefit claims, or the ability of either party to seek appropriate interim injunctive relief pursuant to the California Code of Civil Procedure before or while arbitration proceedings are pending. The parties retain all rights to enter into agreements regarding arbitration after any dispute has arisen. Section 9.05 - Severability: If any court of competent jurisdiction declares that any part of this Arbitration Agreement is illegal, invalid or unenforceable, such a declaration will not affect the legality, validity or enforceability of the remaining parts of the Agreement, and the illegal, invalid or unenforceable part will no longer be part of this Agreement. Section 9.06 - Continuation: The agreements in this part IX shall survive the termination of this agreement and employee's employment with employer and remain in full force and effect thereafter. THIS ARBITRATION AGREEMENT IS A WAIVER OF SOME RIGHTS TO A CIVIL JURY TRIAL FOR CLAIMS ARISING OUT OF EMPOYEE'S EMPLOYMENT WITH THE EMPLOYER. PART X GENERAL PROVISIONS Section 10.01 - Notices: Any notice to be given to Employer under the terms of this business, and any notice to be given to Employee shall be addressed to him at his mailing address as either party may hereafter designate in writing to the other. Any such notice shall be deemed to have been duly given when enclosed in a properly sealed and addressed envelope, registered or certified, and deposited (postage or registry or certification fee prepaid), in a post office or branch post office regularly maintained by the United States government. 7 Section 10.02 - Entire Agreement: This Agreement supersedes any and all other agreements or understandings, whether oral, implied, or in writing, between the parties hereto with respect to the subject matter hereof and contains all of the covenants and agreements between the parties with respect to such matters in their entirety. Each party to this Agreement acknowledges that no representations, inducements, promises or agreements, orally or otherwise, have been made by any party, or anyone acting on behalf of any party, which are not embodied herein, and that no other agreement, statement or promise not contained in this agreement shall be valid or binding. Any modification(s) to this Agreement will be effective only if it is in writing and signed by the parties hereto. Section 10.03 - Partial Invalidity: If any provision in this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remaining provisions shall nevertheless continue in full force and effect without being impaired or invalidated in any way. Section 10.04 - Continuing Obligations: Whether or not Employee's employment relationship with Employer is terminated, neither Employer or Employee shall be relieved of the continuing obligations of the covenants contained in this Agreement. Section 10.05 - Employee's Representatives: Employee represents and warrants that he is free to enter into this Agreement and to perform each of the terms and covenants in it. Employee represents and warrants that he is not restricted or prohibited, contractually or otherwise, from entering into and performing this Agreement, and that his execution and performance of this Agreement is not a violation or breach of any other agreement between Employee and any other person or entity. The effective date of employment under this Agreement is on or about December 10, 2001. Dated December 10, 2001 Dated December 10, 2001 Farmers & Merchants Bank of Central California /s/ Chris C. Nelson /s/ Lamoin V. Schulz - ------------------------- ---------------------------- Chris C. Nelson Lamoin V. Schulz Employee Senior Vice President Director of Personnel 8 EX-10 5 form10k_2002exhibit10-7.txt 10-K 2002 EMPLOYMENT CONTRACT FOR HALEY Exhibit 10.7 EMPLOYMENT AGREEMENT PART I PARTIES TO AGREEMENT Section 1.01 - Parties: This Employment Agreement is entered into by and between Farmers & Merchants Bank of Central California, (hereinafter referred to as "Employer") and Stephen W. Haley (hereinafter referred to as "Employee"). PART II EMPLOYMENT Section 2.01 - Employment: Employer hereby employs Employee and Employee hereby accepts employment with Employer in accordance with the terms and conditions set forth herein. Section 2.02 - Term of Employment: This Employment Agreement shall be in full force and effect for a period of 36 months, commencing on the effective date of employment of this Employment Agreement. At the end of this said term, this Agreement shall renew automatically for additional one year terms, unless either party furnishes written notice of his or its intention not to renew by no later than sixty (60) days prior to the anniversary of the effective date of employment of this Employment Agreement. Section 2.03 - Regulatory Approval: The parties acknowledge that Employee's employment with the Bank is subject to review and approval of governmental regulatory authorities. The parties shall agree to take all steps necessary to cooperate fully with said regulators in order to expedite the approval process. Employee's contract under this Agreement is subject to, and shall not commence until said regulatory approvals have been obtained. 1 PART III DUTIES OF EMPLOYEE Section 3.01 - General Duties: Subject to Bank's Board of Directors approval, Employee is employed as Executive Vice President and Chief Financial Officer of the Bank under the direction of the Bank's Board of Directors and Chief Executive Officer ("CEO") and shall perform and discharge well and faithfully the duties that may be assigned to him from time to time by the Bank's Board of Directors or Chief Executive Officer ("CEO") in connection with the conduct of the Bank's business. Nothing herein shall preclude the Board of Directors or CEO from changing Employee's title or duties as long as the resulting title and duties are reasonably commensurate with the education, employment background, and qualifications of the Employee. Section 3.02 - Outside Activities: Employee agrees that while employed by Bank he will refrain from any outside activity or activities actually in direct conflict with the essential enterprise-related interest of Bank that would cause a material and substantial disruption of the Bank's operation. PART IV COMPENSATION Section 4.01 - Salary: Employee shall be paid a minimum base salary of $178,008.00 per year. This base salary shall be paid to Employee in such intervals and at times as other salaried executives of Employer are presently paid. Employee will be considered for salary increases at the times that other salaried executive officers of Employer are adjusted. Section 4.02 - Incentive Programs: Employee shall be entitled to participate in any Discretionary Incentive Compensation Plan. Beginning with the year ending December 31, 2003, employee shall be eligible for an annual discretionary incentive bonus. The amount of the bonus shall be determined in accordance with the established terms and conditions of the Bank's Discretionary Incentive Compensation Plan adopted by the Bank from time to time which covers employees in positions comparable to that of employee. Also, subject to Bank's Board of Directors Approval, Employee shall participate in the Bank's Deferred Bonus Plan at a bonus Factor (as defined in the Plan Document) of not less than .00158%. 2 PART V BENEFITS Section 5.01 - Benefits: Employee shall be eligible to participate in whatever vacation, medical, dental, pension, sick leave, 401(k), profit-sharing plan, disability insurance or other plans of general application to Employer's senior level employees, as may be in effect from time to time, in accordance with the rules established from time to time for individual participation in any such plans. Section 5.02 - Company Car/Car Allowance: At the discretion of the Employer, Employer shall provide Employee with either an automobile for business and incidental personal use as per Bank policy or an automobile allowance of $700.00 per month. Section 5.03 - Membership Fees: Employer shall reimburse Employee for all appropriate and reasonable expenses incurred in performing his duties, including providing membership in local service and civic clubs and/or organizations as the Bank deems appropriate and necessary for enhancement of its presence within the local business community. In order to be eligible for reimbursement of these expenses, Employee will provide Employer with receipts and documented evidence as is required by Federal and State laws and regulations. PART VI EXPENSES Section 6.01 - Travel and Entertainment Expenses: During the term of Employee's employment, Employer shall reimburse Employee for reasonable out of pocket expenses incurred in connection with Employer's business, including travel expenses, food and lodging while away from his home, subject to such policies as Employer may from time to time establish for its employees. Employee shall keep records of his travel and entertainment expenses in a form suitable to the Internal Revenue Service and the Franchise Tax Board to qualify this reimbursement as a federal and state income tax deduction for Employer. Section 6.02 - Moving Expenses: Employee shall be paid $35,000.00 within 45 days of Employees date of hire to compensate employee for expenses relating to the relocation of Employee to the Lodi, California area. Upon prior approval, Employer will also reimburse Employee for (1) reasonable transportation, food and lodging costs for Employee and his wife incurred during up to 2 house hunting trips to the Lodi area, (2) normal buyers closing costs including a maximum of 1% of any new loan fees associated with purchase of employee's Lodi area residence, and (3) all reasonable expenses (excluding any expenses for temporary storage) for moving Employee's furniture, furnishings and personal items from employee's current residence to the Lodi, California area. 3 Section 6.03 - Temporary Housing: Employee shall be reimbursed for temporary housing expense for up to 6 months (or until employee secures permanent housing whichever comes first) at an amount not to exceed $1,600.00 per month. PART VII TERMINATION OF EMPLOYMENT Section 7.01 - Termination at Option of Employer: Notwithstanding any other section of this Agreement, Employer may terminate this Agreement at any time and without cause by giving Employee sixty (60) days written notice of Employer's intent to terminate this Agreement. In the event Employee's employment is terminated pursuant to Section 7.01 of this Agreement, Employee shall be paid all accrued salary, vacation, and reimbursable expenses for which expense reports have been provided to Employer in accordance with Employer's policies and this Agreement. In addition to the forgoing amounts, if Employee is terminated pursuant to this section of the Agreement, he will be entitled to receipt of additional severance payment as follows: 1. Employee shall be entitled to received up to twelve (12) monthly payments each in the amount equal to one twelfth (1/12) of Employee's then current annual base salary, less any withholding required by law. Any payments due and owing to Employee under this Section will commence on the 15th day of the first month following Employee's termination and shall continue until all payments due and owing Employee are made or until Employee obtains other comparable employment, whichever comes first. 2. In addition, the Employee will also be entitled to all vested awards of benefit plans in which employee is vested (including the Deferred Bonus Plan) in accordance with the terms of those plans. 3. For purposes of implementing subparagraph 1 of Section 7.01, Employee agrees to furnish Employer with prompt written notice describing any subsequent employment he secures (including his compensation for such employment) following any termination under this section. 4. For purposes of subparagraph 1 of Section 7.01, the term "comparable employment" shall mean any employment in which Employee's compensation (measured by any cash or non-cash payments or benefits) is comparable to his compensation under this Agreement. Any compensation comparison undertaken for the purposes of this Agreement shall be done without regard to any vested or unvested earnings from the Deferred Bonus Plan. 5. In addition to any severance payments due and owing under Section 7.01, Employer may, in its sole discretion, provide Employee with a performance bonus prorated for the number of months between the termination date and the end of Employer's last fiscal year. 4 Section 7.02 - Termination by Employer : If, at any time during Employee's employment, Employer finds that Employee is found to be guilty of committing acts of dishonesty, theft, embezzlement or other acts of moral turpitude against the Bank, its subsidiaries or affiliates which adversely impact the interests of the Bank or if Employee is deemed by employer to be negligent in the performance of his assigned duties, Employer may at its option terminate this Agreement by giving written notification of such termination to Employee. In the event Employee is terminated pursuant to this Section, Employee shall be entitled only to the compensation earned by him prior to the date of termination, computed up to and including the date of termination, and shall be entitled to no further compensation or severance payment of any nature. Section 7.03 - Termination at Option of Employee: This Agreement may be terminated by Employee in his sole discretion by giving sixty (60) days written notice of termination to Employer. In the event Employee terminates his employment pursuant to this Section, Employee shall be entitled to the base compensation earned by him computed up to and including the effective date of his termination and he shall be entitled to no further compensation, or severance payment of any nature; provided, however, Employee continues productive employment until such date; and further provided that Employer may, at its option, at any time after Employee gives written notice of resignation as herein provided, pay Employee pro rata compensation as described above up through and including the effective date of termination set forth in Employee's resignation notice, and thereupon immediately release and terminate Employee. Section 7.04 - Continuation of Medical Benefits: In the event Employee's employment is terminated, Employee shall be afforded the right to continue his medical benefits as and to the extent provided in the Consolidated Omnibus Budget Reconciliation Act ("COBRA"). Section 7.05 - Termination of Employee due to Change of Control: In the event of a change of control of the Bank during the term of this Agreement, and in the event Employee is not retained by the purchaser in the same or similar position in which the title and duties are reasonably commensurate with the education, employment background, and qualifications of the Employee, Employer will provide Employee with a severance package equal to one year of the Employee's annual salary as set at the time the change of control occurs, as well as a pro rata annual performance bonus for the year in which the termination occurs. In addition, the Employee will also be entitled to all vested awards of benefit plans in which employee is vested (including the Deferred Bonus Plan) in accordance with the terms of those plans. All payments due Employee under this Section will be paid within ninety (90) days of termination. 1. "Change of Control" means a change of control of the Bank of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934 (the "Act"), whether or not the Bank is then subject to such reporting requirement; provided, however, that without limitation, such a Change of Control shall be deemed to have occurred if: 5 (a) any person or group (as such terms are used in connection with Sections 13(d) and 14(d) of the Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 and 13d-5 under the Act), directly or indirectly, of securities of the Bank representing 40% or more of the combined voting power of the Bank's then outstanding securities; or (b) the Bank is a party to a merger, consolidation, sale of assets or other reorganization, or a proxy contest, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter. Notwithstanding the foregoing provisions of this paragraph 1., a "Change of Control" will not be deemed to have occurred solely because of the acquisition of securities of the Bank (or any reporting requirement under the Act relating thereto) by an employee benefit plan maintained by the Bank for its employees. Section 7.06 - Exclusive Agreement: The agreement of Employer and Employee respecting the extent of the parties' duties, obligations and liabilities in the event of termination of employment as set forth in Part VII herein is intended to be exclusive and in lieu of any other interests, rights or remedies to which Employer or Employee may otherwise be entitled either at law, in equity, or under this Agreement. Employer and Employee expressly waive any and all such other rights and remedies. PART VIII COVENANTS Section 8.01 - Business and Trade Secrets: Employee specifically agrees that he will not at any time, whether during the period of Employee's employment by Employer or at any time thereafter, in any fashion, form or manner, unless specifically consented to in writing by Employer, either directly or indirectly use or divulge, disclose or communicate to any person, firm or corporation, in any manner whatsoever, any confidential information and trade secrets of any kind, nature or description concerning any matters affecting or relating to the business of Employer, including without limiting the generality of the foregoing, the names, contact persons, business habits or practices, and standards of the Employer, or confidential business or financial information, including the Employer's financial and planning data, compilations of business and financial data, records, reports, customer lists, (including contacts), customers' profitability, studies, manuals, memoranda, notebooks, files, documents, correspondence, and other confidential business or financial information of, about, or concerning the business of the Employer, its manner of operation, or other confidential data of any kind, nature or description, the parties hereto stipulating that as between them, the same are important, material and confidential business and trade secrets and affect the successful conduct of the Employer's business and its goodwill, and that any breach in whole or in part of the term of Part VIII of this Agreement is a material breach of this Agreement. 6 Section 8.02 - Employer's Property: All files, records, compilations, reports, studies, manuals, memoranda, notebooks, documents, correspondence, and other confidential information or records and similar items relating to the business of the Employer, whether prepared by Employee or otherwise coming into his possession, are, and shall remain, the exclusive property of the Employer, and shall be promptly delivered to the Employer in the event of Employee's termination. Section 8.03 - Separate Covenants: The covenants of Part VIII of this Agreement shall be construed as separate covenants covering their particular subject matter. In the event that any covenant shall be found to be judicially unenforceable, said covenant shall not affect the enforceability or validity of any other part of this Agreement. Section 8.04 - Continuing Obligation: Employee's obligations set forth in Part VIII of this Agreement shall expressly continue in effect beyond Employee's employment period in accordance with their terms, and such obligations shall be binding on Employee's assigns, executors, administrators and other legal representatives. PART IX ARBITRATION AGREEMENT Section 9.01 - Resolution of Disputes: To resolve disputes which might otherwise become civil court cases, Employee and Employer agree to submit all disputes arising out of Employee's employment which may lawfully be the subject of pre-dispute arbitration agreements to final and binding arbitration after the conclusions of any relevant administrative proceedings. Arbitration shall be the exclusive means of resolving any such disputes and no other action will be brought in any court. Section 9.02 - Notification: Employee begins the arbitration process by delivering a written request for arbitration to Employer within the time limits which would apply to the filing of a civil complaint in court. A late request will be void. Section 9.03 - Selection of Arbitrator: If Employee and Employer are unable to agree upon a neutral arbitrator, Employer will obtain a list of arbitrators from the American Arbitration Association. The arbitrator shall be bound by the arbitration procedures set forth in the Model Employment Arbitration Procedures of the American Arbitration Association, including the requirement for a written decision. Each party shall bear its own costs of arbitration except that the Employer shall bear the cost of the arbitrator and any other costs unique to arbitration as opposed to litigation. The arbitrator shall have the authority to order any legal and equitable remedy that would be available in a civil or administrative action on the claim. 7 Section 9.04 - Effect On Other Proceedings: PLEASE NOTE: Nothing in this agreement affects National Labor Relations Board proceedings, petitions for judicial review of a decision issued by the Fair Employment and Housing Commission after an administrative hearing, California Labor Commissioner claims, workers' compensation benefit claims, or the ability of either party to seek appropriate interim injunctive relief pursuant to the California Code of Civil Procedure before or while arbitration proceedings are pending. The parties retain all rights to enter into agreements regarding arbitration after any dispute has arisen. Section 9.05 - Severability: If any court of competent jurisdiction declares that any part of this Arbitration Agreement is illegal, invalid or unenforceable, such a declaration will not affect the legality, validity or enforceability of the remaining parts of the Agreement, and the illegal, invalid or unenforceable part will no longer be part of this Agreement. Section 9.06 - Continuation: The agreements in this part IX shall survive the termination of this agreement and employee's employment with employer and remain in full force and effect thereafter. THIS ARBITRATION AGREEMENT IS A WAIVER OF SOME RIGHTS TO A CIVIL JURY TRIAL FOR CLAIMS ARISING OUT OF EMPOYEE'S EMPLOYMENT WITH THE EMPLOYER. PART X GENERAL PROVISIONS Section 10.01 - Notices: Any notice to be given to Employer under the terms of this business, and any notice to be given to Employee shall be addressed to him at his mailing address as either party may hereafter designate in writing to the other. Any such notice shall be deemed to have been duly given when enclosed in a properly sealed and addressed envelope, registered or certified, and deposited (postage or registry or certification fee prepaid), in a post office or branch post office regularly maintained by the United States government. Section 10.02 - Entire Agreement: This Agreement supersedes any and all other agreements or understandings, whether oral, implied, or in writing, between the parties hereto with respect to the subject matter hereof and contains all of the covenants and agreements between the parties with respect to such matters in their entirety. Each party to this Agreement acknowledges that no representations, inducements, promises or agreements, orally or otherwise, have been made by any party, or anyone acting on behalf of any party, which are not embodied herein, and that no other agreement, statement or promise not contained in this agreement shall be valid or binding. Any modification(s) to this Agreement will be effective only if it is in writing and signed by the parties hereto. Section 10.03 - Partial Invalidity: If any provision in this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remaining provisions shall nevertheless continue in full force and effect without being impaired or invalidated in any way. Section 10.04 - Continuing Obligations: Whether or not Employee's employment relationship with Employer is terminated, neither Employer or Employee shall be relieved of the continuing obligations of the covenants contained in this Agreement. Section 10.05 - Employee's Representatives: Employee represents and warrants that he is free to enter into this Agreement and to perform each of the terms and covenants in it. Employee represents and warrants that he is not restricted or prohibited, contractually or otherwise, from entering into and performing this Agreement, and that his execution and performance of this Agreement is not a violation or breach of any other agreement between Employee and any other person or entity. The effective date of employment under this Agreement is on or about April 1, 2003. FARMERS & MERCHANTS BANK OF CENTRAL CALIFORNIA By: /s/ Lamoin V. Schulz March 25, 2003 --------------------------- -------------- Lamoin V. Schulz Date Senior Vice President Director of Human Resources Employee: /s/ Stephen W. Haley March 25, 2003 --------------------------- -------------- Stephen W. Haley Date 8 EX-13 6 form10k_2002exhibit13.txt 10-K 2002 ANNUAL REPORT TO SHAREHOLDERS Exhibit 13 Farmers & Merchants Bancorp 2002 Annual Report 1 To Our Shareholders: Farmers & Merchants Bancorp's record 2002 financial results are a testament to the skill and commitment of our employees, the patronage of our valued customers, the vitality of the Central Valley economy, and the dedication of our shareholders. Throughout our 86-year history, these advantages have enabled the Company to prosper financially and at the same time, maintain a strong community focus. During 2002, our established growth trend continued resulting in the Company surpassing a key milestone of $1 billion in total assets. At the same time, we continued to upgrade our product delivery and technological capabilities in preparation for additional expansion. We are pleased to present to you Farmers & Merchants Bancorp's consolidated annual financial reports for fiscal year 2002; the most profitable and successful year in our history. Net income after taxes totaled $13,419,203 or $18.18 per share of common stock, up 11.5% over the prior year. The growth in earnings per share occurred because of a 16% increase in total loans outstanding, a 7% rise in total deposits net of time certificates, and a 30% jump in non-interest income less non-recurring items. Return on assets strengthened to 1.41% from 1.35% the prior year and return on equity improved 37 basis points to 13.51% in 2002 compared to 13.14% in 2001. In conjunction with these strong results, the Company completed over $2,000,000 in capital improvements and increased the allowance for future loan losses to $16,684,487, a $3,975,308 increase over the prior year, to provide a larger level of protection against the financial impact of future economic downturns. Last April, for the 28th consecutive year, the Board of Directors unanimously approved a 5% stock dividend. In addition, cash dividends declared in 2002 totaled $4,403,582 or $6.00 per share of common stock, a 12.3% increase over the prior year. The Board of Directors is currently evaluating the merits of transitioning to a more uniform quarterly cash dividend payment. Their analysis is taking into consideration a variety of factors including the best interests of the shareholders, the Company's financial condition and capacity, and regulatory requirements. Several important initiatives were rolled out this past year including the exciting new image campaign designed to build the F&M Bank brand name. For years, your Company has been affectionately referred to as "F&M Bank". To appeal to a broader customer base, we have updated our image and will more consistently make use of the simpler name, F&M Bank. We have designed a new logo and adopted the catchy slogan "Where Banking is Easy!" to support our strategy of creating new growth opportunities for the Company. Other key initiatives in 2002 included the installation of the new Southwest Bell/Cisco telecommunications system and the opening of our first branch office in over a decade at the prestigious Lincoln Center in Stockton. The new branch was an instant success achieving first year growth targets in just four months. As part of the effort to build our brand name and modernize the Bank's image, we have also completed the model architectural design for future F&M Bank branch offices. Our new Vintage Faire office, scheduled to open this Summer, will be the first branch to use the new model bank design. The design work was also completed for updated F&M Bank signage with installation beginning in 2003. In addition, we upgraded our personal computer network hardware and software and converted to the next generation of check/document imaging technology. Looking to the future, the downward trend of market interest rates will continue to exert pressure on the banking industry's net interest margin creating a challenging earnings environment. The Board of Directors and Management Team at Farmers & Merchants Bancorp will address these challenges by seeking greater operating efficiency, expanding our market penetration, and strengthening capital management and asset/liability discipline. Efforts to enhance our product distribution capabilities will be ongoing. We believe our geographic market offers growth opportunities and are confident the scope, functionality and value of our products and customer solutions will differentiate Farmers & Merchants Bancorp from the competition. These ingredients, in the hands of our talented team of employees, have the potential to build meaningful value for our shareholders. A special thank you is extended to our employees for their hard work and enormous contributions in 2002. Acknowledgement is owed as well to the Board of Directors for their dedication and extraordinary efforts in representing the shareholders' best interests. Furthermore, their guidance and support were of great value to the management team. We also thank our many outstanding customers. We immensely value your business and feel privileged to be able to serve your banking needs. This great financial institution has stood strong for over 86 years. We look back with tremendous pride and forward with great enthusiasm and excitement. Our shareholders have always been a source of strength for the Bank. Your continued confidence and satisfaction with your investment in Farmers & Merchants Bancorp remains of the utmost importance to us. We extend our best wishes to you for a healthy and prosperous 2003. /s/ Kent A. Steinwert /s/ Ole R. Mettler Kent A. Steinwert Ole R. Mettler President & Chief Executive Officer Chairman of the Board 2 FARMERS & MERCHANTS BANCORP Mission Statement To become "THE PREMIER" community bank serving the financial needs of communities throughout California's Great Central Valley. To successfully accomplish this mission, the Company will: |X| Consistently provide shareholders with a competitive return on investment. |X| Strengthen and discipline capital management. |X| Be staffed by highly skilled and motivated employees, properly supported by continuing education, advanced technology and quality products. |X| Carefully target and successfully penetrate desired market segments. |X| Deliver an extraordinary level of personalized service backed by value added financial products. |X| Conservatively manage all risks. |X| Be exemplary in community development, reinvestment and service. |X| Develop and foster local ownership in order to maintain independence. 3 FARMERS & MERCHANTS BANCORP Operating Philosophy Farmers & Merchants Bancorp was founded, and exists today, for the purpose of generating a competitive return for it's shareholders through the delivery of financial services to the communities it serves. In order to accomplish this purpose, we will strive to benefit four distinct constituents: shareholders, customers, employees and the communities we serve. Although the short-term interests of these groups may occasionally differ, in the long run we believe them to be complimentary. We are convinced that our purpose can only be achieved through diligent attention to all four. Building the Company's financial strength by delivering a reliable stream of earnings is fundamental to the interest of each group. The Company's economic viability has positive implications for all concerned. We are committed to maintaining the Company's independence in order to accomplish our purpose of pro-actively benefiting each constituent. The Board of Directors and Executive Management Team recognizes that each constituent has different needs and aspirations, and are committed to the following goals: |X| Shareholders, our owners, can expect a competitive return on their investment, taking into consideration the maintenance of capital adequacy and capital expenditure requirements. We strive to build their pride of ownership in an organization respected for it's accomplishments, and recognized for community leadership. |X| Customers, whose patronage allows us to function and prosper, are entitled to financial services of the highest quality, delivered by knowledgeable and caring employees. Our customers must be assured of a reasonable return on the deposits entrusted to us, and fair terms on borrowed funds. We acknowledge that the protection of their deposits, as well as their personal privacy, are absolute priorities. We will always strive to deliver a level of service that is "beyond their expectations." Making banking easy for the customer is a core strategy. |X| Employees, who are skilled and dedicated, are fundamental to our success. They can anticipate fair compensation, respect, acknowledgment of superior performance, a productive and healthy work environment, equal employment opportunity, and an employer in whom they can take great pride. |X| The communities we serve can expect a commitment to reinvestment, leadership in pursuing economic vitality, and an ongoing effort to improve the overall quality of life. We will be diligent in aiding community based service organizations through both financial and volunteer support. 4 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, 2002, 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, 2002. /s/ Kent A. Steinwert /s/ John R. Olson Kent A. Steinwert John R. Olson President & Executive Vice President & Chief Executive Officer Chief Financial Officer 5 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 statements of income, of changes in shareholders' equity, of comprehensive income and of cash flows present fairly, in all material respects, the financial position of Farmers & Merchants Bancorp and its subsidiaries at December 31, 2002 and 2001, 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. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP February 18, 2003 6 Consolidated Statements of Income
- --------------------------------------------------------------------------------------------------------------------------- (in thousands except per share data) Year Ended December 31, 2002 2001 2000 - --------------------------------------------------------------------------------------------------------------------------- Interest Income Interest and Fees on Loans $41,911 $43,956 $44,171 Interest on Federal Funds Sold and Securities Purchased Under Agreements to Resell 555 1,922 1,300 Interest on Investment Securities: Taxable 9,400 15,112 17,574 Tax-Exempt 2,372 2,540 3,082 - --------------------------------------------------------------------------------------------------------------------------- Total Interest Income 54,238 63,530 66,127 - --------------------------------------------------------------------------------------------------------------------------- Interest Expense Interest on Deposits 11,369 21,038 21,845 Interest on Borrowed Funds 2,227 2,242 2,912 - --------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 13,596 23,280 24,757 - --------------------------------------------------------------------------------------------------------------------------- Net Interest Income 40,642 40,250 41,370 Provision for Loan Losses 4,926 1,000 2,800 - --------------------------------------------------------------------------------------------------------------------------- Net Interest Income After Provision for Loan Losses 35,716 39,250 38,570 - --------------------------------------------------------------------------------------------------------------------------- Non-Interest Income Service Charges on Deposit Accounts 4,760 4,179 3,464 Net Gain (Loss) on Sale of Investment Securities 276 88 (120) Credit Card Merchant Fees 1,415 1,207 976 Gain on Sale of Assets 2,800 - - Increase in Cash Surrender Value of Life Insurance 1,433 - - Other 3,182 2,900 2,328 - --------------------------------------------------------------------------------------------------------------------------- Total Non-Interest Income 13,866 8,374 6,648 - --------------------------------------------------------------------------------------------------------------------------- Non-Interest Expense Salaries and Employee Benefits 17,796 16,986 16,235 Occupancy Expense 1,709 1,680 1,730 Equipment Expense 2,146 2,026 1,916 Other 7,458 6,794 7,667 - --------------------------------------------------------------------------------------------------------------------------- Total Non-Interest Expense 29,109 27,486 27,548 - --------------------------------------------------------------------------------------------------------------------------- Income Before Income Taxes 20,473 20,138 17,670 Provision for Income Taxes 7,054 7,821 6,650 - --------------------------------------------------------------------------------------------------------------------------- Net Income $13,419 $12,317 $11,020 =========================================================================================================================== Earnings Per Share $ 18.18 $ 16.31 $ 14.54 ===========================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 7 Consolidated Balance Sheets
- ---------------------------------------------------------------------------------------------------------------------------- (in thousands except per share data) December 31, Assets 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents: Cash and Due from Banks $ 45,389 $ 32,406 Federal Funds Sold and Securities Purchased Under Agreements to Resell 8,185 31,100 - ---------------------------------------------------------------------------------------------------------------------------- Total Cash and Cash Equivalents 53,574 63,506 - ---------------------------------------------------------------------------------------------------------------------------- Investment Securities: Available-for-Sale 206,063 242,852 Held-to-Maturity 27,870 32,698 - ---------------------------------------------------------------------------------------------------------------------------- Total Investment Securities 233,933 275,550 - ---------------------------------------------------------------------------------------------------------------------------- Loans: 696,675 602,169 Less: Allowance for Loan Losses 16,684 12,709 - ---------------------------------------------------------------------------------------------------------------------------- Loans, Net 679,991 589,460 - ---------------------------------------------------------------------------------------------------------------------------- Premises and Equipment, Net 11,342 11,432 Interest Receivable and Other Assets 43,067 30,935 - ---------------------------------------------------------------------------------------------------------------------------- Total Assets $1,021,907 $970,883 ============================================================================================================================ Liabilities Deposits: Demand $ 205,997 $198,316 Interest-Bearing Transaction Accounts 93,646 100,574 Savings 231,964 198,651 Time 318,618 322,170 - ---------------------------------------------------------------------------------------------------------------------------- Total Deposits 850,225 819,711 - ---------------------------------------------------------------------------------------------------------------------------- Federal Funds Purchased 16,997 - Federal Home Loan Bank Advances 40,965 41,000 Interest Payable and Other Liabilities 10,155 9,436 - ---------------------------------------------------------------------------------------------------------------------------- Total Liabilities 918,342 870,147 - ---------------------------------------------------------------------------------------------------------------------------- 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, 733,021 and 719,269 Issued and Outstanding at December 31, 2002 and 2001, Respectively 7 7 Additional Paid-In Capital 64,979 61,360 Retained Earnings 36,749 36,499 Accumulated Other Comprehensive Income 1,830 2,870 - ---------------------------------------------------------------------------------------------------------------------------- Total Shareholders' Equity 103,565 100,736 - ---------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $1,021,907 $970,883 ============================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 8 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, 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 - --------------------------------------------------------------------------------------------------------------------------- Net Income 13,419 13,419 Cash Dividends Declared on Common Stock (4,404) (4,404) 5% Stock Dividend 34,501 8,625 (8,625) Cash Paid in Lieu of Fractional Shares Related to Stock Dividend (140) (140) Redemption of Stock (20,749) (5,006) (5,006) Unrealized Gains on Derivative Instruments 117 117 Minimum Pension Plan Liability Adjustment (731) (731) Change in Net Unrealized Gain (Loss) on Securities Available-for-Sale (426) (426) - --------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002 733,021 $ 7 $64,979 $36,749 $ 1,830 $103,565 ===========================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 9 Consolidated Statements of Cash Flows
- ---------------------------------------------------------------------------------------------------------------------------- (in thousands) Year Ended December 31, 2002 2001 2000 - ---------------------------------------------------------------------------------------------------------------------------- Operating Activities Net Income $ 13,419 $ 12,317 $ 11,020 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Loan Losses 4,926 1,000 2,800 Depreciation and Amortization 1,584 1,592 1,760 Provision for Deferred Income Taxes (836) (38) (730) Net Amortization of Investment Security Premium & Discounts 10 (314) (435) Net (Gain) Loss on Sale of Investment Securities (276) (88) 120 Net (Increase) Decrease in Interest Receivable and Other Assets (10,945) (18,307) (1,325) Net Increase in Interest Payable and Other Liabilities (12) 479 (4,516) - ---------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Operating Activities 7,870 (3,359) 8,694 - ---------------------------------------------------------------------------------------------------------------------------- Investing Activities Securities Available-for-Sale: Purchased (113,687) (26,704) (42,873) Sold or Matured 150,026 66,548 69,161 Securities Held-to-Maturity: Purchased (329) (6,460) (398) Matured 5,214 15,142 8,493 Net Increase in Loans (95,792) (105,526) (84,916) Principal Collected on Loans Previously Charged Off 335 587 217 Net Additions to Premises and Equipment (1,495) (1,468) (609) - ---------------------------------------------------------------------------------------------------------------------------- Net Cash Used for Investing Activities (55,728) (57,881) (50,925) - ---------------------------------------------------------------------------------------------------------------------------- Financing Activities Net Increase in Demand, Interest-Bearing Transaction, and Savings Accounts 34,066 57,351 10,735 Net (Decrease) in Time Deposits (3,552) (2,318) 68,800 Net Increase in Federal Funds Purchased 16,997 - - Net (Decrease) in Federal Home Loan Bank Advances (35) (33) (31) Stock Redemption (5,006) (488) (1,258) Cash Dividends (4,544) (4,056) (3,709) - ---------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 37,926 50,456 74,537 - ---------------------------------------------------------------------------------------------------------------------------- Increase (Decrease) in Cash and Cash Equivalents (9,932) (10,784) 32,306 Cash and Cash Equivalents at Beginning of Year 63,506 74,290 41,984 - ---------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $53,574 $63,506 $74,290 ============================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 10 Consolidated Statements of Comprehensive Income
- -------------------------------------------------------------------------------------------------------------------------- (in thousands) Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------------------------------------------------- Net Income $13,419 $12,317 $11,020 Other Comprehensive Income (Loss) Unrealized Gains on Derivative Instruments: Unrealized holding gains arising during the period, net of income tax effects of $85 for the year ended December 31, 2002 117 - - Unrealized (Loss) on Minimum Pension Plan Liability Adjustment: Unrealized (loss) arising during the period, net of income tax effects of $(531) for the year ended December 31, 2002 (731) - - Unrealized Gains (Losses) on Securities: Unrealized holding gains (losses) arising during the period, net of income tax effects of $(117), $1,492 and $3,188 for the years ended December 31, 2002, 2001 and 2000, respectively. (266) 2,131 4,558 Less: Reclassification adjustment for realized (gains) losses included in net income, net of related income tax effects of $(116), $(37) and $49 for the years ended December 31, 2002, 2001 and 2000, respectively. (160) (51) 71 - -------------------------------------------------------------------------------------------------------------------------- Total Other Comprehensive Income (Loss) (1,040) 2,080 4,629 - -------------------------------------------------------------------------------------------------------------------------- Comprehensive Income $12,379 $14,397 $15,649 ==========================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 11 Notes to Consolidated Financial Statements 1. Significant Accounting Policies Farmers & Merchants Bancorp (the Company) was organized March 10, 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 subsidiaries, F&M Bancorp, Inc. and the Bank, along with the Bank's wholly owned subsidiaries, Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. The investment in the Bank is carried at the Company's equity in the underlying net assets. Significant intercompany transactions have been eliminated in consolidation. F&M Bancorp, Inc. was created in March 2002 to protect the name F&M Bank, Farmers & Merchants Investment Corporation has been dormant since 1991. Farmers/Merchants Corp. acts as trustee on deeds of trust originated by the Bank. Certain amounts in the prior years' financial statements and related footnote disclosures have been reclassified to conform to the current-year presentation. These reclassifications have no effect on previously reported income. Information in this report dated prior to March 10, 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. 12 Trading securities, if any, are acquired for short-term appreciation and are recorded in a trading portfolio and are carried at fair value, with unrealized gains and losses recorded in non-interest income. Loans Loans are reported at the principal amount outstanding net of unearned discounts and deferred loan fees. Interest income on loans is accrued daily on the outstanding balances using the simple interest method. Loan origination fees are deferred and recognized over the contractual life of the loan as an adjustment to the yield. Loans are placed on a non-accrual status when the collection of principal or interest is in doubt or when they become past due for 90 days or more unless they are both well-secured and in the process of collection. For this purpose a loan is considered well-secured if it is collateralized by property having a net realizable value in excess of the amount of the loan or is guaranteed by a financially capable party. When a loan is placed on non-accrual status, the accrued and unpaid interest receivable is reversed and charged against current income, thereafter, interest income is recognized only as it is collected in cash. Loans placed on a non-accrual status are returned to accrual status when the loans are paid current as to principal and interest and future payments are expected to be made in accordance with the contractual terms of the loan. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is impaired, the recorded amount of the loan in the Consolidated Balance Sheets is based on the present value of expected future cash flows discounted at the loan's effective interest rate or on the observable or estimated market price of the loan or the fair value of the collateral if the loan is collateral dependent. Impaired loans are placed on a non-accrual status with income reported accordingly. Cash payments are first applied as a reduction of the principal balance until collection of the remaining principal and interest can be reasonably assured. 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 employs a systematic methodology for determining the allowance for loan losses. On a quarterly basis, management reviews the credit quality of the loan portfolio and considers problem loans, delinquencies, internal credit reviews, current economic conditions, loan loss experience and other factors in determining the adequacy of the allowance balance. The conditions evaluated in connection with the allowance may include existing general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentration, seasoning of the loan portfolio, specific industry conditions, recent loss experience, duration of the current business cycle, bank regulatory examination results and findings of the Company's internal credit examiners. 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. 13 Premises and Equipment Premises, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is computed principally by the straight line method over the estimated useful lives of the assets. Estimated useful lives of buildings range from 30 to 40 years, and for furniture and equipment from 3 to 8 years. Leasehold improvements are amortized over the lesser of the terms of the respective leases, or their useful lives, which are generally 5 to 10 years. Remodeling and capital improvements are capitalized while maintenance and repairs are charged directly to occupancy expense. Other Real Estate Other real estate owned, which is included in other assets, is comprised of properties acquired through foreclosures in satisfaction of indebtedness. These properties are recorded at fair value less estimated selling costs upon acquisition. Revised estimates to the fair value less cost to sell are reported as adjustments to the carrying amount of the asset, provided that such adjusted value is not in excess of the carrying amount at acquisition. Initial losses on properties acquired through full or partial satisfaction of debt are treated as credit losses and charged to the Allowance for Loan Losses at the time of acquisition. Subsequent declines in value from the recorded amounts, routine holding costs, and gains or losses upon disposition, if any, are included in non-interest income or expense as incurred. Income Taxes As required, the Company uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year. Earnings Per Share 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, 2002. 14 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 derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. Changes in the fair value of those derivatives are accounted for depending on the intended use of the derivative and the resulting designation under specified criteria. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, designed to minimize interest rate risk, the effective portions of the change in the fair value of the derivative are recorded in other comprehensive income. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. As required, SFAS No. 133 was adopted by the Company effective January 1, 2001. The Company utilizes derivative financial instruments such as interest rate caps, floors, swaps and collars. These instruments are purchased and/or sold to reduce the Company's exposure to changing interest rates. The Company marks to market the value of its derivative financial instruments and reflects gain or loss in earnings in the period of change or in other comprehensive income. 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, pension plan liability adjustments and cash flow hedges. 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 2002 and 2001, 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, 2002 Cost Gains Losses Value ---------------------------------------------------------------------------------------------------- Securities of U.S. Government Agencies $ 26,584 $ 400 $ - $ 26,984 Obligations of States and Political Subdivisions 33,372 1,023 43 34,352 Mortgage-Backed Securities 114,878 2,457 - 117,335 Corporate Bonds 17,579 124 - 17,703 Other 9,432 257 - 9,689 - ------------------------------------------------------------------------------------------------------ Total $201,845 $4,261 $ 43 $206,063 ====================================================================================================== December 31, 2001 ---------------------------------------------------------------------------------------------------- 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 ======================================================================================================
15 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, 2002 Value Gains Losses Value ------------------------------------------------------------------------------------------------------ Obligations of States and Political Subdivisions $27,351 $1,230 $ 2 $28,579 Other 519 13 - 532 ------------------------------------------------------------------------------------------------------ Total $27,870 $1,243 $ 2 $29,111 ====================================================================================================== December 31, 2001 ------------------------------------------------------------------------------------------------------ Obligations of States and Political Subdivisions $32,137 $ 825 $ 13 $32,949 Other 561 36 - 597 ------------------------------------------------------------------------------------------------------ Total $32,698 $ 861 $ 13 $33,546 ======================================================================================================
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. The remaining principal maturities of debt securities as of December 31, 2002 and 2001 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, 2002 (in thousands) 1 Year Within 5 Within 10 10 years Value ------------------------------------------------------------------------------------------------------------------ Securities of U.S. Government Agencies $ - $ 26,984 $ - $ - $26,984 Obligations of States and Political Subdivisions 2,088 26,654 4,638 972 34,352 Mortgage-Backed Securities 64,047 43,030 10,257 - 117,334 Corporate Bonds 8,163 9,541 - - 17,704 Other 4,596 5,093 - - 9,689 ------------------------------------------------------------------------------------------------------------------ Total $78,894 $111,302 $14,895 $ 972 $206,063 ================================================================================================================== 2001 Totals $78,495 $154,805 $ 8,567 $ 985 $242,852 ==================================================================================================================
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 $ 7,234 $16,144 $ 1,699 $2,274 $27,351 Other - - - 519 519 ------------------------------------------------------------------------------------------------------------------ Total $ 7,234 $16,144 $ 1,699 $2,793 $27,870 ================================================================================================================== 2001 Totals $ 4,510 $20,566 $ 3,365 $4,257 $32,698 ==================================================================================================================
Proceeds from sales of securities available-for-sale were as follows:
(in thousands) Gross Gross Gross Proceeds Gains Losses - -------------------------------------------------------------------------------------------------------------------- 2002 $24,862 $276 $ - 2001 5,206 88 - 2000 $21,744 $506 $199
As of December 31, 2002, securities carried at $105,949,000 were pledged to secure public and other deposits as required by law. 16 4. Loans and Allowance for Loan Losses Loans as of December 31, consisted of the following:
(in thousands) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- Real Estate $367,224 $304,451 Real Estate Construction 66,467 49,692 Agricultural 109,130 110,707 Commercial 135,877 117,202 Consumer 19,995 21,133 - ------------------------------------------------------------------------------------------------------------------- 698,693 603,185 Less: Unearned Income on Loans (2,018) (1,016) - ------------------------------------------------------------------------------------------------------------------- Total Loans $696,675 $602,169 =================================================================================================================== Non-Accrual Loans $ 2,897 $ 2,353 ===================================================================================================================
Changes in the allowance for loan losses consisted of the following: (in thousands)
2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Balance, January 1 $12,709 $11,876 $ 9,787 Provision Charged to Operating Expense 4,926 1,000 2,800 Recoveries of Loans Previously Charged Off 335 587 218 Loans Charged Off (1,286) (754) (929) - ------------------------------------------------------------------------------------------------------------------- Balance, December 31 $16,684 $12,709 $11,876 ===================================================================================================================
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, 2002 and 2001, the total recorded investment in impaired loans was $2,897,000 and $2,353,000, respectively. The related allowance for impaired loans was $1,289,000 and $190,000 for the years ended 2002 and 2001, 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 $4.7 million, $1.1 million and $2.3 million for the years ended 2002, 2001 and 2000, respectively. There was no interest income reported on impaired loans in 2002, 2001 and 2000. Interest income forgone on loans placed on nonaccrual status was $331,000, $26,000 and $71,000 for the years ended December 31, 2002, 2001 and 2000, respectively. 5. Premises and Equipment Premises and equipment as of December 31, consisted of the following:
(in thousands) 2002 2001 - ----------------------------------------------------------------------------------------------------------------- Land and Buildings $16,023 $15,830 Furniture, Fixtures and Equipment 15,464 14,429 Leasehold Improvements 1,062 835 - ----------------------------------------------------------------------------------------------------------------- 32,549 31,094 Less: Accumulated Depreciation and Amortization 21,207 19,662 - ----------------------------------------------------------------------------------------------------------------- Total $11,342 $11,432 =================================================================================================================
17 Depreciation and amortization on premises and equipment included in occupancy and equipment expense amounted to $1,585,000, $1,592,000 and $1,760,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Total rental expense for premises were $248,000, $212,000 and $270,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Rental income was $73,000, $70,000 and $81,000 for the years ended December 31, 2002, 2001 and 2000, respectively. 6. Other Real Estate The Bank reported no other real estate at December 31, 2002 and 2001. 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. 7. Time Deposits Time Deposits of $100,000 or more were as follows: (in thousands)
December 31, 2002 2001 - ------------------------------------------------------------------------------------------------------------------ Balance $148,005 $146,432 ==================================================================================================================
At December 31, 2002, the scheduled maturities of time deposits were as follows: Scheduled
(in thousands) Maturities - ------------------------------------------------------------------------------------------------------------------- 2003 $272,784 2004 23,778 2005 12,071 2006 9,985 2007 and thereafter - - ------------------------------------------------------------------------------------------------------------------- Total $318,618 ===================================================================================================================
8. Income Taxes Current and deferred income tax expense (benefit) provided for the years ended December 31, consisted of the following:
(in thousands) 2002 2001 2000 ----------------------------------------------------------------------------------------------------------------- Current Federal $5,506 $5,673 $5,229 State 2,384 2,186 2,151 - ----------------------------------------------------------------------------------------------------------------- Total Current 7,890 7,859 7,380 - ----------------------------------------------------------------------------------------------------------------- Deferred Federal (503) (33) (493) State (333) (5) (237) - ----------------------------------------------------------------------------------------------------------------- Total Deferred (836) (38) (730) - ----------------------------------------------------------------------------------------------------------------- Total Provision for Taxes $7,054 $7,821 $6,650 =================================================================================================================
18 The total provision for income taxes differs from the federal statutory rate as follows: (in thousands)
2002 2001 2000 Amount Rate Amount Rate Amount Rate - ------------------------------------------------------------------------------------------------------------------- Tax Provision at Federal Statutory Rate $7,165 35.0 % $7,048 35.0 % $6,185 35.0 % Interest on Obligations of States and Political Subdivisions Exempt from Federal Taxation (806) (3.9)% (658) (3.3)% (740) (4.2)% State and Local Income Taxes, Net of Federal Income Tax Benefit 1,333 6.5 % 1,418 7.0 % 1,263 7.2 % Bank Owned Life Insurance (523) (2.6)% Other, Net (115) (0.6)% 13 0.1 % (58) (0.4)% - ------------------------------------------------------------------------------------------------------------------- Total Provision for Taxes $7,054 34.4 % $7,821 38.8 % $6,650 37.6 % ===================================================================================================================
The components of the net deferred tax assets as of December 31 are as follows:
(in thousands) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- Deferred Tax Assets Allowance for Loan Losses $7,015 $5,084 Accrued Liabilities 507 892 Deferred Compensation 1,160 999 Other Real Estate - 309 State Franchise Tax 834 765 Interest on Non-Accrual Loans 80 11 - ------------------------------------------------------------------------------------------------------------------- Total Deferred Tax Assets 9,596 8,060 - ------------------------------------------------------------------------------------------------------------------- Deferred Tax Liabilities Depreciation (214) (229) Unrealized Gain on Securities Available-for-Sale (1,774) (2,051) Securities Accretion (933) (1,039) Pension (1,079) (269) Other 278 (156) - ------------------------------------------------------------------------------------------------------------------- Total Deferred Tax Liabilities (3,722) (3,744) - ------------------------------------------------------------------------------------------------------------------- Net Deferred Tax Assets $5,874 $4,316 ===================================================================================================================
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, 2002 and 2001, the Company had unused lines of credit available for short term liquidity purposes of $284 million and $136 million, respectively. Federal Funds purchased and advances from the Federal Reserve Bank are generally issued on an overnight basis. 19 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) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- 5.35% note payable due February 4, 2008 with interest due quarterly, callable February 2, $25,000 $25,000 2003 and quarterly thereafter. 5.38% note payable due August 12, 2008 with interest due quarterly, callable August 12, 15,000 15,000 2003 and quarterly thereafter. 5.60% amortizing note, interest and principal payable monthly with final maturity of September 25, 2018. 965 1,000 - ------------------------------------------------------------------------------------------------------------------- Total $40,965 $41,000 ===================================================================================================================
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 $39,097,000. 11. Shareholders' Equity Beginning in 1975 and continuing through 2002, 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, 2002, the Bank could declare dividends of $14,489,000 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, 2002 and 2001, 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. 20
Well Capitalized Regulatory Capital Under Prompt (in thousands) Actual Requirements Corrective Action December 31, 2002 Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------------------------------------------------------------------------------- Total Bank Capital to Risk Weighted Assets $108,191 11.73% $73,766 8.0% $92,208 10.0% Total Consolidated Capital to Risk Weighted Assets $113,370 12.25% $74,058 8.0% N/A N/A Tier I Bank Capital to Risk Weighted Assets $ 96,602 10.48% $36,883 4.0% $55,325 6.0% Tier I Consolidated Capital to Risk Weighted Assets $101,735 10.99% $37,029 4.0% N/A N/A Tier I Bank Capital to Average Assets $ 96,602 9.84% $39,259 4.0% $49,074 5.0% Tier I Consolidated Capital to Average Assets $101,735 10.32% $39,439 4.0% N/A N/A 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
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. The following schedule states the change in benefit obligations for the years ended December 31:
(in thousands) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- Benefit Obligation at Beginning of Year $3,502 $6,033 Service Cost 33 247 Reduction due to Census Gain 233 (597) Reduction due to Curtailment - (1,749) Interest Cost 222 285 Benefits Paid (695) (717) Actuarial Loss 246 - - ------------------------------------------------------------------------------------------------------------------- Total Benefit Obligation at End of Year $3,541 $3,502 =================================================================================================================== The Change in Plan Assets are as follows: (in thousands) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- Fair Value of Plan Assets at Beginning of Year $4,444 $5,346 Employer Contribution - 40 Benefits Paid (695) (717) Actual Return on Plan Assets (645) (225) - ------------------------------------------------------------------------------------------------------------------- Total Fair Value of Plan Assets at End of Year $3,104 $4,444 ===================================================================================================================
21 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) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- Benefit Obligation $3,541 $3,502 Fair Value of Plan Assets 3,104 4,444 - ------------------------------------------------------------------------------------------------------------------- Funded Status (437) 942 Unrecognized Net Asset at Transition - - Unrecognized Prior Service Cost - (2) Unrecognized Net Loss 1,348 20 Adjustment Required to Recognize Minimum Liability (1,262) - - ------------------------------------------------------------------------------------------------------------------- Net Amounts Recognized $ (351) $ 960 =================================================================================================================== Amounts Recognized: (in thousands) - ------------------------------------------------------------------------------------------------------------------- Prepaid Benefit Cost $ - $ 960 Accrued Benefit Liability (351) - Intangible Asset - - - ------------------------------------------------------------------------------------------------------------------- Net Amounts Recognized $ (351) $ 960 ===================================================================================================================
The components of the net periodic benefit costs are as follows:
(in thousands) 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Service Cost $ 33 $ 247 $ 572 Interest Cost 222 284 404 Expected Return on Plan Assets (217) (414) (473) Amortization of Unrecognized Net Asset at Transition - (11) (28) Unrecognized Prior Service Cost ( 1) ( 3) ( 7) Unrecognized Net Loss 13 23 57 - ------------------------------------------------------------------------------------------------------------------- Total Net Periodic Benefit Cost $ 50 $ 126 $ 525 =================================================================================================================== Adjustment Required to Recognize Minimum Liability $1,262 - - =================================================================================================================== Assumptions Used in the Accounting were: Discount Rate (Settlement Rate) 6.75% 7.25% 7.25% Rate of Increase in Salary Levels 4.00% 4.00% 4.00% Expected Return on Assets 6.00% 9.00% 9.00% ===================================================================================================================
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 $625,000, $545,000 and $515,000 for the years ended December 31, 2002, 2001 and 2000, 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. 22 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 $522,000 and $491,000, for the years ended December 31, 2002 and 2001, respectively. 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 $222,000, $175,000 and $132,000 for the years ended December 31, 2002, 2001 and 2000, 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:
2002 2001 Carrying Estimated Carrying Estimated ASSETS: (in thousands) Amount Fair Value Amount Fair Value - ------------------------------------------------------------- ------------- ------------- ------------ ------------- Cash and Cash Equivalents $ 53,574 $ 53,574 $ 63,506 $ 63,506 Investment Securities Held-to-Maturity 27,870 29,111 32,698 33,546 Investment Securities Available-for-Sale 206,063 206,063 242,852 242,852 Loans, Net of Unearned Income 696,675 697,351 602,169 598,817 Less: Allowance for Loan Losses 16,684 16,684 12,709 12,709 Loans, Net of Allowance 679,991 680,667 589,460 586,109 LIABILITIES: Deposits: Noninterest-bearing 205,997 205,997 198,316 198,316 Interest-bearing 644,228 647,291 621,395 597,098 Federal Home Loan Bank Advances 40,965 45,671 41,000 41,241
The methods and assumptions used to estimate the fair value of each class of financial instrument listed in the table above 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. 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. 23 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, 2002 and 2001. 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, 2002 and 2001. 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. Derivative Instruments and Hedging Activities The Company uses derivative instruments to limit its exposure to declining interest rates. The Company's current program relative to interest rate protection primarily contemplates fixing the rates on variable rate loans. To do this, the Company has developed a Hedging Policy to provide guidelines that address instruments to be used, authority limits, implementation guidelines, guidelines for evaluating hedge alternatives, reporting requirements, and the credit worthiness of the instruments counterparty. The Company reviews compliance with these guidelines annually with the ALCO Committee and the Board of Directors. The guidelines may change as the Company's business needs dictate. As of November 6, 2002 the Company entered into a no cost collar with a maturity date of November 8, 2004: one interest rate floor with a notional amount of $40 million and an interest rate cap with a notional amount of $40 million. Every month actual prime rate is reviewed and the collar has the following impact on the Company for the notional amount: |X| For the floor, if prime is less than 4.75%, the Company receives the difference between the current prime and 4.75%, calculated on a daily basis and paid monthly. |X| For the cap, if prime is greater than 5.26%, the Company pays the difference between the current prime and 5.26%, calculated on a daily basis and paid monthly. As required, the Company records in the balance sheet the cap and floor at fair value. Because the transaction meets the criteria for a cash-flow hedge, changes in fair value are reported in other comprehensive income. In the event that a portion of the hedge becomes ineffective, the ineffective portion of the derivative's change in fair value will be immediately recognized in earnings. 24 15. 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 $15,635,000 at December 31, 2002, and $6,163,000 at December 31, 2001. Outstanding standby letters of credit had original terms ranging from 4 to 108 months with final expiration in 2004. 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 $269,211,000 and $245,699,000 as of December 31, 2002 and 2001, 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, 2002 were $151,000, $148,000, $148,000, $111,000, and $45,000 for the years 2003 to 2007 and $98,000 thereafter. 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 2002 or at December 31, 2002 and 2001. 16. 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. 25 Loan transactions with Directors, executive officers and their affiliated companies during the year ended December 31, 2002, were as follows: (in thousands) - ----------------------------------------------------- Loan Balances December 31, 2001 $2,033 Disbursements During 2002 2,943 Loan Reductions During 2002 2,561 - ----------------------------------------------------- Loan Balances December 31, 2002 $2,415 ===================================================== 17. 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. 26 18. Parent Company Financial Information The financial information below is presented as of December 31, 2002 and December 31, 2001. Farmers & Merchants Bancorp Balance Sheet
(in thousands) 2002 2001 - -------------------------------------------------------------------------------------------------------------------- Cash $ 1,597 $ 1,925 Investment in Farmers and Merchants Bank of Central California 96,601 94,011 Investment Securities 3,104 4,380 Loans - 87 Other Assets 491 368 - -------------------------------------------------------------------------------------------------------------------- Total Assets $101,793 $100,771 ==================================================================================================================== Liabilities $ - $ 35 Shareholders' Equity 101,793 100,736 - -------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders Equity $101,793 $100,771 ====================================================================================================================
Farmers & Merchants Bancorp Income Statement for the period ending December 31,
2002 2001 2000 - -------------------------------------------------------------------------------------------------------------------- Equity Earnings in Farmers and Merchants Bank of Central California $ 13,561 $ 12,538 $11,178 Interest Income 167 42 - Other Expenses, Net (309) (263) (158) - -------------------------------------------------------------------------------------------------------------------- Net Income $ 13,419 $ 12,317 $11,020 ====================================================================================================================
Farmers & Merchants Bancorp Statement of Cash Flows for the period ending December 31,
2002 2001 2000 - -------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net Income $13,419 $12,317 $11,020 Adjustments to Reconcile Net Income to Net Cash Used in Operating Activities: Equity in Undistributed Net Earnings from Subsidiary (5,460) (2,938) (5,374) Net Increase in Interest Receivable and Other Assets (200) (161) (122) - -------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 7,759 9,218 5,524 - -------------------------------------------------------------------------------------------------------------------- Investing Activities: Securities Purchased (47) (4,291) (308) Securities Sold or Matured 1,423 254 - Net Loans Originated 87 27 (114) - -------------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities 1,463 (4,010) (422) - -------------------------------------------------------------------------------------------------------------------- Financing Activities: Stock Redemption (5,006) (488) (1,258) Cash Dividends (4,544) (4,056) (3,709) - -------------------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities (9,550) (4,544) (4,967) - -------------------------------------------------------------------------------------------------------------------- Increase in Cash and Cash Equivalents (328) 664 135 Cash and Cash Equivalents at Beginning of Year 1,925 1,261 1,126 - -------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 1,597 $ 1,925 $ 1,261 ====================================================================================================================
27 Five Year Financial Summary of Operations (in thousands, except per share data)
2002 2001 2000 1999 1998 - -------------------------------------------------------------------------------------------------------------------- Total Interest Income $54,238 $63,530 $66,127 $56,055 $51,194 Total Interest Expense 13,596 23,280 24,757 18,862 17,428 ------------------------------------------------------------------------------------------------------------------ Net Interest Income 40,642 40,250 41,370 37,193 33,766 Provision for Loan Losses 4,926 1,000 2,800 1,700 1,400 ------------------------------------------------------------------------------------------------------------------ Net Interest income After Provision for Loan Losses 35,716 39,250 38,570 35,493 32,366 Total Non-Interest Income 13,866 8,374 6,648 5,658 5,819 Total Non-Interest Expense 29,109 27,486 27,548 27,021 26,095 ------------------------------------------------------------------------------------------------------------------ Income Before Income Taxes 20,473 20,138 17,670 14,130 12,090 Provision for Income Taxes 7,054 7,821 6,650 4,914 4,030 ------------------------------------------------------------------------------------------------------------------ Net Income $13,419 $12,317 $11,020 $ 9,216 $ 8,060 ================================================================================================================== Balance Sheet Data Total Assets $1,021,907 $970,883 $905,551 $819,881 $758,799 Loans 696,675 602,169 497,397 413,409 329,178 Allowance for Loan Losses 16,684 12,709 11,876 9,787 8,589 Investment Securities 233,933 275,550 320,654 346,855 374,170 Deposits 850,225 819,711 764,678 685,143 627,387 Federal Home Loan Bank Advances 40,965 41,000 41,033 41,064 41,093 Shareholders' Equity 103,565 100,736 90,883 80,201 79,405 Selected Ratios Return on Average Assets 1.41% 1.35% 1.29% 1.19% 1.17% Return on Average Equity - Net of Accumulated 13.51% 13.14% 12.38% 10.95% 10.31% Other Comprehensive Income Dividend Payout Ratio 33.86% 32.93% 33.66% 36.30% 38.91% Average Loan to Average Deposits 79.71% 68.37% 59.96% 52.93% 48.93% Average Equity - Net of Accumulated Other 10.43% 10.25% 10.40% 10.86% 11.33% Comprehensive Income - to Average Assets Period-end Shareholders' Equity to Total Assets 10.13% 10.38% 10.04% 9.78% 10.46% Per Share Data (1) Net Income $18.18 $16.31 $14.54 $12.08 $10.53 Cash Dividends Declared $6.00 $5.45 $5.00 $4.50 $4.20
(1) Net Income per share is based on the weighted average number of shares outstanding of 738,081, 755,140, 757,974, 763,096 and 765,437 for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively. Prior years' per share data has been restated for the 5% stock dividend issued in each of the above years. 28 Quarterly Financial Data (in thousands, except for per share data)
First Second Third Fourth 2002 Quarter Quarter Quarter Quarter Total ----------------------------------------------------------------------------------------------------------------- Total Interest Income $13,685 $13,554 $13,564 $13,435 $54,238 Total Interest Expense 3,884 3,423 3,218 3,071 13,596 ------------------------------------------------------------------------------------------------------------------ Net Interest Income 9,801 10,131 10,346 10,364 40,642 Provision for Loan Losses 200 300 500 3,926 4,926 ------------------------------------------------------------------------------------------------------------------ Net Interest Income After Provision for Loan Losses 9,601 9,831 9,846 6,438 35,716 Total Non-Interest Income 2,204 2,951 2,731 5,980 13,866 Total Non-Interest Expense 6,946 7,559 7,152 7,452 29,109 ------------------------------------------------------------------------------------------------------------------ Income Before Income Taxes 4,859 5,223 5,425 4,966 20,473 Provision for Income Taxes 1,797 1,903 1,980 1,374 7,054 ------------------------------------------------------------------------------------------------------------------ Net Income $ 3,062 $ 3,320 $ 3,445 $ 3,592 $13,419 ================================================================================================================== Earnings Per Share (1) $ 4.10 $ 4.51 $ 4.68 $ 4.89 $ 18.18 ================================================================================================================== 2001 ------------------------------------------------------------------------------------------------------------------ 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) $ 4.02 $ 4.18 $ 4.19 $ 3.92 $ 16.31 ==================================================================================================================
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 2002, 2001 and 2000, $2.00, $1.95 and $1.85 per share, respectively, and for December 2002, 2001, and 2000, $4.00, $3.50 and $3.40 per share, respectively. Based on information from shareholders and from Company stock transfer records, the prices paid in 2002, 2001 and 2000 ranged from $320.00 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. 29 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 2002 and 2001, 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 March 10, 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 2001 and 2000 have been restated to reflect the 5% stock dividend declared during 2002. Overview At the completion of our 86th year, management is pleased to present the highest reported income in the Company's history. As of December 31, 2002, Farmers & Merchants Bancorp reported net income of $13,419,000, earnings per share of $18.18, return on average assets of 1.41% and return on average equity of 13.51% (net of accumulated other comprehensive income). For the year 2001, net income totaled $12,317,000, earnings per share was $16.31, return on average assets was 1.35% and return on average equity was 13.14% (net of accumulated other comprehensive income). For the year 2000, net income totaled $11,020,000, earnings per share was $14.54 for the year, return on average assets was 1.29%, and the return on average shareholders' equity totaled 12.38% (net of accumulated other comprehensive income). As of December 31, 2002, consolidated assets were $1.0 billion, gross loans were $696.7 million and deposits were $850.2 million. Total consolidated assets increased $51.4 million, gross loans increased $94.5 million and deposits grew $30.5 million. The Company's improved financial performance in 2002 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. 30 The following is a summary of the financial accomplishments achieved during 2002: |X| Net interest income was $40,642,000 compared to $40,250,000 reported during 2001. |X| The provision for loan losses was $4,926,000 during 2002 compared to $1,000,000 in 2001. |X| Non-interest income (net of securities transactions) increased 64.0% during 2002, when compared to 2001. |X| Non-interest expense increased by $2.6 million during 2002 compared to a decrease of $62 thousand in 2001. |X| The Company's effective tax rate was reduced to 34.6% compared to 38.8% in 2001. |X| Total assets increased 5.3% to $1,021,907,000. |X| Total loans increased 15.7% to $696,675,000. |X| Non-accrual loans were $3,021,000 which was 0.43% of total loans at December 31, 2002. |X| Total investment securities were reduced to $233,933,000 from $275,550,000 in 2001. |X| Total Shareholders' Equity increased to $104,296,000 from $100,736,000 in 2001. Net Interest Income The principal component of the Company's earnings is net interest income which 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. The net interest spread is the yield on average earning assets minus the cost of average interest-bearing liabilities. 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. The Company's net interest income, interest spread and net interest margin are affected by general economic conditions. These conditions include interest rates, inflation, monetary supply and strength of the economy in the Company's service area. The Company manages net interest income through affecting changes in the volume and mix of average interest earning assets and average interest bearing liabilities, as well as the growth of earning assets. 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 increased 1.0% to $40.6 million during 2002. During 2001, net interest income was $40.3 million, representing a decrease of 2.7% from 2000. On a fully taxable equivalent basis, net interest income increased 1.0% and totaled $42.0 million during 2002, compared to $41.6 million for 2001. In 2000, on a taxable equivalent basis, net interest income increased 10.1% or $3.9 million from that of 1999. 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 2002, the net interest margin was 4.76% compared to 4.78% in 2001. The decrease in the net interest margin during 2002 was due to a decline in interest rates, the change in the earning asset mix and a change in the liability mix. The decline in net interest margin in 2001, was the result of the unprecedented decline in interest rates and competitive deposit rate climate in the Bank's market area. 31 It is difficult to attribute the changes in net interest income to any one factor. However, the banking and financial services businesses in the Company's market area are highly competitive. This competition has an influence on the strategies the Company employs. The predominant reasons for the increase in net interest income during 2002 was the Company's change in the asset and liability mix of the balance sheet. In addition, interest rates continued to decline throughout 2002, which also had an impact on the year. Average earning assets increased 1.4%, earnings on those assets decreased by $9.3 million. Average interest bearing liabilities grew by 2.8% and interest paid on those liabilities decreased by $9.7 million. The Bank's earning assets reprice more quickly than the deposit products causing a temporary 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 2003. Loans, the Company's highest earning asset, increased $94.5 million as of December 31, 2002 compared to 2001. On an average balance basis, loans increased by $112.7 million during the year, which, considering the decline in interest rates, helped minimize the decrease in interest and fees on loans of $2.0 million. The average yield on the loan portfolio declined 180 basis points to 6.6% in 2002 compared to 8.4% in 2001. 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, high-grade municipals and high-grade corporate bonds. 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 $5.9 million due to a reduction in average investment securities of $81.9 million during 2002. The reduction in investment securities was used to partially fund the growth in loans. The average yield, on a taxable equivalent basis, in the investment portfolio was 6.2% for 2002 and 6.5% for both 2001 and 2000. Net interest income on a taxable equivalent basis is 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 45.9% or $9.7 million in 2002. In spite of the decline in market rates during 2002, the Bank was able to grow average interest bearing deposits by $17.9 million. The increase was primarily in savings deposits, which grew $34.7 million, as higher cost time deposits were reduced by $25.6 million. Total interest expense on deposit accounts for 2002 was $11.4 million. In 2001, interest expense on deposits was $21.0 million. The average rate paid on interest-bearing deposits was 1.8% in 2002 and 3.5% in 2001. 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. 32 The provision for loan losses totaled $4.9 million in 2002, compared to $1.0 million in 2001. The increase in the provision was the result of management's evaluation of the credit quality of the loan portfolio, loan growth, 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, 2002, the allowance for loan losses was $16.7 million, which represented 2.4% of the total loan balance. At December 31, 2001 the allowance for loan losses was $12.7 million or 2.1% 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, the increase in the cash surrender value of bank owned life insurance, the sale of assets and other real estate owned. Before securities transactions, non-interest income totaled $13.6 million for 2002. This represents an increase of $5.3 million, or 64.0%, from non-interest income of $8.3 million for 2001. During 2001, non-interest income increased $1.5 million or 22.4% over non-interest income of $6.8 million for 2000. Service charges on deposit accounts totaled $4.8 million in 2002. This represented an increase of $581 thousand or 13.9% over service charges on deposit accounts of $4.2 million in 2001. Service charges of demand deposit accounts for business customers are generally charged based on an analysis of their activity. The activity charges for a given month may be offset by an earnings credit. The lower interest rate environment resulted in a lower account earnings credit thus increasing service charges on business deposit accounts. Service charges in 2001 increased $715 thousand or 20.6% over service charges on deposit accounts of $3.5 in 2000. The Bank provides merchant bankcard services to business customers in its service area. Fees of $1.4 million were generated in 2002. This represents an increase of $208 thousand or 17.2% over fees generated of $1.2 million in 2001. Fees of $976 thousand were generated in 2000. During 2002 the Bank purchased life insurance on its key executives. The increase in the cash surrender value for 2002 was $1.4 million and is reported as a separate line item on the consolidated statements of income. During the fourth quarter of 2002, the Bank recorded a gain of $2.8 million from the sale of preferred stock previously acquired through a troubled debt restructuring. Other non-interest income increased $282 thousand in 2002 or 9.8%. In 2001, other non-interest income totaled $2.9 million compared to the $2.3 million of non-interest income recorded in 2000. Fees from these services include ATM fees, wire transfer fees, gain on sale of mortgage loans and other miscellaneous charges 33 Non-Interest Expense Non-interest expense for the Company includes expenses for salaries and benefits, occupancy, equipment, supplies, professional services, data processing, marketing, deposit insurance, other real estate, credit card operations, and other miscellaneous expenses. Non interest expense totaled $30.1 million during 2002. For both 2001 and 2000, non-interest expense totaled $27.5 million. Salaries and employee benefits, the largest component of non-interest expense, increased $1.8 million in 2002, representing an increase of 10.3% over that of 2001. During 2001, the increase was $751 thousand or 4.6% over 2000. The increase was primarily the net result of merit increases for Company employees along with incentive bonuses. At the end of 2002, the Company had 292.0 full time equivalent employees compared to 304.0 at the end of 2001 and 296.2 at the end of 2000. Occupancy and equipment expenses represent the cost of operating and maintaining branch and administrative facilities, including the purchase and maintenance of furniture, fixtures, office and equipment and data processing equipment. Occupancy expense increased 1.7% during 2002. Equipment expense increased $120 thousand or 5.9% and totaled $2.1 million during 2002. During 2001, equipment expense increased 5.7% or $110 thousand over the previous year. Other operating expense totaled $7.5 million, a 9.8% increase from the prior year. This increase in other operating expense was due to an increase in marketing and promotional efforts during 2002. During 2001, other operating expense was $6.8 million compared to $7.7 million in 2000. The Company, through the Bank, sponsors a defined benefit pension plan (the Plan) covering Bank employees. In June 2001, the Plan was amended to freeze benefit accruals, except for employees aged 55 with 10 years of service. The Company's recorded liability for Plan benefits is based on a number of assumptions, including life expectancies, retirement rates, long-term interest rates, long-term rates of return on investments and future compensation levels. These assumptions are periodically reviewed by the Company and revised when appropriate. Changes in one or more of these assumptions could affect the amount of the Company's recorded pension expense for Plan benefits. If the actual experience differs from expectations, the Company's results of operations in future periods could be affected. As part of its most recent review, the Company in 2002, reduced its expected long-term rate of return on plan assets to 6.0% from 9.0% to reflect revised expectations for long-term investment returns. It also reduced its discount rate for pensions to 6.75% from 7.25%. The Company presently expects pension expense to increase in future periods. In January of 2003, the Company made a Plan contribution of approximately $1.9 million in respect of its 2002 Plan funding requirements. This contribution will affect the Company's balance sheet, but will not directly impact earnings. The Company's future Plan funding obligation depends on a number of factors and cannot be reasonably estimated at the present time. For additional information, see Note 12 of Notes to Consolidated Financial Statements. Income Taxes The provision for income taxes decreased 9.8% during 2002 as a result of the purchase of bank owned life insurance in which the increase in cash surrender value is tax exempt. The provision for income taxes increased 17.6% in 2001 due to improved earnings and an increase in the effective tax rate over that of 2000. The effective tax rate in 2002 was 34.5% compared to 38.8% in 2001 and 37.6% in 2000. 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. 34 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 22.9% of the Company's total assets during 2002 and 28.4% of the Company's total assets during 2001. Not included in the investment portfolio are overnight investments in Federal Funds Sold. In 2002, average Federal Funds Sold on a year to date basis was $33.0 million compared to $51.9 million in 2001. The Company's investment portfolio at the end of 2002 was $233.9 million a reduction of $41.6 million from 2001. The proceeds from the investment portfolio were used to fund the Company's loan growth during 2002. On an average balance basis, the Company's investments in non-taxable obligations of states and political subdivisions were $51.0 million in 2002, and $54.5 million for 2001. 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 subjected to more stringent reporting and oversight. Fixed-rate real estate loans are comprised primarily of loans with maturities of five years or less. Long-term residential loans are originated by the Company and sold in the secondary market. As of December 31, 2002, loans totaled $696.7 million, a 15.7% increase over that of 2001. On an average balance basis the Company's loan portfolio increased $112.7 million over the average balance in 2001. In 2001, average balances increased from the prior year by 14.8% or $67.7 million. This increase was due to strong loan demand in the Company's market area along with an aggressive calling program. 35 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, 2002, non-accrual loans were $3.0 million compared to $2.4 million at the end of 2001. Managing problem loans continues to be an important Company objective. The Company reported no foreclosed loans as other real estate in 2002 and in 2001. Interest forgone on loans placed on a non-accrual status totaled $331 thousand at December 31, 2002. Non-accrual loans to total loans for the year ended 2002 was 0.4%. For the year ended 2001 the percentage was 0.4%. 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, 2002, deposits totaled $850.2 million. This represents an increase of $30.5 million or 3.7% from the deposit totals of $819.7 million reported in 2001. The increase was concentrated in demand and savings deposits, which increased $7.7 million and $33.3 million, respectively. The Company increased its marketing efforts for deposits during 2002 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 2002, some customers moved from time deposits to demand 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 5.4% in 2002 compared to 5.5% in 2001. 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 $104.3 million at December 31, 2002 and $100.7 million at the end of 2001. 36 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, 2002, the Company's risk based capital was 11.73%; well above regulatory risk based capital guidelines. In 1998, the Shareholders approved a stock repurchase program. During 2002, the company repurchased 20,749 shares at an average share price of $241 per share. In 2001, the Company repurchased 2,053 shares at an average share price of $238. 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. Credit risk in the investment portfolio and correspondent bank accounts is addressed through defined limits in the Bank's policy statements. In addition, certain securities carry insurance to enhance credit quality of the bond. Credit risk in the loan portfolio is controlled by limits on industry concentration, aggregate customer borrowings and geographic boundaries. Standards on loan quality also are designed to reduce loan credit risk. Senior Management, Directors' Committees, and the Board of Directors are provided with information to appropriately identify, measure, control and monitor the credit risk of the Bank. The Company's methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers all loans. The systemic methodology consists of two major elements. The first major element includes a detailed analysis of the loan portfolio in two phases. The first phase is conducted in accordance with SFAS No. 114, "Accounting by Creditors for the Impairment of a Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures." Individual loans are reviewed to identify loans for impairment. A loan is impaired when principal and interest are deemed uncollectable in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan's effective interest rate, the fair value of the loan's collateral if the loan is collateral dependent, or an observable market price of the loan (if one exists). Upon measuring the impairment, the Company will insure an appropriate level of allowance is present or established. Central to the first phase and the Company's credit risk management is its loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is based primarily on a thorough analysis of each borrower's financial position in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior credit administration personnel. Credits are monitored by credit administration personnel for deterioration in a borrower's financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary. 37 Based on the risk rating system specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates the possibility of loss. Management performs a detailed analysis of these loans, including, but not limited to, cash flows, appraisals of the collateral, conditions of the marketplace for liquidating the collateral and assessment of the guarantors. Management then determines the inherent loss potential and allocates a portion of the allowance for losses as a specific allowance for each of these credits. The second phase is conducted by segmenting the loan portfolio by risk rating and into groups of loans with similar characteristics in accordance with SFAS No. 5, "Accounting for Contingencies". In this second phase, groups of loans are reviewed and applied the appropriate allowance percentage to determine a portfolio formula allowance. The second major element in the Company's methodology for assessing the appropriateness of the allowance consists of management's considerations of all known relevant internal and external factors that may affect a loan's collectibility. This includes management's estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral and other relevant factors. The relationship of the two major elements of the allowance to the total allowance may fluctuate from period to period. In the second major element of the analysis which considers all known relevant internal and external factors that may affect a loan's collectibility is based upon management's evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the second element of the analysis of the allowance include, but are not limited to the following conditions that existed as of the balance sheet date: |X| then-existing general economic and business conditions affecting the key lending areas of the Company; |X| credit quality trends (including trends in |X| non-performing loans expected to result from existing conditions); |X| collateral values; |X| loan volumes and concentrations; |X| seasoning of the loan portfolio; |X| specific industry conditions within portfolio segments; |X| recent loss experience in particular segments of the portfolio; |X| duration of the current business cycle; |X| bank regulatory examination results and |X| findings of the Company's internal credit examiners. 38 Management reviews these conditions in discussion with the Company's senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the inherent loss related to such condition is reflected in the second major element allowance. Implicit in lending activities is the risk that losses will and do occur and that the amount of such losses will vary over time. Consequently, the Company maintains an allowance for loan losses by charging a provision for loan losses to earnings. Loans determined to be losses are charged against the allowance for loan losses. The Company's allowance for loan losses is maintained at a level considered by management to be adequate to provide for estimated losses inherent in the existing portfolio along with unused commitments to provide financing including commitments under commercial and standby letters of credit. Management believes that the allowance for loan losses at December 31, 2002 was adequate to provide for both recognized losses and estimated inherent losses in the portfolio. No assurances can be given that future events may not result in increases in delinquencies, non-performing loans or net loan chargeoffs that would increase the provision for loan losses and thereby adversely affect the results of operations. Market Risk - Interest Rate Risk The mismatch between maturities of interest sensitive assets and liabilities results in uncertainty in the Company's earnings and economic value and is referred to as interest rate risk. 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. 39 The simulation model estimates the impact of changing interest rates on interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company's balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 200 basis point upward and a 100 basis point downward shift in interest rates. A shift in rates over a 12-month period is assumed. Results that exceed policy limits, if any, are analyzed for risk tolerance and reported to the Board with appropriate recommendations. At December 31, 2002, the Company's estimated net interest income sensitivity to changes in interest rates, as a percent of net interest income was an increase in net interest income of 3.8% if rates increase by 200 basis points and a decrease in net interest income of 0.2% if rates decline 100 basis points. The estimated sensitivity does not necessarily represent a Company forecast and the results may not be indicative of actual changes to the Company's net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, pricing strategies on loans and deposits, replacement of asset and liability cashflows, and other assumptions. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change. See Note 13 of the Notes to the Consolidated Financial Statements. 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 take advantage of investment opportunities as they arise. The principal sources of liquidity include credit facilities from correspondent banks, brokerage firms and the Federal Home Loan Bank, as well as, interest and principal payments on loans and investments, proceeds from the maturity or sale of investments, and growth in deposits. In general, liquidity risk is managed daily by controlling the level of 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 2002, Federal Funds averaged $33.0 million. The Company maintains Federal Fund credit lines of $61.0 million with major banks subject to the customary terms and conditions for such arrangements and $150 million in repurchase lines with major brokers. In addition the Company has additional borrowing capacity of $ 88.0 million from the Federal Home Loan Bank. At December 31, 2002, the Company had available liquid assets, which included cash and cash equivalents and unpledged investment securities of approximately $171,697,000, which represents 16.8% of total assets. Controls and Procedures The Company maintains controls and procedures designed to ensure that information is recorded and reported in all filings of financial reports. Such information is reported to the Company's management, including its Chief Executive Officer and its Chief Financial Officer to allow timely and accurate disclosure based on the definition of "disclosure controls and procedures" in Rule 13a-14(c). In designing these controls and procedures, management recognizes that they can only provide reasonable assurance of achieving the desired control objectives. Management also evaluated the cost-benefit relationship of possible controls and procedures. 40 Within 90 days prior to the date of this report, the Company carried out an evaluation of the effectiveness of Company's controls and disclosure procedures under the supervision and with the participation of the Chief Executive Officer, the Chief Financial Officer and other senior management of the Company. Based on the foregoing, the Company's Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Company completed its evaluation. Available Information Company reports filed with the Securities and Exchange Commission (the "Commission") including the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information can be accessed through the F&M Bank website. The Company web address is http://www.fmbonline.com. The link to the Securities & Exchange Commission is on the About F&M Bank page. 41 EX-21 7 form10k_2002exhibit21.txt 10-K 2002 SUBSIDIARIES OF THE REGISTRANT Exhibit 21 List of Subsidiaries of Farmers & Merchants Bancorp F & M Bancorp, Inc. (incorporated in California) Farmers & Merchants Bank of Central California (incorporated in California) Farmers & Merchants Investment Corporation (incorporated in California), a subsidiary of Farmers & Merchants Bank of Central California. Farmers/Merchants Corp. (incorporated in California), a subsidiary of Farmers & Merchants Bank of Central California. EX-99 8 form10k_2002exhibit99-1.txt 10-K STATEMENT OF CEO Exhibit 99.1 STATEMENT OF CHIEF EXECUTIVE OFFICER UNDER 10 U.S.C. SECTION 1350 In connection with the filing of the Annual Report of Farmers & Merchants Bancorp (the "Company") on Form 10-K for the period ending December 31, 2002 (the "Report"), I, Kent A. Steinwert, the chief executive officer of the Company, certify pursuant to section 1350 of chapter 63 of title 18 of the United States Code that, to my knowledge, (i) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Kent A. Steinwert --------------------------- Kent A. Steinwert March 25, 2003 EX-99 9 form10k_2002exhibit99-2.txt 10-K 2002 STATEMENT OF CFO Exhibit 99.2 STATEMENT OF CHIEF FINANCIAL OFFICER UNDER 10 U.S.C. SECTION 1350 In connection with the filing of the Annual Report of Farmers & Merchants Bancorp (the "Company") on Form 10-K for the period ending December 31, 2002 (the "Report"), I, John R. Olson, the chief financial officer of the Company, certify pursuant to section 1350 of chapter 63 of title 18 of the United States Code that, to my knowledge, (i) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ John R. Olson --------------------------- John R. Olson March 25, 2003 -----END PRIVACY-ENHANCED MESSAGE-----