-----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, UludNjaFmOj9oKYtXWALuBiplfXDXtV+V8bktDsRwjp8NUjrQsSc0tNXSiyM7kvk /e1m2sDbG3DA4t4nwOcWoQ== 0001085913-04-000030.txt : 20041108 0001085913-04-000030.hdr.sgml : 20041108 20041108172144 ACCESSION NUMBER: 0001085913-04-000030 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041108 DATE AS OF CHANGE: 20041108 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26099 FILM NUMBER: 041126707 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-Q 1 form10-q_3rdqtr2004.txt FORM 10-Q FOR 3RD QUARTER 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 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: 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 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ] Number of shares of common stock of the registrant: Par value $0.01, authorized 2,000,000 shares; issued and outstanding 793,173 as of November 1, 2004. 1 FARMERS & MERCHANTS BANCORP FORM 10-Q TABLE OF CONTENTS PART I. - FINANCIAL INFORMATION Page Item 1 - Financial Statements Consolidated Balance Sheets as of September 30, 2004, December 31, 2003 and September 30, 2003.(Unaudited) 3 Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2004 and 2003.(Unaudited) 4 Consolidated Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2004 and 2003.(Unaudited) 5 Consolidated Statements of Changes in Shareholders' Equity for the Nine Months Ended September 30, 2004 and 2003.(Unaudited) 6 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003.(Unaudited) 7 Notes to Consolidated Financial Statements 8 Item 2 - Management's Discussion and Analysis 14 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 22 Item 4 - Controls and Procedures 26 PART II. - OTHER INFORMATION 30 Signatures 31 Index to Exhibits 32 2 PART I. - FINANCIAL INFORMATION Item 1 - Financial Statements FARMERS & MERCHANTS BANCORP Consolidated Balance Sheets
- ----------------------------------------------------------------------------- -------------- -------------- --------------- (in thousands) September 30, December 31, September 30, 2004 2003 2003 Assets (Unaudited) (Unaudited) - ----------------------------------------------------------------------------- -------------- -------------- --------------- Cash and Cash Equivalents: Cash and Due From $34,321 $35,800 $36,521 Federal Funds Sold and Securities Purchased Under Agreements to Resell 6,500 - 20,800 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Cash and Cash Equivalents 40,821 35,800 57,321 Investment Securities: Available-for Sale 176,720 223,965 194,056 Held-to-Maturity 70,089 37,957 41,182 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Investment Securities 246,809 261,922 235,238 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Loans 843,954 808,998 774,594 Less: Unearned Income (1,964) (2,092) (2,132) Less: Allowance for Loan Losses (18,169) (17,220) (17,126) - ----------------------------------------------------------------------------- -------------- -------------- --------------- Loans, Net 823,821 789,686 755,336 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Land, Buildings & Equipment 12,171 11,209 11,394 Interest Receivable and Other Assets 52,072 49,948 48,111 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Assets $1,175,694 $1,148,565 $1,107,400 ============================================================================= ============== ============== =============== Liabilities & Shareholders' Equity - ----------------------------------------------------------------------------- -------------- -------------- --------------- Deposits: Demand $252,619 $223,000 $200,304 Interest Bearing Transaction 93,146 96,869 86,754 Savings 291,900 276,016 262,549 Time 357,508 308,464 327,472 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Deposits 995,173 904,349 877,079 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Fed Funds Purchased - 1,000 - FHLB Borrowings 40,898 111,928 111,938 Subordinated Debentures 10,310 10,310 - Other Liabilities 13,069 11,373 7,965 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Liabilities 1,059,450 1,038,960 996,982 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Commitments & Contingencies (See Note 4) Shareholders' Equity Common Stock 8 8 8 Additional Paid In Capital 82,694 72,506 72,717 Retained Earnings 34,601 37,650 36,931 Accumulated Other Comprehensive (Loss) Income (1,059) (559) 762 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Shareholders' Equity 116,244 109,605 110,418 - ----------------------------------------------------------------------------- -------------- -------------- --------------- Total Liabilities & Shareholders' Equity $1,175,694 $1,148,565 $1,107,400 ============================================================================= ============== ============== ===============
The accompanying notes are an integral part of these consolidated financial statements 3 FARMERS & MERCHANTS BANCORP Consolidated Statements of Income (Unaudited)
- --------------------------------------------------------------------------------- ------------ ------------ (in thousands) Three Months Nine Months Ended September 30, Ended September 30, 2004 2003 2004 2003 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Interest Income Interest & Fees on Loans $12,648 $11,543 $36,304 $33,219 Federal Funds Sold 64 31 124 128 Securities: Taxable 1,858 1,485 5,612 5,440 Non-taxable 544 716 1,684 2,057 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Total Interest Income 15,114 13,775 43,724 40,844 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Interest Expense Interest Bearing Transaction 15 19 44 98 Savings 272 301 779 998 Time Deposits 1,455 1,615 4,040 5,259 Interest on Borrowed Funds 627 775 2,125 2,180 Interest on Subordinated Debentures 119 - 327 - - ------------------------------------------------------- ------------ ------------ ------------ ------------ Total Interest Expense 2,488 2,710 7,315 8,535 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Net Interest Income 12,626 11,065 36,409 32,309 Provision for Loan Losses 350 150 1,075 475 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Net Interest Income After Provision for Loan Losses 12,276 10,915 35,334 31,834 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Non-Interest Income Service Charges on Deposit Accounts 1,211 1,254 3,669 3,658 Net Gain on Sale of Investment Securities 10 176 757 550 Credit Card Merchant Fees 469 401 1,306 1,144 Increase in Cash Surrender Value of Life Insurance 389 397 1,198 1,170 Other 871 940 2,999 2,784 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Total Non-Interest Income 2,950 3,168 9,929 9,306 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Non-Interest Expense Salaries & Employee Benefits 5,392 5,185 17,230 15,435 Occupancy 432 411 1,282 1,184 Equipment 548 505 1,526 1,603 Other Operating 2,136 1,929 5,898 5,877 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Total Non-Interest Expense 8,508 8,030 25,936 24,099 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Net Income Before Taxes 6,718 6,053 19,327 17,041 Provision for Taxes 2,494 2,173 7,097 6,116 - ------------------------------------------------------- ------------ ------------ ------------ ------------ Net Income $4,224 $3,880 $12,230 $10,925 ======================================================= ============ ============ ============ ============ Earnings Per Share* $5.31 $4.84 $15.33 $13.60 ======================================================= ============ ============ ============ ============
*2003 amounts have been restated to reflect the stock dividend declared during second quarter of 2004. The accompanying notes are an integral part of these consolidated financial statements 4 FARMERS & MERCHANTS BANCORP Consolidated Statements of Comprehensive (Loss) Income (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------- (in thousands) For Three Months For Nine Months Ended September 30, Ended September 30, 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------------------------------------------------- Net Income $4,224 $3,880 $12,230 $10,925 Other Comprehensive (Loss) Income - Unrealized (Losses) Gains on Derivative Instruments: Unrealized holding (losses) gains arising during the period, net of related income tax effects of $59 and ($48) for the quarters ended September 30, 2004 and 2003, respectively, and $123 and $37 for the nine months ended September 30, 2004 and 2003, respectively. 82 (66) 170 51 Less: Reclassification adjustment for realized losses included in net income, net of related income tax effects of ($44) and $0 for the quarters ended September 30, 2004 and 2003, respectively, and ($109) and $0 for the nine months ended June 30, 2004 and 2003, respectively. (61) - (150) - Unrealized (Losses) Gains on Securities: Unrealized holding (losses) gains arising during the period, net of related income tax effects of $1,883 and ($1,262) for the quarters ended September 30, 2004 and 2003, respectively, and of ($60) and ($580)for the nine months ended September 30, 2004 and 2003, respectively. 2,595 (1,740) (82) (800) Less: Reclassification adjustment for realized losses included in net income, net of related income tax effects of ($4) and ($74) for the quarters ended September 30, 2004 and 2003, respectively, and of ($318) and ($231) for the nine months ended September 30, 2004 and 2003, respectively. (5) (102) (438) (319) - ----------------------------------------------------------------------------------------------------------------------------------- Total Other Comprehensive (Loss) Income 2,611 (1,908) (500) (1,068) - ----------------------------------------------------------------------------------------------------------------------------------- Comprehensive Income $6,835 $1,972 $11,730 $9,857 ===================================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 5 FARMERS & MERCHANTS BANCORP Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
- ---------------------------------------------------------------------- ------------ ------------ ---------------- --------------- (in thousands except share data) Accumulated Common Additional Other Total Shares Common Paid-In Retained Comprehensive Shareholders' Outstanding Stock Capital Earnings Income (Loss) Equity - -------------------------------------------- ------------ ------------ ------------ ------------ ---------------- --------------- Balance, December 31, 2002 733,021 $ 7 $ 64,979 $ 36,749 $ 1,830 $ 103,565 - -------------------------------------------- ------------ ------------ ------------ ------------ ---------------- --------------- Net Income - - 10,925 - 10,925 Cash Dividends Declared on Common Stock - - (1,605) - (1,605) 5% Stock Dividend 35,985 1 8,996 (8,996) - 1 Cash Paid in Lieu of Fractional Shares Related to Stock Dividend - - (142) - (142) Redemption of Stock (5,029) - (1,258) - - (1,258) Unrealized Gains on Derivative Instruments 51 51 Changes in Net Unrealized Gain (Loss) on Securities Available for Sale (1,119) (1,119) - -------------------------------------------- ------------ ------------ ------------ ------------ ---------------- --------------- Balance, September 30, 2003 763,977 $ 8 $ 72,717 $ 36,931 $ 762 $ 110,418 ============================================ ============ ============ ============ ============ ================ =============== - -------------------------------------------- ------------ ------------ ------------ ------------ ---------------- --------------- Balance, December 31, 2003 763,274 $ 8 $ 72,506 $ 37,650 $ (559) $ 109,605 - -------------------------------------------- ------------ ------------ ------------ ------------ ---------------- --------------- Net Income - - 12,230 - 12,230 Cash Dividends Declared on - Common Stock - - (2,234) - (2,234) 5% Stock Dividend 37,429 - 12,838 (12,838) - - Cash Paid in Lieu of Fractional Shares Related to Stock Dividend - - (207) - (207) Redemption of Stock (6,905) - (2,650) - - (2,650) Unrealized Gains on Derivitive Instruments 20 20 Changes in Net Unrealized Gain (Loss) on Securities Available for Sale - - - (520) (520) - -------------------------------------------- ------------ ------------ ------------ ------------ ---------------- --------------- Balance, September 30, 2004 793,798 $ 8 $ 82,694 $ 34,601 $ (1,059) $ 116,244 ============================================ ============ ============ ============ ============ ================ ===============
The accompanying notes are an integral part of these consolidated financial statements 6 FARMERS & MERCHANTS BANCORP
Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended - ----------------------------------------------------------------------------------------------------------------------------- (in thousands) Sept. 30, Sept. 30, 2004 2003 - ----- ----------------------------------------------------------------------------------------------------------------------- Operating Activities: Net Income $12,230 $10,925 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Loan Losses 1,075 475 Depreciation and Amortization 1,128 1,168 Provision for Deferred Income Taxes (518) (75) Net Amortization of Investment Security Premium & Discounts 709 1,351 Net Gain on Sale of Investment Securities (757) (730) Net Gain on Sale of Property & Equipment (156) - Net Change in Operating Assets & Liabilities: Increase in Interest Receivable and Other Assets (1,208) (1,539) Increase (Decrease) in Interest Payable and Other Liabilities 1,696 (2,129) - ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 14,199 9,446 Investing Activities: Securities Available-for-Sale: Purchased (63,507) (164,878) Sold or Matured 109,856 174,263 Securities Held-to-Maturity: Purchased (37,980) (22,141) Matured 5,894 8,899 Purchase of Life Insurance Contracts - (2,600) Net Increase in Loans (35,371) (76,230) Principal Collected on Loans Charged Off 161 410 Net Additions to Premises and Equipment (2,139) (1,220) Proceeds from Sale of Property & Equipment 205 - - ----------------------------------------------------------------------------------------------------------------------------- Net Cash Used by Investing Activities (22,881) (83,497) Financing Activities: Net Increase in Demand, Interest-Bearing Transaction, and Savings Deposits 41,780 18,000 Increase in Time Deposits 49,044 8,854 Federal Funds Purchased (1,000) (16,997) Net (Decrease) Increase in Federal Home Loan Bank Borrowings (71,030) 70,946 Cash Dividends (2,441) (1,747) Repurchase of Company Stock (2,650) (1,258) - ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 13,703 77,798 Increase (Decrease) in Cash and Cash Equivalents 5,021 3,747 Cash and Cash Equivalents at Beginning of Year 35,800 53,574 - ----------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents as of Sept. 30, 2004 and Sept. 30, 2003 $40,821 $57,321 =============================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements 7 FARMERS & MERCHANTS BANCORP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited) For the nine months ended September 30, 2004 and September 30, 2003 1. Significant Accounting Policies Farmers & Merchants Bancorp (the Company) was organized March 10, 1999. Primary operations are related to traditional banking activities through its subsidiary Farmers & Merchants Bank of Central California (the Bank) which was established in 1916. The consolidated financial statements of the Company and its subsidiary, the Bank, are prepared in conformity with generally accepted accounting principles (GAAP) 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. 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. In December 2003, the Company formed FMCB Statutory Trust I. FMCB Statutory Trust I is a non-consolidated subsidiary per GAAP, and was formed for the sole purpose of issuing Trust Preferred Securities. 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. 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 Company 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 Company to be other than temporary, are recognized in the period in which they become known. 8 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, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders' equity, net of related income taxes. Fair values are based on quoted market prices or broker/dealer price quotations on a specific identification basis. Gains or losses on the sale of these securities are computed using the specific identification method. Unrealized losses on these securities, reflecting a decline in value judged by the Company to be other than temporary, are recognized in the period in which they become known. Trading securities, if any, are acquired for short-term appreciation and are recorded in a trading portfolio and are carried at fair value, with unrealized gains and losses recorded in non-interest income. Loans Loans are reported at the principal amount outstanding net of unearned discounts and deferred loan fees. Interest income on loans is accrued daily on the outstanding balances using the simple interest method. Loan origination fees are deferred and recognized over the contractual life of the loan as an adjustment to the yield. Loans are placed on a non-accrual status when the collection of principal or interest is in doubt or when they become past due for 90 days or more unless they are both well-secured and in the process of collection. For this purpose a loan is considered well-secured if it is collateralized by property having a net realizable value in excess of the amount of the loan or is guaranteed by a financially capable 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, on the observable or estimated market price of the loan or on 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. Thereafter, interest income is recognized as it is collected in cash. 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 are inherent in the portfolio. 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. 9 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. 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. 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 Farmers & Merchants Bancorp common stock is not traded on any exchange. The shares are primarily held by local residents and are not actively traded. The actual number of shares outstanding at September 30, 2004, was 793,798. Basic earnings per share is calculated on the basis of the weighted average number of shares outstanding during the period. Weighted average number of shares for the nine months ending September 30, 2004 and 2003 were 797,981 and 803,391, respectively. Earnings per share for the nine months ending September 30, 2004 and 2003 were $15.33 and $13.60, respectively. Weighted average number of shares for the three months ending September 30, 2004 and 2003 were 795,702 and 801,406, respectively. Earnings per share for the three months ending September 30, 2004 and 2003 were $5.31 and $4.84, respectively. Prior periods per share amounts have been restated for the 5% stock dividend declared during 2004 and 2003. 10 Dividends On April 6, 2004, the Board of Directors declared a 5% stock dividend payable May 12, 2004, to shareholders of record at the close of business on April 16, 2004. Common stock shareholders of record as of April 16, 2004 received one share of common stock for every 20 shares of common stock owned. Fractional shares were not issued. For common stock share lots of less than 20 shares, a cash dividend in the amount of $17.15 per share was paid in lieu of the stock dividend. The Board of Directors of Farmers & Merchants Bancorp declared a cash dividend on June 1, 2004, in the amount of $2.80 per share, an increase from the $2.10 per share paid last year. The cash dividend was paid on July 1, 2004, to stockholders of record as of June 14, 2004. No stock or cash dividends were declared during the third quarter of 2004. 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 September 30, 2004. 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 and No. 149, 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 net of related income taxes. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. 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. 11 Comprehensive Income The Statement of Financial Accounting Standards No. 130, "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 GAAP recognize as changes in value to an enterprise but are excluded from net income. For the Company, comprehensive income (loss) includes net income and changes in fair value of its available-for-sale investment securities, minimum pension liability adjustments and cash flow hedges. 2. Recent Accounting Developments In June 2004, the Emerging Issues Task Force of the FASB issued final guidance on its Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." A consensus was reached regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This EITF describes a model involving three steps: (1) determine whether an investment is impaired, (2) determine whether the impairment is other-than - -temporary, and (3) recognize the impairment loss in earnings. The EITF also requires several additional disclosures for cost-method investments. The EITF's impairment accounting guidance was effective for reporting periods beginning after June 15, 2004. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective for fiscal years ending after June 15, 2004. The adoption of this EITF did not have a material impact on the Company's consolidated financial statements. At September 30, 2004, management believes the impairments described above are temporary and, accordingly, no impairment loss has been recognized in the Company's consolidated statement of income. FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46") may have an impact on the treatment of the trust preferred securities we have issued and ability for those instruments to continue to provide the Company with Tier 1 capital. FIN 46 prevents the Company from consolidating the trust entity that issued these trust preferred securities. The Federal Reserve has issued Supervisory Letter (SR 03-13) which allows for the inclusion of these instruments in Tier 1 capital regardless of the impact of FIN 46 on the consolidation of the trusts. There remains the potential that this determination by the Federal Reserve may be changed at a later date (see Item 2. - Capital). We do not expect FIN 46 to have any other material impact on the Company's financial condition or operating results. On March 9, 2004, the Staff of the Securities and Exchange Commission (the "SEC Staff") issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 provides guidance on the initial recognition and measurement of loan commitments that meet the definition of a derivative, and summarizes the related disclosure requirements. SAB 105 is effective for all loan commitments accounted for as derivatives that are entered into, or substantially modified, on or after April 1, 2004. SAB 105 addresses loan commitments that the Financial Accounting Standards Board (FASB) defines as derivatives in paragraph 6 of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("FAS 133"). These loan commitments relate to the origination of mortgage loans that will be held for sale. SAB 105 does not apply to (1) commitments to purchase mortgage loans that do not meet the definition of a derivative under paragraph 6 of FAS 133 or (2) commitments that are explicitly excluded from the scope of FAS 133 (i.e., commitments to originate mortgage loans that will be held for investment purposes and loan commitments to originate other types of loans). The Company does not currently originate mortgage loans to be held for sale. If that should change in the future, we would take SAB 105 into consideration but do not expect it to have a material impact on the Company's financial condition or operating results. 12 3. Interim-Period Disclosure of Employee Benefit Plans Components of Net Periodic Pension Cost: Three months ended September 30, Pension Benefits ----------------------------------- (in thousands) 2004 2003 -------------- ------------- Service cost $ 12 $ 13 Interest cost 64 56 Expected return on assets (57) (32) Amortization of loss 126 94 Amortization of prior service cost - - Amortization of transition obligation - - -------------- ------------- Net periodic pension cost $ 145 $ 131 ============== ============= Employer Contributions On July 13, 2004, the Company contributed $225,000 to the Plan. At the current time, the Company does not intend to make additional 2004 contributions. 4. 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. 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 $13.5 million at September 30, 2004, and $16.7 million at September 30, 2003. 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 $333.5 million and $291.1 million as of September 30, 2004 and 2003, 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. 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. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS Forward-Looking Statements Management's discussion and analysis is written to provide greater insight into the results of operations and the financial condition of Farmers & Merchants Bancorp and its subsidiaries. For a more complete understanding of the Company and its operations, reference should be made to the financial statements included in this report and in the Company's 2003 Annual Report on Form 10-K. Certain statements in this Report on Form 10-Q constitute "forward-looking statements" and usually contain 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 laws or regulations; (v) competitive pressure in the banking industry; (vi) changes in governmental fiscal or monetary policies; (vii) 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; (viii) dividend restrictions; (ix) asset/liability pricing risks and liquidity risks; (x) changes in the securities markets; (xi) certain operational risks involving data processing systems or fraud; (xii) the State of California's fiscal difficulties; and (xiii) other external developments which could materially impact the Company's operational and financial performance. Additional information on these and other factors that could affect financial results are included in the Company's Securities and Exchange Commission filings. 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. Overview The Company's primary service area encompasses the northern Central Valley of California, a region that is significantly impacted by the agricultural industry. Accordingly, any discussion of the Company's Financial Condition and Results of Operations is influenced by the seasonal banking needs of its customers. Comparisons of the current quarter's results, both in terms of the balance sheet and income statement, are most meaningful to the same quarter in the prior year, not to the prior calendar quarter. For the three and nine months ended September 30, 2004, Farmers & Merchants Bancorp reported net income of $4,224,000 and $12,230,000, earnings per share of $5.31 and $15.33 and return on average assets of 1.43% and 1.40%. Return on average shareholders' equity was 14.97% and 14.55% for the three and nine months ended September 30, 2004. For the three and nine months ended September 30, 2003, net income totaled $3,880,000 and $10,925,000, earnings per share was $4.84 and $13.60 and return on average assets was 1.40% and 1.36%. Return on average shareholders' equity for the three and nine months ended September 30, 2003 was 14.27% and 13.63%, respectively. 14 The Company's improved earnings performance in the first nine months of 2004 when compared to the same period last year was due to a combination of (1) growth in earning assets, (2) improvement in the mix of earning assets as reflected by an increase in loans as a percentage of average earning assets, (3) improvement in non-interest income and (4) an improvement in the efficiency ratio from 57.91% for the nine months ended September 30, 2003 to 55.97% for the nine months ended September 30, 2004. The following is a summary of the financial results for the nine-month period ended September 30, 2004 compared to September 30, 2003. o Net income increased 11.9% to $12.2 million from $10.9 million. o Earnings per share increased 12.7% to $15.33 from $13.60 o Net interest income increased 12.7% to $36.4 million from $32.3 million. o Total assets increased 6.2% to $1.2 billion. o Gross loans increased 9.0% to $843.9 million. o Total deposits increased 13.5% to $995.2 million. o Total shareholders' equity increased 5.3% to $116.2 million after stock repurchases of $2.7 million and cash dividends of $2.4 million. Results of Operations Net Interest Income Net interest income is the amount by which the interest and fees on loans and other interest earning assets exceed the interest paid on interest bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as "taxable equivalent" and is noted wherever applicable. Interest income and expense are affected by changes in the volume and mix of average interest earning assets and average interest bearing liabilities, as well as fluctuations in interest rates. Therefore, increases or decreases in net interest income are analyzed as changes in volume, changes in rate and changes in the mix of assets and liabilities. 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. Net interest income increased 12.7% to $36.4 million for the first nine months of 2004, compared to $32.3 million for the same period in 2003. On a fully taxable equivalent basis, net interest income increased 11.6% to $37.4 million through September 30, 2004, compared to $33.5 million for the first nine months of 2003. Net interest income for the three months ended September 30, 2004 increased 14.1% to $12.6 million, compared to the three months ended September 30, 2003. The primary reason for the increase in net interest income during the first nine months of 2004 when compared to the same period last year was an improvement in the volume and mix (as reflected by an increase in loans as a percentage of average earning assets) of earning assets. However, since the Federal Reserve Bank began increasing market interest rates in June, 2004, the Company's net interest income has started to benefit from an increase in the yield on earning assets. 15 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. For the nine months ended September 30, 2004, the net interest margin on a taxable equivalent basis was 4.59% compared to 4.50% in 2003. For the three months ended September 30, 2004, the net interest margin on a taxable equivalent basis was 4.64% compared to 4.42% in 2003. This is the second quarter in a row that the Company's net interest margin has increased over the same period in the prior year. Although this improvement is primarily a result of a decrease in the cost of interest bearing liabilities, the Company's yield on earning assets has begun to improve as a result of recent increases in short-term market interest rates. Between June 30, 2004 and September 21, 2004, the Federal Reserve Bank increased market interest rates by 75 basis points. As a result, the Company has increased its prime rate by 75 basis points to 4.75%. Should market interest rates continue to rise, the Company's net interest margin is expected to improve. Loans, generally the Company's highest earning asset, increased $69.4 million as of September 30, 2004 compared to September 30, 2003. On an average balance basis, loans increased by $95.4 million for the nine months ended September 30, 2004. Due, in part, to the continuing negative impact of a decline in interest rates during 2002 and 2003, the yield on the loan portfolio decreased 23 basis points to 5.91% for the nine months ended September 30, 2004 compared to 6.14% for the nine months ended September 30, 2003. This decrease in yield was offset by the growth in loan balances, which resulted in interest revenue from loans increasing 9.3% to $3.1 million for the first nine months of 2004. The investment portfolio is the other main component of the Company's earning assets. The Company's investment policy is conservative. The Company invests primarily in mortgage-backed securities, U.S. Treasuries, U.S. Government Agencies, and high-grade municipals. Since the risk factor for these types of investments is significantly lower than that of loans, the yield earned on investments is generally less than that of loans. Average investment securities decreased $7.5 million compared to the average balance for the nine months ended September 30, 2003. With the decrease in the average balance of investment securities there was a decrease in interest income of $407,000 for the nine months ended September 30, 2004 due also, in part, to the continuing negative impact of a decline in interest rates during 2002 and 2003. The nine months average yield, on a taxable equivalent basis, in the investment portfolio was 4.37% in 2004 compared to 4.51% in 2003. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates located on page 28 is shown on a taxable equivalent basis, which is higher than net interest income on the Consolidated Statements of Income because of adjustments that relate to income on certain securities that are exempt from federal income taxes. Average interest-bearing sources of funds increased $51.5 million or 6.8% for the nine months ended September 30, 2004. Of that increase, average borrowed funds (primarily FHLB Advances) decreased $2.6 million, subordinated debentures increased $10.3 million and interest-bearing deposits increased $43.8 million. Even as interest-bearing sources of funds increased, interest expense decreased 14.3% as a result of declining interest rates paid for those sources of funds and an improvement in the mix of lower cost interest bearing transaction and savings deposits as a percentage of total interest bearing deposits (see Deposits). Overall, the average interest cost on interest-bearing sources of funds was 1.2% for the nine months ending September 30, 2004 and 1.5% for the nine months ending September 30, 2003. 16 Allowance and Provision for Loan Losses As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The allowance for loan losses is established to absorb losses inherent in the portfolio. 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. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. In determining the adequacy of the allowance for loan losses, management takes into consideration examinations by the Company's 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. After reviewing all factors, management concluded that the allowance for loan losses as of September 30, 2004 was adequate. The Company has established credit management policies and procedures that govern both the approval of new loans and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, portfolio diversification guidelines, dollar limits on loans to one borrower and by restricting loans made primarily to its principal market area where management believes it is better able to assess the applicable risk. Management reports regularly to the Board of Directors regarding trends and conditions in the loan portfolio and regularly conducts credit reviews of individual loans. Loans that are performing but have shown some signs of weakness are subjected to more stringent reporting and oversight. As of September 30, 2004, the allowance for loan losses was $18.2 million, which represents 2.2% of the total loan balances. As of September 30, 2003, the allowance was $17.1 million or 2.2% of total loans. The table below illustrates the change in the allowance for the first nine months of 2004 and 2003. Allowance for Loan Losses (in thousands) Balance, December 31, 2003 $ 17,220 Provision Charged to Expense 1,075 Recoveries of Loans Previously Charged Off 162 Loans Charged Off (288) ====================================================================== Balance, September 30, 2004 $ 18,169 ====================================================================== Balance, December 31, 2002 $ 16,684 Provision Charged to Expense 475 Recoveries of Loans Previously Charged Off 411 Loans Charged Off (444) ====================================================================== Balance, September 30, 2003 $ 17,126 ====================================================================== 17 Non-Interest Income Overall, non-interest income increased $623,000 or 6.7% for the nine months ended September 30, 2004 compared to the same period in 2003. A portion of the growth occurred in gain on sale of investment securities, which increased $207,000 through the first nine months of 2004. The increase was mainly the result of the Company's decision to take advantage of the decline in interest rates that began in early January 2004 and continued through early April 2004, by selling approximately $37 million in investment securities for a gain. As a result of increases in overall market interest rates, the Company does not anticipate that these gains will recur during the remainder of 2004. Other factors impacting the increase in non-interest income include gains of $79,000 on derivative contracts, gains on sale of fixed assets of $155,000 and increased Credit Card merchant fees in the amount of $162,000. Non-Interest Expense Overall, non-interest expense increased $1.8 million or 7.6% over the first nine months of 2004, primarily as a result of a $1.8 million increase in Salaries and Employee Benefits. This increase was due primarily to officer salary merit increases which occurred in May 2004 and increased contributions to the Company's retirement plans and incentive compensation plans. Income Taxes The provision for income taxes increased 16.0% to $7.1 million for the first nine months of 2004. The Company's effective tax rate increased for the first nine months of 2004 and was 36.7% compared to 35.9% for the same period in 2003. Financial Condition Investment Securities The Financial Accounting Standards Board Statement No. 115, "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. Securities are classified as held-to-maturity and are carried at amortized cost when the Company has the positive intent and ability to hold the securities to maturity. 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. Securities classified as available-for-sale include securities, which may be sold to effectively manage interest rate risk exposure, satisfy liquidity demand 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. The investment portfolio provides the Company with an income alternative to loans. As of September 30, 2004 the investment portfolio represented 21.0% of the Company's total assets. Total investment securities increased $11.6 million from a year ago and totaled $246.8 million at September 30, 2004. Not included in the investment portfolio are overnight investments in Federal Funds Sold. For the nine months ended September 30, 2004, average Federal Funds Sold was $14.2 million compared to $12.4 million in 2003. Loans The Company's loan portfolio at September 30, 2004 increased $69.4 million from September 30, 2003. The increase was due to strong loan demand in the Company's market area, along with an aggressive calling program on high quality loan prospects. Additionally, on a nine month average balance basis, loans have increased $95.4 million or 13.2% over 2003. The table following sets forth the distribution of the loan portfolio by type as of the dates indicated. 18 Loan Portfolio As Of:
(in thousands) September 30, 2004 December 31, 2003 September 30, 2003 - -------------------------------------- ------------------------ ------------------------ ------------------------ Real Estate $418,289 $386,735 $381,175 Real Estate Construction 64,744 77,115 73,828 Home Equity 61,661 55,827 50,054 Agricultural 138,180 134,862 125,516 Commercial 143,773 136,955 125,385 Consumer 17,307 17,504 18,636 - -------------------------------------- ------------------------ ------------------------ ------------------------ Gross Loans 843,954 808,998 774,594 Less: Unearned Income 1,964 2,092 2,132 Allowance for Loan Losses 18,169 17,220 17,126 - -------------------------------------- ------------------------ ------------------------ ------------------------ Net Loans $823,821 $ 789,686 $ 755,336 ====================================== ======================== ======================== ========================
In the ordinary course of business, the Company enters into commitments to extend credit to its customers. These commitments are not reflected in the accompanying consolidated financial statements. As of September 30, 2004, the Company had entered into commitments with certain customers amounting to $333.5 million compared to $291.1 million at September 30, 2003. Letters of credit at September 30, 2004 and September 30, 2003 were $13.5 million and $16.7 million, respectively. Non-Performing Assets Non-performing assets are comprised of non-performing loans and other real estate owned. As set forth in the table below, non-performing loans as of September 30, 2004 were $517,000 compared to $2.7 million at September 30, 2003. Accrued interest reversed from income on loans placed on a non-accrual status totaled $32,000 at September 30, 2004 compared to $320,000 at September 30, 2003. The Company reported no other real estate owned for both September 30, 2004 and September 30, 2003. Non-Performing Assets
(in thousands) September 30, 2004 December 31, 2003 September 30, 2003 - --------------------------------------- ------------------------ ----------------------- ------------------------ Non-performing Loans $517 $2,584 $2,745 Other Real Estate Owned - - - ======================================= ======================== ======================= ======================== Total $517 $2,584 $2,745 ======================================= ======================== ======================= ======================== Non-Performing Assets as a % of Total Loans 0.1% 0.3% 0.4% - --------------------------------------- ------------------------ ----------------------- ------------------------ Allowance for Loan Losses as a % of Non-Performing Loans 3,514.3% 666.4% 623.9% - --------------------------------------- ------------------------ ----------------------- ------------------------
Except for non-performing loans shown in the table above, the Company's management is not aware of any loans as of September 30, 2004 for which known credit problems of the borrower would cause serious doubts as to the ability of these borrowers to comply with their present loan repayment terms, or any known events that would result in the loan being designated as non-performing at some future date. The Company's management cannot, however, predict the extent to which any deterioration in general economic conditions, real estate values, increase in general rates of interest, change in the financial conditions or business of a borrower may adversely affect a borrower's ability to pay. 19 Deposits One of the key sources of funds to support earning assets (loans and investments) is the generation of deposits from the Company's customer base. The ability to grow the customer base and subsequently deposits is a significant element in the performance of the Company. At September 30, 2004, deposits totaled $995.2 million. This represents an increase of 13.5% or $118.1 million from September 30, 2003. The increase was focused in demand and savings deposits, which increased $52.3 million and $29.4 million, respectively. The Company's calling efforts for prospective customers include acquiring both loan and deposit relationships which results in new demand, interest bearing transaction and savings accounts. Although the Company's time deposits have increased by $30.0 million since September 30, 2003, this growth has been entirely due to increased use of public deposits as part of the Company's asset/liability management funding strategies (See Federal Home Loan Bank Advances). Due to strong growth in demand, interest bearing transaction and savings balances, the Company has reduced its focus on growing higher cost time deposits; therefore, non-public time deposits have decreased $10.2 million period over period. This reduced reliance on higher cost time deposits has had, and should continue to have, a positive impact on the Company's net interest margin (see Net Interest Income). Federal Home Loan Bank Advances Advances from the Federal Home Loan Bank are another key source of funds to support earning assets. These advances are also used to manage the Company's interest rate risk exposure, and as opportunities exist to borrow and invest the proceeds at a positive spread through the investment portfolio. FHLB advances as of September 30, 2004 were $40.9 million compared to $111.9 million as of September 30, 2003. During June, 2004, the Company's asset/liability management committee decided to replace $50.0 million of short-term FHLB advances with three and six month public time deposits since the rates on these public funds were lower than the equivalent FHLB advance rates. Long-term Subordinated Debentures On December 17, 2003 the Company raised $10 million through an offering of trust preferred securities. Although this amount is reflected as subordinated debt on the Company's balance sheet, under applicable regulatory guidelines, trust preferred securities qualify as regulatory capital (see Capital). These securities accrue interest at a variable rate based upon 3-month Libor plus 2.85%. The interest rate resets quarterly and was 4.74% as of September 30, 2004. Capital The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company and the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. 20 Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios set forth in the table below of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier I capital (as defined in the regulations) to average assets (as defined in the regulations). Management believes, as of September 30, 2004, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of September 30, 2003, the most recent notification from the Federal Reserve Bank categorized the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company's categories.
To Be Well Capitalized Under Regulatory Capital Prompt Corrective (in thousands) Actual Requirements Action Provisions - ------------------------------------------------------------------------------------------------------------------ The Company: Amount Ratio Amount Ratio Amount Ratio - ------------------------------------------------------------------------------------------------------------------ As of September 30, 2004 Total Capital to Risk Weighted Assets $ 140,270 13.59% $ 82,567 8.0% N/A N/A Tier I Capital to Risk Weighted Assets $ 127,304 12.33% $ 41,283 4.0% N/A N/A Tier I Capital to Average Assets $ 127,304 10.79% $ 47,176 4.0% N/A N/A To Be Well Capitalized Under Regulatory Capital Prompt Corrective (in thousands) Actual Requirements Action Provisions - ------------------------------------------------------------------------------------------------------------------ The Bank: Amount Ratio Amount Ratio Amount Ratio - ------------------------------------------------------------------------------------------------------------------ As of September 30, 2004 Total Capital to Risk Weighted Assets $ 137,266 13.67% $ 80,351 8.0% $ 100,439 10.0% Tier I Capital to Risk Weighted Assets $ 124,642 12.41% $ 40,175 4.0% $ 60,263 6.0% Tier I Capital to Average Assets $ 124,624 10.60% $ 47,036 4.0% $ 58,795 5.0%
As previously discussed (see Long-term Subordinated Debentures), in order to supplement its regulatory capital base, during December 2003 the Company raised $10 million of trust preferred securities. Under applicable regulatory guidelines, trust preferred securities qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital. Any additional portion of trust preferred securities would qualify as Tier 2 capital. The Company has received notification from the Federal Reserve Bank of San Francisco that all of the Company's trust preferred securities currently qualify as Tier 1 capital. In accordance with the provisions of Financial Accounting Standard Board Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), the Company does not consolidate the subsidiary trust which has issued the trust preferred securities. Previously, financing subsidiaries were generally consolidated with their parents under GAAP. As a result of this new accounting interpretation, on July 2, 2003, the Federal Reserve Board issued Supervisory Letter (SR 03-13) which preserves the historical capital treatment of trust preferred securities as Tier I Capital despite the deconsolidation of these securities. That Supervisory Letter remained in effect at December 31, 2003 and September 30, 2004, and the Company continues to include these securities in its Tier I capital. 21 On May 6, 2004, the FRB issued a proposed ruling on the continuing eligibility of trust preferred securities as Tier I capital. As drafted, the proposed ruling retains the current 25% limit but nets goodwill from the calculation of Tier I capital. Since the Company currently has no goodwill, if implemented, this change would have no impact. Public comments on the proposed ruling were required by July 11, 2004 with a final ruling to follow. The Company cannot predict the ultimate outcome of this issue, however, even in the unlikely event that Tier I capital treatment for the Company's trust preferred securities was fully disallowed the Company would remain "well-capitalized". Additionally, if Tier I capital treatment were disallowed, the Company may be able to redeem the trust preferred securities pursuant to their terms, and have the ability to identify and obtain alternative sources of capital. In 1998, the Board approved the Company's first stock repurchase program which expired on May 1, 2001. During the second quarter of 2004, the Board of Directors of Farmers & Merchants Bancorp approved a second stock repurchase program because it concluded that the Company continues to have more capital than it needs to meet present and anticipated regulatory guidelines to be classified as "well capitalized". Repurchases under the program will be made on the open market or through private transactions. The aggregate price to be paid by the Company for all repurchased stock will not exceed $10,000,000 and the program will expire on May 31, 2007. The repurchase program also requires that no purchases may be made if the Company would not remain "well-capitalized" after the repurchase. All shares repurchased under the repurchase program will be retired. See Part II, Item 2(e). Since 1999, the Company has repurchased nearly 44,000 shares for total consideration of $11.3 million. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Risk Management The Company has adopted a Risk Management Plan which aims 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 the 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 Company'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 regularly provided with information intended to identify, measure, control and monitor the credit risk of the Company. 22 The Company's methodology for assessing the appropriateness of the allowance for loan losses is applied on a regular basis and considers all loans. The systematic 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 ensure 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. 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. 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 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. 23 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 September 30, 2004 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 charge-offs 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. The Company'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 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. 24 The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans. In addition, the magnitude of changes in the rates charged on loans is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest bearing liabilities. The Company also utilizes the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of the Company's net interest income is measured over a rolling one-year horizon. The simulation model estimates the impact of changing interest rates on interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company's balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given 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 September 30, 2004, 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 3.79% if rates increase by 200 basis points and a decrease in net interest income of 2.71% 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 located in the 2003 Annual Report to Shareholders. Liquidity Risk Liquidity risk is the risk to earnings or capital resulting from the Company'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 Company'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 Federal Funds and the use of funds provided by the cash flow from the investment portfolio. The Company maintains overnight investments in Federal Funds as a cushion for temporary liquidity needs. During the first nine months of 2004, Federal Funds averaged $14.2 million. The Company maintains Federal Fund credit lines of $50 million with major banks subject to the customary terms and conditions for such arrangements and $175 million in repurchase lines with major brokers. In addition the Company has additional borrowing capacity of $198.3 million from the Federal Home Loan Bank. 25 At September 30, 2004, the Company had available sources of liquidity, which included cash and cash equivalents and unpledged investment securities of approximately $109.7 million, which represents 9.33% of total assets. ITEM 4. 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-15(e). 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. As of the end of the period covered by 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. Average Balance Sheets The tables on the following pages reflect the Company's average balance sheets and volume and rate analysis for the three and nine-month periods ending September 30, 2004 and 2003. The average yields on earning assets and average rates paid on interest-bearing liabilities have been computed on an annualized basis for purposes of comparability with full year data. Average balance amounts for assets and liabilities are the computed average of daily balances. The volume and rate analysis of net interest revenue summarizes the changes in average asset and liability balances and interest earned and paid resulting from changes in average asset and liability balances (volume) and changes in average interest rates and the total net change in interest income and expenses. The changes in interest due to both rate and volume have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each. 26 Farmers & Merchants Bancorp Quarterly Average Balances and Interest Rates (Interest and Rates on a Taxable Equivalent Basis) (in thousands)
Three Months Ended September 30, Three Months Ended September 30, 2004 2003 Assets Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------ Federal Funds Sold and Securities Purchased Under Agreements to Resell $ 19,004 $ 64 1.34% $ 13,923 $ 31 0.88% Investment Securities Available-for-Sale U.S. Treasuries 0 0 0.00% 0 0 0.00% U.S. Agencies 64,046 586 3.66% 52,514 444 3.43% Municipals - Taxable 964 15 6.22% 1,212 19 6.36% Municipals - Non-Taxable 17,495 277 6.33% 31,931 447 5.68% Mortgage Backed Securities 84,542 827 3.91% 113,266 856 3.06% Other 6,425 95 5.91% 11,408 160 5.69% - ------------------------------------------------------------------------------------------------------------------------------ Total Investment Securities Available-for-Sale 173,472 1,800 4.15% 210,331 1,926 3.71% - ------------------------------------------------------------------------------------------------------------------------------ Investment Securities Held-to-Maturity U.S. Treasuries 0 0 0.00% 0 0 0.00% U.S. Agencies 19,952 195 3.91% 0 0 0.00% Municipals - Taxable 0 0 0.00% 0 0 0.00% Municipals - Non-Taxable 36,618 577 6.31% 41,710 677 6.58% Mortgage Backed Securities 14,386 139 3.86% 0 0 0.00% Other 307 2 2.61% 440 6 5.53% - ------------------------------------------------------------------------------------------------------------------------------ Total Investment Securities Held-to-Maturity 71,263 913 5.13% 42,150 683 6.57% - ------------------------------------------------------------------------------------------------------------------------------ Loans Real Estate 482,262 7,619 6.27% 443,310 7,146 6.40% Home Equity 59,272 720 4.82% 49,073 596 4.82% Agricultural 141,507 1,927 5.40% 122,356 1,563 5.07% Commercial 142,764 2,000 5.56% 130,209 1,778 5.42% Consumer 11,271 258 9.08% 13,547 342 10.02% Credit Card 4,619 112 9.62% 4,343 102 9.32% Municipal 1,047 12 4.55% 1,311 16 4.84% - ------------------------------------------------------------------------------------------------------------------------------ Total Loans 842,742 12,648 5.95% 764,149 11,543 5.99% - ------------------------------------------------------------------------------------------------------------------------------ Total Earning Assets 1,106,481 $15,425 5.54% 1,030,553 $14,183 5.46% ========= ======= ========= ======= Unrealized (Loss)/Gain on Securities Available-for-Sale (911) 2,996 Allowance for Loan Losses (17,964) (17,166) Cash and Due From Banks 33,674 30,345 All Other Assets 63,720 58,764 - ------------------------------------------------------------------ ------------ Total Assets $1,185,000 $1,105,492 ================================================================== ============ Liabilities & Shareholders' Equity Interest Bearing Deposits Transaction $95,006 $ 15 0.06% $89,146 $ 19 0.08% Savings 288,726 273 0.38% 254,582 301 0.47% Time 360,592 1,454 1.60% 330,531 1,615 1.94% - ----------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 744,324 1,742 0.93% 674,259 1,935 1.14% Other Borrowed Funds 60,152 627 4.14% 116,683 775 2.64% Subordinated Debentures 10,310 119 4.58% 0 0 0.00% - ----------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 814,786 $2,488 1.21% 790,942 $2,710 1.36% ===================== ======================= Interest Rate Spread 4.33% 4.10% Demand Deposits (Non-Interest Bearing) 245,105 196,893 All Other Liabilities 12,272 8,862 - ------------------------------------------------------------------ ------------ Total Liabilities 1,072,163 996,697 Shareholders' Equity 112,837 108,795 - ------------------------------------------------------------------ ------------ Total Liabilities & Shareholders' Equity $1,185,000 $1,105,492 ================================================================== ============ Impact of Non-Interest Bearing Deposits and Other Liabilities 0.31% 0.32% Net Interest Income and Margin on Total Earning Assets 12,937 4.64% 11,473 4.42% Tax Equivalent Adjustment (311) (408) - ----------------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 12,626 4.53% $ 11,065 4.26% =============================================================================================================================
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. 27 Farmers & Merchants Bancorp Year-to-Date Average Balances and Interest Rates (Interest and Rates on a Taxable Equivalent Basis) (in thousands)
Nine Months Ended September 30, Nine Months Ended September 30, 2004 2003 Assets Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------ Federal Funds Sold and Securities Purchased Under Agreements to Resell $ 14,217 $ 124 1.16% $ 12,424 $ 128 1.38% Investment Securities Available-for-Sale U.S. Treasuries 0 0 0.00% 0 0 0.00% U.S. Agencies 65,460 1,770 3.61% 42,819 1,082 3.42% Municipals - Taxable 1,033 48 6.20% 1,282 60 6.33% Municipals - Non-Taxable 19,737 900 6.08% 31,953 1,340 5.67% Mortgage Backed Securities 101,958 2,855 3.73% 128,737 3,675 3.86% Other 7,617 307 5.37% 16,429 608 5.00% - ------------------------------------------------------------------------------------------------------------------------------ Total Investment Securities Available-for-Sale 195,805 5,880 4.00% 221,220 6,765 4.13% - ------------------------------------------------------------------------------------------------------------------------------ Investment Securities Held-to-Maturity U.S. Treasuries 0 0 0.00% 0 0 0.00% U.S. Agencies 11,215 370 4.40% 0 0 0.00% Municipals - Taxable 0 0 0.00% 0 0 0.00% Municipals - Non-Taxable 36,588 1,750 6.38% 37,984 1,884 6.70% Mortgage Backed Securities 8,198 251 4.08% 0 0 0.00% Other 344 11 4.26% 463 19 5.55% - ------------------------------------------------------------------------------------------------------------------------------ Total Investment Securities Held-to-Maturity 56,345 2,382 5.64% 38,447 1,903 6.69% - ------------------------------------------------------------------------------------------------------------------------------ Loans Real Estate 474,315 22,226 6.24% 413,504 20,248 6.55% Home Equity 56,794 2,005 4.70% 47,848 1,810 5.06% Agricultural 132,736 5,171 5.19% 109,943 4,241 5.16% Commercial 137,614 5,762 5.58% 132,182 5,520 5.58% Consumer 11,188 775 9.23% 13,804 1,047 10.14% Credit Card 4,556 330 9.65% 4,355 305 9.36% Municipal 1,065 35 4.38% 1,262 48 5.09% - ------------------------------------------------------------------------------------------------------------------------------ Total Loans 818,268 36,304 5.91% 722,898 33,219 6.14% - ------------------------------------------------------------------------------------------------------------------------------ Total Earning Assets 1,084,635 $44,689 5.49% 994,989 $42,015 5.65% ================= ======================== Unrealized Gain on Securities Available-for-Sale 601 3,980 Allowance for Loan Losses (17,691) (17,039) Cash and Due From Banks 32,755 29,595 All Other Assets 61,938 56,288 - -------------------------------------------------------------------- ------------ Total Assets $1,162,238 $1,067,813 ==================================================================== ============ Liabilities & Shareholders' Equity Interest Bearing Deposits Transaction $94,621 $ 44 0.06% $89,182 $ 98 0.15% Savings 281,823 780 0.37% 247,517 997 0.54% Time 328,753 4,039 1.64% 324,661 5,260 2.17% - ------------------------------------------------------------------------------------------------------------------------------ Total Interest Bearing Deposits 705,197 4,863 0.92% 661,360 6,355 1.28% Other Borrowed Funds 94,235 2,125 3.00% 96,878 2,180 3.01% Subordinated Debentures 10,310 327 0.00% 0 0 0.00% - ------------------------------------------------------------------------------------------------------------------------------ Total Interest Bearing Liabilities 809,742 $7,315 1.20% 758,238 $8,535 1.50% ================ ======== ============== Interest Rate Spread 4.29% 4.14% Demand Deposits (Non-Interest Bearing) 229,233 193,623 All Other Liabilities 11,170 9,067 - -------------------------------------------------------------------- ------------ Total Liabilities 1,050,145 960,928 Shareholders' Equity 112,093 106,885 - -------------------------------------------------------------------- ------------ Total Liabilities & Shareholders' Equity $1,162,238 $1,067,813 ==================================================================== ============ Impact of Non-Interest Bearing Deposits and Other Liabilities 0.30% 0.36% Net Interest Income and Margin on Total Earning Assets 37,374 4.59% 33,480 4.50% Tax Equivalent Adjustment (965) (1,171) - ------------------------------------------------------------------------------------------------------------------------------ Net Interest Income $36,409 4.47% $32,309 4.34% - ------------------------------------------------------------------------------------------------------------------------------
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. 28 Farmers & Merchants Bancorp Volume and Rate Analysis of Net Interest Revenue (Rates on a Taxable Equivalent Basis)
(in thousands) Three Months Ended Nine Months Ended Sept. 30, 2004 compared to Sept. 30, 2003 Sept. 30, 2004 compared to Sept. 30, 2003 Interest Earning Assets Volume Rate Net Chg. Volume Rate Net Chg. - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Federal Funds Sold $ 14 $ 19 $ 33 $ 24 $ (28) $ (4) Investment Securities Available for Sale U.S. Treasuries 0 0 0 0 0 0 U.S. Agencies 108 34 142 627 61 688 Municipals - Taxable (3) (1) (4) (10) (2) (12) Municipals - Non-Taxable (467) 297 (170) (581) 141 (440) Mortgage Backed Securities (932) 903 (29) (694) (126) (820) Other (107) 42 (65) (368) 67 (301) - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Investment Securities Available for Sale (1,401) 1,275 (126) (1,026) 141 (885) - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Investment Securities Held to Maturity U.S. Treasuries 0 0 0 0 0 0 U.S. Agencies 98 97 195 185 185 370 Municipals - Taxable 0 0 0 0 0 0 Municipals - Non-Taxable (74) (25) (99) (55) (79) (134) Mortgage Backed Securities 70 69 139 126 125 251 Other (1) (3) (4) (4) (4) (8) - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Investment Securities Held to Maturity 93 138 231 252 227 479 - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Loans: Real Estate 1,306 (833) 473 3,417 (1,439) 1,978 Home Equity 124 0 124 389 (194) 195 Agricultural 256 108 364 903 27 930 Commercial 175 47 222 250 (8) 242 Consumer (54) (30) (84) (184) (88) (272) Credit Card 7 3 10 15 10 25 Other (4) (1) (5) (7) (6) (13) - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Loans 1,810 (706) 1,104 4,783 (1,698) 3,085 - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Earning Assets 516 726 1,242 4,033 (1,358) 2,675 - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Interest Bearing Liabilities Interest Bearing Deposits: Transaction 7 (11) (4) 9 (63) (54) Savings 180 (208) (28) 191 (408) (217) Time Deposits 712 (873) (161) 109 (1,330) (1,221) - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Interest Bearing Deposits 899 (1,092) (193) 309 (1,801) (1,492) Other Borrowed Funds (1,678) 1,530 (148) (53) (1) (54) Subordinated Debentures 60 59 119 164 163 327 - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Interest Bearing Liabilities (719) 497 (222) 420 (1,639) (1,219) - -------------------------------------------------- ------------ -------- ------------ ------------ -------- ------------ Total Change $1,235 $229 $1,464 $3,613 $281 $3,894 ================================================== ============ ======== ============ ============ ======== ============
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. 29 PART II. OTHER INFORMATION ITEM 1. 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 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 2(e) The following table indicates the number of shares repurchased by Farmers & Merchants Bancorp during the third quarter of 2004.
Number of Shares Approximate Dollar Value Average Purchased as Part of a of Shares that May Yet Be Number of Price per Publicly Announced Purchased Under the Plan Third Quarter 2004 Shares Share Plan or Program or Program - ------------------------------- ---------------- -------------- ------------------------ --------------------------- 07/01/2004 - 07/31/2004 571 $391 571 $9,659,000 08/01/2004 - 08/31/2004 2,239 400 2,239 8,764,000 09/01/2004 - 09/30/2004 954 425 954 8,358,000 - ------------------------------- ---------------- -------------- ------------------------ --------------------------- Total 3,764 $405 3,764 $8,358,000
All of the above shares were repurchased in private transactions. 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.OB." Management is aware that there are private transactions in the Company's common stock. When the Company repurchases shares in private transactions the price is determined based upon the most recent transactions that have occurred between third party shareholders. As discussed previously (see Part I, Item 2, "Capital"), during the second quarter of 2004, the Board of Directors of Farmers & Merchants Bancorp approved a resolution authorizing the repurchase, from time to time, of outstanding shares of the common stock of the Company. The Board of Directors approved the repurchase program because it concluded that the Company has more capital than it needs to meet present and anticipated regulatory guidelines to be classified as "well capitalized." Repurchases will be made on the open market or through private transactions. This repurchase program was announced in a press release dated June 21, 2004. The aggregate price to be paid by the Company for all repurchased stock will not exceed $10,000,000 and the program will expire on May 31, 2007. The repurchase program also requires that no purchases may be made if the Company would not remain "well-capitalized" after the repurchase. All shares repurchased under the repurchase program will be retired. 30 ITEM 3. Defaults Upon Senior Securities Not applicable ITEM 4. Submission of Matters to a Vote of Security Holders None ITEM 5. Other Information None ITEM 6(a). Exhibits See Exhibit Index on Page 32. ITEM 6(b). Reports on Form 8-K During the quarter ended September 30, 2004, the Company filed the following Current Reports on Form 8-K: Description Date of Report Second Quarter 2004 results of operations July 23, 2004 SIGNATURES Pursuant to the requirement 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 Date: November 8, 2004 /s/ Kent A. Steinwert ------------------------------ Kent A. Steinwert President and Chief Executive Officer (Principal Executive Officer) Date: November 8, 2004 /s/ Stephen W. Haley ------------------------------ Stephen W. Haley Executive Vice President and Chief Financial Officer (Principal Accounting Officer) 31 Index to Exhibits Exhibit No. Description 31 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32 EX-31 2 form10-q_3rdqtr2004ex31.txt SECTION 302 CERTIFICATIONS FOR 3RD QUARTER 10-Q Exhibit 31 Certification Pursuant to Section 302 Of the Sarbanes-Oxley Act of 2002 For the Chief Executive Officer I, Kent A. Steinwert, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Farmers & Merchants Bancorp; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2004 /s/ Kent A. Steinwrt ------------------------------ Kent A. Steinwert President & Chief Executive Officer Exhibit 31 Certification Pursuant to Section 302 Of the Sarbanes-Oxley Act of 2002 For the Chief Financial Officer I, Stephen W. Haley, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Farmers & Merchants Bancorp; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2004 /s/ Stephen W. Haley ------------------------------ Stephen W. Haley Executive Vice President & Chief Financial Officer EX-32 3 form10-q_3rdqtr2004ex32.txt SECTION 906 CERTIFICATIONS FOR 3RD QTR 2004 10-Q Exhibit 32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Farmers & Merchants Bancorp (the "Company") on Form 10-Q for the quarterly period ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Kent A. Steinwert, President and Chief Executive Officer of the Company, certify pursuant to Rule 13a-14(b) and section 1350 of chapter 63 of title 19 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 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 President & Chief Executive Officer November 8, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Exhibit 32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Farmers & Merchants Bancorp (the "Company") on Form 10-Q for the quarterly period ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen W. Haley, Executive Vice President and Chief Financial Officer of the Company, certify pursuant to Rule 13a-14(b) and section 1350 of chapter 63 of title 19 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 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/ Stephen W. Haley --------------------------- Stephen W. Haley Executive Vice President & CFO November 8, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----