-----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, GJmZvNnpxpeu/IVbwOEVf/5Mrlouz2RWNFSlZWMxbSr1HcItwgStJZ4QDIJ6ycUK AZdQt/hB+yXDr7VlTQe3qw== 0001140361-05-009227.txt : 20051109 0001140361-05-009227.hdr.sgml : 20051109 20051108185049 ACCESSION NUMBER: 0001140361-05-009227 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20050930 FILED AS OF DATE: 20051109 DATE AS OF CHANGE: 20051108 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: 051187473 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 body.txt FARMERS & MERCHANTS 10-Q 9-30-2005 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, 2005 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 [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] Number of shares of common stock of the registrant: Par value $0.01, authorized 2,000,000 shares; issued and outstanding 825,211 as of October 31, 2005.
FARMERS & MERCHANTS BANCORP FORM 10-Q TABLE OF CONTENTS ----------------------------- PART I. - FINANCIAL INFORMATION PAGE --------------------- ---- ITEM 1 - FINANCIAL STATEMENTS Consolidated Balance Sheets (Unaudited) as of September 30, 2005, December 31, 2004 and September 30, 2004. 4 Consolidated Statements of Income (Unaudited) for the Three Months and Nine Months Ended September 30, 2005 and 2004. 5 Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months and Nine Months Ended September 30, 2005 and 2004. 6 Consolidated Statements of Changes in Shareholders' Equity (Unaudited) for the Nine Months Ended September 30, 2005 and 2004. 7 Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2005 and 2004. 8 Notes to the Consolidated Financial Statements 9 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 27 ITEM 4 - CONTROLS AND PROCEDURES 30 PART II. - OTHER INFORMATION ----------------- ITEM 1 - LEGAL PROCEEDINGS 31 ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 31 ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 31 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 31 ITEM 5 - OTHER INFORMATION 31 2 ITEM 6 - EXHIBITS 32 SIGNATURES 33 INDEX TO EXHIBITS 33
3
PART I. - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS FARMERS & MERCHANTS BANCORP CONSOLIDATED BALANCE SHEETS ======================================================================================== (in thousands) Sept. 30, December 31, Sept. 30, 2005 2004 2004 ASSETS (Unaudited) (Unaudited) - ---------------------------------------------------------------------------------------- Cash and Cash Equivalents: Cash and Due From Banks $ 36,871 $ 32,170 $ 34,321 Federal Funds Sold - - 6,500 - ---------------------------------------------------------------------------------------- Total Cash and Cash Equivalents 36,871 32,170 40,821 Investment Securities: Available-for Sale 143,884 185,488 176,720 Held-to-Maturity 110,540 89,952 70,089 - ---------------------------------------------------------------------------------------- Total Investment Securities 254,424 275,440 246,809 - ---------------------------------------------------------------------------------------- Loans 947,039 869,082 843,954 Less: Unearned Income (2,460) (2,174) (1,964) Less: Allowance for Loan Losses (17,905) (17,727) (18,169) - ---------------------------------------------------------------------------------------- Loans, Net 926,674 849,181 823,821 - ---------------------------------------------------------------------------------------- Land, Buildings & Equipment 16,311 14,971 12,171 Bank Owned Life Insurance 36,404 35,235 34,851 Interest Receivable and Other Assets 22,670 19,298 17,221 - ---------------------------------------------------------------------------------------- TOTAL ASSETS $ 1,293,354 $ 1,226,295 $1,175,694 ======================================================================================== LIABILITIES & SHAREHOLDERS' EQUITY - ---------------------------------------------------------------------------------------- Deposits: Demand $ 267,765 $ 273,799 $ 252,619 Interest Bearing Transaction 119,918 108,213 93,146 Savings 289,662 301,225 291,900 Time Deposits 369,271 318,873 357,508 - ---------------------------------------------------------------------------------------- Total Deposits 1,046,616 1,002,110 995,173 - ---------------------------------------------------------------------------------------- Fed Funds Purchased 19,700 - - FHLB Borrowings 75,857 80,889 40,898 Subordinated Debentures 10,310 10,310 10,310 Other Liabilities 17,827 16,439 13,069 - ---------------------------------------------------------------------------------------- Total Liabilities 1,170,310 1,109,748 1,059,450 - ---------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Common Stock 8 8 8 Additional Paid In Capital 96,808 82,237 82,694 Retained Earnings 28,509 35,332 34,601 Accumulated Other Comprehensive Loss (2,281) (1,030) (1,059) - ---------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 123,044 116,547 116,244 - ---------------------------------------------------------------------------------------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 1,293,354 $ 1,226,295 $1,175,694 ======================================================================================== The accompanying notes are an integral part of these unaudited consolidated financial statements
4
FARMERS & MERCHANTS BANCORP CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) ========================================================================================== (in thousands, except per share date) Three Months Nine Months Ended Sept. 30, Ended Sept. 30, 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------ INTEREST INCOME Interest & Fees on Loans $16,061 $12,648 $44,631 $36,304 Federal Funds Sold 41 64 97 124 Securities: Taxable 1,769 1,858 5,498 5,612 Non-taxable 834 544 2,389 1,684 - ------------------------------------------------------------------------------------------ Total Interest Income 18,705 15,114 52,615 43,724 - ------------------------------------------------------------------------------------------ INTEREST EXPENSE Interest Bearing Transaction 20 15 58 44 Savings 324 272 977 779 Time Deposits 2,345 1,455 5,956 4,040 Interest on Borrowed Funds 992 627 2,441 2,125 Interest on Subordinated Debentures 166 119 463 327 - ------------------------------------------------------------------------------------------ Total Interest Expense 3,847 2,488 9,895 7,315 - ------------------------------------------------------------------------------------------ NET INTEREST INCOME 14,858 12,626 42,720 36,409 Provision for Loan Losses - 350 - 1,075 - ------------------------------------------------------------------------------------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 14,858 12,276 42,720 35,334 - ------------------------------------------------------------------------------------------ NON-INTEREST INCOME Service Charges on Deposit Accounts 1,128 1,211 3,273 3,669 Net (Loss) Gain on Sale of Investment Securities (307) 10 (163) 757 Credit Card Merchant Fees 546 469 1,526 1,306 Increase in Cash Surrender Value of Life Insurance 403 389 1,169 1,198 Other 1,214 871 3,104 2,999 - ------------------------------------------------------------------------------------------ Total Non-Interest Income 2,984 2,950 8,909 9,929 - ------------------------------------------------------------------------------------------ NON-INTEREST EXPENSE Salaries & Employee Benefits 7,027 5,392 20,437 17,230 Occupancy 495 432 1,505 1,282 Equipment 772 548 1,733 1,526 Credit Card Merchant Expense 395 328 1,088 890 Other Operating 1,763 1,808 5,345 5,008 - ------------------------------------------------------------------------------------------ Total Non-Interest Expense 10,452 8,508 30,108 25,936 - ------------------------------------------------------------------------------------------ NET INCOME BEFORE TAXES 7,390 6,718 21,521 19,327 Provision for Taxes 2,643 2,494 7,754 7,097 - ------------------------------------------------------------------------------------------ NET INCOME $ 4,747 $ 4,224 $13,767 $12,230 ========================================================================================== EARNINGS PER SHARE $ 5.74 $ 5.06 $ 16.59 $ 14.61 ========================================================================================== The accompanying notes are an integral part of these consolidated financial statements
5
FARMERS & MERCHANTS BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) ======================================================================================================================== (in thousands) For Three Months For Nine Months Ended Sept. 30, Ended Sept. 30, 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------------------------------------ NET INCOME $4,747 $4,224 $13,767 $12,230 OTHER COMPREHENSIVE (LOSS) INCOME - UNREALIZED (LOSS) GAINS ON DERIVATIVE INSTRUMENTS: Unrealized holding gains arising during the period, net of income tax effects of $3 and $59 for the quarters ended September 30, 2005 and 2004, respectively, and $0 and $123 for the nine months ended September 30, 2005 and 2004, respectively. 4 82 - 170 Less: Reclassification adjustment for realized losses included in net income, net of related income tax effects of $(6) and $(44) for the quarters ended September 30, 2005 and 2004, respectively, and $(9) and $(109) for the nine months ended September 30, 2005 and 2004, respectively. (9) (61) (13) (150) UNREALIZED (LOSSES) GAINS ON SECURITIES: Unrealized holding (losses) gains arising during the period, net of income tax effects of $(435) and $1,883 for the quarters ended September 30, 2005 and 2004, respectively, and of $(1,028) and $(60) for the nine months ended September 30, 2005 and 2004, respectively. (598) 2,595 (1,416) (82) Less: Reclassification adjustment for realized gains (losses) included in net income, net of related income tax effects of $129 and $(4) for the quarters ended September 30, 2005 and 2004, respectively, and of $129 and $(318) for the nine months ended September 30, 2005 and 2004, 177 (5) 177 (438) respectively. - ------------------------------------------------------------------------------------------------------------------------ TOTAL OTHER COMPREHENSIVE (LOSS) INCOME (426) 2,611 (1,252) (500) - ------------------------------------------------------------------------------------------------------------------------ COMPREHENSIVE INCOME $4,321 $6,835 $12,515 $11,730 ======================================================================================================================== The accompanying notes are an integral part of these consolidated financial statements
6
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, 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) Repurchase of Stock (6,905) - (2,650) - - (2,650) Change in Net Unrealized Gain (Loss) on Derivative Instruments 20 20 Change in Net Unrealized Loss on Securities Available-for-Sale - - - (520) (520) - ------------------------------------------------------------------------------------------------------------------------------ BALANCE, SEPTEMBER 30, 2004 793,798 $ 8 $ 82,694 $ 34,601 $ (1,059) $ 116,244 ============================================================================================================================== - ------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 2004 792,722 $ 8 $ 82,237 $ 35,332 $ (1,030) $ 116,547 - ------------------------------------------------------------------------------------------------------------------------------ Net Income - - 13,767 - 13,767 Cash Dividends Declared on - Common Stock - - (2,659) - (2,659) 5% Stock Dividend 38,995 - 17,641 (17,641) - - Cash Paid in Lieu of Fractional Shares Related to Stock Dividend - - (290) - (290) Repurchase of Stock (6,143) - (3,070) - - (3,070) Change in Net Unrealized Gain (Loss) on Derivative Instruments (12) (12) Change in Net Unrealized Loss on Securities Available-for-Sale - - - (1,239) (1,239) - ------------------------------------------------------------------------------------------------------------------------------ BALANCE, SEPTEMBER 30, 2005 825,574 $ 8 $ 96,808 $ 28,509 $ (2,281) $ 123,044 ============================================================================================================================== The accompanying notes are an integral part of these consolidated financial statements
7
FARMERS & MERCHANTS BANCORP CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) Nine Months Ended ========================================================================================== (in thousands) Sept 30, Sept 30, 2005 2004 - ------------------------------------------------------------------------------------------ OPERATING ACTIVITIES: Net Income $ 13,767 $ 12,230 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Loan Losses - 1,075 Depreciation and Amortization 1,168 1,128 Net Amortization of Investment Security Premium & Discounts 482 709 Net Loss (Gain) on Sale of Investment Securities 163 (757) Net Gain on Sale of Property & Equipment (1) (156) Increase in Interest Receivable and Other Assets (3,791) (1,726) Increase in Interest Payable and Other Liabilities 1,388 1,696 - ------------------------------------------------------------------------------------------ Net Cash Provided by Operating Activities 13,176 14,199 INVESTING ACTIVITIES: Securities Available-for-Sale: Purchased (15,550) (63,507) Sold, Matured or Called 54,565 109,856 Securities Held-to-Maturity: Purchased (27,703) (37,980) Matured or Called 7,058 5,894 Net Loans Originated or Acquired (78,030) (35,371) Principal Collected on Loans Previously Charged Off 537 161 Net Additions to Premises and Equipment (2,508) (2,139) Proceeds from Sale of Property & Equipment 1 205 - ------------------------------------------------------------------------------------------ Net Cash Used by Investing Activities (61,630) (22,881) FINANCING ACTIVITIES: Net (Decrease) Increase in Demand, Interest-Bearing Transaction, and Savings Accounts (5,892) 41,780 Increase in Time Deposits 50,398 49,044 Net Increase (Decrease) in Federal Funds Purchased 19,700 (1,000) Net Decrease in Federal Home Loan Bank Advances Advances (5,000) (71,000) Paydowns (32) (30) Cash Dividends (2,949) (2,441) Stock Repurchase (3,070) (2,650) - ------------------------------------------------------------------------------------------ Net Cash Provided by Financing Activities 53,155 13,703 Increase in Cash and Cash Equivalents 4,701 5,021 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 32,170 35,800 - ------------------------------------------------------------------------------------------ CASH AND CASH EQUIVALENTS AS OF SEPT. 30, 2005 AND SEPT. 30, 2004 $ 36,871 $ 40,821 ========================================================================================== The accompanying notes are an integral part of these consolidated financial statements
8 FARMERS & MERCHANTS BANCORP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (For the audited year ended December 31, 2004 and the unaudited three and nine months ended September 30, 2005 and September 30, 2004) 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 Bank's wholly owned subsidiaries include Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. 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 a wholly owned subsidiary, FMCB Statutory Trust I. FMCB Statutory Trust I is a non-consolidated subsidiary per generally accepted accounting principles (GAAP), and was formed for the sole purpose of issuing Trust Preferred Securities. The following is a summary of the significant accounting and reporting policies used in preparing the consolidated financial statements. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (which consist solely of normal recurring accruals) considered necessary for a fair presentation of the results for the interim periods presented have been included. These interim consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company's 2004 Annual Report to Shareholders on Form 10-K. 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. The results of operations for the nine-month period ended September 30, 2005 may not necessarily be indicative of the operating results for the full year 2005. Management has determined that since all of the commercial banking products and services offered by the Company are available in each branch of the bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. 9 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, 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 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 probable. 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. 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, or 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 10 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 by recoveries on loans previously charged-off and reduced by 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 many factors in determining the adequacy of the allowance at the balance sheet date. The factors evaluated in connection with the allowance may include existing general economic and business conditions affecting the key lending areas of the Company, current levels of problem loans and delinquencies, credit quality trends, collateral values, loan volumes and concentration, seasoning of the loan portfolio, specific industry conditions, recent loss experience, duration of the current business cycle, bank regulatory examination results and findings of the Company's internal credit examiners. The allowance also incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures". These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans, which are discussed more fully in Note 4 to the Consolidated Financial Statements in the Company's 2004 Annual Report to Shareholders. 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 probable. DIVIDENDS AND 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. On April 21, 2005, the Board of Directors declared a 5% stock dividend payable May 12, 2005, to shareholders of record at the close of business on April 21, 2005. Common stock shareholders of record as of April 21, 2005 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 $22.62 per share was paid in lieu of the stock dividend. The Board of Directors of Farmers & Merchants Bancorp declared a cash dividend on June 7, 2005, in the amount of $3.20 per share, an increase from the $2.80 per share paid last year. The cash dividend was paid on June 30, 2005, to stockholders of record as of June 17, 2005. No stock or cash dividends were declared during the third quarter of 2005. Earnings per share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. The weighted average number of shares outstanding for the three and nine months ending September 30, 2005 and the three and nine months ending September 30, 11 2004 were 827,012, 829,976, 834,697 and 836,976, respectively. Prior periods have been restated for applicable 5% stock dividends paid. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Statement of Financial Accounting Standards, No. 133, "Accounting for Derivative Instruments and Certain Hedging Activities" as amended by the Statement of Financial Accounting Standards, No. 138, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. Changes in the fair value of those derivatives are accounted for depending on the intended use of the derivative and the resulting designation under specified criteria. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, designed to minimize interest rate risk, the effective portions of the change in the fair value of the derivative are recorded in other comprehensive income 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. The Company was not utilizing any derivative instruments as of September 30, 2005. 2. RECENT ACCOUNTING DEVELOPMENTS In March 2004, the FASB approved the consensus reached on the EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The objective of this consensus is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. Originally, the accounting provisions of EITF 03-1 were effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. In September 2004, the FASB issued two FASB Staff Positions (FSP), FSP EITF 03-1-a and FSP EITF 03-1-1, which delayed the measurement and recognition paragraphs of the consensus for further discussion. The disclosure requirements remain effective as originally issued under EITF 03-1 and have been adopted by the Consolidated Corporation. In June 2005, the FASB issued a final FSP EITF 03-1-a (retitled FSP FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments") which will replace the guidance set forth in paragraphs 10-18 of Issue 03-1 and clarifies when an investor should recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The Consolidated Corporation has evaluated the provisions of FSP FAS 115-1 and believes the impact will be immaterial on its overall results of operations or financial position. On June 7, 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements." Under the provisions of SFAS No. 154, voluntary changes in accounting principles are applied retrospectively to prior periods' financial statements unless it would be impractical. SFAS No. 154 supersedes APB Opinion No. 20, which required that most voluntary changes in accounting principles be recognized by including in the current period's net income the cumulative 12 effect of the change. SFAS No. 154 also makes a distinction between "retrospective application" of a change in accounting principle and the "restatement" of financial statements to reflect the correction of an error. The provisions of SFAS No. 154 are effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not expect adoption to have a material impact on the consolidated financial statements, results of operations or liquidity of the Company. 3. INTERIM-PERIOD DISCLOSURE OF EMPLOYEE BENEFIT PLANS
COMPONENTS OF NET PERIODIC PENSION COST: Three months ended Sept. 30, Nine months ended Sept. 30, ---------------------------------------------------------- (in thousands) 2005 2004 2005 2004 ---------------------------------------------------------- Service cost $ 13 $ 12 $ 39 $ 36 Interest cost 65 64 195 192 Expected return on assets (29) (57) (87) (171) Amortization of loss 237 126 711 378 Amortization of prior service cost 0 0 0 0 Amortization of transition obligation 0 0 0 0 ---------------------------------------------------------- Net periodic pension cost $ 286 $ 145 $ 858 $ 435 ==========================================================
See Note 12 to the Consolidated Financial Statements in the Company's 2004 Annual Report to Shareholders for a discussion regarding the Company's intent to terminate the Defined Benefit Pension Plan during 2005. EMPLOYER CONTRIBUTIONS The Company previously disclosed in its financial statements for the year ended December 31, 2004 that it expected to contribute $1.6 million to its Pension Plan in 2005. As part of the process required to terminate the Pension Plan, individual valuations have been prepared for each participant that now indicate the Company's required contribution to the Plan in 2005 will be closer to $1.9 million. The contribution to the Plan will be made during the fourth quarter of 2005. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This quarterly report contains various forward-looking statements, usually containing the words "estimate," "project," "expect," "objective," "goal," or similar expressions and includes assumptions concerning the Company's operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risk and uncertainties. In connection with the "safe-harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions. Such factors include the following: (i) the effect of changing regional and national economic conditions, including loan demand; (ii) significant changes in interest rates and prepayment speeds; (iii) credit risks of commercial, agricultural, 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 13 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 situation; and (xiii) other external developments which could materially impact the Company's operational and financial performance. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. INTRODUCTION Farmers & Merchants Bancorp is a bank holding company formed March 10, 1999. Its operating subsidiary, Farmers & Merchants Bank of Central California was formed in 1916. The Bank services the northern Central Valley of California with 19 banking offices. The service area includes Sacramento, San Joaquin, Stanislaus and Merced Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, Linden, Modesto, Turlock and Hilmar. Substantially all of the Company's business activities are conducted within its market area. As a bank holding company, the Company is subject to regulation and examination by the Board of Governors of the Federal Reserve System ("FRB"). The Bank is a California state-chartered bank subject to the regulation and examination of the California Department of Financial Institutions. Since August 1, 1940, the Bank had also been a member of the Federal Reserve System and the FRB served as its primary Federal regulator. However, at a meeting of the Board of Directors of the Bank on April 5, 2005, the Board decided to withdraw from membership in the Federal Reserve System. The Bank received the FRB's approval for this action on April 18, 2005. As a result, the Bank's primary federal regulator is now the Federal Deposit Insurance Corporation. The FRB will continue to regulate and examine the Company but not the Bank. Management and the Board believe that this change will not have any operating or financial impact on the Company or the Bank. This section should be read in conjunction with the consolidated financial statements and the notes thereto, along with other financial information included in this report. OVERVIEW The Company's primary service area encompasses the northern Central Valley of California, a region that is impacted by the seasonal needs of the agricultural industry. Accordingly, discussion of the Company's Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in fall and winter as crops are harvested and sold). For the three and nine months ended September 30, 2005, Farmers & Merchants Bancorp reported net income of $4,747,000 and $13,767,000, earnings per share of $5.74 and $16.59 and return on average assets of 1.50% and 1.47%, respectively. Return on average shareholders' equity was 15.73% and 15.31% for the three and nine months ended September 30, 2005. For the three and nine months ended September 30, 2004, net income totaled $4,224,000 and $12,230,000, earnings per share was $5.06 and $14.61 and return on average assets was 1.43% and 14 1.40%. Return on average shareholders' equity for the three and nine months ended September 30, 2004 was 14.97% and 14.55%, respectively. The Company's improved earnings performance in the first nine months of 2005 when compared to the same period last year was due to a combination of (1) growth in earning assets; (2) improvement in the net interest margin due to rising interest rates; and (3) a reduction in the provision for loan losses. The following is a summary of the financial results for the nine-month period ended September 30, 2005 compared to September 30, 2004. - - Net income increased 12.6% to $13.8 million from $12.2 million. - - Earnings per share increased 13.6% to $16.59 from $14.61. - - Net interest income increased 17.3% to $42.7 million from $36.4 million. - - Net interest margin increased 48 basis points from 4.59% to 5.07%. - - Total assets increased 10.0% to $1.3 billion. - - Gross loans increased 12.2% to $947.0 million. - - Total deposits increased 5.2% to $1.0 billion. RESULTS OF OPERATIONS NET INTEREST INCOME / NET INTEREST MARGIN 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, 2005 and 2004. 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. 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. The Volume and Rate Analysis of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average asset and liability balances (volume) and changes in average rates (rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in volume (change in volume multiplied by initial rate), (2) changes in rate (change in rate multiplied by initial volume) and (3) changes in rate/volume (allocated in proportion to the respective volume and rate components). 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 15 income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. 3RD QUARTER 2005 VS. 3RD QUARTER 2004 Net interest income for the third quarter of 2005 increased 17.7% to $14.8 million, compared to $12.6 million for the third quarter of 2004. On a fully taxable equivalent basis, net interest income increased 17.4% and totaled $15.2 million for the third quarter of 2005, compared to $12.9 million for the third quarter of 2004. 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 three months ended September 30, 2005, the Company's net interest margin was 5.10% compared to 4.64% for the same period in 2004. Loans, generally the Company's highest earning asset, increased $103.1 million as of September 30, 2005 compared to September 30, 2004. On an average balance basis, loans increased by $71.2 million for the three months ended September 30, 2005 compared to the three months ended September 30, 2004. The yield on the loan portfolio increased 102 basis points to 6.97% for the three months ended September 30, 2005 compared to 5.95% for the three months ended September 30, 2004. This increase in yield and volume resulted in interest revenue from loans increasing 27.0% to $16.1 million for the third quarter of 2005 compared to $12.6 million for the third quarter of 2004. The investment portfolio is the other main component of the Company's earning assets. Management believes the Company's investment policy is conservative. The Company invests primarily in mortgage-backed securities, 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 were $262.4 million for the third quarter of 2005 compared to $244.7 million for the third quarter of 2004. The average yield, on a taxable equivalent basis (TE), in the investment portfolio was 4.48% for the third quarter of 2005 compared to 4.43% for the third quarter of 2004. The increase in the volume and yield on investment securities resulted in an increase in interest income of $223,000, or 8.2%, for the three months ended September 30, 2005. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a taxable equivalent basis (TE), 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. Compared to the third quarter of 2004, the Company has grown average interest-bearing sources of funds by $51.5 million or 6.3%. Interest bearing deposits grew $22.6 million while all other interest bearing sources of funds (including FHLB Advances) increased by $28.9 million (see Deposits and Federal Home Loan Bank Advances and Other Borrowings). Overall, the average interest rate on interest-bearing sources of funds was 1.76% for the three months ended September 30, 2005 and 1.21% for the three months ended September 30, 2004. The increase in the volume and rate on interest-bearing sources of funds resulted in an increase in interest expense of $1.4 million, or 54.6%, for the three months ended September 30, 2005 over the same period in 2004. 16
FARMERS & MERCHANTS BANCORP QUARTERLY AVERAGE BALANCES AND INTEREST RATES (Interest and Rates on a Taxable Equivalent Basis) (in thousands) Three Months Ended Sept. 30, Three Months Ended Sept. 30, 2005 2004 ASSETS Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------- Federal Funds Sold $ 4,817 $ 41 3.38% $ 19,004 $ 64 1.34% Investment Securities Available-for-Sale U.S. Agencies 57,496 548 3.81% 64,046 586 3.66% Municipals - Taxable 0 0 0.00% 964 15 6.22% Municipals - Non-Taxable 15,699 223 5.69% 17,495 277 6.33% Mortgage Backed Securities 75,354 729 3.87% 84,542 827 3.91% Other 3,548 64 7.22% 6,425 95 5.91% - ------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale 152,097 1,564 4.11% 173,472 1,800 4.15% - ------------------------------------------------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Agencies 30,701 308 4.01% 19,952 195 3.91% Municipals - Non-Taxable 67,403 945 5.61% 36,618 577 6.31% Mortgage Backed Securities 11,932 112 3.75% 14,386 139 3.86% Other 277 7 10.11% 307 2 2.61% - ------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity 110,313 1,372 4.97% 71,263 913 5.13% - ------------------------------------------------------------------------------------------------------------------------- Loans Real Estate 506,791 8,689 6.80% 482,262 7,619 6.27% Home Equity 65,976 1,100 6.61% 59,272 720 4.82% Agricultural 152,599 2,747 7.14% 141,507 1,927 5.40% Commercial 169,625 3,089 7.22% 142,764 2,000 5.56% Consumer 12,905 301 9.25% 11,271 258 9.08% Credit Card 5,095 124 9.66% 4,619 112 9.62% Municipal 1,002 11 4.36% 1,047 12 4.55% - ------------------------------------------------------------------------------------------------------------------------- Total Loans 913,993 16,061 6.97% 842,742 12,648 5.95% - ------------------------------------------------------------------------------------------------------------------------- Total Earning Assets 1,181,220 $ 19,038 6.40% 1,106,481 $ 15,425 5.54% ===================== =================== Unrealized Loss on Securities Available-for-Sale (2,053) (911) Allowance for Loan Losses (17,933) (17,964) Cash and Due From Banks 35,904 33,674 All Other Assets 72,959 63,720 - ---------------------------------------------------------------- ----------- TOTAL ASSETS $1,270,097 $1,185,000 ================================================================ =========== LIABILITIES & SHAREHOLDERS' EQUITY Interest Bearing Deposits Interest Bearing DDA $ 116,849 $ 20 0.07% $ 95,006 $ 15 0.06% Savings 291,876 324 0.44% 288,726 273 0.38% Time Deposits 358,160 2,345 2.60% 360,592 1,454 1.60% - ------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 766,885 2,689 1.39% 744,324 1,742 0.93% Other Borrowed Funds 89,120 992 4.42% 60,152 627 4.14% Subordinated Debentures 10,310 166 6.39% 10,310 119 4.58% - ------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 866,315 $ 3,847 1.76% 814,786 $ 2,488 1.21% ===================== =================== Interest Rate Spread 4.64% 4.33% Demand Deposits (Non-Interest Bearing) 266,351 245,105 All Other Liabilities 16,722 12,272 - ---------------------------------------------------------------- ----------- TOTAL LIABILITIES 1,149,388 1,072,163 Shareholders' Equity 120,709 112,837 - ---------------------------------------------------------------- ----------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $1,270,097 $1,185,000 ================================================================ =========== Impact of Non-Interest Bearing Deposits and Other Liabilities 0.46% 0.31% Net Interest Income and Margin on Total Earning Assets 15,191 5.10% 12,937 4.64% Tax Equivalent Adjustment (333) (311) - ------------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 14,858 4.99% $12,626 4.53% ========================================================================================================================= Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount of $877,000 and $688,000 for the third quarter of 2005 and 2004, respectively. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost.
17
FARMERS & MERCHANTS BANCORP YEAR-TO-DATE AVERAGE BALANCES AND INTEREST RATES (Interest and Rates on a Taxable Equivalent Basis) (in thousands) Nine Months Ended September 30, Nine Months Ended September 30, 2005 2004 ASSETS Balance Interest Rate Balance Interest Rate - -------------------------------------------------------------------------------------------------------------------------- Federal Funds Sold $ 4,474 $ 97 2.90% $ 14,217 $ 124 1.16% Investment Securities Available-for-Sale U.S. Agencies 62,360 1,739 3.72% 65,460 1,770 3.61% Municipals - Taxable 108 5 6.17% 1,033 48 6.20% Municipals - Non-Taxable 16,175 741 6.11% 19,737 900 6.08% Mortgage Backed Securities 79,820 2,341 3.91% 101,958 2,855 3.73% Other 4,517 180 5.31% 7,617 307 5.37% - -------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Available-for-Sale 162,980 5,006 4.10% 195,805 5,880 4.00% - -------------------------------------------------------------------------------------------------------------------------- Investment Securities Held-to-Maturity U.S. Agencies 27,443 859 4.17% 11,215 370 4.40% Municipals - Non-Taxable 64,114 2,882 5.99% 36,588 1,750 6.38% Mortgage Backed Securities 12,556 358 3.80% 8,198 251 4.08% Other 286 15 6.99% 344 11 4.26% - -------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Held-to-Maturity 104,399 4,114 5.25% 56,345 2,382 5.64% - -------------------------------------------------------------------------------------------------------------------------- Loans Real Estate 501,071 24,929 6.65% 474,315 22,226 6.24% Home Equity 64,426 2,961 6.14% 56,794 2,005 4.70% Agricultural 139,178 6,999 6.72% 132,736 5,171 5.19% Commercial 164,668 8,518 6.92% 137,614 5,762 5.58% Consumer 12,647 822 8.69% 11,188 775 9.23% Credit Card 4,992 369 9.88% 4,556 330 9.65% Municipal 988 33 4.47% 1,065 35 4.38% - -------------------------------------------------------------------------------------------------------------------------- Total Loans 887,970 44,631 6.72% 818,268 36,304 5.91% - -------------------------------------------------------------------------------------------------------------------------- Total Earning Assets 1,159,823 $53,848 6.21% 1,084,635 $ 44,690 5.49% ================== ================== Unrealized (Loss) Gain on Securities Available-for-Sale (1,496) 601 Allowance for Loan Losses (17,881) (17,691) Cash and Due From Banks 34,268 32,755 All Other Assets 70,682 61,938 - --------------------------------------------------------------------- ----------- TOTAL ASSETS $1,245,396 $1,162,238 ===================================================================== =========== LIABILITIES & SHAREHOLDERS' EQUITY Interest Bearing Deposits Interest Bearing DDA $ 114,493 $ 58 0.07% $ 94,621 $ 44 0.06% Savings 299,336 977 0.44% 281,823 780 0.37% Time Deposits 352,939 5,956 2.26% 328,753 4,039 1.64% - -------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 766,768 6,991 1.22% 705,197 4,863 0.92% Other Borrowed Funds 73,003 2,441 4.47% 94,235 2,125 3.00% Subordinated Debentures 10,310 463 6.00% 10,310 327 4.23% - -------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 850,081 $ 9,895 1.56% 809,742 $ 7,315 1.20% ================== ================== Interest Rate Spread 4.65% 4.29% Demand Deposits (Non-Interest Bearing) 260,482 229,233 All Other Liabilities 14,966 11,170 - --------------------------------------------------------------------- ----------- TOTAL LIABILITIES 1,125,529 1,050,145 ===================================================================== =========== Shareholders' Equity 119,867 112,093 - --------------------------------------------------------------------- ----------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $1,245,396 $1,162,238 ===================================================================== =========== Impact of Non-Interest Bearing Deposits and Other Liabilities 0.42% 0.30% Net Interest Income and Margin on Total Earning Assets 43,953 5.07% 37,375 4.59% Tax Equivalent Adjustment (1,233) (966) - -------------------------------------------------------------------------------------------------------------------------- Net Interest Income $42,720 4.92% $ 36,409 4.47% ========================================================================================================================== Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount of $2.6 million and $2.4 million for the nine months ended September 30, 2005 and 2004, respectively. Nonaccrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost.
18
FARMERS & MERCHANTS BANCORP VOLUME AND RATE ANALYSIS OF NET INTEREST INCOME (Rates on a Taxable Equivalent Basis) (in thousands) Three Months Ended Nine Months Ended Sept. 30, 2005 compared Sept. 30, 2005 compared to Sept. 30, 2004 to Sept. 30, 2004 INTEREST EARNING ASSETS Volume Rate Net Chg. Volume Rate Net Chg. - --------------------------------------------------------------------------------------------------------------------------- Federal Funds Sold $ (262) $ 239 $ (23) $ (164) $ 137 $ (27) Investment Securities Available for Sale U.S. Agencies (166) 128 (38) (108) 77 (31) Municipals - Taxable (7) (8) (15) (43) 0 (43) Municipals - Non-Taxable (28) (26) (54) (167) 8 (159) Mortgage Backed Securities (89) (9) (98) (719) 205 (514) Other (135) 104 (31) (124) (3) (127) - --------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Available for Sale (425) 189 (236) (1,161) 287 (874) - --------------------------------------------------------------------------------------------------------------------------- Investment Securities Held to Maturity U.S. Agencies 107 6 113 521 (32) 489 Municipals - Non-Taxable 779 (411) 368 1,308 (176) 1,132 Mortgage Backed Securities (23) (4) (27) 136 (29) 107 Other (2) 7 5 (3) 7 4 - --------------------------------------------------------------------------------------------------------------------------- Total Investment Securities Held to Maturity 861 (402) 459 1,962 (230) 1,732 - --------------------------------------------------------------------------------------------------------------------------- Loans: Real Estate 400 670 1,070 1,249 1,454 2,703 Home Equity 88 292 380 291 665 956 Agricultural 160 660 820 257 1,571 1,828 Commercial 420 669 1,089 1,241 1,515 2,756 Consumer 39 4 43 116 (69) 47 Credit Card 12 0 12 31 8 39 Other 0 (1) (1) (3) 1 (2) - --------------------------------------------------------------------------------------------------------------------------- Total Loans 1,119 2,294 3,413 3,182 5,145 8,327 - --------------------------------------------------------------------------------------------------------------------------- Total Earning Assets 1,293 2,320 3,613 3,819 5,339 9,158 - --------------------------------------------------------------------------------------------------------------------------- INTEREST BEARING LIABILITIES Interest Bearing Deposits: Transaction 4 1 5 9 5 14 Savings 3 48 51 50 147 197 Time Deposits (68) 959 891 312 1,605 1,917 - --------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits (61) 1,008 947 371 1,757 2,128 Other Borrowed Funds 320 45 365 (773) 1,089 316 Subordinated Debentures 0 47 47 0 136 136 - --------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 259 1,100 1,359 (402) 2,982 2,580 - --------------------------------------------------------------------------------------------------------------------------- TOTAL CHANGE $ 1,034 $ 1,220 $ 2,254 $ 4,221 $ 2,357 $ 6,578 =========================================================================================================================== 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.
NINE MONTHS ENDING SEPTEMBER 30, 2005 VS. NINE MONTHS ENDING SEPTEMBER 30, 2004 During the first nine months of 2005, net interest income increased 17.3% to $42.7 million, compared to $36.4 million at September 30, 2004. On a fully taxable equivalent basis, net interest income increased 19 17.6% and totaled $43.9 million at September 30, 2005, compared to $37.4 million at September 30, 2004. As reported in previous quarters, one of the reasons for the increase in net interest income during the first nine months of 2005 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. Moreover, as a result of the Federal Reserve Bank having increased short-term market interest rates by 275 basis points since June 2004, the Company's net interest income has also benefited substantially from an increase in the rate on earning assets. For the nine months ended September 30, 2005, the Company's net interest margin was 5.07% compared to 4.59% for the same period in 2004. The Company's yield on earning assets has improved over the last twelve months as a result of increases in short-term market interest rates. For further discussion see Market Risk - Interest Rate Risk under Item 3. Quantitative and Qualitative Disclosures About Market Risk. Loans, on an average balance basis, increased by $69.7 million for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004. The yield on the loan portfolio increased 81 basis points to 6.72% for the nine months ended September 30, 2005 compared to 5.91% for the nine months ended September 30, 2004. This increase in yield and volume resulted in interest revenue from loans increasing 22.9% or $8.3 million for the first nine months of 2005. Average investment securities were $267.4 million for the nine months ended September 30, 2005 compared to $252.2 million for the same period in 2004. The average yield (TE) for the nine months ended September 30, 2005 was 4.55% compared to 4.37% for the nine months ended September 30, 2004, partially due to an increase in the mix of longer term, higher yielding municipal securities in conjunction with pay downs of lower yielding mortgage backed securities. The increase in the volume and yield on investment securities resulted in an increase in interest income of $858,000, or 10.4%, for the nine months ended September 30, 2005. Compared to the first nine months of 2004, the Company has grown average interest-bearing sources of funds by $40.3 million or 5.0%. Interest bearing deposits grew $61.6 million while all other interest bearing sources of funds (including FHLB Advances) decreased by $21.2 million (see Deposits and Federal Home Loan Bank Advances and Other Borrowings). Overall, the average interest rate on interest-bearing sources of funds was 1.56% for the nine months ended September 30, 2005 and 1.20% for the nine months ended September 30, 2004. The increase in the volume and rate on interest-bearing sources of funds resulted in an increase in interest expense of $2.6 million, or 35.3%, for the nine months ended September 30, 2005 compared to the same period in 2004. ALLOWANCE AND PROVISION FOR LOAN LOSSES As a financial institution that assumes lending and credit risks as a principal element of its business, some level of credit losses will be experienced in the normal course of business. The Company manages and controls credit risk through credit management policies and procedures, underwriting and approval standards, 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. Additionally, management has established guidelines to ensure the diversification of the Company's credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management actively monitors the existing portfolio and reports regularly to the Board of Directors regarding trends and conditions in the loan 20 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. 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 losses that are 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 many factors including: existing general economic and business conditions affecting the key lending areas of the Company, current levels of problem loans and delinquencies, credit quality trends, collateral values, loan volumes and concentration, seasoning of the loan portfolio, specific industry conditions, recent loss experience, duration of the current business cycle, bank regulatory examination results and findings of the Company's internal credit examiners. The allowance 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 the above factors, management concluded that no provision for loan losses was necessary during the first three quarters of 2005 and the allowance for loan losses as of September 30, 2005 was adequate. The provision for loan losses for the three months and nine months ended September 30, 2004 was $350,000 and $1.1 million, respectively. As of September 30, 2005, the allowance for loan losses was $17.9 million, which represents 1.9% of the total loan balances. As of September 30, 2004, the allowance was $18.2 million or 2.2% of total loans. The table below summarizes the activity in the allowance for loan losses for the periods indicated (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, 2005 2004 2005 2004 - ---------------------------------------------------------------------------------- Balance at Beginning of Period $17,943 $17,776 $17,727 $17,220 Provision Charged to Expense 0 350 0 1,075 Recoveries of Loans Previously Charged Off 41 88 537 162 Loans Charged Off (79) (45) (359) (288) ================================================================================== Balance at End of Period $17,905 $18,169 $17,905 $18,169 ==================================================================================
NON-INTEREST INCOME Overall, non-interest income increased $34,000 or 1.2% for the three months ended September 30, 2005 compared to the same period of 2004. Gain (loss) on sale of investment securities for the quarter was a loss of $307,000 for the third quarter of 2005 as compared to a gain of $10,000 for the third quarter of 2004. During the third quarter of 2005 the Company made the decision to sell $20 million of its investment portfolio in order to better align the portfolio with its evolving asset/liability management objectives. These sales resulted in losses totaling $307,000. As of September 30, 2005, some of these funds had already been reinvested. Additionally, service charges on deposit accounts decreased $83,000 or 6.9% when compared to the prior year (see discussion below). Offsetting the loss on sale of investment securities for the quarter was an increase in other non-interest income which consisted of (1) increased income on non-qualified deferred compensation plans 21 ($217,000); (2) gains on loan sales ($55,000); and (3) ATM fees from increased non-customer usage ($86,000). Non-interest income decreased $1.0 million or 10.3% for the nine months ended September 30, 2005 compared to the same period of 2004. Most of the decline occurred in gain (loss) on sale of investment securities, which was as loss of $163,000 through the first nine months of 2005 (see discussion above) as compared to a gain of $757,000 for the first nine months of 2004. The remaining decrease in non-interest income occurred in service charges on deposit accounts due to: (1) the conversion of certain deposit customers to a newly offered high performance checking product that does not have a monthly service charge; (2) increasing interest rates which reduced service charges for those commercial customers on business account analysis; and (3) a decrease in fees generated from money service business relationships as a result of the Company's strategic decision to exit this product line. NON-INTEREST EXPENSE Non-interest expense increased $1.9 million or 22.8% over the third quarter of 2004, primarily as a result of a $1.6 million increase in Salaries and Employee Benefits. This increase was due to officer salary merit increases which occurred in May 2004 and increased Pension Plan expense related to the Company's decision to terminate its Defined Benefit Pension Plan during 2005. This increased level of Pension Plan expense will continue until the plan is terminated during the fourth quarter of 2005. Refer to Note 3 of the Consolidated Financial Statements of this Form 10-Q and Note 12 of the Consolidated Financial Statements in the Company's 2004 Annual Report to Shareholders for more information. The other factors impacting non-interest expense were: (1) increased branch maintenance and equipment expense; and (2) increased furniture & equipment depreciation related to remodeling and adding branch locations. Non-interest expense for the nine months ended September 30, 2005 increased $4.2 million or 16.1% over the same period in 2004, primarily as a result of a $3.2 million increase in Salaries and Employee Benefits. This increase, as discussed above, was due to officer salary merit increases which occurred in May 2004 and increased Pension Plan expense related to the Company's decision to terminate its Defined Benefit Pension Plan during 2005. The other factors impacting non-interest expense were the introduction of a new high performance checking product and the associated direct mail and other ancillary expenses incurred to promote this product and increases in contract fees for services and software maintenance. PROVISION FOR INCOME TAXES The provision for income taxes increased 6.0% to $2.6 million for the third quarter of 2005. The Company's effective tax rate decreased for the third quarter of 2005 and was 35.8% compared to 37.1% for the same period in 2004. The provision for income taxes increased 9.3% to $7.7 million for the first nine months of 2005. The Company's effective tax rate decreased for the first nine months of 2005 and was 36.0% compared to 36.7% for the same period in 2004. 22 BALANCE SHEET ANALYSIS This section presents a comparison of the Company's balance sheet for the nine month period ending September 30, 2005 and the same period in 2004. As previously discussed (see "Overview") the seasonality of the Company's business due to its agricultural customer base makes a comparison of the September 30th balance sheet to the preceding December 31st not meaningful. INVESTMENT SECURITIES The Financial Accounting Standards Board Statement, "Accounting for Certain Investments in Debt and Equity Securities", requires the Company to classify its investments as held-to-maturity, trading or available-for-sale. 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, prepayment risk, 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, 2005 the investment portfolio represented 19.7% of the Company's total assets. Total investment securities increased $7.6 million from a year ago and now total $254.4 million. Beginning in the fourth quarter of 2004, the Company's asset and liability management strategy called for increasing the size of the Company's longer-term municipal security portfolio. These balances have increased $32.4 million since September 30, 2004. This strategy is intended to provide the Company, which is asset-sensitive, with some protection in the event of a drop in interest rates. For further discussion see Market Risk - Interest Rate Risk under Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not included in the investment portfolio are overnight investments in Federal Funds Sold. For the nine months ended September 30, 2005, average Federal Funds Sold was $4.5 million compared to $14.2 million at September 30, 2004. LOANS The Company's loan portfolio at September 30, 2005 increased $103.1 million from September 30, 2004. The increase was due to strong loan demand in the Company's market area, along with an aggressive calling program on selected loan prospects. Additionally, on an average balance basis loans have increased $69.7 million or 8.5% from prior year. The table following sets forth the distribution of the loan portfolio by type as of the dates indicated. 23
Loan Portfolio As Of: - --------------------- (in thousands) September 30, 2005 Dec. 31, 2004 September 30, 2004 - -------------------------------------------------------------------------------------- Real Estate $ 440,600 $ 431,746 $ 418,289 Real Estate Construction 78,269 62,446 64,744 Home Equity 67,729 63,782 61,661 Agricultural 157,661 151,002 138,180 Commercial 184,088 142,133 143,773 Consumer 18,692 17,973 17,307 - -------------------------------------------------------------------------------------- Gross Loans 947,039 869,082 843,954 Less: Unearned Income 2,460 2,174 1,964 Allowance for Loan Losses 17,905 17,727 18,169 - -------------------------------------------------------------------------------------- Net Loans $ 926,674 $ 849,181 $ 823,821 ======================================================================================
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, 2005, the Company had entered into commitments with certain customers amounting to $411.3 million compared to $333.5 million at September 30, 2004. Letters of credit at September 30, 2005 and September 30, 2004, were $15.2 million and $13.5 million, respectively. NON-PERFORMING ASSETS Non-performing assets are comprised of non-performing loans (defined as non-accrual loans plus accruing loans past due 90 days or more) and other real estate owned. As set forth in the table below, non-performing loans as of September 30, 2005 were $259,000 compared to $517,000 at September 30, 2004. Accrued interest reversed from income on loans placed on a non-accrual status totaled $9,000 at September 30, 2005 compared to $32,000 at September 30, 2004. The Company has reported no other real estate owned from September 30, 2004 through September 30, 2005.
Non-Performing Assets - --------------------- (in thousands) September 30, 2005 Dec. 31, 2004 September 30, 2004 - -------------------------------------------------------------------------------------------- Non-performing Loans $ 259 $ 225 $ 517 Other Real Estate Owned - - - ============================================================================================ Total $ 259 $ 225 $ 517 ============================================================================================ - -------------------------------------------------------------------------------------------- Non-Performing Assets as a % of Total Loans 0.03% 0.03% 0.1% - -------------------------------------------------------------------------------------------- Allowance for Loan Losses as a % of Non-Performing Loans 6,913.1% 7,878.7% 3,514.3% - --------------------------------------------------------------------------------------------
Except for non-performing loans shown in the table above, the Bank's management is not aware of any loans as of September 30, 2005 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 the following or other factors may 24 affect a borrower's ability to pay: 1) deterioration in general economic conditions, real estate values or agricultural commodity prices; 2) increases in interest rates; or 3) changes in the overall financial condition or business of a borrower. 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, 2005, deposits totaled $1.0 billion. This represents an increase of 5.2% or $51.4 million from September 31, 2004. The increase was focused in demand and interest bearing transaction deposit accounts, which increased $41.9 million, or 12.1%, from September 30, 2004. The Company's calling efforts for prospective customers includes acquiring both loan and deposit relationships which results in new demand, interest bearing transaction and savings accounts. Due to strong growth in demand and interest bearing transaction balances, as well as the Company's ability to cost effectively borrow from the FHLB when necessary (see Federal Home Loan Bank Advances and Borrowings), the Company has reduced its focus on generating high cost time deposits. As a result, non-public time deposits have increased only $9.5 million, or 3.3%, since September 30, 2004. This reduced reliance on high cost time deposits has had a positive impact on the Company's net interest margin (see Net Interest Income). FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS Advances from the Federal Home Loan Bank and Federal Funds Purchased are other key sources of funds to support earning assets (see "Part I, Quantitative and Qualitative Disclosures about Market Risk and Liquidity Risk"). These borrowings 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 and Federal Funds Purchased as of September 30, 2005 were $75.8 million and $19.7 million, respectively, compared to $40.9 million of FHLB Advances as of September 30, 2004. This increase of $54.6 million in borrowings occurred as a result of the Company's growth in earning assets exceeding its growth in deposits by $59.0 million over the last twelve months. 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%. Interest rates reset quarterly and were 6.74% as of September 30, 2005, 5.35% at December 31, 2004 and 4.74% at September 30, 2004. CAPITAL The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders' Equity totaled $123.0 million at September 30, 2005 and $116.2 million at September 30, 2004. 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 25 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. 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 to risk-weighted assets and of Tier I capital to average assets (all terms as defined in the regulations). Management believes, as of September 30, 2005, that the Company and the Bank meet all capital adequacy requirements to which it is subject. As of June 30, 2004, 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 following table. There are no conditions or events since that notification that management believes have changed the institutions' 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, 2005 Total Capital to Risk Weighted Assets $ 149,082 12.65% $ 94,297 8.0% N/A N/A Tier I Capital to Risk Weighted Assets $ 134,308 11.39% $ 47,148 4.0% N/A N/A Tier I Capital to Average Assets $ 134,308 10.64% $ 50,472 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, 2005 Total Capital to Risk Weighted Assets $ 146,742 12.47% $ 94,108 8.0% $ 117,636 10.0% Tier I Capital to Risk Weighted Assets $ 131,997 11.22% $ 47,054 4.0% $ 70,582 6.0% Tier I Capital to Average Assets $ 131,997 10.48% $ 50,399 4.0% $ 62,999 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. 26 In a March 1, 2005 press release, the FRB issued its final rule concerning the regulatory capital treatment of trust preferred securities by bank holding companies. The final rule closely follows the proposed rule that was released on May 6, 2004 and states that bank holding companies may include trust preferred securities in Tier 1 capital in an amount equal to 25% of the sum of core capital elements net of goodwill, less any associated deferred tax liability. The Company currently has no goodwill or associated deferred tax liability so this requirement does not impact the Company. The effective date of this final rule is April 11, 2005. 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 has 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 second 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 or before 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. Unregistered Sales of Securities and Use of Proceeds"). Since 1999, the Company has repurchased over 50,000 shares for total consideration of $14.8 million, including 6,143 shares during the first nine months of 2005 at an average price of $500 per share. CRITICAL ACCOUNTING POLICIES AND ESTIMATES This "Management's Discussion and Analysis of Financial Condition and Results of Operations," is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company's financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These judgments govern areas such as the allowance for loan losses, the fair value of financial instruments, accounting for income taxes and pension accounting. For a full discussion of the Company's critical accounting policies and estimates see "Management's Discussion and Analysis" in the Company's Annual Report to Shareholders for the year ended December 31, 2004. OFF BALANCE SHEET ARRANGEMENTS Off-balance sheet arrangements are any contractual arrangement to which an unconsolidated entity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by the Company in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or engages in leasing, hedging or research and development services with the Company. For a full discussion of the Company's off balance sheet arrangements, see the Notes to the Consolidated Financial Statements in the Company's 2004 Annual Report to Shareholders. 27 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK RISK MANAGEMENT The Company has adopted a Risk Management Plan to provide for the proper control and management of risk factors inherent in the operation of the Company. Specifically, credit risk, interest rate risk, liquidity risk, compliance risk, strategic risk, and reputation 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 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 is addressed through defined limits in the Company's policy statements. 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. Additionally, most municipal securities carry insurance to enhance the credit quality of the bond. The Company manages and controls credit risk in the loan portfolio through credit management policies and procedures, underwriting and approval standards, 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. Additionally, management has established guidelines to ensure the diversification of the Company's credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management actively monitors the existing portfolio and 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 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, an 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 by recoveries on loans previously charged-off and reduced by 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 many factors in determining the adequacy of the allowance balance. Central to the Company's evaluation of the adequacy of the allowance for loan losses 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 28 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 Company also segments the loan portfolio by risk rating and into groups of loans with similar characteristics in accordance with SFAS No. 5, "Accounting for Contingencies". During this process groups of loans are reviewed and applied the appropriate allowance percentage to determine a portfolio formula allowance. Finally, the Company's methodology for assessing the appropriateness of the allowance involves management's consideration of all known relevant internal and external factors that may affect a loan's collectibility. The factors evaluated in connection with the allowance may include existing general economic and business conditions affecting the key lending areas of the Company, current levels of problem loans and delinquencies, 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. While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. Management believes that the allowance for loan losses at September 30, 2005 was adequate to provide for losses inherent 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. 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 the potential impact on both its economic value and earnings. Methods for analyzing interest rate risk include: (1) asset/liability mismatch ("GAP") analysis; (2) earnings simulation model; and (3) economic value of equity ("EVE") analysis. The Company's 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 positive gap, indicates that earning assets will reprice faster than interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest rates and a lower net interest margin during periods of declining interest rates. Conversely, a negative gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates. The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans. In addition, the magnitude of changes in the rates charged on loans is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest bearing liabilities. 29 The Company's earnings simulation model quantifies the estimated exposure to net interest income of 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 200 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, 2005, 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 0.80% if rates increase by 200 basis points and a decrease in net interest income of 2.86% if rates decline 200 basis points. As of September 30, 2005 the Company was within all policy limits. 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 2004 Annual Report to Shareholders. The Company's EVE analysis measures the present value of the Company's assets, less the present value of its liabilities, the net present value of any off-balance sheet items. This analysis is compared to policy limits, which specify a maximum tolerance level the Company has established based on the Summary Guidelines found in Thrift Bulletin 13a. As of September 30, 2005 the Company was within all policy limits. 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 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 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 (either purchased or sold) to supplement the cash flows received from operating, investing and other financing activities (see Consolidated Statement of Cash Flows). During the first nine months of 2005, Federal Funds sold averaged $4.5 million and Federal Funds purchased averaged $5.4 million. The Company maintains Federal Funds 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 $168.6 million from the Federal Home Loan Bank. 30 At September 30, 2005, the Company had available liquid assets, which included cash and cash equivalents and unpledged investment securities of approximately $116.8 million, which represents 9.0% of total assets. ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure 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 disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer, the Chief Financial Officer and other senior management of the Company. The evaluation was based, in part, upon reports and affidavits provided by a number of executives. 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 over financial reporting subsequent to the date the Company completed its evaluation. 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. There are no material proceedings adverse to the Company to which any director, officer or affiliate of the Company is a party. 31 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS - -------------------------------------------------------------------- The following table indicates the number of shares repurchased by Farmers & Merchants Bancorp during the third quarter of 2005.
NUMBER OF SHARES APPROXIMATE DOLLAR PURCHASED AS PART VALUE OF SHARES THAT AVERAGE OF A PUBLICLY MAY YET BE NUMBER OF PRICE PER ANNOUNCED PLAN OR PURCHASED UNDER THE SECOND QUARTER 2005 SHARES SHARE PROGRAM PLAN OR PROGRAM - ---------------------------------------------------------------------------------------------------------- 07/01/2005 - 07/31/2005 2,124 $ 500 2,124 $ 5,775,100 08/01/2005 - 08/31/2005 1,228 500 1,228 5,161,100 09/01/2005 - 09/30/2005 661 500 661 4,830,600 - ---------------------------------------------------------------------------------------------------------- Total 4,013 $ 500 4,013 $ 4,830,600
All of the above shares were repurchased in private transactions. The common stock of Farmers & Merchants Bancorp is not widely held, is not listed on any exchange, nor is it included on the NASDAQ National Market or the NASDAQ Small Cap Market. However, trades may be reported on the OTC Bulletin Board under the symbol "FMCB.OB". Additionally, management is aware that there are private transactions in the Company's common stock. 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. EXHIBITS - ----------------- See Exhibit Index on Page 32 32 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 4, 2005 /s/ Kent A. Steinwert ----------------------- Kent A. Steinwert President and Chief Executive Officer (Principal Executive Officer) Date: November 4, 2005 /s/ Stephen W. Haley ------------------------ Stephen W. Haley Executive Vice President and Chief Financial Officer (Principal Accounting Officer) INDEX TO EXHIBITS - ----------------- Exhibit No. Description - ----------- ----------- 31(a) Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31(b) Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certifications 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. 33 EX-31.(A) 2 ex31_a.txt EXHIBIT 31 (A) EXHIBIT 31(a) 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 internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) 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 (d) 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 4, 2005 /s/ Kent A. Steinwert ------------------------ Kent A. Steinwert President & Chief Executive Officer EX-31.(B) 3 ex31_b.txt EXHIBIT 31(B) EXHIBIT 31(b) 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 internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) 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 (d) 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 4, 2005 /s/ Stephen W. Haley ----------------------- Stephen W. Haley Executive Vice President & Chief Financial Officer EX-32 4 ex32.txt EXHIBIT 32 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, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Kent A. Steinwert, President and Chief Executive Officer, and Stephen W. Haley, Executive Vice President and Chief Financial Officer of the Company, certify pursuant to Rule 13a-14(b) or Rule 15d-14(b) under the Securities Exchange act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. $ 1350), that: 1. the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. $ 78m or 78o(d)); and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. November 4, 2005 /s/ Kent A. Steinwert - ------------------------ Kent A. Steinwert President & Chief Executive Officer /s/ Stephen W. Haley - ------------------------ Stephen W. Haley Executive Vice President & Chief Financial Officer 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-----