-----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, RhL2h8ktByiVw8u2KFudWM5oCxO4orrWKXmKUR+x/yT0RmxdUeErebaKFnUeLzEr Z3iNqLvXorKsJGRb07fu3A== 0000930609-04-000051.txt : 20040329 0000930609-04-000051.hdr.sgml : 20040329 20040329103300 ACCESSION NUMBER: 0000930609-04-000051 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: F&M BANK CORP CENTRAL INDEX KEY: 0000740806 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 541280811 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-13273 FILM NUMBER: 04694808 BUSINESS ADDRESS: STREET 1: P.O. BOX 1111 CITY: TIMBERVILLE STATE: VA ZIP: 22853 BUSINESS PHONE: 540-896-8941 MAIL ADDRESS: STREET 1: P. O. BOX 1111 CITY: TIMBERVILLE STATE: VA ZIP: 22853 10-K 1 fm10k2003.txt F & M BANK CORP 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ------ SECURITIES EXCHANGE ACT OF 1934 For fiscal year ended December 31, 2003 Commission file number: 0-13273 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ------ SECURITIES EXCHANGE ACT OF 1934 F & M Bank Corp. (Exact name of registrant as specified in its charter) Virginia 54-1280811 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) P. O. Box 1111, Timberville, Virginia 22853 (Address of principal executive offices) (Zip Code) (540) 896-8941 (Registrant's telephone number including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock - $5 Par value per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes No X ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The registrant's Common Stock is traded Over-the-Counter under the symbol FMBM. The aggregate market value of the 2,144,857 shares of Common Stock of the registrant issued and outstanding held by non-affiliates on June 30, 2003 was approximately $41,610,226 based on the closing sales price of $19.40 per share on that date. For purposes of this calculation, the term "affiliate" refers to all directors and executive officers of the registrant. As of the close of business on March 1, 2004, there were 2,418,678 shares of the registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Proxy Statement for the Annual Meeting of Shareholders to be held on May 8, 2004 (the "Proxy Statement"). 2 F & M Bank Corp. Index Forward-Looking Statements 2 Form 10-K Cross Reference Sheet 3 F & M Bank Corp. 4 Report Format 4 Market for Registrant's Common Equity and Related Stockholder Matters 5 Selected Financial Data 6 Management's Discussion and Analysis of Financial Condition and Results of Operations 7-23 Consolidated Financial Statements 24-27 Notes to Consolidated Financial Statements 28-45 Report of Independent Auditors 46 Other Material Required by Form 10-K 47-51 Description of Business Properties Exhibits, Financial Statements, and Reports on Form 8-K Signatures Forward-Looking Statements F & M Bank Corp. makes forward-looking statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations and in other portions of this Annual Report on Form 10-K that are subject to risks and uncertainties. These forward-looking statements include: estimates of risks and of future costs and benefits; assessments of probable loan losses and statements of goals and expectations. These forward-looking statements are subject to significant uncertainties because they are based upon management's estimates and projections of future interest rates and other economic conditions; future laws and regulations; and a variety of other matters. As a result of these uncertainties, actual results may be materially different from the results indicated by these forward-looking statements. In addition, the Company's past results of operations do not necessarily indicate its future results. 3 F & M Bank Corp. Form 10-K Cross Reference Sheet Material Incorporated by Reference The following table shows the location in this Annual Report on Form 10-K or in the Proxy Statement of the information, which requires disclosure in SEC Form 10-K. As indicated below, information has been incorporated by reference in the Report from the Proxy Statement. Other portions of the Proxy Statement are not included in this Report. This Report is not part of the Proxy Statement. Page references are in this report unless indicated otherwise. Item of Form 10-K Location PART I Item 1 Business "Forward-Looking Statements" on page 2, "F&M Bank Corp." and "Report Format" on page 4 and "Business on pages 47 to 48. Item 2 Properties "Properties" on page 49. Item 3 Legal Proceedings Note 17 "Litigation" on page 40. Item 4 Submission of Matters to a No matters have been submitted to a vote Vote of Security Holders of security holders during the fourth quarter of 2003 PART II Item 5 Market for Registrant's "Market for Registrant's Common Equity Common Equity and Related and Related Stockholder Matters" on Stockholder Matters Page 5 Item 6 Selected Financial Data "Selected Financial Data" on page 6. Item 7 Management's Discussion and "Management's Discussion and Analysis of Analysis of Financial Financial Condition and Results of Condition and Results of Operations" on pages 7-23. Operations Item 7A Quantitative and "Forward-Looking Statements" on page 2 Qualitative Disclosures and "Market Risk Management" on page about Market Risk 20-21. Item 8 Financial Statements and Pages 24 to 45. Supplementary Information Item 9 Changes in and Disagreements There were no changes in or disagreements with Accountants on Accounting with accountants on accounting and and Financial Disclosure financial disclosure during the last two fiscal years. Item 9A Controls and Procedures "Other Material Required in Form 10-K" on page 47 to 48. 4 PART I (CONTINUED) Item of Form 10-K Location PART III Item 10 Directors and Executive The material labeled "Section 16(a) Officers of the Registrant Beneficial Ownership Reporting Compliance" and "Information Concerning Directors and Nominees" in the Proxy Statement is Incorporated in this Report by reference. Item 11 Executive Compensation The material labeled "Summary Compensation" and "Salary Committee Report on Executive Compensation" in the Proxy Statement is incorporated in this Report by reference. Item 12 Security Ownership of The material labeled "Stock Ownership of Certain Beneficial Owners Directors and Executive Officers" in the and Management Proxy Statement is incorporated in this Report by reference. Item 13 Certain Relationships and The material labeled "Indebtedness and Related Transactions Other Transactions" in the Proxy Statement is incorporated in this Report by reference. Item 14 Principal Accounting Fees The information regarding fees and and Services services of F & M Bank Corp.'s principal independent accountant, S. B. Hoover & Company, under the caption "Audit Committee Disclosure - Fees Paid to Auditors" and "Audit Committee Pre-Approval Policy" contained in the 2004 Proxy Statement is incorporated by reference herein. PART IV Item 15 Exhibits, Financial "Exhibits, Financial Statements, and Statement Schedules and Reports on Form 8-K" on page 50. Reports on Form 8-K Signatures "Signatures" on page 51. F & M Bank Corp. F & M Bank Corp. is the holding company for Farmers & Merchants Bank, the oldest banking business native to Rockingham County, Virginia. Operating as an independent community bank, Farmers & Merchants Bank was originally organized as Farmers & Merchants Bank of Timberville in 1908. The bank provides a wide range of financial services to individuals and businesses through eight offices located in Rockingham and Shenandoah Counties. Report Format The format of this report was changed in 2001 in order to increase information distributed to shareholders and to reduce expenses related to preparing and distributing annual financial information. Prior to that time, F & M Bank Corp. provided an annual report to shareholders along with the annual proxy materials, and also prepared and filed a separate Annual Report on Form 10-K under the rules of the United States Securities and Exchange Commission ("SEC"). Beginning in 2001 and for subsequent years, we are distributing the Form 10-K report to shareholders with the annual proxy materials for the annual meeting. This report includes the entire Form 10-K, other than exhibits, as filed with the SEC. Please see page 50 for information regarding how to obtain copies of exhibits and additional copies of the Form 10-K. The SEC has not approved or disapproved this Report or passed upon its accuracy or adequacy. 5 Item 5 Market for Registrant's Common Equity and Related Stockholder Matters Stock Listing The Company's Common Stock trades under the symbol "FMBM" on the OTC Bulletin Board. The bid and asked price of the Company's stock is not published in any newspaper. Although several firms in both Harrisonburg and Richmond, Virginia occasionally take positions in the Company stock, they typically only match buyers and sellers. Transfer Agent and Registrar Farmers & Merchants Bank 205 South Main Street P.O. Box 1111 Timberville, VA 22853 Recent Stock Prices and Dividends Dividends to shareholders totaled $1,693,215 and $1,601,823 in 2003 and 2002, respectively. Regular quarterly dividends have been declared for forty consecutive quarters. Dividends per share increased 6.06% in 2003. The ratio of dividends per share to net income per share was 42.17% in 2003, compared to 45.72% in 2002. The decision as to timing, amount and payment of dividends is at the discretion of the Company's Board of Directors. The payment of dividends depends on the earnings of the Company and its subsidiaries, the financial condition of the Company and other factors including capital adequacy, regulatory requirements, general economic conditions and shareholder returns. In April 2000, the Board of Directors approved a stock repurchase plan, which allows the repurchase of up to 50,000 shares of its outstanding common stock. On June 12, 2003, the Board authorized the repurchase of an additional 50,000 shares of the Company's outstanding common stock. Shares are repurchased either through broker-arranged transactions or directly from the shareholder at the discretion of management. The decision to purchase shares is based on factors including market conditions for the stock and the availability of cash. Shares repurchased through the end of 2003 total 54,484; of this amount, 13,200 shares were repurchased in 2003. The number of common shareholders of record was approximately 1,609 as of March 1, 2004. This amount includes all shareholders, whether titled individually or held by a brokerage firm or custodian in street name. Quarterly Stock Information These quotes were obtained from Davenport & Company and include the terms of trades transacted through a broker. The terms of exchanges occurring between individual parties may not be known to the Company. 2003 2002 ---- ---- Per Share Range Per Share Stock Price Range Per Share Quarter Low High Dividend Low High Dividend 1st 18.65 19.50 .17 18.50 22.00 .16 2nd 19.20 19.60 .17 18.00 20.25 .16 3rd 19.00 22.30 .18 15.70 19.20 .17 4th 21.25 22.90 .18 17.20 19.20 .17 --- -- Total .70 .66 --- -- 6 Item 6 Five Year Summary of Selected Financial Data (Dollars in thousands, 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- except per share data) Income Statement Data: Interest and Dividend Income $ 16,683 $ 17,846 $ 17,681 $ 15,509 $ 14,321 Interest Expense 6,010 7,390 9,494 7,411 6,475 --------- -------- -------- -------- -------- Net Interest Income 10,673 10,456 8,187 8,098 7,846 Provision for Loan Losses 226 387 204 123 140 --------- -------- -------- -------- -------- Net Interest Income after Provision for Loan Losses 10,447 10,069 7,983 7,975 7,706 Noninterest Income 2,308 1,380 1,158 1,038 916 Securities Gains (Losses) 179 (182) 1,252 770 1,179 Noninterest Expenses 7,256 6,448 5,728 4,653 4,313 --------- -------- -------- -------- -------- Income before Income Taxes 5,678 4,819 4,665 5,130 5,488 Income Tax Expense 1,666 1,315 1,435 1,486 1,682 --------- -------- -------- -------- -------- Net Income $ 4,012 $ 3,504 $ 3,230 $ 3,644 $ 3,806 ======== ======== ======== ======== ======== Per Share Data: Net Income $ 1.66 $ 1.44 $ 1.33 $ 1.49 $ 1.55 Dividends Declared .70 .66 .63 .59 .52 Book Value 13.35 12.19 11.74 11.18 10.30 Balance Sheet Data: Assets $ 309,126 $ 303,149 $ 272,673 $ 208,818 $ 195,338 Loans 211,231 201,980 176,625 152,035 140,318 Securities 61,230 69,602 63,987 45,323 44,422 Deposits 240,715 228,284 208,279 152,354 139,507 Long-Term Debt 24,784 32,312 20,983 16,386 18,548 Shareholders' Equity 32,319 29,541 28,597 27,198 25,286 Average Shares Outstanding 2,418 2,429 2,431 2,446 2,454 Financial Ratios: Return on Average Assets1 1.29% 1.21% 1.26% 1.76% 1.96% Return on Average Equity1 13.13% 12.12% 11.47% 13.88% 15.47% Net Interest Margin 3.82% 4.03% 3.52% 4.32% 4.52% Efficiency Ratio 2 53.96% 51.28% 56.93% 50.93% 49.23% Dividend Payout Ratio 42.17% 45.72% 47.45% 39.53% 33.55% Capital and Credit Quality Ratios: Average Equity to Average Assets1 9.86% 9.98% 11.02% 12.70% 12.65% Allowance for Loan Losses to Loans .70% .73% .73% .73% .78% Nonperforming Assets to Total Assets .52% .86% .40% .52% .98% Net Charge-offs to Total Loans .10% .10% .06% .07% .16% 1 Ratios are primarily based on daily average balances. 2 The Efficiency Ratio equals noninterest expenses divided by the sum of tax equivalent net interest income and noninterest income. Noninterest expenses exclude intangible asset amortization. Noninterest income excludes gains (losses) on securities transactions. 7 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion provides information about the major components of the results of operations and financial condition, liquidity and capital resources of F & M Bank Corp. and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Information, of this Form 10-K. Critical Accounting Policies General The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. The Company's financial position and results of operations are affected by management's application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company's consolidated financial position and/or results of operations. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change. Following is a summary of the Company's significant accounting policies that are highly dependent on estimates, assumptions and judgments. Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standard ("SFAS") No. 5, "Accounting for Contingencies", which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The Company's allowance for loan losses is the accumulation of various components that are calculated based on independent methodologies. All components of the allowance represent an estimation performed pursuant to either SFAS No. 5 or SFAS No. 114. Management's estimate of each SFAS No. 5 component is based on certain observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation includes credit quality trends; collateral values; loan volumes; geographic, borrower and industry concentrations; seasoning of the loan portfolio; the findings of internal credit quality assessments and results from external bank regulatory examinations. These factors, as well as historical losses and current economic and business conditions, are used in developing estimated loss factors used in the calculations. Reserves for commercial loans are determined by applying estimated loss factors to the portfolio based on management's evaluation and "risk grading" of the commercial loan portfolio. Reserves are provided for noncommercial loan categories using estimated loss factors applied to the total outstanding loan balance of each loan category. Specific reserves are typically provided on all impaired commercial loans in excess of a defined threshold that are classified in the Special Mention, Substandard or Doubtful risk grades. The specific reserves are determined on a loan-by-loan basis based on management's evaluation the Company's exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. 8 Management's Discussion and Analysis of Financial Condition and Results of Operations Allowance for Loan Losses (Continued) While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates. Goodwill and Intangibles In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. SFAS No. 142 was effective for fiscal years beginning after December 15, 2001 and prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to an annual impairment review and more frequently if certain impairment indicators are in evidence. SFAS No. 142 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill. The Company adopted SFAS No. 142 on January 1, 2002. Goodwill totaled $2,639,000 at January 1, 2002. The goodwill is not amortized but is tested for impairment at least annually. Based on this testing, there were no impairment charges for 2003 or 2002. Application of the non-amortization provisions of the Statement resulted in additional net income of $190,000 for the year ended December 31, 2003 and 2002. Core deposit intangibles are amortized on a straight-line basis over a ten year life. Core deposits, net of amortization, amounted to $1,978,000 and $2,254,000 at December 31, 2003 and 2002, respectively. The Company adopted SFAS 147 on January 1, 2002 and determined that the core deposit intangible will continue to be amortized over its estimated useful life. Securities Impairment The Company evaluates each of its investments in securities, debt and equity, under guidelines contained in SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. These guidelines require the Company to determine whether a decline in value below original cost is other than temporary. In making its determination, management considers current market conditions, historical trends in the individual securities, and historical trends in the overall markets. Expectations are developed regarding potential returns from dividend reinvestment and price appreciation over a reasonable holding period (five years) and current carrying values are compared to these expected values. Declines determined to be other than temporary are charged to operations and included in the gain (loss) on security sales. Such charges were zero for 2003 and $503,000 for 2002. Overview The Company's net income for 2003 totaled $4,012,000 or $1.66 per share, up 15.3% or from $3,504,000 or $1.44 a share in 2002. Return on average equity increased in 2003 to 13.13% from 12.12% in 2002, while the return on average assets increased from 1.21% to 1.29%. The Company's operating earnings, which are net earnings excluding gains (losses) on the sale of investments, redemption of insurance contracts, and the non-cash amortization of acquisition intangibles, were $3,973,000 in 2003 versus $3,785,000 in 2002, an increase of 4.97%. Core profitability improved as net interest income increased by 2.08% and non-interest income, exclusive of securities transactions, was up 72.72%. See page 6 for a five-year summary of selected financial data. 9 Management's Discussion and Analysis of Financial Condition and Results of Operations Changes in Net Income per Common Share 2003 to 2002 2002 to 2001 ------------ ------------ Prior Year Net Income Per Share $ 1.44 $ 1.33 Change from differences in: Net interest income .09 .93 Provision for credit losses .07 (.08) Noninterest income, excluding securities gains .41 .09 Securities gains .15 (.59) Noninterest expenses, excluding intangibles amortization (.36) (.31) Amortization of intangibles .00 .01 Income taxes (.15) .05 Other .01 .01 -------- -------- Total Change .22 .11 -------- -------- Net Income Per Share $ 1.66 $ 1.44 ======== ======== Net Interest Income The largest source of operating revenue for the Company is net interest income, which is calculated as the difference between the interest earned on earning assets and the interest expense paid on interest bearing liabilities. The net interest margin is the net interest income expressed as a percentage of interest earning assets. Changes in the volume and mix of interest earning assets and interest bearing liabilities, along with their yields and rates, have a significant impact on the level of net interest income. Net interest income for 2003 was $10,673,000 representing an increase of $217,000 or 2.08% from 2002. A 27.71% increase in 2002 versus 2001 resulted in total net interest income of $10,456,000. In this discussion and in the tabular analysis of net interest income performance, entitled "Consolidated Average Balances, Yields and Rates," (found on page 10), the interest earned on tax exempt loans and investment securities has been adjusted to reflect the amount that would have been earned had these investments been subject to normal income taxation. This is referred to as tax equivalent net interest income. The analysis on the next page reveals a significantly increasing net interest margin in 2002 followed by a decline of the margin in 2003. The Federal Reserve has continued its accommodative monetary stance throughout 2003. Factors contributing to the declining margin in 2003 included a slow down in the rate of growth in the loan portfolio, lower rates received on adjustable rate mortgages that reached a rate adjustment date, securities maturing with proceeds being reinvested at lower rates and an increase in low yielding, short-term federal funds sold. Although interest bearing liabilities continued to reprice at lower levels, the rate of decline moderated during 2003, with the cost of funds dropping .76% compared to a decline in the rate received on earning assets of .87%. Also contributing to the decrease in the net interest margin is a shift in balance sheet leverage as the percentage of longer-term, higher yielding assets (loans and securities) declined in 2003 to 91.41% of total earning assets as compared to 93.52% in 2002. During 2002 the net interest margin increased as large amounts of time deposits matured and repriced at much lower market rates. Also, management was able to react to the changing market conditions and rapidly reduced rates paid on non-maturing deposits (checking and savings). Loans also grew rapidly during the first half of 2002, resulting in a reduction in lower yielding short-term investments. Longer-term, higher yielding assets (loans and securities) increased from 87.64% in 2001 to 93.52% of earning assets in 2002. In 2001, the margin suffered as rate sensitive assets (adjustable rate loans and fed funds) repriced more quickly than rate sensitive liabilities. Although assets have continued to reprice at somewhat lower levels (down .72%), repricing opportunities on deposits was much greater, resulting in a decline in the cost of funds of 1.32%. 10 Management's Discussion and Analysis of Financial Condition and Results of Operations Consolidated Average Balances, Yields and Rates1
2003 2002 2001 ---- ---- ---- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate ASSETS Loans:2 Commercial $ 48,848 $ 3,020 6.18% $ 46,917 $ 3,201 6.82% $ 40,093 $ 3,297 8.22% Real estate 129,083 8,943 6.93 121,999 9,248 7.58 101,858 8,486 8.33 Installment 24,663 2,218 8.99 27,114 2,465 9.09 24,487 2,426 10.09 -------- -------- ---- --------- ------ ----- -------- ------- ----- Total Loans 202,594 14,181 7.00 196,030 14,914 7.61 166,438 14,209 8.54 Investment securities:3 Fully taxable 47,908 1,765 3.68 43,347 2,083 4.84 31,264 1,910 6.11 Partially taxable 9,194 567 6.17 10,260 610 5.95 10,415 581 5.58 Tax exempt 160 7 4.38 --------- ------- ----- ------- ------ ----- -------- ------- ----- Total Investment Securities 57,262 2,339 4.08 53,607 2,693 5.02 41,679 2,491 5.98 Interest bearing deposits in banks 8,378 178 2.12 10,319 438 4.24 9,140 405 4.43 Federal funds sold 16,043 169 1.05 6,992 109 1.56 20,212 759 3.75 -------- ------ ----- ------- ----- ----- --------- ------- ----- Total Earning Assets 284,277 16,867 5.93 266,948 18,154 6.80 237,469 17,864 7.52 -------- --------- ------- ------- ------- ----- --------- ------- ----- Allowance for loan losses (1,511) (1,400) (1,229) Nonearning assets 27,055 24,147 19,427 ------- -------- -------- Total Assets $ 309,821 $ 289,695 $ 255,667 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand - Interest bearing $ 35,611 $ 214 .60 $ 32,094 $ 307 .96 $ 27,299 $ 436 1.60 Savings 44,547 488 1.10 39,624 710 1.79 32,063 873 2.72 Time deposits 125,430 4,018 3.20 116,699 4,898 4.20 113,035 6,385 5.65 -------- -------- ------- -------- ------ ----- -------- ------- ----- Total Deposits 205,588 4,720 2.30 188,417 5,915 3.14 172,397 7,694 4.46 Short-term debt 7,179 44 .61 8,497 104 1.22 9,127 312 3.42 Long-term debt 28,645 1,246 4.35 30,645 1,372 4.48 20,632 1,488 7.21 --------- ------- ------- -------- ------- ----- -------- ------- ----- Total Interest Bearing Liabilities 241,412 6,010 2.49 227,559 7,391 3.25 202,156 9,494 4.69 -------- ----- ------- ----- ------- ----- Noninterest bearing deposits 31,442 28,300 22,567 Other liabilities 6,408 4,932 2,779 -------- --------- ------- Total Liabilities 279,262 260,791 227,502 Stockholders' equity 30,559 28,904 28,165 -------- -------- -------- Total Liabilities and Stockholders' Equity $ 309,821 $ 289,695 $ 255,667 ========= ======== ======== Net Interest Earnings $ 10,857 $ 10,763 $ 8,370 ======= ======== ====== Net Yield on Interest Earning Assets (NIM) 3.82% 4.03% 3.52% ====== ===== =====
1 Income and yields are presented on a tax-equivalent basis using the applicable federal income tax rate. 2 Interest income on loans includes loan fees. 3 Average balance information is reflective of historical cost and has not been adjusted for changes in market value. 11 Management's Discussion and Analysis of Financial Condition and Results of Operations The following table illustrates the effect of changes in volumes and rates.
2003 Compared to 2002 2002 Compared to 2001 Increase (Decrease) Increase (Decrease) ------------------- ------------------- Due to Change Increase Due to Change Increase in Average: or in Average: or Volume Rate (Decrease) Volume Rate (Decrease) Interest income: Loans $ 499 $ (1,232) $ (733) $ 2,527 $(1,822) $ 705 Investment securities: Taxable 221 (539) (318) 738 (565) 173 Partially taxable (63) 20 (43) (9) 38 29 Tax exempt 7 7 Interest bearing Deposits in banks (82) (178) (260) 52 (19) 33 Federal funds sold 141 (81) 60 (496) (154) (650) ------- --------- ------- -------- ------- -------- Total Interest Income 723 (2,010) (1,287) 2,812 (2,522) 290 ------ ------- ------ ------- ------ ------- Interest expense: Deposits: Demand 34 (127) (93) 77 (206) (129) Savings 88 (310) (222) 206 (369) (163) Time deposits 367 (1,247) (880) 207 (1,694) (1,487) Short-term debt (16) (44) (60) (22) (186) (208) Long-term debt (90) (36) (126) 722 (838) (116) -------- --------- -------- ------- ------- -------- Total Interest Expense 383 (1,764) (1,381) 1,190 (3,293) (2,103) ------ -------- ------- ------- ------- -------- Net Interest Income $ 340 $ (246) $ 94 $ 1,622 $ 771 $ 2,393 ====== ======== ====== ======= ====== =======
Note: Volume changes have been determined by multiplying the prior years' average rate by the change in average balances outstanding. The rate change is the difference between the total change and the volume change. Interest Income Tax equivalent interest income decreased 7.09% or $1,287,000 in 2003, after increasing 1.62% or $290,000 in 2002. Although 2003 earning assets increased $17,329,000, the distribution of the increase and overall decline in portfolio rates resulted in the decline in interest income. Approximately half of the increase in earning assets for the year was in federal funds sold, which only yielded 1.05% for the year. Overall, the yield on earning assets declined .87%, from 6.80% to 5.83%. The combined two year decrease in yields on earning assets now totals 1.59%. Loan growth slowed during 2003, with average outstandings increasing only $6,564,000 to $202,594,000. Factors contributing to the slowdown of loan growth include an increase in long term mortgage loans going to the secondary market due to rates at historically low levels and a greater competition for loans, at much lower rates, as most banks within the region remained highly liquid throughout much of 2003. During 2002, average loans outstanding had increased $29,592,000 to $196,030,000 as all three major loan categories showed increases with the greatest percentage increase shown in real estate loans which increased 19.77%. Average total securities, yielding 4.08%, increased $3,655,000 during 2003. Funding for this increase came from deposit growth and conversion of short-term investments (interest bearing deposits in other banks). With rates at historically low levels, the Bank continued to look for favorable yields on investment securities primarily in the eighteen to thirty month maturity range. 12 Management's Discussion and Analysis of Financial Condition and Results of Operations Interest Expense Interest expense decreased $1,381,000 or 18.68% during 2003, which followed a 22.15% decrease ($2,103,000) in 2002. The average cost of funds of 2.49% declined .76% compared to 2002. Average interest bearing liabilities increased $17,171,000 and $16,020,000 in 2003 and 2002, respectively. This increase may be reflective of customers seeking safety during stock market volatility and economic uncertainty. The Bank also enjoyed growth as a result of continued consolidation among larger banks within its markets. Expense of time deposits decreased $880,000 or 17.97% in 2003 due to market conditions. This followed a decline of 23.29% or $1,487,000 in 2002. These decreases resulted as customer accounts renewed at rates that were often 3.00% to 3.50% lower than rates paid as recently as early 2001. Expense of long-term debt decreased $126,000 and $116,000, respectively in 2003 and 2002. The 2003 decline was a function of lower levels of debt as the rate declined only 13 basis points. The 2002 decline was due to early prepayment penalties recognized in 2001 that were not repeated in 2002. The Company did not obtain any additional long-term debt during 2003. Noninterest Income As a result of the current low interest rate environment placing downward pressure on the net interest margin, noninterest income has become an increasingly important factor in maintaining and growing profitability. Management is conscious of the need to constantly review fee income and develop additional sources of complementary revenue. The Bank continues to enjoy increased revenue from its subsidiary Farmers & Merchants Financial Services (FMFS). Gross revenue for FMFS increased $137,000 in 2003. This increase was a combination of greater levels of commissions from its partnerships in Bankers Title Shenandoah, LLC, Bankers Insurance, LLC and from sales of investment products through UVEST Financial Services and BI Investments, LLC. Exclusive of securities gains and losses, overall noninterest income increased 67.30% in 2003 and 19.21% in 2002. Investments in bank owned life insurance (BOLI) on officers of the Company resulted in tax-free income of $238,000 in 2003, an increase of $107,000 over 2002. During 2003, the Bank invested an additional $2,291,000 in BOLI, through a combination of cash purchases and a tax-free exchange of existing split-dollar life insurance policies. The conversion of the split-dollar policies resulted in non-recurring gains of $164,000 which is included in other operating income. In an effort to generate more fee income, the Bank opened a mortgage and investments office in Harrisonburg, Virginia during December 2002. The office employs three people, all of whom have previous experience in mortgage lending or investments at other institutions in the Harrisonburg area. Mortgage origination fees totaled $209,000, an increase of $184,000 over 2002. Income from investment sales totaled $51,000 and is included in gross revenue of FMFS as discussed above. In April 2003, the Bank began offering an overdraft privilege program called "Bounce Protection." Total overdraft revenue, net of refunds and demand deposit account chargeoffs, increased $222,000 for the year. Securities transactions in 2003 resulted in gains of $179,000 after recognizing a $100,000 write down on the Company's investment in BI Investments, LLC. Although this investment is a minority interest, accounted for at cost, management determined that the losses generated during 2003 were unlikely to be recouped in the near future and recognized an impairment in the investment under SFAS 115. In 2002, the Company suffered its first year of net securities losses since 1991. Losses in 2002 totaled $182,430, and were the result of the Company recognizing an impairment of several of its equity holdings. Based on current market conditions, historical trends of the individual securities and trends during previous increasing and declining markets, management determined that several holdings met the definition of impairment. The impairments were based on management's expectations of potential total returns from dividend reinvestment and price appreciation over a reasonable holding period (five years). This analysis resulted in a total write down of $503,000 affecting five equities held by the Company. The Company reevaluated these investments during 2003 and determined that there was no additional impairment. 13 Management's Discussion and Analysis of Financial Condition and Results of Operations Noninterest Expense Noninterest expenses increased from $6,448,000 in 2002 to $7,255,000 in 2003. Salary and benefits increased 14.67% to $4,129,000 in 2003 and 13.67% in 2002 compared to 2001. The increase in salaries and benefits in 2003 included a full year of salaries and benefits for the Harrisonburg mortgage and investment office, increased staff in several branch offices, normal salary adjustments and increases in insurance and pension expenses. Occupancy and equipment expense increased $127,000 (18.45%) in 2003. This includes a full year of expenses for the Harrisonburg office, additional depreciation on the remodeled Elkton Office and depreciation on upgrades to computer hardware and software. Other operating expense increased $153,000 in 2003, following a $269,000 increase in 2002. Much of the increase was due to increases in audit and examination fees and the bank franchise tax (which is a tax based on capital of the Bank). Also increasing were data processing fees paid for computer software and licensing and maintenance of new and existing programs. Increases in data processing costs include expenses for website hosting, Bounce Protection, online teller software, and internet banking. Although noninterest expenses have increased substantially in both 2003 and 2002, they continue to be substantially less than peer group averages. Total noninterest expense as a percentage of average assets totaled 2.34%, 2.22%, and 2.24% 2003, 2002, and 2001, respectively. Peer group averages are approximately 3.10% over the same time period. Provision for Loan Losses Management evaluates the loan portfolio in light of national and local economic trends, changes in the nature and value of the portfolio and industry standards. Specific factors considered by management in determining the adequacy of the level of the allowance for loan losses include internally generated loan review reports, past due reports and historical loan loss experience. This review also considers concentrations of loans in terms of geography, business type and level of risk. Management evaluates nonperforming loans relative to their collateral value and makes the appropriate adjustments to the allowance for loan losses when needed. Based on the factors outlined above, the current year provision for loan losses decreased from $387,000 in 2002 to $226,000 in 2003. Actual loan charge-offs were $219,000 in 2003 and $199,000 in 2002. Loan losses as a percentage of average loans totaled .10% in both 2003 and 2002, respectively. Losses continue at less than one-half that of the Bank's peer group average, which have ranged between .26% and .29% over the last three years. Balance Sheet Total assets increased 1.97% during the year to $309,126,000, an increase of $5,977,000 from $303,149,000 in 2002. Earning assets increased 1.62% or $4,555,000 to $286,499,000 at December 31, 2003. Interest bearing liabilities declined $694,000 or .29%. The Company continues to utilize its assets well with 92.23% of year-end assets consisting of earning assets. Investment Securities Average balances in investment securities increased 6.82% in 2003 to $57,262,000. This increase came from funds received through continued deposit growth. The Company maintains a high level of earning assets as investment securities to provide liquidity, as security for public deposits and to secure repurchase agreements. Management strives to match the types and maturities of securities owned to balance projected liquidity needs, interest rate sensitivity and to maximize earnings through a portfolio bearing low credit risk. 14 Management's Discussion and Analysis of Financial Condition and Results of Operations Analysis of Securities The composition of securities at December 31 was: (Dollars in thousands) 2003 2002 2001 ---- ---- ---- Available for Sale:1 U.S. Treasury and Agency $25,443 $38,475 $29,428 Municipal 373 Mortgage-backed2 8,989 5,069 7,922 Corporate bonds 10,845 11,338 10,402 Marketable equity securities 9,245 8,026 10,500 ------ ------ ------ Total 54,895 62,908 58,252 Held to Maturity: U.S. Treasury and Agency 110 110 111 Corporate bonds 763 1,767 1,772 ------ ------ ------ Total 873 1,877 1,883 Other Equity Investments 5,461 4,817 3,852 ------ ------ ------ Total Securities $61,229 $69,602 $63,987 ====== ====== ====== 1 At estimated fair value. 2 Issued by a U.S. Government Agency or secured by U.S. Government Agency collateral. Maturities and weighted average yields of debt securities at December 31, 2003 are presented in the table below. Amounts are shown by contractual maturity; expected maturities will differ as issuers may have the right to call or prepay obligations.
Years to Maturity Less One to Over (Dollars in thousands) than one Five Five Amount Yield Amount Yield Amount Yield Total Yield Debt Securities Available for Sale: U.S. Treasury, Agency $ 7,040 4.47% $18,403 2.29% $ % $25,443 .89% Municipal 249 2.90 124 3.40 373 3.07 Mortgage-backed 6,060 3.57 2,929 2.67 8,989 3.28 Corporate bonds 3,054 7.13 7,278 3.77 513 7.18 10,845 4.88 ------ ------ ------ ------ Total $10,094 5.27% $31,990 2.88% $ 3,566 3.34% $45,650 3.44% ------- ------- ------- ------- Debt Securities Held to Maturity: U.S. Treasury & Agency $ 110 1.66% $ 110 1.66% Corporate bonds 763 6.15 763 6.15 ------ ------ Total $ 873 5.88% $ n/a $ n/a $ 873 5.88% ------ ------ ------ ======
15 Management's Discussion and Analysis of Financial Condition and Results of Operations Analysis of Loan Portfolio The Company's loan portfolio totaled $211,231,000 at December 31, 2003 compared with $201,980,000 at the beginning of the year. The Company's policy has been to make conservative loans that are held for future interest income. Collateral required by the Company is determined on an individual basis depending on the purpose of the loan and the financial condition of the borrower. Commercial loans, including agricultural and multi family loans, increased 17.59% during 2003 to $55,523,000. Real estate mortgages were virtually flat for the year, increasing only $224,000, while construction loans increased $3,270,000 or 27.12%. Consumer installment loans were down significantly at $19,630,000, a decrease of $3,074,000 that management believes to be attributable to aggressive auto financing packages offered by the major auto manufacturers and installment debt refinanced into mortgage loans as a result of increasing property values and historically low mortgage rates. Credit card balances were decreased $14,000 to $1,463,000 but are a minor component of the loan portfolio. The following table presents the changes in the loan portfolio over the previous five years. December 31 (Dollars in thousands) 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Real estate - mortgage $ 118,677 $ 118,453 $ 105,305 $ 92,464 $ 84,019 Real estate - construction 15,329 12,059 5,521 4,372 5,481 Consumer installment 19,630 22,704 23,106 20,927 18,082 Commercial 45,011 35,769 28,552 25,628 22,880 Agricultural 10,512 10,966 11,835 6,656 8,392 Multi-family residential 477 484 869 703 414 Credit cards 1,463 1,477 1,348 1,249 1,016 Other 132 68 89 36 34 -------- -------- -------- -------- -------- Total Loans $ 211,231 $ 201,980 $ 176,625 $ 152,035 $ 140,318 -------- ======== ======== ======== ======== The following table shows the Company's loan maturity and interest rate sensitivity as of December 31, 2003: Less Than 1-5 Over (Dollars in thousands) 1 Year Years 5 Years Total ------ ----- ------- ----- Commercial and agricultural loans $33,611 $ 20,171 $ 2,218 $ 56,000 Real Estate - mortgage 18,294 71,187 29,196 118,677 Real Estate - construction 15,329 15,329 Consumer - installment/other 2,860 17,958 407 21,225 ------ ------ ------ ------ Total $70,094 $109,316 $31,821 $211,231 ====== ======= ====== ======= Loans with predetermined rates $ 4,358 $24,029 $20,277 $ 48,664 Loans with variable or adjustable rates 65,736 85,287 11,544 162,567 ------ ------ ------ ------- Total $70,094 $109,316 $31,821 $211,231 ====== ======= ====== ======= Residential real estate loans are generally made for a period not to exceed 25 years and are secured by a first deed of trust which normally does not exceed 90% of the appraised value. If the loan to value ratio exceeds 90%, the Company requires additional collateral, guarantees or mortgage insurance. On approximately 80% of the real estate loans, interest is adjustable after each three or five year period. Fixed rate loans are generally made for a fifteen-year or a twenty-year period with an interest rate adjustment after ten years. 16 Management's Discussion and Analysis of Financial Condition and Results of Operations Since 1992, fixed rate real estate loans have been funded with fixed rate borrowings from the Federal Home Loan Bank, which allows the Company to control its interest rate risk. In addition, the Company makes home equity loans secured by second deeds of trust with total indebtedness not to exceed 90% of the appraised value. Home equity loans are made for three, five or seven year periods at a fixed rate or as a revolving line of credit. The majority of commercial loans are made to small retail, manufacturing and service businesses. Consumer loans are made for a variety of reasons, however, approximately 60% of the loans are secured by automobiles and trucks. The Company's market area has a stable economy which tends to be less cyclical than the national economy. Major industries in the market area include agricultural production and processing, higher education, retail sales, services and light manufacturing. The agricultural production and processing industry is a major contributor to the local economy and its performance and growth tend to be cyclical in nature, however, this cyclical nature is offset by other stable industries in the trade area. In addition to direct agricultural loans, a large percentage of residential real estate loans and consumer installment loans are made to borrowers whose income is derived from the agricultural sector of the economy. A large percentage of the agricultural loans are made to poultry growers. During recent years, real estate values in the Company's market area for commercial, agricultural and residential property increased, on the average, between 5% and 8% annually depending on the location and type of property. Approximately 80% of the Company's loans are secured by real estate, however, policies relating to appraisals and loan to value ratios are adequate to control the related risk. Unemployment rates in the Company's market area continue to be below both the national and state averages. Nonaccrual and Past Due Loans The following table shows loans placed in a nonaccrual status and loans contractually past due 90 days or more as to principal or interest payments. December 31, (Dollars in thousands) 2003 2002 2001 2000 1999 Nonaccruing loans None None None $ 664 None Loans past due 90 Days or more $1,614 $2,594 $1,096 $ 421 $1,917 Percentage of total loans .76% 1.28% .62% .71% 1.37% Interest accruals are continued on past due, secured loans until the principal and accrued interest equal the value of the collateral and on unsecured loans until the financial condition of the borrower deteriorates to the point that any further accrued interest would be determined to be uncollectible. At December 31, 2003, 2002, and 2001, there were no restructured loans on which interest was accruing at a reduced rate or on which payments had been extended. Potential Problem Loans Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources. Nor do they represent material credits about which management is aware of any information which causes it to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. As of December 31, 2003, management is not aware of any potential problem loans which are not already classified for regulatory purposes or on the watch list as part of the Bank's internal grading system. Loan Concentrations At December 31, 2003, no industry category exceeded ten percent of total loans. 17 Management's Discussion and Analysis of Financial Condition and Results of Operations Loan Losses and the Allowance for Loan Losses In evaluating the portfolio, loans are segregated into loans with identified potential losses, and pools of loans by type (commercial, residential, consumer, credit cards). Loans with identified potential losses include examiner and bank classified loans. Classified relationships in excess of $100,000 are reviewed individually for impairment under FAS 114. A variety of factors are taken into account when reviewing these credits, including borrower cash flow, payment history, fair value of collateral, company management, industry and economic factors. Loan relationships that are determined to have no impairment are placed back into the appropriate loan pool and reviewed under SFAS No. 5. Loan pools are further segmented into watch list, past due over 90 days and all other. Watch list loans include loans that are 60 days past due and may include restructured loans, borrowers that are highly leveraged, loans that have been upgraded from classified or loans that contain policy exceptions (term, collateral coverage, etc.). Loss estimates on these loans reflect the increased risk associated with these assets due to any of the above factors. The past due pools contain loans that are currently 90 days or more past due. Loss rates assigned reflect the fact that these loans bear a significant risk of charge-off. Loss rates vary by loan type to reflect the likelihood that collateral values will offset a portion of the anticipated losses. The remainder of the portfolio falls into pools by type of homogenous loans that do not exhibit any of the above described weaknesses. Loss rates are assigned based on historical rates over the prior five years. A multiplier has been applied to these loss rates to reflect the time for loans to season within the portfolio and the inherent imprecision of these estimates. All potential losses are evaluated within a range of low to high. An unallocated allowance has been established to reflect other unidentified losses within the portfolio. The unallocated allowance mitigates the increased risk of loss associated with fluctuations in past due trends, changes in the local and national economies, and other unusual events. The Board approves the loan loss provision for the following quarter based on this evaluation and an effort is made to keep the actual allowance at or above the midpoint of the range established by the evaluation process. The allowance for loan losses of $1,484,000 at December 30, 2003 is equal to ..70% of total loans. This compares to an allowance of $1,477,000 (.73%) at December 31, 2002. The overall level of the allowance remains well below the peer group average of 1.35%. Management feels this is appropriate based on its loan loss history and the composition of its loan portfolio; the current allowance for loan losses is equal to approximately seven years of average loan losses. Based on historical losses, delinquency rates, collateral values of delinquent loans and a thorough review of the loan portfolio, management is of the opinion that the allowance for loan losses fairly states the estimated losses in the current portfolio. Loan losses, net of recoveries, totaled $219,000 in 2003 which is equivalent to ..10% of total loans outstanding. Over the preceding five years, the Company has had an average loss rate of .10% which is approximately forty percent of the loss rate of its peer group. 18 Management's Discussion and Analysis of Financial Condition and Results of Operations A summary of the activity in the allowance for loan losses follows: (Dollars in thousands) 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Balance at beginning of period $1,477 $1,289 $1,108 $1,090 $1,162 Provision charged to expenses 226 387 204 123 140 Other adjustments 84 Loan losses: Commercial 76 20 22 21 107 Installment 219 249 138 125 150 Real estate 31 2 2 ----- ----- ----- ----- ----- Total loan losses 295 300 160 148 259 ----- ----- ----- ----- ----- Recoveries: Commercial 11 28 3 3 5 Installment 65 73 49 39 40 Real estate 1 1 2 ----- ----- ----- ----- ----- Total recoveries 76 101 53 43 47 ----- ----- ----- ----- ----- Net loan losses 219 199 107 105 212 ----- ----- ----- ----- ----- Balance at end of period $1,484 $1,477 $1,289 $1,108 $1,090 ===== ===== ===== ===== ===== Allowance for loan losses as a percentage of loans .70% .73% .73% .73% .78% Net loan losses to loans outstanding .10% .10% .06% .07% .16% The Company has allocated the allowance according to the amounts deemed to be reasonably necessary to provide for the possibility of losses occurring within each of the above categories of loans. The allocation of the allowance as shown below should not be interpreted as an indication that loan losses in future years will occur in the same proportions or that the allocation indicates future loan loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is a general allowance applicable to the entire portfolio. The following table shows the allocation of the allowance by loan type and the related outstanding loan balances to total loans.
(Dollars in thousands) 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- % of % of % of % of % of Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Commercial $ 475 26% $ 443 23% $ 451 23% $ 332 25% $ 327 26% Real estate 297 64% 369 65% 323 63% 277 61% 327 60% Installment 638 10% 591 12% 451 14% 333 14% 273 14% Unallocated 74 74 64 166 163 ----- --- ----- --- ----- --- ----- --- ----- --- Total $1,484 100% $1,477 100% $1,289 100% $1,108 100% $1,090 100% ===== === ===== === ===== === ===== === ===== ===
19 Management's Discussion and Analysis of Financial Condition and Results of Operations Deposits and Borrowings The Bank recognized an increase in year-end deposits in 2003 of 5.45%. The Bank experienced an increase in all account types with the exception of certificates of deposit. Rates of interest declined throughout all of 2003 and, with the exception of advertising a free checking account, the Bank did not have any special promotions to generate deposit growth. Management believes that economic uncertainty, the volatility of the stock market and continued consolidation of larger banks contributed to the growth in deposits in 2003. The Bank has traditionally avoided brokered and large deposits believing that they were unstable and, thus not desirable. This has proven to be a good strategy as the local deposit base is very stable and small increases in rates above the competition have usually resulted in deposit gains in past years. Beginning in 2001 the Bank has, on occasion, accepted certificates of deposit from other financial institutions at below market rates of interest. Typically this has been done to meet loan demand or if liquidity was sufficient, the Bank has reinvested these deposits in certificates of deposit at other institutions which were offering above market rates. Certificates of deposit over $100,000 totaled $21,138,000 at December 31, 2003. The maturity distribution of these certificates is as follows: (Dollars in thousands) 2003 2002 ---------------------- ---- ---- Less than 3 months $ 3,206 $ 2,427 3 to 12 months 7,250 8,573 1 year to 5 years 10,682 7,955 -------- ------- Total $ 21,138 $ 18,955 ======== ======== Non-deposit borrowings include repurchase agreements, federal funds purchased and long-term debt obtained through the Federal Home Loan Bank and SunTrust Bank. Repurchase agreements continue to be an important source of funding and provide commercial customers the opportunity to earn market rates of interest on funds that are secured by specific securities owned by the Bank. Borrowings from the Federal Home Loan Bank are used to support the Bank's mortgage lending program and allow the Bank to offer longer-term mortgages. The Bank did not borrow any additional funds from the FHLB during 2003. Quarterly installment payments on FHLB debt totaled $6,194,000 for the year. These loans carry an average rate of 4.68% at December 31, 2003. Stockholder's Equity Total stockholders' equity increased $2,778,000 or 9.40% in 2003. Earnings retained from operations were the primary source of the increase. As of December 31, 2003, book value per share was $13.35 compared to $12.19 as of December 31, 2002. Dividends are paid to stockholders on a quarterly basis in uniform amounts unless unexpected fluctuations in net income indicate a change to this policy is needed. Banking regulators have established a uniform system to address the adequacy of capital for financial institutions. The rules require minimum capital levels based on risk-adjusted assets. Simply stated, the riskier an entity's investments, the more capital it is required to maintain. The Bank, as well as the Company, is required to maintain these minimum capital levels. The two types of capital guidelines are Tier I capital (referred to as core capital) and Tier II capital (referred to as supplementary capital). At December 31, 2003, the Company had Tier I capital of 13.97% of risk weighted assets and combined Tier I and II capital of 14.72% of risk weighted assets. Regulatory minimums at this date were 4% and 8%, respectively. The Bank has maintained capital levels far above the minimum requirements throughout the year. In the unlikely event that such capital levels are not met, regulatory agencies are empowered to require the Company to raise additional capital and/or reallocate present capital. 20 Management's Discussion and Analysis of Financial Condition and Results of Operations Stockholder's Equity (Continued) In addition, the regulatory agencies have issued guidelines requiring the maintenance of a capital leverage ratio. The leverage ratio is computed by dividing Tier I capital by actual total assets. The regulators have established a minimum of 3% for this ratio, but can increase the minimum requirement based upon an institution's overall financial condition. At December 31, 2003, the Company reported a leverage ratio of 9.00%. The Bank's leverage ratio was also substantially above the minimum. ITEM 7A Quantitative and Qualitative Disclosures about Market Risk Most of the Company's net income is dependent on the Bank's net interest income. As the rapid change in short-term interest rates demonstrated in 2001, net interest income is subject to interest rate risk to the extent that imbalances exist between the maturities or repricing of interest bearing liabilities and interest earning assets. In 2001 for example, interest-earning assets repriced much more quickly than interest bearing liabilities; this resulted in a decrease in the net interest margin compared to 2000. During 2002, the net interest margin increased as the interest bearing liabilities matured and repriced at significantly lower levels. During 2003 this trend again reversed, as longer term assets (principally mortgage loans and securities) matured or repriced at rates that were substantially lower, while most interest bearing liabilities had already repriced at lower rates in either 2001 or 2002. Net interest income is also affected by changes in the mix of funding that supports earning assets. For example, higher levels of non-interest bearing demand deposits and leveraging earning assets by funding with stockholder's equity would result in greater levels of net interest income than if most of the earning assets were funded with higher cost interest-bearing liabilities, such as certificates of deposit. Liquidity as of December 31, 2003 is very strong. The Bank historically has had a stable core deposit base and, therefore, does not have to rely on volatile funding sources. Because of the stable core deposit base, changes in interest rates should not have a significant effect on liquidity. During 2003, the Bank used, maturing investments, and deposit growth to meet its liquidity needs. The Bank's membership in the Federal Home Loan Bank has historically provided liquidity as the Bank borrows money that is repaid over a five to ten year period and uses the money to make fixed rate loans. The matching of the long-term receivables and liabilities helps the Bank reduce its sensitivity to interest rate changes. The Company reviews its interest rate gap periodically and makes adjustments as needed. There are no off balance sheet items that will impair future liquidity. The following table depicts the Company's interest rate sensitivity, as measured by the repricing of its interest sensitive assets and liabilities as of December 31, 2003. As the notes to the table indicate, the data was based in part on assumptions as to when certain assets or liabilities would mature or reprice. The analysis indicates a liability sensitive one-year cumulative GAP position of 1.61% of total earning assets. Approximately 35% of rate sensitive assets and 43% of rate sensitive liabilities are subject to repricing within one year. The one-year cumulative GAP narrowed during 2003, as the Bank held more short-term liquid assets. With rates remaining at historically low rates throughout 2003, the Investment Committee and management choose to not reinvest bond maturities, loan repayments and cash in longer-term investments. Management believes that remaining liquid and keeping investments short-term in nature will allow it to achieve greater earnings in the future when rates rise to higher levels. 21 Management's Discussion and Analysis of Financial Condition and Results of Operations The following GAP analysis shows the time frames from December 31, 2003, in which the Company's assets and liabilities are subject to repricing:
1-90 91-365 1-5 Over 5 Not Total (Dollars in thousands) Days Days Years Years Classified Rate Sensitive Assets: Loans $44,065 $ 26,029 $109,316 $ 31,821 $ $211,231 Investments securities 8,665 7,208 30,012 125 9,758 55,768 Federal Funds Sold 5,035 5,035 Interest bearing bank deposits 3,655 4,457 891 9,003 ------ ------- ------ ------- ------ ------- Total 61,420 37,694 140,219 31,946 9,758 281,037 Rate Sensitive Liabilities: Interest bearing demand deposits 11,501 21,416 4,958 37,875 Savings 9,509 28,527 9,509 47,545 Certificates of deposit $100,000 and over 3,206 7,250 10,682 21,138 Other certificates of deposit 20,343 37,114 43,576 101,033 ------ ------- ------ ------- ------ ------- Total Deposits 23,549 65,374 104,201 14,467 207,591 Short-term debt 6,389 6,389 Long-term debt 2,774 5,548 16,085 377 24,784 ------ ------- ------ ------- ------ ------- Total 32,712 70,922 120,286 14,844 238,764 Discrete Gap 28,708 (33,228) 19,933 17,102 9,758 42,273 Cumulative Gap 28,708 (4,520) 15,413 32,515 42,273 As a % of Earning Assets 10.22% (1.61%) 5.48% 11.56% 15.04%
* In preparing the above table, no assumptions are made with respect to loan prepayments or deposit run off. Loan principal payments are included in the earliest period in which the loan matures or can be repriced. Principal payments on installment loans scheduled prior to maturity are included in the period of maturity or repricing. Proceeds from the redemption of investments and deposits are included in the period of maturity. Estimated maturities on deposits which have no stated maturity dates were derived from guidance contained in FDICIA 305. Recent Accounting Pronouncements In October 2002, FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 147 amends previous interpretive guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and requires the application of SFAS No. 141, Business Combinations, and SFAS No. 142 to branch acquisitions if such transactions meet the definition of a business combination. The provisions of SFAS No. 147 do not apply to transactions between two or more mutual enterprises. In addition, SFAS No. 147 amends SFAS No. 144, Accounting for the Impairment of Long-Lived Assets, to include in its scope core deposit intangibles of financial institutions. Accordingly, such intangibles are subject to a recoverability test based on undiscounted cash flows, and to the impairment recognition and measurement provisions required for other long-lived assets held and used. 22 Management's Discussion and Analysis of Financial Condition and Results of Operations In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"). The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The recognition requirements of the Interpretation were effective beginning January 1, 2003. The initial adoption of the Interpretation did not have an affect on the Company, and management has determined that the recognition requirements of this Interpretation have had little impact on either the Company's consolidated financial position or consolidated results of operations. In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). This Interpretation provides guidance with respect to the identification of variable interest entities and when the assets, liabilities, noncontrolling interests, and results of operations of a variable interest entity need to be included in a company's consolidated financial statements. The Interpretation requires consolidation by business enterprises of variable interest entities in cases where (a) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, or (b) in cases where the equity investors lack one or more of the essential characteristics of a controlling financial interest, which include the ability to make decisions about the entity's activities through voting rights, the obligations to absorb the expected losses of the entity if they occur, or the right to receive the expected residual returns of the entity if they occur. Management has evaluated the Company's investments in variable interest entities and potential variable interest entities or transactions, particularly in limited liability partnerships involved in low-income housing development. The implementation of FIN 46 did not have a significant impact on either the Company's consolidated financial position or consolidated results of operations. Interpretive guidance relating to FIN 46 is continuing to evolve and the Company's management will continue to assess various aspects of consolidations and variable interest entity accounting as additional guidance becomes available. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. It is not expected to have an impact on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and was effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of the Statement did not result in an impact on the Company's consolidated financial statements. In November 2003, the FASB's Emerging Issues Task Force reached a consensus on a new disclosure requirement related to unrealized losses on investment securities. The new disclosure requires a table of securities which have unrealized losses as of the reporting date. The table must distinguish between those securities which have been in a continuous unrealized loss position for twelve months or more and those securities which have been in a continuous unrealized loss position for less than twelve months. The table is to include the aggregate unrealized losses of securities whose fair values are below book values as of the reporting date, and the aggregate fair value of securities whose fair values are below book values as of the reporting date. In addition to the quantitative disclosure, FASB requires a narrative discussion that provides sufficient information to allow financial statement users to understand the quantitative disclosures and the information that was considered in determining whether impairment was not other-than-temporary. The new disclosure requirements apply to fiscal years ending after December 15, 2003. The Company has included the required disclosures in their consolidated financial statements. 23 Management's Discussion and Analysis of Financial Condition and Results of Operations Quarterly Results The table below lists the Company's quarterly performance for the years ended December 31, 2003 and 2002:
2003 Dollars in thousands Fourth Third Second First Total ------ ----- ------ ----- ----- Interest Income $4,078 $4,103 $4,202 $4,300 $16,683 Interest Expense 1,361 1,455 1,564 1,630 6,010 ----- ----- ----- ----- ----- Net Interest Income 2,717 2,648 2,638 2,670 10,673 Provision for Loan Losses 62 31 61 72 226 ----- ----- ----- ----- ----- Net Interest Income after Provision For Loan Losses 2,655 2,617 2,577 2,598 10,447 Non-Interest Income 509 643 993 341 2,486 Non-Interest Expense 1,855 1,846 1,822 1,732 7,255 ----- ----- ----- ----- ----- Income before taxes 1,309 1,414 1,748 1,207 5,678 Income Tax Expense 418 369 525 354 1,666 ----- ----- ----- ----- ----- Net Income $ 891 $1,045 $1,223 $ 853 $4,012 ===== ===== ===== ===== ===== Net Income Per Share $ .37 $ .43 $ .50 $ .36 $ 1.66 2002 Fourth Third Second First Total Interest Income $4,538 $4,499 $4,490 $4,319 $17,846 Interest Expense 1,756 1,803 1,893 1,938 7,390 ----- ----- ----- ----- ----- Net Interest Income 2,782 2,696 2,597 2,381 10,456 Provision for Loan Losses 106 107 107 67 387 ----- ----- ----- ----- ----- Net Interest Income after Provision For Loan Losses 2,676 2,589 2,490 2,314 10,069 Non-Interest Income (341) 386 755 398 1,198 Non-Interest Expense 1,729 1,564 1,573 1,582 6,448 ----- ----- ----- ----- ----- Income Before Taxes 606 1,411 1,672 1,130 4,819 Income Tax Expense 60 403 511 341 1,315 ----- ----- ----- ----- ----- Net Income $ 546 $1,008 $1,161 $ 789 $3,504 ===== ===== ===== ===== ===== Net Income Per Share $ .22 $ .42 $ .48 $ .32 $ 1.44
The fourth quarter results in 2003 include a $100,000 pre-tax charge on the Company's investment in BI Investments, LLC, while the fourth quarter results in 2002 include a $503,000 pre-tax loss on securities that management determined were impaired. 24 Item 8 F & M Bank Corp. and Subsidiaries Consolidated Balance Sheets December 31, ASSETS 2003 2002 ---- ---- Cash and due from banks (notes 3 and 13) $ 5,665,110 $ 6,017,446 Interest bearing deposits (note 13) 9,002,742 5,886,439 Federal funds sold 5,035,000 4,476,000 Securities - Held to maturity - fair value of $897,865 in 2003 and $1,905,012 in 2002 (note 4) 872,978 1,877,258 Available for sale (note 4) 54,895,520 62,908,016 Other investments (note 4) 5,461,316 4,816,386 Loans (notes 5, 10 and 13) 211,231,092 201,979,842 Less allowance for loan losses (note 6) (1,483,667) (1,477,007) ------------ ------------ Net Loans 209,747,425 200,502,835 Bank premises and equipment, net (note 7) 5,001,293 4,485,813 Other real estate 719,268 Interest receivable 1,496,232 1,655,122 Core deposit intangible (note 20) 1,977,583 2,253,525 Goodwill (note 20) 2,638,677 2,638,677 Bank owned life insurance (note 21) 4,831,667 2,302,655 Other assets 2,500,917 2,609,469 ------------ ----------- Total Assets 309,126,460 $303,148,909 ============ =========== LIABILITIES Deposits: Noninterest bearing 33,123,978 $ 29,445,922 Interest bearing: Demand 24,788,355 22,464,540 Money market accounts 13,086,303 11,669,676 Savings 47,545,499 41,661,219 Time deposits over $100,000 (note 8) 21,138,463 18,955,379 All other time deposits (note 8) 101,032,742 104,087,160 ------------ ----------- Total Deposits 240,715,340 228,283,896 ------------ ------------ Short-term debt (note 9) 6,388,958 8,308,382 Accrued liabilities 4,918,788 4,703,427 Long-term debt (note 10) 24,784,207 32,312,024 ------------ ----------- Total Liabilities 276,807,293 273,607,729 ------------ ----------- STOCKHOLDERS' EQUITY (NOTE 19) Common stock $5 par value, 3,000,000 shares authorized, 2,420,478 and 2,423,678 shares issued and outstanding, for 2003 and 2002, respectively 12,102,390 12,118,390 Capital surplus 286,330 302,795 Retained earnings (note 16) 19,709,562 17,390,478 Accumulated other comprehensive income (loss) 220,885 (270,483) ------------ ------------ Total Stockholders' Equity 32,319,167 29,541,180 ------------ ----------- Total Liabilities and Stockholders' Equity $309,126,460 $303,148,909 =========== =========== The accompanying notes are an integral part of this statement. 25 F & M Bank Corp. and Subsidiaries Consolidated Statements of Income Years Ended December 31, 2003 2002 2001 ------------------------- -------- INTEREST AND DIVIDEND INCOME: Interest and fees on loans 14,121,937 $14,846,527 $14,162,330 Interest on deposits and federal funds sold 346,951 438,330 1,163,750 Interest on debt securities 1,715,328 2,004,119 1,837,897 Dividends on equity securities 498,546 557,470 517,435 ---------- --------- --------- Total Interest and Dividend Income 16,682,762 17,846,446 17,681,412 ---------- ---------- ---------- INTEREST EXPENSE: Interest on demand deposits 213,803 306,730 435,919 Interest on savings deposits 488,347 710,489 873,462 Interest on time deposits over $100,000 757,204 657,069 723,697 Interest on all other time deposits 3,260,349 4,240,390 5,661,394 ---------- --------- --------- Total interest on deposits 4,719,703 5,914,678 7,694,472 Interest on short-term debt 44,377 103,951 311,240 Interest on long-term debt 1,245,531 1,371,774 1,488,569 ---------- --------- --------- Total Interest Expense 6,009,611 7,390,403 9,494,281 ---------- --------- --------- NET INTEREST INCOME 10,673,151 10,456,043 8,187,131 ---------- ---------- --------- PROVISION FOR LOAN LOSSES (note 6) 226,000 387,000 204,000 ---------- --------- --------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,447,151 10,069,043 7,983,131 ---------- ---------- --------- NONINTEREST INCOME: Service charges on deposit accounts 904,946 716,590 674,366 Insurance and other commissions 280,156 209,579 141,116 Other operating income 884,806 323,056 341,969 Income on bank owned life insurance 238,369 130,531 Gain (loss) on security transactions (note 4) 178,618 (182,430) 1,252,500 ---------- ---------- --------- Total Noninterest Income 2,486,895 1,197,326 2,409,951 ---------- --------- --------- NONINTEREST EXPENSES: Salaries 3,075,762 2,853,483 2,473,605 Employee benefits (note 12) 1,053,032 747,074 693,933 Occupancy expense 406,816 337,038 324,092 Equipment expense 407,636 350,701 317,597 Amortization of intangibles (notes 2 and 20) 275,942 275,942 304,008 Other operating expenses 2,036,235 1,883,657 1,614,519 ---------- --------- --------- Total Noninterest Expenses 7,255,423 6,447,895 5,727,754 ---------- --------- --------- Income before Income Taxes 5,678,623 4,818,474 4,665,328 INCOME TAX EXPENSE (note 11) 1,666,324 1,314,579 1,434,798 ---------- --------- --------- NET INCOME $4,012,299 $3,503,895 $3,230,530 ========== ========== ========== PER SHARE DATA NET INCOME $ 1.66 $ 1.44 $ 1.33 ========== ========= ========= CASH DIVIDENDS .70 $ .66 $ .63 ========== ========= ========= AVERAGE COMMON SHARES OUTSTANDING 2,417,807 2,428,722 2,430,993 ========== ========= ========= The accompanying notes are an integral part of this statement. 26 F & M Bank Corp. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity
Accumulated Other Common Capital Retained Comprehensive Stock Surplus Earnings Income (Loss) Total BALANCE - December 31, 2000 $12,166,865 $ 479,468 $13,790,628 $ 761,269 $27,198,230 Comprehensive Income: Net income 3,230,530 3,230,530 Net change in other comprehensive income (note 2) (370,306) (370,306) ---------- Comprehensive Income 2,860,224 Dividends on common stock (1,532,752) (1,532,752) Stock sold to ESOP (9,000 shares) 45,000 110,250 155,250 Stock repurchased (3,810 shares) (19,050) (64,703) (83,753) ----------- --------- ---------- --------- ----------- BALANCE - December 31, 2001 12,192,815 525,015 15,488,406 390,963 28,597,199 Comprehensive Income: Net income 3,503,895 3,503,895 Net change in other comprehensive income (note 2) (661,446) (661,446) ---------- Comprehensive Income 2,842,449 Dividends on common stock (1,601,823) (1,601,823) Stock repurchased (14,885 shares) (74,425) (222,220) (296,645) ------------ ---------- ---------- -------- ---------- BALANCE - December 31, 2002 $ 12,118,390 $ 302,795 $ 17,390,478 $(270,483) $29,541,180 Comprehensive Income: Net income 4,012,299 4,012,299 Net change in other comprehensive income (Note 2) 491,368 491,368 ----------- Comprehensive Income 4,503,667 Tax benefit of ESOP dividends 23,969 23,969 Dividends on common stock (1,693,215) (1,693,215) Stock sold to ESOP (10,000 shares) 50,000 158,000 208,000 Stock repurchased (13,200 shares) (66,000) (198,434) (264,434) ----------- --------- ---------- -------- ----------- BALANCE - December 31, 2003 $ 12,102,390 $ 286,330 $19,709,562 $ 220,885 $32,319,167 =========== ========= ========== ========= =========
The accompanying notes are an integral part of this statement. 27 F & M Bank Corp. and Subsidiaries Consolidated Statements of Cash Flows Years Ended December 31, 2003 2002 2001 --------------------------- ------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 4,012,299 $ 3,503,895 $ 3,230,530 Adjustments to reconcile net income to net cash provided by operating activities: (Gain) loss on sale of securities (178,618) 182,430 (1,252,500) Depreciation 429,717 347,867 308,152 Amortization of security premiums 312,301 125,412 40,266 Provision for loan losses 226,000 387,000 204,000 Provision for deferred taxes 210,305 (240,106) (43,982) (Increase) decrease in interest receivable 158,890 (113,581) (60,509) (Increase) decrease in other assets (610,505) (178,301) 51,166 Increase in accrued expenses 69,197 757,679 84,173 Amortization of limited partnership investments 262,227 255,850 218,804 Amortization of intangibles 275,942 275,942 304,008 Income from life insurance investment (238,369) (130,531) (Gain) loss on sale of other real estate (94,754) 22,161 (21,484) ----------- --------- --------- Net Cash Provided by Operating Activities 4,834,632 5,195,717 3,062,624 ------------ --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: (Increase) decrease in interest bearing bank deposits (3,116,303) 8,312,403 (13,886,318) Net (increase) decrease in federal funds sold (559,000) (4,476,000) 909,000 Proceeds from maturities of securities held to maturity 1,000,000 20,100,747 Proceeds from maturities of securities Available or sale 54,755,131 25,794,446 40,828,490 Proceeds from sales of securities Available for sale 2,480,338 5,062,045 3,051,910 Purchases of securities held to maturity (19,990,333) Purchases of securities available for sale (49,557,386) (37,983,540) (62,216,028) Net increase in loans (9,470,590) (25,748,188) (24,955,943) Purchase of life insurance (1,870,528) (2,172,124) Purchase of property and equipment (729,048) (330,302) (1,072,265) Purchase of other real estate (243,204) Construction in progress payments (91,850) Purchase of intangible assets (5,472,152) Sale of other real estate 597,873 263,970 138,774 ----------- ----------- ----------- Net Cash Used in Investing Activities (6,469,513) (31,612,344) (62,564,118) ----------- ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net change in demand and savings deposits 13,315,434 14,978,546 24,893,136 Net increase (decrease) in time deposits (871,334) 5,026,575 31,031,240 Net change in short-term debt (1,932,080) (2,387,313) 1,997,660 Dividends paid in cash (1,645,224) (1,580,138) (1,532,752) Proceeds from long-term debt 18,000,000 13,000,000 Payments to repurchase common stock (264,434) (296,645) (83,753) Proceeds from issuance of common stock 208,000 155,250 Repayments of long-term debt (7,527,817) (6,670,674) (8,403,140) ----------- ----------- ----------- Net Cash Provided by Financing Activities 1,282,545 27,070,351 61,057,641 ----------- ---------- ---------- Net Increase (Decrease) in Cash and Cash Equivalents (352,336) 653,724 1,556,147 Cash and Cash Equivalents, Beginning of Year 6,017,446 5,363,722 3,807,575 =========== ========== =========== Cash and Cash Equivalents, End of Year 5,665,110 $ 6,017,446 $ 5,363,722 =========== ========== =========== Supplemental Disclosure: Cash paid for: Interest expense $6,148,756 $ 7,538,614 $ 9,458,909 Income taxes 750,000 1,100,000 1,050,000 The accompanying notes are an integral part of this statement 28 Notes to the Consolidated Financial Statements NOTE 1 NATURE OF OPERATIONS: F & M Bank Corp. ("Company"), through its subsidiary Farmers & Merchants Bank ("Bank"), operates under a charter issued by the Commonwealth of Virginia and provides commercial banking services. As a state chartered bank, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank. The Bank provides services to customers located mainly in Rockingham and Shenandoah counties in Virginia, and the adjacent counties of Page, and Augusta. Services are provided at eight branch offices. In addition, the Company offers insurance and financial services through its subsidiaries, TEB Life Insurance, Inc. and Farmers & Merchants Financial Services, Inc. NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The accounting and reporting policies of the Company and its subsidiaries conform to generally accepted accounting principles and to accepted practice within the banking industry. The following is a summary of the more significant policies: Principles of Consolidation The consolidated financial statements include the accounts of the Farmers and Merchants Bank, the TEB Life Insurance Company and Farmers & Merchants Financial Services, Inc. Significant intercompany accounts and transactions have been eliminated. Use of Estimates in the Preparation of Financial Statements In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts in those statements; actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term are the determination of the allowance for loan losses, which is sensitive to changes in local and national economic conditions, and the other than temporary impairment of investments in the investment portfolio. Cash and Cash Equivalents Cash and cash equivalents include cash on hand and deposits at other financial institutions whose initial maturity is ninety days or less. Investment Securities Management reviews the securities portfolio and classifies all securities as either held to maturity or available for sale at the date of acquisition. Securities that the Company has both the positive intent and ability to hold to maturity (at time of purchase) are classified as held to maturity securities. All other securities are classified as available for sale. Securities held to maturity are carried at historical cost and adjusted for amortization of premiums and accretion of discounts, using the effective interest method. Securities available for sale are carried at fair value with any valuation adjustments reported, net of deferred taxes, as a part of other accumulated comprehensive income. Also included in securities available for sale are marketable equity securities. Interest, amortization of premiums and accretion of discounts on securities are reported as interest income using the effective interest method. Gains (losses) realized on sales and calls of securities are determined on the specific identification method. Accounting for Historic Rehabilitation and Low Income Housing Partnerships The Company periodically invests in low income housing partnerships whose primary benefit is the distribution of federal tax credits to partners. The Company recognizes these benefits and the cost of the investments over the life of the partnership (usually 15 years). In addition, state and federal historic rehabilitation credits are generated from an investment in one of the partnerships. Amortization of this investment is prorated based on the amount of benefits received in each year to the total estimated benefits over the life of the project. All benefits have been shown as investment income since income tax benefits are the only anticipated benefits of ownership. 29 Notes to the Consolidated Financial Statements NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Loans Loans are carried on the balance sheet net of any unearned interest and the allowance for loan losses. Interest income on loans is determined using the effective interest method on the daily amount of principal outstanding except where serious doubt exists as to collectibility of the loan, in which case the accrual of income is discontinued. Allowance for Loan Losses The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans are charged against the allowance when management believes the collectibility of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management's determination of the adequacy of the allowance is based on an evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Nonaccrual Loans Interest accruals are continued on past due, secured loans until the principal and accrued interest equal the value of the collateral and on unsecured loans until the financial condition of the borrower deteriorates to the point that any further accrued interest would be determined to be uncollectible. 30 Notes to the Consolidated Financial Statements NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is charged to income over the estimated useful lives of the assets on a combination of the straight-line and accelerated methods. The ranges of the useful lives of the premises and equipment are as follows: Buildings and Improvements 10 - 40 years Furniture and Fixtures 5 - 20 years Maintenance, repairs, and minor improvements are charged to operations as incurred. Gains and losses on dispositions are reflected in other income or expense. Intangible Assets Core deposit intangibles are amortized on a straight-line basis over ten years. Core deposit intangibles, net of amortization amounted to $1,978,000 and $2,254,000 at December 31, 2003 and 2002, respectively. The Company adopted SFAS 147 on January 1, 2002 and determined that the core deposit intangible will continue to be amortized over the estimated useful life. Goodwill In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. SFAS No. 142 became effective for fiscal years beginning after December 15, 2001 and prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets will be subject to at least an annual impairment review and more frequently if certain impairment indicators are in evidence. SFAS No. 142 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill. The Company adopted SFAS No. 142 on January 1, 2002. Goodwill totaled $2,639,000 at December 31, 2003 and 2002. The goodwill is no longer amortized, but instead tested for impairment at least annually. Based on the testing, there were no impairment charges for 2003 or 2002. Application of the nonamortization provisions of the Statement resulted in additional net income of $192,000 and $190,000 for the years ended December 31, 2003 and 2002, respectively. Pension Plans Substantially all employees are covered by a pension plan. The net periodic pension expense includes a service cost component, estimated normal return on plan assets, and the effect of deferring and amortizing certain actuarial gains and losses. 31 Notes to the Consolidated Financial Statements NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Advertising Costs The Company follows the policy of charging the cost of advertising to expense as incurred. Total advertising costs included in other operating expenses for 2003, 2002 and 2001 were $139,749, $141,461 and $139,527 respectively. Income Taxes Amounts provided for income tax expense are based on income reported for financial statement purposes rather than amounts currently payable under income tax laws. Deferred taxes, which arise principally from temporary differences between the period in which certain income and expenses are recognized for financial accounting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes. Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities and gains or losses on certain derivative contracts, are reported as a separate component of the equity section of the balance sheet. Such items, along with operating net income, are components of comprehensive income. The components of other comprehensive income and related tax effects are as follows: Years Ended December 31, Changes in: 2003 2002 2001 Unrealized holding gain (loss) on interest rate swap $ $ 4,137 $ (30,106) Unrealized holding gains (losses) on available- for-sale securities 880,766 (1,141,553) 698,279 Reclassification adjustment for (gains) losses realized in income (178,618) 182,430 (1,252,500) ----------- ---------- ---------- Net Unrealized (Gains) Losses 702,148 (954,986) (584,327) Tax effect (210,780) 293,540 214,021 ----------- --------- ---------- Net Change $ 491,368 $ (661,446) $ (370,306) =========== ========= ========== Earnings Per Share Earnings per share are based on the weighted average number of shares outstanding. NOTE 3 CASH AND DUE FROM BANKS: The Bank is required to maintain average reserve balances based on a percentage of deposits. The average balance of cash, which the Federal Reserve Bank requires to be on reserve, was $ 1,962,000 and $1,475,000 for the years ended December 31, 2003 and 2002, respectively. 32 Notes to the Consolidated Financial Statements NOTE 4 INVESTMENT SECURITIES: The amortized cost and fair value of securities held to maturity are as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 2003 U. S. Treasuries and Agencies $ 110,035 $ 515 $ $ 110,550 Corporate bonds $ 762,943 $ 24,372 $ $ 787,315 ------------ ------------ ------------ ------------- Total Securities Held to Maturity$ 872,978 $ 24,887 $ $ 897,865 =========== =========== =========== ============ December 31, 2002 U. S. Treasuries and Agencies $ 110,000 $ $ $ 110,000 Corporate bonds 1,767,258 27,754 1,795,012 ----------- ----------- ------------ ------------ Total Securities Held to Maturity $ 1,877,258 $ 27,754 $ $ 1,905,012 =========== =========== =========== ============ The amortized cost and fair value of securities available for sale are as follows: December 31, 2003 U.S. Agencies $ 25,386,992 $ 65,617 $ 8,888 $ 25,443,721 Mortgage-backed obligations of federal agencies 9,004,266 7,010 21,901 8,989,375 Marketable equities 9,109,546 652,193 516,573 9,245,166 Municipals 375,000 2,427 372,573 Corporate bonds 10,660,326 207,447 23,088 10,844,685 ----------- ---------- ----------- ------------ Total Securities Available for Sale $ 54,536,130 $ 932,267 $ 572,877 $ 54,895,520 =========== ========== =========== ============ December 31, 2002 U.S. Treasuries and $ 38,023,227 $ 453,565 $ 1,834 $ 38,474,958 Agencies Mortgage-backed obligations of federal agencies 5,033,202 36,371 708 5,068,865 Marketable equities 9,103,662 488,951 1,566,930 8,025,683 Corporate bonds 11,088,828 263,682 14,000 11,338,510 ----------- ---------- ----------- ------------ Total Securities Available for Sale $ 63,248,919 $ 1,242,569 $ 1,583,472 $ 62,908,016 =========== =========== =========== ============
33 Notes to the Consolidated Financial Statements NOTE 4 INVESTMENT SECURITIES (CONTINUED): The amortized cost and fair value of securities at December 31, 2003, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities Held to Maturity Securities Available for Sale Amortized Fair Amortized Fair Cost Value Cost Value Due in one year or less $ 872,978 $ 897,865 $ 9,992,979 $10,093,471 Due after one year through five years 31,878,467 31,990,280 Due after five years 3,555,138 3,566,603 -------- -------- ---------- ---------- Total 872,978 897,865 45,426,584 45,650,354 Marketable equities 9,109,546 9,245,166 -------- -------- ---------- ---------- $ 872,978 $ 897,865 $54,536,130 $54,895,520 ======== ======== ========== ========== Realized gains and losses and the gross proceeds from the sale of debt securities were not material in 2003, 2002 or 2001. Gains and losses on marketable equity transactions are summarized below: 2003 2002 2001 ---- ---- ---- Gains 440,340 $ 318,354 $1,283,189 Losses 261,722 500,784 30,689 --------- -------- --------- Net Gains $ 178,618 $(182,430) $1,252,500 ======== ========= =========
Based on a review of its equities portfolio, the Company recognized an impairment of $503,000 in the carrying basis of five of its equity holdings as of December 31, 2002. This write down was a result of management's evaluation and determination that these assets met the definition for impairment under SFAS 115. The carrying value (which approximates fair value) of securities pledged by the Bank to secure deposits and for other purposes amounted to $16,550,000 at December 31, 2003 and $23,487,000 at December 31, 2002. The Company has pledged $4,314,000 of equity securities to secure the $3,667,000 in loans it has outstanding with SunTrust Bank (see note 10). Other investments consist of investments in nine low-income housing and historic equity partnerships (carrying basis of $3,532,487) and stock in the Federal Home Loan Bank, Community Bankers Bank, Federal Reserve Bank, Shenandoah Title, LLC, BI Investments, LLC and Virginia Bankers' Insurance Center, LLC (carrying basis of $1,928,829). The interests in the low-income housing and historic equity partnerships have limited transferability and the interests in the other stocks are restricted as to sales. The market values of these securities are estimated to approximate their carrying value as of December 31, 2003. During 2003, the Company recognized a loss in its investment in BI Investments of $100,000. This write down was the result of substantial losses incurred by BI Investments during its start up phase. At December 31, 2003, the Company was committed to invest an additional $2,555,974 in four low-income housing limited partnerships. These funds will be paid as requested by the general partner to complete the projects. This additional investment has been reflected in the above carrying basis and in accrued liabilities on the balance sheet. 34 Notes to the Consolidated Financial Statements NOTE 4 INVESTMENT SECURITIES (CONTINUED): The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the Company through readily saleable financial instruments. The portfolio includes fixed rate bonds, whose prices move inversely with rates, variable rate bonds and equity securities. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. In 2002, the Company wrote down several equity investments because of price deterioration that was not expected to improve in the near term. Bonds deteriorate in value due to credit quality of the individual issuer and declines in the price of the bonds as market rates rise. There are approximately 28 holdings in the consolidated portfolio that have losses. These losses are relative to the market rates and the timing of purchases and are not a material concern since they have moved up and down with the market. A summary of these losses is as follows:
Less than 12 Months More than 12 Months Total Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses U.S. Treasury & Agency $9,257,000 $ (32,000) $ $ $ 9,257,000 $ (32,000) Municipals 373,000 (2,000) 373,000 (2,000) Mortgage backed obligations 5,302,000 (22,000) 5,302,000 (22,000) Marketable Equities 1,093,000 (21,000) 2,924,000 (414,000) 4,017,000 (435,000) ---------- -------- ----------- -------- --------- -------- Total $16,025,000 $ (77,000) $ 2,924,000 $(414,000) $18,949,000 $(491,000) ========== ======== =========== ======== ========== ========
NOTE 5 LOANS: Loans outstanding as of December 31 are summarized as follows: 2003 2002 Real Estate Construction $ 15,328,810 $ 12,059,185 Mortgage 118,677,266 118,453,009 Commercial and agricultural 55,999,652 47,218,287 Installment 19,630,461 22,703,677 Credit cards 1,463,329 1,477,436 Other 131,574 68,248 ----------- ----------- Total $211,231,092 $201,979,842 =========== =========== 35 Notes to the Consolidated Financial Statements NOTE 5 LOANS (CONTINUED): At December 31, 2003 and 2002, the recorded investment in loans which have been identified as impaired loans, in accordance with Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (SFAS 114), totaled $3,407,000 and $2,719,000, respectively. The valuation allowance related to impaired loans on December 31, 2003 and 2002 is $395,000 and $387,000, respectively, At December 31, 2003, 2002 and 2001, the average investment in impaired loans was $3,075,000, $4,004,000 and $5,225,000, respectively. The amount of interest income recorded by the Company during 2003, 2002 and 2001 on impaired loans was approximately $215,000, $305,000 and $449,000, respectively. There were no nonaccrual loans excluded from impaired loan disclosure at December 31, 2003 or December 31, 2002 The Company has pledged mortgage loans as collateral for borrowings with the Federal Home Loan Bank of Atlanta totaling $25,004,804 and $32,914,047 as of December 31, 2003 and 2002, respectively. NOTE 6 ALLOWANCE FOR LOAN LOSSES: A summary of changes in the allowance for loan losses is shown in the following schedule: 2003 2002 2001 Balance, beginning of year $1,477,007 $1,288,506 $1,107,917 Other adjustments 84,000 Provision charged to operating expenses 226,000 387,000 204,000 Loan recoveries 75,955 100,985 52,848 Loans charged off (295,295) (299,484) (160,259) ---------- ---------- --------- Balance, end of year $1,483,667 $1,477,007 $1,288,506 ========= ========= ========= Percentage of gross loans .70% .73% .73% NOTE 7 BANK PREMISES AND EQUIPMENT: Bank premises and equipment as of December 31 are summarized as follows: 2003 2002 Land $ 644,440 $ 549,723 Buildings and improvements 4,569,581 4,090,723 Furniture and equipment 3,259,321 2,973,131 ---------- ---------- 8,473,342 7,613,577 Less - accumulated depreciation (3,472,049) (3,127,764) ----------- ---------- Net $ 5,001,293 $ 4,485,813 ========== ========== Provisions for depreciation of $429,717 in 2003, $347,687 in 2002, and $ 308,152 in 2001 were charged to operations. 36 Notes to the Consolidated Financial Statements NOTE 8 TIME DEPOSITS: At December 31, 2003, the scheduled maturities of time deposits are as follows: 2004 $ 67,913,958 2005 19,141,511 2006 12,195,917 2007 11,948,702 Thereafter 10,971,117 ----------- Total $122,171,205 NOTE 9 SHORT-TERM DEBT: Short-term borrowings consist of the following at December 31, 2003 and 2002 (dollars in thousands): 2003 2002 Securities sold under agreements to repurchase $6,037,124 $8,286,715 Other short-term borrowings 351,834 21,667 --------- --------- Total $6,388,958 $8,308,382 ========= ========= Weighted interest rate .64% .72% Average for the year ended December 31: Outstanding $7,236,999 $8,496,601 Interest rate .64% 1.23% Maximum month-end outstanding $9,039,633 $1,375,268 Short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. Short-term borrowings may also include Federal funds purchased, which are unsecured overnight borrowings from other financial institutions and margin borrowings secured by investment securities. As of December 31, 2003, the Company had lines of credit with correspondent banks totaling $18,864,000, which are used in the management of short-term liquidity. NOTE 10 LONG-TERM DEBT: New borrowings from the Federal Home Loan Bank of Atlanta (FHLB) were zero in 2003 and $15,000,000 in 2002 and $13,000,000 in 2001. The interest rates on the notes payable are fixed at the time of the advance and range from 4.02% to 5.33%; the weighted average interest rate is 4.61% at December 31, 2003. The balance of this obligation at December 31, 2003 was $21,117,540. During 2001, the Company paid $358,955 in prepayment penalties to refinance portions of this debt. These penalties were expensed in 2001 when paid. The long-term debt is secured by qualifying mortgage loans owned by the Company. The Company borrowed $4,000,000 of long-term debt in March 2001 and an additional $3,000,000 of long-term debt in September 2002. Both loans were made by SunTrust Bank. Of these borrowings, $6,000,000 was used as contributed capital to the Bank, $900,000 was used to payoff a loan from the Bank for securities purchases and the balance was used for working capital needs. The combined outstanding balance at December 31, 2003 was $3,666,667 with quarterly principal payments of $333,333 for two quarters, followed by principal payments of $230,769 over the next thirteen quarters. The interest rate is a floating rate of LIBOR plus 1.10%, adjustable monthly. 37 Notes to the Consolidated Financial Statements NOTE 10 LONG-TERM DEBT (CONTINUED): Repayments of long-term debt are due either quarterly or semi-annually and interest is due monthly. Interest expense of $1,245,531, $1,371,774, and $1,488,569, was incurred on these debts in 2003, 2002, and 2001, respectively. The maturities of long-term debt as of December 31, 2003 are as follows: 2004 $ 8,553,462 2005 7,117,560 2006 5,615,933 2007 2,104,395 2008 1,035,714 Thereafter 357,143 ----------- Total $ 24,784,207 =========== NOTE 11 INCOME TAX EXPENSE: The components of the income tax expense are as follows: 2003 2002 2001 ------------------------ ------- Current expense Federal $1,456,019 $1,554,685 $1,448,500 State 30,280 Deferred benefit Federal 210,305 (240,106) (43,982) -------- --------- --------- Total Income Tax Expense $1,666,324 $1,314,579 $1,434,798 ========= ========= ========= Amounts in above arising from gains (losses) on security transactions $ 60,730 $ (96,711) $ 455,188 ========= ======== ======== The deferred tax effects of temporary differences are as follows: 2003 2002 2001 ------------------------ ------- Tax Effects of Temporary Differences: LIH Partnership Losses $15,223 $ 7,944 $ 19,107 Securities impairment 55,334 (171,032) Provision for loan losses (225) $ (62,050) (30,800) Split dollar life insurance 60,576 30,780 (10,629) Non-qualified deferred compensation (43,810) (41,612) (52,147) Depreciation 43,405 44,271 39,177 Core deposit amortization (33,113) (33,113) Pension expense 117,133 (13,611) (1,736) Other (4,218) (1,683) (6,954) ------- --------- --------- Deferred Income Tax Expense ( Benefit) $210,305 $ (240,106) $(43,982) ======= ============ ======= 38 Notes to the Consolidated Financial Statements NOTE 11 INCOME TAX EXPENSE (CONTINUED): The components of the deferred taxes as of December 31 are as follows: 2003 2002 Deferred Tax Assets: Allowance for loan losses $ 350,133 $ 349,908 Split dollar life insurance 13,647 74,224 Nonqualified deferred compensation 271,632 226,261 Securities impairment 115,696 171,032 Core deposit amortization 66,227 33,113 State historic tax credits 66,766 99,591 Securities available for sale 90,372 Other 8,844 21,917 ---------- --------- Total Assets $ 892,945 $1,066,418 --------- ----------- Deferred Tax Liabilities: Securities available for sale $ 137,550 $ Unearned low income housing credits 553,478 450,157 Depreciation 238,029 185,856 Pension 227,385 110,252 Other 27,971 21,210 ---------- --------- Total Liabilities 1,184,413 767,475 ---------- --------- Deferred Tax Asset (Liability) $ (291,468) $ 298,943 =========== ========= The following table summarizes the differences between the actual income tax expense and the amounts computed using the federal statutory tax rates: 2003 2002 2001 Tax expense at federal statutory rates $1,930,732 $1,638,281 $1,586,212 Increases (decreases) in taxes resulting from: State income taxes, net 9,042 (16,421) 31,613 Partially exempt income (155,416) (141,923) (134,909) Tax-exempt income (116,043) (68,507) (79,739) Other (1,991) (96,851) 31,621 -------- --------- -------- Total Income Tax Expense $1,666,324 $1,314,579 $1,434,798 ========= ========= ========= 39 Notes to the Consolidated Financial Statements NOTE 12 EMPLOYEE BENEFITS: The Bank participates in the Virginia Bankers' Association Master Defined Benefit Pension Plan and Trust. Substantially all bank employees are covered by the plan. Benefits are based upon the participant's length of service and annual earnings with vesting of benefits after five years of service. Plan assets consist primarily of investments in stocks and bonds. Pension expense totaled $290,970, $189,215, and $140,622 for 2003, 2002, and 2001, respectively and reflects the lower returns on investments in the last three years. The Company sponsors an employee stock ownership plan which provides stock ownership to substantially all employees of the Bank. The Plan provides total vesting upon the attainment of five years of service. Contributions to the plan are made at the discretion of the Board of Directors and are allocated based on the compensation of each employee relative to total compensation paid by the Bank. All shares issued and held by the Plan are considered outstanding in the computation of earnings per share. Dividends on Company stock are allocated and paid to participants at least annually. Shares of Company stock, when distributed, have restrictions on transferability. The Company contributed $208,000 in 2003, $190,000 in 2002, and $155,250 in 2001 to the Plan and charged this expense to operations. NOTE 13 CONCENTRATIONS OF CREDIT: The Company had cash deposits in other commercial banks totaling $11,758,833 and $10,165,063 at December 31, 2003 and 2002, respectively. The Company grants commercial, residential real estate and consumer loans to customers located primarily in the northwestern portion of the State of Virginia. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the agribusiness economic sector, specifically the poultry industry for which loans outstanding total $8,737,000. Collateral required by the Company is determined on an individual basis depending on the purpose of the loan and the financial condition of the borrower. Approximately 70% of the loan portfolio is secured by real estate. NOTE 14 COMMITMENTS: The Company makes commitments to extend credit in the normal course of business and issues standby letters of credit to meet the financing needs of its customers. The amount of the commitments represents the Company's exposure to credit loss that is not included in the balance sheet. As of the balance sheet dates, the Company had the following commitments outstanding: 2003 2002 ------------ -------- Commitments to loan money $41,616,194 $51,315,690 Standby letters of credit 1,901,520 594,840 The Company uses the same credit policies in making commitments to lend money and issue standby letters of credit as it does for the loans reflected in the balance sheet. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case by case basis. Collateral required, if any, upon extension of credit is based on management's credit evaluation of the borrower's ability to pay. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment. 40 Notes to the Consolidated Financial Statements NOTE 15 TRANSACTIONS WITH RELATED PARTIES: During the year, officers and directors (and companies controlled by them) were customers of and had transactions with the Company in the normal course of business. These transactions were made on substantially the same terms as those prevailing for other customers and did not involve any abnormal risk. Loan transactions with related parties are shown in the following schedule: 2003 2002 Total loans, beginning of year $ 2,882,127 $ 1,783,345 Designation of new executive officers 216,384 New loans 2,423,879 2,226,099 Repayments (1,362,566) (1,343,701) ---------- ----------- Total loans, end of year $ 3,943,440 $ 2,882,127 ========== ========== NOTE 16 DIVIDEND LIMITATIONS ON SUBSIDIARY BANK: The principal source of funds of F & M Bank Corp. is dividends paid by the Farmers and Merchants Bank. The Federal Reserve Act restricts the amount of dividends the Bank may pay. Approval by the Board of Governors of the Federal Reserve System is required if the dividends declared by a state member bank, in any year, exceed the sum of (1) net income of the current year and (2) income net of dividends for the preceding two years. As of January 1, 2004, approximately $1,965,000 was available for dividend distribution without permission of the Board of Governors. Dividends paid by the Bank to the Company totaled $2,930,000 in 2003, $1,760,000 in 2002 and $954,000 in 2001. NOTE 17 LITIGATION In the normal course of business, the Company may become involved in litigation arising from banking, financial, or other activities of the Company. Management after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Company's financial condition, operating results or liquidity. NOTE 18 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS: Statement of Financial Accounting Standards No. 107 (SFAS 107) "Disclosures about the Fair Value of Financial Statements" defines the fair value of a financial instrument as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced liquidation or sale. As the majority of the Bank's financial instruments lack an available trading market, significant estimates, assumptions and present value calculations are required to determine estimated fair value. 41 Notes to the Consolidated Financial Statements NOTE 18 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED: Estimated fair value and the carrying value of financial instruments at December 31, 2003 and 2002 are as follows (in thousands): 2003 2002 Estimated Carrying Estimated Carrying Fair Value Value Fair Value Value Financial Assets Cash $ 5,665 $ 5,665 $ 6,017 $ 6,017 Interest bearing deposits 9,019 9,003 5,873 5,886 Federal funds sold 5,035 5,035 4,476 4,476 Securities available for sale 54,896 54,896 62,908 62,908 Securities held to maturity 898 873 1,905 1,877 Other investments 5,461 5,461 4,816 4,816 Loans 217,842 211,231 208,022 201,980 Bank owned life insurance 4,832 4,832 2,303 2,303 Accrued interest receivable 1,496 1,496 1,655 1,655 Financial Liabilities Demand Deposits: Non-interest bearing 33,124 33,124 29,446 29,446 Interest bearing 37,875 37,875 34,134 34,134 Savings deposits 47,545 47,545 41,661 41,661 Time deposits 124,750 122,171 125,186 123,042 Accrued liabilities 4,919 4,919 4,703 4,703 Short-term debt 6,389 6,389 8,308 8,308 Long-term debt 25,427 24,784 33,181 32,312 The carrying value of cash and cash equivalents, other investments, deposits with no stated maturities, short-term borrowings, and accrued interest approximate fair value. The fair value of securities was calculated using the most recent transaction price or a pricing model, which takes into consideration maturity, yields and quality. The remaining financial instruments were valued based on the present value of estimated future cash flows, discounted at various rates in effect for similar instruments during the month of December 2003. NOTE 19 REGULATORY MATTERS: The Company and its subsidiary 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 additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. 42 Notes to the Consolidated Financial Statements NOTE 19 REGULATORY MATTERS (CONTINUED): Quantitative measures established by regulation, to ensure capital adequacy, require the Company to maintain minimum amounts and ratios. These ratios are defined in the regulations and the amounts are set forth in the table below. Management believes, as of December 31, 2003, that the Company and its subsidiary bank meet all capital adequacy requirements to which they are subject. As of the most recent notification from the Bureau of Financial Institutions (which was April 3, 2003), the subsidiary bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company must maintain minimum total risk based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Company's actual capital ratios are presented in the following table: Actual Regulatory Requirements December 31, Adequately Well 2003 2002 Capitalized Capitalized Total risk-based ratio 14.72% 14.48% 8.00% 10.00% Tier 1 risk-based ratio 13.97% 13.67% 4.00% 6.00% Total assets leverage ratio 9.00% 8.76% 3.00% 5.00% NOTE 20 BRANCH ACQUISITIONS: On February 23, 2001, the Company closed on its purchase of the Edinburg and Woodstock branches from First Union. The acquisition included deposits totaling $37,244,000, and loans totaling $9,800,000. The Woodstock facility was also purchased at a cost of $625,000, while the Edinburg facility is leased. Equipment and fixtures acquired as part of the transaction totaled $54,893. The core deposit intangibles and goodwill totaled $5,472,153. These core deposit intangible costs are being amortized using the straight-line method over a ten-year period. NOTE 21 INVESTMENT IN LIFE INSURANCE CONTRACTS The Bank currently offers a variety of benefit plans to all full time employees. While the costs of these plans are generally tax deductible to the Bank, the cost has been escalating greatly in recent years. In order to attract and retain good employees, the Bank has determined that additional benefits are necessary. To help offset the growth in these costs, the Bank decided to enter into the BOLI contracts. Dividends received on these policies are tax-deferred and the death benefits under the policies are tax exempt. Rates of return on a tax-equivalent basis are very favorable when compared to other long-term investments which the Bank might make. 43 Notes to the Consolidated Financial Statements NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS: Balance Sheets December 31, ASSETS 2003 2002 ------------- -------- Cash and cash equivalents $ 617,457 $ 292,501 Investment in subsidiaries 26,859,841 26,476,470 Securities available for sale 8,877,366 7,470,322 Limited partnership investments 3,532,487 2,794,715 Due from subsidiaries 190,354 Income tax receivable 215,109 Other real estate 307,891 Interest receivable 3,073 Deferred income taxes 139,306 --------- ----------- Total Assets $39,890,224 $37,886,668 ========== ========== LIABILITIES Notes payable $ 3,666,667 $ 5,000,000 Margin payable 317,511 Accrued interest payable 25,086 46,091 Due to subsidiaries 83,455 Other liabilities 10,449 33,450 Dividends payable 436,046 412,025 Demand obligations for low income housing investment 2,555,974 2,853,922 Deferred income taxes 475,869 ---------- ---------- Total Liabilities 7,571,057 8,345,488 ---------- ---------- STOCKHOLDERS' EQUITY Common stock par value $5 per share, 3,000,000 shares authorized, 2,420,478 and 2,423,678 shares issued and outstanding for 2003 and 2002, respectively 12,102,390 12,118,390 Capital surplus 286,330 302,795 Retained earnings 19,709,562 17,390,478 Accumulated other comprehensive income (loss) 220,885 (270,483) ---------- ---------- Total Stockholders' Equity 32,319,167 29,541,180 ---------- ---------- Total Liabilities and Stockholders' Equity $39,890,224 $37,886,668 ========== ========== 44 Notes to the Consolidated Financial Statements Statements of Net Income and Retained Earnings Years Ended December 31, 2003 2002 2001 ---------------------------- --------- INCOME Dividends from affiliate $2,930,000 $ 1,760,000 $ 954,000 Interest on loans 8,489 Investment income 180 100 11,621 Dividend income 366,892 408,817 382,108 Security gains (losses) 275,943 (307,480) 1,160,235 Net limited partnership income 62,351 20,915 81,361 Other 78,326 2,960 20,537 --------- ---------- --------- Total Income 3,713,692 1,885,312 2,618,351 --------- ---------- --------- EXPENSES Interest expense 127,087 189,915 194,488 Administrative expenses 137,081 132,787 119,167 --------- ---------- --------- Total Expenses 264,168 322,702 313,655 --------- ---------- --------- Net income before income tax expense (benefit) and undistributed subsidiary net income 3,449,524 1,562,610 2,304,696 INCOME TAX EXPENSE (BENEFIT) 120,229 (208,706) 384,990 --------- ----------- --------- Income before undistributed subsidiary net income 3,329,295 1,771,316 1,919,706 Undistributed subsidiary net income 683,004 1,732,579 1,310,824 --------- ---------- --------- NET INCOME 4,012,299 3,503,895 3,230,530 Retained earnings, beginning of year 17,390,478 15,488,406 13,790,628 Dividends on common stock (1,693,215) (1,601,823) (1,532,752) ----------- ----------- ---------- Retained Earnings, End of Year $19,709,562 $17,390,478 $15,488,406 ========== ========== ========== 45 Notes to the Consolidated Financial Statements Statements of Cash Flows Years Ended December 31, 203 2002 2001 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $4,012,299 $ 3,503,895 $3,230,530 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed subsidiary income (683,004) (1,732,579) (1,310,824) Gain (Loss) on sale of securities (275,943) 307,480 (1,160,235) Deferred tax (benefit) expense 71,515 (148,606) 49,387 Decrease (increase) in interest receivable (3,073) 736 Decrease (increase) in due from subsidiary 190,353 (174,356) 52,764 Decrease in other receivables 215,109 3,182 29,795 Increase in due to subsidiary 116,280 Increase (decrease) in other liabilities (18,089) 14,039 39,530 Increase in deferred tax credits 103,321 96,179 65,537 Amortization of limited partnership investments 262,227 255,850 218,804 Securities amortization 17,109 Gain on sale of land (95,434) (20,537) ---------- ---------- --------- Net Cash Provided by Operating Activities 3,912,670 2,125,084 1,195,487 ---------- ----------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital contributed to subsidiary (2,000,000) 6,000,000) Proceeds from sales of securities available for sale 1,849,509 4,377,753 2,695,063 Proceeds from maturity of securities available for sale 298 Purchase of securities available for sale (1,825,119) (2,977,153) (1,273,759) Investments in low income housing partnerships (1,297,948) (14,152) (33,692) Proceeds from sale of real estate 403,325 138,775 Decrease in loans receivable 194,902 ----------- --------- --------- Net Cash Used in Investing Activities (870,233) (613,552) (4,278,413) ------------ --------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds of long-term debt 3,000,000 5,000,000 Payments on long-term debt (1,333,333) (2,333,333) (666,667) Increase (decrease) in short-term debt 317,511 (198,260) 198,260 Payments to repurchase common stock (264,434) (296,645) (83,753) Proceeds from issuance of common stock 208,000 155,250 Dividends paid in cash (1,645,225) (1,580,138) (1,507,418) ----------- ---------- ---------- Net Cash Provided by (Used in) Financing Activities (2,717,481) (1,408,376) 3,095,672 ---------- ----------- ---------- Net Increase in Cash and Cash Equivalents 324,956 103,156 12,746 Cash and Cash Equivalents, Beginning of Year 292,501 189,345 176,599 ---------- ---------- ---------- Cash and Cash Equivalents, End of Year $ 617,457 $ 292,501 $ 189,345 ========= ========== ========= 46 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors F & M Bank Corp. Timberville, Virginia We have audited the accompanying consolidated balance sheets of F & M Bank Corp. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the three years ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of F & M Bank Corp. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the three years ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. S. B. Hoover & Company, L.L.P. February 24, 2004 Harrisonburg, Virginia 47 Item 1 Other Material Required by Form 10-K BUSINESS General F & M Bank Corp., incorporated in Virginia in 1983, is a one-bank holding company pursuant to section 3(a)(1) of the Bank Holding Company Act of 1956, and owns 100% of the outstanding stock of its two affiliates, Farmers & Merchants Bank (Bank) and TEB Life Insurance Company (TEB). Farmers & Merchants Financial Services, Inc. (FMFS) is a wholly owned subsidiary of Farmers & Merchants Bank. Farmers & Merchants Bank was chartered on April 15, 1908, as a state chartered bank under the laws of the Commonwealth of Virginia. TEB was incorporated on January 27, 1988, as a captive life insurance company under the laws of the State of Arizona. FMFS is a Virginia chartered corporation and was incorporated on February 25, 1993. The Bank offers all services normally offered by a full-service commercial bank, including commercial and individual demand and time deposit accounts, repurchase agreements for commercial customers, commercial and individual loans, and drive-in banking services. TEB was organized to re-insure credit life and accident and health insurance currently being sold by the Bank in connection with its lending activities. FMFS was organized to write title insurance but now provides other financial services to customers of Farmers & Merchants Bank. The Bank makes various types of commercial and consumer loans and has a heavy concentration of residential and agricultural real estate loans. The Bank experienced moderate loan demand in 2003 but at a lesser pace than in prior years. The local economy is relatively diverse with strong employment in the agricultural, manufacturing, service and governmental sectors. On December 31, 2003, F & M Bank Corp., the Bank, TEB and FMFS had 97 full-time and part-time employees. No one employee devotes full-time services to F&M Bank Corp. The Company's and the Bank's principal executive office is at 205 South Main Street, Timberville, VA 22853, and its phone number is (540) 896-8941. Competition The Bank's offices compete with approximately sixteen financial institutions. These other institutions include state and nationally chartered banks, nationally chartered savings banks and several credit unions. The main office and the Broadway branch serve the northern portion of Rockingham County, Virginia and the southwestern portion of Shenandoah County. The Elkton branches serve the town of Elkton, the eastern portion of Rockingham County, and the southern portion of Page County. The Bridgewater office serves the town of Bridgewater, the southern portion of Rockingham County and the northwestern portion of Augusta County. The offices in Shenandoah County serve the towns of Edinburg and Woodstock and the surrounding areas. Bank competition in the area of all offices is very strong. 48 Other Material Required by Form 10-K Regulation and Supervision The operations of F & M Bank Corp. and the Bank are subject to federal and state statutes, which apply to state member banks of the Federal Reserve System. The stock of F & M Bank Corp. is subject to the registration requirements of the Securities Act of 1934. F & M Bank Corp. is subject to the periodic reporting requirements of the Securities Exchange Act of 1934. These include, but are not limited to, the filing of annual, quarterly and other current reports with the Securities and Exchange Commission. As an Exchange Act reporting company, the Corporation is directly affected by the Sarbanes-Oxley Act of 2002, which is aimed at improving corporate governance and reporting procedures. The Corporation is complying with new SEC and other rules and regulations implemented pursuant to Sarbanes-Oxley and intends to comply with any applicable rules and regulations implemented in the future. F & M Bank Corp., as a bank holding company, is subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "Act"). It is registered as such and is supervised by the Federal Reserve Board. The Act requires F & M Bank Corp. to secure the prior approval of the Federal Reserve Board before F & M Bank Corp. acquires ownership or control of more than 5% of the voting shares or substantially all of the assets of any institution, including another bank. As a bank holding company, F & M Bank Corp. is required to file with the Federal Reserve Board an annual report and such additional information as it may require pursuant to the Act. The Federal Reserve Board may also conduct examinations of F & M Bank Corp. and any or all of its subsidiaries. Under Section 106 of the 1970 Amendments to the Act and the regulations of the Federal Reserve Board, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with an extension of credit, provision of credit, sale, or lease of property or furnishing of services. Federal Reserve Board regulations permit bank holding companies to engage in non-banking activities closely related to banking or to managing or controlling banks. These activities include the making or servicing of loans, performing certain data processing services, and certain leasing and insurance agency activities. TEB Life acts as the primary re-insurer for credit life insurance sold through the Bank. F & M Bank Corp. owns an interest in the Johnson Williams Project in Berryville, Virginia which provides housing for the elderly and lower income tenants. Since 1994, the Company has entered into agreements with the Virginia Community Development Corporation to purchase equity positions in the Housing Equity Fund of Virginia II, III, IV, V, VII, VIII, IX and Historic Equity Fund I. These funds provide housing for low-income individuals throughout Virginia. Approval of the Federal Reserve Board is necessary to engage in any of the activities described above or to acquire interests engaging in these activities. The Bank as a state member bank is supervised and regularly examined by the Virginia Bureau of Financial Institutions and the Federal Reserve Board. Such supervision and examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Board is intended primarily for the protection of depositors and not for the stockholders of F & M Bank Corp. The information required by Guide 3 has been included under Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. 49 Item 2 Description of Properties The locations of F & M Bank Corp., Inc. and its subsidiaries are shown below. Timberville Main Office Elkton Branch 205 South Main Street 127 West Rockingham Street Timberville, VA 22853 Elkton, VA 22827 Broadway Branch Elkton Plaza Branch 126 Timberway Rt. 33 West Broadway, VA 22815 Elkton, VA 22827 Bridgewater Branch Edinburg Branch 100 Plaza Drive 120 South Main Street Bridgewater, VA 22812 Edinburg, VA 22824 Woodstock Branch Harrisonburg Office 161 South Main Street (Mortgage Origination & Investment Woodstock, VA 22664 Sales) 207 University Blvd, Suite 100 Harrisonburg, VA 22801 With the exception of the Edinburg Branch and the Harrisonburg Office, all facilities are owned by Farmers & Merchants Bank. ATMs are available at all branch locations, with the exception of the Edinburg Branch. Through an agreement with Nationwide Money ATM Services, the Bank also operates cash only ATMs at eight Food Lion grocery stores, one in Mt. Jackson, VA, four in Harrisonburg, VA, three in Charlottesville, VA and one ATM at a convenience store in Edinburg, VA. Item 9A Controls and Procedures Under the supervision and with the participation of the Company's management, including the chief executive officer and chief financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, the chief executive officer and chief financial officer have concluded that these controls and procedures are effective. There were no significant changes in the internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to management of the Company, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. 50 Item 15 - Exhibits, Financial Statements, and Reports on Form 8-K The following financial statements are filed as a part of this report: (a)(1) Financial Statements The following consolidated financial statements and reports of independent auditors of the Company are in Part II, Item 8 on pages 24 thru 45: Consolidated Balance Sheets - December 31, 2003 and 2002 24 Consolidated Statements of Income - Years ended December 31, 2003, 2002 and 2001 25 Consolidated Statements of Stockholders' Equity - Years ended December 31, 2003, 2002 and 2001 26 Consolidated Statements of Cash Flows - Years ended December 31, 2003, 2002 and 2001 27 Notes to the Consolidated Financial Statements 28 Report of the Independent Auditors 46 (a)(2) Financial Statement Schedules All schedules are omitted since they are not required, are not applicable, or the required information is shown in the consolidated financial statements or notes thereto. (a)(3) Exhibits The following exhibits are filed as a part of this form 10-K and this list includes the Exhibit index: Exhibit No. 3.1 Restated Articles of Incorporation of F & M Bank Corp. as incorporated by reference to F & M Bank Corp.'s 10-K filed March 8, 2002. 3.2 Amended and Restated Bylaws of F & M Bank Corp. as incorporated by reference to F & M Bank Corp.'s 10-K filed March 8, 2002. 21.0 Subsidiaries of the Registrant 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8K The Corporation did not file any reports on Form 8-K for the quarter ending December 31, 2003. Shareholders may obtain, free of charge, a copy of the exhibits to this Report on Form 10-K by writing Larry A. Caplinger, Corporate Secretary, at F & M Bank Corp., P.O. Box 1111, Timberville, VA 22853 or our website at www.farmersandmerchants.biz. 51 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. F & M Bank Corp. (Registrant) By: /s/ Julian D. Fisher March 25, 2004 --------------------------- ------------------------- Julian D. Fisher Date Director, President and Chief Executive Officer By: /s/ Neil W. Hayslett March 25, 2004 --------------------------- ------------------------- Neil W. Hayslett Date Senior Vice President and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and as of the date indicated. Signature Title Date /s/ Thomas L. Cline Director March 25, 2004 - ----------------------------- ---------------- Thomas L. Cline Director - ----------------------------- ---------------- John N. Crist /s/ Ellen R. Fitzwater Director March 25, 2004 - ----------------------------- ---------------- Ellen R. Fitzwater /s/ Robert L. Halterman Director March 25, 2004 - ----------------------------- ---------------- Robert L. Halterman /s/ Daniel J. Harshman Director March 25, 2004 - ----------------------------- --------------- Daniel J. Harshman Director, Chairman - ----------------------------- ---------------- Lawrence H. Hoover, Jr Director - ----------------------------- ---------------- Richard S. Myers Director - ------------------------------ ---------------- Michael W. Pugh /s/ Ronald E. Wampler Director March 25, 2004 - ------------------------------ --------------- Ronald E. Wampler EX-21 3 fmexhibit212003.txt F & M BANK CORP EXHIBIT 21 1 Exhibit 21 - List of Subsidiaries of the Registrant Farmers & Merchants Bank (incorporated in Virginia) TEB Life Insurance Company (incorporated in Arizona) Farmers & Merchants Financial Services (incorporated in Virginia), a subsidiary of Farmers & Merchants Bank EX-31 4 fmexhibit3112003.txt F & M BANK CORP EXHIBIT 31.1 1 Exhibit 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 (Chapter 63, Title 18 USC Section 1350 (A) and (B) I, Julian D. Fisher, certify that: 1. I have reviewed this annual report on Form 10-K of F & M Bank Corp.; 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)) 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) 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 as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers 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 function): (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 controls over financial reporting. Date: March 25, 2004 /s/ Julian D. Fisher ------------------------------------- Julian D. Fisher President and Chief Executive Officer A signed original of this written statement required by Section 302 of the Sarbanes-Oxley Act of 2002 has been provided to F & M Bank Corp. and will be retained by F & M Bank Corp. and furnished to the Securities and Exchange Commission or its staff upon request. EX-31 5 fmexhibit3122003.txt F & M BANK CORP EXHIBIT 31.2 1 Exhibit 31.2 CERTIFICATION CHIEF FINANCIAL OFFICER Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 (Chapter 63, Title 18 USC Section 1350 (A) and (B) I, Neil W. Hayslett, certify that: 1. I have reviewed this annual report on Form 10-K of F & M Bank Corp.; 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)) 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) 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 as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers 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 function): (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 controls over financial reporting. Date: March 25, 2004 /s/ Neil W. Hayslett ------------------------------- Neil W. Hayslett Senior Vice President and Chief Financial Officer A signed original of this written statement required by Section 302 of the Sarbanes-Oxley Act of 2002 has been provided to F & M Bank Corp. and will be retained by F & M Bank Corp. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 6 fmexhibit3212003.txt F & M BANK CORP EXHIBIT 32.1 1 Exhibit 32.1 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 Annual Report of F & M Bank Corp. (the "Company") on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned Chief Executive Officer and Chief Financial Officer of the Company hereby certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002 that based on their knowledge and belief: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the periods covered in the Report. /s/ Julian D. Fisher - ------------------------------------------------- Julian D. Fisher President & Chief Executive Officer March 25, 2004 /s/ Neil W. Hayslett - ------------------------------------------------- Neil W. Hayslett Senior Vice President & Chief Financial Officer March 25, 2004 -----END PRIVACY-ENHANCED MESSAGE-----