Exhibit 13
================================================================================
Farmers & Merchants
Bancorp
2000
Annual
Report
================================================================================
28
To the Shareholders:
It is with great pleasure and tremendous pride that we present to you Farmers &
Merchants Bancorp's annual financial reports for 2000; a record year in the
Institution's 84-year history. Throughout 2000, the Board of Directors and
management team remained steadfast in their longstanding commitment to maximize
Shareholder value, exceed customers' expectations, reinvest in the communities
served and foster employee commitment and satisfaction. Our emphasis on
increasing market penetration, improving operating efficiency and increasing
capital management discipline also contributed to the strong financial results
in 2000.
We are pleased to report that 2000 was the most profitable and successful year
in Farmers & Merchants Bancorp's history. Net income after taxes totaled
$11,020,000, a 19.6% increase over the prior year. The growth in profits was
driven by an 11.2% increase in net interest income, a 17.5% surge in non-
interest income and aggressive cost containment measures which limited the
growth in total expenses to only 1.95%. Loans outstanding grew by 20% and
deposits expanded by 11.6% contributing to the jump in net interest income.
Other key financial yardsticks also showed significant improvement. Operating
leverage continued to strengthen as the revenue growth rate exceeded the growth
rate of expenses. In 2000, we achieved a 7.93% spread between revenue and
expense growth, up from 4.3% in 1999. We also continued to exercise the "Common
Stock Repurchase" program originally approved by Shareholders and employed in
1998. As a result, return on equity increased by 184 basis points over the prior
year.
In the future, Management will remain focused on increasing market penetration,
improving operating leverage and further strengthening capital management
discipline. Efforts to enhance our delivery and distribution capabilities will
be ongoing. In June 2001, we will convert our data processing to a state-of-the-
art core operating system. The new computer system will further enhanced our
ability to service customers and enable us to offer several new and improved
products and services. In addition, expanding the Bank's presence in key markets
in order to capitalize on growth opportunities is being evaluated. It is also
important to note that the Board of Directors and management are anticipating
and preparing for greater financial performance challenges in 2001 and 2002 due
to the slowing economy, the Federal Reserve Bank's decision to reduce interest
rates, weak agricultural commodity prices and the current disruption and
imbalance in California's energy supplies.
We deeply appreciate the significant contributions made by the Board of
Directors during 2000. We also wish to acknowledge the Directors' ongoing
commitment to represent the Shareholders' best interests. The record 2000
financial performance would not have been possible without the Bank employees'
extraordinary accomplishments. We are proud of our loyal and talented staff and
extend a special "thank you" for their outstanding results in 2000.
The support provided by our Shareholders has always been a major source of
strength for the Bank. Your continued confidence and satisfaction with your
investment in Farmers & Merchants Bancorp remains of the utmost importance to
us. Please remember that you can help to strengthen your investment by
recommending Farmers & Merchants Bank to your friends, associates and new
acquaintances.
/s/ Kent A. Steinwert /s/ Ole R. Mettler
Kent A. Steinwert Ole R. Mettler
President & Chief Executive Officer Chairman of the Board
29
Report of Management
The management of Farmers & Merchants Bancorp (the Company) and its subsidiary
has the responsibility for the preparation, integrity and reliability of the
consolidated financial statements and related financial information contained in
this annual report. The financial statements were prepared in accordance with
generally accepted accounting principles and prevailing practices of the banking
industry. Where amounts must be based on estimates and judgments, they represent
the best estimates and judgments of management.
Management has established and is responsible for maintaining an adequate
internal control structure designed to provide reasonable, but not absolute,
assurance as to the integrity and reliability of the financial statements,
safeguarding of assets against loss from unauthorized use or disposition and the
prevention and detection of fraudulent financial reporting. The internal
control structure includes: an effective financial accounting environment; a
comprehensive internal audit function; an independent audit committee of the
Board of Directors; and extensive financial and operating policies and
procedures. Management also recognizes its responsibility for fostering a
strong ethical climate which is supported by a code of conduct, appropriate
levels of management authority and responsibility, an effective corporate
organizational structure and appropriate selection and training of personnel.
The Board of Directors, primarily through its audit committee, oversees the
adequacy of the Company's internal control structure. The audit committee,
whose members are neither officers nor employees of the Company, meet
periodically with management, internal auditors and internal credit examiners to
review the functioning of each and to ensure that each is properly discharging
its responsibilities. In addition, PricewaterhouseCoopers LLP, independent
auditors, are engaged to audit the Company's financial statements.
PricewaterhouseCoopers LLP, obtains and maintains an understanding of the
Company's accounting and financial controls and conducts its audit in accordance
with generally accepted auditing standards which includes such audit procedures
as it considers necessary to express the opinion in the report that follows.
Management recognizes that there are inherent limitations in the effectiveness
of any internal control structure. However, management has assessed and
believes that, as of December 31, 2000, the Company's internal control
structure, as described above, provides reasonable assurance as to the integrity
and reliability of the financial statements and related financial information.
Management also is responsible for compliance with federal and state laws and
regulations concerning loans to insiders and dividend restrictions designated by
the FDIC as safety and soundness laws and regulations.
Management assessed its compliance with the designated laws and regulations
relating to safety and soundness. Based on this assessment, Management believes
that the Bank complied with the designated laws and regulations relating to
safety and soundness for the year ended December 31, 2000.
/s/ Kent A. Steinwert /s/ John R. Olson
Kent A. Steinwert John R. Olson
President & Executive Vice President &
Chief Executive Officer Chief Financial Officer
30
[LETTERHEAD OF PRICEWATERHOUSECOOPERS]
Report of Independent Accountants
To the Board of Directors and
Shareholders of Farmers & Merchants Bancorp:
In our opinion, the accompanying consolidated balance sheet as of December 31,
2000 and the related consolidated statement of income, changes in shareholders'
equity, comprehensive income and cash flows present fairly, in all material
respects, the financial position of Farmers & Merchants Bancorp and its
subsidiaries at December 31, 2000, and the results of their operations and their
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audit. We
conducted our audit of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion. The
financial statements of the Company as of December 31, 1999 and for the two
years then ended were audited by other independent accountants whose report
dated February 4, 2000 expressed an unqualified opinion on those statements.
/s/ PricewaterhouseCoopers LLP
February 9, 2001
31
Consolidated Statements of Income
- ------------------------------------------------------------------------------------------------------------------------
(in thousands except per share data)
Year Ended December 31,
2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------
Interest Income
Interest and Fees on Loans $44,171 $34,593 $29,706
Interest on Federal Funds Sold and Securities Purchased
Under Agreements to Resell 1,300 793 943
Interest on Investment Securities:
Taxable 17,574 17,398 17,141
Tax-Exempt 3,082 3,271 3,404
Total Interest Income 66,127 56,055 51,194
- ------------------------------------------------------------------------------------------------------------------------
Interest Expense
Interest on Deposits 21,845 16,500 15,780
Interest on Borrowed Funds 2,912 2,362 1,648
Total Interest Expense 24,757 18,862 17,428
- ------------------------------------------------------------------------------------------------------------------------
Net Interest Income 41,370 37,193 33,766
Provision for Loan Losses 2,800 1,700 1,400
Net Interest Income After Provision for Loan Losses 38,570 35,493 32,366
- ------------------------------------------------------------------------------------------------------------------------
Non-Interest Income
Service Charges on Deposit Accounts 3,464 3,163 2,842
Net Gain (Loss) on Sale of Investment Securities (120) (302) 333
Credit Card Merchant Fees 976 783 611
Other 2,328 2,014 2,033
Total Non-Interest Income 6,648 5,658 5,819
- ------------------------------------------------------------------------------------------------------------------------
Non-Interest Expense
Salaries and Employee Benefits 16,235 15,351 14,493
Occupancy Expense 1,730 1,691 1,787
Equipment Expense 1,916 2,268 2,103
Other 7,667 7,711 7,712
Total Non-Interest Expense 27,548 27,021 26,095
- ------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 17,670 14,130 12,090
Provision for Income Taxes 6,650 4,914 4,030
- ------------------------------------------------------------------------------------------------------------------------
Net Income $11,020 $ 9,216 $ 8,060
========================================================================================================================
Earnings Per Share $ 15.98 $ 13.26 $ 11.56
========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
32
Consolidated Balance Sheets
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands except per share data)
December 31,
Assets 2000 1999
- ----------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents:
Cash and Due from Banks $ 33,290 $ 30,384
Federal Funds Sold and Securities Purchased Under Agreements to Resell 41,000 11,600
Total Cash and Cash Equivalents 74,290 41,984
- ----------------------------------------------------------------------------------------------------------------------------
Investment Securities:
Available-for-Sale 279,386 297,580
Held-to-Maturity 41,268 49,275
Total Investment Securities 320,654 346,855
- ----------------------------------------------------------------------------------------------------------------------------
Loans: 497,397 413,409
Less: Reserve for Loan Losses 11,876 9,787
Loans, Net 485,521 403,622
- ----------------------------------------------------------------------------------------------------------------------------
Premises and Equipment, Net 11,556 12,707
Interest Receivable and Other Assets 13,530 14,713
Total Assets $905,551 $819,881
============================================================================================================================
Liabilities
Deposits:
Demand $183,779 $163,658
Interest-Bearing Transaction Accounts 81,271 73,120
Savings 175,140 192,677
Time 324,488 255,688
Total Deposits 764,678 685,143
- ----------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank Advances 41,033 41,064
Interest Payable and Other Liabilities 8,957 13,473
Total Liabilities 814,668 739,680
- ----------------------------------------------------------------------------------------------------------------------------
Shareholders' Equity
Preferred Stock: No Par Value. 1,000,000 Authorized, None Issued or Outstanding - -
Common Stock: Par Value $0.01, 2,000,000 Shares Authorized, 687,491 and
660,989 Issued and Outstanding at December 31, 2000 and 1999, Respectively 7 7
Additional Paid-In Capital 53,559 47,993
Retained Earnings 36,527 36,040
Accumulated Other Comprehensive Income (Loss) 790 (3,839)
Total Shareholders' Equity 90,883 80,201
- ----------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $905,551 $819,881
============================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
33
Consolidated Statements of Changes in Shareholders' Equity
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands except per share data)
Accumulated
Common Additional Other Total
Shares Common Paid-In Retained Comprehensive Shareholders'
Outstanding Stock Capital Earnings Income(Loss) Equity
Balance, December 31, 1997 603,985 $ 6 $39,406 $34,465 $ 946 $74,823
- --------------------------------------------------------------------------------------------------------------------------
Net Income 8,060 8,060
Cash Dividends Declared on
Common Stock (3,070) (3,070)
5% Stock Dividend 29,720 4,399 (4,399)
Cash Paid in Lieu of Fractional
Shares Related to Stock Dividend (65) (65)
Redemption of Stock (1,520) (229) (229)
Change in Net Unrealized Gain (Loss) on
Securities Available-for-Sale (114) (114)
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 632,185 $ 6 $43,576 $34,991 $ 832 $79,405
- --------------------------------------------------------------------------------------------------------------------------
Net Income 9,216 9,216
Cash Dividends Declared on
Common Stock (3,273) (3,273)
5% Stock Dividend 31,110 1 4,821 (4,822)
Cash Paid in Lieu of Fractional
Shares Related to Stock Dividend (72) (72)
Redemption of Stock (2,306) (404) (404)
Change in Net Unrealized Gain (Loss) on
Securities Available-for-Sale (4,671) (4,671)
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 660,989 $ 7 $47,993 $36,040 $(3,839) $80,201
- --------------------------------------------------------------------------------------------------------------------------
Net Income 11,020 11,020
Cash Dividends Declared on
Common Stock (3,609) (3,609)
5% Stock Dividend 32,496 6,824 (6,824)
Cash Paid in Lieu of Fractional
Shares Related to Stock Dividend (100) (100)
Redemption of Stock (5,994) (1,258) (1,258)
Change in Net Unrealized Gain (Loss) on
Securities Available-for-Sale 4,629 4,629
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 687,491 $ 7 $53,559 $36,527 $ 790 $90,883
==========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
34
Consolidated Statements of Comprehensive Income
- --------------------------------------------------------------------------------------------------------------------------
(in thousands)
Year Ended December 31,
2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
Net Income $11,020 $ 9,216 $8,060
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) on Securities:
Unrealized holding gains (losses) arising during the period, net
of income tax effects of $3,188, $(3,386) and $12 for the
years ended December 31, 2000, 1999 and 1998, respectively. 4,558 (4,841) 18
Less: Reclassification adjustment for realized gains (losses)
included in net income, net of related income tax effects
of $49, $119 and $(92) for the years ended December 31,
2000, 1999 and 1998, respectively. 71 170 (132)
- -------------------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income (Loss) 4,629 (4,671) (114)
- -------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $15,649 $ 4,545 $7,946
=========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
35
Consolidated Statements of Cash Flows
==========================================================================================================================
(in thousands)
Year Ended December 31,
2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Income $ 11,020 $ 9,216 $ 8,060
Adjustments to Reconcile Net Income to Net Cash Provided
by Operating Activities:
Provision for Loan Losses 2,800 1,700 1,400
Depreciation and Amortization 1,760 1,770 1,637
Provision for Deferred Income Taxes (730) (457) (542)
Net Amortization of Investment Security Premium & Discounts (435) 674 221
Net (Gain) Loss on Sale of Investment Securities 120 302 (333)
Trading Securities:
Purchased - (15,490) (30,345)
Sold or Matured - 15,478 30,454
Net (Increase) Decrease in Interest Receivable and Other Assets (1,325) 3,338 (552)
Net Increase in Interest Payable and Other Liabilities (4,516) 4,559 2,454
- --------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 8,694 21,090 12,454
- --------------------------------------------------------------------------------------------------------------------------
Investing Activities
Securities Available-for-Sale:
Purchased (42,873) (171,788) (171,197)
Sold or Matured 69,161 177,675 105,926
Securities Held-to-Maturity:
Purchased (398) (2,114) (4,070)
Matured 8,493 12,927 42,819
Net Increase in Loans (84,916) (85,540) (58,003)
Principal Collected on Loans Previously Charged Off 217 807 432
Net Additions to Premises and Equipment (609) (2,763) (1,742)
- --------------------------------------------------------------------------------------------------------------------------
Net Cash Used for Investing Activities (50,925) (70,796) (85,835)
- --------------------------------------------------------------------------------------------------------------------------
Financing Activities
Net Increase in Demand, Interest-Bearing Transaction,
and Savings Accounts 10,735 30,189 29,520
Net Increase in Time Deposits 68,800 27,567 15,834
Net Increase (Decrease) in Federal Funds Purchased - (2,000) 2,000
Net Increase (Decrease) in Federal Home Loan Bank Advances (31) (29) 41,093
Stock Redemption (1,258) (404) (229)
Cash Dividends (3,709) (3,345) (3,135)
- -------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 74,537 51,978 85,083
- -------------------------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents 32,306 2,272 11,702
Cash and Cash Equivalents at Beginning of Year 41,984 39,712 28,010
- -------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 74,290 $ 41,984 $ 39,712
=========================================================================================================================
Supplementary Data
Cash Payments made for Income Taxes $ 8,100 $ 4,520 $ 5,436
Interest Paid $ 24,139 $ 18,743 $ 17,685
=========================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
36
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
Farmers & Merchants Bancorp (the Company) was organized April 30, 1999. Its'
primary operations are related to traditional banking activities through its
subsidiary Farmers & Merchants Bank of Central California (the Bank). The
consolidated financial statements of the Company and its subsidiary, the Bank,
are prepared in conformity with generally accepted accounting principles and
prevailing practices within the banking industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
reported amounts. These estimates are based on information available as of the
date of the financial statements. Therefore, actual results could differ from
those estimates. The following is a summary of the significant accounting and
reporting policies used in preparing the consolidated financial statements.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the
Company and the Company's wholly owned subsidiary the Bank along with the Bank's
wholly owned subsidiaries, Farmers & Merchants Investment Corporation and
Farmers/Merchants Corp. Significant intercompany transactions have been
eliminated in consolidation. Farmers & Merchants Investment Corporation has been
dormant since 1991. Farmers/Merchants Corp. acts as trustee on deeds of trust
originated by the Bank.
Certain amounts in the prior years' financial statements have been reclassified
to conform with the current presentation. These reclassifications have no effect
on previously reported income. Information in this report dated prior to April
30, 1999 is for Farmers & Merchants Bank of Central California.
Cash and Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Company has
defined cash and cash equivalents as those amounts included in the balance sheet
captions Cash and Due from Banks and Federal Funds Sold and Securities Purchased
Under Agreements to Resell. Generally, these transactions are for one-day
periods. For these instruments, the carrying amount is a reasonable estimate of
fair value.
Investment Securities
Investment securities are classified at the time of purchase as held-to-maturity
if it is management's intent and the Bank has the ability to hold the securities
until maturity. These securities are carried at cost, adjusted for amortization
of premium and accretion of discount using a methodology which approximates a
level yield of interest over the estimated remaining period until maturity.
Losses, reflecting a decline in value judged by the Bank to be other than
temporary, are recognized in the period in which they become known.
Securities are classified as available-for-sale if it is management's intent, at
the time of purchase, to hold the securities for an indefinite period of time
and/or to use the securities as part of the Company's asset/liability management
strategy. Securities classified as available-for-sale include securities which
may be sold to effectively manage interest rate risk exposure, prepayment risk,
satisfy liquidity demands and other factors. These securities are reported at
fair value with aggregate, unrealized gains or losses excluded from income and
included as a separate component of shareholders' equity, net of related income
taxes. Fair values are based on quoted market prices or broker/dealer price
quotations on a specific identification basis. Gains or losses on the sale of
these securities are computed using the specific identification method.
Unrealized losses on these securities, reflecting a decline in value judged by
the Company to be other than temporary, are recognized in the period in which
they become known.
Trading securities are acquired for short-term appreciation and are recorded in
a trading portfolio and are carried at fair value, with unrealized gains and
losses recorded in non-interest income.
Loans
Loans are reported at the principal amount outstanding net of unearned discounts
and deferred loan fees. Interest income on loans is accrued daily on the
outstanding balances using the simple interest method. Loan origination
37
fees are deferred and recognized over the contractual life of the loan as an
adjustment to the yield. Loans are placed on a non-accrual status when the
collection of principal or interest is in doubt or when they become past due for
90 days or more unless they are both well-secured and in the process of
collection. For this purpose a loan is considered well-secured if it is
collateralized by property having a net realizable value in excess of the amount
of the loan or is guaranteed by a financially capable party. When a loan is
placed on non-accrual status, the accrued and unpaid interest receivable is
reversed and charged against current income, thereafter, interest income is
recognized only as it is collected in cash. Loans placed on a non-accrual status
are returned to accrual status when the loans are paid current as to principal
and interest and future payments are expected to be made in accordance with the
contractual terms of the loan.
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. When a loan is impaired, the recorded
amount of the loan in the Consolidated Balance Sheets is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or on the observable or estimated market price of the loan or the fair
value of the collateral if the loan is collateral dependent. Impaired loans are
placed on a non-accrual status with income reported accordingly. Cash payments
are first applied as a reduction of the principal balance until collection of
the remaining principal and interest can be reasonably assured.
Allowance for Loan Losses
As a financial institution which assumes lending and credit risks as a principal
element in its business, the Company anticipates that credit losses will be
experienced in the normal course of business. Accordingly, the allowance for
loan losses is maintained at a level considered adequate by management to
provide for losses that can be reasonably anticipated. The allowance is
increased by provisions charged to operating expense and reduced by net charge-
offs. Management reviews the credit quality of the loan portfolio on a quarterly
basis and considers problem loans, delinquencies, internal credit reviews,
current economic conditions, loan loss experience and other factors in
determining the adequacy of the allowance balance. While the Company utilizes a
systematic methodology in determining its allowance, the allowance is based on
estimates, and ultimate losses may vary from current estimates. The estimates
are reviewed periodically and, as adjustments become necessary, are reported in
earnings in the periods in which they become known. Management has allocated
specific reserves to various loan categories. Nevertheless, the allowance is
general in nature and is available for the loan portfolio as a whole.
Premises and Equipment
Premises, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed principally
by the straight line method over the estimated useful lives of the assets.
Estimated useful lives of buildings range from 30 to 40 years, and for furniture
and equipment from 3 to 8 years. Leasehold improvements are amortized over the
lesser of the terms of the respective leases, or their useful lives, which are
generally 5 to 10 years. Remodeling and capital improvements are capitalized
while maintenance and repairs are charged directly to occupancy expense.
Other Real Estate
Other real estate owned, which is included in other assets, is comprised of
properties acquired through foreclosures in satisfaction of indebtedness. These
properties are carried at the lower of the recorded loan balance or their
estimated net realizable value based on current appraisals. Initial losses on
properties acquired through full or partial satisfaction of debt are treated as
credit losses and charged to the Allowance for Loan Losses at the time of
acquisition. Subsequent declines in value from the recorded amounts, routine
holding costs, and gains or losses upon disposition, if any, are included in
non-interest income or expense as incurred.
Income Taxes
As required, the Company uses the liability method of accounting for income
taxes. This method results in the recognition of deferred tax assets and
liabilities that are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes. The
deferred provision for income taxes is the result of the net change in the
deferred tax asset and deferred tax liability
38
balances during the year. This amount combined with the current taxes payable or
refundable results in the income tax expense for the current year.
Earnings Per Share
Earnings per share amounts are computed by dividing net income by the weighted
average number of common shares outstanding for the period. Prior years have
been restated for the 5% stock dividend paid in each of the years presented.
Comprehensive Income
On January 1, 1998, the Company adopted the Statement of Financial Accounting
Standards, Reporting Comprehensive Income. This statement establishes standards
for the reporting and display of comprehensive income and its components in the
financial statements. Other comprehensive income refers to revenues, expenses,
gains and losses that generally accepted accounting principles recognize as
changes in value to an enterprise but are excluded from net income. For the
Company, comprehensive income includes net income (loss) and changes in fair
value of its available-for-sale investment securities.
2. Securities Purchased Under Agreements to Resell
The Company enters into purchases and sales of securities under agreements to
resell substantially identical securities. These types of security transactions
are generally for one day periods and are primarily whole loan securities rated
AA or better. During 2000, the underlying securities purchased under resale
agreements were delivered into the Bank's account at a third-party custodian
that recognizes the Company's rights and interest in these securities.
3. Investment Securities
The amortized cost, fair values and unrealized gains and losses of the
securities available-for-sale are as follows:
(in thousands)
Amortized Gross Unrealized Fair/Book
-------------------------
December 31, 2000 Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------
U.S. Treasury Securities $ 5,037 $ 10 $ - $ 5,047
Securities of U.S. Government Agencies 7,108 - 18 7,090
Obligations of States and Political Subdivisions 24,184 97 306 23,975
Mortgage-Backed Securities 236,173 1,921 360 237,734
Other 5,540 - - 5,540
- --------------------------------------------------------------------------------------------------------------
Total $278,042 $2,028 $ 684 $279,386
===============================================================================================================
December 31, 1999
- ---------------------------------------------------------------------------------------------------------------
U.S. Treasury Securities $ 12,158 $ 3 $ 286 $ 11,875
Securities of U.S. Government Agencies 7,156 - 143 7,013
Obligations of States and Political Subdivisions 24,093 3 1,054 23,042
Mortgage-Backed Securities 256,051 108 5,156 251,003
Other 4,647 - - 4,647
- ---------------------------------------------------------------------------------------------------------------
Total $304,105 $ 114 $6,639 $297,580
==============================================================================================================
39
The book values, estimated fair values, and unrealized gains and losses of
investments classified as held-to-maturity are as follows: (in thousands)
Book Gross Unrealized Fair
----------------------
December 31, 2000 Value Gains Losses Value
- --------------------------------------------------------------------------------------------------------------
Securities of U.S. Government Agencies $ 1,999 $ - $ 2 $ 1,997
Obligations of States and Political Subdivisions 38,585 537 18 39,104
Other 684 48 - 732
- --------------------------------------------------------------------------------------------------------------
Total $41,268 $585 $ 20 $41,833
==============================================================================================================
December 31, 1999
- --------------------------------------------------------------------------------------------------------------
Securities of U.S. Government Agencies $ 1,995 $ - $ 10 $ 1,985
Obligations of States and Political Subdivisions 46,423 344 257 46,510
Other 857 59 - 916
- --------------------------------------------------------------------------------------------------------------
Total $49,275 $403 $267 $49,411
==============================================================================================================
Fair values are based on quoted market prices or dealer quotes. If a quoted
market price is not available, fair value is estimated using quoted market
prices for similar securities.
The remaining principal maturities of debt securities as of December 31, 2000
and 1999 are shown below. Expected maturities may differ from contractual
maturities as borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
After 1 After 5 Total
Securities Available-for-Sale Within but but Over Fair
December 31, 2000 (in thousands) 1 Year Within 5 Within 10 10 years Value
- ---------------------------------------------------------------------------------------------------------------
U.S. Treasury Securities $ - $ 5,047 $ - $ - $ 5,047
Securities of U.S. Government
Agencies 7,090 - - - 7,090
Obligations of States and Political Subdivisions 757 7,616 13,628 1,974 23,975
Mortgage-Backed Securities 42,210 179,536 15,988 - 237,734
Other 5,540 - - - 5,540
- ---------------------------------------------------------------------------------------------------------------
Total $55,597 $192,199 $29,616 $1,974 $279,386
===============================================================================================================
1999 Totals $16,412 $216,882 $60,021 $4,265 $297,580
===============================================================================================================
After 1 After 5 Total
Securities Held-to-Maturity Within but but Over Book
December 31, 2000 (in thousands) 1 Year Within 5 Within 10 10 years Value
- --------------------------------------------------------------------------------------------------------------
Securities of U.S. Government
Agencies $ 1,999 $ - $ - $ - 1,999
Obligations of States and Political Subdivisions 13,092 20,534 4,959 - 38,585
Other - - - 684 684
- --------------------------------------------------------------------------------------------------------------
Total $15,091 $20,534 $ 4,959 $ 684 $41,268
==============================================================================================================
1999 Totals $ 7,494 $23,879 $16,691 $1,211 $49,275
==============================================================================================================
40
Proceeds from sales of securities available-for-sale were as follows: (in
thousands)
Gross Gross Gross
Proceeds Gains Losses
- --------------------------------------------------------------------------------
2000 $21,744 $ 56 $199
1999 $54,231 $ 285 $118
1998 $16,254 $ 137 $ 1
As of December 31, 2000, securities carried at $192,200,000 were pledged to
secure public and other deposits as required by law.
4. Loans and Allowance for Loan Losses
Loans as of December 31, consisted of the following:
(in thousands) 2000 1999
- ---------------------------------------------------------------------------------------------------------------
Real Estate $261,910 $222,354
Real Estate Construction 28,354 39,186
Commercial 182,611 129,969
Consumer 24,855 22,248
- ---------------------------------------------------------------------------------------------------------------
497,730 413,757
Less: Unearned Income on Loans (333) (348)
- ---------------------------------------------------------------------------------------------------------------
Total Loans $497,397 $413,409
===============================================================================================================
Non-Accrual Loans $ 1,472 $ 2,499
===============================================================================================================
Changes in the allowance for loan losses consisted of the following:
(in thousands)
2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------
Balance, January 1 $ 9,787 $ 8,589 $ 7,188
Provision Charged to Operating Expense 2,800 1,700 1,400
Recoveries of Loans Previously Charged Off 218 807 432
Loans Charged Off (929) (1,309) (431)
- ---------------------------------------------------------------------------------------------------------------
Balance, December 31 $ 11,876 $ 9,787 $ 8,589
===============================================================================================================
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. When a loan is impaired, the recorded
amount of the loan in the Consolidated Balance Sheets is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or on the observable or estimated market price of the loan or the fair
value of the collateral if the loan is collateral dependent. All impaired loans
have been assigned a related allowance for credit losses. As of December 31,
2000 and 1999 the total recorded investment in impaired loans was $1,472,000 and
$2,499,000, respectively. The related allowance for credit losses was $257,000
and $364,000 for the years ended 2000 and 1999, respectively. For income
reporting purposes, impaired loans are placed on a non-accrual status and are
more fully discussed in Note 1. Cash payments are first applied as a reduction
of the loan's principal balance until collection of the remaining principal and
interest can be reasonably assured. Thereafter, interest income is recognized as
it is collected in cash. The average balance of impaired loans was $2.3 million,
$3.4million and $1.4 million for the years ended 2000, 1999 and 1998
respectively. There was no interest income reported on impaired loans in 2000
and 1999. Interest income forgone on loans placed on nonaccrual status was
$71,000, $48,000 and $681,000 for the years ended December 31, 2000, 1999 and
1998 respectively.
41
5. Premises and Equipment
Premises and equipment as of December 31, consisted of the following:
(in thousands) 2000 1999
- -------------------------------------------------------------------------------
Land and Buildings $15,723 $15,226
Furniture, Fixtures and Equipment 13,180 14,085
Leasehold Improvements 835 835
- -------------------------------------------------------------------------------
29,738 30,146
Less: Accumulated Depreciation and Amortization 18,182 17,439
- -------------------------------------------------------------------------------
Total $11,556 $12,707
===============================================================================
Depreciation and amortization on premises and equipment included in occupancy
and equipment expense amounted to $1,760,000, $1,770,000 and $1,637,000 for the
years ended December 31, 2000, 1999 and 1998, respectively. Total rental expense
for premises were $207,000, $240,000 and $228,000 for the years ended December
31, 2000, 1999 and 1998, respectively. Rental income was $81,000, $81,000 and
$68,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
6. Other Real Estate
Other real estate, included in Interest Receivable and Other Assets, totaled
$89,000 and $204,000 at December 31, 2000 and 1999, respectively. Other real
estate includes property no longer utilized for business operations and property
acquired through foreclosure proceedings. These properties are carried at the
lower of cost or estimated net realizable value determined at the date acquired.
Losses arising from the acquisition of these properties are charged against the
allowance for loan losses. Subsequent declines in value, routine holding costs
and net gains or losses on disposition are included in other operating expense
as incurred.
7. Deposits
Deposits of $100,000 or more were as follows:
(in thousands)
December 31,
2000 1999 1998
- ----------------------------------------------------------------------------------------------------------
Balance $135,757 $74,259 $62,371
==========================================================================================================
At December 31, 2000, the scheduled maturities of time deposits were as follows: (in thousands)
Scheduled
Maturities
- ----------------------------------------------------------------------------------------------------------
2001 $ 291,945
2002 22,016
2003 10,328
2004 197
2005 and thereafter 2
- ----------------------------------------------------------------------------------------------------------
Total $ 324,488
==========================================================================================================
42
8. Income Taxes
Current and deferred income tax expense (benefit) provided for the years ended
December 31, consisted of the following:
(in thousands) 2000 1999 1998
- ----------------------------------------------------------------------------
Current
Federal $ 5,229 $ 3,764 $ 3,220
State 2,151 1,607 1,352
- ----------------------------------------------------------------------------
Total Current 7,380 5,371 4,572
- ----------------------------------------------------------------------------
Deferred
Federal (493) (383) (502)
State (237) (74) (40)
- ----------------------------------------------------------------------------
Total Deferred (730) (457) (542)
- ----------------------------------------------------------------------------
Total Provision for Taxes $ 6,650 $ 4,914 $ 4,030
============================================================================
The total provision for income taxes differs from the federal statutory rate as
follows:
(in thousands)
2000 1999 1998
Amount Rate Amount Rate Amount Rate
- -------------------------------------------------------------------------------------------------------
Tax Provision at Federal Statutory Rate $6,185 35.0 % $ 4,804 34.0 % $ 4,111 34.0 %
Interest on Obligations of States
and Political Subdivisions
Exempt from Federal Taxation (740) (4.2)% (1,008) (7.1)% (1,001) (8.3)%
State and Local Income Taxes,
Net of Federal Income Tax Benefit 1,263 7.2 % 1,012 7.2 % 866 7.2 %
Other, Net (58) (0.4)% 106 0.7 % 54 0.4 %
- -------------------------------------------------------------------------------------------------------
Total Provision for Taxes $6,650 37.6 % $ 4,914 34.8 % $ 4,030 33.3 %
=======================================================================================================
The components of the net deferred tax assets as of December 31, are as follows:
(in thousands) 2000 1999
- -------------------------------------------------------------------------------
Deferred Tax Assets
Allowance for Loan Losses $4,628 $3,720
Unrealized (Loss) Gain on Securities Available-for-Sale (553) 2,685
Accrued Liabilities 1,133 1,021
Deferred Compensation 810 666
Other Real Estate 302 468
State Franchise Tax 731 521
Interest on Non-Accrual Loans 83 108
- -------------------------------------------------------------------------------
Total Deferred Tax Assets 7,134 9,189
- -------------------------------------------------------------------------------
Deferred Tax Liabilities
Depreciation (383) (532)
Securities Accretion (842) (477)
Other (463) (226)
- -------------------------------------------------------------------------------
Total Deferred Tax Liabilities (1,688) (1,235)
- -------------------------------------------------------------------------------
Net Deferred Tax Assets $ 5,446 $ 7,954
===============================================================================
The net deferred tax assets are reported in Interest Receivable and Other Assets
on the Company's Consolidated Balance Sheets.
43
9. Short Term Borrowings
As of December 31, 2000 and 1999, the Company had unused lines of credit
available for short term liquidity purposes of $136 million. Federal Funds
purchased and advances from the Federal Reserve Bank are generally issued on an
overnight basis.
10. Federal Home Loan Bank Advances
The Company's Advances from the Federal Home Loan Bank of San Francisco consist
of the following as of December 31,
(in thousands) 2000 1999
- ------------------------------------------------------------------------------------------------------------------
5.35% note payable due February 2, 2008 with interest due quarterly, callable February 2, $25,000 $25,000
2003 and quarterly thereafter.
5.38% note payable due August 12, 2008 with interest due quarterly, callable August 12, 15,000 15,000
2003 and quarterly thereafter.
5.60% amortizing note, interest and principal payable monthly with final maturity of 1,033 1,064
September 25, 2018.
- ------------------------------------------------------------------------------------------------------------------
Total $41,033 $41,064
==================================================================================================================
In accordance with the Collateral Pledge and Security Agreement, advances are
secured by all Federal Home Loan Bank stock held by the company and by agency
and mortgage-backed securities, classified as available-for-sale, with carrying
values of $64,346,000.
11. Shareholders' Equity
Beginning in 1975 and continuing through 2000, the Company has issued an annual
5% stock dividend. Earnings per share amounts have been restated for each year
presented to reflect the stock dividend.
Dividends from the Bank constitute the principal source of cash to the Company.
The Company is a legal entity separate and distinct from the Bank. Under
regulations controlling California state chartered banks, the Bank is, to some
extent, limited in the amount of dividends that can be paid to shareholders
without prior approval of the State Department of Financial Institutions. These
regulations require approval if total dividends declared by a state chartered
bank in any calendar year exceed the bank's net profits for that year combined
with its retained net profits for the preceding two calendar years. As of
December 31, 2000, the Bank could declare dividends of $18,106,000 without
approval of the California State Banking Department. These regulations apply to
all California state chartered banks.
The Accumulated Other Comprehensive Income is the result of the accounting
standard, Reporting Comprehensive Income. This accounting principle requires
securities classified as available-for-sale be reported at their fair values.
Unrealized gains and losses are reported on a net-of-tax basis as a component of
Shareholders' Equity.
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal Reserve Bank of San Francisco and the Federal
Deposit Insurance Corporation. These guidelines are designed to make capital
requirements more sensitive to differences in risk related assets among banking
organizations, to take into account off-balance sheet exposures and aid in
making the definition of banking capital uniform. Bank assets and off-balance
sheet items are categorized by risk. The results of these regulations are that
assets with a higher degree of risk require a larger amount of capital; assets,
such as cash, with a low degree of risk have little or no capital requirements.
Failure to meet these minimum capital requirements can initiate certain
disciplinary actions by regulators. As of December 31, 2000 and 1999, the
Company and the Bank meet all capital adequacy requirements to which they are
subject. The following table illustrates the relationship between the Bank's
regulatory capital requirements and the Bank's capital position.
44
To Be Well
Capitalized Under
Regulatory Capital Prompt Corrective
(in thousands) Actual Requirements Action Provisions
December 31, 2000 Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------------
Total Bank Capital to Risk Weighted Assets $96,150 15.22% $50,548 8.0% $63,185 10.0%
Total Consolidated Capital to Risk Weighted Assets $97,419 15.41% $50,582 8.0% N/A N/A
Tier I Bank Capital to Risk Weighted Assets $88,203 13.96% $25,274 4.0% $37,911 6.0%
Tier I Consolidated Capital to Risk Weighted Assets $90,092 14.25% $25,291 4.0% N/A N/A
Tier I Bank Capital to Average Assets $88,203 10.00% $35,268 4.0% $44,085 5.0%
Tier I Consolidated Capital to Average Assets $90,092 10.21% $35,285 4.0% N/A N/A
December 31, 1999
- -------------------------------------------------------------------------------------------------------------------------
Total Bank Capital to Risk Weighted Assets $89,573 16.70% $42,915 8.0% $53,644 10.0%
Total Consolidated Capital to Risk Weighted Assets $90,784 16.92% $42,922 8.0% N/A N/A
Tier I Bank Capital to Risk Weighted Assets $82,829 15.44% $21,458 4.0% $32,187 6.0%
Tier I Consolidated Capital to Risk Weighted Assets $84,040 15.66% $21,461 4.0% N/A N/A
Tier I Bank Capital to Average Assets $82,829 10.37% $31,938 4.0% $39,923 5.0%
Tier I Consolidated Capital to Average Assets $84,040 10.53% $31,938 4.0% N/A N/A
12. Employee Benefit Plans
The Company, through the Bank, sponsors a defined benefit pension plan covering
all employees of Farmers & Merchants Bank of Central California who have
completed one year of service and attained age 21.
The Plan provides benefits, up to a maximum stated in the plan, based on each
covered employee's years of service and highest five-year average compensation
earned while a participant in the plan. Plan benefits are fully vested after
five years of plan service.
The Company's funding policy is to contribute annually an amount that is not
less than the ERISA minimum funding requirement and not in excess of the maximum
tax-deductible contribution as developed in accordance with the aggregate cost
method.
The following schedule states the change in benefit obligations for the years
ended December 31:
(in thousands) 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
Benefit Obligation at Beginning of Year $5,263 $5,009
Service Cost 572 536
Interest Cost 404 360
Benefits Paid (704) (779)
Actuarial Loss 498 137
- ------------------------------------------------------------------------------------------------------------------------
Total Benefit Obligation at End of Year $6,033 $5,263
========================================================================================================================
The Change in Plan Assets are as follows: (in thousands) 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
Fair Value of Plan Assets at Beginning of Year $5,505 $4,959
Employer Contribution 701 666
Benefits Paid (704) (779)
Actual Return on Plan Assets (156) 659
- ------------------------------------------------------------------------------------------------------------------------
Total Fair Value of Plan Assets at End of Year $5,346 $5,505
========================================================================================================================
45
The following table sets forth the Plan's funded status along with amounts
recognized and not recognized in the Bank's Consolidated Balance Sheets for the
years ended December 31:
(in thousands) 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
Benefit Obligation $6,033 $5,263
Fair Value of Plan Assets 5,346 5,505
- ---------------------------------------------------------------------------------------------------------------------
Funded Status (687) 242
Unrecognized Net Asset at Transition (85) (114)
Unrecognized Prior Service Cost (63) (69)
Unrecognized Net Loss 1,561 492
- ---------------------------------------------------------------------------------------------------------------------
Net Amounts Recognized $ 726 $ 551
=====================================================================================================================
Amounts Recognized:
- ---------------------------------------------------------------------------------------------------------------------
Prepaid Benefit Cost $ 726 $ 551
Accrued Benefit Liability - -
Intangible Asset - -
- ---------------------------------------------------------------------------------------------------------------------
Net Amounts Recognized $ 726 $ 551
=====================================================================================================================
The components of the net periodic benefit costs are as follows:
(in thousands) 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Service Cost $ 572 $ 536 $ 441
Interest Cost 404 360 331
Expected Return on Plan Assets (473) (426) (355)
Amortization of
Unrecognized Net Asset at Transition (28) (28) (28)
Unrecognized Prior Service Cost (7) (7) (7)
Unrecognized Net Loss 57 96 49
- ---------------------------------------------------------------------------------------------------------------------
Total Net Periodic Benefit Cost $ 525 $ 531 $ 431
=====================================================================================================================
Assumptions Used in the Accounting were:
Discount Rate (Settlement Rate) 7.25% 7.50% 6.50%
Rate of Increase in Salary Levels 4.00% 4.00% 5.00%
Expected Return on Assets 9.00% 9.00% 9.00%
=====================================================================================================================
Substantially all full-time employees of the Bank with one or more years of
service also participate in a defined contribution profit sharing plan.
Contributions to this plan are made at the discretion of the Board of Directors
and the Board can terminate the plan at any time. The Bank contributed $515,000,
$485,000 and $465,000 for the years ended December 31, 2000, 1999 and 1998,
respectively. The employees are permitted, within limitations imposed by tax
law, to make pretax contributions to the 401(k) feature of the Plan. The Bank
does not match employee contributions within the 401(k) feature of the Plan.
The Bank sponsors a Deferred Bonus Plan for certain employees. Deferred bonuses
are granted and benefits accumulate based on the cumulative profits during the
employee's participation period. The Bank contributed $132,000, $111,000 and
$54,000 for the years ended December 31, 2000, 1999 and 1998 respectively.
13. Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosure about Fair
Value of Financial Instruments." The estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies. The use of assumptions and various valuation
techniques, as well as the absence of secondary markets for certain financial
instruments, will likely reduce the comparability of fair value disclosures
between financial institutions. In some cases, book value is a reasonable
estimate of fair value due to the relatively short
46
period of time between origination of the instrument and its expected
realization. The following table summarized the book value and estimated fair
value of financial instruments as of December 31:
- ---------------------------------------------------------------------------------------------------------------
2000 1999
Carrying Estimated Carrying Estimated
ASSETS: (in thousands) Amount Fair Value Amount Fair Value
- ---------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents $ 74,290 $ 74,290 $ 41,984 $ 41,984
Investment Securities Held-to-Maturity 41,268 41,833 49,275 49,411
Investment Securities Available-for-Sale 279,386 279,386 297,580 297,580
Loans, Net of Unearned Income 497,397 500,036 413,409 416,857
Less: Allowance for Loan Losses 11,876 11,876 9,787 9,787
Loans, Net of Allowance 485,521 488,160 403,622 407,070
LIABILITIES:
Deposits:
Noninterest-bearing 183,779 183,779 163,658 163,658
Interest-bearing 580,889 581,603 521,485 457,234
Federal Home Loan Bank Advances 41,033 41,397 41,064 38,936
The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below:
Cash and cash equivalents: The carrying amounts reported in the balance sheet
for cash and due from bank and federal funds sold are a reasonable estimate of
fair value.
Investment securities: Fair values for investment securities are based on quoted
market prices, where available. If quoted market prices are not available, fair
values are based on quoted market prices of comparable instruments.
Loans: For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair values
for fixed-rate loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.
Commitments to extend credit and standby letters of credit: The fair value of
commitments is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties. For fixed-rate loan commitments,
fair value also considers the difference between current levels of interest
rates and the committed rates. The fair value of letters of credit is based on
fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the counterparties at
the reporting date.
Deposit liabilities: The fair value of demand deposits, interest bearing
transaction accounts and savings accounts is the amount payable on demand as of
December 31. The fair value of fixed-maturity certificates of deposit is
estimated by discounting expected future cash flows utilizing interest rates
currently being offered for deposits of similar remaining maturities.
Short-term borrowings: The fair value of federal funds purchased and other
short-term borrowings is approximated by the book value. The fair value for
Federal Home Loan Bank borrowings is determined using discounted future cash
flows.
Limitations: Fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2000 and 1999. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date, and
therefore, current estimates of fair value may differ significantly from the
amounts presented above.
47
14. Commitments and Contingencies
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These instruments include commitments to extend credit, letters of credit and
financial guarantees that are not reflected in the Consolidated Balance Sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party with regards to standby letters of credit, undisbursed loan
commitments and financial guarantees is represented by the contractual notional
amount of those instruments. Commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. The Company uses the same credit policies in making commitments
and conditional obligations as it does for recorded balance sheet items. The
Company may or may not require collateral or other security to support financial
instruments with credit risk. Evaluations of each customer's creditworthiness
are performed on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to
guarantee performance of or payment for a customer to a third party. The Company
had standby letters of credit outstanding of $5,054,000 at December 31, 2000,
and $6,635,000 at December 31, 1999. Commitments to extend credit are agreements
to lend to a customer as long as there is no violation of any condition
contained in the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Undisbursed loan
commitments totaled $164,698,000 and $153,329,000 as of December 31, 2000 and
1999, respectively. Since many of these commitments are expected to expire
without fully being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company does not anticipate any loss as
a result of these transactions.
The Company is obligated under a number of noncancellable operating leases for
premises and equipment used for banking purposes. Minimum future rental
commitments under noncancellable operating leases as of December 31, 2000 were
$89,000, $41,000, $41,000, $41,000, and $41,000 for the years 2001 to 2005 and
$171,000 thereafter.
In the ordinary course of business, the Company becomes involved in litigation
arising out of its normal business activities. Management, after consultation
with legal counsel, is of the opinion that the ultimate liability, if any,
resulting from the disposition of such claims would not be material in relation
to the financial position of the Company.
The Company may be required to maintain average reserves on deposit with the
Federal Reserve Bank primarily based on deposits outstanding. There were no
reserve requirements during 2000 or at December 31, 2000 and 1999.
15. Transactions with Related Parties
The Company, in the ordinary course of business, has had, and expects to have in
the future, deposit and loan transactions with Directors, executive officers and
their affiliated companies. These transactions were on substantially the same
terms, including interest rates, as those prevailing at the time for comparable
transactions with unaffiliated parties and do not involve more than normal
credit risk or other unfavorable features.
Loan transactions with Directors, executive officers and their affiliated
companies during the year ended December 31, 2000, were as follows:
(in thousands)
- --------------------------------------------------------------------------------
Loan Balances December 31, 1999 $ 1,105
Disbursements During 2000 3,477
Loan Reductions During 2000 (3,282)
- --------------------------------------------------------------------------------
Loan Balances December 31, 2000 $ 1,300
================================================================================
48
16. Future Impact of Accounting Standards Not Yet Adopted
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133). In June 1999, the FASB issued SFAS 137,
Accounting for Derivative Instruments and Hedging Activities--Deferral of the
Effective Date of FASB Statement No. 133, that amends SFAS 133, deferring its
effective date. SFAS 133 is now effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000 (January 1, 2001 for the Company). SFAS 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in fair value of derivatives are recorded each period
in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if so, the type of
hedge transaction. The gains and losses on the derivative instrument that are
reported in other comprehensive income will be reclassified as earnings in the
periods in which earnings are affected by the variability of the cash flows of
the hedged item. The ineffective portion of all hedges will be recognized in
current period earnings. In June 2000, the FASB issued SFAS 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, which addressed a
limited number of implementation issues arising from SFAS 133.
The Company adopted SFAS 133, as amended by SFAS 138, on January 1, 2001.
Adoption of SFAS 133 did not have a material effect on the Company's financial
position or results of operations.
In September 2000, the FASB issued Statement of Financial Accounting Standards
No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, a replacement of FASB Statement No. 125 (SFAS
140), which replaces FASB Statement No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 125).
SFAS 140 revises the standards for accounting for securitizations, other
transfers of financial assets and collateral, and requires certain disclosures,
but it carries over most of the provisions of SFAS 125, which the Company
adopted in fiscal year 1997, without reconsideration. SFAS 140 also provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities and provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings.
The collateral recognition and disclosure provisions of SFAS 140 are required
for fiscal years ending after December 15, 2000. The provisions of SFAS 140 that
govern transfers and servicing of financial assets and extinguishments of
liabilities are effective for transactions occurring after March 31, 2001. This
Statement is to be applied prospectively with certain exceptions. Other than
those exceptions, earlier or retroactive application of its accounting
provisions is not permitted. The Company adopted the collateral recognition and
disclosure provisions of SFAS 140 in the year ended December 31, 2000, as
required. Adoption of the collateral recognition and disclosure provisions of
SFAS 140 did not significantly impact the Company's financial position, results
of operations or financial statement disclosures. The Company does not expect
that the adoption of the provisions of SFAS 140 on March 31, 2001 will have a
material effect on the Company's financial position or results of operations.
49
17. Parent Company Financial Information
Farmers & Merchants Bancorp was organized April 30, 1999. As a result,
comparative financial information is not available. The financial information
below is for the year ended December 31, 2000 and for the eight- month period
ended December 31, 1999.
Farmers & Merchants Bancorp
Balance Sheet
(in thousands) 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Cash $ 1,261 $ 1,126
Investment in Farmers and Merchants Bank of Central California 88,993 78,991
Other Assets 629 84
- -----------------------------------------------------------------------------------------------------------------------
Total Assets $ 90,883 $80,201
=======================================================================================================================
Liabilities $ - $ -
Shareholders' Equity 90,883 80,201
- -----------------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders Equity $ 90,883 $80,201
=======================================================================================================================
Farmers & Merchants Bancorp
Income Statement
for the period ending December 31,
2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Equity Earnings in Farmers and Merchants Bank of Central California $ 11,178 $ 6,298
Other Expenses, Net (158) (116)
- -----------------------------------------------------------------------------------------------------------------------
Net Income $ 11,020 $ 6,182
=======================================================================================================================
Farmers & Merchants Bancorp
Statement of Cash Flows
for the period ending December 31,
2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net Income $ 11,020 $ 6,182
Adjustments to Reconcile Net Income to Net Cash Used in Operating Activities:
Earnings from Farmers and Merchants Bank of Central California (11,178) (6,298)
Net (Increase) in Interest Receivable and Other Assets (544) (84)
- -----------------------------------------------------------------------------------------------------------------------
Net Cash Used in Operating Activities (702) (200)
- -----------------------------------------------------------------------------------------------------------------------
Investing Activities:
Dividends Received from Farmers and Merchants Bank of Central California 5,804 5,075
- -----------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Investing Activities 5,804 5,075
- -----------------------------------------------------------------------------------------------------------------------
Financing Activities:
Stock Redemption (1,258) (404)
Cash Dividends (3,709) (3,345)
- -----------------------------------------------------------------------------------------------------------------------
Net Cash Used by Financing Activities (4,967) (3,749)
- -----------------------------------------------------------------------------------------------------------------------
Increase in Cash and Cash Equivalents 135 1,126
Cash and Cash Equivalents at Beginning of Year 1,126 -
- -----------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 1,261 $ 1,126
=======================================================================================================================
50
Five Year Financial Summary of Operations
(in thousands, except per share data)
2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
Total Interest Income $ 66,127 $ 56,055 $ 51,194 $ 45,975 $ 45,060
Total Interest Expense 24,757 18,862 17,428 16,422 15,557
- ------------------------------------------------------------------------------------------------------------------------
Net Interest Income 41,370 37,193 33,766 29,553 29,503
Provision for Loan Losses 2,800 1,700 1,400 5,450 4,000
- ------------------------------------------------------------------------------------------------------------------------
Net Interest income After
Provision for Loan Losses 38,570 35,493 32,366 24,103 25,503
Total Non-Interest Income 6,648 5,658 5,819 5,112 5,157
Total Non-Interest Expense 27,548 27,021 26,095 24,177 22,013
- ------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 17,670 14,130 12,090 5,038 8,647
Provision for Income Taxes 6,650 4,914 4,030 1,027 1,566
- ------------------------------------------------------------------------------------------------------------------------
Net Income $ 11,020 $ 9,216 $ 8,060 $ 4,011 $ 7,081
========================================================================================================================
Balance Sheet Data
Total Assets $905,551 $819,881 $758,799 $663,316 $632,805
Loans 497,397 413,409 329,178 271,606 263,287
Allowance for Loan Losses 11,876 9,787 8,589 7,188 10,031
Deposits 764,678 685,143 627,387 582,033 554,617
Federal Home Loan Bank Advances 41,033 41,064 41,093 - -
Shareholders' Equity 90,883 80,201 79,405 74,823 72,717
Selected Ratios
Return on Average Assets 1.29% 1.19% 1.17% .63% 1.17%
Return on Average Equity 12.94% 11.10% 10.16% 5.43% 9.89%
Dividend Payout Ratio 33.66% 36.30% 38.91% 73.10% 39.08%
Average Loan to Average Deposits 59.96% 52.93% 48.93% 47.07% 50.28%
Average Equity to Average Assets Ratio 10.04% 10.86% 11.33% 11.65% 11.91%
Period-end Shareholders' Equity to Total 10.04% 9.78% 10.46% 11.28% 11.49%
Assets
Per Share Data (1)
Net Income $ 15.98 $ 13.26 $ 11.56 $ 5.75 $ 10.15
Cash Dividends Declared $ 5.25 $ 4.72 $ 4.41 $ 4.11 $ 3.88
(1) Net Income is based on the weighted average number of shares outstanding of
689,642, 694,764, 697,105, 697,311 and 697,311 for the years ended December 31,
2000, 1999, 1998, 1997 and 1996, respectively. Prior years' cash dividends
declared have been restated for the 5% stock dividend issued in each of the
above years.
51
Quarterly Financial Data
(in thousands, except for per share data)
First Second Third Fourth
2000 Quarter Quarter Quarter Quarter Total
-------------------------------------------------------------------------------------------------------------
Total Interest Income $15,062 $16,231 $17,097 $17,737 $66,127
Total Interest Expense 5,220 5,900 6,921 6,716 24,757
-------------------------------------------------------------------------------------------------------------
Net Interest Income 9,842 10,331 10,176 11,021 41,370
Provision for Loan Losses 500 500 400 1,400 2,800
-------------------------------------------------------------------------------------------------------------
Net Interest Income After
Provision for Loan Losses 9,342 9,831 9,776 9,621 38,570
Total Non-Interest Income 1,729 1,700 1,692 1,527 6,648
Total Non-Interest Expense 6,735 7,042 6,912 6,859 27,548
-------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 4,336 4,489 4,556 4,289 17,670
Provision for Income Taxes 1,622 1,685 1,728 1,615 6,650
-------------------------------------------------------------------------------------------------------------
Net Income $ 2,714 $ 2,804 $ 2,828 $ 2,674 $11,020
=============================================================================================================
Earnings Per Share $ 3.92 $ 4.06 $ 4.11 $ 3.89 $ 15.98
=============================================================================================================
1999
-------------------------------------------------------------------------------------------------------------
Total Interest Income $12,867 $13,804 $14,481 $14,903 $56,055
Total Interest Expense 4,548 4,564 4,752 4,998 18,862
-------------------------------------------------------------------------------------------------------------
Net Interest Income 8,319 9,240 9,729 9,905 37,193
Provision for Loan Losses 300 600 500 300 1,700
-------------------------------------------------------------------------------------------------------------
Net Interest Income After
Provision for Loan Losses 8,019 8,640 9,229 9,605 35,493
Total Non-Interest Income 1,547 1,479 1,574 1,058 5,658
Total Non-Interest Expense 6,040 6,584 7,084 7,313 27,021
-------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 3,526 3,535 3,719 3,350 14,130
Provision for Income Taxes 1,213 1,222 1,316 1,163 4,914
-------------------------------------------------------------------------------------------------------------
Net Income $ 2,313 $ 2,313 $ 2,403 $ 2,187 $ 9,216
=============================================================================================================
Earnings Per Share $ 3.49 $ 3.49 $ 3.63 $ 3.31 $ 13.92
=============================================================================================================
Farmers & Merchants Bancorp stock is not traded on any exchange. The shares are
primarily held by local residents and are not actively traded. Dividends
declared semiannually during the past three years were for the following
amounts: June 2000, 1999 and 1998, $1.85, $1.70 and $1.65 per share,
respectively, and for December 2000, 1999, and 1998, $3.40, $3.25 and $3.20 per
share, respectively. Based on information from shareholders and from Company
stock transfer records, the prices paid in 2000, 1999 and 1998 ranged from
$135.00 to $245.00 per share
Management's Discussion and Analysis
Forward -Looking Statements
This annual report contains various forward-looking statements, usually
containing the words "estimate," "project," "expect," "objective," "goal," or
similar expressions and includes assumptions concerning the Company's
operations, future results, and prospects. These forward-looking statements are
based upon current expectations and are subject to risk and uncertainties. In
connection with the "safe-harbor" provisions of the private Securities
Litigation Reform Act, the Company provides the following cautionary statement
identifying important factors which could cause the actual results of events to
differ materially from those set forth in or implied by the forward-looking
statements and related assumptions.
52
Such factors include the following: (i) the effect of changing regional and
national economic conditions; (ii) significant changes in interest rates and
prepayment speeds; (iii) credit risks of commercial, real estate, consumer, and
other lending activities; (iv) changes in federal and state banking regulations;
(v) other external developments which could materially impact the Company's
operational and financial performance. Readers are cautioned not to place undue
reliance on these forward-looking statements which speak only as of the date
hereof. The Company undertakes no obligation to update any forward-looking
statements to reflect events or circumstances arising after the date on which
they are made.
Introduction
The following discussion and analysis is intended to provide a better
understanding of Farmers & Merchants Bancorp and subsidiaries' performance
during 2000 and 1999 the material changes in financial condition, operating
income and expense of the Company and its subsidiaries as shown in the
accompanying financial statements.
Farmers & Merchants Bancorp is a bank holding company formed April 30, 1999.
Its subsidiary, Farmers & Merchants Bank of Central California is a state-
chartered bank with 17 offices located in Sacramento, San Joaquin and Stanislaus
Counties. Virtually all of the Company's business activities are conducted
within its market area.
This section should be read in conjunction with the consolidated financial
statements and the notes thereto, along with other financial information
included in this report. Per share amounts for 1999 and 1998 have been restated
to reflect the 5% stock dividend declared during 2000.
Overview
At the completion of our 84th year, management is pleased to present the highest
reported income in the Company's history. As of December 31, 2000, Farmers &
Merchants Bancorp reported net income of $11,020,000, earnings per share of
$15.98, return on average assets of 1.29% and return on average equity of
12.94%. For the year 1999, net income totaled $9,216,000, earnings per share
was $13.26, return on average assets was 1.19% and return on average equity was
11.10%. For the year 1998, net income totaled $8,060,000, earnings per share
was $11.56 for the year, return on average assets was 1.17%, and the return on
average shareholders' equity totaled 10.16%.
As of December 31, 2000, consolidated assets were $905.6 million, gross loans
were $497.4 million and deposits were $764.7 million. Total consolidated assets
increased $85.7 million, gross loans increased $84.0 million and deposits grew
$79.5 million.
The Company's improved financial performance in 2000 was due to a combination of
increased revenue generated from its core business, improvement in the Company's
asset mix and effective capital management strategies.
The following is a summary of the financial accomplishments achieved during
2000:
. Net interest income increased 11.2% to $41,370,000 from $37,193,000
reported during 1999.
. The provision for loan losses increased to $2,800,000 during 2000 compared
to $1,700,000 in 1999.
. Non-interest income (net of securities transactions) increased 17.5% during
2000, when compared to 1999.
. Non-interest expense was limited to a growth of 2.0% during 2000 compared
to an increase of 3.5% in 1999.
. Total assets increased 10.5% to $905,551,000.
. Total loans increased 20.3% to $497,397,000.
. Non-accrual loans decreased 40.5% and totaled $1.5 million at December 31.
53
. Total investment securities decreased to $320,654,000 from $346,855,000 in
1999.
. Total Shareholders' Equity increased to $90,883,000 from $80,201,000 in
1999.
Net Interest Income
Net interest income is the amount by which the interest and fees on loans and
interest earned on earning assets exceeds the interest paid on interest bearing
sources of funds. For the purpose of analysis, the interest earned on tax-exempt
investments and municipal loans is adjusted to an amount comparable to interest
subject to normal income taxes. This adjustment is referred to as "taxable
equivalent" and is noted wherever applicable. Interest income and expense are
affected by changes in the volume and mix of average interest earning assets and
average interest bearing liabilities, as well as fluctuations in interest rates.
Therefore, increases or decreases in net interest income are analyzed as changes
in volume, changes in rate and changes in the mix of assets and liabilities.
Net interest income grew 11.2% to $41.4 million during 2000. During 1999, net
interest income was $37.2 million representing an increase of 10.2% over 1998.
On a fully taxable equivalent basis, net interest income increased 10.1% and
totaled $42.8 million during 2000, compared to $38.9 million for 1999. In 1998,
on a taxable equivalent basis, net interest income increased 12.8% or $4.0
million from that of 1997. Net interest income on a taxable equivalent basis,
expressed as a percentage of average total earning assets, is referred to as the
net interest margin, which represents the average net effective yield on earning
assets. For 2000, the net interest margin was 5.24% compared to 5.31% in 1999.
The decrease in net interest margin was the result of the competitive climate in
the Bank's market area during the year 2000.
The predominant reasons for the growth in net interest income during 2000 was
the increase in the volume of average earning assets as well as the change in
the mix of asset totals and deposit balances. As a result of aggressive
marketing efforts and calling programs, average interest-earning assets
increased $84.4 million during 2000 while average interest bearing liabilities
increased $67.2 million.
Loans, the Company's highest earning asset, increased $84.0 million as of
December 31, 2000 compared to 1999. On an average balance basis, loans increased
by $94.7 million during the year, which contributed to the corresponding
increase in interest and fees on loans of $9.6 million. The yield on the loan
portfolio remained relatively constant at 9.7% in 2000 compared to 9.5% in 1999.
The investment portfolio represents a significant portion of the Company's
earning assets. The Company's investment policy is conservative. The Company
primarily invests in mortgage-backed securities, U.S. Treasuries, U.S.
Government Agencies, and high-grade municipals. Since the risk factor for these
types of investments is significantly lower than that of loans, the yield earned
on investments is substantially less than that of loans.
Interest income from investment securities was virtually unchanged from one year
ago despite a decline in average investment securities of $15.2 million during
2000. During the first quarter the Bank restructured a portion of its available-
for-sale investment portfolio by selling lower yielding securities at a small
loss and replacing them with higher yielding securities. The earnings
improvement over the life of the securities more than offset the losses taken on
the securities sold. This restructuring resulted in an overall improvement in
the portfolio yield. The average yield, on a taxable equivalent basis, in the
investment portfolio was 6.5% in 2000 versus 6.3% in 1999. The tax equivalent
yield in 1998 was 6.6%. Net interest income on a taxable equivalent basis is
higher than net interest income on the Consolidated Statements of Income because
it reflects adjustments that relate to income on certain securities that are
exempt from federal income taxes.
Interest expense increased as a result of an increase in deposit balances, a
general increase in interest rates offered during the second half of 2000 and a
change in the deposit mix. Accordingly, interest expense increased 31.3%.
Average interest cost on interest-bearing deposits increased to $21.8 million in
2000. The percentage increase in interest expense was higher than the increase
in deposit growth due to the growth in time deposits and a general increase in
market rates. Several deposit gathering promotions in conjunction with the
Bank's prospect calling efforts resulted in a growth in total deposits of 11.6%.
The increase was primarily centered in the time deposit area,
54
which grew 26.9%. Total interest expense on deposit accounts for 2000 was $21.80
million. In 1999, interest expense on deposits was $16.5 million. The average
rate paid on interest-bearing deposits was 3.90% in 2000 and 3.30% in 1999.
The Company's earning assets and rate sensitive liabilities are subject to
repricing at different times, which exposes the Company to income fluctuations
when interest rates change. In order to minimize income fluctuations, the
Company attempts to match asset and liability maturities. However, some maturity
mismatch is inherent in the asset and liability mix.
Provision and Allowance for Loan Losses
As a financial institution that assumes lending and credit risks as a principal
element of its business, the Company anticipates that credit losses will be
experienced in the normal course of business. The provision for loan losses
represents the current period credit cost of maintaining an appropriate
allowance for loan losses. The allowance for loan losses is maintained at a
level considered by management to be adequate to provide for risks inherent in
the loan portfolio. In determining the adequacy of the allowance for loan
losses, management takes into consideration examinations of bank supervisory
authorities, results of internal credit reviews, financial condition of
borrowers, loan concentrations, prior loan loss experience, and general economic
conditions. The allowance is based on estimates and ultimate losses may vary
from the current estimates. Management reviews these estimates periodically and,
when adjustments are necessary, they are reported in the period in which they
become known.
The Provision for Loan Losses totaled $2.8 million in 2000, compared to $1.7
million in 1999. The increase in the provision was the result of growth in the
overall loan portfolio, management's evaluation of the credit quality of the
loan portfolio, current loan losses, the prevailing economic climate, and its
effect on borrowers' ability to repay loans in accordance with the terms of the
notes.
As of December 31, 2000, the allowance for loan losses was $11.9 million, which
represented 2.4% of the total loan balance. In 1999, the allowance for loan
losses was $9.8 million or 2.4% of the total loan balance.
Non-Interest Income
Non-Interest income for the Company includes income derived from services
offered by the Bank, such as, merchant card, investment services and other
miscellaneous business services; it also includes service charges and fees from
deposit accounts and net gains and losses from the sale of investment securities
and other real estate owned.
Before securities transactions, non-interest income increased 13.6% in 2000 over
1999. The increase was primarily due to the increase in the service charges on
deposit accounts. Total non-interest income was $6.6 million, which included
$120,000 in security losses. As previously mentioned, security losses were taken
to restructure a portion of the investment portfolio by replacing lower yielding
investments with securities having higher returns. In 1999, non-interest income
was $5.7 million. In 1998, the Company recorded $5.8 million of non-interest
income.
Non-Interest Expense
Non-interest expense totaled $27.5 million during 2000, an increase of $527
thousand or 2.0% over that reported in 1999. The increase in 1999 over 1998 was
3.6% with total non-interest expense reported at $27.0 million.
Salaries and employee benefits, the largest component of non-interest expense,
increased $884 thousand in 2000, representing an increase of 5.8% over that of
1999. During 1999, the increase was $858 thousand or 5.9% over 1998. The
increase was primarily the net result of merit increases for Company employees
along with incentive bonuses. At the end of 2000, the Company had 296.2 full
time equivalent employees compared to 321.9 at the end of 1999.
Occupancy expense increased 2.3% during 2000. Equipment expense decreased $352
thousand or 15.5% and totaled $1.9 million during 2000. During 1999, equipment
expense increased 7.9% or $165 thousand over the previous year. Other operating
expense totaled $7.7 million and remained unchanged from the prior year.
55
Income Taxes
The provision for income taxes increased 35.3% during 2000 as a result of
improved earnings and an increase in the effective tax rate. In 1999 the
provision increased 21.9% due to increased earnings over 1998. The effective tax
rate in 2000 was 37.6% compared to 34.8% in 1999. The increase in the effective
tax rate in 2000 was due to a decline in tax advantaged investment securities
during the year.
Current tax law causes the Company's current taxes payable to approximate or
exceed the current provision for taxes on the income statement. Two provisions
have had a significant effect on the Company's current income tax liability; the
restrictions on the deductibility of loan losses and the mandatory use of
accrual accounting for taxes rather than the cash basis method of accounting.
Balance Sheet Analysis
Investment Securities
The Financial Accounting Standards Board statement, Accounting for Certain
Investments in Debt and Equity Securities, requires the Company to classify its
investments as held-to-maturity, trading or available- for-sale. As of December
31, the Company classified securities as either held-to-maturity or available-
for-sale. Trading securities are securities acquired for short-term appreciation
and are carried at fair value, with unrealized gains and losses recorded in non-
interest income. As of December 31, there were no securities in the trading
portfolio.
Securities are classified as held-to-maturity and accounted for at amortized
cost when the Company has the positive intent and ability to hold the securities
to maturity.
Securities for which the Company does not have the intent to hold to maturity
are classified as available-for-sale. This portion of the investment portfolio
provides the Company with liquidity that may be required to meet the needs of
Company borrowers and satisfy depositor's withdrawals.
The investment portfolio provides the Company with an income alternative to
loans. The Company's total investment portfolio represented 35% of the Company's
total assets during 2000 and 42% of the Company's total assets during 1999. Not
included in the investment portfolio are overnight investments in Federal Funds
Sold. In 2000, average Federal Funds Sold on a year to date basis was $20.5
million compared to $15.6 million in 1999.
The Company's investment portfolio at the end of 2000 decreased $26.2 million or
7.6% from 1999. The proceeds from the decline in the investment portfolio was
used to fund the Company's loan growth during 2000. On an average balance basis,
the Company decreased its investment in Obligations of States and Political
Subdivisions (municipals) by $212 thousand. The Company generally replaces
maturities of municipal securities, to the point of a maximum tax benefit, with
"qualified issues." Qualified issues are municipal obligations that are
considered "small issues" and meet Internal Revenue Service requirements. By
meeting these requirements, the interest earned from qualified issues is exempt
from federal income taxes.
Note 3 in the Notes to Consolidated Financial Statements displays the
classifications of the Company's investment portfolio, the market value of the
Company's investment portfolio and the maturity distribution.
Loans
The Company's written lending policies, along with applicable laws and
regulations governing the extension of credit, require risk analysis as well as
ongoing portfolio and credit management through loan product diversification,
lending limits, ongoing credit reviews and approval policies prior to funding of
any loan. The Company manages and controls credit risk through diversification,
dollar limits on loans to one borrower and by primarily restricting loans made
to its principal market area. Loans that are performing but have shown some
signs of weakness are subjected to more stringent reporting and oversight.
Fixed-rate real estate loans are comprised primarily of loans with maturities of
less than five years. Long-term residential loans are originated by the Company
and sold in the secondary market.
56
As of December 31, 2000, loans totaled $497.4 million, a 20.3% increase over
that of 1999. On an average balance basis the Company's loan portfolio
increased $94.7 million over the average balance in 1999. In 1999, average
balances increased from the prior year by 23.1% or $68.1 million. This increase
was due to strong loan demand in the Company's market area along with an
aggressive calling program.
Non-Performing Loans
The Company's policy is to place loans on non-accrual status when, for any
reason, principal or interest is past due for ninety days or more unless it is
both well secured and in the process of collection. Any interest accrued, but
unpaid, is reversed against current income. Thereafter, interest is recognized
as income only as it is collected in cash.
As a result of events beyond the Company's control, problem loans can and do
occur. As of December 31, 2000, non-accrual loans were $1.5 million compared to
$2.5 million at the end of 1999. Reducing problem loans continues to be an
important Company objective. The Company reported $88 thousand in foreclosed
loans as other real estate in 2000, compared to the $204 thousand reported in
1999. Interest forgone on loans placed on a non-accrual status totaled $71
thousand at December 31, 2000. The reduction in the non-accrual loans and other
real estate resulted from a focused effort to reduce problem assets.
Although management believes that non-performing loans are generally well
secured and that potential losses are provided for in the Company's reserve for
loan losses, there can be no assurance that future deterioration in economic
conditions or collateral values will not result in future credit losses.
Deposits
At December 31, 2000, deposits totaled $764.7 million. This represents an
increase of $79.5 million or 11.6% from the deposit totals of $685.1 million
reported in 1999. The majority of the increase was concentrated in demand and
time deposits, which increased $20.1 million and $68.8 million, respectively.
The Company increased its marketing efforts for deposits during 2000 and ran
several successful deposit campaigns contributing to the strong growth in
deposit balances. The change in the mix of deposits occurs as interest rates
change. The expectations our customers have of future interest rates, dictates
their maturity and account selections. As rates increased during 2000, some
customers locked in rates in anticipation of future declines while other
customers placed their funds in transaction accounts because they anticipated
rates would rise and were unwilling to commit their deposits to long term
investments at the current rates.
The most volatile deposits in any financial institution are certificates of
deposit over $100,000. The Company has not found its certificates of deposit
over $100,000 to be as volatile as some other financial institutions as it does
not solicit these types of deposits from brokers nor does it offer interest rate
premiums. It has been the Company's experience that large depositors have placed
their funds with the Company due to its strong reputation for safety, security
and liquidity.
Federal Home Loan Bank Advances
Advances from the Federal Home Loan Bank are used to match fund long-term real
estate loans and, as opportunities exist, the Bank borrows funds and invests the
proceeds at a positive spread through the investment portfolio. These activities
contribute to the Bank and Company's earnings as well as help offset the Bank's
interest rate risk. The average rate paid for other borrowed funds was 5.60% in
2000 compared to 5.42% in 1999.
Capital
The Company relies on capital generated through the retention of earnings to
satisfy its capital requirements. The Company engages in an ongoing assessment
of its capital needs in order to support business growth and to insure depositor
protection. Shareholders' Equity totaled $90.9 million at December 31, 2000 and
$80.2 million at the end of 1999.
The Board of Governors of the Federal Reserve System and the Federal Deposit
Insurance Corporation have adopted risk-based capital guidelines. The guidelines
are designed to make capital requirements more sensitive to differences in risk
related assets among banking organizations, to take into account off-balance
sheet exposures and
57
to aid in making the definition of bank capital uniform. Company assets and off-
balance sheet items are categorized by risk. The results of these regulations
are that assets with a higher degree of risk require a larger amount of capital;
assets, such as cash, with a low degree of risk have little or no capital
requirements. Under these guidelines the Company is currently required to
maintain regulatory risk based capital equal to at least 8.0%.
As of December 31, 2000, the Company's risk based capital was 15.2%, well above
regulatory risk based capital guidelines.
In 1998, the Shareholders approved a stock repurchase program. During 2000, the
company repurchased 5,994 shares at an average share price of $210 per share. In
1999, the Company repurchased 2,306 shares at an average share price of $175.
Risk Management
The Company has adopted a Risk Management Plan to ensure the proper control and
management of all risk factors inherent in the operation of the Company and the
Bank. Specifically, credit risk, interest rate risk, liquidity risk, compliance
risk, strategic risk, reputation risk and price risk can all affect the market
risk of the Company. These specific risk factors are not mutually exclusive. It
is recognized that any product or service offered by the Company may expose the
Company and Bank to one or more of these risk factors.
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor's failure
to meet the terms of any contract or otherwise fail to perform as agreed. Credit
risk is found in all activities where success depends on counterparty, issuer,
or borrower performance.
Central to the Company's credit risk management is a proven loan risk rating
system. Limitations on industry concentration, aggregate customer borrowings and
geographic boundaries also reduce loan credit risk. Credit risk in the
investment portfolio is minimized through clearly defined limits in the Bank's
policy statements. Senior Management, Directors' Committees, and the Board of
Directors are provided with timely and accurate information to appropriately
identify, measure, control and monitor the credit risk of the Company and the
Bank.
The allowance for loan losses is based on estimates of losses inherent in the
loan portfolio. The amount actually incurred with respect to these losses can
vary significantly from the estimated amounts. The Company's methodology
includes several features that are intended to reduce the difference between
estimated and actual losses.
Implicit in lending activities is the risk that losses will and do occur and
that the amount of such losses will vary over time. Consequently, the Company
maintains an allowance for loan losses by charging a provision for loan losses
to earnings. Loans determined to be losses are charged against the allowance for
loan losses. The Company's allowance for loan losses is maintained at a level
considered by management to be adequate to provide for estimated losses inherent
in the existing portfolio along with unused commitments to provide financing
including commitments under commercial and standby letters of credit.
The Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include the formula allowance, specific
allowances for identified problem loans and portfolio segments and the
unallocated allowance. Specific allowances are established in cases where
management has identified conditions or circumstances related to credit that
management believes indicate the possibility that a loss may be incurred in
excess of the amount determined by the application of the formula reserve.
Management performs a detailed analysis of these loans, including, but not
limited to appraisals of the collateral, conditions of the marketplace for
liquidating the collateral and assessment of the guarantors. Management then
determines the loss potential and allocates a portion of the reserve for losses
as a specific allowance for each of these credits.
Management believes that the allowance for loan losses at December 31, 2000 was
adequate to provide for both recognized losses and estimated inherent losses in
the portfolio. No assurances can be given that future events may
58
not result in increases in delinquencies, non-performing loans or net loan
chargeoffs that would increase the provision for loan losses and thereby
adversely affect the results of operations.
Asset / Liability Management - Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities
results in uncertainty in the Company's earnings and economic value and is
referred to as interest rate risk. Farmers & Merchants Bancorp's primary
objective in managing interest rate risk is to minimize the potential for
significant loss as a result of changes in interest rates.
The Company measures interest rate risk in terms of potential impact on both its
economic value and earnings. The methods for governing the amount of interest
rate risk include: analysis of asset and liability mismatches (GAP analysis),
the utilization of a simulation model and limits on maturities of investment,
loan and deposit products to relatively short periods which reduces the market
volatility of those instruments.
The gap analysis measures, at specific time intervals, the divergence between
earning assets and interest bearing liabilities for which repricing
opportunities will occur. A positive difference, or gap, indicates that earning
assets will reprice faster than interest-bearing liabilities. This will
generally produce a greater net interest margin during periods of rising
interest rates and a lower net interest margin during periods of declining
interest rates. Conversely, a negative gap will generally produce a lower net
interest margin during periods of rising interest rates and a greater net
interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with
the rates charged on loans. In addition, the magnitude of changes in the rates
charged on loans is not always proportionate to the magnitude of changes in the
rate paid for deposits. Consequently, changes in interest rates do not
necessarily result in an increase or decrease in the net interest margin solely
as a result of the differences between repricing opportunities of earning assets
or interest bearing liabilities.
The Company also utilizes the results of a dynamic simulation model to quantify
the estimated exposure of net interest income to sustained interest rate
changes. The sensitivity of the Company's net interest income is measured over a
rolling one-year horizon.
The simulation model estimates the impact of changing interest rates on interest
income from all interest earning assets and the interest expense paid on all
interest bearing liabilities reflected on the Company's balance sheet. This
sensitivity analysis is compared to policy limits, which specify a maximum
tolerance level for net interest income exposure over a one-year horizon
assuming no balance sheet growth, given both a 200 basis point upward and
downward shift in interest rates. A parallel and pro rata shift in rates over a
12-month period is assumed. Results that exceed policy limits, if any, are
analyzed for risk tolerance and reported to the Board with appropriate
recommendations. At December 31, 2000, the Bank's estimated net interest income
sensitivity, as a percent of net interest income, for a parallel change in
interest rates of 200 basis points was 6.09% for rates up and (8.86)% in rates
down.
The estimated sensitivity does not necessarily represent a Company forecast and
the results may not be indicative of actual changes to the Company's net
interest income. These estimates are based upon a number of assumptions
including: the nature and timing of interest rate levels including yield curve
shape, prepayments on loans and securities, pricing strategies on loans and
deposits, replacement of asset and liability cashflows, and other assumptions.
While the assumptions used are based on current economic and local market
conditions, there is no assurance as to the predictive nature of these
conditions including how customer preferences or competitor influences might
change.
Liquidity
Liquidity risk is the risk to earnings or capital resulting from the Bank's
inability to meet its obligations when they come due without incurring
unacceptable losses. It includes the ability to manage unplanned decreases or
changes in funding sources and to recognize or address changes in market
conditions that affect the Bank's ability to liquidate assets or acquire funds
quickly and with minimum loss of value. The Company endeavors to maintain a
cash flow adequate to fund operations, handle fluctuations in deposit levels,
respond to the credit needs of
59
borrowers and to take advantage of investment opportunities as they arise. The
principal sources of liquidity include interest and principal payments on loans
and investments, proceeds from the maturity or sale of investments, and growth
in deposits.
In general, liquidity risk is managed daily by controlling the level of Fed
Funds and the use of funds provided by the cash flow from the investment
portfolio. The Company maintains overnight investments in Fed Funds as a cushion
for temporary liquidity needs. During 2000, Federal Funds averaged $20.5
million. In addition, the Company maintains Federal Fund credit lines of $136
million with major correspondent banks subject to the customary terms and
conditions for such arrangements.
At December 31, 2000, the Company had available liquid assets, which included
cash and unpledged investment securities of approximately $161.9 million, which
represents 17.9% of total assets.
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