UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-13273
F & M Bank Corp.
(Exact name of registrant as specified in its charter)
Virginia 54-1280811
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
P. O. Box 1111, Timberville, Virginia 22853
(Address of principal executive offices) (Zip Code)
(540) 896-8941
(Registrant's telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock - $5 Par value per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes No X
--------- --------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The registrant's Common Stock is traded Over-the-Counter under the symbol
FMBM. The aggregate market value of the 2,191,494 shares of Common Stock of the
registrant issued and outstanding held by non-affiliates on June 30, 2004 was
approximately $52,047,982 based on the closing sales price of $23.75 per share
on that date. For purposes of this calculation, the term "affiliate" refers to
all directors and executive officers of the registrant.
As of the close of business on March 1, 2005, there were 2,410,641 shares of
the registrant's Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement for the Annual Meeting of Shareholders to be held on May 14,
2005 (the "Proxy Statement").
2
F & M Bank Corp.
Index
Forward-Looking Statements 2
Form 10-K Cross Reference Sheet 3
F & M Bank Corp. 4
Report Format 4
Market for Common Equity and Related Stockholder Matters 5
Selected Financial Data 6
Management's Discussion and Analysis of Financial
Condition and Results of Operations 7-24
Consolidated Financial Statements 25-28
Notes to Consolidated Financial Statements 29-48
Report of Independent Auditors 49
Other Material Required by Form 10-K 50-55
Description of Business
Properties
Exhibits, Financial Statements, and Reports on Form 8-K
Signatures
Forward-Looking Statements
F & M Bank Corp. makes forward-looking statements in the Management's Discussion
and Analysis of Financial Condition and Results of Operations and in other
portions of this Annual Report on Form 10-K that are subject to risks and
uncertainties. These forward-looking statements include: estimates of risks and
of future costs and benefits; assessments of probable loan losses and statements
of goals and expectations. These forward-looking statements are subject to
significant uncertainties because they are based upon management's estimates and
projections of future interest rates and other economic conditions; future laws
and regulations; and a variety of other matters. As a result of these
uncertainties, actual results may be materially different from the results
indicated by these forward-looking statements. In addition, the Company's past
results of operations do not necessarily indicate its future results.
3
F & M Bank Corp.
Form 10-K Cross Reference Sheet Material Incorporated by Reference
The following table shows the location in this Annual Report on Form 10-K or in
the Proxy Statement of the information, which requires disclosure in SEC Form
10-K. As indicated below, information has been incorporated by reference in the
Report from the Proxy Statement. Other portions of the Proxy Statement are not
included in this Report. This Report is not part of the Proxy Statement. Page
references are in this report unless indicated otherwise.
Item of Form 10-K Location
PART I
Item 1 Business "Forward-Looking Statements" on page
2, "F&M Bank Corp." and "Report
Format" on page 4 and "Business on
pages 50 and 51.
Item 2 Properties "Properties" on page 52.
Item 3 Legal Proceedings Note 17 "Litigation" on page 43.
Item 4 Submission of Matters to a No matters have been submitted to a
Vote of Security Holders vote of security holders during the
fourth quarter of 2004.
PART II
Item 5 Market for Registrant's Common "Market for Registrant's Common
Equity and Related Equity and Related Stockholder
Stockholder Matters Matters" on page 5.
Item 6 Selected Financial Data "Selected Financial Data" on page 6.
Item 7 Management's Discussion and "Management's Discussion and
Analysis of Financial Analysis of Financial
Condition and Results of Condition and Results of Operations
Operations" on pages 7-24.
Item 7A Quantitative and Qualitative "Forward-Looking Statements" on
Disclosures about Market Risk page 2 and "Market Risk
Management" on page 20-21.
Item 8 Financial Statements and Pages 25 to 48.
Supplementary Information
Item 9 Changes in and Disagreements with There were no changes in or
Accountants on Accounting disagreements with
and Financial Disclosure accountants on accounting and
financial disclosure during
the last two fiscal years.
Item 9A Controls and Procedures "Other Material Required in Form
10-K" on page 52.
PART III
Item 10 Directors and Executive The material labeled "Section
Officers of the Registrant 16(a) Beneficial Ownership
Reporting Compliance" and
"Information Concerning
Directors and Nominees" in the
Proxy Statement is Incorporated
in this Report by
reference.
Item 11 Executive Compensation The material labeled "Summary
Compensation" and "Salary
Committee Report on Executive
Compensation" in the
Proxy Statement is incorporated in
this Report by reference.
Item 12 Security Ownership of Certain The material labeled "Stock
Beneficial Owners and Ownership of Directors and
Management Executive Officers" in the Proxy
Statement is incorporated
in this Report by reference.
Item 13 Certain Relationships and Related The material labeled "Indebtedness
Transactions and Other Transactions" in the Proxy
Statement is incorporated in this
Report by reference.
Item 14 Principal Accounting Fees The information regarding fees
and Services and services of F & M Bank Corp.'s
principal independent accountant,
S. B. Hoover & Company, under the
caption "Audit Committee Disclosure
- Fees Paid to Auditors" and
"Audit Committee Pre-Approval
Policy" contained in the
2004 Proxy Statement is incorporated
by reference herein.
PART IV
Item 15 Exhibits and Financial "Exhibits and Financial
Statement Schedules Statements" on page 53 and 54.
Signatures "Signatures" on page 55.
4
F & M Bank Corp.
F & M Bank Corp. is the holding company for Farmers & Merchants Bank, the oldest
banking business native to Rockingham County, Virginia. Operating as an
independent community bank, Farmers & Merchants Bank was originally organized as
Farmers & Merchants Bank of Timberville in 1908. The bank provides a wide range
of financial services to individuals and businesses through eight offices
located in Rockingham and Shenandoah Counties.
Report Format
The format of this report was changed in 2001 in order to increase information
distributed to shareholders and to reduce expenses related to preparing and
distributing annual financial information. Prior to that time, F & M Bank Corp.
provided an annual report to shareholders along with the annual proxy materials,
and also prepared and filed a separate Annual Report on Form 10-K under the
rules of the United States Securities and Exchange Commission ("SEC"). Beginning
in 2001 and for subsequent years, we are distributing the Form 10-K report to
shareholders with the annual proxy materials for the annual meeting. This report
includes the entire Form 10-K, other than exhibits, as filed with the SEC.
Please see page 53 for information regarding how to obtain copies of exhibits
and additional copies of the Form 10-K.
The SEC has not approved or disapproved this Report or passed upon its accuracy
or adequacy.
5
Item 5
Market for Registrant's Common Equity and Related Stockholder Matters
Stock Listing
The Company's Common Stock trades under the symbol "FMBM" on the OTC Bulletin
Board. The bid and asked price of the Company's stock is not published in any
newspaper. Although several firms in both Harrisonburg and Richmond, Virginia
occasionally take positions in the Company stock, they typically only match
buyers and sellers.
Transfer Agent and Registrar
Farmers & Merchants Bank
205 South Main Street
P.O. Box 1111 Timberville, VA 22853
Recent Stock Prices and Dividends
Dividends to shareholders totaled $1,785,994 and $1,693,215 in 2004 and 2003,
respectively. Regular quarterly dividends have been declared for forty-four
consecutive quarters. Dividends per share increased 5.71% in 2004.
The ratio of dividends per share to net income per share was 41.06% in 2004,
compared to 42.17% in 2003. The decision as to timing, amount and payment of
dividends is at the discretion of the Company's Board of Directors. The payment
of dividends depends on the earnings of the Company and its subsidiaries, the
financial condition of the Company and other factors including capital adequacy,
regulatory requirements, general economic conditions and shareholder returns.
On June 12, 2003, the Board authorized the repurchase of 50,000 shares of the
Company's outstanding common stock. Shares are repurchased either through
broker-arranged transactions or directly from the shareholder at the discretion
of management. The decision to purchase shares is based on factors including
market conditions for the stock and the availability of cash. Shares repurchased
through the end of 2004 total 22,721; of this amount, 18,237 shares were
repurchased in 2004.
The number of common shareholders of record was approximately 1,633 as of March
1, 2005. This amount includes all shareholders, whether titled individually or
held by a brokerage firm or custodian in street name.
Quarterly Stock Information
These quotes were obtained from Davenport & Company and include the terms of
trades transacted through a broker. The terms of exchanges occurring between
individual parties may not be known to the Company.
2004 2003
Per Share Range Per Share Stock Price Range Per Share
Quarter Low High Dividend Low High Dividend
1st 22.40 25.50 .18 18.65 19.50 .17
2nd 23.75 27.25 .18 19.20 19.60 .17
3rd 23.55 24.50 .19 19.00 22.30 .18
4th 24.50 27.00 .19 21.25 22.90 .18
Total .74 .70
6
Item 6
Five Year Summary of Selected Financial Data
(Dollars in thousands, 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
except per share data)
Income Statement Data:
Interest and Dividend
Income $ 16,804 $ 16,683 $ 17,846 $ 17,681 $ 15,509
Interest Expense 5,396 6,010 7,390 9,494 7,411
-------- ------- ------- ------- -------
Net Interest Income 11,408 10,673 10,456 8,187 8,098
Provision for Loan
Losses 240 226 387 204 123
------ ----- ----- ----- ------
Net Interest Income
after Provision
for Loan Losses 11,168 10,447 10,069 7,983 7,975
Noninterest Income 2,254 2,308 1,380 1,158 1,038
Securities Gains (Losses) 532 179 (182) 1,252 770
Noninterest Expenses 7,741 7,256 6,448 5,728 4,653
-------- ------- ------- ------- -------
Income before Income
Taxes 6,213 5,678 4,819 4,665 5,130
Income Tax Expense 1,863 1,666 1,315 1,435 1,486
-------- ------- ------- ------- -------
Net Income $ 4,350 $ 4,012 $ 3,504 $ 3,230 $ 3,644
======= ======= ======= ======= =======
Per Share Data:
Net Income $ 1.80 $ 1.66 $ 1.44 $ 1.33 $ 1.49
Dividends Declared .74 .70 .66 .63 .59
Book Value 14.21 13.35 12.19 11.74 11.18
Balance Sheet Data:
Assets $369,957 $309,126 $303,149 $272,673 $208,818
Loans Held for
Investment 248,972 211,231 201,980 176,625 152,035
Loans Held for Sale 47,150
Securities 38,800 61,230 69,602 63,987 45,323
Deposits 246,505 240,715 228,284 208,279 152,354
Short-Term Debt 57,362 6,389 8,308 10,696 8,698
Long-Term Debt 26,462 24,784 32,312 20,983 16,386
Shareholders' Equity 34,260 32,319 29,541 28,597 27,198
Average Shares
Outstanding 2,414 2,418 2,429 2,431 2,446
Financial Ratios:
Return on Average
Assets 1 1.31% 1.29% 1.21% 1.26% 1.76%
Return on Average
Equity 1 13.11% 13.13% 12.12% 11.47% 13.88%
Net Interest Margin 3.82% 3.82% 4.03% 3.52% 4.32%
Efficiency Ratio 2 54.02% 53.96% 51.28% 56.93% 50.93%
Dividend Payout Ratio 41.06% 42.17% 45.72% 47.45% 39.53%
Capital and Credit Quality Ratios:
Average Equity to
Average Assets 1 10.00% 9.86% 9.98% 11.02% 12.70%
Allowance for Loan
Losses to Loans 3 .61% .70% .73% .73% .73%
Nonperforming Assets
to Total Assets .63% .52% .86% .40% .52%
Net Charge-offs to
Total Loans 3 .09% .10% .10% .06% .07%
1 Ratios are primarily based on daily average balances.
2 The Efficiency Ratio equals noninterest expenses divided by the sum of tax
equivalent net interest income and noninterest income. Noninterest expenses
exclude intangible asset amortization. Noninterest income excludes gains
(losses) on securities transactions.
3 Calculated based on Loans Held for Investment, excludes Loans Held for Sale.
7
Item 7
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion provides information about the major components of the
results of operations and financial condition, liquidity and capital resources
of F & M Bank Corp. and its subsidiaries. This discussion and analysis should be
read in conjunction with the Consolidated Financial Statements and the Notes to
the Consolidated Financial Statements presented in Item 8, Financial Statements
and Supplementary Information, of this Form 10-K.
Critical Accounting Policies
General
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("GAAP"). The financial
information contained within the statements is, to a significant extent,
financial information that is based on measures of the financial effects of
transactions and events that have already occurred. The Company's financial
position and results of operations are affected by management's application of
accounting policies, including estimates, assumptions and judgments made to
arrive at the carrying value of assets and liabilities and amounts reported for
revenues, expenses and related disclosures. Different assumptions in the
application of these policies could result in material changes in the Company's
consolidated financial position and/or results of operations.
In addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of these transactions would be the same,
the timing of events that would impact these transactions could change.
Following is a summary of the Company's significant accounting policies that are
highly dependent on estimates, assumptions and judgments.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained
in the loan portfolio. The allowance is based on two basic principles of
accounting: (i) Statement of Financial Accounting Standard ("SFAS") No. 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and estimable and (ii) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued based
on the differences between the value of collateral, present value of future cash
flows or values that are observable in the secondary market and the loan
balance.
The Company's allowance for loan losses is the accumulation of various
components that are calculated based on independent methodologies. All
components of the allowance represent an estimation performed pursuant to either
SFAS No. 5 or SFAS No. 114. Management's estimate of each SFAS No. 5 component
is based on certain observable data that management believes are most reflective
of the underlying credit losses being estimated. This evaluation includes credit
quality trends; collateral values; loan volumes; geographic, borrower and
industry concentrations; seasoning of the loan portfolio; the findings of
internal credit quality assessments and results from external bank regulatory
examinations. These factors, as well as historical losses and current economic
and business conditions, are used in developing estimated loss factors used in
the calculations.
Allowances for commercial loans are determined by applying estimated loss
factors to the portfolio based on management's evaluation and "risk grading" of
the commercial loan portfolio. Allowances are provided for noncommercial loan
categories using estimated loss factors applied to the total outstanding loan
balance of each loan category. Specific allowances are typically provided on all
impaired commercial loans in excess of a defined threshold that are classified
in the Special Mention, Substandard or Doubtful risk grades. The specific
reserves are determined on a loan-by-loan basis based on management's evaluation
the Company's exposure for each credit, given the current payment status of the
loan and the value of any underlying collateral.
8
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Allowance for Loan Losses (Continued)
While management uses the best information available to establish the allowance
for loan and lease losses, future adjustments to the allowance may be necessary
if economic conditions differ substantially from the assumptions used in making
the valuations or, if required by regulators, based upon information available
to them at the time of their examinations. Such adjustments to original
estimates, as necessary, are made in the period in which these factors and other
relevant considerations indicate that loss levels may vary from previous
estimates.
Goodwill and Intangibles
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Additionally, it further clarifies the criteria for the
initial recognition and measurement of intangible assets separate from goodwill.
SFAS No. 142 was effective for fiscal years beginning after December 15, 2001
and prescribes the accounting for goodwill and intangible assets subsequent to
initial recognition. The provisions of SFAS No. 142 discontinue the amortization
of goodwill and intangible assets with indefinite lives. Instead, these assets
are subject to an annual impairment review and more frequently if certain
impairment indicators are in evidence. SFAS No. 142 also requires that reporting
units be identified for the purpose of assessing potential future impairments of
goodwill.
The Company adopted SFAS No. 142 on January 1, 2002. Goodwill totaled $2,639,000
at January 1, 2002. The goodwill is not amortized but is tested for impairment
at least annually. Based on this testing, there were no impairment charges for
2004 or 2003. Application of the non-amortization provisions of the Statement
resulted in additional net income of $190,000 for the year ended December 31,
2004, 2003 and 2002.
Core deposit intangibles are amortized on a straight-line basis over a ten year
life. Core deposits, net of amortization, amounted to $1,702,000 and $1,978,000
at December 31, 2004 and 2003, respectively. The Company adopted SFAS 147 on
January 1, 2002 and determined that the core deposit intangible will continue to
be amortized over its estimated useful life.
Securities Impairment
The Company evaluates each of its investments in securities, debt and equity,
under guidelines contained in SFAS 115, Accounting for Certain Investments in
Debt and Equity Securities. These guidelines require the Company to determine
whether a decline in value below original cost is other than temporary. In
making its determination, management considers current market conditions,
historical trends in the individual securities, and historical trends in the
overall markets. Expectations are developed regarding potential returns from
dividend reinvestment and price appreciation over a reasonable holding period
(five years) and current carrying values are compared to these expected values.
Declines determined to be other than temporary are charged to operations and
included in the gain (loss) on security sales. Such charges were $62,000 for
2004, zero for 2003 and $503,000 for 2002.
Overview
The Company's net income for 2004 totaled $4,350,000 or $1.80 per share, up 8.4%
from $4,012,000 or $1.66 a share in 2003. Return on average equity was virtually
unchanged in 2004 at 13.11% versus 13.13% in 2003, while the return on average
assets increased from 1.29% to 1.31%. The Company's operating earnings, which
are net earnings excluding gains (losses) on the sale of investments, redemption
of insurance contracts, and the non-cash amortization of acquisition
intangibles, were $4,177,000 in 2004 versus $3,930,000 in 2003, an increase of
6.28%. Core profitability improved as a result of an increase in net interest
income of 6.88%.
See page 6 for a five-year summary of selected financial data.
9
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Changes in Net Income per Common Share
2004 to 2003 2003 to 2002
------------ ------------
Prior Year Net Income Per Share $ 1.66 $ 1.44
Change from differences in:
Net interest income .30 .09
Provision for credit losses (.01) .07
Noninterest income, excluding securities gains (.02) .41
Securities gains .15 .15
Noninterest expenses (.20) (.36)
Income taxes (.08) (.15)
Other .01
-------- --------
Total Change .14 .22
-------- --------
Net Income Per Share $ 1.80 $ 1.66
======== ========
Net Interest Income
The largest source of operating revenue for the Company is net interest income,
which is calculated as the difference between the interest earned on earning
assets and the interest expense paid on interest bearing liabilities. The net
interest margin is the net interest income expressed as a percentage of interest
earning assets. Changes in the volume and mix of interest earning assets and
interest bearing liabilities, along with their yields and rates, have a
significant impact on the level of net interest income.
Net interest income for 2004 was $11,408,000 representing an increase of
$735,000 or 6.88%. A 2.08% increase in 2003 versus 2002 resulted in total net
interest income of $10,673,000. In this discussion and in the tabular analysis
of net interest income performance, entitled "Consolidated Average Balances,
Yields and Rates," (found on page 10), the interest earned on tax exempt loans
and investment securities has been adjusted to reflect the amount that would
have been earned had these investments been subject to normal income taxation.
This is referred to as tax equivalent net interest income.
The analysis on the next page reveals a net interest margin that was flat in
2004 and which followed a decrease in 2003 resulting from the Federal Reserve's
accommodative monetary stance. During 2004, loan volumes generated interest
income that more than offset the decline in volume and rates on other asset
categories. Tax equivalent income on earning assets increased $94,000. Yields on
all loan categories and on taxable and partially taxable investments continued
to fall as assets repriced at lower levels. The yield on earning assets fell
..33%.
Although interest bearing liabilities continued to reprice at lower levels, the
rate of decline moderated during 2004, with the cost of funds dropping .39%
compared to a decline of .76% in 2003. The net interest margin held steady in
2004 at 3.82% primarily due to a shift in balance sheet leverage as the
percentage of, higher yielding assets (loans and securities) increased in 2004
to 96.25% of total earning assets as compared to 91.41% in 2003.
During 2003 the net interest margin decreased in part due to a slow down in the
rate of growth in the loan portfolio, lower rates received on adjustable rate
mortgages that reached a rate adjustment date, securities maturing with proceeds
reinvested at lower rates and an increase in low yielding, short-term federal
funds sold. The percentage of longer-term, higher yielding assets (loans and
securities) declined in 2003 to 91.41% or total earning assets as compared to
93.52% in 2002.
10
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Consolidated Average Balances, Yields and Rates 1
2004 2003 2002
---- ---- ----
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- -------- ------ -------- ------- ------ ------ -------- ------
ASSETS
Loans: 2
Commercial $53,624 $3,078 5.74% $ 48,848 $ 3,020 6.18% $46,917 $3,201 6.82%
Real estate 149,158 9,316 6.25 128,984 8,940 6.93 121,999 9,248 7.58
Installment 24,122 2,020 8.37 24,663 2,218 8.99 27,114 2,465 9.09
------ ------ ----- ------ ----- ---- ------ ----- ----
Loans held for
investment 226,904 14,414 6.35 202,495 14,178 7.00 196,030 14,914 7.61
Loans held for sale 21,147 688 3.25 99 3 3.03
Investment
securities: 3
Fully taxable 34,020 1,058 3.11 47,908 1,765 3.68 43,347 2,083 4.84
Partially taxable 9,335 554 5.93 9,194 567 6.17 10,260 610 5.95
Tax exempt 375 17 4.53 160 7 4.38
------ ------ ----- ------ ----- ---- ------ ----- -----
Total Investment
Securities 43,730 1,629 3.73 57,262 2,339 4.08 53,607 2,693 5.02
Interest bearing
deposits
in banks 8,556 198 2.32 8,378 178 2.12 10,319 438 4.24
Federal funds sold 2,821 32 1.13 16,043 169 1.05 6,992 109 1.56
------ ------ ----- ------ ----- ---- ------ ----- ----
Total Earning
Assets 303,158 16,961 5.60 284,277 16,867 5.93 266,948 18,154 6.80
------- ------ ----- ------ ---- ------ ----
Allowance for loan
losses (1,527) (1,511) (1,400)
Nonearning assets 30,097 27,055 24,147
------ ------ -------
Total Assets $331,728 $ 309,821 $289,695
======== ========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand - Interest
bearing $ 38,223 $ 205 .54 $ 35,611 $ 214 .60 $ 32,094 $ 307 .96
Savings 49,879 453 .91 44,547 488 1.10 39,624 710 1.79
Time deposits 119,140 3,313 2.78 125,430 4,018 3.20 116,699 4,898 4.20
------- ------ ----- ------- ------ ----- ------- ----- ------
Total Deposits 207,242 3,971 1.92 205,588 4,720 2.30 188,417 5,915 3.14
Short-term debt 24,218 419 1.73 7,179 44 .61 8,497 104 1.22
Long-term debt 25,274 1,006 3.98 28,645 1,246 4.35 30,645 1,372 4.48
------ ------ ----- ------ ------ ----- ------ ----- ------
Total Interest
Bearing
Liabilities 256,734 5,396 2.10 241,412 6,010 2.49 227,559 7,391 3.25
------ ----- ------ ---- ----- ------
Noninterest bearing
deposits 37,720 31,442 28,300
Other liabilities 4,105 6,408 4,932
------ ------ -------
Total Liabilities 298,559 279,262 260,791
Stockholders' equity 33,169 30,559 28,904
------ ------ ------
Total Liabilities
and
Stockholders'
Equity $ 331,728 $309,821 $ 289,695
========= ======= =========
Net Interest
Earnings $ 11,565 $ 10,857 $10,763
Net Yield on
Interest Earning
Assets (NIM) 3.82% 3.82% 4.03%
===== ===== =====
1 Income and yields are presented on a tax-equivalent basis using the
applicable federal income tax rate.
2 Interest income on loans includes loan fees.
3 Average balance information is reflective of historical cost and has not been
adjusted for changes in market value.
11
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following table illustrates the effect of changes in volumes and rates.
2004 Compared to 2003 2003 Compared to 2002
Increase (Decrease) Increase (Decrease)
------------------- -------------------
Due to Change Increase Due to Change Increase
in Average: or in Average: or
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- -------- -------- ---- --------
Interest income:
Loans held for
investment $ 1,709 $ (1,473) $ 236 $ 496 $(1,232) $ (736)
Loans held for sale 638 47 685 3 3
Investment securities:
Taxable (511) (196) (707) 221 (539) (318)
Partially taxable 9 (22) (13) (63) 20 (43)
Tax exempt 9 1 10 7 7
Interest bearing
deposits
in banks 4 16 20 (82) (178) (260)
Federal funds sold (139) 2 (137) 141 (81) 60
------- ------ ------- ---- ------ -----
Total Interest
Income 1,719 (1,625) 94 723 (2,010) (1,287)
----- ------ ----- ----- ------ -------
Interest expense:
Deposits:
Demand 16 (25) (9) 34 (127) (93)
Savings 59 (94) (35) 88 (310) (222)
Time deposits (201) (504) (705) 367 (1,247) (880)
Short-term debt 104 277 381 (16) (44) (60)
Long-term debt (147) (99) (246) (90) (36) (126)
------- ------ ----- ----- ----- ------
Total Interest
Expense (169) (445) (614) 383 (1,764) (1,381)
------ ------- ------ ----- ----- ------
Net Interest
Income $1,888 $(1,180) $ 708 $ 340 $ (246) $ 94
===== ======= ===== ===== ====== =====
Note: Volume changes have been determined by multiplying the prior years'
average rate by the change in average balances outstanding. The rate change is
the difference between the total change and the volume change.
Interest Income
Tax equivalent interest income increased $94,000 or .56% in 2004, after
decreasing 7.09% or $1,287,000 in 2003. Although 2004 earning assets increased
$18,881,000, the distribution of the increase and overall decline in portfolio
rates resulted in only a modest increase in interest income. Overall, the yield
on earning assets declined .33%, from 5.93% to 5.60%. The combined two year
decrease in yields on earning assets now totals 1.20%.
Loan growth accelerated during 2004, with average outstandings increasing
$24,409,000 to $226,904,000. Real estate loans increased 18.56% and accounted
for over 68% of the total increase in year ending loans. This increase in real
estate loans resulted as rates for loans that remain in the Bank's portfolio,
primarily three and five year adjustable loans became more favorable as
secondary market rates rebounded somewhat from their historic lows. This
category includes residentially secured loans, as well as loans secured by
commercial real estate.
Average total securities, yielding 3.73%, decreased $13,532,000 during 2004.
Proceeds from the sale and maturity of investment securities were used to fund
loan growth. Income on loans held for sale increased $685,000. These are
short-term real estate loan participations that have an average life of
approximately fifteen days. The bank originally entered into this participation
arrangement as a higher yielding alternative to federal funds sold, however
throughout much of 2004, based on the volume of these participations and the
availability of excess liquidity, the Bank funded these participations with
overnight borrowings from the Federal Home Loan Bank. The spread between the
earnings on these participations and the cost of the overnight borrowings from
the FHLB added approximately $240,000 to pretax earnings and approximately
$158,000 to net income for the year.
12
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Interest Expense
Interest expense decreased $614,000 or 10.22% during 2004, which followed an
18.68% decrease ($1,381,000) in 2003. The average cost of funds of 2.10%
declined .39% compared to 2003. Average interest bearing liabilities increased
$15,322,000 and $13,853,000 in 2004 and 2003, respectively. This increase was
primarily the result of the increase in short-term debt, which was used to fund
short-term real estate loan participations. The Bank also enjoyed growth in
demand and savings accounts as a result of continued consolidation among larger
banks within its markets. Expense of time deposits decreased $705,000 or 17.55%
in 2004. This followed a decline of 17.97% or $880,000 in 2003. These decreases
resulted as customer accounts renewed at rates that were often 3.00% to 3.50%
lower than rates paid as recently as early 2001. Expense of long-term debt
decreased $246,000 and $126,000, respectively in 2004 and 2003. The declines in
both years resulted from a combination of lower levels of debt and lower average
expense as older higher rate debt paid off or paid down. The Company borrowed an
additional $9,000,000 from the FHLB to fund long-term loans during 2004 and did
not obtain any additional long-term debt during 2003.
Noninterest Income
As a result of the current low interest rate environment placing pressure on the
net interest margin, noninterest income continues to be an increasingly
important factor in maintaining and growing profitability. Management is
conscious of the need to constantly review fee income and develop additional
sources of complementary revenue. The Bank continues to enjoy increased revenue
from its subsidiary Farmers & Merchants Financial Services (FMFS). Gross revenue
for FMFS increased $97,000 in 2004. This increase resulted from greater levels
of commissions from its partnerships in Bankers Insurance, LLC and BI
Investments, LLC. This increase followed an increase of $137,000 in 2003.
Exclusive of securities gains and losses, and non-recurring insurance gains
non-interest income increased 5.16% ($111,000) in 2004 following an increase of
67.30% in 2003. Service charges on deposit accounts were virtually flat compared
to 2003, increasing only .65% ($6,000). In 2004, the Bank continued to offer
free regular checking accounts and increased the transaction limits on its small
business checking product in an effort to attract stable low cost deposits.
While we did attract an additional $6,278,000 in average balances of
non-interest bearing checking accounts this resulted in a decrease in account
maintenance fees of $32,000.
Overdraft charges moderated to an annualized growth rate of 5.09% in 2004. This
compared to a 41.93% increase in 2003, which was the first year of the Bank's
new bounce protection program. Bank management has reviewed our position within
the market and determined that an increase in the current overdraft fee from $25
to $29 per item is appropriate. This change will become effective April 1, 2005
and should be accretive to overdraft fee income in the current calendar year.
Investments in bank owned life insurance (BOLI) on officers of the Company
resulted in tax-free income of $251,000 in 2004 versus $238,000 in 2003. During
2003, the Bank invested an additional $2,291,000 in BOLI, through a combination
of cash purchases and a tax-free exchange of existing split-dollar life
insurance policies. The conversion of the split-dollar policies resulted in
non-recurring gains of $164,000 in 2003 which is included in other operating
income.
Securities transactions in 2004 resulted in gains of $532,000 after recognizing
impairment write downs of $162,000 on two of its equity holdings. These write
downs included a $100,000 write down on the Bank's investment in BI Investments,
LLC and a $62,000 write down by the Company on one of its equity holdings. This
followed gains of $179,000 in 2003, which included a similar write down on the
investment in BI Investments, LLC. Although this investment is a minority
interest, accounted for at cost, management determined that the losses generated
during 2004 and 2003 were unlikely to be recouped in the near future and
recognized impairment in the investment under SFAS 115.
13
Management's Discussion and Analysis of Financial Condition and Results of
Operations
In 2002, the Company suffered its first year of net securities losses since
1991. Losses in 2002 totaled $182,000, and were the result of the Company
recognizing impairment on several of its equity holdings. Based on market
conditions, historical trends of the individual securities and trends during
previous market cycles, management determined that several holdings met the
definition of impairment. The impairment recognized was based on management's
expectations of potential total returns from dividend reinvestment and price
appreciation over a reasonable holding period (five years). This analysis
resulted in a total write down in 2002 of $503,000 affecting five equities held
by the Company. The Company has reevaluated the investments that were written
down in 2002 during both 2004 and 2003 and determined that there was no
additional impairment.
Noninterest Expense
Noninterest expenses increased from $7,255,000 in 2003 to $7,741,000 in 2004, a
6.70% increase. Salary and benefits increased 6.36% to $4,392,000 in 2004 and
14.67% in 2003 compared to 2002. The 2004 increase resulted from normal salary
adjustments, increases in insurance and pension expenses. The increase in
salaries and benefits in 2003 included a full year of salaries and benefits for
the Harrisonburg mortgage and investment office, increased staff in several
branch offices, normal salary adjustments and increases in insurance and pension
expenses.
Occupancy and equipment expense increased $21,000 (2.58%) in 2004. This follows
an 18.45% increase in 2003 which resulted from full year of expenses for the
Harrisonburg office, additional depreciation on the remodeled Elkton Office and
depreciation on upgrades to computer hardware and software.
Other operating expense increased $202,000 in 2004, following a $153,000
increase in 2003. Much of the increase was due to increases in data processing
fees paid for computer software, licensing and maintenance of new and existing
programs; advertising, travel and training, ATM expenses, check printing costs
and a non-compete covenant with a retired executive.
Although noninterest expenses have increased substantially in both 2004 and
2003, they continue to be substantially less than peer group averages. Total
noninterest expense as a percentage of average assets totaled 2.33%, 2.34%, and
2.22%, in 2004, 2003 and 2002, respectively. Peer group averages are
approximately 3.10% over the same time period.
Provision for Loan Losses
Management evaluates the loan portfolio in light of national and local economic
trends, changes in the nature and value of the portfolio and industry standards.
Specific factors considered by management in determining the adequacy of the
level of the allowance for loan losses include internally generated loan review
reports, past due reports and historical loan loss experience. This review also
considers concentrations of loans in terms of geography, business type and level
of risk. Management evaluates nonperforming loans relative to their collateral
value and makes the appropriate adjustments to the allowance for loan losses
when needed. Based on the factors outlined above, the current year provision for
loan losses increased from $226,000 in 2003 to $240,000 in 2004. Actual loan
charge-offs were $213,000 in 2004 and $219,000 in 2003. Loan losses as a
percentage of period ending loans held for investment totaled .09% and .10% in
both 2004 and 2003, respectively. Losses continue at less than one-half that of
the Bank's peer group average, which have ranged between .17% and .29% over the
last three years.
Balance Sheet
Total assets increased 19.68% during the year to $369,957,000, an increase of
$60,831,000 from $309,126,000 in 2003. Earning assets increased 20.48% or
$58,671,000 to $345,170,000 at December 31, 2003. Much of the increase in
earning assets resulted from the aforementioned real estate loan participation
portfolio which totaled $47,150,000 at year end 2004. Interest bearing
liabilities increased $50,870,000 or 21.31%. Short-term debt increased
$50,973,000 with most of this increase used to fund mortgage loan
participations. If these mortgage participations decrease significantly, which
has occurred in the first quarter of 2005, the balance sheet will contract as
both loans held for sale and short-term debt will decrease proportionately. The
Company continues to utilize its assets well with 93.30% of year-end assets
consisting of earning assets.
14
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Investment Securities
Average balances in investment securities decreased 23.63% in 2004 to
$43,730,000. This decrease was in the investment portfolio segment of fully
taxable investment securities. The decrease resulted from a combination of
securities sales, maturities and pool pay downs. Securities were sold during the
spring and summer of 2004 to fund loan growth and to take advantage of
securities gains that were available within the portfolio. The securities sales
in these periods resulted in gains to the Bank of $99,000.
At year end, the 11% of earning assets of the Company were held as investment
securities to provide liquidity, as security for public deposits and to secure
repurchase agreements. Management strives to match the types and maturities of
securities owned to balance projected liquidity needs, interest rate sensitivity
and to maximize earnings through a portfolio bearing low credit risk.
Portfolio yields averaged 3.73% for 2004, down from 4.08% in 2003. Average
yields have tended to fall below the peer group due to management's decision to
maintain a relatively short duration portfolio. This has been especially true in
recent periods due to the sale of a significant percentage of the Bank's
holdings of corporate bonds. As previously mentioned, these bonds were sold to
fund loan growth, to assist in the management of risk based capital ratios and
were selected for sale due to gains that were available at the time the sale
decision was made.
Analysis of Securities
The composition of securities at December 31 was:
(Dollars in thousands) 2004 2003 2002
---- ---- ----
Available for Sale:1
U.S. Treasury and Agency $16,011 $25,443 $38,475
Municipal 369 373
Mortgage-backed2 5,425 8,989 5,069
Corporate bonds 2,466 10,845 11,338
Marketable equity securities 6,485 9,245 8,026
------ ------ ------
Total 30,756 54,895 62,908
Held to Maturity:
U.S. Treasury and Agency 110 110 110
Corporate bonds 0 764 1,767
------ ------ ------
Total 110 874 1,877
Other Equity Investments 7,934 5,461 4,817
------ ------ ------
Total Securities $38,800 $61,230 $69,602
====== ====== ======
1 At estimated fair value.
2 Issued by a U.S. Government Agency or secured by U.S. Government Agency
collateral.
15
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Maturities and weighted average yields of debt securities at December 31, 2004
are presented in the table below. Amounts are shown by contractual maturity;
expected maturities will differ as issuers may have the right to call or prepay
obligations.
Years to Maturity
Less One to Over
(Dollars in thousands) than one Five Five
Amount Yield Amount Yield Amount Yield Total Yield
-------- ------ ------- ------- ------- ------ ------ ------
Debt Securities Available
for Sale:
U.S. Treasury,
Agency $ $16,011 3.45% $ $16,011 3.45%
Municipal 369 3.07 369 3.07
Mortgage-backed 3,666 4.50 1,759 3.34% 5,425 4.12
Corporate bonds 1,953 2.34 513 7.15 2,466 3.34
----- ------- ------- -------
Total $ $21,999 3.52% $ 2,272 4.20% $24,271 3.58%
------ ------- -------- -------
Debt Securities Held
to Maturity:
U.S. Treasury &
Agency $ 110 1.89% 110 1.89%
----- ------
Total $ 110 1.89% $ n/a $ n/a $ 110 1.89%
====== ========= ======== =======
Analysis of Loan Portfolio
The Company's portfolio of loans held for investment totaled $248,972,000 at
December 31, 2004 compared with $211,231,000 at the beginning of the year. The
Company's policy has been to make conservative loans that are held for future
interest income. Collateral required by the Company is determined on an
individual basis depending on the purpose of the loan and the financial
condition of the borrower. Commercial loans, including agricultural and multi
family loans, increased 22.78% during 2004 to $62,787,000. Real estate mortgages
increased $23,742,000 (19.22%), while construction loans increased $2,036,000 or
13.28%. Consumer installment loans had a modest increase of $376,000. This
category includes personal loans, auto loans and other loans to individuals. It
appears that this category suffers from strong competition by other providers of
automobile financing, favorable mortgage rates that have led to refinancing of
existing loans and growth in home equity lines of credit. Credit card balances
were increased $15,000 to $1,478,000 but are a minor component of the loan
portfolio.
The following table presents the changes in the loan portfolio over the previous
five years.
December 31
(Dollars in thousands) 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Real estate-mortgage $ 147,281 $ 123,539 $ 118,453 $ 105,305 $ 92,464
Real estate-construction 17,365 15,329 12,059 5,521 4,372
Consumer installment 20,006 19,630 22,704 23,106 20,927
Commercial 43,973 40,149 35,769 28,552 25,628
Agricultural 15,110 10,512 10,966 11,835 6,656
Multi-family residential 3,703 477 484 869 703
Credit cards 1,478 1,463 1,477 1,348 1,249
Other 56 132 68 89 36
-------- ------- ------- ------- ------
Total Loans $ 248,972 $211,231 $ 201,980 $ 176,625 $ 152,035
-------- ======== ======== ======== ========
16
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following table shows the Company's loan maturity and interest rate
sensitivity as of December 31, 2004:
Less Than 1-5 Over
(Dollars in thousands) 1 Year Years 5 Years Total
------ ----- ------- -----
Commercial and
agricultural loans $38,950 $20,001 $ 3,835 $ 62,786
Real Estate - mortgage 13,106 110,343 23,832 147,281
Real Estate - construction 17,365 17,365
Consumer - installment/other 2,692 18,369 479 21,540
------ ------ ------ ------
Total $72,113 $148,713 $28,146 $248,972
Loans with predetermined rates $ 7,992 $ 26,655 $16,715 $ 51,362
Loans with variable or
adjustable rates 64,121 122,058 11,431 197,610
------ ------- ------ -------
Total $72,113 $148,713 $28,146 $248,972
======== ======= ====== ========
Residential real estate loans are generally made for a period not to exceed 25
years and are secured by a first deed of trust which normally does not exceed
90% of the appraised value. If the loan to value ratio exceeds 90%, the Company
requires additional collateral, guarantees or mortgage insurance. On
approximately 80% of the real estate loans, interest is adjustable after each
three or five year period. Fixed rate loans are generally made for a
fifteen-year or a twenty-year period with an interest rate adjustment after ten
years.
Since 1992, fixed rate real estate loans have been funded with fixed rate
borrowings from the Federal Home Loan Bank, which allows the Company to control
its interest rate risk. In addition, the Company makes home equity loans secured
by second deeds of trust with total indebtedness not to exceed 90% of the
appraised value. Home equity loans are made for three, five or seven year
periods at a fixed rate or as a revolving line of credit.
Construction loans may be made to individuals, who have arranged with a
contractor for the construction of a residence, or to contractors that are
involved in building pre-sold, spec-homes or subdivisions. The majority of
commercial loans are made to small retail, manufacturing and service businesses.
Consumer loans are made for a variety of reasons, however, approximately 60% of
the loans are secured by automobiles and trucks.
The Company's market area has a stable economy which tends to be less cyclical
than the national economy. Major industries in the market area include
agricultural production and processing, higher education, retail sales, services
and light manufacturing. The agricultural production and processing industry is
a major contributor to the local economy and its performance and growth tend to
be cyclical in nature, however, this cyclical nature is offset by other stable
industries in the trade area. In addition to direct agricultural loans, a large
percentage of residential real estate loans and consumer installment loans are
made to borrowers whose income is derived from the agricultural sector of the
economy. A large percentage of the agricultural loans are made to poultry
growers.
During recent years, real estate values in the Company's market area for
commercial, agricultural and residential property increased, on the average,
between 5% and 8% annually depending on the location and type of property.
Approximately 80% of the Company's loans are secured by real estate, however,
policies relating to appraisals and loan to value ratios are adequate to control
the related risk. Unemployment rates in the Company's market area continue to be
below both the national and state averages.
The Bank has identified loan concentrations of greater than 25% of capital in
the following categories, poultry related, motel properties, churches and
construction/development. While the Bank has not developed a formal policy
limiting the concentration level to any particular loan type or industry
segment, concentrations are monitored and reported to the board of directors
quarterly. Concentration levels have been used by management to determine how
aggressively they may price or pursue new loan requests. At December 31, 2004,
there are no industry categories of loans that exceed 10% of total loans.
17
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Nonaccrual and Past Due Loans
The following table shows loans placed in a nonaccrual status and loans
contractually past due 90 days or more as to principal or interest payments.
December 31,
(Dollars in thousands) 2004 2003 2002 2001 2000
Nonaccruing loans $ 864 None None $ None 664
Loans past due 90 days
or more $1,379 $1,614 $2,594 $1,096 $ 421
----- ----- ----- ------ -----
Total $2,243 $1,614 $2,594 $1,096 $1,085
Percentage of total
loans .90% .76% 1.28% .62% .71%
Commerical loans are placed on nonaccrual status when they become ninety days or
more past due, unless there is an expectation that the loan will either be
brought current or paid in full in a reasonable period of time. Interest
accruals are continued on past due, secured residential real estate loans and
consumer purpose loans until the principal and accrued interest equal the value
of the collateral and on unsecured loans until the financial condition of the
borrower deteriorates to the point that any further accrued interest would be
determined to be uncollectible. At December 31, 2004, 2003, and 2002, there were
no restructured loans on which interest was accruing at a reduced rate or on
which payments had been extended.
Potential Problem Loans
Loans classified for regulatory purposes as loss, doubtful, substandard, or
special mention do not represent or result from trends or uncertainties which
management reasonably expects will materially impact future operating results,
liquidity or capital resources. Nor do they represent material credits about
which management is aware of any information which causes it to have serious
doubts as to the ability of such borrowers to comply with the loan repayment
terms. As of December 31, 2004, management is not aware of any potential problem
loans which are not already classified for regulatory purposes or on the watch
list as part of the Bank's internal grading system.
Loan Losses and the Allowance for Loan Losses
In evaluating the portfolio, loans are segregated into loans with identified
potential losses, and pools of loans by type (commercial, residential, consumer,
credit cards). Loans with identified potential losses include examiner and bank
classified loans. Classified relationships in excess of $100,000 are reviewed
individually for impairment under FAS 114. A variety of factors are taken into
account when reviewing these credits, including borrower cash flow, payment
history, fair value of collateral, company management, industry and economic
factors. Loan relationships that are determined to have no impairment are placed
back into the appropriate loan pool and reviewed under SFAS No. 5.
Loan pools are further segmented into watch list, past due over 90 days and all
other. Watch list loans include loans that are 60 days past due and may include
restructured loans, borrowers that are highly leveraged, loans that have been
upgraded from classified or loans that contain policy exceptions (term,
collateral coverage, etc.). Loss estimates on these loans reflect the increased
risk associated with these assets due to any of the above factors. The past due
pools contain loans that are currently 90 days or more past due. Loss rates
assigned to these past due loans reflect the fact that these loans bear a
significant risk of charge-off. Loss rates vary by loan type to reflect the
likelihood that collateral values will offset a portion of the anticipated
losses.
The remainder of the portfolio falls into pools by type of homogenous loans that
do not exhibit any of the above described weaknesses. Loss rates are assigned
based on historical rates over either the prior five year or prior two year
period depending on the type of loan. A multiplier has been applied to these
loss rates to reflect the time for loans to season within the portfolio and the
inherent imprecision of these estimates.
18
Management's Discussion and Analysis of Financial Condition and Results of
Operations
All potential losses are evaluated within a range of low to high. An unallocated
allowance has been established to reflect other unidentified losses within the
portfolio. The unallocated allowance mitigates the increased risk of loss
associated with fluctuations in past due trends, changes in the local and
national economies, and other unusual events. The Board approves the loan loss
provision for each quarter based on this evaluation. An effort is made to keep
the actual allowance at or above the midpoint of the range established by the
evaluation process.
The allowance for loan losses of $1,511,000 at December 31, 2004 is equal to
..61% of total loans held for investment. This compares to an allowance of
$1,484,000 (.70%) at December 31, 2003. The overall level of the allowance
remains well below the peer group averages. Management feels this is appropriate
based on its loan loss history and the composition of its loan portfolio; the
current allowance for loan losses is equal to approximately seven years of
average loan losses. Based on historical losses, delinquency rates, collateral
values of delinquent loans and a thorough review of the loan portfolio,
management is of the opinion that the allowance for loan losses fairly states
the estimated losses in the current portfolio.
Loan losses, net of recoveries, totaled $213,000 in 2004 which is equivalent to
..09% of total loans outstanding. Over the preceding five years, the Company has
had an average loss rate of .08% which is approximately forty percent of the
loss rate of its peer group.
A summary of the activity in the allowance for loan losses follows:
(Dollars in thousands) 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Balance at beginning of period $1,484 $1,477 $1,289 $1,108 $1,090
Provision charged to expenses 240 226 387 204 123
Other adjustments 84
Loan losses:
Commercial 123 76 20 22 21
Installment 166 219 249 138 125
Real estate 7 31 2
----- ----- ----- ----- -----
Total loan losses 296 295 300 160 148
----- ----- ----- ----- -----
Recoveries:
Commercial 16 11 28 3 3
Installment 67 65 73 49 39
Real estate 1 1
----- ----- ----- ----- -----
Total recoveries 83 76 101 53 43
----- ----- ----- ----- -----
Net loan losses 213 219 199 107
----- ----- ------ --- ---
105
Balance at end of period $1,511 $1,484 $1,477 $1,289 $1,108
===== ===== ===== ===== =====
Allowance for loan losses as a
percentage of loans .61% .70% .73% .73% .73%
Net loan losses to loans
outstanding .09% .10% .10% .06% .07%
The Company has allocated the allowance according to the amounts deemed to be
reasonably necessary to provide for the possibility of losses occurring within
each of the above categories of loans. The allocation of the allowance as shown
below should not be interpreted as an indication that loan losses in future
years will occur in the same proportions or that the allocation indicates future
loan loss trends.
Furthermore, the portion allocated to each loan category is not the total amount
available for future losses that might occur within such categories since the
total allowance is a general allowance applicable to the entire portfolio.
19
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following table shows the allocation of the allowance by loan type and the
related outstanding loan balances to total loans.
(Dollars in thousands)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
% of % of % of % of % of
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
Commercial $ 506 33% $ 475 26% $ 443 23% $ 451 23% $ 332 25%
Real estate 280 59% 297 64% 369 65% 323 63% 277 61%
Installment 650 8% 638 10% 591 12% 451 14% 333 14%
Unallocated 75 74 74 64 166
---- -- ---- --- ---- --- ---- -- ---- ---
Total $1,511 100% $1,484 100% $1,477 100% $1,289 100% $1,108 100%
======= ===== ======= ===== ====== ==== ====== ==== ====== ====
Deposits and Borrowings
The Bank recognized an increase in year-end deposits in 2004 of 2.41%. The Bank
experienced an increase in all account types with the exception of certificates
of deposit. Rates of interest declined throughout all of 2004. The Bank
advertised free checking throughout the year which resulted in a 22.85%
($7,570,000) increase in noninterest bearing checking accounts. In the fourth
quarter of 2004, the Bank began advertising a special promotion on a thirteen
month time deposit. This certificate was designed to raise cash to fund loan
growth and also as a defensive measure in some parts of our market due to
competition from other banks. In January 2005, the Bank also began offering a
rate special on a nine month certificate of deposit. Time deposits have
increased approximately $6,000,000 through the end of February 2005 as a result
of these two promotions.
The Bank has traditionally avoided brokered and large deposits believing that
they were unstable and, thus not desirable. This has proven to be a good
strategy as the local deposit base is very stable and small increases in rates
above the competition have usually resulted in deposit gains in past years.
Beginning in 2001 the Bank has, on occasion, accepted certificates of deposit
from other financial institutions at below market rates of interest. Typically
this has been done to meet loan demand or if liquidity was sufficient, the Bank
has reinvested these deposits in certificates of deposit at other institutions
which were offering above market rates. Certificates of deposit over $100,000
totaled $24,660,968 at December 31, 2004. The maturity distribution of these
certificates is as follows:
(Dollars in thousands) 2004 2003
---------------------- ---- ----
Less than 3 months $ 3,931 $ 3,206
3 to 12 months 7,173 7,250
1 year to 5 years 13,557 10,682
---------- -------
Total $ 24,661 $ 21,138
========= ==========
Non-deposit borrowings include repurchase agreements, federal funds purchased,
Federal Home Loan Bank (FHLB) daily rate credit and long-term debt obtained
through the FHLB and SunTrust Bank. Repurchase agreements continue to be an
important source of funding and provide commercial customers the opportunity to
earn market rates of interest on funds that are secured by specific securities
owned by the Bank.
Borrowings from the Federal Home Loan Bank are used to support the Bank's
mortgage lending program and allow the Bank to offer longer-term mortgages. The
Bank borrowed $9,000,000 in 2004 and did not borrow any additional funds from
the FHLB during 2003. Quarterly installment payments on FHLB debt totaled
$6,194,000 for the year. These loans carry an average rate of 4.40% at December
31, 2004.
20
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Stockholder's Equity
Total stockholders' equity increased $1,941,000 or 6.01% in 2004. Earnings
retained from operations were the primary source of the increase. As of December
31, 2004, book value per share was $14.21 compared to $13.35 as of December 31,
2003. Dividends are paid to stockholders on a quarterly basis in uniform amounts
unless unexpected fluctuations in net income indicate a change to this policy is
needed.
Banking regulators have established a uniform system to address the adequacy of
capital for financial institutions. The rules require minimum capital levels
based on risk-adjusted assets. Simply stated, the riskier an entity's
investments, the more capital it is required to maintain. The Bank, as well as
the Company, is required to maintain these minimum capital levels. The two types
of capital guidelines are Tier I capital (referred to as core capital) and Tier
II capital (referred to as supplementary capital). At December 31, 2004, the
Company had Tier I capital of 12.59% of risk weighted assets and combined Tier I
and II capital of 13.22% of risk weighted assets. Regulatory minimums at this
date were 4% and 8%, respectively. The Bank has maintained capital levels far
above the minimum requirements throughout the year. In the unlikely event that
such capital levels are not met, regulatory agencies are empowered to require
the Company to raise additional capital and/or reallocate present capital.
In addition, the regulatory agencies have issued guidelines requiring the
maintenance of a capital leverage ratio. The leverage ratio is computed by
dividing Tier I capital by actual total assets. The regulators have established
a minimum of 3% for this ratio, but can increase the minimum requirement based
upon an institution's overall financial condition. At December 31, 2004, the
Company reported a leverage ratio of 8.38%. The Bank's leverage ratio was also
substantially above the minimum.
Market Risk Management
Most of the Company's net income is dependent on the Bank's net interest income.
As the rapid change in short-term interest rates demonstrated in 2001, net
interest income is subject to interest rate risk to the extent that imbalances
exist between the maturities or repricing of interest bearing liabilities and
interest earning assets. In 2002 for example, interest bearing liabilities
repriced much more quickly than interest earning assets; this resulted in an
increase in the net interest margin compared to 2001. During 2003 this trend
reversed, as longer term assets (principally mortgage loans and securities)
matured or repriced at rates that were substantially lower, while most interest
bearing liabilities had already repriced at lower rates in either 2001 or 2002.
In 2004, the net interest margin was unchanged, both interest earning assets and
interest bearing liabilities continued to reprice at lower levels.
Net interest income is also affected by changes in the mix of funding that
supports earning assets. For example, higher levels of non-interest bearing
demand deposits and leveraging earning assets by funding with stockholder's
equity would result in greater levels of net interest income than if most of the
earning assets were funded with higher cost interest-bearing liabilities, such
as certificates of deposit.
Liquidity as of December 31, 2004 is strong. The Bank historically has had a
stable core deposit base and, therefore, does not have to rely on volatile
funding sources. Because of the stable core deposit base, changes in interest
rates should not have a significant effect on liquidity. During 2004, the Bank
used, investment sales, maturing investments, and deposit growth to meet its
funding needs for loans held for investment. The Bank's membership in the
Federal Home Loan Bank has historically provided liquidity as the Bank borrows
money that is repaid over a five to ten year period and uses the money to make
fixed rate loans. The matching of the long-term receivables and liabilities
helps the Bank reduce its sensitivity to interest rate changes. The Company
reviews its interest rate gap periodically and makes adjustments as needed.
There are no off balance sheet items that will impair future liquidity.
As mentioned previously, the Bank has used short-term daily rate credit from the
FHLB to fund its portfolio of loans held for sale. The rate on the daily rate
credit can reprice daily, while the loans held for sale reprice with changes in
the federal funds rates. Since these assets have an average life of
approximately fifteen days, there is very little interest rate risk associated
with the matching of the asset and corresponding liability.
21
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following table depicts the Company's interest rate sensitivity, as measured
by the repricing of its interest sensitive assets and liabilities as of December
31, 2004. As the notes to the table indicate, the data was based in part on
assumptions as to when certain assets or liabilities would mature or reprice.
The analysis indicates a liability sensitive one-year cumulative GAP position of
5.87% of total earning assets. Approximately 37% of rate sensitive assets and
51% of rate sensitive liabilities are subject to repricing within one year. The
one-year cumulative GAP increased during 2004, as the Bank held less short-term
liquid assets. Based on historically low rates on bonds throughout 2004 and
strong loan demand, the Investment Committee and management choose to not
reinvest bond maturities, loan repayments and cash in longer-term investments.
Management believes that remaining liquid and keeping investments short-term in
nature will allow it to achieve greater earnings in the future when rates rise
to higher levels.
The following GAP analysis shows the time frames from December 31, 2004, in
which the Company's assets and liabilities are subject to repricing:
1-90 91-365 1-5 Over 5 Not Total
(Dollars in thousands) Days Days Years Years Classified
Rate Sensitive Assets:
Loans held for investment $ 53,339 $ 18,774 $ 148,713 $ 28,146 $ $ 248,972
Loans held for sale $ 47,150 47,150
Investments securities 962 1,869 21,037 14,932 38,800
Federal Funds Sold 1,017 1,017
Interest bearing
bank deposits 3,352 1,485 793 5,630
------ ------- ------ ------- ------ -------
Total 105,820 22,128 170,543 28,146 14,932 341,569
Rate Sensitive Liabilities:
Interest bearing
demand deposits 11,306 21,181 4,937 37,424
Savings 9,777 29,330 9,777 48,884
Certificates of deposit
$100,000 and over 3,931 7,173 13,557 24,661
Other certificates
of deposit 16,005 32,924 45,901 13 94,843
------ ------- ------ ------- ------ -------
Total Deposits 19,936 61,180 109,969 14,727 205,812
Short-term debt 57,362 57,362
Long-term debt 3,022 6,495 13,188 3,756 26,461
------ ------- ------ ------- ------ -------
Total 80,320 67,675 123,157 18,483 289,635
Discrete Gap 25,500 (45,547) 47,386 9,663 14,932 51,934
Cumulative Gap 25,500 (20,047) 27,339 37,002 51,934
As a % of Earning Assets 7.47% (5.87%) 8.00% 10.83% 15.20%
* In preparing the above table, no assumptions are made with respect to loan
prepayments or deposit run off. Loan principal payments are included in the
earliest period in which the loan matures or can be repriced. Principal
payments on installment loans scheduled prior to maturity are included in
the period of maturity or repricing. Proceeds from the redemption of
investments and deposits are included in the period of maturity. Estimated
maturities on deposits which have no stated maturity dates were derived
from guidance contained in FDICIA 305.
22
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Recent Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). This Interpretation provides guidance
with respect to the identification of variable interest entities and when the
assets, liabilities, noncontrolling interests, and results of operations of a
variable interest entity need to be included in a company's consolidated
financial statements. The Interpretation requires consolidation by business
enterprises of variable interest entities in cases where (a) the equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
which is provided through other interests that will absorb some or all of the
expected losses of the entity, or (b) in cases where the equity investors lack
one or more of the essential characteristics of a controlling financial
interest, which include the ability to make decisions about the entity's
activities through voting rights, the obligations to absorb the expected losses
of the entity if they occur, or the right to receive the expected residual
returns of the entity if they occur. Management has evaluated the Company's
investments in variable interest entities and potential variable interest
entities or transactions, particularly in limited liability partnerships
involved in low-income housing development. The implementation of FIN 46 did not
have a significant impact on either the Company's consolidated financial
position or consolidated results of operations. Interpretive guidance relating
to FIN 46 is continuing to evolve and the Company's management will continue to
assess various aspects of consolidations and variable interest entity accounting
as additional guidance becomes available.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. The Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities. The Statement is effective for contracts entered into or
modified after June 30, 2003, with certain exceptions, and for hedging
relationships designated after June 30, 2003. It is not expected to have an
impact on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of these instruments
were previously classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and was effective at
the beginning of the first interim period beginning after June 15, 2003.
Adoption of the Statement did not result in an impact on the Company's
consolidated financial statements.
In December 2003, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants issued Statement of Position
("SOP") 03-3, Accounting for Certain Loans or Debt Securities Acquired in a
Transfer. The SOP is effective for loans acquired in fiscal years beginning
after December 15, 2004. The scope of the SOP applies to unhealthy "problem"
loans that have been acquired, either individually in a portfolio, or in a
business acquisition. The SOP addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities acquired in a transfer
if those differences are attributable, at least in part, t credit quality. The
SOP does not apply to loans originated by the Company. The Company adopted the
provisions of SOP 03-3 effective January 1, 2005. There was no effect on the
Company's consolidated financial position or consolidated results of operations.
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105,
Application of Accounting Principles to Loan Commitments ("SAB 105"). SAB 105
clarifies existing accounting practices relating to the valuation of issued loan
commitments, including interest rate lock commitments ("IRLC"), subject to SFAS
No. 149 and Derivative Implementation Group Issue C13, Scope Exceptions: When a
Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105
disallows the inclusion of the values of a servicing component and other
internally developed intangible assets in the initial and subsequent IRLC
valuation. The provisions of SAB 105 were effective for loan commitments entered
into after March 31, 2004. The Company has adopted the provisions of SAB 105.
There was no impact on either the Company's consolidated financial position or
consolidated results of operations.
23
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Emerging Issues Task Force Issue No. (EITF) 03-1 The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments was
issued and is effective March 31, 2004. The EITF 03-1 provides guidance for
determining the meaning of "other-than-temporarily impaired" and its application
to certain debt and equity securities within the scope of SFAS No. 115
Accounting for Certain Investments in Debt and Equity Securities and investments
accounted for under the cost method. The guidance requires that investments
which have declined in value due to credit concerns or solely due to changes in
interest rates must be recorded as other-than-temporarily impaired unless the
Company can assert and demonstrate its intention to hold the security for a
period of time sufficient to allow for a recovery of fair value up to or beyond
the cost of the investment which might mean maturity. This issue also requires
disclosures assessing the ability and intent to hold investments in instances in
which an investor determines that an investment with a fair value less than cost
is not other-than-temporarily impaired. On September 30, 2004, the Financial
Accounting Standards Board ("FASB") decided to delay the effective date for the
measurement and recognition guidance contained in EITF 03-1. This delay does not
suspend the requirement to recognize other-than-temporary impairments as
required by existing authoritative literature. The disclosure guidance in EITF
03-1 was not delayed. The Company has included the required disclosures in the
consolidated financial statements.
EITF No. 03-16, Accounting for Investments in Limited Liability Companies was
ratified by the Board and is effective for reporting periods beginning after
June 15, 2004. APB Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock, prescribes the accounting for investments in common
stock of corporations that are not consolidated. AICPA Accounting Interpretation
2, Investments in Partnership Ventures, of Opinion 18 indicates that "many of
the provisions of the Opinion would be appropriate in accounting" for
partnerships. In EITF Abstracts, Topic No. D-46, Accounting for Limited
Partnership Investments, the SEC staff clarified its view that investments of
more than 3 to 5 percent are considered to be more than minor and, therefore,
should be accounted for using the equity method. Limited liability companies
(LLCs) have characteristics of both corporations and partnerships, but are
dissimilar from both in certain respects. Due to those similarities and
differences, diversity in practice exists with respect to accounting for
non-controlling investments in LLCs. The consensus reached was that an LLC
should be viewed as similar to a corporation or similar to a partnership for
purposes of determining whether a non-controlling investment should be accounted
for using the cost method or the equity method of accounting.
On December 16, 2004, the FASB issued SFAS No.123R, Share Based Payment, which
amends SFAS No.123 and SFAS No.95, Statement of Cash Flows, and requires
compensation costs related to share-based payment transactions to be recognized
in the financial statements. With limited exceptions, the amount of compensation
cost will be measured based on the grant-date fair value of the equity or
liability instruments issued. In addition, liability awards will be remeasured
each reporting period. Compensation cost will be recognized over the period that
an employee provides service in exchange for the reward. SFAS No.123R requires
the expense of all unvested grants, including grants prior to 2003, to be
reported in operating expense (the "modified prospective" method). Options with
graded vesting will be expensed more rapidly. This Statement did not have an
effect on the Company's consolidated financial statements.
24
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Quarterly Results
The table below lists the Company's quarterly performance for the years ended
December 31, 2004 and 2003:
2004
------
Dollars in thousands Fourth Third Second First Total
------ ----- ------ ----- -----
Interest and Dividend
Income $ 4,578 $ 4,237 $ 4,018 $ 3,971 $16,804
Interest Expense 1,528 1,362 1,246 1,260 5,396
----- ----- ----- ----- -----
Net Interest Income 3,050 2,875 2,772 2,711 11,408
Provision for Loan Losses 60 60 60 60 240
----- ----- ----- ----- -----
Net Interest Income after
Provision
For Loan Losses 2,990 2,815 2,712 2,651 11,168
Non-Interest Income 701 658 718 709 2,786
Non-Interest Expense 2,006 1,910 1,937 1,888 7,741
----- ----- ----- ----- -----
Income before taxes 1,685 1,563 1,493 1,472 6,213
Income Tax Expense 502 471 451 439 1,863
----- ----- ----- ----- -----
Net Income $1,183 $1,092 $1,042 $1,033 $4,350
===== ===== ===== ===== =====
Net Income Per Share $ .49 $ .45 $ .43 $ .43 $ 1.80
2003
------
Fourth Third Second First Total
Interest and Dividend
Income $4,078 $4,103 $4,202 $4,300 $16,683
Interest Expense 1,361 1,455 1,564 1,630 6,010
----- ----- ----- ----- -----
Net Interest Income 2,717 2,648 2,638 2,670 10,673
Provision for Loan Losses 62 31 61 72 226
----- ----- ----- ----- -----
Net Interest Income after
Provision
For Loan Losses 2,655 2,617 2,577 2,598 10,447
Non-Interest Income 509 643 993 341 2,486
Non-Interest Expense 1,855 1,846 1,822 1,732 7,255
----- ----- ----- ----- -----
Income Before Taxes 1,309 1,414 1,748 1,207 5,678
Income Tax Expense 418 369 525 354 1,666
----- ----- ----- ----- -----
Net Income $ 891 $1,045 $1,223 $ 853 $4,012
===== ===== ===== ===== =====
Net Income Per Share $ .37 $ .43 $ .50 $ .36 $ 1.66
25
Item 8
F & M Bank Corp. and Subsidiaries
Consolidated Balance Sheets
December 31,
ASSETS 2004 2003
-------------- ---------
Cash and due from banks (notes 3 and 13) $ 7,937,958 $5,665,110
Interest bearing deposits (note 13) 9,230,702 9,002,742
Federal funds sold 1,017,000 5,035,000
Securities -
Held to maturity - fair value of
$110,000 in 2004
$897,865 in 2003 (note 4) 110,003 872,978
Available for sale (note 4) 30,755,658 54,895,520
Other investments (note 4) 7,934,426 5,461,316
Loans held for sale 47,149,966
Loans held for investment (notes 5, 10 and 13) 248,972,218 211,231,092
Less allowance for loan losses (note 6) (1,510,860) (1,483,667)
------------ -----------
Net Loans 247,461,358 209,747,425
Bank premises and equipment, net (note 7) 4,824,483 5,001,293
Interest receivable 1,230,828 1,496,232
Core deposit intangible (note 20) 1,701,641 1,977,583
Goodwill (note 20) 2,638,677 2,638,677
Bank owned life insurance (note 21) 5,082,826 4,831,667
Other assets 2,881,649 2,500,917
----------- ---------
Total Assets 369,957,175 $309,126,460
=========== ===========
LIABILITIES
Deposits:
Noninterest bearing $40,693,537 $33,123,978
Interest bearing:
Demand 24,196,170 24,788,355
Money market accounts 13,228,532 13,086,303
Savings 48,882,821 47,545,499
Time deposits over $100,000 (note 8) 24,660,968 21,138,463
All other time deposits (note 8) 94,843,194 101,032,742
----------- -----------
Total Deposits 246,505,222 240,715,340
----------- -----------
Short-term debt (note 9) 57,361,619 6,388,958
Accrued liabilities 5,368,869 4,918,788
Long-term debt (note 10) 26,461,517 24,784,207
----------- ----------
Total Liabilities 335,697,227 276,807,293
----------- -----------
STOCKHOLDERS' EQUITY (NOTE 19)
Common stock $5 par value, 3,000,000 shares
authorized, 2,411,541 and 2,420,478
shares issued and outstanding,
for 2004 and 2003, respectively 12,057,705 12,102,390
Capital surplus 128,376 286,330
Retained earnings (note 16) 22,273,119 19,709,562
Accumulated other comprehensive income (loss) (199,252) 220,885
------------ ---------
Total Stockholders' Equity 34,259,948 32,319,167
----------- ----------
Total Liabilities and Stockholders' Equity 369,957,175 $309,126,460
=========== ===========
The accompanying notes are an integral part of this statement.
26
F & M Bank Corp. and Subsidiaries
Consolidated Statements of Income
Years Ended December 31,
2004 2003 2002
------------------------- --------
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans
held for investment $14,355,476 $14,118,688 $14,846,527
Interest on loans held for sale 687,538 3,249
Interest on deposits and federal
funds sold 230,508 346,951 438,330
Interest on debt securities 1,038,864 1,715,328 2,004,119
Dividends on equity securities 491,158 498,546 557,470
--------- -------- --------
Total Interest and Dividend Income 16,803,544 16,682,762 17,846,446
---------- ---------- ----------
INTEREST EXPENSE:
Interest on demand deposits 205,506 213,803 306,730
Interest on savings deposits 452,712 488,347 710,489
Interest on time deposits over $100,000 703,622 757,204 657,069
Interest on all other time deposits 2,609,054 3,260,349 4,240,390
--------- --------- ---------
Total interest on deposits 3,970,894 4,719,703 5,914,678
Interest on short-term debt 419,070 44,377 103,951
Interest on long-term debt 1,005,606 1,245,531 1,371,774
--------- --------- ---------
Total Interest Expense 5,395,570 6,009,611 7,390,403
--------- --------- ---------
NET INTEREST INCOME 11,407,974 10,673,151 10,456,043
---------- ---------- ----------
PROVISION FOR LOAN LOSSES (note 6) 240,000 226,000 387,000
--------- -------- --------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 11,167,974 10,447,151 10,069,043
---------- ---------- ----------
NONINTEREST INCOME:
Service charges on deposit accounts 910,866 904,946 716,590
Insurance and other commissions 374,349 280,156 209,579
Other operating income 718,063 884,806 323,056
Income on bank owned life insurance 251,159 238,369 130,531
Gain (loss) on security transactions
(note 4) 531,781 178,618 (182,430)
---------- ---------- ---------
Total Noninterest Income 2,786,218 2,486,895 1,197,326
--------- --------- ---------
NONINTEREST EXPENSES:
Salaries 3,184,471 3,075,762 2,853,483
Employee benefits (note 12) 1,207,109 1,053,032 747,074
Occupancy expense 413,736 406,816 337,038
Equipment expense 421,699 407,636 350,701
Amortization of intangibles
(notes 2 and 20) 275,942 275,942 275,942
Other operating expenses 2,238,326 2,036,235 1,883,657
--------- --------- ---------
Total Noninterest Expenses 7,741,283 7,255,423 6,447,895
--------- --------- ---------
Income before Income Taxes 6,212,909 5,678,623 4,818,474
INCOME TAX EXPENSE (note 11) 1,863,358 1,666,324 1,314,579
--------- --------- ---------
NET INCOME $4,349,551 $4,012,299 $3,503,895
========== ========== ==========
PER SHARE DATA
NET INCOME $ 1.80 $ 1.66 $ 1.44
========= ======== ========
CASH DIVIDENDS .74 $ .70 $ .66
========= ======== ========
AVERAGE COMMON SHARES OUTSTANDING 2,413,668 2,417,807 2,428,722
========= ========= =========
The accompanying notes are an integral part of this statement.
27
F & M Bank Corp. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Accumulated
Other
Common Capital Retained Comprehensive
Stock Surplus Earnings Income (Loss) Total
------- ------ -------- ------------- ------
BALANCE - December 31, 2001 $ 12,192,815 $ 525,015 $15,488,406 $ 390,963 $28,597,199
Comprehensive Income:
Net income 3,503,895 3,503,895
Net change in other
comprehensive income(note 2) (661,446) (661,446)
-----------
Comprehensive Income 2,842,449
Dividends on common stock (1,601,823) (1,601,823)
Stock repurchased (14,885
shares) (74,425) (222,220) (296,645)
----------- --------- ----------- ----------- -----------
BALANCE - December 31, 2002 12,118,390 302,795 17,390,478 (270,483) 29,541,180
Comprehensive Income:
Net income 4,012,299 4,012,299
Net change in other
comprehensive income (note 2) 491,368 491,368
---------
Comprehensive Income 4,503,667
Tax benefit of ESOP dividends 23,969 23,969
Dividends on common stock (1,693,215) (1,693,215)
Stock sold to ESOP (10,000 shares) 50,000 158,000 208,000
Stock repurchased (13,200 shares) (66,000) (198,434) (264,434)
----------- -------- ----------- --------- -----------
BALANCE - December 31, 2003 12,102,390 286,330 19,709,562 220,885 32,319,167
Comprehensive Income:
Net income 4,349,551 4,349,551
Net change in other
comprehensive income (note 2) (420,137) (420,137)
---------
Comprehensive Income 3,929,414
Tax benefit of ESOP dividends 27,570 27,570
Dividends on common stock (1,785,994) (1,785,994)
Stock sold to ESOP (9,300 shares) 46,500 174,375 220,875
Stock repurchased (18,237 shares) (91,185) (359,899) (451,084)
--------- --------- ----------- ----------- -----------
BALANCE - December 31, 2004 $12,057,705 $ 128,376 $22,273,119 $ (199,252) $34,259,948
========= ========= ========== ========== ==========
The accompanying notes are an integral part of this statement.
28
F & M Bank Corp. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31,
2004 2003 2002
---------- -------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $4,349,551 $4,012,299 $3,503,895
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
(Gain) loss on sale of securities (531,781) (178,618) 182,430
Depreciation 461,637 429,717 347,867
Amortization of security premiums 309,200 312,301 125,412
Net increase in loans held for sale (47,149,966)
Provision for loan losses 240,000 226,000 387,000
Provision for deferred taxes (24,679) 210,305 (240,106)
(Increase) decrease in interest
receivable 265,404 158,890 (113,581)
Increase in other assets (380,732) (610,505) (178,301)
Increase in accrued expenses 716,009 69,197 757,679
Amortization of limited partnership
investments 244,290 262,227 255,850
Amortization of intangibles 275,942 275,942 275,942
Income from life insurance investment (251,159) (238,369) (130,531)
(Gain) loss on sale of other
real estate (94,754) 22,161
------- -------- --------
Net Cash Provided by (Used in)Operating
Activities (41,476,284) 4,834,632 5,195,717
---------- ---------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest
bearing bank deposits (227,960) (3,116,303) 8,312,403
Net (increase) decrease in federal
funds sold 4,018,000 (559,000) (4,476,000)
Proceeds from maturities of securities
held to maturity 760,000 1,000,000
Proceeds from maturities of
securities available
for sale 18,625,744 54,755,131 25,794,446
Proceeds from sales of securities
available for sale 24,285,388 2,480,338 5,062,045
Purchases of securities available
for sale (21,919,075)(49,557,386)(37,983,540)
Net increase in loans held for investment(37,953,933) (9,470,590)(25,748,188)
Purchase of life insurance (1,870,528) (2,172,124)
Purchase of property and equipment (284,827) (729,048) (330,302)
Purchase of other real estate (243,204)
Construction in progress payments (91,850)
Sale of other real estate 597,873 263,970
--------- -------- --------
Net Cash Used in Investing Activities (12,696,663) (6,469,513)(31,612,344)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in demand and savings
deposits 8,456,925 13,315,434 14,978,546
Net increase (decrease) in time deposits (2,667,043) (871,334) 5,026,575
Net change in short-term debt 50,972,661 (1,932,080) (2,387,313)
Dividends paid in cash (1,763,849) (1,645,224) (1,580,138)
Proceeds from long-term debt 9,000,000 18,000,000
Payments to repurchase common stock (451,084) (264,434) (296,645)
Proceeds from issuance of common stock 220,875 208,000
Repayments of long-term debt (7,322,690) (7,527,817) (6,670,674)
--------- --------- ----------
Net Cash Provided by Financing
Activities 56,445,795 1,282,545 27,070,351
---------- --------- ----------
Net Increase (Decrease) in Cash and
Cash Equivalents 2,272,848 (352,336) 653,724
Cash and Cash Equivalents, Beginning of Year 5,665,110 6,017,446 5,363,722
--------- --------- ---------
Cash and Cash Equivalents, End of Year $7,937,958 $5,665,110 $6,017,446
========= ========= =========
Supplemental Disclosure:
Cash paid for:
Interest expense $5,428,726 $6,148,756 $7,538,614
Income taxes 1,250,000 750,000 1,100,000
The accompanying notes are an integral part of this statement
29
Notes to the Consolidated Financial Statements
NOTE 1 NATURE OF OPERATIONS:
F & M Bank Corp. (the "Company"), through its subsidiary Farmers & Merchants
Bank (the "Bank"), operates under a charter issued by the Commonwealth of
Virginia and provides commercial banking services. As a state chartered bank,
the Bank is subject to regulation by the Virginia Bureau of Financial
Institutions and the Federal Reserve Bank. The Bank provides services to
customers located mainly in Rockingham and Shenandoah counties in Virginia, and
the adjacent counties of Page, and Augusta. Services are provided at eight
branch offices. In addition, the Company offers insurance and financial services
through its subsidiaries, TEB Life Insurance, Inc. and Farmers & Merchants
Financial Services, Inc.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of the Company and its subsidiaries
conform to generally accepted accounting principles and to accepted practice
within the banking industry.
The following is a summary of the more significant policies:
Principles of Consolidation
The consolidated financial statements include the accounts of the
Farmers and Merchants Bank, the TEB Life Insurance Company and Farmers &
Merchants Financial Services, Inc. Significant intercompany accounts and
transactions have been eliminated.
Use of Estimates in the Preparation of Financial Statements
In preparing the financial statements, management is required to make estimates
and assumptions that affect the reported amounts in those statements; actual
results could differ significantly from those estimates. Material estimates that
are particularly susceptible to significant changes in the near term are the
determination of the allowance for loan losses, which is sensitive to changes in
local and national economic conditions, and the other than temporary impairment
of investments in the investment portfolio.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and deposits at other financial
institutions whose initial maturity is ninety days or less.
Investment Securities
Management reviews the securities portfolio and classifies all securities as
either held to maturity or available for sale at the date of acquisition.
Securities that the Company has both the positive intent and ability to hold to
maturity (at time of purchase) are classified as held to maturity securities.
All other securities are classified as available for sale. Securities held to
maturity are carried at historical cost and adjusted for amortization of
premiums and accretion of discounts, using the effective interest method.
Securities available for sale are carried at fair value with any valuation
adjustments reported, net of deferred taxes, as a part of other accumulated
comprehensive income. Also included in securities available for sale are
marketable equity securities.
Interest, amortization of premiums and accretion of discounts on securities are
reported as interest income using the effective interest method. Gains (losses)
realized on sales and calls of securities are determined on the specific
identification method.
Accounting for Historic Rehabilitation and Low Income Housing Partnerships
The Company periodically invests in low income housing partnerships whose
primary benefit is the distribution of federal tax credits to partners. The
Company recognizes these benefits and the cost of the investments over the life
of the partnership (usually 15 years). In addition, state and federal historic
rehabilitation credits were generated from an investment in one of the
partnerships. Amortization of this investment is prorated based on the amount of
benefits received in each year to the total estimated benefits over the life of
the project. All benefits have been shown as investment income since income tax
benefits are the only anticipated benefits of ownership.
30
Notes to the Consolidated Financial Statements
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Loans
Loans are carried on the balance sheet net of any unearned interest and the
allowance for loan losses. Interest income on loans is determined using the
effective interest method on the daily amount of principal outstanding except
where serious doubt exists as to collectibility of the loan, in which case the
accrual of income is discontinued.
Allowance for Loan Losses
The provision for loan losses charged to operations is an amount sufficient to
bring the allowance for loan losses to an estimated balance that management
considers adequate to absorb potential losses in the portfolio. Loans are
charged against the allowance when management believes the collectibility of the
principal is unlikely. Recoveries of amounts previously charged-off are credited
to the allowance. Management's determination of the adequacy of the allowance is
based on an evaluation of the composition of the loan portfolio, the value and
adequacy of collateral, current economic conditions, historical loan loss
experience, and other risk factors. Management believes that the allowance for
loan losses is adequate. While management uses available information to
recognize losses on loans, future additions to the allowance may be necessary
based on changes in economic conditions, particularly those affecting real
estate values. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction loans by either
the present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's obtainable market price, or the fair value
of the collateral if the loan is collateral dependent.
Nonaccrual Loans
Commerical loans are placed on nonaccrual status when they become ninety days or
more past due, unless there is an expectation that the loan will either be
brought current or paid in full in a reasonable period of time. Interest
accruals are continued on past due, secured residential real estate loans and
consumer purpose loans until the principal and accrued interest equal the value
of the collateral and on unsecured loans until the financial condition of the
borrower deteriorates to the point that any further accrued interest would be
determined to be uncollectible.
31
Notes to the Consolidated Financial Statements
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated depreciation.
Depreciation is charged to income over the estimated useful lives of the assets
on a combination of the straight-line and accelerated methods. The ranges of the
useful lives of the premises and equipment are as follows:
Buildings and Improvements 10 - 40 years
Furniture and Fixtures 5 - 20 years
Maintenance, repairs, and minor improvements are charged to operations as
incurred. Gains and losses on dispositions are reflected in other income or
expense.
Intangible Assets
Core deposit intangibles are amortized on a straight-line basis over ten years.
Core deposit intangibles, net of amortization totaled $1,702,000 and $1,978,000
at December 31, 2004 and 2003, respectively. The Company adopted SFAS 147 on
January 1, 2002 and determined that the core deposit intangible will continue to
be amortized over the estimated useful life.
Goodwill
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Additionally, it further clarifies the criteria for the
initial recognition and measurement of intangible assets separate from goodwill.
SFAS No. 142 became effective for fiscal years beginning after December 15, 2001
and prescribes the accounting for goodwill and intangible assets subsequent to
initial recognition. The provisions of SFAS No. 142 discontinue the amortization
of goodwill and intangible assets with indefinite lives. Instead, these assets
are subject to an impairment review on an annual basis and more frequently if
certain impairment indicators are in evidence. SFAS No. 142 also requires that
reporting units be identified for the purpose of assessing potential future
impairments of goodwill.
The Company adopted SFAS No. 142 on January 1, 2002. Goodwill totaled $2,639,000
at December 31, 2004 and 2003. The goodwill is no longer amortized, but instead
tested for impairment at least annually. Based on the testing, there were no
impairment charges for 2004 or 2003. Application of the nonamortization
provisions of the Statement resulted in additional net income of approximately
$190,000 for each the years ended December 31, 2004, 2003 and 2002.
Pension Plans
Substantially all employees are covered by a pension plan. The net periodic
pension expense includes a service cost component, estimated normal return on
plan assets, and the effect of deferring and amortizing certain actuarial gains
and losses.
32
Notes to the Consolidated Financial Statements
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Advertising Costs
The Company follows the policy of charging the cost of advertising to expense as
incurred. Total advertising costs included in other operating expenses for 2004,
2003, and 2002 were $163,082, $139,749, and $141,461, respectively.
Income Taxes
Amounts provided for income tax expense are based on income reported for
financial statement purposes rather than amounts currently payable under income
tax laws. Deferred taxes, which arise principally from temporary differences
between the period in which certain income and expenses are recognized for
financial accounting purposes and the period in which they affect taxable
income, are included in the amounts provided for income taxes.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Certain changes in assets and liabilities,
such as unrealized gains and losses on available-for-sale securities and gains
or losses on certain derivative contracts, are reported as a separate component
of the equity section of the balance sheet. Such items, along with operating net
income, are components of comprehensive income.
The components of other comprehensive income and related tax effects are as
follows:
Years Ended December 31,
Changes in: 2004 2003 2002
---- ---- ----
Unrealized holding gain on
interest rate swap $ $ $ 4,137
Unrealized holding gains (losses)
on available-for-sale
securities (124,180) 880,766 (1,141,553)
Reclassification adjustment for
(gains) losses realized
in income (531,781) (178,618) 182,430
Net Unrealized (Gains) Losses (655,961) 702,148 (954,986)
Tax effect 235,824 (210,780) 293,540
--------- --------- --------
Net Change $(420,137) $ 491,368 $ (661,446)
========= ======== =========
Earnings Per Share
Earnings per share are based on the weighted average number of shares
outstanding.
NOTE 3 CASH AND DUE FROM BANKS:
The Bank is required to maintain average reserve balances based on a percentage
of deposits. The average balance of cash, which the Federal Reserve Bank
requires to be on reserve, was $ 2,656,000 and $1,962,000 for the years ended
December 31, 2004 and 2003, respectively.
33
Notes to the Consolidated Financial Statements
NOTE 4 INVESTMENT SECURITIES:
The amortized cost and fair value of securities held to maturity are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
December 31, 2004
U. S. Treasuries
and Agencies $ 110,003 $ $ 3 $ 110,000
-------- -------- -------- --------
Total Securities
Held to Maturity$ 110,003 $ $ 3 $ 110,000
======== ======== ======== ========
December 31, 2003
U. S. Treasuries
and Agencies $ 110,035 515 110,550
Corporate bonds 762,943 24,372 787,315
-------- -------- --------- --------
Total Securities
Held to Maturity$ 872,978 $ 24,887 $ $ 897,865
======== ======== ======== ========
The amortized cost and fair value of securities available for sale are as
follows:
December 31, 2004
U.S. Agencies $16,085,931 $ 8,489 $ 83,227 $16,011,193
Mortgage-backed
obligations of
federal agencies 5,472,030 47,115 5,424,915
Marketable equities 6,619,270 360,225 494,277 6,485,218
Municipals 375,000 5,627 369,373
Corporate bonds 2,500,000 12,700 47,741 2,464,959
--------- -------- -------- ---------
Total Securities
Available for
Sale $31,052,231 $ 381,414 $ 677,987 $30,755,658
========== ======== ======== ==========
December 31, 2003
U.S. Agencies $25,386,992 $ 65,617 $ 8,888 $25,443,721
Mortgage-backed
obligations of
federal agencies 9,004,266 7,010 21,901 8,989,375
Marketable equities 9,109,546 652,193 516,573 9,245,166
Municipals 375,000 2,427 372,573
Corporate bonds 10,660,326 207,447 23,088 10,844,685
---------- -------- -------- ---------
Total Securities
Available for
Sale $54,536,130 $ 932,267 $ 572,877 $54,895,520
========== ======== ======== ==========
34
Notes to the Consolidated Financial Statements
NOTE 4 INVESTMENT SECURITIES (CONTINUED):
The amortized cost and fair value of securities at December 31, 2004, by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Securities Held Securities Available
to Maturity for Sale
----------------------- ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Due in one year or
less $ 110,003 $ 110,000 $ $
Due after one year
through five years 22,165,186 21,999,058
Due after five years 2,267,775 2,271,382
--------- --------- ---------- ----------
110,003 110,000 24,432,961 24,270,440
Marketable equities 6,619,270 6,485,218
-------- -------- --------- ---------
Total $ 110,003 $ 110,000 $31,052,231 $30,755,658
======== ======== ========== ==========
The Company's gross proceeds from the sale of debt securities for 2004 were
approximately $18,650,000 which resulted in gains of $107,617 and losses of
$9,030. The realized gains and losses and the gross proceeds from the sale of
debt securities were not material in 2003 or 2002. Gains and losses on
marketable equity transactions are summarized below:
2004 2003 2002
---- ---- ----
Gains 738,582 $ 440,340 $ 318,354
Losses 305,388 261,722 500,784
------- -------- ---------
Net Gains $ 433,194 $ 178,618 $ (182,430)
======== ========= =========
Based on a review of its equities portfolio, the Company recognized an
impairment of $503,034 in the carrying basis of five of its equity holdings as
of December 31, 2002. In 2004, the Company recognized an impairment of $161,633
in the carrying basis on two of its equity holdings. These write downs were a
result of management's evaluation and determination that these assets met the
definition for impairment under SFAS 115.
The carrying value (which approximates fair value) of securities pledged by the
Bank to secure deposits and for other purposes amounted to $12,381,675 at
December 31, 2004 and $16,550,000 at December 31, 2003. The Company has pledged
$2,986,426 of equity securities to secure the $2,538,462 indebtedness
outstanding with SunTrust Bank (see note 10).
Other investments consist of investments in nine low-income housing and historic
equity partnerships (carrying basis of $3,288,197) and stock in the Federal Home
Loan Bank, and various other investments (carrying basis of $4,646,229). The
interests in the low-income housing and historic equity partnerships have
limited transferability and the interests in the other stocks are restricted as
to sales. The market values of these securities are estimated to approximate
their carrying value as of December 31, 2004. During 2004 and 2003, the Company
recognized a loss in its investment in BI Investments of $100,000. This write
down was the result of losses incurred by BI Investments during its first and
second years of operation. At December 31, 2004, the Company was committed to
invest an additional $2,555,974 in four low-income housing limited partnerships.
These funds will be paid as requested by the general partner to complete the
projects. This additional investment has been reflected in the above carrying
basis and in accrued liabilities on the balance sheet.
35
Notes to the Consolidated Financial Statements
NOTE 4 INVESTMENT SECURITIES (CONTINUED):
The primary purpose of the investment portfolio is to generate income and meet
liquidity needs of the Company through readily saleable financial instruments.
The portfolio includes fixed rate bonds, whose prices move inversely with rates,
variable rate bonds and equity securities. At the end of any accounting period,
the investment portfolio has unrealized gains and losses. The Company monitors
the portfolio, which is subject to liquidity needs, market rate changes and
credit risk changes, to see if adjustments are needed. The primary concern in a
loss situation is the credit quality of the business behind the instrument. In
2004 and 2002, the Company wrote down several equity investments because of
price deterioration that was not expected to improve in the near term. Bonds
deteriorate in value due to credit quality of the individual issuer and changes
in market conditions. There are approximately 27 holdings in the current
portfolio that have losses. These losses relate to market conditions and the
timing of purchases and are not a material concern since they have moved up and
down with the market.
A summary of these losses is as follows:
Less than 12 Months More than 12 Months Total
------------------ ------------------- ------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
U.S. Treasury
& Agency $10,034,000 $ (52,000) $2,031,000 $ (21,000) $12,065,000 $ (73,000)
Municipals 369,000 (6,000) 369,000 (6,000)
Mortgage
backed
obligations 2,377,000 (16,000) 3,048,000 (31,000) 5,425,000 (47,000)
Marketable
Equities 2,817,000 (184,000) 2,209,000 (350,000) 5,026,000 (534,000)
---------- -------- --------- --------- ----------- -----------
Total $15,228,000 $ (252,000) $7,657,000 $ (408,000) $22,885,000 $ (660,000)
=========== ========== ========== ========== =========== ===========
NOTE 5 LOANS:
Loans held for investment as of December 31:
2004 2003
Real Estate
Construction $17,364,803 $15,328,810
Mortgage 147,281,033 123,538,368
Commercial and agricultural 62,786,983 51,138,550
Installment 20,005,920 19,630,461
Credit cards 1,477,789 1,463,329
Other 55,690 131,574
---------- ----------
Total $248,972,218 $211,231,092
=========== ===========
36
Notes to the Consolidated Financial Statements
NOTE 5 LOANS (CONTINUED):
At December 31, 2004 and 2003, the recorded investment in loans which have been
identified as impaired loans, in accordance with Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan"
(SFAS 114), totaled $4,116,000 and $3,407,000, respectively. The valuation
allowance related to impaired loans on December 31, 2004 and 2003 is $505,000
and $395,000, respectively. For the years of 2004, 2003 and 2002, the average
balances of impaired loans were $4,301,000, $3,075,000, and $4,004,000,
respectively. The amount of interest income recorded by the Company during 2004,
2003 and 2002 on impaired loans was $301,000, $215,000, and $305,000,
respectively. There were no nonaccrual loans excluded from impaired loan
disclosure at December 31, 2004 or December 31, 2003
The Company has pledged loans as collateral for borrowings with the Federal Home
Loan Bank of Atlanta totaling $163,524,000 and $25,004,804 as of December 31,
2004 and 2003, respectively. Prior to 2004, the Company pledged specific
residential real estate loans to secure its borrowings from the FHLB. During
2004, the Company switched to a blanket lien on its entire residential real
estate portfolio and also began pledging commercial and home equity loans.
Loans held for sale as of December 31:
2004 2003
-------- -------
Real Estate $47,149,966
Loans held for sale consists of the Bank's commitment to purchase up to
$55,000,000 in residential mortgage loan participations. These loans are
purchased as a 95% participation in loans that are warehoused by a bank in
California. Loans are originated by a network of mortgage loan originators
throughout the United States. The Bank receives certain loan documents daily for
review, makes its purchase decision and wires funds to the bank in California.
By contract terms, the Bank will hold these loans up to 60 days. The actual
holding period of individual loans has ranged from 1 day to 56 days, with an
average of 15 days during 2004.
The commitment to purchase these loan participations was entered into in 2003,
as a $30,000,000 commitment, but actual purchases were immaterial until March
2004. This program was entered into as an alternative to selling Federal Funds
and other short term investments. As demand within the program increased, the
Bank recognized an opportunity to earn a return based on the spread between the
participation interest received and the cost of borrowing daily rate credit from
the FHLB. The volume of loans purchased fluctuates due to a number of factors
including changes in secondary market rates, which affects demand for mortgage
loans; the number of participating banks involved in the program; the number of
mortgage loan originators selling loans to the lead bank and the funding
capabilities of the lead bank.
NOTE 6 ALLOWANCE FOR LOAN LOSSES:
A summary of changes in the allowance for loan losses is shown in the following
schedule:
2004 2003 2002
---------- ---------- --------
Balance, beginning of year $1,483,667 $1,477,007 $1,288,506
Provision charged to operating
expenses 240,000 226,000 387,000
Loan recoveries 83,188 75,955 100,985
Loans charged off (295,995) (295,295) (299,484)
---------- ---------- ---------
Balance, end of year $1,510,860 $1,483,667 $1,477,007
========= ========= =========
Percentage of loans held
for investment .61% .70% .73%
37
Notes to the Consolidated Financial Statements
NOTE 7 BANK PREMISES AND EQUIPMENT:
Bank premises and equipment as of December 31 are summarized as follows:
2004 2003
Land $ 677,600 $ 644,440
Buildings and improvements 4,582,704 4,569,581
Furniture and equipment 3,482,731 3,259,321
---------- ----------
8,743,035 8,473,342
Less - accumulated depreciation (3,918,552) (3,472,049)
----------- ------------
Net $ 4,824,483 $ 5,001,293
========== ==========
Provisions for depreciation of $461,637 in 2004, $429,717 in 2003, and $347,687
in 2002 were charged to operations.
NOTE 8 TIME DEPOSITS:
At December 31, 2004, the scheduled maturities of time deposits are as follows:
2005 $60,032,655
2006 26,613,378
2007 14,142,912
2008 11,235,599
Thereafter 7,479,618
----------
Total $119,504,162
===========
NOTE 9 SHORT-TERM DEBT:
Short-term debt information is summarized as follows:
Maximum Weighted
Outstanding Outstanding Average Average Year End
at Any at Balance Interest Interest
Month End Year End Outstanding 1 Rate Rate
2004
Federal funds
purchased $6,894,000 $1,045,112 1.69% n/a
Notes payable 299,573 155,940 1.77% 2.22%
FHLB daily rate
credit 53,500,000 50,500,000 16,356,557 2.12% 2.48%
Securities sold
under
agreements to
repurchase 7,133,798 6,861,619 6,535,313 .80% 1.56%
--------- ---------- ---------- ------ ----
Totals $57,361,619 $24,092,922 1.23% 2.22%
========== ========== ====== =====
38
Notes to Consolidated Financial Statements
NOTE 9 SHORT-TERM DEBT (CONTINUED):
Weighted
Maximum Outstanding Average Average Year End
Outstanding at at Balance Interest Interest
Any Month End Year End Outstanding 1 Rate Rate
2003
Notes payable 351,834 351,834 62,103 4.03% 1.66%
Securities sold
under
agreements to
repurchase 8,687,799 6,037,124 7,174,896 .62% .49%
--------- --------- ----------- ------ ------
Totals $6,388,958 $7,236,999 .65% .50%
========== ========= ====== =====
2002
Federal funds
purchased $3,882,000 $ 77,323 2.23% n/a
Notes payable 343,684 156,326 5.45% n/a
Securities sold under
agreements to
repurchase 9,497,671 8,286,715 8,240,723 1.14% .72%
---------- ---------- ---------- ------ ------
Totals $ 8,286,715 $ 8,474,372 1.23% .72%
========== ========== ===== =======
Repurchase agreements are secured transactions with customers and generally
mature the day following the date sold. Federal funds purchased are unsecured
overnight borrowings from other financial institutions. FHLB daily rate credit,
which is secured by the loan portfolio is a variable rate loan that acts as a
line of credit to meet financing needs. Margin borrowings which carry a variable
rate are secured by investment securities and are used to finance equity
acquisitions on a short term basis.
As of December 31, 2004, the Company had lines of credit with correspondent
banks totaling $18,052,000, which are used in the management of short-term
liquidity.
NOTE 10 LONG-TERM DEBT:
New borrowings from the Federal Home Loan Bank of Atlanta (FHLB) were $9,000,000
in 2004, zero in 2003 and $15,000,000 in 2002. The interest rates on the notes
payable are fixed at the time of the advance and range from 3.92% to 5.33%; the
weighted average interest rate is 4.40% at December 31, 2004. The balance of
this obligation at December 31, 2004 was $23,923,056. The long-term debt is
secured by qualifying mortgage loans owned by the Company.
The Company borrowed $3,000,000 of long-term debt in September 2002 from
SunTrust Bank. Of this amount, $2,000,000 was used as contributed capital to the
Bank, $900,000 was used to payoff a loan from the Bank for securities purchases
and the balance was used for working capital needs. The outstanding balance at
December 31, 2004 was $2,538,462 with quarterly principal payments of $230,769
over the next eleven quarters. The interest rate is a floating rate of LIBOR
plus 1.10%, adjustable monthly. Repayments of long-term debt are due either
quarterly or semi-annually and interest is due monthly. Interest expense of
$1,005,606, $1,245,531, and $1,371,774 was incurred on these debts in 2004,
2003, and 2002, respectively. The maturities of long-term debt as of December
31, 2004 are as follows:
2005 $9,517,561
2006 7,015,934
2007 3,735,165
2008 2,435,714
2009 1,757,143
Thereafter 2,000,000
---------
Total $26,461,517
==========
39
Notes to Consolidated Financial Statements
NOTE 11 INCOME TAX EXPENSE:
The components of the income tax expense are as follows:
2004 2003 2002
---------- -------- -------
Current expense
Federal $1,888,037 $1,456,019 $1,554,685
Deferred benefit
Federal (24,679) 210,305 (240,106)
--------- -------- ---------
Total Income Tax Expense $1,863,358 $1,666,324 $1,314,579
========= ========= =========
Amounts in above arising
from gains
(losses) on security
transactions $ 174,026 $ 60,730 $ (96,711)
========= ========= ==========
The deferred tax effects of temporary differences are as follows:
2004 2003 2002
------------------------ -------
Tax Effects of Temporary Differences:
LIH Partnership Losses $ 6,492 $ 15,223 $ 7,944
Securities impairment 18,548 55,334 (171,032)
Provision for loan losses (9,246) (225) (62,050)
Split dollar life insurance 2,358 60,576 30,780
Non-qualified deferred
compensation (35,237) (43,810) (41,612)
Depreciation 26,531 43,405 44,271
Core deposit amortization (33,113) (33,113) (33,113)
Pension expense (9,367) 117,133 (13,611)
Other 8,355 (4,218) (1,683)
------ --------- ---------
Deferred Income Tax Expense
(Benefit) $ (24,679) $ 210,305 $ (240,106)
======== ========= =========
The components of the deferred taxes as of December 31 are as follows:
2004 2003
Deferred Tax Assets:
Allowance for loan losses $ 359,379 $ 350,133
Split dollar life insurance 11,289 13,647
Nonqualified deferred compensation 307,424 271,632
Securities impairment 91,333 115,696
Core deposit amortization 99,340 66,227
State historic tax credits 45,876 66,766
Securities available for sale 97,320
Other 4,868 8,844
-------- --------
Total Assets $1,016,829 $ 892,945
--------- ---------
Deferred Tax Liabilities:
Securities available for sale $ $ 137,550
Unearned low income housing credits 617,809 553,478
Depreciation 264,560 238,029
Pension 218,018 227,385
Other 45,216 27,971
-------- --------
Total Liabilities 1,145,603 1,184,413
--------- ---------
Deferred Tax Liability $ (128,774) $(291,468)
========= =========
40
Notes to Consolidated Financial Statements
NOTE 11 INCOME TAX EXPENSE (CONTINUED):
The following table summarizes the differences between the actual income tax
expense and the amounts computed using the federal statutory tax rates:
2004 2003 2002
--------- ---------- ------
Tax expense at federal
statutory rates $2,112,389 $1,930,732 $1,638,281
Increases (decreases) in taxes
resulting from:
State income taxes, net (21,924) 9,042 (16,421)
Partially exempt income (80,781) (155,416) (141,923)
Tax-exempt income (110,087) (116,043) (68,507)
Other (36,239) (1,991) (96,851)
--------- --------- ---------
Total Income Tax Expense $1,863,358 $1,666,324 $1,314,579
========= ========= =========
NOTE 12 EMPLOYEE BENEFITS:
The Bank participates in the Virginia Bankers' Association Master Defined
Benefit Pension Plan and Trust. Substantially all bank employees are covered by
the plan. Benefits are based upon the participant's length of service and annual
earnings with vesting of benefits after five years of service. Plan assets
consist primarily of investments in stocks and bonds. The following table
provides a reconciliation of the changes in the benefit obligations and fair
value of plan assets for 2004, 2003 and 2002:
2004 2003 2002
------- ------- --------
Change in Benefit Obligation:
Benefit obligation, beginning $4,268,747 $3,509,473 $2,852,318
Service cost 219,536 178,735 149,234
Interest cost 277,031 245,193 213,362
Actuarial gain (loss) (451,323) 440,469 314,074
Benefits paid (1,327,235) (105,123) (19,515)
----------- --------- ----------
Benefit obligation, ending 2,986,756 4,268,747 3,509,473
Change in Plan Assets:
Fair value of plan assets,
beginning 2,724,066 2,256,172 2,318,847
Actual return on plan assets 309,326 427,635 (174,856)
Employer contribution 631,598 145,382 131,696
Benefits paid (1,327,235) (105,123) (19,515)
----------- --------- ---------
Fair value of plan assets,
ending 2,337,755 2,724,066 2,256,172
Deferred asset (gain) loss (70,502) (218,424) 389,001
Funded Status:
Funded Status (649,001) (1,544,681) (1,253,301)
Unrecognized net actuarial
loss 1,122,807 1,720,742 1,566,212
Unrecognized transition
obligation 30,471 40,629 50,787
Unrecognized prior service cost (174,210) (179,510) (184,810)
--------- --------- ---------
Prepaid (accrued) benefits 330,067 37,180 178,888
Accumulated benefit obligation 1,914,138 2,553,367 2,161,492
41
Notes to the Consolidated Financial Statements
NOTE 12 EMPLOYEE BENEFITS (CONTINUED):
Components of net periodic benefit cost:
Service cost 219,536 178,735 1,479,234
Interest cost 277,031 245,193 213,362
Expected return on plan assets (238,824) (209,211) (214,145)
Amortization of prior service
cost (5,300) (5,300) (5,300)
Amortization of transition
obligation 10,158 10,158 10,158
Recognized net actuarial (gain)
loss 76,110 67,515 32,106
------- -------- --------
Net periodic benefit cost 338,711 287,090 1,515,415
Weighted average assumptions used
in benefit obligations as of
December 31:
Discount rate 6.00% 6.50% 7.00%
Expected return on plan assets 8.50% 8.50% 9.00%
Rate of compensation increase 5.00% 5.00% 5.00%
Weighted average assumptions used
in benefit cost as of December 31:
Discount rate 6.50% 7.00% 7.00%
Expected return on plan assets 8.50% 8.50% 9.00%
Rate of compensation increase 5.00% 5.00% 5.00%
The plan sponsor selects the expected long-term rate of return on assets
assumption in consultation with their advisors and the plan actuary. This rate
is intended to reflect the average rate of earnings expected to be earned on the
funds invested or to be invested to provide plan benefits. Historical
performance is reviewed, especially with respect to real rates of return (net of
inflation) for the major asset classes held or anticipated to be held by the
trust. Undue weight is not given to recent experience, which may not continue
over the measurement period, with higher significance placed on current
forecasts of future long-term economic conditions.
The following table provides the pension plan's asset allocation as of December
31:
2004 2003
Mutual funds - equity 65% 60%
Mutual funds -fixed income 35% 40%
The trust fund is sufficiently diversified to maintain a reasonable level of
risk without imprudently sacrificing return, with a targeted asset allocation of
40% fixed income and 60% equity. The Investment Manager selects investment fund
managers with demonstrated experience and expertise, and funds with demonstrated
historical performance, for the implementation of the Plan's investment
strategy. The Investment Manager will consider both actively and passively
managed investment strategies and will allocate funds across the asset classes
to develop an efficient investment structure.
The Company sponsors an employee stock ownership plan which provides stock
ownership to substantially all employees of the Bank. The Plan provides total
vesting upon the attainment of five years of service. Contributions to the plan
are made at the discretion of the Board of Directors and are allocated based on
the compensation of each employee relative to total compensation paid by the
Bank. All shares issued and held by the Plan are considered outstanding in the
computation of earnings per share. Dividends on Company stock are allocated and
paid to participants at least annually. Shares of Company stock, when
distributed, have restrictions on transferability. The Company contributed
$220,875 in 2004, $208,000 in 2003, and $190,000 in 2002 to the Plan and charged
this expense to operations.
42
Notes to the Consolidated Financial Statements
NOTE 12 EMPLOYEE BENEFITS (CONTINUED):
The Company sponsors a 401(k) savings plan under which eligible employees may
choose to save up to 20 percent of their salary on a pretax basis, subject to
certain IRS limits. The Company matches fifty percent (up to six percent of the
employee's salary) of employee contributions. Vesting in the contributions made
by the bank is 20% after two years of service and increases by 20% for each of
the next four years of service. Contributions under the plan amounted to
$70,417, $66,957 and $59,162 in 2004, 2003 and 2002, respectively.
The Company has a nonqualified deferred compensation plan for several of its key
employee's and directors. The Company may make annual contributions to the plan,
and the employee or director has the option to defer a portion of their salary
or bonus based on qualifying annual elections. Company contributions to the plan
totaled $57,000, $60,104 and $54,962 in 2004, 2003 and 2002, respectively.
NOTE 13 CONCENTRATIONS OF CREDIT:
The Company had cash deposits in other commercial banks totaling $8,895,490 and
$11,758,833 at December 31, 2004 and 2003, respectively.
The Company grants commercial, residential real estate and consumer loans to
customers located primarily in the northwestern portion of the State of
Virginia. Although the Company has a diversified loan portfolio, a substantial
portion of its debtors' ability to honor their contracts is dependent upon the
agribusiness economic sector, specifically the poultry industry for which loans
outstanding total $15,110,000. Collateral required by the Company is determined
on an individual basis depending on the purpose of the loan and the financial
condition of the borrower. Approximately 80% of the loan portfolio is secured by
real estate.
NOTE 14 COMMITMENTS:
The Company makes commitments to extend credit in the normal course of business
and issues standby letters of credit to meet the financing needs of its
customers. The amount of the commitments represents the Company's exposure to
credit loss that is not included in the balance sheet. As of the balance sheet
dates, the Company had the following commitments outstanding:
2004 2003
------------ --------
Commitments to loan money $63,083,664 $41,616,194
Standby letters of credit 1,654,807 1,901,520
The Company uses the same credit policies in making commitments to lend money
and issue standby letters of credit as it does for the loans reflected in the
balance sheet.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case by case basis. Collateral required, if any, upon
extension of credit is based on management's credit evaluation of the borrower's
ability to pay. Collateral held varies but may include accounts receivable,
inventory, property, plant and equipment.
43
Notes to Consolidated Financial Statements
NOTE 15 TRANSACTIONS WITH RELATED PARTIES:
During the year, officers and directors (and companies controlled by them) were
customers of and had transactions with the Company in the normal course of
business. These transactions were made on substantially the same terms as those
prevailing for other customers and did not involve any abnormal risk.
Loan transactions with related parties are shown in the following schedule:
2004 2003
Total loans, beginning of year $3,943,440 $2,882,127
Director term expirations (140,738)
New loans 3,160,106 2,423,879
Repayments (2,650,273) (1,362,566)
----------- -----------
Total loans, end of year $4,312,535 $3,943,440
========= =========
NOTE 16 DIVIDEND LIMITATIONS ON SUBSIDIARY BANK:
The principal source of funds of F & M Bank Corp. is dividends paid by the
Farmers and Merchants Bank. The Federal Reserve Act restricts the amount of
dividends the Bank may pay. Approval by the Board of Governors of the Federal
Reserve System is required if the dividends declared by a state member bank, in
any year, exceed the sum of (1) net income of the current year and (2) income
net of dividends for the preceding two years. As of January 1, 2005,
approximately $1,789,000 was available for dividend distribution without
permission of the Board of Governors. Dividends paid by the Bank to the Company
totaled $2,352,000 in 2004, $2,930,000 in 2003 and $1,760,000 in 2002.
NOTE 17 LITIGATION
In the normal course of business, the Company may become involved in litigation
arising from banking, financial, or other activities of the Company. Management
after consultation with legal counsel, does not anticipate that the ultimate
liability, if any, arising out of these matters will have a material effect on
the Company's financial condition, operating results or liquidity.
NOTE 18 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107 (SFAS 107) "Disclosures
about the Fair Value of Financial Statements" defines the fair value of a
financial instrument as the amount at which a financial instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation or sale. As the majority of the Bank's financial instruments
lack an available trading market, significant estimates, assumptions and present
value calculations are required to determine estimated fair value.Estimated fair
value and the carrying value of financial instruments at December 31, 2004 and
2003 are as follows (in thousands):
44
Notes to Consolidated Financial Statements
NOTE 18 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
2004 2003
----------------------- --------------------
Estimated Carrying Estimated Carrying
Fair Value Value Fair Value Value
Financial Assets
Cash $ 7,938 $ 7,938 $ 5,665 $ 5,665
Interest bearing deposits 9,221 9,231 9,019 9,003
Federal funds sold 1,017 1,017 5,035 5,035
Securities available
for sale 30,756 30,756 54,896 54,896
Securities held to
maturity 110 110 898 873
Other investments 7,934 7,934 5,461 5,461
Loans 248,326 248,972 217,842 211,231
Loan held for sale 47,140 47,150
Bank owned life
insurance 5,083 5,083 4,832 4,832
Accrued interest
receivable 1,231 1,231 1,496 1,496
Financial Liabilities
Demand Deposits:
Non-interest bearing 40,694 40,694 33,124 33,124
Interest bearing 37,425 37,425 37,875 37,875
Savings deposits 48,883 48,883 47,545 47,545
Time deposits 120,238 119,504 124,750 122,171
Accrued liabilities 5,369 5,369 4,919 4,919
Short-term debt 57,370 57,370 6,389 6,389
Long-term debt 26,462 26,043 25,427 24,784
The carrying value of cash and cash equivalents, other investments, deposits
with no stated maturities, short-term borrowings, and accrued interest
approximate fair value. The fair value of securities was calculated using the
most recent transaction price or a pricing model, which takes into consideration
maturity, yields and quality. The remaining financial instruments were valued
based on the present value of estimated future cash flows, discounted at various
rates in effect for similar instruments entered into during the month of
December of each year.
NOTE 19 REGULATORY MATTERS:
The Company and its subsidiary bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company must meet specific capital guidelines that involve quantitative
measures of the Company's assets, liabilities, and certain off balance-sheet
items as calculated under regulatory accounting practices. The Company's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation, to ensure capital adequacy,
require the Company to maintain minimum amounts and ratios. These ratios are
defined in the regulations and the amounts are set forth in the table below.
Management believes, as of December 31, 2004, that the Company and its
subsidiary bank meet all capital adequacy requirements to which they are
subject.
45
Notes to Consolidated Financial Statements
NOTE 19 REGULATORY MATTERS (CONTINUED):
As of the most recent notification from the Bureau of Financial Institutions
(which was April 3, 2003), the subsidiary bank was categorized as well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Company must maintain minimum total risk
based, Tier I risk-based, and Tier I leverage ratios as set forth in the table.
There are no conditions or events since that notification that management
believes have changed the institution's category.
The Company's actual capital ratios are presented in the following table:
Actual Regulatory Requirements
--------- -----------------------
December 31,
2004 2003 Adequately Well
$ % $ % Capitalized Capitalized
-- -- -- -- ----------- ------------
Total risk-based ratio
Consolidated $31,462 13.22% $29,046 14.72% 8.00% None
Bank only 23,370 10.33% 20,597 11.27% 8.00% 10.00%
Tier 1 risk-based ratio
Consolidated 29,951 12.59% 27,562 13.97% 4.00% None
Bank only 21,880 9.67% 19,134 10.47% 4.00% 6.00%
Total assets leverage ratio
Consolidated 29,951 8.38% 27,562 9.00% 3.00% None
Bank only 21,880 6.38% 19,134 6.58% 3.00% 5.00%
NOTE 20 INTANGIBLES:
Core deposit intangible costs recognized from the acquisition of the Woodstock
and Edinburg branches are being amortized using the straight-line method over a
ten-year period. The core deposit intangibles and goodwill totaled $5,472,153 at
the acquisition date. Amortization expense for the years ending December 31,
2004, 2003 and 2002 was $276,000 in each year.
NOTE 21 INVESTMENT IN LIFE INSURANCE CONTRACTS
The Bank currently offers a variety of benefit plans to all full time employees.
While the costs of these plans are generally tax deductible to the Bank, the
cost has been escalating greatly in recent years. To help offset escalating
benefit costs and to attract and retain qualified employees, the Bank purchased
Bank Owned Life Insurance (BOLI) contracts that will provide benefits to
employees during their lifetime. Dividends received on these policies are
tax-deferred and the death benefits under the policies are tax exempt. Rates of
return on a tax-equivalent basis are very favorable when compared to other
long-term investments which the Bank might make.
46
Notes to the Consolidated Financial Statements
NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS:
Balance Sheets
December 31,
ASSETS 2004 2003
------------- --------
Cash and cash equivalents $1,164,265 $ 617,457
Investment in subsidiaries 29,308,253 26,859,841
Securities available for sale 6,427,328 8,877,366
Limited partnership investments 3,288,197 3,532,487
Due from subsidiaries 341,712
Interest receivable 3,073
--------- ---------
Total Assets $40,529,755 $39,890,224
========== ==========
LIABILITIES
Notes payable $2,538,461 $3,666,667
Margin payable 317,511
Accrued interest payable 20,476 25,086
Due to subsidiaries 83,455
Other liabilities 217,808 10,449
Dividends payable 458,193 436,046
Demand obligations for low income
housing investment 2,555,974 2,555,974
Deferred income taxes 478,895 475,869
-------- --------
Total Liabilities 6,269,807 7,571,057
--------- ---------
STOCKHOLDERS' EQUITY
Common stock par value $5 per share, 3,000,000
shares authorized, 2,411,541
and 2,420,478 shares issued and
outstanding for 2004 and 2003, respectivel 12,057,705 12,102,390
Capital surplus 128,376 286,330
Retained earnings 22,273,119 19,709,562
Accumulated other comprehensive income (loss) (199,252) 220,885
--------- --------
Total Stockholders' Equity 34,259,948 32,319,167
---------- ----------
Total Liabilities and Stockholders' Equity $40,529,755 $39,890,224
========== ==========
47
Notes to the Consolidated Financial Statements
Statements of Net Income and Retained Earnings
Years Ended December 31,
2004 2003 2002
------------ ----------- ---------
INCOME
Dividends from affiliate $2,352,000 $ 2,930,000 $1,760,000
Investment income 11,142 180 100
Dividend income 371,611 349,783 408,817
Security gains (losses) 513,255 275,943 (307,480)
Net limited partnership income 62,759 62,351 20,915
Other 95,435 2,960
--------- ---------- ---------
Total Income 3,310,767 3,713,692 1,885,312
--------- ---------- ---------
EXPENSES
Interest expense 81,285 127,087 189,915
Administrative expenses 128,002 137,081 132,787
---------- ---------- ---------
Total Expenses 209,287 264,168 322,702
--------- ---------- ---------
Net income before income tax
expense (benefit)
and undistributed subsidiary
net income 3,101,480 3,449,524 1,562,610
INCOME TAX EXPENSE (BENEFIT) 152,738 120,229 (208,706)
--------- ---------- ----------
Income before undistributed subsidiary
net income 2,948,742 3,329,295 1,771,316
Undistributed subsidiary net income 1,400,809 683,004 1,732,579
--------- ---------- ---------
NET INCOME 4,349,551 4,012,299 3,503,895
Retained earnings, beginning of year 19,709,562 17,390,478 15,488,406
Dividends on common stock (1,785,994) (1,693,215) (1,601,823)
----------- ----------- -----------
Retained Earnings, End of Year $22,273,119 $19,709,562 $17,390,478
========== ========== ==========
48
Notes to the Consolidated Financial Statements
Statements of Cash Flows
Years Ended December 31,
2004 2003 2002
----------- ------------ -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $4,349,551 $4,012,299 $3,503,895
Adjustments to reconcile net
income to net
cash provided by operating
activities:
Undistributed subsidiary income (1,400,809) (683,004) (1,732,579)
Gain (Loss) on sale of securities (513,255) (275,943) 307,480
Deferred tax (benefit) expense 29,974 71,515 (148,606)
Decrease (increase) in interest
receivable 3,073 (3,073)
Decrease (increase) in due from
subsidiary (341,712) 190,353 (174,356)
Decrease in other receivables 215,109 3,182
Increase (decrease) in due to
subsidiary (83,455) 116,280
Increase (decrease) in other
liabilities 255,016 (18,089) 14,039
Net change in deferred tax credits 60,522 103,321 96,179
Amortization of limited partnership
investments 244,290 262,227 255,850
Securities amortization 17,109 17,109
Gain on sale of land (95,434)
--------- --------- --------
Net Cash Provided by Operating
Activities 2,620,304 3,912,670 2,125,084
--------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributed to subsidiary (1,250,000) (2,000,000)
Proceeds from sales of securities
available for sale 4,882,132 1,849,509 4,377,753
Proceeds from maturity of securities
available for sale 362,500
Purchase of securities available
for sale (2,628,354) (1,825,119) (2,977,153)
Investments in low income housing
partnerships (1,297,948) (14,152)
Proceeds from sale of real estate 403,325
---------- --------- ---------
Net Cash Provided by (Used in) Investing
Activities 1,366,278 (870,233) (613,552)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds of long-term debt 3,000,000
Payments on long-term debt (1,128,205) (1,333,333) (2,333,333)
Increase (decrease) in short-term debt (317,511) 317,511 (198,260)
Payments to repurchase common stock (451,084) (264,434) (296,645)
Proceeds from issuance of common stock 220,875 208,000
Dividends paid in cash (1,763,849) (1,645,225) (1,580,138)
---------- ---------- ---------
Net Cash Used in Financing Activities (3,439,774) (2,717,481) (1,408,376)
---------- ---------- ----------
Net Increase in Cash and Cash Equivalents 546,808 324,956 103,156
Cash and Cash Equivalents, Beginning
of Year 617,457 292,501 189,345
--------- ---------- ----------
Cash and Cash Equivalents, End of Year $1,164,265 $ 617,457 $ 292,501
========= ======== ========
49
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
The Stockholders and Board of Directors
F & M Bank Corp.
Timberville, Virginia
We have audited the accompanying consolidated balance sheets of F & M Bank Corp.
and subsidiaries as of December 31, 2004 and 2003, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for the
three years ended December 31, 2004. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of F & M Bank Corp. and
subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for the three years ended December 31, 2004, in
conformity with U.S. generally accepted accounting principles.
/s/ S. B. Hoover & Company, L.L.P.
February 19, 2005
Harrisonburg, Virginia
50
Item 1
Other Material Required by Form 10-K
BUSINESS
General
F & M Bank Corp., incorporated in Virginia in 1983, is a one-bank holding
company pursuant to section 3(a)(1) of the Bank Holding Company Act of 1956, and
owns 100% of the outstanding stock of its two affiliates, Farmers & Merchants
Bank (Bank) and TEB Life Insurance Company (TEB). Farmers & Merchants Financial
Services, Inc. (FMFS) is a wholly owned subsidiary of Farmers & Merchants Bank.
Farmers & Merchants Bank was chartered on April 15, 1908, as a state
chartered bank under the laws of the Commonwealth of Virginia. TEB was
incorporated on January 27, 1988, as a captive life insurance company under the
laws of the State of Arizona. FMFS is a Virginia chartered corporation and was
incorporated on February 25, 1993.
The Bank offers all services normally offered by a full-service commercial
bank, including commercial and individual demand and time deposit accounts,
repurchase agreements for commercial customers, commercial and individual loans,
and drive-in banking services. TEB was organized to re-insure credit life and
accident and health insurance currently being sold by the Bank in connection
with its lending activities. FMFS was organized to write title insurance but now
provides brokerage other financial services to customers of Farmers & Merchants
Bank.
The Bank makes various types of commercial and consumer loans and has a
heavy concentration of residential and agricultural real estate loans. The local
economy is relatively diverse with strong employment in the agricultural,
manufacturing, service and governmental sectors.
On December 31, 2004, F & M Bank Corp., the Bank, TEB and FMFS had 104 full-time
and part-time employees. No one employee devotes full-time services to F&M Bank
Corp.
The Company's and the Bank's principal executive office is at 205 South Main
Street, Timberville, VA 22853, and its phone number is (540) 896-8941.
Competition
The Bank's offices compete with approximately sixteen financial institutions.
These other institutions include state and nationally chartered banks,
nationally chartered savings banks and several credit unions. The main office
and the Broadway branch serve the northern portion of Rockingham County,
Virginia and the southwestern portion of Shenandoah County. The Elkton branches
serve the town of Elkton, the eastern portion of Rockingham County, and the
southern portion of Page County. The Bridgewater office serves the town of
Bridgewater, the southern portion of Rockingham County and the northwestern
portion of Augusta County. The offices in Shenandoah County serve the towns of
Edinburg and Woodstock and the surrounding areas. Bank competition in the area
of all offices is very strong.
51
Other Material Required by Form 10-K
Regulation and Supervision
The operations of F & M Bank Corp. and the Bank are subject to federal and state
statutes, which apply to state member banks of the Federal Reserve System.
The stock of F & M Bank Corp. is subject to the registration requirements of the
Securities Act of 1934. F & M Bank Corp. is subject to the periodic reporting
requirements of the Securities Exchange Act of 1934. These include, but are not
limited to, the filing of annual, quarterly and other current reports with the
Securities and Exchange Commission. As an Exchange Act reporting company, the
Corporation is directly affected by the Sarbanes-Oxley Act of 2002, which is
aimed at improving corporate governance and reporting procedures. The
Corporation is complying with new SEC and other rules and regulations
implemented pursuant to Sarbanes-Oxley and intends to comply with any applicable
rules and regulations implemented in the future.
F & M Bank Corp., as a bank holding company, is subject to the provisions of the
Bank Holding Company Act of 1956, as amended (the "Act"). It is registered as
such and is supervised by the Federal Reserve Board. The Act requires F & M Bank
Corp. to secure the prior approval of the Federal Reserve Board before F & M
Bank Corp. acquires ownership or control of more than 5% of the voting shares or
substantially all of the assets of any institution, including another bank.
As a bank holding company, F & M Bank Corp. is required to file with the Federal
Reserve Board an annual report and such additional information as it may require
pursuant to the Act. The Federal Reserve Board may also conduct examinations of
F & M Bank Corp. and any or all of its subsidiaries. Under Section 106 of the
1970 Amendments to the Act and the regulations of the Federal Reserve Board, a
bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with an extension of credit, provision
of credit, sale or lease of property or furnishing of services.
Federal Reserve Board regulations permit bank holding companies to engage in
non-banking activities closely related to banking or to managing or controlling
banks. These activities include the making or servicing of loans, performing
certain data processing services, and certain leasing and insurance agency
activities. TEB Life acts as the primary re-insurer for credit life insurance
sold through the Bank. Since 1994, the Company has entered into agreements with
the Virginia Community Development Corporation to purchase equity positions in
the Housing Equity Fund of Virginia II, III, IV, V, VII, VIII, IX and Historic
Equity Fund I. These funds provide housing for low-income individuals throughout
Virginia. Approval of the Federal Reserve Board is necessary to engage in any of
the activities described above or to acquire interests engaging in these
activities.
The Bank as a state member bank is supervised and regularly examined by the
Virginia Bureau of Financial Institutions and the Federal Reserve Board. Such
supervision and examination by the Virginia Bureau of Financial Institutions and
the Federal Reserve Board is intended primarily for the protection of depositors
and not for the stockholders of F & M Bank Corp.
The information required by Guide 3 has been included under Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations.
52
Item 2 - Description of Properties
The locations of F & M Bank Corp., Inc. and its subsidiaries are shown below.
Timberville Main Office Elkton Branch
205 South Main Street 127 West Rockingham Street
Timberville, VA 22853 Elkton, VA 22827
Broadway Branch Elkton Plaza Branch
126 Timberway Rt. 33 West
Broadway, VA 22815 Elkton, VA 22827
Bridgewater Branch Edinburg Branch
100 Plaza Drive 120 South Main Street
Bridgewater, VA 22812 Edinburg, VA 22824
Woodstock Branch Harrisonburg Office
161 South Main Street (Mortgage Origination & Investment Sales)
Woodstock, VA 22664 207 University Blvd, Suite 100
Harrisonburg, VA 22801
With the exception of the Edinburg Branch and the Harrisonburg Office, all
facilities are owned by Farmers & Merchants Bank. ATMs are available at all
locations, with the exception of Edinburg and Harrisonburg.
Through an agreement with Nationwide Money ATM Services, the Bank also operates
cash only ATMs at eight Food Lion grocery stores, one in Mt. Jackson, VA, four
in Harrisonburg, VA, three in Charlottesville, VA and one ATM at a convenience
store in Edinburg, VA.
Item 9A -Controls and Procedures
Under the supervision and with the participation of the Company's management,
including the chief executive officer and chief financial officer, the Company
has evaluated the effectiveness of the design and operation of its disclosure
controls and procedures as of the end of the period covered by this Annual
Report on Form 10-K. Based on that evaluation, the chief executive officer and
chief financial officer have concluded that these controls and procedures are
effective. There were no significant changes in the internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are the controls and other procedures that
are designed to ensure that information required to be disclosed by the Company
in the reports that it files or submits under the Securities Exchange Act of
1934 is accumulated and communicated to management of the Company, including our
chief executive officer and chief financial officer, as appropriate, to allow
timely decisions regarding required disclosures.
Item 9B. - Other Information
None.
53
PART III
Item 10. - Directors and Executive Officers of the Registrant
Information regarding directors, executive officers and the audit committee
financial expert is incorporated by reference from the Company's definitive
proxy statement for the Company's 2005 Annual Meeting of Shareholders to be held
May 14, 2005 ("Proxy Statement"), under the captions "Election of Directors,"
"Board of Directors and Committees," and "Executive Officers." Information on
Section 16(a) beneficial ownership reporting compliance for the directors and
executive officers of the Company is incorporated by reference from the Proxy
Statement under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance." The Company has adopted a broad based code of ethics for all
employees and directors. The Company has also adopted a code of ethics tailored
to senior officers who have financial responsibilities. A copy of the codes may
be obtained without charge by request from the corporate secretary. Item 11. -
Executive Compensation This information is incorporated by reference from the
Proxy Statement under the caption "Executive Compensation." Item 12. - Security
Ownership of Certain Beneficial Owners and Management This information is
incorporated by reference from the Proxy Statement under the caption "Ownership
of Company Common Stock" and "Executive Compensation" and from Item 5 of this
10-K. Item 13. - Certain Relationships and Related Transactions This information
is incorporated by reference from the Proxy Statement under the caption
"Interest of Directors and Officers in Certain Transactions." Item 14. -
Principal Accounting Fees and Services This information is incorporated by
reference from the Proxy Statement under the caption "Principal Accounting
Fees."
Item 15 - Exhibits and Financial Statement Schedules
The following financial statements are filed as a part of this report:
(a)(1) Financial Statements
The following consolidated financial statements and reports of independent
auditors of the Company are in Part II, Item 8 on pages 24 thru 45:
Consolidated Balance Sheets - December 31, 2004 and 2003 25
Consolidated Statements of Income - Years ended
December 31, 2004, 2003 and 2002 26
Consolidated Statements of Stockholders' Equity - Years
ended December 31, 2004, 2003 and 2002 27
Consolidated Statements of Cash Flows - Years ended December 31, 2004,
2003 and 2002 28
Notes to the Consolidated Financial Statements 29
Report of the Independent Auditors 49
54
(a)(2) Financial Statement Schedules
All schedules are omitted since they are not required, are not applicable, or
the required information is shown in the consolidated financial statements or
notes thereto.
(a)(3) Exhibits
The following exhibits are filed as a part of this form 10-K and this list
includes the Exhibit index:
Exhibit No.
3.1 Restated Articles of Incorporation of F & M Bank Corp. as incorporated by
reference to F & M Bank Corp.'s 10-K filed March 8, 2002.
3.2 Amended and Restated Bylaws of F & M Bank Corp. as incorporated by
reference to F & M Bank Corp.'s 10-K filed March 8, 2002.
21.0 Subsidiaries of the Registrant
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Shareholders may obtain, free of charge, a copy of the exhibits to this Report
on Form 10-K by writing Larry A. Caplinger, Corporate Secretary, at F & M Bank
Corp., P.O. Box 1111, Timberville, VA 22853 or our website at
www.farmersandmerchants.biz.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
F & M Bank Corp.
(Registrant)
By: /s/ Dean W. Withers March 24, 2005
--------------------------- -------------------------------
Dean W. Withers Date
Director, President and Chief Executive Officer
By: /s/ Neil W. Hayslett March 24, 2005
--------------------------- --------------------------
Neil W. Hayslett Date
Senior Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and as of the date indicated.
Signature Title Date
/s/ Thomas L. Cline Director March 24, 2005
- -------------------------- ----------------
Thomas L. Cline
Director
- --------------------------- ----------------
John N. Crist
Director, Chairman
- --------------------------- ----------------
Julian D. Fisher
/s/ Ellen R. Fitzwater Director March 24, 2005
- --------------------------- ----------------
Ellen R. Fitzwater
/s/ Robert L. Halterman Director March 24, 2005
- --------------------------- ---------------
Robert L. Halterman
/s/ Daniel J. Harshman Director March 24, 2005
- ------------------------- ----------------
Daniel J. Harshman
Director
- --------------------------- ----------------
Richard S. Myers
Director
- --------------------------- ----------------
Michael W. Pugh
/s/ Ronald E. Wampler Director March 24, 2005
- --------------------------- ---------------
Ronald E. Wampler