SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 2005
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 if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Sarbanes Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one)
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The registrant's Common Stock is traded Over-the-Counter under the symbol FMBM.
The aggregate market value of the 2,187,895 shares of Common Stock of the
registrant issued and outstanding held by non-affiliates on June 30, 2005 was
approximately $54,916,165 based on the closing sales price of $25.10 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, 2006, there were 2,401,884 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 13,
2006 (the "Proxy Statement").
TABLE OF CONTENTS
PART I
Page
Item 1 Business 1
Item 1A Risk Factors 5
Item 1B Unresolved Staff Comments 6
Item 2 Properties 7
Item 3 Legal Proceedings 7
Item 4 Submission of Matters to a Vote of Security Holders 7
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters and Issuer Purchases of Equity Securities 8
Item 6 Selected Financial Data 9
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 8 Financial Statements and Supplementary Information 29
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 56
Item 9A Controls and Procedures 56
Item 9B Other Information 56
PART III
Item 10 Directors and Executive Officers of the Registrant 57
Item 11 Executive Compensation 57
Item 12 Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 57
Item 13 Certain Relationships and Related Transactions 57
Item 14 Principal Accounting Fees and Services 57
PART IV
Item 15 Exhibits and Financial Statement Schedules 58
1
PART I
Item 1. Business
General
F & M Bank Corp. (the "Company" or "we"), 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 and 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.
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.
Recent Developments
The Bank is currently in various stages of development with three new branch
offices. The first office is a leased facility containing approximately 1312
square feet, located at 1085 Port Republic Road, Harrisonburg, Virginia. This
will be a full-service facility, staffed by approximately six full-time
equivalent employees. The facility will have two drive-in teller lanes and a
drive-up ATM. The facility will open on April 3, 2006.
The second office that has been approved by the banking regulatory agencies is
located at 80 Cross Keys Road, Harrisonburg, Virginia. This facility is
currently under construction, is owned by the Bank and will contain
approximately 6300 square feet. This will be a full-service facility employing
approximately fifteen full-time equivalent employees, including branch staff,
business development officers, an investment officer and mortgage production
staff. The facility will have three drive-in teller lanes, and a drive-up ATM.
We anticipate opening this facility in August 2006. Concurrently with the
opening of this office we will close our branch office located at the Elkton
Plaza Shopping Center, Elkton, Virginia and our mortgage origination/investment
sales office located at 207 University Boulevard, Harrisonburg, Virginia. The
employees at both of these locations will transfer to the new branch to form the
core of the staffing for this new facility.
We also have a pending application with the Federal Reserve and the State
Corporation Commission to establish a branch located at 700 East Main Street,
Luray, Virginia. Action is expected on this application by March 31, 2006. This
is a leased facility containing approximately 1880 square feet. This will be a
full-service facility, staffed by approximately seven full-time equivalent
employees. The facility will have three drive-in lanes and a drive-up ATM and is
expected to open sometime during mid-summer 2006.
2
Filings with the SEC.
The Company files annual, quarterly and other reports under the Securities
Exchange Act of 1934 with the Securities and Exchange Commission ("SEC"). These
reports are posted and are available at no cost on the Company's website,
www.farmersandmerchants.biz, as soon as reasonably practicable after the Company
files such documents with the SEC. The Company's filings are also available
through the SEC's website at www.sec.gov.
Employees
On December 31, 2005, F & M Bank Corp., the Bank, TEB and FMFS had 114 full-time
and part-time employees; including executive officers, loan and other banking
officers, branch personnel, operations personnel and other support personnel.
None of the Company's employees is represented by a union or covered under a
collective bargaining agreement. Management of the Company considers their
employee relations to be excellent. No one employee devotes full-time services
to F&M Bank Corp.
Competition
The Bank's offices face strong competition from numerous other financial
institutions. These other institutions include large national and regional
banks, other community banks, nationally chartered savings banks, credit unions,
consumer finance companies, mortgage companies, loan production offices, mutual
funds and life insurance companies. Competition for loans and deposits is
affected by a variety of factors including interest rates, types of products
offered, the number and locations of branch offices, marketing strategies and
the reputation of the Bank within the communities served.
Regulation and Supervision
General. 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.
3
Regulation and Supervision (Continued)
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, X 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.
Payment of Dividends. The Company is a legal entity, separate and distinct from
its subsidiaries. A significant portion of the revenues of the Company result
from dividends paid to it by the Bank. There are various legal limitations
applicable to the payment of dividends by the Bank to the Company, as well as
the payment of dividends by the Company to its respective shareholders.
The Bank is subject to various statutory restrictions on their ability to pay
dividends to the Company. Under the current regulatory guidelines, prior
approval from the Board of Governors of the Federal Reserve System is required
if cash dividends declared in any given year exceed net income for that year,
plus retained net profits of the two preceding years. The payment of dividends
by the Bank or the Company may also be limited by other factors, such as
requirements to maintain capital above regulatory guidelines.
Bank regulatory agencies have the authority to prohibit the Bank or the Company
from engaging in an unsafe or unsound practice in conducting their business. The
payment of dividends, depending on the financial condition of the Bank, or the
Company, could be deemed to constitute such an unsafe or unsound practice. Based
on the Bank's current financial condition, the Company does not expect that any
of these laws will have any impact on its ability to obtain dividends from the
Bank.
Capital Requirements.The Federal Reserve has issued risk-based and leverage
capital guidelines applicable to United States banking organizations. In
addition, regulatory agencies may from time to time require that a banking
organization maintain capital above the minimum levels because of its financial
condition or actual or anticipated growth. Under the risk-based capital
requirements, the Company and Bank are required to maintain a minimum ratio of
total capital to risk-weighted assets of at least 8%. At least half of the total
capital is required to be "Tier 1 capital", which consists principally of common
and certain qualifying preferred shareholders' equity (including Trust Preferred
Securities), less certain intangibles and other adjustments. The remainder
("Tier 2 capital") consists of a limited amount of subordinated and other
qualifying debt (including certain hybrid capital instruments) and a limited
amount of the general loan loss allowance. The Tier 1 and total capital to
risk-weighted asset ratios of the Company as of December 31, 2005 were 13.54%
and 14.24%, respectively, exceeding the minimum requirements.
4
Regulation and Supervision (Continued)
In addition, each of the federal regulatory agencies has established a minimum
leverage capital ratio (Tier 1 capital to average adjusted assets) ("Tier 1
leverage ratio"). These guidelines provide for a minimum Tier 1 leverage ratio
of 4% for banks and bank holding companies that meet certain specified criteria,
including that they have the highest regulatory examination rating and are not
contemplating significant growth or expansion. The Tier 1 leverage ratio of the
Company as of December 31, 2005, was 9.13%, which is above the minimum
requirements. The guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
The Gramm-Leach-Bliley Act .Effective on March 11, 2001, the Gramm-Leach-Bliley
Act (the "GLB Act") allows a bank holding company or other company to certify
status as a financial holding company, which will allow such company to engage
in activities that are financial in nature, that are incidental to such
activities, or are complementary to such activities. The GLB Act enumerates
certain activities that are deemed financial in nature, such as underwriting
insurance or acting as an insurance principal, agent or broker; underwriting;
dealing in or making markets in securities; and engaging in merchant banking
under certain restrictions. It also authorizes the Federal Reserve to determine
by regulation what other activities are financial in nature, or incidental or
complementary thereto.
USA Patriot Act of 2001. In October, 2001, the USA Patriot Act of 2001 was
enacted in response to the terrorist attacks in New York, Pennsylvania and
Northern Virginia which occurred on September 11, 2001. The Patriot Act is
intended is to strengthen U.S. law enforcements' and the intelligence
communities' abilities to work cohesively to combat terrorism on a variety of
fronts. The continuing and potential impact of the Patriot Act and related
regulations and policies on financial institutions of all kinds is significant
and wide ranging. The Patriot Act contains sweeping anti-money laundering and
financial transparency laws, and imposes various regulations, including
standards for verifying client identification at account opening, and rules to
promote cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering.
Community Reinvestment The requirements of the Community Reinvestment Act are
also applicable to the Bank. The act imposes on financial institutions an
affirmative and ongoing obligation to meet the credit needs of their local
communities, including low and moderate income neighborhoods, consistent with
the safe and sound operation of those institutions. A financial institution's
efforts in meeting community needs currently are evaluated as part of the
examination process pursuant to twelve assessment factors. These factors are
also considered in evaluating mergers, acquisitions and applications to open a
branch or facility.
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.
5
Item 1A. - Risk Factors
General economic conditions, either national or within the Company's local
markets.
The Company is affected by general economic conditions in the United States and
the local markets within which it operates. An economic downturn within the
Company's markets, or the nation as a whole; a significant decline in general
economic conditions caused by inflation, recession, unemployment or other
factors beyond the Company's control could negatively impact the growth rate of
loans and deposits, the quality of the loan portfolio, loan and deposit pricing
and other key factors of the Company's business. Such negative developments
could adversely impact the Company's financial condition and performance.
Changes in interest rates could affect the Company's income and cash flows.
The direction and speed of interest rate changes affects our net interest margin
and net interest income. Typically, in a period of declining interest rates our
net interest income is negatively affected in the short term as our interest
earning assets (primarily loans and investment securities) reprice more quickly
than our interest bearing liabilities (deposits and borrowings).
We attempt to mitigate this risk by maintaining a neutral position regarding the
volume of assets and liabilities that mature or reprice during any period;
however, interest rate fluctuations, loan prepayments, loan production and
deposit flows constantly change and influence the ability to maintain a neutral
position. Generally speaking, the Company's earnings will be more sensitive to
fluctuations in interest rates the greater the variance in volume of assets and
liabilities that mature and reprice in any period. Accordingly, the Company may
not be successful in maintaining a neutral position and, as a result, the
Company's net interest margin may be impacted.
The Company faces substantial competition that could adversely affect the
Company's growth and/or operating results.
The Company operates in a competitive market for financial services and faces
intense competition from other financial institutions both in making loans and
in attracting deposits. Many of these financial institutions have been in
business for many years, are significantly larger, have established customer
bases, and have greater financial resources and lending limits.
There could be an adverse effects on the way in which we do business if we do
not maintain our capital requirements and our status as a `well-capitalized"
bank.
The Bank is subject to regulatory capital adequacy guidelines. If the Bank fails
to meet the capital adequacy guidelines for a "well-capitalized" bank, it could
increase the regulatory scrutiny for the Bank and the Company; increase our FDIC
insurance premiums, and could lead to a decline in the confidence that our
customers have in us and a reduction in the demand for our products and
services.
The inability of the Company to successfully manage its growth or implement its
growth strategy may adversely affect the result of operations and financial
conditions.
The Company may not be able to successfully implement its growth strategy if
unable to identify attractive markets, locations or opportunities to expand in
the future. The ability to manage growth successfully also depends on whether
the Company can maintain capital levels adequate to support its growth, maintain
cost controls, asset quality and successfully integrate any businesses acquired
into the organization.
As the Company continues to implement its growth strategy by opening new
branches it expects to incur increased personnel, occupancy and other operating
expenses. The Company must absorb those higher expenses while it begins to
generate new deposits, and there is a further time lag involved in redeploying
new deposits into attractively priced loans and other higher yielding earning
assets. Thus, the Company's plans to branch could depress earnings in the short
run, even if it efficiently executes a branching strategy leading to long-term
financial benefits.
6
The Company's exposure to operational risk may adversely affect the Company.
Similar to other financial institutions, the Company is exposed to many types of
operational risk, including reputational risk, legal and compliance risk, the
risk of fraud or theft by employees or outsiders, unauthorized transactions by
employees or operational errors, including clerical or record-keeping errors or
those resulting from faulty or disabled computer or telecommunications systems.
The Company's concentration in loans secured by real estate may adversely impact
earnings due to changes in the real estate markets.
The Company offers a variety of secured loans, including commercial lines of
credit, commercial term loans, real estate, construction, home equity, consumer
and other loans. Many of the Company's loans are secured by real estate (both
residential and commercial) in the Company's market area. A major change in the
real estate market, resulting in deterioration in the value of this collateral,
or in the local or national economy, could adversely affect the customers'
ability to pay these loans, which in turn could impact the Company. Risk of loan
defaults and foreclosures are unavoidable in the banking industry, and the
Company tries to limit its exposure to this risk by monitoring extensions of
credit carefully. The Company cannot fully eliminate credit risk, and as a
result credit losses may occur in the future.
Legislative or regulatory changes or actions, or significant litigation, could
adversely impact the Company or the businesses in which the Company is engaged.
The Company is subject to extensive state and federal regulation, supervision
and legislation that govern almost all aspects of its operations. Laws and
regulations may change from time to time and are primarily intended for the
protection of consumers, depositors and the deposit insurance funds. The impact
of any changes to laws and regulations or other actions by regulatory agencies
may negatively impact the Company or its ability to increase the value of its
business. Additionally, actions by regulatory agencies or significant litigation
against the Company could cause it to devote significant time and resources to
defending itself and may lead to penalties that materially affect the Company
and its shareholders. Future changes in the laws or regulations or their
interpretations or enforcement could be materially adverse to the Company and
its shareholders.
Changes in accounting standards could impact reported earnings.
The accounting standard setters, including the FASB, SEC and other regulatory
bodies, periodically change the financial accounting and reporting standards
that govern the preparation of the Company's consolidated financial statements.
These changes can be hard to predict and can materially impact how it records
and reports its financial condition and results of operations. In some cases,
the Company could be required to apply a new or revised standard retroactively,
resulting in the restatement of prior period financial statements.
Item 1B. - Unresolved Staff Comments
The Company does not have any unresolved staff comments to report for the year
ended December 31, 2005.
7
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 five Food Lion grocery stores, one in Mt. Jackson, VA, four in
Harrisonburg, VA, and one ATM at a convenience store in Edinburg, VA.
Item 3. Legal Proceedings
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.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders of the Company during
the fourth quarter of the period covered by this report.
8
PART II
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 $1,878,100 and $1,785,994 in 2005 and 2004,
respectively. Regular quarterly dividends have been declared for forty-eight
consecutive quarters. Dividends per share increased 5.41% in 2005.
The ratio of dividends per share to net income per share was 38.70% in 2005,
compared to 41.06% in 2004. 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.
Stock Repurchases
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 2005 total 35,125; of this amount, 12,404 shares were
repurchased in 2005.
The number of common shareholders of record was approximately 1,672 as of March
1, 2006. 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.
2005 2004
Per Share Range Per Share Stock Price Range Per Share
Quarter Low High Dividend Low High Dividend
1st 26.00 26.50 .19 22.40 25.50 .18
2nd 24.15 26.20 .19 23.75 27.25 .18
3rd 24.60 25.25 .20 23.55 24.50 .19
4th 24.75 26.00 .20 24.50 27.00 .19
Total .78 .74
9
Item 6
Five Year Summary of Selected Financial Data
(Dollars in thousands, 2005 2004 2003 2002 2001
except per share data)
Income Statement Data:
Interest and Dividend
Income $ 19,878 $ 16,804 $ 16,683 $ 17,846 $ 17,681
Interest Expense 6,998 5,396 6,010 7,390 9,494
---------- ---------- ---------- ---------- ----------
Net Interest Income 12,880 11,408 10,673 10,456 8,187
Provision for Loan
Losses 360 240 226 387 204
---------- ---------- ---------- ---------- ----------
Net Interest Income
After Provision for
Loan Losses 12,520 11,168 10,447 10,069 7,983
Noninterest Income 2,643 2,254 2,308 1,380 1,158
Securities Gains
(Losses) 71 532 179 (182) 1,252
Noninterest Expenses 8,608 7,741 7,256 6,448 5,728
---------- ---------- ---------- ---------- ----------
Income before Income
Taxes 6,626 6,213 5,678 4,819 4,665
Income Tax Expense 1,846 1,863 1,666 1,315 1,435
---------- ---------- ---------- ---------- ----------
Net Income $ 4,780 $ 4,350 $ 4,012 $ 3,504 $ 3,230
========== ========== ========== ========== ==========
Per Share Data:
Net Income $ 1.99 $ 1.80 $ 1.66 $ 1.44 $ 1.33
Dividends Declared .78 .74 .70 .66 .63
Book Value 15.22 14.21 13.35 12.19 11.74
Balance Sheet Data:
Assets $ 346,328 $ 369,957 $ 309,126 $ 303,149 $ 272,673
Loans Held for
Investment 277,398 248,972 211,231 201,980 176,625
Loans Held for Sale 3,528 47,150 - - -
Securities 34,921 38,800 61,230 69,602 63,987
Deposits 267,310 246,505 240,715 228,284 208,279
Short-Term Debt 14,345 57,362 6,389 8,308 10,696
Long-Term Debt 22,808 26,462 24,784 32,312 20,983
Shareholders' Equity 36,567 34,260 32,319 29,541 28,597
Average Shares
Outstanding 2,404 2,414 2,418 2,429 2,431
Financial Ratios:
Return on Average
Assets(1) 1.34% 1.31% 1.29% 1.21% 1.26%
Return on Average
Equity(1) 13.56% 13.11% 13.13% 12.12% 11.47%
Net Interest Margin 3.95% 3.82% 3.82% 4.03% 3.52%
Efficiency Ratio (2) 53.07% 54.02% 53.96% 51.28% 56.93%
Dividend Payout Ratio 38.70% 41.06% 42.17% 45.72% 47.45%
Capital and Credit Quality Ratios:
Average Equity to
Average Assets(1) 9.86% 10.00% 9.86% 9.98% 11.02%
Allowance for Loan
Losses to Loans(3) .60% .61% .70% .73% .73%
Nonperforming Assets
to Total Assets .20% .63% .52% .86% .40%
Net Charge-offs to
Total Loans(3) .07% .09% .10% .10% .06%
(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.
10
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.
11
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
2005 or 2004. Application of the non-amortization provisions of the Statement
resulted in additional net income of $190,000 for the years ended December 31,
2005, 2004 and 2003.
Core deposit intangibles are amortized on a straight-line basis over a ten year
life. Core deposits, net of amortization, amounted to $1,426,000 and $1,702,000
at December 31, 2005 and 2004, 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 $119,000 for
2005, $162,000 for 2004 and $100,000 for 2003.
Overview
The Company's net income for 2005 totaled $4,780,000 or $1.99 per share, up
9.90% from $4,350,000 or $1.80 a share in 2004. Return on average equity
increased in 2005 to 13.56% versus 13.11% in 2004, while the return on average
assets increased from 1.31% to 1.34%. The Company's operating earnings, which
are net earnings excluding gains (losses) on the sale of investments,
non-recurring tax entries, and the non-cash amortization of acquisition
intangibles, were $4,765,000 in 2005 versus $4,177,000 in 2004, an increase of
14.07%. Core profitability improved as a result of an increase in net interest
income of 12.90%.
See page 9 for a five-year summary of selected financial data.
12
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Changes in Net Income per Common Share
2005 to 2004 2004 to 2003
Prior Year Net Income Per Share $ 1.80 $ 1.66
Change from differences in:
Net interest income .64 .30
Provision for credit losses (.05) (.01)
Noninterest income, excluding securities gains .17 (.02)
Securities gains (.19) .15
Noninterest expenses (.38) (.20)
Income taxes - (.08)
----------- ---------
Total Change .19 .14
----------- ---------
Net Income Per Share $ 1.99 $ 1.80
=========== =========
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 2005 was $12,880,000 representing an increase of
$1,472,000 or 12.90%. A 6.89% increase in 2004 versus 2003 resulted in total net
interest income of $11,408,000. In this discussion and in the tabular analysis
of net interest income performance, entitled "Consolidated Average Balances,
Yields and Rates," (found on page 13), 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 an increase in net interest margin to
3.95% in 2005 primarily due to the increase in loan volume and the Federal
Reserve's measured increase in rates during the year. During 2004 the net
interest margin was flat resulting from the Federal Reserve's accommodative
monetary stance.
Loans held for investment increased in 2005 to 83.05% of total earning assets as
compared to 74.85% in 2004. This increase in loan volume and the overall
increase in rates generated interest income that more than offset the decline in
volume in other asset categories. Tax equivalent income on earning assets
increased $2,917,000, supported by the increase in loan income of $3,248,000.
Increased yields in most asset categories resulted in overall increase in the
yield on earning assets increased .50 %.
Interest bearing liabilities experienced increased costs during 2005, with the
cost of funds rising .46% compared to a decline of .39% in 2004.
13
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Consolidated Average Balances, Yields and Rates(1)
2005 2004 2003
------------------------- --------------------------- -------------------------
Balance Interest Rate Balance Interest Rate Balance Interest Rate
ASSETS
Loans:(2)
Commercial $ 75,219 $ 4,793 6.37% $ 53,624 $ 3,078 5.74% $ 48,848 $ 3,020 6.18%
Real estate 170,480 10,388 6.09 149,158 9,316 6.25 128,984 8,940 6.93
Installment 24,964 2,481 9.94 24,122 2,020 8.37 24,663 2,218 8.99
------- ------- ----- ------- ------ ---- ------- ------ ----
Loans held
for investment 270,663 17,662 6.53 226,904 14,414 6.35 202,495 14,178 7.00
Loans held for
sale 18,749 870 4.64 21,147 688 3.25 99 3 3.03
Investment securities:(3)
Fully taxable 22,733 826 3.63 34,020 1,058 3.11 47,908 1,765 3.68
Partially taxable 7,035 331 4.71 9,335 554 5.93 9,194 567 6.17
Tax exempt 375 12 3.20 375 17 4.53 160 7 4.38
------- ------- ----- ------- ------- ---- ------- ------ ----
Total Investment
Securities 30,143 1,169 3.88 43,730 1,629 3.73 57,262 2,339 4.08
Interest bearing
deposits
in banks 3,867 97 2.51 8,556 198 2.32 8,378 178 2.12
Federal funds sold 2,496 80 3.21 2,821 32 1.13 16,043 169 1.05
------- ------- ---- ------- ------- ---- ------- ------ ----
Total Earning
Assets 325,918 19,878 6.10 303,158 16,961 5.60 284,277 16,867 5.93
------- ------- ---- ------- ------- ---- ------- ------ ----
Allowance for loan
losses (1,697) (1,527) (1,511)
Nonearning assets 34,309 30,097 27,055
-------- ------- -------
Total Assets $358,530 $331,728 $309,821
======== ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand - Interest
bearing $ 38,872 $ 230 .59 $ 38,223 $ 205 .54 $ 35,611 $ 214 .60
Savings 47,073 520 1.10 49,879 453 .91 44,547 488 1.10
Time deposits 129,773 4,054 3.12 119,140 3,313 2.78 125,430 4,018 3.20
------- ------- ----- ------- ------ ---- ------- ------ ----
Total Interest
Bearing Deposits 215,718 4,804 2.23 207,242 3,971 1.92 205,588 4,720 2.30
Short-term debt 30,687 1,032 3.36 24,218 419 1.73 7,179 44 .61
Long-term debt 27,026 1,162 4.30 25,274 1,006 3.98 28,645 1,246 4.35
------- ------ ---- ------- ------ ---- ------- ------ ----
Total Interest
Bearing
Liabilities 273,431 6,998 2.56 256,734 5,396 2.10 241,412 6,010 2.49
------- ------ ---- ------- ------ ---- ------- ----- ----
Noninterest bearing
deposits 45,230 37,720 31,442
Other liabilities 4,456 4,105 6,408
------- ------- -------
Total Liabilities 323,117 298,559 279,262
Stockholders' equity 35,413 33,169 30,559
------- ------- -------
Total Liabilities
And Stockholders'
Equity $358,530 $331,728 $309,821
======= ======= =======
Net Interest Earnings $ 12,880 $ 11,565 $ 10,857
======= ======= =======
Net Yield on Interest
Earning Assets (NIM) 3.95% 3.82% 3.82%
==== ==== ====
(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.
14
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following table illustrates the effect of changes in volumes and rates.
2005 Compared to 2004 2004 Compared to 2003
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 $2,779 $ 469 $3,248 $1,709 $(1,473) $ 236
Loans held for sale (78) 260 182 638 47 685
Investment securities:
Taxable (351) 119 (232) (511) (196) (707)
Partially taxable (136) (87) (223) 9 (22) (13)
Tax exempt - (5) (5) 9 1 10
Interest bearing
Deposits in banks (109) 8 (101) 4 16 20
Federal funds sold (4) 52 48 (139) 2 (137)
------ ------ ------ ------ ------ ------
Total Interest
Income 2,101 816 2,917 1,719 (1,625) 94
------ ------ ------ ------ ------ ------
Interest expense:
Deposits:
Demand 4 21 25 16 (25) (9)
Savings (26) 93 67 59 (94) (35)
Time deposits 296 445 741 (201) (504) (705)
Short-term debt 112 501 613 104 277 381
Long-term debt 70 86 156 (147) (99) (246)
------ ------ ------ ------ ------ ------
Total Interest
Expense 456 1,146 1,602 (169) (445) (614)
------ ------ ------ ------ ------ ------
Net Interest
Income $1,645 $ (330) $1,315 $1,888 $(1,180) $ 708
===== ===== ===== ===== ====== =====
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 $2,917,000 or 17.20% in 2005, after
decreasing .56% or $94,000 in 2004. Overall, the yield on earning assets
increased .50%, from 5.60% to 6.10%. This reverses the two year decline in yield
that was experienced while the Federal Reserve was aggressively cutting rates.
The increase of .50% is approximately one fourth of the increase in the Federal
Funds rate over the preceding year and reflects the fact that the Company's
balance sheet does not reprice immediately with changes in short term rates.
Loan growth continued at a rapid pace during 2005, with average loans
outstanding increasing $43,759,000 to $270,663,000. Real estate loans increased
14.29% and commercial loans increased 40.27%. Combined these categories
accounted for over 98% of the total increase in year ending loans. The 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. The increase in commercial loans resulted primarily from
the rapid pace of residential development in the area and from loans generated
by two new business development officers that have brought customers with them
from larger banks in the area.
15
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Average total securities, yielding 3.88%, decreased $13,587,000 during 2005.
Proceeds from the sale and maturity of investment securities were used to fund
loan growth. Income on loans held for sale increased $182,000 as compared to the
$685,000 increase during 2004. 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. As in 2004, the participations that were held
during 2005 were funded with Federal Home Loan Bank overnight borrowings. The
spread between the earnings on these participations and the cost of the
overnight borrowings from the FHLB added approximately $205,000 to pretax
earnings and approximately $135,000 to net income for the year.
Interest Expense
Interest expense increased $1,602,000 or 29.69% during 2005, which followed a
10.22% decrease ($614,000) in 2004. The average cost of funds of 2.56% increased
..46% compared to 2004. Average interest bearing liabilities increased
$16,697,000 and $15,322,000 in 2005 and 2004, respectively. This increase was
the result of the increase in short-term debt, which was used to fund short-term
real estate loan participations, the growth in volume of time deposits (average
time deposits increase $10,533,000 or 8.9%) and the measured increase in rates
throughout the year. The Bank also enjoyed growth in demand and savings accounts
as a result of continued consolidation among larger banks within its markets.
Expense of long-term debt increased $156,000 in 2005 after a decline of $240,000
in 2004. The increase is primarily due to additional FHLB borrowings of
$5,000,000 in the first quarter of 2005. The Company borrowed $9,000,000 in
2004. Funds borrowed in both years were used to fund long-term loans.
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 decreased $80,000 in 2005. This decrease resulted from lower levels of
commissions from its partnership in BI Investments, LLC. The reduction in
commissions was caused by a combination of lower sales volume in 2005 and a
reduction in the payout matrix offered by BI Investments, LLC. This decrease
followed an increase of $97,000 in 2004.
Exclusive of securities gains and losses, non-interest income increased 17.26%
($389,000) in 2005 following an decrease of 2.33% in 2004. Service charges on
deposit accounts increased 14.64% ($133,000) compared to 2004 primarily due to
overdraft charges ($157,446 or 19.96%). In 2005, 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 $5,391,000 in average balances of
non-interest bearing checking accounts this resulted in a decrease in account
maintenance fees of $24,000. Investments in bank owned life insurance (BOLI) on
officers of the Company resulted in tax-free income of $251,000 in 2005 and
2004.
Securities transactions in 2005 resulted in gains of $71,000 after recognizing
impairment write downs of $119,000 on two of its equity holdings. These write
downs included a $87,000 write down on the Bank's investment in BI Investments,
LLC and a $32,000 write down by the Company on one of its equity holdings. This
followed gains of $532,000 in 2004, which included a $100,000 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 2005 and 2004 were unlikely to be recouped in the near future and
recognized impairment in the investment under SFAS 115.
16
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Noninterest Expense
Noninterest expenses increased from $7,741,000 in 2004 to $8,607,000 in 2005, an
11.19% increase. Salary and benefits increased 9.65% to $4,815,000 in 2005 and
6.36% in 2004. The 2005 increase resulted from additions to staff to support
Bank growth and expansion, normal salary adjustments, increases in insurance and
pension expenses.
Occupancy and equipment expense increased 5.67% ($47,000) in 2005 and 2.58% in
2004 due to several equipment and software purchases including a generator,
fraud software and Bank vehicles.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Other operating expense increased $395,000 in 2005, following a $202,000
increase in 2004. Much of the increase was due to increases in audit, exam and
legal fees related to documenting internal controls, data processing fees paid
for computer software, licensing and maintenance of new and existing programs;
Bank Franchise tax expense, ATM expenses, FDIC assessment, and postage for on
new deposit account mailings.
Although noninterest expenses have increased substantially in both 2005 and
2004, they continue to be substantially less than peer group averages. Total
noninterest expense as a percentage of average assets totaled 2.41%, 2.33%, and
2.34%, in 2005, 2004 and 2003, 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 $240,000 in 2004 to $360,000 in 2005. Actual net loan
charge-offs were $198,000 in 2005 and $213,000 in 2004. Loan losses as a
percentage of period ending loans held for investment totaled .07% and .09% in
2005 and 2004, respectively. Average losses continue at less than one-half that
of the Bank's peer group average, which have ranged between .13% and .26% over
the last three years.
Balance Sheet
Total assets decreased 6.39% during the year to $346,328,000, a decrease of
$23,629,000 from $369,957,000 in 2004. Earning assets decreased 7.14% or
$24,608,000 to $320,562,000 at December 31, 2005. Much of the decrease in
earning assets resulted from the aforementioned real estate loan participation
portfolio which totaled $3,528,000 and $47,150,000 at year end 2005 and 2004,
respectively. Interest bearing deposits increased $15,173,000 or 7.37%.
Short-term debt decreased $43,016,000 due to the decrease in mortgage loan
participations. The Company continues to utilize its assets well with 92.56% of
year-end assets consisting of earning assets.
Investment Securities
Average balances in investment securities decreased 31.07% in 2005 to
$30,143,000. This decrease was in the investment portfolio segment of fully
taxable investment securities. The decrease resulted from a combination of
securities maturities and mortgage pool pay downs. At year end, the 9.25% 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.
17
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Portfolio yields averaged 3.88% for 2005, up from 3.73% in 2004. 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, during 2004, 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) 2005 2004 2003
---- ---- ----
Available for Sale:(1)
U.S. Treasury and Agency $15,820 $16,011 $25,443
Municipal 365 369 373
Mortgage-backed(2) 3,510 5,425 8,989
Corporate bonds 2,354 2,466 10,845
Marketable equity securities 6,458 6,485 9,245
------- ------- -------
Total 28,507 30,756 54,895
Held to Maturity:
U.S. Treasury and Agency 110 110 110
Corporate bonds - - 764
------- ------- -------
Total 110 110 874
Other Equity Investments 6,304 7,934 5,461
------- ------- -------
Total Securities $34,921 $38,800 $61,230
======= ======= =======
(1) At estimated fair value.
(2) Issued by a U.S. Government Agency or secured by U.S. Government Agency
collateral.
Maturities and weighted average yields of debt securities at December 31, 2005
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 $11,927 3.43% $3,893 3.43% $ - $15,820 3.43%
Municipal - 365 3.07 - 365 3.07
Mortgage-
backed - 2,358 4.50 1,152 4.33% 3,510 4.44
Corporate
bonds - 1,960 4.59 394 9.35 2,354 5.39
------ ----- ----- ------
Total $11,927 3.43% $8,576 3.97% $1,546 5.61% $22,049 3.79%
------- ----- ----- ------
Debt Securities Held to Maturity:
U.S. Treasury &
Agency $ 110 3.39% 110 3.39%
------ ------
Total $ 110 3.39% $ n/a $ n/a $ 110 3.39%
====== ===== ===== ======
18
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Analysis of Loan Portfolio
The Company's portfolio of loans held for investment totaled $277,398,000 at
December 31, 2005 compared with $248,972,000 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 46.4% during 2005 to $91,916,000. Real estate mortgages
decreased $13,455,000 (9.1%). The decrease in real estate loans appears to have
resulted from a combination of normal periodic payments on these amortizing
loans, customers refinancing their real estate loans into fixed rate loans sold
into the secondary market and an increase in the volume of loan originations
that were originated into the secondary market rather than into our portfolio of
loans held for investment.
Construction loans increased $16,175,000 or 93.1%, this increase is indicative
of the strong local real estate development market. The growth in construction
loans within our portfolio was broadly diversified with loans to a variety of
developers, including large multi-unit single family developments, single lot
spec homes; and multifamily properties in various locations throughout our
market area. Consumer installment loans decreased $3,571,000. 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
increased $138,000 to $1,616,000 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) 2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Real estate - mortgage $133,826 $147,281 $123,539 $118,453 $105,305
Real estate -
construction 33,540 17,365 15,329 12,059 5,521
Consumer installment 16,435 20,006 19,630 22,704 23,106
Commercial 73,896 43,973 40,149 35,769 28,552
Agricultural 14,759 15,110 10,512 10,966 11,835
Multi-family residential 3,261 3,703 477 484 869
Credit cards 1,616 1,478 1,463 1,477 1,348
Other 65 56 132 68 89
-------- -------- -------- ------- -------
Total Loans $277,398 $248,972 $211,231 $201,980 $176,625
======= ======= ======= ======= =======
19
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, 2005:
Less Than 1-5 Over
(Dollars in thousands) 1 Year Years 5 Years Total
------ ----- ------- -----
Commercial and
agricultural loans $19,809 $ 66,889 $ 5,218 $ 91,916
Real Estate - mortgage 29,375 87,333 17,118 133,826
Real Estate - construction 29,041 4,499 - 33,540
Consumer - installment/other 6,880 10,104 1,132 18,116
------- ------- ------- -------
Total $85,105 $168,825 $23,468 $277,398
======= ======= ====== ========
Loans with predetermined rates $ 7,639 $26,095 $ 8,972 $ 42,706
Loans with variable or
adjustable rates 77,466 142,730 14,496 234,692
------- ------- ------ -------
Total $85,105 $168,825 $23,468 $277,398
======= ======= ====== ========
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.
20
Management's Discussion and Analysis of Financial Condition and Results of
Operations
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, 2005,
there are no industry categories of loans that exceed 10% of total loans.
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) 2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Nonaccruing loans $ 63 $ 864 None None None
Loans past due 90
Days or more $ 632 $ 1,379 $1,614 $2,594 $1,096
----- ------ ----- ----- ------
Total $ 695 $ 2,243 $1,614 $2,594 $1,096
Percentage of total
loans .25% .90% .76% 1.28% .62%
Commercial 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, 2005, 2004, and 2003, 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, 2005, 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.
21
Management's Discussion and Analysis of Financial Condition and Results of
Operations
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.
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 $1,673,000 at December 31, 2005 is equal to
..60% of total loans held for investment. This compares to an allowance of
$1,511,000 (.61%) at December 31, 2004. 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 $198,000 in 2005 which is equivalent to
..07% 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.
22
Management's Discussion and Analysis of Financial Condition and Results of
Operations
A summary of the activity in the allowance for loan losses follows:
(Dollars in thousands) 2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Balance at beginning
of period $1,511 $1,484 $1,477 $1,289 $1,108
Provision charged to
expenses 360 240 226 387 204
Other adjustments - - - - 84
Loan losses:
Commercial 128 123 76 20 22
Installment 135 166 219 249 138
Real estate - 7 - 31 -
------ ------ ------ ------ ------
Total loan losses 263 296 295 300 160
------ ------ ------ ------ ------
Recoveries:
Commercial 19 16 11 28 3
Installment 46 67 65 73 49
Real estate - - - - 1
------ ------ ------ ------ ------
Total recoveries 65 83 76 101 53
------ ------ ------ ------ ------
Net loan losses 198 213 219 199 107
------ ------ ------ ------ ----
Balance at end of period $1,673 $1,511 $1,484 $1,477 $1,289
====== ====== ====== ====== ======
Allowance for loan losses
as a percentage of loans .60% .61% .70% .73% .73%
Net loan losses to loans
outstanding .07% .09% .10% .10% .06%
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 loan categories as shown below. 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.
23
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)
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
% of % of % of % of % of
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
Commercial $ 648 32% $ 506 33% $ 475 26% $ 443 23% $ 451 23%
Real estate 300 61% 280 59% 297 64% 369 65% 323 63%
Installment 650 7% 650 8% 638 10% 591 12% 451 14%
Unallocated 75 - 75 - 74 - 74 - 64 -
----- --- ----- --- ----- --- ----- --- ----- ----
Total $1,673 100% $1,511 100% $1,484 100% $1,477 100% $1,289 100%
===== === ===== === ===== === ====== === ===== ===
Deposits and Borrowings
The Bank recognized an increase in year-end deposits in 2005 of 8.44%. The Bank
experienced an increase in all account types with the exception of Money Market
accounts and Savings accounts. Rates of interest increased throughout 2005. The
Bank advertised free checking throughout the year which resulted in a 13.8%
($5,632,000) increase in noninterest bearing checking accounts. During 2005, the
Bank began advertising several certificate of deposit specials, ranging in term
from nine months to twenty-one months, 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. As a result of these rate promotions, certificates
of deposit increased 15.61% or $18,655,000.
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 $35,461,925 at December 31, 2005. The maturity distribution of these
certificates is as follows:
(Dollars in thousands) 2005 2004
---------------------- ---- ----
Less than 3 months $ 4,602 $ 3,931
3 to 12 months 13,910 7,173
1 year to 5 years 16,950 13,557
-------- -------
Total $ 35,462 $24,661
======== =======
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.
24
Management's Discussion and Analysis of Financial Condition and Results of
Operations
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 $5,000,000 in 2005 and $9,000,000 in 2004. Quarterly installment
payments on FHLB debt totaled $7,730,000 for the year. These loans carry an
average rate of 4.21% at December 31, 2005.
Stockholder's Equity
Total stockholders' equity increased $2,307,000 or 6.73% in 2005. Earnings
retained from operations were the primary source of the increase. As of December
31, 2005, book value per share was $15.22 compared to $14.21 as of December 31,
2004. 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, 2005, the
Company had Tier I capital of 13.54% of risk weighted assets and combined Tier I
and II capital of 14.24% 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, 2005, the
Company reported a leverage ratio of 9.13%. 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.
Rapid changes in short-term interest rates may lead to volatility in net
interest income resulting in additional interest rate risk to the extent that
imbalances exist between the maturities or repricing of interest bearing
liabilities and interest earning assets. The net interest margin was unchanged
in 2004 and increased 13 BP in 2005. The Federal Reserve's policy of "measured"
rate increases during the last two years facilitated managements ability to
adjust both loan and deposit rates in a manner that reduced the volatility of
the net interest margin.
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, 2005 is good, 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 2005, the Bank
used short term borrowings from the Federal Home Loan Bank to help meet a
portion of 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.
25
Management's Discussion and Analysis of Financial Condition and Results of
Operations
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.
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, 2005. 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
(3.32)% of total earning assets. Approximately 34% of rate sensitive assets and
45% of rate sensitive liabilities are subject to repricing within one year. The
one-year cumulative GAP decreased during 2005. Both short term assets and short
term liabilities decreased due to a decrease in both loans held for sale and
short term debt that funded these assets compared to the prior year. This
decrease in volume, coupled with an increase in variable rate loans held for
investment resulted in the decrease in liability sensitivity. Due to strong loan
demand and relatively low long term interest rates (flat yield curve), 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 as rates rise to higher levels.
The following GAP analysis shows the time frames from December 31, 2005, in
which the Company's assets and liabilities are subject to repricing:
1-90 91-365 1-5 Over 5 Not
(Dollars in thousands) Days Days Years Years Classified Total
Rate Sensitive Assets:
Loans held for
investment $69,954 $15,151 $168,825 $23,468 $ - $277,398
Loans held for
sale 3,528 - - - - 3,528
Investments
securities 2,972 11,079 7,482 121 6,963 28,617
Federal Funds Sold 2,487 - - - - 2,487
Interest bearing
bank deposits 742 990 496 - - 2,228
------ ------ ------- ------ ------ --------
Total 79,683 27,220 176,803 23,589 6,963 314,258
Rate Sensitive Liabilities:
Interest bearing
demand deposits - 11,164 22,259 5,547 - 38,970
Savings - 8,771 26,313 8,771 - 43,855
Certificates of deposit
$100,000 and over 4,602 13,910 16,950 - - 35,462
Other certificates
of deposit 17,251 38,258 47,188 - - 102,697
------ ------ ------- ------ ------ --------
Total Deposits 21,853 72,103 112,710 14,318 - 220,984
Short-term debt 14,345 - - - - 14,345
Long-term debt 3,295 5,735 11,184 2,594 - 22,808
------ ------ ------- ------ ------ --------
Total 39,493 77,838 123,894 16,912 - 258,137
Discrete Gap 40,190 (50,618) 52,909 6,677 6,963 56,121
Cumulative Gap 40,190 (10,428) 42,481 49,158 56,121
As a % of Earning
Assets 12.79% (3.32)% 13.52% 15.64% 17.86%
o 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.
26
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, non-controlling 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, to 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.
27
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.
Proposed Guidance on Commercial Real Estate Lending
Federal bank and thrift regulatory agencies (Office of the Comptroller of the
Currency, Federal Deposit Insurance Corporation, Board of Governors of the
Federal Reserve System and Office of Thrift Supervision) have issued proposed
guidance entitled "Concentrations in Commercial Real Estate Lending, Sound Risk
Management Practices" to stress the need for strong risk management processes
and controls to mitigate the risk associated with these concentrations. The
agencies have determined that concentrations in commercial real estate (CRE)
loans are increasing at a faster rate than the institutions' risk management
practices and capital levels.
The guidance may require institutions that are unable to adequately assess and
meet capital needs to develop a plan to reduce concentrations or to achieve
higher capital ratios.
28
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, 2005 and 2004:
2005
Dollars in thousands Fourth Third Second First Total
Interest and Dividend
Income $5,271 $5,258 $4,823 $4,526 $19,878
Interest Expense 1,884 1,934 1,693 1,487 6,998
------ ------ ------ ------ ------
Net Interest Income 3,387 3,324 3,130 3,039 12,880
Provision for Loan
Losses 90 90 90 90 360
------ ------ ------ ------ ------
Net Interest Income
after Provision
For Loan Losses 3,297 3,234 3,040 2,949 12,520
Non-Interest Income 685 687 700 642 2,714
Non-Interest Expense 2,315 2,154 2,098 2,041 8,608
------ ------ ------ ------ ------
Income before taxes 1,667 1,767 1,642 1,550 6,626
Income Tax Expense 411 557 495 383 1,846
------ ------ ------ ------ ------
Net Income $1,256 $1,210 $1,147 $1,167 $4,780
====== ====== ====== ====== ======
Net Income Per Share $ .53 $ .50 $ .48 $ .48 $ 1.99
2004
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
29
Item 8 Financial Statement and Supplementary Information
F & M Bank Corp. and Subsidiaries
Consolidated Balance Sheets
December 31,
ASSETS 2005 2004
Cash and due from banks (notes 3 and 13) $ 7,904,189 $ 7,937,958
Interest bearing deposits (note 13) 2,228,267 9,230,702
Federal funds sold 2,487,000 1,017,000
Securities -
Held to maturity - fair value of $110,000
in 2005 and in 2004 (note 4) 110,000 110,003
Available for sale (note 4) 28,507,086 30,755,658
Other investments (note 4) 6,303,517 7,934,426
Loans held for sale 3,528,233 47,149,966
Loans held for investment (notes 5, 10 and 13) 277,398,164 248,972,218
Less allowance for loan losses (note 6) (1,672,936) (1,510,860)
------------ -----------
Net Loans Held for Investment 275,725,228 247,461,358
Bank premises and equipment, net (note 7) 5,756,576 4,824,483
Interest receivable 1,366,880 1,230,828
Core deposit intangible (note 20) 1,425,700 1,701,641
Goodwill (note 20) 2,638,677 2,638,677
Bank owned life insurance (note 21) 5,333,824 5,082,826
Other assets 3,013,102 2,881,649
------------ ------------
Total Assets $346,328,279 $369,957,175
-=========== -===========
LIABILITIES
Deposits:
Noninterest bearing $ 46,325,180 $ 40,693,537
Interest bearing:
Demand 27,736,223 24,196,170
Money market accounts 11,234,039 13,228,532
Savings 43,855,334 48,882,821
Time deposits over $100,000 (note 8) 35,461,925 24,660,968
All other time deposits (note 8) 102,697,076 94,843,194
------------ ------------
Total Deposits 267,309,777 246,505,222
------------ ------------
Short-term debt (note 9) 14,345,480 57,361,619
Accrued liabilities 5,297,826 5,368,869
Long-term debt (note 10) 22,808,242 26,461,517
------------ ------------
Total Liabilities 309,761,325 335,697,227
------------ ------------
STOCKHOLDERS' EQUITY (NOTE 19)
Common stock $5 par value, 3,000,000 shares
authorized, 2,402,037 and 2,411,541
shares issued and outstanding, for 2005 and 2004,
respectively 12,010,185 12,057,705
Capital surplus - 128,376
Retained earnings (note 16) 25,135,731 22,273,119
Accumulated other comprehensive income (loss) (578,962) (199,252)
------------ -----------
Total Stockholders' Equity 36,566,954 34,259,948
------------ ------------
Total Liabilities and Stockholders' Equity $346,328,279 $369,957,175
-=========== -===========
The accompanying notes are an integral part of this statement.
30
F & M Bank Corp. and Subsidiaries
Consolidated Statements of Income
Years Ended December 31,
2005 2004 2003
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans held
for investment $17,662,593 $14,355,476 $14,118,688
Interest on loans held for sale 870,007 687,538 3,249
Interest on deposits and federal
funds sold 176,239 230,508 346,951
Interest on debt securities 707,863 1,038,864 1,715,328
Dividends on equity securities 460,812 491,158 498,546
----------- ---------- -----------
Total Interest and Dividend Income 19,877,514 16,803,544 16,682,762
----------- ---------- -----------
INTEREST EXPENSE:
Interest on demand deposits 230,320 205,506 213,803
Interest on savings deposits 520,298 452,712 488,347
Interest on time deposits over
$100,000 1,022,153 703,622 757,204
Interest on all other time
deposits 3,032,431 2,609,054 3,260,349
----------- ---------- -----------
Total interest on deposits 4,805,202 3,970,894 4,719,703
Interest on short-term debt 1,030,865 419,070 44,377
Interest on long-term debt 1,161,860 1,005,606 1,245,531
----------- ---------- -----------
Total Interest Expense 6,997,927 5,395,570 6,009,611
----------- ---------- -----------
NET INTEREST INCOME 12,879,587 11,407,974 10,673,151
----------- ---------- -----------
PROVISION FOR LOAN LOSSES (note 6) 360,000 240,000 226,000
----------- ---------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 12,519,587 11,167,974 10,447,151
----------- ---------- -----------
NONINTEREST INCOME:
Service charges on deposit
accounts 1,044,244 910,866 904,946
Insurance and other commissions 288,089 374,349 280,156
Other operating income 1,059,625 718,063 884,806
Income on bank owned life insurance 250,998 251,159 238,369
Net gain on security transactions
(note 4) 71,044 531,781 178,618
----------- ---------- -----------
Total Noninterest Income 2,714,000 2,786,218 2,486,895
----------- ---------- -----------
NONINTEREST EXPENSES:
Salaries 3,565,776 3,184,471 3,075,762
Employee benefits (note 12) 1,249,559 1,207,109 1,053,032
Occupancy expense 427,353 413,736 406,816
Equipment expense 455,436 421,699 407,636
Amortization of intangibles
(notes 2 and 20) 275,942 275,942 275,942
Other operating expenses 2,632,911 2,238,326 2,036,235
----------- ---------- -----------
Total Noninterest Expenses 8,606,977 7,741,283 7,255,423
----------- ---------- -----------
Income before Income Taxes 6,626,610 6,212,909 5,678,623
INCOME TAX EXPENSE (note 11) 1,846,257 1,863,358 1,666,324
----------- ---------- -----------
NET INCOME $ 4,780,353 $4,349,551 $ 4,012,299
=========== ========== ===========
PER SHARE DATA
NET INCOME $ 1.99 $ 1.80 $ 1.66
=========== ========== ===========
CASH DIVIDENDS .78 .74 $ .70
=========== ========== ===========
AVERAGE COMMON SHARES OUTSTANDING 2,407,989 2,413,668 2,417,807
=========== ========== ===========
The accompanying notes are an integral part of this statement.
31
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,
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
----------
Total 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)
----------
Total 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
Comprehensive Income:
Net income - - 4,780,353 - 4,780,353
Net change in other
comprehensive income
(note 2) - - - (379,710) (379,710)
----------
Total comprehensive
Income 4,400,643
Tax benefit of ESOP
dividends - 27,977 - - 27,977
Dividends on common
stock - - (1,878,100) - (1,878,100)
Stock sold to ESOP
(2,900 shares) 14,500 58,000 - - 72,500
Stock repurchased
(12,404 shares) (62,020) (214,353) (39,641) - (316,014)
----------- --------- ---------- --------- ---------
BALANCE - December 31,
2005 $12,010,185 $ - $25,135,731 $(578,962) $36,566,954
=========== ========= ========== ======== ==========
The accompanying notes are an integral part of this statement.
32
F & M Bank Corp. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31,
2005 2004 2003
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,780,353 $ 4,349,551 $ 4,012,299
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
(Gain) loss on sale of securities (71,044) (531,781) (178,618)
Depreciation 495,052 461,637 429,717
Amortization of security premiums 138,895 309,200 312,301
Net decrease (increase) in
loans held for sale 43,621,733 (47,149,966) -
Provision for loan losses 360,000 240,000 226,000
Provision for deferred taxes (139,409) (24,679) 210,305
(Increase) decrease in interest
receivable (136,052) 265,404 158,890
Increase in other assets 21,281 (380,732) (610,505)
Increase in accrued expenses 99,592 716,009 69,197
Amortization of limited partnership
investments 321,109 244,290 262,227
Amortization of intangibles 275,942 275,942 275,942
Income from life insurance
investment (250,998) (251,159) (238,369)
(Gain) loss on sale of other
real estate (94,754)
----------- ---------- -----------
Net Cash Provided by (Used in)
Operating Activities 49,516,454 (41,476,284) 4,834,632
----------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest
bearing bank deposits 7,002,435 (227,960) (3,116,303)
Net (increase) decrease in federal
funds sold (1,470,000) 4,018,000 (559,000)
Proceeds from maturities of
Securities held to maturity - 760,000 1,000,000
Proceeds from maturities of
securities available for sale 2,747,598 18,625,744 54,755,131
Proceeds from sales of securities
Available for sale 14,335,748 24,285,388 2,480,338
Purchases of securities available
for sale (14,149,802) (21,919,075) (49,557,386)
Net increase in loans held for
investment (28,623,870) (37,953,933) (9,470,590)
Purchase of life insurance - - (1,870,528)
Purchase of property and equipment (874,929) (284,827) (729,048)
Purchase of other real estate - - -
Construction in progress payments (552,216) - -
Sale of other real estate - - 597,873
----------- ----------- -----------
Net Cash Used in Investing
Activities (21,585,036) (12,696,663) (6,469,513)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in demand and savings
deposits 2,149,716 8,456,925 13,315,434
Net increase (decrease) in time
deposits 18,654,839 (2,667,043) (871,334)
Net change in short-term debt (43,016,139) 50,972,661 (1,932,080)
Dividends paid in cash (1,856,814) (1,763,849) (1,645,224)
Proceeds from long-term debt 5,000,000 9,000,000 -
Payments to repurchase common stock (316,014) (451,084) (264,434)
Proceeds from issuance of common
stock 72,500 220,875 208,000
Repayments of long-term debt (8,653,275) (7,322,690) (7,527,817)
----------- ---------- -----------
Net Cash Provided by Financing
Activities (27,965,187) 56,445,795 1,282,545
----------- ---------- -----------
Net Increase (Decrease) in Cash
and Cash Equivalents (33,769) 2,272,848 (352,336)
Cash and Cash Equivalents,
Beginning of Year 7,937,958 5,665,110 6,017,446
----------- ---------- -----------
Cash and Cash Equivalents,
End of Year $ 7,904,189 $ 7,937,958 $ 5,665,110
========== ========== ===========
Supplemental Disclosure:
Cash paid for:
Interest expense $ 6,804,334 $ 5,428,726 $ 6,148,756
Income taxes 1,270,000 1,250,000 750,000
The accompanying notes are an integral part of this statement
33
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 inter-company 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.
34
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
Commercial 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.
Loans Held for Sale
Loans held for sale consist of mortgage loan participations purchased from the
originating bank. The originating bank agrees to repurchase these loans within
60 days of origination.
35
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 $1,426,000 and $1,702,000
at December 31, 2005 and 2004, 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, 2005 and 2004. The goodwill is no longer amortized, but instead
tested for impairment at least annually. Based on the testing, there were no
impairment charges for 2005 or 2004. Application of the non-amortization
provisions of the Statement resulted in additional net income of approximately
$190,000 for each the years ended December 31, 2005, 2004 and 2003.
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.
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 2005,
2004, and 2003 were $182,731, $163,082, and $139,749, respectively.
36
Notes to the Consolidated Financial Statements
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
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: 2005 2004 2003
-------- --------- ---------
Unrealized holding gains (losses)
on available-for-sale
securities $(485,937) $(124,180) $ 880,766
Reclassification adjustment
For (gains) losses realized
in income (71,044) (531,781) (178,618)
--------- -------- --------
Net Unrealized (Gains) Losses (556,981) (655,961) 702,148
Tax effect 177,271 235,824 (210,780)
-------- -------- --------
Net Change $(379,710) $(420,137) $ 491,368
======== ======== ========
Earnings Per Share
Earnings per share are based on the weighted average number of shares
outstanding. The Company had no potentially dilutive instruments during the
three-year period ended December 31, 2005.
Derivative Financial Instruments and Change in Accounting Principle
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities". This statement requires that all derivatives be recognized as
assets or liabilities in the balance sheet and measured at fair value.
Under SFAS No. 133, the gain or loss on a derivative designated and qualifying
as a fair value hedging instrument, as well as the offsetting gain or loss on
the hedging item attributable to the risk being hedged, is recognized currently
in earnings in the same accounting period. The effective portion of the gain or
loss on a derivative designated and qualifying as a cash flow hedging instrument
is initially reported as a component of other comprehensive income and
subsequently reclassified into earnings in the same period or periods during
which the hedged transaction affects earnings. The ineffective portion of the
gain or loss on the derivative instrument, if any, is recognized currently in
earnings.
37
Notes to the Consolidated Financial Statements
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Derivative Financial Instruments and Change in Accounting Principle (Continued)
Interest rate derivative financial instruments receive hedge accounting
treatment only if they are designated as a hedge and are expected to be, and
are, effective in substantially reducing interest rate risk arising from the
assets and liabilities identified as exposing the Company to risk. Those
derivative financial instruments that do not meet the hedging criteria discussed
below would be classified as trading activities and would be recorded at fair
value with changes in fair value recorded in income. Derivative hedge contracts
must meet specific effectiveness tests (i.e., over time the change in their fair
values due to the designated hedge risk must be within 80 to 125 percent of the
opposite change in the fair value of the hedged assets or liabilities). Changes
in fair value of the derivative financial instruments must be effective at
offsetting changes in the fair value of the hedging items due to the designated
hedge risk during the term of the hedge. Further, if the underlying financial
instrument differs from the hedged asset or liability, there must be a clear
economic relationship between the prices of the two financial instruments. If
periodic assessment indicates derivatives no longer provide an effective hedge,
the derivatives contracts would be closed out and settled or classified as a
trading activity.
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 $2,964,000 and $2,656,000 for the years ended
December 31, 2005 and 2004, respectively.
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, 2005
-----------------
U. S. Treasuries and
Agencies $ 110,000 $ - $ - $ 110,000
========== ========== ========== ==========
December 31, 2004
-----------------
U. S. Treasuries and
Agencies $ 110,003 $ - $ 3 $ 110,000
========== ========== ========== ==========
The amortized cost and fair value of securities available for sale are as
follows:
December 31, 2005
U.S. Agencies $16,006,960 $ - $ 186,634 $15,820,326
Mortgage-backed obligations of
federal agencies 3,603,706 - 93,744 3,509,962
Marketable equities 6,874,974 177,143 593,708 6,458,409
Municipals 375,000 - 10,431 364,569
Corporate bonds 2,500,000 - 146,180 2,353,820
---------- --------- --------- ----------
Total Securities Available
for Sale $29,360,640 $ 177,143 $1,030,697 $28,507,086
========== ========= ========= ==========
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
=========== ========= ========= ==========
38
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 to Securities Available
Maturity for Sale
Amortized Fair Amortized Fair
Cost Value Cost Value
Due in one year or less $ 110,000 $ 110,000 $12,042,676 $11,927,170
Due after one year
through five years - - 8,780,490 8,575,153
Due after five years - - 1,662,500 1,546,354
-------- -------- ---------- ----------
110,000 110,000 22,485,666 22,048,677
Marketable equities - - 6,874,974 6,458,409
-------- -------- ---------- ----------
Total $ 110,000 $ 110,000 $29,360,640 $28,507,086
======== ======== =========== ==========
There were no sales of debt securities during 2005, compared to gross proceeds
of $18,650,000, realized gains of $107,617 and losses of $9,030 in 2004. Gains
and losses on marketable equity transactions are summarized below:
2005 2004 2003
-------- -------- ------
Gains $ 375,247 $ 738,582 $ 440,340
Losses 304,203 305,388 261,722
---------- ---------- ----------
Net Gains $ 71,044 $ 433,194 $ 178,618
========== ========== ==========
The carrying value (which approximates fair value) of securities pledged by the
Bank to secure deposits and for other purposes amounted to $15,363,256 at
December 31, 2005 and $12,381,675 at December 31, 2004. The Company has pledged
$1,900,453 of equity securities to secure the $1,615,385 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 $3,7,17,088) and stock in the Federal
Home Loan Bank, and various other investments (carrying basis of $2,586,429).
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, 2005. During 2005 and 2004, the Company
recognized losses on its investment in BI Investments of 87,000 and $100,000,
respectively. This write down was the result of losses incurred by BI
Investments. At December 31, 2005, 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.
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
2005, 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 40 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.
39
Notes to the Consolidated Financial Statements
NOTE 4 INVESTMENT SECURITIES (CONTINUED):
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
2005
U.S. Treasury
& Agency $ 3,910,000 $ (54,000) $ 11,910,000 $ (133,000) $ 15,820,000 $ (187,000)
Municipals - - 365,000 (10,000) 365,000 (10,000)
Mortgage
backed
obligations - - 3,510,000 (94,000) 3,510,000 (94,000)
Marketable
Equities 2,951,000 (275,000) 3,402,000 (465,000) 6,353,000 (740,000)
---------- --------- ----------- --------- ----------- ---------
Total $ 6,861,000 $ (329,000) $ 19,187,000 $ (702,000) $ 26,048,000 $(1,031,000)
========== ========= =========== ========= =========== ==========
2004
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)
========== ========= =========== ========= =========== =========
Based on a review of its equities portfolio, the Company recognized an other
than temporary impairment of $503,034 in the carrying basis of five of its
equity holdings as of December 31, 2002. The Company recognized an impairment of
$119,350 and $161,633 in the carrying basis on two of its equity holdings, in
2005 and 2004, respectively. These write downs were a result of management's
evaluation and determination that these assets met the definition for impairment
under SFAS 115.
NOTE 5 LOANS:
Loans held for investment as of December 31:
2005 2004
Real Estate
Construction $ 33,540,067 $ 17,364,803
Mortgage 137,087,178 147,281,033
Commercial and agricultural 88,655,548 62,786,983
Installment 16,434,140 20,005,920
Credit cards 1,615,799 1,477,789
Other 65,432 55,690
------------ ------------
Total $277,398,164 $248,972,218
============ ============
40
Notes to the Consolidated Financial Statements
NOTE 5 LOANS (CONTINUED):
At December 31, 2005 and 2004, the recorded investment in loans which have been
identified as impaired loans, in accordance with Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan"
(SFAS 114), totaled $3,800,000 and $4,116,000, respectively. All of these loans
had a valuation allowance. The valuation allowance related to impaired loans on
December 31, 2005 and 2004 is $477,000 and $505,000, respectively. For the years
of 2005, 2004 and 2003, the average balances of impaired loans were $3,917,000,
$4,301,000, and $3,075,000, respectively. The amount of interest income recorded
by the Company during 2005, 2004 and 2003 on impaired loans was $256,000,
$301,000, and $215,000, respectively. There were no nonaccrual loans excluded
from impaired loan disclosure at December 31, 2005 or December 31, 2004.
The Company has pledged loans as collateral for borrowings with the Federal Home
Loan Bank of Atlanta totaling $167,423,000 and $163,524,000 as of December 31,
2005 and 2004, respectively. Prior to 2004, the Company pledged specific
residential real estate loans to secure its borrowings from the FHLB. During
2005, 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:
2005 2004
Real Estate $ 3,528,233 $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 and 2005.
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:
2005 2004 2003
--------- --------- ---------
Balance, beginning of year $1,510,860 $ 1,483,667 $1,477,007
Provision charged to operating
expenses 360,000 240,000 226,000
Loan recoveries 65,204 83,188 75,955
Loans charged off (263,128) (295,995) (295,295)
---------- ----------- ----------
Balance, end of year $1,672,936 $ 1,510,860 $1,483,667
========== =========== ==========
Percentage of loans held
for investment .60% .61% .61%
41
Notes to the Consolidated Financial Statements
NOTE 7 BANK PREMISES AND EQUIPMENT:
Bank premises and equipment as of December 31 are summarized as follows:
2005 2004
Land $ 1,128,038 $ 677,600
Buildings and improvements 5,059,156 4,582,704
Furniture and equipment 3,944,547 3,482,731
------------ ------------
10,131,741 8,743,035
Less - accumulated depreciation (4,375,165) (3,918,552)
------------ ------------
Net $ 5,756,576 $ 4,824,483
============ ============
Provisions for depreciation of $495,052 in 2005, $461,637 in 2004, and $429,717
in 2003 were charged to operations.
NOTE 8 TIME DEPOSITS:
At December 31, 2005, the scheduled maturities of time deposits are as follows:
2006 $ 72,584,562
2007 33,886,545
2008 12,341,759
2009 6,757,972
Thereafter 12,588,163
-----------
Total $138,159,001
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 Rate Rate
2005
Federal funds
purchased $ 9,857,990 $ - $ 821,192 3.93% n/a
Notes payable 184,830 - 31,929 6.51% n/a
FHLB daily rate
credit 43,500,000 4,500,000 22,342,466 3.55% 4.46%
Securities sold under
agreements to
repurchase 10,026,892 9,845,480 7,523,384 2.74% 3.99%
---------- ---------- ---- ----
Totals $14,345,480 $30,718,971 3.26% 4.14%
========== ========== ==== ====
42
Notes to Consolidated Financial Statements
NOTE 9 SHORT-TERM DEBT (CONTINUED):
Maximum Weighted
Outstanding Outstanding Average Average Year End
at any at Balance Interest Interest
Month End Year End Outstanding 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%
========== ========== ==== ====
2003
Notes payable $ 351,834 $ 351,834 $ 62,103 4.03% 1.66%
Securities sold
under agreement
to repurchase 8,687,799 6,037,124 7,174,896 .62% .49%
---------- ----------- ---- ----
Totals $ 6,388,958 $ 7,236,999 .65% .50%
========== ========== ==== ====
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, 2005, the Company had lines of credit with correspondent
banks totaling $16,853,000, 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 $5,000,000
in 2005, $9,000,000 in 2004 and $0 in 2003. The interest rates on the notes
payable are fixed at the time of the advance and range from 3.91% to 5.33%; the
weighted average interest rate is 4.21% at December 31, 2005. The balance of
these obligations at December 31, 2005 was $21,192,857. 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, 2005 was $1,615,385 with quarterly principal payments of $230,769
over the next seven 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 $1,161,860,
$1,005,606, and $1,245,531 was incurred on these debts in 2005, 2004, and 2003,
respectively. The maturities of long-term debt as of December 31, 2005 are as
follows:
2006 $ 9,030,219
2007 4,449,452
2008 3,150,000
2009 2,471,429
2010 1,114,286
Thereafter 2,592,856
----------
Total $22,808,242
==========
43
Notes to Consolidated Financial Statements
NOTE 11 INCOME TAX EXPENSE:
The components of the income tax expense are as follows:
2005 2004 2003
--------- --------- ---------
Current expense
Federal $1,985,666 $1,888,037 $1,456,019
Deferred benefit
Federal (139,409) (24,679) 210,305
--------- --------- ---------
Total Income Tax Expense $1,846,257 $1,863,358 $1,666,324
========= ========= =========
Amounts in above arising
from gains (losses) on
security transactions $ 41,367 $ 174,026 $ 60,730
========= ========= =========
The deferred tax effects of temporary differences are as follows:
2005 2004 2003
--------- --------- ---------
Tax Effects of Temporary Differences:
LIH Partnership Losses $ 26,653 $ 6,492 $ 15,223
Securities impairment (5,817) 18,548 55,334
Provision for loan losses (55,106) (9,246) (225)
Split dollar life insurance - 2,358 60,576
Non-qualified deferred compensation (18,043) (35,237) (43,810)
Depreciation (27,320) 26,531 43,405
Core deposit intangible amortization (33,113) (33,113) (33,113)
Pension expense (29,968) (9,367) 117,133
Other 3,305 8,355 (4,218)
--------- --------- ---------
Deferred Income Tax Expense
(Benefit) $(139,409) $ (24,679) $210,305
======== ======== =======
The components of the deferred taxes as of December 31 are as follows:
2005 2004
Deferred Tax Assets:
Allowance for loan losses $ 414,484 $ 359,379
Split dollar life insurance 11,781 11,289
Nonqualified deferred compensation 325,484 307,424
Securities impairment 87,522 91,333
Core deposit amortization 132,453 99,340
State historic tax credits 81,893 45,876
Securities available for sale 269,667 97,320
Other 17,451 4,868
--------- ---------
Total Assets $1,340,735 $1,016,829
--------- ---------
Deferred Tax Liabilities:
Unearned low income housing credits $ 685,867 $ 617,809
Depreciation 237,240 264,560
Pension 188,050 218,018
Other 81,880 45,216
--------- ---------
Total Liabilities 1,193,037 1,145,603
--------- ---------
Deferred Tax Asset (Liability) $ 147,698 $ (128,774)
========= =========
44
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:
2005 2004 2003
--------- --------- ---------
Tax expense at federal statutory rates $2,253,047 $2,112,389 $1,930,732
Increases (decreases) in taxes resulting from:
State income taxes, net (59,430) (21,924) 9,042
Partially exempt income (82,519) (80,781) (155,416)
Tax-exempt income (155,108) (110,087) (116,043)
Goodwill (61,424) (61,424) (61,424)
Other (48,309) 25,185 59,433
--------- --------- ---------
Total Income Tax Expense $1,846,257 $1,863,358 $1,666,324
========= ========= =========
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 2005, 2004 and 2003:
2005 2004 2003
--------- --------- ---------
Change in Benefit Obligation:
Benefit obligation, beginning $2,986,756 $ 4,268,747 $3,509,473
Service cost 246,932 219,536 178,735
Interest cost 178,801 277,031 245,193
Actuarial gain (loss) 253,511 (451,323) 440,469
Benefits paid (13,668) (1,327,235) (105,123)
--------- ---------- ---------
Benefit obligation, ending $3,652,332 $ 2,986,756 $4,268,747
Change in Plan Assets:
Fair value of plan assets, beginning 2,337,755 2,724,066 2,256,172
Actual return on plan assets 320,373 309,326 427,635
Employer contribution 311,162 631,598 145,382
Benefits paid (13,668) (1,327,235) (105,123)
--------- ---------- ---------
Fair value of plan assets, ending $2,955,622 $ 2,337,755 $2,724,066
========= ========== =========
Deferred asset (gain) loss $ (122,233)$ (70,502)$ (218,424)
========= ========== =========
Funded Status:
Funded Status (696,710) (649,001)(1,544,681)
Unrecognized net actuarial loss 1,205,607 1,122,807 1,720,742
Unrecognized transition obligation 20,313 30,471 40,629
Unrecognized prior service cost (168,910) (174,210) (179,510)
--------- --------- ---------
Prepaid (accrued) benefits $ 360,300 $ 330,067 $ 37,180
========= ========= =========
Accumulated benefit obligation 2,287,426 1,914,138 2,553,367
45
Notes to the Consolidated Financial Statements
NOTE 12 EMPLOYEE BENEFITS (CONTINUED):
2005 2004 2003
--------- --------- ---------
Components of net periodic benefit cost:
Service cost $ 246,932 $ 219,536 $ 178,735
Interest cost 178,801 277,031 245,193
Expected return on plan assets (198,140) (238,824) (209,211)
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 48,478 76,110 67,515
--------- --------- ---------
Net periodic benefit cost $ 280,929 $ 338,711 $ 287,090
======== ======== ========
Weighted average assumptions used in benefit obligations as of December
31:
Discount rate 5.75% 6.00% 6.50%
Expected return on plan assets 8.50% 8.50% 8.50%
Rate of compensation increase 5.00% 5.00% 5.00%
Weighted average assumptions used in benefit cost as of December 31:
Discount rate 6.00% 6.50% 7.00%
Expected return on plan assets 8.50% 8.50% 8.50%
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:
2005 2004
Mutual funds - equity 66% 65%
Mutual funds -fixed income 34% 35%
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
$233,850 in 2005, $220,875 in 2004, and $208,000 in 2003 to the Plan and charged
this expense to operations. The Company expects pension cost for 2006 to be
approximately $320,000.
46
Notes to the Consolidated Financial Statements
NOTE 12 EMPLOYEE BENEFITS (CONTINUED):
Projected benefit payments are as follows:
2006 $ 13,668
2007 21,015
2008 20,339
2009 23,095
2010 55,521
2011-2015 466,209
----------
$ 599,847
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
$81,618, $70,417 and $66,957 in 2005, 2004 and 2003, 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 $54,565, $57,000 and $60,104 in 2005, 2004 and 2003, respectively.
NOTE 13 CONCENTRATIONS OF CREDIT:
The Company had cash deposits in other commercial banks totaling $6,260,496 and
$8,895,490 at December 31, 2005 and 2004, 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 $16,378,415. Other identified loan concentration areas greater
than 25% of capital include motel properties, churches and
construction/development. 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:
2005 2004
Commitments to loan money $63,757,625 $63,083,664
Standby letters of credit 1,187,567 1,654,807
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.
47
Notes to Consolidated Financial Statements
NOTE 14 COMMITMENTS (CONTINUED):
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.
NOTE 15 ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES:
Derivative Financial Instruments
The Company has stand alone derivative financial instruments in the form of
forward option contracts. These transactions involve both credit and market
risk. The notional amounts are amounts on which calculations, payments, and the
value of the derivative are based. Notional amounts do not represent direct
credit exposures. Direct credit exposure is limited to the net difference
between the calculated amounts to be received and paid, if any. Such difference,
which represents the fair value of the derivative instruments, is reflected on
the Company's balance sheet as derivative assets and derivative liabilities.
The Company is exposed to credit-related losses in the event of nonperformance
by the counterparties to these agreements. The Company controls the credit risk
of its financial contracts through credit approvals, limits and monitoring
procedures, and does not expect any counterparties to fail their obligations.
The Company deals only with primary dealers.
Derivative instruments are generally either negotiated OTC contracts or
standardized contracts executed on a recognized exchange. Negotiated OTC
derivative contracts are generally entered into between two counterparties that
negotiate specific agreement terms, including the underlying instrument, amount,
exercise prices and maturity.
Indexed Certificates of Deposit
During 2005, the Company began issuing to customers certificates of deposit with
an interest rate that is derived from the rate of return on the stock of the
companies that comprise The Dow Jones Industrial Average. In order to manage the
interest rate risk associated with this deposit product, the Company has
purchased a series of forward option contracts. These contracts provide the
Company with a rate of return commensurate with the return of The Dow Jones
Industrial Average from the time of the contract until maturity of the related
certificate of deposit. These contracts are accounted for as fair value hedges.
Because the certificates of deposit can be redeemed by the customer at anytime
and this related forward options contracts can not be cancelled by the Company,
the hedge is not considered effective.
At December 31, 2005, the information pertaining to the forward option contracts
is as follows:
Notational amount $ 450,000
Fair market value of contracts $ 59,348
48
Notes to Consolidated Financial Statements
NOTE 16 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:
2005 2004
Total loans, beginning of year $ 4,312,535 $3,943,440
Director term expirations (140,738)
New loans 1,306,229 3,160,106
Repayments (1,812,489) (2,650,273)
----------- ----------
Total loans, end of year $ 3,806,275 $4,312,535
=========== ==========
NOTE 17 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, 2006,
approximately $3,449,000 was available for dividend distribution without
permission of the Board of Governors. Dividends paid by the Bank to the Company
totaled $2,000,000 in 2005, $2,352,000 in 2004 and $2,930,000 in 2003.
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, 2005
and 2004 are as follows (in thousands):
49
Notes to Consolidated Financial Statements
NOTE 18 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
2005 2004
-------------------- -------------------
Estimated Carrying Estimated Carrying
Fair Value Value Fair Value Value
Financial Assets
Cash $ 7,904 $ 7,904 $ 7,938 $ 7,938
Interest bearing deposits 2,225 2,228 9,221 9,231
Federal funds sold 2,487 2,487 1,017 1,017
Securities available
for sale 28,507 28,507 30,756 30,756
Securities held to
maturity 110 110 110 110
Other investments 6,304 6,304 7,934 7,934
Loans 264,901 277,398 248,326 248,972
Loan held for sale 3,524 3,528 47,140 47,150
Bank owned life insurance 5,334 5,334 5,083 5,083
Accrued interest
receivable 1,367 1,367 1,231 1,231
Financial Liabilities
Demand Deposits:
Non-interest bearing 46,325 46,325 40,694 40,694
Interest bearing 38,970 38,970 37,425 37,425
Savings deposits 43,855 43,855 48,883 48,883
Time deposits 138,483 138,159 120,238 119,504
Accrued liabilities 5,298 5,298 5,369 5,369
Short-term debt 14,345 14,345 57,370 57,370
Long-term debt 22,808 22,808 26,462 26,043
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, 2005, that the Company and its
subsidiary bank meet all capital adequacy requirements to which they are
subject.
50
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,
2005 2004 Adequately Well
---------------- ---------------
$ % $ % Capitalized Capitalized
------- ------- ------- ------- ----------- ----------
Total risk-based
ratio
Consolidated $ 34,034 14.24% $ 31,462 13.22% 8.00% none
Bank only 26,015 11.42% 23,370 10.33% 8.00% 10.00%
Tier 1 risk-based
ratio
Consolidated 32,361 13.54% 29,951 12.59% 4.00% none
Bank only 24,363 10.70% 21,880 9.67% 4.00% 6.00%
Total assets
leverage ratio
Consolidated 32,361 9.13% 29,951 8.38% 3.00% none
Bank only 24,363 7.15% 21,880 6.38% 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,
2005, 2004 and 2003 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.
51
Notes to the Consolidated Financial Statements
NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS:
Balance Sheets
December 31,
2005 2004
ASSETS
Cash and cash equivalents $ 59,890 $ 1,164,265
Investment in subsidiaries 31,544,053 29,308,253
Securities available for sale 6,091,853 6,427,328
Limited partnership investments 3,717,088 3,288,197
Due from subsidiaries 292,335 341,712
------------ ------------
Total Assets $ 41,705,219 $ 40,529,755
============ ============
LIABILITIES
Notes payable $ 1,615,385 $ 2,538,461
Accrued interest payable 21,518 20,476
Other liabilities 38,662 217,808
Dividends payable 480,451 458,193
Demand obligations for low income
housing investment 2,555,974 2,555,974
Deferred income taxes 426,275 478,895
------------ ------------
Total Liabilities 5,138,265 6,269,807
------------ ------------
STOCKHOLDERS' EQUITY
Common stock par value $5 per share,
3,000,000 shares authorized, 2,402,037
and 2,411,541 shares issued and
outstanding for 2005 and 2004, respectively 12,010,185 12,057,705
Capital surplus - 128,376
Retained earnings 25,135,731 22,273,119
Accumulated other comprehensive income (loss) (578,962) (199,252)
------------ ------------
Total Stockholders' Equity 36,566,954 34,259,948
------------ ------------
Total Liabilities and Stockholders' Equity $ 41,705,219 $ 40,529,755
============ ============
52
Notes to the Consolidated Financial Statements
NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
Statements of Net Income and Retained Earnings
Years Ended December 31,
2005 2004 2003
--------- --------- ---------
INCOME
Dividends from affiliate $ 2,000,000 $2,352,000 $ 2,930,000
Investment income 6,842 11,142 180
Dividend income 285,127 371,611 349,783
Security gains (losses) 121,669 513,255 275,943
Net limited partnership income 185,906 62,759 62,351
Other - - 95,435
----------- ---------- -----------
Total Income 2,599,544 3,310,767 3,713,692
----------- ---------- -----------
EXPENSES
Interest expense 87,217 81,285 127,087
Administrative expenses 135,447 128,002 137,081
----------- ---------- -----------
Total Expenses 222,664 209,287 264,168
----------- ---------- -----------
Net income before income tax expense
(benefit) and undistributed
subsidiary net income 2,376,880 3,101,480 3,449,524
INCOME TAX EXPENSE (BENEFIT) (19,580) 152,738 120,229
----------- ---------- -----------
Income before undistributed
subsidiary net income 2,396,460 2,948,742 3,329,295
Undistributed subsidiary net income 2,383,893 1,400,809 683,004
----------- ---------- -----------
NET INCOME 4,780,353 4,349,551 4,012,299
Retained earnings, beginning of year 22,273,119 19,709,562 17,390,478
Reclassify deficit surplus (39,641) - -
Dividends on common stock (1,878,100) (1,785,994) (1,693,215)
----------- ---------- -----------
Retained Earnings, End of Year $25,135,731 $22,273,119 $19,709,562
=========== ========== ===========
53
Notes to the Consolidated Financial Statements
NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
Statements of Cash Flows
Years Ended December 31,
2005 2004 2003
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,780,353 $4,349,551 $ 4,012,299
Adjustments to reconcile net
income to net cash provided by
operating activities:
Undistributed subsidiary income (2,383,893) (1,400,809) (683,004)
Gain (Loss) on sale of
securities (121,669) (513,255) (275,943)
Deferred tax (benefit) expense 116,537 29,974 71,515
Decrease (increase) in interest
receivable - 3,073 (3,073)
Decrease (increase) in due from
subsidiary 49,379 (341,712) 190,353
Decrease in other assets - - 215,109
Increase (decrease) in due to
subsidiary - (83,455) 116,280
Increase (decrease) in other
liabilities (140,998) 255,016 (18,089)
Net change in deferred tax
credits (58,000) 60,522 103,321
Amortization of limited
Partnership investments 321,109 244,290 262,227
Securities amortization 17,109 17,109 17,109
Gain on sale of land - - (95,434)
----------- ---------- ------------
Net Cash Provided by Operating
Activities 2,579,927 2,620,304 3,912,670
----------- ---------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributed to subsidiary - (1,250,000) -
Proceeds from sales of securities
available for sale 1,838,866 4,882,132 1,849,509
Proceeds from maturity of securities
available for sale - 362,500 -
Purchase of securities available
for sale (2,499,763) (2,628,354) (1,825,119)
Investments in low income housing
partnerships - - (1,297,948)
Proceeds from sale of real estate - - 403,325
----------- ---------- ------------
Net Cash Provided by (Used in)
Investing Activities (660,897) 1,366,278 (870,233)
----------- ---------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds of long-term debt 750,000 - -
Payments on long-term debt (1,673,077) (1,128,205) (1,333,333)
Increase (decrease) in
short-term debt - (317,511) 317,511
Payments to repurchase
common stock (316,014) (451,084) (264,434)
Proceeds from issuance of
common stock 72,500 220,875 208,000
Dividends paid in cash (1,856,814) (1,763,849) (1,645,225)
----------- ---------- ------------
Net Cash Used in Financing
Activities (3,023,405) (3,439,774) (2,717,481)
----------- ---------- ------------
Net Increase in Cash and Cash
Equivalents (1,104,375) 546,808 324,956
Cash and Cash Equivalents, Beginning
of Year 1,164,265 617,457 292,501
----------- ---------- ------------
Cash and Cash Equivalents, End of Year $ 59,890 $1,164,265 $ 617,457
========== ========= ===========
54
Report of Independent Registered Public Accounting Firm
To the Board of Directors
F & M Bank Corp. and Subsidiaries
Timberville, Virginia
We have audited the accompanying consolidated balance sheet of F & M Bank Corp.
and Subsidiaries as of December 31, 2005, and the related consolidated
statements of income, retained earnings and cash flows for the year then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The financial statements of F & M Bank Corp. and
Subsidiaries as of December 31, 2004, were audited by other auditors whose
report dated February 19, 2005, expressed an unqualified opinion on those
statements.
We conducted our audit 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 audit provides 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, 2005, and the results of its operations and its
cash flows for the year then ended in conformity with U.S. generally accepted
accounting principles.
Larrowe & Company, plc
Galax, Virginia
February 3, 2006
55
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 the related consolidated statements
of income, changes in stockholders' equity and cash flows for the two 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 the results of their operations and
their cash flows for the two years ended December 31, 2004, in conformity with
U.S. generally accepted accounting principles.
S. B. Hoover & Company, L.L.P.
February 19, 2005
Harrisonburg, Virginia
56
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On January 20, 2005, F & M Bank Corp. ("F&M" or the "Registrant") terminated the
engagement of S. B. Hoover & Company, LLP ("SBH") as its independent auditor in
order to engage SBH, which has audited the Registrant's financial statements
since January 1, 1984, to perform the Registrant's internal audit function and
assist the Registrant in preparing for compliance with the management report on
internal control required by the Sarbanes-Oxley Act of 2002. This action was
recommended and approved by the Audit Committee of the Registrant's Board of
Directors.
On February 17, 2005, F & M Bank Corp. ("Registrant") engaged Larrowe & Company,
P.L.C. ("Larrowe") as the Registrant's independent auditor for the year ending
December 31, 2005. This change in auditors was recommended and approved by the
Audit Committee of the Registrant's Board of Directors.
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.
57
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 13, 2006 ("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."
58
Part IV
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 29 thru 55:
Consolidated Balance Sheets - December 31, 2005 and 2004....................29
Consolidated Statements of Income - Years ended December 31,
2005, 2004 and 2003.........................................................30
Consolidated Statements of Stockholders' Equity - Years ended
December 31, 2005, 2004 and 2003............................................31
Consolidated Statements of Cash Flows - Years ended December 31,
2005, 2004 and 2003.........................................................32
Notes to the Consolidated Financial Statements..............................33
Report of the Independent Auditors..........................................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.
59
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, 2006
--------------------------- ---------------------
Dean W. Withers Date
Director, President and Chief Executive Officer
By: /s/ Neil W. Hayslett March 24, 2006
--------------------------- ---------------------
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, 2006
- --------------------------- ----------------
Thomas L. Cline
/s/ John N. Crist Director March 24, 2006
- --------------------------- ----------------
John N. Crist
/s/ Julian D. Crist Director, Chairman March 24, 2006
- --------------------------- ----------------
Julian D. Fisher
/s/ Ellen R. Fitzwater Director March 24, 2006
- --------------------------- ----------------
Ellen R. Fitzwater
Director
- --------------------------- ----------------
Daniel J. Harshman
Director
- --------------------------- ----------------
Richard S. Myers
Director
- --------------------------- ----------------
Michael W. Pugh
/s/ Ronald E. Wampler Director March 24, 2006
- --------------------------- ----------------
Ronald E. Wampler
60
Exhibit 21 - List of Subsidiaries of the Registrant
Farmers & Merchants Bank (incorporated in Virginia)
TEB Life Insurance Company (incorporated in Arizona)
Farmers & Merchants Financial Services (incorporated in Virginia), a
subsidiary of Farmers & Merchants Bank