UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from _____ to
Commission File Number 0-14492
FARMERS & MERCHANTS BANCORP, INC.
---------------------------------
OHIO 34-1469491
- ------------------------------- ----------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
307-11 North Defiance Street
Archbold, Ohio 43502
- ------------------------------- ----------------------------
(Address of principal (Zip Code)
Executive offices)
Registrant's telephone number, including area code (419)446-2501
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
None None
- ------------------------------- ---------------------------------
- ------------------------------- ---------------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common shares without par value
- --------------------------------------------------------------------------------
(Title of class)
- --------------------------------------------------------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or Section 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 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12(b) - 2 of the Act). Yes [X] No [ ]
At June 30, 2004, the aggregate market value of the voting stock held by
nonaffiliates of the registrant, based on a share price of $115.00 per share
(based upon last known transaction) was $140,338,065.00.
As of February 27, 2005, the Registrant had 1,300,000 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K - Portions of the definitive Proxy Statement for the 2005
Annual Meeting of Shareholders of Farmers & Merchants Bancorp, Inc.
FARMERS & MERCHANTS BANCORP, INC.
TABLE OF CONTENTS
Form 10-K Items PAGE
- -------------------------------------------------------------------------------- -------
Item 1. Business 4 - 9
Item 2. Properties 9 - 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations 13 - 28
Item 7a.. Quantitative and Qualitative Disclosures About Market Risk 28 - 29
Item 8. Financial Statements 29 - 59
Item 9. Change in and Disagreements with Accounting and Financial Disclosure 60
Item 9a. Controls and Procedures 60 - 63
Item 10. Directors and Executive Officers of the Registrant 64 - 66
Item 11. Executive Compensation 66
Item 12. Security Ownership of Certain Beneficial Owners and Management 66
Item 13. Certain Relationships and Related Transactions 66
Item 14. Principal Accountant Fees and Services 66
Item 15. Exhibits and Financial Statements Schedules 67 - 68
Signatures 69
Statements contained in this portion of the Company's annual report may be
forward-looking statements, as that term is defined in the Private Securities
Litigation Reform Act of 1995. Forward-looking statements may be identified by
the use of such words as "intend," "believe," "expect," "anticipate," "should,"
"planned," "estimated," and "potential." Such forward-looking statements are
based on current expectations, but may differ materially from those currently
anticipated due to a number of factors, which include, but are not limited to,
factors discussed in documents filed by the Company with the Securities and
Exchange Commission from time to time. Other factors which could have a material
adverse effect on the operations of the company and its subsidiaries which
include, but are not limited to, changes in interest rates, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the U.S. Government, including policies of the U.S. Treasury and the Federal
Reserve Board, the quality and composition of the loan or investment portfolios,
demand for loan products, deposit flows, competition, demand for financial
services in the Bank's market area, changes in relevant accounting principles
and guidelines and other factors over which management has no control. The
forward-looking statements are made as of the date of this report, and the
Company assumes no obligation to update the forward-looking statements or to
update the reasons why actual results could differ from those projected in the
forward-looking statements.
PART 1.
ITEM 1. BUSINESS:
General
Farmers & Merchants Bancorp, Inc. (Company) is a bank holding company under the
laws of Ohio and was incorporated in 1985. Our primary subsidiary, The Farmers &
Merchants State Bank (Bank) is a community bank in Northwest Ohio, as it has
been since 1897. Our only other subsidiary, Farmers & Merchants Life Insurance
Company, a reinsurance company for life, accident and health insurance for the
Bank's consumer credits, was formed in 1992. We report our financial condition
and net income on a consolidated basis and we report only one segment.
Our executive offices are located at 307-11 North Defiance Street, Archbold,
Ohio 43502, and our telephone number is (419) 446-2501.
Nature Of Activities
The Farmers & Merchants State Bank engages in general commercial banking and
savings business. Our activities include commercial and residential mortgage,
consumer, and credit card lending activities. Because our Bank's branches are
located in Northwest Ohio, a substantial amount of our loan portfolio is
comprised of loans made to customers in the farming industry for such things as
farm land, farm equipment, livestock and general operation loans for seed,
fertilizer, feed, etc. Other types of lending activities include loans for home
improvements, student loans, and loans for such items as autos, trucks,
recreational vehicles, mobile homes, motorcycles, etc. We have previously
engaged in direct finance leasing and have invested in leveraged type leases,
although the activity in this area has substantially decreased in recent years.
We also provide checking account services, as well as, savings and other time
deposit services such as certificates of deposits. In addition, ATM's (automated
teller machines) (Money Access Corporation) are also provided in our offices in
Archbold, Wauseon, Stryker, West Unity, Bryan, Delta and Napoleon, Montpelier,
Swanton, and Defiance. Two ATM's are also located at Sauder Woodworking Co.,
Inc., a major employer in Archbold. Additional locations are at Northwest State
Community College, Archbold; Williams County Hospital, Bryan; Fairlawn Haven
Wyse Commons, Archbold; Repp Oil, Fayette; Delta Eagles, Bryan; and Sauder
Village Barn Restaurant, Archbold.
Farmers & Merchants Life Insurance Company was established to provide services
to our customers through the issuance of life and disability insurance policies.
Our Bank's lending officers are the selling agents of the policies to customers.
The activities of Farmers & Merchants Life Insurance Co. are not significant to
the consolidated company.
F&M Investments, the brokerage department of the Bank, opened for business in
April, 1999. Securities are offered through Raymond James Financial Services,
Inc.
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956. Our subsidiary bank is in turn regulated and examined by
the Ohio Division of Financial Institutions, the Federal Deposit Insurance
Corporation and the Federal Reserve System. The activities of our bank
subsidiary are also subject to other federal and state laws and regulations,
including usury and consumer credit laws, state laws relating to fiduciaries,
the Federal Truth-in-Lending Act and Regulation Z as promulgated thereunder by
the Board of Governors, the Truth in Savings Act, the Bank Bribery Act, the
Competitive Equality Banking Act of 1987, the Expedited
4
Funds Availability Act, the Community Reinvestment Act, the FDICIA (Federal
Deposit Insurance Corporation Insurance Act), FIRREA (Federal Institutions
Reform, Recovery, and Enforcement Act of 1989), the Bank Merger Act, and the
Graham-Leach-Bliley Act regarding financial modernization among others.
The commercial banking business in the geographical area in which the Bank
operates is highly competitive. In our banking activities, we compete directly
with other commercial banks and savings and loan institutions in each of our
operating localities. In a number of our locations, we compete against entities
which are much larger than us. The primary factors in competing for loans and
deposits are the rates charged as well as location and quality of the services
provided.
At December 31, 2004, we had 230 full time equivalent employees. The employees
are not represented by a collective bargaining unit. We provide our employees
with a comprehensive benefit program, some of which are contributory. We
consider our employee relations to be excellent.
Supervision And Regulation
General
The Company is a corporation organized under the laws of the State of Ohio. The
business in which the Company and its subsidiary are engaged is subject to
extensive supervision, regulation and examination by various bank regulatory
authorities. The supervision, regulation and examination to which the Company
and its subsidiary are subject are intended primarily for the protection of
depositors and the deposit insurance funds that insure the deposits of banks,
rather than for the protection of shareholders.
Several of the more significant regulatory provisions applicable to banks and
bank holding companies to which the Company and its subsidiary are subject are
discussed below, along with certain regulatory matters concerning the Company
and its subsidiary. To the extent that the following information describes
statutory or regulatory provisions, it is qualified in its entirety by reference
to the particular statutory provisions. Any change in applicable law or
regulation may have a material effect on the business and prospects of the
Company and its subsidiary.
Regulatory Agencies
The Company is a registered bank holding company and is subject to inspection,
examination and supervision by the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") pursuant to the Bank Holding Company Act of
1956, as amended.
The Bank is an Ohio chartered commercial bank. It is subject to regulation and
examination by both the Ohio Division of Financial Institutions (the "ODFI") and
the FDIC.
Holding Company Activities
As a bank holding company incorporated and doing business within the State of
Ohio, the Company is subject to regulation and supervision under the Bank
Holding Act of 1956, as amended (the "Act"). The Company is required to file
with the Federal Reserve Board on a quarterly basis information pursuant to the
Act. The Federal Reserve Board may conduct examinations or inspections of the
Company and its subsidiaries.
5
The Company is required to obtain prior approval from the Federal Reserve Board
for the acquisition of more than five percent of the voting shares or
substantially all of the assets of any bank or bank holding company. In
addition, the Company is generally prohibited by the Act from acquiring direct
or indirect ownership or control of more than five percent of the voting shares
of any company which is not a bank or bank holding company and from engaging
directly or indirectly in activities other than those of banking, managing or
controlling banks or furnishing services to its subsidiaries. The Company may,
however, subject to the prior approval of the Federal Reserve Board, engage in,
or acquire shares of companies engaged in activities which are deemed by the
Federal Reserve Board by order or by regulation to be so closely related to
banking or managing and controlling a bank as to be a proper activity.
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted
into law. The GLB Act made sweeping changes with respect to the permissible
financial services which various types of financial institutions may now
provide. The Glass-Steagall Act, which had generally prevented banks from
affiliation with securities and insurance firms, was repealed. Pursuant to the
GLB Act, bank holding companies may elect to become a "financial holding
company," provided that all of the depository institution subsidiaries of the
bank holding company are "well capitalized" and "well managed" under applicable
regulatory standards.
Under the GLB Act, a bank holding company that has elected to become a financial
holding company may affiliate with securities firms and insurance companies and
engage in other activities that are financial in nature. Activities that are
"financial in nature" include securities underwriting, dealing and
market-making, sponsoring mutual funds and investment companies, insurance
underwriting and agency, merchant banking, and activities that the Federal
Reserve Board has determined to be closely related to banking. No Federal
Reserve Board approval is required for the Company to acquire a company, other
than a bank holding company, bank or savings association, engaged in activities
that are financial in nature or incidental to activities that are financial in
nature, as determined by the Federal Reserve Board. Prior Federal Reserve Board
approval is required before the Company may acquire the beneficial ownership or
control of more than 5% of the voting shares, or substantially all of the
assets, of a bank holding company, bank or savings association. If any
subsidiary bank of the Company ceases to be "well capitalized" or "well managed"
under applicable regulatory standards, the Federal Reserve Board may, among
other actions, order the Company to divest the subsidiary bank. Alternatively,
the Company may elect to conform its activities to those permissible for a bank
holding company that is not also a financial holding company. If any subsidiary
bank of the Company receives a rating under the Community Reinvestment Act of
1977 of less than satisfactory, the Company will be prohibited from engaging in
new activities or acquiring companies other than bank holding companies, banks
or savings associations. The Company has not elected to become a financial
holding company and has no current intention of making such an election.
Affiliate Transactions
Various governmental requirements, including Sections 23A and 23B of the Federal
Reserve Act, limit borrowings by holding companies and non-bank subsidiaries
from affiliated insured depository institutions, and also limit various other
transactions between holding companies and their non-bank subsidiaries, on the
one hand, and their affiliated insured depository institutions on the other.
Section 23A of the Federal Reserve Act also generally requires that an insured
depository institution's loan to its non-bank affiliates be secured, and Section
23B of the Federal Reserve Act generally requires that an insured depository
institution's transactions with its non-bank affiliates be on arms-length terms.
6
Interstate Banking and Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act
("Riegle-Neal"), subject to certain concentration limits and other requirements,
bank holding companies such as the Company are permitted to acquire banks and
bank holding companies located in any state. Any bank that is a subsidiary of a
bank holding company is permitted to receive deposits, renew time deposits,
close loans, service loans and receive loan payments as an agent for any other
bank subsidiary of that bank holding company. Banks are permitted to acquire
branch offices outside their home states by merging with out-of-state banks,
purchasing branches in other states and establishing de novo branch offices in
other states. The ability of banks to acquire branch offices is contingent,
however, on the host state having adopted legislation "opting in" to those
provisions of Riegle-Neal. In addition, the ability of a bank to merge with a
bank located in another state is contingent on the host state not having adopted
legislation "opting out" of that provision of Riegle-Neal. The Company could
from time to time use Riegle-Neal to acquire banks in additional states.
Control Acquisitions
The Change in Bank Control Act prohibits a person or group of persons from
acquiring "control" of a bank holding company, unless the Federal Reserve Board
has been notified and has not objected to the transaction. Under the rebuttable
presumption established by the Federal Reserve Board, the acquisition of 10% or
more of a class of voting stock of a bank holding company with a class of
securities registered under Section 12 of the Exchange Act, such as the Company,
would, under the circumstances set forth in the presumption, constitute
acquisition of control of the bank holding company. In addition, a company is
required to obtain the approval of the Federal Reserve Board under the Bank
Holding Company Act before acquiring 25% (5% in the case of an acquiror that is
a bank holding company) or more of any class of outstanding voting stock of a
bank holding company, or otherwise obtaining control or a "controlling
influence" over that bank holding company.
Liability for Banking Subsidiaries
Under the current Federal Reserve Board policy, a bank holding company is
expected to act as a source of financial and managerial strength to each of its
subsidiary banks and to maintain resources adequate to support each subsidiary
bank. This support may be required at times when the bank holding company may
not have the resources to provide it. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a U.S. federal bank
regulatory agency to maintain the capital of a subsidiary bank would be assumed
by the bankruptcy trustee and entitled to priority of payment. Any depository
institution insured by the FDIC can be held liable for any loss incurred, or
reasonably expected to be incurred, by the FDIC in connection with (1) the
"default" of a commonly controlled FDIC-insured depository institution; or (2)
any assistance provided by the FDIC to both a commonly controlled FDIC-insured
depository institution "in danger of default." The Company's subsidiary bank is
an FDIC-insured depository institution. If a default occurred with respect to
the Bank, any capital loans to the Bank from its parent holding company would be
subordinate in right of payment to payment of the Bank's depositors and certain
of its other obligations.
Regulatory Capital Requirements
The Company is required by the various regulatory authorities to maintain
certain capital levels. Bank holding companies are required to maintain minimum
levels of capital in accordance with
7
Federal Reserve capital adequacy guidelines. If capital falls below minimum
guideline levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank businesses. The
required capital levels and the Company's capital position at December 31, 2004
are summarized in the table included in Note 14 to the consolidated financial
statements.
FDICIA
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
and the regulations promulgated under FDICIA, among other things, established
five capital categories for insured depository institutions-well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized-and requires U.S. federal bank regulatory agencies
to implement systems for "prompt corrective action" for insured depository
institutions that do not meet minimum capital requirements based on these
categories. Unless a bank is well capitalized, it is subject to restrictions on
its ability to offer brokered deposits and on certain other aspects of its
operations. An undercapitalized bank must develop a capital restoration plan and
its parent bank holding company must guarantee the bank's compliance with the
plan up to the lesser of 5% of the banks or thrift's assets at the time it
became undercapitalized and the amount needed to comply with the plan. As of
December 31, 2004, the Company's banking subsidiary was well capitalized
pursuant to these prompt corrective action guidelines.
Dividend Restrictions
The ability of the Company to obtain funds for the payment of dividends and for
other cash requirements will be largely dependent on the amount of dividends
which may be declared by its banking subsidiary. Various U.S. federal statutory
provisions limit the amount of dividends the Company's banking subsidiaries can
pay to the Company without regulatory approval. Dividend payments by the Bank
are limited to its retained earnings during the current year and its prior two
years.
The ability of the Company's banking subsidiary to pay dividends in the future
is currently, and could be further, influenced by bank regulatory policies and
capital guidelines. As of June 2004, all dividends were required to be approved
by federal and state regulatory agencies prior to declaration, which
pre-approval requirements will continue into 2005.
Deposit Insurance Assessments
The deposits of the Company's banking subsidiary are insured up to regulatory
limits by the FDIC, and, accordingly, are subject to deposit insurance
assessments to maintain the Bank Insurance Fund (the "BIF") and/or the Savings
Association Insurance Fund (the "SAIF") administered by the FDIC.
Depositor Preference Statute
In the "liquidation or other resolution" of an institution by any receiver, U.S.
federal legislation provides that deposits and certain claims for administrative
expenses and employee compensation against the insured depository institution
would be afforded a priority over general unsecured claims against that
institution, including federal funds and letters of credit.
8
Government Monetary Policy
The earnings of the Company are affected primarily by general economic
conditions, and to a lesser extent by the fiscal and monetary policies of the
federal government and its agencies, particularly the Federal Reserve. Its
policies influence, to some degree, the volume of bank loans and deposits, and
interest rates charged and paid thereon, and thus have an effect on the earnings
of the Company's subsidiary Bank.
Additional Regulation
The Bank is also subject to federal regulation as to such matters as required
reserves, limitation as to the nature and amount of its loans and investments,
regulatory approval of any merger or consolidation, issuance or retirement of
their own securities, limitations upon the payment of dividends and other
aspects of banking operations. In addition, the activities and operations of the
Bank are subject to a number of additional detailed, complex and sometimes
overlapping laws and regulations. These include state usury and consumer credit
laws, state laws relating to fiduciaries, the Federal Truth-in-Lending Act and
Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the
Fair Credit Reporting Act, the Truth in Savings Act, the Community Reinvestment
Act, anti-redlining legislation and antitrust laws.
Future Legislation
Changes to the laws and regulations, both at the federal and state levels, can
affect the operating environment of the Company and its subsidiary in
substantial and unpredictable ways. The Company cannot accurately predict
whether those changes in laws and regulations will occur, and, if those changes
occur, the ultimate effect they would have upon the financial condition or
results of operations of the Company or its subsidiary.
Available Information:
The Company maintains an Internet web site at the following internet address:
http://www.fmbank.com. The Company files reports with the Securities and
Exchange Commission (SEC). Copies of all filings made with the SEC may be read
and copied at the SEC's Public Reference Room, 450 Fifth Street, Washington, DC,
20549. You may obtain information about the SEC's Public Reference Room by
calling (800/SEC-0330). Because the Company makes its filing with the SEC
electronically, you may access such reports at the SEC's website, www.sec.gov.
The Company makes available, free of charge through its internet address, copies
of its annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and any amendments to these reports as soon as reasonable
practicable after such materials have been filed with or furnished to the SEC.
Copies of these documents may also be obtained, either in electronic or paper
form, by contacting Barbara J. Britenriker, Chief Financial Officer of the
Company at (419) 446-2501.
ITEM 2. PROPERTIES
Our principal office is located in Archbold, Ohio.
The Bank operates from the facilities at 307-11 North Defiance Street. In
addition, the Bank owns the property from 200 to 208 Ditto Street, Archbold,
Ohio, which it uses for Bank parking and a community mini-park area. The Bank
owns real estate at two locations, 207 Ditto Street and 209 Ditto Street in
Archbold, Ohio upon which the bank built a commercial building to be used for
storage, and a parking lot for company vehicles and employee parking. The Bank
also owns real estate across from the main facilities to provide for parking.
9
The Bank completed construction in February 2003 of an operations center at 622
Clydes Way in Archbold, Ohio to accommodate our growth.
The Bank owns all of its branch locations. Current locations of retail banking
services are:
Branch Location
- ---------------- --------------------------
Archbold, Ohio 1313 South Defiance Street
Wauseon, Ohio 1130 North Shoop Avenue
119 North Fulton Street
Stryker, Ohio 300 South Defiance Street
West Unity, Ohio 200 West Jackson Street
Bryan, Ohio 924 W. High Street
1000 South Main Street
Delta, Ohio 101 Main Street
Montpelier, Ohio 225 West Main Street
1150 East Main Street
Napoleon, Ohio 2255 Scott Street
Swanton, Ohio 7 Turtle Creek Circle
Defiance, Ohio 1175 Hotel Drive
The majority of the above locations have drive-up service facilities.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine
proceedings incidental to the business of the Bank or the Company, to which we
are a party or of which any of our properties are the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted during the fourth quarter of the year covered by this
report to a vote of the security holders through solicitation of proxies or
otherwise.
10
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is not quoted on the National Association of Securities Dealers
Automated Quotations System (NASDAQ) or any other market or exchange.
Our common stock is traded in the principal market area of Fulton, Williams, and
Henry Counties, Ohio. We had no broker that set a price for our stock;
therefore, the only source as to the high and low sale price was from private
sales of which we have been made aware. The high and low sale prices known to
our management are as follows:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
2004 High $ 115.00 $ 115.00 $ 123.00 $ 115.00
Low $ 100.00 $ 100.00 $ 100.00 $ 100.00
2003 High $ 112.00 $ 113.00 $ 126.00 $ 115.00
Low $ 95.00 $ 95.00 $ 95.00 $ 100.00
The Bank acted as transfer agent for the Company's common stock until December
17, 2004. After December 17, 2004 the Company utilizes Register and Transfer as
its transfer agent.
As of February 19, 2005, there were 1999 record holders of our common stock.
We pay dividends quarterly. Per share dividends for the years ended 2004 and
2003 are as follows:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total
----------- ----------- ----------- ----------- --------
2004 $ .45 $ .45 $ .45 $ .55 $ 1.90
2003 $ .40 $ .40 $ 5.40 $ .55 $ 6.75
The ability of the Company to pay dividends is limited by the dividend that the
Company receives from the Bank. The Bank may pay as dividends to the Company its
retained earnings during the current year and its prior two years. Currently,
such limitation on the payment of dividends from the Bank to the Company does
not materially restrict the Company's ability to pay dividends to its
shareholders. As of June 2004, all dividends were required to be approved by
federal and state regulatory agencies prior to declaration. Regulatory approval
prior to declaration will continue into 2005.
The Company did not repurchase any of its shares during the fourth quarter of
2004.
11
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
SUMMARY OF CONSOLIDATED STATEMENT OF INCOME - UNAUDITED
(In Thousands)
------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ----------- -------------
Summary of Income:
Interest income $ 37,962 $ 41,107 $ 43,424 $ 48,945 $ 48,890
Interest expense 11,222 14,283 18,979 25,448 25,509
---------- ---------- ---------- ----------- -------------
Net Interest Income 26,740 26,824 24,445 23,497 23,381
Provision for loan loss 885 6,903 2,194 2,632 1,496
---------- ---------- ---------- ----------- -------------
Net interest income after provision for loan loss 25,855 19,921 22,251 20,865 21,885
Other income (expense), net (14,052) (9,836) (11,864) (11,217) (11,376)
---------- ---------- ---------- ----------- -------------
Net income before income taxes 11,803 10,085 10,387 9,648 10,509
Income taxes 3,573 2,459 2,989 2,892 3,118
---------- ---------- ---------- ----------- -------------
Net income $ 8,230 $ 7,626 $ 7,398 $ 6,756 $ 7,391
========== ========== ========== =========== =============
Per Share of Common Stock:
Earnings per common share outstanding (Based on weighted
average number of shares outstanding)
Net income $ 6.33 $ 5.87 $ 5.69 $ 5.20 $ 5.69
========== ========== ========== =========== =============
Dividends $ 1.90 $ 6.75 $ 1.65 $ 1.60 $ 1.50
========== ========== ========== =========== =============
Weighted average number of shares outstanding 1,300,000 1,300,000 1,300,000 1,300,000 1,300,000
========== ========== ========== =========== =============
SUMMARY OF CONSOLIDATED BALANCE SHEET - UNAUDITED
(In Thousands)
------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ----------- ---------- -----------
Total assets $ 702,513 $ 705,703 $ 726,486 $ 683,626 $ 635,160
Loans 472,212 480,339 497,515 468,243 480,645
Total Deposits 574,205 575,066 576,373 566,157 516,463
Stockholders' equity 78,845 74,856 77,738 70,350 64,988
Key Ratios
Return on average equity 10.72% 9.87% 9.93% 9.73% 12.02%
Return on average assets 1.16% 1.06% 1.06% 1.02% 1.19%
Loan to deposits 82.24% 83.53% 86.32% 82.71% 93.00%
Capital to assets 11.22% 10.61% 10.70% 10.29% 10.23%
Dividend payout 30.02% 115.07% 28.99% 30.79% 26.38%
12
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Critical Accounting Policy And Estimates
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America, and
the Company follows general practices within the industries in which it
operates. At times the application of these principles requires Management to
make assumptions, estimates and judgments that affect the amounts reported in
the financial statements and accompanying notes. These assumptions, estimates
and judgments are based on information available as of the date of the financial
statements. As this information changes, the financial statements could reflect
different assumptions, estimates and judgments. Certain policies inherently have
a greater reliance on assumptions, estimates and judgments and as such have a
greater possibility of producing results that could be materially different than
originally reported. Examples of critical assumptions, estimates and judgments
are when assets and liabilities are required to be recorded at fair value, when
a decline in the value of an asset not required to be recorded at fair value
warrants an impairment write-down or valuation reserve to be established, or
when an asset or liability must be recorded contingent upon a future event.
All significant accounting policies followed by the Company are presented in
Note 1 to the consolidated financial statements. These policies, along with the
disclosures presented in the notes to the consolidated financial statements and
in the management discussion and analysis of financial condition and results of
operations, provide information on how significant assets and liabilities are
valued and how those values are determined for the financial statements. Based
on the valuation techniques used and the sensitivity of financial statement
amounts to assumptions, estimates and judgments underlying those amounts,
management has identified the determination of the Allowance for Loan and Lease
Losses (ALLL) and the valuation of its Mortgage Servicing Rights as the
accounting areas that requires the most subjective or complex judgments, and as
such could be the most subject to revision as new information becomes available.
The ALLL represents management's estimate of credit losses inherent in the
Bank's loan portfolio at the report date. The estimate is a composite of a
variety of factors including past experience, collateral value, and the general
economy. ALLL includes a specific portion, a formula driven portion, and a
general nonspecific portion. The collection and ultimate recovery of the book
value of the collateral, in most cases, is beyond our control.
The Company is also required to estimate the value of its Mortgage Servicing
Rights. The Company recognizes as separate assets rights to service fixed rate
single-family mortgage loans that it has sold without recourse but services for
others for a fee. Mortgage servicing assets are initially recorded at cost,
based upon pricing multiples as determined by the purchaser, when the loans are
sold. Mortgage servicing assets are carried at the lower of the initial carrying
value, adjusted for amortization, or estimated fair value. Amortization is
determined in proportion to and over the period of estimated net servicing
income using the level yield method. For purposes of determining impairment, the
mortgage servicing assets are stratified by interest rate.
The expected and actual rates of mortgage loan prepayments are the most
significant factors driving the potential for the impairment of the value of
mortgage servicing assets. Increases in mortgage loan prepayments reduce
estimated future net servicing cash flows because the life of the underlying
loan is reduced. For the years presented, mortgage servicing assets and related
amortization were not material.
13
For more information regarding the estimates and calculations used to establish
the ALLL and the value of Mortgage Servicing Rights, please see Note 1 to the
consolidated financial statements provided herewith.
Results Of Operations
With slight improvement in the local economies, Farmers & Merchants Bancorp, Inc
improved its profitability during 2004. The increased net income was achieved by
a much improved asset quality position. Loan Loss Provision of $6.90 million for
2003 decreased to $0.88 million for 2004. Nonaccrual loans decreased during 2004
along with a significant improvement in accruing loans past due 90 days or more,
decreasing by $1.649 million.
The focus on asset quality and the improvement thereof did not come without
additional cost. The addition of a Chief Loan Administrator, Commercial Loan
Documentation Department and increased staffing among many existing departments
contributed to the increase of approximately $1 million of operating expenses
during 2004. The Company experienced negative growth in loans and assets due to
the focus on asset quality. The loan portfolio decreased $8.2 million and total
assets decreased $3.2 million by year end 2004.
Rates began to increase in the second half of 2004. Gains in the net interest
margin from 2003 and first half of 2004 began to erode with the first rate
increase in June of 2004. The net interest margin for 2004 ended at 3.97%
compared to 3.95% for 2003. However, the net interest margin for the Bank for
the month of December 2003 was 4.14% compared to 3.89% for the month of December
2004. The Bank faces the challenge of operating within an environment predicted
to have rising rates that will continue to place pressure on the net interest
margin. The Bank looks for new growth in loans to aid in easing the tightening
of the margin.
Overall, the Company had an increase in net income compared to the previous year
of $604 thousand resulting in an increase in Earnings per Share of $0.46. The
local economy appears to be cautiously optimistic heading into 2005. The Company
seeks to maintain its improved asset quality position while focusing on growth
opportunities.
Net Interest Income
The following tables present net interest income, interest spread and net
interest margin for the three years 2002 through 2004, comparing average
outstanding balances of earning assets and interest bearing liabilities with the
associated interest income and expense. The table also shows their corresponding
average rates of interest earned and paid. The tax-exempt asset yields have been
tax affected to reflect a marginal corporate tax rate of 34%. Average
outstanding loan balances include nonperforming loans and mortgage loans held
for sale. Average outstanding security balances are computed based on carrying
values including unrealized gains and losses on available-for-sale securities.
As the tables indicate, the Company experienced increased growth on an average
basis for year 2003 compared to 2002, but lost a portion of that growth when
comparing 2004 to 2003. The largest decrease in average balances compared to
2003 was in loans. The net interest margin and spread both improved led by the
decreased cost of funds or interest expense yield. The interest
14
income yield also decreased but not as much as the interest expense. The net
interest margin and spread in 2004 are the highest of the three years shown. The
average balances of interest-bearing liabilities decreased in 2004 compared to
2003 with the exception of fed funds purchased and securities sold under
agreement to repurchase. Customers moved money to higher earning instruments as
rates began to increase in the second half of 2004. Due to the decrease in
loans, the Bank did not price deposits as aggressively as competitors and the
average balance decline reflects that pricing strategy.
15
2004
-----------------------------------
(In Thousands)
----------------------------------
Average Interest/
Balance Dividends Yield/Rate
--------- --------- ----------
ASSETS
INTEREST EARNING ASSETS:
Loans (1) $ 490,793 $ 31,767 6.47%
Taxable investment securities 127,432 4,393 3.45%
Tax-exempt investment securities 46,730 1,688 5.47%
Interest bearing deposits 5,141 80 1.56%
Federal funds sold 3,543 34 0.96%
--------- --------
TOTAL INTEREST EARNING ASSETS 673,639 $ 37,962 5.76%
======== ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 14,945
Other assets 20,349
---------
TOTAL ASSETS $ 708,933
=========
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $ 204,049 $ 1,268 0.62%
Other time deposits 323,527 8,712 2.69%
Other borrowed money 23,694 817 3.45%
Federal funds purchased and securities
sold under agreement to repurchase 24,218 425 1.75%
--------- --------
TOTAL INTEREST BEARING LIABILITIES 575,488 $ 11,222 1.95%
======== ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 42,205
Other 14,497
---------
TOTAL LIABILITIES 632,190
SHAREHOLDERS' EQUITY 76,743
---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 708,933
=========
Interest/Dividend income/yield $ 37,962 5.76%
Interest Expense/yield 11,222 1.95%
-------- ----
Net Interest Spread $ 26,740 3.81%
======== ====
Net Interest Margin 3.97%
====
16
2003
---------------------------------
(In Thousands)
---------------------------------
Average Interest/
Balance Dividends Yield/Rate
--------- --------- ----------
ASSETS
INTEREST EARNING ASSETS:
Loans (1) $ 500,517 $34,233 6.84%
Taxable investment securities 128,087 5,105 3.99%
Tax-exempt investment securities 44,981 1,710 5.76%
Interest bearing deposits 2,413 26 1.08%
Federal funds sold 3,163 33 1.04%
--------- -------
TOTAL INTEREST EARNING ASSETS 679,161 $41,107 6.18%
======= ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 17,001
Other assets 21,717
---------
TOTAL ASSETS $ 717,879
=========
LIABILITIES AND SHAREHOLDERS EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $ 209,044 $ 1,494 0.71%
Other time deposits 326,966 11,336 3.47%
Other borrowed money 28,095 1,077 3.83%
Federal funds purchased and securities
sold under agreement to repurchase 21,296 376 1.77%
--------- -------
TOTAL INTEREST BEARING LIABILITIES 585,401 $14,283 2.44%
======= ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 43,924
Other 11,258
---------
TOTAL LIABILITIES 640,583
SHAREHOLDERS' EQUITY 77,296
---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 717,879
=========
Interest/Dividend income/yield $41,107 6.18%
Interest Expense/yield 14,283 2.44%
------- ----
Net Interest Spread $26,824 3.74%
======= ====
Net Interest Margin 3.95%
====
17
2002
----------------------------------
(In Thousands)
----------------------------------
Average Interest/
Balance Dividends Yield/Rate
--------- --------- ----------
ASSETS
INTEREST EARNING ASSETS:
Loans (1) $ 476,981 $35,309 7.40%
Taxable investment securities 134,990 6,410 4.75%
Tax-exempt investment securities 39,812 1,622 4.07%
Interest bearing deposits 823 25 3.04%
Federal funds sold 3,522 58 1.65%
--------- -------
TOTAL INTEREST EARNING ASSETS 656,128 $43,424 6.62%
======= ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 15,873
Other assets 23,135
---------
TOTAL ASSETS $ 695,136
=========
LIABILITIES AND SHAREHOLDERS EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $ 197,819 $ 1,705 0.86%
Other time deposits 333,247 15,869 4.76%
Other borrowed money 17,773 990 5.57%
Federal funds purchased and securities
sold under agreement to repurchase 23,609 415 1.76%
--------- -------
TOTAL INTEREST BEARING LIABILITIES 572,448 $18,979 3.32%
======= ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 40,485
Other 7,708
---------
TOTAL LIABILITIES 620,641
SHAREHOLDERS' EQUITY 74,495
---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 695,136
=========
Interest/Dividend income/yield $43,424 6.62%
Interest Expense/yield 18,979 3.32%
------- ----
Net Interest Spread $24,445 3.30%
======= ====
Net Interest Margin 3.73%
====
(1) For purposes of these computations, non-accruing loans are included in
the daily average outstanding loan amounts.
18
The primary source of the Company's traditional banking revenue is net interest
income. Net interest income is the difference between interest income on
interest earning assets, such as loans and securities, and interest expense on
liabilities used to fund those assets, such as interest bearing deposits and
other borrowings. Net interest income is affected by changes in both interest
rates and the amount and composition of earnings assets and liabilities. The
change in net interest income is most often measured as a result of two
statistics - interest spread and net interest margin. The difference between the
yields on earning assets and the rates paid for interest bearing liabilities
supporting those funds represents the interest spread. Because non-interest
bearing sources of funds such as demand deposits and stockholders' equity also
support earning assets, the net interest margin exceeds the interest spread.
The following tables show changes in interest income, interest expense and net
interest resulting from changes in volume and rate variances for major
categories of earnings assets and interest bearing liabilities.
2004 vs 2003
(In Thousands)
-----------------------------
Net Due to Change in
Change Volume Rate
------- ------ -------
INTEREST EARNED ON:
Loans $(2,466) $(665) $(1,801)
Taxable investment securities (712) (26) (686)
Tax-exempt investment Securities (22) 101 (123)
Interest bearing deposits 54 29 25
Federal funds sold 1 4 (3)
------- ----- -------
TOTAL INTEREST EARNING ASSETS $(3,145) $(557) $(2,588)
======= ===== =======
INTEREST PAID ON:
Savings deposits $ (226) $ (36) $ (190)
Other time deposits (2,624) (119) (2,505)
Other borrowed money (260) (169) (91)
Federal funds and purchased
securities sold under agreement
to repurchase 49 52 (3)
------- ----- -------
TOTAL INTEREST BEARING LIABILITIES $(3,061) $(272) $(2,789)
======= ===== =======
2003 vs 2002
(In Thousands)
-------------------------------
Net Due to Change in
Change Volume Rate
------- ------- -------
INTEREST EARNED ON:
Loans $(1,076) $ 1,742 $(2,818)
Taxable investment securities (1,305) (328) (977)
Tax-exempt investment Securities 88 210 (122)
Interest bearing deposits 1 48 (47)
Federal funds sold (25) (6) (19)
------- ------- -------
TOTAL INTEREST EARNING ASSETS $(2,317) $ 1,667 $(3,984)
======= ======= =======
INTEREST PAID ON:
Savings deposits $ (211) $ 97 $ (308)
Other time deposits (4,533) (299) (4,234)
Other borrowed money 87 575 (488)
Federal funds and purchased
securities sold under agreement
to repurchase (39) (41) 2
------- ------- -------
TOTAL INTEREST BEARING LIABILITIES $(4,696) $ 332 $(5,028)
======= ======= =======
19
Interest income on loans decreased $2.5 million for 2004 and $1.1 million for
2003. The decrease for 2004 and 2003 was primarily due to a drop in interest
rates. This drop was offset by the significant decrease in interest expense on
other time deposits of $2.6 million for 2004 and $4.2 million for 2003. The
interest rate on the matured long term time deposits during the first half of
2004 was often 3% - 4% higher than what the money was able to be reinvested at
due to the lower interest rate environment. As rates began to rise the second
half of 2004 and shorter term time deposits reinvested at higher rates, the
savings on interest expense declined or disappeared completely.
ALLOWANCE FOR LOAN LOSSES
The Company segregated its Allowance for Loan and Lease Losses (ALLL) into two
reserves at the period ending December 31, 2004: The ALLL and the Allowance for
Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these
reserves constitute the total Allowance for Credit Losses (ACL). The portion of
2003 and 2002 ACL attributable to AULC was $402 and $334 thousand respectively.
The Company increased the allowance for credit losses for 2004. The allowance
stands at $7.5 million for 2004 compared to $7.3 million for 2003. The Bank has
worked hard to improve loan quality while making credit available to all of
those who are in need and deemed an acceptable credit risk. This increase was
due to the continued concern of the slow pickup of the economy and its effect on
our customers going forward. Charge-off activity of $1.8 million was extremely
low for 2004 compared to $7.3 and $4.2 million for 2003 and 2002, respectively.
The allowance for credit loss activity resulted in expense of $0.9, $6.9 and
$2.2 million for 2004, 2003 and 2002, respectively. One large credit has
impacted two of the last three years of activity and the Company is no longer
carrying a balance on that credit. The Company expects to see the lower level of
2004 charge-offs in future years.
NON-INTEREST INCOME
Non-interest income of $4.8 million is a decrease of $3.2 million over 2003.
Non-interest income for 2003 of $8.0 million is the highest of the three years
shown. 2003 experienced a dramatic rise due to an increase in fixed rate
mortgage loan activity as a result of the favorable interest rates for such
loans. These types of loans are sold to investors while the Bank retains the
mortgage servicing rights on these loans. As a result, mortgage servicing rights
income was $1.1 million for 2003. Mortgage rates were higher in 2002 and 2004 so
the level of mortgage activity was slower. With more favorable interest rates
during 2003, the mortgage activity was brisk compared to 2004. Sold mortgage
originations dropped to $48.8 million for 2004 from the $179.1 million produced
in 2003. Along with the mortgage servicing rights income, gains on the sale of
those loans increased in 2003. The recognition of both income sources due to the
mortgage activity was $0.9 million in 2004 compared to $3.3 and $1.6 million for
2003 and 2002, respectively.
NON-INTEREST EXPENSE
Non-interest expense has increased during the last three years, growing from
$17.7 million in 2002 to $18.9 million in 2004. The largest increase occurred in
2004 as compared to 2003. Personnel costs were the major component behind the
increase. Additional staffing compiled with increased benefits costs added up to
an additional $1.0 million of expense. The additional staff will remain and the
Bank feels it is now adequately staffed for future growth. Increased costs of
other general and administrative expense totaling $520 thousand over 2003 was
mainly due to the added expense of complying with regulatory issues such as
Sarbanes Oxley (increased audit costs) and in the payment of FDIC assessments.
20
FEDERAL INCOME TAXES
Effective tax rates were 30.27%, 24.38%, and 28.78% for 2004, 2003 and 2002,
respectively. The Company has increased its tax-exempt holdings each year and
also added Bank Owned Life Insurance (BOLI) in the last quarter of 2002.
FINANCIAL CONDITION
Average earning assets decreased during 2004. Average earnings assets for 2004
were $674 million compared to $679 million for 2003 and $656 million for 2002.
This decrease in average earnings assets represent a less than 1.0 percent
change while 2003 increased 3.5 percent. The decrease in 2004 is attributed to
the decrease in loans caused by the focus on asset quality improvement rather
than growth. Average interest bearing liabilities also decreased by $9.9 million
in 2004, negating much of the gain of $13.0 million in 2003. 2004 is only
slightly higher than 2002 by $3.0 million.
SECURITIES
Security balances at December 31 are summarized below:
(In Thousands)
--------------------------------
2004 2003 2002
-------- -------- --------
U.S. Treasury and Government Agencies $ 88,344 $103,470 $104,618
Mortgage-backed securities 30,088 14,178 16,618
State and local governments 54,647 51,016 55,860
Corporate debt securities - 1,981 1,650
Equity securities 48 47 47
-------- -------- --------
$173,127 $170,692 $178,793
======== ======== ========
The following table sets forth (dollars in thousands) the maturities of
investment securities as of December 31, 2004 and the weighted average yields of
such securities calculated on the basis of cost and effective yields weighted
for the scheduled maturity of each security. Tax-equivalent adjustments, using a
thirty-four percent rate have been made in yields on obligations of state and
political subdivisions. Stocks of domestic corporations have not been included.
Maturities
-------------------------------------
After One Year
Within One Year Within Five Years
---------------- -----------------
Amount Yield Amount Yield
------- ----- ------- -----
U.S. Treasury $ 2,722 2.60% $ 2,130 2.95%
U.S. Government agency 23,691 3.46% 59,801 2.78%
Mortgage-backed securities 1 7.28% 21,416 3.81%
State and local governments 14,935 4.43% 20,979 5.45%
Taxable state and local governments 1,640 5.61% 3,262 5.16%
21
Maturities
-----------------------------------
After Five Years
Within Ten Years After Ten Years
---------------- ----------------
Amount Yield Amount Yield
------- ----- ------ -----
U.S. Treasury $ - - $ - -
U.S. Government agency - - - -
Mortgage-backed securities 8,670 3.65% - -
State and local governments 13,831 5.20% - -
Taxable state and local governments - - - -
As of December 31, 2004 the Bank did not hold a large block of any one
investment security, except for U.S. Treasury and other U.S. Government
agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati
at a cost of $3.6 million. This is required in order to obtain Federal Home Loan
Bank Loans.
LOAN PORTFOLIO
The Bank's various loan portfolios are subject to varying levels of credit risk.
Management mitigates these risks through portfolio diversification and through
standardization of lending policies and procedures.
The following table shows the Bank's loan portfolio by category of loan
including loans held for sale:
(In Thousands)
--------------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Loans:
Commercial/industrial $ 98,518 $102,101 $100,119 $ 96,992 $ 96,990
Agricultural 55,219 63,082 66,136 53,717 51,337
Real estate mortgage 274,156 267,312 278,933 247,545 261,289
Consumer 41,276 47,984 51,156 55,845 69,081
Industrial Development Bds 10,687 7,944 7,810 7,590 8,647
-------- -------- -------- -------- --------
Total Loans $479,856 $488,423 $504,154 $461,689 $487,344
======== ======== ======== ======== ========
The following table shows the maturity of loans:
Maturities (In Thousands)
--------------------------------------------
After One
Within Year Within After
One Year Five Years Five Years Total
-------- ----------- ---------- ---------
Commercial and industrial $ 33,329 $ 43,155 $ 22,034 $ 98,518
Agricultural 24,545 26,572 4,102 55,219
Real estate mortgage 15,107 13,406 245,643 274,156
Consumer 8,293 27,769 5,214 41,276
Industrial Development Bonds 3,216 2,432 5,039 10,687
22
The following table presents the total of loans due after one year which have 1)
predetermined interest rates and 2) floating or adjustable interest rates:
(In Thousands)
-------------------------
Fixed Variable
Rate Rate
----------- ----------
Commercial and industrial $ 43,312 $ 21,877
Agricultural 13,882 16,792
Real estate 23,700 235,349
Consumer, Credit Card and overdrafts 32,983 -
Industrial Development Bonds 7,471 -
The following table summarizes the Company's non-accrual and past due loans as
of December 31 for each of the last five years:
(In Thousands)
-----------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------- ------
Non-accrual loans $6,059 $6,236 $5,792 $ 5,353 $6,622
Accruing loans past due
90 days or more 393 2,042 2,674 5,408 2,577
------ ------ ------ ------- ------
Total $6,452 $8,278 $8,466 $10,761 $9,199
====== ====== ====== ======= ======
As of December 31, 2004, management, to the best of their knowledge, is not
aware of any significant loans, group of loans or segments of the loan portfolio
not included above, where there are serious doubts as to the ability of the
borrowers to comply with the present loan payment terms.
Although loans may be classified as non-performing, some pay on a regular basis,
many continue to pay interest irregularly or at less than original contractual
rates. Interest income that would have been recorded under the original terms of
these loans was $1.5 million for 2002 and $530 thousand for 2003 and $561
thousand for 2004. Any collections of interest on non-accrual loans are included
in interest income when collected. This amounted to $279 for 2004, $346 for
2003, $195 thousand for 2002.
Loans are placed on non-accrual status in the event that the loan is in past due
status for more than 90 days or payment in full of principle and interest is not
expected.
The $6.1 million of non-accrual loans as of December 31, 2004 are secured.
At December 31, 2004 the Bank has $26.8 million of loans which it considers to
be potential problem loans in that the borrowers are experiencing financial
difficulties. These loans are subject to constant management attention and are
reviewed more frequently than quarterly.
The amount of the potential problem loans was considered in management's review
of the loan loss reserve required at December 31, 2004.
23
In extending credit to families, businesses and governments, banks accept a
measure of risk against which an allowance for possible loan loss is established
by way of expense charges to earnings. This expense, used to enlarge a bank's
allowance for loan losses, is determined by management based on a detailed
monthly review of the risk factors affecting the loan portfolio, including
general economic conditions, changes in the portfolio mix, past due loan-loss
experience and the financial condition of the bank's borrowers.
At December 31, 2004, the Bank had loans outstanding to individuals and firms
engaged in the various fields of agriculture in the amount of $55 million. The
ratio of this segment of loans to the total loan portfolio is not considered
unusual for a bank engaged in and servicing rural communities.
The allowance for loan losses is evaluated based on an assessment of the losses
inherent in the loan portfolio. This assessment results in an allowance
consisting of two components, allocated and unallocated.
Management considers several different risk assessments in determining the
allowance for loan losses. The allocated component of the allowance for loan
losses reflects expected losses resulting from an analysis of individual loans,
developed through specific credit allocations for individual loans and
historical loss experience for each loan category. For those loans where the
internal credit rating is at or below a predetermined classification and
management can reasonably estimate the loss that will be sustained based upon
collateral, the borrowers operating activity and economic conditions in which
the borrower operates, a specific allocation is made. For those borrowers that
are not currently behind in their payment, but for which management believes
based on economic conditions and operating activities of the borrower, the
possibility exists for future collection problems, a reserve is established. The
amount of reserve allocated to each loan portfolio is based on past loss
experiences and the different levels of risk within each loan portfolio. The
historical loan loss portion is determined using a historical loss analysis by
loan category.
The unallocated portion of the reserve for loan losses is determined based on
management's assessment of general economic conditions as well as specific
economic factors in the Bank's marketing area. This assessment inherently
involves a higher degree of uncertainty. It represents estimated inherent but
undetected losses within the portfolio that are probable due to uncertainties in
economic conditions, delays in obtaining information, including unfavorable
information about a borrower's financial condition and other current risk
factors that may not have yet manifested themselves in the Bank's historical
loss factors used to determine the allocated component of the allowance.
Actual charge-off of loan balances is based upon periodic evaluations of the
loan portfolio by management. These evaluations consider several factors,
including, but not limited to, general economic conditions, financial condition
of the borrower, and collateral.
As presented below, charge-offs decreased to $1.8 million for 2004, and the
provision was $884 thousand. Both of these amounts are down significantly over
prior years. Credit losses in the consumer loan portfolio decreased over 45%
from 2003 with the portfolio down 14%. The decrease was primarily the result of
a few large commercial credits included in the $5.7 charged off in the
commercial and agricultural segment in 2003. The Commercial and Agricultural
segment is in a net recovery position for 2004.
24
The following table presents a reconciliation of the allowance for loan losses:
(In Thousands)
---------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ----------- ----------
Loans $ 479,681 $ 488,247 $ 498,078 $ 461,689 $ 487,344
========== ========== ========== =========== ==========
Daily average of outstanding loans $ 491,104 $ 500,517 $ 475,035 $ 472,181 $ 475,035
========== ========== ========== =========== ==========
Allowance for loan losses-Jan. 1 $ 7,300 $ 6,400 $ 7,275 $ 7,160 $ 6,750
Loans Charged off:
Commercial & Agricultural 491 5,706 2,987 1,826 257
Consumer 739 1,156 1,050 1,254 1,883
Real estate mortgages 549 424 215 54 233
---------- ---------- ---------- ----------- ----------
1,779 7,286 4,252 3,134 2,373
---------- ---------- ---------- ----------- ----------
Loan Recoveries:
Commercial & Agricultural 652 601 801 421 358
Consumer 405 546 366 191 923
Real estate mortgages 38 136 16 5 6
---------- ---------- ---------- ----------- ----------
1,095 1,283 1,183 617 1,287
---------- ---------- ---------- ----------- ----------
Net Charge Offs 684 6,003 3,069 2,517 1,086
---------- ---------- ---------- ----------- ----------
Provision for loan loss 884 6,903 2,194 2,632 1,496
---------- ---------- ---------- ----------- ----------
Allowance for loan & lease losses - Dec 31 $ 6,814 $ 7,300 $ 6,400 $ 7,275 $ 7,160
Allowance for Unfunded Loan Commitments
& Letters of Credit Dec 31 $ 686 $ - $ - $ - $ -
---------- ---------- ---------- ----------- ----------
Total Allowance for credit losses - Dec 31 $ 7,500 $ 7,300 $ 6,400 $ 7,275 $ 7,160
========== ========== ========== =========== ==========
Ratio of net charge - offs to average
Loans outstanding 0.14% 1.20% 0.65% 0.53% 0.23%
========== ========== ========== =========== ==========
Allocation of the allowance for loan losses among the various loan categories is
as follows:
% of Loans
in each
Amount Category to
(000's) Total Loans
------- -----------
Balance at End of Period Applicable To:
Commercial/industrial $ 3,917 3.98%
Agricultural 681 1.23%
Real estate 644 0.23%
Consumer 549 1.33%
Unallocated 1,024 9.58%
-------
Allowance for Loan & Lease Losses $ 6,815 1.42%
Off Balance Sheet Commitments $ 686 0.56%
-------
Total Allowance $ 7,500
=======
25
Deposits
The amount of outstanding time certificates of deposits and other time deposits
in amounts of $100,000 or more by maturity are as follows:
(In Thousands)
------------------------------------------------------------
Over Three Over One
Months Year Less Over
Under Less Than Than Three Three
Three Months One Year Years Years
------------------------------------------------------------
Time Deposits $ 19,827 $ 32,735 $ 32,901 $ 6,534
The following table presents the average amount of and average rate paid on each
deposit category:
(In Thousands)
--------- ---------- ----------- -----------
Demand NOW Savings Time
Deposits Accounts Accounts Accounts
--------- ---------- ----------- -----------
December 31, 2004:
Average balance $ 42,205 $ 88,666 $ 115,383 $ 323,527
Average rate 0.00% 0.67% 0.58% 2.69%
December 31, 2003:
Average balance $ 43,924 $ 101,132 $ 107,912 $ 326,966
Average rate 0.00% 0.77% 0.66% 3.47%
December 31, 2002:
Average balance $ 40,485 $ 93,084 $ 104,735 $ 333,247
Average rate 0.00% 1.18% 1.32% 4.53%
Liquidity
Maintaining sufficient funds to meet depositor and borrower needs on a daily
basis continues to be among our management's top priorities. This is
accomplished not only by the immediately liquid resources of cash, due from
banks and federal funds sold, but also by the Bank's available for sale
securities portfolio. The average aggregate balance of these assets was $196
million during 2003 compared to $198 million for 2004 representing 27 percent
and 28 percent of total average assets, respectively. Of the almost $168 million
of debt securities in the portfolio as of December 31, 2004, $17.9 million or 11
percent of the portfolio is expected to mature in 2004. Taking into
consideration possible calls of the debt securities, the amount climbs to $40.2
million or 24.0 percent of the portfolio becomes a source of funds.
Historically, the primary source of liquidity has been core deposits that
include non-interest bearing demand deposits, NOW, money market accounts and
time deposits of individuals. Core deposits decreased in 2004 pushed by the move
of customers seeking higher rates. Overall deposits decreased an average of
$10.2 million over 2003 compared to 2003's increase over 2002 of $8.4 million in
average deposits. These represent changes of (1.8) percent and 1.5 percent in
average total deposits, respectively.
26
Again, historically, the primary use of new funds is placing the funds back into
the community through loans for the acquisition of new homes, consumer products
and for business development. The use of new funds for loans is measured by the
loan to deposit ratio. The Company's loan to deposit ratio for 2004 was 82.23
percent, 2003 was 83.53 percent, 2002 was 86.32 percent. A decrease in 2003 was
caused by the selling of mortgages to the secondary market, the charge off
activity and the general slowing of loan demand. The decrease in 2004 is due to
the lack of growth in both the credit and deposit portfolios.
Short-term debt such as federal funds purchased and securities sold under
agreement to repurchase also provides the Company with liquidity. Short-term
debt for both federal funds purchased and securities sold under agreement to
repurchase amounted to $22.9 million at the end of 2004 compared to $27.3
million at December 31, 2003 and $38.2 million at the end of 2002.
Other borrowings are also a source of funds. Other borrowings consist of loans
from the Federal Home Loan Bank of Cincinnati. These funds are then used to
provide fixed rate mortgage loans secured by homes in our community. Borrowings
from this source decreased by $2.4 million to $22.0 million at December 31,
2004. This compares to decreased borrowings during 2003 of $4.3 to $24.4 million
at December 31, 2003, and increased borrowings during 2002 to end the year 2002
at $28.7 million.
Contractual Obligations
Contractual Obligations of the Company totaled $358.4 million as of December
31,2004. Time deposits represent contractual agreements for certificates of
deposits held by its customers. Long term debts represents the borrowings with
the Federal Home Loan Bank and are further defined in Note 4 and 9 of the
Consolidated Financial Statements.
Payment Due by Period (In Thousands)
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year Years Years 5 years
- ---------------------------------------------- ----------- ----------- ----------- --------- ---------
Securities sold under agreement to repurchase $ 22,852 $ 22,752 $ 100 $ - $ -
Time Deposits 312,901 134,489 154,985 21,701 1,726
Dividends Payable 715 715
Long Term Debt 21,964 2,011 18,136 1,176 641
----------- ----------- ----------- --------- ---------
Total $ 358,432 $ 159,967 $ 173,221 $ 22,877 $ 2,367
=========== =========== =========== ========= =========
Capital Resources
Shareholders' equity was $78.8 million as of December 31, 2004 compared to $74.9
million at December 31, 2003. Dividends declared during 2004 were $1.90 per
share totaling $2.47 million. The Company reduced capital slightly by an
increased dividend payout during 2003, specifically with a one-time additional
dividend of $5 per share, for an aggregate of $8.78 million. The Company
continues to have a strong capital base and to maintain regulatory capital
ratios that are significantly above the defined regulatory capital ratios.
As of December 31, 2004, The Farmers & Merchants State Bank and Farmers &
Merchants Bancorp, Inc had total risk-based capital ratios of 16.75% and 16.88%,
respectively. Core capital to risk-based asset ratios of 12.52% and 15.62% are
well in excess of regulatory guidelines.
27
The Bank's leverage ratio of 9.0% is also substantially in excess of regulatory
guidelines as is the Company's at 11.2%.
The Company's subsidiaries are restricted by regulations from making dividend
distributions in excess of certain prescribed amounts.
Impact Of Inflation And Changing Prices
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money over time due to inflation. The impact of inflation is reflected
in the increased cost of the Company's operations. Unlike most industrial
companies, nearly all the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the
prices of goods and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates and
equity prices. The primary market risk to which we are subject is interest rate
risk. The majority of our interest rate risk arises from the instruments,
positions and transactions entered into for purposes other than trading such as
loans, available for sale securities, interest bearing deposits, short term
borrowings and long term borrowings. Interest rate risk occurs when interest
bearing assets and liabilities reprice at different times as market interest
rates change. For example, if fixed rate assets are funded with variable rate
debt, the spread between asset and liability rates will decline or turn negative
if rates increase.
Interest rate risk is managed within an overall asset/liability framework. The
principal objectives of asset/liability management are to manage sensitivity of
net interest spreads and net income to potential changes in interest rates.
Funding positions are kept within predetermined limits designed to ensure that
risk-taking is not excessive and that liquidity is properly managed. In the
event that our asset/liabilities management strategies are unsuccessful, our
profitability may be adversely affected.
Asset/Liability Management
The primary functions of asset/liability management are to assure adequate
liquidity and maintain an appropriate balance between interest earning assets
and interest bearing liabilities. It involves the management of the balance
sheet mix, maturities, repricing characteristics and pricing components to
provide an adequate and stable net interest margin with an acceptable level of
risk. Interest rate sensitivity management seeks to avoid fluctuating net
interest margins and to enhance consistent growth of net interest income through
periods of changing interest rates.
Changes in net income, other than those related to volume arise when interest
rates on assets reprice in a time frame or interest rate environment that is
different from that of the repricing period for liabilities. Changes in net
interest income also arise from changes in the mix of interest-earning assets
and interest-bearing liabilities.
28
Historically, the Bank has maintained liquidity through cash flows generated in
the normal course of business, loan repayments, maturing earning assets, the
acquisition of new deposits, and borrowings. The Bank's asset and liability
management program is designed to maximize net interest income over the long
term while taking into consideration both credit and interest rate risk.
Interest rate sensitivity varies with different types of interest-earning assets
and interest bearing liabilities. Overnight federal funds on which rates change
daily and loans that are tied to the market rate differ considerably from
long-term investment securities and fixed rate loans. Similarly, time deposits
over $100,000 and money market certificates are much more interest rate
sensitive than passbook savings accounts. The Bank utilizes shock analysis to
examine the amount of exposure an instant rate change of 100, 200, and 300 basis
points in both increasing and decreasing directions would have on the
financials. Acceptable ranges of earnings and equity at risk are established and
decisions are made to maintain those levels based on the shock results.
ITEM 8. FINANCIAL STATEMENTS
Index To Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Independent Auditors' Report
Consolidated Balance Sheet at December 31, 2004 and 2003
Consolidated Statements of Income for the years ended December 31, 2004, 2003
and 2002
Consolidated Statements of Changes in Shareholders' Equity for the year ended
December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flow for the years ended December 31, 2004, 2003
and 2002
Notes to Consolidated Financial Statements
29
[PLANTE MORAN LOGO] PLANTE & MORAN, PLLC
Suite 500
2601 Cambridge Court
Auburn Hills, MI 48326
Tel: 248.375.7100
Fax: 248.375.7101
plantemoran.com
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Archbold, Ohio
We have audited the accompanying consolidated balance sheet of Farmers &
Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2004 and December
31, 2003 and the related consolidated statements of income, stockholders'
equity, and cash flows for each year in the two year period 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
financial statements based on our audit.
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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Farmers &
Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2004 and December
31, 2003 and the consolidated results of its operations and its cash flows for
each year in the two year period ended December 31, 2004, in conformity with
U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Farmers &
Merchants Bancorp, Inc. and Subsidiaries internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission an dour report dated February 22, 2005, expressed an
unqualified opinion thereon.
/s/ Plante & Moran, PLLC
February 22, 2005
Auburn Hills, Michigan
30
[KK LOGO]
KROUSE, KERN & CO., INC.
CERTIFIED PUBLIC ACCOUNTANTS
6509 MUTUAL DRIVE
FORT WAYNE, INDIANA 46825
260-496-8297
FAX 260-496-8187
-----------------------
1210 WEST HIGH STREET
BRYAN, OHIO 43506
419-636-4569
FAX 419-636-4560
-----------------------
110 WEST AIRPORT HIGHWAY
SUITE 203
SWANTON, OHIO 43558
419-826-9855
Member of
Polaris International
January 10, 2003
Board of Directors
Farmers & Merchants Bancorp, Inc.
Archbold, OH
INDEPENDENT AUDITORS' REPORT
We have audited the consolidated balance sheet of Farmers & Merchants Bancorp,
Inc. and subsidiaries, Archbold, Ohio, as of December 31, 2002 and the related
consolidated statement of income, changes in shareholders' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audit in accordance with auditing standards generally accepted
in the United State of America. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free from 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 consolidated financial position of Farmers
& Merchants Bancorp, Inc. and subsidiaries, as of December 31, 2002, and the
results of its consolidated operations and cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.
/s/ KROUSE, KERN & CO., INC.
KROUSE, KERN & CO., INC.
Fort Wayne, Indiana
31
Consolidated Balance Sheet
December 31, 2004 and 2003
(000's Omitted, Except Per Share Data)
(In Thousands)
------------------------------
2004 2003
------------- -----------
ASSETS
ASSETS
Cash and due from banks $ 15,026 $ 18,873
Interest-bearing deposits in banks 9,230 662
------------- -----------
Total cash and cash equivalents 24,256 19,535
Securities - available for sale (Note 3) 173,127 170,692
Federal Home Loan Bank stock, at cost 3,607 3,462
Loans held for sale 175 176
Loans, net (Note 4) 472,011 480,163
Premises and equipment (Note 5) 15,520 15,874
Other assets (Note 6 & 10) 13,817 15,801
------------- -----------
TOTAL ASSETS $ 702,513 $ 705,703
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits (Note 7)
Noninterest-bearing $ 47,958 $ 50,710
Interest-bearing
NOW accounts 92,178 98,639
Savings 121,168 106,739
Time 312,901 318,978
------------- -----------
Total deposits 574,205 575,066
Federal funds purchased - 6,590
Securities sold under agreement to repurchase 22,852 20,729
Long-term debt (Note 9) 21,964 24,374
Dividend payable 715 715
Accrued expenses and other liabilities 3,932 3,373
------------- -----------
Total liabilities 623,668 630,847
------------- -----------
STOCKHOLDERS' EQUITY (NOTE 14 AND 15)
Common stock - No par value - 1,500,000 shares
authorized; 1,300,000 shares issued & outstanding 12,677 12,677
Retained earnings 65,956 60,196
Accumulated other comprehensive income 212 1,983
------------- -----------
Total stockholders' equity 78,845 74,856
------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 702,513 $ 705,703
============= ===========
32
Consolidated Statement of Income
Years Ended December 31, 2004, 2003 and 2002
(000's Omitted, Except Per Share Data)
(In Thousands, Except Share Data)
------------------------------------------------
2004 2003 2002
------------- ----------- -----------
INTEREST INCOME
Loans, including fees $ 31,767 $ 34,233 $ 35,309
Debt securities:
U.S . Treasury and government agency 3,912 4,454 5,378
Municipalities 2,020 2,196 2,280
Corporate debt securities 3 29 224
Dividends 146 136 150
Federal funds sold 34 33 58
Other 80 26 25
------------- ----------- -----------
Total interest income 37,962 41,107 43,424
INTEREST EXPENSE
Deposits 9,980 12,830 17,574
Federal funds purchased and securities sold
under agreements to repurchase 425 376 415
Borrowed funds 817 1,077 990
------------- ----------- -----------
Total interest expense 11,222 14,283 18,979
------------- ----------- -----------
NET INTEREST INCOME - Before provision for loan losses 26,740 26,824 24,445
PROVISION FOR LOAN LOSSES (Note 4) 884 6,903 2,194
------------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 25,856 19,921 22,251
NONINTEREST INCOME
Customer service fees 2,140 2,028 2,032
Other service charges and fees 1,623 2,120 2,216
Net gain on sale of loans 925 3,309 1,552
Net gain on sale of available-for-sale securities 127 528 76
------------- ----------- -----------
Total noninterest income 4,815 7,985 5,876
NONINTEREST EXPENSES
Salaries 7,970 7,067 7,201
Employee benefits (Note 11) 2,252 2,181 2,140
Occupancy expense 649 592 444
Furniture and equipment 1,437 1,445 1,566
Data processing 1,101 996 1,022
Franchise taxes 712 922 815
Mortgage servicing rights expense 332 723 902
Other general and administrative 4,415 3,895 3,650
------------- ----------- -----------
Total other operating expenses 18,868 17,821 17,740
------------- ----------- -----------
INCOME BEFORE INCOME TAXES 11,803 10,085 10,387
INCOME TAXES (NOTE 10) 3,573 2,459 2,989
------------- ----------- -----------
NET INCOME $ 8,230 $ 7,626 $ 7,398
============= =========== ===========
EARNINGS PER SHARE - BASIC $ 6.33 $ 5.87 $ 5.69
============= =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 1,300,000 1,300,000 1,300,000
============= =========== ===========
33
Consolidated Statement Of Changes in Shareholder's Equity
for the years ended December 31, 2004, 2003 and 2002
(000's Omitted, Except per Share Data)
Accumulated
Shares of Other Total
Common Common Retained Comprehensive Stockholders
Stock Stock Earnings Income (Loss) Equity
--------- ---------- -------- ------------- ------------
BALANCE - January 1, 2002 1,300,000 $ 12,677 $ 56,092 $ 1,581 $ 70,350
Comprehensive income (Note 1):
Net income - $ - $ 7,398 $ - $ 7,398
Change in net unrealized gain on securities
available for sale,net of reclassification
adjustment and tax effects - $ - $ - $ 2,135 $ 2,135
------------
Total comprehensive income $ 9,533
Cash dividends declared - $1.65 per share - $ - $ (2,145) $ - $ (2,145)
--------- ---------- -------- ------------- ------------
BALANCE - December 31, 2002 1,300,000 $ 12,677 $ 61,345 $ 3,716 $ 77,738
Comprehensive income (Note 1):
Net income - $ - $ 7,626 $ - $ 7,626
Change in net unrealized gain on securities
available for sale, net of reclassification
adjustment and tax effects - $ - $ - $ (1,733) $ (1,733)
------------
Total comprehensive income $ 5,893
Cash dividends declared - $6.75 per share - $ - $ (8,775) $ - $ (8,775)
--------- ---------- -------- ------------- ------------
34
Consolidated Statement of Changes in Shareholder's Equity
for the years ended December 31, 2004, 2003 and 2002
(000's Omitted, Except per share Data)
Accumulated
Shares of Other Total
Common Common Retained Comprehensive Stockholders
Stock Stock Earnings Income (Loss) Equity
---------- ------------ -------- ------------- ------------
BALANCE - December 31, 2003 1,300,000 $ 12,677 $ 60,196 $ 1,983 $ 74,856
Comprehensive income (Note 1):
Net income - $ - $ 8,230 $ - $ 8,230
Change in net unrealized gain on securities
available for sale, net of reclassification
adjustment and tax effects - $ - $ - $ (1,771) $ (1,771)
Total comprehensive income $ 6,459
Cash dividends declared - $1.90 per share - $ - $ (2,470) $ - $ (2,470)
---------- ------------ -------- ------------- ------------
BALANCE - December 31, 2004 1,300,000 $ 12,677 $ 65,956 $ 212 $ 78,845
========== ============ ======== ============= ============
35
Consolidated Statements of Cash Flow
For the years ended December 31, 2004, 2003 and 2002
(000's omitted)
2004 2003 2002
------------- --------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 8,230 $ 7,626 $ 7,398
Adjustments to reconcile net income to net cash
from operating activities :
Depreciation 1,142 1,216 1,345
Amortization of servicing rights 332 723 902
Provision for loan loss 884 6,903 2,194
Accretion and amortization of securities 1,223 1,406 1,360
Deferred income taxes (benefit) (14) (126) 240
(Gain) loss on sale of other assets 2 12 (26)
Realized gain on sales of available-for-sale securities, net (127) (528) (76)
Net Change in:
Loans held for sale 1 5,900 (6,076)
Change in other assets and other liabilities, net 3,019 (3,651) 1,106
------------- --------- --------
Net cash provided (used) by operating activities 14,692 19,481 8,367
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities :
Sales 10,740 16,036 8,282
Maturities, prepayments and calls 64,599 75,412 65,280
Purchases (81,553) (86,849) (77,508)
Loan and lease originations and principal collections, net 7,241 3,955 (25,390)
Proceeds from sales of assets 3 - 424
Purchase of life insurance contracts - - (5,057)
Additions to premises and equipment (793) (2,068) (4,551)
------------- --------- --------
Net cash provided (used) by investing activities 237 6,486 (38,520)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits (861) (1,307) 10,215
Net change in federal funds purchased and securities
sold under agreements to repurchase (4,467) (10,881) 11,661
Proceeds from is suance of long-term debt - 10,000 15,000
Repayment of long-term debt (2,410) (14,322) (3,714)
Cash dividends paid on common stock (2,470) (8,709) (2,210)
------------- --------- --------
Net cash provided (used) by financing activities (10,208) (25,219) 30,952
------------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,721 748 799
CASH AND CASH EQUIVALENTS - Beginning of Year 19,535 18,787 17,988
------------- --------- --------
CASH AND CASH EQUIVALENTS - End of Year $ 24,256 $ 19,535 $ 18,787
============= ========= ========
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest (net of amount capitalized) $ 11,283 $ 14,824 $ 19,370
============= ========= ========
Income taxes $ 2,840 $ 5,326 $ 1,316
============= ========= ========
36
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
The Farmers & Merchants Bancorp, Inc. (the Company) through its bank subsidiary,
The Farmers & Merchants State Bank provide a variety of financial services to
individuals and small businesses through its offices in Northwest Ohio.
Consolidation Policy
The consolidated financial statements include the accounts of Farmers &
Merchants Bancorp, Inc. and its wholly-owned subsidiaries, The Farmers &
Merchants State Bank (the Bank), a commercial banking institution, and the
Farmers & Merchants Life Insurance Company, a reinsurance company for life,
accident and health insurance for the Bank's consumer credits. All significant
inter-company balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Material estimates that are particularly
susceptible to significant change in the new term relate to the determination of
the allowance for loan losses and the valuation of mortgage servicing rights.
Actual results could differ from those estimates.
The determination of the adequacy of the allowance for loan losses is based on
estimates that are particularly susceptible to significant changes in the
economic environment and market conditions. In connection with the determination
of the estimated losses on loans, management obtains independent appraisals for
significant collateral.
The Bank's loans are generally secured by specific items of collateral including
real property, consumer assets, and business assets. Although the Bank has a
diversified loan portfolio, a substantial portion of its debtors' ability to
honor their contracts is dependent on local economic conditions in the
agricultural industry.
While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition regulatory agencies, as an
integral part of their examination process, periodically review the estimated
losses on loans. Such agencies may require the Bank to recognize additional
losses based on their judgments about information available to them at the time
of their examination. Because of these factors, it is reasonably possible that
the estimated losses on loans may change materially in the near term. However,
the amount of the change that is reasonably possible cannot be estimated.
Cash and Cash Equivalents
For purposes of the consolidated statement of cash flows, the Company considers
all highly liquid debt instruments purchased with a maturity of three months or
less to be cash equivalents. This includes cash on hand, amounts due from banks,
and federal funds sold. Generally, federal funds are purchased and sold for one
day periods.
Securities
Debt securities are classified as available-for-sale. Securities
available-for-sale are carried at fair value with unrealized gains and losses
reported in other comprehensive income. Realized gains and losses on
37
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
securities available for sale are included in other income (expense) and, when
applicable, are reported as a reclassification adjustment, net of tax, in other
comprehensive income. Gains and losses on sales of securities are determined on
the specific-identification method.
Declines in the fair value of held to maturity and available-for-sale securities
below their cost that are deemed to be other than temporary are reflected in
earnings as realized losses. In estimating other-than-temporary impairment
losses, management considers (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Corporation to
retain its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value. The related write-downs are included in
earnings as realized losses.
Federal Home Loan Bank Stock
The Federal Home Loan Bank stock is recorded at cost since it is not actively
traded. The Federal Home Loan Bank sells and purchases its stock at par;
therefore cost approximates market value. The stock is held as collateral
security for all indebtedness of the Bank to the Federal Home Loan Bank.
Loans
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or pay-off are reported at the amount of unpaid
principal, reduced by unearned discounts and deferred loan fees and costs, as
well as, by the allowance for loan losses. Interest income is accrued on a daily
basis based on the principal outstanding.
Generally, a loan is classified as nonaccrual and the accrual of interest income
is generally discontinued when a loan becomes ninety days past due as to
principal or interest and these loans are placed on a "cash basis" for purposes
of income recognition. Management may elect to continue the accrual of interest
when the estimated net realizable value of collateral is sufficient to cover the
principal and accrued interest, and the loan is in the process of collection.
When a loan is placed on nonaccrual status, all previously accrued and unpaid
interest receivable is charged against income.
Loan origination and commitment fees and certain direct loan origination costs
are deferred and amortized as a net adjustment to the related loan's yield. The
Bank is generally amortizing these costs over the contractual life of such
loans.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses
charged to income. Loans deemed to be uncollectable and changes in the allowance
relating to impaired loans are charged against the allowance for loan losses,
and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based on management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral, and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The
specific components relate to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market
38
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
price) of the impaired loan is lower that the carrying value of that loan. The
general component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. The unallocated component is
maintained to cover uncertainties that could affect management's estimate of
probable losses. The unallocated component of the allowance reflects the margin
of imprecision inherent in the underlying assumptions used in the methodologies
for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it
is probable that the Bank 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 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 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.
Large groups of homogeneous loans are collectively evaluated for impairment.
Accordingly, the Bank does not separately identify individual consumer loans for
impairment disclosures.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated fair value in the aggregate. Net unrealized
losses, if any, are recognized in a valuation allowance by charges to income.
Servicing Assets
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Capitalized servicing
rights are reported in other assets and are amortized into noninterest income in
proportion to, and over the period of, the estimated future net servicing income
of the underlying financial assets. Servicing assets are evaluated for
impairment based upon the fair value of the rights as compared to amortized
cost. Impairment is determined by stratifying rights by predominant
characteristics, such as interest rates and terms. Fair value is determined
using prices for similar assets with similar characteristics, when available, or
based upon discounted cash flows using market based assumptions. Impairment is
recognized through a valuation allowance for an individual stratum, to the
extent that fair value is less than the capitalized amount for the stratum. Fees
received for servicing loans owned by investors are based on a percentage of the
outstanding monthly principal balance of such loans and are included in
operating income as loan payments are received. Costs of servicing loans are
charged to expense as incurred.
Off Balance Sheet Instruments
In the ordinary course of business, the Bank has entered into commitments to
extend credit, including commitments under credit card arrangements, commercial
letters of credit and standby letters of credit. Such financial instruments are
recorded when they are funded.
39
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Bank Premises and Equipment
Land is carried at cost. Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation is based on the estimated useful lives of
the various properties and is computed using straight line and accelerated
methods. Costs for maintenance and repairs are charged to operations as
incurred. Gains and losses on dispositions are included in current operations.
Fair Value of Financial Instruments
FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments",
requires disclosure of the fair value information about financial instruments,
both assets and liabilities, whether or not recognized in the balance sheet, for
which it is practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates using present value
or other valuation techniques. Those techniques are significantly affected by
assumptions used, including the discount rate and estimates of cash flows. In
that regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in
immediate settlement of the instrument. FASB Statement No. 107 excludes certain
financial instruments and all non-financial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.
Federal Income Tax
Deferred income tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the various temporary
differences between the book and tax bases of the various balance sheet assets
and liabilities and gives current recognition to changes in tax rates and laws.
Earnings Per Share
Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the
period. The Company has no dilutive shares.
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, are
reported as a separate component of the equity section of the balance sheet.
Such items, along with net income, are components of comprehensive income.
The components of other comprehensive income and related tax effects are as
follows:
(In Thousands)
------------------------------------
2004 2003 2002
---------- --------- ---------
Net Unrealized gain (loss ) on
available-for-sale securities $ (2,556) $ (2,100) $ 3,311
Tax Effect 869 714 (1,126)
---------- --------- ---------
Net-of-tax amount (1,687) (1,386) 2,185
---------- --------- ---------
Reclassification adjustment for gain on sale of
available-for-sale securities $ (127) $ (528) $ (76)
Tax Effect 43 181 26
---------- --------- ---------
Net-of-tax amount (84) (347) (50)
---------- --------- ---------
Change in accumulated other comprehensive
income other comprehensive income $ (1,771) $ (1,733) $ 2,135
========== ========= =========
40
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Reclassification
Certain amounts in the 2003 and 2002 consolidated financial statements have been
reclassified to conform with the 2004 presentation.
NOTE 2 - RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANK
The Bank is required to maintain average balances on hand with the Federal
Reserve Bank. The aggregate reserves required at December 31, 2004 and 2003 were
$4.6 million and $6.0 million, respectively.
The Company and its subsidiaries maintain cash balances with high quality credit
institutions. At times such balances may be in excess of the federally insured
limits.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities, with gross unrealized gains and
losses, follows:
(In Thousands)
---------------------------------------------------
2004
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ---------
Available-for-Sale:
U.S. Treasury $ 4,856 $ 1 $ 5 $ 4,852
U.S. Government agency 84,095 155 758 83,492
Mortgage-backed securities 30,329 106 347 30,088
State and local governments 53,479 1,292 124 54,647
Equity securities 48 - - 48
---------- ---------- ---------- ---------
$ 172,807 $ 1,554 $ 1,234 $ 173,127
========== ========== ========== =========
(In Thousands)
---------------------------------------------------
2003
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ---------
Available-for-Sale:
U.S. Treasury $ 6,607 $ 30 $ - $ 6,637
U.S. Government agency 95,906 1,246 319 96,833
Mortgage-backed securities 14,138 193 153 14,178
State and local governments 48,991 2,140 115 51,016
Corporate debt securities 1,999 - 18 1,981
Equity securities 47 - - 47
---------- ---------- ---------- ---------
$ 167,688 $ 3,609 $ 605 $ 170,692
========== ========== ========== =========
41
NOTE 3 - SECURITIES (Continued)
Information pertaining to securities with gross unrealized losses at December
31, 2004 and 2003, aggregated by investment category and length of time that
individual securities have been in a continuous loss position follows:
2004
(In Thousands) (In Thousands)
Less Than Twelve Months Over Twelve Months
------------------------ ------------------------
Gross Gross
Unrealized Unrealized
Losses Fair Value Losses Fair Value
---------- ----------- ---------- ----------
U S Treasury $ 5 $ 2,870 $ - $ -
U S Government agency $ 563 $ 58,365 $ 195 $ 5,810
Mortgage-backed securities $ 209 $ 18,317 $ 138 $ 6,347
State and local governments $ 61 $ 9,483 $ 63 $ 2,258
Corporate Debt Securities $ - $ - $ - $ -
Equity Securities $ - $ - $ - $ -
2003
(In Thousands) (In Thousands)
Less Than Twelve Months Over Twelve Months
------------------------ ------------------------
Gross Gross
Unrealized Unrealized
Losses Fair Value Losses Fair Value
---------- ----------- ---------- ----------
U S Treasury $ - $ - $ - $ -
U S Government agency $ 319 $ 18,295 $ - $ -
Mortgage-backed securities $ 153 $ 8,654 $ - $ -
State and local governments $ 115 $ 4,116 $ - $ -
Corporate Debt Securities $ 18 $ 1,981 $ - $ -
Equity Securities $ - $ - $ - $ -
Unrealized losses on securities have not bee n recognized into income because
the issuers' bonds are of high credit quality, the Bank has the intent and
ability to hold the securities for the foreseeable future, and the decline in
fair value is primarily due to increased market interest rates. The fair value
is expected to recover as the bonds approach the maturity date.
42
NOTE 3 - SECURITIES (Continued)
The gross realized gains and losses for the years ended December 31, are
presented below:
(In Thousands)
----------------------------------------
2004 2003 2002
---------- -------- ---------
Gross realized gains $ 133 $ 528 $ 79
Gross realized losses (6) - (3)
---------- -------- --------
Net Realized Gains $ 127 $ 528 $ 76
========== ======== ========
The amortized cost and fair value of debt 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.
(In Thousands)
--------------------------------
Amortized
Cost Fair Value
------------- ------------
One year or less $ 22,627 $ 22,766
After one year through five years 99,664 99,632
After five years through ten years 43,400 43,484
After ten years 7,068 7,197
------------- ------------
172,759 173,079
Equity securities 48 48
------------- ------------
Total $ 172,807 $ 173,127
============= ============
Investments with a carrying value of $127 million at December 31, 2004 and $131
million at December 31, 2003 were pledged to secure public deposits and
securities sold under repurchase agreements.
NOTE 4 - LOANS
Loans at December 31, are summarized below:
(In Thousands)
----------------------------
2004 2003
----------- -----------
Loans:
Real estate $ 273,981 $ 267,136
Commercial and industrial 98,518 102,101
Agricultural (excluding real estate) 55,219 63,082
Consumer, Overdrafts and other loans 41,276 47,984
Industrial Development Bonds 10,687 7,944
----------- -----------
479,681 488,247
Less: Deferred loan fees and costs (856) (784)
----------- -----------
478,825 487,463
Less: Allowance for loan losses (6,814) (7,300)
----------- -----------
Loans - Net $ 472,011 $ 480,163
=========== ===========
43
NOTE 4 - LOANS (Continued)
The following is a maturity schedule by major category of loans including
available for sale loans:
(In Thousands)
-----------------------------------------------
Principal Payments Due Within
-----------------------------------------------
Two to After
One Year Five Years Five Years
----------- ----------- ------------
Real estate loans $ 15,107 $ 13,406 $ 245,643
Commercial and industrial loans 33,329 43,155 22,034
Agricultural (excluding real estate) 24,545 26,572 4,102
Consumer, Master Card and Overdrafts 8,293 27,769 5,214
Industrial Development Bonds 3,216 2,432 5,039
The distribution of fixed rate loans and variable rate loans by major loan
category is as follows as of December 31, 2004:
(In Thousands)
-----------------------------
Fixed Variable
Rate Rate
----------- ------------
Real estate loans $ 38,552 $ 235,604
Commercial and industrial loans 48,999 49,519
Agricultural (excluding real estate) 23,475 31,744
Consumer, Master Card and Overdrafts 39,305 1,971
Industrial Development Bonds 10,687 -
One to four family residential mortgage loans amounting to $95.8 million have
been pledged as security for loans the Bank has received from the Federal Home
Loan Bank.
As of December 31, 2004 and 2003 there were $3.2 and $14.2 million,
respectively, of undisbursed loans in process.
The following is an analysis of the allowance for loan loss:
(In Thousands)
-----------------------------------------
2004 2003 2002
--------- ----------- -----------
Allowance for Loan Losses
Balance at beginning of year $ 7,300 $ 6,400 $ 7,275
Provision for loan loss 884 6,903 2,194
Loans charged off (1,779) (7,286) (4,252)
Recoveries 1,095 1,283 1,183
Allowance for Unfunded Loan Commitments &
Letters of Credit (686) - -
Allowance for Loan & Leases Losses $ 6,814 $ 7,300 $ 6,400
========= =========== ===========
Allowance for Unfunded Loan Commitments &
Letters of Credit $ 686 $ - $ -
--------- ----------- -----------
Total Allowance for Credit Losses $ 7,500 $ 7,300 $ 6,400
========= =========== ===========
44
NOTE 4 - LOANS (Continued)
The company segregated its Allowance for Loan and Lease Losses (ALLL) into two
reserves at the period ending December 31, 2004: The ALLL and the Allowance for
Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these
reserves constitute the total Allowance for Credit Losses (ACL). The portion of
2003 and 2002 ACL attributable to AULC was $402 and $334 thousand respectively.
The AULC is reported within other liabilities on the balance sheet while the
ALLL is netted within the loans, net asset line. The ACL presented above
represents the full amount of reserves available to absorb possible credit
losses.
The following is a summary of information pertaining to impaired loans:
(In Thousands)
---------------------------
2004 2003
----------- -----------
Impaired loans without a valuation allowance $ 397 $ 2,621
Impaired loans with a valuation
allowance 10,960 18,081
----------- -----------
Total impaired loans $ 11,357 $ 20,702
=========== ===========
Valuation allowance related to
impaired loans $ 2,624 $ 3,472
Total non-accrual loans $ 6,059 $ 6,236
Total loans past-due ninety days or more and still accruing $ 393 $ 2,042
(In Thousands)
-----------------------------------------
2004 2003 2002
--------- ---------- ----------
Average investment in
impaired loans $ 16,030 $ 19,040 $ 18,574
========= ========== ==========
Interest income recognized
on impaired loans $ 572 $ 1,227 $ 195
========= ========== ==========
Interest income recognized on
a cash basis on impaired loans $ 279 $ 346 $ 195
========= ========== ==========
No additional funds are committed to be advanced in connection with impaired
loans.
NOTE 5 - PREMISES AND EQUIPMENT
The major categories of banking premises and equipment and accumulated
depreciation at December 31 are summarized below:
(In Thousands)
---------------------------------
2004 2003
-------------- --------------
Land $ 2,756 $ 2,756
Buildings (useful life 15-39 years) 15,052 15,012
Furnishings (useful life 3-15 years) 10,063 9,389
-------------- --------------
27,871 27,157
Less : Accumulated depreciation (12,351) (11,283)
-------------- --------------
Premises and Equipment (Net) $ 15,520 $ 15,874
============== ==============
45
NOTE 6 - SERVICING
Loans serviced for others are not included in the accompanying consolidated
balance sheets. The unpaid principal balances of loans serviced for others were
$244.0 and $242.0 million at December 31, 2004 and 2003, respectively.
The balance of capitalized servicing rights included in other assets at December
31, 2004 and 2003, was $1.5 and $1.4 million, respectively. The Capitalized
addition of servicing rights is included in net gain on sale of loans on the
consolidated statement of income. The capitalized additions are as shown in the
table following.
The fair market value of the capitalized servicing rights as of December 31,
2004, 2003 and 2002 was $2.1, $2.0 and $1.9 million, respectively. The
valuations were calculated using a present value calculation on the discounted
cash flows of each individual capitalized servicing right. The discount rate
utilized was the average internal rate of return of the portfolio, 5.8%, 5.9%
and 6.5%, respectively. The stated fair value represents the present value over
an 84 month time frame.
The following summarizes mortgage servicing rights capitalized and amortized
during each year:
(In Thousands)
-----------------------------------------
2004 2003 2002
---------- ---------- ----------
Beginning Year $ 1,441 $ 1,025 $ 1,667
Capitalized Additions $ 391 $ 1,139 $ 260
Amortization $ (332) $ (723) $ (902)
Valuation Allowance $ - $ - $ -
---------- ---------- ----------
End of Year $ 1,500 $ 1,441 $ 1,025
========== ========== ==========
NOTE 7 - DEPOSITS
Time deposits at December 31 consist of the following:
(In Thousands)
----------------------------------
2004 2003
--------------- -------------
Time deposits under $100,000 $ 220,905 $ 215,899
Time deposits of $100,000 or more 91,996 103,079
--------------- -------------
$ 312,901 $ 318,978
=============== =============
At December 31, 2004, the scheduled maturities for time deposits are as follows:
(In Thousands)
-----------------
2005 $ 134,489
2006 102,480
2007 52,505
2008 3,092
2009 18,609
thereafter 1,726
-----------------
$ 312,901
=================
46
NOTE 8 - SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
The Bank's policy requires qualifying securities as collateral for the
underlying repurchase agreements. As of December 31, 2004 and 2003 securities
with a book value of $31.6 million and $31.8 million, respectively, were
underlying the repurchase agreements and were under the Bank's control.
NOTE 9 - LONG TERM DEBT
Long term debt consists of various loans from the Federal Home Loan Bank.
Repayment structures vary, ranging from monthly installments, annual payments or
upon maturity. Interest payments are due monthly with interest rates on the
loans varying from 2.24% to 7.05%. Total borrowings were $22.0 and $24.4 million
for 2004 and 2003, respectively. Notes are secured by a blanket lien on 100% of
the one to four family residential mortgage loan portfolio.
The following is a schedule by years of future minimum principal payments:
(In Thousands)
--------------
2005 $ 2,011
2006 11,720
2007 6,416
2008 712
2009 464
thereafter 641
-------------
$ 21,964
=============
NOTE 10 - FEDERAL INCOME TAXES
The components of income tax expense for the years ended December 31 are as
follows:
(In Thousands)
-----------------------------------------
2004 2003 2002
----------- ---------- ---------
Current:
Federal $ 3,587 $ 2,585 $ 2,749
Deferred:
Federal (14) (126) 240
----------- ---------- ---------
$ 3,573 $ 2,459 $ 2,989
=========== ========== =========
47
NOTE 10 - FEDERAL INCOME TAXES (Continued)
The following is a reconciliation of the statutory federal income tax rate to
the effective tax rate:
(In Thousands)
---------------------------------------
2004 2003 2002
---------- --------- --------
Income tax at statutory rates $ 4,013 $ 3,429 $ 3,594
Increase(decrease) resulting from:
Tax exempt interest (706) (571) (685)
Change in prior estimates and other 266 (399) 80
---------- --------- --------
$ 3,573 $ 2,459 $ 2,989
========== ========= ========
Deferred tax assets and liabilities at December 31 are comprised of the
following:
(In Thousands)
---------------------------
2004 2003
------------ ----------
Deferred Tax Assets :
Allowance for loan losses $ 2,263 $ 2,211
Other 256 82
------------ ----------
Total deferred tax assets 2,519 2,293
Deferred Tax Liabilities:
Accreted discounts on bonds 29 155
FHLB stock dividends 659 610
Mortgage servicing rights 507 490
Other 494 222
Net unrealized gain on available-
for-sale securities 107 1,020
------------ ----------
Total deferred tax liabilities 1,796 2,497
------------ ----------
Net Deferred Tax Asset (Liability) $ 723 $ (204)
============ ==========
NOTE 11 - EMPLOYEE BENEFIT PLAN
The Bank has established a 401(k) profit sharing plan, which allows eligible
employees to save at a minimum one percent of eligible compensation on a pre-tax
basis, subject to certain Internal Revenue Service limitations. The Bank will
match 50% of employee 401(k) contributions up to four percent of total eligible
compensation. In addition, the Bank may make a discretionary contribution from
time to time. A participant is 100% vested in the participant's deferral
contributions and employer matching contributions. A six-year vesting schedule
applies to employer discretionary contributions. Contributions to the 401(k)
profit sharing plan for both the employer matching contribution and the
discretionary contribution were $546, $505, and $509 thousand for 2004, 2003 and
2002, respectively.
48
NOTE 12 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to senior
officers and directors and their affiliated companies amounting to $20.3 and
$16.5 million at December 31, 2004 and 2003, respectively. Loans made during
2004 were $160.1 million and repayments were $158.4 million. During 2004, one
director retired from the Board and one director was added. Their difference in
related borrowings amounted to $2.1 million, net additions.
Deposits to directors, executive officers and companies in which they have a
direct or indirect ownership as of December 31, 2004 and 2003 amounted to $17.3
million and $6.2 million, respectively.
NOTE 13 - OFF BALANCE SHEET ACTIVITIES
Credit Related Financial Instruments
The Bank is a party to credit related financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
need of its customer. These financial instruments include commitments to extend
credit, standby letters of credit and commercial letters of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the consolidated balance sheets.
The Bank's exposure to credit loss is represented by the contractual amount of
these commitments. The Bank follows the same credit policies in making
commitments as it does for on-balance-sheet instruments. At year end 2004 the
Bank segregated the Allowance for Loan Losses into two components. The allowance
as it relates to unfunded loan commitments (AULC) is included under other
liabilities. The AULC as of December 31, 2004 was $686 thousand. At December 31,
2004 and 2003, the following financial instruments were outstanding whose
contract amounts represent credit risk:
(In Thousands)
-----------------------------
2004 2003
------------ ------------
Commitments to extend credit $ 108,731 $ 111,203
Credit card arrangements 15,404 15,890
Standby letters of credit 1,950 1,762
Commitments to extend credit, credit card arrangements and standby letters of
credit all include exposure to some credit loss in the event of nonperformance
of the customer. The Bank's credit policies and procedures for credit
commitments and financial guarantees are the same as those for extensions of
credit that are recorded in the financial statements. Because these instruments
have fixed maturity dates, and because many of them expire without being drawn
upon, they generally do not present any significant liquidity risk to the Bank.
49
Collateral Requirements
To reduce credit risk related to the use of credit-related financial
instruments, the Bank might deem it necessary to obtain collateral. The amount
and nature of the collateral obtained is based on the Bank's credit evaluation
of the customer. Collateral held varies but may include cash, securities,
accounts receivable, inventory, property, plant, and equipment and real estate.
Legal Contingencies
Various legal claims also arise from time to time in the normal course of
business which, in the opinion of management, will have no material effect on
the Company's consolidated financial statements.
NOTE 14 - MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's and Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities and
certain off balance-sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of: total risk-based
capital and Tier I capital to risk-weighted assets (as defined in the
regulations), and Tier I capital to adjusted total assets (as defined).
Management believes, as of December 31, 2004, that the Bank meets all the
capital adequacy requirements to which it is subject.
As of December 31, 2004 the most recent notification from the FDIC indicated the
Bank was categorized as well capitalized under the regulatory framework for
prompt corrective action. To remain categorized as well capitalized, the Bank
will have to maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as disclosed in the table below. There are no conditions or
events since the most recent notification that management believes have changed
the Bank's prompt corrective action category.
50
The Company and the Bank's actual and required capital amounts and ratios as of
December 31, 2004 and 2003 are as follows:
To Be Well Capitalized
Under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------------------------------------------------------------------------
(000's) (000's) (000's)
Amount Ratio Amount Ratio Amount Ratio
------------- ----- --------- ----- ---------- -------
As of December 31, 2004
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $ 84,939 16.88% $ 40,264 8.00% $ 50,331 10.00%
Farmers & Merchants State Bank 84,313 16.75% 40,271 8.00% 50,339 10.00%
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated 78,633 15.62% 20,132 4.00% 30,198 6.00%
Farmers & Merchants State Bank 63,006 12.52% 20,136 4.00% 30,203 6.00%
Tier 1 Capital
(to Adjusted Total Assets)
Consolidated 78,633 11.17% 28,160 4.00% 35,200 5.00%
Farmers & Merchants State Bank 63,006 8.90% 28,308 4.00% 35,385 5.00%
To Be Well Capitalized
Under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
---------------------------------------------------------------------------
(000's) (000's) (000's)
Amount Ratio Amount Ratio Amount Ratio
------------ ------ ---------- ----- ---------- -------
As of December 31, 2003
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $ 79,267 15.52% $ 40,847 8.00% $ 51,059 10.00%
Farmers & Merchants State Bank 78,693 15.42% 40,831 8.00% 51,039 10.00%
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated 72,873 14.27% 20,423 4.00% 30,635 6.00%
Farmers & Merchants State Bank 57,302 11.23% 20,416 4.00% 30,623 6.00%
Tier 1 Capital
(to Adjusted Total Assets)
Consolidated 72,873 10.23% 28,502 4.00% 35,627 5.00%
Farmers & Merchants State Bank 57,302 8.07% 28,420 4.00% 35,524 5.00%
51
NOTE 15 - RESTRICTIONS OF DIVIDENDS AND INTERCOMPANY BORROWINGS
The Bank is restricted as to the amount of dividends that can be paid. Dividends
declared by the Bank that exceed the net income for the current year plus
retained income for the preceding two years must be approved by federal and
state regulatory agencies. Under this formula dividends of $5.4 million may be
paid without prior regulatory approval. Regardless of formal regulatory
restrictions, the Bank may not pay dividends that would result in its capital
levels being reduced below the minimum requirements shown above. As of June
2004, all dividends were required to be approved by federal and state regulatory
agencies prior to declaration. Regulatory approval prior to declaration will
continue into 2005. Under current Federal Reserve regulations, the Bank is
limited as to the amount and type of loans it may make to the Company and its
non-bank subsidiary. These loans are subject to qualifying collateral
requirements on which the amount of the loan may be based.
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of financial instruments are management's estimate of the values at
which the instruments could be exchanged in a transaction between willing
parties. These estimates are subjective and may vary significantly from amounts
that would be realized in actual transactions. In addition, other significant
assets are not considered financial assets including deferred tax assets,
premises, equipment and intangibles. Further, the tax ramifications related to
the realization of the unrealized gains and losses can have a significant effect
on the fair value estimates and have not been considered in any of the
estimates.
52
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The estimated fair values, and related carrying or notional amounts, for on and
off-balance sheet financial instruments as of December 31, 2004 and 2003 are
reflected below:
(In Thousands)
------------------------------------------
2004 2003
-------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- ---------
Financial Assets:
Cash and due from banks $ 15,026 $ 15,026 $ 18,873 $ 18,873
Interest-bearing deposits in banks 9,230 9,230 662 662
Securities - available for sale 173,127 173,127 170,692 170,692
Federal Home Loan Bank 3,607 3,607 3,462 3,462
Loans, net 472,011 475,228 480,163 487,833
Interest receivable 4,686 4,686 5,192 5,192
Loans held for sale 175 175 176 176
Financial Liabilities:
Deposits $ 574,205 $ 573,616 $ 575,066 $ 575,651
Short-term debt
Federal funds purchased - - 6,590 6,590
Repurchase agreement sold 22,852 22,852 20,729 20,729
Other debt 21,964 20,374 24,374 21,251
Interest payable 879 879 989 989
Dividends payable 715 715 715 715
Off-Balance Sheet Financial Instruments
Commitments to extend credit $ - $ - $ - $ -
Standby letters of credit - - - -
The following assumptions and methods were used in estimating the fair value for
financial instruments:
Cash and Due From Banks
The carrying amounts reported in the balance sheet for cash and due from banks
and federal funds sold approximate their fair values.
Interest Bearing Deposits
The carrying amounts of interest-bearing deposits maturing within ninety days
approximate their fair values. Fair values of other interest-bearing deposits
are estimated using discounted cash flow analyses based on current rates for
similar types of deposits.
Securities and Federal Home Loan Bank Stock
Fair values for securities, excluding Federal Home Loan Bank stock, are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. The carrying value of Federal Home Loan Bank stock approximates
fair value based on the redemption provisions of the Federal Home Loan Bank.
53
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Loans
Most commercial and real estate mortgage loans are made on a variable rate
basis. For those variable-rate loans that reprice frequently, and with no
significant change in credit risk, fair values are based on carrying values. The
fair values of the fixed rate and all other loans are estimated using discounted
cash flow analysis, using interest rates currently being offered for loans with
similar terms to borrowers with similar credit quality.
Loans Held for Sale
Fair values for loan held for sale approximate the carrying values as these
loans are generally sold within forty-five days of being made.
Deposits
The fair values disclosed for deposits with no defined maturities are equal to
their carrying amounts, which represent the amount payable on demand. The
carrying amounts for variable-rate, fixed-term money market accounts and
certificates of deposit approximate their fair value at the reporting date. Fair
value for fixed-rate certificates of deposit are estimated using a discounted
cash flow analysis that applies interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on time
deposits.
Borrowings
Short-term borrowings are carried at cost that approximates fair value. Other
long-term debt was generally valued using a discounted cash flows analysis with
a discounted rate based on current incremental borrowing rates for similar types
of arrangements, or if not available, based on an approach similar to that used
for loans and deposits. Long-term debt includes their related current
maturities.
Accrued Interest Receivable and Payable
The carrying amounts of accrued interest approximate their fair values.
Dividends Payable
The carrying amounts of dividends payable approximate their fair values and are
generally paid within forty days of declaration.
Off Balance Sheet Financial Instruments
Fair values for off-balance-sheet, credit related financial instruments are
based on fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the counterparties' credit
standing.
54
NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
BALANCE SHEET
(In Thousands)
------------------------
2004 2003
--------- ---------
ASSETS
Cash $ 651 $ 903
Related party receivables:
Dividends receivable from subsidiaries 300 -
Note receivable from Bank subsidiary 15,000 15,000
Investment in subsidiaries 63,799 59,883
--------- ---------
TOTAL ASSETS $ 79,750 $ 75,786
========= =========
LIABILITIES
Accrued expenses $ 190 $ 215
Dividends payable 715 715
--------- ---------
Total Liabilities 905 930
--------- ---------
STOCKHOLDERS' EQUITY
Common stock - No par value - 1,500,000 shares
authorized; 1,300,000 shares issued 12,677 12,677
Undivided profits 65,956 60,196
Accumulated other comprehensive income 212 1,983
--------- ---------
Total Stockholders' Equity 78,845 74,856
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 79,750 $ 75,786
========= =========
INCOME STATEMENT
(In Thousands)
----------------------------------------
2004 2003 2002
--------- ---------- --------
INCOME
Dividends from subsidiaires $ 2,185 $ 13,273 $ 1,415
Interest 713 604 600
--------- ---------- --------
Total Income 2,898 13,877 2,015
OPERATING EXPENSES 170 125 131
--------- ---------- --------
INCOME BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED EARNINGS AND SUBSIDIARIES 2,728 13,752 1,884
INCOME TAXES 185 175 147
--------- ---------- --------
2,543 13,577 1,737
Equity in undistributed earnings
of subsidiaries 5,687 (5,951) 5,661
--------- ---------- --------
NET INCOME $ 8,230 $ 7,626 $ 7,398
========= ========== ========
56
NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (Continued)
STATEMENTS OF CASHFLOW
(In Thousands)
-----------------------------------------
2004 2003 2002
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 8,230 $ 7,626 $ 7,398
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Equity in undistributed net income
of subsidiaries (5,687) 5,951 (5,661)
Changes in Operating Assets and
Liabilities:
Note receivable - (5,000) -
Dividends receivable (300) 325 390
Accrued expenses (25) 55 (35)
--------- --------- ---------
Net Cash Provided by
Operating Activities 2,218 8,957 2,092
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of dividends (2,470) (8,709) (2,210)
--------- --------- ---------
Net Change in Cash and
Cash Equivalents (252) 248 (118)
CASH AND CASH EQUIVALENTS
Beginning of year 903 655 773
--------- --------- ---------
CASH AND CASH EQUIVALENTS
End of year $ 651 $ 903 $ 655
========= ========= =========
57
Quarterly Financial Data - UNAUDITED
Quarter Ended in 2004
-------------------------------------------------------------------------
Mar 31 June 30 Sep 30 Dec 31
------------- ------------- ------------- -------------
Summary of Income:
Interest income $ 9,307 $ 9,365 $ 9,249 $ 9,387
Interest expense 2,768 2,758 2,759 2,938
------------- ------------- ------------- -------------
Net Interest Income 6,539 6,607 6,490 6,449
Provision for loan loss 416 375 150 (56)
------------- ------------- ------------- -------------
Net interest income after
provision for loan loss 6,123 6,232 6,340 6,505
Other income (expense) (3,296) (3,312) (3,270) (3,519)
------------- ------------- ------------- -------------
Net income before income taxes 2,827 2,920 3,070 2,986
Income taxes 821 879 929 944
------------- ------------- ------------- -------------
Net income $ 2,006 $ 2,041 $ 2,141 $ 2,042
============= ============= ============= =============
Earnings per Common Share $ 1.54 $ 1.57 $ 1.65 $ 1.57
============= ============= ============= =============
Average common shares outstanding 1,300,000 1,300,000 1,300,000 1,300,000
============= ============= ============= =============
Quarter Ended in 2003
-------------------------------------------------------------------------
Mar 31 June 30 Sep 30 Dec 31
------------- ------------- ------------- -------------
Summary of Income:
Interest income $ 10,462 $ 10,627 $ 10,182 $ 9,836
Interest expense 4,063 3,873 3,361 2,986
------------- ------------- ------------- -------------
Net Interest Income 6,399 6,754 6,821 6,850
Provision for loan loss 3,938 760 675 1,530
------------- ------------- ------------- -------------
Net interest income after
provision for loan loss 2,461 5,994 6,146 5,320
Other income (expense) (2,937) (1,956) (2,455) (2,488)
------------- ------------- ------------- -------------
Net income (loss) before income taxes (476) 4,038 3,691 2,832
Income taxes (credit) (347) 939 1,100 767
------------- ------------- ------------- -------------
Net income (loss) $ (129) $ 3,099 $ 2,591 $ 2,065
============= ============= ============= =============
Earnings per common share $ (0.10) $ 2.38 $ 1.99 $ 1.60
============= ============= ============= =============
Average common shares outstanding 1,300,000 1,300,000 1,300,000 1,300,000
============= ============= ============= =============
58
Market Risk
Market risk is the exposure to loss resulting from changes in interest rates and
equity prices. The primary market risk to which the Company is subject is
interest rate risk. The majority of the Company's interest rate risk arises from
the instruments, positions and transactions entered into for purposes other than
trading such as loans, available for sale securities, interest bearing deposits,
short term borrowings and long term borrowings. Interest rate risk occurs when
interest bearing assets and liabilities reprice at different times as market
interest rates change. For example, if fixed rate assets are funded with
variable rate debt, the spread between asset and liability rates will decline or
turn negative if rates increase.
Interest rate risk is managed within an overall asset/liability framework for
the Company. The principal objectives of asset/liability management are to
manage sensitivity of net interest spreads and net income to potential changes
in interest rates. Funding positions are kept within predetermined limits
designed to ensure that risk-taking is not excessive and that liquidity is
properly managed. The Company employs a sensitivity analysis utilizing interest
rate shocks to help in this analysis. The shocks presented below assume an
immediate change of rate in the percentages and direction shown:
Interest Rate Shock on Interest Rate Shock on
Net Interest Margin Net Interest Income
- ------------------------------ ----------------------------
Net Interest % Change Rate Rate Cumulative % Change
Margin (Ratio) to Flat Rate Direction changes by Total ($000) to Flat Rate
- -------------- ------------ --------- ---------- ------------ ------------
3.63% -6.19% Rising 3.00% 23,831 -7.12%
3.70% -4.27% Rising 2.00% 24,401 -4.90%
3.77% -2.37% Rising 1.00% 24,968 -2.69%
3.87% 0.00% Flat 0 25,659 0.00%
3.96% 2.33% Falling -1.00% 26,340 2.65%
3.86% -0.27% Falling -2.00% 25,698 0.15%
3.71% -3.99% Falling -3.00% 24,752 -3.53%
59
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTING AND FINANCIAL DISCLOSURE
(a) On November 14, 2003, the audit committee of Farmers & Merchants
Bancorp, Inc. (the "Corporation"), accepted the resignation of
Krouse, Kern, and Company, Inc. (Krouse) as the Corporation's
independent public accountants and appointed Plante & Moran, PLLC
("Plante & Moran") as its new independent public accountants for
2003. A report of this event was made on Form 8-K by the Company on
November 18, 2003.
(b) Krouse's report on the consolidated financial statements of the
Corporation for fiscal year ended December 31, 2002 did not contain
an adverse opinion or a disclaimer of opinion and was not qualified
or modified as to uncertainty, audit scope or accounting principles.
During the fiscal year ended December 31, 2002, and the subsequent interim
period through November 14, 2003, there were no disagreements between the
Corporation and Krouse on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure,
which disagreements, if not resolved to the satisfaction of Krouse, would
have caused it to make reference to the subject matter of the disagreement
in connection with its reports. During the fiscal year ended December 31,
2002, and the subsequent interim period through November 14, 2003, there
were no reportable events as defined in Item 304 (a) (1) (v) of SEC
regulation S-K.
(c) Krouse's report on the Corporation's consolidated financial statements
for year ended December 31, 2002, dated January 10, 2003, was issued on an
unqualified basis in conjunction with the filing of the Corporation's
Annual Report on Form 10-K for the year ended December 31, 2002, filed on
March 31, 2003.
(d) During the Corporation's most recent fiscal year ended December 31, 2002,
and the subsequent interim period through November 14, 2003, the
Corporation did not consult with Plante & Moran regarding any of the
matters or events set forth in Item 304 (a) (2) (i) and (ii) of SEC
regulation S-K.
No disagreements exist on accounting and financial disclosures or related
matters.
ITEM 9A. CONTROLS AND PROCEDURES
MANAGEMENTS DISCLOSURE OF INTERNAL CONTROLS & PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as
of December 31, 2004, pursuant to Exchange Act 13a-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective as of
December 31, 2004, in timely alerting them to material information relating
to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic SEC filings.
60
MANAGEMENT REPORT REGARDING INTERNAL CONTROL AND
COMPLIANCE WITH DESIGNATED LAWS AND REGULATIONS
Management of Farmers & Merchants Bancorp, Inc. and Subsidiaries is responsible
for preparing the Bank's annual financial statements. Management is also
responsible for establishing and maintaining internal control over financial
reporting presented in conformity with both generally accepted accounting
principles and regulatory reporting in conformity with the Federal Financial
Institutions Examination Council Instructions for Consolidated Reports of
Condition and Income (call report instructions). The Bank's internal control
contains monitoring mechanisms, and actions are taken to correct deficiencies
identified.
There are inherent limitations in the effectiveness of any internal control,
including the possibility of human error and the circumvention or overriding of
controls. Accordingly, even effective internal control can provide only
reasonable assurance with respect to financial statement preparation. Further,
because of changes in conditions, the effectiveness of internal control may vary
over time.
It is also management's responsibility to ensure satisfactory compliance with
all designated laws and regulations and in particular, those laws and
regulations concerning loans to insiders. The federal laws concerning loans to
insiders are codified at 12 USC 375a and 375b, and the federal regulations are
set forth at 12 CFR 23.5, 31, and 215.
Pursuant to Exchange Act Rule 13a-15, the company carried out an evaluation,
under the supervision and with the participation of the Company's management,
including the Company's Principal Executive Officer and Principal Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of December 31, 2004. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective as of
December 31, 2004 in timely alerting them to material information relating to
the Company (including its consolidated subsidiaries) required to be included in
the Company's periodic SEC filings.
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Under the supervision and with the participation of our management,
including our Principal Executive Officer and Principal Financial Officer, we
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in Internal Control -
Intergrated Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2004.
Plante & Moran, PLLC, the independent registered public accounting firm that
audited the financial statements contained herein, has issued an attestation
report on management's assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2004.
There was no change in the company's internal control over financial reporting
that occurred during the Company's fiscal quarter ended December 31, 2004 that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
February 6, 2005
Farmers & Merchants Bancorp, Inc. and Subsidiaries
/s/ Joe E. Crossgrove
- -----------------------------------
Joe C. Crossgrove, President/CEO
/s/ Barbara J. Britenriker
- -----------------------------------------------
Barbara J. Britenriker, Chief Financial Officer
[PLANTE MORAN LOGO]
61
PLANTE & MORAN, PLLC
Suite 500
2601 Cambridge Court
Auburn Hills, MI 48326
Tel: 248.375.7100
Fax: 248.375.7101
plantemoran.com
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Archbold, Ohio
We have audited management's assessment included in the accompanying Report of
Management on Farmers & Merchants Bancorp, Inc. and Subsidiaries Internal
Control over Financial Reporting, that the Company maintained effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control-Integrated Framework issued by the committee of
Sponsoring Organizations of the Treadway Commission (COSO). Management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the company's internal control
over financial reporting based on our audit.
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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of
62
financial statements for external purposes in accordance with generally accepted
accounting principles. Because management's assessment and our audit were
conducted to also meet the reporting requirements of Section 112 of the Federal
Deposit Insurance Corporations Improvement Act (FDICIA), management's assessment
and our audit of the Company's internal control over financial reporting
included controls over the preparation of financial statements in accordance
with the instructions to the Consolidated Financial Statements for Bank Holding
Companies (Form FR Y-9). A company's internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of inherent limitations, internal control over financial reporting may
not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Farmers & Merchants Bancorp, Inc.
and Subsidiaries maintained effective internal control over financial reporting
as of December 31, 2004, is fairly stated, in all material respects, based on
COSO criteria. Also in our opinion, Farmers & Merchants Bancorp, Inc. and
Subsidiaries maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2004 based oh the COSO criteria.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United State), the Consolidated Balance Sheets of
Farmers & Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2004 and
2003 and the related consolidated statements of earnings, shareholders equity
and cash flow for each of the two years in the period ended December 31, 2004
and our report dated February 22, 2004, expressed an unqualified opinion
thereon.
/s/ Plante & Moran, PLLC
February 22, 2005
Auburn Hills
63
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
BOARD OF DIRECTORS
The information called for herein is presented below:
YEAR FIRST
PRINCIPAL OCCUPATION OR BECAME
NAME AGE EMPLOYMENT FOR PAST FIVE YEARS DIRECTOR
- ---------------------- ------ ------------------------------------------ ----------
Eugene Bernath 71 Farmer 1978
Chairman of the Board,
Farmers & Merchants Bancorp, Inc.
The Farmers & Merchants State Bank
Dexter Benecke 62 President, Viking Trucking, Inc. 1999
Jerry L. Boyers 71 President, Edifice Construction Management 1976
Joe E. Crossgrove 67 President, Chief Executive Officer 1992
The Farmers & Merchants State Bank
Robert G. Frey 64 President, E.H. Frey & Sons, Inc. 1987
Jack C. Johnson 52 President, Hawk's Clothing, Inc. 1991
Partner, REJO Partnership
Dean E. Miller 60 President, MBC Holdings, Inc. 1986
Anthony J. Rupp 55 President, Rupp Furniture Co. 2000
David P. Rupp Jr. 63 Attorney, Plassman, Rupp, Hensel, Short 2001
& Hagans
James C. Saneholtz 58 President, Saneholtz-McKarns, Inc. 1995
Merle J. Short 64 Farmer, President of Promow, Inc. 1987
Steven J. Wyse 60 President, SteelinQ Systems, Inc. 1991
Steven A. Everhart 50 Secretary/Treasurer, MBC Holdings, Inc. 2003
Kevin J. Sauder 44 President, Chief Executive Officer 2004
64
EXECUTIVE OFFICERS
Principal Occupation
Name Age for Past Five Years
- ---------------------- ------ --------------------------------------
Eugene Beranth 71 Farmer
Chairman of the Board
Farmers & Merchants State Bank
Joe E. Crossgrove 67 President, Chief Executive Officer
The Farmers & Merchants State Bank
(since 1991) Executive Vice President
and Treasurer of Farmers & Merchants
Bancorp, Inc.
Director and Vice President of Farmers
& Merchants Life Insurance Co.
Rex D. Rice 45 Executive Vice President
Senior Commercial Loan Officer
Edward A. Leininger 48 Executive Vice President
Chief Operating Officer
Barbara J. Britenriker 43 Executive Vice President
Chief Financial Officer
Allen G. Lantz 51 Senior Vice President
Branch Administrator
Randal H. Schroeder 44 Vice President
Senior Operations Officer
Paul S. Siebenmorgan 55 Senior Executive Vice President
Chief Lending Officer
The information called for under Rule 405 of Regulation S-K regarding compliance
with Section 16(a) is presented in the proxy statement to be furnished in
connection with the solicitation of proxies on behalf of the Board of Directors
of the Registrant for use at its Annual Meeting to be held on April 23, 2005,
and is incorporated herein by reference.
The Board of Directors of the Company adopted a Code of Business Conduct and
Ethics (the "Code") at its meeting on February 13, 2004. While the
Sarbanes-Oxley Act of 2002 mandates the adoption of a code of ethics for the
most senior executive officers of all public companies, the Code adopted by the
Corporation's Board of Directors is broader in the activities covered and
applies to all officers, directors and employees of the Corporation and the
Bank, including the chief executive officer, chief financial officer, principal
accounting officer and other senior officers performing accounting, auditing,
financial management or similar functions. The administration of the Code has
been delegated to the Audit Committee of the Board of Directors, a Committee
comprised entirely of "independent directors." The Board of Directors has
determined that Steven A. Everhart, Chairman of the Audit Committee, is a
"financial expert" as defined under the regulations promulgated under the
Sarbanes Oxley Act discussed above. The Code
65
addresses topics such as compliance with laws and regulations, honest and
ethical conduct, conflicts of interest, confidentiality and protection of
Corporation assets, fair dealing and accurate and timely periodic reports, and
also provides for enforcement mechanisms. The Board and management of the
Corporation intends to continue to monitor not only the developing legal
requirements in this area, but also the best practices of comparable companies,
to assure that the Corporation maintains sound corporate governance practices in
the future.
A copy of the Corporation's Code is available on the website of the Bank
(www.fm-bank.com). In addition, a copy of the Code is available to any
shareholder free of charge upon request. Shareholders desiring a copy of the
Code should address written requests to Mr. Joe E. Crossgrove, President, Chief
Executive Officer and Treasurer of Farmers & Merchants Bancorp, Inc., 307-11
North Defiance Street, Archbold, Ohio 43502, and are asked to mark Code of
Business Conduct and Ethics on the outside of the envelope containing the
request.
ITEM 11. EXECUTIVE COMPENSATION
The information called for herein is presented in the proxy statement to be
furnished in connection with the solicitation of proxies on behalf of the Board
of Directors of the Registrant for use at its Annual Meeting to be held on April
23, 2005, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for herein is presented in the proxy statement to be
furnished in connection with the solicitation of proxies on behalf of the Board
of Directors of the Registrant for use at its Annual Meeting to be held
Saturday, April 23, 2005, and is incorporated herein by reference.
The Company currently has no equity compensation plans or arrangements, such as
stock option or restricted stock arrangements, pursuant to which equity
securities of the Company are authorized for issuance.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for herein is presented in the proxy statement to be
furnished in connection with the solicitation of proxies on behalf of the Board
of Directors of the Registrant for use at its Annual Meeting to be held on April
23, 2005, and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for herein is presented in the proxy statement to be
furnished in connection with the solicitation of proxies on behalf of the Board
of Directors of the Registrant for use at its Annual Meeting to be held on April
23, 2005, and is incorporated herein by reference.
66
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES
(a) The Following documents are filed as part of this report:
(1) Financial Statements (included in this 10-K under item 8)
Report of Independent Accountants
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in
Shareholders' Equity
Consolidated Statements of Cash Flows
Note to Consolidated Financial Statements
(2) Financial Statement Schedules
Five Year Summary of Operations
(3) Exhibits Required by Item 601 of Regulation S-K
(3.1) Articles of Incorporation are incorporated by reference to the
Company's Quarterly Report on Form 10-Q that was filed with
the Commission on May 10, 2004.
(3.2) Code of Regulations are incorporated by reference to the
Company's Quarterly Report on Form 10-Q that was filed with
the Commission on May 10, 2004.
(10.1) Change in Control Agreement executed by and between the Company and
Paul S. Siebenmorgen on February 18, 2005(incorporated by reference
to the Current Report on Form 8-K filed with the Commission on
February 22, 2005).
(10.2) Change in Control Agreement executed by and between the Company and
Barbara J. Britenriker on February 18, 2005 (incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on February 22, 2005).
(10.3) Change in Control Agreement executed by and between the Company and
Edward A. Leininger on February 18, 2005 (incorporated by reference
to the Current Report on Form 8-K filed with the Commission on
February 22, 2005).
(10.4) Change in Control Agreement executed by and between the Company and
Rex D. Rice on February 18, 2005 (incorporated by reference to the
Current Report on Form 8-K filed with the Commission on February 22,
2005).
(10.5) Employment Agreement by and between the Company and Paul S.
Siebenmorgen, dated May 7, 2004 (incorporated by reference to the
Current Report on Form 8-K filed with the Commission on February 22,
2005).
(21) Subsidiaries of Farmers & Merchants Bancorp, Inc.
(31.1) Certification of the Chief Executive Officer Required under Rule
13(a)-14(a)/15d-14(a)
67
(31.2) Certification of the Chief Financial Officer Required under Rule
13(a)- 14(a)/15d-14(a)
(32.1) Certification of the Chief Executive Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(32.2) Certification of the Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
68
FARMERS & MERCHANTS BANCORP, INC
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, herunto duly authorized
By: /s/ Joe E. Crossgrove Date: February 17, 2005
---------------------
Joe E. Crossgrove
Chief Executive 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 on the dates indicated.
/s/ Joe E. Crossgrove Date: February 17, 2005 /s/ Barbara J. Britenriker Date: February 17, 2005
- ---------------------------- -----------------------------
Joe E. Crossgrove, Director Barbara J. Britenriker
Chief Executive Officer Chief Financial Officer
(Principal Executive Officer) (Principal Financial Officer/
Principal Accounting Officer)
/s/ Eugene D. Bernath Date: February 17, 2005 /s/ Kent Roth Date: February 17, 2005
- ---------------------------- -----------------------------
Eugene D. Bernath Kent Roth, Auditor
Director and Chairman
/s/ Jack C. Johnson Date: February 17, 2005 /s/ Anthony J. Rupp Date: February 17, 2005
- ---------------------------- -----------------------------
Jack C. Johnson, Director Anthony J. Rupp, Director
/s/ Dean E. Miller Date: February 17, 2005 /s/ David P. Rupp Jr. Date: February 17, 2005
- ---------------------------- -----------------------------
Dean E. Miller, Director David P. Rupp Jr, Director
/s/ Steven A. Everhart Date: February 17, 2005 /s/ James Saneholtz Date: February 17, 2005
- ---------------------------- -----------------------------
Steven A. Everhart, Director James Saneholtz, Director
/s/ Kevin J. Sauder Date: February 17, 2005 /s/ Merle J. Short Date: February 17, 2005
- ---------------------------- -----------------------------
Kevin J. Sauder, Director Merle J. Short, Director
69
10-K EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
EX-21 Subsidiaries of Farmers & Merchants Bancorp. Inc.
EX-31.1 Certification of Chief Executive Officer pursuant to Section 302
EX-31.2 Certification of Chief Financial Officer pursuant to Section 302
EX-32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EX-32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
</Table>