UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
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: 000-26099
FARMERS & MERCHANTS BANCORP
(Exact name of registrant as specified in its charter)
Delaware 94-3327828
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 W. Pine Street, Lodi, California 95240
(Address of principal Executive offices) (Zip Code)
Registrant's telephone number, including area code (209) 367-2300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
Number of shares of common stock of the registrant: Par value $0.01, authorized
2,000,000 shares; issued and outstanding 792,709 as of April 29, 2004.
1
FARMERS & MERCHANTS BANCORP
FORM 10-Q
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION Page
Item 1 - Financial Statements
Consolidated Balance Sheets as of March 31, 2005,
December 31, 2004 and March 31, 2004. 4
Consolidated Statements of Income for the Three Months
Ended March 31, 2005 and 2004. 5
Consolidated Statements of Comprehensive Income for the Three
Months Ended March 31, 2005 and 2004. 6
Consolidated Statement of Changes in Shareholders' Equity for
the Three Months Ended March 31, 2005 and 2004. 7
Consolidated Statement of Cash Flows for the Three
Months Ended March 31, 2005 and 2004. 8
Notes to Unaudited Consolidated Financial Statements 9
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations 14
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 25
Item 4 - Controls and Procedures 29
PART II. - OTHER INFORMATION 29
-----------------
Item 1 - Legal Proceedings 29
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 3 - Defaults Upon Senior Securities 30
Item 4 - Submission of Matters to a Vote of Security Holders 30
Item 5 - Other Information 30
2
Item 6 - Exhibits 30
Signatures 31
Index to Exhibits 32
3
PART I. - FINANCIAL INFORMATION
Item 1 - Financial Statements
FARMERS & MERCHANTS BANCORP
Consolidated Balance Sheets
- -------------------------------------------------------------- ------------- -------------- ---------------
(in thousands) March 31, December 31, March 31,
2005 2004 2004
Assets (Unaudited) (Unaudited)
- -------------------------------------------------------------- ------------- -------------- ---------------
Cash and Cash Equivalents:
Cash and Due From $32,566 $32,170 $34,764
Federal Funds Sold 2,700 0 2,900
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Cash and Cash Equivalents 35,266 32,170 37,664
Investment Securities:
Available-for Sale 162,763 185,488 210,330
Held-to-Maturity 113,145 89,952 35,981
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Investment Securities 275,908 275,440 246,311
- -------------------------------------------------------------- ------------- -------------- ---------------
Loans 859,066 869,082 799,034
Less: Unearned Income (2,234) (2,174) (1,929)
Less: Allowance for Loan Losses (17,758) (17,727) (17,564)
- -------------------------------------------------------------- ------------- -------------- ---------------
Loans, Net 839,074 849,181 779,541
- -------------------------------------------------------------- ------------- -------------- ---------------
Land, Buildings & Equipment 14,913 14,971 11,130
Bank Owned Life Insurance 35,606 35,235 34,073
Interest Receivable and Other Assets 20,811 19,298 12,842
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Assets $1,221,578 $1,226,295 $1,121,561
============================================================== ============= ============== ===============
Liabilities & Shareholders' Equity
- -------------------------------------------------------------- ------------- -------------- ---------------
Deposits:
Demand $247,812 $273,799 $217,328
Interest Bearing Transaction 114,049 108,213 93,655
Savings 313,099 301,225 279,263
Time Deposits 355,049 318,873 316,346
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Deposits 1,030,009 1,002,110 906,592
- -------------------------------------------------------------- ------------- -------------- ---------------
FHLB Borrowings 40,878 80,889 80,918
Subordinated Debentures 10,310 10,310 10,310
Other Liabilities 20,936 16,439 10,278
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Liabilities 1,102,133 1,109,748 1,008,098
- -------------------------------------------------------------- ------------- -------------- ---------------
Shareholders' Equity
Common Stock 8 8 8
Additional Paid In Capital 82,231 82,237 71,560
Retained Earnings 39,763 35,332 41,551
Accumulated Other Comprehensive (Loss) Income (2,557) (1,030) 344
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Shareholders' Equity 119,445 116,547 113,463
- -------------------------------------------------------------- ------------- -------------- ---------------
Total Liabilities & Shareholders' Equity $1,221,578 $1,226,295 $1,121,561
============================================================== ============= ============== ===============
The accompanying notes are an integral part of these unaudited consolidated
financial statements
4
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Income (Unaudited)
- --------------------------------------------------------------------------------- ------------
(in thousands) Three Months
Ended March 31,
2005 2004
- --------------------------------------------------------------------- ----------- ------------
Interest Income
Interest & Fees on Loans $13,436 $11,673
Federal Funds Sold 42 52
Securities:
Taxable 1,895 1,726
Non-taxable 720 594
- --------------------------------------------------------------------- ----------- ------------
Total Interest Income 16,093 14,045
- --------------------------------------------------------------------- ----------- ------------
Interest Expense
Interest Bearing Transaction 19 14
Savings 326 256
Time Deposits 1,655 1,322
Interest on Borrowed Funds 589 716
Interest on Subordinated Debentures 140 105
- --------------------------------------------------------------------- ----------- ------------
Total Interest Expense 2,729 2,413
- --------------------------------------------------------------------- ----------- ------------
Net Interest Income 13,364 11,632
Provision for Loan Losses - 375
- --------------------------------------------------------------------- ----------- ------------
Net Interest Income After Provision for Loan Losses 13,364 11,257
- --------------------------------------------------------------------- ----------- ------------
Non-Interest Income
Service Charges on Deposit Accounts 1,034 1,189
Net Gain on Sale of Investment Securities 161 641
Credit Card Merchant Fees 460 384
Increase in Cash Surrender Value of Life Insurance 371 420
Other 876 910
- --------------------------------------------------------------------- ----------- ------------
Total Non-Interest Income 2,902 3,544
- --------------------------------------------------------------------- ----------- ------------
Non-Interest Expense
Salaries & Employee Benefits 6,305 6,053
Occupancy 530 459
Equipment 475 440
Credit Card Collection Assessment 319 251
Other Operating 1,670 1,495
- --------------------------------------------------------------------- ----------- ------------
Total Non-Interest Expense 9,299 8,698
- --------------------------------------------------------------------- ----------- ------------
Net Income Before Taxes 6,967 6,103
Provision for Income Taxes 2,536 2,201
- --------------------------------------------------------------------- ----------- ------------
Net Income $4,431 $3,902
===================================================================== =========== ============
Earnings Per Share $ 5.59 $ 4.88
===================================================================== =========== ============
The accompanying notes are an integral part of these unaudited consolidated
financial statements
5
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Comprehensive Income (Unaudited)
- --------------------------------------------------------------------------------------- ---------- -----------
(in thousands) For Three Months
Ended March 31,
2005 2004
- --------------------------------------------------------------------------------------- ---------- -----------
Net Income $4,431 $3,902
Other Comprehensive (Loss)Income -
Unrealized Gains on Derivative Instruments:
Unrealized holding gains arising during the period, net
of income tax effects of $0 and $75 for the quarters ended
March 31, 2005 and 2004, respectively. - 104
Less: Reclassification adjustment for realized gains included in net
income, net of related income tax effects of $(3) and $(32) for the
quarters ended March 31, 2005 and 2004, respectively. (4) (44)
Unrealized Gains (Losses) on Securities:
Unrealized holding gains (losses) arising during the period, net of
income tax effects of $(1,098) and $882 for the quarters ended March 31, 2005
and 2004, respectively. (1,513) 1,215
Less: Reclassification adjustment for realized gains included in net
income, net of related income tax effects of $(7) and $(269) for the
quarters ended March 31, 2005 and 2004, respectively. (10) (372)
- --------------------------------------------------------------------------------------- ---------- -----------
Total Other Comprehensive (Loss)Income (1,527) 903
- --------------------------------------------------------------------------------------- ---------- -----------
Comprehensive Income $2,904 $4,805
======================================================================================= ========== ===========
The accompanying notes are an integral part of these unaudited consolidated
financial statements
6
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
- ----------------------------------------------------------------------------------- ---------------- --------------
(in thousands except share data) Accumulated
Common Additional Other Total
Shares Common Paid-In Retained Comprehensive Shareholders'
Outstanding Stock Capital Earnings Income Equity
- ------------------------------------- ------------ ---------- ----------- --------- ---------------- --------------
Balance, December 31, 2003 763,274 $ 8 $ 72,506 $37,650 $ (559) $ 109,605
===================================== ============ ========== =========== ========= ================ ==============
Net Income - - 3,902 - 3,902
Redemption of Stock (2,632) - (946) (1) - (947)
Unrealized Gains on
Derivitive Instruments 60 60
Changes in Net Unrealized Gain
(Loss)on Securities Available for Sale - - - 843 843
- ------------------------------------- ------------ ---------- ----------- --------- ---------------- --------------
Balance, March 31, 2004 760,642 $ 8 $ 71,560 $41,551 $ 344 $ 113,463
===================================== ============ ========== =========== ========= ================ ==============
Balance, December 31, 2004 792,722 $ 8 $ 82,237 $35,332 $ (1,030) $ 116,547
===================================== ============ ========== =========== ========= ================ ==============
Net Income - - 4,431 - 4,431
Redemption of Stock (13) - (6) - - (6)
Unrealized Gains on
Derivitive Instruments (4) (4)
Changes in Net Unrealized Gain
(Loss)on Securities Available for Sale - - - (1,523) (1,523)
- ------------------------------------- ------------ ---------- ----------- --------- ---------------- --------------
Balance, March 31, 2005 792,709 $ 8 $ 82,231 $39,763 $ (2,557) $ 119,445
===================================== ============ ========== =========== ========= ================ ==============
The accompanying notes are an integral part of these unaudited consolidated
financial statements
7
FARMERS & MERCHANTS BANCORP
Consolidated Statement of Cash Flows (Unaudited) Three Months Ended
- ------------------------------------------------------------------------------------- ----------------------------
(in thousands) Mar. 31 Mar. 31
2005 2004
- ----- ------------------------------------------------------------------------------- ------------- --------------
Operating Activities:
Net Income $4,431 $3,902
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Provision for Loan Losses - 375
Depreciation and Amortization 365 389
Provision for Deferred Income Taxes - (180)
Net Amortization of Investment Security Premium & Discounts 158 344
Net Gain on Sale of Investment Securities (161) (641)
Net Decrease in Interest Receivable and Other Assets (9,410) 3,213
Net (Decrease) Increase in Interest Payable and Other Liabilities 4,497 (1,095)
- ------------------------------------------------------------------------------------- ------------- --------------
Net Cash (Used) Provided by Operating Activities (120) 6,307
Investing Activities:
Securities Available-for-Sale:
Purchased (10,398) (36,981)
Sold, Matured or Called 30,796 51,700
Securities Held-to-Maturity:
Purchased (18,258) -
Matured or Called 3,394 2,092
Net Increase in Loans 10,031 9,740
Principal Collected on Loans Previously Charged Off 76 30
Net Additions to Premises and Equipment (307) (310)
- ------------------------------------------------------------------------------------- ------------- --------------
Net Cash Provided by Investing Activities 15,334 26,271
Financing Activities:
Net Decrease in Demand, Interest-Bearing Transaction,
and Savings Accounts (8,277) (5,639)
Increase in Time Deposits 36,176 7,882
Net Decrease in Federal Funds Purchased - (1,000)
Net Increase (Decrease) in Federal Home Loan Bank Advances
Advances (40,000) (31,000)
Paydowns (11) (10)
Stock Redemption (6) (947)
- ------------------------------------------------------------------------------------- ------------- --------------
Net Cash Used by Financing Activities (12,118) (30,714)
Increase (Decrease) in Cash and Cash Equivalents 3,096 1,864
Cash and Cash Equivalents at Beginning of Year 32,170 35,800
- ------------------------------------------------------------------------------------- ------------- --------------
Cash and Cash Equivalents as of March 31, 2005 and March 31, 2004 $35,266 $37,664
===================================================================================== ============= ==============
The accompanying notes are an integral part of these unaudited consolidated
financial statements
8
FARMERS & MERCHANTS BANCORP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
For the three months ended March 31, 2005 and March 31, 2004
1. Significant Accounting Policies
Farmers & Merchants Bancorp (the Company) was organized March 10, 1999. Primary
operations are related to traditional banking activities through its subsidiary
Farmers & Merchants Bank of Central California (the Bank) which was established
in 1916. The Bank's wholly owned subsidiaries include Farmers & Merchants
Investment Corporation and Farmers/Merchants Corp. F & M Bancorp, Inc. was
created in March 2002 to protect the name F & M Bank. Farmers & Merchants
Investment Corporation has been dormant since 1991. Farmers/Merchants Corp. acts
as trustee on deeds of trust originated by the Bank. In December 2003, the
Company formed a wholly owned subsidiary, FMCB Statutory Trust I. FMCB Statutory
Trust I is a non-consolidated subsidiary per generally accepted accounting
principles (GAAP), and was formed for the sole purpose of issuing Trust
Preferred Securities. The following is a summary of the significant accounting
and reporting policies used in preparing the consolidated financial statements.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of
management, all adjustments (which consist solely of normal recurring accruals)
considered necessary for a fair presentation of the results for the interim
periods presented have been included. These interim consolidated financial
statements should be read in conjunction with the financial statements and
related notes contained in the Company's 2004 Annual Report to Shareholders on
Form 10-K.
The accompanying consolidated financial statements include the accounts of the
Company and the Company's wholly owned subsidiaries, F & M Bancorp, Inc. and the
Bank, along with the Bank's wholly owned subsidiaries, Farmers & Merchants
Investment Corporation and Farmers/Merchants Corp. Significant intercompany
transactions have been eliminated in consolidation. The results of operations
for the three-month period ended March 31, 2005 may not necessarily be
indicative of the operating results for the full year 2005.
Management has determined that since all of the commercial banking products and
services offered by the Company are available in each branch of the bank, all
branches are located within the same economic environment and management does
not allocate resources based on the performance of different lending or
transaction activities, it is appropriate to aggregate the Bank branches and
report them as a single operating segment.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
9
Certain amounts in the prior years' financial statements and related footnote
disclosures have been reclassified to conform to the current-year presentation.
These reclassifications have no effect on previously reported income.
Cash and Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Company has
defined cash and cash equivalents as those amounts included in the balance sheet
captions Cash and Due from Banks, Federal Funds Sold and Securities Purchased
Under Agreements to Resell. Generally, these transactions are for one-day
periods. For these instruments, the carrying amount is a reasonable estimate of
fair value.
Investment Securities
Investment securities are classified at the time of purchase as held-to-maturity
if it is management's intent and the Company has the ability to hold the
securities until maturity. These securities are carried at cost, adjusted for
amortization of premium and accretion of discount using a level yield of
interest over the estimated remaining period until maturity. Losses, reflecting
a decline in value judged by the Company to be other than temporary, are
recognized in the period in which they become probable.
Securities are classified as available-for-sale if it is management's intent, at
the time of purchase, to hold the securities for an indefinite period of time
and/or to use the securities as part of the Company's asset/liability management
strategy. These securities are reported at fair value with aggregate, unrealized
gains or losses excluded from income and included as a separate component of
shareholders' equity, net of related income taxes. Fair values are based on
quoted market prices or broker/dealer price quotations on a specific
identification basis. Gains or losses on the sale of these securities are
computed using the specific identification method. Unrealized losses on these
securities, reflecting a decline in value judged by the Company to be other than
temporary, are recognized in the period in which they become known.
Trading securities, if any, are acquired for short-term appreciation and are
recorded in a trading portfolio and are carried at fair value, with unrealized
gains and losses recorded in non-interest income.
Loans
Loans are reported at the principal amount outstanding net of unearned discounts
and deferred loan fees. Interest income on loans is accrued daily on the
outstanding balances using the simple interest method. Loan origination fees are
deferred and recognized over the contractual life of the loan as an adjustment
to the yield. Loans are placed on a non-accrual status when the collection of
principal or interest is in doubt or when they become past due for 90 days or
more unless they are both well-secured and in the process of collection. For
this purpose a loan is considered well-secured if it is collateralized by
property having a net realizable value in excess of the amount of the loan or is
guaranteed by a financially capable party. When a loan is placed on non-accrual
status, the accrued and unpaid interest receivable is reversed and charged
against current income, thereafter; interest income is recognized only as it is
collected in cash. Loans placed on a non-accrual status are returned to accrual
status when the loans are paid current as to principal and interest and future
payments are expected to be made in accordance with the contractual terms of the
loan.
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. When a loan is impaired, the recorded
amount of the loan in the Consolidated Balance Sheets is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate, or the observable or estimated market price of the loan or on the fair
value of the collateral if the loan is collateral dependent. Impaired loans are
placed on a non-accrual status with income reported accordingly. Cash payments
are first applied as a reduction of the principal balance until collection of
the remaining principal and interest can be reasonably assured. Thereafter,
interest income is recognized as it is collected in cash.
10
Allowance for Loan Losses
As a financial institution which assumes lending and credit risks as a principal
element in its business, the Company anticipates that credit losses will be
experienced in the normal course of business. Accordingly, the allowance for
loan losses is maintained at a level considered adequate by management to
provide for losses that are inherent in the portfolio. The allowance is
increased by provisions charged to operating expense and by recoveries on loans
previously charged-off and reduced by charge-offs. Management employs a
systematic methodology for determining the allowance for loan losses. On a
quarterly basis, management reviews the credit quality of the loan portfolio and
considers many factors in determining the adequacy of the allowance at the
balance sheet date.
The factors evaluated in connection with the allowance may include existing
general economic and business conditions affecting the key lending areas of the
Company, current levels of problem loans and delinquencies, credit quality
trends, collateral values, loan volumes and concentration, seasoning of the loan
portfolio, specific industry conditions, recent loss experience, duration of the
current business cycle, bank regulatory examination results and findings of the
Company's internal credit examiners.
The allowance also incorporates the results of measuring impaired loans as
provided in Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan-Income Recognition and Disclosures". These
accounting standards prescribe the measurement methods, income recognition and
disclosures related to impaired loans, which are discussed more fully in Note 4
to the Consolidated Financial Statements in the Company's Annual Report to
Shareholders.
While the Company utilizes a systematic methodology in determining its
allowance, the allowance is based on estimates, and ultimate losses may vary
from current estimates. The estimates are reviewed periodically and, as
adjustments become necessary, are reported in earnings in the periods in which
they become probable.
Derivative Instruments and Hedging Activities
The Statement of Financial Accounting Standards, No. 133, "Accounting for
Derivative Instruments and Certain Hedging Activities" as amended by the
Statement of Financial Accounting Standards, No. 138, establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. Changes in the fair value of
those derivatives are accounted for depending on the intended use of the
derivative and the resulting designation under specified criteria. If the
derivative is designated as a fair value hedge, the changes in the fair value of
the derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
designed to minimize interest rate risk, the effective portions of the change in
the fair value of the derivative are recorded in other comprehensive income net
of related income taxes. Ineffective portions of changes in the fair value of
cash flow hedges are recognized in earnings.
The Company utilizes derivative financial instruments such as interest rate
caps, floors, swaps and collars. These instruments are purchased and/or sold to
reduce the Company's exposure to changing interest rates. The Company marks to
market the value of its derivative financial instruments and reflects gain or
loss in earnings in the period of change or in other comprehensive income.
11
2. Recent Accounting Developments
In June 2004, the Emerging Issues Task Force of the FASB issued final guidance
on its Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." A consensus was reached regarding
disclosures about unrealized losses on available-for-sale debt and equity
securities accounted for under FASB Statements No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
This EITF describes a model involving three steps: (1) determine whether an
investment is impaired; (2) determine whether the impairment is
other-than-temporary; and (3) recognize the impairment loss in earnings. The
EITF also requires several additional disclosures for cost-method investments.
The EITF's impairment accounting guidance was effective for reporting periods
beginning after June 15, 2004. For all other investments within the scope of
this Issue, the disclosures are effective in annual financial statements for
fiscal years ending after June 15, 2004. The additional disclosures for cost
method investments are effective for fiscal years ending after June 15, 2004.
The adoption of this EITF did not have a material impact on the Company's
consolidated financial statements. At March 31, 2005, management believed the
impairments described above are temporary and, accordingly, no impairment loss
has been recognized in the Company's consolidated statement of income.
Additionally, the Financial Accounting Standards Board (FASB) staff has
indicated that the FASB will likely delay until 2005 the finalization of FASB
Staff Position No. EITF Issue 03-1-a, "Implementation Guidance for the
Application of Paragraph 16 of EITF Issue No. 03-1, `The Meaning of
Other-than-temporary Impairment and Its Application to Certain Investments'"
(EITF 03-1). It is expected that the FASB will be taking a "fresh look" at
accounting for marketable securities and the meaning of other-than-temporary
impairment, and thus will reconsider EITF 03-1 in its entirety. Accordingly, FSP
No. EITF 03-1-a was not issued before the end of 2004.
On March 16, 2005 the FASB agreed to discuss a joint impairment convergence
project with the International Accounting Standards Board (IASB). This
discussion will take place on April 21, 2005. Other than this agreement to
discuss the project, there have been no new developments toward resolving EITF
03-1 and we continue to rely on pre-03-1 guidance when dealing with other than
temporary impairment.
3. Interim-Period Disclosure of Employee Benefit Plans
Components of Net Periodic Pension Cost:
Three months ended March 31 Pension Benefits
-----------------------------------
(in thousands) 2005 2004
-------------- -------------
Service cost $ 13 $ 12
Interest cost 65 64
Expected return on assets (29) (57)
Amortization of (gain)/loss 237 126
Amortization of prior service cost 0 0
Amortization of transition obligation 0 0
-------------- -------------
Net periodic pension cost $286 $145
============== =============
12
See Note 12 to the Consolidated Financial Statements in the Company's 2004
Annual Report to Shareholders for a discussion regarding the Company's intent to
terminate the Defined Benefit Pension Plan during 2005.
Employer Contributions
The Company previously disclosed in its financial statements for the year ended
December 31, 2004 that it expected to contribute $1.6 million to its Pension
Plan in 2005. As of March 31, 2005, $0 has been contributed to the Plan. The
Company still expects to contribute at least $1.6 million to the Plan in 2005.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
This quarterly report contains various forward-looking statements, usually
containing the words "estimate," "project," "expect," "objective," "goal," or
similar expressions and includes assumptions concerning the Company's
operations, future results, and prospects. These forward-looking statements are
based upon current expectations and are subject to risk and uncertainties. In
connection with the "safe-harbor" provisions of the private Securities
Litigation Reform Act, the Company provides the following cautionary statement
identifying important factors which could cause the actual results of events to
differ materially from those set forth in or implied by the forward-looking
statements and related assumptions.
Such factors include the following: (i) the effect of changing regional and
national economic conditions; (ii) significant changes in interest rates and
prepayment speeds; (iii) credit risks of commercial, agricultural, real estate,
consumer, and other lending activities; (iv) changes in federal and state
banking laws or regulations; (v) competitive pressure in the banking industry;
(vi) changes in governmental fiscal or monetary policies; (vii) uncertainty
regarding the economic outlook resulting from the continuing war on terrorism,
as well as actions taken or to be taken by the U.S. or other governments as a
result of further acts or threats of terrorism; (viii) dividend restrictions;
(ix) asset/liability pricing risks and liquidity risks; (x) changes in the
securities markets; (xi) certain operational risks involving data processing
systems or fraud; (xii) the State of California's fiscal difficulties; and
(xiii) other external developments which could materially impact the Company's
operational and financial performance.
Readers are cautioned not to place undue reliance on these forward-looking
statements which speak only as of the date hereof. The Company undertakes no
obligation to update any forward-looking statements to reflect events or
circumstances arising after the date on which they are made.
Introduction
Farmers & Merchants Bancorp is a bank holding company formed March 10, 1999. Its
subsidiary, Farmers & Merchants Bank of Central California was formed in 1916.
The Bank services the northern Central Valley of California with 18 banking
offices. The service area includes Sacramento, San Joaquin, Stanislaus and
Merced Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton,
Linden, Modesto, Turlock and Hilmar. Substantially all of the Company's business
activities are conducted within its market area.
As a bank holding company, the Company is subject to regulation and examination
by the Board of Governors of the Federal Reserve System ("FRB"). The Bank is a
California state-chartered bank subject to the regulation and examination of the
California Department of Financial Institutions. Since August 1, 1940, the Bank
has also been a member of the Federal Reserve System and the FRB has served as
13
its primary Federal regulator. However, at a meeting of the Board of Directors
of the Bank on April 5, 2005, the Board decided to withdraw from membership in
the Federal Reserve System. The Bank received the FRB's approval for this action
on April 18, 2005. As a result, the Bank's primary federal regulator will now be
the Federal Deposit Insurance Corporation. The FRB will continue to regulate and
examine the Company but not the Bank. Management and the Board believe that this
change will not have any operating or financial impact on the Company or the
Bank.
This section should be read in conjunction with the consolidated financial
statements and the notes thereto, along with other financial information
included in this report.
Overview
The Company's primary service area encompasses the northern Central Valley of
California, a region that is impacted by the seasonal needs of the agricultural
industry. Accordingly, discussion of the Company's Financial Condition and
Results of Operations is influenced by the seasonal banking needs of its
agricultural customers (e.g., during the spring and summer customers draw down
their deposit balances and increase loan borrowing to fund the purchase of
equipment and planting of crops. Correspondingly, deposit balances are
replenished and loans repaid in fall and winter as crops are harvested and
sold).
For the three months ended March 31, 2005, Farmers & Merchants Bancorp reported
net income of $4,431,000, earnings per share of $5.59 and return on average
assets of 1.46%. Return on average shareholders' equity was 15.04% for the three
months ended March 31, 2005. For the three months ended March 31, 2004, net
income totaled $3,902,000, earnings per share was $4.88 and return on average
assets was 1.38%. Return on average shareholders' equity for the three months
ended March 31, 2004 was 14.07%.
The Company's improved earnings performance in the first quarter of 2005 when
compared to the same period last year was due primarily to a combination of (1)
growth in earning assets; (2) an improvement in the net interest margin due to
rising interest rates; and (3) a reduction in the provision for loan losses.
The following is a summary of the financial results for the three-month period
ended March 31, 2005 compared to March 31, 2004.
o Net income increased 13.6% to $4.4 million from $3.9 million.
o Earnings per share increased 14.6% to $5.59 from $4.88.
o Net interest income increased 14.9% to $13.4 million from $11.6 million.
o Total assets increased 8.9% to $1.2 billion.
o Gross loans increased 7.5% to $859.1 million.
o Total deposits increased 13.6% to $1.0 billion.
o Total shareholders' equity increased 5.3% to $119.4 million.
14
Results of Operations
Net Interest Income
The tables on the following pages reflect the Company's average balance sheets
and volume and rate analysis for the three month periods ending March 31, 2005
and 2004.
The average yields on earning assets and average rates paid on interest-bearing
liabilities have been computed on an annualized basis for purposes of
comparability with full year data. Average balance amounts for assets and
liabilities are the computed average of daily balances.
The volume and rate analysis of net interest revenue summarizes the changes in
average asset and liability balances and interest earned and paid resulting from
changes in average asset and liability balances (volume) and changes in average
interest rates and the total net change in interest income and expenses. The
changes in interest due to both rate and volume have been allocated to volume
and rate changes in proportion to the relationship of the absolute dollar amount
of the change in each.
Net interest income is the amount by which the interest and fees on loans and
other interest earning assets exceed the interest paid on interest bearing
sources of funds. For the purpose of analysis, the interest earned on tax-exempt
bonds and municipal loans is adjusted to an amount comparable to interest
subject to normal income taxes. This adjustment is referred to as "taxable
equivalent" and is noted wherever applicable. Interest income and expense are
affected by changes in the volume and mix of average interest earning assets and
average interest bearing liabilities, as well as fluctuations in interest rates.
Therefore, increases or decreases in net interest income are analyzed as changes
in volume, changes in rate/yield and changes in the mix of assets and
liabilities.
The Company's earning assets and rate sensitive liabilities are subject to
repricing at different times, which exposes the Company to income fluctuations
when interest rates change. In order to minimize income fluctuations, the
Company attempts to match asset and liability maturities. However, some maturity
mismatch is inherent in the asset and liability mix.
Net interest income increased 14.9% to $13.4 million during the first three
months of 2005, compared to $11.6 million at March 31, 2004. On a fully taxable
equivalent basis, net interest income increased 15.1% and totaled $13.7 million
at March 31, 2005, compared to $11.9 million for the first three months of 2004.
As reported in previous quarters, a significant reason for the increase in net
interest income during the first three months of 2005 when compared to the same
period last year was an improvement in the volume and mix (as reflected by an
increase in loans as a percentage of average earning assets) of earning assets.
However, as a result of the FRB having increased short-term market interest
rates by 175 basis points since June 2004, the Company's net interest income has
also started to benefit from an increase in the rate on earning assets.
Net interest income on a taxable equivalent basis, expressed as a percentage of
average total earning assets, is referred to as the net interest margin. For the
first quarter of 2005, the Company's net interest margin was 4.93% compared to
4.55% in 2004. This is the fourth quarter in a row that the Company's net
interest margin has increased over the same period in the prior year. The
Company's yield on earning assets has begun to improve as a result of recent
increases in short-term market interest rates as mentioned above. As a result,
the Company has increased its prime rate by 175 basis points to 5.75%. Should
market interest rates continue to rise, the Company's net interest margin is
expected to continue to improve. For further discussion see Market Risk -
Interest Rate Risk under Item 3. Quantitative and Qualitative Disclosures About
Market Risk.
15
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Three Months Ended March 31, Three Months Ended March 31,
2005 2004
Assets Balance Interest Rate Balance Interest Rate
- -------------------------------------------------------------------------------------------------------------------------------
Federal Funds Sold $ 6,837 $ 42 2.49% $ 20,585 $ 52 1.02%
Investment Securities Available-for-Sale
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 68,979 620 3.65% 63,061 577 3.71%
Municipals - Taxable 327 5 6.20% 1,089 17 6.33%
Municipals - Non-Taxable 16,532 259 6.35% 24,021 343 5.79%
Mortgage Backed Securities 84,223 832 4.01% 113,393 1,016 3.63%
Other 5,068 64 5.12% 7,867 111 5.72%
- -------------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale 175,129 1,780 4.12% 209,431 2,064 4.00%
- -------------------------------------------------------------------------------------------------------------------------------
Investment Securities Held-to-Maturity
U.S. Treasuries 0 0 0.00% 0 0 0.00%
U.S. Agencies 20,782 243 4.74% 0 0 0.00%
Municipals - Taxable 0 0 0.00% 0 0 0.00%
Municipals - Non-Taxable 56,408 876 6.30% 36,301 590 6.59%
Mortgage Backed Securities 13,180 126 3.88% 0 0 0.00%
Other 294 6 8.28% 372 5 5.45%
- -------------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Held-to-Maturity 90,664 1,251 5.60% 36,673 595 6.58%
- -------------------------------------------------------------------------------------------------------------------------------
Loans
Real Estate 494,307 7,713 6.33% 459,385 7,179 6.29%
Home Equity 63,301 881 5.64% 55,201 637 4.64%
Agricultural 128,835 1,971 6.20% 124,139 1,574 5.10%
Commercial 155,550 2,470 6.44% 133,283 1,884 5.69%
Consumer 12,248 266 8.81% 11,439 275 9.67%
Credit Card 4,896 124 10.27% 4,552 112 9.90%
Municipal 982 11 4.54% 1,096 12 4.40%
- -------------------------------------------------------------------------------------------------------------------------------
Total Loans 860,119 13,436 6.34% 789,095 11,673 5.95%
- -------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 1,132,749 $16,509 5.91% 1,055,784 $14,384 5.48%
===================== =========================
Unrealized Gain/(Loss) on Securities Available-for-Sal (602) 2,832
Allowance for Loan Losses (17,793) (17,382)
Cash and Due From Banks 33,253 31,471
All Other Assets 68,348 60,139
- ------------------------------------------------------------------ -------------
Total Assets $1,215,955 $1,132,844
================================================================== =============
Liabilities & Shareholders' Equity
Interest Bearing Deposits
Interest Bearing DDA $112,691 $ 19 0.07% $94,147 $ 14 0.06%
Savings 308,034 326 0.43% 277,378 256 0.37%
Time Deposits 349,749 1,655 1.92% 313,344 1,322 1.70%
- -------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Deposits 770,474 2,000 1.05% 684,869 1,592 0.93%
Other Borrowed Funds 47,718 589 5.01% 98,766 716 2.92%
Subordinated Debentures 10,310 140 5.51% 10,310 105 4.10%
- -------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities 828,502 $ 2,729 1.34% 793,945 $ 2,413 1.22%
===================== =========================
Interest Rate Spread 4.57% 4.26%
Demand Deposits (Non-Interest Bearing) 256,695 217,893
All Other Liabilities 12,933 10,066
- ------------------------------------------------------------------ -------------
Total Liabilities 1,098,130 1,021,904
Shareholders' Equity 117,825 110,940
- ------------------------------------------------------------------ -------------
Total Liabilities & Shareholders' Equity $1,215,955 $1,132,844
================================================================== =============
Impact of Non-Interest Bearing Deposits and Other Liabilities 0.36% 0.30%
Net Interest Income and Margin on Total Earning Assets 13,780 4.93% 11,971 4.56%
Tax Equivalent Adjustment (416) (339)
- -------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $13,364 4.78% $11,632 4.43%
================================================================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable
equivalent basis using the combined Federal and State income tax rate of 42.06%.
Loan Fees are included in interest income for loans. Unearned discount is
included for rate calculation purposes. Nonaccrual loans and lease financing
receivables have been included in the average balances. Yields on securities
available-for-sale are based on historical cost.
16
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Revenue
(Rates on a Taxable Equivalent Basis)
(in thousands) Three Months Ended
Mar.31, 2005 compared to Mar. 31, 2004
Interest Earning Assets Volume Rate Net Chg.
- ----------------------------------------------------------- ------------- ------------ --------------
Federal Funds Sold $ (194) 184 $ (10)
Investment Securities Available for Sale
U.S. Treasuries 0 0 0
U.S. Agencies 106 (63) 43
Municipals - Taxable (11) (1) (12)
Municipals - Non-Taxable (270) 186 (84)
Mortgage Backed Securities (735) 551 (184)
Other (36) (11) (47)
- ----------------------------------------------------------- ------------- ------------ --------------
Total Investment Securities Available for Sale (946) 662 (284)
- ----------------------------------------------------------- ------------- ------------ --------------
Investment Securities Held to Maturity
U.S. Treasuries 0 0 0
U.S. Agencies 121 122 243
Municipals - Taxable 0 0 0
Municipals - Non-Taxable 461 (175) 286
Mortgage Backed Securities 63 63 126
Other (6) 7 1
- ----------------------------------------------------------- ------------- ------------ --------------
Total Investment Securities Held to Maturity 639 17 656
- ----------------------------------------------------------- ------------- ------------ --------------
Loans:
Real Estate 490 44 534
Home Equity 99 145 244
Agricultural 59 338 397
Commercial 327 259 586
Installment 83 (92) (9)
Credit Card 8 4 12
Other (3) 2 (1)
- ----------------------------------------------------------- ------------- ------------ --------------
Total Loans 1,063 700 1,763
- ----------------------------------------------------------- ------------- ------------ --------------
Total Earning Assets 562 1,563 2,125
- ----------------------------------------------------------- ------------- ------------ --------------
Interest Bearing Liabilities
Interest Bearing Deposits:
Transaction 3 2 5
Savings 29 41 70
Time Deposits 157 176 333
- ----------------------------------------------------------- ------------- ------------ --------------
Total Interest Bearing Deposits 189 219 408
Other Borrowed Funds (1,783) 1,656 (127)
Subordinated Debentures 0 35 35
- ----------------------------------------------------------- ------------- ------------ --------------
Total Interest Bearing Liabilities (1,594) 1,910 316
- ----------------------------------------------------------- ------------- ------------ --------------
Total Change $2,156 $ (347) $ 1,809
=========================================================== ============= ============ ==============
Notes: Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total "net change." The above
figures have been rounded to the nearest whole number.
17
Loans, generally the Company's largest yielding asset, increased $60.0 million
as of March 31, 2005 compared to March 31, 2004. On an average balance basis,
loans increased by $71.0 million for the three months ended March 31, 2005. The
yield on the loan portfolio increased 40 basis points to 6.35% for the three
months ended March 31, 2005 compared to 5.95% for the three months ended March
31, 2004. This increase in yield and volume resulted in interest revenue from
loans increasing 15.1% to $13.4 million for the first three months of 2005.
The investment portfolio is the other main component of the Company's earning
assets. In management's opinion the Company's investment policy is conservative.
The Company invests primarily in mortgage-backed securities, U.S. Treasuries,
U.S. Government Agencies, and high-grade municipals. Since the risk factor for
these types of investments is significantly lower than that of loans, the yield
earned on investments is generally less than that of loans.
Average investment securities increased $19.6 million at March 31, 2005. The
average yield, on a taxable equivalent basis, in the investment portfolio was
4.63% in 2005 compared to 4.38% in 2004, partially due to an increase in the mix
of longer term, higher yielding municipal securities. The increase in the volume
and yield on investment securities resulted in an increase in interest income of
$372,000, or 14.0%, for the three months ended March 31, 2005. Net interest
income on the Schedule of Year-to-Date Average Balances and Interest Rates is
shown on a taxable equivalent basis, which is higher than net interest income on
the Consolidated Statements of Income because of adjustments that relate to
income on certain securities that are exempt from federal income taxes.
Since the first quarter of 2004, the Company has grown average interest-bearing
sources of funds by $34.6 million or 4.4%. The increase was driven by lower cost
savings and interest bearing DDA deposits, which grew $49.2 million. All other
interest bearing sources of funds (including FHLB Advances) decreased by $14.6
million (see Deposits). Overall, the average interest rate on interest-bearing
sources of funds was 1.34% for the three months ended March 31, 2005 and 1.22%
for the three months ended March 31, 2004. The increase in the volume and rate
on interest-bearing sources of funds resulted in an increase in interest expense
of $316,000, or 13.1%, for the three months ended March 31, 2005.
Allowance and Provision for Loan Losses
As a financial institution that assumes lending and credit risks as a principal
element of its business, some level of credit losses will be experienced in the
normal course of business. The Company manages and controls credit risk through
credit management policies and procedures, underwriting and approval standards,
dollar limits on loans to one borrower and by restricting loans made primarily
to its principal market area where management believes it is better able to
assess the applicable risk. Additionally, management has established guidelines
to ensure the diversification of the Company's credit portfolio such that even
within key portfolio sectors such as real estate or agriculture, the portfolio
is diversified across factors such as location, building type, crop type, etc.
Management actively monitors the existing portfolio and reports regularly to the
Board of Directors regarding trends and conditions in the loan portfolio and
regularly conducts credit reviews of individual loans. Loans that are performing
but have shown some signs of weakness are subjected to more stringent reporting
and oversight.
The allowance for loan losses is established to absorb losses inherent in the
portfolio. The allowance for loan losses is maintained at a level considered by
management to be adequate to provide for losses that are inherent in the loan
portfolio. The allowance is increased by provisions charged to operating expense
and reduced by net charge-offs. In determining the adequacy of the allowance for
loan losses, management takes into consideration many factors including:
18
existing general economic and business conditions affecting the key lending
areas of the Company, current levels of problem loans and delinquencies, credit
quality trends, collateral values, loan volumes and concentration, seasoning of
the loan portfolio, specific industry conditions, recent loss experience,
duration of the current business cycle, bank regulatory examination results and
findings of the Company's internal credit examiners. The allowance is based on
estimates and ultimate losses may vary from the current estimates. Management
reviews these estimates periodically and, when adjustments are necessary, they
are reported in the period in which they become known.
After reviewing the above factors, management concluded that, due to the
improvement in non-performing assets (see Non-Performing Assets) from $2.6
million at March 31, 2004 to $510,000 at March 31, 2005, no provision for loan
losses was necessary during the first quarter of 2005 and the allowance for loan
losses as of March 31, 2005 was adequate. The provision for loan losses for the
first quarter of 2004 was $375,000.
As of March 31, 2005, the allowance for loan losses was $17.7 million, which
represents 2.1% of the total loan balances. As of March 31, 2004 the allowance
was $17.6 million or 2.2% of total loans. The following table illustrates the
change in the allowance for the first three months of 2005 and 2004.
Allowance for Loan Losses (in thousands)
Balance, December 31, 2004
$ 17,727
Provision Charged to Expense 0
Recoveries of Loans Previously Charged Off 76
Loans Charged Off (45)
============================================================
Balance, March 31, 2005 $ 17,758
============================================================
Balance, December 31, 2003 $ 17,220
Provision Charged to Expense 375
Recoveries of Loans Previously Charged Off 31
Loans Charged Off (62)
============================================================
Balance, March 31, 2004 $ 17,564
============================================================
Non-Interest Income
Overall, non-interest income decreased $642,000 or 18.0% for the three months
ended March 31, 2005 compared to the same period of 2004. Most of the decrease
occurred in gain on sale of investment securities, which was $480,000 less for
the first three months of 2005 as compared to the first three months of 2004.
During the first three months of 2004 the Company took advantage of a decline in
interest rates by selling approximately $29.8 million in investment securities
for a gain.
The remaining decrease in non-interest income occurred in service charges on
deposit accounts due to: (1) the conversion of certain deposit customers to a
newly offered high performance checking product that does not have a monthly
service charge; (2) increasing interest rates which reduced service charges for
those commercial customers on business account analysis; and (3) a decrease in
fees generated from money service business relationships as a result of the
Company's strategic decision to exit this product line.
19
Non-Interest Expense
Overall, non-interest expense increased $601,000 or 6.9% for the first three
months of 2005 compared to the first three months of 2004, primarily as a result
of a $475,000 increase in Pension Plan expense related to the Company's decision
to terminate its Defined Benefit Pension Plan during 2005. This increased level
of Pension Plan expense will continue until the plan is terminated during the
fourth quarter of 2005. Refer to Note 12 of the Consolidated Financial
Statements in the Company's 2004 Annual Report to Shareholders for more
information. Another factor impacting non-interest expense was the introduction
of a new high performance checking product and the associated direct mail and
other ancillary expenses incurred to promote this product.
Provision for Income Taxes
The provision for income taxes increased 15.2% to $2.5 million for the first
three months of 2005. The Company's effective tax rate increased to 36.40% for
the first three months of 2005 compared to 36.06% for the same period in 2004.
Financial Condition
Investment Securities
The Financial Accounting Standards Board statement, Accounting for Certain
Investments in Debt and Equity Securities, requires the Company to classify its
investments as held-to-maturity, trading or available-for-sale. Securities are
classified as held-to-maturity and are carried at amortized cost when the
Company has the positive intent and ability to hold the securities to maturity.
Trading securities are securities acquired for short-term appreciation and are
carried at fair value, with unrealized gains and losses recorded in non-interest
income. Securities classified as available-for-sale include securities, which
may be sold to effectively manage interest rate risk exposure, prepayment risk,
satisfy liquidity demand and other factors. These securities are reported at
fair value with aggregate, unrealized gains or losses excluded from income and
included as a separate component of shareholders' equity, net of related income
taxes.
The investment portfolio provides the Company with an income alternative to
loans. As of March 31, 2005 the investment portfolio represented 22.6% of the
Company's total assets. Total investment securities increased $29.6 million from
a year ago and now total $275.9 million. Beginning in the fourth quarter of
2004, the Company's asset and liability management strategy called for
increasing the size of the Company's longer-term municipal security portfolio.
These balances have increased $30.7 million since March 31, 2004. This strategy
is intended to provide the Company, which is asset-sensitive, with some
protection in the event of a drop in interest rates. For further discussion see
Market Risk - Interest Rate Risk under Item 3. Quantitative and Qualitative
Disclosures About Market Risk.
Not included in the investment portfolio are overnight investments in Federal
Funds Sold. For the three months ended March 31, 2005, average Federal Funds
Sold was $6.8 million compared to $20.6 million in 2004.
Loans
The Company's loan portfolio at March 31, 2005 increased $60.0 million from
March 31, 2004. The increase was due to strong loan demand in the Company's
market area, along with an aggressive calling program on high quality loan
prospects. Additionally, on an average balance basis loans have increased $71.0
million or 9.0%. The table following sets forth the distribution of the loan
portfolio by type as of the dates indicated.
20
Loan Portfolio As Of:
(in thousands) March 31, 2005 Dec. 31, 2004 March 31, 2004
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Real Estate $ 444,529 $431,746 $407,475
Real Estate Construction 54,468 62,446 65,598
Home Equity 61,720 63,782 54,805
Agricultural 125,115 151,002 124,679
Commercial 154,756 142,133 129,804
Consumer 18,478 17,973 16,673
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Gross Loans 859,066 869,082 799,034
Less:
Unearned Income 2,234 2,174 1,929
Allowance for Loan Losses 17,758 17,727 17,564
- ---------------------------------------- ------------------------- ---------------------- -------------------------
Net Loans $ 839,074 $ 849,181 $779,541
======================================== ========================= ====================== =========================
In the ordinary course of business, the Company enters into commitments to
extend credit to its customers. These commitments are not reflected in the
accompanying consolidated financial statements. As of March 31, 2005, the
Company had entered into commitments with certain customers amounting to $395.6
million compared to $328.3 million at March 31, 2004. Letters of credit at March
31, 2005, and March 31, 2004, were $16.1 million and $12.5 million,
respectively.
Non-Performing Assets
Non-performing assets are comprised of non-performing loans (defined as
non-accrual loans plus accruing loans past due 90 days or more) and other real
estate owned. As set forth in the table below, non-performing loans as of March
31, 2005 were $510,000 compared to $2.6 million at March 31, 2004. Accrued
interest reversed from income on loans placed on a non-accrual status totaled
$42,000 at March 31, 2005 compared to $329,000 at March 31, 2004. The Company
reported no other real estate owned for both March 31, 2005 and March 31, 2004.
Non-Performing Assets
(in thousands) March 31, 2005 December 31, 2004 March 31, 2004
- --------------------------------------- ------------------------ ----------------------- ------------------------
Non-performing Loans $510 $225 $2,580
Other Real Estate Owned 0 0 0
======================================= ======================== ======================= ========================
Total $510 $225 $2,580
======================================= ======================== ======================= ========================
Non-Performing Assets
as a % of Total Loans 0.06% 0.03% 0.3%
Allowance for Loan Losses as a % of
Non-Performing Loans 3,482.0% 7,878.7% 680.77%
Except for non-performing loans shown in the table above, the Company's
management is not aware of any loans as of March 31, 2005 for which known credit
problems of the borrower would cause serious doubts as to the ability of such
borrowers to comply with their present loan repayment terms, or any known events
that would result in the loan being designated as non-performing at some future
date.
21
The Company's management cannot, however, predict the extent to which the
following or other factors may affect a borrower's ability to pay: 1)
deterioration in general economic conditions, real estate values or agricultural
commodity prices; 2) increases in interest rates; or 3) changes in the overall
financial condition or business of a borrower.
Deposits
One of the key sources of funds to support earning assets (loans and
investments) is the generation of deposits from the Company's customer base. The
ability to grow the customer base and subsequently deposits is a significant
element in the performance of the Company.
At March 31, 2005, deposits totaled $1.0 billion. This represents an increase of
13.6% or $123.4 million from March 31, 2004. The increase was focused in demand
and savings deposit accounts, which increased $30.5 million and $33.8 million,
respectively. The Company's calling efforts for prospective customers includes
acquiring both loan and deposit relationships which results in new demand,
interest bearing transaction and savings accounts. Although the Company's time
deposits have increased by $38.7 million since March 31, 2004, this growth has
been predominantly due to increased use of public time deposits as part of the
Company's asset/liability management funding strategies. Due to strong growth in
demand, interest bearing transaction and savings balances, the Company has
reduced its focus on growing higher cost time deposits; therefore, non-public
time deposits have decreased $4.3 million year over year. This reduced reliance
on higher cost time deposits has had, and should continue to have, a positive
impact on the Company's net interest margin (see Net Interest Income).
Federal Home Loan Bank Advances
Advances from the Federal Home Loan Bank are another key source of funds to
support earning assets. These advances are also used to manage the Company's
interest rate risk exposure, and as opportunities exist to borrow and invest the
proceeds at a positive spread through the investment portfolio. FHLB advances as
of March 31, 2005 were $40.9 million compared to $80.9 million as of March 31,
2004. The Company has reduced its FHLB borrowings by $40 million over the last
twelve months and replaced these borrowings with lower cost public time
deposits.
Long-term Subordinated Debentures
On December 17, 2003 the Company raised $10 million through an offering of trust
preferred securities. Although this amount is reflected as subordinated debt on
the Company's balance sheet, under applicable regulatory guidelines, trust
preferred securities qualify as regulatory capital (see Capital). These
securities accrue interest at a variable rate based upon 3-month Libor plus
2.85%. Interest rates reset quarterly and were 5.88% as of March 31, 2005.
Capital
The Company relies primarily on capital generated through the retention of
earnings to satisfy its capital requirements. The Company engages in an ongoing
assessment of its capital needs in order to support business growth and to
insure depositor protection. Shareholders' Equity totaled $119.4 million at
March 31, 2005 and $113.5 million at March 31, 2004.
The Company 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 discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Company and the 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
the Company and the Bank's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The Company and the
22
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors. Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
set forth in the table below of Total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined in the regulations), and of
Tier I capital (as defined in the regulations) to average assets (as defined in
the regulations). Management believes, as of March 31, 2005, that the Company
and the Bank met all capital adequacy requirements to which they are subject. As
of June 30, 2004, the most recent notification from the FRB categorized the
Company and the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Company and
the Bank must maintain minimum Total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the table. There are no conditions or events
since that notification that management believes have changed the institutions'
categories.
To Be Well
Capitalized Under
Regulatory Capital Prompt Corrective
(in thousands) Actual Requirements Action Provisions
The Company: Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
As of March 31, 2005
Total Capital to Risk Weighted Assets $145,310 13.71% $84,800 8.0% N/A N/A
Tier I Capital to Risk Weighted Assets $132,003 12.45% $42,400 4.0% N/A N/A
Tier I Capital to Average Assets $132,003 10.91% $48,401 4.0% N/A N/A
To Be Well
Capitalized Under
Regulatory Capital Prompt Corrective
(in thousands) Actual Requirements Action Provisions
The Bank: Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
As of March 31, 2005
Total Capital to Risk Weighted Assets $141,549 13.37% $ 84,699 8.0% $ 105,874 10.0%
Tier I Capital to Risk Weighted Assets $128,251 12.11% $ 42,349 4.0% $ 63,524 6.0%
Tier I Capital to Average Assets $128,258 10.63% $ 48,260 4.0% $ 60,325 5.0%
As previously discussed (see Long-term Subordinated Debentures), in order to
supplement its regulatory capital base, during December, 2003 the Company raised
$10 million of trust preferred securities. Under applicable regulatory
guidelines, trust preferred securities qualify as Tier 1 capital up to a maximum
of 25% of Tier 1 capital. Any additional portion of trust preferred securities
would qualify as Tier 2 capital. The Company has received notification from the
Federal Reserve Bank of San Francisco that all of the Company's trust preferred
securities currently qualify as Tier 1 capital.
In accordance with the provisions of Financial Accounting Standards Board
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
the Company does not consolidate the subsidiary trust which has issued the trust
preferred securities.
In a March 1, 2005 press release, the FRB issued its final rule concerning the
regulatory capital treatment of trust preferred securities by bank holding
companies. The final rule closely follows the proposed rule that was released on
May 6, 2004 and states that bank holding companies may include trust preferred
securities in Tier 1 capital in an amount equal to 25% of the sum of core
capital elements net of goodwill, less any associated deferred tax liability.
The Company currently has no goodwill or associated deferred tax liability so
this requirement does not impact the Company. The effective date of this final
rule is April 11, 2005.
23
In 1998, the Board approved the Company's first stock repurchase program which
expired on May 1, 2001. During the second quarter of 2004, the Board approved a
second stock repurchase program because it concluded that the Company continues
to have more capital than it needs to meet present and anticipated regulatory
guidelines to be classified as "well capitalized".
Repurchases under the second program will be made on the open market or through
private transactions. The aggregate price to be paid by the Company for all
repurchased stock will not exceed $10,000,000 and the program will expire on May
31, 2007. The repurchase program also requires that no purchases may be made if
the Company would not remain "well-capitalized" after the repurchase. All shares
repurchased under the repurchase program will be retired (see Part II, Item 2.
Unregistered Sales of Securities and Use of Proceeds).
Since 1999, the Company has repurchased over 44,000 shares for total
consideration of $11.7 million, including 13 shares during the first quarter of
2005 at an average price of $425 per share.
Critical Accounting Policies and Estimates
This "Management's Discussion and Analysis of Financial Condition and Results of
Operations," is based upon the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. In preparing the Company's financial statements
management makes estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses. These judgments govern areas such as
the allowance for loan losses, the fair value of financial instruments,
accounting for income taxes and pension accounting.
For a full discussion of the Company's critical accounting policies and
estimates see "Management's Discussion and Analysis" in the Company's Annual
Report to Shareholders for the year ended December 31, 2004.
Off Balance Sheet Arrangements
Off-balance sheet arrangements are any contractual arrangement to which an
unconsolidated entity is a party, under which the Company has: (1) any
obligation under a guarantee contract; (2) a retained or contingent interest in
assets transferred to an unconsolidated entity or similar arrangement that
serves as credit, liquidity or market risk support to that entity for such
assets; (3) any obligation under certain derivative instruments; or (4) any
obligation under a material variable interest held by the Company in an
unconsolidated entity that provides financing, liquidity, market risk or credit
risk support to the Company, or engages in leasing, hedging or research and
development services with the Company.
For a full discussion of the Company's off balance sheet arrangements, see the
Notes to the Consolidated Financial Statements in the Company's 2004 Annual
Report to Shareholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management
The Company has adopted a Risk Management Plan to provide for the proper control
and management of risk factors inherent in the operation of the Company.
Specifically, credit risk, interest rate risk, liquidity risk, compliance risk,
strategic risk, and reputation risk can all affect the market risk of the
Company. These specific risk factors are not mutually exclusive. It is
recognized that any product or service offered by the Company may expose the
Company to one or more of these risk factors.
24
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor's failure
to meet the terms of any contract or otherwise fail to perform as agreed. Credit
risk is found in all activities where success depends on counterparty, issuer or
borrower performance.
Credit risk in the investment portfolio is addressed through defined limits in
the Company's policy statements. The Company's investment policy is
conservative. The Company invests primarily in mortgage-backed securities, U.S.
Treasuries, U.S. Government Agencies, and high-grade municipals. Additionally,
most municipal securities carry insurance to enhance the credit quality of the
bond.
The Company manages and controls credit risk in the loan portfolio through
credit management policies and procedures, underwriting and approval standards,
dollar limits on loans to one borrower and by restricting loans made primarily
to its principal market area where management believes it is better able to
assess the applicable risk. Additionally, management has established guidelines
to ensure the diversification of the Company's credit portfolio such that even
within key portfolio sectors such as real estate or agriculture, the portfolio
is diversified across factors such as location, building type, crop type, etc.
Management actively monitors the existing portfolio and reports regularly to the
Board of Directors regarding trends and conditions in the loan portfolio and
regularly conducts credit reviews of individual loans. Loans that are performing
but have shown some signs of weakness are subjected to more stringent reporting
and oversight.
As a financial institution which assumes lending and credit risks as a principal
element in its business, the Company anticipates that credit losses will be
experienced in the normal course of business. Accordingly, an allowance for loan
losses is maintained at a level considered adequate by management to provide for
losses that are inherent in the portfolio. The allowance is increased by
provisions charged to operating expense and by recoveries on loans previously
charged-off and reduced by charge-offs. Management employs a systematic
methodology for determining the allowance for loan losses. On a quarterly basis,
management reviews the credit quality of the loan portfolio and considers many
factors in determining the adequacy of the allowance balance.
Central to the Company's evaluation of the adequacy of the allowance for loan
losses is its loan risk rating system. The originating credit officer assigns
borrowers an initial risk rating, which is based primarily on a thorough
analysis of each borrower's financial position in conjunction with industry and
economic trends. Approvals are made based upon the amount of inherent credit
risk specific to the transaction and are reviewed for appropriateness by senior
credit administration personnel. Credits are monitored by credit administration
personnel for deterioration in a borrower's financial condition, which would
impact the ability of the borrower to perform under the contract. Risk ratings
are adjusted as necessary.
Based on the risk rating system specific allowances are established in cases
where management has identified significant conditions or circumstances related
to a credit that management believes indicates the possibility of loss.
Management performs a detailed analysis of these loans, including, but not
limited to, cash flows, appraisals of the collateral, conditions of the
marketplace for liquidating the collateral and assessment of the guarantors.
Management then determines the inherent loss potential and allocates a portion
of the allowance for losses as a specific allowance for each of these credits.
The Company also segments the loan portfolio by risk rating and into groups of
loans with similar characteristics in accordance with SFAS No. 5, "Accounting
for Contingencies". During this process groups of loans are reviewed and applied
the appropriate allowance percentage to determine a portfolio formula allowance.
25
Finally, the Company's methodology for assessing the appropriateness of the
allowance involves management's consideration of all known relevant internal and
external factors that may affect a loan's collectibility. The factors evaluated
in connection with the allowance may include existing general economic and
business conditions affecting the key lending areas of the Company, current
levels of problem loans and delinquencies, credit quality trends, collateral
values, loan volumes and concentration, seasoning of the loan portfolio,
specific industry conditions, recent loss experience, duration of the current
business cycle, bank regulatory examination results and findings of the
Company's internal credit examiners.
While the Company utilizes a systematic methodology in determining its
allowance, the allowance is based on estimates, and ultimate losses may vary
from current estimates. The estimates are reviewed periodically and, as
adjustments become necessary, are reported in earnings in the periods in which
they become known.
Management believes that the allowance for loan losses at March 31, 2005 was
adequate to provide for losses inherent in the portfolio. No assurances can be
given that future events may not result in increases in delinquencies,
non-performing loans or net loan charge-offs that would increase the provision
for loan losses and thereby adversely affect the results of operations.
Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities
results in uncertainty in the Company's earnings and economic value and is
referred to as interest rate risk. The Company's primary objective in managing
interest rate risk is to minimize the potential for significant loss as a result
of changes in interest rates.
The Company measures interest rate risk in terms of the potential impact on both
its economic value and earnings. Methods for analyzing interest rate risk
include: (1) asset/liability mismatch ("GAP") analysis; (2) earnings simulation
model; and (3) economic value of equity ("EVE") analysis.
The Company's GAP analysis measures, at specific time intervals, the divergence
between earning assets and interest bearing liabilities for which repricing
opportunities will occur. A positive difference, or Gap, indicates that earning
assets will reprice faster than interest-bearing liabilities. This will
generally produce a greater net interest margin during periods of rising
interest rates and a lower net interest margin during periods of declining
interest rates. Conversely, a negative gap will generally produce a lower net
interest margin during periods of rising interest rates and a greater net
interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with
the rates charged on loans. In addition, the magnitude of changes in the rates
charged on loans is not always proportionate to the magnitude of changes in the
rate paid for deposits. Consequently, changes in interest rates do not
necessarily result in an increase or decrease in the net interest margin solely
as a result of the differences between repricing opportunities of earning assets
or interest bearing liabilities.
The Company's earnings simulation model quantifies the estimated exposure to net
interest income of sustained interest rate changes. The sensitivity of the
Company's net interest income is measured over a rolling one-year horizon.
26
The simulation model estimates the impact of changing interest rates on interest
income from all interest earning assets and the interest expense paid on all
interest bearing liabilities reflected on the Company's balance sheet. This
sensitivity analysis is compared to policy limits, which specify a maximum
tolerance level for net interest income exposure over a one-year horizon
assuming no balance sheet growth, given a 200 basis point upward and a 100 basis
point downward shift in interest rates. A shift in rates over a 12-month period
is assumed. Results that exceed policy limits, if any, are analyzed for risk
tolerance and reported to the Board with appropriate recommendations. At March
31, 2005, the Company's estimated net interest income sensitivity to changes in
interest rates, as a percent of net interest income was an increase in net
interest income of 2.90% if rates increase by 200 basis points and a decrease in
net interest income of 2.29% if rates decline 100 basis points.
The estimated sensitivity does not necessarily represent a Company forecast and
the results may not be indicative of actual changes to the Company's net
interest income. These estimates are based upon a number of assumptions
including: the nature and timing of interest rate levels including yield curve
shape, prepayments on loans and securities, pricing strategies on loans and
deposits, replacement of asset and liability cashflows, and other assumptions.
While the assumptions used are based on current economic and local market
conditions, there is no assurance as to the predictive nature of these
conditions including how customer preferences or competitor influences might
change. See Note 13 of the Notes to the Consolidated Financial Statements
located in the 2004 Annual Report to Shareholders.
The Company's EVE analysis measures the present value of the Company's assets,
less the present value of its liabilities, +/- the net present value of any
off-balance sheet items. This analysis is compared to policy limits, which
specify a maximum tolerance level the Company has established based on the
Summary Guidelines found in Thrift Bulletin 13a.
Liquidity Risk
Liquidity risk is the risk to earnings or capital resulting from the Company's
inability to meet its obligations when they come due without incurring
unacceptable losses. It includes the ability to manage unplanned changes in
funding sources and to recognize or address changes in market conditions that
affect the Company's ability to liquidate assets or acquire funds quickly and
with minimum loss of value. The Company endeavors to maintain a cash flow
adequate to fund operations, handle fluctuations in deposit levels, respond to
the credit needs of borrowers and take advantage of investment opportunities as
they arise. The principal sources of liquidity include credit facilities from
correspondent banks, brokerage firms and the Federal Home Loan Bank, as well as,
interest and principal payments on loans and investments, proceeds from the
maturity or sale of investments, and growth in deposits.
In general, liquidity risk is managed daily by controlling the level of Federal
Funds (either purchased or sold) to supplement the cash flows received from
operating, investing and other financing activities (see Consolidated Statement
of Cash Flows). During the first quarter of 2005, Federal Funds sold averaged
$6.8 million and Federal Funds purchased averaged $3.1 million. The Company
maintains Federal Fund credit lines of $50 million with major banks subject to
the customary terms and conditions for such arrangements and $175 million in
repurchase lines with major brokers. In addition the Company has additional
borrowing capacity of $195.3 million from the Federal Home Loan Bank.
At March 31, 2005, the Company had available liquid assets, which included cash
and cash equivalents and unpledged investment securities of approximately $131.3
million, which represents 10.7% of total assets.
27
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains controls and procedures designed to ensure that
information is recorded and reported in all filings of financial reports. Such
information is reported to the Company's management, including its Chief
Executive Officer and its Chief Financial Officer to allow timely and accurate
disclosure based on the definition of "disclosure controls and procedures" in
Rule 13a-15(e). In designing these controls and procedures, management
recognizes that they can only provide reasonable assurance of achieving the
desired control objectives. Management also evaluated the cost-benefit
relationship of possible controls and procedures.
As of the end of the period covered by this report, the Company carried out an
evaluation of the effectiveness of Company's controls and disclosure procedures
under the supervision and with the participation of the Chief Executive Officer,
the Chief Financial Officer and other senior management of the Company. Based on
the foregoing, the Company's Chief Executive Officer and the Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date the Company completed its evaluation.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Certain lawsuits and claims arising in the ordinary course of business have been
filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
There are no material proceedings adverse to the Company to which any director,
officer or affiliate of the Company is a party.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table indicates the number of shares repurchased by Farmers &
Merchants Bancorp during the first quarter of 2005.
Number of Shares Approximate Dollar Value
Average Purchased as Part of a of Shares that May Yet Be
Number of Price per Publicly Announced Purchased Under the Plan
First Quarter 2004 Shares Share Plan or Program or Program
- ------------------------------- ---------------- -------------- ------------------------ ---------------------------
01/01/2005 - 01/31/2005 $13 $425 13 $7,895,000
02/01/2005 - 02/29/2005 0 0 0 7,895,000
03/01/2005 - 03/31/2005 0 0 0 7,895,000
- ------------------------------- ---------------- -------------- ------------------------ ---------------------------
Total 13 $425 13 $7,895,000
All of the above shares were repurchased in private transactions.
28
The common stock of Farmers & Merchants Bancorp is not widely held, is not
listed on any exchange, nor is it included on the NASDAQ National Market or the
NASDAQ Small Cap Market. However, trades may be reported on the OTC Bulletin
Board under the symbol "FMCB.OB". Additionally, management is aware that there
are private transactions in the Company's common stock.
ITEM 3. Defaults Upon Senior Securities
Not applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's stockholders during the
first quarter of 2005.
ITEM 5. Other Information
On May 3, 2005, the Board of Directors of the Bank adopted a 2005 Deferred Bonus
Plan and an Executive Retention Plan. These Plans are filed as exhibits to this
report.
Since the distribution of the proxy statement for the 2005 annual meeting of
stockholders, there have been no material changes to the procedures by which
stockholders may recommend nominees to the Company's Board of Directors.
ITEM 6. Exhibits
See Exhibit Index on Page 31.
29
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FARMERS & MERCHANTS BANCORP
Date: May 6, 2005 /s/ Kent A. Steinwert
--------------------------
Kent A. Steinwert
President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 6, 2005 /s/ Stephen W. Haley
--------------------------
Stephen W. Haley
Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)
30
Index to Exhibits
Exhibit No. Description
10.15 2005 Deferred Bonus Plan of Farmers & Merchants Bank of Central
California executed May 3, 2005.
10.16 Executive Retention Plan of Farmers & Merchants Bank of Central
California executed May 3, 2005.
31(a) Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31(b) Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
31