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, 2007
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)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]
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. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X]
Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller reporting company)
Indicated by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of June 30, 2007, the aggregate market value of the registrant's common stock
held by non-affiliates of the registrant was $109,158,500.00.
As of February 21, 2008, the Registrant had 5,200,000 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K - Portions of the definitive Proxy Statement for the 2007
Annual Meeting of Shareholders of Farmers & Merchants Bancorp, Inc.
FARMERS & MERCHANTS BANCORP, INC.
TABLE OF CONTENTS
Form 10-K Items PAGE
---------------------------------------------------------------------- -------
Item 1. Business 3 - 7
Item 1.a Risk Factors 8 - 10
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 12 - 14
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15 - 33
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 34 - 35
Item 8. Financial Statements and Supplementary Data 36 - 63
Item 9. Disagreements on Accounting and Financial Disclosure 64
Item 9a. Controls and Procedures 64
Item 10. Directors and Executive Officers of the Registrant 66
Item 11. Executive Compensation 67
Item 12. Security Ownership of Certain Beneficial Owners and
Management 68
Item 13. Certain Relationships and Related Transactions 68
Item 14. Principal Accountant Fees and Services 68
Item 15. Exhibits, Financial Schedules and Reports on Form 8-K 68
Signatures and Certifications 70 - 75
Total Pages: 75
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 operating in Northwest Ohio
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. Farmers & Merchants Life Insurance
Company was dissolved during 2007. 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, agricultural and
residential mortgage, consumer, and credit card lending activities. Because our
Bank's branches are located in Northwest Ohio and Northeast Indiana, 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 since
ceased.
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) are also provided in our Ohio offices in Archbold, Wauseon,
Stryker, West Unity, Bryan, Delta, Napoleon, Montpelier, Swanton, and Defiance,
along with one in our Auburn, Indiana office. Two ATM's are also located at
Sauder Woodworking Co., Inc., a major employer in Archbold. Additional locations
in Ohio are at Northwest State Community College, Archbold; Williams County
Hospital, Bryan; Fairlawn Haven Wyse Commons, Archbold; Repp Oil, Fayette; Delta
Eagles, Bryan Eagles; Sauder Village, Archbold; Fulton County Hospital, Wauseon,
downtown Defiance; and a mobile trailer ATM. In Indiana, three additional ATM's
are located at St. Joe, Butler and at DeKalb Memorial Hospital, Auburn.
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 were the selling agents of the policies to
customers. The activities of Farmers & Merchants Life Insurance Co. are not
significant to the consolidated company. The Company dissolved the Farmers &
Merchants Life Insurance Company subsidiary as the Bank discontinued offering
the credit life, accident and health insurance to its customers.
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
3
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 there under by the Board of Governors, the Truth in Savings Act,
the Bank Bribery Act, the Competitive Equality Banking Act of 1987, the
Expedited 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 Bank's primary market includes communities located in the Ohio counties of
Defiance, Williams, Fulton, Henry and Wood. The commercial banking business in
this market is highly competitive, with approximately 17 other depository
institutions currently doing business in the Bank's primary market. 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. On December 31, 2007, the
Bank acquired the Knisely Bank of Indiana, expanding its market with the
addition of offices in Butler and Auburn, Indiana, both located in DeKalb
County.
At December 31, 2007, we had 245 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.
4
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 quarterly basis information pursuant to the
Act. The Federal Reserve Board may conduct examinations or inspections of the
Company and its subsidiary.
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
5
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.
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 acquirer 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.
6
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 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, 2007 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, 2007, 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. See Note 15 to the consolidated financial statements for the actual
amount.
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 based on the Federal Deposit Insurance Reform Act of 2005, as
adopted and took effect on April 21, 2006.
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.
7
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.fm-bank.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 1A. RISK FACTORS
SIGNIFICANT COMPETITION FROM AN ARRAY OF FINANCIAL SERVICE PROVIDERS
Our ability to achieve strong financial performance and a satisfactory return on
investment to shareholders will depend in part on our ability to expand our
available financial services. In addition to the challenge of attracting and
retaining customers for traditional banking services, our competitors now
include securities dealers, brokers, mortgage bankers, investment advisors
8
and finance and insurance companies who seek to offer one-stop financial
services to their customers that may include services that banks have not been
able or allowed to offer to their customers in the past. The increasingly
competitive environment is a result primarily of changes in regulation,
changes in technology and product delivery systems and the accelerating pace of
consolidation among financial services providers. If we fail to adequately
address each of the competitive pressures in the banking industry, our financial
condition and results of operations could be adversely affected.
CREDIT RISK
The risk of nonpayment of loans is inherent in commercial banking. Such
nonpayment could have an adverse effect on the Company's earnings and our
overall financial condition as well as the value of our common stock. Management
attempts to reduce the Bank's credit exposure by carefully monitoring the
concentration of its loans within specific industries and through loan
application and approval procedures. However, there can be no assurance that
such monitoring and procedures will reduce such lending risks. Credit losses can
cause insolvency and failure of a financial institution and, in such event, its
shareholders could lose their entire investment. For a more information on the
exposure of the Company and the Bank to credit risk, see the section under Part
II, Item 7 of this Form 10-K captioned "Loan Portfolio."
SUSCEPTIBILITY TO CHANGES IN REGULATION
Any changes to state and federal banking laws and regulations may negatively
impact our ability to expand services and to increase the value of our business.
We are subject to extensive state and federal regulation, supervision, and
legislation that govern almost all aspects of our operations. These laws may
change from time to time and are primarily intended for the protection of
consumers, depositors and the deposit insurance funds. In addition, the
Company's earnings are affected by the monetary policies of the Board of
Governors of the Federal Reserve. These policies, which include regulating the
national supply of bank reserves and bank credit, can have a major effect upon
the source and cost of funds and the rates of return earned on loans and
investments. The Federal Reserve influences the size and distribution of bank
reserves through its open market operations and changes in cash reserve
requirements against member bank deposits. The Gramm-Leach-Bliley Act regarding
financial modernization that became effective in November, 1999 removed many of
the barriers to the integration of the banking, securities and insurance
industries and is likely to increase the competitive pressures upon the Bank. We
cannot predict what effect such Act and any presently contemplated or future
changes in the laws or regulations or their interpretations would have on us,
but such changes could be materially adverse to our financial performance. For a
more information on this subject, see the section under Part I, Item 1 of this
Form 10-K captioned "Supervision and Regulation."
INTEREST RATE RISK
Changes in interest rates affect our operating performance and financial
condition in diverse ways. Our profitability depends in substantial part on our
"net interest spread," which is the difference between the rates we receive on
loans and investments and the rates we pay for deposits and other sources of
funds. Our net interest spread will depend on many factors that are partly or
entirely outside our control, including competition, federal economic, monetary
and fiscal policies, and economic conditions generally. Historically, net
interest spreads for other financial institutions have widened and narrowed in
response to these and other factors, which are often collectively referred to as
"interest rate risk." Over the last few years, the Bank, along with most other
financial institutions, has experienced a "margin squeeze" as higher interest
rates have made it difficult to maintain a more favorable net interest spread.
9
The Bank manages interest rate risk 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. For more information regarding the
Company's exposure to interest rate risk, see Part II, Item 7A of this Form
10-K.
ATTRACTION AND RETENTION OF KEY PERSONNEL
Our success depends upon the continued service of our senior management team and
upon our ability to attract and retain qualified financial services personnel.
Competition for qualified employees is intense. In our experience, it can take a
significant period of time to identify and hire personnel with the combination
of skills and attributes required in carrying out our strategy. If we lose the
services of our key personnel, or are unable to attract additional qualified
personnel, our business, financial condition, results of operations and cash
flows could be materially adversely affected.
DIVIDEND PAYOUT RESTRICTIONS
We currently pay a quarterly dividend on our common shares. However, there is no
assurance that we will be able to pay dividends in the future. Dividends are
subject to determination and declaration by our board of directors, which takes
into account many factors. The declaration of dividends by us on our common
stock is subject to the discretion of our board and to applicable state and
federal regulatory limitations. The Company's ability to pay dividends on its
common stock depends on its receipt of dividends from the Bank. The Bank is
subject to restrictions and limitations in the amount and timing of the
dividends it may pay to the Company.
ANTI-TAKEOVER PROVISIONS
Provisions of our Articles of Incorporation and Ohio law could have the effect
of discouraging takeover attempts which certain stockholders might deem to be in
their interest. These anti-takeover provisions may make us a less attractive
target for a takeover bid or merger, potentially depriving shareholders of an
opportunity to sell their shares of common stock at a premium over prevailing
market prices as a result of a takeover bid or merger.
OPERATIONAL RISKS
We are subject to certain operations risks, including, but not limited to, data
processing system failures and errors, customer or employee fraud and
catastrophic failures resulting from terrorist acts or natural disasters. We
maintain a system of internal controls to mitigate against such occurrences and
maintain insurance coverage for such risks that are insurable, but should such
an event occur that is not prevented or detected by our internal controls,
uninsured or in excess of applicable insurance limits, it could have a
significant adverse impact on our business, financial condition or results of
operations.
LIMITED TRADING MARKET
Our common stock is not listed on any exchange or The Nasdaq Stock Market. While
our stock is currently quoted in the over-the-counter markets, it trades
infrequently.
10
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.
The Bank occupies an Operations Center at 622 Clydes Way in Archbold, Ohio to
accommodate our growth over the years.
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
Perrysburg, Ohio 7001 Lighthouse Way
Butler, Indiana 200 S Broadway
Auburn, Indiana 403 Erie Pass
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.
11
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is not listed on the NASDAQ stock market or any other stock
exchange. While there is no established public trading market for our common
stock, our shares are currently dually-quoted by various market makers on the
Pink Sheets and the Over the Counter Bulletin Board, which are both
over-the-counter quotation services for participant broker-dealers.
There are market makers that set a price for our stock; however, private sales
continue to occur. The high and low sale prices were from sales of which we have
been made aware by researching daily on Bloomberg.com. The high and low sale
prices known to our management are as follows:
Quarter Low High
------- ------ ------
2007 - quarter 1st $22.10 $23.50
2nd 22.15 23.00
3rd 20.00 22.50
4th 18.05 20.25
2006 - quarter 1st $21.63 $22.88
2nd 22.25 26.00
3rd 21.25 23.25
4th 21.17 22.50
The Company utilizes Registrar and Transfer Company as its transfer agent.
As of February 5, 2008 there were 2037 record holders of our common stock.
Below is a line-graph presentation comparing the cumulative total shareholder
returns for the Corporation, an index for NASDAQ Stock Market (U.S. Companies)
comprised of all domestic common shares traded on the NASDAQ National Market
System and the NASDAQ Bank Index for the five-year period ended December 31,
2007. The chart compares the value of $100 invested in the Corporation and each
of the indices and assumes investment on December 31, 2002 with all dividends
reinvested.
The Board of Directors recognizes that the market price of stock is influenced
by many factors, only one of which is performance. The stock price performance
shown on the graph is not necessarily indicative of future performance.
(PERFORMANCE GRAPH)
12
Year 2002 as the base
2002 2003 2004 2005 2006 2007
------- ------- ------- ------- ------- -------
FMSB $100.00 $100.06 $100.08 $ 99.88 $ 99.89 $ 99.84
NASDAQ -
COMPOSITE $100.00 $150.64 $164.35 $167.78 $185.12 $204.80
NASDAQ -
BANK IN DEX $100.00 $132.59 $150.40 $147.42 $167.54 $134.67
Dividends are declared and paid quarterly. Per share dividends declared for the
years ended 2007 and 2006 are as follows:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total
----------- ----------- ----------- ----------- ------
2007 $ .16 $.16 $.16 $.16 $ 0.64
2006 $.125 $.15 $.15 $.15 $0.575
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.
Dividends declared during 2007 were $0.64 per share totaling $3.25 million, 11.3
percent higher than 2006 declared dividends of $0.575 per share. During 2006,
the Company purchased 42,000 shares and awarded 6,100 restricted shares to 41
employees under its long term incentive plan. 200 shares were forfeited during
2006. At year end 2006, the Company held 36,180 shares in Treasury stock and
9,820 in unearned stock awards. The Company initiated a 4:1 stock split on May
12, 2006. The Company purchased 228,000 shares throughout 2007. 8,760 shares
were awarded to 46 employees in 2007. 740 restricted shares were forfeited
during 2007 and 600 restricted shares whose vesting was accelerated were
transferred to a retired employee. At December 31, 2007, the Company held
256,160 shares in Treasury stock and 17,240 in unearned stock awards. The
Company continues to have a strong capital base and to maintain regulatory
capital ratios that are significantly above the defined regulatory capital
ratios. The Company has authorization to purchase 250,000 shares throughout
2008.
13
ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER
OF SHARES
PURCHASED
AS PART OF
TOTAL NUMBER PUBLICLY REMAINING SHARE
OF SHARES AVERAGE PRICE ANNOUNCED REPURCHASE
PERIOD PURCHASED PAID PER SHARE PROGRAMS AUTHORIZATION
------------ ------------ -------------- ------------ ---------------
10/1/2007 to -- -- -- 135,702
10/31/2007
11/1/2007 to 30,222 $19.21 30,222(1) 105,480
11/30/2007
12/1/2007 to 105,480 $19.89 105,480(1) 0
12/31/2007
------- ------ ------- -------
Total 135,702 $19.74 135,702(1) 0
======= ====== ======= =======
(1) The Company purchased these shares pursuant to a stock repurchase program
publicly announced on October 20, 2006. On that date, the Board of
Directors authorized the repurchase of up to 250,000 common shares through
December 31, 2007.
RECLASSIFICATION
Certain amounts in the 2006 and 2005 consolidated financial statements have been
reclassified to conform with the 2007 presentation. The Company's Board of
Directors declared a 4 for 1 stock split effective May 12, 2006. Therefore, all
references in the financial statements and other disclosures related to the
number of shares and per share amounts of the Company's stock have been
retroactively restated to reflect the increased number of shares outstanding.
14
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
(In Thousands, except share data)
---------------------------------------------------------------
2007 2006 2005 2004 2003
---------- ---------- ---------- ---------- -----------
Summary of Income:
Interest income $ 45,424 $ 42,269 $ 38,101 $ 37,351 $ 41,107
Interest expense 21,722 18,535 13,539 11,222 14,283
---------- ---------- ---------- ---------- -----------
Net Interest Income 23,702 23,734 24,562 26,129 26,824
Provision for loan loss 871 525 -425 884 6903
---------- ---------- ---------- ---------- -----------
Net interest income after
provision for loan loss 22,831 23,209 24,987 25,245 19,921
Other income (expense), net -12,269 -11,966 -13,209 -13,442 -9,836
---------- ---------- ---------- ---------- -----------
Net income before
income taxes 10,562 11,243 11,778 11,803 10,085
Income taxes 2,828 3,107 3,202 3,573 2,459
---------- ---------- ---------- ---------- -----------
Net income $ 7,734 $ 8,136 $ 8,576 $ 8,230 $ 7,626
Per Share of Common Stock: ========== ========== ========== ========== ===========
Earnings per common share outstanding
(Based on weighted average number of
shares outstanding)
Net income $ 1.52 $ 1.57 $ 1.65 $ 1.58 $ 1.47
========== ========== ========== ========== ===========
Dividends $ 0.640 $ 0.575 $ 0.500 $ 0.475 $ 1.688
========== ========== ========== ========== ===========
Weighted average number
of shares outstanding 5,097,636 5,186,329 5,198,728 5,200,000 (5,200,000)
========== ========== ========== ========== ===========
(In Thousands)
----------------------------------------------------
2007 2006 2005 2004 2003
-------- -------- -------- -------- --------
Total assets $803,974 $737,096 $720,945 $702,513 $705,703
Loans 523,474 498,580 458,704 472,211 480,339
Total Deposits 634,593 585,409 576,297 574,205 575,066
Stockholders' equity 89,375 87,732 82,588 78,845 74,856
Key Ratios
Return on average equity 8.71% 9.64% 10.62% 10.72% 9.87%
Return on average assets 1.06% 1.14% 1.22% 1.16% 1.06%
Loan to deposits 82.49% 85.17% 79.65% 82.24% 83.53%
Capital to assets 11.12% 11.90% 11.46% 11.22% 10.61%
Dividend payout 42.00% 36.63% 30.31% 30.02% 115.07%
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 financial services industry 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
15
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 into like groups based on loan type,
term, new versus seasoned and interest rate. The valuation is completed by an
independent third party.
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 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.
2007 IN REVIEW
Total assets reached a record high for year-end reporting on December 31, 2007
at $804 million. This was achieved with a 5% growth in loans corresponding to a
new five year high year-end balance of $523.5 million. Deposits also grew 8.4%,
as compared to year end 2006, ending at
16
$634.6 million. Growth was accomplished with the acquisition of the Knisely Bank
with total assets of $42.5 million. The transaction was completed December 31,
2007.
The Knisely Bank purchase also added goodwill of slightly over $4 million to the
balance sheet along with $1.1 million of core deposit intangible and fair value
adjustments for both loans and buildings. A deferred tax entry also was recorded
for the allowance for loan loss of $102 thousand. The transaction was completed
as an asset purchase for tax purposes. The Bank extended its market area and is
able to provide many additional services to the Indiana communities of Butler
and Auburn.
Establishing the groundwork from which to provide opportunity for continued
growth was a focus in 2007. Along with the Knisely Bank, Indiana acquisition, a
new office was built and opened in Perrysburg, a new remote ATM was added in
Defiance, Ohio and St. Joe, Indiana and the main office drive up was renovated.
These are all visible additions to the F&M family. Internally, infrastructure
improvement began with the imaging of both internal documents and branch
capture. The internal documents, such as loan files, will take more than a year
to complete but the process is well on its way with checking and savings
signature cards already scanned. This enables an employee to verify customers'
signatures and account ownership at their PC. Branch capture enables the
transaction documents to be scanned at the office locations and electronically
submitted to main office. Along with the completion of the imaging of internal
documents, these two procedures eliminate the need for a courier route. All
information between locations is converted to an electronic presentation which
provides more information in a timely manner to more people.
The foundation for emphasizing a more needs based sales culture was begun in
2007 with the kickoff of the "This Bank is Made For You and Me" campaign. This
represents a change in the approach for customer service and a win-win situation
for both the Bank and its customers. This is an on-going project with its own
dedicated team manager to measure its success. It is to provide better customer
service and more relationship building.
The Company dissolved the Farmers & Merchants Life Insurance Company subsidiary
as the Bank discontinued offering credit life and accident and health insurance
to its customers. As the insurance company was reinsurance of the Bank's
customers, it would no longer be profitable to continue operations. The closing
of the insurance company was a seamless transaction for the Bank's customers as
they realized no change in coverage or claim procedures. The policies were
merely sold back to the original issuer. The Bank is now offering debt
protection products that are similar to the previous insurance products. This
has become possible due to regulatory changes in the State of Ohio regarding
these types of products. It has also broadened the coverage available,
specifically, involuntary unemployment that our customers have been requesting.
Fees will be added to non-interest income on a monthly basis from this product.
MATERIAL CHANGES IN RESULTS OF OPERATIONS
The discussion now turns to more financial based results and trends as a result
of 2007 operations. The increase in non-interest income of other service charges
and fees of $357 thousand over 2006 is mainly attributed to the increase in
earnings due to the additional purchase of Bank Owned Life Insurance of $3
million in January 2007. This offset the decrease in customer service fees of
$347 thousand. This decrease represents a loss of income generated from the
Overdraft Privilege product. Customers' accounts were overdrawn less during 2007
with the trend beginning after the first quarter. With rates increasing through
most of the year, the net gain on sale of loans was impacted by lower
originations and fees being collected. The slower housing market directly
correlates to the gain on sale of loans being $66 thousand lower as
17
compared to 2006. Overall, non-interest income was down a modest $46 thousand as
compared to 2006.
Non-interest expenses were $257 thousand higher than 2006 and $993 thousand
lower than 2005. The increase in 2007 as compared to 2006 was impacted by mainly
two issues: cost of health benefits and other general and administrative
expenses. Important to note is the Bank's focus on doing more with less -
reflected in the decline of salaries and wages expense for the three years
shown. The trend is reversed in the employees benefit line with an increasing
upward trend. 2006 was $181 thousand higher than 2005 and 2007 was $348 thousand
higher than 2006. The higher cost is attributable both to the health insurance
premium expense of the coverage and an increased level of claims. During 2007,
alternatives were explored to minimize the exposure for a new Health Savings
Accounts option. A wellness benefit was also added to the plans to help defray
the cost of the higher deductibles. While the cost may continue to rise in 2008,
these steps were taken to lessen the slant of the slope of the increase and to
provide for employee assistance in the containment of the costs. Healthier
employees directly correlate to lower claims in the long term.
The increase in other general and administrative cost was due to the expense of
Ohio sales use tax. An audit covering the period of 2000 through 2007 was
conducted in 2007. It was discovered that many out of state vendors and small
service providers were not charging the Bank for sales tax. An additional $177
thousand of expense was incurred from the findings. Procedures have been
established to process invoices without sales tax and any future audit would be
limited to a three year look back period.
The last large item to be discussed is the Provision for Loan Losses. A tough
economic environment existed for most businesses in northwest Ohio during 2007.
Gross charge-offs were up 60% over 2006 with net charge-offs up 164% or $526
thousand higher as compared to 2006. The provision is presented in depth in the
pages to follow. However it was important to note the impact here.
Overall, the Company had a solid year of performance in an ever changing and
challenging economic environment. A tightening of the interest margin effected
net interest earnings and growth did not occur until the closing of the
acquisition on the last day of the year. The foundation is laid for future
growth but there was very little additional growth from which to garner income
during 2007. The charts and discussion to follow will confirm the assessment.
NET INTEREST INCOME
The net interest margin tightened during 2007 from the higher rate environment
triggered by the Federal Reserve increases throughout 2006. While interest
income increased from loan rate adjustments and the growth in loans, it did not
outpace the increased interest cost of the liabilities used for funding. The
results are an interest earning yield 4.93% higher than 2006 with an interest
cost yield 13.55% higher resulting in a decrease of 2.69% in the net interest
margin for 2007 as compared to 2006.
Interest income was $45.4 million for 2007, $42.3 million for 2006 and $38.1
million for 2005. Interest expense was $21.7, $18.5 and $13.5 million,
respectively for 2007, 2006, and 2005. Net Interest income was equivalent to
2006 at $23.7 million and 2006 was a decrease from 2005's $24.6 million. With
average assets increasing in 2007, the equivalent earnings are representative of
the lower net interest margin.
The following table presents net interest income, interest spread and net
interest margin for the three years 2005 through 2007, comparing average
outstanding balances of earning assets and
18
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
non-performing 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 charts indicate, the Company experienced increased growth on an average
basis for year 2007 compared to 2006 and 2005. Interest earning assets average
balance increased during all periods. The biggest component of the interest
earning assets was loans with 2007's average being $2.4 million higher than
2006. The yield for 2007 was higher for interest earning assets as compared to
2006 and 2005 in all categories with the exception of Federal Funds sold. More
Federal Funds were sold in the later part of the year after rates began to drop
and cash was anticipated to be needed for the acquisition.
Overall, the tax equivalent yield on interest earning assets increased to 6.84%
compared to 6.49% and 5.93% for 2006 and 2005 respectively. The percentage of
interest earning assets to total assets decreased slightly the past three years
but remained above 90% at a respectable 93.09% for 2007.
As stated previously, the increased yield on the assets was unfortunately
outpaced by the increased cost of funds. The average balances for interest
bearing liabilities increased only slightly, $17.1 million as compared to 2006.
While the balance increased slightly, the cost on those funds trended
significantly higher. The average cost for 2007 was 3.77% compared to 2006's
3.32% and 2005's 2.43%. The balances in non-interest bearing liabilities
increased during the last three years. With the addition of free checking in
2005, the non-interest bearing demand deposits average balance increased 7.48%
in 2006 over 2005 numbers. This was also in part due to the streamlining of the
Bank's checking account offerings and the introduction of Platinum checking in
2006.
As stated previously, the charts show the constriction on the net interest
margin and spread from 2005 to 2007. The largest tightening occurred during
2006. Net interest spread decreased 31 basis points during 2006 compared to a 14
basis points decrease during 2007. The same statement can be made for net
interest margin, a 17 basis point drop in 2006 compared to a 10 basis point drop
in 2007. Competition played a major role in the pressure applied on these
margins along with the rising rate environment and the slope of the yield curve
during 2005 and 2006. The ability to grow loans was directly impacted by the
ability to aggressively price the loans at least equal to competition. The
Company's market was extremely competitive and thus the yields on assets, while
increasing, were not able to be increased as high as management would have
liked. Loan growth was slower in 2007 as seen in the average balance growth of
$2.4 million for 2007 as compared to the $3.7 million growth of 2006. The
acquisition had very minimal impact in 2007 as it closed on December 31. 2007.
19
The yield on Tax-Exempt investments securities shown in the following charts
were computed on a tax equivalent basis. The yield on Loans has been tax
adjusted for the portion of tax-exempt IDB loans included in the total. Total
Interest Earning Assets is therefore also reflecting a tax equivalent yield in
both line items, also with the Net Interest Spread and Margin. The adjustments
were based on a 34% tax rate.
2007
(In Thousands)
-----------------------------
Average Interest/ Yield/
Balance Dividends Rate
-------- --------- ------
ASSETS
INTEREST EARNING ASSETS:
Loans(1) $502,815 $37,429 7.48%
Taxable investment securities 132,047 6,181 4.68%
Tax exempt investment securities 40,433 1,533 5.74%
Interest bearing deposits 286 17 5.94%
Federal funds sold 5,658 264 4.67%
-------- -------
TOTAL INTEREST EARNING ASSETS 681,239 $45,424 6.81%
======= ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 17,318
Other assets 29,684
--------
TOTAL ASSETS $728,241
========
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $193,539 $ 3,978 2.06%
Other time deposits 312,515 14,424 4.62%
Other borrowed money 28,233 1,317 4.66%
Federal funds purchased and securities
sold under agreement to repurchase 41,549 2,003 4.82%
-------- -------
TOTAL INTEREST BEARING LIABILITIES 575,836 $21,722 3.77%
======= ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 44,553
Other 19,029
--------
TOTAL LIABILITIES 639,418
SHAREHOLDERS' EQUITY 88,823
--------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $728,241
========
Interest/Dividend income/yield $45,424 6.81%
Interest Expense / yield 21,722 3.77%
------- ----
Net Interest Spread $23,702 3.04%
======= ====
Net Interest Margin 3.62%
====
20
2006
(In Thousands)
-----------------------------
Average Interest/ Yield/
Balance Dividends Rate
-------- --------- ------
ASSETS
INTEREST EARNING ASSETS:
Loans (1) $484,364 $35,069 7.28%
Taxable investment securities 129,406 5,070 3.92%
Tax exempt investment securities 49,202 1,858 5.72%
Interest bearing deposits 305 13 4.26%
Federal funds sold 5,086 259 5.09%
-------- -------
TOTAL INTEREST EARNING ASSETS 668,363 $42,269 6.49%
======= ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 17,145
Other assets 26,881
--------
TOTAL ASSETS $712,389
========
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $192,754 $ 3,784 1.96%
Other time deposits 305,586 12,063 3.95%
Other borrowed money 30,311 1,268 4.18%
Federal funds purchased and securities
sold under agreement to repurchase 30,042 1,420 4.73%
-------- -------
TOTAL INTEREST BEARING LIABILITIES 558,693 $18,535 3.32%
======= ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 45,531
Other 23,764
--------
TOTAL LIABILITIES 627,988
SHAREHOLDERS' EQUITY 84,401
--------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $712,389
========
Interest/Dividend income/yield $42,269 6.49%
Interest Expense / yield 18,535 3.32%
------- ----
Net Interest Spread $23,734 3.18%
======= ====
Net Interest Margin 3.72%
====
21
2005
(In Thousands)
---------------------------------
Average Interest/
Balance Dividends Yield/Rate
-------- --------- ----------
ASSETS
INTEREST EARNING ASSETS:
Loans (1) $468,934 $31,388 6.75%
Taxable investment securities 134,420 4,609 3.43%
Tax exempt investment securities 51,022 1,839 5.46%
Interest bearing deposits 7,974 256 3.21%
Federal funds sold 204 9 4.41%
-------- -------
TOTAL INTEREST EARNING ASSETS 662,554 $38,101 5.93%
======= ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 16,372
Other assets 22,954
--------
TOTAL ASSETS $701,880
========
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $195,748 $ 2,383 1.22%
Other time deposits 311,855 9,461 3.03%
Other borrowed money 24,995 896 3.58%
Federal funds purchased and securities
sold under agreement to repurchase 25,443 799 3.14%
-------- -------
TOTAL INTEREST BEARING LIABILITIES 558,041 $13,539 2.43%
======= ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 42,363
Other 20,686
--------
TOTAL LIABILITIES 621,090
SHAREHOLDERS' EQUITY 80,790
--------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $701,880
========
Interest/Dividend income/yield $38,101 5.93%
Interest Expense / yield 13,539 2.43%
------- ----
Net Interest Spread $24,562 3.49%
======= ====
Net Interest Margin 3.89%
====
(1) For purposes of these computations, non-accruing loans are included in the
daily average outstanding loan amounts.
22
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 earning 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.
2007 vs 2006
(In Thousands)
-------------------------
Due to Change in
Net ----------------
Change Volume Rate
------ ------ -------
INTEREST EARNED ON:
Loans $2,360 $1,343 $1,017
Taxable investment securities 1,111 103 1,008
Tax-exempt investment securities (325) (502) 177
Interest bearing deposits 4 (1) 5
Federal funds sold 5 29 (24)
------ ------ ------
TOTAL INTEREST EARNING ASSETS $3,155 $ 972 $2,183
====== ====== ======
INTEREST PAID ON:
Savings deposits $ 194 $ 15 $ 179
Other time deposits 2,361 274 2,087
Other borrowed money 49 (87) 136
Federal funds purchased and
securties sold under agreement to
repurchase 583 544 39
------ ------ ------
TOTAL INTEREST BEARING LIABILITIES $3,187 $ 746 $2,441
====== ====== ======
23
2006 vs 2005
(In Thousands)
-------------------------
Due to Change in
Net ----------------
Change Volume Rate
------ ------ -------
INTEREST EARNED ON:
Loans $3,681 $1,041 $2,640
Taxable investment securities 461 (172) 633
Tax-exempt investment securities 19 (99) 118
Interest bearing deposits (243) (246) 3
Federal funds sold 250 215 35
------ ------ ------
TOTAL INTEREST EARNING ASSETS $4,168 $ 739 $3,429
====== ====== ======
INTEREST PAID ON:
Savings deposits $1,401 $ (36) $1,437
Other time deposits 2,602 (190) 2,792
Other borrowed money 372 191 181
Federal funds purchased and
securties sold under agreement to
repurchase 621 144 477
------ ------ ------
TOTAL INTEREST BEARING LIABILITIES $4,996 $ 109 $4,887
====== ====== ======
The Federal Reserve began raising the Federal Funds rate in June of 2004 and
continued along that path through mid 2006. The increased interest income from
loans for 2005 through 2007 is partially due to the increased rate. Rates began
to drop at the end of third quarter 2007. Loans and federal funds sold were the
only assets that had interest income increased due to change in volume in 2006.
In 2007, taxable investment securities also had some rate increase due to a
change in volume. There was minimal change due to volume on the liability side
of the balance sheet during 2006. The Time deposits increase was caused by the
renewing of CD's from lower rates of previous years into higher rate buckets.
With the pausing of Federal Fund rate hikes the second half of 2006 the bank
focused on keeping "specials" shorter term going into 2007. This strategy helped
to slow the increase during 2007 as only $2.1 million of the interest expense
was attributed to rate compared to 2006's $2.8 million. As rates began to fall
in the fourth quarter of 2007, this strategy will continue to help in 2008. In
2007, the expense of commercial sweeps, included under Fed Funds and securities
sold under agreement to repurchases, grew mainly because of increased usage as
shown in change due to volume.
ALLOWANCE FOR CREDIT LOSSES
The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two
reserves: 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 Company increased the allowance for credit losses for 2007 after decreasing
in 2006. $301 thousand of the increase was the allowance that came across from
the acquisition. The allowance stands at $6.1 million for 2007 compared to $5.8
million for 2006. This decrease in 2006 was due to the improvement in asset
quality and the decrease in impaired loans. Charge-off activity of $1.0 million
was extremely low for 2006 compared to $2.1 million for 2005. Net charge-offs
were also lower in 2006 at $319 thousand than 2005's $1.0 million. Increased
activity was recorded in all components of the ALLL. Provision expense was up
$346 thousand in 2007 which totaled $871 thousand compared to $525 thousand for
2006 and $425 thousand for 2005. The AULC decreased during 2006 and 2007, ending
at $156 thousand for 2007. Overall the ACL ended at $6.1 million for 2007. The
increase in the allowance is reflective of the loan balance
24
increase and increased activity of charge-offs and delinquent loans in a tough
economic environment. Historical factors along with current economic conditions
are part of the calculation to determine the adequacy of the allowance.
NON-INTEREST INCOME
Non-interest income of $6.4 million is almost equivalent to 2006 and 2005, down
only $46 thousand for 2006 and 2006 down only $7 thousand from 2005. Mortgage
activity has remained down from 2004 for all three years presented due to higher
interest rates. 2007 had the additional issue of housing market troubles slowing
originations. The largest fluctuations in non-interest income were impacted with
the purchase of additional bank-owned life insurance (BOLI) and decreased usage
of the Bank's Overdraft Privilege product. The increase in BOLI earnings offset
the decrease of fees in the overdraft product. However, overdraft privilege
remains an important portion of non-interest income; even though overall usage
has decreased.
NON-INTEREST EXPENSE
Salaries and wages decreased in 2007 and 2006 as compared to 2005. Two reasons
for the decrease: 1) Full time equivalent numbers of employees for December 2007
compared to December 2006 decreased by seven and decreased by sixteen when
compared to December 2005. 2) The incentive paid based on performance for 2007
was lower than both 2006 and 2005 as the overall performance of the Bank was
lower. Employee benefits were higher as the Bank's cost for medical insurance
increased during 2006 and 2007. This impact was discussed earlier.
The biggest contributor to the improvement of non-interest expense in 2006, the
adjustment for the Allowance for Unfunded Loan Commitments and Letters of Credit
(AULC). The decrease of $673 thousand is reflected in the $1.2 million decrease
in other general and administrative expenses, making up an $828 thousand
decrease when adding the expense of 2005. The second largest contributor to the
improvement was the cost of audit, accounting and exam fees. These were
decreased by $204 thousand compared to 2005. Improvements in audit procedures
and SOX reporting experience were responsible for the decrease.
While 2006 showed an improvement in non-interest expense, the other factor in
2007's $257 thousand net increase was the additional cost from the Ohio Sales
Use Tax audit discussed previously. The focus of the Company remains to decrease
the non-interest expense while increasing the non-interest income. Containing
the cost of providing health care for its employees and the removal of the
one-time audit expense is a step in that direction. Additional revenue
generating services and/or products are also constantly being researched for
compatibility with the Company's markets.
FEDERAL INCOME TAXES
Effective tax rates were 26.78%, 27.63%, and 27.19% for 2007, 2006 and 2005,
respectively. The Company increased its tax-exempt holdings in 2005 with 2006's
average investment balance in tax-exempt securities at $49.2 million compared to
$51 million for 2005. Those holdings decreased by another $8.8 million in
average balance during 2007. Industrial Development Bonds, which may also be tax
exempt, increased almost $2 million at year end 2007 compared to 2006. The
earnings also increased on IDB's for 2007.
FINANCIAL CONDITION
Average earning assets increased $12.9 million during 2007 over 2006 and were
higher by $18.7 million as compared to 2005. The main cause of fluctuation was
loans with investments serving as a contra account in movements, increased loans
- decreased investments. Average interest
25
bearing liabilities increased $17.1 million over 2006 and $17.8 million from
2005. The increase in 2007 over 2006 and 2005 was to fund the increase in loans.
SECURITIES
Security balances as of December 31 are summarized below:
(In Thousands)
------------------------------
2007 2006 2005
-------- -------- --------
U.S. Treasury and Government Agencies $104,737 $ 91,355 $112,199
Mortgage-backed securities 39,367 31,264 28,514
State and local governments 41,467 45,495 62,891
Equity securities 33 47 47
-------- -------- --------
$185,604 $168,161 $203,651
======== ======== ========
The following table sets forth (dollars in thousands) the maturities of
investment securities as of December 31, 2007 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
(Amounts in Thousands)
----------------------------------
Within After One Year
One Year Within Five Years
------- ---- --------- -----
U.S. Treasury $ -- 0.00% $ -- 0.00%
U.S. Government agency 18,484 4.39% 19,533 4.72%
Mortgage-backed securities 3,225 3.92% 24,247 4.45%
State and local governments 5,966 3.62% 16,985 3.68%
Taxable state and local governments 564 5.12% 549 6.29%
Maturities
(Amounts in Thousands)
----------------------------------
After Five Years
Within Ten Years After Ten Years
---------------- ---------------
Amount Yield Amount Yield
-------- ----- ------- -----
U.S. Treasury $ -- 0.00% $ -- 0.00%
U.S. Government agency 34,680 4.94% 32,040 5.40%
Mortgage-backed securities 11,741 5.30% 154 5.90%
State and local governments 16,975 3.95% 428 4.11%
As of December 31, 2007 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 $4.0 million. This is required in order to obtain Federal Home Loan
Bank Loans. The Bank also acquired stock in the Federal Home Loan Bank of
Indianapolis at a cost of $231.4 thousand through its acquisition of Knisely
Bank. There were no
26
borrowings at the time of acquisition associated with Federal Home Loan Bank of
Indianapolis. The Bank also acquired stock in the Federal Reserve Bank with its
acquisition.
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)
----------------------------------------------------
2007 2006 2005 2004 2003
-------- -------- -------- -------- --------
Loans:
Commercial Real Estate $181,340 $162,363 $113,283 $102,314 $ --
Ag Real Estate 45,518 49,564 50,777 49,772 --
Consumer Real Estate 102,660 86,688 115,831 133,772 277,331
Commercial/industrial 104,188 101,788 81,893 88,303 95,009
Agricultural 58,809 69,301 61,502 56,239 63,082
Consumer 27,796 27,388 31,935 38,768 45,057
Industrial Development Bonds 9,289 7,335 9,237 10,687 7,944
-------- -------- -------- -------- --------
Total Loans $529,600 $504,427 $464,458 $479,856 $488,423
======== ======== ======== ======== ========
Note: From year 2004 forward - additional class types were added. In 2003, Ag &
Commercial Real Estate was included in Consumer Real Estate.
The following table shows the maturity of loans as of December 31, 2007:
Maturities (In Thousands)
----------------------------------------------
After One
Within Year Within After
One Year Five Years Five Years Total
-------- ----------- ---------- --------
Commercial Real Estate $ 6,298 $27,770 $147,272 $181,340
Ag Real Estate 250 2,503 42,765 45,518
Consumer Real Estate 7,846 12,686 82,128 102,660
Commercial and Industrial Loans 53,659 27,647 22,882 104,188
Agricultural 42,030 13,129 3,650 58,809
Consumer, Master Card and Overdrafts 6,658 16,538 4,600 27,796
Industrial Development Bonds 19 7,823 1,447 9,289
27
The following table presents the total of loans due after one year which has 1)
predetermined interest rates and 2) floating or adjustable interest rates:
(In Thousands)
-------------------
Fixed Variable
Rate Rate
-------- --------
Commercial Real Estate $ 37,826 $137,216
Ag Real Estate 5,388 39,847
Consumer Real Estate 33,647 63,194
Commercial and Industrial 24,298 19,589
Agricultural 14,869 1,894
Consumer, Overdrafts and other loans 23,511 1,297
Industrial Development Bonds 9,270 --
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)
------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
Non-accrual loans $4,918 $4,254 $4,663 $6,059 $6,236
Accruing loans past due
90 days or more -- -- -- 393 2,042
------ ------ ------ ------ ------
Total $4,918 $4,254 $4,663 $6,452 $8,278
====== ====== ====== ====== ======
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 $246 thousand for 2005, $174 thousand for 2006 and $313 thousand
for 2007. Any collections of interest on non-accrual loans are included in
interest income when collected unless it is on an impaired loan with a specific
allocation. A collection of interest on an impaired loan with a specific
allocation is applied to the loan balance to decrease the allocation needed.
Total interest collections amounted to $473 thousand for 2005, $167 thousand for
2006, and $174 thousand for 2007. $171 thousand of the interest collected in
2006 was applied to reduce the specific allocations for 2006 and $40 thousand of
interest collected in 2007 was applied to reduce the specific allocations.
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 principal and interest is not
expected. The $4.9 million of non-accrual loans as of December 31, 2007 are
secured.
As of December 31, 2007 the Bank has $15.4 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, 2007.
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
28
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.
As of December 31, 2007, the Bank had loans outstanding to individuals and firms
engaged in the various fields of agriculture in the amount of $59 million with
an additional $45.5 million in agricultural real estate loans. 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 increased to $1.58 million for 2007, and the
provision was $871 thousand. An additional $301 thousand is showing in the
provision line for 2007 which represents the allowance for loan losses that was
carried over from the acquisition. A few large commercial credits included in
the $5.7 million charged off in the commercial and agricultural segment was the
only segment in a net recovery for 2007. The consumer segment was also in a net
recovery position for 2006. The negative provision of 2005 was necessary to
decrease the allowance because of the overall decrease of the loan portfolio and
the improved asset quality position. The decrease in the total allowance for
credit losses for 2006 was due to the continued improvement in the asset quality
position and reassessment of the risk existent in the unfunded loan commitments.
The improvement in the ratio of net charge offs to average loans outstanding is
evidence of the improved asset quality during that period.
29
The increase in net charge-offs and past due loans along with the loan growth
were the reasons for the increase in the ALLL for 2007. Overall the Bank has not
experienced the losses many other institutions have during 2007. While the
numbers are up, it is at a manageable level.
The following table presents a reconciliation of the allowance for credit
losses:
(In Thousands)
----------------------------------------------------
2007 2006 2005 2004 2003
-------- -------- -------- -------- --------
Loans $529,600 $504,427 $464,488 $479,681 $488,247
======== ======== ======== ======== ========
Daily average of outstanding loans $503,296 $484,663 $469,326 $491,104 $500,517
======== ======== ======== ======== ========
Allowance for Loan Losses-Jan. 1 $ 5,594 $ 5,388 $ 6,814 $ 6,614 $ 6,400
Loans Charged off:
Commercial Real Estate 376 214 82 11 129
Ag Real Estate -- -- -- 20 --
Consumer Real Estate 252 167 347 537 295
Commercial and Industrial 538 282 933 417 5,705
Agricultural 42 -- 12 102 23
Consumer & Other Loans 368 322 722 739 1,156
-------- -------- -------- -------- --------
1,576 985 2,096 1,826 7,308
-------- -------- -------- -------- --------
Loan Recoveries:
Commercial Real Estate 25 2 -- -- 32
Ag Real Estate -- 214 20 -- --
Consumer Real Estate 5 24 52 38 104
Commercial and Industrial 359 -- 580 514 577
Agricultural 103 74 31 185 47
Consumer & Other Loans 240 352 412 405 545
-------- -------- -------- -------- --------
732 666 1,095 1,142 1,305
-------- -------- -------- -------- --------
Net Charge Offs 844 319 1,001 684 6,003
-------- -------- -------- -------- --------
Provision for loan loss 871 525 (425) 884 6,903
-------- -------- -------- -------- --------
Acquisition allowance for loan loss 301 -- -- -- --
-------- -------- -------- -------- --------
Allowance for Loan & Lease Losses - Dec 31 $ 5,922 $ 5,594 $ 5,388 $ 6,814 $ 7,300
Allowance for Unfunded Loan Commitments
& Letters of Credit Dec 31 $ 156 $ 168 $ 841 $ 686 $ --
-------- -------- -------- -------- --------
Total Allowance for Credit Losses - Dec 31 $ 6,078 $ 5,762 $ 6,229 $ 7,500 $ 7,300
======== ======== ======== ======== ========
Ratio of net charge-offs to average
Loans outstanding 0.17% 0.07% 0.21% 0.14% 1.20%
======== ======== ======== ======== ========
Note: Year 2004 - Jan 1 balance adjusted for reporting change for allowance for
reporting loan & lease commitments & letters as reported within prior year end
balance.
30
Allocation of the allowance for credit losses per Loan Category in terms of
dollars and percentage among the various loan categories is as follows:
2007 2006 2005 2004 2003
Amount Amount Amount Amount Amount
(000's) % (000's) % (000's) % (000's) % (000's) %
------- ------- ------- ------ ------- ------ ------- ------- ------- ------
Balance at End of Period
Applicable To:
Commercial Real Estate $1,358 34.24% $1,221 32.19% $ 756 24.39% $ 671 21.32% $ --
Ag Real Estate 117 8.60% 162 9.82% 88 10.93% 264 10.37% --
Consumer Real Estate 381 19.39% 288 17.19% 719 24.95% 615 27.88% 531 56.78%
Commercial & Industrial 1,859 19.67% 2,721 20.18% 2,246 17.63% 3,152 18.40% 1,816 19.45%
Agricultural 1,676 11.10% 250 13.74% 275 13.24% 423 11.72% 674 12.92%
Consumer, Overdrafts and
other loans 531 7.00% 634 6.88% 526 8.86% 665 10.31% 451 10.85%
Unallocated -- 318 778 1,024 3,828
------ ------ ------ ------ ------
Allowance for Loan &
Lease Losses $5,922 100.00% $5,594 100.00% $5,388 100.00% $6,814 100.00% $7,300 100.00%
Off Balance Sheet
Commitments $ 156 $ 168 $ 841 $ 686 $ --
------ ------ ------ ------ ------
Total Allowance for
Credit Losse $6,078 $5,762 $6,229 $7,500 $7,300
====== ====== ====== ====== ======
Note: From year 2004 forward - additional class types were added. Commercial
real estate and agricultural real estate were previously included in the total
for consumer real estate.
DEPOSITS
The amount of outstanding time certificates of deposits and other time deposits
in amounts of $100,000 or more by maturity as of December 31, 2007 are as
follows:
(In Thousands)
-------------------------------------------------
Over Three Over Six
Months Months Less Over
Under Less than Than One One
Three Months Six Months Year Year
------------ ---------- ----------- -------
Time Deposits $15,238 $15,070 $38,097 $11,051
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, 2007:
Average balance $39,164 $84,674 $108,864 $312,515
Average rate 0.00% 2.30% 1.87% 4.58%
December 31, 2006:
Average balance $42,073 $83,154 $109,601 $305,586
Average rate 0.00% 2.16% 1.81% 3.95%
December 31, 2005:
Average balance $42,363 $83,107 $112,642 $311,855
Average rate 0.00% 1.31% 1.14% 3.03%
31
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 $207
million in 2005, $198 million for 2006, compared to $196 million fro 2007. This
represented 29.7 percent, 28.0 percent, and 26.9 percent of total average
assets, respectively. Of the almost $186 million of debt securities in the
company's portfolio as of December 31, 2007, $28.2 million or 15.2 percent of
the portfolio is expected to mature in 2008. Taking into consideration possible
calls of the debt securities, the amount climbs to $65.6 million or 36.3 percent
of the portfolio becomes a source of funds. This liquidity provides the
opportunity to fund loan growth without having to over aggressively price
deposits.
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 increased as of year end balances in
2007, in all categories. Overall deposits increased an average of $6.7 million
during 2007 compared to 2006's decrease under 2005 of $6.1 million in average
deposits. These represent changes of (1.0) percent and (1.1) percent in average
total deposits, respectively. The Bank also utilized Federal Funds purchased at
times during 2007. The average balance for 2007 was $2.7 million.
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 2007 was 88.82
percent, 2006 was 85.97 percent, and 2005 was 79.6 percent. The lower ratio in
2005 is due to the lack of growth in both the credit and deposit portfolios.
2007 and 2006 represents the increased loan growth outpacing deposit growth. The
Company's goal is for this ratio to be higher with loan growth the driver; this
was achieved in 2006 and 2007.
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 $41.3 million at the end of 2007 compared to $34.8
million at the end of 2006 and to $21.2 million at the end of 2005. Though no
federal funds were purchased at year end, the Bank does have arrangements with
correspondent Banks that can be utilized when necessary. Following is a table
showing the daily securities sold under agreement to repurchase activity for
2007 and 2006. These accounts are used to provide a sweep product to the Bank's
commercial customers.
Securities Sold Under Agreement to Repurchase
Maximum Amount
Amount Oustanding Borrowings Outstanding Approximate Average Approximate Weighted
at End of Period Weighted Average Rate Month End Outstanding in Period Average Interest Rate
(000'S) End of Period (000's) (000's) For the Period
----------------- --------------------- ---------------------- --------------------- ---------------------
2007 $35,059 3.72% $39,205 $31,513 4.64%
2006 $28,433 4.83% $29,712 $23,903 3.64%
2005 $16,302 3.55% $26,180 $19,802 2.41%
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
32
secured by homes in our community. Borrowings from this source increased by $8.6
million to $31.8 million at December 31, 2007. This compares to decreased
borrowings during 2006 of $11.7 million to $23.2 million at December 31, 2006
and increased borrowings during 2005 of $13 million to $34.9 million to end at
December 31, 2005. The increased borrowings in 2007 were used to fund loan
growth and were a cheaper source of funds than certificate of deposits. The
decreased borrowings were payoffs of matured notes. Sufficient funds were
available to fund growth so new advances were not needed in 2006.
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.
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.
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.
33
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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. 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 directions shown:
Net Interest % Change Rate Rate Cumulative % Change
Margin (Ratio) to Flat Rate Direction changes by Total ($000) to Flat Rate
-------------- ------------ --------- ---------- ------------ ------------
2.91% -15.16% Rising 3.00% 25,201 -10.56%
3.09% -10.06% Rising 2.00% 26,200 -7.02%
3.26% -5.00% Rising 1.00% 27,191 -3.50%
3.43% 0.00% Flat 0 28,177 0.00%
3.63% 5.69% Falling -1.00% 29,294 3.96%
3.78% 10.21% Falling -2.00% 29,881 6.05%
3.82% 11.43% Falling -3.00% 29,661 5.27%
34
CONTRACTUAL OBLIGATIONS
Contractual Obligations of the Company totaled $398.3 million as of December 31,
2007. Time deposits represent contractual agreements for certificates of
deposits held by its customers. Long term debt represents the borrowings with
the Federal Home Loan Bank and is 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 $ 41,329 $ 41,329 $ -- $ -- $ --
Time Deposits 324,372 273,651 48,221 1,487 1,013
Dividends Payable 795 795
Long Term Debt 31,816 5,711 15,810 10,295 --
-------- -------- ------- ------- ------
Total $398,312 $321,486 $64,031 $11,782 $1,013
======== ======== ======= ======= ======
CAPITAL RESOURCES
Shareholders' equity was $89.4 million as of December 31, 2007 compared to $87.7
million at December 31, 2006. Dividends declared during 2007 were $0.64 per
share totaling $3.25 million, 11.3 percent higher than 2006 declared dividends
of $0.575 per share. During 2006, the Company purchased 42,000 shares and
awarded 6,100 restricted shares to 41 employees under its long term incentive
plan. 200 shares were forfeited during 2006. At year end, the Company held
36,180 shares in Treasury stock and 9,820 in unearned stock awards. The Company
initiated a 4:1 stock split on May 12, 2006. The Company purchased 228,000
shares throughout 2007. 8,760 shares were awarded to 46 employees in 2007. 740
restricted shares were forfeited during 2007 and 600 restricted shares whose
vesting was accelerated were transferred to a retired employee. At December 31,
2007, the Company held 256,160 shares in Treasury stock and 17,240 in unearned
stock awards. The Company continues to have a strong capital base and to
maintain regulatory capital ratios that are significantly above the defined
regulatory capital ratios. The Company has authorization to purchase 250,000
shares throughout 2008.
At December 31, 2007, The Farmers & Merchants State Bank and Farmers & Merchants
Bancorp, Inc had total risk-based capital ratios of 15.51%. Core capital to
risk-based asset ratios of 17.91% and 14.47% are well in excess of regulatory
guidelines. The Bank's leverage ratio of 9.5% is also substantially in excess of
regulatory guidelines as is the Company's at 11.5%.
The Company's subsidiaries are restricted by regulations from making dividend
distributions in excess of certain prescribed amounts.
35
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheet at December 31, 2007 and 2006
Consolidated Statements of Income for the years ended December 31, 2007, 2006
and 2005
Consolidated Statements of Changes in Shareholders' Equity for the year ended
December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flow for the years ended December 31, 2007, 2006
and 2005
Notes to Consolidated Financial Statements
36
(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
We have audited the accompanying consolidated balance sheets of Farmers &
Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2007 and 2006, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2007. We
also have audited the Company's internal control over financial reporting as of
December 31, 2007, 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 these financial
statements, for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying financial statements. Our responsibility
is to express an opinion on these financial statements and an opinion on the
company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinions.
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 financial statements for external purposes in accordance
with generally accepted accounting principles. 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 its 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, the financial statements referred to above present fairly, in
all material respects, the financial position of Farmers & Merchants Bancorp,
Inc. and Subsidiaries as of December 31, 2007 and 2006, and the results of its
operations and its cash flows for each of the years in the three-year period
ended December 31, 2007 in conformity with accounting principles generally
accepted in the United States of America. 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, 2007,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
PLANTE & MORAN, PLLC
February 27, 2008
Auburn Hills, Michigan
37
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2007 AND 2006
(000'S OMITTED, EXCEPT PER SHARE DATA)
2007 2006
-------- --------
ASSETS
ASSETS
Cash and due from banks (Note 1) $ 21,753 $ 23,583
Interest-bearing deposits in banks -- 311
Federal Funds Sold 27,134 13,353
-------- --------
Total cash and cash equivalents 48,887 37,247
Securities - available for sale (Note 3) 185,604 168,161
Other Securities, at cost (Note 3) 4,313 4,016
Loans, net (Note 4) 523,474 498,580
Premises and equipment (Note 5) 17,051 14,189
Goodwill (Note 2) 4,007 --
Other assets (Note 2, 6 & 10) 20,638 14,903
-------- --------
TOTAL ASSETS $803,974 $737,096
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits (Note 7)
Noninterest-bearing $ 75,670 $ 60,211
Interest-bearing
NOW accounts 105,471 88,235
Savings 129,080 123,176
Time (Note 7) 324,372 313,787
-------- --------
Total deposits 634,593 585,409
Securities sold under agreement to repurchase (Note 8) 41,329 34,818
FHLB Advances (Note 9) 31,816 23,233
Dividend payable 795 774
Accrued expenses and other liabilities 6,066 5,130
-------- --------
Total liabilities 714,599 649,364
-------- --------
STOCKHOLDERS' EQUITY (NOTE 14 AND 15)
Common stock - No par value - 6,500,000 shares
authorized; 5,200,000 shares issued & outstanding 12,677 12,677
Treasury Stock - 256,160 Shares 2007, 36,180 Shares 2006 (5,366) (816)
Unearned Stock Awards - 17,240 Shares 2007, 9,820 Shares 2006 (391) (244)
Retained earnings 81,575 77,089
Accumulated other comprehensive income (Loss) 880 (974)
-------- --------
Total stockholders' equity 89,375 87,732
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $803,974 $737,096
======== ========
See Notes to Consolidated Financial Statements
38
CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(000'S OMITTED)
2007 2006 2005
---------- ----------- ----------
INTEREST INCOME
Loans, including fees $ 37,429 $ 35,069 $ 31,388
Debt securities:
U.S. Treasury and government agency 5,813 4,615 4,142
Municipalities 1,635 2,086 2,121
Dividends 266 227 185
Federal funds sold 264 259 9
Other 17 13 256
---------- ----------- ----------
Total interest income 45,424 42,269 38,101
INTEREST EXPENSE
Deposits 18,402 15,847 11,844
Federal funds purchased and securities sold
under agreements to repurchase 2,003 1,420 799
Borrowed funds 1,317 1,268 896
---------- ----------- ----------
Total interest expense 21,722 18,535 13,539
---------- ----------- ----------
NET INTEREST INCOME - Before provision for loan losses 23,702 23,734 24,562
PROVISION FOR LOAN LOSSES (Note 4) 871 525 (425)
---------- ----------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 22,831 23,209 24,987
NONINTEREST INCOME
Customer service fees 3,201 3,548 3,618
Other service charges and fees 2,569 2,212 2,109
Net gain on sale of loans (Note 6) 617 683 704
Net gain (loss) on sale of available-for-sale securities -- (10) 9
---------- ----------- ----------
Total noninterest income 6,387 6,433 6,440
NONINTEREST EXPENSES
Salaries and Wages 8,084 8,304 8,411
Employee benefits (Note 11) 2,804 2,456 2,275
Occupancy expense 564 605 656
Furniture and equipment 1,321 1,421 1,492
Data processing 1,019 998 1,013
Franchise taxes 873 839 817
Mortgage servicing rights amortization (Note 6) 257 263 293
Other general and administrative 3,734 3,513 4,692
---------- ----------- ----------
Total other operating expenses 18,656 18,399 19,649
---------- ----------- ----------
INCOME BEFORE INCOME TAXES 10,562 11,243 11,778
INCOME TAXES (NOTE 10) 2,828 3,107 3,202
---------- ----------- ----------
NET INCOME $ 7,734 $ 8,136 $ 8,576
========== =========== ==========
EARNINGS PER SHARE - BASIC AND DILUTED $ 1.52 $ 1.57 $ 1.65
========== =========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 5,097,636 5,186,329 5,198,728
========== =========== ==========
See Notes to Consolidated Financial Statements
39
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS END DECEMBER 31, 2007, 2006 AND 2005
(000'S OMITTED, EXCEPT PER SHARE DATA)
Accumulated
Shares of Unearned Other Total
Common Common Treasury Stock Retained Comprehensive Stockholders'
Stock Stock Stock Awards Earnings Income (Loss) Equity
--------- ------- -------- -------- -------- ------------- -------------
BALANCE - January 1, 2005 5,200,000 $12,677 $ -- $ -- $65,956 $ 212 $78,845
Comprehensive income (Note 1):
Net income -- -- -- -- 8,576 -- 8,576
Change in net unrealized gain on securities
available for sale, net of
reclassification adjustment and tax effects (2,119) (2,119)
-------
Total comprehensive income 6,457
Purchase of Treasury Stock 4000 shares (4,000) (115) -- (115)
Grant of Restricted Stock Awards-4000 shares
(Net of Forfeiture - 80) 3,920 113 (113) --
Cash dividends declared - $0.50 per share -- -- -- -- (2,599) -- (2,599)
--------- ------- ------- ----- ------- ------- -------
BALANCE - December 31, 2005 5,199,920 12,677 (2) (113) 71,933 (1,907) 82,588
Comprehensive income (Note 1):
Net income -- -- -- -- 8,136 -- 8,136
Change in net unrealized gain on securities
available for sale, net of reclassification
adjustment and tax effects 933 933
-------
Total comprehensive income 9,069
Purchase of Treasury Stock (42,000) (945) -- (945)
Grant of Restricted Stock Awards-6100 shares
(Net of Forfeiture - 200) 5,900 131 (131) --
Cash dividends declared - $0.575 per share -- -- -- -- (2,980) -- (2,980)
--------- ------- ------- ----- ------- ------- -------
BALANCE - December 31, 2006 5,163,820 12,677 (816) (244) 77,089 (974) 87,732
Comprehensive income (Note 1):
Net income -- -- -- -- 7,734 -- 7,734
Change in net unrealized gain on securities
available for sale, net of reclassification
adjustment and tax effects 1,854 1,854
-------
Total comprehensive income 9,588
Purchase of Treasury Stock (228,000) (4,710) -- (4,710)
Shares issued for vested stock awards 600 -- 13 13
Grant of Restricted Stock Awards-8760 shares
(Net of Forfeiture - 740 Vested - 600) 7,420 160 (160) --
Cash dividends declared - $0.64 per share -- -- -- -- (3,248) -- (3,248)
--------- ------- ------- ----- ------- ------- -------
BALANCE - December 31, 2007 4,943,840 $12,677 $(5,366) $(391) $81,575 $ 880 $89,375
========= ======= ======= ===== ======= ======= =======
See notes to Consolidated Financial Statements
40
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(000'S OMITTED, EXCEPT PER SHARE DATA)
2007 2006 2005
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,734 $ 8,136 $ 8,576
Adjustments to reconcile net income to net cash from operating
activities:
Depreciation 1,059 1,107 1,167
Amortization of servicing rights 257 263 293
Provision for loan loss 871 525 (425)
Accretion and amortization of securities 131 382 989
Deferred income taxes (benefit) (170) 282 387
(Gain) loss on sale of other assets 4 5 (2)
Realized (gain) loss on sales of available-for-sale
securities, net -- 10 (9)
Net Change in:
Loans held for sale (651) -- 175
Change in other assets and other liabilities, net (692) 2,670 (1,931)
-------- -------- --------
Net cash provided (used) by operating activities 8,543 13,380 9,220
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Sales 215 19,006 --
Maturities, prepayments and calls 80,876 61,654 38,477
Purchases (95,804) (44,382) (73,376)
Loan and lease originations and principal collections, net 6,620 (41,630) 13,732
Proceeds from sales of assets -- 1 18
Additions to premises and equipment (2,675) (428) (539)
Purchase of Bank Owned Life Insurance (3,000) -- --
Net cash paid for acquisition (2,400) -- --
-------- -------- --------
Net cash provided (used) by investing activities (16,168) (5,779) (21,688)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 12,108 9,112 2,092
Net change in federal funds purchased and securities
sold under agreements to repurchase 6,511 13,660 (1,694)
Proceeds from issuance of long-term debt 15,000 -- 15,000
Repayment of long-term debt (6,417) (11,720) (2,012)
Purchase of Treasury Stock (4,710) (945) (115)
Cash dividends paid on common stock (3,227) (3,050) (2,470)
-------- -------- --------
Net cash provided (used) by financing activities 19,265 7,057 10,801
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 11,640 14,658 (1,667)
CASH AND CASH EQUIVALENTS - Beginning of Year 37,247 22,589 24,256
-------- -------- --------
CASH AND CASH EQUIVALENTS - End of Year $ 48,887 $ 37,247 $ 22,589
======== ======== ========
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest $ 21,721 $ 18,235 $ 13,227
======== ======== ========
Income taxes $ 3,120 $ 2,757 $ 2,640
======== ======== ========
See Notes to Consolidated Financial Statements
41
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 (the Bank) provides a
variety of financial services to individuals and small businesses
through its offices in Northwest Ohio and Northeast Indiana.
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. The Farmers & Merchants Life Insurance
Company was dissolved during 2007 with the Bank no longer offering the
insurance product. 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 near 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 an
original 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.
42
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain average balances on hand with the
Federal Reserve Bank. The aggregate reserve was $1.5 million for
December 31, 2007 and it was $4.6 million for December 31, 2006.
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.
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 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 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 Company 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 AND FEDERAL RESERVE BANK STOCK
The Federal Home Loan Bank and Federal Reserve Bank stock are recorded
at cost since they are restricted stocks. The Federal Home Loan Bank
and Federal Reserve Bank sell and purchase their stock at par;
therefore cost approximates market value. The Federal Home Loan Bank
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.
43
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
collectability of the loans in light of historical experiences, the
nature and volume of the loan portfolio, adverse situations that may
affect the borrower's ability to repay, estimated value of any
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 component relates to loans that are
classified as 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
price) of the impaired loan is lower than 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 expense in proportion to, and over the
period of, the estimated future net servicing income of the underlying
financial assets.
44
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.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill results from business acquisitions and represents the excess
of the purchase price over the fair value of acquired tangible assets
and liabilities and identifiable intangible assets. Goodwill is
assessed at least annually for impairment and any such impairment is
recognized in the period identified.
Other intangible assets consist of core deposit intangible assets
arising from business acquisitions. They are initially measured at
fair value and then are amortized on a straight line method over their
estimated useful lives.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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.
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 represent income available to common
stockholders divided by the weighted-average number of common shares
outstanding during the period. Basic and dilutive earnings per share
are the same as the restricted stock grants are primarily
anti-dilutive.
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
45
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)
-------------------------
2007 2006 2005
------ ------ -------
Net Unrealized gain (loss) on
available-for-sale securities $2,810 $1,404 $(3,202)
Tax Effect (956) (478) 1,089
------ ------ -------
Net-of-tax amount 1,854 926 (2,113)
------ ------ -------
Reclassification adjustment for gain on sale of
available-for-sale securities $ -- $ 10 $ (9)
Tax Effect -- (3) 3
------ ------ -------
Net-of-tax amount -- 7 (6)
------ ------ -------
Other comprehensive income $1,854 $ 933 $(2,119)
====== ====== =======
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS 157, "Fair Value Measurement."
This statement clarifies the definition of fair value, establishes a
framework for measuring fair value, and expands the disclosures on
fair value measurements. This Statement applies to other accounting
pronouncements that require or permit fair value measurements and does
not require any new fair value measurements. SFAS 157 is effective for
fiscal years beginning after November 15, 2007. The Company has not
determined the impact the adoption of SFAS 157 will have on the
financial statements.
In September 2006, the FASB ratified the Emerging Issues Task Force's
(EITF) Issue 06-4, Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance Arrangements, which requires companies to recognize a
liability and related compensation costs for endorsement split-dollar
life insurance policies that provide a benefit to an employee
extending to postretirement periods. The liability should be
recognized based on the substantive agreement with the employee. This
Issue is effective beginning January 1, 2008. The Issue can be applied
as either a change in accounting principle through a cumulative-
effect adjustment to retained earnings as of the beginning of the year
of adoption, or a change in accounting principle through retrospective
application to all periods. The Company is in the process of
evaluating the impact the adoption of Issue 06-4 will have on the
financial statements.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATION
Certain amounts in the 2006 and 2005 consolidated financial statements
have been reclassified to conform with the 2007 presentation.
The Company's Board of Directors declared a 4 for 1 stock split
effective May 12, 2006. Therefore, all references in the financial
statements and other disclosures related to the number of shares and
per share amounts of the Company's stock have been retroactively
restated to reflect the increased number of shares outstanding.
NOTE 2 - BUSINESS COMBINATION
On December 31, 2007, the Bank acquired 100% of the outstanding shares
of Knisely Bank. Knisely Bank was merged with and into the Bank, and
the Knisely Bank offices now operate as branches of the Bank. The
merger enabled the Company to increase its market share in a community
contiguous to its existing markets.
The aggregate acquisition cost of Knisely Bank was $10.4 million,
which was all paid in cash. Direct acquisition costs approximated $155
thousand. The acquisition cost in excess of the net assets and
identifiable intangible assets acquired, has been recorded as goodwill
of $4 million. Goodwill that is deductible for tax purposes is
approximately $3.85 million. Minor adjustments to the total purchase
price allocation, and thus goodwill, are possible as fair value
allocations are finalized and final billings related to the
acquisition are received.
46
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed on December 31, 2007:
(Dollars in Thousands)
Cash and Cash Equivalents $ 3,517
Federal Funds Sold 4,637
Securities 50
Other Securities 297
Loans, Net of Allowance 31,734
Premises and Equipment 1,250
Core Deposit Intangible Asset 1,100
Goodwill 4,007
Other Assets 1,425
-------
Total Assets Acquired $48,017
=======
Deposits $37,076
Other Liabilities 387
-------
Total Liabilities Assumed $37,463
=======
Net Assets Acquired $10,554
=======
NOTE 2 - BUSINESS COMBINATION (CONTINUED)
In connection with the acquisition, the Company recognized core
deposit intangible assets of $1.1 million, which are being amortized
on a straight line basis over the estimated remaining economic useful
life of the deposits of 7 years. There was no amortization of the core
deposit intangibles for the year ended December 31, 2007. Amortization
of the core deposit intangibles is scheduled to be as follows:
(In Thousands)
----------------------
2008 $ 157
2009 157
2010 157
2011 157
2012 157
Thereafter 315
------
$1,100
======
47
The consolidated statements of income include the results of Knisely
Bank since the effective date of the acquisition. The following table presents
pro forma information for the years ended December 31, 2007, 2006 and 2005 as if
the acquisition had been completed as of the beginning of the years presented.
The pro forma financial information is not necessarily indicative of the results
of operations as they would have been, had the transaction been in effect on the
assumed dates.
(In Thousands , except per share data)
For Year Ending December 31,
--------------------------------------
2007 2006 2005
------- ------- -------
Total Revenues $55,016 $51,741 $47,245
* Net Income $ 8,055 $ 8,432 $ 8,868
Basic EPS $ 1.58 $ 1.63 $ 1.71
Diluted EPS $ 1.58 $ 1.63 $ 1.71
* Knisely Bank was a Subchapter S Corporate filer. The Net Income has been
adjusted using a 34% tax rate.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities, with gross unrealized
gains and losses, follows:
(In Thousands)
2007
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
Available-for-Sale:
U.S. Treasury $ -- $ -- $ -- $ --
U.S. Government agency 103,512 1,321 96 104,737
Mortgage-backed securities 39,461 187 281 39,367
State and local governments 41,264 302 99 41,467
Equity securities 33 -- -- 33
-------- ------ ---- --------
$184,270 $1,810 $476 $185,604
======== ====== ==== ========
NOTE 3 - SECURITIES (CONTINUED)
(In Thousands)
-----------------------------------------------
2006
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
Available-for-Sale:
U.S. Treasury $ 388 $ -- $ 1 $ 387
U.S. Government agency 91,656 131 819 90,968
Mortgage-backed securities 31,911 16 663 31,264
State and local governments 45,636 240 381 45,495
Equity securities 47 -- -- 47
-------- ---- ------ --------
$169,638 $387 $1,864 $168,161
======== ==== ====== ========
48
Information pertaining to securities with gross unrealized losses at
December 31, 2007 and 2006, aggregated by investment category and
length of time that individual securities have been in a continuous
loss position follows:
2007
-------------------------------------------------
(In Thousands) (In Thousands)
Less Than Twelve Months Twelve Months & Over
----------------------- -----------------------
Gross Gross
Unrealized Unrealized
Losses Fair Value Losses Fair Value
---------- ---------- ---------- ----------
U S Treasury $- $ -- $ -- $ --
U S Government agency - 991 96 20,897
Mortgage-backed securities 2 5,079 279 13,803
State and local governments 4 1,621 95 13,117
2006
-------------------------------------------------
(In Thousands) (In Thousands)
Less Than Twelve Months Twelve Months & Over
----------------------- -----------------------
Gross Gross
Unrealized Unrealized
Losses Fair Value Losses Fair Value
---------- ---------- ---------- ----------
U S Treasury $- $ 99 $ 1 $ 174
U S Government agency 18 13,944 801 58,457
Mortgage-backed securities 2 710 661 21,801
State and local governments 35 7,442 346 22,182
Unrealized losses on securities have not been 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.
The gross realized gains and losses for the years ended December 31,
are presented below:
(In Thousands)
------------------
2007 2006 2005
---- ---- ----
Gross realized gains $- $ 27 $9
Gross realized losses - (37) --
-- ---- --
Net Realized Gains (Losses) $- $(10) $9
== ==== ==
Tax expense (benefit) related to net realized gains (losses) $- $ (3) $3
== ==== ==
49
NOTE 3 - SECURITIES (CONTINUED)
The amortized cost and fair value of debt securities at December 31,
2007, 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 $ 24,636 $ 24,623
After one year through five years 57,647 57,978
After five years through ten years 64,003 64,878
After ten years 37,951 38,092
-------- --------
184,237 185,571
Equity securities 33 33
-------- --------
Total $184,270 $185,604
======== ========
Investments with a carrying value and fair value of $161.9 million at
December 31, 2007 and $142.9 million at December 31, 2006 were pledged
to secure public deposits and securities sold under repurchase
agreements.
Other securities as of December 31, 2007, include Federal Home Loan
Bank and Federal Reserve Bank stock. December 31, 2006, included only
Federal Home Loan Bank stock.
NOTE 4 - LOANS
Loans at December 31 are summarized below:
(In Thousands)
-------------------
2007 2006
-------- --------
Loans:
Commercial Real Estate $181,340 $162,363
Ag Real Estate 45,518 49,564
Consumer Real Estate 102,660 86,688
Commercial and industrial 104,188 101,788
Agricultural 58,809 69,301
Consumer, Overdrafts and other loans 27,796 27,388
Industrial Development Bonds 9,289 7,335
-------- --------
529,600 504,427
Less: Deferred loan fees and costs (204) (253)
-------- --------
529,396 504,174
Less: Allowance for loan losses (5,922) (5,594)
-------- --------
Loans - Net $523,474 $498,580
======== ========
50
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
-------- ---------- ----------
Commercial Real Estate $ 6,298 $27,770 $147,272
Ag Real Estate 250 2,503 42,765
Consumer Real Estate 7,846 12,686 82,128
Commercial and industrial loans 53,659 27,647 22,882
Agricultural 42,030 13,129 3,650
Consumer, Master Card and Overdrafts 6,658 16,538 4,600
Industrial Development Bonds 19 7,823 1,447
The distribution of fixed rate loans and variable rate loans by major loan
category is as follows as of December 31, 2007:
(In Thousands)
------------------
Fixed Variable
Rate Rate
------- --------
Commercial Real Estate $39,649 $141,691
Ag Real Estate 5,653 39,865
Consumer Real Estate 37,782 64,878
Commercial and industrial loans 36,779 67,409
Agricultural 23,390 35,419
Consumer, Master Card and Overdrafts 25,572 2,224
Industrial Development Bonds 9,289 --
One to four family residential mortgage loans amounting to $80.4
million have been pledged as security for loans the Bank has received
from the Federal Home Loan Bank.
As of December 31, 2007 and 2006 there were $23.4 and $10.6 million,
respectively, of undisbursed loans in process.
The following is an analysis of the allowance for credit losses:
(In Thousands)
-------------------------
2007 2006 2005
------- ------ ------
Allowance for Loan Losses
Balance at beginning of year $ 5,594 $5,388 $6,814
Provision for loan loss 871 525 (425)
Loans charged off (1,576) (985) (2,096)
Recoveries 732 666 1,095
Acquisition allowance for loan loss 301 -- --
------- ------ ------
Allowance for Loan & Leases Losses $ 5,922 $5,594 $5,388
======= ====== ======
Allowance for Unfunded Loan Commitments &
Letters of Credit $ 156 $ 168 $ 841
------- ------ ------
Total Allowance for Credit Losses $ 6,078 $5,762 $6,229
======= ====== ======
The Company segregates its Allowance for Loan and Lease Losses (ALLL)
into two reserves: 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).
51
NOTE 4 - LOANS (CONTINUED)
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)
---------------
2007 2006
------ ------
Impaired loans without a valuation allowance $4,648 $1,587
Impaired loans with a valuation allowance 4,619 3,095
------ ------
Total impaired loans $9,267 $4,682
====== ======
Valuation allowance related to impaired loans $1,642 $ 838
Total non-accrual loans $4,918 $4,254
Total loans past-due ninety days or more and still accruing $ -- $ --
(In Thousands)
------------------------
2007 2006 2005
------ ------ ------
Average investment in impaired loans $6,975 $6,588 $9,926
====== ====== ======
Interest income recognized on impaired loans $ 592 $ 288 $ 480
====== ====== ======
Interest income recognized on a cash basis on impaired loans $ 161 $ 167 $ 473
====== ====== ======
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)
-------------------
2007 2006
-------- --------
Land $ 3,411 $ 2,811
Buildings (useful life 15-39 years) 17,224 15,100
Furnishings (useful life 3-15 years) 9,843 8,960
-------- --------
30,478 26,871
Less: Accumulated depreciation (13,427) (12,682)
-------- --------
Premises and Equipment (Net) $ 17,051 $ 14,189
======== ========
52
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 $252 and $251 million at December 31, 2007
and 2006, respectively.
The balance of capitalized servicing rights included in other assets
at December 31, 2007 and 2006, was $1.9 and $1.8 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, 2007 and 2006 was $2.4 and $2.2 million, respectively.
The valuations were completed by stratifying the loans into like
groups based on loan type, term and new versus seasoned. Impairment
was measured by estimating the fair value of each stratum, taking into
consideration an estimated level of prepayment based upon current
market conditions. An average constant prepayment rate of 8.9 and 10.0
were utilized for 2007 and 2006, respectively. All stratums showed
positive values compared to carrying value using a discount yield of
8.2% for 2007 and 8.5% for 2006.
The following summarizes mortgage servicing rights capitalized and
amortized during each year:
(In Thousands)
---------------
2007 2006
------ ------
Beginning Year $1,798 $1,690
Capitalized Additions 352 371
Amortization (257) (263)
Valuation Allowance -- --
------ ------
End of Year $1,893 $1,798
====== ======
NOTE 7 - DEPOSITS
Time deposits at December 31 consist of the following:
(In Thousands)
-------------------
2007 2006
-------- --------
Time deposits under $100,000 $244,916 $235,710
Time deposits of $100,000 or more 79,456 78,077
-------- --------
$324,372 $313,787
======== ========
At December 31, 2007 the scheduled maturities for time deposits are as
follows:
(In Thousands)
--------------
2008 $273,651
2009 38,853
2010 9,368
2011 853
2012 634
thereafter 1,013
--------
$324,372
========
53
NOTE 8 - SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
The Bank's policy requires qualifying securities to be used as
collateral for the underlying repurchase agreements. As of December
31, 2007 and 2006 securities with a book value of $64.3 million and
$45.6 million, respectively, were underlying the repurchase agreements
and were under the Bank's control.
NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES
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 2.92% to 7.05%. Total
borrowings were $31.8 and $23.0 million for 2007 and 2006,
respectively. Notes are secured by a blanket lien on 100% of the one
to four family residential mortgage loan portfolios (Note 4).
The following is a schedule by years of future minimum principal
payments:
(In Thousands)
--------------
2008 $ 5,711
2009 5,464
2010 10,346
2011 5,225
2012 5,070
thereafter --
-------
$31,816
=======
NOTE 10 - FEDERAL INCOME TAXES
The components of income tax expense for the years ended December 31
are as follows:
(In Thousands)
------------------------
2007 2006 2005
------ ------ ------
Current:
Federal $2,998 $2,825 $2,815
Deferred:
Federal (170) 282 387
------ ------ ------
$2,828 $3,107 $3,202
====== ====== ======
The following is a reconciliation of the statutory federal income tax
rate to the effective tax rate:
(In Thousands)
------------------------
2007 2006 2005
------ ------ ------
Income tax at statutory rates $3,591 $3,826 $4,004
Increase(decrease) resulting from:
Tax exempt interest (650) (749) (784)
Change in prior estimates and other (113) 30 (18)
------ ------ ------
$2,828 $3,107 $3,202
====== ====== ======
54
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities at December 31 are comprised of
the following:
(In Thousands)
---------------
2007 2006
------ ------
Deferred Tax Assets:
Allowance for loan losses $2,013 $1,902
Net unrealized loss on available-for-sale securities -- 503
Other 369 249
------ ------
Total deferred tax assets 2,382 2,654
Deferred Tax Liabilities:
Accreted discounts on bonds 74 74
FHLB stock dividends 798 798
Mortgage servicing rights 641 610
Other 432 506
Net unrealized gain on available-
for-sale securities 454 --
------ ------
Total deferred tax liabilities 2,399 1,988
------ ------
Net Deferred Tax Asset (Liability) $ (17) $ 666
====== ======
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 $575,
$611, and $608 thousand for 2007, 2006 and 2005, respectively.
The Company has a Long-Term Stock Incentive Plan under which 8,000
shares of restricted stock were issued to 44 employees during 2007,
6,000 shares were issued to 40 employees during 2006 and 4,000 shares
were issued to 38 employees during 2005. Under the plan, the shares
vest 100% in three years. Due to employee termination, there were 740
shares forfeited during 2007, 200 shares forfeited during 2006 and 80
shares forfeited during 2005. During 2007, 600 shares had vesting
accelerated and were paid to a retiring officer. Compensation expense
applicable to the restricted stock totaled $104, $60 and $14 thousand
for the year ended December 31, 2007, 2006 and 2005, respectively.
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 $21.3 and $20.9 million at December 31, 2007 and 2006,
respectively. Loans made during 2007 were $117.9 million and
repayments were $117.5 million. Their difference in related borrowings
amounted to $409 thousand, net addition. Deposits of directors,
executive officers and companies in which they have a direct or
indirect ownership as of December 31, 2007 and 2006 amounted to $28.2
million and $27.6 million, respectively.
In 2007, one director resigned from the Board and an executive officer
also retired. During 2005, two directors retired from the Board and
two directors were added.
55
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, 2007 and 2006 was $156 thousand and $168 thousand,
respectively. At December 31, 2007 and 2006, the following financial
instruments were outstanding whose contract amounts represent credit
risk:
(In Thousands)
-------------------
2007 2006
-------- --------
Commitments to extend credit $133,529 $132,477
Credit card arrangements 16,132 16,098
Standby letters of credit 13,742 11,900
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.
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 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
56
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, 2007,
that the Bank meets all the capital adequacy requirements to which it
is subject.
NOTE 14 - MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
As of December 31, 2007 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 to follow. There are no conditions or
events since the most recent notification that management believes
have changed the Bank's prompt corrective action category.
The Company and the Bank's actual and required capital amounts and
ratios as of December 31, 2007 and 2006 are as follows:
To Be Well
Capitalized
Under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------- ----------------- -----------------
(000's) (000's) (000's)
As of December 31, 2007 Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $90,565 15.51% $46,726 8.00% N/A N/A
Farmers & Merchants State Bank 90,627 15.51% 46,736 8.00% $58,421 10.00%
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated 84,488 14.47% 23,363 4.00% N/A N/A
Farmers & Merchants State Bank 69,550 11.91% 23,368 4.00% 35,052 6.00%
Tier 1 Capital
(to Adjusted Total Assets)
Consolidated 84,488 11.49% 29,407 4.00% N/A N/A
Farmers & Merchants State Bank 69,550 9.47% 29,382 4.00% 36,728 5.00%
57
To Be Well
Capitalized
Under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------- ----------------- -----------------
(000's) (000's) (000's)
As of December 31, 2006 Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $94,468 17.27% $43,753 8.00% N/A N/A
Farmers & Merchants State Bank 93,179 17.04% 43,753 8.00% $54,691 10.00%
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated 88,706 16.22% 21,876 4.00% N/A N/A
Farmers & Merchants State Bank 72,417 13.24% 21,876 4.00% 32,815 6.00%
Tier 1 Capital
(to Adjusted Total Assets)
Consolidated 88,706 12.40% 28,625 4.00% N/A N/A
Farmers & Merchants State Bank 72,417 10.13% 28,585 4.00% 35,731 5.00%
NOTE 15 - RESTRICTIONS OF DIVIDENDS & INTER-COMPANY 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 $10.55 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. 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.
58
The estimated fair values, and related carrying or notional amounts,
for on and off-balance sheet financial instruments as of December 31, 2007
and 2006 are reflected below.
(In Thousands)
-----------------------------------------
2007 2006
------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
Financial Assets:
Cash and Cash Equivalents $ 21,753 $ 21,753 $ 23,894 $ 23,894
Securities - available for sale 185,604 185,604 168,161 168,161
Other Securities 4,313 4,313 4,016 4,016
Loans, net 523,474 524,773 498,580 497,866
Interest receivable 5,343 5,343 5,244 5,244
Loans held for sale -- -- -- --
Financial Liabilities:
Deposits $634,593 $631,020 $585,409 $583,955
Short-term debt
Federal funds purchased -- -- -- --
Repurchase agreement sold 41,329 41,329 34,818 34,818
Long term debt 31,816 32,035 23,233 23,233
Interest payable 1,492 1,492 1,491 1,491
Dividends payable 795 795 774 774
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 CASH EQUIVALENTS
The carrying amounts reported in the balance sheet for cash, cash
equivalents and federal funds sold approximate their fair values. Also
included in this line item are the carrying amounts of
interest-bearing
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
deposits maturing within ninety days which 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 OTHER SECURITIES
Fair values for securities, excluding Federal Home Loan Bank stock and
Federal Reserve 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 and Federal Reserve Bank stock
approximates fair value based on the redemption provisions of the
Federal Home Loan Bank and the Federal Reserve Bank.
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. The loans which were added to
the balance sheet for the December 31, 2007 acquisition were valued
59
separately by an independent third party. A fair value adjustment of
$13 thousand discount was applied to outstanding balances of $32.3
million.
LOANS HELD FOR SALE
Fair values for loans 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 flow 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.
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.
60
NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
BALANCE SHEET
(In Thousands)
-----------------
2007 2006
------- -------
ASSETS
Cash $ 603 $ 916
Related party receivables:
Dividends & Accounts receivable from subsidiaries 801 810
Note receivable from Bank subsidiary 15,000 15,000
Investment in subsidiaries 74,437 72,036
------- -------
TOTAL ASSETS $90,841 $88,762
======= =======
LIABILITIES
Accrued expenses $ 671 $ 256
Dividends payable 795 774
------- -------
Total Liabilities 1,466 1,030
------- -------
STOCKHOLDERS' EQUITY
Common stock - No par value - 6,500,000 shares
authorized; 5,200,000 shares issued 12,677 12,677
Treasury Stock - 256,160 shares, 36,180 shares (5,366) (816)
Unearned Stock Awards - 17,240 shares, 9,820 shares (391) (244)
Retained earnings 81,575 77,089
Accumulated other comprehensive income (Loss) 880 (974)
------- -------
Total Stockholders' Equity 89,375 87,732
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $90,841 $88,762
======= =======
STATEMENT OF INCOME
(In Thousands)
------------------------
2007 2006 2005
------ ------ ------
INCOME
Dividends from subsidiaries $6,238 $3,985 $2,855
Interest 712 713 713
------ ------ ------
Total Income 6,950 4,698 3,568
OPERATING EXPENSES 383 353 344
------ ------ ------
INCOME BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED EARNINGS AND SUBSIDIARIES 6,567 4,345 3,224
INCOME TAXES 105 148 132
------ ------ ------
6,462 4,197 3,092
Equity in undistributed earnings
of subsidiaries 1,272 3,939 5,484
------ ------ ------
NET INCOME $7,734 $8,136 $8,576
====== ====== ======
61
NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (CONTINUED)
STATEMENTS OF CASHFLOWS
(In Thousands)
--------------------------
2007 2006 2005
------- ------- ------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,734 $ 8,136 $8,576
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Equity in undistributed net income
of subsidiaries (1,272) (3,939) (5,484)
Changes in Assets and Liabilities:
Account receivable 35 (35) --
Dividends receivable (26) 325 (800)
Other Liabilities 428 99 (33)
------- ------- ------
Net Cash Provided by Operating Activities 6,899 4,586 2,259
CASH FLOWS FROM INVESTING ACTIVITIES
Return of Capital from Investment in Subsidiary 725
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of dividends (3,227) (3,050) (2,470)
Purchase of Treasury Stock (4,710) (945) (115)
------- ------- ------
Net Change in Cash and Cash Equivalents (313) 591 (326)
CASH AND CASH EQUIVALENTS
Beginning of year 916 325 651
------- ------- ------
CASH AND CASH EQUIVALENTS
End of year $ 603 $ 916 $ 325
======= ======= ======
62
(000S OMITTED EXCEPT PER SHARE DATA)
Quarterly Financial Data - UNAUDITED
Quarter Ended in 2007
-------------------------------------------------
Mar 31 June 30 Sep 30 Dec 31
---------- ---------- ---------- ----------
Summary of Income:
Interest income $ 11,389 $ 11,369 $ 11,384 $ 11,282
Interest expense 5,175 5,370 5,577 5,600
---------- ---------- ---------- ----------
Net Interest Income 6,214 5,999 5,807 5,682
Provision for loan loss (19) 154 309 427
---------- ---------- ---------- ----------
Net interest income after
provision for loan loss 6,233 5,845 5,498 5,255
Other income (expense) (3,342) (3,076) (3,171) (2,680)
---------- ---------- ---------- ----------
Net income before income taxes 2,891 2,769 2,327 2,575
Income taxes 815 778 623 612
---------- ---------- ---------- ----------
Net income $ 2,076 $ 1,991 $ 1,704 $ 1,963
========== ========== ========== ==========
Earnings per Common Share $ 0.40 $ 0.39 $ 0.33 $ 0.40
========== ========== ========== ==========
Average common shares outstanding 5,149,967 5,117,901 5,093,169 5,031,867
========== ========== ========== ==========
Quarter Ended in 2006
-------------------------------------------------
Mar 31 June 30 Sep 30 Dec 31
---------- ---------- ---------- ----------
Summary of Income:
Interest income $ 10,067 $ 10,405 $ 10,731 $ 11,066
Interest expense 4,160 4,385 4,837 5,153
---------- ---------- ---------- ----------
Net Interest Income 5,907 6,020 5,894 5,913
Provision for loan loss (50) 15 652 (92)
---------- ---------- ---------- ----------
Net interest income after
provision for loan loss 5,957 6,005 5,242 6,005
Other income (expense) (3,192) (3,317) (2,336) (3,121)
---------- ---------- ---------- ----------
Net income before income taxes 2,765 2,688 2,906 2,884
Income taxes 747 721 789 850
---------- ---------- ---------- ----------
Net income $ 2,018 $ 1,967 $ 2,117 $ 2,034
========== ========== ========== ==========
Earnings per common share $ 0.390 $ 0.380 $ 0.410 $ 0.390
========== ========== ========== ==========
Average common shares outstanding 5,195,920 5,192,689 5,185,883 5,170,000
========== ========== ========== ==========
63
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTING AND FINANCIAL DISCLOSURE
No disagreements exist on accounting and financial disclosures or
related matters.
ITEM 9A. CONTROLS AND PROCEDURES
Management Report Regarding Disclosure Controls and 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, 2007, 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, 2007, 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.
64
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.
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, 2007.
There was no change in the company's internal control over financial reporting
that occurred during the Company's fiscal quarter ended December 31, 2007 that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
February 21, 2008
Farmers & Merchants Bancorp, Inc. and Subsidiaries
/s/ Paul S. Siebenmorgen
-----------------------------------------------
Paul S. Siebenmorgen, President/CEO
/s/ Barbara J. Britenriker
-----------------------------------------------
Barbara J. Britenriker, Chief Financial Officer
65
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
---- --- ------------------------------ ----------
Dexter Benecke 65 President, Freedom Ridge, Inc 1999
Joe E. Crossgrove(1) 71 Chairman of the Corporation and 1992
The Farmers & Merchants State Bank
Steven A. Everhart 53 Secretary/Treasurer, MBC Holdings, Inc 2003
Robert G. Frey 67 President, E.H. Frey & Sons, Inc. 1987
Jack C. Johnson 55 President, Hawk's Clothing, Inc. 1991
Dean E. Miller 64 Chairman, MBC Holdings, Inc. 1986
Anthony J. Rupp 58 President, Rupp Furniture Co. 2000
David P. Rupp Jr. (3) 66 Attorney 2001
James C. Saneholtz 61 President, Saneholtz-McKarns, Inc. 1995
Kevin J. Sauder 47 President, Chief Executive Officer 2004
Sauder Woodworking Company
Merle J. Short 67 Chairman ProMow, Inc. 1987
Paul S. Siebenmorgen(4) 58 President and CEO of the Corporation and 2005
the Farmers & Merhcants State Bank
Steven J. Wyse 63 Private Investor 1991
Steven J Planson(2) 48 Self-employed Farmer 2008
(1) Mr. Crossgrove discontinued full time employment from The Farmers &
Merchants State Bank as of December 31, 2006. He remains Chairman of the
Corporation and The Farmers & Merchants State Bank.
(2) Mr. Planson was appointed to the Board of Directors of the Company and The
Farmers & Merchants State Bank on January 10, 2008.
(3) David P Rupp Jr. is an attorney with membership in the law firm of
Plassman, Rupp, Short & Hagans of Archbold, Ohio. The law firm has been
retained by the Corporation, and its subsidiaries, during the past twenty
years and is to be retained currently.
(4) Mr. Siebenmorgen became the President and CEO of the Corporation and the
Bank effective February 18, 2005. From June, 2004 to February 18, 2005 he
was Senior Executive Vice President and Chief Lending Officer of the Bank
and was not a member of the Board of Directors of the Corporation or the
Bank. Prior to joining the Corporation in June 2004 Mr. Siebenmorgen was
Senior Vice President of Lincoln Bank, Plainfield, Indiana.
66
EXECUTIVE OFFICERS
Principal Occupation & offices Held with
Name Age Corporation & Bank for Past Five Years
---- --- ----------------------------------------
Joe E. Crossgrove 71 Chairman
Paul S. Siebenmorgen 58 President & Chief Executive Officer
Rex D. Rice 49 Executive Vice President
Senior Commercial Loan Officer
Edward A. Leininger 51 Executive Vice President
Chief Operating Officer
Barbara J. Britenriker 46 Executive Vice President
Chief Financial 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 17, 2008,
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 Code 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. Paul S. Siebenmorgen, 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
17, 2008, and is incorporated herein by reference.
67
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 17, 2008, and is incorporated herein by reference.
On April 23, 2005 the Company's shareholders approved the Farmers & Merchants
Bancorp, Inc. 2005 Long-Term Stock Incentive Plan. The plan authorizes the
issuance of up to 800,000 of the Company's common shares in the form of stock
options, restricted stock, performance shares, and unrestricted stock to
employees of the Company and its subsidiaries. During 2005, 4,000 shares of
restricted stock were issued under the plan to 38 employees of the Bank. These
grants will become completely vested in three years. Due to employee
termination, there were 80 shares forfeited during 2005. During 2006, the
Company purchased 42,000 shares and awarded 6,100 restricted shares to 41
employees. 200 shares were forfeited during 2006. 8,760 shares of restricted
stock were issued to 46 employees during 2007. Due to employee termination, 740
shares were forfeited during 2007. 600 shares had vesting accelerated and were
paid to a retiring officer. At year end, the Company held 256,160 shares in
Treasury stock and 17,240 in unearned stock awards. The Company initiated a 4:1
stock split on May 12, 2006.
EQUITY COMPENSATION PLAN INFORMATION
Number of Number of securities
securities remaining available
to be issued upon for future
exercise of issuance under equity
outstanding Weighted-average compensation plans
options, exercise price of (excluding securities
warrants outstanding options, reflected in
and rights warrants and rights column (a))
(a) (b) (c)
----------------- -------------------- ---------------------
Equity compensation plans approved by 0 $0.00 782,160
security holders
Equity compensation plans not approved
by security holders 0 $0.00 0
--- ----- -------
Total 0 $0.00 782,160
=== ===== =======
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
17, 2008, 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
17, 2008, and is incorporated herein by reference.
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
68
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) a. 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
b. Amendment to Articles of Incorporation, incorporated by
reference to the Company's Current Report on Form 8-K that
was filed with the Commission on April 26, 2006.
(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 November 27, 2007(incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on November 30, 2007).
(10.2) Change in Control Agreement executed by and between the Company
and Barbara J. Britenriker on November 27, 2007 (incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on November 30, 2007).
(10.3) Change in Control Agreement executed by and between the Company
and Edward A. Leininger on November 27, 2007 (incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on November 30, 2007).
(10.4) Change in Control Agreement executed by and between the Company
and Rex D. Rice on November 27, 2007 (incorporated by reference
to the Current Report on Form 8-K filed with the Commission on
November 30, 2007).
(10.5) 2005 Long-Term Stock Incentive Plan (incorporated by reference
to the Quarterly Report on Form 10-Q filed with the Commission on
October 27, 2005)
(10.6) Form of Restricted Stock Agreement (incorporated by reference
to the Quarterly Report on Form 10-Q filed with the Commission on
October 27, 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)
(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.
69
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 signed this report to be signed on its
behalf by the undersigned, her unto duly authorized
Date: February 27, 2008 By: /s/ Paul S. Siebenmorgen
------------------------------------
Paul S. Siebenmorgen
Chief Executive Officer
Director
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/ Paul S Siebenmorgen Date : February 27, 2008
-------------------------------------
Paul S Siebenmorgen
Chief Executive Officer
(Principal Executive Officer)
/s/ Joe E. Crossgrove Date : February 27, 2008
-------------------------------------
Joe E. Crossgrove
Director & Chairman
/s/ Anthony J. Rupp Date : February 27, 2008
-------------------------------------
Anthony J. Rupp, Director
/s/ David P. Rupp Jr. Date : February 27, 2008
-------------------------------------
David P. Rupp Jr, Director
/s/ James Saneholtz Date : February 27, 2008
-------------------------------------
James Saneholtz, Director
/s/ Merle J. Short Date : February 27, 2008
-------------------------------------
Merle J. Short, Director
/s/ Dexter Benecke Date : February 27, 2008
-------------------------------------
Dexter Benecke, Director
/s/ Steven Planson Date : February 27, 2008
-------------------------------------
Steven Planson, Director
/s/ Barbara J. Britenriker Date : February 27, 2008
-------------------------------------
Barbara J. Britenriker
Chief Financial Officer
(Principal Financial Officer/
Principal Accounting Officer
/s/ Jack C. Johnson Date : February 27, 2008
-------------------------------------
Jack C. Johnson, Director
/s/ Dean E. Miller Date : February 27, 2008
-------------------------------------
Dean E. Miller, Director
/s/ Steven A. Everhart Date : February 27, 2008
-------------------------------------
Steven A. Everhart, Director
/s/ Kevin J. Sauder Date : February 27, 2008
-------------------------------------
Kevin J. Sauder, Director
/s/ Robert G. Frey Date : February 27, 2008
-------------------------------------
Robert G. Frey , Director
/s/ Steven J. Wyse Date : February 27, 2008
-------------------------------------
Steven J. Wyse, Director
70