SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended Sepember 30, 2008
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.
(Exact name of registrant as specified in its charter)
OHIO 34-1469491
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
307-11 North Defiance Street, Archbold, Ohio 43502
(Address of principal executive offices) (Zip Code)
(419) 446-2501
Registrant's telephone number, including area code
_______________________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is 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)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares of each of the issuers classes of common stock, as
of the latest practicable date:
Common Stock, No Par Value 4,799,512
Class Outstanding as of October 30, 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10Q
FARMERS & MERCHANTS BANCORP, INC.
INDEX
Form 10-Q Items Page
--------------- -----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets-September 30, 2008 and
December 31, 2007 1
Condensed Consolidated Statements of Net Income-Three and
Nine Months Ended September 30, 2008 and September
30, 2007 2
Condensed Consolidated Statements of Cash Flows-Nine Months
Ended September 30, 2008 and September 30, 2007 3
Notes to Condensed Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 4-10
Item 3. Qualitative and Quantitative Disclosures About Market Risk 10-11
Item 4. Controls and Procedures 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 11
Item 1A. Risk Factors 11
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 11-12
Item 3. Defaults Upon Senior Securities 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 5. Other Information 12
Item 6. Exhibits 12
Signatures 12
Exhibit 31. Certifications Under Section 302 13-14
Exhibit 32. Certifications Under Section 906 15
ITEM 1 FINANCIAL STATEMENTS
FARMERS & MERCHANTS BANCORP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands of dollars)
September Dec
30, 2008 31, 2007
--------- --------
ASSETS:
Cash and due from banks $ 19,006 $ 21,753
Interest bearing deposits with banks 0 0
Federal funds sold 619 27,134
Investment Securities:
U.S. Treasury 0 0
U.S. Government 136,346 144,104
State & political obligations 45,174 41,467
All others 4,498 4,346
Loans and leases (Net of reserve for loan losses of
$5,648 and $5,921 respectively) 542,535 523,474
Bank premises and equipment-net 17,037 17,051
Accrued interest and other assets 20,829 20,638
Goodwill 4,074 4,007
-------- --------
TOTAL ASSETS $790,118 $803,974
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest bearing $ 58,269 $ 75,670
Interest bearing 540,440 558,923
Federal funds purchased and securities
sold under agreement to repurchase 52,946 41,329
Other borrowed money 43,432 31,816
Accrued interest and other liabilities 5,820 6,861
-------- --------
Total Liabilities 700,907 714,599
SHAREHOLDERS' EQUITY:
Common stock, no par value - authorized 6,500,000
shares; issued 5,200,000 shares 12,677 12,677
Treasury Stock - 376,913 shares 2008, 256,160 shares 2007 (7,905) (5,366)
Unearned Stock Awards 23,575 for 2008 and 17,240 for 2007 (503) (391)
Undivided profits 84,388 81,575
Accumulated other comprehensive income (expense) 554 880
-------- --------
Total Shareholders' Equity 89,211 89,375
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY $790,118 $803,974
======== ========
See Notes to Condensed Consolidated Unaudited Financial Statements.
Note: The December 31, 2007 Balance Sheet has been derived from the audited
financial statements of that date.
1
FARMERS & MERCHANTS BANCORP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands of dollars, except per share data)
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
2008 2007 2008 2007
------------- ------------- ------------- -------------
INTEREST INCOME:
Loans and leases $ 8,652 $ 9,501 $ 26,421 $ 28,468
Investment Securities:
U.S. Treasury securities -- 3 -- 11
Securities of U.S. Government agencies 1,673 1,389 5,032 4,107
Obligations of states and political subdivisions 430 405 1,275 1,236
Other 59 66 171 195
Federal funds 3 14 262 92
Deposits in banks -- 6 -- 35
---------- ---------- ---------- ----------
Total Interest Income 10,817 11,384 33,161 34,144
INTEREST EXPENSE:
Deposits 3,655 4,702 12,150 13,724
Borrowed funds 777 875 2,194 2,399
---------- ---------- ---------- ----------
Total Interest Expense 4,432 5,577 14,344 16,123
---------- ---------- ---------- ----------
NET INTEREST INCOME BEFORE
PROVISION FOR LOAN LOSSES 6,385 5,807 18,817 18,021
PROVISION FOR LOAN LOSSES 33 309 482 444
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 6,352 5,498 18,335 17,577
---------- ---------- ---------- ----------
OTHER INCOME:
Service charges 908 808 2,587 2,364
Other 539 720 2,075 2,097
Net securities gains (losses) -- -- 15 --
---------- ---------- ---------- ----------
1,447 1,528 4,677 4,461
OTHER EXPENSES:
Salaries and wages 2,303 1,928 6,419 6,080
Pension and other employee benefits 746 694 2,419 2,253
Occupancy expense (net) 300 186 761 457
Other operating expenses 2,008 1,891 6,001 5,259
---------- ---------- ---------- ----------
5,357 4,699 15,600 14,049
---------- ---------- ---------- ----------
INCOME BEFORE FEDERAL INCOME TAX 2,442 2,327 7,412 7,989
FEDERAL INCOME TAXES 659 623 2,022 2,215
---------- ---------- ---------- ----------
NET INCOME 1,783 1,704 5,390 5,774
========== ========== ========== ==========
OTHER COMPREHENSIVE INCOME (NET OF TAX):
Unrealized gains (losses) on securities 692 1,282 (326) 624
---------- ---------- ---------- ----------
COMPREHENSIVE INCOME (EXPENSE) $ 2,475 $ 2,986 $ 5,064 $ 6,398
NET INCOME PER SHARE $ 0.37 $ 0.33 $ 1.11 $ 1.13
Based upon average weighted shares outstanding of: 4,822,467 5,093,169 4,868,996 5,120,138
DIVIDENDS DECLARED $ 0.18 $ 0.16 $ 0.50 $ 0.48
No disclosure of diluted earnings per share is required as shares are
antidiluted as of quarter end.
See Notes to Condensed Consolidated Unaudited Financial Statements.
2
FARMERS & MERCHANTS BANCORP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands of dollars)
Nine Months Ended
-----------------------------
September 30, September 30,
2008 2007
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,390 $ 5,774
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and amortization 897 894
Premium amortization 287 228
Discount amortization (78) (129)
Provision for loan losses 482 444
Provision (Benefit) for deferred income taxes (211)
(Gain) Loss on sale of fixed assets 108 (30)
(Gain) Loss on sale of investment securities (15) --
Changes in Operating Assets and Liabilities:
Accrued interest receivable and other assets (529) (1,342)
Accrued interest payable and other liabilities (520) (386)
---------- ----------
Net Cash Provided by Operating Activities 5,811 5,453
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (991) (1,417)
Proceeds from maturities of investment securities: 57,609 41,711
Proceeds from sale of investment securities: 25 --
Purchase of investment securities (54,420) (35,302)
Purchase of Bank Owned Life Insurance -- (3,000)
Net (increase) decrease in loans and leases (19,543) (2,968)
---------- ----------
Net Cash Provided (Used) by Investing Activities (17,320) (976)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits (35,884) (39,769)
Net change in short-term borrowings 11,617 7,123
Increase in long-term borrowings 17,000 --
Payments on long-term borrowings (5,384) 14,060
Purchase of Treasury stock (2,749) (2,031)
Payments of dividends (2,353) (2,413)
---------- ----------
Net Cash Provided (Used) by Financing Activities (17,753) (23,030)
---------- ----------
Net change in cash and cash equivalents (29,262) (18,553)
Cash and cash equivalents - Beginning of year 48,887 37,247
---------- ----------
CASH AND CASH EQUIVALENTS - END OF THE YEAR $ 19,625 $ 18,694
========== ==========
RECONCILIATION OF CASH AND CASH EQUIVALENTS:
Cash and cash due from banks $ 19,006 $ 17,241
Interest bearing deposits -- 486
Federal funds sold 619 967
---------- ----------
$ 19,625 $ 18,694
========== ==========
See Notes to Condensed Consolidated Unaudited Financial Statements.
3
FARMERS & MERCHANTS BANCORP, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions
for Form 10Q and Rule 10-01 of Regulation S-X; accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments, consisting of normal recurring
accruals, considered necessary for a fair presentation have been
included. Operating results for the nine months ended September 30, 2008
are not necessarily indicative of the results that are expected for the
year ended December 31, 2008. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31,
2007.
RECENT ACCOUNTING PRONOUNCEMENT
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
post retirement periods. The liability should be recognized based on the
substantive agreement with the employee. This Issue was effective
beginning January 1, 2008. The Issue was applied as a change in
accounting principle through a cumulative-effect adjustment to retained
earnings as of January 1, 2008 approximating $152,000.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS
INTRODUCTION
Farmers & Merchants Bancorp, Inc. was incorporated on February 25, 1985,
under the laws of the State of Ohio. Farmers & Merchants Bancorp, Inc.,
and its subsidiary The Farmers & Merchants State Bank are engaged in
commercial banking. On December 31, 2007 the Bank closed on a agreement
to acquire Knisely Bank, Indiana, adding two more full service locations.
During 2007, the Company operated another subsidiary, Farmers and
Merchants Life Insurance which offered life and disability insurance to
the Bank's credit customers. The subsidiary was dissolved at the end of
2007. The executive offices of Farmers & Merchants Bancorp, Inc are
located at 307-11 North Defiance Street, Archbold, Ohio 43502.
Farmers & Merchants Bancorp weathered a difficult quarter caused by the
uncertainty in the economic markets. While its subsidiary, The Farmers &
Merchants State Bank, is generally not involved in subprime consumer real
estate mortgage markets, the Bank was still impacted by its effects on
correspondent banks and competitors. Several competitors appeared to be
dealing with liquidity issues and an inability to tap into other sources
of funds than consumer deposits. The competition for depositor dollars
forced deposit rates higher. The Bank did not match competitor rates and
therefore saw a significant outflow from its Certificate of Deposit
portfolio.
With the drop in the prime lending rate, the Bank continues to feel
pressure on its net interest margin. The pressure is impacting both
factors of net interest income: asset yields and cost of funds. The rate
for Federal Funds Sold / Purchased fluctuated greatly during the period
providing additional pressure.
4
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS (Continued)
The Bank remains a healthy, stable institution with money to lend to
credit worthy customers. It is and will continue to be impacted by the
tough economy and the issues facing the banking industry. The national
media message has grouped all institutions together while many community
banks do not face the same challenges. The community bank challenge is to
present a more positive local message.
CRITICAL ACCOUNTING POLICY AND ESTIMATES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United
States of America, and the Company follows general practices within the
industries in which it operates. At times the application of these
principles requires Management to make assumptions estimates and
judgments that affect the amounts reported in the financial statements.
These assumptions, estimates and judgments are based on information
available as of the date of the financial statements. As this information
changes, the financial statements could reflect different assumptions,
estimates and judgments. Certain policies inherently have a greater
reliance on assumptions, estimates and judgments and as such have a
greater possibility of producing results that could be materially
different than originally reported. Examples of critical assumptions,
estimates and judgments are when assets and liabilities are required to
be recorded at fair value, when a decline in the value of an asset not
required to be recorded at fair value warrants an impairment write-down
or valuation reserve to be established, or when an asset or liability
must be recorded contingent upon a future event.
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), the valuation of its Mortgage
Servicing Rights, the valuation of goodwill and the valuation of its post
retirement benefit liability as the accounting areas that requires the
most subjective or complex judgments, and as such have the highest
possibility of being 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.
FAIR VALUE MEASUREMENTS
The following tables present information about the Company's assets and
liabilities measured at fair value on a recurring basis at September 30,
2008, and the valuation techniques used by the Company to determine those
fair values.
In general, fair values determined by Level 1 inputs use quoted prices in
active markets for identical assets or liabilities that the Company has
the ability to access.
Fair values determined by Level 2 inputs use other inputs that are
observable, either directly or indirectly. These Level 2 inputs include
quoted prices for similar assets and liabilities in active markets, and
other inputs such as interest rates and yield curves that are observable
at commonly quoted intervals.
Level 3 inputs are unobservable inputs, including inputs that are
available in situations where there is little, if any, market activity
for the related asset or liability.
5
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS (Continued)
In instances where inputs used to measure fair value fall into different
levels in the above fair value hierarchy, fair value measurements in
their entirety are categorized based on the lowest level input that is
significant to the valuation. The Company's assessment of the
significance of particular inputs to these fair value measurements
requires judgment and considers factors specific to each asset or
liability.
Disclosures concerning assets and liabilities measured at fair value are
as follows:
Assets and Liabilities Measured at Fair Value on a Recurring Basis at
September 30, 2008
($ in Thousands)
Significant
Quoted Prices in Active Significant Observable
Markets for Identical Observable Inputs Inputs Balance at
Assets (Level 1) (Level 2) (Level 3) September 30, 2008
----------------------- ----------------- ----------- ------------------
Assets - Securities Available for Sale $136,346 $45,174 $0 $181,520
======== ======= === ========
Liabilities $ 0 $ 0 $0 $ 0
======== ======= === ========
The Company did not have any assets or liabilities measured at fair value
that were categorized as Level 3 during the period. All of the Company's
available for sale securities, including any bonds issued by local
municipalities, have CUSIP numbers making them marketable and comparable
as Level 2.
The Company also has assets that, under certain conditions, are subject
to measurement at fair value on a non-recurring basis. At September 30,
2008, such assets consist primarily of impaired loans. The Company has
established the fair values of these assets using Level 3 inputs,
specifically discounted cash flow projections. During the quarter ended
September 30, 2008, the impairment charges recorded to the income
statement for impaired loans were not significant.
Impaired loans accounted for under FAS 114 categorized as Level 3 assets
consist of non-homogeneous loans that are considered impaired . The
Company estimates the fair value of the loans based on the present value
of expected future cash flows using management's best estimate of key
assumptions. These assumptions include future payment ability, timing of
payment streams, and estimated realizable values of available collateral
(typically based on outside appraisals).
Other assets, including bank owned life insurance, are also subject to
periodic impairment assessments under other accounting principles
generally accepted in the United States of America. These assets are not
considered financial instruments. Effective February 12, 2008, the FASB
issued a staff position, FSP FAS 157-2, which delayed the applicability
of FAS 157 to non-financial instruments. Accordingly, these assets have
been omitted from the above disclosures.
LIQUIDITY, CAPITAL RESOURCES AND MATERIAL CHANGES IN FINANCIAL CONDITION
Overall growth of the Company slowed or reversed during the quarter as
compared to both last year and previous quarter. On the asset side, loans
continue to be higher than year end but the percentage of growth
decreased during the quarter. The slower growth was not due to a lack of
funds or tightening of credit by the Bank but rather by a decrease in
demand. As businesses put off expansions and consumers were concerned
over market values on housing, the demand for loans drastically
decreased. On the liability side of the balance sheet, the decrease in
deposits was offset by an increase in other borrowed money. With some
local competition dealing with liquidity issues and offering above market
rates for deposits, the
6
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS (Continued)
Bank chose to allow Certificate of Deposit rate shoppers to move funds
rather than match expensive rates. The Bank replaced those funds with
cheaper Federal Home Loan Bank borrowings. The decrease in non-interest
deposits is attributable to a $10 million deposit created from a year end
acquisition being dispersed at the first of the year and secondly, from
the success of a new product promotion by the Bank: Reward checking.
Reward offers a high rate of interest to be paid if three qualifications
are met each cycle. Its success has caused movement of non-interest
balances into new interest bearing checking balances. It has also
attracted new money and some funds have also moved from the certificate
of deposit portfolio. The expense of the high interest rate is offset by
an increase in the non-interest fee activity and decrease in non-interest
expense. The new product has been well received by existing customers and
has attracted new customers as well.
Liquidity and capital remain strong with capital decreasing due to the
market value change of securities and the continued repurchasing of
treasury stock. The Company repurchased 228,000 shares during 2007 and
continued with an additional 130,508 repurchased during 2008, 40,163 of
those during the third quarter. In terms of dollars spent, 2007 purchases
cost just over $4.7 million and 2008 purchases cost over $2.75 million.
The Company has authorization to purchase up to 250 thousand shares
during 2008.
The Company continues to be well-capitalized as the capital ratios below
show:
Primary Ratio 11.25%
Tier I Leverage Ratio 10.56%
Risk Based Capital Tier 1 13.87%
Total Risk Based Capital 14.79%
Stockholders' Equity/Total Assets 11.29%
Undivided profits increased with the net income from the Bank. The Bank's
capital was also impacted by the establishment of a post retirement
benefit liability as required by EITF 06-4 of its Bank Owned Life
Insurance (BOLI). The funding of just under $152 thousand was provided by
decreasing retained earnings. The transaction was completed in the first
quarter and the liability was established using the present value
calculation of a third party administrator.
Loans have increased during 2008 by $18.79 million. Past due loans over
30 days ended September 30, 2008 at 2.86% as compared to December 31,
2007's past due percentage of 2.88%. While similar to December's numbers,
the percentage is higher than most of 2007. Driving the percentage is the
commercial and agricultural portfolios. Those same loans have increased
the non-accrual balances of the Bank. A loan is placed in non-accrual
automatically once it has reached 90 days past due or management
questions its collectability. The balance in non-accruals has increased
$8.5 million during 2008. The increases were based on just a few
relationships experiencing difficulty. Residential mortgage delinquency
was under two percent and consumer loan delinquency is less than three
quarters of a percent. A discussion of the additional impact to
profitability caused by the non accruals will follow in the results of
operations.
Unlike many of the industry headlines, the Bank has not experienced
losses due to the subprime mortgage market. The Bank did not participate
in subprime lending and the local economies have dealt more with
decreased working hours and bonuses. Overall the credit quality remains
strong and the issues manageable.
7
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS (Continued)
MATERIAL CHANGES IN RESULTS OF OPERATIONS
Interest income and yield on the loan portfolio continues to decrease
with the lower prime rate and non-accrual loans. This decrease is visible
looking at either the three or nine months ended comparisons. Non-accrual
loans currently total over $13.5 million and account for lost interest
income of over $1 million. Classifying a loan as non-accrual does not
exclude collection of the interest but rather a timing of when the
revenue can be recognized. Non-accrual loan interest is recognized when
collected on a cash basis. As mentioned earlier and as the past due
percentages support, these loans are mainly in the commercial and
agricultural portfolios. The high non-accrual balance remains a barrier
to higher profitability.
The investment portfolio decreased slightly in balance during 2008 while
the interest income increased $940 thousand. This was due to the timing
of the maturities and the rates on the replacement of the government
agencies. The investment portfolio provides liquidity but also is used
heavily for pledging to the Bank's Ohio public funds.
While the yield on the Federal Funds was impacted by the rate cuts, the
sheer volume of Federal Funds in the first quarter 2008 out weighed the
yield. Interest earned on Federal Funds was $170 thousand higher in 2008.
The lower rates are evident in the quarter comparison and continue to be
a concern going forward. Through the Bank's correspondent relationships,
there is a large disparity between the target Federal Funds rate and what
the Bank is receiving. For Federal Funds Sold, the receiving rate is
often a third of the target and for Federal Funds Purchased, the rate is
often twice as high. Until stabilization occurs in the market, these
variables will continue to negatively impact profitability.
With 375 basis point drop in rates over the last thirteen months, it
would be expected for interest expense to have decreased. The positive
statement here is that year-to-date, the drop has been almost $1.8
million when the deposit balances are significantly higher by $54 million
than a year ago. The yield or cost of funds on the deposits dropped 75
basis points as compared to average year-to-date or 131 basis points when
comparing just the month of September to same month last year. This was
accomplished as a large percentage of the certificate of deposit
portfolio reached maturity during 2008 and either left the bank or
repriced at a lower rate. The majority of those maturities occurred
during the third quarter and a lower percentage will mature through the
remainder of 2008. Other borrowings also experienced maturities and new
purchases. The new purchases were at significantly lower interest costs.
Overall net interest income is higher for both quarter and nine month
period comparisons. With the growth in the balance sheet this is to be
expected even with the net interest margin shrinking. For the quarter,
net interest income was approximately $578 thousand higher thereby
accounting for the majority of the nine month increase of $796 thousand
over same time frames last year. The interest reversals caused by the
non-accrual increases occurred mainly in the first six months and the
last quarter had very few adjustments which is the reason for the higher
net interest amount.
Third quarter 2007 had a larger expense in the provision for loan losses
than the current third quarter. However, 2008 provision expense remains
higher than 2007 by $38 thousand. Net charge-offs for the corresponding
periods show 2008 almost $500,000 higher than last year's net charge-offs
of approximately $480,000. Again, management's concern is not with
respect to residential loans, but rather with respect to a few large
commercial and agricultural loans. The Bank continues to work on the
collection process which has been slowed due to an increase in bankruptcy
and foreclosure filings.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS (Continued)
Non interest income increased by $216 thousand for the nine months ended
2008 compared to 2007. The acquisition added core deposits upon which
more revenue was generated in service charges and also in other fees
associated with the accounts. Four Automated Teller Machines (ATM's) were
added from the acquisition. One remote ATM has heavier foreign volume, on
which fees are charged, than typical of the Bank's other ATMs. The new
checking product is increasing non interest income through increased
debit card activity the second half of the year. As the accounts have
switched, the debit card activity has doubled for those customers. The
convenience to the customers and increased revenue to the Bank will
continue to be a positive for all involved. Overall, non interest income
for the three months ended September 30, 2008 was $81 thousand lower than
the same period 2007. This was caused by the losses on fixed assets
stemming from the sale of a bank building in one of our communities in
which the Bank had two offices. The building required major repairs and
it was more sensible for the Bank to sell than to try and maintain after
relocation of the office. The other factor for the quarter was the impact
of a lower revenue stream coming from the reorganization of the Bank's
investment department.
Non interest expense was $1.55 million higher for nine months 2008 as
compared to same period 2007. The third quarter was $658 thousand higher
comparing 2008 to 2007. The Bank has four new offices in the expense for
2008 as compared to 2007. During the third quarter the Bank also began to
fund the accrual for incentive pay which remains $170 thousand behind
September 30, 2007's balance. The Board recognizes the solid performance
of the Bank during these difficult economic times and currently expects
to pay bonuses for the year, which bonuses are expected to be at a lower
percentage than previous years. ROA continues to be the primary
determinant of the incentive compensation. Another factor behind the
large increase of the third quarter was the recruitment cost that was
incurred to find qualified personnel for many loan and investment officer
positions; the majority of which have been filled. Also reflected in the
increased expense is pension and other employee benefits. The Bank
expected medical benefit costs to increase 11% during 2008 over 2007.
Currently pension and other employee benefits are 7.37% higher than 2007.
Occupancy expense is higher with the addition of the three offices in the
fourth quarter of 2007. The Bank's Perrysburg office opened in November
and the acquisition which added two offices was completed on December 31,
2007. The acquired locations are expected to be accretive to earnings in
2008 and the Bank projects the Perrysburg office to be profitable on a
monthly basis within 18 to 24 months. An additional location was added in
August 2008. Remodeling was done to the new location which operates from
a leased property. It too is expected to be profitable on a monthly basis
within 24 months.
Other operating expenses are higher due to the increased asset size of
the Bank. The Bank's data processing expense is based mainly on the
number of accounts under management. Each application such as loan,
checking, certificate of deposit, are priced individually along with the
household account database. Additional expense was also carried the first
part of 2008 until the software conversion of the acquisition was
completed in January.
Overall, net income was down just $384 thousand in comparing 2008 to 2007
nine months performance. The performance of the three months ended
September 30 were actually better than the same three months last year
due to the larger provision for loan loss taken in third quarter 2007.
The last quarter of 2008 will be a challenge in the current economic
conditions. The Bank is strong, well capitalized and has money to lend.
The challenge lies in maintaining the net interest margin and decreasing
the balance in non-accrual loans. The Company expects the work out of
those situations to extend into 2009. Improvement in asset quality will
continue to be a focus for the remainder
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS (Continued)
of 2008. Expected loan growth will require additional provision for loan
loss expense to fund the reserve. The newest locations are anticipated to
continue growing and provide new opportunities for long term
profitability to the Company. In these uncertain times with the many
unprecedented events occurring, each day presents new challenges and more
importantly new opportunities.
FORWARD LOOKING STATEMENTS
Statements contained in this portion of the Company's 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 words such 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 differ from those projected in the
forward-looking statements.
ITEM 3 QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates and equity prices. The primary market risk to which the Company is
subject is interest rate risk. The majority of the Company's interest
rate risk arises from the instruments, positions and transactions entered
into for purposes, other than trading, such as lending, investing and
securing sources of funds. Interest rate risk occurs when interest
bearing assets and liabilities reprice at different times as market
interest rates change. For example, if fixed rate assets are funded with
variable rate debt, the spread between asset and liability rates will
decline or turn negative if rates increase.
Interest rate risk is managed within an overall asset/liability framework
for the Company. The principal objectives of asset/liability management
are to manage sensitivity of net interest spreads and net income to
potential changes in interest rates. Funding positions are kept within
predetermined limits designed to ensure that risk-taking is not excessive
and that liquidity is properly managed. The Company employs a sensitivity
analysis in the form of a net interest rate shock as shown in the table
following.
Interest Rate Shock on Net Interest Rate Shock on Net
Interest Margin Interest Income
----------------------------- --------------------------
Net Interest % Change Rate Rate Cumulative % Change to
Margin (Ratio) to Flat Rate Direction Changes by Total ($000) Flat Rate
-------------- ------------ --------- ---------- ------------ -----------
2.90% 3.080% Rising 3.000% 18,688 3.834%
2.87% 2.035% Rising 2.000% 18,456 2.545%
2.85% 1.009% Rising 1.000% 18,226 1.267%
2.82% 0.000% Flat 0.000% 17,998 0.000%
2.79% -0.783% Falling -1.000% 17,739 -1.442%
2.81% -0.206% Falling -2.000% 17,662 -1.866%
2.82% 0.199% Falling -3.000% 17,619 -2.108%
10
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
The net interest margin represents the forecasted twelve month margin. It
also shows what effect rate changes will have on both the margin and the
net interest income. The shock report has consistently shown an
improvement in a falling rate environment; however the floor has been
reached in many portfolios, specifically deposits. The report now shows a
negative effect to the profitability of the Company should rates continue
to fall. The margin is significantly lower than in previous quarters.
This is a concern for the Company as the cost of funds does not have much
room for improvement. On a more positive note, the percentage of change
is also perhaps the lowest it has ever been, even at the 300 basis point
shock. How valuable is the analysis of the 200 and 300 basis point shock
when the target rate of Federal Funds is at 150 basis points?
The Bank continues to remain focused on gaining more relationships per
customer as a way to help control the cost of funds also. Promotions
continue to focus on special incentives or rewards being based on a
multiple deposit account relationship with each customer. The new deposit
program also promotes a high rate interest bearing checking account with
the increased interest expense offset by fees and savings in operating
efficiency. The promotion has been extremely successful since its release
in early March. This chart however only captures one facet of the account
in the interest cost.
ITEM 4 CONTROLS AND PROCEDURES
As of September 30, 2008, an evaluation was performed under the
supervision and with the participation of the Company's management
including the CEO and CFO, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on
that evaluation, the Company's management, including the CEO and CFO,
concluded that the Company's disclosure controls and procedures were
effective as of September 30, 2008. There have been no significant
changes in the Company's internal controls that occurred during the
quarter ended September 30, 2008.
PART II
ITEM 1 LEGAL PROCEEDINGS None
ITEM 1A RISK FACTORS
There have been no material changes in the risk factors disclosed by
Registrant in its Report on Form 10-K for the fiscal year ended December
31, 2007.
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(d) Maximum Number of Shares
(c) Total Number of Shares that may yet be
(a) Total Number (b) Average Price Purchased as Part of Publicly purchased under
Period of Shares Purchased Paid per Share Announced Plan or Programs the Plans or Programs
--------- ------------------- ----------------- ----------------------------- ----------------------------
7/1/2008
to 159,655
7/31/2008
8/1/2008
to 22,638 $21.78 22,638 137,017
8/31/2008
9/1/2008
to 17,525 $21.86 17,525 119,492
9/30/2008
------ ------ ------ -------
Total 40,163 $21.81 40,163 (1) 119,492
------ ------ ------ -------
11
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (Continued)
(1) The Company purchased these shares in the market pursuant to a stock
repurchase program publicly announced on November 16, 2007. On that date,
the Board of Directors authorized the repurchase of 250,000 common shares
between January 1, 2008 and December 31, 2008.
Under terms of the Company's Long Term Incentive Compensation Plan, 4,000
restricted stock awards granted during 2005, cliff vested on August 19,
2008. The total number of shares vested were 3,420 to 32 officers who
were still employed as of the vesting date. The other 580 shares were
moved to treasury stock as officers left employment during the three year
vesting period.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5 OTHER INFORMATION
ITEM 6 EXHIBITS
3.1 Amended Articles of Incorporation of the Registrant (incorporated
by reference to Registrant's Quarterly Report on Form 10-Q filed
with the Commission on August 1, 2006)
3.2 Code of Regulations of the Registrant (incorporated by reference
to Registrant's Quarterly Report on Form 10-Q filed with the
Commission on May 10, 2004)
31.1 Rule 13-a-14(a) Certification -CEO
31.2 Rule 13-a-14(a) Certification -CFO
32.1 Section 1350 Certification - CEO
32.2 Section 1350 Certification - CFO
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Farmers & Merchants Bancorp, Inc.,
Date: October 30, 2008 By: /s/ Paul S. Siebenmorgen
------------------------------------
Paul S. Siebenmorgen
President and CEO
Date: October 30, 2008 By: /s/ Barbara J. Britenriker
------------------------------------
Barbara J. Britenriker
Exec. Vice-President and CFO
12