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, 2006
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 Executive offices) (Zip Code)
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, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Ace. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
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, 2006, the aggregate market value of the registrant's common stock
held by non-affiliates of the registrant was $119,347,000.00.
As of February 21, 2007, 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 2006
Annual Meeting of Shareholders of Farmers & Merchants Bancorp, Inc.
FARMERS & MERCHANTS BANCORP, INC.
TABLE OF CONTENTS
Form 10-K Items PAGE
--------------- -----
Item 1. Business 4-8
Item 1.a Risk Factors 8-10
Item 2. Properties 10-11
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 11-13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-30
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 30-31
Item 8. Financial Statements and Supplementary Data 32-54
Item 9. Disagreements on Accounting and Financial Disclosure 55
Item 9a. Controls and Procedures 56-59
Item 10. Directors and Executive Officers of the Registrant 60-61
Item 11. Management Remuneration and Transactions 62
Item 12. Security Ownership of Certain Beneficial Owners and Management 62
Item 13. Certain Relationships and Related Transactions 62
Item 14. Principal Accountant Fees and Services 62
Item 15. Exhibits, Financial Schedules and Reports on Form 8-K 63-64
Signatures and Certifications 65-70
Total Pages: 70
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. We report our financial condition
and net income on a consolidated basis and we report only one segment.
Our executive offices are located at 307-11 North Defiance Street, Archbold,
Ohio 43502, and our telephone number is (419) 446-2501.
NATURE OF ACTIVITIES
The Farmers & Merchants State Bank engages in general commercial banking and
savings business. Our activities include commercial and residential mortgage,
consumer, and credit card lending activities. Because our Bank's branches are
located in Northwest Ohio, a substantial amount of our loan portfolio is
comprised of loans made to customers in the farming industry for such things as
farm land, farm equipment, livestock and general operation loans for seed,
fertilizer, feed, etc. Other types of lending activities include loans for home
improvements, student loans, and loans for such items as autos, trucks,
recreational vehicles, mobile homes, motorcycles, etc. We have previously
engaged in direct finance leasing and have invested in leveraged type leases,
although the activity in this area has 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 offices in Archbold, Wauseon, Stryker,
West Unity, Bryan, Delta, Napoleon, Montpelier, Swanton, and Defiance. Two ATM's
are also located at Sauder Woodworking Co., Inc., a major employer in Archbold.
Additional locations are at Northwest State Community College, Archbold;
Williams County Hospital, Bryan; Fairlawn Haven Wyse Commons, Archbold; Repp
Oil, Fayette; Delta Eagles, Bryan Eagles; Sauder Village , Archbold; Fulton
County Hospital, Wauseon; and a Mobil Trailer ATM.
Farmers & Merchants Life Insurance Company was established to provide services
to our customers through the issuance of life and disability insurance policies.
Our Bank's lending officers are the selling agents of the policies to customers.
The activities of Farmers & Merchants Life Insurance Co. are not significant to
the consolidated company.
F&M Investments, the brokerage department of the Bank, opened for business in
April, 1999. Securities are offered through Raymond James Financial Services,
Inc.
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956. Our subsidiary bank is in turn regulated and examined by
the Ohio Division of Financial Institutions, the Federal Deposit Insurance
Corporation and the Federal Reserve System. The activities of our bank
subsidiary are also subject to other federal and state laws and regulations,
including usury and consumer credit laws, state laws relating to fiduciaries,
the Federal Truth-in-Lending Act and Regulation Z as promulgated thereunder by
the Board of Governors, the Truth in Savings Act, the Bank Bribery Act, the
Competitive Equality Banking Act of 1987, the Expedited 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 and Henry. 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,
4
we compete directly with other commercial banks and savings and loan
institutions in each of our operating localities. In a number of our locations,
we compete against entities which are much larger than us. The primary factors
in competing for loans and deposits are the rates charged as well as location
and quality of the services provided.
At December 31, 2006, we had 252 full time equivalent employees. The employees
are not represented by a collective bargaining unit. We provide our employees
with a comprehensive benefit program, some of which are contributory. We
consider our employee relations to be excellent.
SUPERVISION AND REGULATION
General
The Company is a corporation organized under the laws of the State of Ohio. The
business in which the Company and its subsidiary are engaged is subject to
extensive supervision, regulation and examination by various bank regulatory
authorities. The supervision, regulation and examination to which the Company
and its subsidiary are subject are intended primarily for the protection of
depositors and the deposit insurance funds that insure the deposits of banks,
rather than for the protection of shareholders.
Several of the more significant regulatory provisions applicable to banks and
bank holding companies to which the Company and its subsidiary are subject are
discussed below, along with certain regulatory matters concerning the Company
and its subsidiary. To the extent that the following information describes
statutory or regulatory provisions, it is qualified in its entirety by reference
to the particular statutory provisions. Any change in applicable law or
regulation may have a material effect on the business and prospects of the
Company and its subsidiary.
Regulatory Agencies
The Company is a registered bank holding company and is subject to inspection,
examination and supervision by the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") pursuant to the Bank Holding Company Act of
1956, as amended.
The Bank is an Ohio chartered commercial bank. It is subject to regulation and
examination by both the Ohio Division of Financial Institutions (the "ODFI") and
the FDIC.
Holding Company Activities
As a bank holding company incorporated and doing business within the State of
Ohio, the Company is subject to regulation and supervision under the Bank
Holding Act of 1956, as amended (the "Act"). The Company is required to file
with the Federal Reserve Board on a quarterly basis information pursuant to the
Act. The Federal Reserve Board may conduct examinations or inspections of the
Company and its subsidiaries.
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
5
companies may elect to become a "financial holding company," provided that all
of the depository institution subsidiaries of the bank holding company are "well
capitalized" and "well managed" under applicable regulatory standards.
Under the GLB Act, a bank holding company that has elected to become a financial
holding company may affiliate with securities firms and insurance companies and
engage in other activities that are financial in nature. Activities that are
"financial in nature" include securities underwriting, dealing and
market-making, sponsoring mutual funds and investment companies, insurance
underwriting and agency, merchant banking, and activities that the Federal
Reserve Board has determined to be closely related to banking. No Federal
Reserve Board approval is required for the Company to acquire a company, other
than a bank holding company, bank or savings association, engaged in activities
that are financial in nature or incidental to activities that are financial in
nature, as determined by the Federal Reserve Board. Prior Federal Reserve Board
approval is required before the Company may acquire the beneficial ownership or
control of more than 5% of the voting shares, or substantially all of the
assets, of a bank holding company, bank or savings association. If any
subsidiary bank of the Company ceases to be "well capitalized" or "well managed"
under applicable regulatory standards, the Federal Reserve Board may, among
other actions, order the Company to divest the subsidiary bank. Alternatively,
the Company may elect to conform its activities to those permissible for a bank
holding company that is not also a financial holding company. If any subsidiary
bank of the Company receives a rating under the Community Reinvestment Act of
1977 of less than satisfactory, the Company will be prohibited from engaging in
new activities or acquiring companies other than bank holding companies, banks
or savings associations. The Company has not elected to become a financial
holding company and has no current intention of making such an election.
Affiliate Transactions
Various governmental requirements, including Sections 23A and 23B of the Federal
Reserve Act, limit borrowings by holding companies and non-bank subsidiaries
from affiliated insured depository institutions, and also limit various other
transactions between holding companies and their non-bank subsidiaries, on the
one hand, and their affiliated insured depository institutions on the other.
Section 23A of the Federal Reserve Act also generally requires that an insured
depository institution's loan to its non-bank affiliates be secured, and Section
23B of the Federal Reserve Act generally requires that an insured depository
institution's transactions with its non-bank affiliates be on arms-length terms.
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
6
acquiring 25% (5% in the case of an acquiror that is a bank holding company) or
more of any class of outstanding voting stock of a bank holding company, or
otherwise obtaining control or a "controlling influence" over that bank holding
company.
Liability for Banking Subsidiaries
Under the current Federal Reserve Board policy, a bank holding company is
expected to act as a source of financial and managerial strength to each of its
subsidiary banks and to maintain resources adequate to support each subsidiary
bank. This support may be required at times when the bank holding company may
not have the resources to provide it. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a U.S. federal bank
regulatory agency to maintain the capital of a subsidiary bank would be assumed
by the bankruptcy trustee and entitled to priority of payment. Any depository
institution insured by the FDIC can be held liable for any loss incurred, or
reasonably expected to be incurred, by the FDIC in connection with (1) the
"default" of a commonly controlled FDIC-insured depository institution; or (2)
any assistance provided by the FDIC to both a commonly controlled FDIC-insured
depository institution "in danger of default." The Company's subsidiary bank is
an FDIC-insured depository institution. If a default occurred with respect to
the Bank, any capital loans to the Bank from its parent holding company would be
subordinate in right of payment to payment of the Bank's depositors and certain
of its other obligations.
Regulatory Capital Requirements
The Company is required by the various regulatory authorities to maintain
certain capital levels. Bank holding companies are required to maintain minimum
levels of capital in accordance with 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, 2006 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, 2006, 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.
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.
7
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.
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
8
dealers, brokers, mortgage bankers, investment advisors 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.
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.
9
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.
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.
10
The Bank owns all of its branch locations. Current locations of retail banking
services are:
Branch Location
---------------- --------------------------
Archbold, Ohio 1313 South Defiance Street
Wauseon, Ohio 1130 North Shoop Avenue
119 North Fulton Street
Stryker, Ohio 300 South Defiance Street
West Unity, Ohio 200 West Jackson Street
Bryan, Ohio 924 W. High Street
1000 South Main Street
Delta, Ohio 101 Main Street
Montpelier, Ohio 225 West Main Street
1150 East Main Street
Napoleon, Ohio 2255 Scott Street
Swanton, Ohio 7 Turtle Creek Circle
Defiance, Ohio 1175 Hotel Drive
The majority of the above locations have drive-up service facilities.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine
proceedings incidental to the business of the Bank or the Company, to which we
are a party or of which any of our properties are the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted during the fourth quarter of the year covered by this
report to a vote of the security holders through solicitation of proxies or
otherwise.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is not quoted on the National Association of Securities Dealers
Automated Quotations System (NASDAQ) or any other market or exchange. 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.
We have five market makers that set a price for our stock; however, private
sales continue to occur. The high and low sale price was from sales of which we
have been made aware by our Market Makers. The high and low sale prices known to
our management are as follows:
11
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
2006 High $22.88 $26.00 $23.25 $22.50
Low $21.63 $22.25 $21.25 $21.17
2005 High $28.75 $28.75 $28.75 $28.75
Low $27.50 $27.50 $25.31 $20.75
The Company utilizes Registrar and Transfer Company as its transfer agent.
As of February 5, 2007, there were 2055 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,
2006. The chart compares the value of $100 invested in the Corporation and each
of the indices and assumes investment on December 31, 2001 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)
2001 2002 2003 2004 2005 2006
------- ------- ------- ------- ------- -------
FMSB $100.00 $ 89.73 $ 94.92 $ 96.38 $ 78.69 $ 80.15
NASDAQ - COMPOSITE $100.00 $ 68.80 $103.64 $113.07 $115.43 $127.36
NASDAQ - BANK INDEX $100.00 $106.98 $141.83 $160.89 $157.70 $179.22
Dividends are declared and paid quarterly. Per share dividends declared for the
years ended 2006 and 2005 are as follows:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total
----------- ----------- ----------- ----------- ------
2006 $ .125 $ .15 $ .15 $ .15 $0.575
2005 $.1125 $.1125 $.1125 $.1625 $ 0.50
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 2006 were $0.575 per share totaling $3.0 million, 15
percent higher than 2005 declared dividends of $0.50 per share. The Company
purchased back 4,000 shares in the third quarter of 2005 to award to employees
of the
12
Bank under its long-term incentive plan. 80 shares were held in Treasury stock
at year-end after having been forfeited by an employee. During 2006, the Company
purchased 42,000 shares and awarded 6,100 restricted shares to 41 employees. 200
restricted 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 has authorization to
purchase 228,000 shares throughout 2007. The Company continues to have a strong
capital base and to maintain regulatory capital ratios that are significantly
above the defined regulatory capital ratios.
ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER OF
SHARES PURCHASED AS REMAINING SHARE
TOTAL NUMBER OF AVERAGE PRICE PART OF PUBLICLY REPURCHASE
PERIOD SHARES PURCHASED PAID PER SHARE ANNOUNCED PROGRAMS AUTHORIZATION
------ ---------------- -------------- ------------------- ---------------
10/1/2006 to
10/31/2006 -- -- -- 250,000
11/1/2006 to
11/30/2006 -- -- -- 250,000
12/1/2006 to
12/31/2006 22,000 $22.30 22,000(1) 228,000
Total 22,000 $22.30 22,000(1) 228,000
(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 2005 and 2004 consolidated financial statements have been
reclassified to conform with the 2006 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.
13
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
000s omitted except share data)
SUMMARY OF CONSOLIDATED STATEMENT OF INCOME - UNAUDITED
(In Thousands)
--------------------------------------------------------------
2006 2005 2004 2003 2002
---------- ---------- ---------- ---------- ----------
Summary of Income:
Interest income $ 42,269 $ 38,101 $ 37,351 $ 41,107 $ 43,424
Interest expense 18,535 13,539 11,222 14,283 18,979
---------- ---------- ---------- ---------- ----------
Net Interest Income 23,734 24,562 26,129 26,824 24,445
Provision for loan loss 525 (425) 884 6,903 2,194
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan loss 23,209 24,987 25,245 19,921 22,251
Other income (expense), net (11,966) (13,209) (13,442) (9,836) (11,864)
---------- ---------- ---------- ---------- ----------
Net income before income taxes 11,243 11,778 11,803 10,085 10,387
Income taxes 3,107 3,202 3,573 2,459 2,989
---------- ---------- ---------- ---------- ----------
Net income $ 8,136 $ 8,576 $ 8,230 $ 7,626 $ 7,398
========== ========== ========== ========== ==========
Per Share of Common Stock:
Earnings per common share
outstanding (Based on weighted
average number of shares outstanding)
Net income $ 1.57 $ 1.65 $ 1.58 $ 1.47 $ 1.42
========== ========== ========== ========== ==========
Dividends $ 0.575 $ 0.500 $ 0.475 $ 1.688 $ 0.413
========== ========== ========== ========== ==========
Weighted average number
of shares outstanding 5,186,329 5,198,728 5,200,000 5,200,000 5,200,000
========== ========== ========== ========== ==========
In 2003, a special $1.25 dividend was paid
SUMMARY OF CONSOLIDATED BALANCE SHEET - UNAUDITED
(In Thousands)
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Total assets $737,096 $720,945 $702,513 $705,703 $726,486
Loans 498,580 458,704 472,211 480,339 497,515
Total Deposits 585,409 576,297 574,205 575,066 576,373
Stockholders' equity 87,732 82,588 78,845 74,856 77,738
Key Ratios
Return on average equity 9.64% 10.62% 10.72% 9.87% 9.93%
Return on average assets 1.14% 1.22% 1.16% 1.06% 1.06%
Loan to deposits 85.17% 79.65% 82.24% 83.53% 86.32%
Capital to assets 11.90% 11.46% 11.22% 10.61% 10.70%
Dividend payout 36.63% 30.31% 30.02% 115.07% 28.99%
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
14
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 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.
MATERIAL CHANGES IN RESULTS OF OPERATIONS
Total assets reached a record high for year-end reporting on December 31, 2006
at $737 million. This was achieved with an 8.6% growth in loans corresponding to
a new five year high year-end balance of $504.2 million. Asset quality continued
to improve with past due loans as a percentage of total loans hitting record
lows while impaired loans dropped 45% to $4.7 million as compared to 2005 total
impaired loans of $8.5 million.
The continued improvement in asset quality correlated to the decrease of the
total allowance for credit losses (ACL) by $467 thousand during 2006. Provision
for loan loss was $525 thousand and net charge offs were
15
the lowest of the three years presented, $319 thousand for 2006 compared to
$1,001 and $684 thousand for 2005 and 2004 respectively. The net result was an
increase in the allowance for loan and lease losses (ALLL) of $206 thousand to
end at approximately $5.6 million. The allowance for unfunded loan commitments
and letters of credit (AULC) decreased by $673 thousand ending at $168 thousand.
In recognition of the lower risk the AULC represented as compared to the ALLL,
the AULC was lowered during 2006. The utilization percentage of many of the
Bank's lines remained low and/or constant resulting in little movement in the
exposure for which the AULC is to cover. These funds are better utilized in
providing funds for the Bank's funded loans or ALLL.
The decrease of $673 thousand in the AULC comprised over 50% of the improvement
in non-interest expense. Total non-interest expense decreased during 2006 along
with non-interest income's decrease of only $7 thousand during 2006. Netting
both non-interest components resulted in net non-interest expense ending at
$11.97 million for 2006, a 9.41% improvement over 2005's $13.21 million and a
10.98% improvement over 2004's $13.44 million. The additional fees derived from
the first full year of offering overdraft privilege were mainly responsible for
the improvement in non-interest income. The program was originally introduced in
February 2005 and has been well received by the bank's customers. It has been a
boost to non-interest revenue for the bank also. The bank was successful in
controlling costs and focused on improving efficiencies within its processes.
The million and a quarter dollar decrease in non-interest expense highlights the
accomplishment.
Overall, the bank had a solid performance in 2006. Financial performance
measures closely mirrored the ten year averages of the bank. The impact and
causes of the constriction of the net interest margin is discussed in the
following section. While it was a tough year in the interest margin arena, the
bank worked on improving the non-interest side of the business and was
successful in that endeavor.
NET INTEREST INCOME
Tough competition, a flat or inverted yield curve and a raising rate
environment, triggered by the Federal Reserve rate increases, were all factors
in driving the net interest margin down during 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
10.9% higher interest income, 36.9% higher interest expense and 3.4% lower net
interest income in 2006 compared to 2005.
Interest income was $42.3 million for 2006, $38.1 million for 2005 and $37.4
million for 2004. Interest expense was $18.5, $13.5 and $11.2 million,
respectively for 2006, 2005, and 2004. Net Interest income decreased to $23.7
million for 2006 compared to $24.6 million for 2005 and $26.1 million for 2004.
The following table presents net interest income, interest spread and net
interest margin for the three years 2004 through 2006, comparing average
outstanding balances of earning assets and interest bearing liabilities with the
associated interest income and expense. The table also shows their corresponding
average rates of interest earned and paid. The tax-exempt asset yields have been
tax affected to reflect a marginal corporate tax rate of 34%. Average
outstanding loan balances include 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 2006 compared to 2005 and 2004. Interest earning assets average
balance increased from 2005 to 2006 but was lower than 2004. The biggest
component of the interest earning assets was loans with 2004's average being
$6.4 million higher than 2006. The yield for 2006 was higher for interest
earning assets as compared to 2005 and 2004 in all categories.
Overall, the tax equivalent yield on interest earning assets increased to 6.49%
compared to 5.93% and 5.71% for 2005 and 2004 respectively. The percentage of
interest earning assets to total assets decreased slightly the past three years
but remained above 90% at a respectable 93.82% for 2006.
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, $652 thousand as compared to 2005.
While the balance increased slightly, the cost or yield on those funds trended
significantly higher. The average yield for 2006 was 3.32% compared to 2005's
2.43% and 2004's 1.95%. 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%
over
16
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.
Non-interest bearing liabilities also represent a higher portion of the total
liabilities. This is a trend the Company would like to see continue.
As stated previously, the charts show the constriction on the net interest
margin and spread from 2004 to 2006. The largest tightening occurring during
2006. Net interest spread decreased 31 basis points during 2006 compared to a 27
basis points decrease during 2005. The same statement can be made for net
interest margin, a 17 basis point drop in 2006 compared to a 15 basis point drop
in 2005. 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. At least one third of the loan growth came from the assistance of the use
of participations. The bank participated with five other banks to fund loans
outside of the bank's market area. These loans are generally larger commercial
loans with at market or lower yields. These also assisted in keeping the asset
yields low. This is confirmed in the charts to follow showing the impact on
interest components due to volume and rate changes.
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.
17
2006
(In Thousands)
---------------------------------
Average Interest/
Balance Dividends Yield/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%
====
18
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%
====
19
2004
(In Thousands)
---------------------------------
Average Interest/
Balance Dividends Yield/Rate
-------- --------- ----------
ASSETS
INTEREST EARNING ASSETS:
Loans (1) $490,793 $31,156 6.39%
Taxable investment securities 127,432 4,393 3.45%
Tax-exempt investment securities 46,730 1,688 5.47%
Interest bearing deposits 5,141 80 1.56%
Federal funds sold 3,543 34 0.96%
-------- ------- ----
TOTAL INTEREST EARNING ASSETS 673,639 $37,351 5.71%
======= ====
NON-INTEREST EARNING ASSETS:
Cash and cash equivalents 14,945
Other assets 20,349
--------
TOTAL ASSETS $708,933
========
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings deposits $204,049 $ 1,268 0.62%
Other time deposits 323,527 8,712 2.69%
Other borrowed money 23,694 817 3.45%
Federal funds purchased and securities
sold under agreement to repurchase 24,218 425 1.75%
-------- ------- ----
TOTAL INTEREST BEARING LIABILITIES 575,488 $11,222 1.95%
======= ====
NON-INTEREST BEARING LIABILITIES:
Non-interest bearing demand deposits 42,205
Other 14,497
--------
TOTAL LIABILITIES 632,190
SHAREHOLDERS' EQUITY 76,743
--------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $708,933
========
Interest/Dividend income/yield $37,351 5.71%
Interest Expense / yield 11,222 1.95%
------- ----
Net Interest Spread $26,129 3.76%
======= ====
Net Interest Margin 4.04%
====
(1) For purposes of these computations, non-accruing loans are included in the
daily average outstanding loan amounts.
20
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.
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
====== ====== ======
2005 vs 2004
(In Thousands)
-------------------------
Due to Change in
Net ----------------
Change Volume Rate
------ ------- ------
INTEREST EARNED ON:
Loans $ 232 $(1,397) $1,629
Taxable investment securities 216 241 (25)
Tax-exempt investment securities 151 235 (84)
Interest bearing deposits 176 44 132
Federal funds sold (25) (32) 7
------ ------- ------
TOTAL INTEREST EARNING ASSETS $ 750 $ (909) $1,659
====== ======= ======
INTEREST PAID ON:
Savings deposits $1,115 $ (51) $1,166
Other time deposits 749 (315) 1,064
Other borrowed money 79 45 34
Federal funds purchased and
securties sold under agreement to
repurchase 374 22 352
------ ------- ------
TOTAL INTEREST BEARING LIABILITIES $2,317 $ (299) $2,616
====== ======= ======
21
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 is due to the increased rate. In 2006, increased interest income
came from both rate and growth but mainly rate. Loans and federal funds sold
were the only assets that had interest income increased due to change in volume
in 2006. 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.
ALLOWANCE FOR CREDIT LOSSES
The company segregated its Allowance for Loan and Lease Losses (ALLL) into two
reserves at the period ending December 31, 2004: The ALLL and the Allowance for
Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these
reserves constitute the total Allowance for Credit Losses (ACL).
The Company decreased the allowance for credit losses for 2006. The allowance
stands at $5.8 million for 2006 compared to $6.2 million for 2005. The Bank has
worked hard to improve loan quality while making credit available to all of
those who are in need and deemed an acceptable credit risk. This decrease 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 and $1.8 million for 2004. The allowance for credit loss
activity resulted in expense of $0.9 million for 2004. For 2005 and 2006, it
actually resulted in income of $1.3 million and $467 thousand respectively. Net
charge-offs were also lower in 2006 at $319 thousand than 2005's $1.0 million
and 2004's $684 thousand. The Company expects to see the lower levels of 2006
and 2005 charge-offs continue in future years as the indicators of asset quality
have shown improvement.
NON-INTEREST INCOME
Non-interest income of $6.4 million is almost equivalent to 2005, down only $7
thousand and $1.0 million over 2004. Mortgage servicing rights income was $371
thousand for 2006 compared to $483 thousand for 2005. Mortgage rates were higher
in 2005 and 2006 so the level of mortgage activity was slower. Sold mortgage
originations dropped from $48.8 million for 2004 to $42.8 million for 2005 and
further dropped to $33.4 million for 2006. Along with the mortgage servicing
rights income, gains on the sale of those loans decreased in 2006 to $683
compared to $704 and $925 thousand for 2005 and 2004, respectively. The
recognition of both income sources due to the mortgage activity was $1.1 million
in 2006 and $1.2 million in 2005 compared to $1.3 million in 2004.
An increase of over $1 million in non-interest income in 2005 compared to 2004
was generated from the new product Overdraft Privilege. Overdraft Privilege was
introduced in February 2005 along with free personal checking and a free small
business checking account. While maintenance fees collected on the traditional
products declined, Overdraft Privilege more than replaced it. Overdraft
Privilege enabled more automation to be utilized in the overdraft/return check
process and alleviated concern by most customers of having their checks
returned. The increased revenue level of 2005 decreased only slightly in 2006.
Overdraft privilege remains an important portion of non-interest income.
NON-INTEREST EXPENSE
Non-interest expense decreased in 2006 compared to 2005 and 2004. Salaries and
wages decreased in 2006 as compared to 2005. Two reasons for the decrease : 1)
Full time equivalent numbers of employees for December 2006 compared to December
2005 decreased by nine and 2) the incentive paid based on performance for 2006
was lower than 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.
The biggest contributor to the improvement of non-interest expense was mentioned
earlier, 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
22
responsible for the decrease. The Company has worked diligently to decrease
costs while increasing non-interest income and was successful in this endeavor
in 2006.
FEDERAL INCOME TAXES
Effective tax rates were 27.63%, 27.19%, and 30.27% for 2006, 2005 and 2004,
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 and $46.7 million for 2005 and 2004, respectively. In comparing year end
fair market balances, the investment in tax-exempt securities decreased by $17.4
million during 2006. This was accomplished through sales, maturities and
paydowns, with the proceeds used to fund loan growth.
FINANCIAL CONDITION
Average earning assets increased $5.8 million during 2006 over 2005 but were
lower by $5.3 million as compared to 2004. The increase and decrease in average
earning assets each year represents a less than 1 percent change. The main cause
of fluctuation was loans with investments serving as a contra account in
movements, increased loans - decreased investments and vice versa. Average
interest bearing liabilities increased $652 thousand over 2005 and decreased
$16.8 million from 2004. The decrease occurred to offset the decrease of loans
in 2005 and the increase in 2006 over 2005 was to fund the increase in loans.
The average balance in loans is still lower in 2006 as compared to 2004. Slowing
in the increase in average interest- bearing liabilities as compared to the
increase in average interest bearing assets is being done to help ease the
pressure on margin. The increase in non-interest bearing liabilities is helping
to lessen the reliance on interest-bearing liabilities for funding.
SECURITIES
Security balances as of December 31 are summarized below:
(In Thousands)
------------------------------
2006 2005 2004
-------- -------- --------
U.S. Treasury and Government Agencies $ 91,355 $112,199 $ 88,344
Mortgage-backed securities 31,264 28,514 30,088
State and local governments 45,495 62,891 54,647
Corporate debt securities -- -- --
Equity securities 47 47 48
-------- -------- --------
$168,161 $203,651 $173,127
======== ======== ========
The following table sets forth (dollars in thousands) the maturities of
investment securities as of December 31, 2006 and the weighted average yields of
such securities calculated on the basis of cost and effective yields weighted
for the scheduled maturity of each security. Tax-equivalent adjustments, using a
thirty-four percent rate have been made in yields on obligations of state and
political subdivisions. Stocks of domestic corporations have not been included.
Maturities
-----------------------------------
After One Year
Within One Year Within Five Years
--------------- -----------------
Amount Yield Amount Yield
------- ----- ------- -----
U.S. Treasury $ 288 3.80% $ 99 4.40%
U.S. Government agency 42,014 3.61% 47,461 4.38%
Mortgage-backed securities 422 5.02% 30,842 4.40%
State and local governments 3,775 4.86% 15,822 5.18%
Taxable state and local governments 2,982 3.80% 1,121 6.22%
23
Maturities
----------------------------------
After Five Years
Within Ten Years After Ten Years
---------------- ---------------
Amount Yield Amount Yield
------- ----- ------ -----
U.S. Treasury $ -- -- $ -- --
U.S. Government agency 1,493 5.59% -- --
Mortgage-backed securities -- 0.00% -- --
State and local governments 19,528 5.50% 2,267 5.71
Taxable state and local governments -- -- -- --
As of December 31, 2006 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.
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)
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Loans:
Commercial/industrial $105,371 $ 90,227 $ 98,518 $102,101 $100,119
Agricultural 69,771 62,023 55,219 63,082 66,136
Real estate mortgage 294,218 268,315 274,156 267,312 278,933
Consumer 27,732 34,686 41,276 47,984 51,156
Industrial Development Bonds 7,335 9,237 10,687 7,944 7,810
-------- -------- -------- -------- --------
Total Loans $504,427 $464,488 $479,856 $488,423 $504,154
======== ======== ======== ======== ========
The following table shows the maturity of loans as of December 31, 2006:
Maturities (In Thousands)
----------------------------------------------
After One
Within Year Within After
One Year Five Years Five Years Total
-------- ----------- ---------- --------
Commercial and industrial $45,477 $35,068 $ 24,826 $105,371
Agricultural 51,454 15,881 2,436 69,771
Real estate mortgage 9,651 28,635 255,932 294,218
Consumer 5,717 17,323 4,692 27,732
Industrial Development Bonds 4,555 1,678 1,102 7,335
The following table presents the total of loans due after one year which have 1)
predetermined interest rates and 2) floating or adjustable interest rates:
24
(In Thousands)
------------------
Fixed Variable
Rate Rate
------- --------
Commercial and industrial $38,729 $ 21,165
Agricultural 17,718 599
Real estate 37,923 246,644
Consumer, Credit Card and overdrafts 22,015 --
Industrial Development Bonds 2,780 --
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)
------------------------------------------
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Non-accrual loans $4,254 $4,663 $6,059 $6,236 $5,792
Accruing loans past due
90 days or more -- -- 393 2,042 2,674
------ ------ ------ ------ ------
Total $4,254 $4,663 $6,452 $8,278 $8,466
====== ====== ====== ====== ======
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 $561 thousand for 2004 and $246 thousand for 2005 and $174
thousand for 2006. 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 $279 for 2004, $473 for 2005,
$167 thousand for 2006. $171 thousand of the interest collected in 2006 was
applied to reduce the specific allocations on those loans.
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 $4.3 million of non-accrual loans as of December 31, 2006 are secured.
As of December 31, 2006 the Bank has $12.0 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, 2006.
In extending credit to families, businesses and governments, banks accept a
measure of risk against which an allowance for possible loan loss is established
by way of expense charges to earnings. This expense, used to enlarge a bank's
allowance for loan losses, is determined by management based on a detailed
monthly review of the risk factors affecting the loan portfolio, including
general economic conditions, changes in the portfolio mix, past due loan-loss
experience and the financial condition of the bank's borrowers.
As of December 31, 2006, the Bank had loans outstanding to individuals and firms
engaged in the various fields of agriculture in the amount of $69 million. The
ratio of this segment of loans to the total loan portfolio is not considered
unusual for a bank engaged in and servicing rural communities.
The allowance for loan losses is evaluated based on an assessment of the losses
inherent in the loan portfolio. This assessment results in an allowance
consisting of two components, allocated and unallocated.
Management considers several different risk assessments in determining the
allowance for loan losses. The allocated component of the allowance for loan
losses reflects expected losses resulting from an analysis of
25
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 on the next page, charge-offs decreased to $985 thousand for 2006,
and the provision was $525 thousand. A few large commercial credits included in
the $5.7 million charged off in the commercial and agricultural segment in 2003
caused 2003 to have the largest charge offs of the years presented. The
commercial and agricultural segment was in a net recovery position for 2004 and
2006. 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.
The following table presents a reconciliation of the allowance for credit
losses:
26
(In Thousands)
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Loans $504,427 $464,488 $479,681 $488,247 $498,078
======== ======== ======== ======== ========
Daily average of outstanding loans $484,663 $469,326 $491,104 $500,517 $475,035
======== ======== ======== ======== ========
Allowance for Loan Losses-Jan. 1 $ 5,388 $ 6,814 $ 7,300 $ 6,400 $ 7,275
Loans Charged off:
Commercial & Agricultural 282 945 491 5,706 2,987
Consumer 321 722 739 1,156 1,050
Real estate mortgages 382 429 549 424 215
-------- -------- -------- -------- --------
985 2,096 1,779 7,286 4,252
-------- -------- -------- -------- --------
Loan Recoveries:
Commercial & Agricultural 288 631 652 601 801
Consumer 351 412 405 546 366
Real estate mortgages 27 52 38 136 16
-------- -------- -------- -------- --------
666 1,095 1,095 1,283 1,183
-------- -------- -------- -------- --------
Net Charge Offs 319 1,001 684 6,003 3,069
-------- -------- -------- -------- --------
Provision for loan loss 525 (425) 884 6,903 2,194
-------- -------- -------- -------- --------
Allowance for Loan & Lease Losses - Dec 31 $ 5,594 $ 5,388 $ 6,814 $ 7,300 $ 6,400
Allowance for Unfunded Loan Commitments
& Letters of Credit Dec 31 $ 168 $ 841 $ 686 $ -- $ --
-------- -------- -------- -------- --------
Total Allowance for Credit Losses - Dec 31 $ 5,762 $ 6,229 $ 7,500 $ 7,300 $ 6,400
======== ======== ======== ======== ========
Ratio of net charge-offs to average
Loans outstanding 0.07% 0.21% 0.14% 1.20% 0.65%
======== ======== ======== ======== ========
Allocation of the allowance for credit losses per Loan Category in terms of
dollars and percentage among the various loan categories is as follows:
2006 2005 2004 2003 2002
Amount Amount Amount Amount Amount
(000's) % (000's) % (000's) % (000's) % (000's) %
------- ---- ------- ----- ------- ---- ------- ---- ------- ----
Balance at End of Period Applicable To:
Commercial/industrial $2,721 2.58% $2,753 2.77% $3,917 3.98% $1,816 1.78% $3,170 1.91%
Agricultural 250 0.36% 390 0.63% 681 1.23% 674 1.07% -- --
Real estate 1,671 0.57% 910 0.34% 644 0.23% 531 0.20% 1,306 0.48%
Consumer 634 2.29% 557 1.61% 549 1.33% 451 0.94% 1,140 2.23%
Unallocated 318 778 1,024 3,928 784
------ ------ ------ ------ ------
Allowance for Loan & Lease Losses $5,594 1.11% $5,388 1.16% $6,815 1.42% $7,400 1.52% $6,400 4.61%
Off Balance Sheet Commitments $ 168 0.24% $ 841 0.60% $ 686 0.56% $ -- -- $ -- --
------ ------ ------ ------ ------
Total Allowance for Credit Losses $5,762 $6,229 $7,500 $7,500 $7,500
====== ====== ====== ====== ======
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, 2006 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 $16,162 $22,829 $23,350 $15,736
The following table presents the average amount of and average rate paid on each
deposit category:
27
(In Thousands)
-----------------------------------------
Demand NOW Savings Time
Deposits Accounts Accounts Accounts
-------- -------- -------- --------
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%
December 31, 2004:
Average balance $42,205 $88,666 $115,383 $323,527
Average rate 0.00% 0.67% 0.58% 2.69%
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 $198
million during 2004, $207 million for 2005, compared to $198 million for 2006.
This represented 28.0 percent, 29.7 percent, and 28.0 percent of total average
assets, respectively. Of the almost $171.4 million of debt securities in the
company's portfolio as of December 31, 2006, $49.2 million or 28.7 percent of
the portfolio is expected to mature in 2007. Taking into consideration possible
calls of the debt securities, the amount climbs to $64.9 million or 37.9 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
2006, specifically the savings and time deposits portfolios. Overall deposits
decreased an average of $6.1 million during 2006 compared to 2005's decrease
over 2004 of $19.8 million in average deposits. These represent changes of (1.1)
percent and (3.6) percent in average total deposits, respectively. The biggest
change shows in the most expensive time accounts and represents rate shoppers
moving funds out of the Bank. The Bank also utilized Federal Funds purchased at
times during 2006, the average balance for 2006 was $1.2 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 2006 was 85.97
percent, 2005 was 79.6 percent, 2004 was 82.23 percent. The decrease in 2004 and
2005 is due to the lack of growth in both the credit and deposit portfolios.
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.
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 $34.8 million at the end of 2006 compared to $21.2
million at the end of 2005 and $22.9 million at December 31, 2004. Though no
federal funds were purchased at year end, the Bank does have arrangements with
correspondent Banks that can be utilized when necessary.
28
Securities Sold Under
Agreement to Repurchase
For Year Ended 2006
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
----------------- --------------------- ----------------------- --------------------- ---------------------
$34,818 5.07% $35,205 $28,868 4.69%
Other borrowings are also a source of funds. Other borrowings consist of loans
from the Federal Home Loan Bank of Cincinnati. These funds are then used to
provide fixed rate mortgage loans secured by homes in our community. Borrowings
from this source decreased by $11.7 million to $23.2 million at December 31,
2006. This compares to increased borrowings during 2005 of $13 million to $347
million at December 31, 2005 and decreased borrowings during 2004 of $2.4 to $22
million at December 31, 2004. The increased borrowings of 2005 were used to
leverage the Company with the proceeds purchasing tax exempt municipals that
provided a set profit margin. The decreased borrowings were payoffs of matured
notes. Sufficient funds were available to fund growth so new advances were not
needed.
CONTRACTUAL OBLIGATIONS
Contractual Obligations of the Company totaled $372.6 million as of December
31,2006. 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 are further defined in Note 4 and 9 of the
Consolidated Financial Statements.
Payment Due by Period (In Thousands)
----------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year Years Years 5 years
----------------------- -------- --------- ------- ------- ---------
Securities sold under agreement to repurchase $ 34,818 $ 34,818 $ -- $ -- $ --
Time Deposits 313,787 241,303 70,161 1,331 992
Dividends Payable 774 774
Long Term Debt 23,233 6,416 1,176 10,571 5,070
-------- -------- ------- ------- ------
Total $372,612 $283,311 $71,337 $11,902 $6,062
======== ======== ======= ======= ======
CAPITAL RESOURCES
Shareholders' equity was $87.7 million as of December 31, 2006 compared to $82.6
million at December 31, 2005. Dividends declared during 2006 were $0.575 per
share totaling $3.0 million, 15 percent higher than 2005 declared dividends of
$0.50 per share. The Company purchased back 4,000 shares in the third quarter of
2005 to award to employees of the Bank under its long-term incentive plan. 80
shares were held in Treasury stock at year-end after having been forfeited by an
employee. During 2006 the Company purchased 42,000 shares and awarded 6,100
restricted shares to 41 employees. 200 restricted 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 has authorization to purchase 228,000 shares throughout 2007. The
Company continues to have a strong capital base and to maintain regulatory
capital ratios that are significantly above the defined regulatory capital
ratios.
At December 31, 2006, The Farmers & Merchants State Bank and Farmers & Merchants
Bancorp, Inc had total risk-based capital ratios of 17.04% and 17.27%,
respectively. Core capital to risk-based asset ratios of 13.24% and 16.22% 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
12.4%.
29
The Company's subsidiaries are restricted by regulations from making dividend
distributions in excess of certain prescribed amounts.
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.
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
30
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:
Interest Rate Shock on Interest Rate Shock on
Net Interest Margin Net Interest Income
----------------------------- --------------------------
Net Interest % Change Rate Rate Cumulative % Change to
Margin (Ratio) to Flat Rate Direction changes by Total ($000) Flat Rate
-------------- ------------ --------- ---------- ------------ -----------
2.95% -15.35% Rising 3.00% 21,897 -14.74%
3.13% -10.17% Rising 2.00% 23,166 -9.80%
3.31% -5.06% Rising 1.00% 24,428 -4.88%
3.48% 0.00% Flat 0 25,682 0.00%
3.66% 4.99% Falling -1.00% 26,924 4.83%
3.86% 10.74% Falling -2.00% 28,084 9.35%
3.89% 11.76% Falling -3.00% 27,959 8.86%
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.
31
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Independent Auditors' Report
Consolidated Balance Sheet at December 31, 2006 and 2005
Consolidated Statements of Income for the years ended December 31, 2006, 2005
and 2004
Consolidated Statements of Changes in Shareholders' Equity for the year ended
December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flow for the years ended December 31, 2006, 2005
and 2004
Notes to Consolidated Financial Statements
32
(PLANTE & MORAN LOGO) PLANTE & MORAN, PLLC
Suite 500
2601 Cambridge Court
Auburn Hills, MI 48326
Tel: 248.375.7100
Fax: 248.375.7101
plantemoran.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Archbold, Ohio
We have audited the accompanying consolidated balance sheet of Farmers &
Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2006 and December
31, 2005 and the related consolidated statements of income, stockholders'
equity, and cash flows for each year in the three year period ended December 31,
2006. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Farmers &
Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2006 and December
31, 2005 and the consolidated results of its operations and its cash flows for
each year in the three year period ended December 31, 2006, in conformity with
U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Farmers &
Merchants Bancorp, Inc. and Subsidiaries internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission an our report dated February 21, 2007, expressed an
unqualified opinion thereon.
(PLANTE & MORAN, PLLC)
February 21, 2007
Auburn Hills, Michigan
33
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2006 AND 2005
(000'S OMITTED, EXCEPT PER SHARE DATA)
2006 2005
-------- --------
ASSETS
ASSETS
Cash and due from banks (Note 2) $ 23,583 $ 20,056
Interest-bearing deposits in banks 311 2,533
Federal Funds Sold 13,353 --
-------- --------
Total cash and cash equivalents 37,247 22,589
Securities - available for sale (Note 3) 168,161 203,651
Federal Home Loan Bank stock, at cost 4,016 3,791
Loans, net (Note 4) 498,580 458,704
Premises and equipment (Note 5) 14,189 14,874
Other assets (Note 6 & 10) 14,903 17,336
-------- --------
TOTAL ASSETS $737,096 $720,945
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits (Note 7)
Noninterest-bearing $ 60,211 $ 64,791
Interest-bearing
NOW accounts 88,235 84,835
Savings 123,176 114,825
Time (Note 7) 313,787 311,846
-------- --------
Total deposits 585,409 576,297
Securities sold under agreement to repurchase (Note 8) 34,818 21,158
Long-term debt (Note 9) 23,233 34,952
Dividend payable 774 844
Accrued expenses and other liabilities 5,130 5,106
-------- --------
Total liabilities 649,364 638,357
-------- --------
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 - 36,180 Shares 2006, 80 shares 2005 (816) (2)
Unearned Stock Awards - 9,820 Shares 2006, 3,920 shares 2005 (244) (113)
Retained earnings 77,089 71,933
Accumulated other comprehensive income (Loss) (974) (1,907)
-------- --------
Total stockholders' equity 87,732 82,588
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $737,096 $720,945
======== ========
See Notes to Consolidated Financial Statements
34
CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(000'S OMITTED, EXCEPT PER SHARE DATA)
2006 2005 2004
---------- ---------- ----------
INTEREST INCOME
Loans, including fees $ 35,069 $ 31,388 $ 31,156
Debt securities:
U.S. Treasury and government agency 4,615 4,142 3,912
Municipalities 2,086 2,121 2,020
Corporate debt securities -- -- 3
Dividends 227 185 146
Federal funds sold 259 9 34
Other 13 256 80
---------- ---------- ----------
Total interest income 42,269 38,101 37,351
INTEREST EXPENSE
Deposits 15,847 11,844 9,980
Federal funds purchased and securities sold
under agreements to repurchase 1,420 799 425
Borrowed funds 1,268 896 817
---------- ---------- ----------
Total interest expense 18,535 13,539 11,222
---------- ---------- ----------
NET INTEREST INCOME - Before provision for loan losses 23,734 24,562 26,129
PROVISION FOR LOAN LOSSES (Note 4) 525 (425) 884
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 23,209 24,987 25,245
NONINTEREST INCOME
Customer service fees 3,548 3,618 2,140
Other service charges and fees 2,212 2,109 2,234
Net gain on sale of loans (Note 6) 683 704 925
Net gain (loss) on sale of available-for-sale securities (10) 9 127
---------- ---------- ----------
Total noninterest income 6,433 6,440 5,426
NONINTEREST EXPENSES
Salaries and Wages 8,304 8,411 7,970
Employee benefits (Note 11) 2,456 2,275 2,252
Occupancy expense 605 656 649
Furniture and equipment 1,421 1,492 1,437
Data processing 998 1,013 1,101
Franchise taxes 839 817 712
Mortgage servicing rights amortization (Note 6) 263 293 332
Other general and administrative 3,513 4,692 4,415
---------- ---------- ----------
Total other operating expenses 18,399 19,649 18,868
---------- ---------- ----------
INCOME BEFORE INCOME TAXES 11,243 11,778 11,803
INCOME TAXES (NOTE 10) 3,107 3,202 3,573
---------- ---------- ----------
NET INCOME $ 8,136 $ 8,576 $ 8,230
========== ========== ==========
EARNINGS PER SHARE - BASIC $ 1.57 $ 1.65 $ 1.58
========== ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 5,186,329 5,198,728 5,200,000
========== ========== ==========
See Notes to Consolidated Financial Statements
35
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(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, 2004 5,200,000 $12,677 $ -- $ -- $60,196 $ 1,983 $74,856
Comprehensive income (Note 1):
Net income -- $ -- $ -- $ -- $ 8,230 $ -- $ 8,230
Change in net unrealized gain on securities
available for sale, net of
reclassification adjustment and tax
effects -- $ -- $ -- $ -- $ -- $(1,771) $(1,771)
-------
Total comprehensive income $ 6,459
Cash dividends declared - $0.475 per share -- $ -- $ -- $ -- $(2,470) $ -- $(2,470)
--------- ------- ----- ----- ------- ------- -------
BALANCE - December 31, 2004 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
--------- ------- ----- ----- ------- ------- -------
See Notes to Consolidated Financial Statements
36
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(000'S OMITTED)
Accumulated
Shares of Unearned Other Total
Common Common Treasury Stock Retained Comprehensive Stockholders'
Stock Stock Stock Awards Earnings Income (Loss) Equity
--------- ------- -------- -------- -------- ------------- -------------
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
========= ======= ===== ===== ======= ===== ========
See Notes to Consolidated Financial Statements
37
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(000'S OMITTED)
2006 2005 2004
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 8,136 $ 8,576 $ 8,230
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation 1,107 1,167 1,142
Amortization of servicing rights 263 293 332
Provision for loan loss 525 (425) 884
Accretion and amortization of securities 382 989 1,223
Deferred income taxes (benefit) 282 387 (14)
(Gain) loss on sale of other assets 5 (2) 2
Realized (gain) loss on sales of available-for-sale securities, net 10 (9) (127)
Net Change in:
Loans held for sale -- 175 1
Change in other assets and other liabilities, net 2,670 (1,931) 3,019
-------- -------- --------
Net cash provided (used) by operating activities 13,380 9,220 14,692
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Sales 19,006 -- 10,740
Maturities, prepayments and calls 61,654 38,477 64,599
Purchases (44,382) (73,376) (81,553)
Loan and lease originations and principal collections, net (41,630) 13,732 7,241
Proceeds from sales of assets 1 18 3
Additions to premises and equipment (428) (539) (793)
-------- -------- --------
Net cash provided (used) by investing activities (5,779) (21,688) 237
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 9,112 2,092 (861)
Net change in federal funds purchased and securities
sold under agreements to repurchase 13,660 (1,694) (4,467)
Proceeds from issuance of long-term debt -- 15,000 --
Repayment of long-term debt (11,720) (2,012) (2,410)
Purchase of Treasury Stock (945) (115) --
Cash dividends paid on common stock (3,050) (2,470) (2,470)
-------- -------- --------
Net cash provided (used) by financing activities 7,057 10,801 (10,208)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 14,658 (1,667) 4,721
CASH AND CASH EQUIVALENTS - Beginning of Year 22,589 24,256 19,535
-------- -------- --------
CASH AND CASH EQUIVALENTS - End of Year $ 37,247 $ 22,589 $ 24,256
======== ======== ========
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest $ 18,235 $ 13,227 $ 11,283
======== ======== ========
Income taxes $ 2,757 $ 2,640 $ 2,840
======== ======== ========
See Notes to Consolidated Financial Statements
38
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) provide a variety
of financial services to individuals and small businesses through its
offices in Northwest Ohio.
CONSOLIDATION POLICY
The consolidated financial statements include the accounts of Farmers &
Merchants Bancorp, Inc. and its wholly-owned subsidiaries, The Farmers &
Merchants State Bank (the Bank), a commercial banking institution, and the
Farmers & Merchants Life Insurance Company, a reinsurance company for life,
accident and health insurance for the Bank's consumer credits. All
significant inter-company balances and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Material
estimates that are particularly susceptible to significant change in the
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.
36
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 STOCK
The Federal Home Loan Bank stock is recorded at cost since it is a
restricted stock. The Federal Home Loan Bank sells and purchases its stock
at par; therefore cost approximates market value. The stock is held as
collateral security for all indebtedness of the Bank to the Federal Home
Loan Bank.
LOANS
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at the amount
of unpaid principal, reduced by unearned discounts and deferred loan fees
and costs, as well as, by the allowance for loan losses. Interest income is
accrued on a daily basis based on the principal outstanding.
Generally, a loan is classified as nonaccrual and the accrual of interest
income is generally discontinued when a loan becomes ninety days past due
as to principal or interest and these loans are placed on a "cash basis"
for purposes of income recognition. Management may elect to continue the
accrual of interest when the estimated net realizable value of collateral
is sufficient to cover the principal and accrued interest, and the loan is
in the process of collection. When a loan is placed on nonaccrual status,
all previously accrued and unpaid interest receivable is charged against
income.
Loan origination and commitment fees and certain direct loan origination
costs are deferred and amortized as a net adjustment to the related loan's
yield. The Bank is generally amortizing these costs over the contractual
life of such loans.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for loan
losses charged to income. Loans deemed to be uncollectable and changes in
the allowance relating to impaired loans are charged against the allowance
for loan losses, and subsequent recoveries, if any, are credited to the
allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based on management's periodic review of the collectibility of the
loans in light of historical experiences, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral, and prevailing
37
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 either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market 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. 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.
38
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 represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during
the period. The Company has no dilutive shares, as the restricted stock
grants are 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 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)
--------------------------
2006 2005 2004
------ ------- -------
Net Unrealized gain (loss) on
available-for-sale securities $1,404 $(3,202) $(2,556)
Tax Effect (478) 1,089 869
------ ------- -------
Net-of-tax amount 926 (2,113) (1,687)
------ ------- -------
Reclassification adjustment for gain on sale of
available-for-sale securities $ 10 $ (9) $ (127)
Tax Effect (3) 3 43
------ ------- -------
Net-of-tax amount 7 (6) (84)
------ ------- -------
Other comprehensive income $ 933 $(2,119) $(1,771)
====== ======= =======
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140." SFAS 156
requires an entity to recognize a
39
servicing asset or servicing liability each time it undertakes an
obligation to service a financial asset by entering into certain servicing
contracts. SFAS 156 also requires all separately recognized servicing
assets and servicing liabilities to be initially measured at fair value, if
practicable. SFAS 156 permits an entity to choose between the amortization
and fair value methods for subsequent measurements. SFAS 156 also requires
separate presentation of servicing assets and servicing liabilities
subsequently measured at fair value in the statement of financial position
and additional disclosures for all separately recognized servicing assets
and servicing liabilities. SFAS 156 is effective for fiscal years beginning
after September 15, 2006. The Company does not expect the implementation of
SFAS 156 to have a material impact on its financial statements.
In September 2006, the FASB issued SFAS No. 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. FSAS No. 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.
RECLASSIFICATION
Certain amounts in the 2005 and 2004 consolidated financial statements have
been reclassified to conform with the 2006 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 - 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 remains the same at December 31, 2006
as it was for December 31, 2005 at $4.6 million.
The Company and its subsidiaries maintain cash balances with high quality
credit institutions. At times such balances may be in excess of the
federally insured limits.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities, with gross unrealized
gains and losses, follows:
40
(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
========= ==== ====== ========
(In Thousands)
2005
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
Available-for-Sale:
U.S. Treasury $ 2,380 $ -- $ 26 $ 2,354
U.S. Government agency 111,503 4 1,662 109,845
Mortgage-backed securities 29,470 10 966 28,514
State and local governments 63,141 426 676 62,891
Equity securities 47 -- -- 47
-------- ---- ------ --------
$206,541 $440 $3,330 $203,651
======== ==== ====== ========
Information pertaining to securities with gross unrealized losses at
December 31, 2006 and 2005, aggregated by investment category and length of
time that individual securities have been in a continuous loss position
follows:
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
41
2005
-------------------------------------------------
(In Thousands) (In Thousands)
Less Than Twelve Months Twelve Months & Over
----------------------- -----------------------
Gross Gross
Unrealized Unrealized
Losses Fair Value Losses Fair Value
---------- ---------- ---------- ----------
U S Treasury $ 2 $ 237 $ 24 $ 2,117
U S Government agency $286 $39,837 $1,376 $63,039
Mortgage-backed securities $123 $ 8,448 $ 843 $18,738
State and local governments $480 $30,354 $ 196 $ 6,404
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)
------------------
2006 2005 2004
---- ---- ----
Gross realized gains $ 27 $ 9 $133
Gross realized losses (37) -- (6)
---- --- ----
Net Realized Gains $(10) $ 9 $127
==== === ====
Tax expense related to net realized gains $ (3) $ 3 $ 43
==== === ====
The amortized cost and fair value of debt securities at December 31, 2006,
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 $ 47,962 $ 47,688
After one year through five years 74,927 74,125
After five years through ten years 20,203 19,916
After ten years 26,499 26,385
-------- --------
169,591 168,114
Equity securities 47 47
-------- --------
Total $169,638 $168,161
======== ========
Investments with a carrying value and fair value of $142.9 million at
December 31, 2006 and $140.3 million at December 31, 2005 were pledged to
secure public deposits and securities sold under repurchase agreements.
42
NOTE 4 - LOANS
Loans at December 31, are summarized below:
(In Thousands)
-------------------
2006 2005
-------- --------
Loans:
Real estate (Consumer, Cml & Ag) $294,218 $268,315
Commercial and industrial 105,371 90,227
Agricultural 69,771 62,023
Consumer, Overdrafts and other loans 27,732 34,686
Industrial Development Bonds 7,335 9,237
-------- --------
504,427 464,488
Less: Deferred loan fees and costs (253) (396)
-------- --------
504,174 464,092
Less: Allowance for loan losses (5,594) (5,388)
-------- --------
Loans - Net $498,580 $458,704
======== ========
The following is a maturity schedule by major category of loans including
available for sale loans:
(In Thousands)
----------------------------------
Principal Payments Due Within
----------------------------------
Two to After
One Year Five Years Five Years
-------- ---------- ----------
Real estate loans (Consumer, Cml & Ag) $ 9,651 $28,635 $255,932
Commercial and industrial loans 45,477 35,068 24,826
Agricultural 51,454 15,881 2,436
Consumer, Master Card and Overdrafts 5,717 17,323 4,692
Industrial Development Bonds 4,555 1,678 1,102
The distribution of fixed rate loans and variable rate loans by major loan
category is as follows as of December 31, 2006:
(In Thousands)
------------------
Fixed Variable
Rate Rate
------- --------
Real estate loans (Consumer, Cml & Ag) $44,856 $249,362
Commercial and industrial loans 46,613 58,758
Agricultural 22,225 47,546
Consumer, Master Card and Overdrafts 25,958 1,774
Industrial Development Bonds 7,335 --
One to four family residential mortgage loans amounting to $74.1 million
have been pledged as security for loans the Bank has received from the
Federal Home Loan Bank.
As of December 31, 2006 and 2005 there were $10.6 and $8.9 million,
respectively, of undisbursed loans in process.
43
The following is an analysis of the allowance for loan loss:
(In Thousands)
--------------------------
2006 2005 2004
------ ------- -------
Allowance for Loan Losses
Balance at beginning of year $5,388 $ 6,814 $ 7,300
Provision for loan loss 525 (425) 884
Loans charged off (985) (2,096) (1,779)
Recoveries 666 1,095 1,095
Allowance for Unfunded Loan Commitments &
Letters of Credit $ -- $ -- $ (686)
------ ------- -------
Allowance for Loan & Leases Losses $5,594 $ 5,388 $ 6,814
====== ======= =======
Allowance for Unfunded Loan Commitments &
Letters of Credit $ 168 $ 841 $ 686
------ ------- -------
Total Allowance for Credit Losses $5,762 $ 6,229 $ 7,500
====== ======= =======
The company segregated its Allowance for Loan and Lease Losses (ALLL) into
two reserves at the period ending December 31, 2004: The ALLL and the
Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When
combined, these reserves constitute the total Allowance for Credit Losses
(ACL).
The 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)
---------------
2006 2005
------ ------
Impaired loans without a
valuation allowance $1,587 $1,273
Impaired loans with a valuation
allowance 3,095 7,221
------ ------
Total impaired loans $4,682 $8,494
====== ======
Valuation allowance related to
impaired loans $ 838 $1,978
Total non-accrual loans $4,254 $4,663
Total loans past-due ninety days or
more and still accruing $ -- $ --
(In Thousands)
-------------------------
2006 2005 2004
------ ------ -------
Average investment in
impaired loans $6,588 $9,926 $16,030
====== ====== =======
Interest income recognized
on impaired loans $ 288 $ 480 $ 572
====== ====== =======
Interest income recognized on
a cash basis on impaired loans $ 167 $ 473 $ 279
====== ====== =======
No additional funds are committed to be advanced in connection with
impaired loans.
44
NOTE 5 -- PREMISES AND EQUIPMENT
The major categories of banking premises and equipment and accumulated
depreciation at December 31 are summarized below:
(In Thousands)
-------------------
2006 2005
-------- --------
Land $ 2,811 $ 2,756
Buildings (useful life 15-39 years) 15,100 15,080
Furnishings (useful life 3-15 years) 8,960 9,758
-------- --------
26,871 27,594
Less: Accumulated depreciation (12,682) (12,720)
-------- --------
Premises and Equipment (Net) $ 14,189 $ 14,874
======== ========
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 $251 and $249 million at December 31, 2006 and 2005, respectively.
The balance of capitalized servicing rights included in other assets at
December 31, 2006 and 2005, was $1.8 and $1.7 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, 2006 and 2005 was $2.2 and $1.9 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 10.0 and 12.5 were utilized for 2006 and 2005,
respectively. All stratums showed positive values compared to carrying
value using a discount yield of 8.5% for both years.
The following summarizes mortgage servicing rights capitalized and
amortized during each year:
(In Thousands)
---------------
2006 2005
------ ------
Beginning Year $1,690 $1,500
Capitalized Additions $ 371 $ 483
Amortization $ (263) $ (293)
Valuation Allowance $ -- $ --
------ ------
End of Year $1,798 $1,690
====== ======
NOTE 7 - DEPOSITS
Time deposits at December 31 consist of the following:
(In Thousands)
-------------------
2006 2005
-------- --------
Time deposits under $100,000 $235,710 $236,864
Time deposits of $100,000 or more 78,077 74,982
-------- --------
$313,787 $311,846
======== ========
At December 31, 2006 the scheduled maturities for time deposits are as
follows:
45
(In Thousands)
--------------
2007 $241,303
2008 41,511
2009 28,650
2010 907
2011 424
thereafter 992
--------
$313,787
========
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, 2006 and 2005
securities with a book value of $45.6 million and $38.8 million,
respectively, were underlying the repurchase agreements and were under the
Bank's control.
NOTE 9 - LONG TERM DEBT
Long term debt consists of various loans from the Federal Home Loan Bank.
Repayment structures vary, ranging from monthly installments, annual
payments or upon maturity. Interest payments are due monthly with interest
rates on the loans varying from 2.92% to 7.05%. Total borrowings were $23.0
and $35.0 million for 2006 and 2005, respectively. Notes are secured by a
blanket lien on 100% of the one to four family residential mortgage loan
portfolio (Note 4).
The following is a schedule by years of future minimum principal payments:
(In Thousands)
--------------
2007 $ 6,416
2008 712
2009 464
2010 5,346
2011 5,225
thereafter 5,070
-------
$23,233
=======
NOTE 10 - FEDERAL INCOME TAXES
The components of income tax expense for the years ended December 31 are as
follows:
(In Thousands)
-------------------------
2006 2005 2004
------ ------ -------
Current:
Federal $2,825 $2,815 $ 3,587
Deferred:
Federal 282 387 (14)
------ ------ -------
$3,107 $3,202 $ 3,573
====== ====== =======
The following is a reconciliation of the statutory federal income tax rate
to the effective tax rate:
46
(In Thousands)
------------------------
2006 2005 2004
------ ------ ------
Income tax at statutory rates $3,826 $4,004 $4,013
Increase(decrease) resulting from:
Tax exempt interest (749) (784) (706)
Change in prior estimates and other 30 (18) 266
------ ------ ------
$3,107 $3,202 $3,573
====== ====== ======
Deferred tax assets and liabilities at December 31 are comprised of the
following:
(In Thousands)
---------------
2006 2005
------ ------
Deferred Tax Assets:
Allowance for loan losses $1,902 $1,832
Net unrealized loss on available-
for-sale securities 503 984
Other 249 484
------ ------
Total deferred tax assets 2,654 3,300
Deferred Tax Liabilities:
Accreted discounts on bonds 71 74
FHLB stock dividends 798 721
Mortgage servicing rights 610 572
Other 506 505
Net unrealized gain on available-
for-sale securities -- --
------ ------
Total deferred tax liabilities 1,985 1,872
------ ------
Net Deferred Tax Asset (Liability) $ 669 $1,428
====== ======
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 $611, $608, and $546 thousand for 2006,
2005 and 2004, respectively.
The Company has a Long-Term Stock Incentive Plan under which 6,000 shares
of restricted stock 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 200
shares forfeited during 2006 and 80 shares forfeited during 2005.
Compensation expense applicable to the restricted stock totaled $60 and $14
thousand for the year ended December 31, 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 $20.9
and $22.3 million at December 31, 2006 and 2005, respectively. Loans made
during 2006 were $142.4 million and repayments were $143.7 million. During
2005, two directors retired from the Board and two directors were added.
Their difference in related borrowings amounted to $1.3 million,
47
net deletion. Deposits of directors, executive officers and companies in
which they have a direct or indirect ownership as of December 31, 2006 and
2005 amounted to $27.6 million and $23.4 million, respectively.
NOTE 13 - OFF BALANCE SHEET ACTIVITIES
CREDIT RELATED FINANCIAL INSTRUMENTS
The Bank is a party to credit related financial instruments with
off-balance-sheet risk in the normal course of business to meet the
financing need of its customer. These financial instruments include
commitments to extend credit, standby letters of credit and commercial
letters of credit. Such commitments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets.
The Bank's exposure to credit loss is represented by the contractual amount
of these commitments. The Bank follows the same credit policies in making
commitments as it does for on-balance-sheet instruments. At year end 2004
the Bank segregated the Allowance for Loan Losses into two components. The
allowance as it relates to unfunded loan commitments (AULC) is included
under other liabilities. The AULC as of December 31, 2006 and 2005 was $168
thousand and $841 thousand, respectively. At December 31, 2006 and 2005,
the following financial instruments were outstanding whose contract amounts
represent credit risk:
(In Thousands)
-------------------
2006 2005
-------- --------
Commitments to extend credit $132,477 $121,857
Credit card arrangements 16,098 16,092
Standby letters of credit 11,900 12,039
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 minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that,
if undertaken, could have a direct material effect on
48
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, 2006, that the Bank meets
all the capital adequacy requirements to which it is subject.
As of December 31, 2006 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, 2006 and 2005 are as follows:
To Be Well
Capitalized
Under the Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
--------------- --------------- ----------------
(000's) (000's) (000's)
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- ------
As of December 31, 2006
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%
49
To Be Well
Capitalized
Under the Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
--------------- --------------- ----------------
(000's) (000's) (000's)
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- ------
As of December 31, 2005
Total Risk-Based Capital
(to Risk Weighted Assets)
Consolidated $90,724 17.68% $41,042 8.00% N/A N/A
Farmers & Merchants State Bank 89,717 17.49% 41,044 8.00% 51,306 10.00%
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated 84,495 16.47% 20,521 4.00% N/A N/A
Farmers & Merchants State Bank 68,488 13.35% 20,522 4.00% 30,783 6.00%
Tier 1 Capital
(to Adjusted Total Assets)
Consolidated 84,495 11.87% 28,475 4.00% N/A N/A
Farmers & Merchants State Bank 68,488 9.53% 28,759 4.00% 35,949 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
$11.2 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.
The estimated fair values, and related carrying or notional amounts, for on
and off-balance sheet financial instruments as of December 31, 2006 and
2005 are reflected on the next page.
50
(In Thousands)
-----------------------------------------
2006 2005
------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
Financial Assets:
Cash and Cash Equivalents $ 23,894 $ 23,894 $ 22,589 $ 22,589
Securities - available for sale 168,161 168,161 203,651 203,651
Federal Home Loan Bank Stock 4,016 4,016 3,791 3,791
Loans, net 498,580 497,866 458,704 459,598
Interest receivable 5,244 5,244 5,036 5,036
Loans held for sale -- -- -- --
Financial Liabilities:
Deposits $585,409 $583,955 $576,297 $575,554
Short-term debt
Federal funds purchased -- -- -- --
Repurchase agreement sold 34,818 34,818 21,158 21,158
Long -term debt 23,233 22,723 34,952 34,551
Interest payable 1,491 1,491 1,191 1,191
Dividends payable 774 774 844 844
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
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 FEDERAL HOME LOAN BANK STOCK
Fair values for securities, excluding Federal Home Loan Bank stock, are
based on quoted market prices, where available. If quoted market prices are
not available, fair values are based on quoted market prices of comparable
instruments. The carrying value of Federal Home Loan Bank stock
approximates fair value based on the redemption provisions of the Federal
Home Loan Bank.
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.
51
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 flows
analysis with a discounted rate based on current incremental borrowing
rates for similar types of arrangements, or if not available, based on an
approach similar to that used for loans and deposits.
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.
52
NOTE 17 -- CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
BALANCE SHEET
(In Thousands)
-----------------
2006 2005
------- -------
ASSETS
Cash $ 916 $ 325
Related party receivables:
Dividends & Accounts receivable from subsidiaries 810 1,100
Note receivable from Bank subsidiary 15,000 15,000
Investment in subsidiaries 72,036 67,164
------- -------
TOTAL ASSETS $88,762 $83,589
======= =======
LIABILITIES
Accrued expenses $ 256 $ 157
Dividends payable 774 844
------- -------
Total Liabilities 1,030 1,001
------- -------
STOCKHOLDERS' EQUITY
Common stock - No par value - 6,500,000 shares
authorized; 5,200,000 shares issued 12,677 12,677
Treasury Stock - 36,180 shares, 80 shares (816) (2)
Unearned Stock Awards - 9820 shares, 3920 shares (244) (113)
Retained earnings 77,089 71,933
Accumulated other comprehensive income (Loss) (974) (1,907)
------- -------
Total Stockholders' Equity 87,732 82,588
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $88,762 $83,589
======= =======
STATEMENT OF INCOME
(In Thousands)
------------------------
2006 2005 2004
------ ------ ------
INCOME
Dividends from subsidiaires $3,985 $2,855 $2,185
Interest 713 713 713
------ ------ ------
Total Income 4,698 3,568 2,898
OPERATING EXPENSES 353 344 170
------ ------ ------
INCOME BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED EARNINGS AND SUBSIDIARIES 4,345 3,224 2,728
INCOME TAXES 148 132 185
------ ------ ------
4,197 3,092 2,543
Equity in undistributed earnings
of subsidiaries 3,939 5,484 5,687
------ ------ ------
NET INCOME $8,136 $8,576 $8,230
====== ====== ======
53
STATEMENTS OF CASHFLOWS
(In Thousands)
---------------------------
2006 2005 2004
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 8,136 $ 8,576 $ 8,230
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Equity in undistributed net income
of subsidiaries (3,939) (5,484) (5,687)
Changes in Operating Assets and
Liabilities:
Account receivable (35) -- --
Dividends receivable 325 (800) (300)
Other Liabilities 99 (33) (25)
------- ------- -------
Net Cash Provided by
Operating Activities 4,586 2,259 2,218
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of dividends (3,050) (2,470) (2,470)
Purchase of Treasury Stock (945) (115) --
------- ------- -------
Net Change in Cash and
Cash Equivalents 591 (326) (252)
CASH AND CASH EQUIVALENTS
Beginning of year 325 651 903
------- ------- -------
CASH AND CASH EQUIVALENTS
End of year $ 916 $ 325 $ 651
======= ======= =======
54
(000S OMITTED EXCEPT PER SHARE DATA)
Quarterly Financial Data - UNAUDITED
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 $ 0.39 $ 0.38 $ 0.41 $ 0.39
========== ========== ========== ==========
Average common shares outstanding 5,195,920 5,192,689 5,185,883 5,170,000
========== ========== ========== ==========
Quarter Ended in 2005
-------------------------------------------------
Mar 31 June 30 Sep 30 Dec 31
---------- ---------- ---------- ----------
Summary of Income:
Interest income $ 9,285 $ 9,207 $ 9,384 $ 10,135
Interest expense 3,018 3,159 3,442 3,920
---------- ---------- ---------- ----------
Net Interest Income 6,267 6,048 5,942 6,215
Provision for loan loss 96 (205) (352) 36
---------- ---------- ---------- ----------
Net interest income after
provision for loan loss 6,171 6,253 6,294 6,179
Other income (expense) (3,426) (3,243) (3,245) (3,205)
Net income before income taxes 2,745 3,010 3,049 2,974
Income taxes 712 803 821 866
---------- ---------- ---------- ----------
Net income $ 2,033 $ 2,207 $ 2,228 $ 2,108
========== ========== ========== ==========
Earnings per common share $ 0.390 $ 0.425 $ 0.430 $ 0.405
========== ========== ========== ==========
Average common shares outstanding 5,200,000 5,200,000 5,198,956 5,196,000
========== ========== ========== ==========
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTING AND FINANCIAL DISCLOSURE
No disagreements exist on accounting and financial disclosures or related
matters.
55
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, 2006, 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,
2006, 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.
56
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, 2006.
Plante & Moran, PLLC, the independent registered public accounting firm that
audited the financial statements contained herein, has issued an attestation
report on management's assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2006.
There was no change in the company's internal control over financial reporting
that occurred during the Company's fiscal quarter ended December 31, 2006 that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
February 21, 2007
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
57
(PLANTE MORAN LOGO)
Plante & Moran, PLLC
Suite 500
2601 Cambridge Court
Auburn Hills, MI 48326
Tel: 248,375,7100
Fax: 248,378,7101
plantemoran.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Archbold, Ohio
We have audited management's assessment included in the accompanying Report of
Management on Farmers & Merchants Bancorp, Inc. and Subsidiaries Internal
Control over Financial Reporting, that the Company maintained effective internal
control over financial reporting as of December 31, 2006, based on criteria
established in Internal Control-Integrated Framework issued by the committee of
Sponsoring Organizations of the Treadway Commission (COSO). Management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of 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 inherent limitations, internal control over financial reporting may
not prevent or detect misstatements. Also, projections of any evaluation of
58
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Farmers & Merchants Bancorp, Inc.
and Subsidiaries maintained effective internal control over financial reporting
as of December 31, 2006, is fairly stated, in all material respects, based on
COSO criteria. Also in our opinion, Farmers & Merchants Bancorp, Inc. and
Subsidiaries maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2006 based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Consolidated Balance Sheets of
Farmers & Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2006 and
2005 and the related consolidated statements of earnings, shareholders equity
and cash flow for each of the three years in the period ended December 31, 2006
and our report dated February 21, 2007, expressed an unqualified opinion
thereon.
/s/ Plante & Moran, PLLC
February 21, 2007
Auburn Hills, Michigan
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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 64 President, Freedom Ridge, Inc 1999
Joe E. Crossgrove* 70 Chairman of the Corporation and 1992
The Farmers & Merchants State Bank
Steven A. Everhart 52 Secretary/Treasurer, MBC Holdings, Inc 2003
Robert G. Frey 66 President, E.H. Frey & Sons, Inc. 1987
Jack C. Johnson 54 President, Hawk's Clothing, Inc. 1991
Dean E. Miller 63 Chairman, MBC Holdings, Inc. 1986
Anthony J. Rupp 57 President, Rupp Furniture Co. 2000
David P. Rupp Jr. 65 Attorney 2001
James C. Saneholtz 60 President, Saneholtz-McKarns, Inc. 1995
Kevin J. Sauder 46 President, Chief Executive Officer 2004
Sauder Woodworking Company
Merle J. Short 66 President Promow, Inc. 1987
Paul S. Siebenmorgen 57 President and CEO of the Corporation and 2005
the Farmers & Merhcants State Bank
Steven J. Wyse 62 Private Investor 1991
Dr. Betty K. Young 51 President, Northwest State Community 2005
College
* 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.
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EXECUTIVE OFFICERS
Principal Occupation & offices Held with
Name Age Corporation & Bank for Past Five Years
---- --- ----------------------------------------
Joe E. Crossgrove 70 Chairman
Paul S. Siebenmorgan 57 President & Chief Executive Officer
Rex D. Rice 48 Executive Vice President
Senior Commercial Loan Officer
Edward A. Leininger 50 Executive Vice President
Chief Operating Officer
Barbara J. Britenriker 45 Executive Vice President
Chief Financial Officer
Richard J. Lis 65 Executive Vice President
Chief Lending Officer
The information called for under Rule 405 of Regulation S-K regarding
compliance with Section 16(a) is presented in the proxy statement to be
furnished in connection with the soliciation of proxies on behalf of the
Board of Directors of the Registrant for use at its Annual Meeting to be
held on April 21, 2007, 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.
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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
21, 2007, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for herein is presented in the proxy statement to be
furnished in connection with the solicitation of proxies on behalf of the Board
of Directors of the Registrant for use at its Annual Meeting to be held
Saturday, April 21, 2007, 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 subsidiares. 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. 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.
EQUITY COMPENSATION PLAN INFORMATION
Number of securities
remaining available
Number of securities Weighted-average for future issuance
to be issued upon exercise price under equity
exercise of outstanding of outstanding compensation plans
options, warrants options, warrants (excluding securities
and rights and rights reflected in column (a))
(a) (b) (c)
----------------------- ----------------- ------------------------
Equity compensation plans
approved by security holders 0 $0.00 790,180
Equity compensation plans not
approved by security holders 0 $0.00 0
--- ----- -------
Total 0 $0.00 790,180
=== ===== =======
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
21, 2007, 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
21, 2007, and is incorporated herein by reference.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES
(a) The Following documents are filed as part of this report:
(1) Financial Statements (included in this 10-K under item 8)
Report of Independent Accountants
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in
Shareholders' Equity
Consolidated Statements of Cash Flows
Note to Consolidated Financial Statements
(2) Financial Statement Schedules
Five Year Summary of Operations
(3) Exhibits Required by Item 601 of Regulation S-K
(3.1) 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 February 18, 2005(incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on February 22, 2005).
(10.2) Change in Control Agreement executed by and between the Company
and Barbara J. Britenriker on February 18, 2005 (incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on February 22, 2005).
(10.3) Change in Control Agreement executed by and between the Company
and Edward A. Leininger on February 18, 2005 (incorporated by
reference to the Current Report on Form 8-K filed with the
Commission on February 22, 2005).
(10.4) Change in Control Agreement executed by and between the Company
and Rex D. Rice on February 18, 2005 (incorporated by reference
to the Current Report on Form 8-K filed with the Commission on
February 22, 2005).
(10.5) Change in Control Agreement executed by and between the Company
and Richard J Lis on December 16, 2005 (incorporated by Reference
to the Current Report on Form 8-K file with the Commission on
December 16,2005).
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(10.6) 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)
(10.7) 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.
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FARMERS & MERCHANTS BANCORP, INC
Signatures
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934. The registrant has duly caused this report to be signed on its
behalf by the undersigned, herunto duly authorized
By: /s/ Paul S. Siebenmorgen Date: February 16, 2007
---------------------------------
Paul S. Siebenmorgen
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Paul S Siebenmorgen Date: February 16, 2007
-------------------------------------
Paul S Siebenmorgen
Chief Executive Officer (Principal
Executive Officer)
/s/ Joe E. Crossgrove Date: February 16, 2007
-------------------------------------
Joe E. Crossgrove
Director & Chairman
/s/ Anthony J. Rupp Date: February 16, 2007
-------------------------------------
Anthony J. Rupp, Director
/s/ David P. Rupp Jr. Date: February 16, 2007
-------------------------------------
David P. Rupp Jr, Director
/s/ James Saneholtz Date: February 16, 2007
-------------------------------------
James Saneholtz, Director
/s/ Merle J. Short Date: February 16, 2007
-------------------------------------
Merle J. Short, Director
/s/ Dexter Benecke Date: February 16, 2007
-------------------------------------
Dexter Benecke, Director
/s/ Dr. Betty Young Date: February 16, 2007
-------------------------------------
Dr Betty Young, Director
/s/ Barbara J. Britenriker Date: February 16, 2007
-------------------------------------
Barbara J. Britenriker
Chief Financial Officer
(Principal Financial Officer/
Principal Accounting Officer)
/s/ Jack C. Johnson Date: February 16, 2007
-------------------------------------
Jack C. Johnson, Director
/s/ Dean E. Miller Date: February 16, 2007
-------------------------------------
Dean E. Miller, Director
/s/ Steven A. Everhart Date: February 16, 2007
-------------------------------------
Steven A. Everhart, Director
/s/ Kevin J. Sauder Date: February 16, 2007
-------------------------------------
Kevin J. Sauder, Director
/s/ Robert G. Frey Date: February 16, 2007
-------------------------------------
Robert G. Frey, Director
/s/ Steven J. Wyse Date: February 16, 2007
-------------------------------------
Steven J. Wyse, Director
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