UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2007
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE TRANSITION PERIOD FROM ________ TO ________
Commission File Number: 000-26099
FARMERS & MERCHANTS BANCORP
(Exact name of registrant as specified in its charter)
DELAWARE 94-3327828
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 W. Pine Street, Lodi, California 95240
(Address of principal Executive offices) (Zip Code)
Registrant's telephone number, including area code (209) 367-2300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by checkmark 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 Act: (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Number of shares of common stock of the registrant: Par value $0.01, authorized
2,000,000 shares; issued and outstanding 811,739 as of May 1, 2007.
FARMERS & MERCHANTS BANCORP
FORM 10-Q
TABLE OF CONTENTS
----------------------
PART I. - FINANCIAL INFORMATION PAGE
--------------------- ----
ITEM 1 - FINANCIAL STATEMENTS
Consolidated Balance Sheet as of March 31, 2007 (Unaudited),
December 31, 2006 and March 31, 2006 (Unaudited). 3
Consolidated Statement of Income (Unaudited) for the Three Months
Ended March 31, 2007 and 2006. 4
Consolidated Statement of Comprehensive Income (Unaudited) for the Three
Months Ended March 31, 2007 and 2006. 5
Consolidated Statement of Changes in Shareholders' Equity (Unaudited) for the
Three Months Ended March 31, 2007 and 2006. 6
Consolidated Statement of Cash Flows (Unaudited) for the Three Months
Ended March 31, 2007 and 2006. 7
Notes to the Consolidated Financial Statements (Unaudited) 8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 12
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 23
ITEM 4 - CONTROLS AND PROCEDURES 26
PART II. - OTHER INFORMATION
-----------------
ITEM 1 - LEGAL PROCEEDINGS 27
ITEM 1A - RISK FACTORS 27
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 27
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 27
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 27
ITEM 5 - OTHER INFORMATION 27
ITEM 6 - EXHIBITS 27
SIGNATURES 28
INDEX TO EXHIBITS 28
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS & MERCHANTS BANCORP
CONSOLIDATED BALANCE SHEET (UNAUDITED)
=========================================================================================
(in thousands) March 31, December 31, March 31,
2007 2006 2006
ASSETS
-----------------------------------------------------------------------------------------
Cash and Cash Equivalents:
Cash and Due From Banks $ 41,736 $ 47,006 $ 38,846
Federal Funds Sold 49,900 - 10,125
-----------------------------------------------------------------------------------------
Total Cash and Cash Equivalents 91,636 47,006 48,971
Investment Securities:
Available-for-Sale 126,703 132,627 152,249
Held-to-Maturity 110,720 111,240 109,329
-----------------------------------------------------------------------------------------
Total Investment Securities 237,423 243,867 261,578
Loans 1,058,476 1,046,912 958,227
Less: Allowance for Loan Losses 18,060 18,099 18,258
-----------------------------------------------------------------------------------------
Loans, Net 1,040,416 1,028,813 939,969
Premises and Equipment, Net 20,223 20,496 18,491
Bank Owned Life Insurance 38,857 38,444 37,195
Interest Receivable and Other Assets 28,556 32,607 20,979
-----------------------------------------------------------------------------------------
TOTAL ASSETS $1,457,111 $ 1,411,233 $1,327,183
=========================================================================================
LIABILITIES
-----------------------------------------------------------------------------------------
Deposits:
Demand $ 274,846 $ 295,142 $ 277,028
Interest Bearing Transaction 133,314 132,875 130,644
Savings 302,661 271,019 279,162
Time 551,870 499,492 396,984
-----------------------------------------------------------------------------------------
Total Deposits 1,262,691 1,198,528 1,083,818
Fed Funds Purchased - - -
Federal Home Loan Bank Advances 25,790 47,532 90,835
Subordinated Debentures 10,310 10,310 10,310
Interest Payable and Other Liabilities 20,151 22,523 14,805
-----------------------------------------------------------------------------------------
Total Liabilities 1,318,942 1,278,893 1,199,768
SHAREHOLDERS' EQUITY
Common Stock 8 8 8
Additional Paid-In Capital 89,827 89,926 94,821
Retained Earnings 48,595 43,126 34,400
Accumulated Other Comprehensive Loss (261) (720) (1,814)
-----------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 138,169 132,340 127,415
-----------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,457,111 $ 1,411,233 $1,327,183
=========================================================================================
The accompanying notes are an integral part of these unaudited consolidated
financial statements
3
FARMERS & MERCHANTS BANCORP
CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
=============================================================================
(in thousands except per share data) Three Months
Ended March 31,
2007 2006
-----------------------------------------------------------------------------
INTEREST INCOME
Interest and Fees on Loans $20,143 $17,882
Interest on Federal Funds Sold and Securities Purchased
Under Agreements to Resell 275 13
Interest on Investment Securities:
Taxable 1,908 1,997
Tax-Exempt 813 811
-----------------------------------------------------------------------------
Total Interest Income 23,139 20,703
-----------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 6,981 3,393
Borrowed Funds 399 1,172
Subordinated Debentures 214 189
-----------------------------------------------------------------------------
Total Interest Expense 7,594 4,754
-----------------------------------------------------------------------------
NET INTEREST INCOME 15,545 15,949
Provision for Loan Losses - 275
-----------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 15,545 15,674
-----------------------------------------------------------------------------
NON-INTEREST INCOME
Service Charges on Deposit Accounts 1,641 1,045
Net Loss on Investment Securities (768) (419)
Credit Card Merchant Fees 510 518
Increase in Cash Surrender Value of Life Insurance 413 396
ATM Fees 315 279
Other 1,641 785
-----------------------------------------------------------------------------
Total Non-Interest Income 3,752 2,604
-----------------------------------------------------------------------------
NON-INTEREST EXPENSE
Salaries and Employee Benefits 7,390 7,286
Occupancy 650 609
Equipment 663 675
Credit Card Merchant Expense 379 378
Marketing 109 147
Other 1,830 1,439
-----------------------------------------------------------------------------
Total Non-Interest Expense 11,021 10,534
-----------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 8,276 7,744
Provision for Income Taxes 2,807 2,807
-----------------------------------------------------------------------------
NET INCOME $ 5,469 $ 4,937
=============================================================================
EARNINGS PER SHARE $ 6.74 $ 6.00
=============================================================================
The accompanying notes are an integral part of these unaudited consolidated
financial statements
4
FARMERS & MERCHANTS BANCORP
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
======================================================================================================
(in thousands) Three Months
Ended March 31,
2007 2006
------------------------------------------------------------------------------------------------------
NET INCOME $5,469 $4,937
OTHER COMPREHENSIVE INCOME (LOSS) -
UNREALIZED GAINS ON DERIVATIVE INSTRUMENTS:
Unrealized holding gains arising during the period, net
of income tax effects of $0 and $0 for the quarters ended
March 31, 2007 and 2006, respectively. - -
Less: Reclassification adjustment for realized losses included in net
income, net of related income tax effects of $0 and $0 for the
quarters ended March 31, 2007 and 2006, respectively. 1 1
UNREALIZED GAINS (LOSSES) ON SECURITIES:
Unrealized holding gains (losses) arising during the period, net of income tax
benefits of $10 and $271 for the quarters ended March 31, 2007 and
2006, respectively. 13 (373)
Less: Reclassification adjustment for realized losses included in net
income, net of related income tax effects of $323 and $176 for the
quarters ended March 31, 2007 and 2006, respectively. 445 243
------------------------------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE INCOME (LOSS) 459 (129)
------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME $5,928 $4,808
======================================================================================================
The accompanying notes are an integral part of these unaudited consolidated
financial statements
5
FARMERS & MERCHANTS BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
=====================================================================================================================
(in thousands except share data) ACCUMULATED
COMMON ADDITIONAL OTHER TOTAL
SHARES COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
OUTSTANDING STOCK CAPITAL EARNINGS LOSS EQUITY
---------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2005 823,651 $ 8 $ 95,862 $ 29,463 $ (1,685) $ 123,648
---------------------------------------------------------------------------------------------------------------------
Net Income - - 4,937 - 4,937
Repurchase of Stock (2,101) - (1,041) - - (1,041)
Change in Net Unrealized Gains on
Derivitive Instruments 1 1
Change in Net Unrealized Loss
on Securities Available-for-Sale - - - (130) (130)
---------------------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2006 821,550 $ 8 $ 94,821 $ 34,400 $ (1,814) $ 127,415
=====================================================================================================================
---------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2006 811,933 $ 8 $ 89,926 $ 43,126 $ (720) $ 132,340
---------------------------------------------------------------------------------------------------------------------
Net Income - - 5,469 - 5,469
Repurchase of Stock (194) - (99) - - (99)
Change in Net Unrealized Gains on
Derivitive Instruments 1 1
Change in Net Unrealized Loss
on Securities Available-for-Sale - - - 458 458
---------------------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2006 811,739 $ 8 $ 89,827 $ 48,595 $ (261) $ 138,169
=====================================================================================================================
The accompanying notes are an integral part of these unaudited consolidated
financial statements
6
FARMERS & MERCHANTS BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
===========================================================================================
Three Months Ended
(in thousands) March 31 March 31
2007 2006
-------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net Income $ 5,469 $ 4,937
Adjustments to Reconcile Net Income to Net
Cash Provided (Used) by Operating Activities:
Provision for Loan Losses - 275
Depreciation and Amortization 517 458
Provision for Deferred Income Taxes (245) -
Net Amortization of Investment Security Premium & Discounts (86) 24
Net Loss on Investment Securities 768 419
Net Change in Operating Assets & Liabilities:
Net Decrease in Interest Receivable and Other Assets 3,550 3,384
Net Decrease in Interest Payable and Other Liabilities (2,372) (1,389)
-------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 7,601 8,108
INVESTING ACTIVITIES:
Securities Available-for-Sale:
Purchased (11,105) (10,331)
Sold, Matured or Called 17,160 15,457
Securities Held-to-Maturity:
Purchased (2,165) (3)
Matured or Called 2,664 570
Net Loans Originated or Acquired (11,697) 14,895
Principal Collected on Loans Previously Charged Off 94 258
Net Additions to Premises and Equipment (244) (1,427)
-------------------------------------------------------------------------------------------
Net Cash (Used) Provided by Investing Activities (5,293) 19,419
FINANCING ACTIVITIES:
Net Increase (Decrease) in Demand, Interest-Bearing Transaction,
and Savings Accounts 11,785 (60,458)
Increase in Time Deposits 52,378 40,936
Net Decrease in Federal Funds Purchased - (650)
Net Decrease in Federal Home Loan Bank Advances (21,742) (8,012)
Stock Repurchases (99) (1,041)
-------------------------------------------------------------------------------------------
Net Cash Provided (Used) by Financing Activities 42,322 (29,225)
Increase (Decrease) in Cash and Cash Equivalents 44,630 (1,698)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 47,006 50,669
-------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AS OF MARCH 31, 2007 AND MARCH 31, 2006 $ 91,636 $ 48,971
-------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these unaudited consolidated
financial statements
7
FARMERS & MERCHANTS BANCORP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Farmers & Merchants Bancorp (the Company) was organized March 10, 1999. Primary
operations are related to traditional banking activities through its subsidiary
Farmers & Merchants Bank of Central California (the Bank) which was established
in 1916. The Bank's wholly owned subsidiaries include Farmers & Merchants
Investment Corporation and Farmers/Merchants Corp. Farmers & Merchants
Investment Corporation has been dormant since 1991. Farmers/Merchants Corp. acts
as trustee on deeds of trust originated by the Bank.
The Company's other subsidiaries include F & M Bancorp, Inc. and FMCB Statutory
Trust I. F & M Bancorp, Inc. was created in March 2002 to protect the name F & M
Bank. During 2002, the Company completed a fictitious name filing in California
to begin using the streamlined name, "F & M Bank" as part of a larger effort to
enhance the Company's image and build brand name recognition. In December 2003,
the Company formed a wholly owned subsidiary, FMCB Statutory Trust I. FMCB
Statutory Trust I is a non-consolidated subsidiary per generally accepted
accounting principles (GAAP), and was formed for the sole purpose of issuing
Trust Preferred Securities. The accounting and reporting policies of the Company
conform to accounting principles generally accepted in the United States of
America and prevailing practice within the banking industry. The following is a
summary of the significant accounting and reporting policies used in preparing
the consolidated financial statements.
Basis of Presentation
The accompanying consolidated financial statements of the Company have been
prepared in accordance with accounting principles generally accepted in the
United States of America for financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all
adjustments (which consist solely of normal recurring accruals) considered
necessary for a fair presentation of the results for the interim periods
presented have been included. These interim consolidated financial statements
should be read in conjunction with the financial statements and related notes
contained in the Company's 2006 Annual Report to Shareholders on Form 10-K.
The accompanying consolidated financial statements include the accounts of the
Company and the Company's wholly owned subsidiaries, F & M Bancorp, Inc. and the
Bank, along with the Bank's wholly owned subsidiaries, Farmers & Merchants
Investment Corporation and Farmers/Merchants Corp. Significant inter-company
transactions have been eliminated in consolidation. The results of operations
for the three-month period ended March 31, 2007 may not necessarily be
indicative of the operating results for the full year 2007.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
Certain amounts in the prior years' financial statements and related footnote
disclosures have been reclassified to conform to the current-year presentation.
These reclassifications have no effect on previously reported income.
Cash and Cash Equivalents
For purposes of the Consolidated Statement of Cash Flows, the Company has
defined cash and cash equivalents as those amounts included in the balance sheet
captions Cash and Due from Banks, Federal Funds Sold and Securities Purchased
Under Agreements to Resell. Generally, these transactions are for one-day
periods. For these instruments, the carrying amount is a reasonable estimate of
fair value.
8
Investment Securities
Investment securities are classified at the time of purchase as held-to-maturity
if it is management's intent and the Company has the ability to hold the
securities until maturity. These securities are carried at cost, adjusted for
amortization of premium and accretion of discount using a level yield of
interest over the estimated remaining period until maturity. Losses, reflecting
a decline in value judged by the Company to be other than temporary, are
recognized in the period in which they occur.
Securities are classified as available-for-sale if it is management's intent, at
the time of purchase, to hold the securities for an indefinite period of time
and/or to use the securities as part of the Company's asset/liability management
strategy. These securities are reported at fair value with aggregate unrealized
gains or losses excluded from income and included as a separate component of
shareholders' equity, net of related income taxes. Fair values are based on
quoted market prices or broker/dealer price quotations on a specific
identification basis. Gains or losses on the sale of these securities are
computed using the specific identification method.
Trading securities, if any, are acquired for short-term appreciation and are
recorded in a trading portfolio and are carried at fair value, with unrealized
gains and losses recorded in non-interest income.
Investment securities are evaluated for impairment on at least a quarterly basis
and more frequently when economic or market conditions warrant such an
evaluation to determine whether a decline in their value is other than
temporary. Management utilizes criteria such as the magnitude and duration of
the decline and the intent and ability of the Company to retain its investment
in the securities for a period of time sufficient to allow for an anticipated
recovery in fair value, in addition to the reasons underlying the decline, to
determine whether the loss in value is other than temporary. The term "other
than temporary" is not intended to indicate that the decline is permanent, but
indicates that the prospects for a near-term recovery of value are not
necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the investment.
Once a decline in value is determined to be other than temporary, the value of
the security is reduced and a corresponding charge to earnings is recognized.
Loans
Loans are reported at the principal amount outstanding net of unearned discounts
and deferred loan fees. Interest income on loans is accrued daily on the
outstanding balances using the simple interest method. Loan origination fees are
deferred and recognized over the contractual life of the loan as an adjustment
to the yield. Loans are placed on non-accrual status when the collection of
principal or interest is in doubt or when they become past due for 90 days or
more unless they are both well-secured and in the process of collection. For
this purpose a loan is considered well secured if it is collateralized by
property having a net realizable value in excess of the amount of the loan or is
guaranteed by a financially capable party. When a loan is placed on non-accrual
status, the accrued and unpaid interest receivable is reversed and charged
against current income; thereafter, interest income is recognized only as it is
collected in cash. Loans placed on a non-accrual status are returned to accrual
status when the loans are paid current as to principal and interest and future
payments are expected to be made in accordance with the contractual terms of the
loan.
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. When a loan is impaired, the recorded
amount of the loan in the Consolidated Balance Sheet is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate, or the observable or estimated market price of the loan or on the fair
value of the collateral if the loan is collateral dependent. Impaired loans are
placed on non-accrual status with income reported accordingly. Cash payments are
first applied as a reduction of the principal balance until collection of the
remaining principal and interest can be reasonably assured. Thereafter, interest
income is recognized as it is collected in cash.
Allowance for Loan Losses
As a financial institution which assumes lending and credit risks as a principal
element in its business, the Company anticipates that credit losses will be
experienced in the normal course of business. Accordingly, the allowance for
loan losses is maintained at a level considered adequate by management to
provide for losses that are inherent in the portfolio. The allowance is reduced
by charge-offs and increased by provisions charged to operating expense and by
9
recoveries on loans previously charged off. Management employs a systematic
methodology for determining the allowance for loan losses. On a quarterly basis,
management reviews the credit quality of the loan portfolio and considers many
factors in determining the adequacy of the allowance at the balance sheet date.
The factors evaluated in connection with the allowance may include existing
general economic and business conditions affecting the key lending areas of the
Company, current levels of problem loans and delinquencies, credit quality
trends, collateral values, loan volumes and concentration, seasoning of the loan
portfolio, specific industry conditions, recent loss experience, duration of the
current business cycle, bank regulatory examination results and findings of the
Company's internal credit examiners.
The allowance also incorporates the results of measuring impaired loans as
provided in Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan-Income Recognition and Disclosures." These
accounting standards prescribe the measurement methods, income recognition and
disclosures related to impaired loans, which are discussed more fully in Note 4
to the Consolidated Financial Statements in the Company's 2006 Annual Report to
Shareholders on Form 10-K.
While the Company utilizes a systematic methodology in determining its
allowance, the allowance is based on estimates, and ultimate losses may vary
from current estimates. In addition, the Federal Deposit Insurance Corporation
and the California Department of Financial Institutions, as an integral part of
their examination process, review the allowance for loan losses. These agencies
may require additions to the allowance for loan losses based on their judgment
about information available at the time of their examinations.
Premises and Equipment
Premises, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is computed principally
by the straight-line method over the estimated useful lives of the assets.
Estimated useful lives of buildings range from 30 to 40 years, and for furniture
and equipment from three to 8 years. Leasehold improvements are amortized over
the lesser of the terms of the respective leases, or their useful lives, which
are generally 5 to 10 years. Remodeling and capital improvements are capitalized
while maintenance and repairs are charged directly to occupancy expense.
Other Real Estate
Other real estate, which is included in other assets, is comprised of properties
no longer utilized for business operations and property acquired through
foreclosure in satisfaction of indebtedness. These properties are recorded at
fair value less estimated selling costs upon acquisition. Revised estimates to
the fair value less cost to sell are reported as adjustments to the carrying
amount of the asset, provided that such adjusted value is not in excess of the
carrying amount at acquisition. Initial losses on properties acquired through
full or partial satisfaction of debt are treated as credit losses and charged to
the Allowance for Loan Losses at the time of acquisition. Subsequent declines in
value from the recorded amounts, routine holding costs, and gains or losses upon
disposition, if any, are included in non-interest income or expense as incurred.
Income Taxes
The Company uses the liability method of accounting for income taxes. This
method results in the recognition of deferred tax assets and liabilities that
are reflected at currently enacted income tax rates applicable to the period in
which the deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. The deferred
provision for income taxes is the result of the net change in the deferred tax
asset and deferred tax liability balances during the year. This amount combined
with the current taxes payable or refundable results in the income tax expense
for the current year.
Dividends and Earnings Per Share
Farmers & Merchants Bancorp common stock is not traded on any exchange. The
shares are primarily held by local residents and are not actively traded. No
cash dividends were declared during the first quarter of 2007 or 2006.
10
Earnings per share amounts are computed by dividing net income by the weighted
average number of common shares outstanding for the period. The weighted average
number of shares outstanding for the three month periods ended March 31, 2007
and 2006 were 811,866 and 822,275, respectively.
Segment Reporting
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" requires that public companies report
certain information about operating segments. It also requires that public
companies report certain information about their products and services, the
geographic areas in which they operate, and their major customers. The Company
is a holding company for a community bank which offers a wide array of products
and services to its customers. Pursuant to its banking strategy, emphasis is
placed on building relationships with its customers, as opposed to building
specific lines of business. As a result, the Company is not organized around
discernable lines of business and prefers to work as an integrated unit to
customize solutions for its customers, with business line emphasis and product
offerings changing over time as needs and demands change. Therefore, the Company
only reports one segment.
Derivative Instruments and Hedging Activities
Statement of Financial Accounting Standards, No. 133, "Accounting for Derivative
Instruments and Certain Hedging Activities" as amended by the Statement of
Financial Accounting Standards, No. 138, establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. All derivatives,
whether designated in hedging relationships or not, are required to be recorded
on the balance sheet at fair value. Changes in the fair value of those
derivatives are accounted for depending on the intended use of the derivative
and the resulting designation under specified criteria. If the derivative is
designated as a fair value hedge, the changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are recognized
in earnings. If the derivative is designated as a cash flow hedge, designed to
minimize interest rate risk, the effective portions of the change in the fair
value of the derivative are recorded in other comprehensive income (loss), net
of related income taxes. Ineffective portions of changes in the fair value of
cash flow hedges are recognized in earnings.
The Company utilizes derivative financial instruments such as interest rate
caps, floors, swaps and collars. These instruments are purchased and/or sold to
reduce the Company's exposure to changing interest rates. The Company marks to
market the value of its derivative financial instruments and reflects gain or
loss in earnings in the period of change or in other comprehensive income
(loss). The Company was not utilizing any derivative instruments as of March 31,
2007.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" establishes standards for the reporting and display of comprehensive
income and its components in the financial statements. Other comprehensive
income refers to revenues, expenses, gains and losses that generally accepted
accounting principles recognize as changes in value to an enterprise but are
excluded from net income. For the Company, comprehensive income (loss) includes
net income and changes in fair value of its available-for-sale investment
securities, minimum pension liability adjustments and cash flow hedges.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes - an Interpretation of FASB Statement 109 (FIN 48). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in a
company's financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and
measurement standard for the financial statement recognition and measurement of
an income tax position taken or expected to be taken in a tax return. In
addition, FIN 48 provides guidance on derecognition, classification, interest
and penalties, accounting in interim periods, disclosure and transition.
Prior to adopting Fin 48, the Company recognized income tax positions based on
management's estimate of whether it was reasonably possible that a liability had
been incurred for unrecognized income tax benefits by applying FASB Statement
No. 5, Accounting for Contingencies. The provisions of FIN 48 were effective for
the Company on
11
January 1, 2007 and were applied to all tax positions upon initial application
of this standard. Only tax positions that met the more-likely-than-not
recognition threshold at the effective date were recognized upon adoption. The
adoption of FIN 48 did not have a material impact on the Company's financial
position or results of operations.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115". This Statement permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected will be
reported in earnings. The objective is to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. This Statement is expected
to expand the use of fair value measurement, which is consistent with the FASB's
long-term measurement objectives for accounting for financial instruments. SFAS
No. 159 is effective for fiscal years beginning after November 15, 2007. Early
adoption is permitted as of the beginning of the previous fiscal year provided
that the entity makes that choice in the first 120 days of that fiscal year and
also elects to apply the provisions of SFAS No. 157. The Company has not chosen
early adoption of SFAS No. 157. Management is in the process of evaluating the
impact the adoption of SFAS No. 159 will have on the Company's financial
position and results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is management's discussion and analysis of the major factors that
influenced our financial performance for the three months ended March 31, 2007.
This analysis should be read in conjunction with our 2006 Annual Report to
Shareholders on Form 10-K, and with the unaudited financial statements and notes
as set forth in this report.
FORWARD-LOOKING STATEMENTS
This annual report contains various forward-looking statements, usually
containing the words "estimate," "project," "expect," "objective," "goal," or
similar expressions and includes assumptions concerning the Company's
operations, future results, and prospects. These forward-looking statements are
based upon current expectations and are subject to risk and uncertainties. In
connection with the "safe-harbor" provisions of the Private Securities
Litigation Reform Act, the Company provides the following cautionary statement
identifying important factors which could cause the actual results of events to
differ materially from those set forth in or implied by the forward-looking
statements and related assumptions.
Such factors include the following: (i) the effect of changing regional and
national economic conditions; (ii) significant changes in interest rates and
prepayment speeds; (iii) credit risks of commercial, agricultural, real estate,
consumer, and other lending activities; (iv) changes in federal and state
banking laws or regulations; (v) competitive pressure in the banking industry;
(vi) changes in governmental fiscal or monetary policies; (vii) uncertainty
regarding the economic outlook resulting from the continuing war on terrorism,
as well as actions taken or to be taken by the U.S. or other governments as a
result of further acts or threats of terrorism; and (viii) other factors
discussed in the Company's filings with the Securities and Exchange Commission.
Readers are cautioned not to place undue reliance on these forward-looking
statements which speak only as of the date hereof. The Company undertakes no
obligation to update any forward-looking statements to reflect events or
circumstances arising after the date on which they are made.
INTRODUCTION
Farmers & Merchants Bancorp, or the Company, is a bank holding company formed
March 10, 1999. Its subsidiary, Farmers & Merchants Bank of Central California,
or the Bank, is a California state-chartered bank formed in 1916. The Bank
serves the northern Central Valley of California with 21 banking offices. The
service area includes Sacramento, San Joaquin, Stanislaus and Merced Counties
with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, Linden, Modesto,
Turlock and Hilmar.
12
Substantially all of the Company's business activities are conducted within its
market area.
As a bank holding company, the Company is subject to regulation and examination
by the Board of Governors of the Federal Reserve System ("FRB"). As a
California, state-chartered, non-fed member bank, the Bank is subject to
regulation and examination by the California Department of Financial
Institutions and the Federal Deposit Insurance Corporation.
OVERVIEW
The Company's primary service area encompasses the northern Central Valley of
California, a region that is impacted by the seasonal needs of the agricultural
industry. Accordingly, discussion of the Company's Financial Condition and
Results of Operations is influenced by the seasonal banking needs of its
agricultural customers (e.g., during the spring and summer customers draw down
their deposit balances and increase loan borrowing to fund the purchase of
equipment and planting of crops. Correspondingly, deposit balances are
replenished and loans repaid in fall and winter as crops are harvested and
sold).
For the three months ended March 31, 2007, Farmers & Merchants Bancorp reported
net income of $5,469,000, earnings per share of $6.74 and return on average
assets of 1.54%. Return on average shareholders' equity was 16.30% for the
three months ended March 31, 2007.
For the three months ended March 31, 2006, Farmers & Merchants Bancorp reported
net income of $4,937,000, earnings per share of $6.00 and return on average
assets of 1.48%. Return on average shareholders' equity was 15.82% for the
three months ended March 31, 2006.
Factors resulting in the Company's improved earnings performance in the first
quarter of 2007 as compared to the same period last year were: (1) a $71.8
million or 5.8% increase in average earning assets which helped offset the
negative impact on the Company's net interest margin due to rising deposit
costs; (2) an increase of $596,000 in fee income related primarily to the
Company's Overdraft Privilege Service; and (3) an $811,000 liquidating dividend
from the Company's partial ownership position in WSBA, a credit card processing
company.
The following is a summary of the financial results for the three-month period
ended March 31, 2007 compared to March 31, 2006.
- Net income increased 10.8% to $5.5 million from $4.9 million.
- Earnings per share increased 12.3% to $6.74 from $6.00.
- Total assets increased 9.8% to $1.5 billion.
- Total loans increased 10.5% to $1.1 billion.
- Net interest income decreased 2.5% to $15.5 million from $15.9 million.
- Net interest margin on a tax-equivalent basis decreased 42 basis points to
4.95% from 5.37%.
RESULTS OF OPERATIONS
Net Interest Income / Net Interest Margin
The tables on the following pages reflect the Company's average balance sheets
and volume and rate analysis for the three month periods ended March 31, 2007
and 2006.
The average yields on earning assets and average rates paid on interest-bearing
liabilities have been computed on an annualized basis for purposes of
comparability with full year data. Average balance amounts for assets and
liabilities are the computed average of daily balances.
13
Net interest income is the amount by which the interest and fees on loans and
other interest earning assets exceed the interest paid on interest bearing
sources of funds. For the purpose of analysis, the interest earned on
tax-exempt investments and municipal loans is adjusted to an amount comparable
to interest subject to normal income taxes. This adjustment is referred to as
"taxable equivalent" and is noted wherever applicable.
The Volume and Rate Analysis of Net Interest Income summarizes the changes in
interest income and interest expense based on changes in average asset and
liability balances (volume) and changes in average rates (rate). For each
category of interest-earning assets and interest-bearing liabilities,
information is provided with respect to changes attributable to (1) changes in
volume (change in volume multiplied by initial rate), (2) changes in rate
(change in rate multiplied by initial volume) and (3) changes in rate/volume
(allocated in proportion to the respective volume and rate components).
The Company's earning assets and rate sensitive liabilities are subject to
repricing at different times, which exposes the Company to income fluctuations
when interest rates change. In order to minimize income fluctuations, the
Company attempts to match asset and liability maturities. However, some
maturity mismatch is inherent in the asset and liability mix. (See Item 3.
"Quantitative and Qualitative Disclosures about Market Risk - Interest Rate
Risk")
14
FARMERS & MERCHANTS BANCORP
YEAR-TO-DATE AVERAGE BALANCES AND INTEREST RATES
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Three Months Ended March 31, Three Months Ended March 31,
2007 2006
ASSETS Balance Interest Rate Balance Interest Rate
------------------------------------------------------------------------------------- --------------------------------
Federal Funds Sold and Securities Purchased Under
Agreements to Resell $ 20,978 $ 276 5.34% $ 1,361 $ 13 3.87%
Investment Securities Available-for-Sale
U.S. Agencies - - 0.00% 30,859 309 4.06%
Municipals - Non-Taxable 11,190 198 7.18% 15,433 237 6.23%
Mortgage Backed Securities 108,955 1,392 5.18% 105,912 1,184 4.53%
Other 8,511 101 4.81% 4,105 70 6.92%
-----------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale 128,656 1,691 5.33% 156,309 1,800 4.67%
------------------------------------------------------------------------------------- --------------------------------
Investment Securities Held-to-Maturity
U.S. Agencies 30,529 317 4.21% 30,633 317 4.20%
Municipals - Non-Taxable 69,936 1,014 5.88% 66,266 988 6.05%
Mortgage Backed Securities 8,463 81 3.88% 10,644 102 3.89%
Other 2,113 16 3.07% 2,125 15 2.86%
-----------------------------------------------------------------------------------------------------------------------
Total Investment Securities Held-to-Maturity 111,041 1,428 5.21% 109,668 1,422 5.26%
------------------------------------------------------------------------------------- --------------------------------
Loans
Real Estate 616,516 11,172 7.35% 550,124 9,742 7.18%
Home Equity 66,148 1,305 8.00% 67,500 1,272 7.64%
Agricultural 181,751 3,817 8.52% 152,552 2,969 7.89%
Commercial 161,600 3,412 8.56% 178,118 3,469 7.90%
Consumer 13,806 294 8.64% 13,083 286 8.87%
Credit Card 5,485 139 10.28% 5,341 133 10.10%
Municipal 915 4 1.77% 1,013 11 4.40%
-----------------------------------------------------------------------------------------------------------------------
Total Loans 1,046,221 20,143 7.81% 967,731 17,882 7.49%
------------------------------------------------------------------------------------- --------------------------------
Total Earning Assets 1,306,896 $ 23,538 7.30% 1,235,069 $ 21,117 6.93%
=================== ===================
Unrealized Gain (Loss) on Securities
Available-for-Sale (1,245) (2,615)
Allowance for Loan Losses (18,075) (18,217)
Cash and Due From Banks 39,646 38,376
All Other Assets 89,162 77,310
--------------------------------------------------------------- -----------
TOTAL ASSETS $1,416,384 $1,329,923
=============================================================== ===========
LIABILITIES & SHAREHOLDERS' EQUITY
Interest Bearing Deposits
Interest Bearing DDA $ 130,713 $ 22 0.07% $ 130,519 $ 22 0.07%
Savings 288,497 935 1.31% 283,132 355 0.51%
Time Deposits 531,098 6,024 4.60% 381,186 3,016 3.21%
-----------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Deposits 950,308 6,981 2.98% 794,837 3,393 1.73%
Other Borrowed Funds 31,013 399 5.22% 95,982 1,172 4.95%
Subordinated Debentures 10,310 214 8.42% 10,310 189 7.43%
------------------------------------------------------------------------------------- --------------------------------
Total Interest Bearing Liabilities 991,631 $ 7,594 3.11% 901,129 $ 4,754 2.14%
=================== ===================
Interest Rate Spread 4.20% 4.79%
Demand Deposits (Non-Interest Bearing) 270,296 289,840
All Other Liabilities 20,253 14,121
--------------------------------------------------------------- -----------
TOTAL LIABILITIES 1,282,180 1,205,090
Shareholders' Equity 134,204 124,833
--------------------------------------------------------------- -----------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $1,416,384 $1,329,923
=============================================================== ===========
Impact of Non-Interest Bearing Deposits
and Other Liabilities 0.75% 0.58%
Net Interest Income and Margin
on Total Earning Assets 15,944 4.95% 16,363 5.37%
Tax Equivalent Adjustment (399) (414)
-----------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 15,545 4.82% $ 15,949 5.24%
=======================================================================================================================
Notes: Yields on municipal securities have been calculated on a fully taxable
equivalent basis. Loan interest income includes fee income and unearned
discount in the amount of $532,000 and $877,000 for the quarters ended March 31,
2007 and 2006, respectively. Yields on securities available-for-sale are based
on historical cost.
15
FARMERS & MERCHANTS BANCORP
VOLUME AND RATE ANALYSIS OF NET INTEREST REVENUE
(Rates on a Taxable Equivalent Basis)
(in thousands) Three Months Ended
Mar. 31, 2007 compared to Mar. 31, 2006
INTEREST EARNING ASSETS Volume Rate Net Chg.
-----------------------------------------------------------------------------------------------
Federal Funds Sold $ 256 $ 7 $ 263
Investment Securities Available-for-Sale
U.S. Agencies (309) - (309)
Municipals - Non-Taxable (72) 33 (39)
Mortgage Backed Securities 34 174 208
Other 58 (27) 31
-----------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale (289) 180 (109)
-----------------------------------------------------------------------------------------------
Investment Securities Held-to-Maturity
U.S. Agencies (1) 1 -
Municipals - Non-Taxable 54 (28) 26
Mortgage Backed Securities (21) - (21)
Other - 1 1
-----------------------------------------------------------------------------------------------
Total Investment Securities Held-to-Maturity 32 (26) 6
-----------------------------------------------------------------------------------------------
Loans
Real Estate 1,199 231 1,430
Home Equity (26) 59 33
Agricultural 600 248 848
Commercial (340) 283 (57)
Consumer 16 (8) 8
Credit Card 4 2 6
Other (1) (6) (7)
-----------------------------------------------------------------------------------------------
Total Loans 1,452 809 2,261
-----------------------------------------------------------------------------------------------
Total Earning Assets 1,451 970 2,421
-----------------------------------------------------------------------------------------------
INTEREST BEARING LIABILITIES
Interest Bearing Deposits
Savings 7 573 580
Time Deposits 1,431 1,577 3,008
-----------------------------------------------------------------------------------------------
Total Interest Bearing Deposits 1,438 2,150 3,588
Other Borrowed Funds (834) 61 (773)
Subordinated Debentures - 25 25
-----------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities 604 2,236 2,840
-----------------------------------------------------------------------------------------------
TOTAL CHANGE $ 847 $ (1,266) $ (419)
===============================================================================================
Notes: Rate/volume variance is allocated based on the percentage relationship
of changes in volume and changes in rate to the total "net change." The above
figures have been rounded to the nearest whole number.
16
Net interest income decreased 2.5% to $15.5 million during the first quarter of
2007 compared to $15.9 million for the first quarter of 2006. On a fully taxable
equivalent basis, net interest income decreased 2.6% and totaled $15.9 million
at March 31, 2007, compared to $16.4 million at March 31, 2006. The decrease in
net interest income was primarily due to increasing deposit costs.
Net interest income on a taxable equivalent basis, expressed as a percentage of
average total earning assets, is referred to as the net interest margin. At
March 31, 2007, the Company's net interest margin was 4.95% compared to 5.37% at
March 31, 2006. As discussed previously, this reduction is due primarily to
increasing deposit costs.
Loans, generally the Company's highest earning assets, increased $100.2 million
as of March 31, 2007 compared to March 31, 2006. See "Financial Condition -
Loans" for further discussion on this increase. On an average balance basis,
loans increased by $78.5 million for the quarter ended March 31, 2007. As a
result of this loan growth, the mix of the Company's earning assets improved as
loans increased from 78.4% of average earning assets during the first quarter of
2006 to 80.1% during the first quarter of 2007. Due to a 75 basis point increase
in the prime rate occurring between March 28, 2006 and June 29, 2006, the
year-to-date yield on the loan portfolio increased 32 basis points to 7.81% for
the quarter ended March 31, 2007 compared to 7.49% for the quarter ended March
31, 2006. This increase in yield plus the growth in loan balances resulted in
interest revenue from loans increasing 12.6% to $20.1 million for the quarter
ended March 31, 2007. Although the yield on the Company's loans increased over
the same quarter in 2006, the Company is currently experiencing aggressive
competitor pricing for loans that it may need to respond to in order to retain
key customers. This could negatively impact future loan yields.
The investment portfolio is the other main component of the Company's earning
assets. The Company invests primarily in mortgage-backed securities, U.S.
Government Agencies, and high-grade municipals. Since the risk factor for these
types of investments is significantly lower than that of loans, the yield earned
on investments is generally less than that of loans.
Average investment securities totaled $239.7 million at March 31, 2007, a
decrease of $26.3 million compared to the average balance at March 31, 2006. As
a result of the flat or inverted yield curve that existed during the first
quarter of 2007, the Company chose to use the cash flow from its investment
portfolio to pay down FHLB advances as opposed to reinvesting. Interest income
on securities decreased $103,000 to $3.1 million for the quarter ended March 31,
2007 compared to $3.2 million for the quarter ended March 31, 2006. The average
yield, on a taxable equivalent basis, in the investment portfolio was 5.28% at
March 31, 2007 compared to 4.91% at March 31, 2006. Net interest income on the
Schedule of Year-to-Date Average Balances and Interest Rates shown on a taxable
equivalent basis, which is higher than net interest income as reflected on the
Consolidated Statement of Income because of adjustments that relate to income on
securities that are exempt from federal income taxes.
Average interest-bearing sources of funds increased $90.5 million or 10.0%
during the first quarter of 2007. Of that increase, average borrowed funds
(primarily FHLB Advances) decreased $64.9 million (see previous discussion
regarding investment securities); interest-bearing deposits increased $155.4
million, and subordinated debt remained unchanged.
The increase in interest-bearing deposits was primarily in time deposits, which
grew $149.9 million, as lower cost savings and interest bearing DDA increased by
$5.6 million. Total interest expense on deposit accounts for the first quarter
of 2007 was $6.9 million as compared to $3.4 million at March 31, 2006. The
average rate paid on interest-bearing deposits was 2.98% in the first quarter of
2007 and 1.73% in the first quarter of 2006. This increase in rates is a result
of the lagging impact of increases in market interest rates that occurred in
mid-2004 through mid-2006. As a result of continued aggressive competitor
pricing for deposits, the Company anticipates that its deposit rates will
continue to increase in 2007, even though market rates have been stable since
June 2006.
Provision and Allowance for Loan Losses
As a financial institution that assumes lending and credit risks as a principal
element of its business, credit losses will be experienced in the normal course
of business. The allowance for loan losses is established to absorb losses
inherent in the loan portfolio. The allowance for loan losses is maintained at
a level considered by management to be adequate to provide for risks inherent in
the loan portfolio. The allowance is increased by provisions charged to
17
operating expense and reduced by net charge-offs. In determining the adequacy
of the allowance for loan losses, management takes into consideration
examinations by the Company's supervisory authorities, results of internal
credit reviews, financial condition of borrowers, loan concentrations, prior
loan loss experience, and general economic conditions. The allowance is based
on estimates and ultimate losses may vary from the current estimates.
Management reviews these estimates periodically and, when adjustments are
necessary, they are reported in the period in which they become known.
The Company has established credit management policies and procedures that
govern both the approval of new loans and the monitoring of the existing
portfolio. The Company manages and controls credit risk through comprehensive
underwriting and approval standards, dollar limits on loans to one borrower and
by restricting loans made primarily to its principal market area where
management believes it is better able to assess the applicable risk.
Additionally, management has established guidelines to ensure the
diversification of the Company's credit portfolio such that even within key
portfolio sectors such as real estate or agriculture, the portfolio is
diversified across factors such as location, building type, crop type, etc.
Management reports regularly to the Board of Directors regarding trends and
conditions in the loan portfolio and regularly conducts credit reviews of
individual loans. Loans that are performing but have shown some signs of
weakness are subjected to more stringent reporting and oversight.
The Company made no provision for loan losses during the first quarter of 2007,
compared to $275,000 for the first quarter of 2006. Changes in the provision
between the first quarter of 2007 and 2006 were the result of management's
evaluation of the adequacy of the allowance for loan losses relative to factors
such as the credit quality of the loan portfolio, loan growth, current loan
losses and the prevailing economic climate and its effect on borrowers' ability
to repay loans in accordance with the terms of the notes (see "Note 1. Critical
Accounting Policies and Estimates - Allowance for Loan Losses" and "Item 3.
Quantitative and Qualitative Disclosures About Market Risk-Credit Risk").
The allowance for loan losses was $18.1 million or 1.7% of total loan balances
at March 31, 2007 and $18.3 million or 1.9% of total loan balances at March 31,
2006. As of December 31, 2006, the allowance for loan losses was $18.1 million,
which represented 1.7% of the total loan balance. After reviewing all factors
above, management concluded that the allowance for loan losses as of March 31,
2007 was adequate. See the table below for allowance for loan loss activity for
the periods indicated.
Three Months Ended
March 31,
Allowance for Loan Losses (in thousands) 2007 2006
---------------------------------------------------------------
Balance at Beginning of Period $18,099 $17,860
Provision Charged to Expense - 275
Recoveries of Loans Previously Charged Off 94 258
Loans Charged Off (133) (135)
---------------------------------------------------------------
Balance at End of Period $18,060 $18,258
===============================================================
Non-Interest Income
Non-interest income includes (1) service charges and fees from deposit accounts;
(2) net gains and losses on investment securities; (3) credit card merchant
fees; (4) ATM fees; (5) increases in the cash surrender value of bank owned life
insurance and (6) fees from other miscellaneous business services. Overall,
non-interest income increased $1.1 million or 44.1% for the three months ended
March 31, 2007 compared to the same period of 2006.
One reason for this increase was fees from the Company's Overdraft Privilege
Service, which was offered to eligible customers with deposit accounts in good
standing beginning May 1, 2006. These fees increased $596,000 for the three
months ending March 31, 2007 compared to the same period in 2006.
Another factor affecting non-interest income was a loss on investment securities
of $768,000 for the first quarter of 2007 compared to a loss of $419,000 for the
first quarter of 2006. During the first quarter of 2006, the Company made the
decision to sell some of its investment portfolio at a loss in order to better
align the portfolio with its
18
evolving asset/liability management objectives (see "Financial
Condition-Investment Securities"). During the first quarter of 2007 the Company
took an impairment loss on one of its investment securities whose drop in market
value was determined to be "other than temporary".
Also impacting non-interest income during the first quarter of 2007 was the
receipt of an $811,000 liquidating dividend from the Company's partial ownership
in WSBA, a credit card processing company whose operating assets were sold
during 2006 and the company was subsequently liquidated in 2007.
Non-Interest Expense
Non-interest expense for the Company includes expenses for salaries and employee
benefits, occupancy, equipment, supplies, legal fees, professional services,
data processing, marketing, deposit insurance, merchant bankcard operations, and
other miscellaneous expenses.
Non-interest expense increased $487,000 or 4.6% over the first quarter of 2006.
The primary factors affecting non-interest expense were: (1) increased Salaries
and Employee Benefits due to a 6% increase in staffing levels and increased
employee medical insurance premiums paid by the Company; (2) increased furniture
& equipment depreciation related to remodeling and adding branch locations; (3)
increased consulting fees related to the Company's Overdraft Privilege Service;
and (4) increased legal fees related to expanded SEC disclosure requirements.
Income Taxes
The provision for income taxes remained unchanged for the first quarter of 2007
compared to the first quarter of 2006. The effective tax rate for the first
quarter of 2007 was 33.9% compared to 36.2% for the first quarter of 2006. The
Company's effective tax rate can change somewhat from quarter to quarter due
primarily to changes in the mix of taxable and tax-exempt earning sources. The
effective rates were lower than the statutory rate of 42% due primarily to
benefits regarding the cash surrender value of life insurance; California
enterprise zone interest income exclusion; and tax-exempt interest income on
municipal securities and loans.
FINANCIAL CONDITION
This section presents a comparison of the Company's balance sheet for the
three-month period ending March 31, 2007 and the same period in 2006. As
previously discussed (see "Overview") the seasonality of the Company's business
due to its agricultural customer base makes a comparison of the March 31st
balance sheet to the preceding December 31st not meaningful.
Investment Securities
The Company classifies its investments as held-to-maturity, trading or
available-for-sale. Securities are classified as held-to-maturity and are
carried at amortized cost when the Company has the positive intent and ability
to hold the securities to maturity. Trading securities are securities acquired
for short-term appreciation and are carried at fair value, with unrealized gains
and losses recorded in non-interest income. Securities classified as
available-for-sale include securities which may be sold to effectively manage
interest rate risk exposure, prepayment risk, satisfy liquidity demand and other
factors. These securities are reported at fair value with aggregate, unrealized
gains or losses excluded from income and included as a separate component of
shareholders' equity, net of related income taxes. Investment securities are
evaluated for impairment on at least a quarterly basis to determine whether a
decline in their value is other than temporary. During the first quarter of
2007 the Company took an impairment loss on one of its investment securities
(see "Non-Interest Income").
The investment portfolio provides the Company with an income alternative to
loans as well as a tool to better manage its liquidity and interest rate risk.
As of March 31, 2007, the investment portfolio represented 16.3% of the
Company's total assets. Total investment securities decreased $24.2 million or
9.2% from a year ago and now total $237.4 million. As a result of the flat or
inverted yield curve that existed during the first quarter of 2007, the Company
chose to use the cash flow from its investment portfolio to pay down FHLB
advances as opposed to reinvesting. For further discussion, see Market Risk -
Interest Rate Risk under Item 3. Quantitative and Qualitative Disclosures About
Market Risk.
19
Not included in the investment portfolio are overnight investments in Federal
Funds Sold. For the three months ended March 31, 2007, average Federal Funds
Sold was $20.9 million compared to $1.4 million at March 31, 2006.
Loans
The Company's loan portfolio at March 31, 2007 increased $100.2 million or 10.5%
from March 31, 2006. The increase was due to continuing strong loan demand in
the Company's market area, along with a focused calling program on selected loan
prospects. Most of this growth occurred in Agricultural Loans and Real Estate
Loans (primarily those secured by production agricultural properties), market
segments where the Company believes that current market rates are more
reasonable than in the areas of Consumer, Home Equity and Commercial loans.
Additionally, on an average balance basis loans have increased $78.5 million or
8.1% from the same period in the prior year. The table following sets forth the
distribution of the loan portfolio by type as of the dates indicated.
Loan Portfolio As Of:
---------------------
(in thousands) March 31, 2007 Dec. 31, 2006 March 31, 2006
------------------------------------------------------------------------------
Real Estate $ 534,988 $ 516,606 $ 453,559
Real Estate Construction 95,637 95,378 100,200
Home Equity 64,999 67,132 66,017
Agricultural 186,873 183,589 154,025
Commercial 158,410 165,412 167,310
Consumer 20,065 21,222 19,546
------------------------------------------------------------------------------
Gross Loans 1,060,972 1,049,339 960,657
Less:
Unearned Income 2,496 2,427 2,430
Allowance for Loan Losses 18,060 18,099 18,258
------------------------------------------------------------------------------
Net Loans $ 1,040,416 $ 1,028,813 $ 939,969
==============================================================================
Non-Performing Assets
Non-performing assets are comprised of non-performing loans (defined as
non-accrual loans plus accruing loans past due 90 days or more) and other real
estate owned. As set forth in the table below, non-performing loans as of March
31, 2007 were $224,000 compared to $406,000 at March 31, 2006.
Accrued interest reversed from income on loans placed on a non-accrual status
totaled $31,000 at March 31, 2007 compared to $65,000 at March 31, 2006. The
Company reported no real estate owned at either March 31, 2007 or March 31,
2006.
Non-Performing Assets
---------------------
(in thousands) March 31, 2007 Dec. 31, 2006 March 31, 2005
---------------------------------------------------------------------------------------
Non-performing Loans $ 224 $ 54 $ 406
Other Real Estate Owned - - -
=======================================================================================
Total $ 224 $ 54 $ 406
=======================================================================================
---------------------------------------------------------------------------------------
Non-Performing Assets
as a % of Total Loans 0.02% 0.01% 0.04%
---------------------------------------------------------------------------------------
Allowance for Loan Losses as a %
of Non-Performing Assets 8,062.5% 33,516.7% 4,497.0%
---------------------------------------------------------------------------------------
20
Except for non-performing loans shown in the table above, the Bank's management
is not aware of any loans as of March 31, 2007 for which known credit problems
of the borrower would cause serious doubts as to the ability of these borrowers
to comply with their present loan repayment terms, or any known events that
would result in the loan being designated as non-performing at some future date.
The Company's management cannot, however, predict the extent to which the
following or other factors may affect a borrower's ability to pay: 1)
deterioration in general economic conditions, real estate values or agricultural
commodity prices; 2) increases in interest rates; or 3) changes in the overall
financial condition or business of a borrower.
Deposits
One of the key sources of funds to support earning assets (loans and
investments) is the generation of deposits from the Company's customer base.
The ability to grow the customer base and subsequently deposits is a significant
element in the performance of the Company.
At March 31, 2007, deposits totaled $1.3 billion. This represents an increase
of 16.5% or $178.9 million from March 31, 2006. Core deposits (exclusive of
Public Time Deposits) increased 8.5% over the same period. Public Time Deposits
have increased $90.0 million since March 31, 2006 primarily because of the
Company's decision to increase its use of State of California time deposits for
short-term funding needs instead of using FHLB Advances (see "Federal Home Loan
Bank Advances").
Interest bearing transaction, savings and time deposit accounts increased $181.1
million or 22.4% from March 31, 2006. The Company's calling efforts for
prospective customers includes acquiring both loan and deposit relationships
which results in new demand, interest bearing transaction accounts and time
deposits. Demand deposits decreased $2.2 million or 0.8% from March 31, 2006.
Demand deposits have declined as customers have transferred their funds to
higher yielding time deposit accounts with the Bank.
Federal Home Loan Bank Advances
Advances from the Federal Home Loan Bank are another key source of funds to
support earning assets (see "Item 3. Quantitative and Qualitative Disclosures
about Market Risk and Liquidity Risk"). These advances are also used to manage
the Company's interest rate risk exposure, and as opportunities exist, to borrow
and invest the proceeds at a positive spread through the investment portfolio.
FHLB Advances as of March 31, 2007 were $25.8 million compared to $90.8 million
of FHLB Advances as of March 31, 2006. See "Deposits" for a discussion of the
Company's use of Public Deposits from the State of California to replace FHLB
Advances. See "Investment Securities" for a discussion of the Company's use of
investment cash flows to pay down FHLB advances.
Long-term Subordinated Debentures
On December 17, 2003 the Company raised $10 million through an offering of
trust-preferred securities. Although this amount is reflected as subordinated
debt on the Company's balance sheet, under applicable regulatory guidelines,
trust preferred securities qualify as regulatory capital (see "Capital"). These
securities accrue interest at a variable rate based upon 3-month Libor plus
2.85%. Interest rates reset quarterly and were 8.20% as of March 31, 2007,
8.21% at December 31, 2006 and 7.77% at March 31, 2006.
Capital
The Company relies primarily on capital generated through the retention of
earnings to satisfy its capital requirements. The Company engages in an ongoing
assessment of its capital needs in order to support business growth and to
insure depositor protection. Shareholders' Equity totaled $138.2 million at
March 31, 2007 and $127.4 million at March 31, 2006.
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Company and the Bank's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Company and the
Bank must meet specific capital guidelines that involve quantitative measures of
the Company and the Bank's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The Company and the
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
21
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios set
forth in the table below of Total and Tier 1 capital to risk-weighted assets and
of Tier 1 capital to average assets (all terms as defined in the regulations).
Management believes, as of March 31, 2007, that the Company and the Bank meet
all capital adequacy requirements to which it is subject.
In its most recent notification from the Federal Deposit Insurance Corporation
the Bank was categorized as "well capitalized" under the regulatory framework
for prompt corrective action. To be categorized as "well capitalized", the Bank
must maintain minimum Total risk-based, Tier 1 risk-based, Tier 1 leverage
ratios as set forth in the table below. There are no conditions or events since
that notification that management believes have changed the institution's
categories.
TO BE WELL
CAPITALIZED UNDER
REGULATORY CAPITAL PROMPT CORRECTIVE
(IN THOUSANDS) ACTUAL REQUIREMENTS ACTION PROVISIONS
-----------------------------------------------------------------------------------------------------
THE COMPANY: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-----------------------------------------------------------------------------------------------------
As of March 31, 2007
Total Capital to Risk Weighted Assets $164,990,489 12.47% $105,849,457 8.0% N/A N/A
Tier 1 Capital to Risk Weighted Assets $148,430,989 11.22% $ 52,924,729 4.0% N/A N/A
Tier 1 Capital to Average Assets $148,430,989 10.55% $ 56,266,168 4.0% N/A N/A
TO BE WELL
CAPITALIZED UNDER
REGULATORY CAPITAL PROMPT CORRECTIVE
(IN THOUSANDS) ACTUAL REQUIREMENTS ACTION PROVISIONS
--------------------------------------------------------------------------------------------------------
THE BANK: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------------------------------------------------------------------------------------------------------
As of March 31, 2007
Total Capital to Risk Weighted Assets $157,986,632 12.00% $105,293,526 8.0% $131,616,908 10.0%
Tier 1 Capital to Risk Weighted Assets $141,512,923 10.75% $ 52,646,763 4.0% $ 78,970,145 6.0%
Tier 1 Capital to Average Assets $141,512,923 10.10% $ 56,048,218 4.0% $ 71,060,272 5.0%
As previously discussed (see Long-term Subordinated Debentures), in order to
supplement its regulatory capital base, during December 2003 the Company issued
$10 million of trust preferred securities. On March 1, 2005 the Federal Reserve
Board issued its final rule effective April 11, 2005, concerning the regulatory
capital treatment of trust preferred securities ("TPS") by bank holding
companies ("BHCs"). Under the final rule BHCs may include TPS in Tier 1 capital
in an amount equal to 25% of the sum of core capital net of goodwill. The
quantitative limitation concerning goodwill will not be effective until March
31, 2009. Any portion of trust-preferred securities not qualifying as Tier 1
capital would qualify as Tier 2 capital subject to certain limitations. The
Company has received notification from the Federal Reserve Bank of San Francisco
that all of the Company's trust preferred securities currently qualify as Tier 1
capital.
In accordance with the provisions of Financial Accounting Standard Board
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
the Company does not consolidate the subsidiary trust which has issued the
trust-preferred securities.
In 1998, the Board approved the Company's first stock repurchase program which
expired on May 1, 2001. During the second quarter of 2004, the Board approved a
second stock repurchase program because it concluded that the Company continued
to have more capital than it needed to meet present and anticipated regulatory
guidelines for the Bank to be classified as "well capitalized." On April 4,
2006, the Board unanimously approved expanding the Repurchase Program to allow
the repurchase of up to $15 million of stock between May 1, 2006 and April 30,
2009.
Repurchases under the program will continue to be made on the open market or
through private transactions. The repurchase program also requires that no
purchases may be made if the Bank would not remain "well-capitalized"
22
after the repurchase. All shares repurchased under the repurchase program will
be retired. See the Company's 2006 Form 10-K, Part II, "Item 5. Market for
Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities."
During the first quarter of 2007, the Company repurchased 194 shares at an
average share price of $510 per share. During the first quarter of 2006, the
Company repurchased 2,101 shares at an average share price of $495. Since the
second share repurchase program was expanded in 2006, the Company has
repurchased over 8,400 shares for total consideration of $4.3 million.
Critical Accounting Policies and Estimates
This "Management's Discussion and Analysis of Financial Condition and Results of
Operations," is based upon the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. In preparing the Company's financial statements
management makes estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses. These judgments govern areas such
as the allowance for loan losses, the fair value of financial instruments and
accounting for income taxes.
For a full discussion of the Company's critical accounting policies and
estimates see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Company's Annual Report to
Shareholders on Form 10-K for the year ended December 31, 2006.
Off Balance Sheet Arrangements and Aggregate Contractual Obligations and
Commitments
Off-balance sheet arrangements are any contractual arrangement to which an
unconsolidated entity is a party, under which the Company has: (1) any
obligation under a guarantee contract; (2) a retained or contingent interest in
assets transferred to an unconsolidated entity or similar arrangement that
serves as credit, liquidity or market risk support to that entity for such
assets; (3) any obligation under certain derivative instruments; or (4) any
obligation under a material variable interest held by the Company in an
unconsolidated entity that provides financing, liquidity, market risk or credit
risk support to the Company, or engages in leasing, hedging or research and
development services with the Company.
In the ordinary course of business, the Company enters into commitments to
extend credit to its customers. As of March 31, 2007, the Company had entered
into commitments with certain customers amounting to $396.9 million compared to
$442.5 million at December 31, 2006 and $459.9 million at March 31, 2006.
Letters of credit at March 31, 2007, December 31, 2006 and March 31, 2006, were
$10.9 million, $10.9 million and $10.9 million, respectively. These commitments
are not reflected in the accompanying consolidated financial statements and do
not significantly impact operating results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
RISK MANAGEMENT
The Company has adopted a Risk Management Plan which aims to ensure the proper
control and management of all risk factors inherent in the operation of the
Company. Specifically, credit risk, interest rate risk, liquidity risk,
compliance risk, strategic risk, reputation risk and price risk can all affect
the market risk of the Company. These specific risk factors are not mutually
exclusive. It is recognized that any product or service offered by the Company
may expose the Company to one or more of these risk factors.
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor's failure
to meet the terms of any contract or otherwise fail to perform as agreed. Credit
risk is found in all activities where success depends on counterparty, issuer or
borrower performance.
Credit risk in the investment portfolio and correspondent bank accounts is
addressed through defined limits in the Company's policy statements. In
addition, certain securities carry insurance to enhance credit quality of the
bond.
23
Credit risk in the loan portfolio is controlled by limits on industry
concentration, aggregate customer borrowings and geographic boundaries.
Standards on loan quality also are designed to reduce loan credit risk. Senior
Management, Directors' Committees, and the Board of Directors are regularly
provided with information intended to identify, measure, control and monitor the
credit risk of the Company.
The Company's methodology for assessing the appropriateness of the allowance is
applied on a regular basis and considers all loans. The systematic methodology
consists of two major elements. The first major element includes a detailed
analysis of the loan portfolio in two phases. The first phase is conducted in
accordance with SFAS No. 114, "Accounting by Creditors for the Impairment of a
Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a
Loan - Income Recognition and Disclosures." Individual loans are reviewed to
identify loans for impairment. A loan is impaired when principal and interest
are deemed uncollectible in accordance with the original contractual terms of
the loan. Impairment is measured as either the expected future cash flows
discounted at each loan's effective interest rate, the fair value of the loan's
collateral if the loan is collateral dependent, or an observable market price of
the loan (if one exists). Upon measuring the impairment, the Company will ensure
an appropriate level of allowance is present or established.
Central to the first phase and the Company's credit risk management is its loan
risk rating system. The originating credit officer assigns borrowers an initial
risk rating, which is based primarily on a thorough analysis of each borrower's
financial position in conjunction with industry and economic trends. Approvals
are made based upon the amount of inherent credit risk specific to the
transaction and are reviewed for appropriateness by senior credit administration
personnel. Credits are monitored by credit administration personnel for
deterioration in a borrower's financial condition, which would impact the
ability of the borrower to perform under the contract. Risk ratings are adjusted
as necessary.
Based on the risk rating system, specific allowances are established in cases
where management has identified significant conditions or circumstances related
to a credit that management believes indicates the possibility of loss.
Management performs a detailed analysis of these loans, including, but not
limited to, cash flows, appraisals of the collateral, conditions of the
marketplace for liquidating the collateral and assessment of the guarantors.
Management then determines the inherent loss potential and allocates a portion
of the allowance for losses as a specific allowance for each of these credits.
The second phase is conducted by segmenting the loan portfolio by risk rating
and into groups of loans with similar characteristics in accordance with SFAS
No. 5, "Accounting for Contingencies". In this second phase, groups of loans are
reviewed and applied the appropriate allowance percentage to determine a
portfolio formula allowance.
The second major element of the analysis, which considers all known relevant
internal and external factors that may affect a loan's collectibility, is based
upon management's evaluation of various conditions, the effects of which are not
directly measured in the determination of the formula and specific allowances.
The evaluation of the inherent loss with respect to these conditions is subject
to a higher degree of uncertainty because they are not identified with specific
problem credits or portfolio segments. The conditions evaluated in connection
with the second element of the analysis of the allowance include, but are not
limited to the following conditions that existed as of the balance sheet date:
- then-existing general economic and business conditions affecting the key
lending areas of the Company;
- credit quality trends (including trends in non-performing loans expected to
result from existing conditions);
- collateral values;
- loan volumes and concentrations;
- seasoning of the loan portfolio;
- specific industry conditions within portfolio segments;
- recent loss experience within portfolio segments;
- duration of the current business cycle;
- bank regulatory examination results; and
- findings of the Company's internal credit examiners.
24
Management reviews these conditions in discussion with the Company's senior
credit officers. To the extent that any of these conditions are evidenced by a
specifically identifiable problem credit or portfolio segment as of the
evaluation date, management's estimate of the effect of such condition may be
reflected as a specific allowance applicable to such credit or portfolio
segment. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date,
management's evaluation of the inherent loss related to such condition is
reflected in the second major element allowance.
Implicit in lending activities is the risk that losses will and do occur and
that the amount of such losses will vary over time. Consequently, the Company
maintains an allowance for loan losses by charging a provision for loan losses
to earnings. Loans determined to be losses are charged against the allowance for
loan losses. The Company's allowance for loan losses is maintained at a level
considered by management to be adequate to provide for estimated losses inherent
in the existing portfolio.
Management believes that the allowance for loan losses at March 31, 2007 was
adequate to provide for both recognized losses and estimated inherent losses in
the portfolio. No assurances can be given that future events may not result in
increases in delinquencies, non-performing loans or net loan charge-offs that
would increase the provision for loan losses and thereby adversely affect the
results of operations.
Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities
results in uncertainty in the Company's earnings and economic value and is
referred to as interest rate risk. The Company does not attempt to predict
interest rates and positions the balance sheet in a manner which seeks to
minimize, to the extent possible, the effects of changing interest rates.
The Company measures interest rate risk in terms of potential impact on both its
economic value and earnings. The methods for governing the amount of interest
rate risk include: (1) analysis of asset and liability mismatches (GAP
analysis); (2) the utilization of a simulation model; and (3) limits on
maturities of investment, loan and deposit products which reduces the market
volatility of those instruments.
The Gap analysis measures, at specific time intervals, the divergence between
earning assets and interest bearing liabilities for which repricing
opportunities will occur. A positive difference, or Gap, indicates that earning
assets will reprice faster than interest-bearing liabilities. This will
generally produce a greater net interest margin during periods of rising
interest rates and a lower net interest margin during periods of declining
interest rates. Conversely, a negative Gap will generally produce a lower net
interest margin during periods of rising interest rates and a greater net
interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with
the rates charged on loans. In addition, the magnitude of changes in the rates
charged on loans is not always proportionate to the magnitude of changes in the
rate paid for deposits. Consequently, changes in interest rates do not
necessarily result in an increase or decrease in the net interest margin solely
as a result of the differences between repricing opportunities of earning assets
or interest bearing liabilities.
The Company also utilizes the results of a dynamic simulation model to quantify
the estimated exposure of net interest income to sustained interest rate
changes. The sensitivity of the Company's net interest income is measured over a
rolling one-year horizon.
The simulation model estimates the impact of changing interest rates on interest
income from all interest earning assets and the interest expense paid on all
interest bearing liabilities reflected on the Company's balance sheet. This
sensitivity analysis is compared to policy limits, which specify a maximum
tolerance level for net interest income exposure over a one-year horizon
assuming no balance sheet growth, given a 200 basis point upward and a 200 basis
point downward shift in interest rates. A shift in rates over a 12-month period
is assumed. Results that exceed policy limits, if any, are analyzed for risk
tolerance and reported to the Board with appropriate recommendations. At March
31, 2007, the Company's estimated net interest income sensitivity to changes in
interest rates, as a percent of net interest income was an increase in net
interest income of 1.02% if rates increase by 200 basis points and a decrease in
net interest income of 2.43% if rates decline 200 basis points. Comparatively,
at December 31, 2006, the
25
Company's estimated net interest income sensitivity to changes in interest
rates, as a percent of net interest income was an increase in net interest
income of 0.92% if rates increase by 200 basis points and a decrease in net
interest income of 2.43% if rates decline 200 basis points. All results are
within the Company's policy limits.
The estimated sensitivity does not necessarily represent a Company forecast and
the results may not be indicative of actual changes to the Company's net
interest income. These estimates are based upon a number of assumptions
including: the nature and timing of interest rate levels including yield curve
shape; prepayments on loans and securities; pricing strategies on loans and
deposits; replacement of asset and liability cash flows; and other assumptions.
While the assumptions used are based on current economic and local market
conditions, there is no assurance as to the predictive nature of these
conditions including how customer preferences or competitor influences might
change.
Liquidity Risk
Liquidity risk is the risk to earnings or capital resulting from the Company's
inability to meet its obligations when they come due without incurring
unacceptable losses. It includes the ability to manage unplanned decreases or
changes in funding sources and to recognize or address changes in market
conditions that affect the Company's ability to liquidate assets or acquire
funds quickly and with minimum loss of value. The Company endeavors to maintain
a cash flow adequate to fund operations, handle fluctuations in deposit levels,
respond to the credit needs of borrowers and to take advantage of investment
opportunities as they arise. The principal sources of liquidity include credit
facilities from correspondent banks, brokerage firms and the Federal Home Loan
Bank, as well as interest and principal payments on loans and investments,
proceeds from the maturity or sale of investments, and growth in deposits.
In general, liquidity risk is managed daily by controlling the level of Federal
Funds and the use of funds provided by the cash flow from the investment
portfolio. The Company maintains overnight investments in Federal Funds as a
cushion for temporary liquidity needs. During the first quarter of 2007, Federal
Funds Sold averaged $20.9 million. The Company maintains Federal Funds credit
lines of $98 million with major banks subject to the customary terms and
conditions for such arrangements and $150 million in repurchase lines with major
brokers. In addition, the Company has additional borrowing capacity of $199.8
million from the Federal Home Loan Bank.
At March 31, 2007, the Company had available sources of liquidity, which
included cash and cash equivalents and unpledged investment securities of
approximately $109.3 million, which represents 7.5% of total assets.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
information is recorded and reported in all filings of financial reports. Such
information is reported to the Company's management, including its Chief
Executive Officer and its Chief Financial Officer to allow timely and accurate
disclosure based on the definition of "disclosure controls and procedures" in
Rule 13a-15(e). In designing these controls and procedures, management
recognizes that they can only provide reasonable assurance of achieving the
desired control objectives. Management also evaluated the cost-benefit
relationship of possible controls and procedures.
As of the end of the period covered by this report, the Company carried out an
evaluation of the effectiveness of Company's disclosure controls and procedures
under the supervision and with the participation of the Chief Executive Officer,
the Chief Financial Officer and other senior management of the Company. The
evaluation was based, in part, upon reports and affidavits provided by a number
of executives. Based on the foregoing, the Company's Chief Executive Officer and
the Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls over
financial reporting subsequent to the date the Company completed its evaluation.
26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain lawsuits and claims arising in the ordinary course of business have been
filed or are pending against the Company or its subsidiaries. Based upon
information available to the Company, its review of such lawsuits and claims and
consultation with its counsel, the Company believes the liability relating to
these actions, if any, would not have a material adverse effect on its
consolidated financial statements.
There are no material proceedings adverse to the Company to which any director,
officer or affiliate of the Company is a party.
ITEM 1A. RISK FACTORS
See Item 1A. Risk Factors in the Company's 2006 Annual Report to Shareholders on
Form 10-K. In management's opinion there have been no material changes in risk
factors since the filing of the 2006 Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table indicates the number of shares repurchased by Farmers &
Merchants Bancorp during the first quarter of 2007.
NUMBER OF SHARES APPROXIMATE DOLLAR
PURCHASED AS PART OF VALUE OF SHARES THAT
AVERAGE A PUBLICLY MAY YET BE PURCHASED
NUMBER OF PRICE PER ANNOUNCED PLAN OR UNDER THE PLAN OR
FIRST QUARTER 2007 SHARES SHARE PROGRAM PROGRAM
-------------------------------------------------------------------------------------------
01/01/2007 - 01/31/2007 - $ - - $ 10,817,820
02/01/2007 - 02/28/2007 - - - 10,817,820
03/01/2007 - 03/31/2007 194 510 194 10,718,880
-------------------------------------------------------------------------------------------
Total 194 $ 510 194 $ 10,718,880
All of the above shares were repurchased in private transactions.
The common stock of Farmers & Merchants Bancorp is not widely held or listed on
any exchange. However, trades may be reported on the OTC Bulletin Board under
the symbol "FMCB.OB". Additionally, management is aware that there are private
transactions in the Company's common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
See Exhibit Index shown on page 29.
27
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FARMERS & MERCHANTS BANCORP
Date: May 7, 2007 /s/ Kent A. Steinwert
-----------------------------------
Kent A. Steinwert
President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 7, 2007 /s/ Stephen W. Haley
-----------------------------------
Stephen W. Haley
Executive Vice President and
Chief Financial Officer
(Principal Financial & Accounting
Officer)
INDEX TO EXHIBITS
-----------------
Exhibit No. Description
------------ -----------
31(a) Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
31(b) Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32 Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
28