ITEM 1. BUSINESS:
GENERAL
Farmers & Merchants Bancorp, Inc. (Company) is a bank holding company under the laws of Ohio and was incorporated in 1985. Our primary subsidiary, The Farmers & Merchants State Bank (Bank) is a community bank operating in Northwest Ohio since 1897. Our only other subsidiary, Farmers & Merchants Life Insurance Company, a reinsurance company for life, accident and health insurance for the Bank's consumer credits, was formed in 1992. Farmers & Merchants Life Insurance Company was dissolved during 2007. We report our financial condition and net income on a consolidated basis and we report only one segment.
Our executive offices are located at 307-11 North Defiance Street, Archbold, Ohio 43502, and our telephone number is (419) 446-2501.
NATURE OF ACTIVITIES
The Farmers & Merchants State Bank engages in general commercial banking and savings business. Our activities include commercial, agricultural and residential mortgage, consumer, and credit card lending activities. Because our Bank's branches are located in Northwest Ohio and Northeast Indiana, a substantial amount of our loan portfolio is comprised of loans made to customers in the farming industry for such things as farm land, farm equipment, livestock and general operation loans for seed, fertilizer, feed, etc. Other types of lending activities include loans for home improvements, student loans, and loans for such items as autos, trucks, recreational vehicles, mobile homes, motorcycles, etc. We have previously engaged in direct finance leasing and have invested in leveraged type leases, although the activity in this area has since ceased.
We also provide checking account services, as well as savings and other time deposit services such as certificates of deposits. In addition, ATM's (automated teller machines) are also provided in our Ohio offices in Archbold, Wauseon, Stryker, West Unity, Bryan, Delta, Napoleon, Montpelier, Swanton, and Defiance, along with one in our Auburn, Indiana office. Two ATM's are also located at Sauder Woodworking Co., Inc., a major employer in Archbold. Additional locations in Ohio are at Northwest State Community College, Archbold; Williams County Hospital, Bryan; Fairlawn Haven Wyse Commons, Archbold; Repp Oil, Fayette; Delta Eagles, Bryan Eagles; Sauder Village, Archbold; Fulton County Hospital, Wauseon, downtown Defiance; and a mobile trailer ATM. In Indiana, three additional ATM's are located at St. Joe, Butler and at DeKalb Memorial Hospital, Auburn.
Farmers & Merchants Life Insurance Company was established to provide services to our customers through the issuance of life and disability insurance policies. Our Bank's lending officers were the selling agents of the policies to customers. The activities of Farmers & Merchants Life Insurance Co. are not significant to the consolidated company. The Company dissolved the Farmers & Merchants Life Insurance Company subsidiary as the Bank discontinued offering the credit life, accident and health insurance to its customers.
F&M Investments, the brokerage department of the Bank, opened for business in April, 1999. Securities are offered through Raymond James Financial Services, Inc.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956. Our subsidiary bank is in turn regulated and examined by the Ohio Division of Financial
Institutions, the Federal Deposit Insurance Corporation and the Federal Reserve System. The activities of our bank subsidiary are also subject to other federal and state laws and regulations, including usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-in-Lending Act and Regulation Z as promulgated there under by the Board of Governors, the Truth in Savings Act, the Bank Bribery Act, the Competitive Equality Banking Act of 1987, the Expedited Funds Availability Act, the Community Reinvestment Act, the FDICIA (Federal Deposit Insurance Corporation Insurance Act), FIRREA (Federal Institutions Reform, Recovery, and Enforcement Act of 1989), the Bank Merger Act, and the Graham-Leach-Bliley Act regarding financial modernization among others.
The Bank's primary market includes communities located in the Ohio counties of Defiance, Williams, Fulton, Henry and Wood. The commercial banking business in this market is highly competitive, with approximately 17 other depository institutions currently doing business in the Bank's primary market. In our banking activities, we compete directly with other commercial banks and savings and loan institutions in each of our operating localities. In a number of our locations, we compete against entities which are much larger than us. The primary factors in competing for loans and deposits are the rates charged as well as location and quality of the services provided. On December 31, 2007, the Bank acquired the Knisely Bank of Indiana, expanding its market with the addition of offices in Butler and Auburn, Indiana, both located in DeKalb County.
At December 31, 2007, we had 245 full time equivalent employees. The employees are not represented by a collective bargaining unit. We provide our employees with a comprehensive benefit program, some of which are contributory. We consider our employee relations to be excellent.
SUPERVISION AND REGULATION
General
The Company is a corporation organized under the laws of the State of Ohio. The business in which the Company and its subsidiary are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities. The supervision, regulation and examination to which the Company and its subsidiary are subject are intended primarily for the protection of depositors and the deposit insurance funds that insure the deposits of banks, rather than for the protection of shareholders.
Several of the more significant regulatory provisions applicable to banks and bank holding companies to which the Company and its subsidiary are subject are discussed below, along with certain regulatory matters concerning the Company and its subsidiary. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and its subsidiary.
Regulatory Agencies
The Company is a registered bank holding company and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") pursuant to the Bank Holding Company Act of 1956, as amended.
The Bank is an Ohio chartered commercial bank. It is subject to regulation and examination by both the Ohio Division of Financial Institutions (the "ODFI") and the FDIC.
Holding Company Activities
As a bank holding company incorporated and doing business within the State of Ohio, the Company is subject to regulation and supervision under the Bank Holding Act of 1956, as amended (the "Act"). The Company is required to file with the Federal Reserve Board on quarterly basis information pursuant to the Act. The Federal Reserve Board may conduct examinations or inspections of the Company and its subsidiary.
The Company is required to obtain prior approval from the Federal Reserve Board for the acquisition of more than five percent of the voting shares or substantially all of the assets of any bank or bank holding company. In addition, the Company is generally prohibited by the Act from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. The Company may, however, subject to the prior approval of the Federal Reserve Board, engage in, or acquire shares of companies engaged in activities which are deemed by the Federal Reserve Board by order or by regulation to be so closely related to banking or managing and controlling a bank as to be a proper activity.
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted into law. The GLB Act made sweeping changes with respect to the permissible financial services which various types of financial institutions may now provide. The Glass-Steagall Act, which had generally prevented banks from affiliation with securities and insurance firms, was repealed. Pursuant to the GLB Act, bank holding companies may elect to become a "financial holding company," provided that all of the depository institution subsidiaries of the bank holding company are "well capitalized" and "well managed" under applicable regulatory standards.
Under the GLB Act, a bank holding company that has elected to become a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Activities that are "financial in nature" include securities underwriting, dealing and market-making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board has determined to be closely related to banking. No Federal Reserve Board approval is required for the Company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. Prior Federal Reserve Board approval is required before the Company may acquire the beneficial ownership or control of more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. If any subsidiary bank of the Company ceases to be "well capitalized" or "well managed" under applicable regulatory standards, the Federal Reserve Board may, among other actions, order the Company to divest the subsidiary bank. Alternatively, the Company may elect to conform its activities to those permissible for a bank holding company that is not also a financial holding company. If any subsidiary bank of the Company receives a rating under the Community Reinvestment Act of 1977 of less than satisfactory, the Company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations. The Company has not elected to become a financial holding company and has no current intention of making such an election.
Affiliate Transactions
Various governmental requirements, including Sections 23A and 23B of the Federal Reserve Act, limit borrowings by holding companies and non-bank subsidiaries from affiliated insured depository institutions, and also limit various other transactions between holding companies
and their non-bank subsidiaries, on the one hand, and their affiliated insured depository institutions on the other. Section 23A of the Federal Reserve Act also generally requires that an insured depository institution's loan to its non-bank affiliates be secured, and Section 23B of the Federal Reserve Act generally requires that an insured depository institution's transactions with its non-bank affiliates be on arms-length terms.
Interstate Banking and Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act ("Riegle-Neal"), subject to certain concentration limits and other requirements, bank holding companies such as the Company are permitted to acquire banks and bank holding companies located in any state. Any bank that is a subsidiary of a bank holding company is permitted to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of that bank holding company. Banks are permitted to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states and establishing de novo branch offices in other states. The ability of banks to acquire branch offices is contingent, however, on the host state having adopted legislation "opting in" to those provisions of Riegle-Neal. In addition, the ability of a bank to merge with a bank located in another state is contingent on the host state not having adopted legislation "opting out" of that provision of Riegle-Neal. The Company could from time to time use Riegle-Neal to acquire banks in additional states.
Control Acquisitions
The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under the rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Company, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting stock of a bank holding company, or otherwise obtaining control or a "controlling influence" over that bank holding company.
Liability for Banking Subsidiaries
Under the current Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to maintain resources adequate to support each subsidiary bank. This support may be required at times when the bank holding company may not have the resources to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a U.S. federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment. Any depository institution insured by the FDIC can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC in connection with (1) the "default" of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to both a commonly controlled FDIC-insured depository institution "in danger of default." The Company's subsidiary bank is an FDIC-insured depository institution. If a default occurred with respect to the Bank, any capital loans to the Bank from its parent holding company would be subordinate in right of payment to payment of the Bank's depositors and certain of its other obligations.
Regulatory Capital Requirements
The Company is required by the various regulatory authorities to maintain certain capital levels. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The required capital levels and the Company's capital position at December 31, 2007 are summarized in the table included in Note 14 to the consolidated financial statements.
FDICIA
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), and the regulations promulgated under FDICIA, among other things, established five capital categories for insured depository institutions-well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized-and requires U.S. federal bank regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements based on these categories. Unless a bank is well capitalized, it is subject to restrictions on its ability to offer brokered deposits and on certain other aspects of its operations. An undercapitalized bank must develop a capital restoration plan and its parent bank holding company must guarantee the bank's compliance with the plan up to the lesser of 5% of the banks or thrift's assets at the time it became undercapitalized and the amount needed to comply with the plan. As of December 31, 2007, the Company's banking subsidiary was well capitalized pursuant to these prompt corrective action guidelines.
Dividend Restrictions
The ability of the Company to obtain funds for the payment of dividends and for other cash requirements will be largely dependent on the amount of dividends which may be declared by its banking subsidiary. Various U.S. federal statutory provisions limit the amount of dividends the Company's banking subsidiaries can pay to the Company without regulatory approval. Dividend payments by the Bank are limited to its retained earnings during the current year and its prior two years. See Note 15 to the consolidated financial statements for the actual amount.
Deposit Insurance Assessments
The deposits of the Company's banking subsidiary are insured up to regulatory limits by the FDIC, and, accordingly, are subject to deposit insurance assessments based on the Federal Deposit Insurance Reform Act of 2005, as adopted and took effect on April 21, 2006.
Depositor Preference Statute
In the "liquidation or other resolution" of an institution by any receiver, U.S. federal legislation provides that deposits and certain claims for administrative expenses and employee compensation against the insured depository institution would be afforded a priority over general unsecured claims against that institution, including federal funds and letters of credit.
Government Monetary Policy
The earnings of the Company are affected primarily by general economic conditions, and to a lesser extent by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve. Its policies influence, to some degree, the volume of bank loans and deposits, and interest rates charged and paid thereon, and thus have an effect on the earnings of the Company's subsidiary Bank.
Additional Regulation
The Bank is also subject to federal regulation as to such matters as required reserves, limitation as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuance or retirement of their own securities, limitations upon the payment of dividends and other aspects of banking operations. In addition, the activities and operations of the Bank are subject to a number of additional detailed, complex and sometimes overlapping laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-in-Lending Act and Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Truth in Savings Act, the Community Reinvestment Act, anti-redlining legislation and antitrust laws.
Future Legislation
Changes to the laws and regulations, both at the federal and state levels, can affect the operating environment of the Company and its subsidiary in substantial and unpredictable ways. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon the financial condition or results of operations of the Company or its subsidiary.
Available Information:
The Company maintains an Internet web site at the following internet address: http://www.fm-bank.com. The Company files reports with the Securities and Exchange Commission (SEC). Copies of all filings made with the SEC may be read and copied at the SEC's Public Reference Room, 450 Fifth Street, Washington, DC, 20549. You may obtain information about the SEC's Public Reference Room by calling (800/SEC-0330). Because the Company makes its filing with the SEC electronically, you may access such reports at the SEC's website, www.sec.gov. The Company makes available, free of charge through its internet address, copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as reasonable practicable after such materials have been filed with or furnished to the SEC. Copies of these documents may also be obtained, either in electronic or paper form, by contacting Barbara J. Britenriker, Chief Financial Officer of the Company at (419) 446-2501.
ITEM 1A.
ITEM 1A. RISK FACTORS
SIGNIFICANT COMPETITION FROM AN ARRAY OF FINANCIAL SERVICE PROVIDERS
Our ability to achieve strong financial performance and a satisfactory return on investment to shareholders will depend in part on our ability to expand our available financial services. In addition to the challenge of attracting and retaining customers for traditional banking services, our competitors now include securities dealers, brokers, mortgage bankers, investment advisors
and finance and insurance companies who seek to offer one-stop financial services to their customers that may include services that banks have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial services providers. If we fail to adequately address each of the competitive pressures in the banking industry, our financial condition and results of operations could be adversely affected.
CREDIT RISK
The risk of nonpayment of loans is inherent in commercial banking. Such nonpayment could have an adverse effect on the Company's earnings and our overall financial condition as well as the value of our common stock. Management attempts to reduce the Bank's credit exposure by carefully monitoring the concentration of its loans within specific industries and through loan application and approval procedures. However, there can be no assurance that such monitoring and procedures will reduce such lending risks. Credit losses can cause insolvency and failure of a financial institution and, in such event, its shareholders could lose their entire investment. For a more information on the exposure of the Company and the Bank to credit risk, see the section under Part II, Item 7 of this Form 10-K captioned "Loan Portfolio."
SUSCEPTIBILITY TO CHANGES IN REGULATION
Any changes to state and federal banking laws and regulations may negatively impact our ability to expand services and to increase the value of our business. We are subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of our operations. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. In addition, the Company's earnings are affected by the monetary policies of the Board of Governors of the Federal Reserve. These policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits. The Gramm-Leach-Bliley Act regarding financial modernization that became effective in November, 1999 removed many of the barriers to the integration of the banking, securities and insurance industries and is likely to increase the competitive pressures upon the Bank. We cannot predict what effect such Act and any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, but such changes could be materially adverse to our financial performance. For a more information on this subject, see the section under Part I, Item 1 of this Form 10-K captioned "Supervision and Regulation."
INTEREST RATE RISK
Changes in interest rates affect our operating performance and financial condition in diverse ways. Our profitability depends in substantial part on our "net interest spread," which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally. Historically, net interest spreads for other financial institutions have widened and narrowed in response to these and other factors, which are often collectively referred to as "interest rate risk." Over the last few years, the Bank, along with most other financial institutions, has experienced a "margin squeeze" as higher interest rates have made it difficult to maintain a more favorable net interest spread.
The Bank manages interest rate risk within an overall asset/liability framework. The principal objectives of asset/liability management are to manage sensitivity of net interest spreads and net income to potential changes in interest rates. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. In the event that our asset/liabilities management strategies are unsuccessful, our profitability may be adversely affected. For more information regarding the Company's exposure to interest rate risk, see Part II, Item 7A of this Form 10-K.
ATTRACTION AND RETENTION OF KEY PERSONNEL
Our success depends upon the continued service of our senior management team and upon our ability to attract and retain qualified financial services personnel. Competition for qualified employees is intense. In our experience, it can take a significant period of time to identify and hire personnel with the combination of skills and attributes required in carrying out our strategy. If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our business, financial condition, results of operations and cash flows could be materially adversely affected.
DIVIDEND PAYOUT RESTRICTIONS
We currently pay a quarterly dividend on our common shares. However, there is no assurance that we will be able to pay dividends in the future. Dividends are subject to determination and declaration by our board of directors, which takes into account many factors. The declaration of dividends by us on our common stock is subject to the discretion of our board and to applicable state and federal regulatory limitations. The Company's ability to pay dividends on its common stock depends on its receipt of dividends from the Bank. The Bank is subject to restrictions and limitations in the amount and timing of the dividends it may pay to the Company.
ANTI-TAKEOVER PROVISIONS
Provisions of our Articles of Incorporation and Ohio law could have the effect of discouraging takeover attempts which certain stockholders might deem to be in their interest. These anti-takeover provisions may make us a less attractive target for a takeover bid or merger, potentially depriving shareholders of an opportunity to sell their shares of common stock at a premium over prevailing market prices as a result of a takeover bid or merger.
OPERATIONAL RISKS
We are subject to certain operations risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.
LIMITED TRADING MARKET
Our common stock is not listed on any exchange or The Nasdaq Stock Market. While our stock is currently quoted in the over-the-counter markets, it trades infrequently.
ITEM 2.
ITEM 2. PROPERTIES
Our principal office is located in Archbold, Ohio.
The Bank operates from the facilities at 307-11 North Defiance Street. In addition, the Bank owns the property from 200 to 208 Ditto Street, Archbold, Ohio, which it uses for Bank parking and a community mini-park area. The Bank owns real estate at two locations, 207 Ditto Street and 209 Ditto Street in Archbold, Ohio upon which the bank built a commercial building to be used for storage, and a parking lot for company vehicles and employee parking. The Bank also owns real estate across from the main facilities to provide for parking.
The Bank occupies an Operations Center at 622 Clydes Way in Archbold, Ohio to accommodate our growth over the years.
The Bank owns all of its branch locations. Current locations of retail banking services are:
The majority of the above locations have drive-up service facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Bank or the Company, to which we are a party or of which any of our properties are the subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted during the fourth quarter of the year covered by this report to a vote of the security holders through solicitation of proxies or otherwise.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is not listed on the NASDAQ stock market or any other stock exchange. While there is no established public trading market for our common stock, our shares are currently dually-quoted by various market makers on the Pink Sheets and the Over the Counter Bulletin Board, which are both over-the-counter quotation services for participant broker-dealers.
There are market makers that set a price for our stock; however, private sales continue to occur. The high and low sale prices were from sales of which we have been made aware by researching daily on Bloomberg.com. The high and low sale prices known to our management are as follows:
The Company utilizes Registrar and Transfer Company as its transfer agent.
As of February 5, 2008 there were 2037 record holders of our common stock.
Below is a line-graph presentation comparing the cumulative total shareholder returns for the Corporation, an index for NASDAQ Stock Market (U.S. Companies) comprised of all domestic common shares traded on the NASDAQ National Market System and the NASDAQ Bank Index for the five-year period ended December 31, 2007. The chart compares the value of $100 invested in the Corporation and each of the indices and assumes investment on December 31, 2002 with all dividends reinvested.
The Board of Directors recognizes that the market price of stock is influenced by many factors, only one of which is performance. The stock price performance shown on the graph is not necessarily indicative of future performance.
(PERFORMANCE GRAPH)
Year 2002 as the base
Dividends are declared and paid quarterly. Per share dividends declared for the years ended 2007 and 2006 are as follows:
The ability of the Company to pay dividends is limited by the dividend that the Company receives from the Bank. The Bank may pay as dividends to the Company its retained earnings during the current year and its prior two years. Currently, such limitation on the payment of dividends from the Bank to the Company does not materially restrict the Company's ability to pay dividends to its shareholders.
Dividends declared during 2007 were $0.64 per share totaling $3.25 million, 11.3 percent higher than 2006 declared dividends of $0.575 per share. During 2006, the Company purchased 42,000 shares and awarded 6,100 restricted shares to 41 employees under its long term incentive plan. 200 shares were forfeited during 2006. At year end 2006, the Company held 36,180 shares in Treasury stock and 9,820 in unearned stock awards. The Company initiated a 4:1 stock split on May 12, 2006. The Company purchased 228,000 shares throughout 2007. 8,760 shares were awarded to 46 employees in 2007. 740 restricted shares were forfeited during 2007 and 600 restricted shares whose vesting was accelerated were transferred to a retired employee. At December 31, 2007, the Company held 256,160 shares in Treasury stock and 17,240 in unearned stock awards. The Company continues to have a strong capital base and to maintain regulatory capital ratios that are significantly above the defined regulatory capital ratios. The Company has authorization to purchase 250,000 shares throughout 2008.
ISSUER PURCHASES OF EQUITY SECURITIES
(1) The Company purchased these shares pursuant to a stock repurchase program publicly announced on October 20, 2006. On that date, the Board of Directors authorized the repurchase of up to 250,000 common shares through December 31, 2007.
RECLASSIFICATION
Certain amounts in the 2006 and 2005 consolidated financial statements have been reclassified to conform with the 2007 presentation. The Company's Board of Directors declared a 4 for 1 stock split effective May 12, 2006. Therefore, all references in the financial statements and other disclosures related to the number of shares and per share amounts of the Company's stock have been retroactively restated to reflect the increased number of shares outstanding.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICY AND ESTIMATES
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, and the Company follows general practices within the financial services industry in which it operates. At times the application of these principles requires Management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. These assumptions, estimates and judgments are based on information available as of the date of the financial
statements. As this information changes, the financial statements could reflect different assumptions, estimates and judgments. Certain policies inherently have a greater reliance on assumptions, estimates and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Examples of critical assumptions, estimates and judgments are when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not required to be recorded at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event.
All significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the notes to the consolidated financial statements and in the management discussion and analysis of financial condition and results of operations, provide information on how significant assets and liabilities are valued and how those values are determined for the financial statements. Based on the valuation techniques used and the sensitivity of financial statement amounts to assumptions, estimates and judgments underlying those amounts, management has identified the determination of the Allowance for Loan and Lease Losses (ALLL) and the valuation of its Mortgage Servicing Rights as the accounting areas that requires the most subjective or complex judgments, and as such could be the most subject to revision as new information becomes available.
The ALLL represents management's estimate of credit losses inherent in the Bank's loan portfolio at the report date. The estimate is a composite of a variety of factors including past experience, collateral value, and the general economy. ALLL includes a specific portion, a formula driven portion, and a general nonspecific portion. The collection and ultimate recovery of the book value of the collateral, in most cases, is beyond our control.
The Company is also required to estimate the value of its Mortgage Servicing Rights. The Company recognizes as separate assets rights to service fixed rate single-family mortgage loans that it has sold without recourse but services for others for a fee. Mortgage servicing assets are initially recorded at cost, based upon pricing multiples as determined by the purchaser, when the loans are sold. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Amortization is determined in proportion to and over the period of estimated net servicing income using the level yield method. For purposes of determining impairment, the mortgage servicing assets are stratified into like groups based on loan type, term, new versus seasoned and interest rate. The valuation is completed by an independent third party.
The expected and actual rates of mortgage loan prepayments are the most significant factors driving the potential for the impairment of the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.
For more information regarding the estimates and calculations used to establish the ALLL and the value of Mortgage Servicing Rights, please see Note 1 to the consolidated financial statements provided herewith.
2007 IN REVIEW
Total assets reached a record high for year-end reporting on December 31, 2007 at $804 million. This was achieved with a 5% growth in loans corresponding to a new five year high year-end balance of $523.5 million. Deposits also grew 8.4%, as compared to year end 2006, ending at
$634.6 million. Growth was accomplished with the acquisition of the Knisely Bank with total assets of $42.5 million. The transaction was completed December 31, 2007.
The Knisely Bank purchase also added goodwill of slightly over $4 million to the balance sheet along with $1.1 million of core deposit intangible and fair value adjustments for both loans and buildings. A deferred tax entry also was recorded for the allowance for loan loss of $102 thousand. The transaction was completed as an asset purchase for tax purposes. The Bank extended its market area and is able to provide many additional services to the Indiana communities of Butler and Auburn.
Establishing the groundwork from which to provide opportunity for continued growth was a focus in 2007. Along with the Knisely Bank, Indiana acquisition, a new office was built and opened in Perrysburg, a new remote ATM was added in Defiance, Ohio and St. Joe, Indiana and the main office drive up was renovated. These are all visible additions to the F&M family. Internally, infrastructure improvement began with the imaging of both internal documents and branch capture. The internal documents, such as loan files, will take more than a year to complete but the process is well on its way with checking and savings signature cards already scanned. This enables an employee to verify customers' signatures and account ownership at their PC. Branch capture enables the transaction documents to be scanned at the office locations and electronically submitted to main office. Along with the completion of the imaging of internal documents, these two procedures eliminate the need for a courier route. All information between locations is converted to an electronic presentation which provides more information in a timely manner to more people.
The foundation for emphasizing a more needs based sales culture was begun in 2007 with the kickoff of the "This Bank is Made For You and Me" campaign. This represents a change in the approach for customer service and a win-win situation for both the Bank and its customers. This is an on-going project with its own dedicated team manager to measure its success. It is to provide better customer service and more relationship building.
The Company dissolved the Farmers & Merchants Life Insurance Company subsidiary as the Bank discontinued offering credit life and accident and health insurance to its customers. As the insurance company was reinsurance of the Bank's customers, it would no longer be profitable to continue operations. The closing of the insurance company was a seamless transaction for the Bank's customers as they realized no change in coverage or claim procedures. The policies were merely sold back to the original issuer. The Bank is now offering debt protection products that are similar to the previous insurance products. This has become possible due to regulatory changes in the State of Ohio regarding these types of products. It has also broadened the coverage available, specifically, involuntary unemployment that our customers have been requesting. Fees will be added to non-interest income on a monthly basis from this product.
MATERIAL CHANGES IN RESULTS OF OPERATIONS
The discussion now turns to more financial based results and trends as a result of 2007 operations. The increase in non-interest income of other service charges and fees of $357 thousand over 2006 is mainly attributed to the increase in earnings due to the additional purchase of Bank Owned Life Insurance of $3 million in January 2007. This offset the decrease in customer service fees of $347 thousand. This decrease represents a loss of income generated from the Overdraft Privilege product. Customers' accounts were overdrawn less during 2007 with the trend beginning after the first quarter. With rates increasing through most of the year, the net gain on sale of loans was impacted by lower originations and fees being collected. The slower housing market directly correlates to the gain on sale of loans being $66 thousand lower as
compared to 2006. Overall, non-interest income was down a modest $46 thousand as compared to 2006.
Non-interest expenses were $257 thousand higher than 2006 and $993 thousand lower than 2005. The increase in 2007 as compared to 2006 was impacted by mainly two issues: cost of health benefits and other general and administrative expenses. Important to note is the Bank's focus on doing more with less - reflected in the decline of salaries and wages expense for the three years shown. The trend is reversed in the employees benefit line with an increasing upward trend. 2006 was $181 thousand higher than 2005 and 2007 was $348 thousand higher than 2006. The higher cost is attributable both to the health insurance premium expense of the coverage and an increased level of claims. During 2007, alternatives were explored to minimize the exposure for a new Health Savings Accounts option. A wellness benefit was also added to the plans to help defray the cost of the higher deductibles. While the cost may continue to rise in 2008, these steps were taken to lessen the slant of the slope of the increase and to provide for employee assistance in the containment of the costs. Healthier employees directly correlate to lower claims in the long term.
The increase in other general and administrative cost was due to the expense of Ohio sales use tax. An audit covering the period of 2000 through 2007 was conducted in 2007. It was discovered that many out of state vendors and small service providers were not charging the Bank for sales tax. An additional $177 thousand of expense was incurred from the findings. Procedures have been established to process invoices without sales tax and any future audit would be limited to a three year look back period.
The last large item to be discussed is the Provision for Loan Losses. A tough economic environment existed for most businesses in northwest Ohio during 2007. Gross charge-offs were up 60% over 2006 with net charge-offs up 164% or $526 thousand higher as compared to 2006. The provision is presented in depth in the pages to follow. However it was important to note the impact here.
Overall, the Company had a solid year of performance in an ever changing and challenging economic environment. A tightening of the interest margin effected net interest earnings and growth did not occur until the closing of the acquisition on the last day of the year. The foundation is laid for future growth but there was very little additional growth from which to garner income during 2007. The charts and discussion to follow will confirm the assessment.
NET INTEREST INCOME
The net interest margin tightened during 2007 from the higher rate environment triggered by the Federal Reserve increases throughout 2006. While interest income increased from loan rate adjustments and the growth in loans, it did not outpace the increased interest cost of the liabilities used for funding. The results are an interest earning yield 4.93% higher than 2006 with an interest cost yield 13.55% higher resulting in a decrease of 2.69% in the net interest margin for 2007 as compared to 2006.
Interest income was $45.4 million for 2007, $42.3 million for 2006 and $38.1 million for 2005. Interest expense was $21.7, $18.5 and $13.5 million, respectively for 2007, 2006, and 2005. Net Interest income was equivalent to 2006 at $23.7 million and 2006 was a decrease from 2005's $24.6 million. With average assets increasing in 2007, the equivalent earnings are representative of the lower net interest margin.
The following table presents net interest income, interest spread and net interest margin for the three years 2005 through 2007, comparing average outstanding balances of earning assets and
interest bearing liabilities with the associated interest income and expense. The table also shows their corresponding average rates of interest earned and paid. The tax-exempt asset yields have been tax affected to reflect a marginal corporate tax rate of 34%. Average outstanding loan balances include non-performing loans and mortgage loans held for sale. Average outstanding security balances are computed based on carrying values including unrealized gains and losses on available-for-sale securities.
As the charts indicate, the Company experienced increased growth on an average basis for year 2007 compared to 2006 and 2005. Interest earning assets average balance increased during all periods. The biggest component of the interest earning assets was loans with 2007's average being $2.4 million higher than 2006. The yield for 2007 was higher for interest earning assets as compared to 2006 and 2005 in all categories with the exception of Federal Funds sold. More Federal Funds were sold in the later part of the year after rates began to drop and cash was anticipated to be needed for the acquisition.
Overall, the tax equivalent yield on interest earning assets increased to 6.84% compared to 6.49% and 5.93% for 2006 and 2005 respectively. The percentage of interest earning assets to total assets decreased slightly the past three years but remained above 90% at a respectable 93.09% for 2007.
As stated previously, the increased yield on the assets was unfortunately outpaced by the increased cost of funds. The average balances for interest bearing liabilities increased only slightly, $17.1 million as compared to 2006. While the balance increased slightly, the cost on those funds trended significantly higher. The average cost for 2007 was 3.77% compared to 2006's 3.32% and 2005's 2.43%. The balances in non-interest bearing liabilities increased during the last three years. With the addition of free checking in 2005, the non-interest bearing demand deposits average balance increased 7.48% in 2006 over 2005 numbers. This was also in part due to the streamlining of the Bank's checking account offerings and the introduction of Platinum checking in 2006.
As stated previously, the charts show the constriction on the net interest margin and spread from 2005 to 2007. The largest tightening occurred during 2006. Net interest spread decreased 31 basis points during 2006 compared to a 14 basis points decrease during 2007. The same statement can be made for net interest margin, a 17 basis point drop in 2006 compared to a 10 basis point drop in 2007. Competition played a major role in the pressure applied on these margins along with the rising rate environment and the slope of the yield curve during 2005 and 2006. The ability to grow loans was directly impacted by the ability to aggressively price the loans at least equal to competition. The Company's market was extremely competitive and thus the yields on assets, while increasing, were not able to be increased as high as management would have liked. Loan growth was slower in 2007 as seen in the average balance growth of $2.4 million for 2007 as compared to the $3.7 million growth of 2006. The acquisition had very minimal impact in 2007 as it closed on December 31. 2007.
The yield on Tax-Exempt investments securities shown in the following charts were computed on a tax equivalent basis. The yield on Loans has been tax adjusted for the portion of tax-exempt IDB loans included in the total. Total Interest Earning Assets is therefore also reflecting a tax equivalent yield in both line items, also with the Net Interest Spread and Margin. The adjustments were based on a 34% tax rate.
(1) For purposes of these computations, non-accruing loans are included in the daily average outstanding loan amounts.
The primary source of the Company's traditional banking revenue is net interest income. Net interest income is the difference between interest income on interest earning assets, such as loans and securities, and interest expense on liabilities used to fund those assets, such as interest bearing deposits and other borrowings. Net interest income is affected by changes in both interest rates and the amount and composition of earning assets and liabilities. The change in net interest income is most often measured as a result of two statistics - interest spread and net interest margin. The difference between the yields on earning assets and the rates paid for interest bearing liabilities supporting those funds represents the interest spread. Because non-interest bearing sources of funds such as demand deposits and stockholders' equity also support earning assets, the net interest margin exceeds the interest spread.
The following tables show changes in interest income, interest expense and net interest resulting from changes in volume and rate variances for major categories of earnings assets and interest bearing liabilities.
The Federal Reserve began raising the Federal Funds rate in June of 2004 and continued along that path through mid 2006. The increased interest income from loans for 2005 through 2007 is partially due to the increased rate. Rates began to drop at the end of third quarter 2007. Loans and federal funds sold were the only assets that had interest income increased due to change in volume in 2006. In 2007, taxable investment securities also had some rate increase due to a change in volume. There was minimal change due to volume on the liability side of the balance sheet during 2006. The Time deposits increase was caused by the renewing of CD's from lower rates of previous years into higher rate buckets. With the pausing of Federal Fund rate hikes the second half of 2006 the bank focused on keeping "specials" shorter term going into 2007. This strategy helped to slow the increase during 2007 as only $2.1 million of the interest expense was attributed to rate compared to 2006's $2.8 million. As rates began to fall in the fourth quarter of 2007, this strategy will continue to help in 2008. In 2007, the expense of commercial sweeps, included under Fed Funds and securities sold under agreement to repurchases, grew mainly because of increased usage as shown in change due to volume.
ALLOWANCE FOR CREDIT LOSSES
The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two reserves: The ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total Allowance for Credit Losses (ACL).
The Company increased the allowance for credit losses for 2007 after decreasing in 2006. $301 thousand of the increase was the allowance that came across from the acquisition. The allowance stands at $6.1 million for 2007 compared to $5.8 million for 2006. This decrease in 2006 was due to the improvement in asset quality and the decrease in impaired loans. Charge-off activity of $1.0 million was extremely low for 2006 compared to $2.1 million for 2005. Net charge-offs were also lower in 2006 at $319 thousand than 2005's $1.0 million. Increased activity was recorded in all components of the ALLL. Provision expense was up $346 thousand in 2007 which totaled $871 thousand compared to $525 thousand for 2006 and $425 thousand for 2005. The AULC decreased during 2006 and 2007, ending at $156 thousand for 2007. Overall the ACL ended at $6.1 million for 2007. The increase in the allowance is reflective of the loan balance
increase and increased activity of charge-offs and delinquent loans in a tough economic environment. Historical factors along with current economic conditions are part of the calculation to determine the adequacy of the allowance.
NON-INTEREST INCOME
Non-interest income of $6.4 million is almost equivalent to 2006 and 2005, down only $46 thousand for 2006 and 2006 down only $7 thousand from 2005. Mortgage activity has remained down from 2004 for all three years presented due to higher interest rates. 2007 had the additional issue of housing market troubles slowing originations. The largest fluctuations in non-interest income were impacted with the purchase of additional bank-owned life insurance (BOLI) and decreased usage of the Bank's Overdraft Privilege product. The increase in BOLI earnings offset the decrease of fees in the overdraft product. However, overdraft privilege remains an important portion of non-interest income; even though overall usage has decreased.
NON-INTEREST EXPENSE
Salaries and wages decreased in 2007 and 2006 as compared to 2005. Two reasons for the decrease: 1) Full time equivalent numbers of employees for December 2007 compared to December 2006 decreased by seven and decreased by sixteen when compared to December 2005. 2) The incentive paid based on performance for 2007 was lower than both 2006 and 2005 as the overall performance of the Bank was lower. Employee benefits were higher as the Bank's cost for medical insurance increased during 2006 and 2007. This impact was discussed earlier.
The biggest contributor to the improvement of non-interest expense in 2006, the adjustment for the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). The decrease of $673 thousand is reflected in the $1.2 million decrease in other general and administrative expenses, making up an $828 thousand decrease when adding the expense of 2005. The second largest contributor to the improvement was the cost of audit, accounting and exam fees. These were decreased by $204 thousand compared to 2005. Improvements in audit procedures and SOX reporting experience were responsible for the decrease.
While 2006 showed an improvement in non-interest expense, the other factor in 2007's $257 thousand net increase was the additional cost from the Ohio Sales Use Tax audit discussed previously. The focus of the Company remains to decrease the non-interest expense while increasing the non-interest income. Containing the cost of providing health care for its employees and the removal of the one-time audit expense is a step in that direction. Additional revenue generating services and/or products are also constantly being researched for compatibility with the Company's markets.
FEDERAL INCOME TAXES
Effective tax rates were 26.78%, 27.63%, and 27.19% for 2007, 2006 and 2005, respectively. The Company increased its tax-exempt holdings in 2005 with 2006's average investment balance in tax-exempt securities at $49.2 million compared to $51 million for 2005. Those holdings decreased by another $8.8 million in average balance during 2007. Industrial Development Bonds, which may also be tax exempt, increased almost $2 million at year end 2007 compared to 2006. The earnings also increased on IDB's for 2007.
FINANCIAL CONDITION
Average earning assets increased $12.9 million during 2007 over 2006 and were higher by $18.7 million as compared to 2005. The main cause of fluctuation was loans with investments serving as a contra account in movements, increased loans - - decreased investments. Average interest
bearing liabilities increased $17.1 million over 2006 and $17.8 million from 2005. The increase in 2007 over 2006 and 2005 was to fund the increase in loans.
SECURITIES
Security balances as of December 31 are summarized below:
The following table sets forth (dollars in thousands) the maturities of investment securities as of December 31, 2007 and the weighted average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate have been made in yields on obligations of state and political subdivisions. Stocks of domestic corporations have not been included.
As of December 31, 2007 the Bank did not hold a large block of any one investment security, except for U.S. Treasury and other U.S. Government agencies. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $4.0 million. This is required in order to obtain Federal Home Loan Bank Loans. The Bank also acquired stock in the Federal Home Loan Bank of Indianapolis at a cost of $231.4 thousand through its acquisition of Knisely Bank. There were no
borrowings at the time of acquisition associated with Federal Home Loan Bank of Indianapolis. The Bank also acquired stock in the Federal Reserve Bank with its acquisition.
LOAN PORTFOLIO
The Bank's various loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio diversification and through standardization of lending policies and procedures.
The following table shows the Bank's loan portfolio by category of loan including loans held for sale:
Note: From year 2004 forward - additional class types were added. In 2003, Ag & Commercial Real Estate was included in Consumer Real Estate.
The following table shows the maturity of loans as of December 31, 2007:
The following table presents the total of loans due after one year which has 1) predetermined interest rates and 2) floating or adjustable interest rates:
The following table summarizes the Company's non-accrual and past due loans as of December 31 for each of the last five years:
Although loans may be classified as non-performing, some pay on a regular basis, many continue to pay interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans was $246 thousand for 2005, $174 thousand for 2006 and $313 thousand for 2007. Any collections of interest on non-accrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to decrease the allocation needed. Total interest collections amounted to $473 thousand for 2005, $167 thousand for 2006, and $174 thousand for 2007. $171 thousand of the interest collected in 2006 was applied to reduce the specific allocations for 2006 and $40 thousand of interest collected in 2007 was applied to reduce the specific allocations.
Loans are placed on non-accrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The $4.9 million of non-accrual loans as of December 31, 2007 are secured.
As of December 31, 2007 the Bank has $15.4 million of loans which it considers to be potential problem loans in that the borrowers are experiencing financial difficulties. These loans are subject to constant management attention and are reviewed more frequently than quarterly.
The amount of the potential problem loans was considered in management's review of the loan loss reserve required at December 31, 2007.
In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense, used to enlarge a bank's allowance for loan losses, is determined by
management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the bank's borrowers.
As of December 31, 2007, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $59 million with an additional $45.5 million in agricultural real estate loans. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities.
The allowance for loan losses is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated.
Management considers several different risk assessments in determining the allowance for loan losses. The allocated component of the allowance for loan losses reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by loan category.
The unallocated portion of the reserve for loan losses is determined based on management's assessment of general economic conditions as well as specific economic factors in the Bank's marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower's financial condition and other current risk factors that may not have yet manifested themselves in the Bank's historical loss factors used to determine the allocated component of the allowance.
Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral.
As presented below, charge-offs increased to $1.58 million for 2007, and the provision was $871 thousand. An additional $301 thousand is showing in the provision line for 2007 which represents the allowance for loan losses that was carried over from the acquisition. A few large commercial credits included in the $5.7 million charged off in the commercial and agricultural segment was the only segment in a net recovery for 2007. The consumer segment was also in a net recovery position for 2006. The negative provision of 2005 was necessary to decrease the allowance because of the overall decrease of the loan portfolio and the improved asset quality position. The decrease in the total allowance for credit losses for 2006 was due to the continued improvement in the asset quality position and reassessment of the risk existent in the unfunded loan commitments. The improvement in the ratio of net charge offs to average loans outstanding is evidence of the improved asset quality during that period.
The increase in net charge-offs and past due loans along with the loan growth were the reasons for the increase in the ALLL for 2007. Overall the Bank has not experienced the losses many other institutions have during 2007. While the numbers are up, it is at a manageable level.
The following table presents a reconciliation of the allowance for credit losses:
Note: Year 2004 - Jan 1 balance adjusted for reporting change for allowance for reporting loan & lease commitments & letters as reported within prior year end balance.
Allocation of the allowance for credit losses per Loan Category in terms of dollars and percentage among the various loan categories is as follows:
Note: From year 2004 forward - additional class types were added. Commercial real estate and agricultural real estate were previously included in the total for consumer real estate.
DEPOSITS
The amount of outstanding time certificates of deposits and other time deposits in amounts of $100,000 or more by maturity as of December 31, 2007 are as follows:
The following table presents the average amount of and average rate paid on each deposit category:
LIQUIDITY
Maintaining sufficient funds to meet depositor and borrower needs on a daily basis continues to be among our management's top priorities. This is accomplished not only by the immediately liquid resources of cash, due from banks and federal funds sold, but also by the Bank's available for sale securities portfolio. The average aggregate balance of these assets was $207 million in 2005, $198 million for 2006, compared to $196 million fro 2007. This represented 29.7 percent, 28.0 percent, and 26.9 percent of total average assets, respectively. Of the almost $186 million of debt securities in the company's portfolio as of December 31, 2007, $28.2 million or 15.2 percent of the portfolio is expected to mature in 2008. Taking into consideration possible calls of the debt securities, the amount climbs to $65.6 million or 36.3 percent of the portfolio becomes a source of funds. This liquidity provides the opportunity to fund loan growth without having to over aggressively price deposits.
Historically, the primary source of liquidity has been core deposits that include non-interest bearing demand deposits, NOW, money market accounts and time deposits of individuals. Core deposits increased as of year end balances in 2007, in all categories. Overall deposits increased an average of $6.7 million during 2007 compared to 2006's decrease under 2005 of $6.1 million in average deposits. These represent changes of (1.0) percent and (1.1) percent in average total deposits, respectively. The Bank also utilized Federal Funds purchased at times during 2007. The average balance for 2007 was $2.7 million.
Again, historically, the primary use of new funds is placing the funds back into the community through loans for the acquisition of new homes, consumer products and for business development. The use of new funds for loans is measured by the loan to deposit ratio. The Company's loan to deposit ratio for 2007 was 88.82 percent, 2006 was 85.97 percent, and 2005 was 79.6 percent. The lower ratio in 2005 is due to the lack of growth in both the credit and deposit portfolios. 2007 and 2006 represents the increased loan growth outpacing deposit growth. The Company's goal is for this ratio to be higher with loan growth the driver; this was achieved in 2006 and 2007.
Short-term debt such as federal funds purchased and securities sold under agreement to repurchase also provides the Company with liquidity. Short-term debt for both federal funds purchased and securities sold under agreement to repurchase amounted to $41.3 million at the end of 2007 compared to $34.8 million at the end of 2006 and to $21.2 million at the end of 2005. Though no federal funds were purchased at year end, the Bank does have arrangements with correspondent Banks that can be utilized when necessary. Following is a table showing the daily securities sold under agreement to repurchase activity for 2007 and 2006. These accounts are used to provide a sweep product to the Bank's commercial customers.
Securities Sold Under Agreement to Repurchase
Other borrowings are also a source of funds. Other borrowings consist of loans from the Federal Home Loan Bank of Cincinnati. These funds are then used to provide fixed rate mortgage loans
secured by homes in our community. Borrowings from this source increased by $8.6 million to $31.8 million at December 31, 2007. This compares to decreased borrowings during 2006 of $11.7 million to $23.2 million at December 31, 2006 and increased borrowings during 2005 of $13 million to $34.9 million to end at December 31, 2005. The increased borrowings in 2007 were used to fund loan growth and were a cheaper source of funds than certificate of deposits. The decreased borrowings were payoffs of matured notes. Sufficient funds were available to fund growth so new advances were not needed in 2006.
ASSET/LIABILITY MANAGEMENT
The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. It involves the management of the balance sheet mix, maturities, repricing characteristics and pricing components to provide an adequate and stable net interest margin with an acceptable level of risk. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.
Changes in net income, other than those related to volume arise when interest rates on assets reprice in a time frame or interest rate environment that is different from that of the repricing period for liabilities. Changes in net interest income also arise from changes in the mix of interest-earning assets and interest-bearing liabilities.
Historically, the Bank has maintained liquidity through cash flows generated in the normal course of business, loan repayments, maturing earning assets, the acquisition of new deposits, and borrowings. The Bank's asset and liability management program is designed to maximize net interest income over the long term while taking into consideration both credit and interest rate risk.
Interest rate sensitivity varies with different types of interest-earning assets and interest bearing liabilities. Overnight federal funds on which rates change daily and loans that are tied to the market rate differ considerably from long-term investment securities and fixed rate loans. Similarly, time deposits over $100,000 and money market certificates are much more interest rate sensitive than passbook savings accounts. The Bank utilizes shock analysis to examine the amount of exposure an instant rate change of 100, 200, and 300 basis points in both increasing and decreasing directions would have on the financials. Acceptable ranges of earnings and equity at risk are established and decisions are made to maintain those levels based on the shock results.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates and equity prices. The primary market risk to which we are subject is interest rate risk. The majority of our interest rate risk arises from the instruments, positions and transactions entered into for purposes other than trading such as loans, available for sale securities, interest bearing deposits, short term borrowings and long term borrowings. Interest rate risk occurs when interest bearing assets and liabilities reprice at different times as market interest rates change. For example, if fixed rate assets are funded with variable rate debt, the spread between asset and liability rates will decline or turn negative if rates increase.
Interest rate risk is managed within an overall asset/liability framework. The principal objectives of asset/liability management are to manage sensitivity of net interest spreads and net income to potential changes in interest rates. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. In the event that our asset/liabilities management strategies are unsuccessful, our profitability may be adversely affected. The Company employs a sensitivity analysis utilizing interest rate shocks to help in this analysis.
The shocks presented below assume an immediate change of rate in the percentages and directions shown:
CONTRACTUAL OBLIGATIONS
Contractual Obligations of the Company totaled $398.3 million as of December 31, 2007. Time deposits represent contractual agreements for certificates of deposits held by its customers. Long term debt represents the borrowings with the Federal Home Loan Bank and is further defined in Note 4 and 9 of the Consolidated Financial Statements.
CAPITAL RESOURCES
Shareholders' equity was $89.4 million as of December 31, 2007 compared to $87.7 million at December 31, 2006. Dividends declared during 2007 were $0.64 per share totaling $3.25 million, 11.3 percent higher than 2006 declared dividends of $0.575 per share. During 2006, the Company purchased 42,000 shares and awarded 6,100 restricted shares to 41 employees under its long term incentive plan. 200 shares were forfeited during 2006. At year end, the Company held 36,180 shares in Treasury stock and 9,820 in unearned stock awards. The Company initiated a 4:1 stock split on May 12, 2006. The Company purchased 228,000 shares throughout 2007. 8,760 shares were awarded to 46 employees in 2007. 740 restricted shares were forfeited during 2007 and 600 restricted shares whose vesting was accelerated were transferred to a retired employee. At December 31, 2007, the Company held 256,160 shares in Treasury stock and 17,240 in unearned stock awards. The Company continues to have a strong capital base and to maintain regulatory capital ratios that are significantly above the defined regulatory capital ratios. The Company has authorization to purchase 250,000 shares throughout 2008.
At December 31, 2007, The Farmers & Merchants State Bank and Farmers & Merchants Bancorp, Inc had total risk-based capital ratios of 15.51%. Core capital to risk-based asset ratios of 17.91% and 14.47% are well in excess of regulatory guidelines. The Bank's leverage ratio of 9.5% is also substantially in excess of regulatory guidelines as is the Company's at 11.5%.
The Company's subsidiaries are restricted by regulations from making dividend distributions in excess of certain prescribed amounts.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheet at December 31, 2007 and 2006
Consolidated Statements of Income for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Changes in Shareholders' Equity for the year ended December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flow for the years ended December 31, 2007, 2006 and 2005
Notes to Consolidated Financial Statements
(PLANTE MORAN LOGO) PLANTE & MORAN, PLLC Suite 500 2601 Cambridge Court Auburn Hills, MI 48326 Tel: 248.375.7100 Fax: 248.375.7101 plantemoran.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders Farmers & Merchants Bancorp, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Farmers & Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited the Company's internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying financial statements. Our responsibility is to express an opinion on these financial statements and an opinion on the company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Farmers & Merchants Bancorp, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Farmers & Merchants Bancorp, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
PLANTE & MORAN, PLLC
February 27, 2008 Auburn Hills, Michigan
CONSOLIDATED BALANCE SHEET DECEMBER 31, 2007 AND 2006 (000'S OMITTED, EXCEPT PER SHARE DATA)
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENT OF INCOME YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005 (000'S OMITTED)
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS END DECEMBER 31, 2007, 2006 AND 2005 (000'S OMITTED, EXCEPT PER SHARE DATA)
See notes to Consolidated Financial Statements
CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005 (000'S OMITTED, EXCEPT PER SHARE DATA)
See Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Farmers & Merchants Bancorp, Inc. (the Company) through its bank subsidiary, The Farmers & Merchants State Bank (the Bank) provides a variety of financial services to individuals and small businesses through its offices in Northwest Ohio and Northeast Indiana.
CONSOLIDATION POLICY
The consolidated financial statements include the accounts of Farmers & Merchants Bancorp, Inc. and its wholly-owned subsidiaries, The Farmers & Merchants State Bank (the Bank), a commercial banking institution, and the Farmers & Merchants Life Insurance Company, a reinsurance company for life, accident and health insurance for the Bank's consumer credits. The Farmers & Merchants Life Insurance Company was dissolved during 2007 with the Bank no longer offering the insurance product. All significant inter-company balances and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of mortgage servicing rights. Actual results could differ from those estimates.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral.
The Bank's loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent on local economic conditions in the agricultural industry.
While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. This includes cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased and sold for one day periods.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain average balances on hand with the Federal Reserve Bank. The aggregate reserve was $1.5 million for December 31, 2007 and it was $4.6 million for December 31, 2006.
The Company and its subsidiaries maintain cash balances with high quality credit institutions. At times such balances may be in excess of the federally insured limits.
SECURITIES
Debt securities are classified as available-for-sale. Securities available-for-sale are carried at fair value with unrealized gains and losses reported in other comprehensive income. Realized gains and losses on securities available for sale are included in other income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Gains and losses on sales of securities are determined on the specific-identification method.
Declines in the fair value of securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The related write-downs are included in earnings as realized losses.
FEDERAL HOME LOAN BANK AND FEDERAL RESERVE BANK STOCK
The Federal Home Loan Bank and Federal Reserve Bank stock are recorded at cost since they are restricted stocks. The Federal Home Loan Bank and Federal Reserve Bank sell and purchase their stock at par; therefore cost approximates market value. The Federal Home Loan Bank stock is held as collateral security for all indebtedness of the Bank to the Federal Home Loan Bank.
LOANS
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at the amount of unpaid principal, reduced by unearned discounts and deferred loan fees and costs, as well as, by the allowance for loan losses. Interest income is accrued on a daily basis based on the principal outstanding.
Generally, a loan is classified as nonaccrual and the accrual of interest income is generally discontinued when a loan becomes ninety days past due as to principal or interest and these loans are placed on a "cash basis" for purposes of income recognition. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal and accrued interest, and the loan is in the process of collection. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest receivable is charged against income.
Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized as a net adjustment to the related loan's yield. The Bank is generally amortizing these costs over the contractual life of such loans.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for loan losses charged to income. Loans deemed to be uncollectable and changes in the allowance relating to impaired loans are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based on management's periodic review of the collectability of the loans in light of historical experiences, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. The unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer loans for impairment disclosures.
LOANS HELD FOR SALE
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.
SERVICING ASSETS
Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest expense in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum. Fees received for servicing loans owned by investors are based on a percentage of the outstanding monthly principal balance of such loans and are included in operating income as loan payments are received. Costs of servicing loans are charged to expense as incurred.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified.
Other intangible assets consist of core deposit intangible assets arising from business acquisitions. They are initially measured at fair value and then are amortized on a straight line method over their estimated useful lives.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OFF BALANCE SHEET INSTRUMENTS
In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.
BANK PREMISES AND EQUIPMENT
Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is based on the estimated useful lives of the various properties and is computed using straight line and accelerated methods. Costs for maintenance and repairs are charged to operations as incurred. Gains and losses on dispositions are included in current operations.
FEDERAL INCOME TAX
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the various temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
EARNINGS PER SHARE
Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Basic and dilutive earnings per share are the same as the restricted stock grants are primarily anti-dilutive.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.
The components of other comprehensive income and related tax effects are as follows:
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS 157, "Fair Value Measurement." This statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. This Statement applies to other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company has not determined the impact the adoption of SFAS 157 will have on the financial statements.
In September 2006, the FASB ratified the Emerging Issues Task Force's (EITF) Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, which requires companies to recognize a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee extending to postretirement periods. The liability should be recognized based on the substantive agreement with the employee. This Issue is effective beginning January 1, 2008. The Issue can be applied as either a change in accounting principle through a cumulative- effect adjustment to retained earnings as of the beginning of the year of adoption, or a change in accounting principle through retrospective application to all periods. The Company is in the process of evaluating the impact the adoption of Issue 06-4 will have on the financial statements.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATION
Certain amounts in the 2006 and 2005 consolidated financial statements have been reclassified to conform with the 2007 presentation.
The Company's Board of Directors declared a 4 for 1 stock split effective May 12, 2006. Therefore, all references in the financial statements and other disclosures related to the number of shares and per share amounts of the Company's stock have been retroactively restated to reflect the increased number of shares outstanding.
NOTE 2 - BUSINESS COMBINATION
On December 31, 2007, the Bank acquired 100% of the outstanding shares of Knisely Bank. Knisely Bank was merged with and into the Bank, and the Knisely Bank offices now operate as branches of the Bank. The merger enabled the Company to increase its market share in a community contiguous to its existing markets.
The aggregate acquisition cost of Knisely Bank was $10.4 million, which was all paid in cash. Direct acquisition costs approximated $155 thousand. The acquisition cost in excess of the net assets and identifiable intangible assets acquired, has been recorded as goodwill of $4 million. Goodwill that is deductible for tax purposes is approximately $3.85 million. Minor adjustments to the total purchase price allocation, and thus goodwill, are possible as fair value allocations are finalized and final billings related to the acquisition are received.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed on December 31, 2007:
NOTE 2 - BUSINESS COMBINATION (CONTINUED)
In connection with the acquisition, the Company recognized core deposit intangible assets of $1.1 million, which are being amortized on a straight line basis over the estimated remaining economic useful life of the deposits of 7 years. There was no amortization of the core deposit intangibles for the year ended December 31, 2007. Amortization of the core deposit intangibles is scheduled to be as follows:
The consolidated statements of income include the results of Knisely Bank since the effective date of the acquisition. The following table presents pro forma information for the years ended December 31, 2007, 2006 and 2005 as if the acquisition had been completed as of the beginning of the years presented. The pro forma financial information is not necessarily indicative of the results of operations as they would have been, had the transaction been in effect on the assumed dates.
* Knisely Bank was a Subchapter S Corporate filer. The Net Income has been adjusted using a 34% tax rate.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities, with gross unrealized gains and losses, follows:
NOTE 3 - SECURITIES (CONTINUED)
Information pertaining to securities with gross unrealized losses at December 31, 2007 and 2006, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
Unrealized losses on securities have not been recognized into income because the issuers' bonds are of high credit quality, the Bank has the intent and ability to hold the securities for the foreseeable future, and the decline in fair value is primarily due to increased market interest rates. The fair value is expected to recover as the bonds approach the maturity date.
The gross realized gains and losses for the years ended December 31, are presented below:
NOTE 3 - SECURITIES (CONTINUED)
The amortized cost and fair value of debt securities at December 31, 2007, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investments with a carrying value and fair value of $161.9 million at December 31, 2007 and $142.9 million at December 31, 2006 were pledged to secure public deposits and securities sold under repurchase agreements.
Other securities as of December 31, 2007, include Federal Home Loan Bank and Federal Reserve Bank stock. December 31, 2006, included only Federal Home Loan Bank stock.
NOTE 4 - LOANS
Loans at December 31 are summarized below:
NOTE 4 - LOANS (CONTINUED)
The following is a maturity schedule by major category of loans including available for sale loans:
The distribution of fixed rate loans and variable rate loans by major loan category is as follows as of December 31, 2007:
One to four family residential mortgage loans amounting to $80.4 million have been pledged as security for loans the Bank has received from the Federal Home Loan Bank.
As of December 31, 2007 and 2006 there were $23.4 and $10.6 million, respectively, of undisbursed loans in process.
The following is an analysis of the allowance for credit losses:
The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two reserves: The ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total Allowance for Credit Losses (ACL).
NOTE 4 - LOANS (CONTINUED)
The AULC is reported within other liabilities on the balance sheet while the ALLL is netted within the loans, net asset line. The ACL presented above represents the full amount of reserves available to absorb possible credit losses.
The following is a summary of information pertaining to impaired loans:
No additional funds are committed to be advanced in connection with impaired loans.
NOTE 5 - PREMISES AND EQUIPMENT
The major categories of banking premises and equipment and accumulated depreciation at December 31 are summarized below:
NOTE 6 - SERVICING
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others were $252 and $251 million at December 31, 2007 and 2006, respectively.
The balance of capitalized servicing rights included in other assets at December 31, 2007 and 2006, was $1.9 and $1.8 million, respectively. The capitalized addition of servicing rights is included in net gain on sale of loans on the consolidated statement of income. The capitalized additions are as shown in the table following.
The fair market value of the capitalized servicing rights as of December 31, 2007 and 2006 was $2.4 and $2.2 million, respectively. The valuations were completed by stratifying the loans into like groups based on loan type, term and new versus seasoned. Impairment was measured by estimating the fair value of each stratum, taking into consideration an estimated level of prepayment based upon current market conditions. An average constant prepayment rate of 8.9 and 10.0 were utilized for 2007 and 2006, respectively. All stratums showed positive values compared to carrying value using a discount yield of 8.2% for 2007 and 8.5% for 2006.
The following summarizes mortgage servicing rights capitalized and amortized during each year:
NOTE 7 - DEPOSITS
Time deposits at December 31 consist of the following:
At December 31, 2007 the scheduled maturities for time deposits are as follows:
NOTE 8 - SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
The Bank's policy requires qualifying securities to be used as collateral for the underlying repurchase agreements. As of December 31, 2007 and 2006 securities with a book value of $64.3 million and $45.6 million, respectively, were underlying the repurchase agreements and were under the Bank's control.
NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES
Long term debt consists of various loans from the Federal Home Loan Bank. Repayment structures vary, ranging from monthly installments, annual payments or upon maturity. Interest payments are due monthly with interest rates on the loans varying from 2.92% to 7.05%. Total borrowings were $31.8 and $23.0 million for 2007 and 2006, respectively. Notes are secured by a blanket lien on 100% of the one to four family residential mortgage loan portfolios (Note 4).
The following is a schedule by years of future minimum principal payments:
NOTE 10 - FEDERAL INCOME TAXES
The components of income tax expense for the years ended December 31 are as follows:
The following is a reconciliation of the statutory federal income tax rate to the effective tax rate:
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities at December 31 are comprised of the following:
NOTE 11 - EMPLOYEE BENEFIT PLAN
The Bank has established a 401(k) profit sharing plan, which allows eligible employees to save at a minimum one percent of eligible compensation on a pre-tax basis, subject to certain Internal Revenue Service limitations. The Bank will match 50% of employee 401(k) contributions up to four percent of total eligible compensation. In addition, the Bank may make a discretionary contribution from time to time. A participant is 100% vested in the participant's deferral contributions and employer matching contributions. A six-year vesting schedule applies to employer discretionary contributions. Contributions to the 401(k) profit sharing plan for both the employer matching contribution and the discretionary contribution were $575, $611, and $608 thousand for 2007, 2006 and 2005, respectively.
The Company has a Long-Term Stock Incentive Plan under which 8,000 shares of restricted stock were issued to 44 employees during 2007, 6,000 shares were issued to 40 employees during 2006 and 4,000 shares were issued to 38 employees during 2005. Under the plan, the shares vest 100% in three years. Due to employee termination, there were 740 shares forfeited during 2007, 200 shares forfeited during 2006 and 80 shares forfeited during 2005. During 2007, 600 shares had vesting accelerated and were paid to a retiring officer. Compensation expense applicable to the restricted stock totaled $104, $60 and $14 thousand for the year ended December 31, 2007, 2006 and 2005, respectively.
NOTE 12 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to senior officers and directors and their affiliated companies amounting to $21.3 and $20.9 million at December 31, 2007 and 2006, respectively. Loans made during 2007 were $117.9 million and repayments were $117.5 million. Their difference in related borrowings amounted to $409 thousand, net addition. Deposits of directors, executive officers and companies in which they have a direct or indirect ownership as of December 31, 2007 and 2006 amounted to $28.2 million and $27.6 million, respectively.
In 2007, one director resigned from the Board and an executive officer also retired. During 2005, two directors retired from the Board and two directors were added.
NOTE 13 - OFF BALANCE SHEET ACTIVITIES
CREDIT RELATED FINANCIAL INSTRUMENTS
The Bank is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing need of its customer. These financial instruments include commitments to
extend credit, Standby Letters of Credit and Commercial Letters of Credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Bank's exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance-sheet instruments. At year end 2004 the Bank segregated the Allowance for Loan Losses into two components. The allowance as it relates to unfunded loan commitments (AULC) is included under other liabilities. The AULC as of December 31, 2007 and 2006 was $156 thousand and $168 thousand, respectively. At December 31, 2007 and 2006, the following financial instruments were outstanding whose contract amounts represent credit risk:
Commitments to extend credit, credit card arrangements and Standby Letters of Credit all include exposure to some credit loss in the event of nonperformance of the customer. The Bank's credit policies and procedures for credit commitments and financial guarantees are the same as those for extensions of credit that are recorded in the financial statements. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they generally do not present any significant liquidity risk to the Bank.
COLLATERAL REQUIREMENTS
To reduce credit risk related to the use of credit-related financial instruments, the Bank might deem it necessary to obtain collateral. The amount and nature of the collateral obtained is based on the Bank's credit evaluation of the customer. Collateral held varies but may include cash, securities, accounts receivable, inventory, property, plant, and real estate.
LEGAL CONTINGENCIES
Various legal claims also arise from time to time in the normal course of business, which, in the opinion of management, will have no material effect on the Company's consolidated financial statements.
NOTE 14 - MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of: total risk-based capital and Tier I capital to risk-weighted assets (as defined in the regulations), and Tier I capital to adjusted total assets (as defined). Management believes, as of December 31, 2007, that the Bank meets all the capital adequacy requirements to which it is subject.
NOTE 14 - MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
As of December 31, 2007 the most recent notification from the FDIC indicated the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To remain categorized as well capitalized, the Bank will have to maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as disclosed in the table to follow. There are no conditions or events since the most recent notification that management believes have changed the Bank's prompt corrective action category.
The Company and the Bank's actual and required capital amounts and ratios as of December 31, 2007 and 2006 are as follows:
NOTE 15 - RESTRICTIONS OF DIVIDENDS & INTER-COMPANY BORROWINGS
The Bank is restricted as to the amount of dividends that can be paid. Dividends declared by the Bank that exceed the net income for the current year plus retained income for the preceding two years must be approved by federal and state regulatory agencies. Under this formula dividends of $10.55 million may be paid without prior regulatory approval. Regardless of formal regulatory restrictions, the Bank may not pay dividends that would result in its capital levels being reduced below the minimum requirements shown above. Under current Federal Reserve regulations, the Bank is limited as to the amount and type of loans it may make to the Company and its non-bank subsidiary. These loans are subject to qualifying collateral requirements on which the amount of the loan may be based.
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of financial instruments are management's estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including deferred tax assets, premises, equipment and intangibles. Further, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates.
The estimated fair values, and related carrying or notional amounts, for on and off-balance sheet financial instruments as of December 31, 2007 and 2006 are reflected below.
The following assumptions and methods were used in estimating the fair value for financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amounts reported in the balance sheet for cash, cash equivalents and federal funds sold approximate their fair values. Also included in this line item are the carrying amounts of interest-bearing
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
deposits maturing within ninety days which approximate their fair values. Fair values of other interest-bearing deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.
SECURITIES AND OTHER SECURITIES
Fair values for securities, excluding Federal Home Loan Bank stock and Federal Reserve Bank stock, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank and the Federal Reserve Bank.
LOANS
Most commercial and real estate mortgage loans are made on a variable rate basis. For those variable-rate loans that reprice frequently, and with no significant change in credit risk, fair values are based on carrying values. The fair values of the fixed rate and all other loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The loans which were added to the balance sheet for the December 31, 2007 acquisition were valued
separately by an independent third party. A fair value adjustment of $13 thousand discount was applied to outstanding balances of $32.3 million.
LOANS HELD FOR SALE
Fair values for loans held for sale approximate the carrying values as these loans are generally sold within forty-five days of being made.
DEPOSITS
The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date. Fair value for fixed-rate certificates of deposit are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
BORROWINGS
Short-term borrowings are carried at cost that approximates fair value. Other long-term debt was generally valued using a discounted cash flow analysis with a discounted rate based on current incremental borrowing rates for similar types of arrangements, or if not available, based on an approach similar to that used for loans and deposits.
ACCRUED INTEREST RECEIVABLE AND PAYABLE
The carrying amounts of accrued interest approximate their fair values.
DIVIDENDS PAYABLE
The carrying amounts of dividends payable approximate their fair values and are generally paid within forty days of declaration.
OFF BALANCE SHEET FINANCIAL INSTRUMENTS
Fair values for off-balance-sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.
NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
BALANCE SHEET
STATEMENT OF INCOME
NOTE 17 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (CONTINUED)
STATEMENTS OF CASHFLOWS
(000S OMITTED EXCEPT PER SHARE DATA)
Quarterly Financial Data - UNAUDITED
ITEM 9.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTING AND FINANCIAL DISCLOSURE
No disagreements exist on accounting and financial disclosures or related matters.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Management Report Regarding Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of December 31, 2007, pursuant to Exchange Act 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2007, in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings.
MANAGEMENT REPORT REGARDING INTERNAL CONTROL AND COMPLIANCE WITH DESIGNATED LAWS AND REGULATIONS
Management of Farmers & Merchants Bancorp, Inc. and Subsidiaries is responsible for preparing the Bank's annual financial statements. Management is also responsible for establishing and maintaining internal control over financial reporting presented in conformity with both generally accepted accounting principles and regulatory reporting in conformity with the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income (call report instructions). The Bank's internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
It is also management's responsibility to ensure satisfactory compliance with all designated laws and regulations and in particular, those laws and regulations concerning loans to insiders. The federal laws concerning loans to insiders are codified at 12 USC 375a and 375b, and the federal regulations are set forth at 12 CFR 23.5, 31, and 215.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Intergrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.
There was no change in the company's internal control over financial reporting that occurred during the Company's fiscal quarter ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
February 21, 2008
Farmers & Merchants Bancorp, Inc. and Subsidiaries
/s/ Paul S. Siebenmorgen - ----------------------------------------------- Paul S. Siebenmorgen, President/CEO
/s/ Barbara J. Britenriker - ----------------------------------------------- Barbara J. Britenriker, Chief Financial Officer
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
BOARD OF DIRECTORS
The information called for herein is presented below:
(1) Mr. Crossgrove discontinued full time employment from The Farmers & Merchants State Bank as of December 31, 2006. He remains Chairman of the Corporation and The Farmers & Merchants State Bank.
(2) Mr. Planson was appointed to the Board of Directors of the Company and The Farmers & Merchants State Bank on January 10, 2008.
(3) David P Rupp Jr. is an attorney with membership in the law firm of Plassman, Rupp, Short & Hagans of Archbold, Ohio. The law firm has been retained by the Corporation, and its subsidiaries, during the past twenty years and is to be retained currently.
(4) Mr. Siebenmorgen became the President and CEO of the Corporation and the Bank effective February 18, 2005. From June, 2004 to February 18, 2005 he was Senior Executive Vice President and Chief Lending Officer of the Bank and was not a member of the Board of Directors of the Corporation or the Bank. Prior to joining the Corporation in June 2004 Mr. Siebenmorgen was Senior Vice President of Lincoln Bank, Plainfield, Indiana.
EXECUTIVE OFFICERS
The information called for under Rule 405 of Regulation S-K regarding compliance with Section 16(a) is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on April 17, 2008, and is incorporated herein by reference.
The Board of Directors of the Company adopted a Code of Business Conduct and Ethics (the "Code") at its meeting on February 13, 2004. While the Sarbanes-Oxley Act of 2002 mandates the adoption of a code of ethics for the most senior executive officers of all public companies, the Code adopted by the Corporation's Board of Directors is broader in the activities covered and applies to all officers, directors and employees of the Corporation and the Bank, including the chief executive officer, chief financial officer, principal accounting officer and other senior officers performing accounting, auditing, financial management or similar functions. The administration of the Code has been delegated to the Audit Committee of the Board of Directors, a Committee comprised entirely of "independent directors." The Code addresses topics such as compliance with laws and regulations, honest and ethical conduct, conflicts of interest, confidentiality and protection of Corporation assets, fair dealing and accurate and timely periodic reports, and also provides for enforcement mechanisms. The Board and management of the Corporation intends to continue to monitor not only the developing legal requirements in this area, but also the best practices of comparable companies, to assure that the Corporation maintains sound corporate governance practices in the future.
A copy of the Corporation's Code is available on the website of the Bank (www.fm-bank.com). In addition, a copy of the Code is available to any shareholder free of charge upon request. Shareholders desiring a copy of the Code should address written requests to Mr. Paul S. Siebenmorgen, President, Chief Executive Officer and Treasurer of Farmers & Merchants Bancorp, Inc., 307-11 North Defiance Street, Archbold, Ohio 43502, and are asked to mark Code of Business Conduct and Ethics on the outside of the envelope containing the request.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on April 17, 2008, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held Saturday, April 17, 2008, and is incorporated herein by reference.
On April 23, 2005 the Company's shareholders approved the Farmers & Merchants Bancorp, Inc. 2005 Long-Term Stock Incentive Plan. The plan authorizes the issuance of up to 800,000 of the Company's common shares in the form of stock options, restricted stock, performance shares, and unrestricted stock to employees of the Company and its subsidiaries. During 2005, 4,000 shares of restricted stock were issued under the plan to 38 employees of the Bank. These grants will become completely vested in three years. Due to employee termination, there were 80 shares forfeited during 2005. During 2006, the Company purchased 42,000 shares and awarded 6,100 restricted shares to 41 employees. 200 shares were forfeited during 2006. 8,760 shares of restricted stock were issued to 46 employees during 2007. Due to employee termination, 740 shares were forfeited during 2007. 600 shares had vesting accelerated and were paid to a retiring officer. At year end, the Company held 256,160 shares in Treasury stock and 17,240 in unearned stock awards. The Company initiated a 4:1 stock split on May 12, 2006.
EQUITY COMPENSATION PLAN INFORMATION
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on April 17, 2008, and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on April 17, 2008, and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES
(a) The Following documents are filed as part of this report:
(1) Financial Statements (included in this 10-K under item 8) Report of Independent Accountants
Consolidated Balance Sheets Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows Note to Consolidated Financial Statements
(2) Financial Statement Schedules Five Year Summary of Operations
(3) Exhibits Required by Item 601 of Regulation S-K
(3.1) a. Articles of Incorporation are incorporated by reference to the Company's Quarterly Report on Form 10-Q that was filed with the Commission on May 10, 2004
b. Amendment to Articles of Incorporation, incorporated by reference to the Company's Current Report on Form 8-K that was filed with the Commission on April 26, 2006.
(3.2) Code of Regulations are incorporated by reference to the Company's Quarterly Report on Form 10-Q that was filed with the Commission on May 10, 2004.
(10.1) Change in Control Agreement executed by and between the Company and Paul S. Siebenmorgen on November 27, 2007(incorporated by reference to the Current Report on Form 8-K filed with the Commission on November 30, 2007).
(10.2) Change in Control Agreement executed by and between the Company and Barbara J. Britenriker on November 27, 2007 (incorporated by reference to the Current Report on Form 8-K filed with the Commission on November 30, 2007).
(10.3) Change in Control Agreement executed by and between the Company and Edward A. Leininger on November 27, 2007 (incorporated by reference to the Current Report on Form 8-K filed with the Commission on November 30, 2007).
(10.4) Change in Control Agreement executed by and between the Company and Rex D. Rice on November 27, 2007 (incorporated by reference to the Current Report on Form 8-K filed with the Commission on November 30, 2007).
(10.5) 2005 Long-Term Stock Incentive Plan (incorporated by reference to the Quarterly Report on Form 10-Q filed with the Commission on October 27, 2005)
(10.6) Form of Restricted Stock Agreement (incorporated by reference to the Quarterly Report on Form 10-Q filed with the Commission on October 27, 2005)
(21) Subsidiaries of Farmers & Merchants Bancorp, Inc.
(31.1) Certification of the Chief Executive Officer Required under Rule 13(a)-14(a)/15d-14(a)
(31.2) Certification of the Chief Financial Officer Required under Rule 13(a)- 14(a)/15d-14(a)
(32.1) Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(32.2) Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
FARMERS & MERCHANTS BANCORP, INC
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934. The registrant has duly signed this report to be signed on its behalf by the undersigned, her unto duly authorized
Date: February 27, 2008 By: /s/ Paul S. Siebenmorgen ------------------------------------ Paul S. Siebenmorgen Chief Executive Officer Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Paul S Siebenmorgen Date : February 27, 2008 - ------------------------------------- Paul S Siebenmorgen Chief Executive Officer (Principal Executive Officer)
/s/ Joe E. Crossgrove Date : February 27, 2008 - ------------------------------------- Joe E. Crossgrove Director & Chairman
/s/ Anthony J. Rupp Date : February 27, 2008 - ------------------------------------- Anthony J. Rupp, Director
/s/ David P. Rupp Jr. Date : February 27, 2008 - ------------------------------------- David P. Rupp Jr, Director
/s/ James Saneholtz Date : February 27, 2008 - ------------------------------------- James Saneholtz, Director
/s/ Merle J. Short Date : February 27, 2008 - ------------------------------------- Merle J. Short, Director
/s/ Dexter Benecke Date : February 27, 2008 - ------------------------------------- Dexter Benecke, Director
/s/ Steven Planson Date : February 27, 2008 - ------------------------------------- Steven Planson, Director
/s/ Barbara J. Britenriker Date : February 27, 2008 - ------------------------------------- Barbara J. Britenriker Chief Financial Officer (Principal Financial Officer/ Principal Accounting Officer
/s/ Jack C. Johnson Date : February 27, 2008 - ------------------------------------- Jack C. Johnson, Director
/s/ Dean E. Miller Date : February 27, 2008 - ------------------------------------- Dean E. Miller, Director
/s/ Steven A. Everhart Date : February 27, 2008 - ------------------------------------- Steven A. Everhart, Director
/s/ Kevin J. Sauder Date : February 27, 2008 - ------------------------------------- Kevin J. Sauder, Director
/s/ Robert G. Frey Date : February 27, 2008 - ------------------------------------- Robert G. Frey , Director
/s/ Steven J. Wyse Date : February 27, 2008 - ------------------------------------- Steven J. Wyse, Director