United States

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

      For the quarterly period ended September 30, 2004

      or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

      For the transition period from ___________ to ___________

 

Commission File Number:  _0-10972_

First Farmers and Merchants Corporation

(Exact name of registrant as specified in its charter)

Tennessee

62-1148660

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

   

                  816 South Garden Street

Columbia, Tennessee

38402 - 1148

(Address of principal executive offices)

(Zip Code)

(931) 388-3145

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                      Yes   X     No      

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   Yes  __X__    No  _____

     Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  5,840,000 shares as of October 22, 2004



PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements.

The following unaudited consolidated financial statements of the Registrant and its subsidiary are included in this Report:

Consolidated balance sheets - September 30, 2004, and December 31, 2003.

Consolidated statements of income - For the three months and nine months ended September 30, 2004, and September 30, 2003.

Consolidated statements of cash flows - For the nine months ended September 30, 2004, and September 30, 2003.

Selected notes to consolidated financial statements.



FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 

 

 

September 30,

 

December 31,

(Dollars in Thousands)

2004

2003

 

(Unaudited)

(1)

ASSETS

Cash and due from banks

$

    45,119

$

     26,137

Interest-bearing deposits in banks

 

         298

         297

Federal funds sold

 

   -

     12,000

              Total cash and cash equivalents

    45,417

     38,434

Securities

    Available for sale (amortized cost $239,538

 

         and $243,038 respectively)

  242,523

   249,653

    Held to maturity (fair value $81,028

 

 

         and $84,199 respectively)

    76,810

     79,138

              Total securities

  319,333

   328,791

Loans, net of deferred fees

  443,231

   424,504

    Allowance for possible loan losses

    (8,752)

    (10,123)

              Net loans

  434,479

   414,381

Bank premises and equipment, at cost

 

         less allowance for depreciation

    12,691

     12,997

Core deposit and other intangibles

    12,251

     13,042

Other assets

 

    23,270

     21,168

            TOTAL ASSETS

$

847,441

$

   828,813

 

 

 

LIABILITIES

Deposits

 

 

     Noninterest-bearing

$

  127,754

$

   112,334

     Interest-bearing (including certificates of deposit

 

          over $100,000:  2004 - $82,690; 2003 - $71,968)

  592,208

   604,099

            Total deposits

  719,962

   716,433

Federal funds purchased and securities sold

 

           under agreements to repurchase

    15,241

       1,820

Dividends payable

   -

       1,635

Other short term liabilities

         623

         648

Accounts payable and accrued liabilities

      6,642

       5,992

            TOTAL LIABILITIES

 

  742,468

   726,528

 

SHAREHOLDERS'

Common stock - $10 par value, 8,000,000 shares

EQUITY

        authorized;  issued and outstanding -

 

 

        5,840,000

    58,400

     58,400

Additional paid-in capital

      4,320

       4,320

Retained earnings

    40,428

     35,498

Accumulated other comprehensive income

      1,825

       4,067

            TOTAL SHAREHOLDERS' EQUITY

  104,973

   102,285

 

 

            TOTAL LIABILITIES AND

 

                SHAREHOLDERS' EQUITY

$

  847,441

$

   828,813

      (1)  Derived from audited financial statements.

The accompanying notes are an integral part of the consolidated financial statements.

 

 



FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

 

 

 

 

 

 

 

(Dollars In Thousands Except Per Share Data)

Three Months Ended

Nine Months Ended

(Unaudited)

 

September 30,

 

September 30,

 

2004

 

2003

 

2004

 

2003

 

INTEREST INCOME

Interest and fees on loans

$

   6,203

$

     7,054

$

18,078

$

   22,080

Income on investment securities

 

 

 

 

     Taxable interest

   2,497

 

     2,643

   7,871

 

     8,286

     Exempt from federal income tax

      652

 

       644

   1,908

 

     2,106

     Dividends

        30

 

         27

      185

 

       102

   3,179

 

     3,314

   9,964

 

   10,494

Other interest income

          7

 

         56

        63

 

       185

    TOTAL INTEREST INCOME

   9,389

 

   10,424

28,105

 

   32,759

 

 

 

INTEREST EXPENSE

Interest on deposits

   2,054

 

     2,670

   6,300

 

     8,966

Interest on other short term borrowings

 

        25

 

           3

 

        36

 

         18

      TOTAL INTEREST EXPENSE

   2,079

 

     2,673

   6,336

 

     8,984

 

 

            NET INTEREST INCOME

   7,310

 

     7,751

21,769

 

   23,775

PROVISION FOR POSSIBLE LOAN LOSSES

           -

 

         40

     (677)

 

       800

      NET INTEREST INCOME AFTER

 

 

 

 

 

 

           PROVISION FOR LOAN LOSSES

   7,310

 

     7,711

22,446

 

   22,975

 

 

 

NONINTEREST  INCOME

Trust department income

      522

 

       447

   1,579

 

     1,356

Service fees on deposit accounts

   1,852

 

     1,806

   5,433

 

     5,394

Other service fees, commissions, and fees

        92

 

       132

      302

 

       362

Other operating income

      202

 

       (48)

      830

 

       101

Securities gains

           -

 

           -

      917

 

           -

      TOTAL NONINTEREST  INCOME

   2,668

 

     2,337

   9,061

 

     7,213

 

 

 

 

 

NONINTEREST  EXPENSES

Salaries and employee benefits

3,808

     3,913

11,849

   11,280

Net occupancy expense

      582

 

       602

   1,700

 

     1,629

Furniture and equipment expense

 

      302

 

       301

 

      962

 

     1,012

Other operating expenses

   2,515

 

     2,521

 

   7,725

 

     7,793

      TOTAL NONINTEREST EXPENSES

   7,207

 

     7,337

22,236

 

   21,714

           INCOME BEFORE PROVISION FOR

                 INCOME TAXES

   2,771

 

     2,711

   9,271

 

     8,474

PROVISION FOR INCOME TAXES

      859

       625

   2,646

     2,119

 

 

              NET INCOME

$

   1,912

$

     2,086

$

   6,625

$

     6,355

 

 

 

 

 

EARNINGS PER SHARE   (1)

Common stock

      5,840,000 shares outstanding

$

     0.33

$

      0.36

$

     1.13

$

      1.09

(1)  Per share data  has been restated to give retroactive effect to the two-for-one stock split effected as a stock dividend declared on April 20, 2004.

The accompanying notes are an integral part of the consolidated financial statements.

 

 



 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY                

CONSOLIDATED STATEMENTS OF CASH FLOWS                 

 

 

(Dollars In Thousands)

Nine Months Ended

(Unaudited)

September 30,

 

2004

 

2003

 

 

 

 

OPERATING

   Net income

$

      6,625

$

     6,355

ACTIVITIES

   Adjustments to reconcile net income to net cash provided

 

 

     by operating activities

 

       Excess (deficiency) of provision for possible

 

 

          loan losses over net charge offs

 

    (1,372)

      (373)

       Provision for depreciation and amortization of

 

 

          premises and equipment

 

         908

       982

       Amortization of deposit base intangibles

 

         792

       960

       Amortization of investment security premiums,

 

 

          net of accretion of discounts

 

      2,095

     1,935

       Securities gains

 

       (917)

           -

       Increase in cash surrender value of life insurance contracts

 

       (329)

      (328)

       (Increase) decrease in

 

 

              Deferred income taxes

 

         376

         25

              Interest receivable

 

         360

       759

              Other assets

 

       (852)

       281

       Increase (decrease) in

 

 

          Interest payable

 

       (105)

      (396)

          Other liabilities

 

         755

       413

               Total Adjustments

 

      1,711

     4,258

               Net cash provided by operating activities

 

      8,336

   10,613

 

 

INVESTING

   Proceeds from maturities, calls, and sales of

ACTIVITIES

      available-for-sale securities

    29,956

   36,581

   Proceeds from maturities and calls of held-to-maturity securities

 

    18,872

   21,655

   Purchases of investment securities

 

 

      Available-for-sale

 

  (27,587)

(71,963)

      Held-to-maturity

 

  (16,609)

           -

   Net (increase) decrease in loans

 

  (18,726)

   64,708

   Purchases of premises and equipment

 

       (602)

      (723)

   Purchase of single premium life insurance contracts

 

       (253)

      (190)

               Net cash provided by (used by) investing activities

 

  (14,949)

   50,068

 

 

FINANCING

   Net increase (decrease) in noninterest-bearing and interest-bearing deposits

      3,529

(43,215)

ACTIVITIES

   Net increase in short term borrowings

 

    13,396

       182

   Cash dividends

 

    (3,329)

   (3,183)

               Net cash provided by (used by) financing activities

 

    13,596

(46,216)

 

 

               Increase in cash and cash equivalents

 

      6,983

   14,465

               Cash and cash equivalents at beginning of period

 

    38,434

   51,701

               Cash and cash equivalents at end of period

$

    45,417

$

   66,166

      The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - OTHER INFORMATION

The unaudited consolidated financial statements have been prepared on a consistent basis and in accordance with the instructions to Form 10-Q and do not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments considered necessary for a fair presentation have been included.  These adjustments were of a normal, recurring nature and consistent with generally accepted accounting principles.  For further information, refer to the consolidated financial statements and notes included in the Corporation's annual report on Form 10-K for the year ended December 31, 2003.

NOTE 2 - STOCK DIVIDEND

At the Annual Shareholders' Meeting on April 20, 2004, the Corporation announced a two-for-one stock split effected as a 100% stock dividend payable to shareholders of record as of April 20, 2004.  The Corporation issued an additional share of common stock for each share of common stock outstanding, which resulted in 5,840,000 shares of common stock issued and outstanding at a par value of $10 per share.  The transaction was recorded as a transfer from retained earnings to common stock in the amount of $29,200,000 ($10 for each additional share issued).  All per share and share data in the accompanying consolidated financial statements and footnotes have been restated to give retroactive effect to this transaction.

 

 

 

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report may not be based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as "believes," "expects," "may," "will," "pro forma" or "anticipates," or the negatives of such terms.  We caution you not to place undue reliance on such forward-looking statements in this report because results could differ materially from those anticipated due to a variety of factors.  These factors include, but are not limited to, changes in economic conditions; fluctuations in prevailing interest rates and the effectiveness of our risk monitoring systems; the ability of our borrowers to repay loans; adverse changes in our special mention credits; our ability to sell available-for-sale securities to fund increased loan demand; our ability to meet regulatory capital adequacy requirements; our ability to meet liquidity needs from operating activities; the accuracy of assumptions in our rate risk analysis; our ability to recognize deferred tax assets; our ability to maintain credit quality; our ability to provide market competitive products and services; laws and regulations affecting financial institutions in general; and other factors generally understood to affect the financial results of financial services companies.

EXECUTIVE OVERVIEW

At September 30, 2004, the Corporation's consolidated total assets were $847 million, its consolidated net loans were $434 million, its consolidated total deposits were $720 million, and its total shareholders' equity was $105 million.  During recent quarters, the Bank had experienced a decline in loan demand as a result of a slow local economy, evidenced by the closing of manufacturing plants and light commercial and industrial activity, and Bank credit quality initiatives.  Loan demand improved in the second quarter as local economic conditions strengthened and new loan products and marketing efforts were introduced.  The improvement in loan growth continued in the third quarter of 2004 with the loan portfolio increasing 5.5%.  Contributing to the Bank's loan growth were a substantial slowing in the runoff experienced during the last two fiscal years and the first quarter of 2004; an increased volume of direct loans booked, and a portfolio of loans purchased from another bank.  Average total deposits for the nine months ended September 30, 2004 were 5.8% lower than average deposits at December 31, 2003, with 16.1% of the total being non-interest bearing.  Shareholders' equity increased 2.6% compared to shareholders' equity at December 31, 2003.

MATERIAL CHANGES IN FINANCIAL CONDITION

Average earning assets for the nine months ended September 30, 2004 were down 4.4% from average earning assets at December 31, 2003.  Lower loan volume in the first quarter of 2004 reduced the nine months results, but as loan volume improved in the second and third quarters, overnight investment of excess funds declined.  At September 30, 2004, average net loans decreased 6.8% from December 31, 2003, which was lower than the decrease in average net loans of 11.7% at September 30, 2003 from December 31, 2002.  Average overnight investments were down $14.9 million or 65.2% at September 30, 2004 compared to December 31, 2003, which was attributable to the improved loan volume.  Average investment securities at September 30, 2004 increased 3.4% compared to the average at December 31, 2003.  Average total assets of $825 million at September 30, 2004 decreased 4.8% compared to $867 million at December 31, 2003.

 

 

 Securities

Available-for-sale securities are an integral part of the asset/liability management process for the Bank.  Accordingly, they represent an important source of liquidity available to fund loans and accommodate asset reallocation strategies dictated by changes in Bank operating and tax plans, shifting yield spread relationships and changes in configuration of the yield curve.  At September 30, 2004, the Bank's investment securities portfolio had $242.5 million available-for-sale securities and $76.8 million held-to-maturity securities compared to $249.7 million available-for-sale securities and $79.1 million held-to-maturity securities at December 31, 2003.  The $7.2 million, or 2.9%, decrease in available-for-sale securities resulted from not replacing maturing securities and a sale of securities to fund loans as the demand improved.  The Bank is likely to sell additional available-for-sale securities as funding for anticipated increased loan demand when needed.  The $2.3 million, or 2.9%, decrease in the held-to-maturity securities resulted from normal maturities in the portfolio not being replaced.

Loans

The loan portfolio is the largest component of earning assets for the Bank and, consequently, provides the highest amount of revenues for the Corporation.  The loan portfolio also contains, as a result of the possibility of unexpected deterioration in the credit quality of borrowers, the highest exposure to risk in the Bank's earning assets.  When analyzing potential loans, management assesses both interest rate objectives and credit quality objectives in determining whether to make a given loan and the appropriate pricing for that loan.  The loan portfolio is well diversified with loans generally secured by tangible personal property, real property or stock.  The loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrowers.  Collateral requirements for the loan portfolio are based on the credit worthiness of each borrower.  The analysis and review of asset quality by the Bank's credit administration includes a formal review that evaluates the adequacy of the allowance for possible loan losses.  This review is updated monthly and evaluated more completely on a quarterly basis in conjunction with loan review reports and management asset quality reports that are discussed in meetings with loan officers, loan administration and a Bank Board of Directors oversight committee.  This evaluation supported a reversal of specific allocations in the allowance during the second quarter of 2004 as a result of the resolution of certain problem loans associated with those specific allocations.  Credit quality continued to improve during the third quarter as indicated by declines in the volume of loans with past due payments and potential problem loans.  The allowance for possible loan and lease losses was $8.8 million or 1.97% of gross loans at September 30, 2004.  This compares to $10.1 million or 2.4% at December 31, 2003.  Net charge-offs for the nine months ended September 30, 2004 were $695,000, an annualized net charge-off ratio of 0.21% of gross loans.  This compares to net charge-offs for the nine months ended September 30, 2003 of $1.1 million, or an annualized net charge-off ratio of 0.36% of gross loans.  This improvement is another result of credit quality improvements and effective procedures for addressing problem loans.

Management has developed a process to provide control over underwriting of loans and to monitor the collectibility of loans.  This process includes education and training of lending personnel on the Bank's loan policies and procedures, credit analysts to support lenders in credit underwriting, timely identification of loans with adverse characteristics and control of corrective actions, and objective monitoring of loan reviews.  A Special Assets Department of the Bank identifies and monitors assets that need attention.  This process identified loans totaling $16.4 million, or 3.7% of the portfolio, at September 30, 2004 that were classified as special mention loans.  This compares to loans totaling $10.8 million, 2.5% of the portfolio, so classified at December 31, 2003, and $4.7 million, 1.1% of the portfolio, so classified at September 30, 2003.  Special mention loans are in a transitional rating and, while swings in the volume are not unexpected, the Bank expects improvement in these credits and other special mention credits as local market conditions continue to improve.  Loans totaling $10.9 million, 2.5% of the portfolio, were classified as substandard at September 30, 2004.  This compares to loans totaling $22.0 million, 5.2% of the portfolio, so classified at December 31, 2003 and $30.0 million, 6.9% of the portfolio, so classified at September 30, 2003.  Classified loans continued to improve in the third quarter of 2004.  Loans totaling $1.1 million, 0.2% of the portfolio, were classified as doubtful at September 30, 2004.  This compares to $1.9 million, 0.5% of the portfolio, so classified at December 31, 2003, and $1.5 million, 0.3% of the portfolio, so classified at September 30, 2003.  Loans having recorded investments of $6.3 million, 0.1% of the total portfolio, were identified as impaired at September 30, 2004 compared to $11.9 million at December 31, 2003, and $14.2 million at September 30, 2003.  These declines are a result of improved control over underwriting of loans, early detection of developing problem loans, and effective procedures for addressing problem loans.

There were write downs of other real estate associated with declines in real estate values subsequent to foreclosure and disposition of the properties at less than their carrying value during the nine months ended September 30, 2004 that were charged to current income.  The carrying value of other real estate is included in other assets on the balance sheet and represents real estate acquired through foreclosure, which is stated at the lower of cost or fair value minus cost to sell.  An allowance for other real estate owned is not maintained.  Any decreases or losses associated with the properties have been charged to current income.  Management evaluates properties included in this category on a regular basis.  The carrying value for other real estate at September 30, 2004, December 31, 2003, and September 30, 2003, totaled $0.97 million, $1.6 million, and $0.92 million, respectively.  The decrease during the nine months ended September 30, 2004 is another result of effective procedures for addressing problem loans.  The significant increase in the fourth quarter of 2003 was the foreclosure on one large property that was sold in the first quarter of 2004.

Deposits

            The Bank does not have any foreign offices and all deposits are serviced in its twenty domestic offices.  The Bank's average deposits declined 5.8% during the nine months ended September 30, 2004 compared to a decline of 3.0% during the same period in 2003.  The primary reason for this decrease is a Bank Asset/Liability Committee strategy to be less aggressive in bidding for short-term large dollar certificates of deposit.  Average total noninterest-bearing deposits were 16.2% of total deposits at September 30, 2004, contributing to the Bank's low cost of deposits.  This compares to 14.2% at December 31, 2003 and 13.9% at September 30, 2003.  This steady increase in noninterest-bearing deposits reflects the strength of the Bank's core deposit base and improving local economic conditions.

 

Regulatory Requirements for Capital

The Corporation and the Bank are subject to federal regulatory risk-adjusted capital adequacy standards.  Failure to meet capital adequacy requirements could result in certain mandatory and possibly additional discretionary actions by regulators that could have an adverse material effect on the consolidated financial statements of the Corporation and its subsidiary, the Bank.  The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  The capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

            Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of Total Capital and Tier I Capital to risk-weighted assets and of Tier I Capital to average assets.   Equity capital (net of certain adjustments for intangible assets and investments in non-consolidated subsidiaries and certain classes of preferred stock) are considered Tier 1 ("core") capital.  Tier 2 ("total") capital consists of core capital plus subordinated debt, some types of preferred stock and a defined percentage of the allowance for possible loan losses.  At September 30, 2004, the Corporation's total risk-based and core capital ratios were 19.6% and 18.4%, respectively.  The comparable ratios were 18.7% and 17.5% at December 31, 2003.  At September 30, 2004, the Bank's total risk-based and core capital ratios were 19.4% and 18.1%, respectively.  The comparable ratios were 18.5% and 17.2% at December 31, 2003.  At September 30, 2004, the Corporation and the Bank had a ratio of core capital to average total assets of 11.2% and 11.1%, respectively, compared to 10.3% and 10.2% at December 31, 2003.  Capital ratios for the Corporation and the Bank are different because of different dividend payments and additional assets held by the Corporation.  Management believes, at September 30, 2004, that the Corporation and the Bank met all capital adequacy requirements to which they are subject.

Liquidity and Capital Resources

            Most of the capital needs of the Bank have historically been financed with retained earnings and current deposit gathering, and the Corporation's primary source of liquidity is dividends declared by the Bank.  The Corporation and the Bank do not have any long-term debt and do not have major plans for capital expenditures in the near future.  The Corporation's average shareholders' equity at September 30, 2004 was $103.4 million, a 0.7% increase from $102.7 million at December 31, 2003.  The approval of the Office of the Comptroller of the Currency ("OCC") is required before the Bank's dividends in a given year may exceed the total of its net profit (as defined by the OCC) for the year, combined with retained net profits of the preceding two years.  At September 30, 2004, the Bank could have declared additional dividends of approximately $15.6 million, or $2.67 per share, without regulatory agency approval.  The Bank declared a $0.29 per share dividend, 0.11% of the allowable amount, in the second quarter of 2004.  Management believes that the Corporation's traditional sources of cash generated from the Bank's operating activities are adequate to meet the Corporation's liquidity needs for normal ongoing operations.

            The Bank maintains a formal asset and liability management process to control interest rate risk and assist management in maintaining reasonable stability in the gross interest margin as a result of changes in the level of interest rates and/or the spread relationships among interest rates.  The Bank uses an earnings simulation model to evaluate the impact of different interest rate scenarios on the gross margin.  Each month, the Asset/Liability Committee of the Bank monitors the relationship of rate sensitive earning assets to rate sensitive interest bearing liabilities (interest rate sensitivity), which is the principal factor used by the Bank's management in determining the effect that fluctuating interest rates will have on future net interest income.  Rate sensitive earning assets and interest bearing liabilities are financial instruments that can be repriced to current market rates within a defined time period.  A negative dollar change in net interest income for a twelve-month period of less than 4.5% of net interest income for any three hundred basis point shift in interest rates is considered an acceptable rate risk position.  The rate risk analysis for the twelve-month period beginning October 1, 2004 and ending September 30, 2005 showed a worst-case potential change to net interest income of a negative 1.7%, or a decline in net interest income of $532,000 based on facts currently available to management of the Bank.

Critical Accounting Policies

The accounting principles the Bank follows and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry.  In connection with the application of those principles, Bank management has made judgments and estimates which, in the case of the determination of the allowance for loan losses ("ALLL") and the recognition of deferred income tax assets, have been critical to the determination of the Bank's financial position, results of operations and cash flows.  During the nine months ended September 30, 2004, there was no significant change in the Corporation's critical accounting policies and no significant change in the application of critical accounting policies as presented in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2003.

Allowance for Loan Losses

           Management assesses the adequacy of the ALLL prior to the end of each month and prepares a more formal review each quarter to assess the risk in the Bank's loan portfolio.  This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance.  The ALLL represents calculated amounts for specifically identified credit exposure and exposures readily predictable by historical or comparative experience.  Even though this calculation considers specific credits, the entire allowance is available to absorb any credit losses.  There were no changes in methodology or developments in this calculation process during the third quarter of 2004

Deferred Income Tax Assets

Deferred income tax assets consist mainly of the tax effect of excess provisions for loan losses over actual losses incurred and deferred compensation.  Management believes that it is more likely than not that these assets will be realized in future years.  During the second quarter of 2004, the tax effect of excess provisions for loan losses over actual losses incurred declined as specific allocations associated with the resolution of certain problem loans, discussed above, were reversed.  The tax effect of unrealized gains on available-for-sale securities decreased as the market value of investment securities was less than the market value at December 31, 2003.  This decline reduced the deferred income tax liability associated with such gains and net deferred income tax assets increased.  There were not any material changes in deferred income tax assets in the third quarter of 2004.

Off-Balance Sheet Arrangements

            The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and stand-by letters of credit.  Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in those financial instruments.  The total outstanding loan commitments and stand-by letters of credit in the normal course of business at September 30, 2004 were $69 million and $5 million, respectively, and at December 31, 2003 were $64 million and $7 million, respectively.  Loan commitments are agreements to lend to a customer provided there is not a violation of any condition established in the contract.  Stand-by letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.  The credit risk involved in issuing letters of credit is essentially the same as that involved in making a loan.  At September 30, 2004 and December 31, 2003, the Corporation and the Bank did not have any off-balance sheet arrangements other than commitments to extend credit and stand-by letters of credit discussed earlier.

MATERIAL CHANGES IN RESULTS OF OPERATIONS

            Total interest income of $28.1 million for the nine months ended September 30, 2004, was 14.2% lower than the total interest income of $32.8 million for the nine months ended September 30, 2003.  Interest and fees earned on loans and investments are the components of total interest income.  Interest and fees earned on loans decreased 18.1%, from $22 million to $18 million, during the nine months ended September 30, 2004 as compared to the same period of 2003 as a result of the decrease in the volume of average loans during the nine months ended September 30, 2004, and lower interest rates on new loans.  Interest earned on investment securities and other investments decreased 6.1% during the nine months ended September 30, 2004 compared to the same period of 2003 as a result of lower interest yields on new purchases replacing higher yields on matauring securities. 

            Total interest expense of $6.3 million for the nine months ended September 30, 2004 decreased 29.5%, $2.6 million, compared to $9.0 million for the nine months ended September 30, 2003 as a result of the decrease in the volume of average deposits and reduced interest rates.  As a policy, budgeted financial goals are monitored on a monthly basis by the Bank's Asset/Liability Committee, which reviews the actual dollar change in net interest income given different interest rate movements.

            Net interest income of the Corporation on a fully taxable equivalent basis is influenced primarily by changes in:

(1)                the volume and mix of earning assets and sources of funding;

(2)                market rates of interest; and

(3)                income tax rates.

The impact of some of these factors can be controlled by management policies and actions.  External factors also can have a significant impact on changes in net interest income from one period to another.  Some examples of such factors are:

(1)                the strength of credit demands by customers;

(2)                Federal Reserve Board monetary policy; and

(3)                fiscal and debt management policies of the federal government, including changes in tax laws.

The net interest margin, on a tax equivalent basis, at September 30, 2004, December 31, 2003, and September 30, 2003 was 4.07%, 4.21%, and 4.26%, respectively.

            There was a $677,000 reversal of specific allocations in the allowance for loan and lease losses during the nine months ended September 30, 2004 as a result of the resolution of certain loans associated with the specific allowances.  This compares to an addition of $800,000 to the allowance during the nine months ended September 30, 2003.  While the Bank's credit quality has improved, continued efforts to achieve certain targeted credit quality goals are ongoing.  These continued efforts, coupled with continued economic uncertainity, supported the current level of the allowance at September 30, 2004.

            Noninterest income, not including a gain on the sale of available-for-sale securities of $917,000 and a gain on the sale of assets of $519,000, increased 5.7% from $7.6 million for the nine months ended September 30, 2004 compared to $7.2 million for the nine months ended September 30, 2003.  This increase resulted from:

(1)    Income from fiduciary services provided in the Bank's trust department which was up 16.5% compared to the nine months ended September 30, 2003 and represented approximately 20.7% of noninterest income; and

(2)    Service fees, approximately 71% of noninterest income, which increased 0.7% compared to the nine months ended September 30, 2003.

Noninterest expenses, excluding the provision for possible loan losses, were $22.2 million , or 2.4% more in the nine months ended September 30, 2004 than $21.7 million in the nine months ended September 30, 2003.  Salaries and benefits expense was up $569 thousand or 5.1% in this period as a result of an increased number of employees and standard increases in salaries.

Net income for the nine months ended September 30, 2004 was $6.6 million compared to $6.4 million for the nine months ended September 30, 2003.  This yielded $1.13 earnings per share for the nine months ended September 30, 2004 and $0.33 earnings per share for the third quarter of 2004, compared to $1.09 earnings per share for the nine months ended September 30, 2003 and $0.36 per share for the third quarter of 2003.

The Corporation and the Bank do not have any long-term debt or other material contractual obligations, with the exception of certain operating leases.  There has not been a change in these operating leases.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

During the nine months ended September 30, 2004, there were no material changes in quantitative and qualitative disclosures about market risk from those presented in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2003.

Item 4. Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures.  The Corporation carried out an evaluation, under the supervision and with the participation of management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's disclosure controls and procedures as of the end of the period covered by this report pursuant to Exchange Act Rule 13a-15.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Corporation (including the Corporation's consolidated subsidiaries) in reports that the Corporation files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported in a timely manner.

(b) Changes in Internal Control Over Financial Reporting.  There has been no change in the Corporation's internal control over financial reporting that occurred during the quarter ending September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting.

 

 


PART II - OTHER INFORMATION

Item 6.  Exhibits.

(a) List of Exhibits:

EXHIBIT

NUMBER          DESCRIPTION

 

3.1       Charter. (a)

3.2       Articles of Amendment to Charter. (a)

3.3       By-laws. (a)

3.4       Amendment to By-laws. (b)

4.1       Form of Specimen Stock Certificate. (a)

31.1      Certification of the Chief Executive Officer of First Farmers and Merchants Corporation Pursuant to Rule 13a-14(1) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2      Certification of the Chief Financial Officer of First Farmers and Merchants Corporation Pursuant to Rule 13a-14(1) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1      Certification of the Chief Executive Officer and Chief Financial Officer of First Farmers and Merchants Corporation Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(a)          Incorporated by reference from the First Farmers and Merchants Corporation Amendment No. 1 to the Annual Report on Form 10-K/A for the year ended December 31, 2003, File Number 0-10972, as filed with the Securities and Exchange Commission on May 7, 2004.

(b)        Incorporated by reference from the First Farmers and Merchants Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, File Number 0-10972.

 

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

FIRST FARMERS AND MERCHANTS CORPORATION

(Registrant)

Date  October 29, 2004         

By

/s/ T. Randy Stevens

                                   

T. Randy Stevens, President/Chief Executive Officer

Date  October 29, 2004           

By

/s/ Patricia N. McClanahan

                                             

Patricia N. McClanahan, Treasurer/Chief Financial Officer