** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| **ý**                                             | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                   |                                                                                          |
| **For the quarterly period ended  September 30, 2002** |
|                                                   |                                                                                          |
| **OR**                                                 |
|                                                   |                                                                                          |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 0-12638**

 

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**F&M BANCORP**

(Exactname of registrant as specified in its charter)

 

| **Maryland**                                                    |   | **52-1316473**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **110 Thomas  Johnson Drive  Frederick, Maryland 21702**        |
| (Address of principal executive offices)  (Zip Code)            |
|                                                            |   |                                  |
| **(888)  694-4170**                                             |
| (Registrant’s telephone number, including  area code)      |
|                                                            |   |                                  |
| Securities registered pursuant to Section 12(b) of the Act:     |
| **NONE**                                                        |
|                                                            |   |                                  |
| Securities registered pursuant to Section 12(g) of the Act:     |
| **Common Stock  ($5 par value)**                                |
| (Title of class)                                                |

 

Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 ý  No o

 

 

Common Stock of 10,778,280 shares outstanding as of November 7, 2002.

 

 

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Form 10-Q

TABLE OF CONTENTS

 
| **PART I**    | **Financial Information**                                                                               |
|---------------|---------------------------------------------------------------------------------------------------------|
| Item 1.       | Financial Statements                                                                                    |
|          | Consolidated  Statements of Income (Unaudited)                                                          |
|          | Consolidated Balance Sheets  (Unaudited)                                                                |
|          | Consolidated  Statements of Changes in Shareholders’ Equity and Comprehensive Income  (Unaudited)  |
|          | Consolidated  Statements of Cash Flows (Unaudited)                                                      |
|          | Notes  to Financial Statements (Unaudited)                                                              |
|          |                                                                                                    |
| Item  2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations  (MD&A) |
|          | Summary Financial Data                                                                                  |
|          | Overview                                                                                                |
|          | Earnings Performance                                                                                    |
|          |                                                                                                    | Net Interest Income |
|          |                                                                                                    | Noninterest Income |
|          |                                                                                                    | Noninterest Expense |
|          | Balance Sheet Analysis                                                                                  |
|          |                                                                                                    | Securities Available for  Sale |
|          |                                                                                                    | Loan Portfolio |
|          |                                                                                                    | Nonaccrual Loans and  Other Assets |
|          |                                                                                                    | Allowance for Credit Losses |
|          |                                                                                                    | Deposits |
|          |                                                                                                    | Capital Adequacy/Ratios |
|          | Asset/Liability  and Market Risk Management                                                             |
|          | Capital Management                                                                                      |
|          | Evaluation of Internal  Controls                                                                        |
|          | Factors that May  Affect Future Results                                                                 |
|          |                                                                                                    |
| Item 3.       | Quantitative and Qualitative Disclosure about Market  Risk                                              |
|          |                                                                                                    |
| **PART II**   | **Other Information**                                                                                   |
| Item  6.      | Exhibits  and Reports on Form 8-K                                                                       |
|          |                                                                                                    |
| **Signature** |

 

The information furnished in these interim statements reflects alladjustments that are, in the opinion of management, necessary for a fairstatement of the results for such periods. Such adjustments are of a normalrecurring nature, unless otherwise disclosed in this Form 10-Q. The results ofoperations in the interim statements are not necessarily indicative of theresults that may be expected for the full year. The interim financialinformation should be read in conjunction with F&M Bancorp’s 2001 AnnualReport on Form 10-K.

 

2

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**PART I****–FINANCIAL INFORMATIONF&M BANCORP AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME** (Unaudited)

 
|                                                  |   | **Quarter ended  September 30,** |       | **Nine months ended  September 30,** |       |
|-------------------------------------------------------|--------|----------------------------------|------------|--------------------------------------|------------|
| **(in thousands, except per share data)**             |   | **2002**                         |       | **2001**                             |       | **2002** |   | **2001** |   |
| **INTEREST  INCOME**                                  |   |                             |       |                                 |       |   |   |   |   |
| Loans                                                 |   | **$**                            | **20,961** |                                 | $          | 23,534 | ** ** | **$** | **62,399** |   | $ | 72,346 |   |
| Loans held for sale                                   |   | **124**                          |       | 339                                  | ** ** | **619** |   | 881 |   |
| Securities available for sale                         |   | **7,101**                        |       | 6,244                                | ** ** | **20,655** |   | 18,494 |   |
| Other interest income                                 |   | **116**                          |       | 352                                  | ** ** | **411** |   | 1,393 |   |
| Total interest income                                 |   | **28,302**                       |       | 30,469                               | ** ** | **84,084** |   | 93,114 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **INTEREST  EXPENSE**                                 |   |                             |       |                                 |       |   |   |   |   |
| Deposits                                              |   | **7,531**                        |       | 12,046                               | ** ** | **24,451** |   | 36,952 |   |
| Short-term borrowings                                 |   | **462**                          |       | 784                                  | ** ** | **1,104** |   | 4,314 |   |
| Long-term borrowings                                  |   | **945**                          |       | 595                                  | ** ** | **2,551** |   | 1,423 |   |
| Total interest expense                                |   | **8,938**                        |       | 13,425                               | ** ** | **28,106** |   | 42,689 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **NET INTEREST  INCOME**                              |   | **19,364**                       |       | 17,044                               | ** ** | **55,978** |   | 50,425 |   |
| Provision for credit losses                           |   | **350**                          |       | 430                                  | ** ** | **1,325** |   | 3,060 |   |
| Net interest income after provision for credit losses |   | **19,014**                       |       | 16,614                               | ** ** | **54,653** |   | 47,365 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **NONINTEREST  INCOME**                               |   |                             |       |                                 |       |   |   |   |   |
| Service charges on deposit accounts                   |   | **2,348**                        |       | 2,062                                | ** ** | **6,827** |   | 6,133 |   |
| Insurance income                                      |   | **2,194**                        |       | 2,134                                | ** ** | **7,384** |   | 6,930 |   |
| Gains on sales of loans                               |   | **1,295**                        |       | 1,184                                | ** ** | **3,016** |   | 2,782 |   |
| Trust and investment fees                             |   | **407**                          |       | 872                                  | ** ** | **2,238** |   | 2,719 |   |
| Gains on sales of securities                          |   | **—**                       |       | 19                                   | ** ** | **—** |   | 52 |   |
| Gains on sales of property                            |   | **37**                           |       | 130                                  | ** ** | **160** |   | 237 |   |
| Other operating income                                |   | **1,414**                        |       | 1,258                                | ** ** | **4,084** |   | 4,310 |   |
| Total noninterest income                              |   | **7,695**                        |       | 7,659                                | ** ** | **23,709** |   | 23,163 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **NONINTEREST  EXPENSE**                              |   |                             |       |                                 |       |   |   |   |   |
| Salaries                                              |   | **7,199**                        |       | 7,192                                | ** ** | **21,862** |   | 21,381 |   |
| Incentive compensation                                |   | **1,199**                        |       | 478                                  | ** ** | **2,400** |   | 1,642 |   |
| Employee benefits                                     |   | **1,439**                        |       | 1,795                                | ** ** | **4,813** |   | 4,343 |   |
| Occupancy and equipment expense                       |   | **2,345**                        |       | 2,591                                | ** ** | **7,444** |   | 7,871 |   |
| Core deposit intangible                               |   | **246**                          |       | 231                                  | ** ** | **685** |   | 694 |   |
| Other operating expense                               |   | **4,797**                        |       | 4,204                                | ** ** | **14,055** |   | 12,659 |   |
| Total noninterest expenses                            |   | **17,225**                       |       | 16,491                               | ** ** | **51,259** |   | 48,590 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **INCOME BEFORE  INCOME TAX EXPENSE**                 |   | **9,484**                        |       | 7,782                                | ** ** | **27,103** |   | 21,938 |   |
| Income tax expense                                    |   | **3,183**                        |       | 2,269                                | ** ** | **8,909** |   | 6,235 |   |
| **NET INCOME**                                        |   | **$**                            | **6,301**  |                                 | $          | 5,513 | ** ** | **$** | **18,194** |   | $ | 15,703 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **EARNINGS PER  COMMON SHARE**                        |   |                             |       |                                 |       |   |   |   |   |
| Earnings per common chare                             |   | **$**                            | **0.58**   |                                 | $          | 0.50 | ** ** | **$** | **1.68** |   | $ | 1.43 |   |
| Diluted earnings per common share                     |   | **$**                            | **0.58**   |                                 | $          | 0.50 | ** ** | **$** | **1.67** |   | $ | 1.42 |   |
|                                                  |   |                             |       |                                 |       |   |   |   |   |
| **DIVIDENDS  DECLARED PER COMMON SHARE**              |   | **$**                            | **0.28**   |                                 | $          | 0.27 | ** ** | **$** | **0.56** |   | $ | 0.81 |   |
| Average common share outstanding                      |   | **10,776,193**                   |       | 10,967,281                           | ** ** | **10,814,074** |   | 11,002,801 |   |
| Diluted average common shares outstanding             |   | **10,864,211**                   |       | 11,026,378                           | ** ** | **10,880,984** |   | 11,049,532 |   |

 

3

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**F&M BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

 
| **(in thousands, except shares)**                                                                                                           |   | **September 30,  2002** |          | **December 31,  2001** |   | **September 30,  2001** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------------|------------------------|--------|-------------------------|--------|
|                                                                                                                                        |   | **(Unaudited)**         |          |                   |   | **(Unaudited)**         |   |
| **ASSETS**                                                                                                                                  |   |                    |          |                   |   |                    |   |
| Cash and due from banks                                                                                                                     |   | **$**                   | **67,744**    |                   | $      | 65,570                  |   | $ | 58,580 |   |
| Interest-bearing deposits with banks                                                                                                        |   | **3,062**               |          | 13,178                 |   | 11,749                  |   |
| Federal funds sold                                                                                                                          |   | **232**                 |          | 360                    |   | 23,095                  |   |
| Total cash and cash equivalents                                                                                                             |   | **71,038**              |          | 79,108                 |   | 93,424                  |   |
| Loans held for sale                                                                                                                         |   | **19,750**              |          | 28,779                 |   | 17,086                  |   |
| Securities available for sale                                                                                                               |   | **609,926**             |          | 546,522                |   | 496,429                 |   |
| FHLB / FRB stock                                                                                                                            |   | **7,218**               |          | 6,866                  |   | 6,866                   |   |
|                                                                                                                                        |   |                    |          |                   |   |                    |   |
| Loans, net of unearned income                                                                                                               |   | **1,233,792**           |          | 1,162,225              |   | 1,178,949               |   |
| Allowance for credit losses                                                                                                                 |   | **(14,055**             | **)**         | (13,947                | )      | (14,218                 | )      |
| Net loans                                                                                                                                   |   | **1,219,737**           |          | 1,148,278              |   | 1,164,731               |   |
|                                                                                                                                        |   |                    |          |                   |   |                    |   |
| Bank premises and equipment, net                                                                                                            |   | **34,365**              |          | 35,563                 |   | 36,334                  |   |
| Other real estate owned, net                                                                                                                |   | **323**                 |          | 638                    |   | 667                     |   |
| Interest receivable                                                                                                                         |   | **9,559**               |          | 9,417                  |   | 10,322                  |   |
| Core deposit intangible assets                                                                                                              |   | **2,132**               |          | 2,817                  |   | 3,569                   |   |
| Mortgage servicing rights                                                                                                                   |   | **833**                 |          | 1,028                  |   | 1,093                   |   |
| Cash value of life insurance                                                                                                                |   | **11,379**              |          | 10,978                 |   | 10,768                  |   |
| Other assets                                                                                                                                |   | **6,747**               |          | 11,440                 |   | 10,685                  |   |
| Total assets                                                                                                                                |   | **$**                   | **1,993,007** |                   | $      | 1,881,434               |   | $ | 1,851,974 |   |
|                                                                                                                                        |   |                    |          |                   |   |                    |   |
| **LIABILITIES**                                                                                                                             |   |                    |          |                   |   |                    |   |
| Noninterest-bearing deposits                                                                                                                |   | **$**                   | **266,722**   |                   | $      | 234,459                 |   | $ | 214,933 |   |
| Interest-bearing deposits                                                                                                                   |   | **1,294,196**           |          | 1,281,609              |   | 1,274,659               |   |
| Total deposits                                                                                                                              |   | **1,560,918**           |          | 1,516,068              |   | 1,489,592               |   |
|                                                                                                                                        |   |                    |          |                   |   |                    |   |
| Short-term borrowings                                                                                                                       |   | **153,794**             |          | 117,545                |   | 110,516                 |   |
| Long-term borrowings                                                                                                                        |   | **78,122**              |          | 63,444                 |   | 65,003                  |   |
| Accrued taxes and other liabilities                                                                                                         |   | **16,886**              |          | 16,952                 |   | 17,908                  |   |
| Total liabilities                                                                                                                           |   | **1,809,720**           |          | 1,714,009              |   | 1,683,019               |   |
|                                                                                                                                        |   |                    |          |                   |   |                    |   |
| ***COMMITMENTS AND CONTINGENCIES***                                                                                                         |   |                    |          |                   |   |                    |   |
|                                                                                                                                        |   |                    |          |                   |   |                    |   |
| **SHAREHOLDERS’  EQUITY**                                                                                                              |   |                    |          |                   |   |                    |   |
| Common stock - $5 par value; authorized 50,000,000 shares; issued  10,781,375 shares, 10,862,257 shares and 10,895,440 shares, respectively |   | **53,907**              |          | 54,311                 |   | 55,477                  |   |
| Surplus                                                                                                                                     |   | **72,131**              |          | 75,147                 |   | 75,864                  |   |
| Retained earnings                                                                                                                           |   | **46,940**              |          | 34,782                 |   | 32,461                  |   |
| Accumulated other comprehensive income                                                                                                      |   | **10,309**              |          | 3,185                  |   | 6,153                   |   |
| Total shareholders’ equity                                                                                                             |   | **183,287**             |          | 167,425                |   | 168,955                 |   |
| Total liabilities and shareholders’ equity                                                                                             |   | **$**                   | **1,993,007** |                   | $      | 1,881,434               |   | $ | 1,851,974 |   |

 

4

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**F&M BANCORP AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGESIN SHAREHOLDERS’EQUITY AND COMPREHENSIVE INCOME**(Unaudited)

 
| **(in thousands, except shares)**                                                                                          |   | **Number  of shares** |       | **Common  stock** |       | **Additional  paid-in  capital** |       | **Retained  earnings** |       | **Cumulative  other  comprehensive  (loss) income** |       | **Total**  |       |
|----------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-----------------------------------------------------|------------|------------|------------|
|                                                                                                                       |   |                  |       |              |       |                             |       |                   |       |                                                |       |       |       |
| Balance at December 31, 2000                                                                                               |   | 11,014,529            |       | $                 | 55,073     |                             | $          | 78,488                 |       | $                                                   | 25,857     |       | $          | (1,382 | ) | $ | 158,036 |   |
| Comprehensive income:                                                                                                      |   |                  |       |              |       |                             |       |                   |       |                                                |       |       |       |
| Net income                                                                                                                 |   | —                |       | —            |       | —                           |       | 15,703                 |       | —                                              |       | 15,703     |       |
| Other comprehensive income net of tax:                                                                                     |   |                  |       |              |       |                             |       |                   |       |                                                |       |       |       |
| Net unrealized gains on securities available for sale, net of  reclassification of $34 of net gains included in net income |   | —                |       | —            |       | —                           |       | —                 |       | 7,535                                               |       | 7,535      |       |
| Total comprehensive income                                                                                                 |   |                  |       |              |       |                             |       |                   |       |                                                |       | 23,238     |       |
| Dividend reinvestment plan                                                                                                 |   | —                |       | —            |       | —                           |       | (164                   | )          | —                                              |       | (164       | )          |
| Cash dividends declared $(.81 per share)                                                                                   |   | —                |       | —            |       | —                           |       | (8,928                 | )          | —                                              |       | (8,928     | )          |
| Stock consideration for options exercised                                                                                  |   | (624                  | )          | (3                | )          | (4                               | )          | (7                     | )          | —                                              |       | (14        | )          |
| Stock options exercised                                                                                                    |   | 23,935                |       | 119               |       | 357                              |       | —                 |       | —                                              |       | 476        |       |
| Stock repurchase and retirement                                                                                            |   | (153,700              | )          | (712              | )          | (2,977                           | )          | —                 |       | —                                              |       | (3,689     | )          |
| Net change                                                                                                                 |   | (130,389              | )          | (596              | )          | (2,624                           | )          | 6,604                  |       | 7,535                                               |       | 10,919     |       |
|                                                                                                                       |   |                  |       |              |       |                             |       |                   |       |                                                |       |       |       |
| Balance at September 30, 2001                                                                                              |   | 10,884,140            |       | $                 | 54,477     |                             | $          | 75,864                 |       | $                                                   | 32,461     |       | $          | 6,153 |   | $ | 168,955 |   |
|                                                                                                                       |   |                  |       |              |       |                             |       |                   |       |                                                |       |       |       |
| **Balance at  December 31, 2001**                                                                                          |   | **10,862,257**        | ** ** | **$**             | **54,311** | ** **                       | **$**      | **75,147**             | ** ** | **$**                                               | **34,782** | ** ** | **$**      | **3,185** | ** ** | **$** | **167,425** | ** ** |
| **Comprehensive  income:**                                                                                                 |   |                  | ** ** |              | ** ** |                             | ** ** |                   | ** ** |                                                | ** ** |       | ** ** |
| **Net income**                                                                                                             |   | **—**            |       | —            |       | —                           | ** ** | **18,194**             |       | —                                              | ** ** | **18,194** | ** ** |
| **Other  comprehensive income net of tax:**                                                                                |   |                  | ** ** |              | ** ** |                             | ** ** |                   | ** ** |                                                | ** ** |       | ** ** |
| **Net  unrealized gains on securities**                                                                                    |   | **—**            | ** ** | **—**        | ** ** | **—**                       | ** ** | **—**             | ** ** | **7,124**                                           | ** ** | **7,124**  | ** ** |
| **Total  comprehensive income**                                                                                            |   |                  | ** ** |              | ** ** |                             | ** ** |                   | ** ** |                                                | ** ** | **25,318** | ** ** |
| **Dividend  reinvestment plan**                                                                                            |   | **—**            | ** ** | **—**        | ** ** | **—**                       | ** ** | **(24**                | **)**      | **—**                                          | ** ** | **(24**    | **)**      |
| **Cash  dividends declared $(.56 per share)**                                                                              |   | **—**            | ** ** | **—**        | ** ** | **—**                       | ** ** | **(6,001**             | **)**      | **—**                                          | ** ** | **(6,001** | **)**      |
| **Stock  consideration for options exercised**                                                                             |   | **(678**              | **)**      | **(3**            | **)**      | **(675**                         | **)**      | **(11**                | **)**      | **—**                                          | ** ** | **(688**   | **)**      |
| **Stock options  exercised**                                                                                               |   | **40,326**            | ** ** | **201**           | ** ** | **602**                          | ** ** | **—**             | ** ** | **—**                                          | ** ** | **803**    | ** ** |
| **Stock  repurchase and retirement**                                                                                       |   | **(120,530**          | **)**      | **(602**          | **)**      | **(2,943**                       | **)**      | **—**             | ** ** | **—**                                          | ** ** | **(3,546** | **)**      |
| **Net change**                                                                                                             |   | **(80,882**           | **)**      | **(404**          | **)**      | **(3,016**                       | **)**      | **12,158**             | ** ** | **7,124**                                           | ** ** | **15,862** | ** ** |
|                                                                                                                       |   |                  | ** ** |              | ** ** |                             | ** ** |                   | ** ** |                                                | ** ** |       | ** ** |
| **Balance at  September 30, 2002**                                                                                         |   | **10,781,375**        | ** ** | **$**             | **53,907** | ** **                       | **$**      | **72,131**             | ** ** | **$**                                               | **46,940** | ** ** | **$**      | **10,309** | ** ** | **$** | **183,287** | ** ** |

 

5

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**F&M BANCORP AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOW**(Unaudited)

 
|                                                                                                        |   | **Nine months ended September 30,** |       |
|-------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
| **(in thousands)**                                                                                          |   | **2002**                            |       | **2001** |   |
| **Cash Flows  from Operating Activities**                                                                   |   |                                | ** ** |   |   |
| Net Income                                                                                                  |   | **$**                               | **18,194** | ** ** | $ | 15,703 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities                           |   |                                | ** ** |   |   |
| Provision for credit losses                                                                                 |   | **1,325**                           | ** ** | 3,060 |   |
| Depreciation and amortization                                                                               |   | **2,805**                           | ** ** | 2,655 |   |
| Amortization of intangibles                                                                                 |   | **907**                             | ** ** | 845 |   |
| Net premium amortization on investment securities                                                           |   | **1,995**                           | ** ** | 523 |   |
| (Increase) decrease in interest receivable                                                                  |   | **(142**                            | **)**      | 850 |   |
| Decrease in interest payable                                                                                |   | **(409**                            | **)**      | (970 | ) |
| Gain on sales of property                                                                                   |   | **(160**                            | **)**      | (237 | ) |
| Gain on sales of securities                                                                                 |   | **—**                          | ** ** | (52 | ) |
| Decrease (increase)  in loans  held for sale                                                           |   | **9,029**                           | ** ** | (11,092 | ) |
| (Increase) decrease in other assets                                                                         |   | **(52**                             | **)**      | 289 |   |
| Increase (decrease) in other liabilities                                                                    |   | **343**                             | ** ** | (437 | ) |
| Gain on sales of loans                                                                                      |   | **(3,016**                          | **)**      | (2,782 | ) |
| Net cash provided by operating activities                                                                   |   | **30,819**                          | ** ** | 8,355 |   |
| **Cash Flows  from Investing Activities**                                                                   |   |                                | ** ** |   |   |
| Purchases of investment securities available for sale                                                       |   | **(217,069**                        | **)**      | (253,456 | ) |
| Proceeds from sales/maturities of securities available for sale                                             |   | **162,760**                         | ** ** | 194,179 |   |
| Net (increase) decrease in loans                                                                            |   | **(69,843**                         | **)**      | 41,668 |   |
| Purchases of premises and equipment                                                                         |   | **(1,608**                          | **)**      | (3,342 | ) |
| Proceeds from sales of property                                                                             |   | **550**                             | ** ** | 988 |   |
| Net cash used in investing activities                                                                       |   | **(125,210**                        | **)**      | (19,963 | ) |
| **Cash Flows  from Financing Activities**                                                                   |   |                                | ** ** |   |   |
| Net increase in noninterest-bearing deposits, interest-bearing  checking, savings and money market accounts |   | **67,533**                          | ** ** | 27,321 |   |
| Net (decrease) increase in certificates of deposit                                                          |   | **(22,683**                         | **)**      | 98,239 |   |
| Net increase (decrease) in federal funds purchased and securities sold  under agreements to repurchase      |   | **25,544**                          | ** ** | (18,651 | ) |
| Net increase (decrease) in other short-term borrowings                                                      |   | **10,705**                          | ** ** | (108,904 | ) |
| Net increase in long-term borrowings                                                                        |   | **14,678**                          | ** ** | 49,213 |   |
| Cash dividends paid                                                                                         |   | **(6,001**                          | **)**      | (8,928 | ) |
| Dividend reinvestment plan                                                                                  |   | **(24**                             | **)**      | (164 | ) |
| Issuance of common stock                                                                                    |   | **115**                             | ** ** | 462 |   |
| Common stock purchased and retired                                                                          |   | **(3,546**                          | **)**      | (3,689 | ) |
| Net cash provided by financing activities                                                                   |   | **86,321**                          | ** ** | 34,899 |   |
|                                                                                                        |   |                                | ** ** |   |   |
| Net (decrease) increase in cash and cash equivalents                                                        |   | **(8,070**                          | **)**      | 23,291 |   |
| Cash and cash equivalents at beginning of year                                                              |   | **79,108**                          | ** ** | 70,133 |   |
| Cash and cash equivalents at end of period                                                                  |   | **$**                               | **71,038** | ** ** | $ | 93,424 |   |
| **Supplemental  Disclosures of Cash Flow Information**                                                      |   |                                | ** ** |   |   |
| Cash payments for interest                                                                                  |   | **$**                               | **28,515** | ** ** | $ | 43,659 |   |
| Cash payments for income tax                                                                                |   | **7,366**                           | ** ** | 5,711 |   |
| **Non-Cash  Investing and Financing Activities**                                                            |   |                                | ** ** |   |   |
| Fair value adjustment for securities available for sale, net of income  taxes                               |   | **$**                               | **7,124**  | ** ** | $ | 7,535 |   |

 

6

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**F&M BANCORP AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIALSTATEMENTS  **(Unaudited)

 

1. Summary of Significant Accounting Policies

 

Descriptions of the significant accounting policies of F&M Bancorpand Subsidiaries (the Bancorp) are included in Note 1 (Summary of SignificantAccounting Policies) to the audited consolidated financial statements includedin the Bancorp’s 2001 Annual Report on Form 10-K. There have been nosignificant changes to these policies except for accounting policies related togoodwill discussed below.

 

##### **Goodwill and OtherIntangible Assets**

 

Goodwill represents the excess of the purchase priceover the fair value of net assets acquired in business combinations under thepurchase method of accounting. In June 2001, the Financial Accounting StandardsBoard issued SFAS No. 141, *BusinessCombinations*(effective July 1, 2001) and SFAS No. 142, *Goodwill and Other Intangible Assets *(effective January 1, 2002). SFASNo. 141 prohibits pooling-of-interests accounting for acquisitions. SFAS No.141 also specifies the criteria for intangible assets acquired in a purchasemethod business combination to be recognized and reported apart from goodwill.SFAS No. 142 specifies that goodwill and some intangible assets will no longerbe amortized but instead will be subject to periodic impairment testing. SFAS142 also requires intangible assets with definite useful lives to be amortizedover their respective estimated useful lives to their estimated residualvalues, and reviewed for impairment in accordance with SFAS No. 121, *Accounting for the Impairment of Long-Lived Assets andfor Long-Lived Assets to Be Disposed Of*.

 

The Bancorp adopted SFAS No.141 on July 1, 2001and SFAS No. 142 on January 1, 2002 and goodwill will be assessed at leastannually for impairment on a reporting unit level by applying afair-valued-based test using discounted estimated future net cash flows. The Bancorpdoes not currently carry any goodwill attributable to premiums relating fromprior mergers and/or acquisitions. Therefore the “Adjusted” Earnings – SFAS 142Transitional Disclosures does not apply as earnings per share and net incomewould be the same for all years reported.

 

Core deposit intangibles are amortized on an accelerated basis based onuseful lives of up to 15 years. The Bancorp reviews other intangible assets forimpairment annually (except mortgage servicing rights, which are reviewedmonthly), or whenever events or changes in circumstances indicate that theircarrying amounts may not be recoverable. For those intangible assets subject toamortization, impairment is indicated if the sum of undiscounted estimatedfuture net cash flow is less than the carrying amount of the asset. Impairmentis recognized by accelerating the write off of the asset to the extent that thecarrying value exceeds the estimated fair value.

 

7

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2.  EarningsPer Share

 

The table below shows dual presentation of earnings per common shareand diluted earnings per common share and a reconciliation of the numerator anddenominator of both earnings per common share calculations.

 
|                                                    |   | **Quarter ended  September 30,** |      | **Nine months ended  September 30,** |       |
|---------------------------------------------------------|--------|----------------------------------|-----------|--------------------------------------|------------|
| **(in thousands, except per share data)**               |   | **2002**                         |      | **2001**                             |       | **2002** |   | **2001** |   |
|                                                    |   |                             |      |                                 |       |   |   |   |   |
| Net income applicable to common stock (numerator)       |   | **$**                            | **6,301** |                                 | $          | 5,513 | ** ** | **$** | **18,194** |   | $ | 15,703 |   |
|                                                    |   |                             |      |                                 |       |   |   |   |   |
| **EARNINGS PER  COMMON SHARE**                          |   |                             |      |                                 |       |   |   |   |   |
| Average common shares outstanding (denominator)         |   | **10,776.2**                     |      | 10,967.3                             | ** ** | **10,814.1** |   | 11,002.8 |   |
| Per share                                               |   | **$**                            | **0.58**  |                                 | $          | 0.50 | ** ** | **$** | **1.68** |   | $ | 1.43 |   |
|                                                    |   |                             |      |                                 |       |   |   |   |   |
| **DILUTED  EARNINGS PER COMMON SHARE**                  |   |                             |      |                                 |       |   |   |   |   |
| Average common shares outstanding                       |   | **10,776.2**                     |      | 10,967.3                             | ** ** | **10,814.1** |   | 11,002.8 |   |
| Add:  Stock options                                |   | **88.0**                         |      | 59.1                                 | ** ** | **66.9** |   | 46.7 |   |
| Diluted average common shares outstanding (denominator) |   | **10,864.2**                     |      | 11,026.4                             | ** ** | **10,881.0** |   | 11,049.5 |   |
| Per share                                               |   | **$**                            | **0.58**  |                                 | $          | 0.50 | ** ** | **$** | **1.67** |   | $ | 1.42 |   |

 

As allowed for under SFAS No.123, *Accounting for Stock-Based Compensation*,the Bancorp has elected to follow the provisions of Accounting Principles BoardOpinion No. 25 (APB 25), *Accounting for Stock Issued to Employees*,in accounting for its stock option plans for directors and employees. TheBancorp utilizes APB 25, and as such compensation expense for stock options isnot recognized in net income; however, the effect of the shares that would beissued is reflected in diluted earnings per share as an increase to averagecommon shares outstanding and results in a decrease to earnings per share. Forfurther information see Note 9 to the audited consolidated financial statementsincluded in the Bancorp’s 2001 Annual Report on Form 10-K.

 

# **3.  Operating Segments**

 

Operating segments as defined by SFAS No. 131 *Disclosures about Segments of anEnterprise and Related Information* are components of an enterprisewith separate financial information. The component engages in business activities, from which it derivesrevenues and incurs expenses and whose operating result’s management relies onfor decision making and performance assessment. The Bancorp, as defined by thisstandard, does not have any segment whose revenues, reported profit and loss,or assets are 10% or more of the combined revenues of all reporting segments.

 

8

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4.  Intangible Assets

 

The gross carrying amount of intangible assets and the associatedaccumulated amortization at September 30, 2002 is presented in the followingtable.

 
|                         |   | **September 30, 2002**     |   |
|------------------------------|--------|----------------------------|--------|
| **(in thousands)**           |   | **Gross  carrying amount** |   | **Accumulated  amortization** |   | **Net intangible  assets** |   |
|                         |   |                       |   |   |   |   |   |
| Amortized intangible assets: |   |                       |   |   |   |   |   |
| Core deposit intangible      |   | $                          | 8,565  |   | $ | 6,433 |   | $ | 2,132 |   |
| Mortgage servicing rights    |   | 1,757                      |   | 924 |   | 833 |   |
| Total                        |   | $                          | 10,322 |   | $ | 7,357 |   | $ | 2,965 |   |

 

The projections of amortization expense shown below for mortgageservicing rights are based on asset balances and the interest rate environmentas of September 30, 2002. Future amortization expense may be significantlydifferent depending upon changes in the mortgage servicing portfolio, mortgageinterest rates and market conditions.

 

The following table shows the current period and estimated futureamortization expense for amortized intangible assets and should be read inconjunction with Note 1 regarding goodwill and other intangible assets.

 
| **(in  thousands)**                               |   | **Core  deposit  intangibles** |   | **Mortgage  servicing  rights** |   | **Total  expense** |   |
|---------------------------------------------------|--------|--------------------------------|--------|---------------------------------|--------|--------------------|--------|
|                                              |   |                           |   |                            |   |               |   |
| Nine months  ended September 30, 2002 (actual)    |   | $                              | 685    |                            | $      | 222                |   | $ | 907 |   |
|                                              |   |                           |   |                            |   |               |   |
| Three months  ended December 31, 2002 (estimated) |   | 246                            |   | 65                              |   | 311                |   |
|                                              |   |                           |   |                            |   |               |   |
| Estimate for  year ended December 31,             |   |                           |   |                            |   |               |   |
| 2003                                              |   | 819                            |   | 260                             |   | 1,079              |   |
| 2004                                              |   | 737                            |   | 260                             |   | 997                |   |
| 2005                                              |   | 330                            |   | 248                             |   | 578                |   |
| 2006                                              |   | —                         |   | —                          |   | —             |   |
| 2007                                              |   | —                         |   | —                          |   | —             |   |
|                                                   |        |                                |        |                                 |        |                    |        |  |  |  |

 

9

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# **5. Recent Accounting Standards**

 

In April 2002, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 145, *Rescissionof FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, andTechnical Corrections.* SFAS 145 requires that any gains or losses onextinguishment of debt that were classified as an extraordinary item in priorperiods that are not unusual in nature and infrequent in occurrence bereclassified to other income (expense), beginning in fiscal 2003, with earlyadoption encouraged. The Bancorp expects to adopt the requirements of SFAS No.145 in fiscal 2003.

 

In June 2002, the FASB issued SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities*, which addresses accounting forrestructuring and similar costs.  SFAS146 supersedes previous accounting guidance, principally Emerging Issues TaskForce Issue No. 94-3. SFAS No.146 requires that the liability for costsassociated with an exit or disposal activity be recognized when the liabilityis incurred. Under Issue 94-3, a liability for an exit cost was recognized atthe date of the Bancorp’s commitment to an exit plan rather than when theliability is incurred. SFAS No.146 also establishes that the liability shouldinitially be measured and recorded at fair value.  Accordingly, SFAS No.146 may affect the timing of recognizingfuture restructuring costs as well as the amounts recognized. The Bancorp willadopt the provisions of SFAS No. 146 for any restructuring activities which maybe initiated after December 31, 2002.

 

In October 2002, the FASB issued SFAS No. 147, *Acquisitions of Certain Financial Institutions*,which provides guidance on the accounting for the acquisition of a financialinstitution.  This statement requiresthat the excess of the fair value of liabilities assumed over the fair value oftangible and identifiable intangible assets acquired in a business combinationrepresents goodwill that should be accounted for under SFAS No. 142, Goodwilland Other Intangible Assets.  Thus, thespecialized accounting guidance in paragraph 5 of SFAS No. 72, Accounting forCertain Acquisitions of Banking or Thrift Institutions, will not apply afterSeptember 30, 2002.  If certain criteriain SFAS No. 147 are met, the amount of the unidentifiable intangible asset willbe reclassified to goodwill upon adoption of the statement.  Financial institutions meeting conditionsoutlined in SFAS No. 147 will be required to restate previously issuedfinancial statements.  Additionally, thescope of SFAS No. 144, Accounting for the Impairment or Disposal of Long-LivedAssets, is amended to include long-term customer-relationship intangible assetssuch as depositor- and borrower-relationship intangible assets and creditcardholder intangible assets.  Thisstatement is effective for the Bancorp and has been adopted as of October 1,2002.  The adoption of this standard didnot have a material impact on the Bancorp’s financial position or results ofoperation.

 

10

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# **ITEM 2.**  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

**SUMMARY FINANCIAL DATA**

 
|                                                                               |   | **Quarter ended**  |        | **% Change  Sep. 30, 2002  from** |   | **Nine months ended** |   |               |    |
|------------------------------------------------------------------------------------|--------|--------------------|-------------|-----------------------------------|--------|-----------------------|--------|--------------------|---------|
| **(in thousands, except per  share amounts)**                                      |   | **Sep. 30,  2002** |        | **June 30,  2002**                |   | **Sep. 30,  2001**    |   | **June 30,  2002** |    | **Sep. 30,  2001** |   | **Sep. 30,  2002** |   | **Sep. 30,  2001** |   | **%  Change** |   |
| **For the Period**                                                                 |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Net income                                                                         |   | **$**              | **6,301**   | ** **                        | $      | 6,116                 |   | $                  | 5,513   |   | 3 | % | 14 | % | **$** | **18,194** | ** ** | $ | 15,703 |   | 16 | % |
| Diluted earnings  per common share                                                 |   | **0.58**           | ** **  | 0.56                              |   | 0.50                  |   | 3                  |    | 16 |   | **1.67** | ** ** | 1.42 |   | 18 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Profitability  ratios (annualized)                                                 |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Net income to  average total assets (ROA)                                          |   | **1.29**           | **%**       | 1.30                              | %      | 1.21                  | %      | (1                 | )       | 7 |   | **1.28** | **%** | 1.18 | % | 9 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Net income  applicable to common stock to average common stockholders equity (ROE) |   | **13.88**          | **%**       | 14.14                             | %      | 13.01                 | %      | (2                 | )       | 7 |   | **13.91** | **%** | 12.68 | % | 10 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Efficiency  ratio(1)                                                               |   | **62.02**          | **%**       | 63.13                             | %      | 64.79                 | %      | (2                 | )       | (4 | ) | **62.61** | **%** | 64.00 | % | (2 | ) |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Dividends  declared per common share                                               |   | **$**              | **0.28**    | ** **                        | $      | 0.28                  |   | $                  | 0.27    |   | — |   | 4 |   | **$** | **0.56** | ** ** | $ | 0.81 |   | (31 | ) |
| Dividends paid  per common share                                                   |   | **0.28**           | ** **  | 0.28                              |   | 0.27                  |   | —             |    | 4 |   | **0.84** | ** ** | 0.81 |   | 4 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Average common  shares outstanding                                                 |   | **10,776,193**     | ** **  | 10,814,183                        |   | 10,967,281            |   | —             |    | (2 | ) | **10,814,074** | ** ** | 11,002,801 |   | (2 | ) |
| Diluted average  common shares outstanding                                         |   | **10,864,211**     | ** **  | 10,877,815                        |   | 11,026,378            |   | —             |    | (1 | ) | **10,880,984** | ** ** | 11,049,532 |   | (2 | ) |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Total revenue                                                                      |   | **$**              | **27,059**  | ** **                        | $      | 26,565                |   | $                  | 24,703  |   | 2 |   | 10 |   | **$** | **79,687** | ** ** | $ | 73,587 |   | 8 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Average loans                                                                      |   | **1,204,657**      | ** **  | 1,172,164                         |   | 1,169,779             |   | 3                  |    | 3 |   | **1,178,828** | ** ** | 1,179,625 |   | — |   |
| Average assets                                                                     |   | **1,938,984**      | ** **  | 1,912,992                         |   | 1,807,374             |   | 1                  |    | 7 |   | **1,894,309** | ** ** | 1,777,086 |   | 7 |   |
| Average deposits                                                                   |   | **1,526,889**      | ** **  | 1,519,882                         |   | 1,473,294             |   | —             |    | 4 |   | **1,521,174** | ** ** | 1,429,405 |   | 6 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Net interest  margin                                                               |   | **4.34**           | **%**       | 4.36                              | %      | 4.15                  | %      | —             |    | 5 |   | **4.34** | **%** | 4.23 | % | 3 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| **At Period End**                                                                  |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Securities  available for sale                                                     |   | **$**              | **609,926** | ** **                        | $      | 606,826               |   | $                  | 496,429 |   | 1 |   | 23 |   | **$** | **609,926** | ** ** | $ | 496,429 |   | 23 |   |
| Loans                                                                              |   | **1,233,792**      | ** **  | 1,171,946                         |   | 1,178,949             |   | 5                  |    | 5 |   | **1,233,792** | ** ** | 1,178,949 |   | 5 |   |
| Allowance for  credit losses                                                       |   | **(14,055**        | **)**       | (13,999                           | )      | (14,218               | )      | —             |    | (1 | ) | **(14,055** | **)** | (14,218 | ) | (1 | ) |
| Assets                                                                             |   | **1,993,007**      | ** **  | 1,916,104                         |   | 1,851,974             |   | 4                  |    | 8 |   | **1,993,007** | ** ** | 1,851,974 |   | 8 |   |
| Deposits                                                                           |   | **1,560,918**      | ** **  | 1,549,241                         |   | 1,489,592             |   | 1                  |    | 5 |   | **1,560,918** | ** ** | 1,489,592 |   | 5 |   |
| Shareholders’  equity                                                         |   | **183,287**        | ** **  | 177,462                           |   | 168,955               |   | 3                  |    | 8 |   | **183,287** | ** ** | 168,955 |   | 8 |   |
| Tier 1  capital(2)                                                                 |   | **170,479**        | ** **  | 167,161                           |   | 158,932               |   | 2                  |    | 7 |   | **170,479** | ** ** | 158,932 |   | 7 |   |
| Total capital(2)                                                                   |   | **184,534**        | ** **  | 181,160                           |   | 173,151               |   | 2                  |    | 7 |   | **184,534** | ** ** | 173,151 |   | 7 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Capital ratios                                                                     |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Shareholders’  equity to assets                                               |   | **9.20**           | **%**       | 9.26                              | %      | 9.12                  | %      | (1                 | )       | 1 |   | **9.20** | **%** | 9.12 | % | 1 |   |
| Risk-based  capital(2)                                                             |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Tier 1 capital                                                                     |   | **12.12**          | **%**       | 12.20                             | %      | 12.19                 | %      | (1                 | )       | — |   | **12.12** | **%** | 12.19 | % | — |   |
| Total capital                                                                      |   | **13.12**          | **%**       | 13.24                             | %      | 13.28                 | %      | (1                 | )       | (1 | ) | **13.12** | **%** | 13.28 | % | (1 | ) |
| Leverage(2)                                                                        |   | **8.80**           | **%**       | 8.81                              | %      | 8.81                  | %      | —             |    | — |   | **8.80** | **%** | 8.81 | % | — |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Book value per  common share                                                       |   | **$**              | **17.00**   | ** **                        | $      | 16.47                 |   | $                  | 15.51   |   | 3 |   | 10 |   | **$** | **17.00** | ** ** | $ | 15.51 |   | 10 |   |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Staff (active,  full-time equivalent)                                              |   | **694**            | ** **  | 715                               |   | 745                   |   | (3                 | )       | (7 | ) | **694** | ** ** | 745 |   | (7 | ) |
|                                                                               |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| Common Stock  Price                                                                |   |               | ** **  |                              |   |                  |   |               |    |   |   |   | ** ** |   |   |   |   |
| High                                                                               |   | **$**              | **35.27**   | ** **                        | $      | 35.66                 |   | $                  | 29.55   |   | (1 | ) | 19 |   | **$** | **35.66** | ** ** | $ | 29.98 |   | 19 |   |
| Low                                                                                |   | **26.41**          | ** **  | 26.21                             |   | 21.92                 |   | 1                  |    | 20 |   | **25.06** | ** ** | 19.81 |   | 27 |   |
| Period end                                                                         |   | **31.60**          | ** **  | 35.28                             |   | 26.20                 |   | (10                | )       | 21 |   | **31.60** | ** ** | 26.20 |   | 21 |   |

 

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(1)          The efficiency ratio isdefined as noninterest expense divided by the total revenue (net interestincome and noninterest income).

(2)          See the CapitalAdequacy/Ratios section for additional information.

 

11

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*Statementsmade in this document, other than statements of historical information, areforward-looking statements that are made pursuant to the safe harbor provisionsof Section 21E of the Securities Exchange Act of 1934. These forward-lookingstatements may sometimes be identified by words such as “expect”, “may”, “looking forward”,“we plan”, “we believe”, “are planned”, “could be” and “currently anticipate”.Although we believe these statements, as well as other oral and writtenforward-looking statements made by us from time to time, to be true andreasonable, we can give no assurance that these plans, intentions orexpectations will be achieved. Actual results, performance or achievementscould differ materially from those contemplated, expressed or implied by theforward-looking statements. Important factors that could cause actual resultsto differ materially from our forward-looking statements are set forth in ourother filings with the SEC, and in this document under the heading “RiskFactors”, beginning in the section captioned “Management’s Discussion and Analysisof Financial Condition and Results of Operations”. We caution that the risksand factors discussed below and in such filings are not exclusive. We do notundertake to update any forward-looking statement that may be made from time totime by or on behalf of the Bancorp.*

 

OVERVIEW

 

F&M Bancorp is the registered bank holding company for Farmers& Mechanics Bank (the “Bank”), headquartered in Frederick, Maryland. TheBancorp is a $2 billion diversified financial services company providingbanking, insurance, wealth management, and mortgage banking through bankingbranches, the internet and other distribution channels to consumers andcommercial businesses. The Bank operates 49 community offices in Frederick,Howard, Baltimore, Montgomery, Washington, Carroll and Alleghany Counties inMaryland, together with two insurance agencies. The Bancorp has established astrategy of independence, and intends to establish or acquire additionaloffices, banking organizations and nonbanking organizations as appropriate opportunitiespresent themselves.

 

Certain amounts in the financial review for prior quarters have beenreclassified to conform with the current financial statement presentation.

 

Net income for the third quarter of 2002 reached a record $6.3 million,an increase of 14% compared with earnings of $5.51 million for the thirdquarter of 2001. Earnings per diluted share for the third quarter of 2002reached a record $0.58 per share, a 16% increase over the prior year’s $0.50per share results. Return on average assets (ROA) was 1.29% and return onaverage equity (ROE) was 13.88% for the third quarter of 2002, compared with1.21% and 13.01%, respectively, for the same period of 2001.

 

Net income for the first nine months of 2002 reached $18.2 million, or$1.67 per diluted share, compared with $15.7 million, or $1.42 per dilutedshare, for the first nine months of 2001. ROA was 1.28% in the first ninemonths of 2002, compared with 1.18% for the first nine months of 2001. ROE was13.91% in the first nine months of 2002, compared with 12.68% for the sameperiod of 2001.

 

Net interest income on a taxable-equivalent basis was $20.1 million forthe third quarter of 2002 and $58.2 million for the first nine months of 2002compared with $17.8 million and $52.8 million for the same periods of 2001. TheBancorp’s net interest margin was 4.34% for the third quarter and the firstnine months of 2002, compared with 4.15% and 4.23% for the same periods of2001.

 

Noninterest income totaled $7.7 million and $23.7 million for the thirdquarter and the first nine months of 2002, respectively, compared with $7.7million and $23.2 million for the same periods of 2001.

 

Noninterest expense totaled $17.2 million and $51.3 million for thethird quarter and the first nine months of 2002, respectively, compared with$16.5 million and $48.6 million for the same periods of 2001.

 

12

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The provision for credit losses was $350 thousand and $1.3 million inthe third quarter and the first nine months of 2002, respectively, comparedwith $430 thousand and $3.1 million in the same periods in 2001. During thethird quarter of 2002, net charge-offs were $294 thousand, or .10% of averageloans outstanding (annualized), compared with $562 thousand, or .19%, in thethird quarter of 2001. The provision for credit losses for the third quarterwas $57 thousand in excess of net charge-offs largely due to a shift in theloan portfolio mix to higher levels of commercial and commercial real estatewhich carry higher reserves. The allowance for credit losses was $14.0 million,or 1.14% of total loans, at September 30, 2002, compared with $13.9 million, or1.20%, at December 31, 2001 and $14.2 million, or 1.21% at September 30, 2001.

 

At September 30, 2002, total nonperforming assets were $2.7 million, or..13% of total assets, compared with $1.9 million, or .10%, at December 31, 2001and $2.4 million, or .13%, at September 30, 2001. Foreclosed assets amounted to$323 thousand at September 30, 2002, $698 thousand at December 31, 2001 and$667 thousand at September 30, 2001.

 

At September 30, 2002, the ratio of shareholders’ equity to totalassets was 9.20%, compared with 9.12% at September 30, 2001. The Bancorp’stotal risk-based capital (RBC) ratio at September 30, 2002 was 13.12% and itsTier 1 RBC ratio was 12.12%, exceeding the minimum regulatory guidelines of 8%and 4%, respectively for bank holding companies. The Bancorp’s ratios atSeptember 30, 2001 were 13.29% and 12.20%, respectively. The Bancorp’s leverageratio was 8.80% at September 30, 2002 and 8.81% at September 30, 2001,exceeding the minimum regulatory guideline of 3% for bank holding companies.

 

EARNINGS PERFORMANCE

 

NET INTERESTINCOME

 

Net interest income on a taxable-equivalent basis was $20.1 million inthe third quarter 2002, up 13% from the three months ended September 30, 2001,largely due to growth in earning assets and increases in net interest marginfrom 4.15% a year ago to 4.34% in third quarter 2002.

 

Individual components of net interest income and the net interestmargin are presented in the rate/yield table on the following page.

 

Average earning assets increased $136 million in the third quarter fromthe same period last year due to increases in average loans and debt securitiesavailable for sale. Loans averaged $1.205 million in the third quarter of 2002compared with $1.170 million in the third quarter of 2001. The Bancorp hascontinued to be successful in attracting new real estate loans, as well ascommercial loans during the quarter, however the growth experienced has beenoffset by prepayments on its consumer auto loan portfolio. Debt securitiesaveraged $606 million in the third quarter of 2002 compared with $473 millionin the third quarter of 2001. The growth in the securities portfolio wasdirectly attributable to the significant deposit growth achieved during thepast year.

 

13

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**AVERAGEBALANCES, YIELDS AND RATES PAID (TAXABLE-EQUIVALENT BASIS)(1)**

 
|                                                                              |   | **Quarter ended September 30,** |          |
|-----------------------------------------------------------------------------------|--------|---------------------------------|---------------|
|                                                                              |   | **2002**                        |          | **2001** |   |
| **(in thousands)**                                                                |   | **Average  Balance**            |          | **Interest  income/ expense** |   | **Yields/  rates** |   | **Average  Balance** |   | **Interest  income/  expense** |   | **Yields/  rates** |   |
| **ASSETS**                                                                        |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **Interest  earning assets**                                                      |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Short-term funds                                                                  |   | **$**                           | **6,645**     | ** ** | **$** | **26** | ** ** | **1.55** | **%** | $ | 27,020 |   | $ | 238 |   | 3.49 | % |
| Loans held for sale                                                               |   | **11,638**                      | ** **    | **124** | ** ** | **4.23** | ** ** | 19,047 |   | 339 |   | 7.06 |   |
| Securities available for sale(2)                                                  |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| U.S. Treasury and federal agencies                                                |   | **69,386**                      | ** **    | **775** | ** ** | **4.43** | ** ** | 78,412 |   | 1,111 |   | 5.62 |   |
| U.S. States and political subdivisions                                            |   | **114,286**                     | ** **    | **1,883** | ** ** | **6.54** | ** ** | 124,124 |   | 2,086 |   | 6.67 |   |
| Mortgage-backed securities                                                        |   | **386,337**                     | ** **    | **4,745** | ** ** | **4.87** | ** ** | 270,012 |   | 3,707 |   | 5.45 |   |
| Other securities                                                                  |   | **36,015**                      | ** **    | **338** | ** ** | **3.72** | ** ** | 883 |   | 49 |   | 22.02 |   |
| Total investment securities                                                       |   | **606,024**                     | ** **    | **7,741** | ** ** | **5.07** | ** ** | 473,431 |   | 6,953 |   | 5.83 |   |
| FHLB / Federal Reserve stock                                                      |   | **7,153**                       | ** **    | **90** | ** ** | **4.99** | ** ** | 10,835 |   | 114 |   | 4.17 |   |
| Loans(3):                                                                         |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Commercial                                                                        |   | **161,994**                     | ** **    | **2,639** | ** ** | **6.46** | ** ** | 141,385 |   | 2,872 |   | 8.06 |   |
| Residential real estate                                                           |   | **296,946**                     | ** **    | **4,769** | ** ** | **6.37** | ** ** | 276,390 |   | 5,564 |   | 7.99 |   |
| Commercial real estate                                                            |   | **349,211**                     | ** **    | **6,424** | ** ** | **7.30** | ** ** | 326,106 |   | 6,679 |   | 8.13 |   |
| Real estate construction                                                          |   | **105,726**                     | ** **    | **1,595** | ** ** | **5.99** | ** ** | 100,076 |   | 1,800 |   | 7.14 |   |
| Consumer installment                                                              |   | **290,780**                     | ** **    | **5,609** | ** ** | **7.65** | ** ** | 325,822 |   | 6,660 |   | 8.11 |   |
| Total loans                                                                       |   | **1,204,657**                   | ** **    | **21,036** | ** ** | **6.93** | ** ** | 1,169,779 |   | 23,575 |   | 8.00 |   |
| Total interest-earning assets                                                     |   | **1,836,117**                   | ** **    | **29,017** | ** ** | **6.27** | ** ** | 1,700,112 |   | 31,219 |   | 7.29 |   |
| Total noninterest-earning assets                                                  |   | **102,867**                     | ** **    |   | ** ** |   | ** ** | 107,262 |   |   |   |   |   |
| Total assets                                                                      |   | **$**                           | **1,938,984** | ** ** |   | ** ** |   | ** ** | $ | 1,807,374 |   |   |   |   |   |
| **LIABILITIES**                                                                   |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **Interest-bearing  liabilities**                                                 |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Interest-bearing deposits                                                         |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Savings                                                                           |   | **$**                           | **212,613**   | ** ** | **$** | **626** | ** ** | **1.17** | ** ** | $ | 180,244 |   | $ | 756 |   | 1.66 |   |
| Checking                                                                          |   | **201,470**                     | ** **    | **243** | ** ** | **0.48** | ** ** | 187,940 |   | 506 |   | 1.07 |   |
| Money market accounts                                                             |   | **267,280**                     | ** **    | **1,063** | ** ** | **1.58** | ** ** | 257,461 |   | 1,919 |   | 2.96 |   |
| Certificates of deposit                                                           |   | **595,712**                     | ** **    | **5,599** | ** ** | **3.73** | ** ** | 631,558 |   | 8,865 |   | 5.57 |   |
| Total interest-bearing deposits                                                   |   | **1,277,075**                   | ** **    | **7,531** | ** ** | **2.34** | ** ** | 1,257,203 |   | 12,046 |   | 3.80 |   |
| Short-term borrowings                                                             |   | **137,586**                     | ** **    | **462** | ** ** | **1.33** | ** ** | 103,827 |   | 784 |   | 3.00 |   |
| Long-term borrowings                                                              |   | **78,165**                      | ** **    | **945** | ** ** | **4.80** | ** ** | 45,990 |   | 595 |   | 5.13 |   |
| Total interest-bearing liabilities                                                |   | **1,492,826**                   | ** **    | **8,938** | ** ** | **2.38** | ** ** | 1,407,020 |   | 13,425 |   | 3.79 |   |
| Noninterest-bearing liabilities:                                                  |   |                            | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Checking                                                                          |   | **249,814**                     | ** **    |   | ** ** |   | ** ** | 216,091 |   |   |   |   |   |
| Other liabilities                                                                 |   | **16,224**                      | ** **    |   | ** ** |   | ** ** | 16,132 |   |   |   |   |   |
| Total noninterest-bearing liabilities                                             |   | **266,038**                     | ** **    |   | ** ** |   | ** ** | 232,223 |   |   |   |   |   |
| Shareholders’ equity                                                         |   | **180,120**                     | ** **    |   | ** ** |   | ** ** | 168,131 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                                   |   | **$**                           | **1,938,984** | ** ** |   | ** ** |   | ** ** | $ | 1,807,374 |   |   |   |   |   |
| **Net interest  income and net interest margin on a taxable-equivalent basis(4)** |   |                            | ** **    | **$** | **20,079** |   | **4.34** | **%** |   |   | $ | 17,794 |   | 4.15 | % |

 

----

(1)          The average prime rateof the Bancorp was 4.75% and 6.57% for the quarters ended September 30, 2002and 2001, respectively. The average three-month London Interbank Offered Rate(LIBOR) was 1.80% and 3.43% for the quarters ended September 30, 2002 and 2001,respectively.

(2)          Yields are based onamortized cost balances computed on a settlement day basis.

(3)          Loan fee income isincluded in the interest income calculation, and nonaccrual loans are includedin the average loan base upon which the interest rate earned on loans iscalculated.

(4)          Interest and yield onobligations of state and political subdivisions and tax-exempt loans arecomputed on a taxable equivalent basis using U.S. statutory tax rate of 34percent.

 

14

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|                                                                              |   | **Nine months ended   September 30,** |          |
|-----------------------------------------------------------------------------------|--------|--------------------------------------------|---------------|
|                                                                              |   | **2002**                                   |          | **2001** |   |
| **(in thousands)**                                                                |   | **Average  Balance**                       |          | **Interest  income/  expense** |   | **Yields/  rates** |   | **Average  Balance** |   | **Interest  income/  expense** |   | **Yields/  rates** |   |
| **ASSETS**                                                                        |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **Interest  earning assets**                                                      |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Short-term funds                                                                  |   | **$**                                      | **10,742**    | ** ** | **$** | **127** | ** ** | **1.58** | **%** | $ | 27,500 |   | $ | 1,042 |   | 5.07 | % |
| Loans held for sale                                                               |   | **14,114**                                 | ** **    | **619** | ** ** | **5.86** | ** ** | 16,054 |   | 881 |   | 7.34 |   |
| Securities available for sale(2)                                                  |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| U.S. Treasury and federal agencies                                                |   | **54,746**                                 | ** **    | **1,814** | ** ** | **4.43** | ** ** | 120,064 |   | 5,362 |   | 5.97 |   |
| U.S. States and political subdivisions                                            |   | **116,023**                                | ** **    | **5,803** | ** ** | **6.69** | ** ** | 125,610 |   | 6,426 |   | 6.84 |   |
| Mortgage-backed securities                                                        |   | **386,929**                                | ** **    | **14,439** | ** ** | **4.99** | ** ** | 180,271 |   | 8,709 |   | 6.46 |   |
| Other securities                                                                  |   | **22,461**                                 | ** **    | **573** | ** ** | **3.41** | ** ** | 8,471 |   | 181 |   | 2.86 |   |
| Total investment securities                                                       |   | **580,159**                                | ** **    | **22,629** | ** ** | **5.21** | ** ** | 434,416 |   | 20,678 |   | 6.36 |   |
| FHLB / Federal Reserve stock                                                      |   | **6,985**                                  | ** **    | **284** | ** ** | **5.44** | ** ** | 11,093 |   | 351 |   | 4.23 |   |
| Loans(3)                                                                          |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Commercial                                                                        |   | **160,436**                                | ** **    | **8,103** | ** ** | **6.75** | ** ** | 146,293 |   | 9,412 |   | 8.60 |   |
| Residential real estate                                                           |   | **277,103**                                | ** **    | **14,070** | ** ** | **6.79** | ** ** | 283,082 |   | 17,339 |   | 8.19 |   |
| Commercial real estate                                                            |   | **339,515**                                | ** **    | **18,777** | ** ** | **7.39** | ** ** | 324,125 |   | 19,962 |   | 8.23 |   |
| Real estate construction                                                          |   | **105,748**                                | ** **    | **4,573** | ** ** | **5.78** | ** ** | 96,969 |   | 5,667 |   | 7.81 |   |
| Consumer installment                                                              |   | **296,026**                                | ** **    | **17,089** | ** ** | **7.72** | ** ** | 329,156 |   | 20,109 |   | 8.17 |   |
| Total loans                                                                       |   | **1,178,828**                              | ** **    | **62,612** | ** ** | **7.10** | ** ** | 1,179,625 |   | 72,489 |   | 8.22 |   |
| Total interest-earning assets                                                     |   | **1,790,828**                              | ** **    | **86,271** | ** ** | **6.44** | ** ** | 1,668,688 |   | 95,441 |   | 7.65 |   |
| Total noninterest-earning assets                                                  |   | **103,481**                                | ** **    |   | ** ** |   | ** ** | 108,398 |   |   |   |   |   |
| Total assets                                                                      |   | **$**                                      | **1,894,309** | ** ** |   | ** ** |   | ** ** | $ | 1,777,086 |   |   |   |   |   |
| **LIABILITIES**                                                                   |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **Interest-bearing  liabilities**                                                 |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Interest-bearing deposits                                                         |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Savings                                                                           |   | **$**                                      | **206,012**   | ** ** | **$** | **1,834** | ** ** | **1.19** | ** ** | $ | 175,930 |   | $ | 2,668 |   | 2.03 |   |
| Checking                                                                          |   | **201,251**                                | ** **    | **784** | ** ** | **0.52** | ** ** | 184,614 |   | 1,619 |   | 1.17 |   |
| Money market accounts                                                             |   | **268,617**                                | ** **    | **3,295** | ** ** | **1.64** | ** ** | 257,799 |   | 6,832 |   | 3.54 |   |
| Certificates of deposit                                                           |   | **604,620**                                | ** **    | **18,538** | ** ** | **4.10** | ** ** | 603,932 |   | 25,833 |   | 5.72 |   |
| Total interest-bearing deposits                                                   |   | **1,280,500**                              | ** **    | **24,451** | ** ** | **2.55** | ** ** | 1,222,275 |   | 36,952 |   | 4.04 |   |
| Short-term borrowings                                                             |   | **111,646**                                | ** **    | **1,104** | ** ** | **1.32** | ** ** | 120,541 |   | 4,314 |   | 4.78 |   |
| Long-term borrowings                                                              |   | **71,246**                                 | ** **    | **2,551** | ** ** | **4.79** | ** ** | 44,869 |   | 1,423 |   | 4.24 |   |
| Total interest-bearing liabilities                                                |   | **1,463,392**                              | ** **    | **28,106** | ** ** | **2.57** | ** ** | 1,387,685 |   | 42,689 |   | 4.11 |   |
| Noninterest bearing liabilities:                                                  |   |                                       | ** **    |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Checking                                                                          |   | **240,674**                                | ** **    |   | ** ** |   | ** ** | 207,130 |   |   |   |   |   |
| Other liabilities                                                                 |   | **15,372**                                 | ** **    |   | ** ** |   | ** ** | 16,635 |   |   |   |   |   |
| Total noninterest-bearing liabilities                                             |   | **256,046**                                | ** **    |   | ** ** |   | ** ** | 223,765 |   |   |   |   |   |
| Shareholders’ equity                                                         |   | **174,871**                                | ** **    |   | ** ** |   | ** ** | 165,636 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                                   |   | **$**                                      | **1,894,309** | ** ** |   | ** ** |   | ** ** | $ | 1,777,086 |   |   |   |   |   |
| **Net interest  income and net interest margin on a taxable-equivalent basis(4)** |   |                                       | ** **    | **$** | **58,165** |   | **4.34** | **%** |   |   | $ | 52,752 |   | 4.23 | % |

 

----

 

(1)          The average prime rateof the Bancorp was 4.75% and 7.51% for the nine months ended September 30, 2002and 2001, respectively. The average three-month London Interbank Offered Rate(LIBOR) was 1.85% and 4.31% for the nine months ended September 30, 2002 and2001, respectively.

(2)          Yields are based onamortized cost balances computed on a settlement day basis.

(3)          Loan fee income isincluded in the interest income calculation, and nonaccrual loans are includedin the average loan base upon which the interest rate earned on loans iscalculated.

(4)          Interest and yield onobligations of state and political subdivisions and tax-exempt loans arecomputed on a taxable equivalent basis using U.S. statutory tax rate of 34percent.

 

15

----

 

The net interest margin increased to 4.34% in third quarter 2002 from4.15% in third quarter 2001, principally due to a faster decline in deposit andborrowing costs than loan and investment yields. The net interest marginincreased to 4.34% for the first nine months of 2002 from 4.23% for the sameperiod of 2001, primarily due to lower interest rates paid on deposits andborrowings.

 

An important contributor to the growth in net interest income and netinterest margin from third quarter 2001 was a 4% increase in core deposits, theBancorp’s lowest cost source of funding. Average core deposits were $1.527million and $1.473 million and funded 79% and 82% of the Bancorp’s averagetotal assets in the third quarter of 2002 and 2001, respectively. Total averageinterest-bearing deposits increased to $1.277 million in third quarter 2002from $1.257 million a year ago. For the same period, total averagenoninterest-bearing deposits increased to $250 million from $216 million. Whilecertificates of deposits declined on average from $632 million to $596 million,noninterest-bearing checking and other core deposit categories increased onaverage from $842 million to $931 million in third quarter 2002 reflecting theBancorp’s success in growing customer relationships.

 

PROVISION FOR CREDIT LOSSES

 

In 2001, the loan loss reserve increased due to increasing probableloan losses associated with the recessionary environment. The provision forcredit losses for the third quarter of 2002 decreased by $80 thousand over theyear-ago quarter. This provision was $56 thousand in excess of net charge-offslargely due to a shift in the loan portfolio mix to higher levels of commercialand commercial real estate which carry higher reserves. For the nine-monthperiod ended September 30, 2002, the provision decreased to $1.3 million ascompared to $3.1 million for the same period last year, as the loan portfoliocontinued to improve in overall performance.

 

16

----

 

NONINTEREST INCOME

 
|                                   |   | **Quarter ended  September 30,** |       | **%  Change** |   | **Nine months ended  September 30,** |     | **%  Change** |       |
|----------------------------------------|--------|----------------------------------|------------|---------------|--------|--------------------------------------|----------|---------------|------------|
| **(in thousands)**                     |   | **2002**                         |       | **2001**      |   |                                 | **2002** |          | **2001**   |   |   |
|                                   |   |                             | ** ** |          |   |                                 |     |          | ** ** |   |   |   |   |
| Service charges on deposit accounts    |   | **$**                            | **2,348**  | ** **    | $      | 2,062                                |     | 14            | %          | **$** | **6,827** | ** ** | $ | 6,133 |   | 11 | % |
| Trust and investment fees:             |   |                             | ** ** |          |   |                                 |     |          | ** ** |   |   |   |   |
| Asset management and custody fees      |   | **157**                          | ** ** | 642           |   | (76                                  | )        | **1,375**     | ** ** | 1,982 |   | (31 | ) |
| Mutual fund and annuity sales fees     |   | **250**                          | ** ** | 230           |   | 9                                    |     | **863**       | ** ** | 737 |   | 17 |   |
| Total trust and invesment fees         |   | **407**                          | ** ** | 872           |   | (53                                  | )        | **2,238**     | ** ** | 2,719 |   | (18 | ) |
| Other fees:                            |   |                             | ** ** |          |   |                                 |     |          | ** ** |   |   |   |   |
| Cash network fees                      |   | **832**                          | ** ** | 742           |   | 12                                   |     | **2,375**     | ** ** | 2,130 |   | 12 |   |
| Charges and fees on loans              |   | **74**                           | ** ** | 91            |   | (19                                  | )        | **265**       | ** ** | 229 |   | 16 |   |
| Bank-owned life insurance              |   | **135**                          | ** ** | 124           |   | 9                                    |     | **386**       | ** ** | 784 |   | (51 | ) |
| All other fees                         |   | **373**                          | ** ** | 301           |   | 24                                   |     | **1,058**     | ** ** | 1,167 |   | (9 | ) |
| Total other fees                       |   | **1,414**                        | ** ** | 1,258         |   | 12.4                                 |     | **4,084**     | ** ** | 4,310 |   | (5 | ) |
| Mortgage banking fees:                 |   |                             | ** ** |          |   |                                 |     |          | ** ** |   |   |   |   |
| Origination and other closing fees     |   | **435**                          | ** ** | 199           |   | 119                                  |     | **928**       | ** ** | 454 |   | 104 |   |
| Net gains on mortgage loan sales       |   | **780**                          | ** ** | 882           |   | (12                                  | )        | **1,835**     | ** ** | 2,001 |   | (8 | ) |
| Servicing fees, net of amortization    |   | **80**                           | ** ** | 103           |   | (22                                  | )        | **253**       | ** ** | 327 |   | (23 | ) |
| Total mortgage banking fees            |   | **1,295**                        | ** ** | 1,184         |   | 9                                    |     | **3,016**     | ** ** | 2,782 |   | 8 |   |
| Insurance                              |   | **2,194**                        | ** ** | 2,134         |   | 3                                    |     | **7,384**     | ** ** | 6,930 |   | 7 |   |
| Net gains (losses) on securities sold  |   | **—**                       | ** ** | 19            |   | (100                                 | )        | **—**    | ** ** | 52 |   | (100 | ) |
| Net gains (losses) on sale of property |   | **37**                           | ** ** | 130           |   | (72                                  | )        | **160**       | ** ** | 237 |   | (33 | ) |
| Total noninterest income               |   | **$**                            | **7,695**  | ** **    | $      | 7,659                                |     | 1             | %          | **$** | **23,709** | ** ** | $ | 23,163 |   | 2 | % |

 

Deposit service fees increased 14% for the third quarter of 2002 overthe year-ago quarter due to growth in primary accounts, price increase andincreased activity.

 

Fee income in the third quarter from trust and brokerage business linesdeclined 53% from the prior year quarter and 55% from the previous quarter.Third quarter 2002 trust revenues included a net reduction in fee income torefund certain trust clients for a billing error that resulted in overchargesto those accounts. Without this fee reduction trust and brokerage fee incomewould have only declined about 19% from the prior year and 22% from the priorquarter. The Bancorp managed or maintained personal trust, employee benefittrust and agency assets of approximately $290 million and $343 million atSeptember 30, 2002 and 2001, respectively. The reduction in assets undermanagement is largely attributable to the decline in the stock market during2002.

 

Other fees increased to $1.4 million, or 12% in third quarter 2002 fromthe prior year primarily due to increased customer acceptance and usage of theBancorp’s debit card. For the first nine months of 2002, other fee incomedeclined to $4.1 million, or 5% from the prior year primarily due to thereceipt of $525 thousand death benefit on bank-owned life insurance in 2001.Excluding this benefit, total other fees would have increased 8% from the prioryear.

 

The mortgage banking business remained strong, generating $1.3 millionin quarterly revenues, a 9% increase from the third quarter of 2001. Reflectingthe continued strength in the housing sector and low mortgage rates, themortgage banking business had another strong quarter. Mortgage fundings for thequarter were $90.1 million, up 42% over the same quarter last year, bringingyear-to-date fundings to $224.3 million. For the quarter, 49% of the loanfundings were held in portfolio with the remaining loans being sold whichreduced the net gains on mortgage loan sales by 12% from the prior year.

 

17

----

 

Insurance income increased 3% from the third quarter of 2001. Thisincrease from the previous year’s quarter was due to increased sales activitiesand increased pricing on the renewal of existing insurance policies.

 

NONINTEREST EXPENSE

 
|                              |   | **Quarter ended  September 30** |       | **%  Change** |   | **Nine months ended  September 30** |     | **%  Change** |     |
|-----------------------------------|--------|---------------------------------|------------|---------------|--------|-------------------------------------|----------|---------------|----------|
| **(in thousands)**                |   | **2002**                        |       | **2001**      |   |                                | **2002** |          | **2001** |   |   |
|                              |   |                            |       |          |   |                                |     |          |     |   |   |   |   |
| Salaries                          |   | **$**                           | **7,199**  |          | $      | 7,192                               |     | —        | %        | **$** | **21,862** |   | $ | 21,381 |   | 2 | % |
| Incentive compensation            |   | **1,199**                       |       | 478           |   | 151                                 |     | **2,400**     |     | 1,642 |   | 46 |   |
| Employee benefits                 |   | **1,439**                       |       | 1,795         |   | (20                                 | )        | **4,813**     |     | 4,343 |   | 11 |   |
| Occupancy and equipment           |   | **2,345**                       |       | 2,591         |   | (10                                 | )        | **7,444**     |     | 7,871 |   | (5 | ) |
| Professional services             |   | **739**                         |       | 332           |   | 123                                 |     | **1,593**     |     | 967 |   | 65 |   |
| Telecommunications                |   | **353**                         |       | 349           |   | 1                                   |     | **986**       |     | 1,188 |   | (17 | ) |
| Computer software and maintenance |   | **690**                         |       | 531           |   | 30                                  |     | **1,439**     |     | 1,436 |   | — |   |
| Stationary and supplies           |   | **290**                         |       | 289           |   | —                              |     | **1,029**     |     | 1,009 |   | 2 |   |
| Advertising and promotions        |   | **784**                         |       | 421           |   | 86                                  |     | **2,184**     |     | 1,396 |   | 56 |   |
| Intangible amortization           |   | **281**                         |       | 266           |   | 6                                   |     | **791**       |     | 800 |   | (1 | ) |
| Postage                           |   | **258**                         |       | 211           |   | 22                                  |     | **744**       |     | 698 |   | 7 |   |
| Other real estate owned           |   | **2**                           |       | 117           |   | (98                                 | )        | **20**        |     | 119 |   | (83 | ) |
| All other                         |   | **1,646**                       |       | 1,919         |   | (14                                 | )        | **5,954**     |     | 5,740 |   | 4 |   |
|                              |   |                            |       |          |   |                                |     |          |     |   |   |   |   |
| Total                             |   | **$**                           | **17,225** |          | $      | 16,491                              |     | 5             | %        | **$** | **51,259** |   | $ | 48,590 |   | 6 | % |

 

Management views the efficiency ratio (the ratio of noninterest expenseto the sum of tax equivalent net interest income and noninterest income) as animportant measure of overall operating expense performance and cost management.Bancorp’s efficiency ratio decreased to 62.02% for the quarter compared to64.79% for the comparable period in 2001.

 

Salary expenses of $7.2 million for the third quarter 2002 were unchangedfrom the prior year’s quarter. On a year-to-date basis, salary expenseincreased 2% from 2001 to $21.9 million. Salary expenses have been controlledthrough staff reductions associated with branch reconfigurations and sales aswell as the elimination of redundant positions in support functions.

 

Incentive compensation increased to $1.2 million in the third quarterof 2002, a 151% increase over the same period last year. For the first ninemonths of 2002, incentive compensation was $2.4 million, a 46% increase overthe prior year. These increases are directly tied to the Bancorp’s revenue andoverall profitability performance as measured by our team-based compensationand sale programs.

 

Employee benefit costs for the third quarter of 2002 were 20% less thatthe comparable quarter of 2001, due to lower medical claims incurred during theperiod. For the first nine months of 2002, employee benefit costs increased 11%primarily due to higher medical claims experience in the first half of 2002.

 

Occupancy expenses for the quarter of $2.3 million decreased $246thousand or 10% compared to the third quarter of 2001. The Bancorp reevaluatedits retail branch network and incurred expenses related to the consolidation ofseveral branches in prior periods. While costs were incurred at the time ofconsolidation, they have resulted in lower cost and more efficient delivery inthe current quarter.

 

18

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Professional services expenses for the third quarter of 2002 were $407thousand, or 123% higher than the prior year’s quarter. This increase is due toprofessional services relating to expanding and growing our businesses,increased external audit costs associated with the new Sarbanes-Oxley Act of2002 as well as the implementation of the Bancorp’s new check imaging system.

 

Advertising and promotion expenses have increased for both the quarterand on a year-to-date basis to support sales growth and research initiatives inconjunction with ongoing strategic initiatives.

 

Other expenses relating to corporate operating expenses for the quarterincreased to $5.0 million or 13.7% compared to the same quarter of 2001.Expenditures relating to external and internal audit services have increaseddue to the transition of independent public accountants. Bancorp has alsoincurred increased marketing related costs to provide research in conjunctionwith ongoing strategic growth initiatives.

 

INCOME TAXES

 

For the third quarter of 2002, provision for income taxes increased by40.3% to $3.2 million from the previous year quarter due to lower levels of taxdeferred assets in relation to total assets. The third quarter 2002 effectivetax rate was 33.56% compared to 29.16% in the prior year as most of thecomponents of the increased revenues are fully taxable. For the nine monthsended September 30, 2002, the provision for income taxes increased 42.9% to$8.9 million from the comparable 2001 period. The first nine months of 2002 effective tax rate was 32.87% compared to28.4% in the prior year.

 

BALANCE SHEET ANALYSIS

 

SECURITIES AVAILABLE FOR SALE

 

The following table provides the cost and fair value for the majorcomponents of securities available for sale carried at fair value. There wereno securities classified as held to maturity or trading at the end of theperiods presented.

 
|                                                  |   | **September 30, 2002** |        | **December 31, 2001**      |   | **September 30, 2001** |   |
|-------------------------------------------------------|--------|------------------------|-------------|----------------------------|--------|------------------------|--------|
| **(in thousands)**                                    |   | **Cost**               |        | **Estimated  fair  value** |   | **Cost**               |   | **Estimated  fair  value** |   | **Cost** |   | **Estimated  fair  value** |   |
|                                                  |   |                   |        |                       |   |                   |   |   |   |   |   |   |   |
| Securities of U. S. Treasury and federal agencies     |   | **$**                  | **66,401**  | ** **                 | **$**  | **68,486**             |   | $ | 42,316 |   | $ | 43,066 |   | $ | 57,002 |   | $ | 58,021 |   |
| Securities of U. S. states and political subdivisions |   | **110,021**            | ** **  | **114,586**                |   | 117,254                |   | 118,279 |   | 122,089 |   | 125,204 |   |
| Mortgage-backed securities                            |   | **384,129**            | ** **  | **391,652**                |   | 378,341                |   | 380,051 |   | 304,118 |   | 308,342 |   |
| Other                                                 |   | **29,656**             | ** **  | **30,210**                 |   | —                 |   | — |   | — |   | — |   |
| Total debt securities                                 |   | **590,207**            | ** **  | **604,934**                |   | 537,911                |   | 541,396 |   | 483,209 |   | 491,567 |   |
| Marketable equity securities                          |   | **3,813**              | ** **  | **4,992**                  |   | 3,795                  |   | 5,126 |   | 4,995 |   | 4,862 |   |
|                                                  |   |                   |        |                       |   |                   |   |   |   |   |   |   |   |
| Total                                                 |   | **$**                  | **594,020** | ** **                 | **$**  | **609,926**            |   | $ | 541,706 |   | $ | 546,522 |   | $ | 488,204 |   | $ | 496,429 |   |

 

19

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The following table provides the components of the estimated unrealizednet gains on securities available for sale for the end of each periodpresented. The estimated unrealized net gain or loss on securities availablefor sale is reported on an after-tax basis as a component of cumulative othercomprehensive income.

** **
| **(in thousands)**                |   | **September 30,  2002** |       | **December 31,  2001** |   | **September 30,  2001** |   |
|-----------------------------------|--------|-------------------------|------------|------------------------|--------|-------------------------|--------|
|                              |   |                    |       |                   |   |                    |   |
| Estimated unrealized gross gains  |   | **$**                   | **16,031** |                   | $      | 7,101                   |   | $ | 8,443 |   |
| Estimated unrealized gross losses |   | **125**                 |       | 2,285                  |   | 218                     |   |
| Estimated unrealized net gain     |   | **$**                   | **15,906** |                   | $      | 4,816                   |   | $ | 8,225 |   |

 

The weighted average expected remaining maturity of the debt securitiesportion of the securities available for sale portfolio was 2 years at September30, 2002. Expected remaining maturities will differ from contractual maturitiesbecause obligations may be prepaid.

 

LOAN PORTFOLIO

 
|                                                                                              |   |               |          |               |   |               |   | **% Change  Sept. 30, 2002 from** |      |
|---------------------------------------------------------------------------------------------------|--------|--------------------|---------------|--------------------|--------|--------------------|--------|-----------------------------------|-----------|
| **(in thousands)**                                                                                |   | **Sept. 30  2002** |          | **Dec. 31,  2001** |   | **Sept. 30  2001** |   | **Dec. 31,  2001**                |      | **Sept. 30  2001** |   |
|                                                                                              |   |               |          |               |   |               |   |                              |      |   |   |
| Commercial(1)                                                                                     |   | **$**              | **174,380**   |               | $      | 177,745            |   | $                                 | 165,965   |   | (2 | )% | 5 | % |
| Residential real estate(2)                                                                        |   | **337,918**        |          | 301,338            |   | 316,895            |   | 12                                |      | 7 |   |
| Commercial mortgage                                                                               |   | **350,125**        |          | 323,643            |   | 316,157            |   | 8                                 |      | 11 |   |
| Real estate construction                                                                          |   | **103,082**        |          | 85,138             |   | 91,959             |   | 21                                |      | 12 |   |
| Consumer installment                                                                              |   | **268,287**        |          | 274,361            |   | 287,973            |   | (2                                | )         | (7 | ) |
|                                                                                              |   |               |          |               |   |               |   |                              |      |   |   |
| Total loans (net of unearned income, including net deferred loan fees,  of $531, $(30) and $(26)) |   | **$**              | **1,233,792** |               | $      | 1,162,225          |   | $                                 | 1,178,949 |   | 6 | % | 5 | % |

 

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(1)          Includes agriculturalloans (loans to finance agricultural production) of $316 thousand, $507thousand and $431 thousand at September 30, 2002, December 31, 2001 andSeptember 30, 2001, respectively.

(2)          Includes agriculturalloans that are secured by real estate of $6,529 thousand, $5,902 thousand and$5,750 thousand at September 30, 2002, December 31, 2001 and September 30,2001, respectively.

 

NONACCRUAL LOANS AND OTHER ASSETS

 

The table on the next page presents comparative data for nonaccrualloans and other assets. Management’s classification of a loan as nonaccrualdoes not necessarily indicate that the principal of the loan is uncollectiblein whole or in part. The Bancorp anticipates changes in the amount ofnonaccrual loans that result from increases in loans outstanding, changes inborrower’s circumstances or from resolutions of loans in the nonaccrualportfolio. The performance of any individual loan can be affected by externalfactors, such as the interest rate environment or factors particular to aborrower such as actions taken by a borrower’s management.

 

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NONACCRUAL LOANS AND OTHER REAL ESTATE OWNED

 
| **(in thousands)**                                 |   | **Sept. 30,  2002** |      | **Dec. 31,  2001** |   | **Sept. 30,  2001** |   |
|----------------------------------------------------|--------|---------------------|-----------|--------------------|--------|---------------------|--------|
|                                               |   |                |      |               |   |                |   |
| Nonaccrual loans:                                  |   |                |      |               |   |                |   |
| Commercial                                         |   | **$**               | **1,422** |               | $      | 1,279               |   | $ | 1,472 |   |
| Residential real estate                            |   | **127**             |      | —             |   | —              |   |
| Commercial mortgage                                |   | **474**             |      | —             |   | 127                 |   |
| Real estate construction                           |   | **71**              |      | —             |   | 40                  |   |
| Consumer installment                               |   | **238**             |      | —             |   | —              |   |
| Total nonaccrual loans                             |   | **2,332**           |      | 1,279              |   | 1,639               |   |
| As a percentage of total loans                     |   | **0.19**            | **%**     | 0.11               | %      | 0.14                | %      |
|                                               |   |                |      |               |   |                |   |
| Other real estate owned                            |   | **323**             |      | 638                |   | 667                 |   |
| Total nonaccrual loans and other real estate owned |   | **$**               | **2,655** |               | $      | 1,917               |   | $ | 2,306 |   |
| As a percentage of total assets                    |   | **0.13**            | **%**     | 0.10               | %      | 0.12                | %      |
| Loans past due 90 days as to interest or principal |   | $                   | 1,561     |               | $      | 2,819               |   | $ | 1,371 |   |

 

Loans are placed on nonaccrual status when, in theopinion of management, reasonable doubt exists as to the full, timelycollection of interest or principal, or a specific loan meets the criteria fornonaccrual status established by regulatory authorities. When a loan is placedon nonaccrual status, all interest previously accrued but not collected isreversed against current period interest income. No interest is taken intoincome on nonaccrual loans until such time the borrower demonstrates sustainedperformance over a period of time in accordance with contractual terms and isremoved from nonaccrual status.

 

Other real estate owned includes real estate acquired by foreclosure(in partial or complete satisfaction of debt), or otherwise surrendered by theborrower to Bancorp’s possession. Other real estate owned is recorded at thelower of cost or fair value on the date of acquisition or transfer from loans.Write-downs to fair value at the date of acquisition are charged to theallowance for credit losses. Subsequent to transfer, these assets are adjustedthrough a valuation allowance to the lower of the net carrying value or thefair value (net of estimated selling expenses) based on periodic appraisals

 

Loans contractually past due 90 days or more as to interest orprincipal, but not included in nonaccrual loans are both well-secured and inthe process of collection.

 

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ALLOWANCE FOR CREDIT LOSSES

 
|                                                                            |       | **Quarter ended  September 30,** |       | **Nine months ended  September 30,** |   |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|--------|
| **(in thousands)**                                                              |       | **2002**                         |       | **2001**                             |   | **2002** |   | **2001** |   |
|                                                                            |       |                             |       |                                 |   |   |   |   |   |
| Balance, beginning of period                                                    | ** ** | **$**                            | **13,999** |                                 | $      | 14,350 |   | **$** | **13,947** |   | $ | 13,232 |   |
|                                                                            |       |                             |       |                                 |   |   |   |   |   |
| Provision for credit losses                                                     | ** ** | **350**                          |       | 430                                  |   | **1,325** |   | 3,060 |   |
|                                                                            |       |                             |       |                                 |   |   |   |   |   |
| Loan charge-offs:                                                               |       |                             |       |                                 |   |   |   |   |   |
| Commercial                                                                      | ** ** | **—**                       |       | 128                                  |   | **110** |   | 243 |   |
| Residential mortgage                                                            | ** ** | **19**                           |       | 32                                   |   | **73** |   | 175 |   |
| Commercial mortgage                                                             | ** ** | **4**                            |       | —                               |   | **13** |   | 13 |   |
| Real estate construction                                                        | ** ** | **—**                       |       | —                               |   | **—** |   | — |   |
| Consumer installment                                                            | ** ** | **914**                          |       | 1,134                                |   | **3,035** |   | 3,722 |   |
| Total loan charge-offs                                                          | ** ** | **937**                          |       | 1,294                                |   | **3,231** |   | 4,153 |   |
|                                                                            |       |                             |       |                                 |   |   |   |   |   |
| Loan recoveries:                                                                |       |                             |       |                                 |   |   |   |   |   |
| Commercial                                                                      | ** ** | **116**                          |       | 25                                   |   | **307** |   | 131 |   |
| Residential mortgage                                                            | ** ** | **6**                            |       | —                               |   | **9** |   | 2 |   |
| Commercial mortgage                                                             | ** ** | **1**                            |       | 3                                    |   | **2** |   | 3 |   |
| Real estate construction                                                        | ** ** | **—**                       |       | —                               |   | **—** |   | — |   |
| Consumer installment                                                            | ** ** | **520**                          |       | 704                                  |   | **1,696** |   | 1,943 |   |
| Total loan recoveries                                                           | ** ** | **643**                          |       | 732                                  |   | **2,014** |   | 2,079 |   |
| Total net loan charge-offs                                                      | ** ** | **294**                          |       | 562                                  |   | **1,217** |   | 2,074 |   |
|                                                                            |       |                             |       |                                 |   |   |   |   |   |
| Balance, end of period                                                          | ** ** | **$**                            | **14,055** |                                 | $      | 14,218 |   | **$** | **14,055** |   | $ | 14,218 |   |
|                                                                            |       |                             |       |                                 |   |   |   |   |   |
| Total net loan charge-offs as a percentage of average total loans  (annualized) | ** ** | **0.10**                         | **%**      | 0.19                                 | %      | **0.10** | **%** | 0.18 | % |
| Allowance as a percentage of total loans                                        |       | **1.14**                         | **%**      | 1.21                                 | %      | **1.14** | **%** | 1.21 | % |

 

The Bancorp considers the allowance for loan losses of $14.1 millionadequate to cover losses inherent in loans, loan commitments and standby andother letters of credit at September 30, 2002. During the quarter acomprehensive review of the allowance is performed considering such factors asthe levels of loans outstanding, loss experience, delinquency levels, certainindividual loan reviews, and an evaluation of the regional and nationaleconomic environment. The aggregate balance of individual risk-rated loansincreased by $29.5 million from the second quarter of 2002 to the third quarterof 2002, primarily due to growth in the commercial and commercial real estateloan portfolios. This required approximately $300 thousand of additionalreserves from quarter to quarter. Additionally, the qualitative factor forcurrent economic conditions was increased due to national events such as theuncertainty of war, moderate corporate earnings and declining consumer confidence.This required approximately $600 thousand in additional assigned reserves. Theeffects of these additional reserves on the allowance for credit losses reducedthe unallocated portion of the reserve to $1.2 million at September 30, 2002.

 

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DEPOSITS

 

The following table shows comparative detail of deposits.

 
| **(in  thousands)**           |   | **September  30,  2002** |          | **December,  31  2001** |   | **September  30,  2001** |   |
|-------------------------------|--------|--------------------------|---------------|-------------------------|--------|--------------------------|--------|
|                          |   |                     |          |                    |   |                     |   |
| Noninterest-bearing  checking |   | **$**                    | **266,722**   |                    | $      | 234,459                  |   | $ | 214,933 |   |
| Interest-bearing  checking    |   | **212,126**              |          | 200,430                 |   | 192,545                  |   |
| Money market  savings         |   | **261,092**              |          | 296,687                 |   | 259,596                  |   |
| Savings                       |   | **212,913**              |          | 153,744                 |   | 181,220                  |   |
| Certificates of  deposit      |   | **608,065**              |          | 630,748                 |   | 641,298                  |   |
|                          |   |                     |          |                    |   |                     |   |
| Total deposits                |   | **$**                    | **1,560,918** |                    | $      | 1,516,068                |   | $ | 1,489,592 |   |

 

CAPITALADEQUACY/RATIOS

 

The Bancorp and its subsidiary bank are subject to various regulatorycapital adequacy requirements administered by the Federal Reserve Board.Risk-based capital (RBC) guidelines establish a risk-adjusted ratio relatingcapital to different categories of assets and off-balance sheet exposures.

 
|                                                 |   | **Actual** |   | **For capital  adequacy purposes** |   | **To be well  capitalized under  the FDICIA  prompt corrective  action provisions** |   |
|------------------------------------------------------|--------|------------|--------|------------------------------------|--------|-------------------------------------------------------------------------------------|--------|
| **(in thousands)**                                   |   | **Amount** |   | **Ratio**                          |   | **Amount**                                                                          |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
|                                                 |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| As of September 30, 2002:                            |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)              |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| F&M Bancorp                                      |   | $          | 185    |                               | 13.12  | %                                                                                   | $      | 3112 |   | 38.00 | % | $ | 3141 |   | 310.00 | % |
| Farmers & Mechanics Bank                         |   | $          | 178    |                               | 12.69  |                                                                                | $      | 3112 |   | 38.00 |   | $ | 3140 |   | 310.00 |   |
|                                                 |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| Tier 1 capital (to risk-weighted assets)             |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| F&M Bancorp                                      |   | $          | 170    |                               | 12.12  | %                                                                                   | $      | 356 |   | 34.00 | % | $ | 384 |   | 36.00 | % |
| Farmers & Mechanics Bank                         |   | $          | 164    |                               | 11.69  |                                                                                | $      | 356 |   | 34.00 |   | $ | 384 |   | 36.00 |   |
|                                                 |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| Tier 1 capital (to average assets)  (Leverage ratio) |   |       |   |                               |   |                                                                                |   |   |   |   |   |   |   |
| F&M Bancorp                                      |   | $          | 170    |                               | 8.80   | %                                                                                   | $      | 377 |   | 34.00 | %(1) | $ | 397 |   | 35.00 | % |
| Farmers & Mechanics Bank                         |   | $          | 164    |                               | 8.55   |                                                                                | $      | 377 |   | 34.00 | (1) | $ | 396 |   | 35.00 |   |

 

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(1)          The leverage ratioconsists of Tier 1 capital divided by quarterly average total assets, excludinggoodwill and certain other items. The minimum leverage ratio guideline is 3%for banking organizations that do not anticipate significant growth and thathave well-diversified risk, excellent asset quality, high liquidity, goodearnings, effective management and monitoring of market risk and, in general,are considered top-rated, strong banking organizations.

 

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CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS

 

Through the normal course of operations, the Bancorp has entered intocertain contractual obligations and commitments. Such obligations generallyrelate to the funding of operations as well as leases for premises and equipment.As a financial services provider, the Bancorp routinely enters into commitmentsto extend credit, including loan commitments, standby letters of credit andfinancial guarantees. While contractual obligations represent future cashrequirements of the Bancorp, a portion of commitments to extend credit arelikely to expire without being drawn upon. Such commitments are subject to thesame credit policies and approval processes accorded to loans made in theregular course of business.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of our financial results of operations and financialposition require us to make estimates and assumptions that affect the amountsreported in the consolidated financial statements and related notes for theperiod presented, and actual results could differ from our estimates.  The critical accounting estimates, which areboth important to the portrayal of our financial condition and which requirecomplex, subjective judgments, are accrued restructuring costs, determinationof the allowance for loan losses, the classification and carrying value ofinvestments, the recognition of deferred tax assets; these areas are more fullydescribed in “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in our Annual Report on Form 10-K for the year endedDecember 31, 2001.

 

ASSET/LIABILITY ANDMARKET RISK MANAGEMENT

 

Asset/liability management comprises the evaluation, monitoring, andmanagement of the Bancorp’s interest rate risk, market risk and liquidity andfunding. The Asset/Liability Management Committee (ALCO) maintains oversight ofthese risks. The Committee is comprised of senior financial and senior businessexecutives.

 

INTEREST RATE RISK

 

Interest rate risk, one of the more prominent risks in terms ofpotential earnings impact, is an inevitable part of being a financialintermediary. For more information, see “Market Risk and Asset/LiabilityManagement” in the Bancorp’s 2001 Annual Report on Form 10-K.

 

Management believes that medium term (12-month horizon) interest raterisk is best measured by simulation modeling. This analysis calculates expected net interest income based uponhistorical trends, spreads to market rates, historical market relationships,prepayment behavior and current and expected product offerings. As of September30, 2002, the simulation analysis indicated that the Bancorp’s net interestincome would tend to increase if rates were to rise over the next 12 months.For example, if rates were to rise 1.00% or 2.00% over the next 12 months, netinterest income would increase by 1.5% and 1.7%, respectively. Conversely, ifrates were to decline over the next 12 months, net interest income woulddecline by 1.3% and 4.1%, respectively. The principal source of net interest incomerisk in a falling rate scenario is that certain short-term market rates and amajority of the Bank’s deposit rates are below 2.0%. Therefore, these ratescannot decline below a floor rate of 0%.

 

 Computations of prospectiveeffects of hypothetical interest rate changes are based on many assumptions,including relative levels of market interest rates, loan prepayments andchanges in deposit levels.  They are notintended to be a forecast and should not be relied upon as indicative of actualresults.  Further, the computations donot contemplate certain actions that management could take in response tochanges in interest rates.

 

24

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LIQUIDITY AND FUNDING

 

The objective of effective liquidity management is to ensure that theBancorp can meet customer loan requests, customer depositmaturities/withdrawals and other cash commitments efficiently under both normaloperating conditions as well as under unforeseen and unpredictablecircumstances of industry or market stress. To achieve this objective, ALCOestablishes and monitors liquidity guidelines requiring sufficient asset basedliquidity to cover potential funding requirements and to avoid over-dependenceon volatile, less reliable funding sources. The Bancorp manages liquidity atboth the parent and subsidiary levels through active management of the balancesheet.

 

In addition to the immediately liquid resources of cash and due frombanks and federal funds sold, asset liquidity is provided by the debt securitiesin the securities available for sale portfolio. Asset liquidity is furtherenhanced by the Bancorp’s ability to sell loans in secondary markets throughwhole-loan sales.

 

Core customer deposits have historically provided the Bancorp with asizeable source of relatively stable and low-cost funds.

 

Long-term debt, and short-term borrowings (federal funds purchased andsecurities sold under repurchase agreements and other short-term borrowings)mostly provide the remaining funding of assets. The Bank also has extensiveaccess to funds from its membership in the Federal Home Loan Bank of Atlanta.

 

CAPITAL MANAGEMENT

 

The Bancorp has an active program for managing shareholders’ equity.The objective of effective capital management is to produce long-term returnsby opportunistically utilizing capital when returns are perceived to be highand issuing/accumulating capital when the costs of doing so is perceived to below.

 

Uses of capital include investments for organic growth, acquisitions ofbanks and other financial services companies, dividends and share repurchases.During the first nine months of 2002, the Bancorp’s consolidated assetsincreased by $141 million, or 8%. During 2001, the Board of Directorsauthorized the repurchase of up to 500,000 shares of the Bancorp’s outstandingcommon stock. During the first nine months of 2002, the Bancorp repurchased120.5 thousand shares of common stock for an aggregate of $3.5 million. AtSeptember 30, 2002, the total remaining common stock repurchase authority wasapproximately 201 thousand shares.

 

Sources of capital include retained earnings and common stock issuance.In the first nine months of 2002, total net income was $18.1 million and thechange in retained earnings was $12.2 million after payment of $6.0 million incommon stock dividends.

 

EVALUATION OF INTERNAL CONTROLS

 

Management is responsible for establishing and maintaining an internalcontrol structure over financial reporting of the Bancorp that providesreasonable assurance to the Bancorp’s management and board of directors that(i) the Bancorp’s published financial statements are prepared in conformitywith generally accepted accounting principles and (ii) adequate policies are ineffect to safeguard the Bancorp’s assets.

 

We have performed an evaluation of the effectiveness of the Bancorp’sinternal control structure over financial reporting as of September 30, 2002.Based on this evaluation, the Bancorp maintained an effective internal controlstructure over financial reporting as of September 30, 2002 and the publishedfinancial statements are fairly stated, in all material respects. There were nosignificant deficiencies noted in the design or operation of internal controlswhich could adversely affect the Bancorp’s ability to record, process, summarize,and report financial data and therefore no material weaknesses were reported tothe Bancorp’s auditors.

 

There have been no significant changes in internal controls or in otherfactors that could significantly affect internal control subsequent toSeptember 30, 2002 or deficiencies for which corrective action would berequired.

 

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FACTORS THAT MAY AFFECTFUTURE RESULTS

 

We make forward-looking statements in this report and from time to timein other reports and proxy statements we file with the SEC. Also, our seniormanagement might make forward-looking statements orally to analysts, investorsand others. Broadly speaking, forward-looking statements include:

•                  descriptionsof plans or objectives of our management for future operations, products orservices;

•                  descriptionsof assumptions underlying or relating to critical accounting estimates andprojections.

 

In this report, for example, we make forward-looking statements about:

•                  futurecredit losses and non-performing assets;

•                  futurecash requirements relating to commitments to extend credit;

•                  futureamortization expense;

•                  theimpact of new accounting standards;

•                  andthe impact of interest rate changes on our net interest income.

 

 

Forward-looking statements discuss matters that are not historicalfacts. These forward-looking statements may sometimes be identified by wordssuch as “expect”, “may”. “looking forward”, “we plan”, “we believe”, “areplanned”, “could be”, and “currently anticipate”. Although we believe thesestatements, as well as other oral and written forward-looking statements madeby us from time to time, to be true and reasonable, we can give no assurancethat these plans, intentions or expectations will be achieved. Actual results,performance or achievements could differ materially from those contemplated,expressed or implied by the forward-looking statements.

 

There are several factors—many beyond our control—that could causeresults to differ significantly from our expectations. Some of these factorsare described below. Other factors, such as credit, market, operational,liquidity, interest rate and other risks, are described elsewhere in thisreport (see, for example, “Item 2—Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Balance Sheet Analysis” and–Asset/Liability and Market Risk Management”). Factors relating to regulationand supervision of the Bancorp are described in our Annual Report on Form 10-Kfor the year ended December 31, 2001.

 

# **IndustryFactors**

 

**As afinancial services company, our earnings are significantly affected by businessand economic conditions.**

 

Our earnings are impacted by business and economic conditions in theUnited States and the Maryland economic region. These conditions includeshort-term and long-term interest rates, inflation, monetary supply, and thestrength of the U.S. economy and Maryland economies in which we operate.Business and economic conditions that negatively impact household or businessincomes could decrease demand for the Bancorp’s products and increase thenumber of customers who fail to pay their loans.

 

**Ourearnings are significantly affected by the fiscal and monetary polices of thefederal government and its agencies.**

 

The Board of Governors of the Federal Reserve System regulates thesupply of money and credit in the United States. Its policies significantlyimpact our cost of funds for lending and investing and the return we earn onthose loans and investments, both of which impact our net interest margin, andcan materially affect the value of financial instruments we hold. Its policiesalso can affect our borrowers, potentially increasing the risk that they mayfail to repay their loans. Changes in Federal Reserve Board policies are beyondour control and hard to predict or anticipate.

 

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**Thefinancial services industry is highly competitive.**

 

We operate in a highly competitive industry which could become evenmore competitive as a result of legislative, regulatory and technologicalchanges and continued consolidation of banks. Banks, securities firms andinsurance companies can now merge by creating a new type of financial servicescompany called a “financial holding company”, which can offer virtually anytype of financial service. Many of our competitors have fewer regulatoryconstraints and some have lower cost structures.

 

**We areheavily regulated by federal and state agencies.**

 

The holding company and its subsidiaries are heavily regulated at thefederal and state levels. This regulation is to protect customers, federaldeposit insurance funds and the banking system as a whole, not securityholders. Changes to statutes, regulations and regulatory policies, could affectus in substantial and unpredictable ways including limiting the types offinancial services and products we may offer and increasing the ability ofnon-banks to offer competing financial services and products. Also, our failureto comply with laws, regulations and policies could result in sanctions byregulatory agencies and damage our reputation. For more information, refer tothe “Regulation and Supervision” section in our Annual Report on Form 10-K forthe year ended December 31, 2001.

 

# **CompanyFactors**

 

**Maintainingor increasing our market share depends on market acceptance and regulatoryapproval of new products and services.**

 

Our success depends, in part, on our ability to adapt our products andservices to evolving industry standards and the changing need of our customers.There is increasing pressure on financial service companies to provide productsand services at lower prices. This can reduce our net interest margin andrevenues from our fee-based products and services. Also, the wide-spreadadoption of new technologies, including internet-based services, could requireus to make substantial investments to modify or adapt our existing products andservices.

 

**Theholding company relies on dividends from its subsidiaries for most of itsrevenues.**

 

The holding company is a separate and distinct legal entity from itssubsidiaries. It receives substantially all of its revenue from dividends fromits subsidiaries. These dividends are the principal source of funds to paydividends on the holding company’s common stock. Various federal and state lawsand regulations limit the amount of dividends that our bank and certainnon-bank subsidiaries may pay to the holding company. For more information,refer to “Dividend Restrictions” in our Annual Report on Form 10-K as ofDecember 31, 2001.

 

**We havebusinesses other than banking.**

 

We are a diversified financial services company. In addition tobanking, we provide insurance, wealth management, and mortgages. Although webelieve our diversity helps mitigate the impact to the Bancorp when downturnsaffect any one-business line, it also means that our earnings could be subjectto different risks and uncertainties. We discuss some examples below.

 

*MortgageBanking*. The impact of interest rates on our mortgage bankingbusiness can be large and complex. Changes in interest rates can impact loanorigination fees and gains on mortgage loans sold. A decline in mortgage ratesmight be expected to increase the demand for mortgages as borrowers refinance.Conversely, in a constant or increasing rate environment, we would expect fewerloans to be refinanced and a decline in our fee income.

 

*WealthManagement.* The impact of changes in the U.S. stock market onour wealth management business can be large. As much of our fee income isderived based on assets under management, the loss in value of those assets dueto stock market declines can significantly reduce our fee income. Also, ifmarket conditions are volatile many of our investors limit their mutual fundinvestments and in some cases withdraw their funds to invest in saferinvestment alternatives.

 

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# **LegislativeRisk**

 

Our business model relies heavily on our ability to share informationbetween the team of companies owned by F&M Bancorp to better satisfy ourcustomers’ needs. Future laws that restrict our ability to share informationabout customers could negatively impact our revenue and profit.

 

**Ourstock price can be volatile.**

 

Our stock price can fluctuate widely in response to a variety of factorsincluding:

•                  actualor anticipated variations in our quarterly operating results;

•                  recommendationsby security analysts;

•                  operatingand stock price performance of other companies that investors deem comparableto us:

•                  significantacquisitions or business combinations by or involving us or our competitors;

•                  newsreports relating to trends, concerns and other issues in the financial servicesindustry; and

•                  changesin government regulations.

 

General market fluctuations, industry factors and general economictrends, interest rate changes, or credit loss trends, also could cause ourstock price to decrease regardless of our operating results.

 

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**PART II****- OtherInformation**

 

**Item 6.****        Exhibits and Reports on Form 8-K**

 

(a)                                  Exhibits

 

10.2 Unfunded deferredcompensation plan for non-employee directors of F&M Bancorp as amended andrestated effective October 15, 2002. Filed as an exhibit hereto and incorporated herein by reference.

 

11. Computation of per share earnings: Filed as anexhibit hereto and incorporated herein by reference.

 

99.1 CEO Certification of corporate responsibility forfinancial reports. Filed as an exhibit hereto and incorporated herein byreference

 

99.2 CFO Certification of corporate responsibility forfinancial reports. Filed as an exhibit hereto and incorporated herein byreference

 

(b)           Reports on Form 8-K

 

None

 

 

**Signatures**

 

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

 

 
|              | F&M BANCORP |
|-------------------|-----------------|
|              |            |
|              | (Registrant)    |
|              |            |
|              |            |
| November 12, 2002 |            | /s/ Faye E. Cannon |
| Date              |            | FAYE E. CANNON  PRESIDENT AND CEO |
|              |            |   |
|              |            |   |
| November 12, 2002 |            | /s/ Kaye A. Simmons |
| Date              |            | KAYE A. SIMMONS  CFO AND TREASURER |

 

 

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**CERTIFICATION OF CORPORATE RESPONSIBILTY FOR FINANCIALREPORTS**

 

In connection with this Quarterly Report of F&M Bancorp (the“Bancorp”) on Form 10-Q for the period ending September 30, 2002 as filed withthe Securities and Exchange Commission on the date hereof (the “Report”), I,Faye E. Cannon, certify, pursuant to Section 302 of the Sarbanes-Oxley Act of2002, that:

 

1)              I have reviewed the Report;

2)              based on my knowledge, the Report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading;

3)              based on my knowledge, the financialstatements, and other financial information included in the Report, fairlypresent in all material respects the financial condition and results ofoperations of the Bancorp as of, and for, the periods presented in the Report;

4)              the Chief Financial Officer and I –

a)              are responsible for establishing andmaintaining internal controls;

b)             have designed such internal controls toensure that material information relating to the Bancorp and it’s consolidatedsubsidiaries is made known to us by others within those entities, particularlyduring the period in which the Report was being prepared;

c)              have evaluated the effectiveness of theBancorp’s internal controls as of a date within 90 days prior the Report; and

d)             have presented in the Report ourconclusions about the effectiveness of our internal controls based on ourevaluation as of that date;

5)              the Chief Financial Officer and I havedisclosed to the Bancorp’s auditors and the audit committee of the Board ofdirectors –

a)              all significant deficiencies in thedesign or operation of internal controls which could adversely affect theBancorp’s ability to record, process, summarize, and report financial data andhave identified for the Bancorp’s auditors any material weaknesses in internalcontrols; and

b)             any fraud, whether material or notmaterial, that involves management or other employees who have a significantrole in the Bancorp’s internal controls; and

6)              the Chief Financial Officer and I haveindicated in the Report whether or not there were significant changes ininternal controls or in other factors that could significantly affect internalcontrol subsequent to the date of our evaluation, including corrective actionswith regard to significant deficiencies and material weaknesses.

 

 
| /s/ FAYE E. CANNON                    |   |
|---------------------------------------|--------|
| Faye E. Cannon                        |
| President and Chief Executive Officer |
| (principal executive officer)         |
| F&M Bancorp                       |
| November 12, 2002                     |

 

 

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**CERTIFICATION OF CORPORATE RESPONSIBILTY FOR FINANCIALREPORTS**

 

In connection with this Quarterly Report of F&M Bancorp (the“Bancorp”) on Form 10-Q for the period ending September 30, 2002 as filed withthe Securities and Exchange Commission on the date hereof (the “Report”), I,Kaye A. Simmons, certify, pursuant to Section 302 of the Sarbanes-Oxley Act of2002, that:

 

1)              I have reviewed the Report;

2)              based on my knowledge, the Report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading;

3)              based on my knowledge, the financialstatements, and other financial information included in the Report, fairlypresent in all material respects the financial condition and results of operationsof the Bancorp as of, and for, the periods presented in the Report;

4)              the Chief Executive Officer and I –

a)              are responsible for establishing andmaintaining internal controls;

b)             have designed such internal controls toensure that material information relating to the Bancorp and it’s consolidatedsubsidiaries is made known to us by others within those entities, particularlyduring the period in which the Report was being prepared;

c)              have evaluated the effectiveness of theBancorp’s internal controls as of a date within 90 days prior the Report; and

d)             have presented in the Report ourconclusions about the effectiveness of our internal controls based on ourevaluation as of that date;

5)              the Chief Executive Officer and I havedisclosed to the Bancorp’s auditors and the audit committee of the Board ofdirectors –

a)              all significant deficiencies in thedesign or operation of internal controls which could adversely affect theBancorp’s ability to record, process, summarize, and report financial data and haveidentified for the Bancorp’s auditors any material weaknesses in internalcontrols; and

b)             any fraud, whether material or notmaterial, that involves management or other employees who have a significantrole in the Bancorp’s internal controls; and

6)              the Chief Executive Officer and I haveindicated in the Report whether or not there were significant changes ininternal controls or in other factors that could significantly affect internalcontrol subsequent to the date of our evaluation, including corrective actionswith regard to significant deficiencies and material weaknesses.

 

 
| /s/ KAYE A. SIMMONS                   |   |
|---------------------------------------|--------|
| Kaye A. Simmons                       |
| Chief Financial Officer and Treasurer |
| (principal financial officer)         |
| F&M Bancorp                       |
| November 12, 2002                     |

 

 

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