**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

----

 

**FORM 10-Q**

 

| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For thequarterly period ended March 31, 2002**

 

**OR**

 

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**Commission filenumber 0-12638**

 

**F&M BANCORP**

(Exact name of registrant as specified inits 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)                                               |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý No o

 

Common Stock of 10,833,245 shares outstanding as of May 9, 2002.

 

 

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F&M BANCORP

TABLE OF CONTENTS

 

 
| PART I   | FINANCIAL INFORMATION                                                                                                     |
|----------|---------------------------------------------------------------------------------------------------------------------------|
|     |
|     | Consolidated Balance  Sheets, March 31, 2002 (Unaudited) and December 31, 2001                                            |
|     |                                                                                                                      |
|     | Consolidated  Statements of Income and Comprehensive Income (Unaudited), Three Months Ended  March 31, 2002 and 2001      |
|     |                                                                                                                      |
|     | Consolidated  Statements of Changes in Shareholders’ Equity (Unaudited), Three Months Ended  March 31, 2002 and 2001 |
|     |                                                                                                                      |
|     | Consolidated  Statements of Cash Flows (Unaudited), Three Months Ended March 31, 2002 and  2001                           |
|     |                                                                                                                      |
|     | Notes  to Consolidated Financial Statements (Unaudited)                                                                   |
|     |                                                                                                                      |
|     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                               |
|     |                                                                                                                      |
|     | Quantitative  and Qualitative Disclosures about Market Risk                                                               |
|     |
| PART  II | OTHER INFORMATION                                                                                                         |
|     |
|     | Item  4.  Submission of Matters to Vote of  Security Holders                                                         |
|     |                                                                                                                      |
|     | Item 6.  Exhibits and Reports on Form 8-K                                                                            |
|     |                                                                                                                      |
|     | Signatures                                                                                                                |
|          |                                                                                                                           |  |

 

2

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**ConsolidatedBalance Sheets**(Unaudited)

**F&M Bancorp and Subsidiaries**

 
| (in thousands,  except per share data)                                                                                              |   | **March 31,  2002** |      | **December 31,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|------------------------|--------|
| **Assets**                                                                                                                          |   |                |      |                   |   |
| Cash and due from banks                                                                                                             |   | $                   | 55,229    |                   | $      | 65,570 |   |
| Federal funds sold                                                                                                                  |   | 12,909              |      | 360                    |   |
| Interest-bearing deposits with banks                                                                                                |   | 8,446               |      | 13,178                 |   |
| Total cash and cash equivalents                                                                                                     |   | 76,584              |      | 79,108                 |   |
| Loans held for sale                                                                                                                 |   | 15,414              |      | 28,779                 |   |
| Investment securities:                                                                                                              |   |                |      |                   |   |
| Available-for-sale, at fair value                                                                                                   |   | 557,425             |      | 546,522                |   |
| Total investment securities                                                                                                         |   | 557,425             |      | 546,522                |   |
| Loans, net of unearned income                                                                                                       |   | 1,170,385           |      | 1,162,225              |   |
| Less: Allowance for credit losses                                                                                                   |   | (14,132             | )         | (13,947                | )      |
| Net loans                                                                                                                           |   | 1,156,253           |      | 1,148,278              |   |
| Bank premises and equipment, net                                                                                                    |   | 34,952              |      | 35,563                 |   |
| Other real estate owned, net                                                                                                        |   | 610                 |      | 638                    |   |
| Interest receivable                                                                                                                 |   | 9,262               |      | 9,417                  |   |
| Intangible assets                                                                                                                   |   | 3,602               |      | 3,898                  |   |
| Other assets                                                                                                                        |   | 29,421              |      | 29,231                 |   |
| Total other assets                                                                                                                  |   | 77,847              |      | 78,747                 |   |
| Total assets                                                                                                                        |   | $                   | 1,883,523 |                   | $      | 1,881,434 |   |
| **Liabilities:**                                                                                                                    |   |                |      |                   |   |
| Deposits:                                                                                                                           |   |                |      |                   |   |
| Noninterest-bearing                                                                                                                 |   | $                   | 238,430   |                   | $      | 234,459 |   |
| Interest-bearing                                                                                                                    |   | 1,294,259           |      | 1,281,609              |   |
| Total deposits                                                                                                                      |   | 1,532,689           |      | 1,516,068              |   |
| Short-term borrowings:                                                                                                              |   |                |      |                   |   |
| Federal funds purchased and securities  sold under agreements to repurchase                                                         |   | 98,225              |      | 114,505                |   |
| Other short-term borrowings                                                                                                         |   | 2,343               |      | 3,040                  |   |
| Long-term borrowings                                                                                                                |   | 63,420              |      | 63,444                 |   |
| Accrued taxes and other liabilities                                                                                                 |   | 17,853              |      | 16,952                 |   |
| Total liabilities                                                                                                                   |   | 1,714,530           |      | 1,714,009              |   |
| **Shareholders’ equity**                                                                                                       |   |                |      |                   |   |
| Common stock, par value $5 per share;  authorized 50,000,000 shares; issued 10,852,840 shares, and 10,862,257  shares, respectively |   | 54,264              |      | 54,311                 |   |
| Surplus                                                                                                                             |   | 74,815              |      | 75,147                 |   |
| Retained earnings                                                                                                                   |   | 37,549              |      | 34,782                 |   |
| Accumulated other comprehensive income                                                                                              |   | 2,365               |      | 3,185                  |   |
| Total shareholders’ equity                                                                                                     |   | 168,993             |      | 167,425                |   |
| Total liabilities and shareholders’ equity                                                                                     |   | $                   | 1,883,523 |                   | $      | 1,881,434 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

3

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**Consolidated Statements of Income and Comprehensive Income**(Unaudited)

**F&M Bancorp and Subsidiaries**

 
| (in thousands,  except per share data)                                                      |   | **Three Months Ended March  31,** |       |
|---------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                        |   | **2002**                          | ** ** | **2001** | ** ** |
| **Interest Income**                                                                         |   |                              |       |   |   |
| Interest and fees on loans                                                                  |   | $                                 | 21,283     |   | $ | 24,995 |   |
| Interest on deposits with banks                                                             |   | 22                                |       | 177 |   |
| Interest and dividends on investment  securities:                                           |   |                              |       |   |   |
| Taxable                                                                                     |   | 5,321                             |       | 4,768 |   |
| Tax-exempt                                                                                  |   | 1,316                             |       | 1,472 |   |
| Interest on federal funds sold                                                              |   | 21                                |       | 239 |   |
| Total interest income                                                                       |   | 27,963                            |       | 31,651 |   |
| **Interest Expense**                                                                        |   |                              |       |   |   |
| Interest on deposits                                                                        |   | 8,849                             |       | 12,428 |   |
| Interest on federal funds purchased and  securities sold under agreements to repurchase     |   | 271                               |       | 1,263 |   |
| Interest on long-term borrowings                                                            |   | 779                               |       | 410 |   |
| Interest on other short-term borrowings                                                     |   | 41                                |       | 1,260 |   |
| Total interest expense                                                                      |   | 9,940                             |       | 15,361 |   |
| Net interest income                                                                         |   | 18,023                            |       | 16,290 |   |
| Provision for credit losses                                                                 |   | 825                               |       | 1,095 |   |
| Net interest income after provision for  credit losses                                      |   | 17,198                            |       | 15,195 |   |
| **Noninterest Income**                                                                      |   |                              |       |   |   |
| Service charges on deposit accounts                                                         |   | 2,196                             |       | 1,978 |   |
| Insurance income                                                                            |   | 2,650                             |       | 2,539 |   |
| Gains on sales of loans                                                                     |   | 872                               |       | 812 |   |
| Gains on sales of property                                                                  |   | 86                                |       | 43 |   |
| Alternative investment & stock  brokerage income                                        |   | 921                               |       | 915 |   |
| Other operating income                                                                      |   | 1,315                             |       | 1,750 |   |
| Total noninterest income                                                                    |   | 8,040                             |       | 8,037 |   |
| **Noninterest Expenses**                                                                    |   |                              |       |   |   |
| Salaries and employee benefits                                                              |   | 9,657                             |       | 8,856 |   |
| Occupancy and equipment expense                                                             |   | 2,474                             |       | 2,759 |   |
| Other operating expense                                                                     |   | 4,673                             |       | 4,702 |   |
| Total noninterest expenses                                                                  |   | 16,804                            |       | 16,317 |   |
| Income before provision for income taxes                                                    |   | 8,434                             |       | 6,915 |   |
| Provision for income taxes                                                                  |   | 2,657                             |       | 1,935 |   |
| Net Income                                                                                  |   | $                                 | 5,777      |   | $ | 4,980 |   |
| Other comprehensive income (loss), net of  tax:                                             |   |                              |       |   |   |
| Unrealized gains (losses) on securities  available-for-sale                                 |   | (820                              | )          | 4,308 |   |
| Comprehensive income                                                                        |   | $                                 | 4,957      |   | $ | 9,288 |   |
| Earnings per Common Share - Basic                                                           |   |                              |       |   |   |
| Based on weighted average shares  outstanding of 10,852,687 in 2002, and 11,022,394 in 2001 |   | $                                 | 0.53       |   | $ | 0.45 |   |
| Earnings per Common Share - Diluted                                                         |   |                              |       |   |   |
| Based on weighted average shares  outstanding of 10,912,294 in 2002, and 11,055,867 in 2001 |   | $                                 | 0.53       |   | $ | 0.45 |   |
| Dividends per share                                                                         |   | $                                 | 0.28       |   | $ | 0.27 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

4

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**Consolidated Statements of Change in Shareholders’ Equity**(Unaudited)

**F&M Bancorp and Subsidiaries**

 
| (in thousands, except per share data)     |   | **Common  Stock** |   | **Surplus** |   | **Retained  Earnings** |   | **Accumulated  Other****Comprehensive  (Loss) Income** |   | **Total** |   |
|-------------------------------------------|--------|-------------------|--------|-------------|--------|------------------------|--------|--------------------------------------------------------|--------|-----------|--------|
|                                      |   |              |   |        |   |                   |   |                                                   |   |      |   |
| Balance at December 31, 2000              |   | $                 | 55,073 |        | $      | 78,488                 |   | $                                                      | 25,857 |      | $      | (1,382 | ) | $ | 158,036 |   |
|                                      |   |              |   |        |   |                   |   |                                                   |   |      |   |
| Net income                                |   | —            |   | —      |   | 4,980                  |   | —                                                 |   | 4,980     |   |
| Dividend reinvestment plan                |   | —            |   | —      |   | (141                   | )      | —                                                 |   | (141      | )      |
| Cash dividends paid ($.27 per share)      |   | —            |   | —      |   | (2,977                 | )      | —                                                 |   | (2,977    | )      |
| Stock consideration for options exercised |   | (3                | )      | (4          | )      | (7                     | )      | —                                                 |   | (14       | )      |
| Stock options exercised                   |   | 65                |   | 161         |   | —                 |   | —                                                 |   | 226       |   |
| Other comprehensive income                |   | —            |   | —      |   | —                 |   | 4,308                                                  |   | 4,308     |   |
| Balance at March 31, 2001                 |   | $                 | 55,135 |        | $      | 78,645                 |   | $                                                      | 27,712 |      | $      | 2,926 |   | $ | 164,418 |   |
|                                      |   |              |   |        |   |                   |   |                                                   |   |      |   |
|                                      |   |              |   |        |   |                   |   |                                                   |   |      |   |
| Balance at December 31, 2001              |   | $                 | 54,311 |        | $      | 75,147                 |   | $                                                      | 34,782 |      | $      | 3,185 |   | $ | 167,425 |   |
|                                      |   |              |   |        |   |                   |   |                                                   |   |      |   |
| Net income                                |   | —            |   | —      |   | 5,777                  |   | —                                                 |   | 5,777     |   |
| Dividend reinvestment plan                |   | —            |   | —      |   | (12                    | )      | —                                                 |   | (12       | )      |
| Cash dividends paid ($.28 per share)      |   | —            |   | —      |   | (2,989                 | )      | —                                                 |   | (2,989    | )      |
| Stock consideration for options exercised |   | (3                | )      | (4          | )      | (9                     | )      | —                                                 |   | (16       | )      |
| Stock options exercised                   |   | 73                |   | 183         |   | —                 |   | —                                                 |   | 256       |   |
| Stock repurchase and retirement           |   | (117              | )      | (511        | )      | —                 |   | —                                                 |   | (628      | )      |
| Other comprehensive loss                  |   | —            |   | —      |   | —                 |   | (820                                                   | )      | (820      | )      |
| Balance at March 31, 2002                 |   | $                 | 54,264 |        | $      | 74,815                 |   | $                                                      | 37,549 |      | $      | 2,365 |   | $ | 168,993 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

5

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**Consolidated Statements of Cash Flows******(Unaudited)

#### **F&M Bancorpand Subsidiaries**

 
|                                                                                                        |   | **Three  Months Ended March 31,** |   |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| (in thousands)                                                                                              |   | **2002**                          |   | **2001** |   |
| **Cash Flows from Operating Activities**                                                                    |   |                              |   |   |   |
| Net Income                                                                                                  |   | $                                 | 5,777  |   | $ | 4,980 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities                           |   |                              |   |   |   |
| Provision for credit losses                                                                                 |   | 825                               |   | 1,095 |   |
| Depreciation and amortization                                                                               |   | 976                               |   | 875 |   |
| Amortization of intangibles                                                                                 |   | 296                               |   | 288 |   |
| Net premium amortization / accretion on  investment securities                                              |   | 799                               |   | (72 | ) |
| Decrease in interest receivable                                                                             |   | 155                               |   | 1,986 |   |
| Decrease in interest payable                                                                                |   | (300                              | )      | (443 | ) |
| Gain on sales of property                                                                                   |   | (86                               | )      | (43 | ) |
| Decrease in loans held for sale                                                                             |   | 13,365                            |   | 1,049 |   |
| Decrease in other assets                                                                                    |   | 260                               |   | 2,435 |   |
| Increase in other liabilities                                                                               |   | 1,202                             |   | 1,937 |   |
| Gain on sales of loans                                                                                      |   | (872                              | )      | (812 | ) |
| Other operating activities                                                                                  |   | —                            |   | 1,056 |   |
| Net cash provided by operating activities                                                                   |   | 22,397                            |   | 14,331 |   |
| **Cash Flows from Investing Activities**                                                                    |   |                              |   |   |   |
| Purchases of investment securities  available-for-sale                                                      |   | (61,839                           | )      | (24,791 | ) |
| Proceeds from sales/maturities of  securities available-for-sale                                            |   | 48,867                            |   | 50,194 |   |
| Net (increase) decrease in loans                                                                            |   | (7,972                            | )      | 17,287 |   |
| Purchases of premises and equipment                                                                         |   | (365                              | )      | (1,340 | ) |
| Proceeds from sales of property                                                                             |   | 157                               |   | 231 |   |
| Net cash (used in) provided by investing  activities                                                        |   | (21,152                           | )      | 41,581 |   |
| **Cash Flows from Financing Activities**                                                                    |   |                              |   |   |   |
| Net increase in noninterest-bearing  deposits, interest-bearing checking, savings and money market accounts |   | 40,719                            |   | 17,214 |   |
| Net (decrease) increase in certificates of  deposit                                                         |   | (24,098                           | )      | 50,784 |   |
| Net decrease in federal funds purchased  and securities sold under agreements to repurchase                 |   | (16,280                           | )      | (33,117 | ) |
| Net decrease in other short-term  borrowings                                                                |   | (697                              | )      | (90,980 | ) |
| Net (decrease) increase in long-term  borrowings                                                            |   | (24                               | )      | 24,125 |   |
| Cash dividends paid                                                                                         |   | (2,989                            | )      | (2,977 | ) |
| Dividend reinvestment plan                                                                                  |   | (12                               | )      | (141 | ) |
| Proceeds from issuance of common stock                                                                      |   | 240                               |   | 212 |   |
| Common stock purchased and retired                                                                          |   | (628                              | )      | — |   |
| Net cash used in financing activities                                                                       |   | (3,769                            | )      | (34,880 | ) |
| Net (decrease) increase in cash and cash  equivalents                                                       |   | (2,524                            | )      | 21,032 |   |
| Cash and cash equivalents at beginning of  year                                                             |   | 79,108                            |   | 65,167 |   |
| Cash and cash equivalents at end of period                                                                  |   | $                                 | 76,584 |   | $ | 86,199 |   |
| **Supplemental Disclosures of Cash Flow Information**                                                       |   |                              |   |   |   |
| Cash payments for interest                                                                                  |   | 10,239                            |   | 16,733 |   |
| Cash payments for income tax                                                                                |   | 541                               |   | 114 |   |
| **Non-Cash Investing and Financing Activities**                                                             |   |                              |   |   |   |
| Fair value adjustment for securities  available-for-sale, net of income taxes                               |   | (820                              | )      | 4,308 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

6

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**Notesto Consolidated Financial Statements (Unaudited)**

 

**Note1.  General**

 

The consolidated financial statements, which include the accounts ofthe Corporation and its subsidiaries, are prepared in conformity withaccounting principles generally accepted in the United States of America andfollow general practice within the banking industry. In the opinion ofmanagement, the consolidated financial statements include all adjustmentsnecessary for a fair presentation of the results for the interim period. Theseadjustments are of a normal recurring nature and include adjustments to eliminateall significant intercompany transactions. For comparability, certain priorperiod amounts have been reclassified to conform to current periodpresentation. These statements should be read in conjunction with the financialstatements and accompanying footnotes included in F&M Bancorp’s 2001 AnnualReport to Shareholders on Form 10-K. The results shown in this interim reportare not necessarily indicative of results to be expected for the full year of2002.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and contingent assets and liabilities at the date ofthe financial statements, and the disclosure of revenues and expenses duringthe reporting period. These estimates and assumptions are based on informationavailable as of the date of the financial statements and could differ fromactual results.

 

**Note 2.  Earnings Per Share**

 

Earnings per share (“EPS”) data is computed and presented in accordancewith FASB Statement No. 128, “Earnings Per Share.” As prescribed by theStatement, the presentation of primary EPS has been replaced with the dualpresentation of basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing net incomeavailable to common shareholders (“numerator”) by the weighted-average numberof common shares outstanding for the period after giving retroactive effect tostock dividends and stock splits (“denominator”). Diluted EPS reflects thepotential dilution that could occur if outstanding stock options or othercontracts to issue common stock, if any, were exercised or converted intocommon stock or resulted in the issuance of common stock that then shared inthe earnings of Bancorp. Diluted EPS is equal to the numerator divided by thedenominator plus the dilutive effect of outstanding stock options.

 

(in thousands except per share data)

 
|                     |   | **Three Months Ended March  31,** |   |
|--------------------------|--------|-----------------------------------|--------|
|                     |   | **2002**                          |   | **2001** |   |
|                     |   |                              |   |   |   |
| Net income               |   | $                                 | 5,777  |   | $ | 4,980 |   |
| Basic EPS                |   |                              |   |   |   |
| Shares                   |   | 10,852,687                        |   | 11,022,394 |   |
| EPS                      |   | $                                 | 0.53   |   | $ | 0.45 |   |
| Dilutive shares          |   |                              |   |   |   |
| Stock options            |   | 59,607                            |   | 33,473 |   |
| EPS                      |   | $                                 | 0.00   |   | $ | 0.00 |   |
| Diluted EPS              |   |                              |   |   |   |
| Shares including options |   | 10,912,294                        |   | 11,055,867 |   |
| EPS                      |   | $                                 | 0.53   |   | $ | 0.45 |   |

 

7

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**Note 3.Loans**

 

Loans, net of unearned income, consist of the following:

 
| (in thousands)                    |   | **March 31, 2002** |      | **December 31, 2001** |   |
|-----------------------------------|--------|--------------------|-----------|-----------------------|--------|
| Real Estate Loans:                |   |               |      |                  |   |
| Construction and land development |   | $                  | 88,723    |                  | $      | 85,138 |   |
| Secured by farmland               |   | 5,570              |      | 5,902                 |   |
| Residential mortgage              |   | 291,433            |      | 295,436               |   |
| Other mortgage                    |   | 336,339            |      | 323,643               |   |
| Agricultural                      |   | 415                |      | 507                   |   |
| Commercial and industrial loans   |   | 173,447            |      | 175,307               |   |
| Consumer                          |   | 272,905            |      | 274,361               |   |
| Other loans                       |   | 1,553              |      | 1,931                 |   |
| Totals                            |   | $                  | 1,170,385 |                  | $      | 1,162,225 |   |

 

Loans to states and political subdivisions and industrial revenue bondsare included in other loans in the schedule above and in total loans in the balancesheet.

 

The allowance for credit losses is maintained at a level which, inmanagement’s opinion, is considered adequate to provide for possible losses onloans currently held in the loan portfolio.

 

**Note4.  New Accounting Pronouncements**

 

In June 2001, the Financial Accounting StandardsBoard issued SFAS No. 141,”Business Combinations” (effective July 1, 2001) andSFAS No. 142,”Goodwill and Other Intangible Assets” (effective January 1,2002). SFAS No. 141 prohibits pooling-of-interests accounting for acquisitions.SFAS No. 141 also specifies the criteria for intangible assets acquired in apurchase method business combination to be recognized and reported apart fromgoodwill. SFAS No. 142 specifies that goodwill and some intangible assets willno longer be amortized but instead will be subject to periodic impairmenttesting. SFAS 142 also requires intangible assets with definite useful lives tobe amortized over their respective estimated useful lives to their estimatedresidual values, and reviewed for impairment in accordance with SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of”.

 

The Bancorp adopted SFAS 141 and 142 on January1, 2002 and as of March 31, 2002 had $3,602,000 in definite lived intangibleassets that continue to be subject to amortization under SFAS 142. Amortizationexpense related to intangible assets was $296,000 and $288,000 for the threemonths ended March 31, 2002 and 2001, respectively.

 

# **Note 5. Subsequent Event**

 

On April 8, 2002, the Board of Directors ofF&M Bancorp, based on the recommendation of the Audit Committee, decidednot to renew the engagement of its independent public accountants, ArthurAndersen, LLP. Bancorp selected Deloitte & Touche LLP as its new independentpublic accountants for the year ending December 31, 2002.

 

During Bancorp’s two most recent fiscal yearsended December 31, 2001, and the subsequent interim period through April 7,2002, there were no disagreements between Bancorp and Andersen on any mattersof accounting principles, financial statement disclosure, or auditing scope orprocedure which, if not resolved to Andersen’s satisfaction, would causeAndersen to make reference to the matter of the disagreement in connection withtheir reports.

 

8

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

# **OVERVIEW**

 

This management’s discussion and analysis contains certainforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Such forward-looking statements are identifiedby terminology such as “may”, “will”, “believe”, “expect”, “estimate”,“anticipate”, “likely”, “unlikely”, “continue”, or similar terms. AlthoughBancorp believes that the expectations reflected in such forward-lookingstatements are reasonable, actual results may differ from those projected inthe forward-looking statements. In addition, Bancorp’s past results ofoperations do not necessarily indicate its future results.

 

F&M Bancorp is the registered bank holding company for Farmers andMechanics Bank (the “Bank”), headquartered in Frederick, Maryland. The Bankoperates 50 community offices in Frederick, Howard, Baltimore, Montgomery,Washington, Carroll and Alleghany Counties in Maryland, together with twoinsurance agencies. The Corporation has established a strategy of independence,and intends to establish or acquire additional offices, banking organizationsand nonbanking organizations as appropriate opportunities present themselves.

 

Earnings per diluted share for the first quarter of 2002 reached arecord $0.53 per share, an 18% increase over the prior year’s $0.45 per shareresults. Net income for the first quarter of 2002 reached a record $5.777million, an increase of 16% compared with earnings of $4.980 million for thefirst quarter of 2001. These operating results were driven primarily by astrong increase in net interest income due to consistent growth in theCorporation’s earning assets and an increase in the net interest margin from4.20% in 2001 to 4.33% in 2002.

 

F&M Bancorp’s key performance ratios continue to be strong. Firstquarter of 2002 results produced a return on average assets of 1.26% and areturn on average equity of 13.71%. The earnings produced in the three monthsended March 31, 2001 represented a return on average assets of 1.15% and areturn on average equity of 12.40%. These financial performance ratios areindicative of F&M Bancorp’s earnings strength, effective balance sheetmanagement and expense containment initiatives.

 

Bancorp’s efficiency ratio, which is a measure of operating costmanagement, improved from 64.91% in the first quarter of 2001 to 62.68% for thefirst quarter of 2002. Total noninterest expense increased 3% over the firstquarter of 2001 attributable mainly to increased commission expenses onfee-based lines of business and higher costs of employee medical insurancecoverage.

 

Bancorp’s asset quality remained strong throughout the first quarter.Nonperforming assets as a percentage of assets stood at 0.13% at March 31,2002. The allowance for credit losses was $14.1 million or 1.21% of total loanswith net charge-offs representing 0.05% of average loans outstanding.

 

9

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**RESULTS OF OPERATIONS**

 

**NetInterest Income**

 

F&M Bancorp’s principal source of revenue is net interest income,the difference between interest income on earnings assets and interest expenseon deposits and borrowings. Interest income for purposes of analysis, ispresented on a tax-equivalent basis to recognize associated tax benefits. Thepresentation provides a basis for comparison of yields with taxable earningassets. The discussion on net interest income should be read in conjunctionwith the following table – “Consolidated Average Balances, Interest and AverageRates.”

 

The Bancorp’s taxable-equivalent net interest income of $18.8 millionin the first quarter 2002 was 9.8% higher than the comparable quarter in theprior year. The lower interest rate environment favorably impacted theBancorp’s costs for both core deposits and wholesale funding in comparison tolast year and led to a net interest margin in the first quarter of 4.33%  — an increase of 0.13% compared to the sameperiod last year.

 

**InterestIncome**

 

While the level of earning assets grew by $105 million or 6%, Bancorp’stax-equivalent interest income decreased $3.8 million or 12% in the firstquarter of 2002 compared to the first quarter of 2001. This decrease was directlyimpacted by the unprecedented reductions in interest rates experiencedthroughout 2001. The yield on earning assets decreased 1.34% from 7.97% in 2001to 6.63 % for the first three months of 2002.

 

During the first quarter of 2002, average loans yielding 7.31% declined$22.0 million as compared to the first quarter of 2001. This decrease wasattributable to prepayments in residential mortgage loans, consumer automobileloans, and commercial loans.

 

Average total securities yielding 5.29% increased 30% to $560 millionin the first quarter of 2002 compared to the first quarter of 2001. The growthin the securities portfolio was directly attributable to the significantdeposit growth achieved during the past year.

 

# **Interest Expense**

 

Interest expense declined 35% or $5.4 million in the first quarter of2002 compared to the first quarter of 2001. This change was mainly attributableto a change in the composition of funding sources from high cost deposits andborrowings into lower cost transaction accounts.

 

Average interest bearing deposits increased 9% or $101.9 million in thefirst quarter of 2002 as compared to the first quarter of 2001. The averagerate paid on interest-bearing deposits decreased by 147 basis points in thefirst quarter of 2002 compared to 2001, representing a 34% decrease.

 

Average borrowed funds, typically the most expensive funding source,decreased $37.8 million or 19% compared to the first quarter of 2001. Theaverage rate paid on borrowings decreased 3.17% from 5.83% in 2001 to 2.66% for2002.

 

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Consolidated Average Balances, Interest and Average Rates (TaxableEquivalent Basis)

 
|                                                                        |   | **Three Months Ended March 31,** |      |         |
|-----------------------------------------------------------------------------|--------|----------------------------------|-----------|--------------|
|                                                                        |   | **2002**                         |      | **2001**     |   |
| (in thousands)                                                              |   | **Average  Balance**             |      | **Interest** |   | **Average  Rate** |   | **Average  Balance** |   | **Interest** |   | **Average  Rate** |   |
| ASSETS                                                                      |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Interest earning assets:                                                    |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Short-term funds                                                            |   | $                                | 12,461    |         | $ | 44 |   | 1.43 | % | $ | 14,527 |   | $ | 323 |   | 9.02 | % |
| Investment securities/                                                      |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Taxable                                                                     |   | 441,917                          |      | 5,320        |   | 4.88 | % | 304,098 |   | 4,862 |   | 6.48 | % |
| Tax-exempt (1)                                                              |   | 118,399                          |      | 1,994        |   | 6.83 | % | 126,756 |   | 2,229 |   | 7.13 | % |
| Total investment securities                                                 |   | 560,316                          |      | 7,314        |   | 5.29 | % | 430,854 |   | 7,091 |   | 6.67 | % |
| Loans, net, including loans held for sale (1)                               |   | 1,184,006                        |      | 21,352       |   | 7.31 | % | 1,206,048 |   | 25,048 |   | 8.42 | % |
| Total interest-earning assets                                               |   | 1,756,783                        |      | 28,710       |   | 6.63 | % | 1,651,429 |   | 32,462 |   | 7.97 | % |
| Total noninterest-earning assets                                            |   | 104,291                          |      |         |   |   |   | 110,371 |   |   |   |   |   |
| Total assets                                                                |   | $                                | 1,861,074 |         |   |   |   |   | $ | 1,761,800 |   |   |   |   |   |
|                                                                        |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| LIABILITIES                                                                 |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                               |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits                                                   |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Savings                                                                     |   | $                                | 160,448   |         | $ | 451 |   | 1.14 | % | $ | 145,711 |   | $ | 775 |   | 2.16 | % |
| Checking                                                                    |   | 197,763                          |      | 252          |   | 0.52 | % | 180,310 |   | 558 |   | 1.26 | % |
| Money market accounts                                                       |   | 299,693                          |      | 1,250        |   | 1.69 | % | 285,471 |   | 2,882 |   | 4.09 | % |
| Certificates of deposit                                                     |   | 625,509                          |      | 6,896        |   | 4.47 | % | 569,977 |   | 8,211 |   | 5.84 | % |
| Total interest bearing deposits                                             |   | 1,283,413                        |      | 8,849        |   | 2.80 | % | 1,181,469 |   | 12,426 |   | 4.27 | % |
| Short-term borrowings                                                       |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Federal funds purchased and securities sold under agreements to  repurchase |   | 96,963                           |      | 271          |   | 1.13 | % | 97,293 |   | 1,264 |   | 5.27 | % |
| Other short term borrowings                                                 |   | 5,891                            |      | 41           |   | 2.82 | % | 79,400 |   | 1,260 |   | 6.44 | % |
| Total Short Term Borrowings                                                 |   | 102,854                          |      | 312          |   | 1.23 | % | 176,693 |   | 2,524 |   | 5.79 | % |
| Long term borrowings                                                        |   | 63,429                           |      | 779          |   | 4.98 | % | 27,398 |   | 410 |   | 6.07 | % |
| Total borrowed funds                                                        |   | 166,283                          |      | 1,091        |   | 2.66 | % | 204,091 |   | 2,934 |   | 5.83 | % |
| Total interest bearing liabilities                                          |   | 1,449,696                        |      | 9,940        |   | 2.78 | % | 1,385,560 |   | 15,360 |   | 4.50 | % |
| Non-interest bearing liabilities:                                           |   |                             |      |         |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                             |   | 224,821                          |      |         |   |   |   | 196,361 |   |   |   |   |   |
| Other liabilities                                                           |   | 15,610                           |      |         |   |   |   | 16,987 |   |   |   |   |   |
| Total non-interest bearing liabilities                                      |   | 240,431                          |      |         |   |   |   | 213,348 |   |   |   |   |   |
| Shareholders’ equity                                                   |   | 170,947                          |      |         |   |   |   | 162,892 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                             |   | $                                | 1,861,074 |         |   |   |   |   | $ | 1,761,800 |   |   |   |   |   |
| Net interest income                                                         |   |                             |      | 18,770       |   |   |   |   |   | 17,102 |   |   |   |
| Net interest spread                                                         |   |                             |      |         |   | 3.85 | % |   |   |   |   | 3.47 | % |
| Net interest margin                                                         |   |                             |      |         |   | 4.33 | % |   |   |   |   | 4.20 | % |
|                                                                             |        |                                  |           |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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  (1) Interest and yields onobligations of states and political subdivisions and tax-exempt loans arecomputed on a taxable equivalent basis using the U.S. statutory tax rate of 35percent. In addition, loan fee income is included in the interest incomecalculations, and nonaccrual loans are included in the average loan base uponwhich the interest rate earned on loans is calculated.

# ** **

11

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**Provisionfor Credit Losses**.

 

Bancorp decreased the provision for credit losses by 25% to $825thousand for the first quarter 2002 compared to $1,095 thousand for the firstquarter 2001 as significant loan losses have not been experienced to date.Management continues to closely monitor credit quality and maintains anadequate allowance for credit losses for any adverse impact that may arise fromchanges in economic conditions.

 

**NoninterestIncome**.

 

Noninterest income is derived from service charges and fees associatedwith loans and deposits, as well as income from insurance, mortgage banking,investment and brokerage activities. Noninterest income was $8.0 million in2002 and although flat to the first quarter of last year those resultsbenefited from $525 thousand in proceeds from bank owned life insurance.

 

Insurance income of $2.7 million increased 4% from the first quarter of2001. The first quarter of each year benefits from annual profit-sharingdistributions increasing revenues in the quarter that does not continue intoother quarters of the year. To illustrate this seasonality, insurance revenuesfor the first quarter of 2002 increased 45% against the fourth quarter of 2001.

 

The mortgage banking business remained strong generating $872 thousandin quarterly revenues, a 7% increase from the first quarter of 2001. Mortgagerates stabilized during the first quarter of 2002 reducing the levels ofmortgage refinancing activities.

 

Revenues from service charges on deposits rose $218 thousand or 11% inthe first quarter of 2002 as compared to 2001. This increase resulted from theincreases in the overall level of new deposit account customers and inflows ofadditional deposits from existing relationships.

 

Commissions and fees from alternative investments and brokerageservices increased slightly compared to the first quarter of last year. Evenwith the volatility experienced in the current equity markets, revenues areincreased due to our ability to provide innovative financial solutionsindividually designed for the affluent, emerging affluent and small businesscustomer.

 

**NoninterestExpense**.

 

Noninterest expense for the quarter of $16.8 million rose $487 thousandor 3% compared to the first quarter of 2001. Bancorp incurs additional costs toprovide new services and support initiatives that generate additional revenuesand growth for the company.

 

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.Lower efficiency ratios indicate improved levels of productivity. Bancorp’sefficiency ratio decreased to 62.68% for the quarter compared to 64.91% for thecomparable period in 2001.

 

Salary and benefit related expenses of $9.7 million for the quarterincreased $801 thousand or 9% compared to the same period of 2001. Thisincrease was primarily attributable to increased commission costs on therevenues generated by fee-based lines of business and increases in employeemedical insurance coverage.

 

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Occupancy expenses for the quarter of $2.5 million decreased $285thousand or 10% compared to the first quarter of 2001. Continued analysis ofour branch delivery system allowed us to identify redundancies in severalbranch locations and led to the consolidation of branch locations. In 2001Bancorp also sold two Pennsylvania branches that were not located outside ofour market areas.

 

Other expenses for the quarter relating to corporate operationsexpenses decreased to $4.7 million compared to the same quarter of 2001.Continued emphasis on cost containment and improving operating efficiencieshave allowed Bancorp to recognize growth and increased revenues withoutincreasing the costs associated with these strategic initiatives.

 

**IncomeTaxes.**

 

Tax expense varies from one period to the next with changes in thelevel of income before taxes, changes in the amount of tax-exempt income, andthe relationship of these changes to each other. The effective income taxexpense rate differs from the amount computed at statutory rates primarily dueto tax-exempt interest from certain loans and investment securities.

 

The provision for income taxes increased to $2.657 million for thefirst quarter of 2002, from $1.935 million for the first quarter of 2001.  For the first three months of 2002 Bancorp’seffective tax rate was 31.5% compared to 28% on the same period in the prioryear.

 

**NonperformingAssets**

 

The credit quality of the Bancorp’s loan portfolio continues to besound with nonperforming assets at only 0.13% of total assets in the firstquarter 2002. Total nonperforming assets at March 31, 2002 were $2.4 millioncompared to $1.9 million at December 31, 2001. Although there is no direct correlation between nonperforming loans andultimate loan losses, an analysis of nonperforming loans may provide someindication of the quality of the loan portfolio.

 

**PotentialProblem Loans**

 

At March 31, 2002, Bancorp had $11.7 million in loans to borrowers whowere currently experiencing financial difficulties such that management hadreasonable concerns that such loans might become contractually past due or beclassified as a nonperforming asset. These loans are subject to the same closeattention and regular credit reviews as extended to loans past due 90 days ormore and nonperforming assets.

 

Nonperforming Assets and Contractually Past-Due Loans:

 
|                                                              |   | **March 31,  2002** |   | **December 31,  2001** |   |
|-------------------------------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                                              |   |                |   |                   |   |
| Nonaccrual loans (1)                                              |   | $                   | 1,822  |                   | $      | 1,279 |   |
| Other real estate owned net of valuation  allowance (2)           |   | 610                 |   | 638                    |   |
| Total Nonperforming Assets                                        |   | $                   | 2,432  |                   | $      | 1,917 |   |
| Loans past due 90 or more days as to  interest or principal (3)   |   | $                   | 1,302  |                   | $      | 2,819 |   |
| Nonperforming loans to total loans                                |   | 0.16                | %      | 0.11                   | %      |
| Nonperforming assets to total loans plus  other real estate owned |   | 0.21                | %      | 0.16                   | %      |
| Nonperforming assets to total assets                              |   | 0.13                | %      | 0.10                   | %      |
| Allowance for credit losses times  nonperforming loans            |   | 7.76                |   | 10.90                  |   |
| Allowance for credit losses times  nonperforming assets           |   | 5.81                |   | 7.28                   |   |

 

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(1) 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 unless received in cash, or until such time theborrower demonstrates sustained performance over a period of time in accordancewith contractual terms.

 

(2) Other real estateowned includes: banking premises no longer used for business purposes and realestate acquired by foreclosure (in partial or complete satisfaction of debt),or otherwise surrendered by the borrower to Bancorp’s possession. Other realestate owned is recorded at the lower of cost or fair value on the date ofacquisition or transfer from loans. Write-downs to fair value at the date ofacquisition are charged to the allowance for credit losses. Subsequent totransfer, these assets are adjusted through a valuation allowance to the lowerof the net carrying value or the fair value (net of estimated selling expenses)based on periodic appraisals.

 

(3) Nonaccrual loans arenot included.

 

**Allowancefor Credit Losses**

 

The allowance for credit losses is maintained at a level, which inmanagement’s judgment is adequate to absorb probable losses inherent in theloan portfolio. The adequacy of the allowance for credit losses is reviewedregularly by management. Additions to the allowance are made by charges to theprovision for credit losses. On a quarterly basis, a comprehensive review ofthe allowance is performed considering such factors as the levels of loansoutstanding, loss experience, delinquency levels, certain individual loanreviews, and an evaluation of the regional and national economic environment.The methodology for assessing the appropriateness of the allowance consists ofthree primary elements:

 

   •  The FormulaAllowance. The formula allowance is calculated by applying historicallydetermined loss factors to outstanding business loans based on credit riskratings and for pools of homogeneous loans. Individually  risk rated loan loss factors are determinedusing average annual net  charge-offrates for the most recent two years. Pooled loans are loans that are homogeneousin nature such as consumer installment and residential mortgage loans. Pooledloan loss factors are based on net charge-offs experienced over the past year.The historic loss factors on the risk rated loans and the pooled loans are thenconsidered for either positive or  negative adjustment in an attempt to reflect the current dynamics of theportfolios. These adjustments in the loss factors are tied to management’sevaluation of a number of factors including: 1) changes in the trend of thevolume and severity of past due, classified and non-accrual assets; 2) changesin the nature and volume of the portfolio; 3) changes in lending policies,underwriting standards, or collection practices; 4) changes in the experience,ability, depth of lending management and staff;  5) portfolio concentrations; and 6) changes in the national orlocal economy.

 

   •  SpecificAllowances for Identified Problem Loans. The amount of specific reserves isdetermined through a loan-by-loan analysis of non-performing loans. Theanalysis considers expected future cash flows, the value of  collateral or other factors that may impactthe borrower’s ability to repay.

 

   •  TheUnallocated Allowance. The unallocated portion of the allowance is based onloss factors that cannot be associated with specific loans or loan categories.These factors include management’s subjective evaluation of such conditions ascredit quality trends, collateral values, portfolio concentrations, specificindustry conditions in the regional economy, regulatory examination results,internal audit and loan review findings, recent loss experiences in particularportfolio segments, etc. The unallocated portion of the allowance for lossesreflects management’s attempt to ensure that the overall reserve appropriatelyreflects a margin for the imprecision necessarily inherent in estimates ofcredit losses.

 

While management believes the allowance for credit losses was adequateat March 31, 2002, the estimate of losses and related allowance may change inthe near term due to economic and other uncertainties inherent in theestimation process.

 

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Analysis ofAllowance for Credit Losses:

 
|                                                        |   | **Three months ended** |      |
|-------------------------------------------------------------|--------|------------------------|-----------|
| (in thousands)                                              |   | **March 31,2002**      |      | **December 31,2001** |   |
| Average loans outstanding less average  unearned income (1) |   | $                      | 1,165,013 |   | $ | 1,132,711 |   |
| Allowance for credit losses at beginning  of period         |   | $                      | 13,947    |   | $ | 14,219 |   |
| Charge-offs:                                                |   |                   |      |   |   |
| Real estate                                                 |   | 8                      |      | 20 |   |
| Commercial and industrial                                   |   | 73                     |      | 430 |   |
| Consumer                                                    |   | 1,261                  |      | 1,211 |   |
| Total loans charged-off                                     |   | 1,342                  |      | 1,661 |   |
| Recoveries:                                                 |   |                   |      |   |   |
| Real estate                                                 |   | 1                      |      | 83 |   |
| Commercial and industrial                                   |   | 26                     |      | 25 |   |
| Consumer                                                    |   | 675                    |      | 660 |   |
| Total recoveries                                            |   | 702                    |      | 768 |   |
| Net charge-offs                                             |   | 640                    |      | 893 |   |
| Additions charged to operating expense                      |   | 825                    |      | 621 |   |
| Allowance for credit losses at end of  period               |   | $                      | 14,132    |   | $ | 13,947 |   |
| Net charge-offs to average loans  outstanding               |   | 0.05                   | %         | 0.08 | % |

 

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(1)          Excludes loans held for sale

 

The following table presents an allocation of the allowance for creditlosses to various loan categories.  Thisallocation does not limit the amount of the allowance available to absorblosses from any type of loan and should not be viewed as an indicator of thespecific amount or specific loan categories in which future charge-offs mayultimately occur.

 

Allocation ofAllowance for Credit Losses:

** **
|                              |   | **March 31, 2002** |   | **December 31, 2001**     |   |
|-----------------------------------|--------|--------------------|--------|---------------------------|--------|
|                              |   | **Amount**         |   | **% of Total  Allowance** |   | **Amount** |   | **% of Total  Allowance** |   |
|                              |   |               |   |                      |   |   |   |   |   |
| Real estate loans                 |   |               |   |                      |   |   |   |   |   |
| Construction and land development |   | $                  | 1,275  |                      | 9.0    | % | $ | 1,655 |   | 11.9 | % |
| Residential mortgage              |   | 595                |   | 4.2                       | %      | 481 |   | 3.4 | % |
| Other mortgage                    |   | 2,280              |   | 16.1                      | %      | 2,534 |   | 18.2 | % |
| Commercial and industrial         |   | 3,151              |   | 22.3                      | %      | 3,131 |   | 22.4 | % |
| Consumer                          |   | 4,547              |   | 32.2                      | %      | 5,923 |   | 42.5 | % |
| Unallocated                       |   | 2,284              |   | 16.2                      | %      | 223 |   | 1.6 | % |
| Totals                            |   | $                  | 14,132 |                      | 100.0  | % | $ | 13,947 |   | 100.0 | % |

 

15

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**CapitalResources**

 

It is Bancorp’s policy to maintain a level of capital sufficient toprotect the company’s depositors, creditors, and shareholders, and to supportBancorp’s growth. The principal source of capital is retained earnings. Bancorprecorded a total risk-based capital ratio of 13.53% at March 31, 2002, comparedto 13.30% at December 31, 2001; a tier 1 risk-based capital ratio of 12.46%,compared to 12.24%: and a capital leverage ratio of 8.87%, compared to 8.71%.Under each measure, Bancorp and its subsidiaries were substantially in excessof the minimum regulatory requirements and, by definition, were “wellcapitalized” at March 31, 2002 and December 31, 2001. Management believes thelevel of capital at March 31, 2002, is appropriate.

 

Shareholders’ equity totaled $168.9 million ( including $2.4 millionreported for accumulated other comprehensive income) at March 31, 2002; anincrease of 1% compared with the 2001 year-end level of $167.4 million (including$3.2 million reported for accumulated other comprehensive income). Bancorp’saccumulated comprehensive income (loss) category is comprised of net unrealizedgains and losses on available-for-sale securities.

 

**Item 3.  Quantitative and QualitativeDisclosures about Market Risk.**

 

Market risk is defined as a change in the value of financialinstruments, i.e. cash, investments, loans, deposits and debt.  Included in market risk are interest raterisk, foreign currency exchange rate risk, commodity price risk, and otherrelevant market risks.  Bancorp’sprimary source of market risk is interest rate risk.  Market risk-sensitive financial instruments are entered into forpurposes other than trading.

 

Interest rate risk refers to the exposure of Bancorp’s earnings andcapital to changes in interest rates. This risk is driven by potentialmismatches resulting in timing differences in the repricing of assets,liabilities and the potential impact of explicit and embedded options. The goalof asset/liability management is to maintain high-quality and consistent growthof net interest income, while maintaining acceptable levels of risk to changesin interest rates, and acceptable levels of capital and liquidity. This goal isachieved by influencing the maturity and repricing of assets and liabilitiesand by managing discretionary portfolios.

 

There are several common sources of interest rate risk that must beeffectively managed if there is to be minimal impact on Bancorp’s earnings andcapital.  Re-pricing risk arises largelyfrom timing differences in the pricing of assets and liabilities.  Reinvestment risk refers to the reinvestmentof cash flows from interest payments and maturing assets at lower rates.  Basis risk exists when different yieldcurves or pricing indices do not change at precisely the same time or in thesame magnitude such that assets and liabilities with the same maturity are notall affected equally.  Yield curve riskrefers to unequal movements in interest rates across a full range of maturities.

 

In determining the appropriate level of interest rate risk, Bancorpconsiders the impact on earnings and capital of the current outlook on interestrates, potential changes in interest rates, regional economies, liquidity,business strategies, and other factors. The Bancorp uses a number of tools tomeasure interest rate risk, including net interest income simulation,monitoring the sensitivity of the net present value of the balance sheet, andmonitoring the difference or gap between maturing or rate-sensitive assets andliabilities over various time periods.

 

Management believes that interest rate risk is best measured bysimulation modeling which calculates expected net interest income based onprojected interest-earning assets and interest-bearing liabilities.  The model projections are based uponhistorical trends and management’s expectations of balance sheet growthpatterns, spreads to market rates, historical market rate relationships,prepayment behavior, current and expected product offerings and salesactivities. Various sensitivity analyses are performed on a regular basis tosegregate interest rate risk into separate components and understand the riskattributable to prepayments, caps and floors, and other options. Assumptiontesting is performed to understand the degree of impact from changing key

 

16

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assumptions such as the speed of prepayments, the interest rateelasticity of core deposit rates and balance sheet growth.  The Bancorp’s policy guideline limit for netinterest income simulation is a negative impact to net interest income of 15.0percent for the up or down 300 basis points scenarios when compared with theflat rate scenario.  Management hasgenerally maintained a risk position well within the policy guidelinelevel.  The model indicated the impactof a 300 basis point rise in rates over the next 12 months would causeapproximately a 3.1 percent decrease in net interest income at March 31,2002.  A 300 basis point decrease in ratesover the next 12 months would cause approximately a 5.6 percent decrease in netinterest income.

 

Computations of prospective effects of hypothetical interest ratechanges are based on many assumptions, including relative levels of marketinterest rates, loan prepayments and changes in deposit levels.  They are not intended to be a forecast andshould not be relied upon as indicative of actual results.  Further, the computations do not contemplatecertain actions that management could take in response to changes in interestrates.

 

Effects of Changing Prices: Inasmuch as virtually all of a financialinstitution’s assets and liabilities are monetary in nature, changes ininterest rates, or the price paid for money, may have a significant effect onearnings performance. Interest rates, though affected by inflation, do notnecessarily move in the same direction, or in the same magnitude, as the pricesof other goods and services. Movements in interest rates are a result of theperceived changes in the rate of inflation and the effects of monetary andfiscal policies. Reference to Net Interest Income and Market Risk in thissection will assist the reader in understanding of how Bancorp is positioned toaddress changing interest rates.

 

Several major categories of noninterest expense are more directlyaffected by inflationary factors such as salaries and employee benefits andother operating expenses. Management endeavors to overcome, or mitigate, theeffects of inflation by seeking opportunities to improve operating efficiencyand productivity, and by developing strategies for growth that will exceed theprojected rate of inflation.

 

**PART II****- Other Information**

 

**Item 4****.  Submission of Matters to Vote ofSecurity Holders**

 

(a)                                  The annual meeting of stockholders ofF&M Bancorp was held April 16, 2002.

(b)                                 Proxies for the annual meeting weresolicited pursuant to Regulation 14A under the Securities and Exchange Act of1934. There was no solicitation in opposition to management’s nominees aslisted in the proxy statement, and all such nominees were re-elected.

(c)           (1) Election of Directors

 

There were 10,853,300 shares of Common Stock entitled to vote at themeeting and a total of 8,339,942 shares 76.84% were represented at the meeting.Elected to serve as directors until the 2004 annual meeting of stockholders:

 
| **Name**       |   | **For**   |   | **Withheld** |   | **Against** |   |
|----------------|--------|-----------|--------|--------------|--------|-------------|--------|
|           |   |      |   |         |   |        |   |
| Faye E. Cannon |   | 8,181,374 |   | 158,568      |   | —      |   |
| Donald R. Hull |   | 8,151,419 |   | 188,523      |   | —      |   |

 

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

 

(a)                                  Exhibits

 

None

 

(b)           Reports on Form 8-K

 

A report on Form 8-K, Item 5.Other Event, was filed on April 8, 2002 to announce the selection of newindependent external accountants.

 

**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)        |
|         |   |                |
|         |   |                |
| May 11, 2002 |   | /s/ Faye E. Cannon  |   |
| Date         |   | FAYE E. CANNON      |
|         |   | PRESIDENT AND CEO   |
|         |   |                |
|         |   |                |
| May 11, 2002 |   | /s/ Kaye A. Simmons |   |
| Date         |   | KAYE SIMMONS        |
|         |   | CFO AND TREASURER   |
|              |        |                     |        |  |

 

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