**SECURITIESAND 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 June 30, 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 ofregistrant as specified in its charter)*

 

| **Maryland**                                                 |   | **52-1316473**         |
|--------------------------------------------------------------|--------|------------------------|
| *(State or  other jurisdiction of*                           |   | *(I.R.S.  Employer*    |
| *incorporation  or organization)*                            |   | *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 markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes ý  No o

 

Common Stock of 10,026,915 shares outstanding as of August 8, 2002.

 

 

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F&M BANCORP

TABLE OF CONTENTS

 
| PART I  |                                                                                                                        | FINANCIAL INFORMATION |
|---------|-----------------------------------------------------------------------------------------------------------------------------|-----------------------|
|    |                                                                                                                        |
|    | Consolidated  Balance Sheets   June 30, 2002 (Unaudited) and December 31, 2001                                              |                  |
|    |                                                                                                                        |                  |
|    | Consolidated  Statements of Income and Comprehensive Income (Unaudited),  Three and Six Months Ended June 30, 2002 and 2001 |                  |
|    |                                                                                                                        |                  |
|    | Consolidated  Statements of Changes in Shareholders’ Equity (Unaudited),  Six Months Ended June 30, 2002 and 2001      |                  |
|    |                                                                                                                        |                  |
|    | Consolidated  Statements of Cash Flows (Unaudited),  Six Months Ended June 30, 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 6.  Exhibits and Reports on Form 8-K                                                                              |
|    |                                                                                                                        |
|    | Signatures                                                                                                                  |
|         |                                                                                                                             |                       |  |  |  |

 

2

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**Consolidated Balance Sheets**(Unaudited)

**F&M Bancorp and Subsidiaries**

** **
| **(in thousands, except per share data)**                                                                                                    |   | **June 30,  2002** |       | **December 31,  2001** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
| **Assets**                                                                                                                                   |   |               | ** ** |                   | ** ** |
| Cash and due from banks                                                                                                                      |   | $                  | 55,064     |                   | $          | 65,570 |   |
| Federal funds sold                                                                                                                           |   | 8,327              |       | 360                    |       |
| Interest-bearing deposits with banks                                                                                                         |   | 3,668              |       | 13,178                 |       |
| Total cash and cash equivalents                                                                                                              |   | 67,059             |       | 79,108                 |       |
| Loans held for sale                                                                                                                          |   | 10,655             |       | 28,773                 |       |
| Investment securities:                                                                                                                       |   |               |       |                   |       |
| Available-for-sale, at fair value                                                                                                            |   | 606,826            |       | 546,522                |       |
| Total investment securities                                                                                                                  |   | 606,826            |       | 546,522                |       |
| Loans, net of unearned income                                                                                                                |   | 1,171,946          |       | 1,162,230              |       |
| Less: Allowance for credit losses                                                                                                            |   | (13,999            | )          | (13,947                | )          |
| Net loans                                                                                                                                    |   | 1,157,947          |       | 1,148,284              |       |
| Bank premises and equipment, net                                                                                                             |   | 34,751             |       | 35,563                 |       |
| Other real estate owned, net                                                                                                                 |   | 354                |       | 638                    |       |
| Interest receivable                                                                                                                          |   | 8,982              |       | 9,417                  |       |
| Intangible assets                                                                                                                            |   | 3,307              |       | 3,898                  |       |
| Other assets                                                                                                                                 |   | 26,223             |       | 29,231                 |       |
| Total  other assets                                                                                                                     |   | 73,617             |       | 78,747                 |       |
| Total assets                                                                                                                                 |   | $                  | 1,916,104  |                   | $          | 1,881,434 |   |
| **Liabilities  and Stockholder’s Equity**                                                                                               |   |               | ** ** |                   | ** ** |
| Liabilities:                                                                                                                                 |   |               |       |                   |       |
| Deposits:                                                                                                                                    |   |               |       |                   |       |
| Noninterest-bearing                                                                                                                          |   | $                  | 260,082    |                   | $          | 234,459 |   |
| Interest-bearing                                                                                                                             |   | 1,289,159          |       | 1,281,609              |       |
| Total deposits                                                                                                                               |   | 1,549,241          |       | 1,516,068              |       |
| Short-term borrowings:                                                                                                                       |   |               |       |                   |       |
| Federal funds purchased and securities sold under agreements to  repurchase                                                                  |   | 93,715             |       | 114,505                |       |
| Other short-term borrowings                                                                                                                  |   | 2,722              |       | 3,040                  |       |
| Long-term borrowings                                                                                                                         |   | 78,342             |       | 63,444                 |       |
| Accrued taxes and other liabilities                                                                                                          |   | 14,622             |       | 16,952                 |       |
| Total liabilities                                                                                                                            |   | 1,738,642          |       | 1,714,009              |       |
| Shareholders’ equity                                                                                                                    |   |               |       |                   |       |
| Common stock, par value $5 per share; authorized 50,000,000 shares; issued  and outstanding 10,776,315 shares in 2002 and 10,862,257 in 2001 |   | 53,882             |       | 54,311                 |       |
| Surplus                                                                                                                                      |   | 72,121             |       | 75,147                 |       |
| Retained earnings                                                                                                                            |   | 43,657             |       | 34,782                 |       |
| Accumulated other comprehensive income                                                                                                       |   | 7,802              |       | 3,185                  |       |
| Total shareholders’ equity                                                                                                              |   | 177,462            |       | 167,425                |       |
| Total liabilities and shareholders’ equity                                                                                              |   | $                  | 1,916,104  |                   | $          | 1,881,434 |   |

 

The accompanying notes are an integral part ofthese 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  June 30,** |   | **Six Months Ended  June 30,** |   |
|----------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                         |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
| **Interest  Income**                                                                         |   |                             |   |                           |   |   |   |   |   |
| Interest and fees on loans                                                                   |   | $                                | 20,650 |                           | $      | 24,356 |   | $ | 41,934 |   | $ | 49,354 |   |
| Interest on deposits with banks                                                              |   | 20                               |   | 189                            |   | 42 |   | 367 |   |
| Interest and dividends on investment securities:                                             |   |                             |   |                           |   |   |   |   |   |
| Taxable                                                                                      |   | 5,842                            |   | 4,856                          |   | 11,162 |   | 9,621 |   |
| Tax-exempt                                                                                   |   | 1,270                            |   | 1,393                          |   | 2,586 |   | 2,864 |   |
| Interest on federal funds sold                                                               |   | 37                               |   | 198                            |   | 58 |   | 437 |   |
| Total interest income                                                                        |   | 27,819                           |   | 30,992                         |   | 55,782 |   | 62,643 |   |
| **Interest  Expense**                                                                        |   |                             |   |                           |   |   |   |   |   |
| Interest on deposits                                                                         |   | 8,071                            |   | 12,477                         |   | 16,920 |   | 24,906 |   |
| Interest on federal funds purchased and securities sold under agreements  to repurchase      |   | 237                              |   | 905                            |   | 508 |   | 2,169 |   |
| Interest on long-term borrowings                                                             |   | 828                              |   | 419                            |   | 1,607 |   | 1,361 |   |
| Interest on other short-term borrowings                                                      |   | 92                               |   | 102                            |   | 133 |   | 828 |   |
| Total interest expense                                                                       |   | 9,228                            |   | 13,903                         |   | 19,168 |   | 29,264 |   |
| Net interest income                                                                          |   | 18,591                           |   | 17,089                         |   | 36,614 |   | 33,379 |   |
| Provision for credit losses                                                                  |   | 150                              |   | 1,535                          |   | 975 |   | 2,630 |   |
| Net interest income after provision for credit losses                                        |   | 18,441                           |   | 15,554                         |   | 35,639 |   | 30,749 |   |
| **Noninterest  Income**                                                                      |   |                             |   |                           |   |   |   |   |   |
| Service charges on deposit accounts                                                          |   | 2,282                            |   | 2,093                          |   | 4,478 |   | 4,071 |   |
| Insurance income                                                                             |   | 2,540                            |   | 2,257                          |   | 5,190 |   | 4,796 |   |
| Gains on sales of loans                                                                      |   | 849                              |   | 785                            |   | 1,721 |   | 1,597 |   |
| Gains on sales of securities                                                                 |   | —                           |   | 33                             |   | — |   | 33 |   |
| Gains on sales of property                                                                   |   | 36                               |   | 64                             |   | 122 |   | 107 |   |
| Alternative investment and stock brokerage income                                            |   | 910                              |   | 932                            |   | 1,831 |   | 1,847 |   |
| Other operating income                                                                       |   | 1,357                            |   | 1,303                          |   | 2,672 |   | 3,053 |   |
| Total noninterest income                                                                     |   | 7,974                            |   | 7,467                          |   | 16,014 |   | 15,504 |   |
| **Noninterest  Expenses**                                                                    |   |                             |   |                           |   |   |   |   |   |
| Salaries and employee benefits                                                               |   | 9,581                            |   | 9,045                          |   | 19,238 |   | 17,901 |   |
| Occupancy and equipment expense                                                              |   | 2,625                            |   | 2,520                          |   | 5,099 |   | 5,279 |   |
| Other operating expense                                                                      |   | 5,024                            |   | 4,216                          |   | 9,697 |   | 8,918 |   |
| Total noninterest expenses                                                                   |   | 17,230                           |   | 15,781                         |   | 34,034 |   | 32,098 |   |
| Income before provision for income taxes                                                     |   | 9,185                            |   | 7,240                          |   | 17,619 |   | 14,155 |   |
| Provision for income taxes                                                                   |   | 3,069                            |   | 2,029                          |   | 5,726 |   | 3,964 |   |
| Net Income                                                                                   |   | $                                | 6,116  |                           | $      | 5,211 |   | $ | 11,893 |   | $ | 10,191 |   |
| Other Comprehensive Income (Loss), Net of Tax:                                               |   |                             |   |                           |   |   |   |   |   |
| Unrealized gains (losses) on securities available-for-sale                                   |   | $                                | 5,437  |                           | $      | (50 | ) | $ | 4,617 |   | $ | 4,258 |   |
| Reclassification adjustment for gains included in net income                                 |   | —                           |   | 22                             |   | — |   | 22 |   |
| Other comprehensive income (loss)                                                            |   | 5,437                            |   | (28                            | )      | 4,617 |   | 4,280 |   |
| Comprehensive income                                                                         |   | $                                | 11,553 |                           | $      | 5,183 |   | $ | 16,510 |   | $ | 14,471 |   |
| Earnings per Common Share – Basic                                                       |   |                             |   |                           |   |   |   |   |   |
| Based on weighted average shares outstanding of 10,833,329 in 2002, and  11,0020,857 in 2001 |   | $                                | 0.57   |                           | $      | 0.47 |   | $ | 1.10 |   | $ | 0.93 |   |
| Earnings per Common Share – Diluted                                                     |   |                             |   |                           |   |   |   |   |   |
| Based on weighted average shares outstanding of 10,895,311 in 2002, and  11,063,047 in 2001  |   | $                                | 0.56   |                           | $      | 0.47 |   | $ | 1.09 |   | $ | 0.92 |   |
| Dividends per Share                                                                          |   | —                           |   | $                              | 0.27   |   | $ | 0.28 |   | $ | 0.54 |   |

** **

The accompanying notes are an integral part ofthese consolidated financial statements.

 

4

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**Consolidated Statements of Changes 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                                 |   | —            |   | —      |   | 10,191                 |   | —                                               |   | 10,191    |   |
| Dividend reinvestment plan                 |   | —            |   | —      |   | (154                   | )      | —                                               |   | (154      | )      |
| Cash dividends paid ($.54 per share)       |   | —            |   | —      |   | (5,956                 | )      | —                                               |   | (5,956    | )      |
| Stock consideration for options exercised  |   | (3                | )      | (4          | )      | (7                     | )      | —                                               |   | (14       | )      |
| Stock options exercised                    |   | 97                |   | 282         |   | —                 |   | —                                               |   | 379       |   |
| Stock repurchase and retirement            |   | (166              | )      | (690        | )      | —                 |   | —                                               |   | (856      | )      |
| Other comprehensive income                 |   | —            |   | —      |   | —                 |   | 4,280                                                |   | 4,280     |   |
| Balance at June 30, 2001                   |   | $                 | 55,001 |        | $      | 78,076                 |   | $                                                    | 29,931 |      | $      | 2,898 |   | $ | 165,906 |   |
|                                       |   |              |   |        |   |                   |   |                                                 |   |      |   |
| Balance at December 31, 2001               |   | $                 | 54,311 |        | $      | 75,147                 |   | $                                                    | 34,782 |      | $      | 3,185 |   | $ | 167,425 |   |
|                                       |   |              |   |        |   |                   |   |                                                 |   |      |   |
| Net income                                 |   | —            |   | —      |   | 11,893                 |   | —                                               |   | 11,893    |   |
| Dividend reinvestment plan                 |   | —            |   | —      |   | (24                    | )      | —                                               |   | (24       | )      |
| Cash dividends paid ($.28 per share)       |   | —            |   | —      |   | (2,984                 | )      | —                                               |   | (2,984    | )      |
| Stock consideration for options exercised  |   | (3                | )      | (674        | )      | (9                     | )      | —                                               |   | (686      | )      |
| Stock options exercised                    |   | 152               |   | 469         |   | —                 |   | —                                               |   | 621       |   |
| Stock repurchase and retirement            |   | (579              | )      | (2,821      | )      | —                 |   | —                                               |   | (3,400    | )      |
| Other comprehensive income                 |   | —            |   | —      |   | —                 |   | 4,617                                                |   | 4,617     |   |
| Balance at June 30, 2002                   |   | $                 | 53,882 |        | $      | 72,121                 |   | $                                                    | 43,657 |      | $      | 7,802 |   | $ | 177,462 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

5

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

#### **F&M Bancorp and Subsidiaries**

 
|                                                                                                        |   | **Six Months Ended**June 30, |   |
|-------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
| **(in thousands)**                                                                                          |   | **2002**                     |   | **2001** |   |
| **Cash Flows  from Operating Activities**                                                                   |   |                         |   |   |   |
| Net Income                                                                                                  |   | $                            | 11,893 |   | $ | 10,191 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities                           |   |                         |   |   |   |
| Provision for credit losses                                                                                 |   | 975                          |   | 2,630 |   |
| Depreciation and amortization                                                                               |   | 1,939                        |   | 1,779 |   |
| Amortization of intangibles                                                                                 |   | 591                          |   | 542 |   |
| Net premium amortization / accretion on investment securities                                               |   | 1,349                        |   | 200 |   |
| Decrease in interest receivable                                                                             |   | 435                          |   | 1,298 |   |
| Decrease in interest payable                                                                                |   | (407                         | )      | (844 | ) |
| Gains on sales of property                                                                                  |   | (122                         | )      | (107 | ) |
| Gains on sales of securities                                                                                |   | —                       |   | (33 | ) |
| Decrease (increase) in loans held for sale                                                                  |   | 18,124                       |   | (10,995 | ) |
| Decrease in other assets                                                                                    |   | 373                          |   | 8,871 |   |
| Decrease in other liabilities                                                                               |   | (1,923                       | )      | (530 | ) |
| Gain on sales of loans                                                                                      |   | (1,721                       | )      | (1,597 | ) |
| Net cash provided by operating activities                                                                   |   | 31,505                       |   | 11,407 |   |
| **Cash Flows  from Investing Activities**                                                                   |   |                         |   |   |   |
| Purchases of investment securities available-for-sale                                                       |   | (159,741                     | )      | (166,410 | ) |
| Proceeds from sales/maturities of securities available-for-sale                                             |   | 105,340                      |   | 129,634 |   |
| Net (increase) decrease in loans                                                                            |   | (8,998                       | )      | 40,131 |   |
| Purchases of premises and equipment                                                                         |   | (1,126                       | )      | (1,824 | ) |
| Proceeds from sales of property                                                                             |   | 481                          |   | 190 |   |
| Net cash provided by (used in) in investing activities                                                      |   | (64,044                      | )      | 1,721 |   |
| **Cash Flows from  Financing Activities**                                                                   |   |                         |   |   |   |
| Net increase in noninterest-bearing deposits, interest-bearing  checking, savings and money market accounts |   | 74,231                       |   | 26,660 |   |
| Net (decrease) increase in certificates of deposit                                                          |   | (41,058                      | )      | 78,573 |   |
| Net decrease in federal funds purchased and securities sold under  agreements to repurchase                 |   | (20,790                      | )      | (25,116 | ) |
| Net decrease in other short-term borrowings                                                                 |   | (318                         | )      | (108,844 | ) |
| Net increase in long-term borrowings                                                                        |   | 14,898                       |   | 24,536 |   |
| Cash dividends paid                                                                                         |   | (2,984                       | )      | (5,956 | ) |
| Dividend reinvestment plan                                                                                  |   | (24                          | )      | (154 | ) |
| Proceeds from issuance of common stock                                                                      |   | (65                          | )      | 365 |   |
| Common stock purchased and retired                                                                          |   | (3,400                       | )      | (856 | ) |
| Net cash provided by (used in) by financing activities                                                      |   | 20,491                       |   | (10,792 | ) |
| Net increase (decrease) in cash and cash equivalents                                                        |   | (12,049                      | )      | 2,336 |   |
| Cash and cash equivalents at beginning of year                                                              |   | 79,108                       |   | 70,133 |   |
| Cash and cash equivalents at end of period                                                                  |   | $                            | 67,059 |   | $ | 72,469 |   |
| **Supplemental  Disclosures of Cash Flow Information**                                                      |   |                         |   |   |   |
| Cash payments for interest                                                                                  |   | 19,574                       |   | 30,107 |   |
| Cash payments for income tax                                                                                |   | 5,711                        |   | 3,693 |   |
| **Non-Cash  Investing and Financing Activities**                                                            |   |                         |   |   |   |
| Fair value adjustment for securities available-for-sale, net of income  taxes                               |   | 4,617                        |   | 4,280 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

6

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**Notesto Consolidated Financial Statements **(Unaudited)

 

##### **Note1.  General**

 

These unaudited consolidated financial statements, which include theaccounts of F&M Bancorp and its subsidiaries (Bancorp), have been preparedpursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”), and, in the opinion of management, reflect adjustments consisting onlyof normal recurring adjustments necessary to present fairly the financialposition, results of operations and cash flows for the periods presented inconformity with accounting principles generally accepted in the United Statesof America. These unaudited condensed consolidated financial statements shouldbe read in conjunction with the audited annual consolidated financialstatements and notes thereto included in F&M Bancorp’s Annual Report onForm 10-K for the fiscal year ended December 31, 2001.  The results shown in this interim report arenot necessarily indicative of results to be expected for the full year of 2002.

 

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.

 

Certain prior period items in these unaudited condensed consolidatedfinancial statements have been reclassified to conform to the current periodpresentation.

 

**Note2.  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 June 30,** |   | **Six Months Ended June 30,** |   |
|                                      |   | **2002**                        |   | **2001**                      |   | **2002**   |   | **2001**   |   |
|                                      |   |                            |   |                          |   |       |   |       |   |
| Net income(1)                             |   | $                               | 6,116  |                          | $      | 5,211      |   | $          | 11,893 |   | $ | 10,191 |   |
| Basic EPS                                 |   |                            |   |                          |   |       |   |       |   |
| Shares                                    |   | 10,814,183                      |   | 11,019,337                    |   | 10,833,329 |   | 11,020,857 |   |
| EPS                                       |   | $                               | 0.57   |                          | $      | 0.47       |   | $          | 1.10   |   | $ | 0.93 |   |
| Dilutive shares                           |   |                            |   |                          |   |       |   |       |   |
| Stock options                             |   | 63,632                          |   | 55,116                        |   | 61,982     |   | 42,190     |   |
| EPS                                       |   | $                               | 0.01   |                          | $      | 0.00       |   | $          | 0.01   |   | $ | 0.01 |   |
| Diluted EPS                               |   |                            |   |                          |   |       |   |       |   |
| Shares including options                  |   | 10,877,815                      |   | 11,074,453                    |   | 10,895,311 |   | 11,063,047 |   |
| EPS                                       |   | $                               | 0.56   |                          | $      | 0.47       |   | $          | 1.09   |   | $ | 0.92 |   |

 

----

(1)The carrying value of the deposits that have created over 88% of the Bancorp’sinterest expense for the first six months of 2002 and thus contributing greatlyto net income are illustrated in the table below.

 

7

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| **Deposits:  (in thousands)**       |   | **June 30,  2002** |      | **December 31,  2001** |   |
|-------------------------------------|--------|--------------------|-----------|------------------------|--------|
| Noninterest-bearing demand deposits |   | $                  | 260,082   |                   | $      | 234,459 |   |
| Interest-bearing deposits:          |   |               |      |                   |   |
| Checking                            |   | 216,284            |      | 200,430                |   |
| Money market                        |   | 304,953            |      | 296,687                |   |
| Savings                             |   | 178,231            |      | 153,744                |   |
| Certificates of deposit:            |   |               |      |                   |   |
| Under $100,000                      |   | 424,139            |      | 443,465                |   |
| $ 100,000 and over                  |   | 165,551            |      | 187,283                |   |
| Total deposits                      |   | $                  | 1,549,241 |                   | $      | 1,516,068 |   |

 

**Note 3.Loans**

 

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

 
|                              |   | **For the Period Ending** |      |
|-----------------------------------|--------|---------------------------|-----------|
| **(in thousands)**                |   | **June 30,  2002**        |      | **December 31,  2001** |   |
| Real Estate Loans:                |   |                      |      |   |   |
| Construction and land development |   | $                         | 88,482    |   | $ | 85,138 |   |
| Secured by farmland               |   | 5,489                     |      | 5,902 |   |
| Residential mortgage              |   | 300,180                   |      | 295,441 |   |
| Other mortgage                    |   | 331,993                   |      | 323,643 |   |
| Agricultural                      |   | 318                       |      | 507 |   |
| Commercial and industrial loans   |   | 170,021                   |      | 175,307 |   |
| Consumer                          |   | 274,453                   |      | 274,361 |   |
| Other loans                       |   | 1,010                     |      | 1,931 |   |
| Totals                            |   | $                         | 1,171,946 |   | $ | 1,162,230 |   |

 

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

 

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” (effectiveJuly 1, 2001) and SFAS No. 142, “Goodwilland Other Intangible Assets” (effective January 1, 2002). SFAS No. 141prohibits pooling-of-interests accounting for acquisitions. SFAS No. 141 alsospecifies the criteria for intangible assets acquired in a purchase methodbusiness combination to be recognized and reported apart from goodwill. SFASNo. 142 specifies that goodwill and some intangible assets will no longer beamortized but instead will be subject to periodic impairment testing. SFAS 142also requires intangible assets with definite useful lives to be amortized overtheir respective estimated useful lives to their estimated residual values, andreviewed for

 

8

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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 June 30, 2002 had $3,307,000 in definite lived intangibleassets that continue to be subject to amortization under SFAS 142. Amortizationexpense related to intangible assets was $543,000 and $574,000 for the sixmonths ended June 30, 2002 and 2001, respectively.

 

Bancorp does not carry any goodwill attributable to premiums relatingfrom prior mergers and/or acquisitions. The bank does however, have mortgageservicing rights and core deposit intangibles, which qualify as intangibleassets and are subject to impairment analysis as prescribed in SFAS 142.

 

Mortgage servicing rights are an asset which represent the rights toservice mortgage loans for others. At June 30, 2002, based upon the analysis ofmortgage servicing rights valuations, the carrying value of this intangibleasset is not impaired.

 

Core deposit intangibles represent the premium paid in the acquisitionof deposit relationships and balances from other financial institutions.******At June 30, 2002,based upon a valuation analysis of eight branch locations with core depositintangibles, one location was deemed to be impaired. Bancorp has acceleratedthe remaining life on this location from 3.64 years to 2.26 years. That will impact 2002 earnings by approximately $45thousand.

 

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 Company 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 146 requires that the liability for costs associatedwith an exit or disposal activity be recognized when the liability is incurred.Under Issue 94-3, a liability for an exit cost was recognized at the date ofthe Company’s commitment to an exit plan rather than when the liability isincurred. SFAS 146 also establishes that the liability should initially bemeasured and recorded at fair value. Accordingly, SFAS 146 may affect the timing of recognizing futurerestructuring costs as well as the amounts recognized. The Company will adoptthe provisions of SFAS 146 for any restructuring activities which may beinitiated after December 31,2002.

 

**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

# **OVERVIEW**

 

**Forward-LookingStatements**

 

Statements made in this document, other than statements of historicalinformation, are forward-looking statements that are made pursuant to the safeharbor provisions of Section 21E of the Securities Exchange Act of 1934. Theseforward-looking statements may sometimes be identified by words such 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, expressedor implied by the forward-looking statements. Important factors that couldcause actual results to differ materially from our forward-looking statementsare set forth in our other filings with the SEC, and in this document under theheading “Risk Factors”, beginning in the section captioned “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”. Wecaution that the risks and factors discussed below and in such filings are notexclusive. We do not undertake to update any forward-looking statement that maybe made from time to time by or on behalf of Bancorp.

 

**CriticalAccounting 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, accounting for financial derivatives, the recognition of deferredtax assets and the valuation of goodwill; these areas are more fully describedin “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in our Annual Report on Form 10-K for the year ended December 31, 2001.

 

F&M Bancorp is the registered bank holding company for Farmers andMechanics Bank (the “Bank”), headquartered in Frederick, Maryland. The Bankoperates 47 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 second quarter of 2002 reached arecord $0.56 per share, a 19% increase over the prior year’s $0.47 per shareresults. Net income for the second quarter of 2002 reached a record $6.1million, an increase of 17.4% compared with earnings of $5.2 million for thesecond quarter of 2001. A slight decrease in the net interest margin from 4.38%in 2001 to 4.36% in 2002 was experienced due to lower interest rates earned onaverage earning assets. For the six months ended June 30, 2002, earnings perdiluted share reached a record $1.09, a 18.5% increase versus $0.92 per dilutedshare for 2001. Net income for the first six months of 2002 reached $11.9million, compared to earnings of $10.2 million for 2001.

 

9

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F&M Bancorp’s key performance ratios continue to be strong. Secondquarter of 2002 results produced a return on average assets of 1.30% and areturn on average equity of 14.14% compared to 2001 second quarter ratios of1.19% and 12.60%, respectively. The earnings produced in the six months endedJune 30, 2002 represent a return on average assets of 1.28% and a return onaverage equity of 13.93%. These financial performance ratios are indicative ofF&M Bancorp’s earnings strength and effective balance sheet management.

 

Bancorp’s asset quality remained strong throughout the first half.Nonperforming assets as a percentage of assets stood at 0.13% at June 30, 2002.The allowance for credit losses was $14.0 million or 1.21% of total loans withnet annualized charge-offs for the half representing 0.16% of average loansoutstanding.

 

# **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 $19.3 millionin the second quarter 2002 was 8.2% 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 second quarter of 4.36%. Forthe six months of 2002 taxable-equivalent net interest income was $38.1 millionan increase of $3.1 million or 9% over 2001 net interest income. The netinterest margin for the first six months of 2002 improved by 7 basis points dueto lower interest rates paid on deposits and borrowings.

 

**InterestIncome**

 

While the level of earning assets grew by $125 million or 7.5%,Bancorp’s tax-equivalent interest income decreased $3.2 million or 10% in thesecond quarter of 2002 compared to the second quarter of 2001.This decrease wasdirectly impacted by the unprecedented reductions in interest rates. The yieldon earning assets decreased from 7.79% in 2001 to 6.44% for the second quarterof 2002.

 

During the second quarter of 2002, average loans yielding 7.05%declined $14.2 million compared to the second quarter of 2001. This decreasewas attributable to prepayments in residential mortgage loans, and consumerautomobile loans.

 

Average total securities yielding 5.30% increased 36% to $587 millionin the second quarter of 2002 compared to the second quarter of 2001. Thegrowth in the securities portfolio was directly attributable to the significantdeposit growth achieved during the past year.

 

10

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For the six months ended June 30, 2002 tax-equivalent interest incomewas $57.3 million, a decrease of $7.0 million or 10.85% from the $64.2 millionin the first six months of 2001. The yield on earning assets decreased from7.84% in the first half of 2001 to 6.53% in the first half of 2002, as higherinterest rate loans were refinanced or repaid and new loans were made at lowerrates. The increase in balances in the investment portfolio also contributed tothe decline in the earning asset yield.

 

# **Interest Expense**

 

Interest expense declined 34% or $4.7 million in the second quarter of2002 compared to the second quarter of 2001. This change was mainlyattributable to the decreased interest rate environment which significantlylowered the overall cost of funds. Interest expense additionally benefited froma change in the composition of funding sources from high cost deposits andborrowings into lower cost transaction accounts.

 

Average interest bearing deposits increased 4.4% or $53.8 million inthe second quarter of 2002 as compared to the second quarter of 2001. Theaverage rate paid on interest-bearing deposits decreased by 159 basis pointsfrom 4.12% in 2001 to 2.53% in the second quarter of 2002 compared to 2001.

 

Average borrowed funds, typically the most expensive funding source,increased $23.1 million or 16% compared to the second quarter of 2001 asBancorp seeks to take advantage of the low interest rate environment byobtaining longer term funding at historically low costs. The average rate paidon borrowings decreased from 4.04% in 2001 to 2.79% for 2002.

 

Interest expense was reduced $10.1 million or 34.5% from $29.3 millionin the first half 2001 to $19.2 million in 2002. Average interest bearingdeposits increased $77.7 million or 6.45% to in the first half of 2002 comparedto that same period in 2001, while the average rate paid on those depositsdecreased from 4.17% to 2.66%.

 

Total average borrowed funds for the six months decreased $7.1 millionor 4.1% from $173.3 million in the first half of 2001 to $166.2 million in thecomparable period of 2002. The rate paid on those borrowings also decreasedfrom 5.07% in the first half of 2001 to 2.73% in the first half of 2002.

 

11

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

 
|                                                                        |   | **Three Months Ended  June 30,** |       |
|-----------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                        |   | **2002**                         | ** ** | **2001** | ** ** |
| **(in thousands)**                                                          |   | **Average  Balance**             |       | **Interest** |   | **Average(2)  Rate** |   | **Average  Balance** |   | **Interest** |   | **Average(2)  Rate** | ** ** |
| ASSETS                                                                      |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest earning assets:                                                    |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Short-term funds                                                            |   | $                                | 13,183     |   | $ | 57 |   | 1.73 | % | $ | 29,713 |   | $ | 385 |   | 4.44 | % |
| Investment securities:                                                      |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                     |   | 471,928                          |       | 5,842 |   | 4.97 | % | 305,941 |   | 4,856 |   | 6.52 | % |
| Tax-exempt(1)                                                               |   | 115,429                          |       | 1,924 |   | 6.69 | % | 125,980 |   | 2,111 |   | 6.80 | % |
| Total investment securities                                                 |   | 587,357                          |       | 7,766 |   | 5.30 | % | 431,921 |   | 6,967 |   | 6.60 | % |
| Loans, net, including loans held for sale(1)                                |   | 1,178,170                        |       | 20,722 |   | 7.05 | % | 1,192,353 |   | 24,409 |   | 8.30 | % |
| Total interest-earning assets                                               |   | 1,778,710                        |       | 28,545 |   | 6.44 | % | 1,653,987 |   | 31,761 |   | 7.79 | % |
| Total noninterest-earning assets                                            |   | 103,301                          |       |   |   |   |   | 107,595 |   |   |   |   |   |
| Total assets                                                                |   | $                                | 1,882,011  |   |   |   |   |   | $ | 1,761,582 |   |   |   |   |   |
| LIABILITIES                                                                 |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                               |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits                                                   |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                                                     |   | $                                | 174,700    |   | $ | 492 |   | 1.13 | % | $ | 149,489 |   | $ | 810 |   | 2.20 | % |
| Checking                                                                    |   | 204,478                          |       | 278 |   | 0.55 | % | 185,507 |   | 555 |   | 1.21 | % |
| Money market accounts                                                       |   | 308,934                          |       | 1,259 |   | 1.63 | % | 282,739 |   | 2,356 |   | 3.38 | % |
| Certificates of deposit                                                     |   | 592,966                          |       | 6,042 |   | 4.09 | % | 609,584 |   | 8,757 |   | 5.83 | % |
| Total interest bearing deposits                                             |   | 1,281,078                        |       | 8,071 |   | 2.53 | % | 1,227,319 |   | 12,478 |   | 4.12 | % |
| Short-term borrowings                                                       |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds purchased and securities sold under agreements to  repurchase |   | 88,236                           |       | 237 |   | 1.08 | % | 95,178 |   | 905 |   | 3.86 | % |
| Other short-term borrowings                                                 |   | 5,880                            |       | 92 |   | 6.28 | % | 7,842 |   | 102 |   | 5.28 | % |
| Total short-term borrowings                                                 |   | 94,116                           |       | 329 |   | 1.40 | % | 103,020 |   | 1,007 |   | 3.96 | % |
| Long-term borrowings                                                        |   | 71,983                           |       | 828 |   | 4.61 | % | 39,900 |   | 418 |   | 4.25 | % |
| Total borrowed funds                                                        |   | 166,099                          |       | 1,157 |   | 2.79 | % | 142,920 |   | 1,425 |   | 4.04 | % |
| Total interest bearing liabilities                                          |   | 1,447,177                        |       | 9,228 |   | 2.56 | % | 1,370,239 |   | 13,903 |   | 4.11 | % |
| Non-interest bearing liabilities:                                           |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                             |   | 247,113                          |       |   |   |   |   | 208,721 |   |   |   |   |   |
| Other liabilities                                                           |   | 14,276                           |       |   |   |   |   | 16,795 |   |   |   |   |   |
| Total non-interest bearing liabilities                                      |   | 261,389                          |       |   |   |   |   | 225,516 |   |   |   |   |   |
| Shareholders’ equity                                                   |   | 173,445                          |       |   |   |   |   | 165,827 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                             |   | $                                | 1,882,011  |   |   |   |   |   | $ | 1,761,582 |   |   |   |   |   |
| Net interest income                                                         |   |                             |       | 19,317 |   |   |   |   |   | 17,858 |   |   |   |
| Net interest spread                                                         |   |                             |       |   |   | 3.88 | % |   |   |   |   | 3.67 | % |
| Net interest margin                                                         |   |                             |       |   |   | 4.36 | % |   |   |   |   | 4.38 | % |

 

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(1)          Interest and yieldon obligations of state and political subdivisions and tax-exempt loans arecomputed on a taxable equivalent basis using U.S. statutory tax rate of 35percent.  In addition, loan fee incomeis included in the interest income calculation, and nonaccrual loans areincluded in the average loan base upon which the interest rate earned on loansis calculated.

(2)          Average balancesand interest dollars are presented in thousands. Average rates are calculatedusing whole dollars and may differ slightly.

 

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|                                                                        |   | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                        |   | **2002**                       |       | **2001** |   |
| **(in thousands)**                                                          |   | **Average  Balance**           |       | **Interest** |   | **Average(2)  Rate** |   | **Average  Balance** |   | **Interest** |   | **Average(2)  Rate** | ** ** |
| ASSETS                                                                      |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest earning assets:                                                    |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Short-term funds                                                            |   | $                              | 12,824     |   | $ | 101 |   | 1.59 | % | $ | 22,161 |   | $ | 803 |   | 5.90 | % |
| Investment securities                                                       |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                     |   | 457,005                        |       | 11,162 |   | 4.93 | % | 303,263 |   | 9,621 |   | 6.50 | % |
| Tax-exempt(1)                                                               |   | 116,906                        |       | 3,918 |   | 6.76 | % | 126,365 |   | 4,341 |   | 6.93 | % |
| Total investment securities                                                 |   | 573,911                        |       | 15,080 |   | 5.30 | % | 429,628 |   | 13,962 |   | 6.63 | % |
| Loans, net, including loans held for sale(1)                                |   | 1,181,072                      |       | 42,074 |   | 7.18 | % | 1,199,163 |   | 49,455 |   | 8.32 | % |
| Total interest-earning assets                                               |   | 1,767,807                      |       | 57,254 |   | 6.53 | % | 1,650,952 |   | 64,220 |   | 7.84 | % |
| Total noninterest-earning assets                                            |   | 103,793                        |       |   |   |   |   | 110,739 |   |   |   |   |   |
| Total assets                                                                |   | $                              | 1,871,600  |   |   |   |   |   | $ | 1,761,691 |   |   |   |   |   |
| LIABILITIES                                                                 |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                               |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits                                                   |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                                                     |   | $                              | 167,613    |   | $ | 943 |   | 1.13 | % | $ | 165,482 |   | $ | 1,586 |   | 1.93 | % |
| Checking                                                                    |   | 201,139                        |       | 531 |   | 0.53 | % | 182,923 |   | 1,411 |   | 1.56 | % |
| Money market accounts                                                       |   | 304,339                        |       | 2,510 |   | 1.66 | % | 266,225 |   | 4,941 |   | 3.74 | % |
| Certificates of deposit                                                     |   | 609,148                        |       | 12,936 |   | 4.28 | % | 589,891 |   | 16,968 |   | 5.80 | % |
| Total interest bearing deposits                                             |   | 1,282,239                      |       | 16,920 |   | 2.66 | % | 1,204,521 |   | 24,906 |   | 4.17 | % |
| Short-term borrowings                                                       |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds purchased and securities sold under agreements to  repurchase |   | 92,576                         |       | 508 |   | 1.11 | % | 96,175 |   | 2,169 |   | 4.55 | % |
| Other short-term borrowings                                                 |   | 5,885                          |       | 133 |   | 4.52 | % | 41,681 |   | 1,361 |   | 6.58 | % |
| Total short-term borrowings                                                 |   | 98,461                         |       | 641 |   | 1.31 | % | 137,856 |   | 3,530 |   | 5.16 | % |
| Long-term borrowings                                                        |   | 67,730                         |       | 1,607 |   | 4.78 | % | 35,480 |   | 828 |   | 4.71 | % |
| Total borrowed funds                                                        |   | 166,191                        |       | 2,248 |   | 2.73 | % | 173,336 |   | 4,358 |   | 5.07 | % |
| Total interest bearing liabilities                                          |   | 1,448,430                      |       | 19,168 |   | 2.67 | % | 1,377,857 |   | 29,264 |   | 4.28 | % |
| Non-interest bearing liabilities:                                           |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                             |   | 236,028                        |       |   |   |   |   | 202,575 |   |   |   |   |   |
| Other liabilities                                                           |   | 14,939                         |       |   |   |   |   | 16,891 |   |   |   |   |   |
| Total non-interest bearing liabilities                                      |   | 250,967                        |       |   |   |   |   | 219,466 |   |   |   |   |   |
| Shareholders’ equity                                                   |   | 172,203                        |       |   |   |   |   | 164,368 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                             |   | $                              | 1,871,600  |   |   |   |   |   | $ | 1,761,691 |   |   |   |   |   |
| Net interest income                                                         |   |                           |       | 38,086 |   |   |   |   |   | 34,956 |   |   |   |
| Net interest spread                                                         |   |                           |       |   |   | 3.86 | % |   |   |   |   | 3.56 | % |
| Net interest margin                                                         |   |                           |       |   |   | 4.34 | % |   |   |   |   | 4.27 | % |

 

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(1)          Interest and yieldon obligations of state and political subdivisions and tax-exempt loans arecomputed on a taxable equivalent basis using U.S. statutory tax rate of 35percent.  In addition, loan fee incomeis included in the interest income calculation, and nonaccrual loans areincluded in the average loan base upon which the interest rate earned on loansis calculated.

(2)          Average balancesand interest dollars are presented in thousands. Average rates are calculatedusing whole dollars and may differ slightly.

 

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**Provisionfor Credit Losses**

 

In 2001, the loan loss reserve was bolstered with additional provisionsbeing made in anticipation of increasing loan losses due to the recessionaryenvironment. The provision for credit losses for the second quarter of 2002 wasdecreased by $1.4 million over the year-ago quarter. For the six-month periodended June 30, 2002, the provision decreased to $975 thousand as compared to$2.6 million for the same period last year, as the loan portfolio continued toperform extraordinarily well. In the second quarter of 2002 the credit qualityof the loan portfolio continued to improve therefore additional provisions werenot deemed necessary.

 

**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 in thesecond quarter of 2002, 6.8% higher than the $7.5 million in the second quarterof 2001.

 

Insurance income of $2.5 million increased 12.5% from the secondquarter of 2001. This increase from the previous year’s quarter was due toincreased sales activities and increased pricing on the renewal of existinginsurance policies.

 

The mortgage banking business remained strong generating $849 thousandin quarterly revenues, an 8.15% increase from the second quarter of 2001.Traditionally low mortgage rates during the quarter of 2002 increased thelevels of mortgage activities and mortgage revenues continue to benefit fromthe strong housing market.

 

Revenues from service charges on deposits rose $189 thousand or 9% inthe second quarter of 2002 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 decreased slightly compared to the second quarter of last year. Withthe volatility experienced in the current equity markets, and the decreasedtransaction volumes, revenues reflect only a 2% decrease due to our ability toprovide innovative financial solutions individually designed for the affluent,emerging affluent and small business customer.

 

For the six months of 2002, noninterest income of $16 million increased3.3% from the $15.5 million in the comparable period of the previous year. Thisincrease was primarily driven by the increased service charge revenues andstrong results in our insurance and mortgage banking business lines.

 

**NoninterestExpense**

 

Noninterest expense for the quarter of $17.2 million rose $1.45 millionor 9.18% compared to the second quarter of 2001. Bancorp incurs additionalcosts to provide new services and support initiatives that generate additionalrevenues and 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.Bancorp’s efficiency ratio increased to 63.13% for the quarter compared to62.32% for the comparable period in 2001.

 

Salary and benefit related expenses of $9.6 million for the quarterincreased $536 thousand or 6% compared to the same period of 2001. Thisincrease was primarily attributable to normal merit increases for ourassociates, increased commission costs on the revenues generated by fee-basedlines of business and increases in employee medical insurance coverage.

 

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Occupancy expenses for the quarter of $2.6 million increased $105thousand or 4% compared to the second quarter of 2001. Bancorp has beenevaluating its retail branch network and has incurred expenses related to theconsolidation of several branches. While costs are incurred at the time of consolidation,they result in lower cost and more efficient delivery going forward.

 

Other expenses for the quarter relating to corporate operating expensesincreased to $808 thousand or 19% 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.

 

Total noninterest expense for the first half of 2002 increased 6% or$1.9 million thousand over the prior year comparable period. Salaries andemployee benefits increased 7.5%, occupancy expenses decreased 3.4% and otheroperating expenses increased 8.7%.

 

**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.

 

For the second quarter of 2002, provision for income taxes increased by51.3% to $3.1 million from the previous year quarter. The second quarter 2002effective tax rate was 33.41% compared to 28.02% in the prior year as most ofthe components of the increased revenues are fully taxable. For the six monthsended June 30, 2002, the  provision forincome taxes increased 44.5% to $5.7 million from the comparable 2001period.  The first half of 2002effective tax rate was 32.5% compared to 28% in the prior year.

 

**NonperformingAssets**

 

The Bancorp’s asset quality continues to be sound with nonperformingassets at only 0.13% of total assets at the end of the second quarter. Totalnonperforming assets at June 30, 2002 were $2.5 million, an 18.4% increase fromthe previous year. Although there is no direct correlation betweennonperforming loans and ultimate loan losses, an analysis of nonperforming loansmay provide some indication of the quality of the loan portfolio.

 

**PotentialProblem Loans**

 

At June 30, 2002, Bancorp had $11.3 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.

 

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Nonperforming Assets and Contractually Past-Due Loans:

 
| **(in thousands)**                                               |   | **June 30,  2002** |   | **December 31,  2001** |   |
|------------------------------------------------------------------|--------|--------------------|--------|------------------------|--------|
| Nonperforming assets:                                            |   |               |   |                   |   |
| Nonaccrual loans(1)                                              |   | $                  | 2,132  |                   | $      | 1,279 |   |
| Other real estate owned, net of valuation allowance(2)           |   | 354                |   | 638                    |   |
| Total nonperforming assets                                       |   | $                  | 2,486  |                   | $      | 1,917 |   |
| Loans past due 90 or more days as to interest or principal(3)    |   | $                  | 890    |                   | $      | 2,819 |   |
| Nonperforming loans to total loans                               |   | 0.18               | %      | 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            |   | 6.57               |   | 10.90                  |   |
| Allowance for credit losses times nonperforming assets           |   | 5.63               |   | 7.28                   |   |

 

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(1)   Loans areplaced on nonaccrual status when, in the opinion of management, reasonabledoubt exists as to the full, timely collection of interest or principal, or aspecific loan meets the criteria for nonaccrual status established byregulatory authorities. When a loan is placed on nonaccrual status, allinterest previously accrued but not collected is reversed against currentperiod interest income. No interest is taken into income on nonaccrual loansunless received in cash, or until such time the borrower demonstrates sustainedperformance over a period of time in accordance with contractual terms.

 

(2)   Otherreal estate owned includes: banking premises no longer used for businesspurposes and real estate acquired by foreclosure (in partial or complete satisfactionof debt), or otherwise surrendered by the borrower to Bancorp’s possession.Other real estate owned is recorded at the lower of cost or fair value on thedate of acquisition or transfer from loans. Write-downs to fair value at thedate of acquisition are charged to the allowance for credit losses. Subsequentto transfer, these assets are adjusted through a valuation allowance to thelower of the net carrying value or the fair value (net of estimated sellingexpenses) based on periodic appraisals.

 

(3)  Nonaccrual loans are not included.

 

**Allowancefor Credit Losses**

 

At June 30, 2002, the allowance for credit losses was $14.0 million or1.19% of total loans, with net annualized charge-offs for the quarter of lessthan 0.08% of average loans outstanding during the second quarter of 2002. Yearto date 2002 net annualized charge-offs represent 0.16% of average loans

 

The allowance for credit losses is maintained at a level, which inmanagement’s judgment is adequate to absorb losses inherent in the loan portfolio.The adequacy of the allowance for credit losses is reviewed regularly bymanagement. Additions to the allowance are made by charges to the provision forcredit losses. On a quarterly basis, a comprehensive review of the allowance isperformed considering such factors as the levels of loans outstanding, lossexperience, delinquency levels, certain individual loan reviews, and anevaluation of the regional and national economic environment. The methodologyfor assessing the appropriateness of the allowance consists of three primaryelements:

 

•      TheFormula Allowance. 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 lossfactors is determined using average annual net charge-off rates for the mostrecent years. Pooled loans are loans that are homogeneous in nature such asconsumer installment and residential mortgage loans. Pooled loan loss factorsare based on net charge–offs experienced over the past year. The historicloss factors on the risk rated loans and the pooled loans are then consideredfor either positive or negative adjustment in an attempt to reflect the currentdynamics of the portfolios. These adjustments in the loss

 

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factors are tied to management’s evaluation of a number of factorsincluding: 1) changes in the trend of the volume and severity of past due,classified and non-accrual assets; 2) changes in the nature and volume of theportfolio; 3) changes in lending policies, underwriting standards, orcollection practices; 4) changes in the experience, ability, depth of lendingmanagement and staff; 5) portfolio concentrations; and 6) changes in thenational or local 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 otherfactors that may impact the 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 evaluation of such conditions as creditquality trends, collateral values, portfolio concentrations, specific industryconditions in the regional economy, regulatory examination results, internalaudit and loan review findings, recent loss experiences in particular portfoliosegments, etc. The unallocated portion of the allowance for losses reflectsmanagement’s attempt to ensure that the overall reserve appropriately reflectsa margin for the imprecision necessarily inherent in estimates of creditlosses.

 

While management believes the allowance for credit losses was adequateat June 30, 2002, the estimate of losses and related allowance may change inthe near term due to economic and other uncertainties inherent in the estimationprocess.

 

Analysis of Allowance for Credit Losses:

 
|                                                    |   | **Six Months Ended** |      |
|---------------------------------------------------------|--------|----------------------|-----------|
| **(in thousands)**                                      |   | **June 30,  2002**   |      | **June 30,  2001** |   |
| Average loans outstanding                               |   |                 |      |   |   |
| less average unearned income(1)                         |   | $                    | 1,165,698 |   | $ | 1,184,630 |   |
| Allowance for credit losses at beginning of period      |   | $                    | 13,947    |   | $ | 13,232 |   |
| Charge-offs:                                            |   |                 |      |   |   |
| Real estate                                             |   | 18                   |      | 157 |   |
| Commercial and industrial                               |   | 110                  |      | 115 |   |
| Consumer                                                |   | 2,166                |      | 2,588 |   |
| Total loans charged-off                                 |   | 2,294                |      | 2,859 |   |
| Recoveries:                                             |   |                 |      |   |   |
| Real estate                                             |   | 3                    |      | 2 |   |
| Commercial and industrial                               |   | 193                  |      | 106 |   |
| Consumer                                                |   | 1,176                |      | 1,240 |   |
| Total recoveries                                        |   | 1,371                |      | 1,348 |   |
| Net charge-offs                                         |   | 923                  |      | 1,512 |   |
| Additions charged to operating expense                  |   | 975                  |      | 2,630 |   |
| Allowance for credit losses at end of period            |   | $                    | 13,999    |   | $ | 14,350 |   |
| Net annualized charge-offs to average loans outstanding |   | 0.16                 | %         | 0.26 | % |

 

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(1)          Excludes loans held for sale

 

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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 of Allowance for Credit Losses:

 
|                              |   | **For the Period Ending** |   |
|-----------------------------------|--------|---------------------------|--------|
|                              |   | **June 30,  2002**        |   | **December 31,  2001** |   |
| **(in thousands)**                |   | **Amount**                |   | **% of Total  Allowance** |   | **Amount** |   | **% of Total  Allowance** | ** ** |
|                              |   |                      |   |   |   |   |   |   |   |
| Real estate loans                 |   |                      |   |   |   |   |   |   |   |
| Construction and land development |   | $                         | 1,670  |   | 11.9 | % | $ | 1,655 |   | 11.9 | % |
| Residential mortgage              |   | 393                       |   | 2.8 | % | 481 |   | 3.4 | % |
| Other mortgage                    |   | 2,265                     |   | 16.2 | % | 2,534 |   | 18.2 | % |
| Commercial and industrial         |   | 2,873                     |   | 20.5 | % | 3,131 |   | 22.4 | % |
| Consumer                          |   | 4,531                     |   | 32.4 | % | 5,923 |   | 42.5 | % |
| Unallocated                       |   | 2,267                     |   | 16.2 | % | 223 |   | 1.6 | % |
| Totals                            |   | $                         | 13,999 |   | 100.0 | % | $ | 13,947 |   | 100.0 | % |

 

**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 13.24% at June 30, 2002, comparedto 13.30% at December 31, 2001; a tier 1 risk-based capital ratio of 12.20%,compared to 12.24%: and a capital leverage ratio of 8.81%, 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 June 30, 2002 and December 31, 2001. Management believes the levelof capital at June 30, 2002, is appropriate.

 

Shareholders’ equity totaled $177.5 million ( including $7.8 millionreported for accumulated other comprehensive income) at June 30, 2002; anincrease of 6% compared with the 2001 year-end level of $167.4 million(including $3.2 million reported for accumulated other comprehensive income).Bancorp’s accumulated comprehensive income (loss) category is comprised of netunrealized gains and losses on available-for-sale securities.

 

**Item3.  Quantitative and QualitativeDisclosures about Market Risk**

 

Market risk is defined as the future changes in market prices thatincrease or decrease the value of financial instruments, i.e. cash,investments, loans, deposits, and debt. Included in market risk are interest rate risk, foreign currencyexchange rate risk, commodity price risk, and other relevant market risks.  Bancorp’s primary source of market risk isinterest rate risk.  Market risk-sensitivefinancial instruments are entered into for purposes 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 re-pricing 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 re-pricing of assets and liabilitiesand by managing discretionary portfolios.

 

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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 ofmaturities.

 

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 simulating net interest income,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 keyassumptions such as the speed of prepayments, the interest rate elasticity ofcore deposit rates and balance sheet growth. The Bancorp’s policy guideline limit for net interest income simulationis a negative impact to net interest income of 15.0 percent for the up or down300 basis points scenarios when compared with the flat rate scenario.  Management has generally maintained a riskposition well within the policy guideline level.  The model indicated the impact of a 300 basis point rise in ratesover the next 12 months would cause approximately a 4.6% decrease in netinterest income at June 30, 2002.  A 300basis point decrease in rates over the next 12 months would cause approximatelya 4.8% decrease in net interest income. Note that certain short-term marketrates and a majority of the Bank’s deposit rates are below 3.0%.  These rates cannot move below zero in a down300 basis point scenario.  The impact ofthis zero percent floor on deposit rates is the primary reason that netinterest income is negatively impacted in the down 300 basis point scenario.

 

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.

 

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**PART II - Other Information**

 

**Item6.****  ****Exhibitsand Reports on Form 8-K**

 

(a)                                  Exhibits

 

10.5 Post-effective amendment toF&M Bancorp Dividend Reinvestment and Stock Purchase Plan.  File as Prospectus to Registration Statementon Form S-3 (File #33-39940) and incorporated herein by reference.

 

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

 

99.1 CEO Certification pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.Filed as an exhibit hereto and incorporated herein by reference

 

99.2 CFO Certification pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filedas an exhibit hereto and incorporated herein by reference

 

(b)           Reports on Form 8-K

 

A report on Form 8-K, Item 4.Changes in Registrant’s Certifying Accountant and Item 7 Financial Statements,Pro Forma Financial Information and Exhibits. Announce its engagement of Deloitte & Touche LLPas it’s new independent public accountants, filed on April 12, 2002

 

**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)         |   |
|            |   |   |                 |   |
|            |   |   |                 |   |
| August 12, 2002 |   |   | /s/ Faye E.  Cannon  |   |
| Date            |   |   | FAYE E. CANNON       |   |
|            |   |   | PRESIDENT AND  CEO   |   |
|            |   |   |                 |   |
|            |   |   |                 |   |
| August 12, 2002 |   |   | /s/ Kaye A.  Simmons |   |
| Date            |   |   | KAYE SIMMONS         |   |
|            |   |   | CFO AND  TREASURER   |   |

 

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