** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

** **

**(Mark one)**

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

 

**For the quarterly period ended March 31,2008**

**or**

 

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

 

**For the transition period from                          to                          **

 

**Commission File Numbers:000-10972**

 

**First Farmers and Merchants Corporation**

(Exact name ofregistrant as specified in its charter)

 

| **Tennessee**                                                   | ** ** | **62-1148660**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                            |       |                                  |
| **816 South Garden Street**                                     | ** ** | ** **                            |
| **Columbia, Tennessee**                                         | ** ** | **38402-1148**                        |
| (Address  of principal executive offices)                       |       | (Zip  Code)                           |

 

**931-388-3145**

(Registrant’stelephone number, including area code)

 

 

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

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large  accelerated filer o                     |   | Accelerated  filer x         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                       |   | Smaller  reporting company o |
| (Do not check if  a smaller reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct). o Yes xNo

 

Indicate thenumber of shares outstanding of each of the registrant’s classes of commonstock, as of the latest practicable date.

**5,660,000shares as of May 5, 2008**

** **

** **

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**PART I - FINANCIAL INFORMATIO**N

 
| **Item 1.** | **Financial Statements.**                                                                                                       |   |
|-------------|---------------------------------------------------------------------------------------------------------------------------------|--------|
| ** **  | ** **                                                                                                                      |   |
|        | The following unaudited  consolidated financial statements of the Registrant and its subsidiaries are  included in this Report: |   |
|        |                                                                                                                            |   |
|        | Consolidated  balance sheets - March 31, 2008 and December 31, 2007.                                                  |   |
|        |                                                                                                                            |   |
|        | Consolidated  statements of cash flows - For the three  months ended March 31, 2008 and March 31, 2007.               |   |
|        |                                                                                                                            |   |
|        | Consolidated  statements of income - For the three months ended March 31, 2008 and  March 31, 2007.                   |   |
|        |                                                                                                                            |   |
|        | Selected notes to  consolidated financial statements.                                                                           |   |

 

2

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**FIRSTFARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                              | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| **(Dollars in Thousands, Except Per Share Data)**                                                                                                                         | ** ** | **2008**           | ** **  | **2007(1)**           | ** ** |
| ** **                                                                                                                                                                                              | ** ** | **(Unaudited)**    | ** **  | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                              |       |               |        |                  |       |
| Cash and due  from banks                                                                                                                                                                                | ** ** | **$**              | **36,079**  |                  | $          | 35,097 |   |
| Interest-bearing  due from banks                                                                                                                                                                        | ** ** | **1,614**          |        | 176                   |       |
| Federal funds  sold                                                                                                                                                                                     | ** ** | **2,150**          |        | 600                   |       |
| Total cash and  cash equivalents                                                                                                                                                                        | ** ** | **39,843**         |        | 35,873                |       |
| Securities                                                                                                                                                                                              |       |               |        |                  |       |
| Available-for-sale  (amortized cost $179,638 and $163,050, respectively)                                                                                                                                |       | **182,000**        |        | 163,911               |       |
| Held-to-maturity  (fair market value $74,184 and $76,460, respectively)                                                                                                                                 |       | **72,843**         |        | 75,565                |       |
| Total Securities                                                                                                                                                                                        | ** ** | **254,843**        |        | 239,476               |       |
| Loans, net of  deferred fees                                                                                                                                                                            | ** ** | **519,830**        |        | 500,143               |       |
| Allowance for  loan and lease losses                                                                                                                                                                    | ** ** | **(7,382**         | **)**       | (7,381                | )          |
| Net loans                                                                                                                                                                                               | ** ** | **512,448**        |        | 492,762               |       |
| Bank premises  and equipment, at cost less allowance for depreciation                                                                                                                                   |       | **14,375**         |        | 14,306                |       |
| Core deposit and  other intangibles                                                                                                                                                                     | ** ** | **9,243**          |        | 9,318                 |       |
| Other assets                                                                                                                                                                                            | ** ** | **31,513**         |        | 31,311                |       |
| TOTAL ASSETS                                                                                                                                                                                            | ** ** | **$**              | **862,265** |                  | $          | 823,046 |   |
|                                                                                                                                                                                                    |       |               |        |                  |       |
| **LIABILITIES**                                                                                                                                                                                         |       |               |        |                  |       |
| Deposits                                                                                                                                                                                                |       |               |        |                  |       |
| Noninterest-bearing                                                                                                                                                                                     | ** ** | **$**              | **131,000** |                  | $          | 131,043 |   |
| Interest-bearing  (including certificates of deposits over $100: 2008 - $110,287; 2007 -  $107,398)                                                                                                     |       | **569,790**        |        | 567,916               |       |
| Total deposits                                                                                                                                                                                          | ** ** | **700,790**        |        | 698,959               |       |
| Federal funds  purchased and securities sold under agreements to repurchase                                                                                                                             |       | **3,275**          |        | 2,507                 |       |
| Dividends  payable                                                                                                                                                                                      | ** ** | **—**         |        | 1,991                 |       |
| Short-term  borrowings                                                                                                                                                                                  | ** ** | **600**            |        | 600                   |       |
| Accounts payable  and accrued liabilities                                                                                                                                                               | ** ** | **13,856**         |        | 12,650                |       |
| FHLB Borrowings                                                                                                                                                                                         | ** ** | **35,000**         |        | —                |       |
| Minority  interest in consolidated subsidiary                                                                                                                                                           | ** ** | **95**             |        | 95                    |       |
| TOTAL  LIABILITIES                                                                                                                                                                                      | ** ** | **753,616**        |        | 716,802               |       |
|                                                                                                                                                                                                    |       |               |        |                  |       |
| **SHAREHOLDERS’  EQUITY**                                                                                                                                                                          |       |               |        |                  |       |
| Common stock -  $10 par value per share, 8,000,000 shares****authorized;  5,660,000 and 5,680,000 shares issued****and  outstanding as of March 31, 2008 and December 31, 2007,  respectively |       | **56,600**         |        | 56,800                |       |
| Retained  earnings                                                                                                                                                                                      | ** ** | **50,596**         |        | 48,916                |       |
| Accumulated  other comprehensive income                                                                                                                                                                 | ** ** | **1,453**          |        | 528                   |       |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                                                                                        | ** ** | **108,649**        |        | 106,244               |       |
| TOTAL LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                                        |       | **$**              | **862,265** |                  | $          | 823,046 |   |

 

----

(1) Derived from auditedfinancial statements.

 

The accompanying notes are an integral part of theconsolidated financial statements.

 

3

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**FIRST FARMERS AND MERCHANTSCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

 
| ** **                                                                     | ** ** | **Three Months Ended March 31** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                     | ** ** | **March 31,**                                  | ** ** |
| **(Dollars in Thousands Except Per Share Data)** | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **(Unaudited)**                                                                |       |                                                |       |   |   |
| **INTEREST  AND DIVIDEND INCOME**                                              |       |                                                | ** ** | ** ** |   |
| Interest and fees  on loans                                                    |       | **$**                                               | **8,336**  | ** ** | $ | 7,953 |   |
| Income on  investment securities                                               |       |                                                |       |   |   |
| Taxable interest                                                               | ** ** | **1,525**                                           |       | 1,283 |   |
| Exempt from  federal income tax                                                | ** ** | **1,019**                                           |       | 1,023 |   |
| Dividends                                                                      | ** ** | **53**                                              |       | 63 |   |
| ** **                                                                     |       | **2,597**                                           |       | 2,369 |   |
| Other interest  income                                                         | ** ** | **51**                                              |       | 308 |   |
| TOTAL INTEREST  INCOME                                                         | ** ** | **10,984**                                          |       | 10,630 |   |
|                                                                           |       |                                                |       |   |   |
| **INTEREST  EXPENSE**                                                          |       | ** **                                          |       |   |   |
| Interest on  deposits                                                          |       | **3,336**                                           |       | 3,995 |   |
| Interest on  other short term borrowings                                       | ** ** | **50**                                              |       | 31 |   |
| TOTAL INTEREST  EXPENSE                                                        | ** ** | **3,386**                                           |       | 4,026 |   |
| NET INTEREST  INCOME                                                           | ** ** | **7,598**                                           |       | 6,604 |   |
| PROVISION FOR  POSSIBLE LOAN AND LEASE LOSSES                                  | ** ** | **—**                                          |       | — |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES                 | ** ** | **7,598**                                           |       | 6,604 |   |
|                                                                           |       |                                                |       |   |   |
| **NONINTEREST  INCOME**                                                        |       |                                                | ** ** | ** ** |   |
| Trust department income                                                        | ** ** | **647**                                             |       | 707 |   |
| Service fees on deposit accounts                                               | ** ** | **1,872**                                           |       | 1,753 |   |
| Other fees and  commissions                                                    | ** ** | **102**                                             |       | 130 |   |
| Other operating  income                                                        | ** ** | **123**                                             |       | 274 |   |
| Securities gains                                                               | ** ** | **1,008**                                           |       | — |   |
| TOTAL  NONINTEREST INCOME                                                      | ** ** | **3,752**                                           |       | 2,864 |   |
|                                                                           |       |                                                |       |   |   |
| **NONINTEREST  EXPENSE**                                                       |       |                                                | ** ** | ** ** |   |
| Salaries and employee benefits                                                 | ** ** | **4,282**                                           |       | 3,737 |   |
| Net occupancy expense                                                          | ** ** | **602**                                             |       | 543 |   |
| Furniture and  equipment expense                                               | ** ** | **228**                                             |       | 277 |   |
| Other operating  expenses                                                      | ** ** | **2,702**                                           |       | 2,581 |   |
| TOTAL  NONINTEREST EXPENSES                                                    | ** ** | **7,814**                                           |       | 7,138 |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES                                      | ** ** | **3,536**                                           |       | 2,330 |   |
| PROVISION FOR  INCOME TAXES                                                    | ** ** | **788**                                             |       | 284 |   |
| NET INCOME                                                                     | ** ** | **$**                                               | **2,748**  |   | $ | 2,046 |   |
|                                                                           | ** ** | ** **                                          |       |   |   |
| **BASIC  EARNINGS PER SHARE**                                                  |       |                                                |       |   |   |
| Weighted Average Shares Outstanding                                            | ** ** | **5,676,124**                                       |       | 5,757,139 |   |
| ** **                                                                     |       | **$**                                               | **0.48**   |   | $ | 0.36 |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

 

4

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**FIRST FARMERSAND MERCHANTS CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in Thousands)**                                              | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **(Unaudited)**                                                                   | ** ** | ** **                                           | ** ** |   |   |
| **OPERATING ACTIVITIES**                                                          | ** ** | ** **                                           | ** ** |   |   |
| Net income                                                                        | ** ** | **$**                                                | **2,748**  | ** ** | $ | 2,046 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities |       |                                                 | ** ** |   |   |
| Excess of  provision for possible loan and lease losses****over  net charge offs  |       | **—**                                           | ** ** | 41 |   |
| Provision for  depreciation and amortization of premises and equipment            |       | **260**                                              | ** ** | 226 |   |
| Securities gains                                                                  | ** ** | **(1,008**                                           | **)**      | — |   |
| Loss from  disposition of other real estate                                       | ** ** | **283**                                              | ** ** | — |   |
| Amortization of  deposit base intangibles                                         | ** ** | **76**                                               | ** ** | 264 |   |
| Amortization of  investment security premiums, net of accretion of discounts      |       | **91**                                               | ** ** | 171 |   |
| Increase in cash  surrender value of life insurance contracts                     | ** ** | **(670**                                             | **)**      | (108 | ) |
| Decrease  (increase) in                                                           |       |                                                 | ** ** |   |   |
| Deferred income  taxes                                                            |       | **18**                                               | ** ** | (148 | ) |
| Interest  receivable                                                              | ** ** | **7**                                                | ** ** | (92 | ) |
| Other assets                                                                      | ** ** | **(87**                                              | **)**      | (593 | ) |
| (Decrease)  increase in                                                           |       |                                                 | ** ** |   |   |
| Interest payable                                                                  |       | **(385**                                             | **)**      | (157 | ) |
| Other  liabilities                                                                | ** ** | **1,309**                                            | ** ** | 303 |   |
| Total adjustments                                                                 | ** ** | **(106**                                             | **)**      | (93 | ) |
| Net cash  provided by operating activities                                        | ** ** | **2,642**                                            | ** ** | 1,953 |   |
|                                                                              | ** ** | ** **                                           | ** ** |   |   |
| **INVESTING ACTIVITIES**                                                          | ** ** | ** **                                           | ** ** |   |   |
| Proceeds from  maturities, calls, and sales of available-for-sale securities      |       | **64,969**                                           | ** ** | 6,032 |   |
| Proceeds from  maturities and calls of held-to-maturity securities                | ** ** | **2,710**                                            | ** ** | 2,660 |   |
| Purchases of  investment securities Available-for-sale                            | ** ** | **(80,632**                                          | **)**      | (4,752 | ) |
| Net increase in  loans                                                            | ** ** | **(19,687**                                          | **)**      | (15,833 | ) |
| Proceeds from  sale of other real estate owned                                    | ** ** | **385**                                              | ** ** | — |   |
| Purchase of life  insurance policies                                              | ** ** | **(696**                                             | **)**      | (369 | ) |
| Purchases of  premises and equipment                                              | ** ** | **(329**                                             | **)**      | (77 | ) |
| Net cash used in  investing activities                                            | ** ** | **(33,280**                                          | **)**      | (12,339 | ) |
|                                                                              | ** ** | ** **                                           | ** ** |   |   |
| **FINANCING ACTIVITIES**                                                          |       |                                                 | ** ** |   |   |
| Net increase  (decrease) in noninterest-bearing and interest-bearing deposits     |       | **1,831**                                            | ** ** | (25,953 | ) |
| Net increase  (decrease) in short term borrowings                                 | ** ** | **768**                                              | ** ** | 206 |   |
| Proceeds from  FHLB borrowings                                                    | ** ** | **35,000**                                           | ** ** | **—** | ** ** |
| Proceeds from  sale of minority interest in a consolidated subsidiary             | ** ** | **—**                                           | ** ** | 95 |   |
| Repurchase of  common stock                                                       | ** ** | **(1,000**                                           | **)**      | (900 | ) |
| Cash dividends                                                                    | ** ** | **(1,991**                                           | **)**      | (1,971 | ) |
| Net cash used in  financing activities                                            | ** ** | **34,608**                                           | ** ** | (28,523 | ) |
| Increase  (decrease) in cash and cash equivalents                                 | ** ** | **3,970**                                            | ** ** | (38,909 | ) |
| Cash and cash  equivalents at beginning of period                                 | ** ** | **35,873**                                           | ** ** | 74,981 |   |
| Cash and cash  equivalents at end of period                                       | ** ** | **$**                                                | **39,843** | ** ** | $ | 36,072 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

5

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 1 -OTHER INFORMATION**

 

The interim unauditedconsolidated financial statements First Farmers and Merchants Corporation (the “Corporation”)presented in this report have been prepared on a consistent basis and inaccordance with the instructions to Form 10-Q and do not include all ofthe information and notes required by U.S. generally accepted accountingprinciples for complete financial statements. In the opinion of management, all adjustments considered necessary for afair presentation have been included. These adjustments were of a normal, recurring nature and consistent withU.S. generally accepted accounting principles. For further information, refer to the consolidated financial statementsand notes included in the Corporation’s Annual Report on Form 10-K for theyear ended December 31, 2007.

 

**NOTE 2 –STOCK REPURCHASE**

 

Duringthe first quarter of 2008, the Corporation repurchased, through negotiatedtransactions with third-party sellers, 20,000 shares of the Corporation’scommon stock at a price of $50 per share for an aggregate purchase price of$1.0 million.

 

**NOTE 3 – FAIR VALUEMEASUREMENT**

 

In September 2006, theFinancial Accounting Standards Board (the “FASB”) issued Statement of FinancialAccounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS157”), which defines fair value, establishes a framework for measuring fairvalue in U.S. generally accepted accounting principles and expands disclosuresabout fair value measurements.  SFAS 157applies only to fair-value measurements that are already required or permittedby other accounting standards and is expected to increase the consistency ofthose measurements.  The definition offair value focuses on the exit price (i.e., the price that would be received tosell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date) not the entry price (i.e., theprice that would be paid to acquire the asset or received to assume the liabilityat the measurement date).  The statementemphasizes that fair value is a market-based measurement rather than anentity-specific measurement.  Therefore,the fair value measurement should be determined based on the assumptions thatmarket participants would use in pricing the asset or liability.  The effective date for SFAS No. 157 isfor fiscal years beginning after November 15, 2007, and interim periodswithin those fiscal years.  TheCorporation adopted SFAS 157 effective January 1, 2008.

 

InFebruary of 2007, the FASB issued SFAS No. 159, “The Fair ValueOption for Financial Assets and Financial Liabilities” (“SFAS 159”), whichgives entities the option to measure eligible financial assets, and financialliabilities at fair value on an instrument by instrument basis, that areotherwise not permitted to be accounted for at fair value under otheraccounting standards. The election to use the fair value option is availablewhen an entity first recognizes a financial asset or financial liability. Subsequentchanges in fair value must be recorded in earnings. This statement is effectiveas of the beginning of a company’s first fiscal year after November 15,2007. The adoption of SFAS No. 159 did not have a significant impact onour consolidated financial statements. The Corporation also adopted SFAS 159effective January 1, 2008, but did not elect the fair value option for anyfinancial instrument not presently being accounted for at fair value.

 

The Corporation and itswholly-owned subsidiary, First Farmers and Merchants Bank (the “Bank”), has anestablished process for determining fair values. Fair value is based uponquoted market prices, where available. If listed prices or quotes are notavailable, fair value is based upon internally developed models or processesthat use primarily market-based or independently-sourced market data, includinginterest rate yield curves, option volatilities and third party information.Valuation adjustments may be made to ensure that financial instruments arerecorded at fair value. These adjustments include amounts to reflectcounterparty credit quality (for financial assets reflected at fair value), theBank’s creditworthiness (for financial liabilities reflected at fair value),liquidity and other unobservable parameters that are applied consistently overtime.

 

6

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| · |   | Credit valuation  adjustments are necessary when the market price (or parameter) is not  indicative of the credit quality of the counterparty.                                                                                                                                                                                                                                       |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |
| · |   | Debit valuation  adjustments are necessary to reflect the credit quality of Bank in the  valuation of liabilities measured at fair value.                                                                                                                                                                                                                                            |
|   |   |
| · |   | Liquidity valuation  adjustments are necessary when the Firm may not be able to observe a recent  market price for a financial instrument that trades in inactive (or less  active) markets or to reflect the cost of exiting larger-than-normal  market-size risk positions.                                                                                                        |
|   |   |
| · |   | Unobservable parameter  valuation adjustments are necessary when positions are valued using  internally developed models that use as their basis unobservable parameters –  that is, parameters that must be estimated and are, therefore, subject to  management judgment to substantiate the model valuation. These financial  instruments are normally traded less actively. |

 

The methods describedabove may produce a fair value calculation that may not be indicative of netrealizable value or reflective of future fair values. Furthermore, while managementof the Corporation believes that the Corporation’s valuation methods areappropriate and consistent with other market participants, the use of differentmethodologies or assumptions to determine the fair value of certain financialinstruments could result in a different estimate of fair value at the reportingdate.

 

**Valuation Hierarchy**

 

SFAS 157 establishes athree-level valuation hierarchy for disclosure of fair value measurements. Thevaluation hierarchy is based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date. The three levels aredefined as follows.

 
| · |   | Level 1 – inputs to the  valuation methodology are quoted prices (unadjusted) for identical  assets or liabilities in active markets.                                                                                                                                           |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |
| · |   | Level 2 – inputs to the  valuation methodology include quoted prices for similar assets and  liabilities in active markets, and inputs that are observable for the asset  or liability, either directly or indirectly, for substantially the full term  of the financial instrument. |
|   |   |
| · |   | Level 3 – inputs to the  valuation methodology are unobservable and significant to the fair value  measurement.                                                                                                                                                                      |

 

A financial instrument’scategorization within the valuation hierarchy is based upon the lowest level ofinput that is significant to the fair value measurement.  Following is a description of the valuationmethodologies used for instruments measured at fair value, as well as thegeneral classification of such instruments pursuant to the valuation hierarchy.

 

**Assets**

 

*Securities* - Where quoted pricesare available in an active market, securities are classified within level 1 ofthe valuation hierarchy. Level 1 securities include highly liquid governmentbonds, Federal funds sold and certain other products. If quoted market pricesare not available, then fair values are estimated by using pricing models,quoted prices of securities with similar characteristics, or discounted cashflows. Examples of such instruments, which would generally be classified

 

7

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within level 2 of thevaluation hierarchy, include the Corporation’s available-for-sale investmentsecurities portfolio. In certain cases where there is limited activity or lesstransparency around inputs to the valuation, securities are classified withinlevel 3 of the valuation hierarchy. At March 31, 2008, the Corporation hadno securities classified within level 3.

* *

*Otherassets* – Included in other assets are certain assets carriedat fair value, including the cash value of bank owned life insurancepolicies.  The carrying amount of theseassets is based on information received from the insurance carriers indicatingthe financial performance of the policies and the amount the Bank would receiveshould the policies be surrendered.  The Bankreflects these investments within level 2 of the valuation hierarchy.

** **

**Liabilities**

* *

*Securities sold under repurchase agreements (“repurchaseagreements”), Federal funds purchased and other borrowings -*At March 31, 2008, all of the Bank’s repurchase agreements, Federal fundspurchased and other borrowings (overnite borrowings from the Federal Home LoanBank) are settled on a short-term basis, usually daily.  As a result, the fair value of theinstruments approximates their carrying amount and classified such liabilitiesas level 2 within the valuation hierarchy.

* *

*Other liabilities –* The Bank hascertain liabilities carried at fair value. These include future obligations pursuant to a supplemental retirementplan and proceeds of split dollar life insurance policies.  For these obligations, Bank discounts theanticipated future cash flows using current interest rates.  These liabilities are classified as level 3within the valuation hierarchy.

 

The following tablepresents the financial instruments carried at fair value as of March 31,2008, by caption on the consolidated balance sheet and by SFAS 157 valuationhierarchy (as described above) (dollars in thousands):

 

**Assets and liabilities measured at fair value on arecurring basis as of March 31, 2008**

 
| ** **                                   | ** ** | **Total Carrying   value in the   consolidated ** | ** ** | **Quoted market  prices in an  active market** | ** ** | **Internal  models with  significant  observable  market  parameters** | ** ** | **Internal models  with significant  unobservable  market  parameters** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **balance sheet**                                                          | ** ** | **(Level 1)**                                                      | ** ** | **(Level 2)**                                                               | ** ** | **(Level 3)**                                                                     | ** ** |
| Federal funds  sold                          |       | $                                                                               | 2,150      |                                                               | $          | 2,150                                                                       |       | $                                                                                 | —     |   | $ | — |   |
| Available-for-sale  securities               |       | 182,000                                                                         |       | —                                                             |       | 182,000                                                                     |       | —                                                                            |       |
| Other assets                                 |       | 19,578                                                                          |       | —                                                             |       | 19,578                                                                      |       |                                                                              |       |
| Total assets at  fair value                  |       | $                                                                               | 203,728    |                                                               | $          | 2,150                                                                       |       | $                                                                                 | 201,578    |   | $ | — |   |
|                                         |       |                                                                            |       |                                                               |       |                                                                        |       |                                                                              |       |
| Securities sold  under repurchase agreements |       | $                                                                               | 3,275      |                                                               | $          | 3,275                                                                       |       | $                                                                                 | —     |   | $ | — |   |
| Other  liabilities                           |       | 5,647                                                                           |       | —                                                             |       | 5,647                                                                       |       |                                                                              |       |
| Total  liabilities at fair value             |       | $                                                                               | 8,922      |                                                               | $          | 3,275                                                                       |       | $                                                                                 | 5,647      |   | $ | — |   |

 

**NOTE 4- FEDERAL HOME LOAN BANK CREDIT LINE**

 

TheBank has a Blanket Agreement for Advances and Security Agreement (the “BlanketAgreement”) with the Federal Home Loan Bank of Cincinnati (the “FHLB”).  Advances made to the Bank under the BlanketAgreement are collateralized by the FHLB stock and unidentified qualifyingresidential mortgage loans totaling 150% of the outstanding amount borrowed.These collateralization matters are outlined in the Blanket Agreement dated March 31,2008 between the Bank and the FHLB.

 

Scheduledannual principal maturities of borrowings under this credit line as of March 31,2008, are as follows:

 
| 2009  |   | $         | 7,000,000  |   |
|-------|--------|-----------|------------|--------|
| 2010  |   | 7,000,000 |       |
| 2011  |   | 7,000,000 |       |
| 2012  |   | 7,000,000 |       |
| 2013  |   | 7,000,000 |       |
| Total |   | $         | 35,000,000 |   |

 

8

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Stockheld in the FHLB totaling $2.8 million at December 31, 2007 is carried atcost.  The stock is restricted and canonly be sold back to the FHLB at par.

 

TheBank also has a Cash Management Advance (the “CMA”) Line of Credit Agreementdated March 31, 2008 with the Federal Home Loan Bank.  The CMA is a component of the BlanketAgreement.  The purpose of the CMA is toassist with short-term liquidity management. Under the terms of the CMA, the Bank may borrow a maximum of$10,000,000, selecting a variable rate of interest for up to 90 days or a fixedrate for a maximum of 30 days.  Therewere no borrowings outstanding under the CMA Line of Credit as of March 31,2008.

 

**NOTE 5- RECENT ACCOUNTINGPRONOUNCEMENTS**

 

In September 2006,the FASB ratified the consensus the Emerging Issues Task Force (the “EITF”)reached regarding EITF Issue No. 06-4, “Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements” (“EITF 06-4”), which provides accounting guidancefor postretirement benefits related to endorsement split-dollar life insurancearrangements, whereby the employer owns and controls the insurance policies.The consensus concludes that an employer should recognize a liability for thepostretirement benefit in accordance with SFAS No. 106, “Employers’Accounting for Postretirement Benefits Other Than Pensions” (“FAS 106”), or AccountingPrinciples Board Opinion No. 12, “Omnibus Opinion-1967” (“APB 12”). In addition,the consensus states that an employer should also recognize an asset based onthe substance of the arrangement with the employee. EITF 06-4 is effectivefor fiscal years beginning after December 15, 2007 with early applicationpermitted.

 

In March 2007, theFASB ratified the consensus the EITF reached regarding EITF Issue No. 06-10,“Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements”(“EITF 06-10”), which provides accounting guidance for postretirement benefitsrelated to collateral assignment split-dollar life  insurance arrangements, whereby the employeeowns and controls the insurance policies. The consensus concludes that anemployer should recognize a liability for the postretirement benefit inaccordance with FAS 106 or APB 12, as well as recognize an asset based onthe substance of the arrangement with the employee. EITF 06-10 iseffective for fiscal years beginning after December 15, 2007, with earlyapplication permitted. The Corporation and the Bank adopted EITF 06-4 and06-10 on January 1, 2008, and the effect of adoption on the consolidatedfinancial statements was a reduction in retained earnings of approximately$268,000 and accrued liabilities increase by $268,000.

 

In September 2006,the FASB ratified the consensus reached by the EITF on Issue 06-5, Accountingfor Purchases of Life Insurance-Determining the Amount That Could Be Realizedin Accordance with FASB Technical Bulletin No. 85-4, Accounting forPurchases of Life Insurance (“EITF 06-5”). The effective date of EITF 06-5 isfor fiscal years beginning after December 15, 2006. The EITF concludedthat a policyholder should consider any additional amounts included in thecontractual terms of the policy in determining the amount that could berealized under the insurance contract. Amounts that are recoverable by thepolicyholder at the discretion of the insurance company should be excluded fromthe amount that could be realized. The Company adopted EITF 06-5 effective January 1,2007. The adoption of EITF 06-5 had no effect on the Company’s ConsolidatedBalance Sheet or Consolidated Statement of Income.

 

**Item 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations.**

 

**FORWARD-LOOKING STATEMENTS**

 

      Certainstatements contained in this report may not be based on historical facts andare “forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the 

 

9

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Securities Exchange Act of 1934, as amended. These forward-lookingstatements may be identified by, among other things, the use of forward-lookingterminology such as “could,” “expects,” “believes,” “may” or “will,” or futureor conditional verb tenses, and variations or negatives of such terms.  These forward-looking statements include,without limitation, those relating to fair value methodologies, the potentialsale of available-for-sale securities, loan portfolio concentrations, repaymentof loans by borrowers, failure to meet and satisfaction of capital adequacyrequirements, the repayment of Federal Home Loan Bank borrowings, adequacy ofcapital resources and traditional sources of cash generated from operatingactivities to meet liquidity needs, the effect of fluctuating interest ratesand the realization of deferred income tax assets.  We caution you not to place undue reliance onsuch forward-looking statements in this report because results could differmaterially from those anticipated due to a variety of factors.  These factors include, but are not limitedto, changes in economic conditions; fluctuations in prevailing interest ratesand the effectiveness of our risk monitoring systems; the ability of ourborrowers to repay loans; adverse changes in our special mention credits; ourability to sell available-for-sale securities to fund increased loan demand;our ability to meet regulatory capital adequacy requirements; our ability to meetliquidity needs from operating activities; the accuracy of assumptions in ourrate risk analysis; our ability to recognize deferred tax assets; our abilityto maintain credit quality; laws and regulations affecting financialinstitutions in general; our ability to control factors influencing netinterest income; the geographic concentration of our assets, our ability tomaintain sufficient asset quality and cost controls; and other factorsgenerally understood to affect the financial results of financial servicescompanies and other factors detailed from time to time in our filings with theSecurities and Exchange Commission. We undertake no obligation to update theseforward-looking statements to reflect events or circumstances that occur afterthe date of this report.

 

**EXECUTIVE OVERVIEW**

 

AtMarch 31, 2008, theconsolidated total assets of First Farmers and Merchants Corporation (the “Corporation”)were $862.3 million, its consolidated net loans were $512.4 million, its totaldeposits were $700.8 million and its total shareholders’ equity was $108.6million.  The loan portfolio at March 31, 2008 reflected anincrease of $19.7 million, or 4.0%, compared to December 31, 2007.  Total deposits increased $1.8 million andshareholders’ equity increased 2.3% during the first three months of 2008.  Total shareholders’ equity includes anunrealized gain on available-for-sale securities of $1.5 million.

 

**FINANCIALCONDITION**

 

Averageearning assets at March 31,2008 were up 1.3%, or $9.5 million, from average earning assets at December 31,2007.  Average overnight investments at March 31, 2008 were down$12.6 million compared to December 31, 2007.  Average investment securities at March 31, 2008 were up 2.7%compared to the average at December 31, 2007.  Average total assets of $809.8 million at March 31, 2008 increased 1.6%or $12.6 million, compared to $797.2 million at December 31, 2007.

 

**Securities**

 

Available-for-salesecurities are an integral part of the asset/liability management process forFirst Farmers and Merchants Bank, the Corporation’s sole direct subsidiary (the“Bank”).  Accordingly, they represent animportant source of liquidity available to fund loans and accommodate assetreallocation strategies dictated by changes in the Bank’s operating and tax plans,shifting yield spread relationships and changes in configuration of the yieldcurve.  At March 31, 2008, the Bank’s investmentsecurities portfolio had $182.0 million available-for-sale securities, whichare valued at fair market value, and $72.8 million held-to-maturity securities,which are valued at cost on the balance sheet. These compare to $163.9 millionof available-for-sale securities and $75.6 million of held-to-maturitysecurities as of December 31, 2007. The Bank may sell available-for-sale securities to fund plannedincreased loan demand as needed.

 

**Loans**

 

Theloan portfolio is the largest component of earning assets for the Bank and, consequently, provides the highestamount of revenues for the Corporation. The loan portfolio also contains the highestexposure to risk as a result of the 

 

10

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possibility of unexpected deterioration in the credit quality ofborrowers.  When analyzing potentialloans, management of the Bank assesses both interest rate objectives and creditquality objectives in determining whether to make a given loan and theappropriate pricing for that loan.

 

Althoughthere is not an industry concentration as measured by regulatory guidelineswithin the Bank’s loan portfolio, the Bank currently has heavy exposure in fourbroad industry categories: commercial construction and development; real estaterenting and leasing; other services (churches); and public administration.  These industries are monitored closely toensure that underwriting practices, policies and loss allowance levels matchthe level of risk posed.  Real estateloans represented 78.6% of total loans at March 31, 2008 compared to 78.0%at March 31, 2007.  Management of the Bank believes the risk ofthis concentration is acceptable given the quality of underwriting and the lowlevel of historical loss experience. Total construction and development loans accounted for 8.46% of loansoutstanding at March 31, 2008 compared to 4.7% at March 31, 2007,which exceeded the Bank’s internal target of a range of 1% to 7% of totalloans.  Nonetheless, at 45% of capital,construction and development****loans remainwell below a regulatory concentration, defined as 100% of capital.  Therefore, management of the Bank believesthat the current level of exposure, while elevated above historical levels,represents an acceptable level of risk for the Bank.  All loans are expected to be repaid from cashflow or proceeds from the sale of selected assets of the borrowers.  Collateral requirements for the loanportfolio are based on credit evaluation of the borrowers.

 

Theanalysis and review of asset quality by the Bank’s credit administrationincludes a formal review that evaluates the adequacy of the allowance forpossible loan and lease losses.  Thisreview is updated monthly and evaluated more completely quarterly inconjunction with loan review reports and evaluations that are discussed inmeetings with loan officers, credit administration and the Bank’s Board ofDirectors.  The allowance for possibleloan and lease losses was $7.3 million, or 1.4% of gross loans and leases, at March 31, 2008, compared to$7.3 million, or 1.5%, at December 31, 2007.  Net recoveries through March 31, 2008 wereapproximately $12,000, which results in an annualized net charge-off ratio ofnegative 0.001%.

 

Aformal process is in place to provide control over the underwriting of loansand to monitor loan collectability.  Thisprocess includes education and training of personnel about the Bank’s loanpolicies and procedures, credit analysts to support lenders, timelyidentification of loans with adverse characteristics, control of correctiveactions and objective monitoring of loan reviews.  The Special Assets Department of the Bankidentifies and monitors assets that need attention.  At March 31, 2008, this process identifiedloans totaling $10.2 million, or 2.0% of the portfolio, that were classified asother assets especially mentioned, compared to loans totaling $7.5 million, or1.5% of the portfolio, so classified at December 31, 2007.  Loans totaling $7.3 million, or 1.4% of theportfolio, were classified as substandard at March 31, 2008, compared to loans totaling$6.1 million, or 1.2% of the portfolio, so classified at December 31,2007.  No loans were classified asdoubtful at March 31,2008 and December 31, 2007.

 

**Deposits**

 

The Bank does not have any foreign offices and all deposits areserviced in its 20 domestic offices.  TheBank’s average deposits increased 1.1% during the first three months of 2008 comparedto a decline of 1.4% in the first three months of 2007.  The increase results from the Bank offeringmore competitive rates on interest bearing deposits.  Average total noninterest-bearing depositswere 17.6% of total deposits at March 31, 2008, contributing to the Bank’slow cost of deposits, compared to 17.2% at December 31, 2007.

 

**Regulatory Requirements for Capital**

 

TheCorporation and the Bank are subject to federal regulatory risk-adjustedcapital adequacy standards.  Failure tomeet capital adequacy requirements could result in certain mandatory, andpossibly additional discretionary, actions by regulators that could have adirect material adverse effect on the consolidated financial statements of theCorporation and the Bank.  The regulationsrequire the Bank to meet specific capital adequacy guidelines that involvequantitative measures of assets, liabilities and certain off-balance-sheetitems as calculated under regulatory accounting practices.  

 

11

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The capital classification is also subject to qualitative judgments bythe regulators about components, risk weightings and other factors.

 

Quantitative measures established by the Board of Governors of theFederal Reserve System to ensure capital adequacy require the Corporation andthe Bank to maintain minimum amounts and ratios of Tier 1 Capital and TotalCapital (Tier 1 plus Tier 2 Capital) to risk-weighted assets and of Tier 1Capital to average total assets (leverage capital ratio).   Equity capital (net of certain adjustmentsfor intangible assets and investments in non-consolidated subsidiaries andcertain classes of preferred stock) is considered Tier 1 Capital.  Tier 2 Capital consists of core capital plussubordinated debt, some types of preferred stock, and a defined percentage ofthe allowance for possible loan and lease****losses.  To be “well-capitalized” under federal bankregulations, a bank holding company must have a Tier 1 Capital ratio of atleast 6%, a Total Capital ratio of at least 10%, and a leverage capital ratioof at least 5%.  As of March 31, 2008, theCorporation’s Tier 1, Total Capital and leverage capital ratios were 17.2%,18.44% and 11.6 %, respectively.  Theratios were 16.9%, 18.2% and 12.2%, respectively, at December 31,2007.  As of March 31, 2008, the Bank’s Tier 1 Capital,Total Capital and leverage capital were 16.9%, 18.1%, and 12.1%, respectively,compared to 16.6%, 17.9%, and 11.9% at December 31, 2007. Managementbelieves, as of March 31,2008, that the Corporation and the Bank each met all capital adequacyrequirements to which they are subject.

 

**Liquidity and Capital****Resources**

 

Most of the capital needs of the Bank have historically been financedwith retained earnings and deposits received and the Corporation’s primarysource of liquidity is dividends declared by the Bank.  During March 2008, the Bank obtainedfive advances at $7 million each from the FHLB. Scheduled repaymentof the advances will begin in 2009 and end in 2013.  Please refer to Note 4 in the Notes toConsolidated Financial Statements for details.

 

 The Bank is subject to Tennesseestatutes and regulations that impose restrictions on the amount of dividendsthat may be declared.  Furthermore, anydividend payments are subject to the continuing ability of the Bank to maintainits compliance with minimum federal regulatory capital requirements and toretain its characterization under federal regulations as a “well-capitalized”institution. The Bank declared a $0.35 per share dividend in the fourth quarterof 2007, which was paid in the first quarter of 2008.  Management believes that the Corporation’straditional sources of cash generated from the Bank’s operating activities areadequate to meet the Corporation’s liquidity needs for normal ongoingoperations.  The Bank’s Board ofDirectors has adopted a liquidity policy that outlines specific liquiditytarget balances.  Compliance with thispolicy is reviewed quarterly by the Bank’s Asset/Liability Committee andresults are reported to the Bank’s Board of Directors.

 

TheBank maintains a formal asset and liability management process to controlinterest rate risk and assist management in maintaining reasonable stability inthe gross interest margin as a result of changes in the level of interest ratesand/or the spread relationships among interest rates.  The Bank uses an earnings simulation model toevaluate the impact of different interest rate scenarios on the grossmargin.  Each quarter, the Bank’sAsset/Liability Committee monitors the relationship of rate sensitive earningassets to rate sensitive interest-bearing liabilities (interest ratesensitivity), which is the principal factor in determining the effect thatfluctuating interest rates will have on future net interest income.  Rate sensitive earning assets and interestbearing liabilities are financial instruments that can be repriced to currentmarket rates within a defined time period.

 

**Critical Accounting Policies**

 

Theaccounting principles the Bank follows and the methods of applying theseprinciples conform with accounting principles generally accepted in the UnitedStates and with general practices within the banking industry.  In connection with the application of thoseprinciples, the Bank’s management has made judgments and estimates that, in thecase of the determination of the allowance for loan and lease losses (“ALLL”),the recognition of deferred income tax assets has been critical to thedetermination of the Corporation’s financial position, results of operationsand cash flows.

 

12

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Asof March 31, 2008, the deferred income tax asset was $4.2 million, whichwas included with other assets on the balance sheet.

 

*Allowance for Loan and LeaseLosses*

 

The Bank’s management assesses the adequacy of the ALLL prior to theend of each month and prepares a more formal review quarterly to assess therisk in the Bank’s loan portfolio.  Thisassessment includes procedures to estimate the allowance and test the adequacyand appropriateness of the resulting balance. The ALLL represents calculated amounts for specifically identifiedcredit exposure and exposures readily predictable by historical or comparativeexperience.  Even though this calculationconsiders specific credits, the entire allowance is available to absorb anycredit losses.

 

These calculated amounts are determined by assessing loans identifiedas not in compliance with loan agreements. These loans are generally in two different risk groups.  One group is unique loans (commercial loans,including those loans considered impaired). The second group is pools of homogenous loans (generally retail andmortgage loans).  The calculation forunique loans is based primarily on risk rating grades assigned to each of theseloans as a result of the Bank’s loan management and review processes.  Each risk-rating grade is assigned a lossratio, which is determined based on the experience of management, discussionswith banking regulators and the independent loan review process.  The amount allocated for an impaired loan isbased on estimated cash flows discounted at the loan’s original effectiveinterest rate or the underlying collateral value.  Historical data, including actual lossexperience on specific types of homogenous loans, is used to allocate amountsfor loans or groups of loans meeting the specified criteria.  Management is putting procedures in place sothat more detailed historical data can be accumulated by category of retail andconsumer credit and performance characteristics to broaden the analysis andimprove monitoring of potential credit risk.

 

Criteria considered and processes utilized inevaluating the adequacy of the ALLL are:

 

·             Portfolio quality trends;

·             Changes in the nature andvolume of the portfolio;

·             Present and prospectiveeconomic and business conditions, locally and nationally;

·                  Management review systemsand board oversight, including external loan review processes;

·                  Changes in credit policy,credit administration, portfolio management and procedures;

·             Changes in personnel,management and staff; and

·             Existence and effect of anyconcentrations of credit.

 

In assessing the adequacy of the ALLL, the risk characteristics of theentire loan portfolio are evaluated. This process includes the judgment of the Bank’s management, input fromindependent loan reviews and reviews that may have been conducted by bankregulators as part of their usual examination process.

 

*DeferredIncome Tax Assets*

 

Deferred income tax assets consist mainly of the taxeffect of excess provisions for loan and lease****lossesover actual losses incurred and deferred compensation.  Management believes that it is more likelythan not that these assets will be realized in future years.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

TheBank is a party to financial instruments with off-balance-sheet risk in thenormal course of business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and stand-by letters of credit.  Those instruments involve, to varyingdegrees, elements of credit risk in excess of the amount recognized in the balancesheet.  The contract or notional amountsof those instruments reflect the extent of involvement the Bank has in thosefinancial instruments.  The totaloutstanding loan commitments and stand-by letters of credit in the normal courseof business at March 31,2008 were $107.4 million and $17.0 million, respectively, compared to $93.1million and $12.4 million, respectively, at March 31, 2007.  The increase in stand-by letters of credit ofapproximately

 

13

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$4.6million came from additional business from existing large commercialcustomers.  Loan commitments areagreements to lend to a customer as long as there is not a violation of anycondition established in the contract. Stand-by letters of credit are conditional commitments issued by theBank to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued tosupport public and private borrowing arrangements, including commercial paper,bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially thesame as that involved in making a loan.

 

AtMarch 31, 2008, theCorporation and the Bank did not have any off-balance sheet arrangements otherthan commitments to extend credit and stand-by letters of credit.

 

**MATERIAL CHANGES IN RESULTS OF OPERATIONS**

 

Totalinterest income for the first three months of 2008 was $11.0 million comparedto $10.6 million for the first three months of 2007.  Interest and fees earned on loans andinvestments are the components of total interest income.  Interest and fees earned on loans were $8.3million, an increase of approximately $383,000, or 4.8%, during the first threemonths of 2008 compared to the first three months of 2007.  Nominal interest earned on investmentsecurities and other investments was $2.6 million, an increase of approximately$228,000, or 9.6%, during the first three months of 2008 compared to the firstthree months of 2007.

 

Total interest expense in the first three months of 2008 was $3.4million, a decrease of approximately $640,000, or 15.9%, compared to the firstthree months of 2007.  The lower interestrates for certificates of deposits and public funds during the first quarter of2008 were the primary reason for the lower expense.  As a policy, budgeted financial goals aremonitored on a monthly basis by the Bank’s Asset/Liability Committee, whichreviews the actual dollar change in net interest income for different interestrate movements.  A negative dollar changein net interest income for a 12-month period of less than 4.5% of net interestincome given a 200 basis point shift in interest rates is considered anacceptable rate risk position.  The raterisk analysis for the 12-month period beginning April 1, 2008 and ending March 31,2009 showed a worst-case potential change to net interest income of a negative3.5%, or a decline in net interest income of approximately $1.1 million by theend of the period.

 

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

 

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

(2)           market rates ofinterest; and

(3)           income tax rates.

 

The impact of some of these factors can be controlled by managementpolicies and actions.  External factorsalso can have a significant impact on changes in net interest income from oneperiod to another.  Some examples of suchfactors are:

 

(1)                                  the strength ofcredit demands by customers;

(2)                                  Federal ReserveBoard monetary policy; and

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

 

The net interest margin, on a tax equivalent basis, at March 31, 2008, March 31, 2007 and December,31, 2007 was 4.45%, 3.97% and 4.15%, respectively.

 

No additions were made to the allowance for loan and lease****losses in the first quarter of 2008.

 

Noninterest incomewas $3.8 million, an increase of approximately $888,000, or 31.0%, during thefirst three months of 2008 compared to the first three months of 2007.  Contributing to this increase were:

 

(1)   gains on sales of available-for-salesecurities, representing approximately $1.0 million in income; and

(2)   service fees, representing approximately49.9% of noninterest income, which were up 6.8% compared to the first threemonths of 2007.

 

14

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Noninterestexpenses, excluding the provision for possible loan and lease losses, wereapproximately $676,000, or 9.5%, higher in the first three months of 2008 ascompared to the first three months of 2007. Salaries and benefits expense was up approximately$545,000, or 14.6%, for the three months ended March 31, 2008 compared tothe same period in 2007 because of changes in the Bank’s incentive andretirement plans.

 

 The Corporation does not have anylong-term debt or other long-term obligations; however, in the first quarter of2008, the Bank received a $35 million advance from FHLB.  Scheduled repayment of the advances will begin in 2009and end in 2013.  Please refer to Note 4in the Notes to Consolidated Financial Statements for details.

 

TheBank also has leases for bank property. There was not a change during the three-month period ended March 31, 2008 in the termsof these leases.

 

Netincome for the three months ended March 31, 2008 was $2.75 million, comparedto $2.05 million for the three months ended March 31, 2007.  An increase in service fees, along with arealized gain on available-for-sale securities, contributed to theperiod-over-period increase.  TheCorporation earned $0.48 per share in the first quarter of 2008 and $0.36 pershare in the first quarter of 2007.

 

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

 

Duringthe three months ended March 31,2008, there were no material changes in the quantitative and qualitativedisclosures about market risk presented in the Corporation’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

**Item 4.Controls and Procedures.**

 

(a) Evaluationof Disclosure Controls and Procedures. The Corporation, with the participation of its management, including theCorporation’s Chief Executive Officer and Assistant Treasurer (principalfinancial officer), carried out an evaluation of the effectiveness of thedesign and operation of its disclosure controls and procedures (as defined in Rules 13a-15and 15d-15 under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) as of the end of the period covered by this report.  Based upon that evaluation and as of the endof the period covered by this report, the Corporation’s Chief Executive Officerand Assistant Treasurer (principal financial officer) concluded that theCorporation’s disclosure controls and procedures were effective in ensuringthat information required to be disclosed in its reports that the Corporationfiles or submits to the Securities and Exchange Commission under the ExchangeAct is recorded, processed, summarized and reported on a timely basis.

 

(b) Changesin Internal Control Over Financial Reporting.  There has been no change in the Corporation’sinternal control over financial reporting that occurred during the firstquarter of 2008 that has materially affected, or is reasonably likely tomaterially affect, the Corporation’s internal control over financial reporting.

 

**PART II- OTHER INFORMATION**

 

**Item1A. Risk Factors.**

 

There have been no material changes in the risk factors previouslydisclosed in the Corporation’s Annual Report on Form 10-K for the yearended December 31, 2007.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

The following table provides information regarding purchases of theCorporation’s common stock made by the Corporation during the first quarter of2008:

 

15

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**CORPORATION’SPURCHASES OF EQUITY SECURITIES**

 
| **Period**                                           | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number (or  Approximate Dollar  Value) of Shares that  May Yet Be Purchased  Under the Plans or  Programs** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1,  2008 – January 31, 2008   |       | —                                           |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                            |       |
| February 1,  2008 – February 29, 2008 |       | —                                           |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                            |       |
| March 1,  2008 – March 31, 2008       |       | 20,000                                           | *          | $                                            | 50.00      |                                                                                                                             | —     |                                                                                                                                                                              | —     |   |
| Total                                                |       | 20,000                                           |       | $                                            | 50.00      |                                                                                                                             | —     |                                                                                                                                                                              | —     |   |

 

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*Purchased through negotiated transactions with several third-partysellers.

 

**Item 6.  Exhibits.**

 
| **EXHIBIT** | ** ** | ** **                                                                                                                                                                                                                                                                       |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **NUMBER**  | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                             |
| 3.1         |       | Charter (1)                                                                                                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                             |
| 3.2         |       | Articles of Amendment to Charter (1)                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                             |
| 3.3         |       | Amended and Restated By-laws (2)                                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                             |
| 31.1        |       | Certification of the Chief Executive Officer of  First Farmers and Merchants Corporation Pursuant to Rule 13a-14 of the  Securities Exchange Act of 1934, as amended, as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                            |
|        |       |                                                                                                                                                                                                                                                                             |
| 31.2        |       | Certification of the  Assistant Treasurer (principal financial officer) of First Farmers and  Merchants Corporation Pursuant to Rule 13a-14 of the Securities Exchange  Act of 1934, as amended, as Adopted Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 |
|        |       |                                                                                                                                                                                                                                                                             |
| 32.1        |       | Certification of the Chief  Executive Officer and Assistant Treasurer (principal financial officer) of  First Farmers and Merchants Corporation Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002             |

 

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(1)  Incorporated by reference from the First Farmers andMerchants Corporation Amendment No. 1 to the Annual Report on Form 10-K/Afor the year ended December 31, 2003, File Number 000-10972, as filed withthe Securities and Exchange Commission on May 7, 2004.

 

(2)  Incorporated by reference from the First Farmers andMerchants Corporation Current Report on Form 8-K,  File Number 000-10972, as filed with theSecurities and Exchange Commission on April 23, 2007.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

FIRST FARMERS ANDMERCHANTS CORPORATION

(Registrant)

 

 
| Date   | May 12, 2008                                                                                         |   | /s/ T. Randy  Stevens    |
|--------|-----------------------------------------------------------------------------------------------------------|--------|--------------------------|
|   | T. Randy  Stevens, Chief Executive Officer                                                                |
|   |                                                                                                      |   |
|   |                                                                                                      |   |
| Date   | May 12, 2008                                                                                         |   | /s/ Patricia P.  Bearden |
|   | Patricia P.  Bearden, Assistant Treasurer (principal financial officer

and principal accounting officer) |

 

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| **EXHIBIT** | ** ** | ** **                                                                                                                                                                                                                                                                      |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **NUMBER**  | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                            |
| 3.1         |       | Charter  (1)                                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                            |
| 3.2         |       | Articles  of Amendment to Charter (1)                                                                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                            |
| 3.3         |       | Amended  and Restated By-laws (2)                                                                                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                            |
| 31.1        |       | Certification  of the Chief Executive Officer of First Farmers and Merchants Corporation  Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as  amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                          |
|        |       |                                                                                                                                                                                                                                                                            |
| 31.2        |       | Certification of the Assistant Treasurer (principal financial  officer) of First Farmers and Merchants Corporation Pursuant to  Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|        |       |                                                                                                                                                                                                                                                                            |
| 32.1        |       | Certification of the Chief Executive Officer and Assistant Treasurer  (principal financial officer) of First Farmers and Merchants Corporation  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002             |

 

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(1)  Incorporated by reference from the First Farmers andMerchants Corporation Amendment No. 1 to the Annual Report on Form 10-K/Afor the year ended December 31, 2003, File Number 000-10972, as filed withthe Securities and Exchange Commission on May 7, 2004.

 

(2)  Incorporated by reference from the First Farmers andMerchants Corporation Current Report on Form 8-K, File Number 000-10972,as filed with the Securities and Exchange Commission on April 23, 2007.

 

18

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