Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**(Markone)**

 

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

 

**For the quarterly period ended September 30, 2010**

 

**or**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from               to               **

 

**Commission File Numbers: 000-10972**

 

**First Farmers and Merchants Corporation**

(Exact name of registrant as specified in its charter)

 

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

 

**931-388-3145**

(Registrant’s telephone number, including area code)

 

 

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

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. x Yes  o No

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). o Yes  o No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act).  o Yes  x No

 

As of November 5, 2010, the registrant had 5,487,713 shares ofcommon stock outstanding.

 

 

 

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**PART I - FINANCIALINFORMATIO**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 — September 30, 2010 and December 31, 2009.                                               |
|                                                                                                                                  |
| Consolidated  statements of income - For the three months and nine months ended  September 30, 2010 and September 30, 2009. |
|                                                                                                                                  |
| Consolidated  statements of cash flows - For the nine months ended September 30, 2010  and September 30, 2009.              |
|                                                                                                                                  |
| Selected  notes to consolidated financial statements.                                                                                 |

 

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**FIRST FARMERS AND MERCHANTS CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                 | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2010**               | ** **  | **2009**              | ** ** |
| **(Dollars in Thousands, Except Per Share Data)**                                                                                                            | ** ** | **(Unaudited)**        | ** **  | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                 | ** ** | ** **             |        |                  |       |
| Cash and due from banks                                                                                                                                                                    | ** ** | **$**                  | **15,292**  |                  | $          | 11,181 |   |
| Interest-bearing due from banks                                                                                                                                                            | ** ** | **13,098**             |        | 5,557                 |       |
| Federal funds sold                                                                                                                                                                         | ** ** | **12,350**             |        | 16,725                |       |
| Total cash and cash equivalents                                                                                                                                                            | ** ** | **40,740**             |        | 33,463                |       |
| Securities                                                                                                                                                                                 | ** ** | ** **             |        |                  |       |
| Available-for-sale (amortized cost $228,665 and  $207,027, respectively)                                                                                                                   | ** ** | **233,207**            |        | 208,238               |       |
| Held-to-maturity (fair market value $43,010 and  $48,722, respectively)                                                                                                                    | ** ** | **40,589**             |        | 47,613                |       |
| Total securities                                                                                                                                                                           | ** ** | **273,796**            |        | 255,851               |       |
| Loans, net of deferred fees                                                                                                                                                                | ** ** | **575,892**            |        | 576,655               |       |
| Allowance for loan losses                                                                                                                                                                  | ** ** | **(8,964**             | **)**       | (8,929                | )          |
| Net loans                                                                                                                                                                                  | ** ** | **566,928**            |        | 567,726               |       |
| Bank premises and equipment, at cost less  allowance for depreciation                                                                                                                      | ** ** | **23,000**             |        | 20,625                |       |
| Core deposit and other intangibles                                                                                                                                                         | ** ** | **9,055**              |        | 9,111                 |       |
| Other assets                                                                                                                                                                               | ** ** | **49,569**             |        | 48,252                |       |
| TOTAL ASSETS                                                                                                                                                                               | ** ** | **$**                  | **963,088** |                  | $          | 935,028 |   |
| **LIABILITIES**                                                                                                                                                                            | ** ** | ** **             |        |                  |       |
| Deposits                                                                                                                                                                                   | ** ** | ** **             |        |                  |       |
| Noninterest-bearing                                                                                                                                                                        | ** ** | **$**                  | **131,644** |                  | $          | 116,157 |   |
| Interest-bearing (including certificates of deposits  over $100: 2010 - $118,195; 2009 - $97,572)                                                                                          | ** ** | **674,416**            |        | 656,168               |       |
| Total deposits                                                                                                                                                                             | ** ** | **806,060**            |        | 772,325               |       |
| Federal funds purchased and securities sold under  agreements to repurchase                                                                                                                | ** ** | **5,992**              |        | 5,856                 |       |
| Dividends payable                                                                                                                                                                          | ** ** | **—**             |        | 2,038                 |       |
| Short-term borrowings                                                                                                                                                                      | ** ** | **426**                |        | 414                   |       |
| Accounts payable and accrued liabilities                                                                                                                                                   | ** ** | **15,194**             |        | 13,045                |       |
| Federal Home Loan Bank advances                                                                                                                                                            | ** ** | **24,100**             |        | 34,177                |       |
| TOTAL LIABILITIES                                                                                                                                                                          | ** ** | **851,772**            |        | 827,855               |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                                                                              | ** ** | ** **             |        |                  |       |
| Common stock - $10 par value per share, 8,000,000  shares authorized; 5,487,713 and 5,506,993 shares issued and outstanding as  of Sept. 30, 2010 and December 31, 2009, respectively | ** ** | **54,877**             |        | 55,070                |       |
| Retained earnings                                                                                                                                                                          | ** ** | **53,551**             |        | 51,264                |       |
| Accumulated other comprehensive income                                                                                                                                                     | ** ** | **2,793**              |        | 744                   |       |
| TOTAL SHAREHOLDERS’ EQUITY BEFORE NONCONTROLLING INTEREST - PREFERRED  STOCK OF SUBSIDIARY                                                                                            | ** ** | **111,221**            |        | 107,078               |       |
| Noncontrolling interest - preferred stock of  subsidiary                                                                                                                                   | ** ** | **95**                 |        | 95                    |       |
|                                                                                                                                                                                       | ** ** | **111,316**            | ** **  | **107,173**           | ** ** |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                            | ** ** | **$**                  | **963,088** |                  | $          | 935,028 |   |

 

----

(1) Derived from audited financial statements.

 

The accompanying notes are an integral part of consolidated financialstatements.

 

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**FIRST FARMERS AND MERCHANTS CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

 
| ** **                                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(Dollars in Thousands Except Per Share Data)**          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **(Unaudited)**                                                                         | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| **INTEREST AND DIVIDEND INCOME**                                                        | ** ** | ** **                       |       |                            | ** ** | ** ** |   |   |   |
| Interest and fees on loans                                                              | ** ** | **$**                            | **7,890**  |                            | $          | 8,022 | ** ** | **$** | **23,822** |   | $ | 23,799 |   |
| Income on investment securities                                                         | ** ** | ** **                       |       |                            | ** ** | ** ** |   |   |   |
| Taxable interest                                                                        | ** ** | **741**                          |       | 1,205                           | ** ** | **3,098** |   | 3,650 |   |
| Exempt from federal income tax                                                          | ** ** | **902**                          |       | 935                             | ** ** | **2,676** |   | 2,855 |   |
| Dividends                                                                               | ** ** | **14**                           |       | 51                              | ** ** | **116** |   | 157 |   |
|                                                                                    | ** ** | **1,657**                        |       | 2,191                           | ** ** | **5,890** |   | 6,662 |   |
| Other interest income                                                                   | ** ** | **16**                           |       | 11                              | ** ** | **44** |   | 55 |   |
| TOTAL INTEREST INCOME                                                                   | ** ** | **9,563**                        |       | 10,224                          | ** ** | **29,756** |   | 30,516 |   |
|                                                                                    | ** ** | **—**                       |       |                            | ** ** | **—** |   | — |   |
| **INTEREST EXPENSE**                                                                    | ** ** | ** **                       |       |                            | ** ** | ** ** |   |   |   |
| Interest on deposits                                                                    | ** ** | **1,480**                        |       | 1,869                           | ** ** | **4,668** |   | 6,196 |   |
| Interest on other borrowings                                                            | ** ** | **235**                          |       | 278                             | ** ** | **759** |   | 881 |   |
| TOTAL INTEREST EXPENSE                                                                  | ** ** | **1,715**                        |       | 2,147                           | ** ** | **5,427** |   | 7,077 |   |
| NET INTEREST INCOME                                                                     | ** ** | **7,848**                        |       | 8,077                           | ** ** | **24,329** |   | 23,439 |   |
| PROVISION FOR POSSIBLE LOAN AND LEASE LOSSES                                            | ** ** | **—**                       |       | 405                             | ** ** | **1,491** |   | 1,830 |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN AND  LEASE LOSSES                          | ** ** | **7,848**                        |       | 7,672                           | ** ** | **22,838** |   | 21,609 |   |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| **NONINTEREST INCOME**                                                                  | ** ** | ** **                       |       |                            | ** ** | ** ** |   |   |   |
| Trust department income                                                                 | ** ** | **461**                          |       | 475                             | ** ** | **1,486** |   | 1,469 |   |
| Service fees on deposit accounts                                                        | ** ** | **1,759**                        |       | 1,853                           | ** ** | **5,165** |   | 5,408 |   |
| Other fees and commissions                                                              | ** ** | **209**                          |       | 106                             | ** ** | **466** |   | 346 |   |
| Other operating income (loss)                                                           | ** ** | **(1,247**                       | **)**      | 225                             | ** ** | **(1,308** | **)** | 593 |   |
| Securities gains                                                                        | ** ** | **1,112**                        |       | —                          | ** ** | **1,614** |   | 2,482 |   |
| TOTAL NONINTEREST INCOME                                                                | ** ** | **2,294**                        |       | 2,659                           | ** ** | **7,423** |   | 10,298 |   |
| **NONINTEREST EXPENSE**                                                                 | ** ** | ** **                       |       |                            | ** ** | ** ** |   |   |   |
| Salaries and employee benefits                                                          | ** ** | **4,025**                        |       | 4,270                           | ** ** | **12,205** |   | 12,583 |   |
| Net occupancy expense                                                                   | ** ** | **687**                          |       | 728                             | ** ** | **2,001** |   | 1,997 |   |
| Furniture and equipment expense                                                         | ** ** | **257**                          |       | 285                             | ** ** | **789** |   | 833 |   |
| Other operating expenses                                                                | ** ** | **2,869**                        |       | 3,273                           | ** ** | **9,694** |   | 9,351 |   |
| TOTAL NONINTEREST EXPENSES                                                              | ** ** | **7,838**                        |       | 8,556                           | ** ** | **24,689** |   | 24,764 |   |
| INCOME BEFORE PROVISION FOR INCOME TAXES                                                | ** ** | **2,304**                        |       | 1,775                           | ** ** | **5,564** |   | 7,143 |   |
| PROVISION FOR INCOME TAXES                                                              | ** ** | **478**                          |       | 112                             | ** ** | **606** |   | 1,038 |   |
| Net income before noncontrolling interest -  dividends on preferred stock of subsidiary | ** ** | **$**                            | **1,826**  |                            | $          | 1,663 | ** ** | **$** | **4,966** |   | $ | 6,105 |   |
| Noncontrolling interest - dividends on preferred  stock of subsidiary                   | ** ** | **$**                            | **—** |                            | $          | — | ** ** | **$** | **8** |   | $ | 8 |   |
| NET INCOME AVAILABLE FOR COMMON SHAREHOLDERS                                            | ** ** | **$**                            | **1,826**  |                            | $          | 1,663 | ** ** | **$** | **4,958** |   | $ | 6,097 |   |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| **BASIC EARNINGS PER SHARE**                                                            | ** ** | ** **                       |       |                            | ** ** | ** ** |   |   |   |
| Weighted Average Shares Outstanding                                                     | ** ** | **5,487,713**                    |       | 5,522,498                       | ** ** | **5,493,098** |   | 5,547,930 |   |
|                                                                                    | ** ** | **$**                            | **0.33**   |                            | $          | 0.30 |   | $ | 0.90 |   | $ | 1.10 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

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**FIRST FARMERS AND MERCHANTS CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| **(Dollars in Thousands)**                                                        | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Unaudited)**                                                                             | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| **OPERATING ACTIVITIES**                                                                    | ** ** | ** **                                              |       |   |   |
| Net income available for common shareholders                                                | ** ** | **$**                                                   | **4,958**  |   | $ | 6,097 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities | ** ** | ** **                                              |       |   |   |
| Excess (deficiency) of provision for possible loan  losses over net charge-offs             | ** ** | **1,491**                                               |       | (77 | ) |
| Provision for depreciation and amortization of  premises and equipment                      | ** ** | **889**                                                 |       | 911 |   |
| Securities gains                                                                            | ** ** | **(1,615**                                              | **)**      | (2,482 | ) |
| Loss from disposition of fixed assets                                                       | ** ** | **7**                                                   |       | 129 |   |
| Loss (gain) from disposition of other real estate                                           | ** ** | **2,131**                                               |       | (8 | ) |
| Amortization of deposit base intangibles                                                    | ** ** | **57**                                                  |       | 56 |   |
| Amortization of investment security premiums, net  of accretion of discounts                | ** ** | **1,972**                                               |       | 990 |   |
| Increase in cash surrender value of life insurance  contracts                               | ** ** | **(606**                                                | **)**      | (177 | ) |
| (Increase) decrease in                                                                      | ** ** | ** **                                              |       |   |   |
| Deferred income taxes                                                                       | ** ** | **(800**                                                | **)**      | 15 |   |
| Interest receivable                                                                         | ** ** | **285**                                                 |       | (542 | ) |
| Other real estate owned                                                                     | ** ** | **(1,477**                                              | **)**      | — |   |
| Other assets                                                                                | ** ** | **(2,048**                                              | **)**      | (2,115 | ) |
| Increase (decrease) in                                                                      | ** ** | ** **                                              |       |   |   |
| Interest payable                                                                            | ** ** | **30**                                                  |       | (239 | ) |
| Other liabilities                                                                           | ** ** | **2,127**                                               |       | 2,007 |   |
| Total adjustments                                                                           | ** ** | **2,443**                                               |       | (1,532 | ) |
| Net cash provided by operating activities                                                   | ** ** | **7,401**                                               |       | 4,565 |   |
| **INVESTING ACTIVITIES**                                                                    | ** ** | ** **                                              |       |   |   |
| Proceeds from maturities, calls, and sales of  available-for-sale securities                | ** ** | **213,043**                                             |       | 162,801 |   |
| Proceeds from maturities and calls of  held-to-maturity securities                          | ** ** | **6,907**                                               |       | 9,524 |   |
| Purchases of investment securities                                                          | ** ** | ** **                                              |       |   |   |
| Available-for-sale                                                                          | ** ** | **(234,921**                                            | **)**      | (191,416 | ) |
| Net (decrease) increase in loans                                                            | ** ** | **(693**                                                | **)**      | 6,966 |   |
| Proceeds from sale of foreclosed assets                                                     | ** ** | **382**                                                 |       | 37 |   |
| Life insurance premium                                                                      | ** ** | **(468**                                                | **)**      | (833 | ) |
| Purchases of premises and equipment                                                         | ** ** | **(3,271**                                              | **)**      | (4,066 | ) |
| Net cash used in investing activities                                                       | ** ** | **(19,021**                                             | **)**      | (16,987 | ) |
| **FINANCING ACTIVITIES**                                                                    | ** ** | ** **                                              |       |   |   |
| Net increase in noninterest-bearing and  interest-bearing deposits                          | ** ** | **33,735**                                              |       | 23,715 |   |
| Net increase in short term borrowings                                                       | ** ** | **148**                                                 |       | 3,878 |   |
| Payments to FHLB borrowings                                                                 | ** ** | **(10,077**                                             | **)**      | (7,000 | ) |
| Repurchase of common stock                                                                  | ** ** | **(833**                                                | **)**      | (3,650 | ) |
| Cash dividends paid on common stock                                                         | ** ** | **(4,068**                                              | **)**      | (4,027 | ) |
| Cash dividends paid on preferred stock                                                      | ** ** | **(8**                                                  | **)**      | (8 | ) |
| Net cash provided by financing activities                                                   | ** ** | **18,897**                                              |       | 12,908 |   |
| Increase in cash and cash equivalents                                                       | ** ** | **7,277**                                               |       | 486 |   |
| Cash and cash equivalents at beginning of period                                            | ** ** | **33,463**                                              |       | 31,536 |   |
| Cash and cash equivalents at end of period                                                  | ** ** | **$**                                                   | **40,740** |   | $ | 32,022 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

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**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Theinterim unaudited consolidated financial statements of First Farmers andMerchants Corporation (the “Corporation”) presented in this report have beenprepared on a consistent basis and in accordance with the instructions to Form 10-Qand do not include all of the information and notes required by generallyaccepted accounting principles for complete financial statements.  Management has evaluated all significantevents and transactions that occurred through November 5, 2010, forpotential recognition or disclosure in these consolidated financialstatements.  In the opinion ofmanagement, all adjustments considered necessary for a fair presentation havebeen included.  These adjustments were ofa normal, recurring nature and consistent with generally accepted accountingprinciples.  For further information,refer to the consolidated financial statements and notes included in theCorporation’s Annual Report on Form 10-K for the year ended December 31,2009.

 

**NOTE 2 —STOCK REPURCHASE**

 

Duringthe third quarter of 2010, the Corporation did not repurchase any shares of theCorporation’s common stock.

 

**NOTE 3 — FAIR VALUE MEASUREMENT**

 

The fair value of an assetor liability is the price that would be received to sell that asset or paid totransfer that liability in an orderly transaction occurring in the principalmarket (or most advantageous market in the absence of a principal market) forsuch asset or liability. In estimating fair value, the Corporation utilizesvaluation techniques that are consistent with the market approach, the incomeapproach and/or the cost approach. Such valuation techniques are consistentlyapplied. Inputs to valuation techniques include the assumptions that marketparticipants would use in pricing an asset or liability. Financial AccountingStandards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “FairValue Measurements and Disclosures,” establishes a fair value hierarchy forvaluation inputs that gives the highest priority to quoted prices in activemarkets for identical assets or liabilities and the lowest priority tounobservable inputs. The fair value hierarchy is as follows:

 

·                  *Level 1Inputs*- Unadjusted quoted prices in active markets for identical assets orliabilities that the reporting entity has the ability to access at themeasurement date.

 

·                  *Level2 Inputs* - Inputs otherthan quoted prices included in Level 1 that are observable for the asset orliability, either directly or indirectly. These might include quoted prices forsimilar assets or liabilities in active markets, quoted prices for identical orsimilar assets or liabilities in markets that are not active, inputs other thanquoted prices that are observable for the asset or liability (such as interestrates, volatilities, prepayment speeds, credit risks, etc.) or inputs thatare derived principally from or corroborated by market data by correlation orother means.

 

·                  *Level3 Inputs* - Unobservableinputs for determining the fair values of assets or liabilities that reflect anentity’s own assumptions about the assumptions that market participants woulduse in pricing the assets or liabilities.

 

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Financialassets measured at fair value on a recurring basis comprised the following at September 30,2010:

 
| ** **                               | ** ** | **Fair Value Measurements at Reporting Date Using** | ** **  |
|------------------------------------------|------------|-----------------------------------------------------------------------------------|-------------|
| **(Dollars in thousands)**     | ** ** | **Fair Value  9/30/2010**                                                    | ** **  | **Quoted  Prices in  Active  Markets for  Identical  Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Obligations of:                          |       |                                                                              |        |   |   |   |   |   |   |
| U.S. Government agencies                 |       | $                                                                                 | 115,690     |   | $ | — |   | $ | 115,690 |   | $ | — |   |
| States and political subdivisions        |       | 56,182                                                                            |        | — |   | 56,182 |   | — |   |
| Residential mortgage-backed securities   |       | 39,914                                                                            |        | — |   | 39,914 |   | — |   |
| Other domestic debt securities           |       | 17,524                                                                            |        | — |   | 17,524 |   | — |   |
| Equity securities                        |       | 3,897                                                                             |        | — |   | 3,897 |   | — |   |
| **Total available-for-sale  securities** | ** ** | **$**                                                                             | **233,207** | ** ** | **$** | **—** | ** ** | **$** | **233,207** | ** ** | **$** | **—** | ** ** |

 

*Securitiesavailable-for-sale* — Securities classified as available-for-sale arereported at fair value utilizing Level 2 inputs.  For these securities, the fair values used bythe Corporation are obtained from an independent pricing service and representfair values determined by pricing models using a market approach that considersobservable market data, such as interest rate volatilities, LIBOR yield curve,credit spreads and prices from market makers and live trading systems.

 

TheCorporation has no non-financial assets or non-financial liabilities measuredat fair value on a recurring basis. Certain non-financial assets and non-financial liabilities measured atfair value on a non-recurring basis include foreclosed assets (upon initialrecognition or subsequent impairment), non-financial assets and non-financialliabilities measured at fair value in the second step of goodwill impairmenttest, and intangible assets and other non-financial long-lived assets measuredat fair value for impairment assessment.

 

Duringthe third quarter of 2010, certain foreclosed assets, upon initial recognition,were remeasured and reported at fair value through a charge-off to theallowance for possible loan and lease losses based upon the fair value of theforeclosed asset.  The fair value of aforeclosed asset, upon initial recognition, is estimated using Level 2 inputsbased on observable market data or Level 3 inputs based on customizeddiscounting criteria.  Foreclosed assetsmeasured at fair value totaled $8.9 million (utilizing Level 2 inputs) at September 30,2010.

 

Certainfinancial assets and liabilities are measured at fair value on a nonrecurringbasis. These instruments are not measured at fair value on an ongoing basis butare subject to fair value adjustments in certain circumstances (for example,when there is evidence of impairment). The only financial asset or liabilitymeasured at fair value on a non-recurring basis for the third quarter of 2010 wasimpaired loans.

 

*Impaired loans —*Certain impaired loans arereported at the fair value of the underlying collateral if repayment isexpected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observablemarket data or Level 3 inputs based on customized discounting criteria.  During the third quarter of 2010, certainimpaired loans were reevaluated and reported at fair value through a specificvaluation allowance allocation to the allowance for possible loan and leaselosses based on the fair value of the underlying collateral.  Impaired loans with a carrying value of $24.4million were reduced by specific valuation allowance allocations totaling $2.8million to a total reported fair value of $21.6 million based on collateralvaluations utilizing Level 3 valuation inputs.

 

The table below presents thefair value of financial assets and financial liabilities, including thosefinancial assets and financial liabilities that are not measured and reportedat fair value on a recurring basis or non-recurring basis. A detaileddescription of the valuation methodologies used in estimating the fair value ofcertain financial instruments is set forth in Note 12 to the consolidatedfinancial statements incorporated by reference into the Corporation’s AnnualReport on Form 10-K for the year ended December 31, 2009.

 

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Theestimated fair values of financial instruments were as follows (dollars inthousands):

 
| ** **                                                                  | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                  | ** ** | **Carrying**                     | ** ** | **Fair**                        | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                                  | ** ** | **Amount**                       | ** ** | **Value**                       | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets                                                            | ** ** | ** **                       | ** ** | ** **                      |       |   |   |   |   |
| Cash and due from banks                                                     | ** ** | **$**                            | **15,292** | ** **                      | **$**      | **15,292** |   | $ | 11,181 |   | $ | 11,181 |   |
| Interest-bearing deposits in banks                                          | ** ** | **13,098**                       | ** ** | **13,098**                      |       | 5,557 |   | 5,557 |   |
| Federal funds sold                                                          | ** ** | **12,350**                       | ** ** | **12,350**                      |       | 16,725 |   | 16,725 |   |
| Securities available-for-sale                                               | ** ** | **233,207**                      | ** ** | **233,207**                     |       | 208,238 |   | 208,238 |   |
| Securities held-to-maturity                                                 | ** ** | **40,589**                       | ** ** | **43,010**                      |       | 47,613 |   | 48,722 |   |
| Loans, net of deferred fees                                                 | ** ** | **575,892**                      | ** ** | **580,193**                     |       | 567,726 |   | 570,975 |   |
| Accrued interest receivable                                                 | ** ** | **4,164**                        | ** ** | **4,164**                       |       | 4,449 |   | 4,449 |   |
| Financial liabilities                                                       | ** ** | ** **                       | ** ** | ** **                      |       |   |   |   |   |
| Deposits                                                                    | ** ** | **806,060**                      | ** ** | **808,354**                     |       | 772,325 |   | 773,710 |   |
| Federal funds purchased and securities sold under  agreements to repurchase | ** ** | **5,992**                        | ** ** | **5,992**                       |       | 5,856 |   | 5,856 |   |
| Other short term liabilities                                                | ** ** | **426**                          | ** ** | **426**                         |       | 414 |   | 414 |   |
| FHLB borrowings                                                             | ** ** | **24,100**                       | ** ** | **31,526**                      |       | 34,177 |   | 38,616 |   |
| Accrued interest payable                                                    | ** ** | **1,214**                        | ** ** | **1,214**                       |       | 1,184 |   | 1,184 |   |
| Off-balance sheet credit related instruments:                               | ** ** | ** **                       | ** ** | ** **                      |       |   |   |   |   |
| Commitments to extend credit                                                | ** ** | ** **                       | ** ** | **94**                          |       |   |   | 103 |   |
|                                                                             |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

Adescription of the valuation methodologies used for instruments measured atfair value as well as the general classification of such instruments pursuantto the valuation hierarchy is set forth below. These valuation methodologies were applied to all of the financialassets and financial liabilities of the Corporation and its sole wholly-ownedsubsidiary, First Farmers and Merchants Bank (the “Bank”), carried at fairvalue effective September 30, 2010. If quoted market prices are not available, fair value is based oninternally developed models that primarily use, as inputs, observablemarket-based parameters. Valuation adjustments may be made to ensure thatfinancial instruments are recorded at fair value. These adjustments may includeamounts to reflect counterparty credit quality and the Corporation’screditworthiness among other things, as well as unobservable parameters.  Any such valuation adjustments are appliedconsistently over time.  The Corporation’svaluation methodologies may produce a fair value calculation that may not beindicative of net realizable value or reflective of future fair values.  While management believes the valuationmethodologies are appropriate and consistent with other market participants,the use of different methodologies or assumptions to determine the fair valueof certain financial instruments could result in a different estimate of fairvalue at the reporting date.  Furthermore,the reported fair value amounts have not been comprehensively revalued sincethe presentation dates and, therefore, estimates of fair value after thebalance sheet date may differ significantly from the amounts presented herein.

 

Financialassets and financial liabilities measured at fair value on a recurring basisinclude the following:

 

**Loans: **The fair value of portfolioloans assumes sale of the notes to a third party financial investor.  Accordingly, this value is not necessarilythe value to the Corporation if the notes were held to maturity.  The Corporation considered interest rate,credit and market factors in estimating the fair value of loans.  In the current whole loan market, financialinvestors are generally requiring a much higher rate of return than the returninherent in loans if held to maturity given the lack of market liquidity.  This divergence accounts for the majority ofthe difference in carrying amount over fair value.

 

**Deposits:**  The fair value of fixed maturity certificatesof deposit is estimated using a discounted cash flow calculation based oncurrent rates offered for deposits of similar remaining maturities.

 

**FHLB Borrowings: **The fair value of FederalHome Loan Bank of Cincinnati (the “FHLB”) borrowings is estimated usingdiscounted cash flow analysis based on rates currently available to theCorporation for borrowings with similar terms.

 

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**NOTE 4 — FEDERAL HOME LOAN BANKCREDIT LINE**

 

TheBank has a Blanket Agreement for Advances and Security Agreement (the “BlanketAgreement”) with the FHLB dated March 31, 2008.  Advances made to the Bank under the BlanketAgreement are collateralized by FHLB stock and unidentified qualifyingresidential mortgage loans totaling 150% of the outstanding amountborrowed.  The Bank made an annualprincipal payment of $7.0 million to the FHLB under the Blanket Agreement oneach of March 31, 2009 and March 31, 2010, with an additional paymentof $3.1 million on September 15, 2010.

 

Scheduledprincipal maturities of borrowings under this credit line as of September 30,2010, are as follows (dollars in thousands):

 
| 2011  |   | $      | 7,000  |   |
|-------|--------|--------|--------|--------|
| 2012  |   | 7,000  |   |
| 2013  |   | 10,100 |   |
| Total |   | $      | 24,100 |   |

 

Stockheld in the FHLB totaling $3.0 million at September 30, 2010 is carried atcost.  The stock is restricted and canonly be sold to the FHLB at par.

 

TheBank also has a Cash Management Advance Line of Credit Agreement (the “CMA”)dated June 21, 2010, with the FHLB. The CMA is a component of the Blanket Agreement.  The purpose of the CMA is to assist withshort-term liquidity management.  Underthe terms of the CMA, the Bank may borrow a maximum of $40.0 million, selectinga variable rate of interest for up to 90 days or a fixed rate for a maximum of30 days.  There were no borrowingsoutstanding under the CMA as of September 30, 2010.

 

**NOTE 5 —SECURITIES**

 

Securitieswith an amortized cost of $167.7 million and a fair value of $171.3 million at September 30,2010 were pledged to secure deposits and for other purposes as required orpermitted by law.  The fair value isestablished by an independent pricing service as of the approximate datesindicated.  The differences between theamortized cost and fair value reflect current interest rates and represent thepotential gain if the portfolio had been liquidated on that date.  Security gains are realized only in the eventof dispositions prior to maturity.

 

Asummary of the amortized cost and estimated fair value of securities at September 30,2010 is as follows (dollars in thousands):

 
| ** **                             | ** ** | **Amortized** | ** **  | **Gross Unrealized** | ** ** | **Fair**   | ** ** |
|----------------------------------------|------------|---------------|-------------|---------------------------|------------|------------|------------|
| ** **                             | ** ** | **Cost**      | ** **  | **Gains**                 | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available-for-sale securities          |       |          |        |                      |       |       |       |   |   |
| U.S. Government agencies               | ** ** | **$**         | **115,412** | ** **                | **$**      | **281**    | ** ** | **$** | **3** | ** ** | **$** | **115,690** | ** ** |
| Residential mortgage backed securities | ** ** | **39,608**    | ** **  | **306**                   | ** ** | **—** | ** ** | **39,914** | ** ** |
| States and political subdivisions      | ** ** | **53,034**    | ** **  | **3,148**                 | ** ** | **—** | ** ** | **56,182** | ** ** |
| Other securities                       | ** ** | **20,611**    | ** **  | **810**                   | ** ** | **—** | ** ** | **21,421** | ** ** |
|                                   | ** ** | **$**         | **228,665** | ** **                | **$**      | **4,545**  | ** ** | **$** | **3** | ** ** | **$** | **233,207** | ** ** |
| Held-to-maturity securities            | ** ** | ** **    | ** **  | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. Government agencies               | ** ** | **$**         | **—**  | ** **                | **$**      | **—** | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** |
| States and political subdivisions      | ** ** | **40,589**    | ** **  | **2,421**                 | ** ** | **—** | ** ** | **43,010** | ** ** |
| Other securities                       | ** ** | **—**    | ** **  | **—**                | ** ** | **—** | ** ** | **—** | ** ** |
|                                   | ** ** | **$**         | **40,589**  | ** **                | **$**      | **2,421**  | ** ** | **$** | **—** | ** ** | **$** | **43,010** | ** ** |

 

AtSeptember 30, 2010, the Bank did not hold investment securities of anysingle issuer, other than obligations of the U.S. government agencies, whoseaggregate book value exceeded 10% of shareholders’ equity.

 

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Proceeds from the maturity, call or sale of available-for-salesecurities were $213.0 million during the nine months ended September 30,2010.  Proceeds from the maturity or callof held-to-maturity securities were $6.9 million during the nine months ended September 30,2010.

 

Ifthe fair values of any securities at September 30, 2010 did not equal orexceed the cost of those securities, then the current fair value was consideredtemporarily impaired.  The information inthe table below classifies the investments with unrealized losses at September 30,2010 according to the term of the unrealized loss.  Management evaluates securities forother-than-temporary impairment periodically, or more frequently whencircumstances require an evaluation.  Animpairment judgment is based on (i) the amount of time and loss, (ii) thefinancial condition of the issuer and (iii) management’s intent andability to hold the investment long enough for any anticipated recovery invalue.

 

Managementhas the ability and intent to hold the securities classified asheld-to-maturity until they mature. Furthermore, as of September 30, 2010, management also had theability to hold the securities classified as available-for-sale for a period oftime sufficient for a recovery of cost. The unrealized losses are largely a result of market fluctuations andvariations in pricing appraisals. Management does not believe any of the securities are impaired becauseof reasons of credit quality. Accordingly, as of September 30, 2010, management believes theimpairments detailed in the table below are temporary and no impairment losshas been realized in the Corporation’s consolidated income statement.

 

Thefollowing table presents the Bank’s investments with unrealized losses at September 30,2010 according to the term of the unrealized loss:

 
| ** **                           | ** ** | **Less than 12 months** | ** ** | **12 months or Greater** | ** ** | **Total**  | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|------------|------------|
| ** **                           | ** ** | **Fair**                               | ** ** | **Unrealized**                          | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(Dollars in thousands)** | ** ** | **Value**                              | ** ** | **Losses**                              | ** ** | **Value**  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| **Type of Security**                 | ** ** | ** **                             | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US Government agencies**           | ** ** | **$**                                  | **9,998**  | ** **                              | **$**      | **3**      | ** ** | **—** | ** ** | **—** | ** ** | **$** | **9,998** | ** ** | **$** | **3** | ** ** |
| ** **                           | ** ** | **$**                                  | **9,998**  | ** **                              | **$**      | **3**      | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **9,998** | ** ** | **$** | **3** | ** ** |
|                                      |            |                                        |            |                                         |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

AtSeptember 30, 2010, there were no recorded unrealized losses for a periodlonger than 12 months on state and political subdivision securities.

 

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Thetable below shows the amortized cost and fair value of investment securities atSeptember 30, 2010 by contractual or legal maturity.  Expected maturities may differ fromcontractual maturities because issuers may have the right to call or prepayobligations.  Mortgage-backed securitiesand equity securities are shown separately since they are not due at a singlematurity date.

 
| ** **                             | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | ** **  | ** ** |
|----------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|
| **(Dollars in Thousands)**   | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **Yield**   | ** ** |
| **Available-for-sale securities**      |       |          |       |       |       |        |       |
| U.S. Government agencies               |       |          | ** ** | ** ** |       |        |       |
| Within one year                        |       | $             | 10,053     | ** ** | **$**      | **10,041**  |       | 0.4 | % |
| After one but within five years        |       | 86,171        | ** ** | **86,416** |       | 1.3         | %          |
| After five but within ten years        |       | 19,188        | ** ** | **19,234** |       | 1.7         | %          |
| Residential mortgage backed securities |       |          | ** ** | ** ** |       |        |       |
| Within one year                        |       | 5,083         | ** ** | **5,105**  |       | 0.8         | %          |
| After one but within five years        |       | 34,526        | ** ** | **34,808** |       | 2.5         | %          |
| States and political subdivisions      |       |          | ** ** | ** ** |       |        |       |
| After one but within five years        |       | 6,621         | ** ** | **6,937**  |       | 3.0         | %          |
| After five but within ten years        |       | 5,130         | ** ** | **5,409**  |       | 3.9         | %          |
| After ten years                        |       | 41,282        | ** ** | **43,836** |       | 4.1         | %          |
| Other securities                       |       |          |       |       |       |        |       |
| Within one year                        |       | 1,389         | ** ** | **1,410**  |       | 4.7         | %          |
| After one but within five years        |       | 13,818        | ** ** | **14,562** |       | 3.8         | %          |
| After five but within ten years        |       | 1,507         | ** ** | **1,552**  |       | 2.8         | %          |
| After ten years                        |       | 3,897         | ** ** | **3,897**  |       | 1.0         | %          |
|                                   |       | $             | 228,665    | ** ** | **$**      | **233,207** |       |   |   |
| **Held-to-maturity securities**        |       |          |       |       |       |        |       |
| States and political subdivisions      | ** ** | ** **    |       |       |       |        |       |
| Within one year                        | ** ** | **2,497**     |       | $          | 2,551      |        | 4.6        | % |
| After one but within five years        | ** ** | **10,283**    |       | 10,651     |       | 4.5         | %          |
| After five but within ten years        | ** ** | **9,802**     |       | 10,452     |       | 4.0         | %          |
| After ten years                        | ** ** | **18,007**    |       | 19,356     |       | 4.2         | %          |
|                                   | ** ** | **$**         | **40,589** |       | $          | 43,010      |       |   |   |

 

**NOTE 6 —LOANS**

 

Loanswere as follows:

 
| **(Dollars in thousands)**   | ** ** | **September 30,  2010** | ** **  | **Percentage of  Total** | ** ** | **December 31,  2009** | ** ** | **Percentage of  Total** | ** ** |
|----------------------------------------|------------|------------------------------|-------------|-------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
|                                   |       |                         |        |                          |       |                        |       |                          |       |
| Commercial, financial and agricultural | ** ** | **$**                        | **74,250**  | ** **                    | **12.9**   | **%**                       | $          | 66,638                        |       | 11.6 | % |
| Tax exempt municipal loans             | ** ** | **31,183**                   | ** **  | **5.4**                       | **%**      | 34,138                      |       | 5.9                           | %          |
| Real estate                            | ** ** | ** **                   | ** **  | ** **                    |       |                        |       | —                        |       |
| Construction                           | ** ** | **34,597**                   | ** **  | **6.0**                       | **%**      | 38,877                      |       | 6.7                           | %          |
| Commercial mortgages                   | ** ** | **162,565**                  | ** **  | **28.1**                      | **%**      | 149,332                     |       | 25.9                          | %          |
| Residential mortgages                  | ** ** | **225,657**                  | ** **  | **39.2**                      | **%**      | 238,349                     |       | 41.3                          | %          |
| Other                                  | ** ** | **32,264**                   | ** **  | **5.6**                       | **%**      | 32,464                      |       | 5.6                           | %          |
| Retail loans                           | ** ** | **15,861**                   | ** **  | **2.8**                       | **%**      | 17,124                      |       | 3.0                           | %          |
| Lease financing receivables            | ** ** | **116**                      | ** **  | **—**                    |       | 274                         |       | —                        |       |
| Net unamortized loan origination fees  | ** ** | **(601**                     | **)**       | ** **                    |       | (541                        | )          |                          |       |
| Total loans                            | ** ** | **$**                        | **575,892** | ** **                    | **100.0**  | **%**                       | $          | 576,655                       |       | 100.0 | % |

 

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**NOTE 7 —RECENT ACCOUNTING PRONOUNCEMENTS**

 

In January 2010, theFASB issued Accounting Standards Update (“ASU”) No. 2010-06, *Fair Value Measurements and Disclosures (Topic 820):  Improving Disclosures about Fair ValueMeasurements (“ASU 820”).*  ASU820 requires fair value disclosures to be disaggregated below line items in thestatement of financial position.  Itclarifies that fair value disclosures should include a description of theinputs and valuation techniques used for both recurring and nonrecurring Level2 and Level 3 estimates.  It alsorequires entities to disclose any significant transfers between Levels 1, 2,and 3 during a reporting period and the reasons the transfers were made.  These disclosures have been included in thisquarterly report on Form 10-Q, as appropriate.

 

On January 1, 2010, ASUNo. 2009-16, *Transfers and Servicing (Topic 860):  Accounting for Transfers of Financial Assets*(“ASU 860”) became effective.  ASU 860removed the concept of a qualifying special-purpose entity from generallyaccepted accounting principles and changed the requirements for derecognizingfinancial assets.  Upon adoption of theASU, the Bank had no change in its balance sheet or required capital becauseoff-balance sheet financing is not used.

 

OnJuly 21, 2010, ASU No. 2010-20,*Receivables - Disclosures about the Credit Quality of Financing Receivables andthe Allowance for Credit Losses,*became effective*. *ASU 2010-20requires entities to provide disclosures designed to facilitate financialstatement users’ evaluation of (i) the nature of credit risk inherent inthe entity’s portfolio of financing receivables, (ii) how that risk isanalyzed and assessed in arriving at the allowance for credit losses and (iii) thechanges and reasons for those changes in the allowance for credit losses.Disclosures must be disaggregated by portfolio segment, the level at which anentity develops and documents a systematic method for determining its allowancefor credit losses, and class of financing receivable, which is generally adisaggregation of portfolio segment. The required disclosures include, amongother things, a rollforward of the allowance for credit losses as well asinformation about modified, impaired, non-accrual and past due loans and creditquality indicators. ASU 2010-20 will be effective for the Corporation’sfinancial statements as of December 31, 2010, as it relates to disclosuresrequired as of the end of a reporting period. Disclosures that relate toactivity during a reporting period will be required for the Corporation’sfinancial statements that include periods beginning on or after January 1,2011.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

Certain statements contained in this report may notbe based on historical facts and are “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Theseforward-looking statements may be identified by, among other things, the use offorward-looking terminology such as “could,” “would,” “expects,” “believes,” “may”or “will,” or future or conditional verb tenses, and variations or negatives ofsuch terms.  These forward-lookingstatements include, without limitation, those relating to the Corporation’svaluation methodologies, fair value of bonds, impairment of securities,repayment of loans, loan portfolio concentrations, fair value of impairedloans, satisfaction of capital adequacy requirements, payments on advances fromthe Federal Home Loan Bank of Cincinnati (the “FHLB”), adequacy of traditionalsources of cash generated from operating activities to meet liquidity needs andthe realization of deferred income tax assets. We caution you not to place undue reliance on such forward-lookingstatements in this report because results could differ materially from thoseanticipated due to a variety of factors. These factors include, but are not limited to, conditions in thefinancial market, liquidity needs, the sufficiency of our allowance for loanand lease losses (“ALLL”), economic conditions in the communities in the Stateof Tennessee where the Corporation does business, the impact of governmentregulation and supervision, interest rate risk, including changes in monetarypolicy and fluctuating interest rates, the Corporation’s ability to attract andretain key personnel, competition from other financial services, 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 (the “SEC”). We undertake no obligation toupdate these forward-looking statements to reflect events or circumstances thatoccur after the date of this report.

 

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**EXECUTIVE OVERVIEW**

 

AtSeptember 30, 2010, the consolidated total assets of First Farmers andMerchants Corporation (the “Corporation”) were $963.1 million, its consolidatednet loans were $566.9 million, its total deposits were $806.1 million and itstotal shareholders’ equity was $111.3 million. The Corporation’s loan portfolio at September 30, 2010 reflected adecrease of $798,000, or 0.1%, compared to December 31, 2009.  Total deposits increased $33.7 million, or4.4%, and shareholders’ equity increased by 3.9% during the first nine monthsof 2010.  Total shareholders’ equityincludes an unrealized gain on available-for-sale securities of $2.8 million.

 

**FINANCIALCONDITION**

 

Averageearning assets for the quarter ended September 30, 2010 were up 1.6%, or$13.2 million, from average earning assets for the quarter ended December 31,2009.  Average overnight investments forthe quarter ended September 30, 2010 were up 13.6% compared to December 31,2009.  Average investment securities forthe quarter ended September 30, 2010 were up 9.9% compared to December 31,2009.  Average total assets of $951.3million for the quarter ended September 30, 2010 increased 3.1% or $28.7million, compared to $922.6 million for the quarter ended December 31,2009.  The increases in average assetswere primarily the result of an increase in investment securities.

 

**Securities**

 

Available-for-salesecurities are an integral part of the asset/liability management process forFirst Farmers and Merchants Bank (the “Bank”), the Corporation’s sole directsubsidiary.  Accordingly, they representan important source of liquidity available to fund loans and accommodate assetreallocation strategies dictated by changes in the Bank’s operating and taxplans, shifting yield spread relationships and changes in configuration of theyield curve.  At September 30, 2010,the Bank’s investment securities portfolio had $233.2 millionavailable-for-sale securities, which are valued at fair market value, and $40.6million held-to-maturity securities, which are valued at cost on the balancesheet. These compare to $208.2 million of available-for-sale securities and$47.6 million of held-to-maturity securities as of December 31, 2009.

 

**Loansand Loan Losses**

 

Theloan portfolio is the largest component of earning assets for the Bank and,consequently, provides the largest amount of revenue for the Corporation.  The loan portfolio also contains the highestexposure to risk as a result of the possibility of unexpected deterioration inthe credit quality of borrowers.  Whenanalyzing potential loans, management of the Bank assesses both interest rateobjectives and credit quality objectives in determining whether to make a givenloan and the appropriate pricing for that loan. All loans are expected to be repaid from cash flow or proceeds from thesale of selected assets of the borrowers. Collateral requirements for the loan portfolio are based on creditevaluation of the borrowers.

 

Realestate loans represented 79.0% of total loans at September 30, 2010compared to 78.6% at September 30, 2009 and 79.5% at December 31,2009.  Over half of the Bank’s exposureis in owner-occupied real estate, rather than commercial real estate, which isdependent on the lease, sale, or refinance of the underlying collateral.  Management of the Bank believes the risk ofthe concentration in real estate loans is acceptable given the quality ofunderwriting and the low level of historical loss experience.

 

Althoughthe Bank continues to experience growth in the non-farm, non-residential realestate portfolio, growth in the overall loan portfolio has been sluggish in2010.  The Bank’s overall loan portfoliodecreased slightly during the third quarter, making this the fourth consecutivequarterly decline in loans outstanding. The Bank continues to carry a concentration in 1-4 family residentialfirst mortgage lending, but this portfolio declined in the first nine months of2010.  Construction and development loansrepresented 6.0% of total loans as of September 30, 2010, compared to 5.0%at September 30, 2009 and 6.7% at December 31, 2009.  The Bank’s construction and developmentportfolio decreased by $4.4 million in the first nine months of 2010, asexisting construction projects have been completed and few new projects havecome in to replace them.  The Bankcontinues to reserve more heavily against its construction and developmentportfolio than any other segment of the commercial portfolio, given thecomparatively high level of losses that have been 

 

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incurred within this segmentof the portfolio over the previous year. Additionally, higher reserves are being placed against property typeswhich are perceived to be higher risk, such as retail and multi-family realestate.

 

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 in more detail quarterly in conjunctionwith loan review reports and evaluations that are discussed in meetings withloan officers, credit administration and the Bank’s Board of Directors.  No reserve is placed against loans that arerisk rated “1”, as these loans are all cash-secured.  A separate methodology is used for thecriticized and classified portfolios (risk ratings 6-8), and the Bank’shistorical loss methodology is utilized for the pass-grade ratings (riskratings 2-5) of the commercial portfolio. Several smaller segments of the commercial portfolio saw an increase inloss rates in the third quarter. Property types that are deemed to be higher-risk forms of collateral andpresent the highest likelihood of credit losses now carry correspondinglyhigher reserves.  The allowance forpossible loan and lease losses was $9.0 million, or 1.6% of gross loans andleases, at September 30, 2010, compared to $8.9 million, or 1.5%, at December 31,2009.  Net charge-offs through September 30,2010 were $1.5 million, resulting in an annualized net charge-off ratio of0.3%.

 

Aformal process is in place to enhance control over the underwriting of loansand to monitor loan collectability.  Thisprocess includes education and training of personnel about the Bank’s loanpolicies and procedures, assignment of credit analysts to support lenders,timely identification of loans with adverse characteristics, control ofcorrective actions and objective monitoring of loan reviews.  The Special Assets Department of the Bankidentifies and monitors assets that need special attention.  At September 30, 2010, this processidentified loans totaling $15.4 million, or 2.7% of the portfolio, that wereclassified as other assets especially mentioned, compared to loans totaling$8.7 million, or 1.5% of the portfolio, so classified at December 31,2009.  Loans totaling $26.7 million, or4.6% of the portfolio, were classified as substandard at September 30,2010, compared to loans totaling $25.5 million, or 4.4% of the portfolio, soclassified at December 31, 2009. Loans totaling $4.5million, or 0.8% of the portfolio, were classified asdoubtful at September 30, 2010, compared to no loans at December 31,2009.

 

Thefollowing table presents the Bank’s allocation of the Allowance for Loan andLease Losses:

 
| ** **                              | ** ** | **September 30, 2010** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| **(Dollars in thousands)**    | ** ** | **Amount**                       | ** ** | **Percent of loans in  each category to total  loans** | ** ** |
| Balance at End of Period Applicable to: |       |                             |       |   |   |
| Commercial, financial and agricultural  |       | $                                | 7,308      |   | 82 | % |
| Real estate - construction              |       | 168                              |       | 2 | % |
| Real estate -mortgage                   |       | 1,199                            |       | 13 | % |
| Installment loans to individuals        |       | 217                              |       | 2 | % |
|                                    |       |                             |       |   |   |
| Unallocated                             |       | 72                               |       | 1 | % |
| Total loans                             |       | $                                | 8,964      |   | 100 | % |

 

Loansare considered impaired when, based on current information and events, the Bankwill be unable to collect all amounts due (principal and interest) according tothe contractual terms of the loan agreements. If a loan is impaired, a specific valuation allowance is allocated, ifnecessary, so that the loan is reported net, at the present value of estimatedfuture cash flows using the loan’s existing rate or at the fair value ofcollateral if repayment is expected solely from the collateral.  Interest payments on impaired loans aretypically applied to principal unless collectability of the principal amount isreasonably assured, in which case interest is recognized on a cash basis.  Impaired loans, or potions thereof, arecharged off when deemed uncollectible.

 

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Impairedloans were as follows:

 
| **(Dollars in thousands)**                   | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** | **September 30,  2009** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Balance of impaired loans with no allocated  allowance | ** ** | **$**                        | **10,409** |                        | $          | 5,458                        |       | $ | 8,084 |   |
| Balance of impaired loans with an allocated  allowance | ** ** | **14,080**                   |       | 16,537                      |       | 18996                        |       |
| Total recorded investment in impaired loans            | ** ** | **$**                        | **24,489** |                        | $          | 21,995                       |       | $ | 27,080 |   |
|                                                   | ** ** | ** **                   |       |                        |       |                         |       |
| Amount of the allowance allocated to impaired  loans   | ** ** | **$**                        | **2,769**  |                        | $          | 2,869                        |       | $ | 1,835 |   |

 

OnSeptember 30, 2010, the Bank had loans classified as troubled debtrestructurings of $13.3 million.  For restructured loans in the portfolio,the Bank had loss reserves of $1.4 million or 16.0% as of September 30,2010.

 

Thefollowing table presents the Bank’s non-accrual and foreclosed assets as of September 30,2010 and December 31, 2009:

 
| ** **                                       | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Non-accrual loans:                               |       |                             |       |                            |       |
| Commercial and industrial                        |       | $                                | 718        |                            | $          | 363 |   |
| Real estate                                      |       | 6,119                            |       | 7,278                           |       |
| Consumer and other                               |       | 95                               |       | 1,417                           |       |
| Total non-accrual loans                          |       | 6,932                            |       | 9,058                           |       |
| Foreclosed assets:                               |       |                             |       |                            |       |
| Real estate                                      |       | 8,878                            |       | 9,914                           |       |
| Total non-performing assets                      |       | $                                | 15,810     |                            | $          | 18,972 |   |
|                                             |       |                             |       |                            |       |
| Non-performing assets as a percentage of:        |       |                             |       |                            |       |
| Total loans and foreclosed assets                |       | 2.70                             | %          | 3.30                            | %          |
| Total assets                                     |       | 1.64                             | %          | 2.03                            | %          |
|                                             |       |                             |       |                            |       |
| Accruing past due loans:                         |       |                             |       |                            |       |
| 30 to 89 days past due                           |       | $                                | 3,709      |                            | $          | 3,622 |   |
| 90 or more days past due                         |       | —                           |       | 149                             |       |
| Total accruing past due loans                    |       | $                                | 3,709      |                            | $          | 3,771 |   |
|                                             |       |                             |       |                            |       |
| Ratio of accruing past due loans to total loans: |       |                             |       |                            |       |
| 30 to 89 days past due                           |       | 0.64                             | %          | 0.66                            | %          |
| 90 or more days past due                         |       | 0.00                             | %          | 0.00                            | %          |
| Total accruing past due loans                    |       | 0.64                             | %          | 0.66                            | %          |

 

**Deposits**

 

The Bank does not have any foreign offices and all deposits areserviced in its 17 domestic offices.  TheBank’s average deposits increased 4.4% during the first nine months of 2010compared to an increase of 7.8% in the first nine months of 2009.  Average total noninterest-bearing depositswere 15.3% of total deposits at September 30, 2010, contributing to theBank’s low cost of deposits, compared to 15.6% at December 31, 2009.

 

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**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 financial condition of the Corporationand the Bank.  Federal regulationsrequire the Corporation and the Bank to meet specific capital adequacyguidelines that involve quantitative measures of assets, liabilities andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The capital classification isalso subject to qualitative judgments by the regulators about components, riskweightings and other factors.

 

Under federal regulatory standards, to be “well-capitalized,” the Bank’sTier 1 Risk-Based Capital Ratio (ratio of Tier 1 Capital to risk-weightedassets) must be at least 6%, its Total Risk-Based Capital Ratio (ratio of totalcapital to risk-weighted assets) must be at least 10%, and its Tier 1 LeverageCapital Ratio (ratio of Tier 1 Capital to average assets) must be at least 5%.  Equity capital (net of certain adjustmentsfor intangible assets and investments in non-consolidated subsidiaries andcertain classes of preferred stock) and other certain equity like instrumentsare considered Tier 1 Capital.  Tier 2Capital consists of core capital plus supplementary or temporary capital suchas subordinated debt, some types of preferred stock, and a defined percentageof the allowance for possible loan and lease****losses.

 

As of September 30, 2010, the Bank’s Tier 1 Risk-Based CapitalRatio, Total Risk-Based Capital Ratio and Tier 1 Leverage Capital Ratios were14.7%, 15.9%, and 10.3%, respectively, compared to 14.6%, 15.8%, and 10.2% at December 31,2009. At September 30, 2010, the Corporation’s Tier 1 Risk-Based CapitalRatio, Total Risk-Based Capital Ratio and Tier 1 Leverage Capital Ratios were15.0%, 16.3% and 10.5%, respectively. The ratios were 14.9%, 16.2% and 10.5%, respectively, at December 31,2009.  Management believes, as of September 30,2010, that the Corporation and the Bank each met all capital adequacy requirementsto which they are subject.

 

**LIQUIDITY AND CAPITAL****RESOURCES**

 

Most of the capital needs of the Bank historically have been financedwith retained earnings and deposits received, and the Corporation’s primarysource of liquidity has been dividends declared by the Bank.  In March 2008, the Bank obtained fiveadvances at $7 million each from the FHLB. The first two scheduled repayment of the advances were made in March 2009and March 2010 and an additional payment of $3.1 million was made in September 2010.  The remaining payments will continue each March through2013.  In September 2008, the Bankobtained two additional advances of $3.1 million each for a total borrowing in2008 of $41.2 million.  The borrowingsfrom the FHLB have been used generally for investment strategies to enhance theBank’s portfolio.  Please refer to Note 4in the notes to consolidated financial statements for additional informationabout borrowings from the FHLB and the repayment schedule of such borrowings.

 

The Bank is subject to Tennessee statutes and regulations that imposerestrictions on the amount of dividends that may be declared.  Furthermore, any dividend payments aresubject to the continuing ability of the Bank to maintain its compliance withminimum federal regulatory capital requirements and to retain itscharacterization under federal regulations as a “well-capitalized”institution.  Management believes thatthe Corporation’s traditional sources of cash generated from the Bank’soperating activities are adequate to meet the Corporation’s liquidity needs fornormal ongoing operations; however, the Bank also has access to additionalcapital, if necessary, through additional advances from the FHLB or the CashManagement Advance Line of Credit Agreement with the FHLB.  The Bank’s Board of Directors has adopted aliquidity policy that outlines specific liquidity target balances.  Compliance with this policy is reviewedquarterly by the Bank’s Asset/Liability Committee and results are reported tothe Bank’s Board of Directors.

 

TheBank’s formal asset and liability management process is used to manage interestrate risk and assist management in maintaining reasonable stability in thegross 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.

 

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**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 withrespect to the determination of the ALLL and the recognition of deferred incometax assets, have been critical to the determination of the Corporation’sfinancial position, results of operations and cash flows.

 

*Allowance for Loan and Lease Losses*

 

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 consists of pools of homogenous loans (generally retailand mortgage 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 has implemented procedures thatgive more detailed historical data by category of retail and consumer creditand performance characteristics to broaden the analysis and improve monitoringof potential credit risk.

 

Criteria considered and processes utilized in evaluating the adequacyof the ALLL are:

 

·             Portfolio quality trends;

·             Changes in the nature and volume of the portfolio;

·             Present and prospective economic and businessconditions, locally and nationally;

·             Management review systems and 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 any concentrations ofcredit.

 

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.

 

*Deferred Income Tax Assets*

 

Asof September 30, 2010, the deferred income tax asset was $5.0 million andwas included with other assets on the balance sheet.  Deferred income tax assets consist mainly ofthe tax effect 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.

 

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**RESULTS OF OPERATIONS**

 

Totalinterest income for the first nine months of 2010 was $29.8 million compared to$30.5 million for the first nine months of 2009 and $9.6 million for the threemonths ended September 30, 2010 compared to $10.2 million for the threemonths ended September 30, 2009. Interest and fees earned on loans and investments are the components oftotal interest income.  Interest and feesearned on loans were $23.8 million, an increase of approximately $23,000, orless than 1%, during the first nine months of 2010 compared to the first ninemonths of 2009, and $7.9 million for the three months ended September 30,2010, a decrease of approximately $132,000, or 1.7% compared to the threemonths ended September 30, 2009. Nominal interest earned on investment securities and other investmentswas $5.9 million, a decrease of approximately $772,000, or 11.6%, during thefirst nine months of 2010 compared to the first nine months of 2009 and $1.7million for the three months ended September 30, 2010, a decrease****of approximately $534,000, or 24.4%, compared to the threemonths ended September 30, 2009. The decrease in nominal interest earned on investment securities andother investments was primarily the result of market conditions.

 

Total interest expense in the first nine months of 2010 was $5.4million, a decrease of $1.7 million, or 23.3%, compared to the first ninemonths of 2009 and $1.7 million for the three months ended September 30,2010, a****decrease of approximately $433,000, or20.1%, compared to the three months ended September 30, 2009.  The lower interest rates for certificates ofdeposits and public funds during the third quarter of 2010 were the primaryreason for the lower expense.  As apolicy, budgeted financial goals are monitored on a quarterly basis by the Bank’sAsset/Liability Committee, which reviews the actual dollar change in netinterest income for different interest rate movements.  A negative dollar change in net interestincome for a 12-month and 24-month period of less than 10.0% of net interestincome given a 100 to 200 basis point shift in interest rates is considered anacceptable rate risk position.  The raterisk analysis for the 24-month period beginning October 1, 2010 and endingSeptember 30, 2012 showed a worst-case potential change to net interestincome, in the very unlikely event of a negative 100 basis point shift ininterest rates, of 3.9%, or a decrease in net interest income of $1.3 millionby the end 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 September 30,2010, September 30, 2009 and December, 31, 2009 was 4.10%, 4.06% and4.10%, respectively.

 

No additions were made to the provision for possible loan and leaselosses in the third quarter of 2010.

 

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The following table presents the Bank’s analysis of the Allowance forLoan and Lease Loss activity:

 
| ** **                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                      | ** ** | **September   30, 2010**    | ** ** | **June 30,  2010**         | ** ** | **September  30, 2009** | ** ** | **September  30, 2010** | ** ** | **September  30, 2009** | ** ** |
|                                                            |       |                             |       |                            |       |   |   |   |   |   |   |
| Balance at beginning of period                                  |       | $                                | 9,337      |                            | $          | 8,929 |   | $ | 8,210 |   | $ | 8,929 |   | $ | 8,625 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |   |   |
| Provision (reduction) charged (credited) to  operating expenses |       | —                           |       | 1,491                           |       | 405 |   | 1,491 |   | 1,830 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |   |   |
| Charge-offs:                                                    |       |                             |       |                            |       |   |   |   |   |   |   |
| Commercial and industrial                                       |       | (106                             | )          | (439                            | )          | — |   | (545 | ) | (47 | ) |
| Real estate                                                     |       | (487                             | )          | (1,110                          | )          | (54 | ) | (1,597 | ) | (2,049 | ) |
| Consumer and other                                              |       | (36                              | )          | (33                             | )          | (27 | ) | (69 | ) | (56 | ) |
| Total charge-offs                                               |       | (629                             | )          | (1,582                          | )          | (81 | ) | (2,211 | ) | (2,152 | ) |
|                                                            |       |                             |       |                            |       |   |   |   |   |   |   |
| Recoveries:                                                     |       |                             |       |                            |       |   |   |   |   |   |   |
| Commercial and industrial                                       |       | 7                                |       | 30                              |       | 4 |   | 37 |   | 15 |   |
| Real estate                                                     |       | 241                              |       | 450                             |       | 4 |   | 691 |   | 198 |   |
| Consumer and other                                              |       | 8                                |       | 19                              |       | 6 |   | 27 |   | 32 |   |
| Total recoveries                                                |       | 256                              |       | 499                             |       | 14 |   | 755 |   | 245 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |   |   |
| Balance at end of year                                          |       | $                                | 8,964      |                            | $          | 9,337 |   | $ | 8,548 |   | $ | 8,964 |   | $ | 8,548 |   |

 

Noninterest income was $7.4 million, a decrease of $2.9 million, or27.9%, during the first nine months of 2010 compared to the first nine monthsof 2009, and a decrease of approximately $366,000, or 13.8%, during the threemonths ended September 30, 2010 compared to the three months ended September 30,2009.  The loss on sales of other realestate owned, which was $2.1 million in the first nine months of 2010 comparedto approximately $11,000 in the first nine months of 2009, was the primaryreason for the decrease.  The gains onsales of available-for-sale securities, which represented $1.6 million inincome during the first nine months in 2010 compared to $2.5 million in thefirst nine months of 2009, was another reason for the decline in noninterestincome over the nine-month period.

 

Noninterest expense, excluding the provision for possible loan andlease losses was $24.7 million, a decrease of approximately $75,000, or 0.3%,in the first nine months of 2010 as compared to the first nine months of 2009and a decrease of approximately $717,000, or 8.4%, during the three monthsended September 30, 2010 compared to the three months ended September 30,2009.  One of the reasons for the lowernoninterest expense in the first nine months of 2010 was that employee benefitswere less than the previous nine months in 2009.

 

The Bank also leases a certain number of its properties.  There was no change during the three-monthperiod ended September 30, 2010 in the terms of these leases.

 

Netincome for the nine months ended September 30, 2010 and the three monthsended September 30, 2010 was $5.0 million and $1.8 million, respectively,compared to $6.1 million and $1.7 million for the nine months ended September 30,2009 and the three months ended September 30, 2009, respectively.  Losses on other real estate contributed tothe nine month decrease.  The Corporationearned $0.90 per share for the nine months ended in 2010, and $1.1 per sharefor the nine months ended in 2009.

 

**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 

 

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letters of credit.  These instruments involve, to varyingdegrees, elements of credit risk in excess of the amount recognized in thebalance sheet.  The contract or notionalamounts of those instruments reflect the extent of involvement the Bank has inthose financial instruments.  Loancommitments are agreements to lend to a customer as long as there is not aviolation of any condition established in the loan commitment contract.  Stand-by letters of credit are conditionalcommitments issued by the Bank to guarantee the performance of a customer to athird party.  Those guarantees areprimarily issued to support public and private borrowing arrangements,including commercial paper, bond financing and similar transactions.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in making a loan.

 

Thetotal outstanding balance of loan commitments and stand-by letters of credit inthe normal course of business at September 30, 2010 were $94.0 million and$8.9 million, respectively, compared to $110.3 million and $8.9 million,respectively, at September 30, 2009.

 

AtSeptember 30, 2010, the Corporation and the Bank did not have anyoff-balance sheet arrangements other than commitments to extend credit andstand-by letters of credit.

 

**Item3.  Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

Duringthe nine months ended September 30, 2010, there were no material changesin the quantitative and qualitative disclosures about market risk presented inthe Corporation’s Annual Report on Form 10-K for the year ended December 31,2009.

 

**Item4.  Controls and Procedures.**

 

(a) Evaluation ofDisclosure 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 Exchange Act) as of the end of the period covered by thisreport.  Based upon that evaluation andas of the end of the period covered by this report, the Corporation’s ChiefExecutive Officer and Assistant Treasurer (principal financial officer)concluded that the Corporation’s disclosure controls and procedures wereeffective in ensuring that information required to be disclosed in its reportsthat the Corporation files or submits to the SEC under the Exchange Act isrecorded, processed, summarized and reported on a timely basis.

 

(b) Changes inInternal Control Over Financial Reporting. There has been no change in the Corporation’s internal control overfinancial reporting that occurred during the third quarter of 2010 that hasmaterially affected, or is reasonably likely to materially affect, theCorporation’s internal control over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item1A. Risk Factors.**

 

Therehave been no material changes in the risk factors previously disclosed in theCorporation’s Annual Report on Form 10-K for the year ended December 31,2009.

 

**Item6.  Exhibits.**

 
| **EXHIBIT  NUMBER**    | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                   |
|------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                   |       |                                                                                                                                                                                                                                                                              |
|     3.1 |       | Charter.  (1)                                                                                                                                                                                                                                                                     |
|                   |       |                                                                                                                                                                                                                                                                              |
|     3.2 |       | Articles  of Amendment to Charter. (1)                                                                                                                                                                                                                                            |
|                   |       |                                                                                                                                                                                                                                                                              |
|     3.3 |       | Second  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, as filed with the Securities andExchange Commission on May 7, 2004 (File Number 000-10972).

 

(2)  Incorporated by reference from the First Farmers andMerchants Corporation Current Report on Form 8-K, as filed with theSecurities and Exchange Commission on December 21, 2009 (File Number000-10972).

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 

FIRST FARMERS AND MERCHANTS CORPORATION

(Registrant)

 

 
| Date   | November 5,  2010 |   |          /s/  T. Randy Stevens                               |
|--------|------------------------|--------|-----------------------------------------------------------------------------------------------------------|
|   |                   |   | T.  Randy Stevens, Chief Executive Officer                                                                |
|   |                   |   |                                                                                                      |
|   |                   |   |                                                                                                      |
| Date   | November 5,  2010 |   |          /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 |       | Second  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, as filed with the Securities andExchange Commission on May 7, 2004 (File Number 000-10972).

 

(2)  Incorporated by reference from the First Farmers andMerchants Corporation Current Report on Form 8-K, as filed with theSecurities and Exchange Commission on December 21, 2009 (File Number000-10972).

 

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