SECURITIES  AND  EXCHANGE  COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

Quarterly Report Pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

For the quarter ended September 30, 2001

Commission file number 0-10972
 

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 office)s
(Zip Code)

 

(931) 388-3145
(Registrant's telephone number, including area code)

 

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

 

 

 

	Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   X     No 
 

	Indicate the number of shares outstanding of each of the issuer's common stock, as of September 30, 2001.    2,920,000  shares
 

This filing contains   12   pages.

PART 1 - FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

 

The following unaudited consolidated financial statements of the registrant and its subsidiary for the nine months ended September 30, 2001, are as follows: 
Consolidated balance sheets - September 30, 2001, and December 31, 2000. 
Consolidated statements of income - For the three months and nine months ended September 30, 2001 and September 30, 2000. 
Consolidated statements of cash flows - For the nine months ended September 30, 2001 and September 30, 2000.
**FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
September 30,
December 31,
(Dollars in Thousands)        (Unaudited)
2001
2000
ASSETS
Cash and due from banks
$
28,288
$
23,029
Interest-bearing deposits in banks
9
5,008
Total cash and cash equivalents
28,297
28,037
Securities
Available for sale (amortized cost $120,317
and $96,448 respectively)
124,962
96,664
Held to maturity (fair value $131,144
and $130,514 respectively)
126,113
129,403
Total securities
251,075
226,067
Loans, net of deferred fees
510,415
377,092
Allowance for possible loan losses
-6,590
-5,322
Net loans
503,825
371,770
Bank premises and equipment, at cost
less allowance for depreciation
10,628
8,077
Other assets
32,551
18,115
TOTAL ASSETS
$
826,376
$
652,066
LIABILITIES
Deposits
Noninterest-bearing
$
102,830
$
81,435
Interest-bearing (including certificates of deposit
over $100,000:  2001 - $105,491; 2000 - $55,976)
604,467
475,376
Total deposits
707,297
556,811
Federal funds purchased and securities sold
under agreements to repurchase
20,315
7,551
Dividends payable
-
1,139
Other short term liabilities
715
735
Accounts payable and accrued liabilities
8,590
6,021
TOTAL LIABILITIES
736,917
572,257
STOCKHOLDERS'
Common stock - $10 par value, 8,000,000 shares
EQUITY
authorized;  issued and outstanding -
2,920,000
29,200
29,200
Additional paid-in capital
4,320
4,320
Retained earnings
53,060
46,156
Accumulated other comprehensive income
2,879
133
TOTAL STOCKHOLDERS' EQUITY
89,459
79,809
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY
$
826,376
$
652,066
 
**FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY

 CONSOLIDATED STATEMENTS OF INCOME*(Dollars In Thousands Except Per Share Data)
Three Months Ended 
Nine Months Ended *(Unaudited)
September 30,
September 30,**2001
2000**2001
2000**INTEREST INCOME
Interest and fees on loans**$**10,570
$
8,015**$**28,961
$
23,050
Income on investment securities
Taxable interest**2,781
2,506**7,784
7,701
Exempt from federal income tax**796
764**2,473
2,259
Dividends**55
63**255
223**3,632
3,333**10,512
10,183
Other interest income**63
153**314
410
TOTAL INTEREST INCOME**14,265
11,501**39,787
33,643**INTEREST EXPENSE 
Interest on deposits**6,423
5,518**18,461
15,705
Interest on other short term borrowings**39
29**127
87
TOTAL INTEREST EXPENSE**6,462
5,547**18,588
15,792
NET INTEREST INCOME**7,803
5,954**21,199
17,851
PROVISION FOR POSSIBLE LOAN LOSSES**300
225**855
675
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES**7,503
5,729**20,344
17,176**NONINTEREST  INCOME
Trust department income**517
439**1,409
1,371
Service fees on deposit accounts**1,734
1,513**5,103
3,852
Other service fees, commissions, and fees**195
103**403
328
Other operating income**133
163**627
439
TOTAL NONINTEREST  INCOME**2,579
2,218**7,542
5,990**NONINTEREST  EXPENSES
Salaries and employee benefits**3,038
2,458**8,422
7,348
Net occupancy expense**441
376**1,317
1,109
Furniture and equipment expense**214
297**650
901
Other operating expenses**2,402
1,698**6,421
4,964
TOTAL NONINTEREST EXPENSES**6,095
4,829**16,810
14,322
INCOME BEFORE PROVISION FOR
INCOME TAXES**3,987
3,118**11,076
8,844
PROVISION FOR INCOME TAXES**999
946**2,916
2,559
NET INCOME
$**2,988
$
2,172
$**8,160
$
6,285
EARNINGS PER SHARE
Common stock
2,920,000 shares outstanding **$**1.02
$
0.74**$**2.79
$
2.15
 

 

**FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY**CONSOLIDATED STATEMENTS OF CASH FLOWS*(Dollars In Thousands)       (Unaudited)
Nine Months Ended September 30,**2001**2000**OPERATING
Net income**$**8,160
$
6,285**ACTIVITIES
Adjustments to reconcile net income to net cash provided
by operating activities
Excess (deficiency) of provision for possible
loan losses over net charge offs**171
378
Provision for depreciation and amortization of
premises and equipment**601
836
Provision for depreciation of leased equipment**150
225
Amortization of deposit base intangibles**529
167
Amortization of investment security premiums,
net of accretion of discounts**380
502
Increase in cash surrender value of life insurance contracts**(183)
(177)
Deferred income taxes**(457)
(245)
(Increase) decrease, net of effects from purchase of PUB*, in
Interest receivable**(525)
(749)
Other assets**(1,504)
(149)
Increase (decrease) , net of effects from purchase of PUB*, in
Interest payable**(674)
985
Other liabilities**2,051
1,140
Total Adjustments**539
2,913
Net cash provided by operating activities**8,699
9,198**INVESTING
Proceeds from maturities, calls, and sales of**ACTIVITIES
available-for-sale securities**18,103
18,006
Proceeds from maturities and calls of held-to-maturity securities**13,405
6,582
Purchases of investment securities, net of securities acquired from PUB*
Available-for-sale**(23,373)
(7,931)
Held-to-maturity**(10,238)
(10,874)
Increase in loans, net of loans acquired from PUB***(20,857)
(25,809)
Purchases of premises and equipment, net of PUB***(1,495)
(800)
Net increase in cash from purchase of PUB***3,457
-
Purchase of single premium life insurance contracts**(425)
(600)
Net cash used by investing activities**(21,423)
(21,426)**FINANCING
Net increase in noninterest-bearing and interest-bearing deposits, net of liabilities assumed from PUB***2,635
21,243**ACTIVITIES
Net increase (decrease) in short term borrowings**12,743
675
Cash dividends**(2,394)
(2,132)
Net cash provided by financing activities**12,984
19,786
Increase (decrease) in cash and cash equivalents**260
7,558
Cash and cash equivalents at beginning of period**28,037
25,704
Cash and cash equivalents at end of period**$**28,297
$
33,262
*Peoples and Union Bank, Lewisburg, Tennessee

 

 

	The unaudited consolidated financial statements have been prepared on a consistent basis and in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments considered necessary for a fair presentation have been included.  These adjustments were of a normal, recurring nature and consistent with generally accepted accounting principles.  For further information, refer to the consolidated financial statements and footnotes included in the Corporation's annual report on Form 10-K for the year ended December 31, 2000.
**Item 2.   Management's Discussion and Analysis of Financial Condition****Material Changes in Financial Condition

	On April 27, 2001, the Bank purchased Peoples and Union Bank, Lewisburg, Tennessee, an affiliate of First Tennessee Bank National Corporation, Memphis, Tennessee.  The transaction was accounted for by the purchase method of accounting.  The affect of the acquisition on the Bank's assets and liabilities are discussed throughout the following paragraphs. 

	Average earning assets increased 17.7% in the first three quarters of 2001 compared to a 6.8% increase in the first three quarters of 2000.  As a financial institution, the Bank's primary earning asset is loans.  At September 30, 2001, average net loans had increased 27.9% and represented 64% of average earning assets.  Actual net loans increased approximately $132 million from year end, $111 million of which were purchased in the acquisition.   Average investments represented 36% of average earning assets at September 30, 2001, an increase of 3.1% in the first three quarters of 2001.  Average total assets were $761 million at the end of the first three quarters of 2001 compared to $638 million at the end of the first three quarters of 2000.  Period-end assets were $826 million compared to $652 million at December 31, 2000.

	The Bank maintains a formal asset and liability management process to control interest rate risk and assist management in maintaining reasonable stability in the gross interest margin as a result of changes in the level of interest rates and/or the spread relationships among interest rates.  The Bank uses an earnings simulation model to evaluate the impact of different interest rate scenarios on the gross margin.  Each month, the Asset/Liability Committee monitors the relationship of rate sensitive earning assets to rate sensitive interest bearing liabilities (interest rate sensitivity) which is the principal factor in determining the effect that fluctuating interest rates will have on future net interest income.  Rate sensitive earning assets and interest bearing liabilities are those which can be repriced to current market rates within a defined time period.  The following sections analyze the average balance sheet and the major components of the period-end balance sheet.

 
**SECURITIES**
	Available-for-sale securities are an integral part of the asset/liability management process.  As such, they represent an important source of liquidity available to fund loans and accommodate asset reallocation strategies dictated by changes in bank operating and tax plans, shifting yield spread relationships, and changes in configuration of the yield curve.  At  September 30, 2001, the Bank's investment securities portfolio had $124.9 million available-for-sale securities and $126.1 million held-to-maturity securities.  Approximately $18.7 million in securities were purchased in the acquisition and were designated available-for-sale.   There were $96.6 million available-for-sale securities and $129.4 million held-to-maturity securities at December 31, 2000.

 

 

 

 
**LOANS**
	The loan portfolio is the largest component of earning assets and consequently provides the highest amount of revenues.  The loan portfolio also contains, as a result of credit quality, the highest exposure to risk.  The lending activities of the Bank aresubject to written underwriting standards and policies established by the Bank's Board of Directors and management which include loan review procedures and approvals. Applications for loans are taken by designated employees at fifteen of the Bank's offices.  Depending primarily on the amount of the loan, there are various approval levels including an Executive Committee of the Board of Directors that meets weekly.  The average loan portfolio increased $97.7 million or 27.9% in the first nine months of 2001 compared to a $26.8 million or 8.4% increase in the first nine months of 2000.  Commercial loans increased 53.5%, personal loans increased 2.6%, and loans secured by real estate posted a 32% growth for the first three quarters of 2001.  Of the $111 million in loans purchased as a result of the acquisition, approximately $90 million were primarily secured by real estate.

    The Bank has a Credit Administrator who is responsible for assisting loan officers in structuring new loans, reviewing problem loans, monitoring their status from period to period, and assisting in their resolution. This review process includes semiannual reviews by an outside party to assess the quality of the loan portfolio independently.  The Credit Administrator's analysis and review also includes a formal review that is prepared quarterly to assess the risk in the loan portfolio.  After this review during the first three quarters of 2001, loans totaling $5.5 million, 1.1% of the portfolio, were recognized as other assets especially mentioned at September 30, 2001, which is an increase from the $4.4 million recognized at June 30, 2001 and $5.4 million at December 31, 2000.  Loans totaling $14.6 million, 2.9% of the portfolio, were classified as substandard at September 30, 2001, which is down compared to $16.1 million so classified at June 30, 2001 and $17.2 at December 31, 2000.  Loans totaling $.7 million, .1% of the portfolio, were classified as doubtful at September 30, 2001, which is about the same as $.7 million so classified at September 30, 2001 and December 31, 2000.  Any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention do not represent or result from trends or uncertainties which management reasonably expects will materially affect operating results, liquidity, or capital resources.  Management is not aware of any known trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the corporation's liquidity, capital resources or operations.  Loans having recorded investments of $3.2 million, .6% of the total portfolio, were identified as impaired at the end of the first three quarters of 2001 compared to $4.8 million at June 30, 2001, and $5.4 million at December 31, 2000. 

		The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in those particular financial instruments.  The total outstanding loan commitments and stand-by letters of credit in the normal course of business at September 30, 2001, were $43 million and $5.1 million respectively.  Loan commitments are agreements to lend to a customer as long as there is not a violation of any condition established in the contract.  Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third  party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions.  The credit risk involved in issuing letters of credit is essentially the same as that involved in making a loan.

	The loan portfolio is well diversified with loans generally secured by tangible personal property, real property, or stock.  Most of the Bank's activities are with customers located within southern middle Tennessee and are secured by real estate.  Management does not believe that there is a concentration of loans to borrowers engaged in similar activities.  The loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrowers.  Collateral requirements for the loan portfolio are based on credit evaluation of the customer.

 
**DEPOSITS**
	TheBank does not have any foreign offices and all deposits are serviced in its twenty domestic offices.  The bank's average deposits grew during the first three quarters of 2001 reflecting a 19.4% growth, compared with a 5.8% growth during the first three quarters of 2000.  Approximately $147.9 million in deposit liabilities were assumed in the acquisition accounting for a significant share of the increase.  This was a contributing factor to the 10.7% growth in average interest-bearing checking accounts, the 24.3% growth in certificates of deposits under $100 thousand, and the 63.8% growth in certificates of deposit over $100 thousand in the first nine months of 2001.    However, approximately 80% of the deposit liabilities assumed in the acquisition were certificates of deposit accounting for the especially large increase in these products.  Savings deposits with limited transactions increased 7.7% during the first nine months of 2001.  Savings deposits have been strong historically providing a core, low cost, source of funding.  Average noninterest bearing deposits, also known as regular demand deposits, represent 14.0% of average total deposits contributing to the maintenance of a competitive cost of funds.

 
**CAPITAL**
	Average shareholders' equity for the first three quarters of 2001 totaled $84.7 million, a 11.4% increase from the average at December 31, 2000.  The Corporation and the Bank are subject to federal regulatory risk-adjusted capital adequacy standards.  Failure to meet capital adequacy requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that could have a direct material effect on the consolidated financial statements of the Corporation and its subsidiary, the Bank.  The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

		Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of Total Capital and Tier I Capital to risk-weighted assets and of average Tier I Capital to average assets.   Equity capital (net of certain adjustments for intangible assets and investments in non-consolidated subsidiaries and certain classes of preferred stock are considered Tier 1 ("core") capital.  Tier 2 ("total") capital consists of core capital plus subordinated debt, some types of preferred stock, and varying amounts of the Allowance for Possible Loan Losses.  As of  September 30, 2001, the Corporation's total risk-based and core capital ratios were 15.2% and 14.0% respectively.  An adjustment to Tier 1 capital for approximately $12.8 million, representing goodwill and core deposits related to the acquisition, reduced the Corporation's core capital ratio by approximately 6%.  The comparable ratios were 21.3% and 20.0% at year end 2000.  As of  September 30, 2001, the Bank's total risk-based and core capital ratios were 15.0% and 13.8% respectively.  The comparable ratios were 21.2% and 19.9% at year end 2000.  As of September 30, 2001, the Corporation and the Bank had a ratio of core capital to average total assets of 8.7% and 8.6% respectively, compared to 12.1% and 11.9% at December 31, 2000.  Management believes, as of September 30, 2001, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject.  The Bank's calculated risk-adjusted capital ratios exceeded the minimum standard for a "well capitalized" bank.  

		Most of the capital needs of the Bank have historically been financed through internal growth.  The approval of the Comptroller of the Currency is required before the Bank's dividends in a given year may exceed the total of its net profit (as defined) for the year combined with retained net profits of the preceding two years.  As of  September 30, 2001, additional dividends of approximately $18.5 million could have been declared by the Bank to the Corporation without regulatory agency approval.

 
**Material Changes in Results of Operations

	Total interest income was 18.3% higher in the first nine months of 2001 than the first nine months of 2000.  Interest and fees earned on loans increased 25.7% due to the increase in the volume of average loans, a significant portion of which was purchased in the acquisition.  Interest earned on investment securities and other investments increased 2.2%. 

	Total interest expense in the first nine months of 2001 compared to the first nine monhts of 2000 increased 17.7%.  The total cost of interest-bearing deposits increased for the first nine months of the year, primarily due to volume, even though interest rates have been gradually falling.  A considerable portion of the purchased deposits were in certificates of deposit greater than $100 thousand.  As a policy, budgeted financial goals are monitored on a monthly basis by the Asset/Liability Committee where the actual dollar change in net interest income given different interest rate movements is reviewed.  A negative dollar change in net interest income for a twelve month period of less than 4.5% of net interest income given a three hundred basis point shift in interest rates is considered an acceptable rate risk position.  The net interest margin, on a tax equivalent basis, at September 30, 2001, September 30, 2000, and December 31, 2000 was 4.21%, 4.21%, and 4.19% respectively. 

	Net interest income on a fully taxable equivalent basis is influenced primarily by changes in:  (1) the volume and mix of earning assets and sources of funding; (2) market rates of interest, and (3) income tax rates.  The impact of some of these factors can be controlled by management policies and actions.  External factors also can have a significant impact on changes in net interest income from one period to another.  Some examples of such factors are: (1) the strength of credit demands by customers; (2) Federal Reserve Board monetary policy, and (3) fiscal and debt management policies of the federal government, including changes in tax laws. 

	The analysis and review of asset quality by the Bank's loan review function and credit administrator also includes a formal review that is prepared quarterly to assess the risk in the loan portfolio and to determine the adequacy of the allowance for loan losses.  This review supported management's assertion that the allowance was adequate at September 30, 2001.  Additions to the allowance during the first three quarters of 2001 were higher than the first three quarters of 2000.  The allowance for possible loan and lease losses was $6.6 million or 1.29% of gross loans at September 30, 2001 which compares to $5.2 million or 1.44% at September 30, 2000.  The loan loss reserve associated with the loans purchased in the acquisition was just over $1 million.  Net charge offs at the end of  the third quarter of 2001 were $684 thousand, an annualized net charge off ratio of .18%.  Earnings coverage of net charge offs was over 11.9% at September 30, 2001.  Net charge offs at the end of the third quarter of 2000 were $277 thousand, an annualized net charge off ratio of .10%.  Earnings coverage of net charge offs was 22.7% at September 30, 2000.  Non-performing loans as a percentage of the allowance for possible loan and lease losses was 56.0% at the end of the third quarter of 2001 compared to 74.6% at the end of the third quarter of 2000.  

	There were no write downs of other real estate associated with declines in real estate values subsequent to foreclosure and disposition of the properties at less than their carrying value during the first three quarters of 2001.  The carrying value of Other Real Estate is included in other assets on the face of the balance sheet and represents real estate acquired through foreclosure and is stated at the lower of cost or fair value minus cost to sell.  An allowance for other real estate owned is not maintained.  Any decreases or losses associated with the properties have been charged to current income.  Management evaluates properties included in this category on a regular basis.  Actual foreclosures were included in the carrying value for Other Real Estate at September 30, 2001, December 31, 2000, and September 30, 2000, and totaled $932 thousand, $474 thousand, and $498 thousand respectively.

	Noninterest income increased 25.9% during the first nine months of 2001 compared to the first nine months of 2000.  Fees from service charges on deposits increased 32.5%.  The Bank introduced a new deposit program which has provided additional fee income.  Income from fiduciary services provided in the Bank's Trust Department represented approximately 18.7% of noninterest income.  Other operating income increased $188 thousand primarily from the gain on the sale of real estate.

	Noninterest expenses, excluding the provision for possible loan losses, were 17.4% more in the first nine months of 2001 than in the first nine months of 2000.  Other operating expenses, including data processing charges, professional and legal fees, and additional salary expenses contributed to this increase.  Also included was amortization of core deposit intangibles and goodwill, most of which was related to the acquistion.

	Net income is 29.8% higher for the first nine months of 2001 compared to the first nine months of 2000.  It was 19.6% higher for the first three months of 2001 compared to the first three months of 2000.  However, the acquisition in the first part of the second quarter contributed to the overall increase.  The increase in interest income was enough to cover the increase in interest cost, the portion of  noninterest expense not covered by the increase in noninterest income, the increase in taxes, and the increase in additions to the allowance for loan and lease losses.

 

SIGNATURES

 

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

 

 

 

FIRST FARMERS AND MERCHANTS CORPORATION

(Registrant)

 

 

 

Date 
November 9, 2001
/s/ Waymon L. Hickman  
Waymon L. Hickman,  
Chairman of the Board  
(Chief Executive Officer)

 

 

 

Date 
November 9, 2001
/s/ Patricia N. McClanahan  
Patricia N. McClanahan,  
Treasurer  
(Principal Accounting Officer)*******************************************************************************************************************************************************************************************************************************