Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark one)**

 
| **x**                                                                                                                                                                                                                                                                              | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                               |                                                                                                    |
| **For the quarterly period ended March 31,  2009**                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                               |
| **or**                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                               |                                                                                                    |
| **o**                                                                                                                                                                                                                                                                              | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                               |                                                                                                    |
| **For the transition period from                         to                  ** |

 

**CommissionFile Numbers: 000-10972**

 

**First Farmers and Merchants Corporation**

(Exact name ofregistrant as specified in its charter)

 

| **Tennessee**                                                   | ** ** | **62-1148660**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |

 

| **816 South Garden Street**               | ** ** | ** **     |
|-------------------------------------------|------------|----------------|
| **Columbia, Tennessee**                   | ** ** | **38402-1148** |
| (Address  of principal executive offices) |       | (Zip  Code)    |

 

**931-388-3145**

(Registrant’stelephone number, including area code)

 

 

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

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   x Yes   o No

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).   o Yes   o No

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act.

 

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

 

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

 

As of May 7,2009, the registrant had outstanding 5,555,000 shares of common stock.

 

 

 

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**PART I - FINANCIAL INFORMATIO**N

 
| **Item 1. Financial Statements.** |                                                                                                                            |
|-----------------------------------|---------------------------------------------------------------------------------------------------------------------------------|
|                              |                                                                                                                            |
|                              | The following unaudited  consolidated financial statements of the Registrant and its subsidiaries are  included in this Report: |   |
|                              |                                                                                                                            |   |
|                              | Consolidated balance  sheets - March 31, 2009 and December 31, 2008.                                                  |   |
|                              |                                                                                                                            |   |
|                              | Consolidated  statements of income - For the three months ended March 31, 2009 and  March 31, 2008.                   |   |
|                              |                                                                                                                            |   |
|                              | Consolidated statements of  cash flows - For the three months  ended March 31, 2009 and March 31, 2008.               |   |
|                              |                                                                                                                            |   |
|                              | Selected  notes to consolidated financial statements.                                                                           |   |

 

 

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**FIRSTFARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                       | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                       | ** ** | **2009**           | ** **  | **2008**              | ** ** |
| **(Dollars in Thousands, Except Per Share Data)**                                                                                                                  | ** ** | **(Unaudited)**    | ** **  | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                       |       |               |        |                  |       |
| Cash and due  from banks                                                                                                                                                                         | ** ** | **$**              | **16,842**  |                  | $          | 22,656 |   |
| Interest-bearing  due from banks                                                                                                                                                                 | ** ** | **26,772**         |        | 4,680                 |       |
| Federal funds  sold                                                                                                                                                                              | ** ** | **8,300**          |        | 4,200                 |       |
| Total cash and  cash equivalents                                                                                                                                                                 | ** ** | **51,914**         |        | 31,536                |       |
| Securities                                                                                                                                                                                       |       |               |        |                  |       |
| Available-for-sale  (amortized cost $169,476 and $171,891, respectively)                                                                                                                         |       | **169,926**        |        | 174,493               |       |
| Held-to-maturity  (fair market value $58,547 and $59,558, respectively)                                                                                                                          |       | **58,113**         |        | 59,427                |       |
| Total Securities                                                                                                                                                                                 | ** ** | **228,039**        |        | 233,920               |       |
| Loans, net of  deferred fees                                                                                                                                                                     | ** ** | **584,418**        |        | 595,519               |       |
| Allowance for  loan losses                                                                                                                                                                       | ** ** | **(9,389**         | )           | (8,625                | )          |
| Net loans                                                                                                                                                                                        | ** ** | **575,029**        |        | 586,894               |       |
| Bank premises  and equipment, at cost less allowance for depreciation                                                                                                                            |       | **19,012**         |        | 17,669                |       |
| Core deposit and  other intangibles                                                                                                                                                              | ** ** | **9,168**          |        | 9,186                 |       |
| Other assets                                                                                                                                                                                     | ** ** | **33,550**         |        | 31,932                |       |
| TOTAL ASSETS                                                                                                                                                                                     | ** ** | **$**              | **916,712** |                  | $          | 911,137 |   |
|                                                                                                                                                                                             |       |               |        |                  |       |
| **LIABILITIES**                                                                                                                                                                                  |       |               |        |                  |       |
| Deposits                                                                                                                                                                                         |       |               |        |                  |       |
| Noninterest-bearing                                                                                                                                                                              | ** ** | **$**              | **136,077** |                  | $          | 118,111 |   |
| Interest-bearing  (including certificates of deposits over $100: 2009 - $92,375; 2008 -  $107,607)                                                                                               |       | **621,997**        |        | 626,740               |       |
| Total deposits                                                                                                                                                                                   | ** ** | **758,074**        |        | 744,851               |       |
| Federal funds  purchased and securities sold under agreements to repurchase                                                                                                                      |       | **3,351**          |        | 2,645                 |       |
| Dividends  payable                                                                                                                                                                               | ** ** | **—**         |        | 2,009                 |       |
| Short-term  borrowings                                                                                                                                                                           | ** ** | **600**            |        | 294                   |       |
| Accounts payable  and accrued liabilities                                                                                                                                                        | ** ** | **13,439**         |        | 12,985                |       |
| FHLB borrowings                                                                                                                                                                                  | ** ** | **34,177**         |        | 41,177                |       |
| TOTAL  LIABILITIES                                                                                                                                                                               | ** ** | **809,641**        |        | 803,961               |       |
|                                                                                                                                                                                             |       |               |        |                  |       |
| **SHAREHOLDERS’  EQUITY**                                                                                                                                                                   |       |               |        |                  |       |
| Common stock -  $10 par value per share, 8,000,000 shares authorized; 5,555,000 and 5,580,000  shares issued and outstanding as of March 31, 2009 and December 31,  2008, respectively |       | **55,550**         |        | 55,800                |       |
| Retained  earnings                                                                                                                                                                               | ** ** | **51,270**         |        | 49,776                |       |
| Accumulated  other comprehensive income                                                                                                                                                          | ** ** | **251**            |        | 1,600                 |       |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                                                                                 | ** ** | **107,071**        |        | 107,176               |       |
| TOTAL LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                                 |       | **$**              | **916,712** |                  | $          | 911,137 |   |

 

----

(1) Derived from auditedfinancial statements.

 

The accompanying notes are anintegral part of consolidated financial statements.

 

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**FIRST FARMERS AND MERCHANTSCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

 
| **(Dollars in Thousands Except Per Share Data)** | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Unaudited)**                                                                | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                                                           |       |                                             |       |   |   |
| **INTEREST  AND DIVIDEND INCOME**                                              |       |                                             |       |   |   |
| Interest and  fees on loans                                                    | ** ** | **$**                                            | **7,867**  |   | $ | 8,336 |   |
| Income on  investment securities                                               |       |                                             |       |   |   |
| Taxable interest                                                               | ** ** | **1,326**                                        |       | 1,525 |   |
| Exempt from  federal income tax                                                | ** ** | **974**                                          |       | 1,019 |   |
| Dividends                                                                      | ** ** | **60**                                           |       | 53 |   |
| ** **                                                                     |       | **2,360**                                        |       | 2,597 |   |
| Other interest  income                                                         | ** ** | **17**                                           |       | 51 |   |
| TOTAL INTEREST  INCOME                                                         | ** ** | **10,244**                                       |       | 10,984 |   |
| **INTEREST  EXPENSE**                                                          |       |                                             |       |   |   |
| Interest on  deposits                                                          | ** ** | **2,244**                                        |       | 3,336 |   |
| Interest on  other borrowings                                                  | ** ** | **312**                                          |       | 50 |   |
| TOTAL INTEREST  EXPENSE                                                        | ** ** | **2,556**                                        |       | 3,386 |   |
| NET INTEREST  INCOME                                                           | ** ** | **7,688**                                        |       | 7,598 |   |
| PROVISION FOR  POSSIBLE LOAN AND LEASE LOSSES                                  | ** ** | **655**                                          |       | — |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES                 | ** ** | **7,033**                                        |       | 7,598 |   |
| **NONINTEREST  INCOME**                                                        |       |                                             |       |   |   |
| Trust department  income                                                       | ** ** | **558**                                          |       | 647 |   |
| Service fees on  deposit accounts                                              | ** ** | **1,722**                                        |       | 1,872 |   |
| Other fees and  commissions                                                    | ** ** | **84**                                           |       | 102 |   |
| Other operating  income                                                        | ** ** | **99**                                           |       | 123 |   |
| Securities gains                                                               | ** ** | **1,955**                                        |       | 1,008 |   |
| TOTAL  NONINTEREST INCOME                                                      | ** ** | **4,418**                                        |       | 3,752 |   |
| **NONINTEREST  EXPENSE**                                                       |       |                                             |       |   |   |
| Salaries and  employee benefits                                                | ** ** | **4,170**                                        |       | 4,282 |   |
| Net occupancy  expense                                                         | ** ** | **641**                                          |       | 602 |   |
| Furniture and  equipment expense                                               | ** ** | **328**                                          |       | 228 |   |
| Other operating  expenses                                                      | ** ** | **2,907**                                        |       | 2,702 |   |
| TOTAL  NONINTEREST EXPENSES                                                    | ** ** | **8,046**                                        |       | 7,814 |   |
|                                                                           | ** ** | ** **                                       |       |   |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES                                      | ** ** | **3,405**                                        |       | 3,536 |   |
| PROVISION FOR  INCOME TAXES                                                    | ** ** | **697**                                          |       | 788 |   |
| NET INCOME                                                                     | ** ** | **$**                                            | **2,708**  |   | $ | 2,748 |   |
| **BASIC  EARNINGS PER SHARE**                                                  |       |                                             |       |   |   |
| Weighted Average  Shares Outstanding                                           | ** ** | **5,574,778**                                    |       | 5,676,124 |   |
| Basic Earnings  Per Share                                                      | ** ** | **$**                                            | **0.49**   | ** ** | **$** | **0.48** | ** ** |

 

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

 

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**FIRSTFARMERS AND MERCHANTS CORPORATION AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in Thousands)**                                              | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| **OPERATING  ACTIVITIES**                                                         |       |                                                 | ** ** |   |   |
| Net income                                                                        | ** ** | **$**                                                | **2,708**  | ** ** | $ | 2,748 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities |       |                                                 | ** ** |   |   |
| Excess of  provision for possible loan losses over net charge-offs                |       | **764**                                              | ** ** | — |   |
| Provision for  depreciation and amortization of premises and equipment            |       | **264**                                              | ** ** | 260 |   |
| Securities gains                                                                  | ** ** | **(1,955**                                           | **)**      | (1,008 | ) |
| Loss from  disposition of fixed assets                                            | ** ** | **110**                                              | ** ** | — |   |
| Loss from  disposition of other real estate                                       | ** ** | **—**                                           | ** ** | 283 |   |
| Amortization of  deposit base intangibles                                         | ** ** | **18**                                               | ** ** | 76 |   |
| Amortization of  investment security premiums, net of accretion of discounts      |       | **208**                                              | ** ** | 91 |   |
| Increase in cash  surrender value of life insurance contracts                     | ** ** | **(151**                                             | **)**      | (670 | ) |
| (Increase)  decrease in                                                           |       |                                                 | ** ** |   |   |
| Deferred income  taxes                                                            | ** ** | **25**                                               | ** ** | 18 |   |
| Interest  receivable                                                              | ** ** | **112**                                              | ** ** | 7 |   |
| Other assets                                                                      | ** ** | **(503**                                             | **)**      | (87 | ) |
| Increase  (decrease) in                                                           |       |                                                 | ** ** |   |   |
| Interest payable                                                                  | ** ** | **(220**                                             | **)**      | (385 | ) |
| Other  liabilities                                                                | ** ** | **1,488**                                            | ** ** | 1,309 |   |
| Total  adjustments                                                                | ** ** | **160**                                              | ** ** | (106 | ) |
| Net cash  provided by operating activities                                        | ** ** | **2,868**                                            | ** ** | 2,642 |   |
| **INVESTING  ACTIVITIES**                                                         |       |                                                 | ** ** |   |   |
| Proceeds from  maturities, calls, and sales of available-for-sale securities      |       | **91,847**                                           | ** ** | 64,969 |   |
| Proceeds from  maturities and calls of held-to-maturity securities                | ** ** | **1,801**                                            | ** ** | 2,710 |   |
| Purchases of  investment securities                                               |       |                                                 | ** ** |   |   |
| Available-for-sale                                                                | ** ** | **(86,634**                                          | **)**      | (80,632 | ) |
| Held-to-maturity                                                                  | ** ** | **(509**                                             | **)**      | — |   |
| Net (increase)  decrease in loans                                                 | ** ** | **11,100**                                           | ** ** | (19,687 | ) |
| Proceeds from  sale of other real estate                                          | ** ** | **—**                                           | ** ** | 385 |   |
| Purchase of life  insurance premium                                               | ** ** | **(235**                                             | **)**      | (696 | ) |
| Purchases of  premises and equipment                                              | ** ** | **(3,236**                                           | **)**      | (329 | ) |
| Net cash  provided by (used in) investing activities                              | ** ** | **14,134**                                           | ** ** | (33,280 | ) |
| **FINANCING  ACTIVITIES**                                                         |       |                                                 | ** ** |   |   |
| Net increase in  noninterest-bearing and interest-bearing deposits                |       | **13,224**                                           | ** ** | 1,831 |   |
| Net increase in  short term borrowings                                            | ** ** | **411**                                              | ** ** | 768 |   |
| Proceeds  (payments) from FHLB borrowings                                         | ** ** | **(7,000**                                           | **)**      | 35,000 |   |
| Repurchase of  Common Stock                                                       | ** ** | **(1,250**                                           | **)**      | (1,000 | ) |
| Cash dividends                                                                    | ** ** | **(2,009**                                           | **)**      | (1,991 | ) |
| Net cash  provided by financing activities                                        | ** ** | **3,376**                                            | ** ** | 34,608 |   |
| Increase in cash  and cash equivalents                                            | ** ** | **20,378**                                           | ** ** | 3,970 |   |
| Cash and cash  equivalents at beginning of period                                 | ** ** | **31,536**                                           | ** ** | 35,873 |   |
| Cash and cash  equivalents at end of period                                       | ** ** | **$**                                                | **51,914** | ** ** | $ | 39,843 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1- OTHER INFORMATION**

 

The interim unauditedconsolidated financial statements of First Farmers and Merchants Corporation(the “Corporation”) presented in this report have been prepared on a consistentbasis and in accordance with the instructions to Form 10-Q and do notinclude all of the information and notes required by generally acceptedaccounting principles for complete financial statements.  In the opinion of management, all adjustmentsconsidered necessary for a fair presentation have been included.  These adjustments were of a normal, recurringnature and consistent with generally accepted accounting principles.  For further information, refer to theconsolidated financial statements and notes included in the Corporation’sAnnual Report on Form 10-K for the year ended December 31, 2008.

 

**NOTE 2 —STOCK REPURCHASE**

 

Duringthe first quarter of 2009, the Corporation repurchased, through negotiatedtransactions with third-party sellers, 25,000 shares of the Corporation’scommon stock at a price of $50 per share for an aggregate purchase price of$1.25 million.

 

**NOTE 3 — FAIR VALUEMEASUREMENT**

 

Effective January 1, 2008, the Corporation adopted the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 157, “Fair Value Measurements”**(“SFAS 157”), for financial assets andfinancial liabilities.  FinancialAccounting Standards Board (“FASB”) Staff Position (“FSP”) No. SFAS 157-2,“Effective Date of FASB Statement No. 157”, allowed the Corporation todelay application of SFAS 157 for non-financial assets and non-financialliabilities, until January 1, 2009; however, the Corporation elected toapply SFAS 157 to non-financial assets and non-financial liabilities effective January 1,2008. SFAS 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles and expands disclosures aboutfair value measurements.  The applicationof SFAS 157 in situations where the market for a financial asset is not activewas clarified by the issuance of FSP No. SFAS 157-3, “Determining the FairValue of a Financial Asset When the Market for That Asset Is Not Active” (“SFAS157-3”)*,* in October 2008.FSP No. SFAS 157-3 became effective immediately and did not significantlyaffect the methods by which the Corporation determines the fair values of itsfinancial assets.

 

SFAS 157 defines fair value as the price that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants. A fair value measurement assumes that the transaction to sell the assetor transfer the liability occurs in the principal market for the asset orliability or, in the absence of a principal market, the most advantageousmarket for the asset or liability.  Theprice in the principal (or most advantageous) market used to measure the fairvalue of the asset or liability is not adjusted for transaction costs.  An orderly transaction is a transaction that assumes exposure to themarket for a period prior to the measurement date to allow for marketingactivities that are usual and customary for transactions involving such assetsand liabilities; it is not a forced transaction. Market participants are buyersand sellers in the principal market that are (i) independent, (ii) knowledgeable,(iii) able to transact and (iv) willing to transact.

 

SFAS 157 requires the use of valuation techniques that are consistent with themarket approach, the income approach and/or the cost approach.  The market approach uses prices and otherrelevant information generated by market transactions involving identical orcomparable assets and liabilities. The income approach uses valuationtechniques to convert future amounts, such as cash flows or earnings, to asingle present amount on a discounted basis. The cost approach is based on the amount that currently would berequired to replace the service capacity of an asset (i.e., replacement cost).Valuation techniques should be consistently applied.  Inputs to valuation techniques refer to theassumptions that market participants use in pricing the asset or liability.  Inputs may be observable, meaning those thatreflect the assumptions market participants would use in pricing the asset orliability, developed based on market data obtained from

 

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independentsources. Inputs may also be unobservable, meaning those that reflect thereporting entity’s own assumptions about the assumptions market participantscould use in pricing the asset or liability, developed based on the best informationavailable in the circumstances. In that regard, SFAS 157 establishes a fairvalue hierarchy for valuation inputs that gives the highest priority to quotedprices in active markets for identical assets or liabilities and the lowestpriority to unobservable inputs. Thefair 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 the measurementdate.

 

·                  *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 that arederived principally from or corroborated by market data by correlation or othermeans.

 

·                  *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.

 

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 January 1, 2008.  Ifsuch quoted market prices are not available, fair value is based on internallydeveloped models that primarily use, as inputs, observable market-basedparameters. Valuation adjustments may be made to ensure that financialinstruments are recorded at fair value. These adjustments may include amountsto reflect counterparty credit quality and the Corporation’s creditworthinessamong 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 beencomprehensively revalued since the presentation dates and, therefore, estimatesof fair value after the balance sheet date may differ significantly from theamounts presented herein.

 

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

 

*Securities available for sale***—** Securities classified asavailable for sale are reported at fair value utilizing Level 2 inputs.  For these securities, the Corporation obtainsfair value measurements from an independent pricing service.  The fair value measurements consider observabledata that may include dealer quotes, market spreads, cash flows, the U.S.Treasury yield curve, live trading levels, trade execution data, marketconsensus prepayment speeds, credit information and the bond’s terms andconditions, among other things.

 

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

 

*Securities sold under repurchase agreements,federal funds purchased and other borrowings* — At March 31, 2009, all of the Bank’ssecurities sold under repurchase agreements, federal funds purchased and otherborrowings (e.g., overnight borrowings from the Federal Home Loan Bank ofCincinnati (the “FHLB”)) are settled on a short-term basis, usually daily.  As a result, the fair value of theinstruments approximates their carrying amount and such liabilities areclassified as Level 2 within the valuation hierarchy.

 

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*Other liabilities* — The Bank has certain liabilities carried at fairvalue.  These include future obligationspursuant to a supplemental retirement plan and proceeds of split-dollar lifeinsurance policies.  For theseobligations, the Bank discounts the anticipated future cash flows using currentinterest rates.  The liabilities areclassified as Level 2 within the valuation hierarchy.

 

Thefollowing table summarizes financial assets and liabilities measured at fairvalue on a recurring basis as of March 31, 2009, segregated by the levelof the valuation inputs within the fair value hierarchy utilized to measurefair value:

 

**Assets and liabilities measured atfair value on a recurring basis as of March 31, 2009**

 
| ** **                                   | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Federal funds  sold                          |       | $                | 8,300      |             | $          | —           |       | $         | —     |   | $ | 8,300 |   |
| Available-for-sale  securities               |       | —           |       | 169,926          |       | —           |       | 169,926   |       |
| Other assets                                 |       | —           |       | 20,533           |       | —           |       | 20,533    |       |
| **Total  assets at fair value**              |       | $                | 8,300      |             | $          | 190,459          |       | $         | —     |   | $ | 198,759 |   |
| Securities sold  under repurchase agreements |       | $                | —     |             | $          | 3,351            |       | $         | —     |   | $ | 3,351 |   |
| Other  liabilities                           |       | —           |       | 5,022            |       | —           |       | 5,022     |       |
| **Total  liabilities at fair value**         |       | $                | —     |             | $          | 8,373            |       | $         | —     |   | $ | 8,373 |   |

 

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 1st quarter 2009 was impaired loans.

 

*Impaired Loans.*Certain impaired loans arereported at the fair value of the underlying collateral if repayment is expectedsolely from the collateral.  Collateralvalues are estimated using Level 2 inputs based on observable market data orLevel 3 inputs based on customized discounting criteria.  During the first quarter of  2009, certain impaired loans were re-measuredand reported at fair value through a specific valuation allowance allocation ofthe allowance for possible loan losses based on the fair value of theunderlying collateral.  Impaired loanswith a carrying value of $6.5 million were reduced by specific valuationallowance allocations totaling approximately $911,000 to a total reported fairvalue of $5.6 million based on collateral valuations utilizing Level 3valuation inputs.

 

EffectiveJanuary 1, 2008, the Corporation adopted the provisions of SFAS No. 159,*The Fair Value**Option forFinancial Assets and Financial Liabilities - Including an amendment of FASBStatement**No. 115*(SFAS 159). SFAS 159 permits the Corporation to choose to measure eligibleitems at fair value at specified election dates.  Unrealized gains and losses on items forwhich the fair value measurement option has been elected are reported inearnings at each subsequent reporting date. The fair value option (i) maybe applied instrument by instrument, with certain exceptions; therefore, theCorporation may record identical financial assets and liabilities at fair valueor by another measurement basis permitted under generally accepted accountingprinciples; (ii) is irrevocable (unless a new election date occurs) and (iii) isapplied only to entire instruments and not to portions of instruments.  Adoption of SFAS 159 on January 1, 2008did not have a significant impact on the Corporation’s consolidated financialstatements.

 

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

 

TheBank has a Blanket Agreement for Advances and Security Agreement (the “BlanketAgreement”) with the FHLB.  Advances madeto the Bank under the Blanket Agreement are collateralized by the FHLB stockand unidentified qualifying residential mortgage loans totaling 150% of the outstandingamount borrowed. These collateralization matters are outlined in the BlanketAgreement dated March 31, 2008 between the Bank and the FHLB.  The Bankmade a principal payment of $7 million to FHLB on March 31, 2009.

 

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Scheduledannual principal maturities of borrowings under this credit line as of March 31,2009, are as follows:

 
| 2010  |   | 10,077,052 |       |
|-------|--------|------------|------------|
| 2011  |   | 7,000,000  |       |
| 2012  |   | 7,000,000  |       |
| 2013  |   | 10,100,000 |       |
| Total |   | $          | 34,177,052 |   |
|       |        |            |            |  |

 

Stockheld in the FHLB totaling $3.0 million at March 31, 2009 is carried atcost.  The stock is restricted and canonly be sold back to the FHLB at par.

 

TheBank also has a Cash Management Advance Line of Credit Agreement (the “CMA”)dated March 31, 2009 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 $40,000,000, selecting avariable rate of interest for up to 90 days or a fixed rate for a maximum of 30days.  There were no borrowingsoutstanding under the CMA as of March 31, 2009.

 

**NOTE 5- RECENT ACCOUNTINGPRONOUNCEMENTS**

 

In December 2007, the FASB replaced SFAS No. 141,**“Business Combinations” (“SFAS 141”),with SFAS No. 141R (“SFAS 141R”). SFAS 141R applies to all transactions and other events in which oneentity obtains control over one or more other businesses. SFAS 141R requiresan acquirer, upon obtaining control of another entity, to recognize the assets,liabilities and any non-controlling interest in the acquiree at fair value asof the acquisition date. ** **Contingent consideration isrequired to be recognized and measured at fair value on the date of acquisitionrather than at a later date when the amount of that consideration may bedeterminable beyond a reasonable doubt.**** This fair value approach replaces thecost-allocation process required under SFAS 141 whereby the cost of anacquisition was allocated to the individual assets acquired and liabilitiesassumed based on their estimated fair value. SFAS 141R requires acquirersto expense acquisition-related costs as incurred rather than allocating suchcosts to the assets acquired and liabilities assumed, as was previously thecase under SFAS 141. Under SFAS  141R, the requirements of SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,” would haveto be met in order to accrue for a restructuring plan in purchase accounting.Pre-acquisition contingencies are to be recognized at fair value except when anon-contractual contingency is not likely to materialize, in which case nothingshould be recognized in purchase accounting. Instead, that contingency would be subject to the probable and estimablerecognition criteria of SFAS No. 5, “Accounting for Contingencies.”SFAS 141R is applicable to the Corporation’s accounting for businesscombinations closing on or after January 1, 2009.

 

In September 2006,the FASB ratified the consensus the Emerging Issues Task Force (“EITF”) reachedregarding EITF Issue No. 06-4, “Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements” (“EITF 06-4”), which provides accounting guidance forpostretirement benefits related to endorsement split-dollar life insurancearrangements, whereby the employer owns and controls the insurance policies.The consensus concludes that an employer should recognize a liability for thepostretirement benefit in accordance with SFAS No. 106, “Employers’Accounting for Postretirement Benefits Other Than Pensions” (“SFAS 106”) orAccounting Principles Board Opinion No. 12, “Omnibus Opinion-1967” (“APB12”). In addition, the consensus states that an employer should also recognizean asset based on the substance of the arrangement with the employee.EITF 06-4 is effective for fiscal years beginning after December 15,2007.

 

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

 

In December 2008, the FASB issued SFAS No. 132(R)-1“Employers’ Disclosures about Postretirement Benefit Plan Assets”**(“SFAS 132(R)-1”).  SFAS132(R)-1 provides guidance related to an employer’s disclosures aboutplan assets of defined benefit pension or other post-retirement benefit plans.Under SFAS 132(R)-1,disclosures should provide users of financial statements with an understandingof how investment allocation decisions are made, the factors that are pertinentto an understanding of investment policies and strategies, the major categoriesof plan assets, the inputs and valuation techniques used to measure the fairvalue of plan assets, the effect of fair value measurements using significantunobservable inputs on changes in plan assets for the period and significantconcentrations of risk within plan assets. The disclosures required by SFAS 132(R)-1 will be included in theCorporation’s financial statements beginning with the financial statements forthe year ended December 31, 2009.

 

In April 2009, the FASB issued SFAS No. 157-4,“Determining Fair Value When the Volume and Level of Activity for the Asset orLiability Have Significantly Decreased and Identifying Transactions That AreNot Orderly” (“SFAS 157-4”).  SFAS 157-4affirms that the objective of fair value when the market for an asset is notactive is the price that would be received to sell the asset in an orderlytransaction, and clarifies and includes additional factors for determiningwhether there has been a significant decrease in market activity for an assetwhen the market for that asset is not active. SFAS 157-4 requires anentity to base its conclusion about whether a transaction was not orderly onthe weight of the evidence. SFAS 157-4 also amended SFAS 157 to expand certaindisclosure requirements. The Corporation adopted the provisions ofSFAS 157-4 during the first quarter of 2009. Adoption of SFAS 157-4did not significantly impact the Corporation’s financial statements.

 

In April 2009, the FASB issued SFAS No. 115-2and SFAS No. 124-2, “Recognition and Presentation ofOther-Than-Temporary Impairments” (“SFAS 115-2 and SFAS 124-2”).  SFAS 115-2 and SFAS 124-2 (i) changeexisting guidance for determining whether an impairment is other than temporaryto debt securities and (ii) replace the existing requirement that theentity’s management assert that it has both the intent and ability to hold animpaired security until recovery.  Theyalso require that management assert that (a) it does not have the intentto sell the security and (b) it is more likely than not it will not haveto sell the security before recovery of its cost basis. Under SFAS 115-2and SFAS 124-2, declines in the fair value of held-to-maturity andavailable-for-sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses to the extent theimpairment is related to credit losses. The amount of the impairment related toother factors is recognized in other comprehensive income. The Corporation adoptedthe provisions of SFAS 115-2 and SFAS 124-2 during the first quarterof 2009. Adoption of SFAS 115-2 and SFAS 124-2 did not significantlyimpact the Corporation’s financial statements.

 

In April 2009, the FASB issued SFAS No.107-1and APB No. 28-1, “Interim Disclosures about Fair Value of FinancialInstruments” (“SFAS 107-1 and APB 28-1”).  SFAS 107-1 and APB 28-1 amend SFAS No. 107,“Disclosures about Fair Value of Financial Instruments” (“SFAS 107”), torequire an entity to provide disclosures about fair value of financialinstruments in interim financial information. They also amend APB Opinion No. 28, “Interim FinancialReporting” to require disclosures of summarized financial information atinterim reporting periods.  UnderSFAS 107-1 and APB 28-1, a publicly traded company must includedisclosures about the fair value of its financial instruments whenever itissues summarized financial information for interim reporting periods. Inaddition, entities must disclose, in the body or in the accompanying notes ofits summarized financial information for interim reporting periods and in itsfinancial statements for annual reporting periods, the fair value of allfinancial instruments for which it is practicable to estimate that value,whether recognized or not recognized in the statement of financial position, asrequired by SFAS 107. The new interim disclosures required bySFAS 107-1 and APB 28-1 will be included in the Corporation’s interimfinancial statements beginning with the second quarter of 2009.

 

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**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 of such terms.  These forward-looking statements include,without limitation, those relating to the Corporation’s valuationmethodologies, the effect of recent accounting pronouncements, loan portfolioconcentrations, repayment of loans by borrowers, failure to meet and satisfactionof capital adequacy requirements, the repayment of FHLB borrowings, adequacy ofcapital resources and traditional sources of cash generated from operatingactivities to meet liquidity needs, the effect of fluctuating interest ratesand the realization of deferred income tax assets.  We caution you not to place undue reliance onsuch forward-looking statements in this report because results could differmaterially from those anticipated due to a variety of factors.  These factors include, but are not limitedto, changes in economic conditions; fluctuations in prevailing interest ratesand the effectiveness of our risk monitoring systems; the ability of ourborrowers to repay loans; adverse changes in our special mention credits; ourability to meet regulatory capital adequacy requirements; our ability to meetliquidity needs from operating activities; the accuracy of assumptions in ourrate risk analysis; our ability to recognize deferred tax assets; our abilityto maintain credit quality; laws and regulations affecting financialinstitutions in general; our ability to control factors influencing netinterest income; the geographic concentration of our assets; our ability tomaintain sufficient asset quality and cost controls; and other factors generallyunderstood to affect the financial results of financial services companies andother factors detailed from time to time in our filings with the Securities andExchange Commission. We undertake no obligation to update these forward-lookingstatements to reflect events or circumstances that occur after the date of thisreport.

 

**EXECUTIVE OVERVIEW**

 

AtMarch 31, 2009, theconsolidated total assets of the First Farmers and Merchants Corporation (the “Corporation”)were $916.7 million, its consolidated net loans were $575.0 million, its totaldeposits were $758.1 million and its total shareholders’ equity was $107.1million.  The Corporation’s loanportfolio at March 31,2009 reflected a decrease of $11.1 million, or 1.9%, compared to December 31,2008.  Total deposits increased $13.2million and shareholders’ equity decreased 0.1% during the first three monthsof 2009.  Total shareholders’ equityincludes an unrealized gain on available-for-sale securities of approximately$251,000.

 

**FINANCIALCONDITION**

 

Averageearning assets at March 31,2009 were up 6.9%, or $53.5 million, from average earning assets at December 31,2008.  Average overnight investments at March 31, 2009 were up $12.6million compared to December 31, 2008. Average investment securities at March 31, 2009 were down 5.9% compared to December 31,2008.  Average total assets of $915.2million at March 31,2009 increased 7.0% or $59.9 million, compared to $855.3 million at December 31,2008.

 

**Securities**

 

Available-for-salesecurities are an integral part of the asset/liability management process forFirst Farmers and Merchants Bank, the Corporation’s sole direct subsidiary (the“Bank”).  Accordingly, they represent animportant source of liquidity available to fund loans and accommodate assetreallocation strategies dictated by changes in the Bank’s operating and taxplans, shifting yield spread relationships and changes in configuration of theyield curve.  At March 31, 2009, the Bank’sinvestment securities portfolio had $169.9 million available-for-salesecurities, which are valued at fair market value, and $58.1 millionheld-to-maturity securities, which are valued at cost on the balance sheet.These compare 

 

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to $174.5 million ofavailable-for-sale securities and $59.4 million of held-to-maturity securitiesas of December 31, 2008.

 

**Loans**

 

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

 

Althoughthere is not an industry concentration as measured by regulatory guidelineswithin the Bank’s loan portfolio, the Bank currently has heavy exposure in sixbroad industry categories: commercial construction and development; real estaterenting and leasing; religious organizations; trucking; physicians; and publicadministration.  These industries aremonitored closely to ensure that underwriting practices, policies and lossallowance levels match the level of risk posed. Real estate loans represented 77.2% of total loans at March 31,2009 compared to 78.6% at March 31, 2008. Management of the Bank believes the risk of this concentration isacceptable given the quality of underwriting and the low level of historicalloss experience.  Total construction anddevelopment loans accounted for 7.0% of loans outstanding at March 31,2009 compared to 8.5% at March 31, 2008, which is within the Bank’sinternal target of a range of 1% to 7% of total loans.  Therefore, management of the Bank believesthat the current level of exposure, while elevated above historical levels,represents an acceptable level of risk for the Bank.  All loans are expected to be repaid from cashflow or proceeds from the sale of selected assets of the borrowers.  Collateral requirements for the loanportfolio are based on credit evaluation of the borrowers.

 

Theanalysis and review of asset quality by the Bank’s credit administrationincludes a formal review that evaluates the adequacy of the allowance forpossible loan and lease losses.  Thisreview is updated monthly and evaluated more completely quarterly inconjunction with loan review reports and evaluations that are discussed inmeetings with loan officers, credit administration and the Bank’s Board ofDirectors.  The allowance for possibleloan and lease losses was $9.4 million, or 1.6% of gross loans and leases, at March 31, 2009, compared to$8.6 million, or 1.4%, at December 31, 2008.  Net recoveries through March 31, 2009 wereapproximately $109,000, which results in an annualized net charge-off ratio ofnegative 0.07%.

 

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, credit analysts to support lenders, timelyidentification of loans with adverse characteristics, control of correctiveactions and objective monitoring of loan reviews.  The Special Assets Department of the Bankidentifies and monitors assets that need attention.  At March 31, 2009, this process identifiedloans totaling $8.2 million, or 1.4% of the portfolio, that were classified asother assets especially mentioned, compared to loans totaling $9.9 million, or1.7% of the portfolio, so classified at December 31, 2008.  Loans totaling $30.3 million, or 5.2% of theportfolio, were classified as substandard at March 31, 2009, compared to loans totaling$26.1 million, or 4.4% of the portfolio, so classified at December 31,2008.  No loans were classified asdoubtful at March 31,2009 and December 31, 2008.

 

**Deposits**

 

The Bank does not have any foreign offices and all deposits areserviced in its 19 domestic offices.  TheBank’s average deposits increased 6.8% during the first three months of 2009compared to an increase of 1.1% in the first three months of 2008.  The increase results from the Bank offeringmore competitive rates on certificates of deposit.  Average total noninterest-bearing depositswere 15.1% of total deposits at March 31, 2009, contributing to the Bank’slow cost of deposits, compared to 17.1% at December 31, 2008.

 

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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.  The regulations requirethe Corporation and the Bank to meet specific capital adequacy guidelines thatinvolve quantitative measures of assets, liabilities and certainoff-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.

 

 Quantitative measures establishedby the Board of Governors of the Federal Reserve System to ensure capitaladequacy require the Corporation and the Bank to maintain minimum amounts andratios of Tier 1 Capital and Total Capital (Tier 1 plus Tier 2 Capital) torisk-weighted assets and of Tier 1 Capital to average total assets (leveragecapital ratio).   Equity capital (net ofcertain adjustments for intangible assets and investments in non-consolidatedsubsidiaries and certain classes of preferred stock) is considered Tier 1 Capital.  Tier 2 Capital consists of core capital plussubordinated debt, some types of preferred stock, and a defined percentage ofthe allowance for possible loan and lease****losses.  To be “well-capitalized” under federal bankregulations, a bank holding company must have a Tier 1 Capital ratio of atleast 6%, a Total Capital ratio of at least 10%, and a leverage capital ratioof at least 5%.  At March 31, 2009, theCorporation’s Tier 1, Total Capital and leverage capital ratios were 15.6%,16.9% and 10.8 %, respectively.  Theratios were 15.3%, 16.5% and 10.9%, respectively, at December 31,2008.  As of March 31, 2009, the Bank’s Tier 1 Capital,Total Capital and leverage capital were 15.3%, 16.6%, and 10.6%, respectively,compared to 15.0%, 16.2%, and 10.6% at December 31, 2008. Management believes,as of March 31,2009, that the Corporation and the Bank each met all capital adequacyrequirements to which they are subject.

 

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

 

 Most of the capital needs of theBank historically have been financed with retained earnings and depositsreceived, and the Corporation’s primary source of liquidity has been dividendsdeclared by the Bank.  In March 2008,the Bank obtained five advances at $7 million each from the FHLB.  The first scheduled repayment of the advanceswas made in March 2009.  Theremaining payments will continue through 2013.  In September 2008, the Bank obtained two additional advances of$3.1 million each for a total borrowing for 2008 of $41.2 million.  Please refer to Note 4 in the Notes toConsolidated Financial Statements for additional information about borrowingsfrom the FHLB and the repayment schedule of such borrowings.

 

 The Bank is subject to Tennesseestatutes and regulations that impose restrictions on the amount of dividendsthat may be declared.  Furthermore, anydividend payments are subject to the continuing ability of the Bank to maintainits compliance with minimum federal regulatory capital requirements and toretain its characterization under federal regulations as a “well-capitalized”institution. The Bank declared a $0.36 per share dividend in the fourth quarterof 2008, which was paid in the first quarter of 2009.  Management believes that the Corporation’straditional sources of cash generated from the Bank’s operating activities areadequate to meet the Corporation’s liquidity needs for normal ongoingoperations.  The Bank’s Board ofDirectors has adopted a liquidity policy that outlines specific liquiditytarget balances.  Compliance with thispolicy is reviewed quarterly by the Bank’s Asset/Liability Committee andresults are reported to the Bank’s Board of Directors.

 

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

 

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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, in thecase of the determination of the allowance for loan and lease losses (“ALLL”)and the recognition of deferred income tax assets has been critical to thedetermination of the Corporation’s financial position, results of operationsand cash flows.  As of March 31,2009, the deferred income tax asset was $5.7 million, which was included withother assets on the balance sheet.

 

*Allowance for Loan and LeaseLosses*

 

TheBank’s management assesses the adequacy of the ALLL prior to the end of eachmonth and prepares a more formal review quarterly to assess the risk in theBank’s loan portfolio.  This assessmentincludes procedures to estimate the allowance and test the adequacy andappropriateness 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.

 

Thesecalculated amounts are determined by assessing loans identified as not incompliance with loan agreements.  Theseloans are generally in two different risk groups.  One group is unique loans (commercial loans,including those loans considered impaired). The second group is pools of homogenous loans (generally retail andmortgage loans).  The calculation forunique loans is based primarily on risk rating grades assigned to each of theseloans as a result of the Bank’s loan management and review processes.  Each risk-rating grade is assigned a lossratio, which is determined based on the experience of management, discussionswith banking regulators and the independent loan review process.  The amount allocated for an impaired loan isbased on estimated cash flows discounted at the loan’s original effectiveinterest rate or the underlying collateral value.  Historical data, including actual lossexperience on specific types of homogenous loans, is used to allocate amountsfor loans or groups of loans meeting the specified criteria.  Management 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 utilizedin evaluating the adequacy of the ALLL are:

·                  Portfolio quality trends;

·                  Changes in the nature andvolume of the portfolio;

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

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

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

·                  Changes in personnel,management and staff; and

·                  Existence and effect of anyconcentrations of credit.

 

Inassessing the adequacy of the ALLL, the risk characteristics of the entire loanportfolio are evaluated.  This processincludes the judgment of the Bank’s management, input from independent loanreviews and reviews that may have been conducted by bank regulators as part oftheir usual examination process.

 

*DeferredIncome Tax Assets*

 

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

 

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**OFF-BALANCESHEET ARRANGEMENTS**

 

TheBank is a party to financial instruments with off-balance-sheet risk in thenormal course of business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and stand-by letters of credit.  Those instruments involve, to varyingdegrees, elements of credit risk in excess of the amount recognized in thebalance sheet.  The contract or notionalamounts of those instruments reflect the extent of involvement the Bank has inthose financial instruments.  Loan commitmentsare agreements to lend to a customer as long as there is not a violation of anycondition established in the contract. Stand-by letters of credit are conditional commitments issued by theBank to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued tosupport public and private borrowing arrangements, including commercial paper,bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially thesame as that involved in making a loan.

 

Thetotal outstanding loan commitments and stand-by letters of credit in the normalcourse of business at March 31,2009 were $100.4 million and $9.3 million, respectively, compared to $107.4million and $17.0 million, respectively, at March 31, 2008.

 

AtMarch 31, 2009, theCorporation and the Bank did not have any off-balance sheet arrangements otherthan commitments to extend credit and stand-by letters of credit.

 

**RESULTS OF OPERATIONS**

 

Totalinterest income for the first three months of 2009 was $10.2 million comparedto $11.0 million for the first three months of 2008.  Interest and fees earned on loans andinvestments are the components of total interest income.  Interest and fees earned on loans were $7.9million, a decrease of approximately $469,000, or 5.6%, during the first threemonths of 2009 compared to the first three months of 2008.  Nominal interest earned on investmentsecurities and other investments was $2.4 million, a decrease of approximately$237,000, or 10.0%, during the first three months of 2009 compared to the firstthree months of 2008.

 

Totalinterest expense in the first three months of 2009 was $2.6 million, a decreaseof approximately $830,000, or 24.5%, compared to the first three months of2008.  The lower interest rates forcertificates of deposits and public funds during the first quarter of 2009 werethe primary reason for the lower expense. As a policy, budgeted financial goals are monitored on a monthly basisby the Bank’s Asset/Liability Committee, which reviews the actual dollar changein net interest 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 12-month period beginning April 1, 2009 and ending March 31,2010 showed a worst-case potential change to net interest income of a negative 2.2%,or a decline in net interest income of approximately $703,000 by the end of theperiod.

 

Netinterest income of the Corporation on a fully taxable equivalent basis isinfluenced primarily by changes in:

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

(2)                                  market rates ofinterest; and

(3)                                  income taxrates.

 

Theimpact of some of these factors can be controlled by management policies andactions.  External factors also can havea significant impact on changes in net interest income from one period toanother.  Some examples of such factorsare:

(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.

 

Thenet interest margin, on a tax equivalent basis, at March 31, 2009, March 31, 2008 and December,31, 2008 was 4.01%, 4.45% and 4.40%, respectively.

 

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Noninterest income was$4.4 million, an increase of approximately $666,000, or 17.8%, during the firstthree months of 2009 compared to the first three months of 2008.  The gains on sales of available-for-salesecurities, representing approximately $2.0 million in income was the primaryreason for the increase.

 

Additionsof $655,000 were made to the provision for possible loan and lease****losses in the first quarter of 2009.Noninterest expenses,excluding the provision for possible loan and lease losses, were approximately$232,000, or 3.0%, higher in the first three months of 2009 as compared to thefirst three months of 2008. Salaries and benefits expense was down approximately $112,000, or 2.6%,for the three months ended March 31, 2009 compared to the same period in2008 because of changes in the Bank’s incentive and retirement plans.

 

 The Corporation does not have anylong-term debt or other long-term obligations; however, in the 2008, the Bankreceived a $41.2 million advance from FHLB.  The scheduled$7.0 million annual principal maturities of borrowings under this credit lineas of March 31, 2008, began in March 2009 and will end in 2013.  Please refer to Note 4 in the Notes toConsolidated Financial Statements for additional information about borrowingsfrom the FHLB and the repayment schedule of such borrowings.

 

 The Bank also leases certain of itsproperty.  There was not a change duringthe three-month period ended March 31, 2009 in the terms of these leases.

 

Netincome for the three months ended March 31, 2009 was $2.71 million, comparedto $2.75 million for the three months ended March 31, 2008.  A decrease in interest income on loans andsecurities contributed to the period-over-period decrease.  The Corporation earned $0.49 per share in thefirst quarter of 2009 and $0.48 per share in the first quarter of 2008.

 

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

 

Duringthe three months ended March 31,2009, there were no material changes in the quantitative and qualitativedisclosures about market risk presented in the Corporation’s Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

**Item 4.Controls and Procedures.**

 

(a) Evaluationof Disclosure Controls and Procedures. The Corporation, with the participation of its management, including theCorporation’s Chief Executive Officer and Assistant Treasurer (principalfinancial officer), carried out an evaluation of the effectiveness of thedesign and operation of its disclosure controls and procedures (as defined in Rules 13a-15and 15d-15 under the 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 Securities and Exchange Commissionunder the Exchange Act is recorded, processed, summarized and reported on atimely basis.

 

(b) Changesin Internal Control Over Financial Reporting.  There has been no change in the Corporation’sinternal control over financial reporting that occurred during the firstquarter of 2009 that has materially affected, or is reasonably likely tomaterially affect, the Corporation’s internal control over financial reporting.

 

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**PART II- OTHER INFORMATION**

 

**Item1A. Risk Factors.**

 

There have been no material changes in the risk factors previouslydisclosed in the Corporation’s Annual Report on Form 10-K for the yearended December 31, 2008.

 

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

 

The following table provides information regarding purchases of theCorporation’s common stock made by the Corporation during the first quarter of2009:

 

**CORPORATION’S PURCHASES OF EQUITY SECURITIES**

 
| **Period**                                           | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number (or  Approximate Dollar Value)  of Shares that May  Yet Be Purchased Under  the Plans or Programs** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1,  2009 – January 31, 2009   |       | —                                           |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                                |       |
| February 1,  2009 – February 29, 2009 |       | —                                           |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                                |       |
| March 1,  2009 – March 31, 2009       |       | 25,000                                           | *          | $                                            | 50.00      |                                                                                                                             | —     |                                                                                                                                                                                  | —     |   |
| Total                                                |       | 25,000                                           |       | $                                            | 50.00      |                                                                                                                             | —     |                                                                                                                                                                                  | —     |   |

 

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*Purchased through negotiated transactions with several third-partysellers.

 

**Item 6.  Exhibits.**

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

 

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

 

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

 

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**SIGNATURES**

 

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

 

 

FIRST FARMERS ANDMERCHANTS CORPORATION

(Registrant)

 

 
| Date   | May 11, 2009 |   | /s/ T. Randy Stevens                                                                                     |
|--------|-------------------|--------|----------------------------------------------------------------------------------------------------------|
|   |              |   | T. Randy Stevens, Chief  Executive Officer                                                               |
|   |              |   |                                                                                                     |
|   |              |   |                                                                                                     |
| Date   | May 11, 2009 |   | /s/ Patricia P. Bearden                                                                                  |
|   |              |   | Patricia P. Bearden, Assistant  Treasurer (principal financial officer and principal accounting officer) |

 

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

 

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(1)  Incorporated by reference from the First Farmers andMerchants Corporation Amendment No. 1 to the Annual Report on Form 10-K/Afor the year ended December 31, 2003, 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 April 23, 2007 (File Number000-10972).

 

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