UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

**FORM 10-Q**

(Mark one)

**[X] QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

For the quarterly periodended **June 30, 2007**

or

**[ ] TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

For the transition periodfrom _______________ to _______________________

Commission File Number: 000-10972

First Farmers and MerchantsCorporation

(Exact name of registrant as specified in its charter)

 

Tennessee                                                                                                                           62-1148660

(State or otherjurisdiction of incorporation or organization)                                          (I.R.S.Employer Identification No.)

 

                816 South Garden Street

               Columbia, Tennessee                                                                                                         38402-1148

(Address ofprincipal executive offices)                                                                                                (ZipCode)

 

931-388-3145

(Registrant's telephone number, including area code)

 

 

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

 

                Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  [X]Yes           [  ] No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer.  See definition of"accelerated filer and large accelerated filer" in Rule 12b-2 of theExchange Act.  (Check one):  

Largeaccelerated filer [ ]     Accelerated filer [X]            Non-acceleratedfiler [ ]       

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). [ ] Yes [X]No

Indicate the number of shares outstanding of each ofthe registrant's classes of common stock, as of the latest practicable date. 

5,720,000 shares as of August 8, 2007 

**PART I - FINANCIAL INFORMATIO**N

**Item 1. FinancialStatements.**

Thefollowing unaudited consolidated financial statements of the Registrant and itssubsidiaries are included in this Report:

Consolidatedbalance sheets - June 30, 2007 and December 31, 2006.

Consolidatedstatements of income - For the three months and six months ended June 30, 2007and June 30, 2006.

Consolidatedstatements of cash flows - For the sixmonths ended June 30, 2007 and June 30,2006.

Selectednotes to consolidated financial statements.

| **FIRST FARMERS AND MERCHANTS CORPORATION AND  SUBSIDIARIES**                                                         |
|-----------------------------------------------------------------------------------------------------------------------|
| **CONSOLIDATED BALANCE SHEETS**                                                                                       |
|                                                                                                                       |  | **June 30,** | December 31, |
|                                                                                                                       |  | **2007** | 2006 |
|                                                                                                                       | *(Dollars In Thousands, Except Per Share Data)* | **(Unaudited)** | (1) |
|                                                                                                                       |  | ** ** |  |
| **ASSETS**                                                                                                            | Cash and due from banks | ** $** | **19,703 ** |  $ | 45,558  |
|                                                                                                                       | Interest-bearing deposits in banks | **1,949 ** | 2,573  |
|                                                                                                                       | Federal funds sold | **4,100 ** | 26,850  |
|                                                                                                                       |               Total cash and cash equivalents | **25,752 ** | 74,981  |
|                                                                                                                       | Securities | ** ** |  |
|                                                                                                                       |     Available for sale (amortized cost $140,750 | ** ** |  |
|                                                                                                                       |          and $149,040, respectively) | **137,758 ** | 147,001  |
|                                                                                                                       |     Held to maturity (fair market value $76,319 | ** ** |  |
|                                                                                                                       |          and $82,109 respectively) | **76,749 ** | 81,247  |
|                                                                                                                       |               Total securities | **214,507 ** | 228,248  |
|                                                                                                                       | Loans, net of deferred fees | **495,859 ** | 473,353  |
|                                                                                                                       |     Allowance for possible loan and lease losses | **(7,296)** | (7,262) |
|                                                                                                                       |               Net loans | **488,563 ** | 466,091  |
|                                                                                                                       | Bank premises and equipment, at cost | ** ** |  |
|                                                                                                                       |          less allowance for depreciation | **10,260 ** | 10,428  |
|                                                                                                                       | Core deposit and other intangibles | **9,471 ** | 9,874  |
|                                                                                                                       | Other assets | **32,875 ** | 30,462  |
|                                                                                                                       |             TOTAL ASSETS | ** $** | **781,428 ** |  $ | 820,084  |
|                                                                                                                       |  | ** ** |  |
|                                                                                                                       |  | ** ** |  |
| **LIABILITIES**                                                                                                       | Deposits | ** ** |  |
|                                                                                                                       |      Noninterest-bearing | ** $** | **120,695 ** |  $ | 142,933  |
|                                                                                                                       |      Interest-bearing (including certificates of  deposit | ** ** |  |
|                                                                                                                       |           over $100:  2007 - $78,855; 2006 - $98,205) | **538,847 ** | 556,029  |
|                                                                                                                       |             Total deposits | **659,542 ** | 698,962  |
|                                                                                                                       | Federal funds purchased and securities sold | ** ** |  |
|                                                                                                                       |            under agreements to repurchase | **2,122 ** | 2,654  |
|                                                                                                                       | Dividends payable | **1,976 ** | 1,971  |
|                                                                                                                       | Other short-term liabilities | **542 ** | 385  |
|                                                                                                                       | Accounts payable and accrued liabilities | **13,556 ** | 12,305  |
|                                                                                                                       |             TOTAL LIABILITIES | **677,738 ** | 716,277  |
|                                                                                                                       |  | ** ** |  |
| **SHAREHOLDERS'**                                                                                                     | Common stock - $10 par value per share, 8,000,000  shares |  |  |
| **EQUITY**                                                                                                            |         authorized; 5,726,992 and 5,760,000 shares  issued |  |  |
|                                                                                                                       |         and outstanding  as of June 30, 2007 and |  |  |
|                                                                                                                       |          December 31, 2006, respectively | **57,270 ** | 57,600  |
|                                                                                                                       | Additional paid-in capital | **- ** | 1,120  |
|                                                                                                                       | Retained earnings | **48,259 ** | 46,342  |
|                                                                                                                       | Accumulated other comprehensive loss | **(1,839)** | (1,255) |
|                                                                                                                       |             TOTAL SHAREHOLDERS' EQUITY | **103,690 ** | 103,807  |
|                                                                                                                       |             TOTAL LIABILITIES AND | ** ** |  |
|                                                                                                                       |                 SHAREHOLDERS' EQUITY | ** $** | **781,428 ** |  $ | 820,084  |
|                                                                                                                       |  | ** ** |  |
|       (1)  Derived from audited financial statements.                                   |  |  |
|       The accompanying notes are an integral part of  the consolidated financial statements. |  |

|  

 

**FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES**
**CONSOLIDATED STATEMENTS OF INCOME**

*Three Months Ended*

*Six Months Ended*

*(Dollars In Thousands, Except Per Share Data)*

*June 30,*

*June 30,*

*(Unaudited)*

**2007**

2006

**2007**

2006

** **

**INTEREST AND**

Interest and fees on loans

** $**

**8,313 **

 $

7,853  

** $**

**16,266 **

 $

15,121  

**     DIVIDEND INCOME**

Income on investment securities

** **

** **

     Taxable interest

**1,315 **

1,726  

**2,598 **

3,359  

     Exempt from federal income tax

**958 **

1,068  

**1,981 **

2,146  

     Dividends

**44 **

45  

**107 **

94  

**2,317 **

2,839  

**4,686 **

5,599  

Other interest income

**287 **

22  

**595 **

56  

    TOTAL INTEREST INCOME

**10,917 **

10,714  

**21,547 **

20,776  

**INTEREST EXPENSE**

Interest on deposits

**3,969 **

3,031  

**7,964 **

6,019  

Interest on other short-term borrowings

**42 **

193  

**73 **

269  

      TOTAL INTEREST EXPENSE

**4,011 **

3,224  

**8,037 **

6,288  

            NET INTEREST INCOME

**6,906 **

7,490  

**13,510 **

14,488  

PROVISION FOR POSSIBLE LOAN LOSSES

**- **

-  

**- **

-  

      NET INTEREST INCOME AFTER

** **

** **

           PROVISION FOR LOAN LOSSES

**6,906 **

7,490  

**13,510 **

14,488  

** **

** **

**NONINTEREST  INCOME**

Trust department income

**642 **

608  

**1,349 **

1,148  

Service fees on deposit accounts

**1,952 **

2,024  

**3,705 **

3,839  

Other service fees, commissions and fees

**166 **

106  

**296 **

194  

Other operating income

**222 **

212  

**496 **

396  

      TOTAL NONINTEREST  INCOME

**2,982 **

2,950  

**5,846 **

5,577  

** **

** **

**NONINTEREST **

Salaries and employee benefits

**3,784 **

4,212  

**7,521 **

8,347  

**    EXPENSE**

Net occupancy expense

**552 **

551  

**1,095 **

1,113  

Furniture and equipment expense

**261 **

308  

**538 **

605  

Other operating expenses

**2,545 **

2,968  

**5,126 **

5,679  

      TOTAL NONINTEREST EXPENSES

**7,142 **

8,039  

**14,280 **

15,744  

           INCOME BEFORE PROVISION FOR

** **

** **

                 INCOME TAXES

**2,746 **

2,401  

**5,076 **

4,321  

PROVISION FOR INCOME TAXES

**699 **

484  

**983 **

760  

                  NET INCOME	

** $**

**2,047 **

 $

1,917  

** $**

**4,093 **

 $

3,561  

**BASIC EARNINGS PER**

**SHARE**

Weighted Average Shares Outstanding

**5,736,645 **

5,840,000  

**5,746,892 **

5,840,000  

** $**

**0.36 **

 $

0.33 

** $**

**0.71 **

 $

0.61 

      The accompanying notes are an integral part of  the consolidated financial statements.

** **

** **

** **

** **

** **

** **

** **

** **

**FIRST FARMERS AND MERCHANTS CORPORATION AND  SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH  FLOWS                 **

*(Dollars In Thousands)*

*Six Months Ended  June 30,*

*(Unaudited)*

**2007**

2006

**OPERATING**

Net income

** $**

**4,093 **

 $

3,561  

**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

**34 **

(159)

       Provision for depreciation and amortization of

** **

          premises and equipment

**473 **

556  

       Amortization of deposit base intangibles

**403 **

528  

       Amortization of investment security premiums,

** **

          net of accretion of discounts

**325 **

634  

       Increase in cash surrender value of life  insurance contracts

**(948)**

(196)

       Decrease (increase) in

** **

          Deferred income taxes

**(165)**

24  

          Interest receivable

**102 **

107  

          Other assets

**(356)**

(186)

       (Decrease) increase in

** **

          Interest payable

**(205)**

272  

          Other liabilities

**1,346 **

896  

               Total adjustments

**1,009 **

2,476  

               Net cash provided by operating  activities

**5,102 **

6,037  

**INVESTING**

Proceeds from maturities, calls and sales of

** **

**ACTIVITIES**

      available-for-sale securities

**16,049 **

33,082  

Proceeds from maturities and calls of  held-to-maturity securities

**4,440 **

3,650  

Purchases of investment securities

** **

      Available-for-sale

**(6,320)**

(19,401)

      Held-to-maturity

**(1,693)**

-  

Net increase in loans

**(22,506)**

(24,067)

Purchase of life insurance policies

**(676)**

-  

Purchases of premises and equipment

**(305)**

(281)

               Net cash used in investing activities

**(11,011)**

(7,017)

**FINANCING**

Net (decrease) increase in noninterest-bearing

** **

**ACTIVITIES**

      and interest-bearing deposits

**(39,419)**

8,426  

Net decrease in short-term borrowings

**(375)**

(8,146)

Proceeds from sale of minority interest in a  controlled subsidiary

**95 **

-  

Repurchase of common stock

**(1,650)**

-  

Cash dividends

**(1,971)**

(1,869)

               Net cash used in financing activities

**(43,320)**

(1,589)

Decrease in cash and cash equivalents

**(49,229)**

(2,569)

Cash and cash equivalents at beginning of period

**74,981 **

28,538  

Cash and cash equivalents at end of period

** $**

**25,752 **

 $

25,969  

      The accompanying notes are an integral part of  the consolidated financial statements.

** **

 

** **

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1- OTHER INFORMATION**

The unaudited consolidated financial statements have beenprepared on a consistent basis and in accordance with the instructions to Form10-Q and do not include all of the information and notes required by generallyaccepted accounting principles for complete financial statements.  In theopinion of management, all adjustments considered necessary for a fairpresentation have been included.  These adjustments were of a normal, recurringnature and consistent with generally accepted accounting principles.  Forfurther information, refer to the consolidated financial statements and notesincluded in the annual report of First Farmers and Merchants Corporation (the"Corporation") on Form 10-K for the year ended December 31, 2006.

**NOTE 2 - STOCK REPURCHASE**

**           **During the second quarter of 2007, the Corporation repurchased,through negotiated transactions with third-party sellers, 15,008 shares of theCorporation's common stock at a price of $50 per share for an aggregatepurchase price of $750.4 thousand.  

**NOTE 3 - ACCOUNTING FORINCOME TAX UNCERTAINTIES  **

Financial Accounting Standards BoardInterpretation No. 48, "Accounting for Income Tax Uncertainties" ("FIN 48") wasissued in June 2006 and defines the threshold for recognizing the benefits oftax return positions in the financial statements as "more-likely-than-not" tobe sustained by the taxing authority.  FIN 48 also provides guidance on the derecognition,measurement and classification of income tax uncertainties, along with anyrelated interest and penalties and includes guidance concerning accounting forincome tax uncertainties in interim periods.  The Corporation adopted theprovisions of FIN 48 as of January 1, 2007 and determined that no adjustmentsto retained earnings resulted from such adoption.  The Corporation does notanticipate any material increase or decrease in unrecognized tax benefitsduring 2007 relative to any tax positions taken prior to January 1, 2007.

** **

** **

** **

** **

** **

** **

** **

** **

** **

 

 

 

** **

**Item 2.  Management'sDiscussion and Analysis of Financial Condition and Results of Operations.**

**FORWARD-LOOKING STATEMENTS**

    Certain statements contained in this report may not be based on historicalfacts and are "forward-looking statements" within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. These forward-looking statements may beidentified by, among other things, the use of forward-looking terminology suchas "anticipates," "could," "expects," "believes," "may" or "will," or future orconditional verb tenses, and variations or  negatives of such terms.  Theseforward-looking statements include, without limitation, those relating to unrecognizedtax benefits, concentrations within our loan portfolio, the payment ofdividends, the potential sale of available-for-sale securities, failure to meetand satisfaction of capital adequacy requirements, adequacy of capitalresources and traditional sources of cash generated from operating activitiesto meet liquidity needs, material capital expenditures, the effect offluctuating interest rates and deferred income tax assets.  We caution you notto place undue reliance on such forward-looking statements in this reportbecause results could differ materially from those anticipated due to a varietyof factors.  These factors include, but are not limited to, changes in economicconditions; fluctuations in prevailing interest rates and the effectiveness ofour risk monitoring systems; the ability of our borrowers to repay loans;adverse changes in our special mention credits; our ability to sellavailable-for-sale securities to fund increased loan demand; our ability tomeet regulatory capital adequacy requirements; our ability to meet liquidityneeds from operating activities; the accuracy of assumptions in our rate riskanalysis; our ability to recognize deferred tax assets; our ability to maintaincredit quality; our ability to provide market competitive products andservices; laws and regulations affecting financial institutions in general; ourability to control factors influencing net interest income; the geographicconcentration of our assets; our ability to maintain sufficient asset qualityand cost controls; and other factors generally understood to affect thefinancial results of financial services companies and other factors detailedfrom time to time in First Farmers and Merchants Corporation's filings with theSecurities and Exchange Commission. We undertake no obligation to update theseforward-looking statements to reflect events or circumstances that occur afterthe date of this report.

**OVERVIEW**

AtJune30, 2007, the consolidated total assets of First Farmers and MerchantsCorporation (the "Corporation") were $781.4 million, its consolidated net loanswere $488.6 million, its total deposits were $659.5 million and its totalshareholders' equity was $103.7 million.  The loan portfolio at June 30, 2007, increased$22.5 million, or 4.8%, compared to December 31, 2006.  The retail portion ofthe loan portfolio experienced a decrease of $1.2 million, or 0.44%, during thefirst six months of 2007 and the commercial portfolio increased 11.2% or $23.7million, which annualizes to a 22.4% growth rate during the same period.  Totaldeposits decreased $39.4 million, or 5.6%, and shareholders' equity decreased 0.1%during the first six months of 2007.  Total shareholders' equity includes anunrealized loss on available-for-sale securities of $1.8 million.

**FINANCIAL CONDITION**

Averageearning assets at June 30, 2007 were down 1.7% or $12.1 million from averageearning assets at December 31, 2006.  Average overnight investments at June 30, 2007 wereup $13.1 million compared to December 31, 2006.  Average investment securitiesat June 30, 2007 were down 14.6% compared to the average at December 31, 2006. Average total assets of $795.9 million at June 30, 2007 decreased 1.4% or $11.6 million, compared to$807.5 million at December 31, 2006.

**Securities**

Available-for-salesecurities are an integral part of the asset/liability management process for FirstFarmers and Merchants Bank, the Corporation's sole direct subsidiary (the "Bank"). These securities represent an important source of liquidity available to fundloans and accommodate asset reallocation strategies dictated by changes in the Bank'soperating and tax plans, shifting yield spread relationships and changes in configurationof the yield curve.  At June 30, 2007, the Bank's investment securities portfoliohad $137.8 million available-for-sale securities, which are valued at fairmarket value on the balance sheet, and $76.7 million held-to-maturitysecurities, which are valued at cost on the balance sheet.  These compare to $147.0million of available-for-sale securities and $81.2 million of held-to-maturitysecurities as of December 31, 2006.  The 6.3% decrease in available-for-salesecurities for the six months ended June 30, 2007 resulted from investing in the loanportfolio as securities matured.  The Bank may sell available-for-salesecurities to fund planned increased loan demand as needed.  

**Loans**

Theloan portfolio is the largest component of earning assets for the Bank and, consequently, provides the highest amount ofrevenues for the Corporation.  The loan portfolio also contains the highest exposure to risk as a result ofthe possibility of unexpected deterioration in the credit quality ofborrowers.  When analyzing a potential loan, management assesses both interestrate objectives and credit quality objectives in determining whether to make agiven loan and the appropriate pricing for that loan.  

Concentrationswithin the Bank's loan portfolio exist.  First mortgage loans, secured by one-to-fourfamily residential properties, represented 36.1% of the total loan portfolio atJune30, 2007.  The Bank recognizes this concentration, but management believes therisk is acceptable given the quality of underwriting and low level of historicalloss experience.  The Bank continues to manage not only its exposure to singleborrowers, but also its exposure to borrowers operating within the sameindustry.  Within the commercial loan portfolio, the Bank continues to reportheavy exposure in four broad industry categories: construction, real estaterenting and leasing, other services (churches) and public administration.   However,the Bank recognizes a concentration in one industry classification: real estaterental and leasing.  These loans totaled $53.0 million at June 30, 2007, whichrepresented 22.6% of total commercial loans.

Theanalysis and review of asset quality by the Bank's credit administrationincludes a formal review that evaluates the adequacy of the allowance forpossible loan losses.  This review is updated monthly and evaluated morecompletely on a quarterly basis in conjunction with loan review reports and evaluationsthat are discussed in meetings with loan officers, credit administration and theBank's Board of Directors.  The allowance forpossible loan and lease losses was $7.3 million, or 1.5% of gross loans, at June 30, 2007and December 31, 2006.  Net recoveries through June 30, 2007 were $34,000, whichresults in an annualized net charge-off ratio of negative 0.01%.

Aformal process is in place to provide control over underwriting of loans andmonitor loan collectibility.  This process includes education and training ofpersonnel on the Bank's loan policies and procedures, credit analysts tosupport lenders, timely identification of loans with adverse characteristics, controlof corrective actions and objective monitoring of loan reviews.  The Special AssetsDepartment of the Bank identifies and monitors assets that need attention.  At June 30, 2007, thisprocess identified loans totaling $7.2 million, or 1.5% of the portfolio, thatwere classified as other assets especially mentioned, compared to loans totaling$6.5 million, or 1.4 % , so classified at December 31, 2006.  Loans totaling $8.1million, or 1.6% of the portfolio, were classified as substandard at June 30, 2007,compared to loans totaling $8.4 million, or 1.8%, so classified at December 31,2006.  No loans were classified as doubtful at June 30, 2007 or December 31, 2006.

**Deposits**

            The Bank doesnot have any foreign offices and all deposits are serviced in its 19 domesticoffices.  The Bank's average deposits declined 1.6% during the first six monthsof 2007 compared to a decline of 2.1% in the first six months of 2006.  Thedecline slowed primarily because of a re-focused effort on "retail" customerdeposits.  Average total noninterest-bearing deposits were 17.7% of totaldeposits at June 30, 2007, contributing to the Bank's low cost ofdeposits.  This compares to 16.7% at December 31, 2006.

**RegulatoryRequirements for Capital**

TheCorporation and the Bank are subject to federal regulatory risk-adjustedcapital adequacy standards.  Failure to meet capital adequacy requirementscould result in certain mandatory and possibly additional discretionary actionsby regulators that could have a material adverse effect on the financialcondition and results of operations of the Corporation and the Bank.  Federal regulationsrequire the Bank to meet specific capital adequacy guidelines that involvequantitative measures of assets, liabilities and certain off-balance-sheetitems as calculated under regulatory accounting practices.  The capital classificationis also subject to qualitative judgments by the regulators about components,risk weightings and other factors.

            Quantitativemeasures established by the Board of Governors of the Federal Reserve System toensure capital adequacy require the Corporation and the Bank to maintainminimum amounts and ratios of Tier 1 Capital and Total Capital (Tier 1 plusTier 2 Capital) to risk-weighted assets and of Tier 1 Capital to average total assets(leverage capital ratio).   Equity capital (net of certain adjustments forintangible assets and investments in non-consolidated subsidiaries and certainclasses of preferred stock) is considered Tier 1 Capital.  Tier 2 Capitalconsists of core capital plus subordinated debt, some types of preferred stock,and a defined percentage of the allowance for possible loan losses.  To be"well-capitalized" under federal regulations, a bank holding company must havea Tier 1 Capital ratio of at least 6%, a Total Capital ratio of at least 10%,and a leverage capital ratio of at least 5%.  As of June 30, 2007, the Corporation's Tier 1, Total Capital andleverage capital ratios were 17.7%, 19.0% and 12.1 %, respectively.  Theseratios were 19.1%, 20.3% and 12.5%, respectively, at December 31, 2006.  As of June 30, 2007,the Bank's Tier 1 Capital, Total Capital and leverage capital ratios were 17.4%,18.6%, and 11.9%, respectively, compared to 18.9%, 20.2%, and 12.3% at December31, 2006. Management believes, as of June 30, 2007, that the Corporation and the Bank each metall capital adequacy requirements to which they are subject.

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

            Most of thecapital needs of the Bank have historically been financed with retainedearnings and deposits received and the Corporation's primary source ofliquidity is dividends declared by the Bank.  The Corporation and the Bank haveplans for material capital expenditures in the near future.  Management plansto build a branch in Franklin and Dickson, Tennessee.  Land has been purchasedfor both branches and building is anticipated to begin in 2008 for Dickson and2010 for Franklin.  The Corporation's average shareholders' equity at June 30, 2007 was $106.5 million, a 1.1%increase from the average at December 31, 2006.  

            The Bank issubject to Tennessee statutes and regulations that impose restrictions on theamount of dividends that may be declared.  Furthermore, any dividend paymentsare subject to the continuing ability of the Bank to maintain its compliancewith minimum federal regulatory capital requirements and to retain itscharacterization under federal regulations as a "well-capitalized" institution.The Corporation declared a $0.345 per share dividend in the second quarter of2007, which will be  paid in the third quarter of 2007.  Management believesthat the Corporation's traditional sources of cash generated from the Bank's operatingactivities are adequate to meet the Corporation's liquidity needs for normalongoing operations.  The Bank's Board of Directors has adopted a liquiditypolicy that outlines specific liquidity target balances.  Compliance with thispolicy is reviewed quarterly by the Bank's Asset/Liability Committee andresults are reported to the Bank's Board of Directors.

TheBank maintains a formal asset and liability management process to controlinterest rate risk and assist management in maintaining reasonable stability inthe gross interest margin as a result of changes in the level of interest ratesand/or the spread relationships among interest rates.  The Bank uses anearnings simulation model to evaluate the impact of different interest ratescenarios on the gross margin.  Each quarter, the Asset/Liability Committee ofthe Bank monitors the relationship of rate sensitive earning assets to ratesensitive interest bearing liabilities (interest rate sensitivity), which isthe principal factor in determining the effect that fluctuating interest rateswill have on future net interest income.  Rate sensitive earning assets andinterest bearing liabilities are financial instruments that can be repriced tocurrent market rates within a defined time period.

 

 

**Critical AccountingPolicies**

Theaccounting principles the Corporation follows and the methods of applying theseprinciples conform with accounting principles generally accepted in the United States and with general practices within the banking industry.  In connection withthe application of those principles, the Corporation's management has madejudgments and estimates that, in the case of the determination of the allowancefor loan losses ("ALLL") and the recognition of deferred income taxassets, have been critical to the determination of the Corporation's financialposition, results of operations, and cash flows.  

*Allowance for Loan Losses*

           The Bank's managementassesses the adequacy of the ALLL prior to the end of each month and prepares amore formal review quarterly to assess the risk in the Bank's loan portfolio. This assessment includes procedures to estimate the allowance and test theadequacy and appropriateness of the resulting balance.  The ALLL representscalculated amounts for specifically identified credit exposure and exposuresreadily predictable by historical or comparative experience.  Even though thiscalculation considers specific credits, the entire allowance is available toabsorb any credit losses. 

           These calculatedamounts are determined by assessing loans identified as not in compliance withloan agreements.  These loans are generally in two different risk groups.  Onegroup is unique loans (commercial loans, including those loans consideredimpaired) and the second group is pools of homogenous loans (generally retailloans).  The calculation for unique loans is based primarily on risk ratinggrades assigned to each of these loans as a result of the Bank's loanmanagement 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 amountallocated for an impaired loan is based on estimated cash flows discounted atthe loan's original effective interest rate or the underlying collateralvalue.  Historical data, including actual loss experience on specific types ofhomogenous loans, is used to allocate amounts for loans or groups of loansmeeting the specified criteria.  More detailed historical data is accumulatedby category of consumer credit and performance characteristics to broaden theanalysis and improve monitoring of potential credit risk.

     Criteria considered andprocesses utilized in evaluating the adequacy of the ALLL are:

*        Portfolio quality trends;

*        Changes in the nature and volumeof the portfolio;

*        Present and prospective economicand business conditions, locally and nationally;

*        Management review systems andboard oversight, including external loan review processes;

*        Changes in credit policy, creditadministration, portfolio management and procedures; and

*        Changes in personnel, managementand staff.  

           In assessing theadequacy of the ALLL, the risk characteristics of the entire loan portfolio areevaluated.  This process includes the judgment of the Bank's management, inputfrom independent loan reviews and reviews that may have been conducted by bankregulators as part of their usual examination process.

*Deferred Income TaxAssets*

Deferredincome tax assets consist mainly of the tax effect of excess provisions forloan losses over actual losses incurred and deferred compensation.  Managementbelieves that it is more likely than not that these assets will be realized infuture years.  As of June 30, 2007, the deferred income tax asset was $6.6million, which is included with other assets on the balance sheet.  Thiscompares to $6.1 million as of December 31, 2006 and $5.4 million as of June30, 2006.

** **

**OFF-BALANCE SHEET 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.  Thesefinancial instruments include commitments to extend credit and stand-by lettersof credit.  Those instruments involve, to varying degrees, elements of creditrisk in excess of the amount recognized in the balance sheet.  The contract ornotional amounts of those instruments reflect the extent of involvement the Bankhas in those financial instruments.  The total outstanding loan commitments andstand-by letters of credit in the normal course of business at June 30, 2007were $102.8 million and $12.6 million, respectively, compared to $83.6 millionand $10.1 million at June 30, 2006.  The increase in stand-by letters of creditof approximately $2.0 million is a result of additional business from existinglarge commercial customers.   A loan commitment is an agreement to lend to acustomer as long as there is not a violation of any condition established inthe contract.  A stand-by letter of credit is a conditional commitment issuedby the Bank to guarantee the performance of a customer to a third party.  Thoseguarantees are primarily issued to support public and private borrowingarrangements, including commercial paper, bond financing and similartransactions.  The credit risk involved in issuing letters of credit isessentially the same as that involved in making a loan.

AtJune 30, 2007, 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 six months of 2007 was $21.5 million compared to $20.8million for the first six months of 2006.  Total interest income for the threemonths ended June 30, 2007 was $10.9 million compared to $10.7 million for thethree months ended June 30, 2006.  Interest and fees earned on loans andinvestments are the components of total interest income.  Interest and feesearned on loans were $16.3 million, an increase of approximately $1.1 million,or 7.6%, during the first six months of 2007 compared to the first six monthsof 2006 and were $8.3 for the three months ended June 30, 2007, an increase of$0.5 million, or 5.9%, compared to the three months ended June 30, 2006.  Nominalinterest earned on investment securities and other investments was $4.7million, a decrease of approximately $0.9 million, or 16.0% during the first sixmonths of 2007 compared to the first six months of 2006.  Nominal interestearned on investment securities and other investments for the three months endedJune 30, 2007 was $2.3 million compared to $2.8 million for three months endedJune 30, 2006, as a result of the reduced volume of investment securities.

            Total interestexpense in the first six months of 2007 was $8.0 million, an increase of approximately$1.7 million, or 27.8%, compared to the first six months of 2006.  Total interest expense in the three months endedJune 30, 2007 increased $0.8 million, or 24.4%, compared to the three monthsended June 30, 2006.  A slight increase in the "certificates of deposits under$100,000" category and higher interest rates paid are reasons for the higherinterest expense.  As a policy, budgeted financial goals are monitored on amonthly basis by the Bank's Asset/Liability Committee, which reviews the actualdollar change in net interest income for different interest rate movements.  Anegative dollar change in net interest income for a 12-month period of less than 4.5% of net interest income givena 300 basis point shift in interest rates isconsidered an acceptable rate risk position.  The rate risk analysis for the 12-monthperiod beginning July 1, 2007 and ending June 30, 2008 showed a worst-casepotential change to net interest income of a negative 2.5%, or a potential declinein net interest income of approximately $0.7 million, by the end of the period.

            Net interestincome of the Corporation on a fully taxable equivalent basis is influencedprimarily by changes in:

(1)               the volume and mix of earningassets and sources of funding;

(2)               market rates of interest; and 

(3)               income tax rates.

            The impact ofsome of these factors can be controlled by management policies and actions. External factors also can have a significant impact on changes in net interestincome from one period to another.  Some examples of such factors are:

(1)               the strength of credit demands bycustomers;

(2)               Federal Reserve Board monetarypolicy; and

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

            The netinterest margin, on a tax equivalent basis, at June 30, 2007, June 30,2006 and December, 31, 2006 was 4.03%, 4.26% and 4.22%, respectively.

            No additionswere made to the allowance for loan losses in the second quarter of 2007.  

            Noninterest income was $5.8 million, an increase of approximately$0.3 million, or 4.8%, during the first six months of 2007 compared to thefirst six months of 2006.  Noninterest income was $3.0 million, an increase ofapproximately $32,000, or 1.1%, during the second quarter of 2007 compared tothe second quarter of 2006.   This increase resulted from:

(1)   income from services provided inthe Bank's trust department, which was up 17.6% compared to the first six monthsof 2006 and represented approximately 23.1% of noninterest income; and

(2)   service fees, representing approximately63.4% of noninterest income, which were down 3.5% compared to the first sixmonths of 2006, offset part of the increase in trust services income.

Noninterestexpenses, excluding the provision for possible loan losses, were approximately $1.5million, or 9.8%, lower in the first six months of 2007 as compared to thefirst six months of 2006, primarily due to salaries and benefits expense being down$0.8 million, or 9.9%, for the six months ended June 30, 2007 compared to thesame period in 2006.  Noninterest expenses decreased 12.1% during the secondquarter 2007 compared to the second quarter 2006, which is primarily a resultof changes to the Bank's insurance and retirement benefits.     

TheCorporation and the Bank do not have any long-term debt or other long-term obligations,with the exception of leases for bank property.  There has not been a change duringthe six month period ended June 30, 2007 in the terms of these leases.

Netincome for the six months ended June 30, 2007 was $4.1 million, compared to $3.6 million forthe six months ended June 30, 2006.  Net income for the three months ending June30, 2007 was $2.0 million compared to $1.9 million for the three months endingJune 30, 2006.  These increases in net income are primarily because of a decreasein salaries and benefits along with an increase in fiduciary services income.  The Corporation earned $0.71 per share in the secondquarter of 2007 and $0.61 per share in the second quarter of 2006.  

**Item 3.  Quantitativeand Qualitative Disclosures About Market Risk.**

Duringthe six months ended June 30, 2007, there were no materialchanges in the quantitative and qualitative disclosures about market riskpresented in the Corporation's Annual Report on Form 10-K for the year endedDecember 31, 2006. 

**Item 4. Controls andProcedures.**

(a) Evaluation ofDisclosure Controls and Procedures.  The Corporation, with theparticipation of its management, including the Corporation's Chief ExecutiveOfficer and Assistant Treasurer (principal financial officer), carried out anevaluation of the effectiveness of the design and operation of its disclosurecontrols and procedures (as defined in Rules 13a-15 and 15d-15 under theSecurities Exchange Act of 1934, as amended (the "Exchange Act")) as of the endof the period covered by this report.  Based upon that evaluation and as of theend of the period covered by this report, the Corporation's Chief ExecutiveOfficer and Assistant Treasurer (principal financial officer) concluded thatthe Corporation's disclosure controls and procedures were effective in ensuringthat information required to be disclosed in its reports that the Corporationfiles or submits to the Securities and Exchange Commission under the ExchangeAct is recorded, processed, summarized and reported on a timely basis.

 

(b) Changes in InternalControl Over Financial Reporting.  There has been no change in the Corporation'sinternal control over financial reporting that occurred during the secondquarter of 2007 that has materially affected, or is reasonably likely tomaterially affect, the Corporation's internal control over financial reporting.

** **

** **

**PART II - OTHER INFORMATION**

**Item1A. Risk Factors.**

Therehave been no material changes in the risk factors previously disclosed in theCorporation's Annual Report on Form 10-K for the year ended December 31, 2006.

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

                The following table provides information regardingpurchases of the Corporation's common stock made by the Corporation during thesecond quarter of 2007:

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

April 1, 2007 - April 30,  2007

            2,000 *

$50.00

--

--

May 1, 2007 - May 31,  2007

--

--

--

--

June 1, 2007 - June 30,  2007

          13,008 *

$50.00

--

--

Total

          15,008

$50.00

--

--

*Purchasedthrough negotiated transactions with third-party sellers.

** **

** **

** **

 

 

 

 

 

 

 

**Item 4. Submission ofMatters to a Vote of Security Holders.**

            The annualmeeting for shareholders of the Corporation was held on Tuesday, April 17,2007.  At the meeting, the Corporation's shareholders voted to elect directors.At the meeting, votes were cast as follows:

Votes For

Votes Withheld

Abstentions/Broker  Non-Votes

Kenneth A. Abercrombie

3,986,525 

2,578

1,770,897

James L. Bailey, Jr.

3,982,140 

6,963

1,770,897

M. Darlene Baxter

3,987,925 

1,178

1,770,897

Hulet M. Chaney

3,986,425 

2,678

1,770,897

H. Terry Cook, Jr.

3,986,525 

2,578

1,770,897

Thomas Napier Gordon

3,934,069 

55,034

1,770,897

Dr. O. Rebecca Hawkins

3,986,181 

2,922

1,770,897

Dr. Joseph W. Remke, III

3,985,845 

3,258

1,770,897

T. Randy Stevens

3,986,120 

2,983

1,770,897

John P. Tomlinson, III

3,965,160 

23,943

1,770,897

W. Lacy Upchurch

3,985,825 

3,278

1,770,897

William R. Walter

3,985,233 

3,870

1,770,897

Dan C. Wheeler

3,986,505 

2,598

1,770,897

Dr. David S. Williams

3,986,505 

2,598

1,770,897

W. Donald Wright

3,985,633 

3,470

1,770,897

James E. York

3,985,313 

3,790

1,770,897

            As indicated inthe above table, Kenneth A. Abercrombie, James L. Bailey, Jr., M. DarleneBaxter, Hulet M. Chaney, H. Terry Cook, Jr., Tom Napier Gordon, Dr. O. RebeccaHawkins, Dr. Joseph W. Remke, III, T. Randy Stevens, John P. Tomlinson, III, W.Lacy Upchurch, William R. Walter, Dan C. Wheeler, Dr. David S. Williams, W.Donald Wright and James E. York were elected as directors of the Corporation.The terms of the directors will continue until the annual meeting ofshareholders in 2008, or until their respective successors are elected andqualified.

**Item 6.  Exhibits.**

EXHIBIT

NUMBER          DESCRIPTION

     3.1     Charter (1)

     3.2     Articles ofAmendment to Charter (1)

     3.3     Amended andRestated By-laws (2)

     4.1     Form ofSpecimen Stock Certificate (1)

   31.1     Certificationof the Chief Executive Officer of First Farmers and Merchants CorporationPursuant to Rule 13a

                14(1) ofthe Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section302 of the 

                Sarbanes-OxleyAct of 2002

    31.2    Certification of the Chief FinancialOfficer of First Farmers and Merchants Corporation Pursuant to Rule 13a-14(1)of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

    32.1    Certification of the Chief ExecutiveOfficer and Chief Financial Officer of First Farmers and Merchants CorporationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

                              

(1)  Incorporated byreference from the First Farmers and Merchants Corporation Amendment No. 1 tothe Annual Report on Form 10-K/A for the year ended December 31, 2003, FileNumber 000-10972, as filed with the Securities and Exchange Commission on May 7,2004.

(2)  Incorporated byreference from the First Farmers and Merchants Corporation Current Report onForm 8-K,  File Number 000-10972, as filed with the Securities and ExchangeCommission on April 23, 2007.

**SIGNATURES**

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

FIRST FARMERS AND MERCHANTS CORPORATION

(Registrant)

Date             August8, 2007                                                      /s/ T.Randy Stevens                                

                                    T. Randy Stevens,Chief Executive Officer

Date             August8, 2007                                              /s/ Patricia P. Bearden                                      

PatriciaP. Bearden, Assistant Treasurer (principal financial officer andprincipal accounting officer)

 

EXHIBIT

NUMBER          DESCRIPTION

     3.1     Charter (1)

     3.2     Articles ofAmendment to Charter (1)

     3.3     Amended andRestated By-laws (2)

     4.1     Form of SpecimenStock Certificate (1)

   31.1     Certification of the Chief ExecutiveOfficer of First Farmers and Merchants Corporation Pursuant to Rule 13a- 14(1)of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

    31.2    Certification of the Chief FinancialOfficer of First Farmers and Merchants Corporation Pursuant to Rule 13a-14(1)of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

    32.1    Certification of the Chief ExecutiveOfficer and Chief Financial Officer of First Farmers and Merchants CorporationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

                               

(1)  Incorporated byreference from the First Farmers and Merchants Corporation Amendment No. 1 tothe Annual Report on Form 10-K/A for the year ended December 31, 2003, FileNumber 000-10972, as filed with the Securities and Exchange Commission on May 7,2004.

(2)  Incorporated byreference from the First Farmers and Merchants Corporation Current Report onForm 8-K,  File Number 000-10972, as filed with the Securities and ExchangeCommission on April 23, 2007. |
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