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**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  June 30, 2008** |
|                                                   |       |                                                                                                     |
| **or**                                                 |
|                                                   |       |                                                                                                     |
| **o**                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from                         to                         **

 

**Commission File Numbers:****000-10972**

 

**First Farmers and Merchants Corporation**

(Exact name ofregistrant as specified in its charter)

 

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

 

**931-388-3145**

(Registrant’stelephone number, including area code)

 

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    x 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 (Do not check if a smaller reporting  company) |   | Smaller reporting company  o |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct). o Yes x No

 

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

5,624,643 sharesof common stock as of August 7, 2008

 

 

** **

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**PART I - FINANCIAL INFORMATIO****N**

 

**Item 1. Financial Statements.**

 
|   | The following unaudited  consolidated financial statements of the Registrant and its subsidiaries are  included in this Report: |
|--------|---------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                            |
|   | Consolidated  balance sheets – June 30, 2008 and December 31, 2007.                                              |
|   |                                                                                                                            |
|   | Consolidated  statements of income - For the three months and six months ended  June 30, 2008 and June 30, 2007.      |
|   |                                                                                                                            |
|   | Consolidated statements of cash flows - For the six months ended June 30, 2008  and June 30, 2007.                    |
|   |                                                                                                                            |
|   | Selected notes to consolidated financial statements.                                                                            |
|   |                                                                                                                            |

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**FIRSTFARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                      | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|-------------|-----------------------|------------|
| **(Dollars in Thousands, Except Per Share Data)**                                                                                                                 | ** ** | **2008**          | ** **  | **2007**              | ** ** |
| ** **                                                                                                                                                                                      | ** ** | **(Unaudited)**   | ** **  | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                      |       |              |        |                  |       |
| Cash and due  from banks                                                                                                                                                                        | ** ** | **$**             | **30,435**  |                  | $          | 35,097 |   |
| Interest-bearing  due from banks                                                                                                                                                                | ** ** | **2,148**         |        | 176                   |       |
| Federal funds  sold                                                                                                                                                                             | ** ** | **29,025**        |        | 600                   |       |
| Total cash and  cash equivalents                                                                                                                                                                | ** ** | **61,608**        |        | 35,873                |       |
| Securities                                                                                                                                                                                      |       |              |        |                  |       |
| Available-for-sale  (amortized cost $169,064 and $163,050, respectively)                                                                                                                        |       | **164,735**       |        | 163,911               |       |
| Held-to-maturity  (fair market value $68,389 and $76,460, respectively)                                                                                                                         |       | **68,145**        |        | 75,565                |       |
| Total Securities                                                                                                                                                                                | ** ** | **232,880**       |        | 239,476               |       |
| Loans, net of  deferred fees                                                                                                                                                                    | ** ** | **534,525**       |        | 500,143               |       |
| Allowance for  loan losses                                                                                                                                                                      | ** ** | **(7,692**        | **)**       | (7,381                | )          |
| Net loans                                                                                                                                                                                       | ** ** | **526,833**       |        | 492,762               |       |
| Bank premises  and equipment, at cost less allowance for depreciation                                                                                                                           |       | **14,769**        |        | 14,306                |       |
| Core deposit and  other intangibles                                                                                                                                                             | ** ** | **9,223**         |        | 9,318                 |       |
| Other assets                                                                                                                                                                                    | ** ** | **34,320**        |        | 31,311                |       |
| TOTAL ASSETS                                                                                                                                                                                    | ** ** | **$**             | **879,633** |                  | $          | 823,046 |   |
|                                                                                                                                                                                            |       |              |        |                  |       |
| **LIABILITIES**                                                                                                                                                                                 |       |              |        |                  |       |
| Deposits                                                                                                                                                                                        |       |              |        |                  |       |
| Noninterest-bearing                                                                                                                                                                             | ** ** | **$**             | **157,825** |                  | $          | 131,043 |   |
| Interest-bearing  (including certificates of deposits over $100: 2008 - $80,329; 2007 -  $107,398)                                                                                              |       | **563,319**       |        | 567,916               |       |
| Total deposits                                                                                                                                                                                  | ** ** | **721,144**       |        | 698,959               |       |
| Federal funds  purchased and securities sold under agreements to repurchase                                                                                                                     |       | **2,638**         |        | 2,507                 |       |
| Dividends  payable                                                                                                                                                                              | ** ** | **1,997**         |        | 1,991                 |       |
| Short-term  borrowings                                                                                                                                                                          | ** ** | **600**           |        | 600                   |       |
| Accounts payable  and accrued liabilities                                                                                                                                                       | ** ** | **49,864**        |        | 12,650                |       |
| Minority  interest in consolidated subsidiary                                                                                                                                                   | ** ** | **95**            |        | 95                    |       |
| TOTAL  LIABILITIES                                                                                                                                                                              | ** ** | **776,338**       |        | 716,802               |       |
| **SHAREHOLDERS’****EQUITY**                                                                                                                                                                |       |              |        |                  |       |
| Common stock -  $10 par value per share, 8,000,000 shares authorized; 5,624,463 and 5,680,000  shares issued and outstanding as of June 30, 2008 and December 31,  2007, respectively |       | **56,245**        |        | 56,800                |       |
| Retained  earnings                                                                                                                                                                              | ** ** | **49,702**        |        | 48,916                |       |
| Accumulated  other comprehensive income                                                                                                                                                         | ** ** | **(2,652**        | **)**       | 528                   |       |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                                                                                | ** ** | **103,295**       |        | 106,244               |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                |       | **$**             | 879,633     |                  | $          | 823,046 |   |

 

----

(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**

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(Dollars in Thousands, Except Per Share Data)** | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(Unaudited)**                                                                 | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                      | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **INTEREST  AND DIVIDEND INCOME**                                               |       |                             |       |                           |       |   |   |   |   |
| Interest and  fees on loans                                                     | ** ** | **$**                            | **8,141**  |                           | $          | 8,313 | ** ** | **$** | **16,477** |   | $ | 16,266 |   |
| Income on  investment securities                                                |       |                             |       |                           |       |   |   |   |   |
| Taxable interest                                                                | ** ** | **1,775**                        |       | 1,315                          | ** ** | **3,301** |   | 2,598 |   |
| Exempt from  federal income tax                                                 | ** ** | **939**                          |       | 958                            | ** ** | **1,958** |   | 1,981 |   |
| Dividends                                                                       | ** ** | **53**                           |       | 44                             | ** ** | **106** |   | 107 |   |
| ** **                                                                      |       | **2,767**                        |       | 2,317                          | ** ** | **5,365** |   | 4,686 |   |
| Other interest  income                                                          | ** ** | **77**                           |       | 287                            | ** ** | **128** |   | 595 |   |
| TOTAL INTEREST  INCOME                                                          | ** ** | **10,985**                       |       | 10,917                         | ** ** | **21,970** |   | 21,547 |   |
| **INTEREST  EXPENSE**                                                           |       |                             |       |                           |       |   |   |   |   |
| Interest on  deposits                                                           | ** ** | **2,929**                        |       | 3,969                          | ** ** | **6,265** |   | 7,964 |   |
| Interest on  other short term borrowings                                        | ** ** | **193**                          |       | 42                             | ** ** | **244** |   | 73 |   |
| TOTAL INTEREST  EXPENSE                                                         | ** ** | **3,122**                        |       | 4,011                          | ** ** | **6,509** |   | 8,037 |   |
| NET INTEREST  INCOME                                                            | ** ** | **7,863**                        |       | 6,906                          | ** ** | **15,461** |   | 13,510 |   |
| PROVISION FOR  POSSIBLE LOAN AND LEASE LOSSES                                   | ** ** | **—**                       |       | —                         | ** ** | **—** |   | — |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES                  | ** ** | **7,863**                        |       | 6,906                          | ** ** | **15,461** |   | 13,510 |   |
| **NONINTEREST  INCOME**                                                         |       |                             |       |                           |       |   |   |   |   |
| Trust department  income                                                        | ** ** | **609**                          |       | 642                            | ** ** | **1,256** |   | 1,349 |   |
| Service fees on  deposit accounts                                               | ** ** | **1,964**                        |       | 1,952                          | ** ** | **3,836** |   | 3,705 |   |
| Other fees and  commissions                                                     | ** ** | **135**                          |       | 166                            | ** ** | **237** |   | 296 |   |
| Other operating  income                                                         | ** ** | **290**                          |       | 222                            | ** ** | **413** |   | 496 |   |
| Securities gains                                                                | ** ** | **120**                          |       | —                         | ** ** | **1,128** |   | — |   |
| TOTAL  NONINTEREST INCOME                                                       | ** ** | **3,118**                        |       | 2,982                          | ** ** | **6,870** |   | 5,846 |   |
| **NONINTEREST  EXPENSE**                                                        |       |                             |       |                           |       |   |   |   |   |
| Salaries and  employee benefits                                                 | ** ** | **4,296**                        |       | 3,784                          | ** ** | **8,579** |   | 7,521 |   |
| Net occupancy  expense                                                          | ** ** | **638**                          |       | 552                            | ** ** | **1,240** |   | 1,095 |   |
| Furniture and  equipment expense                                                | ** ** | **275**                          |       | 261                            | ** ** | **502** |   | 538 |   |
| Other operating  expenses                                                       | ** ** | **2,798**                        |       | 2,545                          | ** ** | **5,500** |   | 5,126 |   |
| TOTAL  NONINTEREST EXPENSES                                                     | ** ** | **8,007**                        |       | 7,142                          | ** ** | **15,821** |   | 14,280 |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES                                       | ** ** | **2,974**                        |       | 2,746                          | ** ** | **6,510** |   | 5,076 |   |
| PROVISION FOR  INCOME TAXES                                                     | ** ** | **458**                          |       | 699                            | ** ** | **1,246** |   | 983 |   |
| NET INCOME                                                                      | ** ** | **$**                            | **2,516**  |                           | $          | 2,047 | ** ** | **$** | **5,264** |   | $ | 4,093 |   |
| **BASIC  EARNINGS PER SHARE**                                                   |       |                             |       |                           |       |   |   |   |   |
| Weighted Average  Shares Outstanding                                            | ** ** | **5,648,732**                    |       | 5,736,645                      | ** ** | **5,662,428** |   | 5,746,892 |   |
| ** **                                                                      |       | **$**                            | **0.45**   |                           | $          | 0.36 | ** ** | **$** | **0.93** |   | $ | 0.71 |   |

 

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

 

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**FIRSTFARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| **(Dollars in Thousands)**                                              | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **(Unaudited)**                                                                   | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| **OPERATING  ACTIVITIES**                                                         |       |                                              | ** ** |   |   |
| Net income                                                                        | ** ** | **$**                                             | **5,264**  | ** ** | $ | 4,093 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Excess  (deficiency) of provision for possible loan losses over net charge-offs   |       | **311**                                           | ** ** | 34 |   |
| Provision for  depreciation and amortization of premises and equipment            |       | **526**                                           | ** ** | 473 |   |
| Securities gains                                                                  | ** ** | **(1,128**                                        | **)**      | — |   |
| Loss from  disposition of other real estate                                       | ** ** | **283**                                           | ** ** | — |   |
| Amortization of  deposit base intangibles                                         | ** ** | **95**                                            | ** ** | 403 |   |
| Amortization of  investment security premiums,                                    | ** ** | **—**                                        | ** ** | — |   |
| net of accretion  of discounts                                                    | ** ** | **180**                                           | ** ** | 325 |   |
| Increase in cash  surrender value of life insurance contracts                     | ** ** | **(776**                                          | **)**      | (948 | ) |
| (Increase)  decrease in                                                           |       |                                              | ** ** |   |   |
| Deferred income  taxes                                                            |       | **(266**                                          | **)**      | (165 | ) |
| Interest  receivable                                                              | ** ** | **444**                                           | ** ** | 102 |   |
| Other assets                                                                      | ** ** | **(382**                                          | **)**      | (356 | ) |
| Increase  (decrease) in                                                           |       |                                              | ** ** |   |   |
| Interest payable                                                                  |       | **(362**                                          | **)**      | (205 | ) |
| Other  liabilities                                                                | ** ** | **2,308**                                         | ** ** | 1,346 |   |
| Total  adjustments                                                                | ** ** | **1,233**                                         | ** ** | 1,009 |   |
| Net cash  provided by operating activities                                        | ** ** | **6,497**                                         | ** ** | 5,102 |   |
| **INVESTING  ACTIVITIES**                                                         |       |                                              | ** ** |   |   |
| Proceeds from  maturities, calls, and sales of available-for-sale securities      |       | **85,880**                                        | ** ** | 16,049 |   |
| Proceeds from  maturities and calls of held-to-maturity securities                | ** ** | **7,372**                                         | ** ** | 4,440 |   |
| Purchases of  investment securities                                               |       |                                              | ** ** |   |   |
| Available-for-sale                                                                |       | **(90,889**                                       | **)**      | (6,320 | ) |
| Held-to-maturity                                                                  | ** ** | **—**                                        | ** ** | (1,693 | ) |
| Net increase in  loans                                                            | ** ** | **(34,382**                                       | **)**      | (22,506 | ) |
| Proceeds from  sale of other real estate owned                                    | ** ** | **385**                                           | ** ** | — |   |
| Purchase of life  insurance premium                                               | ** ** | **(696**                                          | **)**      | (676 | ) |
| Purchases of  premises and equipment                                              | ** ** | **(989**                                          | **)**      | (305 | ) |
| Net cash used in  investing activities                                            | ** ** | **(33,319**                                       | **)**      | (11,011 | ) |
| **FINANCING  ACTIVITIES**                                                         |       |                                              | ** ** |   |   |
| Net increase  (decrease) in noninterest-bearing and interest-bearing deposits     |       | **22,185**                                        | ** ** | (39,419 | ) |
| Net increase  (decrease) in short term borrowings                                 | ** ** | **131**                                           | ** ** | (375 | ) |
| Proceeds from  FHLB borrowings                                                    | ** ** | **35,000**                                        | ** ** | — |   |
| Proceeds from  sale of minority interest in a controlled subsidiary               | ** ** | **—**                                        | ** ** | 95 |   |
| Repurchase of  Common Stock                                                       | ** ** | **(2,768**                                        | **)**      | (1,650 | ) |
| Cash dividends                                                                    | ** ** | **(1,991**                                        | **)**      | (1,971 | ) |
| Net cash (used  in) provided by financing activities                              | ** ** | **52,557**                                        | ** ** | (43,320 | ) |
| Increase  (decrease) in cash and cash equivalents                                 | ** ** | **25,735**                                        | ** ** | (49,229 | ) |
| Cash and cash  equivalents at beginning of period                                 | ** ** | **35,873**                                        | ** ** | 74,981 |   |
| Cash and cash  equivalents at end of period                                       | ** ** | **$**                                             | **61,608** | ** ** | $ | 25,752 |   |

 

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**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 U.S. 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 U.S. 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, 2007.

 

**NOTE 2 – STOCK REPURCHASE**

 

Duringthe second quarter of 2008, the Corporation repurchased, through negotiatedtransactions with third-party sellers, 35,357 shares of the Corporation’scommon stock at a price of $50 per share for an aggregate purchase price of$1.8 million.

 

**NOTE 3 – FAIR VALUE MEASUREMENT**

 

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

 

In February of 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities” (“SFAS 159”), which gives entities the option tomeasure eligible financial assets and financial liabilities at fair value on aninstrument by instrument basis, that are otherwise not permitted to beaccounted for at fair value under other accounting standards. The election touse the fair value option is available when an entity first recognizes afinancial asset or financial liability. Subsequent changes in fair value mustbe recorded in earnings. This statement is effective as of the beginning of acompany’s first fiscal year after November 15, 2007. The adoption of SFAS No. 159did not have a significant impact on the Corporation’s consolidated financialstatements. The Corporation also adopted SFAS 159 effective January 1,2008, but did not elect the fair value option for any financial instrument notpresently being accounted for at fair value.

 

The Corporation and its wholly-owned subsidiary, FirstFarmers and Merchants Bank (the “Bank”), has an established process fordetermining fair values. Fair value is based upon quoted market 

 

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prices, where available. If listed prices or quotes are not available,fair value is based upon internally developed models or processes that useprimarily market-based or independently-sourced market data, including interestrate yield curves, option volatilities and third party information. Valuationadjustments may be made to ensure that financial instruments are recorded atfair value. These adjustments include amounts to reflect counterparty creditquality (for financial assets reflected at fair value), the Bank’screditworthiness (for financial liabilities reflected at fair value), liquidityand other unobservable parameters that are applied consistently over time asfollows:

 

·                  Credit valuation adjustments are necessary when themarket price (or parameter) is not indicative of the credit quality of thecounterparty;

 

·                  Debit valuation adjustments are necessary to reflectthe credit quality of Bank in the valuation of liabilities measured at fairvalue;

 

·                  Liquidity valuation adjustments are necessary when theBank may not be able to observe a recent market price for a financial instrumentthat trades in inactive (or less active) markets or to reflect the cost ofexiting larger-than-normal market-size risk positions; and

 

·                  Unobservable parameter valuation adjustments arenecessary when positions are valued using internally developed models that useas their basis unobservable parameters – that is, parameters that must beestimated and are, therefore, subject to management judgment to substantiatethe model valuation. These financial instruments are normally traded lessactively.

 

The methods described above may produce a fair valuecalculation that may not be indicative of net realizable value or reflective offuture fair values. Furthermore, while management of the Corporation believesthat the Corporation’s valuation methods are appropriate and consistent withother market participants, the use of different methodologies or assumptions todetermine the fair value of certain financial instruments could result in adifferent estimate of fair value at the reporting date.

 

**Valuation Hierarchy**

 

SFAS 157 establishes a three-level valuation hierarchyfor disclosure of fair value measurements. The valuation hierarchy is basedupon the transparency of inputs to the valuation of an asset or liability as ofthe measurement date. The three levels are defined as follows:

 

·                  Level 1 – inputs to the valuation methodology arequoted prices (unadjusted) for identical assets or liabilities in activemarkets;

 

·                  Level 2 – inputs to the valuation methodology includequoted prices for similar assets and liabilities in active markets, and inputsthat are observable for the asset or liability, either directly or indirectly,for substantially the full term of the financial instrument; and

 

·                  Level 3 – inputs to the valuation methodology areunobservable and significant to the fair value measurement.

 

A financial instrument’s categorization within thevaluation hierarchy is based upon the lowest level of input that is significantto the fair value measurement.  Below isa description of the valuation methodologies used for instruments measured atfair value, as well as the general classification of such instruments pursuantto the valuation hierarchy.

 

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**Assets**

 

*Securities* - Where quoted prices are available in an activemarket, securities are classified within level 1 of the valuation hierarchy.Level 1 securities include highly liquid government bonds, federal funds soldand certain other products. If quoted market prices are not available, thenfair values are estimated by using pricing models, quoted prices of securitieswith similar characteristics, or discounted cash flows. Examples of suchinstruments, which would generally be classified within level 2 of thevaluation hierarchy, include the Corporation’s available-for-sale investmentsecurities portfolio. In certain cases where there is limited activity or lesstransparency around inputs to the valuation, securities are classified withinlevel 3 of the valuation hierarchy. At June 30, 2008, the Corporation hadno securities classified within level 3.

 

*Other assets* – Included in other assets are certain assets carriedat fair value, including the cash value of Bank-owned life insurance policies.  The carrying amount of these assets is basedon information received from the insurance carriers indicating the financialperformance of the policies and the amount the Bank would receive should thepolicies be surrendered.  The Bankreflects these investments within level 2 of the valuation hierarchy.

 

**Liabilities**

 

*Securities sold under repurchase agreements (“repurchaseagreements”), federal funds purchased and other borrowings -* At June 30, 2008, all of the Bank’srepurchase agreements, federal funds purchased and other borrowings (overnightborrowings from the Federal Home Loan Bank) are settled on a short-term basis,usually daily.  As a result, the fairvalue of the instruments approximates their carrying amount and classified suchliabilities as level 2 within the valuation hierarchy.

 

*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 these obligations,the Bank discounts the anticipated future cash flows using current interestrates.  These liabilities are classifiedas level 2 within the valuation hierarchy.

 

The following table presents the financial instrumentscarried at fair value as of June 30, 2008, by caption on the consolidatedbalance sheet and by SFAS 157 valuation hierarchy (as described above) (dollarsin thousands):

 

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**Assets and liabilities measured at fair value on a recurringbasis as of June 30, 2008**

 
| ** **                                   | ** ** | **Total  Carrying  value in the  consolidated  balance sheet** | ** ** | **Quoted market  prices in an  active market  (Level 1)** | ** ** | **Internal  models with  significant  observable  market  parameters  (Level 2)** | ** ** | **Internal  models with  significant  unobservable  market  parameters  (Level 3)** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| Federal funds  sold                          |       | $                                                                             | 29,025     |                                                                               | $          | 29,025                                                                                      |       | $                                                                                             | —     |   | $ | — |   |
| Available-for-sale  securities               |       | 164,735                                                                       |       | —                                                                             |       | 164,735                                                                                     |       | —                                                                                        |       |
| Other assets                                 |       | 19,663                                                                        |       | —                                                                             |       | 19,663                                                                                      |       | —                                                                                        |       |
| Total assets at  fair value                  |       | $                                                                             | 213,423    |                                                                               | $          | 29,025                                                                                      |       | $                                                                                             | 184,398    |   | $ | — |   |
|                                         |       |                                                                          |       |                                                                               |       |                                                                                        |       |                                                                                          |       |
| Securities sold  under repurchase agreements |       | $                                                                             | 2,638      |                                                                               | —     |                                                                                        | $          | 2,638                                                                                         |       | $ | — |   |
| Other  liabilities                           |       | 5,578                                                                         |       | —                                                                             |       | 5,578                                                                                       |       | —                                                                                        |       |
| Total  liabilities at fair value             |       | $                                                                             | 8,216      |                                                                               | $          | 2,638                                                                                       |       | $                                                                                             | 8,216      |   | $ | — |   |

 

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

 

The Bank has a Blanket Agreement for Advances and SecurityAgreement (the “Blanket Agreement”) with the Federal Home Loan Bank ofCincinnati (the “FHLB”).  Advances made tothe Bank under the Blanket Agreement are collateralized by the FHLB stock andunidentified qualifying residential mortgage loans totaling 150% of theoutstanding amount borrowed. These collateralization matters are outlined inthe Blanket Agreement dated March 31, 2008 between the Bank and the FHLB.

 

Scheduled annual principal maturities of borrowings underthis credit line as of June 30, 2008 for the next five years are asfollows:

 

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

 

Stock held in the FHLB totaling $2.9 million at June 30,2008 is carried at cost.  The stock isrestricted and can only be sold back to the FHLB at par.

 

The Bank also has a Cash Management Advance (the “CMA”)Line of Credit Agreement dated June 30, 2008 with the Federal Home LoanBank.  The CMA is a component of theBlanket Agreement.  The purpose of theCMA is to assist with short-term liquidity management.  Under the terms of the CMA, the Bank mayborrow a maximum of $40,000,000, selecting a variable rate of interest for upto 90 

 

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days or a fixed rate for a maximum of 30 days.  There were no borrowings outstanding underthe CMA Line of Credit as of June 30, 2008.

 

**NOTE 5- RECENT ACCOUNTING PRONOUNCEMENTS**

 

In September 2006, the FASB ratified theconsensus the Emerging Issues Task Force (the “EITF”) reached regarding EITFIssue No. 06-4, “Accounting for Deferred Compensation and PostretirementBenefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (“EITF06-4”), which provides accounting guidance for postretirement benefits relatedto endorsement split-dollar life insurance arrangements, whereby the employerowns and controls the insurance policies. The consensus concludes that anemployer should recognize a liability for the postretirement benefit inaccordance with SFAS No. 106, “Employers’ Accounting for PostretirementBenefits Other Than Pensions” (“FAS 106”), or Accounting Principles BoardOpinion No. 12, “Omnibus Opinion-1967” (“APB 12”). In addition, theconsensus states that an employer should also recognize an asset based on thesubstance of the arrangement with the employee. EITF 06-4 is effective forfiscal years beginning after December 15, 2007.

 

In March 2007, the FASB ratified the consensusthe EITF reached regarding EITF Issue No. 06-10, “Accounting forCollateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF 06-10”),which provides accounting guidance for postretirement benefits related tocollateral assignment split-dollar life insurance arrangements, whereby the employee owns and controls theinsurance policies. The consensus concludes that an employer should recognize aliability for the postretirement benefit in accordance with FAS 106 or APB12, as well as recognize an asset based on the substance of the arrangementwith the employee. EITF 06-10 is effective for fiscal years beginningafter December 15, 2007. The Corporation and the Bank adopted EITF06-4 and 06-10 on January 1, 2008, and the effect of adoption on theconsolidated financial statements was a reduction in retained earnings ofapproximately $268,000 and an increase in accrued liabilities of approximately$268,000.

 

In September 2006, the FASB ratified theconsensus reached by the EITF on Issue 06-5, “Accounting for Purchases of LifeInsurance-Determining the Amount That Could Be Realized in Accordance with FASBTechnical Bulletin No. 85-4, Accounting for Purchases of Life Insurance” (“EITF06-5”). The effective date of EITF 06-5 is for fiscal years beginning after December 15,2006. The EITF concluded that a policyholder should consider any additionalamounts included in the contractual terms of the policy in determining theamount that could be realized under the insurance contract. Amounts that arerecoverable by the policyholder at the discretion of the insurance companyshould be excluded from the amount that could be realized. The Company adoptedEITF 06-5 effective January 1, 2007. The adoption of EITF 06-5 had noeffect on the Company’s consolidated balance sheets or consolidated statementsof income.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial 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. These forward-lookingstatements may be identified by, among other things, the use of forward-lookingterminology such as “could,” “expects,” “believes,” “may” or “will,” or futureor conditional verb tenses, and variations or negatives of such terms.  Theseforward-looking statements include, without limitation, those relating to fairvalue methodologies and determinations, the potential sale ofavailable-for-sale securities, loan portfolio concentrations, repayment ofloans by borrowers, satisfaction of capital adequacy requirements, therepayment of borrowings from the Federal Home Loan Bank of Cincinnati (the “FHLB”), adequacy of capital resources and traditional sources of cashgenerated from operating activities to meet liquidity needs, the effect offluctuating interest rates, the realization of deferred income tax assets andinternal control over financial reporting. We caution you not to place undue reliance on such forward-lookingstatements in this report because results could differ materially from thoseanticipated due to a variety of factors. These factors include, but are not limited to, 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; laws and regulations affecting financial institutions ingeneral; our ability to control factors influencing net interest income; thegeographic concentration of our assets; our ability to maintain sufficientasset quality and cost controls; and other factors generally understood toaffect the financial results of financial services companies and other factorsdetailed from time to time in our filings with the Securities and ExchangeCommission. We undertake no obligation to update these forward-lookingstatements to reflect events or circumstances that occur after the date of thisreport.

 

**EXECUTIVEOVERVIEW**

 

AtJune 30, 2008, the consolidatedtotal assets of First Farmers and Merchants Corporation (the “Corporation”)were $879.6 million, its consolidated net loans were $526.8 million, its totaldeposits were $721.1 million and its total shareholders’ equity was $103.3million.  The loan portfolio at June 30, 2008 reflected anincrease of $34.0 million, or 6.9%, compared to December 31, 2007.  Total deposits increased $22.0 million andshareholders’ equity decreased 1.9% during the first half of 2008

 

**FINANCIAL CONDITION**

 

Averageearning assets at June 30,2008 were up 4.3%, or $31.3 million, from average earning assets at December 31,2007.  Average overnight investments at June 30, 2008 were down $7.7million compared to December 31, 2007. Average investment securities at June 30, 2008 were up 6.0% compared tothe average at December 31, 2007. Average total assets of $831.1 million at June 30, 2008 increased 4.2% or $33.8million, compared to $797.2 million at December 31, 2007.

 

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**Securities**

 

The securities portfolio of First Farmers andMerchants Bank, the Corporation’s sole direct subsidiary (the “Bank”), is anintegral part of its asset/liability management process.  These securities represent an importantsource of liquidity available to fund loans and accommodate asset reallocationstrategies dictated by changes in the Bank’s operating and tax plans, shiftingyield spread relationships and changes in configuration of the yieldcurve.  At June 30, 2008, the Bank’s investmentsecurities portfolio held $164.7 million of available-for-sale securities,which are valued at fair market value, and $68.1 million of held-to-maturitysecurities, which are valued at cost on the balance sheet. These compare to$163.9 million of available-for-sale securities and $75.6 million ofheld-to-maturity securities as of December 31, 2007. At June 30, 2008, the amortized costof approximately $169.1 million securities in the available-for-sale categoryexceeded the fair market value by $4.3 million. These securities are predominantly the mortgage-backed securities andthe losses are due to overall increases in the market interest rates subsequentto purchase.  The Corporation has theability and the intent to hold these securities for a period of time sufficientto recover all gross unrealized losses. Accordingly, the Corporation has not recognized any other-than-temporaryimpairment for these securities.

 

**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 fourbroad industry categories: commercial construction and development; real estaterenting and leasing; other services (churches); and public administration.  These industries are monitored closely toensure that underwriting practices, policies and loss allowance levels matchthe level of risk posed.  Real estateloans represented 79.0% of total loans at June 30, 2008 compared to 77.6%at June 30, 2007and 77.9% at December 31, 2007.  Management of the Bank believes the risk ofthis concentration is acceptable given the quality of underwriting and the lowlevel of historical loss experience. Total construction and development loans accounted for 9.3% of loansoutstanding at June 30, 2008, which exceeded the Bank’s internal target ofa range of 1% to 7% of total loans, compared to 4.7% at June 30, 2007 and7.2% at December 31, 2007.  Nonetheless,at 52% of capital, construction and development****loansremain well below a regulatory concentration, defined as 100% of capital.  Therefore, management of the Bank believesthat the current level of exposure, while elevated above the maximum level inour current internal target range, represents an acceptable level of risk forthe Bank.  All loans are expected to berepaid from cash flow or proceeds from the sale of selected assets of theborrowers.  Collateral requirements forthe loan portfolio 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 

 

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of Directors.  The allowance for possible loan and leaselosses was $7.7 million, or 1.4% of gross loans and leases, at June 30, 2008, compared to$7.3 million, or 1.5% of gross loans and leases, at December 31,2007.  Net recoveries through June 30, 2008 wereapproximately $339,000, which results in an annualized net charge-off ratio ofnegative 0.1%.

 

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 June 30, 2008, this process identifiedloans totaling $10.4 million, or 2.0% of the portfolio, that were classified asother assets especially mentioned, compared to loans totaling $7.2 million, or1.5% of the portfolio, so classified at June 30, 2007.  Loans totaling $6.6 million, or 1.2% of theportfolio, were classified as substandard at June 30, 2008, compared to loans totaling$8.1 million, or 1.6% of the portfolio, so classified at June 30,2007.  No loans were classified asdoubtful at June 30,2008 and June 30, 2007.

 

**Deposits**

 

The Bank does not have any foreign offices and all deposits areserviced in its 20 domestic offices.  TheBank’s average deposits increased 1.9% during the first half of 2008 comparedto a decline of 1.1% in the first half of 2007. The increase results from the Bank offering more competitive rates oninterest-bearing deposits.  Average totalnoninterest-bearing deposits, which contribute to the Bank’s low cost ofdeposits, were 17.5% of total deposits at June 30, 2008, compared to 17.7% at June 30,2007 and 18.0% at December 31, 2007.

 

**Regulatory Requirements for Capital**

 

TheCorporation and the Bank are subject to federal regulatory risk-adjustedcapital adequacy standards.  Failure tomeet capital adequacy requirements could result in certain mandatory, andpossibly additional discretionary, actions by regulators that could have adirect material adverse effect on the 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 measuresestablished by the Board of Governors of the Federal Reserve System to ensurecapital adequacy require the Corporation and the Bank to maintain minimumamounts and ratios of Tier 1 Capital and Total Capital (Tier 1 plus Tier 2Capital) to risk-weighted assets and of Tier 1 Capital to average total assets(leverage capital ratio).   Equitycapital (net of certain adjustments for intangible assets and investments innon-consolidated subsidiaries and certain classes of preferred stock) isconsidered Tier 1 Capital.  Tier 2Capital consists of core capital plus subordinated debt, some types ofpreferred stock, and a defined percentage of the allowance for possible loanand lease****losses.  To be “well-capitalized” under federal bankregulations, a bank holding company must have a Tier 1 Capital ratio of atleast 6%, a Total Capital ratio of at least 10%, and a leverage capital ratioof at least 5%.  As of June 30, 2008, theCorporation’s Tier 1, Total Capital and leverage capital ratios were 16.1%,17.4% and 11.5 %, respectively.  Theratios were 16.9%, 18.2% and 12.2%, respectively, at December 31,2007.  As of June 30, 2008, the Bank’s Tier 1 Capital,Total Capital and leverage capital ratios were 15.8%, 17.1%, and 11.3%,respectively, compared to 16.6%, 17.9%, and 11.9% at December 31, 2007. 

 

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Managementbelieves, as of June 30,2008, that the Corporation and the Bank each met all capital adequacyrequirements to which they are subject.

 

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

 

Most of the capital needs ofthe Bank have historically been financed with retained earnings and depositsreceived and the Corporation’s primary source of liquidity is dividendsdeclared by the Bank.  During March 2008,the Bank obtained five advances of $7 million each, for an aggregate borrowingof $35 million, from the FHLB. Scheduled repayment of the advances will begin in 2009 and end in 2013. Please refer to Note 4 in the notes toconsolidated financial statements for details.

 

The Bank is subject toTennessee statutes and regulations that impose restrictions on the amount ofdividends that may be declared.  Furthermore,any dividend payments are subject to the continuing ability of the Bank tomaintain its compliance with minimum federal regulatory capital requirementsand to retain its characterization under federal regulations as a “well-capitalized”institution. The Bank declared a $0.355 per share dividend in the secondquarter of 2008, which was paid in the third quarter of 2008.

 

Managementbelieves that the Corporation’s traditional sources of cash generated from theBank’s operating activities are adequate to meet the Corporation’s liquidityneeds for normal ongoing operations.  TheBank’s Board of Directors has adopted a liquidity policy that outlines specificliquidity target balances.  Compliancewith this policy is reviewed quarterly by the Bank’s Asset/Liability Committeeand results are reported to the Bank’s Board of Directors. The Bank’s formalasset and liability management process is used to control interest rate riskand assist management in maintaining reasonable stability in the gross interestmargin as a result of changes in the level of interest rates and/or the spreadrelationships among interest rates.  TheBank uses an earnings simulation model to evaluate the impact of differentinterest rate scenarios on the gross margin. Each quarter, the Bank’s Asset/Liability Committee monitors therelationship of rate sensitive earning assets to rate sensitiveinterest-bearing liabilities (interest rate sensitivity), which is theprincipal factor in determining the effect that fluctuating interest rates willhave on future net interest income.  Ratesensitive earning assets and interest-bearing liabilities are financialinstruments that can be repriced to current market rates within a defined timeperiod.

 

**CriticalAccounting 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, have been critical to thedetermination of the Corporation’s financial position, results of operationsand cash flows.  As of June 30,2008, the deferred income tax asset was $7.0 million, which was included withother assets on the balance sheet.

 

*Allowance for Loan and Lease Losses*

 

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.

 

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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 is putting procedures in place sothat more detailed historical data can be accumulated by category of retail andconsumer credit and performance characteristics to broaden the analysis andimprove monitoring of potential credit risk.

 

Criteriaconsidered and processes utilized in evaluating the adequacy of the ALLL are:

 

·                  Portfolio quality trends;

·                  Changes in the nature and volume of theportfolio;

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

·                  Management review systems and boardoversight, including external loan review processes;

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

·                  Changes in personnel, management and staff;and

·                  Existence and effect of any concentrations ofcredit.

 

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.

 

*Deferred Income Tax Assets*

 

Deferredincome tax assets consist mainly of the tax effect of excess provisions forloan and lease****losses over actual lossesincurred and deferred compensation. Management believes that it is more likely than not that these assetswill be realized in future years.

 

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

 

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Thetotal outstanding loan commitments and stand-by letters of credit in the normalcourse of business at June 30,2008 were $100.1 million and $17.1 million, respectively, compared to$102.8 million and $12.6 million, respectively, at June 30, 2007 and$139.6 million and $17.7 million, respectively at December 31, 2007.  The increase in stand-by letters of credit of$4.5 million resulted from additional business from existing large commercialcustomers.

 

AtJune 30, 2008, 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 2008 was $22.0 million compared to$21.5 million for the first six months of 2007, and $11.0 million for the threemonths ended June 30, 2008 compared to $10.9 million for the three monthsended June 30, 2007.  Interest andfees earned on loans and investments are the components of total interestincome.  Interest and fees earned onloans were $16.5 million, an increase of approximately $211,000, or 1.3%,during the first six months of 2008 compared to the first six months of 2007,and $8.1 million for the three months ended June 30, 2008, a decrease of$0.2 million, or 2.1%, compared to the three months ended June 30,2007.  Nominal interest earned oninvestment securities and other investments was $5.5 million, an increase ofapproximately $212,000, or 4.0%, during the first six months of 2008 comparedto the first six months of 2007, and $2.8 million for the three months ended June 30,2008 compared to $2.3 million for the three months ended June 30, 2007.

 

Totalinterest expense in the first six months of 2008 was $6.5 million, a decreaseof $1.5 million, or 19.0%, compared to the first six months of 2007, and $3.1million for the three months ended June 30, 2008, a decrease of $0.9million, or 22.2%, compared to the three months ended June 30, 2007.  The lower interest rates for certificates ofdeposits and public funds during the first half of 2008 were the primary reasonfor the lower expense.  As a policy,budgeted financial goals are monitored on a monthly basis by the Bank’sAsset/Liability Committee, which reviews the actual dollar change in netinterest income for different interest rate movements.  A negative dollar change in net interestincome for a 12-month period of less than 4.5% of net interest income given a200 basis point shift in interest rates is considered an acceptable rate riskposition.  The rate risk analysis for the12-month period beginning July 1, 2008 and ending June 30, 2009showed a worst-case potential change to net interest income of a negative 2.0%,reflecting a potential decline in net interest income of $1.7 million by theend of the period.

 

Netinterest income of the Corporation on a fully taxable equivalent basis isinfluenced primarily by changes in:
| (1) |   | the volume and mix of  earning assets and sources of funding; |
|-----|--------|---------------------------------------------------------------|
| (2) |   | market rates of interest;  and                                |
| (3) |   | income tax rates.                                             |

 

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 of credit  demands by customers; |
|-----|--------|-----------------------------------------------|

 

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(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 June 30, 2008, June 30, 2007 and December,31, 2007 was 4.40%, 4.03% and 4.11%, respectively.

 

Becausenet recoveries were sufficient to cover anticipated losses from growth in theloan portfolio, no additions were made to the allowance for loan and lease****losses in the first half of 2008.

 

Noninterest income was$6.9 million, an increase of $1.0 million, or 17.5%, during the first sixmonths of 2008 compared to the first six months of 2007, and $3.1 million forthe three months ended June 30, 2008 compared to $3.0 million for thethree months ended June 30, 2007. Contributing to this increase for the six-month period was gains onsales of available-for-sale securities, representing $1.1 million in income.

 

Noninterestexpenses, excluding the provision for possible loan and lease losses, were up$1.5 million, or 10.8%, in the first six months of 2008 as compared to thefirst six months of 2007, and $0.9 million, or 12.1%, higher for the threemonths ended June 30, 2008 compared to the three months ended June 30,2007. Salaries andbenefits expense was up $1.1 million, or 14.1%, for the six months ended June 30,2008 compared to the same period in 2007, and up $0.5 million, or 13.5%, forthe three months ended June 30, 2008 compared to the same period in 2007because of changes in the Bank’s incentive and retirement plans.  Other operating expenses were upapproximately $400,000, or 7.3%, for the six months ended June 30, 2008compared to the same period in 2007, and up approximately $253,000, or 9.9%,for the three months ended June 30, 2008 compared to the same period in2007 because of increases in advertising expenses and professional fees.

 

 The Corporation does not have anylong-term debt or other long-term obligations other than the $35 millionaggregate advances from the FHLB received by the Bank in March 2008.   Scheduled repayment of the advances will begin in 2009and end in 2013.  Please refer to Note 4in the notes to consolidated financial statements for details.

 

TheBank leases certain bank properties. There was not a change during the six-month period ended June 30, 2008 in the termsof these leases.

 

Netincome for the six months ended June 30, 2008 was $5.3 million, comparedto $4.1 million for the six months ended June 30, 2007, and $2.5 million for the threemonths ending June 30, 2008 compared to $2.0 million for the three monthsending June 30, 2007.  An increasein service fees, along with a realized gain on available-for-sale securities,contributed to the period-over-period increases.  The Corporation earned $0.45 per share in thesecond quarter of 2008 and $0.36 per share in the second quarter of 2007.

 

**Item 3.  Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

Duringthe six months ended June 30,2008, there were no material changes in the quantitative and qualitativedisclosures about market risk presented in the Corporation’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

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**Item 4. Controls and Procedures.**

 

(a)           Evaluation of Disclosure Controls and Procedures.  The Corporation, with the participation ofits management, including the Corporation’s Chief Executive Officer andAssistant Treasurer (principal financial officer), carried out an evaluation ofthe effectiveness of the design and operation of its disclosure controls andprocedures (as defined in Rules 13a-15 and 15d-15 under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) as of the end of theperiod covered by this report.  Basedupon that evaluation and as of the end of the period covered by this report,the Corporation’s Chief Executive Officer and Assistant Treasurer (principalfinancial officer) concluded that the Corporation’s disclosure controls andprocedures were effective in ensuring that information required to be disclosedin its reports that the Corporation files or submits to the Securities andExchange Commission under the Exchange Act is recorded, processed, summarizedand reported on a timely basis.

 

(b)           Changes in Internal Control OverFinancial Reporting.  There has beenno change in the Corporation’s internal control over financial reporting thatoccurred during the second quarter of 2008 that has materially affected, or isreasonably likely to materially affect, the Corporation’s internal control overfinancial reporting.

 

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**PART II- OTHER INFORMATION**

 

**Item 1A. Risk Factors.**

 

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

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds.**

 

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

 

**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,  2008 – April 30, 2008 |       | —                                       |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                            |       |
| May 1, 2008  – May 31, 2008     |       | —                                       |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                            |       |
| June 1,  2008 – June 30, 2008   |       | 35,357                                       | *          | $                                            | 50.00      |                                                                                                                             | —     |                                                                                                                                                                              | —     |   |
| Total                                          |       | 35,357                                       |       | $                                            | 50.00      |                                                                                                                             | —     |                                                                                                                                                                              | —     |   |

 

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*Purchased through negotiated transactions with several third-partysellers.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders.**

 

The annual meeting for shareholders of the Corporationwas held on Tuesday, April 15, 2008. At the meeting, the Corporation’s shareholders voted to elect directors.At the meeting, votes were cast as follows:

 
| **Name**                     | ** ** | **Votes For** | ** ** | **Votes  Against** | ** ** | **Votes  Withheld** | ** ** | **Abstentions/Broker Non-  Votes** | ** ** |
|------------------------------|------------|--------------------|------------|--------------------|------------|---------------------|------------|-----------------------------------------|------------|
| Kenneth A.  Abercrombie      |       | 3,830,063          |       | 3,445              |       | —              |       | 1,736,681                               |       |
| James L. Bailey, Jr.    |       | 3,830,063          |       | 3,445              |       | —              |       | 1,736,681                               |       |
| M. Darlene  Baxter           |       | 3,833,355          |       | 153                |       | —              |       | 1,736,681                               |       |
| H. Terry  Cook, Jr.     |       | 3,830,063          |       | 3,445              |       | —              |       | 1,736,681                               |       |
| Thomas Napier  Gordon        |       | 3,819,809          |       | 13,699             |       | —              |       | 1,736,681                               |       |
| Dr. O.  Rebecca Hawkins |       | 3,831,383          |       | 2,125              |       | —              |       | 1,736,681                               |       |
| Timothy E. Pettus            |       | 3,830,275          |       | 3,233              |       | —              |       | 1,736,681                               |       |

 

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| **Name**                            | ** ** | **Votes For** | ** ** | **Votes  Against** | ** ** | **Votes  Withheld** | ** ** | **Abstentions/Broker Non-  Votes** | ** ** |
|-------------------------------------|------------|--------------------|------------|--------------------|------------|---------------------|------------|-----------------------------------------|------------|
| Dr. Joseph  W. Remke, III |       | 3,830,275          |       | 3,233              |       | —              |       | 1,736,681                               |       |
| Matthew M.  Scoggins, Jr.      |       | 3,830,955          |       | 2,553              |       | —              |       | 1,736,681                               |       |
| T. Randy Stevens                    |       | 3,827,915          |       | 5,593              |       | —              |       | 1,736,681                               |       |
| W. Lacy Upchurch                    |       | 3,830,955          |       | 2,553              |       | —              |       | 1,736,681                               |       |
| William R.  Walter                  |       | 3,829,663          |       | 3,845              |       | —              |       | 1,736,681                               |       |
| Dan C. Wheeler                      |       | 3,830,063          |       | 3,445              |       | —              |       | 1,736,681                               |       |
| Dr. David  S. Williams         |       | 3,830,955          |       | 2,553              |       | —              |       | 1,736,681                               |       |
| W. Donald Wright                    |       | 3,830,063          |       | 3,445              |       | —              |       | 1,736,681                               |       |
| James E. York                       |       | 3,830,063          |       | 3,445              |       | —              |       | 1,736,681                               |       |

 

As indicated in the above table, Kenneth A.Abercrombie, James L. Bailey, Jr., M. Darlene Baxter, H. Terry Cook, Jr.,Tom Napier Gordon, Dr. O. Rebecca Hawkins, Timothy E. Pettus, Dr. JosephW. Remke, III, Matthew M. Scoggins, Jr., T. Randy Stevens, W. LacyUpchurch, 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 2009, or until their respective successors are elected andqualified.

 

**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 |

 

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| 31.2 |   | Certification  of the Assistant Treasurer (principal financial officer) of First Farmers and  Merchants Corporation Pursuant to Rule 13a-14 of the Securities Exchange  Act of 1934, as amended, as Adopted Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.1 |   | Certification  of the Chief Executive Officer and Assistant Treasurer (principal financial  officer) of First Farmers and Merchants Corporation Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002             |

 

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

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

 

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**SIGNATURES**

 

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

 

 
|   |                 |   |   | FIRST FARMERS AND  MERCHANTS CORPORATION                                                                 |
|--------|----------------------|--------|--------|----------------------------------------------------------------------------------------------------------|
|   |                 |   |   | (Registrant)                                                                                             |
|   |                 |   |   |                                                                                                     |
|   |                 |   |   |                                                                                                     |
| Date   | August 11, 2008 |   |   | /s/ T. Randy Stevens                                                                                     |
|   |                 |   |   | T. Randy Stevens, Chief  Executive Officer                                                               |
|   |                 |   |   |                                                                                                     |
|   |                 |   |   |                                                                                                     |
| Date   | August 11, 2008 |   |   | /s/ Patricia P. Bearden                                                                                  |
|   |                 |   |   | Patricia P. Bearden, Assistant Treasurer  (principal financial officer and principal accounting officer) |

 

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

 

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

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

 

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