Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

| **x** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**For thequarterly period ended March 31, 2010**

 

**or**

 

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                              to                               **

 

**CommissionFile Numbers: 000-10972**

 

**First Farmers and Merchants Corporation**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

 

**931-388-3145**

(Registrant’stelephone number, including area code)

 

 

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

 

Indicate by check 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 for thepast 90 days.   x  Yes  o  No

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  o  Yes  o  No

 

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

 

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

 

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

 

As of May 5, 2010,the registrant had 5,489,213 shares of common stock outstanding.

 

 

 

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**PART I - FINANCIALINFORMATIO**N

 

**Item 1. Financial Statements.**

 
|   | The following unaudited  consolidated financial statements of the Registrant and its subsidiaries are  included in this Report: |
|--------|---------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                            |
|   | Consolidated balance sheets —  March 31, 2010 and December 31, 2009.                                             |
|   |                                                                                                                            |
|   | Consolidated statements of  income - For the three months ended March 31, 2010 and March 31,  2009.                   |
|   |                                                                                                                            |
|   | Consolidated statements of  cash flows - For the three months ended March 31, 2010 and  March 31, 2009.               |
|   |                                                                                                                            |
|   | Selected notes to consolidated financial statements.                                                                            |

 

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**FIRSTFARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                          | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                          | ** ** | **2010**           | ** **  | **2009**              | ** ** |
| **(Dollars in Thousands,  Except Per Share Data)**                                                                                                                                                  | ** ** | **(Unaudited)**    | ** **  | **(1)**               | ** ** |
| **ASSETS**                                                                                                                                                                                          |       |               |        |                  |       |
| Cash and due from banks                                                                                                                                                                             | ** ** | **$**              | **14,124**  |                  | $          | 11,181 |   |
| Interest-bearing due from banks                                                                                                                                                                     | ** ** | **4,873**          |        | 5,557                 |       |
| Federal funds sold                                                                                                                                                                                  | ** ** | **19,550**         |        | 16,725                |       |
| Total cash and cash  equivalents                                                                                                                                                                    | ** ** | **38,547**         |        | 33,463                |       |
| Securities                                                                                                                                                                                          |       |               |        |                  |       |
| Available-for-sale  (amortized cost $237,422 and $207,027, respectively)                                                                                                                            |       | **238,736**        |        | 208,238               |       |
| Held-to-maturity  (fair market value $43,685 and $48,722, respectively)                                                                                                                             |       | **42,432**         |        | 47,613                |       |
| Total Securities                                                                                                                                                                                    | ** ** | **281,168**        |        | 255,851               |       |
| Loans, net of deferred fees                                                                                                                                                                         | ** ** | **573,376**        |        | 576,655               |       |
| Allowance for loan and lease losses                                                                                                                                                                 | ** ** | **(9,102**         | **)**       | (8,929                | )          |
| Net loans                                                                                                                                                                                           | ** ** | **564,274**        |        | 567,726               |       |
| Bank  premises and equipment, at cost less allowance for depreciation                                                                                                                               |       | **20,533**         |        | 20,625                |       |
| Core deposit and other intangibles                                                                                                                                                                  | ** ** | **9,093**          |        | 9,111                 |       |
| Other assets                                                                                                                                                                                        | ** ** | **49,173**         |        | 48,252                |       |
| TOTAL ASSETS                                                                                                                                                                                        | ** ** | **$**              | **962,788** |                  | $          | 935,028 |   |
| **LIABILITIES**                                                                                                                                                                                     |       |               |        |                  |       |
| Deposits                                                                                                                                                                                            |       |               |        |                  |       |
| Noninterest-bearing                                                                                                                                                                                 | ** ** | **$**              | **116,239** |                  | $          | 116,157 |   |
| Interest-bearing  (including certificates of deposits over $100: 2010 - $102,674; 2009 -  $97,572)                                                                                                  |       | **694,855**        |        | 656,168               |       |
| Total deposits                                                                                                                                                                                      | ** ** | **811,094**        |        | 772,325               |       |
| Federal  funds purchased and securities sold under agreements to repurchase                                                                                                                         |       | **3,687**          |        | 5,856                 |       |
| Dividends payable                                                                                                                                                                                   | ** ** | **—**         |        | 2,038                 |       |
| Short-term borrowings                                                                                                                                                                               | ** ** | **438**            |        | 414                   |       |
| Accounts payable and accrued liabilities                                                                                                                                                            | ** ** | **12,732**         |        | 13,045                |       |
| Federal Home Loan Bank Advances                                                                                                                                                                     | ** ** | **27,177**         |        | 34,177                |       |
| TOTAL LIABILITIES                                                                                                                                                                                   | ** ** | **855,128**        |        | 827,855               |       |
| **SHAREHOLDERS’****EQUITY**                                                                                                                                                                    |       |               |        |                  |       |
| Common  stock - $10 par value per share, 8,000,000 shares****authorized; 5,489,213 and 5,506,993 shares issued and  outstanding as of March 31, 2010 and December 31, 2009,  respectively |       | **54,892**         |        | 55,070                |       |
| Retained earnings                                                                                                                                                                                   | ** ** | **51,865**         |        | 51,264                |       |
| Accumulated other comprehensive income                                                                                                                                                              | ** ** | **808**            |        | 744                   |       |
| TOTAL  SHAREHOLDERS’ EQUITY BEFORE NONCONTROLLING INTEREST - PREFERRED STOCK OF  SUBSIDIARY                                                                                                    | ** ** | **107,565**        |        | 107,078               |       |
| Noncontrolling interest - preferred stock of  subsidiary                                                                                                                                            | ** ** | **95**             |        | 95                    |       |
| ** **                                                                                                                                                                                          | ** ** | **107,660**        | ** **  | **107,173**           | ** ** |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                    |       | **$**              | **962,788** |                  | $          | 935,028 |   |

 

----

(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** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------|------------|
| **(Dollars  in Thousands Except Per Share Data)**                                       | ** ** | **March 31,**     | ** ** |
| **(Unaudited)**                                                                         | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                                                    |       |                   |       |   |   |
| **INTEREST AND DIVIDEND INCOME**                                                        | ** ** | ** **             |       |   |   |
| Interest and fees on loans                                                              | ** ** | **$**                  | **7,874**  |   | $ | 7,867 |   |
| Income on investment securities                                                         | ** ** | ** **             |       |   |   |
| Taxable interest                                                                        | ** ** | **1,184**              |       | 1,326 |   |
| Exempt from federal income tax                                                          | ** ** | **896**                |       | 974 |   |
| Dividends                                                                               | ** ** | **47**                 |       | 60 |   |
|                                                                                    | ** ** | **2,127**              |       | 2,360 |   |
| Other interest income                                                                   | ** ** | **18**                 |       | 17 |   |
| TOTAL INTEREST INCOME                                                                   | ** ** | **10,019**             |       | 10,244 |   |
|                                                                                    | ** ** | ** **             |       |   |   |
| **INTEREST EXPENSE**                                                                    | ** ** | ** **             |       |   |   |
| Interest on deposits                                                                    | ** ** | **1,653**              |       | 2,244 |   |
| Interest on other borrowings                                                            | ** ** | **274**                |       | 312 |   |
| TOTAL INTEREST EXPENSE                                                                  | ** ** | **1,927**              |       | 2,556 |   |
| NET INTEREST INCOME                                                                     | ** ** | **8,092**              |       | 7,688 |   |
| PROVISION FOR POSSIBLE LOAN AND LEASE LOSSES                                            | ** ** | **1,086**              |       | 655 |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN AND  LEASE LOSSES                          | ** ** | **7,006**              |       | 7,033 |   |
|                                                                                    | ** ** | ** **             |       |   |   |
| **NONINTEREST INCOME**                                                                  | ** ** | ** **             |       |   |   |
| Trust department income                                                                 | ** ** | **560**                |       | 558 |   |
| Service fees on deposit accounts                                                        | ** ** | **1,609**              |       | 1,722 |   |
| Other fees and commissions                                                              | ** ** | **115**                |       | 84 |   |
| Other operating income                                                                  | ** ** | **51**                 |       | 99 |   |
| Securities gains                                                                        | ** ** | **503**                |       | 1,955 |   |
| TOTAL NONINTEREST INCOME                                                                | ** ** | **2,838**              |       | 4,418 |   |
|                                                                                    | ** ** | ** **             |       |   |   |
| **NONINTEREST EXPENSE**                                                                 | ** ** | ** **             |       |   |   |
| Salaries and employee benefits                                                          | ** ** | **4,116**              |       | 4,170 |   |
| Net occupancy expense                                                                   | ** ** | **641**                |       | 641 |   |
| Furniture and equipment expense                                                         | ** ** | **258**                |       | 328 |   |
| Other operating expenses                                                                | ** ** | **3,705**              |       | 2,907 |   |
| TOTAL NONINTEREST EXPENSES                                                              | ** ** | **8,720**              |       | 8,046 |   |
| INCOME  BEFORE PROVISION FOR INCOME TAXES                                               | ** ** | **1,124**              |       | 3,405 |   |
| PROVISION FOR INCOME TAXES                                                              | ** ** | **(68**                | **)**      | 697 |   |
| Net income before noncontrolling interest -  dividends on preferred stock of subsidiary | ** ** | **$**                  | **1,192**  |   | $ | 2,708 |   |
| Noncontrolling interest - dividends on preferred  stock of subsidiary                   | ** ** | **$**                  | **—** |   | $ | — |   |
| NET  INCOME AVAILABLE FOR COMMON SHAREHOLDERS                                           | ** ** | **$**                  | **1,192**  |   | $ | 2,708 |   |
| **BASIC EARNINGS PER SHARE**                                                            | ** ** | ** **             |       |   |   |
| Weighted Average Shares Outstanding                                                     | ** ** | **5,504,030**          |       | 5,574,778 |   |
|                                                                                    | ** ** | **$**                  | **0.22**   |   | $ | 0.49 |   |

 

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

 

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**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| **(Unaudited)**                                                                             | ** ** | **Three  months ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(Dollars  in Thousands)**                                                                 | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| **OPERATING  ACTIVITIES**                                                                   | ** ** | ** **                             |       |   |   |
| Net income available for  common shareholders                                               | ** ** | **$**                                  | **1,192**  |   | $ | 2,708 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities | ** ** | ** **                             |       |   |   |
| Excess of provision for possible loan losses over  net charge-offs                          | ** ** | **1,086**                              |       | 655 |   |
| Provision for depreciation and amortization of premises  and equipment                      | ** ** | **289**                                |       | 264 |   |
| Securities gains                                                                            | ** ** | **(502**                               | **)**      | (1,955 | ) |
| Loss from disposition of  fixed assets                                                      | ** ** | **—**                             |       | 110 |   |
| Gain from disposition of  other real estate                                                 | ** ** | **(49**                                | **)**      | — |   |
| Amortization of deposit  base intangibles                                                   | ** ** | **19**                                 |       | 18 |   |
| Amortization of investment security premiums, net  of accretion of discounts                | ** ** | **393**                                |       | 208 |   |
| Increase in cash surrender  value of life insurance contracts                               | ** ** | **(248**                               | **)**      | (151 | ) |
| (Increase) decrease in Deferred income taxes                                                | ** ** | **(56**                                | **)**      | 25 |   |
| Interest receivable                                                                         | ** ** | **(631**                               | **)**      | 112 |   |
| Other real estate owned                                                                     | ** ** | **(549**                               | **)**      | — |   |
| Other assets                                                                                | ** ** | **(340**                               | **)**      | (503 | ) |
| Increase (decrease) in Interest payable                                                     |       | **22**                                 |       | (220 | ) |
| Other liabilities                                                                           | ** ** | **(335**                               | **)**      | 1,488 |   |
| Total adjustments                                                                           | ** ** | **(901**                               | **)**      | 51 |   |
| Net cash provided by  operating activities                                                  | ** ** | **291**                                |       | 2,759 |   |
| **INVESTING  ACTIVITIES**                                                                   | ** ** | ** **                             |       |   |   |
| Proceeds from maturities, calls, and sales of available-for-sale  securities                | ** ** | **51,592**                             |       | 91,847 |   |
| Proceeds from maturities  and calls of held-to-maturity securities                          | ** ** | **5,181**                              |       | 1,801 |   |
| Purchases of investment securities                                                          | ** ** | ** **                             | ** ** |   |   |
| Available-for-sale                                                                          | ** ** | **(81,877**                            | **)**      | (86,634 | ) |
| Held-to-maturity                                                                            | ** ** | **—**                             |       | (400 | ) |
| Net increase in loans                                                                       | ** ** | **2,366**                              |       | 11,100 |   |
| Proceeds from sale of  foreclosed assets                                                    | ** ** | **910**                                |       | — |   |
| Purchase of life insurance  premium                                                         | ** ** | **—**                             |       | (235 | ) |
| Purchases of premises and  equipment                                                        | ** ** | **(197**                               | **)**      | (3,236 | ) |
| Net cash provided by (used  in) investing activities                                        | ** ** | **(22,025**                            | **)**      | 14,243 |   |
| **FINANCING  ACTIVITIES**                                                                   | ** ** | ** **                             |       |   |   |
| Net increase in noninterest-bearing and  interest-bearing deposits                          | ** ** | **38,769**                             |       | 13,224 |   |
| Net (decrease) increase in  short-term borrowings                                           | ** ** | **(2,145**                             | **)**      | 411 |   |
| Payments to FHLB borrowings                                                                 | ** ** | **(7,000**                             | **)**      | (7,000 | ) |
| Repurchase of common stock                                                                  | ** ** | **(768**                               | **)**      | (1,250 | ) |
| Cash dividends paid on  common stock                                                        | ** ** | **(2,038**                             | **)**      | (2,009 | ) |
| Net cash provided by (used  in) financing activities                                        | ** ** | **26,818**                             |       | 3,376 |   |
| Increase (decrease) in cash  and cash equivalents                                           | ** ** | **5,084**                              |       | 20,378 |   |
| Cash and cash equivalents  at beginning of period                                           | ** ** | **33,463**                             |       | 31,536 |   |
| Cash and cash equivalents  at end of period                                                 | ** ** | **$**                                  | **38,547** |   | $ | 51,914 |   |

 

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

 

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

The interim unauditedconsolidated financial statements of First Farmers and Merchants Corporation(the “Corporation”) presented in this report have been prepared on a consistentbasis and in accordance with the instructions to Form 10-Q and do notinclude all of the information and notes required by generally accepted accountingprinciples for complete financial statements. Management has evaluated all significant events and transactions thatoccurred through May 6, 2010, for potential recognition or disclosure inthese consolidated financial statements. In the opinion of management, all adjustments considered necessary for afair presentation have been included. These adjustments were of a normal, recurring nature and consistent withgenerally accepted accounting principles. For further information, refer to the consolidated financial statementsand notes included in the Corporation’s Annual Report on Form 10-K for theyear ended December 31, 2009.

 

**NOTE 2 —STOCK REPURCHASE**

 

Duringthe first quarter of 2010, the Corporation repurchased, from third-partysellers, 17,780 shares of the Corporation’s common stock at a previouslynegotiated price of $43.20 per share for an aggregate purchase price of$768,000.

 

**NOTE 3 — FAIR VALUEMEASUREMENT**

 

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

 

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

 

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

 

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

 

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Assetsmeasured at fair value on a recurring basis comprised the following at March 31,2010:

 
| ** **                              | ** ** | **Fair Value  Measurements at Reporting Date Using** | ** **  |
|-----------------------------------------|------------|------------------------------------------------------|-------------|
| **(Dollars  in thousands)**             | ** ** | **Fair Value  3/31/2010**                            | ** **  | **Quoted  Prices  in Active  Markets for  Identical  Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Obligations of:                         |       |                                                 |        |   |   |   |   |   |   |
| U.S. government agencies                |       | $                                                    | 143,530     |   | $ | — |   | $ | 143,530 |   | $ | — |   |
| States and political subdivisions       |       | 50,491                                               |        | — |   | 50,491 |   | — |   |
| Residential mortgage-backed securities  |       | 25,258                                               |        | — |   | 25,258 |   | — |   |
| Other domestic debt securities          |       | 15,561                                               |        | — |   | 15,561 |   | — |   |
| Equity securities                       |       | 3,896                                                |        | — |   | 3,896 |   | — |   |
| **Total available-for-sale securities** | ** ** | **$**                                                | **238,736** | ** ** | **$** | **—** | ** ** | **$** | **238,736** | ** ** | **$** | **—** | ** ** |

 

Thefair values used by the Corporation are obtained from an independent pricingservice and represent either quoted market prices for the identical securities(Level 1 inputs) or fair values determined by pricing models using a marketapproach that consider observable market data, such as interest ratevolatilities, LIBOR yield curve, credit spreads and prices from market makersand live trading systems (Level 2).

 

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

 

*Impaired loans —*Certain impaired loans arereported at the fair value of the underlying collateral if repayment isexpected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observablemarket data or Level 3 inputs based on customized discounting criteria.  During the first quarter of 2010, certainimpaired loans were re-measured and reported at fair value through a specificvaluation allowance allocation of the allowance for possible loan losses basedon the fair value of the underlying collateral. Impaired loans with a carrying value of $17.5 million were reduced by specificvaluation allowance allocations totaling $1.2 million to a total reported fairvalue of $16.3 million based on collateral valuations utilizing Level 3valuation inputs.

 

*Non-Financial Assets and Non-Financial Liabilities*— The Corporation has no non-financialassets or non-financial liabilities measured at fair value on a recurringbasis.  Certain  non-financial assets and non-financialliabilities measured at fair value on a non-recurring basis include foreclosedassets (upon initial recognition or subsequent impairment), non-financialassets and non-financial liabilities measured at fair value in the second stepof goodwill impairment test, and intangible assets and other non-financiallong-lived assets measured at fair value for impairment assessment.

 

Duringthe first quarter of 2010, certain foreclosed assets, upon initial recognition,were remeasured and reported at fair value through a charge-off to theallowance for possible loan and lease losses based upon the fair value of theforeclosed asset.  The fair value of aforeclosed asset, upon initial recognition, is estimated using Level 2 inputsbased on observable market data or Level 3 inputs based on customizeddiscounting criteria.  Foreclosed assetsmeasured at fair value totaled $9.6 million (utilizing Level 2 valuationinputs) at March 31, 2010.

 

The table below presents thefair value of financial assets and financial liabilities, including thosefinancial assets and financial liabilities that are not measured and reportedat fair value on a recurring basis or non-recurring basis. A detaileddescription of the valuation methodologies used in estimating the fair value offinancial instruments is set forth in

 

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Note 12 to the consolidatedfinancial statements incorporated by reference into the Corporation’s AnnualReport on Form 10-K for the year ended December 31, 2009.

 

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

 
| ** **                                                                  | ** ** | **March 31,  2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                                  | ** ** | **Carrying**             | ** ** | **Fair**                   | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(Dollars in thousands)**                                                  | ** ** | **Amount**               | ** ** | **Value**                  | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets                                                            | ** ** | ** **               | ** ** | ** **                 |       |   |   |   |   |
| Cash and due from banks                                                     | ** ** | **$**                    | **14,124** | ** **                 | **$**      | **14,124** |   | $ | 11,181 |   | $ | 11,181 |   |
| Interest-bearing deposits in banks                                          | ** ** | **4,873**                | ** ** | **4,873**                  |       | 5,557 |   | 5,557 |   |
| Federal funds sold                                                          | ** ** | **19,550**               | ** ** | **19,550**                 |       | 16,725 |   | 16,725 |   |
| Securities available-for-sale                                               | ** ** | **238,736**              | ** ** | **238,736**                |       | 208,238 |   | 208,238 |   |
| Securities held-to-maturity                                                 | ** ** | **43,685**               | ** ** | **43,685**                 |       | 47,613 |   | 48,722 |   |
| Loans, net                                                                  | ** ** | **564,274**              | ** ** | **571,893**                |       | 567,726 |   | 570,975 |   |
| Accrued interest receivable                                                 | ** ** | **5,080**                | ** ** | **5,080**                  |       | 4,449 |   | 4,449 |   |
| Financial liabilities                                                       | ** ** | ** **               | ** ** | ** **                 |       |   |   |   |   |
| Deposits                                                                    | ** ** | **811,094**              | ** ** | **812,488**                |       | 744,851 |   | 773,710 |   |
| Federal  funds purchased and securities sold under agreements to repurchase | ** ** | **3,687**                | ** ** | **3,687**                  |       | 5,856 |   | 5,856 |   |
| Other short term liabilities                                                | ** ** | **438**                  | ** ** | **438**                    |       | 414 |   | 414 |   |
| FHLB borrowings                                                             | ** ** | **27,177**               | ** ** | **28,131**                 |       | 34,177 |   | 38,616 |   |
| Accrued interest payable                                                    | ** ** | **1,206**                | ** ** | **1,206**                  |       | 1,184 |   | 1,184 |   |
| Off-balance sheet credit related instruments:                               | ** ** | ** **               | ** ** | ** **                 |       |   |   |   |   |
| Commitments to extend credit                                                | ** ** | ** **               | ** ** | **108**                    |       |   |   | 103 |   |
|                                                                             |            |                          |            |                            |            |  |  |  |  |  |  |  |  |

 

Adescription of the valuation methodologies used for instruments measured atfair value as well as the general classification of such instruments pursuantto the valuation hierarchy is set forth below. These valuation methodologies were applied to all of the financialassets and financial liabilities of the Corporation and its sole wholly-ownedsubsidiary, First Farmers and Merchants Bank (the “Bank”), carried at fairvalue effective March 31, 2010.  Ifsuch quoted market prices are not available, fair value is based on internallydeveloped models that primarily use, as inputs, observable market-basedparameters. Valuation adjustments may be made to ensure that financialinstruments are recorded at fair value. These adjustments may include amountsto reflect counterparty credit quality and the Corporation’s creditworthinessamong other things, as well as unobservable parameters.  Any such valuation adjustments are appliedconsistently over time.  The Corporation’svaluation methodologies may produce a fair value calculation that may not beindicative of net realizable value or reflective of future fair values.  While management believes the valuationmethodologies are appropriate and consistent with other market participants,the use of different methodologies or assumptions to determine the fair valueof certain financial instruments could result in a different estimate of fairvalue at the reporting date.  Furthermore,the reported fair value amounts have not been comprehensively revalued sincethe presentation dates and, therefore, estimates of fair value after thebalance sheet date may differ significantly from the amounts presented herein.

 

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

 

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

 

**Deposits:**  The fair valueof fixed maturity certificates of deposit is estimated using a discounted cashflow calculation based on current rates offered for deposits of similarremaining maturities.

 

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**FHLB Borrowings: **The fairvalue of FHLB borrowings is estimated using discounted cash flow analysis basedon rates currently available to the Corporation for borrowings with similarterms.

 

**NOTE 4****—****FEDERAL HOME LOAN BANK CREDITLINE**

 

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

 

Scheduledprincipal maturities of borrowings under this credit line as of March 31,2010, are as follows (dollars in thousands):

 
| 2010  |   | $      | 3,077  |   |
|-------|--------|--------|--------|--------|
| 2011  |   | 7,000  |   |
| 2012  |   | 7,000  |   |
| 2013  |   | 10,100 |   |
| Total |   | $      | 27,177 |   |
|       |        |        |        |        |  |

 

Stockheld in the FHLB totaling $3.0 million at March 31, 2010 is carried atcost.  The stock is restricted and canonly be sold back to the FHLB at par.

 

TheBank also has a Cash Management Advance Line of Credit Agreement (the “CMA”)dated March 31, 2009, with the FHLB. The CMA is a component of the Blanket Agreement.  The purpose of the CMA is to assist with short-termliquidity management.  Under the terms ofthe CMA, the Bank may borrow a maximum of $40.0 million, selecting a variablerate of interest for up to 90 days or a fixed rate for a maximum of 30 days.  There were no borrowings outstanding underthe CMA as of March 31, 2010.

 

**NOTE 5****—****SECURITIES**

 

Securitieswith an amortized cost of $188.3 million at March 31, 2010, (fair value of$189.0 million at March 31, 2010), were pledged to secure deposits and forother purposes as required or permitted by law. The fair value is established by an independent pricing service as ofthe approximate dates indicated.  Thedifferences between the amortized cost and fair value reflect current interestrates and represent the potential gain (or loss) if the portfolio had beenliquidated on that date.  Security gains(or losses) are realized only in the event of dispositions prior to maturity.

 

Asummary of the amortized cost and estimated fair value of securities at March 31,2010 is as follows:

 
| ** **                        | ** ** | **Amortized** | ** **  | **Gross Unrealized** | ** ** | **Fair**   | ** ** |
|-----------------------------------|------------|---------------|-------------|----------------------|------------|------------|------------|
| ** **                        | ** ** | **Cost**      | ** **  | **Gains**            | ** ** | **Losses** | ** ** | **Value** | ** ** |
| **March 31, 2010**           |       |          |        |                 |       |       |       |   |   |
| Available-for-sale securities     |       |          |        |                 |       |       |       |   |   |
| U.S. Government agencies          | ** ** | **$**         | **143,825** | ** **           | **$**      | **156**    | ** ** | **$** | **451** | ** ** | **$** | **143,530** | ** ** |
| Mortgage backed securities        | ** ** | **25,207**    | ** **  | **185**              | ** ** | **135**    | ** ** | **25,257** | ** ** |
| States and political subdivisions | ** ** | **49,527**    | ** **  | **1,114**            | ** ** | **149**    | ** ** | **50,492** | ** ** |
| Other securities                  | ** ** | **18,863**    | ** **  | **598**              | ** ** | **4**      | ** ** | **19,457** | ** ** |
|                              | ** ** | **$**         | **237,422** | ** **           | **$**      | **2,053**  | ** ** | **$** | **739** | ** ** | **$** | **238,736** | ** ** |
|                              | ** ** | ** **    | ** **  | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Held-to-maturity securities       | ** ** | ** **    | ** **  | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| States and political subdivisions | ** ** | **$**         | **42,432**  | ** **           | **$**      | **1,296**  | ** ** | **$** | **43** | ** ** | **$** | **43,685** | ** ** |
|                              | ** ** | **$**         | **42,432**  | ** **           | **$**      | **1,296**  | ** ** | **$** | **43** | ** ** | **$** | **43,685** | ** ** |

 

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At March 31, 2010, the Bank did not hold investment securities ofany single issuer, other than obligations of the U.S. government agencies,whose aggregate book value exceeded 10% of shareholders’ equity.

 

Proceeds from the maturity,call or sale of available-for-sale securities were $51.6 million during thethree months ended March 31, 2010.  Proceeds from the maturity or call ofheld-to-maturity securities were $93.6 million during the three months ended March 31,2009.

 

Thefair values of all securities at March 31, 2010 either equaled or exceededthe cost of those securities, or the fair value is considered temporary.  The information in the table below classifiesthe investments with unrealized losses at March 31, 2010 according to theterm of the unrealized loss.  Managementevaluates securities for other-than-temporary impairment periodically, or morefrequently when circumstances require an evaluation.  An impairment judgment is based on (i) theamount of time and loss, (ii) the financial condition of the issuer and (iii) management’sintent and ability to hold the investment long enough for any anticipatedrecovery in value.

 

Managementhas the ability and intent to hold the securities classified asheld-to-maturity until they mature.  Furthermore,as of March 31, 2010, management also had the ability to hold thesecurities classified as available for sale for a period of time sufficient fora recovery of cost.  The unrealizedlosses are largely as a result of increases in market interest rates over theyield available at the time the underlying securities were purchased.  The fair value is expected to recover as thebonds approach their maturity date or repricing date or if market yields forsuch investments decline.  Managementdoes not believe any of the securities are impaired because of reasons ofcredit quality.  Accordingly, as of March 31,2010, management believes the impairments detailed in the table below aretemporary and no impairment loss has been realized in the Corporation’sconsolidated income statement.

 

Thefollowing table presents the Bank’s investments with unrealized losses at March 31,2010 according to the term of the unrealized loss:

 
| ** **                             | ** ** | **Less than  12 months** | ** **  | **12 months  or Greater** | ** ** | **Total**  | ** ** |
|----------------------------------------|------------|--------------------------|-------------|---------------------------|------------|------------|------------|
| ** **                             | ** ** | **Fair**                 | ** **  | **Unrealized**            | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(Dollars in  thousands)**            | ** ** | **Value**                | ** **  | **Losses**                | ** ** | **Value**  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| **Type of  Security**                  | ** ** | ** **               | ** **  | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **U.S.  Government agencies**          | ** ** | **$**                    | **91,285**  | ** **                | **$**      | **586**    | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **91,285** | ** ** | **$** | **586** | ** ** |
| **States and  political subdivisions** | ** ** | **8,497**                | ** **  | **162**                   | ** ** | **419**    | ** ** | **31** | ** ** | **8,916** | ** ** | **193** | ** ** |
| **Corporate  bonds**                   | ** ** | **1,497**                | ** **  | **4**                     | ** ** | **—** | ** ** | **—** | ** ** | **1,497** | ** ** | **4** | ** ** |
| ** **                             | ** ** | **$**                    | **101,279** | ** **                | **$**      | **752**    | ** ** | **$** | **419** | ** ** | **$** | **31** | ** ** | **$** | **101,698** | ** ** | **$** | **783** | ** ** |

 

AtMarch 31, 2010, one of 198 state and political subdivision securities hadrecorded unrealized losses for a period longer than 12 months.  Because these securities, along with thecorporate securities, declined in value when interest rates began to rise, andnot because of the credit quality of the issuer, and because management hadboth the intent and ability to hold the investments, the securities were notconsidered other-than-temporarily impaired.

 

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The table below shows theamortized cost and fair value of investment securities at March 31, 2010by contractual or legal maturity. Expected maturities may differ from contractual maturities becauseissuers may have the right to call or prepay obligations.  Mortgage-backed securities and equitysecurities are shown separately since they are not due at a single maturity date.

 
| ** **                        | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | **Yield**       | ** ** |
|-----------------------------------|------------|---------------|------------|------------|------------|-----------------|------------|
| **(Dollars in Thousands)**        | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **(Unaudited)** | ** ** |
| **Available-for-sale securities** |       |          |       |       |       |            |       |
| U.S. Government agencies          |       |          | ** ** | ** ** |       |            |       |
| Within one year                   |       | $             | 10,000     | ** ** | **$**      | **10,006**      |       | 3.7 | % |
| After one but within five years   |       | 48,841        | ** ** | **48,702** |       | 1.5             | %          |
| After five but within ten years   |       | 84,984        | ** ** | **84,822** |       | 3.2             | %          |
| Mortgage backed securities        |       |          | ** ** | ** ** |       |            |       |
| Within one year                   |       | 2,088         | ** ** | **2,099**  |       | 1.5             | %          |
| After one but within five years   |       | 18,285        | ** ** | **18,246** |       | 2.6             | %          |
| After five but within ten years   |       | 4,833         | ** ** | **4,912**  |       | 3.8             | %          |
| States and political subdivisions |       |          | ** ** | ** ** |       |            |       |
| Within one year                   |       | 405           | ** ** | **409**    |       | 8.3             | %          |
| After one but within five years   |       | 6,432         | ** ** | **6,667**  |       | 3.8             | %          |
| After five but within ten years   |       | 3,765         | ** ** | **3,807**  |       | 5.5             | %          |
| After ten years                   |       | 38,925        | ** ** | **39,609** |       | 5.9             | %          |
| Other securities                  |       |          |       |       |       |            |       |
| Within one year                   |       | 1,697         | ** ** | **1,738**  |       | 4.5             | %          |
| After one but within five years   |       | 12,510        | ** ** | **13,015** |       | 3.7             | %          |
| After five but within ten years   |       | 761           | ** ** | **808**    |       | 4.5             | %          |
| After ten years                   |       | 3,896         | ** ** | **3,896**  |       | 3.4             | %          |
|                              |       | $             | 237,422    | ** ** | **$**      | **238,736**     |       |   |   |
| **Held-to-maturity securities**   |       |          |       |       |       |            |       |
| U.S. Government agencies          |       |          |       |       |       |            |       |
| States and political subdivisions | ** ** | ** **    |       |       |       |            |       |
| Within one year                   | ** ** | **1,520**     |       | 1,523      |       | 8.1             | %          |
| After one but within five years   | ** ** | **9,928**     |       | 10,264     |       | 6.8             | %          |
| After five but within ten years   | ** ** | **10,815**    |       | 11,233     |       | 6.9             | %          |
| After ten years                   | ** ** | **20,169**    |       | 20,665     |       | 6.2             | %          |
|                              | ** ** | **$**         | **42,432** |       | $          | 43,685          |       |   |   |

 

**NOTE 6****—****RECENT ACCOUNTING PRONOUNCEMENTS**

 

In January 2010, the FASB issued AccountingStandards Update (“ASU”) No. 2010-06, *Fair Value Measurementsand Disclosures (Topic 820):  ImprovingDisclosures about Fair Value Measurements.*  This ASU requires fair value disclosures tobe disaggregated below line items in the statement of financial position.  It clarifies that fair value disclosuresshould include a description of the inputs and valuation techniques used forboth recurring and nonrecurring Level 2 and Level 3 estimates.  It also requires entities to disclose anysignificant transfers between Levels 1, 2, and 3 during a reporting period andthe reasons the transfers were made. These disclosures have been included in this quarterly report on Form 10-Q,as appropriate.

 

On January 1, 2010, ASU No. 2009-16, *Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets* becameeffective.  This ASU removed the conceptof a qualifying special-purpose entity from generally accepted accountingprinciples and changed the requirements for derecognizing financialassets.  Upon adoption of the ASU, theBank had no change in its balance sheet or required capital because off-balancesheet financing is not used.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

Certain statements contained in this report may notbe based on historical facts and are “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Theseforward-looking statements may be identified by, among other things, the use offorward-looking terminology such as “could,” “would,” “expects,” “believes,” “may”or “will,” or future or conditional verb tenses, and variations or  negatives of such terms.  These forward-looking statements include,without limitation, those relating to the Corporation’s valuationmethodologies, impairment of securities, maturity of securities, loan portfolioconcentrations, fair value of impaired loans, satisfaction of capital adequacyrequirements, FHLB borrowings, adequacy of traditional sources of cashgenerated from operating activities to meet liquidity needs and the realizationof deferred income tax assets.  Wecaution you not to place undue reliance on such forward-looking statements inthis report because results could differ materially from those anticipated dueto a variety of factors.  These factorsinclude, but are not limited to, conditions in the financial market, liquidityneed, the sufficiency of our allowance for loan losses, economic conditions inthe communities in the State of Tennessee where the Corporation does business,the impact of government regulation and supervision, interest rate risk,including changes in monetary policy and fluctuating interest rates, theCorporation’s ability to attract and retain key personnel, competition fromother financial services, the liquidity of the Corporation’s common stock,other factors generally understood to affect the financial results of financialservices companies and other factors detailed from time to time in our filingswith the SEC. We undertake no obligation to update these forward-lookingstatements to reflect events or circumstances that occur after the date of thisreport.

 

**EXECUTIVE OVERVIEW**

 

AtMarch 31, 2010, theconsolidated total assets of First Farmers and Merchants Corporation (the “Corporation”)were $962.8 million, its consolidated net loans were $564.3 million, its totaldeposits were $811.1 million and its total shareholders’ equity was $107.7 million.  The Corporation’s loan portfolio at March 31, 2010 reflected adecrease of $3.3 million, or 0.6%, compared to December 31, 2009.  Total deposits increased $38.8 million, or5.0%, and shareholders’ equity increased by less than 0.5% during the first threemonths of 2010.  Total shareholders’equity includes an unrealized gain on available-for-sale securities ofapproximately $808,000.

 

**FINANCIALCONDITION**

 

Averageearning assets at March 31,2010 were up 1.6%, or $13.7 million, from average earning assets at December 31,2009.  Average overnight investments at March 31, 2010 were up $7.8million compared to December 31, 2009. Average investment securities at March 31, 2010 were up 7.5% compared to December 31,2009.  Average total assets of $950.0 millionat March 31,2010 increased 3.0% or $27.4 million, compared to $922.6 million at December 31,2009.

 

**Securities**

 

Available-for-salesecurities are an integral part of the asset/liability management process forFirst Farmers and Merchants Bank, the Corporation’s sole direct subsidiary (the“Bank”).  Accordingly, they represent animportant source of liquidity available to fund loans and accommodate assetreallocation strategies dictated by changes in the Bank’s operating and taxplans, shifting yield spread relationships and changes in configuration of theyield curve.  At March 31, 2010, the Bank’sinvestment securities portfolio had $238.7 million available-for-salesecurities, which are valued at fair market value, and $42.4 millionheld-to-maturity securities, which are valued at cost on the balance sheet.These compare to $208.2 million of available-for-sale securities and $47.6million of held-to-maturity securities as of December 31, 2009.

 

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**Loans**

 

The loan portfolio is the largest component ofearning assets for the Bank and, consequently, provides the highest amount of revenues for theCorporation.  The loan portfolio also contains thehighest exposure to risk as a result of the possibility of unexpecteddeterioration in the credit quality of borrowers.  When analyzing potential loans, management ofthe Bank assesses both interest rate objectives and credit quality objectivesin determining whether to make a given loan and the appropriate pricing forthat loan.  All loans are expected to berepaid from cash flow or proceeds from the sale of selected assets of the borrowers.  Collateral requirements for the loanportfolio are based on credit evaluation of the borrowers.

 

Theloan portfolio contracted slightly during the first quarter, making this thethird consecutive quarterly decline in loans outstanding.  Loan growth has been sluggish in 2010, asboth the commercial and retail portfolios have experienced some deteriorationin the first three months of the year. The Bank continues to carry a concentration in 1-4 family residentialfirst mortgage lending, but this portfolio contracted in the first three monthsof 2010.  On the commercial side, theBank continues to experience growth in the non-farm, non-residential realestate portfolio.  Over half of the Bank’sexposure is in owner-occupied real estate, rather than commercial real estate,which is dependent on the lease, sale, or refinance of the underlyingcollateral.  Higher reserves are beingplaced against property types which are perceived to be higher risk, such asretail and multi-family real estate.

 

Realestate loans represented 80.2% of total loans at March 31, 2010 comparedto 77.2% at March 31, 2009 and 79.5% at December 31, 2009.  Management of the Bank believes the risk ofthis concentration is acceptable given the quality of underwriting and the lowlevel of historical loss experience.  TheBank’s construction and development portfolio has decreased by $5.2 million inthe last three months, as existing construction projects have been completedand few new projects have come in to replace them.  Construction and development loansrepresented only 6.1% of total loans as of March 31, 2010, compared to7.1% at March 31, 2009 and 6.7% at December 31, 2009. However, theBank continues to reserve more heavily against its construction and developmentportfolio than any other segment of the commercial portfolio, given thecomparatively high level of losses that have been incurred within this segmentof the portfolio over the previous year.

 

Theanalysis and review of asset quality by the Bank’s credit administrationincludes a formal review that evaluates the adequacy of the allowance forpossible loan and lease losses.  Thisreview is updated monthly and evaluated in more detail quarterly in conjunctionwith loan review reports and evaluations that are discussed in meetings withloan officers, credit administration and the Bank’s Board of Directors.  No reserve is placed against loans that arerisk rated “1”, as these loans are all cash-secured.  A separate methodology is used for thecriticized and classified portfolios (risk ratings 6-8), and the Bank’shistorical loss methodology is utilized for the pass-grade ratings (riskratings 2-5) of the commercial portfolio. Several smaller segments of the commercial portfolio saw increasing lossrates in the first quarter.    Propertytypes which are deemed to be higher-risk forms of collateral and present thehighest likelihood of credit losses now carry correspondingly higherreserves.   The allowance for possibleloan and lease losses was $9.1 million, or 1.6% of gross loans and leases, at March 31, 2010, compared to$8.9 million, or 1.5%, at December 31, 2009.  Net charge-offs through March 31, 2010 wereapproximately $913,000, which results in an annualized net charge-off ratio of0.6%.

 

Aformal process is in place to enhance control over the underwriting of loansand to monitor loan collectability.  Thisprocess includes education and training of personnel about the Bank’s loanpolicies and procedures, assignment of credit analysts to support lenders, timely identification of loans withadverse characteristics, control of corrective actions and objective monitoringof loan reviews.  The Special AssetsDepartment of the Bank identifies and monitors assets that need specialattention.  At March 31, 2010, this processidentified loans totaling $8.8 million, or 1.5% of the portfolio, that wereclassified as other assets especially mentioned, compared to loans totaling$8.7 million, or 1.5% of the portfolio, so classified at December 31,2009.  Loans totaling $23.8 million, or4.2% of the portfolio, were classified as substandard at March 31, 2010, compared toloans totaling $25.5 million, or 4.4% of the portfolio, so classified at December 31,2009.  Loans totaling $3.8 million, or0.7% of the portfolio, were classified as doubtful at March 31, 2010, compared to noloans at December 31, 2009.

 

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**Deposits**

 

The Bank does not have anyforeign offices and all deposits are serviced in its 19 domestic offices.  The Bank’s average deposits increased 3.9%during the first three months of 2010 compared to an increase of 6.8% in thefirst three months of 2009.  Averagetotal noninterest-bearing deposits were 14.3% of total deposits at March 31, 2010, contributingto the Bank’s low cost of deposits, compared to 15.1% at December 31,2009.

 

**Regulatory Requirements for Capital**

 

TheCorporation and the Bank are subject to federal regulatory risk-adjustedcapital adequacy standards.  Failure tomeet capital adequacy requirements could result in certain mandatory, andpossibly additional discretionary, actions by regulators that could have adirect material adverse effect on the financial condition of the Corporationand the Bank.  Federal regulationsrequire the Corporation and the Bank to meet specific capital adequacyguidelines that involve quantitative measures of assets, liabilities andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The capital classification isalso subject to qualitative judgments by the regulators about components, riskweightings and other factors.

 

Quantitative measures established by the Board of Governors of theFederal Reserve System to ensure capital adequacy require the Corporation andthe Bank to maintain minimum amounts and ratios of Tier 1 Capital and TotalCapital (Tier 1 plus Tier 2 Capital) to risk-weighted assets and of Tier 1Capital to average total assets (leverage capital ratio).   Equity capital (net of certain adjustmentsfor intangible assets and investments in non-consolidated subsidiaries andcertain classes of preferred stock) is considered Tier 1 Capital.  Tier 2 Capital consists of core capital plussubordinated debt, some types of preferred stock, and a defined percentage ofthe allowance for possible loan and lease****losses.  To be “well-capitalized” under federal bankregulations, a bank must have a Tier 1 Capital ratio of at least 6%, a TotalCapital ratio of at least 10%, and a leverage capital ratio of at least5%.  As of March 31, 2010, the Bank’s Tier 1 Capital,Total Capital and leverage capital ratios were 14.5%, 15.8%, and 10.1%,respectively, compared to 14.6%, 15.8%, and 10.2% at December 31, 2009. AtMarch 31, 2010, theCorporation’s Tier 1, Total Capital and leverage capital ratios were 14.9%,16.1% and 10.4%, respectively.  Theratios were 14.9%, 16.2% and 10.5%, respectively, at December 31,2009.  Management believes, as of March 31, 2010, that theCorporation and the Bank each met all capital adequacy requirements to whichthey are subject.

 

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

 

Most of the capital needs of the Bank historically have been financedwith retained earnings and deposits received, and the Corporation’s primarysource of liquidity has been dividends declared by the Bank.  In March 2008, the Bank obtained fiveadvances at $7 million each from the FHLB. The first two scheduled repayment of the advances were made in March 2009and March 2010.  The remainingpayments will continue each March through 2013.   In September 2008, the Bank obtainedtwo additional advances of $3.1 million each for a total borrowing in 2008 of$41.2 million.  The borrowings from theFHLB have been used generally for investment strategies to enhance the Bank’sportfolio.   Please refer to Note 5 inthe notes to consolidated financial statements for additional information aboutborrowings from the FHLB and the repayment schedule of such borrowings.

 

The Bank is subject to Tennessee statutes and regulations that impose restrictionson the amount of dividends that may be declared.  Furthermore, any dividend payments aresubject to the continuing ability of the Bank to maintain its compliance withminimum federal regulatory capital requirements and to retain its characterizationunder federal regulations as a “well-capitalized” institution. The Bankdeclared a $0.37 per share dividend in the fourth quarter of 2009, which waspaid in the first quarter of 2010. Management believes that the Corporation’s traditional sources of cashgenerated from the Bank’s operating activities are adequate to meet theCorporation’s liquidity needs for normal ongoing operations.  The Bank’s Board of Directors has adopted aliquidity policy that outlines specific liquidity target balances.  Compliance with this policy is reviewedquarterly by the Bank’s Asset/Liability Committee and results are reported tothe Bank’s Board of Directors.

 

TheBank’s formal asset and liability management process is used to manage interestrate risk and assist management in maintaining reasonable stability in thegross interest margin as a result of changes in the level of interest 

 

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ratesand/or the spread relationships among interest rates.  The Bank uses an earnings simulation model toevaluate the impact of different interest rate scenarios on the grossmargin.  Each quarter, the Bank’sAsset/Liability Committee monitors the relationship of rate sensitive earningassets to rate sensitive interest-bearing liabilities (interest ratesensitivity), which is the principal factor in determining the effect thatfluctuating interest rates will have on future net interest income.  Rate sensitive earning assets and interestbearing liabilities are financial instruments that can be repriced to currentmarket rates within a defined time period.

 

**CRITICAL ACCOUNTING POLICIES**

 

Theaccounting principles the Bank follows and the methods of applying theseprinciples conform with accounting principles generally accepted in the UnitedStates and with general practices within the banking industry.  In connection with the application of thoseprinciples, the Bank’s management has made judgments and estimates that withrespect to the determination of the 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 March 31,2010 and December 31, 2009, the deferred income tax asset was $5.5 millionand was included with other assets on the balance sheet.

 

*Allowance for Loan and LeaseLosses*

 

The Bank’s management assesses the adequacy of theALLL prior to the end of each month and prepares a more formal review quarterlyto assess the risk in the Bank’s loan portfolio.  This assessment includes procedures toestimate the allowance and test the adequacy and appropriateness of theresulting balance.  The ALLL representscalculated amounts for specifically identified credit exposure and exposuresreadily predictable by historical or comparative experience.  Even though this calculation considersspecific credits, the entire allowance is available to absorb any creditlosses.

 

These calculated amounts are determined by assessingloans identified as not in compliance with loan agreements.  These loans are generally in two differentrisk groups.  One group is unique loans(commercial loans, including those loans considered impaired).  The second group consists of pools ofhomogenous loans (generally retail and mortgage loans).  The calculation for unique loans is basedprimarily on risk rating grades assigned to each of these loans as a result ofthe Bank’s loan management and review processes.  Each risk-rating grade is assigned a lossratio, which is determined based on the experience of management, discussionswith banking regulators and the independent loan review process.  The amount allocated for an impaired loan isbased on estimated cash flows discounted at the loan’s original effectiveinterest rate or the underlying collateral value.  Historical data, including actual lossexperience on specific types of homogenous loans, is used to allocate amountsfor loans or groups of loans meeting the specified criteria.  Management has implemented procedures thatgive more detailed historical data by category of retail and consumer creditand performance characteristics to broaden the analysis and improve monitoringof potential credit risk.

 

Criteria considered and processes utilized inevaluating the adequacy of the ALLL are:

 

·             Portfolio quality trends;

·                  Changes in the nature andvolume of the portfolio;

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

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

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

·                  Changes in personnel,management and staff; and

·                  Existence and effect of anyconcentrations of credit.

 

In assessing the adequacy of the ALLL, the riskcharacteristics of the entire loan portfolio are evaluated.  This process includes the judgment of theBank’s management, input from independent loan reviews and reviews that mayhave been conducted by bank regulators as part of their usual examinationprocess.

 

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*DeferredIncome Tax Assets*

 

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

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

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

 

Thetotal outstanding balance of loan commitments and stand-by letters of credit inthe normal course of business at March 31, 2010 were $108.4 million and$8.5 million, respectively, compared to $100.4 million and $9.3 million,respectively, at March 31, 2009.

 

AtMarch 31, 2010, theCorporation and the Bank did not have any off-balance sheet arrangements otherthan commitments to extend credit and stand-by letters of credit.

 

**RESULTS OF OPERATIONS**

 

Totalinterest income for the first three months of 2010 was $10.0 million comparedto $10.2 million for the first three months of 2009.  Interest and fees earned on loans and investmentsare the components of total interest income. Interest and fees earned on loans were $7.9 million, a slight increaseof approximately $7,000, or 0.1%, during the first three months of 2010compared to the first three months of 2009. Nominal interest earned on investment securities and other investmentswas $2.1 million, a decrease of approximately $233,000, or 10.0%, during thefirst three months of 2010 compared to the first three months of 2009.

 

Total interest expense in the first three months of2010 was $1.9 million, a decrease of approximately $629,000, or 24.6%, comparedto the first three months of 2009.  Thelower interest rates for certificates of deposits and public funds during thefirst quarter of 2010 were the primary reason for the lower expense.  As a policy, budgeted financial goals aremonitored on a quarterly basis by the Bank’s Asset/Liability Committee, whichreviews the actual dollar change in net interest income for different interestrate movements.  A negative dollar changein net interest income for a 12-month and 24-month period of less than 10.0% ofnet interest income given a 100 to 200 basis point shift in interest rates isconsidered an acceptable rate risk position. The rate risk analysis for the 12-month period beginning April 1,2010 and ending March 31, 2011 showed a worst-case potential change to netinterest income of 7.0%, or a decrease in net interest income of $2.2 millionby the end of the period.

 

Net interest income of the Corporation on a fullytaxable equivalent basis is influenced primarily by changes in:

 

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

(2)           market rates ofinterest; and

(3)           income tax rates.

 

The impact of some of these factors can becontrolled by management policies and actions. External factors also can have a significant impact on changes in netinterest income from one period to another. Some examples of such factors are:

 

(1)                                  the strength ofcredit demands by customers;

(2)                                  Federal ReserveBoard monetary policy; and

 

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

 

The net interest margin, on a tax equivalent basis,at March 31,2010, March 31,2009 and December, 31, 2009 was 4.11%, 4.01% and 4.10%, respectively.

 

Additions of $1.1 million were made to the provisionfor possible loan and lease losses in the first quarter of 2010 as a result ofan increase in the level of credit losses on both secured and unsecuredconsumer loans as well as the Bank having to downgrade the credit level on afew commercial loans.

 

Noninterestincome was $2.8 million, a decrease of $1.6 million, or 35.8%, during the firstthree months of 2010 compared to the first three months of 2009.  The gains on sales of available-for-salesecurities, representing approximately $503,000 in income during the firstthree months in 2010, compared to gains on sales of available-for-salesecurities, representing $2.0 million in first quarter 2009, were the primaryreason for the variance in the first three months of 2010.

 

Noninterestexpense, excluding the provision for possible loan and lease losses was $8.7million, an increase of approximately $674,000, or 8.4%, in the first threemonths of 2010 as compared to the first three months of 2009. ** **One of the reasons for the higher expense was theFederal Deposit Insurance Company (“FDIC”) assessment.  The Bank expensed approximately $350,000 forthe FDIC assessment during the first three months of 2010 compared toapproximately $30,000 expensed for the first three months in 2009.  Another reason for the higher noninterestexpense in 2010 was the increased write downs of other real estate for thefirst quarter of 2010.  The Bank hasapproximately $234,000 in 2010, compared to only approximately $2,000 in 2009.

 

The Corporation does not have any long-term debt or other long-termobligations; however, in 2008, the Bank received a $41.2 million advance fromFHLB.   The scheduled $7.0 million annual principal maturities ofborrowings under this credit line began in March 2009 and will end in2013.  Please refer to Note 5 in thenotes to consolidated financial statements included in this report for additionalinformation about borrowings from the FHLB.

 

TheBank also leases a certain number of its properties.  There was no change during the three-monthperiod ended March 31,2010 in the terms of these leases.

 

Netincome for the three months ended March 31, 2010 was $1.2 million, comparedto $2.7 million for the three months ended March 31, 2009.  An increase in operating expenses contributedto the period-over-period decrease.  TheCorporation earned $0.22 per share in the first quarter of 2010 and $0.49 pershare in the first quarter of 2009.

 

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

 

Duringthe three months ended March 31,2010, 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, 2009.

 

**Item4.  Controls and Procedures.**

 

(a) Evaluationof Disclosure Controls and Procedures. The Corporation, with the participation of its management, including theCorporation’s Chief Executive Officer and Assistant Treasurer (principalfinancial officer), carried out an evaluation of the effectiveness of thedesign and operation of its disclosure controls and procedures (as defined in Rules 13a-15and 15d-15 under the Exchange Act) as of the end of the period covered by thisreport.  Based upon that evaluation andas of the end of the period covered by this report, the Corporation’s ChiefExecutive Officer and Assistant Treasurer (principal financial officer)concluded that the Corporation’s disclosure controls and procedures wereeffective in ensuring that information required to be disclosed in its reportsthat the Corporation files or submits to the SEC under the Exchange Act isrecorded, processed, summarized and reported on a timely basis.

 

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(b) Changesin Internal Control Over Financial Reporting.  There has been no change in the Corporation’sinternal control over financial reporting that occurred during the firstquarter of 2010 that has materially affected, or is reasonably likely tomaterially affect, the Corporation’s internal control over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item1A. Risk Factors.**

 

There have been no material changes in the risk factors previouslydisclosed in the Corporation’s Annual Report on Form 10-K for the yearended December 31, 2009.

 

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

 

The following table provides information regarding purchases of theCorporation’s common stock made by the Corporation during the first quarter of2010:

 

**CORPORATION’S PURCHASES OF EQUITY SECURITIES**

 
| **Period**                                           | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average Price  Paid per  Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number (or  Approximate Dollar  Value) of Shares that  May Yet Be Purchased  Under the Plans or  Programs** |
|------------------------------------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|
| January 1,  2010 — January  31, 2010  |       | —                                  |       | —                             |       | —                                                                                        |       | —                                                                                                                     |
| February 1,  2010 — February 28, 2010 |       | —                                  |       | —                             |       | —                                                                                        |       | —                                                                                                                     |
| March1,  2010 — March 31, 2010             |       | 17,780                                  | *          | $                                  | 43.20      |                                                                                          | —     |                                                                                                                       | — |
| Total                                                |       | 17,780                                  |       | $                                  | 43.20      |                                                                                          | —     |                                                                                                                       | — |

 

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*Purchased from several third-party sellers pursuant to previouslynegotiated agreements to purchase.

 

**Item 6.  Exhibits.**

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

 

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

 

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

 

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**SIGNATURES**

 

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   | May 10,  2010 |   |   | /s/  T. Randy Stevens                                                                                    |
|--------|--------------------|--------|--------|----------------------------------------------------------------------------------------------------------|
|   |               |   |   | T. Randy Stevens, Chief  Executive Officer                                                               |
|   |               |   |   |                                                                                                     |
|   |               |   |   |                                                                                                     |
| Date   | May 10,  2010 |   |   | /s/  Patricia P. Bearden                                                                                 |
|   |               |   |   | Patricia P. Bearden, Assistant  Treasurer (principal financial officer and principal accounting officer) |

 

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

 

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

 

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

 

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