UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For quarterly period ended
| | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT |
For the transition period from _______________ to ________________
Commission file number
Farmers and Merchants Bancshares, Inc.
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I. R. S. Employer Identification No.) |
(Address of principal executive offices) (Zip Code)
(
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act:
| Large accelerated filer ☐ | Accelerated filer ☐ | |
| Smaller reporting company | ||
| Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Table of Contents
| Page | |
| PART I – FINANCIAL INFORMATION |
3 |
| Item 1. Financial Statements |
3 |
| Consolidated balance sheets at June 30, 2023 (unaudited) and December 31, 2022 |
3 |
| Consolidated statements of income (unaudited) for the three and six months ended June 30, 2023 and 2022 |
4 |
| Consolidated statements of comprehensive income (loss) (unaudited) for the three and six months ended June 30, 2023 and 2022 |
5 |
| Consolidated statements of changes in stockholders’ equity (unaudited) for the three and six months ended June 30, 2023 and 2022 |
6 |
| Consolidated statements of cash flows (unaudited) for the six months ended June 30, 2023 and 2022 |
7 |
| Notes to financial statements (unaudited) |
9 |
| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations |
36 |
| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
47 |
| Item 4. Controls and Procedures |
47 |
| PART II – OTHER INFORMATION |
48 |
| Item 1. Legal Proceedings |
48 |
| Item 1A. Risk Factors |
48 |
| Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
48 |
| Item 3. Defaults upon Senior Securities |
48 |
| Item 4. Mine Safety Disclosures |
48 |
| Item 5. Other Information |
48 |
| Item 6. Exhibits |
48 |
| SIGNATURES |
49 |
PART I – FINANCIAL INFORMATION
Item 1 – Financial Statements
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Consolidated Balance Sheets
| June 30, | December 31,* | |||||||
| 2023 | 2022 | |||||||
| (Unaudited) | ||||||||
| Assets | ||||||||
| Cash and due from banks | $ | $ | ||||||
| Federal funds sold and other interest-bearing deposits | ||||||||
| Cash and cash equivalents | ||||||||
| Certificates of deposit in other banks | ||||||||
| Securities available for sale, at fair value | ||||||||
| Securities held to maturity, at amortized cost less allowance for credit losses of $ and $ | ||||||||
| Equity security, at fair value | ||||||||
| Restricted stock, at cost | ||||||||
| Mortgage loans held for sale | ||||||||
| Loans, less allowance for credit losses of $ and $ | ||||||||
| Premises and equipment, net | ||||||||
| Accrued interest receivable | ||||||||
| Deferred income taxes, net | ||||||||
| Other real estate owned, net | ||||||||
| Bank owned life insurance | ||||||||
| Goodwill and other intangibles, net | ||||||||
| Other assets | ||||||||
| $ | $ | |||||||
| Liabilities and Stockholders' Equity | ||||||||
| Deposits | ||||||||
| Noninterest-bearing | $ | $ | ||||||
| Interest-bearing | ||||||||
| Total deposits | ||||||||
| Securities sold under repurchase agreements | ||||||||
| Federal Home Loan Bank of Atlanta advances | ||||||||
| Federal Reserve Bank advances | ||||||||
| Long-term debt, net of issuance costs | ||||||||
| Accrued interest payable | ||||||||
| Other liabilities | ||||||||
| Stockholders' equity | ||||||||
| Common stock, par value $ per share, authorized shares; issued and outstanding shares in 2023 and in 2022 | ||||||||
| Additional paid-in capital | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
| $ | $ | |||||||
* Derived from audited consolidated financial statements
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
| Three months ended | Six months ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Interest income | ||||||||||||||||
| Loans, including fees | $ | $ | $ | $ | ||||||||||||
| Investment securities - taxable | ||||||||||||||||
| Investment securities - tax exempt | ||||||||||||||||
| Federal funds sold and other interest earning assets | ||||||||||||||||
| Total interest income | ||||||||||||||||
| Interest expense | ||||||||||||||||
| Deposits | ||||||||||||||||
| Securities sold under repurchase agreements | ||||||||||||||||
| Federal Home Loan Bank advances | ||||||||||||||||
| Federal Reserve Bank advances | ||||||||||||||||
| Long-term debt | ||||||||||||||||
| Total interest expense | ||||||||||||||||
| Net interest income | ||||||||||||||||
| Recovery of credit losses | ( | ) | ( | ) | ||||||||||||
| Net interest income after recovery of credit losses | ||||||||||||||||
| Noninterest income | ||||||||||||||||
| Service charges on deposit accounts | ||||||||||||||||
| Mortgage banking income | ||||||||||||||||
| Bank owned life insurance income | ||||||||||||||||
| Fair value adjustment on equity security | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Gain on sale of SBA loans | ||||||||||||||||
| Other fees and commissions | ||||||||||||||||
| Total noninterest income | ||||||||||||||||
| Noninterest expense | ||||||||||||||||
| Salaries | ||||||||||||||||
| Employee benefits | ||||||||||||||||
| Occupancy | ||||||||||||||||
| Furniture and equipment | ||||||||||||||||
| Other | ||||||||||||||||
| Total noninterest expense | ||||||||||||||||
| Income before income taxes | ||||||||||||||||
| Income taxes | ||||||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Earnings per share - basic and diluted | $ | $ | $ | $ | ||||||||||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Other comprehensive loss, net of income taxes: | ||||||||||||||||
| Securities available for sale | ||||||||||||||||
| Net unrealized loss arising during the period | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Total unrealized loss on investment securities available for sale | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Income tax benefit | ||||||||||||||||
| Total other comprehensive loss | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Total comprehensive (loss) income | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | ||||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
Three and six months Ended June 30, 2023 and 2022
(Unaudited)
| Additional | Accumulated other | Total | ||||||||||||||||||||||
| Common stock | paid-in | Retained | comprehensive | stockholders' | ||||||||||||||||||||
| Shares | Par value | capital | earnings | income (loss) | equity | |||||||||||||||||||
| Three months ended June 30, 2022 | ||||||||||||||||||||||||
| Balance, March 31, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Net income | - | |||||||||||||||||||||||
| Other comprehensive loss | - | ( | ) | ( | ) | |||||||||||||||||||
| Cash dividends, $ per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Dividends reinvested | ||||||||||||||||||||||||
| Balance, June 30, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Six months ended June 30, 2022 | ||||||||||||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Net income | - | |||||||||||||||||||||||
| Other comprehensive loss | - | ( | ) | ( | ) | |||||||||||||||||||
| Cash dividends, $ per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Dividends reinvested | ||||||||||||||||||||||||
| Balance, June 30, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Three months ended June 30, 2023 | ||||||||||||||||||||||||
| Balance, March 31, 2023 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Net income | - | |||||||||||||||||||||||
| Other comprehensive loss | - | ( | ) | ( | ) | |||||||||||||||||||
| Cash dividends, $ per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Dividends reinvested | ||||||||||||||||||||||||
| Balance, June 30, 2023 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Six months ended June 30, 2023 | ||||||||||||||||||||||||
| Balance, December 31, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Net income | - | |||||||||||||||||||||||
| Other comprehensive loss | - | ( | ) | ( | ) | |||||||||||||||||||
| Cash dividends, $ per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Reclassification due to the adoption of ASU 2016-13 | - | ( | ) | ( | ) | |||||||||||||||||||
| Dividends reinvested | ( | ) | ||||||||||||||||||||||
| Balance, June 30, 2023 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| Six Months Ended June 30, | 2023 | 2022 | ||||||
| Reconciliation of net income to net cash provided by operating activities | ||||||||
| Net income | $ | $ | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
| Depreciation and amortization | ||||||||
| Recovery of credit losses | ( | ) | ||||||
| Amortization (accretion) of right of use asset | ( | ) | ||||||
| Equity security dividends reinvested | ( | ) | ( | ) | ||||
| Unrealized loss on equity security | ||||||||
| Gain on sale of SBA loans | ( | ) | ||||||
| Gain on sale of premises and equipment | ( | ) | ||||||
| Gain on fair value hedge | ( | ) | ||||||
| Amortization of debt issuance costs | ||||||||
| Amortization of premiums and (accretion of discounts), net | ( | ) | ||||||
| Bank owned life insurance cash surrender value | ( | ) | ( | ) | ||||
| Increase (decrease) in | ||||||||
| Deferred loan fees and costs, net | ( | ) | ||||||
| Accrued interest payable | ( | ) | ||||||
| Other liabilities | ( | ) | ( | ) | ||||
| Decrease (increase) in | ||||||||
| Mortgage loans held for sale | ||||||||
| Accrued interest receivable | ( | ) | ||||||
| Other assets | ( | ) | ( | ) | ||||
| Net cash provided by operating activities | ||||||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| Six Months Ended June 30, | 2023 | 2022 | ||||||
| Cash flows from investing activities | ||||||||
| Proceeds from maturity and call of securities | ||||||||
| Available for sale | ||||||||
| Held to maturity | ||||||||
| Purchase of securities | ||||||||
| Available for sale | ( | ) | ||||||
| Purchases of certificates of deposit | ||||||||
| Loans made to customers, net of principal collected | ( | ) | ( | ) | ||||
| Proceeds from sale of loans | ||||||||
| Redemption (purchase) of stock in FHLB of Atlanta | ( | ) | ||||||
| Proceeds from sale of premises and equipment | ||||||||
| Purchases of premises, equipment and software | ( | ) | ( | ) | ||||
| Net cash used in investing activities | ( | ) | ( | ) | ||||
| Cash flows from financing activities | ||||||||
| Net increase (decrease) in | ||||||||
| Noninterest-bearing deposits | ( | ) | ||||||
| Interest-bearing deposits | ( | ) | ||||||
| Securities sold under repurchase agreements | ( | ) | ||||||
| Federal Reserve Bank advances | ||||||||
| Federal Home Loan Bank of Atlanta advances | ( | ) | ||||||
| Long-term debt principal payments | ( | ) | ( | ) | ||||
| Dividends paid, net of reinvestments | ( | ) | ( | ) | ||||
| Net cash provided by financing activities | ||||||||
| Net (decrease) increase in cash and cash equivalents | ( | ) | ||||||
| Cash and cash equivalents at beginning of period | ||||||||
| Cash and cash equivalents at end of period | $ | $ | ||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid during the period for interest | $ | $ | ||||||
| Cash paid during the period for income taxes | ||||||||
| Supplemental disclosure of non-cash transactions: | ||||||||
| Net unrealized loss on securities available for sale | ( | ) | ( | ) | ||||
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 1. | Principles of consolidation |
The consolidated financial statements include the accounts of Farmers and Merchants Bancshares, Inc. and its wholly owned subsidiaries, Farmers and Merchants Bank (the “Bank”), and Series Protected Cell FCB-4 (the “Insurance Subsidiary”), and one subsidiary of the Bank, Reliable Community Financial Services, Inc. (collectively the “Company”, “we”, “us”, or “our”). The Insurance Subsidiary constitutes an investment in a series of membership interests,
| 2. | Basis of Presentation |
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three- and six- months ended June 30, 2023 do not necessarily reflect the results that may be expected for the fiscal year ending December 31, 2023 or any future interim period. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, 2022, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2022 that was filed with the Securities and Exchange Commission (the “SEC”).
Recent Accounting Pronouncements
Management has the responsibility for the selection and use of appropriate accounting policies. The significant accounting policies used by the Company are described in the notes to the consolidated financial statements.
The following accounting guidance has been approved by the Financial Accounting Standards Board (“FASB”) and would apply to the Company if the Company entered into an applicable activity.
In March 2020, FASB issued Accounting Standards Update (“ASU”) 2020-04, “Reference Rate Reform (Topic 848)”: Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU Provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effect of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (LIBOR), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. ASU 2020-04 is effective between March 12, 2020 and December 31, 2022. As of June 30, 2023, the Company has converted all its LIBOR loans to an alternative reference rate.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
In December 2022, the FASB issued ASU 2022-06, “Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848”. ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance in Accounting Standards Codification (“ASC”) Topic 848. The objective of the guidance in ASC Topic 848 is to provide relief during the temporary transition period, so the FASB included a sunset provision within Topic 848 based on expectations of when the London Interbank Offered Rate (LIBOR) would cease being published. In 2021, the UK Financial Conduct Authority (FCA) delayed the intended cessation date of certain tenors of USD LIBOR to June 30, 2023. To ensure the relief in Topic 848 covers the period of time during which a significant number of modifications may take place, the ASU defers the sunset date of ASC Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in ASC Topic 848.
The ASU is effective for all entities upon issuance. As of June 30, 2023, the Company has converted all its LIBOR loans to an alternative reference rate.
Recently Adopted Accounting Developments
During June 2016, FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration. The Company adopted ASU 2016-13 as of January 1, 2023. The adjustment recorded at adoption to the overall allowance for credit losses, which consisted of adjustments to the allowance for credit losses on loans and held-to-maturity securities, as well as an adjustment to the Company’s reserve for unfunded loan commitments, was $
The Company is utilizing a third-party model to tabulate its estimate of current expected credit losses, using an average charge off or loss rate methodology. In accordance with ASC Topic 326, the Company has segmented its loan portfolio based on similar risk characteristics which included call report categories as well watch list and collateral-dependent. The Company primarily utilizes historical loss rates for the current expected credit loss (“CECL”) calculation based on Company-specific historical losses and supplemented with peer loss history where applicable. For its reasonable and supportable forecasting of current expected credit losses, the Company analyzes a simple regression using forecasted economic metrics and historical peer loss data. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider the following qualitative adjustment factors: economic conditions, concentrations of credit, interest rates, ability of staff, loan review, trends in loan quality, policy changes, and changes in nature and/or volume of loans. The Company’s CECL implementation process was overseen by the Chief Financial Officer and included an assessment of data availability and gap analysis, data collection, consideration and analysis of multiple loss estimation methodologies, an assessment of relevant qualitative factors and correlation analysis of multiple potential loss drivers and their impact on the Company’s historical loss experience.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
In March 2022, FASB issued ASU 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments in this ASU were applied prospectively, except for the transition method related to the recognition and measurement of troubled debt restructurings an entity had the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. ASU 2022-02 was effective for the Company on January 1, 2023.
In March 2022, FASB issued ASU 2022-01, “Derivatives and Hedging (Topic 815), Fair Value Hedging—Portfolio Layer Method.” ASU 2022-01 clarifies the guidance in ASC Topic 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets and is intended to better align hedge accounting with an organization’s risk management strategies. In 2017, FASB issued ASU 2017-12 to better align the economic results of risk management activities with hedge accounting. One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. ASU 2022-01 renames that method the portfolio layer method. ASU 2022-01 was effective for the Company on January 1, 2023. The Company entered into a fair value hedge in February 2023 with a notional amount of $
Summary of Significant Accounting Policies
There have been no changes to significant accounting policies since the Company’s 10-K was issued other than described below.
Allowance for Credit Losses. As further discussed below, we adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” on January 1, 2020. ASC Topic 326 replaced the previous “incurred loss” model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experience, current conditions, and reasonable and supportable forecasts. In connection with the adoption of ASC Topic 326, we revised certain accounting policies and implemented certain accounting policy elections. The revised accounting policies are described below.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
Allowance for Credit Losses - Held-to-Maturity Securities: The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account, calculated in accordance with ASC Topic 326, which is deducted from the amortized cost basis of held-to-maturity securities to present management's best estimate of the net amount expected to be collected. Held-to-maturity securities are charged-off against the allowance when deemed uncollectible by management. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. Management has made the accounting policy election to exclude accrued interest receivable on held-to-maturity securities from the estimate of credit losses. Further information regarding our policies and methodology used to estimate the allowance for credit losses on held-to-maturity securities is presented in Note 3 - Securities.
Allowance For Credit Losses - Available-for-Sale Securities: For available-for-sale securities in an unrealized loss position, we first assess whether (i) we intend to sell or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously recognized allowances are charged-off and the security's amortized cost is written down to fair value through income. If neither case is affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and any adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive (loss) income. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management has made the accounting policy election to exclude accrued interest receivable on available-for-sale securities from the estimate of credit losses. Available-for-sale securities are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed uncollectible by management or when either of the aforementioned criteria regarding intent or requirement to sell is met. Prior to the adoption of ASU 2016-13, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that were deemed to be other than temporary were reflected in earnings as realized losses. In estimating other-than-temporary impairment losses prior to January 1, 2023, management considered, among other things, (i) the length of time and the extent to which the fair value had been less than cost, (ii) the financial condition and near-term prospects of the issuer and (iii) the intent and our ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Allowance for Credit Losses - Loans: The allowance for credit losses on loans is a contra-asset valuation account, calculated in accordance with ASC Topic 326, which is deducted from the amortized cost basis of loans to present management's best estimate of the net amount expected to be collected. Loans are charged-off against the allowance when deemed uncollectible by management. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
The amount of the allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectability over the loans' contractual terms, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless (i) management has a reasonable expectation that a loan to an individual borrower that is experiencing financial difficulty will be modified or (ii) such extension or renewal options are not unconditionally cancellable by us and, in such cases, the borrower is likely to meet applicable conditions and likely to request extension or renewal. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. The allowance for credit losses is measured on a collective basis for portfolios of loans when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.
Credit loss expense related to loans reflects the totality of actions taken on all loans for a particular period including any necessary increases or decreases in the allowance related to changes in credit loss expectations associated with specific loans or pools of loans. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate appropriateness of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
In calculating the allowance for credit losses, most loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type/purpose of loan, underlying collateral, and historical/expected credit loss patterns. For modeling purposes, our loan pools include (i) commercial real estate - owner occupied, (ii) commercial real estate - non-owner occupied, (iii) construction/land development, (iv) residential – multifamily, (v) residential – single family (vi) residential – single family home equity, (vii) commercial and industrial (viii) consumer and other. We periodically reassess each pool to ensure the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary.
The average charge-off method calculates an estimate of losses based upon past experience which is applied prospectively across the life of each loan. This method allows for analysis and calculation on a note-by-note basis due to the CECL model calculating future cash flows at the individual note level based upon note characteristics. A forward balance is calculated from each note’s prior period balance, less monthly principal paydown and prepayment amount.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
The Company utilizes its own loss data as the source for its historical loss calculations within the CECL model, where appropriate. This information is sourced from call report data and spans back to an effective start date of March 31, 2000. Loss data will continuously be uploaded into the model across subsequent periods, with results always one quarter in arrears. Utilization of loss ratesacross this length of time helps to incorporate results recognized across the full economic cycle and smooth periods of economic recession and recovery. The Company may deviate from utilization of its own loss rates on an as-needed basis when said loss rates have historically been non-existent. The Company may also deviate from its existing loss rates when said rates are no longer indicative of the current portfolio composition/quality, such as historical rates impacted by losses resulting from purchased loan portfolios which have since matured or been divested. In these events, the Company will utilize aggregate loss rates recognized from Banks of comparable asset size throughout the state of Maryland, incurred across the same period, March 31, 2000 to present.
The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Significant loan/borrower attributes utilized in our modeling processes include, among other things, (i) origination date, (ii) maturity date, (iii) payment type, (iv) collateral type and amount, (v) current risk grade, (vi) current unpaid balance and commitment utilization rate, (vii) payment status/delinquency history and (viii) expected recoveries of previously charged-off amounts.
Management qualitatively adjusts model results for risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor (“Q-Factor”) and other qualitative adjustments may increase or decrease management's estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk. The various risks that may be considered in making Q-Factor and other qualitative adjustments include, among other things, the impact of (i) any concentrations of credit, (ii) local and national economic and business conditions, (iii) changes in the nature and volume of the underlying loans, (iv) changes in the experience, ability, and depth of our lending management and staff, (v) changes in volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans, (vi) our credit review function, (vii) changes in lending policies and procedures and, (viii) other factors such as rising interest rates.
In some cases, management may determine that an individual loan exhibits unique risk characteristics which differentiate the loan from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral.
Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures: The allowance for credit losses on off-balance-sheet credit exposures is a liability account, calculated in accordance with ASC Topic 326, representing expected credit losses over the contractual period for which we are exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if we have the unconditional right to cancel the obligation. The allowance is reported as a component of other liabilities in our consolidated balance sheets. Adjustments to the allowance are reported in our income statement as a component of credit loss expense.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
The table below provides the impact of the implementation of ASC Topic 326:
| December 31, 2022 | January 1, 2023 | |||||||||||
| Pre-ASC 326 Adoption | Impact of ASC 326 Adoption | As Reported Under ASC 326 | ||||||||||
| Assets: | ||||||||||||
| Loans, gross | $ | $ | $ | |||||||||
| Allowance for credit losses: | ||||||||||||
| Loans: | ||||||||||||
| Real estate: | ||||||||||||
| Commercial | ( | ) | ||||||||||
| Construction and land development | ||||||||||||
| Residential | ||||||||||||
| Commercial | ||||||||||||
| Consumer | ( | ) | ||||||||||
| Unallocated | ( | ) | ||||||||||
| Allowance for credit losses on loans | ||||||||||||
| Loans, net | ( | ) | ||||||||||
| Allowance for credit losses on debt securities held to maturity | ||||||||||||
| Net deferred tax asset | ||||||||||||
| Liabilities: | ||||||||||||
| Allowance for credit losses on off balance sheet credit exposures | ||||||||||||
| Total equity | $ | $ | ( | ) | $ | |||||||
Derivative Financial Instruments: At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (i) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (ii) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (iii) an instrument with no hedging designation (“stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Changes in the fair value of derivatives not designated or that do not qualify for hedge accounting are reported currently in earnings, as non-interest income.
Accrued settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Accrued settlements on derivatives not designated or that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
| 2. | Basis of Presentation (continued) |
The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
The Company is exposed to losses if a counterparty fails to make its payments under a contract in which the Company is in the net receiving position. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. All the contracts to which the Company is a party settle monthly or quarterly. In addition, the Company obtains collateral above certain thresholds of the fair value of its derivatives for each counterparty based upon their credit standing and the Company has netting agreements with the dealers with which it does business.
The Company’s derivative financial instruments are described more fully in Note 7.
The accounting policies adopted by management are consistent with authoritative GAAP and are consistent with those followed by our peers.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 3. | Investment Securities |
Investments in debt securities are summarized as follows:
| Amortized | Unrealized | Unrealized | Fair | Allowance for | Net Carrying | |||||||||||||||||||
| June 30, 2023 | cost | gains | losses | value | Credit Losses | Amount | ||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||
| State and municipal | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| SBA pools | ||||||||||||||||||||||||
| Corporate bonds | ||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Held to maturity | ||||||||||||||||||||||||
| State and municipal | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| December 31, 2022 | cost | gains | losses | value | ||||||||||||
| Available for sale | ||||||||||||||||
| State and municipal | $ | $ | $ | $ | ||||||||||||
| SBA pools | ||||||||||||||||
| Corporate bonds | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Held to maturity | ||||||||||||||||
| State and municipal | $ | $ | $ | $ | ||||||||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 3. | Investment Securities (continued) |
The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account that is deducted from the amortized cost basis of held-to-maturity securities to present the net amount expected to be collected. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to securities issued by States and political subdivisions, management considers (i) issuer bond ratings, (ii) historical loss rates for given bond ratings, (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, and (iv) internal forecasts. Unrated bonds were underwritten similar to commercial loans and the financial condition of the issuer is monitored periodically. Expectedcredit losses on commercial loans are applied to unrated bonds. The following table summarizes Moody's and/or Standard & Poor's bond ratings (Company’s primary credit quality indicator) for our portfolio of held-to-maturity securities issued by states and political subdivisions as of June 30, 2023 at amortized cost:
| June 30, 2023 | ||||
| AAA | ||||
| AA | ||||
| A | ||||
| BAA | ||||
| Not rated | ||||
| Total | ||||
Historical loss rates associated with securities having similar grades as those in our portfolio have generally not been significant. Furthermore, as of June 30, 2023, there were no past due principal or interest payments associated with these securities and none are on nonaccrual.
The following table details activity in the allowance for credit losses on held-to-maturity securities since December 31, 2022:
| Three Months Ended | Six Months Ended | |||||||
| June 30, 2023 | June 30, 2023 | |||||||
| Beginning balance | $ | $ | ||||||
| Impact of adopting ASC 326 | ||||||||
| Credit loss expense (recovery) | ( | ) | ( | ) | ||||
| Ending balance | $ | $ | ||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 3. | Investment Securities (continued) |
Contractual maturities, shown below, will differ from actual maturities because borrowers and issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
| Available for Sale | Held to Maturity | |||||||||||||||
| Amortized | Fair | Amortized | Fair | |||||||||||||
| June 30, 2023 | cost | value | cost | value | ||||||||||||
| Within one year | $ | $ | $ | $ | ||||||||||||
| Over one to five years | ||||||||||||||||
| Over five to ten years | ||||||||||||||||
| Over ten years | ||||||||||||||||
| Mortgage-backed securities and SBA pools, due in monthly installments | ||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
Securities with a carrying value of $
During the six months ended June 30, 2023 and 2022, there were
The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in available for sale debt securities, by category and length of time, at June 30, 2023 and December 31, 2022.
| June 30, 2023 | Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
| Description of investments | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | ||||||||||||||||||
| State and municipal | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| SBA pools | ||||||||||||||||||||||||
| Corporate bonds | ||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| December 31, 2022 | Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
| Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
| Description of investments | Fair value | losses | Fair value | losses | Fair value | losses | ||||||||||||||||||
| State and municipal | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| SBA pools | ||||||||||||||||||||||||
| Corporate bonds | ||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses |
Major categories of loans are as follows:
| June 30, | December 31, | |||||||
| 2023 | 2022 | |||||||
| Real estate: | ||||||||
| Commercial | $ | $ | ||||||
| Construction and land development | ||||||||
| Residential | ||||||||
| Commercial | ||||||||
| Consumer | ||||||||
| Less: Allowance for credit losses | ||||||||
| Deferred origination fees net of costs | ||||||||
| $ | $ | |||||||
The following tables present the amortized cost basis of loans on nonaccrual status and loans past 90 days or more still accruing as of June 30, 2023 and December 31, 2022:
| Nonaccrual | Loans Past | |||||||||||
| With No | Due 90 Days | |||||||||||
| Allowance | or More and | |||||||||||
| for Credit Loss | Nonaccrual | Still Accruing | ||||||||||
| June 30, 2023 | ||||||||||||
| Real estate: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Construction and land development | ||||||||||||
| Residential | ||||||||||||
| Commercial | ||||||||||||
| Consumer | ||||||||||||
| $ | $ | $ | ||||||||||
| December 31, 2022 | ||||||||||||
| Real estate: | ||||||||||||
| Commercial | $ | $ | $ | |||||||||
| Construction and land development | ||||||||||||
| Residential | ||||||||||||
| Commercial | ||||||||||||
| Consumer | ||||||||||||
| $ | $ | $ | ||||||||||
The Company did recognize any interest income on nonaccrual loans during the six months ended June 30, 2023 or during the year ended December 31. 2022.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses (continued) |
At June 30, 2023, the Company had nonaccrual commercial real estate loan totaling $
At December 31, 2022, the Company had nonaccrual commercial real estate loan totaling $
An age analysis of past due loans, segregated by type of loan, is as follows:
| 90 Days | ||||||||||||||||||||||||
| 30 - 59 Days | 60 - 89 Days | or More | Total | Total | ||||||||||||||||||||
| Past Due | Past Due | Past Due | Past Due | Current | Loans | |||||||||||||||||||
| June 30, 2023 | ||||||||||||||||||||||||
| Real estate: | ||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||
| Residential | ||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||
| Real estate: | ||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||
| Residential | ||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
The following table presents the amortized cost basis of collateral-dependent loans by class of loans as of June 30, 2023:
| Real estate: | ||||
| Commercial | $ | |||
| Construction and land development | ||||
| Residential | ||||
| Commercial | ||||
| Consumer | ||||
| $ |
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses (continued) |
Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the year ended December 31, 2022, are set forth in the following table:
| Unpaid | Recorded | Recorded | ||||||||||||||||||||||||||
| Contractual | Investment | Investment | Total | Average | ||||||||||||||||||||||||
| Principal | With No | With | Recorded | Related | Recorded | Interest | ||||||||||||||||||||||
| Balance | Allowance | Allowance | Investment | Allowance | Investment | Recognized | ||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||
| Commercial real estate | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Residential real estate | ||||||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
These were the disclosures under the incurred method as of December 31, 2022 prior to adopting CECL.
From time to time, loans to borrowers experiencing financial difficulty may be modified. Generally, the modifications we grant are extensions of terms, deferrals of payments for an extended period or interest rate reductions. Occasionally, we may modify a loan by providing principal forgiveness. In some cases, we will modify a loan by providing multiple types, or combinations, of concessions.
There were
Credit Quality Indicators
As part of our portfolio risk management, the Company assigns a risk grade to each loan. The factors used to determine the grade are the payment history of the loan and the borrower, the value of the collateral and net worth of the guarantor, and cash flow projections of the borrower. Excellent, Above Average, Average, Acceptable, and Pass/Watch grades are assigned to loans with limited or no delinquent payments and more than sufficient collateral and/or cash flow.
A description of the general characteristics of loans characterized as watch list or classified is as follows:
Special Mention
A special mention loan is a loan that management believes has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings. Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses (continued) |
Substandard
A substandard loan is a loan that management believes is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Such loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and capitalization. Substandard loans require more intense supervision by Company management.
Doubtful
A doubtful loan is a loan that management believes has all of the weaknesses inherent in a substandard loan with the added characteristic that the weaknesses, based on currently existing facts, conditions, and values, make collection or liquidation in full highly questionable and improbable.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses (continued) |
Loans by credit grade, segregated by loan type, and year originated are as follows:
| Term Loans Amortized Cost Basis by Origination | ||||||||||||||||||||||||||||||||
| June 30, 2023 | ||||||||||||||||||||||||||||||||
| Revolving | ||||||||||||||||||||||||||||||||
| 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Loans | Total | |||||||||||||||||||||||||
| Commercial Real Estate | ||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Construction and Land Development | ||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Residential Real Estate | ||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Aggregate total | ||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses (continued) |
| Above | Pass | Special | ||||||||||||||||||||||||||||||||||
| December 31, 2022 | Excellent | average | Average | Acceptable | watch | mention | Substandard | Doubtful | Total | |||||||||||||||||||||||||||
| Real estate: | ||||||||||||||||||||||||||||||||||||
| Commercial | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Construction and land development | ||||||||||||||||||||||||||||||||||||
| Residential | ||||||||||||||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
The following table details activity in the allowance for credit losses and loan balances by portfolio as of and for the six-month periods ended June 30, 2023 and 2022 and for the year ended December 31, 2022. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
| Impact of | Provision for | Allowance for credit losses ending balance evaluated for impairment: | Outstanding loan balances evaluated: | |||||||||||||||||||||||||||||||||||||
| June 30, 2023 | Beginning balance | ASC 326 Adoption | (recovery of) credit losses | Charge offs | Recoveries | Ending balance | Individually | Collectively | Individually | Collectively | ||||||||||||||||||||||||||||||
| Real estate: | ||||||||||||||||||||||||||||||||||||||||
| Commercial | $ | $ | ( | ) | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Construction and land development | ( | ) | ||||||||||||||||||||||||||||||||||||||
| Residential | ( | ) | ||||||||||||||||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||||||||||||||
| Consumer | ( | ) | ||||||||||||||||||||||||||||||||||||||
| Unallocated | ( | ) | ||||||||||||||||||||||||||||||||||||||
| $ | $ | $ | ( | ) | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Provision for | Allowance for loan losses ending balance evaluated for impairment: | Outstanding loan balances evaluated for impairment: | ||||||||||||||||||||||||||||||||||||||||||
|
| (recovery of) | Charge | Ending | Purchase Credit | Purchase Credit | |||||||||||||||||||||||||||||||||||||||
| June 30, 2022 | Beginning balance | loan losses | offs | Recoveries | balance | Individually | Impaired | Collectively | Individually | Impaired | Collectively | |||||||||||||||||||||||||||||||||
| Real estate: | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial | $ | $ | $ | ( | ) | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
| Construction and land development | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| Residential | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| Consumer | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| Unallocated | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| $ | $ | $ | ( | ) | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 4. | Loans and allowance for credit losses (continued) |
| Allowance for loan losses ending | Outstanding loan balances | |||||||||||||||||||||||||||||||||||||||||||
| Provision for | balance evaluated for impairment: | evaluated for impairment: | ||||||||||||||||||||||||||||||||||||||||||
| Beginning | (recovery of) | Charge | Ending | Purchase Credit | Purchase Credit | |||||||||||||||||||||||||||||||||||||||
| December 31, 2022 | balance | loan losses | offs | Recoveries | balance | Individually | Impaired | Collectively | Individually | Impaired | Collectively | |||||||||||||||||||||||||||||||||
| Real estate: | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial | $ | $ | $ | ( | ) | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
| Construction and land development | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| Residential | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||||||||||
| Unallocated | ( | ) | ||||||||||||||||||||||||||||||||||||||||||
| $ | $ | $ | ( | ) | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
The following table provides activity for the accretable credit discount of purchased loans:
| 2023 | ||||
| Balance at December 31, 2022 | $ | |||
| Accretion | ||||
| Balance at June 30, 2023 | $ | |||
At June 30, 2023, the remaining yield premium on purchased loans was $
The following table details activity in the allowance for credit losses on unfunded loan commitments:
| 2023 | ||||
| Balance at December 31, 2022 | $ | |||
| Impact of adopting ASC 326 | ||||
| Credit loss recovery | ( | ) | ||
| Balance at June 30, 2023 | $ | |||
The following table provides a summary of all of the components of the allowance for credit losses:
| Three Months Ended June 30, 2023 | Six Months Ended June 30, 2023 | |||||||||||||||||||||||||||||||
| Held to maturity securities | Loans | Unfunded loan commitments | Total | Held to maturity securities | Loans | Unfunded loan commitments | Total | |||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Impact of adopting ASC 326 | ||||||||||||||||||||||||||||||||
| Provision (recovery) of credit losses | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||
| Charge-offs | ||||||||||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 5. | Goodwill and Other Intangibles |
The acquisition of Carroll Bancorp, Inc. in October of 2020 resulted in the recording of goodwill and core deposit intangible (“CDI”). The following table presents the changes in both assets:
| Goodwill | CDI | Total | ||||||||||
| Balance at December 31, 2022 | $ | $ | $ | |||||||||
| Amortization | - | ( | ) | ( | ) | |||||||
| Balance at June 30, 2023 | $ | $ | $ | |||||||||
The CDI is being amortized over
| 6. | Capital Standards |
Farmers and Merchants Bancshares, Inc. and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off‑balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to risk‑weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).
In connection with the adoption of the Basel III Capital Rules, the Bank elected to opt-out of the requirement to include accumulated other comprehensive income in Common Equity Tier 1 capital. Common Equity Tier 1 capital for the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions.
Insured depository institutions are required to meet the following in order to qualify as “well capitalized”: (i) a common equity Tier 1 risk-based capital ratio of (ii) a Tier 1 risk-based capital ratio of (iii) a total risk-based capital ratio of and (iv) a Tier 1 leverage ratio of
The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have current applicability to the Bank. As of June 30, 2023, the Bank met all capital adequacy requirements under the Basel III Capital Rules on a fully phased‑in basis.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 6. | Capital Standards (continued) |
The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.
The following table presents actual and required capital ratios as of June 30, 2023 and December 31, 2022 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2023 and December 31, 2022 based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Capital ratios of the Company are substantially the same as the Bank’s.
| Minimum | To Be Well | |||||||||||||||||||||||
| (Dollars in thousands) | Actual | Capital Adequacy | Capitalized | |||||||||||||||||||||
| June 30, 2023 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
| Total capital (to risk-weighted assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Tier 1 capital (to risk-weighted assets) | % | % | % | |||||||||||||||||||||
| Common equity tier 1 (to risk-weighted assets) | % | % | % | |||||||||||||||||||||
| Tier 1 leverage (to average assets) | % | % | % | |||||||||||||||||||||
| Minimum | To Be Well | |||||||||||||||||||||||
| (Dollars in thousands) | Actual | Capital Adequacy | Capitalized | |||||||||||||||||||||
| December 31, 2022 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
| Total capital (to risk-weighted assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Tier 1 capital (to risk-weighted assets) | % | % | % | |||||||||||||||||||||
| Common equity tier 1 (to risk-weighted assets) | % | % | % | |||||||||||||||||||||
| Tier 1 leverage (to average assets) | % | % | % | |||||||||||||||||||||
To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of June 30, 2023, the most recent notification from the Federal Deposit Insurance Company (the “FDIC”) categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events since that notification that management believes have changed the Bank’s category.
The FDIC, through formal or informal agreement, has the authority to require an institution to maintain higher capital ratios than those provided by statute, to be categorized as well capitalized under the regulatory framework for prompt corrective action.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 7. | Derivative Financial Instrument |
The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and other terms of the individual interest rate swap agreements.
Fair Value Hedges: Interest rate swaps with notional amounts totaling $
The following table presents the amounts recorded on the balance sheet related to cumulative basis adjustments for fair value hedges as of June 30, 2023:
| Line Item in the Balance Sheet in Which the Hedged | Carrying Amount of the Hedged Assets | Cumulative Amount of Fair Value Hedging Adjustment | ||||||
| Item is Included | June 30, 2023 | June 30, 2023 | ||||||
| Securities available for sale | $ | $ | ( | ) | ||||
The Company presents derivative position gross on the balance sheet. The following table reflects the derivatives recorded on the balance sheet as of June 30, 2023:
| June 30, 2023 | ||||
| Fair | ||||
| Value | ||||
| Included in other assets: | ||||
| Derivatives designated as hedges: | ||||
| Intrest rate swaps related to securities available for sale | $ | |||
| Total included in other assets | $ | |||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 7. | Derivative Financial Instrument (continued) |
The effect of fair value hedge accounting on the statement of income for the six months ended June 30, 2023 are as follows:
| Location and Amount of Gain or Loss Recognized in Income on | ||||
| Fair Value Hedging Relationships | ||||
| Six Months Ended June 30, 2023 | ||||
| Interest | ||||
| Income | ||||
| Total amounts of income and expense line items presented in the statement of income in which the effects of the fair value hedge is recorded | ||||
| The effects of fair value hedging: | ||||
| (Loss) Gain on fair value hedging relationships: | ||||
| Hedged items | $ | ( | ) | |
| Interest rate contracts designated as hedging instruments | ||||
| Net gain on fair value hedging relationships included in interest income | $ | |||
| 8. | Fair Value |
In accordance with ASC Topic 820, “Fair Value Measurements and Disclosure”, the Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is the most representative of fair value under current market conditions.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 8. | Fair Value (continued) |
In accordance with the guidance, a hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC Topic 820 based on these two types of inputs are as follows:
| ● | Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. |
| ● | Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. |
| ● | Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. |
The Company uses the following methods and significant assumptions to estimate the fair values of the following assets:
| ● | Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices from a nationally recognized securities pricing agent. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities. |
| ● | Equity security at fair value: The Company’s investment in an equity mutual fund is valued based on the net asset value of the fund, which is classified as Level 1. |
| ● | Other real estate owned (“OREO”): Nonrecurring fair value adjustments to OREO reflect full or partial write-downs that are based on the OREO’s observable market price or current appraised value of the real estate. Since the market for OREO is not active, OREO subjected to nonrecurring fair value adjustments based on the current appraised value of the real estate are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been |
| ● | Collateral-dependent loans: Nonrecurring fair value adjustments to collateral-dependent loans reflect full or partial write-downs and reserves that are based on the collateral-dependent loan’s observable market price or current appraised value of the collateral. Because the market for collateral-dependent loans is not active, such loans subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been |
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 8. | Fair Value (continued) |
The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of June 30, 2023 and December 31, 2022, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
| Carrying Value: | ||||||||||||||||
| June 30, 2023 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Recurring: | ||||||||||||||||
| Available for sale securities | ||||||||||||||||
| State and municipal | $ | $ | $ | $ | ||||||||||||
| SBA pools | ||||||||||||||||
| Corporate bonds | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Fair value hedge | $ | $ | $ | $ | ||||||||||||
| Equity security at fair value | ||||||||||||||||
| Mutual fund | $ | $ | $ | $ | ||||||||||||
| Nonrecurring: | ||||||||||||||||
| Other real estate owned, net | $ | $ | $ | $ | ||||||||||||
| Collateral-dependent loans, net | $ | $ | $ | $ | ||||||||||||
| Carrying Value: | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
| December 31, 2022 | ||||||||||||||||
| Recurring: | ||||||||||||||||
| Available for sale securities | ||||||||||||||||
| State and municipal | $ | $ | $ | $ | ||||||||||||
| SBA pools | ||||||||||||||||
| Corporate Bonds | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Equity security at fair value | ||||||||||||||||
| Mutual fund | $ | $ | $ | $ | ||||||||||||
| Nonrecurring: | ||||||||||||||||
| Other real estate owned, net | $ | $ | $ | $ | ||||||||||||
| Impaired loans, net | ||||||||||||||||
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
| 8. | Fair Value (continued) |
The following table provides information describing the unobservable inputs used in level 3 fair value measurements at June 30, 2023 and December 31, 2022:
| June 30, 2023: | |||||||||||||
| Assets | Fair Value | Valuation Technique | Unobservable Inputs | Range (Average) | |||||||||
| Collateral-dependent loans | $ | Third party appraisals and in-house real estate valuations of fair value | Marketability/selling costs and current market conditions | to | ( | ||||||||
|
|
| ||||||||||||
| Other real estate owned | $ | Third party appraisals and in-house real estate valuations of fair value | Marketability/selling costs and current market conditions | to | ( | ||||||||
| December 31, 2022: | |||||||||||||
| Assets | Fair Value | Valuation Techniques | Unobservable Input | Average | |||||||||
| Collateral-dependent loans | $ | Third party appraisals and in-house real estate valuations of fair value | Marketability/selling costs and current market conditions | to | ( | ||||||||
| Other real estate owned | $ | Third party appraisals and in-house real estate valuations of fair value | Marketability/selling costs and current market conditions | to | ( | ||||||||
| Reconciliation of Level 3 Inputs | ||||
| Corporate | ||||
| Bonds | ||||
| December 31, 2022 fair value | $ | |||
| Transfer to level 2 | ( | ) | ||
| June 30, 2023 fair value | $ | |||
The transfer to level 2 occurred because a third party market value was available for this bond at June 30, 2023.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
8. Fair Value (continued)
The estimated fair value of financial instruments that are reported at amortized cost less allowance for credit losses in the Company’s consolidated balance sheets, segregated by the level of the valuation inputs were as follows:
| June 30, 2023 | December 31, 2022 | |||||||||||||||
| Carrying | Estimated | Carrying | Estimated | |||||||||||||
| Amount | Fair Value | Amount | Fair Value | |||||||||||||
| Financial assets | ||||||||||||||||
| Level 1 inputs | ||||||||||||||||
| Cash and cash equivalents | $ | $ | $ | $ | ||||||||||||
| Level 2 inputs | ||||||||||||||||
| Certificates of deposit in other banks | ||||||||||||||||
| Accrued interest receivable | ||||||||||||||||
| Securities held to maturity | ||||||||||||||||
| Mortgage loans held for sale | ||||||||||||||||
| Restricted stock, at cost | ||||||||||||||||
| Bank owned life insurance | ||||||||||||||||
| Fair value hedge | ||||||||||||||||
| Level 3 inputs | ||||||||||||||||
| Securities held to maturity | ||||||||||||||||
| Loans, net | ||||||||||||||||
| Financial liabilities | ||||||||||||||||
| Level 1 inputs | ||||||||||||||||
| Noninterest-bearing deposits | $ | $ | $ | $ | ||||||||||||
| Securities sold under repurchase agreements | ||||||||||||||||
| Level 2 inputs | ||||||||||||||||
| Interest-bearing deposits | ||||||||||||||||
| Federal Home Loan Bank advances | ||||||||||||||||
| Federal Reserve Bank advances | ||||||||||||||||
| Long-term debt | ||||||||||||||||
| Accrued interest payable | ||||||||||||||||
9. Earnings per Share
Basic earnings per share is determined by dividing net income available to stockholders by the weighted-average number of shares of common stock outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents, giving retroactive effect to stock dividends declared during the period. Diluted earnings per share is determined in the same manner, except that the weighted-average number of shares of common stock outstanding is adjusted for the dilutive effect of outstanding common stock equivalents. The following table sets forth the calculation of basic and diluted earnings per share for the three- and six-month periods ended June 30, 2023 and 2022. There were no common stock equivalents outstanding during the three- or six-month periods ended June 30, 2023 or 2022.
Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
9. Earnings per Share (continued)
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Weighted average shares outstanding | ||||||||||||||||
| Earnings per share - basic and diluted | $ | $ | $ | $ | ||||||||||||
10. Retirement Plans
The Company has a profit sharing plan qualifying under Section 401(k) of the Internal Revenue Code. All employees age 21 or older with six months of service are eligible for participation in the plan. The Company matches employee contributions up to
The Company has entered into agreements with
The Company adopted supplemental executive retirement plans for
Retirement plan expenses are included in employee benefits on the consolidated statements of income.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of Farmers and Merchants Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the audited consolidated financial statements and notes thereto, and the other statistical information contained in the Annual Report of Farmers and Merchants Bancshares, Inc. on Form 10-K for the year ended December 31, 2022 (the “Form 10-K”). References in this report to “us”, “we”, “our”, and “the Company” are to Farmers and Merchants Bancshares, Inc. and, unless the context clearly suggests otherwise, its consolidated subsidiaries.
Forward-Looking Statements
This report may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature, including those that include the words “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.
Farmers and Merchants Bancshares, Inc.
Farmers and Merchants Bancshares, Inc. is a Maryland corporation and a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Company was incorporated on August 8, 2016 for the purpose of becoming the holding company of Farmers and Merchants Bank (the “Bank”) in a share exchange transaction that was intended to constitute a tax-free exchange under Section 351 of the Internal Revenue Code of 1986, as amended (the “Reorganization”). The Reorganization was consummated on November 1, 2016, at which time the Bank became a wholly-owned subsidiary of the Company and all of the Bank’s stockholders became stockholders of the Company by virtue of the conversion of their shares of common stock of the Bank into an equal number of shares of common stock of the Company.
The Company’s primary business activities are serving as the parent company of the Bank and holding a series investment in First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed protected cell captive insurance company (“FCBI”). The Company owns 100% of one series of membership interests issued by FCBI, which series is deemed a “protected cell” under Tennessee law and has been designated “Series Protected Cell FCB-4” (such series investment is hereinafter referred to as the “Insurance Subsidiary”).
The Bank is a Maryland commercial bank chartered on October 24, 1919 that is engaged in a general commercial and retail banking business. The Bank has had one inactive subsidiary, Reliable Community Financial Services, Inc., a Maryland corporation that was incorporated in April 1992 to facilitate the sale of fixed rate annuity products and later positioned to sell a full array of investment and insurance products.
The Insurance Subsidiary represents one protected cell of a protected cell captive insurance company (i.e., FCBI) that was formed on November 9, 2016 to better manage our risk programs, provide insurance efficiencies, and add operating income by both keeping insurance premiums paid with respect to such risks within our affiliated group of entities and realizing certain tax benefits that are unique to captive insurance companies. The Company’s investment in the Insurance Subsidiary represents one series of membership interests in FCBI. As a “series” limited liability company, FCBI is authorized by state law and its governing instruments to issue one or more series of membership interests, each of which, for all purposes under state law, is deemed to be a legal entity separate and apart from FCBI and its other series.
Effective October 1, 2020, pursuant to a series of merger transactions, Farmers and Merchants Bancshares, Inc. acquired Carroll Bancorp, Inc. (“Carroll”) and the Bank acquired Carroll Bancshares, Inc.’s wholly-owned bank subsidiary, Carroll Community Bank (collectively, the “Merger”).
The Company maintains an Internet site at www.fmb1919.bank on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.
Estimates and Critical Accounting Policies
This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. See Note 1 of the Notes to the audited consolidated financial statements as of and for the year ended December 31, 2022, which were included in Item 8 of Part II of the Form 10-K. On an on-going basis, management evaluates estimates, including those related to credit losses and intangible assets, impairment of investment securities, income taxes, and fair value of investments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.
The allowance for credit losses on loans represents management’s estimate of expected credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on collateral dependent loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet.
Management applies various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit and other intangible assets, other assets and liabilities obtained or assumed in business combinations. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on our results of operations, financial condition or disclosures of fair value information. In addition to valuation, we must assess whether there are any declines in value below the carrying value of assets that should be considered impaired or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statements of income. Examples include investment securities, goodwill and core deposit intangible, among others.
Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2022 other than the adoption of ASC 326 as described in footnote 2.
Financial Condition
Total assets increased by $12,051,453, or 1.7%, to $730,262,125 at June 30, 2023 from $718,210,672 at December 31, 2022. The increase in total assets was due primarily to an increase of $14,078,552 in loans and an increase of $5,023,981 in cash and cash equivalents, offset by a decrease of $6,874,208 in debt securities.
Total liabilities increased $9,992,172, or 1.5%, to $680,427,881 at June 30, 2023 from $670,435,709 at December 31, 2022. The increase was due primarily to an $8,199,766 increase in deposits and a $10,000,000 increase in advances from the Federal Reserve Bank of Richmond (the “Reserve Bank”), offset by a $6,000,000 decrease in advances from the Federal Home Loan Bank (“FHLB”), a $1,112,365 decrease in securities sold under repurchase agreements, and a $941,632 decrease in long-term debt.
Stockholders’ equity increased by $2,059,281 to $49,834,244 at June 30, 2023 from $47,774,963 at December 31, 2022. The increase was due to net income of $3,570,968, offset by dividends paid, net of reinvestments, of $629,576, an increase of $540,719 in accumulated other comprehensive loss and a $341,392 adjustment for the adoption of the Financial Accounting Standards Board’s Accounting Standard Update 2016-13.
Loans
Major categories of loans at June 30, 2023 and December 31, 2022 were as follows:
| June 30, |
December 31, |
|||||||||||||||
| 2023 |
2022 |
|||||||||||||||
| Real estate: |
||||||||||||||||
| Commercial |
$ | 367,211,191 | 68 | % | $ | 351,794,702 | 67 | % | ||||||||
| Construction/Land development |
24,940,684 | 5 | % | 23,978,373 | 5 | % | ||||||||||
| Residential |
112,054,777 | 21 | % | 114,683,149 | 22 | % | ||||||||||
| Commercial |
31,873,881 | 6 | % | 31,066,497 | 6 | % | ||||||||||
| Consumer |
182,095 | 0 | % | 156,422 | 0 | % | ||||||||||
| 536,262,628 | 100 | % | 521,679,143 | 100 | % | |||||||||||
| Less: Allowance for credit losses on loans |
4,646,836 | 4,150,198 | ||||||||||||||
| Deferred origination fees net of costs |
616,700 | 608,405 | ||||||||||||||
| $ | 530,999,092 | $ | 516,920,540 | |||||||||||||
Loans increased by $14,078,552, or 2.7%, to $530,999,092 at June 30, 2023 from $516,920,540 at December 31, 2022. The increase was due primarily to increases of $15,416,489 in commercial real estate loans, $962,311 in construction/land development loans and $807,384 in commercial loans, offset by a decrease of $2,628,372 in residential loans. The allowance for credit losses on loans increased by $496,638 to $4,646,836 at June 30, 2023 from $4,150,198 at December 31, 2022. Deferred origination fees, net of costs, increased to $616,700 at June 30, 2023 from $608,405 at December 31, 2022.
The Company has adopted policies and procedures that seek to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for credit losses on loans. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan, and the experience of the lending officer. The Company’s policy is to make the majority of its loan commitments in the market area it serves. Management believes that this tends to reduce risk because management is familiar with the credit histories of loan applicants and has in-depth knowledge of the risk to which a given credit is subject. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.
There was a recovery for credit losses of $495,000 recorded for the six-month period ended June 30, 2023. No provision or recovery was recorded for the six-month period ended June 30, 2022.
During the six-month periods ended June 30, 2023 and 2022, the Company had recoveries from loans written off in prior periods totaling $386,973 and $8,100, respectively, and charge-offs of $0 and $10,240, respectively, for the same periods.
Watch list loans include loans classified as Special Mention, Substandard, and Doubtful. As of June 30, 2023, the Company had $10,468,873 of loans on a watch list, other than collateral-dependent loans, for which the borrowers have the potential for experiencing financial difficulties. As of December 31, 2022, the Company had $9,926,932 of such loans. Watch List loans are subject to ongoing management attention and their classifications are reviewed regularly.
Management believes that the $4.7 million reserve at June 30, 2023 and the $495,000 recovery for the six-month period ended June 30, 2023 are appropriate to adequately cover the expected losses in the loan portfolio. $457,682 of this recovery relates to loans and is due to a recovery of $375,000 was from loans charged off over 10 years ago which also resulted in a decrease in the required reserve for loans of $82,682. The reserve was increased by $0.5 million from December 31, 2022 due primarily to the current expected credit loss (“CECL”) adjustment effective January 1, 2023. The Company’s loan portfolio grew by $14.6 million during the first half of 2023. The allowance for credit losses on loans was 0.85% of the loan portfolio at June 30, 2023 compared to 0.85% at December 31, 2022.
Investment Securities
Investments in debt securities decreased by $6,874,208, or 4.7%, to $139,949,238 at June 30, 2023 from $146,823,446 at December 31, 2022. At June 30, 2023 and December 31, 2022, the Company had classified 86% and 87% of the investment portfolio as available for sale, respectively. The balance of the portfolio was classified as held to maturity.
Securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the Company’s asset/liability management strategy. Available for sale debt securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of income taxes. Securities classified as held to maturity, which the Company has both the positive intent and ability to hold to maturity, are reported at amortized cost. The Company records unrealized gains and losses on equity securities in earnings. The Company does not currently follow a strategy of making security purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolio within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity, meet earnings objectives, and provide required collateral for deposit and borrowing activities.
Other Real Estate Owned
Other real estate owned (“OREO”) at June 30, 2023 and December 31, 2022 included two properties with an aggregate carrying value of $1,242,365. The first property is an apartment building in Baltimore, Maryland with a carrying value of $1,242,365 that was acquired in the Merger. The property is under a sales contract with a projected closing in the third quarter. The other property is land in Cecil County, Maryland with a carrying value of $0. It was acquired through foreclosure in 2007. The latter property consists of 10.43 acres and is currently under contract for a gross sales price of $295,000 with closing expected in 2023. Due to the length of time the property has been held, Maryland banking law required a write-down of the value to $0 in 2019.
Deposits
Total deposits increased by $8,199,766, or 1.3%, to $631,810,890 at June 30, 2023 from $623,611,124 at December 31, 2022. The increase in deposits was due to a $51,692,656 increase in time deposits and a $1,054,525 increase in interest bearing checking accounts, offset by a $5,723,680 decrease in noninterest-bearing accounts and a $38,823,735 decrease in savings and money market accounts.
The following table shows the average balances and average costs of deposits for the six-month periods ended June 30, 2023 and 2022:
| June 30, 2023 |
June 30, 2022 |
|||||||||||||||
| Average |
Average |
|||||||||||||||
| Balance |
Cost |
Balance |
Cost |
|||||||||||||
| Noninterest bearing demand deposits |
$ | 122,819,264 | 0.00 | % | $ | 127,882,743 | 0.00 | % | ||||||||
| Interest bearing demand deposits |
131,807,475 | 0.40 | % | 131,282,487 | 0.16 | % | ||||||||||
| Savings and money market deposits |
179,967,388 | 0.29 | % | 195,108,443 | 0.11 | % | ||||||||||
| Time deposits |
193,840,056 | 2.31 | % | 173,716,027 | 0.51 | % | ||||||||||
| $ | 628,434,183 | 1.05 | % | $ | 627,989,700 | 0.21 | % | |||||||||
Liquidity Management
Liquidity describes our ability to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet depositor withdrawal requirements, to fund loans, and to fund our other debts and obligations as they come due in the normal course of business. We maintain our asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments, and income from earning assets. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed.
The Bank is approved to borrow 75% of eligible pledged single-family residential loans and 50% of eligible pledged commercial loans as well as investment securities, or approximately $48.5 million under a secured line of credit with the FHLB. The Bank also has two facilities with the Reserve Bank. Under the first facility, which has been in place for over 10 years and is collateralized by loans, the Bank can borrow approximately $27.0 million. The second facility is the Bank Term Funding Program (“BTFP”) that the Reserve Bank created in 2023. The BTFP facility allows securities to be pledged at par, provides fixed rates for up to one-year terms, and allows prepayments in whole or in part at any time. Finally, the Bank has $23,500,000 ($14,500,000 unsecured and $9,000,000 secured) of overnight federal funds lines of credit available from commercial banks.
FHLB advances of $14,000,000 and $20,000,000 were outstanding as of June 30, 2023 and December 31, 2022, respectively. BTFP advances of $10,000,000 and $0 were outstanding as of June 30, 2023 and December 31, 2022, respectively. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll in 2020 as more fully described below. There were no borrowings from the Reserve Bank other than the BTFP advances noted above or our commercial bank lenders at June 30, 2023 and December 31, 2022. Management believes that we have adequate liquidity sources to meet all anticipated liquidity needs over the next 12 months. Management knows of no trend or event which is likely to have a material impact on our ability to maintain liquidity at satisfactory levels. Uninsured deposits were approximately $74,937,000 or 12% of total deposits at June 30, 2023.
Borrowings and Other Contractual Obligations
The Company’s contractual obligations consist primarily of borrowings and operating leases for various facilities.
On September 30, 2020, the Company borrowed $17,000,000 from First Horizon Bank (“FHN”) for the purpose of funding a portion of the consideration that was payable to the stockholders of Carroll in the Merger. Net of issuance costs, the amount of the net long-term debt was $14,154,010 and $15,095,642 as of June 30, 2023 and December 31, 2022, respectively. The loan matures on September 30, 2025. The interest rate on the loan is fixed at 4.10%. Quarterly interest-only payments were made through October 1, 2021. During the remaining term of the loan, the Company is required to make quarterly interest and principal payments of approximately $646,472, which will be based on a nine-year straight-line amortization schedule. The remaining balance of approximately $9,916,667 will be due at maturity. To secure its obligations under this loan, the Company pledged all of its shares of common stock of the Bank to FHN.
Securities sold under agreements to repurchase represent overnight borrowings from customers. Securities owned by the Company which are used as collateral for these borrowings are primarily U.S. government agency securities.
Specific information about the Company’s borrowings and contractual obligations is set forth in the following table:
| June 30, |
December 31, |
||||||||
| 2023 |
2022 |
||||||||
| Amount oustanding at period-end: |
|||||||||
| Securities sold under repurchase agreements |
$ | 4,062,938 | $ | 5,175,303 | |||||
| Federal Home Loan Bank advances |
14,000,000 | 20,000,000 | |||||||
| Federal Home Loan Bank advances mature in: |
2023 |
9,000,000 | 15,000,000 | ||||||
| 2025 |
5,000,000 | 5,000,000 | |||||||
| Federal Reserve Bank advances mature in: |
2024 |
10,000,000 | - | ||||||
| Long-term debt (net of issuance costs) |
14,154,010 | 15,095,642 | |||||||
| Weighted average rate paid at period-end: |
|||||||||
| Securites sold under repurchase agreements |
1.25 | % | 0.30 | % | |||||
| Federal Home Loan Bank advances |
3.78 | % | 1.55 | % | |||||
| Federal Reserve Bank advances |
5.37 | % | 0.00 | % | |||||
| Long-term debt |
4.10 | % | 4.10 | % | |||||
The advances from the Reserve Bank and the FHLB and the long-term debt outstanding at June 30, 2023 will require the following principal payments:
| Year ending December 31, 2023 |
9,944,445 | |||
| Year ending December 31, 2024 |
11,888,889 | |||
| Year ending December 31, 2025 |
16,333,333 |
Off-Balance Sheet Arrangements
In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. Outstanding loan commitments, unused lines of credit, and letters of credit as of June 30, 2023 and December 31, 2022 are as follows:
| June 30, |
December 31, |
|||||||
| 2023 |
2022 |
|||||||
| Loan commitments |
||||||||
| Construction and land development |
$ | 4,993,750 | $ | 911,500 | ||||
| Commercial |
5,778,000 | 398,046 | ||||||
| Commercial real estate |
2,380,000 | 9,264,000 | ||||||
| Residential |
5,756,616 | 3,402,371 | ||||||
| $ | 18,908,366 | $ | 13,975,917 | |||||
| Unused lines of credit |
||||||||
| Home-equity lines |
$ | 12,993,282 | $ | 12,086,758 | ||||
| Commercial lines |
29,558,716 | 25,464,025 | ||||||
| $ | 42,551,998 | $ | 37,550,783 | |||||
| Letters of credit |
$ | 1,249,946 | $ | 1,403,956 | ||||
Loan commitments and lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.
The maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment. Loan commitments, lines of credit and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss that is likely to be incurred as a result of funding its credit commitments.
RESULTS OF OPERATIONS
Comparison of Operating Results for the Six Months Ended June 30, 2023 and 2022
General
Net income for the six months ended June 30, 2023 was $3,570,968, compared to $4,101,535 for the same period of 2022. The decrease of $530,567, or 12.9%, was primarily due to an $808,376 decrease in net interest income, a $151,784 decrease in noninterest income and a $74,898 increase in noninterest expense, offset by a $495,000 decrease in the credit loss provision.
Net Interest Income
Net interest income was $10,927,898 for the six months ended June 30, 2023, compared to $11,736,274 for the same period of 2022. The net yield on interest earning assets decreased to 3.09% for the six months ended June 30, 2023 from 3.48% for the same period last year.
Total interest income for the six months ended June 30, 2023 was $14,436,751, compared to $12,764,872 for the same period of 2022, an increase of $1,671,879, or 13.1%.
Total interest income on loans for the six months ended June 30, 2023 increased by $1,360,557 when compared to the same period of 2022 due to a $40.2 million higher average loan balance for the six months ended June 30, 2023 when compared to the same period of 2022 and a higher loan yield of 4.70% for the six months ended June 30, 2023 versus 4.53% for the same period of 2022. Investment income for the six months ended June 30, 2023 increased by $134,721, or 8.0%, when compared to the same period of 2022 due to an increase in the fully-taxable equivalent yield to 2.24% for the six months ended June 30, 2023, compared to 2.01% for the same period of 2022, offset by a $6.7 million lower average investment balance. The fully-taxable equivalent yield on total interest-earning assets increased 31 basis points to 4.09% for the six months ended June 30, 2023 from 3.78% for the same period of 2022. The average balance of total interest-earning assets increased by $26.5 million to $705.8 million for the six months ended June 30, 2023, compared to $679.3 million for the same period of 2022.
Total interest expense for the six months ended June 30, 2023 was $3,508,853, compared to $1,028,598 for the same period of 2022, an increase of $2,480,255, or 241.1%. The increase was due to a $20.5 million increase in the average balance of interest-bearing liabilities to $545.8 million for the six months ended June 30, 2023, compared to $525.3 million in the same period of 2022, and a higher overall cost of funds on interest bearing deposits and borrowings of 1.29% for the six months ended June 30, 2023, compared to 0.39% for the same period of 2022. Cost of funds for time deposits increased to 2.31% for the six months ended June 30, 2023 from 0.51% for the same period of 2022. FHLB, Reserve Bank and other borrowings cost of funds increased to 4.02% for the six months ended June 30, 2023 from 1.00% for the same period of 2022.
Average noninterest-earning assets decreased by $13.9 million to $18.9 million for the six months ended June 30, 2023, compared to $32.8 million in the same period of 2022. Average noninterest-bearing deposits decreased by $5.1 million to $122.8 million during the six months ended June 30, 2023, compared to $127.9 million in the same period of 2022. The average balance in stockholders’ equity decreased by $3.6 million for the six months ended June 30, 2023 when compared with the same period of 2022.
The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the six-month periods ended June 30, 2023 and 2022. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.
| Six Months Ended |
Six Months Ended |
|||||||||||||||||||||||
| June 30, 2023 |
June 30, 2022 |
|||||||||||||||||||||||
| Average |
Average |
|||||||||||||||||||||||
| Balance |
Interest |
Yield |
Balance |
Interest |
Yield |
|||||||||||||||||||
| Assets: |
||||||||||||||||||||||||
| Loans |
$ | 528,367,564 | $ | 12,414,269 | 4.70 | % | $ | 488,119,522 | $ | 11,053,712 | 4.53 | % | ||||||||||||
| Securities, taxable |
150,112,394 | 1,534,613 | 2.04 | % | 156,034,198 | 1,389,115 | 1.78 | % | ||||||||||||||||
| Securities, tax exempt |
18,370,406 | 355,798 | 3.87 | % | 19,120,619 | 374,745 | 3.92 | % | ||||||||||||||||
| Federal funds sold and other interest-earning assets |
8,935,974 | 118,902 | 2.66 | % | 16,036,876 | 36,349 | 0.45 | % | ||||||||||||||||
| Total interest-earning assets |
705,786,338 | 14,423,582 | 4.09 | % | 679,311,215 | 12,853,921 | 3.78 | % | ||||||||||||||||
| Noninterest-earning assets |
18,882,574 | 32,812,683 | ||||||||||||||||||||||
| Total assets |
$ | 724,668,912 | $ | 712,123,898 | ||||||||||||||||||||
| Liabilities and Stockholders’ Equity: |
||||||||||||||||||||||||
| NOW, savings, and money market |
$ | 311,774,863 | 527,666 | 0.34 | % | $ | 326,390,930 | 213,748 | 0.13 | % | ||||||||||||||
| Certificates of deposit |
193,840,056 | 2,243,150 | 2.31 | % | 173,716,027 | 444,016 | 0.51 | % | ||||||||||||||||
| Securities sold under repurchase agreements |
4,543,985 | 11,839 | 0.52 | % | 3,820,287 | 5,684 | 0.30 | % | ||||||||||||||||
| Long-term debt |
14,489,906 | 299,952 | 4.14 | % | 16,418,169 | 340,112 | 4.14 | % | ||||||||||||||||
| FRB advances and other borrowings |
519,337 | 13,263 | 5.11 | % | - | - | 0.00 | % | ||||||||||||||||
| FHLB advances |
20,679,558 | 412,983 | 3.99 | % | 5,000,000 | 25,038 | 1.00 | % | ||||||||||||||||
| Total interest-bearing liabilities |
545,847,705 | 3,508,853 | 1.29 | % | 525,345,413 | 1,028,598 | 0.39 | % | ||||||||||||||||
| Noninterest-bearing deposits |
122,819,264 | 127,882,743 | ||||||||||||||||||||||
| Noninterest-bearing liabilities |
6,200,054 | 5,514,639 | ||||||||||||||||||||||
| Total liabilities |
674,867,023 | 658,742,795 | ||||||||||||||||||||||
| Stockholders' equity |
49,801,889 | 53,381,103 | ||||||||||||||||||||||
| Total liabilities and stockholders' equity |
$ | 724,668,912 | $ | 712,123,898 | ||||||||||||||||||||
| Net interest income |
$ | 10,914,729 | $ | 11,825,323 | ||||||||||||||||||||
| Interest rate spread |
2.80 | % | 3.39 | % | ||||||||||||||||||||
| Net yield on interest-earning assets |
3.09 | % | 3.48 | % | ||||||||||||||||||||
| Ratio of average interest-earning assets to Average interest-bearing liabilities |
129.30 | % | 129.31 | % | ||||||||||||||||||||
(1) - Interest on tax-exempt securities and other tax-exempt investments are reported on a fully taxable equivalent basis. The federal, state and combined tax rates used were 21.00%, 8.25% and 27.5175% respectively.
Noninterest Income
Noninterest income for the six months ended June 30, 2023 was $785,664, compared to $937,448 for the same period of 2022, a decrease of $151,784, or 16.2%. The decrease was primarily a result of a $158,123 decrease in the gain on the sale of SBA loans and a $128,745 decrease in mortgage banking income as a result of residential refinance activity declining due to rising interest rates, offset by an increase of $62,590 in Bank owned life insurance income and a $43,339 increase in the fair value adjustment on equity securities.
Noninterest Expense
Noninterest expense for the six months ended June 30, 2023 totaled $7,443,082, compared to $7,368,184 for the same period of 2022, an increase of $74,898, or 1.0%. The increase was due primarily to increases in salaries and benefits of $244,109, offset by a decrease in other expenses of $197,252. Salaries and benefits increased due to normal and usual annual salary increases that are effective January 1 as well as an increase in the overall headcount. The other expense decrease was due to a $272,421 decrease in professional fees as a result of recruitment fees paid to fill several positions in 2022, offset by a $90,856 increase in FDIC assessments due to an increase in the minimum assessment rate.
Income Tax Expense
Income tax expense for the six months ended June 30, 2023 was $1,194,512, compared to $1,204,003 for the same period of 2022. The effective tax rate was 25.1% for the six months ended June 30, 2023, compared to 22.7% for the same period of 2022. The increase in the effective tax rate is due to lower tax exempt revenue in 2023 versus 2022 as a result of the non-renewal of the captive insurance policy.
Comparison of Operating Results for the Three Months Ended June 30, 2023 and 2022
General
Net income for the three months ended June 30, 2023 was $1,670,117, compared to $2,050,733 for the same period of 2022. The decrease of $380,616, or 18.6%, was primarily due to a $501,355 decrease in net interest income, a $38,391 decrease in noninterest income and an $117,061 increase in noninterest expense, offset by a $225,000 decrease in the credit loss provision.
Net Interest Income
Net interest income was $5,270,830 for the three months ended June 30, 2023, compared to $5,772,185 for the same period of 2022. The net yield on interest earning assets decreased to 3.00% for the three months ended June 30, 2023 from 3.40% for the same period last year.
Total interest income for the three months ended June 30, 2023 was $7,384,222, compared to $6,275,147 for the same period of 2022, an increase of $1.1 million, or 17.7%.
Total interest income on loans for the three months ended June 30, 2023 increased by $998,371 when compared to the same period of 2022 due to a $39.8 million higher average loan balance for the three months ended June 30, 2023 when compared to the same period of 2022 and a higher loan yield of 4.80% for the three months ended June 30, 2023 versus 4.37% for the same period of 2022. Investment income for the three months ended June 30, 2023 increased by $26,617, or 3.0%, when compared to the same period of 2022 due to an increase in the fully-taxable equivalent yield to 2.27% for the three months ended June 30, 2023, compared to 2.08% for the same period of 2022, offset by a $10.8 million lower average investment balance. The fully-taxable equivalent yield on total interest-earning assets increased 50 basis points to 4.20% for the three months ended June 30, 2023 from 3.70% for the same period of 2022. The average balance of total interest-earning assets increased by $23.5 million to $707.4 million for the three months ended June 30, 2023, compared to $683.9 million for the same period of 2022.
Total interest expense for the three months ended June 30, 2023 was $2,113,392, compared to $502,962 for the same period of 2022, an increase of $1,610,430, or 320.2%. The increase was due to a $21.8 million increase in the average balance of interest-bearing liabilities to $548.5 million for the three months ended June 30, 2023, compared to $526.7 million in the same period of 2022, and a higher overall cost of funds on interest bearing deposits and borrowings of 1.54% for the three months ended June 30, 2023, compared to 0.38% for the same period of 2022. Cost of funds for time deposits increased to 2.76% for the three months ended June 30, 2023 from 0.49% for the same period of 2022. FHLB, Reserve Bank and other borrowings cost of funds increased to 4.22% for the six months ended June 30, 2023 from 1.01% for the same period of 2022.
Average noninterest-earning assets decreased by $11.0 million to $18.9 million for the three months ended June 30, 2023, compared to $29.8 million in the same period of 2022. Average noninterest-bearing deposits decreased by $10.6 million to $120.6 million during the three months ended June 30, 2023, compared to $131.1 million in the same period of 2022. The average balance in stockholders’ equity increased by $107,136 for the three months ended June 30, 2023 when compared with the same period of 2022.
The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the three-month periods ended June 30, 2023 and 2022. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.
| Three Months Ended |
Three Months Ended |
|||||||||||||||||||||||
| June 30, 2023 |
June 30, 2022 |
|||||||||||||||||||||||
| Average |
Average |
|||||||||||||||||||||||
| Balance |
Interest |
Yield |
Balance |
Interest |
Yield |
|||||||||||||||||||
| Assets: |
||||||||||||||||||||||||
| Loans |
$ | 531,172,647 | $ | 6,368,721 | 4.80 | % | $ | 491,362,854 | $ | 5,370,350 | 4.37 | % | ||||||||||||
| Securities, taxable |
148,752,039 | 771,193 | 2.07 | % | 159,346,098 | 743,371 | 1.87 | % | ||||||||||||||||
| Securities, tax exempt |
18,355,423 | 177,020 | 3.86 | % | 18,596,437 | 182,047 | 3.92 | % | ||||||||||||||||
| Federal funds sold and other interest-earning assets |
9,150,832 | 110,170 | 4.82 | % | 14,580,803 | 23,232 | 0.64 | % | ||||||||||||||||
| Total interest-earning assets |
707,430,941 | 7,427,104 | 4.20 | % | 683,886,192 | 6,319,000 | 3.70 | % | ||||||||||||||||
| Noninterest-earning assets |
18,780,691 | 29,803,177 | ||||||||||||||||||||||
| Total assets |
$ | 726,211,632 | $ | 713,689,369 | ||||||||||||||||||||
| Liabilities and Stockholders’ Equity: |
||||||||||||||||||||||||
| NOW, savings, and money market |
$ | 302,592,016 | 306,274 | 0.40 | % | $ | 330,810,077 | 108,871 | 0.13 | % | ||||||||||||||
| Certificates of deposit |
207,403,977 | 1,429,691 | 2.76 | % | 171,426,446 | 210,333 | 0.49 | % | ||||||||||||||||
| Securities sold under repurchase agreements |
3,238,673 | 7,501 | 0.93 | % | 3,251,791 | 2,433 | 0.30 | % | ||||||||||||||||
| Long-term debt |
14,271,363 | 148,389 | 4.16 | % | 16,210,876 | 168,737 | 4.16 | % | ||||||||||||||||
| FRB advances and other borrowings |
989,011 | 13,000 | 5.26 | % | - | - | 0.00 | % | ||||||||||||||||
| FHLB advances |
19,989,011 | 208,537 | 4.17 | % | 5,000,000 | 12,588 | 1.01 | % | ||||||||||||||||
| Total interest-bearing liabilities |
548,484,051 | 2,113,392 | 1.54 | % | 526,699,190 | 502,962 | 0.38 | % | ||||||||||||||||
| Noninterest-bearing deposits |
120,571,321 | 131,130,343 | ||||||||||||||||||||||
| Noninterest-bearing liabilities |
6,618,321 | 5,429,033 | ||||||||||||||||||||||
| Total liabilities |
675,673,693 | 663,258,566 | ||||||||||||||||||||||
| Stockholders' equity |
50,537,939 | 50,430,803 | ||||||||||||||||||||||
| Total liabilities and stockholders' equity |
$ | 726,211,632 | $ | 713,689,369 | ||||||||||||||||||||
| Net interest income |
$ | 5,313,712 | $ | 5,816,038 | ||||||||||||||||||||
| Interest rate spread |
2.66 | % | 3.32 | % | ||||||||||||||||||||
| Net yield on interest-earning assets |
3.00 | % | 3.40 | % | ||||||||||||||||||||
| Ratio of average interest-earning assets to Average interest-bearing liabilities |
128.98 | % | 129.84 | % | ||||||||||||||||||||
(1) - Interest on tax-exempt securities and other tax-exempt investments are reported on a fully taxable equivalent basis. The federal, state and combined tax rates used were 21.00%, 8.25% and 27.5175% respectively.
Noninterest Income
Noninterest income for the three months ended June 30, 2023 was $403,250, compared to $441,641 for the same period of 2022, a decrease of $38,391, or 8.7%. The decrease resulted primarily from a $64,523 decrease in the gain on the sale of SBA loans and a $31,350 decrease in mortgage banking income as a result of residential refinance activity declining due to rising interest rates, offset by an increase of $32,475 in Bank owned life insurance income and a $10,755 increase in the fair value adjustment on equity securities.
Noninterest Expense
Noninterest expense for the three months ended June 30, 2023 totaled $3,685,647, compared to $3,568,586 for the same period of 2022, an increase of $117,061, or 3.3%. The increase was due primarily to increases in salaries and benefits of $25,795 and an increase in other expenses of $74,026. Salaries and benefits increased due to normal and usual annual salary increases that are effective January 1 as well as an increase in the overall headcount. The other expense increase was due to an $85,973 increase in the FDIC assessment due to an increase in the minimum assessment rate.
Income Tax Expense
Income tax expense for the three months ended June 30, 2023 was $543,316, compared to $594,507 for the same period of 2022. The effective tax rate was 24.5% for the three months ended June 30, 2023, compared to 22.5% for the same period of 2022. The increase in the effective tax rate is due to lower tax exempt revenue in 2023 versus 2022 as a result of the non-renewal of the captive insurance policy.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Farmers and Merchants Bancshares, Inc. is a “smaller reporting company” as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, accordingly, is not required to include the information required by this item.
Item 4. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our management, including Farmers and Merchants Bancshares, Inc.’s principal executive officer (“PEO”) and the principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.
An evaluation of the effectiveness of these disclosure controls as of June 30, 2023 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.
During the quarter ended June 30, 2023, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Part II – OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Form 10-K. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
None.
Item 6. Exhibits
The exhibits filed or furnished with this quarterly report are listed in the following Exhibit Index:
| Exhibit | Description |
| 31.1 | Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith) |
| 31.2 | Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith) |
| 32 | Certification of the Principal Executive Officer and the Principal Financial Office pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith) |
| 101 | Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith) |
| 104 | The cover page of Farmers and Merchants Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2023 formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| FARMERS AND MERCHANTS BANCSHARES, INC. |
|||
|
|
|
|
|
|
|
|
|
|
| Date: August 14, 2023 |
By: |
/s/ Gary A. Harris |
|
|
|
|
Gary A. Harris Chief Executive Officer (Principal Executive Officer) |
|
|
|
|
|
|
| Date: August 14, 2023 |
By: |
/s/ Mark C. Krebs |
|
|
|
|
Mark C. Krebs Treasurer and Chief Financial Officer (Principal Financial Officer & Principal Accounting Officer) |
|