Farmers & Merchants Bancorp, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited consolidated results; financial amounts below are in millions unless otherwise noted.
Business context
F&M is a community banking holding company operating in northwest Ohio and northeast Indiana. Its principal revenue sources are loan and investment interest income and banking service fees. Results were shaped by COVID-19, lower interest rates, strong loan and deposit growth, and increased credit-loss provisioning.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income, before provision | $14.6 | $14.5 | $28.6 | $27.3 |
| Provision for loan losses | $1.6 | $0.1 | $3.0 | $0.2 |
| Noninterest income | $3.3 | $3.0 | $6.4 | $5.7 |
| Noninterest expense | $10.4 | $9.7 | $21.1 | $21.2 |
| Net income | $4.8 | $6.2 | $8.9 | $9.4 |
| Basic and diluted EPS | $0.43 | $0.56 | $0.80 | $0.85 |
| Net interest margin | 3.59% | 4.17% | 3.67% | 4.03% |
Q2 net income fell about 22% year over year; first-half net income fell about 5%. Q2 net interest income was nearly flat as lower interest income was offset by lower funding costs. The six-month increase in net interest income was $1.3 million.
- Balance sheet at June 30: Assets $1.784 billion, up 11.0% from year-end 2019. Net loans were $1.335 billion, up $123 million from year-end; deposits were $1.477 billion, up $189 million.
- Cash and liquidity: Cash and cash equivalents were $85.4 million, up $34.1 million from year-end. First-half operating cash flow was $8.0 million, investing cash outflow $135.8 million, and financing cash inflow $162.0 million, principally reflecting loan growth funded by deposits.
- Credit reserves and quality: Allowance for loan losses was $9.9 million, versus $7.2 million at year-end; total allowance for credit losses, including unfunded commitments, was $10.5 million. Nonaccrual loans increased to $8.5 million from $3.4 million at year-end. Loans past due 30 days or more were $3.6 million; none were over 90 days and accruing.
- Borrowings and capital: Federal funds purchased were zero, versus $17.8 million at year-end; repurchase agreements were $30.9 million and FHLB advances $19.1 million. Reported capital ratios included a 9.44% Tier 1 leverage ratio, 11.12% Tier 1 risk-based capital ratio, and 11.86% total risk-based capital ratio. Stockholders’ equity was $240.3 million.
- Dividends: $0.16 per share declared in Q2, versus $0.15 in Q2 2019. Management said it expected to maintain quarterly dividends consistent with past practice, subject to conditions.
Material changes versus prior periods
- Loan growth included approximately $87 million of Paycheck Protection Program loans. Loans increased 23.2% year over year; deposits increased 18.9%.
- Q2 interest income declined $1.0 million year over year, while interest expense declined approximately $1.1 million. The quarterly earning-asset yield fell to 4.25% from 5.25%; net interest spread narrowed to 3.34% from 3.80%.
- Credit-loss provision rose sharply: $1.6 million in Q2 versus $0.1 million, and $3.0 million for the first half versus $0.2 million. Management attributed the increase chiefly to COVID-19 uncertainty and loan growth.
- Q2 2019 included a roughly $2.0 million reversal of estimated credit losses on payoff of two acquired credit-impaired loans, benefiting the prior-year comparison.
- First-half noninterest income increased $0.8 million, including higher mortgage-related and servicing income and a $0.27 million securities gain. First-half expenses were down $0.1 million, partly because 2019 included $1.3 million in acquisition-related costs.
- Available-for-sale securities had a $6.8 million net unrealized gain at June 30, contributing to accumulated other comprehensive income of $5.4 million, compared with $1.1 million at year-end.
Outlook, commentary, and risks
Management planned to continue growth in 2020, particularly in newer markets, and expected mortgage refinancing activity to remain strong into Q3. It stated that the duration and financial effects of COVID-19 were highly uncertain and that it could not reliably predict the pandemic’s impact on the remainder of the year. No quantified earnings or margin guidance was provided.
- The Bank reported approximately 947 PPP borrowers and $87 million funded; it expected to begin processing forgiveness applications in the second half of 2020.
- As of June 30, 95 mortgage customers had entered forbearance agreements totaling just under $8.8 million. The company also reported consumer payment extensions and waived fees as customer assistance measures.
- Management identified elevated risks in hospitality, restaurants, retail commercial real estate, entertainment, and other affected businesses. It said hotels, entertainment, and food-related businesses represented less than 10% of the overall loan portfolio, and reported no direct energy-industry exposure.
- COVID-related risks include higher delinquencies, defaults and foreclosures; falling collateral values; additional provisions; pressure on net interest margins from low rates; and possible effects on liquidity, earnings, and dividends. Agricultural borrowers also faced commodity-price, livestock-supply-chain, and economic uncertainty.
- Management described the company as well capitalized and said it had additional borrowing capacity, including $148.1 million of unsecured correspondent-bank capacity and potential additional FHLB borrowing subject to collateral.
- Other relevant matters: no material legal proceedings were reported; management concluded disclosure controls were effective. CECL adoption was deferred, with the company stating it would not adopt in 2020 and was evaluating possible early adoption.
Most important facts for investors to verify
- Whether COVID-related deferrals and PPP borrowers resume regular payments, and the pace and amount of PPP loan forgiveness.
- Subsequent trends in nonaccrual loans, impaired and restructured loans, charge-offs, and adequacy of the $9.9 million loan-loss allowance.
- Whether deposit growth continues and funds loan growth without materially higher funding costs or reliance on borrowings.
- Future net interest margin and asset yields after the rapid rate cuts, and the effects of mortgage refinancing and prepayments on servicing income and expense.
- Capital and liquidity levels, dividend policy, and any changes to management’s growth plans as economic conditions develop.