Farmers & Merchants Bancorp, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unless noted, financial amounts below are in millions of dollars. Results are unaudited.
Business context and reporting period
F&M is a community bank operating in northwest Ohio and northeast Indiana. On January 1, 2019, it acquired Limberlost Bancshares, parent of Bank of Geneva, adding six branches and materially increasing the company’s balance sheet. The acquisition makes year-over-year reported results less directly comparable because Bank of Geneva’s operations are included from the acquisition date.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Interest income | $18.283 | $11.537 | $34.145 | $22.673 |
| Net interest income, before provision | $14.534 | $10.010 | $27.311 | $19.683 |
| Provision for loan losses | $0.133 | $0.132 | $0.163 | $0.172 |
| Noninterest income | $2.981 | $2.806 | $5.676 | $5.416 |
| Noninterest expense | $9.712 | $7.638 | $21.223 | $15.278 |
| Net income | $6.180 | $4.114 | $9.404 | $7.881 |
| Diluted EPS | $0.56 | $0.44 | $0.85 | $0.85 |
Q2 net interest margin was 4.18%, versus 3.83% a year earlier; the six-month margin was 4.03%, versus 3.78%. Management reported six-month asset yield of 5.03% and cost of interest-bearing funds of 1.36%, compared with 4.35% and 0.78%, respectively, a year earlier. Deposit pricing competition is increasing funding costs.
Net income rose 50% in Q2 and 19% for the first half on a reported basis, while first-half EPS was flat as the acquisition issuance increased shares outstanding. Results included an approximately $1.985 million reversal of the estimated credit loss on two acquired purchased credit-impaired loans that were paid off. Management also disclosed $1.246 million of 2019 acquisition-related costs through June 30; its non-GAAP calculation excluding those costs, net of tax, was $10.402 million of first-half net income. Separately, acquisition pro forma results, assuming the deal had occurred at the start of the comparative periods, show first-half 2019 net income of $10.402 million and EPS of $0.94 versus $11.589 million and $1.04 for 2018. The pro forma presentation is not a forecast.
Financial position, liquidity, and asset quality
- At June 30, total assets were $1.531 billion, versus $1.116 billion at year-end 2018. Net loans were $1.084 billion, versus $839.6 million; deposits were $1.242 billion, versus $928.8 million.
- Cash and cash equivalents were $123.3 million, versus $38.4 million at year-end. Available-for-sale securities were $204.4 million. Management cited $14.5 million of additional FHLB borrowing capacity against current collateral, potentially up to $97 million with adequate collateral, and $123.4 million of unsecured correspondent-bank borrowing capacity.
- FHLB advances were $24.5 million and repurchase-agreement borrowings were $27.1 million. Stockholders’ equity was $224.0 million, versus $143.3 million at year-end.
- First-half operating cash flow was $13.1 million; investing activities used $3.2 million and financing activities provided $75.0 million, principally reflecting deposit growth. Cash increased $84.9 million during the half.
- The loan-loss allowance was $6.683 million; total credit-loss reserves, including unfunded commitments, were $7.053 million. First-half net charge-offs were $255,000. Nonaccrual loans were $1.328 million, up from $542,000 at year-end and $903,000 a year earlier; loans 30 or more days past due increased $3.5 million year over year. No loans over 90 days past due were still accruing.
- Management reported capital ratios of 11.77% Tier 1 leverage, 14.98% Tier 1 risk-based capital and 15.59% total risk-based capital, and stated the company and bank were above regulatory requirements.
Material changes, outlook, and risks
The Limberlost transaction involved approximately $78.9 million of consideration ($70.4 million in stock and $8.5 million in cash), including $43.3 million of goodwill and a $3.9 million core deposit intangible. Management expects opportunities from broader lending capacity, new markets, deposit growth and operating scale; it said integration and acquisition expenses weighed on near-term profitability, with those costs expected to lessen.
Management said core operations were on track with 2019 expectations, but provided no specific numerical earnings guidance. It expects loan growth and the acquired markets to support results, while warning that deposit competition may pressure margins. It described wet conditions that prevented some local farmers from planting, potential feed-cost pressure for livestock producers, and labor shortages affecting commercial customers. Crop insurance was cited as a mitigant for many farm borrowers; equipment dealers and other agricultural businesses may be more exposed.
Key risks include interest-rate and funding-cost changes, credit quality and loan concentrations, local agricultural conditions, competition, economic conditions, and regulatory changes. Management’s rate-sensitivity model estimated net interest income 9.64% higher under an immediate +100-basis-point shock and 1.90% lower under a −100-basis-point shock over 12 months; larger rate declines showed greater modeled downside. These are model estimates, not forecasts. Management reported effective disclosure controls, no material change in risk factors from the 2018 Form 10-K, and no legal proceedings.
Important facts for investors to verify
- How much of reported earnings growth came from the acquisition, the acquired-loan credit-loss reversal, and acquisition-related expenses; compare reported with pro forma results.
- Whether deposit costs continue to rise faster than asset yields, and how that affects net interest margin and earnings.
- Loan performance trends, including past-due and nonaccrual balances, troubled debt restructurings, charge-offs, and reserve adequacy as the acquired portfolio seasons.
- Progress in integrating Limberlost, realizing expected cost savings, growing deposits and loans, and managing goodwill and core-deposit-intangible amortization.
- Liquidity and capital capacity under faster-than-expected loan growth or adverse agricultural, economic, or interest-rate conditions.