Farmers & Merchants Bancorp, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; financial statements are unaudited. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
The company is an Ohio bank holding company operating through Farmers & Merchants State Bank and a captive insurance subsidiary. On January 1, 2019, it acquired Limberlost Bancshares, parent of Bank of Geneva, adding six Indiana offices. Limberlost’s results are included from the acquisition date, so reported year-over-year comparisons include a larger business and are affected by acquisition costs.
Key financial results and position
| Metric | Q1 2019 / March 31, 2019 | Comparable / prior balance |
|---|---|---|
| Interest income | $15.862 million | $11.136 million in Q1 2018 |
| Net interest income | $12.777 million | $9.673 million in Q1 2018 |
| Net interest margin | 3.87% | 3.72% in Q1 2018 |
| Noninterest income | $2.695 million | $2.610 million in Q1 2018 |
| Noninterest expense | $11.511 million | $7.640 million in Q1 2018 |
| Net income | $3.224 million | $3.767 million in Q1 2018 |
| Basic and diluted EPS | $0.29 | $0.41 in Q1 2018 |
| Total assets | $1,465.661 million | $1,116.163 million at Dec. 31, 2018 |
| Net loans | $1,091.829 million | $839.599 million at Dec. 31, 2018 |
| Total deposits | $1,187.424 million | $928.790 million at Dec. 31, 2018 |
| Cash and cash equivalents | $81.849 million | $38.365 million at Dec. 31, 2018 |
| Total liabilities | $1,248.727 million | $972.876 million at Dec. 31, 2018 |
| Stockholders’ equity | $216.934 million | $143.287 million at Dec. 31, 2018 |
Provision for loan losses was $30,000 versus $40,000 in Q1 2018. Operating cash flow was $7.803 million, compared with cash used of $0.989 million in Q1 2018; cash increased $43.484 million during the quarter. Financing cash flow was $20.513 million. These cash-flow figures reflect acquisition and balance-sheet movements and should not be read as a standalone measure of recurring earnings.
Bank regulatory capital ratios at March 31, 2019 were: Tier 1 leverage 10.86%, Tier 1 risk-based capital 13.13%, total risk-based capital 13.74%, and capital conservation buffer 5.74%. Management stated that both the company and the bank were above applicable 2019 capital requirements. The filing does not provide a company-specific debt-to-equity ratio.
Material changes and comparison
- Limberlost acquisition consideration was approximately $78.9 million: $70.4 million in F&M stock and $8.5 million in cash. The acquisition added $257.2 million of loans and $206.1 million of deposits at fair value, and generated $43.3 million of goodwill.
- Loans increased $252.2 million from year-end, principally due to the acquisition. Deposits rose $258.6 million, and total assets increased 31.3% from year-end.
- Interest income rose 42.4% year over year, driven mainly by acquired and expanded loan balances and higher loan yields. Interest expense also increased, to $3.085 million from $1.463 million, as deposit funding costs rose and acquired borrowings added expense.
- Net income fell $543,000 year over year, while noninterest expense increased $3.871 million. Management attributed $1.287 million of Q1 expense to direct acquisition costs. The company’s non-GAAP reconciliation states net income excluding those costs, tax-effected, was $4.253 million; this is a management-adjusted measure, not reported GAAP net income.
- EPS declined in part amid the increase in shares issued for the acquisition. The company declared a $0.15 per-share dividend, versus $0.13 in Q1 2018.
- Other comprehensive income was $1.402 million, versus a $1.952 million loss in Q1 2018, largely reflecting a less adverse securities valuation movement.
Outlook, commentary, and risks
- Management expects the Limberlost merger to be accretive to 2019 earnings and cited opportunities from a larger lending limit, additional products, expanded offices, deposit growth, and economies of scale. It said integration and employee training would continue over the next two quarters. No numerical earnings or revenue guidance was provided.
- Management described local economies as generally strong, but noted recession concerns for 2020, low unemployment and hiring difficulty, and agricultural pressure from low grain prices and wet weather. It said land values for marginal soils showed some deterioration.
- Management said deposit competition and higher offered rates are pressuring funding costs and could tighten margins. It expects loan growth and balance-sheet repositioning to support net interest income, while acknowledging ongoing competitive pressure on net interest margin.
- Liquidity resources cited include cash, available-for-sale securities, deposit growth, $31.2 million of additional FHLB capacity on current collateral, and $123.1 million of unsecured correspondent-bank borrowing capacity. Management also stated that up to $119 million of FHLB capacity could be available with adequate collateral.
- Credit indicators included $1.188 million of nonaccrual loans, up from $542,000 at year-end 2018; loans past due increased year over year, and net charge-offs were $169,000 versus $108,000 in Q1 2018. The allowance for loan losses was $6.636 million, and total allowance for credit losses, including unfunded commitments, was $6.982 million.
- Interest-rate sensitivity analysis showed projected net interest income increasing in rising-rate scenarios and declining in falling-rate scenarios over the modeled 12-month period. The company identifies interest-rate risk, credit quality, deposit flows, competition, economic conditions, and regulatory changes among relevant risks.
- The company adopted lease accounting guidance on January 1, 2019, recording a $491,700 right-of-use asset and corresponding liability, with no significant reported financial-statement impact. It was preparing for CECL adoption in 2020 and was in the early stages of methodology and data analysis.
- The filing reports no legal proceedings, no defaults upon senior securities, no material change in previously disclosed risk factors, and effective disclosure controls as of March 31, 2019.
Most important facts for investors to verify
- Whether integration of the six acquired offices and the expected cost savings and revenue opportunities are progressing as management anticipated.
- How recurring earnings compare with reported GAAP results after acquisition costs, and whether the company’s adjusted earnings calculation is appropriate for comparison.
- Whether deposit pricing pressure, funding costs, and the acquired deposit mix affect net interest margin and earnings as rates and competition change.
- Credit quality trends in acquired and legacy portfolios, including past-due and nonaccrual loans, charge-offs, agricultural exposures, and adequacy of the allowance.
- Whether liquidity and regulatory capital remain adequate as loan growth continues, and how much borrowing capacity is available under actual collateral and funding conditions.