Farmers & Merchants Bancorp, Inc. — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021. Amounts below are in millions of dollars unless otherwise noted. Comparisons are with Q2 or the first six months of 2020, or with December 31, 2020 for balance-sheet figures.
Business context and reporting period
F&M is an Ohio-based financial holding company operating a community bank in northwest Ohio and northeast Indiana, with loan production offices in Ohio, Indiana and Michigan. It reports one segment. The quarter included two months of results from Ossian State Bank, acquired April 30, 2021.
Key financial metrics
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Interest income | $17.530 | $17.273 | $34.295 | $34.737 |
| Net interest income, before provision | $15.976 | $14.575 | $31.013 | $28.628 |
| Provision for loan losses | $0.641 | $1.569 | $2.341 | $2.999 |
| Noninterest income | $4.027 | $3.326 | $9.018 | $6.448 |
| Noninterest expense | $13.060 | $10.367 | $25.419 | $21.035 |
| Net income | $4.983 | $4.804 | $9.892 | $8.909 |
| Diluted EPS | $0.44 | $0.43 | $0.88 | $0.80 |
| Net interest margin | 3.21% | 3.59% | 3.27% | 3.67% |
At June 30, total assets were $2,166.9 million, up 13.5% from year-end; net loans were $1,443.3 million, up $154.0 million; and deposits were $1,854.1 million, up $257.9 million. Cash and cash equivalents were $151.1 million, down $24.6 million from year-end. Stockholders’ equity was $250.6 million. The allowance for loan losses was $15.1 million; total allowance for credit losses, including unfunded commitments, was $16.2 million.
For the first six months, operating cash flow was $13.0 million, investing cash flow was negative $175.0 million, and financing cash flow was positive $137.4 million. Cash and cash equivalents declined $24.6 million to $151.1 million.
At quarter-end, borrowings included $29.9 million of securities sold under repurchase agreements and $17.9 million of FHLB advances. Management reported Bank capital ratios of 8.16% Tier 1 leverage, 10.84% Tier 1 risk-based capital, and 11.90% total risk-based capital. It cited $163.2 million of unsecured correspondent borrowing capacity and $5.2 million of additional FHLB availability based on pledged collateral.
Material changes versus comparable periods
- Q2 net income rose $0.2 million year over year; first-half net income rose $1.0 million, or about 11%. First-half EPS increased from $0.80 to $0.88.
- First-half net interest income increased $2.4 million, primarily as interest expense fell $2.8 million, partly offset by a $0.4 million decline in interest income. Lower asset yields reduced margin: first-half margin was 3.27%, versus 3.67% a year earlier.
- First-half noninterest income increased $2.6 million, led by loan-sale gains and higher debit-card income. Noninterest expense increased $4.4 million, including acquisition-related costs and higher personnel and operating expenses.
- Net loans increased from year-end, reflecting organic growth and the Ossian acquisition. Management reported 3.9% organic loan growth excluding PPP and acquired loans, and 11.9% growth including them.
- Unrealized securities gains declined: accumulated other comprehensive income fell from $5.7 million at year-end to $0.8 million at June 30, principally reflecting securities valuation changes.
- Nonaccrual loans declined to $7.0 million from $9.4 million at year-end; loans past due 30 days or more totaled $1.7 million. First-half net charge-offs were $0.9 million, up from $0.3 million a year earlier.
Outlook, management commentary, risks and unusual items
- Management described loan pipelines as strong and the agricultural portfolio as healthy, while noting commercial customers faced labor shortages and supply-chain delays. It expected mortgage refinancing and loan-sale gains to slow in the second half compared with 2020. Management anticipated continued expansion and said deposit competition could pressure margins; no specific earnings or revenue guidance was provided.
- Ossian was acquired for approximately $20.0 million in cash. The transaction added $52.4 million of loans and $116.0 million of deposits, and generated $8.7 million of goodwill. The company recorded $1.0 million of Ossian-related costs in 2021 through June and also incurred costs on the proposed Perpetual transaction.
- The proposed Perpetual Federal Savings Bank acquisition had an implied value of approximately $103.7 million, with closing expected around October 1, 2021, subject to approvals. Management said the Ossian and Perpetual transactions together would expand assets and footprint by over half a billion dollars by year-end.
- On July 30, 2021, after quarter-end, the company completed a $35 million subordinated-note offering, bearing 3.25% fixed interest for five years and then a floating rate, intended to qualify as Tier 2 capital. Proceeds are for general corporate purposes, including acquisitions and growth.
- Other unusual expenses included approximately $0.2 million loss on sale of buildings in Q2 and a $0.3 million mortgage-servicing-rights valuation allowance. Four offices ceased operations by June 30; management estimated about $0.7 million of closure costs in the first year and more than $0.76 million of total savings.
- COVID-19 remains a source of uncertainty. At quarter-end, two loans remained under principal deferral, while management continued monitoring vulnerable borrowers and adjusting credit-loss estimates as needed. PPP activity generated accelerated net fee income; the company reported 993 second-draw PPP loans totaling $43.5 million and $3.2 million of estimated associated fees.
- Interest-rate risk is a key exposure. The company’s model projected margin expansion in rising-rate scenarios and contraction in falling-rate scenarios. Management identified credit-loss reserves, mortgage-servicing-rights valuation and foreclosed real estate valuation as significant judgment areas.
- The company had not adopted CECL as of the filing date and could postpone adoption until 2023 as a smaller reporting company. Management was evaluating adoption timing. No material risk-factor changes or legal proceedings were reported; disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether loan growth and asset quality remain sound as acquired balances and PPP-related effects are separated from organic performance.
- Whether expense growth, including acquisition, integration and office-closure costs, moderates and anticipated savings are realized.
- How deposit costs, asset yields and net interest margin respond to changing rates and competition for deposits.
- Regulatory approval, closing terms, funding and integration progress for the Perpetual acquisition, and the effect of the $35 million notes on capital and interest expense.
- Whether credit-loss reserves remain adequate given COVID-19 uncertainty, higher first-half net charge-offs and exposure to commercial real estate, agriculture and vulnerable sectors.
- Whether mortgage refinancing, loan-sale gains and PPP fee income decline as management expects, and what that means for recurring earnings.