Farmers & Merchants Bancorp, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; financial statements are unaudited and consolidated. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Business context and reporting period
The company is an Ohio-based financial holding company operating a community bank in Northwest Ohio and Northeast Indiana, with commercial, agricultural, residential mortgage, and consumer lending. It opened its 25th full-service office in Findlay, Ohio, during the quarter, using interactive teller technology. Management says growth in 2018 is focused on loans and deposits in newer markets.
Financial results and condition
- Earnings: Net income was $3.767 million, up 32.7% from $2.839 million in Q1 2017. Diluted and basic earnings per share were $0.41, versus $0.31. Income before taxes rose to $4.603 million from $3.982 million; income tax expense declined to $0.836 million from $1.143 million.
- Revenue and margins: Interest income increased 14.6% to $11.136 million, primarily from loan growth and higher loan yields. Net interest income before provision rose 13.2% to $9.673 million. Net interest margin was 3.72%, compared with 3.50% a year earlier; net interest spread was 3.53%, versus 3.33%. Noninterest income was $2.610 million, little changed from $2.584 million.
- Expenses and credit costs: Noninterest expense increased 8.0% to $7.640 million, including higher salaries and benefits associated in part with office expansion. Loan-loss provision fell to $40,000 from $73,000. Net charge-offs were $108,000, compared with $7,000 in Q1 2017.
- Loans and asset quality: Loans net of deferred fees and costs were $834.7 million, up 8.2% year over year and $11.8 million from year-end. Commercial real estate was the largest category at $414.7 million. Nonaccrual loans declined to $0.9 million from $1.43 million at March 31, 2017; past-due loans were $0.733 million. The allowance for loan losses was $6.8 million, and total credit-loss allowances, including unfunded commitments, were $7.065 million.
- Funding and liquidity: Total assets were $1.124 billion, up 1.5% from year-end 2017. Deposits rose $34.0 million from year-end to $953.3 million. Cash and cash equivalents increased to $39.9 million from $34.5 million. At quarter-end, repurchase-agreement funding was $23.3 million, FHLB advances were $5.0 million, and no federal funds were purchased. Management reported $120.8 million of unsecured correspondent-bank borrowing capacity.
- Cash flow: Operating activities used $0.991 million, versus providing $5.414 million in Q1 2017; investing activities used $10.185 million, while financing activities provided $16.617 million. Cash and cash equivalents increased $5.441 million during the quarter.
- Capital and shareholder returns: Stockholders’ equity was $134.9 million. Reported capital ratios included a 12.11% Tier I leverage ratio, 14.90% Tier I risk-based capital, and 15.68% total risk-based capital. The quarterly dividend declared was $0.13 per share, up from $0.12. The company repurchased no shares during the quarter under its 400,000-share authorization.
Material changes versus comparable periods
- Loan growth and higher loan yields drove increased interest income and net interest margin. Interest expense also rose, to $1.463 million from $1.179 million, as deposit balances and funding costs increased.
- Net income increased $928,000 year over year. Noninterest expense rose $569,000, chiefly from salaries and employee benefits, including staffing associated with expanded offices.
- Available-for-sale securities declined to $192.9 million from $196.4 million at year-end. Their net unrealized loss was about $5.2 million at March 31, contributing to accumulated other comprehensive loss of $4.138 million, versus $1.826 million at year-end.
- Compared with Q4 2017, Q1 2018 net income increased $331,000. Management attributed the improvement principally to higher net interest income; expenses were also higher, including building depreciation and employee benefits.
Outlook, management commentary, risks, and unusual items
- Management expects continued focus on loan and deposit growth, particularly in newer markets, and says the loan pipeline remained strong. It cautioned that sustained margin expansion with further rate increases is uncertain as funding costs rise and the yield curve flattens. No numerical earnings or growth guidance was provided.
- Management cited labor shortages, agricultural-policy volatility, wet and cold weather, and slight deterioration in prices for marginal farmland as operating concerns. Agricultural borrowers are exposed to commodity prices and weather; commercial real estate and business lending also carry repayment, collateral, and economic risks.
- The company reported no securities considered other-than-temporarily impaired. Management said unrealized securities losses were primarily rate-related and that it intended and was able to hold the securities for the foreseeable future. Interest-rate shock analysis showed modeled margin improvement under rising-rate scenarios and compression under falling-rate scenarios; management noted results depend on assumptions and balance-sheet behavior.
- Accounting changes effective in 2018 included a roughly $360,000 reclassification from accumulated other comprehensive income to retained earnings related to tax effects, and just over $30,000 of accelerated premium amortization on callable municipal securities. Adoption of the revenue standard and financial-instrument measurement standard had no significant or material impact, respectively.
- The company is preparing for the expected 2020 adoption of the current expected credit loss standard (CECL); it described implementation as early-stage and said it had engaged an external adviser. Management identified credit-loss allowances, mortgage servicing rights, foreclosed real estate valuations, and revenue recognition as areas involving significant estimates.
- There were no material changes to previously disclosed risk factors, no reported legal proceedings, and management concluded disclosure controls were effective as of March 31, 2018.
Important facts for investors to verify
- Whether loan and deposit growth in newer markets can continue without materially increasing funding costs, credit losses, or operating expenses.
- How rising rates, a flatter yield curve, and deposit repricing affect net interest margin and earnings; review the assumptions underlying the interest-rate sensitivity analysis.
- Credit quality and concentration trends, particularly commercial real estate and agricultural exposures, charge-offs, past-due loans, and allowance adequacy.
- The effect of unrealized available-for-sale securities losses on equity and liquidity, and management’s stated ability and intent to hold securities through recovery.
- CECL implementation progress and eventual impact on credit-loss reserves, capital, and reported earnings.
- Whether reported capital ratios, liquidity sources, and the $120.8 million correspondent borrowing capacity remain available as the balance sheet grows.