Business context and reporting period
Farmers & Merchants Bancorp, Inc. (NASDAQ: FMAO) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2020. The Ohio-based bank holding company operates through Farmers & Merchants State Bank, with a community-banking footprint in northwest Ohio and northeast Indiana. Comparisons below are year over year unless noted; dollar figures are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income, before provision | $15.0 | $12.9 | $43.7 | $40.2 |
| Provision for loan losses | $2.0 | $0.2 | $5.0 | $0.4 |
| Noninterest income | $4.7 | $3.2 | $11.2 | $8.8 |
| Noninterest expense | $12.3 | $10.6 | $33.4 | $31.8 |
| Net income | $4.4 | $4.3 | $13.3 | $13.7 |
| Basic and diluted EPS | $0.40 | $0.38 | $1.20 | $1.23 |
| Net interest margin | 3.51% | 3.60% | 3.61% | 3.88% |
Balance sheet at September 30, 2020: Total assets were $1,826.6 million, up from $1,607.3 million at year-end 2019. Net loans were $1,352.0 million, versus $1,211.8 million; deposits were $1,518.9 million, versus $1,288.3 million. Cash and cash equivalents totaled $87.8 million. Available-for-sale securities were $259.0 million. Federal funds purchased and repurchase agreements were $29.9 million, and FHLB advances were $17.7 million, together about $47.6 million in these borrowings. Stockholders’ equity was $243.4 million.
Cash flow and capital: For the first nine months, operating activities provided $16.5 million, investing activities used $179.0 million, and financing activities provided $199.0 million. Cash and cash equivalents increased $36.5 million to $87.8 million. Management reported Bank capital ratios of 9.26% Tier 1 leverage, 11.04% Tier 1 risk-based capital, and 11.90% total risk-based capital; the capital conservation buffer was 3.90%.
Material changes versus comparable periods
- Q3 net income increased $0.1 million, or about 3%, while nine-month net income declined $0.4 million, or about 3%.
- Nine-month provision for loan losses rose $4.6 million year over year, primarily reflecting COVID-19 uncertainty and loan growth. The allowance for loan losses increased to $11.9 million from $7.2 million at year-end 2019; total credit-loss reserves, including unfunded commitments, were $12.5 million.
- Loan growth included approximately $87 million of Paycheck Protection Program (PPP) loans. Management reported loans up 11.9% from year-end and deposits up 17.9%; growth in deposits supported liquidity and loan funding.
- Q3 net interest income rose $2.1 million as lower funding costs more than offset lower asset yields. Nine-month net interest income rose $3.4 million, but net interest margin narrowed 27 basis points to 3.61%.
- Noninterest income increased, supported by mortgage and agricultural loan sales and servicing activity. Q3 noninterest expense was $1.7 million higher, including a $0.5 million one-time incentive-program true-up. Nine-month expense comparisons also reflect $1.3 million of Limberlost acquisition costs in 2019.
- Nonaccrual loans increased to $7.9 million from $3.4 million at year-end 2019. Past-due loans over 30 days were $0.3 million at quarter-end, versus $1.1 million at year-end. Impaired loans totaled $15.3 million, compared with $3.1 million at year-end.
Outlook, commentary, risks, and unusual items
- Management said it plans to continue growth, with an emphasis on newer markets, and expects home-loan application activity to remain strong into Q4. It expects to maintain quarterly dividends in line with past practice; the Q3 dividend declared was $0.17 per share, up from $0.16 in each of the first two quarters.
- The bank originated about $87 million of PPP loans to approximately 947 businesses. Management expects to recognize $3.2 million of net PPP fees over 24 months, subject to earlier acceleration upon loan payoff.
- COVID-19 remains a significant uncertainty. The filing cites potential deterioration in borrower repayment, collateral values, liquidity, credit quality, and earnings, as well as pressure on margins from the low-rate environment. Management said it could not reliably predict the pandemic’s remaining financial impact and may increase provisions as warranted.
- As of September 30, the company reported $8.5 million of commercial and agricultural loans in deferral or interest-only arrangements. It also reported 95 residential mortgage forbearance agreements totaling nearly $8.9 million, including loans serviced for others. Management said loans still in commercial/agricultural deferral or interest-only status were expected to be current by year-end.
- Management described agricultural credit quality as healthy and concerns as manageable, while noting pandemic-related pressure on some commercial borrowers. It reported limited direct exposure to energy and said hotels, entertainment, and food-related businesses represented less than 10% of the loan portfolio.
- The company had not adopted the current expected credit losses standard (CECL) and stated it would not adopt it in 2020; the filing says management was evaluating whether to adopt early. Goodwill was scheduled for external testing in Q4 2020; management reported no pandemic impact on goodwill to date.
- The filing identifies interest-rate risk, economic conditions, credit quality, deposit flows, competition, regulatory changes, and the duration and severity of COVID-19 as risks. Management’s rate-shock analysis shows margin pressure in a rising-rate scenario at 100 basis points and in falling-rate scenarios, while modeled net interest income increases under rising-rate scenarios.
- No legal proceedings were reported. Management stated disclosure controls were effective as of September 30, 2020, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the higher allowance and provision prove sufficient as COVID-19 relief arrangements expire and borrowers’ repayment capacity becomes clearer.
- Trends in nonaccrual, impaired, and restructured loans, particularly agricultural real estate and commercial exposures; the filing reports $6.4 million of TDR loans at quarter-end.
- How PPP forgiveness, loan payoffs, and the timing of fee recognition affect future interest income and noninterest income.
- Whether rapid deposit and loan growth can be sustained without greater reliance on borrowings or pressure on liquidity and net interest margin.
- Q4 goodwill impairment testing, CECL adoption timing, and any subsequent changes in dividend policy, credit provisions, or pandemic-related loan modifications.