Farmers & Merchants Bancorp, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017 unless noted. The Ohio-based financial holding company operates a community bank in northwest Ohio and northeast Indiana, with lending concentrated in commercial real estate, agriculture, commercial and industrial, and consumer loans.
Key financial metrics
Amounts are in millions of dollars, except per-share data, percentages, and where noted.
| Metric | Q3 2018 | Q3 2017 | YTD 2018 | YTD 2017 |
|---|---|---|---|---|
| Interest income | $11.753 | $10.535 | $34.426 | $30.380 |
| Net interest income | $9.988 | $9.202 | $29.671 | $26.615 |
| Provision for loan losses | $0.047 | $0.099 | $0.219 | $0.197 |
| Noninterest income | $2.683 | $2.635 | $8.099 | $7.992 |
| Noninterest expense | $8.126 | $7.357 | $23.404 | $21.526 |
| Net income | $3.875 | $3.222 | $11.756 | $9.284 |
| Basic and diluted EPS | $0.42 | $0.35 | $1.27 | $1.01 |
| Net interest margin | 3.85% | 3.71% | 3.80% | 3.61% |
- Balance sheet at September 30: assets $1,108.0 million; net loans $831.9 million; deposits $928.9 million; stockholders’ equity $139.3 million; cash and cash equivalents $29.7 million.
- Funding and liquidity: federal funds purchased and repurchase agreements totaled $27.0 million, down from $39.5 million at year-end; FHLB advances were $5.0 million. Management reported $4.2 million of additional FHLB availability based on current pledged collateral, up to $114.0 million with adequate collateral, and $123.1 million of unsecured correspondent-bank capacity.
- Cash flow, nine months: operating cash flow was $9.8 million, investing cash use $7.4 million, and financing cash use $7.1 million. Cash and equivalents declined $4.7 million to $29.7 million.
- Credit: the allowance for loan losses was $6.8 million and the total allowance for credit losses, including unfunded commitments, was $7.1 million. Nonaccrual loans were $0.5 million; no loans 90 days past due were still accruing. Year-to-date net charge-offs were $0.332 million.
- Capital: reported company ratios were 12.68% Tier I leverage, 15.45% Tier I risk-based capital, 16.24% total risk-based capital, and 12.58% equity to assets. Management said the company and bank were above the 2019 capital-buffer requirement.
Material changes versus comparable periods
- Q3 net income increased $0.653 million year over year; management attributed about $0.4 million of the improvement to the federal tax-rate reduction. YTD net income rose $2.472 million, with about $1.5 million attributed to the tax change.
- YTD net interest income grew $3.056 million as loan balances and yields increased. YTD average earning-asset yield rose to 4.41% from 4.12%, while cost of interest-bearing funds rose to 0.83% from 0.68%. Management noted that deposit-cost increases may constrain further margin expansion.
- Net loans increased $15.8 million from year-end and 5.5% from September 2017. Growth was strongest in agricultural and commercial real estate lending; commercial and industrial loans declined year over year.
- Deposits increased $9.5 million from year-end. Available-for-sale securities declined $13.3 million; their net unrealized loss position widened, contributing to accumulated other comprehensive loss of $4.9 million versus $1.8 million at year-end.
- YTD noninterest expense increased $1.9 million, including higher compensation, benefits, equipment costs, and consulting. Reported drivers included the new Findlay office, merit and benefit costs, CEO-search and possible-acquisition consulting, and acquisition-related system-conversion expense.
Outlook, management commentary, and risks
- Management’s stated priorities were sustainable loan and deposit growth, particularly in newer markets, and continued expansion of its footprint. It provided no quantified earnings or financial guidance.
- Management described local economic conditions and the loan pipeline as strong, but cited tariffs’ effect on crop prices—especially soybeans—and uncertainty over crop storage. Labor shortages were also a concern for local businesses and the company.
- Management expects deposit competition and higher funding costs to pressure margins; the sustainability of margin improvement with further rate increases was described as uncertain. Slower loan growth could also weigh on margin.
- Interest-rate sensitivity analysis indicated modest margin improvement in rising-rate scenarios and contraction in falling-rate scenarios. Management noted that repricing of some commercial real estate loans falls outside the analysis’s 12-month period.
- The bank’s portfolio has significant commercial real estate and agricultural exposure. Disclosed risks include borrower repayment capacity, collateral values, construction and vacancy risk, commodity prices, and weather. Management said it monitors credit quality and uses stress testing on larger loans.
- The company signed an agreement to acquire Limberlost Bancshares, parent of Bank of Geneva, in a stock-and-cash transaction valued at approximately $88.8 million based on the cited share price. Limberlost reported $287 million of assets, $257 million of loans, and $212 million of deposits at June 30, 2018. Completion was subject to regulatory and shareholder approvals; management targeted year-end 2018 or early Q1 2019.
- Unusual accounting and market items: the company adopted the new revenue standard and reported no significant impact; it reclassified approximately $0.360 million from AOCI to retained earnings following tax-accounting guidance. The filing reported no other-than-temporary impairment of investment securities, despite a $6.2 million net unrealized loss position. The CECL implementation was in early analysis, with an external advisor engaged.
- The filing reported no material change in previously disclosed risk factors, no legal proceedings, and effective disclosure controls as of September 30, 2018.
Important facts for investors to verify
- Progress, approval status, final consideration, integration costs, and expected financial impact of the Limberlost acquisition.
- Whether loan and deposit growth can continue while deposit pricing pressures and rising funding costs affect net interest margin.
- Credit performance in commercial real estate and agricultural portfolios, including charge-offs, criticized loans, collateral values, and allowance adequacy.
- Potential effects of tariffs, commodity prices, crop conditions, and labor constraints in the company’s markets.
- Future changes in available-for-sale securities’ unrealized losses, capital, and liquidity as loans grow and interest rates move.
- Timing and estimated impact of CECL adoption; the filing does not provide a clear quantitative estimate.