Farmers & Merchants Bancorp, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Financial statements are unaudited; balance-sheet comparisons are to December 31, 2015 unless noted. Amounts below are U.S. dollars.
Business context
The Ohio-based financial holding company operates a community bank focused on commercial, agricultural, residential mortgage and consumer banking in northwest Ohio and northeast Indiana. It opened a Fort Wayne-area office in April 2016 and planned to open a 24th location in Bowling Green in Q4. Management attributes growth primarily to lending and deposit relationships and expansion into new markets.
Key financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Interest income | $9.59m | $8.44m | $27.98m | $24.92m |
| Net interest income, before provision | $8.49m | $7.51m | $24.84m | $22.25m |
| Provision for loan losses | $0.31m | $0.24m | $0.92m | $0.54m |
| Noninterest income | $2.92m | $2.83m | $8.47m | $8.08m |
| Noninterest expense | $6.92m | $6.51m | $20.57m | $19.46m |
| Net income | $3.02m | $2.62m | $8.47m | $7.57m |
| Basic and diluted EPS | $0.65 | $0.57 | $1.84 | $1.64 |
| Net interest margin | 3.57% | 3.53% | 3.56% | 3.52% |
- Management reported Q3 net income up 15.1% and EPS up 14.0% year over year. Nine-month net income increased about 11.9%.
- At September 30, total assets were $1.044bn, loans net of allowance were $732.1m, deposits were $838.1m, and stockholders’ equity was $126.9m.
- Recorded loans before allowance and net deferred fees were $738.7m, up 16.3% year over year. Commercial real estate was the largest category at $369.7m; commercial and industrial loans were $106.1m.
- Cash and cash equivalents were $31.5m. Nine-month operating cash flow was $9.6m; investing cash flow was negative $44.3m and financing cash flow was positive $44.2m.
- Funding included $59.5m of securities sold under repurchase agreements and $10.0m of FHLB advances; federal funds purchased were zero at quarter-end. Deposits increased $66.8m from year-end, while repurchase and federal-funds balances declined $19.3m.
- Reported capital measures included a 11.74% Tier 1 leverage ratio, 14.04% Tier 1 risk-based capital ratio, 14.83% total risk-based capital ratio and 12.15% equity-to-assets ratio. Management said the Company and Bank exceeded the fully phased-in Basel III capital conservation buffer requirement.
Material changes and credit quality
- Growth in loan balances drove higher interest income and net interest income; the loan portfolio grew while the available-for-sale securities portfolio declined $10.6m from year-end, partly funding loan growth.
- Deposits rose 8.7% from year-end. Management cited core-deposit growth and $25.3m of received one-way CDARS network deposits, with original maturities of six months or less.
- Q3 provision expense rose to $308,000 from $243,000, and nine-month provision expense rose to $924,000 from $540,000, reflecting loan growth and management’s credit-loss assessment. Nine-month net charge-offs were $369,000.
- Asset-quality measures remained favorable by management’s account: nonaccrual loans were $1.13m versus $2.29m a year earlier; loans 30 or more days past due were 0.13% of loans versus 0.35% a year earlier. The allowance for loan losses was $6.61m; total allowance for credit losses, including unfunded commitments, was $6.84m.
- Q3 noninterest expense increased 6.3% year over year, including higher staffing and benefits associated with office expansion and increased data-processing costs, including EMV debit-card upgrades. Nine-month expenses were also higher, partly due to staffing, technology and marketing.
- Available-for-sale securities had a net unrealized gain position; management said no securities were considered other-than-temporarily impaired. Nine-month net realized gains on securities sales were $503,000.
Outlook, commentary and risks
- No quantitative earnings or revenue guidance was provided. Management said loan growth and balance-sheet repositioning should continue to support net interest income, while new offices may weigh on results in the short term.
- Management described local agricultural yields as generally high but crop prices as weak; it expected farm profits to remain above breakeven, while noting farmers may increase line usage for 2017 inputs. Used-equipment margins and land values were also under pressure.
- Key disclosed risks include interest-rate changes, local and national economic conditions, loan and investment portfolio quality, competition, deposit flows, and regulatory or accounting changes. The portfolio’s commercial real estate concentration and agricultural exposure warrant monitoring.
- Interest-rate modeling indicated potential net-interest-margin tightening in both rising- and falling-rate scenarios. Management noted that many newer commercial real estate loans have initial fixed-rate periods of three to five years, limiting near-term repricing benefits.
- The filing reports no legal proceedings and no material changes to previously disclosed risk factors. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
- Management was evaluating recently issued accounting standards, including the expected-credit-loss standard (ASU 2016-13); the filing did not quantify the expected financial impact.
Important facts for investors to verify
- Whether loan growth, particularly in commercial real estate, continues without deterioration in delinquencies, nonaccruals or charge-offs, and whether the allowance remains adequate.
- Deposit composition and retention, including the short-maturity CDARS funds, and the bank’s cost and availability of alternative funding.
- Whether loan yields and net interest margin can offset rising funding costs and interest-rate sensitivity.
- The earnings and expense trajectory of the new offices, technology investments and continued expansion.
- The detailed capital ratios, rate-sensitivity assumptions and eventual effect of new accounting standards in the complete filing and subsequent disclosures.