Business context and reporting period
Farmers & Merchants Bancorp, Inc. is an Ohio bank holding company operating through The Farmers & Merchants State Bank, a community bank serving northwest Ohio and northeast Indiana, and a captive insurance subsidiary. This Form 10-K covers the fiscal year ended December 31, 2016; comparisons are primarily with 2015.
Financial performance and condition
| Metric | 2016 | 2015 | Change / context |
|---|---|---|---|
| Interest income | $37.7 million | $33.7 million | Up 12.1%, chiefly from loan growth |
| Net interest income | $33.5 million | $30.1 million | Up $3.4 million |
| Net interest margin | 3.56% | 3.49% | Up 7 basis points |
| Provision for loan losses | $1.1 million | $0.6 million | Higher, principally reflecting loan growth |
| Net income | $11.7 million | $10.3 million | Record earnings; up 12.8% |
| Basic and diluted EPS | $2.53 | $2.24 | Up 13.0% |
| Total assets | $1.056 billion | $989.1 million | Up 6.8% |
| Net loans | $753.4 million | $679.8 million | Up $73.5 million |
| Total deposits | $842.2 million | $771.3 million | Up $70.9 million |
| Stockholders’ equity | $125.6 million | $120.1 million | Up $5.5 million |
| Cash and cash equivalents | $28.3 million | $22.0 million | Year-end balance |
Net interest margin improved as loans grew and the loan share of earning assets rose; the December 2015 and December 2016 rate increases also supported interest income. Interest expense increased $636,000 as interest-bearing balances and rates rose. The average cost of funds was 0.59%, compared with 0.54% in 2015. Noninterest income increased $580,000 to $11.4 million; noninterest expense rose 5.2% to $27.4 million, with salaries and wages the largest contributor.
Operating cash flow was $12.4 million, versus $14.8 million in 2015. Investing activities used $64.2 million, including net loan growth and securities activity; financing activities provided $58.1 million, mainly from deposit growth. Cash and cash equivalents increased $6.3 million during the year. The filing describes liquidity as adequate, with $58 million of unsecured correspondent borrowing capacity, $71.9 million of unpledged securities and additional FHLB capacity subject to collateral.
Year-end borrowings included $70.3 million of federal funds purchased and repurchase agreements and $10.0 million of FHLB advances. The company reported a consolidated Tier 1 leverage ratio of 11.77% and total risk-based capital ratio of 15.28%; the Bank was categorized as well capitalized. Dividends declared were $0.91 per share, or $4.16 million, up from $0.87 per share in 2015.
Material changes versus the prior comparable period
- Loan growth was concentrated in commercial real estate: balances increased to $377.5 million from $322.8 million. Total loans were $760.9 million before deferred fees and allowance.
- Available-for-sale securities declined to $218.5 million from $235.1 million, as securities sales and maturities helped fund lending. The company recorded $588,000 in net securities sale gains, versus $451,000 in 2015.
- Net charge-offs declined to $394,000 from $473,000; nonaccrual loans fell to $1.4 million from $2.0 million. However, potential problem loans increased to $20.4 million from $7.0 million, mainly due to two borrower relationships.
- Other comprehensive loss was $2.2 million, primarily reflecting unrealized securities losses; accumulated other comprehensive income shifted from $212,000 to a loss of $2.0 million.
- The Bank opened an office in the Fort Wayne area in 2016 and a Bowling Green, Ohio office late in the year. Management said these newer offices could weigh slightly on 2017 earnings because of startup costs.
Outlook, commentary, risks and unusual items
Management said it expects continued profitability improvement through 2017 and 2018 and intends to pursue growth through new branches or acquisitions, while seeking core-deposit growth and loan opportunities. It provided no quantified earnings or revenue guidance. It expects the newer offices to have startup costs in 2017 and described securities sales as a possible funding source for loan growth, not a guaranteed ongoing source of income.
Key risks include credit exposure to commercial real estate and agricultural borrowers, local economic and commodity-price conditions, changing interest rates, deposit competition, regulatory compliance, and operational and cybersecurity events. Management’s rate-shock model projected lower net interest income under rising-rate scenarios over the next 12 months; its modeled 100-basis-point increase showed a 1.16% decline versus the flat-rate case. Actual results may differ from model assumptions.
The allowance for credit losses was $7.0 million, including $6.8 million for loan losses; the loan-loss allowance was 0.89% of loans. Management identified allowance estimates, mortgage servicing rights and other real estate owned valuations as areas requiring significant judgment. The filing reports no material pending legal proceedings. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting, and management concluded disclosure controls and internal controls were effective.
Important facts for investors to verify
- Review the composition and performance of the $20.4 million in potential problem loans, particularly the two commercial real estate relationships, and monitor subsequent delinquency, restructuring and charge-off trends.
- Assess the quality and concentration of the loan book, including commercial real estate’s share, agricultural exposures and collateral valuations.
- Confirm that deposit growth and available borrowing capacity continue to support loan growth and liquidity, and monitor the cost and maturity profile of deposits, repurchase agreements and FHLB advances.
- Track the effect of rising rates on net interest margin, funding costs and the value of available-for-sale securities, including the accumulated other comprehensive loss.
- Evaluate whether branch expansion, operating-cost increases and securities-sale gains are sustainable contributors to earnings; note the 2017 share-repurchase authorization for up to 200,000 shares.