Farmers & Merchants Bancorp, Inc. — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Unaudited consolidated results. Dollar amounts below are in millions unless stated otherwise. F&M is a community banking holding company operating primarily in northwest Ohio and northeast Indiana.
Financial results and condition
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net interest income | $21.864 | $15.976 | $41.647 | $31.013 |
| Provision for loan losses | $1.628 | $0.641 | $2.208 | $2.341 |
| Noninterest income | $3.320 | $4.027 | $7.663 | $9.018 |
| Noninterest expense | $13.235 | $13.060 | $26.728 | $25.419 |
| Net income | $8.271 | $4.983 | $16.373 | $9.892 |
| Diluted earnings per share | $0.63 | $0.44 | $1.25 | $0.88 |
| Net interest margin | 3.47% | 3.21% | 3.30% | 3.27% |
- Balance sheet at June 30: Assets were $2.675 billion, up 1.4% from year-end 2021. Net loans were $2.016 billion, up $175.2 million; deposits were $2.224 billion, up $30.6 million. Loan growth was led by commercial real estate. Management reported 19.9% year-over-year organic loan growth, excluding acquisitions and PPP loans.
- Cash flow and liquidity: Cash and cash equivalents fell $109.4 million during the first half to $71.4 million. Operating cash flow was $22.4 million, investing cash flow was negative $180.0 million, and financing cash flow was positive $48.1 million. The decline reflected loan growth funded partly by cash, deposits and borrowings. Management cited $68.3 million of additional FHLB capacity against currently pledged collateral and $69 million of unsecured correspondent-bank borrowing capacity.
- Borrowings: At June 30, federal funds purchased and repurchase agreements totaled $71.9 million, FHLB advances were $42.6 million, and subordinated notes were $34.5 million net of issuance costs. The $35 million subordinated notes carry a 3.25% fixed rate for five years, then a floating rate, and mature in 2031. The $40 million acquisition-related borrowing reported at year-end was repaid in Q2.
- Capital and equity: Stockholders’ equity was $280.9 million, down $16.3 million from year-end, primarily reflecting a $28.1 million increase in accumulated other comprehensive loss from securities valuation. The Bank reported a 9.16% Tier 1 leverage ratio, 11.58% Tier 1 risk-based capital ratio and 12.54% total risk-based capital ratio, and was described as well-capitalized.
- Credit quality: Nonaccrual loans were $5.2 million, or 0.26% of loans, down from $8.1 million at year-end; loans past due over 30 days were 0.20% of loans. The allowance for loan losses was $18.4 million, 0.91% of loans; total credit-loss allowance including unfunded commitments was $19.6 million. Second-quarter provision rose year over year, while first-half provision declined slightly.
Material changes and management commentary
- First-half net income rose 65.5% and diluted EPS increased 42.0% year over year. Higher interest income, particularly from loan growth, drove the improvement; interest income increased $11.5 million, partly offset by $0.9 million higher interest expense.
- Comparisons reflect acquisitions, including Ossian State Bank (April 2021) and Perpetual Federal Savings Bank (October 2021), as well as organic growth. Management attributed roughly $10.6 million of first-half NII growth to higher net interest income before provision versus the prior-year period.
- Noninterest income fell $1.4 million in the first half, mainly due to lower gains on mortgage and agricultural loan sales, reduced servicing-rights income, and a $0.3 million securities sale gain in 2021 that did not recur. Mortgage refinancing slowed as rates rose; management expected further slowing.
- Noninterest expense increased $1.3 million in the first half, including $1.9 million higher salaries and wages, partly offset by acquisition-related costs incurred in 2021 that did not recur. Management noted higher franchise taxes and data-processing costs.
- Interest rates rose during the quarter. Management said higher rates had not materially slowed commercial activity to date, but customers were monitoring borrowing costs, labor availability, supply-chain delays, energy prices and inflation. Agricultural conditions and commodity prices were described as favorable, with input-cost and supply concerns.
Outlook, risks and unusual items
- Management stated its strategic objective was to grow into a $3 billion bank by the end of 2022. No formal earnings or margin guidance was provided. It expected loan growth to support net interest income but warned that deposit competition could pressure margins.
- On June 14, 2022, F&M agreed to acquire Peoples-Sidney Financial Corporation for an estimated transaction value of approximately $27 million based on F&M’s share price on that date. Shareholders may elect stock or cash, subject to agreement terms; completion was anticipated in Q3 or Q4 2022, subject to shareholder and regulatory approvals and other conditions.
- Available-for-sale securities had $39.7 million of gross unrealized losses at quarter-end, contributing to a $31.3 million accumulated other comprehensive loss after tax. Management attributed the losses to interest-rate changes, stated it had no securities considered other-than-temporarily impaired, and said it intended and was able to hold the securities for the foreseeable future.
- Key risks include interest-rate changes, inflation and economic or geopolitical instability, deposit flows and competition, loan demand and credit quality, and ongoing effects of COVID-19. Management specifically cited possible credit vulnerability in consumer and residential mortgage lending and stress in restaurant and hospitality sectors.
- The company planned to adopt CECL on January 1, 2023. It was refining its methodology and evaluating the effects of the pending acquisition. The filing states interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- How much reported earnings and loan growth reflect acquisitions versus continuing organic growth, and whether organic growth remains near management’s reported 19.9% year-over-year rate.
- Whether deposit growth and funding costs keep pace with loan expansion, and the effect of further rate changes on net interest margin and liquidity.
- Whether the unrealized securities losses, including any future sales or funding needs, affect capital or earnings; management said the current unrealized loss did not affect regulatory tangible book value.
- Trends in past-due, nonaccrual, criticized and impaired loans, allowance adequacy, and credit exposure to commercial real estate, agriculture, consumer and mortgage borrowers.
- Completion, final consideration and integration of the Peoples-Sidney transaction, and progress toward the stated $3 billion asset objective.
- CECL implementation assumptions and any resulting change in the allowance for credit losses beginning in 2023.