Farmers & Merchants Bancorp, Inc. — Q2 2017 Form 10-Q
Business context and period. Ohio-based community banking holding company reporting unaudited results for the quarter and six months ended June 30, 2017. It operates primarily in northwest Ohio and northeast Indiana, with commercial real estate, commercial and industrial, and agricultural lending among its principal activities. Dollar amounts below are in millions unless stated otherwise.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Interest income | $10.124 | $9.387 | $19.845 | $18.391 |
| Net interest income, before provision | $8.871 | $8.340 | $17.413 | $16.348 |
| Provision for loan losses | $0.025 | $0.339 | $0.098 | $0.616 |
| Noninterest income | $2.773 | $2.884 | $5.357 | $5.554 |
| Noninterest expense | $7.098 | $6.657 | $14.169 | $13.643 |
| Net income | $3.223 | $2.974 | $6.062 | $5.455 |
| Basic and diluted EPS | $0.70 | $0.65 | $1.31 | $1.18 |
| Net interest margin | 3.61% | 3.56% | 3.56% | 3.55% |
- Balance sheet at June 30: assets $1,066.2 million; deposits $877.5 million; net loans on the balance sheet $784.0 million; stockholders’ equity $131.2 million. Gross loans net of deferred fees, before the allowance, were $790.8 million.
- Loan growth and mix: net loans, using the filing’s portfolio measure, rose $32.7 million from year-end 2016 and $60.9 million (8.3%) year over year. Commercial real estate was $394.1 million, approximately half of that portfolio measure.
- Funding and liquidity: deposits increased $35.3 million from year-end. Federal funds purchased and repurchase agreements fell to $40.1 million from $70.3 million; FHLB advances remained $10.0 million. Management reported $111.5 million of unsecured correspondent-bank borrowing capacity and additional liquidity from securities, deposits, and borrowings.
- Cash flow, six months: operating cash flow was $8.4 million, investing cash flow was negative $10.4 million, and financing cash flow was $2.9 million. Cash and cash equivalents increased $0.9 million to $29.3 million.
- Credit quality and reserves: allowance for loan losses was $6.9 million and total allowance for credit losses, including unfunded commitments, was $7.1 million. Nonaccrual loans were $1.365 million; loans 90 days past due and still accruing were zero. The filing reports allowance coverage of nonperforming loans at 502%.
- Capital: reported ratios included Tier 1 leverage of 11.96%, Tier 1 risk-based capital of 14.85%, total risk-based capital of 15.68%, and a capital conservation buffer of 7.68%.
Material changes versus comparable periods
- Q2 net income increased 8.4%; first-half net income increased 11.1%. First-half EPS rose 11.0% to $1.31.
- Higher loan balances and improved loan yields drove interest income and net interest income higher. First-half net interest income increased about $1.1 million, while the cost of funds rose to 0.66% from 0.58%.
- Provision expense declined substantially year over year, reflecting low net charge-offs and management’s assessment of asset quality. First-half net charge-offs were $24,000 versus $180,000 a year earlier.
- Noninterest income declined, chiefly because securities-sale gains fell to $47,000 for the first half from $456,000. Noninterest expense rose $526,000, including higher payroll and benefits associated with new offices and incentive accruals; lower data-processing and FDIC assessment costs partly offset the increase.
- Available-for-sale securities declined $22.9 million from year-end, partly funding loan growth. Their net unrealized loss position improved, contributing to a $1.6 million reduction in accumulated other comprehensive loss.
- Deposits grew, while the company reduced reliance on repurchase-agreement funding and short-term network time deposits. Management attributed some movement from repurchase balances to interest-bearing NOW accounts to its Insured Cash Sweep product.
Outlook, commentary, and risks
- Management intends to continue growth in 2017, led by loans in newer markets, while growing deposits and seeking lower-cost funding. It provided no numerical earnings or revenue guidance and cautioned that interim results are not necessarily indicative of full-year results.
- Management said loan growth, rate increases on variable-rate loans, and continued balance-sheet repositioning should support net interest income. It also noted rising deposit costs and that much of the newer commercial real estate lending has initial fixed-rate periods of three to five years.
- Management described local agricultural conditions as affected by wet weather and some replanting, but said borrowers remained well capitalized and land values had declined only slightly. Agricultural borrowers remain exposed to weather and commodity prices; commercial lending faces borrower cash-flow, collateral-value, and economic risks.
- Interest-rate sensitivity is a key risk. The filing’s analysis indicates some potential margin tightening under rising-rate scenarios; outcomes depend on deposit pricing, loan repricing, and balance-sheet composition.
- Other material risks include competition, regulatory and compliance obligations, loan and investment portfolio quality, deposit flows, and economic conditions. The company identified the allowance for credit losses, mortgage servicing rights, and foreclosed real estate valuations as areas requiring significant estimates.
- There were no material changes to previously disclosed risk factors, no legal proceedings reported, and no shares were repurchased during the quarter. The company listed on Nasdaq in May and joined the Russell 3000 Index in June. Management said the listing improved trading liquidity; market impact is not quantified.
Important facts for investors to verify
- Whether commercial real estate concentration and continued loan growth remain consistent with underwriting standards and credit-loss reserves.
- Whether deposit growth and the shift in funding mix can continue without materially increasing funding costs or liquidity risk.
- The assumptions behind the rate-sensitivity analysis, particularly deposit repricing and the timing of fixed-rate loan resets.
- Whether lower securities gains and higher staffing and expansion costs affect earnings in subsequent periods; the filing provides no quantitative forward guidance.
- The company’s implementation plans and eventual impact from the expected credit-loss accounting standard (CECL), effective for it beginning in 2020 under the filing’s stated timetable.