Farmers & Merchants Bancorp, Inc. — 2021 Form 10-K
Reporting period: Fiscal year ended December 31, 2021; comparisons are primarily with 2020. Amounts are in U.S. dollars unless otherwise noted. This is an annual filing, not a standalone fourth-quarter report.
Business context
The Ohio bank holding company operates primarily through Farmers & Merchants State Bank, serving Northwest Ohio and Northeast Indiana, with a captive insurance subsidiary. It reports one business segment. The Bank provides commercial, agricultural, residential mortgage and consumer lending, deposits, and related financial services. Two 2021 acquisitions expanded its footprint and balance sheet: Ossian State Bank, completed April 30, and Perpetual Federal Savings Bank, completed October 1.
Financial performance and condition
| Metric | 2021 | 2020 | Change/comment |
|---|---|---|---|
| Total interest income | $76.8 million | $70.2 million | Up 9.5% |
| Net interest income | $69.5 million | $59.8 million | Up $9.7 million |
| Provision for loan losses | $3.4 million | $7.0 million | Down $3.5 million |
| Noninterest income | $17.6 million | $16.8 million | Up 4.9% |
| Noninterest expense | $54.2 million | $44.4 million | Up 22.1%, including acquisition-related costs |
| Net income | $23.5 million | $20.1 million | Record; up 16.9% |
| Diluted earnings per share | $2.01 | $1.80 | Up 11.7% |
| Return on average assets | 1.05% | 1.14% | Down 9 basis points |
| Return on average equity | 9.09% | 8.38% | Up 71 basis points |
| Net interest margin | 3.31% | 3.62% | Down 31 basis points |
| Net interest spread | 3.18% | 3.38% | Down 20 basis points |
- Balance sheet: Total assets increased 38.2% to $2.64 billion; net loans rose to $1.84 billion from $1.29 billion; deposits increased to $2.19 billion from $1.60 billion. Management reported 15.9% organic loan growth excluding PPP balances and acquired loans.
- Cash flow: Operating cash flow was $34.7 million; investing activities used $265.7 million, largely reflecting securities and loan activity and acquisitions; financing activities provided $236.1 million. Cash and cash equivalents ended the year at $180.8 million, up $5.1 million from year-end 2020.
- Credit quality and reserves: Nonaccrual loans declined to $8.1 million from $9.4 million; net charge-offs increased to $874,000 from $537,000. The allowance for loan losses was $16.2 million and total allowance for credit losses, including unfunded commitments, was $17.3 million. Watch-list loans were approximately $55.4 million, slightly lower than a year earlier.
- Capital and liquidity: Stockholders’ equity was $297.2 million, or 11.26% of assets. The Bank reported a 14.26% Tier 1 risk-based capital ratio, 15.22% total risk-based capital ratio and 10.25% Tier 1 leverage ratio, and was categorized as well capitalized. Year-end liquidity included $180.8 million in cash and cash equivalents and $429.9 million in available-for-sale securities. Management also cited access to correspondent and Federal Home Loan Bank borrowing facilities.
- Debt and funding: Year-end liabilities included $29.3 million of repurchase-agreement funding, $24.1 million of FHLB advances, $40.0 million of acquisition-related borrowings and $34.5 million net carrying value of subordinated notes. The company issued $35 million of 3.25% fixed-to-floating subordinated notes due 2031; it also borrowed $40 million for the Perpetual acquisition, with repayment plans subject to regulatory approval.
- Shareholder returns: Declared dividends rose to $0.71 per share from $0.66, totaling $8.2 million. In January 2022, the Board authorized repurchases of up to 600,000 shares through December 31, 2022.
Material changes versus 2020
- Net income rose 16.9%, driven chiefly by higher net interest income and a lower loan-loss provision, despite substantially higher operating expenses.
- Acquisitions drove much of the expansion in assets, loans, deposits and goodwill. Ossian was acquired for approximately $20.0 million cash; Perpetual consideration was approximately $100.3 million, comprising $59.2 million cash and $41.1 million stock. Year-end goodwill increased to $80.4 million from $47.3 million.
- Net interest margin contracted as asset yields fell more than funding costs. Average earning-asset yield declined 59 basis points; cost of interest-bearing funds fell 39 basis points.
- The available-for-sale securities portfolio increased to $429.9 million from $307.8 million. Rising market rates contributed to a net-of-tax unrealized securities loss of $8.9 million, moving accumulated other comprehensive income from positive $5.7 million to negative $3.2 million. Comprehensive income consequently fell to $14.6 million from $24.7 million, despite higher net income.
- The 2021 loan-loss provision was lower than 2020’s pandemic-related elevated provision. Management said previously concerning sectors performed and recovered better than expected, while continuing to monitor credit quality.
Outlook, risks and unusual items
- Management said the strategic goal of reaching $3 billion in assets by 2023 was within reach following acquisitions and organic growth. It expected strong 2022 earnings, with minimal impact from prior acquisitions and PPP activity, and planned to update its strategic plan in the second half of 2022. No formal numerical earnings or revenue guidance was provided.
- Management noted risks from continued pandemic effects, labor shortages and supply-chain disruption; agricultural input costs; competition; and pressure on net interest margin. Key exposures include commercial and real-estate lending, agricultural borrowers, local economic conditions, interest-rate movements, deposit flows, cybersecurity and reliance on third-party vendors.
- Noninterest expense included $3.9 million of acquisition costs in 2021. Management also cited $3.5 million of tax-adjusted PPP net income, partly offsetting $3.1 million of tax-adjusted acquisition costs. Mortgage servicing rights required a $414,000 valuation allowance; year-end servicing rights were $3.2 million.
- The Bank’s CECL adoption is scheduled for January 1, 2023. Management was evaluating the impact and anticipated a one-time cumulative-effect adjustment; the amount was not stated.
- The filing reports no material pending legal proceedings. The independent auditor gave an unqualified opinion on the financial statements and identified the loan-loss allowance and acquisition accounting as critical audit matters. Management concluded disclosure controls and internal control over financial reporting were effective at year-end.
Most important facts for investors to verify
- How much of reported earnings and balance-sheet growth is attributable to acquired institutions versus sustainable organic growth, and whether expected acquisition synergies are being realized.
- Whether the lower 2021 provision adequately reflects credit risk as acquired loans season, particularly in commercial real estate, commercial and industrial, and agricultural portfolios.
- How deposit costs, asset yields and net interest margin respond to changing interest rates and the Bank’s large fixed-rate loan exposure.
- The effects of unrealized securities losses, acquisition-related borrowings and the subordinated notes on tangible capital, parent-company liquidity and future shareholder distributions.
- The eventual CECL transition adjustment and any further impairment or valuation changes to goodwill and mortgage servicing rights.
- Whether management’s 2022 earnings outlook, $3 billion asset-growth target and planned share repurchases remain consistent with capital, credit and liquidity conditions.