Farmers & Merchants Bancorp, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results; dollar figures below are in millions unless otherwise noted. Comparisons are to 2017 unless stated otherwise.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest income | $11.537 | $10.124 | $22.673 | $19.845 |
| Net interest income, before provision | $10.010 | $8.871 | $19.683 | $17.413 |
| Provision for loan losses | $0.132 | $0.025 | $0.172 | $0.098 |
| Noninterest income | $2.806 | $2.773 | $5.416 | $5.357 |
| Noninterest expense | $7.638 | $7.098 | $15.278 | $14.169 |
| Net income | $4.114 | $3.223 | $7.881 | $6.062 |
| Diluted earnings per share | $0.44 | $0.35 | $0.85 | $0.66 |
- Q2 net income increased about 28%; first-half net income increased about 30%. Management attributed the improvement to loan growth, higher loan yields, and the lower federal tax rate, while noting that growth in earnings was not solely tax-related.
- Net interest margin was 3.83% for Q2 versus 3.61% a year earlier, and 3.78% for the first half versus 3.56%. First-half earning-asset yield rose to 4.35% from 4.05%, while cost of interest-bearing funds increased to 0.78% from 0.66%.
- Six-month operating cash flow was $8.532, investing cash use was $3.879, and financing cash use was $6.556. Cash and cash equivalents ended at $32.564, down $1.903 from year-end 2017.
Financial position, credit, and liquidity
- Total assets were $1,105.3 at June 30, down $1.7 from year-end 2017. Net loans were $824.2 on the balance sheet; loans net of deferred fees and costs were $831.0, up $8.1 from year-end and $40.2 (5.1%) from June 2017.
- Loan growth was strongest in agricultural real estate and agricultural lending. Commercial real estate was $410.9, approximately half of loans net of deferred fees and costs; commercial and industrial balances declined year over year.
- Deposits totaled $930.8, up $11.4 (1.2%) from year-end and $53.3 (6.1%) year over year. Repurchase agreements and federal funds purchased totaled $23.9, down $15.6 from year-end; FHLB advances remained $5.0.
- Shareholders’ equity was $137.6, up $3.4 from year-end. The Tier 1 leverage ratio was 12.38%, Tier 1 risk-based capital 15.28%, total risk-based capital 16.07%, and the reported capital conservation buffer 8.07%. Management said the Company and Bank were well capitalized and above the 2019 buffer requirement.
- The allowance for loan losses was $6.789; total allowance for credit losses, including unfunded commitments, was $7.104. Nonaccrual loans were $0.903 versus $1.003 at year-end; no loans over 90 days past due were still accruing. Net charge-offs for the first half were $0.251, compared with $0.024 in 2017.
- Available-for-sale securities were $187.0, with gross unrealized losses of $5.916 and a net unrealized loss position described by management as $5.6 million. The company reported no securities with other-than-temporary impairment. AOCI loss increased to $4.410 from $1.826 at year-end.
- Management cited additional liquidity sources of $6.1 currently available from the FHLB, up to $114.0 with adequate collateral, and $123.1 of unsecured correspondent borrowing capacity. It also described deposits and securities maturities or sales as funding sources for growth.
Changes, outlook, and risks
- Management reported continued local economic growth and a strong loan pipeline, though slightly below the prior year. It plans to focus 2018 growth on loans and deposits in newer markets. No quantified earnings or balance-sheet guidance was provided.
- The bank opened its 25th office in Findlay in February and began adopting interactive teller machines and a redesigned, relationship-focused branch model. Management said expansion and employee investments raise near-term expenses but support longer-term sustainable growth.
- Management said rising rates had widened margins, but warned that deposit-cost competition and a flatter yield curve could pressure margins; slower loan growth could also weigh on them. Interest-rate sensitivity analysis showed projected margin improvement under rising-rate shocks and tightening under falling-rate shocks, subject to the filing’s assumptions.
- Risks discussed include tariffs and their effect on crop prices, particularly soybeans; uncertainty around steel supply and business projects; labor shortages; competition for deposits; agricultural exposure to commodity prices and weather; and commercial real estate and other borrower and collateral risks.
- The federal corporate tax rate change from 34% to 21% reduced tax expense. The company adopted several accounting standards in 2018; most had no material impact. Adoption of callable-debt-security premium amortization accelerated just over $30,000 of expense, and a tax-effects standard resulted in an approximately $360,000 reclassification from AOCI to retained earnings.
- The filing reports no material changes to previously disclosed risk factors and no legal proceedings. Management concluded disclosure controls were effective, with no material quarter changes to internal control over financial reporting.
- Dividend declared was $0.14 per share for Q2, versus $0.12 a year earlier. The company repurchased no shares during the quarter; 400,000 shares remained authorized for repurchase under the program.
Important facts for investors to verify
- Reconcile the filing’s first-half provision-for-loan-losses comparison: the financial statements show $0.172 in 2018 versus $0.098 in 2017, while MD&A says the first-half provision was $74,000 lower year over year.
- Monitor credit quality and reserve adequacy, particularly higher first-half net charge-offs, the commercial real estate concentration, and agricultural borrowers’ sensitivity to commodity prices and weather.
- Track deposit pricing, funding mix, and net interest margin as rates and competition evolve, alongside the company’s stated plans to fund loan growth.
- Assess the effect of unrealized securities losses on AOCI and capital, and confirm that reported capital and liquidity remain adequate as expansion continues.
- Evaluate whether the new office and technology investments generate the expected longer-term growth while containing expense growth.