Farmers & Merchants Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Financial statements are unaudited. Unless otherwise indicated, dollar amounts are in millions; the filing presents most financial-statement figures in thousands.
Business context
The company is an Ohio-based financial holding company whose principal subsidiary is a community bank serving northwest Ohio and northeast Indiana. Lending includes commercial real estate, commercial and industrial, agricultural, residential real estate, and consumer loans. The Bank opened an office in the Fort Wayne area in April and expected to open a Bowling Green, Ohio office in the third quarter.
Financial results and key metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income, before provision | $8.340 | $7.418 | $16.348 | $14.744 |
| Provision for loan losses | $0.339 | $0.183 | $0.616 | $0.297 |
| Noninterest income | $2.884 | $2.699 | $5.554 | $5.256 |
| Noninterest expense | $6.657 | $6.381 | $13.643 | $12.946 |
| Net income | $2.974 | $2.597 | $5.455 | $4.948 |
| Basic and diluted EPS | $0.65 | $0.56 | $1.18 | $1.07 |
| Dividends declared per share | $0.23 | $0.22 | $0.45 | $0.43 |
- Growth and profitability: First-half net income rose about 10.3%; earnings per share rose 10.3%. Q2 net income increased $0.377 million year over year. First-half net interest income after provision was $15.732 million, up 8.9%.
- Margins: Net interest margin was 3.56% in Q2 versus 3.45% a year earlier, and 3.55% for the first half versus 3.45%. First-half earning-asset yield was 3.98%, while cost of interest-bearing funds was 0.58%.
- Balance sheet at June 30: Total assets were $1,021.3 million, up 3.3% from year-end 2015. Net loans were $725.2 million on the balance sheet; loans net of deferred fees and costs were $731.7 million, up 17.9% from June 2015. Deposits totaled $802.8 million, up 4.1% from year-end.
- Funding and liquidity: Cash and cash equivalents were $23.4 million. Federal funds purchased and repurchase-agreement balances totaled $75.9 million, and FHLB advances were $10.0 million. Management cited $91.2 million of unsecured correspondent-bank borrowing capacity and potential liquidity from securities runoff or sales, deposit growth, and additional borrowing.
- Cash flows, first half: Operating activities provided $3.954 million, investing activities used $29.021 million, and financing activities provided $26.428 million. Cash and cash equivalents increased $1.361 million to $23.379 million.
- Capital: The filing reports a Tier 1 leverage ratio of 11.74%, Tier 1 risk-based capital of 13.83%, total risk-based capital of 14.61%, and equity-to-assets of 12.23%. Management said the Company and Bank exceeded the 2019 capital conservation-buffer requirement.
Material changes versus comparable periods
- Loan growth drove higher interest income: first-half interest income increased 11.6% to $18.391 million, including a $2.111 million increase in loan interest income. Net interest income increased $1.604 million.
- Higher funding costs partly offset loan growth: first-half interest expense rose 18.2% to $2.043 million. Average interest-bearing liabilities and their cost increased, with the reported cost rising from 0.53% to 0.58%.
- Provision expense more than doubled year over year, reflecting loan growth and reserve needs. The allowance for loan losses was $6.493 million, and total allowance for credit losses, including unfunded commitments, was $6.712 million.
- Noninterest income rose 5.7% for the first half, helped by $0.456 million in net securities-sale gains versus $0.246 million a year earlier. The Company sold $42.7 million of securities, with proceeds used partly to fund loan growth.
- Noninterest expense increased 5.4% for the first half. Salary and data-processing costs rose; management also cited higher debit-card conversion and marketing costs. Employee benefits declined year over year.
- Available-for-sale securities fell to $217.1 million from $235.1 million at year-end, while accumulated other comprehensive income rose to $1.624 million from $0.212 million, reflecting unrealized valuation changes.
Outlook, commentary, risks, and unusual items
- Management expected loan growth and balance-sheet repositioning to continue supporting net interest income, while noting new offices may create a modest short-term drag. No specific earnings or revenue guidance was provided.
- Management described agricultural conditions as tougher, citing lower commodity prices, higher input costs, and decreasing farm working capital; it said most farms observed still had sufficient working capital. Tighter margins were also affecting used-equipment values and land prices.
- Credit indicators included $1.407 million of loans past due at least 30 days, or 0.19% of loans; nonaccrual loans were $1.528 million, down from $3.063 million at June 30, 2015. No loans 90 days past due were still accruing. One new troubled debt restructuring was recorded in the first half; the filing reports no subsequent defaults of modified TDRs during the periods discussed.
- Commercial real estate represented $357.2 million of loans, the largest portfolio category. Management cited competition for larger commercial customers and identified agricultural commodity prices, weather, borrower repayment capacity, collateral values, and local economic conditions as credit risks.
- Interest-rate risk remains material. The Company’s modeled scenarios show margin tightening under significant rate shocks; management noted that many newer commercial real estate loans have fixed initial periods of three to five years, limiting near-term repricing benefits. Actual outcomes may differ from modeled results.
- Other considerations include continued mortgage-regulatory compliance work, Basel III requirements, and valuation uncertainty in the allowance for loan losses, mortgage servicing rights, and foreclosed property. Management reported no material changes to previously disclosed risk factors, no legal proceedings, and effective disclosure controls.
Important facts for investors to verify
- Whether loan growth—particularly in commercial real estate—continues without deterioration in delinquencies, criticized credits, or required loan-loss provisions.
- How deposit growth, funding costs, and use of short-term borrowings affect net interest margin and liquidity as assets expand.
- Whether securities-sale gains recur; they contributed to reported noninterest income and helped fund loan growth.
- Progress, costs, and returns from the new Fort Wayne-area and planned Bowling Green offices.
- Capital ratios, the reported capital conservation buffer, and the underlying regulatory capital schedules in the full filing.
- Management’s assumptions for interest-rate sensitivity, loan-loss reserves, mortgage servicing rights, and collateral valuations.