UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


	For quarterly period ended September 30, ~~2019~~ 2020

☐	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _______________ to ________________

Commission file number 000-55756

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Maryland

81-3605835

(State or other jurisdiction of

~~incorporation or organization)~~

~~(I.~~(I. R. S. Employer Identification No.)

incorporation or organization)

4510 Lower Beckleysville Road, Suite H, Hampstead, Maryland 21074

(Address of principal executive offices) (Zip Code)

(410) 374-1510

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act:

	Large accelerated filer ☐		Accelerated filer ☐ Non-accelerated filer ☑ Smaller reporting company ☑ Emerging growth company ☐

	~~Non-accelerated filer ☑~~		~~Smaller reporting company ☑~~

	~~Emerging growth company ☐~~

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: ~~2,959,777~~2,991,964 as of November ~~7, 2019.~~9, 2020.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Table of Contents

	Page

PART I – FINANCIAL INFORMATION		3

Item 1.	Financial Statements	3

	Consolidated balance sheets at September 30, ~~2019~~2020 (unaudited) and December 31, ~~2018~~ 2019	3

	Consolidated statements of income (unaudited) for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~ 2019	4

	Consolidated statements of comprehensive income (unaudited) for the three and nine months ~~Ended~~ended September 30, 2020 and 2019 ~~and 2018~~	5

	Consolidated statements of changes in stockholders’ equity (unaudited) for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~ 2019	6

	Consolidated statements of cash flows (unaudited) for the nine months ended September 30, ~~2019~~2020 and ~~2018~~2019	7

	Notes to financial statements (unaudited)	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2627

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	4145

Item 4.	Controls and Procedures	4145

PART II – OTHER INFORMATION	4246

Item 1.	Legal Proceedings	4246

Item 1A.	Risk Factors	4246

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	4246

Item 3.	Defaults upon Senior Securities	4246

Item 4.	Mine Safety Disclosures	4246

Item 5.	Other Information	4246

Item 6.	Exhibits	4347

SIGNATURES	4347

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

September 30,

December 31,

2019

2018

(Unaudited)

Assets

Cash and due from banks
$ 16,281,158 $ 11,480,608
Federal funds sold and other interest-bearing deposits
3,313,899 3,137,629
Cash and cash equivalents
19,595,057 14,618,237
Certificate of deposit in other bank
100,000 100,000
Securities available for sale
40,101,155 26,591,991
Securities held to maturity
19,509,907 18,127,067
Equity security at fair value
531,714 503,827
Federal Home Loan Bank stock, at cost
503,700 575,800
Mortgage loans held for sale
1,538,574 573,638
Loans, less allowance for loan losses of $2,546,114 and $2,509,334
336,748,866 340,900,635
Premises and equipment
4,913,640 5,075,310
Accrued interest receivable
978,300 990,529
Deferred income taxes
950,207 1,179,454
Other real estate owned
- 210,150
Bank owned life insurance
7,102,589 7,053,354
Other assets
1,931,803 657,885
$ 434,505,512 $ 417,157,877

Liabilities and Stockholders' Equity

Deposits

Noninterest-bearing
$ 58,298,592 $ 62,717,520
Interest-bearing
313,897,923 291,995,483
Total deposits
372,196,515 354,713,003
Securities sold under repurchase agreements
7,583,212 11,012,000
Federal Home Loan Bank of Atlanta advances
1,000,000 3,000,000
Accrued interest payable
348,862 311,489
Other liabilities
4,382,403 2,726,678
385,510,992 371,763,170
Stockholders' equity

Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 2,959,777 in 2019 and 1,682,997 shares in 2018
29,598 16,830
Additional paid-in capital
27,561,138 27,324,794
Retained earnings
21,276,789 18,621,382
Accumulated other comprehensive income
126,995 (568,299 )
48,994,520 45,394,707
$ 434,505,512 $ 417,157,877

~~The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.~~

~~Farmers and Merchants Bancshares, Inc. and Subsidiaries~~

~~Consolidated Statements of Income~~

~~(Unaudited)~~

Three months ended

Nine months ended

September 30,

September 30,

2019

2018

2019

2018

Interest income

Loans, including fees
$ 4,250,071 $ 4,189,626 $ 12,582,392 $ 12,171,765
Investment securities - taxable
234,274 145,791 631,382 450,649
Investment securities - tax exempt
150,141 142,493 431,354 428,055
Federal funds sold and other interest earning assets
84,526 47,280 280,876 117,973
Total interest income
4,719,012 4,525,190 13,926,004 13,168,442

Interest expense

Deposits
916,452 604,697 2,577,229 1,543,023
Securities sold under repurchase agreements
29,190 42,841 82,912 112,242
Federal Home Loan Bank advances and other borrowings
10,769 16,480 42,517 125,427
Total interest expense
956,411 664,018 2,702,658 1,780,692
Net interest income
3,762,601 3,861,172 11,223,346 11,387,750
��
Provision for loan losses
(13,000 ) (100,000 ) - 25,000

Net interest income after provision for loan losses
3,775,601 3,961,172 11,223,346 11,362,750

Noninterest income

Service charges on deposit accounts
176,577 160,665 494,752 496,393
Mortgage banking income
144,268 105,144 249,867 219,805
Bank owned life insurance income
39,443 40,880 321,841 121,274
Unrealized gain (loss) on equity security
3,966 (3,869 ) 18,721 (15,348 )
Write down of other real estate owned
- (55,350 ) (210,150 ) (55,350 )
Gain on sale of SBA loans
- 3,317 139,535 63,825
Other fees and commissions
28,714 21,634 94,031 73,433
Total noninterest income
392,968 272,421 1,108,597 904,032

Noninterest expense

Salaries
1,358,208 1,344,759 3,993,998 3,892,971
Employee benefits
312,119 328,258 1,008,228 1,018,280
Occupancy
189,603 168,759 594,566 535,448
Furniture and equipment
149,191 148,945 460,271 475,953
Other
673,814 606,346 1,990,354 1,932,585
Total noninterest expense
2,682,935 2,597,067 8,047,417 7,855,237

Income before income taxes
1,485,634 1,636,526 4,284,526 4,411,545
Income taxes
307,724 327,838 784,508 835,674
Net income
$ 1,177,910 $ 1,308,688 $ 3,500,018 $ 3,575,871

Earnings per share - basic and diluted
$ 0.40 $ 0.45 $ 1.19 $ 1.22

~~The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.~~

~~Farmers and Merchants Bancshares, Inc. and Subsidiaries~~

~~Consolidated Statements of Comprehensive Income~~

~~(Unaudited)~~

Three Months Ended

Nine Months Ended

September 30,

September 30,

2019

2018

2019

2018

Net income
$ 1,177,910 $ 1,308,688 $ 3,500,018 $ 3,575,871

Other comprehensive income (loss), net of income taxes:

Securities available for sale

Net unrealized gain (loss) arising during the period
113,117 (115,428 ) 959,257 (534,867 )
Income tax expense (benefit)
31,127 (31,762 ) 263,963 (147,181 )
Total other comprehensive income (loss)
81,990 (83,666 ) 695,294 (387,686 )

Total comprehensive income
$ 1,259,900 $ 1,225,022 $ 4,195,312 $ 3,188,185

	September, 30		December 31,
	2020		2019
	(Unaudited)
Assets

Cash and due from banks	$	14,766,830	$	6,664,307
Federal funds sold and other interest-bearing deposits		465,755		2,457,045
Cash and cash equivalents		15,232,585		9,121,352
Certificate of deposit in other bank		100,000		100,000
Securities available for sale		39,882,135		36,531,774
Securities held to maturity		22,602,562		19,510,018
Equity security at fair value		553,057		532,321
Federal Home Loan Bank stock, at cost		696,300		376,200
Mortgage loans held for sale		2,650,459		242,000
Loans, less allowance for loan losses of $3,141,312 and $2,593,715		390,114,430		359,382,843
Premises and equipment		5,096,063		5,036,851
Accrued interest receivable		1,215,284		1,019,540
Deferred income taxes		754,417		1,036,078
Bank owned life insurance		7,272,949		7,145,477
Other assets		27,307,504		2,180,644
	$	513,477,745	$	442,215,098

Liabilities and Stockholders' Equity

Deposits
Noninterest-bearing	$	79,010,403	$	60,659,015
Interest-bearing		347,065,245		315,954,299
Total deposits		426,075,648		376,613,314
Securities sold under repurchase agreements		6,317,682		10,958,118
Federal Home Loan Bank of Atlanta advances		7,000,000		-
Long-term debt		16,971,874		-
Accrued interest payable		230,177		346,214
Other liabilities		4,954,184		4,843,936
		461,549,565		392,761,582
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 2,991,964 in 2020 and 2,974,019 in 2019		29,920		29,740
Additional paid-in capital		28,054,158		27,812,991
Retained earnings		23,059,567		21,568,161
Accumulated other comprehensive income		784,535		42,624
		51,928,180		49,453,516
	$	513,477,745	$	442,215,098

The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

	Three months ended					Nine months ended
	September 30,					September 30,
	2020		2019			2020		2019

Interest income
Loans, including fees	$	4,489,992	$	4,250,071		$	13,205,913	$	12,582,392
Investment securities - taxable		159,277		234,274			561,038		631,382
Investment securities - tax exempt		163,522		150,141			462,305		431,354
Federal funds sold and other interest earning assets		9,563		84,526			58,362		280,876
Total interest income		4,822,354		4,719,012			14,287,618		13,926,004

Interest expense
Deposits		690,833		916,452			2,429,496		2,577,229
Securities sold under repurchase agreements		18,020		29,190			95,710		82,912
Federal Home Loan Bank advances and other borrowings		12,752		10,769			25,726		42,517
Total interest expense		721,605		956,411			2,550,932		2,702,658
Net interest income		4,100,749		3,762,601			11,736,686		11,223,346

Provision for loan losses		-		(13,000	)		475,000		-

Net interest income after provision for loan losses		4,100,749		3,775,601			11,261,686		11,223,346

Noninterest income
Service charges on deposit accounts		138,288		176,577			414,501		494,752
Mortgage banking income		272,297		144,268			684,664		249,867
Bank owned life insurance income		42,250		39,443			127,473		321,841
Unrealized gain on equity security		1		3,966			13,046		18,721
Write down of other real estate owned		-		-			-		(210,150	)
Gain on sale of SBA loans		-		-			63,635		139,535
Other fees and commissions		34,532		28,714			94,277		94,031
Total noninterest income		487,368		392,968			1,397,596		1,108,597

Noninterest expense
Salaries		1,462,946		1,358,208			4,114,143		3,993,998
Employee benefits		376,860		312,119			1,183,414		1,008,228
Occupancy		183,719		189,603			552,265		594,566
Furniture and equipment		175,006		149,191			501,267		460,271
Acquisition		1,267,401		-			1,612,321		-
Other		660,075		673,814			1,970,913		1,990,354
Total noninterest expense		4,126,007		2,682,935			9,934,323		8,047,417

Income before income taxes		462,110		1,485,634			2,724,959		4,284,526
Income taxes		76,863		307,724			460,350		784,508
Net income	$	385,247	$	1,177,910		$	2,264,609	$	3,500,018

Earnings per share - basic and diluted	$	0.13	$	0.40		$	0.76	$	1.19

The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended					Nine Months Ended
	Sepember 30,					September 30,
	2020			2019		2020		2019

Net income	$	385,247		$	1,177,910	$	2,264,609	$	3,500,018

Other comprehensive income, net of income taxes:

Securities available for sale
Net unrealized gain (loss) arising during the period		(32,263	)		113,117		1,023,573		959,257
Income tax expense (benefit)		(8,878	)		31,127		281,662		263,963
Total other comprehensive income (loss)		(23,385	)		81,990		741,911		695,294

Total comprehensive income	$	361,862		$	1,259,900	$	3,006,520	$	4,195,312

The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three and Nine ~~months ended~~Months Ended September 30, ~~2019~~2020 and ~~2018~~2019

(Unaudited except for year-end amounts)

					Additional					Accumulated other			Total								Additional						Accumulated other			Total
	Common stock				paid-in		Retained			comprehensive			stockholders'				Common stock				paid-in			Retained			comprehensive			stockholders'
	Shares		Par value		capital		earnings			income			equity				Shares		Par value		capital			earnings			income			equity
Balance, December 31, 2017		1,667,813	$	16,678	$	26,869,796	$	15,306,625		$	(394,167	)	$	41,798,932
Three months ended September, 2019
Balance, June 30, 2019																		1,691,091	$	16,911	$	27,561,593		$	20,111,524		$	45,005		$	47,735,033

Net income		-		-		-		3,575,871			-			3,575,871				-		-		-			1,177,910			-			1,177,910
Unrealized loss on securities available for sale net of income tax benefit of $147,181		-		-		-		-			(387,686	)		(387,686	)
Reclassification due to adoption of ASU No. 2016-01		-		-		-		(10,416	)		10,416			-
Cash dividends, $0.23 per share		-		-		-		(667,192	)		-			(667,192	)
Dividends reinvested		7,337		73		215,406		-			-			215,479
Shares Issued		50		1		1,549		-			-			1,550
Unrealized gain on securities available for sale net of income tax expense of $31,127																		-		-		-			-			81,990			81,990
Dividends reinvested adjustment																		1		-		(455	)		42			-			(413	)
Stock dividend																		1,268,685		12,687		-			(12,687	)		-			-

Balance, September 30, 2018		1,675,200	$	16,752	$	27,086,751	$	18,204,888		$	(771,437	)	$	44,536,954
Balance, September 30, 2019																		2,959,777	$	29,598	$	27,561,138		$	21,276,789		$	126,995		$	48,994,520

Nine months ended September 30, 2019																Nine months ended September 30, 2019
Balance, December 31, 2018		1,682,997	$	16,830	$	27,324,794	$	18,621,382		$	(568,299	)	$	45,394,707				1,682,997	$	16,830	$	27,324,794		$	18,621,382		$	(568,299	)	$	45,394,707

Net income		-		-		-		3,500,018			-			3,500,018				-		-		-			3,500,018			-			3,500,018
Unrealized gain on securities available for sale net of income tax expense of $263,963		-		-		-		-			695,294			695,294				-		-		-			-			695,294			695,294
Adjustment due to adoption of ASU No. 2016-02		-		-		-		(91,447	)		-			(91,447	)
Reclassification due to adoption of ASU No. 2016-02																		-		-		-			(91,447	)		-			(91,447	)
Cash dividends, $0.25 per share		-		-		-		(740,477	)		-			(740,477	)			-		-		-			(740,477	)		-			(740,477	)
Dividends reinvested		8,095		81		236,344		-			-			236,425				8,095		81		236,344			-			-			236,425
Stock dividend		1,268,685		12,687		-		(12,687	)		-			-				1,268,685		12,687		-			(12,687	)		-			-

Balance, September 30, 2019		2,959,777	$	29,598	$	27,561,138	$	21,276,789		$	126,995		$	48,994,520				2,959,777	$	29,598	$	27,561,138		$	21,276,789		$	126,995		$	48,994,520

Three months ended September 30, 2020																Three months ended September 30, 2020
Balance, June 30, 2020																		2,991,963	$	29,920	$	28,054,158		$	22,674,059		$	807,920		$	51,566,057

Net income																		-		-		-			385,247			-			385,247
Unrealized loss on securities available for sale net of income tax benefit of $8,878																		-		-		-			-			(23,385	)		(23,385	)
Dividends reinvested adjustment																		1		-		-			261			-			261

Balance, September 30, 2020																		2,991,964	$	29,920	$	28,054,158		$	23,059,567		$	784,535		$	51,928,180

Nine months ended September 30, 2020																Nine months ended September 30, 2020
Balance, December 31, 2019																		2,974,019	$	29,740	$	27,812,991		$	21,568,161		$	42,624		$	49,453,516

Net income																		-		-		-			2,264,609			-			2,264,609
Unrealized gain on securities available for sale net of income tax expense of $281,662																		-		-		-			-			741,911			741,911
Cash dividends, $0.26 per share																		-		-		-			(773,203	)		-			(773,203	)
Dividends reinvested																		17,945		180		241,167			-			-			241,347

Balance, September 30, 2020																		2,991,964	$	29,920	$	28,054,158		$	23,059,567		$	784,535		$	51,928,180

The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30,	2019				2018			2020			2019

Cash flows from operating activities
Interest received	$	13,871,203			$	13,200,699		$	14,615,625		$	13,871,203
Fees and commissions received		1,111,256				789,631			1,193,443			1,111,256
Interest paid		(2,665,285	)			(1,664,444	)		(2,666,969	)		(2,665,285	)
Proceeds from sale of mortgage loans held for sale		12,266,054				10,513,771			35,230,924			12,266,054
Origination of mortgage loans held for sale		(13,230,990	)			(10,336,071	)		(37,639,383	)		(13,230,990	)
Cash paid to suppliers and employees		(7,504,291	)			(7,490,137	)		(9,241,695	)		(7,504,291	)
Income taxes paid, net of refunds received		(761,512	)			(588,898	)		(838,335	)		(761,512	)
		3,086,435				4,424,551			653,610			3,086,435

Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale		5,103,515				3,867,038			15,222,262			5,103,515
Held to maturity		1,043,420				165,000			1,898,420			1,043,420
Proceeds from sale of securities
Available for sale									2,025,000			-
Purchase of securities
Available for sale		(17,761,884	)			-			(19,890,543	)		(17,761,884	)
Held to maturity		(2,406,339	)			(63,242	)		(4,957,679	)		(2,406,339	)
Purchase of certificate of deposit		-				(242,000	)
Loans made to customers, net of principal collected		2,766,804				(9,473,587	)		(32,358,278	)		2,766,804
Proceeds from sale of loans		1,582,364				729,511			683,885			1,582,364
Redemption of stock in FHLB of Atlanta		72,100				487,800
Redemption (purchase) of stock in FHLB of Atlanta									(320,100	)		72,100
Deposit to transfer agent for subsequent acquisition									(24,807,728	)		-
Purchases of premises, equipment and software		(60,267	)			(176,346	)		(299,532	)		(60,267	)
		(9,660,287	)			(4,705,826	)		(62,804,293	)		(9,660,287	)

Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits		(4,418,928	)			(4,841,569	)		18,351,388			(4,418,928	)
Interest-bearing deposits		21,902,440				34,559,400			31,110,946			21,902,440
Securities sold under repurchase agreements		(3,428,788	)			(9,605,084	)		(4,640,436	)		(3,428,788	)
Federal Home Loan Bank of Atlanta advances (repayments)		(2,000,000	)			(14,000,000	)
Federal Home Loan Bank of Atlanta advances									7,000,000			(2,000,000	)
Long-term debt proceeds									16,971,874			-
Dividends paid, net of reinvestments		(504,052	)	��		(451,713	)		(531,856	)		(504,052	)
Common stock issued		-				1,550

		11,550,672				5,662,584			68,261,916			11,550,672

Net increase (decrease) in cash and cash equivalents		4,976,820				5,381,309
Net increase in cash and cash equivalents									6,111,233			4,976,820

Cash and cash equivalents at beginning of period		14,618,237				7,237,385			9,121,352			14,618,237
Cash and cash equivalents at end of period	$	19,595,057			$	12,618,694		$	15,232,585		$	19,595,057

The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30,	2019			2018			2020			2019

Reconciliation of net income to net cash provided by operating activities
Net income	$	3,500,018		$	3,575,871		$	2,264,609		$	3,500,018
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		259,626			289,097			274,241			259,626
Provision for loan losses		-			25,000			475,000			-
Lease expense in excess of rent paid		31,403			-			25,677			31,403
Write down of other real estate owned		210,150			55,350			-			210,150
Equity security dividend reinvested		(9,166	)		(8,383	)
Unrealized (gain) loss on equity security		(18,721	)		15,348
Gain on sale of loans		(139,535	)		(63,825	)
Decrease (increase) in mortgage loans held for sale		(964,936	)		177,700
Equity security dividends reinvested								(7,690	)		(9,166	)
Unrealized gain on equity security								(13,046	)		(18,721	)
Gain on sale of SBA loans								(63,635	)		(139,535	)
Amortization of premiums and accretion of discounts, net		88,541			100,989			283,207			88,541
Increase (decrease) in
Deferred loan fees		(57,864	)		(10,665	)		531,441			(57,864	)
Accrued interest payable		37,373			116,248			(116,037	)		37,373
Other liabilities		200,398			312,878			196,658			200,398
Decrease (increase) in
Mortgage loans held for sale								(2,408,459	)		(964,936	)
Accrued interest receivable		12,229			51,305			(195,744	)		12,229
Bank owned life insurance cash surrender value		(49,235	)		(121,274	)		(127,472	)		(49,235	)
Other assets		(13,846	)		(91,088	)		(465,140	)		(13,846	)
	$	3,086,435		$	4,424,551		$	653,610		$	3,086,435

The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1.	Principles of consolidation

The consolidated financial statements include the accounts of Farmers and Merchants Bancshares, Inc. and its wholly owned subsidiaries, Farmers and Merchants Bank (the “Bank”), and Series Protected Cell FCB-4 (the “Insurance Subsidiary”), and one subsidiary of the Bank, Reliable Community Financial Services, Inc. (collectively the “Company”, “we”, “us”, or “our”). The Insurance Subsidiary constitutes an investment in a series of membership interests, 100% owned by the Company, issued by First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed property and casualty insurance company. Intercompany balances and transactions have been eliminated.

2.	Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three ~~months~~ and nine months ended September 30, ~~2019~~2020 do not necessarily reflect the results that may be expected for the entire fiscal year ending December 31, ~~2019~~2020 or any future interim period. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, ~~2018,~~2019, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form ~~10-K.~~10-K for the year ended December 31, 2019.

~~Recent Accounting Pronouncements~~Acquisition of Carroll Bancorp, Inc.

~~In February 2016,~~On October 1, 2020, the ~~Financial Accounting Standards Board~~Company consummated its previously-announced acquisition by merger (the ~~“FASB”~~“Merger”) ~~issued Accounting Standards Update~~of Carroll Bancorp, Inc. (“~~ASU”~~Carroll”) ~~No. 2016-02, “Leases (Topic 841).” Among other things,~~and its wholly-owned subsidiary, Carroll Community Bank. Each share of common stock of Carroll (“Carroll Common Stock”) that was outstanding immediately prior to the effective time of the Merger (the “Effective Time”) was converted into the right to receive cash in the ~~amendments~~amount $21.63 (the “Per Share Consideration”). Immediately prior to the Effective Time, there were 1,146,913 outstanding shares of Carroll Common Stock, all of which were converted into the Per Share Consideration. The merger consideration was paid by the Company using $8 million in ASU 2016-02, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arisingcash and $17 million in proceeds from a ~~lease, measured on a discounted basis;~~third-party term loan obtained in connection with the Merger. Because the Merger was consummated after the end of the period covered by this report, this report does not take into account the financial condition or results of operations of Carroll and ~~(ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset~~its subsidiaries for the ~~lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model~~three- or nine-month periods ended September 30, 2020. At September 30, 2020, Carroll had total assets of $176,159,890, net loans of $145,153,100, and Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginningtotal liabilities of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company adopted the provisions$157,992,286, of ~~ASU 2016-02, effective January 1, 2019, by recording an asset of $1,400,855, a liability of $1,527,019, a $91,447 adjustment to retained earnings, and a $34,717 adjustment to deferred income taxes.~~

which $144,896,990 represented deposits.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.	Basis of Presentation (continued)

The following table presents the book values and estimated fair values of the assets, liabilities, and equity of Carroll as of October 1, 2020. The estimates of fair value are subject to change.

			Estimated
	Book value		fair value

Cash	$	5,441,610	$	5,441,610
Investments		14,540,495		14,599,320
Loans held for sale		1,702,950		1,743,195
Loans		145,153,100		145,233,219
Premises and equipment		2,619,413		2,791,286
Other real estate owned		1,411,605		1,411,605
Other assets		5,290,717		5,480,538
Goodwill and other intangibles		-		6,770,000

Total assets	$	176,159,890	$	183,470,773

Deposits	$	144,896,990	$	145,512,990
FHLB advances		13,000,000		13,000,000
Other liabilities		95,296		95,296

Total liabilities		157,992,286		158,608,286

Stockholders' equity		18,167,604		24,862,487

Total liabilities and stockholders equity	$	176,159,890	$	183,470,773

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.	Basis of Presentation (continued)

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses”. The ASU sets forth a “current expected credit loss” (CECL) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. ~~This~~ ASU ~~is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. However, in July 2019, the FASB proposed extending~~2019-10 “Financial Instruments – Credit Losses (Topic 326), Derivatives and hedging (Topic 815), and Leases (Topic 842): Effective Dates” extended the implementation date to 2023 for SEC registered smaller reporting companies and private companies. The Company is considered a smaller reporting company. The ~~proposal is expected to be enacted before the end of 2019. The~~ Company has engaged a third-party vendor to assist in the implementation of this ASU.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies the disclosure requirements on fair value measurements in ASC Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 will be effective for us on January 1, 2020, with early adoption permitted, and is not expected to have a material impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-14, “Compensation - Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20).” ASU 2018-14 amends and modifies the disclosure requirements for employers that sponsor defined benefit pension or other post-retirement plans. The amendments in this update remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. ASU 2018-14 will be effective for us on January 1, 2021, with early adoption permitted, and is not expected to have a material impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 does not affect the accounting for the service element of a hosting arrangement that is a service contract. ASU 2018-15 ~~will be~~was effective for us on January 1, 2020, with early adoption permitted, and isdid not ~~expected to~~ have a material impact on the Company’s financial statements.

~~Subsequent Events~~In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (LIBOR), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. As of September 30, 2020, the Company has only one adjustable rate loan tied to LIBOR.

In December 2019, FASB released ASU 2019-12 - Income Taxes (Topic 740), which simplifies the accounting for income taxes by removing multiple exceptions to the general principals in Topic 740. ASU 2019-12 is effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2020. The Company ~~has evaluated subsequent events for potential recognition and/or disclosure through~~is in the ~~date~~process of reviewing the ~~consolidated~~impact of adopting this standard on the Company’s financial ~~statements were issued. No significant subsequent events were identified which would affect the presentation of the financial statements except as noted below.~~

On September 16, 2019, the Board of Directors of the Company declared a 75% stock dividend payable on October 31, 2019 to stockholders of record as of October 4, 2019. Accordingly, all per share information, including note 8, reflects the stock dividend.statements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities

Investments in debt securities are summarized as follows:

	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
September 30, 2019	cost		gains		losses		value
September 30, 2020									cost		gains		losses		value

Available for sale

State and municipal	$	1,378,761	$	11,464	$	-	$	1,390,225	$	506,267	$	22,530	$	-	$	528,797
SBA pools		2,388,707		-		51,269		2,337,438		1,885,788		-		42,632		1,843,156
Corporate bonds										2,095,456		92,089		-		2,187,545
Mortgage-backed securities		36,158,480		351,762		136,750		36,373,492		34,312,246		1,036,284		25,893		35,322,637
	$	39,925,948	$	363,226	$	188,019	$	40,101,155	$	38,799,757	$	1,150,903	$	68,525	$	39,882,135

Held to maturity

State and municipal	$	19,509,907	$	644,737	$	563	$	20,154,081	$	22,602,562	$	1,044,046	$	13,309	$	23,633,299

	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
December 31, 2018	cost		gains		losses		value
December 31, 2019									cost		gains		losses		value

Available for sale

State and municipal	$	1,506,011	$	11,161	$	10,667	$	1,506,505	$	508,134	$	4,536	$	-	$	512,670
SBA pools		2,779,411		-		60,039		2,719,372		2,203,834		-		52,037		2,151,797
Mortgage-backed securities		23,090,618		33,594		758,098		22,366,114		33,760,999		255,843		149,535		33,867,307
	$	27,376,040	$	44,755	$	828,804	$	26,591,991	$	36,472,967	$	260,379	$	201,572	$	36,531,774

Held to maturity

State and municipal	$	18,127,067	$	115,220	$	209,194	$	18,033,093	$	19,510,018	$	588,393	$	480	$	20,097,931

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities (continued)

Contractual maturities, shown below, will differ from actual maturities because borrowers and issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Available for Sale

Held to Maturity

Amortized

Fair

Amortized

Fair

September 30, 2019

cost

value

cost

value

Within one year
$ - $ - $ 258,014 $ 263,101
Over one to five years
258,761 260,187 330,000 330,611
Over five to ten years
1,120,000 1,130,038 2,948,579 3,029,811
Over ten years
- - 15,973,314 16,530,558
1,378,761 1,390,225 19,509,907 20,154,081
Mortgage-backed securities and

SBA pools, due in monthly installments
38,547,187 38,710,930 - -
$ 39,925,948 $ 40,101,155 $ 19,509,907 $ 20,154,081

December 31, 2018
									Available for Sale				Held to Maturity
									Amortized		Fair		Amortized		Fair
September 30, 2020									cost		value		cost		value

Within one year	$	375,000	$	375,653	$	1,009,284	$	1,011,165	$	-	$	-	$	-	$	-
Over one to five years		260,587		249,920		590,522		598,528		2,351,723		2,450,600		792,990		813,269
Over five to ten years		870,424		880,932		1,858,695		1,876,364		250,000		265,742		2,957,174		3,156,466
Over ten years		-		-		14,668,566		14,547,036		-		-		18,852,398		19,663,564
		1,506,011		1,506,505		18,127,067		18,033,093		2,601,723		2,716,342		22,602,562		23,633,299
Mortgage-backed securities and
SBA pools, due in monthly installments		25,870,029		25,085,486		-		-
Mortgage-backed securities and SBA pools, due in monthly installments										36,198,034		37,165,793		-		-
	$	27,376,040	$	26,591,991	$	18,127,067	$	18,033,093	$	38,799,757	$	39,882,135	$	22,602,562	$	23,633,299

December 31, 2019

Within one year									$	-	$	-	$	257,150	$	261,204
Over one to five years										258,134		258,838		562,587		565,140
Over five to ten years										250,000		253,832		2,717,125		2,782,474
Over ten years										-		-		15,973,156		16,489,113
										508,134		512,670		19,510,018		20,097,931
Mortgage-backed securities and SBA pools, due in monthly installments										35,964,833		36,019,104		-		-
										36,472,967	$	36,531,774	$	19,510,018	$	20,097,931

Securities with a carrying value of $~~7,465,493~~7,746,036 and ~~$11,706,765~~$11,441,474 as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

During the nine months ended September 30, 2020, the Company received proceeds of $2,025,000 from the sale of investment securities available for sale. The Company realized no gain or loss on the sale of the securities. There were no sales of securities during the nine months ended September 20, 2019.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities (continued)

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in debt securities, by category and length of time, at September 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

September 30, 2019	Less than 12 months				12 months or more				Total
September 30, 2020													Less than 12 months				12 months or more				Total
Description of investments	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

State and municipal	$	-	$	-	$	252,000	$	563	$	252,000	$	563	$	1,724,366	$	13,309	$	-	$	-	$	1,724,366	$	13,309
SBA pools		-		-		2,337,438		51,269		2,337,438		51,269		-		-		1,843,156		42,632		1,843,156		42,632
Corporate bonds														-		-		-		-		-		-
Mortgage-backed securities		7,726,619		41,199		8,286,586		95,551		16,013,205		136,750		4,138,537		25,392		145,797		501		4,284,334		25,893
Total	$	7,726,619	$	41,199	$	10,876,024	$	147,383	$	18,602,643	$	188,582	$	5,862,903	$	38,701	$	1,988,953	$	43,133	$	7,851,856	$	81,834

December 31, 2019	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
Description of investments	Fair value		losses		Fair value		losses		Fair value		losses

State and municipal	$	251,618	$	480	$	-	$	-	$	251,618	$	480
SBA pools		-		-		2,151,797		52,037		2,151,797		52,037
Mortgage-backed securities		10,643,624		58,063		7,295,788		91,472		17,939,412		149,535
Total	$	10,895,242	$	58,543	$	9,447,585	$	143,509	$	20,342,827	$	202,052

December 31, 2018

Less than 12 months

12 months or more

Total

Unrealized

Unrealized

Unrealized

Description of investments

Fair value

losses

Fair value

losses

Fair value

losses

State and municipal
$ 3,435,052 $ 42,080 $ 3,740,467 $ 177,781 $ 7,175,519 $ 219,861
SBA pools
443,288 6,707 2,276,084 53,332 2,719,372 60,039
Mortgage-backed securities
596,002 6,631 17,770,790 751,467 18,366,792 758,098
Total
$ 4,474,342 $ 55,418 $ 23,787,341 $ 982,580 $ 28,261,683 $ 1,037,998

Management has the ability and intent to hold securities classified as held to maturity until they mature, at which time the Company should receive full value for the securities. As of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, management did not have the intent to sell any of the held to maturity or available for sale securities with unrealized losses before a recovery of cost. The unrealized losses detailed in the table above were due to increases in market interest rates over the yields available at the time the underlying securities were purchased as well as other market conditions for each particular security based upon the structure and remaining principal balance. The fair values of the ~~investment~~debt securities are expected to recover as the securities approach their maturity dates or repricing dates or if market yields for such investments decline. Based on the foregoing factors, as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, management believes that these unrealized losses are temporary and, accordingly, have not been recognized in the Company’s consolidated statement of income.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Loans

Major categories of loans are as follows:

September 30,

December 31,

2019

2018

Real estate:

Commercial
$ 233,140,797 $ 238,834,149
Construction and land development
16,132,994 18,265,505
Residential
69,049,698 63,024,106
Commercial
21,134,598 23,323,073
Consumer
309,902 494,009
339,767,989 343,940,842
Less: Allowance for loan losses
2,546,114 2,509,334
Deferred origination fees net of costs
473,009 530,873
$ 336,748,866 $ 340,900,635

~~Non-accrual loans, segregated by class of loans, were as follows:~~

September 30,

December 31,

2019

2018

Commercial real estate
$ - $ 988,811

	September 30,		December 31,
	2020		2019

Real estate:
Commercial	$	239,106,276	$	240,938,149
Construction and land development		23,889,344		18,194,955
Residential		70,628,272		76,122,069
Commercial		60,442,374		26,947,503
Consumer		239,062		292,027
		394,305,328		362,494,703
Less: Allowance for loan losses		3,141,312		2,593,715
Deferred origination fees net of costs		1,049,586		518,145
	$	390,114,430	$	359,382,843

At September 30, 2020 and December 31, 2019 the Company had no nonaccrual loans.

~~At December 31, 2018, the Company had two nonaccrual commercial real estate~~An age analysis of past due loans, ~~to the same borrower totaling $988,811.~~ segregated by type of loan, is as follows:

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or More		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
September 30, 2020
Real estate:
Commercial	$	-	$	-	$	-	$	-	$	239,106,276	$	239,106,276	$	-
Construction and land development		-		-		-		-		23,889,344		23,889,344		-
Residential		-		-		1,514,012		1,514,012		69,114,260		70,628,272		1,514,012
Commercial		-		-		-		-		60,442,374		60,442,374		-
Consumer		-		-		-		-		239,062		239,062		-
Total	$	-	$	-	$	1,514,012	$	1,514,012	$	392,791,316	$	394,305,328	$	1,514,012

December 31, 2019
Real estate:
Commercial	$	224,794	$	-	$	-	$	224,794	$	240,713,355	$	240,938,149	$	-
Construction and land development		-		-		-		-		18,194,955		18,194,955		-
Residential		59,892		-		-		59,892		76,062,177		76,122,069		-
Commercial		-		-		-		-		26,947,503		26,947,503		-
Consumer		-		-		-		-		292,027		292,027		-
Total	$	284,686	$	-	$	-	$	284,686	$	362,210,017	$	362,494,703	$	-

The loans were secured by real estate and business assets and were personally guaranteed. Gross interest income of $115,168 would have been recorded during the year ended December 31, 2018 if these nonaccrual loans had been current and performing in accordanceone loan that is 90 days or more past due with ~~the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The~~a principal balance of $1,514,012 has not been placed on nonaccrual because the borrower is in the process of requesting a second 90 day payment deferral. The loan will be placed on nonaccrual ~~loans was net of charge-offs of $690,000 at December 31, 2018. The loans paid off during~~in the ~~nine months ended September 30, 2019~~fourth quarter if the additional payment deferral is not granted and the ~~Company recorded a recovery of $15,299.~~borrower does not make sufficient payments.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

~~An age analysis of past due loans, segregated by type of loan, is as follows:~~

90 Days

Past Due 90

30 - 59 Days

60 - 89 Days

or More

Total

Total

Days or More

Past Due

Past Due

Past Due

Past Due

Current

Loans

and Accruing

September 30, 2019

Real estate:

Commercial
$ - $ - $ - $ - $ 233,140,797 $ 233,140,797 $ -
Construction and land development
- - - - 16,132,994 16,132,994 -
Residential
31,857 - - 31,857 69,017,841 69,049,698 -
Commercial
- - - - 21,134,598 21,134,598 -
Consumer
- - - - 309,902 309,902 -
Total
$ 31,857 $ - $ - $ 31,857 $ 339,736,132 $ 339,767,989 $ -

December 31, 2018

Real estate:

Commercial
$ - $ - $ 988,811 $ 988,811 $ 237,845,338 $ 238,834,149 $ -
Construction and land development
- - - - 18,265,505 18,265,505 -
Residential
- - 10,507 10,507 63,013,599 63,024,106 10,507
Commercial
- 25,000 - 25,000 23,298,073 23,323,073 -
Consumer
- - - - 494,009 494,009 -
Total
$ - $ 25,000 $ 999,318 $ 1,024,318 $ 342,916,524 $ 343,940,842 $ 10,507

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the nine months ended September 30, ~~2019~~2020 and the year ended December 31, ~~2018,~~2019, are set forth in the following table:

	Unpaid		Recorded		Recorded								Unpaid		Recorded		Recorded
	Contractual		Investment		Investment		Total				Average		Contractual		Investment		Investment		Total				Average
	Principal		With No		With		Recorded		Related		Recorded		Principal		With No		With		Recorded		Related		Recorded		Interest
	Balance		Allowance		Allowance		Investment		Allowance		Investment		Balance		Allowance		Allowance		Investment		Allowance		Investment		Recognized
September 30, 2019
September 30, 2020
Real estate:
Commercial	$	2,097,690	$	2,097,690	$	-	$	2,097,690	$	-	$	2,610,536	$	2,266,855	$	2,266,855	$	-	$	2,266,855	$	-	$	2,175,922	$	87,252
Residential		50,790		50,790		-		50,790		-		25,395		46,075		46,075		-		46,075		-		48,066		2,014
	$	2,148,480	$	2,148,480	$	-	$	2,148,480	$	-	$	2,635,931	$	2,312,930	$	2,312,930	$	-	$	2,312,930	$	-	$	2,223,988	$	89,266

December 31, 2018
December 31, 2019
Real estate:
Commercial	$	3,813,381	$	3,123,381	$	-	$	3,123,381	$	-	$	4,153,282	$	2,084,988	$	2,084,988	$	-	$	2,084,988	$	-	$	2,631,185	$	106,874
Residential		54,000		54,000		-		54,000		-		27,000		50,057		50,057		-		50,057		-		25,029		2,876
	$	3,867,381	$	3,177,381	$	-	$	3,177,381	$	-	$	4,180,282	$	2,135,045	$	2,135,045	$	-	$	2,135,045	$	-	$	2,656,214	$	109,750

Impaired loans include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

At September 30, 2020, the Company had two commercial real estate loans totaling $2,266,855 and one residential real estate loan totaling $46,075 that were classified as TDRs. All are included in impaired loans above. At September 30, 2020, all three loans were paying as agreed. There have been no charge-offs or allowances associated with these three loans.

At December 31, 2019, the Company had one commercial real estate loan totaling $2,084,988 and one residential real estate loan totaling $50,057 that were classified as TDRs. All are included in impaired loans above. Each loan was paying as agreed at December 31, 2019. There have been no charge-offs or allowances associated with these two loans.

Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act allows financial institutions to suspend application of certain current TDRs accounting guidance under ASC 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest, or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (e.g., six months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40. The Company continues to prudently work with borrowers negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for loan losses on its loan portfolio. During the second quarter of 2020, the Company modified loans, due to the pandemic and at the borrower’s request, with an aggregate principal balance of $109.2 million, or 30% of its loan portfolio. As of September 30, 2020, $21.8 million, or 6% of the Company’s loan portfolio, of these previously-deferred loans were granted additional three-month deferrals. None of these loans were classified as TDRs as of September 30, 2020 because they met the criteria discussed above.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

~~At September 30, 2019, the Company had~~ ~~one~~ ~~commercial real estate loan totaling~~ ~~$2,097,690~~ ~~and~~ ~~one~~ ~~residential real estate loan totaling~~ ~~$50,790~~ ~~that were classified as TDRs. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these~~ ~~two~~ ~~loans.~~

At December 31, 2018, the Company had one commercial real estate loan totaling $2,134,570 and one residential real estate loan totaling $54,000 that were classified as TDRs. The $54,000 loan was restructured as a TDR during 2018. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these two loans.

As part of our portfolio risk management, the Company assigns a risk grade to each loan. The factors used to determine the grade are the payment history of the loan and the borrower, the value of the collateral and net worth of the guarantor, and cash flow projections of the borrower. Excellent, Above Average, Average and Acceptable grades are assigned to loans with limited or no delinquent payments and more than sufficient collateral and/or cash flow.

A description of the general characteristics of loans characterized as watch list or classified is as follows:

Pass/Watch

Loans graded as Pass/Watch are secured by generally acceptable assets which reflect above-average risk. The loans warrant closer scrutiny by management than is routine, due to circumstances affecting the borrower, the borrower’s industry, or the overall economic environment. Borrowers may reflect weaknesses such as inconsistent or weak earnings, break even or moderately deficit cash flow, thin liquidity, minimal capacity to increase leverage, or volatile market fundamentals or other industry risks. Such loans are typically secured by acceptable collateral, at or near appropriate margins, with realizable liquidation values.

Special Mention

A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings. Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers.

Substandard

A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and capitalization. These loans require more intense supervision by Company management.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

Doubtful

A doubtful loan has all the weaknesses inherent in a substandard loan with the added characteristic that the weaknesses, based on currently existing facts, conditions, and values, make collection or liquidation in full highly questionable and improbable.

Loans by credit grade, segregated by loan type, are as follows:

			Above						Pass		Special										Above						Pass		Special
September 30, 2019	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total
September 30, 2020																			Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total

Real estate:
Commercial	$	-	$	3,056,485	$	90,131,537	$	108,685,401	$	22,306,448	$	-	$	8,960,926	$	-	$	233,140,797	$	-	$	2,259,854	$	48,681,901	$	86,002,900	$	93,453,659	$	182,656	$	8,525,306	$	-	$	239,106,276
Construction and land development		-		202,500		4,820,218		8,187,688		2,922,588		-		-		-		16,132,994		-		-		2,877,340		11,374,057		9,637,947		-		-		-		23,889,344
Residential		37,425		1,572,805		24,944,785		33,582,371		6,372,666		-		2,539,646		-		69,049,698		35,380		976,572		26,380,985		32,580,138		8,257,416		-		2,397,781		-		70,628,272
Commercial		192,622		37,519		9,850,802		8,138,156		2,915,499		-		-		-		21,134,598		31,112,843		-		6,396,533		17,794,459		5,138,539		-		-		-		60,442,374
Consumer		2,659		102,472		98,925		63,494		20,000		-		440		21,912		309,902		16,773		89,963		54,779		9,264		16,744		-		-		51,539		239,062
	$	232,706	$	4,971,781	$	129,846,267	$	158,657,110	$	34,537,201	$	-	$	11,501,012	$	21,912	$	339,767,989	$	31,164,996	$	3,326,389	$	84,391,538	$	147,760,818	$	116,504,305	$	182,656	$	10,923,087	$	51,539	$	394,305,328

			Above						Pass		Special										Above						Pass		Special
December 31, 2018	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total
December 31, 2019																			Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total

Real estate:
Commercial	$	-	$	3,632,231	$	101,633,803	$	104,454,812	$	20,356,642	$	-	$	8,756,661	$	-	$	238,834,149	$	-	$	2,769,944	$	91,274,940	$	110,566,629	$	27,438,005	$	-	$	8,888,631	$	-	$	240,938,149
Construction and land development		-		-		8,190,212		7,871,642		2,203,651		-		-		-		18,265,505		-		216,000		4,737,737		8,572,151		4,669,067		-		-		-		18,194,955
Residential		35,926		1,178,899		26,856,131		30,169,305		2,093,825		-		2,690,020		-		63,024,106		39,817		1,633,783		30,767,418		34,784,120		6,386,377		-		2,510,554		-		76,122,069
Commercial		977,054		24,180		12,373,503		7,130,122		2,818,214		-		-		-		23,323,073		153,848		20,000		11,682,299		11,995,143		3,096,213		-		-		-		26,947,503
Consumer		3,668		80,670		266,704		63,160		-		-		1,340		78,467		494,009		2,327		99,385		91,620		60,049		19,214		-		240		19,192		292,027
	$	1,016,648	$	4,915,980	$	149,320,353	$	149,689,041	$	27,472,332	$	-	$	11,448,021	$	78,467	$	343,940,842	$	195,992	$	4,739,112	$	138,554,014	$	165,978,092	$	41,608,876	$	-	$	11,399,425	$	19,192	$	362,494,703

The principal balance of loans in the Pass/Watch category as of September 30, 2020 increased significantly over the balance as of December 31, 2019 because all of the loans that were granted payment deferrals due to COVID -19 were downgraded to the Pass/Watch category if they were in a higher rated category at the time the deferral was granted. Loans that completed their initial 90 day deferral and are making scheduled payments again are being re-evaluated on a loan by loan basis to determine if they warrant upgrading.

The Company’s allowance for loan losses is based on management’s evaluation of the risks inherent in the Company’s loan portfolio and the general economy. The allowance for loan losses is maintained at the amount management considers adequate to cover estimated losses in loans receivable that are deemed probable based on information currently known to management. The allowance is based upon a number of factors, including current economic conditions, actual loss experience by pools of similar loans, diversification and size of the portfolio, adequacy of the collateral, the amount of non-performing loans and industry trends. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (Continued)

The following table details activity in the allowance for loan losses by portfolio for the ~~nine months~~nine-month periods ended September 30, 2020 and 2019 and ~~2018, and~~for the year ended December 31, ~~2018.~~2019. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2020	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,763,861	$	340,084		$	-	$	45,962	$	2,149,907	$	-	$	2,149,907	$	2,266,855	$	236,839,421
Construction and land development		192,828		51,804			-		10,800		255,432		-		255,432		-		23,889,344
Residential		478,124		102,515			-		-		580,639		-		580,639		46,075		70,582,197
Commercial		107,782		5,429			-		15,835		129,046		-		129,046		-		60,442,374
Consumer		4,133		2,260			-		-		6,393		-		6,393		-		239,062
Unallocated		46,987		(27,092	)		-		-		19,895		-		19,895		-		-
	$	2,593,715	$	475,000		$	-	$	72,597	$	3,141,312	$	-	$	3,141,312	$	2,312,930	$	391,992,398

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(47,253	)	$	-	$	19,689	$	1,726,808	$	-	$	1,726,808	$	2,097,690	$	231,043,107
Construction and land development		196,374		(34,932	)		-		10,425		171,867		-		171,867		-		16,132,994
Residential		401,626		45,242			-		-		446,868		-		446,868		50,790		68,998,908
Commercial		102,610		(14,180	)		-		6,666		95,096		-		95,096		-		21,134,598
Consumer		10,428		(5,521	)		-		-		4,907		-		4,907		-		309,902
Unallocated		43,924		56,644			-		-		100,568		-		100,568		-		-
	$	2,509,334	$	-		$	-	$	36,780	$	2,546,114	$	-	$	2,546,114	$	2,148,480	$	337,619,509

Allowance for loan losses

Outstanding loan

Provision

ending balance evaluated

balances evaluated

Beginning

for loan

Charge

Ending

for impairment:

for impairment:

September 30, 2018

balance

losses

offs

Recoveries

balance

Individually

Collectively

Individually

Collectively

Real estate:

Commercial
$ 1,867,397 $ (252,948 ) $ - $ 202,660 $ 1,817,109 $ 210,686 $ 1,606,423 $ 3,825,462 $ 234,744,541
Construction and land development
223,274 99,933 (22,116 ) 1,462 302,553 - 302,553 - 23,971,982
Residential
247,953 143,681 - - 391,634 - 391,634 44,254 60,271,255
Commercial
87,353 1,539 - 6,667 95,559 - 95,559 - 21,238,222
Consumer
7,027 (1,523 ) - - 5,504 - 5,504 - 467,592
Unallocated
25,907 34,318 - - 60,225 - 60,225 - -
$ 2,458,911 $ 25,000 $ (22,116 ) $ 210,789 $ 2,672,584 $ 210,686 $ 2,461,898 $ 3,869,716 $ 340,693,592

													Allowance for loan losses				Outstanding loan															Allowance for loan losses				Outstanding loan
			Provision										ending balance evaluated				balances evaluated						Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge					Ending		for impairment:				for impairment:				Beginning		for loan			Charge				Ending		for impairment:				for impairment:
December 31, 2018	balance		losses			offs			Recoveries		balance		Individually		Collectively		Individually		Collectively
December 31, 2019																					balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,867,397	$	372,315		$	(690,000	)	$	204,660	$	1,754,372	$	-	$	1,754,372	$	3,177,381	$	235,656,768	$	1,754,372	$	(11,700	)	$	-	$	21,189	$	1,763,861	$	-	$	1,763,861	$	2,084,988	$	238,853,161
Construction and land development		223,274		(78,496	)		(12,115	)		63,711		196,374		-		196,374		-		18,265,505		196,374		(17,571	)		-		14,025		192,828		-		192,828		-		18,194,955
Residential		247,953		153,673			-			-		401,626		-		401,626		-		63,024,106		401,626		76,498			-		-		478,124		-		478,124		50,057		76,072,012
Commercial		87,353		6,090			-			9,167		102,610		-		102,610		-		23,323,073		102,610		(3,995	)		-		9,167		107,782		-		107,782		-		26,947,503
Consumer		7,027		3,401			-			-		10,428		-		10,428		-		494,009		10,428		(6,295	)		-		-		4,133		-		4,133		-		292,027
Unallocated		25,907		18,017			-			-		43,924		-		43,924		-		-		43,924		3,063			-		-		46,987		-		46,987		-		-
	$	2,458,911	$	475,000		$	(702,115	)	$	277,538	$	2,509,334	$	-	$	2,509,334	$	3,177,381	$	340,763,461	$	2,509,334	$	40,000		$	-	$	44,381	$	2,593,715	$	-	$	2,593,715	$	2,135,045	$	360,359,658

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

5.	Lease Commitments

The Company and its subsidiaries are obligated under operating ~~lease~~leases for certain office premises.

The following table shows operating lease right of use assets and operating lease liabilities as of September 30, 2020 and December 31, 2019:

	Consolidated Balance			Consolidated Balance
	Sheet classification	September 30, 2019		Sheet classification	September 30, 2020		December 31, 2019
Operating lease right of use asset	Other assets	$	1,297,761	Other assets	$	1,280,194	$	1,392,281
Operating lease liabilities	Other liabilities	$	1,455,327	Other liabilities		1,472,946		1,559,356

Operating lease cost included in occupancy expense in the statement of income for the three months ended September 30, 2020 and 2019 was $49,926 and $50,630, respectively. Operating lease cost included in occupancy expense in the statement of income for the nine months ended September 30, 2020 and 2019 was ~~$50,630~~$144,060 and $144,851, respectively.

Future minimum payments under the agreements, including those option years for which the Company is reasonably certain to renew, are as follows:

Year	Amount				Amount

2019	$	35,058
2020		141,680			$	50,490
2021		146,120				210,955
2022		150,707				221,497
2023		155,447				228,531
2024						234,910
Thereafter		911,770		Thereafter		1,140,679
Total lease payments		1,540,782		Total lease payments		2,087,062
Less imputed interest		(85,455	)	Less imputed interest		(614,116	)
Present value of operating lease liabilities	$	1,455,327		Present value of operating lease liabilities	$	1,472,946

For operating leases as of September 30, ~~2019,~~2020, the weighted average remaining lease term is ~~9.65~~8.8 years and the weighted average discount rate is ~~3.36%~~3.25%. During the three ~~and nine~~ months ended September 30, 2020 and 2019, cash paid for amounts included in the measurement of lease liabilities was $41,463 and $39,500, respectively. During the nine months ended September 30, 2020 and 2019, cash paid for amounts included in the measurement of lease liabilities was $118,383 and $113,448, respectively.

6.	Capital Standards

Farmers and Merchants Bancshares, Inc. and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6.	Capital Standards (continued)

The Basel III Capital Rules became effective for the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).

In connection with the adoption of the Basel III Capital Rules, the Bank elected to opt-out of the requirement to include accumulated other comprehensive income in Common Equity Tier 1 capital. Common Equity Tier 1 capital for the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions.

Under the revised prompt corrective action requirements, as of January 1, 2015, insured depository institutions are required to meet the following in order to qualify as “well capitalized”: (i) a common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8%; (iii) a total risk-based capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5%.

The implementation of the capital conservation buffer began on January 1, 2016, at the 0.625% level and was phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have current applicability to the Bank. As of September 30, ~~2019,~~2020, the Bank met all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in ~~basis as if such requirements were currently in effect.~~basis.

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The following table presents actual and required capital ratios as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Capital ratios of the Company are substantially the same as the Bank’s.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6.	Capital Standards (continued)

						Minimum															Minimum
						Capital Adequacy					To Be Well										Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phase-In Schedule					Capitalized					Actual					Phase-In Schedule					Capitalized
September 30, 2019	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2020																Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	50,078		14.37	%	$	36,590		10.50	%	$	34,848		10.00	%	$	44,784		12.05	%	$	39,027		10.50	%	$	37,169		10.00	%
Tier 1 capital (to risk-weighted assets)		47,532		13.64	%		29,621		8.50	%		27,878		8.00	%		41,643		11.20	%		31,593		8.50	%		29,735		8.00	%
Common equity tier 1 (to risk- weighted assets)		47,532		13.64	%		24,393		7.00	%		22,651		6.50	%		41,643		11.20	%		26,018		7.00	%		24,160		6.50	%
Tier 1 leverage (to average assets)		47,532		11.00	%		17,280		4.00	%		21,600		5.00	%		41,643		8.41	%		19,816		4.00	%		24,771		5.00	%

						Minimum															Minimum
						Capital Adequacy					To Be Well										Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phase-In Schedule					Capitalized					Actual					Phase-In Schedule					Capitalized
December 31, 2018	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2019																Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	47,857		13.50	%	$	34,996		9.88	%	$	35,439		10.00	%	$	51,274		13.88	%	$	38,775		10.50	%	$	36,928		10.00	%
Tier 1 capital (to risk-weighted assets)		45,348		12.80	%		27,908		7.88	%		28,351		8.00	%		48,681		13.18	%		31,389		8.50	%		29,543		8.00	%
Common equity tier 1 (to risk- weighted assets)		45,348		12.80	%		22,593		6.38	%		23,036		6.50	%		48,681		13.18	%		25,850		7.00	%		24,003		6.50	%
Tier 1 leverage (to average assets)		45,348		10.86	%		16,698		4.00	%		20,872		5.00	%		48,681		10.94	%		17,798		4.00	%		22,247		5.00	%

On September 30, 2020, the Bank paid an $8 million dividend to the Company to be used as a portion of the purchase price to be paid for the acquisition of Carroll.

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of September 30, ~~2019,~~2020, the most recent notification from the FDIC ~~has~~ categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

The FDIC, through formal or informal agreement, has the authority to require an institution to maintain higher capital ratios than those provided by statute, to be categorized as well capitalized under the regulatory framework for prompt corrective action.

7.	Fair Value

Accounting standards define fair value as the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants. The price in the principal market used to measure the fair value of the asset or liability is not adjusted for transaction costs. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

The standards require the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. The standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Fair Value (continued)

The fair value hierarchy is as follows:

●

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

●

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

●

Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company uses the following methods and significant assumptions to estimate the fair values of the following assets:

●

Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices from a nationally recognized securities pricing agent. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities.

●

Equity security at fair value: The Company’s investment in an equity mutual fund is valued based on the net asset value of the fund, which is classified as Level 1.

●

Other real estate owned (“OREO”): Nonrecurring fair value adjustments to OREO reflect full or partial write-downs that are based on the OREO’s observable market price or current appraised value of the real estate. Since the market for OREO is not active, OREO subjected to nonrecurring fair value adjustments based on the current appraised value of the real estate are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been 10% of the appraised value.

●

Impaired loans: Nonrecurring fair value adjustments to impaired loans reflect full or partial write-downs and reserves that are based on the impaired loan’s observable market price or current appraised value of the collateral. Since the market for impaired loans is not active, such loans subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been 10% of the appraised value.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Fair Value (continued)

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

	Carrying Value:								Carrying Value:
									Level 1		Level 2		Level 3		Total
September 30, 2020
	Level 1		Level 2		Level 3		Total
September 30, 2019
Recurring
Available for sale securities
State and municipal									$	-	$	528,797	$	-	$	528,797
SBA pools										-		1,843,156		-		1,843,156
Corporate bonds										-		2,187,545		-		2,187,545
Mortgage-backed securities										-		35,322,637		-		35,322,637
									$	-	$	39,882,135	$	-	$	39,882,135

Equity security at fair value Mutual fund									$	553,057	$	-	$	-	$	553,057

Nonrecurring
Impaired loans									$	-	$	-	$	2,312,930	$	2,312,930

December 31, 2019

Recurring
Available for sale securities
State and municipal	$	-	$	1,390,225	$	-	$	1,390,225	$	-	$	512,670	$	-	$	512,670
SBA pools		-		2,337,438		-		2,337,438		-		2,151,797		-		2,151,797
Mortgage-backed securities		-		36,373,492		-		36,373,492		-		33,867,307		-		33,867,307
	$	-	$	40,101,155	$	-	$	40,101,155	$	-	$	36,531,774	$	-	$	36,531,774

Equity security at fair value
Mutual fund	$	531,714	$	-	$	-	$	531,714
Equity security at fair value Mutual fund									$	532,321	$	-	$	-	$	532,321

Nonrecurring
Impaired loans		-		-		2,148,480		2,148,480	$	-	$	-	$	2,135,045	$	2,135,045

December 31, 2018

Recurring
Available for sale securities
State and municipal	$	-	$	1,506,505	$	-	$	1,506,505
SBA pools		-		2,719,372		-		2,719,372
Mortgage-backed securities		-		22,366,114		-		22,366,114
	$	-	$	26,591,991	$	-	$	26,591,991

Equity security at fair value
Mutual fund	$	503,827	$	-	$	-	$	503,827

Nonrecurring
Other real estate owned	$	-	$	-	$	210,150	$	210,150
Impaired loans		-		-		3,177,381		3,177,381

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Fair Value (continued)

The estimated fair value of financial instruments that are reported at amortized cost in the Company’s consolidated balance sheets, segregated by the level of the valuation inputs were as follows:

	September 30, 2019				December 31, 2018				September 30, 2020				December 31, 2019
	Carrying		Estimated		Carrying		Estimated		Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
Financial assets
Level 2 inputs
Securities held to maturity	$	19,509,907	$	20,154,081	$	18,127,067	$	18,033,093	$	22,602,562	$	23,633,299	$	19,510,018	$	20,097,931
Mortgage loans held for sale		1,538,574		1,558,493		573,638		582,248		2,650,459		2,686,558		242,000		245,857
Federal Home Loan Bank stock		503,700		503,700		575,800		575,800		696,300		696,300		376,200		376,200
Level 3 inputs
Loans, net		336,748,866		335,928,611		340,900,635		337,385,842		390,114,430		390,036,407		359,382,843		359,346,031

Financial liabilities
Level 1 inputs
Noninterest-bearing deposits	$	58,298,592	$	58,298,592	$	62,717,520	$	62,717,520	$	79,010,403	$	79,010,403	$	60,659,015	$	60,659,015
Securities sold under repurchase agreements		7,583,212		7,583,212		11,012,000		11,012,000		6,317,682		6,317,682		10,958,118		10,958,118
Level 2 inputs
Interest-bearing deposits		313,897,923		314,857,923		291,995,483		281,761,483		347,065,245		352,695,245		315,954,299		313,622,299
Federal Home Loan Bank advances		1,000,000		1,000,000		3,000,000		2,971,000		7,000,000		7,154,000		-		-
Long-term debt										16,971,874		16,971,874		-		-

The fair value of mortgage loans held for sale is determined by the expected sales price. ~~Beginning in the first quarter 2018, the~~The fair value of loans were determined using an exit price ~~methodology as prescribed by ASU 2016-01, which became effective in the first quarter of 2018.~~methodology. The exit price estimation of fair value is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and use of a discount rate based on the relative risk of the cash flows, taking into account the loan type, maturity of the loan, liquidity risk, servicing costs, and a required return on debt and capital (Level 3). In addition, an incremental liquidity discount is applied to certain loans, using historical sales of loans during periods of similar economic conditions as a benchmark.

The fair values of interest-bearing checking, savings, and money market deposit accounts are equal to their carrying amounts. The fair values of fixed-maturity time deposits are estimated based on interest rates currently offered for deposits of similar remaining maturities.

The fair value of credit commitments are considered to be the same as the contractual amounts, and are not included in the table above. These commitments generate fees that approximate those currently charged to originate similar commitments.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Earnings per Share

Basic earnings per share is determined by dividing net income available to stockholders by the weighted-average number of shares of common stock outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents, giving retroactive effect to stock dividends declared during the period. Diluted earnings per share is determined in the same manner, except that the weighted-average number of shares of common stock outstanding is adjusted for the dilutive effect of outstanding common stock equivalents. The following table sets forth the calculation of basic and diluted earnings per share for the three and nine ~~months~~month periods ended September 30, ~~2019~~2020 and ~~2018.~~2019. There were no common stock equivalents outstanding for the three ~~and nine months~~or nine-month periods ended September 30, ~~2019~~2020 or ~~2018.~~

~~On September 16, 2019, the Board of Directors of the Company declared a 75% stock dividend payable on October 31,~~ 2019. ~~Accordingly, the weighted average shares and the earnings per share reflect the stock dividend for all periods presented.~~

	Three months ended				Nine months ended				Three Months Ended				Nine Months Ended
	September 30,				September 30,				September 30				September 30
	2019		2018		2019		2018		2020		2019		2020		2019

Net income	$	1,177,910	$	1,308,688	$	3,500,018	$	3,575,871	$	385,247	$	1,177,910	$	2,264,609	$	3,500,018
Weighted average shares outstanding		2,959,411		2,931,602		2,950,122		2,923,102		2,991,964		2,959,411		2,980,372		2,950,122
Earnings per share - basic and diluted	$	0.40	$	0.45	$	1.19	$	1.22	$	0.13	$	0.40	$	0.76	$	1.19

9.	Retirement Plans

The Company has a profit sharing plan qualifying under Section 401(k) of the Internal Revenue Code. All employees age 21 or more with six months of service are eligible for participation in the plan. The Company matches employee contributions up to 4% of total compensation and may make additional discretionary contributions. Employee and employer contributions are 100% vested when made. The Company’s contributions to this plan were $~~46,398~~51,347 and ~~$45,130~~$46,398 for the ~~three months~~three-month periods ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively, and $~~148,991~~160,937 and ~~$133,118~~$148,991 for the ~~nine months~~nine-month periods ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively.

The Company has entered into agreements with 12 employees to provide certain life insurance benefits payable in connection with policies of life insurance on those employees that are owned by the Company. Each of the agreements provides for the amount of death insurance benefits to be paid to beneficiaries of the insured. For this plan, the Company expensed $~~1,468~~1,589 and ~~$1,418~~$1,468 for the ~~three months~~three-month periods ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively, and $~~4,405~~4,767 and ~~$4,255~~$4,405 for the ~~nine months~~nine-month periods ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively.

The Company adopted supplemental executive retirement plans for three of its executives. The plans provide cash compensation to the executive officers under certain circumstances, including a separation of service. The benefits vest over the period from adoption to a specified age for each executive. The Company recorded expenses, including interest, of $~~30,600~~51,300 and ~~$60,457~~$30,600 for the ~~three months~~three-month periods ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively, and $~~$91,800~~ 153,900and ~~$180,457~~$91,800 for the ~~nine months~~nine-month periods ended September 30, 2020 and 2019, ~~and 2018, respectively, for these plans.~~respectively.

Retirement plan expenses are included in employee benefits on the consolidated statements of income.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of Farmers and Merchants Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the audited consolidated financial statements and notes thereto, and the other statistical information contained in the Annual Report of Farmers and Merchants Bancshares, Inc. on Form 10-K for the year ended December 31, ~~2018.~~2019 (the “Form 10-K”). References in this report to “us”, “we”, “our”, and “the Company” are to Farmers and Merchants Bancshares, Inc. and, unless the context clearly suggests otherwise, its consolidated subsidiaries.

Forward-Looking Statements

This report may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature, including those that include the words “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business ~~conditions;~~conditions, including those impacted and/or driven by the COVID-19 pandemic; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; our ability to successfully integrate the business and operations of Carroll Community Bank (“Carroll Bank”) into our business and operations; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

Farmers and Merchants Bancshares, Inc.

Farmers and Merchants Bancshares, Inc. is a Maryland corporation and a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Company was incorporated on August 8, 2016 for the purpose of becoming the holding company of Farmers and Merchants Bank (the “Bank”) in a share exchange transaction that was intended to constitute a tax-free exchange under Section 351 of the Internal Revenue Code of 1986, as amended (the “Reorganization”). The Reorganization was consummated on November 1, 2016, at which time the Bank became a wholly-owned subsidiary of the Company and all of the Bank’s stockholders became stockholders of the Company by virtue of the conversion of their shares of common stock of the Bank into an equal number of shares of common stock of the Company.

The Company’s primary business activities are serving as the parent company of the Bank and holding a series investment in First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed protected cell captive insurance company (“FCBI”). The Company owns 100% of one series of membership interests issued by FCBI, which series is deemed a “protected cell” under Tennessee law and has been designated “Series Protected Cell FCB-4” (such series investment is hereinafter referred to as the “Insurance Subsidiary”).

The Bank is a Maryland commercial bank chartered on October 24, 1919 that is engaged in a general commercial and retail banking business. The Bank has had one inactive subsidiary, Reliable Community Financial Services, Inc., a Maryland corporation that was incorporated in April 1992 to facilitate the sale of fixed rate annuity products and later positioned to sell a full array of investment and insurance products.

The Insurance Subsidiary represents one protected cell of a protected cell captive insurance company (FCBI) that was formed on November 9, 2016 to better manage our risk programs, provide insurance efficiencies, and add operating income by both keeping insurance premiums paid with respect to such risks within our affiliated group of entities and realizing certain tax benefits that are unique to captive insurance companies. The Company’s investment in the Insurance Subsidiary represents one series of membership interests in FCBI. As a “series” limited liability company, FCBI is authorized by state law and its governing instruments to issue one or more series of membership interests, each of which, for all purposes under state law, is deemed to be a legal entity separate and apart from FCBI and its other series.

On October 1, 2020, the Company consummated its previously-announced acquisition by merger (the “Merger”) of Carroll Bancorp, Inc. (“Carroll”) and its wholly-owned subsidiary, Carroll Community Bank. Each share of common stock of Carroll (“Carroll Common Stock”) that was outstanding immediately prior to the effective time of the Merger (the “Effective Time”) was converted into the right to receive cash in the amount $21.63 (the “Per Share Consideration”). Immediately prior to the Effective Time, there were 1,146,913 outstanding shares of Carroll Common Stock, all of which were converted into the Per Share Consideration. The merger consideration was paid by the Company using $8 million in cash and $17 million in proceeds from a third-party term loan obtained in connection with the Merger. Because the Merger was consummated after the end of the period covered by this report, this report does not take into account the financial condition or results of operations of Carroll and its subsidiaries for the three- or nine-month periods ended September 30, 2020. At September 30, 2020, Carroll had total assets of $176,159,890, net loans of $145,153,100, and total liabilities of $157,992,286, of which $144,896,990 represented deposits.

The Company maintains an Internet site at www.fmb1919.bank on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

Estimates and Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. See Note 1 of the Notes to the audited consolidated financial statements as of and for the year ended December 31, ~~2018,~~2019, which were included in Item 8 of Part II of Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019. On an on-going basis, management evaluates estimates, including those related to loan losses and intangible assets, other-than-temporary impairment (“OTTI”) of investment securities, income taxes, and fair value of investments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, ~~2018.~~2019.

COVID-19 Pandemic

The COVID-19 pandemic has been wreaking havoc on the U.S. economy since the World Health Organization declared it a pandemic on March 11, 2020. The full impact and its effect on the banking industry, including the Company, will not be known for several quarters, but will be significant.

The U.S. and state governments reacted to the outbreak of the pandemic by issuing shelter-at-home orders and requiring that non-essential businesses be closed to prevent spread of the virus. The health crisis quickly turned into a financial crisis resulting in guidance and mandates regarding foreclosures and repossessions and accounting and regulatory changes designed to encourage banks to work with customers suffering detrimental financial impact.

Although states, including Maryland, have eased several of the COVID-19 restrictions, including stay-at-home orders and the required closure of non-essential businesses, there appears to be a resurgence of COVID-19 cases in many states, including Maryland. As a result, it is possible that states, including Maryland, will re-implement some or all of the COVID-19 related restrictions and again require some or all non-essential businesses to close or drastically alter their business operations, which could have a material adverse impact on our customers and, thus, our financial condition and results of operations.

Paycheck Protection Program

The U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) which provides small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. Following the enactment of the CARES Act and the establishment of the PPP, we acted expeditiously to prepare our associates so they could guide our customers on the proper procedures necessary to enable them to take advantage of this program. We developed an SBA PPP specific information site within our website that provided detailed information, links and materials for eligible customers to access. Internally, we reallocated resources to review, process and data enter customer applications, working tirelessly over extended hours to provide access to as many local business owners as possible. We were able to fund 172 loan applications for approximately $25.3 million from the first tranche of PPP designated funds. Congress allocated additional funding to the PPP on April 23, 2020. Due to our advance preparation and software implementation, we were able to quickly gain approval for an additional 101 loan applications for approximately $5.8 million. In total, we have gained approval for over $31 million to 273 small businesses. Approximately 70% of the loans were under $100,000 in size. All PPP loans are 100% guaranteed by the SBA, have up to a five-year maturity (the majority of our PPP originations have a two-year maturity), provide for a six-month deferral period, and have an interest rate of 1%. These loans may be forgiven by the SBA if the borrower meets certain conditions, including by using at least 75% of the loan proceeds for payroll costs. The SBA also established processing fees from 1% to 5%, depending on the loan amount. We have received $1,285,719 in fees which, net of related origination costs, will be amortized into interest income over the life of the loans.

In April 2020, the Bank established eligibility to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”) which was established by Congress and administered by the Federal Reserve Bank. This facility uses the SBA guaranteed PPP loans as collateral, offering 100% collateral coverage with no recourse to the Bank. The majority of the PPP loan disbursements were to internal, non-interest-bearing accounts for use by borrowers. As a result, we have not yet accessed the PPPLF, but are prepared to utilize the fund when management determines the timing is appropriate.

Financial Condition

Total assets increased by ~~$17,347,635~~$71,262,647 or ~~4.2%~~16.1% to ~~$434,505,512~~$513,477,745 at September 30, ~~2019~~2020 from ~~$417,157,877~~$442,215,098 at December 31, ~~2018.~~2019. The increase in total assets was due primarily to increases of ~~$4,976,820~~$30,731,587 in loans, $25,126,860 in other assets, $6,111,233 in cash and cash equivalents, and ~~$14,892,004~~$6,442,905 in debt ~~securities, offset by a decrease~~securities. The increase in loans was due primarily to the origination of ~~$4,151,769.~~the aforementioned PPP loans. The increase in other assets is a result of depositing in escrow the acquisition price of Carroll on September 30, 2020.

Total liabilities increased ~~$13,747,822~~$68,787,983 or ~~3.7%~~17.5% to ~~$385,510,992~~$461,549,565 at September 30, ~~2019~~2020 from ~~$371,763,170~~$392,761,582 at December 31, ~~2018.~~2019. The increase was due primarily to ana $49,462,334 increase ~~of $17,483,512~~ in deposits, a $16,971,874 increase in long-term debt and ~~$1,655,725~~a $7,000,000 increase in ~~other liabilities,~~FHLB advances, offset by ~~reductions of $3,428,788~~a $4,640,436 decrease in securities sold under repurchase ~~agreements~~agreements. The increase in deposits was due to an inflow of funds from depositors who abandoned riskier investments for the safety of a bank and ~~$2,000,000~~to the aforementioned PPP loans. The majority of PPP loans were made to existing customers, so the loan proceeds were deposited in ~~FHLB advances.~~checking accounts. In many cases, the customer has not withdrawn the PPP funds.

Stockholders’ equity increased by ~~$3,599,813~~$2,474,664 to ~~$48,994,520~~$51,928,180 at September 30, ~~2019~~2020 from ~~$45,394,707~~$49,453,516 at December 31, ~~2018.~~2019. The increase was due primarily to net income for the period of ~~$3,500,018~~$2,264,609 and an increase of ~~$695,294~~$741,911 in accumulated other comprehensive income, offset by dividends paid, net of reinvestments of ~~$504,052.~~$531,856.

Loans

Major categories of loans at September 30, ~~2019~~2020 and December 31, ~~2018~~2019 are as follows:

	September 30,				December 31,				September 30,				December 31,
	2019				2018				2020				2019

Real estate:
Commercial	$	233,140,797	69	%	$	238,834,149	70	%	$	239,106,276	61	%	$	240,938,149	67	%
Construction/Land development		16,132,994	5	%		18,265,505	5	%		23,889,344	6	%		18,194,955	5	%
Residential		69,049,698	20	%		63,024,106	18	%		70,628,272	18	%		76,122,069	21	%
Commercial		21,134,598	6	%		23,323,073	7	%		60,442,374	15	%		26,947,503	7	%
Consumer		309,902	0	%		494,009	0	%		239,062	0	%		292,027	0	%
		339,767,989	100	%		343,940,842	100	%		394,305,328	100	%		362,494,703	100	%
Less: Allowance for loan losses		2,546,114				2,509,334				3,141,312				2,593,715
Deferred origination fees net of costs		473,009				530,873				1,049,586				518,145
	$	336,748,866			$	340,900,635			$	390,114,430			$	359,382,843

Loans ~~decreased~~increased by ~~$4,151,769~~$30,731,587 or ~~1.2%~~8.6% to ~~$336,748,866~~$390,114,430 at September 30, ~~2019~~2020 from ~~$340,900,635~~$359,382,843 at December 31, ~~2018.~~2019. The ~~decline~~increase was due primarily to a ~~$5,693,352~~$33,494,871 increase in commercial loans because of the origination of $31,112,843 of PPP loans and an increase in construction/land development loans of $5,694,389, offset by a $1,831,873 decrease in commercial real estate loans and a ~~$2,132,511~~$5,493,797 decrease in ~~construction/land development loans, and a decrease in commercial loans of $2,188,475, offset by an increase in~~ residential ~~loans of $6,025,592.~~loans. The allowance for loan losses increased ~~$36,780~~$547,597 to ~~$2,546,114~~$3,141,312 at September 30, ~~2019~~2020 from ~~$2,509,334~~$2,593,715 at December 31, ~~2018 as a result~~2019. Deferred origination fees increased to $1,049,586 at September 30, 2020 from $518,145 at December 31, 2020 due to the origination of ~~net recoveries.~~the PPP loans.

The Company has adopted policies and procedures that seek to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for loan losses. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan, and the experience of the lending officer. The Company’s policy is to make the majority of its loan commitments in the market area it serves. Management believes that this tends to reduce risk because management is familiar with the credit histories of loan applicants and has in-depth knowledge of the risk to which a given credit is subject. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.

An age analysis of past due loans, segregated by class of loans, as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, is as follows:

					90 Days								Past Due 90							90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More			30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing			Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
September 30, 2019
September 30, 2020															September 30, 2020
Real estate:															Real estate:
Commerical	$	-	$	-	$	-	$	-	$	233,140,797	$	233,140,797	$	-		$	-	$	-	$	-	$	-	$	239,106,276	$	239,106,276	$	-
Construction/Land development		-		-		-		-		16,132,994		16,132,994		-			-		-		-		-		23,889,344		23,889,344		-
Residential		31,857		-		-		31,857		69,017,841		69,049,698		-			-		-		1,514,012		1,514,012		69,114,260		70,628,272		1,514,012
Commercial		-		-		-		-		21,134,598		21,134,598		-			-		-		-		-		60,442,374		60,442,374		-
Consumer		-		-		-		-		309,902		309,902		-			-		-		-		-		239,062		239,062		-

Total	$	31,857	$	-	$	-	$	31,857	$	339,736,132	$	339,767,989	$	-		$	-	$	-	$	1,514,012	$	1,514,012	$	392,791,316	$	394,305,328	$	1,514,012

					90 Days								Past Due 90							90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More			30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing			Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
December 31, 2018
December 31, 2019															December 31, 2019
Real estate:															Real estate:
Commerical	$	-	$	-	$	988,811	$	988,811	$	237,845,338	$	238,834,149	$	-		$	224,794	$	-	$	-	$	224,794	$	240,713,355	$	240,938,149	$	-
Construction/Land development		-		-		-		-		18,265,505		18,265,505		-			-		-		-		-		18,194,955		18,194,955		-
Residential		-		-		10,507		10,507		63,013,599		63,024,106		10,507			59,892		-		-		59,892		76,062,177		76,122,069		-
Commercial		-		25,000		-		25,000		23,298,073		23,323,073		-			-		-		-		-		26,947,503		26,947,503		-
Consumer		-		-		-		-		494,009		494,009		-			-		-		-		-		292,027		292,027		-

Total	$	-	$	25,000	$	999,318	$	1,024,318	$	342,916,524	$	343,940,842	$	10,507		$	284,686	$	-	$	-	$	284,686	$	362,210,017	$	362,494,703	$	-

It is the Company’s policy to place a loan in nonaccrual status whenever there is substantial doubt about the ability of the borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan, and the overall economic situation of the borrower when making a nonaccrual decision. Management closely monitors nonaccrual loans. The Company returns a nonaccrual loan to accruing status when (i) the loan is brought current with the full payment of all principal and interest arrearages, (ii) all contractual payments are thereafter made on a timely basis for at least ~~six~~nine months, and (iii) management determines, based on a credit review, that it is reasonable to expect that future payments will be made as and when required by the contract.

~~Non-accrual loans as of September 30, 2019 and December~~

31 ~~2018, segregated by class of loans, were as follows:~~

September 30,

December 31,

2019

2018

Commercial real estate
$ - $ 988,811

At September 30, 2020 and December 31, 2019 the Company had no nonaccrual ~~loans or loans~~loans.

The one loan that ~~were delinquent~~is 90 days or ~~greater.~~

At December 31, 2018, the Company had two nonaccrual commercial real estate loans to the same borrower totaling $988,811. The loans were secured by real estate and business assets and were personally guaranteed. Gross interest income of $115,168 would have been recorded during the year ended December 31, 2018 if these nonaccrual loans had been current and performing in accordancemore past due with ~~the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The~~a principal balance of $1,514,012 has not been placed on nonaccrual because the borrower is in the process of requesting a second 90 day payment deferral. The loan will be placed on nonaccrual ~~loans was net of charge-offs of $690,000 at December 31, 2018. These loans paid off during~~in the ~~nine months ended September 30, 2019~~fourth quarter if the additional payment deferral is not granted and the ~~Company recorded a recovery of $15,299.~~borrower does not make sufficient payments.

Impaired loans as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 are set forth in the following table:

	September 30,		December 31,		September 30		December 31,
	2019		2018		2020		2019

Impaired loans with no valuation allowance	$	2,148,480	$	3,177,381	$	2,312,930	$	2,135,045
Impaired loans with a valuation allowance		-		-		-		-
Total impaired loans	$	2,148,480	$	3,177,381	$	2,312,930	$	2,135,045

The Company has provided loan modifications to its borrowers who are impacted by the COVID-19 pandemic. Modifications include deferrals of principal and interest for periods up to three months and interest only periods of three months. These deferrals can be extended for an additional three months, subject to approval by the Company. During the second quarter of 2020, the Company modified loans having an aggregate principal balance of $109.2 million, or 30% of its loan portfolio. None of these loans were classified as TDRs as of June 30, 2020 because they met the criteria discussed above. Of these previously-deferred loans, borrowers owing a total of $21.8 million, or 6% of the Company’s loan portfolio, have been granted additional three-month deferrals. None of these loans were classified as TDRs as of September 30, 2020 because they met the criteria discussed above.

The Company continues to prudently work with borrowers that have been negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for loan losses on its loan portfolio. See Note 4 to the financial statements included elsewhere in this report for additional information.

At December 31, 2019, the Company had one commercial real estate loan totaling ~~$2,097,690~~$2,084,988 and one residential real estate loan totaling ~~$50,790~~$50,057 that were classified as TDRs. All are included in impaired loans above. Each loan iswas paying as ~~agreed.~~agreed at December 31, 2019. There have been no charge-offs or allowances associated with these two loans.

	September 30,		December 31,
	2020		2019

Restructured loans (TDRs):
Performing as agreed	$	2,312,930	$	2,135,045
Not performing as agreed		-		-
Total TDRs	$	2,312,930	$	2,135,045

September 30,

December 31,

2019

2018

Restructured loans (TDRs):

Performing as agreed
$ 2,148,480 $ 2,188,570
Not performing as agreed
- -
Total TDRs
$ 2,148,480 $ 2,188,570

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense. The allowance for loan losses represents an amount which, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ~~Accounting Standards Codification (“ASC”)~~ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions.

The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, classified and criticized loans and net charge-offs or recoveries, among other factors.

Although management believes that, based on information currently available, the Company’s allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Company’s level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Company or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions at the time management determined the current level of the allowance for loan losses.

The following table details activity in the allowance for loan losses by portfolio for the ~~nine months~~nine-month periods ended September 30, 2020 and 2019 and ~~2018, and for~~ the year ended December 31, ~~2018.~~2019. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

												Allowance for loan losses				Outstanding loan															Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated						Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:				Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively
September 30, 2020																				balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(47,253	)	$	-	$	19,689	$	1,726,808	$	-	$	1,726,808	$	2,097,690	$	231,043,107	$	1,763,861	$	340,084		$	-	$	45,962	$	2,149,907	$	-	$	2,149,907	$	2,266,855	$	236,839,421
Construction and land development		196,374		(34,932	)		-		10,425		171,867		-		171,867		-		16,132,994		192,828		51,804			-		10,800		255,432		-		255,432		-		23,889,344
Residential		401,626		45,242			-		-		446,868		-		446,868		50,790		68,998,908		478,124		102,515			-		-		580,639		-		580,639		46,075		70,582,197
Commercial		102,610		(14,180	)		-		6,666		95,096		-		95,096		-		21,134,598		107,782		5,429			-		15,835		129,046		-		129,046		-		60,442,374
Consumer		10,428		(5,521	)		-		-		4,907		-		4,907		-		309,902		4,133		2,260			-		-		6,393		-		6,393		-		239,062
Unallocated		43,924		56,644			-		-		100,568		-		100,568		-		-		46,987		(27,092	)		-		-		19,895		-		19,895		-		-
	$	2,509,334	$	-		$	-	$	36,780	$	2,546,114	$	-	$	2,546,114	$	2,148,480	$	337,619,509	$	2,593,715	$	475,000		$	-	$	72,597	$	3,141,312	$	-	$	3,141,312	$	2,312,930	$	391,992,398

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(47,253	)	$	-	$	19,689	$	1,726,808	$	-	$	1,726,808	$	2,097,690	$	231,043,107
Construction and land development		196,374		(34,932	)		-		10,425		171,867		-		171,867		-		16,132,994
Residential		401,626		45,242			-		-		446,868		-		446,868		50,790		68,998,908
Commercial		102,610		(14,180	)		-		6,666		95,096		-		95,096		-		21,134,598
Consumer		10,428		(5,521	)		-		-		4,907		-		4,907		-		309,902
Unallocated		43,924		56,644			-		-		100,568		-		100,568		-		-
	$	2,509,334	$	-		$	-	$	36,780	$	2,546,114	$	-	$	2,546,114	$	2,148,480	$	337,619,509

Allowance for loan losses

Outstanding loan

Provision

ending balance evaluated

balances evaluated

Beginning

for loan

Charge

Ending

for impairment:

for impairment:

September 30, 2018

balance

losses

offs

Recoveries

balance

Individually

Collectively

Individually

Collectively

Real estate:

Commercial
$ 1,867,397 $ (252,948 ) $ - $ 202,660 $ 1,817,109 $ 210,686 $ 1,606,423 $ 3,825,462 $ 234,744,541
Construction and
land development
223,274 99,933 22,116 1,462 302,553 - 302,553 - 23,971,982
Residential
247,953 143,681 - - 391,634 - 391,634 44,254 60,271,255
Commercial
87,353 1,539 - 6,667 95,559 - 95,559 - 21,238,222
Consumer
7,027 (1,523 ) - - 5,504 - 5,504 - 467,592
Unallocated
25,907 34,318 - - 60,225 - 60,225 - -
$ 2,458,911 $ 25,000 $ 22,116 $ 210,789 $ 2,672,584 $ 210,686 $ 2,461,898 $ 3,869,716 $ 340,693,592

													Allowance for loan losses				Outstanding loan															Allowance for loan losses				Outstanding loan
			Provision										ending balance evaluated				balances evaluated						Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge					Ending		for impairment:				for impairment:				Beginning		for loan			Charge				Ending		for impairment:				for impairment:
December 31, 2018	balance		losses			offs			Recoveries		balance		Individually		Collectively		Individually		Collectively
December 31, 2019																					balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,867,397	$	372,315		$	(690,000	)	$	204,660	$	1,754,372	$	-	$	1,754,372	$	3,177,381	$	235,656,768	$	1,754,372	$	(11,700	)	$	-	$	21,189	$	1,763,861	$	-	$	1,763,861	$	2,084,988	$	238,853,161
Construction and land development		223,274		(78,496	)		(12,115	)		63,711		196,374		-		196,374		-		18,265,505		196,374		(17,571	)		-		14,025		192,828		-		192,828		-		18,194,955
Residential		247,953		153,673			-			-		401,626		-		401,626		-		63,024,106		401,626		76,498			-		-		478,124		-		478,124		50,057		76,072,012
Commercial		87,353		6,090			-			9,167		102,610		-		102,610		-		23,323,073		102,610		(3,995	)		-		9,167		107,782		-		107,782		-		26,947,503
Consumer		7,027		3,401			-			-		10,428		-		10,428		-		494,009		10,428		(6,295	)		-		-		4,133		-		4,133		-		292,027
Unallocated		25,907		18,017			-			-		43,924		-		43,924		-		-		43,924		3,063			-		-		46,987		-		46,987		-		-
	$	2,458,911	$	475,000		$	(702,115	)	$	277,538	$	2,509,334	$	-	$	2,509,334	$	3,177,381	$	340,763,461	$	2,509,334	$	40,000		$	-	$	44,381	$	2,593,715	$	-	$	2,593,715	$	2,135,045	$	360,359,658

The provision for loan losses was $475,000 for the nine months ended September 30, 2020 and $0 for the nine months ended September 30, ~~2019 and $25,000 for the nine months ended September 30, 2018.~~2019.

During the ~~nine months~~nine-month periods ended September 30, 2020 and 2019, the Company had no loan ~~charge-offs and had recoveries of $36,780~~charge-offs. Recoveries from loans written off in prior ~~periods. During~~periods totaled $72,597 and $36,780 for the ~~nine months~~nine-month periods ended September 30, ~~2018, the Company had loan charge-offs of $22,116~~2020 and ~~had recoveries of $210,789 from loans written off in prior periods.~~2019, respectively.

As of September 30, ~~2019,~~2020, the Company had ~~$9,352,531~~$8,792,813 of loans on a watch list, other than impaired loans, for which the borrowers have the potential for experiencing financial difficulties. As of December 31, ~~2018,~~2019, the Company had ~~$7,079,718~~$9,264,380 of such loans. These loans are subject to ongoing management attention and their classifications are reviewed regularly. Watch list loans include loans classified as Special Mention, Substandard, and Doubtful.

Investment Securities

Investments in debt securities increased by ~~$14,892,004~~$6,442,905 or ~~33.3%~~11.5% to ~~$59,611,062~~$62,484,697 at September 30, ~~2019~~2020 from ~~$44,719,058~~$56,041,792 at December 31, ~~2018.~~2019. At September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, the Company had classified ~~67%~~64% and ~~59%~~65%, respectively, of the investment portfolio as available for sale. The balance of the portfolio was classified as held to maturity.

Securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the Company’s asset/liability management strategy. Available for sale debt securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of income taxes. Securities classified as held to maturity, which ~~management~~the Company has both the positive intent and ability to hold to maturity, are reported at amortized cost. ~~Effective January 1, 2018, the~~The Company ~~began recording~~records unrealized gains and losses on equity securities in earnings. The Company does not currently follow a strategy of making security purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolio within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity, meet earnings objectives, and provide required collateral for deposit and borrowing activities.

The following table sets forth the carrying value of investments in debt securities at September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:

	September 30,		December 31,		September		December 31,
	2019		2018		2020		2019
Available for sale
State and municipal	$	1,390,225	$	1,506,505	$	528,797	$	512,670
SBA pools		2,337,438		2,719,372		1,843,156		2,151,797
Corporate bonds						2,187,545		-
Mortgage-backed securities		36,373,492		22,366,114		35,322,637		33,867,307
	$	40,101,155	$	26,591,991	$	39,882,135	$	36,531,774

Held to maturity
State and municipal	$	19,509,907	$	18,127,067	$	22,602,562	$	19,510,018

The following table sets forth the scheduled maturities of investments in debt securities at September 30, ~~2019:~~2020:

	Available for Sale				Held to Maturity				Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value

Within 1 year	$	-	$	-	$	258,014	$	263,101	$	-	$	-	$	-	$	-
Over 1 to 5 years		258,761		260,187		330,000		330,611		2,351,723		2,450,600		792,990		813,269
Over 5 to 10 years		1,120,000		1,130,038		2,948,579		3,029,811		250,000		265,742		2,957,174		3,156,466
Over 10 years		-		-		15,973,314		16,530,558		-		-		18,852,398		19,663,564
		1,378,761		1,390,225		19,509,907		20,154,081		2,601,723		2,716,342		22,602,562		23,633,299
SBA Pools		2,388,707		2,337,438		-		-		1,885,788		1,843,156		-		-
Mortgage-backed securities		36,158,480		36,373,492		-		-		34,312,246		35,322,637		-		-
	$	39,925,948	$	40,101,155	$	19,509,907	$	20,154,081	$	38,799,757	$	39,882,135	$	22,602,562	$	23,633,299

SBA pools and mortgage-backed securities are due in monthly installments.

Other Real Estate Owned

The Bank owns one property in Cecil County, Maryland that was acquired through foreclosure in 2007 and is classified as other real estate owned (“OREO”). The Bank was required by statute to write this property down during 2019 to $0 due to the length of time that it has been held by the Bank. The property is under contract to be sold by the end of ~~2020.~~2021.

~~Other real estate owned at December 31, 2018 included the one property discussed above and had a carrying value of $210,150.~~

Deposits

Total deposits increased by ~~$17,483,512~~$49,462,334 or ~~4.9%~~13.1% to ~~$372,196,515~~$426,075,648 at September 30, ~~2019~~2020 from ~~$354,713,003~~$376,613,314 at December 31, ~~2018.~~2019. The increase in deposits was due to a ~~$5,953,085 increase in savings accounts, a $3,004,524~~$24,693,308 increase in interest bearing checking accounts, ~~and~~ a ~~$15,695,738~~$7,733,446 increase ~~in time deposits, offset by a $2,750,907 decrease~~ in money market accounts, a $3,824,247 increase in savings accounts, and a ~~$4,418,928~~$18,351,388 increase in noninterest-bearing accounts, offset by a $5,140,055 decrease in ~~noninterest-bearing accounts.~~time deposits.

The following table shows the average balances and average costs of deposits for the ~~nine months~~nine-month periods ended September 30, ~~2019~~2020 and ~~2018:~~2019:

	September 30, 2019					September 30, 2018					September 30, 2020					September 30, 2019
	Average					Average					Average					Average
	Balance		Cost			Balance		Cost			Balance		Cost			Balance		Cost

Noninterest bearing demand deposits	$	58,922,450		0.00	%	$	62,012,619		0.00	%	$	74,243,150		0.00	%	$	58,922,450		0.00	%
Interest bearing demand deposits		55,466,882		0.32	%		45,806,884		0.18	%		73,702,521		0.30	%		55,466,882		0.32	%
Savings and money market deposits		100,681,579		0.31	%		97,016,596		0.24	%		107,353,960		0.26	%		100,681,579		0.31	%
Time deposits		148,466,527		1.98	%		130,107,665		1.34	%		153,264,507		1.79	%		148,466,527		1.98	%
	$	363,537,438		0.94	%	$	334,943,764		0.61	%	$	408,564,138		0.79	%	$	363,537,438		0.94	%

Liquidity Management

Liquidity describes our ability to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet depositor withdrawal requirements, to fund loans, and to fund our other debts and obligations as they come due in the normal course of business. We maintain our asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments, and income from earning assets. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. The Bank is approved to borrow 75% of eligible pledged ~~single family~~single-family residential loans and 50% of eligible pledged commercial loans as well as investment securities, or approximately ~~$53.2~~$62.7 million under a secured line of credit with the FHLB. The Bank also has a facility with the Federal Reserve Bank of Richmond (the “Reserve Bank”) under which the Bank can borrow approximately ~~$22.8~~$22.2 million. Finally, the Bank has an $18,500,000 ($9,500,000 unsecured and $9,000,000 secured) overnight federal funds line of credit available from two commercial banks. FHLB advances of ~~$1,000,000~~$7,000,000 and ~~$3,000,000~~$0 were outstanding as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll as more fully described below. There were no borrowings from the Reserve Bank or our commercial bank lenders at September 30, ~~2019~~2020 and December 31, ~~2018.~~2019. Management believes that we have adequate liquidity sources to meet all anticipated liquidity needs over the next 12 months. Management knows of no trend or event which is likely to have a material impact on our ability to maintain liquidity at satisfactory levels.

Borrowings and Other Contractual Obligations

The Company’s contractual obligations consist primarily of borrowings and operating leases for various facilities.

On September 30, 2020, the Company borrowed $17,000,000 from First Horizon Bank (“FHN”) to be used in the acquisition of Carroll on October 1, 2020. Net of issuance costs of $28,126, the amount of the net long-term debt was $16,971,874 as of September 30, 2020. The loan matures on September 30, 2025. The interest rate on the loan is fixed at 4.10%. The Company is required to make quarterly interest-only payments through October 1, 2021. The Company expects that the amount of these quarterly interest-only payments to be $174,250. During the remaining term of the loan, the Company is required to make quarterly interest and principal payments of approximately $646,472, which will be based on a nine-year straight-line amortization schedule. The remaining balance of approximately $9,916,667 will be due at maturity. To secure its obligations under this loan, the Company pledged all of its shares of common stock of the Bank to the lender.

Securities sold under agreements to repurchase represent overnight borrowings from customers. Securities owned by the Company which are used as collateral for these borrowings are primarily U.S. government agency securities.

Specific information about the Company’s borrowings and contractual obligations is set forth in the following table:

	September 30,			December 31,			September 30,			December 31,
	2019			2018			2020			2019
Amount oustanding at period-end:
Securities sold under repurchase agreements	$	7,583,212		$	11,012,000		$	6,317,682		$	10,958,118
Federal Home Loan Bank advances mature in 2019		1,000,000			3,000,000
Federal Home Loan Bank advances								7,000,000			-
Long-term debt (net of issuance costs)								16,971,874			-
Weighted average rate paid at period-end:
Securites sold under repurchase agreements		1.13	%		1.07	%		0.60	%		1.49	%
Federal Home Loan Bank advances		1.99	%		1.50	%		0.78	%		-
Long-term debt								4.10	%		-

The Federal Home Loan Bank advances and the long-term debt outstanding at September 30, 2020 will require the following principal payments:

Three months ending December 31, 2020	$	2,000,000
Year ending December 31, 2021		-
Year ending December 31, 2022		1,888,889
Year ending December 31, 2023		1,888,889
Year ending December 31, 2024		1,888,889
Year ending December 31, 2025		16,333,333

Capital Resources and Adequacy

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

Additional information regarding the capital requirements that apply to us can be found in Note 6 to the consolidated financial statements presented elsewhere in this report and in Item 1 of Part I of ~~Farmers and Merchants Bancshares, Inc.’s Annual Report on~~the Form 10-K ~~for the year ended December 31, 2018~~ under the heading, “Supervision and Regulation – Capital Requirements”.

The following table presents actual and required capital ratios as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

						Minimum															Minimum
						Capital Adequacy					To Be Well										Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phased In Schedule					Capitalized					Actual					Phased In Schedule					Capitalized
September 30, 2019	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2020																Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	50,078		14.37	%	$	37,046		10.50	%	$	35,282		10.00	%	$	44,784		12.05	%	$	39,027		10.50	%	$	37,169		10.00	%
Tier 1 capital (to risk-weighted assets)		47,532		13.64	%		29,990		8.50	%		28,226		8.00	%		41,643		11.20	%		31,593		8.50	%		29,735		8.00	%
Common equity tier 1 (to risk- weighted assets)		47,532		13.64	%		24,697		7.00	%		22,933		6.50	%		41,643		11.20	%		26,018		7.00	%		24,160		6.50	%
Tier 1 leverage (to average assets)		47,532		11.00	%		17,307		4.00	%		21,633		5.00	%		41,643		8.41	%		19,816		4.00	%		24,771		5.00	%

December 31, 2018
December 31, 2019

Total capital (to risk-weighted assets)	$	47,857		13.50	%	$	34,996		9.88	%	$	35,439		10.00	%	$	51,274		13.88	%	$	38,775		10.50	%	$	36,928		10.00	%
Tier 1 capital (to risk-weighted assets)		45,348		12.80	%		27,908		7.88	%		28,351		8.00	%		48,681		13.18	%		31,389		8.50	%		29,543		8.00	%
Common equity tier 1 (to risk- weighted assets)		45,348		12.80	%		22,593		6.38	%		23,036		6.50	%
Common equity tier 1(to risk- weighted assets)																	48,681		13.18	%		25,850		7.00	%		24,003		6.50	%
Tier 1 leverage (to average assets)		45,348		10.86	%		16,698		4.00	%		20,872		5.00	%		48,681		10.94	%		17,798		4.00	%		22,247		5.00	%

On September 30, 2020, the Bank paid an $8 million dividend to the Company to be used as a portion of the purchase price to be paid for the acquisition of Carroll.

The Company intends to fund future growth primarily with cash, federal funds, maturities of investment securities and deposit growth. Management knows of no other trend or event that will have a material impact on capital.

Off-Balance Sheet Arrangements

In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. Outstanding loan commitments, unused lines of credit, and letters of credit as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 are as follows:

	September 30,		December 31,		September 30,		December 31,
	2019		2018		2020		2019

Loan commitments
Construction and land development	$	5,625,475	$	6,800,240	$	1,206,500	$	1,322,275
Commercial		6,988,541		1,143,217		-		4,102,000
Commercial real estate		8,688,778		2,853,913		10,833,965		7,560,714
Residential		3,267,400		1,557,500		1,030,000		770,499
	$	24,570,194	$	12,354,870	$	13,070,465	$	13,755,488

Unused lines of credit
Home-equity lines	$	3,770,253	$	3,594,847	$	3,856,821	$	3,700,404
Commercial lines		18,955,684		23,389,326		15,535,650		22,229,095
	$	22,725,937	$	26,984,173	$	19,392,471	$	25,929,499

Letters of credit	$	2,069,910	$	1,905,553	$	2,077,969	$	1,935,613

Loan commitments and lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

The maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment. Loan commitments, lines of credit and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss that is likely to be incurred as a result of funding its credit commitments.

RESULTS OF OPERATIONS

Comparison of Operating Results for the Nine Months Ended September 30, 2020 and 2019 ~~and 2018~~

General

Net income for the nine months ended September 30, ~~2019~~2020 was ~~$3,500,018,~~$2,264,609, compared to ~~$3,575,871~~$3,500,018, for the same period of ~~2018.~~2019. The decrease of ~~$75,853~~$1,235,409 or ~~2.1%~~35.3% was due to a ~~$164,404 decrease~~$1,886,906 increase in noninterest expenses and a $475,000 increase in the loan loss provision, offset by a $288,999 increase in noninterest income, a $513,340 increase in net interest income, and a ~~$192,180 increase~~$324,158 decrease in income taxes. Included in noninterest expense ~~offset by~~is $1,612,321 of one-time expenses incurred in connection with the Merger. Without these Merger costs, net income would have been $3,488,045 for the nine months ended September 30, 2020. The table below provides a ~~$204,565 increase in noninterest income, a $25,000 decrease in~~comparison of the ~~loan loss provision,~~Company’s results for the nine-month periods ended September 30, 2020 and ~~a $51,166 decrease in income taxes.~~2019, both with and without the Merger costs.

	Nine Months Ended
	September 30, 2020						September 30, 2019
				Excluding
	As Reported			Acquisition Costs			As Reported

Income before taxes	$	2,724,959		$	4,337,280		$	4,284,526
Income taxes		460,350			849,235			784,508
Net income	$	2,264,609		$	3,488,045		$	3,500,018
Earnings per share	$	0.76		$	1.17		$	1.19
Return on average assets		0.63	%		0.97	%		1.09	%
Return on average equity		5.88	%		9.06	%		9.84	%

Net Interest Income

Net interest income, which is the difference between interest income on loans and investments and interest expense on deposits and borrowings, was ~~$11,223,346~~$11,736,686 for the nine months ended September 30, ~~2019,~~2020, compared to ~~$11,387,750~~$11,223,346 for the same period of ~~2018.~~2019.

Total interest income for the nine months ended September 30, ~~2019~~2020 was ~~$13,926,004,~~$14,287,618, compared to ~~$13,168,442~~$13,926,004 for the same period of ~~2018,~~2019, an increase of ~~$757,562~~$361,614 or ~~5.8%~~2.6%.

Total interest income on loans for the nine months ended September 30, ~~2019~~2020 increased by ~~$410,627~~$623,521 when compared to the same period of ~~2018~~2019 due to a ~~higher loan yield of 4.90% for the first nine months of 2019 versus 4.73% for the same period of 2018, offset by a $0.7~~$38.8 million ~~lower~~higher average loan balance for the first nine months of ~~2019~~2020 when compared to the same period of ~~2018.~~2019, offset by a lower loan yield of 4.62% for the first nine months of 2020 versus 4.90% for the same period of 2019. Investment income for the first nine months of ~~2019 increased~~2020 decreased by ~~$184,032~~$39,393 or ~~20.9%~~3.7% when compared to the same period of ~~2018~~2019 due to a ~~$6.8 million higher average investment balance and an increase~~decrease in the fully-taxable equivalent yield to ~~3.06%~~2.46% for nine months ended September 30, ~~2019,~~2020, compared to ~~2.96%~~3.06% for the same period of ~~2018.~~2019, offset by a $11.1 million higher average investment balance. Interest income on federal funds sold and other interest earning assets decreased $222,514 due to a decrease in the fully-taxable equivalent yield to 0.60% for the nine months ended September 30, 2020, compared to 2.44% for the same period of 2019. The fully-taxable equivalent yield on total interest-earning assets ~~increased 10~~decreased 37 basis points to ~~4.58%~~4.21% for the nine months ended September 30, ~~2019,~~2020, compared to ~~4.48%~~4.58% for the same period of ~~2018.~~2019. The average balance of total interest-earning assets increased by ~~$14.7~~$47.5 million to ~~$409.8~~$457.4 million for the nine months ended September 30, ~~2019,~~2020, compared to ~~$395.1~~$409.8 million for the same period of ~~2018.~~2019.

Total interest expense for the nine months ended September 30, ~~2019~~2020 was ~~$2,702,658,~~$2,550,932, compared to ~~$1,780,692~~$2,702,658 for the same period of ~~2018, an increase~~2019, a decrease of ~~$921,966,~~$151,726, or ~~51.8%~~5.6%. The ~~increase~~decrease was due to a ~~higher~~lower overall cost of funds on interest bearing deposits and borrowings of ~~1.14%~~0.98% for the nine months ended September 30, ~~2019,~~2020, compared to ~~0.78%~~1.14% for the same period of ~~2018, and~~2019, offset by a ~~$13.6~~$30.5 million increase in the average balance of interest-bearing liabilities to ~~$317.0~~$347.5 million in the first ~~six~~nine months of ~~2019,~~2020 compared to ~~$303.4~~$317.0 million in the same period of ~~2018.~~2019. Cost of funds for time deposits ~~increased~~decreased to ~~1.98%~~1.79% for the nine months ended September 30, ~~2019~~2020 from ~~1.34%~~1.98% for the same period of ~~2018.~~2019. Securities sold under repurchase agreements cost of funds increased to 1.30% for the first nine months of 2020 from 1.23% for the first nine months of ~~2019 from 0.77% for the first nine months~~2019. Federal Home Loan Bank of ~~2018. FHLB~~Atlanta advances and other borrowings cost of funds ~~increased~~decreased to ~~1.66%~~1.01% for the first nine months of ~~2019~~2020 from ~~1.51%~~1.66% for the ~~first nine months of 2018.~~same period in 2019.

Average noninterest-earning assets increased by ~~$1.3~~$3.2 million to ~~$17.4~~$20.6 million in the first nine months of ~~2019,~~2020, compared to ~~$16.1~~$17.4 million in the same period of ~~2018.~~2019. Average noninterest-bearing deposits ~~decreased~~increased by ~~$3.1~~$15.3 million to ~~$58.9~~$74.2 million during the first nine months of ~~2019,~~2020 compared to ~~$62.0~~$58.9 million in the same period of ~~2018.~~2019. The average balance in stockholders’ equity increased by ~~$4.1~~$3.9 million for the nine months ended September 30, ~~2019,~~2020 when compared with the same period of ~~2018.~~2019.

~~The~~In 2020, the FRB ~~raised rates nine times from 2015~~reduced the federal funds range to ~~2018. The cost of deposits and borrowings has increased significantly over that time. However, the~~0.00% to 0.25%. As a result, yields on loans and investments have ~~increased only slightly. During 2019, the FRB has reduced rates three times and management currently anticipates that more rate cuts will occur in the near term. This should begin to reduce our~~decreased. Our cost of ~~funds.~~funds is lower than the same period of 2019 and will continue to decline as higher rate certificates of deposit mature and are replaced by lower rate certificates. Management will closely monitor its asset-liability position so that it can respond to any future changes in interest rates and/or changes to the Bank’s interest rate spread.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the nine-month periods ended September 30, ~~2019~~2020 and ~~2018.~~2019. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

Nine Months Ended September 30, 2019

Nine Months Ended September 30, 2018

Average

Average

Balance

Interest

Yield

Balance

Interest

Yield

Assets:

Loans
$ 342,398,030 $ 12,582,392 4.90 % $ 343,101,120 $ 12,171,765 4.73 %
Securities, taxable
33,467,239 636,235 2.53 % 26,976,380 455,372 2.25 %
Securities, tax exempt
17,942,912 545,007 4.05 % 17,676,548 536,856 4.05 %
Federal funds sold and other interest-earning assets
16,034,923 293,151 2.44 % 7,367,251 125,224 2.27 %
Total interest-earning assets
409,843,104 14,056,785 4.58 % 395,121,299 13,289,217 4.48 %
Noninterest-earning assets
17,395,304 16,135,350
Total assets
$ 427,238,408 $ 411,256,649

Liabilities and Stockholders’ Equity:

NOW, savings, and money market
$ 156,148,461 370,726 0.32 % $ 142,823,480 232,740 0.22 %
Certificates of deposit
148,466,527 2,206,503 1.98 % 130,107,665 1,310,283 1.34 %
Securities sold under repurchase agreements
9,006,627 82,912 1.23 % 19,376,770 112,242 0.77 %
FHLB advances and other borrowings
3,421,989 42,517 1.66 % 11,082,051 125,427 1.51 %
Total interest-bearing liabilities
317,043,604 2,702,658 1.14 % 303,389,966 1,780,692 0.78 %

Noninterest-bearing deposits
58,922,450 62,012,619
Noninterest-bearing liabilities
3,868,457 2,574,249
Total liabilities
379,834,511 367,976,834
Stockholders' equity
47,403,897 43,279,815
Total liabilities and stockholders' equity
$ 427,238,408 $ 411,256,649

Net interest income
$ 11,354,127 $ 11,508,525

Interest rate spread
3.44 % 3.70 %

Net yield on interest-earning assets
3.69 % 3.88 %

Ratio of average interest-earning assets to

Average interest-bearing liabilities
129.27 % 130.24 %

	Nine Months Ended							Nine Months Ended
	September 30, 2020							September 30, 2019
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	381,189,719	$	13,205,913		4.62	%	$	342,398,030	$	12,582,392		4.90	%
Securities, taxable		41,209,087		564,540		1.83	%		33,467,239		636,235		2.53	%
Securities, tax exempt		21,334,547		590,741		3.69	%		17,942,912		545,007		4.05	%
Federal funds sold and other interest-earning assets		13,641,105		60,940		0.60	%		16,034,923		293,151		2.44	%
Total interest-earning assets		457,374,458		14,422,134		4.21	%		409,843,104		14,056,785		4.58	%
Noninterest-earning assets		20,569,704							17,395,304
Total assets	$	477,944,162						$	427,238,408

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	181,056,481		376,248		0.28	%	$	156,148,461		370,726		0.32	%
Certificates of deposit		153,264,507		2,053,248		1.79	%		148,466,527		2,206,503		1.98	%
Securities sold under repurchase agreements		9,804,072		95,710		1.30	%		9,006,627		82,912		1.23	%
FHLB advances and other borrowings		3,397,814		25,726		1.01	%		3,421,989		42,517		1.66	%
Total interest-bearing liabilities		347,522,874		2,550,932		0.98	%		317,043,604		2,702,658		1.14	%

Noninterest-bearing deposits		74,243,150							58,922,450
Noninterest-bearing liabilities		4,858,736							3,868,457
Total liabilities		426,624,760							379,834,511
Stockholders' equity		51,319,402							47,403,897
Total liabilities and stockholders' equity	$	477,944,162						$	427,238,408

Net interest income			$	11,871,202						$	11,354,127

Interest rate spread						3.23	%						3.44	%

Net yield on interest-earning assets						3.46	%						3.69	%

Ratio of average interest-earning assets to average interest-bearing liabilities						131.61	%						129.27	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis.

Noninterest Income

Noninterest income for the nine months ended September 30, ~~2019~~2020 was ~~$1,108,597,~~$1,397,596 compared to ~~$904,032~~$1,108,597 for the same period of ~~2018,~~2019, an increase of ~~$204,565~~$288,999 or ~~22.6%~~26.1%. The increase was primarily a result of a ~~$75,710 higher~~$434,797 increase in mortgage banking income and a $210,150 lower write down of OREO, offset by a $75,900 lower gain on the sale of SBA loans, ~~a $200,567 increase in~~$194,368 lower bank owned life insurance income, and $80,251 lower service charges on deposit accounts. Our mortgage banking division has experienced strong mortgage origination activity as a result of historically low interest rates. Lower service charges are a result of less customer transaction activity due to ~~proceeds received from a policy, a $30,062 increase in mortgage banking income, and a $34,069 increase in~~ the ~~unrealized gain on equity security, offset by a $154,800 increase in the write-down of other real estate owned required by regulation.~~COVID-19 pandemic.

Noninterest Expense

Noninterest ~~expenses~~expense for the nine months ended September 30, ~~2019~~2020 totaled ~~$8,047,417~~$9,934,323, compared to ~~$7,855,237~~$8,047,417 for the same period of ~~2018,~~2019, an increase of ~~$192,180~~$1,886,906 or ~~2.5%~~23.5%. The increase was due primarily to ~~increases~~$1,612,321 in Merger-related costs and an increase in salaries and benefits of ~~$90,975, an increase in occupancy of $59,118, and an increase in other of $57,769.~~$295,331.

Income Tax Expense

Income tax expense for the nine months ended September 30, ~~2019~~2020 was ~~$784,508,~~$460,350, compared to ~~$835,674~~$784,508 for the same period of ~~2018.~~2019. The effective tax rate was 16.9% and 18.3% for the ~~nine months~~nine-month periods ended September 30, 2020 and 2019, ~~compared to 18.9% for the same period of 2018.~~respectively. The decrease in ~~income~~the effective tax ~~expense~~rate was due ~~primarily~~ to ~~lower income before income taxes and~~ a higher percentage of tax exempt revenue for the nine months ended September 30, ~~2019~~2020 when compared to the same period in ~~2018.~~2019.

Comparison of Operating Results for the Three Months Ended September 30, ~~2019~~2020 and ~~2018~~2019

Net income for the three months ended September 30, ~~2019~~2020 was ~~$1,177,910,~~$385,247 compared to ~~$1,308,688~~$1,177,910 for the same period of ~~2018.~~2019. The decrease of ~~$130,778~~$792,663 or ~~10.0%~~67.3% was due to a ~~$98,571 decrease~~$13,000 increase in ~~net interest income, an $87,000 smaller reversal of~~ the provision for loan losses ~~an $85,868~~and a $1,443,072 increase in noninterest expense, offset by a ~~$120,547~~$230,861 decrease in income taxes, a $338,148 increase in net interest income and a $94,400 increase in noninterest income. Included in noninterest expense are one-time expenses of $1,267,401 incurred in connection with the Merger. Without these acquisition costs, net income would have been $1,358,676 for the three months ended September 30, 2020. The table below provides a comparison of the Company’s results for the three-month periods ended September 30, 2020 and ~~a $20,114 decrease in income taxes.~~2019, both with and without the Merger costs.

	Three Months Ended
	September 30, 2020						September 30, 2019
				Excluding
	As Reported			Acquisition Costs			As Reported

Income before taxes	$	462,110		$	1,729,511		$	1,485,634
Income taxes		76,863			370,835			307,724
Net income	$	385,247		$	1,358,676		$	1,177,910
Earnings per share	$	0.13		$	0.45		$	0.40
Return on average assets		0.31	%		1.10	%		1.09	%
Return on average equity		2.95	%		10.40	%		9.70	%

Net Interest Income

Net interest income was ~~$3,762,601~~$4,100,749 for the three months ended September 30, ~~2019,~~2020, compared to ~~$3,861,172~~$3,762,601 for the same period of ~~2018.~~2019.

Total interest income for the three months ended September 30, ~~2019~~2020 was ~~$4,719,012,~~$4,822,354, compared to ~~$4,525,190~~$4,719,012 for the same period of ~~2018,~~2019, an increase of ~~$193,822~~$103,342 or ~~4.3%~~2.2%.

Total interest income on loans for the three months ended September 30, ~~2019~~2020 increased by ~~$60,445~~$239,921 when compared to the same period of ~~2018~~2019 due to a ~~higher loan yield of 4.97% for the three months ended September 30, 2019 versus 4.83% for the same period of 2018, offset by a $5.1~~$51.2 million ~~lower~~higher average loan balance for the three months ended September 30, ~~2019~~2020 when compared to the same period of ~~2018.~~2019, offset by a lower loan yield of 4.57% for the three months ended September 30, 2020 versus 4.97% for the same period of 2019. Investment income for the three months ended September 30, ~~2019 increased~~2020 decreased by ~~$96,131~~$61,616 or ~~33.4%~~16.0% when compared to the same period of ~~2018~~2019 due to a ~~$13.5~~decrease in the fully-taxable equivalent yield to 2.12% for three months ended September 30, 2020, compared to 3.01% for the same period of 2019, offset by a $10.6 million higher average investment balance. Interest income on federal funds sold and other interest earning assets decreased $74,963 due to a decrease in the fully-taxable equivalent yield to 0.42% for the three months ended September 30, 2020, compared to 2.39% for the same period of 2019. The fully-taxable equivalent yield on total interest-earning assets was ~~4.61%~~4.13% for the three months ended September 30, ~~2019~~2020, compared to ~~4.58%~~4.61% for the same period in ~~2018.~~2019. The average balance of total interest-earning assets increased by ~~$14.5~~$56.6 million to ~~$413.7~~$470.3 million for the three months ended September 30, ~~2019,~~2020, compared to ~~$399.2~~$413.7 million for the same period of ~~2018.~~2019.

Total interest expense for the three months ended September 30, ~~2019~~2020 was ~~$956,411,~~$721,605, compared to ~~664,018~~$956,411 for the same period of ~~2018, an increase~~2019, a decrease of ~~$292,393~~$234,806 or ~~44.0%~~24.6%. The ~~increase~~decrease was due to a ~~higher~~lower overall cost of funds ~~on interest bearing deposits and borrowings~~ of ~~1.20%~~0.81% for the three months ended September 30, ~~2019,~~2020, compared to ~~0.87%~~1.20% for the same period of ~~2018, and~~2019, offset by a ~~$15.6~~$36.1 million increase in the average balance of interest-bearing liabilities to ~~$320.4~~$356.5 million for the three months ended September 30, ~~2019,~~2020, compared to ~~$304.8~~$320.4 million in the same period of ~~2018.~~2019. Cost of funds for time deposits ~~increased~~decreased to ~~2.09%~~1.58% for the three months ended September 30, ~~2019~~2020 from ~~1.49%~~2.09% for the same period of ~~2018.~~2019. Securities sold under repurchase agreements cost of funds ~~increased~~decreased to ~~1.24%~~0.83% for the three months ended September 30, ~~2019~~2020 from ~~0.95%~~1.24% for the same period of ~~2018.~~2019. Federal Home Loan Bank of Atlanta advances and other borrowings cost of funds decreased to 1.01% for the three months ended September 30, 2020 from 1.52% for the same period in 2019.

Average noninterest-earning assets increased by ~~$3.0~~$7.4 million to ~~$18.4~~$25.8 million for the three months ended September 30, ~~2019,~~2020, compared to ~~$15.4~~$18.4 million in the same period of ~~2018.~~2019. Average noninterest-bearing deposits ~~decreased~~increased by ~~$4.4~~$24.0 million to ~~$58.5~~$82.5 million during the three months ended September 30, ~~2019,~~2020, compared to ~~$62.9~~$58.5 million in the same period of ~~2018.~~2019. The average balance in stockholders’ equity increased by ~~$4.5~~$3.7 million for the three months ended September 30, ~~2019~~2020 when compared with the same period of ~~2018.~~2019.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the three-month periods ended September 30, ~~2019~~2020 and ~~2018.~~2019. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Three Months Ended							Three Months Ended							Three Months Ended,							Three Months Ended,
	September 30, 2019							September 30, 2018							September 30, 2020							September 30, 2019
	Average							Average							Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield			Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	342,050,963	$	4,250,071		4.97	%	$	347,166,050	$	4,189,626		4.83	%	$	393,225,957	$	4,489,992		4.57	%	$	342,050,963	$	4,250,071		4.97	%
Securities, taxable		38,073,848		235,978		2.48	%		25,669,789		147,363		2.30	%		43,770,543		150,272		1.37	%		38,073,848		235,978		2.48	%
Securities, tax exempt		18,759,966		191,462		4.08	%		17,630,254		178,493		4.05	%		23,659,811		207,940		3.52	%		18,759,966		191,462		4.08	%
Federal funds sold and other interest-earning assets		14,790,327		88,506		2.39	%		8,748,562		50,022		2.29	%		9,651,367		10,069		0.42	%		14,790,327		88,506		2.39	%
Total interest-earning assets		413,675,104		4,766,017		4.61	%		399,214,655		4,565,504		4.58	%		470,307,678		4,858,273		4.13	%		413,675,104		4,766,017		4.61	%
Noninterest-earning assets		18,389,380							15,378,346							25,768,859							18,389,380
Total assets	$	432,064,484						$	414,593,001						$	496,076,537						$	432,064,484

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	156,924,885		124,712		0.32	%	$	145,991,228		95,337		0.26	%	$	194,896,794		106,356		0.22	%	$	156,924,885		124,712		0.32	%
Certificates of deposit		151,279,838		791,740		2.09	%		136,310,325		509,360		1.49	%		147,923,538		584,477		1.58	%		151,279,838		791,740		2.09	%
Securities sold under repurchase agreements		9,394,922		29,190		1.24	%		18,098,334		42,841		0.95	%		8,651,764		18,020		0.83	%		9,394,922		29,190		1.24	%
FHLB advances and other borrowings		2,826,120		10,769		1.52	%		4,369,565		16,480		1.51	%		5,043,489		12,752		1.01	%		2,826,120		10,769		1.52	%
Total interest-bearing liabilities		320,425,765		956,411		1.20	%		304,769,452		664,018		0.87	%		356,515,585		721,605		0.81	%		320,425,765		956,411		1.20	%

Noninterest-bearing deposits		58,548,434							62,940,499							82,493,506							58,548,434
Noninterest-bearing liabilities		4,523,982							2,807,530							4,804,935							4,523,982
Total liabilities		383,498,181							370,517,481							443,814,026							383,498,181
Stockholders' equity		48,566,303							44,075,520							52,262,511							48,566,303
Total liabilities and stockholders' equity	$	432,064,484						$	414,593,001						$	496,076,537						$	432,064,484

Net interest income			$	3,809,606						$	3,901,486						$	4,136,668						$	3,809,606

Interest rate spread						3.41	%						3.71	%						3.32	%						3.41	%

Net yield on interest-earning assets						3.68	%						3.91	%						3.52	%						3.68	%

Ratio of average interest-earning assets to
Average interest-bearing liabilities						129.10	%						130.99	%
Ratio of average interest-earning assets to average interest-bearing liabilities																				131.92	%						129.10	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis.

Noninterest Income

Noninterest income for the three months ended September 30, ~~2019~~2020 was ~~$392,968,~~$487,368, compared to ~~$272,421~~$392,968 for the same period of ~~2018,~~2019, an increase of ~~$120,547~~$94,400 or ~~44.3%~~24.0%. The increase was primarily a result of an increase in mortgage banking ~~income~~revenue of ~~$39,124,~~$128,029, offset by a ~~$15,912 increase~~$38,289 decrease in service charges on deposit ~~accounts, and a $55,350 reduction in the write-down of other real estate owned.~~accounts.

Noninterest Expense

Noninterest expenses for the three months ended September 30, ~~2019~~2020 totaled ~~$2,682,935,~~$4,126,007, compared to ~~$2,597,067~~$2,682,935 for the same period of ~~2018,~~2019, an increase of ~~$85,868~~$1,443,072 or ~~3.3%~~53.8%. The increase was due primarily to $1,267,401 in Merger-related costs and increases in ~~other expenses~~salaries and benefits of ~~$67,468 and occupancy expenses of $20,844.~~$169,479.

Income Tax Expense

Income tax expense for the three months ended September 30, ~~2019~~2020 was ~~$307,724,~~$76,863, compared to ~~$327,838~~$307,724 for the same period of ~~2018.~~2019. The effective tax rate was ~~20.7%~~16.6% for the three months ended September 30, ~~2019,~~2020, compared to ~~20.0%~~20.7% for the same period of ~~2018.~~2019. The decrease in the effective tax rate was due to a higher percentage of tax exempt revenue for the three months ended September 30, 2020 when compared to the same period in 2019.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our primary market risk is interest rate fluctuation and we have procedures in place to evaluate and mitigate this risk. This market risk and our procedures are described in Item 7 of Part II ~~of Farmers and Merchants Bancshares, Inc.’s Annual Report~~the on Form 10-K ~~for the year ended December 31, 2018~~ under the heading, “Interest Rate Risk”, which provides information as of December 31, ~~2018.~~2019. Management believes that no material changes in market risk or our procedures used to evaluate and mitigate these risks have occurred since December 31, ~~2018.~~2019.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our management, including Farmers and Merchants Bancshares, Inc.’s principal executive officer (“PEO”) and the principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of September 30, ~~2019~~2020 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended September 30, ~~2019,~~2020, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II – OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Form ~~10-K. Except as set forth below, management~~10-K and in Item 1A of Part II of Farmers and Merchants Bancshares, Inc.’s Quarter Report on Form 10-Q for the quarter ended March 31, 2020. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

~~Our 2016 U.S. consolidated federal income tax return is currently being audited.~~

In April 2018, we were notified by the IRS that our 2016 U.S. consolidated federal tax return was selected for audit. As part of its audit, the IRS is reviewing the deductions related to, and the income generated by, the Insurance Subsidiary. Management cannot predict whether any of our tax positions, including those relating to the Insurance Subsidiary, will be challenged by the IRS or, if challenged, whether we will be successful in defending those tax positions. Defending our tax positions and challenging adverse IRS tax conclusions could require us to expend significant funds and there can be no assurance that we would be successful in any such defense or challenge. If we are not successful in defending a challenge, then we may be required to amend our tax return and pay additional taxes, interest, fines and/or penalties and our taxable earnings and/or the effective tax rate on our future earnings could increase substantially, any of which could have a material adverse effect on our business, financial condition and results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits filed or furnished with this quarterly report are listed in the following Exhibit Index:

~~Exhibit~~
Exhibit Description
2.1
Agreement and Plan of Merger, dated as of September 28, 2020, between Farmers and Merchants Bancshares, Inc. and Carroll Bancorp (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on October 1, 2020)

31.1	Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)

31.2	Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)

32	Certification of the Principal Executive Officer and the Principal Financial Office pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)

101	Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith)

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		FARMERS AND MERCHANTS BANCSHARES, INC.


Date: November ~~13, 2019~~ 10, 2020	/s/ James R. Bosley, Jr.
	James R. Bosley, Jr.
	President and Chief Executive Officer
	(Principal Executive Officer)



Date November ~~13, 2019~~ 10, 2020	/s/ Mark C. Krebs
	~~/s/~~ Mark C. Krebs,
	~~Mark C. Krebs,~~ Treasurer and Chief Financial Officer
	~~(Principal~~(Principal Financial Officer & Principal Accounting Officer)

	Nine Months Ended September 30, 2019							Nine Months Ended September 30, 2018
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	342,398,030	$	12,582,392		4.90	%	$	343,101,120	$	12,171,765		4.73	%
Securities, taxable		33,467,239		636,235		2.53	%		26,976,380		455,372		2.25	%
Securities, tax exempt		17,942,912		545,007		4.05	%		17,676,548		536,856		4.05	%
Federal funds sold and other interest-earning assets		16,034,923		293,151		2.44	%		7,367,251		125,224		2.27	%
Total interest-earning assets		409,843,104		14,056,785		4.58	%		395,121,299		13,289,217		4.48	%
Noninterest-earning assets		17,395,304							16,135,350
Total assets	$	427,238,408						$	411,256,649

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	156,148,461		370,726		0.32	%	$	142,823,480		232,740		0.22	%
Certificates of deposit		148,466,527		2,206,503		1.98	%		130,107,665		1,310,283		1.34	%
Securities sold under repurchase agreements		9,006,627		82,912		1.23	%		19,376,770		112,242		0.77	%
FHLB advances and other borrowings		3,421,989		42,517		1.66	%		11,082,051		125,427		1.51	%
Total interest-bearing liabilities		317,043,604		2,702,658		1.14	%		303,389,966		1,780,692		0.78	%

Noninterest-bearing deposits		58,922,450							62,012,619
Noninterest-bearing liabilities		3,868,457							2,574,249
Total liabilities		379,834,511							367,976,834
Stockholders' equity		47,403,897							43,279,815
Total liabilities and stockholders' equity	$	427,238,408						$	411,256,649

Net interest income			$	11,354,127						$	11,508,525

Interest rate spread						3.44	%						3.70	%

Net yield on interest-earning assets						3.69	%						3.88	%

Ratio of average interest-earning assets to
Average interest-bearing liabilities						129.27	%						130.24	%

Exhibit	Description

2.1	Agreement and Plan of Merger, dated as of September 28, 2020, between Farmers and Merchants Bancshares, Inc. and Carroll Bancorp (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on October 1, 2020)