| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following is management’s discussion and analysis of the major factors that influenced our financial performance for the three and nine-month periods ended September 30, 2021. This analysis should be read in conjunction with our 2020 Annual Report to Shareholders on Form 10-K, and with the unaudited consolidated financial statements and notes as set forth in this report.
Forward–Looking Statements
This Form 10-Q contains various forward-looking statements, usually containing the words “estimate,” “project,” “expect,” “objective,” “goal,” or similar expressions and includes assumptions concerning Farmers & Merchants Bancorp’s (together with its subsidiaries, the “Company” or “we”) operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risks and uncertainties. In connection with the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions.
Such factors include, but are not limited to, the following: (1) economic conditions in the Central Valley of California; (2) significant changes in interest rates and loan prepayment speeds; (3) credit risks of lending and investment activities; (4) changes in federal and state banking laws or regulations; (5) competitive pressure in the banking industry; (6) changes in governmental fiscal or monetary policies; (7) uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the U.S. or other governments as a result of further acts or threats of terrorism; (8) water management issues in California and the resulting impact on the Company’s agricultural customers; (9) expansion into new geographic markets and new lines of business; (10) the impact of COVID-19 on the Company and its customers (see COVID-19 Disclosure below); and (11) other factors discussed in Item 1A. Risk Factors located in the Company’s 2020 Annual Report on Form 10-K.
Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
COVID-19 (Coronavirus) Disclosure
While tremendous strides have been made in fighting the COVID-19 virus, particularly with the development of a vaccine, the lingering effects of COVID-19 are still with us, and it is impossible to predict the future impact that this will have on our communities and customers.
Designated as an “essential business”, Farmers & Merchants Bank of Central California has kept all branches open and maintained regular business hours during this difficult time. Our staffing levels have remained stable during the COVID-19 crisis.
Impact on the Banking Industry
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law by Congress and was amended and extended by the Consolidated Appropriations Act of 2021 (“H.R. 133”) on December 21, 2020. The primary impact of this legislation, as well as related federal and state regulatory actions, is as follows:
| • | Paycheck Protection Program (“PPP”) … The Small Business Administration (“SBA”) was directed by Congress to provide loans to small businesses with less than 500 employees to assist these businesses in meeting their payroll and other financial obligations over the next several months (H.R. 133 reduced the number of employees to 300 for “second draw” PPP loans). These government guaranteed loans are made with an interest rate of 1%, a risk weight of 0% under risk-based capital rules, have a term of two to five years, and under certain conditions the SBA can forgive them after eight or twenty-four weeks. Farmers & Merchants Bank of Central California has actively participated in the PPP, and since April 2020 we have funded $494.9 million of loans for over 2,000 of our small business customers. As of September 30, 2021, $121.2 million of these loans remain outstanding. Although these loans carry a nominal interest rate of 1%, the SBA will pay the banks an origination fee of 1-5% depending on the size of the loan. All fees have been capitalized and are being amortized over the life of the loans. The Company has collected $17.9 million in fees from the SBA and as of September 30, 2021, $13.5 million of these fees have been accreted into income, since inception. Since these loans are currently in the process of being forgiven by the SBA, the income statement impact to the Company in the fourth quarter of 2021 could be significant. |
| • | Temporary Relief from Troubled Debt Restructurings … The CARES Act and H.R. 133 provide financial institutions, under specific circumstances, the opportunity to temporarily suspend certain requirements under generally accepted accounting principles related to troubled debt restructurings (“TDR”) for a limited period of time to account for the effects of COVID-19. Farmers & Merchants Bank of Central California has, and continues to, actively work with existing borrowers to restructure loans, primarily for up to six months, moving to either interest only payments or full deferral of principal and interest payments. After the deferral period ends, any deferred amounts would then be added to the final principal balance. We believe that these actions will assist these borrowers in getting through these difficult times, but no guaranties can be made that at some time in the future these loans will not be required to be accounted for as a TDR. |
Since April 2020, we have restructured $278.1 million of loans under the CARES Act and H.R. 133 guidelines. As of September 30, 2021 all of these loans have returned to some form of payment status, whether interest-only or full principal and interest.
| • | Foreclosure Actions … The CARES Act and H.R. 133 restrict the ability of financial institutions to exercise their foreclosure rights on residential and multi-family properties backed by federally guaranteed mortgage loans. The State of California went further and temporarily suspended all residential and commercial foreclosures through September 30, 2021, but these guidelines have now expired. The Company continues to work with its borrowers when they make requests to defer payments on their mortgage loans. |
| • | CECL Implementation Deferral … The Company was originally scheduled to implement ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”) as of January 1, 2020. The CARES Act and H.R. 133 provide the election to defer CECL implementation until January 1, 2022. In addition, the national banking regulators have issued a joint statement allowing financial institutions to mitigate the effects of CECL in their regulatory capital calculations for up to two years. The Company has elected to delay CECL implementation. |
Impact on Farmers & Merchants Bancorp and Farmers & Merchants Bank of Central California
Although as vaccination rates increase the impact of COVID-19 may diminish, the Company remains exposed to the following COVID-19 risks and uncertainties:
| • | We may not be able to maintain staff levels in order to operate key activities of our business. |
| • | Our earnings may be affected by borrowers that cannot make payments on their loans. We have credit exposure to industries that have been impacted by either: (1) the public’s changing habits in response to the risks of COVID-19 (e.g., hotels, movie theaters, health clubs and restaurants); or (2) possible reinstatements of “shelter-in-place” orders by local, state and federal officials (e.g., small businesses determined to be “non-essential”). |
| • | Our liquidity position may be affected as a result of significant and unusual deposit outflows or loan drawdowns. |
However, from a financial perspective, as reflected by the following September 30, 2021 measures, the Company enters the fourth quarter of 2021 with strong fundamentals which should assist us in continuing to respond to the risks of COVID-19:
| • | Liquidity consisting of $804 million of Fed Funds Sold and $884 million of Investment Securities; |
| • | Strong Asset Quality as reflected by only $516,000 of non-performing loans, and a negligible delinquency ratio of .036% of total loans and leases; |
| • | Risk Based Capital Ratio of 13.28%; |
| • | Allowance for Credit Losses of $60.3 million or 1.92% of total loans and leases (2.00% exclusive of government fully guaranteed loans issued under the SBA’s PPP); and |
| • | ROAA of 1.39% and ROAE of 15.64% in third quarter 2021. |
Our credit exposure to the “Hospitality” (primarily hotels) and “Entertainment” (primarily restaurants, health clubs and movie theaters) industries totals $153.5 million in loans and leases outstanding at September 30, 2021. This represents 4.9% of total loans and leases outstanding and 33.8% of total shareholders’ equity, both measures that are thought to be reasonable when compared to peers. Most of these loans: (1) were underwritten with an original LTV of 50-70% on the underlying real estate, providing us what should be adequate collateral coverage; and (2) have financially strong guarantors with liquidity that provides additional protection. Over and above the impact on the Hospitality and Entertainment industries there has been a general economic slowdown in some areas as a result of COVID-19. The Central Valley of California has been and should continue to be in a better position than other areas to weather this impact because agricultural activity has substantially continued. Although the financial position of these borrowers has improved over the past three months as the economy has opened up, we continue to monitor the impact on our borrowers, and continue to work closely with them using all of the tools at our disposal to help them move through this period of reduced business activity.
Although our 2021 financial performance could still be negatively impacted by sustained low interest rates and the potential for increased borrower stress, the full extent of this impact cannot be determined at this time. Additionally, these negative impacts may be somewhat mitigated by the fees paid by the SBA under the PPP. We believe that we are well positioned to continue moving through this difficult period with sustained profitability.
Introduction
Farmers & Merchants Bancorp, or the Company, is a bank holding company formed March 10, 1999. Its subsidiary, Farmers & Merchants Bank of Central California, or the Bank, is a California state-chartered bank formed in 1916. Banking services are provided in twenty-nine full-service branches and three stand-alone ATM’s in the Company’s service area. The service area includes Sacramento, San Joaquin, Stanislaus, Merced, Contra Costa, Napa and Solano Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, Linden, Modesto, Turlock, Hilmar, Merced, Manteca, Riverbank, Napa, Walnut Creek, Concord, Rio Vista, Walnut Grove and Lockeford.
As a bank holding company, the Company is subject to regulation and examination by the Board of Governors of the Federal Reserve System (“FRB”). The Bank is a California state-chartered non-FRB member bank subject to the regulation and examination of the California Department of Financial Protection and Innovation (“DFPI”) and the Federal Deposit Insurance Corporation (“FDIC”).
Overview
Although the Company has initiated efforts to expand its geographic footprint into the East Bay area of San Francisco and Napa, California (see Item 1: Business – Service Area located in the Company’s 2020 Annual Report on Form 10-K), the Company’s primary service area remains the mid Central Valley of California. Accordingly, discussion of the Company’s Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).
For the three and nine months ended September 30, 2021, Farmers & Merchants Bancorp reported net income of $17,502,000 and $50,368,000, earnings per share of $22.16 and $63.79 and return on average assets of 1.39% and 1.39%, respectively. Return on average shareholders’ equity was 15.64% and 15.37% for the three and nine months ended September 30, 2021, respectively.
For the three and nine months ended September 30, 2020, Farmers & Merchants Bancorp reported net income of $14,810,000 and $43,241,000, earnings per share of $18.66 and $54.49 and return on average assets of 1.40% and 1.44%, respectively. Return on average shareholders’ equity was 14.40% and 14.54% for the three and nine months ended September 30, 2020, respectively.
The following is a summary of the financial results for the nine-month period ended September 30, 2021, compared to September 30, 2020:
| • | Net income increased 16.5% to $50.4 million from $43.2 million. |
| • | Earnings per share increased 17.1% to $63.79 from $54.49. |
| • | Total assets increased 18.6% to $5.1 billion from $4.3 billion. |
| • | Loans & leases (exclusive of SBA PPP loans) increased 9.2% to $3.02 billion from $2.76 billion. |
| • | Total deposits increased 19.8% to $4.6 billion from $3.8 billion. |
The primary reasons for the Company’s $7.1 million or 16.5% increase in net income in the first nine months of 2021 as compared to the same period of 2020 were:
| • | A $10.5 million increase in net interest income related to the growth in earning assets. |
| • | A $2.5 million increase in gain on investment securities sold. |
| • | A $1.1 million increase in Debit Card and ATM fees. |
| • | A $1.1 million increase in other non-interest income. |
| • | A $750,000 decrease in the provision for credit losses. |
These positive impacts were partially offset by:
| • | A $5.1 million increase in salaries and employee benefits. |
| • | A $646,000 increase in FDIC insurance expense. |
| • | A $499,000 increase in other non-interest expense. |
| • | An increase in the tax provision from 24.4% to 24.8%. |
Results of Operations
Net Interest Income / Net Interest Margin
The tables on the following pages reflect the Company’s average balance sheets and volume and rate analysis for the three and nine-month periods ended September 30, 2021 and 2020.
The average yields on earning assets and average rates paid on interest-bearing liabilities have been computed on an annualized basis for purposes of comparability with full year data. Average balance amounts for assets and liabilities are the computed average of daily balances.
Net interest income is the amount by which the interest and fees on loans & leases and other interest-earning assets exceed the interest paid on interest-bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as “tax equivalent” adjustment and is noted wherever applicable. The presentation of net interest income and net interest margin on a tax equivalent basis is a common practice within the banking industry.
The Volume and Rate Analysis of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average asset and liability balances (volume) and changes in average rates (rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to: (1) changes in volume (change in volume multiplied by initial rate); (2) changes in rate (change in rate multiplied by initial volume); and (3) changes in rate/volume, also called “changes in mix” (allocated in proportion to the respective volume and rate components).
The Company’s earning assets and rate sensitive liabilities are subject to repricing at different times, which exposes the Company to income fluctuations when interest rates change. In order to minimize income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk – Interest Rate Risk
Farmers & Merchants Bancorp
Quarterly Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
| | | Three Months Ended Sept 30, 2021 | | | Three Months Ended Sept 30, 2020 | |
| Assets | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| Interest Bearing Deposits with Banks | | $ | 856,159 | | | $ | 328 | | | | 0.15 | % | | $ | 314,049 | | | $ | 81 | | | | 0.10 | % |
| Investment Securities: |
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| U.S. Treasury Notes | | | 9,911 | | | | 59 | | | | 2.36 | % | | | 27,423 | | | | 89 | | | | 1.29 | % |
| U.S. Government Agency SBA | | | 7,151 | | | | 14 | | | | 0.78 | % | | | 9,167 | | | | 24 | | | | 1.05 | % |
| Municipals - Taxable | | | 15,088 | | | | 141 | | | | 3.74 | % | | | 19,966 | | | | 156 | | | | 3.13 | % |
Obligations of States and Political Subdivisions - Non-Taxable (1) | | | 49,616 | | | | 503 | | | | 4.06 | % | | | 49,452 | | | | 525 | | | | 4.24 | % |
| Mortgage-Backed Securities | | | 708,322 | | | | 2,937 | | | | 1.66 | % | | | 430,145 | | | | 2,567 | | | | 2.39 | % |
| Other | | | 46,511 | | | | 132 | | | | 1.14 | % | | | 25,477 | | | | 53 | | | | 0.83 | % |
| Total Investment Securities | | | 836,599 | | | | 3,786 | | | | 1.81 | % | | | 561,630 | | | | 3,414 | | | | 2.43 | % |
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Loans & Leases: (2) | | | | | | | | | | | | | | | | | | | | | | | | |
| Real Estate | | | 2,169,270 | | | | 25,354 | | | | 4.64 | % | | | 1,952,892 | | | | 24,193 | | | | 4.93 | % |
| Home Equity Lines & Loans | | | 32,112 | | | | 360 | | | | 4.45 | % | | | 37,815 | | | | 423 | | | | 4.45 | % |
| Agricultural | | | 236,071 | | | | 2,637 | | | | 4.43 | % | | | 263,706 | | | | 3,365 | | | | 5.08 | % |
| Commercial | | | 374,162 | | | | 4,111 | | | | 4.36 | % | | | 362,880 | | | | 4,377 | | | | 4.80 | % |
| Consumer | | | 8,521 | | | | 125 | | | | 5.82 | % | | | 12,261 | | | | 190 | | | | 6.16 | % |
Other (3) | | | 146,661 | | | | 2,138 | | | | 5.78 | % | | | 348,093 | | | | 2,415 | | | | 2.76 | % |
| Leases | | | 96,690 | | | | 1,363 | | | | 5.59 | % | | | 106,272 | | | | 1,446 | | | | 5.41 | % |
| Total Loans & Leases | | | 3,063,487 | | | | 36,088 | | | | 4.67 | % | | | 3,083,919 | | | | 36,409 | | | | 4.70 | % |
| Total Earning Assets | | | 4,756,245 | | | $ | 40,202 | | | | 3.35 | % | | | 3,959,598 | | | $ | 39,904 | | | | 4.01 | % |
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Unrealized Gain on Securities Available-for-Sale | | | 1,995 | | | | | | | | | | | | 20,960 | | | | | | | | | |
| Allowance for Credit Losses | | | (60,268 | ) | | | | | | | | | | | (55,782 | ) | | | | | | | | |
| Cash and Due From Banks | | | 72,887 | | | | | | | | | | | | 61,633 | | | | | | | | | |
| All Other Assets | | | 264,724 | | | | | | | | | | | | 244,056 | | | | | | | | | |
| Total Assets | | $ | 5,035,583 | | | | | | | | | | | $ | 4,230,465 | | | | | | | | | |
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| Liabilities & Shareholders’ Equity | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing DDA | | $ | 1,068,707 | | | $ | 293 | | | | 0.11 | % | | $ | 824,587 | | | $ | 383 | | | | 0.18 | % |
| Savings and Money Market | | | 1,385,430 | | | | 346 | | | | 0.10 | % | | | 1,176,238 | | | | 594 | | | | 0.20 | % |
| Time Deposits | | | 399,246 | | | | 290 | | | | 0.29 | % | | | 468,072 | | | | 1,034 | | | | 0.88 | % |
| Total Interest Bearing Deposits | | | 2,853,383 | | | | 929 | | | | 0.13 | % | | | 2,468,897 | | | | 2,011 | | | | 0.32 | % |
| Subordinated Debentures | | | 10,310 | | | | 78 | | | | 3.00 | % | | | 10,310 | | | | 83 | | | | 3.20 | % |
| Total Interest Bearing Liabilities | | | 2,863,693 | | | $ | 1,007 | | | | 0.14 | % | | | 2,479,207 | | | $ | 2,094 | | | | 0.34 | % |
Interest Rate Spread (4) | | | | | | | | | | | 3.21 | % | | | | | | | | | | | 3.67 | % |
| Demand Deposits (Non-Interest Bearing) | | | 1,655,738 | | | | | | | | | | | | 1,279,142 | | | | | | | | | |
| All Other Liabilities | | | 68,564 | | | | | | | | | | | | 60,812 | | | | | | | | | |
| Total Liabilities | | | 4,587,995 | | | | | | | | | | | | 3,819,161 | | | | | | | | | |
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| Shareholders’ Equity | | | 447,588 | | | | | | | | | | | | 411,304 | | | | | | | | | |
| Total Liabilities & Shareholders’ Equity | | $ | 5,035,583 | | | | | | | | | | | $ | 4,230,465 | | | | | | | | | |
Net Interest Income and Margin on Total Earning Assets (5) | | | | | | | 39,195 | | | | 3.27 | % | | | | | | | 37,810 | | | | 3.80 | % |
| Tax Equivalent Adjustment | | | | | | | (104 | ) | | | | | | | | | | | (111 | ) | | | | |
| Net Interest Income | | | | | | $ | 39,091 | | | | 3.26 | % | | | | | | $ | 37,699 | | | | 3.79 | % |
(1) Yields and interest income are calculated on an fully taxable equivalent basis using the current statutory federal tax rate.
(2) Average balances on loans & leases outstanding include non-performing loans, if any. The amortized portion of net loan origination fees is included in interest income on loans & leases, representing an adjustment to the yield.
(3) Includes Cares Act Small Business Administration Paycheck Protection Progam loans.
(4) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(5) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
| | | Nine Months Ended Sept. 30, 2021 | | | Nine Months Ended Sept. 30, 2020 | |
| Assets | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| Interest Bearing Deposits with Banks | | $ | 620,757 | | | $ | 595 | | | | 0.13 | % | | $ | 286,049 | | | $ | 1,093 | | | | 0.51 | % |
| Investment Securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury Notes | | | 12,071 | | | | 212 | | | | 2.35 | % | | | 19,897 | | | | 267 | | | | 1.79 | % |
| U.S. Government Agency SBA | | | 7,590 | | | | 41 | | | | 0.72 | % | | | 9,799 | | | | 94 | | | | 1.28 | % |
| Municipals - Taxable | | | 15,662 | | | | 445 | | | | 3.79 | % | | | 11,362 | | | | 359 | | | | 4.21 | % |
Obligations of States and Political Subdivisions - Non-Taxable (1) | | | 52,816 | | | | 1,562 | | | | 3.94 | % | | | 52,741 | | | | 1,587 | | | | 4.01 | % |
| Mortgage-Backed Securities | | | 738,454 | | | | 9,396 | | | | 1.70 | % | | | 445,336 | | | | 8,432 | | | | 2.52 | % |
| Other | | | 45,970 | | | | 687 | | | | 1.99 | % | | | 10,747 | | | | 64 | | | | 0.79 | % |
| Total Investment Securities | | | 872,563 | | | | 12,343 | | | | 1.89 | % | | | 549,882 | | | | 10,803 | | | | 2.62 | % |
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Loans & Leases: (2) | | | | | | | | | | | | | | | | | | | | | | | | |
| Real Estate | | | 2,131,071 | | | | 75,041 | | | | 4.71 | % | | | 1,885,455 | | | | 71,031 | | | | 5.03 | % |
| Home Equity Lines & Loans | | | 32,417 | | | | 1,083 | | | | 4.47 | % | | | 39,162 | | | | 1,447 | | | | 4.94 | % |
| Agricultural | | | 229,862 | | | | 7,758 | | | | 4.51 | % | | | 264,528 | | | | 10,180 | | | | 5.14 | % |
| Commercial | | | 365,744 | | | | 12,567 | | | | 4.59 | % | | | 378,272 | | | | 13,810 | | | | 4.88 | % |
| Consumer | | | 9,388 | | | | 1,010 | | | | 14.38 | % | | | 13,294 | | | | 619 | | | | 6.22 | % |
Other (3) | | | 194,295 | | | | 8,245 | | | | 5.67 | % | | | 209,653 | | | | 3,521 | | | | 2.24 | % |
| Leases | | | 100,347 | | | | 4,135 | | | | 5.51 | % | | | 105,880 | | | | 4,272 | | | | 5.39 | % |
| Total Loans & Leases | | | 3,063,124 | | | | 109,839 | | | | 4.79 | % | | | 2,896,244 | | | | 104,880 | �� | | | 4.84 | % |
| Total Earning Assets | | | 4,556,444 | | | $ | 122,777 | | | | 3.60 | % | | | 3,732,175 | | | $ | 116,776 | | | | 4.18 | % |
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Unrealized Gain on Securities Available-for-Sale | | | 5,431 | | | | | | | | | | | | 16,096 | | | | | | | | | |
| Allowance for Credit Losses | | | (59,971 | ) | | | | | | | | | | | (55,190 | ) | | | | | | | | |
| Cash and Due From Banks | | | 68,755 | | | | | | | | | | | | 61,588 | | | | | | | | | |
| All Other Assets | | | 255,847 | | | | | | | | | | | | 238,898 | | | | | | | | | |
| Total Assets | | $ | 4,826,506 | | | | | | | | | | | $ | 3,993,567 | | | | | | | | | |
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| Liabilities & Shareholders’ Equity | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing DDA | | $ | 1,002,267 | | | $ | 869 | | | | 0.12 | % | | $ | 761,437 | | | $ | 1,342 | | | | 0.24 | % |
| Savings and Money Market | | | 1,336,826 | | | | 1,136 | | | | 0.11 | % | | | 1,091,672 | | | | 2,280 | | | | 0.28 | % |
| Time Deposits | | | 408,730 | | | | 1,195 | | | | 0.39 | % | | | 503,319 | | | | 3,991 | | | | 1.06 | % |
| Total Interest Bearing Deposits | | | 2,747,823 | | | | 3,200 | | | | 0.16 | % | | | 2,356,428 | | | | 7,613 | | | | 0.43 | % |
| Federal Home Loan Bank Advances | | | - | | | | - | | | | 0.00 | % | | | 1 | | | | - | | | | 0.00 | % |
| Subordinated Debentures | | | 10,310 | | | | 236 | | | | 3.06 | % | | | 10,310 | | | | 296 | | | | 3.83 | % |
| Total Interest Bearing Liabilities | | | 2,758,133 | | | $ | 3,436 | | | | 0.17 | % | | | 2,366,739 | | | $ | 7,909 | | | | 0.45 | % |
Interest Rate Spread(4) | | | | | | | | | | | 3.44 | % | | | | | | | | | | | 3.73 | % |
| Demand Deposits (Non-Interest Bearing) | | | 1,567,089 | | | | | | | | | | | | 1,169,333 | | | | | | | | | |
| All Other Liabilities | | | 64,439 | | | | | | | | | | | | 61,024 | | | | | | | | | |
| Total Liabilities | | | 4,389,661 | | | | | | | | | | | | 3,597,096 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders’ Equity | | | 436,845 | | | | | | | | | | | | 396,471 | | | | | | | | | |
| Total Liabilities & Shareholders’ Equity | | $ | 4,826,506 | | | | | | | | | | | $ | 3,993,567 | | | | | | | | | |
Net Interest Income and Margin on Total Earning Assets (5) | | | | | | | 119,341 | | | | 3.50 | % | | | | | | | 108,867 | | | | 3.90 | % |
| Tax Equivalent Adjustment | | | | | | | (324 | ) | | | | | | | | | | | (327 | ) | | | | |
| Net Interest Income | | | | | | $ | 119,017 | | | | 3.49 | % | | | | | | $ | 108,540 | | | | 3.88 | % |
(1) Yields and interest income are calculated on an fully taxable equivalent basis using the current statutory federal tax rate.
(2) Average balances on loans & leases outstanding include non-performing loans, if any. The amortized portion of net loan origination fees is included in interest income on loans & leases, representing an adjustment to the yield.
(3) Includes CARES Act Small Business Administration Paycheck Protection Progam loans.
(4) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(5) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Revenue
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
| | Three Months Ended Sept. 30, 2021 compared to Sept. 30, 2020 | | | Nine Months Ended Sept. 30, 2021 compared to Sept. 30, 2020 |
| Interest Earning Assets | | Volume | | | Rate | | | Net Chg. | | | Volume | | | Rate | | | Net Chg. | |
| Interest Bearing Deposits with Banks | | $ | 193 | | | $ | 54 | | | $ | 247 | | | $ | 696 | | | $ | (1,194 | ) | | $ | (498 | ) |
| Investment Securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasuries | | | (78 | ) | | | 47 | | | | (30 | ) | | | (123 | ) | | | 68 | | | | (55 | ) |
| U.S. Government Agency SBA | | | (14 | ) | | | 4 | | | | (10 | ) | | | (31 | ) | | | (22 | ) | | | (53 | ) |
| Municipals - Taxable | | | (42 | ) | | | 28 | | | | (15 | ) | | | 117 | | | | (31 | ) | | | 86 | |
| Obligations of States and Political Subdivisions - Non-Taxable | | | 2 | | | | (23 | ) | | | (21 | ) | | | 2 | | | | (27 | ) | | | (25 | ) |
| Mortgage-Backed Securities | | | 700 | | | | (330 | ) | | | 370 | | | | 1,922 | | | | (958 | ) | | | 964 | |
| Other | | | 55 | | | | 24 | | | | 79 | | | | 427 | | | | 197 | | | | 623 | |
| Total Investment Securities | | | 623 | | | | (250 | ) | | | 373 | | | | 2,313 | | | | (773 | ) | | | 1,540 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans & Leases: | | | | | | | | | | | | | | | | | | | | | | | | |
| Real Estate | | | 2,490 | | | | (1,329 | ) | | | 1,161 | | | | 7,936 | | | | (3,926 | ) | | | 4,010 | |
| Home Equity Lines & Loans | | | (62 | ) | | | (0 | ) | | | (63 | ) | | | (198 | ) | | | (167 | ) | | | (364 | ) |
| Agricultural | | | (576 | ) | | | (152 | ) | | | (728 | ) | | | 1,035 | | | | (3,457 | ) | | | (2,422 | ) |
| Commercial | | | 136 | | | | (403 | ) | | | (266 | ) | | | (481 | ) | | | (762 | ) | | | (1,243 | ) |
| Consumer | | | (54 | ) | | | (12 | ) | | | (65 | ) | | | (226 | ) | | | 617 | | | | 391 | |
Other(1) | | | (1,915 | ) | | | 1,638 | | | | (277 | ) | | | (277 | ) | | | 5,002 | | | | 4,724 | |
| Leases | | | (131 | ) | | | 48 | | | | (83 | ) | | | (230 | ) | | | 92 | | | | (137 | ) |
| Total Loans & Leases | | | (113 | ) | | | (209 | ) | | | (321 | ) | | | 7,559 | | | | (2,601 | ) | | | 4,958 | |
| Total Earning Assets | | | 703 | | | | (405 | ) | | | 299 | | | | 10,569 | | | | (4,568 | ) | | | 6,001 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing DDA | | | 231 | | | | (321 | ) | | | (90 | ) | | | 782 | | | | (1,255 | ) | | | (473 | ) |
| Savings and Money Market | | | 134 | | | | (382 | ) | | | (248 | ) | | | 698 | | | | (1,842 | ) | | | (1,144 | ) |
| Time | | | (179 | ) | | | (565 | ) | | | (744 | ) | | | (954 | ) | | | (1,842 | ) | | | (2,796 | ) |
| Total Interest Bearing Deposits | | | 186 | | | | (1,268 | ) | | | (1,082 | ) | | | 526 | | | | (4,939 | ) | | | (4,413 | ) |
| Subordinated Debentures | | | - | | | | (5 | ) | | | (5 | ) | | | - | | | | (60 | ) | | | (60 | ) |
| Total Interest Bearing Liabilities | | | 186 | | | | (1,273 | ) | | | (1,087 | ) | | | 526 | | | | (4,999 | ) | | | (4,473 | ) |
| Total Change on a Tax Equivalent Basis | | $ | 517 | | | $ | 868 | | | $ | 1,386 | | | $ | 10,043 | | | $ | 431 | | | $ | 10,474 | |
(1) Includes CARES Act Small Business Administration Paycheck Protection Progam loans.
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total “net change.” The above figures have been rounded to the nearest whole number.
Third Quarter 2021 vs. Third Quarter 2020
Net interest income for the third quarter of 2021 increased 3.7% or $1.4 million to $39.1 million. On a fully taxable equivalent basis, net interest income increased 3.7% and totaled $39.2 million for the third quarter of 2021. As more fully discussed below, the increase in net interest income was due primarily to a $796.6 million increase in average earning assets offset by a 53 basis point decrease in the net interest margin.
Net interest income on a taxable equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For the quarter ended September 30, 2021, the Company’s net interest margin was 3.27% compared to 3.80% for the quarter ended September 30, 2020. This decrease in net interest margin was due primarily to a 66 basis point decrease in yield on earning assets offset somewhat by a 20 basis point decrease in the cost of interest bearing liabilities.
Average loans & leases totaled $3.1 billion for the quarter ended September 30, 2021; a decrease of $20.4 million compared to the average balance for the quarter ended September 30, 2020. Loans & leases decreased from 77.9% of average earning assets at September 30, 2020 to 64.4% at September 30, 2021. The annualized yield on the Company’s loan & lease portfolio decreased slightly to 4.67% for the quarter ended September 30, 2021, compared to 4.70% for the quarter ended September 30, 2020. This decrease in the current quarter as compared to the same quarter last year was due to the decline in rates across loan types due to an overall drop in market interest rates offset by an increase in PPP loans earning at a rate of 5.78% as compared to 2.76% in the third quarter of 2020. This increase in yield on PPP loans was due to the SBA’s forgiveness of a significant volume of these loans during the third quarter of 2021, which resulted in a large amount of deferred loan fees being accreted into income during the quarter.
A lower yield, when combined with the impact of a decrease in average loan & lease balances, resulted in interest revenue from loans & leases decreasing slightly by 3 basis points to $36.1 million. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to continue to respond in order to retain key customers. This could place negative pressure on future loan & lease yields and net interest margin.
The investment portfolio is the other main component of the Company’s earning assets. Historically, the Company has invested primarily in: (1) mortgage-backed securities issued by U.S. government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than seven years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.
Average investment securities totaled $836.6 million for the quarter ended September 30, 2021; an increase of $275 million compared to the average balance for the quarter ended September 30, 2020. The average investment portfolio yield, on a tax equivalent (TE) basis, was 1.81% for the quarter ended September 30, 2021, compared to 2.43% for the quarter ended September 30, 2020. This overall decrease in yield was caused primarily by a drop in market interest rates. As a result of the combined impact of these balance and yield changes, tax equivalent interest income on securities increased $373,000 to $3.79 million for the quarter ended September 30, 2021, compared to $3.41 million for the quarter ended September 30, 2020. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2021. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.
Interest-bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earn interest at the Fed Funds rate, which was .15% in September 2021 compared to .10% in September 2020. Average interest-bearing deposits with banks for the quarter ended September 30, 2021, was $856.2 million, an increase of $542.1 million compared to the average balance for the quarter ended September 30, 2020. Interest income on interest-bearing deposits with banks for the quarter ended September 30, 2021, increased $247,000 to $328,000 compared to the quarter ended September 30, 2020.
Average interest-bearing liabilities increased $384.5 million or 15.5% during the third quarter of 2021. Of that increase: (1) interest-bearing transaction deposits increased $244.1 million; (2) savings and money market deposits increased $209.2 million; (3) time deposits decreased $68.8 million (see “Financial Condition – Deposits”); (4) FHLB advances remained unchanged (see “Financial Condition – Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”); and (5) subordinated debt remained unchanged (see “Financial Condition – Subordinated Debentures”). A significant portion of this deposit growth was a result of funds from the SBA PPP being deposited into borrower accounts until those funds will be used for operating expenses.
Total interest expense on interest-bearing deposits was $929,000 for the third quarter of 2021 as compared to $2.0 million for the third quarter of 2020. The average rate paid on interest-bearing deposits was 0.13% for the third quarter of 2021 compared to 0.32% for the third quarter of 2020 due to the significant drop in market interest rates.
Nine Months Ended September 30, 2021 vs. Nine Months Ended September 30, 2020
During the first nine months of 2021, net interest income increased 9.65% to $119.0 million, compared to $108.5 million at September 30, 2020. On a fully taxable equivalent basis, net interest income increased 9.62% and totaled $119.3 million at September 30, 2021, compared to $108.9 million at September 30, 2020. As more fully discussed below the increase in net interest income was primarily due to a $824.3 million increase in average earning assets offset by a 40 basis point decrease in the net interest margin.
For the nine months ended September 30, 2021, the Company’s net interest margin was 3.50% compared to 3.90% for the same period in 2020. This decrease in net interest margin was due primarily to a decrease of 0.58% in the yield received on earning assets, offset somewhat by a 28 basis point decrease in the cost of interest-bearing liabilities.
The average balance of loans & leases increased by $166.9 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. The yield on the loan & lease portfolio decreased 5 basis points to 4.79% for the nine months ended September 30, 2021, compared to 4.84% for the nine months ended September 30, 2020. This lower yield offset somewhat the positive impact of increased average loan & lease balances resulting in interest revenue from loans & leases increasing 4.73% or $4.9 million for the first nine months of 2021.
Average investment securities were $872.6 million for the nine months ended September 30, 2021 compared to $549.9 million for the same period in 2020. The average investment portfolio yield, on a tax equivalent basis, for the nine months ended September 30, 2021, was 1.89% compared to 2.62% for the nine months ended September 30, 2020. This overall decrease in yield was caused primarily by a drop in market interest rates. As a result of the combined impact of these balance and yield changes, tax equivalent interest income on securities increased $1.5 million to $12.3 million for nine months ended September 30, 2021 compared to $10.8 million for the nine months ended September 30, 2020. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2021. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.
Interest-bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company. Interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earn interest at the Fed Funds rate, which was .13% for the nine months ended September 2021, compared to .51% for the nine months ended September 2020. Average interest-bearing deposits with banks for the nine months ended September 30, 2021, was $620.7 million, an increase of $334.7 million compared to the average balance for the nine months ended September 30, 2020. Interest income on interest-bearing deposits with banks for the nine months ended September 30, 2021, decreased $498,000 to $595,000 million compared to the nine months ended September 30, 2020.
Average interest-bearing liabilities increased $391.4 million or 16.5% during the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020. Of that increase: (1) interest-bearing transaction deposits increased $240.8 million; (2) savings and money market deposits increased $245.2 million; (3) time deposits decreased $94.6 million (see “Financial Condition – Deposits”); and (4) FHLB advances remained unchanged (see “Financial Condition – Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”); and (5) subordinated debt remained unchanged (see “Financial Condition – Subordinated Debentures”).
Total interest expense on interest-bearing deposits was $3.2 million for the first nine months of 2021 as compared to $7.6 million for the first nine months of 2020. The average rate paid on interest-bearing deposits was 0.16% in the first nine months of 2021 and 0.43% in the first nine months of 2020, due to the significant drop in market interest rates.
Provision and Allowance for Credit Losses
As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management reports regularly to the Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts credit reviews of individual loans & leases. Loans & leases that are performing but have shown some signs of weakness are subject to more stringent reporting and oversight.
Allowance for Credit Losses
The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company’s loan & lease portfolio as of the balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans & leases determined to be impaired are individually evaluated for impairment. When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s or lease’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease’s observable market price, or the fair value of the collateral if the loan or lease is collateral dependent. A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying collateral.
A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons related to the borrower’s financial difficulties grants a more than insignificant concession to the borrower that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on non-accrual status at the time they become TDR, remain on non-accrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
The determination of the general reserve for loans or leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1st mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer & other; and (9) equipment leases. See “Financial Condition – Loans & Leases” for examples of loans & leases made by the Company. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company’s overall allowance, which is included on the consolidated balance sheet.
The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans or leases, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by independent specialists engaged by the Company. The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment. See “Note 1 Significant Accounting Policies - Allowance for Credit Losses.”
In addition, the Company’s and Bank’s regulators, including the FRB, DFPI and FDIC, as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Provision for Credit Losses
Changes in the provision for credit losses between years are the result of management’s evaluation, based upon information currently available, of the adequacy of the allowance for credit losses relative to factors such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on borrowers’ ability to repay loans & leases in accordance with the terms of the notes.
The State of California experienced drought conditions from 2013 through most of 2016. After 2016, reasonable levels of rain and snow alleviated drought conditions in our primary service area, but the winter of 2020-2021 was once again dry. Despite this, the availability of water in our primary service area was not an issue for the 2021 growing season. However, the weather patterns over the past eight years further reinforce the fact that the long-term risks associated with the availability of water are significant.
The Company made a $1.25 million provision for credit losses during the first nine months of 2021 compared to $2.0 million for the same period in 2020. Net recoveries during the first nine months of 2021 were $191,000 compared to net charge-offs of $214,000 in the first nine months of 2020. See “Overview – Looking Forward: 2021 and Beyond”, “Critical Accounting Policies and Estimates – Allowance for Credit Losses” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” located in the Company’s 2020 Annual Report on Form 10-K.
After reviewing all factors above, management concluded that the allowance for credit losses, as of September 30, 2021 were adequate.
The following table contains the allowance for credit losses for the three and nine-month periods ended September 2021 and 2020:
| | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, | | | September 30, | |
| | | | | | | | | | | | | |
| (in thousands) | | 2021 | | | 2020 | | | 2021 | | | 2020 | |
| Balance at Beginning of Period | | $ | 60,229 | | | $ | 55,058 | | | $ | 58,862 | | | $ | 55,012 | |
| Charge-Offs | | | (17 | ) | | | (25 | ) | | | (33 | ) | | | (487 | ) |
| Recoveries | | | 91 | | | | 65 | | | | 224 | | | | 273 | |
| Provision | | | - | | | | 1,700 | | | | 1,250 | | | | 2,000 | |
| Balance at End of Period | | $ | 60,303 | | | $ | 56,798 | | | $ | 60,303 | | | $ | 56,798 | |
The table below breaks out current quarter activity by portfolio segment (in thousands):
| September 30, 2021 | | Commercial Real Estate | | | Agricultural Real Estate | | | Real Estate Construction | | | Residential 1st Mortgages | | | Home Equity Lines & Loans | | | Agricultural | | | Commercial | | | Consumer & Other | | | Leases | | | Unallocated | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year-To-Date Allowance for Credit Losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Beginning Balance- December 31, 2020 | | $ | 27,679 | | | $ | 8,633 | | | $ | 1,643 | | | $ | 960 | | | $ | 2,024 | | | $ | 4,814 | | | $ | 9,961 | | | $ | 333 | | | $ | 1,731 | | | $ | 1,084 | | | $ | 58,862 | |
| Charge-Offs | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (33 | ) | | | - | | | | - | | | | (33 | ) |
| Recoveries | | | - | | | | - | | | | - | | | | 74 | | | | 17 | | | | 29 | | | | 83 | | | | 21 | | | | - | | | | - | | | | 224 | |
| Provision | | | 1,200 | | | | 794 | | | | (210 | ) | | | (70 | ) | | | (129 | ) | | | (238 | ) | | | 738 | | | | (23 | ) | | | (872 | ) | | | 60 | | | | 1,250 | |
| Ending Balance- September 30, 2021 | | $ | 28,879 | | | $ | 9,427 | | | $ | 1,433 | | | $ | 964 | | | $ | 1,912 | | | $ | 4,605 | | | $ | 10,782 | | | $ | 298 | | | $ | 859 | | | $ | 1,144 | | | $ | 60,303 | |
| Third Quarter Allowance for Credit Losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Beginning Balance- June 30, 2021 | | $ | 28,890 | | | $ | 9,107 | | | $ | 1,405 | | | $ | 957 | | | $ | 1,899 | | | $ | 4,552 | | | $ | 9,920 | | | $ | 281 | | | $ | 1,639 | | | $ | 1,579 | | | $ | 60,229 | |
| Charge-Offs | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (17 | ) | | | - | | | | - | | | | (17 | ) |
| Recoveries | | | - | | | | - | | | | - | | | | 15 | | | | 6 | | | | 24 | | | | 38 | | | | 8 | | | | - | | | | - | | | | 91 | |
| Provision | | | (11 | ) | | | 320 | | | | 28 | | | | (8 | ) | | | 7 | | | | 29 | | | | 824 | | | | 26 | | | | (780 | ) | | | (435 | ) | | | - | |
| Ending Balance- September 30, 2021 | | $ | 28,879 | | | $ | 9,427 | | | $ | 1,433 | | | $ | 964 | | | $ | 1,912 | | | $ | 4,605 | | | $ | 10,782 | | | $ | 298 | | | $ | 859 | | | $ | 1,144 | | | $ | 60,303 | |
The Allowance for Credit Losses at September 30, 2021 increased $3.5 million from September 30, 2020 and increased $1.41 million from December 31, 2020. The Company believes that an allowance of 1.92% of gross loans (2.00% when government guaranteed SBA PPP loans are excluded) provides sufficiently for our exposure at the current time.
Changes to the reserve during the first nine months of 2021 are due to: (1) changes in volume by segment and (2) changes in the underlying credit quality of the loan and lease portfolio. Overall: (1) reserves for “Agricultural” and “Agricultural Real Estate” loans (which are currently thought to have more limited COVID-19 loss exposure since agricultural activity has substantially continued) have remained relatively stable or increased due to volume changes; (2) reserves for Commercial Real Estate (where our COVID-19 exposure is thought to be greater since many of these companies and consumers were, and may continue to be, impacted by “non-essential” designations and “shelter-in-place” orders) have been increased; (3) reserves for Commercial loans have increased with volume; and (4) reserves for “Leases” have decreased as that relatively new product segment matures within our portfolio and the risk is perceived to be lower. See “Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.
See “Management’s Discussion and Analysis - Financial Condition – Classified Loans & Leases and Non-Performing Assets” for further discussion regarding these loan categories.
See “Note 6. Allowance for Credit Losses” for additional details regarding the provision and allowance for credit losses.
Non-Interest Income
Non-interest income includes: (1) service charges and fees from deposit accounts; (2) net gains and losses from investment securities; (3) increases in the cash surrender value of bank owned life insurance; (4) debit card and ATM fees; (5) net gains and losses on non-qualified deferred compensation plans; and (6) fees from other miscellaneous business services.
Third Quarter 2021 vs. Third Quarter 2020
Non-interest income increased $321,000 or 7.1% for the three months ended September 30, 2021, compared to the same period of 2020. This increase was primarily due to: (1) a $323,000 increase in debit card/ATM fees; (2) a $154,000 increase in service charges collected on deposit accounts; (3) a $136,000 increase in other miscellaneous non-interest income; (4) an increase of $76,000 in dividends received from the FHLB; (5) a $21,000 increase in value of Bank owned life insurance; and (6) an $18,600 increase in gain on sales of leases. This increase is partially offset by: (1) a $407,000 decrease in the net gain on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income).
Nine Months Ended September 30, 2021 vs. Nine Months Ended September 30, 2020
Non‑interest income increased $5.9 million or 54.3% for the nine months ended September 30, 2021, compared to the same period of 2020. This increase was primarily due to: (1) a $2.5 million increase in gain on the sale of investment securities; (2) a $1.1 million increase in debit card/ATM fees; (3) a $945,000 increase in the net gain on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income); (4) a $687,000 increase in gain on sales of leases; (5) a $177,000 increase in service charges collected on deposit accounts; and (6) a $156,000 increase in dividend income received from FHLB.
Non-Interest Expense
Non-interest expense for the Company includes expenses for: (1) salaries and employee benefits; (2) net gains and losses on non-qualified deferred compensation plan investments; (3) occupancy; (4) equipment; (5) supplies; (6) legal fees; (7) professional services; (8) data processing; (9) marketing; (10) deposit insurance; (11) ORE carrying costs and gains/losses on sale; and (12) other miscellaneous expenses.
Third Quarter 2021 vs. Third Quarter 2020
Overall, non-interest expense decreased $198,000 or 1.0% for the three months ended September 30, 2021, compared to the same period in 2020. This decrease was primarily comprised of: (1) a $524,000 decrease in other miscellaneous expenses; (2) a $407,000 decrease in the net gain on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income); and (3) a $182,000 decrease in marketing expenses. These decreases were partially offset by (1) an $847,000 increase in salaries and employee benefits; (2) a $68,000 increase in FDIC insurance.
Nine Months Ended September 30, 2021 vs. Nine Months Ended September 30, 2020
Non-interest expense increased $7.4 million or 12.2% for the nine months ended September 30, 2021, compared to the same period of 2020. This increase was primarily comprised of: (1) a $5.1 million increase in salaries and employee benefits; (2) a $945,000 increase in the net gain on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income); (3) a $646,000 increase in FDIC insurance; (4) a $385,000 increase in legal expense; (5) a $154,000 increase in marketing expense; and (6) a $125,000 increase in occupancy expense.
Income Taxes
The Bank’s provision for income taxes increased 18.6% to $5.9 million for the third quarter of 2021 compared to the third quarter of 2020. The Company’s effective tax rate for the third quarter of 2021 was 25.10% compared to 25.03% for the third quarter of 2020. The Company’s effective tax rate can fluctuate from quarter to quarter due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to benefits regarding the cash surrender value of life insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans.
Financial Condition
This section discusses material changes in the Company’s consolidated balance sheet at September 30, 2021, as compared to December 31, 2020, and to September 30, 2020. As previously discussed (see “Overview”), the Company’s consolidated financial condition can be influenced by the seasonal banking needs of its agricultural customers.
Investment Securities and Federal Funds Sold
The investment portfolio provides the Company with an income alternative to loans & leases. The debt securities in the Company’s investment portfolio have historically been comprised primarily of: (1) mortgage-backed securities issued by U.S. government-sponsored entities; (2) debt securities issued by U.S. Treasury, government agencies and U.S. government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than seven years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.
The Company’s investment portfolio at September 30, 2021, was $883.8 million compared to $638.4 million at the end of 2020, an increase of $245.3 million or 38.4%. At December 31, 2020, the investment portfolio totaled $876.7 million.
The Company’s total investment portfolio currently represents 17.3% of the Company’s total assets as compared to 19.3% at December 31, 2020, and 14.8% at September 30, 2020.
As of September 30, 2021, the Company held $62.9 million of municipal investments, all classified as HTM. Of this balance, $21.3 million were bank-qualified municipal bonds, and $41.6 million were private placement municipal bonds, and CRA qualified investments in our service area. In order to comply with Section 939A of the Dodd-Frank Act, the Company performs its own credit analysis on new purchases of municipal bonds. As of September 30, 2021, all of the Company’s bank-qualified municipal bond portfolio was rated at either the issue or issuer level, and all of these ratings were “investment grade.” The Company monitors the status of all municipal investments, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.
Not included in the investment portfolio are interest-bearing deposits with banks and overnight investments in Federal Funds Sold. Interest-bearing deposits with banks consisted of FRB deposits. The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest-bearing deposits with banks totaled $804.3 million at September 30, 2021, $317.5 million at December 31, 2020, and $299.6 million at September 30, 2020.
The Company classifies its investments as held-to-maturity (“HTM”), trading, or available-for-sale (“AFS”). Securities are classified as HTM and are carried at amortized cost when the Company has the intent and ability to hold the securities to maturity. During the first quarter of 2021, $316.9 million in mortgage-backed securities were transferred from available-for-sale securities to held-to-maturity at fair value. See “Note 3 – Investment Securities” for additional details regarding the transfer of investment securities. Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income. As of September 30, 2021, December 31, 2020, and September 30, 2020, there were no securities in the trading portfolio. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes.
Loans & Leases
Loans & leases can be categorized by borrowing purpose and use of funds. Common examples of loans & leases made by the Company include:
Commercial and Agricultural Real Estate - These are loans secured by farmland, commercial real estate, multifamily residential properties, and other non-farm, non-residential properties generally within our market area. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, and the income will be the Bank’s primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe); have debt service coverage ratios of 1.00 or better with a target of greater than 1.25; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Real Estate Construction - These are loans for development and construction (the Company generally requires the borrower to fund the land acquisition) and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with whom the Bank has a successful track record; for projects in our service area; with Loan To Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are made only when there is a written take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate or LIBOR with an appropriate spread based on the amount of perceived risk in the loan.
Residential 1st Mortgages - These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC; however, we will make loans on rural residential properties up to 40 acres. Most residential loans have terms from ten to twenty years and carry fixed rates priced off of treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”
Home Equity Lines and Loans - These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $250,000; Combined Loan To Value (CLTV) does not exceed 80%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1st lien position.
Agricultural - These are loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 24 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Commercial - These are loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 24 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Consumer - These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a minimal consumer loan portfolio, and loans are primarily made as an accommodation to deposit customers.
Leases - These are leases to businesses or individuals, for the purpose of financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
The Company accounts for leases with Investment Tax Credits (ITC) under the deferred method as established in ASC 740-10. ITC are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.
See “ITEM 3. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” for a discussion about the credit risks the Company assumes and its overall credit risk management practices.
Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type. The Company’s policies require that loans & leases are approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.
Most loans & leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made.
In order to be responsive to borrower needs, the Company prices loans & leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices; as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 3. Quantitative and Qualitative Disclosures About Market Risk-Interest Rate Risk” for further details.
Overall, the Company’s loan & lease portfolio at September 30, 2021, totaled $3.1 billion, an increase of $27.9 million or 0.9% over September 30, 2020. Exclusive of SBA PPP loans, the loan portfolio grew $253.9 million, or 9.2%, over September 30, 2020. This increase in the non-PPP loan portfolio occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; and (2) expansion of our service area into the East Bay of San Francisco and Napa. No assurances can be made that this growth in the loan & lease portfolio will continue. Loans & leases at September 30, 2021 increased $40.2 million from $3.1 billion at December 31, 2020.
The following table sets forth the distribution of the loan & lease portfolio by type and percent as of the periods indicated.
| (in thousands) | | September 30, 2021 | | | December 31, 2020 | | | September 30, 2020 | |
| Commercial Real Estate | | $ | 1,126,230 | | | | 35.7 | % | | $ | 971,326 | | | | 31.2 | % | | $ | 887,999 | | | | 28.4 | % |
| Agricultural Real Estate | | | 656,337 | | | | 20.8 | % | | | 643,014 | | | | 20.7 | % | | | 639,172 | | | | 20.4 | % |
| Real Estate Construction | | | 178,451 | | | | 5.7 | % | | | 185,741 | | | | 6.0 | % | | | 186,623 | | | | 6.0 | % |
| Residential 1st Mortgages | | | 309,728 | | | | 9.8 | % | | | 299,379 | | | | 9.6 | % | | | 293,489 | | | | 9.4 | % |
| Home Equity Lines & Loans | | | 31,664 | | | | 1.0 | % | | | 34,239 | | | | 1.1 | % | | | 35,875 | | | | 1.1 | % |
| Agricultural | | | 235,085 | | | | 7.5 | % | | | 264,372 | | | | 8.5 | % | | | 252,031 | | | | 8.1 | % |
| Commercial | | | 394,326 | | | | 12.5 | % | | | 374,816 | | | | 12.0 | % | | | 367,052 | | | | 11.7 | % |
Consumer & Other (1) | | | 129,665 | | | | 4.1 | % | | | 235,529 | | | | 7.6 | % | | | 359,697 | | | | 11.5 | % |
| Leases | | | 90,022 | | | | 2.9 | % | | | 103,117 | | | | 3.3 | % | | | 105,511 | | | | 3.4 | % |
| Total Gross Loans & Leases | | | 3,151,508 | | | | 100.0 | % | | | 3,111,533 | | | | 100.0 | % | | | 3,127,449 | | | | 100.0 | % |
| Less: Unearned Income | | | 11,707 | | | | | | | | 11,941 | | | | | | | | 15,518 | | | | | |
| Subtotal | | | 3,139,801 | | | | | | | | 3,099,592 | | | | | | | | 3,111,931 | | | | | |
| Less: Allowance for Credit Losses | | | 60,303 | | | | | | | | 58,862 | | | | | | | | 56,798 | | | | | |
| Net Loans & Leases | | $ | 3,079,498 | | | | | | | $ | 3,040,730 | | | | | | | $ | 3,055,133 | | | | | |
(1) Includes CARES Act Small Business Administration Paycheck Protection Program loans of $121,182, $224,309 and $347,180 as of September 30, 2021, December 31,2020 and September 30, 2020, respectively.
Classified Loans & Leases and Non-Performing Assets
All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies. See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk grades. The Company utilizes the services of a third-party independent loan & lease review firm to perform evaluations of individual loans & leases and review the credit risk grades the Company places on loans & leases. Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified” and these loans & leases receive increased management attention. As of September 30, 2021, classified loans totaled $16.8 million compared to $18.6 million at December 31, 2020, and $20.8 million at September 30, 2020.
Classified loans & leases with higher levels of credit risk can be further designated as “impaired” loans & leases. A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. See “Results of Operations - Provision and Allowance for Credit Losses” for further details. Impaired loans & leases consist of: (1) non-accrual loans & leases; and/or (2) restructured loans & leases that are still performing (i.e., accruing interest).
Non-Accrual Loans & leases - Accrual of interest on loans & leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans & leases are 90 days past due, but in management’s judgment are well secured and in the process of collection, they may not be classified as non-accrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans & leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. At September 30, 2021, non-accrual loans & leases totaled $516,000. At December 31, 2020 and September 30, 2020, non-accrual loans & leases totaled $495,000 and $498,000, respectively.
Restructured Loans & Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on non-accrual status at the time they become TDR loans or leases, remain on non-accrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
As of September 30, 2021, restructured loans & leases on accrual totaled $7.6 million as compared to $7.9 million at December 31, 2020, and $7.9 million at September 30, 2020.
Other Real Estate - Loans where the collateral has been repossessed are classified as other real estate (“ORE”) or, if the collateral is personal property, the loan is classified as other assets on the Company’s financial statements.
Not included in the table below, but relevant to a discussion of asset quality are loans that were granted some form of relief because of COVID-19 and are not considered TDRs because of the CARES Act and H.R. 133. Since April 2020, we have restructured $278.1 million of loans under the CARES Act and H.R. 133 guidelines (see “Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure”).
The following table sets forth the amount of the Company’s non-performing loans & leases (defined as non-accrual loans & leases plus accruing loans & leases past due 90 days or more) and ORE as of the dates indicated.
Non-Performing Assets
| (in thousands) | | September 30, 2021 | | | December 31, 2020 | | | September 30, 2020 | |
| Non-Performing Loans & Leases | | $ | 516 | | | $ | 495 | | | $ | 498 | |
| Other Real Estate | | | 873 | | | | 873 | | | | 873 | |
| Total Non-Performing Assets | | $ | 1,389 | | | $ | 1,368 | | | $ | 1,371 | |
| Non-Performing Loans & Leases | | | | | | | | | | | | |
| as a % of Total Loans & Leases | | | 0.02 | % | | | 0.02 | % | | | 0.02 | % |
| Restructured Loans & Leases (Performing) | | $ | 7,631 | | | $ | 7,868 | | | $ | 7,890 | |
Although management believes that non-performing loans & leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. Specific reserves of $0, $92,000, and $92,400 have been established for non-performing loans & leases at September 30, 2021, December 31, 2020 and September 30, 2020, respectively.
Foregone interest income on non-accrual loans & leases, which would have been recognized during the period, if all such loans & leases had been current in accordance with their original terms, totaled $35,700 $22,000 and $15,530 at September 30, 2021, December 31, 2020, and September 30, 2020, respectively.
The Company reported $873,000 of ORE at September 30, 2021, December 31, 2020, and September 30, 2020.
Except for: (i) those classified and non-performing loans & leases discussed above; and (ii) those loans modified under the COVID-19 guidelines of the CARES Act and H.R. 133, the Company’s management is not aware of any loans or leases as of June 30, 2021, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However:
| • | The State of California experienced drought conditions from 2013 through most of 2016. After 2016, reasonable levels of rain and snow alleviated drought conditions in our primary service area, but the winter of 2020-2021 was once again dry. Despite this, the availability of water in our primary service area was not an issue for the 2021 growing season. However, the weather patterns over the past eight years further reinforce the fact that the long-term risks associated with the availability of water are significant. |
| • | While tremendous strides have been made in fighting the COVID-19 virus, particularly with the development of a vaccine, the lingering effects of COVID-19 are still with us, and it is impossible to predict the ultimate impact on classified and non-performing loans and leases (see “Part I, ITEM 2. COVID-19 (Coronavirus) Disclosure”). |
See “Part I, Item 1A. Risk Factors” in the Company’s 2020 Annual Report on Form 10-K, and “Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.
Deposits
One of the key sources of funds to support earning assets is the generation of deposits from the Company’s customer base. The ability to grow the customer base, and subsequently deposits, is a significant element in the performance of the Company.
The Company’s deposit balances at September 30, 2021, have increased $753.6 million or 19.8% compared to September 30, 2020. In addition to the Company’s ongoing business development activities for deposits, the following factors positively impacted year-over-year deposit growth: (1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and sound banks in its market area; (2) the Company’s expansion of its service area into Walnut Creek, Concord and Napa; and (3) borrowers under the PPP depositing loan proceeds into their deposit accounts until those funds are used for operating expenses.
Although total deposits have increased 19.8% since September 30, 2020, importantly, low cost transaction accounts have grown at a strong pace as well:
| • | Demand and interest-bearing transaction accounts increased $619 million or 28.8% since September 30, 2020. |
| • | Savings and money market accounts have increased $201 million or 16.7% since September 30, 2020. |
| • | Time deposit accounts have decreased $66.4 million or 14.4% since September 30, 2020. |
The Company’s deposit balances at September 30, 2021, have increased $508.1 million or 12.5% compared to December 31, 2020. Interest-bearing transaction accounts increased by $394 million or 16.6%, savings and money market deposits increased 11.3% or $142.1 million and time deposit accounts decreased by $28 million or 6.6%.
Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings
Lines of credit with the Federal Reserve Bank and the Federal Home Loan Bank are other key sources of funds to support earning assets. These sources of funds are also used to manage the Company’s interest rate risk exposure, and as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB Advances at September 30, 2021, December 31, 2020, or September 30, 2020. There were no Federal Funds purchased or advances from the FRB at September 30, 2021, December 31, 2020, or September 30, 2020.
As of September 30, 2021, the Company has additional borrowing capacity of $749.5 million with the Federal Home Loan Bank and $467.8 million with the Federal Reserve Bank. Any borrowings under these lines would be collateralized with loans that have been accepted for pledging at the FHLB and FRB.
Long-Term Subordinated Debentures
On December 17, 2003, the Company raised $10 million through an offering of trust-preferred securities (“TPS”). See Financial Condition located in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s 2020 Annual Report on Form 10-K. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue to qualify as regulatory capital (See “Capital”). These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly and were 2.97% as of September 30, 2021, 3.08% at December 31, 2020, and 3.10% at September 30, 2020. The average rate paid for these securities for the first nine months of 2021 was 3.06% and 3.83% for the first nine months of 2020. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.
Capital
The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $454.2 million at September 30, 2021, $423.7 million at December 31, 2020, and $416.9 million at September 30, 2020.
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 actions by regulators that, if undertaken, could have a material effect on the Company and the Bank’s 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 the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The minimum capital level requirements applicable to the Company and the Bank are: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA; and (iv) a Tier 1 leverage ratio of 4% of total assets. A “capital conservation buffer” of 2.5% above each of the regulatory minimum capital ratios, which would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA; and (iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The Company’s subordinated debentures issued in 2003 continue to be counted as Tier 1 capital.
The Company believes that it is currently in compliance with all of these capital requirements and that they did not result in any restrictions on the Company’s business activity.
In addition, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.
| (in thousands) | | Actual | | | Current Regulatory Capital Requirements | | | Well Capitalized Under Prompt Corrective Action | |
| The Company: | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| As of September 30, 2021 | | | | | | | | | | | | | | | | | | |
| Total Capital Ratio | | $ | 497,797 | | | | 13.28 | % | | $ | 299,941 | | | | 8.0 | % | | | N/A | | | | N/A | |
| Common Equity Tier 1 Capital Ratio | | $ | 440,761 | | | | 11.76 | % | | $ | 168,717 | | | | 4.5 | % | | | N/A | | | | N/A | |
| Tier 1 Capital Ratio | | $ | 450,761 | | | | 12.02 | % | | $ | 224,956 | | | | 6.0 | % | | | N/A | | | | N/A | |
| Tier 1 Leverage Ratio | | $ | 450,761 | | | | 8.97 | % | | $ | 200,908 | | | | 4.0 | % | | | N/A | | | | N/A | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| (in thousands) | | Actual | | | Current Regulatory Capital Requirements | | | Well Capitalized Under Prompt Corrective Action | |
| The Bank: | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| As of September 30, 2021 | | | | | | | | | | | | | | | | | | |
| Total Capital Ratio | | $ | 497,783 | | | | 13.28 | % | | $ | 299,906 | | | | 8.0 | % | | $ | 374,883 | | | | 10.0 | % |
| Common Equity Tier 1 Capital Ratio | | $ | 450,753 | | | | 12.02 | % | | $ | 168,697 | | | | 4.5 | % | | $ | 243,674 | | | | 6.5 | % |
| Tier 1 Capital Ratio | | $ | 450,753 | | | | 12.02 | % | | $ | 224,930 | | | | 6.0 | % | | $ | 299,906 | | | | 8.0 | % |
| Tier 1 Leverage Ratio | | $ | 450,753 | | | | 8.98 | % | | $ | 200,850 | | | | 4.0 | % | | $ | 251,063 | | | | 5.0 | % |
Loans originated under the SBA’s PPP are assigned a risk-weighting of 0% so they have no impact on the Company’s RBC ratios. However, they are fully includable in the tier 1 leverage capital ratio calculation, which has resulted in a short-term reduction in that ratio (until the PPP loans are forgiven). Had the Company not participated in the PPP program, the net result would have been a 26 basis point improvement to the September 30, 2021 tier 1 leverage capital ratio, increasing the ratio to 9.23%.
As previously discussed (see “Long-Term Subordinated Debentures”), in order to supplement its regulatory capital base, during December 2003 the Company issued $10 million of trust preferred securities. On March 1, 2005, the Federal Reserve Board issued its final rule effective April 11, 2005, concerning the regulatory capital treatment of trust preferred securities (“TPS”) by bank holding companies (“BHCs”). Under the final rule BHCs may include TPS in Tier 1 capital in an amount equal to 25% of the sum of core capital net of goodwill. Any portion of trust-preferred securities not qualifying as Tier 1 capital would qualify as Tier 2 capital subject to certain limitations. The Company has received notification from the Federal Reserve Bank of San Francisco that all of the Company’s trust preferred securities currently qualify as Tier 1 capital.
The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability.
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on November 6, 2018, the Board of Directors approved an extension of the $20 million stock repurchase program over the three-year period ending December 31, 2021. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2020 Annual Report on Form 10-K for additional information.
There were no stock repurchases during the first nine months of 2021 or 2020. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.
On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021. These repurchases were done outside of the Company’s current repurchase plan. All repurchases were made at the then prevailing market prices. The Company did not repurchase shares during the first nine months of 2021. During the fourth quarter of 2020 the Company repurchased $2.8 million of shares from shareholders.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent. The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2020 Annual Report on Form 10-K for further explanation.
The Company did not issue any new shares during the nine months ended September 30, 2021. During the nine months ended September 30, 2020, the Company issued 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. These shares were issued at a price of $770.00 per share based upon a valuation completed by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
Critical Accounting Policies and Estimates
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These judgments govern areas such as the allowance for credit losses, the fair value of financial instruments and accounting for income taxes.
For a full discussion of the Company’s critical accounting policies and estimates see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2020 Annual Report on Form 10-K.
Off Balance Sheet Commitments
In the normal course of business, the Company enters into financial instruments with off balance sheet risks in order to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit, letters of credit and other types of financial guarantees. The Company had the following off balance sheet commitments as of the dates indicated.
| (in thousands) | | September 30, 2021 | | | December 31, 2020 | | | September 30, 2020 | |
| Commitments to Extend Credit | | $ | 1,058,760 | | | $ | 1,040,844 | | | $ | 969,258 | |
| Letters of Credit | | | 19,391 | | | | 18,846 | | | | 19,816 | |
| Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties | | | 1,808 | | | | 2,786 | | | | 3,797 | |
The Company’s exposure to credit loss in the event of non-performance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each customer’s creditworthiness are performed on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third party. Most standby letters of credit are issued for 12 months or less. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Additionally, the Company maintains a reserve for off balance sheet commitments, which totaled $315,000 at September 30, 2021, December 31, 2020, and September 30, 2020. We do not anticipate any material losses as a result of these transactions.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Risk Management
The Company has adopted risk management policies and procedures, which aim to ensure the proper control and management of all risk factors inherent in the operation of the Company, most importantly credit risk, interest rate risk and liquidity risk. These risk factors are not mutually exclusive. It is recognized that any product or service offered by the Company may expose the Company to one or more of these risk factors.
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract or otherwise fail to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance.
Credit risk in the investment portfolio and correspondent bank accounts is addressed through defined limits in the Company’s policy statements. In addition, certain securities carry insurance to enhance credit quality of the bond.
In order to control credit risk in the loan & lease portfolio the Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower, and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. However, as a financial institution that assumes credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The allowance for credit losses is maintained at a level considered by management to be adequate to provide for risks inherent in the loan & lease portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs.
The Company’s methodology for assessing the appropriateness of the allowance is applied on a regular basis and considers all loans & leases. The systematic methodology consists of three parts.
Part 1 - includes a detailed analysis of the loan & lease portfolio in two phases. The first phase is conducted in accordance with the “Receivables” topic of the FASB ASC 310. Individual loans & leases are reviewed to identify them for impairment. A loan or lease is impaired when principal and interest are deemed uncollectible in accordance with the original contractual terms of the loan or lease. Impairment is measured as either the expected future cash flows discounted at each loan’s or lease’s effective interest rate, the fair value of the loan’s or lease’s collateral if the loan or lease is collateral dependent, or an observable market price of the loan or lease, if one exists. Upon measuring the impairment, the Company will ensure an appropriate level of allowance is present or established.
Central to the first phase of the analysis of the loan & lease portfolio is the risk rating system. The originating credit officer assigns each borrower an initial risk rating, which is based primarily on a thorough analysis of that borrower’s financial position in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior credit administration personnel. Credits are monitored by credit administration personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary. Risk ratings are reviewed by both the Company’s independent third-party credit examiners and bank examiners from the DFPI and FDIC.
Based on the risk rating system, specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates that the loan or lease is impaired and there is a probability of loss. Management performs a detailed analysis of these loans & leases, including, but not limited to, cash flows, appraisals of the collateral, conditions of the marketplace for liquidating the collateral, and assessment of the guarantors. Management then determines the inherent loss potential and allocates a portion of the allowance for losses as a specific allowance for each of these credits.
The second phase is conducted by segmenting the loan & lease portfolio by risk rating and into groups of loans & leases with similar characteristics in accordance with the “Contingency” topic of the FASB ASC 450. In this second phase, groups of loans & leases with similar characteristics are reviewed and the appropriate allowance factor is applied based on the historical average charge-off rate for each particular group of loans or leases.
Part 2 - considers qualitative internal and external factors that may affect a loan or lease’s collectability, based upon management’s evaluation of various conditions, the effects of which are not directly measured in the determination of the historical and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the second element of the analysis of the allowance include, but are not limited to the following conditions that existed as of the balance sheet date:
| • | general economic and business conditions affecting the key service areas of the Company; |
| • | credit quality trends (including trends in collateral values, delinquencies and non-performing loans & leases); |
| • | loan & lease volumes, growth rates and concentrations; |
| • | loan & lease portfolio seasoning; |
| • | specific industry and crop conditions; |
| • | recent loss experience; and |
| • | duration of the current business cycle. |
Part 3 - An unallocated allowance generally occurs due to the imprecision in estimating and allocating allowance balances associated with macro factors such as: (1) economic conditions in the Central Valley; and (2) the long-term risks associated with the availability of water in the Central Valley.
Management reviews all of these conditions in discussion with the Company’s senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable impaired credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable impaired credit or portfolio segment as of the evaluation date, management’s evaluation of the inherent loss related to such condition is reflected in the second element of the allowance or in the unallocated allowance.
Management believes, that based upon the preceding methodology, and using information currently available, the allowance for credit losses at September 30, 2021, was adequate. No assurances can be given that future events may not result in increases in delinquencies, non-performing loans & leases, or net loan & lease charge-offs that would require increases in the provision for credit losses and thereby adversely affect the results of operations.
See “PART 1. – Item 2. - Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for a discussion of how COVID-19 may impact credit risk.
Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities results in uncertainty in the Company’s earnings and economic value and is referred to as interest rate risk. The Company does not attempt to predict interest rates and positions the balance sheet in a manner, which seeks to minimize, to the extent possible, the effects of changing interest rates.
The Company measures interest rate risk in terms of potential impact on both its economic value and earnings. The methods for governing the amount of interest rate risk include: (1) analysis of asset and liability mismatches (Gap analysis); (2) the utilization of a simulation model; and (3) limits on maturities of investment, loan & lease, and deposit products, which reduces the market volatility of those instruments.
The Gap analysis measures, at specific time intervals, the divergence between earning assets and interest-bearing liabilities for which repricing opportunities will occur. A positive difference, or Gap, indicates that earning assets will reprice faster than interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest rates and a lower net interest margin during periods of declining interest rates. Conversely, a negative Gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans & leases. In addition, the magnitude of changes in the rates charged on loans & leases is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest-bearing liabilities.
The Company also utilizes the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of the Company’s net interest income is measured over a rolling one-year horizon.
The simulation model estimates the impact of changing interest rates on interest income from all interest-earning assets and the interest expense paid on all interest-bearing liabilities reflected on the Company’s balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 200 basis point upward and a 100 basis point downward shift in interest rates. A shift in rates over a 12-month period is assumed. Results that exceed policy limits, if any, are analyzed for risk tolerance and reported to the Board with appropriate recommendations. At September 30, 2021, the Company’s estimated net interest income sensitivity to changes in interest rates, as a percent of net interest income was an increase in net interest income of 3.4% if rates increase by 200 basis points and a decrease in net interest income of 0.9% if rates decline 100 basis points. Comparatively, at December 31, 2020, the Company’s estimated net interest income sensitivity to changes in interest rates, as a percent of net interest income was a decrease in net interest income of .03% if rates increase by 200 basis points and a decrease in net interest income of .2% if rates decline 100 basis points.
The estimated sensitivity does not necessarily represent a Company forecast and the results may not be indicative of actual changes to the Company’s net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape; prepayments on loans & leases and securities; pricing strategies on loans & leases and deposits; replacement of asset and liability cash flows; and other assumptions. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.
Liquidity Risk
Liquidity risk is the risk to earnings or capital resulting from the Company’s inability to meet its obligations when they come due without incurring unacceptable losses. It includes the ability to manage unplanned decreases or changes in funding sources and to recognize or address changes in market conditions that affect the Company’s ability to liquidate assets or acquire funds quickly and with minimum loss of value. The Company endeavors to maintain a cash flow adequate to fund operations, handle fluctuations in deposit levels, respond to the credit needs of borrowers, and to take advantage of investment opportunities as they arise.
The Company’s principal operating sources of liquidity include (see “Item 8. Financial Statements and Supplementary Data – Consolidated Statements of Cash Flows” of the Company’s 20 Annual Report on Form 10-K) cash and cash equivalents, cash provided by operating activities, principal payments on loans & leases, proceeds from the maturity or sale of investments, and growth in deposits. To supplement these operating sources of funds the Company maintains Federal Funds credit lines of $118 million and repurchase lines of $112 million with major banks. As of September 30, 2021, the Company has additional borrowing capacity of $749.5 million with the FHLB and $467.8 million with the FRB. Borrowings under these lines are collateralized with loans or securities that have been accepted for pledging at the FHLB and FRB.
At September 30, 2021, the Company had available sources of liquidity, which included cash and cash equivalents and unpledged investment securities AFS of approximately $1.8 billion, which represents 34.7% of total assets.
See “PART 1. – Item 2. - Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for a discussion of how COVID-19 may impact liquidity risk.
| Item 4. | Controls and Procedures |
The Company maintains disclosure controls and procedures designed to ensure that information is recorded and reported in all filings of financial reports. Such information is reported to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer to allow timely and accurate disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e). In designing these controls and procedures, management recognizes that they can only provide reasonable assurance of achieving the desired control objectives. Management also evaluated the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report, the Company carried out an evaluation of the effectiveness of Company’s disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer, the Chief Financial Officer and other senior management of the Company. The evaluation was based, in part, upon reports and affidavits provided by a number of executives. Based on the foregoing, the Company’s Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls over financial reporting subsequent to the date the Company completed its evaluation.
PART II. OTHER INFORMATION
Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. Based upon information available to the Company, its review of such lawsuits and claims and consultation with its counsel, the Company believes the liability relating to these actions, if any, would not have a material adverse effect on its consolidated financial statements.
There are no material proceedings adverse to the Company to which any director, officer or affiliate of the Company is a party.
See “Item 1A. Risk Factors” in the Company’s 2020 Annual Report to Shareholders on Form 10-K. In management’s opinion, with the exception of the disclosure regarding COVID-19 (see “PART I. – Item 2. - Management’s Discussion and Analysis - COVID-19 Disclosure”), there have been no material changes in risk factors since the filing of the 2020 Form 10-K.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
There were no shares repurchased by Farmers & Merchants Bancorp during the first nine months of 2021. The remaining dollar value of shares that may yet be purchased under the Company’s Stock Repurchase Plan is approximately $20.0 million.
The common stock of Farmers & Merchants Bancorp is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol “FMCB”.
| Item 3. | Defaults Upon Senior Securities |
Not applicable
| Item 4. | Mine Safety Disclosures |
Not applicable
None
| Exhibit No. | Description |
| | |
| | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
| | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 101.INS | Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document). |
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document. |
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document. |
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document. |
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document. |
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document. |
| 104 | Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101). |
Pursuant to the requirement 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 & MERCHANTS BANCORP |
| | |
| Date: November 8, 2021 | /s/ Kent A. Steinwert |
| | |
| | Kent A. Steinwert |
| | Chairman, President |
| | & Chief Executive Officer |
| | (Principal Executive Officer) |
| | |
| | |
| Date: November 8, 2021 | /s/ Stephen W. Haley |
| | | |
| | Stephen W. Haley |
| | Executive Vice President and |
| | Chief Financial Officer |
| | (Principal Financial & Accounting Officer) |
