10-Q 1 fmfg20230930_10q.htm FORM 10-Q fmfg20230930_10q.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For quarterly period ended September 30, 2023

 

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

For the transition period from _______________ to ________________

 

Commission file number 000-55756

 

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland 81-3605835
(State or other jurisdiction of
incorporation or organization)
 (I. R. S. Employer Identification No.)

 

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

(Address of principal executive offices)          (Zip Code)

 

(410) 374-1510

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

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

 

Large accelerated filer ☐Accelerated filer ☐
Non-accelerated filerSmaller reporting company    
Emerging growth company  

                       

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

 

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

Yes No ☑

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,092,368 as of November 13, 2023.

 

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

 

Table of Contents

 

  Page

PART I – FINANCIAL INFORMATION

3

Item 1.  Financial Statements

3
Consolidated balance sheets at September 30, 2023 (unaudited) and December 31, 2022

3

Consolidated statements of income (unaudited) for the three and nine months ended  September 30, 2023 and 2022

4

Consolidated statements of comprehensive income (loss) (unaudited) for the three and nine months ended September 30, 2023 and 2022

5

Consolidated statements of changes in stockholders’ equity (unaudited) for the three and nine months ended September 30, 2023 and 2022

6

Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2023 and 2022

7

Notes to financial statements (unaudited)

9

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

37

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

49

Item 4.  Controls and Procedures

49

PART II – OTHER INFORMATION

50

Item 1.  Legal Proceedings

50

Item 1A.  Risk Factors

50

Item 2.  Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities

50

Item 3.  Defaults upon Senior Securities

50

Item 4.  Mine Safety Disclosures

50

Item 5.  Other Information

50

Item 6.  Exhibits

50

SIGNATURES

51

 

 

 
 

 

PART I FINANCIAL INFORMATION

Item 1 Financial Statements

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

 

  

September 30,

  

December 31,*

 
  

2023

  

2022

 
  

(Unaudited)

     

Assets

 
         

Cash and due from banks

 $23,474,989  $6,414,822 

Federal funds sold and other interest-bearing deposits

  1,536,689   848,715 

Cash and cash equivalents

  25,011,678   7,263,537 

Certificates of deposit in other banks

  100,000   100,000 

Securities available for sale, at fair value

  136,563,220   126,314,449 

Securities held to maturity, at amortized cost less allowance for credit losses of $92,045 and $0

  20,134,028   20,508,997 

Equity security, at fair value

  482,907   489,145 

Restricted stock, at cost

  863,500   1,332,500 

Mortgage loans held for sale

  -   428,355 

Loans, less allowance for credit losses of $4,516,402 and $4,150,198

  526,133,041   516,920,540 

Premises and equipment, net

  6,093,372   6,186,594 

Accrued interest receivable

  2,018,786   1,815,784 

Deferred income taxes, net

  9,901,701   8,392,658 

Other real estate owned, net

  1,242,365   1,242,365 

Bank owned life insurance

  14,846,937   14,585,342 

Goodwill and other intangibles, net

  7,036,506   7,042,752 

Other assets

  6,209,726   5,587,654 
  $756,637,767  $718,210,672 
         

Liabilities and Stockholders' Equity

 
         

Deposits

        

Noninterest-bearing

 $113,326,966  $126,695,349 

Interest-bearing

  530,935,768   496,915,775 

Total deposits

  644,262,734   623,611,124 

Securities sold under repurchase agreements

  5,357,674   5,175,303 

Federal Home Loan Bank of Atlanta advances

  5,000,000   20,000,000 

Federal Reserve Bank advances

  33,000,000   - 

Long-term debt, net of issuance costs

  13,683,195   15,095,642 

Accrued interest payable

  1,491,099   349,910 

Other liabilities

  5,581,129   6,203,730 
   708,375,831   670,435,709 

Stockholders' equity

        

Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 3,092,368 shares in 2023 and 3,071,214 in 2022

  30,924   30,712 

Additional paid-in capital

  29,979,718   29,549,914 

Retained earnings

  38,940,539   35,300,166 

Accumulated other comprehensive loss

  (20,689,245)  (17,105,829)
   48,261,936   47,774,963 
  $756,637,767  $718,210,672 

 

* Derived from audited consolidated financial statements

 

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

 

- 3 -

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

 

  

Three months ended

  

Nine months ended

 
  

September 30,

  

September 30,

 
  

2023

  

2022

  

2023

  

2022

 
                 

Interest income

                

Loans, including fees

 $6,609,039  $5,606,913  $19,023,308  $16,660,625 

Investment securities - taxable

  996,586   783,606   2,528,793   2,170,154 

Investment securities - tax exempt

  137,254   140,185   416,626   430,495 

Federal funds sold and other interest earning assets

  258,818   55,361   469,721   89,663 

Total interest income

  8,001,697   6,586,065   22,438,448   19,350,937 
                 

Interest expense

                

Deposits

  2,239,808   313,556   5,010,624   971,320 

Securities sold under repurchase agreements

  12,110   2,874   23,949   8,558 

Federal Home Loan Bank advances

  39,289   12,727   452,272   37,765 

Federal Reserve Bank advances

  378,500   -   391,763   - 

Long-term debt

  145,001   165,156   444,953   505,268 

Total interest expense

  2,814,708   494,313   6,323,561   1,522,911 

Net interest income

  5,186,989   6,091,752   16,114,887   17,828,026 
                 

(Recovery of) provision for credit losses

  (75,000)  95,000   (570,000)  95,000 
                 

Net interest income after (recovery of) provision for credit losses

  5,261,989   5,996,752   16,684,887   17,733,026 
                 

Noninterest income

                

Service charges on deposit accounts

  195,566   201,251   586,999   574,444 

Mortgage banking income

  33,585   8,155   92,514   195,829 

Bank owned life insurance income

  89,748   70,479   261,595   179,735 

Fair value adjustment on equity security

  (13,769)  (17,611)  (15,343)  (62,524)

Gain on sale of SBA loans

  -   -   -   158,123 

Other fees and commissions

  78,096   75,211   243,125   229,326 

Total noninterest income

  383,226   337,485   1,168,890   1,274,933 
                 

Noninterest expense

                

Salaries

  1,916,804   1,987,991   5,643,742   5,656,643 

Employee benefits

  348,048   418,422   1,483,278   1,367,829 

Occupancy

  229,135   229,273   645,398   670,938 

Furniture and equipment

  246,896   203,075   739,547   642,283 

Other

  1,005,065   945,930   2,677,065   2,815,182 

Total noninterest expense

  3,745,948   3,784,691   11,189,030   11,152,875 
                 

Income before income taxes

  1,899,267   2,549,546   6,664,747   7,855,084 

Income taxes

  467,128   575,236   1,661,640   1,779,239 

Net income

 $1,432,139  $1,974,310  $5,003,107  $6,075,845 
                 

Earnings per share - basic and diluted

 $0.46  $0.65  $1.63  $2.00 

 

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

 

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

 

- 4 -

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

  

Three Months Ended

  

Nine Months Ended

 
  

September 30,

  

September 30,

 
  

2023

  

2022

  

2023

  

2022

 
                 

Net income

 $1,432,139  $1,974,310  $5,003,107  $6,075,845 
                 

Other comprehensive loss, net of income taxes:

                
                 

Securities available for sale

                

Net unrealized loss arising during the period

  (4,197,837)  (5,960,588)  (4,943,835)  (22,423,388)
                 

Total unrealized loss on investment securities available for sale

  (4,197,837)  (5,960,588)  (4,943,835)  (22,423,388)
                 

Income tax benefit

  1,155,140   1,640,205   1,360,419   6,170,356 
                 

Total other comprehensive loss

  (3,042,697)  (4,320,383)  (3,583,416)  (16,253,032)
                 

Total comprehensive (loss) income

 $(1,610,558) $(2,346,073) $1,419,691  $(10,177,187)

 

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

 

- 5 -

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three and Nine months Ended September 30, 2023 and 2022

(Unaudited)

 

          

Additional

      

Accumulated other

  

Total

 
  

Common stock

  

paid-in

  

Retained

  

comprehensive

  

stockholders'

 
  

Shares

  

Par value

  

capital

  

earnings

  

income (loss)

  

equity

 

Three months ended September 30, 2022

                     

Balance, June 30, 2022

  3,053,487  $30,535  $29,197,475  $32,288,555  $(13,327,585) $48,188,980 

Net income

  -   -   -   1,974,310   -   1,974,310 

Other comprehensive loss

  -   -   -   -   (4,320,383)  (4,320,383)

Dividends reinvested

  -   -   (135)  136   -   1 
                         

Balance, September 30, 2022

  3,053,487  $30,535  $29,197,340  $34,263,001  $(17,647,968) $45,842,908 
                         

Nine months ended September 30, 2022

                     

Balance, December 31, 2021

  3,037,137  $30,372  $28,857,422  $29,128,600  $(1,394,936) $56,621,458 

Net income

  -   -   -   6,075,845   -   6,075,845 

Other comprehensive loss

  -   -   -   -   (16,253,032)  (16,253,032)

Cash dividends, $0.31 per share

  -   -   -   (941,444)  -   (941,444)

Dividends reinvested

  16,350   163   339,918   -   -   340,081 
                         

Balance, September 30, 2022

  3,053,487  $30,535  $29,197,340  $34,263,001  $(17,647,968) $45,842,908 
                         

Three months ended September 30, 2023

                     

Balance, June 30, 2023

  3,090,368  $30,904  $29,941,488  $37,508,400  $(17,646,548) $49,834,244 

Net income

  -   -   -   1,432,139   -   1,432,139 

Other comprehensive loss

  -   -   -   -   (3,042,697)  (3,042,697)

Stock-based compensation

  2,000   20   38,230   -   -   38,250 
                         

Balance, September 30, 2023

  3,092,368  $30,924  $29,979,718  $38,940,539  $(20,689,245) $48,261,936 
                         

Nine months ended September 30, 2023

                     

Balance, December 31, 2022

  3,071,214  $30,712  $29,549,914  $35,300,166  $(17,105,829) $47,774,963 

Net income

  -   -   -   5,003,107   -   5,003,107 

Other comprehensive loss

  -   -   -   -   (3,583,416)  (3,583,416)

Stock-based compensation

  2,000   20   38,230   -   -   38,250 

Cash dividends, $0.31 per share

  -   -   -   (1,013,499)  -   (1,013,499)

Reclassification due to the adoption of ASU 2016-13

  -   -   -   (341,392)  -   (341,392)

Dividends reinvested

  19,154   192   391,574   (7,843)  -   383,923 
                         

Balance, September 30, 2023

  3,092,368  $30,924  $29,979,718  $38,940,539  $(20,689,245) $48,261,936 

 

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

 

- 6 -

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

Nine Months Ended September 30,

 

2023

  

2022

 
         

Reconciliation of net income to net cash provided by operating activities

        

Net income

 $5,003,107  $6,075,845 

Adjustments to reconcile net income to net cash provided by operating activities

        

Depreciation and amortization

  382,691   354,814 

(Recovery of) provision for credit losses

  (570,000)  95,000 

(Accretion) amortization of right of use asset

  (3,920)  4,412 

Equity security dividends reinvested

  (9,105)  (5,156)

Unrealized loss on equity security

  15,343   62,524 

Gain on sale of SBA loans

  -   (158,123)

Gain on sale of premises and equipment

  (9,000)  - 

Gain on fair value hedge

  (28,133)  - 

Stock based compensation

  38,250   - 

Amortization of debt issuance costs

  4,219   4,218 

Amortization of premiums and (accretion of discounts), net

  (82,391)  (237,876)

Bank owned life insurance cash surrender value

  (261,595)  (179,735)

Increase (decrease) in

        

Deferred loan fees and costs, net

  (7,148)  (136,377)

Accrued interest payable

  1,141,189   (35,644)

Other liabilities

  (702,985)  228,072 

Decrease (increase) in

        

Mortgage loans held for sale

  428,355   (243,500)

Accrued interest receivable

  (203,002)  8,681 

Other assets

  (52,244)  (433,594)

Net cash provided by operating activities

  5,083,631   5,403,561 

 

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

 

- 7 -

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

Nine Months Ended September 30,

 

2023

  

2022

 
         

Cash flows from investing activities

        

Proceeds from maturity and call of securities

        

Available for sale

  9,033,423   15,121,772 

Held to maturity

  373,420   1,398,420 

Purchase of securities

        

Available for sale

  (24,888,256)  (17,278,216)

Purchases of certificates of deposit

  -   250,000 

Loans made to customers, net of principal collected

  (8,927,917)  (24,044,676)

Proceeds from sale of loans

  -   1,250,154 

Redemption (purchase) of stock in FHLB of Atlanta

  469,000   (19,600)

Purchase of bank owned life insurance

  -   (2,800,000)

Proceeds from sale of premises and equipment

  9,000   - 

Purchases of premises, equipment and software

  (256,735)  (384,873)

Net cash used in investing activities

  (24,188,065)  (26,507,019)
         

Cash flows from financing activities

        

Net increase (decrease) in

        

Noninterest-bearing deposits

  (13,368,383)  7,094,065 

Interest-bearing deposits

  34,084,829   5,588,443 

Securities sold under repurchase agreements

  182,371   8,616 

Federal Home Loan Bank of Atlanta advances

  -   - 

Federal Reserve Bank advances

  33,000,000   - 

Federal Home Loan Bank of Atlanta advances

  (15,000,000)  - 

Long-term debt principal payments

  (1,416,666)  (1,416,665)

Dividends paid, net of reinvestments

  (629,576)  (601,363)

Net cash provided by financing activities

  36,852,575   10,673,096 
         

Net (decrease) increase in cash and cash equivalents

  17,748,141   (10,430,362)
         

Cash and cash equivalents at beginning of period

  7,263,537   26,462,106 

Cash and cash equivalents at end of period

 $25,011,678  $16,031,744 
         

Supplemental disclosure of cash flow information:

        

Cash paid during the period for interest

 $5,236,743  $1,675,435 

Cash paid during the period for income taxes

  1,850,848   2,531,122 

Supplemental disclosure of non-cash transactions:

        

Net unrealized loss on securities available for sale

  (5,614,156)  (22,423,388)

 

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

 

 
- 8 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

 

1.

Principles of consolidation

 

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

 

 

2.

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three- and nine-month periods ended September 30, 2023 do not necessarily reflect the results that may be expected for the fiscal year ending December 31, 2023 or any future interim period. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, 2022, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2022 that was filed with the Securities and Exchange Commission (the “SEC”). 

 

Recent Accounting Pronouncements

 

Management has the responsibility for the selection and use of appropriate accounting policies. The significant accounting policies used by the Company are described in the notes to the consolidated financial statements.

 

The following accounting guidance has been approved by the Financial Accounting Standards Board (“FASB”) and would apply to the Company if the Company entered into an applicable activity.

 

In March 2020, FASB issued Accounting Standards Update (“ASU”) 2020-04, “Reference Rate Reform (Topic 848)”: Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU Provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effect of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (“LIBOR”), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. ASU 2020-04 is effective between March 12, 2020 and December 31, 2022. As of September 30, 2023, the Company has converted all of its LIBOR loans to an alternative reference rate.

 

- 9 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

In December 2022, FASB issued ASU 2022-06, “Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848”. ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance in Accounting Standards Codification (“ASC”) Topic 848. The objective of the guidance in ASC Topic 848 is to provide relief during the temporary transition period, so the FASB included a sunset provision within Topic 848 based on expectations of when the LIBOR would cease being published. In 2021, the UK Financial Conduct Authority delayed the intended cessation date of certain tenors of USD LIBOR to September 30, 2023. To ensure the relief in ASC Topic 848 covers the period of time during which a significant number of modifications may take place, the ASU defers the sunset date of ASC Topic 848 from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief in ASC Topic 848. The ASU is effective for all entities upon issuance. As of September 30, 2023, the Company has converted all of its LIBOR loans to an alternative reference rate.

 

Recently Adopted Accounting Developments

 

During June 2016, FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”.  The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration.   The Company adopted ASU 2016-13 as of January 1, 2023. The adjustment recorded at adoption to the overall allowance for credit losses, which consisted of adjustments to the allowance for credit losses on loans and held-to-maturity securities, as well as an adjustment to the Company’s reserve for unfunded loan commitments, was $704,410. The adjustment net of tax recorded to stockholders’ equity totaled $341,392.

 

The Company is utilizing a third-party model to tabulate its estimate of current expected credit losses (“CECL”), using an average charge off or loss rate methodology. In accordance with ASC Topic 326, the Company has segmented its loan portfolio based on similar risk characteristics which included call report categories as well watch list and collateral-dependent. The Company primarily utilizes historical loss rates for the CECL calculation based on Company-specific historical losses and supplemented with peer loss history where applicable.  For its reasonable and supportable forecasting of CECL, the Company analyzes a simple regression using forecasted economic metrics and historical peer loss data. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider the following qualitative adjustment factors: economic conditions; concentrations of credit; interest rates; ability of staff; loan review; trends in loan quality; policy changes; and changes in nature and/or volume of loans. The Company’s CECL implementation process was overseen by the Chief Financial Officer and included an assessment of data availability and gap analysis, data collection, consideration and analysis of multiple loss estimation methodologies, an assessment of relevant qualitative factors and correlation analysis of multiple potential loss drivers and their impact on the Company’s historical loss experience.

 

- 10 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

In March 2022, FASB issued ASU 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments in this ASU were applied prospectively, except for the transition method related to the recognition and measurement of troubled debt restructurings an entity had the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. ASU 2022-02 was effective for the Company on January 1, 2023, and it did not have a material impact on the Company’s consolidated financial statements.

 

In March 2022, FASB issued ASU 2022-01, “Derivatives and Hedging (Topic 815), Fair Value Hedging - Portfolio Layer Method.” ASU 2022-01 clarifies the guidance in ASC Topic 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets and is intended to better align hedge accounting with an organization’s risk management strategies. In 2017, FASB issued ASU 2017-12 to better align the economic results of risk management activities with hedge accounting. One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. ASU 2022-01 renames that method the portfolio layer method. ASU 2022-01 was effective for the Company on January 1, 2023.

 

Summary of Significant Accounting Policies

 

There have been no changes to significant accounting policies since the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 was issued other than described below.

 

Allowance for Credit Losses. As further discussed below, we adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” on January 1, 2023. ASC Topic 326 replaced the previous “incurred loss” model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experience, current conditions, and reasonable and supportable forecasts. In connection with the adoption of ASC Topic 326, we revised certain accounting policies and implemented certain accounting policy elections. Results for reporting periods beginning after January 1, 2023 will be presented under ASC Topic 326, while periods prior to January 1, 2023 will be reported in accordance with GAAP applicable for the time period. The revised accounting policies are described below.

 

 

- 11 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

Allowance for Credit Losses - Held-to-Maturity Securities: The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account, calculated in accordance with ASC Topic 326, which is deducted from the amortized cost basis of held-to-maturity securities to present management's best estimate of the net amount expected to be collected. Held-to-maturity securities are charged-off against the allowance when deemed uncollectible by management. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. Management has made the accounting policy election to exclude accrued interest receivable on held-to-maturity securities from the estimate of credit losses. Further information regarding our policies and methodology used to estimate the allowance for credit losses on held-to-maturity securities is presented in Note 3 - Securities.

 

Allowance For Credit Losses - Available-for-Sale Securities: For available-for-sale securities in an unrealized loss position, we first assess whether (i) we intend to sell the security or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously recognized allowances are charged-off and the security's amortized cost is written down to fair value through income. If neither case is affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and any adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive (loss) income. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management has made the accounting policy election to exclude accrued interest receivable on available-for-sale securities from the estimate of credit losses. Available-for-sale securities are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed uncollectible by management or when either of the aforementioned criteria regarding intent or requirement to sell is met. Prior to the adoption of ASU 2016-13, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that were deemed to be other than temporary were reflected in earnings as realized losses. In estimating other-than-temporary impairment losses prior to January 1, 2023, management considered, among other things, (i) the length of time and the extent to which the fair value had been less than cost, (ii) the financial condition and near-term prospects of the issuer and (iii) the intent and our ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

Allowance for Credit Losses - Loans: The allowance for credit losses on loans is a contra-asset valuation account, calculated in accordance with ASC Topic 326, which is deducted from the amortized cost basis of loans to present management's best estimate of the net amount expected to be collected. Loans are charged-off against the allowance when deemed uncollectible by management. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses.

 

- 12 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

The amount of the allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectability over the loans' contractual terms, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless (i) management has a reasonable expectation that a loan to an individual borrower that is experiencing financial difficulty will be modified or (ii) such extension or renewal options are not unconditionally cancellable by us and, in such cases, the borrower is likely to meet applicable conditions and likely to request extension or renewal. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. The allowance for credit losses is measured on a collective basis for portfolios of loans when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.

 

Credit loss expense related to loans reflects the totality of actions taken on all loans for a particular period including any necessary increases or decreases in the allowance related to changes in credit loss expectations associated with specific loans or pools of loans. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate appropriateness of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

 

In calculating the allowance for credit losses, most loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type/purpose of loan, underlying collateral, and historical/expected credit loss patterns. For modeling purposes, our loan pools include (i) commercial real estate - owner occupied, (ii) commercial real estate - non-owner occupied, (iii) construction/land development, (iv) residential – multifamily, (v) residential – single family (vi) residential – single family home equity, (vii) commercial and industrial (viii) consumer and other. We periodically reassess each pool to ensure that the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary.

 

The average charge-off method calculates an estimate of losses based upon past experience, which is applied prospectively across the life of each loan. This method allows for analysis and calculation on a note-by-note basis due to the CECL model calculating future cash flows at the individual note level based upon note characteristics. A forward balance is calculated from each note’s prior period balance, less monthly principal paydown and prepayment amount.

 

The Company utilizes its own loss data as the source for its historical loss calculations within the CECL model, where appropriate. This information is sourced from call report data and spans back to an effective start date of March 31, 2000. Loss data will continuously be uploaded into the model across subsequent periods, with results always one quarter in arrears. Utilization of loss rates

 

- 13 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

across this length of time helps to incorporate results recognized across the full economic cycle and smooth periods of economic recession and recovery. The Company may deviate from utilization of its own loss rates on an as-needed basis when said loss rates have historically been non-existent. The Company may also deviate from its existing loss rates when said rates are no longer indicative of the current portfolio composition/quality, such as historical rates impacted by losses resulting from purchased loan portfolios which have since matured or been divested. In these events, the Company will utilize aggregate loss rates recognized from banks of comparable asset size throughout the state of Maryland, incurred across the same period, March 31, 2000 to present.

 

The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Significant loan/borrower attributes utilized in our modeling processes include, among other things, (i) origination date, (ii) maturity date, (iii) payment type, (iv) collateral type and amount, (v) current risk grade, (vi) current unpaid balance and commitment utilization rate, (vii) payment status/delinquency history and (viii) expected recoveries of previously charged-off amounts.

 

Management qualitatively adjusts model results for risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor (“Q-Factor”) and other qualitative adjustments may increase or decrease management's estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk. The various risks that may be considered in making Q-Factor and other qualitative adjustments include, among other things, the impact of (i) any concentrations of credit, (ii) local and national economic and business conditions, (iii) changes in the nature and volume of the underlying loans, (iv) changes in the experience, ability, and depth of our lending management and staff, (v) changes in volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans, (vi) our credit review function, (vii) changes in lending policies and procedures and, (viii) other factors such as rising interest rates.

 

In some cases, management may determine that an individual loan exhibits unique risk characteristics which differentiate the loan from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral.

 

Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures: The allowance for credit losses on off-balance-sheet credit exposures is a liability account, calculated in accordance with ASC Topic 326, representing expected credit losses over the contractual period for which we are exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if we have the unconditional right to cancel the obligation. The allowance is reported as a component of other liabilities in our consolidated balance sheets. Adjustments to the allowance are reported in our income statement as a component of credit loss expense.

 

- 14 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

The table below provides the impact of the implementation of ASC Topic 326:

 

  

December 31, 2022

  

January 1, 2023

 
  

Pre-ASC 326
Adoption

  

Impact of ASC
326 Adoption

  

As Reported
Under ASC
326

 

Assets:

            

Loans, gross

 $521,679,143  $233,411  $521,912,554 
             

Allowance for credit losses:

            
             

Loans:

            

Real estate:

            

Commercial

  2,818,582   (350,838)  2,467,744 

Construction and land development

  164,596   280,179   444,775 

Residential

  793,919   538,435   1,332,354 

Commercial

  337,303   135,200   472,503 

Consumer

  4,706   (4,537)  169 

Unallocated

  31,092   (31,092)  - 

Allowance for credit losses on loans

  4,150,198   567,347   4,717,545 
             

Loans, net

  517,528,945   (333,936)  517,195,009 
             

Allowance for credit losses on debt securities held to maturity

  -   51,990   51,990 
             

Net deferred tax asset

  -   129,607   129,607 
             

Liabilities:

            

Allowance for credit losses on off balance sheet credit exposures

  -   85,073   85,073 
             

Total equity

 $49,834,244  $(341,392) $49,492,852 

 

Derivative Financial Instruments: At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (i) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (ii) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), and (iii) an instrument with no hedging designation (“stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income (loss) and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Changes in the fair value of derivatives not designated or that do not qualify for hedge accounting are reported currently in earnings, as non-interest income.

 

Accrued settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Accrued settlements on derivatives not designated or that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

 

- 15 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

 

2.

Basis of Presentation (continued)

 

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

 

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

 

The Company is exposed to losses if a counterparty fails to make its payments under a contract in which the Company is in the net receiving position. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. All the contracts to which the Company is a party settle monthly or quarterly. In addition, the Company obtains collateral above certain thresholds of the fair value of its derivatives for each counterparty based upon their credit standing and the Company has netting agreements with the dealers with which it does business.

 

The Company’s derivative financial instruments are described more fully in Note 7.

 

Stock-based Compensation: The Company recognizes in the income statement the grant date fair value of stock awards, restricted stock and restricted stock units. The fair value related to forfeitures of stock awards, restricted stock and restricted stock units are recorded to the income statement as they occur, reducing stock-based compensation expense in that period. The Company classifies stock-based compensation as either an equity award or a liability award. Equity classified awards are valued as of the grant date using either an observable market price or a valuation methodology. Liability classified awards are valued at fair value at each reporting date. For the periods presented, all of the Company's stock awards, restricted stock, and restricted stock units are classified as equity awards.

 

During the third quarter of 2023, the Company granted stock awards under the Farmers and Merchants Bancshares, Inc. 2023 Equity Compensation Plan (the “Plan).  Each share of common stock subject to such awards is valued at the fair market value of such share (as defined in the Plan”) as of the grant date.

 

The Company’s stock-based compensation is described more fully in Note 12.

 

Management believes that the accounting policies adopted by management are consistent with authoritative GAAP and are consistent with those followed by our peers.

 

 

 
- 16 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
 
 

3.

Investment Securities

 

Investments in debt securities are summarized as follows:

 

  

Amortized

  

Unrealized

  

Unrealized

  

Fair

  

Allowance for

  

Net Carrying

 

September 30, 2023

 

cost

  

gains

  

losses

  

value

  

Credit Losses

  

Amount

 
                         

Available for sale

                        
                         

State and municipal

 $500,000  $-  $28,965  $471,035  $-  $471,035 

SBA pools

  839,905   1,520   11,577   829,848   -   829,848 

Corporate bonds

  10,367,728   -   1,443,028   8,924,700   -   8,924,700 

Mortgage-backed securities

  153,977,642   -   27,640,005   126,337,637   -   126,337,637 
  $165,685,275  $1,520  $29,123,575  $136,563,220  $-  $136,563,220 
                         

Held to maturity

                        
                         

State and municipal

 $20,226,073  $-  $2,248,646  $17,977,427  $92,045  $20,134,028 

 

  

Amortized

  

Unrealized

  

Unrealized

  

Fair

 

December 31, 2022

 

cost

  

gains

  

losses

  

value

 
                 

Available for sale

                
                 

State and municipal

 $570,122  $-  $17,841  $552,281 

SBA pools

  1,033,606   1,425   15,234   1,019,797 

Corporate bonds

  10,414,146   -   1,024,250   9,389,896 

Mortgage-backed securities

  137,896,519   -   22,544,044   115,352,475 
  $149,914,393  $1,425  $23,601,369  $126,314,449 
                 

Held to maturity

                
                 

State and municipal

 $20,508,997  $4,176  $1,633,378  $18,879,795 

 

The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account that is deducted from the amortized cost basis of held-to-maturity securities to present the net amount expected to be collected. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to securities issued by states and political subdivisions, management considers (i) issuer bond ratings, (ii) historical loss rates for given bond ratings, (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, and (iv) internal forecasts. Unrated bonds were underwritten similar to commercial loans and the financial condition of the issuer is monitored periodically. Expected credit losses on commercial loans are applied to unrated bonds.

 

- 17 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)

 

3.

Investment Securities (continued)

 

The following table summarizes Moody's and/or Standard & Poor's bond ratings (Company’s primary credit quality indicator) for our portfolio of held-to-maturity securities issued by states and political subdivisions as of September 30, 2023 at amortized cost:

 

  

September 30, 2023

 

AAA

  2,782,091 

AA

  10,413,097 

A

  3,804,166 

BAA

  249,202 

Not rated

  2,977,517 

Total

  20,226,073 

 

Historical loss rates associated with securities having similar grades as those in our portfolio have generally not been significant. Furthermore, as of September 30, 2023, there were no past due principal or interest payments associated with these securities and none are on nonaccrual.

 

The following table details activity in the allowance for credit losses on held-to-maturity securities for the three and nine months ended September 30, 2023:

 

  

Three Months Ended

  

Nine Months Ended

 
  

September 30, 2023

  

September 30, 2023

 
         

Beginning balance

 $50,445  $- 

Impact of adopting ASC 326

  -   51,990 

Credit loss expense

  41,600   40,055 

Ending balance

 $92,045  $92,045 

 

Available for sale securities accrued interest receivable totaled $354,729 and $310,324 and held to maturity securities accrued interest receivable totaled $103,064 and $122,874 as of September 30, 2023 and December 31, 2022, respectively.  Both are grouped in accrued interest receivable on the balance sheet.

 

- 18 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(Unaudited)

 

3.

Investment Securities (continued)

 

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

 

  

Available for Sale

  

Held to Maturity

 
  

Amortized

  

Fair

  

Amortized

  

Fair

 

September 30, 2023

 

cost

  

value

  

cost

  

value

 
                 

Within one year

 $1,509,228  $1,453,715  $-  $- 

Over one to five years

  8,541,532   7,237,103   893,845   863,621 

Over five to ten years

  816,968   704,917   5,839,636   5,327,247 

Over ten years

  -   -   13,492,592   11,786,559 
   10,867,728   9,395,735   20,226,073   17,977,427 

Mortgage-backed securities and

                

SBA pools, due in monthly installments

  154,817,547   127,167,485   -   - 
  $165,685,275  $136,563,220  $20,226,073  $17,977,427 

 

Securities with a carrying value of $49,830,882 and $24,258,980 as of September 30, 2023 and December 31, 2022, respectively, were pledged as collateral for government deposits, securities sold under repurchase agreements, and the Federal Reserve’s Bank Term Funding Program.

 

During the nine-month periods ended September 30, 2023 and 2022, there were no sales of securities.

 

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in available for sale (“AFS”) debt securities, by category and length of time, at September 30, 2023. At December 31, 2022 held to maturity debt securities are included in addition to AFS.

 

September 30, 2023

 

Less than 12 months

  

12 months or more

  

Total

 

Description of investments

 

Fair Value

  

Unrealized
Loss

  

Fair Value

  

Unrealized Loss

  

Fair Value

  

Unrealized Loss

 
                         

State and municipal

 $239,978  $10,023  $231,057  $18,942  $471,035  $28,965 

SBA pools

  -   -   700,027