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FARMERS & MERCHANTS BANCORP - Quarter Report: 2019 September (Form 10-Q)


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 the quarterly period ended September 30, 2019

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________

Commission File Number:  000-26099

FARMERS & MERCHANTS BANCORP
(Exact name of registrant as specified in its charter)

Delaware
 
94-3327828
(State or other jurisdiction of incorporation or organization)
 
(I.R.S.  Employer Identification No.)
     
111 W. Pine Street, Lodi, California
 
95240
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code (209) 367-2300

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 period 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 smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ☐
Accelerated filer  ☒
Non-accelerated filer  ☐
Smaller Reporting Company ☐
 
Emerging growth company ☐

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 ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:
 
Trading Symbol(s)
 
Name of each exchange on which registered:
Common Stock
 
FMCB
 
OTCQX

Number of shares of common stock of the registrant 787,307 outstanding as of October 31, 2019.



FARMERS & MERCHANTS BANCORP

FORM 10-Q
TABLE OF CONTENTS



PART I. - FINANCIAL INFORMATION
 Page
       
 
Item 1 - Financial Statements
 
       
   
 3
       
   
4
       
   
5
       
   
6
       
   
7
       
   
8
       
 
36
       
 
57
       
 
60
       
PART II. - OTHER INFORMATION
 
       
 
60
       
 
60
       
 
61
       
 
61
       
 
61
       
 
61
       
 
61
       
62

PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements

FARMERS & MERCHANTS BANCORP
                 
Consolidated Balance Sheets   (Unaudited)
                 
(in thousands except share data)
                 
   
Sept. 30,
2019
   
December 31,
2018
   
Sept. 30,
2018
 
Assets
                 
Cash and Cash Equivalents:
                 
Cash and Due from Banks
 
$
73,129
   
$
61,058
   
$
52,709
 
Interest Bearing Deposits with Banks
   
150,947
     
84,506
     
58,072
 
Total Cash and Cash Equivalents
   
224,076
     
145,564
     
110,781
 
                         
Investment Securities:
                       
Available-for-Sale
   
492,930
     
495,396
     
458,311
 
Held-to-Maturity
   
60,354
     
53,566
     
51,459
 
Total Investment Securities
   
553,284
     
548,962
     
509,770
 
                         
Loans & Leases:
   
2,617,122
     
2,571,241
     
2,416,602
 
Less: Allowance for Credit Losses
   
54,954
     
55,266
     
53,067
 
Loans & Leases, Net
   
2,562,168
     
2,515,975
     
2,363,535
 
                         
Premises and Equipment, Net
   
31,528
     
32,623
     
29,614
 
Bank Owned Life Insurance
   
66,626
     
65,117
     
60,968
 
Interest Receivable and Other Assets
   
131,519
     
126,002
     
108,794
 
Total Assets
 
$
3,569,201
   
$
3,434,243
   
$
3,183,462
 
                         
Liabilities
                       
Deposits:
                       
Demand
 
$
994,860
   
$
974,756
   
$
867,552
 
Interest Bearing Transaction
   
669,926
     
694,384
     
602,494
 
Savings and Money Market
   
948,358
     
903,665
     
844,553
 
Time
   
526,269
     
490,027
     
462,324
 
Total Deposits
   
3,139,413
     
3,062,832
     
2,776,923
 
                         
Subordinated Debentures
   
10,310
     
10,310
     
10,310
 
Interest Payable and Other Liabilities
   
63,751
     
49,886
     
96,138
 
Total Liabilities
   
3,213,474
     
3,123,028
     
2,883,371
 
                         
Shareholders' Equity
                       
Preferred Stock:  No Par Value,  1,000,000 Shares Authorized, None Issued or Outstanding
   
-
     
-
     
-
 
Common Stock:  Par Value $0.01, 7,500,000 Shares Authorized, 787,307, 783,721, and 783,721 Shares Issued and Outstanding at September 30, 2019, December 31, 2018 and September 30, 2018, Respectively
   
8
     
8
     
8
 
Additional Paid-In Capital
   
75,538
     
72,974
     
72,974
 
Retained Earnings
   
277,063
     
241,221
     
233,671
 
Accumulated Other Comprehensive Income (Loss)
   
3,118
     
(2,988
)
   
(6,562
)
Total Shareholders' Equity
   
355,727
     
311,215
     
300,091
 
Total Liabilities and Shareholders' Equity
 
$
3,569,201
   
$
3,434,243
   
$
3,183,462
 

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

FARMERS & MERCHANTS BANCORP
Consolidated Statements of Income  (Unaudited)
(in thousands except per share data)
 
Three Months
Ended September 30,
   
Nine Months
Ended September 30,
 
   
2019
   
2018
   
2019
   
2018
 
Interest Income
                       
Interest and Fees on Loans & Leases
 
$
34,835
   
$
30,959
   
$
102,728
   
$
86,930
 
Interest on Deposits with Banks
   
1,396
     
638
     
3,682
     
1,737
 
Interest on Investment Securities:
                               
Taxable
   
2,332
     
2,074
     
7,003
     
6,770
 
Exempt from Federal Tax
   
247
     
394
     
1,196
     
1,217
 
Total Interest Income
   
38,810
     
34,065
     
114,609
     
96,654
 
                                 
Interest Expense
                               
Deposits
   
3,392
     
2,020
     
9,325
     
4,954
 
Subordinated Debentures
   
138
     
137
     
424
     
385
 
Total Interest Expense
   
3,530
     
2,157
     
9,749
     
5,339
 
                                 
Net Interest Income
   
35,280
     
31,908
     
104,860
     
91,315
 
Provision for Credit Losses
   
-
     
2,500
     
200
     
3,333
 
Net Interest Income After Provision for Loan Losses
   
35,280
     
29,408
     
104,660
     
87,982
 
                                 
Non-Interest Income
                               
Service Charges on Deposit Accounts
   
958
     
915
     
2,735
     
2,574
 
Net Gain (Loss) on Sale of Investment Securities
   
1
     
-
     
1
     
(1,330
)
Increase in Cash Surrender Value of Bank Owned Life Insurance
   
512
     
473
     
1,509
     
1,385
 
Debit Card and ATM Fees
   
1,306
     
1,101
     
3,774
     
3,213
 
Net Gain on Deferred Compensation Investments
   
207
     
715
     
2,070
     
1,904
 
Other
   
990
     
1,004
     
2,749
     
3,410
 
Total Non-Interest Income
   
3,974
     
4,208
     
12,838
     
11,156
 
                                 
Non-Interest Expense
                               
Salaries and Employee Benefits
   
14,321
     
12,329
     
41,184
     
37,509
 
Net Gain on Deferred Compensation Investments
   
207
     
715
     
2,070
     
1,904
 
Occupancy
   
1,107
     
984
     
3,161
     
2,833
 
Equipment
   
1,188
     
1,078
     
3,541
     
3,119
 
Marketing
   
235
     
257
     
848
     
976
 
Legal
   
600
     
261
     
2,320
     
1,553
 
FDIC Insurance
   
153
     
227
     
624
     
693
 
Other
   
3,045
     
2,770
     
8,118
     
8,115
 
Total Non-Interest Expense
   
20,856
     
18,621
     
61,866
     
56,702
 
                                 
Income Before Provision for Income Taxes
   
18,398
     
14,995
     
55,632
     
42,436
 
Provision for Income Taxes
   
4,660
     
2,995
     
14,240
     
9,945
 
Net Income
 
$
13,738
   
$
12,000
   
$
41,392
   
$
32,491
 
Basic Earnings Per Common Share
 
$
17.45
   
$
15.12
   
$
52.64
   
$
40.26
 

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

FARMERS & MERCHANTS BANCORP
Consolidated Statements of Comprehensive Income (Unaudited)
(in thousands)
 
Three Months
Ended September 30,
   
Nine Months
Ended September 30,
 
   
2019
   
2018
   
2019
   
2018
 
Net Income
 
$
13,738
   
$
12,000
   
$
41,392
   
$
32,491
 
                                 
Other Comprehensive Income
                               
Increase in Net Unrealized Gain (Loss) on Available-for-Sale Securities
   
684
     
(1,679
)
   
8,671
     
(9,486
)
Deferred Tax (Expense) Benefit  Related to Unrealized Gains
   
(203
)
   
496
     
(2,564
)
   
2,816
 
Reclassification Adjustment for Realized (Gains) Losses  on Available-for-Sale Securities Included in Net Income
   
(1
)
   
-
     
(1
)
   
1,330
 
Deferred Tax Benefit (Expense) Related to Reclassification Adjustment
   
-
     
-
     
-
     
(405
)
Total Other Comprehensive Income (Loss)
   
480
     
(1,183
)
   
6,106
     
(5,745
)
Comprehensive Income
 
$
14,218
   
$
10,817
   
$
47,498
   
$
26,746
 

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

FARMERS & MERCHANTS BANCORP
     
Consolidated Statements of Changes in Shareholders' Equity  (Unaudited)
For the three and nine months ended September 30, 2019 and 2018
 
 
 
(in thousands except share data)
 
 
Common
Shares
Outstanding
   
Common
Stock
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
(Loss) Income, net
   
Total
Shareholders'
Equity
 
   
Three Months Ended September 30, 2019
 
Balance, July 1, 2019
   
787,307
   
$
8
   
$
75,538
   
$
263,325
   
$
2,638
   
$
341,509
 
Net Income
                   
-
     
13,738
     
-
     
13,738
 
Cash Dividends Declared on
                                           
-
 
Common Stock ($7.05 per share)
           
-
     
-
     
-
     
-
     
-
 
Issuance of Common Stock
   
-
     
-
     
-
     
-
     
-
     
-
 
Change in Net Unrealized Loss on Securities Available-for-Sale, net of tax
           
-
     
-
     
-
     
480
     
480
 
Balance, September 30, 2019
   
787,307
   
$
8
   
$
75,538
   
$
277,063
   
$
3,118
   
$
355,727
 
                                                 
   
Three Months Ended September 30, 2018
 
Balance, July 1, 2018
   
821,073
   
$
8
   
$
99,192
   
$
221,671
   
$
(5,379
)
 
$
315,492
 
Net Income
                   
-
     
12,000
     
-
     
12,000
 
Cash Dividends Declared on
                                           
-
 
Common Stock ($6.90 per share)
           
-
     
-
     
-
     
-
     
-
 
Repurchase of Common Stock
   
(44,503
)
   
-
     
(31,152
)
   
-
     
-
     
(31,152
)
Issuance of Common Stock
   
7,151
     
-
     
4,934
     
-
     
-
     
4,934
 
Change in Net Unrealized Loss on Securities Available-for-Sale, net of tax
           
-
     
-
     
-
     
(1,183
)
   
(1,183
)
Balance, September 30, 2018
   
783,721
   
$
8
   
$
72,974
   
$
233,671
   
$
(6,562
)
 
$
300,091
 
                                                 
   
Nine Months Ended September 30, 2019
 
Balance, January 1, 2019
   
783,721
   
$
8
   
$
72,974
   
$
241,221
   
$
(2,988
)
 
$
311,215
 
Net Income
                   
-
     
41,392
     
-
     
41,392
 
Cash Dividends Declared on
                                           
-
 
Common Stock ($7.05 per share)
           
-
     
-
     
(5,550
)
   
-
     
(5,550
)
Issuance of Common Stock
   
3,586
     
-
     
2,564
     
-
     
-
     
2,564
 
Change in Net Unrealized Loss on Securities Available-for-Sale, net of tax
           
-
     
-
     
-
     
6,106
     
6,106
 
Balance, September 30, 2019
   
787,307
   
$
8
   
$
75,538
   
$
277,063
   
$
3,118
   
$
355,727
 
                                                 
   
Nine Months Ended September 2018
 
Balance, January 1, 2018
   
812,304
   
$
8
   
$
93,624
   
$
206,845
   
$
(817
)
 
$
299,660
 
Net Income
                   
-
     
32,491
     
-
     
32,491
 
Cash Dividends Declared on
                                           
-
 
Common Stock ($6.90 per share)
           
-
     
-
     
(5,665
)
   
-
     
(5,665
)
Repurchase of Common Stock
   
(44,503
)
   
-
     
(31,152
)
   
-
     
-
     
(31,152
)
Issuance of Common Stock
   
15,920
     
-
     
10,502
     
-
     
-
     
10,502
 
Change in Net Unrealized Loss on Securities Available-for-Sale, net of tax
           
-
     
-
     
-
     
(5,745
)
   
(5,745
)
Balance, September 30, 2018
   
783,721
   
$
8
   
$
72,974
   
$
233,671
   
$
(6,562
)
 
$
300,091
 

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

FARMERS & MERCHANTS BANCORP
   
Consolidated Statements of Cash Flows (Unaudited)
 
 
   
Nine Months
 
    Ended September 30,  
(in thousands)
 
2019
   
2018
 
Operating Activities:
           
Net Income
 
$
41,392
   
$
32,491
 
Adjustments to Reconcile Net Income to Net
               
Cash Provided by Operating Activities:
               
Provision for Credit Losses
   
200
     
3,333
 
Depreciation and Amortization
   
2,071
     
1,751
 
Net Amortization of Investment Security Premiums & Discounts
   
365
     
768
 
Amortization of Core Deposit Intangible
   
479
     
81
 
Accretion of Discount on Acquired Loans
   
(22
)
   
(115
)
Net (Gain) Loss on Sale of Investment Securities
   
(1
)
   
1,330
 
Net Loss (Gain) on Sale of Property & Equipment
   
83
     
(295
)
Earnings from Equity Investment
   
-
     
(381
)
Dividends from Equity Investment
   
-
     
63
 
Net Change in Operating Assets & Liabilities:
               
Net Decrease in Interest Receivable and Other Assets
   
814
     
2,083
 
Net Increase in Interest Payable and Other Liabilities
   
8,789
     
3,441
 
Net Cash Provided by Operating Activities
   
54,170
     
44,550
 
Investing Activities:
               
Purchase of Investment Securities Available-for-Sale
   
(502,221
)
   
(274,440
)
Proceeds from Sold, Matured or Called Securities Available-for-Sale
   
511,590
     
342,208
 
Purchase of Investment Securities Held-to-Maturity
   
(14,271
)
   
(3,042
)
Proceeds from Matured or Called Securities Held-to-Maturity
   
8,658
     
5,998
 
Net Loans & Leases Paid, Originated or Acquired
   
(46,513
)
   
(201,914
)
Principal Collected on Loans & Leases Previously Charged Off
   
142
     
115
 
Additions to Premises and Equipment
   
(1,100
)
   
(3,654
)
Purchase of Other Investments
   
(3,015
)
   
(4,053
)
Proceeds from Sale of Property & Equipment
   
41
     
986
 
Net Cash Used in Investing Activities
   
(46,689
)
   
(137,796
)
Financing Activities:
               
Net Increase  in Deposits
   
76,581
     
53,695
 
Common Stock Repurchases
   
-
     
(31,152
)
Cash Dividends
   
(5,550
)
   
(5,665
)
Net Cash Provided by Financing Activities
   
71,031
     
16,878
 
Increase (Decrease) in Cash and Cash Equivalents
   
78,512
     
(76,368
)
Cash and Cash Equivalents at Beginning of Period
   
145,564
     
187,149
 
Cash and Cash Equivalents at End of Period
 
$
224,076
   
$
110,781
 
Supplementary Data
               
Cash Payments Made for Income Taxes
 
$
4,782
   
$
5,421
 
Issuance of Common Stock to the Bank's Non-Qualified Retirement Plans
 
$
2,564
   
$
10,502
 
Interest Paid
 
$
8,584
   
$
5,248
 
Supplementary Noncash Disclosure
               
Security (purchases) sales settled in subsequent period
 
$
-
   
$
(55,000
)

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

FARMERS & MERCHANTS BANCORP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Significant Accounting Policies

Farmers & Merchants Bancorp (the “Company”) was organized March 10, 1999. Primary operations are related to traditional banking activities through its subsidiary Farmers & Merchants Bank of Central California (the “Bank”) which was established in 1916. The Bank’s wholly owned subsidiaries include Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. Farmers & Merchants Investment Corporation has been dormant since 1991. Farmers/Merchants Corp. acts as trustee on deeds of trust originated by the Bank.

The Company’s other wholly owned subsidiaries include F & M Bancorp, Inc. and FMCB Statutory Trust I. F & M Bancorp, Inc. was created in March 2002 to protect the name F & M Bank. During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name “F & M Bank” as part of a larger effort to enhance the Company’s image and build brand name recognition. In December 2003, the Company formed a wholly owned subsidiary, FMCB Statutory Trust I, for the sole purpose of issuing Trust Preferred Securities and related subordinated debentures, in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). FMCB Statutory Trust I is a non-consolidated subsidiary.

On October 10, 2018, Farmers & Merchants Bancorp completed the acquisition of the Bank of Rio Vista, headquartered in Rio Vista, California, a locally owned and operated community bank established in 1904. As of the acquisition date, Bank of Rio Vista had approximately $217.5 million in assets and three branch locations in the communities of Rio Vista, Walnut Grove, and Lodi. At the effective time of the acquisition, Bank of Rio Vista was merged into Farmers & Merchants Bank of Central California.

The accounting and reporting policies of the Company conform to U.S. GAAP and prevailing practice within the banking industry. The following is a summary of the significant accounting and reporting policies used in preparing the consolidated financial statements.

Basis of Presentation
The accompanying consolidated financial statements and notes thereto have been prepared in accordance with accounting principles generally accepted in the United States of America for financial information.

The accompanying consolidated financial statements include the accounts of the Company and the Company’s wholly owned subsidiaries, F & M Bancorp, Inc. and the Bank, along with the Bank’s wholly owned subsidiaries, Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. Significant inter-company transactions have been eliminated in consolidation.

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and accompanying notes required by U.S. GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. In the opinion of Management, the unaudited consolidated financial statements reflect all adjustments, which are necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income, changes in stockholders’ equity, and cash flows for the periods presented. All material intercompany transactions have been eliminated. The results of these interim periods may not be indicative of the results for the full year or for any other period. Actual results could differ from these estimates. See “Financial Condition – Critical Accounting Policies and Estimates” in the Company’s 2018 Annual Report to Shareholders on Form 10-K.

Certain amounts in the prior years' financial statements and related footnote disclosures have been reclassified to conform to the current-year presentation. These reclassifications had no effect on previously reported net income or total shareholders’ equity.

New Accounting Changes
The FASB issued guidance in February 2016, with amendments in 2018 and 2019, which changed the accounting for leases. The guidance requires lessees to recognize right-of-use (ROU) assets and lease liabilities for most leases where we are the lessee in the Consolidated Statement of Financial Position. The guidance also made some changes to lessor accounting, including the elimination of the use of third-party residual value guarantee insurance in the lease classification test, and overall aligns with the new revenue recognition guidance. The guidance also requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 provides for a modified retrospective transition approach requiring lessees to recognize and measure leases on the consolidated balance sheet at the beginning of either the earliest period presented or as of the beginning of the period of adoption with the option to elect certain practical expedients. The Company elected the package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs (IDC’s). From a lessor perspective, the changes in lease termination guidance, IDC and removal of third-party residual value guarantee insurance in the lease classification test did not have a material impact on the consolidated financial results. We adopted ASU No. 2016-02 Leases (Topic 842), as of January 1, 2019, using the cumulative effect transition approach. The cumulative effect transition approach provides a method for recording existing leases at adoption and not restated comparative periods; rather the effect of the change is recorded at the beginning of the year of adoption.  The Company elected the ASU’s package of three practical expedients, which allowed the Company to forego a reassessment of (i) whether any expired or existing contracts contain leases, (ii) the lease classification for any expired or existing leases and (iii) the initial direct costs for any existing leases. The Company elected the option not to separate lease and non-lease components and instead to account for them as a single lease component and the hindsight practical expedient, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets.

The Company has several lease agreements, such as branch locations, which are considered operating leases, and therefore, were not previously recognized on the Company’s consolidated statements of condition. The new guidance requires these lease agreements to be recognized as a right-of-use asset and corresponding lease liability.

Our operating leases relate primarily to office space and bank branches. As a result of implementing ASU 2016-02, we recognized an operating lease right-of-use ("ROU") asset of $4.73 million and an operating lease liability of $4.73 million on January 1, 2019, with no impact on our consolidated statement of income or consolidated statement of cash flows compared to the prior lease accounting model. The ROU asset and operating lease liability are recorded in other assets and other liabilities, respectively, in the consolidated balance sheets. See Note 7 – “Leases” for additional information.

Cash and Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Company has defined cash and cash equivalents as those amounts included in the balance sheet captions Cash and Due from Banks, Interest Bearing Deposits with Banks, Federal Funds Sold which have maturity dates of 3 months or less. For these instruments, the carrying amount is a reasonable estimate of fair value.

Investment Securities
Investment securities are debt securities classified at the time of purchase as held-to-maturity (“HTM”) if it is management’s intent and the Company has the ability to hold the securities until maturity. These securities are carried at cost, adjusted for amortization of premium and accretion of discount using a level yield of interest over the estimated remaining period until maturity. Losses, reflecting a decline in value judged by the Company to be other than temporary, are recognized in the period in which they occur.

Debt securities are classified as available-for-sale (“AFS”) if it is management’s intent, at the time of purchase, to hold the securities for an indefinite period of time and/or to use the securities as part of the Company’s asset/liability management strategy. 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. Fair values are based on quoted market prices or broker/dealer price quotations on a specific identification basis. Gains or losses on the sale of these securities are computed using the specific identification method.

Trading debt securities, if any, are acquired for short-term appreciation and are recorded in a trading portfolio and are carried at fair value, with unrealized gains and losses recorded in non-interest income.

Management evaluates debt securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For debt securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement; and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

Equity securities are carried at fair value with the entire amount of a market adjustment recognized through earnings.

Securities Sold Under Agreement to Repurchase
Securities Sold Under Agreement to Repurchase are used as secured borrowing alternatives to FHLB Advances or FRB Borrowings.

Loans & Leases
Loans & leases are reported at the principal amount outstanding net of unearned discounts and deferred loan & lease fees and costs. Interest income on loans & leases is accrued daily on the outstanding balances using the simple interest method. Loan & lease origination fees are deferred and recognized over the contractual life of the loan or lease as an adjustment to the yield. Loans & leases are placed on non-accrual status when the collection of principal or interest is in doubt or when they become past due for 90 days or more unless they are both well-secured and in the process of collection. For this purpose, a loan or lease is considered well-secured if it is collateralized by property having a net realizable value in excess of the amount of the loan or lease or is guaranteed by a financially capable party. When a loan or lease is placed on non-accrual status, the accrued and unpaid interest receivable is reversed and charged against current income; thereafter, interest income is recognized only as it is collected in cash. Additionally, cash would be applied to principal if all principal was not expected to be collected. Loans & leases placed on non-accrual status are returned to accrual status when the loans or leases are paid current as to principal and interest and future payments are expected to be made in accordance with the contractual terms of the loan or lease.

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. Impaired loans & leases are either: (1) non-accrual loans & leases; or (2) restructured loans & leases that are still accruing interest. Loans or 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 or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan 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) if the Company for economic or legal reasons related to the borrower’s (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction) financial difficulties grants a concession to the borrower that it would not otherwise consider. Restructured loans & 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 nonaccrual status at the time they become TDR, remain on nonaccrual 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 described above.

Generally, the Company will not restructure loans or leases for borrowers unless: (1) the existing loan or lease is brought current as to principal and interest payments; and (2) the restructured loan or lease can be underwritten to reasonable underwriting standards. If these standards are not met other actions will be pursued (e.g., foreclosure) to collect outstanding loan or lease amounts. After restructure, a determination is made whether the loan or lease will be kept on accrual status based upon the underwriting and historical performance of the restructured credit.

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.

The determination of the general reserve for loans & 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, 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 and other; and (9) equipment leases. The allowance for credit losses attributable to each portfolio segment, which includes both individually evaluated impaired loans & leases and loans & leases that are collectively evaluated for impairment, 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, 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 risk ratings can be grouped into five major categories, defined as follows:

Pass – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention.

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

Substandard – A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any. Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable or improbable.

Loss – Loans or leases classified as loss are considered uncollectible. Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Company will estimate its probable loss and immediately charge-off some or all of the balance.

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 described below:

Commercial Real Estate – Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.

Real Estate Construction – Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. A major risk arises from the necessity to complete projects within specified cost and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.

Commercial – These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term; typically made to relationship customers; generally underwritten to existing cash flows of operating businesses; and may be collateralized by fixed assets, inventory and/or accounts receivable. Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.

Agricultural Real Estate and Agricultural – These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production, livestock and related real estate. These loans are vulnerable to two risk factors that are largely outside the control of Company and borrowers: commodity prices and weather conditions.

Leases – Equipment leases are generally considered to possess a moderate inherent risk of loss. As lessor, the Company is subject to both the credit risk of the borrower and the residual value risk of the equipment. 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.

Residential 1st Mortgages and Home Equity Lines and Loans – These loans are generally considered to possess a low inherent risk of loss, although this is not always true as evidenced by the correction in residential real estate values that occurred between 2007 and 2012. The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower's ability to repay in an orderly fashion. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.

Consumer & Other – A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.

At least quarterly, the Board of Directors reviews the adequacy of the allowance, including consideration of the relative risks in the portfolio, current economic conditions and other factors. If the Board of Directors and management determine that changes are warranted based on those reviews, the allowance is adjusted. In addition, the Company's and Bank's regulators, including the Federal Reserve Board (“FRB”), the California Department of Business Oversight (“DBO”) and the Federal Deposit Insurance Corporation (“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. See Note 9 “Recent Accounting Pronouncements” for a discussion of ASU 2016-13 and the accounting changes which will impact our allowance for credit losses in 2020.

Acquired Loans
Loans acquired through purchase or through a business combination are recorded at their fair value at the acquisition date. Credit discounts, which reflect estimates of credit losses, expected to be incurred over the life of the loan, are included in the determination of fair value; therefore, an allowance for loan losses is not recorded for loans acquired at the acquisition date.

Allowance for Credit Losses on Off-Balance-Sheet Credit Exposures
The Company also maintains a separate allowance for off-balance-sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance-sheet commitments is included in Interest Payable and Other Liabilities on the Company’s Consolidated Balance Sheet.

Premises and Equipment
Premises, equipment, and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is computed principally by the straight-line method over the estimated useful lives of the assets. Estimated useful lives of buildings range from 30 to 40 years, and for furniture and equipment from 3 to 7 years. Leasehold improvements are amortized over the lesser of the terms of the respective leases, or their useful lives, which are generally 5 to 10 years. Remodeling and capital improvements are capitalized while maintenance and repairs are charged directly to occupancy expense.

Other Real Estate
Other real estate, which is included in other assets, is expected to be sold and is comprised of properties no longer utilized for business operations and property acquired through foreclosure in satisfaction of indebtedness. These properties are recorded at fair value less estimated selling costs upon acquisition. Revised estimates to the fair value less cost to sell are reported as adjustments to the carrying amount of the asset, provided that such adjusted value is not in excess of the carrying amount at acquisition. Initial losses on properties acquired through full or partial satisfaction of debt are treated as credit losses and charged to the allowance for credit losses at the time of acquisition. Subsequent declines in value from the recorded amounts, routine holding costs, and gains or losses upon disposition, if any, are included in non-interest expense as incurred.

Income Taxes
The Company uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year.

The Company follows the standards set forth in the “Income Taxes” topic of the Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. This standard prescribes a recognition threshold and measurement standard for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

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 tax on the Company’s financial statement.

The Company accounts for its interest in LIHTC using the cost method as established in ASC 323-740. As an investor, the Company obtains income tax credits and deductions from the operating losses of these tax credit entities. The income tax credits and deductions are allocated to the investors based on their ownership percentages and are recorded as a reduction of income tax expense (or an increase to income tax benefit) and a reduction of federal income taxes payable.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the consolidated financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

At September 30, 2019 and 2018, the Company has no material uncertain tax positions and recognized no interest or penalties. The Company's policy is to recognize interest and penalties related to income taxes in the provision for income taxes in the Consolidated Statement of Income.

Basic and Diluted Earnings Per Common Share
The Company’s common stock is not traded on any exchange. The shares are primarily held by local residents and are not actively traded. Basic earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. There are no common stock equivalent shares. Therefore, basic and diluted earnings per common share are reflected as the same amounts. See Note 6 for additional information.

Segment Reporting
The “Segment Reporting” topic of the FASB ASC requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. The Company is a holding company for a community bank, which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, the Company is not organized around discernible lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change.

Comprehensive Income
The “Comprehensive Income” topic of the FASB ASC establishes standards for the reporting and display of comprehensive income and its components in the consolidated financial statements. Other comprehensive income refers to revenues, expenses, gains, and losses that U.S. GAAP recognize as changes in value to an enterprise but are excluded from net income. For the Company, comprehensive income includes net income and changes in fair value of its available-for-sale investment securities.

Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the consolidated financial statements.

Business Combinations and Related Matters
Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method, the acquiring entity in a business combination recognizes 100 percent of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the fair value over the purchase price of net assets and other identifiable intangible assets acquired is recorded as bargain purchase gain. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the consolidated statement of operations from the date of acquisition. Acquisition-related costs, including conversion charges, are expensed as incurred. The Company applied this guidance to the acquisition of Bank of Rio Vista (BRV) which was consummated on October 10, 2018. The Company's consolidated financial statements reflect the operations of Bank of Rio Vista beginning October 11, 2018.

Goodwill and Other Intangible Assets: Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill that arises from a business combination is periodically evaluated for impairment at the reporting unit level, at least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Core deposit intangible ("CDI") represents the estimated future benefit of deposits related to an acquisition and is booked separately from the related deposits and evaluated periodically for impairment. The CDI asset is amortized on a straight-line method over its estimated useful life of ten years. At September 30, 2019, the future estimated amortization expense for the CDI arising from our past acquisitions is as follows:

(in thousands)
 
2019
   
2020
   
2021
   
2022
   
2023
   
Thereafter
   
Total
 
Core Deposit Intangible Amortization
 
$
160
   
$
626
   
$
611
   
$
593
   
$
573
   
$
2,236
   
$
4,799
 

We make a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit where goodwill is assigned is less than its carrying amount. If we conclude that it is more likely than not that the fair value is more than its carrying amount, no impairment is recorded. Goodwill is tested for impairment on an interim basis if circumstances change or an event occurs between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive and mitigating events. Such indicators may include, among others, a significant change in legal factors or in the general business climate, significant change in our stock price and market capitalization, unanticipated competition, and an action or assessment by a regulator. If the fair value of a reporting unit is less than its carrying amount, an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value is recognized. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.

2. Investment Securities

The amortized cost, fair values, and unrealized gains and losses of the debt securities available-for-sale are as follows
(in thousands):

    Amortized    
Gross Unrealized
   
Fair
 
September 30, 2019
 
Cost
   
Gains
   
Losses
   
Value
 
US Treasury Notes
 
$
129,724
    $
270
    $
5
    $
129,989
 
US Government Agency SBA
   
11,844
     
15
     
115
     
11,744
 
Mortgage Backed Securities (1)
   
343,295
     
4,425
     
163
     
347,557
 
Other
   
3,640
     
-
     
-
     
3,640
 
Total
 
$
488,503
   
$
4,710
   
$
283
   
$
492,930
 

   
Amortized
   
Gross Unrealized
   
Fair
 
December 31, 2018
 
Cost
   
Gains
   
Losses
   
Value
 
Government Agency & Government-Sponsored Entities
 
$
3,033
   
$
6
   
$
-
   
$
3,039
 
US Treasury Notes
   
164,672
     
-
     
158
     
164,514
 
US Government Agency SBA
   
15,601
     
6
     
160
     
15,447
 
Mortgage Backed Securities (1)
   
310,982
     
1,196
     
5,133
     
307,045
 
Other
   
5,351
     
-
     
-
     
5,351
 
Total
 
$
499,639
   
$
1,208
   
$
5,451
   
$
495,396
 

   
Amortized
   
Gross Unrealized
   
Fair
 
September 30, 2018
 
Cost
   
Gains
   
Losses
   
Value
 
Government Agency & Government-Sponsored Entities
 
$
3,045
   
$
7
   
$
-
   
$
3,052
 
US Treasury Notes
   
164,671
     
-
     
463
     
164,208
 
US Government Agency SBA
   
17,144
     
6
     
177
     
16,973
 
Mortgage Backed Securities (1)
   
279,757
     
265
     
8,955
     
271,067
 
Other
   
3,011
     
-
     
-
     
3,011
 
Total
 
$
467,628
   
$
278
   
$
9,595
   
$
458,311
 

(1) All Mortgage Backed Securities consist of securities collateralized by residential real estate and were issued by an agency or government sponsored entity of the U.S. government.

The book values, estimated fair values and unrealized gains and losses of debt securities classified as held-to-maturity are as follows (in thousands):


 
Book
   
Gross Unrealized
    Fair  
September 30, 2019
 
Value
   
Gains
   
Losses
   
Value
 
Obligations of States and Political Subdivisions
 
$
60,354
   
$
946
   
$
7
   
$
61,293
 
Total
 
$
60,354
   
$
946
   
$
7
   
$
61,293
 


 
Book
   
Gross Unrealized
    Fair  
December 31, 2018
 
Value
   
Gains
   
Losses
   
Value
 
Obligations of States and Political Subdivisions
 
$
53,566
   
$
211
   
$
39
   
$
53,738
 
Total
 
$
53,566
   
$
211
   
$
39
   
$
53,738
 


 
Book
   
Gross Unrealized
    Fair  
September 30, 2018
 
Value
   
Gains
   
Losses
   
Value
 
Obligations of States and Political Subdivisions
 
$
51,459
   
$
97
   
$
174
   
$
51,382
 
Total
 
$
51,459
   
$
97
   
$
174
   
$
51,382
 

Fair values are based on quoted market prices or dealer quotes. If a quoted market price or dealer quote is not available, fair value is estimated using quoted market prices for similar securities.

The amortized cost and estimated fair values of investment securities at September 30, 2019 by contractual maturity are shown in the following table (in thousands):

   
Available-for-Sale
   
Held-to-Maturity
 
September 30, 2019
 
Amortized
Cost
   
Fair
Value
   
Book
Value
   
Fair
Value
 
Within one year
 
$
118,646
   
$
118,641
   
$
2,151
   
$
2,152
 
After one year through five years
   
15,118
     
15,387
     
4,696
     
4,702
 
After five years through ten years
   
1,126
     
1,126
     
25,426
     
26,174
 
After ten years
   
10,318
     
10,219
     
28,081
     
28,265
 
     
145,208
     
145,373
     
60,354
     
61,293
 
Investment securities not due at a single maturity date:
                               
Mortgage-backed securities
   
343,295
     
347,557
     
-
     
-
 
                                 
Total
 
$
488,503
   
$
492,930
   
$
60,354
   
$
61,293
 

Expected maturities of mortgage-backed securities can differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.

The following tables show those investments with gross unrealized losses and their market value (in thousands) aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at the dates indicated. (in thousands)

   
Less Than 12 Months
   
12 Months or More
   
Total
 
September 30, 2019
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
                                     
Securities Available-for-Sale
                                   
US Treasury Notes
 
$
114,995
   
$
5
   
$
-
   
$
-
   
$
114,995
   
$
5
 
US Government Agency SBA
   
2,046
     
3
     
5,779
     
112
     
7,825
     
115
 
Mortgage Backed Securities
   
107,628
     
146
     
876
     
17
     
108,504
     
163
 
Total
 
$
224,669
   
$
154
   
$
6,655
   
$
129
   
$
231,324
   
$
283
 
                                                 
Securities Held-to-Maturity
                                               
Obligations of States and Political Subdivisions
 
$
212
   
$
7
   
$
-
   
$
-
   
$
212
   
$
7
 
Total
 
$
212
   
$
7
   
$
-
   
$
-
   
$
212
   
$
7
 

   
Less Than 12 Months
   
12 Months or More
   
Total
 
December 31, 2018
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
                                     
Securities Available-for-Sale
                                   
US Treasury Notes
 
$
124,985
   
$
7
   
$
39,529
   
$
151
   
$
164,514
   
$
158
 
US Government Agency SBA
   
3,250
     
28
     
8,618
     
132
     
11,868
     
160
 
Mortgage Backed Securities
   
52,289
     
528
     
207,271
     
4,605
     
259,560
     
5,133
 
Total
 
$
180,524
   
$
563
   
$
255,418
   
$
4,888
   
$
435,942
   
$
5,451
 
                                                 
Securities Held-to-Maturity
                                               
Obligations of States and Political Subdivisions
 
$
6,052
   
$
23
   
$
849
   
$
16
   
$
6,901
   
$
39
 
Total
 
$
6,052
   
$
23
   
$
849
   
$
16
   
$
6,901
   
$
39
 

   
Less Than 12 Months
   
12 Months or More
   
Total
 
 
September 30, 2018
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
                                     
Securities Available-for-Sale
                                   
US Treasury Notes
 
$
84,315
   
$
290
   
$
24,902
   
$
173
   
$
109,217
   
$
463
 
US Government Agency SBA
   
4,965
     
62
     
8,467
     
115
     
13,432
     
177
 
Mortgage Backed Securities
   
182,243
     
5,772
     
78,272
     
3,183
     
260,515
     
8,955
 
Total
 
$
271,523
   
$
6,124
   
$
111,641
   
$
3,471
   
$
383,164
   
$
9,595
 
                                                 
Securities Held-to-Maturity
                                               
Obligations of States and Political Subdivisions
 
$
15,309
   
$
174
   
$
-
   
$
-
   
$
15,309
   
$
174
 
Total
 
$
15,309
   
$
174
   
$
-
   
$
-
   
$
15,309
   
$
174
 

As of September 30, 2019, the Company held 595 investment securities of which 26 were in an unrealized loss position for less than twelve months. 74 securities were in a loss position for twelve months or more. Management periodically evaluates each investment security for other-than-temporary impairment relying primarily on industry analyst reports and observations of market conditions and interest rate fluctuations. Management believes it will be able to collect all amounts due according to the contractual terms of the underlying investment securities.

Securities of Government Agency and Government Sponsored Entities – At September 30, 2019, December 31, 2018, and September 30, 2018, no securities of government agency and government sponsored entities were in an unrealized loss position for less than 12 months or for 12 months or more.

U.S. Treasury Notes – At September 30, 2019, three U.S. Treasury Note security investments were in an unrealized loss position for less than 12 months and none were in a loss position for 12 months or more. The unrealized losses on the Company's investment in U.S. Treasury Notes were $5,000, $158,000, and $463,000 at September 30, 2019, December 31, 2018, and September 30, 2018, respectively.  The unrealized losses were caused by interest rate fluctuations. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company did not consider these investments to be other-than-temporarily impaired at September 30, 2019, December 31, 2018, and September 30, 2018.

U.S. Government SBA – At September 30, 2019, 13 U.S. Government SBA security investments were in an unrealized loss position for less than 12 months and 53 were in a loss position for 12 months or more. The unrealized losses on the Company's investment in U.S. Government SBA securities were $115,000, $160,000, and $177,000 at September 30, 2019, December 31, 2018, and September 30, 2018, respectively. The unrealized losses were caused by interest rate fluctuations. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company did not consider these investments to be other-than-temporarily impaired at September 30, 2019, December 31, 2018, and September 30, 2018.

Mortgage Backed Securities – At September 30, 2019, 9 mortgage backed security investments were in an unrealized loss position for less than 12 months and 21 were in a loss position for 12 months or more. The unrealized losses on the Company's investment in mortgage backed securities were $163,000, $5.1 million, and $8.9 million at September 30, 2019, December 31, 2018, and September 30, 2018, respectively. The unrealized losses on the Company’s investment in mortgage backed securities were caused by interest rate fluctuations. The contractual cash flows of these investments are guaranteed by an agency or government sponsored entity of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company's investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2019, December 31, 2018, and September 30, 2018.

Obligations of States and Political Subdivisions - At September 30, 2019, one obligation of states and political subdivisions were in an unrealized loss position for less than 12 months. None were in a loss position for 12 months or more. As of September 30, 2019, over ninety-nine percent of the Company’s bank-qualified municipal bond portfolio is rated at either the issue or issuer level, and all of these ratings are “investment grade.” The Company monitors the status of the one percent of the portfolio that is not rated 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.

The unrealized losses on the Company’s investment in obligations of states and political subdivisions were $7,000, $39,000 and $174,000 at September 30, 2019, December 31, 2018, and September 30, 2018, respectively. Management believes that any unrealized losses on the Company's investments in obligations of states and political subdivisions were primarily caused by interest rate fluctuations. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2019, December 31, 2018, and September 30, 2018.

Proceeds from sales and calls of securities for the periods shown were as follows:

   
Three Months
Ended September 30,
   
Nine Months
Ended September 30,
 
(in thousands)
 
2019
   
2018
   
2019
   
2018
 
Proceeds
 
$
2,780
   
$
-
   
$
4,090
   
$
31,370
 
Gains
   
1
     
-
     
1
     
8
 
Losses
   
-
     
-
     
-
     
1,338
 

Pledged Securities
As of September 30, 2019, securities carried at $267.2 million were pledged to secure public deposits, Federal Home Loan Bank (“FHLB”) borrowings, and other government agency deposits as required by law. This amount was $268.8 million at December 31, 2018, and $241.8 million at September 30, 2018.

3. Loans & Leases and Allowance for Credit Losses

The following tables show the allocation of the allowance for credit losses by portfolio segment and by impairment methodology at the dates indicated (in thousands):

September 30, 2019
 
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- January 1, 2019
 
$
11,609
   
$
14,092
   
$
1,249
   
$
880
   
$
2,761
   
$
8,242
   
$
11,656
   
$
494
   
$
4,022
   
$
261
   
$
55,266
 
Charge-Offs
   
-
     
-
     
-
     
-
     
-
     
-
     
(592
)
   
(62
)
   
-
     
-
     
(654
)
Recoveries
   
-
     
-
     
-
     
8
     
20
     
34
     
40
     
40
     
-
     
-
     
142
 
Provision
   
(847
)
   
731
     
480
     
(33
)
   
(79
)
   
(431
)
   
601
     
3
     
(969
)
   
744
     
200
 
Ending Balance- September 30, 2019
 
$
10,762
   
$
14,823
   
$
1,729
   
$
855
   
$
2,702
   
$
7,845
   
$
11,705
   
$
475
   
$
3,053
   
$
1,005
   
$
54,954
 
Third Quarter Allowance for Credit Losses:
                                                                         
Beginning Balance- July 1, 2019
 
$
10,680
   
$
14,572
   
$
1,697
   
$
864
   
$
2,743
   
$
7,481
   
$
12,267
   
$
464
   
$
3,100
   
$
1,257
   
$
55,125
 
Charge-Offs
   
-
     
-
     
-
     
-
     
-
     
-
     
(213
)
   
(22
)
   
-
     
-
     
(235
)
Recoveries
   
-
     
-
     
-
     
2
     
9
     
23
     
17
     
13
     
-
     
-
     
64
 
Provision
   
82
     
251
     
32
     
(11
)
   
(50
)
   
341
     
(366
)
   
20
     
(47
)
   
(252
)
   
-
 
Ending Balance- September 30, 2019
 
$
10,762
   
$
14,823
   
$
1,729
   
$
855
   
$
2,702
   
$
7,845
   
$
11,705
   
$
475
   
$
3,053
   
$
1,005
   
$
54,954
 
Ending Balance Individually Evaluated for Impairment
   
253
     
-
     
-
     
121
     
12
     
95
     
147
     
5
     
-
     
-
     
633
 
Ending Balance Collectively Evaluated for Impairment
   
10,509
     
14,823
     
1,729
     
734
     
2,690
     
7,750
     
11,558
     
470
     
3,053
     
1,005
     
54,321
 
Loans & Leases:
                                                                                       
Ending Balance
 
$
816,668
   
$
617,310
   
$
98,662
   
$
255,394
   
$
39,490
   
$
289,182
   
$
381,774
   
$
16,871
   
$
101,771
   
$
-
   
$
2,617,122
 
Ending Balance Individually Evaluated for Impairment
   
4,563
     
5,678
     
-
     
2,422
     
237
     
192
     
1,538
     
5
     
-
     
-
     
14,635
 
Ending Balance Collectively Evaluated for Impairment
 
$
812,105
   
$
611,632
   
$
98,662
   
$
252,972
   
$
39,253
   
$
288,990
   
$
380,236
   
$
16,866
   
$
101,771
   
$
-
   
$
2,602,487
 

December 31, 2018
 
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- January 1, 2018
 
$
10,922
   
$
12,085
   
$
1,846
   
$
815
   
$
2,324
   
$
8,159
   
$
9,197
   
$
209
   
$
3,363
   
$
1,422
   
$
50,342
 
Charge-Offs
   
-
     
-
     
-
     
(31
)
   
(8
)
   
-
     
(613
)
   
(115
)
   
-
     
-
     
(767
)
Recoveries
   
2
     
-
     
-
     
15
     
6
     
61
     
20
     
54
     
-
     
-
     
158
 
Provision
   
685
     
2,007
     
(597
)
   
81
     
439
     
22
     
3,052
     
346
     
659
     
(1,161
)
   
5,533
 
Ending Balance- December 31, 2018
 
$
11,609
   
$
14,092
   
$
1,249
   
$
880
   
$
2,761
   
$
8,242
   
$
11,656
   
$
494
   
$
4,022
   
$
261
   
$
55,266
 
Ending Balance Individually Evaluated for Impairment
   
234
     
-
     
-
     
125
     
15
     
-
     
185
     
6
     
-
     
-
     
565
 
Ending Balance Collectively Evaluated for Impairment
   
11,375
     
14,092
     
1,249
     
755
     
2,746
     
8,242
     
11,471
     
488
     
4,022
     
261
     
54,701
 
Loans & Leases:
                                                                                       
Ending Balance
 
$
826,549
   
$
584,625
   
$
98,568
   
$
259,736
   
$
40,789
   
$
290,463
   
$
343,834
   
$
19,412
   
$
107,265
   
$
-
   
$
2,571,241
 
Ending Balance Individually Evaluated for Impairment
   
4,676
     
7,238
     
-
     
2,491
     
297
     
-
     
1,639
     
6
     
-
     
-
     
16,347
 
Ending Balance Collectively Evaluated for Impairment
   
821,873
     
577,387
     
98,568
     
257,245
     
40,492
     
290,463
     
342,195
     
19,406
     
107,265
     
-
     
2,554,894
 

September 30, 2018
 
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- January 1, 2018
 
$
10,922
   
$
12,085
   
$
1,846
   
$
815
   
$
2,324
   
$
8,159
   
$
9,197
   
$
209
   
$
3,363
   
$
1,422
   
$
50,342
 
Charge-Offs
   
-
     
-
     
-
     
(12
)
   
(14
)
   
-
     
(613
)
   
(84
)
   
-
     
-
     
(723
)
Recoveries
   
-
     
-
     
-
     
12
     
4
     
40
     
19
     
40
     
-
     
-
     
115
 
Provision
   
(31
)
   
1,422
     
(372
)
   
59
     
284
     
4
     
1,029
     
142
     
430
     
366
     
3,333
 
Ending Balance- September 30, 2018
 
$
10,891
   
$
13,507
   
$
1,474
   
$
874
   
$
2,598
   
$
8,203
   
$
9,632
   
$
307
   
$
3,793
   
$
1,788
   
$
53,067
 
Third Quarter Allowance for Credit Losses:
                                                                                 
Beginning Balance- July 1, 2018
 
$
10,783
   
$
13,314
   
$
1,616
   
$
864
   
$
2,548
   
$
7,658
   
$
9,436
   
$
270
   
$
3,400
   
$
1,248
   
$
51,137
 
Charge-Offs
   
-
     
-
     
-
     
-
     
(10
)
   
-
     
(599
)
   
(25
)
   
-
     
-
     
(634
)
Recoveries
   
-
     
-
     
-
     
6
     
2
     
27
     
16
     
13
     
-
     
-
     
64
 
Provision
   
108
     
193
     
(142
)
   
4
     
58
     
518
     
779
     
49
     
393
     
540
     
2,500
 
Ending Balance- September 30, 2018
 
$
10,891
   
$
13,507
   
$
1,474
   
$
874
   
$
2,598
   
$
8,203
   
$
9,632
   
$
307
   
$
3,793
   
$
1,788
   
$
53,067
 
Ending Balance Individually Evaluated for Impairment
   
314
     
-
     
-
     
121
     
15
     
-
     
192
     
7
     
-
     
-
     
649
 
Ending Balance Collectively Evaluated for Impairment
   
10,577
     
13,507
     
1,474
     
753
     
2,583
     
8,203
     
9,440
     
300
     
3,793
     
1,788
     
52,418
 
Loans & Leases:
                                                                                       
Ending Balance
 
$
767,410
   
$
553,608
   
$
92,521
   
$
263,549
   
$
38,490
   
$
287,821
   
$
304,333
   
$
7,723
   
$
101,147
   
$
-
   
$
2,416,602
 
Ending Balance Individually Evaluated for Impairment
   
4,713
     
7,238
     
-
     
2,426
     
305
     
-
     
1,670
     
7
     
-
     
-
     
16,359
 
Ending Balance Collectively Evaluated for Impairment
 
$
762,697
   
$
546,370
   
$
92,521
   
$
261,123
   
$
38,185
   
$
287,821
   
$
302,663
   
$
7,716
   
$
101,147
   
$
-
   
$
2,400,243
 

The ending balance of loans individually evaluated for impairment includes restructured loans in the amount of $2.6 million at September 30, 2019, $2.8 million at December 31, 2018, and $2.8 million at September 30, 2018, which are no longer classified as TDRs.

The following tables show the loan & lease portfolio allocated by management’s internal risk ratings at the dates indicated (in thousands):

September 30, 2019
 
Pass
   
Special
Mention
   
Substandard
   
Total Loans
& Leases
 
Loans & Leases:
                       
Commercial Real Estate
 
$
814,560
   
$
2,108
   
$
-
   
$
816,668
 
Agricultural Real Estate
   
602,781
     
2,491
     
12,038
     
617,310
 
Real Estate Construction
   
98,662
     
-
     
-
     
98,662
 
Residential 1st Mortgages
   
254,594
     
-
     
800
     
255,394
 
Home Equity Lines & Loans
   
39,374
     
-
     
116
     
39,490
 
Agricultural
   
284,211
     
4,168
     
803
     
289,182
 
Commercial
   
377,779
     
2,839
     
1,156
     
381,774
 
Consumer & Other
   
16,436
     
-
     
435
     
16,871
 
Leases
   
101,771
     
-
     
-
     
101,771
 
Total
 
$
2,590,168
   
$
11,606
   
$
15,348
   
$
2,617,122
 

December 31, 2018
 
Pass
   
Special
Mention
   
Substandard
   
Total Loans
& Leases
 
Loans & Leases:
                       
Commercial Real Estate
 
$
823,983
   
$
2,566
   
$
-
   
$
826,549
 
Agricultural Real Estate
   
566,612
     
4,703
     
13,310
     
584,625
 
Real Estate Construction
   
98,568
     
-
     
-
     
98,568
 
Residential 1st Mortgages
   
259,208
     
-
     
528
     
259,736
 
Home Equity Lines & Loans
   
40,744
     
-
     
45
     
40,789
 
Agricultural
   
284,561
     
5,433
     
469
     
290,463
 
Commercial
   
343,085
     
163
     
586
     
343,834
 
Consumer & Other
   
19,229
     
-
     
183
     
19,412
 
Leases
   
107,265
     
-
     
-
     
107,265
 
Total
 
$
2,543,255
   
$
12,865
   
$
15,121
   
$
2,571,241
 

September 30, 2018
 
Pass
   
Special Mention
   
Substandard
   
Total Loans
& Leases
 
Loans & Leases:
                       
Commercial Real Estate
 
$
764,839
   
$
2,571
   
$
-
   
$
767,410
 
Agricultural Real Estate
   
537,027
     
3,271
     
13,310
     
553,608
 
Real Estate Construction
   
92,521
     
-
     
-
     
92,521
 
Residential 1st Mortgages
   
262,946
     
-
     
603
     
263,549
 
Home Equity Lines & Loans
   
38,443
     
-
     
47
     
38,490
 
Agricultural
   
281,698
     
4,635
     
1,488
     
287,821
 
Commercial
   
303,507
     
171
     
655
     
304,333
 
Consumer & Other
   
7,552
     
-
     
171
     
7,723
 
Leases
   
101,147
     
-
     
-
     
101,147
 
Total
 
$
2,389,680
   
$
10,648
   
$
16,274
   
$
2,416,602
 

See “Note 1. Significant Accounting Policies - Allowance for Credit Losses” for a description of the internal risk ratings used by the Company. There were no loans or leases outstanding at September 30, 2019, December 31, 2018, and September 30, 2018, rated doubtful or loss.

The following tables show an aging analysis of the loan & lease portfolio by the time past due at the dates indicated (in thousands):

September 30, 2019
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days and
Still Accruing
   
Nonaccrual
   
Total Past
Due
   
Current
   
Total
Loans & Leases
 
Loans & Leases:
                                         
Commercial Real Estate
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
816,668
   
$
816,668
 
Agricultural Real Estate
   
-
     
-
     
-
     
-
     
-
     
617,310
     
617,310
 
Real Estate Construction
   
-
     
-
     
-
     
-
     
-
     
98,662
     
98,662
 
Residential 1st Mortgages
   
-
     
-
     
-
     
-
     
-
     
255,394
     
255,394
 
Home Equity Lines & Loans
   
-
     
84
     
-
     
-
     
84
     
39,406
     
39,490
 
Agricultural
   
250
     
-
     
-
     
-
     
250
     
288,932
     
289,182
 
Commercial
   
258
     
-
     
-
     
-
     
258
     
381,516
     
381,774
 
Consumer & Other
   
9
     
60
     
-
     
-
     
69
     
16,802
     
16,871
 
Leases
   
-
     
-
     
-
     
-
     
-
     
101,771
     
101,771
 
Total
 
$
517
   
$
144
   
$
-
   
$
-
   
$
661
   
$
2,616,461
   
$
2,617,122
 

December 31, 2018
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days and
Still Accruing
   
Nonaccrual
   
Total Past
Due
   
Current
   
Total
Loans & Leases
 
Loans & Leases:
                                         
Commercial Real Estate
 
$
-
   
$
731
   
$
-
   
$
-
   
$
731
   
$
825,818
   
$
826,549
 
Agricultural Real Estate
   
-
     
-
     
-
     
-
     
-
     
584,625
     
584,625
 
Real Estate Construction
   
327
     
-
     
-
     
-
     
327
     
98,241
     
98,568
 
Residential 1st Mortgages
   
367
     
-
     
-
     
-
     
367
     
259,369
     
259,736
 
Home Equity Lines & Loans
   
-
     
-
     
-
     
-
     
-
     
40,789
     
40,789
 
Agricultural
   
-
     
-
     
-
     
-
     
-
     
290,463
     
290,463
 
Commercial
   
-
     
-
     
-
     
-
     
-
     
343,834
     
343,834
 
Consumer & Other
   
13
     
-
     
-
     
-
     
13
     
19,399
     
19,412
 
Leases
   
-
     
-
     
-
     
-
     
-
     
107,265
     
107,265
 
Total
 
$
707
   
$
731
   
$
-
   
$
-
   
$
1,438
   
$
2,569,803
   
$
2,571,241
 

September 30, 2018
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days and
Still Accruing
   
Nonaccrual
   
Total Past
Due
   
Current
   
Total
Loans & Leases
 
Loans & Leases:
                                         
Commercial Real Estate
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
767,410
   
$
767,410
 
Agricultural Real Estate
   
-
     
-
     
-
     
-
     
-
     
553,608
     
553,608
 
Real Estate Construction
   
-
     
-
     
-
     
-
     
-
     
92,521
     
92,521
 
Residential 1st Mortgages
   
167
     
-
     
-
     
-
     
167
     
263,382
     
263,549
 
Home Equity Lines & Loans
   
-
     
-
     
-
     
-
     
-
     
38,490
     
38,490
 
Agricultural
   
150
     
-
     
-
     
-
     
150
     
287,671
     
287,821
 
Commercial
   
21
     
-
     
-
     
-
     
21
     
304,312
     
304,333
 
Consumer & Other
   
17
     
-
     
-
             
17
     
7,706
     
7,723
 
Leases
   
-
     
-
     
-
             
-
     
101,147
     
101,147
 
Total
 
$
355
   
$
-
   
$
-
   
$
-
   
$
355
   
$
2,416,247
   
$
2,416,602
 

The following tables show information related to impaired loans & leases for the periods indicated (in thousands):

                     
Three Months Ended
September 30, 2019
   
Nine Months Ended
September 30, 2019
 
September 30, 2019
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
                                         
Commercial Real Estate
 
$
89
   
$
89
   
$
-
   
$
90
   
$
2
   
$
92
   
$
6
 
Agricultural Real Estate
   
5,678
     
5,678
     
-
     
5,691
     
89
     
6,467
     
290
 
Commercial
   
-
     
-
     
-
     
16
     
-
     
11
     
1
 
 
 
$
5,767
   
$
5,767
   
$
-
   
$
5,797
   
$
91
   
$
6,570
   
$
297
 
With an allowance recorded:
                                                       
Commercial Real Estate
 
$
2,840
   
$
2,840
   
$
253
   
$
2,853
   
$
24
   
$
2,873
   
$
71
 
Residential 1st Mortgages
   
1,601
     
1,810
     
80
     
1,608
     
18
     
1,620
     
56
 
Home Equity Lines & Loans
   
70
     
80
     
4
     
71
     
1
     
72
     
3
 
Agricultural
   
192
     
192
     
95
     
195
     
2
     
165
     
4
 
Commercial
   
1,538
     
1,538
     
147
     
1,545
     
13
     
1,580
     
40
 
Consumer & Other
   
5
     
6
     
5
     
6
     
-
     
6
     
-
 
   
$
6,246
   
$
6,466
   
$
584
   
$
6,278
   
$
58
     
6,316
   
$
174
 
Total
 
$
12,013
   
$
12,233
   
$
584
   
$
12,075
   
$
149
   
$
12,886
   
$
471
 

December 31, 2018
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
                             
Commercial Real Estate
 
$
95
   
$
96
   
$
-
   
$
99
   
$
8
 
Agricultural Real Estate
   
7,239
     
7,238
     
-
     
3,620
     
119
 
Residential 1st Mortgages
   
-
     
-
     
-
     
226
     
8
 
 
 
$
7,334
   
$
7,334
   
$
-
   
$
3,945
   
$
135
 
With an allowance recorded:
                                       
Commercial Real Estate
 
$
2,902
   
$
2,892
   
$
234
   
$
2,929
   
$
96
 
Residential 1st Mortgages
   
1,640
     
1,838
     
82
     
1,371
     
48
 
Home Equity Lines & Loans
   
74
     
84
     
4
     
76
     
4
 
Commercial
   
1,644
     
1,639
     
185
     
1,834
     
58
 
Consumer & Other
   
6
     
7
     
6
     
7
     
-
 
   
$
6,266
   
$
6,460
   
$
511
   
$
6,217
   
$
206
 
Total
 
$
13,600
   
$
13,794
   
$
511
   
$
10,162
   
$
341
 


                   
Three Months Ended
September 30, 2018
   
Nine Months Ended
September 30, 2018
 
September 30, 2018
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance recorded:
                                         
Commercial Real Estate
 
$
98
   
$
98
   
$
-
   
$
99
   
$
2
   
$
101
   
$
6
 
Agricultural Real Estate
   
7,239
     
7,238
     
-
     
3,620
     
6
     
804
     
6
 
Residential 1st Mortgages
   
-
     
-
     
-
     
-
     
-
     
553
     
8
 
   
$
7,337
   
$
7,336
   
$
-
   
$
3,719
   
$
8
   
$
1,458
   
$
20
 
With an allowance recorded:
                                                       
Commercial Real Estate
 
$
2,920
   
$
2,910
   
$
314
   
$
2,929
   
$
24
   
$
2,950
   
$
72
 
Residential 1st Mortgages
   
1,562
     
1,739
     
77
     
1,630
     
12
     
989
     
32
 
Home Equity Lines & Loans
   
75
     
85
     
4
     
76
     
1
     
76
     
3
 
Commercial
   
1,675
     
1,670
     
192
     
1,986
     
14
     
1,879
     
44
 
Consumer & Other
   
7
     
7
     
7
     
7
     
-
     
8
     
-
 
   
$
6,239
   
$
6,411
   
$
594
   
$
6,628
   
$
51
     
5,902
   
$
151
 
Total
 
$
13,576
   
$
13,747
   
$
594
   
$
10,347
   
$
59
   
$
7,360
   
$
171
 

Total recorded investment shown in the prior table will not equal the total ending balance of loans & leases individually evaluated for impairment on the allocation of allowance table. This is because this table does not include impaired loans that were previously modified in a troubled debt restructuring at a market rate, are currently performing and are no longer disclosed or classified as TDR’s. 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.

At September 30, 2019, there were no formal foreclosure proceedings in process for consumer mortgage loans secured by residential real estate properties.

At September 30, 2019, the Company allocated $584,000 of specific reserves to $12.0 million of troubled debt restructured loans & leases, all of which were performing. The Company had no commitments at September 30, 2019, to lend additional amounts to customers with outstanding loans or leases that are classified as TDRs.

During the nine-month period ended September 30, 2019, there was one loan modified as a troubled debt restructuring. When a loan is restructured, the modification of the terms can include one or a combination of the following: a reduction of the stated interest rate; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. This loan had no rate reduction but the maturity date was extended for 6 years.

The following table presents loans or leases by class modified as troubled debt restructured loans or leases during the three and nine-month periods ended September 30, 2019 (in thousands):

   
Three Months Ended September 30, 2019
   
Nine Months Ended September 30, 2019
 
Troubled Debt Restructurings
 
Number of
Loans
   
Pre-Modification
Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
   
Number of
Loans
   
Pre-Modification
Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
 
Agricultural
   
-
   
$
-
   
$
-
     
1
   
$
201
   
$
201
 
Total
   
-
   
$
-
   
$
-
     
1
   
$
201
   
$
201
 

The TDRs described above had minimal impact on the allowance for credit losses for the three and nine-month periods ended September 30, 2019.

During the three and nine-months ended September 30, 2019, the year ended December 31, 2018, and the three and nine-month periods ended September 30, 2018, there were no payment defaults on loans or leases modified as troubled debt restructurings within twelve months following the modification. The Company considers a loan or lease to be in payment default once it is greater than 90 days contractually past due under the modified terms.

At December 31, 2018, the Company allocated $511,000 of specific reserves to $13.6 million of troubled debt restructured loans, all of which were performing. The Company had no commitments at December 31, 2018, to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

During the year ended December 31, 2018, the terms of certain loans were modified as troubled debt restructurings. Modifications involving a reduction of the stated interest rate of the loan were for 5 years. Modifications involving an extension of the maturity date were for 10 years.

The following table presents loans by class modified as troubled debt restructured loans for the year ended December 31, 2018 (in thousands):

   
Year ended December 31, 2018
 
Troubled Debt Restructurings
 
Number of
Loans
   
Pre-Modification
Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
 
Agricultural Real Estate
   
1
   
$
7,239
   
$
7,239
 
Residential 1st Mortgages
   
2
     
286
     
255
 
Total
   
3
   
$
7,525
   
$
7,494
 

The troubled debt restructurings described above had minimal impact on the allowance for credit losses and resulted in charge-offs of $31,000 for the year ended December 31, 2018.

During the year ended December 31, 2018, there were no payment defaults on loans modified as troubled debt restructurings within twelve months following the modification. The Company considers a loan to be in payment default once it is greater than 90 days contractually past due under the modified terms.

At September 30, 2018, the Company allocated $594,000 of specific reserves to $13.6 million of troubled debt restructured loans & leases, all of which were performing. The Company had no commitments at September 30, 2018, to lend additional amounts to customers with outstanding loans or leases that are classified as TDRs.

During the nine-month period ended September 30, 2018, there were two loans & leases modified as a troubled debt restructuring. Modifications involving a reduction of the stated interest rate were for 5 years. Modifications involving an extension of the maturity date was 10 years.

The following table presents loans or leases by class modified as troubled debt restructured loans or leases during the three and nine-month periods ended September 30, 2018 (in thousands):

   
Three Months Ended September 30, 2018
   
Nine Months Ended September 30, 2018
 
Troubled Debt Restructurings
 
Number of
 Loans
   
Pre-Modification
 Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
   
Number of
Loans
   
Pre-Modification
Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
 
Agricultural Real Estate
   
1
   
$
7,239
   
$
7,239
     
1
   
$
7,239
   
$
7,239
 
Residential 1st Mortgages
   
-
     
-
     
-
     
1
     
175
     
163
 
Total
   
1
   
$
7,239
   
$
7,239
     
2
   
$
7,414
   
$
7,402
 

The TDRs described above had minimal impact on the allowance for credit losses for the three and nine-month periods ended September 30, 2018.

4. Fair Value Measurements

The Company follows the “Fair Value Measurement and Disclosures” topic of the FASB ASC, which establishes a framework for measuring fair value in U.S. GAAP and expands disclosures about fair value measurements. This standard applies whenever other standards require, or permit, assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, this standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings.

Securities classified as available-for-sale are reported at fair value on a recurring basis utilizing Level 1, 2 and 3 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions, among other things.

The Company does not record originated loans & leases at fair value on a recurring basis. However, from time to time, a loan or lease is considered impaired and an allowance for credit losses is established. Once a loan or lease is identified as individually impaired, management measures impairment in accordance with the “Receivable” topic of the FASB ASC. The fair value of impaired loans or leases is estimated using one of several methods, including collateral value when the loan is collateral dependent, market value of similar debt, enterprise value, and discounted cash flows. Impaired loans & leases not requiring an allowance represent loans & leases for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans & leases. Impaired loans & leases where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The fair value of collateral dependent impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take into account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring impaired loans is primarily the sales comparison approach less selling costs of 10%.

Other Real Estate (“ORE”) is reported at fair value on a non-recurring basis. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take into account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring ORE is primarily the sales comparison approach less selling costs of 10%.

The following tables present information about the Company’s assets measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated.


         
Fair Value Measurements
At September 30, 2019, Using
 
   
Fair Value
   
Quoted Prices in
Active Markets
for Identical
Assets
   
Other
Observable
Inputs
   
Significant
Unobservable
Inputs
 
(in thousands)
 
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available for Sale Securities:
                       
US Treasury Notes
  $
129,989
    $
129,989
    $
-
    $
-
 
US Government Agency SBA
   
11,744
     
-
     
11,744
     
-
 
Mortgage Backed Securities
   
347,557
     
-
     
347,557
     
-
 
Other
   
514
     
204
     
310
     
-
 
SBA Loan Fund Investment measured at NAV
   
3,126
     
-
     
-
     
-
 
Total Assets Measured at Fair Value On a Recurring Basis
 
$
492,930
   
$
130,193
   
$
359,611
   
$
-
 

         
Fair Value Measurements
At December 31, 2018, Using
 
   
Fair Value
   
Quoted Prices in
Active Markets
for Identical
Assets
   
Other
Observable
Inputs
   
Significant
Unobservable
Inputs
 
(in thousands)
 
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available for Sale Securities:
                       
Government Agency & Government-Sponsored Entities
 
$
3,039
   
$
-
   
$
3,039
   
$
-
 
US Treasury Notes
   
164,514
     
164,514
     
-
     
-
 
US Government Agency SBA
   
15,447
     
-
     
15,447
     
-
 
Mortgage Backed Securities
   
307,045
     
-
     
307,045
     
-
 
Other
   
5,351
     
202
     
310
     
4,839
 
Total Assets Measured at Fair Value On a Recurring Basis
 
$
495,396
   
$
164,716
   
$
325,841
   
$
4,839
 

         
Fair Value Measurements
At September 30, 2018, Using
 
   
Fair Value
   
Quoted Prices in
Active Markets
for Identical
Assets
   
Other
Observable
Inputs
   
Significant
Unobservable
Inputs
 
(in thousands)
 
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available for Sale Securities:
                       
Government Agency & Government-Sponsored Entities
 
$
3,052
   
$
-
   
$
3,052
   
$
-
 
US Treasury Notes
   
164,208
     
164,208
     
-
     
-
 
US Government Agency SBA
   
16,973
     
-
     
16,973
     
-
 
Mortgage Backed Securities
   
271,067
     
-
     
271,067
     
-
 
Other
   
3,011
     
201
     
310
     
2,500
 
Total Assets Measured at Fair Value On a Recurring Basis
 
$
458,311
   
$
164,409
   
$
291,402
   
$
2,500
 

Fair values for Level 2 available-for-sale investment debt securities are based on quoted market prices for similar securities. During the three and nine-months ended September 30, 2019 and 2018, there were no transfers in or out of Level 1, 2, or 3.

As of September 30, 2019, we had an SBA Loan Fund Investment measured at Net Asset Value which consisted of $3.1 million in limited liability companies (LLC) that invest in CRA qualified SBA loans. Units held in the investment fund are valued using the net asset value practical expedient (NAV practical expedient) of the investment fund as reported by the fund managers. The NAV practical expedient is based on the fair value of the underlying assets owned by the fund, minus its liabilities, and then divided by the number of units outstanding. There were $700,000 in unfunded commitments for the period ended September 30, 2019. During the three and nine-months ended September 30, 2019 and 2018, there were no unrealized gain or losses.

The following tables present information about the Company’s other real estate and impaired loans or leases, classes of assets or liabilities that the Company carries at fair value on a non-recurring basis, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated. Not all impaired loans or leases are carried at fair value. Impaired loans or leases are only included in the following tables when their fair value is based upon a current appraisal of the collateral, and if that appraisal results in a partial charge-off or the establishment of a specific reserve.

         
Fair Value Measurements
At September 30, 2019, Using
 
(in thousands)
 
Fair Value
Total
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Impaired Loans
                       
Commercial Real Estate
 
$
2,587
   
$
-
   
$
-
   
$
2,587
 
Residential 1st Mortgage
   
1,518
     
-
     
-
     
1,518
 
Home Equity Lines and Loans
   
66
     
-
     
-
     
66
 
Agricultural
   
97
     
-
     
-
     
97
 
Commercial
   
1,390
     
-
     
-
     
1,390
 
Total Impaired Loans
   
5,658
     
-
     
-
     
5,658
 
Other Real Estate
                               
Real Estate Construction
   
873
     
-
     
-
     
873
 
Total Other Real Estate
   
873
     
-
     
-
     
873
 
Total Assets Measured at Fair Value On a Non-Recurring Basis
 
$
6,531
   
$
-
   
$
-
   
$
6,531
 

         
Fair Value Measurements
At December 31, 2018, Using
 
(in thousands)
 
Fair Value
Total
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Impaired Loans:
                       
Commercial Real Estate
 
$
2,658
   
$
-
   
$
-
   
$
2,658
 
Residential 1st Mortgage
   
1,550
     
-
     
-
     
1,550
 
Home Equity Lines and Loans
   
70
     
-
     
-
     
70
 
Commercial
   
1,454
     
-
     
-
     
1,454
 
Total Impaired Loans
   
5,732
     
-
     
-
     
5,732
 
Other Real Estate:
                               
Real Estate Construction
   
873
     
-
     
-
     
873
 
Total Other Real Estate
   
873
     
-
     
-
     
873
 
Total Assets Measured at Fair Value On a Non-Recurring Basis
 
$
6,605
   
$
-
   
$
-
   
$
6,605
 

         
Fair Value Measurements
At September 30, 2018, Using
 
(in thousands)
 
Fair Value
Total
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Impaired Loans
                       
Commercial Real Estate
 
$
2,596
   
$
-
   
$
-
   
$
2,596
 
Residential 1st Mortgage
   
1,476
     
-
     
-
     
1,476
 
Home Equity Lines and Loans
   
71
     
-
     
-
     
71
 
Commercial
   
1,478
     
-
     
-
     
1,478
 
Total Impaired Loans
   
5,621
     
-
     
-
     
5,621
 
Other Real Estate
                               
Real Estate Construction
   
873
     
-
     
-
     
873
 
Total Other Real Estate
   
873
     
-
     
-
     
873
 
Total Assets Measured at Fair Value On a Non-Recurring Basis
 
$
6,494
   
$
-
   
$
-
   
$
6,494
 

The Company’s property appraisals are primarily based on the sales comparison approach and the income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period to period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at the dates indicated:

September 30, 2019
(in thousands)
 
Fair Value
 
Valuation Technique
Unobservable Inputs
 
Range, Weighted Avg.
 
Impaired Loans
               
Commercial Real Estate
 
$
2,587
 
Income Approach
Capitalization Rate
   
3.25%, 3.25
%
Residential 1st Mortgage
 
$
1,518
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
1.00% - 4.50%, 2.81
%
Home Equity Lines and Loans
 
$
66
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
1.00% - 2.00%, 1.38
%
Agricultural
 
$
97
 
Income Approach
Capitalization Rate
   
3.25%, 3.25
%
Commercial
 
$
1,390
 
Income Approach
Capitalization Rate
   
3.25%, 3.25
%
                     
Other Real Estate
                   
Real Estate Construction
 
$
873
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
10%, 10
%

December 31, 2018
(in thousands)
 
Fair Value
 
Valuation Technique
Unobservable Inputs
 
Range, Weighted Avg.
 
Impaired Loans:
               
Commercial Real Estate
 
$
2,658
 
Income Approach
Capitalization Rate
   
3.25%, 3.25
%
Residential 1st Mortgages
 
$
1,550
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
1% - 4%, 3
%
Home Equity Lines and Loans
 
$
70
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
1% - 2%, 2
%
Commercial
 
$
1,454
 
Income Approach
Capitalization Rate
   
2.95% - 8.70%, 3.40
%
                     
Other Real Estate:
                   
Real Estate Construction
 
$
873
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
10%, 10
%

September 30, 2018
(in thousands)
 
Fair Value
 
Valuation Technique
Unobservable Inputs
 
Range, Weighted Avg.
 
Impaired Loans
               
Commercial Real Estate
 
$
2,596
 
Income Approach
Capitalization Rate
   
3.25%, 3.25
%
Residential 1st Mortgage
 
$
1,476
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
1% -4%, 3
%
Home Equity Lines and Loans
 
$
71
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
1% - 2%, 1
%
Commercial
 
$
1,478
 
Income Approach
Capitalization Rate
   
2.95% - 8.70%, 3.40
%
                     
Other Real Estate
                   
Real Estate Construction
 
$
873
 
      Sales Comparison Approach
Adjustment for Difference Between Comparable Sales
   
10%, 10
%

5. Fair Value of Financial Instruments

U.S. GAAP requires disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practical to estimate. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies pursuant to ASC 820, Fair Value Measurements. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization.

The following tables summarize the book value and estimated fair value of financial instruments for the periods indicated:

         
Fair Value of Financial Instruments Using
       
September 30, 2019
(in thousands)
 
Carrying
Amount
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Other Observable
Inputs (Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Total
Estimated
Fair Value
 
Assets:
                             
Cash and Cash Equivalents
 
$
224,076
   
$
224,076
   
$
-
   
$
-
   
$
224,076
 
                                         
Investment Securities Available-for-Sale
   
492,930
     
130,193
     
359,611
     
3,126
     
492,930
 
 
                                       
Investment Securities Held-to-Maturity
   
60,354
     
-
     
32,183
     
27,333
     
59,516
 
                                         
Loans & Leases, Net of Deferred Fees & Allowance
   
2,562,168
     
-
     
-
     
2,537,599
     
2,537,599
 
Accrued Interest Receivable
   
18,229
     
-
     
18,229
     
-
     
18,229
 
                                         
Liabilities:
                                       
Deposits
   
3,139,413
     
2,613,146
     
525,106
     
-
     
3,138,252
 
Subordinated Debentures
   
10,310
     
-
     
7,475
     
-
     
7,475
 
Accrued Interest Payable
   
2,521
     
-
     
2,521
     
-
     
2,521
 

         
Fair Value of Financial Instruments Using
       
December 31, 2018
(in thousands)
 
Carrying
Amount
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Other Observable
Inputs (Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Total
Estimated
Fair Value
 
Assets:
                             
Cash and Cash Equivalents
 
$
145,564
   
$
145,564
   
$
-
   
$
-
   
$
145,564
 
 
                                       
Investment Securities Available-for-Sale
   
495,396
     
164,716
     
325,841
     
4,839
     
495,396
 
 
                                       
Investment Securities Held-to-Maturity
   
53,566
     
-
     
35,083
     
18,655
     
53,738
 
                                         
Loans & Leases, Net of Deferred Fees & Allowance
   
2,515,975
     
-
     
-
     
2,485,182
     
2,485,182
 
Accrued Interest Receivable
   
14,098
     
-
     
14,098
     
-
     
14,098
 
                                         
Liabilities:
                                       
Deposits
   
3,062,832
     
2,572,805
     
485,766
     
-
     
3,058,571
 
Subordinated Debentures
   
10,310
     
-
     
7,745
     
-
     
7,745
 
Accrued Interest Payable
   
1,365
     
-
     
1,365
     
-
     
1,365
 

         
Fair Value of Financial Instruments Using
       
September 30, 2018
(in thousands)
 
Carrying
Amount
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Other Observable
Inputs (Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Total
Estimated
Fair Value
 
Assets:
                             
Cash and Cash Equivalents
 
$
110,781
   
$
110,781
   
$
-
   
$
-
   
$
110,781
 
                                         
Investment Securities Available-for-Sale
   
458,311
     
164,409
     
291,402
     
2,500
     
458,311
 
                                         
Investment Securities Held-to-Maturity
   
51,459
     
-
     
35,716
     
15,663
     
51,379
 
                                         
Loans & Leases, Net of Deferred Fees & Allowance
   
2,363,535
     
-
     
-
     
2,317,185
     
2,317,185
 
Accrued Interest Receivable
   
14,612
     
-
     
14,612
     
-
     
14,612
 
                                         
Liabilities:
                                       
Deposits
   
2,776,923
     
2,314,600
     
457,526
     
-
     
2,772,126
 
Subordinated Debentures
   
10,310
     
-
     
7,579
     
-
     
7,579
 
Accrued Interest Payable
   
1,227
     
-
     
1,227
     
-
     
1,227
 

6. Dividends and Basic Earnings Per Common Share

Farmers & Merchants Bancorp common stock is not traded on any exchange. The shares are primarily held by local residents and are not actively traded. However, trades are reported on the OTCQX under the symbol “FMCB.”

On May 14, 2019, the Board of Directors declared a mid-year cash dividend of $7.05 per share, a 2.2% increase over the $6.90 per share paid on July 2, 2018. The cash dividend was paid on July 1, 2019, to shareholders of record on June 14, 2019.

Basic earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. The Company has no securities or other contracts, such as stock options, that could require the issuance of common stock. Accordingly, diluted earnings per share is the same amount as basic earnings per share. The following table calculates the basic earnings per common share for the three and nine months ended September 30, 2019 and 2018.

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
                         
(net income in thousands)
 
2019
   
2018
   
2019
   
2018
 
Net Income
 
$
13,738
   
$
12,000
   
$
41,392
   
$
32,491
 
Weighted Average Number of Common Shares Outstanding
   
787,307
     
793,418
     
786,361
     
807,129
 
Basic Earnings Per Common Share Amount
 
$
17.45
   
$
15.12
   
$
52.64
   
$
40.26
 

7. Leases

Lessee – Operating Leases
Effective January 1, 2019, the Company adopted the provisions of Accounting Standards Update (ASU) No. 2016-02, “Leases (Topic 842),” (ASU 2016-02), for all open leases with a term greater than one year as of the adoption date, using the modified retrospective approach. Prior comparable periods are presented in accordance with previous guidance under Accounting Standards Codification (ASC) 840, “Leases.”

Operating leases in which we are the lessee are recorded as operating lease ROU assets and operating lease liabilities, included in other assets and other liabilities, respectively, on our consolidated balance sheets. We do not currently have any significant finance leases in which we are the lessee.

Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date. ROU assets are further adjusted for lease incentives. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded net in occupancy expense in the consolidated statements of income.

Our leases relate primarily to office space and bank branches with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options which typically range from 5 to 10 years at the then fair market rental rates. ASC 842 requires lessees to evaluate whether option periods, if available, will be exercised in order to determine the full life of the lease. The Company used the first option period, unless it is a relatively new lease that has a long initial lease term or other extenuating circumstances. As of September 30, 2019, operating lease ROU assets and liabilities were $5.14 million and $5.19 million, respectively. Operating lease expenses that were in scope of ASU 2016-02 totaled $207,000 and $629,000 for the three and nine-month period ended September 30, 2019.

The table below summarizes the information related to our operating leases:

(in thousands except for percent and period data)
 
Three Months Ended
September 30, 2019
   
Nine Months Ended
September 30, 2019
 
Cash Paid for Amounts Included in the Measurement of Lease Liabilities
           
Operating Cash Flow from Operating Leases
 
$
195
   
$
588
 
Right-of-Use Assets Obtained in Exchange for New Operating Lease Liabilities
 
$
-
   
$
5,645
 
Weighted-Average Remaining Lease Term - Operating Leases, in Years
   
8.09
     
8.09
 
Weighted-Average Discount Rate - Operating Leases
   
3.2
%
   
3.2
%

The table below summarizes the maturity of remaining lease liability:

(in thousands)
 
September 30, 2019
 
2019
 
$
196
 
2020
   
795
 
2021
   
719
 
2022
   
686
 
2023
   
697
 
2024 and thereafter
   
2,811
 
Total Lease Payments
   
5,904
 
Less: Interest
   
(719
)
Present Value of Lease Liabilities
 
$
5,185
 

As of September 30, 2019, we have no additional operating leases for office space that have not yet commenced or that are anticipated to commence during the fourth quarter of 2019.

Lessor - Direct Financing Leases
The Company is the lessor in direct finance lease arrangements. Leases are recorded at the principal balance outstanding, net of unearned income and charge-offs.  Interest income is recognized using the interest method. 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 impact of adopting Topic 842 for lessor accounting was not significant.

Lease payments due to the Company are typically fixed and paid in equal installments over the lease term. Variable lease payments that do not depend on an index or a rate (e.g., property taxes) that are paid directly by the Company are minimal. The majority of property taxes are paid directly by the client to a third party and are not considered part of variable payments and therefore are not recorded by the Company.

As a lessor, the Company leases certain types of agriculture equipment, solar equipment, construction equipment and other equipment to its customers. At September 30, 2019, the Company's net investment in direct financing leases was $101.8 million.

8. Shareholders’ Equity

During the first nine months of 2019, the Company issued 3,586 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. These shares were issued at a price of $715.00 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.

During the nine months ended September 30, 2018, the Company issued a combined total 13,520 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. There were also 2,400 shares issued to individuals during the third quarter of 2018. All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance 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.

On July 31, 2018, Farmers & Merchants Bancorp purchased 44,503 shares of the Company’s Common Stock from the estate of a former Director. The purchase price was $700.00 per share for a total consideration of $31,152,100. After the transaction, the Company remained “well capitalized” under the regulatory framework for prompt corrective action.

9. Recent Accounting Pronouncements

Recently Adopted Accounting Guidance
The following paragraphs provide descriptions of recently adopted accounting standards that may have had a material effect on the Company’s financial position or results of operations.

In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for stranded tax effects resulting from the newly enacted Tax Cuts and Jobs Act (“Tax Act”). The amount of the reclassification consists of the difference between the historical corporate income tax rates and the newly enacted 21 percent corporate federal income tax rate. The amendments are effective for all entities for the interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted, including interim periods in those years. The Company adopted the amendments as of December 31, 2017, which resulted in a net reclassification of $144,000 between AOCI and retained earnings.

Accounting Guidance Pending Adoption at September 30, 2019
The following paragraphs provide descriptions of newly issued but not yet effective accounting standards that could have a material effect on the Company’s financial position or results of operations.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU will require the earlier recognition of credit losses on loans and other financial instruments based on an expected loss model, replacing the incurred loss model that is currently in use. Under the new guidance, an entity will measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The expected loss model will apply to loans and leases, unfunded lending commitments, held-to-maturity debt securities and other debt instruments measured at amortized cost. The impairment model for available-for-sale debt securities will require the recognition of credit losses through a valuation allowance when fair value is less than amortized cost, regardless of whether the impairment is considered to be other-than-temporary. The new guidance is effective on January 1, 2020, with early adoption permitted on January 1, 2019. The Company has completed an assessment of its CECL data and system needs, and has engaged a third-party vendor to assist in developing a CECL model. The Company, in conjunction with this vendor, has researched and analyzed modeling standards, loan segmentation, as well as potential external inputs to supplement our historical loss history. Model validation began in the third quarter, enabling us to complete a parallel run using second quarter 2019 data. Another parallel run, using third quarter 2019 data, will be completed early in the fourth quarter. During the fourth quarter, we will complete validation of our forecast model, as well as documentation of our processes and controls. At the current time we cannot quantify the magnitude, if any, of the required one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the ASUs are effective.

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 months ended September 30, 2019. This analysis should be read in conjunction with our 2018 Annual Report to Shareholders on Form 10-K, and with the unaudited 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; and (10) other factors discussed in Item 1A. Risk Factors located in the Company’s 2018 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.

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 thirty branches 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”). As a California, state-chartered, non-fed member bank, the Bank is subject to regulation and examination by the California Department of Business Oversight (“DBO”) 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 2018 Annual Report on Form 10-K), the Company’s primary service area remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry. 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).

The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are normal and the availability of water in our primary service area should not be an issue. Even though the vast majority of the Company’s agricultural customers are located in the more northern portion of the Central Valley where even during the worst of the drought, farmers still had access to reasonable ground water sources, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.

For the three and nine months ended September 30, 2019, Farmers & Merchants Bancorp reported net income of $13,738,000 and $41,392,000, earnings per share of $17.45 and $52.64 and return on average assets of 1.58% and 1.61%, respectively. Return on average shareholders’ equity was 15.76% and 16.52% for the three and nine months ended September 30, 2019.

For the three and nine months ended September 30, 2018, Farmers & Merchants Bancorp reported net income of $12,000,000 and $32,491,000, earnings per share of $15.12 and $40.26 and return on average assets of 1.55% and 1.41%, respectively. Return on average shareholders’ equity was 15.97% and 14.24% for the three and nine months ended September 30, 2018.

The following is a summary of the financial results for the nine-month period ended September 30, 2019, compared to September 30, 2018.

Net income increased 27.4% to $41.4 million from $32.5 million.
Earnings per share increased 30.8% to $52.64 from $40.26.
Total assets increased 12.1% to $3.6 billion from $3.2 billion.
Total loans & leases increased 8.3% to $2.6 billion from $2.4 billion.
Total deposits increased 13.1% to $3.1 billion from $2.8 billion.

The primary reasons for the Company’s $8.9 million or 27.4% increase in net income in the first nine months of 2019 as compared to the same period of 2018 were:

A $13.5 million increase in net interest income related to the growth in earning assets and the improvement in the net interest margin.
A $3.1 million decrease in the provision for credit losses
A $1.3 million decrease in the net loss on the sale of investment securities during the first nine months of the prior year (2018).

This positive impact was partially offset by:

A $3.7 million increase in salaries and employee benefits.
A $328,000 increase in occupancy expenses due to branch expansion and acquisition.
A $767,000 increase in legal expenses.
A $4.3 million increase in the provision for income taxes.

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, 2019 and 2018.

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,
2019
   
Three Months Ended Sept 30,
2018
 
Assets
 
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
Interest Bearing Deposits with Banks
 
$
255,335
   
$
1,396
     
2.17
%
 
$
127,570
   
$
638
     
1.98
%
Investment Securities:
                                               
U.S. Treasuries
   
21,445
     
114
     
2.13
%
   
49,530
     
181
     
1.46
%
U.S. Govt SBA
   
12,665
     
71
     
2.24
%
   
18,136
     
97
     
2.14
%
Government Agency & Government-Sponsored Entities
   
2,418
     
18
     
2.98
%
   
3,052
     
22
     
2.88
%
Municipals - Taxable
   
6,545
     
86
     
5.26
%
   
-
     
-
     
-
 
Obligations of States and Political Subdivisions - Non-Taxable (1)
   
52,985
     
484
     
3.65
%
   
51,667
     
497
     
3.85
%
Mortgage Backed Securities
   
282,305
     
1,832
     
2.60
%
   
287,599
     
1,754
     
2.44
%
Other
   
4,726
     
38
     
3.22
%
   
3,011
     
21
     
2.79
%
Total Investment Securities
   
383,089
     
2,643
     
2.76
%
   
412,995
     
2,572
     
2.49
%
                                                 
Loans & Leases: (2)
                                               
Real Estate
   
1,790,970
     
23,339
     
5.17
%
   
1,666,801
     
21,416
     
5.10
%
Home Equity Lines & Loans
   
39,820
     
605
     
6.03
%
   
38,193
     
533
     
5.54
%
Agricultural
   
288,085
     
4,089
     
5.63
%
   
283,078
     
3,760
     
5.27
%
Commercial
   
378,210
     
5,131
     
5.38
%
   
290,588
     
3,867
     
5.28
%
Consumer
   
16,284
     
266
     
6.48
%
   
6,298
     
98
     
6.17
%
Other
   
1,079
     
7
     
2.57
%
   
1,382
     
8
     
2.30
%
Leases
   
103,247
     
1,399
     
5.38
%
   
98,316
     
1,277
     
5.15
%
Total Loans & Leases
   
2,617,695
     
34,836
     
5.28
%
   
2,384,656
     
30,959
     
5.15
%
Total Earning Assets
   
3,256,119
   
$
38,875
     
4.74
%
   
2,925,221
   
$
34,169
     
4.63
%
                                                 
Unrealized Gain (Loss) on Securities Available-for-Sale
   
3,992
                     
(7,668
)
               
Allowance for Credit Losses
   
(55,045
)
                   
(51,831
)
               
Cash and Due From Banks
   
57,094
                     
47,381
                 
All Other Assets
   
226,769
                     
191,562
                 
Total Assets
 
$
3,488,929
                   
$
3,104,665
                 
                                                 
Liabilities & Shareholders' Equity
                                               
Interest Bearing Deposits:
                                               
Interest Bearing DDA
 
$
667,687
   
$
666
     
0.40
%
 
$
619,697
   
$
509
     
0.33
%
Savings and Money Market
   
930,490
     
886
     
0.38
%
   
830,680
     
467
     
0.22
%
Time Deposits
   
524,076
     
1,840
     
1.39
%
   
467,443
     
1,044
     
0.89
%
Total Interest Bearing Deposits
   
2,122,253
     
3,392
     
0.63
%
   
1,917,820
     
2,020
     
0.42
%
Federal Home Loan Bank Advances
   
-
     
-
     
-
     
46
     
-
     
0.00
%
Subordinated Debentures
   
10,310
     
138
     
5.31
%
   
10,310
     
137
     
5.27
%
Total Interest Bearing Liabilities
   
2,132,563
   
$
3,530
     
0.66
%
   
1,928,176
   
$
2,157
     
0.44
%
Interest Rate Spread (3)
                   
4.08
%
                   
4.19
%
Demand Deposits (Non-Interest Bearing)
   
947,854
                     
832,752
                 
All Other Liabilities
   
59,765
                     
43,239
                 
Total Liabilities
   
3,140,182
                     
2,804,167
                 
                                                 
Shareholders' Equity
   
348,747
                     
300,498
                 
Total Liabilities & Shareholders' Equity
 
$
3,488,929
                   
$
3,104,665
                 
Net Interest Income and Margin on Total Earning Assets (4)
           
35,345
     
4.31
%
           
32,012
     
4.34
%
Tax Equivalent Adjustment
           
(65
)
                   
(104
)
       
Net Interest Income
         
$
35,280
     
4.30
%
         
$
31,908
     
4.33
%

(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) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(4) 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,
2019
   
Nine Months Ended Sept. 30,
2018
 
Assets
 
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
Interest Bearing Deposits with Banks
 
$
212,388
   
$
3,682
     
2.32
%
 
$
131,509
   
$
1,737
     
1.77
%
Investment Securities:
                                               
U.S. Treasuries
   
30,382
     
440
     
1.93
%
   
69,374
     
728
     
1.40
%
U.S. Govt SBA
   
13,995
     
267
     
2.54
%
   
24,559
     
339
     
1.84
%
Government Agency & Government-Sponsored Entities
   
2,818
     
62
     
2.93
%
   
3,063
     
66
     
2.87
%
Municipals - Taxable
   
6,545
     
258
     
5.26
%
   
-
     
-
     
-
 
Obligations of States and Political Subdivisions - Non-Taxable (1)
   
51,474
     
1,509
     
3.91
%
   
53,120
     
1,536
     
3.86
%
Mortgage Backed Securities
   
295,524
     
5,828
     
2.63
%
   
308,835
     
5,578
     
2.41
%
Other
   
4,958
     
148
     
3.98
%
   
3,010
     
60
     
2.66
%
Total Investment Securities
   
405,696
     
8,512
     
2.80
%
   
461,961
     
8,307
     
2.40
%
                                                 
Loans & Leases: (2)
                                               
Real Estate
   
1,777,258
     
69,588
     
5.23
%
   
1,607,127
     
60,612
     
5.04
%
Home Equity Lines & Loans
   
39,810
     
1,806
     
6.07
%
   
36,221
     
1,464
     
5.40
%
Agricultural
   
272,498
     
11,565
     
5.67
%
   
265,812
     
10,127
     
5.09
%
Commercial
   
365,316
     
14,679
     
5.37
%
   
281,664
     
10,933
     
5.19
%
Consumer
   
17,106
     
775
     
6.06
%
   
5,795
     
240
     
5.54
%
Other
   
1,079
     
18
     
2.23
%
   
1,382
     
23
     
2.23
%
Leases
   
105,672
     
4,297
     
5.44
%
   
93,484
     
3,531
     
5.05
%
Total Loans & Leases
   
2,578,739
     
102,728
     
5.33
%
   
2,291,485
     
86,930
     
5.07
%
Total Earning Assets
   
3,196,823
   
$
114,922
     
4.81
%
   
2,884,955
   
$
96,974
     
4.49
%
                                                 
Unrealized (Loss) on Securities Available-for-Sale
   
(126
)
                   
(7,064
)
               
Allowance for Credit Losses
   
(55,113
)
                   
(51,113
)
               
Cash and Due From Banks
   
55,897
                     
46,448
                 
All Other Assets
   
222,670
                     
190,733
                 
Total Assets
 
$
3,420,151
                   
$
3,063,959
                 
                                                 
Liabilities & Shareholders' Equity
                                               
Interest Bearing Deposits:
                                               
Interest Bearing DDA
 
$
661,462
   
$
1,792
     
0.36
%
 
$
596,872
   
$
1,086
     
0.24
%
Savings and Money Market
   
913,942
     
2,413
     
0.35
%
   
823,595
     
1,130
     
0.18
%
Time Deposits
   
518,646
     
5,120
     
1.32
%
   
472,460
     
2,738
     
0.77
%
Total Interest Bearing Deposits
   
2,094,050
     
9,325
     
0.60
%
   
1,892,927
     
4,954
     
0.35
%
Federal Home Loan Bank Advances
   
1
     
-
     
0.00
%
   
16
     
-
     
0.00
%
Subordinated Debentures
   
10,310
     
424
     
5.50
%
   
10,310
     
385
     
4.99
%
Total Interest Bearing Liabilities
   
2,104,361
   
$
9,749
     
0.62
%
   
1,903,253
   
$
5,339
     
0.38
%
Interest Rate Spread (3)
                   
4.19
%
                   
4.12
%
Demand Deposits (Non-Interest Bearing)
   
928,246
                     
813,129
                 
All Other Liabilities
   
53,380
                     
43,352
                 
Total Liabilities
   
3,085,987
                     
2,759,734
                 
                                                 
Shareholders' Equity
   
334,164
                     
304,225
                 
Total Liabilities & Shareholders' Equity
 
$
3,420,151
                   
$
3,063,959
                 
Net Interest Income and Margin on Total Earning Assets (4)
           
105,173
     
4.40
%
           
91,635
     
4.25
%
Tax Equivalent Adjustment
           
(313
)
                   
(320
)
       
Net Interest Income
         
$
104,860
     
4.39
%
         
$
91,315
     
4.23
%

(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) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(4) 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, 2019 compared to Sept. 30, 2018
   
Nine Months Ended
Sept. 30, 2019 compared to Sept. 30, 2018
 
Interest Earning Assets
 
Volume
   
Rate
   
Net Chg.
   
Volume
   
Rate
   
Net Chg.
 
Interest Bearing Deposits with Banks
 
$
694
   
$
64
   
$
758
     
1,289
     
656
   
$
1,945
 
Investment Securities:
                                               
U.S. Treasuries
   
(128
)
   
61
     
(67
)
   
(502
)
   
214
     
(288
)
U.S. Govt SBA
   
(31
)
   
5
     
(26
)
   
595
     
(667
)
   
(72
)
Government Agency & Government-Sponsored Entities
   
(5
)
   
1
     
(4
)
   
(5
)
   
1
     
(4
)
Municipals - Taxable
   
86
     
-
     
86
     
258
     
-
     
258
 
Obligations of States and Political Subdivisions - Non-Taxable
   
12
     
(26
)
   
(14
)
   
(46
)
   
19
     
(27
)
Mortgage Backed Securities
   
(32
)
   
110
     
78
     
(247
)
   
497
     
250
 
Other
   
14
     
3
     
17
     
50
     
38
     
88
 
Total Investment Securities
   
(84
)
   
154
     
70
     
103
     
102
     
205
 
                                                 
Loans & Leases:
                                               
Real Estate
   
1,614
     
309
     
1,923
     
6,596
     
2,380
     
8,976
 
Home Equity Lines & Loans
   
24
     
48
     
72
     
153
     
189
     
342
 
Agricultural
   
67
     
262
     
329
     
259
     
1,179
     
1,438
 
Commercial
   
1,188
     
76
     
1,264
     
3,349
     
397
     
3,746
 
Consumer
   
163
     
5
     
168
     
511
     
24
     
535
 
Other
   
(2
)
   
1
     
(1
)
   
(5
)
   
-
     
(5
)
Leases
   
66
     
56
     
122
     
483
     
283
     
766
 
Total Loans & Leases
   
3,120
     
757
     
3,877
     
11,346
     
4,452
     
15,798
 
Total Earning Assets
   
3,730
     
975
     
4,705
     
12,738
     
5,210
     
17,948
 
                                                 
Interest Bearing Liabilities
                                               
Interest Bearing Deposits:
                                               
Interest Bearing DDA
   
42
     
115
     
157
     
128
     
578
     
706
 
Savings and Money Market
   
62
     
357
     
419
     
135
     
1,148
     
1,283
 
Time
   
139
     
657
     
796
     
290
     
2,092
     
2,382
 
Total Interest Bearing Deposits
   
243
     
1,129
     
1,372
     
553
     
3,818
     
4,371
 
Subordinated Debentures
   
-
     
1
     
1
     
-
     
39
     
39
 
Total Interest Bearing Liabilities
   
243
     
1,130
     
1,373
     
555
     
3,856
     
4,410
 
Total Change on a Tax Equivalent Basis
 
$
3,668
   
$
(335
)
 
$
3,332
   
$
12,318
   
$
1,220
   
$
13,538
 

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 2019 vs. Third Quarter 2018
Net interest income for the third quarter of 2019 increased 10.6% or $3.4 million to $35.3 million. On a fully taxable equivalent basis, net interest income increased 10.4% and totaled $35.3 million for the third quarter of 2019. As more fully discussed below, the increase in net interest income was due primarily to a $330.9 million increase in average earning assets.

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, 2019, the Company’s net interest margin was 4.31% compared to 4.34% for the quarter ended September 30, 2018. This decrease in net interest margin was due primarily to the increase in the rate paid on interest bearing liabilities exceeding the increase in the rate earned on earning assets.

Average loans & leases totaled $2.6 billion for the quarter ended September 30, 2019; an increase of $233.0 million compared to the average balance for the quarter ended September 30, 2018. Loans & leases decreased from 81.5% of average earning assets at September 30, 2018, to 80.4% at September 30, 2019. The annualized yield on the Company’s loan & lease portfolio increased to 5.28% for the quarter ended September 30, 2019, compared to 5.15% for the quarter ended September 30, 2018. This increase in yield was primarily due to an increase in market interest rates (despite the fact that market interest rates have decreased recently). Overall, the positive impact on interest revenue from: (1) the increase in loan & lease balances and (2) rising yields resulted in interest income from loans & leases increasing 12.5% to $34.8 million for quarter ended September 30, 2019. The Company has been experiencing 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 invested primarily in: (1) mortgage-backed securities issued by 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 selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 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 $383.1 million for the quarter ended September 30, 2019; a decrease of $29.9 million compared to the average balance for the quarter ended September 30, 2018. Tax equivalent interest income on securities increased $70,000 to $2.64 million for the quarter ended September 30, 2019, compared to $2.57 million for the quarter ended September 30, 2018. The average investment portfolio yield, on a tax equivalent (TE) basis, was 2.76% for the quarter ended September 30, 2019, compared to 2.49% for the quarter ended September 30, 2018. This overall increase in yield was caused primarily by an increase in market interest rates. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2019. 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 1.80% in September 2019, compared to 2.20% in September 2018. Average interest bearing deposits with banks for the quarter ended September 30, 2019, was $255.3 million, an increase of $127.7 million compared to the average balance for the quarter ended September 30, 2018. Interest income on interest bearing deposits with banks for the quarter ended September 30, 2019, increased $758,000 to $1.4 million compared to the quarter ended September 30, 2018.

Average interest-bearing liabilities increased $204.4 million or 10.6% during the third quarter of 2019. Of that increase: (1) interest-bearing transaction deposits increased $48.0 million; (2) savings and money market deposits increased $99.8 million; (3) time deposits increased $56.6 million (see “Financial Condition – Deposits”); (4) Federal Home Loan Bank (“FHLB”) Advances decreased $46,000 (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 $3.4 million for the third quarter of 2019 as compared to $2.0 million for the third quarter of 2018. The average rate paid on interest-bearing deposits was 0.63% for the third quarter of 2019 compared to 0.42% for the third quarter of 2018. As a result of the 2.25% increase in short-term market interest rates that occurred between December 2015 and December 2018, the Company experienced aggressive competitor rates on interest bearing deposits, which it needed to meet in order to retain key customers. Since August 2019, short-term market interest rates have decreased .50%, but any impact on deposit rates has been lagging and relatively limited.

At the current time, the market is expecting the Federal Reserve Bank will decrease short-term interest rates one or more times during the remainder of 2019. The Company is “asset sensitive” based upon the mix of its assets and liabilities, so future decreases in market interest rates could negatively impact our net interest margin. See Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk.

Nine Months Ended September 30, 2019 vs. Nine Months Ended September 30, 2018
During the first nine months of 2019, net interest income increased 14.8% to $104.9 million, compared to $91.3 million at September 30, 2018. On a fully taxable equivalent basis, net interest income increased 14.8% and totaled $105.2 million at September 30, 2019, compared to $91.6 million at September 30, 2018. The increase in net interest income was due to a $311.9 million increase in average earning assets, and a 15 basis point increase in the net interest margin.

For the nine months ended September 30, 2019, the Company’s net interest margin was 4.40% compared to 4.25% for the same period in 2018. This increase in net interest margin was due primarily to an increase of 0.32% in the yield received on earning assets, offset somewhat by a 0.24% increase in the rates paid on interest bearing liabilities.

The average balance of loans & leases increased by $287.3 million for the nine months ended September 30, 2019, compared to the nine months ended September 30, 2018. The yield on the loan & lease portfolio increased 26 basis points to 5.33% for the nine months ended September 30, 2019, compared to 5.07% for the nine months ended September 30, 2018. Overall, the positive impact from: (1) the increase in loan and lease balances and (2) rising yields resulted in interest income from loans & leases increasing 18.2% or $15.8 million for the first nine months of 2019.

Average investment securities were $405.7 million for the nine months ended September 30, 2019, compared to $462.0 million for the same period in 2018. The average tax equivalent yield for the nine months ended September 30, 2019, was 2.80% compared to 2.40% for the nine months ended September 30, 2018. This overall increase in yield was caused primarily by an increase in market interest rates. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2019. 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 1.80% in September 2019, compared to 2.20% in September 2018. Average interest bearing deposits with banks for the nine-months ended September 30, 2019, was $212.4 million, an increase of $80.9 million compared to the average balance for the nine-months ended September 30, 2018. Interest income on interest bearing deposits with banks for the nine-months ended September 30, 2019, increased $1.9 million to $3.7 million compared to the nine-months ended September 30, 2018.

Average interest-bearing liabilities increased $201.1 million or 10.6% during the nine months ended September 30, 2019, as compared to the nine months ended September 30, 2018. Of that increase: (1) interest-bearing transaction deposits increased $64.6 million; (2) savings and money market deposits increased $90.3 million; (3) time deposits increased $46.2 million (see “Financial Condition – Deposits”); (4) Federal Home Loan Bank (“FHLB”) Advances decreased $15,000 (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 $9.3 million for the first nine months of 2019 as compared to $5.0 million for the first nine months of 2018. The average rate paid on interest-bearing deposits was 0.60% in the first nine months of 2019 and 0.35% in the first nine months of 2018. As a result of the 2.25% increase in short-term market interest rates that occurred between December 2015 and December 2018, the Company is experienced more aggressive competitor rates on interest bearing deposits, which it needed to meet in order to retain key customers. Since August 2019, short-term market interest rates have decreased .50%, but any impact on deposit rates has been lagging and relatively limited.

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 consolidated 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 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 nonaccrual status at the time they become TDR, remain on nonaccrual 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, 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” and “Note 3 Loans & Leases and Allowances for Credit Losses.”

In addition, the Company's and Bank's regulators, including the FRB, DBO 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 Central Valley of California was one of the hardest hit areas in the country during the recession. In many areas, housing prices declined as much as 60% and unemployment reached 15% or more. Although the economy has improved throughout most of the Central Valley, in some of the Company’s market segments housing prices remain below peak levels and unemployment rates remain above those in other areas of the state and country. While, in management’s opinion, the Company’s levels of net charge-offs and non-performing assets as of September 30, 2019, compare very favorably to our peers at the present time, carefully managing credit risk remains a key focus of the Company.

The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are normal and the availability of water in our primary service area should not be an issue.  Even though the vast majority of the Company’s agricultural customers are located in the more northern portion of the Central Valley where even during the worst of the drought, farmers still had access to reasonable ground water sources, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.

The Company made a $200,000 provision for credit losses during the first nine months of 2019 compared to $3.3 million for the same period in 2018. Net charge-offs during the first nine months of 2019 were $512,000 compared to net charge-offs of $608,000 in the first nine months of 2018. See “Overview – Looking Forward: 2019 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 2018 Annual Report on Form 10-K.

The table below contains the allowance for credit losses for the three and nine-month periods ended September 2019 and 2018:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(in thousands)
 
2019
   
2018
   
2019
   
2018
 
Balance at Beginning of Period
 
$
55,125
   
$
51,137
   
$
55,266
   
$
50,342
 
Charge-Offs
   
(235
)
   
(634
)
   
(654
)
   
(723
)
Recoveries
   
64
     
64
     
142
     
115
 
Provision
   
-
     
2,500
     
200
     
3,333
 
Balance at End of Period
 
$
54,954
   
$
53,067
   
$
54,954
   
$
53,067
 

The table below breaks out current quarter activity by portfolio segment (in thousands):

September 30, 2019
 
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- January 1, 2019
 
$
11,609
   
$
14,092
   
$
1,249
   
$
880
   
$
2,761
   
$
8,242
   
$
11,656
   
$
494
   
$
4,022
   
$
261
   
$
55,266
 
Charge-Offs
   
-
     
-
     
-
     
-
     
-
     
-
     
(592
)
   
(62
)
   
-
     
-
     
(654
)
Recoveries
   
-
     
-
     
-
     
8
     
20
     
34
     
40
     
40
     
-
     
-
     
142
 
Provision
   
(847
)
   
731
     
480
     
(33
)
   
(79
)
   
(431
)
   
601
     
3
     
(969
)
   
744
     
200
 
Ending Balance- September 30, 2019
 
$
10,762
   
$
14,823
   
$
1,729
   
$
855
   
$
2,702
   
$
7,845
   
$
11,705
   
$
475
   
$
3,053
   
$
1,005
   
$
54,954
 
Third Quarter Allowance for Credit Losses:
                                                                                 
Beginning Balance- July 1, 2019
 
$
10,680
   
$
14,572
   
$
1,697
   
$
864
   
$
2,743
   
$
7,481
   
$
12,267
   
$
464
   
$
3,100
   
$
1,257
   
$
55,125
 
Charge-Offs
   
-
     
-
     
-
     
-
     
-
     
-
     
(213
)
   
(22
)
   
-
     
-
     
(235
)
Recoveries
   
-
     
-
     
-
     
2
     
9
     
23
     
17
     
13
     
-
     
-
     
64
 
Provision
   
82
     
251
     
32
     
(11
)
   
(50
)
   
341
     
(366
)
   
20
     
(47
)
   
(252
)
   
-
 
Ending Balance- September 30, 2019
 
$
10,762
   
$
14,823
   
$
1,729
   
$
855
   
$
2,702
   
$
7,845
   
$
11,705
   
$
475
   
$
3,053
   
$
1,005
   
$
54,954
 

The Allowance for Credit Losses at September 30, 2019, decreased $312,000 from December 31, 2018. The allowance allocated to the following portfolio segments changed materially during the first nine months of 2019:


The allowance for commercial real estate loans, agricultural loans and leases decreased primarily due to paydowns in loan balances in these portfolio segments.

The allowance for commercial loans increased primarily due to balance increases along with a $3.25 million increase in special mention and substandard loans in this portfolio segment.

The allowance for agricultural real estate loans increased primarily due to net originations in loan balances in this portfolio segment.

The allowance for leases decreased due to paydowns in lease balances since December 2018.

After reviewing all factors above, based upon information currently available, management concluded that the allowance for credit losses as of September 30, 2019, was adequate.

See “Management’s Discussion and Analysis - Financial Condition – Classified Loans & Leases and Non-Performing Assets” for further discussion regarding these loan categories.

See “Note 3. 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 2019 vs. Third Quarter 2018
Non-interest income decreased $234,000 or 5.6% for the three months ended September 30, 2019, compared to the same period of 2018. This decrease was due to a $508,000 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). This decrease was partially offset by: (1) a $205,000 increase related to Debit Card and ATM Fees; (2) a $43,000 increase in Service Charges on Deposit Accounts; and (3) a $39,000 increase in the cash surrender value of Bank Owned Life Insurance.

Nine Months Ended September 30, 2019 vs. Nine Months Ended September 30, 2018
Non‑interest income increased $1.7 million or 15.1% for the nine months ended September 30, 2019, compared to the same period of 2018. This increase was primarily due to: (1) a $1.3 million increase resulting from the net loss on sale of investment securities during the first half of the prior year (2018); (2) a $561,000 increase in Debit Card and ATM Fees; (3) a $161,000 increase in in Service Charges on Deposit Accounts; and (4) a $166,000 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).  These increases were partially offset by a $661,000 decrease related to non-recurring income received during the first half of 2018.

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 2019 vs. Third Quarter 2018
Overall, non-interest expense increased $2.2 million or 12.0% for the three months ended September 30, 2019, compared to the same period in 2018. This increase was primarily comprised of: (1) a $2.0 million increase in salaries and employee benefits; (2) a $233,000 increase in occupancy and equipment; and (3) a $339,000 increase in legal expense. These increases were partially offset by a $508,000 decrease in the net gain on deferred compensation investments.

Nine Months Ended September 30, 2019 vs. Nine Months Ended September 30, 2018
Non-interest expense increased $5.2 million or 9.1% for the nine months ended September 30, 2019, compared to the same period of 2018. This increase was primarily comprised of: (1) a $3.7 million increase in salaries and employee benefits; (2) a $767,000 increase in legal expense; and (3) a $750,000 increase in occupancy and equipment.  These increases were partially offset by a $128,000 decrease in marketing expenses.

Income Taxes
The Bank’s provision for income taxes increased 55.6% to $4.7 million for the third quarter of 2019 compared to the third quarter of 2018. The Company’s effective tax rate for the third quarter of 2019 was 25.33% compared to 20.0% for the third quarter of 2018, which reflected the impact of a onetime adjustment to the Company’s 2018 deferred tax asset. The Company’s effective tax rate fluctuates 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.

With the exception of the one-time DTA re-measurement that took place in 2017, tax law causes the Company’s taxes payable to approximate or exceed the current provision for taxes on the income statement. Three provisions have had a significant effect on the Company’s current income tax liability:  (1) the restrictions on the deductibility of credit losses; (2) deductibility of pension and other long-term employee benefits only when paid; and (3) the statutory deferral of deductibility of California franchise taxes on the Company’s federal return

Financial Condition

This section discusses material changes in the Company’s consolidated balance sheet at September 30, 2019, as compared to December 31, 2018, and to September 30, 2018. 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 federal government-sponsored entities; (2) debt securities issued by US 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 debt securities (floating rate and fixed rate with maturities less than 5 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, 2019, was $553.3 million compared to $549.0 million at the end of 2018, a decrease of $4.2 million or 0.8%. At September 30, 2018, the investment portfolio totaled $509.8 million. The Company currently invests most of its available funds in either shorter term U.S. Treasury, government agency & government-sponsored entity securities or mortgage-backed securities.

The Company's total investment portfolio currently represents 15.5% of the Company’s total assets as compared to 16.0% at December 31, 2018, and 16.0% at September 30, 2018.

As of September 30, 2019, the Company held $60.4 million of municipal investments, all classified as HTM. Of this balance, $31.5 million were bank-qualified municipal bonds, and $28.9 million were private placement municipal bonds, warrants, 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, 2019, ninety-nine percent of the Company’s bank-qualified municipal bond portfolio is rated at either the issue or issuer level, and all of these ratings are “investment grade.” The Company monitors the status of all municipal investments with particular attention paid to the approximately one percent ($150,000) of the portfolio that is not rated, 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 $150.9 million at September 30, 2019, $84.5 million at December 31, 2018, and $58.1 million at September 30, 2018.

The Company classifies its investments in debt securities as HTM, trading, or 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. 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, 2019, December 31, 2018, and September 30, 2018, 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 10 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 36 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 very 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, 2019, totaled $2.6 billion, an increase of $200.5 million or 8.3% over September 30, 2018. This increase has occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; (2) expansion in the equipment leasing business; (3) expansion of our service area into the East Bay of San Francisco and Napa; and (4) the acquisition of the Bank of Rio Vista which added $80.5 million to loan balances. No assurances can be made that this growth in the loan & lease portfolio will continue.

Loans & leases at September 30, 2019, increased $45.9 million from $2.6 billion at December 31, 2018.

The following table sets forth the distribution of the loan & lease portfolio by type and percent as of the periods indicated.

Loan & Lease Portfolio
 
September 30, 2019
   
December 31, 2018
   
September 30, 2018
 
(in thousands)
 
$
   
%
     $    
%
    $
   
%
 
Commercial Real Estate
 
$
824,283
     
31.5
%
 
$
834,476
     
32.4
%
 
$
774,837
     
31.9
%
Agricultural Real Estate
   
617,310
     
23.5
%
   
584,625
     
22.7
%
   
553,608
     
22.8
%
Real Estate Construction
   
98,662
     
3.8
%
   
98,568
     
3.8
%
   
92,521
     
3.8
%
Residential 1st Mortgages
   
255,394
     
9.7
%
   
259,736
     
10.1
%
   
263,549
     
10.9
%
Home Equity Lines and Loans
   
39,490
     
1.5
%
   
40,789
     
1.6
%
   
38,490
     
1.6
%
Agricultural
   
289,182
     
11.0
%
   
290,463
     
11.3
%
   
287,821
     
11.9
%
Commercial
   
381,774
     
14.6
%
   
343,834
     
13.3
%
   
304,333
     
12.6
%
Consumer & Other
   
16,871
     
0.6
%
   
19,412
     
0.8
%
   
7,723
     
0.3
%
Leases
   
100,784
     
3.8
%
   
106,217
     
4.0
%
   
101,081
     
4.2
%
Total Gross Loans & Leases
   
2,623,750
     
100.0
%
   
2,578,120
     
100.0
%
   
2,423,963
     
100.0
%
Less: Unearned Income
   
6,628
             
6,879
             
7,361
         
Subtotal
   
2,617,122
             
2,571,241
             
2,416,602
         
Less: Allowance for Credit Losses
   
54,954
             
55,266
             
53,067
         
Net Loans & Leases
 
$
2,562,168
           
$
2,515,975
           
$
2,363,535
         

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 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 loans & leases,” and these loans & leases receive increased management attention. As of September 30, 2019, classified loans totaled $15.3 million compared to $15.1 million at December 31, 2018, and $16.3 million at September 30, 2018.

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, 2019, December 31, 2018, and September 30, 2018, non-accrual loans & leases totaled $0.

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 nonaccrual status at the time they become TDR loans, remain on nonaccrual 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, 2019, restructured loans & leases on accrual totaled $12.0 million as compared to $13.6 million at December 31, 2018, and September 30, 2018.

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.

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, 2019
   
Dec. 31, 2018
   
September 30, 2018
 
Non-Performing Loans & Leases
 
$
0
   
$
0
   
$
0
 
Other Real Estate
   
873
     
873
     
873
 
Total Non-Performing Assets
 
$
873
   
$
873
   
$
873
 
                         
Non-Performing Loans & Leases as a % of Total Loans & Leases
   
0.00
%
   
0.00
%
   
0.00
%
Restructured Loans & Leases (Performing)
 
$
12,010
   
$
13,577
   
$
13,551
 

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.

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 $0 for the periods ended September 30, 2019, December 31, 2018, and September 30, 2018.

The Company reported $873,000 of ORE at September 30, 2019, December 31, 2018, and September 30, 2018.

Except for those classified and non-performing loans & leases discussed above, the Company’s management is not aware of any loans & leases as of September 30, 2019, 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 Central Valley was one of the hardest hit areas in the country during the recession. In many areas, housing prices declined as much as 60% and unemployment reached 15% or more. Although the economy has strengthened throughout most of the Central Valley, in some of the Company’s market segments housing prices remain below peak levels and unemployment levels remain above those in other areas of the state and country.

The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are normal and the availability of water in our primary service area should not be an issue. Even though the vast majority of the Company’s agricultural customers are located in the more northern portion of the Central Valley, where even during the worst of the drought, farmers still had access to reasonable ground water sources, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.

Segments of the agricultural industry are facing challenges associated with: (1) weakness in export markets due to a stronger dollar and current trade disputes; (2) tight labor markets and higher wages due to legislative changes at the state and federal levels.

See “Part I, Item 1A. Risk Factors” in the Company’s 2018 Annual Report on Form 10-K.

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, 2019, have increased $362.5 million or 13.1% compared to September 30, 2018. 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 the East Bay of San Francisco and Napa; and (3) the acquisition of the Bank of Rio Vista which added $191.6 million in deposit balances. Short-term market interest rates increased 2.25% between December 2015 and December 2018. Although these rates have decreased .50% since August 2019, significant competitive pressures remain for deposit rates. The Company remains selective in how they respond to competitor rates, which may impact future deposit growth.

Although total deposits have increased 13.1% since September 30, 2018, importantly, low cost transaction accounts have grown at a strong pace as well:

Demand and interest-bearing transaction accounts increased $194.7 million or 13.25% since September 30, 2018.
Savings and money market accounts have increased $103.8 million or 12.3% since September 30, 2018.
Time deposit accounts have increased $63.9 million or 13.8% since September 30, 2018.

The Company's deposit balances at September 30, 2019, have increased $76.6 million or 2.5% compared to December 31, 2018. Savings and money market deposits increased 13.25% or $44.7 million and time deposit accounts increased by $36.2 million or 7.4% while demand and interest-bearing transaction accounts decreased by $4.4 million or 0.26%. Deposit trends in the first six-to-nine months of the year can be impacted by the seasonal needs of our agricultural customers.

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, 2019, December 31, 2018, or September 30, 2018. There were no Federal Funds purchased or advances from the FRB at September 30, 2019, December 31, 2018, or September 30, 2018.

As of September 30, 2019, the Company has additional borrowing capacity of $603.6 million with the Federal Home Loan Bank and $462.7 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 Note 13 located in “Item 8. Financial Statements and Supplementary Data” of the Company’s 2018 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 4.99% as of September 30, 2019, 5.64% at December 31, 2018, and 5.18% at September 30, 2018. The average rate paid for these securities for the first nine months of 2019 was 5.50% and 4.99% for the first nine months of 2018. 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 $355.7 million at September 30, 2019, $311.2 million at December 31, 2018, and $300.1 million at September 30, 2018.

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 implementation of Basel III requirements increased the required capital levels that the Company and the Bank must maintain. The final rules include new minimum risk-based capital and leverage ratios, which were fully phased in on January 1, 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules 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. The final rules established a "capital conservation buffer" of 2.5% above each of the new regulatory minimum capital ratios, which results 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 final rules also permit the Company’s subordinated debentures issued in 2003 to continue to be counted as Tier 1 capital. The Company is currently in compliance with all of these new capital requirements and they do 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, 2019
                                   
Total Capital Ratio
 
$
386,683
     
12.36
%
 
$
250,373
     
8.0
%
   
N/A
     
N/A
 
Common Equity Tier 1 Capital Ratio
 
$
337,363
     
10.78
%
 
$
140,835
     
4.5
%
   
N/A
     
N/A
 
Tier 1 Capital Ratio
 
$
347,363
     
11.10
%
 
$
187,780
     
6.0
%
   
N/A
     
N/A
 
Tier 1 Leverage Ratio
 
$
347,363
     
10.00
%
 
$
138,935
     
3.0
%
   
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, 2019
                                   
Total Capital Ratio
 
$
385,793
     
12.33
%
 
$
250,327
     
8.0
%
 
$
312,909
     
10.0
%
Common Equity Tier 1 Capital Ratio
 
$
346,480
     
11.07
%
 
$
140,809
     
4.5
%
 
$
203,391
     
6.5
%
Tier 1 Capital Ratio
 
$
346,480
     
11.07
%
 
$
187,745
     
6.0
%
 
$
250,327
     
8.0
%
Tier 1 Leverage Ratio
 
$
346,480
     
9.98
%
 
$
138,858
     
3.0
%
 
$
173,573
     
5.0
%

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 2018 Annual Report on Form 10-K for additional information.

There were no stock repurchases during the first nine months of 2019 and in the third quarter of 2018 the Company repurchased $31.2 million of shares. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.

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 2018 Annual Report on Form 10-K for further explanation.

During the nine months ended September 30, 2019, the Company issued 3,586 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. These shares were issued at a price of $715.00 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. There were no shares issued during the second quarter of 2019.

During the nine months ended September 30, 2018, the Company issued a combined total 13,520 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. There were also 2,400 shares issued to individuals during the third quarter of 2018. All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance 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 2018 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, 2019
   
December 31, 2018
   
September 30, 2018
 
Commitments to Extend Credit
 
$
838,049
   
$
828,539
   
$
789,169
 
Letters of Credit
   
19,960
     
19,108
     
20,176
 
Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties
   
2,003
     
-
     
-
 

The Company's exposure to credit loss in the event of nonperformance 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, 2019, and December 31, 2018. At September 30, 2018, the reserve was $267,000. 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. 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 DBO 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. 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, is 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, 2019, 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.

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 (called “asset sensitive”). 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 (called “liability sensitive”) 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, 2019, 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 2.4% if rates increase by 200 basis points and a decrease in net interest income of 2.1% if rates decline 100 basis points. Comparatively, at December 31, 2018, 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 2.25% if rates increase by 200 basis points and a decrease in net interest income of 5.80% if rates decline 200 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 2018 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 $78 million and repurchase lines of $130 million with major banks. As of September 30, 2019, the Company has additional borrowing capacity of $603.6 million with the FHLB and $462.7 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, 2019, the Company had available sources of liquidity, which included cash and cash equivalents and unpledged investment securities AFS of approximately $405 million, which represents 11.35% of total assets.

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

ITEM 1. Legal Proceedings

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.

ITEM 1A. Risk Factors

See “Item 1A. Risk Factors” in the Company’s 2018 Annual Report to Shareholders on Form 10-K. In management’s opinion, there have been no material changes in risk factors since the filing of the 2018 Form 10-K.

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

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.” Additionally, management is aware that there are private transactions in the Company’s common stock.

There were 44,503 shares repurchased by Farmers & Merchants Bancorp during the first nine months of 2018.

During the nine months ended September 30, 2019, the Company issued 3,586 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. These shares were issued at a price of $715.00 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.

During the nine months ended September 30, 2018, the Company issued a combined total 13,520 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. There were also 2,400 shares issued to individuals during the third quarter of 2018. All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance 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.

ITEM 3. Defaults Upon Senior Securities

Not applicable

ITEM 4. Mine Safety Disclosures

Not applicable

ITEM 5. Other Information

None

ITEM 6. Exhibits

 
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
XBRL Instance Document
 
101.SCH
XBRL Schema Document
 
101.CAL
XBRL Calculation Linkbase Document
 
101.LAB
XBRL Label Linkbase Document
 
101.PRE XBRL
Presentation Linkbase Document
 
101.DEF
XBRL Definition Linkbase Document

SIGNATURES

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, 2019
/s/ Kent A. Steinwert

   
 
Kent A. Steinwert
 
Chairman, President
 
& Chief Executive Officer
 
(Principal Executive Officer)
   
Date:  November 8, 2019
/s/ Stephen W. Haley
     
 
Stephen W. Haley
 
Executive Vice President and
 
Chief Financial Officer
 
(Principal Financial & Accounting Officer)


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