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FARMERS & MERCHANTS BANCORP - Quarter Report: 2022 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, 2022

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

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

Title of each class
Trading Symbol(s)
Name of each exchange on which registered
None
Not Applicable
Not Applicable

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $0.01 Par Value Per Share

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 

As of October 31, 2022, the registrant had 769,357 shares of common stock $0.01 par value per share, outstanding.



FARMERS & MERCHANTS BANCORP
FORM 10-Q

TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION
Page
 
 
 
 
 
Item 1 - Financial Statements
 
 
 
  4
 
 
5
 
 
6
 
 
7
 
 
8
 
 
  9
 
 
       
 
 
31
 
 
32
 
 
37
 
 
44
 
 
 
 
 
57
 
 
 
 
 
57
 
 
 
 
PART II. - OTHER INFORMATION
 
 
 
 
 
 
           57
 
57
 
58
 
58
 
58
 
58
 
58
 
59

Special Note Regarding Forward-Looking Statements

Certain matters in this Quarterly Report on 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”, “FMCB”, 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 mid Central Valley or the East Bay region of San Francisco in 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) the possible adverse impacts on the banking industry and our business from a period of significant, prolonged inflation; (8) 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; (9) water availability and management issues in California and the resulting impact on the Company’s agricultural and industrial customers; (10) expansion into new geographic markets and new lines of business; (11) the impact of COVID-19 (Coronavirus) on the Company and its customers (see “Note 2 – Risks and Uncertainties”); (12) the impact of changes in Federal and State taxation policies and rates; and (13) other factors discussed in “Item 1A. Risk Factors” on our Annual Report on Form 10-K filed with the SEC on March 15, 2022.

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.

PART 1. FINANCIAL INFORMATION

Item 1.
Financial Statements

FARMERS & MERCHANTS BANCORP 
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except share and per share amounts)
 
September 30,
2022
   
December 31,
2021
 
ASSETS
           
Cash and due from banks
 
$
82,932
   
$
52,499
 
Interest bearing deposits with banks
   
799,951
     
662,961
 
Total cash and cash equivalents
   
882,883
     
715,460
 
Securities available-for-sale, at fair value
   
177,454
     
270,454
 
Securities held-to-maturity, fair value $690,922 and $725,841, respectively
   
852,665
     
737,052
 
Allowance for credit losses
    (393 )     -  
Total investment securities
   
1,029,726
     
1,007,506
 
Non-marketable securities
   
15,549
     
15,549
 
Loans and leases held for investment
   
3,323,862
     
3,237,177
 
Allowance for credit losses
   
(63,617
)
   
(61,007
)
Loans held for investment, net
   
3,260,245
     
3,176,170
 
Bank-owned life insurance
   
72,566
     
71,411
 
Premises and equipment, net
   
49,183
     
47,730
 
Deferred income tax assets
   
34,411
     
25,542
 
Accrued interest receivable
   
20,069
     
18,098
 
Goodwill
   
11,183
     
11,183
 
Other intangibles
   
2,957
     
3,402
 
Other real estate owned
   
873
     
873
 
Other assets
   
87,136
     
84,796
 
TOTAL ASSETS
 
$
5,466,781
   
$
5,177,720
 
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Deposits:
               
Non-interest bearing
 
$
1,802,623
   
$
1,750,330
 
Interest bearing:
               
Demand
   
1,158,588
     
1,097,337
 
Savings and money market
   
1,587,662
     
1,400,000
 
Certificates of deposit
   
360,384
     
392,485
 
Total interest bearing
   
3,106,634
     
2,889,822
 
Total deposits
   
4,909,257
     
4,640,152
 
Subordinated debentures
   
10,310
     
10,310
 
Interest payable and other liabilities
   
79,036
     
64,122
 
TOTAL LIABILITIES
   
4,998,603
     
4,714,584
 
                 
SHAREHOLDERS’ EQUITY
               
Preferred shares, no par value, 1,000,000 shares authorized and, none issued or outstanding
   
-
     
-
 
Common shares, $0.01 par value, 7,500,000 authorized 770,822 and 789,646 outstanding at September 30, 2022 and December 31, 2021, respectively
   
8
     
8
 
Additional paid-in capital
   
59,611
     
77,516
 
Retained earnings
   
436,258
     
387,331
 
Accumulated other comprehensive (loss) / income, net of taxes
   
(27,699
)
   
(1,719
)
TOTAL SHAREHOLDERS’ EQUITY
   
468,178
     
463,136
 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
5,466,781
   
$
5,177,720
 

FARMERS & MERCHANTS BANCORP
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME


 
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(Dollars in thousands, except share and per share amounts)  
2022
   
2021
   
2022
   
2021
 
Interest income
                       
Interest and fees on loans and leases
 
$
41,868
   
$
36,088
   
$
117,871
   
$
109,839
 
Interest and dividends on investments
   
5,686
     
3,925
     
16,697
     
12,664
 
Interest on deposits with others
    4,159       328       5,934       595  
Total interest income
   
51,713
     
40,341
     
140,502
     
123,098
 
Interest expense
                               
Deposits
   
1,122
     
929
     
2,798
     
3,200
 
Subordinated debentures
   
134
     
78
     
319
     
236
 
Total interest expense
   
1,256
     
1,007
     
3,117
     
3,436
 
Net interest income
   
50,457
     
39,334
     
137,385
     
119,662
 
Provision for credit losses
   
1,500
     
-
     
3,000
     
1,250
 
Net interest income after provision for credit losses
   
48,957
     
39,334
     
134,385
     
118,412
 
Non-interest income
                               
Card processing
    1,791       1,788       5,375       5,173  
Service charges on deposit accounts
   
638
     
808
     
2,318
     
2,125
 
Increase in cash surrender value of BOLI
   
566
     
549
     
1,668
     
1,616
 
Net (loss)/gain on sale of investment securities available-for-sale
   
(2,987
)
   
-
     
(2,985
)
   
2,554
 
Net gain/(loss) on deferred compensation benefits
   
352
     
615
     
(227
)
   
1,828
 
Other
   
1,199
     
857
     
3,234
     
2,996
 
Total non-interest income
   
1,559
     
4,617
     
9,383
     
16,292
 
Non-interest expense
                               
Salaries and employee benefits
   
15,994
     
14,453
     
49,181
     
47,375
 
Net gain/(loss) on deferred compensation benefits
   
352
     
615
     
(227
)
   
1,828
 
Occupancy
   
1,196
     
1,145
     
3,500
     
3,554
 
Data Processing
    1,250       1,251       3,698       3,688  
FDIC insurance
    366       317       1,076       902  
Marketing
   
303
     
63
     
959
     
669
 
Legal
   
49
     
85
     
733
     
485
 
Other
   
4,865
     
2,656
     
12,274
     
9,231
 
Total non-interest expense
   
24,375
     
20,585
     
71,194
     
67,732
 
INCOME BEFORE INCOME TAXES
   
26,141
     
23,366
     
72,574
     
66,972
 
Income tax expense
   
6,605
     
5,864
     
17,537
     
16,604
 
NET INCOME
 
$
19,536
   
$
17,502
   
$
55,037
   
$
50,368
 
                                 
Earnings per common share:
                               
Basic
  $ 25.20     $ 22.16     $ 70.47     $ 63.79  
Diluted
  $ 25.20     $ 22.16     $ 70.47     $ 63.79  
                                 
Weighted average number of common shares                                
Basic
    775,109       789,646       780,988       789,646  
Diluted
    775,109       789,646       780,988       789,646  

FARMERS & MERCHANTS BANCORP 
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME


 
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(Dollars in thousands)  
2022
   
2021
   
2022
   
2021
 
Net income
 
$
19,536
   
$
17,502
   
$
55,037
   
$
50,368
 
Other comprehensive income
                               
Unrealized holding (losses)/gains on securities available-for-sale
   
(12,378
)
   
(2,237
)
   
(39,677
)
   
(16,846
)
Reclassification adjustment for (gains)/losses on available-for-sale securities
   
2,987
     
-
     
2,985
     
(2,554
)
Amortization of unrealized loss on securities transferred to held-to-maturity
   
(52
)
   
(135
)
   
(193
)
   
(373
)
Net unrealized holding (losses)/gains on securities available-for-sale
    (9,443 )     (2,372 )     (36,885 )     (19,773 )
Income tax benefit/(expense)
   
2,792
     
702
     
10,905
     
5,846
 
Other comprehensive (loss)/income, net of tax
   
(6,651
)
   
(1,670
)
   
(25,980
)
   
(13,927
)
Total comprehensive income
 
$
12,885
   
$
15,832
   
$
29,057
   
$
36,441
 

FARMERS & MERCHANTS BANCORP
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the three and nine months ended September 30, 2022 and 2021


 

(Dollars in thousands, except share and per share amounts)
 
Common
Shares
    Amount
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
(Loss)/Income
   
Total
 
Balance as of July 1, 2022
   
777,190
   
$
8
   
$
65,671
   
$
416,722
   
$
(21,048
)
 
$
461,353
 
Net income
    -       -      
-
     
19,536
     
-
     
19,536
 
Other comprehensive loss, net of tax
    -      
-
     
-
     
-
     
(6,651
)
   
(6,651
)
Repurchase of common stock     (6,368 )     -       (6,060 )     -       -       (6,060 )
Balance as of September 30, 2022
   
770,822
   
$
8
   
$
59,611
   
$
436,258
   
$
(27,699
)
 
$
468,178
 
                                                 
Balance as of July 1, 2021
   
789,646
   
$
8
   
$
77,516
   
$
360,021
   
$
814
   
$
438,359
 
Net income
    -       -      
-
     
17,502
     
-
     
17,502
 
Other comprehensive loss, net of tax
    -      
-
     
-
     
-
     
(1,670
)
   
(1,670
)
Balance as of September 30, 2021
   
789,646
   
$
8
   
$
77,516
   
$
377,523
   
$
(856
)
 
$
454,191
 


 

(Dollars in thousands, except share and per share amounts)
 
Common
Shares
    Amount
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
(Loss)/Income
   
Total
 
Balance as of January 1, 2022
   
789,646
   
$
8
   
$
77,516
   
$
387,331
   
$
(1,719
)
 
$
463,136
 
Net income
    -       -      
-
     
55,037
     
-
     
55,037
 
Other comprehensive loss, net of tax
    -      
-
     
-
     
-
     
(25,980
)
   
(25,980
)
Cash dividends declared ($7.85 per share)
    -       -       -       (6,110 )     -       (6,110 )
Repurchase of common stock     (18,824 )     -       (17,905 )     -       -       (17,905 )
Balance as of September 30, 2022
   
770,822
   
$
8
   
$
59,611
   
$
436,258
   
$
(27,699
)
 
$
468,178
 
                                                 
Balance as of January 1, 2021
   
789,646
   
$
8
   
$
77,516
   
$
333,070
   
$
13,071
   
$
423,665
 
Net income
    -       -      
-
     
50,368
     
-
     
50,368
 
Other comprehensive loss, net of tax
    -      
-
     
-
     
-
     
(13,927
)
   
(13,927
)
Cash dividends declared ($7.50 per share)
    -       -       -       (5,922 )     -       (5,922 )
Cash dividends returned
    -       -       -       7       -       7  
Balance as of September 30, 2021
   
789,646
   
$
8
   
$
77,516
   
$
377,523
   
$
(856
)
 
$
454,191
 

FARMERS & MERCHANTS BANCORP
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

   
Nine Months Ended
September 30,
 
(Dollars in thousands)
 
2022
   
2021
 
Cash flows from operating activities:
           
Net income
 
$
55,037
   
$
50,368
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for credit losses
   
3,000
     
1,250
 
Depreciation and amortization
   
1,849
     
1,971
 
Net amortization of securities premiums and discounts
   
341
     
1,133
 
Increase in cash surrender value of BOLI
   
(1,666
)
   
(1,616
)
Decrease /(increase) in deferred income taxes, net
   
2,356
     
(456
)
Loss/(gains) on sale of securities available-for-sale
   
2,985
     
(2,554
)
Net changes in:
               
Other assets
   
(2,362
)
   
(8,772
)
Other liabilities
   
18,134
     
10,738
 
Net cash provided by operating activities
   
79,674
     
52,062
 
Cash flows from investing activities:
               
Net change in loans held for investment
   
(86,401
)
   
(39,956
)
Purchase of available-for-sale securities
   
(10,135
)
   
(257,228
)
Purchase of held-to-maturity securities
   
(168,634
)
   
(194,332
)
Proceeds from sales, maturities, calls and pay downs of available-for-sale securities
   
62,979
     
397,454
 
Proceeds from maturities, calls and pay downs of held-to-maturity securities
   
52,884
     
29,042
 
Purchase of premises and equipment
   
(3,318
)
   
(1,001
)
Purchase of other investments
   
(5,300
)
   
(4,516
)
Redemption of other investments     -       2,556  
Proceeds from bank-owned life insurance     511       -  
Proceeds from sale of assets
   
73
     
635
 
Net cash used in investing activities
   
(157,341
)
   
(67,346
)
Cash flows from financing activities:
               
Net increase in deposits
   
269,105
     
508,127
 
Cash dividends paid
   
(6,110
)
   
(5,915
)
Net cash used in share repurchase of common stock
   
(17,905
)
   
-
 
Net provided by financing activities
   
245,090
     
502,212
 
Net change in cash and cash equivalents
   
167,423
     
486,928
 
Cash and cash equivalents, beginning of period
   
715,460
     
383,837
 
Cash and cash equivalents, end of period
 
$
882,883
   
$
870,765
 
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest
 
$
3,832
   
$
4,369
 
Income taxes paid
  $ 11,451     $ 22,530  
                 
Supplemental disclosures of non-cash transactions:
               
Investment securities available-for-sale transferred to held-to-maturity
 
$
-
   
$
316,925
 
Lease Liabilities Arising from Obtaining Right-of-Use Assets   $ -     $ 302  

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS


Note 1—Basis of Presentation and Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements include the accounts of Farmers & Merchants Bancorp (“FMCB” or “Bancorp”), a bank holding company incorporated in the State of Delaware and its wholly owned subsidiary, Farmers & Merchants Bank of Central California (“FMB” or “Bank”) collectively (the “Company”).

These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). In preparing these financial statements, the Company has evaluated events and transactions subsequent to September 30, 2022 for potential recognition or disclosure. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and note disclosures have been condensed or omitted pursuant to the rules and regulations of the SEC and the accounting standards for interim financial statements. Certain reclassifications have been made to the 2021 Consolidated Financial Statements and/or schedules to conform to the 2022 presentation. All significant intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are significant to an understanding of Bank’s financial statements. These policies relate to: (i) the methodology for the recognition of interest income; (ii) the determination of the provision and allowance for credit losses; (iii) the valuation of financial assets and liabilities recorded at fair value; (iv) the valuation of intangibles, such as goodwill and core deposit intangibles (“CDI”); (v) the valuation of other real estate owned (“OREO”); and (vi) the valuation or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail in subsequent notes to the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations, Summary of Critical Accounting Policies and Estimates, in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 15, 2022 and Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations Summary of Critical Accounting Policies and Estimates included in this Quarterly Report on Form 10-Q.

The information included in this Form 10-Q should be read in conjunction with our 2021 Form 10-K. Interim results are not necessarily indicative of results for a full year or any other interim period.

Accounting Standards Pending Adoption — 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 March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Since the issuance of this guidance, the publication cessation of the U.S. dollar LIBOR has been extended to June 30, 2023.  We have not elected to apply these amendments. However, we will assess the applicability of the ASU to us and continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

9

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 1—Basis of Presentation and Significant Accounting Policies—Continued

In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). The main amendments in this ASU are intended to clarify certain optional expedients and scope of derivative instruments. The amendments are elective and effective immediately upon issuance of this ASU. Amendments may be elected through December 31, 2022. We have not elected to apply amendments at this time, however, will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

In March 2022, the FASB issued guidance within ASU 2022-02, Financial Instruments  Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The amendments in this ASU eliminate the current troubled debt restructuring (TDR) recognition and measurement guidance and, instead, require that a creditor evaluate (consistent with the accounting for other loan modifications) whether the modification represents a new loan or a continuation of an existing loan. The amendments also introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty.

These amendments require vintage disclosures including current-period gross write-offs by year of origination for financing receivables. Gross write-off information must be included in the vintage disclosures in accordance with ASC 326-20-50-6, which requires disclosure of the amortized cost basis of financing receivables by credit quality indicator and class of financing receivable by year of origination.

The amendments in this ASU are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years since the Company previously adopted the amendments in ASU 2016-13, which is commonly referred to as the current expected credit loss methodology, on January 1, 2020. These amendments should be applied prospectively, though for the transition method related to the recognition and measurement of TDRs, an entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption.

Early adoption is permitted, including adoption in an interim period. If an entity elects to early adopt in an interim period, the guidance should be applied as of the beginning of the fiscal year that includes the interim period. An entity may elect to early adopt the amendments about TDRs and related disclosure enhancements separately from the amendments related to the vintage disclosures. The adoption of this ASU is not expected to have a material impact on the Company’s Consolidated Financial Statements.

In June 2022, the FASB issued guidance within ASU 2022-03, Fair Value Measurement of Equity Securities Subject to contractual Sale Restrictions. The amendments in this ASU affect all entities that have investments in equity securities measured at fair value that are subject to a contractual sale restriction. These amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value.

The amendments in this ASU are effective for fiscal years, beginning after December 15, 2023, including interim periods within those fiscal years.  Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance.  The adoption of this ASU is not expected to have material impact on the Company’s Consolidated Financial Statements.

Impact of recent authoritative accounting guidance  The Accounting Standards Codification™ (“ASC”) is the FASB officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities. Periodically, the FASB will issue Accounting Standard updates (“ASU”) to its ASC. Rules and interpretive releases of the SEC under the authority of the federal securities laws are also sources of authoritative GAAP for the Company as an SEC registrant. All other accounting literature is non-authoritative.
10

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 1—Basis of Presentation and Significant Accounting Policies—Continued
 
On January 1, 2022, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology that delays recognition until it is probable a loss has been incurred with an expected loss methodology that is referred to as CECL.


In adopting ASU 2016-13 (Topic 326) Management determined that the Weighted Average Remaining Maturity (“WARM”) method was most appropriate given the Company’s current size and complexity.


The implementation of CECL did not result in any material change in the calculation of the Company’s December 31, 2021 Allowance for Credit Losses, therefore, no adjustment to Shareholders’ Equity was made as of January 1, 2022.

The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The ASU affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial asset not excluded from the scope that have the contractual right to receive cash. The ASU replaces the incurred loss impairment methodology in previous GAAP with CECL, a methodology that reflects current expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This ASU broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss, which will be more decision useful to users of the financial statements.

The following table illustrates the pre-tax impact of the adoption of this ASU:

 
 
January-2022
 
(Dollars in thousands)
 
Reported
under
ASC 326
   
Reported
Pre-
Adoption
   
Impact of
ASC 326
Adoption
 
Allowance for credit losses:
                 
Real estate:
                 
Commercial
 
$
(17,379
)
 
$
(28,536
)
 
$
11,157
 
Agricultural
   
(14,580
)
   
(9,613
)
   
(4,967
)
Residential and home equity
   
(5,879
)
   
(2,847
)
   
(3,032
)
Construction
   
(3,311
)
   
(1,456
)
   
(1,855
)
Total real estate
   
(41,149
)
   
(42,452
)
   
1,303
 
Commercial & industrial
   
(11,417
)
   
(11,489
)
   
72
 
Agricultural
   
(6,363
)
   
(5,465
)
   
(898
)
Commercial leases
   
(1,567
)
   
(938
)
   
(629
)
Consumer and other
   
(511
)
   
(663
)
   
152
 
Total allowance for credit losses
 
$
(61,007
)
 
$
(61,007
)
 
$
-
 
 
11

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 1—Basis of Presentation and Significant Accounting Policies—Continued
 
Subsequent events  The Company has evaluated events occurring subsequent to September 30, 2022 for disclosure in the consolidated financial statements.


Note 2Risks and Uncertainties

The COVID-19 pandemic has affected the economy and businesses throughout the U.S., in California and in the markets served by the Company. Designated as an “essential business”, the Company’s subsidiary, Farmers & Merchants Bank of Central California, has kept all branches open and maintained regular business hours during the COVID-19 pandemic. Our staffing levels have remained stable during the COVID-19 pandemic.

Through the CARES Act and H.R. 133, as well as related federal and state regulatory actions, the federal government has taken extraordinary efforts to provide financial assistance to individuals and companies to help them move through these difficult times. However, there are no guarantees how long the COVID-19 virus may continue to impact our economy, and therefore, the Company.

While the effects of COVID-19 might still have an adverse future impact on our business, financial condition and results of operations, we are unable to predict the full extent or nature of these impacts at the current time.

12

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)

Note 3—Investment Securities

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

Available-for-Sale Securities
 
     Gross Unrealized    
 
(Dollars in thousands)
 
Amortized
Cost
   
Gains
   
Losses
   
Fair
Value
 
As of September 30, 2022                                
U.S. Treasury notes
 
$
4,979
   
$
-
   
$
38
   
$
4,941
 
U.S. Government-sponsored securities
   
4,695
     
27
     
24
     
4,698
 
Mortgage-backed securities (1)
   
194,600
     
16
     
38,163
     
156,453
 
Collateralized mortgage obligations (1)
    1,499       -       41       1,458  
Corporate securities
   
10,046
     
-
     
452
     
9,594
 
Other
   
310
     
-
     
-
     
310
 
Total available-for-sale securities
 
$
216,129
   
$
43
   
$
38,718
   
$
177,454
 
   
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.


 

   
Gross Unrealized
   

 
(Dollars in thousands)
 
Amortized
Cost
   
Gains
   
Losses
   
Fair
Value
 
As of December 31, 2021
                               
U.S. Treasury notes
 
$
9,938
   
$
151
   
$
-
   
$
10,089
 
U.S. Government-sponsored securities
   
6,351
     
62
     
39
     
6,374
 
Mortgage-backed securities (1)
   
253,300
     
3,200
     
5,380
     
251,120
 
Collateralized mortgage obligations (1)
    2,412       24       -       2,436  
Other
   
435
     
-
     
-
     
435
 
Total available-for-sale securities
 
$
272,436
   
$
3,437
   
$
5,419
   
$
270,454
 
   
(1) All mortgage-backed securities and collateralized mortgage obligations 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 investments classified as held-to-maturity are as follows:
 
Held-to-Maturity Securities  

   
Gross Unrealized
   

       
(Dollars in thousands)
 
Amortized
Cost
   
Gains
   
Losses
   
Fair
Value
   
Allowance
for Credit
Losses
 
As of September 30, 2022                              
Municipal securities
 
$
60,827
   
$
-
   
$
735
   
$
60,092
    $ 393  
Mortgage-backed securities (1)
   
709,541
     
-
     
145,836
     
563,705
      -  
Collateralized mortgage obligations (1)
    82,297
      -
      15,172
      67,125
      -
 
Total held-to-maturity securities
 
$
852,665
   
$
-
   
$
161,743
   
$
690,922
    $ 393  
   
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
13

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 3—Investment Securities—Continued

 
       
Gross Unrealized
             
(Dollars in thousands)
 
Amortized Cost
   
Gains
   
Losses
   
Fair
Value
   
Allowance
for Credit
Losses
 
As of December 31, 2021
                             
Municipal securities
 
$
66,496
   
$
701
   
$
-
   
$
67,197
   
$
-
 
Mortgage-backed securities(1)
   
596,775
     
45
     
11,764
     
585,056
     
-
 
Collateralized mortgage obligations(1)
   
73,781
     
36
     
229
     
73,588
     
-
 
Total held-to-maturity securities
 
$
737,052
   
$
782
   
$
11,993
   
$
725,841
   
$
-
 
   
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

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.

As of September 30, 2022, the Company held 200 available-for-sale investment securities of which 86 were in an unrealized loss position for less than twelve months and 77 securities were in an unrealized loss position for twelve months or more without an allowance for credit losses. Management evaluates the available-for-sale investment securities in an unrealized loss position, 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.

The following tables show the gross unrealized losses for available-for-sale securities, for which an allowance for credit losses has not been recorded, that are less than 12 months and 12 months or more:

Available-for-Sale Securities
      As of September 30, 2022      

 
Less Than 12 Months
 
12 Months or More
 
Total
 
(Dollars in thousands)
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
As of September 30, 2022
                         
U.S. Treasury notes
  $
4,941     $
38     $
-     $
-     $
4,941     $
38  
U.S. Government-sponsored securities
 

128
   

1
   

1,409
   

23
   

1,537
   

24
 
Mortgage-backed securities (1)
   
37,141
     
1,928
     
117,680
     
36,235
     
154,821
     
38,163
 
Collateralized mortgage obligations (1)
    1,458       41       -       -       1,458       41  
Corporate securities
    9,594       452       -       -       9,594       452  
Total available-for-sale securities
 
$
53,262
   
$
2,460
   
$
119,089
   
$
36,258
   
$
172,351
   
$
38,718
 

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

          As of December 31, 2021        

 
Less Than 12 Months
   
12 Months or More
   
Total
 
(Dollars in thousands)
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
As of December 31, 2021
                                   
U.S. Government-sponsored securities
 
$
183
   
$
-
   
$
2,007
   
$
39
   
$
2,190
   
$
39
 
Mortgage-backed securities (1)
   
61,469
     
1,192
     
104,489
     
4,188
     
165,958
     
5,380
 
Total available-for-sale securities
 
$
61,652
   
$
1,192
   
$
106,496
   
$
4,227
   
$
168,148
   
$
5,419
 

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.


14

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 3—Investment Securities—Continued

The following table presents the activity in the allowance for credit losses for held-to-maturity debt securities by major type for the nine months ended September 30, 2022.

   
For the Nine Months Ended September 30, 2022
 
(Dollars in thousands)
 
Municipal securities
   
Mortgage-backed securities
   
Collateralized Mortgage obligations
   
Total
 
Allowance for credit losses - securities
                       
Beginning Balance
 
$
-
   
$
-
   
$
-
   
$
-
 
Provision for credit losses
   
393
     
-
     
-
     
393
 
Ending Balance
 
$
393
   
$
-
   
$
-
   
$
393
 

Management measures expected credit losses on held-to-maturity (“HTM”) debt securities on a collective basis by major security type. The Company’s HTM portfolio contains securities issued by U.S. government entities and agencies and municipalities. The Company uses industry historical credit loss information adjusted for current conditions to establish the allowance for credit losses on its HTM municipal bond portfolio.
 
U.S. Government-sponsored securities. The unrealized losses were caused by interest rate fluctuations. The decline in market value is attributable to changes in interest rates and not credit quality.

Mortgage-backed securities and collateralized mortgage obligations. The unrealized losses 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. The decline in market value is attributable to changes in interest rates and not credit quality.

Corporate securities. Changes in the prices of corporate securities are primarily influenced by: (1) changes in market interest rates; (2) changes in perceived credit risk in the general economy or in particular industries; (3) changes in the perceived credit risk of a particular company; and (4) day to day trading supply, demand and liquidity. The Company monitors the status of each of our corporate securities 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.

Obligations of states and political subdivisions. The Company’s bank-qualified municipal bond portfolio is comprised of two different segments: (1) publicly issued debt of $18.4 million purchased on the open market, all rated at either the issue or issuer level and all of these ratings are “investment grade” and (2) municipal debt of $42.4 million purchased directly from the Bank’s customers, all of which is monitored through quarterly or annual financial reviews of the issuer. The Company monitors the status of all municipal investments in the portfolio 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 Company does not intend to sell the held-to-maturity investments and it is more likely than not that the Company will not be required to sell the investments before recovery of their amortized cost basis.
15

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)

Note 3—Investment Securities—Continued

The amortized cost and estimated fair values of investment securities at September 30, 2022 by contractual final maturity are shown in the following table:


 
Available-for-Sale
   
Held-to-Maturity
 
(Dollars in thousands)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
Securities maturing in:
                               
One year or less
 
$
5,312
   
$
5,274
   
$
883
   
$
883
 
After one year through five years
   
21,418
     
20,600
     
7,484
     
7,324
 
After five years through ten years
   
25,492
     
23,196
     
28,907
     
26,852
 
After ten years
   
163,907
     
128,384
     
815,391
     
655,863
 
Total   $
216,129
    $
177,454
    $
852,665
    $
690,922
 
 
The Company monitors the credit quality of those available-for-sale and held-to-maturity debt securities not issued by the U.S. government or one of its agencies or government sponsored entities, through the use of credit ratings. Credit ratings are reviewed and updated quarterly. The following table summarizes the fair value of available-for-sale and amortized cost of held-to-maturity debt securities by credit rating at September 30, 2022:

     Available-for-Sale      Held-to-Maturity  
   
Fair Value
   
Amortized Cost
 
(Dollars in thousands)
 
AAA/AA/A
   
BBB/BB/B
   
Not Rated
   
AAA/AA/A
   
BBB/BB/B
   
Not Rated
 
September 30, 2022
                                   
                                     
Breakdown by Category:
                                   
U.S. Treasury notes
 
$
4,941
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
U.S. Government-sponsored securities
   
-
     
-
     
4,698
     
-
     
-
     
-
 
Mortgage-backed securities (1)
   
-
     
-
     
156,453
     
-
     
-
     
709,541
 
Collateralized mortgage obligations (1)
   
-
     
-
     
1,458
     
-
     
-
     
82,297
 
Municipal securities
    -


-


-


18,025


386


42,416  
Corporate securities
   
4,795
     
4,799
     
-
     
-
     
-
     
-
 
Other
   
-
     
-
     
310
     
-
     
-
     
-
 
Total Investment Grade
 
$
9,736
   
$
4,799
   
$
162,919
   
$
18,025
   
$
386
   
$
834,254
 

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. government.

Proceeds from sales and calls of these securities were as follows:

(Dollars in thousands)
 
Gross Proceeds
   
Gross Gains
   
Gross Losses
 
Nine months ended September 30, 2022
 
$
31,394
   
$
2
   
$
2,987
 
Nine months ended September 30, 2021
 
$
301,320
   
$
5,570
   
$
3,016
 

Pledged Securities
As of September 30, 2022, securities carried at $493.8 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 $426 million at December 31, 2021.

16

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases

Loans and leases as of the dates indicated consisted of the following:

(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Loans and leases held for investment, net
           
Real estate:
           
Commercial
 
$
1,246,805
   
$
1,167,516
 
Agricultural
   
722,448
     
672,830
 
Residential and home equity
   
377,249
     
350,581
 
Construction
   
169,624
     
177,163
 
Total real estate
   
2,516,126
     
2,368,090
 
Commercial & industrial
   
454,185
     
427,799
 
Agricultural
   
260,296
     
276,684
 
Commercial leases
   
94,089
     
96,971
 
Consumer and other(1)
   
7,776
     
78,367
 
Total gross loans and leases
   
3,332,472
     
3,247,911
 
Unearned income
   
(8,610
)
   
(10,734
)
Total net loans and leases
   
3,323,862
     
3,237,177
 
Allowance for credit losses
   
(63,617
)
   
(61,007
)
Total loans and leases held for investment, net
 
$
3,260,245
   
$
3,176,170
 

(1) Includes SBA PPP loans.

Paycheck Protection Program (“PPP”)Under the CARES Act and H.R. 133 (see “Note 2 – Risks and Uncertainties”) the Small Business Administration (“SBA”) was directed by Congress to provide loans to small businesses with less than 500 employees to assist these businesses in meeting their payroll and other financial obligations during the COVID-19 pandemic. These government guaranteed loans are made with an interest rate of 1%, a risk weight of 0% under risk-based capital rules, have a term of 2 to 5 years, and under certain conditions the SBA will forgive them. The Bank actively participated in the PPP, and since April 2020, the Bank has funded $494.4 million of loans for 2,680 small business customers. PPP loans outstanding were $1.8 million and $70.8 million at September 30, 2022 and December 31, 2021, respectively.

At September 30, 2022, the portion of loans that were approved for pledging as collateral on borrowing lines with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank (“FRB”) were $1.2 billion and $890.6 million, respectively. The borrowing capacity on these loans was $766 million from FHLB and $657 million from the FRB.

17

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued

 

The following tables show an aging analysis of the loan & lease portfolio, including unearned income, by the time past due for the periods indicated:


   
September 30, 2022
 
(Dollars in thousands)
 
Current
   
30-89 Days
Past Due
   
90+ Days
Past Due
   
Non-
accrual
   
Total Past
Due
   
Total
 
Loans and leases held for investment, net
                                   
Real estate:
                                   
Commercial
 
$
1,238,110
   
$
170
   
$
-
   
$
411
   
$
581
   
$
1,238,691
 
Agricultural
   
722,448
     
-
     
-
     
-
     
-
     
722,448
 
Residential and home equity
   
377,224
     
25
     
-
     
-
     
25
     
377,249
 
Construction
   
169,624
     
-
     
-
     
-
     
-
     
169,624
 
Total real estate
   
2,507,406
     
195
     
-
     
411
     
606
     
2,508,012
 
Commercial & industrial
   
454,185
     
-
     
-
     
-
     
-
     
454,185
 
Agricultural
   
260,296
     
-
     
-
     
-
     
-
     
260,296
 
Commercial leases
   
93,593
     
-
     
-
     
-
     
-
     
93,593
 
Consumer and other
   
7,766
     
10
     
-
     
-
     
10
     
7,776
 
Total loans and leases, net
 
$
3,323,246
   
$
205
   
$
-
   
$
411
   
$
616
   
$
3,323,862
 


   
December 31, 2021
 
(Dollars in thousands)
 
Current
   
30-89 Days
Past Due
   
90+ Days
Past Due
   
Non-
accrual
   
Total Past
Due
   
Total
 
Loans and leases held for investment, net
                                   
Real estate:
                                   
Commercial
 
$
1,156,879
   
$
459
   
$
-
   
$
-
   
$
459
   
$
1,157,338
 
Agricultural
   
672,812
     
-
     
-
     
18
     
18
     
672,830
 
Residential and home equity
   
350,492
     
89
     
-
     
-
     
89
     
350,581
 
Construction
   
177,163
     
-
     
-
     
-
     
-
     
177,163
 
Total real estate
   
2,357,346
     
548
     
-
     
18
     
566
     
2,357,912
 
Commercial & industrial
   
427,799
     
-
     
-
     
-
     
-
     
427,799
 
Agricultural
   
276,186
     
-
     
-
     
498
     
498
     
276,684
 
Commercial leases
   
96,415
     
-
     
-
     
-
     
-
     
96,415
 
Consumer and other
   
78,363
     
4
     
-
     
-
     
4
     
78,367
 
Total loans and leases, net
 
$
3,236,109
   
$
552
   
$
-
   
$
516
   
$
1,068
   
$
3,237,177
 

18

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued

 

Non-accrual loans are summarized as follows:


(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Non-accrual loans and leases:
           
Non-accrual loans and leases, not TDRs
           
Real estate:
           
Commercial
 
$
411
   
$
-
 
Agricultural
   
-
     
18
 
Residential and home equity
   
-
     
-
 
Construction
   
-
     
-
 
Total real estate
   
411
     
18
 
Commercial & industrial
   
-
     
-
 
Agricultural
   
-
     
-
 
Commercial leases
   
-
     
-
 
Consumer and other
   
-
     
-
 
Subtotal
   
411
     
18
 
Non-accrual loans and leases, are TDRs
               
Real estate:
               
Commercial
 
$
-
   
$
-
 
Agricultural
   
-
     
-
 
Residential and home equity
   
-
     
-
 
Construction
   
-
     
-
 
Total real estate
   
-
     
-
 
Commercial & industrial
   
-
     
-
 
Agricultural
   
-
     
498
 
Commercial leases
   
-
     
-
 
Consumer and other
   
-
     
-
 
Subtotal
   
-
     
498
 
Total non-accrual loans and leases
 
$
411
   
$
516
 


19

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued 
 

The following table lists total troubled debt restructured loans that the Company is either accruing or not accruing interest by loan category:


(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Troubled debt restructured loans and leases:
           
Accruing TDR loans and leases
           
Real estate:
           
Commercial
 
$
-
   
$
41
 
Agricultural
   
-
     
-
 
Residential and home equity
   
1,319
     
1,522
 
Construction
   
-
     
-
 
Total real estate
   
1,319
     
1,563
 
Commercial & industrial
   
6
     
260
 
Agricultural
   
-
     
-
 
Commercial leases
   
-
     
-
 
Consumer and other
   
-
     
1
 
Subtotal
   
1,325
     
1,824
 
Non-accruing TDR loans and leases
               
Real estate:
               
Commercial
  $
-
    $
-
 
Agricultural
   
-
     
-
 
Residential and home equity
   
-
     
-
 
Construction
   
-
     
-
 
Total real estate
   
-
     
-
 
Commercial & industrial
   
-
     
-
 
Agricultural
   
-
     
498
 
Commercial leases
   
-
     
-
 
Consumer and other
   
-
     
-
 
Subtotal
   
-
     
498
 
Total TDR loans and leases
 
$
1,325
   
$
2,322
 



The below table summarize TDRs outstanding as of September 30, 2022, by year of occurrence:


   
September 30, 2022
 
(Dollars in thousands)
 
# of Accruing
TDR
   
$ of Accruing
TDR
   
# of Non-
Accruing TDR
   
$ of Non-
Accruing TDR
   
# of Total TDR
   
$ of Total TDR
 
Loan and lease TDRs
                                   
2022
   
-
   
$
-
     
-
   
$
-
     
-
   
$
-
 
2021
   
-
     
-
     
-
     
-
     
-
     
-
 
2020
   
4
     
260
     
-
     
-
     
4
     
260
 
2019
   
-
     
-
     
-
     
-
     
-
     
-
 
Prior
   
8
     
1,065
     
-
     
-
     
8
     
1,065
 
Total
   
12
   
$
1,325
     
-
   
$
-
     
12
   
$
1,325
 



The Company did not enter into any troubled debt restructuring with borrowers during the nine months ended September 30, 2022 and 2021, respectively.
 
20

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued

 

Outstanding loan balances (accruing and non-accruing) categorized by these credit quality indicators are summarized as follows:


   
September 30, 2022
 
(Dollars in thousands)
 
Pass
   
Special
Mention
   
Sub-
standard
   
Doubtful
   
Total Loans
& Leases
   
Total
Allowance
for Credit
Losses
 
Loans and leases held for investment, net
                                   
Real estate:
                                   
Commercial
 
$
1,229,837
   
$
7,320
   
$
1,534
   
$
-
   
$
1,238,691
   
$
16,540
 
Agricultural
   
705,404
     
10,891
     
6,153
     
-
     
722,448
     
16,560
 
Residential and home equity
   
377,021
     
-
     
228
     
-
     
377,249
     
6,865
 
Construction
   
169,624
     
-
     
-
     
-
     
169,624
     
2,995
 
Total real estate
   
2,481,886
     
18,211
     
7,915
     
-
     
2,508,012
     
42,960
 
Commercial & industrial
   
453,832
     
70
     
283
     
-
     
454,185
     
10,392
 
Agricultural
   
253,554
     
6,726
     
16
     
-
     
260,296
     
8,523
 
Commercial leases
   
93,493
     
100
     
-
     
-
     
93,593
     
1,588
 
Consumer and other
   
7,583
     
-
     
193
     
-
     
7,776
     
154
 
Total loans and leases, net
 
$
3,290,348
   
$
25,107
   
$
8,407
   
$
-
   
$
3,323,862
   
$
63,617
 


   
December 31, 2021
 
(Dollars in thousands)
 
Pass
   
Special
Mention
   
Sub-
standard
   
Doubtful
   
Total Loans
& Leases
   
Total
Allowance
for Credit
Losses
 
Loans and leases held for investment, net
                                   
Real estate:
                                   
Commercial
 
$
1,142,175
   
$
6,903
   
$
8,260
   
$
-
   
$
1,157,338
   
$
28,536
 
Agricultural
   
663,157
     
3,292
     
6,381
     
-
     
672,830
     
9,613
 
Residential and home equity
   
350,148
     
-
     
433
     
-
     
350,581
     
2,847
 
Construction
   
177,163
     
-
     
-
     
-
     
177,163
     
1,456
 
Total real estate
   
2,332,643
     
10,195
     
15,074
     
-
     
2,357,912
     
42,452
 
Commercial & industrial
   
417,806
     
9,321
     
672
     
-
     
427,799
     
11,489
 
Agricultural
   
275,206
     
958
     
520
     
-
     
276,684
     
5,465
 
Commercial leases
   
96,415
     
-
     
-
     
-
     
96,415
     
938
 
Consumer and other
   
78,181
     
-
     
186
     
-
     
78,367
     
663
 
Total loans and leases, net
 
$
3,200,251
   
$
20,474
   
$
16,452
   
$
-
   
$
3,237,177
   
$
61,007
 

21

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued

 

The following table represents outstanding loan balances by credit quality indicators and vintage year by class of financing receivable and current period gross charge-offs by year of origination as of September 30, 2022:


   
September 30, 2022
 
   
Term Loans Amortized Cost Basis by Origination Year
             
(Dollars in thousands)
 
2022
   
2021
   
2020
   
2019
   
2018
   
Prior
   
Revolving
Loans
Amortized
Cost
   
Total
 
Net loans and leases held for investment
                                               
Real estate:
                                               
Commercial
                                               
Pass
 
$
140,036
   
$
236,947
   
$
153,480
   
$
72,167
   
$
86,063
   
$
227,146
   
$
313,998
   
$
1,229,837
 
Special mention
   
-
     
-
     
-
     
-
     
3,844
     
-
     
3,476
     
7,320
 
Substandard
   
-
     
-
     
-
     
-
     
-
     
1,534
     
-
     
1,534
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Commercial
 
$
140,036
   
$
236,947
   
$
153,480
   
$
72,167
   
$
89,907
   
$
228,680
   
$
317,474
   
$
1,238,691
 
Commercial
                                                               
Current-period gross charge-offs
  $
-     $
-     $
-     $
-     $
-     $
-     $
-     $
-  
                                                                 
Agricultural
                                                               
Pass
 
$
54,480
   
$
43,117
   
$
56,965
   
$
15,297
   
$
51,194
   
$
151,470
   
$
332,881
   
$
705,404
 
Special mention
   
-
     
-
     
-
     
2,636
     
-
     
-
     
8,255
     
10,891
 
Substandard
   
-
     
-
     
-
     
-
     
119
     
6,034
     
-
     
6,153
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Agricultural
 
$
54,480
   
$
43,117
   
$
56,965
   
$
17,933
   
$
51,313
   
$
157,504
   
$
341,136
   
$
722,448
 
Agricultural
                                                               
Current-period gross charge-offs
  $
-     $
-     $
-     $
-     $
-     $
-     $
-     $
-  
                                                                 
Residential and home equity
                                                               
Pass
 
$
51,888
   
$
97,973
   
$
88,214
   
$
14,851
   
$
6,910
   
$
78,458
   
$
38,727
   
$
377,021
 
Special mention
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Substandard
   
-
     
-
     
-
     
-
     
-
     
144
     
84
     
228
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Residential and home equity
 
$
51,888
   
$
97,973
   
$
88,214
   
$
14,851
   
$
6,910
   
$
78,602
   
$
38,811
   
$
377,249
 
Residential and home equity
                                                               
Current-period gross charge-offs
  $
-     $
-     $
-     $
-     $
-     $
-     $
-     $
-  
                                                                 
Construction
                                                               
Pass
 
$
-
   
$
-
   
$
-
   
$
1,575
   
$
-
   
$
62
   
$
167,987
   
$
169,624
 
Special mention
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Substandard
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total construction
 
$
-
   
$
-
   
$
-
   
$
1,575
   
$
-
   
$
62
   
$
167,987
   
$
169,624
 
Construction
                                                               
Current-period gross charge-offs
  $
-     $
-     $
-     $
-     $
-     $
-     $
-     $
-  
                                                                 
Total Real estate
 
$
246,404
   
$
378,037
   
$
298,659
   
$
106,526
   
$
148,130
   
$
464,848
   
$
865,408
   
$
2,508,012
 
                                                                 
Commercial & industrial
                                                               
Pass
 
$
24,852
   
$
41,476
   
$
13,975
   
$
10,646
   
$
8,774
   
$
6,386
   
$
347,723
   
$
453,832
 
Special mention
   
-
     
69
     
-
     
-
     
-
     
1
     
-
     
70
 
Substandard
   
-
     
-
     
-
     
-
     
6
     
6
     
271
     
283
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Commercial & industrial
 
$
24,852
   
$
41,545
   
$
13,975
   
$
10,646
   
$
8,780
   
$
6,393
   
$
347,994
   
$
454,185
 
Commercial & industrial
                                                               
Current-period gross charge-offs
  $
-     $ -     $
-     $
246     $
78     $
-     $
-     $
324  
                                                                 
Agricultural
                                                               
Pass
 
$
4,387
   
$
3,789
   
$
1,082
   
$
1,617
   
$
731
   
$
2,211
   
$
239,737
   
$
253,554
 
Special mention
   
-
     
-
     
-
     
-
     
-
     
7
     
6,719
     
6,726
 
Substandard
   
-
     
-
     
-
     
13
     
3
     
-
     
-
     
16
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Agricultural
 
$
4,387
   
$
3,789
   
$
1,082
   
$
1,630
   
$
734
   
$
2,218
   
$
246,456
   
$
260,296
 
Agricultural
                                                               
Current-period gross charge-offs
  $
-     $
-     $
-     $
-     $
-     $
-     $
-     $
-  
                                                                 
Commercial leases
                                                               
Pass
 
$
11,541
   
$
16,541
   
$
13,664
   
$
7,643
   
$
21,387
   
$
22,717
   
$
-
   
$
93,493
 
Special mention
   
-
     
-
     
-
     
100
     
-
     
-
     
-
     
100
 
Substandard
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Commercial leases
 
$
11,541
   
$
16,541
   
$
13,664
   
$
7,743
   
$
21,387
   
$
22,717
   
$
-
   
$
93,593
 
Commercial leases
                                                               
Current-period gross charge-offs
  $
-     $ -     $
-     $
-     $
-     $
-     $
-     $
-  
                                                                 
Consumer and other
                                                               
Pass
 
$
965
   
$
2,463
   
$
359
   
$
235
   
$
386
   
$
2,481
   
$
694
   
$
7,583
 
Special mention
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Substandard
   
193
     
-
     
-
     
-
     
-
     
-
     
-
     
193
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total Consumer and other
 
$
1,158
   
$
2,463
   
$
359
   
$
235
   
$
386
   
$
2,481
   
$
694
   
$
7,776
 
Consumer and other
                                                               
Current-period gross charge-offs
  $
25     $
5     $
4     $
1     $
3     $
-     $
-     $
38  
                                                                 
Total net loans and leases
 
$
288,342
   
$
442,375
   
$
327,739
   
$
126,780
   
$
179,417
   
$
498,657
   
$
1,460,552
   
$
3,323,862
 

22

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued

 

The following tables provide amortized cost basis for collateral dependent loans as of September 30, 2022 and December 31, 2021, respectively:


   
September 30, 2022
 
(Dollars in thousands)
 
Real Estate
   
Vehicles
and
Equipment
   
Total
 
Collateral dependent loans and leases
                 
Real estate:
                 
Commercial
 
$
1,124
   
$
-
   
$
1,124
 
Agricultural
   
11,944
     
-
     
11,944
 
Residential and home equity
   
2,002
     
-
     
2,002
 
Construction
   
-
     
-
     
-
 
Total Real estate
   
15,070
     
-
     
15,070
 
Commercial & industrial
   
-
     
-
     
-
 
Agricultural
   
-
     
16
     
16
 
Commercial leases
   
-
     
-
     
-
 
Consumer and other
   
-
     
161
     
161
 
Total gross loans and leases
 
$
15,070
   
$
177
   
$
15,247
 


   
December 31, 2021
 
(Dollars in thousands)
 
Real Estate
   
Vehicles
and
Equipment
   
Total
 
Collateral dependent loans and leases
                 
Real estate:
                 
Commercial
 
$
5
   
$
-
   
$
5
 
Agricultural
   
5,587
     
-
     
5,587
 
Residential and home equity
   
330
     
-
     
330
 
Construction
   
-
     
-
     
-
 
Total Real estate
   
5,922
     
-
     
5,922
 
Commercial & industrial
   
-
     
-
     
-
 
Agricultural
   
-
     
-
     
-
 
Commercial leases
   
-
     
-
     
-
 
Consumer and other
   
-
     
173
     
173
 
Total gross loans and leases
 
$
5,922
   
$
173
   
$
6,095
 

23

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 4—Loans and Leases—Continued

 

Changes in the allowance for credit losses are as follows:


   
For the three Months Ended September 30, 2022
 
(Dollars in thousands)
 
Commercial &
Agricultural
R/E
   
Construction
   
Residential &
Home Equity
   
Commercial
&
Agricultural
   
Commercial
Leases
   
Consumer
& Other
   
Total
 
Allowance for credit losses:
                                         
Beginning balance
  $ 34,716     $ 2,876     $ 6,874     $ 15,808     $ 1,645     $ 161     $ 62,080  
Provision / (recapture) for credit losses
    (1,616 )     119       (15 )     3,063       (57 )     5       1,499  
Charge-offs
    -       -       -       (48 )     -       (20 )     (68 )
Recoveries
    -       -       6       92       -       8       106  
Net (charge-offs) / recoveries
    -       -       6       44       -       (12 )     38  
Ending balance
  $ 33,100     $ 2,995     $ 6,865     $ 18,915     $ 1,588     $ 154     $ 63,617  



   
For the Nine Months Ended September 30, 2022
 
(Dollars in thousands)
 
Commercial &
Agricultural
R/E
   
Construction
   
Residential &
Home Equity
   
Commercial
&
Agricultural
   
Commercial
Leases
   
Consumer
& Other
   
Total
 
Allowance for credit losses:
                                         
Beginning balance
  $ 38,149     $ 1,456     $ 2,847     $ 16,954     $ 938    
$
663
   
$
61,007
 
Impact of Adopting ASC 326
    -       -       -       -       -       -       -  
Provision / (recapture) for credit losses
    (5,049 )     1,539       3,893       2,058       650       (485 )    
2,606
 
Charge-offs
    -       -       -       (324 )     -       (38 )    
(362
)
Recoveries
    -       -       125       227       -       14      
366
 
Net (charge-offs) / recoveries
    -       -       125       (97 )     -       (24 )    
4
 
Ending balance
  $ 33,100     $ 2,995     $ 6,865     $ 18,915     $ 1,588     $ 154     $ 63,617  


Note 5—Deposits



Certificates of deposit greater than and less than or equal to the FDIC insurance limit are summarized as follows:


(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Certificates of deposit:
           
Certificates of deposit less than or equal to $250,000
 
$
208,242
   
$
223,620
 
Certificates of deposit greater than $250,000
   
152,142
     
168,865
 
Total certificates of  deposit
 
$
360,384
   
$
392,485
 



Scheduled maturities for certificates of deposit are as follows:


(Dollars in thousands)
 
Amount
 
2022
 
$
107,966
 
2023
   
224,552
 
2024
   
22,362
 
2025
   
2,783
 
2026 and beyond
   
2,721
 
Total certificates of  deposit
 
$
360,384
 

24

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)

Note 6—Shareholders’ Equity


The Company and the Bank are subject to various regulatory capital adequacy guidelines as outlined under Part 324 of the FDIC Rules and Regulations. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company 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 Company believes that it is currently in compliance with all of these capital requirements and that they will not result in any restrictions on the Company’s business activity.



Management believes that the Bank meets the requirements to be categorized as “well capitalized” under the FDIC regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables.



The Company’s and Bank’s actual and required capital amounts and ratios are as follows: 


   
September 30, 2022
 
   
Actual
   
Minimum to be
Categorized as
“Adequately Capitalized”
   
Minimum to be
Categorized as
“Well Capitalized”
 
(Dollars in thousands)
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
Farmers & Merchants Bancorp
                                   
CET1 capital to risk-weighted assets
 
$
482,053
     
11.82
%
 
$
183,537
     
4.50
%
   
N/A
     
N/A
 
Tier 1 capital to risk-weighted assets
   
492,053
     
12.06
%
   
244,716
     
6.00
%
   
N/A
     
N/A
 
Risk-based capital to risk-weighted assets
   
543,218
     
13.32
%
   
326,288
     
8.00
%
   
N/A
     
N/A
 
Tier 1 leverage capital ratio
   
492,053
     
9.12
%
   
215,702
     
4.00
%
   
N/A
     
N/A
 
                                                 
Farmers & Merchants Bank
                                               
CET1 capital to risk-weighted assets
 
$
491,237
     
12.04
%
 
$
183,531
     
4.50
%
 
$
265,101
     
6.50
%
Tier 1 capital to risk-weighted assets
   
491,237
     
12.04
%
   
244,708
     
6.00
%
   
326,278
     
8.00
%
Risk-based capital to risk-weighted assets
   
542,400
     
13.30
%
   
326,278
     
8.00
%
   
407,847
     
10.00
%
Tier 1 leverage capital ratio
   
491,237
     
9.12
%
   
215,498
     
4.00
%
   
269,372
     
5.00
%

25

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 6—Shareholders’ Equity—Continued


   
December 31, 2021
 
   
Actual
   
Minimum to be
Categorized as
“Adequately Capitalized”
   
Minimum to be
Categorized as
“Well Capitalized”
 
(Dollars in thousands)
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
Farmers & Merchants Bancorp
                                   
CET1 capital to risk-weighted assets
 
$
450,687
     
11.68
%
 
$
173,674
     
4.50
%
   
N/A
     
N/A
 
Tier 1 capital to risk-weighted assets
   
460,687
     
11.94
%
   
231,566
     
6.00
%
   
N/A
     
N/A
 
Risk-based capital to risk-weighted assets
   
509,091
     
13.19
%
   
308,755
     
8.00
%
   
N/A
     
N/A
 
Tier 1 leverage capital ratio
   
460,687
     
8.92
%
   
206,606
     
4.00
%
   
N/A
     
N/A
 
                                                 
Farmers & Merchants Bank
                                               
CET1 capital to risk-weighted assets
 
$
459,813
     
11.91
%
 
$
173,664
     
4.50
%
 
$
250,847
     
6.50
%
Tier 1 capital to risk-weighted assets
   
459,813
     
11.91
%
   
231,551
     
6.00
%
   
308,735
     
8.00
%
Risk-based capital to risk-weighted assets
   
508,215
     
13.17
%
   
308,735
     
8.00
%
   
385,919
     
10.00
%
Tier 1 leverage capital ratio
   
459,813
     
8.91
%
   
206,426
     
4.00
%
   
258,033
     
5.00
%
 
Basic and diluted earnings per common share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period.



Earnings per common share have been computed based on the following:

   
Three Months Ended
September 30,
 
(Dollars in thousands, except share and per share amounts)
 
2022
   
2021
 
Numerator
           
Net income
 
$
19,536
   
$
17,502
 

               
Denominator                
Weighted average number of common shares outstanding
   
775,109
     
789,646
 
Weighted average number of dilutive shares outstanding
   
775,109
     
789,646
 
                 
Basic earnings per common share
 
$
25.20
   
$
22.16
 
Diluted earnings per common share
 
$
25.20
   
$
22.16
 

   
Nine Months Ended
September 30,
 
(Dollars in thousands, except share and per share amounts)
 
2022
   
2021
 
Numerator
           
Net income
 
$
55,037
   
$
50,368
 
                 
Denominator
               
Weighted average number of common shares outstanding
   
780,988
     
789,646
 
Weighted average number of dilutive shares outstanding
   
780,988
     
789,646
 
                 
Basic earnings per common share
 
$
70.47
   
$
63.79
 
Diluted earnings per common share
 
$
70.47
   
$
63.79
 

On November 15, 2021, the Board of Directors reauthorized the Company’s share repurchase program for up to $20.0 million of the Company’s common stock (“Repurchase Plan”), representing approximately 4% of outstanding shareholders’ equity. Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means.

During the first nine months of 2022 the Company repurchased 18,824 shares under the Repurchase Plan, for a total of $17.9 million.

26

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 7—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. 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 that value. 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 all loans and leases at fair value on a recurring basis. However, from time to time, a loan or lease is considered collateral dependent and an allowance for credit losses is established. Once a loan or lease is identified as collaterally dependent, management measures impairment in accordance with the “Receivable” topic of the FASB ASC. The fair value of collateral dependent 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. Collateral dependent loans and leases not requiring an allowance represent loans and leases for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans and leases. Collateral dependent loans and 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 loans is generally based on recent real estate appraisals.
27

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 7—Fair Value Measurements—Continued

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 collateral dependent loans is primarily the sales comparison approach less selling costs of 10%.

OREO 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 in to 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 OREO is primarily the sales comparison approach less selling costs of 10%.

The following tables summarize the carrying value and estimated fair values of the Company’s financial assets and liabilities 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.

September 30, 2022
       
Fair Value
 
(Dollars in thousands)
 
Carrying
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total Fair
Value
 
Financial Assets:
                             
Cash and cash equivalents
 
$
882,883
   
$
882,883
   
$
-
   
$
-
   
$
882,883
 
Investment securities available-for-sale
   
177,454
     
4,941
     
172,513
     
-
     
177,454
 
Investment securities held-to-maturity
   
852,272
     
-
     
663,285
     
42,416
     
705,701
 
Non-marketable securities
   
15,549
     
-
     
-
     
15,549
     
15,549
 
Loans and leases, net
   
3,260,245
     
-
     
-
     
3,203,611
     
3,203,611
 
Bank-owned life insurance
   
72,566
     
72,566
     
-
     
-
     
72,566
 
                                         
Financial Liabilities:
                                       
Total deposits
  $
4,909,257
   
$
-
   
$
4,548,873
   
$
352,319
   
$
4,901,192
 
Subordinated debentures
   
10,310
     
-
     
9,707
     
-
     
9,707
 

December 31, 2021
       
Fair Value
 
(Dollars in thousands)
 
Carrying
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total Fair
Value
 
Financial Assets:
                             
Cash and cash equivalents
 
$
715,460
   
$
715,460
   
$
-
   
$
-
   
$
715,460
 
Investment securities available-for-sale
   
270,454
     
10,214
     
260,240
     
-
     
270,454
 
Investment securities held-to-maturity
   
737,052
     
-
     
681,588
     
44,446
     
726,034
 
Non-marketable securities
   
15,549
     
-
     
-
     
15,549
     
15,549
 
Loans and leases, net
   
3,176,170
     
-
     
-
     
3,179,857
     
3,179,857
 
Bank-owned life insurance
   
71,411
     
71,411
     
-
     
-
     
71,411
 
                                         
Financial Liabilities:
                                       
Total deposits
 
$
4,640,152
   
$
-
   
$
4,247,666
   
$
391,732
   
$
4,639,398
 
Subordinated debentures
   
10,310
     
-
     
6,890
     
-
     
6,890
 

28

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)
Note 7—Fair Value Measurements—Continued

Non-recurring Measurements: collateral dependent loans and OREO are classified with Level 3 of the fair value hierarchy. The estimated fair value of collateral dependent loans is based on the fair value of the collateral, less estimated costs to sell. The Company receives an appraisal or performs an evaluation for each collateral dependent loan. The key inputs used to determine the fair value of collateral dependent loans include selling costs, and adjustment to comparable collateral. Valuations and significant inputs obtained by independent sources are reviewed by the Company for accuracy and reasonableness. Appraisals are typically obtained at least on an annual basis. The Company also considers other factors and events that may affect the fair value. The appraisals or evaluations are reviewed at least on a quarterly basis to determine if any adjustments are needed. After review and acceptance of the appraisal or evaluation, adjustments to collateral dependent loans may occur.

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

September 30, 2022
       
Fair Value
 
(Dollars in thousands)
 
Carrying
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total Fair
Value
 
Fair valued on a recurring basis:
                             
Investment securities available-for-sale
                             
U.S. Treasury notes
 
$
4,941
   
$
4,941
   
$
-
   
$
-
   
$
4,941
 
U.S. Government-sponsored securities
   
4,698
     
-
     
4,698
     
-
     
4,698
 
Mortgage-backed securities
   
156,453
     
-
     
156,453
     
-
     
156,453
 
Collateralized mortgage obligations
   
1,458
     
-
     
1,458
     
-
     
1,458
 
Corporate securities
   
9,594
     
-
     
9,594
     
-
     
9,594
 
Other
   
310
     
-
     
310
     
-
     
310
 
                                         
Fair valued on a non-recurring basis:
                                       
Other real estate
  $
873
    $
-
    $
-
    $
873
    $
873
 

December 31, 2021         Fair Value  
(Dollars in thousands)
 
Carrying
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total Fair
Value
 
Fair valued on a recurring basis:
                             
Investment securities available-for-sale
                             
U.S. Treasury notes
 
$
10,089
   
$
10,089
   
$
-
   
$
-
   
$
10,089
 
U.S. Government-sponsored securities
   
6,374
     
-
     
6,374
     
-
     
6,374
 
Mortgage-backed securities
   
251,120
     
-
     
251,120
     
-
     
251,120
 
Collateralized mortgage obligations
   
2,436
     
-
     
2,436
     
-
     
2,436
 
Other
   
435
     
125
     
310
     
-
     
435
 
                                         
Fair valued on a non-recurring basis:
                                       
Individually evaluated loans
 
$
2,562
   
$
-
   
$
-
   
$
2,562
   
$
2,562
 
Other real estate
   
873
     
-
     
-
     
873
     
873
 

29

FARMERS & MERCHANTS BANCORP
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (CONTINUED)

Note 8—Commitments and Contingencies



In the normal course of business, the Company enters into financial instruments with off balance sheet risk in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These instruments include 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.


(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Commitments to extend credit, including unsecured commitments of $20,552 and $21,036 as of September 30, 2022 and  December 31, 2021, respectively
 
$
1,128,340
   
$
937,009
 
Stand-by letters of credit, including unsecured commitments of $7,352 and $9,091 as of September 30, 2022 and December 31, 2021, respectively
   
16,629
     
17,880
 
Performance guarantees under interest rate swap contracts entered into with our clients and third-parties
   
-
     
1,433
 



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. Outstanding standby letters of credit have maturity dates ranging from 1 to 60 months with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.



In the ordinary course of business, the Company becomes involved in litigation arising out of its normal business activities. Management, after consultation with legal counsel, believes that the ultimate liability, if any, resulting from the disposition of such claims would not be material in relation to the financial position of the Company.



The Company may be required to maintain average reserves on deposit with the Federal Reserve Bank primarily based on deposits outstanding. Reserve requirements are offset by the Company’s vault cash and deposit balances maintained with the Federal Reserve Bank.

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

The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition than can be obtained from reading the Unaudited Consolidated Financial Statements alone. The discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and the notes thereto included in “Part I. Item 1. Financial Statements.”

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10–Q may contain certain forward-looking statements within the meaning of Section 27A the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements reflect the Company’s current views and are not historical facts. These statements can generally be identified by use of phrases such as “believe,” “expect,” “will,” “seek,” “should,” “anticipate,” “estimate,” “intend,” “plan,” “target,” “project,” “commit” or other words of similar import. Similarly, statements that describe the Company’s future financial condition, results of operations, objectives, strategies, plans, goals or future performance and business are also forward-looking statements. Statements that project future financial conditions, results of operations, and shareholder value are not guarantees of performance and many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve known and unknown risks, uncertainties and other factors, including, but not limited to, those described in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 (“Form 10-K”), and other parts of this report that could cause actual results to differ materially from those anticipated in these forward-looking statements. The following is a non-exclusive list of factors which could cause actual results to differ materially from forward-looking statements in this Quarterly Report on Form 10-Q:

the pendency, duration, and impact of the COVID-19 pandemic;
changes in general economic conditions, either nationally, in California, or in our local markets;
inflation, changes in interest rates, securities market volatility and monetary fluctuations;
increases in competitive pressures among financial institutions and businesses offering similar products and services;
higher defaults in our loan portfolio than we expect;
changes in management’s estimate of the adequacy of the allowance for credit losses;
risks associated with our growth and expansion strategy and related costs;
increased lending risks associated with our high concentration of real estate loans;
legislative or regulatory changes or changes in accounting principles, policies or guidelines;
technological changes; and
regulatory or judicial proceedings.

Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed.

Please take into account that forward-looking statements speak only as of the date of this Form 10-Q. The Company does not undertake any obligation to release publicly revisions to such forward-looking statements to reflect events or circumstances after the date of this Form 10-Q, except as required by law.

Overview

Farmers & Merchants Bancorp is a Delaware registered bank holding company organized in 1999. As a registered bank holding company, FMCB is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (“FRB”) and by the California Department of Financial Protection and Innovation (“DFPI”). The Company’s principal business is to serve as a holding company for the Bank and for other banking or banking related subsidiaries, which the Company may establish or acquire. As a legal entity separate and distinct from its subsidiary, the Company’s principal source of funds is, and will continue to be, dividends paid by and other funds received from the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company.

The Company’s outstanding common stock as of September 30, 2022, consisted of 770,822 shares of common stock, $0.01 par value and no shares of preferred stock were issued or outstanding. 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.”

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. Since 2002, the Company has converted all of its daily operating and image advertising to the “F & M Bank” name and the Company’s logo, slogan and signage were redesigned to incorporate the trade name, “F & M Bank”.

The primary source of funding for the Company’s asset growth has been the generation of core deposits, which the Company raises through its existing branch locations, newly opened branch locations, or through acquisitions. Recent loan growth is the result of organic growth generated by the Company’s seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to the Company’s clients.

The Company’s results of operations are largely dependent on net interest income. Net interest income is the difference between interest income earned on interest earning assets, which are comprised of loans, investment securities and short-term investments, and the interest the Company pays on interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings. Management strives to match the re-pricing characteristics of the interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve.

The Company measures its performance by calculating the net interest margin, return on average assets, and return on average equity. Net interest margin is calculated by dividing net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets. Net interest income is the Company’s largest source of revenue. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. The Company also measures its performance by the efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income and non-interest income.

Summary of Critical Accounting Policies and Estimates

In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Income, Comprehensive Income, Changes in Shareholders’ Equity and Cash Flows reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements.

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified certain accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements.
 
Management believes the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Further, subsequent changes in economic or market conditions could have a material impact on these estimates and our financial condition and operating results in future periods. For additional information concerning critical accounting policies, see the Selected Notes to the Consolidated Financial Statements and the following:

Use of Estimates — The preparation of our financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances and the actual results may differ from these estimates under different assumptions. The allowance for credit losses, deferred income taxes, and fair values of financial instruments are estimates, which are particularly subject to change.

Allowance for Credit Losses Loans  The methodology for determining the allowance for credit losses (“ACL”) on loans is considered a critical accounting policy by Management because of the high degree of judgment involved. The subjectivity of the assumptions used and the potential for changes in the economic environment could result in changes to the amount of the recorded ACL. Among the material estimates required to establish the ACL are: (i) a reasonable and supportable forecast; (ii) a reasonable and supportable forecast period and the reversion period; (iii) value of collateral; strength of guarantors; (iv) the amount and timing of future cash flows for loans individually evaluated; and (v) the determination of the qualitative loss factors. All of these estimates are susceptible to significant change.

The Company has established systematic methodologies for the determination of the adequacy of the ACL. The methodologies are set forth in a formal policy and take into consideration the need for a valuation allowance for loans evaluated on a collective (pool) basis, which have similar risk characteristics as well as allowances to individual loans that do not share risk characteristics.

The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. The provision for credit losses reflects the amount required to maintain the ACL at an appropriate level based upon management’s evaluation of the adequacy of loss reserves. The Company increases its ACL by charging provisions for credit losses on its consolidated statement of income. Losses related to specific assets are applied as a reduction of the carrying value of the assets and charged against the ACL when management believes a loan balance is uncollectable. Recoveries on previously charged off loans are credited to the ACL.

Management estimates the ACL using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience, either internal or peer information, provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made, using qualitative factors, when management expects current conditions and reasonable and supportable forecasts to differ from the conditions that existed for the period over which historical information was evaluated. The ACL is maintained at a level sufficient to provide for expected credit losses over the life of the loan based on evaluating historical credit loss experience and making adjustments to historical loss information for differences in the specific risk characteristics in the current loan portfolio. These factors include, among others, changes in the size and composition of the loan portfolio, differences in underwriting standards, delinquency rates, actual loss experience and current economic conditions.

On January 1, 2022, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology that delays recognition until it is probable a loss has been incurred with an expected loss methodology that is referred to as CECL. Both the Financial Accounting Standards Board (“FASB Staff Q&A Topic 326, No. 1”) and the federal financial institution regulatory agencies (“Financial Institution Letter FIL-17-2019”), along with the Securities and Exchange Commission, have confirmed that smaller, less complex organizations are not required to implement complex models, developed by outside vendors to calculate current expected credit losses. Accordingly, in adopting ASU 2016-13 (Topic 326) Management determined that the Weighted Average Remaining Maturity (“WARM”) method was most appropriate given the Company’s current size and complexity.

Management will incorporate reasonable and supportable information in order to calculate CECL reserves. This includes the ability to reliably forecast and document exogenous events that may affect the credit performance of the Company’s loan portfolio. Management is confident with its ability to effectively identify historical loss information by the appropriate portfolio segmentation.  In addition, Management believes that it can reasonably obtain historical loss information by its respective peers to further improve historical loss information. Additionally, the Company believes that it can effectively evaluate the potential impact that both macro and micro-economic conditions can have on its loan portfolio. Management is also comfortable that it can rely on weighted average maturity calculations, including estimated prepayments with its existing third party Asset/Liability Management (“ALM”) applications.

Management determined that the most effective approach to segment its portfolio and to extract the relevant information it needed to calculate its CECL reserves was to utilize the seventeen loan segments used in preparing regulatory Call Reports. This allows Management the ability to obtain historical loss information for itself as well as its peer group. Additionally, Management’s ALM application also utilizes a similar loan segmentation in calculating weighted average remaining terms.

The foundation of CECL modeling is the ability to estimate expected credit losses over the lifetime of a loan. Management must use relevant available information about past events (e.g. historical losses) current conditions, and reasonable and supportable forecasts about future conditions. Historical losses serve as the starting point to estimate expected credit losses. When available, historical losses should include cumulative actual losses incurred over the lifetime of the various loan segments of the loans being evaluated. In cases where such information is not available, companies may need to rely on external data, such as peer data of historical losses for similar loan segments.

Management has determined to use a “through-the-cycle” historical credit loss experience as its baseline for historical credit losses. Management has determined a representative period for a full credit cycle would be from 2008 to 2022 (fifteen-year credit cycle). Management has collected historical loss information on its own loan portfolio as well as peer group information by the seventeen loan segments over this time horizon using information available from Federal Regulators on the Uniform Bank Performance Report (“UBPR”).

Federal Regulators have placed the Company into a peer group of banks with assets between $3 billion to $10 billion. This peer group segmentation includes 181 banks across the nation. The model calculates the mean historical loss rate over the fifteen year economic cycle for both the Bank and its peer group. The model calculates the stressed historical loss rate over the fifteen year economic cycle for both the Bank and its peer group.

Management evaluates macro and micro economic information as well as internal trends in credit performance on the Company’s loan portfolio to determine where they believe it is in an economic credit cycle. Depending upon estimations of what point in the credit cycle the current economy may exist, management adjust, on a quantitative basis, historical loss rates either upwards or downwards from the mean. If Management believes we are nearing the end on a credit cycle, the Company may adjust historical losses in increments higher from the mean (e.g. one standard deviation from the mean). If the Company believes that we are in the recovery stage of a credit cycle, it may adjust historical losses downwards from the mean. Management understands that historical credit losses may not exactly follow a normal bell-shaped curve, but that the approach provides consistency across all loan segments as well as a measured probability of credit loss coverage.

Management evaluated current economic metrics as its basis to determine that we believe that we are at the beginning of an economic recession. Based on this determination, management has used a one-standard deviation from the mean to capture 68.2% of all credit losses over the 15-year economic cycle.

Management used the duration of each loan segment to estimate the remaining life of loans to ensure that the model covers credit losses over the expect life of such loans.

Management will continue to employ the use of qualitative factors as defined by the Interagency Policy Statement on the Allowance for Loan and Lease Losses (“SR 2006-17”). Management will consider qualitative or environmental factors that are likely to cause estimated credit losses associated with our existing portfolio to differ from historical loss experience, as defined in the Interagency Guidance, including but not limited to:


Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses.
 

Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments.
 

Changes in the nature and volume of the portfolio and in the terms of loans.
 

Changes in the experience, ability, and depth of lending management and other relevant staff.
 

Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans.
 

Changes in the quality of the institution’s loan review system.
 

Changes in the value of underlying collateral for collateral-dependent loans.
 

The existence and effect of any concentrations of credit, and changes in the level of such concentrations.
 

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio.
 
These qualitative factors are applied primarily to our agriculture and agricultural real estate loan exposure.

Investment Securities — Investment securities are classified as held-to-maturity (“HTM”) when the Company has the positive intent and ability to hold the securities to maturity.  Investment securities are classified as available-for-sale (“AFS”) when the Company has the intent of holding the security for an indefinite period of time, but not necessarily to maturity. The Company determines the appropriate classification at the time of purchase, and periodically thereafter. Investment securities classified at HTM are carried at amortized cost. Investment securities classified at AFS are reported at fair value. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Debt securities classified as held-to-maturity are carried at cost, net of the allowance for credit losses - securities, adjusted for amortization of premiums and discounts to the earliest callable date. Debt securities classified as available-for-sale are measured at fair value. Unrealized holding gains and losses on debt securities classified as available-for-sale are excluded from earnings and are reported net of tax as accumulated other comprehensive income (AOCI), a component of shareholders’ equity, until realized. When AFS securities, specifically identified, are sold, the unrealized gain or loss is reclassified from AOCI to non-interest income.

Allowance for Credit Losses – Securities — Management measures expected credit losses on held-to-maturity debt securities on a collective basis by major security type. The Company’s HTM portfolio contains securities issued by U.S. government entities and agencies and municipalities. The Company uses industry historical credit loss information adjusted for current conditions to establish the allowance for credit losses on its HTM municipal bond portfolio.

For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or it is more likely than not that, the Company will be required to sell the security before recovering its cost basis; the entire impairment loss would be recognized in earnings. If the Company does not intend to sell the security and it is not more likely than not that, the Company will be required to sell the security the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized costs, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. Projected cash flows are discounted by the current effective interest rate. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to AOCI.

Changes in the allowance for credit losses-securities are recorded as provision for (or reversal of) credit losses. Losses are charged against the allowance when management believes the non-collectability of an available-for-sale security is confirmed or when either criteria regarding intent of requirement to sell is met.

Goodwill — Goodwill represents the excess of the purchase considerations paid over the fair value of the assets acquired, net of the fair values of liabilities assumed in a business combination it is not amortized but is reviewed annually, or more frequently as current circumstances and conditions warrant, for impairment. An assessment of qualitative factors is completed to determine if it is more likely than not that, the fair value of a reporting unit is less than its carrying amount. If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The quantitative goodwill impairment compares the reporting unit's estimated fair values, including goodwill, to its carrying amount. If the carrying amount exceeds its reporting unit’s fair value, then an impairment loss would be recognized as a charge to earnings, but is limited by the amount of goodwill allocated to that reporting unit.

Other Intangible Assets — Other intangible assets consists primarily of core deposit intangibles (“CDI”), which are amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the client relationships associated with the deposits. Core deposit intangibles are amortized over the estimated useful lives of such deposits. These assets are reviewed at least annually for events or circumstances that could affect their recoverability. These events could include loss of the underlying core deposits, increased competition or adverse changes in the economy. The amortization of our CDI is recorded in other non-interest expense. To the extent other identifiable intangible assets are deemed unrecoverable; impairment losses are recorded in other non-interest expense to reduce the carrying amount of the assets.

Fair Value Measurements — The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values. The Company, using available market information and appropriate valuation methodologies has determined the estimated fair value amounts. 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 between origination of the instrument and its expected realization.

Income Taxes — Income taxes are filed on a consolidated basis with our subsidiaries and allocate income tax expense (benefit) based on each entity’s proportionate share of the consolidated provision for income taxes. Deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their respective tax bases.

Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The determination of the amount of deferred income tax assets, that are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred income tax asset will not be realized. “More likely than not” is defined as greater than a 50% probability. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed.

Only tax positions that meet the more likely than not recognition threshold are recognized. The benefit of a tax position is recognized in the 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 sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest expense and penalties associated with unrecognized tax benefits are classified as income tax expense in the consolidated statements of income.

Impact of Recently Issued Accounting Standards

See Note 1. “Basis of Presentation and Significant Accounting Policies” to the Consolidated Financial Statements in “Item 1. Financial Information” in this Quarterly Report on Form 10-Q.

Results of Operations

The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ financial condition at September 30, 2022 and December 31, 2021 and results of operations during the three and nine months ended September 30, 2022 and 2021, respectively. Information related to the comparison of the results of operations for the three years ended December 31, 2021, 2020, and 2019 can be found in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022.

Factors that determine the level of net income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, fee income, non-interest expense, the level of non-performing loans and other non-earning assets, and the amount of non-interest bearing liabilities supporting earning assets. Non-interest income includes card processing fees, service charges on deposit accounts, bank-owned life insurance income, gains/losses on the sale of investment securities, and gains/losses on deferred compensation investments. Non-interest expense consists primarily of salaries and employee benefits, cost of deferred compensation benefits, occupancy, data processing, FDIC insurance, marketing, legal and other expenses.

Average Balance and Yields. The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield, cost and net interest margin information for the periods presented. Average balances are derived from daily balances.

 
 
For the Three Months Ended September 30,
 
 
 
2022
   
2021
 
(Dollars in thousands)
 
Average
Balance
   
Interest
Income /
Expense
   
Average
Yield /
Rate
   
Average
Balance
   
Interest
Income /
Expense
   
Average
Yield /
Rate
 
ASSETS
                                   
Interest earnings deposits in other banks and federal funds sold
 
$
718,794
   
$
4,159
     
2.30
%
 
$
856,159
   
$
328
     
0.15
%
Securities:(1)
                                               
Taxable securities
   
1,063,166
     
5,091
     
1.92
%
   
786,983
     
3,282
     
1.67
%
Non-taxable securities(2)
   
47,005
     
386
     
3.28
%
   
49,616
     
399
     
3.22
%
Total investment securities
   
1,110,171
     
5,477
     
1.96
%
   
836,599
     
3,681
     
1.76
%
Loans:(3)
                                               
Real estate:
                                               
Commercial
   
1,224,689
     
15,179
     
4.92
%
   
1,046,626
     
11,255
     
4.27
%
Agricultural
   
715,286
     
9,243
     
5.13
%
   
640,330
     
8,301
     
5.14
%
Residential and home equity
   
375,699
     
3,836
     
4.05
%
   
338,520
     
3,858
     
4.52
%
Construction
   
164,664
     
2,468
     
5.95
%
   
175,906
     
2,300
     
5.19
%
Total real estate
   
2,480,338
     
30,726
     
4.91
%
   
2,201,382
     
25,714
     
4.63
%
Commercial & industrial
   
438,761
     
5,770
     
5.22
%
   
374,162
     
4,111
     
4.36
%
Agricultural
   
259,345
     
3,607
     
5.52
%
   
236,071
     
2,637
     
4.43
%
Commercial leases
   
93,051
     
1,365
     
5.82
%
   
96,690
     
1,363
     
5.59
%
Consumer and other
   
8,929
     
400
     
17.77
%
   
155,182
     
2,263
     
5.79
%
Total loans and leases
   
3,280,424
     
41,868
     
5.06
%
   
3,063,487
     
36,088
     
4.67
%
Non-marketable securities
   
15,549
     
209
     
5.33
%
   
15,549
     
244
     
6.23
%
Total interest earning assets
   
5,124,938
     
51,713
     
4.00
%
   
4,771,794
     
40,341
     
3.35
%
Allowance for credit losses
   
(63,107
)
                   
(60,268
)
               
Non-interest earning assets
   
318,078
                     
324,057
                 
Total average assets
 
$
5,379,909
                   
$
5,035,583
                 
                                                 
LIABILITIES AND SHAREHOLDERS' EQUITY
                                               
Interest bearing deposits:
                                               
Demand
 
$
1,101,830
     
445
     
0.16
%
 
$
1,068,707
     
293
     
0.11
%
Savings and money market accounts
   
1,588,234
     
476
     
0.12
%
   
1,385,430
     
346
     
0.10
%
Certificates of deposit greater than $250,000
   
156,110
     
96
     
0.24
%
   
168,714
     
143
     
0.34
%
Certificates of deposit less than $250,000
   
212,036
     
105
     
0.20
%
   
230,532
     
147
     
0.25
%
Total interest bearing deposits
   
3,058,210
     
1,122
     
0.15
%
   
2,853,383
     
929
     
0.13
%
Short-term borrowings
   
-
     
-
     
0.00
%
   
-
     
-
     
0.00
%
Subordinated debentures
   
10,310
     
134
     
5.16
%
   
10,310
     
78
     
3.00
%
Total interest bearing liabilities
   
3,068,520
     
1,256
     
0.16
%
   
2,863,693
     
1,007
     
0.14
%
Non-interest bearing deposits
   
1,764,266
                     
1,655,738
                 
Total funding
   
4,832,786
     
1,256
     
0.10
%
   
4,519,431
     
1,007
     
0.09
%
Other non-interest bearing liabilities
   
77,389
                     
68,564
                 
Shareholders' equity
   
469,734
                     
447,588
                 
Total average liabilities and shareholders' equity
 
$
5,379,909
                   
$
5,035,583
                 
                                                 
Net interest income
         
$
50,457
                   
$
39,334
         
Interest rate spread
                   
3.84
%
                   
3.21
%
Net interest margin(4)
                   
3.95
%
                   
3.26
%

(1)Excludes average unrealized (losses) gains of ($28.5) million and $2 million for the three months ended September 30, 2022, and 2021, respectively, which are included in non-interest earning assets.
(2)The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $102,000 and $104,000 for the three months ended September 30, 2022, and 2021, respectively.
(3)Loan interest income includes loan fees of $2.6 million and $3.5 million for the three months ended September 30, 2022 and 2021, respectively.
(4)Net interest margin is computed by dividing net interest income by average interest earning assets.

 
 
For the Nine Months Ended September 30,
 
 
 
2022
   
2021
 
(Dollars in thousands)
 
Average
Balance
   
Interest
Income /
Expense
   
Average
Yield / Rate
   
Average
Balance
   
Interest
Income /
Expense
   
Average
Yield / Rate
 
ASSETS
                                   
Interest earnings deposits in other banks and federal funds sold
 
$
720,692
   
$
5,934
     
1.10
%
 
$
620,757
   
$
595
     
0.13
%
Securities:(1)
                                               
Taxable securities
   
1,058,859
     
14,786
     
1.86
%
   
819,747
     
10,780
     
1.75
%
Non-taxable securities(2)
   
48,436
     
1,179
     
3.25
%
   
52,816
     
1,238
     
3.13
%
Total investment securities
   
1,107,295
     
15,965
     
1.92
%
   
872,563
     
12,018
     
1.84
%
Loans:(3)
                                               
Real estate:
                                               
Commercial
   
1,178,731
     
41,986
     
4.76
%
   
1,005,970
     
36,602
     
4.86
%
Agricultural
   
699,205
     
25,545
     
4.88
%
   
633,874
     
22,884
     
4.83
%
Residential and home equity
   
365,062
     
10,728
     
3.93
%
   
337,307
     
10,191
     
4.04
%
Construction
   
187,181
     
7,075
     
5.05
%
   
186,337
     
6,447
     
4.63
%
Total real estate
   
2,430,179
     
85,334
     
4.69
%
   
2,163,488
     
76,124
     
4.70
%
Commercial & industrial
   
434,217
     
15,460
     
4.76
%
   
365,744
     
12,567
     
4.59
%
Agricultural
   
257,555
     
9,350
     
4.85
%
   
229,862
     
7,758
     
4.51
%
Commercial leases
   
92,914
     
4,158
     
5.98
%
   
100,347
     
4,135
     
5.51
%
Consumer and other
   
27,330
     
3,569
     
17.46
%
   
203,683
     
9,255
     
6.08
%
Total loans and leases
   
3,242,195
     
117,871
     
4.86
%
   
3,063,124
     
109,839
     
4.79
%
Non-marketable securities
   
15,549
     
732
     
6.29
%
   
14,451
     
646
     
5.98
%
Total interest earning assets
   
5,085,731
     
140,502
     
3.69
%
   
4,570,895
     
123,098
     
3.60
%
Allowance for credit losses
   
(61,864
)
                   
(59,971
)
               
Non-interest earning assets
   
314,520
                     
315,582
                 
Total average assets
 
$
5,338,387
                   
$
4,826,506
                 
 
                                               
LIABILITIES AND SHAREHOLDERS' EQUITY
                                               
Interest bearing deposits:
                                               
Demand
 
$
1,111,513
     
1,023
     
0.12
%
 
$
1,002,267
     
869
     
0.12
%
Savings and money market accounts
   
1,550,334
     
1,179
     
0.10
%
   
1,336,826
     
1,136
     
0.11
%
Certificates of deposit greater than $250,000
   
163,148
     
299
     
0.25
%
   
169,545
     
587
     
0.46
%
Certificates of deposit less than $250,000
   
218,302
     
297
     
0.18
%
   
239,185
     
608
     
0.34
%
Total interest bearing deposits
   
3,043,297
     
2,798
     
0.12
%
   
2,747,823
     
3,200
     
0.16
%
Short-term borrowings
   
1
     
-
     
0.00
%
   
-
     
-
     
0.00
%
Subordinated debentures
   
10,310
     
319
     
4.14
%
   
10,310
     
236
     
3.06
%
Total interest bearing liabilities
   
3,053,608
     
3,117
     
0.14
%
   
2,758,133
     
3,436
     
0.17
%
Non-interest bearing deposits
   
1,740,859
                     
1,567,089
                 
Total funding
   
4,794,467
     
3,117
     
0.09
%
   
4,325,222
     
3,436
     
0.11
%
Other non-interest bearing liabilities
   
77,953
                     
64,439
                 
Shareholders' equity
   
465,967
                     
436,845
                 
Total average liabilities and shareholders' equity
 
$
5,338,387
                   
$
4,826,506
                 
 
                                               
Net interest income
         
$
137,385
                   
$
119,662
         
Interest rate spread
                   
3.56
%
                   
3.43
%
Net interest margin(4)
                   
3.61
%
                   
3.50
%

(1)Excludes average unrealized (losses) gains of ($20.1) million and $5.4 million for the nine months ended September 30, 2022, and 2021, respectively, which are included in non-interest earning assets.
(2)The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $312,000 and $324,000 for the nine months ended September 30, 2022, and 2021, respectively.
(3)Loan interest income includes loan fees of $9.8 million and $13.1 million for the nine months ended September 30, 2022 and 2021, respectively.
(4)Net interest margin is computed by dividing net interest income by average interest earning assets.

Third Quarter 2022 vs. Third Quarter 2021
Interest-bearing deposits with banks and Federal Reserve balances consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of 2.30% and 0.15% during the third quarter of 2022 and 2021, respectively. Average interest-bearing deposits with banks were $719 million and $856 million for the quarter ended September 30, 2022 and 2021, respectively. Interest income on interest-bearing deposits with banks was $4.2 million and $0.3 million for the quarter ended September 30, 2022 and 2021, respectively.

The investment securities portfolio consists primarily of: (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 has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 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 and leases, the yield earned on investments is generally less than that of loans and leases.

Total investment securities averaged $1.1 billion and $836.6 million for the quarter ended September 30, 2022 and 2021, respectively. Total interest income on investments was $5.5 million and $3.7 million for the quarter ended September 30, 2022 and 2021, respectively. The average yield on total investment securities was 1.96% and 1.76% for the quarter ended September 30, 2022 and 2021, respectively. See “Investment Securities and Federal Reserve balances” for a discussion of the Company’s investment strategy in 2022.
 
Loans and leases held for investment averaged $3.3 billion and $3.1 billion for the quarter ended September 30, 2022 and 2021, respectively. Total interest income on loans was $41.9 million and $36.1 million for the quarter ended September 30, 2022 and 2021, respectively. The average yield on the loan & lease portfolio was 5.06% and 4.67% for the quarter ended September 30, 2022 and 2021, respectively. The Company continues to experience aggressive competitor pricing for loans and leases to which it may need to respond in order to retain key customers. This could continue to place negative pressure on future loan & lease yields and net interest margin.

Interest-bearing liabilities averaged $3.1 billion and $2.9 billion for the quarter ended September 30, 2022 and 2021, respectively. Total interest expense on interest-bearing deposits was $1.1 million, $.9 million for the quarter ended September 30, 2022 and 2021, respectively. The average rate paid on interest-bearing liabilities was 0.15% and 0.13% for the quarter ended September 30, 2022 and 2021, respectively. As a result of recent increases in short-term market interest rates, the Company is experiencing more aggressive competitor rates on interest bearing deposits, which it may need to meet in order to retain key customers.  This could place negative pressure on future deposit rates and net interest margin.

Nine Months Ended September 30, 2022 vs. Nine Months Ended September 30, 2021
Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of 1.10% and 0.13% for the first nine months ended September 30, 2022 and 2021, respectively. Average interest-bearing deposits were $721 million and $621 million for the nine months ended September 30, 2022 and 2021, respectively. Interest income on interest-bearing deposits with banks was $5.9 million and $0.6 million for the nine months ended September 30, 2022 and 2021, respectively.

Average total investment securities were $1.1 billion and $873 million for the nine months ended September 30, 2022 and 2021, respectively. Total interest income on investments was $16.0 million and $12.0 million for the nine months ended September 30, 2022 and 2021, respectively. The average yield on total investment securities were 1.92% and 1.84% for the nine months ended September 30, 2022 and 2021, respectively. See “Investment Securities and Federal Reserve balances” for a discussion of the Company’s investment strategy in 2022.
 
Average loans and leases held for investment were $3.2 billion and $3.1 billion for the nine months ended September 30, 2022 and 2021, respectively. Total interest income on loans was $117.9 million and $109.8 million for the nine months ended September 30, 2022 and 2021, respectively. The average yield on the loan & lease portfolio was 4.86% and 4.79% for the nine months ended September 30, 2022 and 2021, respectively.

Average interest-bearing liabilities were $3.1 billion and $2.8 billion for the nine months ended September 30, 2022 and 2021, respectively. Total interest expense on interest-bearing deposits was $2.8 million and $3.2 million for the nine months ended September 30, 2022 and 2021, respectively. The average rate paid on interest-bearing liabilities was 0.14% and 0.17% for the nine months ended September 30, 2022 and 2021, respectively.

Rate/Volume Analysis. The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates. For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each.

 
 
Three Months Ended
September 30, 2022
compared with 2021
   
Nine Months Ended
September 30, 2022
compared with 2021
 
 
 
Increase (Decrease) Due to:
   
Increase (Decrease) Due to:
 
(Dollars in thousands)
 
Volume
   
Rate
   
Net
   
Volume
   
Rate
   
Net
 
Interest income:
                                   
Interest earnings deposits in other banks and federal funds sold
 
$
(370
)
 
$
4,201
   
$
3,831
   
$
111
   
$
5,228
   
$
5,339
 
Securities:
                                               
Taxable securities
   
1,272
     
537
     
1,809
     
3,305
     
701
     
4,006
 
Non-taxable securities
   
(57
)
   
44
     
(13
)
   
(127
)
   
68
     
(59
)
Total securities
   
1,214
     
582
     
1,796
     
3,178
     
769
     
3,947
 
Loans:
                                               
Real estate:
                                               
Commercial
   
2,069
     
1,855
     
3,924
     
6,630
     
(1,246
)
   
5,384
 
Agricultural
   
1,122
     
(180
)
   
942
     
2,384
     
277
     
2,661
 
Residential and home equity
   
1,625
     
(1,647
)
   
(22
)
   
962
     
(425
)
   
537
 
Construction
   
(761
)
   
929
     
168
     
29
     
599
     
628
 
Total real estate
   
4,055
     
957
     
5,012
     
10,006
     
(796
)
   
9,210
 
Commercial & industrial
   
775
     
884
     
1,659
     
2,424
     
469
     
2,893
 
Agricultural
   
278
     
692
     
970
     
978
     
614
     
1,592
 
Commercial leases
   
(210
)
   
212
     
2
     
(429
)
   
452
     
23
 
Consumer and other
   
(12,215
)
   
10,352
     
(1,863
)
   
(16,453
)
   
10,767
     
(5,686
)
Total loans
   
(7,316
)
   
13,096
     
5,780
     
(3,474
)
   
11,506
     
8,032
 
Non-marketable securities
   
0
     
(35
)
   
(35
)
   
51
     
35
     
86
 
Total interest income
   
(6,472
)
   
17,844
     
11,372
     
(135
)
   
17,539
     
17,404
 
 
                                               
Interest expense:
                                               
Interest bearing deposits:
                                               
Demand
   
9
     
143
     
152
     
98
     
56
     
154
 
Savings and money market accounts
   
55
     
75
     
130
     
218
     
(175
)
   
43
 
Certificates of deposit greater than $250,000
   
(10
)
   
(37
)
   
(47
)
   
(21
)
   
(267
)
   
(288
)
Certificates of deposit less than $250,000
   
(11
)
   
(31
)
   
(42
)
   
(49
)
   
(262
)
   
(311
)
Total interest bearing deposits
   
43
     
150
     
193
     
246
     
(648
)
   
(402
)
Short-term borrowings
   
-
     
-
     
-
     
-
     
-
     
-
 
Subordinated debentures
   
-
     
56
     
56
     
-
     
83
     
83
 
Total interest expense
   
43
     
206
     
249
     
246
     
(565
)
   
(319
)
Net interest income
 
$
(6,515
)
 
$
17,638
   
$
11,123
   
$
(381
)
 
$
18,104
   
$
17,723
 

Net interest income increased by $17.7 million, or 14.81% to $137.4 million for the nine months ended September 30, 2022 compared to $119.7 million for the same period one year earlier. The increase in net interest income was driven primarily by increased interest rates.

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2022 and 2021
 
 
 
Three Months Ended
September 30,
               
Nine Months Ended
September 30,
             
(Dollars in thousands)
 
2022
   
2021
   
$ Better /
(Worse)
   
% Better /
(Worse)
   
2022
   
2021
   
$ Better /
(Worse)
   
% Better /
(Worse)
 
Selected Income Statement Information:
                                               
Interest income
 
$
51,713
   
$
40,341
   
$
11,372
     
28.19
%
 
$
140,502
   
$
123,098
   
$
17,404
     
14.14
%
Interest expense
   
1,256
     
1,007
     
(249
)
   
(24.73
%)
   
3,117
     
3,436
     
319
     
9.28
%
Net interest income
   
50,457
     
39,334
     
11,123
     
28.28
%
   
137,385
     
119,662
     
17,723
     
14.81
%
Provision for credit losses
   
1,500
     
-
     
(1,500
)
 
N/A
     
3,000
     
1,250
     
(1,750
)
   
(140.00
%)
Net interest income after provision for credit losses
   
48,957
     
39,334
     
9,623
     
24.46
%
   
134,385
     
118,412
     
15,973
     
13.49
%
Non-interest income
   
1,559
     
4,617
     
(3,058
)
   
(66.23
%)
   
9,383
     
16,292
     
(6,909
)
   
(42.41
%)
Non-interest expense
   
24,375
     
20,585
     
(3,790
)
   
(18.41
%)
   
71,194
     
67,732
     
(3,462
)
   
(5.11
%)
Income before income tax expense
   
26,141
     
23,366
     
2,775
     
11.88
%
   
72,574
     
66,972
     
5,602
     
8.36
%
Income tax expense
   
6,605
     
5,864
     
(741
)
   
(12.64
%)
   
17,537
     
16,604
     
(933
)
   
(5.62
%)
Net income
 
$
19,536
   
$
17,502
   
$
2,034
     
11.62
%
 
$
55,037
   
$
50,368
   
$
4,669
     
9.27
%
 
Net Income. For the three and nine months ended September 30, 2022, Farmers & Merchants Bancorp reported net income of $19.5 million and $55 million, earnings per share of $25.20 and $70.47 and return on average assets of 1.45% and 1.37%, respectively. Return on average shareholders’ equity was 16.64% and 15.75% for the three and nine months ended September 30, 2022.

For the three and nine months ended September 30, 2021, Farmers & Merchants Bancorp reported net income of $17.5 million and $50.4 million, earnings per share of $22.16 and $63.79 and return on average assets of 1.39% and 1.39%, respectively. Return on average shareholders’ equity was 15.64% and 15.37% for the three and nine months ended September 30, 2021.

Net Interest Income and Net Interest Margin. For the quarter ended September 30, 2022, net interest income increased $11.1 million, or 28.28%, to $50.5 million compared with $39.3 million for the same quarter a year earlier. The increase is the result of: (1) average interest earning assets increasing $353 million, or 7.40% to $5.1 billion compared with $4.8 billion for the same period a year earlier; and (2) the net interest margin increasing by 69 basis point to 3.95% for the quarter ended September 30, 2022, compared with 3.26% for the same period a year earlier.
 
Net interest income for the nine months ended September 30, 2022 increased by $17.7 million, or 14.81%, to $137.4 million, compared to $119.7 million at September 30, 2021. The increase in net interest income was primarily due to a $515 million increase in average earning assets and an 11 basis point increase in the net interest margin. For the nine months ended September 30, 2022, the Company’s net interest margin was 3.61% compared to 3.50% for the same period in 2021.
 
Provision for Credit Losses. The provision for credit losses in each period is a charge against earnings in that period. The provision is the amount required to maintain the allowance for credit losses at a level that, in management’s judgment, is adequate to absorb expected losses over the life of the loan and HTM securities portfolios.

The Company made a $3.0 million provision for credit losses during the first nine months of 2022 compared to $1.3 million for the same period in 2021. Net recoveries during the first nine months of 2022 were $4,000 compared to net recoveries of $191,000 in the first nine months of 2021.

Non-interest Income. Non-interest income decreased $3.0 million, or 66.23%, to $1.6 million for the quarter ended September 30, 2022 compared with $4.6 million for the same period a year earlier. This decrease in non-interest income was primarily due to a $3.0 million loss on sale of investment securities and a $0.2 million decrease in service charges on deposit accounts.  Service charges on deposit accounts dropped because the Company eliminated NSF fees during the quarter ended September 30, 2022.

The Company recorded net gains on deferred compensation plan investments of $0.3 million for the quarter ended September 30, 2022 compared with net gains of $0.6 million for the same respective period. See Note 12, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2021 Form 10-K filed on March 15, 2022 for a description of these plans. 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 GAAP requires these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income.

Non-interest income decreased $6.9 million, or 42.41%, to $9.4 million for the nine months ended September 30, 2022 compared with $16.3 million for the same period of 2021. The year-over-year decrease in non-interest income was primarily due to a $3.0 million loss on sale of investment securities during the third quarter of 2022, a $2.5 million reduction in gain on sale of investment securities recorded in the first quarter of 2021 and a $2.0 million decline in gains/(losses) on deferred compensation plan investments. These reductions were partially off-set by a $0.4 million increase in services charges and processing fees received on deposit accounts and an increase of $0.2 million in other non-interest income.

The Company recorded net losses on deferred compensation plan investments of $0.2 million for the nine months ended September 30, 2022 compared with net gains of $1.8 million for the same respective period. See Note 12, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2021 Form 10-K filed on March 15, 2022 for a description of these plans. 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 GAAP requires these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income.

Non-interest Expense. Non-interest expense increased $3.8 million, or 18.41%, to $24.4 million for the quarter ended September 30, 2022 compared with $20.6 million for the same period a year ago. This increase was primarily comprised of: (1) a $1.5 million increase in salaries and employee benefits; (2) a $1.0 million increase in provision for unused commitments; (3) a $0.7 million increase in other miscellaneous expenses; (4) a $0.4 million increase in recruitment and relocation expenses; and (5) an increase of $0.2 in marketing expenses. These increases were partially off-set by a $0.3 million decline in gains/(losses) on deferred compensation plan investments.

The Company recorded net gains on deferred compensation plan investments of $0.3 million for the quarter ended September 30, 2022 compared with net gains of $0.6 million for the same respective period. See Note 12, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2021 Form 10-K filed on March 15, 2022 for a description of these plans. 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 GAAP requires gains/(losses) on deferred compensation plan investments to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income.

Non-interest expense increased $3.5 million, or 5.11%, to $71.2 million for the nine months ended September 30, 2022 compared with $67.7 million for the same period a year ago. This increase was primarily comprised of: (1) a $1.8 million increase in salaries and employee benefits; (2) a $1.0 million increase in provision for unused commitments; (3) a $0.6 million increase in recruitment and relocation expenses; (4) a $0.4 million increase in professional fees; (5) a $0.5 million increase in marketing and legal expenses; and (6) a $0.7 million increase in other miscellaneous expenses. These increases were partially off-set by a $2.0 million decline in gains/(losses) on deferred compensation plan investments.

The Company recorded net losses on deferred compensation plan investments of $0.2 million for the nine months ended September 30, 2022 compared with net gains of $1.8 million for the same period of 2021. See Note 12, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2021 Form 10-K filed on March 15, 2022 for a description of these plans. 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 GAAP requires gains/(losses) on deferred compensation plan investments to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income.

Income Tax Expense. The Bank’s provision for income taxes increased 5.62% to $17.5 million for the first nine months of 2022 compared to the first nine months of 2021. The Company’s effective tax rate for the first nine months of 2022 was 24.16% compared to 24.79% for the same period in 2021. The Company’s effective tax rate can fluctuate from quarter to quarter due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to benefits regarding the cash surrender value of life insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans.

Financial Condition

Total assets grew $289 million, or 5.58%, to $5.5 billion at September 30, 2022 compared with $5.2 billion at December 31, 2021. Loans held for investment were $3.3 billion at September 30, 2022, an increase of $86.7 million, or 2.68% compared with $3.2 billion at December 31, 2021. Exclusive of SBA PPP loans, the loan portfolio grew $145.0 million, or 4.56%, over December 31, 2021. This data constitutes non-GAAP financial data. The Company believes that excluding the temporary effect of the PPP loans furnishes useful information regarding the Company’s growth. Total deposits grew $269 million, or 5.80%, to $4.9 billion at September 30, 2022 compared with $4.6 billion at December 31, 2021. The increase in total assets and deposits was primarily the result of continued strong organic deposit growth.
 
Investment Securities and Federal Reserve Balances

The Company’s investment portfolio increased $23 million, or 2.24%, to $1.0 billion at September 30, 2022 compared to December 31, 2021. This increase is net of the impact of $30.8 million that the Company sold for interest rate risk management purposes. The Company uses its investment portfolio to manage interest rate and liquidity risks. Accordingly, when market rates are increasing it invests most of its funds in shorter-term Treasury and Agency securities or shorter-term (10, 15 and 20 year) mortgage-backed securities. Conversely, when rates are falling, 30-year mortgage-backed securities or longer term Treasury and Agency securities may be increased. The Company's total investment portfolio currently represents 18.84% of the Company’s total assets at September 30, 2022 as compared with 19.46% at December 31, 2021. Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Reserve balances. Interest bearing deposits with banks consisted primarily 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 $800 million at September 30, 2022 and $663 million at December 31, 2021.

The Company classifies its investment securities as either held-to-maturity (“HTM”) or available-for-sale (“AFS”). Securities are classified as held-to-maturity and are carried at amortized cost, net of an allowance for credit losses, when the Company has the intent and ability to hold the securities to maturity. See Note 3 “Investment Securities” to the Unaudited Consolidated Financial Statements in “Item 1. Financial Statements” in this quarterly Report on Form 10-Q.  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. As of September 30, 2022, the Company held no investment securities from any issuer (other than the U.S. Treasury or an agency of the U.S. government or a government sponsored entity) that totaled over 10% of our shareholders’ equity.

The carrying value of our portfolio of investment securities was as follows:

(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Available-for-Sale Securities
           
U.S. Treasury notes
 
$
4,941
   
$
10,089
 
U.S. Government-sponsored securities
   
4,698
     
6,374
 
Mortgage-backed securities(1)
   
156,453
     
251,120
 
Collateralized mortgage obligations(1)
   
1,458
     
2,436
 
Corporate securities
   
9,594
     
-
 
Other
   
310
     
435
 
Total available-for-sale securities
 
$
177,454
   
$
270,454
 
 
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
 
(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Held-to-Maturity Securities
           
Mortgage-backed securities(1)
 
$
709,541
   
$
596,775
 
Collateralized mortgage obligations(1)
   
82,297
     
73,781
 
Municipal securities(2)
   
60,434
     
66,496
 
Total held-to-maturity securities
 
$
852,272
   
$
737,052
 

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
(2) Municipal securities are net of allowance for credit losses of $393 and $0, respectively.

The following table shows the carrying value for contractual maturities of investment securities and the weighted average yields of such securities, including the benefit of tax-exempt securities:

 
 
As of September 30, 2022
 
 
 
Within One Year
   
After One but
Within Five Years
   
After Five but
Within Ten Years
   
After Ten Years
   
Total
 
(Dollars in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
 
Securities available-for-sale
                                                           
U.S. Treasury notes
 
$
4,941
     
2.38
%
 
$
-
     
0.00
%
 
$
-
     
0.00
%
 
$
-
     
0.00
%
 
$
4,941
     
2.38
%
U.S. Government-sponsored securities
   
7
     
1.74
%
   
81
     
3.97
%
   
436
     
3.01
%
   
4,174
     
2.79
%
   
4,698
     
2.83
%
Mortgage-backed securities(1)
   
16
     
3.13
%
   
15,725
     
2.27
%
   
17,961
     
2.40
%
   
122,751
     
1.74
%
   
156,453
     
1.87
%
Collateralized mortgage obligations(1)
   
-
     
0.00
%
   
-
     
0.00
%
   
-
     
0.00
%
   
1,458
     
2.35
%
   
1,458
     
2.35
%
Corporate securities
   
-
     
0.00
%
   
4,795
     
1.59
%
   
4,799
     
1.72
%
   
-
     
0.00
%
   
9,594
     
1.65
%
Other
   
310
     
2.99
%
   
-
     
0.00
%
   
-
     
0.00
%
   
-
     
0.00
%
   
310
     
2.99
%
Total securities available-for-sale
 
$
5,274
     
2.42
%
 
$
20,601
     
2.12
%
 
$
23,196
     
2.27
%
 
$
128,383
     
1.78
%
 
$
177,454
     
1.90
%
 
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
 
 
 
As of September 30, 2022
 
 
 
Within One Year
   
After One but
Within Five Years
   
After Five but
Within Ten Years
   
After Ten Years
   
Total
 
(Dollars in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
 
Securities held-to-maturity
                                                           
Mortgage-backed securities(1)
 
$
-
     
0.00
%
 
$
-
     
0.00
%
 
$
13,906
     
0.89
%
 
$
695,635
     
1.88
%
 
$
709,541
     
1.86
%
Collateralized Mortgage Obligations(1)
   
-
     
0.00
%
   
-
     
0.00
%
   
-
     
0.00
%
   
82,297
     
1.80
%
   
82,297
     
1.80
%
Municipal securities
   
883
     
4.93
%
   
7,484
     
3.40
%
   
15,000
     
3.43
%
   
37,460
     
3.52
%
   
60,827
     
3.50
%
Total securities held-to-maturity
 
$
883
     
4.93
%
 
$
7,484
     
3.40
%
 
$
28,906
     
2.06
%
 
$
815,392
     
1.95
%
 
$
852,665
     
1.97
%

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
 
   
As of December 31, 2021
 
   
Within One Year
   
After One but
Within Five Years
   
After Five but
Within Ten Years
   
After Ten Years
   
Total
 
(Dollars in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
 
Securities available-for-sale
                                                           
U.S. Treasury notes
 
$
5,028
     
2.33
%
 
$
5,061
     
2.38
%
 
$
-
     
0.00
%
 
$
-
     
0.00
%
 
$
10,089
     
2.36
%
U.S. Government-sponsored securities
   
2
     
1.80
%
   
148
     
2.29
%
   
512
     
1.55
%
   
5,712
     
1.26
%
   
6,374
     
1.30
%
Mortgage-backed securities(1)
   
13
     
1.50
%
   
21,155
     
2.36
%
   
50,554
     
2.36
%
   
179,398
     
1.61
%
   
251,120
     
1.83
%
Collateralized mortgage obligations(1)
   
-
     
0.00
%
   
-
     
0.00
%
   
-
     
0.00
%
   
2,436
     
2.30
%
   
2,436
     
2.30
%
Other
   
435
     
3.31
%
   
-
     
0.00
%
   
-
     
0.00
%
   
-
     
0.00
%
   
435
     
3.31
%
Total securities available-for-sale
 
$
5,478
     
2.41
%
 
$
26,364
     
2.36
%
 
$
51,066
     
2.35
%
 
$
187,546
     
1.61
%
 
$
270,454
     
1.84
%

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
 
   
As of December 31, 2021
 
   
Within One Year
   
After One but
Within Five Years
   
After Five but
Within Ten Years
   
After Ten Years
   
Total
 
(Dollars in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
 
Securities held-to-maturity
                                                           
Mortgage-backed securities(1)
 
$
-
     
0.00
%
 
$
-
     
0.00
%
 
$
10,641
     
0.41
%
 
$
586,134
     
1.72
%
 
$
596,775
     
1.70
%
Collateralized Mortgage Obligations(1)
   
-
     
0.00
%
   
-
     
0.00
%
   
-
     
0.00
%
   
73,781
     
1.71
%
   
73,781
     
1.71
%
Municipal securities
   
308
     
1.10
%
   
8,487
     
2.19
%
   
18,433
     
3.42
%
   
39,268
     
4.52
%
   
66,496
     
3.90
%
Total securities held-to-maturity
 
$
308
     
1.10
%
 
$
8,487
     
2.19
%
 
$
29,074
     
2.32
%
 
$
699,183
     
1.88
%
 
$
737,052
     
1.90
%

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
 
Expected maturities may differ from contractual maturities because issuers may have the right to call obligations with or without penalties.  The Company evaluates securities for expected credit losses at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

Loans and Leases

Loans and leases can be categorized by borrowing purpose and use of funds. Common examples of loans and leases made by the Company include:

Commercial and Agricultural Real Estate – These are loans secured by owner-occupied real estate, non-owner-occupied real estate, owner-occupied farmland, and multifamily residential properties. 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, or the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; maturities generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe) amortizations of up to 25 years (30 years for multifamily residential properties); have debt service coverage ratios of 1.00 or better with a target of 1.25 or greater; 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 acquisition, development and construction 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 an approved 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 with an appropriate spread based on the amount of perceived risk in the loan.
 
Single Family Residential Real Estate – 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, the Company will make loans on rural residential properties up to 41 acres. Most residential loans have terms from ten to thirty years and carry fixed or variable rates priced to 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” loans.
 
Home Equity Lines and Loans – These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $500,000; but can be made for up to $1,000,000 in high cost counties. Combined Loan To Value (CLTV) does not exceed 75%; 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 non-real estate 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 or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Commercial – These are non-real estate 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 36 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 or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Consumer – These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a minimal consumer loan portfolio.

Commercial Leases – These are leases primarily to businesses and farmers for 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 with 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. ITCs 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.

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 and leases be 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 and 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 and 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” in this Report on Form 10-Q for further details.

Overall, the Company's loan & lease portfolio at September 30, 2022 totaled $3.3 billion, an increase of $86.7 million over December 31, 2021. Exclusive of SBA PPP loans, the loan portfolio grew $145.0 million, or 4.56%, over December 31, 2021. This increase in the non-PPP loans occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; and (2) expansion of our service area into the East Bay of San Francisco and Napa. This data constitutes non-GAAP financial data. The Company believes that excluding the temporary effect of the PPP loans furnishes useful information regarding the Company’s growth.

The following table sets forth the distribution of the loan & lease portfolio by type and percent at the end of each period presented:

 
 
September 30, 2022
   
December 31, 2021
 
(Dollars in thousands)
 
Dollars
   
Percent
of Total
   
Dollars
   
Percent
of Total
 
Gross Loans and Leases
                       
Real estate:
                       
Commercial
 
$
1,246,805
     
37.41
%
 
$
1,167,516
     
35.95
%
Agricultural
   
722,448
     
21.68
%
   
672,830
     
20.72
%
Residential and home equity
   
377,249
     
11.32
%
   
350,581
     
10.79
%
Construction
   
169,624
     
5.09
%
   
177,163
     
5.45
%
Total real estate
   
2,516,126
     
75.50
%
   
2,368,090
     
72.91
%
Commercial & industrial
   
454,185
     
13.63
%
   
427,799
     
13.17
%
Agricultural
   
260,296
     
7.81
%
   
276,684
     
8.52
%
Commercial leases
   
94,089
     
2.83
%
   
96,971
     
2.99
%
Consumer and other(1)
   
7,776
     
0.23
%
   
78,367
     
2.41
%
Total gross loans and leases
 
$
3,332,472
     
100.00
%
 
$
3,247,911
     
100.00
%
 (1) Includes SBA PPP loans which were $1.8 million and $70.8 million at September 30, 2022 and December 31, 2021, respectively.

The following table shows the maturity distribution and interest rate sensitivity of the loan portfolio of the Company as of September 30, 2022.

 
 
Loan Contractual Maturity
 
(Dollars in thousands)
 
One Year or Less
   
After One But
Within Five
Years
   
After Five Years
But Within
Fifteen Years
   
After Fifteen
Years
   
Total
 
Gross loan and leases:
                             
Real estate:
                             
Commercial
 
$
54,825
   
$
300,999
   
$
853,261
   
$
37,720
   
$
1,246,805
 
Agricultural
   
26,331
     
155,660
     
466,352
     
74,105
     
722,448
 
Residential and home equity
   
407
     
4,616
     
117,436
     
254,790
     
377,249
 
Construction
   
105,343
     
64,281
     
-
     
-
     
169,624
 
Total real estate
   
186,906
     
525,556
     
1,437,049
     
366,615
     
2,516,126
 
Commercial & industrial
   
180,294
     
206,003
     
61,714
     
6,174
     
454,185
 
Agricultural
   
164,616
     
79,574
     
16,106
     
-
     
260,296
 
Commercial leases
   
7,299
     
32,471
     
54,319
     
-
     
94,089
 
Consumer and other(1)
   
707
     
5,639
     
1,430
     
-
     
7,776
 
Total gross loans and leases
 
$
539,822
   
$
849,243
   
$
1,570,618
   
$
372,789
   
$
3,332,472
 
Rate Structure for Loans
                                       
Fixed Rate
 
$
87,323
   
$
354,357
   
$
1,188,033
   
$
241,872
   
$
1,871,585
 
Adjustable Rate
   
452,499
     
494,886
     
382,585
     
130,917
     
1,460,887
 
Total gross loans and leases
 
$
539,822
   
$
849,243
   
$
1,570,618
   
$
372,789
   
$
3,332,472
 
(1) Includes SBA PPP loans.

Non-Accrual Loans and Leases - Accrual of interest on loans and 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 and 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 and leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. Non-accrual loans and leases totaled $411,000 and $516,000 at September 30, 2022 and December 31, 2021, respectively.

Restructured Loans and 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 borrower that it would not otherwise consider, except when subject to the CARES Act and H.R. 133. 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 and leases that are on nonaccrual status at the time they become TDR loans or leases, 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 collateral dependent and are individually evaluated for impairment.

At September 30, 2022, restructured loans totaled $1.3 million compared with $2.3 million at December 31, 2021, all of which were performing.  See Note 4 “Loans and Leases” to the Unaudited Consolidated Financial Statements in “Item 1. Financial Statements” in this quarterly Report on Form 10-Q.

Other Real Estate Owned –OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the borrower. The Company records all OREO properties at amounts equal to or less than the fair market value of the properties based on current independent appraisals reduced by estimated selling costs. The Company reported $873,000 of foreclosed OREO at September 30, 2022, and at December 31, 2021.

Not included in the table below, but relevant to a discussion of asset quality are loans that were granted some form of relief because of COVID-19 and are not considered TDRs because of the CARES Act and H.R. 133. Since April 2020, the Company has restructured $304 million of loans under the CARES Act and H.R. 133 guidelines.  At September 30, 2022, all loans that were restructured as part of the CARES Act have returned to the contractual terms and conditions of the loans, without exception.

The following table summarizes the loans for which the accrual of interest has been discontinued and loans more than 90 days past due and still accruing interest, including those non-accrual loans that are troubled debt restructured loans, and OREO (as hereinafter defined):

(Dollars in thousands)
 
September 30,
2022
   
December 31,
2021
 
Non-performing assets:
           
Non-accrual loans and leases, not TDRs
           
Real estate:
           
Commercial
 
$
411
   
$
-
 
Agricultural
   
-
     
18
 
Residential and home equity
   
-
     
-
 
Construction
   
-
     
-
 
Total real estate
   
411
     
18
 
Commercial & industrial
   
-
     
-
 
Agricultural
   
-
     
-
 
Commercial leases
   
-
     
-
 
Consumer and other
   
-
     
-
 
Subtotal
   
411
     
18
 
Non-accrual loans and leases, are TDRs
               
Real estate:
               
Commercial
   
-
     
-
 
Agricultural
   
-
     
498
 
Residential and home equity
   
-
     
-
 
Construction
   
-
     
-
 
Total real estate
   
-
     
498
 
Commercial & industrial
   
-
     
-
 
Agricultural
   
-
     
-
 
Commercial leases
   
-
     
-
 
Consumer and other
   
-
     
-
 
Subtotal
   
-
     
498
 
Total non-performing loans and leases
 
$
411
   
$
516
 
Other real estate owned ("OREO")
 
$
873
   
$
873
 
Total non-performing assets
 
$
1,284
   
$
1,389
 
Performing TDRs
 
$
1,325
   
$
1,824
 

Although management believes that non-performing loans and 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. See Note 4. “Loans and Leases”, located in “Item 1. Financial Statements” in this Quarterly Report on Form 10-Q for an allocation of the allowance classified to collateral dependent loans and leases.

Except for non-performing loans and leases discussed above, the Company’s management is not aware of any loans and leases as of September 30, 2022, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However:

The State of California experienced drought conditions from 2013 through most of 2016. After 2016, reasonable levels of rain and snow alleviated drought conditions in our primary service area, but the winters of 2020-2021 and 2021-2022 were once again dry. Despite this, the availability of water in our primary service area was not an issue for the 2022 growing season. However, the weather patterns over the past eight years further reinforce the fact that the long-term risks associated with the availability of water are significant.

While tremendous strides have been made in fighting the COVID-19 virus, particularly with the development of a vaccine, the effects of COVID-19 are still with us, and it is impossible to predict the ultimate impact on classified and non-performing loans and leases (see Part I. Note 2).

Allowance for Credit Losses—Loans and Leases

The Company maintains an allowance for credit losses (“ACL”) on loans based on current expected credit losses 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 collateral dependent loans and leases; general reserves for current expected credit losses related to loans and leases that are not collateral dependent; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. See “Summary of Critical Accounting Policies and Estimates - Allowance for Credit LossesLoans.”

The following table sets forth the activity in our ACL for the periods indicated:

 
 
Nine Months Ended
September 30,
 
(Dollars in thousands)
 
2022
   
2021
 
Allowance for credit losses:
           
Balance at beginning of year
 
$
61,007
   
$
58,862
 
Provision / (recapture) for credit losses
   
2,606
     
1,250
 
Charge-offs:
               
Real estate:
               
Commercial
   
-
     
-
 
Agricultural
   
-
     
-
 
Residential and home equity
   
-
     
-
 
Construction
   
-
     
-
 
Total real estate
   
-
     
-
 
Commercial & industrial
   
(324
)
   
-
 
Agricultural
   
-
     
-
 
Commercial leases
   
-
     
-
 
Consumer and other
   
(38
)
   
(33
)
Total charge-offs
   
(362
)
   
(33
)
Recoveries:
               
Real estate:
               
Commercial
   
-
     
-
 
Agricultural
   
-
     
-
 
Residential and home equity
   
125
     
91
 
Construction
   
-
     
-
 
Total real estate
   
125
     
91
 
Commercial & industrial
   
176
     
83
 
Agricultural
   
51
     
29
 
Commercial leases
   
-
     
-
 
Consumer and other
   
14
     
21
 
Total recoveries
   
366
     
224
 
Net recoveries / charge-offs
   
4
     
191
 
 
               
Balance at end of period
 
$
63,617
   
$
60,303
 
 
               
Selected financial information:
               
Gross loans held for investment
 
$
3,332,472
   
$
3,151,508
 
Average loans
   
3,242,195
     
3,063,124
 
Non-performing loans
   
411
     
516
 
Allowance for credit losses to non-performing loans
   
15478.59
%
   
11686.63
%
Net (recoveries)/charge-offs to average loans
   
0.00
%
   
(0.01
)%
Provision for credit losses to average loans
   
0.08
%
   
0.04
%
Allowance for credit losses to loans held for investment
   
1.91
%
   
1.91
%

The following table indicates management’s allocation of the ACL by loan type as of each of the following dates:
 
 
September 30, 2022
   
December 31, 2021
 
(Dollars in thousands)
 
Dollars
   
Percent of
Total
   
Dollars
   
Percent
of Total
 
Allowance for credit losses:
                       
Real estate:
                       
Commercial
 
$
16,540
     
37.41
%
 
$
28,536
     
35.95
%
Agricultural
   
16,560
     
21.68
%
   
9,613
     
20.72
%
Residential and home equity
   
6,865
     
11.32
%
   
2,847
     
10.79
%
Construction
   
2,995
     
5.09
%
   
1,456
     
5.45
%
Total real estate
   
42,960
     
75.50
%
   
42,452
     
72.91
%
Commercial & Industrial
   
10,392
     
13.63
%
   
11,489
     
13.17
%
Agricultural
   
8,523
     
7.81
%
   
5,465
     
8.52
%
Commercial leases
   
1,588
     
2.83
%
   
938
     
2.99
%
Consumer and other
   
154
     
0.23
%
   
663
     
2.41
%
Total allowance for credit losses
 
$
63,617
     
100.00
%
 
$
61,007
     
100.00
%

Deposits

Total deposits were $4.9 billion and $4.6 billion as of September 30, 2022 and December 31, 2021, respectively. In addition to the Company’s ongoing business development activities for deposits, in management’s opinion 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; and (2) the Company’s expansion of its service area into Walnut Creek, Oakland, Concord and Napa.

Non-interest bearing demand deposits increased by $52.3 million and were $1.8 billion as of September 30, 2022 and December 31, 2021.  Non-interest bearing deposits were 36.72% of total deposits, as of September 30, 2022 and 37.72% as of December 31, 2021. Interest bearing deposits are comprised of interest-bearing transaction accounts, money market accounts, regular savings accounts, and certificates of deposit.

The following table shows the average amount and average rate paid on the categories of deposits for each of the periods presented:

 
 
Nine Months Ended September 30,
 
 
 
2022
   
2021
 
(Dollars in thousands)
 
Average Balance
   
Interest Expense
   
Average
Rate
   
Average Balance
   
Interest Expense
   
Average
Rate
 
Total deposits:
                                   
Interest bearing deposits:
                                   
Demand
 
$
1,111,513
     
1,023
     
0.12
%
 
$
1,002,267
   
$
869
     
0.12
%
Savings and money market
   
1,550,334
     
1,179
     
0.10
%
   
1,336,826
     
1,136
     
0.11
%
Certificates of deposit greater than $250,000
   
163,148
     
299
     
0.25
%
   
169,545
     
587
     
0.46
%
Certificates of deposit less than $250,000
   
218,302
     
297
     
0.18
%
   
239,185
     
608
     
0.34
%
Total interest-bearing deposits
   
3,043,297
     
2,798
     
0.12
%
   
2,747,823
     
3,200
     
0.16
%
Non-interest bearing deposits
   
1,740,859
                     
1,567,089
                 
Total deposits
 
$
4,784,156
   
$
2,798
     
0.08
%
 
$
4,314,912
   
$
3,200
     
0.10
%

Deposits are gathered from individuals and businesses in our market areas. The interest rates paid are competitively priced for each particular deposit product and structured to meet our funding requirements. We will continue to manage interest expense through deposit pricing.  The average cost of deposits, including non-interest bearing deposits, declined to 0.08% for the nine months ended September 2022 compared with 0.10% for the same period a year ago.

The following table shows deposits with a balance greater than $250,000 at September 30, 2022 and December 31, 2021:

 
 
September 30,
   
December 31,
 
(Dollars in thousands)
 
2022
   
2021
 
Deposits greater than $250,000
 
$
2,990,165
   
$
2,708,576
 
Certificates of deposit greater than $250,000, by maturity:
               
Less than 3 months
   
58,384
     
59,591
 
3 months to 6 months
   
38,722
     
37,182
 
6 months to 12 months
   
43,161
     
59,945
 
More than 12 months
   
11,875
     
12,147
 
Total certificates of deposit greater than $250,000
 
$
152,142
   
$
168,865
 
Total deposits greater than $250,000
 
$
3,142,307
   
$
2,877,441
 

Refer to the Year-To-Date Average Balances and Rate Schedules located in this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on separate deposit categories.

The Bank participates in a program wherein the State of California places time deposits with the Bank at the Bank’s option.  At September 30, 2022 and December 31, 2021, the Bank had $3.0 million, of these deposits.

Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings

Lines of Credit with the Federal Reserve Bank and 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, 2022 or December 31, 2021. There were no Federal Funds purchased or advances from the FRB at September 30, 2022 or December 31, 2021.

Long-Term Subordinated Debentures

On December 17, 2003, the Company raised $10.0 million through the sale of subordinated debentures to an off-balance sheet trust and its sale of trust-preferred securities. See Note 10. “Long-Term Subordinated Debentures” located in “Item 8. Financial Statements and Supplementary Data” in our Annual Report on Form 10-K filed with the SEC on March 15, 2022. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our Trust Preferred Securities will continue to qualify as regulatory capital.

These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly (the next reset is December 19, 2022) and the rate was 6.38% as of September 30, 2022 and 2.97% at September 30, 2021. The average rate paid for these securities was 4.14% for the first nine months of 2022 and 3.06% for the first nine months of 2021. 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 Resources

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 $468 million at September 30, 2022, and $463 million at December 31, 2021.

The Company and the Bank are subject to various regulatory capital adequacy guidelines as outlined under Part 324 of the FDIC Rules and Regulations. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company 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 Company believes that it is currently in compliance with all of these capital requirements and that they will not result in any restrictions on the Company’s business activity.

Management believes that the Bank meets the requirements to be categorized as “well capitalized” under the FDIC regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables.

The following table sets forth our capital ratios and the related regulatory guidelines:

(Dollars in thousands)
 
Minimum to be
Categorized as
"Well Capitalized"
   
Minimum to be
Categorized as
"Adequately
Capitalized"
   
September 30,
2022
   
December 31,
2021
 
Farmers & Merchants Bancorp
                       
CET1 capital to risk-weighted assets
   
N/A
     
4.50
%
   
11.82
%
   
11.68
%
Tier 1 capital to risk-weighted assets
   
N/A
     
6.00
%
   
12.06
%
   
11.94
%
Risk-based capital to risk-weighted assets
   
N/A
     
8.00
%
   
13.32
%
   
13.19
%
Tier 1 leverage capital ratio
   
N/A
     
4.00
%
   
9.12
%
   
8.92
%
 
                               
Farmers & Merchants Bank
                               
CET1 capital to risk-weighted assets
   
6.50
%
   
4.50
%
   
12.04
%
   
11.91
%
Tier 1 capital to risk-weighted assets
   
8.00
%
   
6.00
%
   
12.04
%
   
11.91
%
Risk-based capital to risk-weighted assets
   
10.00
%
   
8.00
%
   
13.30
%
   
13.17
%
Tier 1 leverage capital ratio
   
5.00
%
   
4.00
%
   
9.12
%
   
8.91
%

On November 15, 2021, the Board of Directors reauthorized the Company’s share repurchase program for up to $20.0 million of the Company’s common stock (“Repurchase Plan”), representing approximately 4% of outstanding shareholders’ equity.  Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means.

During the first nine months of 2022 the Company repurchased 18,824 shares under the Repurchase Plan, for a total of $17.9 million.

Off-Balance-Sheet Arrangements

Off-balance-sheet arrangements are any contractual arrangement to which an unconsolidated entity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company. The Company had the following off balance sheet commitments as of the dates indicated.

The following table sets forth our off-balance sheet lending commitments as of September 30, 2022:

 
       
Amount of Commitment Expiration per Period
 
(Dollars in thousands)
 
Total
Committed
Amount
   
Less than
One Year
   
One to
Three
Years
   
Three to
Five Years
   
After Five
Years
 
Off-balance sheet commitments
                             
Commitments to extend credit
 
$
1,128,340
   
$
401,604
   
$
477,113
   
$
46,626
   
$
202,997
 
Standby letters of credit
   
16,629
     
10,403
     
4,326
     
1,470
     
430
 
Total off-balance sheet commitments
 
$
1,144,969
   
$
412,007
   
$
481,439
   
$
48,096
   
$
203,427
 

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 have maturity dates ranging from 1 to 60 months with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

Liquidity

The ability to have readily available funds sufficient to repay maturing liabilities is of primary importance to depositors, creditors and regulators. Our liquidity, represented by cash borrowing lines, federal funds and available for sale securities, is a result of our operating, investing and financing activities and related cash flows. In order to ensure funds are available at all times, we devote resources to projecting the amount of funds that will be required and we maintain relationships with a diversified client base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets. We had the following borrowing lines available at September 30, 2022:

   
September 30, 2022
 
(Dollars in thousands)
 
Total Credit
Line Limit
   
Current
Credit Line
Available
   
Outstanding
Amount
   
Remaining
Credit Line
Available
   
Value of
Collateral
Pledged
 
Additional liquidity sources:
                             
Federal Home Loan Bank
 
$
766,011
   
$
766,011
   
$
-
   
$
766,011
   
$
1,183,540
 
Federal Reserve BIC
   
657,350
     
657,350
     
-
     
657,350
     
890,564
 
FHLB Fed Funds
   
18,000
     
18,000
     
-
     
18,000
     
-
 
US Bank Fed Funds
   
35,000
     
35,000
     
-
     
35,000
     
-
 
MUFG Union Bank Fed Funds
   
15,000
     
15,000
     
-
     
15,000
     
-
 
PCBB Fed Funds
   
50,000
     
50,000
     
-
     
50,000
     
-
 
Total additional liquidity sources
 
$
1,541,361
   
$
1,541,361
   
$
-
   
$
1,541,361
   
$
2,074,104
 

We believe our liquid assets and short-term borrowing credit lines are adequate to meet our cash flow needs for loan funding and deposit cash withdrawal for the foreseeable future. As of September 30, 2022, we had $1.3 billion in cash and unencumbered investment securities; $2.2 million in investment securities and $2.1 billion in loans pledged as collateral on short-term borrowing credit lines. We have the option of either borrowing on our credit lines or selling these investment securities for cash flow needs.

Our liquidity is comprised of three primary classifications: cash flows from or used in operating activities; cash flows from or used in investing activities; and cash flows from or used in financing activities. Net cash provided by or used in operating activities has consisted primarily of net income adjusted for certain non-cash income and expense items such as the credit loss provision, investment and other amortization and depreciation.

Our primary investing activities are the origination of loans and purchases and sales of investment securities. As of September 30, 2022, we had outstanding loan commitments of $1.1 billion and outstanding letters of credit of $16.6 million. We anticipate that we will have sufficient funds available to meet current loan commitments.

Net cash provided by financing activities has been impacted significantly by higher deposit levels. At September 30, 2022 and 2021, deposits increased $269 million and $508 million compared to December 31, 2021 and 2020, respectively.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk

The Company’s assessment of market risk at September 30, 2022 indicates there have been no material changes in the quantitative and qualitative disclosures from those made in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2022.

Item 4.
Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as required by Exchange Act Rules 240.13a-15(b) and 15d-14(a)) at September 30, 2022. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective and timely, providing them with material information relating to the Company required to be disclosed in the reports the Company files or submits under the Exchange Act.

Changes in Internal Controls

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the nine months ended September 30, 2022, to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.
Legal Proceedings

The Company is involved in various claims, legal actions, and complaints that arise in the ordinary course of business. In the Company’s opinion, all such matters are adequately covered by insurance, are without merit or are of such kind, or involve such amounts, that unfavorable disposition would not have a material adverse effect on the financial condition or results of operations of the Company.

Item 1A.
Risk Factors

There have been no material changes in the risk factors previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2021.

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

On November 15, 2021, the Board of Directors reauthorized the Company’s share repurchase program for up to $20.0 million of the Company’s common stock (“Repurchase Plan”), representing approximately 4% of outstanding shareholders’ equity.  Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means.

During the first nine months of 2022 the Company repurchased 18,824 shares under the Repurchase Plan, for a total of $17.905 million.  All of these shares were purchased at prices ranging from $925.00 to $975.00 per share, based upon the then current price on the OTCQX.

Item 3.
Defaults upon Senior Securities

Not Applicable

Item 4.
Mine Safety Disclosures

Not Applicable

Item 5.
Other Information

Not Applicable

Item 6.
Exhibits
 
List of Financial Statements and Financial Statement Schedules
 
(a) The following documents are filed as a part of this Quarterly Report on Form 10-Q:
 
(1) Financial Statements and
 
(2) Financial Statement schedules required to be filed by Item 1 of this Quarterly Report on Form
     10-Q.
 
(3) The following exhibits are required by Item 601 of Regulation S-K and are included as part of
      this Quarterly Report on Form 10-Q:

Exhibit
Number
Description
Employment Agreement effective August 1, 2022, between Farmers & Merchants Bank of Central California and Kyle Koelbel, filed on Registrant’s Form 10-Q for the quarter ended September 30, 2022.
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.*
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101.INS
Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document).
101.SCH
Inline XBRL Taxonomy Extension Schema Document.
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

*
Filed herewith

SIGNATURES

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

 
FARMERS & MERCHANTS BANCORP
   
Date:  November 7, 2022
/s/ Kent A. Steinwert
 
Kent A. Steinwert
 
Director, Chairman, President and Chief Executive Officer
(Principal Executive Officer)
   
Date:  November 7, 2022
/s/ Stephen W. Haley
 
Stephen W. Haley
 
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)


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