Farmers & Merchants Bancshares, Inc. - Quarter Report: 2020 March (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 quarterly period ended March 31, 2020

 

 

☐	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
	For the transition period from _______________ to ________________

 

Commission file number 000-55756

 

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

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

                                           

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

       (Address of principal executive offices)         (Zip Code)

 

(410) 374-1510

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

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

 

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

                                           

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐ No ☑

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 2,974,019 as of May 12, 2020.

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

 

Table of Contents

 

	Page
PART I – FINANCIAL INFORMATION	3
Item 1. Financial Statements	3
Consolidated balance sheets at March 31, 2020 (unaudited)	3
Consolidated statements of income (unaudited) for the three months ended March 31, 2020	4
Consolidated statements of comprehensive income (unaudited) for the three months ended March 31, 2020	5
Consolidated statements of changes in stockholders’ equity (unaudited) for the three months ended March 31, 2020	6
Consolidated statements of cash flows (unaudited) for the three months ended March 31, 2020	7
Notes to financial statements (unaudited)	9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3. Quantitative and Qualitative Disclosures About Market Risk	41
Item 4. Controls and Procedures	41
PART II – OTHER INFORMATION	41
Item 1. Legal Proceedings	41
Item 1A. Risk Factors	42
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3. Defaults upon Senior Securities	45
Item 4. Mine Safety Disclosures	45
Item 5. Other Information	45
Item 6. Exhibits	46
SIGNATURES	46

 

 

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

 

		March 31,				December 31,
		2020				2019
		(Unaudited)
Assets
Cash and due from banks		$	17,409,858			$	6,664,307
Federal funds sold and other interest-bearing deposits			5,233,944				2,457,045
Cash and cash equivalents			22,643,802				9,121,352
Certificate of deposit in other bank			100,000				100,000
Securities available for sale			40,666,044				36,531,774
Securities held to maturity			19,017,782				19,510,018
Equity security at fair value			543,600				532,321
Federal Home Loan Bank stock, at cost			611,300				376,200
Mortgage loans held for sale			1,481,450				242,000
Loans, less allowance for loan losses of $2,740,150 and $2,593,715			358,319,859				359,382,843
Premises and equipment			5,136,920				5,036,851
Accrued interest receivable			1,065,397				1,019,540
Deferred income taxes			988,558				1,036,078
Bank owned life insurance			7,187,489				7,145,477
Other assets			1,839,179				2,180,644
		$	459,601,380			$	442,215,098
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing		$	61,153,068			$	60,659,015
Interest-bearing			328,611,361				315,954,299
Total deposits			389,764,429				376,613,314
Securities sold under repurchase agreements			9,708,344				10,958,118
Federal Home Loan Bank of Atlanta advances			5,000,000				-
Accrued interest payable			349,725				346,214
Other liabilities			4,356,888				4,843,936
			409,179,386				392,761,582
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 2,974,019 in 2020 and 2019			29,740				29,740
Additional paid-in capital			27,812,991				27,812,991
Retained earnings			22,411,468				21,568,161
Accumulated other comprehensive income			167,795				42,624
			50,421,994				49,453,516
		$	459,601,380			$	442,215,098

 

		Three months ended
		March 31
		2020				2019
Interest income
Loans, including fees		$	4,322,654			$	4,160,086
Investment securities - taxable			210,506				152,317
Investment securities - tax exempt			144,084				160,607
Federal funds sold and other interest earning assets			32,792				74,526
Total interest income			4,710,036				4,547,536
Interest expense
Deposits			906,199				775,531
Securities sold under repurchase agreements			38,194				25,299
Federal Home Loan Bank advances and other borrowings			109				20,553
Total interest expense			944,502				821,383
Net interest income			3,765,534				3,726,153
Provision for loan losses			125,000				13,000
Net interest income after provision for loan losses			3,640,534				3,713,153
Noninterest income
Service charges on deposit accounts			158,555				152,060
Mortgage banking income			62,257				32,719
Bank owned life insurance income			42,012				40,386
Unrealized gain on equity security			8,510				7,845
Gain on sale of SBA loans			-				130,015
Other fees and commissions			30,668				29,371
Total noninterest income			302,002				392,396
Noninterest expense
Salaries			1,354,919				1,326,783
Employee benefits			447,104				381,964
Occupancy			183,152				214,420
Furniture and equipment			160,449				155,147
Acquisition			179,824				-
Other			620,865				676,972
Total noninterest expense			2,946,313				2,755,286
Income before income taxes			996,223				1,350,263
Income taxes			152,916				253,976
Net income		$	843,307			$	1,096,287
Earnings per share - basic and diluted		$	0.28			$	0.37

 

		Three Months Ended
		March 31,
		2020				2019
Net income		$	843,307			$	1,096,287
Other comprehensive income, net of income taxes:
Securities available for sale
Net unrealized gain arising during the period			172,691				412,306
Income tax expense			47,520				113,456
Total other comprehensive income			125,171				298,850
Total comprehensive income		$	968,478			$	1,395,137

 

										Additional								Accumulated other				Total
		Common stock								paid-in				Retained				comprehensive				stockholders'
		Shares				Par value				capital				earnings				income				equity
Balance, December 31, 2018			1,682,997			$	16,830			$	27,324,794			$	18,621,382			$	(568,299	)		$	45,394,707
Net income			-				-				-				1,096,287				-				1,096,287
Unrealized loss on securities available for sale net of income tax expense of $113,456			-				-				-				-				298,850				298,850
Reclassification due to adoption of ASU No. 2016-02			-				-				-				(91,447	)			-				(91,447	)
Balance, March 31, 2019			1,682,997			$	16,830			$	27,324,794			$	19,626,222			$	(269,449	)		$	46,698,397
Balance, December 31, 2019			2,974,019			$	29,740			$	27,812,991			$	21,568,161			$	42,624			$	49,453,516
Net income			-				-				-				843,307				-				843,307
Unrealized gain on securities available for sale net of income tax expense of $47,520			-				-				-				-				125,171				125,171
Balance, March 31, 2020			2,974,019			$	29,740			$	27,812,991			$	22,411,468			$	167,795			$	50,421,994

 

Three Months Ended March 31,		2020				2019
Cash flows from operating activities
Interest received		$	4,640,609			$	4,508,539
Fees and commissions received			251,480				214,151
Interest paid			(940,991	)			(782,666	)
Proceeds from sale of mortgage loans held for sale			3,148,200				1,488,092
Origination of mortgage loans held for sale			(4,387,650	)			(1,331,919	)
Cash paid to suppliers and employees			(3,112,503	)			(2,865,997	)
			(400,855	)			1,230,200
Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale			2,412,263				1,438,497
Held to maturity			500,000				200,000
Purchase of securities
Available for sale			(6,434,692	)			(5,062,430	)
Held to maturity			-				(132,187	)
Loans made to customers, net of principal collected			958,785				4,403,357
Proceeds from sale of loans			-				1,483,594
Redemption (purchase) of stock in FHLB of Atlanta			(235,100	)			72,100
Purchases of premises, equipment and software			(179,292	)			(33,464	)
			(2,978,036	)			2,369,467
Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits			494,053				(2,285,616	)
Interest-bearing deposits			12,657,062				12,760,098
Securities sold under repurchase agreements			(1,249,774	)			(1,879,205	)
Federal Home Loan Bank of Atlanta advances			5,000,000				-
			16,901,341				8,595,277
Net increase in cash and cash equivalents			13,522,450				12,194,944
Cash and cash equivalents at beginning of period			9,121,352				14,618,237
Cash and cash equivalents at end of period		$	22,643,802			$	26,813,181

Three Months Ended March 31,		2020				2019
Reconciliation of net income to net cash provided by operating activities
Net income		$	843,307			$	1,096,287
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			89,852				90,167
Provision for loan losses			125,000				13,000
Lease expense in excess of rent paid			8,672				11,083
Equity security dividend reinvested			(2,769	)			(3,045	)
Unrealized gain on equity security			(8,510	)			(7,845	)
Gain on sale of loans			-				(130,015	)
Decrease (increase) in mortgage loans held for sale			(1,239,450	)			156,173
Amortization of premiums and accretion of discounts, net			53,086				19,721
Increase (decrease) in
Deferred loan fees			(20,801	)			(11,680	)
Accrued interest payable			3,511				38,717
Other liabilities			(458,358	)			(115,566	)
Decrease (increase) in
Accrued interest receivable			(45,857	)			(24,271	)
Bank owned life insurance cash surrender value			(42,012	)			(40,386	)
Other assets			293,474				137,860
		$	(400,855	)		$	1,230,200

 

1.	Principles of consolidation

 

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

 

2.	Basis of Presentation

 

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

 

Recent Accounting Pronouncements

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 841).” Among other things, in the amendments in ASU 2016-02, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company adopted the provisions of ASU 2016-02, effective January 1, 2019, by recording an asset of $1,400,855, a liability of $1,527,019, a $91,447 adjustment to retained earnings, and a $34,717 adjustment to deferred income taxes.

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

 

2.	Basis of Presentation (continued)

 

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

 

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

 

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

 

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

 

Subsequent Events

 

On March 11, 2020, the World Health Organization declared a pandemic as a result of the global spread of the coronavirus, commonly referred to as COVID-19.  The spread of the disease quickly accelerated in the United States and to date, all 50 states have reported cases.  The U.S. and state governments reacted to the pandemic by issuing shelter-at-home orders and requiring that non-essential businesses be closed to prevent spread of the virus.  The health crisis quickly turned into a financial crisis resulting in guidance and mandates regarding foreclosures and repossessions and accounting and regulatory changes designed to encourage banks to work with customers suffering detrimental financial impact.

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

 

As a result of the pandemic effecting the states and local markets in which it operates, the Company successfully implemented its Pandemic Contingency Plan with the goal of protecting the health, safety and financial well-being of its associates and customers.  As part of its plan to protect the financial well-being of its customers, the Company chose to participate and educate its customers on the government sponsored plans established to provide financial assistance to businesses.

 

The U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) which provides small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses.  We acted expeditiously to prepare our associates so they could guide our customers on the proper procedures necessary to enable them to take advantage of this program.  We developed an SBA PPP specific information site within our website that provided detailed information, links and materials for eligible customers to access.  Internally, we reallocated resources to review, process and data enter customer applications, working tirelessly over extended hours to provide access to as many local business owners as possible.  We were able to fund 172 loan applications for approximately $25.3 million from the first tranche of PPP designated funds.  Congress allocated additional funding to the PPP on April 23, 2020.  Due to our advance preparation and software implementation, we were able to quickly gain approval for an additional 78 loan applications for approximately $5.1 million through May 11, 2020.  In total, we have gained approval for over $30 million dollars to 250 small businesses.  Approximately 68% of the loans were under $100,000 in size. We will continue to provide access to the PPP and process applications for as long as the PPP is open and funds are available so that we can assist as many small business owners in our markets as possible.  These loans are 100% guaranteed by the SBA, have up to a two-year maturity, provide for a six-month deferral period, and have an interest rate of 1%.  These loans may be forgiven by the SBA if the borrower meets certain conditions, including by using at least 75% of the loan proceeds for payroll costs.  The SBA also established processing fees from 1% to 5%, depending on the loan amount.  We anticipate receiving approximately $1,257,000 in fees.

 

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

 

The Company’s allowance for loan losses (the “ALL”) increased $146,435 to $2,740,150 at March 31, 2020 compared to $2,593,715 at December 31, 2019.  The ALL to total loans was 0.76% and 0.72% at March 31, 2020 and December 31, 2019, respectively.  This increase was driven by the increased provision expense which was adjusted for qualitative factors related to the economic uncertainty and increased unemployment rates related to the COVID-19 pandemic.

 

The Company has provided loan modifications to its borrowers who are impacted by the COVID-19. Modifications include deferrals of principal and interest for periods up to three months and interest only periods of three months. These deferrals could be extended an additional three months. As of May 6, 2020, the Company has modified loans with an aggregate principal balance of $80.4 million, or 22% of its loan portfolio.  The Company is currently evaluating requests for relief on an additional $33.8 million in loans, or 9% of its loan portfolio. The pandemic has had an impact on most industries represented by the Company’s loan portfolio with respect to which these modifications have been made, including retail, mixed use, residential rental, land development, accommodations, senior living, commercial office, and warehouse. 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

 

3.	Investment Securities

 

Investments in debt securities are summarized as follows:

 

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

3.	Investment Securities (continued)

 

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

 

 

Securities with a carrying value of $10,258,557 and $11,441,474 as of March 31, 2020 and December 31, 2019, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

3.	Investment Securities (continued)

 

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

 

 

 

 

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

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

 

4.

Loans

 

Major categories of loans are as follows:

 

 

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

 

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

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

4.	Loans (continued)

 

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

 

 

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

 

At March 31, 2020, the Company had one commercial real estate loan totaling $2,071,836 and one residential real estate loan totaling $49,342 that were classified as TDRs. All are included in impaired loans above. At March 31, 2020, the commercial real estate loan is paying as agreed while the residential real estate loan was 30 to 59 days delinquent. There have been no charge-offs or allowances associated with these two loans.

 

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

 

Section 4013 of the CARES Act allows financial institutions to suspend application of certain current TDRs accounting guidance under ASC 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest, or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (e.g., six months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40. The Company continues to prudently work with borrowers negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for loan losses on its loan portfolio.  As of May 6, 2020, the Company has modified loans, due to the pandemic and at the borrower’s request, with an aggregate principal balance of $80.4 million, or 22% of its loan portfolio.  The Company is currently evaluating requests for relief on an additional $33.8 million in loans, or 9% of its loan portfolio.  All of these modifications are not be accounted for as TDRs since they currently meet the guidelines of the CARES Act. See Note 2 to the financial statements included elsewhere in this report for additional information. 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

4.	Loans (continued)

 

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

 

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

 

Pass/Watch

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

 

Special Mention

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

 

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

 

Substandard

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

 

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

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

4.	Loans (continued)

 

Doubtful

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

 

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

 

 

 

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

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

 

4.	Loans (Continued)

 

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

 

 

 

 

 

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)