Farmers & Merchants Bancshares, Inc. - Quarter Report: 2021 June (Form 10-Q)

fmfg20210630_10q.htm

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 June 30, 2021

☐	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: 3,023,487 as of August 6, 2021.

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 June 30, 2021 (unaudited) and December 31, 2020	3

Consolidated statements of income (unaudited) for the three and six months ended June 30, 2021 and 2020	4

Consolidated statements of comprehensive income (unaudited) for the three and six months ended June 30, 2021 and 2020	5

Consolidated statements of changes in stockholders’ equity (unaudited) for the three and six months ended June 30, 2021 and 2020	6

Consolidated statements of cash flows (unaudited) for the six months ended June 30, 2021 and 2020	7

Notes to financial statements (unaudited)	9

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3. Quantitative and Qualitative Disclosures About Market Risk	48

Item 4. Controls and Procedures	48

PART II – OTHER INFORMATION	49

Item 1. Legal Proceedings	49

Item 1A. Risk Factors	49

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 3. Defaults upon Senior Securities	49

Item 4. Mine Safety Disclosures	49

Item 5. Other Information	49

Item 6. Exhibits	49

SIGNATURES	50

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

	June 30,			December 31,
	2021			2020
	(Unaudited)
*Assets*

Cash and due from banks	$	31,687,027		$	39,898,557
Federal funds sold and other interest-bearing deposits		769,123			1,077,113
Cash and cash equivalents		32,456,150			40,975,670
Certificates of deposit in other banks		350,000			850,000
Securities available for sale, at fair value		98,251,607			54,477,286
Securities held to maturity, at cost		21,401,599			23,078,519
Equity security at fair value		547,914			552,566
Restricted stock, at cost		675,169			900,500
Mortgage loans held for sale		1,317,820			1,673,350
Loans, less allowance for loan losses of $3,404,168 and $3,296,538		517,356,334			521,690,514
Premises and equipment, net		6,304,771			7,736,556
Accrued interest receivable		1,777,967			2,057,491
Deferred income taxes, net		1,521,861			1,219,668
Other real estate owned		1,411,605			1,411,605
Bank owned life insurance		15,150,383			11,297,342
Goodwill and other intangibles		7,055,274			7,059,408
Other assets		1,908,201			2,336,607
	$	707,486,655		$	677,317,082

*Liabilities and Stockholders' Equity*

Deposits
Noninterest-bearing	$	126,712,827		$	103,155,113
Interest-bearing		485,417,230			470,246,434
Total deposits		612,130,057			573,401,547
Securities sold under repurchase agreements		13,686,564			24,753,972
Federal Home Loan Bank of Atlanta advances		5,000,000			5,000,000
Long-term debt, net of issuance costs		16,976,093			16,973,280
Accrued interest payable		154,780			409,622
Other liabilities		5,123,819			5,049,178
		653,071,313			625,587,599
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 3,023,487 in 2021 and 3,011,255 in 2020		30,235			30,113
Additional paid-in capital		28,557,249			28,294,139
Retained earnings		25,917,571			22,698,954
Accumulated other comprehensive (loss) income		(89,713	)		706,277
		54,415,342			51,729,483
	$	707,486,655		$	677,317,082

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

	Three months ended					Six months ended
	June 30,					June 30,
	2021			2020		2021			2020

Interest income
Loans, including fees	$	5,783,660		$	4,393,267	$	11,768,317		$	8,715,921
Investment securities - taxable		329,731			191,255		540,955			401,761
Investment securities - tax exempt		152,412			154,699		312,986			298,783
Federal funds sold and other interest earning assets		15,308			16,007		29,445			48,799
Total interest income		6,281,111			4,755,228		12,651,703			9,465,264

Interest expense
Deposits		533,437			832,464		1,128,957			1,738,663
Securities sold under repurchase agreements		14,972			39,496		28,483			77,690
Federal Home Loan Bank advances and other borrowings		190,181			12,865		378,287			12,974
Total interest expense		738,590			884,825		1,535,727			1,829,327
Net interest income		5,542,521			3,870,403		11,115,976			7,635,937

(Recovery of) provision for loan losses		(20,000	)		350,000		100,000			475,000

Net interest income after (recovery of) provision for loan losses		5,562,521			3,520,403		11,015,976			7,160,937

Noninterest income
Service charges on deposit accounts		176,483			117,658		335,674			276,213
Mortgage banking income		240,666			350,110		496,933			412,367
Bank owned life insurance income		82,922			43,211		153,041			85,223
Gain on sale of premises and equipment		-			-		37,613			-
Fair value adjustment on equity security		511			4,535		(8,158	)		13,045
Gain on sale of SBA loans		-			63,635		-			63,635
Gain on premium call of debt security		-			-		8,569			-
Other fees and commissions		47,974			29,077		81,829			59,745
Total noninterest income		548,556			608,226		1,105,501			910,228

Noninterest expense
Salaries		1,844,736			1,296,278		3,471,074			2,651,197
Employee benefits		438,133			359,450		911,021			806,554
Occupancy		245,318			185,394		495,530			368,546
Furniture and equipment		183,689			165,812		380,372			326,261
Acquisition		-			165,096		-			344,920
Other		797,257			689,973		1,646,260			1,310,838
Total noninterest expense		3,509,133			2,862,003		6,904,257			5,808,316

Income before income taxes		2,601,944			1,266,626		5,217,220			2,262,849
Income taxes		569,725			230,571		1,155,426			383,487
Net income	$	2,032,219		$	1,036,055	$	4,061,794		$	1,879,362

Earnings per share - basic and diluted	$	0.67		$	0.35	$	1.35		$	0.63

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2021			2020		2021			2020

Net income	$	2,032,219		$	1,036,055	$	4,061,794		$	1,879,362

Other comprehensive income (loss), net of income taxes:

Securities available for sale
Net unrealized gain (loss) arising during the period		(207,421	)		883,144		(1,106,751	)		1,055,835
Reclassification adjustment for realized gains and losses included in net income		-			-		8,569			-
Total unrealized gain (loss) on investment securities available for sale		(207,421	)		883,144		(1,098,182	)		1,055,835

Income tax expense (benefit)		(57,077	)		243,019		(302,192	)		290,539
Total other comprehensive income (loss)		(150,344	)		640,125		(795,990	)		765,296

Total comprehensive income	$	1,881,875		$	1,676,180	$	3,265,804		$	2,644,658

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three and six months Ended June 30, 2021 and 2020

(Unaudited)

					Additional					Accumulated other			Total
	Common stock				paid-in		Retained			comprehensive			stockholders'
	Shares		Par value		capital		earnings			income (loss)			equity
Three months ended June 30, 2020
Balance, March 31, 2020		2,974,019	$	29,740	$	27,812,991	$	22,411,468		$	167,795		$	50,421,994

Net income		-		-		-		1,036,055			-			1,036,055
Other comprehensive income		-		-		-		-			640,125			640,125
Cash dividends, $0.26 per share		-		-		-		(773,464	)		-			(773,464	)
Dividends reinvested		17,944		180		241,167		-			-			241,347

Balance, June 30, 2020		2,991,963	$	29,920	$	28,054,158	$	22,674,059		$	807,920		$	51,566,057

Six months ended June 30, 2020
Balance, December 31, 2019		2,974,019	$	29,740	$	27,812,991	$	21,568,161		$	42,624		$	49,453,516

Net income		-		-		-		1,879,362			-			1,879,362
Other comprehensive income		-		-		-		-			765,296			765,296
Cash dividends, $0.26 per share		-		-		-		(773,464	)		-			(773,464	)
Dividends reinvested		17,944		180		241,167		-			-			241,347

Balance, June 30, 2020		2,991,963	$	29,920	$	28,054,158	$	22,674,059		$	807,920		$	51,566,057

Three months ended June 30, 2021
Balance, March 31, 2021		3,011,255	$	30,113	$	28,294,139	$	24,728,529		$	60,631		$	53,113,412

Net income		-		-		-		2,032,219			-			2,032,219
Other comprehensive loss		-		-		-		-			(150,344	)		(150,344	)
Cash dividends, $0.28 per share		-		-		-		(843,177	)		-			(843,177	)
Dividends reinvested		12,232		122		263,110		-			-			263,232

Balance, June 30, 2021		3,023,487	$	30,235	$	28,557,249	$	25,917,571		$	(89,713	)	$	54,415,342

Six months ended June 30, 2021
Balance, December 31, 2020		3,011,255	$	30,113	$	28,294,139	$	22,698,954		$	706,277		$	51,729,483

Net income		-		-		-		4,061,794			-			4,061,794
Other comprehensive loss		-		-		-		-			(795,990	)		(795,990	)
Cash dividends, $0.28 per share		-		-		-		(843,177	)		-			(843,177	)
Dividends reinvested		12,232		122		263,110		-			-			263,232

Balance, June 30, 2021		3,023,487	$	30,235	$	28,557,249	$	25,917,571		$	(89,713	)	$	54,415,342

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Six Months Ended June 30,	2021			2020

Cash flows from operating activities
Interest received	$	13,180,690		$	9,404,760
Fees and commissions received		914,436			748,326
Interest paid		(1,931,141	)		(1,866,535	)
Proceeds from sale of mortgage loans held for sale		24,664,376			21,655,071
Origination of mortgage loans held for sale		(24,308,846	)		(22,887,047	)
Cash paid to suppliers and employees		(6,385,841	)		(5,413,489	)
Income taxes paid, net of refunds received		(650,000	)		-
		5,483,674			1,641,086

Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale		17,250,486			6,711,028
Held to maturity		2,078,569			500,000
Purchase of securities
Available for sale		(62,471,145	)		(19,890,543	)
Held to maturity		(342,062	)		(3,065,625	)
Purchases of certificates of deposit		500,000			(1,500,000	)
Loans made to customers, net of principal collected		3,981,211			(26,132,027	)
Proceeds from sale of loans		-			683,885
Redemption(purchase) of stock in FHLB of Atlanta		225,331			(235,100	)
Purchase of bank owned life insurance		(3,700,000	)		-
Proceeds from sale of premises and equipment		1,359,613			-
Purchases of premises, equipment and software		(113,873	)		(148,898	)
		(41,231,870	)		(43,077,280	)

Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits		23,557,714			25,292,071
Interest-bearing deposits		15,318,315			29,255,715
Securities sold under repurchase agreements		(11,067,408	)		292,803
Federal Home Loan Bank of Atlanta advances		-			5,000,000
Dividends paid, net of reinvestments		(579,945	)		(532,117	)

		27,228,676			59,308,472

Net increase in cash and cash equivalents		(8,519,520	)		17,872,278

Cash and cash equivalents at beginning of period		40,975,670			9,121,352
Cash and cash equivalents at end of period	$	32,456,150		$	26,993,630

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Six Months Ended June 30,	2021			2020

Reconciliation of net income to net cash provided by operating activities
Net income	$	4,061,794		$	1,879,362
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		241,912			164,949
Provision for loan losses		100,000			475,000
Amortization of right of use asset		15,475			17,215
Equity security dividends reinvested		(3,506	)		(5,440	)
Fair value adjustment on equity securities		8,158			(13,045	)
Gain on sale of SBA loans		-			(63,635	)
Gain on sale of premises and equipment		(37,613	)		-
Gain on premium call of debt security		(8,569	)		-
Amortization of debt issuance costs		2,813			-
Amortization of premiums and accretion of discounts, net		130,805			154,435
Bank owned life insurance cash surrender value		(153,041	)		(85,222	)
Increase (decrease) in
Deferred loan fees and costs, net		275,916			649,928
Accrued interest payable		(254,842	)		(37,208	)
Other liabilities		133,891			419,608
Decrease (increase) in
Mortgage loans held for sale		355,530			(1,231,976	)
Accrued interest receivable		279,524			(704,992	)
Other assets		335,427			22,107
	$	5,483,674		$	1,641,086

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1.	Principles of consolidation

The consolidated financial statements include the accounts of Farmers and Merchants Bancshares, Inc. and its wholly owned subsidiaries, Farmers and Merchants Bank (the “Bank”), and Series Protected Cell FCB-4 (the “Insurance Subsidiary”), and one subsidiary of the Bank, Reliable Community Financial Services, Inc. (collectively the “Company”, “we”, “us”, or “our”). The Insurance Subsidiary constitutes an investment in a series of membership interests, 100% owned by the Company, issued by First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed property and casualty insurance company. Intercompany balances and transactions have been eliminated. This includes the insurance premium paid by the Bank to the Insurance Subsidiary through an intermediary. Effective October 1, 2020, the Company acquired Carroll Bancorp, Inc. and its wholly-owned subsidiary, Carroll Community Bank (collectively, “Carroll”), both of which were based in Eldersburg, Maryland, through a series of merger transactions (the “Merger”). The results of operations and assets acquired and liabilities assumed from Carroll are included only from the effective date of the Merger. The comparability of the Company's results of operations for the three and six months ended June 30, 2021, and 2020 have been impacted by the Merger.

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- and six- months ended June 30, 2021 do not necessarily reflect the results that may be expected for the fiscal year ending December 31, 2021 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, 2020, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2020.

Summary of Significant Accounting Policies

The accounting and reporting policies reflected in the financial statements conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Management makes estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosures of commitments and contingent liabilities at the balance sheet date, and revenues and expenses during the year. These estimates and assumptions may affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Loans and allowance for loan losses

Loans are stated at the current amount of unpaid principal, adjusted for deferred origination costs, deferred origination fees, premiums and discounts on acquired loans, and the allowance for loan losses. Interest on loans is accrued based on the principal amounts outstanding. Origination fees and costs, along with premiums and accretable discounts, are amortized to income over the terms of loans.

Past due status is based on the contractual terms of the loan. Management may make an exception to reporting a loan as past due, if the past due status is solely due to the loan being past maturity, the Company intends to extend the loan, and the borrower is making principal and interest payments in accordance with the terms of the matured note. The accrual of interest is discontinued when any portion of the principal or interest is 90 days past due and collateral is insufficient to discharge the debt in full. If collection of principal is evaluated as doubtful, all payments are applied to principal. Loans are considered impaired when, based on current information, management considers it unlikely that the collection of principal and interest payments will be made according to contractual terms. Generally, loans are not reviewed for impairment until the accrual of interest has been discontinued or the loans are included on the watch list.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.	Basis of Presentation (continued)

The allowance for loan losses represents an amount which, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The Company’s allowance for loan losses consists of three elements: (i) segregating the loan portfolio into pools based upon similar characteristics and risk profiles and applying a loss factor to the pools, based on historical losses within those pools, (ii) applying qualitative factors to the loan pools that consider economic and other factors, both internal and external, affecting the Company and the pools, and (iii) determining specific reserves based on individual evaluation of impaired loans that are not included in the pools discussed above.

The allowances established for probable losses on impaired loans are based on a regular analysis and evaluation of problem loans. Management maintains a watch list of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor's ability to repay; (ii) the underlying collateral, if any; (iii) the economic environment; and (iv) for commercial borrowers, the industry in which the borrower operates. Specific valuation allowances are determined when the collateral value, if the loan is collateral dependent, or the discounted cash flows of the impaired loan is lower than the carrying value.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool over the prior twenty quarters. The historical loss ratios are updated quarterly based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool.

Adjustments to the historical valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such adjustments are determined by evaluating, among other things: (i) the impact of economic conditions on the portfolio; (ii) changes in asset quality, including delinquency trends; (iii) the impact of changing interest rates on portfolio risk; (iv) changes in legislative and regulatory policy; (v) the composition and concentrations of credit; and (vi) the effectiveness of the internal loan review function as well as changes to policies and experience of loan personnel. Management evaluates these qualitative factors on a quarterly basis. Each factor could result in an adjustment that is positive, negative, or no impact.

Loan losses are charged to the allowance when management believes that collection is unlikely. Collections of loans previously charged off are added to the allowance at the time of recovery.

Loans acquired in connection with business combinations are recorded at fair value with no carryover of any allowance for loan losses. Fair value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.	Basis of Presentation (continued)

The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. These loans are accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The nonaccretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases in expected cash flows will require us to evaluate the need for an addition to the allowance for loan losses. Subsequent improvement in expected cash flows will result in the reversal of a corresponding amount of the nonaccretable discount, which we will then reclassify as accretable discount to be recognized into interest income over the remaining life of the loan.

Loans acquired through business combinations that meet the specific criteria of ASC 310-30 are individually evaluated each period to analyze expected cash flows. To the extent that the expected cash flows of a loan have decreased due to credit deterioration, the Company establishes an allowance.

Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30 are accounted for under ASC 310-20, Receivables - Nonrefundable Fees and Other Costs. These loans are initially recorded at fair value, and include credit and interest rate marks associated with acquisition accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans subsequent to acquisition which is evaluated quarterly based on a comparison of the remaining fair value discount to the required allowance under appropriate methodology.

Goodwill and other intangible assets

Goodwill is calculated as the purchase premium, if any, after adjusting for the fair value of net assets acquired in purchase transactions. Goodwill is not amortized but is reviewed for potential impairment on at least an annual basis, with testing between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit. Other intangible assets represent purchased assets that can be distinguished from goodwill because of contractual or other legal rights. The Company’s other intangible asset, core deposit intangible (“CDI”) has a finite life and is amortized over 10 years on a straight line basis.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.	Basis of Presentation (continued)

Recent Accounting Pronouncements

In June 2016, the FASB issued Accounting Standards Update (“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 December 2019, FASB released ASU 2019-12, “Income Taxes (Topic 740)”, which simplifies the accounting for income taxes by removing multiple exceptions to the general principals in Topic 740. ASU 2019-12 is effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2020. The standard did not have a significant impact on the Company’s financial statements.

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities

Investments in debt securities are summarized as follows:

Amortized

Unrealized

Fair

June 30, 2021

cost

gains

losses

value

Available for sale

State and municipal

756,552

14,425

770,977

SBA pools

1,682,144

1,957

27,013

1,657,088

Corporate bonds

7,955,863

121,417

2,694

8,074,586

Mortgage-backed securities

87,980,820

672,743

904,607

87,748,956

98,375,379

810,542

934,314

98,251,607

Held to maturity

State and municipal

21,401,599

1,013,209

56,888

22,357,920

	Amortized		Unrealized		Unrealized		Fair
December 31, 2020	cost		gains		losses		value

*Available for sale*

State and municipal	$	962,438	$	24,094	$	-	$	986,532
SBA pools		1,822,226		-		38,419		1,783,807
Corporate bonds		6,692,156		108,172		2,897		6,797,431
Mortgage-backed securities		44,026,055		941,987		58,526		44,909,516
	$	53,502,875	$	1,074,253	$	99,842	$	54,477,286

*Held to maturity*

State and municipal	$	23,078,519	$	1,177,125	$	10,858	$	24,244,786

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities (continued)

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

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
June 30, 2021	cost		value		cost		value

Within one year	$	499,816	$	511,785	$	-	$	-
Over one to five years		4,122,839		4,234,922		796,579		811,970
Over five to ten years		4,089,760		4,098,856		2,032,001		2,101,343
Over ten years		-		-		18,573,019		19,444,607
		8,712,415		8,845,563		21,401,599		22,357,920
Mortgage-backed securities and SBA pools, due in monthly installments		89,662,964		89,406,044		-		-
	$	98,375,379	$	98,251,607	$	21,401,599	$	22,357,920

December 31, 2020

Within one year	$	505,372	$	502,475	$	487,741	$	496,463
Over one to five years		4,646,388		4,755,483		793,876		813,523
Over five to ten years		2,300,591		2,323,451		2,476,827		2,687,063
Over ten years		202,243		202,554		19,320,075		20,247,737
		7,654,594		7,783,963		23,078,519		24,244,786
Mortgage-backed securities and SBA pools, due in monthly installments		45,848,281		46,693,323		-		-
	$	53,502,875	$	54,477,286	$	23,078,519	$	24,244,786

Securities with a carrying value of $23,432,296 and $34,958,212 as of June 30, 2021 and December 31, 2020, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

During the six months ended June 30, 2021, the Company received proceeds of $513,845 from the call at a premium of an available for sale investment security. The Company realized an $8,569 gain on the call of the security. There were no sales of securities during the six months ended June 30, 2020.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

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 June 30, 2021 and December 31, 2020.

June 30, 2021

Less than 12 months

12 months or more

Total

Description of investments

Fair Value

Unrealized

Loss

Fair Value

Unrealized

Loss

Fair Value

Unrealized

Loss

State and municipal

1,538,840

56,888

1,538,840

56,888

SBA pools

1,338,764

27,013

1,338,764

27,013

Corporate bonds

1,610,022

2,694

1,610,022

2,694

Mortgage-backed securities

50,748,391

894,680

943,976

9,927

51,692,367

904,607

Total

53,897,253

954,262

2,282,740

36,940

56,179,993

991,202

December 31, 2020	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
Description of investments	Fair value		losses		Fair value		losses		Fair value		losses

State and municipal	$	719,430	$	10,858	$	-	$	-	$	719,430	$	10,858
SBA pools		-		-		1,783,807		38,419		1,783,807		38,419
Corporate bonds		502,754		2,897		-		-		502,754		2,897
Mortgage-backed securities		9,286,525		57,987		96,652		539		9,383,177		58,526
Total	$	10,508,709	$	71,742	$	1,880,459	$	38,958	$	12,389,168	$	110,700

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 June 30, 2021 and December 31, 2020, 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 debt 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 June 30, 2021 and December 31, 2020, management believes that these unrealized losses are temporary and, accordingly, have not been recognized in the Company’s consolidated statement of income. At June 30, 2021, 46 available for sale and 3 held to maturity investments had unrealized losses.

At June 30, 2021, none of the available for sale or held to maturity investments were impaired. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

The factors considered in evaluating securities for impairment include whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Loans

Major categories of loans are as follows:

	June 30,		December 31,
	2021		2020
Real estate:
Commercial	$	319,322,780	$	309,284,811
Construction and land development		31,411,527		33,641,916
Residential		119,493,617		121,327,761
Commercial		51,330,242		61,368,105
Consumer		402,457		288,454
		521,960,623		525,911,047
Less: Allowance for loan losses		3,404,168		3,296,538
Deferred origination fees net of costs		1,200,121		923,995
	$	517,356,334	$	521,690,514

Commercial loans in the table above include $26.5 million and $31.1 million of Paycheck Protection Program (“PPP”) loans as of June 30, 2021 and December 31, 2020, respectively, which are 100% guaranteed by the Small Business Administration (“SBA”). $22.0 million were originated during the six months ended June 30, 2021. A substantial portion of the PPP loans in the Company’s portfolio are expected to be forgiven by the SBA. During the six months ended June 30, 2021, the Company collected approximately $1,037,000 in fees from the SBA in connection with the originations of the PPP loans. The fees, net of related origination costs, are being recognized as interest income over the term of the loans using the straight-line method, with accelerated recognition when the loan pays off before maturity through SBA forgiveness or other means.

Nonaccrual loans, segregated by class of loans, were as follows:

	June 30,		December 31,
	2021		2020
Real estate:
Commercial	$	4,388,004	$	4,407,829
Residential		31,500		220,967
	$	4,419,504	$	4,628,796

At June 30, 2021, the Company had one nonaccrual commercial real estate loan totaling $4,388,004 and one nonaccrual residential real estate loan totaling $31,500. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $124,308 would have been recorded for the six months ended June 30, 2021 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $8,176 at June 30, 2021.

At December 31, 2020, the Company had one nonaccrual commercial real estate loan totaling $4,407,829 and two nonaccrual residential real estate loans totaling $220,967. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $13,395 would have been recorded in 2020 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $8,176 at December 31, 2020.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

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

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or More		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
June 30, 2021
Real estate:
Commercial	$	-	$	-	$	-	$	-	$	319,322,780	$	319,322,780	$	-
Construction and land development		-		-		-		-		31,411,527		31,411,527		-
Residential		-		-		31,500		31,500		119,462,117		119,493,617		-
Commercial		-		-		-		-		51,330,242		51,330,242		-
Consumer		-		-		-		-		402,457		402,457		-
Total	$	-	$	-	$	31,500	$	31,500	$	521,929,123	$	521,960,623	$	-

December 31, 2020
Real estate:
Commercial	$	182,656	$	-	$	-	$	182,656	$	309,102,155	$	309,284,811	$	-
Construction and land development		-		-		-		-		33,641,916		33,641,916		-
Residential		24,591		-		220,967		245,558		121,082,203		121,327,761		-
Commercial		-		-		-		-		61,368,105		61,368,105		-
Consumer		-		-		-		-		288,454		288,454		-
Total	$	207,247	$	-	$	220,967	$	428,214	$	525,482,833	$	525,911,047	$	-

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the six months ended June 30, 2021 and the year ended December 31, 2020, are set forth in the following table:

	Unpaid		Recorded		Recorded
	Contractual		Investment		Investment		Total				Average
	Principal		With No		With		Recorded		Related		Recorded		Interest
	Balance		Allowance		Allowance		Investment		Allowance		Investment		Recognized
June 30, 2021
Commercial real estate	$	6,609,506	$	6,609,506	$	-	$	6,609,506	$	-	$	6,634,826	$	56,179
Construction and land development		-		-		-		-		-		-		-
Residential real estate		42,005		42,005		-		42,005		-		43,369		857
	$	6,651,511	$	6,651,511	$	-	$	6,651,511	$	-	$	6,678,195	$	57,036

December 31, 2020
Commercial real estate	$	6,660,145	$	6,660,145	$	-	$	6,660,145	$	-	$	4,448,343	$	345,570
Construction and land development		-		-		-		-		-		-		-
Residential real estate		44,733		44,733		-		44,733		-		430,360		2,139
	$	6,704,878	$	6,704,878	$	-	$	6,704,878	$	-	$	4,878,703	$	347,709

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

Impaired loans include troubled debt restructurings (“TDRs”), which are loans that have been modified to provide economic concessions to borrowers who have experienced 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 June 30, 2021, the Company had two commercial real estate loans totaling $2,221,502 and one residential real estate loan totaling $42,005 that were classified as TDRs. All are included in impaired loans above. At June 30, 2021, all three loans were paying as agreed. There have been no charge-offs or allowances associated with these three loans.

At December 31, 2020, the Company had two commercial real estate loans totaling $2,252,316 and one residential real estate loan totaling $44,733 classified as TDRs. One of the commercial real estate loans with a principal balance of $182,656 was restructured as a TDR during 2020. All three loans are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these three loans.

Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security 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 January 1, 2022 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 June 30, 2021, $5.1 million, or 1% of the Company’s loan portfolio, were granted three-month deferrals. None of these loans were classified as TDRs as of June 30, 2021 because they met the criteria discussed above.

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:

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

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.

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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

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

Above

Pass

Special

June 30, 2021

Excellent

average

Average

Acceptable

watch

mention

Substandard

Doubtful

Total

Real estate:

Commercial

1,678,287

87,503,664

113,377,554

103,216,843

5,700,716

7,845,716

319,322,780

Construction and land development

5,758,191

11,984,373

8,893,951

1,841,696

2,933,316

31,411,527

Residential

49,334

902,490

57,430,049

48,605,991

9,981,116

2,524,637

119,493,617

Commercial

26,227,641

6,978,988

13,448,027

4,675,586

51,330,242

Consumer

8,279

227,779

131,465

4,668

13,854

16,412

402,457

26,285,254

2,808,556

157,802,357

187,420,613

126,781,350

7,542,412

13,303,669

16,412

521,960,623

			Above						Pass		Special
December 31, 2020	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total

Real estate:
Commercial	$	-	$	2,010,472	$	96,178,011	$	87,860,036	$	108,045,730	$	5,951,177	$	9,239,385	$	-	$	309,284,811
Construction and land development		-		-		2,962,300		15,944,499		13,168,844		-		1,566,273		-		33,641,916
Residential		36,285		1,026,824		63,811,389		40,947,548		12,579,311		-		2,926,404		-		121,327,761
Commercial		32,088,058		-		10,037,516		13,532,170		5,710,361		-		-		-		61,368,105
Consumer		13,729		109,955		131,171		6,671		15,663		-		-		11,265		288,454
	$	32,138,072	$	3,147,251	$	173,120,387	$	158,290,924	$	139,519,909	$	5,951,177	$	13,732,062	$	11,265	$	525,911,047

The principal balance of loans in the Pass/Watch category as of June 30, 2021 and December 31, 2020 include loans that were granted payment deferrals due to COVID -19. The loans were downgraded to the Pass/Watch category if they were in a higher rated category at the time the deferral was granted. Loans that completed their initial 90 day deferral and are making scheduled payments again are being re-evaluated on a loan by loan basis to determine if they warrant upgrading.

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 six-month periods ended June 30, 2021 and 2020 and for the year ended December 31, 2020. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

June 30, 2021

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

2,230,129

373,796

3,500

2,607,425

6,609,506

312,713,274

Construction and land development

201,692

(67,611

)

8,100

142,181

1,544,309

29,867,218

Residential

644,639

(148,627

)

(18,970

)

477,042

42,005

511,413

118,940,199

Commercial

111,390

(18,184

)

15,000

108,206

51,330,242

Consumer

2,138

450

2,588

402,457

Unallocated

106,550

(39,824

)

66,726

3,296,538

100,000

(18,970

)

26,600

3,404,168

6,651,511

2,055,722

513,253,390

												Allowance for loan losses ending						Outstanding loan balances
			Provision									balance evaluated for impairment:						evaluated for impairment:
	Beginning		for loan			Charge				Ending		Purchase Credit						Purchase Credit
June 30, 2020	balance		losses			offs		Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	1,763,861	$	396,409		$	-	$	44,962	$	2,205,232	$	-	$	-	$	2,205,232	$	2,502,296	$	-	$	233,437,877
Construction and land development		192,828		22,302			-		7,200		222,330		-		-		222,330		-		-		20,550,954
Residential		478,124		55,640			-		-		533,764		-		-		533,764		49,342		-		75,045,229
Commercial		107,782		(7,709	)		-		15,835		115,908		-		-		115,908		-		-		56,272,588
Consumer		4,133		(740	)		-		-		3,393		-		-		3,393		-		-		216,190
Unallocated		46,987		9,098			-		-		56,085		-		-		56,085		-		-		-
	$	2,593,715	$	475,000		$	-	$	67,997	$	3,136,712	$	-	$	-	$	3,136,712	$	2,551,638	$	-	$	385,522,838

												Allowance for loan losses ending						Outstanding loan balances
			Provision									balance evaluated for impairment:						evaluated for impairment:
	Beginning		for loan			Charge				Ending		Purchase Credit						Purchase Credit
December 31, 2020	balance		losses			offs		Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	1,763,861	$	418,806		$	-	$	47,462	$	2,230,129	$	-	$	-	$	2,230,129	$	6,660,245	$	151,453	$	302,473,113
Construction and land development		192,828		(5,536	)		-		14,400		201,692		-		-		201,692		-		1,566,174		32,075,742
Residential		478,124		166,515			-		-		644,639		-		-		644,639		215,230		595,433		120,517,098
Commercial		107,782		(12,353	)		-		15,961		111,390		-		-		111,390		-		-		61,368,105
Consumer		4,133		(1,995	)		-		-		2,138		-		-		2,138		-		-		288,454
Unallocated		46,987		59,563			-		-		106,550		-		-		106,550		-		-		-
	$	2,593,715	$	625,000		$	-	$	77,823	$	3,296,538	$	-	$	-	$	3,296,538	$	6,875,475	$	2,313,060	$	516,722,512

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (Continued)

The following table provides activity for the accretable credit discount of purchased loans:

	2021

Balance at December 31, 2020	$	2,250,232
Acquired during the year		-
Accretion		409,056
Adjustments		-
Balance at June 30, 2021	$	1,841,176

At June 30, 2021, the nonaccretable discount on purchased impaired loans was $927,000. At June 30, 2021, the remaining yield premium on purchased loans was $1,737,899. At June 30, 2021, the principal balance of purchased loans was $120,592,735 and the carrying value was $119,562,458. At June 30, 2021, there no residential real estate loans in the process of foreclosure.

5.	Goodwill and Other Intangibles

The acquisition of Carroll in October of 2020 resulted in the recording of goodwill and CDI. The following table presents the changes in both assets:

Goodwill

CDI

Total

Balance at December 31, 2020

6,978,208

81,200

7,059,408

Acquired during the year

Amortization

(4,134

)

(4,134

)

Adjustments

Balance at June 30, 2021

6,978,208

77,066

7,055,274

The CDI is being amortized over 10 years on a straight line basis. Annual amortization will be $8,328 for each of the years ended December 31, 2021 through 2029 and $6,246 in 2030. Since the acquisition was a tax-free reorganization, goodwill and CDI are not deductible for income tax purposes.

6.	Lease Commitments

The Company and its subsidiaries are obligated under operating leases for certain office premises.

The following table shows operating lease right of use assets and operating lease liabilities as of June 30, 2021 and December 31, 2020:

	Consolidated Balance
	Sheet classification	June 30, 2021		December 31, 2020
Operating lease right of use asset	Other assets	$	1,168,107	$	1,242,832
Operating lease liabilities	Other liabilities		1,384,716		1,443,966

Operating lease cost included in occupancy expense in the statement of income for the six months ended June 30, 2021 and 2020 was $101,351 and $94,134, respectively.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6.	Lease Commitments (continued)

A maturity analysis of operating lease liabilities, including those option years for which the Company is reasonably certain to renew, and reconciliation of the undiscounted cash flows to the total operating lease liabilities are as follows:

Year	Amount

2021	$	107,384
2022		221,497
2023		228,531
2024		234,910
2025		241,483
Thereafter		899,195
Total undiscounted cash flow		1,933,000
Discount		(548,284	)
Lease liabilities	$	1,384,716

For operating leases as of June 30, 2021, the weighted average remaining lease term is 8.0 years and the weighted average discount rate is 3.25%. During the six-month periods ended June 30, 2021 and 2020, cash paid for amounts included in the measurement of lease liabilities was $85,876 and $76,920, respectively.

7.	Capital Standards

Farmers and Merchants Bancshares, Inc. and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off‑balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to risk‑weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).

In connection with the adoption of the Basel III Capital Rules, the Bank elected to opt-out of the requirement to include accumulated other comprehensive income in Common Equity Tier 1 capital. Common Equity Tier 1 capital for the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions.

Insured depository institutions are required to meet the following in order to qualify as “well capitalized”: (i) a common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8%; (iii) a total risk-based capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5%.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Capital Standards (continued)

The implementation of the capital conservation buffer began on January 1, 2016, at the 0.625% level and was phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have current applicability to the Bank. As of June 30, 2021, the Bank met all capital adequacy requirements under the Basel III Capital Rules on a fully phased‑in basis.

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The following table presents actual and required capital ratios as of June 30, 2021 and December 31, 2020 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2021 and December 31, 2020 based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Capital ratios of the Company are substantially the same as the Bank’s.

Minimum

To Be Well

(Dollars in thousands)

Actual

Capital Adequacy

Capitalized

June 30, 2021

Amount

Ratio

Amount

Ratio

Amount

Ratio

Total capital (to risk-weighted assets)

66,196

12.58

55,251

10.50

52,620

10.00

Tier 1 capital (to risk-weighted assets)

62,792

11.93

44,727

8.50

42,096

8.00

Common equity tier 1 (to risk- weighted assets)

62,792

11.93

36,834

7.00

34,203

6.50

Tier 1 leverage (to average assets)

62,792

9.00

27,896

4.00

34,870

5.00

						Minimum					To Be Well
(Dollars in thousands)	Actual					Capital Adequacy					Capitalized
December 31, 2020	Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	63,400		12.62	%	$	52,732		10.50	%	$	50,221		10.00	%
Tier 1 capital (to risk-weighted assets)		60,104		11.97	%		42,688		8.50	%		40,177		8.00	%
Common equity tier 1 (to risk- weighted assets)		60,104		11.97	%		35,155		7.00	%		32,644		6.50	%
Tier 1 leverage (to average assets)		60,104		9.05	%		26,569		4.00	%		33,211		5.00	%

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of June 30, 2021, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

The FDIC, through formal or informal agreement, has the authority to require an institution to maintain higher capital ratios than those provided by statute, to be categorized as well capitalized under the regulatory framework for prompt corrective action.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value

In accordance with FASB ASC 820, “Fair Value Measurements and Disclosure”, the Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is the most representative of fair value under current market conditions.

In accordance with the guidance, a hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under FASB ASC 820 based on these two types of inputs are as follows:

●

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

●

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

●

Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company uses the following methods and significant assumptions to estimate the fair values of the following assets:

●

Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices from a nationally recognized securities pricing agent. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities.

●

Equity security at fair value: The Company’s investment in an equity mutual fund is valued based on the net asset value of the fund, which is classified as Level 1.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value (continued)

●

Other real estate owned (“OREO”): Nonrecurring fair value adjustments to OREO reflect full or partial write-downs that are based on the OREO’s observable market price or current appraised value of the real estate. Since the market for OREO is not active, OREO subjected to nonrecurring fair value adjustments based on the current appraised value of the real estate are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been 10% of the appraised value.

●

Impaired loans: Nonrecurring fair value adjustments to impaired loans reflect full or partial write-downs and reserves that are based on the impaired loan’s observable market price or current appraised value of the collateral. Since the market for impaired loans is not active, such loans subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been 10% of the appraised value.

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of June 30, 2021 and December 31, 2020, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Carrying Value:

Level 1

Level 2

Level 3

Total

June 30, 2021

Recurring

Available for sale securities

State and municipal

770,977

SBA pools

1,657,088

Corporate bonds

8,074,586

Mortgage-backed securities

87,748,956

98,251,607

Equity security at fair value

Mutual fund

547,914

Nonrecurring

Other real estate owned

1,411,605

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value (continued)

	Carrying Value:

	Level 1		Level 2		Level 3		Total
December 31, 2020

Recurring
Available for sale securities
State and municipal	$	-	$	986,532	$	-	$	986,532
SBA pools		-		1,783,807		-		1,783,807
Corporate Bonds		-		6,797,431		-		6,797,431
Mortgage-backed securities		-		44,909,516		-		44,909,516
	$	-	$	54,477,286	$	-	$	54,477,286

Equity security at fair value
Mutual fund	$	552,566	$	-	$	-	$	552,566

Nonrecurring
Other real estate owned	$	-	$	-	$	1,411,605	$	1,411,605

The estimated fair value of financial instruments that are reported at amortized cost in the Company’s consolidated balance sheets, segregated by the level of the valuation inputs were as follows:

June 30, 2021

December 31, 2020

Carrying

Estimated

Carrying

Estimated

Amount

Fair Value

Amount

Fair Value

Financial assets

Level 1 inputs

Cash and cash equivalents

32,456,150

40,975,670

Level 2 inputs

Certificates of deposit in other banks

350,000

850,000

Accrued interest receivable

1,777,967

2,057,491

Securities held to maturity

21,401,599

22,357,920

23,078,519

24,244,786

Mortgage loans held for sale

1,317,820

1,342,904

1,673,350

1,705,781

Restricted stock

547,914

900,500

Bank owned life insurance

15,150,383

11,297,342

Level 3 inputs

Loans, net

517,356,334

525,395,623

521,690,514

527,132,047

Financial liabilities

Level 1 inputs

Noninterest-bearing deposits

126,712,827

103,155,113

Securities sold under repurchase agreements

13,686,564

24,753,972

Level 2 inputs

Interest-bearing deposits

485,417,230

486,656,230

470,246,434

474,096,434

Federal Home Loan Bank advances

5,000,000

5,049,000

5,000,000

5,136,000

Long-term debt

16,976,093

17,298,274

16,973,280

17,018,416

Accrued interest payable

154,780

409,622

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

9.	Earnings per Share

Basic earnings per share is determined by dividing net income available to stockholders by the weighted-average number of shares of common stock outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents, giving retroactive effect to stock dividends declared during the period. Diluted earnings per share is determined in the same manner, except that the weighted-average number of shares of common stock outstanding is adjusted for the dilutive effect of outstanding common stock equivalents. The following table sets forth the calculation of basic and diluted earnings per share for the three and six-month periods ended June 30, 2021 and 2020. There were no common stock equivalents outstanding for the six-month periods ended June 30, 2021 or 2020.

	Three Months Ended				Six Months Ended
	June 30				June 30
	2021		2020		2021		2020

Net income	$	2,032,219	$	1,036,055	$	4,061,794	$	1,879,362
Weighted average shares outstanding		3,011,927		2,975,005		3,011,593		2,974,512
Earnings per share - basic and diluted	$	0.67	$	0.35	$	1.35	$	0.63

10.

Retirement Plans

The Company has a profit sharing plan qualifying under Section 401(k) of the Internal Revenue Code. All employees age 21 or more with six months of service are eligible for participation in the plan. The Company matches employee contributions up to 4% of total compensation and may make additional discretionary contributions. Employee and employer contributions are 100% vested when made. The Company’s contributions to this plan were $64,824 and $42,941 for the three- month periods ended June 30, 2021 and 2020, respectively, and $141,748 and $109,590 for the six-month periods ended June 30, 2021 and 2020.

The Company has entered into agreements with 12 employees to provide certain life insurance benefits payable in connection with policies of life insurance on those employees that are owned by the Company. Each of the agreements provides for the amount of death insurance benefits to be paid to beneficiaries of the insured. For this plan, the Company expensed $1,661 and $1,589 for the three-month periods ended June 30, 2021 and 2020, respectively, and $3,322 and $3,178 for the six-month periods ended June 30, 2021 and 2020.

The Company adopted supplemental executive retirement plans for three of its executives. The plans provide cash compensation to the executive officers under certain circumstances, including a separation of service. The benefits vest over the period from adoption to a specified age for each executive. The Company recorded expenses, including interest, of $42,000 and $51,300 for the three-month periods ended June 30, 2021 and 2020, respectively, and $84,000 and $102,600 for the six-month periods ended June 30, 2021 and 2020 related to these plans.

Retirement plan expenses are included in employee benefits on the consolidated statements of income.

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

Introduction

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of Farmers and Merchants Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the audited consolidated financial statements and notes thereto, and the other statistical information contained in the Annual Report of Farmers and Merchants Bancshares, Inc. on Form 10-K for the year ended December 31, 2020 (the “Form 10-K”). References in this report to “us”, “we”, “our”, and “the Company” are to Farmers and Merchants Bancshares, Inc. and, unless the context clearly suggests otherwise, its consolidated subsidiaries.

Forward-Looking Statements

This report may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature, including those that include the words “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions, including those impacted and/or driven by the COVID-19 pandemic; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

Farmers and Merchants Bancshares, Inc.

Farmers and Merchants Bancshares, Inc. is a Maryland corporation and a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Company was incorporated on August 8, 2016 for the purpose of becoming the holding company of Farmers and Merchants Bank (the “Bank”) in a share exchange transaction that was intended to constitute a tax-free exchange under Section 351 of the Internal Revenue Code of 1986, as amended (the “Reorganization”). The Reorganization was consummated on November 1, 2016, at which time the Bank became a wholly-owned subsidiary of the Company and all of the Bank’s stockholders became stockholders of the Company by virtue of the conversion of their shares of common stock of the Bank into an equal number of shares of common stock of the Company.

The Company’s primary business activities are serving as the parent company of the Bank and holding a series investment in First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed protected cell captive insurance company (“FCBI”). The Company owns 100% of one series of membership interests issued by FCBI, which series is deemed a “protected cell” under Tennessee law and has been designated “Series Protected Cell FCB-4” (such series investment is hereinafter referred to as the “Insurance Subsidiary”).

The Bank is a Maryland commercial bank chartered on October 24, 1919 that is engaged in a general commercial and retail banking business. The Bank has had one inactive subsidiary, Reliable Community Financial Services, Inc., a Maryland corporation that was incorporated in April 1992 to facilitate the sale of fixed rate annuity products and later positioned to sell a full array of investment and insurance products.

The Insurance Subsidiary represents one protected cell of a protected cell captive insurance company (i.e., FCBI) that was formed on November 9, 2016 to better manage our risk programs, provide insurance efficiencies, and add operating income by both keeping insurance premiums paid with respect to such risks within our affiliated group of entities and realizing certain tax benefits that are unique to captive insurance companies. The Company’s investment in the Insurance Subsidiary represents one series of membership interests in FCBI. As a “series” limited liability company, FCBI is authorized by state law and its governing instruments to issue one or more series of membership interests, each of which, for all purposes under state law, is deemed to be a legal entity separate and apart from FCBI and its other series.

The Company maintains an Internet site at www.fmb1919.bank on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

Estimates and Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. See Note 1 of the Notes to the audited consolidated financial statements as of and for the year ended December 31, 2020, which were included in Item 8 of Part II of the Form 10-K. On an on-going basis, management evaluates estimates, including those related to loan losses and intangible assets, other-than-temporary impairment (“OTTI”) of investment securities, income taxes, and fair value of investments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet.

Management applies various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit and other intangible assets, other assets and liabilities obtained or assumed in business combinations. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on our results of operations, financial condition or disclosures of fair value information. In addition to valuation, we must assess whether there are any declines in value below the carrying value of assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statements of income. Examples include investment securities, goodwill and core deposit intangible, among others.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2020.

COVID-19 Pandemic

The COVID-19 pandemic has been wreaking havoc on the U.S. economy since the World Health Organization declared it a pandemic on March 11, 2020. The full impact and its effect on the banking industry, including the Company, will not be known for several quarters, but will be significant.

The U.S. and state governments reacted to the outbreak of 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.

Although states, including Maryland, have eased many of the previously-imposed COVID-19 restrictions, including stay-at-home orders and the required closure of non-essential businesses, and many individuals have been vaccinated, there are still a significant number of active infections throughout the Country, including in the State of Maryland, and individuals continue to become infected. As a result, it is possible that states, including Maryland, will re-implement some or all of the COVID-19 related restrictions that have been lifted and again require some or all non-essential businesses to close or drastically alter their business operations, which could have a material adverse impact on our customers and, thus, our financial condition and results of operations.

Paycheck Protection Program

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. During 2020, we made over $31 million in PPP loans. During the first six months of 2021, we made an additional $22 million of PPP loans. All PPP loans are 100% guaranteed by the SBA, have up to a five-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 majority of the PPP loans made in 2020 have been forgiven as of June 30, 2021 The SBA also established processing fees from 1% to 5%, depending on the loan amount. We received $1,037,000 in fees during the six months ended June 30, 2021 which, net of related origination costs, will be amortized into interest income over the life of the loans.

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 were to internal, non-interest-bearing accounts for 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.

Financial Condition

Total assets increased by $30,169,573, or 4.5%, to $707,486,655 at June 30, 2021 from $677,317,082 at December 31, 2020. The increase in total assets was due primarily to increases of $42,097,401 in debt securities and $3,853,041 in bank owned life insurance, offset by decreases of $4,334,180 in loans, $8,519,520 in cash and cash equivalents, and $1,431,785 in premises and equipment due to the sale of a former branch location.

Total liabilities increased $27,483,714, or 4.4%, to $653,071,313 at June 30, 2021 from $625,587,599 at December 31, 2020. The increase was due primarily to a $38,728,510 increase in deposits, offset by an $11,067,408 decrease in securities sold under repurchase agreements. The increase in deposits was due to an inflow of funds from depositors who have received numerous government stimulus funds.

Stockholders’ equity increased by $2,685,859 to $54,415,342 at June 30, 2021 from $51,729,483 at December 31, 2020. The increase was due primarily to net income for the six-month period ended June 30, 2021 of $4,061,794, offset by a decrease of $795.990 in accumulated other comprehensive (loss) income and dividends paid, net of reinvestment, of $579,945.

Loans

Major categories of loans at June 30, 2021 and December 31, 2020 were as follows:

	June 30,				December 31,
	2021				2020

Real estate:
Commercial	$	319,322,780	61	%	$	309,284,811	59	%
Construction/Land development		31,411,527	6	%		33,641,916	6	%
Residential		119,493,617	23	%		121,327,761	23	%
Commercial		51,330,242	10	%		61,368,105	12	%
Consumer		402,457	0	%		288,454	0	%
		521,960,623	100	%		525,911,047	100	%
Less: Allowance for loan losses		3,404,168				3,296,538
Deferred origination fees net of costs		1,200,121				923,995
	$	517,356,334			$	521,690,514

Loans decreased by $4,334,180, or 0.8%, to $517,356,334 at June 30, 2021 from $521,690,514 at December 31, 2020. The decrease was due primarily to decreases of $10,037,863 in commercial loans, $2,230,389 in construction/land development loans, and $1,834,144 in residential loans, offset by an increase of $10,037,969 in commercial real estate loans. The decrease in commercial loans was driven primarily by a decrease of $5,582,359 in PPP loans. The allowance for loan losses increased $107,630 to $3,404,168 at June 30, 2021 from $3,296,538 at December 31, 2020. Deferred origination fees, net of costs, increased to $1,200,121 at June 30, 2021 from $923,995 at December 31, 2020 due to the origination of the PPP loans.

The Company has adopted policies and procedures that seek to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for loan losses. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan, and the experience of the lending officer. The Company’s policy is to make the majority of its loan commitments in the market area it serves. Management believes that this tends to reduce risk because management is familiar with the credit histories of loan applicants and has in-depth knowledge of the risk to which a given credit is subject. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.

An age analysis of past due loans, segregated by class of loans, as of June 30, 2021 and December 31, 2020, is as follows:

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
June 30, 2021
Real estate:
Commerical	$	-	$	-	$	-	$	-	$	319,322,780	$	319,322,780	$	-
Construction/Land development		-		-		-		-		31,411,527		31,411,527		-
Residential		-		-		31,500		31,500		119,462,117		119,493,617		-
Commercial		-		-		-		-		51,330,242		51,330,242		-
Consumer		-		-		-		-		402,457		402,457		-

Total	$	-	$	-	$	31,500	$	31,500	$	521,929,123	$	521,960,623	$	-

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
December 31, 2020
Real estate:
Commerical	$	182,656	$	-	$	-	$	182,656	$	309,102,155	$	309,284,811	$	-
Construction/Land development		-		-		-		-		33,641,916		33,641,916		-
Residential		24,591		-		220,967		245,558		121,082,203		121,327,761		-
Commercial		-		-		-		-		61,368,105		61,368,105		-
Consumer		-		-		-		-		288,454		288,454		-

Total	$	207,247	$	-	$	220,967	$	428,214	$	525,482,833	$	525,911,047	$	-

It is the Company’s policy to place a loan in nonaccrual status whenever there is substantial doubt about the ability of the borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan, and the overall economic situation of the borrower when making a nonaccrual decision. Management closely monitors nonaccrual loans. The Company returns a nonaccrual loan to accruing status when (i) the loan is brought current with the full payment of all principal and interest arrearages, (ii) all contractual payments are thereafter made on a timely basis for at least nine months, and (iii) management determines, based on a credit review, that it is reasonable to expect that future payments will be made as and when required by the contract.

At June 30, 2021, the Company had one nonaccrual commercial real estate loan totaling $4,388,004 and one nonaccrual residential real estate loan totaling $31,500. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $124,308 would have been recorded for the three months ended June 30, 2021 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $8,176 at June 30, 2021.

At December 31, 2020, the Company had one nonaccrual commercial real estate loan totaling $4,407,829 and two nonaccrual residential real estate loans totaling $220,967. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $13,395 would have been recorded in 2020 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $8,176 at December 31, 2020.

Impaired loans as of June 30, 2021 and December 31, 2020 are set forth in the following table:

	June 30		December 31,
	2021		2020

Impaired loans with no valuation allowance	$	6,651,511	$	6,704,878
Impaired loans with a valuation allowance		-		-
Total impaired loans	$	6,651,511	$	6,704,878
Valuation allowance related to impaired loans	$	-	$	-

Impaired loans include troubled debt restructurings (“TDRs”), which are loans that were modified to provide economic concessions 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.

Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security 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 January 1, 2022 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 (i.e., 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.

The Company has provided loan modifications to its borrowers who are impacted by the COVID-19 pandemic. Modifications include deferrals of principal and interest for periods up to three months and interest only periods of three months. These deferrals can be extended for an additional three months, subject to approval by the Company. As of June 30, 2021, loans totaling $5.1 million, or 1% of the Company’s loan portfolio, were granted three-month deferrals. None of these loans were classified as TDRs as of June 30, 2021 because they met the criteria discussed above. See Note 4 to the financial statements included elsewhere in this report for additional information.

At June 30, 2021, the Company had two commercial real estate loans totaling $2,221,502 and one residential real estate loan totaling $42,005 that were classified as TDRs. All are included in impaired loans above. At June 30, 2021, all three loans were paying as agreed. There have been no charge-offs or allowances associated with these three loans.

At December 31, 2020, the Company had two commercial real estate loans totaling $2,252,316 and one residential loan totaling $44,733 classified as TDRs. One of the commercial real estate loans with a principal balance of $182,656 was restructured as a TDR during 2020. All three loans are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these three loans

	June 30,		December 31,
	2021		2020

Restructured loans (TDRs):
Performing as agreed	$	2,263,507	$	2,297,049
Not performing as agreed		-		-
Total TDRs	$	2,263,507	$	2,297,049

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense. The allowance for loan losses represents an amount which, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions.

The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, classified and criticized loans and net charge-offs or recoveries, among other factors.

Although management believes that, based on information currently available, the Company’s allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Company’s level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Company or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions at the time management determined the current level of the allowance for loan losses.

The following table details activity in the allowance for loan losses by portfolio for the six-month periods ended June 30, 2021 and 2020 and the year ended December 31, 2020. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

													Allowance for loan losses ending						Outstanding loan balances
			Provision										balance evaluated for impairment:						evaluated for impairment:
	Beginning		for loan			Charge					Ending		Purchase Credit						Purchase Credit
June 30, 2021	balance		losses			offs			Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	2,230,129	$	373,796		$	-		$	3,500	$	2,607,425	$	-	$	-	$	2,607,425	$	6,609,506	$	-	$	312,770,436
Construction and land development		201,692		(67,611	)		-			8,100		142,181		-		-		142,181		-		1,544,309		29,867,218
Residential		644,639		(148,627	)		(18,970	)		-		477,042		-		-		477,042		42,005		511,413		118,883,037
Commercial		111,390		(18,184	)		-			15,000		108,206		-		-		108,206		-		-		51,330,242
Consumer		2,138		450			-			-		2,588		-		-		2,588		-		-		402,457
Unallocated		106,550		(39,824	)		-			-		66,726		-		-		66,726		-		-		-
	$	3,296,538	$	100,000		$	(18,970	)	$	26,600	$	3,404,168	$	-	$	-	$	3,404,168	$	6,651,511	$	2,055,722	$	513,253,390

												Allowance for loan losses ending						Outstanding loan balances
			Provision									balance evaluated for impairment:						evaluated for impairment:
	Beginning		for loan			Charge				Ending		Purchase Credit						Purchase Credit
June 30, 2020	balance		losses			offs		Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	1,763,861	$	396,409		$	-	$	44,962	$	2,205,232	$	-	$	-	$	2,205,232	$	2,502,296	$	-	$	233,437,877
Construction and land development		192,828		22,302			-		7,200		222,330		-		-		222,330		-		-		20,550,954
Residential		478,124		55,640			-		-		533,764		-		-		533,764		49,342		-		75,045,229
Commercial		107,782		(7,709	)		-		15,835		115,908		-		-		115,908		-		-		56,272,588
Consumer		4,133		(740	)		-		-		3,393		-		-		3,393		-		-		216,190
Unallocated		46,987		9,098			-		-		56,085		-		-		56,085		-		-		-
	$	2,593,715	$	475,000		$	-	$	67,997	$	3,136,712	$	-	$	-	$	3,136,712	$	2,551,638	$	-	$	385,522,838

												Allowance for loan losses ending						Outstanding loan balances
			Provision									balance evaluated for impairment:						evaluated for impairment:
	Beginning		for loan			Charge				Ending		Purchase Credit						Purchase Credit
December 31, 2020	balance		losses			offs		Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	1,763,861	$	418,806		$	-	$	47,462	$	2,230,129	$	-	$	-	$	2,230,129	$	6,660,245	$	151,453	$	302,473,113
Construction and land development		192,828		(5,536	)		-		14,400		201,692		-		-		201,692		-		1,566,174		32,075,742
Residential		478,124		166,515			-		-		644,639		-		-		644,639		215,230		595,433		120,517,098
Commercial		107,782		(12,353	)		-		15,961		111,390		-		-		111,390		-		-		61,368,105
Consumer		4,133		(1,995	)		-		-		2,138		-		-		2,138		-		-		288,454
Unallocated		46,987		59,563			-		-		106,550		-		-		106,550		-		-		-
	$	2,593,715	$	625,000		$	-	$	77,823	$	3,296,538	$	-	$	-	$	3,296,538	$	6,875,475	$	2,313,060	$	516,722,512

The provision for loan losses was $100,000 and $475,000 for the six-month periods ended June 30, 2021 and 2020, respectively.

During the three-month periods ended June 30, 2021 and 2020, the Company had recoveries from loans written off in prior periods totaling $26,660 and $67,997, respectively, and charge-offs of $18,970 and $0, respectively.

As of June 30, 2021, the Company had $7,986,257 of loans on a watch list, other than impaired loans, for which the borrowers have the potential for experiencing financial difficulties. As of December 31, 2020, the Company had $9,546,879 of such loans. These loans are subject to ongoing management attention and their classifications are reviewed regularly. Watch list loans include loans classified as Special Mention, Substandard, and Doubtful.

The $3.4 million reserve at June 30, 2021 and the $100,000 provision for the 6 month period ended June 30, 2021 are appropriate due to the following factors:

●

The loan portfolio excluding PPP loans increased $1.6 million in the first six months of 2021.

PPP loans are fully insured by the SBA and carry no risk of loss and therefore no reserve.

●

COVID related payment deferrals – while overall payment deferrals are down from their peak at June 30, 2020, the loans that have had deferrals in 2021 have been given higher reserve percentages:

A $4.4 million loan has been on deferral for 15 months. The reserve percentage attributed to loans still on payment deferral increase each quarter and is currently at 10%.

$.7 million of loans were granted COVID related deferrals in the second quarter of 2021.

$11.4 million of payment deferred loans which began making full payments in the second quarter will have a declining reserve percentage until six full payments have been made.

Investment Securities

Investments in debt securities increased by $42,097,401 or 54.3% to $119,653,206 at June 30, 2021 from $77,555,805 at December 31, 2020. At June 30, 2021 and December 31, 2020, the Company had classified 82% and 70%, respectively, of the investment portfolio as available for sale. The balance of the portfolio was classified as held to maturity.

Securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the Company’s asset/liability management strategy. Available for sale debt securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of income taxes. Securities classified as held to maturity, which the Company has both the positive intent and ability to hold to maturity, are reported at amortized cost. The Company records unrealized gains and losses on equity securities in earnings. The Company does not currently follow a strategy of making security purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolio within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity, meet earnings objectives, and provide required collateral for deposit and borrowing activities.

The following table sets forth the carrying value of investments in debt securities at June 30, 2021 and December 31, 2020:

	June 30,		December 31,
	2021		2020
Available for sale
State and municipal	$	770,977	$	986,532
SBA pools		1,657,088		1,783,807
Corporate bonds		8,074,586		6,797,431
Mortgage-backed securities		87,748,956		44,909,516
	$	98,251,607	$	54,477,286

Held to maturity
State and municipal	$	21,401,599	$	23,078,519

The following table sets forth the scheduled maturities of investments in debt securities at June 30, 2021:

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Within 1 year	$	499,816	$	511,785	$	-	$	-
Over 1 to 5 years		4,122,839		4,234,922		796,579		811,970
Over 5 to 10 years		4,089,760		4,098,856		2,032,001		2,101,343
Over 10 years		-		-		18,573,019		19,444,607
		8,712,415		8,845,563		21,401,599		22,357,920
SBA Pools		1,682,144		1,657,088		-		-
Mortgage-backed securities		87,980,820		87,748,956		-		-
	$	98,375,379	$	98,251,607	$	21,401,599	$	22,357,920

SBA pools and mortgage-backed securities are due in monthly installments.

Other Real Estate Owned

Other real estate owned (“OREO”) at June 30, 2021 and December 31, 2020 included two properties with an aggregate carrying value of $1,411,605. The first property is an apartment building in Baltimore, Maryland with a carrying value of $1,411,605 that was obtained in the Merger. The property is under an optional sales contract with no projected closing date. The other property is land in Cecil County, Maryland with a carrying value of $0. It was acquired through foreclosure in 2007. The latter property consists of 10.43 acres and is currently under contract for a gross sales price of $295,000 with closing expected in 2021. Due to the length of time the property has been held, Maryland banking law required a write-down of the value to $0 in 2019.

Deposits

Total deposits increased by $38,728,510, or 6.8%, to $612,130,057 at June 30, 2021 from $573,401,547 at December 31, 2020. The increase in deposits was due to a $23,557,714 increase in noninterest-bearing accounts, a $17,311,175 increase in savings and money market accounts, and a $9,650,921 increase in interest bearing checking accounts, offset by an $11,791,300 decrease in time deposits.

The following table shows the average balances and average costs of deposits for the six months ended June 30, 2021 and 2020:

	June 30, 2021					June 30, 2020
	Average					Average
	Balance		Cost			Balance		Cost

Noninterest bearing demand deposits	$	116,817,132		0.00	%	$	70,072,698		0.00	%
Interest bearing demand deposits		112,810,820		0.20	%		68,862,747		0.33	%
Savings and money market deposits		177,924,515		0.17	%		105,378,381		0.29	%
Time deposits		191,615,321		0.91	%		155,964,337		1.88	%
	$	599,167,788		0.38	%	$	400,278,163		0.87	%

Liquidity Management

Liquidity describes our ability to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet depositor withdrawal requirements, to fund loans, and to fund our other debts and obligations as they come due in the normal course of business. We maintain our asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments, and income from earning assets. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. The Bank is approved to borrow 75% of eligible pledged single-family residential loans and 50% of eligible pledged commercial loans as well as investment securities, or approximately $85.5 million under a secured line of credit with the Federal Home Loan Bank (“FHLB”). The Bank also has a facility with the Federal Reserve Bank of Richmond (the “Reserve Bank”) under which the Bank can borrow approximately $30.3 million. Finally, the Bank has $23,500,000 ($14,500,000 unsecured and $9,000,000 secured) of overnight federal funds lines of credit available from commercial banks. FHLB advances of $5,000,000 were outstanding as of June 30, 2021 and December 31, 2020. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll as more fully described below. There were no borrowings from the Reserve Bank or our commercial bank lenders at June 30, 2021 and December 31, 2020. Management believes that we have adequate liquidity sources to meet all anticipated liquidity needs over the next 12 months. Management knows of no trend or event which is likely to have a material impact on our ability to maintain liquidity at satisfactory levels.

Borrowings and Other Contractual Obligations

The Company’s contractual obligations consist primarily of borrowings and operating leases for various facilities.

On September 30, 2020, the Company borrowed $17,000,000 from First Horizon Bank (“FHN”) for the purpose of funding a portion of the merger consideration that was payable to the stockholders of Carroll when it was merged with and into the Company on October 1, 2020. Net of issuance costs, the amount of the net long-term debt was $16,976,093 and $16,973,280 as of June 30, 2021 and December 31, 2020, respectively. The loan matures on September 30, 2025. The interest rate on the loan is fixed at 4.10%. The Company is required to make quarterly interest-only payments through October 1, 2021. The Company expects that the amount of these quarterly interest-only payments to be $174,250. During the remaining term of the loan, the Company is required to make quarterly interest and principal payments of approximately $646,472, which will be based on a nine-year straight-line amortization schedule. The remaining balance of approximately $9,916,667 will be due at maturity. To secure its obligations under this loan, the Company pledged all of its shares of common stock of the Bank to FHN.

Securities sold under agreements to repurchase represent overnight borrowings from customers. Securities owned by the Company which are used as collateral for these borrowings are primarily U.S. government agency securities.

Specific information about the Company’s borrowings and contractual obligations is set forth in the following table:

	June 30,			December 31,
	2021			2020
Amount oustanding at period-end:
Securities sold under repurchase agreements	$	13,686,564		$	24,753,972
Federal Home Loan Bank advances		5,000,000			5,000,000
Long-term debt (net of issuance costs)		16,976,093			16,973,280
Weighted average rate paid at period-end:
Securites sold under repurchase agreements		0.48	%		0.61	%
Federal Home Loan Bank advances		1.00	%		1.00	%
Long-term debt		4.10	%		4.10	%

The Federal Home Loan Bank advances and the long-term debt outstanding at June 30, 2021 will require the following principal payments:

Year ending December 31, 2022			1,888,889
Year ending December 31, 2023			1,888,889
Year ending December 31, 2024			1,888,889
Year ending December 31, 2025			16,333,333

Capital Resources and Adequacy

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off‑balance sheet items as calculated under regulatory accounting practices.

Additional information regarding the capital requirements that apply to us can be found in Note 6 to the consolidated financial statements presented elsewhere in this report and in Item 1 of Part I of the Form 10-K under the heading, “Supervision and Regulation – Capital Requirements”.

The following table presents actual and required capital ratios as of June 30, 2021 and December 31, 2020 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2021 and December 31, 2020, based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

						Minimum					To Be Well
(Dollars in thousands)	Actual					Capital Adequacy					Capitalized
June 30, 2021	Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	66,196		12.58	%	$	55,251		10.50	%	$	52,620		10.00	%
Tier 1 capital (to risk-weighted assets)		62,792		11.93	%		44,727		8.50	%		42,096		8.00	%
Common equity tier 1 (to risk-weighted assets)		62,792		11.93	%		36,834		7.00	%		34,203		6.50	%
Tier 1 leverage (to average assets)		62,792		9.00	%		27,896		4.00	%		34,870		5.00	%

December 31, 2020

Total capital (to risk-weighted assets)	$	63,400		12.62	%	$	52,732		10.50	%	$	50,221		10.00	%
Tier 1 capital (to risk-weighted assets)		60,104		11.97	%		42,688		8.50	%		40,177		8.00	%
Common equity tier 1 (to risk-weighted assets)		60,104		11.97	%		35,155		7.00	%		32,644		6.50	%
Tier 1 leverage (to average assets)		60,104		9.05	%		26,569		4.00	%		33,211		5.00	%

The Company intends to fund future growth primarily with cash, federal funds, maturities of investment securities and deposit growth. Management knows of no other trend or event that will have a material impact on capital.

Off-Balance Sheet Arrangements

In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. Outstanding loan commitments, unused lines of credit, and letters of credit as of June 30, 2021 and December 31, 2020 are as follows:

	June 30,		December 31,
	2021		2020

Loan commitments
Construction and land development	$	3,890,714	$	4,668,250
Commercial		2,607,079		1,000,000
Consumer		-		-
Commercial real estate		21,019,909		15,772,020
Residential		930,500		4,668,750
	$	28,448,202	$	26,109,020

Unused lines of credit
Home-equity lines	$	12,507,053	$	13,716,894
Commercial lines		22,200,746		23,996,679
	$	34,707,799	$	37,713,573

Letters of credit	$	1,553,018	$	1,891,428

Loan commitments and lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

The maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment. Loan commitments, lines of credit and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss that is likely to be incurred as a result of funding its credit commitments.

RESULTS OF OPERATIONS

Comparison of Operating Results for the Six Months Ended June 30, 2021 and 2020

General

Net income for the six months ended June 30, 2021 was $4,061,794, compared to $1,879,362 for the same period of 2020. The increase of $2,182,432, or 116.1%, was due to a $3,480,039 increase in net interest income, a $195,273 increase in noninterest income, and a $375,000 decrease in the loan loss provision, offset by a $1,095,941 increase in noninterest expenses and a $771,939 increase in income taxes.

The Company incurred significant one-time costs during 2020 in connection with the Company’s acquisition of Carroll. The table below provides a comparison of the Company’s results for the six months ended June 30, 2021 versus the same period of the prior year with and without $344,920 of acquisition costs incurred during the six months ended June 30, 2020.

	Six Months Ended
	June 30, 2021			June 30, 2020
							Excluding
	As Reported			As Reported			Acquisition Costs

Income before taxes	$	5,217,220		$	2,262,849		$	2,607,769
Income taxes		1,155,426			383,487			478,400
Net income	$	4,061,794		$	1,879,362		$	2,129,369
Earnings per share	$	1.35		$	0.63		$	0.72
Return on average assets		1.18	%		0.80	%		0.91	%
Return on average equity		15.18	%		7.39	%		8.38	%

Net Interest Income

Net interest income was $11,115,976 for the six months ended June 30, 2021, compared to $7,635,937 for the same period of 2020.

Total interest income for the six months ended June 30, 2021 was $12,651,703, compared to $9,465,264 for the same period of 2020, an increase of $3,186,439, or 33.7%.

Total interest income on loans for the six months ended June 30, 2021 increased by $3,052,396 when compared to the same period of 2021 due to a $151.5 million higher average loan balance for the first six months of 2021 when compared to the same period of 2020 primarily due to the acquisition of Carroll, offset by a lower loan yield of 4.47% for the first six months of 2021 versus 4.65% for the same period of 2020. Investment income for the six months ended June 30, 2021 increased by $153,397, or 21.9%, when compared to the same period of 2020 due to a $34.9 million higher average investment balance, offset by a decrease in fully-taxable equivalent yield to 1.99% for six months ended June 30, 2021, compared to 2.72% for the same period of 2020. The fully-taxable equivalent yield on total interest-earning assets decreased 33 basis points to 3.92% for the six months ended June 30, 2021 compared to 4.25% for the same period of 2020. The average balance of total interest-earning assets increased by $199.5 million to $650.3 million for the six months ended June 30, 2021, compared to $450.8 million for the same period of 2020 primarily due to the acquisition of Carroll.

Total interest expense for the six months ended June 30, 2021 was $1,535,727, compared to $1,829,327 for the same period of 2020, a decrease of $293,600, or 16.1%. The decrease was due to a lower overall cost of funds on interest bearing deposits and borrowings of 0.60% for the six months ended June 30, 2021, compared to 1.07% for the same period of 2020, offset by a $172.7 million increase in the average balance of interest-bearing liabilities to $515.8 million in the first six months of 2021, compared to $343.2 million in the same period of 2020. Cost of funds for time deposits decreased to 0.91% for the six months ended June 30, 2021 from 1.88% for the same period of 2020. Securities sold under repurchase agreements cost of funds decreased to 0.50% for the first six months of 2021 from 1.50% for the first six months of 2020.

Average noninterest-earning assets increased by $22.9 million to $41.9 million in the first six months of 2021, compared to $17.9 million in the same period of 2020. Average noninterest-bearing deposits increased by $46.7 million to $116.8 million during the first six months of 2021, compared to $70.1 million in the same period of 2020. The average balance in stockholders’ equity increased by $2.7 million for the six months ended June 30, 2021, when compared with the same period of 2020.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the six-month periods ended June 30, 2021 and 2020. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Six Months Ended June 30, 2021							Six Months Ended June 30, 2020
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	526,586,402	$	11,768,317		4.47	%	$	375,105,468	$	8,715,921		4.65	%
Securities, taxable		74,326,338		543,033		1.46	%		39,914,284		434,268		2.18	%
Securities, tax exempt		20,689,680		403,933		3.90	%		20,159,139		381,238		3.78	%
Federal funds sold and other interest-earning assets		28,720,770		30,971		0.22	%		15,658,843		50,871		0.65	%
Total interest-earning assets		650,323,190		12,746,254		3.92	%		450,837,734		9,582,298		4.25	%
Noninterest-earning assets		40,851,762							17,930,373
Total assets	$	691,174,952						$	468,768,107

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	290,735,335		259,248		0.18	%	$	174,241,128		269,892		0.31	%
Certificates of deposit		191,615,321		869,709		0.91	%		155,964,337		1,468,771		1.88	%
Securities sold under repurchase agreements		11,484,379		28,483		0.50	%		10,386,558		77,690		1.50	%
Long-term debt		16,974,687		353,249		4.16	%		-		-		-
FHLB advances and other borrowings		5,000,000		25,038		1.00	%		2,565,934		12,974		1.01	%
Total interest-bearing liabilities		515,809,722		1,535,727		0.60	%		343,157,957		1,829,327		1.07	%

Noninterest-bearing deposits		116,817,132							70,072,698
Noninterest-bearing liabilities		5,033,798							4,708,605
Total liabilities		637,660,652							417,939,260
Stockholders' equity		53,514,300							50,828,847
Total liabilities and stockholders' equity	$	691,174,952						$	468,768,107

Net interest income			$	11,210,527						$	7,752,971

Interest rate spread						3.32	%						3.18	%

Net yield on interest-earning assets						3.45	%						3.44	%

Ratio of average interest-earning assets to
Average interest-bearing liabilities						126.08	%						131.38	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis based upon tax rates of 21% for Federal and 8.25% for State.

Noninterest Income

Noninterest income for the six months ended June 30, 2021 was $1,105,501, compared to $910,228 for the same period of 2020, an increase of $195,273, or 21.5%. The increase was primarily a result of an $84,566 increase in mortgage banking income due to continued low interest rates driving strong residential purchase and refinance activity, a $67,818 increase in bank owned life insurance income due to the Carroll acquisition along with a $3.7 million purchase in the first quarter of 2021, a $59,461 increase in service charges as ATM usage and other bank services returned to normal levels compared to the beginning of the pandemic in 2020, and a $37,613 gain on the sale of a former Carroll branch office, offset by a $63,635 decrease in the gain on sale of SBA loans.

Noninterest Expense

Noninterest expense for the six months ended June 30, 2021 totaled $6,904,257, compared to $5,808,316 for the same period of 2020, an increase of $1,095,941, or 18.9%. The increase was due primarily to, increases in salaries and benefits of $924,344, in occupancy, furniture and equipment of $181,095, and in other of $335,422, offset by a decrease in costs incurred related to the acquisition of Carroll of $344,920. The increases are all a result of the employees, locations, and customers added from the acquisition of Carroll.

Income Tax Expense

Income tax expense for the six months ended June 30, 2021 was $1,155,426, compared to $383,487 for the same period of 2020. The effective tax rate was 22.2% for the six months ended June 30, 2021, compared to 17.0% for the same period of 2020. The increase in income tax expense was due primarily to higher income before income taxes and a lower percentage of tax exempt revenue for the six months ended June 30, 2021 when compared to the same period in 2020.

Comparison of Operating Results for the Three Months Ended June 30, 2021 and 2020

General

Net income for the three months ended June 30, 2021 was $2,032,219, compared to $1,036,055 for the same period of 2020. The increase of $996,164, or 96.2%, was due to a $1,672,118 increase in net interest income and a $370,000 decrease in the loan loss provision, offset by a $647,130 increase in noninterest expenses, a $59,670 decrease in noninterest income and a $339,154 increase in income taxes.

The Company incurred significant one-time costs during 2020 in connection with the Company’s acquisition of Carroll. The table below provides a comparison of the Company’s results for the second quarter of 2021 versus the same period of the prior year with and without $165,096 of acquisition costs incurred during the second quarter of 2020.

	Three Months Ended
	June 30, 2021			June 30, 2020
							Excluding
	As Reported			As Reported			Acquisition Costs

Income before taxes	$	2,601,944		$	1,266,626		$	1,431,722
Income taxes		569,725			230,571			276,001
Net income	$	2,032,219		$	1,036,055		$	1,155,721
Earnings per share	$	0.67		$	0.35		$	0.39
Return on average assets		1.16	%		0.85	%		0.94	%
Return on average equity		15.02	%		8.05	%		8.98	%

Net Interest Income

Net interest income was $5,542,521 for the three months ended June 30, 2021, compared to $3,870,403 for the same period of 2020.

Total interest income for the three months ended June 30, 2021 was $6,281,111, compared to $4,755,228 for the same period of 2020, an increase of $1,525,883, or 32.1%.

Total interest income on loans for the three months ended June 30, 2021 increased by $1,390,393 when compared to the same period of 2020 due to a $140.2 million higher average loan balance for the three months ended June 30, 2021 when compared to the same period of 2020 primarily due to the acquisition of Carroll, offset by a lower loan yield of 4.40% for the three months ended June 30, 2021 versus 4.56% for the same period of 2020. Investment income for the three months ended June 30, 2021 increased by $136,189, or 39.4%, when compared to the same period of 2020 due to a $41.1 million higher average investment balance, offset by a decrease in fully-taxable equivalent yield to 2.00% for three months ended June 30, 2021, compared to 2.15% for the same period of 2020. The fully-taxable equivalent yield on total interest-earning assets decreased 23 basis points to 3.80% for the three months ended June 30, 2021 compared to 4.03% for the same period of 2020. The average balance of total interest-earning assets increased by $193.5 million to $655.2 million for the three months ended June 30, 2021, compared to $471.7 million for the same period of 2020 primarily due to the acquisition of Carroll.

Total interest expense for the three months ended June 30, 2021 was $738,500, compared to $884,825 for the same period of 2020, a decrease of $146,235, or 16.5%. The decrease was due to a lower overall cost of funds on interest bearing deposits and borrowings of 0.57% for the three months ended June 30, 2021, compared to 1.00% for the same period of 2020, offset by a $169.0 million increase in the average balance of interest-bearing liabilities to $522.3 million in the three months ended June 30, 2021, compared to $353.3 million in the same period of 2020 primarily due to the acquisition of Carroll. Cost of funds for time deposits decreased to 0.86% for the three months ended June 30, 2021 from 1.78% for the same period of 2020. Securities sold under repurchase agreements cost of funds decreased to 0.48% for the three months ended June 30, 2021 from 1.52% for the same period of 2020.

Average noninterest-earning assets increased by $20.4 million to $38.6 million for the three months ended June 30, 2021, compared to $18.1 million in the same period of 2020. Average noninterest-bearing deposits increased by $41.8 million to $121.9 million during the three months ended June 30, 2021, compared to $80.2 million in the same period of 2020. The average balance in stockholders’ equity increased by $2.6 million for the three months ended June 30, 2021, when compared with the same period of 2020.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the three-month periods ended June 30, 2021 and 2020. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Three Months Ended June 30, 2021							Three Months Ended June 30, 2020
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	525,734,302	$	5,783,660		4.40	%	$	385,504,008	$	4,393,267		4.56	%
Securities, taxable		85,334,627		330,789		1.55	%		42,130,062		191,255		1.82	%
Securities, tax exempt		20,233,549		196,176		3.88	%		22,294,431		154,699		2.78	%
Federal funds sold and other interest-earning assets		33,856,811		16,153		0.19	%		21,732,471		16,007		0.29	%
Total interest-earning assets		665,159,289		6,326,778		3.80	%		471,660,972		4,755,228		4.03	%
Noninterest-earning assets		38,562,515							18,145,977
Total assets	$	703,721,804						$	489,806,949

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	298,812,807		128,663		0.17	%	$	182,463,181		142,326		0.31	%
Certificates of deposit		188,963,169		404,774		0.86	%		155,435,092		690,138		1.78	%
Securities sold under repurchase agreements		12,512,074		14,972		0.48	%		10,381,347		39,496		1.52	%
Long-term debt		16,975,038		177,593					-		-		-
FHLB advances and other borrowings		5,000,000		12,588		1.01	%		5,000,000		12,865		1.03	%
Total interest-bearing liabilities		522,263,088		738,590		0.57	%		353,279,620		884,825		1.00	%

Noninterest-bearing deposits		121,919,509							80,162,475
Noninterest-bearing liabilities		5,418,568							4,880,166
Total liabilities		649,601,165							438,322,261
Stockholders' equity		54,120,639							51,484,688
Total liabilities and stockholders' equity	$	703,721,804						$	489,806,949

Net interest income			$	5,588,188						$	3,870,403

Interest rate spread						3.24	%						3.03	%

Net yield on interest-earning assets						3.36	%						3.28	%

Ratio of average interest-earning assets to
Average interest-bearing liabilities						127.36	%						133.51	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis based upon tax rates of 21% for Federal and 8.25% for State.

Noninterest Income

Noninterest income for the three months ended June 30, 2021 was $548,556, compared to $608,226 for the same period of 2020, a decrease of $59,670, or 9.8%. The decrease was primarily a result of a $109,444 decrease in mortgage banking income and a $63,635 decrease in the gain on sale of SBA loans, offset by a $39,711 increase in bank owned life insurance income and a $58,825 increase in service charge revenue as ATM usage and other bank services returned to normal levels compared to the beginning of the pandemic in 2020. The decrease in mortgage banking income is the result of residential refinance activity declining from the all-time high levels at the beginning of the pandemic in the second quarter of 2020 when the Federal Reserve reduced interest rates to historic lows.

Noninterest Expense

Noninterest expense for the three months ended June 30, 2021 totaled $3,509,133, compared to $2,862,003 for the same period of 2020, an increase of $647,130, or 22.6%. The increase was due primarily to, increases in salaries and benefits of $627,141, in occupancy, furniture and equipment of $77,801, and in other of $107,284, offset by a decrease in costs incurred related to the acquisition of Carroll of $165,096. The increases are all a result of the employees, locations, and customers added from the acquisition of Carroll.

Income Tax Expense

Income tax expense for the three months ended June 30, 2021 was $569,725, compared to $230,571 for the same period of 2020. The effective tax rate was 21.9% for the three months ended June 30, 2021, compared to 18.2% for the same period of 2020. The increase in income tax expense was due primarily to higher income before income taxes and a lower percentage of tax exempt revenue for the three months ended June 30, 2021 when compared to the same period in 2020.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our primary market risk is interest rate fluctuation and we have procedures in place to evaluate and mitigate this risk. This market risk and our procedures are described in Item 7 of Part II the on Form 10-K under the heading, “Interest Rate Risk”, which provides information as of December 31, 2020. Management believes that no material changes in market risk or our procedures used to evaluate and mitigate these risks have occurred since December 31, 2020.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our management, including Farmers and Merchants Bancshares, Inc.’s principal executive officer (“PEO”) and the principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of June 30, 2021 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended June 30, 2021, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II – OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Form 10-K. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

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

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits filed or furnished with this quarterly report are listed in the following Exhibit Index:

Exhibit

Description

31.1	Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)

31.2	Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)

32	Certification of the Principal Executive Officer and the Principal Financial Office pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)

101	Inline Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith)

104	Cover Page Interactive Data File (embedded within the Inline XBRL and contained in Exhibit 101)

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 AND MERCHANS BANCSHARES, INC.


Date: August 16, 2021		/s/ James R. Bosley, Jr.
		James R. Bosley, Jr.
		President and Chief Executive Officer
		(Principal Executive Officer)


Date: August 16, 2021		/s/ Mark C. Krebs
		Mark C. Krebs
		Treasurer and Chief Financial Officer
		(Principal Financial Officer & Principal Accounting Officer)