Farmers & Merchants Bancshares, Inc. - Quarter Report: 2022 September (Form 10-Q)

fmfg20220930_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 September 30, 2022

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

Commission file number 000-55756

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Maryland

81-3605835

(State or other jurisdiction of

incorporation or organization)

(I. R. S. Employer Identification No.)

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

(Address of principal executive offices) (Zip Code)

(410) 374-1510

(Registrant’s telephone number, including area code)

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

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

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

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

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated 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: 3,053,487 as of November 10, 2022.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Table of Contents

		Page

PART I – FINANCIAL INFORMATION		3

Item 1. Financial Statements		3

	Consolidated balance sheets at September 30, 2022 (unaudited) and December 31, 2021	3

	Consolidated statements of income (unaudited) for the three and nine months ended September 30, 2022 and 2021	4

	Consolidated statements of comprehensive income (loss) (unaudited) for the three and nine months ended September 30, 2022 and 2021	5

	Consolidated statements of changes in stockholders’ equity (unaudited) for the three and nine months ended September 30, 2022 and 2021	6

	Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2022 and 2021	7

	Notes to financial statements (unaudited)	9

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		28

Item 3. Quantitative and Qualitative Disclosures About Market Risk		41

Item 4. Controls and Procedures		41

PART II – OTHER INFORMATION		42

Item 1. Legal Proceedings		42

Item 1A. Risk Factors		42

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		42

Item 3. Defaults upon Senior Securities		42

Item 4. Mine Safety Disclosures		42

Item 5. Other Information		42

Item 6. Exhibits		42

SIGNATURES		44

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

	September 30,			December 31,
	2022			2021

Assets

Cash and due from banks	$	14,495,448		$	25,258,932
Federal funds sold and other interest-bearing deposits		1,536,296			1,203,174
Cash and cash equivalents		16,031,744			26,462,106
Certificates of deposit in other banks		100,000			350,000
Securities available for sale, at fair value		128,614,033			149,237,916
Securities held to maturity, at cost		20,537,254			21,851,975
Equity security, at fair value		486,237			543,605
Restricted stock, at cost		695,000			675,400
Mortgage loans held for sale		370,000			126,500
Loans, less allowance for loan losses of $3,747,178 and $3,650,268		505,395,375			482,011,334
Premises and equipment, net		6,316,605			6,259,421
Accrued interest receivable		1,600,382			1,609,063
Deferred income taxes, net		8,347,805			2,177,450
Other real estate owned, net		1,242,365			1,242,365
Bank owned life insurance		14,535,898			11,556,163
Goodwill and other intangibles, net		7,044,834			7,051,080
Other assets		5,817,259			5,522,877
	$	717,134,791		$	716,677,255

Liabilities and Stockholders' Equity

Deposits
Noninterest-bearing	$	131,269,680		$	124,175,615
Interest-bearing		507,700,154			502,239,055
Total deposits		638,969,834			626,414,670
Securities sold under repurchase agreements		5,422,642			5,414,026
Federal Home Loan Bank of Atlanta advances		5,000,000			5,000,000
Long-term debt, net of issuance costs		15,566,458			16,978,905
Accrued interest payable		260,266			295,910
Other liabilities		6,072,683			5,952,286
		671,291,883			660,055,797
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 3,053,487 in 2022 and 3,037,137 shares in 2021		30,535			30,372
Additional paid-in capital		29,197,340			28,857,422
Retained earnings		34,263,001			29,128,600
Accumulated other comprehensive loss		(17,647,968	)		(1,394,936	)
		45,842,908			56,621,458
	$	717,134,791		$	716,677,255

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						Nine months ended
	September 30,						September 30,
	2022			2021			2022			2021

Interest income
Loans, including fees	$	5,606,913		$	6,059,709		$	16,660,625		$	17,828,026
Investment securities - taxable		783,606			426,886			2,170,154			967,841
Investment securities - tax exempt		140,185			149,375			430,495			462,361
Federal funds sold and other interest earning assets		55,361			18,298			89,663			47,743
Total interest income		6,586,065			6,654,268			19,350,937			19,305,971

Interest expense
Deposits		313,556			460,377			971,320			1,589,334
Securities sold under repurchase agreements		2,874			9,647			8,558			38,130
Federal Home Loan Bank advances and long-term debt		177,883			192,255			543,033			570,542
Total interest expense		494,313			662,279			1,522,911			2,198,006
Net interest income		6,091,752			5,991,989			17,828,026			17,107,965

Provision for loan losses		95,000			330,000			95,000			430,000

Net interest income after provision for loan losses		5,996,752			5,661,989			17,733,026			16,677,965

Noninterest income
Service charges on deposit accounts		201,251			187,141			574,444			522,815
Mortgage banking income		8,155			207,471			195,829			704,404
Bank owned life insurance income		70,479			49,116			179,735			174,602
Fair value adjustment on equity security		(17,611	)		(2,056	)		(62,524	)		(10,214	)
Gain on sale of SBA loans		-			6,917			158,123			6,917
Gain on premium call of debt security		-			621			-			9,190
Other fees and commissions		75,211			82,768			229,326			229,765
Total noninterest income		337,485			531,978			1,274,933			1,637,479

Noninterest expense
Salaries		1,987,991			1,895,780			5,656,643			5,366,854
Employee benefits		418,422			388,879			1,367,829			1,299,900
Occupancy		229,273			241,557			670,938			737,087
Furniture and equipment		203,075			198,190			642,283			578,562
Other		945,930			740,722			2,815,182			2,386,982
Total noninterest expense		3,784,691			3,465,128			11,152,875			10,369,385

Income before income taxes		2,549,546			2,728,839			7,855,084			7,946,059
Income taxes		575,236			606,292			1,779,239			1,761,718
Net income	$	1,974,310		$	2,122,547		$	6,075,845		$	6,184,341

Earnings per share - basic and diluted	$	0.65		$	0.70		$	2.00		$	2.05

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 (Loss)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2022			2021			2022			2021

Net income	$	1,974,310		$	2,122,547		$	6,075,845		$	6,184,341

Other comprehensive loss, net of income taxes:

Securities available for sale
Net unrealized loss arising during the period		(5,960,588	)		(321,489	)		(22,423,388	)		(1,428,240	)

Reclassification adjustment for realized gains and losses included in net income		-			621			-			9,190
Total unrealized loss on investment securities available for sale

Income tax benefit		(1,640,205	)		(88,295	)		(6,170,356	)		(390,487	)
Total other comprehensive loss		(4,320,383	)		(232,573	)		(16,253,032	)		(1,028,563	)

Total comprehensive (loss) income	$	(2,346,073	)	$	1,889,974		$	(10,177,187	)	$	5,155,778

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 nine months Ended September 30, 2022 and 2021

(Unaudited)

					Additional						Accumulated other			Total
	Common stock				paid-in			Retained			comprehensive			stockholders'
	Shares		Par value		capital			earnings			income (loss)			equity
*Three months ended September 30, 2021*
Balance, June 30, 2021		3,023,487	$	30,235	$	28,557,249		$	25,917,571		$	(89,713	)	$	54,415,342
Net income		-		-		-			2,122,547			-			2,122,547
Other comprehensive loss		-		-		-			-			(232,573	)		(232,573	)

Balance, September 30, 2021		3,023,487	$	30,235	$	28,557,249		$	28,040,118		$	(322,286	)	$	56,305,316

*Nine months ended September 30, 2021*
Balance, December 31, 2020		3,011,255	$	30,113	$	28,294,139		$	22,698,954		$	706,277		$	51,729,483
Net income		-		-		-			6,184,341			-			6,184,341
Other comprehensive loss		-		-		-			-			(1,028,563	)		(1,028,563	)
Cash dividends, $0.28 per share		-		-		-			(843,177	)		-			(843,177	)
Dividends reinvested		12,232		122		263,110			-			-			263,232

Balance, September 30, 2021		3,023,487	$	30,235	$	28,557,249		$	28,040,118		$	(322,286	)	$	56,305,316

*Three months ended September 30, 2022*
Balance, June 30, 2022		3,053,487	$	30,535	$	29,197,475		$	32,288,555		$	(13,327,585	)	$	48,188,980
Net income		-		-		-			1,974,310			-			1,974,310
Other comprehensive loss		-		-		-			-			(4,320,383	)		(4,320,383	)
Dividend reinvestment adjustment		-		-		(135	)		136			-			1

Balance, September 30, 2022		3,053,487	$	30,535	$	29,197,340		$	34,263,001		$	(17,647,968	)	$	45,842,908

*Nine months ended September 30, 2022*
Balance, December 31, 2021		3,037,137	$	30,372	$	28,857,422		$	29,128,600		$	(1,394,936	)	$	56,621,458
Net income		-		-		-			6,075,845			-			6,075,845
Other comprehensive loss		-		-		-			-			(16,253,032	)		(16,253,032	)
Cash dividends, $0.31 per share		-		-		-			(941,444	)		-			(941,444	)
Dividends reinvested		16,350		163		339,918			-			-			340,081

Balance, September 30, 2022		3,053,487	$	30,535	$	29,197,340		$	34,263,001		$	(17,647,968	)	$	45,842,908

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)

Nine Months Ended September 30,	2022			2021

Reconciliation of net income to net cash provided by operating activities
Net income	$	6,075,845		$	6,184,341
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		354,814			356,439
Provision for loan losses		95,000			430,000
Amortization of right of use asset		4,412			14,023
Equity security dividends reinvested		(5,156	)		(4,997	)
Fair value adjustment on equity security		62,524			10,214
Gain on sale of SBA loans		(158,123	)		(6,917	)
Gain on sale of premises and equipment		-			(44,510	)
Gain on premium call of debt security		-			(9,190	)
Amortization of debt issuance costs		4,218			4,219
Amortization of premiums and accretion of discounts, net		(237,876	)		(38,029	)
Bank owned life insurance cash surrender value		(179,735	)		(232,983	)
Increase (decrease) in
Deferred loan fees and costs, net		(136,377	)		105
Accrued interest payable		(35,644	)		(86,202	)
Other liabilities		228,072			777,175
Decrease (increase) in
Mortgage loans held for sale		(243,500	)		(84,200	)
Accrued interest receivable		8,681			478,044
Other assets		(433,594	)		493,856
Net cash provided by operating activities		5,403,561			8,241,388

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

Nine Months Ended September 30,	2022			2021


Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale		15,121,772			24,273,762
Held to maturity		1,398,420			2,121,989
Purchase of securities
Available for sale		(17,278,216	)		(92,992,748	)
Held to maturity		-			(842,061	)
Maturity of certificates of deposit		250,000			500,000
Loans made to customers, net of principal collected		(24,044,676	)		25,701,580
Proceeds from sale of SBA loans		1,250,154			61,595
Redemption (purchase) of stock in FHLB of Atlanta		(19,600	)		225,100
Purchase of bank owned life insurance		(2,800,000	)		(28,855	)
Purchase of annuity		-			(3,671,145	)
Proceeds from sale of premises and equipment		-			1,387,613
Purchases of premises, equipment and software		(384,873	)		(227,010	)
Net cash used in investing activities		(26,507,019	)		(43,490,180	)

Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits		7,094,065			22,686,309
Interest-bearing deposits		5,588,443			26,047,473
Securities sold under repurchase agreements		8,616			(14,278,851	)
Long-term debt principal payments		(1,416,665	)		-
Dividends paid, net of reinvestments		(601,363	)		(579,945	)

Net cash provided by financing activities		10,673,096			33,874,986

Net decrease in cash and cash equivalents		(10,430,362	)		(1,373,806	)

Cash and cash equivalents at beginning of period		26,462,106			40,975,670
Cash and cash equivalents at end of period	$	16,031,744		$	39,601,864

Supplementary disclosure of cash flow information:
Cash paid during the period for interest	$	1,675,435		$	2,476,513
Cash paid during the period for income taxes		2,531,122			1,065,000
Supplementary disclosure of noncash investing an financing activities:
Net unrealized loss on securities available for sale	$	(22,423,388	)	$	(1,428,240	)

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 by Farmers and Merchants Bancshares, Inc. in 100% of a series of membership interests issued by First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed property and casualty insurance company. Intercompany balances and transactions, including the insurance premium paid by the Bank to the Insurance Subsidiary through an intermediary, have been eliminated.

2. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 (“GAAP”) for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three- and nine- month periods ended September 30, 2022 do not necessarily reflect the results that may be expected for the fiscal year ending December 31, 2022 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, 2021, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2021 that was filed with the Securities and Exchange Commission (the “SEC”).

Recent Accounting Pronouncements

In June 2016, FASB issued Accounting Standards Update (“ASU”) 2016‑13, “Financial Instruments – Credit Losses”. The ASU sets forth a “current expected credit loss” (CECL) model that 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 January 1, 2023 for SEC-registered smaller reporting companies and private companies. The Company is a smaller reporting company. The Company has engaged a third-party vendor to assist in the implementation of this ASU. The CECL model is being run parallel with the current calculation of the allowance for loan losses during 2022. The detailed loan data was successfully uploaded to the new model for both March 31, June 30, 2022, and September 30, 2022. Loan categories have been finalized and qualitative factors are being fine-tuned. Model validation is in process. Several members of the Company’s senior management and credit administration teams are participating in the implementation.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2. Basis of Presentation (continued)

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 843)”: 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 the Secured Overnight Financing Rate in 2023. Borrowers have been notified of the pending change.

In March 2022, the FASB issued ASU No. 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments in this ASU should be applied prospectively, except for the transition method related to the recognition and measurement of TDRs, an entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. For entities that have adopted ASU 2016-13, ASU 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that have not yet adopted ASU 2016-13, the effective dates for ASU 2022-02 are the same as the effective dates in ASU 2016-13. Early adoption is permitted if an entity has adopted ASU 2016-13. An entity may elect to early adopt the amendments about TDRs and related disclosure enhancements separately from the amendments related to vintage disclosures. The Company is currently assessing the impact that ASU 2022-02 will have on its consolidated financial statements.

The accounting policies adopted by management are consistent with authoritative GAAP and are consistent with those followed by our peers.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities

Investments in debt securities are summarized as follows:

	Amortized		Unrealized		Unrealized		Fair
September 30, 2022	cost		gains		losses		value

*Available for sale*

State and municipal	$	570,310	$	-	$	22,581	$	547,729
SBA pools		1,119,622		1,796		15,363		1,106,055
Corporate bonds		10,429,690		-		1,001,138		9,428,552
Mortgage-backed securities		140,842,314		152		23,310,769		117,531,697
	$	152,961,936	$	1,948	$	24,349,851	$	128,614,033

*Held to maturity*

State and municipal	$	20,537,254	$	1,375	$	2,112,198	$	18,426,431

	Amortized		Unrealized		Unrealized		Fair
December 31, 2021	cost		gains		losses		value

*Available for sale*

State and municipal	$	753,061	$	10,437	$	-	$	763,498
SBA pools		1,418,770		1,656		22,664		1,397,762
Corporate bonds		9,225,153		64,595		55,541		9,234,207
Mortgage-backed securities		139,765,445		336,084		2,259,080		137,842,449
	$	151,162,429	$	412,772	$	2,337,285	$	149,237,916

*Held to maturity*

State and municipal	$	21,851,975	$	1,020,877	$	67,251	$	22,805,601

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities (continued)

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

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
September 30, 2022	cost		value		cost		value

Within one year	$	70,310	$	69,699	$	330,000	$	330,172
Over one to five years		3,602,980		3,415,812		473,510		464,965
Over five to ten years		7,326,710		6,490,770		2,246,345		2,088,287
Over ten years		-		-		17,487,399		15,543,007
		11,000,000		9,976,281		20,537,254		18,426,431
Mortgage-backed securities and
SBA pools, due in monthlyinstallments		141,961,936		118,637,752		-		-
	$	152,961,936	$	128,614,033	$	20,537,254	$	18,426,431

Securities with a carrying value of $14,245,224 and $14,307,989 as of September 30, 2022 and December 31, 2021, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

During the nine months ended September 30, 2022, there were no sales of securities. During the nine months ended September 30, 2021, the Company received proceeds of $1,263,845 from the call at a premium of available for sale investment securities. The Company realized a $9,190 gain on the call of the securities.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities (continued)

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in debt securities, by category and length of time, at September 30, 2022 and December 31, 2021.

September 30, 2022	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	$	13,564,241	$	1,565,843	$	1,556,463	$	568,936	$	15,120,704	$	2,134,779
SBA pools		-		-		923,700		15,363		923,700		15,363
Corporate bonds		8,039,155		875,570		989,397		125,568		9,028,552		1,001,138
Mortgage-backed securities		64,335,274		10,303,353		53,002,811		13,007,416		117,338,085		23,310,769
Total	$	85,938,670	$	12,744,766	$	56,472,371	$	13,717,283	$	142,411,041	$	26,462,049

December 31, 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	$	1,324,648	$	35,720	$	715,650	$	31,531	$	2,040,298	$	67,251
SBA pools		-		-		1,133,398		22,664		1,133,398		22,664
Corporate bonds		5,443,886		55,541		-		-		5,443,886		55,541
Mortgage-backed securities		117,840,965		2,034,858		4,781,586		224,222		122,622,551		2,259,080
Total	$	124,609,499	$	2,126,119	$	6,630,634	$	278,417	$	131,240,133	$	2,404,536

Held to maturity securities are securities that the Company has both the ability and the intent to hold until they mature, at which time the Company should receive full value for the securities. As of September 30, 2022 and December 31, 2021, 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 September 30, 2022 and December 31, 2021, management believes that these unrealized losses are temporary and, accordingly, they have not been recognized in the Company’s consolidated statements of income. At September 30, 2022, 179 available for sale securities and 38 held to maturity securities had unrealized losses.

At September 30, 2022, none of the available for sale securities or held to maturity securities were other-than-temporarily impaired. In determining whether other-than-temporary impairment exists, management considers many factors, including (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) 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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans

Major categories of loans are as follows:

	September 30,		December 31,
	2022		2021
Real estate:
Commercial	$	342,620,080	$	319,185,116
Construction and land development		24,416,365		28,221,854
Residential		113,435,287		107,436,033
Commercial		28,885,402		31,182,206
Consumer		368,607		355,958
		509,725,741		486,381,167
Less: Allowance for loan losses		3,747,178		3,650,268
Deferred origination fees net of costs		583,188		719,565
	$	505,395,375	$	482,011,334

Commercial loans in the table above include $0.7 million and $9.7 million of Paycheck Protection Program (“PPP”) loans as of September 30, 2022 and December 31, 2021, respectively, which are 100% guaranteed by the Small Business Administration (“SBA”). $60 million were originated during 2021 and 2020 and we collected approximately $2,323,000 in fees from the SBA. 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. Income from PPP loans, net of taxes, added approximately $181,000 for the nine months ended September 30, 2022 compared to $679,000 for the same period in 2021.

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

	September 30,		December 31,
	2022		2021
Commercial real estate	$	502,961	$	4,810,965
Residential real estate		31,500		31,500
Commercial		152,449		152,449
	$	686,910	$	4,994,914

At September 30, 2022, the Company had one nonaccrual commercial real estate loan totaling $502,961, one nonaccrual residential real estate loan totaling $31,500, and one nonaccrual commercial loan totaling $152,449. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $38,155 would have been recorded for the nine months ended September 30, 2022 had these nonaccrual loans been current and performing in accordance with their original terms. The Company allocated $281,910 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 September 30, 2022. The decrease in commercial real estate nonaccrual loans from December 31, 2021 to September 30, 2022 was due to a loan with a principal balance of approximately $4.3 million at December 31, 2021 resuming full principal and interest payments in July 2022.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (continued)

At December 31, 2021, the Company had two nonaccrual commercial real estate loan totaling $4,810,965 and one nonaccrual residential real estate loan totaling $31,500, and one commercial loan totaling $152,449. The real estate loans were secured by real estate and business assets and were personally guaranteed. The commercial loan was secured by business assets and was personally guaranteed. Gross interest income of $219,734 would have been recorded in 2021 if these nonaccrual loans had been current and performing in accordance with their original terms. The Company allocated $281,910 of its allowance for loan losses to these nonaccrual loans. The balance of nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $27,146 at December 31, 2021.

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
September 30, 2022
Real estate:
Commercial	$	-	$	166,386	$	502,961	$	669,347	$	341,950,733	$	342,620,080	$	-
Construction and land development		-		-		-		-		24,416,365		24,416,365		-
Residential		-		-		31,500		31,500		113,403,787		113,435,287		-
Commercial		-		-		152,449		152,449		28,732,953		28,885,402		-
Consumer		-		-		-		-		368,607		368,607		-
Total	$	-	$	166,386	$	686,910	$	853,296	$	508,872,445	$	509,725,741	$	-

December 31, 2021
Real estate:
Commercial	$	-	$	-	$	502,961	$	502,961	$	318,682,155	$	319,185,116	$	-
Construction and land development		-		-		-		-		28,221,854		28,221,854		-
Residential		-		-		249,161		249,161		107,186,872		107,436,033		217,661
Commercial		-		-		415,690		415,690		30,766,516		31,182,206		263,241
Consumer		-		-		-		-		355,958		355,958		-
Total	$	-	$	-	$	1,167,812	$	1,167,812	$	485,213,355	$	486,381,167	$	480,902

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (continued)

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the nine months ended September 30, 2022 and the year ended December 31, 2021, 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
September 30, 2022
Commercial real estate	$	7,210,361	$	6,707,400	$	502,961	$	7,210,361	$	129,461	$	7,015,647	$	141,479
Residential real estate		34,954		34,954		-		34,954		-		37,091		1,104
Commercial		152,449		-		152,449		152,449		152,449		152,449		-
		7,397,764		6,742,354		655,410		7,397,764		281,910		7,205,187		142,583

September 30, 2021
Commercial real estate	$	6,875,087	$	6,367,416	$	408,198	$	6,775,614	$	99,473	$	3,387,807	$	77,603
Residential real estate		40,626		40,626		-		40,626		-		39,927		-
Commercial		154,469		-		-		-		154,469		76,225		1,271
	$	7,070,182	$	6,408,042	$	408,198	$	6,816,240	$	253,942	$	3,503,959	$	78,874
December 31, 2021
Commercial real estate	$	6,820,932	$	6,317,971	$	502,961	$	6,820,932	$	129,461	$	6,740,539	$	125,079
Residential real estate		39,228		39,228		-		39,228		-		41,981		1,672
Commercial		152,449		-		152,449		152,449		152,449		76,225		69,005
	$	7,012,609	$	6,357,199	$	655,410	$	7,012,609	$	281,910	$	6,858,745	$	195,756

Impaired loans include 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 September 30, 2022, the Company had two commercial real estate loans totaling $6,540,014 and one residential real estate loan totaling $34,954 that were classified as TDRs. One of the commercial real estate loans with a principal balance of $4,567,456 was restructured as TDRs during the 9 months ended September 30, 2022. All are included in impaired loans above. At September 30, 2022, all three loans were paying as agreed. There have been no charge-offs or allowances associated with these loans.

At December 31, 2021, the Company had one commercial real estate loan totaling $2,009,967 and one residential real estate loan totaling $39,288 classified as TDRs. Both loans are included in impaired loans above and were paying as agreed. There have been no charge-offs or allowances associated with these loans.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (continued)

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

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

Pass/Watch

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

Special Mention

A special mention loan is a loan that management believes 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 a loan that management believes is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Such 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. Substandard loans require more intense supervision by Company management.

Doubtful

A doubtful loan is a loan that management believes has all of 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
September 30, 2022	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total

Real estate:
Commercial	$	-	$	18,082	$	69,687,996	$	186,657,806	$	76,663,355	$	166,386	$	9,426,455	$	-	$	342,620,080
Construction and land development		-		-		3,664,371		13,405,947		7,346,047		-		-		-		24,416,365
Residential		11,139		592,377		41,671,626		61,873,489		6,958,191		-		2,328,465		-		113,435,287
Commercial		772,026		-		8,742,069		15,547,728		3,671,130		-		152,449		-		28,885,402
Consumer		2,007		18,292		108,459		214,861		7,996		-		-		16,992		368,607
	$	785,172	$	628,751	$	123,874,521	$	277,699,831	$	94,646,719	$	166,386	$	11,907,369	$	16,992	$	509,725,741

			Above						Pass		Special
December 31, 2021	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total

Real estate:
Commercial	$	-	$	1,225,732	$	73,924,748	$	146,174,439	$	82,018,890	$	3,345,788	$	12,495,519	$	-	$	319,185,116
Construction and land development		-		-		3,853,775		12,452,257		9,973,457		1,942,365		-		-		28,221,854
Residential		41,152		708,162		46,358,477		48,295,430		9,570,815		-		2,461,997		-		107,436,033
Commercial		9,774,570		-		5,292,721		12,585,396		3,377,070		-		152,449		-		31,182,206
Consumer		5,813		168,037		147,903		2,280		11,298		-		-		20,627		355,958
	$	9,821,535	$	2,101,931	$	129,577,624	$	219,509,802	$	104,951,530	$	5,288,153	$	15,109,965	$	20,627	$	486,381,167

The principal balances of loans in the Pass/Watch category as of September 30, 2022 and December 31, 2021 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 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 and loan balances by portfolio as of and for the nine-month periods ended September 30, 2022 and 2021 and for the year ended December 31, 2021. 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 for										balance evaluated for impairment:						evaluated for impairment:
	Beginning		(recovery of)			Charge					Ending		Purchase Credit						Purchase Credit
September 30, 2022	balance		loan losses			offs			Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	2,482,930	$	126,385		$	(7,772	)	$	-	$	2,601,543	$	129,461	$	-	$	2,472,082	$	7,210,361	$	-	$	335,409,719
Construction and land development		214,547		(69,938	)		-			12,150		156,759		-		-		156,759		-		-		24,416,365
Residential		603,558		67,729			-			-		671,287		-		-		671,287		34,954		375,844		113,024,489
Commercial		255,413		35,949			(2,468	)		-		288,894		152,449		-		136,445		152,449		242,382		28,490,571
Consumer		4,370		(383	)		-			-		3,987		-		-		3,987		-		-		368,607
Unallocated		89,450		(64,742	)		-			-		24,708		-		-		24,708		-		-		-
	$	3,650,268	$	95,000		$	(10,240	)	$	12,150	$	3,747,178	$	281,910	$	-	$	3,465,268	$	7,397,764	$	618,226	$	501,709,751

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

Real estate:
Commercial	$	2,230,129	$	348,650		$	-		$	9,500	$	2,588,279	$	99,473	$	-	$	2,488,806	$	6,875,087	$	87,708	$	309,189,806
Construction and land development		201,692		32,105			-			12,150		245,947		-		-		245,947		-		1,531,846		27,136,796
Residential		644,639		(28,549	)		(18,970	)		-		597,120		-		-		597,120		40,626		570,860		113,982,176
Commercial		111,390		125,133			-			15,000		251,523		154,469		-		97,054		154,469		-		40,500,608
Consumer		2,138		1,863			-			-		4,001		-		-		4,001		-		-		379,530
Unallocated		106,550		(49,202	)		-			-		57,348		-		-		57,348		-		-		-
	$	3,296,538	$	430,000		$	(18,970	)	$	36,650	$	3,744,218	$	253,942	$	-	$	3,490,276	$	7,070,182	$	2,190,414	$	491,188,916

													Allowance for loan losses ending						Outstanding loan balances
			Provision for										balance evaluated for impairment:						evaluated for impairment:
	Beginning		(recovery of)			Charge					Ending		Purchase Credit						Purchase Credit
December 31, 2021	balance		loan losses			offs			Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively

Real estate:
Commercial	$	2,230,129	$	241,301		$	-		$	11,500	$	2,482,930	$	129,461	$	-	$	2,353,469	$	6,820,932	$	56,825	$	312,307,359
Construction and land development		201,692		(3,345	)		-			16,200		214,547		-		-		214,547		-		383,666		27,838,188
Residential		644,639		(22,111	)		(18,970	)		-		603,558		-		-		603,558		39,228		568,151		106,828,654
Commercial		111,390		129,023			-			15,000		255,413		152,449		-		102,964		152,449		-		31,029,757
Consumer		2,138		2,232			-			-		4,370		-		-		4,370		-		-		355,958
Unallocated		106,550		(17,100	)		-			-		89,450		-		-		89,450		-		-		-
	$	3,296,538	$	330,000		$	(18,970	)	$	42,700	$	3,650,268	$	281,910	$	-	$	3,368,358	$	7,012,609	$	1,008,642	$	478,359,916

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:

	2022

Balance at December 31, 2021	$	1,629,242
Accretion		575,746
Balance at September 30, 2022	$	1,053,496

At September 30, 2022, the nonaccretable discount on purchased impaired loans was $241,587, a decrease of $225,000 from December 31, 2021 as a result of one of the loans paying off in full. At September 30, 2022, the accretable discount on purchased impaired loans was $0 after the accretion of $140,608. At September 30, 2022, the remaining yield premium on purchased loans was $994,406. At September 30, 2022, the principal balance of purchased loans was $88,567,633 and the carrying value was $88,266,956. At September 30, 2022, there were no residential real estate loans in the process of foreclosure.

5. Goodwill and Other Intangibles

The acquisition of Carroll Bancorp, Inc. in October of 2020 resulted in the recording of goodwill and core deposit intangible (“CDI”). The following table presents the changes in both assets:

	Goodwill		CDI			Total

Balance at December 31, 2021	$	6,978,208	$	72,872		$	7,051,080
Amortization		-		(6,246	)		(6,246	)
Balance at September 30, 2022	$	6,978,208	$	66,626		$	7,044,834

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, 2022 through 2029 and $6,246 in 2030. Since the merger 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 September 30, 2022 and December 31, 2021:

	Consolidated Balance
	Sheet classification	September 30, 2022		December 31, 2021
Operating lease right of use asset	Other assets	$	981,295	$	1,093,382
Operating lease liabilities	Other liabilities		1,203,895		1,311,570

Operating lease cost included in occupancy expense in the statement of income for the three months ended September 30, 2022 and 2021 was $47,308 and $43,178, respectively. Operating lease cost included in occupancy expense in the statement of income for the nine months ended September 30, 2022 and 2021 was $142,160 and $144,529, 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

2022	$	46,700
2023		190,356
2024		195,946
2025		201,713
2026		207,664
Thereafter		495,063
Total undiscounted cash flow		1,337,442
Discount		(133,547	)
Lease liabilities	$	1,203,895

For operating leases as of September 30, 2022, the weighted average remaining lease term is 6.8 years and the weighted average discount rate is 3.25%. During the nine-month periods ended September 30, 2022 and 2021, cash paid for amounts included in the measurement of lease liabilities was $137,748 and $130,506, 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 September 30, 2022, 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 September 30, 2022 and December 31, 2021 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2022 and December 31, 2021 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
September 30, 2022	Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	73,913		12.82	%	$	60,520		10.50	%	$	57,638		10.00	%
Tier 1 capital (to risk-weighted assets)		70,166		12.17	%		48,992		8.50	%		46,110		8.00	%
Common equity tier 1 (to risk-weighted assets)		70,166		12.17	%		40,347		7.00	%		37,465		6.50	%
Tier 1 leverage (to average assets)		70,166		9.73	%		28,835		4.00	%		36,044		5.00	%

						Minimum					To Be Well
(Dollars in thousands)	Actual					Capital Adequacy					Capitalized
December 31, 2021	Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	69,957		13.24	%	$	55,471		10.50	%	$	52,830		10.00	%
Tier 1 capital (to risk-weighted assets)		66,307		12.55	%		44,905		8.50	%		42,264		8.00	%
Common equity tier 1 (to risk-weighted assets)		66,307		12.55	%		36,981		7.00	%		34,339		6.50	%
Tier 1 leverage (to average assets)		66,307		9.27	%		28,614		4.00	%		35,767		5.00	%

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of September 30, 2022, the most recent notification from the Federal Deposit Insurance Corporation (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 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 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 September 30, 2022 and December 31, 2021, 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
September 30, 2022

Recurring:
Available for sale securities
State and municipal	$	-	$	547,729	$	-	$	547,729
SBA pools		-		1,106,055		-		1,106,055
Corporate bonds		-		9,428,552		-		9,428,552
Mortgage-backed securities		-		117,531,697		-		117,531,697
	$	-	$	128,614,033	$	-	$	128,614,033

Equity security at fair value
Mutual fund	$	486,237	$	-	$	-	$	486,237

Nonrecurring:
Other real estate owned, net	$	-	$	-	$	1,242,365	$	1,242,365
Impaired loans, net	$	-	$	-	$	373,500	$	373,500

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, 2021

Recurring:
Available for sale securities
State and municipal	$	-	$	763,498	$	-	$	763,498
SBA pools		-		1,397,762		-		1,397,762
Corporate Bonds		-		8,584,207		650,000		9,234,207
Mortgage-backed securities		-		137,842,449		-		137,842,449
	$	-	$	148,587,916	$	650,000	$	149,237,916

Equity security at fair value
Mutual fund	$	543,605	$	-	$	-	$	543,605

Nonrecurring:
Other real estate owned, net	$	-	$	-	$	1,242,365	$	1,242,365
Impaired loans, net		-		-		373,500		373,500

The following table displays quantitative information about level 3 inputs for September 30, 2022 and December 31, 2021:

September 30, 2022:
Assets	Fair Value		Valuation Techniques	Unobservable Input	Average
Impaired loans

Commercial real estate	$	373,500	Discounted appraised value	Marketability/selling costs		10	%
Commercial		-	Discounted appraised value	Marketability/selling costs		10	%
Total impaired loans	$	373,500	Discounted appraised value	Marketability/selling costs		10	%

OREO	$	1,242,365	Discounted appraised value	Marketability/selling costs		10	%

December 31, 2021:
Assets	Fair Value		Valuation Techniques	Unobservable Input	Average
Impaired loans

Commercial real estate	$	373,500	Discounted appraised value	Marketability/selling costs		10	%
Commercial		-	Discounted appraised value	Marketability/selling costs		10	%
Total impaired loans	$	373,500	Discounted appraised value	Marketability/selling costs		10	%

OREO	$	1,242,365	Discounted appraised value	Marketability/selling costs		10	%

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value (continued)

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:

	September 30, 2022				December 31, 2021
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	16,031,744	$	16,031,744	$	26,462,106	$	26,462,106
Level 2 inputs
Certificates of deposit in other banks		100,000		100,000		350,000		350,000
Accrued interest receivable		1,600,382		1,600,382		1,609,063		1,609,063
Securities held to maturity		17,507,634		15,396,811		21,851,975		22,805,601
Mortgage loans held for sale		370,000		375,136		126,500		128,829
Restricted stock, at cost		695,000		695,000		675,400		675,400
Bank owned life insurance		14,535,898		14,535,898		11,556,163		11,556,163
Level 3 inputs
Securities held to maturity		3,029,620		3,029,620		3,073,040		3,073,040
Loans, net		505,395,375		471,500,501		482,011,334		487,012,970

Financial liabilities
Level 1 inputs
Noninterest-bearing deposits	$	131,269,680	$	131,269,680	$	124,175,615	$	124,175,615
Securities sold under repurchase agreements		5,422,642		5,422,642		5,414,026		5,414,026
Level 2 inputs
Interest-bearing deposits		507,700,154		503,645,154		502,239,055		502,396,172
Federal Home Loan Bank advances		5,000,000		4,596,000		5,000,000		4,967,000
Long-term debt		15,566,458		15,436,251		16,978,905		17,298,111
Accrued interest payable		260,266		260,266		295,910		295,910

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 nine-month periods ended September 30, 2022 and 2021. There were no common stock equivalents outstanding during the nine-month periods ended September 30, 2022 or 2021.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

9. Earnings per Share (continued)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021

Net income	$	1,974,310	$	2,122,547	$	6,075,845	$	6,184,341
Weighted average shares outstanding		3,053,487		3,023,487		3,043,006		3,015,602
Earnings per share - basic and diluted	$	0.65	$	0.70	$	2.00	$	2.05

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 older 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 $53,057 and $52,818 for the three-month periods ended September 30, 2022 and 2021, respectively, and $192,223 and $194,566 for the nine-month periods ended September 30, 2022 and 2021.

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 $1,702 and $1,661 for the three-month periods ended September 30, 2022 and 2021, respectively, and $5,107 and $4,982 for the nine-month periods ended September 30, 2022 and 2021.

The Company adopted supplemental executive retirement plans for four 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 related to these plans, including interest, of $46,250 and $42,000 for the three-month periods ended September 30, 2022 and 2021, respectively, and $136,250 and $126,000 for the nine-month periods ended September 30, 2022 and 2021.

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, 2021 (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 geopolitical activity and 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.

Effective October 1, 2020, pursuant to a series of merger transactions, Farmers and Merchants Bancshares, Inc. acquired Carroll Bancorp, Inc., and the Bank acquired Carroll Bancshares, Inc.’s wholly-owned bank subsidiary, Carroll Community Bank.

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, 2021, 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, 2021.

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 provided small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. During 2021 and 2020, we originated approximately $60 million in PPP. All PPP loans are 100% guaranteed by the SBA, have up to a five-year maturity, 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 by the Bank have been forgiven as of September 30, 2022. The SBA also established processing fees from 1% to 5%, depending on the loan amount. During 2021 and 2020, the Company collected approximately $2,323,000 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. During the nine months ended September 30, 2022, approximately $250,000 in fees were recognized, compared to approximately $937,000 in the nine months ended September 30, 2021. Approximately $19,000 of fees were unrecognized at September 30, 2022.

Financial Condition

Total assets increased by $457,536, or 0.1%, to $717,134,791 at September 30, 2022 from $716,677,255 at December 31, 2021. The increase in total assets was due primarily to an increase of $23,384,041 in loans, an increase of $6,170,355 in deferred income taxes, and an increase in bank owned life insurance of $2,979,735, offset by decreases of $21,938,064 in debt securities and $10,430,362 in cash and cash equivalents.

Total liabilities increased $11,236,086, or 1.7%, to $671,291,883 at September 30, 2022 from $660,055,797 at December 31, 2021. The increase was due primarily to a $12,555,164 increase in deposits, offset by a $1,412,447 decrease in long-term debt.

Stockholders’ equity decreased by $10,778,550 to $45,842,908 at September 30, 2022 from $56,621,458 at December 31, 2021. The decrease was due to an increase of $16,253,032 in accumulated other comprehensive loss as a result of the decline in the market value of available for sale securities which resulted from the significant increase in interest rates and dividends paid, net of reinvestments, of $601,363, offset by net income for the nine-month period ended September 30, 2022 of $6,075,845.

Loans

Major categories of loans at September 30, 2022 and December 31, 2021 were as follows:

	September 30,				December 31,
	2022				2021

Real estate:
Commercial	$	342,620,080	67	%	$	319,185,116	66	%
Construction/Land development		24,416,365	5	%		28,221,854	6	%
Residential		113,435,287	22	%		107,436,033	22	%
Commercial		28,885,402	6	%		31,182,206	6	%
Consumer		368,607	0	%		355,958	0	%
		509,725,741	100	%		486,381,167	100	%
Less: Allowance for loan losses		3,747,178				3,650,268
Deferred origination fees net of costs		583,188				719,565
	$	505,395,375			$	482,011,334

Loans increased by $23,384,041, or 4.9%, to $505,395,375 at September 30, 2022 from $482,011,334 at December 31, 2021. The increase was due primarily to increases of $23,434,964 in commercial real estate loans and $5,999,254 in residential loans, offset by decreases of $2,296,804 in commercial loans and $3,805,489 in construction/land development loans. The decrease in commercial loans was driven primarily by a decrease of $8,988,663 in PPP loans. The allowance for loan losses increased by $96,910 to $3,747,178 at September 30, 2022 from $3,650,268 at December 31, 2021. Deferred origination fees, net of costs, decreased to $583,188 at September 30, 2022 from $719,565 at December 31, 2021, due primarily to the forgiveness of 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.

The provision for loan losses was $95,000 and $330,000 for the three-month periods ended September 30, 2022 and 2021, respectively. The provision for loan losses was $95,000 and $430,000 for the nine-month periods ended September 30, 2022 and 2021, respectively.

During the three-month periods ended September 30, 2022 and 2021, the Company had recoveries from loans written off in prior periods totaling $4,050 and $9,990, respectively, and no charge-offs. During the nine-month periods ended September 30, 2022 and 2021, the Company had recoveries from loans written off in prior periods totaling $12,150 and $36,650, respectively, and charge-offs of $10,240 and $18,970, respectively.

Watch list loans include loans classified as Special Mention, Substandard, and Doubtful. As of September 30, 2022, the Company had $4,435,585 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, 2021, the Company had $13,140,695 of such loans. The decrease was due primarily to the repayment in full of six loans totaling approximately $6.6 million and the upgrading of one loan totaling $2.0 million. Watch List loans are subject to ongoing management attention and their classifications are reviewed regularly.

Management believes that the $3.7 million reserve at September 30, 2022 and the $95,000 provision for the nine-month period ended September 30, 2022 are appropriate to adequately cover the probable and estimable losses inherent in the loan portfolio. The reserve is materially unchanged from December 31, 2021. Excluding PPP loans, the Company’s loan portfolio grew by $31.7 million during the first nine months of 2022. An increasing portfolio could typically require a commensurate increase in the provision. In addition, several qualitative factors were increased to reflect the potential impact of rising interest rates. However, as noted above, the amount of watch list loans in the portfolio declined by $8.9 million. These loans receive a much higher reserve than the rest of the portfolio, so their decline offset the increasing portfolio and impact of the higher qualitative factors. Furthermore, there was no additional deterioration to the loans that were negatively impacted by COVID -19, so there was minimal change in their reserve.

Investment Securities

Investments in debt securities decreased by $21,938,604, or 12.8%, to $149,151,287 at September 30, 2022 from $171,089,891 at December 31, 2021. At September 30, 2022 and December 31, 2021, the Company had classified 86% 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.

Other Real Estate Owned

Other real estate owned (“OREO”) at September 30, 2022 and December 31, 2021 included two properties with an aggregate carrying value of $1,242,365. The first property is an apartment building in Baltimore, Maryland with a carrying value of $1,242,365 that was acquired in the Merger. The property is under a sales contract with a projected closing in the fourth quarter. 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 2022. 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 $12,555,164, or 2.0%, to $638,969,834 at September 30, 2022 from $626,414,670 at December 31, 2021. The increase in deposits was due to a $7,094,065 increase in noninterest-bearing accounts, a $15,448,625 increase in savings and money market accounts, and an $8,494,330 increase in interest bearing checking accounts and offset by a $18,481,856 decrease in time deposits.

The following table shows the average balances and average costs of deposits for the nine months ended September 30, 2022 and 2021:

	September 30, 2022					September 30, 2021
	Average					Average
	Balance		Cost			Balance		Cost

Noninterest bearing demand deposits	$	128,933,942		0.00	%	$	119,284,008		0.00	%
Interest bearing demand deposits		132,951,644		0.15	%		115,751,651		0.19	%
Savings and money market deposits		197,244,419		0.12	%		180,734,271		0.16	%
Time deposits		171,266,359		0.50	%		189,068,595		0.94	%
	$	630,396,364		0.21	%	$	604,838,525		0.38	%

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 $55.2 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 $28.9 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 September 30, 2022 and December 31, 2021. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll Bancorp, Inc. (“Carroll”) in 2020 as more fully described below. There were no borrowings from the Reserve Bank or our commercial bank lenders at September 30, 2022 and December 31, 2021. 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 paid 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 $15,566,458 and $16,978,905 as of September 30, 2022 and December 31, 2021, respectively. The loan matures on September 30, 2025. The interest rate on the loan is fixed at 4.10%. Quarterly interest-only payments were made through October 1, 2021. 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:

	September 30,			December 31,
	2022			2021
Amount oustanding at period-end:
Securities sold under repurchase agreements	$	5,422,642		$	5,414,026
Federal Home Loan Bank advances		5,000,000			5,000,000
Long-term debt (net of issuance costs)		15,566,458			16,978,905
Weighted average rate paid at period-end:
Securites sold under repurchase agreements		0.30	%		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 September 30, 2022 will require the following principal payments:

Year ending December 31, 2022			472,222
Year ending December 31, 2023			1,888,889
Year ending December 31, 2024			1,888,889
Year ending December 31, 2025			16,333,333

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 September 30, 2022 and December 31, 2021 are as follows:

	September 30,		December 31,
	2022		2021

Loan commitments
Construction and land development	$	2,611,014	$	6,810,353
Commercial		4,780,000		630,000
Commercial real estate		19,228,000		23,552,400
Residential		6,011,750		3,804,617
	$	32,630,764	$	34,797,370

Unused lines of credit
Home-equity lines	$	12,323,385	$	12,707,519
Commercial lines		29,617,368		28,828,911
	$	41,940,753	$	41,536,430

Letters of credit	$	1,388,610	$	1,470,742

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 Nine Months Ended September 30, 2022 and 2021

General

Net income for the nine months ended September 30, 2022 was $6,075,845, compared to $6,184,341 for the same period of 2021. The decrease of $108,496, or 1.8%, was due to a $362,546 decrease in noninterest income, a $783,490 increase in noninterest expenses, and a $17,521 increase in income taxes, offset by a $720,061 increase in net interest income and a $335,000 decrease in the loan loss provision.

Net Interest Income

Net interest income was $17,828,026 for the nine months ended September 30, 2022, compared to $17,107,965 for the same period of 2021.

Total interest income for the nine months ended September 30, 2022 was $19,350,937, compared to $19,305,971 for the same period of 2021, an increase of $44,966, or 0.2%.

Total interest income on loans for the nine months ended September 30, 2022 decreased by $1,167,401 when compared to the same period of 2021 due to a $29.8 million lower average loan balance for the nine months ended September 30, 2022 when compared to the same period of 2021 and a lower loan yield of 4.51% for the nine months ended September 30, 2022 versus 4.55% for the same period of 2021. The decline in yield is attributable to a decrease of approximately $687,000 in fees recognized on PPP loans during the nine months ended September 30, 2022 when compared to the same period in 2021. Excluding fees recognized on PPP loans, the loan yield was 4.45% for the nine months ended September 30, 2022 versus 4.31% for the same period in 2021. The increase is due to higher yields on adjustable rate loans as well as new originations. Investment income for the nine months ended September 30, 2022 increased by $1,170,447, or 81.8%, when compared to the same period of 2021 due to an $69.4 million higher average investment balance and an increase in fully-taxable equivalent yield to 2.07% for the nine months ended September 30, 2022, compared to 1.97% for the same period of 2021. The fully-taxable equivalent yield on total interest-earning assets decreased 13 basis points to 3.81% for the nine months ended September 30, 2022, compared to 3.94% for the same period of 2021. The average balance of total interest-earning assets increased by $24.9 million to $682.6 million for the nine months ended September 30, 2022, compared to $657.7 million for the same period of 2021.

Total interest expense for the nine months ended September 30, 2022 was $1,522,911, compared to $2,198,006 for the same period of 2021, a decrease of $675,095, or 30.7%. The decrease was due to a lower overall cost of funds on interest bearing deposits and borrowings of 0.39% for the nine months ended September 30, 2022, compared to 0.56% for the same period of 2021, offset by a $7.6 million increase in the average balance of interest-bearing liabilities to $526.4 million for the nine months ended September 30, 2022, compared to $518.8 million in the same period of 2021. Cost of funds for time deposits decreased to 0.50% for the nine months ended September 30, 2022 from 0.94% for the same period of 2021. Securities sold under repurchase agreements cost of funds decreased to 0.30% for the nine months ended September 30, 2022 from 0.45% for the same period of 2021.

Average noninterest-earning assets decreased by $9.5 million to $30.5 million for the nine months ended September 30, 2022, compared to $40.0 million in the same period of 2021. Average noninterest-bearing deposits increased by $9.6 million to $128.9 million during the nine months ended September 30, 2022, compared to $119.3 million in the same period of 2021. The average balance in stockholders’ equity decreased by $2,198,237 for the nine months ended September 30, 2022 when compared with the same period of 2021.

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 nine-month periods ended September 30, 2022 and 2021. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Nine Months Ended							Nine Months Ended
	September 30, 2022							September 30, 2021
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	492,180,338	$	16,660,625		4.51	%	$	521,978,666	$	17,828,026		4.55	%
Securities, taxable		156,586,314		2,173,853		1.85	%		85,644,831		971,070		1.51	%
Securities, tax exempt		18,890,763		556,009		3.92	%		20,393,689		595,078		3.89	%
Federal funds sold and other interest-earning assets		14,934,097		95,357		0.85	%		29,701,715		50,341		0.23	%
Total interest-earning assets		682,591,512		19,485,844		3.81	%		657,718,901		19,444,515		3.94	%
Noninterest-earning assets		30,461,709							39,965,396
Total assets	$	713,053,221						$	697,684,297

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	330,196,063		332,810		0.13	%	$	296,485,922		259,248		0.12	%
Certificates of deposit		171,266,359		638,510		0.50	%		189,068,595		1,330,086		0.94	%
Securities sold under repurchase agreements		3,813,719		8,558		0.30	%		11,269,845		38,130		0.45	%
Long-term debt		16,162,515		505,268		4.17	%		16,975,390		532,777
FHLB advances and other borrowings		5,000,000		37,765		1.01	%		5,000,000		37,765		1.01	%
Total interest-bearing liabilities		526,438,656		1,522,911		0.39	%		518,799,752		2,198,006		0.56	%

Noninterest-bearing deposits		128,933,242							119,284,008
Noninterest-bearing liabilities		5,525,793							5,246,770
Total liabilities		660,897,691							643,330,530
Stockholders' equity		52,155,530							54,353,767
Total liabilities and stockholders' equity	$	713,053,221						$	697,684,297

Net interest income			$	17,962,933						$	17,246,509

Interest rate spread						3.42	%						3.38	%

Net yield on interest-earning assets						3.51	%						3.50	%

Ratio of average interest-earning assets to average interest-bearing liabilities						129.66	%						126.78	%

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 nine months ended September 30, 2022 was $1,274,933, compared to $1,637,479 for the same period of 2021, a decrease of $362,546, or 22.1%. The decrease was due primarily to a $508,575 decrease in mortgage banking income as a result of residential refinance activity declining due to rising interest rates, offset by a $151,206 increase in the gain on the sale of SBA loans.

Noninterest Expense

Noninterest expense for the nine months ended September 30, 2022 totaled $11,152,875, compared to $10,369,385 for the same period of 2021, an increase of $783,490, or 7.6%. The increase was due primarily to increases in salaries and benefits of $357,718, and in other expenses of $428,200. Salaries and benefits increased due to normal and usual annual salary increases that are effective January 1 as well as an increase in the overall headcount. The other expense increase was due primarily to a $292,140 increase in professional fees as a result of recruitment fees paid to fill several positions.

Income Tax Expense

Income tax expense for the nine months ended September 30, 2022 was $1,779,239 compared to $1,761,718 for the same period of 2021. The effective tax rate was 22.7% for the nine months ended September 30, 2022, compared to 22.2% for the same period of 2021.

Comparison of Operating Results for the Three Months Ended September 30, 2022 and 2021

General

Net income for the three months ended September 30, 2022 was $1,974,310, compared to $2,122,547 for the same period of 2021. The decrease of $148,237, or 7.0%, was due to a $194,493 decrease in noninterest income and a $319,563 increase in noninterest expenses, offset by a $99,763 increase in net interest income, a $235,000 decrease in the loan loss provision, and a $31,056 decrease in income taxes.

Net Interest Income

Net interest income was $6,091,752 for the three months ended September 30, 2022, compared to $5,991,989 for the same period of 2021.

Total interest income for the three months ended September 30, 2022 was $6,586,065, compared to $6,654,268 for the same period of 2021, a decrease of $68,203, or 1.0%.

Total interest income on loans for the three months ended September 30, 2022 decreased by $452,796 when compared to the same period of 2021 due to a $12.8 million lower average loan balance for the three months ended September 30, 2022 when compared to the same period of 2021, and a lower loan yield of 4.48% for the three months ended September 30, 2022 versus 4.73% for the same period of 2021. The decline in yield is attributable to a decrease of approximately $481,000 in fees recognized on PPP loans during the three months ended September 30, 2022 when compared to the same period in 2021. Excluding fees recognized on PPP loans, the loan yield was 4.31% for the three months ended September 30, 2022 versus 4.18% for the same period in 2021. The increase is due to higher yields on adjustable rate loans as well as new originations. Investment income for the three months ended September 30, 2022 increased by $347,530, or 60.3%, when compared to the same period of 2021 due to a $48.4 million higher average investment balance and an increase in fully-taxable equivalent yield to 2.19% for the three months ended September 30, 2022, compared to 1.94% for the same period of 2021. The fully-taxable equivalent yield on total interest-earning assets decreased 9 basis points to 3.89% for the three months ended September 30, 2022, compared to 3.98% for the same period of 2021. The average balance of total interest-earning assets increased by $10.2 million to $682.5 million for the three months ended September 30, 2022, compared to $672.3 million for the same period of 2021.

Total interest expense for the three months ended September 30, 2022 was $494,313, compared to $662,279 for the same period of 2021, a decrease of $167,966, or 25.4%. The decrease was due to a lower overall cost of funds on interest bearing deposits and borrowings of 0.37% for the three months ended September 30, 2022, compared to 0.50% for the same period of 2021, offset by a $3.9 million increase in the average balance of interest-bearing liabilities to $528.6 million for the three months ended September 30, 2022, compared to $524.7 million in the same period of 2021. Cost of funds for time deposits decreased to 0.47% for the three months ended September 30, 2022 from 0.75% for the same period of 2021. Securities sold under repurchase agreements cost of funds decreased to 0.30% for the three months ended September 30, 2022 from 0.36% for the same period of 2021.

Average noninterest-earning assets decreased by $5.9 million to $32.4 million for the three months ended September 30, 2022, compared to $38.2 million in the same period of 2021. Average noninterest-bearing deposits increased by $6.7 million to $130.9 million during the three months ended September 30, 2022, compared to $124.1 million in the same period of 2021. The average balance in stockholders’ equity decreased by $6.2 million for the three months ended September 30, 2022 when compared with the same period of 2021 due to the change in the market value of the available-for-sale securities portfolio.

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 September 30, 2022 and 2021. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Three Months Ended							Three Months Ended
	Septembere 30, 2022							September 30, 2021
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	500,169,548	$	5,606,913		4.48	%	$	512,953,631	$	6,059,709		4.73	%
Securities, taxable		157,672,542		784,738		1.99	%		107,912,735		428,037		1.59	%
Securities, tax exempt		18,438,547		181,264		3.93	%		19,811,359		189,950		3.84	%
Federal funds sold and other interest-earning assets		6,246,364		59,008		3.78	%		31,630,398		19,369		0.24	%
Total interest-earning assets		682,527,001		6,631,923		3.89	%		672,308,123		6,697,065		3.98	%
Noninterest-earning assets		32,366,316							38,217,888
Total assets	$	714,893,317						$	710,526,011

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	337,682,240		119,062		0.14	%	$	307,799,463		115,652		0.15	%
Certificates of deposit		166,446,902		194,494		0.47	%		184,058,190		344,725		0.75	%
Securities sold under repurchase agreements		3,800,797		2,874		0.30	%		10,847,773		9,647		0.36	%
Long-term debt		15,683,811		165,156		4.21	%		16,976,796		179,528		4.23	%
FHLB advances and other borrowings		5,000,000		12,727		1.02	%		5,000,120		12,727		1.02	%
Total interest-bearing liabilities		528,613,750		494,313		0.37	%		524,682,342		662,279		0.50	%

Noninterest-bearing deposits		130,880,729							124,149,640
Noninterest-bearing liabilities		5,564,389							5,667,596
Total liabilities		665,058,868							654,499,578
Stockholders' equity		49,834,449							56,026,433
Total liabilities and stockholders' equity	$	714,893,317						$	710,526,011

Net interest income			$	6,137,610						$	6,034,786

Interest rate spread						3.51	%						3.48	%

Net yield on interest-earning assets						3.60	%						3.59	%

Ratio of average interest-earning assets to average interest-bearing liabilities						129.12	%						128.14	%

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 September 30, 2022 was $337,485, compared to $531,978 for the same period of 2021, a decrease of $194,493, or 36.6%. The decrease was primarily a result of a $199,316 decrease in mortgage banking income as a result of residential refinance activity declining due to rising interest rates.

Noninterest Expense

Noninterest expense for the three months ended September 30, 2022 totaled $3,784,691 compared to $3,465,128 for the same period of 2021, an increase of $319,563, or 9.2%. The increase was due primarily to an increase in salaries and benefits of $121,754 and an increase in other expenses of $205,208. Salaries and benefits increased due to normal and usual annual salary increases that are effective January 1 as well as an increase in the overall headcount.

Income Tax Expense

Income tax expense for the three months ended September 30, 2022 was $575,236, compared to $606,292 for the same period of 2021. The effective tax rate was 22.6% for the three months ended September 30, 2022, compared to 22.2% for the same period of 2021.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Farmers and Merchants Bancshares, Inc. is a “smaller reporting company” as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, accordingly, is not required to include the information required by this item.

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 September 30, 2022 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 September 30, 2022, 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. Except as set forth below, management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

Certain of our U.S. consolidated federal income tax returns are currently being audited.

In April 2018, we were notified by the Internal Revenue Service the “IRS”) that our 2016 U.S. consolidated federal tax return was selected for audit. In April 2020, we were notified by the IRS that our 2017 and 2018 U.S. consolidated federal tax returns had also been selected for audit. As part of its audits, the IRS reviewed the deductions related to, and the income generated by, the Insurance Subsidiary. Following the completion of its audits, the IRS determined that it disagreed with our tax treatment of the Insurance Subsidiary, and we are in the process of appealing such determination. Management cannot predict whether our appeal and defense of our tax positions will be successful. If our appeal is not successful, then we believe that we could be required to pay taxes, interest, and penalties totaling approximately $3.0 million as of December 31, 2021 for the tax years under audit and our taxable earnings and/or the effective tax rate on our future earnings could increase substantially, any of which could have a material adverse effect on our business, financial condition and results of operations. See Note 13 to the consolidated financial statements presented in Form 10-K for further information about this risk.

In August 2022, we were notified by the IRS that our 2019 and 2020 U.S. consolidated federal tax returns were selected for audit. We believe that the primary focus of the audits will be the income and deductions related to the Insurance Subsidiary, but it is possible that the IRS will expand the scope of its audits to cover any other aspect of our operations. At this time, we do not know whether or how such audits could affect our financial condition or results of operations.

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

3.2	First Amendment to Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K filed on July 20, 2022)

10.1	Change in Control Severance Agreement, dated as of July 18, 2022, between the Company and Gary Harris (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on July 20, 2022)

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	The cover page of Farmers and Merchants Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2022 formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith).

SIGNATURES

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

FARMERS AND MERCHANTS BANCSHARES, INC.

Date:	November 14, 2022	/s/ James R. Bosley, Jr.
		James R. Bosley, Jr.
		Chief Executive Officer
		(Principal Executive Officer)


Date	November 14, 2022	/s/ Mark C. Krebs
		Mark C. Krebs
		Treasurer and Chief Financial Officer
		(Principal Financial Officer & Principal Accounting Officer)