The Company’s property appraisals are primarily based on the sales comparison approach and the income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period to period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property.
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at June 30, 2017:
5. Fair Value of Financial Instruments
U.S. GAAP requires disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practical to estimate that value. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization.
The following tables summarize the book value and estimated fair value of financial instruments for the periods indicated:
Fair value estimates presented herein are based on pertinent information available to management as of June 30, 2017, December 31, 2016, and June 30, 2016. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purpose of these financial statements since that date, and; therefore, current estimates of fair value may differ significantly from the amounts presented above. The methods and assumptions used to estimate the fair value of each class of financial instrument listed in the table above are explained below.
Cash and Cash Equivalents - The carrying amounts reported in the balance sheet for cash and due from banks, interest-bearing deposits with banks, federal funds sold, and securities purchased under agreements to resell are a reasonable estimate of fair value. All cash and cash equivalents are classified as Level 1.
Investment Securities - Fair values for investment securities consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions, among other things. Based on the available market information the classification level could be 1, 2, or 3.
Federal Home Loan Bank Stock - It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
Loans & Leases, Net of Deferred Loan & Lease Fees & Allowance - Fair values of loans & leases are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans & leases are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans & leases are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans & leases do not necessarily represent an exit price.
Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair values for fixed-maturity certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
Subordinated Debentures - The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.
Accrued Interest Receivable and Payable - The carrying amount of accrued interest receivable and payable approximates their fair value resulting in a Level 2 classification.
6. Dividends and Basic Earnings Per Common Share
Farmers & Merchants Bancorp common stock is not traded on any exchange. The shares are primarily held by local residents and are not actively traded. On May 9, 2017, the Board of Directors of Farmers & Merchants Bancorp announced a mid-year cash dividend of $6.75 per share, a 3.1% increase over the $6.55 per share paid on July 1, 2016. The cash dividend was paid on July 1, 2017, to shareholders of record on June 9, 2017.
Basic earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. The Company has no securities or other contracts, such as stock options, that could require the issuance of common stock. Accordingly, diluted earnings per share are not presented. The following table calculates the basic earnings per common share for the three and six months ended June 30, 2017 and 2016.
7. Recent Accounting Pronouncements
8. Subsequent Events
On April 5, 2017 the Company purchased 4.9% of the voting shares of Bank of Rio Vista, Rio Vista, California for $1.4 million. On July 3, 2017 the Federal Reserve Bank of San Francisco approved the Company’s application to acquire an additional 34.55% of the voting shares for $10.5 million. The purchase of the additional shares closed on July 20, 2017.
|
Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
|
The following is management’s discussion and analysis of the major factors that influenced our financial performance for the three and six months ended June 30, 2017. This analysis should be read in conjunction with our 2016 Annual Report to Shareholders on Form 10-K, and with the unaudited financial statements and notes as set forth in this report.
Forward–Looking Statements
This Form 10-Q contains various forward-looking statements, usually containing the words “estimate,” “project,” “expect,” “objective,” “goal,” or similar expressions and includes assumptions concerning Farmers & Merchants Bancorp’s (together with its subsidiaries, the “Company” or “we”) operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risks and uncertainties. In connection with the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions.
Such factors include the following: (1) economic conditions in the Central Valley of California; (2) significant changes in interest rates and loan prepayment speeds; (3) credit risks of lending and investment activities; (4) changes in federal and state banking laws or regulations; (5) competitive pressure in the banking industry; (6) changes in governmental fiscal or monetary policies; (7) uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the U.S. or other governments as a result of further acts or threats of terrorism; (8) water management issues in California and the resulting impact on the Company’s agricultural customers; (9) expansion into new geographic markets and new lines of business; and (10) other factors discussed in Item 1A. Risk Factors located in the Company’s 2016 Annual Report on Form 10-K.
Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
Introduction
Farmers & Merchants Bancorp, or the Company, is a bank holding company formed March 10, 1999. Its subsidiary, Farmers & Merchants Bank of Central California, or the Bank, is a California state-chartered bank formed in 1916. Banking services are provided in twenty-seven locations in the Company's service area. The service area includes Sacramento, San Joaquin, Stanislaus, Merced and Contra Costa Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, Linden, Modesto, Turlock, Hilmar, Merced, Manteca, Riverbank, Walnut Creek and Concord.
As a bank holding company, the Company is subject to regulation and examination by the Board of Governors of the Federal Reserve System (“FRB”). As a California, state-chartered, non-fed member bank, the Bank is subject to regulation and examination by the California Department of Business Oversight (“DBO”) and the Federal Deposit Insurance Corporation (“FDIC”).
Overview
Although the Company has initiated efforts to expand its geographic footprint into the East Bay area of San Francisco, California, the Company’s primary service area remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry. Accordingly, discussion of the Company’s Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).
The State of California experienced drought conditions from 2013 through most of 2016. Although significant levels of rain and snow in late 2016 and early 2017 have alleviated drought conditions in many areas of California, including the Company’s primary service area, the long-term risks associated with the availability of water continue to exist.
For the three and six months ended June 30, 2017, Farmers & Merchants Bancorp reported net income of $8,187,000 and $16,008,000, earnings per share of $10.12 and $19.80 and return on average assets of 1.11% and 1.09%, respectively. Return on average shareholders’ equity was 11.28% and 11.14% for the three and six months ended June 30, 2017.
For the three and six months ended June 30, 2016, Farmers & Merchants Bancorp reported net income of $7,332,000 and $14,504,000, earnings per share of $9.25 and $18.31 and return on average assets of 1.14% and 1.12%, respectively. Return on average shareholders’ equity was 11.14% and 11.13% for the three and six months ended June 30, 2016.
The following is a summary of the financial results for the six-month period ended June 30, 2017 compared to June 30, 2016.
·
|
Net income increased 10.4% to $16,008,000 from $14,504,000.
|
·
|
Earnings per share increased 8.1% to $19.80 from $18.31.
|
·
|
Total assets increased 12.0% to $3.0 billion from $2.7 billion.
|
·
|
Total loans & leases increased 6.6% to $2.2 billion from $2.1 billion.
|
·
|
Total deposits increased 14.3% to $2.7 billion from $2.3 billion.
|
The primary reasons for the Company’s $2.4 million or 10.7% increase in pre-tax income in the first half of 2017 as compared to the same period of 2016 were:
·
|
A $5.93 million increase in net interest income related to the growth in earning assets.
|
·
|
A $1.35 million decrease in the provision for credit losses.
|
·
|
A $1.17 million increase in the gain on sale of fixed assets related to the disposition of one of the Company’s properties.
|
·
|
A $420,000 increase in gain on sale of investment securities.
|
·
|
A $919,000 reduction in non-interest expense related to the Delta Bancorp acquisition that took place in 2016.
|
These positive impacts were partially offset by:
·
|
A $5.53 million increase in non-interest expense related to a non-recurring gain on sale of ORE that took place in the first quarter of the prior year (2016) and was recorded as a reduction to non-interest expense.
|
·
|
A $2.15 million increase in salaries and employee benefits.
|
Results of Operations
Net Interest Income / Net Interest Margin
The tables on the following pages reflect the Company's average balance sheets and volume and rate analysis for the three and six-month periods ended June 30, 2017 and 2016.
The average yields on earning assets and average rates paid on interest-bearing liabilities have been computed on an annualized basis for purposes of comparability with full year data. Average balance amounts for assets and liabilities are the computed average of daily balances.
Net interest income is the amount by which the interest and fees on loans & leases and other interest earning assets exceed the interest paid on interest bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as “taxable equivalent” and is noted wherever applicable.
The Volume and Rate Analysis of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average asset and liability balances (volume) and changes in average rates (rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to: (1) changes in volume (change in volume multiplied by initial rate); (2) changes in rate (change in rate multiplied by initial volume); and (3) changes in rate/volume (allocated in proportion to the respective volume and rate components).
The Company’s earning assets and rate sensitive liabilities are subject to repricing at different times, which exposes the Company to income fluctuations when interest rates change. In order to minimize income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk – Interest Rate Risk.”
Farmers & Merchants Bancorp
Quarterly Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
|
|
Three Months Ended June 30,
2017
|
|
|
Three Months Ended June 30,
2016
|
|
Assets
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
Interest Bearing Deposits with Banks
|
|
$
|
112,458
|
|
|
$
|
258
|
|
|
|
0.92
|
%
|
|
$
|
28,395
|
|
|
$
|
36
|
|
|
|
0.51
|
%
|
Investment Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasuries
|
|
|
82,953
|
|
|
|
224
|
|
|
|
1.08
|
%
|
|
|
65,552
|
|
|
|
155
|
|
|
|
0.95
|
%
|
U.S. Govt SBA
|
|
|
34,083
|
|
|
|
125
|
|
|
|
1.47
|
%
|
|
|
0
|
|
|
|
0
|
|
|
|
0.00
|
%
|
Government Agency & Government-Sponsored Entities
|
|
|
3,110
|
|
|
|
22
|
|
|
|
2.83
|
%
|
|
|
16,397
|
|
|
|
28
|
|
|
|
0.68
|
%
|
Obligations of States and Political Subdivisions - Non-Taxable
|
|
|
56,984
|
|
|
|
673
|
|
|
|
4.73
|
%
|
|
|
61,385
|
|
|
|
744
|
|
|
|
4.85
|
%
|
Mortgage Backed Securities
|
|
|
302,579
|
|
|
|
1,747
|
|
|
|
2.31
|
%
|
|
|
202,494
|
|
|
|
1,115
|
|
|
|
2.20
|
%
|
Other
|
|
|
2,352
|
|
|
|
6
|
|
|
|
1.02
|
%
|
|
|
515
|
|
|
|
3
|
|
|
|
2.33
|
%
|
Total Investment Securities
|
|
|
482,061
|
|
|
|
2,797
|
|
|
|
2.32
|
%
|
|
|
346,343
|
|
|
|
2,045
|
|
|
|
2.36
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans & Leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate
|
|
|
1,557,716
|
|
|
|
18,201
|
|
|
|
4.70
|
%
|
|
|
1,443,510
|
|
|
|
16,463
|
|
|
|
4.59
|
%
|
Home Equity Lines & Loans
|
|
|
31,916
|
|
|
|
405
|
|
|
|
5.10
|
%
|
|
|
31,415
|
|
|
|
391
|
|
|
|
5.01
|
%
|
Agricultural
|
|
|
270,594
|
|
|
|
3,041
|
|
|
|
4.52
|
%
|
|
|
260,242
|
|
|
|
2,640
|
|
|
|
4.08
|
%
|
Commercial
|
|
|
227,983
|
|
|
|
2,563
|
|
|
|
4.52
|
%
|
|
|
222,044
|
|
|
|
2,238
|
|
|
|
4.05
|
%
|
Consumer
|
|
|
5,578
|
|
|
|
80
|
|
|
|
5.77
|
%
|
|
|
5,080
|
|
|
|
69
|
|
|
|
5.46
|
%
|
Other
|
|
|
1,678
|
|
|
|
10
|
|
|
|
2.40
|
%
|
|
|
1,968
|
|
|
|
11
|
|
|
|
2.25
|
%
|
Leases
|
|
|
79,891
|
|
|
|
948
|
|
|
|
4.77
|
%
|
|
|
65,096
|
|
|
|
680
|
|
|
|
4.20
|
%
|
Total Loans & Leases
|
|
|
2,175,356
|
|
|
|
25,248
|
|
|
|
4.67
|
%
|
|
|
2,029,355
|
|
|
|
22,492
|
|
|
|
4.46
|
%
|
Total Earning Assets
|
|
|
2,769,875
|
|
|
$
|
28,303
|
|
|
|
4.11
|
%
|
|
|
2,404,093
|
|
|
$
|
24,573
|
|
|
|
4.11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Gain on Securities Available-for-Sale
|
|
|
1,245
|
|
|
|
|
|
|
|
|
|
|
|
5,628
|
|
|
|
|
|
|
|
|
|
Allowance for Credit Losses
|
|
|
(48,690
|
)
|
|
|
|
|
|
|
|
|
|
|
(44,126
|
)
|
|
|
|
|
|
|
|
|
Cash and Due From Banks
|
|
|
43,129
|
|
|
|
|
|
|
|
|
|
|
|
43,185
|
|
|
|
|
|
|
|
|
|
All Other Assets
|
|
|
188,434
|
|
|
|
|
|
|
|
|
|
|
|
171,778
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
2,953,993
|
|
|
|
|
|
|
|
|
|
|
$
|
2,580,558
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities & Shareholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing DDA
|
|
$
|
501,008
|
|
|
|
221
|
|
|
|
0.18
|
%
|
|
$
|
414,876
|
|
|
|
128
|
|
|
|
0.12
|
%
|
Savings and Money Market
|
|
|
792,839
|
|
|
|
306
|
|
|
|
0.16
|
%
|
|
|
718,077
|
|
|
|
262
|
|
|
|
0.15
|
%
|
Time Deposits
|
|
|
594,866
|
|
|
|
906
|
|
|
|
0.61
|
%
|
|
|
487,861
|
|
|
|
469
|
|
|
|
0.39
|
%
|
Total Interest Bearing Deposits
|
|
|
1,888,713
|
|
|
|
1,433
|
|
|
|
0.31
|
%
|
|
|
1,620,814
|
|
|
|
859
|
|
|
|
0.21
|
%
|
Federal Home Loan Bank Advances
|
|
|
-
|
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
393
|
|
|
|
-
|
|
|
|
0.00
|
%
|
Subordinated Debentures
|
|
|
10,310
|
|
|
|
105
|
|
|
|
4.10
|
%
|
|
|
10,310
|
|
|
|
92
|
|
|
|
3.59
|
%
|
Total Interest Bearing Liabilities
|
|
|
1,899,023
|
|
|
$
|
1,538
|
|
|
|
0.33
|
%
|
|
|
1,631,517
|
|
|
$
|
951
|
|
|
|
0.23
|
%
|
Interest Rate Spread
|
|
|
|
|
|
|
|
|
|
|
3.78
|
%
|
|
|
|
|
|
|
|
|
|
|
3.88
|
%
|
Demand Deposits (Non-Interest Bearing)
|
|
|
710,533
|
|
|
|
|
|
|
|
|
|
|
|
633,394
|
|
|
|
|
|
|
|
|
|
All Other Liabilities
|
|
|
54,135
|
|
|
|
|
|
|
|
|
|
|
|
52,321
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
2,663,691
|
|
|
|
|
|
|
|
|
|
|
|
2,317,232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders' Equity
|
|
|
290,302
|
|
|
|
|
|
|
|
|
|
|
|
263,326
|
|
|
|
|
|
|
|
|
|
Total Liabilities & Shareholders' Equity
|
|
$
|
2,953,993
|
|
|
|
|
|
|
|
|
|
|
$
|
2,580,558
|
|
|
|
|
|
|
|
|
|
Impact of Non-Interest Bearing Deposits and Other Liabilities
|
|
|
|
|
|
|
|
|
|
|
0.10
|
%
|
|
|
|
|
|
|
|
|
|
|
0.08
|
%
|
Net Interest Income and Margin on Total Earning Assets
|
|
|
|
|
|
|
26,765
|
|
|
|
3.89
|
%
|
|
|
|
|
|
|
23,622
|
|
|
|
3.95
|
%
|
Tax Equivalent Adjustment
|
|
|
|
|
|
|
(234
|
)
|
|
|
|
|
|
|
|
|
|
|
(259
|
)
|
|
|
|
|
Net Interest Income
|
|
|
|
|
|
$
|
26,531
|
|
|
|
3.85
|
%
|
|
|
|
|
|
$
|
23,363
|
|
|
|
3.91
|
%
|
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount in the amount of $1.0 million and $1.2 million for the quarters ended June 30, 2017 and 2016, respectively. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
|
|
Six Months Ended June 30,
2017
|
|
|
Six Months Ended June 30,
2016
|
|
Assets
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
Interest Bearing Deposits with Banks
|
|
$
|
118,863
|
|
|
$
|
507
|
|
|
|
0.86
|
%
|
|
$
|
32,674
|
|
|
$
|
82
|
|
|
|
0.50
|
%
|
Investment Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasuries
|
|
|
83,182
|
|
|
|
441
|
|
|
|
1.06
|
%
|
|
|
48,856
|
|
|
|
227
|
|
|
|
0.93
|
%
|
U.S. Govt SBA
|
|
|
34,971
|
|
|
|
250
|
|
|
|
1.43
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
0.00
|
%
|
Government Agency & Government-Sponsored Entities
|
|
|
3,115
|
|
|
|
44
|
|
|
|
2.83
|
%
|
|
|
25,172
|
|
|
|
133
|
|
|
|
1.06
|
%
|
Obligations of States and Political Subdivisions - Non-Taxable
|
|
|
57,407
|
|
|
|
1,363
|
|
|
|
4.75
|
%
|
|
|
61,404
|
|
|
|
1,487
|
|
|
|
4.84
|
%
|
Mortgage Backed Securities
|
|
|
295,602
|
|
|
|
3,390
|
|
|
|
2.29
|
%
|
|
|
228,613
|
|
|
|
2,537
|
|
|
|
2.22
|
%
|
Other
|
|
|
1,685
|
|
|
|
11
|
|
|
|
1.31
|
%
|
|
|
512
|
|
|
|
6
|
|
|
|
2.34
|
%
|
Total Investment Securities
|
|
|
475,962
|
|
|
|
5,499
|
|
|
|
2.31
|
%
|
|
|
364,557
|
|
|
|
4,390
|
|
|
|
2.41
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans & Leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate
|
|
|
1,559,873
|
|
|
|
36,132
|
|
|
|
4.67
|
%
|
|
|
1,427,211
|
|
|
|
32,429
|
|
|
|
4.57
|
%
|
Home Equity Lines & Loans
|
|
|
31,805
|
|
|
|
787
|
|
|
|
4.99
|
%
|
|
|
31,862
|
|
|
|
780
|
|
|
|
4.92
|
%
|
Agricultural
|
|
|
269,158
|
|
|
|
5,932
|
|
|
|
4.44
|
%
|
|
|
260,072
|
|
|
|
5,254
|
|
|
|
4.06
|
%
|
Commercial
|
|
|
221,287
|
|
|
|
5,023
|
|
|
|
4.58
|
%
|
|
|
219,253
|
|
|
|
4,395
|
|
|
|
4.03
|
%
|
Consumer
|
|
|
5,452
|
|
|
|
148
|
|
|
|
5.47
|
%
|
|
|
4,987
|
|
|
|
147
|
|
|
|
5.93
|
%
|
Other
|
|
|
1,678
|
|
|
|
19
|
|
|
|
2.28
|
%
|
|
|
1,968
|
|
|
|
22
|
|
|
|
2.25
|
%
|
Leases
|
|
|
75,922
|
|
|
|
1,738
|
|
|
|
4.62
|
%
|
|
|
65,389
|
|
|
|
1,359
|
|
|
|
4.18
|
%
|
Total Loans & Leases
|
|
|
2,165,175
|
|
|
|
49,779
|
|
|
|
4.64
|
%
|
|
|
2,010,742
|
|
|
|
44,386
|
|
|
|
4.44
|
%
|
Total Earning Assets
|
|
|
2,760,000
|
|
|
$
|
55,785
|
|
|
|
4.08
|
%
|
|
|
2,407,973
|
|
|
$
|
48,858
|
|
|
|
4.08
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Gain on Securities Available-for-Sale
|
|
|
447
|
|
|
|
|
|
|
|
|
|
|
|
4,833
|
|
|
|
|
|
|
|
|
|
Allowance for Credit Losses
|
|
|
(48,378
|
)
|
|
|
|
|
|
|
|
|
|
|
(42,865
|
)
|
|
|
|
|
|
|
|
|
Cash and Due From Banks
|
|
|
44,801
|
|
|
|
|
|
|
|
|
|
|
|
42,115
|
|
|
|
|
|
|
|
|
|
All Other Assets
|
|
|
186,324
|
|
|
|
|
|
|
|
|
|
|
|
170,060
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
2,943,194
|
|
|
|
|
|
|
|
|
|
|
$
|
2,582,116
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities & Shareholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing DDA
|
|
$
|
498,301
|
|
|
$
|
402
|
|
|
|
0.16
|
%
|
|
$
|
403,697
|
|
|
$
|
236
|
|
|
|
0.12
|
%
|
Savings and Money Market
|
|
|
797,709
|
|
|
|
614
|
|
|
|
0.16
|
%
|
|
|
727,970
|
|
|
|
542
|
|
|
|
0.15
|
%
|
Time Deposits
|
|
|
587,440
|
|
|
|
1,693
|
|
|
|
0.58
|
%
|
|
|
485,358
|
|
|
|
909
|
|
|
|
0.38
|
%
|
Total Interest Bearing Deposits
|
|
|
1,883,450
|
|
|
|
2,709
|
|
|
|
0.29
|
%
|
|
|
1,617,025
|
|
|
|
1,687
|
|
|
|
0.21
|
%
|
Federal Home Loan Bank Advances
|
|
|
2
|
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
1,910
|
|
|
|
4
|
|
|
|
0.42
|
%
|
Subordinated Debentures
|
|
|
10,310
|
|
|
|
205
|
|
|
|
4.01
|
%
|
|
|
10,310
|
|
|
|
180
|
|
|
|
3.51
|
%
|
Total Interest Bearing Liabilities
|
|
|
1,893,762
|
|
|
$
|
2,914
|
|
|
|
0.31
|
%
|
|
|
1,629,245
|
|
|
$
|
1,871
|
|
|
|
0.23
|
%
|
Interest Rate Spread
|
|
|
|
|
|
|
|
|
|
|
3.77
|
%
|
|
|
|
|
|
|
|
|
|
|
3.85
|
%
|
Demand Deposits (Non-Interest Bearing)
|
|
|
711,627
|
|
|
|
|
|
|
|
|
|
|
|
642,354
|
|
|
|
|
|
|
|
|
|
All Other Liabilities
|
|
|
50,408
|
|
|
|
|
|
|
|
|
|
|
|
49,802
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
2,655,797
|
|
|
|
|
|
|
|
|
|
|
|
2,321,401
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders' Equity
|
|
|
287,397
|
|
|
|
|
|
|
|
|
|
|
|
260,715
|
|
|
|
|
|
|
|
|
|
Total Liabilities & Shareholders' Equity
|
|
$
|
2,943,194
|
|
|
|
|
|
|
|
|
|
|
$
|
2,582,116
|
|
|
|
|
|
|
|
|
|
Impact of Non-Interest Bearing Deposits and Other Liabilities
|
|
|
|
|
|
|
|
|
|
|
0.10
|
%
|
|
|
|
|
|
|
|
|
|
|
0.07
|
%
|
Net Interest Income and Margin on Total Earning Assets
|
|
|
|
|
|
|
52,871
|
|
|
|
3.86
|
%
|
|
|
|
|
|
|
46,987
|
|
|
|
3.92
|
%
|
Tax Equivalent Adjustment
|
|
|
|
|
|
|
(474
|
)
|
|
|
|
|
|
|
|
|
|
|
(518
|
)
|
|
|
|
|
Net Interest Income
|
|
|
|
|
|
$
|
52,397
|
|
|
|
3.83
|
%
|
|
|
|
|
|
$
|
46,469
|
|
|
|
3.88
|
%
|
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount in the amount of $2.3 million and $2.2 million for the six months ended June 30, 2017 and 2016, respectively. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Revenue
(in thousands)
|
|
Three Months Ended
June 30, 2017 compared to June 30, 2016
|
|
|
Six Months Ended
June 30, 2017 compared to June 30, 2016
|
|
Interest Earning Assets
|
|
Volume
|
|
|
Rate
|
|
|
Net Chg.
|
|
|
Volume
|
|
|
Rate
|
|
|
Net Chg.
|
|
Interest Bearing Deposits with Banks
|
|
$
|
175
|
|
|
$
|
47
|
|
|
$
|
222
|
|
|
$
|
336
|
|
|
$
|
89
|
|
|
$
|
425
|
|
Investment Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasuries
|
|
|
45
|
|
|
|
24
|
|
|
|
69
|
|
|
|
178
|
|
|
|
36
|
|
|
|
214
|
|
U.S. Govt SBA
|
|
|
125
|
|
|
|
-
|
|
|
|
125
|
|
|
|
250
|
|
|
|
-
|
|
|
|
250
|
|
Government Agency & Government-Sponsored Entities
|
|
|
(38
|
)
|
|
|
32
|
|
|
|
(6
|
)
|
|
|
(184
|
)
|
|
|
95
|
|
|
|
(89
|
)
|
Obligations of States and Political Subdivisions - Non-Taxable
|
|
|
(52
|
)
|
|
|
(18
|
)
|
|
|
(70
|
)
|
|
|
(95
|
)
|
|
|
(29
|
)
|
|
|
(124
|
)
|
Mortgage Backed Securities
|
|
|
576
|
|
|
|
56
|
|
|
|
632
|
|
|
|
765
|
|
|
|
88
|
|
|
|
853
|
|
Other
|
|
|
6
|
|
|
|
(3
|
)
|
|
|
3
|
|
|
|
9
|
|
|
|
(4
|
)
|
|
|
5
|
|
Total Investment Securities
|
|
|
662
|
|
|
|
91
|
|
|
|
753
|
|
|
|
923
|
|
|
|
186
|
|
|
|
1,109
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans & Leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate
|
|
|
1,327
|
|
|
|
411
|
|
|
|
1,738
|
|
|
|
2,987
|
|
|
|
716
|
|
|
|
3,703
|
|
Home Equity Lines & Loans
|
|
|
6
|
|
|
|
8
|
|
|
|
14
|
|
|
|
(2
|
)
|
|
|
9
|
|
|
|
7
|
|
Agricultural
|
|
|
108
|
|
|
|
293
|
|
|
|
401
|
|
|
|
184
|
|
|
|
494
|
|
|
|
678
|
|
Commercial
|
|
|
61
|
|
|
|
264
|
|
|
|
325
|
|
|
|
40
|
|
|
|
588
|
|
|
|
628
|
|
Consumer
|
|
|
7
|
|
|
|
4
|
|
|
|
11
|
|
|
|
13
|
|
|
|
(12
|
)
|
|
|
1
|
|
Other
|
|
|
(2
|
)
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
(3
|
)
|
|
|
0
|
|
|
|
(3
|
)
|
Leases
|
|
|
167
|
|
|
|
101
|
|
|
|
268
|
|
|
|
230
|
|
|
|
149
|
|
|
|
379
|
|
Total Loans & Leases
|
|
|
1,674
|
|
|
|
1,082
|
|
|
|
2,756
|
|
|
|
3,449
|
|
|
|
1,944
|
|
|
|
5,393
|
|
Total Earning Assets
|
|
|
2,511
|
|
|
|
1,220
|
|
|
|
3,731
|
|
|
|
4,708
|
|
|
|
2,219
|
|
|
|
6,927
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing DDA
|
|
|
31
|
|
|
|
62
|
|
|
|
93
|
|
|
|
63
|
|
|
|
103
|
|
|
|
166
|
|
Savings and Money Market
|
|
|
29
|
|
|
|
15
|
|
|
|
44
|
|
|
|
52
|
|
|
|
20
|
|
|
|
72
|
|
Time
|
|
|
119
|
|
|
|
318
|
|
|
|
437
|
|
|
|
219
|
|
|
|
565
|
|
|
|
784
|
|
Total Interest Bearing Deposits
|
|
|
179
|
|
|
|
395
|
|
|
|
574
|
|
|
|
334
|
|
|
|
688
|
|
|
|
1,022
|
|
Other Borrowed Funds
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(2
|
)
|
|
|
(2
|
)
|
|
|
(4
|
)
|
Subordinated Debentures
|
|
|
-
|
|
|
|
13
|
|
|
|
13
|
|
|
|
-
|
|
|
|
25
|
|
|
|
25
|
|
Total Interest Bearing Liabilities
|
|
|
179
|
|
|
|
408
|
|
|
|
587
|
|
|
|
332
|
|
|
|
711
|
|
|
|
1,043
|
|
Total Change on a Tax Equivalent Basis
|
|
$
|
2,332
|
|
|
$
|
812
|
|
|
$
|
3,144
|
|
|
$
|
4,376
|
|
|
$
|
1,508
|
|
|
$
|
5,884
|
|
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.
Second Quarter 2017 vs. Second Quarter 2016
Net interest income for the second quarter of 2017 increased 13.6% or $6.2 million to $26.5 million. On a fully taxable equivalent basis, net interest income increased 13.3% and totaled $26.8 million for the second quarter of 2017. As more fully discussed below, the increase in net interest income was due to a $365.8 million increase in average earning assets.
Net interest income on a taxable equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For the quarter ended June 30, 2017, the Company’s net interest margin was 3.89% compared to 3.95% for the quarter ended June 30, 2016. This decrease in net interest margin was due to an increase in the rate paid on interest bearing liabilities.
Average loans & leases totaled $2.2 billion for the quarter ended June 30, 2017; an increase of $146.0 million compared to the average balance for the quarter ended June 30, 2016. Loans & leases decreased from 84.4% of average earning assets at June 30, 2016 to 78.5% at June 30, 2017. The annualized yield on the Company’s loan & lease portfolio increased to 4.67% for the quarter ended June 30, 2017, compared to 4.46% for the quarter ended June 30, 2016. Overall, the positive impact on interest revenue from the increase in loan & lease balances and rising yields resulted in interest revenue from loans & leases increasing 12.3% to $25.2 million for quarter ended June 30, 2016. The Company has been experiencing aggressive competitor pricing for loans & leases to which it may need to continue to respond in order to retain key customers. This could place even greater negative pressure on future loan & lease yields and net interest margin.
The investment portfolio is the other main component of the Company’s earning assets. Since the risk factor for investments is typically lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases. Average investment securities totaled $482.1 million for the quarter ended June 30, 2017; an increase of $135.7 million compared to the average balance for the quarter ended June 30, 2016. Tax equivalent interest income on securities increased $753,000 to $2.8 million for the quarter ended June 30, 2017, compared to $2.0 million for the quarter ended June 30, 2016. The average investment portfolio yield, on a tax equivalent basis, was 2.32% for the quarter ended June 30, 2017, compared to 2.36% for the quarter ended June 30, 2016. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2017. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statement of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.
Interest bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company. Average interest bearing deposits with banks consisted of FRB deposits. Balances with the FRB
earn interest at the Fed Funds rate, which increased to 1.25% in June 2017. Average interest bearing deposits with banks for the quarter ended June 30, 2017, were $112.5 million, an increase of $84.1 million compared to the average balance for the quarter ended June 30, 2016. Interest income on interest bearing deposits with banks for the quarter ended June 30, 2017, increased $222,000 to $258,000 compared to the quarter ended June 30, 2016.
Average interest-bearing liabilities increased $267.5 million or 16.4% during the second quarter of 2017. Of that increase: (1) interest-bearing transaction deposits increased $86.1 million; (2) savings and money market deposits increased $74.8 million; (3) time deposits increased $107.0 million; (4) Federal Home Loan Bank (“FHLB”) Advances decreased $393,000 (see “Financial Condition – Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”); and (5) subordinated debt remained unchanged (see “Financial Condition – Subordinated Debentures”).
Total interest expense on interest bearing deposits was $1.4 million for the second quarter of 2017 as compared to $859,000 for the second quarter of 2016. The average rate paid on interest-bearing deposits was 0.31% for the second quarter of 2017 compared to 0.21% for the second quarter of 2016.
Six Months Ending June 30, 2017 vs. Six Months Ending June 30, 2016
During the first six months of 2017, net interest income increased 12.8% to $52.4 million, compared to $46.5 million at June 30, 2016. On a fully taxable equivalent basis, net interest income increased 12.5% and totaled $52.9 million at June 30, 2017, compared to $47.0 million at June 30, 2016. The increase in net interest income was due to a $352.0 million increase in average earning assets.
For the six months ended June 30, 2017, the Company’s net interest margin was 3.86% compared to 3.92% for the same period in 2016. This decrease in net interest margin was due to an increase in the rate paid on interest bearing liabilities.
The average balance of loans & leases increased by $154.4 million for the six months ended June 30, 2017 compared to the six months ended June 30, 2016. The yield on the loan & lease portfolio increased 20 basis points to 4.64% for the six months ended June 30, 2017 compared to 4.44% for the six months ended June 30, 2016. This increase in yield was enhanced by the increase in the average balance of loans resulting in interest income from loans & leases increasing 12.2% or $5.4 million for the first six months of 2017.
Average investment securities were $476.0 million for the six months ended June 30, 2017 compared to $364.6 million for the same period in 2016. The average tax equivalent yield for the six months ended June 30, 2017 was 2.31% compared to 2.41% for the six months ended June 30, 2016. Despite this decrease in yield, because of the increase in balances, interest income increased $1.1 million or 25.3%, for the six months ended
June 30, 2016.
Average interest bearing deposits with banks consisted of FRB deposits. Deposits with the FRB earn interest at the
Fed Funds rate, which increased to 1.25% in June 2017. Average interest bearing deposits with banks for the six-months ended June 30, 2017, was $118.9 million, an increase of $86.2 million compared to the average balance for the six-months ended June 30, 2016. Interest income on interest bearing deposits with banks for the six-months ended June 30, 2017, increased $425,000 to $507,000 compared to the six-months ended June 30, 2016.
Average interest-bearing liabilities increased $264.5 million or 16.2% during the six months ended June 30, 2017 as compared to the six months ended June 30, 2016. Of that increase: (1) interest-bearing deposits increased $266.4 million; (2) FHLB advances decreased $1.9 million; and (3) subordinated debentures remained unchanged.
Total interest expense on interest bearing deposits was $2.7 million for the first six months of 2017 as compared to $1.7 million for the first six months of 2016. The average rate paid on interest-bearing deposits was 0.29% in the first six months of 2017 and 0.21% in the first six months of 2016.
Provision and Allowance for Credit Losses
As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management reports regularly to the Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts credit reviews of individual loans & leases. Loans & leases that are performing but have shown some signs of weakness are subject to more stringent reporting and oversight.
Allowance for Credit Losses
The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company's loan & lease portfolio as of the balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans & leases determined to be impaired are individually evaluated for impairment. When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease's observable market price, or the fair value of the collateral if the loan or lease is collateral dependent. A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying collateral.
A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrower that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
The determination of the general reserve for loans or leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1
st
mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer & other; and (9) equipment leases. See “Financial Condition – Loans & Leases” for examples of loans & leases made by the Company. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company's overall allowance, which is included on the consolidated balance sheet.
The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by independent specialists engaged by the Company. The risk ratings can be grouped into five major categories, defined as follows:
Pass – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention.
Special Mention – A special mention loan or lease has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease position at some future date. Special mention loans & leases are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard – A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any. Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable or improbable.
Loss – Loans or leases classified as loss are considered uncollectible. Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss and immediately charge-off some or all of the balance.
The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management's assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment described below:
Commercial Real Estate – Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.
Real Estate Construction – Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. A major risk arises from the necessity to complete projects within specified cost and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.
Commercial – These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term; typically made to relationship customers; generally underwritten to existing cash flows of operating businesses; and may be collateralized by fixed assets, inventory and/or accounts receivable. Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.
Agricultural Real Estate and Agricultural – These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production, livestock and related real estate. These loans are vulnerable to two risk factors that are largely outside the control of Company and borrowers: commodity prices and weather conditions.
Leases – Equipment leases are generally considered to possess a moderate inherent risk of loss. As Lessor, the company is subject to both the credit risk of the borrower and the residual value risk of the equipment. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
Residential 1st Mortgages and Home Equity Lines and Loans – These loans are generally considered to possess a low inherent risk of loss, although this is not always true as evidenced by the correction in residential real estate values that occurred between 2007 and 2012. The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower's ability to repay in an orderly fashion. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
Consumer & Other – A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
Provision for Credit Losses
Changes in the provision for credit losses between years are the result of management’s evaluation, based upon information currently available, of the adequacy of the allowance for credit losses relative to factors such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on borrowers’ ability to repay loans & leases in accordance with the terms of the notes.
The Central Valley of California was one of the hardest hit areas in the country during the recession. In many areas, housing prices declined as much as 60% and unemployment reached 15% or more. Although the economy has improved throughout most of the Central Valley, it remains fragile with housing prices that for the most part remain below peak levels and unemployment rates that remain above those in other areas of the state and country. While, in management’s opinion, the Company’s levels of net charge-offs and non-performing assets as of June 30, 2017, compare very favorably to our peers at the present time, carefully managing credit risk remains a key focus of the Company.
The State of California experienced drought conditions from 2013 through most of 2016. Although significant levels of rain and snow in late 2016 and early 2017 have alleviated drought conditions in many areas of California, including the Company’s primary service area, the long-term risks associated with the availability of water continue to exist.
The Company made a $1.3 million provision for credit losses during the first half of 2017 compared to $2.6 million during the first half of 2016. Net charge-offs during the first half of 2017 were $105,000 compared to net charge-off of $5,000 in the first half of 2016. See “Overview – Looking Forward: 2017 and Beyond”, “Critical Accounting Policies and Estimates – Allowance for Credit Losses” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” located in the Company’s 2016 Annual Report on Form 10-K.
After reviewing all factors above, based upon information currently available, management concluded that the allowance for credit losses as of June 30, 2017, was adequate
.
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Balance at Beginning of Period
|
|
$
|
48,400
|
|
|
$
|
44,129
|
|
|
$
|
47,919
|
|
|
$
|
41,523
|
|
Charge-Offs
|
|
|
(25
|
)
|
|
|
(61
|
)
|
|
|
(176
|
)
|
|
|
(105
|
)
|
Recoveries
|
|
|
39
|
|
|
|
50
|
|
|
|
71
|
|
|
|
100
|
|
Provision
|
|
|
-650
|
|
|
|
-
|
|
|
|
1,250
|
|
|
|
2,600
|
|
Balance at End of Period
|
|
$
|
49,064
|
|
|
$
|
44,118
|
|
|
$
|
49,064
|
|
|
$
|
44,118
|
|
June 30, 2017
|
|
Commercial
Real Estate
|
|
|
Agricultural
Real Estate
|
|
|
Real Estate
Construction
|
|
|
Residential 1st
Mortgages
|
|
|
Home Equity
Lines & Loans
|
|
|
Agricultural
|
|
|
Commercial
|
|
|
Consumer &
Other
|
|
|
Leases
|
|
|
Unallocated
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year-To-Date Allowance for Credit Losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning Balance- January 1, 2017
|
|
$
|
11,110
|
|
|
$
|
9,450
|
|
|
$
|
3,223
|
|
|
$
|
865
|
|
|
$
|
2,140
|
|
|
$
|
7,381
|
|
|
$
|
8,515
|
|
|
$
|
200
|
|
|
$
|
3,586
|
|
|
$
|
1,449
|
|
|
$
|
47,919
|
|
Charge-Offs
|
|
|
(109
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(7
|
)
|
|
|
-
|
|
|
|
(60
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(176
|
)
|
Recoveries
|
|
|
10
|
|
|
|
-
|
|
|
|
-
|
|
|
|
19
|
|
|
|
5
|
|
|
|
-
|
|
|
|
4
|
|
|
|
33
|
|
|
|
-
|
|
|
|
-
|
|
|
|
71
|
|
Provision
|
|
|
231
|
|
|
|
815
|
|
|
|
(536
|
)
|
|
|
(12
|
)
|
|
|
25
|
|
|
|
(138
|
)
|
|
|
1,025
|
|
|
|
32
|
|
|
|
(634
|
)
|
|
|
442
|
|
|
|
1,250
|
|
Ending Balance- June 30, 2017
|
|
$
|
11,242
|
|
|
$
|
10,265
|
|
|
$
|
2,687
|
|
|
$
|
872
|
|
|
$
|
2,170
|
|
|
$
|
7,236
|
|
|
$
|
9,544
|
|
|
$
|
205
|
|
|
$
|
2,952
|
|
|
$
|
1,891
|
|
|
$
|
49,064
|
|
Second Quarter Allowance for Credit Losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning Balance- April 1, 2017
|
|
$
|
11,665
|
|
|
$
|
9,393
|
|
|
$
|
2,946
|
|
|
$
|
880
|
|
|
$
|
2,125
|
|
|
$
|
6,511
|
|
|
$
|
8,479
|
|
|
$
|
198
|
|
|
$
|
3,866
|
|
|
$
|
2,337
|
|
|
$
|
48,400
|
|
Charge-Offs
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(25
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(25
|
)
|
Recoveries
|
|
|
3
|
|
|
|
-
|
|
|
|
-
|
|
|
|
16
|
|
|
|
3
|
|
|
|
-
|
|
|
|
-
|
|
|
|
17
|
|
|
|
-
|
|
|
|
-
|
|
|
|
39
|
|
Provision
|
|
|
(426
|
)
|
|
|
872
|
|
|
|
(259
|
)
|
|
|
(24
|
)
|
|
|
42
|
|
|
|
725
|
|
|
|
1,065
|
|
|
|
15
|
|
|
|
(914
|
)
|
|
|
(446
|
)
|
|
|
650
|
|
Ending Balance- June 30, 2017
|
|
$
|
11,242
|
|
|
$
|
10,265
|
|
|
$
|
2,687
|
|
|
$
|
872
|
|
|
$
|
2,170
|
|
|
$
|
7,236
|
|
|
$
|
9,544
|
|
|
$
|
205
|
|
|
$
|
2,952
|
|
|
$
|
1,891
|
|
|
$
|
49,064
|
|
The table below breaks out current quarter activity by portfolio segment
(in thousands):
The Allowance for Credit Losses at June 30, 2017 increased $1.1 million from December 31, 2016. The allowance allocated to the following portfolio segments changed materially during the first half of 2017:
·
|
Agricultural and Agricultural Real Estate allowance balances increased $670,000 due primarily to an increase of $6.8 million in substandard loans related to one borrower, offset somewhat by a decrease in agricultural loan balances.
|
·
|
Real Estate Construction allowance balances decreased $536,000 due to a decrease in loan balances combined with a decline in the overall risk of the portfolio as several major projects moved out of the construction phase and into lease-up.
|
·
|
Commercial allowance balances increased $1.0 million due to an increase in loan balances.
|
·
|
Lease allowance balances decreased $634,000 due to the Company’s assessment that approximately five years of experience in this financing segment supported the elimination of the qualitative factor for “new market segments” in the loan loss allowance.
|
See “Management’s Discussion and Analysis - Financial Condition – Classified Loans & Leases and Non-Performing Assets” for further discussion regarding these loan categories.
See “Note 3. Allowance for Credit Losses” for additional details regarding the provision and allowance for credit losses.
Non-Interest Income
Non-interest income includes: (1) service charges and fees from deposit accounts; (2) net gains and losses from investment securities; (3
) increases in the cash surrender value of bank owned life insurance; (4) debit card and ATM fees; (5) net gains and losses on non-qualified deferred compensation plans; and (6) fees from other miscellaneous business services.
Second Quarter 2017 vs. Second Quarter 2016
Non-interest income increased $664,000 or 23.1% for the three months ended June 30, 2017, compared to the same period of 2016. This increase was primarily due to: (1) a $131,000 gain on sale of investment securities; (2) a $119,000 increase in debit card and ATM fees; and (3) a $351,000 increase in the net gain on
deferred compensation investments for the second quarter of 2017 compared to the same period in 2016.
Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Six Months Ending June 30, 2017 vs. Six Months Ending June 30, 2016
Non‑interest income increased $3.3 million or 59.8% for the six months ended June 30, 2017 compared to the same period of 2016. This increase was primarily due to: (1) a $420,000 increase in the net gain on the sale of investment securities; (2) a $194,000 increase in debit card and ATM fees; (3) an $854,000 increase in the net gain on deferred compensation investments; (4) a $1.2 million increase in the gain on sale of fixed assets related to the disposition of one of the Company’s properties; and (5) $453,000 in non-recurring fees from certain loan customers.
Non-Interest Expense
Non-interest expense for the Company includes expenses for: (1) salaries and employee benefits; (2) net gains and losses on non-qualified deferred compensation plan investments; (3) occupancy; (4) equipment; (5) supplies; (6) legal fees; (7) professional services; (8) data processing; (9) marketing; (10) deposit insurance; (11) ORE carrying costs and gains/losses on sale; and (12) other miscellaneous expenses.
Second Quarter 2017 vs. Second Quarter 2016
Overall, non-interest expense increased $1.8 million or 12.1% for the three months ended June 30, 2017, compared to the same period in 2016. This increase was primarily comprised
:
(1) a $1.4 million increase in salaries and employee benefits primarily related increased contributions to retirement and profit sharing plans; and (2) a $351,000 increase in the net gain on deferred compensation investments.
Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Six Months Ending June 30, 2017 vs. Six Months Ending June 30, 2016
Non-interest expense increased $8.2 million or 30.6% for the six months ended June 30, 2017, compared to the same period of 2016. This increase was primarily comprised of: (1) a $5.5 million gain on the sale of ORE property that took place in the prior year (2016) and was recorded as a reduction to non-interest expense; (2) an $854,000 increase in the net gain on deferred compensation investments; and (3) a $2.2 million increase in salaries and employee benefits primarily related to increased contributions to retirement and profit sharing plans. These increases were partially offset by a $919,000 decrease in legal, consulting and other professional services related to the Delta Bancorp acquisition that took place in 2016.
Income Taxes
The provision for income taxes increased 12.9% to $4.7 million for the second quarter of 2017. The Company’s effective tax rate was 36.5% for the second quarter of 2017 and 36.2% for the second quarter of 2016.
The provision for income taxes increased 11.4% to $9.1 million for the first six months of 2017. The Company’s effective tax rate for the first six months of 2017 was 36.3% compared to 36.1% for the same period in 2016.
The Company’s effective tax rate fluctuates from quarter to quarter due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the statutory rate of 42% due primarily to benefits regarding the cash surrender value of life insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans.
Current tax law causes the Company’s current taxes payable to approximate or exceed the current provision for taxes on the income statement. Three provisions have had a significant effect on the Company’s current income tax liability: (1) the restrictions on the deductibility of credit losses; (2) deductibility of retirement and other long-term employee benefits only when paid; and (3) the statutory deferral of deductibility of California franchise taxes on the Company’s federal return.
Financial Condition
This section discusses material changes in the Company’s balance sheet at June 30, 2017, as compared to December 31, 2016 and to June 30, 2016. As previously discussed (see “Overview”) the Company’s financial condition can be influenced by the seasonal banking needs of its agricultural customers.
Investment Securities and Federal Funds Sold
The investment portfolio provides the Company with an income alternative to loans & leases. The debt securities in the Company’s investment portfolio have historically been comprised primarily of: (1) mortgage-backed securities issued by federal government-sponsored entities; (2) debt securities issued by US Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.
The Company’s investment portfolio at June 30, 2017 was $518.2 million compared to $506.4 million at the end of 2016, an increase of $11.9 million or 2.3%. At June 30, 2016, the investment portfolio totaled $423.2 million. To protect against future increases in market interest rates, while at the same time generating some reasonable level of current yields, the Company currently invests most of its available funds in either shorter term U.S. Treasury, government agency & government-sponsored entity securities or shorter term (10, 15, and 20 year) mortgage-backed securities. As part of the acquisition of Delta National Bancorp that took place in November, 2016, the Company now owns $32.8 million of floating rate U.S. Government SBA securities.
The Company's total investment portfolio currently represents 17.2% of the Company’s total assets as compared to 17.3% at December 31, 2016, and 15.7% at June 30, 2016.
As of June 30, 2017 the Company held $56.4 million of municipal investments, of which $39.3 million were bank-qualified municipal bonds, all classified as HTM. In order to comply with Section 939A of the Dodd-Frank Act, the Company: (1) only invests in bonds rated AA or better; and (2) performs its own credit analysis on new purchases of municipal bonds. As of June 30, 2017, ninety-eight percent of the Company’s bank-qualified municipal bond portfolio is rated at either the issue or issuer level, and all of these ratings are “investment grade.” The Company monitors the status of all municipal investments with particular attention paid to the approximately two percent ($419,000) of the portfolio that is not rated, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.
Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Funds Sold. Interest bearing deposits with banks consisted of FRB deposits. The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled $97.2 million at June 30, 2017, $43.9 million at December 31, 2016 and $23.2 million at June 30, 2016.
The Company classifies its investments as HTM, trading, or AFS. Securities are classified as HTM and are carried at amortized cost when the Company has the intent and ability to hold the securities to maturity. Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income. As of June 30, 2017, December 31, 2016 and June 30, 2016, there were no securities in the trading portfolio. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes.
Loans
&
Leases
Loans & leases can be categorized by borrowing purpose and use of funds. Common examples of loans & leases made by the Company include:
Commercial and Agricultural Real Estate - These are loans secured by farmland, commercial real estate, multifamily residential properties, and other non-farm, non-residential properties generally within our market area. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, and the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; generally do not exceed 10 years (and may have pricing adjustments on a shorter timeframe); have debt service coverage ratios of 1.00 or better with a target of greater than 1.25; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Real Estate Construction - These are loans for development and construction (the Company generally requires the borrower to fund the land acquisition) and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with whom the Bank has a successful track record; for projects in our service area; with Loan To Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are made only when there is a written take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate or LIBOR with an appropriate spread based on the amount of perceived risk in the loan.
Residential 1
st
Mortgages - These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC; however, we will make loans on rural residential properties up to 40 acres. Most residential loans have terms from ten to twenty years and carry fixed rates priced off of treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”
Home Equity Lines and Loans - These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $250,000; Combined Loan To Value (CLTV) does not exceed 80%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1
st
lien position.
Agricultural - These are loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Commercial - These are loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 24 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Consumer - These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a very minimal consumer loan portfolio, and loans are primarily made as an accommodation to deposit customers.
Leases –These are leases to businesses or individuals, for the purpose of financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
The Company accounts for leases with Investment Tax Credits (ITC) under the deferred method as established in ASC 740-10. ITC are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.
See “Item 3. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” for a discussion about the credit risks the Company assumes and its overall credit risk management practices.
Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type. The Company’s policies require that loans & leases are approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.
Most loans & leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made.
In order to be responsive to borrower needs, the Company prices loans & leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices; as long as these structures are consistent with the Company’s interest rate risk management policies and procedures (see Item 3. Quantitative and Qualitative Disclosures About Market Risk-Interest Rate Risk).
Overall, the Company's loan & lease portfolio at June 30, 2017 totaled $2.2 billion, an increase of $136.0 million or 6.6% over June 30, 2016. This increase has occurred as a result of: (1) the Company’s intensified business development efforts directed toward credit-qualified borrowers; (2) entry into the equipment leasing business; and (3) expansion of our service area into Walnut Creek and Concord. No assurances can be made that this growth in the loan & lease portfolio will continue.
Loans & leases at June 30, 2017 increased $26.5 million from $2.2 billion at December 31, 2016, primarily as a result of growth in real estate and commercial segments offset to some extent by normal seasonal pay downs of loans made to the Company’s agricultural customer customers.
The following table sets forth the distribution of the loan & lease portfolio by type and percent as of the periods indicated.
Loan & Lease Portfolio
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
|
June 30, 2016
|
|
(in thousands)
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Commercial Real Estate
|
|
$
|
677,282
|
|
|
|
30.6
|
%
|
|
$
|
674,445
|
|
|
|
30.9
|
%
|
|
$
|
632,275
|
|
|
|
30.4
|
%
|
Agricultural Real Estate
|
|
|
473,153
|
|
|
|
21.4
|
%
|
|
|
467,685
|
|
|
|
21.4
|
%
|
|
|
454,069
|
|
|
|
21.9
|
%
|
Real Estate Construction
|
|
|
168,487
|
|
|
|
7.6
|
%
|
|
|
176,462
|
|
|
|
8.1
|
%
|
|
|
166,218
|
|
|
|
8.0
|
%
|
Residential 1st Mortgages
|
|
|
252,653
|
|
|
|
11.4
|
%
|
|
|
242,247
|
|
|
|
11.1
|
%
|
|
|
217,176
|
|
|
|
10.5
|
%
|
Home Equity Lines and Loans
|
|
|
32,174
|
|
|
|
1.5
|
%
|
|
|
31,625
|
|
|
|
1.4
|
%
|
|
|
32,150
|
|
|
|
1.6
|
%
|
Agricultural
|
|
|
265,899
|
|
|
|
12.0
|
%
|
|
|
295,325
|
|
|
|
13.5
|
%
|
|
|
276,039
|
|
|
|
13.3
|
%
|
Commercial
|
|
|
254,887
|
|
|
|
11.5
|
%
|
|
|
217,577
|
|
|
|
10.0
|
%
|
|
|
220,284
|
|
|
|
10.6
|
%
|
Consumer & Other
|
|
|
7,533
|
|
|
|
0.3
|
%
|
|
|
6,913
|
|
|
|
0.3
|
%
|
|
|
6,830
|
|
|
|
0.3
|
%
|
Leases
|
|
|
78,010
|
|
|
|
3.7
|
%
|
|
|
70,986
|
|
|
|
3.3
|
%
|
|
|
68,068
|
|
|
|
3.3
|
%
|
Total Gross Loans & Leases
|
|
|
2,210,078
|
|
|
|
100.0
|
%
|
|
|
2,183,265
|
|
|
|
100.0
|
%
|
|
|
2,073,109
|
|
|
|
100.0
|
%
|
Less: Unearned Income
|
|
|
5,996
|
|
|
|
|
|
|
|
5,664
|
|
|
|
|
|
|
|
5,002
|
|
|
|
|
|
Subtotal
|
|
|
2,204,082
|
|
|
|
|
|
|
|
2,177,601
|
|
|
|
|
|
|
|
2,068,107
|
|
|
|
|
|
Less: Allowance for Credit Losses
|
|
|
49,064
|
|
|
|
|
|
|
|
47,919
|
|
|
|
|
|
|
|
44,118
|
|
|
|
|
|
Net Loans & Leases
|
|
$
|
2,155,018
|
|
|
|
|
|
|
$
|
2,129,682
|
|
|
|
|
|
|
$
|
2,023,989
|
|
|
|
|
|
Classified Loans & Leases and Non-Performing Assets
All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies. See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk grades. The Company utilizes the services of a third-party independent loan review firm to perform evaluations of individual loans & leases and review the credit risk grades the Company places on loans & leases. Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified loans & leases,” and these loans & leases receive increased management attention. As of June 30, 2017, classified loans totaled $11.2 million compared to $6.4 million at December 31, 2016 and $5.6 million at June 30, 2016.
Classified loans & leases with higher levels of credit risk can be further designated as “impaired” loans & leases. A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. See “Results of Operations - Provision and Allowance for Credit Losses” for further details. Impaired loans & leases consist of: (1) non-accrual loans & leases; and/or (2) restructured loans & leases that are still performing (i.e., accruing interest).
Non-Accrual Loans & Leases
-
Accrual of interest on loans & leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans & leases are 90 days past due, but in management's judgment are well secured and in the process of collection, they may not be classified as non-accrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans & leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. As of June 30, 2017 non-accrual loans & leases totaled $1.4 million. At December 31, 2016 and June 30, 2016, non-accrual loans & leases totaled $3.1 million and $2.3 million,
respectively.
Restructured Loans & Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR loans, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
As of June 30, 2017, restructured loans & leases on accrual totaled $5.9 million as compared to $6.0 million at December 31, 2016. Restructured loans on accrual at June 30, 2016 were $4.6 million.
Other Real Estate
-
Loans where the collateral has been repossessed are classified as other real estate ("ORE") or, if the collateral is personal property, the loan is classified as other assets on the Company's financial statements.
The following table sets forth the amount of the Company's non-performing loans & leases (defined as non-accrual loans & leases plus accruing loans & leases past due 90 days or more) and ORE as of the dates indicated.
Non-Performing Assets
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
June 30, 2017
|
|
|
Dec. 31, 2016
|
|
|
June 30, 2016
|
|
Non-Performing Loans & Leases
|
|
$
|
1,363
|
|
|
$
|
3,074
|
|
|
$
|
2,260
|
|
Other Real Estate
|
|
|
873
|
|
|
|
3,745
|
|
|
|
779
|
|
Total Non-Performing Assets
|
|
$
|
2,236
|
|
|
$
|
6,819
|
|
|
$
|
3,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Performing Loans & Leases as a % of Total Loans & Leases
|
|
|
0.06
|
%
|
|
|
0.14
|
%
|
|
|
0.11
|
%
|
Restructured Loans & Leases (Performing)
|
|
$
|
5,915
|
|
|
$
|
4,462
|
|
|
$
|
4,565
|
|
Although management believes that non-performing loans & leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. Specific reserves of $253,000, $631,000, and $657,000 have been established for non-performing loans & leases at June 30, 2017, December 31, 2016 and June 30, 2016, respectively.
Foregone interest income on non-accrual loans & leases which would have been recognized during the period, if all such loans & leases had been current in accordance with their original terms, totaled $49,500 for the six months ended
June 30
, 2017, $127,000 for the year ended December 31, 2016, and $51,000 for the six months ended
June 30
, 2016.
The Company reported $873,000 of ORE at
June 30
, 2017, $3.7 million at December 31, 2016, and $779,000 at
June 30
, 2016.
Except for those classified and non-performing loans & leases discussed above, the Company’s management is not aware of any loans & leases as of June 30, 2017, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However:
·
|
The Central Valley was one of the hardest hit areas in the country during the recession. In many areas housing prices declined as much as 60% and unemployment reached 15% or more. Although the economy has improved throughout most of the Central Valley, housing prices for the most part still remain below peak levels and unemployment levels remain above those in other areas of the state and country.
|
·
|
The State of California experienced drought conditions from 2013 through most of 2016. Although significant levels of rain and snow in late 2016 and early 2017 have alleviated drought conditions in many areas of California, including the Company’s primary service area, the long-term risks associated with the availability of water continue to exist.
|
·
|
The agricultural industry is facing challenges associated with: (1) weakness in export markets due to a stronger dollar and proposed changes in trade policies; (2) tight labor markets and higher wages due to legislative changes at the state and federal levels; and (3) proposed changes in immigration policy and the resulting impact on the labor pool.
|
In addition to the other information set forth in this report, readers should carefully consider the factors discussed in “Part I, Item 1A. Risk Factors” in the Company’s 2016 Annual Report on Form 10-K.
Deposits
One of the key sources of funds to support earning assets is the generation of deposits from the Company’s customer base. The ability to grow the customer base, and subsequently deposits, is a significant element in the performance of the Company.
The Company's deposit balances at June 30, 2017 have increased $333.9 million or 14.3% compared to June 30, 2016. In addition to the Company’s ongoing business development activities for deposits, the following factors positively impacted year-over-year deposit growth: (1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and sound banks in its market area; (2) the Company’s expansion of its service area into Walnut Creek and Concord; and (3) $103.7 million in deposits from the acquisition of Delta National Bank. The Company expects that, at some point, deposit customers may begin to diversify how they invest their money (e.g., move funds back into the stock market or other investments) and this could impact future deposit growth.
Although total deposits have increased 14.3% since June 30, 2016, importantly, low cost transaction accounts continue to grow at a strong pace as well:
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Demand and interest-bearing transaction accounts increased $164.5 million or 15.0% since June 30, 2016.
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·
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Savings and money market accounts have increased $74.9 million or 10.3% since June 30, 2016.
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·
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Time deposit accounts have increased $94.5 million or 18.8% since June 30, 2016.
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The Company's deposit balances at June 30, 2017 have increased $80.2 million or 3.1% compared to December 31, 2016. Savings and money market deposits increased 5.4% or $41.4 million while demand and interest-bearing transaction accounts increased by $12.3 million or 1.0% and time deposit accounts increased by $26.4 million or 4.6%. Deposit trends in the first half of the year can be impacted by the seasonal needs of our agricultural customers.
Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings
Lines of credit with the Federal Reserve Bank and the Federal Home Loan Bank are other key sources of funds to support earning assets. These sources of funds are also used to manage the Company’s interest rate risk exposure, and as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB Advances at June 30, 2017, December 31, 2016, or June 30, 2016. There were no Federal Funds purchased or advances from the FRB at June 30, 2017, December 31, 2016 or June 30, 2016.
As of June 30, 2017 the Company has additional borrowing capacity of $396.7 million with the Federal Home Loan Bank and $373.8 million with the Federal Reserve Bank. Any borrowings under these lines would be collateralized with loans that have been accepted for pledging at the FHLB and FRB.
Long-Term Subordinated Debentures
On December 17, 2003, the Company raised $10 million through an offering of trust-preferred securities (“TPS”). See Note 14 located in “Item 8. Financial Statements and Supplementary Data” of the Company’s 2016 Annual Report on Form 10-K. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue to qualify as regulatory capital (See “Capital”). These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly and were 4.45% as of June 30, 2017, 3.84% at December 31, 2016 and 3.51% at June 30, 2016. The average rate paid for these securities for the first half of 2017 was 4.01% and 3.51% for the first half of 2016. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.
Capital
The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $291.7 million at June 30, 2017, $280.0 million at December 31, 2016, and $265.3 million at June 30, 2016.
The Company and the Bank are subject to various federal regulatory capital requirements under the Basel III Capital Rules. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The implementation of Basel III requirements will increase the required capital levels that the Company and the Bank must maintain. The final rules include new minimum risk-based capital and leverage ratios, which would be phased in over time. The new minimum capital level requirements applicable to the Company and the Bank under the final rules will be: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA; and (iv) a Tier 1 leverage ratio of 4% of total assets. The final rules also establish a "capital conservation buffer" of 2.5% above each of the new regulatory minimum capital ratios, which would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA; and (iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The final rules also permit the Company’s subordinated debentures issued in 2003 to continue to be counted as Tier 1 capital.
The final rules became effective as applied to the Company and the Bank on January 1, 2015, with a phase in period through January 1, 2019. The Company believes that it is currently in compliance with all of these new capital requirements (as fully phased-in) and that they will not result in any restrictions on the Company’s business activity.
In addition, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the Bank’s category.
(in thousands)
|
|
Actual
|
|
|
Current
Regulatory
Capital
Requirements
|
|
|
Well Capitalized
Under Prompt
Corrective Action
|
|
The Company:
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
As of June 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital Ratio
|
|
$
|
331,863
|
|
|
|
13.04
|
%
|
|
$
|
203,606
|
|
|
|
8.0
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
Common Equity Tier 1 Capital Ratio
|
|
$
|
290,055
|
|
|
|
11.40
|
%
|
|
$
|
114,528
|
|
|
|
4.5
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
Tier 1 Capital Ratio
|
|
$
|
299,834
|
|
|
|
11.78
|
%
|
|
$
|
152,704
|
|
|
|
6.0
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
Tier 1 Leverage Ratio
|
|
$
|
299,834
|
|
|
|
10.16
|
%
|
|
$
|
118,095
|
|
|
|
4.0
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
(
in thousands)
|
|
Actual
|
|
|
Current
Regulatory
Capital
Requirements
|
|
|
Well Capitalized
Under Prompt
Corrective Action
|
|
The Bank:
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
As of June 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital Ratio
|
|
$
|
330,274
|
|
|
|
12.99
|
%
|
|
$
|
203,477
|
|
|
|
8.0
|
%
|
|
$
|
254,346
|
|
|
|
10.0
|
%
|
Common Equity Tier 1 Capital Ratio
|
|
$
|
298,264
|
|
|
|
11.73
|
%
|
|
$
|
114,456
|
|
|
|
4.5
|
%
|
|
$
|
165,325
|
|
|
|
6.5
|
%
|
Tier 1 Capital Ratio
|
|
$
|
298,264
|
|
|
|
11.73
|
%
|
|
$
|
152,608
|
|
|
|
6.0
|
%
|
|
$
|
203,477
|
|
|
|
8.0
|
%
|
Tier 1 Leverage Ratio
|
|
$
|
298,264
|
|
|
|
10.12
|
%
|
|
$
|
117,901
|
|
|
|
4.0
|
%
|
|
$
|
147,376
|
|
|
|
5.0
|
%
|
As previously discussed (see “Long-Term Subordinated Debentures”), in order to supplement its regulatory capital base, during December 2003 the Company issued $10 million of trust preferred securities. On March 1, 2005, the Federal Reserve Board issued its final rule effective April 11, 2005, concerning the regulatory capital treatment of trust preferred securities (“TPS”) by bank holding companies (“BHCs”). Under the final rule BHCs may include TPS in Tier 1 capital in an amount equal to 25% of the sum of core capital net of goodwill. Any portion of trust-preferred securities not qualifying as Tier 1 capital would qualify as Tier 2 capital subject to certain limitations. The Company has received notification from the Federal Reserve Bank of San Francisco that all of the Company’s trust preferred securities currently qualify as Tier 1 capital.
The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability.
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on August 11, 2015, the Board of Directors approved an extension of the $20 million stock repurchase program over the three-year period ending September 30, 2018. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2016 Annual Report on Form 10-K for additional information.
There were no stock repurchases during the first half of 2017 or 2016. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent. The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2016 Annual Report on Form 10-K for further explanation.
On February 17, 2017, the Company issued 1,375 shares of common stock to the Bank’s non-qualified defined contribution retirement plans. These shares were issued at a price of $590.00 per share based upon a valuation completed by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
Critical Accounting Policies and Estimates
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These judgments govern areas such as the allowance for credit losses, the fair value of financial instruments and accounting for income taxes.
For a full discussion of the Company’s critical accounting policies and estimates see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2016 Annual Report on Form 10-K.