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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2012

OR

 

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             

Commission File Number 0-14492

 

 

FARMERS & MERCHANTS BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

OHIO		34-1469491
(State or other jurisdiction of incorporation or organization)		(I.R.S Employer Identification No.)
307 North Defiance Street, Archbold, Ohio		43502
(Address of principal executive offices)		(Zip Code)

(419) 446-2501

Registrant’s telephone number, including area code

(Former name, former address and former fiscal year, if changed since last report.)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

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

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

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

Indicate the number of shares of each of the issuers classes of common stock, as of the latest practicable date:

 

Common Stock, No Par Value		4,689,258
Class		Outstanding as of October 24, 2012

 

 

 

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10Q

FARMERS & MERCHANTS BANCORP, INC.

INDEX

 

Form 10-Q Items				Page
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets-September 30, 2012 and December 31, 2011			1
		Condensed Consolidated Statements of Net Income-Three and Nine Months Ended September 30, 2012 and September 30, 2011			2
		Condensed Consolidated Statements of Cash Flows-Nine Months Ended September 30, 2012 and September 30, 2011			3
		Notes to Condensed Financial Statements			4-16
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			17-29
Item 3.		Qualitative and Quantitative Disclosures About Market Risk			29
Item 4.		Controls and Procedures			30
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings			30
Item 1A.		Risk Factors			30
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			30
Item 3.		Defaults Upon Senior Securities			30
Item 4.		Mine Safety Disclosures			30
Item 5.		Other Information			30
Item 6.		Exhibits			30
Signatures					31-35
Exhibit 31.		Certifications Under Section 302
Exhibit 32.		Certifications Under Section 906
Exhibit 101		Interactive Data File (XBRL) **

 

**

The interactive data file (XBRL) exhibit is only available electronically. You can obtain copies of these files electronically at the SEC’s website at www.sec.gov. The files are also available on the Farmers and Merchants State Bank’s website at www.fm-bank.com under the shareholder’s information tab.

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ITEM 1 FINANCIAL STATEMENTS

FARMERS & MERCHANTS BANCORP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands of dollars)

 

		September 30, 2012				December 31, 2011
ASSETS:
Cash and due from banks		$	13,994			$	17,563
Interest bearing deposits with banks			10,561				14,046
Federal funds sold			5,074				11,534
Total cash and cash equivalents			29,629				43,143
Securities - available for sale (Note 2)			353,455				327,519
Other Securities, at cost			4,365				4,365
Loans, net (Note 4)			486,170				501,124
Bank premises and equipment			16,680				16,984
Goodwill			4,074				4,074
Mortgage Servicing Rights			2,087				2,071
Other Real Estate Owned			3,118				3,572
Accrued interest and other assets			21,401				20,141
TOTAL ASSETS		$	920,979			$	922,993
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest bearing		$	87,354			$	84,567
Interest bearing
NOW accounts			186,129				193,137
Savings			183,459				170,052
Time			277,889				291,626
Total deposits			734,831				739,382
Federal funds purchased and securities sold under agreement to repurchase			54,847				52,440
FHLB Advances			11,611				16,662
Dividend Payable			931				890
Accrued expenses and other liabilities			8,748				8,528
Total Liabilities			810,968				817,902
SHAREHOLDERS’ EQUITY:
Common stock, no par value - authorized 6,500,000 shares; issued & outstanding 5,200,000 shares			12,677				12,677
Treasury Stock - 510,742 shares 2012, 478,663 shares 2011			(10,483	)			(9,898	)
Unearned Stock Awards 30,670 shares 2012, 29,715 shares 2011			(584	)			(564	)
Retained Earnings			101,048				96,495
Accumulated other comprehensive income			7,353				6,381
Total Shareholders’ Equity			110,011				105,091
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	920,979			$	922,993

See Notes to Condensed Consolidated Unaudited Financial Statements.

Note: The December 31, 2011 Balance Sheet has been derived from the audited financial statements of that date.

 

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FARMERS & MERCHANTS BANCORP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(in thousands of dollars, except per share data)

 

		Three Months Ended								Nine Months Ended
		September 30, 2012				September 30, 2011				September 30, 2012				September 30, 2011
INTEREST INCOME:
Loans, including fees		$	6,564			$	7,142			$	20,165			$	22,253
Debt Securities:
U.S. Treasury securities			93				86				266				293
Securities of U.S. Government Agencies			1,012				1,052				3,092				3,032
Municipalities			555				520				1,583				1,588
Dividends			46				43				141				140
Federal funds sold			2				3				13				12
Other			6				9				19				36
Total Interest Income			8,278				8,855				25,279				27,354
INTEREST EXPENSE:
Deposits			1,345				1,686				4,254				5,341
Federal Funds purchased and securities sold under agreements to repurchase			63				76				184				227
Borrowed funds			124				229				371				753
Total Interest Expense			1,532				1,991				4,809				6,321
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES			6,746				6,864				20,470				21,033
PROVISION FOR LOAN LOSSES (Note 4)			236				93				442				1,522
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			6,510				6,771				20,028				19,511
NONINTEREST INCOME
Customer service fees			1,239				610				3,808				2,315
Other service charges and fees			943				908				2,561				2,521
Net gain (loss) on sale of other assets owned			(209	)			(195	)			(486	)			(1,009	)
Net gain on sale of loans			602				111				1,385				249
Net gain on sale of securities			30				132				199				504
Total Noninterest Income			2,605				1,566				7,467				4,580
NONINTEREST EXPENSE
Salaries and wages			2,303				2,377				6,782				6,785
Pension and other employee benefits			713				636				2,285				1,997
Occupancy expense (net)			268				358				1,059				1,128
Furniture and Equipment			371				315				1,072				1,059
Data processing			292				258				843				718
Franchise Taxes			237				225				710				667
FDIC Assessment			126				161				345				601
Mortgage servicing rights amortization			177				133				549				314
Other general and administrative			1,240				1,074				3,690				3,402
Total Noninterest Expense			5,727				5,537				17,335				16,671
INCOME BEFORE FEDERAL INCOME TAX			3,388				2,800				10,160				7,420
FEDERAL INCOME TAXES			947				719				2,897				1,791
NET INCOME		$	2,441			$	2,081			$	7,263			$	5,629
OTHER COMPREHENSIVE INCOME (NET OF TAX):
Unrealized gains on securities		$	589			$	3,794			$	7,353			$	6,408
COMPREHENSIVE INCOME		$	3,030			$	5,875			$	14,616			$	12,037
NET INCOME PER SHARE		$	0.52			$	0.44			$	1.55			$	1.20
Weighted Average Shares Outstanding			4,685,879				4,687,169				4,698,364				4,688,731
DIVIDENDS DECLARED		$	0.20			$	0.19			$	0.58			$	0.57

See Notes to Condensed Consolidated Unaudited Financial Statements.

 

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FARMERS & MERCHANTS BANCORP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands of dollars)

 

		Nine Months Ended
		September 30, 2012				September 30, 2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	7,263			$	5,629
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation			899				894
Accretion and amortization of securities			2,346				2,146
Amortization of servicing rights			549				314
Amortization of core deposit intangible			234				234
Provision for loan losses			442				1,522
Gain on sale of loans held for sale			(1,385	)			(249	)
Originations of loans held for sale			(100,759	)			(30,252	)
Proceeds from sale of loans held for sale			104,147				32,018
Loss on sale of other assets			486				1,000
Gain on sale of investment securities			(199	)			(504	)
Change in Operating Assets and Liabilities, net			(805	)			(301	)
Net Cash Provided by Operating Activities			13,218				12,451
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in securities:
Maturities, prepayments and calls			30,404				28,621
Sales			29,084				30,376
Purchases			(86,101	)			(79,935	)
Proceeds from sale of assets			2				10
Additions to premises and equipment			(597	)			(746	)
Loan originations and principal collections, net			11,124				18,269
Net Cash (Used) in Investing Activities			(16,084	)			(3,405	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits			(4,551	)			(4,928	)
Net change in short-term debt			2,407				1,966
Repayments of long-term debt			(5,051	)			(8,164	)
Purchase of Treasury stock			(789	)			(220	)
Cash dividends paid on common stock			(2,664	)			(2,675	)
Net Cash Provided (Used) by Financing Activities			(10,648	)			(14,021	)
Net (Decrease) in cash and cash equivalents			(13,514	)			(4,975	)
Cash and cash equivalents - Beginning of year			43,143				43,379
Cash and cash equivalents - End of period		$	29,629			$	38,404
RECONCILIATION OF CASH AND CASH EQUIVALENTS:
Cash and cash due from banks		$	13,994			$	13,987
Interest bearing deposits with banks			10,561				16,668
Federal funds sold			5,074				7,749
Cash at end of period		$	29,629			$	38,404
Supplemental Information
Cash paid during the period for:
Interest		$	4,833			$	6,460
Income Taxes		$	3,386			$	1,220
Noncash investing activities:
Transfer of loans to other real estate owned		$	334			$	2,146

See Notes to Condensed Consolidated Unaudited Financial Statements.

 

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

NOTE 1 BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10Q and Rule 10-01 of Regulation S-X; accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2012 are not necessarily indicative of the results that are expected for the year ended December 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

NOTE 2 FAIR VALUE OF INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair values of financial instruments are management’s estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including deferred tax assets, premises, equipment and intangibles. Further, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the elements.

The following assumptions and methods were used in estimating the fair value for financial instruments.

Cash and Cash Equivalents

The carrying amounts reported in the balance sheet for cash, cash equivalents and federal funds sold approximate their fair values. Also included in this line item are the carrying amounts of interest-bearing deposits maturing within ninety days which approximate their fair values. Fair values of other interest-bearing deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.

Securities

Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market price, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Other Securities

The carrying value of Federal Home Loan Bank stock, listed as “other securities”, approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

Loans

Most commercial and real estate mortgage loans are made on a variable rate basis. For those variable-rate loans that re-price frequently, and with no significant change in credit risk, fair values are based on carrying values. The fair values of the fixed rate and all other loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.

Deposits - Interest Bearing, Non-interest Bearing and Time

The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable-rate, fixed term money market accounts and certificates of deposit approximate their fair value at the reporting date. Fair value for fixed-rate certificates of deposit are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-Term Borrowings

The carrying value of short-term borrowings approximates fair values.

FHLB Advances

Fair values of FHLB advances are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types or borrowing arrangements.

 

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate their fair values.

Dividends Payable

The carrying amounts of dividends payable approximate their fair values and are generally paid within forty days of declaration.

Off Balance Sheet Financial Instruments

Fair values for off-balance sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counter-parties’ credit standing.

The estimated fair values, and related carrying or notional amounts, for on and off-balance sheet financial instruments as of September 30, 2012 and December 31, 2011 are reflected below.

 

		(In Thousands)
		September 2012																				December 2011
		Carrying				Fair																Carrying				Fair
		Amount				Value				Level 1				Level 2				Level 3				Amount				Value
Financial Assets:
Cash and Cash Equivalents		$	29,629			$	29,629			$	29,629			$	—			$	—			$	43,143			$	43,143
Securities - available for sale			353,455				353,455				31,511				301,494				20,450				327,519				327,519
Other Securities			4,365				4,365				—				—				4,365				4,365				4,365
Loans, net			486,170				490,764				—				—				490,764				501,124				504,629
Interest receivable			4,614				4,614				—				—				4,614				3,481				3,481
Total Assets		$	878,233			$	882,827			$	61,140			$	301,494			$	520,193			$	879,632			$	883,137
Financial Liabilities:
Interest bearing Deposits		$	369,588			$	372,026			$	—			$	—			$	372,026			$	363,189			$	363,727
Non-interest bearing Deposits			87,354				87,559				—				87,559				—			$	84,568			$	85,517
Time Deposits			277,889				279,464				—				—				279,464			$	291,625			$	292,731
Total Deposits		$	734,831			$	739,049			$	—			$	87,559			$	651,490			$	739,382			$	741,975
Short-term debt			54,847				54,847				—				—				54,847				52,440				52,440
Federal Home Loan Bank advances			11,611				12,943				—				—				12,943				16,662				16,638
Interest payable			318				318				—				—				318				342				342
Dividends payable			931				931				—				931				—				890				890
Total Liabilities		$	802,538			$	808,088			$	—			$	88,490			$	719,598			$	809,716			$	812,285

Fair Value Measurements

The preceding table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis at September 30, 2012 and December 31, 2011. September 30, 2012 is segregated by the valuation techniques used by the Company to determine those fair values.

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities in active markets that the Company has the ability to access.

Available-for-sale securities- When quoted prices are available in an active market, securities are valued using the quoted price and are classified as Level 1. The quoted prices are not adjusted.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Available-for-sale securities classified as Level 2 are valued using the prices obtained from an independent pricing service. The prices are not adjusted. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate base on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the market place.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability. Local municipals have been purchased that the Bank evaluates based on the credit strength of the underlying project such as the hospital or retirement home. The fair value is determined by valuing similar credit payment streams at similar rates.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurments in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

 

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Fair Value Measurements (Continued)

 

The following summarizes financial assets measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011, segregated by level or the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

		Assets and Liabilities Measured at Fair Value on a Recurring Basis (In  Thousands)
		Quoted Prices in Active Markets for Identical Assets(Level 1)				Significant Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
September 30, 2012
Assets-Securities Available for Sale
U.S. Treasury		$	31,511			$	—			$	—
U.S. Government agency			—				193,058				—
Mortgage-backed securities			—				58,079				—
State and local governments			—				50,357			$	20,450
Total Securities Available for Sale		$	31,511			$	301,494			$	20,450
		Quoted Prices in Active Markets for Identical Assets(Level 1)				Significant Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
December 31, 2011
Assets-Securities Available for Sale
U.S. Treasury		$	26,691			$	—			$	—
U.S. Government agency			—				177,797				—
Mortgage-backed securities			—				55,413				—
State and local governments			—				53,917				13,701
Total Securities Available for Sale		$	26,691			$	287,127			$	13,701

Most of the Company’s available for sale securities, including any bonds issued by local municipalities, have CUSIP numbers or have similar characteristics of those in the municipal markets, making them marketable and comparable as Level 2.

At September 30, 2012 and beginning as of December 31, 2011, the Company classified only US Treasuries as Level 1 and considered all Government Agency and Mortgage-backed securities as Level 2.

The Company also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. At September 30, 2012 and December 31, 2011, such assets consist primarily of impaired loans. Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Company estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals.)

At September 30, 2012 and December 31, 2011, impaired loans categorized as Level 3 were $4.52 and $1.85 million, respectively. The specific allocation for impaired loans was $453 and $175 thousand as of September 30, 2012 and December 31, 2011, respectively, which are accounted for in the allowance for loan losses (see Note 4).

Other real estate is reported at either the lower of the fair value of the real estate minus the estimated costs to sell the asset or the cost of the asset. The determination of fair value of the real estate relies primarily on appraisals from third parties. If the fair value of the real estate, minus the estimated costs to sell the asset, is less than the asset’s cost, the deficiency is recognized as a valuation allowance against the asset through a charge to expense. The valuation allowance is therefore increased or decreased, through charges or credits to expense, for changes in the asset’s fair value or estimated selling costs.

The following table presents impaired loans and other real estate owned as recorded at fair value on September 30, 2012 and December 31, 2011:

 

		Assets Measured at Fair Value on a Nonrecurring Basis at September 30, 2012 (In Thousands)
		Balance at September 30, 2012				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Change in fair value for nine-month period ended September 30, 2012
Impaired loans		$	4,516			$	—			$	—			$	4,516			$	(72	)
Other real estate owned - residential mortgages		$	865			$	—			$	—			$	865			$	(25	)
Other real estate owned - commercial		$	2,253			$	—			$	—			$	2,253			$	(346	)
																		$	(443	)

 

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Fair Value Measurements (Continued)

 

		Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2011 (In Thousands)
		Balance at December 31, 2011				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Change in fair value for twelve-month period ended Dec. 31, 2011
Impaired loans		$	1,854			$	—			$	—			$	1,854			$	(150	)
Other real estate owned - residential mortgages		$	958			$	—			$	—			$	958			$	(145	)
Other real estate owned commercial		$	2,614			$	—			$	—			$	2,614			$	(633	)
																		$	(928	)

The Company also has other assets, which under certain conditions, are subject to measurement at fair value. These assets include loans held for sale, bank owned life insurance, and mortgage servicing rights. The Company estimated the fair values of these assets utilizing Level 3 inputs, including, the discounted present value of expected future cash flows. At September 30, 2012 and December 31, 2011, the Company estimates that there is no impairment of these assets and therefore, no impairment charge to other expense was required to adjust these assets to their estimated fair values.

NOTE 3 ASSET PURCHASE

On July 9, 2010, the Bank completed its purchase of a branch office in Hicksville, Ohio from First Place Bank. Deposits of close to $28 million and loans of $14 million were included in the purchase. The new office is located within the Bank’s current market area, shortening the distance between offices in the Ohio and Indiana market area. The following table summarizes the estimated values of the assets acquired and the liabilities assumed:

 

		(In Thousands)
Cash		$	114
Loans, Net of Discount			13,792
Accrued Interest on Loans			64
Premises and Equipment			1,803
Core Deposit Intangible			1,087
Other Assets			11
Total Assets Acquired		$	16,871
Deposits		$	27,749
Accrued Interest on Deposits			13
Other Liabilities			10
Total Liabilities Assumed		$	27,772
Net Liabilities Assumed		$	10,901

In connection with a December 31, 2007 Knisely acquisition, the Company recognized a core deposit intangible asset of $1.1 million, which is being amortized on a straight line basis over 7 years, which represents the estimated remaining economic useful life of the deposits.

The Company also recognized core deposit intangible assets of $1.09 million with the purchase of the Hicksville office. These are being amortized over an estimated remaining economic useful life of the deposits of 7 years on a straight line basis.

The amortization expense for the year ended December 31, 2011 was $312 thousand. Of the $312 thousand to be expensed in 2012, $234 thousand has been expensed as of September 30, 2012.

 

		(In Thousands)
		Knisely				Hicksville				Total
2012		$	157			$	155			$	312
2013			157				155				312
2014			157				155				312
2015			—				155				155
2016			—				155				155
Thereafter			—				80				80
		$	471			$	855			$	1,326

 

7

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Table of Contents

ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

LOANS

 

NOTE 4

LOANS

Loan balances as of September 30, 2012 and December 31, 2011:

 

		(In Thousands)
		September 30, 2012				December 31, 2011
Loans:
Commercial real estate		$	198,856			$	201,158
Agricultural real estate			32,221				31,993
Consumer real estate			81,041				81,585
Commercial and industrial			100,126				114,497
Agricultural			56,581				52,598
Consumer			21,166				23,375
Industrial Development Bonds			1,427				1,196
		$	491,418			$	506,402
Less: Net deferred loan fees and costs			(114	)			(187	)
			491,304				506,215
Less: Allowance for loan losses			(5,134	)			(5,091	)
Loans - Net		$	486,170			$	501,124

The following is a maturity schedule by major category of loans as of September 30, 2012:

 

		(In Thousands)
		Within One Year				After One Year Within Five Years				After Five Years
Commercial Real Estate		$	24,132			$	105,178			$	69,546
Agricultural Real Estate			3,207				9,586				19,428
Consumer Real Estate			6,954				14,650				59,437
Commercial/Industrial			64,640				32,475				3,011
Agricultural			36,501				17,961				2,119
Consumer			5,062				13,891				2,099
Industrial Development Bonds			442				93				892

The distribution of fixed rate loans and variable rate loans by major loan category is as follows as of September 30, 2012. Variable rate loans whose current rates are equal to their floor or ceiling are classified as fixed in this table.

 

		(In Thousands)
		Fixed Rate				Variable Rate
Commercial Real Estate		$	118,823			$	80,033
Agricultural Real Estate			22,198				10,023
Consumer Real Estate			68,836				12,205
Commercial/Industrial			77,469				22,657
Agricultural			52,395				4,186
Consumer			20,409				643
Industrial Development Bonds			1,427				0

As of September 30, 2012 and December 31, 2011 one to four family residential mortgage loans amounting to $28.6 and $67.4 million, respectively, have been pledged as security for loans the Bank has received from the Federal Home Loan Bank.

The percentage of delinquent loans has trended downward since the beginning of January 2010 from a high of 2.85% of total loans to a low of .64% as of March 31, 2012. As of September 30, 2012, past dues were 1.13%. These percentages do not include nonaccrual loans which are not past due (nonaccruals are not considered past due if current). This level of delinquency is due in part to an adherence to sound underwriting practices over the course of time, an improvement in the financial status of companies to which the Bank extends credit, continued financial stability in the agricultural loan portfolio, and the writing down of uncollectable credits in a timely manner.

Industrial Development Bonds are included in the commercial and industrial category for the remainder of the tables in this Note 4.

 

8

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Table of Contents

ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

The following table represents the contractual aging of the recorded investment in past due loans by class or loans as of September 30, 2012 and December 31, 2011, net of deferred fees:

 

		(In Thousands)
		30-59 Days Past Due				60-89 Days Past Due				Greater Than 90 Days Past Due				Total Past Due				Current				Total Financing Receivables				Recorded Investment > 90 Days and Accruing
September 30, 2012
Consumer real estate		$	887			$	189			$	776			$	1,852			$	79,189			$	81,041			$	—
Agricultural real estate			30				—				—				30				32,191				32,221				—
Agricultural			—				21				—				21				56,560				56,581				—
Commercial Real Estate			179				—				894				1,073				197,783				198,856				—
Commercial and Industrial			130				3				2,325				2,458				99,095				101,553				—
Consumer			35				6				—				41				21,011				21,052				—
Total		$	1,261			$	219			$	3,995			$	5,475			$	485,829			$	491,304			$	—
		30-59 Days Past Due				60-89 Days Past Due				Greater Than 90 Days Past Due				Total Past Due				Current				Total Financing Receivables				Recorded Investment > 90 Days and Accruing
December 31, 2011
Consumer real estate		$	753			$	248			$	441			$	1,442			$	80,143			$	81,585			$	—
Agricultural real estate			—				—				—				—				31,993				31,993				—
Agricultural			7				—				—				7				52,591				52,598				—
Commercial Real Estate			46				611				927				1,584				199,574				201,158				—
Commercial and Industrial			78				—				420				498				115,195				115,693				—
Consumer			24				—				—				24				23,164				23,188				—
Total		$	908			$	859			$	1,788			$	3,555			$	502,660			$	506,215			$	—

The following table presents the recorded investment in nonaccrual loans by class of loans as of September 30, 2012 and December 31, 2011:

 

		(In Thousands)
		September 30 2012				December 31 2011
Consumer real estate		$	1,107			$	700
Agricultural real estate			—				—
Agricultural			—				7
Commercial Real Estate			1,408				1,003
Commercial and Industrial			2,745				421
Consumer			—				—
Total		$	5,260			$	2,131

The Bank uses a nine tier risk rating system to grade its loans. The grade of a loan may change during the life of the loan.

The risk ratings are described as follows.

 

1.

Zero (0) Unclassified. Any loan which has not been assigned a classification.

 

2.

One (1) Excellent. Credit to premier customers having the highest credit rating based on an extremely strong financial condition, which compares favorably with industry standards (upper quartile of RMA ratios). Financial statements indicate a sound earnings and financial ratio trend for several years with satisfactory profit margins and excellent liquidity exhibited. Prime credits may also be borrowers with loans fully secured by highly liquid collateral such as traded stocks, bonds, certificates of deposit, savings account, etc. No credit or collateral exceptions exist and the loan adheres to the Bank’s loan policy in every respect. Financing alternatives would be readily available and would qualify for unsecured credit. This grade is summarized by high liquidity, minimum risk, strong ratios, and low handling costs.

 

3.

Two (2) Good. Desirable loans of somewhat less stature than Grade 1, but with strong financial statements. Loan supported by financial statements containing strong balance sheets, generally with a leverage position less than 1.50, and a history of profitability. Probability of serious financial deterioration is unlikely. Possessing a sound repayment source (and a secondary source), which would allow repayment in a reasonable period of time. Individual loans backed by liquid personal assets, established history and unquestionable character.

 

9

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

4.

Three (3) Satisfactory. Satisfactory loans of average or slightly above average risk – having some deficiency or vulnerability to changing economic conditions, but still fully collectible. Projects should normally demonstrate acceptable debt service coverage. Generally, customers should have a leverage position less than 2.00. May be some weakness but with offsetting features of other support readily available. Loans that are meeting the terms of repayment.

Loans may be graded 3 when there is no recent information on which to base a current risk evaluation and the following conditions apply:

At inception, the loan was properly underwritten and did not possess an unwarranted level of credit risk:

 

a.

At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss;

 

b.

The loan exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance;

 

c.

During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the business is in an industry which is known to be experiencing problems. If any of the credit weaknesses is observed, a lower risk grade is warranted.

 

5.

Four (4) Satisfactory / Monitored. A “4” (Satisfactory/Monitored) risk grade may be established for a loan considered satisfactory but which is of average credit risk due to financial weakness or uncertainty. The loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in Satisfactory/Monitored classification is considered acceptable and within normal underwriting guidelines, so long as the loan is given management supervision.

 

6.

Five (5) Special Mention. Loans that possess some credit deficiency or potential weakness which deserves close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future. The key distinctions of a 5 (Special Mention) classification are that (1) it is indicative of an unwarranted level of risk, and (2) weaknesses are considered “potential”, versus “defined”, impairments to the primary source of loan repayment and collateral.

 

7.

Six (6) Substandard. One or more of the following characteristics may be exhibited in loans classified substandard:

 

a.

Loans, which possess a defined credit weakness and the likelihood that a loan will be paid from the primary source, are uncertain. Financial deterioration is underway and very close attention is warranted to ensure that the loan is collected without loss.

 

b.

Loans are inadequately protected by the current net worth and paying capacity of the borrower.

 

c.

The primary source of repayment is weakened, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees.

 

d.

Loans are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

 

e.

Unusual courses of action are needed to maintain a high probability of repayment.

 

f.

The borrower is not generating enough cash flow to repay loan principal; however, continues to make interest payments.

 

g.

The lender is forced into a subordinate position or unsecured collateral position due to flaws in documentation.

 

h.

Loans have been restructured so that payment schedules, terms and collateral represent concessions to the borrower when compared to the normal loan terms.

 

i.

The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

 

j.

There is significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

 

8.

Seven (7) Doubtful. One or more of the following characteristics may be exhibited in loans classified Doubtful:

 

a.

Loans have all of the weaknesses of those classified as Substandard. Additionally, however, these weaknesses make collection or liquidation in full based on existing conditions improbable.

 

b.

The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

 

c.

The possibility of loss is high, but, because of certain important pending factors which may strengthen the loan, loss classification is deferred until its exact status is known. A Doubtful classification is established deferring the realization of the loss.

 

10

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

9.

Eight (8) Loss. Loans are considered uncollectable and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The following table represents the risk category of loans by class based on the most recent analysis performed as of September 30, 2012 and December 31, 2011 (in thousands):

 

		Agriculture Real Estate				Agriculture				Commercial Real Estate				Commercial and Industrial				Industrial Development Bonds
September 30, 2012
1-2		$	1,800			$	2,696			$	4,018			$	967			$	97
3			11,279				20,389				36,049				23,919				942
4			18,426				33,453				143,015				66,567				388
5			661				43				6,199				4,055				—
6			55				—				8,975				2,238				—
7			—				—				600				2,380				—
8			—				—				—				—				—
Total		$	32,221			$	56,581			$	198,856			$	100,126			$	1,427
		Agriculture Real Estate				Agriculture				Commercial Real Estate				Commercial and Industrial				Industrial Development Bonds
December 31, 2011
1-2		$	1,059			$	1,500			$	3,545			$	710			$	188
3			12,613				25,019				23,346				22,506				622
4			17,255				26,008				162,788				82,745				386
5			383				57				6,098				3,897				—
6			683				7				4,677				4,219				—
7			—				7				704				420				—
8			—				—				—				—				—
Total		$	31,993			$	52,598			$	201,158			$	114,497			$	1,196

For consumer residential real estate, and other consumer, the Company also evaluates credit quality based on the aging status of the loan, which was previously stated, and by payment activity. The following tables present the recorded investment in those classes based on payment activity and assigned grading as of September 30, 2012 and December 31, 2011.

 

		(In Thousands)
		Consumer Real Estate				Consumer Real Estate
		September 30 2012				December 31 2011
Grade
Pass		$	80,242			$	81,062
Special Mention (5)			—				—
Substandard (6)			535				240
Doubtful (7)			264				283
Total		$	81,041			$	81,585

 

		(In Thousands)
		Consumer Credit				Consumer Credit				Consumer Other				Consumer Other
		September 30 2012				December 31 2011				September 30 2012				December 31 2011
Performing		$	3,350			$	3,607			$	17,518			$	19,531
Nonperforming			—				—				184				50
Total		$	3,350			$	3,607			$	17,702			$	19,581

 

11

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

The following table represents three months ended September 30, 2012 and nine months ended September 30, 2012.

 

		September 30, 2012 Last 3 Months												September 30, 2012 Last 9 Months
Troubled Debt Restructurings		Number of Contracts Modified in the Last 3 Months				Pre- Modification Outstanding Recorded Investment				Post- Modification Outstanding Recorded Investment				Number of Contracts Modified in the Last 9 Months				Pre- Modification Outstanding Recorded Investment				Post- Modification Outstanding Recorded Investment
Commercial Real Estate			—			$	—			$	—				1			$	1,937			$	1,937
Ag Real Estate			—			$	—			$	—				—			$	—			$	—
Commercial and Industrial			2			$	420			$	420				2			$	420			$	420
Troubled Debt Restructurings That Subsequently Defaulted		Number of Contracts Modified in the Last 3 Months				Recorded Investment								Number of Contracts Modified in the Last 9 Months				Recorded Investment
Commercial Real Estate			—			$	—								—			$	—
Ag Real Estate			—			$	—								—			$	—
Commercial and Industrial			—			$	—								—			$	—

The following table represents three months ended September 30, 2011 and nine months ended September 30, 2011.

 

		September 30, 2011 Last 3 Months												September 30, 2011 Last 9 Months
Troubled Debt Restructurings		Number of Contracts Modified in the Last 3 Months				Pre- Modification Outstanding Recorded Investment				Post- Modification Outstanding Recorded Investment				Number of Contracts Modified in the Last 9 Months				Pre- Modification Outstanding Recorded Investment				Post- Modification Outstanding Recorded Investment
Commercial Real Estate			—			$	—			$	—				2			$	923			$	688
Ag Real Estate			—			$	—			$	—				—			$	—			$	—
Commercial and Industrial			—			$	—			$	—				—			$	—			$	—
Troubled Debt Restructurings That Subsequently Defaulted		Number of Contracts Modified in the Last 3 Months				Recorded Investment								Number of Contracts Modified in the Last 9 Months				Recorded Investment
Commercial Real Estate			1			$	—								1			$	207
Ag Real Estate			—			$	—								—			$	—
Commercial and Industrial			—			$	—								—			$	—

The Bank had approximately $207 thousand of its impaired loans classified as troubled debt restructured as of September 30, 2012 and December 31, 2011. For the majority of the Bank’s impaired loans, the Bank will apply the observable market price methodology. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan’s effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time for re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the collateral value used.

The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge-off in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of the collateral, if repossession of the collateral is assured and/or in the process of repossession. Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial and agricultural credits are charged down at 120 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance. Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.

 

12

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

The following table presents loans individually evaluated for impairment by class of loans for three months ended September 30, 2012 and September 30, 2011.

 

Three Months Ended September 30, 2012		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Consumer real estate		$	573			$	645			$	—			$	485			$	2
Agriculture real estate			—				—				—				—				—
Agriculture			—				—				—				—				—
Commercial real estate			207				384				—				207				—
Commercial and industrial			365				365				—				365				—
Consumer			—				4				—				—				—
With a specific allowance recorded:
Consumer real estate			391				391				69				489				1
Agriculture real estate			—				—				—				—				—
Agriculture			—				—				—				—				—
Commercial real estate			600				847				—				620				—
Commercial and industrial			2,380				2,380				383				2,380				7
Consumer			—				—				—				—				—
Totals:
Consumer real estate		$	964			$	1,036			$	69			$	974			$	3
Agriculture real estate		$	—			$	—			$	—			$	—			$	—
Agriculture		$	—			$	—			$	—			$	—			$	—
Commercial real estate		$	807			$	1,231			$	—			$	827			$	—
Commercial and industrial		$	2,745			$	2,745			$	383			$	2,745			$	7
Consumer		$	—			$	4			$	—			$	—			$	—
Three Months Ended September 30, 2011		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Consumer real estate		$	—			$	—			$	—			$	133			$	7
Agriculture real estate			—				—				—				223				—
Agriculture			5,036				5,036				—				4,768				3
Commercial real estate			1,567				1,744				—				1,717				9
Commercial and industrial			—				—				—				118				—
Consumer			—				—				—				—				—
With a specific allowance recorded:
Consumer real estate			479				492				101				382				2
Agriculture real estate			—				—				—				—				—
Agriculture			—				—				—				—				—
Commercial real estate			—				—				—				104				—
Commercial and industrial			—				—				—				—				—
Consumer			—				—				—				—				—
Totals:
Consumer real estate		$	479			$	492			$	101			$	515			$	9
Agriculture real estate		$	—			$	—			$	—			$	223			$	—
Agriculture		$	5,036			$	5,036			$	—			$	4,768			$	3
Commercial real estate		$	1,567			$	1,744			$	—			$	1,821			$	9
Commercial and industrial		$	—			$	—			$	—			$	118			$	—
Consumer		$	—			$	—			$	—			$	—			$	—

 

13

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

The following table presents loans individually evaluated for impairment by class of loans for nine months ended September 30, 2012 and September 30, 2011.

 

Nine Months Ended September 30, 2012		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Consumer real estate		$	573			$	645			$	—			$	285			$	7
Agriculture real estate			—				—				—				—				—
Agriculture			—				—				—				—				—
Commercial real estate			207				384				—				207				—
Commercial and industrial			365				365				—				162				—
Consumer			—				4				—				—				—
With a specific allowance recorded:
Consumer real estate			391				391				69				427				1
Agriculture real estate			—				—				—				—				—
Agriculture			—				—				—				—				—
Commercial real estate			600				847				—				662				—
Commercial and industrial			2,380				2,380				383				1,345				—
Consumer			—				—				—				3				10
Totals:
Consumer real estate		$	964			$	1,036			$	69			$	712			$	8
Agriculture real estate		$	—			$	—			$	—			$	—			$	—
Agriculture		$	—			$	—			$	—			$	—			$	—
Commercial real estate		$	807			$	1,231			$	—			$	869			$	—
Commercial and industrial		$	2,745			$	2,745			$	383			$	1,507			$	—
Consumer		$	—			$	4			$	—			$	3			$	10
Nine Months Ended September 30, 2011		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Consumer real estate		$	—			$	—			$	—			$	202			$	12
Agriculture real estate			—				—				—				240				—
Agriculture			5,036				5,036				—				3,276				3
Commercial real estate			1,567				1,744				—				1,550				20
Commercial and industrial			—				—				—				73				—
Consumer			—				—				—				1				—
With a specific allowance recorded:
Consumer real estate			479				492				101				391				2
Agriculture real estate			—				—				—				—				—
Agriculture			—				—				—				—				—
Commercial real estate			—				—				—				171				—
Commercial and industrial			—				—				—				536				—
Consumer			—				—				—				—				—
Totals:
Consumer real estate		$	479			$	492			$	101			$	593			$	14
Agriculture real estate		$	—			$	—			$	—			$	240			$	—
Agriculture		$	5,036			$	5,036			$	—			$	3,276			$	3
Commercial real estate		$	1,567			$	1,744			$	—			$	1,721			$	20
Commercial and industrial		$	—			$	—			$	—			$	609			$	—
Consumer		$	—			$	—			$	—			$	1			$	—

The ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense. The following tables summarize the activities in the allowance for credit losses.

 

		(In Thousands)
		September 30, 2012				December 31, 2011
Allowance for Loan Losses
Balance at beginning of year		$	5,091			$	5,706
Provision for loan loss			442				1,715
Loans charged off			(639	)			(2,681	)
Recoveries			240				351
Allowance for Loan & Leases Losses		$	5,134			$	5,091
Allowance for Unfunded Loan Commitments & Letters of Credit		$	149			$	130
Total Allowance for Credit Losses		$	5,283			$	5,221

 

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two reserves: The ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total Allowance for Credit Losses (ACL).

The AULC is reported within other liabilities on the balance sheet while the ALLL is netted within the loans, net asset line. The ACL presented above represents the full amount of reserves available to absorb possible credit losses.

The following table breaks down the activity within ALLL for each loan portfolio segment and shows the contribution provided by both the recoveries and the provision along with the reduction of the allowance caused by charge-offs.

Additional analysis related to the allowance for credit losses for three months ended September 30, 2012 and September 30, 2011 is as follows (in thousands):

 

		Consumer Real Estate				Agriculture Real Estate				Agriculture				Commercial Real Estate				Commercial				Consumer (incl. Credit Cards)				Unfunded Loan Commitment & Letters of Credit				Unallocated				Total
Three Months Ended September 30, 2012
ALLOWANCE FOR CREDIT LOSSES:
Beginning balance		$	460			$	92			$	275			$	1,722			$	1,856			$	283			$	141			$	348			$	5,177
Charge Offs			(92	)			—				(6	)			—				—				(142	)			—				—			$	(240	)
Recoveries			23				—				1				3				5				71				—				—			$	103
Provision			(37	)			(1	)			14				64				14				58				—				123			$	235
Other Non-interest expense related to unfunded			—				—				—				—				—				—				8				—			$	8
Ending Balance		$	354			$	91			$	284			$	1,789			$	1,875			$	270			$	149			$	471			$	5,283
Ending balance: individually evaluated for impairment		$	69			$	—			$	—			$	—			$	383			$	—			$	—			$	—			$	452
Ending balance: collectively evaluated for impairment		$	285			$	91			$	284			$	1,789			$	1,492			$	270			$	149			$	471			$	4,831
Ending balance: loans acquired with deteriorated credit quality		$	1			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	1
FINANCING RECEIVABLES:
Ending balance		$	81,041			$	32,221			$	56,581			$	198,856			$	101,553			$	21,052			$	—			$	—			$	491,304
Ending balance: individually evaluated for impairment		$	964			$	—			$	—			$	807			$	2,745			$	—			$	—			$	—			$	4,516
Ending balance: collectively evaluated for impairment		$	80,077			$	32,221			$	56,581			$	198,049			$	98,808			$	21,052			$	—			$	—			$	486,788
Ending balance: loans acquired with deteriorated credit quality		$	547			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	547
		Consumer Real Estate				Agriculture Real Estate				Agriculture				Commercial Real Estate				Commercial				Consumer (incl. Credit Cards)				Unfunded Loan Commitment & Letters of Credit				Unallocated				Total
Three Months Ended September 30, 2011
ALLOWANCE FOR CREDIT LOSSES:
Beginning balance		$	524			$	156			$	287			$	2,052			$	2,047			$	340			$	144			$	83			$	5,633
Charge Offs			(190	)			—			$	(1	)			(55	)			(180	)			(98	)			—				—			$	(524	)
Recoveries			25				—				—				1				5				49				—				—			$	80
Provision			(30	)			(3	)			(35	)			28				33				24				—				76			$	93
Other Non-interest expense related to unfunded			—				—				—				—				—				—				12				—			$	12
Ending Balance		$	329			$	153			$	251			$	2,026			$	1,905			$	315			$	156			$	159			$	5,294
Ending balance: individually evaluated for impairment		$	101			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	101
Ending balance: collectively evaluated for impairment		$	228			$	153			$	251			$	2,026			$	1,905			$	315			$	156			$	159			$	5,193
Ending balance: loans acquired with deteriorated credit quality		$	2			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	2
FINANCING RECEIVABLES:
Ending balance		$	80,607			$	31,806			$	54,134			$	201,167			$	113,889			$	23,861			$	—			$	—			$	505,464
Ending balance: individually evaluated for impairment		$	479			$	—			$	5,036			$	1,567			$	—			$	—			$	—			$	—			$	7,082
Ending balance: collectively evaluated for impairment		$	80,128			$	31,806			$	49,098			$	199,600			$	113,889			$	23,861			$	—			$	—			$	498,382
Ending balance: loans acquired with deteriorated credit quality		$	986			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	986

 

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ITEM 1 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (Continued)

NOTE 4 LOANS (Continued)

 

Additional analysis related to the allowance for credit losses for nine months ended September 30, 2012 and September 30, 2011 is as follows (in thousands):

 

Nine Months Ended September 30, 2012		Consumer Real Estate				Agriculture Real Estate				Agriculture				Commercial Real Estate				Commercial				Consumer (incl. Credit Cards)				Unfunded Loan Commitment & Letters of Credit				Unallocated				Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning balance		$	261			$	140			$	266			$	2,088			$	1,947			$	315			$	130			$	74			$	5,221
Charge Offs			(185	)			—				(6	)			(97	)			—				(351	)			—				—			$	(639	)
Recoveries			52				—				11				5				24				148				—				—			$	240
Provision			225				(49	)			13				(207	)			(96	)			159				—				397			$	442
Other Non-interest expense related to unfunded			—				—				—				—				—				—				19				—			$	19
Ending Balance		$	353			$	91			$	284			$	1,789			$	1,875			$	271			$	149			$	471			$	5,283
Ending balance: individually evaluated for impairment		$	69			$	—			$	—			$	—			$	383			$	—			$	—			$	—			$	452
Ending balance: collectively evaluated for impairment		$	284			$	91			$	284			$	1,789			$	1,492			$	271			$	149			$	471			$	4,831
Ending balance: loans acquired with deteriorated credit quality		$	1			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	1
FINANCING RECEIVABLES:
Ending balance		$	81,041			$	32,221			$	56,581			$	198,856			$	101,553			$	21,052			$	—			$	—			$	491,304
Ending balance: individually evaluated for impairment		$	964			$	—			$	—			$	807			$	2,745			$	—			$	—			$	—			$	4,516
Ending balance: collectively evaluated for impairment		$	80,077			$	32,221			$	56,581			$	198,049			$	98,808			$	21,052			$	—			$	—			$	486,788
Ending balance: loans acquired with deteriorated credit quality		$	547			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	547

 

Nine Months Ended September 30, 2011		Consumer Real Estate				Agriculture Real Estate				Agriculture				Commercial Real Estate				Commercial				Consumer (incl. Credit Cards)				Unfunded Loan Commitment & Letters of Credit				Unallocated				Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning balance		$	258			$	122			$	327			$	1,868			$	2,354			$	380			$	153			$	397			$	5,859
Charge Offs			(380	)			—				(25	)			(210	)			(1,496	)			(267	)			—				—			$	(2,378	)
Recoveries			48				—				65				30				11				134				—				—			$	288
Provision			403				31				(116	)			338				1,036				68				—				(238	)		$	1,522
Other Non-interest expense related to unfunded			—				—				—				—				—				—				3				—			$	3
Ending Balance		$	329			$	153			$	251			$	2,026			$	1,905			$	315			$	156			$	159			$	5,294
Ending balance: individually evaluated for impairment		$	101			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	101
Ending balance: collectively evaluated for impairment		$	228			$	153			$	251			$	2,026			$	1,905			$	315			$	156			$	159			$	5,193
Ending balance: loans acquired with deteriorated credit quality		$	2			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	2
FINANCING RECEIVABLES:
Ending balance		$	80,607			$	31,806			$	54,134			$	201,167			$	113,889			$	23,861			$	—			$	—			$	505,464
Ending balance: individually evaluated for impairment		$	479			$	—			$	5,036			$	1,567			$	—			$	—			$	—			$	—			$	7,082
Ending balance: collectively evaluated for impairment		$	80,128			$	31,806			$	49,098			$	199,600			$	113,889			$	23,861			$	—			$	—			$	498,382
Ending balance: loans acquired with deteriorated credit quality		$	986			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	986

 

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ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION

Farmers & Merchants Bancorp, Inc. (Company) is a bank holding company incorporated under the laws of Ohio in 1985. Our primary subsidiary, The Farmers & Merchants State Bank (Bank) is a community bank operating in Northwest Ohio since 1897. We report our financial condition and net income on a consolidated basis and we report only one segment.

Our executive offices are located at 307 North Defiance Street, Archbold, Ohio 43502, and our telephone number is (419)446-2501.

The Bank’s primary market includes communities located in the Ohio counties of Defiance, Fulton, Henry, Williams and Wood and in the Indiana counties of DeKalb and Steuben. The commercial banking business in this market is highly competitive with approximately 17 other depository institutions currently doing business in the Bank’s primary market. In our banking activities, we compete directly with other commercial banks, credit unions and farm credit services and savings and loan institutions in each of their operating localities. In a number of locations, we compete against entities which are much larger than us. The primary factors in competing for loans and deposits are the rates charged as well as location and quality of service provided. On December 31, 2007, the Bank acquired the Knisely Bank of Indiana, expanding its market with the addition of offices in Butler and Auburn, Indiana, both located in DeKalb County. An additional office was opened in the summer of 2008 in Angola, Indiana, located in Steuben County. On July 9, 2010 the Bank purchased a branch office in Hicksville, Ohio shortening the distance between our Ohio and Indiana offices. Construction has begun on the Bank’s 20th full service office located in Waterville, Lucas County, Ohio. A second quarter 2013 opening is planned.

For a discussion of the general development of the Company’s business throughout 2012, please see the portion of Management’s Discussion and Analysis of Financial Condition and Results of Operations captioned “2012 in Review”.

The Bank’s primary service area, Northwest Ohio and Northeast Indiana, continued to experience high unemployment. After reaching a high of 11% unemployment for Ohio in March, 2010, the unemployment rate decreased in each of the ensuing months in Ohio and closed July 2012 at 7.7% for Ohio. Indiana declined through May 2012; however Indiana increased during June and July to end at 8.2%. National and State unemployment reports for July 2012, show a slight improvement while the majority of the market areas served by the Company have rates higher than the State averages as of July 2012. The agricultural industry continued its strong performance in 2011 evidenced by strengthened financial statements. Automotive showed improvement with car dealers in our marketing area ending with more profitable numbers than in recent years. Overall, business profits are improving, however borrowing activity remains sluggish and loan balances declined during the quarter. New 1-4 family residential and construction remain weak while refinancing activity remains brisk.

The Farmers & Merchants State Bank engages in general commercial banking and savings business. Their activities include commercial, agricultural and residential mortgage, consumer and credit card lending activities. Because the Bank’s offices are located in Northwest Ohio and Northeast Indiana, a substantial amount of the loan portfolio is comprised of loans made to customers in the farming industry for such things as farm land, farm equipment, livestock and operating loans for seed, fertilizer, and feed. Other types of lending activities include loans for home improvements, and loans for such items as autos, trucks, recreational vehicles, motorcycles, etc.

The Bank also provides checking account services, as well as savings and time deposit services such as a certificates of deposits. In addition ATM’s (Automated Teller Machines) are provided at most branch locations along with other independent locations such as major employers and hospitals in the market area. The Bank has custodial services for IRA’s (Individual Retirement Accounts) and HSA’s (Health Savings Accounts). The Bank provides on-line banking access for consumer and business customers. For consumers, this includes bill-pay, on-line statement opportunities and mobile banking. For business customers, it provides the option of electronic transaction origination such as wire and ACH file transmittal. In addition the Bank offers remote deposit capture or electronic deposit processing and merchant credit card services.

The Bank’s underwriting policies exercised through established procedures facilitates operating in a safe and sound manner in accordance with supervisory and regulatory guidance. Within this sphere of safety and soundness, the Bank’s practice has been not to promote innovative, unproven credit products which will not be in the best interest of the Bank or its customers. The Bank does offer a hybrid mortgage loan. Hybrid loans are loans that start out as a fixed rate mortgage but after a set number of years automatically adjust to an adjustable rate mortgage. The Bank offers a three year fixed rate mortgage after which the interest rate will adjust annually. The majority of the Bank’s adjustable rate mortgages are of this type. In order to offer longer term fixed rate mortgages, the Bank does participate in the Freddie Mac, Farmer Mac and Small Business Lending programs. The Bank does also retain the servicing on these partially or 100% sold loans. In order for the customer to participate in these programs they must meet the requirements established by these agencies. In addition, the Bank does sell some of its longer term fixed rate agricultural mortgages into the secondary market with the aid of a broker.

The Bank does not have a program to fund sub-prime loans. Sub-prime loans are characterized as a lending program or strategy that target borrowers who pose a significantly higher risk of default than traditional retail banking customers.

Following are the characteristics and underwriting criteria for each major type of loan the Bank offers:

Commercial Real Estate –Construction, purchase, and refinance of business purpose real estate. Risks include loan amount in relation to construction delays and overruns, vacancies, collateral value subject to market value fluctuations, interest rate, market demands, borrower’s ability to repay in orderly fashion, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer’s ability to repay in a changing rate environment before granting loan approval.

Agricultural Real Estate – Purchase of farm real estate or for permanent improvements to the farm real estate. Cash flow from the farm operation is the repayment source and is therefore subject to the financial success of the farm operation.

 

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ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (Continued)

INTRODUCTION (Continued)

 

Consumer Real Estate – Purchase, refinance, or equity financing of one to four family owner occupied dwelling. Success in repayment is subject to borrower’s income, debt level, character in fulfilling payment obligations, employment, and others.

Commercial/Industrial – Loans to proprietorships, partnerships, or corporations to provide temporary working capital and seasonal loans as well as long term loans for capital asset acquisition. Risks include adequacy of cash flow, reasonableness of profit projections, financial leverage, economic trends, management ability, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer’s ability to repay in a changing rate environment before granting loan approval.

Agricultural – Loans for the production and housing of crops, fruits, vegetables, and livestock or to fund the purchase or re-finance of capital assets such as machinery and equipment, and livestock. The production of crops and livestock is especially vulnerable to commodity prices and weather. The vulnerability to commodity prices is offset by the farmers ability to hedge their position by the use of the future contracts. The risk related to weather is often mitigated by requiring federal crop insurance.

Consumer – Funding for individual and family purposes. Success in repayment is subject to borrower’s income, debt level, character in fulfilling payment obligations, employment, and others.

Industrial Development Bonds – Funds for public improvements in the Bank’s service area. Repayment ability is usually based on the continuance of the taxation revenue as the source of repayment.

All loan requests are reviewed as to credit worthiness and are subject to the Bank’s underwriting guidelines as to secured versus unsecured credit. Secured loans are in turn subject to loan to value (LTV) requirements based on collateral types as set forth in the Bank’s Loan Policy. In addition, credit scores of principal borrowers are reviewed and an approved exception from an additional officer is required should a credit score not meet the Bank’s Loan Policy guidelines.

Consumer Loans:

Maximum loan to value (LTV) for cars, trucks and light trucks vary from 90% to 110% depending on whether direct or indirect.

Loans above 100% are generally due to additional charges for extended warranties and/or insurance coverage periods of lost wages or death.

Boats, campers, motorcycles, RV’s and Motor Coaches range from 80%-90% based on age of vehicle.

1st or 2nd mortgages on 1-4 family homes range from 75%-90% with “in-house” first real estate mortgages requiring private mortgage insurance on those exceeding 80% LTV.

Raw land LTV maximum ranges from 65%-75% depending on whether or not the property has been improved.

Commercial/Agriculture/Real Estate:

Maximum LTVs range from 70%-80% depending on type.

Accounts Receivable:

Up to 80% LTV.

Inventory:

Agriculture:

Livestock and grain up to 80% LTV, crops (insured) up to 75% and Warehouse Receipts up to 87%.

Commercial:

Maximum LTV of 50% on raw and finished goods.

Used vehicles, new recreational vehicles and manufactured homes not to exceed (NTE) 80% LTV.

Equipment:

New not to exceed 80% of invoice, used NTE 50% of listed book or 75% of appraised value.

Restaurant equipment up to 35% of market value.

Heavy trucks, titled trailers, NTE 75% LTV and aircraft up to 75% of appraised value.

We also provide checking account services, as well as savings and time deposit services such as certificates of deposits. In addition ATM’s are provided at our Ohio offices in Archbold, Wauseon, Stryker, West Unity, Bryan, Delta, Napoleon, Montpelier, Swanton, Defiance, and Perrysburg, along with ones at our Auburn and Angola, Indiana offices. Two ATM’s are located at Sauder Woodworking Co., Inc., a major employer in Archbold. Additional locations in Ohio are at Northwest State Community College, Archbold; Community Hospitals of Williams County, Bryan; Fairlawn Haven Wyse Commons, Archbold; R&H Restaurant, Fayette; Delta Eagles; Sauder Village, Archbold; Fulton County Health Center, Wauseon; downtown Defiance; and a mobile trailer ATM. In Indiana, four additional ATM’s are located at St. Joe; at Kaiser’s Supermarket and Therma-Tru in Butler; and at DeKalb Memorial Hospital in Auburn.

F&M Investment Services, the brokerage department of the Bank, opened for business in April, 1999. Securities are offered through Raymond James Financial Services Inc.

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 and regulated by the Federal Reserve. Our subsidiary bank is in turn regulated and examined by the Ohio Division of Financial Institutions, and the Federal Deposit Insurance Corporation. The activities of our bank subsidiary are also subject to other federal and state laws and regulations.

At September 30, 2012, we had 247 full time equivalent employees. The employees are not represented by a collective bargaining unit. We provide our employees with a comprehensive benefit program, some of which are contributory. We consider our employee relations to be excellent.

 

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ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATION (Continued)

 

2012 IN REVIEW

The Company’s 2012 performance results continued to be bolstered by gains on sales from real estate loans. The third quarter had more noninterest income generated from the consumer real estate portfolio as compared to second quarter’s developing more from the agricultural real estate segment. Pressure continues on the net interest margin though the dollars were just $118 thousand lower for the quarter than the same period period last year. A lower net interest position is also evident on the income statement in the year-to-date figures. Asset quality continued to improve.

All rates remain low and are expected to remain low throughout 2013. This has enabled the Company to continue to sell investment securities and recognize a gain without compromising the yield while modestly increasing the duration of the investment portfolio. As of September 30, 2012, the favorable gain produced from the sale of securities was $199 thousand. Most of the securities sold were agencies maturing in a shorter time period than the securities that were purchased to replace them. As of September 30, 2011, the favorable gain was at $504 thousand and the majority of securities sold were out of state municipals and agencies. The Bank was able to continue to capitalize on the steepness of the yield curve and the unrealized market gain position at the start of 2012. The market value of the security portfolio remains high as evidenced by the high comprehensive income reported on the income statement. Additional opportunity to se1l investment securities for a gain remains.

During the first quarter of 2011, the Bank received a payoff on a large nonaccrual loan. The collection of which included over $600 thousand of interest and a reimbursement of over $300 thousand in legal fees. The collection process took almost three years to complete. This boost to income is evident throughout from net interest margin, improved asset quality to lower non-interest expense. It also offset tightening margins due to soft loan demand and high liquidity caused from higher deposit growth. As was expected, 2012 numbers, as they relate to interest earnings, were lower in yield than 2011 without an additional large influx of nonaccrual interest collection. The yield has been lower though overall net income is higher. The Bank has been able to realize improvement as a result of a lower loan provision requirement. As compared to a year ago, provision expense was $1.1 million lower for the first nine months. This contributed to ROA and ROE remaining higher than a year ago.

Noninterest income was significantly higher than a year ago, not only for the quarter but also in terms of year-to-date. Customer service fees were $1.5 million higher as of September 30, 2012 compared to the same period 2011. An increase in mortgage servicing rights due to the high volume of consumer mortgage activity, increased debit card usage by our customers and the service fees generated from our secondary agricultural real estate loans, were the main drivers of the improvement. All remain strong and are expected to contribute to improved earnings for the fourth quarter.

Consumer and agricultural real estate loan sales in the secondary market provided a $1.4 million boost to non interest income so far in 2012 as compared to 2011. This activity is also predicted to continue through the fourth quarter of 2012 as customers seek to lock in long term fixed rates.

A large amount of write-downs and losses on the sale of other real estate owned (ORE) hampered 2011 as compared to the same time period 2012. The balance in ORE is at $3.1 million which is $737.5 thousand lower as of September 30, 2012 compared to September 30, 2011. While September 30, 2012 recognized $474.9 thousand in write-downs and losses from sales of ORE, as of September 30, 2011, the Bank had recognized $999.6 thousand in a compilation of write-downs and losses on ORE. This impact is evidenced in the higher non-interest income for nine months ended 2012.

The impact of new legislation, such as Patient Protection and Affordable Care Act and Dodd-Frank Wall Street Reform and Consumer Protection Act (Collectively, “Financial Reform legislation”), weighs heavily on the minds of bankers along with their customers during its implementation. Legislation has impacted the collection of fees related to discretionary overdraft protection since the second half of 201