UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2015
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.
OHIO | 34-1469491 | |
(State or other jurisdiction of | (IRS Employer | |
incorporation or organization)
|
Identification No.) | |
307 North Defiance Street | ||
Archbold, Ohio | 43502 | |
(Address of principal Executive offices) | (Zip Code) |
Registrants telephone number, including area code (419) 446-2501
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of each exchange on which registered | |
None | None |
Securities registered pursuant to Section 12(g) of the Act:
Common shares without par value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or Section 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). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes ¨ No x
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. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of June 30, 2015, the aggregate market value of the registrants common stock held by non-affiliates of the registrant was $125,349,922.
As of February 24, 2016, the Registrant had 5,200,000 shares of common stock issued of which 4,612,534 shares are outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K Portions of the definitive Proxy Statement for the 2016 Annual Meeting of Shareholders of Farmers & Merchants Bancorp, Inc.
FARMERS & MERCHANTS BANCORP, INC.
** |
The following materials from Farmers & Merchants Bancorp, Inc. on Form 10-K for the year ended December 31, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Income and Comprehensive Income; (iii) the Consolidated Statements of Cash Flows and (iv) Notes to Consolidated Financial Statements, tagged as blocks of text. |
Total Pages: |
111 |
Forward Looking Statements
Statements contained in this portion of the Companys annual report may be forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of such words as intend, believe, expect, anticipate, should, planned, estimated, and potential. Such forward-looking statements are based on current expectations, but may differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with the Securities and Exchange Commission from time to time. Other factors which could have a material adverse effect on the operations of the Company and its subsidiaries which include, but are not limited to, changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Banks market area, changes in relevant accounting principles and guidelines and other factors over which management has no control. The forward-looking statements are made as of the date of this report, and the Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.
PART 1.
General
Farmers & Merchants Bancorp, Inc. (Company) is a bank holding company incorporated under the laws of Ohio in 1985 and elected to become a financial holding company under the Federal Reserve in 2014. Our primary subsidiary, The Farmers & Merchants State Bank (Bank) is a community bank operating in Northwest Ohio since 1897. Our other subsidiary, Farmers & Merchants Risk Management (Captive) is a captive insurance company formed in December 2014 and located in Nevada. 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.
For a discussion of the general development of the Companys business throughout 2015, please see the portion of Managements Discussion and Analysis of Financial Condition and Results of Operations captioned 2015 in Review.
Nature of Activities
The local economies of Northwest Ohio and Northeast Indiana continued to improve throughout 2015. Based on asset quality remaining strong, indicated by low delinquency levels, businesses profits also improved or held steady to 2014. Some industries, such as car dealers, recorded more sales in 2015 than in prior years. Farm customers dealt with lower commodity prices and most were still able to operate profitably. The farm community is better prepared to handle challenges in 2016 than it was in the 1980s. 2016 begins with the first prime rate increase in seven years and overall, the local economies should continue to improve while addressing the new challenges of a rising rate environment.
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The Farmers & Merchants State Bank engages in general commercial banking business. Its activities include commercial, agricultural and residential mortgage, consumer and credit card lending activities. Because the Banks 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. With the expansion into newer market areas, the most recent increases in loan activity have been in commercial real estate, providing operation lines of credit and machinery purchases.
The Bank also provides checking account services, as well as savings and time deposit services such as certificates of deposits. In addition, ATMs (automated teller machines) are provided at most branch locations along with other independent locations including major employers and hospitals in the market area. The Bank has custodial services for IRAs (Individual Retirement Accounts) and HSAs (Health Savings Accounts). The Bank provides on-line banking access for consumer and business customers. For consumers, this includes bill-pay and on-line statement opportunities. 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. Mobile banking was added in 2012 and has been widely accepted and used by consumers.
The Banks underwriting policies, exercised through established procedures, facilitate operating in a safe and sound manner in accordance with supervisory and regulatory guidance. Within this sphere of safety and soundness, the Banks practice has been to avoid promoting innovative, unproven credit products which may not be in the best interest of the Bank or its customers. The Bank does offer a hybrid loan. Hybrid loans are loans that start 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 Banks 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 also retains 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. The Banks policies focus on initiating mainly qualified mortgages.
All loan requests are reviewed as to credit worthiness and are subject to the Banks 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 Banks 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 Banks 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, RVs 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 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 up to NTE 75% LTV and aircraft up to 75% of appraised value
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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.
In December of 2014, the Company became a financial holding company within the meaning of the Bank Holding Company Act of 1956 as amended, in order to provide the flexibility to take advantage of the expanded powers available to a financial holding company under the Act. 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. The Company also formed a Captive insurance company in December 2014. The Captive is located in Nevada and regulated by the State of Nevada Division of Insurance.
The Banks primary market includes communities located in the Ohio counties of Defiance, Fulton, Henry, Lucas, Williams, Wood and in the Indiana counties of DeKalb and Steuben. In the first half of 2016 the Bank will add the Indiana county of Allen to its service area with the opening of its newly constructed office in Fort Wayne. The commercial banking business in this market is highly competitive, with approximately 17 other depository institutions currently doing business in the Banks primary market. In our banking activities, we compete directly with other commercial banks, credit unions, farm credit services, and savings and loan institutions in each of our operating localities. In a number of our 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 the services provided.
At December 31, 2015, we had 265 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 good.
Supervision and Regulation
General
The Company is a corporation organized under the laws of the State of Ohio. The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities. The supervision, regulation and examination to which the Company and its subsidiaries are subject are intended primarily for the protection of depositors and the deposit insurance funds that insure the deposits of banks, rather than for the protection of shareholders.
Several of the more significant regulatory provisions applicable to banks and bank holding companies to which the Company and its subsidiary are subject are discussed below, along with certain regulatory matters concerning the Company and its subsidiaries. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and its subsidiaries.
Regulatory Agencies
The Company is a financial holding company and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the Federal Reserve Board) pursuant to the Bank Holding Company Act of 1956, as amended. As a financial holding company, the Company is still subject to all the bank holding company regulations.
The Bank is an Ohio chartered commercial bank. It is subject to regulation and examination by both the Ohio Division of Financial Institutions (ODFI) and the Federal Deposit Insurance Corporation (FDIC).
The Captive is an insurance company incorporated in Nevada and regulated by the State of Nevada, Division of Insurance.
Holding Company Activities
As a financial holding company incorporated and doing business within the State of Ohio, the Company is subject to regulation and supervision under the Bank Holding Act of 1956, as amended (the Act). The Company is required to file with the Federal Reserve Board on quarterly basis information pursuant to the Act. The Federal Reserve Board may conduct examinations or inspections of the Company and its subsidiaries.
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On November 12, 1999, the Gramm-Leach-Bliley Act (the GLB Act) was enacted into law. The GLB Act made sweeping changes with respect to the permissible financial services which various types of financial institutions may now provide. The Glass-Steagall Act, which had generally prevented banks from affiliation with securities and insurance firms, was repealed. Pursuant to the GLB Act, bank holding companies may elect to become a financial holding company, provided that all of the depository institution subsidiaries of the bank holding company are well capitalized and well managed under applicable regulatory standards.
Under the GLB Act, a bank holding company that has elected to become a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Activities that are financial in nature include securities underwriting, dealing and market-making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board has determined to be closely related to banking. Federal Reserve Board approval is not required for the Company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. Prior Federal Reserve Board approval is required before the Company may acquire the beneficial ownership or control of more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. If any subsidiary bank of the Company ceases to be well capitalized or well managed under applicable regulatory standards, the Federal Reserve Board may, among other actions, order the Company to divest the subsidiary bank. Alternatively, the Company may elect to conform its activities to those permissible for a bank holding company that is not also a financial holding company. If any subsidiary bank of the Company receives a rating under the Community Reinvestment Act of 1977 of less than satisfactory, the Company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations.
Affiliate Transactions
Various governmental requirements, including Sections 23A and 23B of the Federal Reserve Act and Regulation W promulgated thereunder limit borrowings by holding companies and non-bank subsidiaries from affiliated insured depository institutions, and also limit various other transactions between holding companies and their non-bank subsidiaries, on the one hand, and their affiliated insured depository institutions on the other. Section 23A of the Federal Reserve Act also generally requires that an insured depository institutions loan to its non-bank affiliates be secured, and Section 23B of the Federal Reserve Act generally requires that an insured depository institutions transactions with its non-bank affiliates be on arms-length terms.
Interstate Banking and Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act (Riegle-Neal), subject to certain concentration limits and other requirements, adequately capitalized bank holding companies such as the Company are permitted to acquire banks and bank holding companies located in any state. Any bank that is a subsidiary of a bank holding company is permitted to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of that bank holding company. Banks are permitted to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states and establishing de novo branch offices in other states. The ability of banks to acquire branch offices is contingent, however, on the host state having adopted legislation opting in to those provisions of Riegle-Neal. In addition, the ability of a bank to merge with a bank located in another state is contingent on the host state not having adopted legislation opting out of that provision of Riegle-Neal. The Company could from time to time use Riegle-Neal to acquire banks in additional states.
Control Acquisitions
The Change in Bank Control Act prohibits a person or group of persons from acquiring control of a bank holding company, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under the rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Company, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve Board under the
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Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting stock of a bank holding company, or otherwise obtaining control or a controlling influence over that bank holding company.
Liability for Banking Subsidiaries
Under the current Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to maintain resources adequate to support each subsidiary bank. This support may be required at times when the bank holding company may not have the resources to provide it. In the event of a bank holding companys bankruptcy, any commitment by the bank holding company to a U.S. federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment. Any depository institution insured by the FDIC can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC in connection with (1) the default of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to both a commonly controlled FDIC-insured depository institution in danger of default. The Bank is an FDIC-insured depository institution. If a default occurred with respect to the Bank, any capital loans to the Bank from its parent holding company would be subordinate in right of payment to payment of the Banks depositors and certain of its other obligations.
Regulatory Capital Requirements
The Company is required by the various regulatory authorities to maintain certain capital levels. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve Board capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The required capital levels and the Companys capital position at December 31, 2015 and 2014 are summarized in the table included in Note 15 to the consolidated financial statements.
Beginning in 2015, the Company and Bank were required to measure capital adequacy using Basel III accounting. Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. Implementation of the rules will be overseen by the Federal Reserve, the FDIC and the OCC. Reporting under the new rules began with the March 2015 quarterly regulatory filings.
FDICIA
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), and the regulations promulgated under FDICIA, among other things, established five capital categories for insured depository institutions-well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized-and requires U.S. federal bank regulatory agencies to implement systems for prompt corrective action for insured depository institutions that do not meet minimum capital requirements based on these categories. Unless a bank is well capitalized, it is subject to restrictions on its ability to offer brokered deposits and on certain other aspects of its operations. An undercapitalized bank must develop a capital restoration plan and its parent bank holding company must guarantee the banks compliance with the plan up to the lesser of 5% of the banks assets at the time it became undercapitalized and the amount needed to comply with the plan. As of December 31, 2015 the Bank was well capitalized pursuant to these prompt corrective action guidelines.
Dividend Restrictions
The ability of the Company to obtain funds for the payment of dividends and for other cash requirements will be largely dependent on the amount of dividends which may be declared by its banking subsidiary. Various U.S. federal statutory provisions limit the amount of dividends the Companys banking subsidiary can pay to the Company without regulatory approval. In 2009, The Board of Governors of the Federal Reserve Division of Banking Supervision and Regulation issued SR09-4 regarding the safe and sound payment of dividends by bank holding companies. In addition, dividend payments by the Bank are limited to its retained earnings during the current year and its prior two years. See Note 15 to the consolidated financial statements for the actual amount.
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Deposit Insurance Assessments
The deposits of the Bank are insured up to the regulatory limits set by the FDIC. The FDIC maintains the Deposit Insurance fund (DIF) by assessing depository institutions an insurance premium (assessment). The amount assessed to each institution is based on statutory factors that take into account the degree of risk the institution poses to the DIF. The primary purposes of the DIF are to (1) insure the deposits and protect the depositors of insured depository institutions; and (2) resolve failed banks. The DIF is primarily funded through quarterly assessments on insured depository institutions, but it also earns interest income on its securities. Decreases in the DIF result from loss provisions associated with the resolution of failed banks and FDIC operating expenses.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) revised the statutory authorities governing the FDICs management of the DIF. A key requirement from the Dodd-Frank Act resulted in the FDICs adoption of new rules in February 2011 regarding Assessments, Dividends, Assessment Base, and Large Bank Pricing. The new rules implemented the following changes: (1) redefined the definition of an institutions deposit insurance assessment base from one based on domestic deposits to one based on assets now defined as average consolidated total assets minus average tangible equity; (2) changed the assessment rate adjustments to better account for risk based on an institutions funding sources; (3) revised the deposit insurance assessment rate schedule in light of the new assessment base and assessment rate adjustments; (4) implemented Dodd-Frank Act dividend provisions; (5) revised the large insured depository institution assessment system to better differentiate for risk and to take into account losses the FDIC may incur from large institution failures; and (6) provided technical and other changes to the FDICs assessment rules. Though deposit insurance assessments maintain a risk-based approach, the FDIC imposed a more extensive risk-based assessment system on large insured depository institutions with at least $10 billion in total assets since they are more complex in nature and could pose greater risk. The rules became effective April 1, 2011 implementing the revised assessment rate schedule for the quarter beginning April 1, 2011. The revised assessment rate schedule was used to calculate the June 30, 2011 assessments which were due September 30, 2011 and subsequent quarterly assessments thereafter.
Due to the changes to the assessment base and assessment rates, as well as the DIF restoration time frame, the impact on the Companys future deposit insurance assessments has been and should continue to be favorable.
The Dodd-Frank Act permanently raised the standard maximum deposit insurance coverage amount to $250,000.
The FDIC deposit insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.
Depositor Preference Statute
In the liquidation or other resolution of an institution by any receiver, U.S. federal legislation provides that deposits and certain claims for administrative expenses and employee compensation against the insured depository institution would be afforded a priority over general unsecured claims against that institution, including federal funds and letters of credit.
Government Monetary Policy
The earnings of the Company are affected primarily by general economic conditions and to a lesser extent by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve. Its policies influence, to some degree, the volume of bank loans and deposits, and interest rates charged and paid thereon, and thus have an effect on the earnings of the Companys subsidiary Bank.
Additional Regulation
Implementation of the Dodd-Frank Act provisions has resulted in new rulemaking by the federal regulatory agencies and new rules yet to be issued. Implementing the new and expanded regulations involve extreme diligence to ensure compliance with the complexities of the rules, as well as extensive new disclosure and reporting requirements.
The Dodd-Frank Act created an independent regulatory body, the Bureau of Consumer Financial Protection (Bureau), with authority and responsibility to set rules and regulations for most consumer protection laws applicable to all banks large and small - adds another regulator to scrutinize and police financial activities. Transfer to the Bureau of all consumer financial protection functions for designated laws by the other federal agencies was completed on July 21, 2011. The Bureau has responsibility for mortgage reform and enforcement, as well as broad new powers over consumer financial activities which could impact consumer financial products and services and how they are provided.
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Significant mortgage rules mandated by the Dodd-Frank Act provisions have been enacted in response to the breakdown in the mortgage lending markets and to provide for consumer protections. Final rules were issued by the Bureau or jointly with other regulatory agencies to implement requirements under the Dodd-Frank Act regarding mortgage-related matters such as ability-to-repay, qualified mortgage standards, mortgage servicing, mortgage loan originator compensation, escrow requirements for higher-priced mortgage loans, and providing appraisals. Most of these rules were effective January 2014 and have been successfully implemented. New mortgage rules were intended to address problems consumers face in the three major steps in buying a home shopping for a mortgage, closing on a mortgage, and paying off a mortgage.
Final rules on integrated mortgage disclosures under the Real Estate Settlement Act (RESPA) and Truth in Lending Act (TILA), issued in November 2013 to originally be effective on August 1, 2015, were subsequently postponed until October 3, 2015. Amendments to the integrated mortgage disclosure rules finalized on January 20, 2015, to be effective on August 1, 2015 were also subsequently postponed until October 3, 2015. The TILA-RESPA Integrated Disclosure rule commonly referred to as TRID combined required disclosures into a two single forms: 1) The Loan Estimate which is provided shortly after a mortgage loan application and 2) The Closing Disclosure which is provided prior to loan consummation. In addition, a mandated appraisal notice under the Equal Credit Opportunity Act and the servicing application disclosure under RESPA were also combined into the new integrated disclosures. Significant systems changes, as well as process and procedural adjustments were necessary to appropriately implement the new requirements. Implementation to successfully achieve TRID compliance involved extensive collaboration with the Mortgage Loan Origination software vendor, as well as outreach and coordination efforts with real estate agents, attorneys, and closing agents to cultivate preparedness for the new integrated mortgage loan disclosure forms. Overall mortgage loan volume was up through the end of the year. New TRID requirements, especially the timing requirements that had to be met, did slow the loan origination process slightly but did not result in excessive delays of scheduled loan closings. Due to the complexities of the TRID rule, the industry questions that remain to be answered with absolute clarity, and the status or existence of a safe harbor or protection from liability during the initial live implementation period, remaining attentive to these matters will ensure practices and procedures continue to be fully compliant.
On June 22, 2015, five federal agencies announced the approval of a joint final rule implementing provisions of the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA) and the Biggert-Waters Flood Insurance Reform Act of 2012 (the Biggert-Waters Act). The final rule, mostly effective on October 1, 2015, was issued by the Board of Governors of the Federal Reserve System, the Farm Credit Administration, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency. This rule amended regulations which apply to loans secured by properties located in special flood hazard areas and included the following:
| Implementation of a statutory exemption from the requirement to purchase flood insurance for a detached structure that is part of a residential property and does not serve as a residence. Under the HFIAA lenders may require flood insurance on these detached structures to protect collateral securing the mortgage. The Bank is presently evaluating all instances on a case-by-case basis as they are identified and determining the appropriate action to be taken. |
| Effective January 1, 2016 in accordance with the HFIAA, for loans made, increased, extended, or renewed to be secured by residential real estate or mobile homes, regulated lending institutions must; |
¡ | Require an escrow for flood insurance premiums and fees, unless the loan qualifies for a statutory exception; |
¡ | Provide borrowers with residential loans outstanding as of January 1, 2016 the option to escrow flood insurance premiums and fees. |
¡ | Provide new and revised samples notice forms and clauses regarding the escrow requirements and the option to escrow. |
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| The Biggert-Waters Act provisions on force placement of flood insurance coverage: |
¡ | Beginning on the date a borrowers flood coverage lapses or becomes insufficient, a regulated lending institutions has the authority to charge a borrower for the cost of force-placed insurance coverage. |
¡ | Circumstances under which a lender must terminate force-placed flood insurance coverage and refund payments to the borrower are also stipulated. |
Changes to existing processes and procedures along with the implementation of new forms and notifications resulted from this new rule. Fines and penalties for compliance with flood insurance requirements promote a continued focused attention on adherence to the new flood rule and existing requirements.
The Department of Defense (DOD) announced new rules amending its regulation that implements the Military Lending Act (MLA) on July 21, 2015. The MLA was enacted as part of the John Warner National Defense Act of 2007. These new rules significantly expanded the scope of the Act to cover all consumer credit except residential mortgages and purchase money loans. With an effective date of October 1, 2015, compliance is required by October 3, 2016. For credit cards, the required compliance date is October 3, 2017. Coverage applies to consumer credit defined as credit offered or extended for personal, family, or household purpose and that is subject to a finance charge or payable by written agreement in more than four installments. A covered borrower is a consumer who at the time of becoming obligated on a consumer credit transaction or establishing an account for consumer credit, is a covered member or dependent (including a spouse) of a covered member. A covered member is a member of the armed forces serving on active duty or active guard or reserve duty. More specifically, the final rule:
| Makes financial institutions responsible for determining an applicants military status through inquiry using the database maintained by the DOD or a consumer reporting agency that provides such information. |
| Limits what may be charged in fees and interest on covered consumer loans by imposing a 36% military annual percentage rate (MAPR) cap. The 36% cap is an all-in annual percentage rate (APR) that includes interest and fees associated with the loan such as application fee and annual fees, as well as fees and premiums for add-on products such as credit insurance, debt cancellation, and debt suspension often sold in connection with a consumer credit transaction. Providing a loan to a covered borrower that exceeds the 36% MAPR is prohibited. |
| Requires additional disclosures which must be provided to military personnel, their spouses, and dependents when they obtain a loan. |
| Prohibits certain terms or provisions that require arbitration, involve assessment of a prepayment penalty, or require service members or their dependents to waive any rights under the Service members Civil Relief Act or any other federal or state law. |
Any covered loans made without providing proper disclosures or in violation of the MLA is void. Creditors who knowingly or willfully violate the rules could be subject to a fine, imprisonment up to one year or both. Full implementation of these new rules involve understanding its impact on the covered consumer credit products offered, collaboration with Loan Origination System vendors for assistance with calculations and required disclosures, and an efficient and effective process for identifying covered borrowers. Though the rule is designed to benefit service members, it involves a series of price controls which in essence may restrict the availability of some forms of conventional consumer credit for service members and their dependents.
Amendments to the final rule regarding Small Creditors and Rural or underserved areas under the TILA were published on October 2, 2015. This expanded the definition of small creditor to a limit of 2,000 first-lien mortgage loans during the preceding calendar year and excluded loans held in portfolio by the lender. In addition, the definition of rural areas was expanded from counties that are considered rural to include smaller census blocks within a county that are not in urban areas. An automated tool for assessing whether a property is located in a rural or underserved area was made available by the Bureau. The Bank meets the criteria to qualify as a small creditor based on the number of loans made during the prior calendar year and due to its asset size of less than $2.052 billion (the asset size threshold subject to an annual CPI adjustment as of December 31, 2015) Due to an ambiguity created between the final rule amendments and the Helping Expand Lending Practices in Rural Communities Act of 2015 enacted on December 4, 2015, further clarification is needed to clearly define what constitutes whether a
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lender is operating in a rural or underserved area. The Bank continues to seek Qualified Mortgage (QM) status for mortgage loans made as they provide certain presumptions of compliance under the Ability to Repay Regulation adopted under the Dodd-Frank Act. In satisfying QM requirements, any mortgage lender regardless of their size can make loans which are entitled to the QM presumption of compliance.
Revised Regulation C rules which implement the Home Mortgage Disclosure Act (HMDA) were published by the Bureau. The effective date for these revisions starts on January 1, 2018 for reportable loan applications. The Dodd Frank Act provisions added new data points for HMDA and authorized the Bureau to require additional information. The types of transactions reportable have expanded to include most consumer purpose transactions that are dwelling-secured loans or open-end lines of credit. Reportable date fields were significantly expanded to 52 fields which included applicant or borrower age, credit score, automated underwriting system information, property value, application channel, points and fees, borrower-paid origination charges, discount points, lender credits, loan term, prepayment penalty, interest rate, loan originator identifier, as well as other data fields. Ethnicity categories were expanded to include certain subcategories. A requirement was added to report how information about an applicants or borrowers ethnicity, race, and sex was collected by the institution. Year-end submission of the data to be reported will be completed using a yet-to-be-developed web-based tool. Steps to implement the new requirements will involve a thorough review of the final rule and requirements. A thorough assessment will be conducted regarding the impact on the data collection processes and procedures within each affected business line along with data collection provided within the loan origination systems utilized to generate loan applications and loan closing documentation.
Section 5 of the Federal Trade Commission Act provides banking regulatory agencies with authority to take supervisory or enforcement actions on banks with regard to Unfair or Deceptive Acts or Practices (UDAP). UDAP standards developed years ago by the Federal Trade Commission address unacceptable practices that may not specifically be addressed elsewhere in banking or consumer finance law. Banking regulatory agencies have increasingly used this authority over the last few years to address acts or practices that are deemed harmful, deceptive, or misleading to consumers. The Dodd-Frank Act gave the Bureau similar authority to take action in connection with unfair and deceptive acts or practices, as well as abusive acts or practices by entities subject to Bureaus supervisory or enforcement authority.
The Bank is also subject to federal regulation as to such matters as required reserves, limitation as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuance or retirement of their own securities, limitations upon the payment of dividends and other aspects of banking operations. In addition, the activities and operations of the Bank are subject to a number of additional detailed, complex and sometimes overlapping laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the federal Equal Credit Opportunity Act and Regulation B, the federal Home Mortgage Disclosure Act and Regulation C, the federal Electronic Funds Transfer Act and Regulation E, the federal Fair Credit Reporting Act and Regulation V, the federal Real Estate Settlement Procedures Act (RESPA) and Regulation X, the federal Truth in Lending Act and Regulation Z, the federal Truth in Savings Act and Regulation DD, the Bank Secrecy Act, the federal Community Reinvestment Act, anti-discrimination laws and legislation, and antitrust laws.
Future Legislation
Changes to the laws and regulations, both at the federal and state levels, can affect the operating environment of the Company and its subsidiary in substantial and unpredictable ways. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon the financial condition or results of operations of the Company or its subsidiary. Various provisions and regulations authorized or required by the Dodd-Frank Act have not yet been proposed or implemented by federal regulators. Uncertainty also exists with respect to the Dodd-Frank Act regulations authorized or required that have not yet been proposed or finalized.
Available Information
The Company maintains an Internet web site at the following internet address: www.fm-bank.com. The Company files reports with the Securities and Exchange Commission (SEC). Because the Company makes its filing with the SEC
12
electronically, you may access such reports at the SECs website (www.sec.gov). The Company makes available, free of charge through its internet address, copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as reasonable practicable after such materials have been filed with or furnished to the SEC. Copies of these documents may also be obtained, either in electronic or paper form, by contacting Barbara J. Britenriker, Chief Financial Officer of the Company at (419) 446-2501.
Significant Competition from an Array of Financial Service Providers
Our ability to achieve strong financial performance and a satisfactory return on investment to shareholders will depend in part on our ability to expand our available financial services. In addition to the challenge of attracting and retaining customers for traditional banking services, our competitors now include securities dealers, brokers, mortgage bankers, investment advisors and finance and insurance companies who seek to offer one-stop financial services to their customers that may include services that banks have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial services providers. If we fail to adequately address each of the competitive pressures in the banking industry, our financial condition and results of operations could be adversely affected.
Credit Risk
The risk of nonpayment of loans is inherent in commercial banking. Such nonpayment could have an adverse effect on the Companys earnings and our overall financial condition as well as the value of our common stock. Management attempts to reduce the Banks credit exposure by carefully monitoring the concentration of its loans within specific industries and through the loan approval process. However, there can be no assurance that such monitoring and procedures will totally mitigate the risks. Credit losses can cause insolvency and failure of a financial institution and, in such event, its shareholders could lose their entire investment. For more information on the exposure of the Company and the Bank to credit risk, see the section under Part II, Item 7 of this Form 10-K captioned Loan Portfolio.
Our loan portfolio has a large concentration of real estate loans
Real estate loans, which constitute a large portion of our loan portfolio, include home equity, commercial, construction and residential loans, and such loans are concentrated in the Banks primary markets in northwest Ohio and Northeast Indiana. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in our market could increase the credit risk associated with our loan portfolio. Also, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower could negatively impact the future cash flow and market values of the affected properties.
If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.
Our real estate loans also include construction loans, including land acquisition and development. Construction, land acquisition and development lending involve additional risks because funds are advanced based upon estimates of costs and the estimated value of the completed project. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, commercial construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project.
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Commercial loans make up a significant portion of our loan portfolio
Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Repayment of our commercial loans is often dependent on the cash flows of the borrower, which may be unpredictable. Most often, this collateral is accounts receivable, inventory, machinery or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The other types of collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Payments on agricultural real estate loans are dependent on the profitable operation or management of the farm property securing the loan. The success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally) and the impact of government regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrowers ability to repay the loan may be impaired. The primary crops in our market areas are corn and soybeans. Accordingly, adverse circumstances affecting these crops could have an adverse effect on our agricultural real estate loan portfolio.
We also originate agricultural operating loans. As with agricultural real estate loans, the repayment of operating loans is dependent on the successful operation or management of the farm property. Likewise, agricultural operating loans involve a greater degree of risk than lending on residential properties, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment or assets such as livestock or crops. The primary livestock in our market areas is hogs. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.
Susceptibility to Changes in Regulation
Any changes to state and federal banking laws and regulations may negatively impact our ability to expand services and to increase the value of our business. We are subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of our operations. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. In addition, the Companys earnings are affected by the monetary policies of the Board of Governors of the Federal Reserve. These policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits. The Gramm-Leach-Bliley Act regarding financial modernization that became effective in November, 1999 removed many of the barriers to the integration of the banking, securities and insurance industries and is likely to increase the competitive pressures upon the Bank. We cannot predict what effect such Act and any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, but such changes could be materially adverse to our financial performance. For more information on this subject, see the section under Part I, Item 1 of this Form 10-K captioned Supervision and Regulation.
Interest Rate Risk
Changes in interest rates affect our operating performance and financial condition in diverse ways. Our profitability depends in substantial part on our net interest spread, which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally. Historically, net interest spreads for other financial institutions have widened and narrowed in response to these and other factors, which are often collectively referred to as interest rate risk. Over the last few years, the Bank, along with most other financial institutions, has experienced a margin squeeze as drastic interest rate decreases have made it difficult to maintain a more favorable net interest spread. During 2014, the Banks margin and spread began to improve slightly even though the rate environment remained low
14
and flat. Overall, 2015 ended with a slight tightening of the margin as compared to 2014 though remained above 2013s levels. We have experienced the first increase in rates by the Federal Reserve in December. Maturities of higher rate deposits aided the decrease in cost of funds. This widening of the margin directly correlated to the improvement of the Banks loan to asset ratio.
The Bank manages interest rate risk within an overall asset/liability framework. The principal objectives of asset/liability management are to manage sensitivity of net interest spreads and net interest income to potential changes in interest rates. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. In the event that our asset/liabilities management strategies are unsuccessful, our profitability may be adversely affected. For more information regarding the Companys exposure to interest rate risk, see Part II, Item 7A of this Form 10-K.
Attraction and Retention of Key Personnel
Our success depends upon the continued service of our senior management team and upon our ability to attract and retain qualified financial services personnel. Competition for qualified employees is intense. In our experience, it can take a significant period of time to identify and hire personnel with the combination of skills and attributes required in carrying out our strategy. If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our business, financial condition, results of operations and cash flows could be adversely affected.
A key component of employee retention is providing a fair compensation base combined with the opportunity for additional compensation for above average performance. In this regard, the Company and the Bank use two incentive programs. The Company uses a stock award program to recognize and incent officers of the Bank. Under the long-term incentive compensation plan, restricted stock awards may be granted to officers. The amount of shares to be granted each year is determined by the Board Compensation Committee and may vary each year in its amount of shares and the number of recipients. The Compensation Committee determines the number of shares to be awarded overall and to the Chief Executive Officer (CEO) specifically. The CEO then makes recommendations to the committee as to the recipients of the remaining shares. The full Board of Directors approves the action of the Committee. Since the plans inception in 2005, all granted stock awards have utilized a three year cliff vesting feature. This is viewed as a retention aid as the awards may be forfeited should an officer leave employment during the vesting period.
A second incentive program of the Bank is based on cash compensation of which almost all employees participate (excluding commission based employees and other employees paid for specific higher paid positions, such as peak time.) A discussion of executive officer pay is incorporated within the proxy and as such, this discussion will pertain to all other employees. Non-officer employees are paid a cash incentive based on the projected overall performance of the Bank in terms of Return of Average Assets (ROA). The Compensation Committee determines the target performance levels on which the percentage of pay will be based. The Committee takes into account the five and ten year trend of ROA along with budget forecasted for the next year and the Banks past year performance. The Committee also considers the predicted banking environment under which the Bank will be operating with the formation of the Captive, 2015s ROA goal was exclusive of the effect of the additional insurance expense at the Bank level. Non-officers receive incentive pay in December of the same year based on the year-to-date base compensation through the last pay received in November.
Officers, other than executive, receive incentive pay based on additional criterion. The officers are rewarded based on overall ROA of the Bank along with individual pre-established goals. Officers, therefore, have incentive pay at risk for individual performance. The individualized goals are recommended by each officers supervisor and are approved by an incentive committee of the Bank. The goals are designed to improve the performance of the Bank while also limiting the risk of a short-term performance focus. For example, a lending officer may be given two goals of which one is to grow loans within specific targets and another is tied to a specific level of past dues and charge-offs. The second goal limits the ability to be rewarded for growth at all costs along with the specific target levels within the growth goal itself. Officers in a support department may be given goals which create efficiencies, ensure compliance with procedures, or generate new fee or product opportunities. On average, three to four goals were given to each officer in 2015. Officers are paid cash incentives based on the year-end ROA of the Bank and receive it within the first quarter of the following year. Should the ROA be forecasted to be positive but below the base target set by the Board, the officers are paid an incentive under the same basis and timing as non-officers disclosed above.
The percentages of base pay on which the incentive is calculated graduates higher as does the responsibility level of the employee and their ability to impact the financial performance of the Bank. These percentages are recommended by management to the Compensation Committee and Board for approval. The cash incentive plan along with its targets and goals are subject to modification at the Compensation Committee and Boards discretion throughout each year.
15
Dividend Payout Restrictions
We currently pay a quarterly dividend on our common shares. However, there is no assurance that we will be able to pay dividends in the future. Dividends are subject to determination and declaration by our Board of Directors, which takes into account many factors. The declaration of dividends by us on our common stock is subject to the discretion of our Board and to applicable state and federal regulatory limitations. The Company may receive dividends from the Bank which is subject to restrictions and limitations in the amount and timing of the dividends it may pay to the Company. The Bank has been declaring additional dividends each quarter to provide this liquidity to the Company. In future years, we anticipate the Captive will also upstream dividends to the Company once reserve levels are adequately provided for.
Anti-Takeover Provisions
Provisions of our Articles of Incorporation and Ohio law could have the effect of discouraging takeover attempts which certain stockholders might deem to be in their interest. These anti-takeover provisions may make us a less attractive target for a takeover bid or merger, potentially depriving shareholders of an opportunity to sell their shares of common stock at a premium over prevailing market prices as a result of a takeover bid or merger.
Technological Change
Our industry is susceptible to significant technological changes in the future as there continue to be a high level of new technology driven products and services introduced. Technological advancement aids the Company in providing customer service and increases efficiency. Our national competitors have more resources to invest in technological changes and associated required resources. As a result they may be able to offer products and services that are more technologically advanced and that may put us at a competitive disadvantage. Our future depends on our ability to analyze technological changes to determine the best course of action for our business, customers and shareholders.
Operational Risks
We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.
In addition, our operations are dependent on our ability to process financial transactions in a secure manner. Failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers could disrupt our businesses or the businesses of our customers, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses. We must ensure that information is properly protected from a variety of threats such as cyber-attacks, error, fraud, sabotage, terrorism, industrial espionage, privacy violation, service interruption, and natural disaster. The Company, with the assistance of third-party service providers, intends to continue to implement security technology and establish procedures to maintain network security, but there is no assurance that these measures will be successful. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any activity that jeopardizes our network and the security of the information stored on our network may result in significant cost to the Company and have a significant negative effect on our reputation.
Limited Trading Market
The Company has its shares of stock listed on the OTC Markets Group trading platform. Our stock is traded on the OTC-QX platform. The Companys trading symbol is FMAO.
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ITEM 1b. UNRESOLVED STAFF COMMENTS
None.
Our principal office is located in Archbold, Ohio.
The Bank operates from the facilities at 307 North Defiance Street. In addition, the Bank owns the property from 200 to 208 Ditto Street, Archbold, Ohio, which it uses for Bank parking and a community mini-park area. The Bank owns real estate at two locations, 207 Ditto Street and 209 Ditto Street in Archbold, Ohio upon which the bank built a commercial building to be used for storage, and a parking lot for company vehicles and employee parking. The Bank also owns real estate across from the main facilities to provide for parking.
The Bank occupies an Operations Center at 620 S. Clydes Way in Archbold, Ohio to accommodate our growth over the years. The bank owns a parking lot in downtown Montpelier which is provided for community use.
The Bank owns all of its office locations, with the exception of Angola, Indiana. The Angola office location is leased.
Current locations of retail banking services are:
Office |
Location | |
Archbold, Ohio |
1313 S Defiance Street | |
Wauseon, Ohio |
1130 N Shoop Avenue 119 N Fulton Street | |
Stryker, Ohio |
300 S Defiance Street | |
West Unity, Ohio |
200 W Jackson Street | |
Bryan, Ohio |
929 E High Street 1000 S Main Street | |
Delta, Ohio |
101 Main Street | |
Montpelier, Ohio |
1150 E Main Street | |
Napoleon, Ohio |
2255 Scott Street | |
Swanton, Ohio |
7 Turtle Creek Circle | |
Defiance, Ohio |
1175 Hotel Drive | |
Perrysburg, Ohio |
7001 Lighthouse Way | |
Butler, Indiana |
200 S Broadway | |
Auburn, Indiana |
403 Erie Pass | |
Angola, Indiana |
2310 N Wayne Street | |
Hicksville, Ohio |
100 N Main Street | |
Waterville, Ohio |
8720 Waterville-Swanton Road | |
Custar, Ohio |
22973 Defiance Pike | |
Sylvania, Ohio |
5830 Monroe Street |
All but one of the above locations has drive-up service facilities and an ATM. The Captive operates from leased office space at 101 Convention Center Dr., Suite 850, Las Vegas, NV 89109.
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There are no material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Company or its subsidiaries, to which we are a party or of which any of our properties are the subject.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company has its shares of stock listed on the OTC Markets Group trading platform. Our stock is traded on the OTC-QX platform. OTC Markets Group developed QX platform specifically for community banks. The separate market is intended to help community banks improve liquidity by increasing the trading volume of their shares.
There are market makers that set a price for our stock; however, private sales continue to occur. The high and low sale prices were from sales of which we have been made aware by researching daily on Bloomberg.com. The high and low sale prices known to our management are as follows:
Stock Prices 2015 |
||||||||
Quarter |
Low | High | ||||||
1st |
$ | 25.35 | $ | 27.25 | ||||
2nd |
25.56 | 27.80 | ||||||
3rd |
25.60 | 28.25 | ||||||
4th |
25.50 | 27.00 | ||||||
Stock Prices 2014 |
||||||||
Quarter |
Low | High | ||||||
1st |
$ | 22.10 | $ | 25.39 | ||||
2nd |
23.20 | 26.00 | ||||||
3rd |
24.50 | 26.25 | ||||||
4th |
25.00 | 27.00 |
The Company utilizes Computershare as its transfer agent.
As of January 29, 2016 there were 1,876 record holders of our common stock of which 27.84% of the outstanding shares are being held in brokerage accounts or street name and only considered as one record holder.
On the following page is a line-graph presentation comparing the cumulative total shareholder returns for the Corporation, an index for NASDAQ Stock Market (U.S. Companies) comprised of all domestic common shares traded on the NASDAQ National Market System and the NASDAQ Bank Index for the five-year period ended December 31, 2015. The chart compares the value of $100 invested in the Corporation and each of the indices and assumes investment on December 31, 2010 with all dividends reinvested.
The Board of Directors recognizes that the market price of stock is influenced by many factors, only one of which is performance. The stock price performance shown on the graph is not necessarily indicative of future performance.
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2010 | 2011 | 2012 | 2013 | 2014 | 2015 | |||||||||||||||||||
FMAO |
100.00 | 101.78 | 119.67 | 135.61 | 166.28 | 172.00 | ||||||||||||||||||
NASDAQ - COMPOSITE |
100.00 | 99.23 | 116.61 | 162.01 | 185.18 | 197.82 | ||||||||||||||||||
NASDAQ-BANK INDEX |
100.00 | 89.54 | 105.78 | 147.67 | 154.44 | 167.14 |
Dividends are declared and paid quarterly. Per share dividends declared for the years ended 2015 and 2014 are as follows:
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | Total | ||||||
2015 |
$0.21 | $0.22 | $0.22 | $0.22 | $0.87 | |||||
2014 |
$0.21 | $0.21 | $0.21 | $0.21 | $0.84 |
The ability of the Company to pay dividends is impacted by the dividend that the Company receives from the Bank. The Bank may pay as dividends to the Company its retained earnings during the current year and its prior two years. Currently, such limitation on the payment of dividends from the Bank to the Company does not materially restrict the Companys ability to pay dividends to its shareholders.
Dividends declared during 2015 were $0.87 per share totaling $3.99 million, 3.58% higher than 2014 declared dividends of $0.84 per share. During 2015, the Company repurchased 30,685 shares and awarded 16,000 shares to 67 employees and 100 shares were forfeited under its long term incentive plan. At yearend, 2015, the Company held 587,466 shares in Treasury stock and 38,995 in unearned stock awards.
Dividends declared during 2014 were $0.84 per share totaling $3.86 million, 3.71% higher than 2013 declared dividends of $0.81 per share. During 2014, the Company purchased 23,750 shares and awarded 13,250 restricted shares to 61 employees under its long term incentive plan. 780 shares were forfeited during 2014. At yearend 2014, the Company held 572,662 shares in Treasury stock and 33,390 in unearned stock awards.
The Company continues to have a strong capital base and to maintain regulatory capital ratios that are significantly above the defined regulatory capital ratios.
2015 | 2014 | |||
Primary Ratio |
14.18% | 12.29% | ||
Common Equity Tier 1 |
14.18% | N/A | ||
Tier I Leverage Ratio |
11.91% | 11.70% | ||
Risk Based Capital Tier I |
14.18% | 15.79% | ||
Total Risk Based Capital |
14.95% | 16.68% | ||
Stockholders Equity/Total Assets |
12.14% | 12.16% |
On January 15, 2016, the Company announced the authorization by its Board of Directors for the Companys repurchase, either on the open market, or in privately negotiated transactions, of up to 200,000 shares of its outstanding common stock commencing January 15, 2016 and ending December 31, 2016.
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ISSUER PURCHASES OF EQUITY SECURITIES
Period |
Total Number of Shares Purchased |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Programs |
Remaining Share Repurchase Authorization |
||||||||||||
10/1/2015 to 10/31/2015 |
| | | 181,134 | ||||||||||||
11/1/2015 to 11/30/2015 |
6,000 | 27 | 6,000 | 175,134 | ||||||||||||
12/1/2015 to 12/31/2015 |
5,819 | 27 | 5,819 | 169,315 | ||||||||||||
|
|
|
|
|
|
|
|
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Total |
11,819 | 27 | 11,819 | 169,315 | ||||||||||||
|
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|
|
|
|
|
(1) | The Company purchased shares in the market pursuant to stock repurchase program publicly announced on January 16, 2015. On that date, the Board of Directors authorized the repurchase of 200,000 common shares between January 16, 2015 and December 31, 2015. In total for 2015, 30,685 shares were repurchased. |
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ITEM 6. SELECTED FINANCIAL DATA
Reclassification
Certain amounts in the 2014 and 2013 consolidated financial statements have been reclassified to conform with the 2015 presentation.
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
(In Thousands, except share data) | ||||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||||
Summary of Income: |
||||||||||||||||||||
Interest income |
$ | 33,650 | $ | 33,453 | $ | 31,428 | $ | 33,273 | $ | 36,660 | ||||||||||
Interest expense |
3,587 | 3,716 | 4,604 | 6,250 | 8,156 | |||||||||||||||
|
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|
|
|
|
|
|
|
|
|||||||||||
Net Interest Income |
30,063 | 29,737 | 26,824 | 27,023 | 28,504 | |||||||||||||||
Provision for loan losses |
625 | 1,191 | 858 | 738 | 1,715 | |||||||||||||||
|
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|
|
|
|
|
|
|
|
|||||||||||
Net interest income after provision for loan loss |
29,438 | 28,546 | 25,966 | 26,285 | 26,789 | |||||||||||||||
Other income (expense), net |
(15,279 | ) | (15,029 | ) | (13,363 | ) | (12,593 | ) | (15,382 | ) | ||||||||||
Net income before income taxes |
14,159 | 13,517 | 12,603 | 13,692 | 11,407 | |||||||||||||||
Income taxes |
3,819 | 3,871 | 3,596 | 3,904 | 2,893 | |||||||||||||||
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|
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Net income |
$ | 10,340 | $ | 9,646 | $ | 9,007 | $ | 9,788 | $ | 8,514 | ||||||||||
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Per Share of Common Stock: |
||||||||||||||||||||
Earnings per common share outstanding * |
||||||||||||||||||||
Net income |
$ | 2.24 | $ | 2.08 | $ | 1.93 | $ | 2.08 | $ | 1.82 | ||||||||||
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|
|
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|
|
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|
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Dividends |
$ | 0.87 | $ | 0.84 | $ | 0.81 | $ | 0.78 | $ | 0.76 | ||||||||||
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|
|
|
|
|
|
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Weighted average number of shares outstanding, including participating securities |
4,617,058 | 4,628,178 | 4,676,547 | 4,695,876 | 4,689,021 | |||||||||||||||
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* | Based on weighted average number of shares outstanding |
(In Thousands) | ||||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||||
Total assets |
$ | 989,068 | $ | 941,213 | $ | 965,938 | $ | 946,660 | $ | 922,993 | ||||||||||
Loans, net |
679,821 | 616,021 | 570,919 | 496,178 | 501,124 | |||||||||||||||
Total Deposits |
771,339 | 762,560 | 776,464 | 763,252 | 739,382 | |||||||||||||||
Stockholders equity |
120,097 | 114,493 | 108,340 | 110,239 | 105,091 | |||||||||||||||
Key Ratios |
||||||||||||||||||||
Return on average equity |
8.80 | % | 8.72 | % | 8.28 | % | 9.08 | % | 8.56 | % | ||||||||||
Return on average assets |
1.08 | % | 1.02 | % | 0.96 | % | 1.05 | % | 0.93 | % | ||||||||||
Loans to deposits |
88.14 | % | 80.78 | % | 73.53 | % | 65.01 | % | 67.78 | % | ||||||||||
Capital to assets |
12.14 | % | 12.16 | % | 11.22 | % | 11.65 | % | 11.39 | % | ||||||||||
Dividend payout |
38.54 | % | 40.04 | % | 41.69 | % | 37.15 | % | 41.85 | % |
21
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates
The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, and the Company follows general practices within the financial services industry in which it operates. At times the application of these principles requires management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. These assumptions, estimates and judgments are based on information available as of the date of the financial statements. As this information changes, the financial statements could reflect different assumptions, estimates and judgments. Certain policies inherently have a greater reliance on assumptions, estimates and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Examples of critical assumptions, estimates and judgments are when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not required to be recorded at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event.
All significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the notes to the consolidated financial statements and in the management discussion and analysis of financial condition and results of operations, provide information on how significant assets and liabilities are valued and how those values are determined for the financial statements. Based on the valuation techniques used and the sensitivity of financial statement amounts to assumptions, estimates and judgments underlying those amounts, management has identified the determination of the Allowance for Loan and Lease Losses (ALLL) and the valuation of its Mortgage Servicing Rights (MSR) and Other Real Estate Owned (ORE) as the accounting areas that requires the most subjective or complex judgments, and as such could be the most subject to revision as new information becomes available.
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.
The ALLL represents managements estimate of credit losses inherent in the Banks loan portfolio at the report date. The estimate is a composite of a variety of factors including experience, collateral value, and the general economy. ALLL includes a specific portion, a formula driven portion, and a general nonspecific portion. The collection and ultimate recovery of the book value of the collateral, in most cases, is beyond our control.
The Company is also required to estimate the value of its MSR. The Company recognizes as separate assets rights to service fixed rate single-family mortgage loans that it has sold without recourse but services for others for a fee. Mortgage servicing assets are initially recorded at cost, based upon pricing multiples as determined by the purchaser, when the loans are sold. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Amortization is determined in proportion to and over the period of estimated net servicing income using the level yield method. For purposes of determining impairment, the mortgage servicing assets are stratified into like groups based on loan type, term, new versus seasoned and interest rate. The valuation is completed by an independent third party.
The expected and actual rates of mortgage loan prepayments are the most significant factors driving the potential for the impairment of the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.
The Companys mortgage servicing rights relating to loans serviced for others represent an asset of the Company. This asset is initially capitalized and included in other assets on the Companys consolidated balance sheet. The mortgage servicing rights are then amortized against noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying mortgage servicing rights. There are a number of factors, however, that can affect the ultimate value of the mortgage servicing rights to the Company, including the estimated prepayment speed of the loan and the discount rate used to present value the servicing right. For example, if the mortgage loan is prepaid, the Company will receive fewer servicing fees, meaning that the present value of the mortgage servicing rights is less than the carrying value of those rights on the Companys balance sheet. Therefore, in an attempt to reflect an accurate expected value to the Company of the mortgage servicing rights, the Company
22
receives a valuation of its mortgage servicing rights from an independent third party. The independent third partys valuation of the mortgage servicing rights is based on relevant characteristics of the Companys loan servicing portfolio, such as loan terms, interest rates and recent national prepayment experience, as well as current national market interest rate levels, market forecasts and other economic conditions. Management, with the advice from its third party valuation firm, review the assumptions related to prepayment speeds, discount rates, and capitalized mortgage servicing income on a quarterly basis. Changes are reflected in the following quarters analysis related to the mortgage servicing asset. In addition, based upon the independent third partys valuation of the Companys mortgage servicing rights, management then establishes a valuation allowance by each strata, if necessary, to quantify the likely impairment of the value of the mortgage servicing rights to the Company. The estimates of prepayment speeds and discount rates are inherently uncertain, and different estimates could have a material impact on the Companys net income and results of operations. The valuation allowance is evaluated and adjusted quarterly by management to reflect changes in the fair value of the underlying mortgage servicing rights based on market conditions. The accuracy of these estimates and assumptions by management and its third party can be directly tied back to the fact that management has not been required to record a valuation allowance through its income statement based upon the valuation of each stratum of serving rights.
For more information regarding the estimates and calculations used to establish the ALLL and the value of Mortgage Servicing Rights, please see Note 1 to the consolidated financial statements provided herewith.
2015 in Review
The Company experienced record earnings for 2015, with net income over a milestone of $10 million. Profitability improved due to the increased loan balances, new product offerings and continued strong asset quality. Net loans grew by $63.8 million with asset size increasing by a smaller $47.9 million. Loans were funded by higher deposit levels, sales and maturities of investment securities and Federal Home Loan Bank borrowings.
The largest contributor to 2014s improved profitability was net interest income. For 2015, improvement in net interest income was just one factor of many. Lower loan provision and increased noninterest income were also major factors. 2015s bottom line was $694 thousand or 7.2% over 2014s. 2013 was bolstered by gain on sale of loans and securities which were a smaller part of 2014s and 2015s overall profitability.
The performance of our newest Sylvania office, which opened during the second half of 2014, exceeded our expectations and contributed profitably with its first year of operation. The Company continues to focus on expansion and our next office in Indiana is under construction with completion scheduled for end of first quarter 2016. Our location is situated within Huntertown but with a Fort Wayne address. We expect the office to be a slight drag on earnings during 2016 as a result of start-up costs, with great potential for later years.
A deposit strategy to revamp the Banks deposit mix was begun in the later part of 2014. The strategy included offering a new product line to checking and discontinuing some of the older products. An emphasis was on realigning our products to provide value to our depositors while building revenue or decreasing costs to the Bank. Secure checking and FM eXpress were two of the revamped or new offerings. This contributed to the almost $600 thousand improvement in customer service fees and other service charges and fees in noninterest income. The focus remains on growing core deposits and offering additional services. The success of this strategy is evidenced by the growth in core deposits along with increased debit card activity, on-line statement usage and lower cost of funds.
Short-term rates increased slightly in December of 2015. The slope of the yield curve for most of 2015, enabled the Company to continue to sell investment securities with shorter term maturities and recognize a gain without compromising the yield. In prior years, the proceeds were mainly reinvested in the security portfolio while 2014s and 2015s proceeds were used to fund loan growth. For 2015, the recognized gain was $451 thousand, which was lower than 2014s $494 thousand and 2013s $775 thousand. The Bank was able to continue to capitalize on the steepness of the yield curve. The market value of the security portfolio has decreased as evidenced by the comprehensive income reported on the income statement. The Company will continue to look for opportunities to utilize the investment portfolio to fund loan growth.
Throughout 2014 and 2015, the Company has done an exceptional job of recognizing opportunities to provide services and products that the low rate environment made possible. A commitment to improve asset quality over the years also benefited the Company during the period of 2012 through 2015. These opportunities are further discussed in the Material Changes in Results of Operations. The Company remains strong, stable and well capitalized and has the
23
capacity to continue to cover the increased costs of doing business in a tough economy while seeking good loans to improve profitability. The Company continues to look for new opportunities to generate and protect revenue while providing additional channels through which to serve our customers and maintain our high level of customer satisfaction.
Material Changes in Results of Operations
Net Interest Income
The discussion now centers on the individual line items of the consolidated statement of income and their effect on net income. This section will focus on the most traditional source of revenue contributing to the profitability of the Company, net interest income.
Net interest income is the difference between interest income on interest earning assets, such as loans and securities, and interest expense on liabilities used to fund those assets, such as interest bearing deposits and other borrowings. Net interest income is affected by changes in both interest rates and the amount and composition of earning assets and liabilities. The change in net interest income is most often measured as a result of two statistics interest spread and net interest margin. The difference between the yields on earning assets and the rates paid for interest bearing liabilities supporting those funds represents the interest spread. Because noninterest bearing sources of funds such as demand deposits and stockholders equity also support earning assets, the net interest margin exceeds the interest spread.
Net interest income showed an increase of $326 thousand in 2015 as compared to 2014 and an increase of $3.2 million when compared to 2013. Interest and fee income from loans were responsible for the improvement. Given that securities were sold to fund the loan growth, interest income from that balance sheet component has declined each of the last two years. Total interest income was $197 thousand higher for 2015 than 2014 and 2014 was $2.0 million higher than 2013.
A trend of declining interest expense also positively impacted net interest income in terms of dollars. Two strategies employed during 2014 and 2015 were responsible. One was to allow expensive time deposit funds to run off and secondly to offer new non-interest bearing deposit products. The new secure checking product also caused some movement of existing funds out of interest bearing products to this new non-interest bearing account. Interest on deposits decreased $189 thousand in 2015 as compared to 2014 which followed a $735 thousand decrease for 2014 as compared to 2013. For 2015, total interest expense (which includes federal funds purchased, securities sold under agreement to repurchase, and borrowed funds) totaled $3.6 million which was down $129 thousand from 2014s $3.7 million. Total interest expense for 2014 was down $888 thousand from 2013s $4.6 million.
The success of 2015 and 2014 in improving net interest income confirmed that managements long term strategy of repositioning the balance sheet was the correct approach. Funding loan growth with internal funds, whether from the liquidation of investment securities or core deposits, was a beneficial move.
Overall, we began to see an increase in the net interest margin and spread starting the fourth quarter of 2013 and the expansion continued throughout 2014 and lessened in 2015. The net interest margin decreased by 14 basis points during 2015 as compared to 2014 with the yield on interest earning assets the main factor. Loan volume was behind the improvement in interest income as the yield on the overall loan portfolio decreased 15 basis points during 2015. 2014 had already decreased by 10 basis points as compared to 2013. Decrease in loan yield was caused by a change in portfolio mix and by the lower repricing of loans. The only category of asset yield to increase was the short term federal funds sold and interest bearing deposits which was aided by the Federal Reserve increase in rates of 25 basis points in December 2015. Asset yield decreased 17 basis points in 2015 as compared to 2014 and was preceded by an increase of 39 basis points.
Cost of funds were nearing a half of one percent and ended at 0.54% for the average during 2015. This was down 1 basis point from 2014 and 2014 had been down 10 basis points from 2013. As mentioned previously, the movement of some of the interest bearing checking accounts greatly helped to decrease interest expense in terms of dollars; however, it also removed some of the lowest cost of funds out of the cost percentages. Therefore, the correlation to improvement in margin and spread is not easily visible.
24
The Company will always prefer to see improvement in real dollars over percentages. The strategy for increasing core deposits remains for 2016 for all the dollar reasons behind it to decrease interest expense and to continue to establish the opportunity for fee dollars from services provided.
Total assets of the Company increased overall as did the earning assets in both average and actual during 2015. This matched the movement in interest dollars, just not in yield. 2014 experienced just the opposite: a decrease in asset size and an improvement in yield. The earnings were over $2 million higher and the yield 39 basis points higher for 2014 as compared to 2013. The largest increase in balances and interest income was in the loan portfolio. One similarity between 2015 and 2014 was that loan volume was the driver to income improvement not rate. For 2015, the growth in loan volume yielded $2.2 million in interest income versus a decrease of $1.0 million due to rate. For 2014, the growth in the balances earned an amount higher at $3.7 million, than the $575 thousand given up due to lower yields on the portfolio as compared to 2013. The interest earning line item made up of investment securities had lower earnings in 2015 and 2014 than in 2013. Lower average balances, with the exception of tax-exempt investment securities, were the cause as the balances decreased to fund loan growth. The improvement in interest earnings from loan growth far outweighed the decreased earnings in the remaining earning assets for both 2015 and 2014.
Before switching to the interest expense discussion, a quick review of 2013s interest income will be summarized. 2014 was a reversal to the trends of previous years with its significant loan growth and higher interest earnings. During 2013 the Company experienced compression on the yield of earning assets.
During 2013, earning assets increased during the year in actual and average balance. The interest collected on the earning assets decreased; with the yield decreasing as compared to 2012 in most portfolios. The largest decrease in yield occurred in the loans. 2013s loan growth occurred mainly in commercial real estate which pushed lower yields along with variable repricing continuing to price down. Investment securities had lower yields due to the large amount of calls on government sponsored agencies and the lower yield on new purchases. The portfolio decreased $3.1 million in average during 2013 as compared to 2012. It was not unusual for a called security to be replaced with a new security with a yield lower by 50 basis points or more. Overall, this portfolios yield was 7 basis points lower in 2013 than in 2012.
Loans, which have the highest earning asset yield, increased on average by $14.4 million from 2012 to 2013. The overall change in yield in the loan portfolio for 2013 and 2012 was due mainly to the change in rate. Given that the loan portfolio represented only 57.5% of the earning assets in 2013 as compared to 56% in 2012, it stands to reason that the overall asset yield decreased in every year since 2010 until 2014. The overall yield on earning assets decreased 24 basis points as compared to 2012. The higher ratio of loans to earning assets of 1.5% corresponded to a smaller decrease in the overall asset yield of 26 basis points between 2013 and 2012. This emphasizes how important and how significant an impact an increase in loan balances had on the Banks profitability
Net interest spread is the difference between what the Company earns on its assets and what it pays on its liabilities. It is generally from this spread that the Company must fund its operations and generate profit. When the asset yield decreases so must funding costs in order to maintain profitability. It becomes increasingly challenging as the asset yield gets closer to the prime lending rate, or the break-even point, of operations.
With respect to interest expense, a decrease in the cost is apparent for 2015 as compared to both 2014 and 2013. Fortunately, for 2014, both the interest factors of the net interest margin ratio improved to raise the margin by 48 basis points over 2013. Unfortunately, in 2015 and 2013, as compared to each preceding year, the asset yield decreased more than funding costs. As a result, both the net interest margin and spread decreased for both those periods as of 2015 and 2013.
The impact of the change in the portfolio mix was a factor in the liabilities as it was in the assets. Time deposits and other borrowed money term liabilities decreased in interest expense in comparing 2015 to 2014 and 2014 to 2013. Saving deposits increased in cost for 2015 as compared to 2014. Approximately two thirds was due to balances increasing and the other one third due to rate. Fed Funds purchased and securities sold under agreement to repurchase increased for both 2015 and 2014. While 2014 was due to increased balance, 2015 was due to higher rates. Time deposits and other borrowed money both decreased in cost and balances during all three years presented. The Bank paid off $4.5 and $7.1 million of FHLB borrowings during 2014 and 2013 respectively. The Bank again borrowed $10 million in December 2015 to fund loan, growth. The average balance of other borrowed money was lower by $50 thousand for 2015 which calculated to $108 thousand. The average balance was $158 thousand for 2014 and a much higher $6.7 million for 2013.
25
The following tables present net interest income, interest spread and net interest margin for the three years 2013 through 2015, comparing average outstanding balances of earning assets and interest bearing liabilities with the associated interest income and expense. The tables show the corresponding average rates of interest earned and paid. The tax-exempt asset yields have been tax adjusted to reflect a marginal corporate tax rate of 34%. Average outstanding loan balances include non-performing loans and mortgage loans held for sale. Average outstanding security balances are computed based on carrying values including unrealized gains and losses on available-for-sale securities.
The percentage of interest earning assets to total assets increased to 92.8% in 2015 from 2014, preceded by a decrease to 89.1% in 2014 from 93.9% 2013. Noninterest earning assets increased during 2014 by $46.1 million as the earning credit rates paid by our correspondent banks were higher than the interest rates. The Bank switched those accounts to noninterest bearing to save costs which resulted in a lower percentage of interest earning assets.
Noninterest bearing liabilities increased on average $9.7 million in 2015 over 2014, providing the lowest cost of funds possible. Movement in the Banks deposits, specifically checking products, to the newer noninterest bearing Pure and Secure checking product lines was the main driver.
The deposit strategy was implemented during 2014 to alter the deposit mix and introduce new products resulted in lower interest bearing liabilities. In average balances, 2014 had $41.3 million less than 2013 in interest bearing liabilities. Secure and Pure checking were the main launches. Secure checking offers ID Protect along with credit score monitoring (reporting the score quarterly and providing notification of any access occurring) for a monthly charge. Pure provides depositors options to reduce or eliminate fees through modification of usage or having a total deposit relationship over a specified amount. The majority of the new offered accounts were noninterest bearing which caused the reduction in interest bearing liabilities. Time deposits also continued to run off during 2014 thereby reducing in average balance, by approximately $36.1 million as compared to 2013. The average cost of deposits also decreased 10 basis points, aided by the decrease in time deposits and payoff of all other borrowed money during 2014. The average cost of funds for 2015 was 0.54%, the average cost in 2014 for interest bearing liabilities was 0.55% compared to 0.65% in 2013.
The yield on Tax-Exempt investment securities shown in the following charts were computed on a tax equivalent basis. The yield on Loans has been tax adjusted for the portion of tax-exempt IDB loans included in the total. Total Interest Earning Assets is therefore also reflecting a tax equivalent yield in both line items, also with the Net Interest Spread and Margin. The adjustments were based on a 34% tax rate.
26
2015 | ||||||||||||
(In Thousands) | ||||||||||||
Average Balance |
Interest/ Dividends |
Yield/Rate | ||||||||||
ASSETS |
||||||||||||
Interest Earning Assets: |
||||||||||||
Loans |
$ | 627,194 | $ | 29,293 | 4.68 | % | ||||||
Taxable investment securities |
177,833 | 2,808 | 1.58 | % | ||||||||
Tax-exempt investment securities |
66,156 | 1,513 | 3.47 | % | ||||||||
Federal funds sold & interest bearing deposits |
14,359 | 36 | 0.25 | % | ||||||||
|
|
|
|
|||||||||
Total Interest Earning Assets |
885,542 | $ | 33,650 | 3.90 | % | |||||||
|
|
|
|
|||||||||
Non-Interest Earning Assets: |
||||||||||||
Cash and cash equivalents |
21,333 | |||||||||||
Other assets |
47,284 | |||||||||||
|
|
|||||||||||
Total Assets |
$ | 954,159 | ||||||||||
|
|
|||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||
Interest Bearing Liabilities: |
||||||||||||
Savings deposits |
$ | 412,269 | $ | 1,557 | 0.38 | % | ||||||
Other time deposits |
189,822 | 1,712 | 0.90 | % | ||||||||
Other borrowed money |
108 | 1 | 0.93 | % | ||||||||
Federal funds purchased and securties sold under agreement to repurchase |
57,918 | 317 | 0.55 | % | ||||||||
|
|
|
|
|||||||||
Total Interest Bearing Liabilities |
660,117 | $ | 3,587 | 0.54 | % | |||||||
|
|
|
|
|||||||||
Non-Interest Bearing Liabilities: |
||||||||||||
Non-interest bearing demand deposits |
162,028 | |||||||||||
Other |
14,461 | |||||||||||
|
|
|||||||||||
Total Liabilities |
836,606 | |||||||||||
|
|
|||||||||||
Shareholders Equity |
117,553 | |||||||||||
|
|
|||||||||||
Total Liabilities and |
||||||||||||
Shareholders Equity |
$ | 954,159 | ||||||||||
|
|
|||||||||||
Interest/Dividend income/yield |
$ | 33,650 | 3.90 | % | ||||||||
Interest Expense / yield |
3,587 | 0.54 | % | |||||||||
|
|
|
|
|||||||||
Net Interest Spread |
$ | 30,063 | 3.35 | % | ||||||||
|
|
|
|
|||||||||
Net Interest Margin |
3.49 | % | ||||||||||
|
|
27
2014 | ||||||||||||
(In Thousands) | ||||||||||||
Average Balance |
Interest/ Dividends |
Yield/Rate | ||||||||||
ASSETS |
||||||||||||
Interest Earning Assets: |
||||||||||||
Loans |
$ | 581,483 | $ | 28,070 | 4.83 | % | ||||||
Taxable investment securities |
189,003 | 3,570 | 1.89 | % | ||||||||
Tax-exempt investment securities |
65,520 | 1,794 | 4.15 | % | ||||||||
Federal funds sold & interest bearing deposits |
8,992 | 19 | 0.21 | % | ||||||||
|
|
|
|
|||||||||
Total Interest Earning Assets |
844,998 | $ | 33,453 | 4.07 | % | |||||||
|
|
|
|
|||||||||
Non-Interest Earning Assets: |
||||||||||||
Cash and cash equivalents |
23,634 | |||||||||||
Other assets |
79,296 | |||||||||||
|
|
|||||||||||
Total Assets |
$ | 947,928 | ||||||||||
|
|
|||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||
Interest Bearing Liabilities: |
||||||||||||
Savings deposits |
$ | 394,690 | $ | 1,449 | 0.37 | % | ||||||
Other time deposits |
214,680 | 2,009 | 0.94 | % | ||||||||
Other borrowed money |
158 | 4 | 2.53 | % | ||||||||
Federal funds purchased and securties sold under agreement to repurchase |
60,989 | 254 | 0.42 | % | ||||||||
|
|
|
|
|||||||||
Total Interest Bearing Liabilities |
670,517 | $ | 3,716 | 0.55 | % | |||||||
|
|
|
|
|||||||||
Non-Interest Bearing Liabilities: |
||||||||||||
Non-interest bearing demand deposits |
152,155 | |||||||||||
Other |
14,622 | |||||||||||
|
|
|||||||||||
Total Liabilities |
837,294 | |||||||||||
|
|
|||||||||||
Shareholders Equity |
110,634 | |||||||||||
|
|
|||||||||||
Total Liabilities and |
||||||||||||
Shareholders Equity |
$ | 947,928 | ||||||||||
|
|
|||||||||||
Interest/Dividend income/yield |
$ | 33,453 | 4.07 | % | ||||||||
Interest Expense / yield |
3,716 | 0.55 | % | |||||||||
|
|
|
|
|||||||||
Net Interest Spread |
$ | 29,737 | 3.52 | % | ||||||||
|
|
|
|
|||||||||
Net Interest Margin |
3.63 | % | ||||||||||
|
|
28
2013 | ||||||||||||
(In Thousands) | ||||||||||||
Average Balance |
Interest/ Dividends |
Yield/Rate | ||||||||||
ASSETS |
||||||||||||
Interest Earning Assets: |
||||||||||||
Loans |
$ | 507,126 | $ | 24,978 | 4.93 | % | ||||||
Taxable investment securities |
287,736 | 4,597 | 1.60 | % | ||||||||
Tax-exempt investment securities |
64,355 | 1,819 | 4.28 | % | ||||||||
Federal funds sold & interest bearing deposits |
22,243 | 34 | 0.15 | % | ||||||||
|
|
|
|
|||||||||
Total Interest Earning Assets |
881,460 | $ | 31,428 | 3.68 | % | |||||||
|
|
|
|
|||||||||
Non-Interest Earning Assets: |
||||||||||||
Cash and cash equivalents |
17,691 | |||||||||||
Other assets |
39,107 | |||||||||||
|
|
|||||||||||
Total Assets |
$ | 938,258 | ||||||||||
|
|
|||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||
Interest Bearing Liabilities: |
||||||||||||
Savings deposits |
$ | 400,071 | $ | 1,475 | 0.37 | % | ||||||
Other time deposits |
250,737 | 2,718 | 1.08 | % | ||||||||
Other borrowed money |
6,690 | 163 | 2.44 | % | ||||||||
Federal funds purchased and securties sold under agreement to repurchase |
54,312 | 248 | 0.46 | % | ||||||||
|
|
|
|
|||||||||
Total Interest Bearing Liabilities |
711,810 | $ | 4,604 | 0.65 | % | |||||||
|
|
|
|
|||||||||
Non-Interest Bearing Liabilities: |
||||||||||||
Non-interest bearing demand deposits |
109,804 | |||||||||||
Other |
7,895 | |||||||||||
|
|
|||||||||||
Total Liabilities |
829,509 | |||||||||||
|
|
|||||||||||
Shareholders Equity |
108,749 | |||||||||||
|
|
|||||||||||
Total Liabilities and |
||||||||||||
Shareholders Equity |
$ | 938,258 | ||||||||||
|
|
|||||||||||
Interest/Dividend income/yield |
$ | 31,428 | 3.68 | % | ||||||||
Interest Expense / yield |
4,604 | 0.65 | % | |||||||||
|
|
|
|
|||||||||
Net Interest Spread |
$ | 26,824 | 3.03 | % | ||||||||
|
|
|
|
|||||||||
Net Interest Margin |
3.15 | % | ||||||||||
|
|
29
The following tables show changes in interest income, interest expense and net interest resulting from changes in volume and rate variances for major categories of earnings assets and interest bearing liabilities.
2015 vs 2014 | ||||||||||||
(In Thousands) | ||||||||||||
Net Change |
Due to change in Volume |
Rate | ||||||||||
Interest Earning Assets: |
||||||||||||
Loans |
$ | 1,223 | $ | 2,210 | $ | (987 | ) | |||||
Taxable investment securities |
(762 | ) | (211 | ) | (551 | ) | ||||||
Tax-exempt investment securities |
(281 | ) | 26 | (307 | ) | |||||||
Federal funds sold & interest bearing deposits |
17 | 11 | 6 | |||||||||
|
|
|
|
|
|
|||||||
Total Interest Earning Assets |
$ | 197 | $ | 2,036 | $ | (1,839 | ) | |||||
|
|
|
|
|
|
|||||||
Interest Bearing Liabilities: |
||||||||||||
Savings deposits |
$ | 108 | $ | 65 | $ | 43 | ||||||
Other time deposits |
(297 | ) | (233 | ) | (64 | ) | ||||||
Other borrowed money |
(3 | ) | (1 | ) | (2 | ) | ||||||
Federal funds purchased and securities sold under agreement to repurchase |
63 | (13 | ) | 76 | ||||||||
|
|
|
|
|
|
|||||||
Total Interest Bearing Liabilities |
$ | (129 | ) | $ | (182 | ) | $ | 53 | ||||
|
|
|
|
|
|
|||||||
2014 vs 2013 | ||||||||||||
(In Thousands) | ||||||||||||
Net Change |
Due to change in Volume |
Rate | ||||||||||
Interest Earning Assets: |
||||||||||||
Loans |
$ | 3,092 | $ | 3,667 | $ | (575 | ) | |||||
Taxable investment securities |
(1,027 | ) | (1,577 | ) | 550 | |||||||
Tax-exempt investment securities |
(25 | ) | 50 | (75 | ) | |||||||
Federal funds sold & interest bearing deposits |
(15 | ) | (20 | ) | 5 | |||||||
|
|
|
|
|
|
|||||||
Total Interest Earning Assets |
$ | 2,025 | $ | 2,120 | $ | (95 | ) | |||||
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Interest Bearing Liabilities: |
||||||||||||
Savings deposits |
$ | (26 | ) | $ | (20 | ) | $ | (6 | ) | |||
Other time deposits |
(709 | ) | (391 | ) | (318 | ) | ||||||
Other borrowed money |
(159 | ) | (159 | ) | | |||||||
Federal funds purchased and securities sold under agreement to repurchase |
6 | 30 | (24 | ) | ||||||||
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|
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|||||||
Total Interest Bearing Liabilities |
$ | (888 | ) | $ | (540 | ) | $ | (348 | ) | |||
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As mentioned in the discussion earlier, in reviewing years 2014 to 2013, the change in volume is the main driver for the improved ratio which is opposite of the change between 2013 to 2012 the largest impact was due to rate. The strategy since 2010 has been to extend the maturities of time deposit specials to over 24 months to prepare for a rising rate environment. The other strategy employed since 2011 was to increase core deposits by offering innovative products focused on customer needs, such as higher interest rates and fraud notification. In exchange for these
30
accounts, customers were asked to utilize services that benefited both the Bank and themselves. Smaller time deposit rate shoppers had an option to perhaps change their behavior of banking or allow those deposits to run off. The new core deposit products were indeed embraced by our customers and have helped to attain the deposit portfolio mix sought by the Bank.
Non-Interest Income
The discussion now turns to the noninterest activity of 2015 operations, beginning with the revenue portion. In comparing line items of the consolidated statements of income for years ended 2013 through 2015, it can be seen where the Company has been spending its time and the impact of the recession and slow recovery. This section will focus on the significant noninterest items that impacted the operations of the Company.
The Company has concerns with the increased costs associated with regulatory compliance such as the possible loss of revenue from new regulations stemming from the Dodd-Frank Act. History has proven the concern is justified. One area of revenue impacted was overdraft fees. Updated Regulation E guidelines were implemented on August 15, 2010 and the Bank has ended each year since with a lower revenue stream from overdraft fees. This has occurred in spite of the addition of the new offices since 2010. Each year, the number of checking accounts increased along with the balances; however average collected overdraft fees per account decreased. Overdraft fees in 2015 accounted for $2.4 million in noninterest income, compared to $2.5 million in 2014 and $2.7 million for 2013. The Bank had made this an area of focus for 2015 as this revenue stream remains under intense regulator review. In 2015, the Bank adjusted its overdraft program and renamed it Courtesy Pay. Courtesy Pay establishes dynamic limits based on a customers behavior and likelihood of repayment. The Bank has sought to better service the customers needs while decreasing the need for collections and improving profitability. At the current time, profitability has not been impacted. Service charges on checking accounts, excluding Health Savings Accounts, were up $120 thousand for 2015 and $208.7 thousand for 2014. This improvement is credited to the new checking accounts mentioned previously.
The Bank has long promoted the use of debit cards by its customers and continued that philosophy with the introduction of additional new products. 2015 revenue improved $142.9 thousand and 2014 revenue improved $250.5 from ATM/debit card usage as compared to 2014 and 2013, respectively. The Bank receives interchange revenue from each use by a customer of the card. In 2011, this revenue stream was at risk of being reduced by the Federal Reserve regulation of the interchange fee. The establishment by the Federal Reserve of a tiered pricing for banks under $10 billion has helped to protect the profitability from such fees, although the concern remains as to how long this tiered pricing will remain in effect. While this revenue stream continues to improve with more depositors using electronic methods for purchasing, the expense of fraud has offset a portion of the revenue gain. Further discussion can be found in the non-interest expense section regarding the net effect of debit card activity.
Noninterest income from net gain on sales of loans decreased for both 2015 and 2014 as compared to 2013. Unfortunately, this has become a trend mainly due to the duration of the flat rate interest environment. The net gain on sale of loans is derived from sales of real estate loans into the secondary market. Of these loan types, the Bank sells 100% of the residential loans and 90% of the agricultural loans into the secondary market. 2014 or 2015 activity did not reach the same high levels as 2013. Gains of $559.6 and $140.8 thousand were recorded for residential and agricultural real estate respectively for 2015 along with gains of $452.7 and $194.3 thousand were recorded for residential and agricultural real estate respectively for 2014. In conjunction with these sales, the Bank maintains servicing rights and those income amounts during all three years are included in the customer service fees line item and account for over $300 thousand in revenue each year.
The last line item in the noninterest income section as was discussed previously is the net gain on sale of investments. The Bank has taken advantage of this opportunity the last three years and expects to continue as long as the rates remain low and the yield curve is favorable to the transaction. The Bank will not increase short-term gains at the sacrifice of long-term profitability. All of the sales of securities in 2015 and 2014 of $47.0 and $57.9 million respectively were used to fund loan growth while only some of the $91 million in proceeds realized on the sale of securities in 2013 were used to fund loan growth. This is a source of funds that will continue to be analyzed for use in the coming year. Gains of $451 thousand were recorded for 2015, $494 thousand for 2014 as compared to $775 thousand for 2013.
Customer service fees show a nice improvement of $623 thousand collected in 2015 as compared to 2014. Almost $200 thousand can be attributed to classifying foreign ATM fees out of service charges into miscellaneous fees in 2015. An additional $104.7 thousand comes from servicing those sold secondary loans mentioned in gain on sale of loans, as the volume increased in 2015 as compared to 2014. Total loan service fees collected in 2015 was $1.2 million compared to $1.1 million in 2014.
31
Overall, noninterest income increased $604 thousand in 2015 following a year where it had decreased $654 thousand. Some of the revenue may not be easily duplicated as it is dependent on economic and market conditions to provide the opportunity. However, the increased revenue amounts from deposit and loan services should continue to provide improved profitability in the future. Gains on sales should also continue in the near term though when it will change is unknown at this time.
Non-Interest Expense
Noninterest expense increased 3.4% in 2015 as compared to 2014 and was preceded by a 4.2% increase in 2014 as compared to 2013. Represented in dollars, 2015 was $854 thousand higher than 2014 and 2014 was $1 million higher than 2013. The largest factor behind both years increase was the expense of employee salaries and wages. During 2015, an additional $721 thousand was spent over 2014 which correlates to a 7.1% increase. When making the same analysis for 2014 as compared to 2013, 2014s costs increased $633 thousand or 6.6%. Three main components flow into salaries and wages: base salary, deferred costs, and incentives composed of the expense of restricted stock awards and performance incentives. Base pay has increased with the addition of the three offices of Waterville, Custar and Sylvania, the Captive and through normal yearly increases to the remainder of the employees. Base pay was up $559.3 thousand for 2015 over the previous year and 2014 was up $474.1 thousand over 2013. The full time equivalent number of employees at each yearend increased to 265 for 2015, to 260 for 2014 compared to 2013s 251.
Incentive pay as it related to performance was up $209.5 thousand in 2014 over 2013. Both measurements used to award incentive pay had improved in 2015 and 2014 and employees benefited accordingly. These followed 2013, a year in which the incentive performance pay was down $110.1 thousand from 2012. The expense for the restricted stock awards has also increased each of the last three years as more shares have been granted to a larger number of employees. 2015s cost for this program was $82 thousand higher than 2014 and 2014 was $20.9 thousand higher than 2013. The awards incorporate a three year vesting period so the increase of any one year carries forward through the next two years. This expense should continue to increase as the Company continues its expansion strategy. (For further discussion in incentive pay and restricted stock awards, see note 11 of the consolidated financial statements.)
Employee benefits increased by similar percentages as the salaries and wages for 2015 increased by 6.9% over 2014 and 2014 increased by 3.3% over 2013. The cost of the 401-K retirement plan increased each year as the profit share component increased along with the number of employees participating. The Company has been able to hold steady the expense of the employees group insurance while paying higher premiums. Being partially self-insured has helped with lower claim experience though it is an unknown each year what that experience will be. For 2014 and 2015, a switch in the medical provider and comparison pricing also assisted to control the cost. Employees do participate in any premium increases.
Net occupancy expense typically increases as the Company expands, with 2014 being an exception due to an increase in building rent. Building rent is netted out to offset occupancy expense. The greatest contributor to building rent comes from the division of FM Investments within the Bank. This division experienced a strong 2014; however the department was short staffed most of 2015. This has been remedied in 2016 and performance is expected to improve.
While net loss on sale of other assets owned, mainly ORE property, does not represent income for the years presented, the decrease in the amount of the loss for 2015 as compared to 2014, does contribute to improved profitability. Loss on sale of assets included any write downs in the carrying values of ORE property on the Banks balance sheet. In 2015 and 2014, the number of properties and the corresponding carrying values decreased as compared to 2013. The Bank also sold its St. Joe, Indiana property during 2015. While taking a loss for the sale, the Bank eliminated the continued maintenance expense of an unoccupied building. An easement was agreed upon to enable the ATM located on the property to remain operational.
The mortgage refinancing activity has been lower over the last three years. A correlating expense to that activity is the amortization of mortgage servicing rights. The amortization is the expense that offsets the income recognized when the loan is first made. Income is recorded when the mortgage loan is first sold with servicing retained and is therefore recognized within one year. The amortization, however, is calculated over the life of the loan and accelerated as loans are paid off early. An increase in this expense can be driven by two activities: an increase in the number of sold loans and/or by the acceleration of the expense from payoff and refinance activity. The best picture of the bottom line impact is achieved by netting the income with the expense each year. 2015 had net income of $33 thousand, a switch from
32
2014 which had net expense of $42.7 thousand and 2013 had a net income of $2 thousand. Of course, the value (or income) of the mortgage servicing right when sold also impacts the net position. 2015 had higher additions and lower amortization expense from refinanced loans. 2013 had new loan activity and lower refinance activity making the additions and amortization almost equal. The number of loans and balances also indicates this as the levels have remained fairly constant. 2014 was a year with limited sales and the amortization expense was therefore higher than the capitalized additions. As of December 2015, 3,598 loans are being serviced with balances of $275.7 million. As of December 31, 2014, there were 3,638 loans serviced with balances of $275.4 million and as of December 2013, there were 3,684 loans serviced with balances of $282.1 million.
The impact of mortgage servicing rights to both noninterest income and expense is shown in the following table:
(In Thousands) | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
Beginning Year |
$ | 2,023 | $ | 2,066 | $ | 2,063 | ||||||
Capitalized Additions |
407 | 301 | 429 | |||||||||
Amortization |
(374 | ) | (344 | ) | (426 | ) | ||||||
Valuation Allowance |
| | | |||||||||
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|
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|||||||
End of Year |
$ | 2,056 | $ | 2,023 | $ | 2,066 | ||||||
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Furniture and equipment steadily increases as we continue to add facilities and invest in technology. Annual maintenance costs continue to grow and become a greater piece of the overall cost. As new services are provided to our customers, the backroom cost to supply them continues to rise. The Company accepts it is an expected cost of doing business and keeping our services relevant to the industry.
Data processing expense increased $50 thousand during 2015 and by $38 thousand in 2014. The Company continues to investigate ways to reduce this expense. The pricing on many services, however, is based on number of accounts and the Bank fully expects those to increase with the growth from the newer offices and overall Bank growth.
The last line item with significant variation in noninterest expense to discuss is other general and administrative. The decrease of $348 thousand for 2015 as compared to 2014 can be mainly attributed to a $195.7 thousand reduction in marketing and consulting costs. A renegotiation of one service provider contract along with the maturity of another during 2015 lead to the decrease. Another contributor to the reduction was lower losses due to NSF and fraud. The Bank applauds the work of our front-line staff to recognize possible fraud and scams attempted on our customers and stopping them before they can occur. An investment in additional fraud detection software has also helped our back office personnel to detect possible digital fraud. This was down $60.2 thousand in 2015 compared to an increase in 2014 of $40.9 thousand.
Other general and administrative was higher by $461 thousand in 2014. The fluctuation was not isolated to a single source. The primary factors impacting this fluctuation in 2014 are increases in both ATM expense and core deposit intangible expenses. The increased expense of $52.7 thousand relating to ATM and debit cards in 2015 and 2014 over the previous year is caused by many factors. Increased usage during both years corresponds to increases in both revenue and cost. Finally, fraud increases cost as new cards have to be issued to limit the risk exposure. The fraud losses themselves are not recognized in this breakout, however the cost of replacement cards is. The Bank is currently deploying chip technology within its cards; the Bank is aware the adoption of embedded chips will increase this expense in the coming years. 2014 experienced additional expense over 2013 in consulting ($161.7 thousand), audit and accounting fees ($166.5 thousand) and advertising ($101.3 thousand).
Allowance for Credit Losses
Provision expense decreased by $566 thousand for 2015, following an increase of $333 thousand for 2014. The decrease for 2015 was due to the consistent strong asset quality of the Banks loan portfolio as evidenced by low levels of both net charge-offs and delinquencies. The increase for 2014 was needed to account for the loan growth and the net charge-off activity of 2014. Sustained strong asset quality kept the provision expense lower than the growth alone would have warranted. Net charge-offs were $473, $480 and $888 thousand for 2015, 2014 and 2013, respectively. Commercial and Industrial loans had the largest charge-off activity in 2015 and 2013, while 2014 was impacted with higher levels in the consumer portfolios.
33
The Company segregates its Allowance for Credit Losses (ACL) into two reserves: The ACL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total ACL. The AUCL is included in other liabilities on the consolidated balance sheets.
The Banks ALLL methodology captures trends in leading, current, and lagging indicators which will directly affect the Banks allocation amount. The Bank monitors trends in such leading indicators as delinquency, unemployment changes in the Banks service area, experience and ability of staff, regulatory trends, and credit concentrations. A current indicator such as the total watch list loan amount to Capital, and a lagging indicator such as the charge off amount are referenced as well. A matrix formed by loan type from these indicators is used in making ALLL adjustments.
Watch list loan balances are comprised of loans graded 5-8. These loan balances decreased 53.6% or $7.2 million from December 31, 2014 to December 31, 2015. The balances decreased mainly due to successful results from collection efforts. Given the size of the decrease, it is no surprise it is attributed mainly to the commercial real estate portfolio decreasing by $5.9 million. Three customers made up the bulk of the balances with one of three finding funding elsewhere. Commercial loans (non-real estate) on the Banks watch list also had a nice decrease during 2015, though just not as high at $1.9 million.
Of the aggregate watch list loan balances, as of December 31, 2015, special mention accounted for 36.6% with substandard comprising 49.1% and doubtful accounting for the final 14.3%. In comparison to 2014, special mention was down $7.2 million, substandard up slightly by $161 thousand and doubtful down almost exactly the same amount at $162 thousand.
Special mention loan balances increased 21.2% or $1.7 million overall as of yearend 2014 compared to same date 2013. The increase was in the commercial and commercial real estate portfolios. The largest increase of $2.1 million was in the commercial real estate, which was caused mainly by one large relationship being downgraded. Agricultural real estate decreased $618 thousand, thereby offsetting the above-referenced increase.
For 2014, the increase in special mention is offset by significant decreases in the substandard classifications of those same commercial related portfolios. Overall, substandard and doubtful loans decreased 42.5% or $2.9 million as compared to yearend 2013. In response to these fluctuations and loan growth during 2014 and 2015, the Bank changed ALLL to outstanding loan coverage percentage changed to 0.88% as of December 31, 2015, 0.95% as of December 31, 2014 from and 0.90% as of December 31, 2013.
The above indicators are reviewed quarterly. Some of the indicators are quantifiable and, as such, will automatically adjust the ALLL once calculated. These indicators include the ratio of past due loans to total loans, loans past due greater than 30 days, and the ration of watch list loans to capital, with the watch list made up of loans graded 5, 6 or 7 on a scale of 1 (best) to 7 (worst). Other indicators use more subjective data to the extent possible to evaluate the potential for inherent losses in the Banks loan portfolio. For example, the economic indicator uses the unemployment statistics from the communities in our market area to help determine whether the ALLL should be adjusted. At the end of each of 2013, 2014 and 2015, a slight improvement was noted in unemployment figures.
All aggregate commercial and agricultural credits including real estate loans of $250,000 and over are reviewed annually by both credit committees and internal loan review to look for early signs of deterioration.
To establish the specific reserve allocation for real estate, a discount to the market value is established to account for liquidation expenses. The discounting percentage used for real estate mirrors the discounting of real estate as provided for in the Banks Loan Policy. However, unique or unusual circumstances may be present which will affect the real estate value and, when appropriately identified, can adjust the discounting percentage at the discretion of management.
The ACL increased $153 and $755 thousand during 2015 and 2014 respectively, which was preceded by a $29 thousand decrease during 2013. The large increase in 2014 directly correlates to the large increase in loan balances. With the improved asset quality, the metrics upon which the ACL is calculated did not support a larger increase in 2015 even though loan growth occurred. The percentage of ACL to the total loan portfolio was 0.93% as of December 31, 2013, 0.98% as of December 31, 2014 and 0.91% as of December 31, 2015. December 31, 2013 had the lowest loans past due 30+ day percentage at 0.25% in the Banks known history, December 31, 2014 and 2015 were still at respectable lows of 0.37% and 0.32%.
34
Please see Note 4 in the consolidated financial statement for additional tables regarding the composition of the ACL.
Federal Income Taxes
Effective tax rates were 26.97%, 28.64% and 28.53% for 2015, 2014 and 2013 respectively. The effect of tax-exempt interest from holding tax-exempt securities and Industrial Development Bonds (IDBs) was $554, $634, and $640 thousand for 2015, 2014, and 2013, respectively. All years included an increase into a higher tax bracket for income over $10 million. Behind the decrease in 2015 is one of the benefits from the establishment of the Captive subsidiary.
Material Changes in Financial Condition
The shifts in the balance sheet during 2015 and 2014 have positioned the Company for continued improvement in profitability. On the asset side, the Company experiences an increase in interest income due to loan growth with funding provided by a decrease in the investment portfolio, core deposit growth and 2015 also utilized other borrowings. The cost of funds was impacted by the shift of interest bearing liabilities to noninterest and the decrease in time deposits and other borrowed money as borrowings didnt increase until December 2015. Both contributed to improved profitability in 2015 and 2014 and leads to expected liabilities improvement in future years.
Average earning assets increased throughout 2015 and 2014. Loan growth in both years was the main factor. 2014 was also aided by the Custar acquisition which took place in December 2013 and brought in $29 million in deposits. 2015 also had the addition of the Sylvania office for a full year along with the growth in the other newer offices.
Securities
The investment portfolio is primarily used to provide overall liquidity for the Bank. It is also used to provide required collateral for pledging to the Banks Ohio public depositors for amounts on deposit in excess of the FDIC coverage limits. It may also be used to pledge for additional borrowings from third parties. Investments are made with the above criteria in mind while still seeking a fair market rate of return, and looking for maturities that fall within the projected overall strategy of the Bank. The possible need to fund growth is also a consideration.
All of the Banks security portfolio is categorized as available for sale and as such is recorded at market value.
Security balances as of December 31 are summarized below:
(In Thousands) | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
U.S. Treasury |
$ | 38,505 | $ | 25,393 | $ | 25,272 | ||||||
U.S. Government agencies |
98,220 | 119,234 | 172,972 | |||||||||
Mortgage-backed securities |
26,324 | 29,562 | 44,792 | |||||||||
State and local governments |
72,066 | 74,303 | 81,473 | |||||||||
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$ | 235,115 | $ | 248,492 | $ | 324,509 | |||||||
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The following table sets forth the maturities of investment securities as of December 31, 2015 and the weighted average yields of such securities calculated on the basis of cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent adjustments, using a thirty-four percent rate, have been made in yields on obligations of state and political subdivisions. Stocks of domestic corporations have not been included.
35
Maturities (Amounts in Thousands) |
||||||||||||||||
Within One Year | After One Year Within Five Years |
|||||||||||||||
Amount | Yield | Amount | Yield | |||||||||||||
U.S. Treasury |
$ | 5,091 | 0.56 | % | $ | 28,345 | 1.09 | % | ||||||||
U.S. Government agencies |
| 0.00 | % | 87,994 | 1.31 | % | ||||||||||
Mortgage-backed securities |
| 0.00 | % | 254 | 4.39 | % | ||||||||||
State and local governments |
7,630 | 1.91 | % | 29,479 | 2.10 | % | ||||||||||
Taxable state and local governments |
1,141 | 2.21 | % | 6,076 | 1.79 | % | ||||||||||
After Five Years Within Ten Years |
After Ten Years | |||||||||||||||
Amount | Yield | Amount | Yield | |||||||||||||
U.S. Treasury |
$ | 5,069 | 2.00 | % | $ | | 0.00 | % | ||||||||
U.S. Government agencies |
10,226 | 2.02 | % | | 0.00 | % | ||||||||||
Mortgage-backed securities |
8,394 | 2.94 | % | 17,676 | 2.20 | % | ||||||||||
State and local governments |
19,659 | 2.55 | % | 5,634 | 2.27 | % | ||||||||||
Taxable state and local governments |
999 | 2.60 | % | 1,448 | 5.57 | % |
As of December 31, 2015 the Bank did not hold a large block of any one investment security in excess of 10% of stockholders equity. The largest segment of holdings is in US Governments. The Bank also holds stock in the Federal Home Loan Bank of Cincinnati at a cost of $3.7 million. This is required in order to obtain Federal Home Loan Bank loans. The Bank also owns stock of Farmer Mac with a carrying value of $37.4 thousand which is required to participate loans in the program.
Loan Portfolio
The Banks various loan portfolios are subject to varying levels of credit risk. Management mitigates these risks through portfolio diversification and through standardization of lending policies and procedures.
Risks are mitigated through an adherence to the Banks loan policies, with any exception being recorded and approved by senior management or committees comprised of senior management. The Banks loan policies define parameters to essential underwriting guidelines such as loan-to-value ratio, cash flow and debt-to-income ratio, loan requirements and covenants, financial information tracking, collection practice and others. The maximum loan amount to any one borrower is limited by the Banks legal lending limits and is stated in policy. On a broader basis, the Bank restricts total aggregate funding in comparison to Bank capital to any one business or agricultural sector by an approved sector percentage to capital limitation.
36
The following table shows the Banks loan portfolio by category of loan as of December 31st of each year, including loans held for sale:
(In Thousands) | ||||||||||||||||||||
Loans: | 2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||
Consumer Real Estate |
$ | 88,189 | $ | 97,550 | $ | 92,438 | $ | 80,287 | $ | 84,477 | ||||||||||
Agricultural Real estate |
58,525 | 50,895 | 44,301 | 40,143 | 31,993 | |||||||||||||||
Agricultural |
82,654 | 74,611 | 65,449 | 57,770 | 52,598 | |||||||||||||||
Commercial Real Estate |
322,762 | 270,188 | 248,893 | 199,999 | 198,266 | |||||||||||||||
Commercial and Industrial |
100,125 | 100,126 | 99,498 | 101,624 | 114,497 | |||||||||||||||
Consumer |
27,770 | 24,277 | 21,406 | 20,413 | 23,375 | |||||||||||||||
Industrial Development Bonds |
6,491 | 4,698 | 4,358 | 1,299 | 1,196 | |||||||||||||||
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$ | 686,516 | $ | 622,345 | $ | 576,343 | $ | 501,535 | $ | 506,402 | |||||||||||
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The following table shows the maturity of loans as of December 31, 2015:
(In Thousands) | ||||||||||||||||
Within One Year |
After One Year Within Five Years |
After Five Years |
Total | |||||||||||||
Consumer Real Estate |
$ | 1,270 | $ | 11,486 | $ | 75,433 | $ | 88,189 | ||||||||
Agricultural Real Estate |
1,073 | 3,300 | 54,152 | 58,525 | ||||||||||||
Agricultrual |
52,939 | 24,239 | 5,476 | 82,654 | ||||||||||||
Commercial Real Estate |
13,030 | 70,699 | 239,033 | 322,762 | ||||||||||||
Commercial and Industrial |
45,971 | 34,791 | 19,363 | 100,125 | ||||||||||||
Consumer |
5,480 | 17,228 | 5,062 | 27,770 | ||||||||||||
Industrial Development Bonds |
1,300 | 185 | 5,006 | 6,491 | ||||||||||||
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$ | 121,063 | $ | 161,928 | $ | 403,525 | $ | 686,516 | |||||||||
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The following table presents the total of loans due after one year which has either 1) predetermined interest rates (fixed) or 2) floating or adjustable interest rates (variable):
(In Thousands) | ||||||||||||
Fixed Rate |
Variable Rate |
Total | ||||||||||
Consumer Real Estate |
$ | 81,987 | $ | 4,932 | $ | 86,919 | ||||||
Agricultural Real Estate |
47,252 | 10,200 | 57,452 | |||||||||
Agricultural |
29,108 | 607 | 29,715 | |||||||||
Commercial Real Estate |
236,384 | 73,348 | 309,732 | |||||||||
Commercial and Industrial |
53,292 | 862 | 54,154 | |||||||||
Consumer |
22,290 | | 22,290 | |||||||||
Industrial Development Bonds |
5,050 | 141 | 5,191 |
37
The following table summarizes the Companys nonaccrual, past due 90 days or more and still accruing loans, and accruing troubled debt restructurings as of December 31 for each of the last five years:
(In Thousands) | ||||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||||
Non-accrual loans |
$ | 2,041 | $ | 1,705 | $ | 3,329 | $ | 4,828 | $ | 2,131 | ||||||||||
Accruing loans past due 90 days or more |
| | | 1 | | |||||||||||||||
Troubled debt restructurings, not included above |
878 | 471 | 485 | | | |||||||||||||||
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Total |
$ | 2,919 | $ | 2,176 | $ | 3,814 | $ | 4,829 | $ | 2,131 | ||||||||||
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Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest irregularly or at less than original contractual rates. Interest income that would have been recorded under the original terms of these loans would have aggregated $117.1 thousand for 2015, $52.3 thousand for 2014 and $139.1 thousand for 2013. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation. A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $76 thousand for 2015, $87 thousand for 2014 and $60 thousand for 2013. $20.6 thousand of interest collected in 2015 was applied to reduce the specific allocation and was applied for the same reason in 2014.
Loans are placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected. The Bank had nonaccrual loan balances of $2.1 million at December 31, 2015 compared to balances of $3.3 and $1.7 million as of year-end 2013 and 2014, respectively. All of the balances of nonaccrual loans for the past three years were collaterally secured.
As of December 31, 2015 the Bank had $7.0 million of loans which it considers to be potential problem loans in that the borrowers are experiencing financial difficulties. At December 31, 2014, the Bank had $13.5 million of these loans. These loans are subject to constant management attention and are reviewed at least monthly. The amount of the potential problem loans was considered in managements review of the loan loss reserve at December 31, 2015 and 2014.
In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the banks borrowers.
As of December 31, 2015, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $82.8 million with an additional $58.5 million in agricultural real estate loans these compared to $74.6 and $50.9 million respectively as of December 31, 2014. The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities.
Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2015, the Bank had $1.1 million of its loans that were classified as troubled debt restructurings, of which $182.4 thousand are included in non-accrual loans. This compares to $797.2 thousand as of same date 2014 and the Bank had almost $911.2 thousand classified as such as of December 31, 2013.
Updated appraisals are required on all collateral dependent loans once they are deemed impaired. The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a change in value has occurred.
To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of 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 existing collateral value used.
38
Performing non-watch list loans secured in whole or in part by real estate, do not require an updated appraisal unless the loan is rewritten and additional funds advanced. Watch List loans secured in whole or in part by real estate require updated appraisals every two years. All loans are subject to loan to values as found in the Banks loan policies irrespective of their grade. The Banks watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time.
The majority of the Banks loans are made in the market by lenders who live and work in the market. Thus, their evaluation of the independent valuation is also valuable and serves as a double check.
On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Banks senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Banks watch list. In addition to analyzing the recent performance of these loans, management and the Enterprise Risk Management Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market conditions impacting a specific property or other relevant factors are considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Banks general policies for updating appraisal.
Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Banks loans and ALLL.
ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated.
Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made. For those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is established. The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio. The historical loan loss portion is determined using a historical loss analysis by loan category.
The unallocated portion of the reserve for loan losses is determined based on managements assessment of general economic conditions as well as specific economic factors in the Banks marketing area. This assessment inherently involves a higher degree of uncertainty. It represents estimated inherent but undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrowers financial condition and other current risk factors that may not have yet manifested themselves in the Banks historical loss factors used to determine the allocated component of the allowance.
Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral.
39
As presented below, charge-offs increased to $1.0 million for 2015, preceded by a decrease to $778 thousand for 2014, an increase to $1.3 million for 2013, decreased to $891 thousand for 2012 and 2011 recorded $2.7 million. The provision expense also decreased in 2012 and 2011 and increased for 2013 and 2014. 2015 had the lowest provision expense of all years presented at $625 thousand. 2014 and 2013 had provision expense of $1.2 million and $858 thousand respectively. 2012 had provision expense of $738 thousand with 2011 having provision expense of $1.7 million. The Commercial and Industrial portfolio had the largest net charge-off position in 2011 through 2015. The improvement in asset quality during the periods shown is reflected in the increased percentage of the allowance for loan loss to nonperforming loans.
In reviewing the bigger picture of the allowance for credit loss, the years with the higher percentage of ACL to total nonperforming loans ratio account for the lower level of nonaccrual and watch list loans. This demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. In 2012, the provision expense was to offset the higher year-end watch list values. A smaller portion of the allowance was needed to fund the impaired loans as collateral remained sufficient to cover the outstanding amounts in most cases. 2014s significant and continued loan growth since fourth quarter 2013 was the reason behind 2014s higher balances as asset quality remained strong. The ratio of ACL to nonperforming loans increased significantly in 2014 which is why provision loan expense was lower in 2015 in comparison. The ACL to nonperforming loans for 2015 remained more than adequate and emphasizes the existing strong level of credit quality.
40
The following table presents a reconciliation of the allowance for credit losses for the years ended December 31, 2015, 2014, 2013, 2012 and 2011:
(In Thousands) | ||||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||||
Loans |
$ | 685,878 | $ | 621,926 | $ | 576,113 | $ | 501,402 | $ | 506,215 | ||||||||||
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|||||||||||
Daily average of outstanding loans |
$ | 627,194 | $ | 581,483 | $ | 507,126 | $ | 492,697 | $ | 504,058 | ||||||||||
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Allowance for Loan Losses-Jan 1 |
$ | 5,905 | $ | 5,194 | $ | 5,224 | $ | 5,091 | $ | 5,706 | ||||||||||
Loans Charged off: |
||||||||||||||||||||
Consumer Real Estate |
38 | 168 | 147 | 246 | 423 | |||||||||||||||
Agricultural Real Estate |
| | | | | |||||||||||||||
Agricultural |
| | | 6 | 24 | |||||||||||||||
Commercial Real Estate |
143 | 229 | 164 | 98 | 360 | |||||||||||||||
Commercial and Industrial |
536 | | 513 | 47 | 1,500 | |||||||||||||||
Consumer |
313 | 381 | 438 | 494 | 374 | |||||||||||||||
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|
|||||||||||
$ | 1,030 | $ | 778 | $ | 1,262 | $ | 891 | $ | 2,681 | |||||||||||
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Loan Recoveries: |
||||||||||||||||||||
Consumer Real Estate |
$ | 41 | $ | 34 | $ | 20 | $ | 60 | $ | 61 | ||||||||||
Agricultural Real Estate |
| | | | | |||||||||||||||
Agricultural |
64 | 44 | 5 | 12 | 67 | |||||||||||||||
Commercial Real Estate |
204 | 4 | 23 | 7 | 32 | |||||||||||||||
Commercial and Industrial |
91 | 20 | 141 | 30 | 19 | |||||||||||||||
Consumer |
157 | 196 | 185 | 177 | 172 | |||||||||||||||
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|
|||||||||||
$ | 557 | $ | 298 | $ | 374 | $ | 286 | $ | 351 | |||||||||||
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Net Charge Offs |
$ | 473 | $ | 480 | $ | 888 | $ | 605 | $ | 2,330 | ||||||||||
Provision for loan loss |
625 | 1,191 | 858 | 738 | 1,715 | |||||||||||||||
Acquisition provision for loan loss |
| | | | | |||||||||||||||
Allowance for Loan & Lease Losses - Dec 31 |
$ | 6,057 | $ | 5,905 | $ | 5,194 | $ | 5,224 | $ | 5,090 | ||||||||||
Allowance for Unfunded Loan Commitments & Letters of Credit Dec 31 |
208 | 207 | 163 | 162 | 130 | |||||||||||||||
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|||||||||||
Total Allowance for Credit Losses - Dec 31 |
$ | 6,265 | $ | 6,112 | $ | 5,357 | $ | 5,386 | $ | 5,221 | ||||||||||
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Ratio of net charge-offs to average |
||||||||||||||||||||
Loans outstanding |
0.08 | % | 0.08 | % | 0.18 | % | 0.12 | % | 0.46 | % | ||||||||||
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Ratio of the Allowance for Loan Loss to |
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Nonperforming Loans |
293.75 | % | 346.30 | % | 156.03 | % | 108.20 | % | 238.89 | % | ||||||||||
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* | Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual. |
41
Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans is as follows:
2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||||||||||||||||||||||||
Amount (000s) |
% | Amount (000s) |
% | Amount (000s) |
% | Amount (000s) |
% | Amount (000s) |
% | |||||||||||||||||||||||||||||||
Balance at End of Period Applicable To: |
||||||||||||||||||||||||||||||||||||||||
Consumer Real Estate |
$ | 338 | 12.82 | $ | 537 | 15.69 | $ | 257 | 16.05 | $ | 368 | 16.01 | $ | 260 | 16.12 | |||||||||||||||||||||||||
Agricultural Real Estate |
211 | 8.52 | 184 | 8.18 | 131 | 7.69 | 113 | 8.01 | 140 | 6.32 | ||||||||||||||||||||||||||||||
Agricultural |
582 | 12.07 | 547 | 12.00 | 326 | 11.36 | 290 | 11.52 | 267 | 10.39 | ||||||||||||||||||||||||||||||
Commercial Real Estate |
2,516 | 46.98 | 2,367 | 43.43 | 2,107 | 43.19 | 1,749 | 39.89 | 2,087 | 39.74 | ||||||||||||||||||||||||||||||
Commercial and Industrial |
1,229 | 15.56 | 1,421 | 16.86 | 1,359 | 18.03 | 2,183 | 20.53 | 1,948 | 22.85 | ||||||||||||||||||||||||||||||
Consumer |
337 | 4.05 | 323 | 3.84 | 292 | 3.68 | 268 | 4.04 | 315 | 4.58 | ||||||||||||||||||||||||||||||
Unallocated |
844 | 0.00 | 526 | 0.00 | 722 | 0.00 | 253 | 0.00 | 74 | 0.00 | ||||||||||||||||||||||||||||||
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Allowance for Loan & Lease Losses |
$ | 6,057 | 100.00 | $ | 5,905 | 100.00 | $ | 5,194 | 100.00 | $ | 5,224 | 100.00 | $ | 5,091 | 100.00 | |||||||||||||||||||||||||
Off Balance Sheet Commitments |
208 | 207 | 163 | 162 | $ | 130 | ||||||||||||||||||||||||||||||||||
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Total Allowance for Credit Losses |
$ | 6,265 | $ | 6,112 | $ | 5,357 | $ | 5,386 | $ | 5,221 | ||||||||||||||||||||||||||||||
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Deposits
The amount of outstanding time certificates of deposits and other time deposits in amounts of $100,000 or more by maturity as of December 31, 2015 are as follows:
(In Thousands) | ||||||||||||||||
Under Three Months |
Over Three Months Less than Six Months |
Over Six Months Less Than One Year |
Over One Year |
|||||||||||||
Time Deposits |
$ | 8,904 | $ | 13,404 | $ | 20,513 | $ | 38,040 | ||||||||
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The following table presents the average amount of and average rate paid on each deposit category:
(In Thousands) | ||||||||||||||||
Non-Interest DDAs |
Interest DDAs |
Savings Accounts |
Time Accounts |
|||||||||||||
December 31, 2015: |
||||||||||||||||
Average balance |
$ | 162,028 | $ | 184,941 | $ | 227,328 | $ | 189,822 | ||||||||
Average rate |
0.00 | % | 0.62 | % | 0.18 | % | 0.90 | % | ||||||||
December 31, 2014: |
||||||||||||||||
Average balance |
$ | 152,155 | $ | 178,285 | $ | 216,405 | $ | 214.680 | ||||||||
Average rate |
0.00 | % | 0.51 | % | 0.92 | % | ||||||||||
December 31, 2013: |
||||||||||||||||
Average balance |
$ | 109,804 | $ | 202,914 | $ | 197,157 | $ | 250,737 | ||||||||
Average rate |
0.53 | % | 0.19 | % | 1.06 | % |
42
Liquidity
Liquidity remains adequate though down from prior years as the Bank has decreased the investment portfolio to fund loans. The Bank has access to $58 million of unsecured borrowings through correspondent banks and $29.4 million of unpledged securities which may be sold or used as collateral. An additional $4.1 million is also available from the Federal Home Loan Bank based on current collateral pledging with up to $118.5 million available provided adequate collateral is pledged.
Maintaining sufficient funds to meet depositor and borrower needs on a daily basis continues to be among managements top priorities. This is accomplished not only by immediate liquid resources of cash, due from banks and federal funds sold, but also by the Banks available for sale securities portfolio. The average aggregate balance of these assets was $262.1 for 2015 and $296.5 million for 2014, and $387.7 million for 2013. This represented 28.0%, 31.8% and 42.5% of total average assets, respectively. Of the almost $218.7 million of debt securities in the banks portfolio as of December 31, 2015, $12.7 million, or 5.8% of the portfolio, is expected to receive payments or mature in 2016. The availability of the funds may be reduced by the need to utilize securities for pledging purposes on public deposits. This liquidity provides the opportunity to fund loan growth by analysis of the lowest cost and source of funds whether by increasing deposits, sales or runoff of investments or utilizing debt.
In addition to the Banks investment portfolio, the Company has $16.4 million held in the holding companys investment portfolio. $1.5 million of those investments will mature or receive payments in the next twelve months. These funds provide liquidity to the Company. The Bank has been declaring additional dividends each quarter to provide this liquidity to the Company. In future years, the Captive will also upstream dividends to the Company once reserve levels are adequately provided for. This will also provide additional liquidity for Company activities.
Historically, the primary source of liquidity has been core deposits that include noninterest bearing and interest bearing demand deposits, savings, money market accounts and time deposits of individuals. Core deposit balances as of year-end 2015 increased in all categories with the exception of time deposits. Overall deposits increased an average of $2.6 million in 2015, $913 thousand in 2014 and $4.7 million during 2013. The Bank also utilized Federal Funds purchased at times during 2013 through 2015. The average balance for 2015 and 2014 was $1.2 million and $1.4 million respectively. The Bank began using this temporary funding source heavier in December 2015 while it secured more permanent funding.
Historically, the primary use of new funds is placing the funds back into the community through loans for the acquisition of new homes, consumer products and for business development. The use of new funds for loans is measured by the loan to deposit ratio. The Banks average loan to deposit ratio was 80.7% for 2015, 76.4% for 2014 and 66.2% for 2013. The lower ratio in 2013 was due to the success of the deposit gathering function, the residential mortgage loans being sold in the secondary market and the lack of loan demand. The Banks goal is for this ratio to be higher in the 80-90 percent range with loan growth being the driver. The Bank ended the year 2015 at an 88.1% loan to deposit ratio.
Short-term debt such as federal funds purchased and securities sold under agreement to repurchase also provides the Company with liquidity. Short-term debt for both federal funds purchased and securities sold under agreement to repurchase amounted to $78.8 million at the end of 2015 compared to $56.0 million at the end of 2014 and $69.8 million at the end of 2013. These accounts are used to provide a sweep product to the Banks commercial customers.
Other borrowings are also a source of funds. Other borrowings consist of loans from the Federal Home Loan Bank of Cincinnati. These funds are then used to provide loans in our community. The Bank utilized this funding source in December 2015 by borrowing $10 million. Prior borrowings from this source had decreased by $4.5 million to none at December 31, 2014. This compares to decreased borrowings during 2013 of $7.1 million. The decreased borrowings were payoffs of matured notes in 2013 and 2014.
Asset/Liability Management
The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. It involves the management of the balance sheet mix, maturities, re-pricing characteristics and pricing components to provide an adequate and stable net interest margin with an acceptable level of risk. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.
43
Changes in net income, other than those related to volume arise when interest rates on assets re-price in a time frame or interest rate environment that is different from that of the re-pricing period for liabilities. Changes in net interest income also arise from changes in the mix of interest-earning assets and interest-bearing liabilities.
Historically, the Bank has maintained liquidity through cash flows generated in the normal course of business, loan repayments, maturing earning assets, the acquisition of new deposits, and borrowings. The Banks asset and liability management program is designed to maximize net interest income over the long term while taking into consideration both credit and interest rate risk. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans that are tied to the market rate differ considerably from long-term investment securities and fixed rate loans. Similarly, time deposits over $100,000 and money market certificates are much more interest rate sensitive than passbook savings accounts. The Bank utilizes shock analysis to examine the amount of exposure an instant rate change of 100, 200, 300 and 400 basis points in both increasing and decreasing directions would have on the financials. Acceptable ranges of earnings and equity at risk are established and decisions are made to maintain those levels based on the shock results.
Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Companys operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Companys performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and service.
Contractual Obligations
Contractual Obligations of the Company totaled $252.1 million as of December 31, 2015. Time deposits represent contractual agreements for certificates of deposits held by its customers. Long term debt represents the borrowings with the Federal Home Loan Bank and is further defined in Note 4 and 9 of the Consolidated Financial Statements.
Payment Due by Period (In Thousands) | ||||||||||||||||||||
Contractual Obligations |
Total | Less than 1 year |
1-3 Years |
3-5 Years |
More than 5 years |
|||||||||||||||
Securities sold under agreement to repurchase |
$ | 56,815 | $ | 39,691 | $ | | $ | 17,124 | $ | | ||||||||||
Time Deposits |
184,285 | 89,862 | 60,381 | 33,198 | 844 | |||||||||||||||
Dividends Payable |
1,007 | 1,007 | | | | |||||||||||||||
Long Term Debt |
10,000 | | 10,000 | | | |||||||||||||||
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Total |
$ | 252,107 | $ | 130,560 | $ | 70,381 | $ | 50,322 | $ | 844 | ||||||||||
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Capital Resources
Stockholders equity was $120.1 million as of December 31, 2015 compared to $114.5 million at December 31, 2014. Dividends declared during 2015 were $0.87 per share totaling $3.99 million and during 2014 were $0.84 per share totaling $3.86 million. During 2015, the Company purchased 30,685 shares and awarded 16,000 shares of restricted stock to 67 employees. During 2014, the Company purchased 23,570 shares and awarded 13,250 restricted shared to 61 employees. For a summary of activity as it relates to the Companys restricted stock awards, please refer to Note 11: Employee Benefit Plans in the consolidated financial statements. At yearend 2015, the Company held 587,466 shares in Treasury stock and 38,995 unvested shares of restricted stock. At yearend 2014, the Company held 572,662 shares in Treasury stock and 33,390 unvested shares of restricted stock. On January 15, 2016 the Company announced the authorization by its Board of Directors for the Companys repurchase, either on the open market, or in privately negotiated transactions, of up to 200,000 shares of its outstanding common stock commencing January 15, 2016 and ending December 31, 2016. The Company has a history of approving a similar resolution to be in effect each year for at least the last five years.
44
The Company continues to have a strong capital base and maintains regulatory capital ratios that are above the defined regulatory capital ratios. At December 31, 2015, the Bank and the Company had total risk-based capital ratios of 12.64% and 14.95%, respectively. Core capital to risk-based asset ratios of 11.87% and 14.18% for the Bank and the Company, respectively, are well in excess of regulatory guidelines. The Banks leverage ratio of 10.12% is also substantially in excess of regulatory guidelines, as is the Companys at 11.91%. Under Basel III, the common equity Tier 1 Capital to risk-weighted assets ratios are also well above the required 4.50% and the 6.50% well capitalized levels with the Company at 14.18% and the Bank at 11.87%. For further discussion and analysis of regulatory capital requirements, refer to Note 15 of the Audited Financial Statements.
The Companys subsidiaries are restricted by regulations from making dividend distributions in excess of certain prescribed amounts. Upon prior regulatory approval, the Bank may be allowed to pay above the prescribed amount.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is the exposure to loss resulting from changes in interest rates and equity prices. The primary market risk to which we are subject is interest rate risk. The majority of our interest rate risk arises from the instruments, positions and transactions entered into for purposes other than trading such as loans, available for sale securities, interest bearing deposits, short term borrowings and long term borrowings. Interest rate risk occurs when interest bearing assets and liabilities re-price at different times as market interest rates change. For example, if fixed rate assets are funded with variable rate debt, the spread between asset and liability rates will decline or turn negative if rates increase.
Interest rate risk is managed within an overall asset/liability framework. The principal objectives of asset/liability management are to manage sensitivity of net interest spreads and net income to potential changes in interest rates. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. In the event that our asset/liabilities management strategies are unsuccessful, our profitability may be adversely affected. The Company employs a sensitivity analysis utilizing interest rate shocks to help in this analysis.
The shocks presented below assume an immediate change of rate in the percentages and directions shown:
Net Interest Margin |
Net Interest Income | |||||||||
Net Interest Margin (Ratio) |
% Change to Flat Rate |
Rate Direction |
Rate changes by |
Cumulative Total (000) |
% Change to Flat Rate | |||||
3.64% |
3.33% | Rising | 3.00% | $33,500 | 3.32% | |||||
3.59% |
2.12% | Rising | 2.00% | $33,106 | 2.11% | |||||
3.57% |
1.29% | Rising | 1.00% | $32,842 | 1.29% | |||||
3.52% |
| Flat | | $32,423 | | |||||
3.37% |
-4.14% | Falling | -1.00% | $31,061 | -4.20% | |||||
3.11% |
-11.67% | Falling | -2.00% | $28,571 | -11.88% | |||||
2.84% |
-19.23% | Falling | -3.00% | $26,082 | -19.56% |
45
The shock chart currently shows a tightening in net interest margin over the next twelve months in a decreasing rate environment and a slight increase in a rising rate environment. Due to the length of and existence of such a low rate environment, the model does not predict expansion of net interest margin in a further decreasing rate environment. Cost of funds are below 1% so at even the lowest shock of 100 basis points, the Bank cannot take full advantage and reprice funds to match the level of shock. Because of the long duration of the low rate environment, assets have been able to shorten the time frame when repricing will occur and therefore an increasing rate environment has become favorable. The Bank continues to enhance its use of the software model and performs additional stress tests whose results management and the directors review. Both directional changes are well within risk exposure guidelines. The effect of the rate shocks may be mitigated to the extent that not all lines of business are directly tied to an external index and actual balance sheet composition may differ from prediction.
Index To Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firms.
Consolidated Balance Sheets at December 31, 2015 and 2014.
Consolidated Statements of Cash Flow for the years ended December 31, 2015, 2014 and 2013.
Notes to Consolidated Financial Statements.
46
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Farmers & Merchants Bancorp, Inc.
Archbold, Ohio
We have audited the accompanying consolidated balance sheets of Farmers & Merchants Bancorp, Inc. (Company) as of December 31, 2015 and 2014, and the related consolidated statements of income and comprehensive income, changes to stockholders equity and cash flows for the years then ended. The Companys management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Farmers & Merchants Bancorp, Inc. as of December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Farmers & Merchants Bancorp Inc.s internal control over financial reporting as of December 31, 2015, based on criteria established in 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 24, 2016, expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting.
/s/ BKD, LLP
BKD, LLP
Fort Wayne, Indiana
February 24, 2016
47
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Farmers & Merchants Bancorp, Inc.
Archbold, Ohio
We have audited Farmers & Merchants Bancorp, Inc.s (Company) internal control over financial reporting as of December 31, 2015, based on criteria established in 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Farmers & Merchants Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
48
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Farmers & Merchants Bancorp, Inc. and our report dated February 24, 2016, expressed an unqualified opinion thereon.
/s/ BKD, LLP
BKD, LLP
Fort Wayne, Indiana
February 24, 2016
49
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Farmers & Merchants Bancorp, Inc. and Subsidiary
We have audited the accompanying consolidated statements of income and comprehensive income, stockholders equity and cash flows of Farmers & Merchants Bancorp, Inc. and Subsidiary for the year ended December 31, 2013. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the companys internal control over financial reporting based on our audits.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinions.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of Farmers & Merchants Bancorp, Inc. and Subsidiarys operations and its cash flows for the year ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America.
/s/ Plante & Moran, PLLC
February 26, 2014
Auburn Hills, MI
50
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets December 31, 2015 and 2014 (000s Omitted, Except Per Share Data) |
| |||||||
2015 | 2014 | |||||||
Assets |
||||||||
Assets |
||||||||
Cash and due from banks |
$ | 21,333 | $ | 22,246 | ||||
Federal Funds Sold |
685 | 2,049 | ||||||
|
|
|
|
|||||
Total cash and cash equivalents |
22,018 | 24,295 | ||||||
Securities - available for sale |
235,115 | 248,492 | ||||||
Other securities, at cost |
3,717 | 3,717 | ||||||
Loans, net |
679,821 | 616,021 | ||||||
Premises and equipment |
20,587 | 20,300 | ||||||
Goodwill |
4,074 | 4,074 | ||||||
Mortgage servicing rights |
2,056 | 2,023 | ||||||
Other real estate owned |
1,175 | 1,094 | ||||||
Other assets |
20,505 | 21,197 | ||||||
|
|
|
|
|||||
Total Assets |
$ | 989,068 | $ | 941,213 | ||||
|
|
|
|
|||||
Liabilities and Stockholders Equity |
||||||||
Liabilities |
||||||||
Deposits |
||||||||
Noninterest-bearing |
$ | 171,112 | $ | 164,009 | ||||
Interest-bearing |
||||||||
NOW accounts |
190,890 | 179,862 | ||||||
Savings |
225,052 | 223,189 | ||||||
Time |
184,285 | 195,500 | ||||||
|
|
|
|
|||||
Total deposits |
771,339 | 762,560 | ||||||
Federal Funds purchased and Securities sold under agreement to repurchase |
78,815 | 55,962 | ||||||
Federal Home Loan Bank (FHLB) advances |
10,000 | | ||||||
Dividend payable |
1,007 | 965 | ||||||
Accrued expenses and other liabilities |
7,810 | 7,233 | ||||||
|
|
|
|
|||||
Total liabilities |
868,971 | 826,720 | ||||||
|
|
|
|
|||||
Commitments and Contingencies |
||||||||
Stockholders Equity |
||||||||
Common stock - No par value - 6,500,000 shares authorized; 5,200,000 shares issued & outstanding |
12,086 | 12,222 | ||||||
Treasury stock - 587,466 shares 2015, 572,662 shares 2014 |
(12,389 | ) | (11,928 | ) | ||||
Retained earnings |
120,188 | 113,755 | ||||||
Accumulated other comprehensive income |
212 | 444 | ||||||
|
|
|
|
|||||
Total stockholders equity |
120,097 | 114,493 | ||||||
|
|
|
|
|||||
Total Liabilities and Stockholders Equity |
$ | 989,068 | $ | 941,213 | ||||
|
|
|
|
See Notes to Consolidated Financial Statements
51
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income & Comprehensive Income
Years Ended December 31, 2015, 2014 and 2013
(000s Omitted, Except Per Share Data)
2015 | 2014 | 2013 | ||||||||||
Interest Income |
||||||||||||
Loans, including fees |
$ | 29,293 | $ | 28,070 | $ | 24,978 | ||||||
Debt securities: |
||||||||||||
U.S. Treasury and government agencies |
2,434 | 3,171 | 4,151 | |||||||||
Municipalities |
1,739 | 2,037 | 2,080 | |||||||||
Dividends |
148 | 156 | 185 | |||||||||
Federal funds sold |
8 | 7 | 11 | |||||||||
Other |
28 | 12 | 23 | |||||||||
|
|
|
|
|
|
|||||||
Total interest income |
33,650 | 33,453 | 31,428 | |||||||||
Interest Expense |
||||||||||||
Deposits |
3,269 | 3,458 | 4,193 | |||||||||
Federal funds purchased and securities sold under agreements to repurchase |
317 | 254 | 248 | |||||||||
Borrowed funds |
1 | 4 | 163 | |||||||||
|
|
|
|
|
|
|||||||
Total interest expense |
3,587 | 3,716 | 4,604 | |||||||||
|
|
|
|
|
|
|||||||
Net Interest Income - Before provision for loan losses |
30,063 | 29,737 | 26,824 | |||||||||
Provision for Loan Losses |
625 | 1,191 | 858 | |||||||||
|
|
|
|
|
|
|||||||
Net Interest Income After Provision |
||||||||||||
For Loan Losses |
29,438 | 28,546 | 25,966 | |||||||||
Noninterest Income |
||||||||||||
Customer service fees |
5,847 | 5,224 | 5,194 | |||||||||
Other service charges and fees |
3,790 | 3,819 | 3,746 | |||||||||
Net gain on sale of loans |
700 | 647 | 1,123 | |||||||||
Net gain on sale of available for sale securities |
451 | 494 | 775 | |||||||||
|
|
|
|
|
|
|||||||
Total noninterest income |
10,788 | 10,184 | 10,838 | |||||||||
Noninterest Expense |
||||||||||||
Salaries and wages |
10,907 | 10,186 | 9,553 | |||||||||
Employee benefits |
3,555 | 3,324 | 3,219 | |||||||||
Net occupancy expense |
1,352 | 1,107 | 1,251 | |||||||||
Furniture and equipment |
1,629 | 1,541 | 1,349 | |||||||||
Data processing |
1,300 | 1,250 | 1,212 | |||||||||
Franchise taxes |
746 | 781 | 953 | |||||||||
Net loss on sale of other assets owned |
47 | 157 | 144 | |||||||||
FDIC assessment |
485 | 503 | 535 | |||||||||
Mortgage servicing rights amortization |
374 | 344 | 426 | |||||||||
Other general and administrative |
5,672 | 6,020 | 5,559 | |||||||||
|
|
|
|
|
|
|||||||
Total other operating expenses |
26,067 | 25,213 | 24,201 | |||||||||
|
|
|
|
|
|
|||||||
Income Before Income Taxes |
14,159 | 13,517 | 12,603 | |||||||||
Income Taxes |
3,819 | 3,871 | 3,596 | |||||||||
|
|
|
|
|
|
|||||||
Net Income |
10,340 | 9,646 | 9,007 | |||||||||
|
|
|
|
|
|
|||||||
Other Comprehensive Income (Loss) (Net of Tax): |
||||||||||||
Net unrealized gain (loss) on available for sale securities |
100 | 1,158 | (8,448 | ) | ||||||||
Reclassification adjustment for gain on sale of available for sale securities |
(451 | ) | (494 | ) | (775 | ) | ||||||
|
|
|
|
|
|
|||||||
Net unrealized gain (loss) on available for sale securities |
(351 | ) | 664 | (9,223 | ) | |||||||
Tax expense (benefit) |
(119 | ) | 226 | (3,136 | ) | |||||||
|
|
|
|
|
|
|||||||
Other comprehensive income (loss) |
(232 | ) | 438 | (6,087 | ) | |||||||
|
|
|
|
|
|
|||||||
Comprehensive Income |
$ | 10,108 | $ | 10,084 | $ | 2,920 | ||||||
|
|
|
|
|
|
|||||||
Earnings Per Share - Basic and Diluted |
$ | 2.24 | $ | 2.08 | $ | 1.93 | ||||||
|
|
|
|
|
|
|||||||
See Notes to Consolidated Financial Statements
52
Accumulated | ||||||||||||||||||||||||
Shares of Common Stock |
Common Stock |
Treasury Stock |
Retained Earnings |
Other Comprehensive Income |
Total Stockholders Equity |
|||||||||||||||||||
Balance - January 1, 2013 |
4,684,058 | $ | 12,343 | $ | (10,588 | ) | $ | 102,641 | $ | 6,093 | $ | 110,489 | ||||||||||||
Net income |
9,007 | 9,007 | ||||||||||||||||||||||
Other comprehensive loss |
(6,087 | ) | (6,087 | ) | ||||||||||||||||||||
Purchase of Treasury Stock |
(56,000 | ) | (1,236 | ) | (1,236 | ) | ||||||||||||||||||
Issuance of 11,000 shares of restricted stock (Net of Forfeitures - 620) |
10,380 | (284 | ) | 213 | 17 | (54 | ) | |||||||||||||||||
Stock-based compensation expense |
253 | 253 | ||||||||||||||||||||||
Cash dividends declared - $0.81 per share |
(3,755 | ) | (3,755 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Balance - December 31, 2013 |
4,638,438 | $ | 12,312 | $ | (11,611 | ) | $ | 107,910 | $ | 6 | $ | 108,617 | ||||||||||||
Net income |
9,646 | 9,646 | ||||||||||||||||||||||
Other comprehensive income |
438 | 438 | ||||||||||||||||||||||
Purchase of Treasury Stock |
(23,570 | ) | (576 | ) | (576 | ) | ||||||||||||||||||
Issuance of 13,250 shares of restricted stock (Net of Forfeitures - 780) |
12,470 | (322 | ) | 259 | 61 | (2 | ) | |||||||||||||||||
Stock-based compensation expense |
232 | 232 | ||||||||||||||||||||||
Cash dividends declared - $0.84 per share |
(3,862 | ) | (3,862 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Balance - December 31, 2014 |
4,627,338 | $ | 12,222 | $ | (11,928 | ) | $ | 113,755 | $ | 444 | $ | 114,493 | ||||||||||||
Net income |
10,340 | 10,340 | ||||||||||||||||||||||
Other comprehensive loss |
(232 | ) | (232 | ) | ||||||||||||||||||||
Purchase of Treasury Stock |
(30,685 | ) | (803 | ) | (803 | ) | ||||||||||||||||||
Issuance of 16,000 shares of restricted stock (Net of Forfeitures - 100 Repurchases - 19) |
15,881 | (450 | ) | 342 | 78 | (30 | ) | |||||||||||||||||
Stock-based compensation expense |
314 | 314 | ||||||||||||||||||||||
Cash dividends declared - $0.87 per share |
(3,985 | ) | (3,985 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Balance - December 31, 2015 |
4,612,534 | $ | 12,086 | $ | (12,389 | ) | $ | 120,188 | $ | 212 | $ | 120,097 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
53
Consolidated Statements of Cash Flows
Years Ended December 31, 2015, 2014 and 2013
(000s Omitted)
2015 | 2014 | 2013 | ||||||||||
Cash Flows from Operating Activities |
||||||||||||
Net income |
$ | 10,340 | $ | 9,646 | $ | 9,007 | ||||||
Adjustments to reconcile net income to net cash from operating activities: |
||||||||||||
Depreciation |
1,365 | 1,293 | 1,184 | |||||||||
Amortization of available for sale securities, net |
1,239 | 1,430 | 2,149 | |||||||||
Amortization of servicing rights |
374 | 344 | 426 | |||||||||
Amortization of core deposit intangible |
323 | 480 | 319 | |||||||||
Compensation expense related to stock awards |
314 | 232 | 253 | |||||||||
Provision for loan loss |
625 | 1,191 | 858 | |||||||||
Gain on sale of loans held for sale |
(700 | ) | (647 | ) | (1,123 | ) | ||||||
Originations of loans held for sale |
(52,706 | ) | (37,432 | ) | (62,360 | ) | ||||||
Proceeds from sale of loans held for sale |
52,764 | 41,992 | 65,391 | |||||||||
Loss on sale of other assets |
47 | 157 | 144 | |||||||||
Gain on sales of available for sale securities |
(451 | ) | (494 | ) | (775 | ) | ||||||
Change in other assets and other liabilities, net |
1,275 | 971 | 1,520 | |||||||||
|
|
|
|
|
|
|||||||
Net cash provided by operating activities |
14,809 | 19,163 | 16,993 | |||||||||
Cash Flows from Investing Activities |
||||||||||||
Activity in securities: |
||||||||||||
Maturities, prepayments and calls |
26,059 | 17,817 | 33,228 | |||||||||
Sales |
47,029 | 57,928 | 91,039 | |||||||||
Purchases |
(60,925 | ) | | (103,320 | ) | |||||||
Proceeds from redemption of FHLB stock |
| 499 | | |||||||||
Proceeds from sales of assets |
64 | 24 | 1,138 | |||||||||
Additions to premises and equipment |
(1,716 | ) | (2,908 | ) | (2,063 | ) | ||||||
Loan originations and principal collections, net |
(64,483 | ) | (50,853 | ) | (67,194 | ) | ||||||
Net cash received for acquisition |
| | 15,215 | |||||||||
|
|
|
|
|
|
|||||||
Net cash provided by (used in) investing activities |
(53,972 | ) | 22,507 | (31,957 | ) | |||||||
Cash Flows from Financing Activities |
||||||||||||
Net change in deposits |
8,779 | (13,904 | ) | (16,254 | ) | |||||||
Net change in federal funds purchased and securities sold under agreements to repurchase |
22,853 | (13,794 | ) | 18,444 | ||||||||
Proceeds of FHLB advances |
10,000 | | | |||||||||
Repayment of FHLB advances |
| (4,500 | ) | (7,100 | ) | |||||||
Purchase of Treasury Stock |
(803 | ) | (576 | ) | (1,236 | ) | ||||||
Cash dividends paid on common stock |
(3,943 | ) | (3,864 | ) | (3,719 | ) | ||||||
|
|
|
|
|
|
|||||||
Net cash provided by (used in) financing activities |
36,886 | (36,638 | ) | (9,865 | ) | |||||||
|
|
|
|
|
|
|||||||
Net Increase (Decrease) in Cash and Cash Equivalents |
(2,277 | ) | 5,032 | (24,829 | ) | |||||||
|
|
|
|
|
|
|||||||
Cash and Cash Equivalents - Beginning of Year |
24,295 | 19,263 | 44,092 | |||||||||
|
|
|
|
|
|
|||||||
Cash and Cash Equivalents - End of Year |
$ | 22,018 | $ | 24,295 | $ | 19,263 | ||||||
|
|
|
|
|
|
|||||||
Supplemental Information |
||||||||||||
Cash paid during the year for: |
||||||||||||
Interest |
$ | 3,610 | $ | 3,732 | $ | 4,679 | ||||||
|
|
|
|
|
|
|||||||
Income taxes |
$ | 3,079 | $ | 4,285 | $ | 3,240 | ||||||
|
|
|
|
|
|
|||||||
Noncash investing activities: |
||||||||||||
Transfer of loans to other real estate owned |
$ | 231 | $ | 139 | $ | 1,053 | ||||||
|
|
|
|
|
|
See Notes to Consolidated Financial Statements
54
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 Summary of Significant Accounting Policies
Nature of Operations
The Farmers & Merchants Bancorp, Inc. (the Company) through its bank subsidiary, The Farmers & Merchants State Bank (the Bank) provides a variety of financial services to individuals and small businesses through its offices in Northwest Ohio and Northeast Indiana.
Consolidation Policy
The consolidated financial statements include the accounts of Farmers & Merchants Bancorp, Inc. and its wholly-owned subsidiaries, The Farmers & Merchants State Bank (the Bank), a commercial banking institution and Farmers & Merchants Risk Management, Inc. (the Captive), a Captive insurance company. All significant inter-company balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of mortgage servicing rights, goodwill, available for sale investment securities, other real estate owned and impaired loans. Actual results could differ from those estimates.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral.
The Banks loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors ability to honor their contracts is dependent on local economic conditions in the agricultural industry.
While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
Cash and Cash Equivalents
For purposes of the consolidated statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. This includes cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased for one day periods.
Restrictions on Cash and Amounts Due from Banks
The Bank is required to maintain average balances on hand with the Federal Reserve Bank. The aggregate reserve was $6.5 million for December 31, 2015 and it was $7.1 million for December 31, 2014. The Company and its subsidiaries maintain cash balances with high quality credit institutions. At times such balances may be in excess of the federally insured limits.
55
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 Summary of Significant Accounting Policies (Continued)
Securities
Debt securities are classified as available-for-sale. Securities available-for-sale are carried at fair value with unrealized gains and losses reported in other comprehensive income (loss). Net realized gains and losses on securities available for sale are included in noninterest income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income (loss). Gains and losses on sales of securities are determined on the specific-identification method.
Declines in the fair value of securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The related write-downs are included in earnings as realized losses.
Other Securities
Other Securities consists of Federal Home Loan Bank of Cincinnati and Indianapolis stock and Farmer Mac stock. The Federal Home Loan Bank of Indianapolis stock was completely redeemed during 2013. These stocks are carried at cost and are held to enable the Bank to conduct business with the entities. The Federal Home Loan Banks sell and purchase their stock at par. The Federal Home Loan Bank of Cincinnati stock is held as collateral security for all indebtedness of the Bank to the Federal Home Loan Bank. The Federal Home Loan Bank of Cincinnati is evaluated for impairment as conditions warrant.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at the amount of unpaid principal, reduced by unearned discounts and deferred loan fees and costs, as well as, by the allowance for loan losses. Interest income is accrued on a daily basis based on the principal outstanding.
Generally, a loan is classified as nonaccrual and the accrual of interest income is generally discontinued when a loan becomes ninety days past due as to principal or interest and these loans are placed on a cash basis for purposes of income recognition. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal and accrued interest, and the loan is in the process of collection. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest receivable is charged against income.
Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized as a net adjustment to the related loans yield. The Bank is generally amortizing these costs over the contractual life of such loans.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to income. Loans deemed to be uncollectable and changes in the allowance relating to loans are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based on managements periodic review of the collectability of the loans in light of historical experiences, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are subject to revision as more information becomes available.
56
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 Summary of Significant Accounting Policies (Continued)
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market
price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. The unallocated component is maintained to cover uncertainties that could affect managements estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and agricultural loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
At 90 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.
For the majority of the Banks impaired loans, the Bank will apply the fair value of collateral or use a measurement incorporating the present value of expected future cash flows discounted at the loans effective rate of interest. To determine fair value of collateral, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of 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. Until such time that updated appraisals are received, the Bank may discount the collateral value used.
Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer loans for impairment, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
For more information regarding the actual composition and classification of loans involved in the establishment of the allowance for loan loss, please see Note 4 provided here with the notes to consolidated financial statements.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.
Servicing Assets
Servicing assets are recognized as separate assets when rights are acquired through purchase or sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest expense in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest
57
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 Summary of Significant Accounting Policies (Continued)
rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum. Fees received for servicing loans owned by investors are based on a percentage of the outstanding monthly principal balance of such loans and are included in operating income as loan payments are received. Costs of servicing loans are charged to expense as incurred.
Goodwill and Other Intangible Assets
Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually. If possible impairment is likely, the Bank will utilize the assistance of an independent third party for impairment and any such impairment is recognized in the period identified. The Bank considered the following qualitative factors to determine if impairment was likely: 1) the Bank continued to perform above peer and remains profitable with capital growth, 2) the Bank had improved asset quality and does not see any change in the trend, 3) the Bank had strong liquidity and capital positions, 4) in quantitative testing done in 2015, the excess fair value of capital was $20.4 million or 20.3% over the carrying value and was over 5 times the value of the goodwill being carried and 5) the Bank was unaware of any likely circumstances that would indicate the fair value of the entity would be greatly decreased in the near future. Therefore, the Bank concluded it is unlikely impairment of Goodwill has occurred from the goodwill established from the Banks acquisition which occurred on December 31, 2007.
Other intangible assets consist of core deposit intangible assets arising from business acquisitions. They are initially measured at fair value and then are amortized on a straight line method over their estimated useful lives and evaluated for impairment.
Off Balance Sheet Instruments
In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.
Foreclosed Real Estate
Foreclosed real estate held for sale is carried at the lower of fair value minus estimated costs to sell, or cost. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. Foreclosed real estate is classified as other real estate owned. The net income from operations of foreclosed real estate held for sale is reported in non-interest income. At December 31, the Banks holding of other real estate owned totaled approximately $1.2 and $1.1 million for 2015 and 2014 respectively.
Bank Premises and Equipment
Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is based on the estimated useful lives of the various properties and is computed using straight line and accelerated methods. Costs for maintenance and repairs are charged to operations as incurred. Gains and losses on dispositions are included in current operations.
Federal Income Tax
The Companys income tax expense consists of the following components: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
58
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 - Summary of Significant Accounting Policies (Continued)
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to managements judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in tax expense. Based on managements analysis, the Company did not have any uncertain tax positions as of December 31, 2015 and 2014. With a few exceptions, the Company is no longer subject to U.S. Federal, state or local examinations by tax authorities for years before 2012.
Earnings Per Share
Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. See Note 12 for additional information.
Stock-Based Compensation
The fair value of restricted common stock is their fair market value on the date of grant. The fair value of restricted stock is amortized as compensation expense on a straight-line basis over the vesting period of the grants. Compensation expense recognized is included in personnel expense in the consolidated statement of income
Other Comprehensive Income (Loss)
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of other comprehensive income (loss).
The components of other comprehensive income and related tax effects are as follows:
(In Thousands) | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
Net unrealized gain (loss) on available-for-sale securities |
$ | 100 | $ | 1,158 | $ | (8,448 | ) | |||||
Reclassification adjustment for gain on sale of available-for-sale securities |
(451 | ) | (494 | ) | (775 | ) | ||||||
|
|
|
|
|
|
|||||||
Net unrealized gains (losses) |
(351 | ) | 664 | (9,223 | ) | |||||||
Tax expense (benefit) |
(119 | ) | 226 | (3,136 | ) | |||||||
|
|
|
|
|
|
|||||||
Other comprehensive income (loss) |
$ | (232 | ) | $ | 438 | $ | (6,087 | ) | ||||
|
|
|
|
|
|
59
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 - Summary of Significant Accounting Policies (Continued)
Reclassification
Certain amounts in the 2014 and 2013 consolidated financial statements have been reclassified to conform with the 2015 presentation.
Subsequent Events
On January 15, 2016, the Company announced the authorization by its Board of Directors for the Companys repurchase, either on the open market, or in privately negotiated transactions, of up to 200,000 shares of its outstanding common stock commencing January 15, 2016 and ending December 31, 2016.
Recent Accounting Pronouncements
In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (Topic 810). The amendments in this ASU clarify when a company is required to consolidate another legal entity in situations in which the reporting entitys contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entitys voting rights, or the reporting entity is not exposed to a majority of the legal entitys economic benefits or obligations. The amendments in this ASU have the following three main provisions that affect limited partnerships and similar legal entities: (1) there is an additional requirement that limited partnerships and similar legal entities must meet to qualify as voting interest entities. A limited partnership must provide partners with either substantive kick-out rights or substantive participating rights over the general partner to meet this requirement; (2) the specialized consolidation model and guidance for limited partnerships and similar legal entities have been eliminated. There is no longer a presumption that a general partner should consolidate a limited partnership; and (3) for limited partnerships and similar entities that qualify as voting interest entities, a limited partner with a controlling financial interest should consolidate a limited partnership. A controlling financial interest may be achieved through holding a limited partner interest that provides substantive kick-out rights. The amendments in the ASU are effective for public companies for fiscal years beginning after December 15, 2015, and early adoption is permitted. The Company does not expect that the adoption of this ASU will have an impact on the Companys results of operations or financial position.
In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (Topic 805). The amendments in the ASU identify, evaluate, and improve areas of generally accepted accounting principles for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of the financial statements. The amendment addresses the requirement to retrospectively apply adjustments made to provisional amounts recognized in a business combination. The amendments in this ASU require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. Additionally, the acquirer should record, in the same periods financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in the ASU require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in the current-period earning by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments for this ASU are effective for fiscal years beginning after December 15, 2015, and should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this ASU with earlier adoption permitted for financial statements that have not been issued. The Company does not expect that the adoption of this ASU will have an impact on the Companys results of operations or financial position.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes (Topic 740). The amendments in this ASU modify the current requirement that separates deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. To simplify the presentation of deferred income taxes, the amendments in this ASU require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in the ASU are effective for financial statements issued for annual periods beginning after December 15, 2016,
60
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 1 - Summary of Significant Accounting Policies (Continued)
and early application is permitted as of the beginning of an interim or annual reporting period either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company does not expect that the adoption of this ASU will have an impact on the Companys results of operation or financial position.
ASU 2016-1, No. 2016-01, Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-1, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for sale. ASU 2016-1 is effective for fiscal years beginning after December 15, 2017 and is not expected to have a significant impact on our financial statements.
Note 2 Business Combination & Asset Purchase
On December 13, 2013, the Bank completed its purchase of a branch office in Custar, Ohio from Croghan Colonial Bank. Deposits of approximately $29.5 million and loans of $11.4 million were included in the purchase. The aggregate acquisition cost of the Custar office was $1.2 million, which was all paid in cash. The office is located within the Banks current market area and expanded our presence in Wood County.
The following table summarizes the estimated values of the assets acquired and the liabilities assumed:
($ in Thousands) | ||||
Cash |
$ | 204 | ||
Loans |
11,436 | |||
Accrued Interest on Loans |
31 | |||
Premises and Equipment |
271 | |||
Core Deposit Intangible Asset |
1,171 | |||
Other Assets |
1 | |||
|
|
|||
Total Assets Acquired |
$ | 13,114 | ||
|
|
|||
Deposits |
$ | 29,466 | ||
Accrued Interest on Deposits |
17 | |||
Other Liabilities |
17 | |||
|
|
|||
Total Liabilities Assumed |
$ | 29,500 | ||
|
|
|||
Net Liabilities Assumed |
$ | (16,386 | ) | |
|
|
The Company also recognized core deposit intangible assets of $2.26 million with the purchase of offices. $1.17 million was recognized with the purchase of the Custar office on December 13, 2013 and $1.09 million with the Hicksville office on July 9, 2010. These are being amortized over an estimated remaining economic
61
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 2 Business Combination & Asset Purchase (Continued)
useful life of the deposits of 7 years on a straight line basis. In connection with a December 31, 2007 Knisely acquisition, the Company recognized a core deposit intangible asset of $1.1 million, which was fully amortized during 2014. The core deposit intangible is included in other assets on the consolidated balance sheets.
The estimated amortization expense for the years ended December 31, 2015, 2014 and 2013 was $323, $480, and $319 thousand, respectively.
Amortization expense of the core deposit intangible assets remaining is as follows:
Hicksville | Custar | Total | ||||||||||
2016 |
155 | 167 | 322 | |||||||||
2017 |
78 | 167 | 245 | |||||||||
2018 |
| 167 | 167 | |||||||||
2019 |
| 167 | 167 | |||||||||
2020 |
| 162 | 162 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 233 | $ | 830 | $ | 1,063 | ||||||
|
|
|
|
|
|
Note 3 Securities
The amortized cost and fair value of securities, with gross unrealized gains and losses, follows:
(In Thousands) | ||||||||||||||||
2015 | ||||||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | |||||||||||||
Available-for-Sale: |
||||||||||||||||
U.S. Treasury |
$ | 38,778 | $ | 36 | $ | (309 | ) | $ | 38,505 | |||||||
U.S. Government agencies |
99,000 | 55 | (835 | ) | 98,220 | |||||||||||
Mortgage-backed securities |
26,157 | 283 | (116 | ) | 26,324 | |||||||||||
State and local governments |
70,858 | 1,290 | (82 | ) | 72,066 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total available-for-sale securities |
$ | 234,793 | $ | 1,664 | $ | (1,342 | ) | $ | 235,115 | |||||||
|
|
|
|
|
|
|
|
62
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 3 Securities (Continued)
(In Thousands) | ||||||||||||||||
2014 | ||||||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
|||||||||||||
Available-for-Sale: |
||||||||||||||||
U.S. Treasury |
$ | 25,833 | $ | | $ | (440 | ) | $ | 25,393 | |||||||
U.S. Government agencies |
120,154 | 391 | (1,311 | ) | 119,234 | |||||||||||
Mortgage-backed securities |
29,067 | 557 | (62 | ) | 29,562 | |||||||||||
State and local governments |
72,765 | 1,671 | (133 | ) | 74,303 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total available-for-sale securities |
$ | 247,819 | $ | 2,619 | $ | (1,946 | ) | $ | 248,492 | |||||||
|
|
|
|
|
|
|
|
Investment securities will at times depreciate to an unrealized loss position. The Bank utilizes the following criteria to assess whether impairment is other than temporary. No one item by itself will necessarily signal that a security should be recognized as an other than temporary impairment.
1. | The fair value of the security has significantly declined from book value. |
2. | A downgrade has occurred that lowered the credit rating to below investment grade (below Baa3 by Moody and BBB by Standard and Poors.) |
3. | Dividends have been reduced or eliminated or scheduled interest payments have not been made. |
4. | The underwater security has longer than 10 years to maturity and the loss position had existed for more than 3 years. |
5. | Management does not possess both the intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. |
If the impairment is judged to be other than temporary, the cost basis of the individual security shall be written down to fair value, thereby establishing a new cost basis. The new cost basis shall not be changed for subsequent recoveries in fair value. The amount of the write down shall be included in current earnings as a realized loss. The recovery in fair value, if any, shall be recognized in earnings when the security is sold. The table below is presented by category of security and length of time in a continuous loss position. The Bank currently does not hold any securities with other than temporary impairment.
63
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 3 Securities (Continued)
Information pertaining to securities with gross unrealized losses at December 31, 2015 and 2014, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
2015 | ||||||||||||||||
(In Thousands) Less Than Twelve Months |
(In Thousands) Twelve Months & Over |
|||||||||||||||
Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | |||||||||||||
U.S. Treasury |
$ | (142 | ) | $ | 23,241 | $ | (167 | ) | $ | 10,195 | ||||||
U.S. Government agencies |
(635 | ) | 68,957 | (200 | ) | 9,793 | ||||||||||
Mortgage-backed securities |
(60 | ) | 6,331 | (56 | ) | 3,580 | ||||||||||
State and local governments |
(54 | ) | 7,920 | (28 | ) | 1,725 | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total available-for-sales securities |
$ | (891 | ) | $ | 106,449 | $ | (451 | ) | $ | 25,293 | ||||||
|
|
|
|
|
|
|
|
|||||||||
2014 | ||||||||||||||||
(In Thousands) Less Than Twelve Months |
(In Thousands) Twelve Months & Over |
|||||||||||||||
Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | |||||||||||||
U.S. Treasury |
$ | | $ | | $ | (440 | ) | $ | 25,393 | |||||||
U.S. Government agencies |
(1 | ) | 5,458 | (1,310 | ) | 82,803 | ||||||||||
Mortgage-backed securities |
| | (62 | ) | 7,900 | |||||||||||
State and local governments |
(31 | ) | 3,442 | (102 | ) | 7,756 | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total available-for-sales securities |
$ | (32 | ) | $ | 8,900 | $ | (1,914 | ) | $ | 123,852 | ||||||
|
|
|
|
|
|
|
|
Unrealized losses on securities have not been recognized into income because the issuers bonds are of high credit quality, values have only been impacted by rate changes, and the Company has the intent and ability to hold the securities for the foreseeable future. The fair value is expected to recover as the bonds approach the maturity date.
Sales of $47.0, $57.9, and $91.0 million for 2015, 2014, and 2013 respectively, generated gross realized gains and losses for the years ended December 31, as presented below:
(In Thousands) | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
Gross realized gains |
$ | 451 | $ | 638 | $ | 839 | ||||||
Gross realized losses |
| (144 | ) | (64 | ) | |||||||
|
|
|
|
|
|
|||||||
Net realized gains |
$ | 451 | $ | 494 | $ | 775 | ||||||
|
|
|
|
|
|
|||||||
Tax expense related to net realized gains |
$ | 153 | $ | 168 | $ | 264 | ||||||
|
|
|
|
|
|
64
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 3 Securities (Continued)
The net realized gain on sales and related tax expense is a reclassification out of accumulated other comprehensive income. The net realized gain is included in net gain on sale of securities available-for-sale and
the related tax expense is included in income tax expense in the consolidated statements of income and comprehensive income.
The amortized cost and fair value of debt securities at December 31, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(In Thousands) | ||||||||
Amortized Cost |
Fair Value | |||||||
One year or less |
$ | 13,812 | $ | 13,862 | ||||
After one year through five years |
152,266 | 151,894 | ||||||
After five years through ten years |
35,674 | 35,953 | ||||||
After ten years |
6,884 | 7,082 | ||||||
|
|
|
|
|||||
Total |
$ | 208,636 | $ | 208,791 | ||||
Mortgage-backed securities |
26,157 | 26,324 | ||||||
|
|
|
|
|||||
Total |
$ | 234,793 | $ | 235,115 | ||||
|
|
|
|
Investments with a carrying value and fair value of $189.3 million at December 31, 2015 and $176.9 million at December 31, 2014 were pledged to secure public deposits and securities sold under repurchase agreements.
Other securities include Federal Home Loan Bank of Cincinnati and Farmer Mac stock as of December 31, 2015 and 2014.
Note 4 Loans
The Company had $1.2 million in loans held for sale at December 31, 2015 as compared to $459 thousand in loans held for sale at December 31, 2014. Due to materiality, these loans are included in the Consumer Real Estate and Agricultural Real Estate loan categories at the lower of cost or market.
65
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
Loans at December 31 are summarized below:
(In Thousands) | ||||||||
Loans: |
2015 | 2014 | ||||||
Consumer Real Estate |
$ | 88,189 | $ | 97,550 | ||||
Agricultural Real Estate |
58,525 | 50,895 | ||||||
Agricultural |
82,654 | 74,611 | ||||||
Commercial Real Estate |
322,762 | 270,188 | ||||||
Commercial and Industrial |
100,125 | 100,126 | ||||||
Consumer |
27,770 | 24,277 | ||||||
Industrial Development Bonds |
6,491 | 4,698 | ||||||
|
|
|
|
|||||
$ | 686,516 | $ | 622,345 | |||||
Less: Net deferred loan fees and costs |
(638 | ) | (419 | ) | ||||
|
|
|
|
|||||
685,878 | 621,926 | |||||||
Less: Allowance for loan losses |
(6,057 | ) | (5,905 | ) | ||||
|
|
|
|
|||||
Loans - Net |
$ | 679,821 | $ | 616,021 | ||||
|
|
|
|
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, borrowers ability to repay in orderly fashion, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customers 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.
Consumer Real Estate: Purchase, refinance, or equity financing of one to four family owner occupied dwelling. Success in repayment is subject to borrowers income, debt level, character in fulfilling payment obligations, employment, and others.
Commercial and 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 customers 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 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 borrowers income, debt level, character in fulfilling payment obligations, employment, and others.
Industrial Development Bonds (IDB): Funds for public improvements in the Banks service area. Repayment ability is based on the continuance of the taxation revenue as the source of repayment.
66
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
The following is a maturity schedule by major category of loans at December 31, 2015:
(In Thousands) | ||||||||||||||||
Within One Year |
After One Year Within Five Years |
After Five Years |
Total | |||||||||||||
Consumer Real Estate |
$ | 1,270 | $ | 11,486 | $ | 75,433 | $ | 88,189 | ||||||||
Agricultural Real Estate |
1,073 | 3,300 | 54,152 | 58,525 | ||||||||||||
Agricultural |
52,939 | 24,239 | 5,476 | 82,654 | ||||||||||||
Commercial Real Estate |
13,030 | 70,699 | 239,033 | 322,762 | ||||||||||||
Commercial and Industrial |
45,971 | 34,791 | 19,363 | 100,125 | ||||||||||||
Consumer |
5,480 | 17,228 | 5,062 | 27,770 | ||||||||||||
Industrial Development Bonds |
1,300 | 185 | 5,006 | 6,491 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 121,063 | $ | 161,928 | $ | 403,525 | $ | 686,516 | |||||||||
|
|
|
|
|
|
|
|
The distribution of fixed rate loans and variable rate loans by major loan category is as follows as of December 31, 2015:
(In Thousands) | ||||||||
Fixed Rate |
Variable Rate |
|||||||
Consumer Real Estate |
$ | 54,940 | $ | 33,249 | ||||
Agricultural Real Estate |
42,480 | 16,045 | ||||||
Agricultural |
47,305 | 35,349 | ||||||
Commercial Real Estate |
206,383 | 116,379 | ||||||
Commercial and Industrial loans |
54,669 | 45,456 | ||||||
Consumer, Master Card and Overdrafts |
23,305 | 4,465 | ||||||
Industrial Development Bonds |
6,350 | 141 |
As of December 31, 2015 and 2014 one to four family residential mortgage loans amounting to $20.0 million and $20.8 million, respectively, have been pledged as security for loans the Bank has received from the Federal Home Loan Bank.
Industrial Development Bonds are included in the commercial and industrial category for the remainder of the tables in this Note 4, unless specifically noted separately.
67
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
The following table represents the contractual aging of the recorded investment in past due loans by portfolio classification of loans as of December 31, 2015 and 2014, net of deferred loan fees and costs:
December 31, 2015 | 30-59 Days Past Due |
60-89 Days Past Due |
Greater Than 90 Days |
Total Past Due |
Current | Total Financing Receivables |
Recorded Investment > 90 Days and Accruing |
|||||||||||||||||||||
Consumer Real Estate |
$ | 303 | $ | 47 | $ | 357 | $ | 707 | $ | 87,240 | $ | 87,947 | $ | | ||||||||||||||
Agricultural Real Estate |
| | 162 | 162 | 58,301 | 58,463 | | |||||||||||||||||||||
Agricultural |
| 145 | | 145 | 82,617 | 82,762 | | |||||||||||||||||||||
Commercial Real Estate |
236 | | 841 | 1,077 | 321,153 | 322,230 | | |||||||||||||||||||||
Commercial and Industrial |
51 | | 20 | 71 | 106,618 | 106,689 | | |||||||||||||||||||||
Consumer |
19 | 9 | | 28 | 27,759 | 27,787 | | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Total |
$ | 609 | $ | 201 | $ | 1,380 | $ | 2,190 | $ | 683,688 | $ | 685,878 | $ | | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2014 | 30-59 Days Past Due |
60-89 Days Past Due |
Greater Than 90 Days |
Total Past Due |
Current | Total Financing Receivables |
Recorded Investment > 90 Days and Accruing |
|||||||||||||||||||||
Consumer Real Estate |
$ | 713 | $ | 50 | $ | 436 | $ | 1,199 | $ | 96,351 | $ | 97,550 | $ | | ||||||||||||||
Agricultural Real Estate |
| | | | 50,895 | 50,895 | | |||||||||||||||||||||
Agricultural |
25 | | | 25 | 74,586 | 74,611 | | |||||||||||||||||||||
Commercial Real Estate |
78 | 204 | 709 | 991 | 269,197 | 270,188 | | |||||||||||||||||||||
Commercial and Industrial |
| 8 | | 8 | 104,816 | 104,824 | | |||||||||||||||||||||
Consumer |
25 | 8 | 29 | 62 | 23,796 | 23,858 | | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Total |
$ | 841 | $ | 270 | $ | 1,174 | $ | 2,285 | $ | 619,641 | $ | 621,926 | $ | | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table presents the recorded investment in nonaccrual loans by portfolio class of loans as of December 31, 2015 and December 31, 2014:
(In Thousands) | ||||||||
2015 | 2014 | |||||||
Consumer real estate |
$ | 1,155 | $ | 628 | ||||
Agricultural real estate |
162 | | ||||||
Agriculture |
| | ||||||
Commercial real estate |
484 | 709 | ||||||
Commercial |
202 | 339 | ||||||
Consumer |
38 | 29 | ||||||
|
|
|
|
|||||
Total |
$ | 2,041 | $ | 1,705 | ||||
|
|
|
|
68
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
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 The Risk Management Association 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 Banks 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. |
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 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 |
69
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
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. |
9. | Eight (8) Loss. Loans are considered uncollectable and of such little value that continuing to carry them as assets on the institutions 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 portfolio class, net of deferred fees, based on the most recent analysis performed as of the time periods shown of December 31, 2015 and December 31, 2014.
(In Thousands) | ||||||||||||||||||||||||||||||||||||||||
Agricultural Real Estate | Agricultural | Commercial Real Estate | Commercial and Industrial |
Industrial Development Bonds |
||||||||||||||||||||||||||||||||||||
2015 | 2014 | 2015 | 2014 | 2015 | 2014 | 2015 | 2014 | 2015 | 2014 | |||||||||||||||||||||||||||||||
1-2 |
$ | 5,841 | $ | 4,319 | $ | 12,025 | $ | 11,490 | $ | 597 | $ | 1,072 | $ | 261 | $ | 1,771 | $ | | $ | | ||||||||||||||||||||
3 |
16,593 | 15,780 | 21,247 | 26,871 | 24,264 | 34,229 | 22,300 | 15,582 | 3,100 | 4,289 | ||||||||||||||||||||||||||||||
4 |
35,475 | 30,472 | 49,220 | 36,225 | 293,381 | 225,015 | 76,855 | 80,079 | 3,391 | 409 | ||||||||||||||||||||||||||||||
5 |
192 | 111 | 250 | | 1,738 | 7,083 | 57 | 2,299 | | | ||||||||||||||||||||||||||||||
6 |
362 | 213 | | | 1,828 | 2,080 | 543 | 165 | | | ||||||||||||||||||||||||||||||
7 |
| | 20 | 25 | 422 | 709 | 182 | 230 | | | ||||||||||||||||||||||||||||||
8 |
| | | | | | | | | | ||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
Total |
$ | 58,463 | $ | 50,895 | $ | 82,762 | $ | 74,611 | $ | 322,230 | $ | 270,188 | $ | 100,198 | $ | 100,126 | $ | 6,491 | $ | 4,698 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
70
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
For consumer residential real estate, and other, 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 risk grading as of December 31, 2015 and December 31, 2014.
(In Thousands) | ||||||||
Consumer Real Estate | ||||||||
2015 | 2014 | |||||||
Grade |
||||||||
Pass |
$ | 87,292 | $ | 97,007 | ||||
Special mention (5) |
48 | | ||||||
Substandard (6) |
332 | 446 | ||||||
Doubtful (7) |
275 | 97 | ||||||
|
|
|
|
|||||
Total |
$ | 87,947 | $ | 97,550 | ||||
|
|
|
|
Consumer - Credit Card | Consumer - Other | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Performing |
$ | 3,901 | $ | 3,987 | $ | 23,863 | $ | 19,846 | ||||||||
Nonperforming |
| | 23 | 25 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total, net of deferred fees |
$ | 3,901 | $ | 3,987 | $ | 23,886 | $ | 19,871 | ||||||||
|
|
|
|
|
|
|
|
Information about impaired loans as of and for the years ended December 31, 2015 and 2014 are as follows:
(In Thousands) | ||||||||
2015 | 2014 | |||||||
Impaired loans without a valuation allowance |
$ | 1,257 | $ | 675 | ||||
Impaired loans with a valuation allowance |
879 | 1,168 | ||||||
|
|
|
|
|||||
Total impaired loans |
$ | 2,136 | $ | 1,843 | ||||
|
|
|
|
|||||
Valuation allowance related to impaired loans |
$ | 330 | $ | 387 | ||||
|
|
|
|
|||||
Total non-accrual loans |
$ | 2,041 | $ | 1,705 | ||||
|
|
|
|
|||||
Total loans past-due ninety days or more and still accruing |
$ | | $ | | ||||
|
|
|
|
71
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
(In Thousands) | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
Average investment in impaired loans |
$ | 2,509 | $ | 1,929 | $ | 3,274 | ||||||
|
|
|
|
|
|
|||||||
Interest income recognized on impaired loans |
$ | 96 | $ | 87 | $ | 60 | ||||||
|
|
|
|
|
|
|||||||
Interest income recognized on a cash basis on impaired loans |
$ | 60 | $ | 51 | $ | 17 | ||||||
|
|
|
|
|
|
No additional funds are committed to be advanced in connection with impaired loans.
The Bank had approximately $1.1 million of its impaired loans classified as trouble debt restructured as of December 31, 2015 as compared to $797.2 thousand of its impaired loans classified as trouble debt restructured as of December 31, 2014.
72
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
The following table represents the years ended December 31, 2015 and 2014.
December 31, 2015
Troubled Debt Restructurings |
Number of Contracts Modified in the Last 12 Months |
Pre- Modification Outstanding Recorded Investment |
Post- Modification Outstanding Recorded Investment |
December 31, 2014
Troubled Debt Restructurings |
Number of Contracts Modified in the Last 12 Months |
Pre- Modification Outstanding Recorded Investment |
Post- Modification Outstanding Recorded Investment |
|||||||||||||||||||
Commercial Real Estate |
1 | $ | 528 | $ | 430 | Commercial Real Estate | 0 | $ | | $ | | |||||||||||||||
Commercial and Industrial |
1 | 25 | 24 | Commercial and Industrial | 0 | | |
For the years ended December 31, 2015 and 2014, there were no TDRs that subsequently defaulted after modification.
For the majority of the Banks 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 loans effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of 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 down 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.
73
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
The following table presents loans individually evaluated for impairment by portfolio class of loans as of December 31, 2015 and 2014:
(In Thousands) | ||||||||||||||||||||||||
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Average Recorded Investment |
Interest Income Recognized |
Interest Income Recognized Cash Basis |
|||||||||||||||||||
2015 |
||||||||||||||||||||||||
With no related allowance recorded: |
||||||||||||||||||||||||
Consumer real estate |
$ | 156 | $ | 156 | $ | | $ | 158 | $ | 5 | $ | 5 | ||||||||||||
Agricultural real estate |
63 | 63 | | 120 | | | ||||||||||||||||||
Agricultural |
| | | | | | ||||||||||||||||||
Commercial real estate |
1,038 | 1,038 | | 421 | 27 | 27 | ||||||||||||||||||
Commercial and Industrial |
| | | 429 | 27 | | ||||||||||||||||||
Consumer |
| | | | | | ||||||||||||||||||
With a specific allowance recorded: |
||||||||||||||||||||||||
Consumer real estate |
275 | 323 | 64 | 181 | 7 | 6 | ||||||||||||||||||
Agricultural real estate |
| | | | | | ||||||||||||||||||
Agricultural |
| | | | | | ||||||||||||||||||
Commercial real estate |
422 | 422 | 152 | 907 | 30 | 22 | ||||||||||||||||||
Commercial and Industrial |
182 | 182 | 114 | 291 | | | ||||||||||||||||||
Consumer |
| | | 2 | | | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Totals: |
||||||||||||||||||||||||
Consumer real estate |
$ | 431 | $ | 479 | $ | 64 | $ | 339 | $ | 12 | $ | 11 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Agricultural real estate |
$ | 63 | $ | 63 | $ | | $ | 120 | $ | | $ | | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Agricultural |
$ | | $ | | $ | | $ | | $ | | $ | | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Commercial real estate |
$ | 1,460 | $ | 1,460 | $ | 152 | $ | 1,328 | $ | 57 | $ | 49 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Commercial and Industrial |
$ | 182 | $ | 182 | $ | 114 | $ | 720 | $ | 27 | $ | | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Consumer |
$ | | $ | | $ | | $ | 2 | $ | | $ | | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
74
Farmers & Merchants Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014, and 2013
Note 4 Loans (Continued)
(In Thousands) | ||||||||||||||||||||||||
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Average Recorded Investment |
Interest Income Recognized |
Interest Income Recognized Cash Basis |
|||||||||||||||||||
2014 |
||||||||||||||||||||||||
With no related allowance recorded: |
||||||||||||||||||||||||
Consumer real estate |
$ | 204 | $ | 229 | $ | | $ | 52 | $ | 1 | $ | 1 | ||||||||||||
Agricultural real estate |
| | | 93 | 7 | | ||||||||||||||||||
Agricultural |
| | | | | | ||||||||||||||||||
Commercial real estate |
471 | 471 | | 740 | 7 | 5 | ||||||||||||||||||
Commercial and Industrial |
| | | 319 | 45 | 18 | ||||||||||||||||||
Consumer |
| | | | | | ||||||||||||||||||
With a specific allowance recorded: |
||||||||||||||||||||||||
Consumer real estate |
97 | 97 | 36 | 118 | 6 | 6 | ||||||||||||||||||
Agricultural real estate |
| | | 15 | | | ||||||||||||||||||
Agricultural |
25 | 25 | 25 | 2 | | | ||||||||||||||||||
Commercial real estate |
709 | 709 | 111 | 83 | 21 | 21 | ||||||||||||||||||
Commercial and Industrial |
326 | 326 | 204 | 506 | | | ||||||||||||||||||
Consumer |
11 | 11 | 11 | 1 | | | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Totals: |
||||||||||||||||||||||||